10-K 1 file001.txt ANNUAL REPORT ON FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) Of the Securities Exchange Act of 1934 For the Year Ended December 31, 2000 Commission File No. 0-16950 Prometheus Income Partners, a California Limited Partnership ------------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) California 77-0082138 -------------------------------------------- --------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 350 Bridge Parkway Redwood City, CA 94065-1517 -------------------------------------------- --------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number, Including Area Code: (650) 596-5300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Units of Limited Partnership Interest Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- No market for the Units of Limited Partnership Interest exists and therefore a market value for such Units cannot be determined. DOCUMENTS INCORPORATED BY REFERENCE Prospectus, dated February 12, 1987, and Supplement No. 1, dated September 18, 1987, incorporated into Registration Statement Form S-11 (Registration #33-9164), thereto filed pursuant to Section 424(b) under the Securities Act of 1933, and Solicitation/Recommendation Statement pursuant to Section 14(d)(4) of the Securities Exchange Act of 1934, Schedule 14D-9, dated November 4, 1996 and Schedules 14D-91A, Amendments 1, 2 and 3, dated November 15, 1996, December 12, 1996 and December 20, 1996, respectively are incorporated into Parts I, II, III and IV. Exhibit index located on page 16 Table of Contents Form 10-K Part I Page Item 1 Business............................................................3 Item 2 Properties..........................................................4 Item 3 Legal Proceedings...................................................5 Item 4 Submission of Matters to Vote of Security Holders...................5 Part II Item 5 Market for Registrant's Units and Related Security Holder Matters...6 Item 6 Selected Financial Data.............................................7 Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations.............................................8 Item 8 Financial Statements and Supplementary Data........................13 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............................13 Part III Item 10 Directors and Executive Officers of the Registrant.................14 Item 11 Executive Compensation.............................................14 Item 12 Security Ownership of Certain Beneficial Owners and Management.....15 Item 13 Certain Relationships and Related Transactions.....................15 Part IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K...........................................16-30 PART I ITEM 1. BUSINESS Prometheus Income Partners, a California Limited Partnership, (hereinafter referred to as "Partnership" or "Registrant") was formed on April 15, 1985, under the California Revised Limited Partnership Act. Prometheus Development Co., Inc., a California corporation, is the General Partner of the Partnership. The principal business of the Partnership is to invest in, construct, hold, operate, and ultimately sell two residential rental properties in Santa Clara, California, Alderwood Apartments ("Alderwood") and Timberleaf Apartments ("Timberleaf"), (collectively, the "Properties"). The principal investment objectives of the Partnership are to preserve and protect the Partnership's capital, to obtain capital appreciation from the sale of the Properties, and, beginning in 1987, to provide "tax sheltered" distributions of cash from operations due to the cost recovery and other non-cash tax deductions available to the Partnership. See Item 7, Liquidity and Capital Resources and Construction Defects discussions concerning deferment of distributions. For a further description of the Properties and the business of the Partnership; see Item 2 below, and the section entitled "Business of the Partnership" (pages 24-26) and "Properties" (pages 27-35) in the Prospectus. For financial information, see Item 8, below. Beginning in February 1987 through December 1987, the Partnership offered and sold 19,000 Units of Limited Partnership Interests ("Units") for $19,000,000. The net proceeds of this offering, together with the proceeds of the permanent financing, were used to satisfy construction loans with respect to Alderwood and Timberleaf and to exercise the purchase option for the Alderwood land site. The Partnership's investments in real property are affected by, and subject to, the general competitive conditions of the residential real estate rental market in the Santa Clara area. The Partnership's properties are located in an area which contains numerous other competitive residential rental properties. The Partnership is engaged solely in the business of real estate investment. The business of the Partnership is not seasonal. The Partnership does not engage in foreign operations or derive revenues from foreign sources. The Partnership has no employees, officers or directors. The officers and employees of the General Partner and its Affiliates perform services for the Partnership. The income of the Properties may be affected by factors outside the Partnership's control. For example, changes in the supply of rental properties, population shifts, the availability of mortgage funds or changes in zoning laws could affect apartment rental rates. It is also possible that some form of rent control may be legislated at the state or local level. Expenses of operating the Properties, such as administrative and maintenance costs and real estate taxes, are subject to change due to inflation, supply factors or legislation. These increases in expenses may be offset by increases in rental rates, although such increases may be limited due to market conditions or other factors as discussed above. Certain expenses, such as debt service, are at fixed rates and are not affected by inflation. The General Partner is unable to predict the effect, if any, of such events on the future operations of the Partnership. There is no assurance there will be a ready market for the sale of the Properties or, if sold, such a sale would be made on favorable terms. -3- ITEM 2. PROPERTIES The Partnership has constructed two residential income-producing properties, Alderwood and Timberleaf, both in Santa Clara, California. The City of Santa Clara, with a population of approximately 104,000, is the third largest city in Santa Clara County, commonly referred to as Silicon Valley, is approximately 47 miles south of San Francisco, encompasses 1,300 square miles and has a population of approximately 1.7 million people, making it the most populous of the nine counties in the greater San Francisco Bay Area. The Alderwood luxury garden apartment complex is located at 900 Pepper Tree Lane in Santa Clara, California. Construction began in November 1985 and was fully completed by December 31, 1986. The complex contains 234 apartment units housed in 19 two-story buildings on a 9.4 acre site. Covered and uncovered parking for 468 cars is provided. See Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations, for a discussion of current operations. The Timberleaf luxury garden apartment complex is located at 2147 Newhall Street in Santa Clara, California. Construction began in November 1985 and was fully completed by December 31, 1986. The complex contains 124 apartment units housed in nine buildings of two or three stories on a five acre site. Covered and uncovered parking for 248 cars is provided. See Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations, for a discussion of current operations. Alderwood and Timberleaf are encumbered by first mortgage liens, which secure promissory notes payable in the amount of $16,703,000 and $9,176,000, respectively. The notes (collectively, the "Notes") bear interest at the rate of 6.99% per annum for Alderwood, and 7.09% per annum for Timberleaf, and mature in 2007. The Notes, if prepaid more than thirty (30) days from maturity, are subject to a prepayment penalty. -4- ITEM 3. LEGAL PROCEEDINGS See Item 7 for a discussion of construction defects. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the period covered by this report. -5- PART II ITEM 5. MARKET FOR THE REGISTRANT'S UNITS AND RELATED SECURITY HOLDER MATTERS A) No public trading market exists or is expected to be established for the Registrant's Units. The Units were issued by the Partnership for $1,000 per Unit. The General Partner established a Limited Liquidity Plan which commenced in 1989 and provides Limited Partners with the option, subject to certain conditions, to have their Units repurchased by the Partnership (or a person designated by the Partnership). A further description of the repurchase terms can be found in the section entitled "Business of the Partnership-Limited Liquidity Plan" (pages 24-25) in the Prospectus. B) At December 31, 2000, the 18,995 outstanding Units were held by 1,001 investors. C) Tender Offers To Purchase Units During 1996, competing tender offers were made for limited partner interests ("Units") in the Partnership. One tender offer from Prom Investment Partners, LLC ("Prom"), an unrelated third party, expired in December 1996. The second tender offer from PIP Partners - General, LLC ("PIP Partners"), an affiliate of the General Partner, expired in January 1997. An aggregate 2,750.5 Units were tendered to the competing bidders -- 1,430 to PIP Partners and 1,320.5 to Prom, or 7.5283% and 6.9518% of the total outstanding Units, respectively. Under the terms of the Partnership Agreement, the transfers were effective as of April 1, 1997. All Units were purchased for $495 per unit. During 1998, Bond Purchase, LLC, an unrelated third party, made an unsuccessful offer to purchase Units. The offer was for less than 5% of outstanding Units and nominal legal costs were incurred by the Partnership. On October 16, 1998 Bond Purchase, LLC cancelled its transfer request and no Units were acquired. On June 27, 2000, Everest Properties II, LLC ("Everest"), an unrelated third party made a tender offer for up to 2% of the units, or 379 units, for $650 per unit. This tender expired by its terms on July 31, 2000. Under the terms of the Partnership Agreement, Everest was admitted as a limited partner on October 1, 2000 with respect to 289 units that were tendered pursuant to this tender offer, 1.522% of the total outstanding units. On March 5, 2001, Everest made an additional tender offer for up to 300 units, or 1.579% of the outstanding units, for $800 per unit. The tender offer expires on March 30, 2001. D) Distributions to Limited Partners began with the quarter ending September 30, 1987. Cash distributions were suspended in 1996. See Item 7, Liquidity and Capital Resources and Construction Defects for discussions concerning the deferment of distributions. No distributions were made for 1997, 1998, 1999 and 2000. -6- ITEM 6. SELECTED FINANCIAL DATA The following represent selected financial data for the Partnership for the years ended December 31, 2000, 1999, 1998, 1997 and 1996. The data should be read in conjunction with the financial statements and related notes included elsewhere in this Form 10-K. The selected financial data presented below are unaudited. Refer also to Item 7, Management's Discussion and Analysis of Financial Conditions and Results of Operations. For the Years Ended December 31, ---------------------------------------------------- 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- (In Thousands, Except for Unit Data) Rental revenues $6,695 $5,674 $5,578 $5,256 $4,813 Net income (loss) $2,409 $1,431 $896 $477 $ (173) Net income (loss) per $1,000 limited partnership unit $126 $75 $47 $25 $ (9) Cash and cash equivalents per $1,000 limited partnership unit, subsequent to Limited Partner distributions $186 $101 $62 $34 $117 Number of units used in computation 18,995 18,995 18,995 18,995 18,995 Total assets $31,088 $28,873 $27,830 $27,016 $25,259 Notes payable $25,879 $26,188 $26,476 $26,723 $25,248 Cash distributions per $1,000 limited partnership unit, representing a return of capital $ -- $-- $-- $-- $20

-7- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS Introduction ------------ The Partnership was organized in April 1985. Construction of Alderwood and Timberleaf commenced in November 1985 and was completed by December 1986. Lease-up activities began in November 1986 and continued through the third quarter of 1987. The Partnership Registration Statement was declared effective on February 12, 1987 and completed in December 1987. This Item should be read in conjunction with the financial statements, footnotes and other Items contained elsewhere in this report. Liquidity and Capital Resources ------------------------------- The primary sources of funding for the Partnership's activities through 1987 were capital contributions of its Limited Partners, construction financing and permanent financing. The Partnership obtained $15,800,000 in permanent financing in November 1987. These proceeds, together with the Limited Partners' capital contributions, were applied towards the various construction costs and offering expenses as outlined in the Prospectus. In addition, proceeds from the loan were used to purchase the previously leased Alderwood land site. Once lease-up began in 1986, operating expenses, debt service and Limited Partner distributions were funded from apartment rental receipts and cash reserves. Quarterly distributions have been suspended in order to continue building reserves for the potential cost of dealing with the construction defect problems. See Construction Defects below for a more comprehensive discussion of this matter. Each property has a non-recourse note payable, secured by a first deed of trust. These Notes bear fixed interest of 6.99% for Alderwood, and 7.09% for Timberleaf. The terms of the Notes require that each property maintain a hardboard siding security account. These security accounts are additional collateral for the lender. Cash held in these security accounts was $3,039,000 and $2,217,000 for Alderwood and Timberleaf, respectively, as of December 31, 2000. Until the Completion Date, as defined annually, an additional 10%, as defined, or monthly cash flow, whichever is less, shall be deposited into each security account. Should the hardboard siding repairs not be completed by December 2002, or every two years thereafter, and insufficient cash has been accumulated to cure the defects based upon the lender's determination of the cost, then all cash flow shall be deposited into each applicable security account, as necessary, to fully fund the cost of construction. If the projected cash flow is insufficient to satisfy this deficiency contribution, then the Partnership has 60 days to fund the shortage over the projected cash flow. No withdrawals are permitted from the security accounts except to cure the siding defects. The lender shall have the right to hire its own consultants to review, approve and inspect the construction. All such reasonable fees and expenses incurred by the lender shall be paid by the Partnership. -8- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (Continued) Should the litigation not be settled by December 2002, and the Partnership has met all its obligations under the Notes, then the Completion Date shall be extended 18 months from the earlier of the pending settlement date or the last day for filing an appeal. Should construction not be completed by the Completion Date due to an act of force majeure, the Completion Date can be further extended to complete the construction work. Cash and cash equivalents not being held by the lender are comprised of cash invested in market rate, checking and investment accounts. Cash balances were approximately $3,568,000, $1,942,000, and $1,183,000 at December 31, 2000, 1999 and 1998, respectively. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by the Construction Defects, determination of liability for potential costs and expenses of dealing with the Construction Defects problems, and continued stabilized operations at the Properties. Construction Defects -------------------- In June 1996, the general partner learned that the hardboard siding used at both Alderwood and Timberleaf was beginning to fail. That was the first indication of potential product failure at these properties, and the general partner commissioned a survey of the sites. On June 26, 1996, experts conducted the first visual inspection of Alderwood with respect to the defects on behalf of Prometheus Income Partners. Throughout 1997 and 1998, the partnership inspected and investigated Alderwood with respect to the construction defects, and in March and November 1998, various defendants inspected and investigated Alderwood as well. Similarly, on July 11, 1996 experts conducted the first visual inspection of Timberleaf. Additional investigations took place in 1997, 1998 and 2000. As of the dates of these inspections, moisture had accumulated in the walls of these projects through a combination of construction defects and endemic problems with the hardboard siding. Sufficient moisture over time causes rot and decay in the wood, framing and siding which necessitates repairs which, in some cases, are structural in nature. Rot and decay, which form inside the wall, are not visible, and until rot and decay have caused changes in the physical appearance of the exterior of the buildings, it is difficult to ascertain all the locations where rot and decay exist. On September 23, 1996, Prometheus Income Partners filed two lawsuits against the siding manufacturer, the general contractor, the subcontractors and the architects, one for each of its properties, regarding problems at the properties stemming from the hardboard siding. Each of these persons has denied responsibility for the defects. In October 1997, a cross-claim was filed by one of the defendants in each of these lawsuits against the partnership seeking relief against other parties to the litigation if either filing party is found liable in the litigation. This cross claim was tendered to the partnership's insurance carrier, counsel for whom has denied all allegations. The general partner does not believe there is a substantial risk of recovery against the partnership on this claim, but there is no assurance a judgment will not be rendered against the partnership based on this claim. As part of the inspections discussed above, certain structural issues caused by the defects in the hardboard siding were uncovered at Alderwood and Timberleaf and were rebuilt as part of an immediate repair process. The general partner subsequently determined that additional immediate repairs were necessary, which, with the exception of roof repairs noted below, have been completed. The general partner continues to monitor the condition of the property to look for any other signs of rot and decay that would necessitate immediate attention and repair. -9- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (Continued) In addition to the hardboard siding problems, in September 1999 routine roofing inspection uncovered failing roof substrate at dormer roof assemblies for Alderwood and Timberleaf. The general partner traced the cause of this roofing problem to inadequate venting of the roof space. Inadequate venting leads to condensation in roof areas. This has been sufficient to cause deflection and decay of the roof and its structural support, requiring replacement. The general partner received design specifications for remedial roof repairs and has completed a prototype repair of four dormer roof assemblies. The General Partner has executed a contract for those dormer roof assemblies identified by the Partnership's consulting engineer as in need of immediate repairs. These repairs are currently underway. Based on information currently available to the general partner, damages and economic loss appear to be in the range of $19-$20 million. Since 1997, both cases have been under the supervision of a Special Master who is appointed and empowered by the court to assist in resolving the cases. Investigations and other subsequent discoveries have been ordered by the Special Master on behalf of both plaintiffs and defendants in an effort to come to a settlement. Destructive investigation, completed under the order of the Special Master in March 1998 for Alderwood and May 1998 for Timberleaf, has produced a preliminary issues list which the Special Master will use in attempting to prompt a settlement from the defendants. This information is protected by the Special Master and is not for general distribution. Additional testing and investigations have been conducted periodically on the properties and continue to be performed from time to time. The first settlement conference supervised by the Special Master was held on March 11, 1997 among the various defendants and Prometheus Income Partners. Since then, there have been conferences with respect to Timberleaf in May, June, September and December 1997, April, June, August, October and December 1998, and February, June and October 1999. There have also been conferences with respect to Alderwood in January, March, April, September, October and November of 1999. None of these conferences produced a settlement, and so on May 5, 2000, the judge ordered another mandatory settlement conference to be held on August 16, 2000. No settlement was reached at this conference. It is possible that a settlement of pending litigation can occur anytime. The Partnership has entered into a settlement with one of the principal defendants in these actions, subject to court approval. A trial date has been set for Timberleaf on May 14, 2001, and Alderwood's trial is set to commence immediately thereafter. The terms of the mortgages on the properties require that a security account be maintained for each property to cover contingent liabilities with respect to defects in the properties' hardboard siding. These security accounts are additional collateral for the lender, and total, as of December 31, 2000, approximately $5,256,000. Because there is no current prospect for settling the hardboard siding litigation nor the Partnership's intention of refinancing the properties to remove these covenants, there are no current prospects for the liquidation and distribution of these accounts to limited partners. -10- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (Continued) In addition to the security accounts mandated under the partnerships' financing arrangements, the general partner has determined that it is in the best interest of the partnership to continue building reserves for the potential cost of dealing with known and unknown construction defects. The general partner currently maintains an additional account totaling as of December 31, 2000 approximately $2,885,000, which is primarily intended to cover additional contingent liabilities related to the construction defects and other matters. The extent and magnitude of the construction defects continues to worsen with time. The general partner believes that Prometheus Income Partners can no longer wait for the cases to be resolved and has authorized the start of repairs using the cash reserve funds currently held. As of December 31, 2000, Prometheus Income Partners has spent approximately $1,568,000 on emergency repairs and litigation expenditures. Assuming that the litigation is not successfully resolved, over the next twelve months the partnership anticipates spending approximately $1,900,000 to $2,400,000 on additional urgent repairs. It is anticipated that funds held in reserve are not adequate to repair the entire project, so completion of the most critical projects will be prioritized. The cost of pursuing litigation also is significant. The general partner cannot predict or estimate what amounts, if any, will be recovered through litigation. At this time, the general partner cannot predict when distributions will resume due to the build up of reserves; however, it is the general partner's current intention to resume distributions as soon as reasonably possible and prudent. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by construction defects, determination of liability for potential costs and expenses of dealing with the construction defects, and continued stabilized operations at the Properties. Operations ---------- For the years ended December 31, 2000, 1999, and 1998, the average occupied rent obtained from leased units, and the average occupancy were as follows: Average Occupied Rental Rates ----------------------------- 2000 1999 1998 ---- ---- ---- One Bedroom Units $1,641 $1,285 $1,222 Two Bedroom Units $2,115 $1,567 $1,546 Average Occupancy ----------------- 2000 1999 1998 ---- ---- ---- Alderwood 98% 97% 97% Timberleaf 99% 97% 96% -11- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS (Continued) Operating expenses include on-site management, maintenance, utilities, marketing and other expenses related to earning rental revenues. Some of the operating expenses vary as occupancy changes throughout the year. Others, such as property taxes, do not fluctuate in response to changing occupancy levels. Operating expenses have fluctuated between years due principally to the destructive testing, emergency repairs and litigation fees associated with Hardboard Siding Defects. These three expenditure components of Hardboard Siding Defects have fluctuated based upon where in the litigation and repair cycles the Properties happened to be. After initial owner investigations, came the quantification phase wherein preliminary investigation subsequently led to extensive destructive testing and emergency repairs were undertaken to preserve the assets. Legal and expert consultant fees increased as the cases were prepared for the ensuing litigation. Once the cases were placed under the control of a Special Master, further investigations are ordered for both the plaintiff and defendants, thus reducing the costs of which are shared between the plaintiff and the defendants, thus reducing the associated costs to the Partnership. Overall, other than the fluctuation in operating expenses between years caused by the expenditures associated with the Hardboard Siding Defects and related litigation, the properties' income streams have not been materially impacted due to the immediate attention given the defects and the emergency repairs undertaken. Both Properties are located in Santa Clara County, in an area commonly referred to as Silicon Valley. The area has seen continued job growth and low unemployment, which has in turn created a housing shortage driving up the value of housing prices--both homes and apartment rents. Interest expense on Notes is at a fixed rate of 6.99% per annum for Alderwood, and 7.09% per annum for Timberleaf commencing December 26, 1997. Monthly principal and interest payments under these notes are $114,659 and $63,587, respectively. (Through December 26, 1997, interest expense for the Properties on Notes was accrued at 10.375% with a pay rate of 6.25%, with the deferred interest added to principal and incurring additional interest expense at a rate of 4.125% thereon.) Depreciation and amortization remained consistent between 2000 and 1999. Depreciation expense was $618,000 and $573,000 in 2000 and 1999, respectively. Amortization expense was $30,000 each year. Although inflation impacts the Partnership's expenses, increases in expenses can sometimes be offset by increases in rental rates. However, the ability to affect increases in rental rates may be impacted by market conditions such as the supply of rental housing or local economic conditions. As noted in a preceding paragraph, average occupied rental rates from 1999 to 2000 increased 28%, and from 1998 to 1999 increased 3%. Certain expenses, such as property taxes and debt service, may not be impacted by inflation. Property taxes are affected primarily by limits placed by legislation. Debt financing is at a fixed rate. ITEM 7a.QUALITATIVE AND QUANTITATIVE INFORMATION ABOUT MARKET RISK The Company has no debt subject to variable rates of interest and does not invest in derivatives or similar types of instruments. -12- ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The response to this item is submitted as a separate section of this Form 10-K. See Item 14. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE As reported in a Form 8-K filing of March 5, 2001, (see Item 14[b]), the sole director in a Consent to Action Without Meeting of the Board of Directors of Prometheus Development Co., Inc., as General Partner of Prometheus Income Partners, a California limited partnership (the "Company"), dated February 26, 2001, approved the engagement of Ernst & Young LLP as its independent auditors for the calendar year ending December 31, 2000 to replace the firm of Arthur Andersen LLP, who were dismissed as auditors of the Company. The reports of Arthur Andersen LLP on the Company's financial statements for the past two calendar years did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope, or accounting principles. In connection with the audits of the Company's financial statements for each of the two fiscal years ended December 31, 1998 and 1999, and in the subsequent interim period, there were no disagreements with Arthur Andersen LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures which, if not resolved to the satisfaction of Arthur Andersen LLP would have caused Arthur Andersen LLP to make reference to the matter in their report. There are no "reportable events" as that term is described in Item 304(a)(1)(v) of Regulation S-K. In accordance with the rules of the Securities and Exchange Commission, the Company provided Arthur Andersen LLP a copy of the disclosures made under The Form 8-K filing of March 5, 2001. Arthur Andersen LLP's response to that disclosure was included in the afore referenced Form 8-K filing. Further, the Company has not consulted with Ernst & Young LLP during the two years ended December 31, 2000, and during the subsequent period to the date hereof, on either the application of accounting principles or the type of opinion Ernst & Young LLP might issue on the Company's financial statements. -13- PART III ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Partnership has no directors or executive officers. For informational purposes only, the following are the names and additional information relating to controlling persons, directors, executives and senior management of Prometheus Development Co., Inc., the General Partner of the Registrant. Sanford N. Diller. Age 72. President, Secretary and sole Director. Mr. Diller supervises the acquisition, disposition and financial structuring of properties. Mr. Diller founded the General Partner, and effectively controls all of its outstanding stock. Mr. Diller received his undergraduate education at the University of California at Berkeley and his Doctor of Jurisprudence from the University of San Francisco. He has been an attorney since 1953. Since the mid 1960's, he has been involved in the development and/or acquisition of more than 70 properties, totaling more than 13,000 residential units and over 2,000,000 square feet of office space. Vicki R. Mullins. Age 41. Vice President. Ms. Mullins' responsibilities include supervising all property operations, information systems and finance, as well as manages the disposition and financial structuring of properties. Ms. Mullins came to Prometheus Development Co. from The Irvine Company where she spent seven years as Vice President of Finance and Accounting, and Director of Internal Controls. Prior to the Irvine Company, she spent six years with Ernst & Young as an audit manager. Ms. Mullins is a Certified Public Accountant and holds a B.S. degree in Accounting with honors from the University of Illinois. John J. Murphy. Age 38. Vice President. Mr. Murphy's responsibilities include managing all financial, accounting and reporting activities, and insurance. Mr. Murphy came to Prometheus Development Co. from KPMG Peat Marwick where he spent seven years and was a Senior Manager. He is a Certified Public Accountant and holds a B.S. degree in Accounting with honors from the University of San Francisco. ITEM 11.EXECUTIVE COMPENSATION The Partnership does not pay or employ directly any officers or directors. Compensation to executives and employees of the General Partner is not based on the operations of the Partnership. The General Partner and its affiliates receive a management fee as compensation for services rendered and reimbursement of certain Partnership expenses. See Item 13, Certain Relationships and Related Transactions. -14- ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a)Other than PIP Partners - General, LLC ("PIP Partners"), an affiliate of the General Partner, which owns 18.1679%, of the outstanding units, no person of record owns or is known by the Registrant to own beneficially more than 5% of the outstanding Units. (b)The General Partner owns no Units. However, the General Partner, pursuant to the Partnership Agreement, has discretionary control over most of the decisions made for the Partnership. The executive officers of the General Partner, as a group, own no Units. PIP Partners, acquired 7.5283% of outstanding Limited Partner Units in the Partnership during 1997. (See Item 5 for further discussion.) During 1998, 1999 and 2000, PIP Partners acquired .716%, 1.2371% and 8.6865% of outstanding Limited Partner Units, respectively. As of December 31, 2000 PIP Partners owns 18.1679% of the outstanding Units. (c)Not applicable. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Partnership pays or has paid fees to the General Partner and its Affiliates. See Footnote 3 - Related Party Transactions of the financial statements found in Item 14 and the Prospectus (pages 14-16 and 46-48) filed pursuant to Rule 424(b) under the Securities Act of 1934, which is incorporated by reference herein. -15- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. FINANCIAL STATEMENTS AND REPORT OF ERNST & YOUNG LLP, INDEPENDENT PUBLIC ACCOUNTANTS Page ---- Report of Ernst & Young LLP, Independent Auditors...................17 Report of Arthur Anderson LLP, Independent Auditors.................18 Financial Statements: Balance Sheets as of December 31, 2000 and 1999.....................19 Statements of Operations for the years ended December 31, 2000, 1999 and 1998..................................20 Statements of Partners' Capital (Deficit) for the years ended December 31, 2000, 1999 and 1998......................21 Statements of Cash Flows for the years ended December 31, 2000, 1999 and 1998..................................22 Notes to Financial Statements.......................................23 2. FINANCIAL STATEMENT SCHEDULES: Schedule III - Real Estate and Accumulated Depreciation .........29-30 All other schedules are omitted because they are not required or the required information is shown in the financial statements or notes thereto. (b) The following reports on Form 8-K's were filed during the period covered by this report. The company filed Form 8-K on November 27, 2000, with respect to matters not required to be disclosed in a Form 10-K filing. The company filed Form 8-K on March 5, 2001, with respect to the notification of the change in accounting firms for the fiscal year ended December 31, 2000. The company filed Form 8-K on March 12, 2001 with respect to matters not required to be disclosed in a Form 10-K filing. (c) No additional exhibits are required pursuant to Item 601(b) of Regulation S-K. -16- Report of Ernst & Young LLP, Independent Auditors To the Partners Prometheus Income Partners, A California Limited Partnership: We have audited the accompanying balance sheet of Prometheus Income Partners (a California Limited Partnership) as of December 31, 2000, and the related statements of operations, partners' capital (deficit), and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Prometheus Income Partners (a California Limited Partnership) at December 31, 2000, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP San Francisco, California March 9, 2001 -17- REPORT OF ARTHUR ANDERSEN LLP, INDEPENDENT AUDITORS To the Partners of Prometheus Income Partners, a California Limited Partnership: We have audited the accompanying balance sheet of Prometheus Income Partners, a California Limited Partnership, as of December 31, 1999, and the related statements of operations, partners' capital (deficit) and cash flows for each of the two years in the period ended December 31, 1999. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Prometheus Income Partners, a California Limited Partnership, as of December 31, 1999, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ Arthur Andersen LLP San Francisco, California March 28, 2000 -18- PROMETHEUS INCOME PARTNERS a California Limited Partnership BALANCE SHEETS As of December 31, 2000 and 1999 (In Thousands, Except for Unit Data) 2000 1999 ------- ------- ASSETS Real Estate Land, buildings and improvements $30,778 $30,288 Accumulated depreciation (8,801) (8,183) ------- ------- 21,977 22,105 Cash and cash equivalents 3,568 1,942 Restricted cash 5,256 4,558 Deferred financing costs, net of accumulated amortization of $90 and $60 209 239 Accounts receivable and other assets 78 29 ------- ------- Total assets $31,088 $28,873 ======= ======= LIABILITIES AND PARTNERS' CAPITAL (DEFICIT) Notes payable $25,879 $26,188 Accounts payable and accrued liabilities 439 324 ------- ------- Total liabilities 26,318 26,512 ------ ------ Commitments and contingencies (see Note 4) Partner Capital (Deficit) General partner deficit (354) (378) Limited partners' capital, 18,995 limited partnership units issued and outstanding 5,124 2,739 ----- ----- Total partners' capital (deficit) 4,770 2,361 ----- ----- Total liabilities and partners' capital (deficit) $31,088 $28,873 ======= ======= The accompanying notes are an integral part of these financial statements -19- PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF OPERATIONS For the years ended December 31, 2000, 1999 and 1998 (In Thousands, Except for Unit Data) 2000 1999 1998 ------- ------- ------- REVENUES Rental $ 6,695 $ 5,674 $ 5,578 Interest 464 250 235 Other 88 182 178 ------- ------- ------- Total revenues 7,247 6,106 5,991 ------- ------- ------- EXPENSES Interest and amortization 1,860 1,881 1,898 Operating 1,421 1,400 1,807 Depreciation 618 573 569 Administrative 40 40 43 Payments to general partner and affiliates: Management fees 372 300 303 Operating and administrative 527 481 475 ------ ------- ------- Total expenses 4,838 4,675 5,095 ------- ------- ------- NET INCOME $ 2,409 $ 1,431 $ 896 ======= ======= ======= Net income per $1,000 limited partnership unit $ 126 $ 75 $ 47 ======= ======= ======= Number of limited partnership units used in computation 18,995 18,995 18,995 ======= ======= ======= The accompanying notes are an integral part of these financial statements -20- PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF PARTNERS' CAPITAL (DEFICIT) For the years ended December 31, 2000, 1999 and 1998 (In Thousands) General Limited Partner Partners Total ------- -------- ------ Balance as of December 31, 1997 $(401) $435 $34 Net Income 9 887 896 ------- ------ ------ Balance as of December 31, 1998 (392) 1,322 930 Net Income 14 1,417 1,431 ------- ------ ------ Balance as of December 31, 1999 (378) 2,739 2,361 Net Income 24 2,385 2,409 ------- ------ ------ Balance as of December 31, 2000 $(354) $5,124 $4,770 ======= ====== ====== The accompanying notes are an integral part of these financial statements -21- PROMETHEUS INCOME PARTNERS a California Limited Partnership STATEMENTS OF CASH FLOWS For the years ended December 31, 2000, 1999 and 1998 (In Thousands) 2000 1999 1998 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 2,409 $ 1,431 $ 896 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 618 573 569 Amortization 30 30 30 (Decrease)increase in accounts receivable and other assets (49) 32 (42) Increase(decrease) in payables and accrued liabilities 115 (101) 165 ------- ------ ------ Net cash provided by operating activities 3,123 1,965 1,618 ------- ------ ------ CASH FLOWS FROM INVESTING ACTIVITIES Additions to buildings and improvements (490) (350) (324) ------- ------ ------ CASH FLOWS FROM FINANCING ACTIVITIES Principal reductions on notes payable (309) (288) (247) Additions to deferred financing costs -- -- (15) Deposits to restricted cash (698) (568) (487) ------- ------ ------ Net cash used for financing activities (1,007) (856) (749) ------- ------ ------ Net increase in cash 1,626 759 545 Cash and cash equivalents at beginning of year 1,942 1,183 638 ------- ------ ------ Cash and cash equivalents at end of year $ 3,568 $ 1,942 $ 1,183 ======= ======= ======= Supplemental disclosure of non cash transaction Deletion of fully amortized financing costs $ -- $ -- $ 773 ======= ======= ======= The accompanying notes are an integral part of these financial statements -22- PROMETHEUS INCOME PARTNERS a California Limited Partnership NOTES TO FINANCIAL STATEMENTS December 31, 2000 and 1999 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Prometheus Income Partners, a California Limited Partnership (the "Partnership"), was formed to invest in, construct, hold, operate and ultimately sell two multi-family apartment projects, Alderwood Apartments ("Alderwood") and Timberleaf Apartments ("Timberleaf"), located in Santa Clara, California (collectively, the "Properties"). The General Partner is Prometheus Development Co., Inc., ("Prometheus") a California corporation. The Partnership operates in one segment, residential real estate. In accordance with the terms of the Partnership Agreement, income or loss is allocated 1% to the General Partner and 99% to the Limited Partners. Net income or loss per limited partner unit is computed by dividing the net income or loss allocable to the Limited Partners by the number of units outstanding during the period in which the income or losses are allocated. 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. Real estate, which includes development costs, construction costs, property taxes and interest incurred during the construction period, is valued at cost unless circumstances indicate that cost cannot be recovered, in which case the carrying value is reduced to estimated fair value. At December 31, 2000, the Partnership's management believes that the carrying value of the Partnership's real estate does not exceed its estimated fair value. However, no provision has been made to record any impairment that might arise due to construction defect problems. (See Note 4 for further discussion.) Emergency repairs undertaken to preserve the real estate due to the construction defects, which do not extend the life of the assets, are not capitalized. The materials affected by the emergency repairs will have to be removed and replaced when the construction defects are permanently repaired. Buildings and improvements are depreciated using the straight-line method over their estimated useful lives, which range from 5 to 40 years, as follows. Buildings 40 years Land Improvements 30 years Structural Improvements 30 years Personal property 5 years Loan fees, incurred in conjunction with the notes payable have been deferred and will be amortized, using the straight-line method which approximates the effective interest method, over the terms of the related notes payable. -23- NOTES TO FINANCIAL STATEMENTS (Continued) 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) All leases are classified as operating leases. Rental revenues are recognized when contractually due based on the terms of signed lease agreements, which range in duration from month-to-month to one year. No income taxes are levied on the Partnership; rather, such taxes are levied on the individual partners. Consequently, no provision or liability for federal or California income taxes has been reflected in the accompanying financial statements. The net income or loss for financial reporting purposes differs from the net income or loss for income tax reporting purposes primarily due to differences in useful lives and depreciation methods for buildings and improvements and amortization of construction period interest and taxes. Syndication costs incurred in raising Limited Partners' capital were charged to Limited Partners' capital. Statement of Financial Accounting Standards No. 107, "Fair Value of Financial Instruments" requires disclosure about fair value for all financial instruments. It is management's opinion that the carrying value of its financial instruments approximates fair value at December 31, 2000. Cash and cash equivalents consist of amounts held in market rate, checking and investment accounts with maturities of three months or less. Restricted cash is invested in a government fund with original maturities of three months or less. (See Note 5 for further discussion.) In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133" ("FAS 137"), which amends FAS 133 to be effective for all fiscal quarters or all fiscal years beginning after June 15, 2000, or the quarter ending December 31, 2000 for the Partnership. As the Partnership currently has no derivative instruments, the adoption of FAS 137 has no impact on the Partnership's financial position or results of operations. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101") and in June 2000 issued SAB 101B, "Second Amendment: Revenue Recognition in Financial Statements." SAB 101 and 101B are effective for the Partnership in the quarter ending December 31, 2000. The adoption of SAB 101 and 101B did not have a material impact on the Partnership's financial position or results of operations. -24- NOTES TO FINANCIAL STATEMENTS (Continued) 2. NOTES PAYABLE The Partnership had the following notes payable (The "Notes") at December 31, 2000 and 1999: 2000 1999 ---- ---- (In Thousands) Non recourse note payable, secured by a first deed of trust on Alderwood; interest is payable monthly at 6.99% interest rate; the balance is payable at maturity, December 2007. $ 16,703 $ 16,904 Non recourse note payable, secured by a first deed of trust on Timberleaf; interest is payable monthly at 7.09% interest rate; the balance is payable at maturity, December 2007. 9,176 9,284 --------- --------- $ 25,879 $ 26,188 ========= ========= One of the terms of Notes requires that cash be set aside in a hardboard siding security account, as additional collateral. See Notes 4 and 5 for further discussions. Cash paid for interest in each of the years ended 2000, 1999 and 1998 was approximately $1,830,000, $1,851,000, and $1,787,000, respectively. As of December 31, 2000, maturities on the Notes (In Thousands) are as follows: 2001 $ 331 2002 355 2003 381 2004 409 2005 439 2006 and thereafter 23,964 ------- $25,879 ======= The Notes, if prepaid more than thirty (30) days from maturity, are subject to a prepayment penalty. -25- NOTES TO FINANCIAL STATEMENTS (Continued) 3. RELATED PARTY TRANSACTIONS Prometheus Real Estate Group, Inc. ("Prometheus"), an affiliate of the General Partner, manages the Properties. Management fees and payments to the General Partner and Affiliates represent compensation for services provided and certain expense reimbursements in accordance with the Partnership Agreement. 4. COMMITMENTS AND CONTINGENCIES Repurchase of Limited Partnership Units --------------------------------------- Commencing on January 1, 1989, under the terms of the Limited Liquidity Plan ("Plan"), the Partnership may repurchase up to 5% in aggregate of the outstanding units from the Limited Partners, at the Limited Partners' option, in accordance with the Partnership Agreement. The General Partner may allocate up to 10% of the distributable cash from operations in the current year for the purpose of making such repurchases. The price of any units repurchased by the Partnership will be determined in accordance with the Partnership Agreement. The Partnership made no repurchases under the Plan during the years ended December 31, 2000, 1999 and 1998. Construction Defects -------------------- In June 1996, the general partner learned that the hardboard siding used at both Alderwood and Timberleaf was beginning to fail. That was the first indication of potential product failure at these properties, and the general partner commissioned a survey of the sites. On June 26, 1996, experts conducted the first visual inspection of Alderwood with respect to the defects on behalf of Prometheus Income Partners. Throughout 1997 and 1998, the partnership inspected and investigated Alderwood with respect to the construction defects, and in March and November 1998, various defendants inspected and investigated Alderwood as well. Similarly, on July 11, 1996 experts conducted the first visual inspection of Timberleaf. Additional investigations took place in 1997, 1998 and 2000. As of the dates of these inspections, moisture had accumulated in the walls of these projects through a combination of construction defects and endemic problems with the hardboard siding. Sufficient moisture over time causes rot and decay in the wood, framing and siding which necessitates repairs which, in some cases, are structural in nature. Rot and decay, which form inside the wall, are not visible, and until rot and decay have caused changes in the physical appearance of the exterior of the buildings, it is difficult to ascertain all the locations where rot and decay exist. On September 23, 1996, Prometheus Income Partners filed two lawsuits against the siding manufacturer, the general contractor, the subcontractors and the architects, one for each of its properties, regarding problems at the properties stemming from the hardboard siding. Each of these persons has denied responsibility for the defects. In October 1997, a cross-claim was filed by one of the defendants in each of these lawsuits against the partnership seeking relief against other parties to the litigation if either filing party is found liable in the litigation. This cross claim was tendered to the partnership's insurance carrier, counsel for whom has denied all allegations. The general partner does not believe there is a substantial risk of recovery against the partnership on this claim, but there is no assurance a judgment will not be rendered against the partnership based on this claim. -26- NOTES TO FINANCIAL STATEMENTS (Continued) 4. COMMITMENTS AND CONTINGENCIES (Continued) Construction Defects (Continued) -------------------- As part of the inspections discussed above, certain structural issues caused by the defects in the hardboard siding were uncovered at Alderwood and Timberleaf and were rebuilt as part of an immediate repair process. The general partner subsequently determined that additional immediate repairs were necessary, which, with the exception of roof repairs noted below, have been completed. The general partner continues to monitor the condition of the property to look for any other signs of rot and decay that would necessitate immediate attention and repair. In addition to the hardboard siding problems, in September 1999 routine roofing inspection uncovered failing roof substrate at dormer roof assemblies for Alderwood and Timberleaf. The general partner traced the cause of this roofing problem to inadequate venting of the roof space. Inadequate venting leads to condensation in roof areas. This has been sufficient to cause deflection and decay of the roof and its structural support, requiring replacement. The general partner received design specifications for remedial roof repairs and has completed a prototype repair of four dormer roof assemblies. The General Partner has executed a contract for those dormer roof assemblies identified by the Partnership's consulting engineer as in need of immediate repairs. These repairs are currently underway. Based on information currently available to the general partner, damages and economic loss appear to be in the range of $19-$20 million. Since 1997, both cases have been under the supervision of a Special Master who is appointed and empowered by the court to assist in resolving the cases. Investigations and other subsequent discoveries have been ordered by the Special Master on behalf of both plaintiffs and defendants in an effort to come to a settlement. Destructive investigation, completed under the order of the Special Master in March 1998 for Alderwood and May 1998 for Timberleaf, has produced a preliminary issues list which the Special Master will use in attempting to prompt a settlement from the defendants. This information is protected by the Special Master and is not for general distribution. Additional testing and investigations have been conducted periodically on the properties and continue to be performed from time to time. The first settlement conference supervised by the Special Master was held on March 11, 1997 among the various defendants and Prometheus Income Partners. Since then, there have been conferences with respect to Timberleaf in May, June, September and December 1997, April, June, August, October and December 1998, and February, June and October 1999. There have also been conferences with respect to Alderwood in January, March, April, September, October and November of 1999. None of these conferences produced a settlement, and so on May 5, 2000, the judge ordered another mandatory settlement conference to be held on August 16, 2000. No settlement was reached at this conference. It is possible that a settlement of pending litigation can occur anytime. The Partnership has entered into a settlement with one of the principal defendants in these actions, subject to court approval. A trial date has been set for Timberleaf on May 14, 2001, and Alderwood's trial is set to commence immediately thereafter. -27- NOTES TO FINANCIAL STATEMENTS (Continued) 4. COMMITMENTS AND CONTINGENCIES (Continued) Construction Defects (Continued) -------------------- The terms of the mortgages on the properties require that a security account be maintained for each property to cover contingent liabilities with respect to defects in the properties' hardboard siding. These security accounts are additional collateral for the lender, and total, as of December 31, 2000, approximately $5,256,000. Because there is no current prospect for settling the hardboard siding litigation nor the Partnership's intention of refinancing the properties to remove these covenants, there are no current prospects for the liquidation and distribution of these accounts to limited partners. At this time, the General Partner cannot predict when distributions will resume due to the build up of reserves; however, it is the General Partner's current intention to resume distributions as soon as reasonably possible and prudent. The reinstatement and level of future distributions will be dependent on several factors, including the degree of damage caused by construction defects, determination of liability for potential costs and expenses of dealing with the construction defects, and continued stabilized operations at the Properties. Statement of Financial Accounting Standards 121 ("SFAS 121"), "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of", requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In connection with the construction defect problems, the General Partner reviewed the projected cash flows of both Properties to ensure an adjustment of the book value was not required in accordance with SFAS 121. Further, although the full extent of the damage to the hardboard siding for the Properties is unknown, management believes that the fair market value of each Property still remains greater than its respective book value. 5. RESTRICTED CASH - CASH COLLATERAL The terms of the Notes (See Note 2 for further discussion) require that each property maintain a hardboard siding security account. These security accounts are additional collateral for the lender. Cash held in these security accounts was $3,039,000 and $2,217,000 for Alderwood and Timberleaf, respectively, at December 31, 2000. Until the Completion Date, as defined annually, an additional 10%, as defined, or monthly cash flow, whichever is less, shall be deposited into each security account. Should the hardboard siding repairs not be completed by December 2002, or every two years thereafter, and insufficient cash has been accumulated to cure the defects based upon the lender's determination of the cost, then all cash flow shall be deposited into each applicable security account, as necessary, to fully fund the cost of construction. If the projected cash flow is insufficient to satisfy this deficiency contribution, then the Partnership has 60 days to fund the shortage over the projected cash flow. No withdrawals are permitted from the security accounts except to cure the siding defects. The lender shall have the right to hire its own consultants to review, approve and inspect the construction. All such reasonable fees and expenses incurred by the lender shall be paid by the Partnership. Should the litigation not be settled by December 2002, and the Partnership has met all its obligations under the Notes, then the Completion Date shall be extended 18 months from the earlier of the pending settlement date or the last day for filing an appeal. Should construction not be completed by the Completion Date due to an act of force majeure, the Completion Date can be further extended to complete the construction work. -28- The security accounts are to be invested in either a treasury or government fund. -29- SCHEDULE III

-30- SCHEDULE III PROMETHEUS INCOME PARTNERS a California Limited Partnership REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) As of December 31, 2000 (In Thousands) NOTES: (1) The aggregate cost for federal income tax purposes is $28,746. (2) Depreciation is computed on lives ranging from 5 to 40 years. (3) Balance, December 31, 1997 $ 29,614 Additions 324 ------ Balance, December 31, 1998 29,938 Additions 350 ------ Balance, December 31, 1999 30,288 Additions 490 ------ Balance December 31, 2000 $30,778 ====== (4) Balance, December 31, 1997 $7,041 Provision charged to expense 569 ------ Balance, December 31, 1998 7,610 Provision charged to expense 573 ------ Balance, December 31, 1999 8,183 Provision charged to expense 618 ------ Balance, December 31, 2000 $8,801 ====== (5) The Land site was leased through November 1987 and acquired in December 1987. -31- SIGNATURES Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the date indicated. PROMETHEUS INCOME PARTNERS, a California Limited Partnership By PROMETHEUS DEVELOPMENT CO., INC., a California corporation, Its General Partner Date: March 30, 2001 By /s/ Vicki R. Mullins -------------- -------------------------------- Vicki R. Mullins, Vice President Date: March 30, 2001 By /s/ John J. Murphy -------------- -------------------------------- John J. Murphy, Vice President Supplemental Information to be furnished with Report, filed pursuant to Section 15(d) of the Act by Registrants, which have not registered Securities pursuant to Section 12 of the Act: None -32-

PROMETHEUS INCOME PARTNERS 10-K