10-Q 1 pro10q.txt 1ST QUARTER 01 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 March 31, 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 months ended March 31, 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 MARCH 31, 2001 AND DECEMBER 31, 2000 (Unaudited and in Thousands, Except for Unit Data) March 31, December 31, 2001 2000 --------- ------------ ASSETS Real Estate: Land, buildings and improvements $ 30,857 $ 30,778 Accumulated depreciation (8,976) (8,801) -------- -------- 21,881 21,977 Cash and cash equivalents 3,932 3,568 Restricted cash 5,713 5,256 Deferred expenses, net 201 209 Accounts receivable and other assets 42 78 -------- -------- Total assets $ 31,769 $ 31,088 ======== ======== LIABILITIES AND PARTNERS' CAPITAL (DEFICIT) Notes payable $ 25,799 $ 25,879 Payables and accrued liabilities 414 439 -------- -------- Total liabilities 26,213 26,318 -------- -------- General partner deficit (345) (354) Limited partners' capital 18,995 limited partnership units issued and outstanding 5,901 5,124 -------- -------- Total partners' capital (deficit) 5,556 4,770 -------- -------- Total liabilities and partners' capital (deficit) $ 31,769 $ 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 MARCH 31, 2001 AND 2000 (Unaudited and in Thousands, Except for Unit Data) 2001 2000 ---- ---- REVENUES Rental $ 1,929 $ 1,520 Other income 11 26 Interest income 125 114 ------- ------- Total revenues 2,065 1,660 ------- ------- EXPENSES Interest and amortization 462 468 Operating 391 360 Depreciation 175 167 Administrative 13 13 Payments to general partner and affiliates: Management fees 97 77 Operating and administrative 141 116 ------- ------- Total expenses 1,279 1,201 ------- ------- NET INCOME $ 786 $ 459 ======= ======= Net income per $1,000 limited partnership unit $ 41 $ 24 ======= ======= 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 THREE MONTHS ENDED MARCH 31, 2001 AND 2000 (Unaudited and in Thousands) 2001 2000 ---- ---- CASH FLOW FROM OPERATING ACTIVITIES Net income $ 786 $ 459 Adjustments to reconcile net income to cash provided by operating activities: Depreciation 175 167 Amortization 8 7 Decrease in accounts receivable and other assets 36 24 Increase in payables and accrued liabilities (25) 40 ------- ------- Net cash provided by operating activities 980 697 ======= ======= CASH FLOW FROM INVESTING ACTIVITIES Increase in fixed asset additions (79) (78) ------- ------- Net cash used for investing activities (79) (78) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Increase in restricted cash (457) (466) Principal reductions on notes payable (80) (75) ------- ------- Net cash used for financing activities (537) (541) ------- ------- Net increase in cash and cash equivalents 364 78 Cash and cash equivalents at beginning of year 3,568 1,942 ------- ------- Cash and cash equivalents at end of period $ 3,932 $ 2,020 ======= ======= 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 March 31, 2001 and for the three months ended March 31, 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 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. 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 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. A trial date has been set for Timberleaf on May 14, 2001, and Alderwood's trial is set to commence immediately thereafter. 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 and the acquiring parties. 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. The Partnership intends to continue to pursue vigorously its claims against the remaining defendants. 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 March 31, 2001, approximately $5,713,000. 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 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 cash accounts totaling as of March 31, 2001 approximately $3,932,000, which is primarily intended to cover additional contingent liabilities related to the construction defects and other matters. The extent and magnitude of the construction defects continues to worsen with time. The General Partner 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 March 31, 20010, Prometheus Income Partners has spent approximately $1,667,000 on emergency NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. CONSTRUCTION DEFECTS (CONTINUED) 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. The General Partner cannot predict or estimate what amounts, if any, will be recovered through 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 three 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 $3,304,000 and $2,409,000 for Alderwood and Timberleaf, respectively, as of March 31, 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 --------------------- During the past year, Santa Clara County has experienced a relatively flat growth in the creation of new jobs, unemployment increased from 1.5% in the fourth quarter of 2000 to 2.2% in the first quarter of 2001. In the first quarter of 2001, the Properties marketed available units at rents that averaged $1,803 for one-bedroom units and $2,370 for two-bedroom units. Average occupied rent per unit for the quarter was $1,815 and average occupancy during the quarter was 98% for Alderwood and Timberleaf. As of March 31, 2001, Alderwood was 98% occupied and Timberleaf was 100% occupied. In the first quarter of 2000, the Properties marketed available units at rents that average $1,430 for one-bedroom units and $1,815 for two bedroom units. Average occupied rent per unit for the quarter was $1,438 and average occupancy during the quarter was 99% for Alderwood and 98% for Timberleaf. As of March 31, 2000, Alderwood and Timberleaf were both 99% occupied. Excluding expenditures relating to quantification of the extent of construction defects and associated litigation costs, operating expenses increased 22%. The following first quarter operating expenses increased between years: Payroll, Benefits and Payroll Taxes due to salary increases; Utilities primarily due to increases of water and sewer usage and rates; Marketing due to print and internet advertising; Management Fees due to increased rents given to residents upon turnover. Operating expenses, inclusive of hardboard siding related costs, increased 14%. Overall, net operating income increased 33% during the first three months of 2001 when compared to the first three months of 2000. PART II: OTHER INFORMATION Item 1. Legal Proceedings. See Note 3 to Financial Statements, Construction Defects, for a discussion of this matter. 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 reports on Form 8-K's were filed during the period covered by this report. The company filed Form 8-K on March 5, 2001, with respect to the notification of the change in accounting firms for the fiscal year ended December 31, 2000. The company filed Form 8-K on March 12, 2001 with respect to matters not required to be disclosed in a Form 10-Q filing. The company filed Form 8-K on March 26, 2000 with respect to a settlement with one of several principal defendants in its two lawsuits 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: May, 14, 2001 By: /s/ Vicki R. Mullins -------------------------- Vice President Date: May, 14, 2001 By: /s/ John J. Murphy -------------------------- Vice President