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 June 30, 2001 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 Employer 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, 2000. 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.
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 and six months ended June 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001.
PROMETHEUS INCOME PARTNERS
a California Limited Partnership
BALANCE SHEETS
JUNE 30, 2001 AND DECEMBER 31, 2000
(Unaudited and in Thousands, Except for Unit Data)
June 30, December 31,
2001 2000
---------- ------------
ASSETS
Real Estate:
Land, buildings and improvements $ 31,002 $ 30,778
Accumulated depreciation (9,155) (8,801)
-------- --------
21,847 21,977
Cash and cash equivalents 3,987 3,568
Restricted cash 5,773 5,256
Deferred financial costs, net
of accumulated amortization of $105 and $90 194 209
Accounts receivable and other assets 327 78
-------- --------
Total assets $ 32,128 $ 31,088
======== ========
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT)
Notes payable $ 25,716 $ 25,879
Payables and accrued liabilities 326 439
-------- --------
Total liabilities 26,042 26,318
-------- --------
General partner deficit (340) (354)
Limited partners' capital
18,995 limited partnership units
issued and outstanding 6,426 5,124
-------- --------
Total partners' capital (deficit) 6,086 4,770
-------- --------
Total liabilities and partners' capital (deficit) $ 32,128 $ 31,088
======== ========
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 JUNE 30, 2001 AND 2000
(Unaudited and in Thousands, Except for Unit Data)
2001 2000
---- ----
REVENUES
Rental $ 1,935 $ 1,595
Other income 14 24
Interest income 104 104
------- -------
Total revenues 2,053 1,723
------- -------
EXPENSES
Interest and amortization 460 465
Operating 622 405
Depreciation 179 174
Administrative 12 10
Payments to general partner and affiliates:
Management fees 100 104
Operating and administrative 168 138
------- -------
Total expenses 1,541 1,296
------- -------
NET INCOME $ 512 $ 427
======= =======
Net income per $1,000
limited partnership unit $ 27 $ 22
======= =======
Number of limited partnership
units used in computation 18,995 18,995
======= =======
The accompanying notes are an integral
part of these financial tatements.
PROMETHEUS INCOME PARTNERS
a California Limited Partnership
STATEMENTS OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000
(Unaudited and in Thousands, Except for Unit Data)
2001 2000
---- ----
REVENUES
Rental $ 3,863 $ 3,115
Other income 27 51
Interest income 229 218
------- -------
Total revenues 4,119 3,384
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EXPENSES
Interest and amortization 922 933
Operating 994 773
Depreciation 354 348
Administrative 25 23
Payments to general partner and affiliates:
Management fees 198 182
Operating and administrative 310 247
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Total expenses 2,803 2,506
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NET INCOME $ 1,316 $ 878
======= =======
Net income per $1,000
limited partnership unit $ 69 $ 46
======= =======
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 SIX MONTHS ENDED JUNE 30, 2001 AND 2000
(Unaudited and in Thousands)
2001 2000
---- ----
CASH FLOW FROM OPERATING ACTIVITIES
Net income $ 1,316 $ 878
Adjustments to reconcile net income
to cash provided by operating activities:
Depreciation 354 348
Amortization 15 15
Increase in accounts receivable and other assets (249) (32)
Decrease in payables and accrued liabilities (113) (45)
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Net cash provided by operating activities 1,323 1,164
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CASH FLOW FROM INVESTING ACTIVITIES
Increase in fixed asset additions (224) (214)
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CASH FLOWS FROM FINANCING ACTIVITIES
Increase in restricted cash (517) (539)
Principal reductions on notes payable (163) (152)
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Net cash used for financing activities (680) (691)
------- -------
Net increase in cash and cash equivalents 419 259
Cash and cash equivalents at beginning of year 3,568 1,942
------- -------
Cash and cash equivalents at end of period $ 3,987 $ 2,201
======= =======
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 (the "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 included herein at June 30, 2001 and for the
three and six months ended June 30, 2001 and 2000 is unaudited and, in the
opinion of the Partnership, reflects all adjustments (which include only normal
recurring adjustments) 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 requirements, at cost, in
accordance with the Partnership Agreement. The information in the Balance Sheets
at December 31, 2000 was derived from the Partnership's audited annual report
for 2000.
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 buildings and
improvements and amortization of construction period interest and taxes.
Syndication costs incurred in raising Limited Partners' capital were charged to
Limited Partners' capital.
3. CONSTRUCTION DEFECTS
In June 1996, The General Partner 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.
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 Alderwood as well. Similarly, on
July 11, 1996 experts conducted the first visual inspection of Timberleaf.
Additional investigations took place in 1997, 1998 and 2000.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. CONSTRUCTION DEFECTS (CONTINUED)
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 parties 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. The General
Partner subsequently determined that additional immediate repairs were
necessary, which, with the exception of a portion of the roof repairs noted
below, have been completed. The General Partner 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. The General Partner 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. The General Partner has received design specifications for remedial
roof repairs and has completed a prototype repair of four dormer roof
assemblies. The General Partner has executed a contract for those dormer roof
assemblies identified by the Partnership's consulting engineer as in need of
immediate repairs. These repairs are currently underway at Alderwood.
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
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. CONSTRUCTION DEFECTS (CONTINUED)
produced a preliminary issues list, which the Special Master has used in the
settlement efforts for both properties. 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. A final settlement conference was held May 14,
2001, as further discussed below on the eve of trial and a global agreement was
reached with all parties and entered into the record.
There have also been conferences with respect to Alderwood in January,
March, April, September, October and November of 1999. Alderwood is scheduled
for trial October 1, 2001 and additional settlement conferences will be held in
conjunction with the trial date in an attempt to reach agreement with the
parties.
On March 26, 2001, the Partnership reached a settlement with one of
several principal defendants in the two lawsuits. Under the terms of this
settlement, this defendant has agreed to pay an aggregate of $3.58 million for
the full and final settlement of the claims against it. Of this amount, the
Partnership would receive a net amount of approximately $2.3 million, after
payment of attorneys' fees, costs and a litigation management fee of 3% of the
gross settlement to an affiliate of the General Partner. This settlement is
subject to the approval of the court and the approval of interconnected
settlements in related lawsuits by the respective courts in which such suits are
being tried.
On May 22, 2001, the Partnership reached a settlement with the remaining
defendants in the litigation relating to the Partnership's Timberleaf apartment
property. Under the terms of the Timberleaf settlement, the remaining defendants
have agreed to pay an aggregate of $4.86 million to the Partnership for the full
and final settlement of the claims against them. Of this amount, the Partnership
will receive a net amount of approximately $3.3 million, after payment of
attorney's fees, costs and a litigation management fee of 3% of the gross
settlement to an affiliate of the General Partner. This settlement is subject to
the approval of the court.
The partnership intends to continue to pursue vigorously its claims
against the remaining defendants in the litigation regarding the Alderwood
apartment property.
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 June 30, 2001,
approximately $5,773,000.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. CONSTRUCTION DEFECTS (CONTINUED)
In addition to the security accounts mandated under the Partnership's
financing arrangements, the General Partner has determined that it is in the
best interest of the Partnership to continue building reserves for the potential
cost of dealing with known and unknown construction defects. The General Partner
currently maintains an additional cash account totaling, as of June 30, 2001,
approximately $3,987,000, which is primarily intended to cover additional
contingent liabilities related to the construction defects and other matters.
As of June 30, 2001, Prometheus Income Partners has spent approximately
$2,153,000 on emergency repairs and litigation expenditures. Assuming that the
remaining 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. The General Partner cannot predict or estimate what amounts will be
recovered through the remaining litigation.
4. REAL ESTATE
Statement of Financial Accounting Standards 121 ("SFAS 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 defect problems, the General
Partner reviewed the projected cash flows of both Properties to ensure an
adjustment of the book value was not required in accordance with SFAS 121.
Further, although the full extent of the damage to the hardboard siding for the
Properties is unknown, management believes that the fair market value of each
Property still remains greater than its respective book value.
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 six months of 2001 was
used to pay current operating expenses and debt service, including payments to
the hardboard siding security accounts.
Quarterly distributions have been suspended in order to accumulate
working capital reserves until the degree of damage from 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 $3,338,000 and $2,435,000
for Alderwood and Timberleaf, respectively, as of June 30, 2001. 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
- ---------------------
Santa Clara County has experienced a decrease of 7,300 jobs since the
first quarter of 2001, and unemployment increased from 2.2% in the first quarter
of 2001 to 4.2% in the second quarter of 2001. The volatility being experienced
in the high tech industry and the layoffs from local companies has caused the
demand from prospective residents to drop off significantly and has caused many
current residents to leave the area. Along with the drop in demand and
occupancy, there has been an average decrease of 8.7% in market rates. In
response to the market, Alderwood and Timberleaf offered rental concessions
ranging from $300 off the first month's rent to one month free for a one-year
lease. In the second quarter of 2001, the Properties marketed available units at
rents that averaged $1,618 for one-bedroom units and $2,070 for two-bedroom
units. Average occupied rent per unit for the quarter was $1,874 and average
occupancy during the quarter was 96% for Alderwood and 95% for Timberleaf. As of
June 30, 2001, Alderwood was 93% occupied and Timberleaf was 90% occupied.
In the second quarter of 2000, the Properties marketed available units
at rents that average $1,653 for one-bedroom units and $2,082 for two bedroom
units. Average occupied rent per unit for the quarter was $1,505 and average
occupancy during the quarter was 99% for Alderwood and Timberleaf. As of June
30, 2000, Alderwood was 99% occupied and Timberleaf was 100% occupied.
Excluding expenditures relating to quantification of the extent of
construction defects and associated litigation costs, operating expenses
increased 14%. The following second quarter operating expenses increased between
years: Payroll, Benefits and Payroll Taxes due to salary and benefit increases,
the use of roving maintenance and temporary help, and overtime paid; Utilities
primarily due to increases in gas rates; Marketing due to media and advertising;
Insurance due to premium increases. These increases were offset by a decrease in
Repairs and Maintenance due to timing of window cleaning expenses. Operating
expenses, inclusive of hardboard siding related costs, increased 37%.
Overall, net operating income increased 8% during the three months ended June
30, 2001 when compared to the three months ended June 30, 2000.
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. The following report on Form 8-K was filed during the period covered by
this report.
The company filed Form 8-K on May 22, 2001 with respect to
settlements with the remaining defendants in its Timberleaf lawsuit
filed September 1996 against the siding manufacturer, the general
contractor, the subcontractors and the architect.
SIGNATURES
Pursuant to the requirements of 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: August 13, 2001 By: /s/ Vicki R. Mullins
-----------------------------
Vice President
Date: August 13, 2001 By: /s/ John J. Murphy
-----------------------------
Vice President