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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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
incorporation or organization) Identification No.)
10172 Linn Station Road,
Louisville, Kentucky 40223
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code: (502) 426-4800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock
(Title of Class)
Indicate by check mark whether the registrant (l) 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of March 1, 1998, there were approximately 3,187,000 shares of common stock
outstanding. The aggregate sales price for shares sold was approximately
$63,690,000. There is no current market for these shares although it is possible
that one will develop.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Prospectus of the registrant dated March 31, 1989, as
supplemented by Supplements No. 1, No. 2, No. 3, No. 4, No. 5 and No. 6 dated
October 16, 1989, March 29, 1990, April 23, 1990, July 25, 1990, September 6,
1990, and August 23, 1991, respectively, (collective with the "Prospectus") and
filed pursuant to Rule 424 under the Securities Act of 1933, are incorporated by
reference into this Annual Report on Form 10-K.
Index to Exhibits is located on page 53.
Total Pages: 54
TABLE OF CONTENTS
Pages
PART I
Items 1 and 2 Business and Properties 3-6
Item 3 Legal Proceedings 6
Item 4 Submission of Matters to a Vote of Security Holders 6
PART II
Item 5 Market for the Registrant's Shares and Related
Stockholder Matters 7-8
Item 6 Selected Financial Data 9
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-20
Item 8 Financial Statements and Supplementary Data 21-45
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 46
PART III
Item 10 Directors and Executive Officers of the Registrant 47-49
Item 11 Executive Compensation 49
Item 12 Security Ownership of Certain Beneficial Owners and
Management 49-50
Item 13 Certain Relationships and Related Transactions 50-52
PART IV
Item 14 Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 53
Signatures 54
2
PART I
Items 1. and 2. Business and Properties
- ---------------------------------------
Some of the statements included in Items 1. and 2., Business and Properties, or
elsewhere in this report, may be considered to be "forward-looking statements"
since such statements relate to matters which have not yet occurred. For
example, phrases such as "the Fund anticipates," "believes" or "expects"
indicate that it is possible that the event anticipated, believed or expected
may not occur. Should such event not occur, then the result which the Fund
expected also may not occur or occur in a different manner, which may be more or
less favorable to the Fund. The Fund does not undertake any obligations to
publicly release the result of any revisions to these forward-looking statements
that may be made to reflect any future events or circumstances.
Capitalized terms shall have the meaning ascribed them in the "Glossary" on
pages 75 to 81 of the Fund's Prospectus, which is filed herewith and
incorporated herein by reference.
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was formed on
September 26, 1988. The Fund operated as a real estate investment trust (REIT)
under the Internal Revenue Code of 1986 (the "Code"), as amended from inception
through December 31, 1996. The acquisition of the capital stock of NTS/Lake
Forest II Residential Corporation and NTS/Virginia Development Company, which is
discussed below, has caused the Fund to change its tax status to a "C"
corporation under the Code as of January 1, 1997. NTS Corporation was the
sponsor of the Fund (the "Sponsor") through September 30, 1997. NTS Advisory
Corporation is the advisor to the Fund (the "Advisor") and NTS Residential
Management Company is the manager of the operations of the Fund's wholly-owned
subsidiaries (NTS Management). NTS Advisory and NTS Management are Affiliates of
and are under common control with NTS Corporation.
The Fund's objectives as originally described in the Prospectus were to (i)
preserve and protect capital; (ii) distribute cash flow on a regular basis as it
was available; and (iii) increase the value of the Fund's Net Assets and the
Shares through receipt of Incentive Interest or Gross Receipts Interest and, to
a lesser extent, through the acquisition, operation and disposition of Real
Estate Investments. Incentive Interest is defined as the Fund's share in the
Increase in Value of a property securing a Mortgage Loan and was to be payable
in connection with Mortgage Loans secured by Real Estate not held for sale in
the ordinary course of business. Gross Receipts Interest is defined as an amount
equal to a specified percentage of the Affiliated Borrower's Gross Receipts from
the sale of the underlying Real Estate received during the term of the Mortgage
Loan and was to be payable in connection with Mortgage Loans secured by Real
Estate held for sale in the ordinary course of business. It was not an objective
of the Fund to provide tax-sheltered income.
As discussed below, effective October 1, 1997, the Fund no longer had
investments in Mortgage Loans. Prior to October 1, 1997, the Fund's primary
investments were Mortgage Loans. The Fund's investments at September 30, 1997
were as follows:
A Mortgage Loan to NTS/Lake Forest II Residential Corporation, an Affiliated
Borrower, to fund the development of Lake Forest North, a specified investment.
Interest accrued at an annualized rate equal to the greater of 17% of Gross
Receipts from the sale of residential lots or 5.76% of the average outstanding
loan balance. The Fund's loan balance was $23,483,811 and interest due the Fund
was $199,474 as of September 30, 1997.
A Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower, to
fund the development of Fawn Lake, a specified investment. Interest accrued at
an annualized rate equal to the greater of 17% of Gross Receipts from the sale
of residential lots or 5.76% of the average outstanding loan balance. The Fund's
loan balance was $30,175,175 and interest due the Fund was $909,246 as of
September 30, 1997.
A Temporary Mortgage Loan to NTS/Virginia Development Company, an Affiliated
Borrower, to fund the construction of the Fawn Lake Golf Course. Interest
accrued at the Prime Rate plus 3/4%, payable monthly. The Fund's loan balance
was $2,499,532 as of September 30, 1997. The loan was paid in full on December
30, 1997, with proceeds obtained from a third party lender.
3
Items 1. and 2. Business and Properties - Continued
- ---------------------------------------------------
As previously reported, on February 12, 1997, the Fund entered into a letter of
intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund,
NTS/Lake Forest II Residential Corporation, a Kentucky corporation which then
was an Affiliate of and under common control with NTS Corporation (NTS/LFII),
NTS/Virginia Development Company, a Virginia corporation which then was an
Affiliate of and under control with NTS Corporation (NTS/VA) and NTS Development
Company, a Kentucky corporation and a wholly-owned subsidiary of NTS
Corporation. The Letter of Intent contemplated the restructuring of the Fund's
loans to NTS/LFII and NTS/VA, and the acquisition of control by the Fund of the
Lake Forest North project in Louisville, Kentucky, and the Fawn Lake project
near Fredericksburg, Virginia.
The Fund consummated the restructuring contemplated by the Letter of Intent by
acquiring all of the issued and outstanding common capital stock of NTS/LFII and
NTS/VA effective as of October 1, 1997, for a nominal purchase price. The
acquisition was closed pursuant to (i) an Agreement executed on December 30,
1997, and dated as of October 1, 1997, by and among the Fund, NTS/LFII and its
shareholders, NTS/VA and certain of its shareholders, NTS Corporation, the
Advisor, and NTS Management, and (ii) an Agreement executed on December 30,
1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and certain
shareholders of NTS/VA and NTS Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family
residential community located in Louisville, Kentucky, and will continue to own
and develop the Lake Forest North project to completion and orderly sale as a
wholly-owned subsidiary of the Fund. As of December 31, 1998, approximately 530
of 726 total acres have been developed and approximately 52% of the total
projected lots to be developed have been sold.
NTS/VA is the owner and developer of the Fawn Lake single-family residential
community located near Fredericksburg, Virginia, and will continue to own and
develop the Fawn Lake project to completion and orderly sale as a wholly-owned
subsidiary of the Fund. NTS/Residential Properties, Inc. - Virginia, a Virginia
corporation and an Affiliate of the Sponsor of the Fund, will continue to act as
a broker and agent for NTS/VA for the sale of lots within the Fawn Lake project,
and as broker and agent for approved builders in the Fawn Lake project for the
sale of new homes. As of December 31, 1998, approximately 1,200 of 2,825 total
acres have been developed and approximately 26% of the total projected lots to
be developed have been sold.
The Fund purchased all of the issued and outstanding common capital stock of
NTS/LFII and NTS/ VA for a nominal purchase price. Concurrent with this
transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the
Fund has been converted to equity as of October 1, 1997, and the Fund has
released the first mortgages in favor of the Fund on the Lake Forest North and
Fawn Lake projects.
The Fund, as the sole shareholder of NTS/LFII and NTS/VA, controls the ongoing
operations of the Lake Forest North and Fawn Lake projects. The ongoing
operation and management of the Lake Forest North and Fawn Lake projects is now
conducted by NTS Management under the terms of (i) a Property Management
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and NTS Management for the Lake Forest North project,
and (ii) a Property Management Agreement executed on December 30, 1997, and
dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management
for the Fawn Lake project (collectively, the Management Agreements). The
Management Agreements have an initial term through December 31, 2003, subject to
extension under certain conditions, and are renewable for successive six (6)
year terms thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake Forest
North and Fawn Lake projects, and will accrue an incentive payment payable as
provided therein.
The terms of the restructuring and of the Management Agreements were negotiated
on behalf of the Fund by a committee of the Fund's Board of Directors (the
Special Committee) consisting only of the Independent Directors. The Special
Committee believes that the terms of the restructuring and of the Management
Agreements are as favorable to the Fund as could have been obtained from
unrelated third parties under the circumstances.
4
Items 1. and 2. Business and Properties - Continued
- ---------------------------------------------------
In August 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in the Orlando Lake
Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The
other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando
Capital Corporation and OLF II Corporation, all of whom are Affiliates of and
are under common control with NTS Corporation, the Fund's Sponsor. The Joint
Venture will continue to operate under its current legal name as the Orlando
Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and improvements and
approximately 20 acres of commercial land. The Joint Venture will continue to
own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest
in the principal and interest of the first mortgage loan on the Orlando Lake
Forest project, and obtained a 50% interest in the Joint Venture. The NTS
entities named above hold cumulatively the remaining 50% interest in the Joint
Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was
50% and the Fund's share of the Joint Venture's net income (loss) for year ended
December 31, 1998 and from August 16, 1997 (when the Fund was admitted as a
partner) through December 31, 1997 was ($247,879) and $106,667 respectively.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the
Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid
in full.
The Fund elected and was qualified to be treated as a real estate investment
trust under the Internal Revenue Code Sections 856-860 for the years ended
December 31, 1996 and 1995. The Fund operated as a "C" corporation under the
Code during the year ended December 31, 1997. Currently, the Fund is required to
terminate and liquidate its assets by December 31, 2008.
There are currently five directors of the Fund, two of whom are affiliated with
the Advisor and three of whom are Independent Directors. The Directors are
responsible for the management and control of the affairs of the Fund.
However, in accordance with the Fund's Certificate of Incorporation and By-Laws,
the Directors have, in the Advisory Agreement and in certain management
agreements with NTS Management, delegated broad powers to the Advisor and NTS
Management to administer the day-to-day operations of the Fund and its
subsidiaries. The Advisor has delegated substantially all its duties to the
Sponsor. All personnel rendering services to the Fund are employees of companies
affiliated with the Sponsor. The Fund does not directly employ any persons other
than the Independent Directors, the Advisor and NTS Management.
The business of the Fund is not seasonal.
The Fund initially used the proceeds of the offering primarily to make
Residential Land Development Loans to Affiliated Borrowers. Mortgage Loans were
secured by a lien on the Borrower's real estate or by other REIT qualifying
security approved by the Board of Directors, including, without limitation, by
an interest in the Borrower or by a similar security interest.
Transactions entered into between the Fund, the Advisor and its Affiliates, and
NTS Management and its Affiliates are subject to an inherent conflict of
interest. The Affiliated Directors of the Fund and the Advisor may have faced
certain conflicts of interest in enforcing the rights of the Fund against any
Affiliated Borrower; however, the Board of Directors feels that it has fulfilled
all of its duties in enforcing the fund's rights.
5
Items 1. and 2. Business and Properties - Continued
- ---------------------------------------------------
The Directors would have considered the following factors in resolving certain
inherent conflicts of interest:
(1) When considering an advance of additional funds to an Affiliated
Borrower, factors such as projections for the development and operation of the
property, market value and market conditions generally and for the type of
property anticipated to be developed by the Affiliated Borrower, the credit
worthiness and equity interest of the Affiliated Borrower, the current value of
the property, the security and the availability of additional collateral.
(2) In deciding whether to waive a default by an Affiliated Borrower,
foreclose on a Mortgage Loan or remedy a default on senior indebtedness, the
Directors considered the nature of the default, its materiality, the anticipated
time and expense of pursuing the foreclosure as well as the cost of waiving the
default, the anticipated viability of the Affiliated Borrower and the likelihood
of the Affiliated Borrower remedying the default within a reasonable time. When
considering enforcing a due-on-sale clause, the Directors reviewed the Fund's
anticipated investments and the need for additional funds, as well as market
conditions, focusing on the specific intended use of the property and the credit
worthiness of the purchaser.
(3) In establishing the amount of the Interest Reserve to be funded, the
Directors reviewed the expected return on the reserve, the variability of the
interest rate on the Mortgage Loan, the outstanding indebtedness, the Affiliated
Borrower's anticipated cash flow, the operating history and the appraised value
and potential appreciation of the property.
(4) In determining whether to vary the terms of Mortgage Loans from the
anticipated terms specified in the Prospectus, the Directors reviewed economic
and market conditions and focused upon the locale of the property, the
availability of additional security to collateralize the loan and the equity
that the Affiliated Borrower had invested in the property.
(5) In considering whether to refinance a property, factors relating to the
value of the property compared to the Affiliated Borrower's total debt, the
terms of the proposed financing and the Affiliated Borrower's ability to service
the total debt, the Fund's participation in the potential appreciation of the
property, as well as other investment opportunities available to the Fund were
considered. If the Affiliated Borrower sought to refinance to prevent a default
and subsequent foreclosure, the Directors considered the factors set forth in
(2) above.
Item 3. Legal Proceedings
- -------------------------
In July 1994, the Fund was named as a defendant in a complaint originally filed
by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation
(the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The lawsuit
was settled during the first quarter of 1997. The terms of the settlement
agreement are confidential; however, the settlement did not have a material
impact on the Fund's financial position or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
The Fund did not submit any matters to a vote of its security holders during the
quarter ended December 31, 1998.
6
PART II
Item 5. Market for the Registrant's Shares and Related Stockholder Matters
- --------------------------------------------------------------------------
The selling price of the Shares was $20 per Share. The Fund's Shares are freely
transferable but are not listed or included for quotation on a national
securities exchange. As of March 1, 1999, there were 3,678 record holders of the
Fund's Shares. Cash dividends declared varied based upon the date of Stockholder
admittance. Dividends in 1996 represent a return on invested capital of 0.95%.
The amount of dividends declared was based on net taxable income earned per
year. No dividends were declared during 1998 and 1997.
Dividends per share for the year ended December 31, 1996 were declared as
follows:
First Quarter $ .045
Second Quarter .045
Third Quarter .045
Fourth Quarter .055
------
$ .190
======
The Fund operated as a real estate investment trust during 1996. The Fund was a
"C" corporation effective January 1, 1997.
The following table presents that portion of the Fund's dividends that represent
a return of capital under Generally Accepted Accounting Principals (GAAP) for
the year ended December 31, 1996.
1996
----
Net Income (Loss) $850,309
Dividends Declared $605,601
Return of Capital (GAAP Basis) $ --
========
The Fund used tax-reporting accounting in applying the REIT-qualifying test that
requires 95% of taxable income to be paid out in dividends for the year ended
December 31, 1996.
The following table presents that portion of the Fund's dividends that represent
a return of capital under tax-reporting accounting.
1996
----
Net Taxable Income $631,114
Dividends Declared $605,601
Return of Capital (Tax Basis) $ --
========
7
Item 5. Market for the Registrant's Shares and Related Stockholder Matters -
- ----------------------------------------------------------------------------
Continued
---------
See Note 11 of the Notes to Consolidated Financial Statements and the Results of
Operations under Management's Discussion for a detailed discussion of the
differences between GAAP net income and net taxable income.
The continued needs of the Fund and its subsidiaries (to which the Fund formerly
had outstanding Mortgage Loans) may significantly reduce the Fund's cash flows.
Therefore, the Fund's Board of Directors has determined to terminate the Fund's
quarterly distribution for the foreseeable future effective as of the first
quarter of 1997.
8
Item 6. Selected Financial Data
- -------------------------------
Years ended December 31, 1998, 1997, 1996, 1995 and 1994. (1)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Inventory $ 53,264,438 $ 51,917,990 $ -- $ -- $ --
============ ============ =========== =========== ===========
Affiliated Mortgage Loans Receivable,
Net (3) $ -- $ -- $66,287,764 $63,655,706 $50,583,397
============ ============ =========== =========== ===========
Total Assets $ 65,552,757 $ 64,184,368 $68,745,709 $65,511,633 $51,264,380
============ ============ =========== =========== ===========
Total Notes Payable (6) $ 28,850,539 $ 24,505,233 $18,801,517 $16,034,873 $ 1,936,528
============ ============ =========== =========== ===========
Total Revenues and Other (4) $ 2,628,950 $ 4,678,937 $ 3,304,995 $ 2,884,652 $ 2,985,004
Total Expenses (2) 4,098,561 18,385,887 2,454,686 2,026,318 1,202,833
--------- ---------- --------- --------- ---------
Net Income (Loss) $ (1,469,611) $(13,706,950)$ 850,309 $ 858,334 $ 1,782,171
============ ============ =========== =========== ===========
Weighted Average Number
of Shares 3,187,333 3,187,333 3,187,333 3,187,333 3,187,333
========= ========= ========= ========= =========
Net Income per Share of
Common Stock $ (.46) $ (4.30)$ .27 $ .27 $ .56
============ ============ =========== =========== ===========
Taxable Income (Loss)
(prior to dividend paid
deduction) (5) $ -- $ (387,081)$ 631,114 $ 672,098 $ 1,540,323
============ ============ =========== =========== ===========
Taxable Income (Loss)
(prior to dividend paid
deduction)per Share of $ -- $ (.12)$ .20 $ .21 $ .48
Common Stock ============ ============ =========== =========== ===========
Cash Dividends Declared
$ -- $ -- $ 605,601 $ 643,841 $ 1,466,166
============ ============ =========== =========== ===========
Cash Dividends Declared
per Share of Common
Stock $ -- $ -- $ .19 $ .20 $ .46
============ ============ =========== =========== ===========
(1) The above selected financial data should be read in conjunction with the
consolidated financial statements and related notes appearing elsewhere
in this Form 10-K report.
(2) Expenses for 1997 include a non-cash charge in the amount of $11,600,000.
This related to the Fund's acquisition of the stock of NTS/Lake Forest II
Residential Corporation (NTS/LFII) and NTS/Virginia Development Company
(NTS/VA). Also included in expenses is a non-cash charge of approximately
$3.7 million related to the Fund's investment in an unconsolidated
affiliate. (See Notes 3 and 4 to Consolidated Financial Statements).
(3) Represents the carrying amount of the mortgage loans, which is equal to
their face amount less unamortized commitment fees and unaccreted
discounts. The 1996, 1995 and 1994 balances are net of an allowance for
loan losses of $1,500,000, $1,553,397 and $1,638,855, respectively.
(4) Revenues for 1997 include approximately $370,000 of gross profit from lot
sales generated by NTS/LFII and NTS/VA from October 1, 1997 (the date of
acquisition) through December 31, 1997. Prior to October 1, 1997, the
Fund's primary source of revenues was interest income earned on
affiliated mortgage loans.
(5) See Note 11 of the Notes to Consolidated Financial Statements for an
explanation of differences between net income and taxable income.
(6) The balances presented as notes payable include notes payable to third
parties and notes payable to affiliates.
9
Item 7. Management's Discussion and Analysis of Financial Condition and
- -----------------------------------------------------------------------
Results of Operations
---------------------
The Fund commenced an offering to the public on March 31, 1989 and was
authorized to sell up to 2,500,000 shares of common stock at $20.00 per share
(subject to an increase to 5,000,000 shares at the option of the Fund).
Approximately 3,187,000 shares were sold representing approximately $64 million
in sales and approximately $9.5 million in selling expenses and other offering
costs. The net offering proceeds remaining, after payment of brokerage
commissions, organizational expenses and other costs, were used to make Mortgage
Loans and Temporary Investments and such other investments as permitted by the
Fund's Prospectus.
Throughout 1997, the Fund's Board of Directors and NTS Corporation, the Fund's
Sponsor, were involved in a restructuring of the Fund's Mortgage Loan portfolio.
The Fund's Affiliated Borrowers had included NTS/Lake Forest II Residential
Corporation (NTS/LFII), NTS/Virginia Development Company (NTS/VA), and the
Orlando Lake Forest Joint Venture (OLFJV).
In August 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in OLFJV. The Fund
contributed its interest in the principal of the first mortgage loan on the
Orlando Lake Forest project and obtained a 50% interest in OLFJV.
In December 1997, the Fund acquired all the issued and outstanding common
capital stock of NTS/LFII and NTS/VA, effective October 1, 1997, for a nominal
purchase price. Concurrent with this transaction, the existing indebtedness of
NTS/LFII and NTS/VA to the Fund was converted to equity as of October 1, 1997.
This marked the beginning of the Fund's operations focusing solely on the
continuing development, operations, marketing and sale of single-family,
residential real estate. As a result, the Fund no longer operates as a Real
Estate Investment Trust.
Reference is made to Notes 3 and 4 of the Notes to Financial Statements for
further information regarding these investments and acquisitions.
Liquidity and Capital Resources
- -------------------------------
Prior to October 1, 1997, the Fund's primary source of liquidity had been from
the interest earned on the Mortgage Loans and on the Temporary Investments. The
Fund's current source of liquidity is primarily the ability of its subsidiaries
(to which the Fund formerly had outstanding Mortgage Loans) to draw upon their
respective development loans. Additional liquidity is provided by net proceeds
retained from residential lot closings by the properties owned by the Fund's
subsidiaries and OLFJV in which the Fund has a 50% interest. The various
development loans call for principal payments ranging from 67% to 91% of Gross
Receipts from lot sales.
The continued cash needs of the Fund and its subsidiaries have significantly
reduced the Fund's cash flows. Therefore, the Fund's Board of Directors has
determined to terminate the Fund's quarterly distribution for the foreseeable
future effective as of the first quarter of 1997.
As previously reported, on February 12, 1997, the Fund entered into a letter of
intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund,
NTS/LFII, NTS/VA and NTS Development Company, a Kentucky corporation and a
wholly-owned subsidiary of NTS Corporation. The Letter of Intent contemplated
the restructuring of the Fund's loans to NTS/LFII and NTS/VA, and the
acquisition of control by the Fund of the Lake Forest North project in
Louisville, Kentucky, and the Fawn Lake project near Fredericksburg, Virginia.
10
Liquidity and Capital Resources - Continued
- -------------------------------------------
The Fund consummated the restructuring as described in the Letter of Intent by
acquiring all of the issued and outstanding common capital stock of NTS/LFII and
NTS/VA effective as of October 1, 1997, for a nominal purchase price. Concurrent
with this transaction, the existing indebtedness of NTS/LFII and NTS/VA to the
Fund was converted to equity. The acquisition was closed pursuant to (i) an
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and its shareholders, NTS/VA and certain of its
shareholders, NTS Corporation, NTS Advisory Corporation, a Kentucky corporation
and Advisor to the Fund (the Advisor) and NTS Residential Management Company, a
Kentucky corporation (NTS Management), and (ii) an Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/VA and certain shareholders of NTS/VA and NTS Corporation. The Advisor and
NTS Management are Affiliates of and are under common control with NTS
Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family
residential community located in Louisville, Kentucky, and will continue to own
and develop the Lake Forest North project to completion and orderly sale as a
wholly-owned subsidiary of the Fund.
NTS/VA is the owner and developer of the Fawn Lake single-family residential
community located near Fredericksburg, Virginia, and will continue to own and
develop the Fawn Lake project to completion and orderly sale as a wholly-owned
subsidiary of the Fund. Fawn Lake Realty, Inc. a division of NTS/Residential
Properties, Inc.- Virginia, a Virginia corporation and an Affiliate of NTS
Corporation, the Sponsor of the Fund, will continue to act as a broker and agent
for NTS/VA for the sale of lots within the Fawn Lake project, and as broker and
agent for approved builders in the Fawn Lake project for the sale of new homes.
The Fund, as the sole shareholder of NTS/LFII and NTS/VA controls the ongoing
operations of the Lake Forest North and Fawn Lake projects. The ongoing
operation and management of the Lake Forest North and Fawn Lake projects is
conducted by NTS Management under the terms of (i) a Property Management
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and NTS Management for the Lake Forest North project,
and (ii) a Property Management Agreement executed on December 30, 1997, and
dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management
for the Fawn Lake project (collectively, the Management Agreements). The
Management Agreements have an initial term through December 31, 2003, subject to
extension under certain conditions, and are renewable for successive six (6)
year terms thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake Forest
North and Fawn Lake projects, will be entitled to an Overhead Recovery, and will
accrue an incentive payment payable all as provided therein.
Reimbursements of approximately $1,439,000 and $527,000 were made to NTS
Management or an Affiliate during the year ended December 31, 1998 and the
period from October 1, 1997 through December 31, 1997, respectively. These
expense reimbursements include direct and pro-rated costs incurred in the
management and operation of NTS/LF II and NTS/VA. Such costs include
compensation costs of management, accounting, professional, engineering and
development, marketing and office personnel employed by NTS Management and/or
certain affiliates as well as various non-payroll related operating expenses.
Compensation costs are for those individuals rendering services full time and on
site at the residential projects, with respect to the residential projects but
who are not on site and with respect to the residential projects but who have
multiple residential project responsibilities some of which may be affiliated
entities of NTS Management. For services provided by individuals not on site or
those with multiple residential project responsibilities, costs are pro-rated by
NTS Management and allocated to the appropriate residential project. These
reimbursements are included within Selling, General and Administrative -
Affiliated in the accompanying Statements of Operations.
11
Liquidity and Capital Resources - Continued
- -------------------------------------------
In addition to the expense reimbursement noted above, NTS Management is also
entitled to an Overhead Recovery, which is a reimbursement for overhead expenses
attributable to the employees and the efforts of NTS Management under the
Management Agreements, in an amount equal to 3.75% of the projects' gross cash
receipts, as defined in the Management Agreements. Overhead recovery for the
year ended December 31, 1998 was $496,174 and $106,473 for the period October 1,
1997 through December 31, 1997. These amounts are classified as Selling, General
and Administrative - Affiliated in the accompanying Statements of Operations.
Reference is made to Note 9 of the Notes to Financial Statements for a breakdown
of these related party charges.
The Management Agreements also call for NTS Management to potentially receive an
Incentive Payment, as defined in the Management Agreements, equal to 10% of the
Net Cash Flows of the projects. The Incentive Payment will not begin accruing
until after the cumulative cash flows of NTS/LFII, NTS VA and the Fund's share
of the cash flow of the Orlando Lake Forest Joint Venture would have been
sufficient to enable the Fund to have returned to the then existing shareholders
of the Fund an amount which, after adding thereto all other payments actually
remitted or distributed to such shareholders of the Fund, is at least equal to
the shareholders' Original Capital Contribution. As of December 31, 1998, the
Fund had raised approximately $63,690,000 and had paid distributions of
approximately $23,141,000. As of December 31 ,1998, no amount had been accrued
as an Incentive Payment in the Fund's consolidated financial statements.
The terms of the restructuring and of the Management Agreements were negotiated
on behalf of the Fund by a committee of the Fund's Board of Directors (the
Special Committee) consisting only of the Independent Directors. The Special
Committee believes that the terms of the restructuring and of the Management
Agreements are at least as favorable to the Fund as could have been obtained
from unrelated third parties under the circumstances.
On December 30, 1997, NTS/VA closed on development financing for the Fawn Lake
project committed by an unaffiliated bank. The $10,700,000 revolving credit
facility is currently anticipated to provide funds for the continued development
and operations of the Fawn Lake project through December 1, 2002, the maturity
of the credit facility. Mr. J. D. Nichols, Chairman of the Board of the Fund's
Sponsor and of the Fund, has individually guaranteed the repayment of up to
$3,000,000 of the credit facility (See Financing Activity).
The credit facility bears interest at the Prime Rate + 1 1/2%, payable monthly,
and principal payments generally equal 91% of the Gross Receipts from the sale
of lots at the Fawn Lake project. In addition, the total outstanding principal
amount must be brought to within the following levels by the applicable date:
December 31, 1999 $9,300,000
December 31, 2000 $7,800,000
December 31, 2001 $5,900,000
December 1, 2002 $4,500,000
The loan balance was $9,581,963 as of December 31, 1998.
On January 6, 1998, NTS/LFII closed on development financing for the Lake Forest
North project committed by an unaffiliated bank. The $8,000,000 revolving credit
facility is currently anticipated to provide funds for the continued development
and operations of the Lake Forest North project through October 31, 2003, the
maturity of the credit facility, and the repayment thereof has been guaranteed
by the Fund. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and
of the Fund, has individually guaranteed the repayment of fifty percent (50%) of
the credit facility.
12
Liquidity and Capital Resources - Continued
- -------------------------------------------
The credit facility bears interest at the Prime Rate + 1%, payable monthly, and
principal payments generally equal 90% of the Gross Receipts from the sale of
lots at the Lake Forest North project. In addition, the principal amount
outstanding on the credit facility must be brought to within the following
levels by the applicable date:
January 1, 1999 $7,800,000
January 1, 2000 $7,200,000
January 1, 2001 $7,000,000
July 1, 2001 $6,100,000
January 1, 2002 $5,500,000
July 1, 2002 $4,900,000
January 1, 2003 $4,000,000
July 1, 2003 $2,400,000
The net worth of NTS/LFII cannot be allowed to decrease by 20% or more
throughout the term of the agreement. The loan balance was $6,113,434 as of
December 31, 1998.
NTS/LFII is also encumbered by a mortgage loan in the amount of $4,000,000 (with
an outstanding balance of $3,250,000 as of December 31, 1998) from an
unaffiliated lender which is secured by a first mortgage on the Lake Forest
Country Club and golf course (approximately 176 acres of residential land and
improvements thereon). The note bears interest at the Prime Rate + 1/2%, payable
monthly. Principal payments totaling $300,000 are due twice a year, February
through July and August through January. The primary source of principal
payments will be initiation fees received. The loan is guaranteed by the Fund's
Sponsor.
In August 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in the Orlando Lake
Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The
other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando
Capital Corporation and OLF II Corporation, all of whom are Affiliates of and
are under common control with the Fund's Sponsor. The Joint Venture will
continue to operate under its current legal name as the Orlando Lake Forest
Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and improvements and
approximately 20 acres of commercial land. The Joint Venture will continue to
own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest
in the principal and interest of the first mortgage loan on the Orlando Lake
Forest project, and obtained a 50% interest in the Joint Venture. The NTS
entities named above hold cumulatively the remaining 50% interest in the Joint
Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1998 and 1997, the Fund's percentage interest was
50% and the Fund's investment balance in the Joint Venture was $4,462,990 and
$4,525,369 as of December 31, 1998 and 1997 respectively. The Fund's share of
the Joint Venture's net income (loss) from the year ended December 31, 1998 from
August 16, 1997 (when the Fund was admitted as a partner) through December 31,
1997 was ($247,879) and $106,667, respectively.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the
Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid
in full.
In July 1994, the Fund was named as a defendant in a complaint originally filed
by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation
(the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The lawsuit
was settled in the first quarter of 1997. The terms of the settlement agreement
are confidential; however, the settlement did not have a material impact on the
Fund's financial position or results of operations.
13
Liquidity and Capital Resources - Continued
- -------------------------------------------
Key elements of the Consolidated Statements of Cash Flows:
1998 1997 1996
---- ---- ----
Net cash provided by (used for)
operating activities $(3,152,180) $ 459,795 $ 392,077
Net cash provided by (used for)
investing activities (446,334) 3,626,775 (2,463,586)
----------- ----------- ----------
Net cash flows from operating and
investing activities (3,598,514) 4,086,570 (2,071,509)
Net cash provided by (used for)
financing activities 3,246,678 (3,389,918) 2,252,615
----------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents $ (351,836) $ 696,652 $ 181,106
=========== =========== ==========
Operating Activity
- ------------------
Cash used for operating activities was approximately $3,152,000 for the year
ended December 31, 1998. The primary components of the use of cash for operating
activities were a net loss of approximately $1,470,000, a decrease in accounts
payable of approximately $949,000 and net additions to inventory of
approximately $1,346,000.
Cash provided by operations was approximately $460,000 for the year ended
December 31, 1997. The Fund received approximately $71,000 from cash revenues in
excess of cash expenses. The Fund received approximately $481,000 in interest
receivable payments from affiliates. NTS/LFII and NTS/VA used approximately
$790,000 of cash to increase inventory. NTS/LFII and NTS/VA provided
approximately $540,000 of cash from collection of initiation fees and other
receivables and notes receivable during the period October 1, 1997 through
December 31, 1997. In addition, payables increased approximately $159,000.
Cash provided by operations was approximately $392,000 during the year ended
December 31, 1996. This amount was driven by net income as reported offset by
increases in interest receivable from affiliates.
Investing Activity
- ------------------
Cash used for investing activities was approximately $446,000 for the year ended
December 31, 1998. The primary components of the use of cash for investing
activities were an additional capital contribution to an unconsolidated
affiliate of $186,000 and capital additions, primarily at the Lake Forest North
and Fawn Lake golf operations of approximately $261,000.
During the year ended December 31, 1997, the Fund received repayment on three
mortgage loans and two temporary investments in the aggregate principal amount
of approximately $9,299,000. Repayments on mortgage loans were generally equal
to approximately 83% of the Gross Receipts received on lot sales less closing
costs. The Fund made investments in three mortgage loans and one temporary
investment in the aggregate principal amount of approximately $5,700,000.
During the year ended December 31, 1996, the Fund received repayment on four
mortgage loans and two temporary investments in the aggregate principal amount
of approximately $8,099,000. The repayments on mortgage loans were generally
equal to approximately 83% of the Gross Receipts received on lot sales less
closing costs. The Fund made investments in three mortgage loans and one
temporary investment in the aggregate principal amount of approximately
$10,563,000.
14
Financing Activity
- ------------------
Cash provided by financing activities was approximately $3,247,000 for the year
ended December 31, 1998. The primary components of the cash provided by
financing activities were net borrowings on notes payable relating to the
development loans for Lake Forest North and Fawn Lake projects of approximately
$3,565,000, net borrowings on notes payable to affiliates of approximately
$781,000 which were used primarily to fund activities of the Fawn Lake project
and repayment of advances to affiliates of approximately $601,000 which were
initially used to fund development costs at the Fawn Lake project.
Cash used for financing activities was approximately $3,390,000 for the year
ended December 31, 1997. During the year ended December 31, 1997, the Fund and
its subsidiaries borrowed approximately $8,516,000 from their various lenders.
The Fund and its subsidiaries repaid approximately $2,380,000 of their
borrowings from lot proceeds generated by NTS/LFII, NTS/VA and OLFJV. In
addition, approximately $9,425,000 of borrowings were repaid using proceeds from
the NTS/VA and OLFJV development loans. The Fund and its subsidiaries also
borrowed approximately $2,436,000 from Affiliates of the Fund's Sponsor. They
repaid approximately $1,651,000 of these borrowings primarily from loan
repayments made by OLFJV during the period from January 1, 1997 though August
15, 1997.
Cash provided by financing activities was approximately $2,253,000 for the year
ended December 31, 1996. During the year ended December 31, 1996, the Fund
borrowed approximately $1,202,000 from its various lenders. The Fund repaid
approximately $1,075,000 of its borrowings primarily from loan repayments made
by NTS/LFII. In addition, the Fund borrowed approximately $4,077,000 from an
Affiliate of the Fund's Sponsor. The Fund repaid approximately $1,438,000 of
these affiliated borrowings primarily from loan repayments made by OLFJV.
The Fund declared dividends of approximately $606,000 for the year ended
December 31, 1996. Total dividends declared provided Stockholders with an
annualized return of 0.95%. No dividends were declared in 1998 or 1997. The Fund
paid dividends of approximately $0, $175,000 and $469,000 during the years ended
December 31, 1998, 1997 and 1996, respectively.
Management's projection for Fawn Lake indicates the development will reach the
maximum funding level allowed by the current development loan of $10.7 million
during 1999 and in fact require additional funding to achieve its development
plan which includes projected 1999 sales of $6.5 million. The current
development loan is secured by the inventory of the Fawn Lake Project, an
approximately $2 million letter of credit issued by a third party lender with
the Fawn Lake lender stated as the beneficiary, and a $3 million guarantee by
Mr. J.D. Nichols. Management's projections indicate the outstanding debt balance
as of December 31, 1999 will be approximately $12.1 million. Management's
present plans and actions include (1) approaching the Fawn Lake lender and
requesting that the loan agreement be modified to allow the outstanding balance
to remain at the loan maximum of $10.7 Million as opposed to the contractually
required maximum of $9.3 million as of December 31, 1999, (2) obtaining approval
and additional funding from the Lake Forest North lender thereby allowing Fawn
Lake to utilize such funds for development purposes and (3) borrowing additional
funds from an affiliate via the loan agreement between the affiliate and the
Mortgage Income Fund. Although management believes that it will be successful in
such negotiations, there can be no assurances that these third party lenders
will approve of management's plans and intentions for the Fawn Lake Project.
However, if management is unsuccessful in that effort, consideration will be
given to implementing an alternative development plan.
15
Results of Operations
- ---------------------
Comparability
- -------------
On an overall basis, the Fund experienced net income/(loss) of approximately
$(1.5) million, $(13.7) million, $850,000 or $(.46), $(4.30) and $.27 per share
of common stock for the years ended December 31, 1998, 1997 and 1996,
respectively. In the context of the restructuring and acquisitions which
occurred during the fourth quarter of 1997, comparisons of results of operations
are complex. The fourth quarter 1997 charge relating to the acquisition of
NTS/LFII and NTS/VA and the adjustment of the carrying value of the Fund's
investment in OLFJV also represent significant items which complicated
year-to-year comparisons.
The historical financial statements are also impacted by the Fund's lack of
history as a real estate development company, therefore, management believes
that certain areas of the Fund's results of operations for 1998 and the fourth
quarter of 1997 are not comparable with prior years and a discussion comparing
these periods is not included.
Revenues
- --------
Revenue for the year ended December 31, 1998 includes $8.1 million in lot sales
consisting of approximately $5.9 million and $2.2 million from the Lake Forest
North and Fawn Lake projects, respectively. Cost of sales of approximately $6.2
million resulted in a gross profit margin of approximately 23%. During this
period 136 lots were sold for an average selling price of $59,272. The decrease
in the average sales price compared to the period October 1, 1997 through
December 31, 1997 is primarily attributable to the sale of an entire lot section
to a single home builder in the Fawn Lake project during 1998.
Revenue for the year ended December 31, 1997 includes $1.6 million of lot sales
consisting of approximately $1.4 million and $200,000 from the Lake Forest North
and Fawn Lake projects, respectively, for the period from October 1, 1997 (when
the Fund acquired the stock of these entities) to December 31, 1997. Cost of
sales was $1.2 million resulting in a gross profit of approximately 23%. During
this period 21 lots
were sold for an average selling price of $76,202.
During 1996 and for the nine months ended September 30, 1997, the Fund's primary
revenue source was interest income earned on affiliated mortgage loans. The
average outstanding balances of the earning loans increased from $62,878,000
(1996) to $63,600,000 (1997). The average interest rate earned by the Fund for
the years ended December 31, 1997 and 1996 was approximately 5.5% and 5.1%,
respectively, of the average outstanding loan balances.
Commitment fees paid at loan closings were amortized over the life of the loan
using the interest method. Letter of credit fees were amortized over the term of
the letter of credit. Fee income on mortgage loans and financial services is the
amount of commitment fees and letter of credit fees being amortized for the
period. Commitment fee income was recognized in 1996 only.
During the year ended December 31, 1998, the Fund realized approximately
$382,000 of proceeds from a loan previously made to the Orlando Lake Forest
project during the time the Fund operated as a REIT. This loan was written off
by the Fund prior to its investment in the Orlando Lake Forest Joint Venture.
The Fund had previously established a $1,500,000 loan loss reserve regarding a
Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture. During the
third quarter 1997, the Fund received 100% of the amount due on this loan and
determined the loan loss reserve was no longer needed.
Interest income on cash equivalents and miscellaneous income includes interest
income earned from short-term investments made by the Fund with cash reserves
for each of the three years in the period ended December 31, 1998, as well as
interest earnings on notes receivable for the fiscal year ended December 31,
1998 and for the period from October 1, 1997 through December 31, 1997.
16
Results of Operations - Continued
- ---------------------------------
Revenues - Continued
- --------------------
Net income using generally accepted accounting principles (GAAP) was $850,309
and using tax-reporting accounting (TRA) was $631,114 for the year ended
December 31, 1996. The difference between GAAP income and TRA income was due
primarily to the treatment of loan discount accretion, loan commitment fee
income, letters of credit income, Supplemental Interest income and provision for
loan losses. GAAP requires that discounts on mortgage loan receivables be
recognized as an adjustment to yield over the estimated life of the loan; for
tax purposes the discount is recognized as income when the proceeds are
received. GAAP requires that loan commitment fee income be recognized as income
over the term of the related loans; for tax purposes the fees are recognized as
income when received. GAAP requires that income received from letters of credit
be recognized on a straight-line basis over the term of the letter of credit
(typically one year); for tax purposes, this income is recognized as income when
received. For GAAP purposes, Gross Receipts Interest was reported as earned on
the accrual basis of accounting; for tax purposes 50% of the amount of Gross
Receipts Interest earned was credited against Supplemental Interest Income paid
in prior years. For GAAP purposes, a provision for loan losses is recognized
when the fair value of the asset is less than the carrying value of the asset;
for tax purposes, a provision for loan losses is allowed when the debt becomes
worthless within the taxable year. TRA income was used in applying the
REIT-qualifying test that requires 95% of taxable income to be paid out in
dividends. (See Note 11 of the Notes to Consolidated Financial Statements).
Expenses
- --------
For years prior to 1998, operating expenses of the Fund include a Management
Expense Allowance (Advisory Fee) of 1% of the Fund's Net Assets, per annum,
which could be increased annually by an amount corresponding to the percentage
increase in the Consumer Price Index. Pursuant to the Advisory Agreement, the
Advisory Fee was paid to the Advisor (NTS Advisory Corporation) or its
affiliate. Effective July 1, 1994, the Fund's Mortgage Loans to NTS/VA and
NTS/LFII were converted to cash flow mortgage loans. As part of the
consideration for this restructuring, the Fund's Board of Directors required,
among other things, that beginning in 1995, NTS Advisory Corporation pay
$100,000 annually towards the expenses of the Fund until the maturity of the
Mortgage Loans. As such, the Advisory Fee was reduced $100,000 for the year 1996
and $75,000 for the year ended December 31, 1997.
The Advisory Fee for the years ended December 31, 1997 and 1996 was $418,950 and
$544,776, respectively. Increases and decreases in the Advisory Fee generally
correspond directly to increases and decreases in the Fund's Net Assets.
Effective October 1, 1997, the Fund no longer incurs an Advisory Fee but is
responsible for the actual general and administrative costs pursuant to certain
property management agreements discussed below.
The ongoing operation and management of the Lake Forest North and Fawn Lake
projects will be conducted by NTS Residential Management (NTS Management) under
the terms of (i) a Property Management Agreement executed on December 30, 1997,
and dated as of October 1, 1997, by and among the Fund, NTS/LFII and NTS
Management for the Lake Forest North project, and (ii) a Property Management
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/VA and NTS Management for the Fawn Lake project
(collectively, the Management Agreements). NTS Management is a wholly-owned
subsidiary of NTS Development Company. NTS Development Company is a wholly-owned
subsidiary of the Fund's Sponsor. The Management Agreements have an initial term
through December 31, 2003, subject to extension under certain conditions, and
are renewable for successive six (6) year terms thereafter. Under the Management
Agreements, NTS Management will be reimbursed for costs incurred in the
operation and management of the Lake Forest North and Fawn Lake projects, will
be entitled to an Overhead Recovery, and will accrue an incentive payment
payable all as provided therein.
17
Results of Operations - Continued
- ---------------------------------
Expenses - Continued
- --------------------
The expenses related to the Property Management agreement are presented as
selling, general and administrative - Affiliated on the accompanying
consolidated statements of operations. As defined in the Management Agreements,
the expenses are classified in two ways, Expense Recovery and Overhead Recovery.
The expense recovery included direct and pro-rated costs incurred in the
management and operation of NTS/LF II and NTS/VA. Such costs include
compensation costs of management, accounting, professional, engineering and
development, marketing and office personnel employed by NTS management and/or
certain of its affiliates as well as various non payroll related operating
expenses. Compensation costs are for those individuals who rendered services
full time and on site at the residential projects, with respect to the
residential projects but who are not on site and with respect to the residential
projects but who have multiple residential projects responsibilities some of
which may be affiliated entities of NTS Management. For services provided by
individuals not on site or those with multiple residential project
responsibilities, costs are pro-rated by NTS Management and allocated to the
appropriate residential project.
Reimbursements for Expense Recovery of approximately $1,439,000 and $527,000
were made to NTS Management or an Affiliate during the year ended December 31,
1998 and the period from October 1, 1997 through December 31, 1997,
respectively, for actual personnel, marketing and administrative costs as they
relate to NTS/LFII, NTS/VA and the Fund.
During 1998, the Fund elected to forego the Expense Recovery portion of the
Management Agreements relative to NTS/VA. NTS/VA pays expenses directly as
incurred rather than allowing NTS Management to pay expenses initially and then
make reimbursement to NTS Management. Therefore selling, general and
administrative expenses include those costs incurred directly by NTS/VA for
marketing related activities.
Additionally, NTS Management is entitled to an Overhead Recovery, which is a
reimbursement for overhead expenses attributable to the employees and the
efforts of NTS Management under the Management Agreements, in an amount equal to
3.75% of the projects' gross cash receipts, as defined in the Management
Agreements.
For the year ended December 31, 1998 and the period from inception (October 1,
1997) through December 31, 1997, Overhead Recovery incurred was approximately
$496,000 and $106,000, respectively.
Increases and decreases in interest expense generally correspond directly to
increases and decreases in the outstanding balances of the Fund's borrowings and
its subsidiaries borrowings.
Selling, general and administrative expenses also include directors' fees,
legal, outside accounting, other investor related cost.
For years prior to 1998, selling, general and administrative expenses include
primarily directors' fees, legal, outside accounting and investor processing
fees, and printing costs for financial reports.
The increase in expenses for the year ended December 31, 1997, is due primarily
to increased professional fees related to the Fund's acquisitions and loan
restructurings discussed in Part 1, Items 1. and 2. of this Form 10-K.
Depreciation expense relates to equipment used for development activity which is
being depreciated over five to seven years. Amortization expense relates
primarily to loan costs which are being amortized over the life of the related
loan.
No benefit for income taxes was provided during 1998 or 1997 as the Fund has
recorded a valuation allowance equal to the amount of the recorded benefit. The
Fund has determined that it is more likely than not that the net deferred tax
asset will not be realized. See Note 11 to the Fund's Consolidated Financial
Statements for a discussion of the components of the deferred tax asset.
18
Results of Operations - Continued
- ---------------------------------
Expenses - Continued
- --------------------
Income tax expense is the Fund's estimated liability for Federal, state, and
local income taxes due on the amount of earnings which are in excess of
dividends for the period for the year ended December 31, 1996.
The Fund had a net book loss of approximately $13,707,000 for the year ended
December 31, 1997, which includes a non-cash charge of approximately $11,600,000
related to the acquisition of NTS/LFII and NTS/VA and an adjustment to the
carrying value of the Fund's investment in the OLFJV of approximately
$3,707,000.
Generally Accepted Accounting Principles required that the acquisitions of
NTS/LFII and NTS/VA be recorded at fair market value on the day of acquisition.
The application of these principles resulted in a non-cash charge of
approximately $11,600,000 during the fourth quarter of 1997. In addition, the
Fund's investment in an unconsolidated affiliate should be recorded at the lower
of cost or fair market value. A non-cash charge of approximately $3.7 million
was recorded in the third quarter of 1997 related to this investment. All
estimates used in these evaluations represented management's best estimates
based on the facts present at the date of such evaluations.
Year 2000
- ---------
NTS Management and its affiliates are reviewing the effort necessary to prepare
our information systems (IT) and non-information technology with embedded
technology (ET) for the Year 2000. The information technology solutions have
been addressed separate for the Year 2000 since the Fund saw the need to move to
more advanced management and accounting systems made available by new technology
and software developments during the decade of the 1990s.
The PILOT software system, purchased in the early 1990s, needs to be replaced by
a windows based network system both for headquarters functions and other
locations. The real estate accounting system developed, sold and supported by
the Yardi Company of Santa Barbara, California has been selected to supercede
PILOT. The Yardi system has been tested and is compatible with Year 2000 and
beyond. This system is being implemented and should be fully operational by the
end of third quarter of 1999.
The few remaining systems not addressed by these conversions are being modified
by our in-house staff of programmers. The Hewlett Packard 3000 system, used for
PILOT and custom applications, was purchased in 1997 and will be part of our new
network. It will be retained as long as necessary to assure smooth operations
and has been upgraded to meet Year 2000 requirements.
All risks identified with information technology are believed to be addressed by
these plans.
The cost of these advances in our systems technology is not all attributable to
the Year 2000 issue since the need to move to a network based system had been
determined regardless of the Year 2000. The portion of the cost attributed to
the Mortgage Income Fund was approximately $42,000 for 1998 and is projected to
be approximately $63,000 during 1999 for hardware and software costs.
NTS management staff has been surveying our vendors to evaluate embedded
technology in our alarm systems, HVAC controls, telephone systems and other
computer associated facilities. In a few cases, equipment is being replaced. In
some cases circuitry is being upgraded. The cost involved is still being
evaluated. There are no known significant risks that are currently without
solutions. Management anticipates that applications involving ET will be Year
2000 compliant by the third quarter of 1999.
We are also currently addressing the Year 2000 readiness of third parties whose
business interruption could have a material negative impact on our business. All
significant vendors have indicated that they will be compliant by the end of
1999. Such assurances are being evaluated and documented.
19
Results of Operations - Continued
- ---------------------------------
Year 2000 - Continued
- ---------------------
Management has determined that at our current state of readiness, the need does
not presently exist for a contingency plan. We will continue to evaluate the
need for such a plan.
Despite diligent preparation, unanticipated third-party failures, more general
public infrastructure failures or failure to successfully conclude our
remediation efforts as planned could have a material adverse impact on our
results of operations, financial conditions and/or cash flows in 1999 and
beyond.
Quantitative and Qualitative Disclosures About Market Risk
- ----------------------------------------------------------
Our primary market risk exposure with regard to financial instruments is changes
in interest rates. The Fund's debt instruments bear interest at both variable
and fixed rates as further discussed in Note 8 of the Fund's financial
statements under Item 8 of this Form 10-K. At December 31, 1998, a hypothetical
100 basis point increase in interest rates would result in an approximately
$220,000 increase in interest expense. During the year ended December 31, 1998,
the majority of interest expense incurred was capitalized in inventory.
Cautionary Statements
- ---------------------
Any forward-looking statements included in Management's Discussion and Analysis
of Financial Condition and Results of Operations, or elsewhere in this report,
which reflect management's best judgement based on factors known, involve risks
and uncertainties. Readers are cautioned not to place undue reliance on any
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Fund undertakes no obligation to publicly revise these
forward-looking statements to reflect events or circumstances that arise after
the date hereof. Actual results could differ materially from those anticipated
in any forward-looking statements as a result of a number of factors, including
but not limited to those discussed below. Any forward-looking information
provided by the Fund pursuant to the safe harbor established by recent
securities legislation should be evaluated in the context of these factors.
The Fund's subsidiaries, NTS/LFII and NTS/VA, and the Orlando Lake Forest Joint
Venture, in which the Fund has a 50% interest, are engaged in the development
and sale of residential subdivision building lots, the pricing and sale of which
are subject to risks generally associated with real estate development and
applicable market forces beyond the control of the Fund and/or its subsidiaries,
including general and local economic conditions, competition, interest rates,
real estate tax rates, other operating expenses, the supply of and demand for
properties, zoning laws, other governmental rules and fiscal policies, and acts
of God. All of the properties owned by NTS/LFII, NTS/VA and OLFJV are encumbered
by development loans from third party lenders which, given the nature of the
risks incumbent in real estate investment and development activities as stated
above, are inherently subject to default should the ability of NTS/LFII, NTS/VA,
OLFJV and/or the Fund to make principal and interest payments under such
development loans become impaired.
There is the potential for occurrences which could affect the Fund's ability to
reduce, or limit the increase in, its professional and administrative expenses.
Furthermore, the debt service regarding the Fund's borrowings is variable based
on current interest rates, any fluctuations in which are beyond the control of
the Fund. These variances could, for example, impact the Fund's projected cash
and cash requirements as well as projected returns.
20
Item 8. Financial Statements and Supplementary Data
- ---------------------------------------------------
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of the NTS Mortgage Income Fund:
We have audited the accompanying consolidated balance sheets of the NTS Mortgage
Income Fund and subsidiaries (the Fund) (a Delaware corporation) as of December
31, 1998 and 1997, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These consolidated financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Fund as of
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998 in conformity
with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky
March 19, 1999
21
NTS MORTGAGE INCOME FUND
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
1998 1997
---- ----
ASSETS
Cash and equivalents $ 1,061,609 $ 1,413,445
Membership initiation fees and other
accounts receivable 1,884,472 1,625,489
Notes receivable 3,303,761 3,573,162
Inventory 53,264,438 51,917,990
Property and equipment, net of accumulated
depreciation of $257,612 and $45,788 501,921 452,913
Investment in unconsolidated affiliate 4,462,990 4,525,369
Advances to affiliates 30,338 --
Other assets 1,043,228 676,000
------------ ------------
Total assets $ 65,552,757 $ 64,184,368
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 2,091,630 $ 3,040,468
Advances from affiliates -- 600,542
Notes payable - affiliates 6,090,293 5,309,492
Notes payable 22,760,246 19,195,741
Lot deposits 131,395 97,500
Deferred revenues 154,968 146,789
------------ ------------
Total liabilities 31,228,532 28,390,532
------------ ------------
Commitments and contingencies (Note 14)
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 (19,842,359) (18,372,748)
------------ ------------
Total stockholders' equity 34,324,225 35,793,836
------------ ------------
Total liabilities and stockholders'
equity $ 65,552,757 $ 64,184,368
============ ============
The accompanying notes are an integral part of these financial statements.
22
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
Revenues:
Lot sales, net of discounts $ 8,061,027 $ 1,600,237 $ --
Cost of sales 6,167,853 1,230,168 --
----------- ----------- ----------
Gross profit 1,893,174 370,069 --
Interest income on affiliated mortgage
loans receivable -- 2,617,126 3,256,148
Fee income on affiliated mortgage loans
and other financial services -- 8,598 24,873
Recovery of provision for loan losses 382,096 1,500,000 --
Interest income on cash equivalents
and miscellaneous income 353,680 183,144 23,974
----------- ----------- ----------
2,628,950 4,678,937 3,304,995
----------- ----------- ----------
Expenses:
Advisory fee -- 418,950 544,776
Selling, general and administrative -
affiliated 1,934,784 633,044 --
Selling, general and administrative 1,437,413 274,977 201,688
Interest expense 364,173 1,304,157 1,343,241
Interest expense - affiliated -- 358,262 258,191
Other taxes and licenses 28,116 23,060 27,340
Depreciation and amortization expense 86,196 172,877 72,050
Loss from investment in unconsolidated
affiliate 247,879 3,600,560 --
Other charges -- 11,600,000 --
----------- ----------- ----------
4,098,561 18,385,887 2,447,286
----------- ----------- ----------
Income(loss)before income tax expense (1,469,611) (13,706,950) 857,709
Income tax expense -- -- 7,400
----------- ----------- ----------
Net income(loss) $ (1,469,611) $(13,706,950) $ 850,309
============ =========== ==========
Net income(loss)per share of common
stock $ (.46) $ (4.30) $ .27
============ =========== ==========
Weighted average number of shares 3,187,333 3,187,333 3,187,333
============ =========== ==========
The accompanying notes are an integral part of these financial statements.
23
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (1)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Common Common Additional
Stock Stock Paid-in- Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
Stockholders' equity
December 31, 1995 3,187,333 $ 3,187 $54,163,397 $ (4,910,506) $ 49,256,078
Net income -- -- -- 850,309 850,309
Dividends declared -- -- -- (605,601) (605,601)
--------- ------ ---------- ------------ ------------
Stockholders' equity
December 31, 1996 3,187,333 3,187 54,163,397 (4,665,798) 49,500,786
Net loss -- -- -- (13,706,950) (13,706,950)
--------- ------ ---------- ------------ ------------
Stockholders' equity
December 31, 1997 3,187,333 3,187 54,163,397 (18,372,748) 35,793,836
Net loss -- -- -- (1,469,611) (1,469,611)
--------- ------ ---------- ------------ ------------
Stockholders' equity
December 31, 1998 3,187,333 $ 3,187 $54,163,397 $(19,842,359) $ 34,324,225
========= ======== =========== ============ ============
The accompanying notes are an integral part of these financial statements.
(1) For the periods presented, there are no elements of other comprehensive
income as defined by the Financial Accounting Standards Board, Statement of
Financial Accounting Standards, No. 130 Reporting Comprehensive Income.
24
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
---- ---- ----
CASH FLOWS PROVIDED BY (USED FOR) OPERATING
ACTIVITIES
Net income (loss) $ (1,469,611) $(13,706,950) $ 850,309
Adjustments to reconcile net income (loss) to
net cash provided by (used for) operating
activities:
Accretion of discount on affiliated mortgage
loans receivable -- (95,932) (148,472)
Recovery of provision for loan losses -- (1,500,000) --
Depreciation and amortization expense 312,346 172,877 72,050
Loss from investment in unconsolidated affiliate 247,879 3,600,560 --
Other non-cash charges -- 11,600,000 --
Changes in assets and liabilities: (1)
Interest receivable - affiliates -- 480,778 (447,477)
Membership initiation fees and other accounts
receivable (258,983) 123,364 --
Notes receivable 269,401 416,352 --
Inventory (1,346,448) (789,991) --
Accounts payable (948,838) 158,721 88,493
Lot deposits 33,895 (14,000) --
Deferred revenues 8,179 14,016 (22,826)
------------ ------------ ------------
Net cash provided by (used for) operating (3,152,180) 459,795 392,077
activities ------------ ------------ ------------
CASH FLOWS PROVIDED BY (USED FOR) INVESTING
ACTIVITIES
Principal collections on affiliated mortgage
loans receivable -- 9,299,287 8,099,364
Investment in affiliated mortgage loans
receivable -- (5,700,037) (10,562,950)
Purchase of stock of acquired subsidiaries -- (30) --
Capital contribution to unconsolidated affiliate (185,500) -- --
Property and equipment (260,834) 27,555 --
------------ ------------ ------------
Net cash provided by (used for) investing
activities (446,334) 3,626,775 (2,463,586)
------------ ------------ ------------
CASH FLOWS PROVIDED BY (USED FOR) FINANCING
ACTIVITIES
Payments on advances from affiliates (600,542) (519,797) --
Advances to affiliates (30,338) -- --
Proceeds from notes payable 17,798,287 8,515,946 1,201,999
Proceeds from notes payable - affiliates 3,225,385 2,436,291 4,077,457
Payments on notes payable (14,233,781) (11,805,279) (1,075,022)
Payments on notes payable - affiliates (2,444,584) (1,651,466) (1,437,790)
Loan costs (270,724) (260,026) --
Other assets (197,025) 69,718 (45,485)
Dividends paid -- (175,305) (468,544)
------------ ------------ ------------
Net cash provided by (used for) financing
activities 3,246,678 (3,389,918) 2,252,615
------------ ------------ ------------
Net increase (decrease) in cash and (351,836) 696,652 181,106
equivalents
CASH AND EQUIVALENTS, beginning of period 1,413,445 716,793 535,687
------------ ------------ ------------
CASH AND EQUIVALENTS, end of period $ 1,061,609 $ 1,413,445 $ 716,793
============ ============ ============
The accompanying notes are an integral part of these financial statements
(1) Net of the effects of acquisitions, where applicable. See Note 12 for
information on non-cash investing and financing activities.
25
NTS MORTGAGE INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
- -- ------------------------------------------
A) Organization
-- ------------
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was
formed on September 26, 1988. The Fund operated as a real estate
investment trust (REIT) under the Internal Revenue Code of 1986 (the
"Code"), as amended, from its inception through December 31, 1996.
The Fund began operating as a "C" corporation under the Code for tax
purposes effective January 1, 1997. NTS Corporation is the sponsor of
the Fund (the "Sponsor"). NTS Advisory Corporation is the advisor to
the Fund (the "Advisor"), and NTS Residential Management Company is
the manager to the Fund ("NTS Management"). The Advisor and NTS
Management are affiliates of and are under common control with NTS
Corporation.
The Fund's subsidiaries include NTS/Lake Forest II Residential
Corporation (NTS/LFII) and NTS/Virginia Development Company (NTS/VA).
These subsidiaries were acquired effective October 1, 1997. The
acquisitions were accounted for under the purchase method of
accounting. See Note 3, "Acquisitions", for further information
pertaining to the acquisitions. Prior to making the acquisitions, the
Fund had been the primary creditor of these entities.
NTS/LFII is in the process of developing approximately 726 acres of
land located in Louisville, Kentucky into a single-family residential
community and a country club with a championship golf course for the
purpose of selling such residential lots and country club
memberships. As of December 31, 1998, approximately 530 of the 726
acres have been developed and approximately 52% of the total
projected lots to be developed have been sold. In addition, Lake
Forest has amenities consisting of a clubhouse, pools, tennis courts,
recreation fields and several lakes.
NTS/VA is in the process of developing approximately 2,825 acres
located in the Chancellor district of Spotsylvania County, Virginia,
approximately 60 miles south of Washington D.C., into a single-family
residential community and a country club with a championship golf
course for the purpose of selling such residential lots and country
club memberships. As of December 31, 1998, approximately 1200 of the
2825 total acres have been developed and approximately 26% of the
total projected lots to be developed have been sold. Included on the
property is a 285 acre lake. In addition, Fawn Lake has amenities
consisting of a clubhouse, pool, tennis courts and boat docks.
The Fund purchased a 50% interest in the Orlando Lake Forest Joint
Venture effective August 16, 1997. Prior to becoming a joint venture
partner, the Fund had been the Joint Venture's primary creditor. See
Note 4, "Investment in Unconsolidated Affiliate", for further
information pertaining to the investment.
B) Basis of Accounting
-- -------------------
The Fund's records are maintained on the accrual basis of accounting
in accordance with generally accepted accounting principles (GAAP).
C) Principals of Consolidation and Basis of Presentation
-- -----------------------------------------------------
The consolidated financial statements of the Fund include the assets,
liabilities, revenues and expenses of its 100% owned subsidiaries.
The consolidated statements of operations include the results of
acquired businesses accounted for under the purchase method of
accounting from the date of acquisition. Investments of 50% or less
in affiliated companies are accounted for under the equity method.
All significant intercompany transactions have been eliminated.
26
1. Summary of Significant Accounting Policies - Continued
- -- ------------------------------------------------------
D) Use of Estimates in Preparation of Financial Statements
-- -------------------------------------------------------
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
E) Revenue Recognition and Reserves for Loan Losses
-- ------------------------------------------------
The Fund recognizes revenue and related costs from lot sales using
the accrual method in accordance with generally accepted accounting
principles, which is when payment has been received and title,
possession and other attributes of ownership have been transferred to
the buyer, and the Fund and its subsidiaries are not obligated to
perform significant activities after the sale. The Fund and its
subsidiaries generally require a minimum down payment of at least 10%
of the sales price of the lot.
Interest income from mortgage loans and notes receivable was reported
as earned on the accrual basis of accounting. If the Fund had any
reason to doubt the collectability of any principal or interest
amounts due pursuant to the terms of the mortgage loans or notes,
appropriate reserves would have been established for any principal
and accrued interest amounts deemed unrealizable. Impaired loans are
measured based on the present value of expected future cash flows
discounted at each loan's effective interest rate, at each loan's
observable market price or at the fair value of the collateral if the
loan is collateral dependent.
F) Inventory
-- ---------
Inventory is stated at the lower of cost or net realizable value.
Inventory includes all direct costs of land, land development, and
amenities, including interest, real estate taxes, and certain other
costs incurred during the development period, less amounts charged to
cost of sales. Inventory costs are allocated to individual lots sold
using the relative sales values. The use of the relative sales value
method to record cost of sales requires the use of estimates of sales
values, development costs and absorption periods over the life of the
project. Given the long-term nature of the projects and inherent
economic volatility of residential real estate, it is reasonably
possible that such estimates could change in the near term. Any
changes in estimates would be accounted for prospectively over the
life of the project.
G) Long-Lived Assets
-- -----------------
Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of, specifies circumstances in which certain
long-lived assets must be reviewed for impairment. If such review
indicates that the carrying amount of an asset exceeds the sum of its
expected future cash flows, the asset's carrying value must be
written down to fair market value.
H) Advertising
-- -----------
The Fund expenses advertising-type costs as incurred. Advertising
expense, a component of Cost Reimbursements (see Note 9), was
approximately $718,000 and $100,000 during the years ended December
31, 1998 and 1997, respectively.
27
1. Summary of Significant Accounting Policies - Continued
- -- ------------------------------------------------------
I) Operating Expense Limitations
-- -----------------------------
Prior to January 1, 1997, the annual Operating Expenses of the Fund
when functioning as a REIT, based upon guidelines promulgated by the
North American Securities Administrators Association, Inc., were
prohibited from exceeding in any fiscal year the greater of (i) 2% of
the Fund's Average Invested Assets during such fiscal year or (ii)
25% of the Fund's Net Income during such fiscal year. In the event
the Fund's annual Operating Expenses exceeded this limitation, the
Advisor would reimburse the Fund within 60 days after the end of the
fiscal year, the amount by which the aggregate annual Operating
Expenses paid or incurred by the Fund exceed the foregoing
limitations. The Fund did not exceed this limitation for the year
ended December 31, 1996.
J) Environmental Remediation and Compliance
-- ----------------------------------------
Environmental liabilities for remediation costs are accrued based on
estimates of known environmental remediation exposures. Liabilities
are recognized when they can be reasonably estimated. Environmental
compliance costs are expensed as incurred.
K) Per Share Information
-- ---------------------
The Financial Accounting Standards Board recently issued Standard No.
128, Earnings Per Share (SFAS 128). The Statement simplifies the
standards for computing earnings per share (EPS) and replaces the
presentation of primary and fully diluted EPS with a presentation of
basic and diluted EPS. SFAS 128 is effective for financial statements
for periods ending after December 15, 1997. For all periods
presented, the Fund did not have common stock equivalents, therefore,
the adoption of SFAS 128 did not have any impact on the Fund's
financial statements.
L) Statement of Cash Flows
-- -----------------------
For purposes of reporting cash flows, cash and equivalents include
cash on hand and short-term, highly liquid investments with an
original maturity of three (3) months or less that are readily
convertible to cash.
2. Affiliations
- -- ------------
The Fund operates under the direction of its Board of Directors who have
retained NTS Management to be the sole and exclusive agent of the Fund
for day-to-day control and management of the business of the Fund's
subsidiaries including (a) the continued operation of NTS/LFII and
NTS/VA, (b) the operations of the Lake Forest Country Club and the Fawn
Lake Country Club, (c) the operations of the Lake Forest Community
Association and the Fawn Lake Community Association and (d) the provision
and/or sale of ancillary goods and services as selected by NTS Management
with respect to any of the foregoing. The Management Agreements have an
initial term through and including December 31, 2003, and automatically
renew for successive six year terms unless terminated by the Fund, its
subsidiaries, or NTS Management upon six months written notice. See Note
9 for further discussion of the Management Agreements. NTS Management is
an Affiliate of and under common control with NTS Corporation, the Fund's
Sponsor. The Chairman of the Board of Directors of the Fund is also the
majority shareholder of NTS Corporation and is a majority shareholder of
the managing general partner in the Orlando Lake Forest Joint Venture of
which the Fund is a 50% joint venture partner. NTS Advisory and NTS
Management are Affiliates of and are under common control with NTS
Corporation.
28
3. Acquisitions
- -- ------------
The Fund acquired all of the issued and outstanding common stock of
NTS/LFII and NTS/VA effective October 1, 1997, for a nominal purchase
price. Concurrent with this transaction, the existing indebtedness of
each of NTS/LFII and NTS/VA to the Fund was converted to equity.
The transaction has been accounted for using the purchase method of
accounting. The purchase price (approximately $14.5 million for NTS/LFII
and approximately $28.7 million for NTS/VA) was allocated to the assets
and liabilities of NTS/LFII and NTS/VA based on their estimated fair
market value. The acquisition of NTS/LFII included inventory of
approximately $19 million, debt of approximately $5 million and other net
assets and liabilities of approximately $500,000. The acquisition of
NTS/VA included inventory of approximately $32 million, debt of
approximately $5.5 million and other net assets and liabilities of
approximately $2.2 million. The results of operations for NTS/LFII and
NTS/VA from the date of acquisition (October 1, 1997) are included in the
consolidated financial statements of the Fund.
Generally Accepted Accounting Principles require that these acquisitions
be recorded at fair market value. The application of these principles
resulted in a non-cash charge of approximately $11,600,000 during the
fourth quarter of 1997 related to these transactions. All estimates used
in these evaluations represented management's best estimates based on the
facts present at the date of the evaluations.
4. Investment in Unconsolidated Affiliate
- -- --------------------------------------
In September 1997, the Fund entered into an Amended and Restated Joint
Venture Agreement evidencing the Fund's admission as a partner in the
Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of
August 16, 1997. The other partners in the Joint Venture are Orlando Lake
Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of
whom are Affiliates of and are under common control with the Fund's
Sponsor. The Joint Venture will continue to operate under its current
legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and
improvements and approximately 20 acres of commercial land. The Joint
Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its
interest in the principal and interest of the first mortgage loan on the
Orlando Lake Forest project, and obtained a 50% interest in the Joint
Venture. The NTS entities named above hold cumulatively the remaining 50%
interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1998 and 1997, the Fund's percentage
interest was 50%, and the Fund's investment balance in the Joint Venture
was $4,462,990 and $4,525,369 as of December 31, 1998 and 1997,
respectively. The Fund's share of the Joint Venture's net income (loss)
for the year ended December 31, 1998 was $(247,879) and from August 16,
1997 (when the Fund was admitted as a partner) through December 31, 1997
was $106,667.
Generally Accepted Accounting Principles require that such investments be
recorded at the lower of carrying value or fair market value. The
application of these principles resulted in a non-cash charge of
approximately $3.7 million in the third quarter of 1997. All estimates
used in this evaluation represent management's best estimates based on
the facts present at the date of such evaluations.
29
4. Investment in Unconsolidated Affiliate - Continued
- -- --------------------------------------------------
During fiscal 1998, the Fund and the other joint venture partners
contributed as a capital contribution of $371,000 to the joint venture,
the Fund's portion being $185,500.
The following presents condensed financial information for the Joint
Venture as of December 31, 1998 and 1997 and for the year ended December
31, 1998 as well as the period August 16, 1997 through December 31, 1997:
1998 1997
---- ----
Balance Sheet
Notes receivable $ 550,272 $ 647,448
Inventory 14,461,364 13,376,714
Other, net 512,976 1,935,254
------------ ------------
Total assets $ 15,524,612 $ 15,959,416
============ ============
Notes payable $ 5,323,241 $ 4,793,014
Other liabilities 1,275,389 2,115,662
Equity 8,925,982 9,050,740
------------ ------------
Total liabilities and equity $ 15,524,612 $ 15,959,416
============ ============
Statement of Operations
Lot sales $ 2,624,548 $ 1,678,079
Cost of sales (1,836,386) (1,150,339)
Other income (expenses), net (1,283,920) (314,404)
---------- --------
Net income (loss) $ (495,758) $ 213,336
============ ============
5. Member Initiation Fees and Other Accounts Receivable
- -- ----------------------------------------------------
Fawn Lake Country Club and Lake Forest Country Club membership initiation
fees receivable totaled approximately $1,370,000 and $1,209,000 as of
December 31, 1998 and 1997. The receivable is net of a discount recorded
to allow for the present value of the membership initiation fee
receivables considering the estimated timing of collections.
6. Notes Receivable
- -- ----------------
Notes receivable are secured by a first mortgage on lots sold to
individuals. The notes bear interest at the prevailing market rates at
the time the lots were sold. The majority of the notes are due between
five and seven years, monthly payments are based on a 30-year
amortization and the balance is due at the maturity date. Notes totaling
approximately $3,179,000 and $3,443,000 are pledged as security for notes
payable to banks under certain Warehouse Line of Credit Agreements and
other debt agreements as of December 31, 1998 and 1997, respectively.
There are also $125,000 and $130,500 of notes held by NTS/VA that are not
pledged as of 1998 and 1997, respectively. Approximately $1,883,000,
$426,000, $39,000, and $61,000 of the notes receivable balance as of
December 31, 1998 are due for the years ended December 1999 through 2002,
respectively. Approximately $787,000 of the notes receivable balance
relates to the sale of 24 lots to one builder in fiscal 1998 at NTS/VA.
The note bears interest at the Prime Rate plus 1%, is due in monthly
installments commencing June 29, 2001, with any outstanding principal and
interest payable in full on December 29, 2003.
30
7. Inventory
- -- ---------
Inventory consists of the following as of December 31, 1998:
NTS/LFII NTS/VA Consolidated
-------- ------ ------------
Land held for future
development, under development
and completed lots $ 5,855,000 $21,971,000 $27,826,000
Country club (net of membership
initiation fees) 10,225,000 8,099,000 18,324,000
Amenities 2,176,000 4,938,000 7,114,000
----------- ----------- ------------
$18,256,000 $35,008,000 $ 53,264,000
=========== =========== ============
Inventory consists of the following as of December 31, 1997:
NTS/LFII NTS/VA Consolidated
-------- ------ ------------
Land held for future
development, under
development and completed
lots $ 6,874,000 $21,787,000 $28,661,000
Country club (net of
Membership initiation fees) 7,329,000 7,175,000 14,504,000
Amenities 4,590,000 4,163,000 8,753,000
----------- ----------- ------------
$18,793,000 $33,125,000 $ 51,918,000
=========== =========== ============
NTS/LFII and NTS/VA capitalized in inventory approximately $2,064,000 and
$214,000 of interest and real estate taxes during 1998 and from October
1, 1997 though December 31, 1997, respectively. Interest and real estate
taxes incurred was approximately $2,296,000 and $396,000 as of December
31, 1998 and from October 1, 1997 through December 31, 1997,
respectively.
Inventory for 1998 as reflected above includes $26,586,000, net of
$8,262,000 of country club membership initiation fees, of costs incurred
to date for the development of the Fawn Lake Country Club and the Lake
Forest Country Club.
Inventory for 1997 as reflected above includes $21,708,355, net of
$7,204,605 of country club membership initiation fees, of costs incurred
to date for the development of the Fawn Lake Country Club and the Lake
Forest Country Club.
Pursuant to an agreement between NTS/LFII and the Lake Forest Country
Club regarding the cost to develop the Country Club, NTS/LFII is to
receive all initiation fees from the initial issuance of memberships to
the Country Club. The remaining cost to be incurred for the current
projected Country Club operating deficit for the period covered by the
agreement is approximately $2,330,000 which is expected to be offset by
member initiation fees. During 1998 and for the fourth quarter of 1997
the Country Club operating deficit was approximately $279,000 and
$160,000, respectively, and was capitalized as a cost of inventory.
31
8. Notes and Mortgage Loans Payable
- -- --------------------------------
Notes and mortgage loans payable consist of the following:
1998 1997
---- ----
Note payable to a bank in the amount of $13,800,000, bearing interest
at the Prime Rate + 1%, payable monthly, due December 27, 1997, secured
by a collateral assignment of the Fund's mortgages on Lake Forest and
Fawn Lake, guaranteed by Mr. J. D. Nichols, Chairman of the Board of
the Fund's Sponsor, paid in full on January 7, 1998. $ -- $ 3,607,283
Mortgage loan payable to a bank in the amount of $10,700,000, bearing
interest at the Prime Rate + 1 1/2%, due December 1, 2002, secured by
inventory of NTS/VA, generally principal payments consist of
approximately 91% of the Gross Receipts of lot sales, guaranteed by Mr.
J. D. Nichols up to $3,000,000 and a $2 million letter of credit from
a third party lender with the beneficiary being the bank. 9,581,963 8,005,034
Note payable to a bank in the amount of $8,000,000, bearing interest at
the Prime Rate + 1%, payable monthly, due October 31, 2003, secured by
inventory of NTS/LFII, generally principal payments consist of
approximately 90% of the Gross Receipts from lot sales, guaranteed by
Mr. JD Nichols up to 50% of the credit facility. The Note contains certain
covenants which among other things require the net worth of NTS/LFII not
be allowed to decrease by 20% or more throughout the term of the agreement. 6,113,434 --
Mortgage loan payable to a bank in the amount of $4,000,000, bearing
interest at the Prime Rate + 1/2%, payable monthly, due July 31, 2002,
secured by the Lake Forest Country Club and golf course, principal
reductions of $300,000 payable every six months, guaranteed by NTS
Corporation, the Fund's Sponsor. 3,250,000 3,950,000
Warehouse Line of Credit Agreements with three banks bearing interest
at the Prime Rate + 1%, the Prime Rate + 3/4% and the Prime Rate +
1/2%, due December 15, 1999 ($519,052), September 30, 1999($1,396,680)
and February 28, 1999 ($488,853), secured by notes receivable (see Note
6), principal payments consist of payments received from notes
receivable securing the obligation. 2,404,585 3,495,299
Bank note payable in the amount of $1,174,800, bearing interest at a
rate of prime + .5%, secured by note receivable (see Note 6), due in
monthly installments of $5,000 commencing February 1, 1999 with any
outstanding principal and accrued interest due and payable in full on
December 29, 2000. 1,174,800 --
(Continued on next page)
32
8. Notes and Mortgage Loans Payable - Continued
- -- --------------------------------------------
Mortgage loan payable to a bank in the amount of $150,000, bearing
interest at the Prime Rate + 1%, payable monthly, due August 4, 1999,
secured by land, guaranteed by NTS Corporation, the Fund's Sponsor. $ 150,000 $ --
Equipment loan in the amount of $50,180, bearing interest at a rate of
2,9%, due May 15, 2001, secured by equipment for use at the Lake Forest
Country Club. 40,755 --
Equipment loan in the amount of $27,736, bearing interest at a rate of
5.94%, due April 1, 2000, secured by equipment purchased for use at the
Lake Forest Country Club. 12,871 21,970
Bank note payable in the amount of $165,276, bearing interest at the
rate of 8.75%, due January 14, 1999, secured by golf course maintenance
equipment. 5,358 60,123
Bank note payable in the amount of $42,435, bearing interest at the
rate of 10.5%, due October 15, 1999, secured by golf course maintenance
equipment. 11,853 24,778
Bank note payable in the amount of $34,555, bearing interest at the
rate of 10.5%, due October 15, 1999, secured by golf course maintenance
equipment.
9,265 20,063
Bank note payable in the amount of $19,194, bearing interest at the
rate of 10.5%, due October 15, 1999, secured by golf course maintenance
equipment. 5,362 11,191
----- ------
$22,760,246 $19,195,741
========== ==========
The Prime Rate was 7 3/4% and 8 1/2% at December 31, 1998 and 1997,
respectively.
The $519,052 and $488,853 Warehouse Line of Credit agreements are guaranteed by
NTS Corporation.
The minimum scheduled principal payments on debt outstanding at December 31,
1998 are as follows:
1999 $ 3,399,447
2000 3,240,138
2001 2,520,661
2002 4,200,000
2003 9,400,000
Thereafter ---------
$ 22,760,246 (1)
(1) The minimum scheduled principal payments regarding the $10.7 and $8
million credit facilities are reflected in the table such that the
outstanding principle amount is brought to within the following levels
by the applicable date.
33
8. Notes and Mortgage Loans Payable - Continued
- -- --------------------------------------------
$10.7 Million Facility
----------------------
December 31, 1999 $9,300,000
December 31, 2000 $7,800,000
December 31, 2001 $5,900,000
December 1, 2002 $4,500,000
$8 Million Facility
-------------------
January 1, 1999 $7,800,000
January 1, 2000 $7,200,000
January 1, 2001 $7,000,000
July 1, 2001 $6,100,000
January 1, 2002 $5,500,000
July 1, 2002 $4,900,000
January 1, 2003 $4,000,000
July 1, 2003 $2,400,000
Management's projection for Fawn Lake indicates the development will reach
the maximum funding level allowed by the current development loan of $10.7
million during 1999 and in fact require additional funding to achieve its
1999 development plan which includes projected sales of $6.5 million. The
current development loan is secured by the inventory of the Fawn Lake
Project, an approximately $2 million letter of credit issued by a third
party lender with the Fawn Lake lender stated as the beneficiary, and a $3
million guarantee by Mr J.D. Nichols. Management's projections indicate the
outstanding debt balance as of December 31, 1999 will be approximately
$12.1 million. Management's present plans and actions include (1)
approaching the Fawn Lake lender and requesting that the loan agreement be
modified to allow the outstanding balance to remain at the loan maximum of
$10.7 Million as opposed to the contractual required maximum of $9.3
million as of December 31, 1999, (2) obtaining additional funding from the
Lake Forest North lender thereby allowing Fawn Lake to utilize such funds
for development purposes, and (3) borrowing additional funds from an
affiliate via the loan agreement between the affiliate and the Mortgage
Income Fund. Although management believes that it will be successful in
such negotiations, there can be no assurances that these third party
lenders will approve of management's plans and intentions for Fawn Lake.
However, if management is unsuccessful in that effort, consideration will
be given to implementing an alternative development plan.
9. Related Party Transactions
- -- --------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares
of the Fund. The Fund thereby allowing Fawn Lake to utilize such funds
for development purposes entered into the following agreements with
various Affiliates of the Sponsor regarding the ongoing operation of the
Fund.
Advisory Agreement
------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS
Advisory Corporation) a Management Expense Allowance from inception of
the Fund through September 30, 1997 (Advisory Fee) relating to services
performed for the Fund in an amount equal to 1% of the Fund's Net Assets,
per annum, which amount was increased annually by an amount corresponding
to the percentage increase in the Consumer Price Index. Effective July 1,
1994, the Fund's Mortgage Loans to Fawn Lake and Lake Forest were
converted to cash flow mortgage loans. As part of the consideration for
this restructuring, the Fund's Board of Directors required, among other
things, that beginning in 1995, NTS Advisory Corporation pay
$100,000 annually towards the expenses of the Fund until the maturity
of the Mortgage Loans. As such, the Advisory Fee has been reduced
$100,000 for the year ended December 31, 1996 and $75,000 for the year
ended December 31, 1997.
34
Advisory Agreement - Continued
- ------------------------------
For the years ended December 31, 1997 and 1996, $418,950 and $544,776,
respectively, had been incurred as an Advisory Fee. Effective October 1, 1997,
the Fund no longer incurred an Advisory Fee but is now responsible for the
actual general and administrative costs pursuant to certain property management
agreements discussed below.
Property Management Agreements
- ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake
projects will be conducted by NTS Residential Management Company (NTS
Management) under the terms of (i) a Property Management Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a
Property Management Agreement executed on December 30, 1997, and dated as of
October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn
Lake project (collectively, the Management Agreements). NTS Management is a
wholly-owned subsidiary of NTS Development Company. NTS Development Company is a
wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an
initial term through December 31, 2003, subject to extension under certain
conditions, and are renewable for successive six (6) year terms thereafter.
Under the Management Agreements, NTS Management will be reimbursed for costs
incurred in the operation and management of the Lake Forest North and Fawn Lake
projects, will be entitled to an Overhead Recovery, and will accrue an incentive
payment payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the
management and operation of NTS/LF II and NTS/VA. Such costs include
compensation costs of management, accounting, professional, engineering and
development, marketing and office personnel employed by NTS management and/or
certain of its affiliates as well as various non payroll related operating
expenses. Compensation costs are for those individuals who rendered services
full time and on site at the residential projects, with respect to the
residential projects but who are not on site and with respect to the residential
projects but who have multiple residential projects responsibilities some of
which may be affiliated entities of NTS Management. For services provided by
individuals not on site or those with multiple residential project
responsibilities, costs are pro-rated by NTS Management and allocated to the
appropriate residential project. As permitted by the Property Management
Agreements, the Fund was charged the following amounts for the year ended
December 31, 1998 and the period from October 1, 1997 through December 31, 1997.
These amounts are reflected in Selling, General and Administrative - Affiliated
on the accompanying Statement of Operations:
1998 1997
---- ----
Personnel Related Costs:
Finance and Accounting $ 172,409 $ 23,624
Data Processing 6,037 --
Human Resources 35,299 --
Executive and Administrative Services 186,199 105,920
Construction Management 38,616 8,539
Sales and Marketing 712,582 185,295
Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428
------ ------
Total Expense Reimbursements $ 1,438,610 $ 526,571
========== =========
35
Property Management Agreements - Continued
- ------------------------------------------
Additionally, NTS Management is entitled to an Overhead Recovery, which is a
reimbursement for overhead expenses attributable to the employees and the
efforts of NTS Management under the Management Agreements, in an amount equal to
3.75% of the projects' gross cash receipts, as defined in the Management
Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174
and $106,473 for the period October 1, 1997 through December 31, 1997. These
amounts are classified with Selling, General and Administrative - Affiliated in
the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive
Payment, as defined in the Management Agreements, equal to 10% of the Net Cash
Flows of the projects. The Incentive Payment will not begin accruing until after
the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash
flow of the Orlando Lake Forest Joint Venture would have been sufficient to
enable the Fund to return to the then existing shareholders of the Fund an
amount which, after adding thereto all other payments actually remitted or
distributed to such shareholders of the Fund, is at least equal to the
shareholders' Original Capital Contribution. As of December 31, 1997, the Fund
had raised approximately $63,690,000 and had paid distributions of approximately
$23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive
Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates
- -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's
Sponsor totaling $600,542 as of December 31, 1997. The advances were used to
fund development costs and were to be repaid to the Affiliates as cash flow
permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of
repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997,
respectively. As of December 31, 1998, the advances bear interest at
approximately the Prime Rate and mature on May 31, 2006. The Affiliate has
represented that it will not demand repayment on any amounts owed during 1999,
unless cash flows are adequate to allow such repayment. For the year ended
December 31, 1998, the interest expense to affiliate totaling $341,213 was
capitalized in inventory. For the years ended December 31, 1997 and 1996,
interest was expensed totaling $358,262 and $258,191, respectively.
10. Affiliated Mortgage Loans Receivable
- --- ------------------------------------
The following table outlines the activity regarding the Fund's mortgage loan
portfolio for the three years in the period ended December 31, 1998.
Balance at December 31, 1995 $ 65,209,103
Additions:
Mortgage Loans $ 9,371,032
Temporary Mortgage Loans 1,191,918
Accretion of discount 148,472
Amortization of loan fees 20,000 10,731,422
-------- ----------
Reductions:
Mortgage Loans (6,692,948)
Temporary Mortgage Loans (1,406,416)
Mortgage Loan written-off (53,397)
Loan fees received -- (8,152,761)
--------- ----------
Balance at December 31, 1996 $ 67,787,764
36
10. Affiliated Mortgage Loans Receivable - Continued
- --- ------------------------------------------------
Additions:
Mortgage Loans $ 5,186,594
Temporary Mortgage Loans 513,443
Accretion of discount 95,932
Amortization of loan fees -- 5,795,969
----------- ----------
Reductions:
Mortgage Loans (5,447,696)
Temporary Mortgage Loans (6,351,123)
Investment in unconsolidated
affiliate (Note 4) (8,125,928)
Purchase of net assets of subsidiaries
(Note 3) (53,658,986) (73,583,733)
----------- -----------
Balance at December 31, 1997 $ --
===========
Reserves for Loan Losses:
Balance at December 31, 1995 $ 1,553,397
Additions charged to expenses $ --
Deductions for Mortgage Loan
written-off (53,397) (53,397)
------------ -----------
Balance at December 31, 1996 $ 1,500,000
Additions charges to expenses $ --
Recovery of provisions for loan
loss (1,500,000) (1,500,000)
------------ -----------
Balance at December 31, 1997 $ --
===========
11. Income Taxes
- --- ------------
The Fund adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109), effective January 1, 1997. SFAS 109
requires recognition of deferred tax assets and liabilities for the expected
future tax consequence of events that have been included in the financial
statements or tax returns. Under this method, deferred tax assets and
liabilities are determined based on the difference between the Fund's book and
tax bases of assets and liabilities and tax carryforwards using enacted tax
rates in effect for the year in which the differences are expected to reverse.
The principal tax carryforwards and temporary differences giving rise to the
Fund's deferred taxes consist of tax net operating loss carryforwards, valuation
allowances and differences in inventory basis for book and tax.
37
11. Income Taxes - Continued
- --- ------------------------
The Fund's deferred tax assets and liabilities as of December 31, are as
follows:
Deferred tax assets 1998 1997
- ------------------- ---- ----
Net operating loss carryforwards $ 687,000 $ 132,000
Inventory 2,972,000 3,199,000
Deferred revenue 157,000 --
----------- -----------
Net deferred tax assets 3,816,000 3,331,000
Valuation allowance (3,816,000) (3,331,000)
----------- -----------
$ -- $ --
=========== ===========
A valuation allowance is provided when the probability that the deferred tax
asset to be realized does not meet the criteria established by the Financial
Accounting Standards Board. The Fund has determined, based on its history of
operating losses by its subsidiaries and its expectations for the future, that
it is more likely than not that the net deferred tax assets at December 31, 1998
and 1997, will not be realized.
As of December 31, 1998, the Fund has a federal net operating loss carryforward
of approximately $687,000 expiring during 2012 and 2013.
A reconciliation of the statutory to the effective rate of the Fund for the year
ended December 31, is as follows:
1998 1997
---- ----
Tax benefit using statutory rate $ 500,000 $ 4,660,000
Recovery on provision for loan losses -- 510,000
Establishing deferred tax liabilities
other due to a change in tax status -- (1,839,000)
Valuation allowance (486,000) (3,331,000)
Other (14,000) --
-------- ---------
Income tax expense $ -- $ --
======== =========
Prior to January 1, 1997, the Fund elected and qualified to be treated as a REIT
under Internal Revenue Code Sections 856-860. In order to qualify, the Fund was
required to distribute at least 95% of its taxable income to Stockholders and
meet certain other requirements. A reconciliation of net income for financial
statement purposes versus that for income tax reporting at December 31 is as
follows:
1996
----
Net income (GAAP) $ 850,309
Accretion of note discount (148,472)
Loan commitment fee income (20,000)
Letters of credit income (2,326)
Supplemental interest income --
Federal income tax expense 5,000
Provision for loan losses (53,397)
--------
Taxable income before dividends paid
deduction $ 631,114
=========
Dividends declared $ 605,601
=========
Distribution percentage 96%
38
12. Supplemental Cash Flow Information
- --- ----------------------------------
a) Cash payments for interest, net of amounts capitalized and cash
payments for income taxes, net of refunds are as follows:
1998 1997 1996
---- ---- ----
Interest $ 244,295 $1,767,786 $1,510,384
Income taxes $ -- $ 5,320 $ --
b) Supplemental Non-Cash Investing and Financing Activity:
In 1997, the Fund made an investment in an unconsolidated affiliate
by contributing the principal amount outstanding on mortgage loans
receivable of approximately $8,125,000. (See Notes 4 and 10).
In 1997, the Fund acquired all of the outstanding common stock of
NTS/LFII and NTS/VA for a nominal purchase price. Concurrent with
this transaction, the existing indebtedness of each of NTS/LFII and
NTS/VA to the Fund totaling approximately $53,659,000 was converted
to equity (See Notes 3 and 10).
13. Financial Instruments
- --- ---------------------
The book values of cash and cash equivalents, trade receivables and trade
payables are considered to be representative of their respective fair
values because of the immediate or short-term maturity of these financial
instruments. The fair value of the Fund's notes receivable and debt
instruments approximated the book value because a substantial portion of
the underlying instruments are variable rate notes.
14. Commitments and Contingencies
- --- -----------------------------
At December 31, 1998 and 1997, the Fund had outstanding funding
commitments under standby letters of credit aggregating to $194,347 and
$48,821, respectively, regarding the Orlando Lake Forest Joint Venture.
NTS/LFII and NTS/VA have various letters of credit outstanding to
governmental agencies and utility companies totaling approximately
$2,277,053 and $2,892,500 as of December 31, 1998 and 1997, respectively.
It is estimated that development of the remaining homeowners association
amenities at the Lake Forest North project will be substantially complete
by May 2001. Based on engineering studies and projections, NTS/LFII will
incur additional costs, excluding interest, of approximately $500,000
during 2001 to complete the homeowners association amenities.
It is estimated that the country club and homeowners association
amenities at the Fawn Lake project will be substantially completed by
December 2004. Based on engineering studies and projections, NTS/VA will
incur additional costs, excluding interest, of approximately $3,165,000
to complete the country club and homeowners association amenities for the
project. These costs are estimated to be incurred as follows: $1,500,000
for 1999, $75,000 for 2002, $440,000 for 2003 and $1,150,000 for 2004.
In July 1994, the Fund was named as a defendant in a complaint originally
filed by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against the
Fund's Sponsor and various Affiliates of the Fund's Sponsor. The suit was
settled in the first quarter of 1997. The terms of the settlement
agreement are confidential; however, the settlement did not have a
material impact on the Fund's financial position or results of
operations.
39
15. Guaranties to the Fund
- --- ----------------------
NTS Guaranty Corporation (the "Guarantor"), an Affiliate of the Sponsor,
has guaranteed that investors of the Fund will receive, over the life of
the Fund, aggregate distributions from the Fund (from all sources) in an
amount at least equal to their Original Capital Contributions, as defined
in the Fund's Prospectus. As of December 31, 1998, the Fund has raised
approximately $63,690,000 and has paid distributions of $23,141,000.
The liability of the Guarantor under the above guaranties is expressly
limited to its assets and its ability to draw upon a $10 million demand
note receivable from Mr. J.D. Nichols, Chairman of the Board of Directors
of the Sponsor. There can be no assurance that Mr. Nichols will, if
called upon, be able to honor his obligation to the Guarantor. The total
amounts guaranteed by the Guarantor are in excess of its net worth, and
there is no assurance that the Guarantor will be able to satisfy its
obligation under these guaranties. The Guarantor may in the future
provide guaranties for other Affiliates of the Fund.
16. Dividends Paid and Payable
- ------------------------------
Dividends declared for the period ended December 31, 1996 were as follows:
Average
Date Date of Date Outstand Amount
Declared Record (1) Paid Shares Per Share Amount
- -------- ---------- ---- ------ --------- ------
03/12/96 03/31/96 04/15/96 3,187,333 $.045 $ 143,432
03/12/96 06/30/96 07/19/96 3,187,333 .045 143,432
06/27/96 09/30/96 10/18/96 3,187,333 .045 143,432
06/27/96 12/31/96 01/27/97 3,187,333 .055 175,305
----- ---------
Total dividends declared in 1996 $.190 $ 605,601
===== =========
(1) Cash dividends vary based upon the date of stockholder admittance.
It was the Fund's policy during the periods it operated as a REIT to
distribute to its Stockholders an amount equal to at least 95% of taxable
income. A portion of the dividends paid during a subsequent year may have
been allocable to taxable income earned in the prior year. For 1996,
dividends to Stockholders represent ordinary income.
The continued needs of the Fund's subsidiaries have significantly reduced
the Fund's cash flows. Therefore, the Fund's Board of Directors has
determined to terminate the Fund's quarterly distribution for the
foreseeable future effective as of the first quarter of 1997.
40
17. Unaudited Quarterly Financial Data
- --- ----------------------------------
1998 March 31 June 30 September 30 December 31 Total
---- -------- ------- ------------ ----------- -----
Total revenues $ 774,091 (3) $ 615,161 $ 515,855 $ 723,843 $ 2,628,950
Total expenses 957,730 1,097,418 1,026,038 1,017,375 4,098,561
---------- ---------- ---------- ---------- -----------
Income (loss)
before income
taxes (183,639) (482,257) (510,183) (293,532) (1,469,611)
Income tax
expense -- -- -- -- --
---------- ---------- ---------- ---------- -----------
Net income
(loss) $ (183,639) $ (482,257) $ (510,183) $ (293,532) $(1,469,611)
========== ========== ========== ========== ===========
Net income
(loss) per
share of
common
stock $ (.06) $ (.15) $ (.16) $ (.09) $ (.46)
========== ========== ========== ========== ===========
1997 March 31 June 30 September 30 December 31 Total
---- -------- ------- ------------ ----------- -----
Total revenues $817,183 $857,083 $ 2,476,139 (1) $ 528,532 $ 4,678,937
Total expenses 643,029 643,341 4,368,968 (4) 12,730,549 18,385,887
--------- -------- ----------- ------------ ------------
Income (loss)
before income
taxes 174,154 213,742 (1,892,829) (12,202,017) (13,706,950)
Income tax
expense 1,850 1,850 2,650 (6,350) --
--------- -------- ----------- ------------ ------------
Net income
(loss) $172,304 $211,892 $(1,895,479) $(12,195,667) $(13,706,950)
========= ======== =========== ============ ============
Net income
(loss) per
share of
common stock $ .05 $ .07 $ (.59) $ (3.83) $ (4.30)
========= ======== =========== ============ ============
(1) Includes $1,500,000 for recovery of provision for loan losses.
(2) The fourth quarter reflects the Fund's acquisition of the stock of NTS/LFII
and NTS/VA and consists substantially of the results of operations of NTS/LFII
and NTS/VA from October 1, 1997. The fourth quarter is also reflective of the
Fund's 50% share of the results of operations of the Orlando Lake Forest Joint
Venture. Total expenses include a non-cash charge of approximately $11,600,000
relating to the acquisition of NTS/LFII and NTS/VA.
(3) Includes approximately $382,000 for recovery of loan previously written off.
(4) Total expenses include a non-cash charge of approximately $3.7 million
related to the Fund's investment in unconsolidated affiliate.
41
18. Subsequent Events
- --- -----------------
Beginning January 1, 1999, the Fund has agreed to defray the remaining cost of
the capital improvements made by Beckley Station Disposal Systems, Inc.
("Beckley"), an affiliate of the Sponsor relative to Beckley's waste water
treatment facility. The facility is providing waste water treatment to the homes
constructed in the Lake Forest North project. The costs are to be reimbursed to
Beckley on a per lot basis over the remaining life of the Lake Forest North
project. The cost to be incurred will be approximately $1,598,000 over the life
of the project based on a per lot fee of approximately $2,400.
42
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of NTS Guaranty Corporation:
We have audited the accompanying balance sheets of NTS Guaranty Corporation (a
Kentucky corporation) as of December 31, 1998 and 1997. These balance sheets are
the responsibility of NTS Guaranty Corporation's management. Our responsibility
is to express an opinion on these balance sheets based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheets are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheets. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the balance sheets referred to above present fairly, in all
material respects, the financial position of NTS Guaranty Corporation as of
December 31, 1998 and 1997, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky
March 19, 1999
43
NTS GUARANTY CORPORATION
(A KENTUCKY CORPORATION)
BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1997
ASSETS
------
1998 1997
---- ----
Cash $100 $100
---- ----
$100 $100
==== ====
STOCKHOLDER'S EQUITY
--------------------
Common stock, no par value; 100 shares
issued and outstanding $ 10 $ 10
Additional paid-in capital 10,000,090 10,000,090
------------ ------------
10,000,100 10,000,100
Less non-interest bearing demand note
receivable from a majority stockholder
of NTS Corporation (10,000,000) (10,000,000)
------------ ------------
$ 100 $ 100
============ ============
NOTES TO BALANCE SHEETS
-----------------------
1. Significant Accounting Policies
- -- -------------------------------
A. Organization
-- ------------
NTS Guaranty Corporation (the "Guarantor"), a Kentucky corporation,
was formed in February 1987 and is an affiliate of NTS Corporation.
NTS Corporation is the Sponsor of the NTS Mortgage Income Fund (the
"Fund"). The balance sheets include only those assets and liabilities
which relate to the Guarantor. The Guarantor is authorized to issue
up to 2,000 shares of common stock with no par value. There are 100
shares issued and outstanding which were purchased by Mr. J. D.
Nichols, Chairman of the Board of Directors of the Sponsor and of the
Fund. In addition, Mr. Nichols has given the Guarantor a non-interest
bearing demand note receivable for $10,000,000, the receipt of which
is included in additional paid-in capital. Expenses (consisting
mostly of state taxes and licenses) of the Guarantor totaling
approximately $15 for each of the years ended December 31, 1998 and
1997, were paid by an affiliate of the Sponsor and therefore no
income statement is presented. These expenses will not be reimbursed
to the affiliate.
B. Use of Estimates in Preparation of Financial Statements
-- -------------------------------------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
44
2. Commitments
- -- -----------
The Guarantor has guaranteed that Investors of the Fund will receive,
over the life of the Fund, aggregate distributions from the Fund (from
all sources) in an amount at least equal to their Original Capital
Contributions, as defined in the Fund's Prospectus. As of December 31,
1998, the Fund has raised approximately $63,690,000 and has paid
distributions of approximately $23,141,000.
The liability of the Guarantor under the above guaranty is expressly
limited to its assets and its ability to draw upon a $10 million demand
note receivable from Mr. J. D. Nichols. Mr. Nichols has contingent
liabilities which have arisen in connection with the acquisition of
properties by himself or his affiliates. There can be no assurance that
Mr. Nichols will, if called upon, be able to honor his obligation to the
Guarantor. The total amounts guaranteed by the Guarantor are in excess of
its net worth, and there is no assurance that the Guarantor will be able
to satisfy its obligation under these commitments. The Guarantor may in
the future provide guaranties to other Affiliates of the Fund.
45
Item 9. Changes in and Disagreements with Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure
--------------------
There have been no changes in accountants or reported disagreements on any
matter of accounting principles, practices or financial statement disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
- -----------------------------------------------------------
The directors and principal officers of the Fund are as follows:
Name Office With the Fund
---- --------------------
J. D. Nichols Chairman of the Board of Directors
Robert M. Day Director*
Gerald B. Thomas Director*
Gerald B. Brenzel Director*
Richard L. Good President and Director
- --------------------------------------------------------------------------------
* Messr. Day, Thomas and Brenzel are the Independent Directors of the Fund.
Neither of them are employees, partners, officers or directors of the Sponsor or
any of its Affiliates.
J. D. Nichols (age 57) is Chairman of the Board and Chief Executive Officer of
- -------------
NTS Corporation and its various Affiliates and is a member and Chairman of the
Board of Directors of the NTS Mortgage Income Fund. He is a graduate of the
University of Louisville School of Law. His undergraduate studies were at the
University of Kentucky, where he concentrated in Accounting, Marketing and
Business Administration. Mr. Nichols entered the real estate construction and
development business in 1965 and has been involved in the development and
construction of over 6,500 acres of land and over 6,500,000 square feet of
office, residential, commercial and industrial space in numerous states
throughout the eastern half of the United States. He is a member of both the
Louisville and National Homebuilders Associations, and has served as Vice
President and Director of the Louisville and National Apartment Associations.
Mr. Nichols is also lifetime member of the President's Society of Bellarmine
College, Louisville, Kentucky and a past member of the Board of Overseers and
Board of Trustee of the University of Louisville, the Governors Council for
Education Technology and the Board of Directors of the Louisville Chamber of
Commerce. Mr. Nichols is currently a member of the Board of Directors of the
Regional Airport Authority of Louisville and Jefferson County and is a member of
the Board of Directors of the Greater Louisville Economic Development
Partnership.
Robert M. Day (age 46) has been Managing Director of Lambert, Smith & Hampton
- -------------
and its predecessor companies, Atlanta, Georgia, a commercial and industrial
real estate brokerage firm since 1985. Mr. Day received a Bachelor of Business
Administration degree from Georgia State University and holds an MAI designation
from the Appraisal Institute. Mr. Day is a member of the Atlanta Board of
Realtors, the Urban Land Institute and is on the operating committee of the
Atlanta Chapter of Young Life.
Gerald B. Thomas (age 60) has 25 years experience in Commercial Real Estate
- -----------------
lending. Formerly a Senior Vice President with Mid-American Bank of Louisville,
Mr. Thomas joined Citizens Bank of Kentucky in February 1996 as Vice President,
with responsibility of developing real estate portfolios for four Kentucky
affiliate banks of CNB Bancshares, Inc., Evansville, Indiana. Mr. Thomas has
attended Eastern Kentucky University, National School of Real Estate Finance
(Ohio State University) and National Institute of Real Estate Appraisers
(University of Louisville). He is a board member of Big Brothers/Big Sisters,
Louisville and Co-chairman of the Programs, Planning and Evaluation Committee.
46
Item 10. Directors and Executive Officers of the Registrant - Continued
- -----------------------------------------------------------------------
Gerald B. Brenzel (age 67) has over forty years experience in the securities
- -----------------
industry, most recently as First Vice President of Morgan, Keegin & Company in
Louisville, Kentucky. Prior to that, Mr. Brenzel was founder and CEO of
Commonwealth Investment Group, Inc., an investment money managers and regional
brokerage firm in Louisville. From 1964 to 1988, Mr. Benzel was regional Vice
President and Branch Manager of Stifel, Nicolaus & Company, and is a member of
the Board of that firm, was also an allied member of the New York Stock Exchange
(1964 thru 1988). A former Governor of the National Association of Securities
Dealers, Mr. Benzel attended the University of Louisville for three years and
also served three years in the U.S. Air Force during the Korean War.
Richard L. Good (age 59) is Vice Chairman of NTS Corporation, and Chairman of
- ---------------
the Board of NTS Securities, Inc. As such, Mr. Good oversees all operations of
NTS Corporation and its various subsidiaries and is responsible for residential
developments, commercial properties, property management, securities, finance
and corporate administration. From 1981 to 1984, Mr. Good was Executive Vice
President of Jacques-Miller, Inc., a real estate syndication, property
management and financial planning firm, and was responsible for corporate
systems, marketing and planning. Prior to 1981, Mr. Good held sales, marketing
and management positions, including sixteen years with IBM Corporation, where he
served as Branch Manager of the Data Processing Division in Nashville. Mr. Good
attended Stanford University and Case Western Reserve University and holds a
Bachelor of Science degree in Management Science from Case. He is a registered
securities principal and member of the International Association for Financial
Planning and the Real Estate Securities and Syndication Institute and is past
President of the Hurstbourne Corridor Business Association in Louisville. In
addition, he has served on the Board of Directors of Junior Achievement, the Boy
Scouts and Christ Church United Methodist and is a member of the Leadership
Louisville Class of 1990.
The Directors are not required to devote all of their time to the Fund, they are
only required to devote such of their time to the affairs of the Fund as their
duties require, and will meet quarterly or more frequently if necessary. It is
not expected that the Directors will be required to devote substantial portions
of their time to discharge their duties as Directors. For a description of
provisions concerning indemnification, see "Fiduciary Responsibility" on page 14
of the Fund's Prospectus, which description is filed herewith and incorporated
herein by reference.
The Directors, although not precluded from engaging in activities similar to the
Fund's, are required to disclose any interest held directly or indirectly by
them, or an Affiliate in an investment presented to the Fund. Furthermore,
Affiliated Directors must offer the Fund the right to engage in an investment
opportunity, which is within the Fund's objectives and policies, prior to
entering into such transaction themselves. The Fund will not pay a commission to
an Affiliate of any Director for presenting or disposing of the Fund's
investments.
The Fund will initially pay to each Independent Director a fee of $1,000 per
month (which amount may be increased or decreased in the discretion of the
Directors) and will reimburse such persons and Affiliated Directors for travel
expenses and other out-of-pocket disbursements incurred in connection with
attending any meetings. Affiliated Directors will not receive any compensation
from the Fund for their services as Directors or Officers of the Fund.
The Directors have retained NTS Advisory Corporation (the Advisor) to manage the
Fund's day-to-day affairs, and recommend investments suitable for the Fund. The
Advisor has delegated substantially all of its duties to NTS Corporation (NTS),
an affiliate of the Advisor. NTS has substantial experience in all phases of
real estate activities, including acquisition, financing, property management
and disposition.
47
Item 10. Directors and Executive Officers of the Registrant - Continued
- -----------------------------------------------------------------------
The following persons are the executive officers and key employees of NTS and/or
an affiliate and will provide services to the Advisor and the Fund:
Name Office
---- ------
J. D. Nichols Chairman and Chief Executive Officer
Richard L. Good Vice Chairman
Michael H. Hannon Executive Vice President, NTS Development Company
Brian F. Lavin President, NTS Development Company
Margaret O. Templeton President, NTS/Residential Properties, Inc. -
Florida
Gary D. Adams Senior Vice President, NTS Development Company
Sally A. Judah Senior Vice President, NTS Corporation
The following provides additional information regarding the above-mentioned
persons. Information regarding Messrs. Nichols and Good is provided in the
section entitled "Directors and Officers of the Fund."
Brian F. Lavin (age 45) serves as President of NTS Corporation and NTS
- ----------------
Development Company. As such, Mr. Lavin is responsible for all NTS commercial
real estate development and land acquisitions and oversees the management of all
commercial office buildings, business centers and multi-family residential
communities. Prior to joining NTS, Mr. Lavin served as President of the
Residential Division of Paragon Group, Inc., and as a Vice President of
Paragon's Midwest Division. In this capacity, he directed the development,
marketing, leasing and management operations for the firm's expanding
portfolios. Mr. Lavin attended the University of Missouri where he received his
Bachelor's Degree in Business Administration. He has served as a Director of the
Louisville Apartment Association. He is a licensed Kentucky Real Estate Broker
and Certified Property Manager. Mr. Lavin is a member of the Institute of Real
Estate Management, and council member of the Urban Land Institute. He currently
serves on the University of Louisville Board of Overseers and is on the Board of
Directors of the National Multi-Housing Council and the Louisville Science
Center.
Michael H. Hannon (age 55) serves as Executive Vice President of NTS Development
- -----------------
Company and President of NTS Residential Properties, Inc. Virginia where he
oversees the development, land acquisitions, marketing, operations, and general
management. Immediately prior to joining NTS, Mr. Hannon was employed by Hines
Interest Limited Partners as general manager for the Hines Rocky Mountain Region
from 1995 to February 1998. In addition to his responsibilities in The Rocky
Mountain Region, Mr. Hannon was responsible for Hines national residential
acquisition evaluations. Prior to 1995, Mr. Hannon served as Division President
for Arvida's South Atlantic Division, which included eleven residential
communities, including two Arnold Palmer Designed Golf Courses. Mr. Hannon
attended Grand View Junior College in Des Moines, Iowa and Parsons College in
Fairfield, Iowa. He is an active Member of the Urban Land Institute, National
Association of Home Builders and a licensed real estate broker in Colorado and
Florida. Mr. Hannon is a decorated Viet Nam Veteran, serving with the 1st
Infantry Division in Dian, South Viet Nam during 1965-1966.
Margaret O. Templeton (age 49) is President of NTS/Residential Properties, Inc.
- ---------------------
- - Florida with responsibility for single family residential development,
marketing and operations in the state of Florida. Prior to joining NTS in
November 1994, Ms. Templeton was President of Templeton Development Corporation,
a real estate development firm in Tampa, Florida from 1992 to November 1994. She
has extensive experience in marketing, construction and land development
including seven years (1985 to 1992) as Vice President of Tampa Palms and
Gulfstream Land and Development Company, whose holdings included 30,000 acres in
Florida, Georgia and Virginia. Ms. Templeton received a Bachelor of Arts degree
from the University of Florida. Ms. Templeton is a member and Director of the
National Association of Homebuilders, Florida Homebuilders Association as well
as Director and Vice President of the Builders Association of Greater Tampa and
Orlando. Ms. Templeton is also a member of the Florida Board of Realtors and the
Urban Land Institute.
48
Item 10. Directors and Executive Officers of the Registrant - Continued
- -----------------------------------------------------------------------
Gary D. Adams (age 53) is Senior Vice President of NTS Development Company with
- -------------
responsibility for multi-family operations and commercial properties in the
state of Florida. Since joining the NTS organization in May 1977, Mr. Adams has
been involved in the development, construction and management of numerous
apartment, office, industrial and commercial developments in the southeastern
portion of the United States. Mr. Adams received his undergraduate degree in
Engineering from the University of Cincinnati, and he holds a Master of Business
Administration from Xavier University. He is a member of the Building Owners and
Managers Association and is a licensed general contractor in the State of
Florida.
Sally A. Judah (age 40) is Senior Vice President of NTS Corporation with
- ---------------
responsibility for multi-family property management of NTS's apartment
communities in Kentucky and Indiana and the Human Resources area of Corporate
Administration of NTS Development Company. From July 1991 to 1994, Ms. Judah was
Vice President of NTS Corporation with responsibility for Corporate Marketing,
Human Resources and the Graphics Division. From June of 1987 when she joined NTS
until July 1991, Ms. Judah was responsible for leasing activities for commercial
properties in Louisville, Kentucky. Ms. Judah is a member of the Louisville
Board of Realtors and is a Certified Commercial Investment Member (CCIM)
Candidate and is a member of the national and Kentucky CCIM chapters. Ms. Judah
is also a member of the Louisville Apartment Association and is a member of the
Leadership Louisville Class of 1993. Ms. Judah holds a Bachelor of Arts degree
from the University of Kentucky.
Item 11. Executive Compensation
- -------------------------------
(a, b, c & d) The Fund will pay each Independent Director a fee of $12,000 per
year and will reimburse such persons and Affiliated Directors for travel
expenses and other out-of-pocket disbursements incurred in connection with
attending any meetings of the Board of Directors. During the years ended
December 31, 1998, 1997 and 1996, the Fund paid directors fees of $36,000,
$36,000 and $34,000, respectively, representing annual compensation. The
Affiliated Directors will not receive any compensation from the Fund for their
services to the Fund. The present officers of the Fund receive compensation from
the Advisor or its affiliates which indirectly relates to services to the Fund
(see Item 13).
The Fund is entitled to engage in various transactions involving the Advisor and
its affiliates, as described under captions "Compensation Table" at pages 9 and
10 of the Prospectus and "Conflicts of Interest" on pages 11 to 14 of the
Prospectus, which descriptions are filed herewith and incorporated herein by
reference. Reference is made to Note 9 of the Notes to the Fund's Consolidated
Financial Statements filed with this report for various transactions with
affiliates.
(e) There are no compensatory plans or arrangements resulting from resignation
or retirement of the Directors and executive officers which require payments to
be received from the Fund.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- -----------------------------------------------------------------------
(a) As of the date hereof, no person owns of record or is known by the Fund to
own beneficially more than five percent (5%) of the outstanding shares of common
stock of the Fund.
49
Item 12. Security Ownership of Certain Beneficial Owners and Management
- -----------------------------------------------------------------------
- Continued
-----------
(b) The following table sets forth the ownership of shares owned directly or
indirectly by the Directors and principal officers of the Fund as of the date
hereof:
Amount of Percent
Name of Beneficial of
Title of Class Beneficial Owner Ownership Interest
-------------- ---------------- --------- --------
Shares of Common J. D. Nichols 96,468 * 3.0%
Stock, $0.001 Shares
Par Shares
* These shares are owned of record by NTS Corporation or an Affiliate of which
Mr. Nichols directly or beneficially holds voting and investment authority.
(c) There are no known arrangements which may at a subsequent date result in
change in control of the Fund.
Item 13. Certain Relationships and Related Transactions
- -------------------------------------------------------
As of December 31, 1998, the Sponsor or an Affiliate owned 105,955 shares of the
Fund. The Fund thereby allowing Fawn Lake to utilize such funds for development
purposes entered into the following agreements with various Affiliates of the
Sponsor regarding the ongoing operation of the Fund.
Advisory Agreement
- ------------------
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS Advisory
Corporation) a Management Expense Allowance from inception of the Fund through
September 30, 1997 (Advisory Fee) relating to services performed for the Fund in
an amount equal to 1% of the Fund's Net Assets, per annum, which amount was
increased annually by an amount corresponding to the percentage increase in the
Consumer Price Index. Effective July 1, 1994, the Fund's Mortgage Loans to Fawn
Lake and Lake Forest were converted to cash flow mortgage loans. As part of the
consideration for this restructuring, the Fund's Board of Directors required,
among other things, that beginning in 1995, NTS Advisory Corporation pay
$100,000 annually towards the expenses of the Fund until the maturity of the
Mortgage Loans. As such, the Advisory Fee has been reduced $100,000 for the year
ended December 31, 1996 and $75,000 for the year ended December 31, 1997.
For the years ended December 31, 1997 and 1996, $418,950 and $544,776,
respectively, had been incurred as an Advisory Fee. Effective October 1, 1997,
the Fund no longer incurred an Advisory Fee but is now responsible for the
actual general and administrative costs pursuant to certain property management
agreements discussed below.
Property Management Agreements
- ------------------------------
The ongoing operation and management of the Lake Forest North and Fawn Lake
projects will be conducted by NTS Residential Management Company (NTS
Management) under the terms of (i) a Property Management Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a
Property Management Agreement executed on December 30, 1997, and dated as of
October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn
Lake project (collectively, the Management Agreements). NTS Management is a
wholly-owned subsidiary of NTS Development Company. NTS Development Company is a
wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an
initial term through December 31, 2003, subject to extension under certain
conditions, and are
50
Property Management Agreements - Continued
- ------------------------------------------
renewable for successive six (6) year terms thereafter. Under the Management
Agreements, NTS Management will be reimbursed for costs incurred in the
operation and management of the Lake Forest North and Fawn Lake projects, will
be entitled to an Overhead Recovery, and will accrue an incentive payment
payable all as provided therein.
These expense reimbursements included direct and pro-rated costs incurred in the
management and operation of NTS/LF II and NTS/VA. Such costs include
compensation costs of management, accounting, professional, engineering and
development, marketing and office personnel employed by NTS management and/or
certain of its affiliates as well as various non payroll related operating
expenses. Compensation costs are for those individuals who rendered services
full time and on site at the residential projects, with respect to the
residential projects but who are not on site and with respect to the residential
projects but who have multiple residential projects responsibilities some of
which may be affiliated entities of NTS Management. For services provided by
individuals not on site or those with multiple residential project
responsibilities, costs are pro-rated by NTS Management and allocated to the
appropriate residential project. As permitted by the Property Management
Agreements, the Fund was charged the following amounts for the year ended
December 31, 1998 and the period from October 1, 1997 through December 31, 1997.
These amounts are reflected in Selling, General and Administrative - Affiliated
on the accompanying Statement of Operations:
1998 1997
---- ----
Personnel Related Costs:
Finance and Accounting $ 172,409 $ 23,624
Data Processing 6,037 --
Human Resources 35,299 --
Executive and Administrative Services 186,199 105,920
Construction Management 38,616 8,539
Sales and Marketing 712,582 185,295
Legal 72,488 --
Marketing 124,840 129,124
Rent 33,584 13,641
Other General and Administrative 56,556 60,428
---------- ---------
Total Expense Reimbursements $ 1,438,610 $ 526,571
========== =========
Additionally, NTS Management is entitled to an Overhead Recovery, which is a
reimbursement for overhead expenses attributable to the employees and the
efforts of NTS Management under the Management Agreements, in an amount equal to
3.75% of the projects' gross cash receipts, as defined in the Management
Agreements. Overhead recovery for the year ended December 31, 1998 was $496,174
and $106,473 for the period October 1, 1997 through December 31, 1997. These
amounts are classified with Selling, General and Administrative - Affiliated in
the accompanying Statements of Operations.
The Management Agreements also call for NTS Management to receive an Incentive
Payment, as defined in the Management Agreements, equal to 10% of the Net Cash
Flows of the projects. The Incentive Payment will not begin accruing until after
the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash
flow of the Orlando Lake Forest Joint Venture would have been sufficient to
enable the Fund to return to the then existing shareholders of the Fund an
amount
51
Property Management Agreements - Continued
- ------------------------------------------
which, after adding thereto all other payments actually remitted or distributed
to such shareholders of the Fund, is at least equal to the shareholders'
Original Capital Contribution. As of December 31, 1997, the Fund had raised
approximately $63,690,000 and had paid distributions of approximately
$23,141,000. As of December 31, 1998, no amount had been accrued as an Incentive
Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates
- -------------------------------------
NTS/VA has received non-interest bearing advances from Affiliates of the Fund's
Sponsor totaling $600,542 as of December 31, 1997. The advances were used to
fund development costs and were to be repaid to the Affiliates as cash flow
permits. As of December 31, 1998, the balance has been paid in full.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of
repayments, totaling $6,090,293 and $5,309,492 as of December 31, 1998 and 1997,
respectively. As of December 31, 1998, the advances bear interest at
approximately the Prime Rate and mature on May 31, 2006. The Affiliate has
represented that it will not demand repayment on any amounts owed during 1999,
unless cash flows are adequate to allow such repayment. For the year ended
December 31, 1998, the interest expense to affiliate totaling $341,213 was
capitalized in inventory. For the years ended December 31, 1997 and 1996,
interest was expensed totaling $358,226 and $258,191, respectively.
52
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- -------------------------------------------------------------------------
1. Financial statements
The financial statements for the NTS Mortgage Income Fund and NTS
Guaranty Corporation together with the reports of Arthur Andersen LLP
dated March 19, 1999.
2. Financial statement schedules
All schedules have been omitted because they are not applicable, are not
required, or because the required information is included in the
financial statements or notes thereto.
3. Exhibits
a) The following exhibits are incorporated by reference from the
Fund's Registration Statement on Form S-11, referencing the
exhibit number used in such Registration Statement.
Exhibit Number Description
-------------- -----------
3 (a)(2) Restated Certificate of Incorporation
3 (b) By-Laws
10 (c) Form of Advisory Agreement
10 (b) Form of Guaranty Agreement
b) The following exhibits are incorporated by reference from the Fund's
Form 8-K dated January 14, 1998.
Exhibit Number Description
-------------- -----------
10 Material contracts - The agreements
whereby the Fund acquired all of the
issued and outstanding common capital
stock of NTS/LFII and NTS/VA, and the
Property Management Agreements between
the Fund and NTS Management.
c) The following are additional exhibits filed with the Form 10-K Report.
Exhibit Number Description
-------------- -----------
27 Financial Data Schedule
99 Additional Exhibits - Pages
from the Fund's prospectus
which have been
specifically incorporated
by reference and copies of
which are attached hereto
which include pages 9 to 14
and pages 75 to 81.
4. Reports on Form 8-K.
None.
53
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities exchange
Act of 1934, NTS Mortgage Income Fund has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
NTS MORTGAGE INCOME FUND
/s/ Richard L. Good Date: March 31, 1999
- -----------------------------------------
Richard L. Good
President and Director of the NTS Mortgage Income Fund
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Form 10-K has been signed below by the following persons on behalf of the
registrant in their capacities and on the date indicated.
/s/ J. D. Nichols Date: March 31, 1999
- -----------------------------------------
J. D. Nichols
Chairman of the Board of Directors
of the NTS Mortgage Income Fund
/s/ Gerald B. Brenzel Date: March 31, 1999
- -----------------------------------------
Gerald B. Brenzel
Director of the NTS Mortgage Income Fund
/s/ Robert M. Day Date: March 31, 1999
- -----------------------------------------
Robert M. Day
Director of the NTS Mortgage Income Fund
/s/ Gerald B. Thomas Date: March 31, 1999
- -----------------------------------------
Gerald B. Thomas
Director of the NTS Mortgage Income Fund
/s/ Richard L. Good Date: March 31, 1999
- -----------------------------------------
Richard L. Good
President and Director of the
NTS Mortgage Income Fund (acting as
Chief Financial Officer)
54