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 lawsuit was settled during the first quarter of 1997. The terms of the settlement agreement are confidential; however, the settlement did not 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, 1998.
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, 1999, there were 3,678 record holders of the Fund's Shares. Cash dividends declared varied based upon the date of Stockholder admittance. Dividends in 1996 represent a return on invested capital of 0.95%. The amount of dividends declared was based on net taxable income earned per year. No dividends were declared during 1998 and 1997.
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 ======
The Fund operated as a real estate investment trust during 1996. The Fund was a "C" corporation effective January 1, 1997.
The following table presents that portion of the Fund's dividends that represent a return of capital under Generally Accepted Accounting Principals (GAAP) for the year ended December 31, 1996.
----
Net Income (Loss) $850,309
Dividends Declared $605,601
Return of Capital (GAAP Basis) $ -- ========
The Fund used tax-reporting accounting in applying the REIT-qualifying test that requires 95% of taxable income to be paid out in dividends for the year ended December 31, 1996.
The following table presents that portion of the Fund's dividends that represent a return of capital under tax-reporting accounting.
----
Net Taxable Income $631,114
Dividends Declared $605,601
Return of Capital (Tax Basis) $ -- ========
Item 5. Market for the Registrant's Shares and Related Stockholder Matters - - ---------------------------------------------------------------------------- Continued ---------
See Note 11 of the Notes to Consolidated 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 Fund and its subsidiaries (to which the Fund formerly had outstanding Mortgage 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) The above selected financial data should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Form 10-K report.
(2) Expenses for 1997 include a non-cash charge in the amount of $11,600,000. This related to the Fund's acquisition of the stock of NTS/Lake Forest II Residential Corporation (NTS/LFII) and NTS/Virginia Development Company (NTS/VA). Also included in expenses is a non-cash charge of approximately $3.7 million related to the Fund's investment in an unconsolidated affiliate. (See Notes 3 and 4 to Consolidated Financial Statements).
(3) 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 and 1994 balances are net of an allowance for loan losses of $1,500,000, $1,553,397 and $1,638,855, respectively.
(4) Revenues for 1997 include approximately $370,000 of gross profit from lot sales generated by NTS/LFII and NTS/VA from October 1, 1997 (the date of acquisition) through December 31, 1997. Prior to October 1, 1997, the Fund's primary source of revenues was interest income earned on affiliated mortgage loans.
(5) See Note 11 of the Notes to Consolidated Financial Statements for an explanation of differences between net income and taxable income.
(6) The balances presented as notes payable include notes payable to third parties and notes payable to affiliates.
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, were used to make Mortgage Loans and Temporary Investments and such other investments as permitted by the Fund's Prospectus.
Throughout 1997, the Fund's Board of Directors and NTS Corporation, the Fund's Sponsor, were involved in a restructuring of the Fund's Mortgage Loan portfolio. The Fund's Affiliated Borrowers had included NTS/Lake Forest II Residential Corporation (NTS/LFII), NTS/Virginia Development Company (NTS/VA), and the Orlando Lake Forest Joint Venture (OLFJV).
In August 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in OLFJV. The Fund contributed its interest in the principal of the first mortgage loan on the Orlando Lake Forest project and obtained a 50% interest in OLFJV.
In December 1997, the Fund acquired all the issued and outstanding common capital stock of NTS/LFII and NTS/VA, effective October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of NTS/LFII and NTS/VA to the Fund was converted to equity as of October 1, 1997. This marked the beginning of the Fund's operations focusing solely on the continuing development, operations, marketing and sale of single-family, residential real estate. As a result, the Fund no longer operates as a Real Estate Investment Trust.
Reference is made to Notes 3 and 4 of the Notes to Financial Statements for further information regarding these investments and acquisitions.
Liquidity and Capital Resources - -------------------------------
Prior to October 1, 1997, the Fund's primary source of liquidity had been from the interest earned on the Mortgage Loans and on the Temporary Investments. The Fund's current source of liquidity is primarily the ability of its subsidiaries (to which the Fund formerly had outstanding Mortgage Loans) to draw upon their respective development loans. Additional liquidity is provided by net proceeds retained from residential lot closings by the properties owned by the Fund's subsidiaries and OLFJV in which the Fund has a 50% interest. The various development loans call for principal payments ranging from 67% to 91% of Gross Receipts from lot sales.
The continued cash needs of the Fund and its subsidiaries have significantly reduced 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.
As previously reported, on February 12, 1997, the Fund entered into a letter of intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund, NTS/LFII, NTS/VA and NTS Development Company, a Kentucky corporation and a wholly-owned subsidiary of NTS Corporation. The Letter of Intent contemplated the restructuring of the Fund's loans to NTS/LFII and NTS/VA, and the acquisition of control by the Fund of the Lake Forest North project in Louisville, Kentucky, and the Fawn Lake project near Fredericksburg, Virginia.
Liquidity and Capital Resources - Continued - -------------------------------------------
The Fund consummated the restructuring as described in the Letter of Intent by acquiring all of the issued and outstanding common capital stock of NTS/LFII and NTS/VA effective as of October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of NTS/LFII and NTS/VA to the Fund was converted to equity. The acquisition was closed pursuant to (i) an Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and its shareholders, NTS/VA and certain of its shareholders, NTS Corporation, NTS Advisory Corporation, a Kentucky corporation and Advisor to the Fund (the Advisor) and NTS Residential Management Company, a Kentucky corporation (NTS Management), and (ii) an Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and certain shareholders of NTS/VA and NTS Corporation. The Advisor and NTS Management are Affiliates of and are under common control with NTS Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family residential community located in Louisville, Kentucky, and will continue to own and develop the Lake Forest North project to completion and orderly sale as a wholly-owned subsidiary of the Fund.
NTS/VA is the owner and developer of the Fawn Lake single-family residential community located near Fredericksburg, Virginia, and will continue to own and develop the Fawn Lake project to completion and orderly sale as a wholly-owned subsidiary of the Fund. Fawn Lake Realty, Inc. a division of NTS/Residential Properties, Inc.- Virginia, a Virginia corporation and an Affiliate of NTS Corporation, the Sponsor of the Fund, will continue to act as a broker and agent for NTS/VA for the sale of lots within the Fawn Lake project, and as broker and agent for approved builders in the Fawn Lake project for the sale of new homes.
The Fund, as the sole shareholder of NTS/LFII and NTS/VA controls the ongoing operations of the Lake Forest North and Fawn Lake projects. The ongoing operation and management of the Lake Forest North and Fawn Lake projects is conducted by NTS Management under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
Reimbursements of approximately $1,439,000 and $527,000 were made to NTS Management or an Affiliate during the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997, respectively. These expense reimbursements include direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS Management and/or certain affiliates as well as various non-payroll related operating expenses. Compensation costs are for those individuals rendering services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential project responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. These reimbursements are included within Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
Liquidity and Capital Resources - Continued - -------------------------------------------
In addition to the expense reimbursement noted above, NTS Management is also entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified as Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
Reference is made to Note 9 of the Notes to Financial Statements for a breakdown of these related party charges.
The Management Agreements also call for NTS Management to potentially receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to have returned to the then existing shareholders of the Fund an amount which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1998, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31 ,1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
The terms of the restructuring and of the Management Agreements were negotiated on behalf of the Fund by a committee of the Fund's Board of Directors (the Special Committee) consisting only of the Independent Directors. The Special Committee believes that the terms of the restructuring and of the Management Agreements are at least as favorable to the Fund as could have been obtained from unrelated third parties under the circumstances.
On December 30, 1997, NTS/VA closed on development financing for the Fawn Lake project committed by an unaffiliated bank. The $10,700,000 revolving credit facility is currently anticipated to provide funds for the continued development and operations of the Fawn Lake project through December 1, 2002, the maturity of the credit facility. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and of the Fund, has individually guaranteed the repayment of up to $3,000,000 of the credit facility (See Financing Activity).
The credit facility bears interest at the Prime Rate + 1 1/2%, payable monthly, and principal payments generally equal 91% of the Gross Receipts from the sale of lots at the Fawn Lake project. In addition, the total outstanding principal amount must be brought to within the following levels by the applicable date:
December 31, 1999 $9,300,000 December 31, 2000 $7,800,000 December 31, 2001 $5,900,000 December 1, 2002 $4,500,000
The loan balance was $9,581,963 as of December 31, 1998.
On January 6, 1998, NTS/LFII closed on development financing for the Lake Forest North project committed by an unaffiliated bank. The $8,000,000 revolving credit facility is currently anticipated to provide funds for the continued development and operations of the Lake Forest North project through October 31, 2003, the maturity of the credit facility, and the repayment thereof has been guaranteed by the Fund. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and of the Fund, has individually guaranteed the repayment of fifty percent (50%) of the credit facility.
Liquidity and Capital Resources - Continued - -------------------------------------------
The credit facility bears interest at the Prime Rate + 1%, payable monthly, and principal payments generally equal 90% of the Gross Receipts from the sale of lots at the Lake Forest North project. In addition, the principal amount outstanding on the credit facility must be brought to within the following levels by the applicable date:
January 1, 1999 $7,800,000 January 1, 2000 $7,200,000 January 1, 2001 $7,000,000 July 1, 2001 $6,100,000 January 1, 2002 $5,500,000 July 1, 2002 $4,900,000 January 1, 2003 $4,000,000 July 1, 2003 $2,400,000
The net worth of NTS/LFII cannot be allowed to decrease by 20% or more throughout the term of the agreement. The loan balance was $6,113,434 as of December 31, 1998.
NTS/LFII is also encumbered by a mortgage loan in the amount of $4,000,000 (with an outstanding balance of $3,250,000 as of December 31, 1998) from an unaffiliated lender which is secured by a first mortgage on the Lake Forest Country Club and golf course (approximately 176 acres of residential land and improvements thereon). The note bears interest at the Prime Rate + 1/2%, payable monthly. Principal payments totaling $300,000 are due twice a year, February through July and August through January. The primary source of principal payments will be initiation fees received. The loan is guaranteed by the Fund's Sponsor.
In August 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in the Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of whom are Affiliates of and are under common control with the Fund's Sponsor. The Joint Venture will continue to operate under its current legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family residential community located in Seminole County, Florida (near Orlando) consisting of approximately 360 acres of residential land and improvements and approximately 20 acres of commercial land. The Joint Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest in the principal and interest of the first mortgage loan on the Orlando Lake Forest project, and obtained a 50% interest in the Joint Venture. The NTS entities named above hold cumulatively the remaining 50% interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the respective partner's percentage interest, as defined in the joint venture agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was 50% and the Fund's investment balance in the Joint Venture was $4,462,990 and $4,525,369 as of December 31, 1998 and 1997 respectively. The Fund's share of the Joint Venture's net income (loss) from the year ended December 31, 1998 from August 16, 1997 (when the Fund was admitted as a partner) through December 31, 1997 was ($247,879) and $106,667, respectively.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid in full.
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 lawsuit was settled in the first quarter of 1997. The terms of the settlement agreement are confidential; however, the settlement did not have a material impact on the Fund's financial position or results of operations.
Liquidity and Capital Resources - Continued - -------------------------------------------
Key elements of the Consolidated Statements of Cash Flows:
1998 1997 1996 ---- ---- ---- Net cash provided by (used for) operating activities $(3,152,180) $ 459,795 $ 392,077
Net cash provided by (used for) investing activities (446,334) 3,626,775 (2,463,586) ----------- ----------- ----------
Net cash flows from operating and investing activities (3,598,514) 4,086,570 (2,071,509)
Net cash provided by (used for) financing activities 3,246,678 (3,389,918) 2,252,615 ----------- ----------- ---------- Net increase (decrease) in cash and cash equivalents $ (351,836) $ 696,652 $ 181,106 =========== =========== ==========
Operating Activity - ------------------
Cash used for operating activities was approximately $3,152,000 for the year ended December 31, 1998. The primary components of the use of cash for operating activities were a net loss of approximately $1,470,000, a decrease in accounts payable of approximately $949,000 and net additions to inventory of approximately $1,346,000.
Cash provided by operations was approximately $460,000 for the year ended December 31, 1997. The Fund received approximately $71,000 from cash revenues in excess of cash expenses. The Fund received approximately $481,000 in interest receivable payments from affiliates. NTS/LFII and NTS/VA used approximately $790,000 of cash to increase inventory. NTS/LFII and NTS/VA provided approximately $540,000 of cash from collection of initiation fees and other receivables and notes receivable during the period October 1, 1997 through December 31, 1997. In addition, payables increased approximately $159,000.
Cash provided by operations was approximately $392,000 during the year ended December 31, 1996. This amount was driven by net income as reported offset by increases in interest receivable from affiliates.
Investing Activity - ------------------
Cash used for investing activities was approximately $446,000 for the year ended December 31, 1998. The primary components of the use of cash for investing activities were an additional capital contribution to an unconsolidated affiliate of $186,000 and capital additions, primarily at the Lake Forest North and Fawn Lake golf operations of approximately $261,000.
During the year ended December 31, 1997, the Fund received repayment on three mortgage loans and two temporary investments in the aggregate principal amount of approximately $9,299,000. 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 approximately $5,700,000.
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 approximately $8,099,000. 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 approximately $10,563,000.
Financing Activity - ------------------
Cash provided by financing activities was approximately $3,247,000 for the year ended December 31, 1998. The primary components of the cash provided by financing activities were net borrowings on notes payable relating to the development loans for Lake Forest North and Fawn Lake projects of approximately $3,565,000, net borrowings on notes payable to affiliates of approximately $781,000 which were used primarily to fund activities of the Fawn Lake project and repayment of advances to affiliates of approximately $601,000 which were initially used to fund development costs at the Fawn Lake project.
Cash used for financing activities was approximately $3,390,000 for the year ended December 31, 1997. During the year ended December 31, 1997, the Fund and its subsidiaries borrowed approximately $8,516,000 from their various lenders. The Fund and its subsidiaries repaid approximately $2,380,000 of their borrowings from lot proceeds generated by NTS/LFII, NTS/VA and OLFJV. In addition, approximately $9,425,000 of borrowings were repaid using proceeds from the NTS/VA and OLFJV development loans. The Fund and its subsidiaries also borrowed approximately $2,436,000 from Affiliates of the Fund's Sponsor. They repaid approximately $1,651,000 of these borrowings primarily from loan repayments made by OLFJV during the period from January 1, 1997 though August 15, 1997.
Cash provided by financing activities was approximately $2,253,000 for the year ended December 31, 1996. During the year ended December 31, 1996, the Fund borrowed approximately $1,202,000 from its various lenders. The Fund repaid approximately $1,075,000 of its borrowings primarily from loan repayments made by NTS/LFII. In addition, the Fund borrowed approximately $4,077,000 from an Affiliate of the Fund's Sponsor. The Fund repaid approximately $1,438,000 of these affiliated borrowings primarily from loan repayments made by OLFJV.
The Fund declared dividends of approximately $606,000 for the year ended December 31, 1996. Total dividends declared provided Stockholders with an annualized return of 0.95%. No dividends were declared in 1998 or 1997. The Fund paid dividends of approximately $0, $175,000 and $469,000 during the years ended December 31, 1998, 1997 and 1996, respectively.
Management's projection for Fawn Lake indicates the development will reach the maximum funding level allowed by the current development loan of $10.7 million during 1999 and in fact require additional funding to achieve its development plan which includes projected 1999 sales of $6.5 million. The current development loan is secured by the inventory of the Fawn Lake Project, an approximately $2 million letter of credit issued by a third party lender with the Fawn Lake lender stated as the beneficiary, and a $3 million guarantee by Mr. J.D. Nichols. Management's projections indicate the outstanding debt balance as of December 31, 1999 will be approximately $12.1 million. Management's present plans and actions include (1) approaching the Fawn Lake lender and requesting that the loan agreement be modified to allow the outstanding balance to remain at the loan maximum of $10.7 Million as opposed to the contractually required maximum of $9.3 million as of December 31, 1999, (2) obtaining approval and additional funding from the Lake Forest North lender thereby allowing Fawn Lake to utilize such funds for development purposes and (3) borrowing additional funds from an affiliate via the loan agreement between the affiliate and the Mortgage Income Fund. Although management believes that it will be successful in such negotiations, there can be no assurances that these third party lenders will approve of management's plans and intentions for the Fawn Lake Project. However, if management is unsuccessful in that effort, consideration will be given to implementing an alternative development plan.
Results of Operations - ---------------------
Comparability - -------------
On an overall basis, the Fund experienced net income/(loss) of approximately $(1.5) million, $(13.7) million, $850,000 or $(.46), $(4.30) and $.27 per share of common stock for the years ended December 31, 1998, 1997 and 1996, respectively. In the context of the restructuring and acquisitions which occurred during the fourth quarter of 1997, comparisons of results of operations are complex. The fourth quarter 1997 charge relating to the acquisition of NTS/LFII and NTS/VA and the adjustment of the carrying value of the Fund's investment in OLFJV also represent significant items which complicated year-to-year comparisons.
The historical financial statements are also impacted by the Fund's lack of history as a real estate development company, therefore, management believes that certain areas of the Fund's results of operations for 1998 and the fourth quarter of 1997 are not comparable with prior years and a discussion comparing these periods is not included.
Revenues - --------
Revenue for the year ended December 31, 1998 includes $8.1 million in lot sales consisting of approximately $5.9 million and $2.2 million from the Lake Forest North and Fawn Lake projects, respectively. Cost of sales of approximately $6.2 million resulted in a gross profit margin of approximately 23%. During this period 136 lots were sold for an average selling price of $59,272. The decrease in the average sales price compared to the period October 1, 1997 through December 31, 1997 is primarily attributable to the sale of an entire lot section to a single home builder in the Fawn Lake project during 1998.
Revenue for the year ended December 31, 1997 includes $1.6 million of lot sales consisting of approximately $1.4 million and $200,000 from the Lake Forest North and Fawn Lake projects, respectively, for the period from October 1, 1997 (when the Fund acquired the stock of these entities) to December 31, 1997. Cost of sales was $1.2 million resulting in a gross profit of approximately 23%. During this period 21 lots were sold for an average selling price of $76,202.
During 1996 and for the nine months ended September 30, 1997, the Fund's primary revenue source was interest income earned on affiliated mortgage loans. The average outstanding balances of the earning loans increased from $62,878,000 (1996) to $63,600,000 (1997). The average interest rate earned by the Fund for the years ended December 31, 1997 and 1996 was approximately 5.5% and 5.1%, respectively, of the average outstanding loan balances.
Commitment fees paid at loan closings were amortized over the life of the loan using the interest method. Letter of credit fees were 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. Commitment fee income was recognized in 1996 only.
During the year ended December 31, 1998, the Fund realized approximately $382,000 of proceeds from a loan previously made to the Orlando Lake Forest project during the time the Fund operated as a REIT. This loan was written off by the Fund prior to its investment in the Orlando Lake Forest Joint Venture. The Fund had previously established a $1,500,000 loan loss reserve regarding a Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture. During the third quarter 1997, the Fund received 100% of the amount due on this loan and determined the loan loss reserve was no longer needed.
Interest income on cash equivalents and miscellaneous income includes interest income earned from short-term investments made by the Fund with cash reserves for each of the three years in the period ended December 31, 1998, as well as interest earnings on notes receivable for the fiscal year ended December 31, 1998 and for the period from October 1, 1997 through December 31, 1997.
Results of Operations - Continued - ---------------------------------
Revenues - Continued - --------------------
Net income using generally accepted accounting principles (GAAP) was $850,309 and using tax-reporting accounting (TRA) was $631,114 for the year ended December 31, 1996. 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 was reported as earned on the accrual basis of accounting; for tax purposes 50% of the amount of Gross Receipts Interest earned was credited against Supplemental Interest Income paid in prior years. 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 was used in applying the REIT-qualifying test that requires 95% of taxable income to be paid out in dividends. (See Note 11 of the Notes to Consolidated Financial Statements).
Expenses - --------
For years prior to 1998, operating expenses of the Fund include a Management Expense Allowance (Advisory Fee) of 1% of the Fund's Net Assets, per annum, which could be increased annually by an amount corresponding to the percentage increase in the Consumer Price Index. Pursuant to the Advisory Agreement, the Advisory Fee was paid to the Advisor (NTS Advisory Corporation) or its affiliate. Effective July 1, 1994, the Fund's Mortgage Loans to NTS/VA and NTS/LFII 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 was reduced $100,000 for the year 1996 and $75,000 for the year ended December 31, 1997.
The Advisory Fee for the years ended December 31, 1997 and 1996 was $418,950 and $544,776, respectively. Increases and decreases in the Advisory Fee generally correspond directly to increases and decreases in the Fund's Net Assets. Effective October 1, 1997, the Fund no longer incurs an Advisory Fee but is responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
Results of Operations - Continued - ---------------------------------
Expenses - Continued - --------------------
The expenses related to the Property Management agreement are presented as selling, general and administrative - Affiliated on the accompanying consolidated statements of operations. As defined in the Management Agreements, the expenses are classified in two ways, Expense Recovery and Overhead Recovery. The expense recovery included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project.
Reimbursements for Expense Recovery of approximately $1,439,000 and $527,000 were made to NTS Management or an Affiliate during the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997, respectively, for actual personnel, marketing and administrative costs as they relate to NTS/LFII, NTS/VA and the Fund.
During 1998, the Fund elected to forego the Expense Recovery portion of the Management Agreements relative to NTS/VA. NTS/VA pays expenses directly as incurred rather than allowing NTS Management to pay expenses initially and then make reimbursement to NTS Management. Therefore selling, general and administrative expenses include those costs incurred directly by NTS/VA for marketing related activities.
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements.
For the year ended December 31, 1998 and the period from inception (October 1, 1997) through December 31, 1997, Overhead Recovery incurred was approximately $496,000 and $106,000, respectively.
Increases and decreases in interest expense generally correspond directly to increases and decreases in the outstanding balances of the Fund's borrowings and its subsidiaries borrowings.
Selling, general and administrative expenses also include directors' fees, legal, outside accounting, other investor related cost.
For years prior to 1998, selling, general 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, 1997, is due primarily to increased professional fees related to the Fund's acquisitions and loan restructurings discussed in Part 1, Items 1. and 2. of this Form 10-K.
Depreciation expense relates to equipment used for development activity which is being depreciated over five to seven years. Amortization expense relates primarily to loan costs which are being amortized over the life of the related loan.
No benefit for income taxes was provided during 1998 or 1997 as the Fund has recorded a valuation allowance equal to the amount of the recorded benefit. The Fund has determined that it is more likely than not that the net deferred tax asset will not be realized. See Note 11 to the Fund's Consolidated Financial Statements for a discussion of the components of the deferred tax asset.
Results of Operations - Continued - ---------------------------------
Expenses - 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 for the year ended December 31, 1996.
The Fund had a net book loss of approximately $13,707,000 for the year ended December 31, 1997, which includes a non-cash charge of approximately $11,600,000 related to the acquisition of NTS/LFII and NTS/VA and an adjustment to the carrying value of the Fund's investment in the OLFJV of approximately $3,707,000.
Generally Accepted Accounting Principles required that the acquisitions of NTS/LFII and NTS/VA be recorded at fair market value on the day of acquisition. The application of these principles resulted in a non-cash charge of approximately $11,600,000 during the fourth quarter of 1997. In addition, the Fund's investment in an unconsolidated affiliate should be recorded at the lower of cost or fair market value. A non-cash charge of approximately $3.7 million was recorded in the third quarter of 1997 related to this investment. All estimates used in these evaluations represented management's best estimates based on the facts present at the date of such evaluations.
Year 2000 - ---------
NTS Management and its affiliates are reviewing the effort necessary to prepare our information systems (IT) and non-information technology with embedded technology (ET) for the Year 2000. The information technology solutions have been addressed separate for the Year 2000 since the Fund saw the need to move to more advanced management and accounting systems made available by new technology and software developments during the decade of the 1990s.
The PILOT software system, purchased in the early 1990s, needs to be replaced by a windows based network system both for headquarters functions and other locations. The real estate accounting system developed, sold and supported by the Yardi Company of Santa Barbara, California has been selected to supercede PILOT. The Yardi system has been tested and is compatible with Year 2000 and beyond. This system is being implemented and should be fully operational by the end of third quarter of 1999.
The few remaining systems not addressed by these conversions are being modified by our in-house staff of programmers. The Hewlett Packard 3000 system, used for PILOT and custom applications, was purchased in 1997 and will be part of our new network. It will be retained as long as necessary to assure smooth operations and has been upgraded to meet Year 2000 requirements.
All risks identified with information technology are believed to be addressed by these plans.
The cost of these advances in our systems technology is not all attributable to the Year 2000 issue since the need to move to a network based system had been determined regardless of the Year 2000. The portion of the cost attributed to the Mortgage Income Fund was approximately $42,000 for 1998 and is projected to be approximately $63,000 during 1999 for hardware and software costs.
NTS management staff has been surveying our vendors to evaluate embedded technology in our alarm systems, HVAC controls, telephone systems and other computer associated facilities. In a few cases, equipment is being replaced. In some cases circuitry is being upgraded. The cost involved is still being evaluated. There are no known significant risks that are currently without solutions. Management anticipates that applications involving ET will be Year 2000 compliant by the third quarter of 1999.
We are also currently addressing the Year 2000 readiness of third parties whose business interruption could have a material negative impact on our business. All significant vendors have indicated that they will be compliant by the end of 1999. Such assurances are being evaluated and documented.
Results of Operations - Continued - ---------------------------------
Year 2000 - Continued - ---------------------
Management has determined that at our current state of readiness, the need does not presently exist for a contingency plan. We will continue to evaluate the need for such a plan.
Despite diligent preparation, unanticipated third-party failures, more general public infrastructure failures or failure to successfully conclude our remediation efforts as planned could have a material adverse impact on our results of operations, financial conditions and/or cash flows in 1999 and beyond.
Quantitative and Qualitative Disclosures About Market Risk - ----------------------------------------------------------
Our primary market risk exposure with regard to financial instruments is changes in interest rates. The Fund's debt instruments bear interest at both variable and fixed rates as further discussed in Note 8 of the Fund's financial statements under Item 8 of this Form 10-K. At December 31, 1998, a hypothetical 100 basis point increase in interest rates would result in an approximately $220,000 increase in interest expense. During the year ended December 31, 1998, the majority of interest expense incurred was capitalized in inventory.
Cautionary Statements - ---------------------
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 subsidiaries, NTS/LFII and NTS/VA, and the Orlando Lake Forest Joint Venture, in which the Fund has a 50% interest, are engaged in the development and sale of residential subdivision building lots, the pricing and sale of which are subject to risks generally associated with real estate development and applicable market forces beyond the control of the Fund and/or its subsidiaries, including general and local 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. All of the properties owned by NTS/LFII, NTS/VA and OLFJV are encumbered by development loans from third party lenders which, given the nature of the risks incumbent in real estate investment and development activities as stated above, are inherently subject to default should the ability of NTS/LFII, NTS/VA, OLFJV and/or the Fund to make principal and interest payments under such development loans become impaired.
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.
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 consolidated balance sheets of the NTS Mortgage Income Fund and subsidiaries (the Fund) (a Delaware corporation) as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Fund's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Fund as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 19, 1999
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
(1) For the periods presented, there are no elements of other comprehensive income as defined by the Financial Accounting Standards Board, Statement of Financial Accounting Standards, No. 130 Reporting Comprehensive Income.
The accompanying notes are an integral part of these financial statements
(1) Net of the effects of acquisitions, where applicable. See Note 12 for information on non-cash investing and financing activities.
NTS MORTGAGE INCOME FUND
NOTES TO CONSOLIDATED 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 operated as a real estate investment trust (REIT) under the Internal Revenue Code of 1986 (the "Code"), as amended, from its inception through December 31, 1996. The Fund began operating as a "C" corporation under the Code for tax purposes effective January 1, 1997. NTS Corporation is the sponsor of the Fund (the "Sponsor"). NTS Advisory Corporation is the advisor to the Fund (the "Advisor"), and NTS Residential Management Company is the manager to the Fund ("NTS Management"). The Advisor and NTS Management are affiliates of and are under common control with NTS Corporation.
The Fund's subsidiaries include NTS/Lake Forest II Residential Corporation (NTS/LFII) and NTS/Virginia Development Company (NTS/VA). These subsidiaries were acquired effective October 1, 1997. The acquisitions were accounted for under the purchase method of accounting. See Note 3, "Acquisitions", for further information pertaining to the acquisitions. Prior to making the acquisitions, the Fund had been the primary creditor of these entities.
NTS/LFII 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. As of December 31, 1998, approximately 530 of the 726 acres have been developed and approximately 52% of the total projected lots to be developed have been sold. In addition, Lake Forest has amenities consisting of a clubhouse, pools, tennis courts, recreation fields and several lakes.
NTS/VA is in the process of developing approximately 2,825 acres 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. As of December 31, 1998, approximately 1200 of the 2825 total acres have been developed and approximately 26% of the total projected lots to be developed have been sold. Included on the property is a 285 acre lake. In addition, Fawn Lake has amenities consisting of a clubhouse, pool, tennis courts and boat docks.
The Fund purchased a 50% interest in the Orlando Lake Forest Joint Venture effective August 16, 1997. Prior to becoming a joint venture partner, the Fund had been the Joint Venture's primary creditor. See Note 4, "Investment in Unconsolidated Affiliate", for further information pertaining to the investment.
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) Principals of Consolidation and Basis of Presentation -- -----------------------------------------------------
The consolidated financial statements of the Fund include the assets, liabilities, revenues and expenses of its 100% owned subsidiaries. The consolidated statements of operations include the results of acquired businesses accounted for under the purchase method of accounting from the date of acquisition. Investments of 50% or less in affiliated companies are accounted for under the equity method. All significant intercompany transactions have been eliminated.
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 -- ------------------------------------------------
The Fund 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 the Fund and its subsidiaries are not obligated to perform significant activities after the sale. The Fund and its subsidiaries generally require a minimum down payment of at least 10% of the sales price of the lot.
Interest income from mortgage loans and notes receivable was reported as earned on the accrual basis of accounting. If the Fund had any reason to doubt the collectability of any principal or interest amounts due pursuant to the terms of the mortgage loans or notes, appropriate reserves would have been established for any principal and accrued interest amounts deemed unrealizable. Impaired loans are 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.
F) 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 projects 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.
G) Long-Lived Assets -- -----------------
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.
H) Advertising -- -----------
The Fund expenses advertising-type costs as incurred. Advertising expense, a component of Cost Reimbursements (see Note 9), was approximately $718,000 and $100,000 during the years ended December 31, 1998 and 1997, respectively.
1. Summary of Significant Accounting Policies - Continued - -- ------------------------------------------------------
I) Operating Expense Limitations -- -----------------------------
Prior to January 1, 1997, the annual Operating Expenses of the Fund when functioning as a REIT, based upon guidelines promulgated by the North American Securities Administrators Association, Inc., were 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 exceeded this limitation, the Advisor would 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 year ended December 31, 1996.
J) Environmental Remediation and Compliance -- ----------------------------------------
Environmental liabilities for remediation costs are accrued based on estimates of known environmental remediation exposures. Liabilities are recognized when they can be reasonably estimated. Environmental compliance costs are expensed as incurred.
K) Per Share Information -- ---------------------
The Financial Accounting Standards Board recently issued Standard No. 128, Earnings Per Share (SFAS 128). The Statement simplifies the standards for computing earnings per share (EPS) and replaces the presentation of primary and fully diluted EPS with a presentation of basic and diluted EPS. SFAS 128 is effective for financial statements for periods ending after December 15, 1997. For all periods presented, the Fund did not have common stock equivalents, therefore, the adoption of SFAS 128 did not have any impact on the Fund's financial statements.
L) 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.
2. Affiliations - -- ------------
The Fund operates under the direction of its Board of Directors who have retained NTS Management to be the sole and exclusive agent of the Fund for day-to-day control and management of the business of the Fund's subsidiaries including (a) the continued operation of NTS/LFII and NTS/VA, (b) the operations of the Lake Forest Country Club and the Fawn Lake Country Club, (c) the operations of the Lake Forest Community Association and the Fawn Lake Community Association and (d) the provision and/or sale of ancillary goods and services as selected by NTS Management with respect to any of the foregoing. The Management Agreements have an initial term through and including December 31, 2003, and automatically renew for successive six year terms unless terminated by the Fund, its subsidiaries, or NTS Management upon six months written notice. See Note 9 for further discussion of the Management Agreements. NTS Management is an Affiliate of and under common control with NTS Corporation, the Fund's Sponsor. The Chairman of the Board of Directors of the Fund is also the majority shareholder of NTS Corporation and is a majority shareholder of the managing general partner in the Orlando Lake Forest Joint Venture of which the Fund is a 50% joint venture partner. NTS Advisory and NTS Management are Affiliates of and are under common control with NTS Corporation.
3. Acquisitions - -- ------------
The Fund acquired all of the issued and outstanding common stock of NTS/LFII and NTS/VA effective October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the Fund was converted to equity.
The transaction has been accounted for using the purchase method of accounting. The purchase price (approximately $14.5 million for NTS/LFII and approximately $28.7 million for NTS/VA) was allocated to the assets and liabilities of NTS/LFII and NTS/VA based on their estimated fair market value. The acquisition of NTS/LFII included inventory of approximately $19 million, debt of approximately $5 million and other net assets and liabilities of approximately $500,000. The acquisition of NTS/VA included inventory of approximately $32 million, debt of approximately $5.5 million and other net assets and liabilities of approximately $2.2 million. The results of operations for NTS/LFII and NTS/VA from the date of acquisition (October 1, 1997) are included in the consolidated financial statements of the Fund.
Generally Accepted Accounting Principles require that these acquisitions be recorded at fair market value. The application of these principles resulted in a non-cash charge of approximately $11,600,000 during the fourth quarter of 1997 related to these transactions. All estimates used in these evaluations represented management's best estimates based on the facts present at the date of the evaluations.
4. Investment in Unconsolidated Affiliate - -- --------------------------------------
In September 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in the Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of whom are Affiliates of and are under common control with the Fund's Sponsor. The Joint Venture will continue to operate under its current legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family residential community located in Seminole County, Florida (near Orlando) consisting of approximately 360 acres of residential land and improvements and approximately 20 acres of commercial land. The Joint Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest in the principal and interest of the first mortgage loan on the Orlando Lake Forest project, and obtained a 50% interest in the Joint Venture. The NTS entities named above hold cumulatively the remaining 50% interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the respective partner's percentage interest, as defined in the joint venture agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was 50%, and the Fund's investment balance in the Joint Venture was $4,462,990 and $4,525,369 as of December 31, 1998 and 1997, respectively. The Fund's share of the Joint Venture's net income (loss) for the year ended December 31, 1998 was $(247,879) and from August 16, 1997 (when the Fund was admitted as a partner) through December 31, 1997 was $106,667.
Generally Accepted Accounting Principles require that such investments be recorded at the lower of carrying value or fair market value. The application of these principles resulted in a non-cash charge of approximately $3.7 million in the third quarter of 1997. All estimates used in this evaluation represent management's best estimates based on the facts present at the date of such evaluations.
4. Investment in Unconsolidated Affiliate - Continued - -- --------------------------------------------------
During fiscal 1998, the Fund and the other joint venture partners contributed as a capital contribution of $371,000 to the joint venture, the Fund's portion being $185,500.
The following presents condensed financial information for the Joint Venture as of December 31, 1998 and 1997 and for the year ended December 31, 1998 as well as the period August 16, 1997 through December 31, 1997:
1998 1997 ---- ---- Balance Sheet Notes receivable $ 550,272 $ 647,448 Inventory 14,461,364 13,376,714 Other, net 512,976 1,935,254 ------------ ------------
Total assets $ 15,524,612 $ 15,959,416 ============ ============
Notes payable $ 5,323,241 $ 4,793,014 Other liabilities 1,275,389 2,115,662 Equity 8,925,982 9,050,740 ------------ ------------
Total liabilities and equity $ 15,524,612 $ 15,959,416 ============ ============
Statement of Operations Lot sales $ 2,624,548 $ 1,678,079 Cost of sales (1,836,386) (1,150,339) Other income (expenses), net (1,283,920) (314,404) ---------- --------
Net income (loss) $ (495,758) $ 213,336 ============ ============
5. Member Initiation Fees and Other Accounts Receivable - -- ----------------------------------------------------
Fawn Lake Country Club and Lake Forest Country Club membership initiation fees receivable totaled approximately $1,370,000 and $1,209,000 as of December 31, 1998 and 1997. 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.
6. 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 and seven years, monthly payments are based on a 30-year amortization and the balance is due at the maturity date. Notes totaling approximately $3,179,000 and $3,443,000 are pledged as security for notes payable to banks under certain Warehouse Line of Credit Agreements and other debt agreements as of December 31, 1998 and 1997, respectively. There are also $125,000 and $130,500 of notes held by NTS/VA that are not pledged as of 1998 and 1997, respectively. Approximately $1,883,000, $426,000, $39,000, and $61,000 of the notes receivable balance as of December 31, 1998 are due for the years ended December 1999 through 2002, respectively. Approximately $787,000 of the notes receivable balance relates to the sale of 24 lots to one builder in fiscal 1998 at NTS/VA. The note bears interest at the Prime Rate plus 1%, is due in monthly installments commencing June 29, 2001, with any outstanding principal and interest payable in full on December 29, 2003.
7. Inventory - -- ---------
Inventory consists of the following as of December 31, 1998:
NTS/LFII NTS/VA Consolidated -------- ------ ------------ Land held for future development, under development and completed lots $ 5,855,000 $21,971,000 $27,826,000 Country club (net of membership initiation fees) 10,225,000 8,099,000 18,324,000 Amenities 2,176,000 4,938,000 7,114,000 ----------- ----------- ------------
$18,256,000 $35,008,000 $ 53,264,000 =========== =========== ============
Inventory consists of the following as of December 31, 1997:
NTS/LFII NTS/VA Consolidated -------- ------ ------------ Land held for future development, under development and completed lots $ 6,874,000 $21,787,000 $28,661,000 Country club (net of Membership initiation fees) 7,329,000 7,175,000 14,504,000 Amenities 4,590,000 4,163,000 8,753,000 ----------- ----------- ------------
$18,793,000 $33,125,000 $ 51,918,000 =========== =========== ============
NTS/LFII and NTS/VA capitalized in inventory approximately $2,064,000 and $214,000 of interest and real estate taxes during 1998 and from October 1, 1997 though December 31, 1997, respectively. Interest and real estate taxes incurred was approximately $2,296,000 and $396,000 as of December 31, 1998 and from October 1, 1997 through December 31, 1997, respectively.
Inventory for 1998 as reflected above includes $26,586,000, net of $8,262,000 of country club membership initiation fees, of costs incurred to date for the development of the Fawn Lake Country Club and the Lake Forest Country Club.
Inventory for 1997 as reflected above includes $21,708,355, net of $7,204,605 of country club membership initiation fees, of costs incurred to date for the development of the Fawn Lake Country Club and the Lake Forest Country Club.
Pursuant to an agreement between NTS/LFII and the Lake Forest Country Club regarding the cost to develop the Country Club, NTS/LFII is to receive all initiation fees from the initial issuance of memberships to the Country Club. The remaining cost to be incurred for the current projected Country Club operating deficit for the period covered by the agreement is approximately $2,330,000 which is expected to be offset by member initiation fees. During 1998 and for the fourth quarter of 1997 the Country Club operating deficit was approximately $279,000 and $160,000, respectively, and was capitalized as a cost of inventory.
The Prime Rate was 7 3/4% and 8 1/2% at December 31, 1998 and 1997, respectively.
The $519,052 and $488,853 Warehouse Line of Credit agreements are guaranteed by NTS Corporation.
The minimum scheduled principal payments on debt outstanding at December 31, 1998 are as follows: 1999 $ 3,399,447 2000 3,240,138 2001 2,520,661 2002 4,200,000 2003 9,400,000 Thereafter ---------
$ 22,760,246 (1)
(1) The minimum scheduled principal payments regarding the $10.7 and $8 million credit facilities are reflected in the table such that the outstanding principle amount is brought to within the following levels by the applicable date.
8. Notes and Mortgage Loans Payable - Continued - -- --------------------------------------------
$10.7 Million Facility ----------------------
December 31, 1999 $9,300,000 December 31, 2000 $7,800,000 December 31, 2001 $5,900,000 December 1, 2002 $4,500,000
$8 Million Facility -------------------
January 1, 1999 $7,800,000 January 1, 2000 $7,200,000 January 1, 2001 $7,000,000 July 1, 2001 $6,100,000 January 1, 2002 $5,500,000 July 1, 2002 $4,900,000 January 1, 2003 $4,000,000 July 1, 2003 $2,400,000
Management's projection for Fawn Lake indicates the development will reach the maximum funding level allowed by the current development loan of $10.7 million during 1999 and in fact require additional funding to achieve its 1999 development plan which includes projected sales of $6.5 million. The current development loan is secured by the inventory of the Fawn Lake Project, an approximately $2 million letter of credit issued by a third party lender with the Fawn Lake lender stated as the beneficiary, and a $3 million guarantee by Mr J.D. Nichols. Management's projections indicate the outstanding debt balance as of December 31, 1999 will be approximately $12.1 million. Management's present plans and actions include (1) approaching the Fawn Lake lender and requesting that the loan agreement be modified to allow the outstanding balance to remain at the loan maximum of $10.7 Million as opposed to the contractual required maximum of $9.3 million as of December 31, 1999, (2) obtaining additional funding from the Lake Forest North lender thereby allowing Fawn Lake to utilize such funds for development purposes, and (3) borrowing additional funds from an affiliate via the loan agreement between the affiliate and the Mortgage Income Fund. Although management believes that it will be successful in such negotiations, there can be no assurances that these third party lenders will approve of management's plans and intentions for Fawn Lake. However, if management is unsuccessful in that effort, consideration will be given to implementing an alternative development plan.
9. Related Party Transactions - -- --------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares of the Fund. The Fund thereby allowing Fawn Lake to utilize such funds for development purposes entered into the following agreements with various Affiliates of the Sponsor regarding the ongoing operation of the Fund.
Advisory Agreement ------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS Advisory Corporation) a Management Expense Allowance from inception of the Fund through September 30, 1997 (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 was 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 the year ended December 31, 1996 and $75,000 for the year ended December 31, 1997.
Advisory Agreement - Continued - ------------------------------
For the years ended December 31, 1997 and 1996, $418,950 and $544,776, respectively, had been incurred as an Advisory Fee. Effective October 1, 1997, the Fund no longer incurred an Advisory Fee but is now responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
Property Management Agreements - ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management Company (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. As permitted by the Property Management Agreements, the Fund was charged the following amounts for the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997. These amounts are reflected in Selling, General and Administrative - Affiliated on the accompanying Statement of Operations:
1998 1997 ---- ---- Personnel Related Costs: Finance and Accounting $ 172,409 $ 23,624 Data Processing 6,037 -- Human Resources 35,299 -- Executive and Administrative Services 186,199 105,920 Construction Management 38,616 8,539 Sales and Marketing 712,582 185,295 Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428 ------ ------
Total Expense Reimbursements $ 1,438,610 $ 526,571 ========== =========
Property Management Agreements - Continued - ------------------------------------------
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified with Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to return to the then existing shareholders of the Fund an amount which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1997, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates - -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's Sponsor totaling $600,542 as of December 31, 1997. The advances were used to fund development costs and were to be repaid to the Affiliates as cash flow permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997, respectively. As of December 31, 1998, the advances bear interest at approximately the Prime Rate and mature on May 31, 2006. The Affiliate has represented that it will not demand repayment on any amounts owed during 1999, unless cash flows are adequate to allow such repayment. For the year ended December 31, 1998, the interest expense to affiliate totaling $341,213 was capitalized in inventory. For the years ended December 31, 1997 and 1996, interest was expensed totaling $358,262 and $258,191, respectively.
10. Affiliated Mortgage Loans Receivable - --- ------------------------------------
The following table outlines the activity regarding the Fund's mortgage loan portfolio for the three years in the period ended December 31, 1998.
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
10. Affiliated Mortgage Loans Receivable - Continued - --- ------------------------------------------------
Additions:
Mortgage Loans $ 5,186,594 Temporary Mortgage Loans 513,443 Accretion of discount 95,932 Amortization of loan fees -- 5,795,969 ----------- ---------- Reductions:
Mortgage Loans (5,447,696) Temporary Mortgage Loans (6,351,123) Investment in unconsolidated affiliate (Note 4) (8,125,928) Purchase of net assets of subsidiaries (Note 3) (53,658,986) (73,583,733) ----------- ----------- Balance at December 31, 1997 $ -- ===========
Reserves for Loan Losses:
Balance at December 31, 1995 $ 1,553,397
Additions charged to expenses $ -- Deductions for Mortgage Loan written-off (53,397) (53,397) ------------ ----------- Balance at December 31, 1996 $ 1,500,000
Additions charges to expenses $ -- Recovery of provisions for loan loss (1,500,000) (1,500,000) ------------ ----------- Balance at December 31, 1997 $ -- ===========
11. Income Taxes - --- ------------
The Fund adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), effective January 1, 1997. SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the Fund's book and tax bases of assets and liabilities and tax carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The principal tax carryforwards and temporary differences giving rise to the Fund's deferred taxes consist of tax net operating loss carryforwards, valuation allowances and differences in inventory basis for book and tax.
11. Income Taxes - Continued - --- ------------------------
The Fund's deferred tax assets and liabilities as of December 31, are as follows:
Deferred tax assets 1998 1997 - ------------------- ---- ---- Net operating loss carryforwards $ 687,000 $ 132,000 Inventory 2,972,000 3,199,000 Deferred revenue 157,000 -- ----------- ----------- Net deferred tax assets 3,816,000 3,331,000
Valuation allowance (3,816,000) (3,331,000) ----------- ----------- $ -- $ -- =========== ===========
A valuation allowance is provided when the probability that the deferred tax asset to be realized does not meet the criteria established by the Financial Accounting Standards Board. The Fund has determined, based on its history of operating losses by its subsidiaries and its expectations for the future, that it is more likely than not that the net deferred tax assets at December 31, 1998 and 1997, will not be realized.
As of December 31, 1998, the Fund has a federal net operating loss carryforward of approximately $687,000 expiring during 2012 and 2013.
A reconciliation of the statutory to the effective rate of the Fund for the year ended December 31, is as follows:
1998 1997 ---- ---- Tax benefit using statutory rate $ 500,000 $ 4,660,000 Recovery on provision for loan losses -- 510,000 Establishing deferred tax liabilities other due to a change in tax status -- (1,839,000) Valuation allowance (486,000) (3,331,000) Other (14,000) -- -------- ---------
Income tax expense $ -- $ -- ======== =========
Prior to January 1, 1997, the Fund elected and qualified to be treated as a REIT under Internal Revenue Code Sections 856-860. In order to qualify, the Fund was required to distribute at least 95% of its taxable income to Stockholders and meet certain other requirements. A reconciliation of net income for financial statement purposes versus that for income tax reporting at December 31 is as follows:
----
Net income (GAAP) $ 850,309 Accretion of note discount (148,472) Loan commitment fee income (20,000) Letters of credit income (2,326) Supplemental interest income -- Federal income tax expense 5,000 Provision for loan losses (53,397) --------
Taxable income before dividends paid deduction $ 631,114 ========= Dividends declared $ 605,601 ========= Distribution percentage 96%
12. Supplemental Cash Flow Information - --- ----------------------------------
a) Cash payments for interest, net of amounts capitalized and cash payments for income taxes, net of refunds are as follows:
1998 1997 1996 ---- ---- ---- Interest $ 244,295 $1,767,786 $1,510,384
Income taxes $ -- $ 5,320 $ --
b) Supplemental Non-Cash Investing and Financing Activity: In 1997, the Fund made an investment in an unconsolidated affiliate by contributing the principal amount outstanding on mortgage loans receivable of approximately $8,125,000. (See Notes 4 and 10).
In 1997, the Fund acquired all of the outstanding common stock of NTS/LFII and NTS/VA for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the Fund totaling approximately $53,659,000 was converted to equity (See Notes 3 and 10).
13. Financial Instruments - --- ---------------------
The book values of cash and cash equivalents, trade receivables and trade payables are considered to be representative of their respective fair values because of the immediate or short-term maturity of these financial instruments. The fair value of the Fund's notes receivable and debt instruments approximated the book value because a substantial portion of the underlying instruments are variable rate notes.
14. Commitments and Contingencies - --- -----------------------------
At December 31, 1998 and 1997, the Fund had outstanding funding commitments under standby letters of credit aggregating to $194,347 and $48,821, respectively, regarding the Orlando Lake Forest Joint Venture.
NTS/LFII and NTS/VA have various letters of credit outstanding to governmental agencies and utility companies totaling approximately $2,277,053 and $2,892,500 as of December 31, 1998 and 1997, respectively.
It is estimated that development of the remaining homeowners association amenities at the Lake Forest North project will be substantially complete by May 2001. Based on engineering studies and projections, NTS/LFII will incur additional costs, excluding interest, of approximately $500,000 during 2001 to complete the homeowners association amenities.
It is estimated that the country club and homeowners association amenities at the Fawn Lake project will be substantially completed by December 2004. Based on engineering studies and projections, NTS/VA will incur additional costs, excluding interest, of approximately $3,165,000 to complete the country club and homeowners association amenities for the project. These costs are estimated to be incurred as follows: $1,500,000 for 1999, $75,000 for 2002, $440,000 for 2003 and $1,150,000 for 2004.
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 the Fund's Sponsor and various Affiliates of the Fund's Sponsor. The suit was settled in the first quarter of 1997. The terms of the settlement agreement are confidential; however, the settlement did not have a material impact on the Fund's financial position or results of operations.
15. Guaranties to the Fund - --- ----------------------
NTS Guaranty Corporation (the "Guarantor"), an Affiliate of the Sponsor, 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, 1998, the Fund has raised approximately $63,690,000 and has paid distributions of $23,141,000.
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.
16. Dividends Paid and Payable - ------------------------------
Dividends declared for the period ended December 31, 1996 were as follows:
Average Date Date of Date Outstand Amount Declared Record (1) Paid Shares Per Share Amount - -------- ---------- ---- ------ --------- ------ 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 ===== =========
(1) Cash dividends vary based upon the date of stockholder admittance.
It was the Fund's policy during the periods it operated as a REIT 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 have been allocable to taxable income earned in the prior year. For 1996, dividends to Stockholders represent ordinary income.
The continued needs of the Fund's subsidiaries have significantly reduced 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) Includes $1,500,000 for recovery of provision for loan losses.
(2) The fourth quarter reflects the Fund's acquisition of the stock of NTS/LFII and NTS/VA and consists substantially of the results of operations of NTS/LFII and NTS/VA from October 1, 1997. The fourth quarter is also reflective of the Fund's 50% share of the results of operations of the Orlando Lake Forest Joint Venture. Total expenses include a non-cash charge of approximately $11,600,000 relating to the acquisition of NTS/LFII and NTS/VA.
(3) Includes approximately $382,000 for recovery of loan previously written off.
(4) Total expenses include a non-cash charge of approximately $3.7 million related to the Fund's investment in unconsolidated affiliate.
18. Subsequent Events - --- -----------------
Beginning January 1, 1999, the Fund has agreed to defray the remaining cost of the capital improvements made by Beckley Station Disposal Systems, Inc. ("Beckley"), an affiliate of the Sponsor relative to Beckley's waste water treatment facility. The facility is providing waste water treatment to the homes constructed in the Lake Forest North project. The costs are to be reimbursed to Beckley on a per lot basis over the remaining life of the Lake Forest North project. The cost to be incurred will be approximately $1,598,000 over the life of the project based on a per lot fee of approximately $2,400.
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, 1998 and 1997. 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, 1998 and 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 19, 1999
NTS GUARANTY CORPORATION (A KENTUCKY CORPORATION) BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997
ASSETS ------
1998 1997 ---- ----
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 totaling approximately $15 for each of the years ended December 31, 1998 and 1997, 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 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.
2. Commitments - -- -----------
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, 1998, the Fund has raised approximately $63,690,000 and has paid distributions of approximately $23,141,000.
The liability of the Guarantor under the above guaranty 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.
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. 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* Gerald B. Brenzel Director* Richard L. Good President and Director
- -------------------------------------------------------------------------------- * Messr. Day, Thomas and Brenzel 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 57) 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 46) 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 60) has 25 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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
Gerald B. Brenzel (age 67) has over forty years experience in the securities - ----------------- industry, most recently as First Vice President of Morgan, Keegin & Company in Louisville, Kentucky. Prior to that, Mr. Brenzel was founder and CEO of Commonwealth Investment Group, Inc., an investment money managers and regional brokerage firm in Louisville. From 1964 to 1988, Mr. Benzel was regional Vice President and Branch Manager of Stifel, Nicolaus & Company, and is a member of the Board of that firm, was also an allied member of the New York Stock Exchange (1964 thru 1988). A former Governor of the National Association of Securities Dealers, Mr. Benzel attended the University of Louisville for three years and also served three years in the U.S. Air Force during the Korean War.
Richard L. Good (age 59) is Vice Chairman 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.
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.
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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
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 Vice Chairman Michael H. Hannon Executive Vice President, NTS Development Company Brian F. Lavin President, NTS Development Company Margaret O. Templeton President, NTS/Residential Properties, Inc. - Florida Gary D. Adams Senior Vice President, NTS Development Company Sally A. Judah Senior Vice President, NTS Corporation
The following provides additional information regarding the above-mentioned persons. Information regarding Messrs. Nichols and Good is provided in the section entitled "Directors and Officers of the Fund."
Brian F. Lavin (age 45) serves as President of NTS Corporation and NTS - ---------------- Development Company. As such, Mr. Lavin is responsible for all NTS commercial real estate development and land acquisitions and oversees the management of all commercial office buildings, business centers and multi-family residential communities. Prior to joining NTS, Mr. Lavin served as President of the Residential Division of Paragon Group, Inc., and as a Vice President of Paragon's Midwest Division. In this capacity, he directed the development, marketing, leasing and management operations for the firm's expanding portfolios. Mr. Lavin attended the University of Missouri where he received his Bachelor's Degree in Business Administration. He has served as a Director of the Louisville Apartment Association. He is a licensed Kentucky Real Estate Broker and Certified Property Manager. Mr. Lavin is a member of the Institute of Real Estate Management, and council member of the Urban Land Institute. He currently serves on the University of Louisville Board of Overseers and is on the Board of Directors of the National Multi-Housing Council and the Louisville Science Center.
Michael H. Hannon (age 55) serves as Executive Vice President of NTS Development - ----------------- Company and President of NTS Residential Properties, Inc. Virginia where he oversees the development, land acquisitions, marketing, operations, and general management. Immediately prior to joining NTS, Mr. Hannon was employed by Hines Interest Limited Partners as general manager for the Hines Rocky Mountain Region from 1995 to February 1998. In addition to his responsibilities in The Rocky Mountain Region, Mr. Hannon was responsible for Hines national residential acquisition evaluations. Prior to 1995, Mr. Hannon served as Division President for Arvida's South Atlantic Division, which included eleven residential communities, including two Arnold Palmer Designed Golf Courses. Mr. Hannon attended Grand View Junior College in Des Moines, Iowa and Parsons College in Fairfield, Iowa. He is an active Member of the Urban Land Institute, National Association of Home Builders and a licensed real estate broker in Colorado and Florida. Mr. Hannon is a decorated Viet Nam Veteran, serving with the 1st Infantry Division in Dian, South Viet Nam during 1965-1966.
Margaret O. Templeton (age 49) 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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
Gary D. Adams (age 53) is Senior Vice President of NTS Development Company with - ------------- responsibility for 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.
Sally A. Judah (age 40) 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.
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, 1998, 1997 and 1996, the Fund paid directors fees of $36,000, $36,000 and $34,000, 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 9 of the Notes to the Fund's Consolidated 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. 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.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ----------------------------------------------------------------------- - Continued -----------
(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. Certain Relationships and Related Transactions - -------------------------------------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares of the Fund. The Fund thereby allowing Fawn Lake to utilize such funds for development purposes entered into the following agreements with various Affiliates of the Sponsor regarding the ongoing operation of the Fund.
Advisory Agreement - ------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS Advisory Corporation) a Management Expense Allowance from inception of the Fund through September 30, 1997 (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 was 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 the year ended December 31, 1996 and $75,000 for the year ended December 31, 1997.
For the years ended December 31, 1997 and 1996, $418,950 and $544,776, respectively, had been incurred as an Advisory Fee. Effective October 1, 1997, the Fund no longer incurred an Advisory Fee but is now responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
Property Management Agreements - ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management Company (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are
Property Management Agreements - Continued - ------------------------------------------
renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. As permitted by the Property Management Agreements, the Fund was charged the following amounts for the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997. These amounts are reflected in Selling, General and Administrative - Affiliated on the accompanying Statement of Operations:
1998 1997 ---- ---- Personnel Related Costs: Finance and Accounting $ 172,409 $ 23,624 Data Processing 6,037 -- Human Resources 35,299 -- Executive and Administrative Services 186,199 105,920 Construction Management 38,616 8,539 Sales and Marketing 712,582 185,295 Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428 ---------- ---------
Total Expense Reimbursements $ 1,438,610 $ 526,571 ========== =========
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified with Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to return to the then existing shareholders of the Fund an amount
Property Management Agreements - Continued - ------------------------------------------
which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1997, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates - -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's Sponsor totaling $600,542 as of December 31, 1997. The advances were used to fund development costs and were to be repaid to the Affiliates as cash flow permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997, respectively. As of December 31, 1998, the advances bear interest at approximately the Prime Rate and mature on May 31, 2006. The Affiliate has represented that it will not demand repayment on any amounts owed during 1999, unless cash flows are adequate to allow such repayment. For the year ended December 31, 1998, the interest expense to affiliate totaling $341,213 was capitalized in inventory. For the years ended December 31, 1997 and 1996, interest was expensed totaling $358,226 and $258,191, respectively.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------
1. Financial statements
The financial statements for the NTS Mortgage Income Fund and NTS Guaranty Corporation together with the reports of Arthur Andersen LLP dated March 19, 1999.
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
a) 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
b) The following exhibits are incorporated by reference from the Fund's Form 8-K dated January 14, 1998.
Exhibit Number Description -------------- -----------
10 Material contracts - The agreements whereby the Fund acquired all of the issued and outstanding common capital stock of NTS/LFII and NTS/VA, and the Property Management Agreements between the Fund and NTS Management.
c) 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.
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 31, 1999 - ----------------------------------------- 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 31, 1999 - ----------------------------------------- J. D. Nichols Chairman of the Board of Directors of the NTS Mortgage Income Fund
/s/ Gerald B. Brenzel Date: March 31, 1999 - ----------------------------------------- Gerald B. Brenzel Director of the NTS Mortgage Income Fund
/s/ Robert M. Day Date: March 31, 1999 - ----------------------------------------- Robert M. Day Director of the NTS Mortgage Income Fund
/s/ Gerald B. Thomas Date: March 31, 1999 - ----------------------------------------- Gerald B. Thomas Director of the NTS Mortgage Income Fund
/s/ Richard L. Good Date: March 31, 1999 - ----------------------------------------- Richard L. Good President and Director of the NTS Mortgage Income Fund (acting as Chief Financial Officer)
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, were used to make Mortgage Loans and Temporary Investments and such other investments as permitted by the Fund's Prospectus.
Throughout 1997, the Fund's Board of Directors and NTS Corporation, the Fund's Sponsor, were involved in a restructuring of the Fund's Mortgage Loan portfolio. The Fund's Affiliated Borrowers had included NTS/Lake Forest II Residential Corporation (NTS/LFII), NTS/Virginia Development Company (NTS/VA), and the Orlando Lake Forest Joint Venture (OLFJV).
In August 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in OLFJV. The Fund contributed its interest in the principal of the first mortgage loan on the Orlando Lake Forest project and obtained a 50% interest in OLFJV.
In December 1997, the Fund acquired all the issued and outstanding common capital stock of NTS/LFII and NTS/VA, effective October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of NTS/LFII and NTS/VA to the Fund was converted to equity as of October 1, 1997. This marked the beginning of the Fund's operations focusing solely on the continuing development, operations, marketing and sale of single-family, residential real estate. As a result, the Fund no longer operates as a Real Estate Investment Trust.
Reference is made to Notes 3 and 4 of the Notes to Financial Statements for further information regarding these investments and acquisitions.
Liquidity and Capital Resources - -------------------------------
Prior to October 1, 1997, the Fund's primary source of liquidity had been from the interest earned on the Mortgage Loans and on the Temporary Investments. The Fund's current source of liquidity is primarily the ability of its subsidiaries (to which the Fund formerly had outstanding Mortgage Loans) to draw upon their respective development loans. Additional liquidity is provided by net proceeds retained from residential lot closings by the properties owned by the Fund's subsidiaries and OLFJV in which the Fund has a 50% interest. The various development loans call for principal payments ranging from 67% to 91% of Gross Receipts from lot sales.
The continued cash needs of the Fund and its subsidiaries have significantly reduced 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.
As previously reported, on February 12, 1997, the Fund entered into a letter of intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund, NTS/LFII, NTS/VA and NTS Development Company, a Kentucky corporation and a wholly-owned subsidiary of NTS Corporation. The Letter of Intent contemplated the restructuring of the Fund's loans to NTS/LFII and NTS/VA, and the acquisition of control by the Fund of the Lake Forest North project in Louisville, Kentucky, and the Fawn Lake project near Fredericksburg, Virginia.
Liquidity and Capital Resources - Continued - -------------------------------------------
The Fund consummated the restructuring as described in the Letter of Intent by acquiring all of the issued and outstanding common capital stock of NTS/LFII and NTS/VA effective as of October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of NTS/LFII and NTS/VA to the Fund was converted to equity. The acquisition was closed pursuant to (i) an Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and its shareholders, NTS/VA and certain of its shareholders, NTS Corporation, NTS Advisory Corporation, a Kentucky corporation and Advisor to the Fund (the Advisor) and NTS Residential Management Company, a Kentucky corporation (NTS Management), and (ii) an Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and certain shareholders of NTS/VA and NTS Corporation. The Advisor and NTS Management are Affiliates of and are under common control with NTS Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family residential community located in Louisville, Kentucky, and will continue to own and develop the Lake Forest North project to completion and orderly sale as a wholly-owned subsidiary of the Fund.
NTS/VA is the owner and developer of the Fawn Lake single-family residential community located near Fredericksburg, Virginia, and will continue to own and develop the Fawn Lake project to completion and orderly sale as a wholly-owned subsidiary of the Fund. Fawn Lake Realty, Inc. a division of NTS/Residential Properties, Inc.- Virginia, a Virginia corporation and an Affiliate of NTS Corporation, the Sponsor of the Fund, will continue to act as a broker and agent for NTS/VA for the sale of lots within the Fawn Lake project, and as broker and agent for approved builders in the Fawn Lake project for the sale of new homes.
The Fund, as the sole shareholder of NTS/LFII and NTS/VA controls the ongoing operations of the Lake Forest North and Fawn Lake projects. The ongoing operation and management of the Lake Forest North and Fawn Lake projects is conducted by NTS Management under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
Reimbursements of approximately $1,439,000 and $527,000 were made to NTS Management or an Affiliate during the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997, respectively. These expense reimbursements include direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS Management and/or certain affiliates as well as various non-payroll related operating expenses. Compensation costs are for those individuals rendering services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential project responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. These reimbursements are included within Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
Liquidity and Capital Resources - Continued - -------------------------------------------
In addition to the expense reimbursement noted above, NTS Management is also entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified as Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
Reference is made to Note 9 of the Notes to Financial Statements for a breakdown of these related party charges.
The Management Agreements also call for NTS Management to potentially receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to have returned to the then existing shareholders of the Fund an amount which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1998, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31 ,1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
The terms of the restructuring and of the Management Agreements were negotiated on behalf of the Fund by a committee of the Fund's Board of Directors (the Special Committee) consisting only of the Independent Directors. The Special Committee believes that the terms of the restructuring and of the Management Agreements are at least as favorable to the Fund as could have been obtained from unrelated third parties under the circumstances.
On December 30, 1997, NTS/VA closed on development financing for the Fawn Lake project committed by an unaffiliated bank. The $10,700,000 revolving credit facility is currently anticipated to provide funds for the continued development and operations of the Fawn Lake project through December 1, 2002, the maturity of the credit facility. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and of the Fund, has individually guaranteed the repayment of up to $3,000,000 of the credit facility (See Financing Activity).
The credit facility bears interest at the Prime Rate + 1 1/2%, payable monthly, and principal payments generally equal 91% of the Gross Receipts from the sale of lots at the Fawn Lake project. In addition, the total outstanding principal amount must be brought to within the following levels by the applicable date:
December 31, 1999 $9,300,000 December 31, 2000 $7,800,000 December 31, 2001 $5,900,000 December 1, 2002 $4,500,000
The loan balance was $9,581,963 as of December 31, 1998.
On January 6, 1998, NTS/LFII closed on development financing for the Lake Forest North project committed by an unaffiliated bank. The $8,000,000 revolving credit facility is currently anticipated to provide funds for the continued development and operations of the Lake Forest North project through October 31, 2003, the maturity of the credit facility, and the repayment thereof has been guaranteed by the Fund. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and of the Fund, has individually guaranteed the repayment of fifty percent (50%) of the credit facility.
Liquidity and Capital Resources - Continued - -------------------------------------------
The credit facility bears interest at the Prime Rate + 1%, payable monthly, and principal payments generally equal 90% of the Gross Receipts from the sale of lots at the Lake Forest North project. In addition, the principal amount outstanding on the credit facility must be brought to within the following levels by the applicable date:
January 1, 1999 $7,800,000 January 1, 2000 $7,200,000 January 1, 2001 $7,000,000 July 1, 2001 $6,100,000 January 1, 2002 $5,500,000 July 1, 2002 $4,900,000 January 1, 2003 $4,000,000 July 1, 2003 $2,400,000
The net worth of NTS/LFII cannot be allowed to decrease by 20% or more throughout the term of the agreement. The loan balance was $6,113,434 as of December 31, 1998.
NTS/LFII is also encumbered by a mortgage loan in the amount of $4,000,000 (with an outstanding balance of $3,250,000 as of December 31, 1998) from an unaffiliated lender which is secured by a first mortgage on the Lake Forest Country Club and golf course (approximately 176 acres of residential land and improvements thereon). The note bears interest at the Prime Rate + 1/2%, payable monthly. Principal payments totaling $300,000 are due twice a year, February through July and August through January. The primary source of principal payments will be initiation fees received. The loan is guaranteed by the Fund's Sponsor.
In August 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in the Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of whom are Affiliates of and are under common control with the Fund's Sponsor. The Joint Venture will continue to operate under its current legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family residential community located in Seminole County, Florida (near Orlando) consisting of approximately 360 acres of residential land and improvements and approximately 20 acres of commercial land. The Joint Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest in the principal and interest of the first mortgage loan on the Orlando Lake Forest project, and obtained a 50% interest in the Joint Venture. The NTS entities named above hold cumulatively the remaining 50% interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the respective partner's percentage interest, as defined in the joint venture agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was 50% and the Fund's investment balance in the Joint Venture was $4,462,990 and $4,525,369 as of December 31, 1998 and 1997 respectively. The Fund's share of the Joint Venture's net income (loss) from the year ended December 31, 1998 from August 16, 1997 (when the Fund was admitted as a partner) through December 31, 1997 was ($247,879) and $106,667, respectively.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid in full.
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 lawsuit was settled in the first quarter of 1997. The terms of the settlement agreement are confidential; however, the settlement did not have a material impact on the Fund's financial position or results of operations.
Liquidity and Capital Resources - Continued - -------------------------------------------
Key elements of the Consolidated Statements of Cash Flows:
1998 1997 1996 ---- ---- ---- Net cash provided by (used for) operating activities $(3,152,180) $ 459,795 $ 392,077
Net cash provided by (used for) investing activities (446,334) 3,626,775 (2,463,586) ----------- ----------- ----------
Net cash flows from operating and investing activities (3,598,514) 4,086,570 (2,071,509)
Net cash provided by (used for) financing activities 3,246,678 (3,389,918) 2,252,615 ----------- ----------- ---------- Net increase (decrease) in cash and cash equivalents $ (351,836) $ 696,652 $ 181,106 =========== =========== ==========
Operating Activity - ------------------
Cash used for operating activities was approximately $3,152,000 for the year ended December 31, 1998. The primary components of the use of cash for operating activities were a net loss of approximately $1,470,000, a decrease in accounts payable of approximately $949,000 and net additions to inventory of approximately $1,346,000.
Cash provided by operations was approximately $460,000 for the year ended December 31, 1997. The Fund received approximately $71,000 from cash revenues in excess of cash expenses. The Fund received approximately $481,000 in interest receivable payments from affiliates. NTS/LFII and NTS/VA used approximately $790,000 of cash to increase inventory. NTS/LFII and NTS/VA provided approximately $540,000 of cash from collection of initiation fees and other receivables and notes receivable during the period October 1, 1997 through December 31, 1997. In addition, payables increased approximately $159,000.
Cash provided by operations was approximately $392,000 during the year ended December 31, 1996. This amount was driven by net income as reported offset by increases in interest receivable from affiliates.
Investing Activity - ------------------
Cash used for investing activities was approximately $446,000 for the year ended December 31, 1998. The primary components of the use of cash for investing activities were an additional capital contribution to an unconsolidated affiliate of $186,000 and capital additions, primarily at the Lake Forest North and Fawn Lake golf operations of approximately $261,000.
During the year ended December 31, 1997, the Fund received repayment on three mortgage loans and two temporary investments in the aggregate principal amount of approximately $9,299,000. 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 approximately $5,700,000.
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 approximately $8,099,000. 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 approximately $10,563,000.
Financing Activity - ------------------
Cash provided by financing activities was approximately $3,247,000 for the year ended December 31, 1998. The primary components of the cash provided by financing activities were net borrowings on notes payable relating to the development loans for Lake Forest North and Fawn Lake projects of approximately $3,565,000, net borrowings on notes payable to affiliates of approximately $781,000 which were used primarily to fund activities of the Fawn Lake project and repayment of advances to affiliates of approximately $601,000 which were initially used to fund development costs at the Fawn Lake project.
Cash used for financing activities was approximately $3,390,000 for the year ended December 31, 1997. During the year ended December 31, 1997, the Fund and its subsidiaries borrowed approximately $8,516,000 from their various lenders. The Fund and its subsidiaries repaid approximately $2,380,000 of their borrowings from lot proceeds generated by NTS/LFII, NTS/VA and OLFJV. In addition, approximately $9,425,000 of borrowings were repaid using proceeds from the NTS/VA and OLFJV development loans. The Fund and its subsidiaries also borrowed approximately $2,436,000 from Affiliates of the Fund's Sponsor. They repaid approximately $1,651,000 of these borrowings primarily from loan repayments made by OLFJV during the period from January 1, 1997 though August 15, 1997.
Cash provided by financing activities was approximately $2,253,000 for the year ended December 31, 1996. During the year ended December 31, 1996, the Fund borrowed approximately $1,202,000 from its various lenders. The Fund repaid approximately $1,075,000 of its borrowings primarily from loan repayments made by NTS/LFII. In addition, the Fund borrowed approximately $4,077,000 from an Affiliate of the Fund's Sponsor. The Fund repaid approximately $1,438,000 of these affiliated borrowings primarily from loan repayments made by OLFJV.
The Fund declared dividends of approximately $606,000 for the year ended December 31, 1996. Total dividends declared provided Stockholders with an annualized return of 0.95%. No dividends were declared in 1998 or 1997. The Fund paid dividends of approximately $0, $175,000 and $469,000 during the years ended December 31, 1998, 1997 and 1996, respectively.
Management's projection for Fawn Lake indicates the development will reach the maximum funding level allowed by the current development loan of $10.7 million during 1999 and in fact require additional funding to achieve its development plan which includes projected 1999 sales of $6.5 million. The current development loan is secured by the inventory of the Fawn Lake Project, an approximately $2 million letter of credit issued by a third party lender with the Fawn Lake lender stated as the beneficiary, and a $3 million guarantee by Mr. J.D. Nichols. Management's projections indicate the outstanding debt balance as of December 31, 1999 will be approximately $12.1 million. Management's present plans and actions include (1) approaching the Fawn Lake lender and requesting that the loan agreement be modified to allow the outstanding balance to remain at the loan maximum of $10.7 Million as opposed to the contractually required maximum of $9.3 million as of December 31, 1999, (2) obtaining approval and additional funding from the Lake Forest North lender thereby allowing Fawn Lake to utilize such funds for development purposes and (3) borrowing additional funds from an affiliate via the loan agreement between the affiliate and the Mortgage Income Fund. Although management believes that it will be successful in such negotiations, there can be no assurances that these third party lenders will approve of management's plans and intentions for the Fawn Lake Project. However, if management is unsuccessful in that effort, consideration will be given to implementing an alternative development plan.
Results of Operations - ---------------------
Comparability - -------------
On an overall basis, the Fund experienced net income/(loss) of approximately $(1.5) million, $(13.7) million, $850,000 or $(.46), $(4.30) and $.27 per share of common stock for the years ended December 31, 1998, 1997 and 1996, respectively. In the context of the restructuring and acquisitions which occurred during the fourth quarter of 1997, comparisons of results of operations are complex. The fourth quarter 1997 charge relating to the acquisition of NTS/LFII and NTS/VA and the adjustment of the carrying value of the Fund's investment in OLFJV also represent significant items which complicated year-to-year comparisons.
The historical financial statements are also impacted by the Fund's lack of history as a real estate development company, therefore, management believes that certain areas of the Fund's results of operations for 1998 and the fourth quarter of 1997 are not comparable with prior years and a discussion comparing these periods is not included.
Revenues - --------
Revenue for the year ended December 31, 1998 includes $8.1 million in lot sales consisting of approximately $5.9 million and $2.2 million from the Lake Forest North and Fawn Lake projects, respectively. Cost of sales of approximately $6.2 million resulted in a gross profit margin of approximately 23%. During this period 136 lots were sold for an average selling price of $59,272. The decrease in the average sales price compared to the period October 1, 1997 through December 31, 1997 is primarily attributable to the sale of an entire lot section to a single home builder in the Fawn Lake project during 1998.
Revenue for the year ended December 31, 1997 includes $1.6 million of lot sales consisting of approximately $1.4 million and $200,000 from the Lake Forest North and Fawn Lake projects, respectively, for the period from October 1, 1997 (when the Fund acquired the stock of these entities) to December 31, 1997. Cost of sales was $1.2 million resulting in a gross profit of approximately 23%. During this period 21 lots were sold for an average selling price of $76,202.
During 1996 and for the nine months ended September 30, 1997, the Fund's primary revenue source was interest income earned on affiliated mortgage loans. The average outstanding balances of the earning loans increased from $62,878,000 (1996) to $63,600,000 (1997). The average interest rate earned by the Fund for the years ended December 31, 1997 and 1996 was approximately 5.5% and 5.1%, respectively, of the average outstanding loan balances.
Commitment fees paid at loan closings were amortized over the life of the loan using the interest method. Letter of credit fees were 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. Commitment fee income was recognized in 1996 only.
During the year ended December 31, 1998, the Fund realized approximately $382,000 of proceeds from a loan previously made to the Orlando Lake Forest project during the time the Fund operated as a REIT. This loan was written off by the Fund prior to its investment in the Orlando Lake Forest Joint Venture. The Fund had previously established a $1,500,000 loan loss reserve regarding a Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture. During the third quarter 1997, the Fund received 100% of the amount due on this loan and determined the loan loss reserve was no longer needed.
Interest income on cash equivalents and miscellaneous income includes interest income earned from short-term investments made by the Fund with cash reserves for each of the three years in the period ended December 31, 1998, as well as interest earnings on notes receivable for the fiscal year ended December 31, 1998 and for the period from October 1, 1997 through December 31, 1997.
Results of Operations - Continued - ---------------------------------
Revenues - Continued - --------------------
Net income using generally accepted accounting principles (GAAP) was $850,309 and using tax-reporting accounting (TRA) was $631,114 for the year ended December 31, 1996. 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 was reported as earned on the accrual basis of accounting; for tax purposes 50% of the amount of Gross Receipts Interest earned was credited against Supplemental Interest Income paid in prior years. 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 was used in applying the REIT-qualifying test that requires 95% of taxable income to be paid out in dividends. (See Note 11 of the Notes to Consolidated Financial Statements).
Expenses - --------
For years prior to 1998, operating expenses of the Fund include a Management Expense Allowance (Advisory Fee) of 1% of the Fund's Net Assets, per annum, which could be increased annually by an amount corresponding to the percentage increase in the Consumer Price Index. Pursuant to the Advisory Agreement, the Advisory Fee was paid to the Advisor (NTS Advisory Corporation) or its affiliate. Effective July 1, 1994, the Fund's Mortgage Loans to NTS/VA and NTS/LFII 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 was reduced $100,000 for the year 1996 and $75,000 for the year ended December 31, 1997.
The Advisory Fee for the years ended December 31, 1997 and 1996 was $418,950 and $544,776, respectively. Increases and decreases in the Advisory Fee generally correspond directly to increases and decreases in the Fund's Net Assets. Effective October 1, 1997, the Fund no longer incurs an Advisory Fee but is responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
Results of Operations - Continued - ---------------------------------
Expenses - Continued - --------------------
The expenses related to the Property Management agreement are presented as selling, general and administrative - Affiliated on the accompanying consolidated statements of operations. As defined in the Management Agreements, the expenses are classified in two ways, Expense Recovery and Overhead Recovery. The expense recovery included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project.
Reimbursements for Expense Recovery of approximately $1,439,000 and $527,000 were made to NTS Management or an Affiliate during the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997, respectively, for actual personnel, marketing and administrative costs as they relate to NTS/LFII, NTS/VA and the Fund.
During 1998, the Fund elected to forego the Expense Recovery portion of the Management Agreements relative to NTS/VA. NTS/VA pays expenses directly as incurred rather than allowing NTS Management to pay expenses initially and then make reimbursement to NTS Management. Therefore selling, general and administrative expenses include those costs incurred directly by NTS/VA for marketing related activities.
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements.
For the year ended December 31, 1998 and the period from inception (October 1, 1997) through December 31, 1997, Overhead Recovery incurred was approximately $496,000 and $106,000, respectively.
Increases and decreases in interest expense generally correspond directly to increases and decreases in the outstanding balances of the Fund's borrowings and its subsidiaries borrowings.
Selling, general and administrative expenses also include directors' fees, legal, outside accounting, other investor related cost.
For years prior to 1998, selling, general 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, 1997, is due primarily to increased professional fees related to the Fund's acquisitions and loan restructurings discussed in Part 1, Items 1. and 2. of this Form 10-K.
Depreciation expense relates to equipment used for development activity which is being depreciated over five to seven years. Amortization expense relates primarily to loan costs which are being amortized over the life of the related loan.
No benefit for income taxes was provided during 1998 or 1997 as the Fund has recorded a valuation allowance equal to the amount of the recorded benefit. The Fund has determined that it is more likely than not that the net deferred tax asset will not be realized. See Note 11 to the Fund's Consolidated Financial Statements for a discussion of the components of the deferred tax asset.
Results of Operations - Continued - ---------------------------------
Expenses - 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 for the year ended December 31, 1996.
The Fund had a net book loss of approximately $13,707,000 for the year ended December 31, 1997, which includes a non-cash charge of approximately $11,600,000 related to the acquisition of NTS/LFII and NTS/VA and an adjustment to the carrying value of the Fund's investment in the OLFJV of approximately $3,707,000.
Generally Accepted Accounting Principles required that the acquisitions of NTS/LFII and NTS/VA be recorded at fair market value on the day of acquisition. The application of these principles resulted in a non-cash charge of approximately $11,600,000 during the fourth quarter of 1997. In addition, the Fund's investment in an unconsolidated affiliate should be recorded at the lower of cost or fair market value. A non-cash charge of approximately $3.7 million was recorded in the third quarter of 1997 related to this investment. All estimates used in these evaluations represented management's best estimates based on the facts present at the date of such evaluations.
Year 2000 - ---------
NTS Management and its affiliates are reviewing the effort necessary to prepare our information systems (IT) and non-information technology with embedded technology (ET) for the Year 2000. The information technology solutions have been addressed separate for the Year 2000 since the Fund saw the need to move to more advanced management and accounting systems made available by new technology and software developments during the decade of the 1990s.
The PILOT software system, purchased in the early 1990s, needs to be replaced by a windows based network system both for headquarters functions and other locations. The real estate accounting system developed, sold and supported by the Yardi Company of Santa Barbara, California has been selected to supercede PILOT. The Yardi system has been tested and is compatible with Year 2000 and beyond. This system is being implemented and should be fully operational by the end of third quarter of 1999.
The few remaining systems not addressed by these conversions are being modified by our in-house staff of programmers. The Hewlett Packard 3000 system, used for PILOT and custom applications, was purchased in 1997 and will be part of our new network. It will be retained as long as necessary to assure smooth operations and has been upgraded to meet Year 2000 requirements.
All risks identified with information technology are believed to be addressed by these plans.
The cost of these advances in our systems technology is not all attributable to the Year 2000 issue since the need to move to a network based system had been determined regardless of the Year 2000. The portion of the cost attributed to the Mortgage Income Fund was approximately $42,000 for 1998 and is projected to be approximately $63,000 during 1999 for hardware and software costs.
NTS management staff has been surveying our vendors to evaluate embedded technology in our alarm systems, HVAC controls, telephone systems and other computer associated facilities. In a few cases, equipment is being replaced. In some cases circuitry is being upgraded. The cost involved is still being evaluated. There are no known significant risks that are currently without solutions. Management anticipates that applications involving ET will be Year 2000 compliant by the third quarter of 1999.
We are also currently addressing the Year 2000 readiness of third parties whose business interruption could have a material negative impact on our business. All significant vendors have indicated that they will be compliant by the end of 1999. Such assurances are being evaluated and documented.
Results of Operations - Continued - ---------------------------------
Year 2000 - Continued - ---------------------
Management has determined that at our current state of readiness, the need does not presently exist for a contingency plan. We will continue to evaluate the need for such a plan.
Despite diligent preparation, unanticipated third-party failures, more general public infrastructure failures or failure to successfully conclude our remediation efforts as planned could have a material adverse impact on our results of operations, financial conditions and/or cash flows in 1999 and beyond.
Quantitative and Qualitative Disclosures About Market Risk - ----------------------------------------------------------
Our primary market risk exposure with regard to financial instruments is changes in interest rates. The Fund's debt instruments bear interest at both variable and fixed rates as further discussed in Note 8 of the Fund's financial statements under 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 consolidated balance sheets of the NTS Mortgage Income Fund and subsidiaries (the Fund) (a Delaware corporation) as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These consolidated financial statements are the responsibility of the Fund's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Fund as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 19, 1999
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
(1) For the periods presented, there are no elements of other comprehensive income as defined by the Financial Accounting Standards Board, Statement of Financial Accounting Standards, No. 130 Reporting Comprehensive Income.
The accompanying notes are an integral part of these financial statements
(1) Net of the effects of acquisitions, where applicable. See Note 12 for information on non-cash investing and financing activities.
NTS MORTGAGE INCOME FUND
NOTES TO CONSOLIDATED 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 operated as a real estate investment trust (REIT) under the Internal Revenue Code of 1986 (the "Code"), as amended, from its inception through December 31, 1996. The Fund began operating as a "C" corporation under the Code for tax purposes effective January 1, 1997. NTS Corporation is the sponsor of the Fund (the "Sponsor"). NTS Advisory Corporation is the advisor to the Fund (the "Advisor"), and NTS Residential Management Company is the manager to the Fund ("NTS Management"). The Advisor and NTS Management are affiliates of and are under common control with NTS Corporation.
The Fund's subsidiaries include NTS/Lake Forest II Residential Corporation (NTS/LFII) and NTS/Virginia Development Company (NTS/VA). These subsidiaries were acquired effective October 1, 1997. The acquisitions were accounted for under the purchase method of accounting. See Note 3, "Acquisitions", for further information pertaining to the acquisitions. Prior to making the acquisitions, the Fund had been the primary creditor of these entities.
NTS/LFII 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. As of December 31, 1998, approximately 530 of the 726 acres have been developed and approximately 52% of the total projected lots to be developed have been sold. In addition, Lake Forest has amenities consisting of a clubhouse, pools, tennis courts, recreation fields and several lakes.
NTS/VA is in the process of developing approximately 2,825 acres 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. As of December 31, 1998, approximately 1200 of the 2825 total acres have been developed and approximately 26% of the total projected lots to be developed have been sold. Included on the property is a 285 acre lake. In addition, Fawn Lake has amenities consisting of a clubhouse, pool, tennis courts and boat docks.
The Fund purchased a 50% interest in the Orlando Lake Forest Joint Venture effective August 16, 1997. Prior to becoming a joint venture partner, the Fund had been the Joint Venture's primary creditor. See Note 4, "Investment in Unconsolidated Affiliate", for further information pertaining to the investment.
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) Principals of Consolidation and Basis of Presentation -- -----------------------------------------------------
The consolidated financial statements of the Fund include the assets, liabilities, revenues and expenses of its 100% owned subsidiaries. The consolidated statements of operations include the results of acquired businesses accounted for under the purchase method of accounting from the date of acquisition. Investments of 50% or less in affiliated companies are accounted for under the equity method. All significant intercompany transactions have been eliminated.
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 -- ------------------------------------------------
The Fund 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 the Fund and its subsidiaries are not obligated to perform significant activities after the sale. The Fund and its subsidiaries generally require a minimum down payment of at least 10% of the sales price of the lot.
Interest income from mortgage loans and notes receivable was reported as earned on the accrual basis of accounting. If the Fund had any reason to doubt the collectability of any principal or interest amounts due pursuant to the terms of the mortgage loans or notes, appropriate reserves would have been established for any principal and accrued interest amounts deemed unrealizable. Impaired loans are 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.
F) 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 projects 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.
G) Long-Lived Assets -- -----------------
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.
H) Advertising -- -----------
The Fund expenses advertising-type costs as incurred. Advertising expense, a component of Cost Reimbursements (see Note 9), was approximately $718,000 and $100,000 during the years ended December 31, 1998 and 1997, respectively.
1. Summary of Significant Accounting Policies - Continued - -- ------------------------------------------------------
I) Operating Expense Limitations -- -----------------------------
Prior to January 1, 1997, the annual Operating Expenses of the Fund when functioning as a REIT, based upon guidelines promulgated by the North American Securities Administrators Association, Inc., were 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 exceeded this limitation, the Advisor would 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 year ended December 31, 1996.
J) Environmental Remediation and Compliance -- ----------------------------------------
Environmental liabilities for remediation costs are accrued based on estimates of known environmental remediation exposures. Liabilities are recognized when they can be reasonably estimated. Environmental compliance costs are expensed as incurred.
K) Per Share Information -- ---------------------
The Financial Accounting Standards Board recently issued Standard No. 128, Earnings Per Share (SFAS 128). The Statement simplifies the standards for computing earnings per share (EPS) and replaces the presentation of primary and fully diluted EPS with a presentation of basic and diluted EPS. SFAS 128 is effective for financial statements for periods ending after December 15, 1997. For all periods presented, the Fund did not have common stock equivalents, therefore, the adoption of SFAS 128 did not have any impact on the Fund's financial statements.
L) 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.
2. Affiliations - -- ------------
The Fund operates under the direction of its Board of Directors who have retained NTS Management to be the sole and exclusive agent of the Fund for day-to-day control and management of the business of the Fund's subsidiaries including (a) the continued operation of NTS/LFII and NTS/VA, (b) the operations of the Lake Forest Country Club and the Fawn Lake Country Club, (c) the operations of the Lake Forest Community Association and the Fawn Lake Community Association and (d) the provision and/or sale of ancillary goods and services as selected by NTS Management with respect to any of the foregoing. The Management Agreements have an initial term through and including December 31, 2003, and automatically renew for successive six year terms unless terminated by the Fund, its subsidiaries, or NTS Management upon six months written notice. See Note 9 for further discussion of the Management Agreements. NTS Management is an Affiliate of and under common control with NTS Corporation, the Fund's Sponsor. The Chairman of the Board of Directors of the Fund is also the majority shareholder of NTS Corporation and is a majority shareholder of the managing general partner in the Orlando Lake Forest Joint Venture of which the Fund is a 50% joint venture partner. NTS Advisory and NTS Management are Affiliates of and are under common control with NTS Corporation.
3. Acquisitions - -- ------------
The Fund acquired all of the issued and outstanding common stock of NTS/LFII and NTS/VA effective October 1, 1997, for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the Fund was converted to equity.
The transaction has been accounted for using the purchase method of accounting. The purchase price (approximately $14.5 million for NTS/LFII and approximately $28.7 million for NTS/VA) was allocated to the assets and liabilities of NTS/LFII and NTS/VA based on their estimated fair market value. The acquisition of NTS/LFII included inventory of approximately $19 million, debt of approximately $5 million and other net assets and liabilities of approximately $500,000. The acquisition of NTS/VA included inventory of approximately $32 million, debt of approximately $5.5 million and other net assets and liabilities of approximately $2.2 million. The results of operations for NTS/LFII and NTS/VA from the date of acquisition (October 1, 1997) are included in the consolidated financial statements of the Fund.
Generally Accepted Accounting Principles require that these acquisitions be recorded at fair market value. The application of these principles resulted in a non-cash charge of approximately $11,600,000 during the fourth quarter of 1997 related to these transactions. All estimates used in these evaluations represented management's best estimates based on the facts present at the date of the evaluations.
4. Investment in Unconsolidated Affiliate - -- --------------------------------------
In September 1997, the Fund entered into an Amended and Restated Joint Venture Agreement evidencing the Fund's admission as a partner in the Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of whom are Affiliates of and are under common control with the Fund's Sponsor. The Joint Venture will continue to operate under its current legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family residential community located in Seminole County, Florida (near Orlando) consisting of approximately 360 acres of residential land and improvements and approximately 20 acres of commercial land. The Joint Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest in the principal and interest of the first mortgage loan on the Orlando Lake Forest project, and obtained a 50% interest in the Joint Venture. The NTS entities named above hold cumulatively the remaining 50% interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the respective partner's percentage interest, as defined in the joint venture agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was 50%, and the Fund's investment balance in the Joint Venture was $4,462,990 and $4,525,369 as of December 31, 1998 and 1997, respectively. The Fund's share of the Joint Venture's net income (loss) for the year ended December 31, 1998 was $(247,879) and from August 16, 1997 (when the Fund was admitted as a partner) through December 31, 1997 was $106,667.
Generally Accepted Accounting Principles require that such investments be recorded at the lower of carrying value or fair market value. The application of these principles resulted in a non-cash charge of approximately $3.7 million in the third quarter of 1997. All estimates used in this evaluation represent management's best estimates based on the facts present at the date of such evaluations.
4. Investment in Unconsolidated Affiliate - Continued - -- --------------------------------------------------
During fiscal 1998, the Fund and the other joint venture partners contributed as a capital contribution of $371,000 to the joint venture, the Fund's portion being $185,500.
The following presents condensed financial information for the Joint Venture as of December 31, 1998 and 1997 and for the year ended December 31, 1998 as well as the period August 16, 1997 through December 31, 1997:
1998 1997 ---- ---- Balance Sheet Notes receivable $ 550,272 $ 647,448 Inventory 14,461,364 13,376,714 Other, net 512,976 1,935,254 ------------ ------------
Total assets $ 15,524,612 $ 15,959,416 ============ ============
Notes payable $ 5,323,241 $ 4,793,014 Other liabilities 1,275,389 2,115,662 Equity 8,925,982 9,050,740 ------------ ------------
Total liabilities and equity $ 15,524,612 $ 15,959,416 ============ ============
Statement of Operations Lot sales $ 2,624,548 $ 1,678,079 Cost of sales (1,836,386) (1,150,339) Other income (expenses), net (1,283,920) (314,404) ---------- --------
Net income (loss) $ (495,758) $ 213,336 ============ ============
5. Member Initiation Fees and Other Accounts Receivable - -- ----------------------------------------------------
Fawn Lake Country Club and Lake Forest Country Club membership initiation fees receivable totaled approximately $1,370,000 and $1,209,000 as of December 31, 1998 and 1997. 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.
6. 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 and seven years, monthly payments are based on a 30-year amortization and the balance is due at the maturity date. Notes totaling approximately $3,179,000 and $3,443,000 are pledged as security for notes payable to banks under certain Warehouse Line of Credit Agreements and other debt agreements as of December 31, 1998 and 1997, respectively. There are also $125,000 and $130,500 of notes held by NTS/VA that are not pledged as of 1998 and 1997, respectively. Approximately $1,883,000, $426,000, $39,000, and $61,000 of the notes receivable balance as of December 31, 1998 are due for the years ended December 1999 through 2002, respectively. Approximately $787,000 of the notes receivable balance relates to the sale of 24 lots to one builder in fiscal 1998 at NTS/VA. The note bears interest at the Prime Rate plus 1%, is due in monthly installments commencing June 29, 2001, with any outstanding principal and interest payable in full on December 29, 2003.
7. Inventory - -- ---------
Inventory consists of the following as of December 31, 1998:
NTS/LFII NTS/VA Consolidated -------- ------ ------------ Land held for future development, under development and completed lots $ 5,855,000 $21,971,000 $27,826,000 Country club (net of membership initiation fees) 10,225,000 8,099,000 18,324,000 Amenities 2,176,000 4,938,000 7,114,000 ----------- ----------- ------------
$18,256,000 $35,008,000 $ 53,264,000 =========== =========== ============
Inventory consists of the following as of December 31, 1997:
NTS/LFII NTS/VA Consolidated -------- ------ ------------ Land held for future development, under development and completed lots $ 6,874,000 $21,787,000 $28,661,000 Country club (net of Membership initiation fees) 7,329,000 7,175,000 14,504,000 Amenities 4,590,000 4,163,000 8,753,000 ----------- ----------- ------------
$18,793,000 $33,125,000 $ 51,918,000 =========== =========== ============
NTS/LFII and NTS/VA capitalized in inventory approximately $2,064,000 and $214,000 of interest and real estate taxes during 1998 and from October 1, 1997 though December 31, 1997, respectively. Interest and real estate taxes incurred was approximately $2,296,000 and $396,000 as of December 31, 1998 and from October 1, 1997 through December 31, 1997, respectively.
Inventory for 1998 as reflected above includes $26,586,000, net of $8,262,000 of country club membership initiation fees, of costs incurred to date for the development of the Fawn Lake Country Club and the Lake Forest Country Club.
Inventory for 1997 as reflected above includes $21,708,355, net of $7,204,605 of country club membership initiation fees, of costs incurred to date for the development of the Fawn Lake Country Club and the Lake Forest Country Club.
Pursuant to an agreement between NTS/LFII and the Lake Forest Country Club regarding the cost to develop the Country Club, NTS/LFII is to receive all initiation fees from the initial issuance of memberships to the Country Club. The remaining cost to be incurred for the current projected Country Club operating deficit for the period covered by the agreement is approximately $2,330,000 which is expected to be offset by member initiation fees. During 1998 and for the fourth quarter of 1997 the Country Club operating deficit was approximately $279,000 and $160,000, respectively, and was capitalized as a cost of inventory.
The Prime Rate was 7 3/4% and 8 1/2% at December 31, 1998 and 1997, respectively.
The $519,052 and $488,853 Warehouse Line of Credit agreements are guaranteed by NTS Corporation.
The minimum scheduled principal payments on debt outstanding at December 31, 1998 are as follows: 1999 $ 3,399,447 2000 3,240,138 2001 2,520,661 2002 4,200,000 2003 9,400,000 Thereafter ---------
$ 22,760,246 (1)
(1) The minimum scheduled principal payments regarding the $10.7 and $8 million credit facilities are reflected in the table such that the outstanding principle amount is brought to within the following levels by the applicable date.
8. Notes and Mortgage Loans Payable - Continued - -- --------------------------------------------
$10.7 Million Facility ----------------------
December 31, 1999 $9,300,000 December 31, 2000 $7,800,000 December 31, 2001 $5,900,000 December 1, 2002 $4,500,000
$8 Million Facility -------------------
January 1, 1999 $7,800,000 January 1, 2000 $7,200,000 January 1, 2001 $7,000,000 July 1, 2001 $6,100,000 January 1, 2002 $5,500,000 July 1, 2002 $4,900,000 January 1, 2003 $4,000,000 July 1, 2003 $2,400,000
Management's projection for Fawn Lake indicates the development will reach the maximum funding level allowed by the current development loan of $10.7 million during 1999 and in fact require additional funding to achieve its 1999 development plan which includes projected sales of $6.5 million. The current development loan is secured by the inventory of the Fawn Lake Project, an approximately $2 million letter of credit issued by a third party lender with the Fawn Lake lender stated as the beneficiary, and a $3 million guarantee by Mr J.D. Nichols. Management's projections indicate the outstanding debt balance as of December 31, 1999 will be approximately $12.1 million. Management's present plans and actions include (1) approaching the Fawn Lake lender and requesting that the loan agreement be modified to allow the outstanding balance to remain at the loan maximum of $10.7 Million as opposed to the contractual required maximum of $9.3 million as of December 31, 1999, (2) obtaining additional funding from the Lake Forest North lender thereby allowing Fawn Lake to utilize such funds for development purposes, and (3) borrowing additional funds from an affiliate via the loan agreement between the affiliate and the Mortgage Income Fund. Although management believes that it will be successful in such negotiations, there can be no assurances that these third party lenders will approve of management's plans and intentions for Fawn Lake. However, if management is unsuccessful in that effort, consideration will be given to implementing an alternative development plan.
9. Related Party Transactions - -- --------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares of the Fund. The Fund thereby allowing Fawn Lake to utilize such funds for development purposes entered into the following agreements with various Affiliates of the Sponsor regarding the ongoing operation of the Fund.
Advisory Agreement ------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS Advisory Corporation) a Management Expense Allowance from inception of the Fund through September 30, 1997 (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 was 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 the year ended December 31, 1996 and $75,000 for the year ended December 31, 1997.
Advisory Agreement - Continued - ------------------------------
For the years ended December 31, 1997 and 1996, $418,950 and $544,776, respectively, had been incurred as an Advisory Fee. Effective October 1, 1997, the Fund no longer incurred an Advisory Fee but is now responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
Property Management Agreements - ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management Company (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. As permitted by the Property Management Agreements, the Fund was charged the following amounts for the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997. These amounts are reflected in Selling, General and Administrative - Affiliated on the accompanying Statement of Operations:
1998 1997 ---- ---- Personnel Related Costs: Finance and Accounting $ 172,409 $ 23,624 Data Processing 6,037 -- Human Resources 35,299 -- Executive and Administrative Services 186,199 105,920 Construction Management 38,616 8,539 Sales and Marketing 712,582 185,295 Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428 ------ ------
Total Expense Reimbursements $ 1,438,610 $ 526,571 ========== =========
Property Management Agreements - Continued - ------------------------------------------
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified with Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to return to the then existing shareholders of the Fund an amount which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1997, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates - -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's Sponsor totaling $600,542 as of December 31, 1997. The advances were used to fund development costs and were to be repaid to the Affiliates as cash flow permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997, respectively. As of December 31, 1998, the advances bear interest at approximately the Prime Rate and mature on May 31, 2006. The Affiliate has represented that it will not demand repayment on any amounts owed during 1999, unless cash flows are adequate to allow such repayment. For the year ended December 31, 1998, the interest expense to affiliate totaling $341,213 was capitalized in inventory. For the years ended December 31, 1997 and 1996, interest was expensed totaling $358,262 and $258,191, respectively.
10. Affiliated Mortgage Loans Receivable - --- ------------------------------------
The following table outlines the activity regarding the Fund's mortgage loan portfolio for the three years in the period ended December 31, 1998.
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
10. Affiliated Mortgage Loans Receivable - Continued - --- ------------------------------------------------
Additions:
Mortgage Loans $ 5,186,594 Temporary Mortgage Loans 513,443 Accretion of discount 95,932 Amortization of loan fees -- 5,795,969 ----------- ---------- Reductions:
Mortgage Loans (5,447,696) Temporary Mortgage Loans (6,351,123) Investment in unconsolidated affiliate (Note 4) (8,125,928) Purchase of net assets of subsidiaries (Note 3) (53,658,986) (73,583,733) ----------- ----------- Balance at December 31, 1997 $ -- ===========
Reserves for Loan Losses:
Balance at December 31, 1995 $ 1,553,397
Additions charged to expenses $ -- Deductions for Mortgage Loan written-off (53,397) (53,397) ------------ ----------- Balance at December 31, 1996 $ 1,500,000
Additions charges to expenses $ -- Recovery of provisions for loan loss (1,500,000) (1,500,000) ------------ ----------- Balance at December 31, 1997 $ -- ===========
11. Income Taxes - --- ------------
The Fund adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), effective January 1, 1997. SFAS 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequence of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the Fund's book and tax bases of assets and liabilities and tax carryforwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The principal tax carryforwards and temporary differences giving rise to the Fund's deferred taxes consist of tax net operating loss carryforwards, valuation allowances and differences in inventory basis for book and tax.
11. Income Taxes - Continued - --- ------------------------
The Fund's deferred tax assets and liabilities as of December 31, are as follows:
Deferred tax assets 1998 1997 - ------------------- ---- ---- Net operating loss carryforwards $ 687,000 $ 132,000 Inventory 2,972,000 3,199,000 Deferred revenue 157,000 -- ----------- ----------- Net deferred tax assets 3,816,000 3,331,000
Valuation allowance (3,816,000) (3,331,000) ----------- ----------- $ -- $ -- =========== ===========
A valuation allowance is provided when the probability that the deferred tax asset to be realized does not meet the criteria established by the Financial Accounting Standards Board. The Fund has determined, based on its history of operating losses by its subsidiaries and its expectations for the future, that it is more likely than not that the net deferred tax assets at December 31, 1998 and 1997, will not be realized.
As of December 31, 1998, the Fund has a federal net operating loss carryforward of approximately $687,000 expiring during 2012 and 2013.
A reconciliation of the statutory to the effective rate of the Fund for the year ended December 31, is as follows:
1998 1997 ---- ---- Tax benefit using statutory rate $ 500,000 $ 4,660,000 Recovery on provision for loan losses -- 510,000 Establishing deferred tax liabilities other due to a change in tax status -- (1,839,000) Valuation allowance (486,000) (3,331,000) Other (14,000) -- -------- ---------
Income tax expense $ -- $ -- ======== =========
Prior to January 1, 1997, the Fund elected and qualified to be treated as a REIT under Internal Revenue Code Sections 856-860. In order to qualify, the Fund was required to distribute at least 95% of its taxable income to Stockholders and meet certain other requirements. A reconciliation of net income for financial statement purposes versus that for income tax reporting at December 31 is as follows:
----
Net income (GAAP) $ 850,309 Accretion of note discount (148,472) Loan commitment fee income (20,000) Letters of credit income (2,326) Supplemental interest income -- Federal income tax expense 5,000 Provision for loan losses (53,397) --------
Taxable income before dividends paid deduction $ 631,114 ========= Dividends declared $ 605,601 ========= Distribution percentage 96%
12. Supplemental Cash Flow Information - --- ----------------------------------
a) Cash payments for interest, net of amounts capitalized and cash payments for income taxes, net of refunds are as follows:
1998 1997 1996 ---- ---- ---- Interest $ 244,295 $1,767,786 $1,510,384
Income taxes $ -- $ 5,320 $ --
b) Supplemental Non-Cash Investing and Financing Activity: In 1997, the Fund made an investment in an unconsolidated affiliate by contributing the principal amount outstanding on mortgage loans receivable of approximately $8,125,000. (See Notes 4 and 10).
In 1997, the Fund acquired all of the outstanding common stock of NTS/LFII and NTS/VA for a nominal purchase price. Concurrent with this transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the Fund totaling approximately $53,659,000 was converted to equity (See Notes 3 and 10).
13. Financial Instruments - --- ---------------------
The book values of cash and cash equivalents, trade receivables and trade payables are considered to be representative of their respective fair values because of the immediate or short-term maturity of these financial instruments. The fair value of the Fund's notes receivable and debt instruments approximated the book value because a substantial portion of the underlying instruments are variable rate notes.
14. Commitments and Contingencies - --- -----------------------------
At December 31, 1998 and 1997, the Fund had outstanding funding commitments under standby letters of credit aggregating to $194,347 and $48,821, respectively, regarding the Orlando Lake Forest Joint Venture.
NTS/LFII and NTS/VA have various letters of credit outstanding to governmental agencies and utility companies totaling approximately $2,277,053 and $2,892,500 as of December 31, 1998 and 1997, respectively.
It is estimated that development of the remaining homeowners association amenities at the Lake Forest North project will be substantially complete by May 2001. Based on engineering studies and projections, NTS/LFII will incur additional costs, excluding interest, of approximately $500,000 during 2001 to complete the homeowners association amenities.
It is estimated that the country club and homeowners association amenities at the Fawn Lake project will be substantially completed by December 2004. Based on engineering studies and projections, NTS/VA will incur additional costs, excluding interest, of approximately $3,165,000 to complete the country club and homeowners association amenities for the project. These costs are estimated to be incurred as follows: $1,500,000 for 1999, $75,000 for 2002, $440,000 for 2003 and $1,150,000 for 2004.
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 the Fund's Sponsor and various Affiliates of the Fund's Sponsor. The suit was settled in the first quarter of 1997. The terms of the settlement agreement are confidential; however, the settlement did not have a material impact on the Fund's financial position or results of operations.
15. Guaranties to the Fund - --- ----------------------
NTS Guaranty Corporation (the "Guarantor"), an Affiliate of the Sponsor, 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, 1998, the Fund has raised approximately $63,690,000 and has paid distributions of $23,141,000.
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.
16. Dividends Paid and Payable - ------------------------------
Dividends declared for the period ended December 31, 1996 were as follows:
Average Date Date of Date Outstand Amount Declared Record (1) Paid Shares Per Share Amount - -------- ---------- ---- ------ --------- ------ 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 ===== =========
(1) Cash dividends vary based upon the date of stockholder admittance.
It was the Fund's policy during the periods it operated as a REIT 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 have been allocable to taxable income earned in the prior year. For 1996, dividends to Stockholders represent ordinary income.
The continued needs of the Fund's subsidiaries have significantly reduced 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) Includes $1,500,000 for recovery of provision for loan losses.
(2) The fourth quarter reflects the Fund's acquisition of the stock of NTS/LFII and NTS/VA and consists substantially of the results of operations of NTS/LFII and NTS/VA from October 1, 1997. The fourth quarter is also reflective of the Fund's 50% share of the results of operations of the Orlando Lake Forest Joint Venture. Total expenses include a non-cash charge of approximately $11,600,000 relating to the acquisition of NTS/LFII and NTS/VA.
(3) Includes approximately $382,000 for recovery of loan previously written off.
(4) Total expenses include a non-cash charge of approximately $3.7 million related to the Fund's investment in unconsolidated affiliate.
18. Subsequent Events - --- -----------------
Beginning January 1, 1999, the Fund has agreed to defray the remaining cost of the capital improvements made by Beckley Station Disposal Systems, Inc. ("Beckley"), an affiliate of the Sponsor relative to Beckley's waste water treatment facility. The facility is providing waste water treatment to the homes constructed in the Lake Forest North project. The costs are to be reimbursed to Beckley on a per lot basis over the remaining life of the Lake Forest North project. The cost to be incurred will be approximately $1,598,000 over the life of the project based on a per lot fee of approximately $2,400.
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, 1998 and 1997. 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, 1998 and 1997, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky March 19, 1999
NTS GUARANTY CORPORATION (A KENTUCKY CORPORATION) BALANCE SHEETS AS OF DECEMBER 31, 1998 AND 1997
ASSETS ------
1998 1997 ---- ----
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 totaling approximately $15 for each of the years ended December 31, 1998 and 1997, 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 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.
2. Commitments - -- -----------
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, 1998, the Fund has raised approximately $63,690,000 and has paid distributions of approximately $23,141,000.
The liability of the Guarantor under the above guaranty 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.
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* Gerald B. Brenzel Director* Richard L. Good President and Director
- -------------------------------------------------------------------------------- * Messr. Day, Thomas and Brenzel 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 57) 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 46) 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 60) has 25 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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
Gerald B. Brenzel (age 67) has over forty years experience in the securities - ----------------- industry, most recently as First Vice President of Morgan, Keegin & Company in Louisville, Kentucky. Prior to that, Mr. Brenzel was founder and CEO of Commonwealth Investment Group, Inc., an investment money managers and regional brokerage firm in Louisville. From 1964 to 1988, Mr. Benzel was regional Vice President and Branch Manager of Stifel, Nicolaus & Company, and is a member of the Board of that firm, was also an allied member of the New York Stock Exchange (1964 thru 1988). A former Governor of the National Association of Securities Dealers, Mr. Benzel attended the University of Louisville for three years and also served three years in the U.S. Air Force during the Korean War.
Richard L. Good (age 59) is Vice Chairman 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.
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.
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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
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 Vice Chairman Michael H. Hannon Executive Vice President, NTS Development Company Brian F. Lavin President, NTS Development Company Margaret O. Templeton President, NTS/Residential Properties, Inc. - Florida Gary D. Adams Senior Vice President, NTS Development Company Sally A. Judah Senior Vice President, NTS Corporation
The following provides additional information regarding the above-mentioned persons. Information regarding Messrs. Nichols and Good is provided in the section entitled "Directors and Officers of the Fund."
Brian F. Lavin (age 45) serves as President of NTS Corporation and NTS - ---------------- Development Company. As such, Mr. Lavin is responsible for all NTS commercial real estate development and land acquisitions and oversees the management of all commercial office buildings, business centers and multi-family residential communities. Prior to joining NTS, Mr. Lavin served as President of the Residential Division of Paragon Group, Inc., and as a Vice President of Paragon's Midwest Division. In this capacity, he directed the development, marketing, leasing and management operations for the firm's expanding portfolios. Mr. Lavin attended the University of Missouri where he received his Bachelor's Degree in Business Administration. He has served as a Director of the Louisville Apartment Association. He is a licensed Kentucky Real Estate Broker and Certified Property Manager. Mr. Lavin is a member of the Institute of Real Estate Management, and council member of the Urban Land Institute. He currently serves on the University of Louisville Board of Overseers and is on the Board of Directors of the National Multi-Housing Council and the Louisville Science Center.
Michael H. Hannon (age 55) serves as Executive Vice President of NTS Development - ----------------- Company and President of NTS Residential Properties, Inc. Virginia where he oversees the development, land acquisitions, marketing, operations, and general management. Immediately prior to joining NTS, Mr. Hannon was employed by Hines Interest Limited Partners as general manager for the Hines Rocky Mountain Region from 1995 to February 1998. In addition to his responsibilities in The Rocky Mountain Region, Mr. Hannon was responsible for Hines national residential acquisition evaluations. Prior to 1995, Mr. Hannon served as Division President for Arvida's South Atlantic Division, which included eleven residential communities, including two Arnold Palmer Designed Golf Courses. Mr. Hannon attended Grand View Junior College in Des Moines, Iowa and Parsons College in Fairfield, Iowa. He is an active Member of the Urban Land Institute, National Association of Home Builders and a licensed real estate broker in Colorado and Florida. Mr. Hannon is a decorated Viet Nam Veteran, serving with the 1st Infantry Division in Dian, South Viet Nam during 1965-1966.
Margaret O. Templeton (age 49) 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.
Item 10. Directors and Executive Officers of the Registrant - Continued - -----------------------------------------------------------------------
Gary D. Adams (age 53) is Senior Vice President of NTS Development Company with - ------------- responsibility for 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.
Sally A. Judah (age 40) 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.
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, 1998, 1997 and 1996, the Fund paid directors fees of $36,000, $36,000 and $34,000, 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 9 of the Notes to the Fund's Consolidated 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.
Item 12. Security Ownership of Certain Beneficial Owners and Management - ----------------------------------------------------------------------- - Continued -----------
(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 - -------------------------------------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares of the Fund. The Fund thereby allowing Fawn Lake to utilize such funds for development purposes entered into the following agreements with various Affiliates of the Sponsor regarding the ongoing operation of the Fund.
Advisory Agreement - ------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS Advisory Corporation) a Management Expense Allowance from inception of the Fund through September 30, 1997 (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 was 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 the year ended December 31, 1996 and $75,000 for the year ended December 31, 1997.
For the years ended December 31, 1997 and 1996, $418,950 and $544,776, respectively, had been incurred as an Advisory Fee. Effective October 1, 1997, the Fund no longer incurred an Advisory Fee but is now responsible for the actual general and administrative costs pursuant to certain property management agreements discussed below.
Property Management Agreements - ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake projects will be conducted by NTS Residential Management Company (NTS Management) under the terms of (i) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a Property Management Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn Lake project (collectively, the Management Agreements). NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an initial term through December 31, 2003, subject to extension under certain conditions, and are
Property Management Agreements - Continued - ------------------------------------------
renewable for successive six (6) year terms thereafter. Under the Management Agreements, NTS Management will be reimbursed for costs incurred in the operation and management of the Lake Forest North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will accrue an incentive payment payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the management and operation of NTS/LF II and NTS/VA. Such costs include compensation costs of management, accounting, professional, engineering and development, marketing and office personnel employed by NTS management and/or certain of its affiliates as well as various non payroll related operating expenses. Compensation costs are for those individuals who rendered services full time and on site at the residential projects, with respect to the residential projects but who are not on site and with respect to the residential projects but who have multiple residential projects responsibilities some of which may be affiliated entities of NTS Management. For services provided by individuals not on site or those with multiple residential project responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. As permitted by the Property Management Agreements, the Fund was charged the following amounts for the year ended December 31, 1998 and the period from October 1, 1997 through December 31, 1997. These amounts are reflected in Selling, General and Administrative - Affiliated on the accompanying Statement of Operations:
1998 1997 ---- ---- Personnel Related Costs: Finance and Accounting $ 172,409 $ 23,624 Data Processing 6,037 -- Human Resources 35,299 -- Executive and Administrative Services 186,199 105,920 Construction Management 38,616 8,539 Sales and Marketing 712,582 185,295 Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428 ---------- ---------
Total Expense Reimbursements $ 1,438,610 $ 526,571 ========== =========
Additionally, NTS Management is entitled to an Overhead Recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of NTS Management under the Management Agreements, in an amount equal to 3.75% of the projects' gross cash receipts, as defined in the Management Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174 and $106,473 for the period October 1, 1997 through December 31, 1997. These amounts are classified with Selling, General and Administrative - Affiliated in the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive Payment, as defined in the Management Agreements, equal to 10% of the Net Cash Flows of the projects. The Incentive Payment will not begin accruing until after the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash flow of the Orlando Lake Forest Joint Venture would have been sufficient to enable the Fund to return to the then existing shareholders of the Fund an amount
Property Management Agreements - Continued - ------------------------------------------
which, after adding thereto all other payments actually remitted or distributed to such shareholders of the Fund, is at least equal to the shareholders' Original Capital Contribution. As of December 31, 1997, the Fund had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates - -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's Sponsor totaling $600,542 as of December 31, 1997. The advances were used to fund development costs and were to be repaid to the Affiliates as cash flow permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997, respectively. As of December 31, 1998, the advances bear interest at approximately the Prime Rate and mature on May 31, 2006. The Affiliate has represented that it will not demand repayment on any amounts owed during 1999, unless cash flows are adequate to allow such repayment. For the year ended December 31, 1998, the interest expense to affiliate totaling $341,213 was capitalized in inventory. For the years ended December 31, 1997 and 1996, interest was expensed totaling $358,226 and $258,191, respectively.
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 and NTS Guaranty Corporation together with the reports of Arthur Andersen LLP dated March 19, 1999.
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
a) 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
b) The following exhibits are incorporated by reference from the Fund's Form 8-K dated January 14, 1998.
Exhibit Number Description -------------- -----------
10 Material contracts - The agreements whereby the Fund acquired all of the issued and outstanding common capital stock of NTS/LFII and NTS/VA, and the Property Management Agreements between the Fund and NTS Management.
c) 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.
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 31, 1999 - ----------------------------------------- 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 31, 1999 - ----------------------------------------- J. D. Nichols Chairman of the Board of Directors of the NTS Mortgage Income Fund
/s/ Gerald B. Brenzel Date: March 31, 1999 - ----------------------------------------- Gerald B. Brenzel Director of the NTS Mortgage Income Fund
/s/ Robert M. Day Date: March 31, 1999 - ----------------------------------------- Robert M. Day Director of the NTS Mortgage Income Fund
/s/ Gerald B. Thomas Date: March 31, 1999 - ----------------------------------------- Gerald B. Thomas Director of the NTS Mortgage Income Fund
/s/ Richard L. Good Date: March 31, 1999 - ----------------------------------------- Richard L. Good President and Director of the NTS Mortgage Income Fund (acting as Chief Financial Officer)