-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DK9RaLBy+iREsP+fI4fLNJY/z0sk3ihGavxpwPQfBaOmmUhvJX2Ane6cxLWfWJJY FRDsukmjbQjlIuDFz9fYVw== 0000803026-98-000002.txt : 19980401 0000803026-98-000002.hdr.sgml : 19980401 ACCESSION NUMBER: 0000803026-98-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROMETHEUS INCOME PARTNERS CENTRAL INDEX KEY: 0000803026 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 770082138 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-16950 FILM NUMBER: 98580882 BUSINESS ADDRESS: STREET 1: 350 BRIDGE PARKWAY CITY: REDWOOD CITY STATE: CA ZIP: 94065-1517 BUSINESS PHONE: 4155965300 MAIL ADDRESS: STREET 2: 2600 CAMPUS DRIVE SUITE 200 CITY: CAMPUS DRIVE STATE: CA ZIP: 94403 FORMER COMPANY: FORMER CONFORMED NAME: PROMETHEUS DEVELOPMENT INCOME PARTNERS DATE OF NAME CHANGE: 19861229 10-K 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) Of the Securities Exchange Act of 1934 For the Year Ended December 31, 1997 Commission File No. 0-16950 Prometheus Income Partners, a California Limited Partnership (Exact Name of Registrant as Specified in its Charter) California 77-0082138 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 350 Bridge Parkway Redwood City, CA 94065-1517 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (650) 596-5300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Units of Limited Partnership Interest 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 No market for the Units of Limited Partnership Interest exists and therefore a market value for such Units cannot be determined. DOCUMENTS INCORPORATED BY REFERENCE Prospectus, dated February 12, 1987, and Supplement No. 1, dated September 18, 1987, incorporated into Registration Statement Form S-11 (Registration #33- 9164), thereto filed pursuant to Section 424(b) under the Securities Act of 1933, and Solicitation/Recommendation Statement pursuant to Section 14(d)(4) of the Securities Exchange Act of 1934, Schedule 14D-9, dated November 4, 1996 and Schedules 14D-91A, Amendments 1, 2 and 3, dated November 15, 1996, December 12, 1996 and December 20, 1996, respectively are incorporated into Parts I, II, III and IV. Exhibit index located on page 16 Table of Contents Form 10-K Part I Page Item 1 Business 3 Item 2 Properties 4 Item 3 Legal Proceedings 5 Item 4 Submission of Matters to Vote of Security Holders 5 Part II Item 5 Market for Registrant's Units and Related Security Holder Matters 6 Item 6 Selected Financial Data 8 Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations 9 Item 8 Financial Statements and Supplementary Data 13 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 13 Part III Item 10 Directors and Executive Officers of the Registrant 14 Item 11 Executive Compensation 14 Item 12 Security Ownership of Certain Beneficial Owners and Management 15 Item 13 Certain Relationships and Related Transactions 15 Part IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 16 PART I ITEM 1. BUSINESS Prometheus Income Partners, a California Limited Partnership, (hereinafter referred to as "Partnership" or "Registrant") was formed on April 15, 1985, under the California Revised Limited Partnership Act. Prometheus Development Co., Inc., a California corporation, is the General Partner of the Partnership. The principal business of the Partnership is to invest in, construct, hold, operate, and ultimately sell two residential rental properties in Santa Clara, California, Alderwood Apartments and Timberleaf Apartments. The principal investment objectives of the Partnership are to preserve and protect the Partnership's capital, to obtain capital appreciation from the sale of the properties, and, beginning in 1987, to provide "tax sheltered" distributions of cash from operations due to the cost recovery and other non-cash tax deductions available to the Partnership. See Item 7, Liquidity and Capital Resources and Hardboard Siding discussion concerning deferment of distributions. For a further description of the properties and the business of the Partnership, see Item 2 below and the section entitled "Business of the Partnership" (pages 24- 26) and "Properties" (pages 27-35) in the Prospectus. For financial information, see Item 8, below. Beginning in February 1987 through December 1987, the Partnership offered and sold 19,000 Units of Limited Partnership Interests ("Units") for $19,000,000. The net proceeds of this offering, together with the proceeds of the permanent financing, were used to satisfy construction loans with respect to Alderwood and Timberleaf and to exercise the purchase option for the Alderwood land site. The Partnership's investments in real property are affected by and subject to the general competitive conditions of the residential real estate rental market in the Santa Clara area. The Partnership's properties are located in an area which contains numerous other competitive residential rental properties. The Partnership is engaged solely in the business of real estate investment. The business of the Partnership is not seasonal. The Partnership does not engage in foreign operations or derive revenues from foreign sources. The Partnership has no employees, officers or directors. The officers and employees of the General Partner and its Affiliates perform services for the Partnership. The income of the properties may be affected by factors outside the Partnership's control. For example, changes in the supply of rental facilities, population shifts, the availability of mortgage funds or changes in zoning laws could affect apartment rental rates. It is also possible that some form of rent control may be legislated at the state or local level. Expenses of operating the properties, such as administrative and maintenance costs and real estate taxes, are subject to change due to inflation, supply factors or legislation. These increases in expenses may be offset by increases in rental rates, although such increases may be limited due to market conditions or other factors as discussed above. Certain expenses, such as debt service, are at fixed rates and are not affected by inflation. The General Partner is unable to predict the effect, if any, of such events on the future operations of the Partnership. There is no assurance there will be a ready market for the sale of the properties or, if sold, such a sale would be made on favorable terms. ITEM 2. PROPERTIES The Partnership has constructed two residential income-producing properties, Alderwood and Timberleaf, both in Santa Clara, California. The City of Santa Clara, with a population of approximately 100,000, is the third largest city in Santa Clara County, commonly referred to as Silicon Valley, is approximately 47 miles south of San Francisco, encompasses 1,300 square miles and has a population of approximately 1.7 million people, making it the most populous of the nine counties in the greater San Francisco Bay Area. The Alderwood luxury garden apartment complex is located at 900 Pepper Tree Lane in Santa Clara, California. Construction began in November 1985 and was fully completed by December 31, 1986. The complex contains 234 apartment units housed in 19 two-story buildings on a 9.4 acre site. Covered and uncovered parking for 468 cars is provided. See Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations, for a discussion of current operations. The Timberleaf luxury garden apartment complex is located at 2147 Newhall Street in Santa Clara, California. Construction began in November 1985 and was fully completed by December 31, 1986. The complex contains 124 apartment units housed in 9 buildings of two or three stories on a five acre site. Covered and uncovered parking for 248 cars is provided. See Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations, for a discussion of current operations. Alderwood and Timberleaf are encumbered by first mortgage liens which secure promissory notes payable to Prudential Insurance Company in the amount of $17,251,596 and $9,471,431, respectively. Both notes (collectively, the "Notes") bear interest at the rate of 6.99% per annum for Alderwood and 7.09% per annum for Timberleaf and mature in 2007. The notes, if prepaid more than thirty (30) days from maturity, are subject to a prepayment penalty. ITEM 3. LEGAL PROCEEDINGS Fisher Friedman, the project architects, have filed a cross complaint against the Partnership. The cross complaint seeks a determination of the proportionate share of responsibility of the various defendants for the damage to the property arising from the defective hardboard siding, but does not specify any basis for making such an apportionment. The cross complaint further claims that if negligence is found, that Fisher Friedman's be found to be secondary (rather than primary) in nature, thereby obligating the primarily liable defendants to indemnify Fisher Friedman for its liability. Again, the cross complaint fails to state any basis for which the Partnership has primary liability for the defective hardboarding siding. Also see Item 7 for a discussion of Hardboard Siding. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the period covered by this report. PART II ITEM 5. MARKET FOR THE REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS A) No public trading market exists or is expected to be established for the Registrant's Units. The Units were issued by the Partnership for $1,000 per Unit. The General Partner established a Limited Liquidity Plan which commenced in 1989 and provides Limited Partners with the option, subject to certain conditions, to have their Units repurchased by the Partnership (or a person designated by the Partnership). A further description of the repurchase terms can be found in the section entitled "Business of the Partnership-Limited Liquidity Plan" (pages 24-25) in the Prospectus. B) At December 31, 1997, the 18,995 outstanding Units were held by 1,039 investors. C) Tender Offers To Purchase Units During 1996, competing tender offers were made for limited partner interests ("Units") in the Partnership. One tender offer from Prom Investment Partners, LLC ("Prom"), an unrelated third party, expired in December 1996. The second tender offer from PIP Partners-General, LLC ("PIP Partners"), an affiliate of the General Partner, expired in January 1997. An aggregate 2,750.5 units were tendered to the competing bidders -- 1,430 to PIP Partners and 1,320.5 to Prom, or 7.5283% and 6.9518% of the total outstanding units, respectively. Under the terms of the Partnership Agreement, the transfers were effective as of April 1, 1997. All units were purchased for $495 per unit. D) Distributions to Limited Partners began with the quarter ending September 30, 1987. Cash distributions were suspended in 1996. See Item 7, Hardboard Siding for a discussion concerning the deferment of cash distributions. Cash distributions for the year 1995 were made as follows: Total Distribution Distribution Period Covered Date (In Thousands) January 1, through March 31, 1995 05/15/95 $375 April 1 through June 30, 1995 08/15/95 $375 July 1 through September 30, 1995 11/15/95 $375 October 1 through December 31, 1995 02/15/96 $375 No distributions were made for 1996 and 1997. ITEM 6. SELECTED FINANCIAL DATA The following represent selected financial data for the Partnership for the years ended December 31, 1997, 1996, 1995, 1994 and 1993. The data should be read in conjunction with the financial statements and related notes included elsewhere in this Form 10-K. The selected financial data presented below are unaudited. Refer also to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. For the Years Ended December 31, 1997 1996 1995 1994 1993 (Amounts in thousands except unit data) Rental revenues $ 5,256 $ 4,813 $ 4,188 $ 3,899 $ 3,864 Net income (loss) $ 477 $ (173) $ (192) $ (382) $ (275) Net income (loss) per $1,000 unit $ 25 $ (9) $ (10) $ (20) $ (14) Cash per $1,000 unit subsequent to partner distributions $ 34 $ 117 $ 32 $ 27 $ 39 Number of units used in Computation 18,995 18,995 18,995 18,995 19,000 Total assets $ 27,016 $ 25,259 $ 24,172 $ 24,553 $ 25,385 Notes payable $ 26,723 $ 25,248 $ 23,791 $ 22,477 $ 21,292 Cash distributions per $1,000 unit, representing a return of capital $ -- $ 20 $ 82 $ 88 $ 79 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Introduction The Partnership was organized in April 1985. Construction of Alderwood and Timberleaf commenced in November 1985 and was completed by December 1986. Lease-up activities began in November 1986 and continued through the third quarter of 1987. The Partnership Registration Statement was declared effective on February 12, 1987 and completed in December 1987. This Item should be read in conjunction with the financial statements, footnotes and other Items contained elsewhere in this report. Liquidity and Capital Resources The primary sources of funding for the Partnership's activities through 1987 were capital contributions of its Limited Partners, construction financing and permanent financing. The Partnership obtained $15,800,000 in permanent financing in November 1987. These proceeds, together with the Limited Partners' capital contributions, were applied towards the various construction costs and offering expenses as outlined in the Prospectus. In addition, proceeds from the loan were used to purchase the Alderwood land site. Once lease-up began in 1986, operating expenses, debt service and Limited Partner distributions were funded from apartment rental receipts and cash reserves. Quarterly distributions have been suspended in order to accumulate working capital reserves until the degree of damage to the hardboard siding and determination of liability are known. See Hardboard Siding below, 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 new notes payable 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 $1,902,000 and $1,601,000 for Alderwood and Timberleaf, respectively, as of December 31, 1997. The Alderwood trust deed requires that the security account be increased to $2,200,000 by December 1998. Thereafter, until the Completion Date, as defined, an additional 10%, 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 payable, 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. Cash and cash equivalents are comprised of cash invested in market rate, checking and investment accounts. Cash balances were approximately $638,000, $2,227,000, and $603,000, at December 31, 1997, 1996 and 1995, respectively. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by the hardboard siding, determination of liability for potential costs and expenses of dealing with the hardboard siding problem, and continued stabilized operations at the properties. Hardboard Siding The General Partner has learned that the type of hardboard siding which was used at Alderwood and Timberleaf is failing to perform as expected in a number of projects in various parts of the United States. A wood technology expert was retained to test the performance of the hardboard. This expert presented a report which indicated that the physical characteristics of the hardboard siding at Alderwood and Timberleaf have deteriorated since the construction of the properties A construction consultant retained by the General Partner to investigate the hardboard siding reported that its preliminary findings indicated damage, which on the surface does not currently appear to be major. However, they recommended further investigation in view of the deterioration, since there could be significant problems, which are not evident from prior tests that were conducted. Several property owners are currently in litigation against the hardboard siding manufacturer. One such case is scheduled to go to trial in March 1998. While each case is different and the extent of the hardboard siding damage at each property is different, the General Partner is closely following the aforementioned case and its potential impact to the Partnership's case. In addition, the courts recently ordered destructive testing, under court supervision to begin at both properties. Lastly, one defendant named in the Partnership's complaint recently filed a cross complaint against the Partnership. The amount of damages being sought is unspecified at this time. In addition to the security accounts mandated by the lender, 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 the hardboard siding problems. At this time, the General Partner cannot predict when cash distributions will resume due to the build up of reserves; however, it is the General Partner's current intention to resume distributions as soon as reasonably possible and prudent. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by the hardboard siding, determination of liability for potential costs and expenses of dealing with the hardboard siding problem, and continued stabilized operations at the properties. Impact of the Year 2000 The year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities. The General Partner believes that it will not be required to modify or replace significant portions of its software and that the year 2000 issue will not pose significant operational problems for its computer systems. Ultimately, the potential impact of the year 2000 issue will depend not only on the corrective measures the General Partner undertakes, but also on the way in which the year 2000 issue is addressed by businesses and other entities whose financial condition or operational capability is important to the Partnership. Therefore, the General Partner is communicating with the parties to ensure they are aware of the year 2000 issue, to learn how they are addressing it, and to evaluate any likely impact on the Partnership. Operations For the years ended December 31, 1997, 1996 and 1995, the average rents obtained from leased units and the average occupancy were as follows: Average Rental Rates 1997 1996 1995 One Bedroom Units $ 1,241 $ 1,147 $ 982 Two Bedroom Units $ 1,521 $ 1,409 $ 1,193 Average Occupancy 1997 1996 1995 Alderwood 97% 97% 97% Timberleaf 96% 97% 98% Commencing in June 1997, rental income includes income from a significant tenant, ExecuStay, Inc. ("ExecuStay"). ExecuStay owns and operates a corporate housing program. ExecuStay entered into a three year agreement whereby ExecuStay will lease for periods of at least six months, at the then current market rent, a minimum of 5% up to a maximum of 7% of the total units at Alderwood and Timberleaf. As of December 31, 1997, ExecuStay has leased 15 units and 8 units at Alderwood and Timberleaf, respectively. Operating expenses include on-site management, maintenance, utilities, marketing and other expenses related to earning rental revenues. Some of the operating expenses vary as occupancy changes throughout the year. Others, such as property taxes, do not fluctuate in response to changing occupancy levels. In 1997, operating expenses include $87,912 of professional services related to responding to the tender offer. Interest expense on notes is at a fixed rate of 6.99% per annum for Alderwood and 7.09% per annum for Timberleaf commencing December 26, 1997. Through December 26, 1997, interest expense on notes payable was accrued at 10.375% with a pay rate of 6.25%, with the deferred interest added to principal and incurring additional interest expense at a rate of 4.125% thereon. Depreciation and amortization remained consistent between 1997 and 1996. Although inflation impacts the Partnership's expenses, increases in expenses can sometimes be offset by increases in rental rates. However, the ability to affect increases in rental rates may be impacted by market conditions such as the supply of rental housing or local economic conditions. As noted in a preceding paragraph, average rental rates increased from 1995 to 1996, and from 1996 to 1997. Certain expenses, such as property taxes and debt service, may not be impacted by inflation. Property taxes are affected primarily by limits placed by legislation. Debt financing is at a fixed rate. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is submitted as a separate section of this Form 10-K. See Item 14. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Partnership has no directors or executive officers. For informational purposes only, the following are the names and additional information relating to controlling persons, directors, executives and senior management of Prometheus Development Co., Inc., the General Partner of the Registrant. Sanford N. Diller. Age 69. President, Secretary and sole Director. Mr. Diller supervises the acquisition, disposition and financial structuring of properties. Mr. Diller founded the General Partner, and effectively controls all of its outstanding stock. Mr. Diller received his undergraduate education at the University of California at Berkeley and his Doctor of Jurisprudence from the University of San Francisco. He has been an attorney since 1953. Since the mid 1960's, he has been involved in the development and/or acquisition of more than 70 properties, totaling approximately 13,000 residential units and over 2,000,000 square feet of office space. Vicki R. Mullins. Age 38. Executive Vice President and Chief Financial Officer. Ms. Mullins' responsibilities include supervising all financial, accounting and reporting activities, as well as manages the disposition and financial structuring of properties. Ms. Mullins came to Prometheus Development Co. from The Irvine Company where she spent seven years as Vice President of Finance and Accounting, and Director of Internal Controls. Prior to the Irvine Company, she spent six years with Ernst & Young as audit manager. Ms. Mullins is a Certified Public Accountant and holds a B.S. degree in Accounting with honors from the University of Illinois. John J. Murphy. Age 35. Vice President of Finance and Accounting. Mr. Murphy's responsibilities include managing all financial, accounting and reporting activities. Mr. Murphy came to Prometheus Development Co. from KPMG Peat Marwick where he spent seven years as a Senior Manager. He is a Certified Public Accountant and holds a B.S. degree in Accounting with honors from the University of San Francisco. ITEM 11. EXECUTIVE COMPENSATION The Partnership does not pay or employ directly any officers or directors. Compensation to executives and employees of the General Partner is not based on the operations of the Partnership. The General Partner and its affiliates receive a management fee as compensation for services rendered and reimbursement of certain Partnership expenses. (See Item 13. Certain Relationships and Related Transactions.) ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Other than PIP Partners - General, LLC ("PIP Partners") which owns 7.5283% and Prom Investment Partners, LLC, an unrelated third party, which owns 7.3203% of the outstanding Units, no person of record owns or is known by the Registrant to own beneficially more than 5% of the outstanding Units. (b) The General Partner owns no Units. However, the General Partner, pursuant to the Partnership Agreement, has discretionary control over most of the decisions made for the Partnership. The executive officers of the General Partner, as a group, own no Units. An affiliate of the General Partner, PIP Partners, acquired 7.5283% of outstanding limited partner interests in the Partnership on April 1, 1997. See Item 5 for further discussion. (c) Not applicable. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Partnership pays or has paid fees to the General Partner and its Affiliates. See Footnote 3 - Related Party Transactions of the financial statements found in Item 8 and the Prospectus (pages 14-16 and 46-48) filed pursuant to Rule 424(b) under the Securities Act of 1934, which is incorporated by reference herein. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. FINANCIAL STATEMENTS AND REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT PUBLIC ACCOUNTANTS Page Report of Independent Public Accountants 17 Financial Statements: Balance Sheets as of December 31, 1997 and 1996 18 Statements of Operations for the years ended December 31, 1997, 1996 and 1995 19 Statements of Partners' Capital (Deficit) for the years ended December 31, 1997, 1996 and 1995 20 Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 21 Notes to Financial Statements 22 2. FINANCIAL STATEMENT SCHEDULES: Schedule III - Real Estate and Accumulated Depreciation 28 All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto. 3. EXHIBITS None (b) No report on Form 8-K was filed during the period covered by this report. (c) No additional exhibits are required pursuant to Item 601(b) of Regulation S-K. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Partners of Prometheus Income Partners, a California Limited Partnership: We have audited the accompanying balance sheets of Prometheus Income Partners, a California Limited Partnership, as of December 31, 1997 and 1996 and the related statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1997. These financial statements and the schedule referred to below are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and the schedule 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 financial statements referred to above present fairly, in all material respects, the financial position of Prometheus Income Partners, a California Limited Partnership, as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedule listed in the index to the financial statements is presented for purposes of complying with the Securities and Exchange Commission's Rules and is not a required part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole. /s/Arthur Andersen, LLP San Francisco, California March 12, l998 PROMETHEUS INCOME PARTNERS a California Limited Partnership BALANCE SHEETS As of December 31, 1997 and 1996 (In Thousands, Except for Unit Data) 1997 1996 ASSETS Real Estate: Land, buildings and improvements $ 29,614 $ 29,420 Accumulated depreciation (7,041) (6,491) 22,573 22,929 Cash and cash equivalents 638 2,227 Restricted cash 3,503 -- Deferred loan fees, net of accumulated amortization of $0 and $773 283 78 Accounts receivable and other assets 19 25 Total assets $ 27,016 $ 25,259 LIABILITIES AND PARTNERS' CAPITAL (DEFICIT) Notes payable $ 26,723 $ 25,248 Payables and accrued liabilities 259 454 Total liabilities 26,982 25,702 Commitments and contingencies (see Note 4) General partner deficit (401) (405) Limited partners' capital (deficit), 18,995 limited partnership units issued and outstanding 435 (38) Total partners' capital (deficit) 34 (443) Total liabilities and partners' capital (deficit) $ 27,016 $ 25,259 The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF OPERATIONS For the years ended December 31, 1997, 1996 and 1995 (In Thousands, Except for Unit Data) 1997 1996 1995 REVENUES Rental (including revenue from affiliates of $248, $478 and $0, respectively) $ 5,256 $ 4,813 $ 4,188 Interest 165 61 23 Other 137 123 100 Total revenues 5,558 4,997 4,311 EXPENSES Interest 2,638 2,536 2,393 Operating 1,104 1,310 892 Depreciation and amortization 629 638 634 Administrative 41 43 42 Payments to general partner and affiliates: Management fees 278 265 219 Operating and administrative 391 378 323 Total expenses 5,081 5,170 4,503 NET INCOME (LOSS) $ 477 $(173) $ (192) Net income (loss) per $1,000 limited partnership unit $ 25 $ (9) $ (10) Number of limited partnership units used in computation 18,995 18,995 18,995 The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF PARTNERS' CAPITAL (DEFICIT) For the years ended December 31, 1997, 1996 and 1995 (In Thousands) General Limited Partner Partners Total Balance as of December 31, 1994 $ (402) $ 2,249 $ 1,847 Cash distributions ($82 per limited partnership unit, representing a return of capital) -- (1,550) (1,550) Net Loss (2) (190) (192) Balance as of December 31, 1995 (404) 509 105 Cash distributions ($20 per limited partnership unit, representing a return of capital) -- (375) (375) Net Loss (1) (172) (173) Balance as of December 31, 1996 (405) (38) (443) Net Income 4 473 477 Balance as of December 31, 1997 $ (401) $ 435 $ 34 The accompanying notes are an integral part of these financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF CASH FLOWS For the years ended December 31, 1997, 1996 and 1995 (In Thousands) 1997 1996 1995 CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 477 $ (173) $ (192) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 629 638 634 Decrease (increase) in accounts receivable and other assets 6 31 (25) Deferral of interest on notes Payable 1,559 1,549 1,406 (Increase) decrease in payables and accrued liabilities (195) 178 50 Decrease in due to affiliates -- -- (3) Net cash provided by operating Activities 2,476 2,223 1,870 CASH FLOWS FROM INVESTING ACTIVITIES Additions to buildings and improvements (194) (132) (139) CASH FLOWS FROM FINANCING ACTIVITIES Principal additions on notes Payable 26,723 -- -- Principal reductions on notes payable (26,807) (92) (92) Increase in deferred loan fees (284) -- -- Distributions to partners -- (375) (1,550) Increase in restricted cash (3,503) -- -- Net cash used for financing activities (3,871) (467) (1,642) Net (decrease) increase in cash (1,589) 1,624 89 Cash at beginning of year 2,227 603 514 Cash and cash equivalents at end of year $ 638 $ 2,227 $ 603 The accompanying notes are an integral part of the financial statements. PROMETHEUS INCOME PARTNERS a California Limited Partnership NOTES TO FINANCIAL STATEMENTS December 31, 1997 and 1996 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Prometheus Income Partners, a California Limited Partnership (the Partnership), was formed to invest in, construct, hold, operate and ultimately sell two multi-family apartment projects, Alderwood Apartments (Alderwood) and Timberleaf Apartments (Timberleaf), located in Santa Clara, California. The General Partner is Prometheus Development Co., Inc., (Prometheus) a California corporation. The preparation of financial statements in conformity with generally accepted accounting principles require 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. In accordance with Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", real estate, which includes development costs, construction costs, property taxes and interest incurred during the construction period, is valued at cost unless circumstances indicate that cost cannot be recovered, in which case the carrying value is reduced to estimated fair value. Buildings and improvements are depreciated using the straight-line method over their estimated useful lives, which range from 5 to 40 years. At December 31, 1997, the Partnership's management believes that the carrying value of the Partnership's real estate does not exceed its estimated fair value. However, no provision has been made to record any impairment that might arise due to defective hardboard siding. (See Note 4 for further discussion.) Loan fees of $283,000 have been deferred in conjunction with the new notes payable (See Note 2 for further discussion) and will be amortized, using the straight-line method which approximates the effective interest method, over the terms of the related notes payable. The previous loan fees of $851,000 have been fully amortized using the same method. All leases are classified as operating leases. Rental revenues are recognized when contractually due based on the terms of signed lease agreements which range in duration from month-to-month to one year. (See Note 6 regarding significant tenant.) Statement of Financial Accounting Standards No. 107, "Fair Value of Financial Instruments" requires disclosure about fair value for all financial instruments. It is management's opinion that the carrying value of its financial instruments approximates fair value at December 31, 1997. 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 partners' capital were charged to partners' capital. In accordance with the terms of the Partnership Agreement, income or loss is allocated 1% to the General Partner and 99% to the Limited Partners. Net income or loss per limited partnership unit is computed by dividing the net income or loss allocable to the Limited Partners by the number of units outstanding during the period in which the losses are allocated. Cash and cash equivalents consists of amounts held in operating and investment bank accounts with original maturity dates of three months or less. Restricted cash is invested in either a treasury or government fund with original maturity dates of three months or less. (See Note 5 for further discussion.) 2. NOTES PAYABLE The Partnership had the following notes payable at December 31, 1997 and 1996: 1997 1996 (In Thousands) Non recourse note payable, secured by a first deed of trust on Alderwood; interest is payable monthly at 6.99% interest rate; the balance is payable at maturity, December 2007. $ 17,252 $ -- Non recourse note payable, secured by a first deed of trust on Timberleaf; interest is payable monthly at 7.09% interest rate; the balance is payable at maturity, December 2007. 9,471 -- Non recourse note payable, secured by a first deed of trust on Alderwood, accruing interest at 10.375%; interest is payable monthly at 6.25% on the original principal balance, with the difference between the accrual rate and the pay rate being added to principal; principal payments of $4,928 are due monthly; the balance was payable at maturity, December 1997. -- 16,300 Non recourse note payable, secured by a first deed of trust on Timberleaf, accruing interest at 10.375%; interest is payable monthly at 6.25% on the original principal balance, with the difference between the accrual rate and the pay rate being added to principal; principal payments of $2,706 are due monthly; the balance was payable at maturity, December 1997. -- 8,948 $ 26,723 $ 25,248 One of the terms of new notes requires that cash be set aside in a hardboard siding security account, as additional collateral. See Notes 4 and 5 for further discussions. Cash paid for interest in each of the years ended 1997, 1996 and 1995 was approximately $905,000, $987,000 and $987,000. Principal payments, including deferred interest on the matured notes payable of $25,248,000 were paid in 1997. The partnership refinanced the notes payable in December 1997. As of December 31, 1997, maturities on the notes payable (in thousands) are as follows: Year ending December 31, 1998 $ 247 1999 288 2000 309 2001 331 2002 355 2003 and thereafter 25,193 $ 26,723 3. RELATED PARTY TRANSACTIONS Prom Management Group, Inc., dba Maxim Property Management ("Maxim"), an affiliate of the General Partner, manages the properties. Management fees and payments to the General Partner and Affiliates represent compensation for services provided and certain expense reimbursements in accordance with the Partnership Agreement. The Partnership leased apartment units through May 31, 1997 to Prom X, Inc., dba The Corporate Living Network, ("TCLN") an affiliate of Prometheus, to provide corporate housing services. The Partnership earned and received revenues of $248,000 and $478,000 during the years ended December 31, 1997, and 1996, respectively. (See Note 6 regarding significant tenant.) 4. COMMITMENTS AND CONTINGENCIES Repurchase of Limited Partnership Units Commencing on January 1, 1989, the Partnership may repurchase up to 5% in aggregate of the outstanding units from the Limited Partners, at the Limited Partners' option, in accordance with the Partnership Agreement. The General Partner may allocate up to 10% of the distributable cash from operations in the current year for the purpose of making such repurchases. The price of any units repurchased by the Partnership will be determined in accordance with the Partnership Agreement. Hardboard Siding The General Partner has learned that the type of hardboard siding which was used at Alderwood and Timberleaf is failing to perform as expected in a number of projects in various parts of the United States. A wood technology expert was retained to test the performance of the hardboard. This expert presented a report which indicated that the physical characteristics of the hardboard siding at Alderwood and Timberleaf have deteriorated since the construction of the properties. A construction consultant retained by the General Partner to investigate the hardboard siding reported that its preliminary findings indicated damage, which on the surface does not currently appear to be major. However, they recommended further investigation in view of the deterioration, since there could be significant problems, which are not evident from prior tests that were conducted. The General Partner has filed litigation on behalf of the Partnership as a result of this problem. Several unrelated property owners are currently in litigation against the hardboard siding manufacturer. One such case is scheduled to go to trial in March 1998. While each case is different and the extent of the hardboard siding damage at each property is different, the General Partner is closely following the aforementioned case and its potential impact to the Partnership's case. In addition, the court recently ordered destructive testing, under court supervision to begin at both properties. Lastly, one defendant named in the Partnership's complaint recently filed a cross complaint against the Partnership. The amount of damages being sought is unspecified at this time. In addition to the security accounts mandated by the lender, 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 the hardboard siding problems. As it is uncertain at this time what the degree of damage is and who will ultimately be liable for the costs, the General Partner cannot predict when cash distributions will resume due to the build up of reserves; however, it is the General Partner's current intention to resume distributions as soon as reasonably possible and prudent. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by the hardboard siding, determination of liability for potential costs and expenses of dealing with the hardboard siding problem, and continued stabilized operations at the properties. Due to the uncertainty of the degree of damage to the hardboard siding and determination of liability for potential costs, no provision for repairs or replacement has been made at this time. 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 hardboard siding matter, 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 FASB 121. Further, although the full extent of the damage to the hardboard siding for these two properties is unknown, management believes that the fair market value of each property still remains greater than their respective book values. 5. RESTRICTED CASH - CASH COLLATERAL The terms of the new notes payable (See Note 2 for further discussion) 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 $1,902,000 and $1,601,000 for Alderwood and Timberleaf, respectively, at December 31, 1997. The Alderwood trust deed requires that the security account be increased to $2,200,000 by December 1998 by making monthly payments of $25,000 to the security account. Thereafter, until the Completion Date, as defined, an additional 10%, 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 payable, 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. 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. The security accounts are to be invested in either a treasury or government fund. 6. SIGNIFICANT TENANT Effective June 1, 1997, ExecuStay, Inc. ("ExecuStay"), an unrelated third party entered in to an agreement to operate a corporate housing program at both properties. Under the terms of the three year agreement ExecuStay will lease for periods of at least six months, at the then current market rent, a minimum of 5% up to a maximum of 7% of the total units at Alderwood and Timberleaf. As of December 31, 1997, ExecuStay has leased 6% of the units at both Alderwood and Timberleaf. 7. IMPACT OF THE YEAR 2000 (Unaudited) The year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions or engage in normal business activities. The General Partner believes that it will not be required to modify or replace significant portions of its software and that the year 2000 issue will not pose significant operational problems for its computer systems. Ultimately, the potential impact of the year 2000 issue, will depend not only on the corrective measures the General Partner undertakes, but also on the way in which the year 2000 issue is addressed by businesses and other entities whose financial condition or operational capability is important to the Partnership. Therefore, the General Partner is communicating with the parties to ensure they are aware of the year 2000 issue, to learn how they are addressing it, and to evaluate any likely impact on the Partnership. SCHEDULE III PROMETHEUS INCOME PARTNERS a California Limited Partnership REAL ESTATE AND ACCUMULATED DEPRECIATION As of December 31, 1997 (In thousands) Initial Cost to Cost Capitalized Subsequent the Partnership To Acquisition Building And Encum- Improve- Improve- Carrying brances Land ments ments costs Alderwood Apts. Santa Clara, California $ 15,359 $ 5,931 $ -- $ 12,600 $ 441 Timberleaf Apts. Santa Clara, California 8,432 3,145 -- 6,793 510 Total $ 23,791 $ 9,076 $ -- $ 19,393 $ 951 Gross Amount at Which Carried at Close of Period (1) Build- Accumu- ings and lated De- Date of Date Improve- Total preciation Construc- Acquired Land ments (3) (4) tion (2) Alderwood Apts. Santa Clara, California $5,931 $13,165 $19,096 $4,502 11/86 12/87 (5) Timberleaf Apts. Santa Clara, California 3,145 7,373 10,518 2,539 11/86 11/86 Total $9,076 $20,538 $29,614 $7,041 NOTES: (1) The aggregate cost for federal income tax purposes is $27,582. (2) Depreciation is computed on lives ranging from 5 to 40 years. (3) Balance, December 31, 1994 $ 29,149 Additions 139 Balance, December 31, 1995 29,288 Additions 132 Balance, December 31, 1996 29,420 Additions 194 Balance, December 31, 1997 $ 29,614 (4) Balance, December 31, 1994 $ 5,389 Provision charged to expense 549 Balance, December 31, 1995 5,938 Provision charged to expense 553 Balance, December 31, 1996 6,491 Provision charged to expense 550 Balance, December 31, 1997 $ 7,041 (5) The Land site was leased through November 1987 and acquired in December 1987. SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated. PROMETHEUS INCOME PARTNERS, a California Limited Partnership By PROMETHEUS DEVELOPMENT CO., INC., a California corporation, Its General Partner Date: March 12, 1998 By /s/Vicki R.Mullins Executive Vice President and Chief Financial Officer Date: March 12, 1998 By /s/John J. Murphy Vice President of Finance and Accounting Supplemental Information to be furnished with Report, filed pursuant to Section 15(d) of the Act by Registrants, which have not registered Securities pursuant to Section 12 of the Act: None EX-27 2 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the Balance Sheets and the Statements of Operations filed as part of the annual report on Form 10-K. 12-MOS DEC-31-1997 DEC-31-1997 4,141 0 19 0 0 4,160 29,614 7,041 27,016 259 0 0 0 34 0 27,016 5,256 5,558 0 0 2,443 0 2,638 477 0 477 0 0 0 477 25 0
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