For the quarterly period ended September 30, 2003
OR
Commission File Number 0-18550
| Delaware | 61-1146077 |
| (State or other jurisdiction of | (IRS Employer Identification No.) |
| incorporation or organization) |
10172 Linn Station
Road, Louisville, Kentucky 40223
(Address of Principal Executive Offices)
(502) 426-4800
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [ ] No [X]
As of September 30, 2003, the registrant had approximately 3,187,000 shares of common stock outstanding.
| Pages |
| Item 1. | Financial Statements | |||
| Consolidated Balance Sheets as of September 30, 2003 | ||||
| and December 31, 2002 | 4 | |||
| Consolidated Statements of Operations for the Three | ||||
| and Nine Months Ended September 30, 2003 and 2002 | 5 | |||
| Consolidated Statements of Cash Flows for the Nine Months | ||||
| Ended Setember 30, 2003 and 2002 | 6 | |||
| Notes to Consolidated Financial Statements | 7-18 | |||
| Item 2. | Management's Discussion and Analysis of Financial | |||
| Condition and Results of Operations | 19-28 | |||
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 28 | ||
| Item 4. | Controls and Procedures | 28 | ||
| Items 1 - 6 | 29 | |||
| Signatures | 30 | |||
| Exhibit Index | 31 |
2
Some of the statements included in this Quarterly Report on Form 10-Q, particularly those included in Part I, Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), may be considered “forward-looking statements” because the statements relate to matters which have not yet occurred. For example, phrases such as “we anticipate,” “believe” or “expect” indicate that it is possible that the event anticipated, believed or expected may not occur. If these events do not occur, the result which we expected also may not occur, or may occur in a different manner which may be more or less favorable to us. We do not undertake any obligation to update these forward-looking statements.
Any forward-looking statements included in MD&A, or elsewhere in this report, reflect our best judgment based on known factors, but involve risks and uncertainties. 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 described in our filings with the Securities and Exchange Commission, particularly our Annual Report on Form 10-K for the year ended December 31, 2002. Any forward-looking information provided by us pursuant to the safe harbor established by securities legislation should be evaluated in the context of these factors.
3
As of As of
September 30, December 31,
2003 2002
------------------- -------------------
(UNAUDITED)
ASSETS
Cash and equivalents $ 1,142,744 $ 813,009
Membership initiation fees and other accounts receivable,
net of allowance of approximately $86,000, respectively 909,667 1,224,241
Notes receivable 583,406 795,168
Inventory 38,711,126 38,397,019
Property and equipment, net of accumulated depreciation
of approximately $1,793,000 and $1,515,000, respectively 3,710,729 3,670,591
Investment in unconsolidated affiliate 1,768,872 1,581,209
Other assets 504,577 445,780
------------------- -------------------
TOTAL ASSETS $ 47,331,121 $ 46,927,017
=================== ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 2,675,180 $ 2,682,404
Accounts payable and accrued expenses - affiliates 10,102,083 8,875,945
Mortgages and notes payable 15,506,788 14,386,442
Other liabilities 439,555 391,955
------------------- -------------------
TOTAL LIABILITIES 28,723,606 26,336,746
------------------- -------------------
COMMITMENTS AND CONTINGENCIES (Note 16)
STOCKHOLDERS' EQUITY
Common stock, $0.001 par value,
6,000,000 shares authorized;
3,187,333 shares issued and outstanding $ 3,187 $ 3,187
Additional paid-in-capital 54,163,397 54,163,397
Accumulated deficit (35,559,069) (33,576,313)
------------------- -------------------
TOTAL STOCKHOLDERS' EQUITY 18,607,515 20,590,271
------------------- -------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 47,331,121 $ 46,927,017
=================== ===================
The accompanying notes to consolidated financial statements are an integral part of these statements.
4
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- -----------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
REVENUES
Lot sales, net of discounts $ 3,886,247 $ 4,970,922 $ 7,646,092 $ 11,106,401
Land sale (Note 7) -- -- -- 6,100,000
------------- ------------- ------------- -------------
Total sales 3,886,247 4,970,922 7,646,092 17,206,401
Cost of sales 3,178,699 3,686,628 6,269,694 13,046,129
------------- ------------- ------------- -------------
Gross profit 707,548 1,284,294 1,376,398 4,160,272
------------- ------------- ------------- -------------
Country Club income 406,564 416,375 1,083,504 1,042,829
Interest and miscellaneous income 25,209 16,847 100,503 54,818
------------- ------------- ------------- -------------
TOTAL REVENUES 1,139,321 1,717,516 2,560,405 5,257,919
------------- ------------- ------------- -------------
EXPENSES
Selling, general and administrative -
affiliated 537,212 767,018 1,552,552 2,302,982
Selling, general and administrative 321,447 494,636 1,091,496 1,339,600
Country Club expenses 717,876 658,913 1,900,807 1,739,189
Interest expense 6,527 30,418 31,460 75,400
Other taxes and licenses 12,391 13,811 38,092 87,452
Depreciation and amortization 37,992 44,410 116,417 120,979
Income from investment in
unconsolidated affiliate (100,143) (162,703) (187,663) (76,828)
------------- ------------- ------------- -------------
TOTAL EXPENSES 1,533,302 1,846,503 4,543,161 5,588,774
------------- ------------- ------------- -------------
Net loss $ (393,981)$ (128,987)$ (1,982,756) $ (330,855)
============= ============= ============= =============
Net loss per share of common stock $ (0.12)$ (0.04)$ (0.62) $ (0.10)
============= ============= ============= =============
Weighted average number of shares 3,187,333 3,187,333 3,187,333 3,187,333
============= ============= ============= =============
The accompanying notes to consolidated financial statements are an integral part of these statements.
5
Nine Months Ended
September 30,
----------------------------------------
2003 2002
------------------ ------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,982,756)$ (330,855)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization expense 116,417 120,979
(Income) loss from investment in unconsolidated affiliate (187,663) (76,828)
Changes in assets and liabilities:
Membership initiation fees and other accounts receivable 314,574 108,839
Notes receivable 211,762 195,390
Inventory (104,915) 8,405,867
Accounts payable and accrued expenses (7,224) (95,989)
Lot deposits 121,000 (7,851)
Deferred revenues (73,400) 52,922
Other assets (74,674) (30,405)
------------------ ------------------
Net cash (used in) provided by operating activities (1,666,879) 8,342,069
------------------ ------------------
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of property and equipment (317,770) (281,901)
Capital contribution to unconsolidated affiliate -- (43,500)
------------------ ------------------
Net cash used in investing activities (317,770) (325,401)
------------------ ------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Advances to/from affiliates (12,100) 11,605
Accounts payable and accrued expenses - affiliates 1,226,138 1,815,247
Proceeds from mortgage and notes payable 10,269,316 7,108,332
Proceeds from notes payable - affiliated -- 18,971
Payments on mortgages and notes payable (9,148,970) (16,258,951)
Payments on notes payable - affiliated -- (231,857)
Other assets (20,000) (18,657)
------------------ ------------------
Net cash provided by (used in) financing activities 2,314,384 (7,555,310)
------------------ ------------------
Net increase in cash and equivalents 329,735 461,358
------------------ ------------------
CASH AND EQUIVALENTS, beginning of period 813,009 566,146
------------------ ------------------
CASH AND EQUIVALENTS, end of period $ 1,142,744 $ 1,027,504
================== ==================
Cash paid for interest, net of amounts capitalized $ 24,598 $ 32,582
================== ==================
The accompanying notes to consolidated financial statements are an integral part of these statements.
6
The unaudited consolidated financial statements included herein should be read in conjunction with NTS Mortgage Income Fund’s 2002 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission on March 31, 2003. In the opinion of our management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation have been made to the accompanying consolidated financial statements for the three and nine months ended September 30, 2003 and 2002. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period. As used in this Quarterly Report on Form 10-Q the terms “we,” “us” or “our,” as the context requires, may refer to NTS Mortgage Income Fund or its interests in its properties and joint venture.
We were formed as a Delaware corporation, on September 26, 1988. We operated as a real estate investment trust (REIT) under the Internal Revenue Code of 1986 (the “Code”), as amended, from our inception through December 31, 1996. We began operating as a “C” corporation under the Code for tax purposes effective January 1, 1997. NTS Corporation is our sponsor (the “Sponsor”), NTS Advisory Corporation is our advisor (the “Advisor”), and NTS Residential Management Company is our manager (“NTS Management”). The Advisor and NTS Management are affiliates of and are under common control with the Sponsor.
Our wholly-owned subsidiaries are NTS/Lake Forest II Residential Corporation (“NTS/LFII”) and NTS/Virginia Development Company (“NTS/VA”).
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 ours. NTS Residential Realty, Inc., a Kentucky corporation and an affiliate of the Sponsor, was formed on April 6, 1999, to act as a broker and agent for NTS/LFII for the sale of lots within the Lake Forest North project, and as a broker and agent for the sale of new homes within the Lake Forest North project.
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. Fawn Lake Realty, Inc., a division of NTS/Residential Properties, Inc.-Virginia, a Virginia corporation and an affiliate of the Sponsor, will continue to act as a broker and agent for NTS/VA for the sale of lots within the Fawn Lake project, and as a broker and agent for approved builders in the Fawn Lake project for the sale of new homes.
7
We own a 50% interest in the Orlando Lake Forest Joint Venture (the “Joint Venture”). See Note 10 for further information pertaining to this investment.
Our records are maintained on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States.
Our consolidated financial statements include the assets, liabilities, revenues and expenses of our wholly-owned subsidiaries (see Note 1). Investments of 50% or less in affiliated companies are accounted for under the equity method. All significant intercompany transactions and balances have been eliminated.
Consolidation of Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities. FIN 46 provides guidance on how to identify a variable interest entity (“VIE”) and determine when the assets, liabilities, noncontrolling interests and results of operations of a VIE are to be included in an entity’s consolidated financial statements. A VIE exists when either the total equity investment at risk is not sufficient to permit the entity to finance its activities by itself, or the equity investors lack one of three characteristics associated with owning a controlling financial interest. Those characteristics include the direct or indirect ability to make decisions about an entity’s activities through voting rights or similar rights, the obligation to absorb the expected losses of an entity if they occur, and the right to receive the expected residual returns of the entity if they occur.
FIN 46 was effective immediately for new entities created or acquired after February 1, 2003, and will become effective for the period ended December 31, 2003 for entities in which we had a variable interest prior to February 1, 2003. We are presently evaluating the effect of this pronouncement.
Reclassifications
Certain reclassifications have been made to the 2002 balance sheet and cash flow statement to conform to the presentation for 2003. These reclassifications had no effect on previously reported operating results.
8
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and equivalents include cash on hand and short-term, highly liquid investments with initial maturities of three months or less.
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 our notes receivable and debt instruments approximated their book value because a substantial portion of the underlying instruments are variable rate notes.
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 including the operating deficits of the Lake Forest Country Club, less amounts charged to cost of sales. Inventory costs are allocated to individual lots sold using their 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 and the use of estimates to determine sales values, development costs and absorption periods, it is reasonably possible that such estimates could change in the near term. Any changes in estimates are accounted for prospectively over the life of the project.
Inventory consisted of approximately the following as of September 30, 2003:
NTS/LFII NTS/VA Consolidated
------------------ ----------------- -----------------
Land held for future development, under
development, and completed lots $ 2,022,000 $ 18,924,000 $ 20,946,000
Country club (net of membership initiation fees) 4,094,000 -- 4,094,000
Amenities 896,000 12,775,000 13,671,000
------------------ ----------------- -----------------
$ 7,012,000 $ 31,699,000 $ 38,711,000
================== ================= =================
9
Inventory consisted of approximately the following as of December 31, 2002:
NTS/LFII NTS/VA Consolidated
------------------ ----------------- -----------------
Land held for future development, under
development, and completed lots $ 1,903,000 $ 17,874,000 $ 19,777,000
Country club (net of membership initiation fees) 4,199,000 -- 4,199,000
Amenities 1,180,000 13,241,000 14,421,000
------------------ ----------------- -----------------
$ 7,282,000 $ 31,115,000 $ 38,397,000
================== ================= =================
We capitalized in inventory approximately $721,000 of interest and real estate taxes for the nine months ended September 30, 2003. Interest and real estate taxes incurred during this period were approximately $793,000.
We capitalized in inventory approximately $972,000 of interest and real estate taxes for the nine months ended September 30, 2002. Interest and real estate taxes incurred during this period were approximately $1,091,000.
Inventory as of September 30, 2003, as reflected above, includes approximately $12,314,000, net of $8,220,000 of country club membership initiation fees, of costs incurred to date for the development of the Lake Forest Country Club.
Inventory as of December 31, 2002, as reflected above, includes approximately $12,474,000, net of $8,275,000 of country club membership initiation fees, of costs incurred to date for the development of 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 $205,000, which is expected to be offset by member initiation fees. During the nine months ended September 30, 2003, approximately $708,000 of the Lake Forest Country Club deficit was capitalized as a cost of inventory. During the nine months ended September 30, 2002, approximately $680,000 of the Lake Forest Country Club deficit was capitalized as a cost of inventory.
During April 2001, the Fawn Lake Country Club was substantially completed. As a result of our intention to sell the Club as a single asset, SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects” requires that the Club be reported separately from inventory on our balance sheet. The asset’s estimated fair market value was determined to be approximately $3,000,000 and was included in property and equipment on the accompanying balance sheets. This asset is being depreciated according to our normal depreciation policy.
10
On April 15, 2002, NTS/Virginia Development Company, a subsidiary of NTS Mortgage Income Fund, sold approximately 456 acres of land to the U.S. Department of the Interior’s National Park Service. This land is located in Spotsylvania County, Virginia, adjacent to the Fredericksburg and Spotsylvania County Battlefields Memorial National Military Park. The sales price of the land was approximately $6,100,000. The price was determined by arms-length negotiation between the buyer and seller, aided by an appraisal commissioned by the National Park Service. Approximately $5,500,000 of the sales proceeds was utilized to reduce outstanding debt. The net proceeds after reducing debt and paying closing costs and fees related to the sale were used as working capital.
The following schedule provides an analysis of our approximate investment in property and equipment as of September 30, 2003 and December 31, 2002:
As of As of
September 30, December 31,
2003 2002
----------------- ------------------
Land and buildings $ 3,445,000 $ 3,429,000
Equipment 2,059,000 1,757,000
----------------- ------------------
5,504,000 5,186,000
Less accumulated depreciation (1,793,000) (1,515,000)
----------------- ------------------
$ 3,711,000 $ 3,671,000
================= ==================
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” specifies circumstances in which certain long-lived assets must be reviewed for impairment. If the carrying amount of an asset exceeds the sum of its expected future cash flows, the asset’s carrying value must be written down to fair value. Application of this standard during the three and nine months ended September 30, 2003 and 2002 did not result in an impairment loss.
Effective August 16, 1997, we became a partner in the Joint Venture. 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 Sponsor. The Joint Venture will continue to operate under its current legal name as the Orlando Lake Forest Joint Venture.
11
The Joint Venture owns the Orlando Lake Forest project, a single-family residential community located in Seminole County, Florida (near Orlando). The Joint Venture will continue to own and develop the Orlando Lake Forest project.
We contributed to the Joint Venture as a capital contribution our 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 September 30, 2003 and December 31, 2002, our percentage interest was 50%, and our investment balance in the Joint Venture was approximately $1,769,000 and $1,581,000, respectively. Our share of the Joint Venture’s net income for the three and nine months ended September 30, 2003, was approximately $100,000 and $188,000, respectively.
Presented below are condensed balance sheets for the Joint Venture as of September 30, 2003 and December 31, 2002, and statements of operations for the three and nine months ended September 30, 2003 and 2002:
September 30, December 31,
2003 2002
----------------- ------------------
Inventory $ 3,994,000 $ 6,557,000
Other, net 1,681,000 209,000
----------------- ------------------
Total assets $ 5,675,000 $ 6,766,000
================= ==================
Mortgages and notes payable 474,000 206,000
Other liabilities 1,663,000 3,398,000
Equity 3,538,000 3,162,000
----------------- ------------------
Total liabilities and equity $ 5,675,000 $ 6,766,000
================= ==================
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------- -------------------------------------
2003 2002 2003 2002
------------------ ----------------- ----------------- ------------------
Lot sales, net of discounts $ 1,656,000 $ 2,233,000 $ 5,287,000 $ 4,439,000
Cost of sales (1,210,000) (1,584,000) (3,873,000) (3,157,000)
Other expenses, net (246,000) (324,000) (1,039,000) (1,128,000)
------------------ ----------------- ----------------- ------------------
Net income $ 200,000 $ 325,000 $ 375,000 $ 154,000
================== ================= ================= ==================
12
Mortgages and notes payable consist of the following:
September 30, December 31,
2003 2002
------------------ -------------------
Mortgage loan payable to a bank in the amount of $18,000,000,
bearing interest at the prime rate + 1.0%, payable monthly, due
December 31, 2007, secured by inventory of NTS/VA and
NTS/LFII, generally principal payments consist of
approximately 91% of the gross receipts from lot sales,
personally guaranteed by Mr. J.D. Nichols, Chairman of the
Board of the Sponsor, for 50% of the outstanding loan balance
and a $2 million letter of credit from a third party lender with
the beneficiary being the bank. $ 8,082,810 $ 4,961,203
Note payable to a bank in the amount of $9,000,000, bearing
interest at 8.25%, payable monthly, due March 31, 2004, secured
by a certificate of deposit owned by NTS Financial Partnership,
an affiliate of NTS Mortgage Income Fund. 6,696,959 6,696,959
Mortgage loan payable to a bank in the amount of $4,000,000,
bearing interest at the prime rate + 0.5%, paid in June 2003,
secured by the Lake Forest Country Club and golf course, and
a $200,000 letter of credit from a third party lender with the
beneficiary being the bank, guaranteed by the Sponsor. -- 1,730,000
Warehouse line of credit agreement with a bank bearing interest
at the prime rate + 0.75%, due September 30, 2003, secured by
notes receivable, principal payments consist of payments
received from notes receivable securing the obligation. 436,968 795,168
Other 290,051 203,112
------------------ -------------------
$ 15,506,788 $ 14,386,442
================== ===================
As of September 30, 2003 we are in negotiations with a bank to refinance the warehouse line of credit agreement.
We anticipate seeking renewals or refinancing of the debts coming due within the next twelve months with existing creditors. However, there can be no assurances that we will be successful in doing so. The prime rate was 4% on September 30, 2003 and 4.25% on December 31, 2002.
On October 31, 2000, NTS/VA and NTS/LFII entered into a loan agreement with a financial institution for a combined principal sum of up to $18,000,000 and used approximately $5,930,000 and $10,494,000 to pay the entire principal balance of the NTS/LFII and NTS/VA loans, respectively. The loan is secured by the NTS/LFII and NTS/VA projects, a $2 million letter of credit issued by a third party lender with the NTS/VA and NTS/LFII lender stated as the
13
beneficiary, a guarantee by us for the full $18,000,000, and a personal guarantee by Mr. J.D. Nichols for 50% of the outstanding loan balance. The lender requires contracts on lots with gross proceeds exceeding 80% of a section’s development costs before advancing funds for a newly developed section at NTS/VA. On May 16, 2003, the loan was amended to remove the requirement that 50% of the Joint Ventures net sales proceeds be applied against the outstanding balance and to include the payment to the lender of 90% of the gross initiation fees from Lake Forest Country Club. The loan is a reducing revolver and the maximum amount outstanding at the end of each year will be as follows:
December 31, 2003 $ 12,000,000
December 31, 2004 $ 9,500,000
December 31, 2005 $ 9,000,000
December 31, 2006 $ 5,500,000
December 31, 2007 $ 1,000,000
We recognize revenue and related costs from lot sales using the accrual method in accordance with accounting principles generally accepted in the United States, which is when payment has been received and title, possession and other attributes of ownership have been transferred to the buyer, and we are not obligated to perform significant activities after the sale. We generally require a minimum down payment of at least 10% of the sales price of the lot. The country clubs recognize operating revenue as services are performed.
As of September 30, 2003, the Sponsor and an affiliate owned approximately 273,000 of our outstanding shares. We have entered into the following agreements with various affiliates of the Sponsor regarding our ongoing operations.
Property Management Agreements
The operation and management of the Lake Forest North and Fawn Lake projects are 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 us, 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 us, 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”). NTS Development is a wholly-owned subsidiary of the 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 NTS/LFII and NTS/VA, will be entitled to an overhead recovery, and will accrue an incentive payment payable, all as provided in the agreements.
14
These expense reimbursements include direct and pro-rated costs incurred by NTS Management in the management and operation of the Properties. 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. NTS Management receives reimbursement for compensation costs associated with individuals who rendered services full time on and off site of the residential projects. For services provided by individuals not on site, or those with multiple residential projects responsibilities, costs are pro-rated by NTS Management and allocated to the appropriate residential project. As permitted by the Management Agreements, we were charged the following approximate amounts for the three and nine months ended September 30, 2003 and 2002. These amounts are reflected in selling, general and administrative — affiliated on the accompanying consolidated statements of operations.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ---------------------------
2003 2002 2003 2002
-------------- ------------- ------------- ------------
Personnel related costs:
Financing and accounting $ 64,000 $ 57,000 $ 206,000 $ 182,000
Data processing 13,000 16,000 41,000 57,000
Human resources 13,000 9,000 38,000 30,000
Executive and administrative services 32,000 33,000 115,000 104,000
Construction management 2,000 35,000 49,000 106,000
Sales and marketing 202,000 356,000 593,000 946,000
Legal 27,000 15,000 75,000 56,000
-------------- ------------- ------------- ------------
Total personnel related costs 353,000 521,000 1,117,000 1,481,000
-------------- ------------- ------------- ------------
Marketing 5,000 39,000 48,000 91,000
Rent 13,000 8,000 42,000 40,000
Other general and administrative 15,000 4,000 39,000 22,000
-------------- ------------- ------------- ------------
Total expense reimbursements $ 386,000 $ 572,000 $ 1,246,000 $ 1,634,000
============== ============= ============= ============
Additionally, NTS Management is to be reimbursed for overhead expenses in an amount equal to 3.75% of the projects’ gross cash receipts, as defined in the Management Agreements. Overhead recovery for the three and nine months ended September 30, 2003, was approximately $151,000 and $307,000, respectively. Overhead recovery for the three and nine months ended September 30, 2002, was approximately $195,000 and $669,000, respectively. These amounts are classified with selling, general and administrative — affiliated in the accompanying consolidated statements of operations.
Expense reimbursements owed to NTS Management or an affiliate of approximately $2,479,000 and $2,434,000 were accrued but not paid for the nine months ended September 30, 2003 and 2002, respectively, for Fawn Lake Country Club and Lake Forest Country Club. These costs
15
include compensation costs of management, golf course maintenance, golf professional, kitchen personnel, and accounting as well as various non-payroll related operating expenses. In addition, there were overhead recovery fees of approximately $137,000 and $135,000 accrued to NTS Management for overhead recovery fees at Fawn Lake Country Club and Lake Forest Country Club for the nine months ended September 30, 2003 and 2002, respectively. The Lake Forest Country Club expense reimbursements and overhead recovery fees were capitalized in inventory for the nine months ended September 30, 2003 and 2002.
Under the Management Agreements, NTS Management may also 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 our share of the cash flow of the Joint Venture is sufficient to enable us to distribute to our shareholders an amount which, after adding thereto all other payments previously distributed to our shareholders, is at least equal to the original capital contributions attributable to our then outstanding shares. As of September 30, 2003, the original capital contributions attributable to our outstanding shares were $63,690,000 and we had paid distributions of approximately $23,141,000, and no incentive payments had been accrued in our consolidated financial statements.
Advances to Affiliates
As of September 30, 2003, we owed approximately $10,102,000 to affiliates for fees and reimbursements, including $9,172,000 owed to NTS Development and NTS Management for salary and overhead reimbursements included in accounts payable and accrued expenses — affiliates.
NTS Development and NTS Management have agreed to defer, until March 31, 2004, amounts owed to them by us as of December 31, 2002 and those amounts accruing from January 1, 2003 through March 31, 2004, other than as permitted by our cash flows. There can be no assurances that NTS Development and NTS Management will continue to defer amounts due them past March 31, 2004. If these amounts are not deferred, such action could have a material adverse effect on our liquidity and financial condition. Payment of such deferred amounts would be dependent upon available operating cash flow or funding from potential third-party resources in the form of loans or advances.
During April 2001, the Fawn Lake Country Club was substantially completed. As a result of our intention to sell the Club as a single asset, SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects” requires that the Club’s operations no longer be capitalized to inventory costs upon substantial completion. Instead, the Club’s results of operations have been included in our statement of operations beginning with April 1, 2001.
16
Presented below are the approximate condensed statements of operations for the Fawn Lake Country Club for the nine months ended September 30, 2003 and 2002:
Nine Months Ended
September 30,
---------------------------------------------------
2003 2002
------------------------ ------------------------
Revenues
Operating revenue $ 1,084,000 $ 1,042,000
Other revenue 1,000
------------------------ ------------------------
Total revenues 1,084,000 1,043,000
Expenses
Cost of goods sold 227,000 187,000
Selling, general and administrative - affiliates 1,036,000 1,012,000
Selling, general and administrative 584,000 511,000
Depreciation 54,000 29,000
------------------------ ------------------------
Total expenses 1,901,000 1,739,000
------------------------ ------------------------
Net loss $ (817,000) $ (696,000)
======================== ========================
We recognize 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 our book and tax bases of assets and liabilities and tax carry forwards using enacted tax rates in effect for the year in which the differences are expected to reverse. The principal tax carry forwards and temporary differences giving rise to our deferred taxes, consist of tax net operating loss carry forwards, valuation allowances and differences in inventory basis for book and tax.
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. We have determined, based on a history of operating losses by our subsidiaries and our expectations for the future, that it is more likely than not that the net deferred tax assets on September 30, 2003 and December 31, 2002, will not be realized. As of December 31, 2002, we had a federal net operating loss carry forward of approximately $17,539,000 expiring during various years beginning in 2012 and ending in 2022.
We, as an owner of real estate, are subject to various environmental laws of federal and local governments. Compliance by us with existing laws has not had a material adverse effect on our financial condition or results of operations. However, we cannot predict the impact of new or changed laws or regulations on our current properties or on properties that we may acquire in the future.
17
We do not believe there is any litigation threatened against us other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by insurance and none of which is expected to have a material adverse effect on our consolidated financial statements.
NTS/LFII and NTS/VA have various letters of credit outstanding to governmental agencies and utility companies totaling approximately $2,000,000 and $2,200,000 as of September 30, 2003 and December 31, 2002, respectively. The primary purpose of these documents is to ensure the work at the developments is completed in accordance with the construction plans as approved by the appropriate governmental agency or utility company.
It is estimated that development of the remaining homeowner’s association amenities at NTS/LFII will be substantially complete by December 2003. Based on engineering studies and projections, NTS/LFII will incur additional costs, excluding interest, of approximately $5,000 to complete the homeowner’s association amenities.
It is estimated that the amenities at NTS/VA will be substantially complete by December 2008. Based on engineering studies and projections, NTS/VA will incur additional costs, excluding interest, of approximately $870,000 to complete the amenities for the project. These costs are estimated to be incurred as follows: $350,000 for 2003, $0 for 2004, $50,000 for 2005, $420,000 for 2006, $0 for 2007, and $50,000 for 2008.
NTS/Lake Forest II Residential Corporation entered into an agreement with Lake Forest Country Club, Inc. in February, 1992 which governed the transfer of control, conveyance of assets and management of the Lake Forest Country Club, Inc. to its members. The transfer was dependent on the occurrence of certain future events and once one of these events occurred, transfer would take place within sixty days. If other events triggering the transfer did not occur by October 29, 2003, then the transfer was to occur within 60 days of this date. It is expected the Club and its operations will transfer to the members no later than December 28, 2003.
NTS Guaranty Corporation (the “Guarantor”), an affiliate of the Sponsor, has guaranteed that, at the time that we are liquidated and dissolved, the total distributions we have made to shareholders from all sources during our existence is at least equal to the original capital contributions attributable to our then outstanding shares. As of September 30, 2003, the original capital contributions attributable to our outstanding shares were $63,690,000, and we had paid distributions of approximately $23,141,000.
The liability of the Guarantor under the guaranty is expressly limited to its assets. The Guarantor’s sole asset presently consists of 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 or that the Guarantor will be able to satisfy its obligation under the guaranty. The Guarantor may in the future guarantee obligations of other third parties including guaranties of obligations owed by our affiliates to other entities.
18
Management’s Discussion and Analysis of Financial condition and Results of Operations (“MD&A”) should be read in conjunction with the Consolidated Financial Statements in Item 1 and the cautionary statements below.
The accompanying consolidated financial statements were prepared in conformity with accounting principles generally accepted in the United States. Application of these accounting principles requires us to make estimates about the future resolution of existing uncertainties; as a result, actual results could differ from these estimates. In preparing these financial statements, we have made our best estimates and judgments of the amounts and disclosures included in the financial statements, giving due regard to materiality.
Revenue Recognition
Revenues are recorded when the sales of lots are completed and ownership has transferred to the customer. We do not engage in arrangements where we have ongoing relationships with our customers that require us to repurchase our lots or provide for a right of return.
Inventory
Our finished inventories are stated at the lower of accumulated cost or net realizable value. Included in inventories are all direct development costs. We also capitalize interest, real estate taxes and the operating deficits of the Lake Forest Country Club into inventories. Inventories under development or held for development are stated at accumulated cost, unless they are determined to be impaired, in which case these inventories are measured at fair value. If actual market conditions are less favorable than those projected by management, additional inventory adjustments may be required.
During April 2001, the Fawn Lake Country Club was substantially completed. As a result of our intention to sell the Club as a single asset, Statement of Financial Accounting Standards (“SFAS”) No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” requires that the Club be reported separately from inventory on our balance sheets as an asset available for sale.
The assets’ estimated fair market value was determined to be approximately $3,000,000 and is included in property and equipment on the September 30, 2003 and December 31, 2002, balance sheet as an asset held for use pursuant to SFAS No. 144 and is being depreciated according to our normal depreciation policy.
19
Cost of Sales
We calculate our costs of sales using a percentage based on estimates of total sales and project costs, principally acquisition and development costs. We estimate cost of sales percentages at the end of each fiscal year, and the resulting cost of sales percentages are applied prospectively. Total estimates are based on an analysis of actual costs incurred to date and the estimated costs of completion. Adjustments to estimated total project sales and development costs for the project affect the cost of goods sold percentage. The difference in the cost of sales percentage of NTS/LFII compared to NTS/VA and the difference in the lot sales mix will create a proportionate change in the combined gross profit margin throughout a given year. Costs of sales for a specific period also include direct selling costs, such as those relating to sales concessions, incurred during the period. These costs are not included in the estimated cost of sales percentage.
Income Tax
No benefit or provision for income taxes was provided during 2003 or 2002, as we have recorded a valuation allowance equal to the amount of the recorded benefit. We have determined that it is more likely than not that the net deferred tax asset will not be realized based upon the guidance in SFAS No. 109. See Note 15 to our Consolidated Financial Statements for further discussion.
The following tables include our selected summarized operating data for the three and nine months ended September 30, 2003 and 2002. This data should be read in conjunction with our financial statements, including the notes thereto, in Part I, Item 1 of this report.
Three Months Ended September 30, 2003
---------------------------------------------------------------------
MIF NTS/LFII NTS/VA Total
---------------------------------------------------------------------
Lot sales, net of discounts $ -- $ 1,216,000 $ 2,670,000 $ 3,886,000
Cost of sales -- (1,038,000) (2,141,000) (3,179,000)
Country Club income -- -- 407,000 407,000
Interest and miscellaneous income -- -- 25,000 25,000
Operating expenses (101,000) (225,000) (544,000) (870,000)
Country Club expenses -- -- (718,000) (718,000)
Interest expense -- -- (7,000) (7,000)
Depreciation and amortization -- (1,000) (37,000) (38,000)
Income from investment in
unconsolidated affiliate 100,000 -- -- 100,000
Net loss (1,000) (48,000) (345,000) (394,000)
20
Three Months Ended September 30, 2002
---------------------------------------------------------------------
MIF NTS/LFII NTS/VA Total
---------------------------------------------------------------------
Lot sales, net of discounts $ -- $ 597,000 $ 4,374,000 $ 4,971,000
Land sales -- -- -- --
Cost of sales -- (470,000) (3,217,000) (3,687,000)
Country Club income -- -- 416,000 416,000
Interest and miscellaneous income -- -- 17,000 17,000
Operating expenses (81,000) (257,000) (938,000) (1,276,000)
Country Club expenses -- -- (659,000) (659,000)
Interest expense -- -- (30,000) (30,000)
Depreciation and amortization -- (3,000) (41,000) (44,000)
Income from investment in
unconsolidated affiliate 163,000 -- -- 163,000
Net income (loss) 82,000 (133,000) (78,000) (129,000)
Nine Months Ended September 30, 2003
---------------------------------------------------------------------
MIF NTS/LFII NTS/VA Total
---------------------------------------------------------------------
Lot sales, net of discounts $ -- $ 2,778,000 $ 4,868,000 $ 7,646,000
Cost of sales -- (2,396,000) (3,874,000) (6,270,000)
Country Club income -- -- 1,084,000 1,084,000
Interest and miscellaneous income -- 9,000 92,000 101,000
Operating expenses (333,000) (779,000) (1,572,000) (2,684,000)
Country Club expenses -- -- (1,901,000) (1,901,000)
Interest expense -- -- (31,000) (31,000)
Depreciation and amortization -- (2,000) (114,000) (116,000)
Income from investment in
unconsolidated affiliate 188,000 -- -- 188,000
Net loss (145,000) (390,000) (1,448,000) (1,983,000)
Nine Months Ended September 30, 2002
---------------------------------------------------------------------
MIF NTS/LFII NTS/VA Total
---------------------------------------------------------------------
Lot sales, net of discounts $ -- $ 3,111,000 $ 7,995,000 $ 11,106,000
Land sales -- -- 6,100,000 6,100,000
Cost of sales -- (2,435,000) (10,611,000) (13,046,000)
Country Club income -- -- 1,043,000 1,043,000
Interest and miscellaneous income 2,000 2,000 51,000 55,000
Operating expenses (357,000) (891,000) (2,482,000) (3,730,000)
Country Club expenses -- -- (1,739,000) (1,739,000)
Interest expense (24,000) -- (52,000) (76,000)
Depreciation and amortization -- (2,000) (119,000) (121,000)
Income from investment in
unconsolidated affiliate 77,000 -- -- 77,000
Net (loss) income (302,000) (215,000) 186,000 (331,000)
21
The following discussion relating to changes in our results of operations includes only those line items within our Statements of Operations for which there was a material change between the three and nine months ending September 30, 2002 and 2003.
Revenues
Revenue from lot sales decreased to $3,866,000 in the three months ended September 30, 2003, from $4,902,000 in the comparable period in 2002. This decrease was the result of our selling 31 lots in the three months ending September 30, 2003, as compared with 44 in the comparable period in 2002, offset by an increase in the average sales price, to $125,000 in the three months ended September 30, 2003 from $112,000 in the comparable period in 2002.
Revenue from lot sales decreased to $7,646,000 in the nine months ended September 30, 2003, from $10,957,000 in the comparable period in 2002. This decrease was the result of our selling 61 lots in the nine months ending September 30, 2003, as compared with the 93 in the comparable period in 2002, offset by an increase in the average sales price, to $125,000 in the nine months ended September 30, 2003 from $118,000 in the comparable period 2002.
The decrease in cost of sales to $3,179,000 in the three months ended September 30, 2003, from $3,687,000 in the comparable period in 2002 was due to the sale of fewer lots in 2003.
The decrease in cost of sales to $6,270,000 in the nine months ended September 30, 2003 from $13,046,000 in the comparable period in 2002 was due, in addition to the sale of fewer lots, to the inclusion of $4,569,000 in cost of sales in the nine months ended September 30, 2002 due to the land sale at NTS/VA.
Presented below are the gross profit margins for the three and nine months ended September 30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2003 2002 2003 2002
------------- ------------- ------------- -------------
NTS/LF II 15% 21% 14% 22%
NTS/VA 20% 27% 20% 25%
Combined gross profit margins 18% 26% 18% 24%
The decline in gross margin percentages for the nine months ended September 30, 2003 as compared with the comparable period in 2002 is due to revised estimates of the ultimate sales values, development costs and absorption periods for both NTS/LFII and NTS/VA. As a result of the inherent economic volatility of residential real estate, we cannot be certain that the current estimated gross profit percentages will not be revised in the future.
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We periodically review the value of land and inventories and determine whether any impairment charges are needed to reflect declines in value. We did not record any impairment charges during the periods ended September 30, 2003 and 2002. The estimated net realizable value of real estate inventories represents our best estimate based on present plans and intentions, selling prices in the ordinary course of business and anticipated economic and market conditions. Accordingly, the realization of the value of our real estate inventories is dependent on future events and conditions that may cause actual results to differ from amounts presently estimated.
Beginning with April 1, 2001, the income and expenses of the Fawn Lake Country Club have been included in our statement of operations. This was the result of the substantial completion of the Club and the intention to sell the Club as a single asset. The net impact on the results of operations was a net operating deficit of approximately $817,000 and $696,000 for the nine months ended September 30, 2003 and 2002, respectively.
Presented below are the approximate condensed statements of operations for the Fawn Lake Country Club for the nine months ended September 30, 2003 and 2002:
2003 2002
---------------- ----------------
Revenues
Operating revenue $ 1,084,000 $ 1,042,000
Other revenue 1,000
---------------- ----------------
Total revenues 1,084,000 1,043,000
Expenses
Cost of goods sold 227,000 187,000
Selling, general and administrative - affiliates 1,036,000 1,012,000
Selling, general and administrative 584,000 511,000
Depreciation 54,000 29,000
---------------- ----------------
Total expenses 1,901,000 1,739,000
---------------- ----------------
Net loss $ (817,000) $ (696,000)
================ ================
Expenses
Reimbursements for expense recovery of approximately $386,000 and $572,000 were accrued to NTS Residential Management Company (“NTS Management”) or an affiliate during the three months September 30, 2003 and 2002, respectively, for actual personnel, marketing and administrative costs as they relate to us, NTS/LFII and NTS/VA. For the nine months ended September 30, 2003 and 2002, the expense recovery accrued to NTS Management or an affiliate was approximately $1,246,000 and $1,634,000.
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Reimbursements for expense recovery decreased approximately $186,000 for the three months ended September 30, 2003, as compared to the same period in 2002. Reimbursements for expense recovery decreased approximately $388,000 for the nine months ended September 30, 2003, as compared to the same period in 2002. The decrease is primarily a result of a decrease in commissions paid to sales agents employed by NTS/LFII and NTS/VA for the three months and nine months ended September 30, 2003, as compared to the same period in 2002.
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 three months ended September 30, 2003 and 2002, overhead recovery incurred was approximately $151,000 and $195,000, respectively. For the nine months ended September 30, 2003 and 2002 overhead recovery incurred was approximately $307,000 and $669,000, respectively. This decrease is a direct result of decreased cash receipts. For the three months ended September 30, 2003, the decrease in cash receipts is a result of the decrease in lot sales, as compared to the same period in 2002. For the nine months ended September 30, 2003, the decrease is primarily due to the one time sale of land in April 2002 to the National Park Service and the decrease in lot sales as compared to the same period in 2002.
Selling, general and administrative expenses include directors’ fees, legal, outside accounting, other investor related cost, repairs and maintenance cost. Selling, general and administrative expenses also include those costs incurred directly by NTS/VA for marketing related activities.
For the three months ended September 30, 2003 and 2002, the amounts incurred for selling, general and administrative expenses were approximately $321,000 and $495,000. For the nine months ended September 30, 2003 and 2002, the amounts incurred for selling, general and administrative expenses were approximately $1,091,000 and $1,340,000. The decrease in the selling, general and administrative expenses is primarily a result of a decrease in advertising, for the three and nine months ended September 30, 2003, compared to the same period in 2002.
Increases and decreases in interest expense generally correspond directly to increases and decreases in the outstanding balances of our borrowings and our subsidiaries borrowings as well as in the capitalization percentage. For the nine months ended September 30, 2003 and 2002, approximately $721,000 and $783,000, respectively, was capitalized in inventory and approximately $31,000 and $75,000, respectively, was expensed. The decrease in total interest is primarily due to the decrease in outstanding balances of loans.
No benefit or provision for income taxes was provided during the nine months ended September 30, 2003 and 2002, as we have recorded a valuation allowance equal to the amount of the recorded benefit. We have determined that it is more likely than not that the net deferred tax asset will not be realized.
24
The primary sources of our liquidity are the ability of us and our subsidiaries, NTS/LFII and NTS/VA, to draw upon our development loan and the net proceeds retained from sales of residential lots and homes owned by our subsidiaries and the Joint Venture. Under the development loan we are required to make principal payments equal to 72% of the gross receipts from lot sales in the Lake Forest development owned by NTS/LFII, and 91% of gross receipts from lot sales in the Fawn Lake development owned by NTS/VA. The development loan also requires that 90% of proceeds from the sale of the country club memberships be applied to the outstanding development loan balance.
Under the terms of our development loan, we may draw up to $12,000,000. As of September 30, 2003, the loan balance was approximately $8,083,000. If the balance on the loan exceeds $12,000,000 as of December 31, 2003, the lender would be entitled, pursuant to provisions of the development loan, to take possession of the unsold lots and all other security pledged for this loan. Failure to generate sufficient proceeds from lot sales or the lack of further availability under the development loan may have a material adverse effect on our liquidity and capital resources.
On April 15, 2002, Fawn Lake sold approximately 456 acres of land to the U.S. Department of the Interior’s National Park Service. This land is located in Spotsylvania County, Virginia, adjacent to the Fredericksburg and Spotsylvania County Battlefields Memorial National Military Park. The sales price of the land was approximately $6,100,000. The price was determined by arms-length negotiation between the buyer and seller, aided by an appraisal commissioned by the National Park Service. Approximately $5,500,000 of the sales proceeds was utilized to reduce outstanding debt. The net proceeds after reducing debt and paying closing costs and fees related to the sale was used as working capital.
The following table summarizes our sources/uses of cash flow for the nine months ended September 30, 2003 and 2002, respectively:
Nine Months Ended
September 30,
---------------------------------------
2003 2002
------------------ ------------------
Operating Activities $ (1,666,879)$ 8,342,069
Investing Activities (317,770) (325,401)
Financing Activities 2,314,384 (7,555,310)
------------------ ------------------
Net increase in cash and equivalents $ 329,735 $ 461,358
================== ==================
Cash used in operating activities was approximately $1,667,000 for the nine months ended September 30, 2003. One of the primary components of the cash used in operating activities was a net loss of approximately $1,983,000 which was due to, among other things, our lower gross
25
margin on lot sales as described under “Results of Operations/Revenues” above. Other significant components of cash used in operating activities were an increase in inventory of $105,000, which were partially offset by decreases in initiation fees receivable of approximately $315,000, and notes receivable of approximately $212,000.
Cash provided by operating activities was approximately $8,342,000 for the nine months ended September 30, 2002. The primary component of the cash provided by operating activities was the decrease in inventory of approximately $8,406,000, which is a direct result of a land sale by one of our subsidiaries to the National Park Service in April 2002.
Cash used for investing activities was approximately $318,000 for the nine months ended September 30, 2003, consisting primarily of capital expenditures associated with golf operations conducted by our subsidiaries.
Cash used for investing activities was approximately $325,000 for the nine months ended September 30, 2002. The components of the cash used for investing activities were additional capital contributions to an unconsolidated affiliate of approximately $44,000 and capital additions, primarily at the NTS/LFII and NTS/VA golf operations, of approximately $282,000.
Cash provided by financing activities was approximately $2,314,000 for the nine months ended September 30, 2003, consisting primarily of amounts deferred by NTS Development and NTS Management and other affiliates of approximately $1,214,000 plus net proceeds from notes payable relating to the development loans for NTS/LFII and NTS/VA projects of approximately $1,120,000.
Cash used in financing activities was approximately $7,555,000 for the nine months ended September 30, 2002. This is primarily the result of loan payments made using the proceeds of the land sale at NTS/VA. The components of the cash used in financing activities included the continued deferral of accounts payable to affiliates of approximately $1,815,000 which is owed to NTS Development Company and NTS Residential Management Company for salary and overhead reimbursements.
NTS/Lake Forest II Residential Corporation entered into an agreement with Lake Forest Country Club, Inc. in February, 1992 which governed the transfer of control, conveyance of assets and management of the Lake Forest Country Club, Inc. to its members. The transfer was dependent on the occurrence of certain future events, and once one of these events occurred transfer would take place within sixty days. If other events triggering the transfer did not occur by October 29, 2003, then the transfer was to occur within 60 days of this date. It is expected the Club and its operations will transfer to the members no later than December 28, 2003. Historically, the Club has experienced operating deficits which have been capitalized into inventory. Subsequent to the turnover of the Club, its operations will be the responsibility of its members.
26
We intend to satisfy our future liquidity needs through cash provided by operations, cash reserves, additional borrowings secured by our properties and deferrals of amounts owed to NTS Development and NTS Management. There can be no assurance that funds from operations, reserves or borrowings will be available, or that NTS Development and NTS Management will continue to defer amounts due them past March 31, 2004. If these sources of liquidity are not available our Advisor will manage the demand on liquidity according to our best interest.
As noted above, NTS Management is entitled to be reimbursed for direct and pro-rated costs incurred in operating and managing NTS/LFII and NTS/VA and to an overhead recovery in an amount equal to 3.75% of the project’s gross cash receipts, under the management agreements with NTS/LFII and NTS/VA. In addition to the amounts payable to NTS Management under the Management Agreements, NTS Development is entitled to be reimbursed for overhead expenses incurred in connection with performing administrative services, such as accounting, on our behalf.
As of September 30, 2003, we owed approximately $10,102,000 to affiliates for reimbursements and fees, including $9,172,000 owed to NTS Development and NTS Management for salary and overhead reimbursements.
We will repay amounts owed to NTS Development and NTS Management as a result of deferred expenses or advances made to NTS LF/II or NTS/VA to the extent permitted by our cash flow. NTS Development and NTS Management have agreed to defer, through March 31, 2004, amounts owed to them by us as of December 31, 2002, and any further amounts accruing from January 1, 2003 through March 31, 2004. There can be no assurance that NTS Development and NTS Management will continue to defer amounts due them past March 31, 2004. If these amounts are not deferred, such action could have a material adverse effect on our liquidity and financial condition. Payment of such deferred amounts would be dependent upon available operating cash flow or funding from potential third-party resources in the form of loans or advances.
NTS Guaranty Corporation (the “Guarantor”), an affiliate of the Sponsor, has guaranteed that, at the time that we are liquidated and dissolved, the total distributions we have made to shareholders from all sources during our existence is at least equal to the original capital contributions attributable to our then outstanding shares. As of September 30, 2003, the original capital contributions attributable to our outstanding shares were $63,690,000, and we had paid distributions of approximately $23,141,000.
27
The liability of the Guarantor under the guaranty is expressly limited to its assets. The Guarantor’s sole asset presently consists of 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 or that the Guarantor will be able to satisfy its obligation under the guaranty. The Guarantor may in the future guarantee obligations of other third parties including guaranties of obligations owed by our affiliates to other entities.
Our website address is www.ntsdevelopment.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act are available and may be accessed free of charge through the “About NTS” section of our website as soon as reasonably practicable after we electronically file this material with, or furnish it to, the SEC. Our website and the information contained therein or connected thereto are not incorporated into this Quarterly Report on Form 10-Q.
Our primary market risk exposure with regard to financial instruments stems from changes in interest rates. Our debt instruments bear interest at both variable and fixed rates as discussed in Note 11 of our financial statements. For the nine months ended September 30, 2003, a hypothetical 100 basis point increase in interest rates would result in an approximate $110,000 increase in interest expense and an approximate $64,000 decrease in the fair value of debt for the nine months then ended. During the nine months ended September 30, 2003, the majority of interest expense incurred was capitalized in inventory.
The President and Director of NTS Mortgage Income Fund and the Chief Financial Officer of NTS Development, the equivalent of the Chief Financial Officer of the Company, have concluded, based on their evaluation as of September 30, 2003, that our disclosure controls and procedures are effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934. There have been no significant changes in our internal controls over financial reporting or in other factors that could significantly affect these controls subsequent to the date of the above evaluation.
28
Items 1 through 5 are omitted because these items are inapplicable or the answers to the items are negative.
Item 6 — Exhibits and Reports on Form 8-K
| (a) | Exhibits | |
| (3 (a)(2)) | Restated Certificate of Incorporation * | |
| (3 (b)) | By-Laws * | |
| (10.1) | Form of Advisory Agreement * | |
| (10.2) | Form of Guaranty Agreement * | |
| (10.3) | Agreements governing acquisition of the issued and outstanding common capital stock of NTS/LFII and NTS/VA. ** | |
| (10.4) | Property Management Agreements between the Fund and NTS Management. ** | |
| (10.5) | Second Amended and Restated Revolving Promissory Note Construction Mortgage Loan. *** | |
| (10.6) | Mortgage Loan Modification Agreement. *** | |
| (31.1) | Certification of Chief Executive Officer Pursuant to SEC Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. **** | |
| (31.2) | Certification of Chief Financial Officer Pursuant to SEC Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. **** | |
| (32.1) | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **** | |
| (32.2) | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **** | |
| (b) | Reports on Form 8-K | |
| None. |
| * | Incorporated by reference from our Registration Statement on Form S-11, referencing the exhibit number used in such Registration Statement. |
| ** | Incorporated by reference from our Form 8-K dated January 14, 1998. |
| *** | Incorporated by reference from our Quarterly Report on Form 10-Q filed on August 14, 2003. |
| **** | Included with this original Quarterly Report on Form 10-Q. |
29
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NTS Mortgage Income Fund | |||
| /s/ Brian F. Lavin |
| Brian F. Lavin |
| President and Director of the |
| NTS Mortgage Income Fund |
Date: November 14, 2003
30
| Exhibit Number | Description of Document | |
| 3a2 | Restated Certificate of Incorporation * | |
| 3b | By-Laws * | |
| 10.1 | Form of Advisory Agreement * | |
| 10.2 | Form of Guaranty Agreement * | |
| 10.3 | Agreements governing acquisition of the issued and outstanding common capital stock of NTS/LFII and NTS/VA. ** | |
| 10.4 | Property Management Agreements between the Fund and NTS Management. ** | |
| 10.5 | Second Amended and Restated Revolving Promissory Note Construction Mortgage Loan. *** | |
| 10.6 | Mortgage Loan Modification Agreement. *** | |
| 31.1 | Certification of Chief Executive Officer Pursuant to SEC Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. **** | |
| 31.2 | Certification of Chief Financial Officer Pursuant to SEC Rules 13a-15(e) and 15d-15(e), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. **** | |
| 32.1 | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **** | |
| 32.2 | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. **** |
| * | Incorporated by reference from our Registration Statement on Form S-11, referencing the exhibit number used in such Registration Statement. |
| ** | Incorporated by reference from our Form 8-K dated January 14, 1998. |
| *** | Incorporated by reference from our Quarterly Report on Form 10-Q filed on August 14, 2003. |
| **** | Included with this Quarterly Form 10-Q Report. |
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