UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-18550
NTS MORTGAGE INCOME FUND
(Exact name of registrant as specified in its charter)
Delaware 61-1146077
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10172 Linn Station Road, Louisville, Kentucky 40223
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (502) 426-4800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock
(Title of Class)
Indicate by check mark whether the registrant (l) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by reference in
Part III of this Form 10-K or any amendment to this Form 10-K. [X]
As of March 1, 1998, there were approximately 3,187,000 shares of common stock
outstanding. The aggregate sales price for shares sold was approximately
$63,690,000. There is no current market for these shares although it is possible
that one will develop.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Prospectus of the registrant dated March 31, 1989, as
supplemented by Supplements No. 1, No. 2, No. 3, No. 4, No. 5 and No. 6
dated October 16, 1989, March 29, 1990, April 23, 1990, July 25, 1990,
September 6, 1990, and August 23, 1991, respectively, (collective with the
"Prospectus") and filed pursuant to Rule 424 under the Securities Act of
1933, are incorporated by reference into this Annual Report on Form 10-K.
Index to Exhibits is located on page 53.
<PAGE>
TABLE OF CONTENTS
Pages
PART I
Item 1 and 2 Business and Properties 3-6
Item 3 Legal Proceedings 7
Item 4 Submission of Matters to a Vote of Security Holders 7
PART II
Item 5 Market for the Registrant's Shares and Related
Stockholder Matters 8-9
Item 6 Selected Financial Data 10
Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-20
Item 8 Financial Statements and Supplementary Data 21-45
Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 46
PART III
Item 10 Directors and Executive Officers of the Registrant 46-49
Item 11 Executive Compensation 50
Item 12 Security Ownership of Certain Beneficial Owners and
Management 50
Item 13 Certain Relationships and Related Transactions 51-52
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports
on Form 8-K 53
Signatures 54
- 1 -
<PAGE>
PART I
Items 1. and 2. Business and Properties
Some of the statements included in Items 1. and 2., Business and Properties, or
elsewhere in this report, may be considered to be "forward-looking statements"
since such statements relate to matters which have not yet occurred. For
example, phrases such as "the Fund anticipates," "believes" or "expects"
indicate that it is possible that the event anticipated, believed or expected
may not occur. Should such event not occur, then the result which the Fund
expected also may not occur or occur in a different manner, which may be more or
less favorable to the Fund. The Fund does not undertake any obligations to
publicly release the result of any revisions to these forward- looking
statements that may be made to reflect any future events or circumstances.
Capitalized terms shall have the meaning ascribed them in the "Glossary" on
pages 75 to 81 of the Fund's Prospectus, which is filed herewith and
incorporated herein by reference.
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was formed on
September 26, 1988. The Fund operated as a real estate investment trust (REIT)
under the Internal Revenue Code of 1986 (the "Code"), as amended from inception
through December 31, 1996. The acquisition of the capital stock of NTS/Lake
Forest II Residential Corporation and NTS/Virginia Development Company, which is
discussed below, has caused the Fund to change its tax status to a "C"
corporation under the Code as of January 1, 1997. NTS Corporation is the sponsor
of the Fund (the "Sponsor"). NTS Advisory Corporation is the advisor to the Fund
(the "Advisor") and NTS Residential Management Company is the manager of the
operations of the Fund's wholly-owned subsidiaries (NTS Management). NTS
Advisory and NTS Management are Affiliates of and are under common control with
NTS Corporation.
The Fund's objectives as originally described in the Prospectus were to (i)
preserve and protect capital; (ii) distribute cash flow on a regular basis as it
was available; and (iii) increase the value of the Fund's Net Assets and the
Shares through receipt of Incentive Interest or Gross Receipts Interest and, to
a lesser extent, through the acquisition, operation and disposition of Real
Estate Investments. Incentive Interest is the Fund's share in the Increase in
Value of a property securing a Mortgage Loan and shall be payable in connection
with Mortgage Loans secured by Real Estate not held for sale in the ordinary
course of business. Gross Receipts Interest is an amount equal to a specified
percentage of the Affiliated Borrower's Gross Receipts from the sale of the
underlying Real Estate received during the term of the Mortgage Loan and was to
be payable in connection with Mortgage Loans secured by Real Estate held for
sale in the ordinary course of business. It was not an objective of the Fund to
provide tax-sheltered income.
As discussed below, effective October 1, 1997, the Fund no longer has
investments in Mortgage Loans. Prior to October 1, 1997, the Fund's primary
investments were Mortgage Loans. The Fund's investments at September 30, 1997
were as follows:
A Mortgage Loan to NTS/Lake Forest II Residential Corporation, an Affiliated
Borrower, to fund the development of Lake Forest North, a specified
investment. Interest accrued at an annualized rate equal to the greater of
17% of Gross Receipts from the sale of residential lots or 5.76% of the
average outstanding loan balance. The Fund's loan balance was $23,483,811 and
interest due the Fund was $199,474 as of September 30, 1997.
A Mortgage Loan to NTS/Virginia Development Company, an Affiliated Borrower,
to fund the development of Fawn Lake, a specified investment. Interest
accrued at an annualized rate equal to the greater of 17% of Gross Receipts
- 2 -
<PAGE>
Items 1. and 2. Business and Properties - Continued
from the sale of residential lots or 5.76% of the average outstanding loan
balance. The Fund's loan balance was $30,175,175 and interest due the Fund was
$909,246 as of September 30, 1997.
A Temporary Mortgage Loan to NTS/Virginia Development Company, an Affiliated
Borrower, to fund the construction of the Fawn Lake Golf Course. Interest
accrued at the Prime Rate plus 3/4%, payable monthly. The Fund's loan balance
was $2,499,532 as of September 30, 1997. The loan was paid in full on
December 30, 1997, with proceeds obtained from a third party lender.
As previously reported, on February 12, 1997, the Fund entered into a letter of
intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund,
NTS/Lake Forest II Residential Corporation, a Kentucky corporation which then
was an Affiliate of and under common control with NTS Corporation (NTS/LFII),
NTS/Virginia Development Company, a Virginia corporation which then was an
Affiliate of and under control with NTS Corporation (NTS/VA) and NTS Development
Company, a Kentucky corporation and a wholly-owned subsidiary of NTS
Corporation. The Letter of Intent contemplated the restructuring of the Fund's
loans to NTS/LFII and NTS/VA, and the acquisition of control by the Fund of the
Lake Forest North project in Louisville, Kentucky, and the Fawn Lake project
near Fredericksburg, Virginia.
The Fund has now consummated the restructuring contemplated by the Letter of
Intent by acquiring all of the issued and outstanding common capital stock of
NTS/LFII and NTS/VA effective as of October 1, 1997, for a nominal purchase
price. The acquisition was closed pursuant to (i) an Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/LFII and its shareholders, NTS/VA and certain of its shareholders, NTS
Corporation, the Advisor, and NTS Management, and (ii) an Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/VA and certain shareholders of NTS/VA and NTS Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family
residential community located in Louisville, Kentucky, and will continue to own
and develop the Lake Forest North project to completion and orderly sale as a
wholly-owned subsidiary of the Fund. As of December 31, 1997, approximately 500
of 726 total acres have been developed of which approximately 240 have been
sold.
NTS/VA is the owner and developer of the Fawn Lake single-family residential
community located near Fredericksburg, Virginia, and will continue to own and
develop the Fawn Lake project to completion and orderly sale as a wholly-owned
subsidiary of the Fund. NTS/Residential Properties, Inc. - Virginia, a Virginia
corporation and an Affiliate of the Sponsor of the Fund, will continue to act as
a broker and agent for NTS/VA for the sale of lots within the Fawn Lake project,
and as broker and agent for approved builders in the Fawn Lake project for the
sale of new homes. As of December 31, 1997, approximately 1,200 of 2,825 total
acres have been developed of which approximately 400 have been sold.
The Fund purchased all of the issued and outstanding common capital stock of
NTS/LFII and NTS/ VA for a nominal purchase price. Concurrent with this
transaction, the existing indebtedness of each of NTS/LFII and NTS/VA to the
Fund has been converted to equity as of October 1, 1997, and the Fund has
released the first mortgages in favor of the Fund on the Lake Forest North and
Fawn Lake projects.
- 3 -
<PAGE>
Items 1. and 2. Business and Properties - Continued
The Fund, as the sole shareholder of NTS/LFII and NTS/VA, will hereafter control
the ongoing operations of the Lake Forest North and Fawn Lake projects. The
ongoing operation and management of the Lake Forest North and Fawn Lake projects
will be conducted by NTS Management under the terms of (i) a Property Management
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and NTS Management for the Lake Forest North project,
and (ii) a Property Management Agreement executed on December 30, 1997, and
dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management
for the Fawn Lake project (collectively, the Management Agreements). The
Management Agreements have an initial term through December 31, 2003, subject to
extension under certain conditions, and are renewable for successive six (6)
year terms thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake Forest
North and Fawn Lake projects, and will accrue an incentive payment payable as
provided therein.
The terms of the restructuring and of the Management Agreements were negotiated
on behalf of the Fund by a committee of the Fund's Board of Directors (the
Special Committee) consisting only of the Independent Directors. The Special
Committee believes that the terms of the restructuring and of the Management
Agreements are as favorable to the Fund as could have been obtained from
unrelated third parties under the circumstances.
In September 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in the Orlando Lake
Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The
other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando
Capital Corporation and OLF II Corporation, all of whom are Affiliates of and
are under common control with NTS Corporation, the Fund's Sponsor. The Joint
Venture will continue to operate under its current legal name as the Orlando
Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and improvements and
approximately 20 acres of commercial land. The Joint Venture will continue to
own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest
in the principal and interest of the first mortgage loan on the Orlando Lake
Forest project, and obtained a 50% interest in the Joint Venture. The NTS
entities named above hold cumulatively the remaining 50% interest in the Joint
Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1997, the Fund's percentage interest was 50%, and
the Fund's share of the Joint Venture's net income from August 16, 1997 (when
the Fund was admitted as a partner) through December 31, 1997 was $106,667.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the
Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid
in full.
The Fund elected and was qualified to be treated as a real estate investment
trust under the Internal Revenue Code Sections 856-860 for the years ended
December 31, 1996 and 1995. The Fund operated as a "C" corporation under the
Code during the year ended December 31, 1997. Currently, the Fund is required to
terminate and liquidate its assets by December 31, 2008.
There are currently five directors of the Fund, two of whom are affiliated with
the Advisor and three of whom are Independent Directors. The Directors are
responsible for the management and control of the affairs of the Fund.
- 4 -
<PAGE>
Items 1. and 2. Business and Properties - Continued
However, in accordance with the Fund's Certificate of Incorporation and By-Laws,
the Directors have, in the Advisory Agreement and in certain management
agreements with NTS Management, delegated broad powers to the Advisor and NTS
Management to administer the day-to-day operations of the Fund and its
subsidiaries. The Advisor has delegated substantially all its duties to the
Sponsor. All personnel rendering services to the Fund are employees of companies
affiliated with the Sponsor. The Fund does not directly employ any persons other
than the Independent Directors, the Advisor and NTS Management.
The business of the Fund is not seasonal and the Fund does no foreign or export
business.
The Fund initially used the proceeds of the offering primarily to make
Residential Land Development Loans to Affiliated Borrowers. Mortgage Loans were
secured by a lien on the Borrower's real estate or by other REIT qualifying
security approved by the Board of Directors, including, without limitation, by
an interest in the Borrower or by a similar security interest.
Transactions entered into between the Fund, the Advisor and its Affiliates, and
NTS Management and its Affiliates are subject to an inherent conflict of
interest. The Directors of the Fund and the Advisor may have faced certain
conflicts of interest in enforcing the rights of the Fund against any Affiliated
Borrower.
The Directors would have considered the following factors in resolving certain
inherent conflicts of interest:
(1) When considering an advance of additional funds to an Affiliated
Borrower, factors such as projections for the development and operation of the
property, market value and market conditions generally and for the type of
property anticipated to be developed by the Affiliated Borrower, the credit
worthiness and equity interest of the Affiliated Borrower, the current value of
the property, the security and the availability of additional collateral.
(2) In deciding whether to waive a default by an Affiliated Borrower,
foreclose on a Mortgage Loan or remedy a default on senior indebtedness, the
Directors considered the nature of the default, its materiality, the anticipated
time and expense of pursuing the foreclosure as well as the cost of waiving the
default, the anticipated viability of the Affiliated Borrower and the likelihood
of the Affiliated Borrower remedying the default within a reasonable time. When
considering enforcing a due-on-sale clause, the Directors reviewed the Fund's
anticipated investments and the need for additional funds, as well as market
conditions, focusing on the specific intended use of the property and the credit
worthiness of the purchaser.
(3) In establishing the amount of the Interest Reserve to be funded, the
Directors reviewed the expected return on the reserve, the variability of the
interest rate on the Mortgage Loan, the outstanding indebtedness, the Affiliated
Borrower's anticipated cash flow, the operating history and the appraised value
and potential appreciation of the property.
(4) In determining whether to vary the terms of Mortgage Loans from the
anticipated terms specified in the Prospectus, the Directors reviewed economic
and market conditions and focused upon the locale of the property, the
availability of additional security to collateralize the loan and the equity
that the Affiliated Borrower had invested in the property.
(5) In considering whether to refinance a property, factors relating to the
value of the property compared to the Affiliated Borrower's total debt, the
terms of the proposed financing and the Affiliated Borrower's ability to service
the total debt, the Fund's participation in the potential appreciation of the
property, as well as other investment opportunities available to the Fund were
considered. If the Affiliated Borrower sought to refinance to prevent a default
and subsequent foreclosure, the Directors considered the factors set forth in
(2) above.
- 5 -
<PAGE>
Item 3. Legal Proceedings
In July 1994, the Fund was named as a defendant in a complaint originally filed
by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation
(the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The lawsuit
was settled during the first quarter of 1997. The terms of the settlement
agreement are confidential, however, it is not anticipated that the settlement
will have a material impact on the Fund's financial position or results of
operations.
Item 4. Submission of Matters to a Vote of Security Holders
The Fund did not submit any matters to a vote of its security holders during the
quarter ended December 31, 1997.
- 6 -
<PAGE>
PART II
Item 5. Market for the Registrant's Shares and Related Stockholder Matters
The selling price of the Shares was $20 per Share. The Fund's Shares are freely
transferable but are not listed or included for quotation on a national
securities exchange. As of March 1, 1998, there were 3,778 record holders of the
Fund's Shares. Cash dividends declared varied based upon the date of Stockholder
admittance. Dividends in 1996 and 1995 represent a return on invested capital of
0.95% and 1.01%, respectively. The amount of dividends declared was based on net
taxable income earned per year. No dividends were declared during 1997.
Dividends per share for the year ended December 31, 1996 were declared as
follows:
First Quarter $ .045
Second Quarter .045
Third Quarter .045
Fourth Quarter .055
------
$ .190
======
Dividends per share for the year ended December 31, 1995 were declared as
follows:
January $.03
February .03
March .03
April .03
May .01
June .01
July .01
August .01
September .01
October .01
November .01
December .01
----
$.20
====
The Fund operated as a real estate investment trust during 1995 and 1996. The
Fund was a "C" corporation effective January 1, 1997.
- 7 -
<PAGE>
Item 5. Market for the Registrant's Shares and Related Stockholder Matters
- Continued
The following table presents that portion of the Fund's dividends that represent
a return of capital under Generally Accepted Accounting Principals (GAAP) for
each of the three years in the period ended December 31, 1997.
1997 1996 1995
----------- --------- ---------
Net Income (Loss) $(13,706,950) $ 850,309 $ 858,334
============ ========= =========
Dividends Declared $ -- $ 605,601 $ 643,841
============ ========= =========
Return of Capital
(GAAP Basis) $ -- $ -- $ --
============ ========= =========
The Fund used tax-reporting accounting in applying the REIT-qualifying test that
requires 95% of taxable income to be paid out in dividends for the years ended
December 31, 1996 and 1995.
The following table presents that portion of the Fund's dividends that represent
a return of capital under tax-reporting accounting.
1996 1995
---------- ---------
Net Taxable Income $ 631,114 $ 672,098
========= =========
Dividends Declared $ 605,601 $ 643,841
========= =========
Return of Capital
(TAX Basis) $ -- $ --
========= =========
See Note 11 of the Notes to Consolidated Financial Statements and the Results of
Operations under Management's Discussion for a detailed discussion of the
differences between GAAP net income and net taxable income.
The continued needs of the Fund and its subsidiaries (to which the Fund formerly
had outstanding Mortgage Loans) may significantly reduce the Fund's cash flows.
Therefore, the Fund's Board of Directors has determined to terminate the Fund's
quarterly distribution for the foreseeable future effective as of the first
quarter of 1997.
- 8 -
<PAGE>
<TABLE>
Item 6. Selected Financial Data
Years ended December 31, 1997, 1996, 1995, 1994 and 1993. (1)
<CAPTION>
1997 (2) 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Inventory $ 51,917,990 $ -- $ -- $ -- $ --
========== ========== ========== ========== ==========
Affiliated Mortgage Loans
Receivable, net (3) $ -- $66,287,764 $63,655,706 $50,583,397 $50,884,695
========== ========== ========== ========== ==========
Total Assets $ 64,184,368 $68,745,709 $65,511,633 $51,264,380 $51,635,523
========== ========== ========== ========== ==========
Total Revenues (4) $ 4,678,937 $ 3,304,995 $ 2,884,652 $ 2,985,004 $ 4,025,301
Total Expenses 18,385,887 2,454,686 2,026,318 1,202,833 2,494,705
---------- ---------- ---------- ---------- ----------
Net Income (Loss) $(13,706,950) $ 850,309 $ 858,334 $ 1,782,171 $ 1,530,596
============ ========== ========== ========== ==========
Weighted Average Number
of Shares 3,187,333 3,187,333 3,187,333 3,187,333 3,187,333
========== ========== ========== ========== ==========
Net Income per Share of
Common Stock $ (4.30) $ .27 $ .27 $ .56 $ .48
=========== ========== ========== ========== ==========
Taxable Income (Loss)
(prior to dividend paid
deduction) (5) $ (387,081) $ 631,114 $ 672,098 $ 1,540,323 $ 2,553,129
========== ========== ========== ========== ==========
Taxable Income (Loss)
(prior to dividend paid
deduction)per Share of
Common Stock $ (.12) $ .20 $ .21 $ .48 $ .80
========== ========== ========== ========== ==========
Cash Dividends Declared
(6) $ -- $ 605,601 $ 643,841 $ 1,466,166 $ 2,439,335
========== ========== ========== ========== ==========
Cash Dividends Declared
per Share of Common
Stock $ -- $ .19 $ .20 $ .46 $ .77
========== ========== ========== ========== ==========
<FN>
(1) The above selected financial data should be read in conjunction with the
consolidated financial statements and related notes appearing elsewhere
in this Form 10-K report.
(2) Expenses for 1997 include a non-cash charge in the amount of $11,600,000.
This related to the Fund's acquisition of the stock of NTS/Lake Forest II
Residential Corporation (NTS/LFII) and NTS/Virginia Development Company
(NTS/VA). Also included in expenses is a non-cash charge of approximately
$3.7 million related to the Fund's investment in an unconsolidated
affiliate.
(See Notes 3 and 4 to Consolidated Financial Statements).
(3) Represents the carrying amount of the mortgage loans, which is equal to
their face amount less unamortized commitment fees and unaccreted
discounts. The 1996, 1995, 1994 and 1993 balances are net of an allowance
for loan losses of $1,500,000, $1,553,397, $1,638,855 and $1,730,000
respectively.
(4) Revenues for 1997 include approximately $370,000 of gross profit from lot
sales generated by NTS/LFII and NTS/VA from October 1, 1997 (the date of
acquisition) through December 31, 1997.
(5) See Note 11 of the Notes to Consolidated Financial Statements for an
explanation of differences between net income and taxable income.
(6) Cash dividends declared during 1996, 1995, 1994 and 1993 varied based upon the date of
Stockholder admittance.
</FN>
</TABLE>
- 9 -
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The Fund commenced an offering to the public on March 31, 1989 and was
authorized to sell up to 2,500,000 shares of common stock at $20.00 per share
(subject to an increase to 5,000,000 shares at the option of the Fund).
Approximately 3,187,000 shares were sold representing approximately $64 million
in sales and approximately $9.5 million in selling expenses and other offering
costs. The net offering proceeds remaining, after payment of brokerage
commissions, organizational expenses and other costs, were used to make Mortgage
Loans and Temporary Investments and such other investments as permitted by the
Fund's Prospectus.
Throughout 1997, the Fund's Board of Directors and NTS Corporation, the Fund's
Sponsor, were involved in a restructuring of the Fund's Mortgage Loan portfolio.
The Fund's Affiliated Borrowers had included NTS/Lake Forest II Residential
Corporation (NTS/LFII), NTS/Virginia Development Company (NTS/VA), and the
Orlando Lake Forest Joint Venture (OLFJV).
In September 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in OLFJV. The Fund
contributed its interest in the principal of the first mortgage loan on the
Orlando Lake Forest project and obtained a 50% interest in OLFJV.
In December 1997, the Fund acquired all the issued and outstanding common
capital stock of NTS/LFII and NTS/VA, effective October 1, 1997, for a nominal
purchase price. Concurrent with this transaction, the existing indebtedness of
NTS/LFII and NTS/VA to the Fund was converted to equity as of October 1, 1997.
This marks the beginning of the Fund's operations focusing solely on the
continuing development, operations, marketing and sale of single-family,
residential real estate. As a result, the Fund will no longer operate as a Real
Estate Investment Trust.
Reference is made to Notes 3 and 4 of the Notes to Financial Statements for
further information regarding these investments and acquisitions.
Liquidity and Capital Resources
The Fund's primary source of liquidity has been from the interest earned on the
Mortgage Loans and on the Temporary Investments. The Fund's current source of
liquidity is primarily the ability of its subsidiaries (to which the Fund
formerly had outstanding Mortgage Loans)to draw upon their respective
development loans. Additional liquidity is provided by proceeds received from
residential lot closings by the properties owned by the Fund's subsidiaries and
OLFJV in which the Fund has a 50% interest.
The continued cash needs of the Fund and its subsidiaries have significantly
reduced the Fund's cash flows. Therefore, the Fund's Board of Directors has
determined to terminate the Fund's quarterly distribution for the foreseeable
future effective as of the first quarter of 1997. However, the Fund's cash and
cash equivalents are expected to be sufficient to meet its anticipated needs for
liquidity and capital resources.
As previously reported, on February 12, 1997, the Fund entered into a letter of
intent (Letter of Intent) with NTS Corporation, the Sponsor of the Fund,
NTS/LFII, NTS/VA and NTS Development Company, a Kentucky corporation and a
wholly-owned subsidiary of NTS Corporation. The Letter of Intent contemplated
the restructuring of the Fund's loans to NTS/LFII and NTS/VA, and the
acquisition of control by the Fund of the Lake Forest North project in
Louisville, Kentucky, and the Fawn Lake project near Fredericksburg, Virginia.
- 10 -
<PAGE>
Liquidity and Capital Resources - Continued
The Fund has now consummated the restructuring contemplated by the Letter of
Intent by acquiring all of the issued and outstanding common capital stock of
NTS/LFII and NTS/VA effective as of October 1, 1997, for a nominal purchase
price. Concurrent with this transaction, the existing indebtedness of NTS/LFII
and NTS/VA to the Fund was converted to equity. The acquisition was closed
pursuant to (i) an Agreement executed on December 30, 1997, and dated as of
October 1, 1997, by and among the Fund, NTS/LFII and its shareholders, NTS/VA
and certain of its shareholders, NTS Corporation, NTS Advisory Corporation, a
Kentucky corporation and Advisor to the Fund (the Advisor) and NTS Residential
Management Company, a Kentucky corporation (NTS Management), and (ii) an
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/VA and certain shareholders of NTS/VA and NTS Corporation.
The Advisor and NTS Management are Affiliates of and are under common control
with NTS Corporation.
NTS/LFII is the owner and developer of the Lake Forest North single-family
residential community located in Louisville, Kentucky, and will continue to own
and develop the Lake Forest North project to completion and orderly sale as a
wholly-owned subsidiary of the Fund.
NTS/VA is the owner and developer of the Fawn Lake single-family residential
community located near Fredericksburg, Virginia, and will continue to own and
develop the Fawn Lake project to completion and orderly sale as a wholly-owned
subsidiary of the Fund. NTS/Residential Properties, Inc.- Virginia, a Virginia
corporation and an Affiliate of NTS Corporation, the sponsor of the Fund, will
continue to act as a broker and agent for NTS/VA for the sale of lots within the
Fawn Lake project, and as broker and agent for approved builders in the Fawn
Lake project for the sale of new homes.
The Fund, as the sole shareholder of NTS/LFII and NTS/VA, will hereafter control
the ongoing operations of the Lake Forest North and Fawn Lake projects. The
ongoing operation and management of the Lake Forest North and Fawn Lake projects
will be conducted by NTS Management under the terms of (i) a Property Management
Agreement executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and NTS Management for the Lake Forest North project,
and (ii) a Property Management Agreement executed on December 30, 1997, and
dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS Management
for the Fawn Lake project (collectively, the Management Agreements). The
Management Agreements have an initial term through December 31, 2003, subject to
extension under certain conditions, and are renewable for successive six (6)
year terms thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake Forest
North and Fawn Lake projects, and will accrue an incentive payment payable as
provided therein.
The terms of the restructuring and of the Management Agreements were negotiated
on behalf of the Fund by a committee of the Fund's Board of Directors (the
Special Committee) consisting only of the Independent Directors. The Special
Committee believes that the terms of the restructuring and of the Management
Agreements are as favorable to the Fund as could have been obtained from
unrelated third parties under the circumstances.
- 11 -
<PAGE>
Liquidity and Capital Resources - Continued
On December 30, 1997, NTS/VA closed on development financing for the Fawn Lake
project committed by an unaffiliated bank. The $10,700,000 revolving credit
facility is currently anticipated to provide funds for the continued development
and operations of the Fawn Lake project through December 1, 2002, the maturity
of the credit facility. Mr. J. D. Nichols, Chairman of the Board of the Fund's
Sponsor and of the Fund, has individually guaranteed the repayment of up to
$3,000,000 of the credit facility.
The credit facility bears interest at the Prime Rate + 1 1/2%, payable monthly,
and principal payments generally equal 91% of the Gross Receipts from the sale
of lots at the Fawn Lake project. In addition, the total outstanding principal
amount must be brought to within the following levels by the applicable date:
December 31, 1998 $10,700,000
December 31, 1999 $ 9,300,000
December 31, 2000 $ 7,800,000
December 31, 2001 $ 5,900,000
December 1, 2002 $ 4,500,000
The loan balance was $8,005,034 as of December 31, 1997. The loan balance was
$10,036,452 as of March 31, 1998.
On January 6, 1998, NTS/LFII closed on development financing for the Lake Forest
North project committed by an unaffiliated bank. The $8,000,000 revolving credit
facility is currently anticipated to provide funds for the continued development
and operations of the Lake Forest North project through October 31, 2003, the
maturity of the credit facility, and the repayment thereof has been guaranteed
by the Fund. Mr. J. D. Nichols, Chairman of the Board of the Fund's Sponsor and
of the Fund, has individually guaranteed the repayment of fifty percent (50%) of
the credit facility.
The credit facility bears interest at the Prime Rate + 1%, payable monthly, and
principal payments generally equal 90% of the Gross Receipts from the sale of
lots at the Lake Forest North project. In addition, the principal amount
outstanding on the credit facility must be brought to within the following
levels by the applicable date:
January 1, 1999 $7,800,000
January 1, 2000 $7,200,000
January 1, 2001 $7,000,000
July 1, 2001 $6,100,000
January 1, 2002 $5,500,000
July 1, 2002 $4,900,000
January 1, 2003 $4,000,000
July 1, 2003 $2,400,000
The net worth of NTS/LFII cannot be allowed to decrease by 20% or more
throughout the term of the agreement. The loan balance was $6,209,247 as of
March 31, 1998.
NTS/LFII is also encumbered by a mortgage loan in the amount of $4,000,000 (with
an outstanding balance of $3,950,000 as of December 31, 1997) from an
unaffiliated lender which is secured by a first mortgage on the Lake Forest
Country Club and golf course (approximately 176 acres of residential land and
improvements thereon). The note bears interest at the Prime Rate + 1/2%, payable
monthly. Principal payments totaling $300,000 are due twice a year, February
through July and August through January. The primary source of principal
payments will be initiation fees received. The loan is guaranteed by the Fund's
Sponsor.
- 12 -
<PAGE>
Liquidity and Capital Resources - Continued
In September 1997, the Fund entered into an Amended and Restated Joint Venture
Agreement evidencing the Fund's admission as a partner in the Orlando Lake
Forest Joint Venture (the "Joint Venture") effective as of August 16, 1997. The
other partners in the Joint Venture are Orlando Lake Forest, Inc., Orlando
Capital Corporation and OLF II Corporation, all of whom are Affiliates of and
are under common control with the Fund's Sponsor. The Joint Venture will
continue to operate under its current legal name as the Orlando Lake Forest
Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and improvements and
approximately 20 acres of commercial land. The Joint Venture will continue to
own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its interest
in the principal and interest of the first mortgage loan on the Orlando Lake
Forest project, and obtained a 50% interest in the Joint Venture. The NTS
entities named above hold cumulatively the remaining 50% interest in the Joint
Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1997, the Fund's percentage interest was 50%, and
the Fund's share of the Joint Venture's net income from August 16, 1997 (when
the Fund was admitted as a partner) through December 31, 1997 was $106,667.
On September 30, 1997, the principal balance outstanding of $3,214,647 on the
Fund's Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture was paid
in full.
In July 1994, the Fund was named as a defendant in a complaint originally filed
by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against NTS Corporation
(the Fund's Sponsor) and various Affiliates of the Fund's Sponsor. The lawsuit
was settled in the first quarter of 1997. The terms of the settlement agreement
are confidential, however, it is not anticipated that the settlement will have a
material impact on the Fund's financial position or results of operations.
Operating Activity
Cash provided by operations was $459,795 for the year ended December 31, 1997.
The Fund received $70,555 from cash revenues in excess of cash expenses. The
Fund received $480,778 in interest receivable payments from affiliates. NTS/LFII
and NTS/VA used $789,991 of cash to increase inventory. NTS/LFII and NTS/VA
provided $539,716 of cash from collection of initiation fees and other
receivables and notes receivable during the period October 1, 1997 through
December 31, 1997. In addition, payables increased $158,721.
Cash provided by operations was $392,077 and $59,772 during the years ended
December 31, 1996 and 1995, respectively. These amounts were driven by net
income as reported offset by increases in interest receivable from affiliates.
- 13 -
<PAGE>
Liquidity and Capital Resources - Continued
Investing Activity
During the year ended December 31, 1997, the Fund received repayment on three
mortgage loans and two temporary investments in the aggregate principal amount
of $9,299,287. Repayments on mortgage loans were generally equal to
approximately 83% of the Gross Receipts received on lot sales less closing
costs. The Fund made investments in three mortgage loans and one temporary
investment in the aggregate principal amount of $5,700,037.
During the year ended December 31, 1996, the Fund received repayment on four
mortgage loans and two temporary investments in the aggregate principal amount
of $8,099,364. The repayments on mortgage loans were generally equal to
approximately 83% of the Gross Receipts received on lot sales less closing
costs. The Fund made investments in three mortgage loans and one temporary
investment in the aggregate principal amount of $10,562,950.
During the year ended December 31, 1995, the Fund received repayment on four
mortgage loans and two temporary investments in the aggregate principal amount
of $8,219,874. The repayments on mortgage loans were generally equal to
approximately 83% of the Gross Receipts received on lot sales less closing
costs. The Fund made investments in three mortgage loans and one temporary
investment in the aggregate principal amount of $21,187,154.
Financing Activity
On January 10, 1995, the Fund entered into a loan agreement with an unaffiliated
bank providing for a credit facility of up to $13.8 million secured by a
collateral assignment of the Fund's mortgages to NTS/LFII and NTS/VA. The
purpose of the loan was to refinance the Fund's existing credit facility,
increase the Fund's investment portfolio and provide additional operating
capital for the Fund. Interest accrued at the Prime Rate plus 1%, payable
monthly, and the loan matured December 27, 1997. The Fund made principal
payments on the loan equal to $12,000 per lot from lot sales at NTS/LFII and
$1,000 per lot from lot sales at NTS/VA during 1995 and $13,500 per lot from lot
sales at NTS/LFII and $1,000 per lot from lot sales at NTS/VA during 1996. The
Fund made principal payments on the loan equal to $27,500 per lot from lot sales
at NTS/LFII and $1,000 per lot from lot sales at NTS/VA during 1997. The loan
was paid in full on January 7, 1998 with proceeds from the NTS/LFII $8,000,000
revolving development loan discussed on page 13.
In the fourth quarter of 1995, the Fund entered into a loan agreement with an
unaffiliated bank for $2,000,000 secured by a collateral assignment of the
Fund's mortgage to NTS/VA regarding approximately 187 acres of residential land
and improvements known as the Fawn Lake Golf Course. The purpose of the loan was
to fund the then remaining construction of the Fawn Lake Golf Course. Interest
accrued at the Prime Rate + 3/4%, payable monthly. In February 1997, the loan
balance was increased to $2,500,000. The loan was paid in full on December 30,
1997 with proceeds from the NTS/VA $10.7 million revolving development loan
discussed on page 13.
The Fund has received advances from Affiliates of the Fund's Sponsor, net of
repayments, totaling $5,309,492 and $4,524,667 as of December 31, 1997 and 1996,
respectively. The advances had been at various rates averaging approximately
5.75% when they matured April 15, 1996. On April 15, 1996, the interest rate on
all borrowings from Affiliates of the Fund's Sponsor increased to approximately
the Prime Rate. As of December 31, 1997, the maturity date on $1,774,000 of the
borrowings is March 31, 1999, $1,124,158 is due May 1, 1999 and $2,411,334 is
due on demand. In addition, the Fund made principal payments on the advances
equal to $3,000 per lot from lot sales at NTS/VA, NTS/LFII and the Orlando
Project from April 15, 1996 through March 31, 1997 and $5,000 per lot from April
1, 1997 through September 30, 1997. Pursuant to an agreement with the
Affiliates, additional principal payments will be made to the Affiliates as cash
flow permits. Interest paid to the Affiliates was $358,262, $258,191 and $82,050
for the years ended December 31, 1997, 1996 and 1995, respectively. The advances
were made to meet the development plans of the projects to which the Fund had
outstanding loans.
- 14 -
<PAGE>
Liquidity and Capital Resources - Continued
Financing Activity - Continued
NTS/VA has received non-interest bearing advances from Affiliates totaling
$600,542 as of December 31, 1997. The advances were used to fund development
costs and will be repaid to the Affiliates as cash flow permits.
During the year ended December 31, 1997, the Fund and its subsidiaries borrowed
$8,515,946 from their various lenders. The Fund and its subsidiaries repaid
$2,380,556 of their borrowings from lot proceeds generated by NTS/LFII, NTS/VA
and OLFJV. In addition, $9,424,723 of borrowings were repaid using proceeds from
the NTS/VA and OLFJV development loans. The Fund and its subsidiaries also
borrowed $2,436,291 from Affiliates of the Fund's Sponsor. They repaid
$1,651,466 of these borrowings primarily from loan repayments made by OLFJV
during the period from January 1, 1997 though August 15, 1997.
During the year ended December 31, 1996, the Fund borrowed $1,201,999 from its
various lenders. The Fund repaid $1,075,022 of its borrowings primarily from
loan repayments made by NTS/LFII. In addition, the Fund borrowed $4,077,457 from
an Affiliate of the Fund's Sponsor. The Fund repaid $1,437,790 of these
affiliated borrowings primarily from loan repayments made by OLFJV.
During the year ended December 31, 1995, the Fund borrowed $15,186,873 from its
various lenders. The Fund repaid $1,991,528 of its borrowings using proceeds
from a $13.8 million credit facility and repaid $268,000 of its borrowings using
proceeds from a $2,000,000 mortgage loan. The remaining $714,000 reduction in
debt came primarily from loan repayments made by NTS/LFII. The Fund also
borrowed $1,885,000 from Affiliates of the Fund's Sponsor.
The Fund declared dividends of $605,601 and $643,841 for the years ended
December 31, 1996 and 1995, respectively. Total dividends declared provided
Stockholders with an annualized return of 0.95% (1996) and 1.01% (1995). No
dividends were declared in 1997. The Fund paid dividends of $175,305, $468,544
and $733,086 during the years ended December 31, 1997, 1996 and 1995
respectively.
Results of Operations
Comparability
On an overall basis, the Fund lost $13.7 million or $4.30 per share of common
stock for the year ended December 31, 1997. In the context of the restructuring
and acquisitions which occurred during the fourth quarter, comparisons of
results of operations for the year are complex. The fourth quarter charge
relating to the acquisition of NTS/LFII and NTS/VA and the adjustment of the
carrying value of the Fund's investment in OLFJV also represent significant
items which complicated year-to-year comparisons.
The historical financial statements are also impacted by the Fund's lack of
history as a real estate development company, therefore, management believes
that certain areas of the Fund's results of operations for 1997 are not
comparable with prior years and a discussion comparing these periods is not
included.
Revenues
The Fund had a net book loss of $13,706,950 for the year ended December 31,
1997, which includes a non-cash charge of $11,600,000 related to the acquisition
of NTS/LFII and NTS/VA and an adjustment to the carrying value of the Fund's
investment in the OLFJV of $3,707,227.
Generally Accepted Accounting Principles require that the acquisitions of
NTS/LFII and NTS/VA be recorded at fair market value on the day of acquisition.
The application of these principles resulted in a non-cash charge of
approximately $11,600,000 during the fourth quarter of 1997. In addition, the
Fund's investment in an unconsolidated affiliate should be recorded at the lower
of cost or fair market value. A non-cash charge of approximately $3.7 million
- 15 -
<PAGE>
Results of Operations - Continued
Revenues - Continued
was recorded in the third quarter of 1997 related to this investment. All
estimates used in these evaluations represented management's best estimates
based on the facts present at the date of such evaluations.
Revenue for the year ended December 31, 1997 includes $1.6 million of lot sales
from NTS/LFII and NTS/VA for the period from October 1, 1997 (when the Fund
acquired the stock of these entities) to December 31, 1997. Cost of sales was
$1.2 million resulting in a gross profit of approximately 23%.
During 1995, 1996 and for the nine months ended September 30, 1997, the Fund's
primary revenue source was interest income earned on affiliated mortgage loans.
The average outstanding balances of the earning loans increased from $57,668,000
(1995) to $62,878,000 (1996) to $63,600,000 (1997). The average interest rate
earned by the Fund for the years ended December 31, 1997, 1996 and 1995 was
approximately 5.5%, 5.1% and 4.9%, respectively, of the average outstanding loan
balances.
Commitment fees paid at loan closings were amortized over the life of the loan
using the interest method. Letter of credit fees were amortized over the term of
the letter of credit. Fee income on mortgage loans and financial services is the
amount of commitment fees and letter of credit fees being amortized for the
period. There was no commitment fee income recognized in 1995 nor any in 1997.
The Fund had previously established a $1,500,000 loan loss reserve regarding a
Temporary Mortgage Loan to the Orlando Lake Forest Joint Venture. During the
third quarter 1997, the Fund received 100% of the amount due on this loan and
determined the loan loss reserve was no longer needed.
Net income using generally accepted accounting principles (GAAP) was $850,309
and $858,334 and using tax-reporting accounting (TRA) was $631,114 and $672,098
for the years ended December 31, 1996 and 1995, respectively. The difference
between GAAP income and TRA income was due primarily to the treatment of loan
discount accretion, loan commitment fee income, letters of credit income,
Supplemental Interest income and provision for loan losses. GAAP requires that
discounts on mortgage loan receivables be recognized as an adjustment to yield
over the estimated life of the loan; for tax purposes the discount is recognized
as income when the proceeds are received. GAAP requires that loan commitment fee
income be recognized as income over the term of the related loans; for tax
purposes the fees are recognized as income when received. GAAP requires that
income received from letters of credit be recognized on a straight-line basis
over the term of the letter of credit (typically one year); for tax purposes,
this income is recognized as income when received. For GAAP purposes, Gross
Receipts Interest was reported as earned on the accrual basis of accounting; for
tax purposes 50% of the amount of Gross Receipts Interest earned was credited
against Supplemental Interest Income paid in prior years. For GAAP purposes, a
provision for loan losses is recognized when the fair value of the asset is less
than the carrying value of the asset; for tax purposes, a provision for loan
losses is allowed when the debt becomes worthless within the taxable year. TRA
income was used in applying the REIT-qualifying test that requires 95% of
taxable income to be paid out in dividends. (See Note 11 of the Notes to
Consolidated Financial Statements).
Expenses
Operating expenses of the Fund include a Management Expense Allowance (Advisory
Fee) of 1% of the Fund's Net Assets, per annum, which may be increased annually
by an amount corresponding to the percentage increase in the Consumer Price
Index. Pursuant to the Advisory Agreement, the Advisory Fee was paid to the
Advisor (NTS Advisory Corporation) or its affiliate. Effective July 1, 1994, the
Fund's Mortgage Loans to NTS/VA and NTS/LFII were converted to cash flow
mortgage loans. As part of the consideration for this restructuring, the Fund's
Board of Directors required, among other things, that beginning in 1995, NTS
- 16 -
<PAGE>
Results of Operations - Continued
Expenses - Continued
Advisory Corporation pay $100,000 annually towards the expenses of the Fund
until the maturity of the Mortgage Loans. As such, the Advisory Fee has been
reduced $100,000 for each of the years ended December 31, 1995 and 1996 and
$75,000 for the year ended December 31, 1997. The Advisory Fee for the years
ended December 31, 1997, 1996 and 1995 was $418,950, $544,776 and $528,973,
respectively. Increases and decreases in the Advisory Fee generally correspond
directly to increases and decreases in the Fund's Net Assets. Effective October
1, 1997, the Fund will no longer incur an Advisory Fee but will be responsible
for the actual general and administrative costs pursuant to certain property
management agreements discussed below.
The ongoing operation and management of the Lake Forest North and Fawn Lake
projects will be conducted by NTS Management under the terms of (i) a Property
Management Agreement executed on December 30, 1997, and dated as of October 1,
1997, by and among the Fund, NTS/LFII and NTS Management for the Lake Forest
North project, and (ii) a Property Management Agreement executed on December 30,
1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA and NTS
Management for the Fawn Lake project (collectively, the Management Agreements).
NTS Management is a wholly-owned subsidiary of NTS Development Company. NTS
Development Company is a wholly-owned subsidiary of the Fund's Sponsor. The
Management Agreements have an initial term through December 31, 2003, subject to
extension under certain conditions, and are renewable for successive six (6)
year terms thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake Forest
North and Fawn Lake projects, and will accrue an incentive payment payable as
provided therein.
Reimbursements of approximately $527,000 were made to NTS Management or an
Affiliate during the period from October 1, 1997 through December 31, 1997 for
actual personnel, marketing and administrative costs as they relate to NTS/LFII,
NTS/VA and the Fund.
Additionally, NTS Management is entitled to an Overhead Recovery, which is a
reimbursement for overhead expenses attributable to the employees and the
efforts of NTS Management under the Management Agreements, in an amount equal to
3.75% of the projects' gross cash receipts, as defined in the Management
Agreements. $106,473 was incurred as an Overhead Recovery during the period from
October 1, 1997 through December 31, 1997.
Increases and decreases in interest expense generally correspond directly to
increases and decreases in the outstanding balances of the Fund's borrowings.
The average interest rate paid by the Fund for the years ended December 31, 1997
1996 and 1995 was 9.0% 8.9% and 9.7%, respectively.
Professional and administrative expenses include primarily directors' fees,
legal, outside accounting and investor processing fees, and printing costs for
financial reports. The increase in expenses for the year ended December 31, 1996
is due to the fees associated with the addition of an Independent Director and
increased professional fees related to the lawsuit discussed in Part 1, Item 3
of this Form 10-K. The increase in expenses for the year ended December 31,
1997, is due primarily to increased professional fees related to the Fund's
acquisitions and loan restructurings discussed in Part 1, Items 1. and 2. of
this Form 10-K.
Depreciation expense relates to equipment used for development activity which is
being depreciated over five years. Amortization expense relates primarily to
loan costs which are being amortized over the life of the related loan.
- 17 -
<PAGE>
Results of Operations - Continued
Expenses - Continued
No benefit for income taxes was provided during 1997 as the Fund has recorded a
valuation allowance equal to the amount of the benefit. The Fund has determined
that it is more likely than not that the net deferred tax asset will not be
realized. See Note 11 to the Fund's Consolidated Financial Statements for a
discussion of the components of the deferred tax asset.
Income tax expense is the Fund's estimated liability for Federal, state, and
local income taxes due on the amount of earnings which are in excess of
dividends for the period for the years ended December 31, 1996 and 1995.
Net Income (Loss)
The Fund's gross revenues increased approximately 30% from 1996 to 1997
exclusive of a $1.5 million non-cash recovery on provision for loan losses. This
increase is due to the transition from a mortgage REIT that generated its
revenues from interest earned on mortgage loans to a real estate development
company that generates its revenues primarily from the sale of single-family
residential lots. Net income for 1997 of $100,277 (exclusive of the $1.5 million
recovery of loan loss provision, the $11.6 million of other charges and a $3.7
million charge related to the Fund's unconsolidated affiliate)represents a
decline of approximately 88% from $850,309 earned in 1996. In the context of the
restructuring of the operations of the Fund from a REIT to a real estate
development company, management believes that the results of operations for 1997
are not comparable to prior years.
The Fund's revenues increased approximately 15% from 1995 to 1996 while net
income declined approximately 1% from 1995 to 1996. The disproportionate decline
in net income compared to the increase in revenues is due to the fact that the
sales volumes at the residential projects and the corresponding interest income
earned by the Fund were not sufficient to offset the increase in the Fund's cost
of debt service.
Year 2000
The Fund has conducted a comprehensive review of its computer systems to
identify the systems that could be affected by the Year 2000 Issue and is
developing an implementation plan to resolve the issue. The Year 2000 Issue, a
worldwide problem, is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Fund's
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 major system
failure or miscalculations. The Fund presently believes that, with modifications
to existing software and conversions to new software, the Year 2000 Issue will
not pose significant operational problems for the Fund's computer systems. The
Fund continues to evaluate appropriate courses of corrective action, including
replacement of certain systems whose associated costs would be recorded as
assets and amortized. The Fund does not expect the costs associated with the
resolution of the Year 2000 Issue to have a material effect on its financial
position or results of operations. The associated costs will be funded by cash
flow from operations or cash reserves. The amounts expensed in each of the three
years in the period ended December 31, 1997 were immaterial.
Cautionary Statements
Any forward-looking statements included in Management's Discussion and Analysis
of Financial Condition and Results of Operations, or elsewhere in this report,
which reflect management's best judgement based on factors known, involve risks
and uncertainties. Readers are cautioned not to place undue reliance on any
forward-looking statements, which reflect management's analysis only as of the
date hereof. The Fund undertakes no obligation to publicly revise these forward-
- 18 -
<PAGE>
Results of Operations - Continued
Cautionary Statements - Continued
looking statements to reflect events or circumstances that arise after the date
hereof. Actual results could differ materially from those anticipated in any
forward-looking statements as a result of a number of factors, including but not
limited to those discussed below. Any forward-looking information provided by
the Fund pursuant to the safe harbor established by recent securities
legislation should be evaluated in the context of these factors.
The Fund's subsidiaries, NTS/LFII and NTS/VA, and the Orlando Lake Forest
Joint Venture, in which the Fund has a 50% interest, are engaged in the
development and sale of residential subdivision building lots, the pricing and
sale of which are subject to risks generally associated with real estate
development and applicable market forces beyond the control of the Fund and/or
its subsidiaries, including general and local economic conditions, competition,
interest rates, real estate tax rates, other operating expenses, the supply of
and demand for properties, zoning laws, other governmental rules and fiscal
policies, and acts of God. All of the properties owned by NTS/LFII, NTS/VA and
OLFJV are encumbered by development loans from third party lenders which, given
the nature of the risks incumbent in real estate investment and development
activities as stated above, are inherently subject to default should the ability
of NTS/LFII, NTS/VA, OLFJV and/or the Fund to make principal and interest
payments under such development loans become impaired.
There is the potential for occurrences which could affect the Fund's ability
to reduce, or limit the increase in, its professional and administrative
expenses. Furthermore, the debt service regarding the Fund's borrowings is
variable based on current interest rates, any fluctuations in which are beyond
the control of the Fund. These variances could, for example, impact the Fund's
projected cash and cash requirements as well as projected returns.
- 19 -
<PAGE>
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of the NTS Mortgage Income Fund:
We have audited the accompanying consolidated balance sheets of the NTS Mortgage
Income Fund and subsidiaries (the Fund) (a Delaware corporation) as of December
31, 1997 and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These consolidated financial statements are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Fund as of
December 31, 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.
ARTHUR ANDERSEN LLP
Louisville, Kentucky
April 6, 1998
- 20 -
<PAGE>
NTS MORTGAGE INCOME FUND
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
1997 1996
------------- ---------
ASSETS
Cash and equivalents $ 1,413,445 $ 716,793
Interest receivable - affiliates -- 1,589,498
Membership initiation fees and other
accounts receivable 1,625,489 --
Notes receivable 3,573,162 --
Inventory 51,917,990 --
Property and equipment, net of accumulated
depreciation of $45,788 452,913 --
Investment in unconsolidated affiliate
(Note 4) 4,525,369 --
Other assets 676,000 151,654
Affiliated mortgage loans receivable:
Earning loans -- 63,948,933
Non-earning loans, net of reserves for
loan losses of $1,500,000 -- 2,338,831
------------ -----------
Total assets $ 64,184,368 $ 68,745,709
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 3,040,468 $ 267,800
Dividends payable -- 175,305
Advances from affiliates (Note 9) 600,542 --
Notes payable - affiliates (Note 9) 5,309,492 4,524,667
Notes payable 19,195,741 14,276,850
Lot deposits 97,500 --
Deferred revenues 146,789 301
------------ -----------
Total liabilities 28,390,532 19,244,923
------------ -----------
Commitments and contingencies (Note 14)
Stockholders' equity:
Common stock, $0.001 par value,
6,000,000 shares authorized;
3,187,333 shares issued and
outstanding $ 3,187 $ 3,187
Additional paid-in-capital 54,163,397 54,163,397
Accumulated deficit (18,372,748) (4,665,798)
------------ ------------
Total stockholders' equity 35,793,836 49,500,786
------------ -----------
Total liabilities and stockholders'
equity $ 64,184,368 $ 68,745,709
============ ===========
The accompanying notes are an integral part of these financial statements.
- 21 -
<PAGE>
<TABLE>
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 and 1995
<CAPTION>
1997 1996 1995
------------- ------------ -----------
<S> <C> <C> <C>
Revenues:
Lot sales, net of discounts $ 1,600,237 $ -- $ --
Cost of sales 1,230,168 -- --
------------ ----------- ----------
Gross profit 370,069 -- --
Interest income on affiliated mortgage
loans receivable 2,617,126 $ 3,256,148 $ 2,849,807
Fee income on affiliated mortgage loans
and other financial services 8,598 24,873 12,924
Recovery of provision for loan losses 1,500,000 -- --
Interest income on cash equivalents
and miscellaneous income 183,144 23,974 21,921
------------ ----------- ----------
4,678,937 3,304,995 2,884,652
------------ ----------- ----------
Expenses:
Advisory fee (Note 9) $ 418,950 $ 544,776 $ 528,973
Cost reimbursements-affiliate (Note 9) 526,571 -- --
Overhead reimbursement-affiliate (Note 9) 106,473 -- --
Professional and administrative 274,977 201,688 162,427
Interest expense 1,304,157 1,343,241 1,165,078
Interest expense-affiliates (Note 9) 358,262 258,191 82,050
Other taxes and licenses 23,060 27,340 25,790
Depreciation and amortization expense 172,877 72,050 52,000
Loss from investment in unconsolidated
affiliate (Note 4) 3,600,560 -- --
Other charges (Note 3) 11,600,000 -- --
------------ ----------- ----------
18,385,887 2,447,286 2,016,318
------------ ----------- ----------
Income(loss)before income tax expense (13,706,950) 857,709 868,334
Income tax expense -- 7,400 10,000
------------ ----------- ----------
Net income(loss) $(13,706,950) $ 850,309 $ 858,334
============ =========== ==========
Net income(loss)per share of common
stock $ (4.30) $ .27 $ .27
============ =========== ==========
Weighted average number of shares 3,187,333 3,187,333 3,187,333
============ =========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 22 -
<PAGE>
<TABLE>
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
Common Common Additional
Stock Stock Paid-in- Accumulated
Shares Amount Capital Deficit Total
<S> <C> <C> <C> <C> <C>
Stockholders' equity
December 31, 1994 3,187,333 $ 3,187 $54,163,397 $ (5,124,999) $49,041,585
Net income -- -- 858,334 858,334
Dividends declared -- -- (643,841) (643,841)
---------- -------- ---------- ------------ ------------
Stockholders' equity
December 31, 1995 3,187,333 $ 3,187 $54,163,397 $ (4,910,506) $49,256,078
Net income -- -- 850,309 850,309
Dividends declared -- -- (605,601) (605,601)
---------- -------- ---------- ------------ ------------
Stockholders' equity
December 31, 1996 3,187,333 $ 3,187 $54,163,397 $ (4,665,798) $49,500,786
Net loss -- -- (13,706,950) (13,706,950)
---------- -------- ---------- ------------ ------------
Stockholders' equity
December 31, 1997 3,187,333 $ 3,187 $54,163,397 $(18,372,748) $35,793,836
========== ======== ========== ============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 23 -
<PAGE>
<TABLE>
NTS MORTGAGE INCOME FUND
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<CAPTION>
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM (USED FOR) OPERATING ACTIVITIES
Net income (loss) $(13,706,950) $ 850,309 $ 858,334
Adjustments to reconcile net income to
net cash provided by operating activities:
Accretion of discount on affiliated mortgage
loans receivable (95,932) (148,472) (125,029)
Recovery of provision for loan losses (1,500,000) -- --
Depreciation and amortization expense 172,877 72,050 52,000
Loss from investment in unconsolidated affiliate 3,600,560 -- --
Other non-cash charges 11,600,000 -- --
Changes in assets and liabilities: (1)
Interest receivable - affiliates 480,778 (447,477) (769,193)
Membership initiation fees and other accounts
receivable 123,364 -- --
Notes receivable 416,352 -- --
Inventory (789,991) -- --
Accounts payable 158,721 88,493 24,692
Lot deposits (14,000) -- --
Deferred revenues 14,016 (22,826) 18,968
------------ ------------ -----------
Net cash provided by operating activities 459,795 392,077 59,772
------------ ------------ -----------
CASH FLOWS FROM (USED FOR) INVESTING ACTIVITIES
Principal collections on affiliated mortgage
loans receivable $ 9,299,287 $ 8,099,364 $ 8,219,874
Investment in affiliated mortgage loans receivable (5,700,037) (10,562,950) (21,187,154)
Purchase of stock of acquired subsidiaries (30) -- --
Property and equipment 27,555 -- --
------------ ------------ -----------
Net cash provided by (used for) investing
activities 3,626,775 (2,463,586) (12,967,280)
------------ ------------ ------------
CASH FLOWS FROM (USED FOR) FINANCING ACTIVITIES
Payments on advances from affiliates $ (519,797) $ -- $ --
Proceeds from notes payable 8,515,946 1,201,999 15,186,873
Proceeds from notes payable - affiliates 2,436,291 4,077,457 1,885,000
Payments on notes payable (11,805,279) (1,075,022) (2,973,528)
Payments on notes payable - affiliates (1,651,466) (1,437,790) --
Loan costs (260,026) -- --
Other assets 69,718 (45,485) (230,219)
Dividends paid (175,305) (468,544) (733,086)
------------ ------------ ------------
Net cash provided by (used for) financing
activities (3,389,918) 2,252,615 13,135,040
------------ ------------ -----------
Net increase in cash and equivalents $ 696,652 $ 181,106 $ 227,532
CASH AND EQUIVALENTS, beginning of period 716,793 535,687 308,155
------------ ------------ -----------
CASH AND EQUIVALENTS, end of period $ 1,413,445 $ 716,793 $ 535,687
============ ============ ===========
<FN>
(1) Net of the effects of acquisitions, where applicable. See Note 12
for information on non-cash investing and financing activities.
</FN>
</TABLE>
The accompanying notes are an integral part of these financial statements.
- 24 -
<PAGE>
NTS MORTGAGE INCOME FUND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
A) Organization
NTS Mortgage Income Fund (the "Fund"), a Delaware corporation, was
formed on September 26, 1988. The Fund operated as a real estate
investment trust (REIT) under the Internal Revenue Code of 1986 (the
"Code"), as amended, from its inception through December 31, 1996.
The Fund began operating as a "C" corporation under the Code for tax
purposes effective January 1, 1997. NTS Corporation is the sponsor of
the Fund (the "Sponsor"). NTS Advisory Corporation is the advisor to
the Fund (the "Advisor"), and NTS Residential Management Company is
the manager to the Fund ("NTS Management"). The Advisor and NTS
Management are affiliates of and are under common control with NTS
Corporation.
The Fund's subsidiaries include NTS/Lake Forest II Residential
Corporation (NTS/LFII) and NTS/Virginia Development Company (NTS/VA).
These subsidiaries were acquired effective October 1, 1997. The
acquisitions were accounted for under the purchase method of
accounting. See Note 3, "Acquisitions", for further information
pertaining to the acquisitions. Prior to making the acquisitions, the
Fund had been the primary creditor of these entities.
NTS/LFII is in the process of developing approximately 726 acres of
land located in Louisville, Kentucky into a single-family residential
community and a country club with a championship golf course for the
purpose of selling such residential lots and country club
memberships. In addition, Lake Forest has amenities consisting of a
clubhouse, pools, tennis courts, recreation fields and several lakes.
As of December 31, 1997, approximately 500 acres have been developed
including approximately 240 acres related to a golf course and
various amenities. Approximately 240 of the 500 developed acres had
been sold as of December 31, 1997.
NTS/VA is in the process of developing approximately 2,825 acres
located in the Chancellor district of Spotsylvania County, Virginia,
approximately 60 miles south of Washington, D.C., into a
single-family residential community and a country club with a
championship golf course for the purpose of selling such residential
lots and country club memberships. Included on the property is a 285
acre lake. In addition, Fawn Lake has amenities consisting of a
clubhouse, pool, tennis courts and boat docks. As of December 31,
1997 approximately 1,100 acres have been developed including a 300
acre lake and approximately 220 acres related to a golf course and
other amenities. Approximately 400 of the 1,100 developed acres had
been sold as of December 31, 1997.
The Fund purchased a 50% interest in the Orlando Lake Forest Joint
Venture effective August 16, 1997. Prior to becoming a joint venture
partner, the Fund had been the Joint Venture's primary creditor. See
Note 4, "Investment in Unconsolidated Affiliate", for further
information pertaining to the investment.
B) Basis of Accounting
The Fund's records are maintained on the accrual basis of accounting
in accordance with generally accepted accounting principles (GAAP).
- 25 -
<PAGE>
1. Summary of Significant Accounting Policies - Continued
C) Principles of Consolidation and Basis of Presentation
The consolidated financial statements of the Fund include the assets,
liabilities, revenues and expenses of its 100% owned subsidiaries.
The consolidated statements of operations include the results of
acquired businesses accounted for under the purchase method of
accounting from the date of acquisition. Investments of 50% or less
in affiliated companies are accounted for under the equity method.
All significant intercompany transactions have been eliminated.
D) Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those
estimates.
E) Revenue Recognition and Reserves for Loan Losses
The Fund recognizes revenue and related costs from lot sales using
the accrual method in accordance with generally accepted accounting
principles, which is when payment has been received and title,
possession and other attributes of ownership have been transferred to
the buyer, and the Fund and its subsidiaries are not obligated to
perform significant activities after the sale. The Fund and its
subsidiaries generally require a minimum down payment of at least 10%
of the sales price of the lot.
Interest income from mortgage loans and notes receivable was reported
as earned on the accrual basis of accounting. If the Fund had any
reason to doubt the collectability of any principal or interest
amounts due pursuant to the terms of the mortgage loans or notes,
appropriate reserves would have been established for any principal
and accrued interest amounts deemed unrealizable. Statements of
Financial Accounting Standards Nos. 114 and 118 require that impaired
loans be measured based on the present value of expected future cash
flows discounted at each loan's effective interest rate, at each
loan's observable market price or at the fair value of the collateral
if the loan is collateral dependent.
F) Inventory
Inventory is stated at the lower of cost or net realizable value.
Inventory includes all direct costs of land, land development, and
amenities, including interest, real estate taxes, and certain other
costs incurred during the development period, less amounts charged to
cost of sales. Inventory costs are allocated to individual lots sold
using the relative sales values. The use of the relative sales value
method to record cost of sales requires the use of estimates of sales
values, development costs and absorption periods over the life of the
project. Given the long-term nature of the projects and inherent
economic volatility of residential real estate, it is reasonably
possible that such estimates could change in the near term. Any
changes in estimates would be accounted for prospectively over the
life of the project.
- 26 -
<PAGE>
1. Summary of Significant Accounting Policies - Continued
G) Long-Lived Assets
Statement of Financial Accounting Standards (SFAS) No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of, specifies circumstances in which
certain long-lived assets must be reviewed for impairment. If such
review indicates that the carrying amount of an asset exceeds the sum
of its expected future cash flows, the asset's carrying value must be
written down to fair market value.
H) Advertising
The Fund expenses advertising-type costs as incurred. Advertising
expense, a component of Cost Reimbursements (see Note 9), was
approximately $100,000 during the year ended December 31, 1997.
I) Operating Expense Limitations
Prior to January 1, 1997, the annual Operating Expenses of the Fund
when functioning as a REIT, based upon guidelines promulgated by the
North American Securities Administrators Association, Inc., were
prohibited from exceeding in any fiscal year the greater of (i) 2% of
the Fund's Average Invested Assets during such fiscal year or (ii)
25% of the Fund's Net Income during such fiscal year. In the event
the Fund's annual Operating Expenses exceeded this limitation, the
Advisor would reimburse the Fund within 60 days after the end of the
fiscal year, the amount by which the aggregate annual Operating
Expenses paid or incurred by the Fund exceed the foregoing
limitations. The Fund did not exceed this limitation for the years
ended December 31, 1996 and 1995.
J) Environmental Remediation and Compliance
Environmental liabilities for remediation costs are accrued based on
estimates of known environmental remediation exposures. Liabilities
are recognized when they can be reasonably estimated. Environmental
compliance costs are expensed as incurred.
K) Per Share Information
The Financial Accounting Standards Board recently issued Standard No.
128, Earnings Per Share (FAS 128). The Statement simplifies the
standards for computing earnings per share (EPS) and replaces the
presentation of primary and fully diluted EPS with a presentation of
basic and diluted EPS. FAS 128 is effective for financial statements
for periods ending after December 15, 1997. For all periods
presented, the Fund did not have common stock equivalents, therefore,
the adoption of FAS 128 did not have any impact on the Fund's
financial statements.
L) Statement of Cash Flows
For purposes of reporting cash flows, cash and equivalents include
cash on hand and short-term, highly liquid investments with an
original maturity of three (3) months or less that are readily
convertible to cash.
- 27 -
<PAGE>
2. Affiliations
The Fund operates under the direction of its Board of Directors who have
retained NTS Management to be the sole and exclusive agent of the Fund
for day-to-day control and management of the business of the Fund's
subsidiaries including (a) the continued operation of NTS/LFII and
NTS/VA, (b) the operations of the Lake Forest Country Club and the Fawn
Lake Country Club, (c) the operations of the Lake Forest Community
Association and the Fawn Lake Community Association and (d) the provision
and/or sale of ancillary goods and services as selected by NTS Management
with respect to any of the foregoing. The Management Agreements have an
initial term through and including December 31, 2003, and automatically
renew for successive six year terms unless terminated by the Fund, its
subsidiaries, or NTS Management upon six months written notice. See Note
9 for further discussion of the Management Agreements. NTS Management is
an Affiliate of and under common control with NTS Corporation, the Fund's
Sponsor. The Chairman of the Board of Directors of the Fund is also the
majority shareholder of NTS Corporation and is a majority shareholder of
the managing general partner in the Orlando Lake Forest Joint Venture of
which the Fund is a 50% joint venture partner. NTS Advisory and NTS
Management are Affiliates of and are under common control with NTS
Corporation.
3. Acquisitions
The Fund acquired all of the issued and outstanding common stock of
NTS/LFII and NTS/VA effective October 1, 1997, for a nominal purchase
price. Concurrent with this transaction, the existing indebtedness of
each of NTS/LFII and NTS/VA to the Fund was converted to equity.
The transaction is being accounted for using the purchase method of
accounting. The purchase price (approximately $14.5 million for NTS/LFII
and approximately $28.7 million for NTS/VA) has been allocated to the
assets and liabilities of NTS/LFII and NTS/VA based on their estimated
fair market value. The acquisition of NTS/LFII included inventory of
approximately $19 million, debt of approximately $5 million and other net
assets and liabilities of approximately $500,000. The acquisition of
NTS/VA included inventory of approximately $32 million, debt of
approximately $5.5 million and other net assets and liabilities of
approximately $2.2 million. The results of operations for NTS/LFII and
NTS/VA from the date of acquisition (October 1, 1997) are included in the
consolidated financial statements of the Fund.
Generally Accepted Accounting Principles require that these acquisitions
be recorded at fair market value. The application of these principles
resulted in a non-cash charge of approximately $11,600,000 during the
fourth quarter of 1997 related to these transactions. All estimates used
in these evaluations represented management's best estimates based on the
facts present at the date of the evaluations.
- 28 -
<PAGE>
3. Acquisitions - Continued
The following unaudited pro forma information for the Fund for the
periods shown below gives effect to the NTS/LFII and NTS/VA acquisitions
as if they had occurred as of the beginning of 1996.
Year Ended
December 31,
(unaudited)
1997 1996
------------- --------
Lot sales $ 6,894,385 $ 6,243,567
Cost of sales (5,078,124) (4,352,972)
Other income (expenses), net (6,003,425) (3,914,324)
------------- ------------
Net loss $ (4,187,164) $(2,023,729)
============= ============
Net loss per share of common stock $ (1.31) $ (.64)
============= ============
Weighted average number of shares 3,187,333 3,187,333
============= ===========
The unaudited pro forma information assumes the acquisitions occurred
January 1, 1996 and, accordingly, includes adjustments for interest
income on affiliated mortgages loans receivable, interest expense,
certain administrative costs and income taxes. The 1997 unaudited pro
forma data does not include the non-recurring, non-cash charge of
$11,600,000 related to the acquisitions. The 1997 unaudited pro forma
data does include a non-cash charge of approximately $3.7 million related
to the Fund's evaluation of its investment in an unconsolidated affiliate
(See Note 4). This charge is included in "Other income (expenses), net."
The unaudited pro forma financial data is presented for information
purposes only and is not necessarily indicative of the results of
operations that actually would have been achieved had the acquisition of
NTS/LFII and NTS/VA been consummated at the beginning of the periods
presented.
4. Investment in Unconsolidated Affiliate
In September 1997, the Fund entered into an Amended and Restated Joint
Venture Agreement evidencing the Fund's admission as a partner in the
Orlando Lake Forest Joint Venture (the "Joint Venture") effective as of
August 16, 1997. The other partners in the Joint Venture are Orlando Lake
Forest, Inc., Orlando Capital Corporation and OLF II Corporation, all of
whom are Affiliates of and are under common control with the Fund's
Sponsor. The Joint Venture will continue to operate under its current
legal name as the Orlando Lake Forest Joint Venture.
The Joint Venture owns the Orlando Lake Forest project, a single-family
residential community located in Seminole County, Florida (near Orlando)
consisting of approximately 360 acres of residential land and
improvements and approximately 20 acres of commercial land. The Joint
Venture will continue to own and develop the Orlando Lake Forest project.
The Fund contributed to the Joint Venture as a capital contribution its
interest in the principal and interest of the first mortgage loan on the
Orlando Lake Forest project, and obtained a 50% interest in the Joint
Venture. The NTS entities named above hold cumulatively the remaining 50%
interest in the Joint Venture.
The net income or net loss of the Joint Venture is allocated based on the
respective partner's percentage interest, as defined in the joint venture
agreement. As of December 31, 1997, the Fund's percentage interest was
50%, and the Fund's investment balance in the Joint Venture was
$4,525,369. The Fund's share of the Joint Venture's net income from
August 16, 1997 (when the Fund was admitted as a partner) through
December 31, 1997 was $106,667.
- 29 -
<PAGE>
4. Investment in Unconsolidated Affiliate - Continued
Generally Accepted Accounting Principles require that such investments be
recorded at the lower of carrying value or fair market value. The
application of these principles resulted in a non-cash charge of
approximately $3.7 million in the third quarter of 1997. All estimates
used in this evaluation represent management's best estimates based on
the facts present at the date of such evaluations.
The following presents condensed financial information for the Joint
Venture as of December 31, 1997 and for the period August 16, 1997
through December 31, 1997:
Balance Sheet
Notes receivable $ 647,448
Inventory 13,376,714
Other, net 1,935,254
-----------
Total assets $ 15,959,416
===========
Notes payable $ 4,793,014
Other liabilities 2,115,662
Equity 9,050,740
-----------
Total liabilities and equity $ 15,959,416
===========
Statement of Operations
Lot sales $ 1,678,079
Cost of sales (1,150,339)
Other income (expenses), net (314,404)
------------
Net income $ 213,336
===========
5. Member Initiation Fees and Other Accounts Receivable
Fawn Lake Country Club and Lake Forest Country Club membership initiation
fees receivable totaled approximately $1,209,000 as of December 31, 1997.
The receivable is net of a discount recorded to allow for the present
value of the membership initiation fee receivables considering the
estimated timing of collections.
6. Notes Receivable
Notes receivable are secured by a first mortgage on lots sold to
individuals. The notes bear interest at the prevailing market rates at
the time the lots were sold. The majority of the notes are due between
five and seven years, monthly payments are based on a 30-year
amortization and the balance is due at the maturity date. As of December
31, 1997, notes totaling $3,442,662 are pledged as security for notes
payable to banks under certain Warehouse Line of Credit Agreements. There
are also $130,500 of notes held by NTS/VA that are not pledged.
Approximately $1,392,091, $908,602, $770,145, $154,204 and $217,620 of
the notes receivable balance as of December 31, 1997 are due for the
years ended December 1998 through 2002, respectively.
- 30 -
<PAGE>
7. Inventory
Inventory consists of the following as of December 31, 1997:
NTS/LFII NTS/VA Consolidated
---------- ---------- ------------
Land held for future
development, under
development and completed lots $ 6,874,432 $21,787,093 $28,661,525
Country club (net of
membership initiation fees) 7,329,088 7,174,662 14,503,750
Amenities 4,589,548 4,163,167 8,752,715
---------- ---------- ----------
$18,793,068 $33,124,922 $51,917,990
========== ========== ==========
NTS/LFII and NTS/VA capitalized in inventory approximately $214,000 of
interest and real estate taxes from October 1, 1997 though December 31,
1997. Interest and real estate taxes incurred was approximately $396,000
as of December 31, 1997.
Inventory for 1997 as reflected above includes $21,708,355, net of
$7,204,605 of country club membership initiation fees, of costs incurred
to date for the development of the Fawn Lake Country Club and the Lake
Forest Country Club.
Pursuant to an agreement between NTS/LFII and the Lake Forest Country
Club regarding the cost to develop the Country Club, NTS/LFII is to
receive all initiation fees from membership sales for a period not to
exceed 12 years from the date of the agreement (ending 2003). The
remaining cost to be incurred for the current projected Country Club
operating deficit for the period covered by the agreement is
approximately $2,330,000 which is expected to be offset by member
initiation fees. During the fourth quarter of 1997 the Country Club
operating deficit was approximately $160,000 and was capitalized as a
cost of inventory.
8. Notes and Mortgage Loans Payable
Notes and mortgage loans payable consist of the following:
1997 1996
----------- --------
Note payable to a bank in the amount of
$13,800,000, bearing interest at the Prime
Rate + 1%, payable monthly, due December
27, 1997, secured by a collateral
assignment of the Fund's mortgages on Lake
Forest and Fawn Lake, guaranteed by Mr. J.
D. Nichols, Chairman of the Board of the
Fund's Sponsor, paid in full on January 7,
1998 (See Note 18) $ 3,607,283 $12,278,000
Mortgage loan payable to a bank in the
amount of $10,700,000, bearing interest at
the Prime Rate + 1 1/2%, due December 1,
2002, secured by inventory of NTS/VA,
generally principal payments consist of
approximately 91% of the Gross Receipts of
lot sales, guaranteed by Mr. J. D. Nichols
up to $3,000,000 8,005,034 --
(Continued next page)
- 31 -
<PAGE>
1997 1996
------------ --------
Mortgage loan payable to a bank in the
amount of $4,000,000, bearing interest at
the Prime Rate + 1/2%, payable monthly,
due July 31, 2002, secured by the Lake
Forest Country Club and golf course,
annual principal reductions of $300,000
every six months are guaranteed by NTS
Corporation, the Fund's Sponsor $ 3,950,000 $ --
Warehouse Line of Credit Agreements with
three banks bearing interest at the
Prime Rate + 1%, the Prime Rate + 3/4% and
the Prime Rate + 1/2%, due December 15, 1998
($597,774), September 30, 1998 ($2,403,103)
and February 28, 1999 ($494,422), secured by
notes receivable (see Note 6), principal
payments consist of payments received from
notes receivable securing the obligation 3,495,299 --
Equipment loan in the amount of $27,736,
bearing interest at a rate of 5.94%, due
April 1, 2000, secured by equipment
purchased for use at the Lake Forest
Country Club 21,970 --
Bank note payable in the amount of
$165,276, bearing interest at the rate of
8.75%, due January 14, 1999, secured by
golf course maintenance equipment 60,123 --
Bank note payable in the amount of
$42,435, bearing interest at the rate of
10.5%, due October 15, 1999, secured by
golf course maintenance equipment 24,778 --
Bank note payable in the amount of
$34,555, bearing interest at the rate of
10.5%, due October 15, 1999, secured by
golf course maintenance equipment 20,063 --
Bank note payable in the amount of
$19,194, bearing interest at the rate of
10.5%, due October 15, 1999, secured by
golf course maintenance equipment 11,191 --
Note payable to a bank in the amount of
$2,500,000, bearing interest at the Prime
Rate + 3/4%, payable monthly, due July 31,
1997, secured by approximately 187 acres
of residential land and improvements
thereon -- 1,998,850
---------- ----------
$19,195,741 $14,276,850
========== ==========
The Prime Rate was 8 1/2% and 8 1/4% at December 31, 1997 and 1996,
respectively.
The $597,774 and $494,422 Warehouse Line of Credit agreements are
guaranteed by NTS Corporation.
- 32 -
<PAGE>
8. Notes and Mortgage Loans Payable - Continued
The minimum scheduled principal payments on debt outstanding at December
31, 1997 are as follows:
1998 (1) $ 7,800,945
1999 636,452
2000 808,344
2001 2,500,000
2002 7,450,000
-----------
$ 19,195,741 (2)
============
(1)1998 includes $3,607,283 of debt which was repaid from the proceeds of
additional borrowings (See Note 18) and $3,495,299 of Warehouse Line
of Credit agreements which have historically renewed for one year
periods.
(2)The minimum scheduled principal payments regarding the $10.7 million
credit facilities are reflected in the table such that the outstanding
principle amount is brought to within the following levels by the
applicable date:
December 31, 1998 $10,700,000
December 31, 1999 $ 9,300,000
December 31, 2000 $ 7,800,000
December 31, 2001 $ 5,900,000
December 1, 2002 $ 4,500,000
9. Related Party Transactions
As of December 31, 1997, the Sponsor or an Affiliate owned 96,468 shares
of the Fund. The Fund has entered into the following agreements with
various Affiliates of the Sponsor regarding the ongoing operation of the
Fund.
Advisory Agreement
Pursuant to the Advisory Agreement, the Fund paid the Advisor (NTS
Advisory Corporation) a Management Expense Allowance through September
30, 1997 (Advisory Fee) relating to services performed for the Fund in an
amount equal to 1% of the Fund's Net Assets, per annum, which amount was
increased annually by an amount corresponding to the percentage increase
in the Consumer Price Index. Effective July 1, 1994, the Fund's Mortgage
Loans to Fawn Lake and Lake Forest were converted to cash flow mortgage
loans. As part of the consideration for this restructuring, the Fund's
Board of Directors required, among other things, that beginning in 1995,
NTS Advisory Corporation pay $100,000 annually towards the expenses of
the Fund until the maturity of the Mortgage Loans. As such, the Advisory
Fee has been reduced $100,000 for each of the years ended December 31,
1996 and 1995 and $75,000 for the year ended December 31, 1997. For the
years ended December 31, 1997, 1996 and 1995, $418,950, $544,776 and
$528,973, respectively, has been incurred as an Advisory Fee. Effective
October 1, 1997, the Fund will no longer incur an Advisory Fee but will
be responsible for the actual general and administrative costs pursuant
to certain property management agreements discussed below.
Property Management Agreements
The ongoing operation and management of the Lake Forest North and Fawn
Lake projects will be conducted by NTS Residential Management Company
(NTS Management) under the terms of (i) a Property Management Agreement
executed on December 30, 1997, and dated as of October 1, 1997, by and
among the Fund, NTS/LFII and NTS Management for the Lake Forest North
project, and (ii) a Property Management Agreement executed on December
30, 1997, and dated as of October 1, 1997, by and among the Fund, NTS/VA
and NTS Management for the Fawn Lake project (collectively, the
Management Agreements). NTS Management is a wholly-owned subsidiary of
NTS Development Company. NTS Development Company is a wholly-owned
subsidiary of the Fund's Sponsor. The Management Agreements have an
initial term through December 31, 2003, subject to extension under
- 33 -
<PAGE>
9. Related Party Transactions - Continued
Property Management Agreements - Continued
certain conditions, and are renewable for successive six (6) year terms
thereafter. Under the Management Agreements, NTS Management will be
reimbursed for costs incurred in the operation and management of the Lake
Forest North and Fawn Lake projects, and will accrue an incentive payment
payable as provided therein.
Reimbursements of approximately $527,000 were made to NTS Management or
an Affiliate during the period from October 1, 1997 through December 31,
1997 for actual personnel, marketing and administrative costs as they
relate to NTS/LFII, NTS/VA and the Fund. These reimbursements are
reflected as Cost Reimbursements in the accompanying Statements of
Operations.
Additionally, NTS Management is entitled to an Overhead Recovery, which
is a reimbursement for overhead expenses attributable to the employees
and the efforts of NTS Management under the Management Agreements, in an
amount equal to 3.75% of the projects' gross cash receipts, as defined in
the Management Agreements. $106,473 was incurred as an Overhead Recovery
during the period from October 1, 1997 through December 31, 1997. This
amount is classified as Overhead Reimbursement in the accompanying
Statements of Operations.
The Management Agreements also call for NTS Management to receive an
Incentive Payment, as defined in the Management Agreements, equal to 10%
of the Net Cash Flows of the projects. The Incentive Payment will not
begin accruing until after the cumulative cash flows of NTS/LFII, NTS/VA
and the Fund's share of the cash flow of the Orlando Lake Forest Joint
Venture would have been sufficient to enable the Fund to return to the
then existing shareholders of the Fund an amount which, after adding
thereto all other payments actually remitted or distributed to such
shareholders of the Fund, is at least equal to the shareholders' Original
Capital Contribution. As of December 31, 1997, the Fund had raised
approximately $63,690,000 and had paid distributions of approximately
$23,141,000. As of December 31, 1997, no amount had been accrued as an
Incentive Payment in the Fund's consolidated financial statements.
Advances and Notes Payable Affiliates
NTS/VA has received non-interest bearing advances from Affiliates of the
Fund's Sponsor totaling $600,542 as of December 31, 1997. The advances
were used to fund development costs and will be repaid to the Affiliates
as cash flow permits.
The Fund has received advances from Affiliates of the Fund's Sponsor, net
of repayments, totaling $5,309,492 and $4,524,667 as of December 31, 1997
and 1996, respectively. As of December 31, 1997, the advances bear
interest at approximately the Prime Rate and mature as follows:
$1,774,000 on March 31, 1999, $1,124,158 on May 1, 1999 and $2,411,334 is
due on demand. Interest expense to the Affiliates was $358,262, $258,191
and $82,050 for the years ended December 31, 1997, 1996 and 1995,
respectively.
- 34 -
<PAGE>
10. Affiliated Mortgage Loans Receivable
The following table outlines the activity regarding the Fund's mortgage
loan portfolio for the three years in the period ended December 31, 1997.
Affiliated Mortgage Loans Receivable:
Balance at December 31, 1994 $52,222,252
Additions:
Mortgage Loans $20,113,201
Temporary Mortgage Loans 1,073,953
Accretion of discount 125,029
Amortization of loan fees --
------------
21,312,183
Reductions:
Mortgage Loans (6,177,976)
Temporary Mortgage Loans (2,041,898)
Mortgage Loan written-off (85,458)
Loan fees received (20,000) (8,325,332)
------------ ------------
Balance at December 31, 1995 $65,209,103
Additions:
Mortgage Loans $ 9,371,032
Temporary Mortgage Loans 1,191,918
Accretion of discount 148,472
Amortization of loan fees 20,000
------------
10,731,422
Reductions:
Mortgage Loans (6,692,948)
Temporary Mortgage Loans (1,406,416)
Mortgage Loan written-off (53,397)
Loan fees received -- (8,152,761)
------------ ------------
Balance at December 31, 1996 $67,787,764
Additions:
Mortgage Loans $ 5,186,594
Temporary Mortgage Loans 513,443
Accretion of discount 95,932
Amortization of loan fees --
------------
5,795,969
Reductions:
Mortgage Loans (5,447,696)
Temporary Mortgage Loans (6,351,123)
Investment in unconsolidated
affiliate (Note 4) (8,125,928)
Purchase of net assets
of subsidiaries (Note 3) (53,658,986) (73,583,733)
------------- ------------
Balance at December 31, 1997 $ --
============
(Continued next page)
- 35 -
<PAGE>
10. Affiliated Mortgage Loans Receivable - Continued
Reserves for Loan Losses:
Balance at December 31, 1994 $ 1,638,855
Additions charged to expenses $ --
Deduction for Mortgage Loan
written-off (85,458) (85,458)
----------- -----------
Balance at December 31, 1995 $ 1,553,397
Additions charged to expenses $ --
Deductions for Mortgage Loan
written-off (53,397) (53,397)
----------- -----------
Balance at December 31, 1996 $ 1,500,000
Additions charges to expenses $ --
Recovery of provisions for loan loss (1,500,000) (1,500,000)
----------- -----------
Balance at December 31, 1997 $ --
===========
11. Income Taxes
The Fund adopted Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109), effective January 1, 1997. SFAS
109 requires recognition of deferred tax assets and liabilities for the
expected future tax consequence of events that have been included in the
financial statements or tax returns. Under this method, deferred tax
assets and liabilities are determined based on the difference between the
Fund's book and tax bases of assets and liabilities and tax carryforwards
using enacted tax rates in effect for the year in which the differences
are expected to reverse. The principal tax carryforwards and temporary
differences giving rise to the Fund's deferred taxes consist of tax net
operating loss carryforwards, valuation allowances and differences in
inventory basis for book and tax.
The Fund's deferred tax assets and liabilities are as follows:
Deferred tax assets December 31, 1997
Net operating loss carryforwards $ 132,000
Inventory 3,199,000
------------
Net deferred tax assets 3,331,000
Valuation Allowance (3,331,000)
------------
$ --
============
A valuation allowance is provided when the probability that the deferred
tax asset to be realized does not meet the criteria established by the
Financial Accounting Standards Board. The Fund has determined, based on a
history of operating losses by its subsidiaries and its expectations for
the future, that it is more likely than not that the net deferred tax
assets at December 31, 1997, will not be realized.
As of December 31, 1997, the Fund has a federal net operating loss
carryforward of approximately $387,000 expiring in 2012.
- 36 -
<PAGE>
11. Income Taxes - Continued
A reconciliation of the statutory to the effective rate of the Fund is as
follows:
December 31, 1997
Tax benefit using statutory rate $ 4,660,000
Recovery on provision for loan losses 510,000
Establishing deferred tax liabilities
due to change in tax status (1,839,000)
Valuation Allowance (3,331,000)
----------
Income tax expense $ --
==========
Prior to January 1, 1997, the Fund elected and qualified to be treated as
a REIT under Internal Revenue Code Sections 856-860. In order to qualify,
the Fund was required to distribute at least 95% of its taxable income to
Stockholders and meet certain other requirements. A reconciliation of net
income for financial statement purposes versus that for income tax
reporting at December 31 is as follows:
1996 1995
----------- --------
Net income (GAAP) $ 850,309 $ 858,334
Accretion of note discount (148,472) (125,029)
Loan commitment fee income (20,000) 20,000
Letters of credit income (2,326) (1,032)
Supplemental interest income -- (1,717)
Federal income tax expense 5,000 7,000
Provision for loan losses (53,397) (85,458)
---------- ---------
Taxable income before dividends paid
deduction $ 631,114 $ 672,098
========== ========
Dividends declared $ 605,601 $ 643,841
========== ========
Distribution percentage 96% 96%
========== ========
12. Supplemental Cash Flow Information
a) Cash payments for interest, net of amounts capitalized and cash
payments for income taxes, net of refunds are as follows;
1997 1996 1995
---------- ---------- ---------
Interest $1,767,786 $1,510,384 $1,130,832
Income taxes $ 5,320 $ -- $ 700
b) Supplemental Non-Cash Investing and Financing Activity: In 1997,
the Fund made an investment in an unconsolidated affiliate by
contributing the principal amount outstanding on mortgage loans
receivable of approximately $8,125,000. (See Note 4).
In 1997, the Fund acquired all of the outstanding common stock of
NTS/LFII and NTS/VA for a nominal purchase price. Concurrent with
this transaction, the existing indebtedness of each of NTS/LFII
and NTS/VA to the Fund totaling approximately $53,659,000 was
converted to equity (See Note 3).
- 37 -
<PAGE>
13. Financial Instruments
The book values of cash and cash equivalents, trade receivables and trade
payables are considered to be representative of their respective fair
values because of the immediate or short-term maturity of these financial
instruments. The fair value of the Fund's debt instruments approximated
the book value because a substantial portion of the underlying instruments
are variable rate notes which re-price frequently.
14. Commitments and Contingencies
The Fund has commitments to extend credit made in the normal course of
business that are not reflected in the financial statements. At December
31, 1997, the Fund had outstanding funding commitments under standby
letters of credit aggregating $48,821 regarding the Orlando Lake Forest
Joint Venture.
NTS/LFII and NTS/VA have various letters of credit outstanding to
governmental agencies and utility companies totaling approximately
$2,892,500.
It is estimated that development of the remaining homeowners association
amenities at the Lake Forest North project will be substantially complete
by May 2000. Based on engineering studies and projections, NTS/LFII will
incur additional costs, excluding interest, of approximately $500,000
during 2000 to complete the homeowners association amenities.
It is estimated that the country club and homeowners association amenities
at the Fawn Lake project will be substantially completed by December 2002.
Based on engineering studies and projections, NTS/VA will incur additional
costs, excluding interest, of approximately $3,465,000 to complete the
country club and homeowners association amenities for the project. These
costs are estimated to be incurred as follows: $440,000 for 1998,
$2,425,000 for 1999, $200,000 for 2000 and $400,000 for 2002.
In July 1994, the Fund was named as a defendant in a complaint originally
filed by Jeno Paulucci & Silver Lakes I, Inc. in August 1992 against the
Fund's Sponsor and various Affiliates of the Fund's Sponsor. The suit was
settled in the first quarter of 1997. The terms of the settlement
agreement are confidential, however, it is not anticipated that the
settlement will have a material impact on the Fund's financial position or
results of operations.
15. Guaranties to the Fund
NTS Guaranty Corporation (the "Guarantor"), an Affiliate of the Sponsor,
has guaranteed that investors of the Fund will receive, over the life of
the Fund, aggregate distributions from the Fund (from all sources) in an
amount at least equal to their Original Capital Contributions, as defined
in the Fund's Prospectus. As of December 31, 1997, the Fund has raised
approximately $63,690,000 and has paid distributions of $23,141,000.
The liability of the Guarantor under the above guaranties is expressly
limited to its assets and its ability to draw upon a $10 million demand
note receivable from Mr. J.D. Nichols, Chairman of the Board of Directors
of the Sponsor. There can be no assurance that Mr. Nichols will, if called
upon, be able to honor his obligation to the Guarantor. The total amounts
guaranteed by the Guarantor are in excess of its net worth, and there is
no assurance that the Guarantor will be able to satisfy its obligation
under these guaranties. The Guarantor may in the future provide guaranties
for other Affiliates of the Fund.
- 38 -
<PAGE>
16. Dividends Paid and Payable
Dividends declared for the periods ended December 31, 1995 and 1996 were
as follows:
Average
Date Date of Date Outstanding Amount
Declared Record (1) Paid Shares Per Share Amount
-------- ---------- -------- ----------- --------- --------
03/09/95 01/31/95 02/27/95 3,187,333 $ .03 $ 95,620
03/09/95 02/28/95 03/28/95 3,187,333 .03 95,620
03/09/95 03/31/95 04/27/95 3,187,333 .03 95,620
03/09/95 04/30/95 05/26/95 3,187,333 .03 95,620
03/09/95 05/31/95 06/27/95 3,187,333 .01 31,873
03/09/95 06/30/95 07/27/95 3,187,333 .01 31,873
03/09/95 07/31/95 08/25/95 3,187,333 .01 31,873
03/09/95 08/31/95 09/26/95 3,187,333 .01 31,873
03/09/95 09/30/95 10/26/95 3,187,333 .01 31,873
03/09/95 10/31/95 11/29/95 3,187,333 .01 31,873
03/09/95 11/30/95 12/26/95 3,187,333 .01 31,873
03/09/95 12/31/95 01/26/96 3,187,333 .01 38,250
----- ---------
Total dividends declared in 1995 $ .20 $ 643,841
===== =========
03/12/96 03/31/96 04/15/96 3,187,333 $ .045 $ 143,432
03/12/96 06/30/96 07/19/96 3,187,333 .045 143,432
06/27/96 09/30/96 10/18/96 3,187,333 .045 143,432
06/27/96 12/31/96 01/27/97 3,187,333 .055 175,305
----- --------
Total dividends declared in 1996 $ .190 $ 605,601
===== ========
It was the Fund's policy during the periods it operated as a REIT to
distribute to its Stockholders an amount equal to at least 95% of taxable
income. A portion of the dividends paid during a subsequent year may have
been allocable to taxable income earned in the prior year. For 1995 and
1996, dividends to Stockholders represent ordinary income.
The continued needs of the Fund's subsidiaries have significantly reduced
the Fund's cash flows. Therefore, the Fund's Board of Directors has
determined to terminate the Fund's quarterly distribution for the
foreseeable future effective as of the first quarter of 1997.
(1) Cash dividends vary based upon the date of stockholder admittance.
- 39 -
<PAGE>
<TABLE>
17. Unaudited Quarterly Financial Data
<CAPTION>
Quarters Ended
1997 March 31 June 30 September 30(1) December 31(3) Total
---- ---------- ----------- --------------- ------------ ----------
<S> <C> <C> <C> <C> <C>
Total revenues $ 817,183 $ 857,083 $ 2,476,139(2) $ 528,532 $ 4,678,937
Total expenses 643,029 643,341 4,368,968 12,730,549 18,385,887
--------- ---------- ----------- ----------- -----------
Income (loss)
before income
taxes 174,154 213,742 (1,892,829) (12,202,017) (13,706,950)
Income tax expense 1,850 1,850 2,650 (6,350) --
--------- --------- ----------- ------------ -----------
Net income (loss) $ 172,304 $ 211,892 $(1,895,479) $(12,195,667) $(13,706,950)
========= ========= =========== ============ ===========
Net income (loss)
per share of
common stock $ .05 $ .07 $ (.59) $ (3.83) $ (4.30)
========= ========= =========== ============ ===========
1996 March 31 June 30 September 30 December 31 Total
---- ---------- ----------- ------------ ----------- ---------
Total revenues $ 768,848 $ 847,287 $ 843,784 $ 845,076 $ 3,304,995
Total expenses 556,974 611,440 645,275 633,597 2,447,286
--------- ---------- ---------- ---------- -----------
Income before
income taxes 211,874 235,847 198,509 211,479 857,709
Income tax expense 1,850 1,850 1,850 1,850 7,400
--------- ---------- ---------- ----------- -----------
Net income $ 210,024 $ 233,997 $ 196,659 $ 209,629 $ 850,309
========= ========== ========= ========= ===========
Net income per
share of common
stock $ .07 $ .07 $ .06 $ .07 $ .27
========= ========== ========== ========== ===========
<FN>
(1) The results of the quarter ended September 30, 1997, do not correspond
to the results as reported in the Fund's 10-Q dated September 30,
1997. An amended 10-Q is currently being prepared to describe an
additional loss of approximately $3.7 million on the Fund's investment
in an unconsolidated affiliate. The loss is the result of a non-cash
charge to adjust the investment to fair market value.
(2) Includes $1,500,000 for recovery of provision for loan losses.
(3) The fourth quarter reflects the Fund's acquisition of the stock of
NTS/LFII and NTS/VA and consists substantially of the results of
operations of NTS/LFII and NTS/VA from October 1, 1997. The fourth
quarter is also reflective of the Fund's 50% share of the results of
operations of the Orlando Lake Forest Joint Venture. Total expenses
include a non-cash charge of approximately $11,600,000 relating to the
acquisition of NTS/LFII and NTS/VA.
</FN>
</TABLE>
- 40 -
<PAGE>
18. Subsequent Events
On January 6, 1998, NTS/LFII closed on development financing for the
Lake Forest North project committed by an unaffiliated bank. The
$8,000,000 revolving credit facility is currently anticipated to
provide funds for the continued development and operations of the Lake
Forest North project through October 31, 2003, the maturity of the
credit facility, and the repayment thereof has been guaranteed by the
Fund. Mr. J. D. Nichols, Chairman of the Board of NTS Corporation and
of the Fund, has individually guaranteed the repayment of fifty percent
(50%) of the credit facility. The loan bears interest at the Prime Rate
+ 1%, payable monthly. Generally principal payments will consists of
approximately 90% of the Gross Receipts of lot sales. The net worth of
NTS/LFII cannot be allowed to decrease by 20% or more throughout the
term of the agreement. In addition, the principle amount outstanding on
the credit facility must be brought to within the following levels by
the applicable date:
January 1, 1999 $ 7,800,000
January 1, 2000 $ 7,200,000
January 1, 2001 $ 7,000,000
July 1, 2001 $ 6,100,000
January 1, 2002 $ 5,500,000
July 1, 2002 $ 4,900,000
January 1, 2003 $ 4,000,000
July 1, 2003 $ 2,400,000
Proceeds from the loan were used to retire approximately $3.6 million
of the existing debt (See Note 8). The loan balance was $6,209,247 as
of March 31, 1998.
- 41 -
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder of NTS Guaranty Corporation:
We have audited the accompanying balance sheets of NTS Guaranty Corporation (a
Kentucky corporation) as of December 31, 1997 and 1996. These balance sheets are
the responsibility of NTS Guaranty Corporation's management. Our responsibility
is to express an opinion on these balance sheets based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the balance sheets are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the balance sheets. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the balance sheets referred to above present fairly, in all
material respects, the financial position of NTS Guaranty Corporation as of
December 31, 1997, and 1996, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Louisville, Kentucky
April 6, 1998
- 42 -
<PAGE>
NTS GUARANTY CORPORATION
(A KENTUCKY CORPORATION)
BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1996
ASSETS
1997 1996
------------ -----------
Cash $ 100 $ 100
------------ -----------
$ 100 $ 100
============ ===========
STOCKHOLDER'S EQUITY
Common stock, no par value;
100 shares issued and outstanding $ 10 $ 10
Additional paid-in capital 10,000,090 10,000,090
------------ -----------
10,000,100 10,000,100
Less non-interest bearing demand
note receivable from a majority
stockholder of NTS Corporation (10,000,000) (10,000,000)
------------ ------------
$ 100 $ 100
============ ===========
NOTES TO BALANCE SHEETS
1. Significant Accounting Policies
A. Organization
NTS Guaranty Corporation (the "Guarantor"), a Kentucky corporation,
was formed in February 1987 and is an affiliate of NTS Corporation.
NTS Corporation is the Sponsor of the NTS Mortgage Income Fund (the
"Fund"). The balance sheets include only those assets and liabilities
which relate to the Guarantor. The Guarantor is authorized to issue
up to 2,000 shares of common stock with no par value. There are 100
shares issued and outstanding which were purchased by Mr. J. D.
Nichols, Chairman of the Board of Directors of the Sponsor and of the
Fund. In addition, Mr. Nichols has given the Guarantor a non-interest
bearing demand note receivable for $10,000,000, the receipt of which
is included in additional paid-in capital. Expenses (consisting
mostly of state taxes and licenses) of the Guarantor totaling
approximately $15 for each of the years ended December 31, 1997 and
1996, were paid by an affiliate of the Sponsor and therefore no
income statement is presented. These expenses will not be reimbursed
to the affiliate.
B. Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results
could differ from those estimates.
- 43 -
<PAGE>
2. Commitments
The Guarantor has guaranteed that Investors of the Fund will receive,
over the life of the Fund, aggregate distributions from the Fund (from
all sources) in an amount at least equal to their Original Capital
Contributions, as defined in the Fund's Prospectus. As of December 31,
1997, the Fund has raised approximately $63,690,000 and has paid
distributions of approximately $23,141,000.
The liability of the Guarantor under the above guaranty is expressly
limited to its assets and its ability to draw upon a $10 million demand
note receivable from Mr. J. D. Nichols. Mr. Nichols has contingent
liabilities which have arisen in connection with the acquisition of
properties by himself or his affiliates. There can be no assurance that
Mr. Nichols will, if called upon, be able to honor his obligation to the
Guarantor. The total amounts guaranteed by the Guarantor are in excess of
its net worth, and there is no assurance that the Guarantor will be able
to satisfy its obligation under these commitments. The Guarantor may in
the future provide guaranties to other Affiliates of the Fund.
- 44 -
<PAGE>
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There have been no changes in accountants or reported disagreements on any
matter of accounting principles, practices or financial statement disclosure.
Part III
Item 10. Directors and Executive Officers of the Registrant
The directors and principal officers of the Fund are as follows:
Name Office With the Fund
J. D. Nichols Chairman of the Board of Directors
Robert M. Day Director*
Gerald B. Thomas Director*
F. Everett Warren, J.D. Director*
Richard L. Good President and Director
John W. Hampton Secretary and Treasurer
* Messrs. Day, Thomas and Warren are the Independent Directors of the Fund.
Neither of them are employees, partners, officers or directors of the Sponsor or
any of its Affiliates.
J. D. Nichols (age 56)is Chairman of the Board and Chief Executive Officer of
NTS Corporation and its various Affiliates and is a member and Chairman of the
Board of Directors of the NTS Mortgage Income Fund. He is a graduate of the
University of Louisville School of Law. His undergraduate studies were at the
University of Kentucky, where he concentrated in Accounting, Marketing and
Business Administration. Mr. Nichols entered the real estate construction and
development business in 1965 and has been involved in the development and
construction of over 6,500 acres of land and over 6,500,000 square feet of
office, residential, commercial and industrial space in numerous states
throughout the eastern half of the United States. He is a member of both the
Louisville and National Homebuilders Associations, and has served as Vice
President and Director of the Louisville and National Apartment Associations.
Mr. Nichols is also lifetime member of the President's Society of Bellarmine
College, Louisville, Kentucky and a past member of the Board of Overseers and
Board of Trustee of the University of Louisville, the Governors Council for
Education Technology and the Board of Directors of the Louisville Chamber of
Commerce. Mr. Nichols is currently a member of the Board of Directors of the
Regional Airport Authority of Louisville and Jefferson County and is a member of
the Board of Directors of the Greater Louisville Economic Development
Partnership.
Robert M. Day (age 45) has been Managing Director of Lambert, Smith & Hampton
and its predecessor companies, Atlanta, Georgia, a commercial and industrial
real estate brokerage firm since 1985. Mr. Day received a Bachelor of Business
Administration degree from Georgia State University and holds an MAI designation
from the Appraisal Institute. Mr. Day is a member of the Atlanta Board of
Realtors, the Urban Land Institute and is on the operating committee of the
Atlanta Chapter of Young Life.
Gerald B. Thomas (age 59) has 25 years experience in Commercial Real Estate
lending. Formerly a Senior Vice President with Mid-American Bank of Louisville,
Mr. Thomas joined Citizens Bank of Kentucky in February 1996 as Vice President,
with responsibility of developing real estate portfolios for four Kentucky
affiliate banks of CNB Bancshares, Inc., Evansville, Indiana. Mr. Thomas has
attended Eastern Kentucky University, National School of Real Estate Finance
(Ohio State University) and National Institute of Real Estate Appraisers
(University of Louisville). He is a board member of Big Brothers/Big Sisters,
Louisville and Co-chairman of the Programs, Planning and Evaluation Committee.
- 45 -
<PAGE>
Item 10. Directors and Executive Officers of the Registrant - Continued
F. Everett Warren, J.D. (age 74) retired in 1985 from Citizens Fidelity Mortgage
Company, Louisville, Kentucky, a division of Citizens Fidelity Bank Corporation
and Pittsburgh National Corporation. From 1972 to 1985, Mr. Warren served as
Chairman, President and Chief Executive Officer of Citizens Fidelity Mortgage
Company. Mr. Warren attended both the University of Kentucky and University of
Louisville and received a Bachelor of Law degree and a Juris Doctorate degree.
He serves on the Board of Directors of Louisville Mortgage Bankers Association,
National Mortgage Bankers Association, United Cerebral Palsy and Louisville Deaf
Oral School. Mr. Warren is a member of both the Kentucky and Louisville Bar
Associations.
Richard L. Good (age 58) is President and Chief Operating Officer of NTS
Corporation, and Chairman of the Board of NTS Securities, Inc. As such, Mr. Good
oversees all operations of NTS Corporation and its various subsidiaries and is
responsible for residential developments, commercial properties, property
management, securities, finance and corporate administration. From 1981 to 1984,
Mr. Good was Executive Vice President of Jacques-Miller, Inc., a real estate
syndication, property management and financial planning firm, and was
responsible for corporate systems, marketing and planning. Prior to 1981, Mr.
Good held sales, marketing and management positions, including sixteen years
with IBM Corporation, where he served as Branch Manager of the Data Processing
Division in Nashville. Mr. Good attended Stanford University and Case Western
Reserve University and holds a Bachelor of Science degree in Management Science
from Case. He is a registered securities principal and member of the
International Association for Financial Planning and the Real Estate Securities
and Syndication Institute and is past President of the Hurstbourne Corridor
Business Association in Louisville. In addition, he has served on the Board of
Directors of Junior Achievement, the Boy Scouts and Christ Church United
Methodist and is a member of the Leadership Louisville Class of 1990.
John W. Hampton (age 48) is Senior Vice President of NTS Corporation with
responsibility for all accounting operations. Before joining NTS in March 1991,
Mr. Hampton was Vice President - Finance and Chief Financial Officer of the
Sturgeon-Thornton-Marrett Development Company in Louisville, Kentucky for nine
years. Prior to that he was with Alexander Grant & Company CPA's. Mr. Hampton is
a Certified Public Accountant and a graduate of the University of Louisville
with a Bachelor of Science degree in Commerce. He is a member of the American
Institute of CPA's and the Kentucky Society of CPA's.
The Directors are not required to devote all of their time to the Fund, they are
only required to devote such of their time to the affairs of the Fund as their
duties require, and will meet quarterly or more frequently if necessary. It is
not expected that the Directors will be required to devote substantial portions
of their time to discharge their duties as Directors. For a description of
provisions concerning indemnification, see "Fiduciary Responsibility" on page 14
of the Fund's Prospectus, which description is filed herewith and incorporated
herein by reference.
The Directors, although not precluded from engaging in activities similar to the
Fund's, are required to disclose any interest held directly or indirectly by
them, or an Affiliate in an investment presented to the Fund. Furthermore,
Affiliated Directors must offer the Fund the right to engage in an investment
opportunity, which is within the Fund's objectives and policies, prior to
entering into such transaction themselves. The Fund will not pay a commission to
an Affiliate of any Director for presenting or disposing of the Fund's
investments.
- 46 -
<PAGE>
Item 10. Directors and Executive Officers of the Registrant - Continued
The Fund will initially pay to each Independent Director a fee of $1,000 per
month (which amount may be increased or decreased in the discretion of the
Directors) and will reimburse such persons and Affiliated Directors for travel
expenses and other out-of-pocket disbursements incurred in connection with
attending any meetings. Affiliated Directors will not receive any compensation
from the Fund for their services as Directors or Officers of the Fund.
The Directors have retained NTS Advisory Corporation (the Advisor) to manage the
Fund's day-to-day affairs, and recommend investments suitable for the Fund. The
Advisor has delegated substantially all of its duties to NTS Corporation (NTS),
an affiliate of the Advisor. NTS has substantial experience in all phases of
real estate activities, including acquisition, financing, property management
and disposition.
The following persons are the executive officers and key employees of NTS and/or
an affiliate and will provide services to the Advisor and the Fund:
Name Office
J. D. Nichols Chairman and Chief Executive Officer
Richard L. Good President and Chief Operating Officer
Michael H. Hannon Executive Vice President, NTS Development Company
Brian F. Lavin Executive Vice President, NTS Development Company
B. J. DeVries President, NTS Residential Properties, Inc.
Margaret O. Templeton President, NTS/Residential Properties, Inc. -
Florida
John W. Hampton, CPA Senior Vice President, NTS Corporation
Gary D. Adams Senior Vice President, NTS Development Company
Gregory A. Compton Senior Vice President, NTS Corporation
Sally A. Judah Senior Vice President, NTS Corporation
The following provides additional information regarding the above-mentioned
persons. Information regarding Messrs. Nichols, Good and Hampton is provided in
the section entitled "Directors and Officers of the Fund."
Brian F. Lavin (age 44) serves as Executive Vice President of NTS Development
Company and President of the Company's Income Properties. As such, Mr. Lavin is
responsible for all NTS commercial real estate development and land acquisitions
and oversees the management of all commercial office buildings, business centers
and multi-family residential communities. Prior to joining NTS, Mr. Lavin served
as President of the Residential Division of Paragon Group, Inc., and as a Vice
President of Paragon's Midwest Division. In this capacity, he directed the
development, marketing, leasing and management operations for the firm's
expanding portfolios. Mr. Lavin attended the University of Missouri where he
received his Bachelor's Degree in Business Administration. He has served as a
Director of the Louisville Apartment Association. He is a licensed Kentucky Real
Estate Broker and Certified Property Manager. Mr. Lavin is a member of the
Institute of Real Estate Management, and council member of the Urban Land
Institute. He currently serves on the University of Louisville Board of
Overseers and is on the Board of Directors of the National Multi-Housing Council
and the Louisville Science Center.
Michael H. Hannon (age 54) serves as Executive Vice President of NTS Development
Company and President of NTS Virginia Development Company where he oversees the
development, land acquisitions, marketing, operations, and general management.
Immediately prior to joining NTS, Mr. Hannon was employed by Hines Interest
Limited Partners as general manager for the Hines Rocky Mountain Region from
1995 to February 1998. In addition to his responsibilities in The Rocky Mountain
Region, Mr. Hannon was responsible for Hines national residential acquisition
evaluations. Prior to 1995, Mr. Hannon served as Division President for Arvida's
South Atlantic Division, which included eleven residential communities,
including two Arnold Palmer Designed Golf Courses. Mr. Hannon attended Grand
View Junior College in Des Moines, Iowa and Parsons College in Fairfield, Iowa.
He is an active Member of the Urban Land Institute, National Association of Home
Builders and a licensed real estate broker in Colorado and Florida. Mr. Hannon
is a decorated Viet Nam Veteran, serving with the 1st Infantry Division in Dian,
South Viet Nam during 1965-1966.
- 47 -
<PAGE>
Item 10. Directors and Executive Officers of the Registrant - Continued
B. J. DeVries (age 37) is President of NTS Residential Properties, Inc. in
Kentucky and President of NTS/ Residential Properties, Inc. - Virginia with
responsibility for single-family residential development, marketing and
operations, in the states of Kentucky and Virginia. Mr. DeVries' experience with
NTS includes the positions of Residential Sales Representative, Builder Sales
Representative, Residential Sales Manager and Vice President - Sales and
Marketing. Prior to joining NTS in June 1992, Mr. DeVries served eight years as
a United States Marine Corps officer. Mr. DeVries was a pilot with additional
management experience in operations, maintenance and logistics. Mr. DeVries
received his Bachelor of Arts degree from Centre College.
Margaret O. Templeton (age 48) is President of NTS/Residential Properties, Inc.
- - Florida with responsibility for single family residential development,
marketing and operations in the state of Florida. Prior to joining NTS in
November 1994, Ms. Templeton was President of Templeton Development Corporation,
a real estate development firm in Tampa, Florida from 1992 to November 1994. She
has extensive experience in marketing, construction and land development
including seven years (1985 to 1992) as Vice President of Tampa Palms and
Gulfstream Land and Development Company, whose holdings included 30,000 acres in
Florida, Georgia and Virginia. Ms. Templeton received a Bachelor of Arts degree
from the University of Florida. Ms. Templeton is a member and Director of the
National Association of Homebuilders, Florida Homebuilders Association as well
as Director and Vice President of the Builders Association of Greater Tampa and
Orlando. Ms. Templeton is also a member of the Florida Board of Realtors and the
Urban Land Institute.
Gary D. Adams (age 52) is Senior Vice President of NTS Development Company with
responsibility for multi-family operations and commercial properties in the
state of Florida. Since joining the NTS organization in May 1977, Mr. Adams has
been involved in the development, construction and management of numerous
apartment, office, industrial and commercial developments in the southeastern
portion of the United States. Mr. Adams received his undergraduate degree in
Engineering from the University of Cincinnati, and he holds a Master of Business
Administration from Xavier University. He is a member of the Building Owners and
Managers Association and is a licensed general contractor in the State of
Florida.
Gregory A. Compton (age 37) is Senior Vice President, Secretary and General
Counsel of NTS Corporation. Prior to joining NTS in March 1992, Mr. Compton was
a senior associate in the Real Estate and Finance Department of Greenebaum, Doll
& McDonald for seven years, where he was responsible for many of NTS's corporate
real estate transactions. He is a member of the Board of Directors of and is
General Counsel for Goodwill Industries of Kentucky. He received a B.B.A. in
Finance from the University of Kentucky and a J. D. from the University of
Cincinnati College of Law.
Sally A. Judah (age 39) is Senior Vice President of NTS Corporation with
responsibility for multi-family property management of NTS's apartment
communities in Kentucky and Indiana and the Human Resources area of Corporate
Administration of NTS Development Company. From July 1991 to 1994, Ms. Judah was
Vice President of NTS Corporation with responsibility for Corporate Marketing,
Human Resources and the Graphics Division. From June of 1987 when she joined NTS
until July 1991, Ms. Judah was responsible for leasing activities for commercial
properties in Louisville, Kentucky. Ms. Judah is a member of the Louisville
Board of Realtors and is a Certified Commercial Investment Member (CCIM)
Candidate and is a member of the national and Kentucky CCIM chapters. Ms. Judah
is also a member of the Louisville Apartment Association and is a member of the
Leadership Louisville Class of 1993. Ms. Judah holds a Bachelor of Arts degree
from the University of Kentucky.
- 48 -
<PAGE>
Item 11. Executive Compensation
(a, b, c & d) The Fund will pay each Independent Director a fee of $12,000 per
year and will reimburse such persons and Affiliated Directors for travel
expenses and other out-of-pocket disbursements incurred in connection with
attending any meetings of the Board of Directors. During the years ended
December 31, 1997, 1996 and 1995, the Fund paid directors fees of $36,000,
$34,000 and $24,000, respectively, representing annual compensation. The
Affiliated Directors will not receive any compensation from the Fund for their
services to the Fund. The present officers of the Fund receive compensation from
the Advisor or its affiliates which indirectly relates to services to the Fund
(see Item 13).
The Fund is entitled to engage in various transactions involving the Advisor and
its affiliates, as described under captions "Compensation Table" at pages 9 and
10 of the Prospectus and "Conflicts of Interest" on pages 11 to 14 of the
Prospectus, which descriptions are filed herewith and incorporated herein by
reference. Reference is made to Note 9 of the Notes to the Fund's Consolidated
Financial Statements filed with this report for various transactions with
affiliates.
(e) There are no compensatory plans or arrangements resulting from resignation
or retirement of the Directors and executive officers which require payments to
be received from the Fund.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) As of the date hereof, no person owns of record or is known by the Fund to
own beneficially more than five percent (5%) of the outstanding shares of common
stock of the Fund.
(b) The following table sets forth the ownership of shares owned directly or
indirectly by the Directors and principal officers of the Fund as of the date
hereof:
Amount of Percent
Name of Beneficial of
Title of Class Beneficial Owner Ownership Interest
-------------- ---------------- --------- --------
Shares of Common J. D. Nichols 96,468 * 3.0%
Stock, $0.001 Shares
Par Shares
* These shares are owned of record by NTS Corporation or an Affiliate of which
Mr. Nichols directly or beneficially holds voting and investment authority.
(c) There are no known arrangements which may at a subsequent date result in
change in control of the Fund.
- 49 -
<PAGE>
Item 13. Certain Relationships and Related Transactions
Pursuant to the Advisory Agreement, the Fund will pay the Advisor a Management
Expense Allowance relating to services performed for the Fund in an amount equal
to 1% of the Fund's Net Assets, per annum, which amount may be increased
annually by an amount corresponding to the percentage increase in the Consumer
Price Index. Effective July 1, 1994, the Fund's Mortgage Loans to Fawn Lake and
Lake Forest were converted to cash flow mortgage loans. As part of the
consideration for this restructuring, the Fund's Board of Directors required,
among other things, that beginning in 1995, NTS Advisory Corporation pay
$100,000 annually towards the expenses of the Fund until the maturity of the
Mortgage Loans. As such, the Management Expense Allowance for each of the years
ended December 31, 1996 and 1995 has been reduced by $100,000 and by $75,000 for
the year ended December 31, 1997. For the years ended December 31, 1997, 1996
and 1995, $418,950, $544,776 and $528,973, respectively, has been incurred as a
Management Expense Allowance. Effective October 1, 1997, the Fund will no longer
incur an Advisory Fee but will be responsible for the actual general and
administrative costs pursuant to certain property management agreements
discussed below.
The ongoing operation and management of the Lake Forest North and Fawn Lake
projects will be conducted by NTS Residential Management Company (NTS
Management) under the terms of (i) a Property Management Agreement executed on
December 30, 1997, and dated as of October 1, 1997, by and among the Fund,
NTS/LFII and NTS Management for the Lake Forest North project, and (ii) a
Property Management Agreement executed on December 30, 1997, and dated as of
October 1, 1997, by and among the Fund, NTS/VA and NTS Management for the Fawn
Lake project (collectively, the Management Agreements). NTS Management is a
wholly-owned subsidiary of NTS Development Company. NTS Development Company is a
wholly-owned subsidiary of the Fund's Sponsor. The Management Agreements have an
initial term through December 31, 2003, subject to extension under certain
conditions, and are renewable for successive six (6) year terms thereafter.
Under the Management Agreements, NTS Management will be reimbursed for costs
incurred in the operation and management of the Lake Forest North and Fawn Lake
projects, and will accrue an incentive payment payable as provided therein.
Reimbursements of approximately $527,000 were made to NTS Management or an
Affiliate during the period from October 1, 1997 through December 31, 1997 for
actual personnel, marketing and administrative costs as they relate to NTS/LFII,
NTS/VA and the Fund.
Additionally, NTS Management is entitled to an Overhead Recovery, which is a
reimbursement for overhead expenses attributable to the employees and the
efforts of NTS Management under the Management Agreements, in an amount equal to
3.75% of the projects' gross cash receipts, as defined in the Management
Agreements. $106,473 was incurred as an Overhead Recovery during the period from
October 1, 1997 through December 31, 1997.
The Management Agreements also call for NTS Management to receive an Incentive
Payment, as defined in the Management Agreements, equal to 10% of the Net Cash
Flows of the projects. The Incentive Payment will not begin accruing until after
the cumulative cash flows of NTS/LFII, NTS/VA and the Fund's share of the cash
flow of the Orlando Lake Forest Joint Venture would have been sufficient to
enable the Fund to return to the then existing shareholders of the Fund an
amount which, after adding thereto all other payments actually remitted or
distributed to such shareholders of the Fund, is at least equal to the
shareholders' Original Capital Contribution. As of December 31, 1997, the Fund
had raised approximately $63,690,000 and had paid distributions of approximately
$23,141,000. As of December 31, 1997, no amount had been accrued as an Incentive
Payment in the Fund's consolidated financial statements.
- 50 -
<PAGE>
Item 13. Certain Relationships and Related Transactions - Continued
Neither the Certificate of Incorporation, By-Laws the Advisory Agreement nor the
Property Management Agreements restrict the Affiliated Directors, the Advisor,
NTS Management or their affiliates from engaging in other business activities
which may give rise to conflicts of interest with the Fund. Two of the five
Directors are Affiliated Directors. These individuals hold a position with the
Advisor and NTS Management, and are affiliated with other related entities. In
such cases, these individuals will have fiduciary obligations to such other
entities which may conflict with their fiduciary obligations to the Fund.
Transactions between the Fund and any affiliates will be subject to potential
conflicts of interest. With respect to the conflicts of interest described
herein, the Advisor, NTS Management and their affiliates will endeavor to
balance the interests of the Fund with the interests of the Advisor, NTS
Management and their affiliates in making any determinations.
- 51 -
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K
1. Financial statements
The financial statements for the NTS Mortgage Income Fund and NTS
Guaranty Corporation together with the reports of Arthur Andersen LLP
dated April 6, 1998.
2. Financial statement schedules
All schedules have been omitted because they are not applicable, are not
required, or because the required information is included in the
financial statements or notes thereto.
3. Exhibits
a) The following exhibits are incorporated by reference from the
Fund's Registration Statement on Form S-11, referencing the
exhibit number used in such Registration Statement.
Exhibit Number Description
3 (a)(2) Restated Certificate of Incorporation
3 (b) By-Laws
10 (c) Form of Advisory Agreement
10 (b) Form of Guaranty Agreement
b) The following exhibits are incorporated by reference from the Fund's
Form 8-K dated January 14, 1998.
Exhibit Number Description
10 Material contracts - The agreements whereby
the Fund acquired all of the issued and
outstanding common capital stock of NTS/LFII
and NTS/VA, and the Property Management
Agreements between the Fund and NTS
Management.
c) The following are additional exhibits filed with the Form 10-K
Report.
Exhibit Number Description
27 Financial Data Schedule
99 Additional Exhibits - Pages from the Fund's
prospectus which have been specifically
incorporated by reference and copies of which
are attached hereto which include pages 9 to
14 and pages 75 to 81.
4. Reports on Form 8-K.
None.
- 52 -
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities exchange
Act of 1934, NTS Mortgage Income Fund has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
NTS MORTGAGE INCOME FUND
/s/ Richard L. Good Date: April 14, 1998
- -----------------------------------------
Richard L. Good
President and Director of the NTS Mortgage Income Fund
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
Form 10-K has been signed below by the following persons on behalf of the
registrant in their capacities and on the date indicated.
/s/ J. D. Nichols Date: April 14, 1998
- -----------------------------------------
J. D. Nichols
Chairman of the Board of Directors
of the NTS Mortgage Income Fund
/s/ F. Everett Warren J.D. Date: April 14, 1998
F. Everett Warren J.D.
Director of the NTS Mortgage Income Fund
/s/ Robert M. Day Date: April 14, 1998
- -----------------------------------------
Robert M. Day
Director of the NTS Mortgage Income Fund
/s/ Gerald B. Thomas Date: April 14, 1998
- -----------------------------------------
Gerald B. Thomas
Director of the NTS Mortgage Income Fund
/s/ Richard L. Good Date: April 14, 1998
- -----------------------------------------
Richard L. Good
President and Director of the
NTS Mortgage Income Fund
/s/ John W. Hampton Date: April 14, 1998
- -----------------------------------------
John W. Hampton
Secretary and Treasurer (principal
financial and chief accounting officer)
- 53 -
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997 AND FROM THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE T0 CONSOLIDATED SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,413,445
<SECURITIES> 0
<RECEIVABLES> 3,573,162
<ALLOWANCES> 0
<INVENTORY> 51,917,990
<CURRENT-ASSETS> 0<F1>
<PP&E> 452,913
<DEPRECIATION> 45,788
<TOTAL-ASSETS> 64,184,368
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 24,505,233
0
0
<COMMON> 3,187
<OTHER-SE> 35,790,649
<TOTAL-LIABILITY-AND-EQUITY> 64,184,368
<SALES> 1,600,237
<TOTAL-REVENUES> 5,909,105
<CGS> 1,230,168
<TOTAL-COSTS> 1,230,168
<OTHER-EXPENSES> 1,051,994
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,662,419
<INCOME-PRETAX> (13,706,950)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,706,950)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,706,950)
<EPS-PRIMARY> (4.30)
<EPS-DILUTED> 0
<FN>
<F1>THE COMPANY HAS AN UNCLASSIFIED BALANCE SHEET; THEREFORE, THE VALUE IS $0.
</FN>
</TABLE>
- 77 -
<PAGE>
EXHIBIT NO. 99 - ADDITIONAL EXHIBITS
Included is this Exhibit Number 99 are pages 9 to 14 of the NTS Mortgage Income
Fund's Prospectus dated March 31, 1989 which discuss Compensation, Conflicts of
Interest and Fiduciary Responsibility and the Glossary of Terms from pages 75 to
81 of NTS Mortgage Income Fund's Prospectus. The text of these pages has been
duplicated in type style and font compatible with the other portions of the
Fund's Form 10-K Annual Report and suitable for electronic filing with the
Securities and Exchange Commission. As a result, although Exhibit 99 contains
all of the words contained in the respective sections of the Prospectus, the
total text of each page of this Exhibit does not exactly correspond to the total
text of the page of the Prospectus from which it is taken.
COMPENSATION TABLE
The following table is a description of the compensation and fees which the
Advisor and its Affiliates are anticipated to receive from the Fund. These
amounts are estimated and were not determined by arm's-length negotiations.
Other than as set forth herein, no other compensation is expected to be paid
to the Advisor and its Affiliates by the Fund. See "Conflicts of Interest."
Method and Amount of Compensation Assuming
Form of Compensation Minimum Amount/Maximum Amount/Increased
and Entity Receiving Maximum Amount
- -------------------- --------------
Organization and Offering Stage
Sales Commissions -
NTS Securities Up to 8% of the Gross Proceeds for each
Share sold by NTS Securities directly. Up
to $120,000/$4,000,000/$8,000,000 if NTS
Securities, which acts primarily as a
wholesaler, sells all the Shares directly.
It is anticipated that a substantial portion
of these fees will be paid to Non-Affiliated
Participating Dealers.
Non-Accountable
Expense Allowance -
NTS Securities 1% of the Gross
Proceeds.(1)(2) $15,000/
$500,000/$1,000,000.
Operational Stage (3)
Management Expense
Allowance - The Advisor Relating to services performed for the Fund
in an amount equal to 1% of the Fund's Net
Assets per annum, payable quarterly(4). The
actual amount is not determinable at this
time.(5)(6)
- 9 -
<PAGE>
Real Estate Management
Fee - Advisor or its
Affiliates 5% and 6% of gross revenues from any
residential and commercial Real Estate
Investments of the Fund, respectively, and
properties acquired through foreclosure,
plus certain reimbursed expenses, paid
monthly. If NTS or an Affiliate does not
perform substantially all of the leasing,
releasing and leasing related services with
respect to a property, the fee payable for
that property will be limited to 3% of the
gross revenues of the property. A
competitive fee may be paid for the one-time
initial rent-up or lease-up of a newly
constructed property (provided such fee is
not already included in the purchase price
of the property). In the event industrial
or commercial properties are leased on a
long-term (defined as at least ten years,
excluding renewals) triple net basis, the
management fee will be 1% of the gross
revenues from such property, except for a
one-time initial leasing fee equal to 3% of
total base rents payable for the entire
lease term (excluding renewals), which
amount shall be paid in five equal annual
installments. The actual amount is not
determinable at this time and the
acquisition and development of this type of
property is not anticipated by the
Fund.(5)(6)
Distributions - NTS and
its Affiliates Distributions on Shares acquired pursuant to
this Offering on the same basis as
distributions paid to other Stockholders.
The amount to be received by NTS and its
Affiliates as Stockholders is dependent upon
the operation of the Fund and will be
equivalent to that received by other
Stockholders.(6)
Loan Repayments -
Affiliated lenders Repayment of loans with proceeds from
Mortgage Loans made by the Fund.(6)(7)
- 10 -
<PAGE>
Affiliate Indebtedness -
NTS and its Affiliates Benefits that all shareholders and partners
of Affiliated entities receive in
conjunction with distributions made on the
refinancing of loans made to such entities
with proceeds from Mortgage Loans made by
the Fund; and benefits from the use of Fund
funds as compensating balances.(6)(8)
Service Fees - NTS
Development Corporation
and other Affiliates Fees paid by Affiliated Borrowers for
services performed with proceeds from
Mortgage Loans made by the Fund.(6)(9)
Liquidation Stage
Subordinated Advisory
Fee - The Advisor For services in connection with the
liquidation of the Fund's investments, a fee
equal to 5% of the Capital Proceeds
remaining after Stockholders have received
(i) Capital Proceeds in an amount equal to
100% of their Original Capital Contributions
and (ii) total distributions from all
sources in an amount equal to a 15% per
annum cumulative, non compounded return on
their Adjusted Contributions, to the extent
not already received, beginning on the
Offering Termination Date. The actual
amount is not determinable at this time.(6)
Distributions - The
Advisor On Shares acquired pursuant to this Offering
on the same basis as distributions to other
Stockholders. The actual amount is not
determinable at this time.(5)(6)
(1) The Non-Accountable Expense Allowance to NTS Securities will be paid
for overhead expenses such as rent, remuneration for personnel,
telephone, travel, marketing and other expenses, related to the
Offering. In addition, NTS Securities will receive an Accountable Due
Diligence Expense Allowance up to 1/2% of the Gross Proceeds. The Fund
will also reimburse NTS Securities for expenses included in the Fund's
Organization and Offering Expenses which are also subject to the
restriction discussed in footnote 3 below. See "Plan of Distribution."
(2) NTS Securities may reallow a portion of its Non-Accountable Expense
Allowance to Participating Dealers. See "Plan of Distribution."
- 11 -
<PAGE>
(3) Based on guidelines promulgated by the North American Securities
Administrators Association, Inc., the annual Operating Expenses of the
Fund, including compensation and reimbursement to the Advisor and its
Affiliates during the operational stage of the Fund, may not exceed in
any fiscal year the greater of (i) 2% of the Fund's Average Invested
Assets during such fiscal year or (ii) 25% of the Fund's Net Income
during such fiscal year. See "Business and Objectives of the
Fund-Operating Expense Limitations."
If the Fund acquires a property because of a foreclosure, an Affiliate
of the Advisor, subject to such Affiliate qualifying as an "independent
contractor" pursuant to the Code, may provide property management
services, should such services be required by the Fund, for a fee equal
to the usual and customary amounts charged for similar services in the
geographic area.
(4) The Advisor's 1% Management Expense Allowance will be increased
annually by an amount corresponding to the percentage increase in the
Consumer Price Index for all urban consumers ("CPI-AUC")-Louisville or
a comparable Consumer Price Index, if any, which increase will in no
event result in the Fund's Operating Expenses exceeding the limitation
noted in footnote (3) above. The Management Expense Allowance shall
exclude amounts paid by the Advisor on behalf of the Fund to third
parties.
(5) No Acquisition Fees or Acquisition Expenses will be paid by the Fund in
connection with the selection, acquisition, or origination of the
Fund's Mortgage Loans and no Acquisition Fees will be paid by the Fund
to Affiliated parties in connection with the acquisition of Real Estate
Investments. Since it is expected that most if not all Fund Mortgage
Loans will be made to Affiliated Borrowers, Affiliates of the Advisor
may realize benefits and receive compensation from such Affiliated
Borrowers. See "Compensation Table."
(6) The Advisor and its Affiliates cannot accurately estimate this amount.
Any such prediction would necessarily involve assumptions of future
events or operating results which cannot be made at this time.
(7) Proceeds of loans made by the Fund may be used to repay amounts
borrowed from other Affiliated persons, which repayment may benefit the
Affiliated lenders. However, this benefit cannot be quantified.
(8) Proceeds of loans by the Fund may be distributed to partners and
shareholders of the Affiliated Borrower, and Affiliates may benefit
from the economies of scale which may result from contracting for
services with the Fund. The value of these benefits cannot be
quantified.
- 12 -
<PAGE>
(9) NTS and its Affiliates may receive fees for services rendered to
Affiliated Borrowers which could, in certain instances, be deemed to be
from the proceeds of the Fund's Mortgage Loans. These services could
include such items as management, leasing or construction and
development related fees. For example, NTS Development Corporation,
itself and through subsidiaries, will receive fees in connection with
the management of the developments which will secure the Initial Fund
Investments. The amount of the compensation to be received by NTS
Development Corporation, itself and through subsidiaries, in connection
with these loans and other properties with which it is engaged is
dependent upon many factors including the time period, amount of
development undertaken and the actual costs of the development.
CONFLICTS OF INTEREST
A majority of the Directors of the Fund will be Independent Directors.
Nonetheless, because the Fund's principal activity will be the investment in
Mortgage Loans to Affiliated Borrowers and because NTS and its Affiliates are
engaged in business activities involving real estate investments and anticipate
engaging in additional business activities in the future which may be
competitive with the Fund, the relationship between the Fund, the Directors
(Affiliated and Independent), the Advisor and its Affiliates will result in
various conflicts of interest. In order to resolve these conflicts, all
transactions between the Fund and any Director, the Advisor or any of its
Affiliates must be approved by a majority of the Independent Directors prior to
entering into the transaction. As discussed elsewhere in this Prospectus, the
Directors will exercise their fiduciary duties to the Fund and the Stockholders
in a manner which is intended to preserve and protect the rights of the Fund and
the Stockholders.
(a) Loans to Affiliated Borrowers. The principal purpose of the Fund is to
invest in Mortgage Loans secured by properties owned or to be acquired by
Affiliated Borrowers (and, to a lesser extent, in Real Estate Investments). Each
such Mortgage Loan will be secured by a lien on the property, by an interest in
the Borrower or by a similar security interest. In addition, the Guarantor has
agreed to guaranty repayment of the Principal of all Junior Mortgage Loans and
Temporary Mortgage Loans made to Affiliated Borrowers. The expected terms and
conditions of non-specified Mortgage Loans are set forth under "Business and
Objectives of the Fund." Transactions entered into between the Fund and the
Advisor and its Affiliates are subject to an inherent conflict of interest. The
Directors and the Advisor may face certain conflicts of interest in enforcing
the rights of the Fund against any Affiliated Borrower.
The Directors would consider the following factors in resolving certain
inherent conflicts of interest:
(1) When considering an advance of additional funds to an Affiliated
Borrower, factors such as projections for the development and operation
of the property, market value and market conditions generally and for
the type of property anticipated to be developed by
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the Affiliated Borrower, the creditworthiness and equity interest of
the Affiliated Borrower, the current value of the property, the
security and the availability of additional collateral.
(2) In deciding whether to waive a default by an Affiliated Borrower,
foreclose on a Mortgage Loan or remedy a default on senior
indebtedness, the Directors will consider the nature of the default,
its materiality, the anticipated time and expense of pursuing the
foreclosure as well as the cost of waiving the default, the anticipated
viability of the Affiliated Borrower and the likelihood of the
Affiliated Borrower remedying the default within a reasonable time.
When considering enforcing a due-on-sale clause, the Directors will
review the Fund's anticipated investments and the need for additional
funds, as well as market conditions, focusing on the specific intended
use of the property and the creditworthiness of the purchaser.
(3) In establishing the amount of the Interest Reserve to be funded,
the Directors will review the expected return on the reserve, the
variability of the interest rate on the Mortgage Loan, the outstanding
indebtedness, the Affiliated Borrower's anticipated cash flow, the
operating history and the appraised value and potential appreciation of
the property.
(4) In determining whether to vary the terms of Mortgage Loans from the
anticipated terms specified in the Prospectus, the Directors will
review economic and market conditions and focus upon the locale of the
property, the availability of additional security to collateralize the
loan and the equity that the Affiliated Borrower has invested in the
property.
(5) In considering whether to refinance a property, factors relating to
the value of the property compared to the Affiliated Borrower's total
debt, the terms of the proposed financing and the Affiliated Borrower's
ability to service the total debt, the Fund's participation in the
potential appreciation of the property, as well as other investment
opportunities available to the Fund will be considered. If the
Affiliated Borrower seeks to refinance to prevent a default and
subsequent foreclosure, the Directors would consider the factors set
forth in (2) above.
(b) Purchase of Real Estate Investments from Affiliates. The Fund may purchase
Real Estate Investments from the Advisor and its Affiliates. Any such purchase
by the Fund from an Affiliate of the Advisor will require the receipt of an
appraisal evidencing the property's fair market value and must be at a price not
exceeding the lesser of the fair market value of the property or its cost to the
Affiliate increased by amounts expended to improve and hold the asset through
its sale to the Fund (unless the Directors, including a majority of the
Independent Directors, determine that substantial justification exists for an
increased amount but in no event exceeding the Appraised Value). The Fund will
also obtain an opinion of a qualified, Independent Advisor that the terms of
such purchase are as fair
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to the Fund as would be available from an unaffiliated party. In addition, any
such transaction must be approved by a majority of the Independent Directors of
the Fund.
(c) Provision of Property Management Services by Affiliates. Affiliates of NTS
manage certain of the properties owned by Affiliates and are anticipated to
provide management services with regard to Real Estate Investments acquired by
the Fund. Any such agreement will be on terms no less favorable to the Fund than
those customarily required for similar services in the areas in which the Real
Estate Investments are located and will be terminable by either party without
penalty upon 60 days prior notice. Although the affiliated property management
entity may provide services to Affiliates as well as the Fund, NTS believes that
it has sufficient personnel and resources to adequately manage the Real Estate
Investments.
(d) Receipt of Opinion of Independent Advisor. In connection with the making of
any Mortgage Loan to an Affiliated Borrower the Independent Directors are
required to obtain an opinion from an independent advisor that the proposed
Mortgage Loan is as fair and at least as favorable to the Fund as a Mortgage
Loan to a Non-Affiliated borrower in similar circumstances. The Independent
Advisor's fees will generally be paid by the Affiliated Borrower. The
Independent Advisor may face certain conflicts of interest in rendering its
opinion due to the fact that its fees may be paid by the Affiliated Borrower.
However, the opinion of the Independent Advisor will be requested by and
rendered to the Fund.
(e) Competition by Affiliates for Real Estate and Mortgage Loan Investments.
Existing, contemplated and future real estate investment entities managed or
advised directly or through Affiliates of the Advisor, as well as other real
estate investment entities in which Affiliates of the Advisor are participants,
may compete for and with the Fund for Real Estate and Mortgage Loan Investments.
If at the time the Fund is actively seeking to acquire a Real Estate or Mortgage
Loan Investment, the Advisor and its Affiliates or any entity managed or advised
by any of them (a "Competing Entity"), are also seeking to acquire such an
investment, and an opportunity to acquire such an investment arises, the Advisor
will initially review the portfolio of the Fund and of the Competing Entities
and will determine whether or not such investment should be acquired by the Fund
or such Competing Entity based upon such factors as cash flow, investment
objectives, borrowing limitations, type and location of the Real Estate or the
collateral property for the Loan, proposed loan or acquisition terms, economic
conditions around the location of the property, risks associated with
acquisition of the property, the estimated income tax effects of the purchase
and operation on each such Competing Entity, the amount of funds available and
the length of time such funds have been available for investment. In the event
that an investment opportunity appears equally appropriate for the Fund and one
or more Competing Entities, the acquisition or Loan will be made by the entity
which first had uninvested funds available to make the acquisition or Mortgage
Loan, or if the Fund and a Competing Entity have had available funds for equal
periods, the entity which has the greatest amount of time weighted funds
available for the acquisition of properties or the making of a Mortgage Loan.
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(f) Provision of Services. The Fund will not have independent management and
will rely on the Advisor and its Affiliates for the day-to-day management of the
operations of the Fund, subject to the direction of the Board of Directors.
These Affiliates (including officers and directors) will have conflicts of
interest in allocating management time, services and functions among the various
Affiliated publicly-held and privately-held entities and any other entities
which they have or may organize. Furthermore, there is no prohibition from
having an interest, direct or indirect, in entities which will be engaged to
provide services to the Fund. The Advisor and its Affiliates believe they have
sufficient staff personnel to be fully capable of discharging their
responsibilities to all entities to which they are responsible and to ensure
that any conflicts which other relationships may create will be dealt with
fairly. The officers of the Affiliates of the Advisor will devote such time to
the affairs of the Fund as they, within their sole discretion, exercised in good
faith, determine to be necessary to carry out their obligations. These conflicts
will be reviewed by Directors and if they determine that the Advisor or its
Affiliates are not satisfactorily performing their duties the Agreement in
question will not be renewed. See "Management."
(g) Non-Arm's Length Agreements. The following factors will lessen the conflicts
that result because the agreements made by the Fund with the Advisor and its
Affiliates are not a result of arm's length negotiations: (i) such agreements
and arrangements are subject to approval by a majority of the Independent
Directors; (ii) the offering is registered in all states and the Fund is
therefore subject to specific state securities laws as well as the Statement of
Policy Regarding Real Estate Investment Trusts adopted by the North American
Securities Administrators Association, Inc. or NASD rules, which limit fees and
the amount of the Fund's Operating Expenses, including compensation to the
Selling Agent and Advisor; and (iii) the Advisor's performance will be affected
by other lending programs being offered in the marketplace with which the Fund
will compete.
(h) Common Representation. Shefsky, Saitlin & Froelich, Ltd. ("Counsel")
represents the Fund, the Advisor and the Selling Agent in connection with this
Offering. Counsel may in the future act as counsel to NTS and its Affiliates in
connection with other matters. In addition, Counsel is expected to represent the
Fund in connection with its future activities. There is a possibility that in
the future the interests of the various Affiliated parties may become adverse
and, under the Code of Professional Responsibility of the legal profession
Counsel may be precluded from representing any one or all of such parties. If
any situation arises in which the interests of the Fund appear to be in conflict
with those of the Advisor, its Affiliates or the Selling Agent, the Independent
Directors will decide whether separate counsel should be retained by the Fund to
assure that the interests of the Fund are adequately protected. (i) Computation
and Payment of Incentive or Gross Receipts Interest. There may be conflicts
between the Fund and an Affiliated Borrower in establishing Incentive interest
or Gross Receipts Interest, which is based on either the increase in value
("Increase in Value") of the property securing the loan or the Gross Receipts
from the sale of the property. The Fund will resolve this conflict by requiring
that a majority of the Independent Directors
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approve each Mortgage Loan to an Affiliated Borrower and that the Independent
Advisor issue a fairness opinion for each such Mortgage Loan. In joint ventures,
the Fund's right to participate fully in the Increase in Value will be affected
if the Non-Affiliate prohibits the Fund from participating in the
Non-Affiliate's share in the Increase in Value. In such a case, the Fund may
only be entitled to a percentage interest in the Affiliate's share in the
Increase in Value. A conflict arises because the Affiliate might agree to the
Non-Affiliate's insistence on this reduced amount of Incentive Interest or Gross
Receipts Interest in exchange for some other concession that benefits the
Affiliate but not the Fund. In addition, because the Fund's Mortgage Loans will
generally be prepayable by the Affiliated Borrowers, the possibility exists that
Mortgage Loans may be prepaid in a manner intended to minimize Gross Receipts or
Incentive Interest due to the Fund. The Board will monitor such prepayments and,
if necessary, modify the terms of Mortgage Loans.
(j) Joint Investments with Affiliates. To the extent the Fund enters into joint
investments with Affiliates, there may under certain circumstances be risks not
otherwise present, including, for example, risks associated with the possibility
that the Fund's joint venturer might become bankrupt, and that such joint
venturer may at any time have economic or business interests or goals which are
inconsistent with the interests or goals of the Fund. Prior to entering into
joint investments with an Affiliate, the Fund is required to obtain the approval
of a majority of Directors, including a majority of Independent Directors, which
approval must find that the joint investment is fair and reasonable to the Fund
and on substantially the same terms and conditions as those of the other
Affiliates participating in the joint investment.
(k) Other Transactions and Affiliates. The Fund may make a Mortgage Loan which
is secured by a property in which an Affiliate of the Advisor also has a
security interest. In such case, the Advisor would face certain conflicts of
interest in the event of a default on the investment if, by enforcing the Fund's
rights, the Affiliated entity's interest in the property would be lost. The Fund
may also have conflicts of interest in negotiating the terms of a Mortgage Loan
with an unaffiliated entity if such entity is negotiating to purchase a property
from an Affiliate of the Advisor. Furthermore, if the Advisor or its Affiliates
acquire properties which are adjacent to properties or other activities in which
the Fund has an interest as a mortgagee or otherwise, there could be conflicts
because the properties may be enhanced by the development of the properties in
which the Fund holds an interest.
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(l) Purchase of Adjacent Properties. In the event that the Advisor or its
Affiliates acquire a property which is adjacent to properties or other
activities in which the Fund has an interest, there could be conflicts of
interest due to the potential that the adjacent property could be enhanced by
the improvement of the property in which the Fund has an interest. Neither the
Advisor nor its Affiliates have any current intention to acquire properties
adjacent to those in which the Fund will hold an interest.
(m) Receipt of Commissions, Fees and Other Compensation by the Advisor and its
Affiliates. The Advisor and its Affiliates will be subject to a conflict of
interest in recommending investments and in structuring these investments. The
Fund will retain an Independent Advisor to render an opinion regarding the
choice and structure of an investment prior to making a Mortgage Loan to an
Affiliated Borrower or purchasing property from an Affiliate. See "Business and
Objectives of the Fund-Independent Advisor."
(n) Selling Agent. The Selling Agent is a wholly-owned subsidiary of the Sponsor
and will therefore experience a conflict in performing its obligation to
exercise due diligence with respect to the statements made in the Prospectus.
This due diligence review cannot be considered independent although NTS
Securities believes that such due diligence has in fact been exercised. However,
NTS Securities is subject to potential liability under the Securities Act of
1933.
(o) Initial Fund Investments. The Fund has stated that it intends to invest in
the initial Fund Loans as discussed under "Specified Investments." These
Mortgage Loans will be made to Affiliated Borrowers and will be secured by a
lien on the underlying property, by an interest in the Borrower or by similar
security interest. These Mortgage Loans are expected to generate Regular
Interest as well as either Incentive Interest or Gross Receipts Interest. The
Initial Fund Loans are to be made to Affiliates of the Fund and will be subject
to an inherent conflict of interest, including a conflict over the order in
which the Initial Fund Loans are made, a desire on the part of the Affiliated
Borrower to retire the Mortgage Loan early to avoid the payment of increased
Incentive Interest or Gross Receipts Interest and a conflict in negotiating any
modifications to the terms of the Mortgage Loans subsequent to their initial
funding. The Fund believes that it has mitigated these conflicts of interest by
the requirement that a majority of the Independent Directors approve any changes
in the terms of a Mortgage Loan as well as requiring the opinion of an
Independent Advisor prior to funding a Mortgage Loan.
FIDUCIARY RESPONSIBILITY
Consistent with the duties and obligations of, and limitations on, the
Directors, as set forth in the Fund's Organizational Documents and under the
laws of Delaware, the Directors are accountable to the Fund and the Stockholders
as fiduciaries and are required to perform their duties in good faith in a
manner which each Director believes to be in the best interests of the Fund and
the Stockholders with such care, including reasonable inquiry, as an ordinarily
prudent person in a like position would use under similar circumstances.
However, the Organizational Documents and the
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Advisory Agreement provide that the Directors, the Advisor and their Affiliates
will be indemnified against certain liabilities incurred in connection with
serving in such capacities. Generally, any such person will be entitled to
indemnification if (i) such person has determined, in good faith, that the
course of conduct which caused the loss or liability was in the best interest of
the Fund, (ii) such liability or loss was not the result of negligence or
misconduct by such person, and (iii) such indemnification is recoverable only
out of the assets of the Fund and not from the Stockholders.
Notwithstanding the foregoing, indemnification will not be allowed for any
liability imposed by judgment arising from or out of a violation of state or
federal securities laws. Indemnification will not be allowed for losses,
liabilities, settlements and related expenses of lawsuits alleging securities
law violations unless a court (i) approves the settlement and finds that
indemnification of the settlement and related costs should be made, or (ii)
approves indemnification of litigation costs if there has been a dismissal with
prejudice or a successful adjudication on the merits of each count involving
alleged securities law violations as to the particular indemnitee.
To the extent that any provision concerning indemnification or limitation of
liabilities applies to liabilities arising under the Securities Act of 1933, the
Fund has been advised that, in the opinion of the Securities and Exchange
Commission, such provisions are contrary to public policy and therefore
unenforceable. In the event that a claim for indemnification against such
liabilities is asserted by such person in connection with the offering of the
Shares (other than for the payment by the Fund of expenses incurred or paid by a
Director or any of his agents in the successful defense of any action, suit or
proceeding), the Fund will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification is against public
policy as expressed in the Securities Act of 1933 and will be governed by the
final adjudication of such issue.
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GLOSSARY
"Accountable Due Diligence Expense Allowance" shall mean an amount equal to 1/2%
of the Gross Proceeds payable to the Selling Agent as reimbursement for its
accountable expenses incurred in connection with bona fide due diligence
activities.
"Acquisition Expenses" shall mean expenses related to the Fund's selection of
and investment in, Mortgage Loans and Real Estate Investments (whether or not
made), including but not limited to legal fees and expenses, travel and
communication expenses, costs of appraisals, accounting fees and expenses, title
insurance and miscellaneous other expenses.
"Acquisition Fees" shall mean the total of all fees and commissions, however
designated, paid by any party in connection with the making or investing in
Mortgage Loans or Real Estate Investments.
"Adjusted Contribution" shall mean the Original Capital Contribution paid by the
original purchaser of a Share, reduced by the total cash distributed with
respect to such Share from Capital Proceeds.
"Advisor" shall mean NTS Advisory Corporation, a Delaware Corporation which will
serve as the initial investment advisor and administrator of the Fund, or any
successor Advisor selected by the Directors, or any person or entity to which
the Advisor subcontracts substantially all of its administrative functions.
"Advisory Agreement" shall mean the agreement between the Fund and the Advisor,
pursuant to which the Advisor will act as the investment advisor and
administrator of the Fund.
Affiliate" shall mean (i) any person directly or indirectly controlling,
controlled by or under common control with another person, (ii) any person
owning or controlling 10% or more of the outstanding voting securities or
beneficial interests of such other person, (iii) any officer, director, trustee
or general partner of such person or (iv) if such other person is an officer,
director, trustee or partner of another entity, then the entity for which that
person acts in any such capacity.
"Affiliated Borrower" shall mean Affiliates of NTS which obtain a Mortgage Loan
from the Fund.
"Affiliated Directors" shall mean those Directors who are not Independent
Directors.
"Appraised Value" of a Real Estate Investment or the Real Estate securing a
Mortgage Loan shall mean the value of the subject Real Estate at a specified
point in time as determined by an MAI Appraisal acceptable to the Directors.
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"As-Built Appraised Value of the Property" shall mean (i) for Development Loans,
Residential Land Development Loans and Commercial Land Development Loans, the
land portion of the appraised value of the mortgaged property, and (ii) for
Construction Loans, the appraised value of the mortgaged property (as determined
by MAI Appraisal), in each case including improvements to be made by the
Borrower, taking into account the Borrower's planned construction and
development of the property.
"Average Invested Assets" shall mean for any period, the average Total Assets of
the Fund invested, directly or indirectly, in Mortgage Loans and Real Estate
Investments, before reserves for bad debts or other similar non-cash reserves,
computed by taking the average of such values at the end of each month during
such period.
"Below Market Interest Obligation" shall mean any note, agreement, contract or
other obligation pursuant to which a purchaser agrees to make periodic payments
in respect of the Real Estate purchased, which provides for the payment of
interest in respect of the amount due at a rate which is lower than an interest
rate 400 basis points below the then applicable Prime Rate.
"Board of Directors" shall mean all of the Directors having been duly elected or
otherwise properly in office pursuant to the Organizational Documents.
"Borrower" shall mean any person, including an Affiliated Borrower, which
obtains a Mortgage Loan from the Fund.
"Bylaws" shall mean the Bylaws of the Fund, as they may be amended from time to
time.
"Capital Proceeds" shall mean the net cash realized from the repayment,
retirement, refinancing, sale or other disposition of the Fund's Real Estate
Investments and Mortgage Loan investments, including payments of Principal,
Interest Reserve, Gross Receipts Interest and Incentive Interest, but excluding
Points and Regular Interest, after reduction for the following: (i) payment of
all expenses related to the transaction; (ii) payment of all debts and
obligations of the Fund arising from or otherwise related to the transaction,
including fees to the Advisor or its Affiliates; and (iii) any amount set aside
by the Advisor for working capital reserves; provided, however, that proceeds
from a disposition of a Fund investment shall not be deemed to be "Capital
Proceeds" to the extent such proceeds are reinvested by the Fund and not
distributed to Stockholders.
"Cash Flow Guaranty" shall mean the obligation of the Guarantor to provide
investors, directly or indirectly, a minimum return (from all sources) equal to
an annual 12% cumulative, non-compounded, return on their Original Capital
Contributions during the Cash Flow Guaranty Period.
"Cash Flow Guaranty Period" shall mean the period beginning with the 90th day
following the Initial Closing and ending upon the later of two years thereafter
or one year following the Offering Termination Date.
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"Certificate of Incorporation" shall mean the certificate of incorporation filed
by the Fund in Delaware, as it may be amended from time to time.
"Code" shall mean the Internal Revenue Code of 1986, as amended, or
corresponding provisions of any successor legislation.
"Commercial Land Development Loan" shall mean a Mortgage Loan, secured by
unimproved or partially improved real property subject to a development plan,
obtained by a Borrower for the purpose of acquiring, carrying and improving the
parcel through pre-development and in certain instances development activities,
including, without limitation, the construction of infrastructure and other
improvements necessary to prepare the parcel for the construction of commercial
or industrial developments, including zoning, planning and construction of
amenity packages, and landscaping, for resale (or in limited cases, lease) in
the ordinary course of business of the Borrower or an Affiliate.
"Construction Loan" shall mean a Mortgage Loan obtained by a Borrower for the
purpose of constructing improvements on real property.
"Dealer Property" shall mean property held primarily for sale to customers in
the ordinary course of one's trade or business.
"Dealers" shall mean the Participating Dealers and the Selling Agent.
"Deficiency Dividend" shall mean a distribution of the Fund within the meaning
of Section 859(d) of the Code.
"Delaware Corporation Statute" shall mean the General Corporation Law of the
State of Delaware, as it may be amended from time to time.
"Development Loan" shall mean a Mortgage Loan obtained by a Borrower for the
purpose of acquiring, carrying and engaging in pre-development and development
activities with respect to real property prior to the construction of
improvements thereon, which activities shall include, without limitation,
engineering, zoning, planning and construction of common area and amenities
including the construction of clubhouses, pools, etc., but shall exclude
Residential and Commercial Land Development Loans.
"Directors" shall mean, as of any particular time, Directors holding office
under the Certificate of Incorporation and Bylaws at such time, whether they are
the Directors named therein or additional or successor Directors appointed by
the initial Board of Directors or duly elected by the Stockholders.
"Dividend Reinvestment Plan" or "Plan" shall mean the plan pursuant to which
Stockholders may direct that cash distributions otherwise payable to them from
the Fund with respect to Shares owned by them be delivered instead to the
Reinvestment Agent, who is directed, pursuant to the terms of the plan, to
acquire additional Shares with such cash.
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"Escrow Agent" shall mean Liberty National Bank & Trust Company of Louisville,
Kentucky, or any other entity selected by the Directors to serve as escrow agent
for the Fund.
"Escrow Guaranty" shall mean the Guarantor's obligation to advance to the Fund,
directly or indirectly, the amount necessary to supplement the interest
generated by subscription proceeds so as to provide subscribers with an 8%
annual, non-compounded return on their subscriptions, calculated from the date
the subscriber's proceeds were deposited in the escrow account through the 89th
day following the Initial Closing Date (or if the Minimum Number of Shares is
not sold, through the date on which the proceeds are released from the escrow
account).
"Federal Funds Rate" shall mean the average of the prior month's rate at which
reserves are traded among commercial banks for overnight use in amounts of one
million dollars or more, as published in the Federal Reserve Statistical Release
H.15(519), or, in the event that such a release does not exist, "Federal Funds
Rate" shall mean that announced in the Wall Street Journal, or its successor, as
it shall change from time to time.
"First Mortgage Loans" shall refer to Mortgage Loans which have as security a
first mortgage or first priority lien on the collateral property.
"Foreclosure Property" shall mean real property (including interests in real
property), and any personal property incident thereto, which is acquired by the
Fund as the result of a bid in foreclosure, or by agreement or legal process,
following a default (or where a default was imminent) on a lease of the property
or on an indebtedness secured by such property.
"Foreign Investor" shall mean a nonresident alien, a foreign corporation or an
entity consisting of such persons.
"Fund" shall mean NTS Mortgage Income Fund, a Delaware corporation, or any
successor thereto.
"Funds Available for Investment" shall mean the Gross Proceeds to be Raised in
this Offering ($100,000,000) plus an amount equal to the aggregate borrowings
which the Fund is authorized to make (300% of Net Assets).
"Gross Proceeds" shall mean the aggregate Original Capital Contributions of
all Stockholders.
"Gross Proceeds to be Raised" shall mean $100,000,000.
"Gross Receipts" shall mean, with regard to (i) any Real Estate serving as
collateral for a Mortgage Loan the record title to which has been conveyed to
the purchaser, the total fair market value of the consideration, inclusive of
the face amount of the notes or other payment obligations received by an
Affiliated Borrower from the sale of such Real Estate, without reduction for any
costs or expenses incurred in connection with the sale, development or
improvement of the Real Estate, real estate commissions or other closing
expenses, but net of amounts to be repaid or credits allowed to the purchaser
such as builder discounts or rebates, landscaping allowances or similar expenses
as well as any sale or transfer tax imposed
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on the transaction, provided, however, that Gross Receipts shall not include the
face amount of any Below Market Interest Obligation, and (ii) any Real Estate
serving as collateral for a Mortgage Loan which the Borrower has agreed to sell
to a purchaser but as to which the record title has not been conveyed to the
purchaser or which has been conveyed to the purchaser in exchange for a Below
Market Interest Obligation, the amount of cash received by the Affiliated
Borrower as and when received.
"Gross Receipts Interest" shall mean, with respect to a Mortgage Loan secured by
Real Estate held for sale in the ordinary course of business, an amount equal to
a specified percentage of the Affiliated Borrower's Gross Receipts from the sale
of the underlying Real Estate received during the term of the Mortgage loan.
"Guarantor" shall mean NTS Guaranty Corporation, a Delaware corporation or any
successor thereto.
"Incentive Interest" shall mean the Fund's share in the Increase in Value of a
property securing a Mortgage Loan and shall be payable in connection with
Mortgage Loans secured by Real Estate not held for sale in the ordinary course
of business.
"Incentive Interest Agent" shall mean the independent party authorized to
receive Incentive Interest payments from Borrowers and pay to the Fund the
amount of such payments to which it is entitled, with the remainder of such
payments to be returned to the Borrowers.
"Increase in Value" shall mean the difference between the Appraised Value of a
property at the time of funding a Mortgage Loan and the Appraised Value of such
property (or the fair market value of the consideration received in the case of
a sale) upon the earlier of the maturity of the Mortgage Loan or the sale or
refinancing of the collateral property, net of the actual cost incurred in
connection with the improvement of the collateral property since the date of the
funding of the Mortgage Loan. For purposes of this definition, the phrase
"actual cost incurred" shall refer to all costs paid by the Borrower to
Affiliated and Non-Affiliated parties in connection with the acquisition,
holding, ownership, or development or improvement of the property, including
without limitation, costs of acquiring and financing the property.
"Increased Maximum Number of Shares" shall mean 5,000,000 Shares in this public
offering.
"Independent Advisor" shall mean Laventhol and Horwath or any alternative person
selected by the Independent Directors to provide an opinion concerning the
fairness of the terms of proposed Mortgage Loans to Affiliated Borrowers and
acquisitions of Real Estate Investments from Affiliates.
"Independent Directors" shall mean the Directors who: (i) are not Affiliated,
directly or indirectly, with the Advisor, whether by ownership of, ownership
interest in, employment by, any business or professional relationship with, or
service as an officer or director of, the Advisor or its Affiliates; (ii) do not
serve as a director or trustee for more than two other REITs organized by the
Advisor or its Affiliates; and (iii) perform
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no other services for the Fund, except as Directors. An indirect relationship
shall include circumstances in which the immediate family of a Director has one
of the foregoing relationships with the Advisor or the Fund.
"Initial Closing Date" shall mean the date on which the first closing for Shares
sold pursuant to the Prospectus occurs.
"Initial Fund Investments" shall mean those investments which the Fund has
specified as of the date of this Prospectus being the Fawn Lake Loan, Orlando
Lake Forest Loan, the Louisville Lake Forest North Loan and the Blankenbaker
Crossings Loan.
"Interest Reserve" shall mean the amount loaned or committed to be loaned to a
Borrower to Fund the Borrower's projected future payments of Regular Interest to
the Fund and upon which Regular Interest shall be charged once disbursed.
"Investable Proceeds" shall mean the Gross Proceeds less Organization and
Offering Expenses, plus an amount equal to the outstanding borrowings of the
Fund, exclusive of borrowings made in connection with Real Estate Investments.
"IRA" shall mean an Individual Retirement Account established pursuant to
Section 408 of the Code or any successor provision.
"Junior Mortgage Loan" shall refer to any Mortgage Loan which is subordinate to
another mortgage or deed of trust secured by the collateral real property and
shall exclude Temporary Mortgage Loans and loans which are outstanding and being
"phased-in" pending full funding of a First Mortgage Loan.
"Junior Mortgage Loan Guaranty" shall mean the Guarantor's obligation to pay the
Fund the Principal amount of any Junior or Temporary Mortgage Loan on which the
Affiliated Borrower has defaulted.
"Land Acquisition Loans" shall mean a Mortgage Loan obtained by a Borrower for
the purpose of acquiring Unimproved Real Property.
"Loan" shall mean a Mortgage Loan or Temporary Mortgage Loan made by the Fund.
"MAI Appraisal" shall mean an appraisal made by a member in good standing of the
American Institute of Real Estate Appraisers.
"Majority Vote" shall mean the vote or consent in person or by proxy of
Stockholders owning more than 50% of the outstanding Shares.
"Management Expense Allowance" shall mean a non-accountable expense allowance
relating to services performed for the Fund (but excluding amounts paid by the
Advisor on behalf of the Fund to third parties) in an amount equal to 1% of the
Fund's Net Assets, per annum, payable quarterly to the Advisor which may be
increased annually by an amount corresponding to the
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percentage increase in the Consumer Price Index for all urban consumers-
Louisville or a comparable consumer price index, which increase will in no event
cause the Fund's Operating Expenses to exceed the limitation imposed by the
Bylaws.
"Maximum Number of Shares" shall mean 2,500,000 Shares in this public offering.
"Minimum Number of Shares" shall mean 75,000 Shares to at least 100 independent
investors in this public offering.
"Mortgage Loans" shall mean Residential Land Development Loans, Commercial Land
Development Loans, Permanent Mortgage Loans, Construction Loans, Development
Loans and Land Acquisition Loans evidenced by notes, debentures, bonds and other
evidences of indebtedness or obligations (other than Temporary Mortgage Loans
made by the Fund) which are secured or collateralized by: (i) interests in real
property; (ii) other beneficial interests essentially equivalent to a mortgage
on real property; or (iii) interests in partnerships, joint ventures, or other
entities which own real property.
"NASD" shall mean the National Association of Securities Dealers, Inc.
"NASDAQ" shall mean the nationwide automated quotations system operated by
the NASD.
"Net Assets" shall mean the Total Assets (other than intangibles) at cost before
deducting depreciation or other non-cash reserves, less total liabilities,
calculated quarterly according to generally accepted accounting principles on a
basis consistently applied.
"Net Income" for any period shall mean total revenues applicable to such period
as determined for federal income tax purposes, less the expenses applicable to
such period, other than additions to reserves for bad debts or other similar
non-cash reserves. In connection with the calculation of any incentive type fee,
Net Income, for purposes of calculating Operating Expenses, shall not include
the gain from the sale of the Fund's assets.
"Non-Accountable Expense Allowance" shall mean an amount equal to 1% of the
Gross Proceeds payable to the Selling Agent as reimbursement for its
non-accountable sales and other expenses incurred in connection with the offer
and sale of Shares.
"Non-Affiliate" shall mean persons who are not Affiliates.
"NTS" shall mean NTS Corporation, a Delaware corporation which is the Sponsor
for the Fund.
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"Offering Termination Date" shall mean the date on which the last closing for
Shares sold pursuant to the Prospectus occurs which shall occur either one year
from the date of this Prospectus subject to increase for up to an additional
year in the discretion of the Board of Directors and subject to compliance with
applicable state and federal laws.
"Operating Expenses" shall mean all operating, general and administrative
expenses of the Fund as determined under generally accepted accounting
principles, including but not limited to rent, utilities, capital equipment,
salaries, fringe benefits, travel expenses, the Management Expense Allowance,
expenses paid by third parties to the Advisor and its Affiliates based upon its
relationship with the Fund (e.g. loan administration, servicing, engineering and
inspection expenses) and other administrative items, but excluding the expenses
of raising capital, interest payments, taxes, non-cash expenditures (e.g.
depreciation, amortization, bad debt reserve), the Subordinated Advisory Fee and
the costs related directly to a specific Mortgage Loan or Real Estate Investment
by the Fund, such as expenses for originating, acquiring, servicing or disposing
of said specific Real Estate Investment or a Mortgage Loan.
"Organization and Offering Expenses" shall mean those expenses payable by the
Fund in connection with the formation, qualification and registration of the
Fund and in marketing, distributing and processing Shares, including any Sales
Commissions, Non-Accountable Expense Allowance, Accountable Due Diligence
Expense Allowance, and any other expenses actually incurred and directly related
to the registration, offering and sale of Shares, including such expenses as:
(a) fees and expenses paid to attorneys in connection with the offering; (b)
registration fees, filing fees and taxes; (c) the costs of qualifying, printing,
amending, supplementing, mailing and distributing the Fund's Registration
Statement and Prospectus, including telephone and telegraphic costs; (d) the
costs of qualifying, printing, amending, supplementing, mailing and distributing
sales materials used in connection with the issuance of Shares, including
telephone and telegraphic costs; (e) remuneration of officers and employees of
the Advisor and its Affiliates while directly engaged in marketing,
distributing, processing and establishing records of Shares and establishing
records and paying Sales Commissions; and (f) accounting and legal fees and
expenses incurred in connection therewith to the Advisor or its Affiliates.
"Organizational Documents" shall mean the Fund's Certificate of Incorporation
and By-Laws, as they may be amended from time to time.
"Original Capital Contribution" shall mean the amount of $20.00 for each Share,
which amount shall be attributed to such Share in the hands of subsequent
holders thereof.
"Participating Dealers" shall mean members in good standing of the National
Association of Securities Dealers, Inc., ("NASD") engaged by the Selling Agent
to offer and sell Shares on a "best efforts" basis, as well as certain selected
foreign broker dealers, who are not eligible for membership in the NASD, who
agree to abide by the provisions of Section 25 of the NASD Rules of Fair
Practice.
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"Permanent Mortgage Loans" shall mean notes, bonds and other evidences of
indebtedness or obligations (other than temporary investments made by the Fund)
which are secured or collateralized by interests in (i) income producing real
property, (ii) other beneficial interest essentially equivalent to a mortgage on
income producing real property or (iii) partnerships, joint ventures or other
entities which own income producing real property. Such Mortgage Loans may be
Junior or First Mortgage Loans and will generally have terms of between three
and five years, subject to extension for up to two two-year periods.
"Points" shall mean the fee payable to the Fund at the time funds are advanced
under a Mortgage Loan.
"Prime Rate" shall mean the rate of interest as published in the Federal Reserve
Statistical Release H.15(519), as it shall change from time to time. In the
event that such a release does not exist, "Prime Rate" shall mean the prime
lending rate as published in the Wall Street Journal, or its successor.
"Principal" shall mean the funds loaned to a Borrower, excluding the amount of
the Interest Reserve.
"Prohibited Transaction" shall mean the sale of Dealer Property other than both
Foreclosure Property and certain Dealer Property held by the Fund for at least
four years.
"Prospectus" shall mean the final prospectus of the Fund with respect to the
offer and sale of Shares filed with the Securities and Exchange Commission as
part of the Fund's Registration Statement on Form S-11, as amended.
"Qualified Plans" shall mean qualified pension, profit-sharing and other
employee retirement benefit plans (including Keogh [HR 10] plans) and trusts,
bank commingled trust funds for such plans and individual retirement accounts.
"Real Estate" shall mean all real properties or any interest therein acquired
directly or indirectly by the Fund, including real properties acting as
collateral for Mortgage Loans.
"Real Estate Investments" shall mean direct or indirect equity investments by
the Fund in all forms in Real Estate, and shall exclude investments in Mortgage
Loans as well as any investments in Mortgage Loans characterized as equity
investments for financial accounting purposes.
"Regular Interest" shall mean the rate of interest payable periodically on a
Mortgage Loan, as determined by the Board of Directors at the beginning of each
Mortgage Loan or any extension thereof.
"Regular Interest Rate" shall mean the rate of interest payable periodically on
a Mortgage Loan and shall be equal to (i) 500 basis points and 300 basis points
in excess of the rate on a treasury obligation having a maturity substantially
similar to that of the Mortgage Loan for fixed rate Junior and
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First Mortgage Loans, respectively, and 400 basis points and 200 basis points in
excess of the Prime Rate, or 570 basis points and 370 basis points in excess of
the Federal Funds Rate, for variable rate Junior and First Mortgage Loans,
respectively.
"Reinvestment Agent" shall mean NTS Depositary Corporation, Louisville,
Kentucky, or its successor as agent for the dividend reinvestment plan.
"REIT" and "real estate investment trust" shall mean a real estate investment
trust as defined in Sections 856 to 860 of the Code.
"REIT Qualifying Investment" shall mean an investment in assets described in
Section 856(c)(5) of the Code, or any successor provision.
"REIT Taxable Income" shall mean the taxable income as computed for a
corporation which is not a REIT: (i) without the deductions allowed by Code
Sections 241 through 247, 249 and 250 (relating generally to the deduction for
dividends received); (ii) excluding amounts equal to (a) the net income from
foreclosure property and (b) the net income derived from prohibited
transactions; and (iii) deducting amounts equal to (a) any net loss derived from
prohibited transactions, (b) the tax imposed by Code Section 857(b)(5) upon a
failure to meet the 95% and/or 75% gross income tests and (c) the dividends
paid, computed without regard to the amount of the net income from foreclosure
property which is excluded from REIT Taxable Income.
"Residential Land Development Loan" shall mean a Mortgage Loan obtained by a
Borrower for the purpose of acquiring, carrying, improving, through pre-
development, development and sale, the underlying real estate, including,
without limitation, engineering, zoning, planning and construction of common
areas and amenity packages, necessary to prepare the parcel and its individual
sites for the construction of homes (and in limited circumstances minor portions
for commercial purposes) and the sale of such sites in the ordinary course of
business of the Borrower or an Affiliate.
"Sales Commissions" shall mean an amount equal to 8% of the Gross Proceeds from
the sale of each Share, subject to certain discounts, payable to the Dealers who
sell such Shares.
"Selling Agent" shall mean NTS Securities, Inc.
"Shares" shall mean the Fund's shares of common stock with a par value of
$0.001.
"Sponsor" shall mean NTS Corporation, a Kentucky corporation, or any person
directly or indirectly instrumental in organizing, wholly or in part, the Fund
or any person who will manage or participate in the management of the Fund, and
any Affiliate of any such person, but excluding (i) a person whose only
relationship with the Fund is that of an independent property manager and whose
only compensation is as such, and (iii) wholly independent third parties such as
attorneys, accountants and underwriters whose only compensation is for
professional services.
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"Stockholders" shall mean as of any particular time the registered holders of
outstanding Shares at such time.
"Subordinated Advisory Fee" shall mean the fee payable to the Advisor or its
Affiliates for services in connection with the liquidation of the Fund's
investments, equal to 5% of the Capital Proceeds remaining after distributions
to Stockholders from all sources in an amount equal to 100% of their Original
Capital Contribution plus a 15% per annum cumulative, non-compounded return on
their Adjusted Contributions to the extent not already paid, beginning on the
Offering Termination Date.
"Supplemental Interest" shall mean the amount, if any, in excess of Regular
Interest, Points, Incentive and Gross Receipts Interest, other cash balances
available for distribution in the discretion of the Board of Directors, and all
other cash receipts of the Fund net of all cash expenditures of the Fund, that
Affiliated Borrowers shall pay the Fund to enable it to make quarterly
distributions to Stockholders equal to an annual 12% cumulative, non-compounded
return on their Original Capital Contributions during the Cash Flow Guaranty
Period.
"Temporary Investments" shall refer to those investments made by the Fund
pending the receipt of sufficient Investable Proceeds to fund the Initial Fund
Investments, or reinvestment in later Fund loans.
"Temporary Mortgage Loan" shall refer to any temporary mortgage loan investment
made by the Fund to an Affiliated Borrower pending investment or reinvestment in
a Mortgage Loan if such Temporary Mortgage Loan (i) matures within one year of
making the loan subject to any extension in the discretion of the Board of
Directors (ii) is anticipated to generate yields higher than other temporary
investments, (iii) is approved by a majority of the Independent Directors, and
(iv) constitutes a REIT qualifying investment.
"Tax-Exempt Entities" shall mean Qualified Plans and other entities exempt from
federal income taxation, such as endowment funds and foundations and charitable,
religious, scientific or educational organizations.
"Total Assets" shall mean the book value of all assets of the Fund, determined
in accordance with generally accepted accounting principles.
"Transfer Agent" shall mean an independent national agent selected by the
Directors or any entity designated at some later date.
"Treasury Rate" shall mean the rate of interest paid on United States Treasury
investments, as published in the Federal Reserve statistical Release H.15(519),
as it shall change from time to time, having a maturity substantially similar to
that of the Mortgage Loan; in the event that such a release is not published,
any other nationally-recognized publication. If there is more than one such
treasury investment, then the rate of that investment priced closest to par
shall be used; provided, however, that this definition may be modified with the
approval of a majority of the Directors, including a majority of the Independent
Directors.
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"Unimproved Real Estate" shall mean property which has each of the following
three characteristics: (i) it was not acquired for the purpose of producing
rental or other operating income; (ii) there is no development or construction
in process on such land, and (iii) there is no development or construction
planned in good faith to commence on such land within one year.
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