<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
[ ] TRANSITION REPORT PERSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13951
------------------------
LEXFORD RESIDENTIAL TRUST
(Exact Name of Registrant as Specified in its Charter)
Maryland 31-4427382
(State or other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification No.)
41 SOUTH HIGH STREET, SUITE 2410
COLUMBUS, OHIO 43215
(Address of Principal Executive Offices including Zip Code)
(614) 242-3850
(Registrant's Telephone Number, including Area Code)
-----------------------------
Indicate by check [X] whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No __
As of November 10, 1998, there were 9,522,471 common shares of beneficial
interest issued and outstanding.
Exhibit Index on page 34
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<PAGE> 2
LEXFORD RESIDENTIAL TRUST
INDEX
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page No.
<S> <C>
Item 1. Financial Statements:
Consolidated Balance Sheets as of September 30, 1998
(Unaudited) and December 31, 1997 (Audited) 3
Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 1998 and 1997 (Unaudited) 4
Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 1998 (Unaudited) 5
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997 (Unaudited) 6 - 7
Notes to Consolidated Financial Statements 8 - 18
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19 - 32
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Changes in Securities 33
Item 3. Defaults upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 34
Item 6. Exhibits and Reports on Form 8-K 34
Signatures 35
</TABLE>
2
<PAGE> 3
LEXFORD RESIDENTIAL TRUST
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998 (UNAUDITED) AND
DECEMBER 31, 1997 (AUDITED)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------------------ -----------------
<S> <C> <C>
ASSETS
Rental Properties (Note 2):
Land................................................................................ $ 59,916,288 $ 23,124,313
Buildings, Improvements and Fixtures................................................ 541,360,765 138,244,903
-------------- --------------
601,277,053 161,369,216
Accumulated Depreciation............................................................ (23,470,836) (9,151,786)
-------------- ---------------
577,806,217 152,217,430
Investments in and Advances to Unconsolidated Partnerships, net of an allowance
of $1.4 and $2.6 million at September 30, 1998 and December 31,1997,
Respectively (Note 1) .............................................................. 12,270,911 57,111,374
Cash (Note 1) ......................................................................... - 2,568,890
Accounts Receivable, Affiliates (net of an allowance of $437,806 and $941,521 at
September 30, 1998 and December 31, 1997, Respectively), Residents, Officers and
Other (Note 4) .................................................................... 1,898,603 4,898,993
Furniture, Fixtures and Other, Net..................................................... 2,153,103 1,719,521
Funds Held in Escrow (Note 1).......................................................... 24,528,154 11,887,936
Intangible Assets (Note 1)............................................................. 6,015,061 9,200,531
Prepaids and Other (Note 1)............................................................ 7,785,607 1,992,921
--------------- --------------
$ 632,457,656 $ 241,597,596
=============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Mortgages and Revolving/Term Debt
Non Recourse Mortgages (Note 3)..................................................... $ 499,187,295 $ 142,636,874
Revolving/Term Debt................................................................. 27,015,816 7,361,682
--------------- ---------------
526,203,111 149,998,556
--------------- ---------------
Accounts Payable....................................................................... 1,064,186 1,287,753
Accrued Interest, Real Estate and Other Taxes.......................................... 13,004,594 3,719,625
Other Accrued Expenses................................................................. 6,638,132 8,241,526
Other Liabilities...................................................................... 7,280,565 3,503,640
Dividends Payable...................................................................... 4,118,471 -
Deferred Compensation (Note 1)......................................................... 11,398,102 -
--------------- --------------
Total Liabilities................................................................... 569,707,161 166,751,100
-------------- --------------
Shareholders' Equity (Note 1):
Preferred Shares, $.01 par value, 5,000,000 Shares Authorized, None Issued......... - -
Common Shares, $.01 par value, 50,000,000 Shares Authorized, 9,522,471
and 8,493,648 Shares Issued and Outstanding, at September 30, 1998 and
December 31, 1997, Respectively................................................. 95,225 84,936
Additional Paid-in Capital............................................................. 65,470,562 54,137,777
Retained Earnings...................................................................... 11,442,262 20,623,783
Less Cost of Treasury Shares (Note 1).................................................. (14,257,554) -
---------------- ---------------
62,750,495 74,846,496
--------------- ---------------
$ 632,457,656 $ 241,597,596
=============== ===============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE> 4
LEXFORD RESIDENTIAL TRUST
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues:
Rental and Other Property Revenues ..................... $ 37,403,563 $ 10,742,992 $ 100,191,654 $ 31,371,970
Fee Based .............................................. 1,163,472 4,303,034 4,390,764 12,385,791
Income from Unconsolidated Partnerships ................ 625,341 2,619,671 2,194,699 7,765,913
------------- ------------- ------------- -------------
39,192,376 17,665,697 106,777,117 51,523,674
Expenses:
Property Operating and Maintenance ..................... 12,417,538 2,784,527 32,530,146 9,785,837
Real Estate Taxes and Insurance ........................ 3,129,863 1,037,478 8,227,637 3,020,763
Property Management .................................... 2,842,991 4,071,795 9,604,514 12,030,017
Administration ......................................... 1,658,196 1,267,699 4,708,375 3,632,387
Performance Equity Plan (Note 1) ....................... 829,500 -- 1,659,000 --
Non-recurring Costs (Note 1) ........................... -- 538,489 1,808,181 788,489
Interest-Non Recourse Mortgages ........................ 11,154,565 3,569,134 30,263,826 10,505,661
Interest-Revolving/Term Debt ........................... 517,785 174,254 1,098,256 481,578
Depreciation and Amortization .......................... 5,919,509 1,993,256 15,924,758 4,933,698
Loss on Sale of Third Party Management Business (Note 1) -- -- 6,300,000 --
------------- ------------- ------------- -------------
38,469,947 15,436,632 112,124,693 45,178,430
------------- ------------- ------------- -------------
Income/(Loss) Before Gain on Disposal of Assets and
Income Taxes ............................................... 722,429 2,229,065 (5,347,576) 6,345,244
Provision for Income Taxes (Note 1): ....................... -- (1,161,000) -- (3,035,000)
Gain on Disposal of Assets - Net ........................... 34,612 772,910 284,526 1,462,266
------------- ------------- ------------- -------------
Income/(Loss) Before Extraordinary Item .................... 757,041 1,840,975 (5,063,050) 4,772,510
Extraordinary Loss, Net of Income
Tax Benefit of $115,000 (Note 3) ....................... -- -- -- (180,534)
------------- ------------- ------------- -------------
Net Income/(Loss) .......................................... $ 757,041 $ 1,840,975 $ (5,063,050) $ 4,591,976
============= ============= ============= =============
Basic Earnings Per Share:
Net Income/(Loss) ....................................... $ .08 $ .23 $ (.57) $ .58
============= ============= ============= =============
Diluted Earnings Per Share:
Net Income/(Loss) ...................................... $ .08 $ .22 $ (.57) $ .56
============= ============= ============= =============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
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LEXFORD RESIDENTIAL TRUST
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Common Shares
-----------------------------
Less Cost
Additional Retained of Treasury
Shares Amount Paid-in Capital Earnings Shares Total
-------------- -------------- -------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1998 8,493,648 $ 84,936 $ 54,137,777 $ 20,623,783 $ 0 $ 74,846,496
Contingent shares issued
in connection with Lexford
Properties, Inc.
acquisition released in
exchange for forfeiture of
600,000 unvested shares 300,000 3,000 2,997,000 3,000,000
(Note 1)
Exercise of options under
non-qualified stock option 303,995 3,040 1,819,603 1,822,643
plan
Trustee restricted stock
plan shares (Note 1) 8,798 88 170,467 (88,754) 81,801
Retiring Trustees Net
Withdrawal from Rabbi Trust - - - 88,813 88,813
Adjust for shares held in
Rabbi Trust at December
31, 1997 (Note 1) 275,856 2,759 4,168,652 (12,091,547) (7,920,136)
1998 share compensation,
primarily issued to Rabbi 140,174 1,402 2,177,063 (2,166,066) 12,399
Trust
Dividends to common
shareholders (Note 6) (4,118,471) (4,118,471)
Net Loss for the period (5,063,050) (5,063,050)
---------- ------------ ------------ ------------ ------------ -------------
Balance, September 30, 1998 9,522,471 $ 95,225 $ 65,470,562 $ 11,442,262 $(14,257,554) $ 62,750,495
========== ============ ============ ============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
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LEXFORD RESIDENTIAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows provided by/(used in) Operating activities:
Net Income/(Loss) ............................................................. $ (5,063,050) $ 4,591,976
Adjustments to reconcile Net Income/(Loss) to Net Cash
provided by Operating activities:
Depreciation .............................................................. 14,814,010 4,278,158
Amortization .............................................................. 1,110,748 655,540
Loss on Sale of Third Party Management Business ........................... 6,300,000 --
Provision for Losses on Accounts Receivable ............................... 1,117,424 109,940
Loss on Debt Restructuring ................................................ -- 295,534
Gain on Disposal of Assets ................................................ (284,526) (1,462,266)
Provision for Income Taxes Credited to Additional Paid-In Capital ......... -- 2,620,000
Share Compensation Credited to Additional Paid-In Capital and Common Shares 3,489,618 952,168
Changes in Operating Assets and Liabilities:
Investments in and Advances to Unconsolidated Partnerships ............. 851,278 1,405,518
Accounts Receivable and Other Assets ................................... (66,135) 3,244,552
Accounts Payable and Other Liabilities ................................. (1,408,338) (2,096,880)
------------ ------------
Net Cash provided by Operating activities ........................................ 20,861,029 14,594,240
------------ ------------
Cash Flows provided by/(used in) Investing activities:
Proceeds from Sale of Assets ................................................ 335,123 1,840,588
Capital Expenditures ........................................................ (928,058) (786,018)
Net Repayment from Unconsolidated Partnerships .............................. 8,339 579,082
Investments in Unconsolidated Partnerships and Other ........................ (3,405,398) (1,468,082)
Purchase of 324 Unconsolidated Partnerships, Net of Cash Acquired ........... (25,506,117) --
Capital Expenditures - Real Estate .......................................... (8,926,103) (1,529,553)
------------ ------------
Net Cash (used in) Investing activities .......................................... (38,422,214) (1,363,983)
------------ ------------
Cash Flows provided by/(used in) Financing activities:
Proceeds from the exercise of Stock Options ................................. 1,822,643 35,677
Proceeds from Revolving/Term Debt ........................................... 20,696,083 --
Principal Payments on Revolving/Term Debt and Other ......................... (1,041,948) (10,237,033)
Proceeds from Mortgage Debt ................................................. -- 2,560,000
Payments on Mortgages - principal amortization .............................. (4,976,468) (1,514,788)
Payments on Mortgages - lump sum ............................................ (1,508,015) (3,842,734)
------------ ------------
Net Cash provided by/(used in) Financing activities .............................. 14,992,295 (12,998,878)
------------ ------------
Increase / (Decrease) in Cash .................................................... (2,568,890) 231,379
Cash at Beginning of Period ...................................................... 2,568,890 3,593,121
------------ ------------
Cash at End of Period (1) ........................................................ $ -- $ 3,824,500
============ ============
Supplemental Disclosure of Cash Flow Information
Cash Payments for Interest .................................................. $ 30,667,643 $ 10,933,195
============ ============
(1) All unrestricted cash is applied to the Company's revolving credit facility with draws on the credit facility as
funds are needed.
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE> 7
LEXFORD RESIDENTIAL TRUST
CONSOLIDATED STATEMENTS OF CASH FLOWS (con't)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
In 1998, the Company acquired the entire ownership interest in 324
Unconsolidated Partnerships owning 326 apartment communities. Such acquisitions
resulted in the following increases (decreases) to the Company's balance sheet
(SEE NOTE 2):
<TABLE>
<CAPTION>
(In thousands)
-----------------
<S> <C>
Non-Cash Effects:
- -----------------
Investments in and Advances to Unconsolidated Partnerships............................. $ (81,237)
Land and Building...................................................................... $ 30,981
Accounts Receivable and Other Assets................................................... $ 9,409
Mortgages.............................................................................. $ 362,610
Accounts Payable and Other Liabilities................................................. $ 14,939
Cash Effects:
- -------------
Cash Paid to Former Partner(s)......................................................... $ (33,902)
Net Cash Acquired...................................................................... 8,396
--------------
$ 25,506
==============
</TABLE>
On March 13, 1998, the Company negotiated a settlement with the former
shareholders of Lexford Properties, Inc. whereby 300,000 out of an aggregate of
900,000 common shares of beneficial interest subject to forfeiture, per the
terms of the merger agreement dated August 1, 1996, were released to such former
shareholders in exchange for the forfeiture of the remaining 600,000 shares (SEE
NOTE 1).
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7
<PAGE> 8
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION
In December 1997, Lexford, Inc. announced that it would seek to qualify
and elect to be taxed as a real estate investment trust for Federal income tax
purposes ("REIT") in 1998. In connection with this decision, Lexford, Inc.
established a new entity known as Lexford Residential Trust (the "Company"). On
March 3, 1998, the shareholders of Lexford, Inc. approved the merger of Lexford,
Inc. with and into the Company. The terms of the merger transaction provided
that each share of Lexford, Inc.'s issued and outstanding common stock be
canceled and converted to two common shares of beneficial interest in the
Company. The merger transaction was consummated on March 18, 1998 and the
Company has therefore acquired all of the assets and assumed all of the
liabilities of the former Lexford, Inc. Share numbers and per share amounts in
the Company's financial statements and footnotes have been adjusted to reflect
the results of the merger transaction. The consolidated financial statements
include the accounts of Lexford Residential Trust, formerly known as Lexford,
Inc. and Cardinal Realty Services, Inc., and its wholly owned subsidiaries and
partnerships (collectively the "Company"). The Company, for consolidated
financial statement purposes, includes corporations, limited partnerships and
other legal entities which own multifamily apartment communities (the "Rental
Properties") in which the Company, in turn, owns 100% equity interest. The
Company also holds equity ownership or significant economic interests (i.e.
mortgage loans and management contracts entitling the Company to a substantial
portion of an apartment community's net cash flow) in multifamily apartment
communities in its capacity as general partner or property manager,
respectively, in various limited partnerships (the "Unconsolidated
Partnerships"). The Rental Properties and the Unconsolidated Partnerships are
collectively referred to as the "Properties." The accounts of the Unconsolidated
Partnerships are not included within the Company's consolidated financial
statements but are accounted for under the equity method. All significant
intercompany balances and transactions have been eliminated in this
consolidation. The accompanying consolidated financial statements, except for
the Consolidated Balance Sheet as of December 31, 1997, are unaudited and have
been prepared in accordance with generally accepted accounting principles
("GAAP") for interim financial information and in accordance with the rules and
regulations of the Securities and Exchange Commission (the "SEC"). Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for a complete financial statement presentation.
The consolidated financial statements, the notes hereto and the capitalized
terms included herein should be read in conjunction with the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997.
The interim consolidated financial statements have been prepared in
accordance with the Company's customary accounting practices. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. Operating results for the
nine month period ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998.
Business Overview
- -----------------
The Company is a fully integrated REIT which owns, manages and
opportunistically acquires apartment communities. The Company is the seventh
largest multifamily REIT in terms of equity ownership of units, with a strong
focus in the value-conscious segment of the apartment industry. The Company's
Properties generally consist of relatively smaller apartment communities,
averaging approximately 90 units per site. As of September 30, 1998, the Company
has whole ownership interest
8
<PAGE> 9
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
in 437 Rental Properties located on 339 sites comprising 28,929 residential
units, a partial equity interest in 65 Unconsolidated Partnerships located on 49
sites comprising 4,481 residential units and a significant economic interest as
property manager in 14 apartment communities located on 14 sites comprising
2,995 residential units. The combined 516 Properties are located at 402 sites
throughout the midwestern and southeastern United States.
The Company's primary mission is to become the leading multifamily REIT
operating in the value-conscious segment. The Company defines value-conscious
renters as those who prefer clean, attractive living accommodations without
unnecessary amenities at rental rates below the median rent in the relevant
housing market. The Company seeks to serve this segment by maintaining
competitively priced rental structures, as represented by its typical monthly
rent that currently ranges from $350 to $550 per apartment unit.
Third Party Management Business
- -------------------------------
In the first quarter of 1998 the Company was also engaged in providing
management services to third party owners of multifamily apartment communities
(the "Third Party Management Business"). Because of Internal Revenue Code
limitations on the nature and amount of non-qualified REIT income, the Company
contributed the majority of its assets related to the Third Party Management
Business to a newly formed corporation in exchange for all of the preferred
stock of such corporation on February 20, 1998. Effective as of April 1, 1998,
the Company sold all its preferred equity interest in the Third Party Management
Business. The Company has retained a significant number of the executive
officers and other personnel dedicated to the Company's property management
activities, its proprietary interest in property management training programs
and systems, and management agreements for 14 apartment communities in which the
Company currently does not own an equity interest. (SEE "SALE OF THIRD PARTY
MANAGEMENT BUSINESS").
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 secured by certain assets owned by the Company
exceeded the estimated fair value of the respective Rental Property, the Company
reduced the contractual amount of the related non-recourse mortgage debt by the
amount of the deficiency (the "Mortgage Deficiency"). The contractual mortgage
balance net of any applicable Mortgage Deficiency, is referred to as the
"Carrying Value" of the mortgage (SEE NOTE 3).
9
<PAGE> 10
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
Cash and Funds Held in Escrow
- -----------------------------
In the second quarter of 1998, with the completion of the consolidation
of ownership of the Rental Properties, the Company revised its cash management
system to ensure that all available unrestricted cash is applied to the
Company's credit facility with draws on the credit facility as funds are needed.
This change has resulted in the elimination of unrestricted cash.
Funds Held in Escrow at September 30, 1998 includes funds of $23.3
million held in escrow for the benefit of Rental Properties for improvements and
deferred maintenance, real estate taxes, insurance and resident security
deposits.
Intangible Assets and Prepaids and Other Assets
- -----------------------------------------------
Intangible Assets at September 30, 1998 is comprised of approximately
$3.2 million of management contracts on a portfolio of properties and
approximately $490,300 of goodwill related to the trade name, executive officers
and other personnel, training programs and property management systems retained
from the Third Party Management Business. The management contracts and goodwill
are net of amortization of approximately $432,500 (SEE "SALE OF THIRD PARTY
MANAGEMENT BUSINESS"). In addition, Intangible Assets includes deferred
financing costs of $2.3 million at September 30, 1998. The deferred financing
costs relate to mortgage refinancings on the Rental Properties and are amortized
over the terms of the respective loans.
Prepaids and Other assets at September 30, 1998 includes $4.3 million
of deferred offering costs related to the Company's Form S-3 "shelf"
registration statement filed with the SEC and a $1.8 million note receivable
related to the sale of the Third Party Management Business. In addition,
Prepaids and Other assets consists of $1.1 million of prepaid rent, insurance
and real estate taxes, approximately $299,100 of utility and other deposits and
approximately $320,000 of other prepaid expenses.
Investments in and Advances to Unconsolidated Partnerships
- ----------------------------------------------------------
Investments in and Advances to Unconsolidated Partnerships represent
the Company's general partners' interest in and advances to Unconsolidated
Partnerships. The carrying value represents the allocation of the estimated fair
value of the underlying real estate assets as of the Effective Date or, if
later, date of purchase or investment. The contractual amounts of the
receivables are significantly more than the recorded carrying values.
Prior to November 1, 1997, the Company accounted for its investments by
the cost method. Effective November 1, 1997, based on the Company's decision to
seek to acquire ownership of third party equity interests in substantially all
of the Unconsolidated Partnerships, the Company began accounting for its
investments on the equity method. The Company's share of net Loss of the
Unconsolidated Partnerships, amounted to approximately $19,900 for the first
nine months of 1998, and is included in Income from Unconsolidated Partnerships
in the Consolidated Statements of Income.
10
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LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
In the first quarter of 1998, the Company invested in a joint venture
with a developer for the construction of an apartment community. The investment
of $3.4 million is included in Investments in and Advances to Unconsolidated
Partnerships at September 30, 1998.
Reclassifications
- -----------------
Certain amounts in the 1997 consolidated financial statements have been
reclassified to conform to the 1998 presentation.
Provision for Income Taxes
- --------------------------
The Company intends to elect to be taxed as a REIT under sections 856
through 860 of the Internal Revenue Code, commencing with its taxable year
beginning January 1, 1998. As a REIT, the Company generally will not be subject
to Federal Income Tax on income it distributes to shareholders as long as it
distributes at least 95% of its REIT taxable income and satisfies a number of
organizational, ownership and operational requirements. In addition, primarily
due to its organization as a Maryland real estate investment trust, the Company
believes it will not be subject to state income taxes in jurisdictions where the
Properties are located. Therefore, the Consolidated Statements of Income for the
three and nine months ended September 30, 1998 do not include a provision for
Federal or state income taxes.
Sale of Third Party Management Business
- ---------------------------------------
Due to the non-qualified REIT income generated by the Third Party
Management Business, the Company classified this business as Held for Sale in
the first quarter of 1998 and closed the sale of the business effective as of
April 1, 1998. The Company, however, retained management agreements for 14
apartment communities, and all of the Unconsolidated Partnerships, as well as
its interests in Lexford Properties, Inc.'s training programs and property
management systems and certain of its former executive officers and other
personnel to facilitate improved management of the Company's Properties. As a
result of the decision to sell and in order to facilitate such sale of the Third
Party Management Business, the Company has taken the following actions:
The original merger agreement for the acquisition of Lexford
Properties, Inc. (the former owner of the Third Party Management
Business) included a provision that approximately $9.0 million, or
900,000 shares (valued at the time of acquisition), of the purchase
price was subject to forfeiture in whole or in part in the event the
Third Party Management Business did not achieve certain profitability
criteria by December 31, 1999. On March 13, 1998, the Company
negotiated a settlement with the prior shareholders of Lexford
Properties, Inc. whereby 300,000 of the 900,000 shares subject to
forfeiture were released in exchange for the forfeiture of the
remaining 600,000 shares. The release of the 300,000 shares resulted in
a $3.0 million charge in the first quarter of 1998.
11
<PAGE> 12
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
The Company adjusted the carrying value of goodwill associated with the
original acquisition of the Third Party Management Business by writing
off $2.0 million of goodwill. Due to the reclassification of the Third
Party Management Business as Held for Sale, the Company recorded a $1.3
million reserve for sale/disposal costs associated with this sale. The
above charges totaling $6.3 million have been classified as Loss on
Sale of Third Party Management Business.
Lexford Properties, Inc. formed a subsidiary, Lexford Property
Management, Inc. ("LPM") and contributed all of its interests in its
management contracts for multifamily apartment communities owned
entirely by third parties (other than its management contracts acquired
in December 1997 on a portfolio of 14 apartment communities) to LPM in
exchange for all of LPM's issued and outstanding preferred stock.
Effective as of April 1, 1998, the Company sold its entire preferred
stock interest in LPM to a company formed to acquire the Third Party Management
Business by FSC Realty LLC, a company affiliated with Stanley R. Fimberg, a
consultant to, and Trustee of, the Company at the time of the sale, Ralph V.
Williams, a consultant to the Company at the time of the sale and Bruce
Woodward, an executive officer of Lexford Properties, Inc. at the time of the
sale. As a result of the sale, each of Messrs. Fimberg, Williams and Woodward
severed their respective consulting and employment relationships with the
Company. Mr. Fimberg remains a Trustee of the Company. Each of Messrs. Fimberg,
Williams and Woodward were also former beneficial equity owners of Lexford
Properties, Inc. prior to the Company's original acquisition of the Third Party
Management Business in August 1996. The Company received a promissory note in
the principal amount of $1.8 million payable over a ten year period which bears
interest at 6% per annum until April 1, 2000 and 11% per annum thereafter, in
exchange for all of the outstanding preferred stock of LPM. Mr. Fimberg did not
participate in the Company's decision to sell the Third Party Management
Business. Management believes that the terms for the sale of the Third Party
Management Business are representative of terms which would have been available
from an unrelated purchaser.
Non-recurring Costs
- -------------------
Non-recurring Costs were approximately $1.8 million for the nine months
ended September 30, 1998. Approximately $1.6 million of the charge related to
the retirement plan ("Trustee Retirement Plan") for four Trustees who retired
April 15, 1998. Each retiring Trustee received a package consisting of the right
to receive a cash payment of $225,000 (the "Retirement Payment"), vesting of all
non-vested common share awards and the opportunity to continue participation in
the Company's Executive Deferred Compensation Plan and the Executive Deferred
Compensation Rabbi Trust (the "Rabbi Trust") for up to five years. The retiring
Trustees were also afforded the opportunity to defer receipt of all or any
portion of the Retirement Payment and direct that the deferred portion be
contributed to the Rabbi Trust and invested in the Company's common shares for
their benefit. In connection with their participation in the Trustee Retirement
Plan, two of the retiring Trustees elected to defer receipt of a total of
$400,000 of Retirement Payments in such manner. The majority of the remaining
$200,000 of Non-recurring Costs relates to severance costs associated with
terminated employees.
12
<PAGE> 13
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
Performance Equity Plan
- -----------------------
In October 1997, the shareholders of the Company approved the Company's
1997 Performance Equity Plan (the "Performance Plan"). The Performance Plan
authorizes the grant of restricted share awards to certain officers and
non-employee trustees. The Performance Plan has a three year term (1997 through
1999), with increasing performance goals associated with each year of the term.
A total of 636,000 restricted Common Shares are available for grants and have
been issued. Vesting under the Performance Plan occurs only upon attainment of
specified performance goals. The performance goals are stated as percentage
increases over base line amounts established, and as defined, in the Performance
Plan approved by shareholders. Any awards that remain non-vested after the third
year (i.e., the Company's 1999 fiscal year) will be forfeited.
Upon the attainment of certain of the performance goals set forth in
the Performance Plan as of the end of 1997, two thirds (424,000) of the shares
awarded under the Performance Plan became vested. An additional 44,000 shares
vested in April 1998 pursuant to the terms of the Trustee Retirement Plan (see
"Non-recurring Costs"). As of September 30, 1998, the Company has accrued $1.7
million related to the potential vesting of the remaining shares under the Plan.
Rabbi Trust
- -----------
The Company established the Rabbi Trust in 1996. The Rabbi Trust was
established to permit executive officers and trustees to defer taxes on awards
of Company shares. The Rabbi Trust is currently restricted to holding Company
shares or cash equivalents. In 1998, the Emerging Issues Task Force of the
Financial Accounting Standards Board ("EITF") reached a consensus on Issue No.
97-14, Accounting for Deferred Compensation Arrangements. The EITF concluded
that the deferred compensation liability and the securities issued to fund
deferred compensation must be consolidated by the Company and carried on the
Company's balance sheet. Further, the Company's common shares held in the Rabbi
Trust should be accounted for as treasury shares by the Company. The Company has
applied EITF No. 97-14 commencing with the first quarter of 1998. At September
30, 1998, 860,474 shares held in the Company's Rabbi Trust are included in
weighted average shares outstanding for earnings per share purposes and 168,000
non-vested contingent shares held in the Rabbi Trust are reflected in Treasury
Shares and excluded from weighted average shares outstanding for earnings per
share purposes.
13
<PAGE> 14
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 BASIS OF PRESENTATION (con't)
Earnings Per Share
- ------------------
The following table shows the amounts used in computing basic and
diluted earnings per share as well as weighted average numbers of shares
outstanding and the effect on income of restricted common shares and stock
option dilutive potential.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Numerator for Basic and Diluted Earnings Per Share:
Net Income/(Loss) $ 757,041 $ 1,840,975 $ (5,063,050) $ 4,591,976
=============== ============== =============== ==============
Denominator:
Denominator for Basic Earnings Per Share-
Weighted Average Shares 9,244,000 7,969,916 8,918,429 7,969,916
--------------- -------------- --------------- --------------
Effect of Dilutive Securities:
Stock options (1) 67,488 192,944 - 170,478
Time Vesting Restricted Share Awards 27,839 79,000 37,839 69,000
--------------- -------------- --------------- --------------
Dilutive Potential Common Shares 95,327 271,944 37,839 239,478
--------------- -------------- --------------- --------------
Denominator for Diluted Earnings Per Share-
Adjusted Weighted Average Shares 9,339,327 8,241,860 8,956,268 8,209,394
=============== ============== =============== ==============
Basic Earnings Per Share:
Net Income/(Loss) $ .08 $ .23 $ (.57) $ .58
=============== ============== =============== ==============
Diluted Earnings Per Share:
Net Income/(Loss) $ .08 $ .22 $ (.57) $ .56
=============== ============== =============== ==============
</TABLE>
(1) Stock Options for 67,488 shares were excluded from diluted earnings per
share for the nine months ended September 30, 1998 because including the
shares would be anti-dilutive as a result of the net loss the Company
recognized for the first nine months of the year.
In August 1996, the Company issued 1.4 million shares in connection
with the acquisition of Lexford Properties, Inc., 900,000 shares of which were
subject to forfeiture in whole or in part. The 900,000 contingent shares were
excluded from the weighted average shares outstanding. On March 13, 1998, the
Company negotiated a settlement whereby 300,000 of the contingent shares were
released in exchange for the forfeiture and cancellation of the remaining
600,000 shares. The 300,000 shares released are included in the weighted average
shares outstanding in 1998 (SEE "SALE OF THIRD PARTY MANAGEMENT BUSINESS").
14
<PAGE> 15
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 PROPERTY ACQUISITIONS
In conjunction with its determination to elect REIT status, the Company
initiated a consolidation plan, the purpose of which was to minimize third party
equity interests in the Unconsolidated Partnerships owning apartment communities
(the "Consolidation Plan"). In the first quarter of 1998, the Company had
acquired the entire equity ownership interest in 287 former Unconsolidated
Partnerships. The acquisition of the 287 former Unconsolidated Partnerships was
effective as of January 31, 1998.
Effective as of April 1, 1998, the Company acquired the entire
ownership interest in an additional 37 Unconsolidated Partnerships that owned 39
Properties, which were accounted for under the equity method in the first
quarter of 1998. The Company has made cash payments to the former partners of
the 324 former Unconsolidated Partnerships totaling $33.9 million. The acquired
former Unconsolidated Partnerships are now classified as Rental Properties.
The acquisition of the 324 former Unconsolidated Partnerships was
recorded as a purchase. The purchase price of $443.8 million was comprised of
$33.9 million to purchase former partners' equity interests, $47.3 million of
carrying value of investments in and advances to the 324 former Unconsolidated
Partnerships and the assumption of $362.6 million of non-recourse mortgage debt
on the acquired Properties (SEE NOTE 5).
NOTE 3 MORTGAGE DEBT
As of the Effective Date, the mortgages on 15 Rental Properties were
restated to estimated fair value (the "Carrying Value") because the Fresh Start
value of the respective Rental Property was less than the outstanding principal
amount of its mortgage. The difference between the Carrying Value of each such
mortgage and the full unpaid principal amount thereof is characterized as a
"Mortgage Deficiency" for Fresh Start purposes. Although the value of the Rental
Properties may have increased since the Effective Date, the Carrying Values of
the mortgages and the Rental Properties have not been adjusted. Interest expense
is recorded based on the Carrying Value of the mortgage using the effective
interest rate method. Mortgages which have been originated or assumed following
the Effective Date (including non-recourse mortgages on the 326 Properties
acquired pursuant to the Consolidation Plan) are recorded as liabilities on the
Consolidated Balance Sheets in their full principal amount. Typically, each
Rental Property is secured by a separate mortgage loan. The mortgage loans on a
portfolio of 26 Rental Properties contain cross collateral and cross default
provisions; however, all of the mortgage loans secured by the Rental Properties
are non-recourse to the Company.
In December 1997, in furtherance of its deleveraging strategy, the
Company arranged for a mortgage purchase facility with a financial institution
wherein the lender agreed to purchase outstanding mortgage notes on certain of
the Properties. Mortgage purchase transactions were arranged to facilitate
either a discount of the face amount of the mortgage or a negotiated pre-payment
for a pre-payment premium of less than that otherwise contracted for under the
terms of the mortgage loans purchased. In connection with the mortgage purchase
facility, the lender engaged in a series of transactions pursuant to which the
lender has purchased mortgage loans on twenty-seven Properties from the
predecessor holders. The purchased mortgage loans (net of any discount and
inclusive of any pre-payment premium received from, or paid to, the predecessor
lender) total approximately $34.5 million in principal outstanding as of
September 30, 1998. Pursuant to the agreements governing the mortgage purchase
facility, the Company
15
<PAGE> 16
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 3 MORTGAGE DEBT (con't)
has the right to purchase, and the lender has the right to require the Company
to purchase, the mortgage loans at a price equal to the lender's cost basis,
less any principal payments made while the lender has owned the loans. The
Company is seeking to either (a) obtain an alternative facility for the purchase
of these loans, or (b) refinance these mortgage loans, in order to provide for
funding in the event the lender determines to require the Company to purchase
the loans.
The outstanding non-recourse mortgage debt on the Rental Properties,
including the mortgage debt assumed in relation to the acquisition of the 324
former Unconsolidated Partnerships at September 30, 1998 and December 31, 1997
is as follows:
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
------------------------ --------------------------
<S> <C> <C>
Contractual Mortgage Payable $ 506,410,263 $ 150,284,725
Mortgage Deficiency (7,222,968) (7,647,851)
------------------------ ----------------------
$ 499,187,295 $ 142,636,874
======================== ======================
</TABLE>
Approximately $190.0 million of the contractual mortgage debt including
the Company's credit facility, is prepayable without substantial penalty at
September 30, 1998. The Company is seeking alternative financing to fund
prepayment of the mortgage debt. Any prepayment of mortgage debt at the
contractual value in excess of its carrying value will result in an
extraordinary charge equal to the amount of Mortgage Deficiency associated with
such debt.
In the second quarter of 1997 an extraordinary non-cash loss of
$180,534, net of income tax benefits of $115,000, resulted from the mortgage
debt refinancing of one Rental Property.
NOTE 4 RELATED PARTY TRANSACTIONS
The Company manages all but one of the Properties owned by the
Unconsolidated Partnerships. The Company earned fee based revenues from the
Unconsolidated Partnerships of approximately $443,000 and $2.7 million for the
three months ended September 30, 1998 and 1997, respectively and $2.2 million
and $8.5 million for the nine months ended September 30, 1998 and 1997,
respectively. The Company also earned a majority of its interest income on its
receivables (including second mortgages) from the Unconsolidated Partnerships.
Approximately $536,000 and $1.9 million of the Company's Accounts Receivable
(net of allowances) were due from the Unconsolidated Partnerships as of
September 30, 1998 and December 31, 1997, respectively. The decline in the
accounts receivable is due primarily to the acquisition of the 324 former
Unconsolidated Partnerships pursuant to the Consolidation Plan. Fee Based
Revenues and Accounts Receivable related to the Rental Properties are eliminated
in consolidation.
The Company received net principal repayment of advances from
Unconsolidated Partnerships of approximately $8,000 in the first nine months of
1998 as compared to approximately $579,000 in the first nine months of 1997.
These advance repayments were credited to Investments in and Advances to
Unconsolidated Partnerships (SEE NOTE 1 -- "INVESTMENTS IN AND ADVANCES TO
UNCONSOLIDATED PARTNERSHIPS").
16
<PAGE> 17
LEXFORD RESIDENTIAL TRUST
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 5 UNAUDITED PRO FORMA CONDENSED CONSOLIDATED INCOME
STATEMENTS
The following unaudited pro forma condensed consolidated income
statements for the three and nine months ended September 30, 1998 and 1997
assume that all 324 former Unconsolidated Partnerships acquired in 1998 were
purchased as of January 1, 1998, and 1997, respectively. The unaudited pro forma
condensed consolidated income statements do not purport to present what the
Company's results of operations would actually have been had such events in fact
occurred on the date or at the beginning of the periods indicated above or to
project the Company's results of operations for any future date or period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
Pro Forma Condensed Consolidated Income Statements September 30, September 30,
- -------------------------------------------------- 1998 1997 1998 1997
----------------------------------------------------
Unaudited Unaudited Unaudited Unaudited
----------------------------------------------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
REVENUES:
Rental and Other Property Revenues $ 37,404 $ 36,980 $ 111,101 $ 108,085
Fee Based and Income from Unconsolidated Partnerships (a) 1,788 2,948 5,477 8,117
---------- ---------- ---------- ----------
39,192 39,928 116,578 116,202
---------- ---------- ---------- ----------
EXPENSES:
Property Operating and Maintenance 12,418 11,632 35,811 34,824
Real Estate Taxes and Insurance 3,130 3,282 9,108 9,857
Property Management (a) 2,843 4,072 9,604 12,008
Administration 1,658 1,268 4,708 3,630
Non-recurring Costs/Performance Equity Plan (b) 829 539 3,466 789
Interest 11,672 12,029 35,006 36,090
Depreciation and Amortization 5,920 5,456 17,679 15,256
Loss on Sale of Third Party Management Business (c) -- -- 6,300 --
---------- ---------- ---------- ----------
38,470 38,278 121,682 112,454
---------- ---------- ---------- ----------
Income/(Loss) before Gain on Disposal of Assets,
Income Taxes and Extraordinary Items 722 1,650 (5,104) 3,748
Provision for Income Taxes -- (935) -- (2,020)
Extraordinary Loss -- -- -- (181)
Gain on Disposal of Assets - net 35 773 285 1,462
---------- ---------- ---------- ----------
Net Income/(Loss) $ 757 $ 1,488 $ (4,819) $ 3,009
========== ========== ========== ==========
Basic Earnings/(Loss) Per Share $ .08 $ .19 $ (.54) $ .38
========== ========== ========== ==========
Diluted Earnings/(Loss) Per Share $ .08 $ .18 $ (.54) $ .37
========== ========== ========== ==========
(a) Includes management fees received and expenses incurred in connection with the operation of the Company's
Third Party Management Business during 1997. (See Note 1 - - "Sale of Third Party Management Business".)
The decline in Fee Based revenues is primarily attributable to the sale described therein.
(b) See Note 1 - - "Non-recurring Costs" and "Performance Equity Plan".
(c) See Note 1 - - "Sale of Third Party Management Business".
</TABLE>
17
<PAGE> 18
NOTE 6 SUBSEQUENT EVENT
On July 10, 1998, the Company declared its first quarterly dividend of
$0.4325 per share. A dividend of $4.1 million was paid on October 15, 1998 to
shareholders of record on September 30, 1998. This dividend was declared by the
Board of Trustees in furtherance of its previously announced initial dividend
policy of an annualized dividend rate of $1.73 per share.
On October 30, 1998, the Company reached a settlement in its lawsuit
against Hartford Fire Insurance Company related to claims for termite damage
losses. Pursuant to the terms of the settlement agreement the Company, in its
capacity as general partner of limited partnerships that own Rental Properties
and Unconsolidated Partnerships and as agent for parties that have purchased
apartment communities formerly owned by Unconsolidated Partnerships, has
received cash payment in the gross amount of $3,075,000 and has paid contingency
legal fees of $975,000 from the settlement proceeds. The net proceeds of the
settlement will be allocated among the properties (including those owned by
third parties) based upon the extent of the termite damage at each such
property. The Company's portion of the proceeds from the settlement will be
utilized to offset costs to be incurred for termite repairs.
18
<PAGE> 19
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion explains material changes in the Company's
results of operations, comparing the three and nine months ended September 30,
1998 and 1997, and significant developments affecting the Company's financial
condition since the end of 1997. As a result of the Company's consolidation of
324 former Unconsolidated Partnerships in January and April 1998, the operating
results of such Unconsolidated Partnerships are included in the Company's
financial statements for the quarter and a portion of the nine months ended
September 30, 1998. Therefore, the Company's results for the three and nine
months ended September 30, 1998 will not be comparable to the same periods in
1997. The following discussion should be read in conjunction with the historical
financial statements of the Company.
RESULTS OF OPERATIONS
RENTAL AND OTHER PROPERTY REVENUES are derived from the Rental
Properties which own and operate apartment communities. Rental and Other
Property Revenues increased approximately $26.7 million, or 248%, for the three
months ended September 30, 1998, and $68.8 million, or 219% for the nine months
ended September 30, 1998, as compared to the same periods in 1997. The majority
of the increase, $26.6 million for the three month period and $68.5 million for
the nine month period, is related to the acquisition of the 324 former
Unconsolidated Partnerships in 1998. On a comparable unit basis (111 Rental
Properties in operation for both periods), the average monthly rent collected
per occupied unit during the nine month period increased from $427 in 1997 to
$434 in 1998.
FEE BASED REVENUES no longer represent a material source of revenues
for the Company as a result of the Consolidation Plan (see the discussion
following the tabular presentation below). Fee based revenues are comprised of
management services and investment management revenues generated from services
provided to Unconsolidated Partnerships, third party owners and residents at the
Properties. Management services revenues principally relate to property
management and accounting services provided to the Unconsolidated Partnerships
and third party property owners (SEE NOTE 1 OF NOTES TO THE CONSOLIDATED
FINANCIAL STATEMENTS). The Company also provides ancillary services to the
Unconsolidated Partnerships, including a "Preferred Resource" discount buying
program and laundry services. The Company enters into group buying, volume
discount contracts with major vendors as agent for the Unconsolidated
Partnerships and third party owned properties and receives a discount from
vendors for every purchase made through the Preferred Resource program, as well
as a rebate from residents' use of laundry equipment. Investment management
revenues consist of partnership administration fees as well as, in 1997, fees
generated from loan refinancing and restructuring.
The following are the major components of management services revenues
and investment management fee-based revenues for the three and nine months ended
September 30, 1998 as compared to the same periods in 1997 (certain amounts
previously reported have been reclassified herein between Property Management
Services and Preferred Resource for all periods presented):
19
<PAGE> 20
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
(In thousands) (In thousands)
1998 1997 1998 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Management Services:
Property Management Services:
Unconsolidated Partnerships $ 437 $ 2,536 $ 2,155 $ 7,084
Third Party 376 1,054 1,237 3,047
Preferred Resources Revenues 300 413 757 1,282
-------------- -------------- -------------- --------------
Total Management Services Revenues 1,113 4,003 4,149 11,413
-------------- -------------- -------------- --------------
Investment Management:
Partnership Administration & Other Fees 50 292 242 859
Loan Refinancing and Restructuring Fees -- 8 -- 114
-------------- -------------- -------------- --------------
Total Investment Management Fee Revenues 50 300 242 973
-------------- -------------- -------------- --------------
Total Fee Based Revenues $ 1,163 $ 4,303 $ 4,391 $ 12,386
============== ============== ============== ==============
</TABLE>
FEE BASED REVENUES decreased approximately $3.1 million, or 73%, for
the three months ended September 30, 1998, and $8.0 million, or 65%, for the
nine months ended September 30, 1998 as compared to the same periods in 1997.
The decrease for the three month period was primarily due to the elimination of
fee based revenues related to the acquisition of the 324 former Unconsolidated
Partnerships in 1998. In addition, the sale of the Third Party Management
Business resulted in a net decrease in third party management fees of
approximately $678,000 and $1.8 million for the three and nine months ended
September 30, 1998 as compared to the same periods in 1997, partially offset by
third party management fees generated from management agreements on 14 apartment
communities. The Company originated these management agreements in December 1997
and retained them when the Third Party Management Business was sold. Preferred
Resource revenues decreased approximately $113,000 for the three months ended
September 30, 1998, and $525,000 for the nine months ended September 30, 1998 as
compared to the same periods in 1997. The decrease was due to the classification
of vendor rebates on purchases made by the 324 former Unconsolidated
Partnerships from and after the implementation of the Consolidation Plan as an
offset to maintenance expense instead of revenues from services provided to
Unconsolidated Partnerships.
INCOME FROM UNCONSOLIDATED PARTNERSHIPS decreased approximately $2.0
million, or 76%, for the three months ended September 30, 1998, and $5.6
million, or 72%, for the nine months ended September 30, 1998, as compared to
the same periods in 1997. This income is primarily derived from the interest
collected or accrued on the recorded value of Investments in and Advances to
Unconsolidated Partnerships (SEE NOTE 1 OF NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS). The decrease in Income from Unconsolidated Partnerships was due to
the acquisition of the 324 former Unconsolidated Partnerships in 1998 and the
corresponding reclassification of recorded values of $47.3 million from
Investments in and Advances to Unconsolidated Partnerships to Rental Properties
(SEE NOTE 2 OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS).
PROPERTY OPERATING AND MAINTENANCE expense increased approximately $9.6
million, or 346%, for the three months ended September 30, 1998, and $22.7
million, or 232%, for the nine months ended September 30, 1998, as compared to
the same periods in 1997. The majority of the increase is related to the
acquisition of the 324 former Unconsolidated Partnerships in 1998. On a
comparable unit basis, Property Operating and Maintenance expense from the 111
Rental Properties in operation for both periods increased approximately $695,500
or 25.0%, for the three months ended September 30, 1998 and
20
<PAGE> 21
approximately $612,500 or 6.3%, for the nine months ended September 30, 1998 as
compared to the same periods in 1997. The increase for the three month period
was primarily due to an approximately $504,000 adjustment recorded in the third
quarter of 1997 to capitalize furniture and fixture replacements expensed in the
first half of the year. In the third quarter of 1997, management reviewed its
replacement maintenance costs and determined that certain expenditures had a
longer useful life and did not require frequent replacement. The balance of the
increase for the three months primarily relates to increased lawn care and
landscaping costs in 1998 as compared to 1997. The increase for the nine month
period was primarily due to a write-down of approximately $400,000 in insurance
claim receivables in the first quarter of 1998.
REAL ESTATE TAXES AND INSURANCE expense increased approximately $2.1
million, or 202%, for the three months ended September 30, 1998, and $5.2
million, or 172%, for the nine months ended September 30, 1998, as compared to
the same periods in 1997. The increase was due to the acquisition of the 324
former Unconsolidated Partnerships in 1998. Real Estate Taxes and Insurance
expense from the 111 Rental Properties in operation for both periods decreased
approximately $87,200, or 8.4%, for the three months ended September 30, 1998
and approximately $192,900, or 6.4% for the nine months ended September 30,
1998, as compared to the same periods in 1997. The decrease resulted from
reduced insurance premiums upon the renewal of insurance policies, which also
benefited Unconsolidated Partnerships.
PROPERTY MANAGEMENT expense decreased approximately $1.2 million, or
30.2%, for the three months ended September 30, 1998, and $2.4 million or 20.2%,
for the nine months ended September 30, 1998, as compared to the same periods in
1997. Property Management expense decreased primarily due to the sale of the
Third Party Management Business effective April 1, 1998 (SEE NOTE 1 OF NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS). The Company records Property Management
expense for all Properties under management, including all Unconsolidated
Partnerships and Rental Properties.
ADMINISTRATION expense increased approximately $390,500, or 30.8% for
the three months ended September 30, 1998, and approximately $1.1 million, or
29.6%, for the nine months ended September 30, 1998 as compared to the same
periods in 1997. The increase in administration expense was primarily due to the
following: an increase of approximately $122,800 and $273,200 for the three and
nine months ended September 30, 1998, respectively, as compared to the same
periods in 1997 related to the creation of an Acquisition and Disposition
Department in 1998; an increase of approximately $166,000 and $483,000 for the
three and nine months ended September 30, 1998, respectively, as compared to the
same periods in 1997 related to salary, stock compensation and relocation for
two new executives; an increase of approximately $65,800 and $210,400 for the
three and nine months ended September 30, 1998, respectively, as compared to the
same periods in 1997 related to facility costs for the Company's separate
executive offices opened in September 1997, offset by lower facility costs
included in Property Management; and the reclassification of certain continuing
employee related expenses from Property Management to Administration expense.
NON-RECURRING COSTS were approximately $1.8 million for the nine months
ended September 30, 1998. Approximately $1.6 million of the charge related to
the retirement plan for four Trustees who retired April 15, 1998. Each retiring
Trustee received a package consisting of the right to receive a cash payment of
$225,000 (the "Retirement Payment"), vesting of all non-vested common share
awards and the opportunity to continue participation in the Company's Deferred
Compensation Plan and Rabbi Trust for up to five years. The retiring Trustees
were also afforded the opportunity to defer receipt of all or any portion of the
Retirement Payment and direct that the deferred portion be contributed to the
Rabbi Trust and invested in the Company's common shares for their benefit. In
connection with their
21
<PAGE> 22
participation in the Trustee Retirement Plan, two of the retiring Trustees
elected to defer receipt of a total of $400,000 of Retirement Payments in such
manner. The majority of the remaining $200,000 of Non-recurring Costs relates to
severance costs associated with terminated employees.
PERFORMANCE EQUITY PLAN expense represents the non-cash charge recorded
based upon the potential vesting of the remaining shares available under the
1997 Performance Equity Plan which was approved by the Company's shareholders at
the 1997 annual meeting. (SEE NOTE 1 OF NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS).
INTEREST expense for mortgages on the Rental Properties increased
approximately $7.6 million for the three months ended September 30, 1998, and
approximately $19.8 million for the nine months ended September 30, 1998, as
compared to the same periods in 1997. The majority of the increase was due to
the acquisition of the 324 former Unconsolidated Partnerships in 1998. On a
comparable unit basis, Interest Expense from the 111 Rental Properties in
operation for both periods remained relatively constant. Interest Expense on the
Company's revolving and term credit line increased approximately $343,500 for
the three months ended September 30, 1998 and approximately $616,700 for the
nine months ended September 30, 1998 as compared to the same periods in 1997.
This increase was due primarily to the increase in the principal amount
outstanding related to costs incurred with the acquisition of the 324 former
Unconsolidated Partnerships.
DEPRECIATION AND AMORTIZATION expense increased approximately $3.9
million for the three months ended September 30, 1998, and $11.0 million for the
nine months ended September 30, 1998 as compared to the same periods in 1997.
The increase is due to a $300,000 write-off of the value of a land lease and
approximately $4.3 million and $10.7 million for the three and nine months ended
September 30, 1998, respectively, related to depreciation on the Properties
owned by the 324 former Unconsolidated Partnerships acquired in 1998.
LOSS ON SALE OF THIRD PARTY MANAGEMENT BUSINESS was $6.3 million for
the nine months ended September 30, 1998. Due to the non-qualifying REIT income
generated by the Third Party Management Business, the Company classified this
business as Held for Sale in the first quarter of 1998 and closed the sale of
the business effective as of April 1, 1998. The Company, however, retained
management agreements for 14 apartment communities acquired in December 1997,
Lexford Properties, Inc.'s training programs, property management systems and
certain of its executive officers and other personnel to facilitate improved
management of the Company's Properties. As a result of the decision to sell and
in order to facilitate such sale of the Third Party Management Business, the
Company has taken the following actions:
The original merger agreement for the acquisition of Lexford
Properties, Inc. (the former owner of the Third Party Management
Business) included a provision that approximately $9.0 million, or
900,000 shares (valued at the time of acquisition), of the purchase
price was subject to forfeiture in whole or in part in the event the
Third Party Management Business did not achieve certain profitability
criteria by December 31, 1999. On March 13, 1998, the Company
negotiated a settlement with the prior shareholders of Lexford
Properties, Inc. whereby 300,000 of the 900,000 shares subject to
forfeiture were released in exchange for the forfeiture of the
remaining 600,000 shares. The release of the 300,000 shares resulted in
a $3.0 million charge in the first quarter of 1998.
The Company adjusted the carrying value of goodwill associated with the
original acquisition of the Third Party Management Business by writing
off $2.0 million of goodwill. Due to the
22
<PAGE> 23
reclassification of the Third Party Management Business as Held for
Sale, the Company recorded a $1.3 million reserve for sale/disposal
costs associated with this sale.
Lexford Properties, Inc. formed a subsidiary, Lexford Property
Management, Inc. ("LPM"), and contributed all of its interests in its
management contracts for multifamily apartment communities owned
entirely by third parties (other than its management contracts on a
portfolio of 14 properties acquired in December 1997) to LPM in
exchange for all of LPM's issued and outstanding preferred stock.
Effective as of April 1, 1998, the Company sold its entire preferred
stock interest in LPM to a company formed to acquire the Third Party Management
Business by FSC Realty, LLC, a company affiliated with Stanley R. Fimberg, a
consultant to, and Trustee of, the Company at the time of the sale, Ralph V.
Williams, a consultant to the Company at the time of the sale and Bruce
Woodward, an executive officer of Lexford Properties, Inc. at the time of the
sale. As a result of the sale, each of Messrs. Fimberg, Williams and Woodward
severed their respective consulting and employment relationships with the
Company. Mr. Fimberg remains a Trustee of the Company. Each of Messrs. Fimberg,
Williams and Woodward were also former beneficial equity owners of Lexford
Properties, Inc. prior to the Company's original acquisition of the Third Party
Management Business in August 1996. The Company received a promissory note in
the principal amount of $1.8 million payable over a ten year period which bears
interest at 6% per annum until April 1, 2000 and 11% per annum thereafter, in
exchange for all of the outstanding preferred stock of LPM. Mr. Fimberg did not
participate in the Company's decision to sell the Third Party Management
Business. Management believes that the terms for the sale of the Third Party
Management Business are representative of terms which would have been available
from an unrelated purchaser.
GAIN ON DISPOSAL OF ASSETS decreased approximately $738,300 for the
three months ended September 30, 1998, and approximately $1.2 million for the
nine months ended September 30, 1998, as compared to the same periods in 1997.
This income is derived from the disposition of miscellaneous assets. Gain on
Disposal of Assets is not a recurring, long-term source of revenue.
Earnings before Interest, Taxes, Depreciation and Amortization
EBITDA is computed as net income before extraordinary items plus
interest expense, taxes and depreciation and amortization. Recurring EBITDA is
computed as EBITDA, as adjusted for non-recurring items. Adjusted EBITDA is
computed as Recurring EBITDA plus principal payments received on account of
receivables from Unconsolidated Partnerships less interest on Rental Property
mortgage debt. Management believes that, in addition to cash flows and net
income, Recurring EBITDA is a useful financial performance measure for assessing
the operating performance of an equity REIT because, together with net income
and cash flows, Recurring EBITDA provides investors with an additional basis to
evaluate the ability of a REIT to incur and service debt and to fund
acquisitions and other capital expenditures and to make distributions to
shareholders. To evaluate Recurring EBITDA and the trends it depicts, the
components of Recurring EBITDA, such as rental and other revenues, operating and
maintenance expenses, real estate taxes and general and administrative expenses,
should be considered. Excluded from EBITDA and Recurring EBITDA are financing
costs such as interest expense as well as depreciation and amortization, each of
which can significantly affect a REIT's results of operations and liquidity and
should be considered in evaluating a REIT's operating performance. Further,
Recurring EBITDA does not represent net income or cash flows provided by (used
in) operating, financing and investing activities as defined by Generally
Accepted Accounting Principles ("GAAP") and does not necessarily indicate that
cash flows will be sufficient to fund cash needs. It should not be
23
<PAGE> 24
considered as an alternative to net income as an indicator of the Company's
operating performance or to cash flows as a measure of liquidity.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) (In thousands)
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
EBITDA $ 18,315 $ 7,966 $ 41,939 $ 22,266
---------- ---------- ---------- ----------
Loss on Sale of Third Party Management Business -- -- 6,300 --
Loan Fees -- (7) -- (114)
Reserve of Non-Operating Property Receivables -- -- 400 --
Non-recurring Costs -- 538 1,808 788
---------- ---------- ---------- ----------
Recurring EBITDA 18,315 8,497 50,447 22,940
---------- ---------- ---------- ----------
Interest on Mortgage Loans to Rental Properties (11,155) (3,569) (30,264) (10,505)
Principal Payments from Unconsolidated
Partnerships 59 783 354 783
---------- ---------- ---------- ----------
Adjusted EBITDA $ 7,219 $ 5,711 $ 20,537 $ 13,218
========== ========== ========== ==========
</TABLE>
Adjusted EBITDA increased approximately $1.5 million, or 26.4%, for the
three months ended September 30, 1998, and $7.3 million, or 55.4%, for the nine
months ended September 30, 1998, as compared to the same periods in 1997. The
increase in Adjusted EBITDA was primarily related to the acquisition of the 324
former Unconsolidated Partnerships.
Funds from Operations
Funds from Operations ("Funds from Operations" or "FFO") is calculated
in accordance with the White Paper on FFO approved by the Board of Governors of
the National Association of Real Estate Investment Trusts ("NAREIT") in March
1995 (net income (loss) in accordance with GAAP, excluding gains (or losses)
from debt restructuring and sales of property, plus real estate related
depreciation and amortization (excluding amortization of deferred financing
costs and after similar adjustments for unconsolidated partnerships and joint
ventures)), further adjusted by the Company to eliminate expenses attributable
to certain non-cash share awards and compensation, operations from sold
properties and certain non-recurring expenditures. In addition to cash flows and
net income, management considers FFO to be an additional measure of the
performance of an equity REIT because, together with net income and cash flows,
FFO provides investors with an additional basis to evaluate the ability of an
entity to fund acquisitions and other capital expenditures and to make
distributions to shareholders. However, FFO does not measure whether cash flow
is sufficient to fund all of an entity's cash needs including principal
amortization, capital improvements and distributions to shareholders. FFO does
not actually represent the cash made available to investors during any
particular period. FFO also does not represent cash flows provided by (used in)
operating, investing or financing activities as determined in accordance with
GAAP. FFO should not be considered as an alternative to net income as an
indicator of the Company's operating performance or to cash flows as a measure
of liquidity. Further, FFO as disclosed by other REITs may not be comparable to
the Company's calculation of FFO.
24
<PAGE> 25
<TABLE>
<CAPTION>
Funds from Operations
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) (In thousands)
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net Income / (Loss) $ 757 $ 1,840 $ (5,063) $ 4,592
------------ ------------ ------------ ------------
Real Estate Depreciation 5,459 1,255 14,320 3,556
Gain on Disposal of Assets (35) (773) (284) (1,462)
Non-Cash Stock Compensation 1,102 203 2,838 952
Non-Recurring Items -- 538 1,808 788
Loss on Sale of Third Party Management
Business -- -- 6,300 --
Reserve for Non-Operating Receivables -- -- 400 --
Amortization associated with Land Lease and
Goodwill -- 52 388 181
Capitalization of Replacement Items Recorded in
the Third Quarter of 1997 -- (500) -- --
Extraordinary Loss -- -- -- 180
Provision for Income Taxes -- 1,161 -- 3,035
------------ ------------ ------------ ------------
$ 7,283 $ 3,776 $ 20,707 $ 11,822
============ ============ ============ ============
</TABLE>
FFO increased approximately $3.5 million, or 92.9% for the three months
ended September 30, 1998 and $8.9 million, or 75.2% for the nine months ended
September 30, 1998, as compared to the same periods in 1997. The increase in FFO
was principally due to the acquisition of the 324 former Unconsolidated
Partnerships in 1998. Accordingly, management does not consider a comparison of
FFO for the three and nine months ended September 30, 1998 to the same periods
in 1997 to be meaningful.
Same Store Property Operating Results
The following table summarizes the unaudited combined operating
results, excluding management and other fees charged by the Company, of the 501
Properties the Company has owned or maintained an ownership interest in at all
times during the three and nine months ended September 30, 1998 and 1997 (the
"501 Property Same Store Portfolio") (SEE "RENTAL AND OTHER PROPERTY REVENUES"):
25
<PAGE> 26
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
STATISTICAL INFORMATION
Properties 501 501 501 501
Units 32,973 32,973 32,973 32,973
Average Economic Occupancy 93.0% 92.6% 92.3% 91.6%
Average Physical Occupancy 94.8% 93.6% 93.9% 92.6%
Average Rent Collected / Unit / Month $ 437 $ 432 $ 435 $ 429
FINANCIAL INFORMATION (In thousands)
Revenues
Rental Income $ 40,975 $ 39,979 $ 121,310 $ 117,875
Other Property Income 1,852 2,097 5,760 5,067
------------ ------------ ------------ ------------
Total Revenues 42,827 42,076 127,070 122,942
------------ ------------ ------------ ------------
Expenses
Property Operating and Maintenance 13,129 12,496 37,584 36,320
Real Estate Taxes and Insurance 3,626 3,811 10,806 11,458
Major Maintenance (1) 1,301 1,450 2,702 3,400
Other 176 263 885 608
------------ ------------ ------------ ------------
Total Expenses 18,232 18,020 51,977 51,786
------------ ------------ ------------ ------------
Property Operating Income 24,595 24,056 75,093 71,156
Interest - Mortgage Debt 12,454 12,689 37,571 38,319
------------ ------------ ------------ ------------
Income after operating, maintenance, improvement
and interest expenses $ 12,141 $ 11,367 $ 37,522 $ 32,837
============ ============ ============ ============
Capital Expenditures (1) $ 5,764 $ 3,567 $ 10,796 $ 7,945
============ ============ ============ ============
</TABLE>
(1) The September 30, 1997 Major Maintenance and Capital Expenditures line items
have been adjusted as if the capitalization policy that was revised in the third
quarter of 1997 to include capitalization of certain replacement items (formerly
expensed) had been in effect during the first nine months of 1997.
Same Store Property Operating Results - By Region
The Company's 501 Property Same Store Portfolio is located in four
distinct regions. The Northeast region is comprised of northern and central
Ohio, Pennsylvania, and West Virginia; the Central region is comprised of
southern Ohio, Indiana, Kentucky and Michigan; the Mid-Atlantic region is
primarily Georgia; and the Southeast region is Florida. The Company owns, or
maintains ownership interests in three Properties comprised of 190 units that
are not managed by the Company and are not included in the following regional
information.
26
<PAGE> 27
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
Northeast Region
Units 8,885
Average Economic Occupancy ===== 94.1% 93.8% 93.2% 92.4%
Average Physical Occupancy 94.9% 94.4% 94.0% 92.9%
Average Rent collected/Unit/Month $ 446 $ 439 $ 443 $ 436
Central Region
Units 9,268
Average Economic Occupancy ===== 93.5% 93.5% 93.1% 92.4%
Average Physical Occupancy 94.8% 93.8% 94.3% 92.7%
Average Rent collected/Unit/Month $ 419 $ 416 $ 416 $ 414
Mid-Atlantic Region
Units 5,056
Average Economic Occupancy ===== 91.6% 91.4% 91.0% 91.1%
Average Physical Occupancy 94.8% 93.3% 93.5% 92.2%
Average Rent collected/Unit/Month $ 467 $ 460 $ 467 $ 461
Southeast Region
Units 9,574
Average Economic Occupancy ===== 92.6% 91.6% 91.8% 90.5%
Average Physical Occupancy 94.6% 92.9% 93.7% 92.2%
Average Rent collected/Unit/Month $ 433 $ 426 $ 432 $ 423
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
- ---------
The following discussion regarding liquidity and capital resources
should be read in conjunction with the Company's Consolidated Balance Sheets as
of September 30, 1998 and December 31, 1997 and the Consolidated Statements of
Cash Flows for the nine months ended September 30, 1998 and 1997.
The Company anticipates that cash flow from its operations and
borrowings available under the Company's credit facility should be adequate to
meet the foreseeable capital and liquidity requirements of the Company.
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 increased approximately $6.3
million for the nine months ended September 30, 1998, as compared to the same
period in 1997. The increase was due primarily to the acquisition of 324 former
Unconsolidated Partnerships in 1998.
The other factors impacting the Company's cash flow in 1998 as compared
to the same period in 1997 are discussed in "Results of Operations."
27
<PAGE> 28
REIT Election
- -------------
After careful consideration and consultation with its legal, tax and
financial advisers, the Company announced on December 19, 1997 that it would
seek to elect to be taxed as a REIT. To help facilitate REIT qualification and
to position itself to meet the expectations which management believes the
capital markets apply to REITs, the Company engaged in the following
transactions (collectively referred to as the "REIT Conversion"): (i) the merger
of the Company's predecessor, Lexford, Inc., with and into the Company (SEE NOTE
1 OF NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS), and (ii) the sale of the
Third Party Management Business. The REIT Conversion was structured so as to
allow the Company to carry on the pre-existing business of owning and managing
multifamily residential apartment communities but at the same time to take
advantage of favorable Federal and state income tax consequences available to
REITs. In addition, the Company believes the market valuations and access to
capital markets are more favorable to REITs as compared to the traditional "C"
corporation real estate operating companies. The Company believes its REIT
status will enhance its ability to pursue its growth strategy.
In connection with the REIT Conversion, the Company announced a
strategy to deleverage its balance sheet (i.e. reduce its total mortgage
indebtedness thereby improving the ratio of its total debt to its total
capitalization). In order to implement its deleveraging strategy, the Company
conducted a secondary offering of its common shares of beneficial interest;
however, in late May 1998 when the SEC had declared the Company's Form S-3
Registration Statement filed in connection with such public offering effective,
the Company's Board of Trustees and executive management determined that
pursuing the offering would not be in the best interest of the Company's
shareholders because the price at which the Company could issue and sell its
common shares would be excessively dilutive to the Company's existing
shareholders. Since that time, in the opinion of management and the Trustees,
the equity capital markets for REITs have not improved such that a public
offering of the Company's common shares is warranted at this time. For these
reasons, the Company has determined to consider other strategic alternatives to
implement its goal of deleveraging its balance sheet, although it will continue
to maintain its "shelf" registration statement in order to facilitate an
expeditious offering of common shares in the event market conditions so warrant.
Such strategic alternatives may include, but are not limited to, the sale of
Properties and application of net proceeds of sale to the reduction of the
Company's indebtedness. The Company may consider the sale of Properties or other
alternatives, but no firm decision has been made at this time with respect to
the advisability or implementation of any of them.
Shelf Registration
- ------------------
On May 21, 1998, the Company announced that it had postponed the
securities offering it had planned due to the current market conditions for REIT
securities. The Company had planned a public offering of 11 million common
shares of beneficial interest. On June 2, 1998, the Company filed a shelf
registration statement with the SEC for the potential offering of up to 12.65
million common shares of beneficial interest. The Company intends to undertake
an offering under this shelf registration depending upon market conditions and
capital requirements. The costs associated with the proposed offering have been
deferred pending potential share issuance under the shelf registration.
The Company had obtained a commitment letter from Bank Boston, NA for a
$150.0 million credit facility that was contingent upon the Company raising new
equity capital of at least $240.0
28
<PAGE> 29
million. Due to the withdrawal of the proposed offering of 11 million shares,
this facility is not available to the Company.
In October 1997, the Company retained Morgan Stanley & Co.,
Incorporated ("Morgan Stanley") as its financial advisor in connection with the
proposed securities offering. In July 1998, the Company reached an agreement for
the termination of the engagement of Morgan Stanley as its managing underwriter
for public offering equity securities. In connection with this termination,
Morgan Stanley agreed that it is not entitled to any fees or reimbursement of
out of pocket costs and expenses from the Company in consideration for the
Company's agreement to continue its retention of Morgan Stanley as its financial
advisor (as contemplated by the October 1997 letter agreement) in the event of
sale, merger or divestiture/spin-off commenced on or before January 22, 2000.
Credit Facility
- ---------------
On September 30, 1998, the Company entered into the Second Amended and
Restated Loan and Security Agreement with The Provident Bank. The amended
revolving credit facility ("Facility"), is for $40 million and represents an
increase to and replacement of all former revolving credit facilities with The
Provident Bank (the "Bank"). The scheduled term of the Facility expires March
30, 2000, although the Company may elect from time to time to convert all or any
portion of the principal amount outstanding under the Facility into a five year
term loan. Revolving loans outstanding under the Facility bear interest at a
variable interest rate equal to the Bank's prime rate of interest, 8.00%, minus
1% at October 31, 1998. As of September 30, 1998 the outstanding balance under
the Facility was $23.3 million compared to $2.6 million at December 31, 1997.
The increase in borrowings was due to the costs to acquire the 324 former
Unconsolidated Partnerships. The Company's former $7.0 million revolving line of
credit for acquisitions and Property debt restructuring (the "Acquisition Line")
was converted into a term loan which matures in March 2001 and has a 7.25% fixed
interest rate with monthly installments of principal and interest of $139,435.
As of September 30, 1998, the unpaid principal balance outstanding under the
Acquisition Line was approximately $3.7 million.
Financing Arrangements for the Properties
- -----------------------------------------
In December 1997, in furtherance of its deleveraging strategy, the
Company arranged for a mortgage purchase facility with a financial institution
wherein the lender agreed to purchase outstanding mortgage notes on certain of
the Properties. Mortgage purchase transactions were arranged to facilitate
either a discount of the face amount of the mortgage or a negotiated pre-payment
for a pre-payment premium of less than that otherwise contracted for under the
terms of the mortgage loans purchased. In connection with the mortgage purchase
facility, the lender engaged in a series of transactions pursuant to which the
lender has purchased mortgage loans on twenty-seven Properties from the
predecessor holders. The purchased mortgage loans (net of any discount and
inclusive of any pre-payment premium received from, or paid to, the predecessor
lender) total approximately $34.5 million in principal outstanding as of
September 30, 1998. Pursuant to the agreements governing the mortgage purchase
facility, the Company has the right to purchase, and the lender has the right to
require the Company to purchase, the mortgage loans at a price equal to the
lender's cost basis, less any principal payments made while the lender has owned
the loans. The Company is seeking to either (a) obtain an alternative facility
for the purchase of these loans, or (b) refinance these mortgage loans, in order
to provide for funding in the event the lender determines to require the Company
to purchase the loans.
29
<PAGE> 30
Capital Expenditures
- --------------------
The Company's non-real estate capital expenditures, including computer
hardware and software and leasehold improvements, for the nine months ended
September 30, 1998 amounted to approximately $928,000 funded from cash flow and
borrowings under the Company's credit facility. The Company anticipates that its
capital needs in the future can be satisfied out of cash flow from operations or
the Company's credit facility.
The Company's capital expenditures for the nine months ended September
30, 1998 amounted to approximately $8.9 million for the Rental Properties. In
addition, approximately $1.5 million of Major Maintenance and Replacement costs
were expensed in the first nine months of 1998. These expenditures were funded
from cash flow and maintenance escrow funds. The Company has identified 224
Properties (approximately 15,000 units) for which it believes disciplined
capital spending will yield substantial rent increases while maintaining high
occupancy rates, therefore generating an attractive return on investment.
Subject to available financing and its continuing review of investment returns
from funds expended in connection with such plan, the Company plans to invest
approximately $19.0 million over the next five years on such Properties in
excess of its targeted annual capital and major maintenance spending of $400 per
unit.
Year 2000
- ---------
The "Year 2000" problem is due to the fact that many computer systems
only use the last two digits to refer to a year. Therefore the computer systems
do not properly recognize a year that begins with "20" instead of "19". If not
corrected, computer applications could fail or provide erroneous results.
Prior to 1998, as part of the Company's normal cycle of enhancing and
upgrading hardware and implementing new software, Year 2000 compliance concerns
were addressed. As new equipment and software was acquired and installed,
testing and warranties as to Year 2000 compliance were obtained. Furthermore, in
1998, due to the magnitude of the Year 2000 issue a formal project team and plan
was developed to review, and, where appropriate, identify and test all systems
to ensure Year 2000 compliance for all critical systems utilized by the Company.
The Year 2000 plan will also assess the risks the Company may have related to
vendors' and service suppliers' failures to remediate their own Year 2000
issues. The Company anticipates completing Year 2000 projects by June 1999,
which is in advance of any anticipated impact on its operating systems. The
Company is currently surveying all critical vendors and service suppliers as to
their Year 2000 readiness. Contingency plans for Year 2000 failures for both
internal and external vendors and service suppliers will be completed by
September 1999.
30
<PAGE> 31
The following is the status of the Company's Year 2000 compliance as of
September 30, 1998. Systems of a critical nature have either been remedied or a
formal plan for resolution is in place. The following table summarizes the
status and plans for resolution for these systems. Areas are ordered by level of
risk (C = critical, H = high, M = medium, L = low) and compliance status.
<TABLE>
<CAPTION>
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
CATEGORY PLATFORM/APPLICATION RISK STATUS ACTION PLAN COMPLIANCE DATE
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
<S> <S> <C> <C> <C> <C>
HARDWARE AS/400 C Compliant
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Telephone Systems M Compliant
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
PCs M Undetermined Currently evaluating. January 1999
30% of systems replaced.
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Servers M Undetermined Currently evaluating. January 1999
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
OPERATING AS/400 -OS/400 C Compliant
SYSTEMS
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Network - Novell 4.1 C Undetermined
December 1998
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Servers - Microsoft N/T C Undetermined December 1998
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Servers - Citrix C Undetermined December 1998
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
SOFTWARE AS/400 - (General Ledger, C Compliant
MIDRANGE Accounts Payable)
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
AS/400 - (Rent Receivables) C Non-Compliant Project in-progress to June 1999
upgrade. Formal Plan.
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
AS/400 - (Fixed Assets) C Non-Compliant Project in-progress to December 1998
upgrade. Formal Plan.
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
AS/400 - In-house (Investment L Non-Compliant Project in-progress to December 1998
Management) utilize external tax
service. Formal Plan.
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
SOFTWARE PCS Server - (Payroll) C Compliant
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
PLANT Building Security C Compliant
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
Air Conditioning M Compliant
- -------------- ------------------------------- -------- ----------------- --------------------------- ----------------
</TABLE>
The costs associated with the Year 2000 compliance issue is currently
estimated in the range of $200,000 to $300,000 to address internal Year 2000
issues. As of September 30, 1998, the Company has not incurred any material
costs specifically related to the Year 2000 issue. Potential costs that may be
incurred due to external vendors and service provider Year 2000 failure can not
be determined at this time. The Company will fund Year 2000 costs from cash flow
from operations or its credit facility which the Company believes is adequate to
fund the Year 2000 costs.
The success of the Company's business is not closely tied to the
operations of any one manufacturer, vendor or supplier with the exception of
utilities and lenders as a group. Utilities and lenders could impact the
operations of the Company if they encountered significant Year 2000 problems.
The Company is in the process of contacting the utilities and Lenders to
determine their status regarding Year 2000. The Company has been working with
its working capital lenders in testing system interfaces for Year 2000
compliance. Although the portfolio of Properties is spread across several
utilities there is a significant material concentration of Properties in Ohio
and Florida such that if the Year 2000 problem interrupted utility service to
these Properties it would have a significant impact on the financial condition
and results of operations of the Company. If any other manufacturers, vendors or
service providers, cease to conduct business due to Year 2000 related problems,
the Company expects to be able to contract with alternative providers without
any material adverse effect on the Company's financial condition or results of
operations.
31
<PAGE> 32
Because of the Company's broad resident base, Its business success is
not closely tied to the collection of rents from any particular resident.
Accordingly, management believes that there should not be a material adverse
effect on the Company's financial condition and the results of operations if any
residents become unable to pay rent due to Year 2000 related problems
encountered by resident employers or banking institutions.
The Company anticipates completing all Year 2000 projects prior to any
anticipated impact on its operating systems and business operations. This
assumption is based on management's best estimates, which were derived utilizing
numerous assumptions of future events, including the continued availability of
third party software and reliance on vendor and service provider assurances of
compliance with Year 2000 issues and other factors. There can no assurance that
these estimates will be achieved and actual results could differ materially from
those anticipated.
Quarterly Dividend
- ------------------
On July 10, 1998, the Company declared its first quarterly dividend of
$0.4325 per share for the quarter ending September 30, 1998. A dividend of $4.1
million was paid on October 15, 1998 to shareholders of record on September 30,
1998. This dividend is equal to an annualized dividend rate of $1.73 per share.
The Company has instituted a policy of paying a quarterly dividend approximately
15 days after the close of each calendar quarter. The Company's distribution
policy is subject to modification by the Company's Board of Trustees.
32
<PAGE> 33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
-----------------
On October 30, 1998, the Company reached a settlement in its lawsuit
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.
Pursuant to the terms of the settlement agreement the Company, in its capacity
as general partner of limited partnerships that own Rental Properties and
Unconsolidated Partnerships and as agent for parties that have purchased
apartment communities formerly owned by Unconsolidated Partnerships, has
received cash payment in the gross amount of $3,075,000 and has paid contingency
legal fees of $975,000 from the settlement proceeds. As a result of the
settlement all claims against Hartford for termite-related losses at
approximately 150 properties in which the Company holds (or formerly held) an
interest, pursuant to an excess property insurance policy issued to the Company
by Hartford, have been settled and discharged in full. The termite related
losses are the same as those which formed the subject matter of prior litigation
against the Company's former primary insurance carrier, National Union Fire
Insurance Company in which the Company arrived at a mutual settlement. The net
proceeds of the settlement will be allocated among the properties (including
those owned by third parties) based upon the extent of the termite damage at
each such property and will be distributed for the benefit of each such property
upon completion of the allocation process.
Item 2. Changes in Securities
---------------------
None.
Item 3. Defaults Upon Senior Securities
-------------------------------
None.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Company held its annual meeting of shareholders on September 29,
1998. At the meeting, the Company's shareholders:
- Elected the following slate of Trustees nominated by the
disinterested members of the Company's Board of Trustees for
terms expiring in 2001: John B. Bartling and Robert J. Weiler.
The continuing Trustees are Stanley R. Fimberg, Joseph E.
Madigan, Glenn C. Pollack and H. Jeffrey Schwartz.
The votes cast for, against, withheld and abstained for the election of
the two Trustees were as follows:
John B. Bartling received 8,354,200 for and 33,766 withheld votes with
no abstentions; and Robert J. Weiler received 8,356,035 for and 31,931
withheld votes with no abstentions.
33
<PAGE> 34
Item 5. Other Information
-----------------
This Form 10-Q contains certain forward-looking statements regarding
prospects for (i) proposed mortgage loan repayments and capital improvements to
Properties, contingent, in all cases, upon available financing, successful
implementation and availability and achievement of projected returns on
investment, (ii) possible improvements in net operating income from the
Properties, (iii) the Company's quarterly dividends and its distribution policy,
(iv) the Company's foreseeable capital and liquidity requirements and sources,
and (v) its successful resolution of all internal and external Year 2000
compliance issues in a timely manner and within an estimated range of costs. The
forward-looking statements represent management's good faith evaluations based,
among other things, upon existing market, financial and economic conditions, the
availability and ability to satisfy anticipated conditions precedent to proposed
financing arrangements, the physical condition of the Rental Properties and cost
and timing estimates as well as third party assurances of Year 2000 compliance.
There can be no assurance that the forward-looking statements will prove to be
correct. Any differences in actual results or developments may be material.
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION SEQUENTIAL PAGE
NO.
<S> <C> <C>
11.1 Statement re: computation of Per Share Earnings See Note 1 of Notes to Consolidated Financial
Statements
27 Financial Data Schedule Filed as an Exhibit to this Form 10-Q
</TABLE>
34
<PAGE> 35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LEXFORD RESIDENTIAL TRUST
(Registrant)
<TABLE>
<S> <C>
Dated: November 13, 1998 By: /s/ John B. Bartling
------------------------
John B. Bartling
President and Chief Executive Officer
Dated: November 13, 1998 By: /s/ Mark D. Thompson
-----------------------
Mark D. Thompson
Executive Vice President and Chief Financial Officer
(Principal Accounting Officer)
Dated: November 13, 1998 By: /s/ Ronald P. Koegler
------------------------
Ronald P. Koegler
Senior Vice President and Controller
</TABLE>
35
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AND THE STATEMENT OF INCOME AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 2,182
<ALLOWANCES> 283
<INVENTORY> 0
<CURRENT-ASSETS> 0<F1>
<PP&E> 601,277
<DEPRECIATION> 23,471
<TOTAL-ASSETS> 632,458
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 526,203
0
0
<COMMON> 95
<OTHER-SE> 62,655
<TOTAL-LIABILITY-AND-EQUITY> 632,458
<SALES> 285
<TOTAL-REVENUES> 106,777
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 80,763
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31,362
<INCOME-PRETAX> (5,063)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,063)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,063)
<EPS-PRIMARY> (0.57)
<EPS-DILUTED> (0.57)
<FN>
<F1>THE REGISTRANT HAS A NON-CLASSIFIED BALANCE SHEET
</FN>
</TABLE>
