ITEM 1. BUSINESS --------
THE COMPANY
Cardinal Realty Services, Inc. (the "Company"), an Ohio corporation, invests in, and holds direct and indirect ownership interests in, multi-family real estate. Its wholly owned subsidiary, Lexford Properties, Inc. ("Lexford"), a Texas corporation, provides property management and related services to owners of multi-family real estate. According to 1997 rankings by the National Multi Housing Council, the Company is the nation's 19th largest owner of multi-family properties and Lexford is the 9th largest manager of multi-family properties.
As of December 31, 1996, the Company had an ownership interest in 522 apartment communities (consisting of an aggregate of 34,363 apartment units) in 14 states. As of the same date, Lexford managed 609 apartment communities (consisting of an aggregate of 55,397 apartment units) in 22 states. Lexford's management portfolio included 519 apartment communities (34,209 units) in which the Company has an ownership interest (the "Properties" or "Portfolio") and 90 apartment communities (21,188 units) managed for third party owners.
The majority of the Portfolio was constructed during the 1980s and is comprised entirely of buildings of modular construction. On December 31, 1996, the average economic occupancy of the Portfolio was 92.5% and the average rent collected per unit was $396. The Portfolio is mostly located in suburban, secondary and tertiary markets in the eastern United States.
The Company's headquarters is located in suburban Columbus, Ohio at 6954 Americana Parkway, Reynoldsburg, Ohio 43068. The Company's telephone number is (614) 759 - 1566. Lexford's headquarters is in suburban Dallas, Texas at 8615 Freeport Parkway, Suite 200, Irving, Texas 75063. Lexford also maintains regional operations offices in: Columbus, Ohio; Orlando, Florida; Seattle, Washington; and Houston and San Antonio, Texas. On December 31, 1996, the Company employed 167 employees at its corporate headquarters and in the regional office, an additional 61 employees who work at Lexford headquarters and in its regional offices, and 1,665 employees at the Properties.
The Company's common stock, without par value ("Common Stock"), is traded on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol "CRSI." (SEE ITEM 5 - "MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS").
The Company is successor by name only to Cardinal Industries, Inc. ("CII") (SEE THE COMPANY'S FORM 10 REGISTRATION STATEMENT). The Company registered its Common Stock with the Securities and Exchange Commission in June 1993. Prior to March 1995, the Company's Common Stock was traded on the OTC Bulletin Board (trading symbol "CNRV").
1996 DEVELOPMENTS
In January 1996, the Company implemented a corporate restructuring to segregate its services and ownership businesses, creating a Management Services division and an Investment Management division, respectively. The Investment Management division was formerly referred to as Advisory Services. The corporate restructuring allowed the Management Services division to pursue its growth strategy of improving the performance of the apartment communities under management and entering the third-party fee based property management business, and allowed the Investment Management division to focus on its growth strategy of improving return on the Company's investments in real estate. Related to the corporate restructuring, the Company made a number of changes in senior-level management.
Effective August 1, 1996, the Company significantly enhanced its Management Services business when it acquired Lexford by merger (the "Lexford Merger") of a wholly owned subsidiary of the Company with and into Lexford. Under the terms of the Lexford Merger, the Company succeeded to the ownership of all the issued and outstanding stock of Lexford and the shareholders of Lexford received 700,000 shares of restricted, newly issued Common Stock. For purposes of the Lexford Merger, the Common Stock was valued at $20 per share. Approximately $9.0 million, or 450,000 shares, of the purchase price is subject to forfeiture in whole or in part in the event Lexford does not achieve certain profitability criteria within the three full fiscal years ending December 31, 1999. The Lexford shareholders received 250,000 shares of Common Stock free of contingencies in the Lexford Merger.
Lexford has been engaged in the practice of third-party property management since commencing business in June 1988. The executives of Lexford have extensive experience in managing apartment communities for third- party owners - a busines which the Company had identified as an important part of its growth strategy prior to the Lexford Merger. At the time of the Lexford Merger, Lexford managed approximately 22,000 apartment units and enjoyed a reputation for extensive training programs and the accuracy of its reporting systems. Through the Lexford Merger, the Company was also able to expand its geographic scope to establish a national presence, and to add class A and B residential properties to its management portfolio. The unaffiliated properties managed by Lexford are located primarily in the western U.S. and include a range of property types (from affordable to luxury) while the Company's Portfolio is located primarily in the eastern U.S. and consists entirely of affordable apartment communities of single story modular construction. Since completing the Lexford Merger, the Company has consolidated its Management Services division property and financial operations with those of Lexford, and combined other functions, including payroll, training and human resources. The Company's property management operations are conducted under the Lexford name and the Lexford executives (who were among the former owners of Lexford) direct day-to-day operations of the former Management Services division.
THE COMPANY'S BUSINESS
The Company is engaged in two core business activities: 1) providing management and other services to owners of multi-family real estate; and 2) investing in real estate. The Company's real estate investments include investments in limited partnerships or other entities that own apartment communities in which the Company or one of its subsidiaries owns all of the equity interest (the "Wholly Owned Properties"), and investments in limited partnerships that own apartment communities in which the Company or one of its subsidiaries serves as general partner of, and in most cases, also owns some limited partner interests (the "Syndicated Partnerships").
The unaudited net contribution to profit (revenues less direct expenses) and Adjusted EBITDA (defined as Recurring Earnings Before Interest, Income Taxes, Depreciation and Amortization excluding interest on mortgages secured by the Wholly Owned Properties) by the two core business activities of the Company for the years ended December 31, 1996 and 1995, are as follows. Financial information presented includes revenue generated from the Wholly Owned Properties which is eliminated in the Consolidated Financial Statements, and does not include allocation of general corporate overhead. The 1995 financial information is based on a Pro Forma Income Statement since the results of operations of the Wholly Owned Properties were excluded from the consolidated income statement during the period the assets were Held for Sale (SEE ITEM 7 -- "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS").
Lexford - Management Services - Net Contribution to Profit
1996 1995 --------------- --------------- Revenues Controlled Contracts............. $11,916,175 $11,592,409 Third Party Contracts............ 2,135,429 0 Ancillary........................ 617,098 1,036,482 Other............................ 460,639 637,744 --------------- --------------- 15,129,341 13,266,635 --------------- --------------- Direct Expenses....................... 9,386,591 6,707,291 --------------- --------------- Net Contribution to Profit............ $5,742,750 $6,559,344 =============== =============== Adjusted EBITDA....................... $5,742,750 $6,559,344 =============== ===============
The decline in Management Services' Net Contribution to Profit is primarily due to two factors: 1) a decline in Ancillary Revenues associated with the Company's restructuring of its parts supply operation (see "Ancillary Services"), and 2) a decline in Other Income due to the one-time recovery in 1995 of accounts receivable which had previously been written off. The increase in direct expenses primarily is due to the Lexford Merger.
Investment Management - Net Contribution to Profit
1996 1995 ---------------- -----------------
Revenues
Interest Income.......................... $9,298,650 $4,361,497 Fee Based Services Administrative Fees................ 1,532,447 1,573,694 Loan Fees.......................... 751,994 966,398 Income from Disposal of Non-Core Assets.. 962,761 3,408,379 Other.................................... 52,631 99,827 ---------------- ----------------- 12,598,483 10,409,795 ---------------- -----------------
Direct Expenses............................. 1,958,136 1,960,068 ---------------- ----------------- Net Equity in Wholly Owned Properties....... (455,234) (2,745,738) ---------------- ----------------- Net Contribution to Profit.................. $10,185,113 $5,703,989 ================ =================
Adjusted EBITDA............................. $11,278,914 $6,052,544 ================ =================
The increase in the Investment Management contribution was derived principally from the improved financial operating performances of the Syndicated Partnerships (reflected in Interest Income) and the Wholly Owned Properties.
CONSOLIDATED SUMMARY --------------------------- 1996 1995 ------------- -------------
Net Contribution to Profit:
Lexford - Management Services................. $5,742,750 $6,559,344 Investment Management......................... 10,185,113 5,703,989 ------------- -------------
15,927,863 12,263,333 ------------- ------------- Other Expenses:
Administration................................ 5,030,967 4,399,349 Restructure Costs............................. 242,899 1,537,073 Interest - Corporate.......................... 1,098,333 1,522,087 Depreciation and Amortization................. 769,434 537,849 ------------- ------------- 7,141,633 7,996,358 ------------- ------------- Income before Income Taxes & Extraordinary Items.. $8,786,230 $4,266,975 ============= =============
Adjusted EBITDA by Business Activity ---------------------------- 1996 1995 -------------- -------------
Adjusted EBITDA - Net Contribution:
Lexford - Management Services............ $5,742,750 $6,559,344 Investment Management ................... 11,278,914 6,052,544 Corporate Administration................. (5,030,967) (4,399,349) -------------- ------------- Adjusted EBITDA.......................... $11,990,697 $8,212,539 ============== =============
Lexford - Management Services
The Company's management services business, conducted by Lexford, provides traditional property management services to owners of multi-family real estate. Lexford earns fees for these services, which services include: day-to-day management and maintenance of apartment communities; attracting and retaining qualified residents; collecting rents and other receivables from residents; providing cash management services for rental revenues, security deposits, taxes, insurance and deferred maintenance escrows; and compiling and reporting information to property owners. Lexford's client base includes 519 of the 522 apartment communities (34,209 units) in which the Company has an ownership interest. Management contracts for the Properties are almost all long-term and include incentive fees for rent collection. The revenue stream from managing the Properties is considered to be stable and recurring. Lexford clients also include unrelated third-party owners. The terms of management contracts for third-party owners vary considerably according to the objectives of the owners, and are typically subject to termination on 30-days' notice. Due to the combination of controlled and third-party management contracts, the Company expects that the number of units managed will fluctuate somewhat over time. Lexford intends to aggressively seek to expand its third-party business, which it may do without jeopardizing its base of long-term management contracts for the Properties.
Lexford's management philosophy centers on maximizing the financial performance of the properties it manages for owners. Lexford believes that managers must have detailed knowledge of their properties to maximize performance. Consequently, Lexford's property management operations are decentralized, with on-site managers responsible for day-to-day leasing and maintenance issues, and multi-property managers frequently visiting the properties to manage personnel and review the property's appearance and financial performance. To maintain control and realize efficiencies, financial operations, including payroll and cash management, are centralized in Columbus, Ohio and Dallas, Texas. To help ensure compliance with legal and customer service standards, Lexford has developed a system of policies and procedures for on-site employees, who receive continuous training from Lexford's Training Department. Lexford encourages its employees to pursue continuing education opportunities, and a number of managers have earned the designation of Certified Property Manager. Lexford holds the designation of Accredited Management Organization from the Institute of Real Estate Management.
Location of Properties
The table below indicates the geographic locations of apartment communities managed by Lexford as of December 31, 1996.
No. of No. of State Properties Units ---------------- --------------- ---------------- Alabama 2 159 Arkansas 1 232 Arizona 3 1,015 California 9 2,764 Colorado 5 2,255 Florida 142 9,915 Georgia 74 5,059 Illinois 4 289 Indiana 71 4,817 Kentucky 35 2,132 Maryland 6 465 Michigan 25 1,739 Ohio 140 8,524 Oklahoma 1 138 Oregon 2 800 Pennsylvania 9 582 South Carolina 3 269 Tennessee 7 465 Texas 46 10,309 Virginia 2 732 Washington 15 2,259 West Virginia 7 478 --------------- ---------------- 609 55,397 =============== ================
Operating Performance
In the aggregate, Net Operating Income ("NOI") of the Portfolio increased approximately 7.4% over 1995, (7.9% on a same unit basis) due primarily to an approximate 4.5% increase in rental revenue (5.0% on a same unit basis). Management also believes that the results were favorably influenced by increased emphasis on accountability at the property management level, an incentive compensation plan for on-site managers and leadership from the Lexford staff.
Ancillary Services
Lexford also provides ancillary services to real estate owners, including replacement parts, laundry services and maintenance supplies. In prior years, the Company maintained a warehouse with an inventory of parts and supplies, which were shipped to the apartment communities upon the receipt of orders. In November 1996, the Company disposed of such inventory and Lexford established a "Preferred Vendor" program that features discounts with major vendors (including General Electric, Whirlpool, Glidden, Sherman Williams, Sears, Roebuck & Co., and Maintenance Warehouse/Home Depot). The program allows Lexford clients to benefit from volume purchasing by paying discounted prices for high-quality goods. By outsourcing the replacement parts and supplies, Lexford eliminated its inventory and reduced overhead significantly. As of December 31, 1996, more than 95% of the Portfolio were participating in the Preferred Vendor program. The program was made available to third- party clients effective December 1, 1996. Lexford receives a rebate for every purchase made through the Preferred Vendor program, as well as a rebate from residents' use of laundry equipment. Lexford expects that it can improve third party client participation in the "Preferred Vendor" program in 1997.
Lexford also provides services to apartment residents, including renters insurance and leased apartment furnishings. As of December 31, 1995, 20% of residents at apartment communities in which the Company has an ownership interest selected renters insurance offered through an insurance agency affiliated with Lexford. As of December 31, 1996, the percentage increased to 27%. Lexford plans to make the renters insurance program available to residents of third-party clients in the second quarter of 1997. Lexford receives compensation for services rendered and a reimbursement of expenses. Lexford also offers leased apartment furnishings through agreements with national companies such as Aaron Rents, Inc. and Globe Furniture Rentals, and receives a rebate on furniture packages leased by residents. Although there can be no assurance, the Company believes that Lexford can continue to increase the number of residents who select renters insurance and leased apartment furnishings offered through Lexford or its affiliates.
On a very limited basis, Lexford offers telecommunications and cable television services to residents. The Company expects that Lexford will expand those services in 1997.
Investment Management
The Company's equity investments in real estate are comprised of the Wholly Owned Properties, the Syndicated Partnerships and a small number of non-core assets. The Portfolio Managers and Assets Managers employed in the Company's Investment Management division are charged with maximizing the value of the Company's real estate assets (the Wholly Owned Properties and Syndicated Partnerships are collectively referred to herein as the "Properties") and its return on real estate investments. The Company maintains at least a 1% partnership interest in each of the Syndicated Partnerships, and typically a 9% to 10% managing general partner interest. In addition to its equity investments (i.e., partnership interests) in the Syndicated Partnerships, the Company holds interest earning receivables from a majority of the Syndicated Partnerships. In most instances, the Company's interest earning receivable from a Syndicated Partnership is the Company's more meaningful, income producing asset. Positive cash flow generated from the operations of Syndicated Partnerships is generally available to pay accrued interest on receivables owing to the Company. Interest income on receivables from Syndicated Partnerships is a major source of Company revenue. (SEE NOTE 1 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
The Company's Investment Management division administers the Company's duties and functions as general partner of the Syndicated Partnerships by
providing asset management services to the Syndicated Partnerships. In addition, the Investment Management division performs the following services for the accounts of the co-owners (limited partners) of the Syndicated Partnerships: informational and financial reporting services, including tax return preparation and provision of tax return information; and capital and financial planning, including determination of reserves, funding of capital requirements and administration of capital distributions to partners. The Investment Management division earns fees for providing these services, as well as for its efforts in successful mortgage loan refinancing transactions.
Wholly Owned Properties
As of December 31, 1996, the Company's portfolio included 113 Wholly Owned Properties (8,504 units). The Wholly Owned Properties are owned by (i) limited partnerships in which the Company or one of its wholly owned subsidiaries owns both the general partner interest and limited partner interests (ii) limited liability companies in which the Company or one of its wholly owned subsidiaries own all the member interests, or (iii) wholly owned subsidiaries of the Company. Revenues from the Wholly Owned Properties, primarily generated from rent payments collected from residents, increased approximately $1.9 million or 4.8% in 1996.
The following table summarizes the unaudited operating results of the Wholly Owned Properties by quarter in 1996 and for the years ended December 31, 1996 and 1995:
Wholly Owned Properties (cont'd)
Same Units Comparison
The Company uses a "same unit" comparison as an indicator of the performance of the 108 Wholly Owned Properties owned for the entire year in 1996 and 1995. Total Revenues increased 5.7%, while expenses increased 3.6% resulting in a same unit net operating income increase of 7.5%. The average rent collected was $391 in 1996 versus $373 for 1995 with economic occupancy at 92.5% in 1996 versus 91.8% in 1995.
Deconsolidated Balance Sheet
Effective January 1, 1996, the Company's Wholly Owned Properties were reclassified from "Real Estate Assets Held For Sale" to operating assets on the Company's Consolidated Balance Sheet and their results of operations were reflected in the Company's Consolidated Income and Cash Flow Statements (SEE NOTE 2 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS). The following unaudited table is a pro forma presentation of the Company's Consolidated Balance Sheet as of December 31, 1996 without the consolidation of the Wholly Owned Properties, which highlights the impact of consolidating the Wholly Owned Properties on the Company's Balance Sheet.
Funds From Operations
Funds From Operations ("FFO") is a financial statistic primarily used by real estate investment trusts ("REITs") to report performance of owned real estate. FFO represents net income excluding depreciation, extraordinary gains or losses and funding from escrows for deferred maintenance. The following table sets forth unaudited condensed, combined FFO of the Wholly Owned Properties for the years ended December 31, 1996, 1995, and 1994.
Syndicated Partnerships
The Company holds receivables from substantially all of the 409 Syndicated Partnerships, in which the Company had an ownership interest on December 31, 1996, primarily in the form of second mortgages and general partner advances to the Syndicated Partnerships. Interest payments on these receivables generate a majority of the interest income recognized by the Company. On December 31, 1996, the contractual value of the Company's interest in second mortgages, advances and other receivables, including related accrued interest, was $238.9 million (SEE NOTE 3 TO NOTES TO CONSOLIDATED FINANCIAL STATEMENTS). Over the past four years, cash flow from the Syndicated Partnerships has improved, largely as a result of refinanced first mortgage debt, investment in property improvements and increased NOI. The improved cash flow allows for increased interest and, in certain instances, principal reduction payments from the Syndicated Partnerships to the Company.
The following table summarizes the overall unaudited operating results of the Syndicated Partnerships by quarter in 1996 and for the years ended December 31, 1996 and 1995. The financial information presented is based upon accrual accounting at the partnership level. Certain transactions between the Company and the Syndicated Partnerships are recorded at amounts at the partnership level that will not necessarily correspond to amounts recorded at the Company level as Interest Income due to "Fresh Start" accounting (SEE NOTE 1 TO NOTES TO CONSOLIDATED FINANCIAL STATEMENTS).
Syndicated Partnerships (cont'd)
Note: See Exhibit 99 for Syndicated Partnership performance, by property, for all Properties in which the Company had an ownership interest as of December 31, 1996.
The Company's interest income is principally derived from the Syndicated Partnerships. The following unaudited table reflects interest income from Syndicated Partnerships recognized over the prior three years:
000s omitted ---------------------------------------------------- Interest Income 1996 1995 1994 ----------------- --------------- ---------------- Recurring $ 6,960 $ 4,099 $ 2,633 Refinancing 1,937 0 0 ----------------- --------------- ---------------- Total $ 8,897 $ 4,099 $ 2,633 ================= =============== ================
The $2.9 million increase in recurring interest income was generated by the aggregate $4.9 million increase in net operating income and the approximately $700,000 decrease in interest expense at the Syndicated Partnerships. This $5.6 million increase in cash flow at the Syndicated Partnership level was partially offset by (i) an approximately $852,000 increase in distributions to outside limited partners in 1996 as compared to 1995 (ii) an approximately $683,000 increase in principal payments on cash flow secondary mortgages ("B Notes"). The $1.1 million balance of the partnership cash flow increase did not flow to the Company as interest income for several reasons, including: (1) many partnerships which experienced cash flow increases in 1996 were in negative cash flow situations in 1995, and the 1996 increases therefore do not equate to distributable positive cash flow in whole or in part; and (2) in connection with refinancings and major maintenance, partnerships may require temporary advances (or holdbacks of cash distributions) which may not be repaid as of the end of a fiscal year, thereby diminishing or delaying interest income to the Company. (SEE "CAPITALIZATION OF PROPERTIES").
Capitalization of Properties
The Company believes that obtaining and maintaining the best available financing for the Properties is vital to maximizing their operating performance and managing refinancing risk. Over the past four years, the Company has successfully negotiated long-term, non-recourse, fixed interest rate financing for approximately 92% of the Properties. The Company has also negotiated and established escrows for property improvements, real property tax liabilities and working capital as provisions of refinancing.
The Company applies a two-fold first mortgage loan refinancing strategy. First, securing serviceable long-term, fixed rate financing for the Properties' first mortgage debt improves the chances of relatively stable cash flow with sufficient coverage to properly maintain the Properties and thereby enhance long-term Property performance. Second, to the extent NOIs increase, the Company benefits from increased cash flow from operation of the Wholly Owned Properties and, generally, from increased interest income from the Syndicated Partnerships. The Company earns mortgage restructuring fees for successful refinancing efforts on behalf of the Syndicated Partnerships.
In 1996, the Company refinanced (i) 98 Property mortgages (with a total principal amount of $115.4 million) through an affiliate of PaineWebber Incorporated (ii) 21 Property mortgages (with a total principal amount of $26.1 million) through First Union Capital Markets Group, and (iii) five Property mortgages (with a total principal amount of $5.4 million) through Donaldson, Lufkin & Jenrette Securities Corporation. These refinancings reduced annual Property debt service requirements, including B Note cash flow payments, by $1.3 million and funded escrows in the aggregate amount of $4.2 million.
The refinancing transactions mentioned above eliminated B Notes with principal balances amounting to $1.2 million on six Wholly Owned Properties and $3.9 million on 21 Syndicated Partnerships. During 1996, excess cash flow at the Property level applied to these eliminated B Notes amounted to approximately $98,000 and $338,000 on the Wholly Owned Properties and the Syndicated Partnerships, respectively. Approximately $255,000 of principal payments were made on B Notes of Wholly Owned Properties which remained outstanding at December 31, 1996. Approximately $1.1 million of principal payments were made on B Notes of Syndicated Partnerships which remained outstanding at December 31, 1996.
As of December 31, 1996, more than 83% of the mortgage loans on the Properties had scheduled maturities beyond December 31, 1999. This represents approximately 82% of the mortgage loans to the Syndicated Partnerships and approximately 89% of the mortgage loans to the Wholly Owned Properties.
Non-Core Assets
The Company also owns or holds an ownership interest in a small number of properties and parcels of land (the "Non-Core Assets"). The Company intends to dispose of these assets on the best terms it can obtain. In 1996, the Company recognized approximately $963,000 from the sale of Non-Core Assets. The Company does not expect the sale of Non-Core Assets to be a continuing source of revenue, as a minimal number of Non-Core Assets remain to be sold.
COMPETITION
Lexford competes nationally for management contracts, and locally for apartment community residents. The Company believes that the property management business continues to follow the consolidation trend of the real estate industry in general.
Competition for Apartment Residents
Competition for residents at apartment communities is subject to the condition and pricing of individual units, local market conditions, the location of the apartment community, the apartment community owner's capitalization and other factors. Lexford's portfolio of managed properties is spread over a large geographic area and, therefore, not subject to any one set of local economic circumstances. Additionally, the Company believes that Lexford benefits from managing a diverse portfolio that includes luxury apartments in major markets as well as affordable apartments in secondary and tertiary markets.
To remain competitive and provide opportunities for increases in rental rates, the Company continues to invest in improvements to the Properties. The following table displays Property improvement expenditures for the years 1994 through 1996 for both Wholly Owned Properties and Syndicated Partnerships. The improvements were funded primarily by escrows established under the terms of agreements for refinanced mortgage loans entered into since January 1, 1994. The Company expects that these investments in the Properties will increase their value. The Company will continue to address capital improvements and routine maintenance requirements in future years.
Major Maintenance by Year (000s omitted) -------------------------------------------------------
1996 1995 1994 ---------------- ---------------- -----------------
Major Maintenance...... $13,122 $19,422 $13,514
Capital Improvements... 3,935 N/A N/A ---------------- ---------------- -----------------
$17,057 $19,422 $13,514 ================ ================ =================
Major Maintenance expenditures are typically concentrated in years immediately following mortgage refinancings due to requirements of mortgage lenders. The 1996 activity declined due to a "trailing off" of expenditures related to properties refinanced in 1994 and 1995. Reserves for major maintenance established in the 1996 refinancing program will be expended primarily in 1997. These expenditures, combined with termite repairs funded from the proceeds of the termite litigation, are expected to reverse, at least for 1997, the downward expenditure trend experienced in 1996.
Competition for Management Contracts
Lexford competes with numerous other fee based property managers for third-party management contracts. Competition in this arena is keen, as well as highly fragmented, according to geographic region and property type. The Company is Lexford's largest client, by virtue of the number of apartment communities
controlled by the Company. These contracts provide a base that will remain stable as Lexford seeks to acquire additional management contracts from third-party owners.
Although there can be no assurance, the Company believes that Lexford's experience and track record with respect to financial controls, quality service, lower operating costs and emphasis on employee training are competitive advantages. The Company also believes that its ability to co-invest with owners or developers of multi-family real estate may provide opportunities to control additional apartment communities.
CORPORATE STRATEGY
The Company's overall business objective is to maximize the total return to shareholders and investors through increases in the value of the Company's Properties, cash flows and earnings. The Company believes that this objective is best accomplished by providing high-quality services to owners of real estate and to residents of apartment communities. The Company currently offers property management, ancillary and investment management services; it intends to improve margins from, and participation in, these services as well as to explore opportunities to offer additional services.
Lexford will strive to expand its business by soliciting additional fee-based contracts for providing management and other services to multi-family communities. To that end, Lexford plans to implement an advertising and promotional campaign to increase its visibility, and to devote additional resources to improve and expand its marketing efforts. Lexford's growth strategy will be primarily targeted at regions in which it has properties under management, so that economies of scale may be realized. Lexford will seek to expand into regions where large congregations of apartments are located, and where it believes there are opportunities for future growth.
With respect to apartment communities in which it has an ownership interest, the Company intends to continue its conservative financial strategies, including funding reserves of at least $300 per unit annually for capital improvements, and seeking opportunities for refinancing when improved terms can be achieved. The Company also intends to carefully evaluate return on investment from the Properties with the goal of disposing of under-performing or non-performing Properties, and replacing them with assets from which it can achieve higher investment returns.
The Company also plans to invest in technology to enhance the capabilities of both Lexford and the Investment Management division. In 1996, the Company invested in new hardware and software at its corporate headquarters to improve processing and reporting capabilities. The Company plans to continue this investment by migrating computer technology to the Properties through the second quarter of 1998 (SEE ITEM 7: "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" -- LIQUIDITY AND CAPITAL RESOURCES).
ITEM 2.

ITEM 2. PROPERTIES ----------
The Company maintains ownership interests in the Wholly Owned Properties and the Syndicated Partnerships (SEE ITEM 1. "BUSINESS" - INVESTMENT MANAGEMENT).
The Company's corporate headquarters are located in a 52,168 square-foot, single-story office building at 6954 Americana Parkway, in suburban Columbus, Ohio. The Company entered into a lease for the building with Americana Investment Company (an entity affiliated with an outside director of the Company - - SEE PART II ITEM 13: "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS") in late 1992. Management believes that the lease terms are competitive with commercial lease rates in the suburban Columbus market.
Lexford's corporate headquarters are located in a 15,185 square-foot suite of offices located in an office park at 8615 Freeport Parkway in suburban
Dallas, Texas. Lexford entered into a lease for the office suite in 1993. In addition to the corporate headquarters, Lexford leases regional operations offices in Orlando, Florida; Seattle, Washington; and in Houston and San Antonio, Texas.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS -----------------
The Company reached a settlement in THE ESTATE OF HAROLD MURPHY, ET AL V. CARDINAL REALTY SERVICES, INC. ET AL., pending in the United States District Court for the Southern District of Indiana. The settlement resulted in the judgment entered against the Company being vacated, the withdrawal of the pending action and a release of all claims against the Company in consideration of the Company's payment of $370,000 to the Plaintiffs. Pursuant to the terms of the proposed settlement, there was no admission of liability by the Company. The $370,000 settlement amount was paid in the second quarter of 1996.
The Company reached a settlement in CARDINAL INDUSTRIES, INC. V. NATIONAL UNION FIRE INSURANCE COMPANY OF PITTSBURGH, PA ET AL., pending in the United States District Court for the Southern District of Ohio, Eastern Division. The settlement provided for a gross payment of $7.5 million to the Company, for the benefit of the affected Properties, and certain other parties to be paid in two installments. The first installment of $4.0 million was received in October 1996, with the balance received in November 1996. A large portion of the settlement payments was paid to the Company's attorneys in the case (who handled the case on a contingency fee basis). The settlement provides for the release of all claims between the Company and National Union Fire Insurance Company. Pursuant to the terms of the settlement, there was no admission of liability by either party. The settlement funds are being held by the Company, pending the finalization of an allocation of proceeds to the affected Properties.
On March 7, 1996, the Company filed suit against Hartford Fire Insurance Company ("Hartford") in the United States District Court for the Middle District of Florida, in a case captioned CARDINAL REALTY SERVICES, INC. V. HARTFORD FIRE INSURANCE CO., Case No. 96-458-CIV T-24A. In that case, the Company seeks to recover from Hartford, pursuant to an excess property insurance policy issued to the Company by Hartford, for termite-related losses at approximately 150 Properties in which the Company holds an interest. The termite related losses are the same as those which formed the object matter of the NATIONAL UNION litigation. Hartford's insurance policy provides coverage for such losses to the extent they exceed $25 million. The parties are presently engaged in the discovery process, and a trial has been scheduled for September 1997.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ---------------------------------------------------------------------
Effective March 9, 1995, the Company commenced trading of its Common Stock on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol "CRSI". Prior to this date, the Company's Common Stock traded on the OTC Bulletin Board as "CNRV". On December 31, 1996, there were approximately 1,431 registered holders of the Company's Common Stock. The following table sets forth the high and low bid prices of the Common Stock for the periods indicated. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
1996 1995 ----------------------- --------------------- High Low High Low ---------- ------------ ----------- ---------
First Quarter........... $18.75 $17.50 $13.75 $10.50
Second Quarter.......... 21.75 17.50 18.00 12.75
Third Quarter........... 20.75 18.50 18.50 16.88
Fourth Quarter.......... 21.25 19.38 19.75 16.00
The Company's transfer agent is:
The Huntington National Bank Trust Department The Huntington Center Attention: HC 1112 Columbus, Ohio 43287
The Company has paid no dividends since it became a public reporting company. Until August 1995, the Company's ability to pay dividends was subject to a prohibition contained in its financing arrangements with The Huntington National Bank. The terms of the Company's current credit facility provided by The Provident Bank no longer restrict dividends. (SEE ITEM 7 - "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS"--"Liquidity and Capital Resources").
In connection with its acquisition of Lexford on August 1, 1996, the Company issued 700,000 shares of its Common Stock to the former shareholders of Lexford Properties, Inc. as merger consideration for the cancellation of all the issued and outstanding shares of capital stock of Lexford Properties, Inc. 450,000 shares of Common Stock issued to the former shareholders of Lexford Properties, Inc. are subject to forfeiture, in whole or in part, in the event that Lexford fails to produce net income from property management operations in sufficient amounts in the 1997, 1998 or 1999 fiscal years.
During 1996, the Company issued 30,000 shares of restricted Common Stock and 8,750 shares of Common Stock underlying matching stock grants to The Provident Bank, as trustee (the "Trustee") of the Cardinal Realty Services, Inc. Executive Deferred Compensation Rabbi Trust for the benefit of certain executive officers of the Company. (SEE PART III, ITEM 11 "EXECUTIVE COMPENSATION - (F) EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT").
All of the shares of Common Stock issued to the former shareholders of Lexford Properties, Inc., as well as to the trustee, were issued without registration under the Securities Act of 1933, as amended (the "Act") based upon the Company's claim (on account of the private and limited nature of the issuances) to the exemption from registration provided under Section 4(2) of the Act.
ITEM 6:

ITEM 6: SELECTED FINANCIAL DATA -----------------------
The information below should be read in conjunction with the CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO AND ITEM 7

ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
INTRODUCTION
The following discussion should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto (SEE ITEM 1 - "BUSINESS" AND NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
The financial statements for the years ended December 31, 1995 and 1994 do not include the results of operations (revenues or expenses) attributable to the Wholly Owned Properties previously classified as "Real Estate Assets Held for Sale". Commencing January 1, 1996 the Results of Operations, including depreciation of the Wholly Owned Properties, have been included in the Consolidated Statements of Income. Therefore, the Consolidated Statement of Income for the year ended December 31, 1996 is not comparable to the Consolidated Statements of Income for the years ended December 31, 1995 and 1994.
In order to facilitate the comparison of operations in 1996 to prior years, the following "pro forma" Income Statements (the "Pro Forma Income Statements") has been prepared for the year ended December 31, 1995 as if the Wholly Owned Properties were previously consolidated. All intercompany transactions have been eliminated. Depreciation expense for the Wholly Owned Properties has been estimated for 1995 (SEE NOTES 1 AND 2 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
The following discussion of Results of Operations for the year ended December 31, 1996 as compared to 1995 is based upon the Pro Forma Income Statement.
RESULTS OF OPERATIONS
Comparison of Results of Operations for the Years ended December 31, 1996 and Pro forma 1995
Rental and Other Operating Real Estate Revenues are derived from the Wholly Owned Properties which are apartment communities that comprise the Company's Operating Real Estate Assets. Revenues increased $1.9 million, or 4.8%, in 1996 as compared to 1995. The increase was primarily due to the increase in average rent collected from $366 in 1995 to $387 in 1996. The average economic occupancy of the 108 Wholly Owned Properties in operation at all times during 1996 and 1995 was 92.5% in 1996 compared to 91.8% in 1995. Economic occupancy is defined as the amount of revenue collected from residents as a percentage of the revenue a property could generate if full rents for all units were collected.
Fee Based Revenues are comprised of Lexford and Investment Management revenues generated from services provided to Properties and residents at the Properties. Property Management Services revenues principally relate to property management and accounting services provided to the Properties. Ancillary Services revenues consist principally of revenue generated from the sale of replacement and maintenance material to the Properties. In addition, Ancillary Services revenues include revenue generated from furniture leasing and renters insurance services provided to residents. Investment Management revenues consist of partnership administration fees as well as loan refinancing and restructuring fees.
The following are the major components of Lexford Revenues and Investment Management Revenues (unaudited) for 1996 as compared to pro forma 1995:
Fee Based Revenues increased approximately $1.8 million, or 15.6%, in 1996 as compared to 1995. The increase was primarily due to the acquisition of Lexford Properties, a third party property management company, which generated $2.1 million in Fee Revenue since its acquisition on August 1, 1996 (SEE NOTE 1 TO NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - "LEXFORD ACQUISITION"). The increase in property management revenues was offset by an approximately $487,000 decrease in replacement and maintenance material sales to Syndicated Partnerships. The decline in replacement and maintenance material sales occurred as the Company transitioned from a warehouse operation to a coordinated buying group for replacement and maintenance material. Revenue in the future will be derived from a portion of the volume discounts generated by the property purchases.
Fee Based Revenues are dependent to a certain extent on the financial condition of the Properties owned and managed by the Company and the Company's ability to retain its ownership interests. Loss of these interests, due to an increase in interest rates or an inability to refinance matured loans, could have a material adverse impact on Fee Based Revenues and the financial condition of the Company. Although there can be no assurance, management does not currently foresee any material loss of ownership interests in the Properties in 1997 that would adversely affect the Company's Fee Based Revenues. In addition, Lexford derives its third party property management revenues from 30 day cancelable contracts. Therefore, the amount of revenue generated from third party management contracts may be subject to significant fluctuation from period to period. Lexford, for example, in early 1997 lost the management of approximately 3,000 units in a portfolio involved in bankruptcy proceedings which resulted in a change of control of the ownership of these units.
Fee Based Revenues are also directly related to the occupancy and level of rents collected at the properties managed by the Company. For the past two years the Company has maintained occupancy, on average, above 90% at the properties managed by the Company. The Company's ability to obtain rental increases and maintain occupancy are highly dependent upon market conditions, the physical condition of the properties and the competitive environments affecting such properties.
Interest Income increased $4.8 million or 117% in 1996 compared to 1995. Interest Income is primarily derived from the interest collected or accrued on the recorded value of interests in, and receivables from, Syndicated Partnerships. (SEE NOTE 3 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS). Approximately $1.9 million of the increase was generated from the excess proceeds derived from refinancing of Syndicated Partnerships (SEE LIQUIDITY AND
CAPITAL RESOURCES -- FINANCING AND DEBT RESTRUCTURING OF THE PROPERTIES). Although the interest income generated from excess refinance proceeds is not recurring, Interest Income may be favorably impacted in the future by the lower debt service as a result of the refinancing transactions completed in 1996. The balance of the increase was a result of improved cash flow due to increased operating performance of the Syndicated Partnerships (a same unit 7.9% increase in net operating income in 1996 as compared to 1995) and lower debt service requirements on mortgage debt refinanced in prior years. Although there can be no assurance, Interest Income should continue to be favorably impacted in the future from the improved cash flow on the Syndicated Partnerships generated from lower debt service requirements and increases in operating income.
Income from Disposal of Non-Core Assets -- Net, decreased approximately $2.4 million in 1996 as compared to 1995. This income is derived from the proceeds of the sale of Non-Core Assets and the recovery of investor notes receivables in excess of the aggregate recorded value of these assets. During 1994 the Company recovered the entire recorded value of these assets and, as a result, began recognizing the proceeds, net of collection and closing costs, as income. Additional income from the disposal of Non-Core Assets may be recognized in the future although it is not a significant long term source of revenue for the Company.
Other Income decreased approximately $224,000 in 1996 as compared to 1995. The decrease was principally due to income in 1995 from the recovery of trade accounts receivable which had previously been written off.
Rental Operating Expenses decreased approximately $848,000, or 3.8%, in 1996 as compared to 1995. The decrease was primarily due to the implementation in 1996 of a capitalization program which resulted in the capitalization of major building exterior improvements. Previously all items were expensed. In 1996 approximately $700,000 of improvements were capitalized that would have been expensed in prior years. In addition, major maintenance expense decreased approximately $487,000 in 1996 as compared to 1995. The decrease in 1996 primarily related to major maintenance on Wholly Owned Properties refinanced in 1995 and 1994. Reserves for major maintenance established in the 1996 refinancing program will be expended in 1997 and reverse the decrease experienced in 1996.
Fee Based Expenses increased approximately $2.5 million in 1996 as compared to 1995. Approximately $2.0 million of the increase was related to the third-party management operation of Lexford, which was acquired effective August 1, 1996.
Administration Expenses increased approximately $632,000 in 1996 compared to 1995. The increase was primarily due to bonuses payable to employees pursuant to the Company's 1996 Incentive Compensation Plan. The incentive compensation is based upon certain increases in Company profitability. The percentage increase used as a measurement for the majority of the incentive compensation is computed net of the cost of such plan. The increase in incentive compensation in 1996 compared to 1995 is reflective of the significant increases in profitability achieved in 1996 compared to 1995.
Restructuring Costs in 1996 of $242,899 related to realignments to the Company's organization to eliminate overlapping responsibilities. The restructuring in 1996 was a follow up to the restructuring costs incurred in 1995 of $1.5 million. The restructuring costs are primarily comprised of severance and separation costs. Management anticipates that the restructurings completed in 1995 and 1996 should result in annual savings in excess of $1.0 million, primarily related to reductions in payroll and related fringe benefit costs.
Interest Expense on mortgages on the Wholly Owned Properties increased approximately $582,000 in 1996 as compared to 1995. The increase in interest expense was due to the refinancing transactions completed in 1996 and 1995. Although the overall contractual interest rates decreased, interest expense increased, due to the impact of "Fresh Start" reporting with effective interest rates applied to the Carrying Value of the mortgages. Interest expense on the Company's corporate lines of credit decreased approximately $424,000 in 1996 compared to 1995. The decrease is due to lower outstanding balances on the lines, and the refinancing of the Company's corporate credit lines in August 1995 at a more favorable interest rates (SEE "LIQUIDITY AND CAPITAL RESOURCES").
Depreciation and Amortization Expense increased approximately $253,000 in 1996 as compared to 1995. The increase is primarily due to amortization expense related to loan origination costs capitalized in connection with the refinancing of corporate debt and mortgages on the Wholly Owned Properties, combined with amortization of management contracts and goodwill associated with the Lexford acquisition.
Income before Extraordinary Item increased from $2.6 million in 1995 to $5.4 million in 1996. The Extraordinary charge of $1.6 million, net of taxes was a result of mortgage debt refinancing on certain Wholly Owned Properties (SEE NOTE 6 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS AND "LIQUIDITY AND CAPITAL RESOURCES"--FINANCING AND DEBT RESTRUCTURING OF THE PROPERTIES). The extraordinary gain of $804,000 recognized in 1995 was due to debt forgiveness generated from the debt restructuring and refinancing of mortgages on Wholly Owned Properties. Net income increased from $3.4 million in 1995 to $3.8 million in 1996.
The financial position of the Company may be impacted by the availability to the Company of certain tax benefits, such as net operating loss carryforwards and other tax attributes. To the extent all or a portion of the Company's tax attributes are unavailable to offset taxable income, the cash flow of the Company could be materially impacted (SEE NOTE 10 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
Comparison of Results of Operations for the Years ended December 31, 1995 and
Fee Based Revenues are comprised of Management Services and Investment Management revenues generated from services provided to Properties and residents of the apartment communities. The following are the major components of Management Services Revenues and Investment Management Revenues for 1995 as compared to 1994:
Fee Based Revenues decreased approximately $110,000 in 1995 as compared to 1994, due to a decrease in Investment Management revenues of approximately $661,000, which was partially offset by increases in Property Management Services and Ancillary Services Revenues of approximately $348,000 and $203,000, respectively. The decrease in Investment Management revenues was principally due to a decrease of approximately $548,000 in loan refinancing and restructuring fees in 1995 as compared to 1994. Loan refinancing and restructuring fees are subject to significant fluctuation from period to period based upon the volume of loans maturing in a given year, and a property owner's ability to refinance
based on the current interest rate environment. The balance of the decrease in Investment Management revenues was due to fees earned in 1994 related to bankruptcy services provided to properties in Chapter 11 bankruptcy proceedings. The increase in Property Management Services revenues was due to an increase in management and accounting services fees of approximately $280,000. The increase was primarily due to an increase in the number of Properties managed after management of six properties was returned to the Company due to the cancellation of a third party management contract in the third quarter of 1995. The aggregate increase in Ancillary Services revenues of approximately $203,000 was principally due to an increase in replacement and maintenance material sales to properties. The increased sales were attributable to the deferred maintenance escrow funds established with the refinancing and restructuring of mortgage debt on a significant number of the Properties in 1994 and 1995.
Interest Income increased $1.7 million in 1995 as compared to 1994. Interest Income is primarily derived from the interest collected or accrued on the recorded value of interests in, and receivables from, Syndicated Partnerships. (SEE NOTE 3 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS). The increase in Interest Income was due to increased cash flow from the Syndicated Partnerships primarily as a result of lower debt service requirements on refinanced or restructured mortgage debt.
Income from Disposal of Non-Core Assets -- Net increased approximately $219,000 in 1995 as compared to 1994. This income is derived from the proceeds of the sale of Non-Core Assets and the recovery of investor notes receivable in excess of the aggregate recorded value of these assets. During 1994 the Company recovered the entire recorded value of these assets and, as a result, began recognizing the proceeds, net of collection and closing costs, as income.
Other Income decreased approximately $692,000 in 1995 as compared to 1994. The decrease was principally due to the settlement of a pending claim in 1994. The settlement resulted in a release of an accrued liability of approximately $726,000 in exchange for the Company's dismissal of a preference action.
Fee Based Expenses decreased approximately $336,000 in 1995 as compared to 1994. The decrease in Fee Based Expenses reflects the staff reductions and realignments implemented by the Company in 1993 and 1994.
Administration Expenses increased approximately $406,000 in 1995 as compared to 1994. The increase was primarily due to the recording of a litigation reserve in the fourth quarter of 1995. The reserves were established for ongoing and potential legal and litigation costs involving the Company. Administration Expenses also increased in 1995 due to additional corporate governance costs and expenses associated with the registration of the Company's Common Stock on the Nasdaq National Market tier of the Nasdaq Stock Market.
Restructuring Costs of $1.5 million were incurred in 1995 as a charge related to the corporate restructuring implemented at the end of 1995 which aligned the Company's organization structure with current and future business goals. The $1.5 million charge is primarily comprised of severance and separation costs.
Interest Expense decreased approximately $121,000 in 1995 as compared to 1994. The decrease was due to a reduction in the average debt outstanding of approximately $2.0 million in 1995 versus 1994. In addition, in August 1995, the Company obtained more favorable financing terms on its corporate debt by negotiating a variable interest rate with a new lender, The Provident Bank (the "Bank"), at the Bank's prime rate of interest minus 1.0% as compared to a previous variable interest rate at the Huntington National Bank's prime rate of interest plus 0.5%. These favorable factors were partially offset by an increase in the prime interest rate charged by most lenders in 1995. The prime interest rate charged by the Company's lender ranged from 6.0% to 8.5% in 1994 as compared to a range of 8.5% to 9.0% in 1995 (SEE LIQUIDITY AND CAPITAL RESOURCES).
Depreciation Expense increased approximately $90,000 due to depreciation on capital improvements undertaken at the end of 1994 and throughout 1995.
Income before Extraordinary Item. As a result of the approximately $1.1 million aggregate increase in revenues less an increase in expenses and taxes of approximately $728,000, Income before Extraordinary Item improved from $3.9 million in 1994 to $4.3 million in 1995. The extraordinary gain, due to debt forgiveness generated from the debt restructuring and refinancing on Wholly Owned Properties, was $804,000 in 1995 versus $3.2 million in 1994. Net Income amounted to $5.1 million in 1995 as compared to $7.1 million in 1994.
Earnings before Interest, Taxes, Depreciation and Amortization
The Company believes that earnings before interest, income taxes, depreciation, amortization and extraordinary items ("EBITDA"), Recurring EBITDA and Adjusted EBITDA are significant indicators of the strength of its results. EBITDA is a measure of a Company's ability to generate cash to service its obligations, including debt service obligation, and to finance capital and other expenditures, including expenditures for acquisitions. EBITDA does not represent cash flow as defined by Generally Accepted Accounting Principles ("GAAP") and does not necessarily represent amounts of cash available to fund the Company's cash requirements. Unaudited EBITDA and the computation of Adjusted EBITDA for the years ended December 31, 1996, 1995 and 1994 is as follows: (000s omitted)
EBITDA increased $4.9 million, or 20.0%, and Adjusted EBITDA increased $3.8 million, or 46.0%, in 1996 as compared to 1995. EBITDA decreased $152,000, or 1%; however, Adjusted EBITDA increased $1.4 million, or 19.9%, in 1995 as compared to 1994.
LIQUIDITY AND CAPITAL RESOURCES
The following discussion regarding liquidity and capital resources should be read in conjunction with the Company's Consolidated Balance Sheets as of December 31, 1996 and 1995 and the Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994.
The principal sources of liquidity for the Company are cash flow from its operations and borrowing available under the Company's credit facility. The Company's Net Cash Provided by Operating Activities has increased significantly over the past three years, from approximately $1.0 million in 1994; to approximately $5.6 million in 1995; to approximately $12.7 million in 1996.
Increases in Cash Received from Interests in and Receivables from Syndicated Partnerships has been a major factor in such increase. Cash Received from Interests in and Receivables from Syndicated Partnerships, which is primarily comprised of payments of accrued interest, increased 82.7%, or $4.1 million, in 1996 as compared to 1995 and 98.5%, or $2.4 million, in 1995 as compared to 1994. In 1996, 294 Syndicated Partnerships provided operating cash flow to the Company, as compared to 220 in 1995 and 160 in 1994.
The increase in Net Cash Provided by Operating Activities was also due to $4.5 million of operating cash flow from the Wholly Owned Properties. This operating cash flow was formerly treated as cash flow from investing activity while the Wholly Owned Properties were classified as "Real Estate Assets Held for Sale" (SEE NOTES 1 AND 2 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS).
The other factors impacting the Company's cash flow in 1996, 1995 and 1994 are discussed in "Results from Operations" and "Financing and Debt Restructuring of the Properties".
The Company anticipates that cash flow from its operations and borrowings available under the Company's credit facility will be adequate to meet the reasonably foreseeable capital and liquidity needs of the Company. If the Company is successful in its future growth plans, it may be necessary to seek additional capital sources through other debt or equity sources (SEE ITEM 1 - "BUSINESS").
In August 1995, The Provident Bank (the "Bank") and the Company closed on a new credit facility that retired the Company's credit facility with The Huntington National Bank ("HNB") as well as provided additional borrowing capacity with more flexible terms. The new credit facility has lower interest rates than the previous facility with HNB and also reduced or eliminated certain restrictive covenants.
The new credit facility provides credit up to $32.0 million, and is comprised of: a $3.0 million revolving line of credit for operating needs subject to annual review and extension by the Bank; a $7.0 million line of credit for acquisitions and Property debt restructuring (the "Acquisition Line") due in six years with interest only, payable in the first year; a $22.0 million reducing balance line of credit (the "Reducing Line") due in six years with interest, only, payable during the first year (collectively, the "Loans"). The Reducing Line was used to retire HNB credit facility. The credit facility provided that the interest rate on the Loans would be the Bank's prime rate of interest minus 1%; however, in February 1996, the Company entered into an agreement with the Bank to fix the interest rate on the Acquisition Line at 7.25% with principal amortization beginning in March 1996 in 60 equal monthly installments of principal and interest. Excess corporate cash is applied to pay down the Reducing Line and reborrowed as needed (SEE NOTE 4 TO NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
In July 1996, the Company received a commitment letter from the Bank for an additional $10.0 million line of credit. The new line will bear interest at the Bank's prime rate of interest minus 1% with interest only during the first year, and will be due in six years. The Company did not draw on this line in 1996. On December 31, 1996, including the $10.0 million commitment, the Company had unrestricted credit availability of approximately $25.4 million.
In addition, all of the Company and the majority of Property bank accounts are maintained at the Bank. The banking relationship has increased cash flow at the Properties as a result of reduced service charges and increased interest income on the Property bank account balances. The Company may benefit from a portion of the improved cash flow at the Properties.
Presently, the Company plans to finance its working capital needs from cash flow and through borrowing under its credit facility. Although it is anticipated that the Company will have access to sufficient funds to meet its requirements, if opportunities develop on favorable terms for additional mortgage restructuring, or acquisitions, the Company may seek alternative outside debt or equity sources to fund such activities. In addition, any significant decrease or increase in interest rates will affect the Company's earnings and cash flows favorably or unfavorably, respectively.
In November 1995, the shareholders of the Company approved an increase in the number of authorized shares of Common Stock from 4,500,000 to 13,500,000 and also authorized 1,500,000 shares of "Blank Check" Preferred Stock. The Company has no current commitments or arrangements which would require the issuance of a material number of additional shares. The Company sought the increase in authorized shares to provide an additional source of capital and provide greater flexibility in structuring potential transactions, such as the Lexford acquisition.
The Company's capital expenditures for 1996 amounted to approximately $423,000 funded from cash flow and the Company's credit facility. The Company anticipates that its capital needs in the future can be satisfied out of cash flow or the Company's credit facility. The Company currently forecasts capital expenditures of approximately $400,000 in 1997, principally for enhanced computer system hardware and software. The Company is currently implementing new software systems in order to obtain optimal efficiencies from technology.
Improvement and Replacement Expense for the Wholly Owned Properties was $2.8 million and capital expenditures amounted to approximately $682,000 during 1996. Improvement and Replacement Expense was funded from Wholly Owned Property cash flow and maintenance escrow funds. The 1997 combined budget for improvement and replacement expense and capital expenditures for the Wholly Owned Properties is anticipated to be $4.5 million.
Lexford Acquisition
Effective August 1, 1996, the Company acquired Lexford, a privately held, third-party multi-family management company headquartered in Dallas, Texas (SEE NOTE 1 - BUSINESS - MANAGEMENT SERVICES OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS). The acquisition added approximately 22,000 apartment units to the Company's management portfolio which totals 55,397 units at December 31, 1996. Based on 1997 rankings by the National Multi Housing Council, Lexford has become the nation's ninth largest manager of multi-family real estate. The Company intends to maintain Lexford's Dallas office as headquarters for its combined property management business, which will be conducted under the Lexford name.
To acquire Lexford, the Company issued 700,000 shares of Common Stock valued, for acquisition purposes, at $20 per share representing a maximum purchase price of $14 million. Approximately $9 million of the purchase price (450,000 shares) is subject to forfeiture in the event the Company's combined property management operations do not achieve certain profitability criteria. Lexford shareholders received 250,000 shares of the Company's Common Stock free of contingencies. The remaining 450,000 contingent shares will cease to be subject to risk of forfeiture if and when specified increases in the profitability of the Company's property management operations are achieved during the three full fiscal years following the merger (i.e. on or before the end of the Company's 1999 fiscal year). If, during the specified period, profit from property management operations increases $1.8 million or more from 1995 levels, the former Lexford shareholders would own 150,000 of the contingent shares free of contingencies, and if the increase is $4.0 million or more from 1995 levels, the former Lexford shareholders would own the entire 700,000 shares free of contingencies, or approximately 15.4% of the Company's shares outstanding as of December 31, 1996.
Selected pro forma, unaudited financial information relating to Lexford third party management operations for the years ended December 31, 1996 and 1995, is as follows:
Lexford Pro Forma Year Ended December 31, --------------------------------------------------
1996 1995 ---------------------- ------------------------
Fee Based Revenues......... $5,588,563 $4,685,735 ---------------------- ------------------------
Fee Based Expenses......... 4,781,933 4,027,520 Interest Expense........... 61,507 73,879 ---------------------- ------------------------ 4,843,440 4,101,399 ---------------------- ------------------------ Income Before Taxes........ 745,123 584,336 ---------------------- ------------------------
EBITDA..................... $806,630 $658,215 ======================= ========================
The acquisition of Lexford was accounted for as a purchase, with a portion of the purchase price, ($1.6 million), assigned to the value of the Lexford management contracts, and the balance ($3.9 million) assigned to the value of the "Lexford" name and goodwill (to the extent that the purchase price exceeds the fair market value of Lexford's net tangible assets). The portion of the purchase subject to forfeiture (450,000 shares or $9.0 million) will not be recorded until the shares become free of contingencies.
Financing and Debt Restructuring of the Properties
In 1996 the Company refinanced first mortgages on 125 Properties comprised of 35 Wholly Owned Properties (SEE NOTE 6 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) and 90 Syndicated Partnerships. The new mortgages on 98 Properties were financed through PaineWebber Incorporated ("PaineWebber"); the mortgages on 21 Properties were financed through First Union Capital Markets Group ("First Union"); the mortgages on five Properties were financed through Donaldson, Lufkin & Jenrette Securities Corporation; and the mortgage on one Property was financed with the Department of Housing and Urban Development ("HUD"). The new PaineWebber mortgages on the 26 Wholly Owned Properties have fixed interest rates of 8.8% with a 30 year principal amortization and a 10 year maturity, and the 72 Syndicated Partnerships have fixed interest rates from 8.8% to 9.0 % with a 25 year principal amortization schedule beginning in year four, and a 10 year maturity. The new First Union mortgages have fixed interest rates ranging from 8.0% to 9.1% with a 25 year principal amortization and a 10 year maturity. The other mortgages refinanced in 1996 have terms similar to the First Union mortgages. While the PaineWebber mortgages secured by the Wholly Owned Properties are cross collateralized and cross defaulted, all of the mortgage loans are without recourse to the Company.
Aggregate mortgage debt, and related interest on the 35 Wholly Owned Properties with a contractual balance of $46.8 million and a carrying value of $45.6 million was refinanced with mortgage debt having a carrying and contractual balance of $47.8 million. A fourth quarter extraordinary non cash charge of $1.6 million was triggered by the mortgage debt refinancing on certain Wholly Owned Properties. The charge occurred related to Properties that had a carrying value (recorded in 1992 under the "Fresh Start" accounting method upon confirmation of the bankruptcy plan of reorganization of the Company's predecessor) less than the unpaid contractual balance of the mortgage loan at such time. Generally Accepted Accounting Principles required the Company to record the charge upon refinancing the prior mortgage as the previous lender was repaid at the contractual balance. Additional extraordinary charges may occur in the future on Wholly Owned Properties with contractual mortgage debt in excess of the "Fresh Start" carrying value. The required annual debt service on the Wholly Owned Properties refinanced in 1996 decreased by approximately $300,000
with the Company investing $1.1 million, net of excess proceeds from refinancing certain Wholly Owned Properties. In addition, $1.2 million of cash flow secondary mortgages ("B Notes") on six Wholly Owned Properties were refinanced in 1996. The B Notes previously required 100% of the excess cash flow to be applied to the principal. In 1996 the excess cash flow applied to these B Notes amounted to approximately $98,000.
Aggregate mortgage debt, and related interest, on the 90 Syndicated Partnerships with a balance of $95.2 million was refinanced with mortgage debt totaling $101.7 million. The Company advanced $5.6 million to certain Syndicated Partnerships to facilitate the refinancing (debited to Interests in and Receivables from Syndicated Partnerships), but received excess proceeds of $5.0 million from the refinancing of other Syndicated Partnerships. The required annual debt service on the Syndicated Partnerships will decrease approximately $600,000 per year for the first three years. In addition, $3.9 million of B Notes on 21 Syndicated Partnerships were refinanced in 1996. In 1996, excess cash flow applied to these B Notes amounted to approximately $338,000. Although there can be no assurance, management anticipates that cash distributions to the Company will increase from these Syndicated Partnerships due to the lower debt service requirements and the elimination of the B Notes. Increased cash flow at the Syndicated Partnerships, if it occurs, may enhance recovery of Interests in and Receivables from Syndicated Partnerships, including Interest Income, to the Company in the future.
During 1996 the Company granted deeds in lieu of foreclosure to the mortgagees of three Wholly Owned Properties. No significant gain or loss was recognized on these transactions because the assets and the non recourse mortgages on each of these Wholly Owned Properties had been recorded in equal amounts.
In June 1995, the Company purchased mortgages amounting to $8.8 million in the aggregate, related to one Syndicated Partnership and four Wholly Owned Properties, financed with a $7.8 million note payable. As of June 30, 1996, the Company had obtained permanent non-recourse mortgages on these five Properties. The proceeds of the refinancing were applied to the Company's note payable.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- Not applicable.
ITEM 9.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------
(a) DIRECTORS
The Board of Directors ("Board") of the Company consists of nine members. The Company's Regulations classify the directors into three classes, with the directors in each class serving for three year terms and until their successors are elected. The terms of the directors listed below will expire at the 1997, 1998 and 1999 annual meetings of the Company's shareholders, respectively, as indicated below.
CLASS II DIRECTORS SERVING UNTIL THE 1997 ANNUAL MEETING
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
Joseph E. 64 1992 A corporate financial consultant, Mr. Madigan Madigan also is a Director of Cooker Restaurant Corp., Skyline Chili, Inc., VOCA Corporation and The Frank Gates Service Company. Mr. Madigan currently serves as Chairman of the Company's Board of Directors and served as Acting Chief Executive Officer of the Company from June 13, 1995 to December 1, 1995. Mr. Madigan was Executive Vice President, Chief Financial Officer and Director of Wendy's International, Inc. from 1980 through 1987. He was Treasurer and Vice President of Borden, Inc. between 1968 and 1980. Mr. Madigan is also a former Trustee of Excelsior Income Shares, Inc., a closed-end income fund, and NCC Funds, a Cleveland-based closed-end investment fund.
George J. 61 1992 President of Allstate Development Neilan Company, and has been involved in land acquisition and development in the Charleston, West Virginia area since 1982. He also maintains an intellectual property legal practice in South Charleston, West Virginia.
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
Glenn C. 39 1992 Senior Vice President of Brown, Gibbons, Pollack Lang & Company, L.P., an investment banking firm located in Cleveland, Ohio, since January 6, 1997. Mr. Pollack served as President of Zeus Advisors, Inc., a consulting firm located in Cleveland, Ohio, from November 1994 to December 1996. From September 1989 to October 1994, Mr. Pollack was Chief Executive Officer of A & W Foods, Inc., a regional food distributor. Mr. Pollack was a senior manager in the Corporate Strategies Group at the Cleveland Office of Price Waterhouse in 1988 and 1989, and served in a similar capacity from 1984 to 1988 with Siedmann & Associates, a Cleveland-based consulting firm.
CLASS III DIRECTORS SERVING UNTIL THE 1998 ANNUAL MEETING
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
John B. 39 1995 President and Chief Executive Officer of Bartling, Jr. the Company since December 1, 1995. From April 1993 until December 1995, Mr. Bartling was a Director in the Real Estate Products Group of CS First Boston, an investment banking firm. He was an executive officer of NHP, Inc., a company specializing in the development, ownership and management of real estate assets, from June 1987 to April 1993. In addition, Mr. Bartling served as Executive Vice President of NHP Real Estate Corp., NHP Capital Corp. and NHP Servicing Inc., wholly owned subsidiaries of NHP, Inc., from 1991 to April 1993.
George R. 69 1992 Chairman of the Board and past President Oberer, Sr. and CEO of Oberer Development Company since the early 1970s. He was President of the predecessor corporation, Oberer Construction Company, since 1953. Mr. Oberer is President and CEO of Gold Key Realty Company. Oberer Development Company and Gold Key Realty Company are engaged in real estate development and management, respectively.
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
Robert J. 61 1992 A central Ohio real estate developer, Weiler Mr. Weiler joined The Robert Weiler Company in 1957 and has been Chairman of the Board since 1987. A real estate consultant since 1970, Mr. Weiler also is a licensed real estate appraiser and a member of the Appraisal Institute, having served as President of the Ohio Chapter. He was a Director of the National and Ohio Association of Realtors and is a past President of the Columbus Board of Realtors. Formerly, he was a Director of Main Federal, Freedom Federal and Buckeye Federal Savings & Loan.
CLASS I DIRECTORS SERVING UNTIL THE 1999 ANNUAL MEETING
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
Robert V. 49 1992 President of RVG Management & Gothier, Sr. Development Company, a manager and developer of residential and commercial properties, since 1976 and general partner of Rostan Associates, a real estate holding company associated with RVG Management and Development Company, since 1986. Mr. Gothier also is a member of the Harrisburg Board of Realtors and the legislative board of the Pennsylvania Manufactured Home Association.
H. Jeffrey 42 1992 Partner in the law firm of Benesch, Schwartz Friedlander, Coplan & Aronoff LLP ("BFCA") since 1988 and Chairman of the firm's Bankruptcy and Commercial Department. Prior to joining BFCA, Mr. Schwartz was a law clerk to the Honorable William J. O'Neill, United States Bankruptcy Court for the Northern District of Ohio, from 1982 to 1983 and to the Honorable Joseph T. Molitoris, United States Bankruptcy Court for the Northern District of Ohio from 1980 to 1982. Mr. Schwartz is a faculty member of the Bankruptcy Litigation Institute, has written numerous articles on bankruptcy law and is the former Chairman of the Section of Bankruptcy and Commercial Law of the Cleveland Bar Association.
Has Served as Principal Occupation Name Age Director Since and Business Experience - ------------ -------- ---------------- ---------------------------------------
Gerald K. 60 1992 President of Craig Capital Co., a Wedren Washington, D.C.-based merger and acquisition firm, since 1973. Mr. Wedren has been Managing Partner of Tavern Real Estate Limited Partnership and Wedren Associates, which own and lease properties in the Washington and Baltimore area, since 1988. Mr. Wedren was President of G.E.W., Inc., an owner of fast food restaurants, from 1981 to 1988; was of counsel with the Columbus law firm of Brownfield, Bowen, Bally & Sturtz from 1973 to 1981; and was Acting Director of the Department of Commerce and Commissioner of Securities for the State of Ohio in 1971 and 1972. He is a Director of Marwed Corporation and Tavern Realty Co.
(b) EXECUTIVE OFFICERS
In addition to John B. Bartling, Jr., Chief Executive Officer and President and a director of the Company, listed below are the executive officers of the Company as of March 28, 1997. Each executive officer will serve until his or her successor is selected by the Board or until his or her earlier resignation or removal. There are no family relationships among these officers.
Principal Occupation During the Name Age Past Five or More Years - ----------------------- ---------- ------------------------------------------
Mark D. Thompson 39 Chief Financial Officer and Executive Vice President of the Company since October 31, 1996. Prior to that time, Mr. Thompson was Executive Vice President of Corporate Acquisitions of the Company since April 1, 1996. Mr. Thompson was a partner in the law firm of McDonald, Hopkins, Burke & Haber from January 1995 to such time. Prior to that time, Mr. Thompson was an associate and partner in the law firm of Benesch, Friedlander, Coplan & Aronoff LLP from January 1985 and October 1992, respectively.
Patrick M. Holder 49 Executive Vice President of the Company since December 20, 1996 and President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. Mr. Holder was President of Lexford Partners, a property management firm, from 1988 to July 31, 1996. Mr. Holder previously served as President of Brentwood Properties from 1987 to 1988.
Paul R. Selid 34 Senior Vice President of the Company since April 15, 1996. Prior to that time, Mr. Selid was Vice President of Acquisitions of NHP, Inc. since December 1994. Mr. Selid also served as Vice President of Asset Management & Underwriting of NHP, Inc. from September 1992 to December 1994. Mr. Selid previously served as Vice President of Finance of Hall Financial Group, Inc. from January 1990 to September 1992.
Principal Occupation During the Name Age Past Five or More Years - ----------------------- ---------- ------------------------------------------
Michele R. Souder 35 Vice President of the Company since January 16, 1996 and Chief Financial Officer of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since November 1, 1996. Prior to that time, Ms. Souder was Director of Audit of the Company since August 1993. From October 1992 to August 1993, she served as an Associate in the Turnaround and Crisis Management division of Jay Alix & Associates, a management consulting firm. She previously served in various positions as Portfolio Analyst, Product Manager and Manager of Asset Management of the Company, from July 1987 to October 1992.
Ronald P. Koegler 44 Vice President and Controller of the Company since December 20, 1996. Mr. Koegler served as Vice President and Treasurer of the Company from January 16, 1996 to December 20, 1996. Prior to that time, Mr. Koegler was Controller of the Company since April 1992. He served as Assistant Controller of the Company from October 1989 to April 1992. Mr. Koegler holds a B.S.B.A. degree in accounting from The Ohio State University, where he graduated Summa Cum Laude.
Michael F. Sosh 35 Vice President and Treasurer of the Company since January 9, 1997. Prior to that time, Mr. Sosh served as Divisional Vice President and Assistant Treasurer of The Bon-Ton Stores, Inc. since March 1995. He previously served as Manager of Financial Planning and Financial Analyst of The Bon- Ton Stores, Inc. from 1987 to 1995. Mr. Sosh was a banking officer with Meridian Bancorp, Inc. from 1983 to 1987.
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
Section 16(a) of the Exchange Act requires the Company's officers and directors, and persons who own more than 10% of the Company's Common Stock, to file initial statements of beneficial ownership (Form 3), and statements of changes in beneficial ownership (Forms 4 or 5) of Common Stock of the Company with the Securities and Exchange Commission (the "SEC"). Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish the Company with copies of all such forms they file.
To the Company's knowledge, based on its review of the copies of such forms received by it, or written representations from certain reporting persons that no additional forms were required for those persons, the Company believes that during the previous fiscal year, all filing requirements applicable to its officers, directors, and greater than 10% beneficial owners were complied with.
(c) CERTAIN SIGNIFICANT EMPLOYEES
In addition to the executive officers named above, listed below are certain officers of the Company and its wholly owned subsidiary, Lexford Properties, Inc., as of March 28, 1997. Each officer will serve until his or her successor is selected by the Board or until his or her earlier resignation or removal. There are no family relationships among these officers.
Principal Occupation During the Name Age Past Five or More Years - ----------------------- ---------- ------------------------------------------
Annette Hoover 68 Vice President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. From 1988 to August 1996, Ms. Hoover was Vice President of Lexford Partners, a property management firm.
Bruce P. Woodward 45 Vice President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. From 1988 to August 1996, Mr. Woodward was Vice President of Lexford Partners, a property management firm.
James D. Alexander 47 Vice President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. From February 1992 to August 1996, Mr. Alexander was Vice President of Lexford Partners, a property management firm. From May 1988 to February 1992, Mr. Alexander served as Executive Vice President and Director of Portfolio Management at Southwest Savings Bank, where he handled asset management and marketing services for the bank's $3 billion real estate portfolio.
Peggy C. Smith 45 Vice President of the Company since December 20, 1996 and Vice President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. From 1988 to August 1996, Ms. Smith was Vice President of Lexford Partners, a property management firm.
Thomas Trubiana 45 Vice President of Lexford Properties, Inc., a wholly owned subsidiary of the Company, since August 1, 1996. Mr. Trubiana served as Vice President of the Company from 1988 to 1996. Prior to joining the Company, Mr. Trubiana was Regional Manager and Director of Development with Allen & O'Hara, Inc., a real estate development and management firm, from 1982 to 1987.
Dain C. Akin 44 Vice President and Acting General Counsel of the Company since March 18, 1996. From February 1992 to March 1996, Mr. Akin served as Director of Tax of the Company.
Jeffrey D. Meyer 31 Secretary and Associate General Counsel of the Company since February 26, 1996. Mr. Meyer was an associate in the law firm of Benesch, Friedlander, Coplan and Aronoff LLP from May 1992 to February 1996.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION ----------------------
(a) SUMMARY COMPENSATION TABLE
The following table sets forth the compensation earned by the Company's Chief Executive Officer during 1996 and the other four most highly compensated executive officers (and two additional individuals for whom disclosure would have been provided but for the fact such individuals were not serving as executive officers at the end of the last completed fiscal year) for services rendered in all capacities to the Company during 1996 as well as 1995 and 1994, where applicable.
(b) STOCK OPTIONS GRANTS TABLE
The following table sets forth the information noted for all grants of stock options to each of the executive officers named in the Summary Compensation Table during 1996:
(c) STOCK OPTIONS VALUE TABLE
The following table sets forth the fiscal year-end value of unexercised stock options for each of the executive officers named in the Summary Compensation Table for the 1996 fiscal year.
(d) LONG-TERM INCENTIVE PLANS TABLE
The following table sets forth the information noted for all long-term incentive plans awards granted to each of the executive officers named in the Summary Compensation Table during 1996:
(e) DIRECTOR COMPENSATION
Each director of the Company who is not an employee of the Company is paid an annual retainer fee of $15,000, plus (a) meeting fees of $1,000 for attendance at each meeting of the Board and (b) $750 for each committee meeting that occurs on a date when the full Board does not meet. Pursuant to the Company's 1992 Incentive Equity Plan, as amended (the "Incentive Equity Plan"), each member of the Board who was not employed by the Company was granted, at the commencement of the director's term, a stock option to purchase shares of the Company's Common Stock representing 0.1875% of the Company's "Total Committed Equity", subject to certain vesting requirements (all of which have been satisfied), which was subsequently calculated to be an option to purchase 7,500 shares of the Company's Common Stock for each director. The foregoing stock options expire on September 19, 2002. "Total Committed Equity" is defined in the Incentive Equity Plan as the total number of shares of the Company's Common Stock (a) issued upon the allowance of claims (as defined in Section 101(5) of the Bankruptcy Code) pursuant to the Third Amended Plan of Reorganization of the Company and its substantively consolidated subsidiaries (the "Plan of Reorganization") that was confirmed by the United States Bankruptcy Court for the Southern District of Ohio, Eastern Division (the "Bankruptcy Court") on August 26, 1992 and became effective on September 11, 1992 (the "Effective Date") and (b) issued or reserved for issuance under the Incentive Equity Plan as of September 11, 1992. In addition, each director was granted on November 30, 1995 and May 23, 1996, and will be granted annually on the day after the Company's Annual Meeting of Shareholders, so long as each director remains a director of the Company, an option to purchase 2,000 shares of the Company's Common Stock with an exercise price equal to the fair market value on the date of the grant a ten year term from date of grant and a vesting period of the lesser of one year or the period from the date of the grant to the next annual meeting of shareholders.
At the Company's annual shareholders meeting held on May 22, 1996, the shareholders approved the Company's Non-Employee Director Restricted Stock Plan (the "Directors Restricted Stock Plan"). Under the terms of the Directors Restricted Stock Plan, each non-employee director of the Company may elect to receive shares of the Company's Common Stock in lieu of cash directors fees otherwise payable to him. The Company has reserved 50,000 shares for issuance under the Directors Restricted Stock Plan and is also authorized to purchase shares of the Company's Common Stock on the open market or in private transactions in order to provide for the payment of shares of Common Stock to non-employee directors under the Directors Restricted Stock Plan. Each non-employee director who participates in the Directors Restricted Stock Plan receives shares of restricted Common Stock in lieu of cash compensation with the shares paid to such director being valued at a 20% discount from their fair
market value on the date of payment. Shares of restricted Common Stock issued or paid to directors under the Directors Restricted Stock Plan have a restriction period of 3 years. The director may not sell, exchange, transfer, pledge, hypothecate, assign or otherwise dispose of the shares during the restriction period, except by bequest pursuant to a will or by intestacy. All restrictions will lapse and the holder of the restricted Common Stock will be entitled to receipt of the shares following the earliest of (a) 3 years from the date of the issuance or payment of the restricted Common Stock to the holder; (b) the date of the holder's death or disability; (c) the date the holder, after being nominated by the Board, is not elected by the shareholders in an election for the Board; or (d) the date on which the Board determines that the holder will not be nominated for election to the Board. Shares of the restricted Common Stock will be forfeited to the Company in the event that, during the restriction period, the holder (a) resigns (other than by reason of disability) or is dismissed for cause from the Board during his elected term as a director; (b) declines to stand for an election to the Board after having been nominated by the Board; or (c) sells, exchanges, transfers, pledges, hypothecates, assigns or otherwise attempts to dispose of shares of restricted Common Stock except by bequest pursuant to a will or intestacy. As of the end of the Company's 1996 fiscal year, each non- employee director had elected to participate in the Directors Restricted Stock Plan by electing to receive shares of restricted Common Stock in lieu of a percentage of directors fees otherwise payable in cash, such elective percentages ranging from 25% to 100% of directors fees.
(f) EMPLOYMENT AGREEMENTS AND TERMINATION OF EMPLOYMENT
John B. Bartling, Jr. Employment Agreement ------------------------------------------
The Company and Mr. Bartling entered into an employment agreement, dated as of December 1, 1995 (the "Bartling Employment Agreement") for an original term through December 31, 1998 and an annual base salary of $285,000 ("Bartling's Base Salary"), plus an annual cash bonus of 2% of Bartling's Base Salary for each 1% increase in the Company's recurring earnings before interest (other than interest paid on mortgage loans secured by the Company's Wholly Owned Properties), taxes, depreciation and amortization determined in accordance with generally accepted accounting principles without regard to extraordinary gains or losses ("Adjusted EBITDA") from the previous fiscal year's Adjusted EBITDA, limited to 60% of Bartling's Base Salary.
Under the terms of the Bartling Employment Agreement, the Company granted Mr. Bartling (i) 22,500 shares of Restricted Stock (see footnote 3 of the Summary Compensation Table), (ii) the right to receive up to 20,000 deferred shares of Restricted Stock (see footnote 1 of the Long-Term Incentive Plans Table), (iii) one share of the Company's Common Stock, at no additional cost to him, for each share of the Company's Common Stock purchased by Mr. Bartling in 1996 up to a maximum of 10,000 shares (the "Bartling Matching Shares"), and (iv) options to purchase 20,000 shares of the Company's Common Stock (see footnote 1 of the Stock Options Grants Table).
The Bartling Employment Agreement was amended effective as of December 20, 1996 to provide that Mr. Bartling could elect to receive shares of the Company's Common Stock in lieu of his cash bonus earned in 1996. Shares of Common Stock made subject to such election would be valued at the December 31, 1996 closing price for the Company's Common Stock. Such amendment further provided that any such shares which Mr. Bartling might elect to receive in lieu of his cash bonus earned for 1996 would qualify for the grant of the 5,000 Bartling Matching Shares not yet awarded to Mr. Bartling as of such date. In March, 1997, Mr. Bartling elected to receive 6,940 shares in lieu of a portion of his 1996 cash bonus (see footnote 1 of the Summary Compensation Table). Accordingly, pursuant to Mr. Bartling's election, Mr. Bartling was entitled to receive the balance of the 5,000 Bartling Matching Shares not yet awarded to him as of such date.
Upon termination of Mr. Bartling's employment without cause, Mr. Bartling would be entitled to receive: (i) any of Bartling's Base Salary, and any other benefits due him under the Bartling Employment Agreement, payable for the remaining period of the original term or any extension thereof; (ii) the cash bonus, if any, applicable to the fiscal year in which such termination without cause occurs; and (iii) all of the shares of Restricted Stock, all shares of deferred Common Stock (whether or not any of the Market Capitalization targets are then met) and stock options, fully vested, and otherwise free of any forfeiture provisions or other restrictions imposed under the documents evidencing such awards, except for any restrictions or limitations imposed by applicable state and federal securities laws and regulations.
Furthermore, in the event the Company's Market Capitalization exceeds $150 million or there is a change in control of the Company, the vesting of all Restricted Stock and stock options awarded to Mr. Bartling will be accelerated.
The Bartling Employment Agreement and related Award Agreements were amended to permit Mr. Bartling to defer the receipt of all shares of the Company's Common Stock which would otherwise be payable to him under the terms of the
Bartling Employment Agreement and the related Award Agreements. Pursuant to these amendments made in conjunction with the adoption of the Cardinal Realty Services, Inc. Executive Deferred Compensation Plan, all such shares of Common Stock have been or will be issued for the benefit of Mr. Bartling to The Provident Bank as Trustee (the "Trustee") of the Cardinal Realty Services, Inc. Executive Deferred Compensation Rabbi Trust.
The Bartling Employment Agreement has been further amended effective as of January 1, 1997 to increase Mr. Bartling's base salary to $340,000; $298,750 of which is payable in cash and the balance is payable in the form of 2,000 shares of the Company's Common Stock (valued at $20.625 per share, being the closing price of the Company's Common Stock on December 31, 1996) issuable to the Trustee for Mr. Bartling's benefit.
Mark D. Thompson Employment Agreement -------------------------------------
The Company and Mr. Thompson entered into an employment agreement, dated as of April 1, 1996 (the "Thompson Employment Agreement") for an original term through April 14, 1997 and an annual base salary of $175,000 ("Thompson's Base Salary"), plus bonuses under the Company's Incentive Compensation Plan for its 1996 fiscal year, under which Mr. Thompson will receive a cash bonus of up to 60% of Thompson's Base Salary based on incremental increases in the Company's Adjusted EBITDA from the previous fiscal year's Adjusted EBITDA.
Under the terms of the Thompson Employment Agreement and the Incentive Equity Plan, the Company granted Mr. Thompson 7,500 shares of Restricted Stock (see footnote 11 of the Summary Compensation Table), (ii) the right to receive up to 9,000 deferred shares of Restricted Stock (see footnote 2 of the Long-Term Incentive Plans Table), (iii) one share of the Company's Common Stock, at no additional cost to him, for each share of the Company's Common Stock purchased by Mr. Thompson in 1996 up to a maximum of 5,000 shares (the "Thompson Matching Shares"), and (iv) options to purchase 12,500 shares of the Company's Common Stock (see footnote 2 of the Stock Options Grants Table).
The Thompson Employment Agreement was amended effective as of December 20, 1996 to provide that Mr. Thompson could elect to receive shares of the Company's Common Stock in lieu of his cash bonus earned in 1996. Shares of Common Stock made subject to such election would be valued at the December 31, 1996 closing price for the Company's Common Stock. Such amendment further provided that any such shares which Mr. Thompson might elect to receive in lieu of his cash bonus earned for 1996 would qualify for the grant of the 2,500 Thompson Matching Shares not yet awarded to Mr. Thompson as of such date. In March, 1997, Mr. Thompson elected to receive 3,772 shares in lieu of a portion of his 1996 cash bonus (see footnote 8 of the Summary Compensation Table). Accordingly, pursuant to Mr. Thompson's election, Mr. Thompson was entitled to receive the balance of the 2,500 Thompson Matching Shares not yet awarded to him as of such date.
Upon termination of Mr. Thompson's employment without cause, Mr. Thompson would be entitled to receive: (i) any of Thompson's Base Salary, and any other benefits due him under the Thompson Employment Agreement, payable for the remaining period of the original term, if any, plus the immediately succeeding nine months; (ii) a prorated portion of the cash bonus, if any, applicable to the fiscal year in which such termination without cause occurs; and (iii) all of the shares of Restricted Stock (other than those shares of Restricted Stock based on Market Capitalization which have not theretofore vested) and stock options, fully vested, and otherwise free of any forfeiture provisions or other restrictions imposed under the documents evidencing such awards, except for any restrictions or limitations imposed by applicable state and federal securities laws and regulations.
Furthermore, in the event the Company's Market Capitalization exceeds $150 million or there is a change in control of the Company, the vesting of all Restricted Stock and stock options awarded to Mr. Thompson will be accelerated.
The Thompson Employment Agreement and related Award Agreements were amended to permit Mr. Thompson to defer the receipt of all shares of the Company's Common Stock which would otherwise be payable to him under the terms of the Thompson Employment Agreement and the related Award Agreements. Pursuant to these amendments made in conjunction with the adoption of the Cardinal Realty Services, Inc. Executive Deferred Compensation Plan, all such shares of Common Stock have been or will be issued for the benefit of Mr. Thompson to The Provident Bank as Trustee (the "Trustee") of the Cardinal Realty Services, Inc. Executive Deferred Compensation Rabbi Trust.
The Thompson Employment Agreement has been further amended effective as of January 1, 1997 to increase Mr. Thompson's base salary to $230,000, of which $200,000 is payable in cash and the balance is payable in the form of 1,455 shares of the Company's Common Stock (valued at $20.625 per share, being the closing price of the Company's Common Stock on December 31, 1996) issuable to the Trustee for Mr. Thompson's benefit.
Paul R. Selid Employment Agreement ----------------------------------
The Company and Mr. Selid entered into an employment agreement, dated as of April 15, 1996 (the "Selid Employment Agreement") for an original term through April 14, 1997 and an annual base salary of $125,000 ("Selid's Base Salary"), plus bonuses under the Company's Incentive Compensation Plan for its 1996 fiscal year, under which Mr. Selid will receive a cash bonus of up to 60% of Selid's Base Salary based on incremental increases in the Company's return on investment percentage ("ROI") from the previous fiscal year's ROI.
Under the terms of the Selid Employment Agreement and the Incentive Equity Plan, the Company granted Mr. Selid (i) the right to receive up to 9,000 deferred shares of Restricted Stock (see footnote 2 of the Long-Term Incentive Plans Table), (ii) one share of the Company's Common Stock, at no additional cost to him, for each share of the Company's Common Stock purchased by Mr. Selid in 1996 up to a maximum of 2,500 shares (the "Selid Matching Shares"), and (iii) options to purchase 12,500 shares of the Company's Common Stock (see footnote 3 of the Stock Options Grants Table).
The Selid Employment Agreement was amended effective as of December 20, 1996 to provide that Mr. Selid could elect to receive shares of the Company's Common Stock in lieu of his cash bonus earned in 1996. Shares of Common Stock made subject to such election would be valued at the December 31, 1996 closing price for the Company's Common Stock. Such amendment further provided that any such shares which Mr. Selid might elect to receive in lieu of his cash bonus earned for 1996 would qualify for the grant of the 1,250 Selid Matching Shares not yet awarded to Mr. Selid as of such date. In March, 1997, Mr. Selid elected to receive 2,304 shares in lieu of a portion of his 1996 cash bonus (see footnote 15 of the Summary Compensation Table). Accordingly, pursuant to Mr. Selid's election, Mr. Selid was entitled to receive the balance of the 1,250 Selid Matching Shares not yet awarded to him as of such date.
Upon termination of Mr. Selid's employment without cause, Mr. Selid would be entitled to receive: (i) any of Selid's Base Salary, and any other benefits due him under the Selid Employment Agreement, payable for the remaining period of the original term, if any, plus the immediately succeeding nine months; (ii) a prorated portion of the cash bonus, if any, applicable to the fiscal year in which such termination without cause occurs; and (iii) all of the stock options, fully vested, and otherwise free of any forfeiture provisions or other restrictions imposed under the documents evidencing such awards, except for any restrictions or limitations imposed by applicable state and federal securities laws and regulations.
Furthermore, in the event the Company's Market Capitalization exceeds $150 million or there is a change in control of the Company, the vesting of all Restricted Stock and stock options awarded to Mr. Selid will be accelerated.
The Selid Employment Agreement and related Award Agreements were amended to permit Mr. Selid to defer the receipt of all shares of the Company's Common Stock which would otherwise be payable to him under the terms of the Selid Employment Agreement and the related Award Agreements. Pursuant to these amendments made in conjunction with the adoption of the Cardinal Realty Services, Inc. Executive Deferred Compensation Plan, all such shares of Common Stock have been or will be issued for the benefit of Mr. Selid to The Provident Bank as Trustee of the Cardinal Realty Services, Inc. Executive Deferred Compensation Rabbi Trust.
Termination of Employment of Certain Executive Officers -------------------------------------------------------
Michael F. Carbone resigned as Vice President and Chief Financial Officer of the Company effective as of January 16, 1996 and entered into a Severance Agreement and Mutual Release (the "Carbone Severance Agreement") and a consulting agreement (the "Carbone Consulting Agreement") each dated as of January 16, 1996. The Carbone Severance Agreement provided that Mr. Carbone would receive (i) regular payments of base annual compensation through December
31, 1996; (ii) a cash bonus equal to 50% of his annual base salary (being a cash payment of $102,952.50); and (iii) an additional cash bonus in the amount of $325,000 in compromise of any and all disputes regarding cash bonuses earned or to be earned for fiscal years 1995 and 1996. In addition, in consideration of Mr. Carbone's release of any and all claims against the Company, his irrevocable proxy and covenants of confidentiality and cooperation, Mr. Carbone received a cash payment of $102,952.50 and a tax loan to cover his income tax obligations incurred as a result of the exercise of his stock options. The Carbone Consulting Agreement provides that Mr. Carbone will provide financial and business consulting services as requested by the Company for up to 12 hours per month during the one year period beginning June 1, 1996 and in consideration therefor, Mr. Carbone received a payment in the amount of $150,000. The Carbone Consulting Agreement also provides that Mr. Carbone will be entitled to an incentive fee (at market rates to be agreed upon between the Company and Mr. Carbone) in consideration for any financings obtained by the Company from financing sources solicited by Mr. Carbone on the Company's behalf; provided that the financings are completed within one year following the completion of the term of consulting services. In consideration of the Carbone Consulting and Carbone Severance Agreements, Mr. Carbone granted the Company's nominees an irrevocable proxy for the voting of all shares of the Company's Common Stock held by him over a specified period of time ending not later than July 1, 1999, or if later, the date of final adjournment of the Company's 1999 annual shareholders meeting.
David P. Blackmore resigned as Chief Financial Officer and Executive Vice President of the Company effective October 31, 1996 and entered into a Severance Agreement and Mutual Release (the "Blackmore Severance Agreement") and a Consulting Agreement (the "Blackmore Consulting Agreement") with the Company each dated as of September 4, 1996. The Blackmore Severance Agreement provided that Mr. Blackmore would receive (i) a payment in the amount of $112,500 payable over nine months representing a bonus for Mr. Blackmore's prior services as an executive officer of the Company, (ii) 83 1/3% of the cash bonus and stock bonus he would otherwise have been entitled to receive pursuant to the Company's 1996 Incentive Compensation Plan (which, based upon the Company's fiscal year 1996 results amounted to $37,338 in cash and 2,263 shares of Common Stock valued at $20.625 per share), (iii) an award of an additional 2,000 shares of Common Stock issued in conjunction with the payment of the cash bonus and stock bonus and (iv) executive outplacement services and certain other benefits. The Blackmore Consulting Agreement provided that Mr. Blackmore would receive the sum of $50,000 either in a lump sum or payable over nine months, which amount is being paid over nine months. In consideration of the Blackmore Severance and Blackmore Consulting Agreements, Mr. Blackmore granted the Company's nominees an irrevocable proxy for the voting of all shares of the Company's Common Stock held by him over a specified period of time ending not later than July 1, 1999, or if later, the date of final adjournment of the Company's 1999 annual shareholders meeting. The Company also agreed to provide Mr. Blackmore with a tax loan to cover his tax obligations incurred as a result of the exercise of his stock options.
The Company currently maintains a policy of providing its executive officers with nine months of their base salary in the event of a termination of their employment without cause.
(g) COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
The following Report of the Compensation Committee and the Performance Graph included in this Form 10-K shall not be deemed to be incorporated by reference by any general statement incorporating by reference this Form 10-K into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent the Company specifically incorporates this Report or the Performance Graph by reference therein, and shall not be deemed soliciting material or otherwise deemed filed under either of such Acts.
The Compensation Committee administers the Company's various compensation plans and reviews and recommends to the Board of Directors compensation levels for executive officers, evaluates executive management's performance and considers executive management succession and related matters. The Compensation Committee is composed exclusively of independent, non-employee directors.
Philosophy of Compensation Committee
The Compensation Committee believes that executive compensation should reflect the value created for the Company's shareholders while supporting the Company's long-term strategic goals. It is the belief of the Compensation Committee that executive compensation should serve to:
o reward individuals for significant contribution to the Company's success; o align the interests of executives with those of the Company's long-term investors; o retain, motivate and attract qualified executives; and o provide incentives to executives to achieve strategic objectives in a manner consistent with the Company's values.
Executive Officer Compensation
Individual executive officer compensation consists of three components: base salary, annual cash and stock incentive bonuses and long-term equity incentives. Each component will be discussed below.
In 1996, the Company through the efforts of its Chief Executive Officer and the Compensation Committee, retained an entirely new group of executive officers, some of whom were newly hired by the Company and others of whom received promotions based upon their prior superior performance in non-executive officer positions with the Company. In 1996, the Company also accepted the resignations of, and negotiated severance agreements with, all former executive officers (other than its Chief Executive Officer whose term of employment commenced only on December 1, 1995). In addition, in 1996 the Company acquired Lexford Properties which now, as the Company's wholly owned subsidiary, performs all of the Company's fee based property management services. An integral part of the negotiation of the Company's acquisition of Lexford Properties was the structuring negotiation and documentation of terms of employment between Lexford Properties, Inc. and the former equity owners of Lexford Properties engaged in the active management of that entity, including, without limitation, Patrick M. Holder who is now an executive officer of the Company. In determining the annual salaries of each new executive officer and significant employee retained or promoted during 1996, the Compensation Committee retained a nationally recognized executive compensation and benefits consultant in order to obtain and benefit from its advice and assistance concerning appropriate levels of executive compensation and information regarding compensation trends and levels of compensation paid by comparable companies participating in the multi-family residential real estate industry generally. The Compensation Committee met several times in 1996 and thoroughly deliberated the complete compensation packages payable to each such newly retained or promoted executive officer and significant employee.
Salaries for executive officers are reviewed by the Compensation Committee on an annual basis and may be increased based on (a) individual performance and contribution and (b) increases in competitive pay levels.
The Compensation Committee believes that the compensation packages agreed to with its executive officers and other significant employees genuinely preserves its philosophical objectives by placing significant emphasis on the latter two components of the Compensation Committee's stated compensation components, namely, annual cash and stock incentive bonus and long term equity incentives. In this regard, the Company's compensation arrangements are weighted heavily towards incentive bonuses based upon the Company's financial performance measured in terms of its earnings before interest, taxes, depreciation, and amortization without regard to extraordinary gains or losses ("Adjusted EBITDA") and awards of restricted stock which will vest on the basis of growth in the Company's market capitalization. It should be noted that the Compensation Committee, in consultation with the full Board, the Company's Chief Executive and Financial Officers and industry analysts, continued to refine the best measure of the Company's growth in financial results from period to period during 1996. The Company announced the results of these deliberations in its Form 10-Q for the nine months ended September 30, 1996 by stating that Adjusted EBITDA represented, in the Company's view, the best measure of recurring financial performance from period to period. These analyses and definitive results represented in the opinion of the Compensation Committee, the full Board and Company's management, a definitive departure from emphasizing non-recurring gains and income from the sale of non-core assets thereby re-defining the Company as a growth company with the goal of expanding its business, operations, revenues, assets and profits. In addition, in 1996, the Compensation Committee continued its expanding emphasis on stressing compensation of management in the
form of management's equity ownership in the Company as the best means of aligning the long-term goals of management with the long-terms goals of the Company's shareholders. A significant portion of management's compensation takes the form of equity ownership in the Company. In this way, the Compensation Committee believes that Mr. Bartling's Chief Executive Officer compensation package and the compensation packages of the Company's other executive officers implements its goal of aligning his interests with those of the Company's long-term investors.
The Compensation Committee has confirmed that all base salaries for the Company's executive officers, including Mr. Bartling's base compensation, are reasonable and competitive, based upon the surveys compiled by management, as well as the advice and consultation of the representatives of the consulting firm.
Management Incentive Plan
Annual bonuses for the executive officers on account of the Company's 1996 fiscal year were governed by the Company's 1996 Incentive Compensation Plan (the "Incentive Compensation Plan"), which was specifically designed to link executive compensation to the Company's achieving certain operating goals and exceeding certain projected increases in specific financial measures applicable to the specific role in which each executive officer (and each other employee of the Company participating in the Incentive Compensation Plan) is engaged. The financial measures include Adjusted EBIDTA for the Company's Chief Executive Officer and senior financial and legal officers, net income from property management for the Company's property management employees, and return on equity for the Company's Investment Management division employees (i.e., those employees committed to maximizing the Company's return on its investments in real property assets). Under the terms of the Incentive Compensation Plan, upon achieving increases in the designated financial performance measure when compared to the Company's 1995 results, the executive officers and other participating employees are entitled to certain cash and stock awards.
As discussed above and disclosed elsewhere in this Form 10-K, a significant part of Mr. Bartling's compensation package includes the award of the aggregate of 42,500 shares of restricted stock which will vest in part based upon Mr. Bartling's continued employment and in part upon increases in the Company's market capitalization as well as the award of stock options and matching stock. These awards were provided for in Mr. Bartling's Employment Agreement, which became effective on December 1, 1995, while the shares of restricted stock as well as the stock option award were issued on April 5, 1996. Similar awards, albeit in lesser amounts, were granted to the Company's new Executive Vice President and Chief Financial Officer and Senior Vice President when such executive officers were retained in April 1996.
Deductibility
The Company intends, to the extent practicable, to preserve the deductibility under the Internal Revenue Code of compensation paid to its executive officers, while maintaining compensation programs that will attract and retain its executives in a competitive environment; provided, that, in light of the Company's ability to offset current income taxes through the utilization of net operating loss carry forwards and passive activity loss carry forwards, the Compensation Committee will consider facilitating executives' ability to defer taxable incentive compensation (thereby also deferring, but not reducing, the Company's deductibility of such items). In keeping with this philosophy to provide for maximizing compensation payable in the form of the Company's Common Stock, as well as to provide its executives with the ability to defer taxable incentive compensation, the Company adopted its Executive Deferred Compensation Plan and Executive Deferred Compensation Rabbi Trust in 1996. Pursuant to the Executive Deferred Compensation Plan, the Company's highly compensated executive officers can elect to direct the Company to issue any shares of the Company's Common Stock to The Provident Bank, as Trustee under the Executive Deferred Compensation Rabbi Trust, rather than directly to the employee otherwise entitled to receive the shares of Common Stock, thereby deferring the recognition of taxable income for federal income tax purposes. The Company believes that, for the foreseeable future, this practice will not otherwise result in increased income tax liability to the Company due to the availability of net operating and passive activity loss carry forwards for federal income tax purposes.
Conclusion
In conclusion, the Compensation Committee will enable the Company to retain highly qualified executive management and motivate its officers with respect to the attainment of important goals and objectives. The Compensation Committee believes the focus on Common Stock ownership by the executive officers and other long-term stock programs has aligned and will continue to align the interests of management with the interests of shareholders of the Company. The Compensation Committee further believes that its continuing efforts to refine the best measures of the Company's long-term growth and improving financial results are reflected in the terms of the 1996 Incentive Compensation Plan and will continue to be reflected in future management incentive programs.
The Compensation Committee of the Board of Directors
Glenn C. Pollack, Chairman George R. Oberer, Sr. Gerald E. Wedren
(h) PERFORMANCE GRAPH
The graph below compares the cumulative total shareholder return on the Company's Common Stock, to that of the Dow Jones Real Estate Investment Index and the Dow Jones Market Index. In calculating cumulative total shareholder return, reinvestment of dividends is assumed. This graph is shown for the four full fiscal years in which the Company's Common Stock (Nasdaq: CRSI) has been registered under the Securities Exchange Act of 1934, as amended. [GRAPHIC OMITTED]
VALUE OF $100 INVESTED AT 12/31/92 - -------------------------------------------------------------------------------- | 12/31/92 | 12/31/93 | 12/31/94 | 12/31/95 | 12/31/96 - ----------------------|----------|----------|-----------|------------|---------- CRSI Market Value | 100 | 250 | 350 | 583 | 687 - ----------------------|----------|----------|-----------|------------|---------- Dow Jones Real Estate | 100 | 112 | 103 | 121 | 150 - ----------------------|----------|----------|-----------|------------|---------- Dow Jones Equity Mkt | 100 | 107 | 104 | 139 | 167 - --------------------------------------------------------------------------------
ITEM 12:

ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT --------------------------------------------------------------
SECURITY OWNERSHIP OF CERTAIN PERSONS
On March 26, 1997, the Company had outstanding 4,445,531 shares of Common Stock. The following table sets forth the information as of March 26, 1997 regarding Common Stock owned beneficially by (a) each person known by the Company to own beneficially more than 5% of the Company's outstanding Common Stock, (b) each director of the Company and executive officer named in the Summary Compensation table above and (c) all present executive officers and directors of the Company as a group.
ITEM 13:

ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ----------------------------------------------
Joseph E. Madigan, Chairman of the Company's Board of Directors, received a retainer in 1996 of $4,000 per month (which amount was increased in December 1996 to $5,000 per month). Mr. Madigan also received in December 1996, and will receive annually during his tenure as chairman, an award of 2,000 shares of restricted Common Stock, one-third of which shares vest annually over a three year period.
H. Jeffrey Schwartz, director of the Company, is a partner in the law firm of Benesch, Friedlander, Coplan & Aronoff LLP, which serves as outside legal counsel to the Company.
Robert J. Weiler, a director of the Company, is a principal of Americana Investment Company, the lessor of the building housing the Company's principal executive offices. Mr. Weiler did not participate in the Company's decision to relocate to the headquarters or in the lease negotiations. Management believes that the lease terms for the Company's executive offices are competitive with commercial lease rates in the Columbus, Ohio market. The annual lease payments are as follows:
1997 (thru 10/31) $282,580 ($6.50/sq.ft.)
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K ---------------------------------------------------------------
(a) Documents filed as part of this report:
1. Financial Statements: The Audited Consolidated Balance Sheets of the Company and Subsidiaries as of December 31, 1996 and 1995, and the related Consolidated Statements of Income, Shareholders'
Equity and Cash Flows of the Company and Subsidiaries for the years ended December 31, 1996, 1995 and 1994.
2. Consolidated Financial Statement Schedules: (See the financial statement schedules listed on Index to Consolidated Financial Statement Schedules on Page of this report).
3. Exhibits:
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Financial Statements: The Audited Consolidated Balance Sheets of the Company and Subsidiaries as of December 31, 1996 and 1995, and the related Consolidated Statements of Income, Shareholders' Equity and Cash Flows of the Company and Subsidiaries for the years ended December 31, 1996, 1995 and 1994.
2. Consolidated Financial Statement Schedules: (See the financial statement schedules listed on Index to Consolidated Financial Statement Schedules on Page of this report).
3. Exhibits:
EXHIBIT INDEX
EXHIBIT SEQUENTIAL NO. DESCRIPTION PAGE
2.1 Third Amended Disclosure Incorporated by Statement Pursuant to reference to Exhibit Section 1125 of Bankruptcy 2.1 to the Code to Accompany Company's the Plan of Reorganization Registration Statement of Jay Alix, Chapter on Form 10 (the "Form 11 Trustee for Cardinal 10") Industries, Inc. and its Substantively Consolidated Subsidiaries and Third Amended Plan of Reorganization of Jay Alix, Chapter 11 Trustee, for Cardinal Industries, Inc. and its Substantively Consolidated Subsidiaries
2.2 Findings of Fact, Conclusions Incorporated by of Law and Order Confirming reference to Exhibit Third Amended Plan of 2.2 to the Form 10 Reorganization of Jay Alix, Chapter 11 Trustee, for Cardinal Industries, Inc. and its Substantively Consolidated Subsidiaries
3.1 Amended and Restated Articles Incorporated by of Incorporation filed reference to Exhibit September 11, 1992 with the 3.1 to the Form 10 Ohio Secretary of State of State
3.2 Certificate of Amendment to Incorporated by the Articles of reference to Exhibit Incorporation filed October 3.2 to the Form 10 27, 1992 with the Ohio Secretary of State
3.3 Certificate of Amendment to Incorporated by reference to Exhibit the Articles of 3.3 to the Company's Annual Report Incorporation filed January on Form 10-K for the fiscal year ended 9, 1996 with the Ohio December 31, 1995 Secretary of State (the "1995 Form 10-K")
3.4 Amended Code of Regulations Incorporated by reference to Exhibit 3.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (the "1993 Form 10-K")
4.1 Form of Common Stock Incorporated by reference to Exhibit Certificate 4.1 to Form 10
EXHIBIT SEQUENTIAL NO. DESCRIPTION PAGE
10.1 Loan and Security Agreement, Incorporated by dated as of August reference to Exhibit 11, 1995, between The 10.1 to the 1995 Form Provident Bank and the 10-K Company and certain of its subsidiaries
10.2 Cognovit Promissory Note Incorporated by dated August 11, 1995 reference to Exhibit in the amount of $22,000,000 10.2 to the 1995 Form issued by the 10-K Company and certain of its subsidiaries in favor of The Provident Bank.
10.3 Cognovit Promissory Note Incorporated by dated August 11, 1995 reference to Exhibit in the amount of $3,000,000 10.3 to the 1995 Form issued by the Company 10-K and certain of its subsidiaries in favor of The Provident Bank.
10.4 Cognovit Promissory Note Incorporated by dated August 11, 1995 reference to Exhibit in the amount of $7,000,000 10.4 to the 1995 Form issued by the Company 10-K and certain of its subsidiaries in favor of The Provident Bank.
10.5 Agreement for Modification Incorporated by of Management reference to Exhibit Agreement dated as of August 10.5 to the 1995 Form 11, 1995 among 10-K Cardinal Apartment Management Group, Inc., the Company and certain of its subsidiaries
10.6 Assignment of Management Incorporated by Contracts dated August reference to Exhibit 11, 1995 between Cardinal 10.6 to the 1995 Form Apartment Management 10-K Group, Inc. and The Provident Bank
10.7 Stock Pledge Agreement dated Incorporated by August 11, 1995 reference to Exhibit between Cardinal Realty 10.7 to the 1995 Form Services, Inc. and The 10-K Provident Bank
10.8 Stock Pledge Agreement dated Incorporated by August 11, 1995 reference to Exhibit between Cardinal Industries 10.8 to the 1995 Form of Texas, Inc. and The 10-K Provident Bank
10.9 Stock Pledge Agreement dated Incorporated by August 11, 1995 reference to Exhibit between Cardinal Industries 10.9 to the 1995 Form Development 10-K Corporation and The Provident Bank
10.10 Stock Pledge Agreement dated Incorporated by August 11, 1995 reference to Exhibit between Cardinal Realty 10.10 to the 1995 Company and The Form 10-K Provident Bank
10.11 Limited Power of Attorney Incorporated by dated August 11, 1995 reference to Exhibit by certain subsidiaries of 10.11 to the 1995 the Company to the Form 10-K Company
EXHIBIT SEQUENTIAL NO. DESCRIPTION PAGE
10.12 Limited Power of Attorney Incorporated by dated August 11, 1995 reference to Exhibit by the Company and certain 10.12 to the 1995 of its subsidiaries to Form 10-K The Provident Bank
10.13 Waiver Agreement dated Incorporated by August 11, 1995 among reference to Exhibit The Provident Bank and the 10.13 to the 1995 Company and certain Form 10-K of its subsidiaries
10.14 Post Closing Agreement dated Incorporated by as of August 11, reference to Exhibit 1995 among The Provident 10.14 to the 1995 Bank and the Company Form 10-K and certain of its subsidiaries
10.15 Form of Management Agreement Incorporated by between Cardinal reference to Exhibit Apartment Management Group, 10.10 to the Form 10 Inc. and certain Properties
10.16 Form of Management Agreement Incorporated by between Cardinal reference to Exhibit Apartment Management Group, 10.16 to the 1995 Inc. (which was Form 10-K merged with and into the Company) and certain of the Properties (as amended August 11, 1995)
10.17 Form of Partnership Asset Incorporated by Management Agreement reference to Exhibit between Cardinal Industries 10.11 to the Form 10 Services Corporation and certain Properties
10.18 Form of Extended Partnership Incorporated by Administration reference to Exhibit Agreement between Cardinal 10.12 to the Form 10 Industries, Inc. and certain Properties
10.19 Form of Agreement for Tax Incorporated by Appeal Services reference to Exhibit between the Company and 10.13 to the Form 10 certain Properties
10.20 Asset Purchase Agreement Incorporated by dated April 24, 1991, reference to Exhibit among Economy Lodging 10.14 to the Form 10 Systems, Inc., HMS Property Management Group, Inc., Cardinal Industries, Inc. and Cardinal Industries Services Corporation
10.21 Lease, dated September 24, Incorporated by 1992, between the reference to Exhibit Company and the Americana 10.15 to the Form 10 Investment Company
10.22 Term Lease Master Agreement Incorporated by and Term Lease reference to Exhibit Supplement, dated October 6, 10.16 to the Form 10 1992, between the Company and IBM Credit Corporation
10.23 Bankruptcy Court Orders, Incorporated by entered June 28, 1990 reference to Exhibit and July 27, 1990, approving 10.17 to the Form 10 Trustee's First Employee Retention Plan
10.24 Bankruptcy Court Order, Incorporated by entered April 3, 1992, reference to Exhibit approving Trustee's Second 10.18 to the Form 10 Employee Retention Plan
10.25 Description of Cash Bonus Incorporated by Plan of the Company reference to Exhibit 10.28 to the Form 10
10.26 1992 Incentive Equity Plan Incorporated by of the Company, as reference to Exhibit amended (effective November 10.26 to the 1995 30, 1995) Form 10-K
10.27 Tax Obligation Loan Program Incorporated by of the Company reference to Exhibit 10.30 to the Form 10
10.28 Form of Deferred Shares Incorporated by Agreement for Employees reference to Exhibit of the Company 10.31 to the Form 10
10.29 Form of Restricted Shares Incorporated by Agreement for Key reference to Exhibit Employees of the Company 10.32 to the Form 10
10.30 Form of Restricted Shares Incorporated by Agreement for Executive reference to Exhibit Officers of the Company 10.33 to the Form 10
10.31 Form of Non-Qualified Stock Incorporated by Option Agreement for reference to Exhibit Participants in Trustee's 10.33 to the Form 10 Employee Retention Plan
10.32 Form of Non-Qualified Stock Incorporated by Option Agreement for reference to Exhibit Non-Employee Directors 10.36 to the Form 10
10.33 Form of Indemnification Incorporated by Agreement between the reference to Exhibit Company and its officers and 10.37 to the Form 10 directors
10.34 Undeliverable Distributions Incorporated by Trust dated as of reference to Exhibit September 11, 1992, between 10.38 to the Form 10 The Company and James H. Bownas, Trustee
10.35 401(k) Plan of the Company Incorporated by reference to Exhibit 10.41 to the Form 10
10.36 Premium Finance Agreement Incorporated by dated September 12, reference to Exhibit 1995 between the Company and 10.36 to the 1995 Transamerica Form 10-K Insurance Finance Corporation
10.37 Premium Finance Agreement Incorporated by dated December 4, 1995 reference to Exhibit between the Company and 10.37 to the 1995 First Premium Form 10-K Services, Inc.
10.38 Employment Agreement dated Incorporated by as of December 1, reference to Exhibit 1995 between the Company and 10.38 to the 1995 John B. Bartling, Form 10-K Jr., President and Chief Executive Officer of the Company
10.39 Severance Agreement and Filed as an Exhibit Mutual Release dated as to this Form 10-K of September 4, 1996 between the Company and David P. Blackmore
10.40 Severance Agreement and Filed as an Exhibit Mutual Release dated as to this Form 10-K of January 16, 1996 between the Company and Michael F. Carbone
10.41 Assumption of Loan and Filed as an Exhibit Security Agreement dated to this Form 10-K as of February 26, 1997 between The Provident Bank and Lexford Properties, Inc.
11.1 Statement re: computation of See Index to per share earnings Financial Information - Note 1 in the Notes to Consolidated Financial Statements
21.1 Subsidiaries of The Company Filed as an Exhibit to the 1995 Form 10-K
27 Financial Data Schedule Filed as an Exhibit to this Form 10-K
99 Individual Property Filed as an Exhibit Financial Information to this Form 10-K Summary
SIGNATURES
Pursuant to requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
CARDINAL REALTY SERVICES, INC. (Registrant)
Date: March 28, 1997 By: /s/ John B. Bartling, Jr. ---------------------- John B. Bartling, Jr.,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
Signature Title Date - --------- ----- -----
/s/ Joseph E. Madigan Chairman of the Board March 28, 1997 - ----------------------------- Joseph E. Madigan
/s/ John B. Bartling, Jr. President, Chief Executive March 28, 1997 - ----------------------------- Officer and Director John B. Bartling, Jr.
/s/ Mark D. Thompson Executive Vice President and March 28, 1997 - ----------------------------- Chief Financial Officer Mark D. Thompson
/s/ Ronald P. Koegler Vice President and Controller March 28, 1997 - ----------------------------- Ronald P. Koegler
/s/ Robert V. Gothier, Sr. Director March 28, 1997 - ----------------------------- Robert V. Gothier, Sr.
/s/ George J. Neilan Director March 28, 1997 - ----------------------------- George J. Neilan
/s/ George R. Oberer, Sr. Director March 28, 1997 - ----------------------------- George R. Oberer, Sr.
/s/ Glenn C. Pollack Director March 28, 1997 - ----------------------------- Glenn C. Pollack
/s/ H. Jeffrey Schwartz Director March 28, 1997 - ----------------------------- H. Jeffrey Schwartz
/s/ Gerald E. Wedren Director March 28, 1997 - ----------------------------- Gerald E. Wedren
/s/ Robert J. Weiler Director March 28, 1997 - ----------------------------- Robert J. Weiler
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.
No annual report or proxy materials have been sent to the Registrant's shareholders. An annual report and proxy materials are expected to be distributed on or about May 15, 1997 to shareholders of record on or about May 13, 1997.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
Audited Financial Information - Cardinal Realty Services, Inc. and Subsidiaries
Report of Independent Auditors............................................F-2
Consolidated Balance Sheets at December 31, 1996 and 1995.................F-3
Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994 ....................................F-4
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 ........................F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 ..............................F-6 -
Notes to Consolidated Financial Statements.........................F-8 -
Consolidated Financial Statement Schedules:
Schedule II - Valuation and Qualifying Accounts.....................F-33
Schedule III - Real Estate and Accumulated Depreciation......F-34 -
All other schedules have been omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedules or because the information required is included in the consolidated financial statements or notes thereafter.
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors Cardinal Realty Services, Inc.
We have audited the accompanying consolidated balance sheets of Cardinal Realty Services, Inc. and subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedules listed in the accompanying index. These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules 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 consolidated financial position of Cardinal Realty Services, Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The Consolidated Financial Statements for 1994 have been restated to reflect the changes with respect to income taxes as described in Note 1.
/s/ ERNST & YOUNG LLP
Columbus, Ohio March 6, 1997
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
In 1995, the Company acquired four apartment properties primarily financed with $4,770,000 of first mortgages on the properties.
In June 1995, the Company purchased from a mortgage lender the non-recourse mortgages on one Syndicated Partnership and four Wholly Owned Properties. The mortgages totaled $8.8 million and were acquired for $7.8 million. The Company financed the acquisition with a $7.8 million note payable to the mortgage lender. The note was repaid in June 1996.
In 1996, the Company granted deeds in lieu of foreclosure to the mortgagee for three Wholly Owned Properties. The properties had an aggregate carrying value of $3.9 million. In 1995 and 1994 the Company granted deeds in lieu of foreclosure to the mortgagees for certain Wholly Owned Properties. The properties had an aggregate carrying value of $3.5 million and $3.6 million, respectively. No significant gain or loss was recognized on these transactions because the assets and the non-recourse mortgages on each of these Wholly Owned Properties had been recorded in equal amounts.
Effective August 1, 1996, the Company acquired Lexford Properties, Inc. through a merger with a wholly owned subsidiary of the Company. The Company issued 700,000 shares of its Common Stock (valued at $14,000,000) in consideration of the acquisition; however 450,000 of the shares issued (valued at $9,000,000) are subject to forfeiture, in whole or in part, if the Company's combined property management operations fail to achieve certain profitability criteria on or before the end of the Company's 1999 fiscal year.
In 1996, all interest incurred was expensed. In 1995 and 1994 the interest incurred on the Wholly Owned Properties was capitalized as the properties were Held for Sale, while interest on corporate term debt was expensed (Note 2).
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business --------
Cardinal Realty Services, Inc. and its subsidiaries (the "Company") principal business is the ownership and management of multifamily apartment properties. The Company is also involved in the acquisition and redevelopment of multifamily apartment properties. The Company holds an ownership interest in apartment communities either as (i) the sole owner of various limited partnerships or subsidiaries which own apartment communities (the "Wholly Owned Properties"), or (ii) the general partner in various limited partnerships which own apartment communities (the "Syndicated Partnerships"), collectively referred to as the "Properties". With respect to the Syndicated Partnerships, the Company retains a general partner interest ranging from 1.0% to 10.0%, but typically 9.0% to 10.0%. The limited partnership interests are substantially all owned by unrelated third party investors. The Company also has receivables, typically in the form of second mortgages, from the Syndicated Partnerships that generate a majority of the interest income recognized by the Company.
The majority of the Properties are located in the midwest and southeast United States, with the heaviest concentrations in Florida, Ohio, Georgia, Indiana, Michigan and Kentucky. The typical Property averages 65 rental units which are located in multiple single story buildings with studio, one and two bedroom apartments. All of the Properties have non-recourse first mortgage indebtedness which is owed to financial institutions. The Company is not dependent for its revenues on any particular property and the loss of any property would not be material to the Company's financial position. Geographic distribution of the Properties also minimizes the Company's exposure to local economic conditions.
The Company derives revenues from two core business activities: 1) management of multifamily residential real property, including provision of management services to owners of property in which the Company does not have an ownership interest ("Management Services"); and 2) activities related to the ownership of multifamily residential real property (including provision of asset management services to passive co-owners) ("Investment Management"). In December 1995, the Company restructured along these business lines. The restructuring was implemented, in part, to cause the Company and its management to focus attention on these two distinct, yet complementary, business activities.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Management Services -------------------
The Company's Management Services division is charged with the conduct of the Company's property management business. The Company's property management business involves all traditional elements of third party property management including: day-to-day management and maintenance of multi-family residential apartment properties, attracting and retaining qualified residents, collecting rents and other receivables from residents, providing cash management services for rental revenues, security deposits, taxes and insurance and deferred maintenance escrows, and compiling and furnishing information to property owners.
Effective August 1, 1996, the Company acquired Lexford Properties, Inc. ("Lexford") by merger of a wholly owned subsidiary of the Company with and into Lexford. On that date, Lexford became a wholly owned subsidiary of the Company. Lexford has been engaged in the business of third party property management services to the owners of multifamily residential real property since commencing business operations in June 1988. At the time the Company acquired Lexford, Lexford managed approximately 22,000 apartment units for third party owners. The Company currently intends that Lexford will continue to provide and expand its third party property management services as well as oversee the operation of the Company's Management Services division which managed approximately 34,000 units in 1996, including the Wholly Owned Properties. Accordingly, the Company's property management business will be conducted through its wholly owned subsidiary, Lexford Properties, Inc. Management believes that the acquisition of Lexford has enhanced the Company's property management capabilities and will facilitate the Company's ability to acquire, as well as service, additional multifamily residential properties in the future including properties not built by the Company. (SEE "LEXFORD ACQUISITION").
The Company's Management Services division also operates an adjunct business which the Company refers to as "Ancillary Services". The Company's Ancillary Services includes the sale of parts and supplies to both the Wholly Owned Properties and Syndicated Partnerships and also the leasing of furniture and sale of renters insurance to residents at the Properties. In June 1996, the Company announced realignments in its organization. As part of this restructure, the Company contracted to out source the parts and supply inventory previously handled internally by the Company's Ancillary Services function. The Company completed the transition to the out sourcing by the end of 1996. Thereafter, the Company's Ancillary Services department will continue to provide assistance to the Properties, in the acquisition of needed parts and supplies and the management of a coordinated buying group obtaining substantial volume discounts. In consideration of these services, the Company will generate income by retaining some portion of discounts earned.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Investment Management ---------------------
The objective of the Company's Investment Management division is to maximize the value of its real estate holdings and its returns on real estate investments. The Company performs these functions both with respect to the Wholly Owned Properties as well as the Syndicated Partnerships. The Company strives to obtain and maintain the best available financing for the Properties and to maximize the Properties' operating performance. The Company evaluates the performance of all real estate holdings to identify investment requirements, under-performing Properties or those that can be sold at an attractive price relative to their performance.
The Company's Investment Management division acting in the Company's capacity as general partner of the Syndicated Partnerships provides asset management services to the Syndicated Partnerships. In addition, the Company's Investment Management division performs the following services for the accounts of the co-owners (limited partners) of the Syndicated Partnerships: informational and financial reporting services (including tax return preparation and provision of tax return information to the limited partners) and capital and financial planning, (including determination of reserves, funding of capital requirements and administration of capital distributions to partners).
Fresh Start Accounting ----------------------
The Company adopted a method of accounting referred to as fresh start ("Fresh Start") reporting as of September 11, 1992 ("The Effective Date") as a result of the Company's judicial plan of reorganization (the "Plan of Reorganization"). The Company prepared financial statements on the basis that a new reporting entity was created with assets and liabilities recorded at their estimated fair values as of the Effective Date. At the Effective Date, to the extent the non-recourse debt on certain Wholly Owned assets exceeded the estimated fair value of the Wholly Owned Property, the Company reduced the contractual amount of the related non-recourse first mortgage debt by the amounts of the deficiency (the "Mortgage Deficiencies"). The contractual mortgage balance, net of any applicable Mortgage Deficiency, is referred to as the "Carrying Value" of the mortgage.
Non-Core Assets ---------------
The Company also has interests in motel properties, vacant land, single family homes, investor notes receivable and certain other assets (collectively the "Non-Core Assets"). The Company valued these Non- Core Assets, at the Effective Date, based on previous sales activity and independent appraisals. In 1994, the Company recovered the entire carrying value of the Non-Core Assets from the collection of receivables and proceeds from disposal. The Company began recognizing income, net of collection and closing costs, from the proceeds of disposal of these Non-Core Assets once the carrying value was fully recovered. As of December 31, 1996, the Company still has an ownership interest in certain Non-Core Assets that may have potential value.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Lexford Acquisition -------------------
Effective August 1, 1996 the Company acquired Lexford by way of a merger (the "Lexford Merger") of a wholly owned subsidiary of the Company with and into Lexford. The acquisition was accounted for as a purchase. The terms of the Lexford Merger provided that the Company would succeed to the ownership of all of the issued and outstanding stock of Lexford and the shareholders of Lexford would receive 700,000 shares of restricted, newly issued Common Stock. For purposes of the Lexford Merger, the Common Stock was valued at $20 per share. Approximately $9.0 million, or 450,000 shares, of the purchase price is subject to forfeiture in whole or in part in the event Lexford does not achieve certain profitability criteria by December 31, 1999. These shares are held in escrow pending release. At the time the shares subject to forfeiture are released without contingency, the Company will record the additional purchase price. The Lexford shareholders received 250,000 shares of Common Stock free of contingencies.
Use of Estimates ----------------
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Long-Lived Assets -- FASB Statement No. 121 -------------------------------------------
In March 1995, the Financial Accounting Standards Board ("FASB") issued Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, ("FASB 121") which requires impairment losses to be recorded on long-lived assets used in operations, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. FASB 121 became effective beginning fiscal year 1996. Management is not aware of any indicator that would result in any significant impairment loss.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Fair Value of Financial Instruments -----------------------------------
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments. The fair value of Cash and Funds Held in Escrow is equal to their respective carrying amounts. For Interests in and Receivables from Syndicated Partnerships the Company used the Fresh Start accounting methodology used at the Effective Date to estimate the value at December 31, 1996 and 1995, which value approximated $133.4 million and $107.6 million, respectively. Such methodology is generally based on estimates of the fair market value of the apartment communities owned by the Syndicated Partnerships, less related indebtedness. The Interests in and Receivables from Syndicated Partnerships substantially consist of second mortgage loans receivable, whose ultimate repayment is subject to a number of variables, including the performance and value of the underlying real estate property and the ultimate timing of repayments of the receivables. Considerable judgment is required in the interpretation of market data to develop estimates of fair value, accordingly, the estimates are not necessarily indicative of the amounts that could be realized or would be paid in a current market exchange. The effect of using different market assumptions and/or estimation methodologies may be material to the estimated fair value amounts (See Note 3).
The carrying value of the amounts comprising the Company's term debt and other notes payable as described in Notes 3 and 7 approximate their fair value.
As further described in Note 5, at December 31, 1996 the Company's mortgages on Wholly Owned Properties in the amount of $148.1 million had contractual balances totaling $157.4 million. Interest rates on the mortgages ranged from 7.0% to 10.0% with rates being fixed on approximately $144.2 million of the contractual balances. In addition, mortgages with a contractual and carrying value of $4.8 million had matured as of December 31, 1996 (See Note 5). Management believes that using the Company's incremental borrowing rate to estimate fair value of the mortgages is not appropriate and, because of excessive costs, considers estimates of fair value to otherwise be impracticable.
Principles of Consolidation ---------------------------
The consolidated financial statements include the accounts of Cardinal Realty Services, Inc. and its wholly owned subsidiaries, including Wholly Owned Properties. All significant intercompany balances and transactions (except for Fee Based Revenues and related expenses generated from Wholly Owned Properties in 1995 and 1994) have been eliminated in consolidation. Total Revenues from Wholly Owned Properties (during the period such properties were held for sale) amounted to $3.6 million and $3.4 million for the years ended December 31, 1995 and 1994, respectively. Any gross profit on such revenues has been eliminated in consolidation (See Note 2).
Reclassification ----------------
Certain reclassifications have been made in the Consolidated Financial Statements resulting from changes in classification of Wholly Owned Properties in 1996 previously Held for Sale or to provide comparable information in the Consolidated Statements of Income and Cash Flows. These reclassifications had no effect on shareholders' equity.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Restatement -----------
The net income previously reported in the 1994 Consolidated Statements of Income has been adjusted in order to comply with Statement of Position ("SOP") 90-7 "Reorganization Under the Bankruptcy Code" pertaining to accounting for deferred income taxes. SOP 90-7 requires that benefits realized from pre-confirmation net operating loss carryforwards be reported as an increase to Additional Paid-in Capital. The Company reported net income but was not required to pay taxes on such income as the result of having the benefit of deductions for tax purposes including net operating loss carryforwards to offset the income. The financial statements as adjusted, reflect a non-cash charge in the form of a tax provision in the Consolidated Statements of Income. The valuation reserve against net deferred tax assets has been reduced by an amount equivalent to the non-cash charge with a corresponding increase being made to Additional Paid-in Capital. The adjustment does not affect the Company's cash flows or total shareholders' equity. The effect of the adjustment is as follows:
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Wholly Owned Properties (previously Held for Sale) --------------------------------------------------
During 1995 and prior years, the Company classified the Wholly Owned Properties as Held for Sale. However, based upon mortgage debt that has since been restructured with favorable amortization terms, combined with improved net operating income and cash flow performance, management decided to retain the Wholly Owned Properties for investment. Therefore, commencing January 1, 1996, the Company changed the classification of the Wholly Owned Properties and discontinued the Held for Sale accounting treatment. The Wholly Owned Properties are depreciated over their estimated remaining useful lives, typically approximately 30 years, using the straight-line method for financial reporting purposes and tax purposes. The Company expensed all interior replacement costs and capitalized major building exterior improvements (See Note 2).
Interests in and Receivables from Syndicated Partnerships ---------------------------------------------------------
The carrying value of the interests in and receivables from Syndicated Partnerships represents the allocation of the estimated fair value of the assets as of the Effective Date and, as described in Note 3, the face amounts of the receivables are significantly more than recorded amounts. These receivables generally include long-term second mortgages and other receivables. In addition, subsequent to the Effective Date, the Company has made advances to the Syndicated partnerships. These advances primarily relate to supplemental funding for refinancing transactions, and bear interest at prime plus one percent. Interest is accrued on the recorded values of the second mortgages and certain of the other receivables based upon contractual interest rates, and allowances are provided for estimated uncollectible interest based upon the underlying properties' net cash flow. In certain instances, cash flow received in excess of accrued second mortgage interest on the recorded values of the second mortgages is recorded as income. The Company is also entitled to receive incentive management fees and supplemental second mortgage interest based upon certain levels of cash flow of certain of the underlying properties. Also, in the event the underlying properties are sold or refinanced, the Company is generally entitled to a participation interest in the net proceeds, as a general partner and/or a second mortgage holder. The Company accounts for its general partner interests by the cost method; no significant recorded value has been ascribed to these interests arising prior to the Effective Date. The realization of the interests in and receivables from Syndicated Partnerships is dependent on the future operating performance of the Syndicated Partnerships.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
Cash ----
Operating cash as of December 31, 1996 and 1995 is comprised of $3.3 million and $2.7 million respectively, related to Wholly Owned Properties which is held in separate property bank accounts and approximately $270,000 and $52,000 in corporate funds, respectively. The majority of excess corporate cash is applied to the corporate term debt and reborrowed as needed.
Furniture, Fixtures and Other, Net ----------------------------------
Furniture and fixtures are recorded at cost. Furniture and fixtures are depreciated over their estimated useful lives using the straight-line method for financial reporting purposes and various accelerated or straight-line methods for income tax purposes.
Funds Held in Escrow --------------------
The amounts at December 31, 1996 and 1995 include funds of $7.0 million and $7.1 million, respectively, escrowed by Wholly Owned Properties for improvements and deferred maintenance, real estate taxes, insurance and resident security deposits. In addition, the Company is holding $3.0 million and $2.3 million, at December 31, 1996 and 1995, respectively, as funds held primarily for payment of insurance premiums which are collected on behalf of the Properties. At December 31, 1996 the Company's funds held in escrow also includes $4.0 million of funds received from the settlement of termite litigation. The funds are being held pending the finalization of an allocation of proceeds to the affected properties. Applicable corresponding liabilities have been recorded at December 31, 1996 and 1995.
Prepaids and Other Assets -------------------------
Prepaids and Other Assets as of December 31, 1996 and 1995 is comprised of the following:
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1: BACKGROUND AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd)
The management contracts purchased with the Lexford Acquisition are being amortized on the straight line basis over 10 years. The Goodwill related to the Lexford acquisition is being amortized on the straight line basis over 25 years. The capitalized refinancing costs are associated with the refinancing of the mortgages on the Wholly Owned Properties. The costs are being amortized over six to ten years based upon the maturity of the new loans.
Net Income Per Share --------------------
Net income per share is computed based on the total weighted average number of shares of the Company's Common Stock, without par value ("Common Stock"), outstanding during the period and those contingent shares estimated to be issued to officers, employees and directors in accordance with the Company's 1992 Incentive Equity Plan, as amended (the "Incentive Equity Plan"). In August 1996, the Company issued 700,000 shares of Common Stock in connection with the Lexford merger, 450,000 shares of which remain subject to forfeiture in whole or in part. The 450,000 shares subject to forfeiture are excluded from the weighted average shares outstanding because the shares are not dilutive. The weighted average shares outstanding, as of December 31, 1996, was approximately 3,933,000, (less 210,000 treasury shares) including approximately 244,000 estimated to be issued in the future pursuant to the Incentive Equity Plan. As of December 31, 1995 and 1994 the weighted average shares outstanding was approximately 3,850,000 shares. In November 1995, the shareholders of the Company approved an increase in the number of authorized shares of Common Stock of the Company from 4,500,000 to 13,500,000 and also authorized 1,500,000 shares of "Blank Check" Preferred Stock. The Company currently has no commitments or arrangements which would require the issuance of additional shares.
Treasury shares include approximately 70,000 shares issued to Wholly Owned Properties and subsidiaries as part of the Company's plan of reorganization. In addition, approximately 126,000 unclaimed shares, related to stock issued for prepetition unsecured claims, have been converted to treasury shares. The Plan of Reorganization provided that all stock issued, but not deliverable, to any unsecured creditor, be held in trust for a period of two years from the Effective Date, at which time such stock would either be canceled or revert to the Company as treasury shares at the Company's discretion. The Company elected to treat undeliverable stock as treasury shares.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 2: WHOLLY OWNED PROPERTIES
During 1995 and prior years, the Company had attempted to market and sell the Wholly Owned Properties and classified the Wholly Owned Properties as Held for Sale. While the Wholly Owned Properties were held for sale, the results of operations from the Wholly Owned Properties were credited to the carrying value of the real estate and no revenues, operating expenses or depreciation were included in the Consolidated Statements of Income. Cash flows from the Wholly Owned Properties prior to 1996 were classified as Cash Flow Provided by Investing Activities. Commencing January 1, 1996, based upon management's decision to retain the Wholly Owned Properties for investment, the operations, including a provision for depreciation, of the Wholly Owned Properties have been fully consolidated in the Company's Statements of Income. Further, the cash flows of the Wholly Owned Properties have been reclassified as Cash Flows Provided by Operating Activities. The Company will continue to monitor and evaluate any changes in circumstances and/or economic conditions affecting its investment in the Wholly Owned Properties. The Company is currently analyzing alternatives for its majority interest in the Wholly Owned Properties, which may include a disposition to third parties resulting in deconsolidation of the entities.
The number of Wholly Owned Properties by year is as follows:
1996 1995 1994 -------------- --------------- -------------
Beginning of Year 116 116 120 Acquisitions 1 4 0 Disposals (4) (2) (2) Properties Combined 0 (2) (2) -------------- --------------- ------------- End of Year 113 116 116 ============== =============== =============
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 2: WHOLLY OWNED PROPERTIES (cont'd)
Condensed combined balance sheets, with intercompany payables and receivables eliminated, of the Company's Wholly Owned Properties as of December 31, 1996 and 1995 are as follows:
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 2: WHOLLY OWNED PROPERTIES (cont'd)
Condensed consolidated statements of income of the Wholly Owned Properties while Held for Sale, including intercompany expenses, for the years ended December 31, 1995 and 1994 are as follows:
Revenues from rental of apartment units is recognized ratably over the term of the related operating leases, which are generally for a period of one year or less.
NOTE 3: INTERESTS IN AND RECEIVABLES FROM SYNDICATED PARTNERSHIPS
The Interests in and Receivables from Syndicated Partnerships net of reserves of $2.3 million and $1.9 million, respectively, are comprised of the following major components:
The majority of second mortgage notes bear interest at 6%. Interest income is accrued based upon the Fresh Start value of the second mortgage notes, as described in Note 1. Advances made to Syndicated Partnerships since the Effective Date primarily were for supplemental financing for the debt restructuring or refinancing transactions as described in Note 6. These advances currently bear interest at prime plus 1%. At December 31, 1996 and 1995, the contractual value of the Company's interest in second mortgages, advances and other receivables, including related interest, amounted to $238.9 million and $237.1 million, respectively. There can be no assurance that the Company will collect any amounts above the carrying value of these receivables.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 4: CORPORATE TERM DEBT
In August 1995 the Company closed a loan agreement with The Provident Bank (the "Bank") which provided a new $32.0 million credit facility for the Company. The new credit facility retired the previous corporate credit facility with The Huntington National Bank ("HNB"). During 1995, the variable interest rates on the HNB debt ranged from 9.0% to 10.0% with fixed rates of 5.54% to 6.03%. At the time of refinancing, approximately $6.5 million of the HNB facility was subject to a fixed interest rate of 6.03% with an overall weighted average rate on the total HNB credit facility of 8.25%
The bank credit facility is comprised of three separate lines of credit, two of the lines bear interest at the Bank's prime rate of interest minus 1% and the third line at 7.25% fixed. During 1996, the variable interest rate on the Bank debt was 7.25%. The loans are secured by all assets of the Company.
The credit facility was comprised of the following terms and balances at December 31, 1996 and 1995:
Borrowings under the Working Capital Line will amortize over 36 months if the Bank does not renew the facility when due in August 1997. The Acquisition Line is subject to annual renewal and is restricted to provide funds for the acquisition of, or refinancing/restructuring of mortgages on affiliated properties. The Reducing Line was used to retire the HNB credit facility.
In July 1996, the Company received a commitment letter from the Bank for a new $10.0 million Acquisition Line (the "Acquisition Line II) of credit generally under the same terms as the existing facility. The Company's capital requirements in 1996 did not require the Company to access this new facility.
At December 31, 1996 the Company had unrestricted credit availability of approximately $25.4 million, inclusive of the new $10.0 million commitment from the Bank, but excluding credit availability restricted for approximately $767,000 of unfunded letters of credit. At December 31, 1995, the Company had $10.7 million available for future credit which excluded $829,000 of availability restricted for specific credit needs.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 4: CORPORATE TERM DEBT (cont'd)
The Company's minimum annual long term debt maturities following December 31, 1996 are:
1997 $ 4,285,595 1998 4,376,035 1999 4,479,181 2000 1,700,874 2001 276,363 ------------------- $ 15,118,048 ===================
NOTE 5: NON RECOURSE MORTGAGES ON WHOLLY OWNED PROPERTIES
In connection with Fresh Start reporting as further described in Note 1, mortgages on real estate assets have been restated to their estimated fair value as of the Effective Date. The contractual principal balances of the mortgages on Real Estate Assets exceed the carrying values by $9.3 million and $15.6 million at December 31, 1996 and 1995, respectively. The mortgages are non-recourse and are collateralized by real estate properties and are payable over periods through 2006. At December 31, 1996 contractual interest rates ranged from 7.0% to 10.0% with fixed rates on approximately $144.2 million of the outstanding contractual mortgage balances. Interest expense is recorded using the effective interest method based upon the carrying value of the mortgage debt. The weighted average effective interest rate was 9.0% at December 31, 1996. The weighted average contractual interest rate and term to maturity on the mortgages on Real Estate Assets, excluding matured loans, was 8.7% and 7.1 years at December 31, 1996. Annual debt service requirement was $15.7 million at December 31, 1996. In addition, 15 Wholly Owned Properties have secondary mortgage debt totaling $2.9 million that requires the application of all excess cash flow from operations to be applied to the outstanding principal on such debt. The range of interest rates and related carrying amounts of mortgages payable at December 31, 1996 is as follows:
Contractual Contractual Carrying Rate Balance Value - ------------------------- ----------------------- ----------------------- Less than 8.0% $ 15,339,067 $ 13,042,258 8.0% - 9.0% 127,440,097 121,908,563 More than 9.0% 14,602,439 13,105,196 ----------------------- ----------------------- $ 157,381,603 $ 148,056,017 ======================= =======================
At December 31, 1996, four Wholly Owned Properties had mortgage loans which had matured with an aggregate contractual and carrying value of $4.8 million. The Company will either refinance the mortgages or deed the property to the lender depending upon the outcome of negotiations with the respective lenders.
Minimum estimated repayment requirements of mortgages for the next five years based upon the contractual principal balances, exclusive of those mortgages which have matured, are as follows:
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 5: NON RECOURSE MORTGAGES ON WHOLLY OWNED PROPERTIES (cont'd)
Contractual Amounts --------------------- 1997 $ 3,055,003 1998 8,961,786 1999 6,572,553 2000 6,574,634 2001 22,371,767 Thereafter 109,845,860 --------------------- $ 157,381,603 =====================
NOTE 6: REFINANCED MORTGAGE DEBT
In 1996, the Company refinanced the mortgage and related interest debt on 35 Wholly Owned Properties. Mortgage and related interest debt with a contractual balance of $46.8 million and a Carrying Value of $45.6 million was refinanced with new carrying value and contractual mortgage debt of $47.8 million. The new mortgages carry a weighted average fixed interest rate of 8.8%, 25 to 30 year amortization and typically, a 10 year maturity. Annual debt service requirements decreased from $4.9 million to $4.6 million. In these transactions, cash flow secondary mortgages ("B Notes") on six properties were refinanced. These "B Notes" required 100% of excess cash flow from operations of the properties to be applied to the principal outstanding on the B Notes. In 1996 the excess cash flow applied to the B Notes on these six properties amounted to approximately $98,000. The Wholly Owned Properties incurred loan origination costs of $1.7 million which have been capitalized and are being amortized over the maturity term of the new mortgages. The Company provided net funding of $1.1 million to complete these transactions.
A fourth quarter 1996 extraordinary non-cash charge of $1.6 million, net of tax benefits, resulted from mortgage debt refinancing on certain of the above Wholly Owned Properties. The repayment of the existing mortgage at the contractual balance was possible due to the improvements in performance resulting in the increased value of certain properties to levels in excess of the carrying value established on the Effective Date. The charge arose from those mortgages repaid from refinance proceeds at the contractual balance which exceeded the Carrying Value of the mortgage. (Note 1).
The Company also completed the refinancing of mortgage and related interest debt of $95.3 million on 90 Syndicated Partnerships. The Company provided net advances to Syndicated Partnerships of approximately $600,000 to facilitate these transactions. Annual debt service requirements decreased, in the aggregate, approximately $626,000 per year. The new mortgages on 72 Syndicated Partnerships are interest only for three years; after the third year the annual debt service reduction will be offset by the commencement of principal amortization.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 6: REFINANCED MORTGAGE DEBT (cont'd)
The refinancing on the Syndicated Partnerships generated loan fee revenue of approximately $752,000 in 1996 as compared to $886,000 and $1.3 million in 1995 and 1994, respectively. The fees were based upon a graduated percentage of the new loan amounts.
In 1995 and 1994, the Company completed modification or refinancing transactions on Wholly Owned Properties and Syndicated Partnerships which resulted in an extraordinary gain on discharge of indebtedness on the Wholly Owned Properties, net of closing costs reserves and taxes, of approximately $804,000 and $3.2 million, respectively.
NOTE 7: OTHER NOTES PAYABLE
In June 1995, the Company purchased from a mortgage lender the mortgages on one Syndicated Partnership and four Wholly Owned Properties for $7.8 million. The Company, on an interim basis, financed the purchase of the mortgages with a promissory note payable to the mortgage lender. Approximately $1.2 million of the $7.8 million note payable relates to a Syndicated Partnership and was classified with other notes payable at December 31, 1995. The balance of the note payable relates to Wholly Owned Properties and was classified with mortgages on Wholly Owned Properties at December 31, 1995. The note was repaid from the proceeds of permanent non recourse financing on the Properties in 1996.
The remaining $145,220 of Other Notes Payable consists of obligations which are payable through 1997, bear interest at approximately 9.0% and are secured by equipment and other collateral.
NOTE 8: OTHER LIABILITIES
Other Liabilities at December 31, 1996 and 1995 consists of approximately $683,000 and $964,000, respectively, of liabilities of the Wholly Owned Properties and $4.7 million and $1.3 million, respectively, of obligations of the Company. The Other Liabilities of the Wholly Owned Properties at December 31, 1996 consists principally of general operating accruals and obligations of the properties. The Company's Other Liabilities includes $3.4 million due to Syndicated Partnerships related to a litigation settlement to be funded from restricted cash held in escrow (See Note 1). The remaining other liabilities principally relate to obligations from the Company's Plan of Reorganization.
In 1994, the Company settled a pending claim in its bankruptcy case which resulted in a reduction of a recorded liability of approximately $726,000 in exchange for the Company's dismissal of a bankruptcy preference action against an insurance company and an insurance broker. The income recognized due to the release of the liability is reflected in Other Income.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 9: INCENTIVE COMPENSATION PLAN
The Company's 1992 Incentive Equity Plan which benefits its officers, key employees and non-employee directors, was established as of the Effective Date of the Company's Plan of Reorganization. Under this plan approximately 481,200 shares are available for awards of stock options and restricted stock. In addition to the Incentive Equity Plan, as of the Effective Date, the bankruptcy trustee awarded options to purchase approximately 36,000 shares to certain key employees under an employee retention plan. Since the shares included in the 1992 Incentive Equity Plan and the trustee awarded options were provided in the Plan of Reorganization, the shares have been deemed awarded prior to the Effective Date with no compensation expense recorded for periods subsequent to the Effective Date. In November 1995, the Board of Directors adopted and the shareholders approved an amendment to the Incentive Equity Plan (the "Plan Amendment"). The Plan Amendment provided for an additional 200,000 shares of Common Stock to be available for the granting of future awards for officers and key employees. In addition, the Plan Amendment provides for 50,000 shares of Common Stock to be available for the granting of stock options to non-employee directors. Awards of shares provided in the Plan Amendment, depending on the nature of the award, may be reflected as compensation. The shares of stock available for future awards may be awarded at the discretion of the Company's Board of Directors.
In 1996 the Company awarded to officers and non-employee directors 49,500 shares of restricted stock, 38,000 shares of deferred stock and stock options for the purchase of 76,000 shares. The restricted stock is comprised of up to 17,500 shares awarded as a Company match of shares if purchased by certain officers by April 1997, and 32,000 shares which will vest ratably over time. The deferred stock vests based upon the Company achieving specified levels of total market capitalization. The grant date weighted fair value of restricted and deferred stock was approximately $18.57 per share. Included in the 76,000 of stock options awarded in 1996 were options to purchase 2,000 shares that were awarded to each of the eight non-employee directors of the Company. Approximately 32,500 shares of restricted stock awards and the options to purchase 30,000 shares were awarded out of the shares included in the original 1992 Incentive Equity Plan. Approximately 173,000 shares remain available for future awards. The Company's performance based Incentive Bonus Plan implemented in 1996 includes awards of restricted stock and stock options if specified Company performance criteria are achieved.
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee and director stock options because, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock Based Compensation," ("FASB 123") requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is required by FASB 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of the grant using Black-Scholes option pricing model.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 9: INCENTIVE COMPENSATION PLAN (cont'd)
The following assumptions were utilized in the pricing model; a weighted average risk free interest rate of 6.5% in 1995 and 1996; dividend yield of one percent; volatility factors of the expected market price of the Company's common stock of 0.236; and a weighted average expected life of seven years in 1996 and eight years in 1995.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restriction and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options is amortized over the options vesting period. The Company's pro forma information follows:
1996 1995 ------------------- ------------------- Pro forma net income $ 3,629,797 $ 5,090,716 =================== =================== Pro forma earnings per share $ 0.92 $ 1.32 =================== =================== As reported Earnings per share $ 0.96 $ 1.32 =================== ===================
Pro forma net income may not be representative of compensation expense under FASB 123 when the effect of the amortization of multiple awards would be reflected.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 9: INCENTIVE COMPENSATION PLAN (cont'd)
The following table summarizes the Company's stock option activity, and related information for the years ended December 31, 1996, 1995 and 1994 (in thousands except for exercise prices)
Options awarded have an exercise price equal to or greater than the market price of the Common Stock at the time of the award, and are subject to vesting schedules as determined by the Company's Board of Directors. The options granted expire, if not exercised, ten years from the date on which the option was granted. Exercise prices for options outstanding as of December 31, 1996 ranged from $1.42 to $21.25 per share with a weighted average remaining term of 7.7 years.
NOTE 10: INCOME TAXES
The Company and its subsidiaries file a consolidated Federal income tax return. For financial reporting purposes, the Company follows FASB Statement No. 109 ("FASB 109"). In accordance with FASB 109, as well as SOP 90-7, income taxes have been provided at statutory rates in effect during the period. Tax benefits associated with net operating loss carryforwards and other temporary differences that existed at the time fresh start reporting was adopted are reflected as an increase to Additional Paid-in Capital in the period in which they were realized.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 10: INCOME TAXES (cont'd)
The provision for income taxes in the Consolidated Statements of Income (including amounts applicable to extraordinary items) is as follows:
Years Ended -------------------------------------------------- 1996 1995 1994 ---------------- ---------------- ----------------
Current:
Federal $ 0 $ 50,000 $ 0
State 250,000 314,000 201,000
Amounts not payable in cash 2,151,000 2,866,000 4,464,000 ---------------- ---------------- ---------------- $ 2,401,000 $ 3,230,000 $ 4,665,000 ================ ================ ================
The Company's actual income tax payments for the years 1996, 1995 and 1994 were significantly less than the total provision for income taxes because of available net operating loss carryforwards and other tax benefits. The amounts included in the provision for taxes for which no amounts were payable in cash are set forth in the table above.
The effective income tax rates varied from the federal statutory rates as follows:
1996 1995 1994 ------------ ------------ ------------
Federal Tax provision at statutory rates $ 2,094,000 $ 2,832,000 $ 4,118,000
State Income Taxes, Net of Federal Income Tax Benefit 288,000 386,000 537,000
Other Permanent Differences 19,000 12,000 10,000 ------------ ------------ ------------ $ 2,401,000 $ 3,230,000 $ 4,665,000 ============ ============ ============ Effective Income Tax Rate 39.0% 38.8% 39.6% ============ ============ ============
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 10: INCOME TAXES (cont'd)
Significant components of the Company's deferred tax assets and liabilities are as follows at December 31, 1996 and 1995.
The valuation reserve against deferred tax assets has been reduced by amounts equivalent to the portions of the tax provisions which are not payable in cash. Corresponding increases have been made to Additional Paid-in Capital.
As a result of the uncertainties relating to the ultimate utilization of favorable tax attributes described below, the Company has provided a valuation reserve for the remaining excess of the net deferred tax assets as of December 31, 1996 and 1995.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 10: INCOME TAXES (cont'd)
In addition to regular corporate income tax, corporations are subject to an alternative minimum tax liability to the extent alternative minimum tax exceeds regular tax. The Company will record an alternative minimum tax liability in the year that events and transactions create an alternative minimum tax which is probable of being paid and can be reasonably estimated by the Company. As of December 31, 1996, the Company has estimated that it has net operating loss ("NOL") carryforwards for tax purposes of approximately $44.3 million which if not utilized, expires in the years 2001 through 2009. In the event that current or future 5% shareholders (as defined by the Internal Revenue Code) acquire or dispose of shares, over a defined time period, representing in the aggregate 50% or more of the Company's outstanding shares, a limitation on the use of NOL carryforwards will occur. The Company has also estimated that it has approximately $108.7 million in suspended passive activity losses ("PALs") which may be available to offset future passive and active income. The Company's determination of its NOLs, PALs, and other tax attributes, as well as its ability to utilize them to reduce taxable income is subject to uncertainties. Although the Company believes that its determinations concerning its tax attributes are supportable under applicable tax laws, there can be no assurance that taxing authorities, upon examination will not argue to the contrary.
NOTE 11: RESTRUCTURING/TENDER OFFER COSTS
In 1995, the Company implemented a corporate restructuring plan and initiated further restructuring in 1996. The Company recorded a charge of approximately $243,000 and $1.5 million in 1996 and 1995, respectively, related to the costs of the restructuring, principally severance and separation costs. Approximately 26 employees were released as a result of the restructurings in 1995 and 1996. In 1996 the Company paid $1.7 million of costs related to the 1995 and 1996 restructuring.
In 1994, the Company received proposed tender offers for the acquisition of at least 80% of the outstanding shares of the Company's Common Stock. The Board of Directors of the Company engaged various outside professionals to assist in the analysis of the proposed tender offers. The costs associated with the outside professionals were deferred pending the resolution of the proposed tender offers. Due to the termination of all proposed tender offers, the Company expensed approximately $977,000 of costs incurred in connection with the proposed tender offers.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 12: COMMITMENTS AND CONTINGENCIES
Office Lease ------------
The Company leases its corporate office space under an operating lease which expires in October, 1997. The Company has an option for five additional terms of three years each. The Company is responsible for the payment of insurance, real estate taxes and operating expenses of the leased facility. (See Note 14). The Company's Lexford wholly owned subsidiary leases office space in four cities to support its third party management operations. The majority of leases expire in 1999. Annual rental requirements are approximately $558,000 in 1997, $272,000 in 1998 and $133,000 in 1999. The Company also leases various equipment, typically over five years, and management offices under operating leases which generally have remaining terms of less than one year. The equipment rental requirements are approximately $241,000 in 1997, $211,000 in 1998 and $146,000 in 1999. Rent expense for the years ended December 31, 1996, 1995, and 1994 was approximately $749,000, $512,000 and $391,000, respectively.
Litigation ----------
The Company is involved in various legal actions arising out of the normal course of its business. Management of the Company, based upon knowledge of facts and the advice of counsel, believes potential exposure to loss from legal actions has been adequately reserved for in the financial statements and should not result in a material adverse effect on the Company's consolidated financial position.
NOTE 13: RETIREMENT PLAN
The Company maintains the Cardinal Realty Services, Inc. Savings Plan (the "Savings Plan") under section 401(k) of the Internal Revenue Service Code (the "Code"), to which participants may contribute a percentage of their base pay and overtime earnings up to limits established by the Code. The Savings Plan was amended and restated, effective July 1, 1993, to (i) provide for discretionary matching contributions by the Company, (ii) provide for immediate vesting in all Company contributions and (iii) allow loans to participants. Effective December 31, 1995 the Savings Plan was amended to exclude highly compensated employees. Effective July 1, 1996, the Savings Plan was amended to include employees of the Properties as participants, increase the Company match from 1% for every 3% of wages contributed to 1% for every 2% of wages contributed, and to allow highly compensated employees to participate in the Plan. The Company contribution amounts to 1% of wages for every 2% of wages contributed by a participant up to a maximum of the lesser of 3% of wages or $2,000 per year. In 1996, 1995 and 1994, the Company's cash contributions amounted to approximately $134,000, $92,000, and $88,000, respectively. The Company cash contributions are then invested in Company stock held by the Savings Plan Trustee.
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 14: RELATED PARTY TRANSACTIONS
The Company is the general and limited partner in, or the owner of, all Wholly Owned Properties and is a general partner in the Syndicated Partnerships. The Company also serves as the management company for substantially all of these properties and provides various ancillary services including sales of parts and supplies to the properties and furniture rentals and renters insurance to residents. The Company's fee based revenue, interest income and ancillary income result primarily from properties affiliated with the Company. Approximately $4.1 million and $3.9 million of the Company's accounts receivable are due from the Syndicated Partnerships as of December 31, 1996, and 1995, respectively.
The Company advanced, net of amounts repaid, to Syndicated Partnerships $2.6 million, $8.6 million, and $1.4 million in 1996, 1995 and 1994, respectively. The majority of the advances relate to supplemental financing provided for the refinancing of the mortgages on the properties as described in Note 6. Effective October 1, 1995, in conjunction with the favorable terms the Company achieved on its credit facility, the interest rate on these advances was revised to prime plus one percent from principally prime plus six percent. The interest rate on advances will be adjusted in the future based on prevailing market rates.
During 1994, the Company loaned approximately $331,000 to certain key officers and certain key employees. The majority of the loans bear interest at the rate of 1% in excess of the prime rate of the Bank, and are due in five years. The loans were made to fund the personal income tax obligations arising from the tax effect of the vesting in the Company's Common Stock awarded to these individuals and are secured by the Common Stock awarded. All loans were repaid in 1996. At December 31, 1995, the amount of loans and related interest outstanding amounted to approximately $109,900.
An outside director of the company is a partner in the law firm which serves as outside general counsel to the Company. Legal fees paid related to services provided to the Company by this law firm were approximately $286,000 in 1996, $255,000 in 1995, and $432,000 in 1994. In addition, legal fees paid related to debt restructuring and refinancing services provided by this law firm to the Wholly Owned Properties and Syndicated Partnerships were approximately $523,000 in 1996, $739,400 in 1995 and $935,000 in 1994, respectively.
Another outside director of the Company has an ownership interest in the lessor of the Company's Ohio office facility (as discussed in Note 12).
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 15: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
SCHEDULE II
CARDINAL REALTY SERVICES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Allowance for Doubtful Accounts --------------------------- 1996 1995 - --------------------------------------------------- --------------- ------------ Balance at Beginning of Period $2,468,845 $2,056,051
Add: Charged to Costs and Expenses:
(Recovery)/Reserves associated with loan fees (300,000) 291,164
Other reserves 92,692 121,630
Less: Account Charge Offs (227,247) 0 --------------- ------------ Balance at End of Period $2,034,290 $2,468,845 =============== ============