For the quarterly period ended March 31, 2005
OR
Commission File Number 0-18550
NTS MORTGAGE INCOME FUND
(Exact name of registrant as specified in its charter)
| Delaware | 61-1146077 |
| (State or other jurisdiction of | (I.R.S. 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)
N/A
(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 Exchange Act). Yes [ ] No [X]
As of March 31, 2005, the registrant had approximately 3,187,000 shares of common stock outstanding.
| Pages |
| Item 1. | Consolidated Financial Statements | |||
| Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004 | 4 | |||
| Consolidated Statements of Operations for the Three Moonths Ended March 31, 2005 and 2004 | 5 | |||
| Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004 | 6 | |||
| Notes to Consolidated Financial Statements | 7-16 | |||
| Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations | 17-24 | ||
| Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 24 | ||
| Item 4. | Controls and Procedures | 24 | ||
| Items 1 - 6 | 25 | |||
| Signatures | 26 |
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, or may not, 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. Any forward-looking information provided by us pursuant to the safe harbor established by the Private Securities Litigation Reform Act of 1995 should be evaluated in the context of these factors.
3
(UNAUDITED)
--------------------- --------------------
As of As of
March 31, 2005 December 31, 2004
--------------------- --------------------
ASSETS
Cash and equivalents $ 1,400,830 $ 1,309,537
Membership initiation fees and other accounts receivable, net
of allowance of approximately $109,000 and $134,000, respectively 489,367 519,016
Notes receivable 518,651 545,055
Inventory 26,717,672 26,637,219
Property and equipment, net of accumulated depreciation of
approximately $1,424,000 and $1,371,000, respectively 3,155,017 3,187,785
Investment in unconsolidated affiliate 2,599,346 2,265,179
Other assets 281,826 236,569
--------------------- --------------------
TOTAL ASSETS $ 35,162,709 $ 34,700,360
===================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 2,208,340 $ 1,801,897
Accounts payable and accrued expenses - affiliates 12,304,695 13,087,453
Mortgages and notes payable 2,759,741 1,831,975
Other liabilities 485,570 341,080
--------------------- --------------------
TOTAL LIABILITIES 17,758,346 17,062,405
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 (36,762,221) (36,528,629)
--------------------- --------------------
TOTAL STOCKHOLDERS' EQUITY 17,404,363 17,637,955
--------------------- --------------------
TOTAL LIABILITES AND STOCKHOLDERS' EQUITY $ 35,162,709 $ 34,700,360
===================== ====================
The accompanying notes to consolidated financial statements are an integral part of these statements.
4
Three Months Ended
March 31,
---------------------------------------------
2005 2004
--------------------- --------------------
REVENUES
Lot sales, net of discounts $ 1,807,193 $ 3,035,955
Cost of sales (1,216,646) (2,498,122)
--------------------- --------------------
Gross profit 590,547 537,833
Country Club revenue 341,759 309,276
Interest income on cash equivalents and miscellaneous income 13,547 39,431
--------------------- --------------------
945,853 886,540
--------------------- --------------------
EXPENSES
Selling, general and administrative - affiliates 369,105 478,038
Selling, general and administrative 494,382 415,060
Interest expense - 168
Other taxes and licenses 23,452 4,701
Depreciation and amortization expense 24,750 30,749
Country Club operations 601,923 484,125
--------------------- --------------------
TOTAL OPERATING EXPENSES 1,513,612 1,412,841
--------------------- --------------------
Loss before other income and income taxes (567,759) (526,301)
Income from investment in unconsolidated affiliate 334,167 80,009
--------------------- --------------------
Loss before income taxes (233,592) (446,292)
Income taxes - -
--------------------- --------------------
Net loss $ (233,592) $ (446,292)
===================== ====================
Net loss per share of common stock $ (0.07) $ (0.14)
===================== ====================
Weighted average number of shares 3,187,333 3,187,333
===================== ====================
The accompanying notes to consolidated financial statements are an integral part of these statements.
5
Three Months Ended
March 31,
---------------------------------------------
2005 2004
--------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (233,592) $ (446,292)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization expense 24,750 30,749
Income from investment in unconsolidated affiliate (334,167) (80,009)
Changes in assets and liabilities:
Membership initiation fees and other accounts receivable 29,649 134,800
Notes receivable 26,404 44,475
Inventory (41,081) 832,308
Accounts payable and accrued expenses 406,443 324,652
Other liabilities 144,490 64,183
Other assets (57,147) (119,168)
--------------------- --------------------
Net cash (used in) provided by operating activities (34,251) 785,698
--------------------- --------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment (19,464) (18,145)
--------------------- --------------------
Net cash used in investing activities (19,464) (18,145)
--------------------- --------------------
CASH FLOWS FROM FINANCING ACTIVITES
Accounts payable - affiliates (782,758) 99,397
Proceeds from mortgages and notes payable 3,130,047 1,805,989
Payments on mortgages and notes payable (2,202,281) (2,903,500)
--------------------- --------------------
Net cash provided by (used in) financing activities 145,008 (998,114)
--------------------- --------------------
Net increase (decrease) in cash and equivalents 91,293 (230,561)
CASH AND EQUIVALENTS, beginning of period 1,309,537 889,675
--------------------- --------------------
CASH AND EQUIVALENTS, end of period $ 1,400,830 $ 659,114
===================== ====================
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 2004 annual report on Form 10-K as filed with the Securities and Exchange Commission on March 30, 2005. In the opinion of the Fund’s 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 months ended March 31, 2005 and 2004. 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 the Fund or its interests in its properties and joint venture.
NTS Mortgage Income Fund (the “Fund”), a Delaware corporation, was formed on September 26, 1988. The Fund operated as a real estate investment trust 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.
Our wholly-owned subsidiaries include NTS/Lake Forest II Residential Corporation (“NTS/LFII”) and NTS/Virginia Development Company (“NTS/VA”).
We are a finite life entity. Our organizational documents require us to commence an orderly liquidation by December 31, 2008. Delaware law, our state of incorporation, provides us with a three-year period after the initiation of our liquidation to wind up our affairs and issue final distributions to shareholders.
NTS/LFII is in the process of developing approximately 1,109 residential lots of land located in Louisville, Kentucky into a single-family residential community (Lake Forest). Lake Forest has amenities consisting of a clubhouse, pools, tennis courts, recreation fields and several lakes and a country club with a championship golf course.
NTS/VA is in the process of developing approximately 1,398 residential lots of land located in the Chancellor District of Spotsylvania County, Virginia, approximately 60 miles south of Washington D.C., into a single-family residential community (Fawn Lake) and has completed a country club with a championship golf course for the purpose of selling such residential lots and country club memberships. Fawn Lake has amenities consisting of a 285 acre lake, clubhouse, pool, tennis courts and boat docks.
We also own a 50% interest in the Orlando Lake Forest Joint Venture (the “Joint Venture”). See Note 10 — Investment in Unconsolidated Affiliate for further information pertaining to the investment.
7
Our records are maintained on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles.
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.
The preparation of financial statements in conformity with U.S. 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 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 marketing costs of initial membership sales 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 (net of country club initiation fees) 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.
8
Inventory consists of approximately the following as of March 31, 2005:
(UNAUDITED)
-----------------------------------------------------------------
NTS/LFII NTS/VA Consolidated
--------------------- --------------------- --------------------
Land held for future development,
under development and completed lots $ 674,000 $ 16,601,000 $ 17,275,000
Country club (net of $9,143,000
membership initiation fees) 190,000 - 190,000
Amenities 50,000 9,203,000 9,253,000
--------------------- --------------------- --------------------
$ 914,000 $ 25,804,000 $ 26,718,000
===================== ===================== ====================
Items capitalized to inventory for the
three months ended March 31, 2005
Capitalized interest $ 1,000 $ 26,000 $ 27,000
===================== ===================== ====================
Capitalized property taxes $ 2,000 $ 47,000 $ 49,000
===================== ===================== ====================
Inventory consists of approximately the following as of December 31, 2004:
NTS/LFII NTS/VA Consolidated
--------------------- --------------------- --------------------
Land held for future development,
under development and completed lots $ 283,000 $ 16,678,000 $ 16,961,000
Country club (net of $9,134,000
membership initiation fees) 219,000 - 219,000
Amenities 54,000 9,403,000 9,457,000
--------------------- --------------------- --------------------
$ 556,000 $ 26,081,000 $ 26,637,000
===================== ===================== ====================
Items capitalized to inventory for 2004
Capitalized interest $ 3,000 $ 374,000 $ 377,000
===================== ===================== ====================
Capitalized property taxes $ 10,000 $ 188,000 $ 198,000
===================== ===================== ====================
Pursuant to the Membership Marketing Agreement, dated June 7, 2004, between NTS/LFII and the Lake Forest Country Club, NTS/LFII is to receive 50% of initiation fees from the initial issuance of the remaining initial memberships to the Country Club. As long as the agreement is in effect, we expect that we will not incur any marketing or selling expenses related to issuance of initial memberships. We are not responsible for any refund related to any issued memberships. On December 28, 2003, the Lake Forest Country Club ownership and operations were turned over to its members.
9
The following schedule provides an analysis of our approximate investment in property and equipment:
(UNAUDITED)
------------------------
As of As of
March 31, 2005 December 31, 2004
------------------------ ------------------------
Land and buildings $ 3,313,000 $ 3,313,000
Equipment 1,266,000 1,246,000
------------------------ ------------------------
4,579,000 4,559,000
Less accumulated depreciation 1,424,000 1,371,000
------------------------ ------------------------
$ 3,155,000 $ 3,188,000
======================== ========================
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. There were no impairment losses during any of the periods presented.
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 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.
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 March 31, 2005 and December 31, 2004, our percentage interest was 50%, and our investment balance in the Joint Venture was approximately $2,599,000 and $2,265,000, respectively. Our share of the Joint Venture’s net income for the three months ended March 31, 2005 and 2004 was approximately $334,000 and $80,000, respectively.
10
Presented below are approximate condensed balance sheets for the Joint Venture as of March 31, 2005 and December 31, 2004, and approximate condensed statements of operations for the three months ended March 31, 2005 and 2004:
(UNAUDITED)
------------------------
March 31, 2005 December 31, 2004
------------------------ ------------------------
Condensed Balance Sheets
Inventory $ 2,637,000 $ 3,262,000
Other, net 3,116,000 2,323,000
------------------------ ------------------------
Total assets $ 5,753,000 $ 5,585,000
======================== ========================
Other liabilities 554,000 1,055,000
Equity 5,199,000 4,530,000
------------------------ ------------------------
Total liabilities and equity $ 5,753,000 $ 5,585,000
======================== ========================
(UNAUDITED)
--------------------------------------------------
Three Months Ended
March 31,
--------------------------------------------------
2005 2004
------------------------ ------------------------
Condensed Statements of Operations
Lot sales, net of discounts $ 2,066,000 $ 1,702,000
Cost of sales (1,133,000) (1,182,000)
Other expenses, net (265,000) (360,000)
------------------------ ------------------------
Net income $ 668,000 $ 160,000
======================== ========================
11
Mortgages and notes payable consist of the following:
(UNAUDITED)
----------------------
March 31, 2005 December 31, 2004
---------------------- ----------------------
Mortgage loan payable to a bank in the amount of $5,000,000, bearing
interest at the Prime Rate, with a revolving principal balance and
interest payable monthly, due May 1, 2006, secured by approximately 500
acres of undeveloped land at NTS/VA. $ - $ -
Note payable to a bank in the amount of $9,000,000, bearing interest at
8.25%, payable monthly, due May 1, 2006, secured by a $3,701,155
Certificate of Deposit owned by NTS Financial Partnership, an affiliate of
the Fund. 2,356,503 1,405,810
Warehouse line of credit agreement with a bank, bearing interest at the
Prime Rate + .75% , due June 15, 2005, secured by notes receivable,
principal payments consist of payments received from notes receivable
securing the obligation 283,954 297,979
Other 119,284 128,186
---------------------- ----------------------
$ 2,759,741 $ 1,831,975
====================== ======================
We anticipate seeking renewals or refinancing the debts coming due within the next twelve months with our existing creditors, however, there can be no assurances that we will be successful in doing so. The Prime Rate was 5.75% on March 31, 2005 and 5.25% on December 31, 2004.
We recently amended and restated our mortgage loan. It is secured by approximately 500 acres of undeveloped land at the NTS/VA project. All previous security and collateral pledges were released. Paydowns from lot sales are no longer required. The loan is a revolver, with $300,000 of the credit commitment set aside as an interest reserve. The maximum amount outstanding at any time shall be no greater than $4,700,000.
We recognize revenue and related costs from lot sales using the accrual method in accordance with U.S. 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 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 club recognizes operating revenue as services are performed.
12
During 2004, an affiliate of the Fund, Cedar Creek Virginia LLC, entered into an agreement to purchase 13 lots from the Fund for the purpose of building homes on speculation for sale to individuals. Cedar Creek Virginia LLC is partially owned by J.D. Nichols and Brian F. Lavin, our Chairman and President, respectively. The Fund agreed to defer actual sale of these lots until final closing where each home would be sold to an individual purchaser. The lot price in the agreement was determined by comparing the sales price of competitive lots within the NTS/VA Fawn Lake Development. We have sold 8 lots for $650,000 as of March 31, 2005 under this agreement.
As of March 31, 2005, the Sponsor or an affiliate owned approximately 606,000 shares of the Fund. The Fund has entered into the following agreements with various affiliates of the Sponsor regarding the ongoing operation of the Fund.
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 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”). NTS Development is a wholly-owned subsidiary of the Fund’s Sponsor. The Management Agreements have been renewed through December 31, 2008. 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 as provided therein.
These expense reimbursements include direct and pro-rated costs incurred in the management and operation of NTS/LFII 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 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, we were charged the following amounts for the three months ended March 31, 2005 and 2004. These amounts are reflected in selling, general and administrative — affiliates on the accompanying consolidated statements of operations in accordance with the Management Agreements.
13
(UNAUDITED)
--------------------------------------------------
Three Months Ended
March 31,
--------------------------------------------------
2005 2004
------------------------ ------------------------
Personnel related costs:
Financing and accounting $ 81,000 $ 66,000
Data processing 5,000 7,000
Human resources 17,000 14,000
Executive and administrative services 49,000 31,000
Sales and marketing 112,000 223,000
Legal 28,000 14,000
------------------------ ------------------------
Total personnel related costs 292,000 355,000
------------------------ ------------------------
Rent 6,000 5,000
------------------------ ------------------------
Total expense reimbursements $ 298,000 $ 360,000
======================== ========================
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 three months ended March 31, 2005 and 2004 was approximately $71,000 and $118,000, respectively. These amounts are classified with selling, general and administrative-affiliates in the accompanying consolidated statements of operations.
There were also expense reimbursements of approximately $362,000 and $228,000 accrued to NTS Management or an affiliate during the three months ended March 31, 2005 and 2004, respectively, for Fawn Lake Country Club. Such costs 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 $15,000 and $12,000 accrued to NTS Management for overhead recovery fees at Fawn Lake Country Club for the three months ended March 31, 2005 and 2004.
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 Joint Venture would have been sufficient to enable us 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 March 31, 2005, we had raised approximately $63,690,000 and had paid distributions of approximately $23,141,000. As of March 31, 2005, no amount had been accrued as an incentive payment in our consolidated financial statements.
Accounts Payable and Accrued Expenses — Affiliates
As of March 31, 2005, we owed approximately $12,305,000 to affiliates for fees and reimbursements, including $11,093,000 owed to NTS Development and NTS Management for salary and overhead reimbursements included in accounts payable and accrued expenses — affiliates.
14
NTS Development and NTS Management have agreed to defer, until March 31, 2006, amounts owed to them by us as of December 31, 2004 and those amounts accruing from January 1, 2005 through March 31, 2006, 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, 2006.
Presented below are the approximate condensed statements of operations for the Fawn Lake Country Club for the three months ended March 31, 2005 and 2004:
(UNAUDITED)
--------------------------------------------------
Three Months Ended
March 31,
--------------------------------------------------
2005 2004
------------------------ ------------------------
Condensed Statements of Operations
Revenues
Operating revenue $ 342,000 $ 309,000
------------------------ ------------------------
Total revenues 342,000 309,000
Expenses
Cost of goods sold 48,000 57,000
Selling, general and administrative - affiliates 361,000 240,000
Selling, general and administrative 166,000 162,000
Depreciation 27,000 25,000
------------------------ ------------------------
Total expenses 602,000 484,000
------------------------ ------------------------
Net loss $ (260,000) $ (175,000)
======================== ========================
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 the Fund’s 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. The Fund has determined, based on its history of operating losses and its expectations for the future, that it is more likely than not that the net deferred tax assets on March 31, 2005 and December 31, 2004, will not be realized and have provided a valuation allowance for the net deferred tax assets. We have a federal net operating loss carryforward of approximately $26,128,000 expiring during various years beginning in 2012 and ending in 2024.
15
We, as an owner of real estate, are subject to various environmental laws of federal, state and local governments. Compliance by us with existing laws has not had a material adverse effect on our financial condition and results of operations. However, we cannot predict the impact of new or changed laws or regulations on our current properties or on properties that it may acquire in the future.
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. We believe we have adequate insurance.
NTS/LFII and NTS/VA have various certificates of deposit, bonds and letters of credits outstanding to governmental agencies and utility companies. NTS/VA had outstanding letters of credit totaling approximately $767,000 at March 31, 2005. The primary purpose of these documents is to ensure that 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 the homeowners’ association amenities at the Fawn Lake project will be substantially completed by December 2009. Based on engineering studies and projections, NTS/VA will incur additional costs, excluding interest, of approximately $3,810,000 to complete the homeowners’ association amenities for the project. These costs are estimated to be incurred as follows: $2,101,000 for 2005, $1,346,000 for 2006, $211,000 for 2007, $81,000 for 2008, and $71,000 for 2009.
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 March 31, 2005, the original capital contributions attributable to our outstanding shares were $63,690,000, and we had paid distributions of approximately $23,141,000.
Any liability of the Guarantor under the guaranty is expressly limited to its assets. The Guarantor holds 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.
16
Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 U.S. generally accepted accounting principles. 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
We recognize revenue and related costs from lot sales using the accrual method in accordance with U.S. 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 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 club recognizes operating revenue as services are performed.
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 including marketing costs of initial membership sales 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 (net of country club initiation fees) 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.
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. There were no impairment losses during any of the periods presented.
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 within property and equipment. The assets’ estimated fair market value was determined to be approximately $3,000,000 and is included in property
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and equipment on the March 31, 2005 and December 31, 2004, balance sheets as an asset held for use pursuant to SFAS No. 144 and is being depreciated according to our normal depreciation policy.
Joint Venture Investment
Our consolidated financial statements include the assets, liabilities, revenues and expenses of our wholly-owned subsidiaries. Investments of 50% or less in affiliated companies are accounted for under the equity method. All significant intercompany transactions and balances have been eliminated.
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 for income taxes was provided during 2004 or 2003 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.
The following tables include our selected summarized operating data for the three months ended March 31, 2005 and 2004. This data is presented to provide assistance in identifying trends in our operating results and other factors affecting our business. 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 March 31, 2005
----------------------------------------------------------------------------
MIF NTS/LFII NTS/VA Total
----------------------------------------------------------------------------
Lot sales, net of discounts $ - $ 317,000 $ 1,490,000 $ 1,807,000
Cost of sales - (94,000) (1,123,000) (1,217,000)
Country Club income - - 342,000 342,000
Interest and miscellaneous income 6,000 4,000 4,000 14,000
Operating expenses (132,000) (155,000) (600,000) (887,000)
Country Club expenses - - (602,000) (602,000)
Depreciation and amortization - - (25,000) (25,000)
Income from investment in
unconsolidated affiliate 334,000 - - 334,000
Net (loss) income 208,000 72,000 (514,000) (234,000)
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Three Months Ended March 31, 2004
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MIF NTS/LFII NTS/VA Total
----------------------------------------------------------------------------
Lot sales, net of discounts $ - $ 801,000 $ 2,235,000 $ 3,036,000
Cost of sales - (705,000) (1,793,000) (2,498,000)
Country Club income - - 309,000 309,000
Interest and miscellaneous income - - 39,000 39,000
Operating expenses (87,000) (176,000) (634,000) (897,000)
Country Club expenses - - (484,000) (484,000)
Depreciation and amortization - - (31,000) (31,000)
Income from investment in
unconsolidated affiliate 80,000 - - 80,000
Net loss (7,000) (80,000) (359,000) (446,000)
The following discussion relating to changes in our results of operations includes only material line items within our Statements of Operations and line items for which there was a material change between the three months ending March 31, 2005 and 2004.
Revenues
Revenue from lot sales decreased to $1,807,000 in the three months ended March 31, 2005, from $3,036,000 in the comparable period in 2004. The decrease of $1,229,000, or 40%, was the result of our selling 16 lots in the three months ending March 31, 2005, as compared with 22 lots in the comparable period in 2004.
Additionally, there was a decrease in the average sales price to $113,000 in the three months ended March 31, 2005 from $138,000 due to one lot being sold for approximately $500,000 in the comparable period in 2004.
Cost of Sales
Cost of sales decreased to $1,217,000 in the three months ended March 31, 2005, from $2,498,000 in the comparable period in 2004. The decrease of $1,281,000, or 51%, was due to the sale of fewer lots in 2005.
Presented below are the gross profit margins for the three months ended March 31, 2005 and 2004:
Three Months Ended
March 31,
----------------------------------------------------
2005 2004
------------------------- ------------------------
NTS/LFII 70% 12%
NTS/VA 25% 20%
Combined gross profit margins 33% 18%
The increase in gross margin percentages for the three months ended March 31, 2005 as compared with the comparable period in 2004 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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NTS/LFII’s increased profit margin in 2005 is a result of the near term completion of this development. With fewer than 40 lots remaining to be developed, our expected development costs have become more predictable with fewer anticipated contingencies. We have already recognized the costs of sales associated with the sale of land to Lake Forest Fairways, LLC (“Fairways”). We will only recognize revenue from this transaction once our costs are recovered as Fairways’ remaining 77 home units are sold. One remaining tract of land is expected to be sold as a parcel for a 48 home unit project.
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 March 31, 2005 and 2004. 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.
The income and expenses of the Fawn Lake Country Club have been included in our statements of operations. It is our intention to sell the Club as a single asset.
Presented below are the approximate condensed statements of operations for the Fawn Lake Country Club for the three months ended March 31, 2005 and 2004:
Three Months Ended
March 31,
--------------------------------------------------
2005 2004
------------------------ ------------------------
Condensed Statements of Operations
Revenues
Operating revenue $ 342,000 $ 309,000
------------------------ ------------------------
Total revenues 342,000 309,000
Expenses
Cost of goods sold 48,000 57,000
Selling, general and administrative - affiliates 361,000 240,000
Selling, general and administrative 166,000 162,000
Depreciation 27,000 25,000
------------------------ ------------------------
Total expenses 602,000 484,000
--------------------------------------------------
Net loss $ (260,000) $ (175,000)
======================== ========================
Expenses
Selling, general and administrative – affiliates expenses were approximately $369,000 and $478,000, respectively for the three months ended March 31, 2005 and 2004. The decrease of $109,000, or 23%, was primarily a result of the decrease of approximately $85,000 in salaries commissions due to less lot sales to individuals and a decrease in the overhead recovery fee on cash receipts of approximately $47,000 offset by legal salaries of approximately $25,000. The decrease in the overhead recovery fee is a direct result of the cash receipts from decreased lot sales, as compared to the same period in 2004.
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Selling and administrative expenses – affiliates are for actual personnel, marketing and administrative costs as they relate to us, NTS/LFII and NTS/VA which were accrued to NTS Residential Management Company (“NTS Management”). In addition, NTS Management is entitled to an overhead recovery, which is a reimbursement for overhead expenses attributable to the employees and the efforts of the 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.
Selling, general and administrative expenses were approximately $494,000 and $415,000, respectively for the three months ended March 31, 2005 and 2004. The increase of $79,000, or 19%, was primarily a result of an increase in advertising and marketing of approximately $61,000 and an increase in legal fees of approximately $18,000, for the three months ended March 31, 2005, compared to the same period in 2004.
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 for marketing related activities.
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 three months ended March 31, 2005 and 2004, approximately $27,000 and $133,000, respectively, was capitalized in inventory. 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 three months ended March 31, 2005 and 2004, 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.
The primary sources of our liquidity are the ability of us and our subsidiaries, NTS/LFII and NTS/VA, to continue to defer payment of amounts owed to NTS Development Company and NTS Residential Management Company, to draw upon our mortgage loan and the net proceeds retained from sales of residential lots and homes owned by our subsidiaries and the Joint Venture.
Under the terms of our mortgage loan, we may draw up to $4,700,000 for certain development costs in accordance with the provisions of the loan agreement. The available balance is not immediately drawable except for the items included in the loan agreement. As of March 31, 2005, the loan balance was $0. 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.
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The following table summarizes our sources/uses of cash flow for the three months ended March 31, 2005 and 2004, respectively:
(UNAUDITED)
-------------------------------------------------
Three Months Ended
March 31,
-------------------------------------------------
2005 2004
------------------------ -----------------------
Operating activities $ (34,251) $ 785,698
Investing activities (19,464) (18,145)
Financing activities 145,008 (998,114)
------------------------ -----------------------
Net increase (decrease) in cash and equivalents $ 91,293 $ (230,561)
======================== =======================
Cash used in operating activities was approximately $34,000 for the three months ended March 31, 2005. The primary components of the cash used in operating activities were income on investment in unconsolidated affiliate of approximately $334,000 and an increase in accounts payable of approximately $406,000, which were partially offset by a net loss of approximately $234,000. The increase in accounts payable is due to amounts owed to vendors related to development activities.
Cash provided by operating activities was approximately $786,000 for the three months ended March 31, 2004. The primary components of the cash provided by operating activities were a decrease in inventory of approximately $832,000 and an increase in accounts payable of approximately $325,000, which were partially offset by a net loss of approximately $446,000. The decrease in inventory was due to the liquidation of inventory by lot sales. The increase in accounts payable was due to amounts owed to vendors related to development activities.
Cash used for investing activities was approximately $19,000 for the three months ended March 31, 2005. The components of the use of cash for investing activities were capital additions at the NTS/VA project of approximately $7,000 for computers and approximately $12,000 for golf operations.
Cash used for investing activities was approximately $18,000 for the three months ended March 31, 2004. The component of the use of cash for investing activities was capital additions primarily at NTS/VA golf operations.
Cash provided by financing activities was approximately $145,000 for the three months ended March 31, 2005. The primary component of the cash provided by financing activities was net proceeds related to the notes payable of approximately $928,000 which was partially offset by the continued deferral of accounts payable to affiliates of approximately $783,000 which was owed to NTS Development Company and NTS Residential Management Company for salary and overhead reimbursements.
Cash used for financing activities was approximately $998,000 for the three months ended March 31, 2004. The primary component of the cash used in financing activities was net payments related to the mortgage loan for NTS/LFII and NTS/VA projects of approximately $1,098,000 which was partially offset by the continued deferral of accounts payable to affiliates of approximately $99,000 which was owed to NTS Development Company and NTS Residential Management Company for salary and overhead reimbursements.
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Future Liquidity
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, 2006. If these sources of liquidity are not available our Advisor will manage the demand on liquidity according to our best interest.
In the next twelve months, we expect to use approximately $7,000,000 to $11,000,000 of our cash for development costs. We expect future lot sales and borrowings secured by our properties to be the source of this cash. The projected development costs assume demand for lots to continue at the current rate and that weather patterns are near normal for the following twelve months.
Dissolution and Liquidation
We are a finite life entity. Our organizational documents require us to commence an orderly liquidation by December 31, 2008. Delaware law, our state of incorporation, provides us with a three-year period after the initiation of our liquidation to wind up our affairs and issue final distributions to shareholders. We anticipate initiating our liquidation on or before December 31, 2008.
NTS Guaranty Corporation (the “Guarantor”), an affiliate of the Sponsor, has guaranteed that, at the time that we complete our liquidation and dissolve, the total distributions we have made to shareholders from all sources during our existence will be at least equal to the original capital contributions attributable to our then outstanding shares. As of December 31, 2004, the date of our most recent analysis of the status of our properties, the original capital contributions attributable to our outstanding shares were $63,690,000, and we had paid distributions of approximately $23,141,000.
In connection with our ongoing review of the status of our properties and progress to liquidation, we have completed our most recent analysis as of December 31, 2004 as to the approximate total distributions which we anticipate making to our shareholders through dissolution. As final liquidating distributions are not likely for several years, these estimates may change significantly prior to dissolution.
The final liquidating distributions will be made after payment of all of our debts and obligations, including $12,304,695 currently owed to Affiliates of the Sponsor by us, our portion of the $38,756 (as of March 31, 2005 our portion is approximately $19,378) currently deferred and owed to Affiliates of the Sponsor by the Orlando Lake Forest Joint Venture, and the release of collateral provided by Affiliates of the Sponsor securing our $2,356,503 loan from Provident Bank. Based upon the preliminary analysis referred to above, we currently do not anticipate that the ultimate proceeds from future asset sales and final liquidation will be sufficient to return to shareholders an amount equal to original capital contributions attributable to then outstanding shares. Thus, we anticipate the guaranty to be called upon in order to return original capital contributions attributable to the then outstanding shares.
Any liability of the Guarantor under the guaranty is expressly limited to its assets. The Guarantor holds 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
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guaranty. The Guarantor may in the future guarantee obligations of other third parties, including guaranties of obligations owed by our affiliates to other entities. Based on the preliminary analysis referred to above and the $10,000,000 to be provided for by the Guarantor, the remaining amount projected to be distributed to shareholders appears to be sufficient to meet the return of capital guaranty to shareholders. The amount available for distribution to our shareholders, however, cannot be estimated with any certainty given that final distributions are not likely for several years. This estimate may change significantly prior to dissolution.
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. The Fund’s debt instruments bear interest at both variable and fixed rates as discussed in Note 11 of the Fund’s financial statements. For the three months ended March 31, 2005, a hypothetical 100 basis point increase in interest rates would result in an approximate $5,000 increase in interest expense and an approximate $23,000 decrease in the fair value of debt for the three months then ended. During the three months ended March 31, 2005, the majority of interest expense incurred was capitalized in inventory.
The President of the NTS Mortgage Income Fund and the Chief Financial Officer of NTS Development Company* (the equivalent of the Chief Financial Officer of the Company) have evaluated our disclosure controls and procedures as of March 31, 2005. Based on that evaluation, the President of the NTS Mortgage Income Fund and the Chief Financial Officer of NTS Development Company concluded that our disclosure controls and procedures were effective as of March 31, 2005. There were no material changes in our internal controls over financial reporting during the first quarter of 2005.
* NTS Development Company provides services to the Company under property management agreements as described in Part II, Note 13 – Related Party Transactions.
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Items 1 through 5 are omitted because these items are inapplicable or the answers to the items are negative.
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 No. | 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 No. | 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 exhibits can be found on our website www.ntsdevelopment.com.
| Exhibit No. | Description | |
| 14 | Code of Ethics |
d) The following are additional exhibits filed with this Form 10-Q Report.
| Exhibit No. | Description | |
| 31.1 | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | |
| 31.2 | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | |
| 32.1 | Certification of Chief Executive Officer Pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
| 32.2 | Certification of Chief Financial Officer Pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| /s/ Brian F. Lavin |
| Brian F. Lavin |
| President of NTS Mortgage Income Fund |
| Date: May 13, 2005 |
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