SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q Quarterly Report Under Section 13 or 15(d) Of the Securities Exchange Act of 1934 For Quarter Ended September 30, 2000 Commission File No. 000-16950 Prometheus Income Partners, a California Limited Partnership (Exact name of registrant as specified in its charter) California 77-0082138 (State or other jurisdiction of (IRS employee ID Number) incorporation or organization) 350 Bridge Parkway Redwood City, California 94065-1517 (Address of principal (Zip code) executive offices) Registrant's telephone number, including area code: (650) 596-5300 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] PART I: FINANCIAL INFORMATION Item 1. Condensed Financial Statements The accompanying unaudited financial statements should be read in conjunction with the Form 10-K filed by the Partnership for the year ended December 31, 1999. These statements have been prepared in accordance with the instructions of the Securities and Exchange Commission Form 10-Q and do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Historically the Registrant's Form 10-Q filings have not made any adjustments for the capitalization of improvements except in conjunction with the year-end financial statements. While the financial information is unaudited, in the opinion of the Partnership, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. The results of operations for the three months and nine months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. PROMETHEUS INCOME PARTNERS a California Limited Partnership BALANCE SHEETS SEPTEMBER 30, 2000 AND DECEMBER 31, 1999 (Unaudited and In Thousands, Except for Unit Data) September 30, December 31, 	 2000 1999 						 		 ------------ ------------ ASSETS Real Estate: Land, buildings and improvements $ 30,635 $ 30,288 Accumulated depreciation (8,714) (8,183) 						 		 ------------ ------------ 21,921 22,105 Cash and cash equivalents 2,823 1,942 Restricted cash 5,176 4,558 Deferred expenses, net 217 239 Accounts receivable and other assets 39 29 						 		 ----------- ------------ Total assets $ 30,176 $ 28,873 						 		 ----------- ------------ 					 	 		 ----------- ------------ LIABILITIES AND PARTNERS' CAPITAL (DEFICIT) Notes payable $ 25,958 $ 26,188 Payables and accrued liabilities 389 323 						 ----------- ------------ Total liabilities 26,347 26,511 						 ----------- ------------ General partner capital deficit (363) (378) Limited partners' capital 18,995 limited partnership units issued and outstanding 4,192 2,740 						 ----------- ------------ Total partners' capital 3,829 2,362 Total liabilities and partners' capital $ 30,176 $ 28,873 								 ----------- ------------ 								 ----------- ------------ The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 (Unaudited and In Thousands, Except for Unit Data) 	 2000 1999 							 -------- -------- REVENUES Rental $ 1,724 $ 1,422 Other income 20 55 Interest income 117 49 							 -------- -------- Total revenues 1,861 1,526 							 -------- -------- EXPENSES Interest and amortization 465 470 Operating 368 325 Depreciation 173 142 Administrative 18 14 Payments to general partner and affiliates: Operating and administrative 143 121 Management fees 92 74 							 -------- -------- Total expenses 1,259 1,146 							 -------- -------- NET INCOME $ 602 $ 380 							 -------- -------- 							 -------- -------- Net income per $1,000 limited partnership unit $ 31 $ 20 							 -------- -------- 							 -------- -------- Number of limited partnership units used in computation 18,995 18,995 							 -------- -------- 							 -------- -------- The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 (Unaudited and In Thousands, Except for Unit Data) 2000 1999 							 -------- -------- REVENUES Rental $ 4,839 $ 4,219 Other income 71 149 Interest income 335 172 							 -------- -------- Total revenues 5,245 4,540 							 -------- -------- EXPENSES Interest and amortization 1,397 1,331 Operating 1,176 946 Depreciation 531 433 Administrative 41 46 Payments to general partner and affiliates: Operating and administrative 358 351 Management fees 274 221 							 -------- -------- Total expenses 3,777 3,328 							 -------- -------- NET INCOME $ 1,468 $ 1,212 							 -------- -------- 							 -------- -------- Net income per $1,000 limited partnership unit $ 77 $ 63 							 -------- -------- 									 -------- -------- Number of limited partnership units used in computation 18,995 18,995 							 -------- -------- 							 -------- -------- The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999 (Unaudited and In Thousands) 2000 1999 							 -------- -------- CASH FLOW FROM OPERATING ACTIVITIES Net income $ 1,468 $ 1,212 Adjustments to reconcile net income to cash provided by operating activities: Depreciation 531 433 Amortization 22 22 (Increase) decrease in accounts receivable and other assets (10) 35 Decrease (increase) in payables and accrued liabilities 65 (145) Net cash provided by operating activities 2,076 1,557 							 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Increase in fixed assets additions (347) (183) 							 -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Increase in restricted cash (618) (512) Principal reductions on notes payable (230) (214) 							 -------- -------- Net cash used for financing activities (848) (726) 							 -------- -------- Net increase in cash and cash equivalents 881 648 Cash and cash equivalents at beginning of year 1,942 1,183 							 -------- -------- Cash and cash equivalents at end of period $ 2,823 $ 1,831 							 -------- -------- 							 -------- -------- The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership NOTES TO FINANCIAL STATEMENTS 1. THE PARTNERSHIP Prometheus Income Partners, a California Limited Partnership (the Partnership"),was formed to construct, invest in, operate and ultimately sell two multi-family apartment projects ("Properties"), Alderwood Apartments ("Alderwood") and Timberleaf Apartments ("Timberleaf"), located in Santa Clara, California. The General Partner is Prometheus Development Co., Inc., a California corporation. The financial information has been restated to reflect capitalization of improvements on a basis consistent with the practice followed annually. The financial information included herein at September 30, 2000 and for the three and nine months ended September 30, 2000 and 1999 is unaudited and, in the opinion of the Partnership, reflects all adjustments (which include only normal recurring accruals) necessary for a fair presentation of the financial position as of those dates and the results of operations for those periods. Management fees and payments to the General Partner and Affiliates represent compensation for services provided and certain expense reimbursements, at cost, in accordance with the Partnership Agreement. The information in the Balance Sheets at December 31, 1999 was derived from the Partnership's audited annual report for 1999. Partnership profits, losses and distributions are allocated among the partners based on the provisions of the Partnership Agreement, which generally provide for allocations to begin when the partners are admitted to the partnership. 2. INCOME TAXES No income taxes are levied on the Partnership; rather, such taxes are levied on the individual partners. Consequently, no provision or liability for federal or California income taxes has been reflected in the accompanying financial statements. The net income or loss for financial reporting purposes differs from the net income or loss for income tax reporting purposes primarily due to differences in useful lives and depreciation methods for building and improvements and amortization of construction period interest and taxes. 3. CONSTRUCTION DEFECTS In June 1996, Prometheus Development Co. learned that the hardboard siding used at both Alderwood and Timberleaf was beginning to fail. That was the first indication of potential product failure at these properties, and the general partner commissioned a survey of the sites. NOTES TO FINANCIAL STATEMENTS 3. CONSTRUCTION DEFECTS (Continued) On June 26, 1996, experts conducted the first visual inspection of Alderwood with respect to the defects on behalf of Prometheus Income Partners. Throughout 1997 and 1998, the partnership inspected and investigated Alderwood with respect to the construction defects, and in March and November 1998, various defendants inspected and investigated Adlerwood as well. Similarly, on July 11, 1996 experts conducted the first visual inspection of Timberleaf. Additional investigations took place in 1997, 1998 and 2000. As of the dates of these inspections, moisture had accumulated in the walls of these projects through a combination of construction defects and endemic problems with the hardboard siding. Sufficient moisture over time causes rot and decay in the wood, framing and siding which necessitates repairs which, in some cases, are structural in nature. Rot and decay, which form inside the wall, are not visible, and until rot and decay have caused changes in the physical appearance of the exterior of the buildings, it is difficult to ascertain all the locations where rot and decay exist. On September 23, 1996, Prometheus Income Partners filed two lawsuits against the siding manufacturer, the general contractor, the subcontractors and the architects, one for each of its properties, regarding problems at the properties stemming from the hardboard siding. Each of these persons has denied responsibility for the defects. In October 1997, a cross-claim was filed by one of the defendants in each of these lawsuits against the partnership seeking relief against other parties to the litigation if either filing party is found liable in the litigation. This cross claim was tendered to the partnership's insurance carrier, counsel for whom has denied all allegations. The general partner does not believe there is a substantial risk of recovery against the partnership on this claim, but there is no assurance a judgment will not be rendered against the partnership based on this claim. As part of the inspections discussed above, certain structural issues caused by the defects in the hardboard siding were uncovered at Alderwood and Timberleaf and were rebuilt as part of an immediate repair process. Prometheus Development Co. subsequently determined that additional immediate repairs were necessary, which, with the exception of roof repairs noted below, have been completed. Prometheus Development Co. continues to monitor the condition of the property to look for any other signs of rot and decay that would necessitate immediate attention and repair. In addition to the hardboard siding problems, in September 1999 routine roofing inspection uncovered failing roof substrate at dormer roof assemblies for Alderwood and Timberleaf. Prometheus Development Co. traced the cause of this roofing problem to inadequate venting of the roof space. Inadequate venting leads to condensation in roof areas. This has been sufficient to cause deflection and decay of the roof and its structural support, requiring replacement. Prometheus Development Co. is in the process of getting roof repair design and repair bids, some of which have been received, and is evaluating these bids and defining the scope of necessary repairs (a small fraction of which have been made to date). NOTES TO FINANCIAL STATEMENTS 3. CONSTRUCTION DEFECTS (Continued) Based on information currently available to the general partner, damages and economic loss appear to be in the range of $19-$20 million. Since 1997, both cases have been under the supervision of a Special Master who is appointed and empowered by the court to assist in resolving the cases. Investigations and other subsequent discoveries have been ordered by the Special Master on behalf of both plaintiffs and defendants in an effort to come to a settlement. Destructive investigation, completed under the order of the Special Master in March 1998 for Alderwood and May 1998 for Timberleaf, has produced a preliminary issues list which the Special Master will use in attempting to prompt a settlement from the defendants. This information is protected by the Special Master and is not for general distribution. Additional testing and investigations have been conducted periodically on the properties and continue to be performed from time to time. The first settlement conference supervised by the Special Master was held on March 11, 1997 among the various defendants and Prometheus Income Partners. Since then, there have been conferences with respect to Timberleaf in May, June, September and December 1997, April, June, August, October and December 1998, and February, June and October 1999. There have also been conferences with respect to Alderwood in January, March, April, September, October and November of 1999. None of these conferences produced a settlement, and so on May 5, 2000, the judge ordered another mandatory settlement conference to be held on August 16, 2000. No settlement was reached at this conference. It is possible that a settlement of pending litigation can occur anytime, but based on the lack of any agreement on the terms or parameters of a settlement arising out of prior settlement conferences and discussions, and that the sides are far apart in terms of the framework for any potential settlement, Prometheus Development Co. believes settlement in the near term to be unlikely. A trial date is expected to be set by the superior court for the second quarter of 2001. Under applicable law and court rules, a trial date must be set prior to September 9, 2001, five years after Prometheus Development Co. filed the initial complaints. The discovery of additional construction defect problems, as discussed above, may result in additional delays. The terms of the mortgages on the properties require that a security account be maintained for each property to cover contingent liabilities with respect to defects in the properties' hardboard siding. These security accounts are additional collateral for the lender, and total, as of September 30, 2000, approximately $5,176,000. Because there is no current prospect for settling the hardboard siding litigation or of refinancing the properties to remove these covenants, there are no current prospects for the liquidation and distribution of these accounts to limited partners. In addition to the security accounts mandated under the partnerships' financing arrangements, Prometheus Development Co. has determined that it is in the best interest of the partnership NOTES TO FINANCIAL STATEMENTS 3. CONSTRUCTION DEFECTS (Continued) to continue building reserves for the potential cost of dealing with known and unknown construction defects. Prometheus Development Co. currently maintains an additional account totaling as of September 30, 2000 approximately $2,154,000, which is primarily intended to cover additional contingent liabilities related to the hardboard siding defects and other matters. The extent and magnitude of the construction defects continues to worsen with time. Prometheus Development Co. believes that Prometheus Income Partners can no longer wait for the cases to be resolved and has authorized the start of repairs using the cash reserve funds currently held. As of September 30, 2000, Prometheus Income Partners has spent approximately $1,550,000 on emergency repairs and litigation expenditures. Assuming that the litigation is not successfully resolved, over the next twelve months the partnership anticipates spending approximately $1,900,000 to $2,400,000 on additional urgent repairs. It is anticipated that funds held in reserve are not adequate to repair the entire project, so completion of the most critical projects will be prioritized. The cost of pursuing litigation also is significant. Prometheus Development Co. cannot predict or estimate what amounts, if any, will be recovered through litigation. 4. REAL ESTATE Statement of Financial Accounting Standards 121 ("FASB 121"), Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of, requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In connection with the construction defects (see Note 3), the General Partner reviewed the cash flows of both properties to ensure an adjustment of the book value was not required in accordance with FASB 121. Further, although the full extent of the damage to the construction defects for these two properties is unknown, management believes that the fair market value of each property still remains greater than their respective book values. ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction Alderwood and Timberleaf, which are located in Santa Clara, California, are apartment complexes with 234 units and 124 units, respectively. The properties commenced operations at completion of construction in December 1986. Liquidity and Capital Resources Cash generated by operations during the first nine months of 2000 was used to pay current operating expenses and debt service, including payments to the hardboard siding security account. Quarterly distributions have been suspended in order to accumulate working capital reserves until the degree of damage to the construction defects and determination of liability are known. See Note 3 to Financial Statements, Construction Defects, for a more comprehensive discussion of this matter. Each property has a non-recourse note payable, secured by a first deed of trust. These notes bear fixed interest of 6.99% for Alderwood and 7.09% for Timberleaf. The terms of the notes require that each property maintain a hardboard siding security account. These security accounts are additional collateral for the lender. Cash held in these security accounts was $2,993,000 and $2,183,000 for Alderwood and Timberleaf, respectively, as of September 2000. Until the Completion Date, as defined, an additional 10% of the initial contributions, as defined, or monthly cash flow, whichever is less, shall be deposited into each security account. Should the hardboard siding repairs not be completed by December 2002, or every two years thereafter, and insufficient cash has been accumulated to cure the defects based upon the lender's determination of the cost, then all cash flow shall be deposited into each applicable security account, as necessary, to fully fund the cost of construction. If the projected cash flow is insufficient to satisfy this deficiency contribution, then the Partnership has 60 days to fund the shortage over the projected cash flow. No withdrawals are permitted from the account except to cure the siding defects. The lender shall have the right to hire its own consultants to review, approve and inspect the construction. All such reasonable fees and expenses incurred by the lender shall be paid by the Partnership. Should the litigation not be settled by December 2002, and the Partnership has met all its obligations under the notes, then the Completion Date shall be extended 18 months from the earlier of the pending settlement date or the last day for filing an appeal. Should construction not be completed by the Completion Date due to an act of force majeure, the Completion Date can be further extended to complete the construction work. Results of Operations During the past year, Santa Clara County has continued to experience growth in the creation of new jobs; the unemployment rate fell to a low of 3.1%. This continued job growth has helped offset the impact of new housing developed. The increased demand allowed for increases in market rates during the third quarter on both unit types at both properties. In the third quarter of 2000, the properties marketed available units at rents that averaged $1,832 for one-bedroom units and $2,238 for two bedroom units. Average occupied rent per unit for the quarter was $1,620 and average occupancy during the quarter was 98% for both Alderwood and Timberleaf. As of September 30, 2000, Alderwood and Timberleaf were 99% and 100% occupied, respectively. In the third quarter of 1999, the properties marketed available units at rents that averaged $1,334 for one-bedroom units and $1,569 for two bedroom units. Average occupied rent per unit for the quarter was $1,378, and average occupancy during the quarter was 98% for both Alderwood and Timberleaf. As of September 30, 1999, Alderwood and Timberleaf were both 98% occupied. Excluding expenditures, relating to quantification of the extent of damage to the hardboard siding and associated litigation costs, and other construction defects, operating expenses increased 13%. The following third quarter operating expenses increased between years: Payroll, Benefits and Taxes primarily due to rental agent commissions and employee benefits; On- Site Administration due to employee training and help wanted ads; Management Fees due to increased revenue and timing of construction management; Professional Services due to increased unlawful detainers filed; and Major Repairs & Maintenance primarily due to fountain repairs and landscaping. These increases were offset by decreases in expenses between years for: Repairs & Maintenance due to window cleaning and fire prevention, and a decease in supplies purchased for lighting, glass and screens, and doors, locks and keys; and Miscellaneous Partnership primarily due to the timing of the audit and tax services. Operating expenses, inclusive of hardboard siding related costs, increased 16%. Overall, net operating income increased 19% during the three months ended September 30, 2000 when compared to 1999. PART II: OTHER INFORMATION Item 1. Legal Proceedings. None. Item 2. Changes in Securities. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. None. SIGNATURES Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROMETHEUS INCOME PARTNERS, a California Limited Partnership By: PROMETHEUS DEVELOPMENT CO., INC., a California corporation, it's General Partner Date: November 10, 2000 By: /s/ Vicki R. Mullins Vice President Date: November 10, 2000 By: /s/ John J. Murphy Vice President