ITEM 1. BUSINESS
A. BUSINESS
DVL, Inc. ("DVL"), is a Delaware corporation established in 1978. Since August 1995, the common stock of DVL is traded on the over-the-counter market and is quoted on the NASD OTC Bulletin Board under the symbol "DVLN". DVL stock traded on the New York Stock Exchange ("NYSE") through August 3, 1995. The principal address of DVL is 24 River Road, P.O. Box 408, Bogota, New Jersey 07603; telephone number: (201) 487-1300. DVL is a commercial finance company which manages numerous properties and partnerships and owns and services commercial mortgage loans all of which are secured by properties for which DVL or an affiliate serves as general partner.
DVL's business has been to invest in and service mortgage loans to affiliates secured principally by income-producing commercial, office and industrial properties. In addition, DVL purchased loans to limited partners and affiliates secured by limited partnership interests in affiliated partnerships in which Kenbee Management, Inc. ("Kenbee"), a Delaware corporation, and DVL's former manager and borrower, was a general partner. See "Mortgage Loans and Loans Secured by Limited Partner Interests". In 1993, pursuant to the settlement of litigation with limited partners, DVL succeeded to Kenbee's position as general partner in substantially all of the partnerships.
Effective January 1, 1994 DVL revoked its election to be taxed as a real estate investment trust ("REIT") and elected to be treated as a "Sub-chapter C" corporation for tax purposes. Management's intent in making this change was to enable DVL to pursue new business activities which would generate income which is either not qualified as REIT income or which would otherwise have been taxable at a rate of 100%.
From 1992 through 1994, DVL ventured into two additional business areas, real estate lot development and the financing of tools used by automobile mechanics. DVL has terminated the real estate lot development business and sold its interest in the financing business to an unrelated third party.
Because of DVL's lack of cash resources to develop a new business, DVL is currently focused on managing, administering and servicing it's existing real estate properties, the affiliated partnerships and the mortgages it holds on such properties. DVL is the general partner of approximately 100 affiliated limited partnerships from which it receives management and other fees. In addition, through Professional Service Corporation ("PSC"), a wholly-owned subsidiary, DVL is engaged in the management of certain properties located in New Jersey pursuant to master lease interests. DVL is managing these partnerships and properties as a result of the 1993 limited partner litigation settlement.
DVL has been implementing significant measures to reduce its current operating expenses and is currently pursuing additional overhead reductions. However, to enable DVL to continue to meet its short term operating needs, DVL must continue to augment its cash flow with additional cash provided by proceeds from the sale or refinancing of assets and/or borrowings.
B. RECENT DEVELOPMENTS
NPM LOAN TRANSACTION -------------------- To better enable DVL to resolve its liquidity problems and to meet its certain mandatory repayment requirements, on September 27, 1996, DVL and NPM Capital, LLC ("NPM") closed a loan transaction under a certain Loan Agreement dated March 27, 1996, pursuant to which NPM purchased three loans from three creditors, and agreed to make principal installment payments of up to $600,000 on DVL's obligation to two additional creditors (the "Loan"). The three purchased loans represented an aggregate outstanding balance of $7,501,000. Two of the five loans had negotiated discounts of $2,773,000. The actual amount loaned by NPM at the closing, which included the balances due to the above mentioned creditors, less the realized discount, plus NPM's costs, equaled $5,232,000. Included in the loan balance were NPM's costs (in excess of $175,000) incurred in connection with this transaction, such excess totaled approximately $503,000. In consideration of NPM's loan enabling DVL to avail
itself of discounts to existing lenders, and for providing DVL with the extended payment schedule, the principal amount of the loan was increased by $3,150,000. All such funds advanced at the closing were consolidated into a single note with NPM in the amount of $8,382,000. For financial reporting purposes, DVL recognized an extraordinary loss of $880,000 on this transaction.
Under the terms of the NPM loan, the principal balance is payable over six years with interest at the rate of 10.25%. DVL is required to make certain mandatory payments towards the principal balance over the term of the loan. The first such principal reduction of 15% of the original loan, plus additional funds advanced, is due by March 31, 1998. From September 27, 1996 through March 31, 1997, DVL made principal payments from the liquidation of collateral and refinancing activities totaling $1,658,000 which represents approximately 19% of the original principal balance, plus additional funds advanced. DVL is required to pay NPM the cash flow generated from certain of NPM's collateral, but in no event less than accrued interest at a rate of 5% per annum. The initial internal rate of return to NPM on this loan was approximately 27.5%. The initial effective interest rate for financial reporting purposes to DVL, including DVL's costs associated with the Loan and the value of the Warrants (described below) was 15%. These rates assumed that payments would be made according to the original payment terms of the Loan. In the event of prepayments, delays in payment or additional fundings under the loan, the internal rate of return and the effective interest rate will increase or decrease, respectively.
In connection with the transactions contemplated by the Loan Agreement in March 1996, DVL and NPO Management LLC ("NPO"), an affiliate of NPM, entered into an Asset Servicing Agreement, pursuant to which NPO is providing DVL with administrative and advisory services relating to the assets of DVL and its affiliated partnerships. In consideration for such services, DVL is required to pay NPO $600,000 per year (with cost of living increases beginning in 1998) over the seven (7) year term of the agreement, subject to early termination under certain conditions. DVL has the right to defer up to $600,000 of such fees, with interest at 15% per annum, for two years and to defer a reduced amount through the third year. DVL had accrued service fees of $372,000 as of December 31, 1996.
In connection with the Loan, affiliates of NPM acquired 1,000,000 shares (the "Shares") of DVL common stock for $200,000 representing approximately 7% of the current outstanding common stock of DVL. An affiliate of NPM also acquired 100 shares of preferred stock for $1,000. DVL issued to affiliates of NPM 12,911,628 warrants (the "Warrants") which when added to the 1,000,000 shares, represent rights to acquire up to 49% of the outstanding common stock of DVL on a fully diluted basis. Unless certain conditions are met, the Warrants are not exercisable prior to January 1, 1999 without satisfaction of certain conditions and expire December 31, 2007 at a price of $.16 per share. The Warrants were valued for financial statement purposes at $516,000 at the date of issuance and such value resulted in a debt discount to be amortized over the life of the Loan.
At the annual meeting in September of 1996, the shareholders of DVL approved (a) the Loan Agreement; (b) the Asset Servicing Agreement; (c) an Amendment to DVL's certificate of Incorporation creating 100 shares of preferred stock to be issued to NPM which enabled NPM to elect a special purpose director to DVL's Board of Directors; (d) an Amendment to DVL's Certificate of Incorporation and By-Laws creating certain restrictions on the transferability of shares of DVL's common stock to help preserve the utilization of DVL's carry forwards of net operating losses and credits for federal income tax purposes and (e) a stock option plan to replace DVL's stock appreciation rights.
OTHER -----
During 1996, DVL made the final installments due pursuant to its 1995 settlement with the Federal Deposit Insurance Corporation. The settlement resulted in a gain during 1996 of $7,400,000.
Even after the transactions described above, DVL continues to experience liquidity problems. DVL's ability to continue as a going concern is dependent upon (1) the sale or refinancing of certain assets to improve its cash position to meet operating expenses and mandatory debt payments; (2) the settlement of its remaining litigation; (3) the realization of the estimated value of the assets collateralizing its loan portfolio over an extended period of time rather than the value of the assets on a liquidation basis; and (4) the return to profitable operations and (5) availability of additional borrowings. C. BUSINESS ACTIVITIES.
1. MORTGAGE LOANS AND LOANS SECURED BY LIMITED PARTNER INTERESTS
At December 31, 1996, DVL had investments in long-term mortgage loans to affiliated partnerships totaling $29,838,000 all of which are pledged to secure indebtedness of DVL. Certain of the mortgage loans due from affiliated partnerships, were transferred in prior years from Kenbee and its affiliates to DVL in settlement of DVL's loans to Kenbee and Kenbee's affiliates. These transfers significantly reduced the non-performing portion of DVL's loan portfolio. However, the reclassification did not result in significant income or cash flow on the majority of such mortgages, as the mortgage debt service is currently used to pay liens senior to DVL's before cash flow from such mortgages is available to DVL. In addition, as part of the limited partnership settlement most of the mortgages were modified to reduce the payments and/or interest rates. The balance of DVL's long-term mortgage loans to affiliated partnerships were previously funded by DVL and bear interest at effective rates of up to 15% per annum. At December 31, 1996, $5,104,000 of DVL's mortgage loans were non- performing. DVL has established a loan loss reserve of approximately $10,619,000 in connection with its mortgage loan portfolio.
The affiliated partnerships' properties provide the security for DVL's loans and are leased, typically on a long-term basis, to unaffiliated national tenants. For virtually all properties, the leases are current and the mortgages are being paid on a timely basis.
In addition, DVL holds loans due from individual limited partners secured by limited partnership interests, aggregating $3,066,000 of which all were non- performing at December 31, 1996. Consequently, DVL has established a loan loss reserve of approximately $2,235,000 in connection with these loans. NPO on behalf of DVL has been aggressively attempting to collect these loans.
DVL holds $65,000 of loans originated by Del-Val Capital Corp. ("DVCC") a wholly-owned subsidiary of DVL, secured primarily by consumer receivables arising from sales of interests in vacation ownership (timeshare) condominiums, improved homesites and membership campgrounds. DVCC's remaining assets, net of an additional reserve of $175,000 taken in 1994, were absorbed by DVL, which treated these transactions as the final disposal of DVCC.
2. INVESTMENTS IN AFFILIATED PARTNERSHIPS.
DVL has acquired various interests in affiliated partnerships pursuant to the terms of certain settlement agreements. Management originally valued all of these investments at 33% of the original investment amount (the expected recovery for such investments) except for interests acquired in one partnership with an original investment aggregating $2,450,000 which are assigned to one of DVL's creditors and were valued at 40% of their original investment amount based upon the anticipated proceeds through the future sale of the partnership's property. In 1994 and 1996, management provided for a general reserve on these investments to bring the net carrying value down to 25.2% and 14.5%, respectively, of the original investment amount, exclusive of the $2,450,000 discussed above, due to potential anticipated losses upon liquidation of these investments to meet DVL's mandatory repayment requirements and operating cash flow deficiency. As distributions are received or the investments disposed of, the carrying value is reduced. No income will be recognized until the actual cash flow exceeds the carrying value.
3. PARTNERSHIP AND PROPERTY MANAGEMENT.
As part of the limited partner settlement, DVL became general partner of more than 100 affiliated partnerships for which DVL has received management and other fees.
As part of another settlement agreement, PSC acquired master lease positions for two industrial properties located in New Jersey.
D. LINE OF BUSINESS
DVL has continuously been deemed to be in one line of business, finance (including the management of the assets which secure its loans), for the past five years.
E. INVESTMENTS
DVL's investments, the majority of which arose out of transactions with affiliates, consist of commercial and other mortgage loans, loans and notes secured by limited partnership interests, investments in affiliated partnerships and commercial real estate. DVL also owns 100% of the Common Stock of DVCC, PSC and RH Interests, Inc. See "Financial Statements and Supplementary Data".
A more detailed description of DVL's business follows. Certain information in the description is incorporated herein by reference to the Notes to the Consolidated Financial Statements of DVL (the "Notes") included in Item 8 hereof.
F. LOAN PORTFOLIO
DVL's mortgage loan portfolio consists primarily of long term wrap-around and other mortgage loans due from affiliated partnerships secured by income- producing commercial, office and industrial properties. In addition, DVL maintains a portfolio of loans to limited partners secured by their interests in affiliated partnerships. DVL does not anticipate making any substantial loans to affiliated partnerships or any loans to limited partners.
Virtually all of DVL's mortgage loans receivable arose out of transactions arranged by Kenbee in which affiliated partnerships purchased commercial, office and industrial properties typically leased on a long-term basis to unaffiliated, creditworthy tenants. Each of DVL's mortgage loans is collateralized by a lien, primarily subordinate to senior liens in favor of an unaffiliated party, on real estate owned by the affiliated partnership.
The following table sets forth the number of loans outstanding, aggregate loan balances, including accrued interest, and the allowances for loan losses, of the above investments at December 31, 1996. See Tables 1 through 4 of Appendix "A" to this Form 10-K for detailed information as to each such loan. Following the table is a brief description of each type of loan.
DVL's loans to affiliated partnerships are secured by mortgages on properties leased to various tenants. For a list of these tenants see Tables 1 through 3. The number of properties leased by any one company from affiliated partnerships in which DVL holds a mortgage loan ranges from one to four except for Wal-Mart, which is the tenant of 36 properties.
Generally, the tenants of single asset partnerships executed "triple-net" leases under which they are responsible for the payment of all taxes, insurance and other property costs. In certain instances, the partnership is required to maintain the roof and structure of the premises. In addition to base rent, most leases also require the tenant to pay additional rent equal to a percentage of gross receipts from the tenant's operation of a property above a specified amount ("Percentage Rent"). In virtually all cases where the partnership is entitled to receive Percentage Rent, a portion of such rent is required to be paid to DVL as additional interest or additional debt service on the long-term mortgage.
G. COLLATERALIZED LOANS
1. LONG-TERM MORTGAGES DUE FROM AFFILIATED PARTNERSHIPS.
DVL's long-term wrap-around and other mortgage loans due from affiliated partnerships consist of (1) loans purchased primarily from Kenbee under prior commitments made by DVL to affiliated partnerships on which DVL yields up to 15% per annum or (2) loans to affiliated partnerships acquired pursuant to the Limited Partner Settlement, the principal amount of which equals DVL's net investment in the related loan previously due from Kenbee or its affiliates; less specific write-downs on certain of these loans based on the anticipated cash flow to be generated by each loan. Interest on these loans, if any, is imputed based on anticipated cash flow.
Substantially, all of DVL's long term mortgages due from affiliated partnerships are self-amortizing.
DVL's wrap-around mortgages are all collateralized by second or third mortgages on commercial and industrial properties located in various states and mature through June 2031. DVL is obligated to make principal and interest payments on the underlying mortgage loan or loans to the extent proceeds are received from the borrower and, in certain instances, has the right to refinance or pay off the underlying mortgage loans. Some of the underlying mortgages require that the tenants make their rental payments directly to the respective underlying lenders and DVL is crediting such payments to its wrap-around mortgage loans. To the extent that the underlying mortgage payment is less than the wrap- around mortgage payment, the partnership is obligated to pay DVL the difference. 2. COMMERCIAL LOAN - OTHER
In 1994, DVL received a $1,450,000 mortgage note from the Grand Union Company in partial satisfaction of one of its partnership mortgage loans. The note, which bore interest at 9% per annum and required monthly payments of $18,000, with a balloon payment of $1,161,000 due in December 1996, was repaid in December of 1996.
3. LOANS COLLATERALIZED BY LIMITED PARTNERSHIP INTERESTS.
DVL made loans directly to limited partners to finance their partnership investments. As a result of the Limited Partner Settlement, DVL received additional limited partner loans from Kenbee in satisfaction of loans due from Kenbee collateralized by such limited partner loans. All of such loans due from limited partners ("Partners Notes") matured at various dates through December 1995 and bear interest at fixed rates of 15% to 16% and at variable rates of up to 2 1/2% over prime. Certain of the variable rate loans were payable at fixed interest rates, with interest accruing at variable rates subject to minimum and maximum levels, payable upon the maturity of the loan. All of the loans are in default. DVL is attempting to collect these loans either through negotiation or litigation with borrowers.
H. REFINANCING RIGHTS
DVL has the right to refinance certain of the presently outstanding mortgage loans underlying its wrap-around mortgage loans due from affiliated partnerships, subject to any prepayment penalties, provided that the debt service and principal amount of a refinanced loan are no greater than that of the existing wrap-around loan. DVL also has the right to arrange senior financing secured by properties on which it holds first or second mortgage loans by subordinating its mortgage loan subject to the same such limitations.
In 1994, DVL refinanced a portion of its mortgage portfolio which generated cash proceeds of approximately $5.9 million, which was used to satisfy existing indebtedness. In 1996, DVL refinanced 19 mortgages which generated approximately $6 million. These funds were used to satisfy existing indebtedness. The amounts obtained from these refinancings were primarily based on the value of the base rents due from tenants during the period of the base lease term subsequent to the payoff of the existing first mortgages. As a result of DVL's refinancings, DVL's asset base available for future refinancings has diminished.
I. REAL ESTATE
DVL currently owns two real estate properties located in Kearny, New Jersey. The parcels in Kearny, New Jersey are leased under long-term leases to affiliated partnerships which purchased the buildings and improvements thereon.
The Kearny properties include 8.2 acres of land underlying approximately 134,800 square feet of manufacturing, warehousing and commercial buildings leased to (a) Toch Associates (2.6 acres) for an annual rent of $7,000 until 2074; and (b) Kearny Associates (5.6 acres) for an annual rent of $30,000 until 2079. DVL currently maintains a reserve of $208,000 on the value of the land.
J. EMPLOYEES
On March 31, 1997, DVL had twelve (12) employees.
K. FOREIGN ACTIVITY
DVL or its subsidiaries have not engaged in any business activity outside of the United States.
ITEM 2.
ITEM 2. PROPERTIES
A description of the properties owned by DVL, appears in "Real Estate", Item 1I above.
ITEM 3.
ITEM 3. LEGAL AND ADMINISTRATIVE PROCEEDINGS
Substantially all of the various litigations brought against DVL, its Board members and certain current and former officers and affiliates by shareholders, banks and others since 1990 have been settled. The following is a summary of the status of all material outstanding cases, as well as cases settled in 1996.
CONTINUING LITIGATION ---------------------
(1) A suit entitled DONALD LEVY, ET AL. V. ROGER D. STERN, ET AL. ("LEVY"), originally filed in New Castle County, Delaware on February 13, 1991, on behalf of certain individual shareholders alleged breaches of fiduciary duty of care and candor. The defendants prevailed on a motion for summary judgment and plaintiffs filed an appeal. On appeal, the court reopened discovery for the plaintiffs. Plaintiffs in IN RE DEL-VAL, the shareholder class action case, which settled in 1995 permitted the Plaintiffs in LEVY to participate in their settlement with certain third party defendants. As of March 1997, discovery is continuing.
(2) Federal Insurance Company ("Federal"), which carried DVL's directors and officers insurance policy, declined to cover DVL for any legal costs or liability. DVL commenced an action against its insurance broker and Federal entitled DEL-VAL FINANCIAL CORPORATION, ET AL. V. FEDERAL INSURANCE COMPANY ET AL. ("FEDERAL INSURANCE") on September 23, 1991 in the Supreme Court of the State of New York, County of New York in which DVL alleged negligence against its broker and sought declaratory and injunctive relief against Federal. The New York Court in this matter has held that the Settling Defendants' insurance excluded coverage of these matters. DVL has filed a notice of appeal of that decision.
(3) DVL was named in an action entitled VANGUARD CAPITAL V. KENBEE MANAGEMENT, INC. ET AL. ("VANGUARD"), which was filed in 1994 in the Superior Court of the State of California, in which Vanguard sought contractual indemnity, equitable indemnity and declaratory relief on certain matters filed against Vanguard in the Superior Court, State of California, by an investor. This action is based on complaints by an investor with a $350,000 investment in an affiliated limited partnership who alleged that the investor's broker sold to her unsuitable investments. DVL defended the case and Vanguard voluntarily dismissed the action without prejudice. On March 22, 1996, the investor in the underlying matter against VANGUARD filed in the Superior Court of Los Angeles, a motion to vacate an NASD Arbitration award made in July 1995 in favor of VANGUARD and has named DVL as an additional respondent in that Petition.
SETTLED LITIGATION ------------------
A) DVL and certain former officers were named as defendants in an action brought by a former employee of Kenbee entitled MICHAEL A. BECKER V. KENBEE MANAGEMENT, INC. ET AL. ("BECKER"), and filed in the Superior Court of New Jersey, Bergen County Law Division on September 22, 1993. In BECKER, plaintiff alleged violations of the New Jersey Law Against Discrimination by Reason of Religious Discrimination, of oral contract not to terminate plaintiff, of an implied promise not to terminate employee for reasons violative of public policy, and for intentional infliction of emotional distress, intentional interference with contractual relations and slander and slander PER SE. A settlement in this matter was completed in March 1996.
B) DVL was named as a defendant in a class action entitled PHILLIP AND CHERYL WEISS V. WINNER'S CIRCLE OF CHICAGO, INC. ET AL. which was filed in the United States District Court for the Northern District of Illinois on April 14, 1995 in which Plaintiffs allege that DVL, as a holder of certain consumer credit contracts issued by Del-Val Capital Corp., a subsidiary of DVL, is subject to claims and defenses against the consumer credit contracts and that DVL aided and abetted violations of the Illinois Consumer Fraud Act. This matter was settled in 1996 for a nominal payment by DVL.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR DVL'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Since August 1995, the common stock of DVL is traded on the over-the- counter market and is quoted on the NASD OTC Bulletin Board under the symbol "DVLN". Prior to that time, the common stock was traded on the NYSE. As of March 31, 1997, DVL stock was trading at $.20 based on the last sale price. The following table sets forth, for the calendar periods indicated, the high and low bid prices of the Common Stock as reported by the NASD for 1996 and the third and fourth quarters of 1995, and the high and low sales prices as quoted by the NYSE for the first and second quarters of 1995.
The NASD prices are inter-dealer prices without retail mark-up, mark-down or commission, and do not represent actual transactions.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DVL continues to experience liquidity problems principally as a result of the reduced cash flow received on the restructured and non-performing portions of its loan portfolio. Although the limited partner settlement substantially reduced the non-performing portion of DVL's loan portfolio, this reclassification has not resulted, nor is it expected to result, in significant income or cash flow on the majority of the restructured mortgages, as the mortgage debt service is used to pay liens senior to DVL's.
To enable DVL to meet its short-term operating needs, DVL must continue to augment its cash flow with the proceeds from the sale or refinancing of assets and borrowings. See "Recent Developments". There is a risk that DVL may not be able to raise the necessary funds with which to continue operations.
DVL's ability to continue as a going concern is dependent upon (1) the sale or refinancing of certain assets to improve its cash position to meet operating expenses and mandatory debt payments; (2) the settlement of its remaining litigation; (3) the realization of the estimated value of the assets collateralizing its loan portfolio over an extended period of time rather than the value of the assets on a liquidation basis; (4) the return to profitable operations and (5) availability of additional borrowings.
RESULTS OF OPERATIONS
DVL realized net income of $3,878,000 in 1996, as compared to net income of $2,120,000 in 1995 and a net loss of $11,175,000 in 1994. The net income in 1996 and 1995 was attributable to extraordinary gains realized upon creditor settlements. DVL experienced operating losses in 1996, 1995 and 1994.
Interest income on mortgage loans due from affiliates decreased by $325,000 in 1996 and by $934,000 in 1995. The decrease in 1996 primarily resulted from the reduction in the amount of such loans to affiliated partnerships due to the satisfaction of certain loans upon the sale of partnership properties.
Management fees from partnerships decreased by $35,000 in 1996 and decreased by $ 30,000 in 1995. The decrease of 1996 is a result of the liquidation of certain partnerships during 1996 partially offset by an increase in the management fees on the remaining partnerships.
Transaction and other fees from partnerships aggregating $561,000 in 1996 and $881,000 in 1995 represent the fees received upon the sale or refinancing of certain partnership properties. The decrease in 1996 was the result of an decrease in the number of properties sold.
Rent income from affiliated partnerships increased by $5,000 in 1996 and increased by $5,000 in 1995. The increase of 1996 is attributable to DVL receiving past due rent on one of its land leases.
Other income from affiliates represents the receipt of distributions and proceeds upon liquidation on fully reserved limited partnership investments.
Interest income on loans to limited partners decreased by $195,000 in 1996 and decreased by $107,000 in 1995 primarily a result of a decrease in the average outstanding balance of the performing portion of this portfolio. At December 31, 1996, all of these loans were non-performing.
Other income in 1996 represents collections on the balance of the note obtained by DVL from the sale of FMF. In 1996, DVL recorded $260,000 as the final amounts due from FMF.
General and administrative expenses decreased by $357,000 in 1996 and increased by $107,000 in 1995. The decrease in 1996 was primarily a result of a decrease in payroll and operating costs incurred in 1996. However, this decrease was offset by a $464,000 Asset Servicing Fee to NPO.
The provision for losses was $1,810,000, $2,222,000 and $7,814,000 in 1996, 1995 and 1994, respectively. The provisions in 1996 and 1995 were primarily a result of potential losses to be incurred upon the liquidation of assets to meet mandatory repayment obligations on certain indebtedness beginning in 1994 and to fund DVL's operating cash flow deficiency. Furthermore, DVL provided for losses based upon updated information on certain properties.
Legal and professional expenses decreased by $615,000 in 1996 and increased by $189,000 in 1995. These fees were substantially reduced as a result of the settlement of litigation. Such fees are expected to continue to decrease in the future.
Interest expense decreased by $1,155,000 in 1996 and $248,000 in 1995 partially as a result of a decrease in indebtedness and decreases in interest rates on certain restructured indebtedness, which was principally offset by imputed interest on the notes issued in connection with the Shareholder Settlement. The decrease in indebtedness is primarily the result of DVL reaching an agreement with its final unsettled creditors, as well as significant payments to creditors resulting from the principal payments made from collections on the collateral pledged to secure indebtedness. Such collections were principally obtained from the satisfaction of certain loans upon the sale of partnership properties. Management anticipates that such interest expense on its existing indebtedness will decline in the future as a result of the completed settlements and restructuring agreements with DVL's creditors. However, this decline may be more than offset by the interest, including imputed interest, on the notes issued in connection with the Shareholder Settlement.
There was no settlement or litigation loss in 1996. The loss was $35,000 in 1995. This loss represents both actual losses and management's estimate of potential losses to be realized in connection with claims originating from Kenbee's indebtedness to certain creditors and for certain other litigation matters.
DVL has reached settlements with the majority of the shareholders and virtually all of the limited partners and creditors who have previously commenced litigation against DVL. As a result, management anticipates (a) decreasing partnership management and other fees as properties are sold, (b) a decrease in interest income on mortgage loans transferred to satisfy indebtedness or liquidated for repayment of indebtedness or cash flow purposes, (c) a decrease in interest expense as indebtedness is satisfied by transferring assets to certain creditors and as a result of restructured indebtedness with reduced interests rates, (d) an increase in interest expense on the notes issued in connection with the Shareholder Settlement, (e) potential gains on the settlement of DVL's indebtedness as DVL meets discounted payment requirements, (f) a reduction in the costs incurred to defend against litigation and (g) continued operating losses.
LIQUIDITY AND CAPITAL RESOURCES
DVL continues to experience liquidity problems and its cash flow provided by operations is not sufficient to meet its operating needs. DVL is attempting to augment its cash flow with the proceeds from the sale or refinancing of assets. See "Recent Developments". There is a risk that DVL may not be able to raise the necessary funds with which to continue operations.
DVL's revocation of its election to be taxed as a REIT effective January 1, 1994 eliminated the requirement that DVL distribute at least 95% of its taxable income and will allow DVL to enter into new business ventures that were not permitted or were subject to taxation at a rate of 100% for a REIT. DVL does not anticipate making distributions to its shareholders in the foreseeable future. DVL currently has net operating loss carryforwards of approximately $60,000,000 which it may use as a "C" Corporation to offset future taxable income, if any, and subject to certain limitations, from federal income taxes. DVL believes that its ability to utilize its tax loss carryforward will not be adversely affected by the issuance of stock, stock options and warrants, pursuant to existing agreements with various lenders and with its shareholders, nor the issuance of convertible debentures.
DVL has the right to refinance a number of mortgage loans underlying its wrap-around mortgages due from affiliated partnerships and arrange senior financing secured by properties on which it holds first or second mortgage loans
by subordinating its mortgage position. In 1996, DVL refinanced 19 mortgages which generated approximately $6 million which has been used to satisfy existing indebtedness. The amounts obtained from these refinancings were primarily based on the value of the base rents during the period of the base lease term subsequent to the payoff of the existing first mortgages. As a result of DVL's prior and current refinancings, DVL's asset base available for future refinancings has diminished.
During 1994, DVL reduced the portion of its indebtedness which was in default for non-payment of scheduled interest and/or principal by approximately $3.6 million. This reduction resulted from the restructuring of the principal balance, payment terms and interest rate with one creditor. The restructuring agreement was signed in the first quarter of 1995 and closed in the second quarter of 1995.
In December 1995, DVL reached a settlement with its final unsettled creditor and recognized an extraordinary gain on the settlement of indebtedness of $6.1 million. Such indebtedness had been undercollateralized and the settlement eliminated such undercollateralization. The restructured indebtedness required a $400,000 payment at closing and five quarterly payments totaling $600,000 commencing June 30, 1996. The payments were made, and DVL recognized additional gains in 1996 of approximately $7.4 million.
IMPACT OF INFLATION AND CHANGES IN INTEREST RATES
DVL's mortgage loan portfolio due from affiliated partnerships is primarily at fixed rates. Management has restructured most of its indebtedness to fixed rates. Therefore, increases or decreases in interest rates are generally not expected to have an effect on DVL's earnings. See "Recent Developments". Other than as manifested in interest rates, inflation has not had a significant effect on DVL's net income for the past three years.
OTHER MATTERS
At December 31, 1996, DVL had net operating loss carryforwards for income tax purposes of approximately $60,000,000 available to offset future taxable income, if any, expiring through 2010. DVL believes that its ability to utilize its tax loss carryforward will not be adversely affected by the issuance of stock, stock options and warrants, pursuant to existing agreements with various lenders and with its shareholders, nor the issuance of convertible debentures.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and notes thereto, together with the report thereon of Richard A. Eisner & Company, LLP, are set forth on pages through, which follow. The financial statements are listed in Item 14(a)(1) hereof.
ITEM 9.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no disagreements on any matter of accounting principles or practices or financial statement disclosure between DVL and its independent auditors within the twenty-four months prior to the date of DVL's most recent financial statements.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF DVL
The information called for by this Item is incorporated herein by reference to DVL's definitive proxy statement for its 1996 Annual Meeting of Stockholders which DVL intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this Item is incorporated herein by reference to DVL's definitive proxy statement for its 1996 Annual Meeting of Stockholders which DVL intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this Item is incorporated herein by reference to DVL's definitive proxy statement for its 1996 Annual Meeting of Stockholders which DVL intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by this Item is incorporated herein by reference to DVL's definitive proxy statement for its 1996 Annual Meeting of Stockholders which DVL intends to file with the Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K.
PART IV
ITEM L. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
(1) The Financial Statements required by Item 8 of this report are listed below:
Item 8 Page No. --------
Report of Independent Auditors F- 1
Consolidated Balance Sheets - December 31, 1996 and 1995 F- 2
Consolidated Statements of Operations for each of the years in the three year period ended December 31, 1996 F- 4
Consolidated Statements of Shareholders' Equity (Deficiency) for each of the years in the three year period ended December 31, 1996 F- 6
Consolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1996 F- 7
Notes to Consolidated Financial Statements
(2) The Financial Statement Schedules required by Item 8 of this report are listed below:
None
Other schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the financial statements or notes thereto.
(3) INDEX OF EXHIBITS
The following is a list of the Exhibits filed as a part of this report (those marked * are filed herewith):
3. ARTICLES OF INCORPORATION AND BY-LAWS.
(a) Copy of DVL's Certificate of Incorporation. (Incorporated by reference to Exhibit 6(d) to DVL's Form S-L. Registration Statement No. 2-58847 dated April 28, l977.)
(b) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion. (Incorporated by reference to Exhibit 6(e) to Amendment No. 1. to DVL's Form S-L. Registration Statement No. 2-58847 dated August 25, l977.)
(c) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion dated August 3, 1982. (Incorporated by reference to Exhibit 3 (c) to DVL's Form 10-K for the fiscal year ended December 31, 1982.)
(d) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion dated May 27, 1983. (Incorporated by reference to Exhibit 3(d) to DVL's Form 10-K for the fiscal year ended December 31, 1983.)
(e) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion dated July 24, 1987. (Incorporated by reference to Exhibit 3(e) to DVL's Form 10-K for the fiscal year ended December 31, 1987).
(f) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion adding new Article Fourth dated September 1996.(Incorporated by reference to DVL's proxy statement dated July 31, 1996 - Exhibit "I".)
(g) Copy of DVL's By-Laws, as in full force and effect at all times since March 28, l977. (Incorporated by reference to Exhibit 3(c) to DVL's Form 10-K for the fiscal year ended December 31, 1980.)
(h) Copy of DVL's Certificate of Amendment to Certificate of Incorpora- tion dated December 17, 1993. (Incorporated by reference to DVL's Form 10-K for fiscal year ended December 31, 1993.)
(i) Copy of DVL's First Amendment to By-Laws dated as of January 1, 1994. (Incorporated by reference to Exhibit 3(d) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
(j) Copy of DVL's By-Laws Amendment of 1996 and Amendment to Certificate of Incorporation adding new Article Eleventh. (Incorporated by reference to DVL's proxy statement dated July 31, 1996 - Exhibit J.)
4. INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS.
There are no instruments defining the rights of holders of equity securities required to be filed hereunder. Instruments defining the rights of holders of long-term debt of DVL are summarized in Note 8 to DVL's consolidated financial statements included in Item 8 hereof. None of such instruments authorizes amounts to be borrowed by DVL in excess of 10% of the total assets of DVL. DVL agrees to provide copies of such debt instruments to the Commission upon request.
9. VOTING TRUST AGREEMENT.
Not applicable
10. MATERIAL CONTRACTS.
10.1 Copy of Agreement between Martin Scheinberg and DVL dated January 17, 1991. (Incorporated by reference to Exhibit 10(a)(11) to DVL's Form 10-K for the fiscal year ended December 31, 1990.)
10.2 Copy of Employment Agreement between DVL and Ben S. Read, Jr., dated November 1, 1990. (Incorporated by reference to Exhibit 10(a)(12) to DVL's Form 10-K for the fiscal year ended December 31, 1990.)
10.3 Copy of Employment Agreement between DVL and Alan E. Casnoff dated January 1, 1991. (Incorporated by reference to Exhibit 10(a)(13) to DVL's Form 10-K for the fiscal year ended December 31, 1990.)
10.4 Copy of DVL Performance Unit Plan. (Incorporated by reference to Exhibit 10(a)(14) to DVL's Form 10-K for the fiscal year ended December 31, 1990.) 10.5 Copy of Resignation and Indemnification Agreement dated May 3, 1991 between Roger D. Stern, Kenbee and DVL. (Incorporated by reference to Exhibit 10(a)(15) to DVL's Form 10-K for the fiscal year ended December 31, 1990.)
10.6 Copy of Employment Agreement between DVL and Joel Zbar dated October 1, 1991. (Incorporated by reference to Exhibit 10(a)(16) to DVL's Form 10-K for the fiscal year ended December 31, 1991.)
10.7 Copy of Voting Trust Agreement between R&M Holding Company and Alan Casnoff dated May 15, 1991. (Incorporated by reference to Exhibit 10 (a)(18) to DVL's Form 10-K for the fiscal year ended December 31, 1991.)
10.8 Copy of Voting Trust Extension by Roger D. Stern dated December 10, 1991. (Incorporated by reference to Exhibit 10(a)(19) to DVL's Form 10-K for the fiscal year ended December 31, 1991.)
10.9 Copy of Voting Trust Extension Agreement between R&M Holding Company and Alan Casnoff dated April 7, 1992. (Incorporated by reference to Exhibit 10(a)(20) to DVL's Form 10-K for the fiscal year ended December 31, 1991.)
10.10 Form of Second Deed to Secure Debt between an affiliated partnership and DVL. (Incorporated by reference to Exhibit 10(b)(1) to DVL's Form 10-K for the fiscal year ended December 31, 1983.)
10.11 Form of Note of an affiliated partnership to DVL. (Incorporated by reference to Exhibit 10(b)(2) to DVL's Form 10-K for the fiscal year ended December 31, 1983.)
10.12 Form of Note of a subsidiary of Kenbee to DVL. (Incorporated by reference to Exhibit 10(b)(3) to DVL's Form 10-K for the fiscal year ended December 31, 1983.)
10.13 Assumption Agreement between DVL and North Lake Corporation dated as of November 22, 1983. (Incorporated by reference to Exhibit 10(b)(8) to DVL's Form 10-K for the fiscal year ended December 31, 1983.)
10.14 Loan and Security Agreement between DVL and Kenbee dated September 10, 1984. (Incorporated by reference to Exhibit 10(b)(11) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.15 Letter Agreement between DVL and Kenbee dated as of December 31, 1984. Incorporated by reference to Exhibit 10(b)(16) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.16 Loan and Security Agreement between DVL and Kenbee dated as of December 31, 1984. (Incorporated by reference to Exhibit 10(b)(17) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.17 Letter Agreement between DVL and Kenbee dated January 30, 1985. (Incorporated by reference to Exhibit 10(b)(14) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.18 Supplemental Letter Agreement between DVL and Kenbee dated March 12, 1985. (Incorporated by reference to Exhibit 10(b)(15) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.19 Letter Agreement between DVL and Kenbee dated as of December 31, 1984. (Incorporated by reference to Exhibit 10(b)(12) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.20 Letter Agreement between DVL, LW Industries, Inc. and Kenbee dated as of March 12, 1985. (Incorporated by reference to Exhibit 10(b) (13) to DVL's Form 10-K for the fiscal year ended December 31, 1984.)
10.21 Note of DVL to LW Industries, Inc. Defined Benefit Pension Plan dated as of December 31, 1987. (Incorporated by reference to Exhibit 10(b)(30) to DVL's Form 10-K for the fiscal year ended December 31, 1987.)
10.22 Letter Agreement between DVL and Kenbee dated November 30, 1987. (Incorporated by reference to Exhibit 10(b)(30) to DVL's Form 10-K for the fiscal year ended December 31, 1987.)
10.23 Form of Mortgage and Security Agreement between DVL and an affili- ated partnership. (Incorporated by reference to Exhibit 10(b)(33) to DVL's Form 10-K for the fiscal year ended December 31, 1988.)
10.24 Letter Agreement between P & A Associates and Kenbee dated April 19, 1989. (Incorporated by reference to Exhibit 10(b)(5) of DVL's Form S-2 Registration Statement No. 33-29184, dated June 7, 1989.)
10.25 Copy of Stipulation of Settlement of IN RE KENBEE LIMITED PARTNERSHIP LITIGATION dated August 12, 1992. (Incorporated by reference to Exhibit 10(b)(25) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.26 Copy of forms of DVL's Convertible Subordinated 12% Promissory Note, Purchase Agreement, First Amendment to Purchase Agreement, Second Amendment to Purchase Agreement and Warrant to Purchase Common Stock of DVL. (Incorporated by reference to Exhibit 10(b)(26) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.27 Copy of forms of DVL's Convertible Subordinated 10% Promissory Note, Purchase Agreement and Warrant to Purchase Common Stock of DVL. (Incorporated by reference to Exhibit 10(b)(27) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.28 Copy of Stipulation of Partial Settlement and Order in IN RE DEL-VAL FINANCIAL CORPORATION SECURITIES LITIGATION Master File #MDL872. (Incorporated by reference to Exhibit 10(b)(28) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.29 Copy of Employment Agreement between DVL and Robert W. LoSchiavo dated January 1, 1994. (Incorporated by reference to Exhibit 10(b) (29) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.30 Copy of Employment Agreement between DVL and Robert W. LoSchiavo dated January 1, 1995. (Incorporated by reference to Exhibit 10(b) (30) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.31 Copy of Employment Agreement between DVL and Robert W. LoSchiavo dated January 1, 1996. (Incorporated by reference to Exhibit 10(b) (31) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.32 Copy of Conditional Compromise Agreement between DVL and the Federal Deposit Insurance Corporation as Receiver for American Savings Bank dated March 26, 1996. (Incorporated by reference to Exhibit 10(b) (32) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.33 Amended and Restated Loan Agreement between DVL and NPM Capital LLC, dated March 27, 1996. (Incorporated by reference to Exhibit 10(b) (33) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.34 Asset Servicing Agreement between DVL, PSC, Kenbee Realty and NPO Management LLC dated March 27, 1996. (Incorporated by reference to Exhibit 10(b)(34) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.35 Copy of Third Voting Trust Extension between R&M Holding Company and Alan Casnoff dated March 7, 1996. (Incorporated by reference to Exhibit 10(b)(35) to DVL's Form 10-K for the fiscal year ended December 31, 1995.)
10.36 Amended and Restated Loan Agreement between DVL, Inc and NPM Capital LLC, dated March 27, 1996 (Incorporated by reference to Proxy Statement dated July 31, 1996 - Exhibit "A".)
10.37 Amended and Restated Negotiable Promissory Note (Incorporated by reference to DVL's Proxy Statement dated July 31, 1996 - Exhibit "B".)
10.38 Asset Servicing Agreement between DVL, Inc. and NPO Management LLC (Incorporated by Reference to DVL's Proxy Statement dated July 31, 1996 - Exhibit "C".)
10.39 Stock Purchase Agreement between DVL, Inc and NPO Capital LLC (Incorporated by Reference to DVL's Proxy Statement dated July 31, 1996 - Exhibit "D".)
10.40 Securities Purchase Agreement between DVL, Inc. and NPM Capital LLC (Incorporated by Reference to DVL's Proxy statement dated July 31, 1996 - Exhibit "E".)
10.41 Common Stock Warrant issued by DVL, Inc. to NPO Holdings LLC (Incorporated by Reference to DVL's Proxy statement dated July 31, 1996 - Exhibit "F".)
10.42 DVL, Inc. 1996 Stock Option Plan (Incorporated by Reference to DVL's Proxy statement dated July 31, 1996 - Exhibit "K".)
*11. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS.
12. STATEMENTS RE COMPUTATION OF RATIOS.
Not applicable since there are no ratios of earnings to fixed charges in DVL's Form 10-K.
13. LETTER RE CHANGE IN ACCOUNTING PRINCIPLES.
There has been no change in accounting principles or practices followed by DVL, or any change in the method of applying such accounting principles or practices, which affect the financial statements of DVL included in Item 8 hereof.
14. PREVIOUSLY UNFILED DOCUMENTS.
None
15. SUBSIDIARIES OF DVL.
(Incorporated by reference to Exhibit 15 to DVL Form 10-K for the fiscal year ended December 31, 1989.) Three additional subsid- iaries, DV/MHC and Professional Service Corporation (both Delaware Corporations) and RH Interests, a New Jersey Corporation, were formed prior to the date of this Form 10-K and all are wholly-owned by DVL.
16. Published report regarding matters submitted to vote OF SECURITY HOLDERS.
Not applicable.
17. CONSENTS OF EXPERTS AND COUNSEL.
Not applicable.
18. POWER OF ATTORNEY.
Not applicable.
19. ADDITIONAL EXHIBITS.
There are no additional exhibits.
20. INFORMATION FROM REPORTS FURNISHED TO STATE INSURANCE REGULATORY AUTHORITIES.
Not applicable.
*27. FINANCIAL DATA SCHEDULE
(b) No reports on Form 8-K were filed during the fiscal quarter ended December 31, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, DVL has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DVL, INC.
Date: April 15, 1997 By: Alan E. Casnoff ___________________________ Alan E. Casnoff, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of DVL and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
Alan E. Casnoff ______________________ Alan E. Casnoff President, Chief Executive April 15, 1997 Officer (Principal Executive, Financial and Accounting Officer)
Frederick E. Smithline ______________________ Frederick E. Smithline Director April 15, 1997
Allen Yudell ______________________ Allen Yudell Director April 15, 1997
Myron Rosenberg ______________________ Myron Rosenberg Director April 15, 1997
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, DVL has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DVL, INC.
Date: April 15, 1997 By: /s/ ___________________________ Alan E. Casnoff, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of DVL and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ----
/s/ ______________________ Alan E. Casnoff President, Chief Executive April 15, 1997 Officer (Principal Executive, Financial and Accounting Officer)
/s/ ______________________ Frederick E. Smithline Director April 15, 1997
/s/ ______________________ Allen Yudell Director April 15, 1997
/s/ ______________________ Myron Rosenberg Director April 15, 1997
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------
Consolidated Financial Statements of DVL, Inc. and Subsidiaries and Report of Independent Auditors
Page ----
Report of Independent Auditors F- 1
Consolidated Balance Sheets-December 31, 1996 and 1995 F- 2
Consolidated Statements of Operations for each of the years in the three year period ended December 31, 1996 F- 4
Consolidated Statements of Shareholders' Equity (Deficiency) for each of the years in the three year period ended December 31, 1996 F- 6
Consolidated Statements of Cash Flows for each of the years in the three year period ended December 31, 1996 F- 7
Notes to Consolidated Financial Statements
RICHARD A. EISNER & COMPANY, LLP 575 Madison Avenue New York, NY 10022-2597 - -------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders DVL, Inc. Bogota, New Jersey
We have audited the accompanying consolidated balance sheets of DVL, Inc. and subsidiaries as at December 31, 1996 and December 31, 1995, and the related consolidated statements of operations, shareholders' equity (deficiency), and cash flows for each of the years in the three year period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all material respects, the consolidated financial position of DVL, Inc. and subsidiaries as at December 31, 1996 and December 31, 1995, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2, the Company has suffered significant losses from operations in each of the last three years and is continuing to have liquidity problems. These factors raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
RICHARD A. EISNER & COMPANY, LLP
New York, New York April 4, 1997
DVL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
a. THE COMPANY: DVL, Inc. ("DVL") is a Delaware corporation headquartered in Bogota, New Jersey. DVL's common stock is traded on the over-the-counter market and is quoted on the NASD OTC Bulletin Board under the symbol "DVLN". DVL stock was traded on the New York Stock Exchange ("NYSE") through August 3, 1995. DVL is a commercial finance company which manages numerous properties and partnerships, and holds and services commercial mortgage loans. DVL's investments consist primarily of commercial mortgage loans due from affiliated partnerships, loans due from limited partners collateralized by their interests in affiliated partnerships, limited partnership investments in affiliated partnerships and other real estate interests. DVL's sole active subsidiary is Professional Service Corporation ("PSC") DVL has three inactive subsidiaries Del- Val Capital Corp. (DVCC), RH Interests Inc. (RH) and DV/MHC. DVL acquired RH from Kenbee Management, Inc. ("Kenbee"), DVL's former manager, on January 1, 1994 (Note 4). RH held interests in several real estate development projects. The accounts of DVCC, RH (reflected as discontinued operations - see Note 3) and PSC have been consolidated in these financial statements. All material intercompany transactions and accounts are eliminated in consolidation. DVCC was organized in 1989 to acquire, make and service full recourse loans due from unaffiliated borrowers collateralized by consumer receivables. PSC was organized in 1991 and holds certain master lease positions acquired by DVL through a creditor settlement (Notes 6).
In 1994, DVL organized the First Mechanics Finance Company ("FMF") as a wholly-owned subsidiary to develop a specialized tool loan purchasing and servicing business. Due to the lack of cash resources and as part of DVL's decision to refocus on its existing commercial finance business, DVL sold FMF in 1994 in an effort to recoup some of its initial investment. FMF was sold principally for a note and subordinated debenture. The results of FMF's operations were not consolidated in these financial statements as FMF was reflected as a temporary investment.
Kenbee was DVL's largest debtor and served as DVL's manager through October, 1990. DVL's management assumed operational control of Kenbee during 1991 and all of Kenbee's remaining unencumbered assets were transferred to DVL in 1992. DVL replaced Kenbee as the general partner of certain limited partnerships, which are treated as affiliates in these financial statements. DVL has operational control over the limited partnerships, however, significant transactions are subject to limited partner approval.
b. EFFECT OF NEW PRONOUNCEMENTS
LONG LIVED ASSETS: DVL adopted Financial Accounting Standards (FASB) No. 121 - "Accounting for the impairment of long-lived assets to be disposed of." This Statement requires that long-lived assets and certain identifiable intangibles to be held by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable from future cash flows. The adoption of FASB No. 121 in 1995 had no impact on DVL's financial statements.
ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN: DVL adopted FASB No. 114 as amended by FASB No. 118 which requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans effective interest rate or at the fair value of the collateral if the loan is collateral dependent. The adoption of FASB No. 114 as amended by FASB No. 118 in 1995 had no impact on DVL's financial statements.
c. USE OF ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
d. ALLOWANCE FOR LOSSES: Specific loss reserves are provided as required based on management's evaluation of the underlying collateral on each loan or investment (Note 5).
e. DEPRECIATION: Depreciation is provided by charges to operations on either a straight-line basis or accelerated basis at rates which will allocate the cost of the assets over their estimated useful lives.
f. DEFERRED CHARGES: Deferred charges applicable to debt financing are amortized over the term of the related debt.
g. INCOME RECOGNITION: Interest income is not recognized on the non- performing portion of DVL's loan portfolio. A loan is considered non-performing when scheduled interest or principal payments are not received on a timely basis and, in the opinion of management, the collection of such payments in the future appears doubtful. Interest income on DVL's restructured mortgage loan portfolio is recognized using an imputed interest rate based upon the anticipated future cash flow and yield to maturity (Note 4). Gains on sales of real estate to affiliates are recognized in income generally under the installment method, whereby the gain on the portion of the sales price which is not received in cash is deferred at the time of sale and recognized proportionately as cash is subsequently collected. Any cash received on the collection of the note or debenture obtained from the sale of FMF, subsequent to March 30, 1995, has been recognized into income when received.
h. FEDERAL INCOME TAXES: DVCC, PSC and RH will be included in DVL's consolidated federal income tax return for 1996. DVL revoked its election to be taxed as a real estate investment trust ("REIT") under Sections 856-860 of the Internal Revenue Code ("Code"), effective January 1, 1994. As a REIT, DVL was required to distribute to its shareholders at least 95% of its federal taxable income, and assuming compliance with certain other requirements, income so distributed would not be taxable to DVL.
The revocation of DVL's REIT status was approved by its shareholders in order to permit DVL to earn income in ways which are not permitted or which are subject to taxation at a rate of 100% for a REIT under the Code. In this manner, DVL believes that it will be best able to utilize its significant net operating loss carryforwards generated during the last six years to offset taxable income, if any, subject to certain limitations, in the future.
The company accounts for income taxes under the provisions of Statement of Financial Accounting Standards No. 109 ("FAS 109"), which requires the Company to recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. In addition, FAS 109 requires the recognition of future tax benefits such as net operating loss carryforwards, to the extent that realization of such benefits is more likely than not.
At December 31, 1996, DVL had net operating loss carryforwards for income tax purposes of approximately $60 million available to offset future taxable income, if any, expiring through 2010. Temporary differences arise from differences between financial reporting and income tax reporting relating primarily to provision for loan and other losses and the issuance of the notes payable pursuant to the shareholder litigation settlement, which are currently not deductible for income tax purposes. DVL's deferred tax asset of approximately $33 million, which is comprised of the tax benefit of net operating loss carryforwards of approximately $24 million and temporary differences represented primarily by non-deductible loan reserves and the issuance of the notes payable pursuant to the shareholder litigation is fully reserved for due to the uncertainty of realizing taxable income in the future (Notes 2, 11, 12 and 13). The reduction in the valuation reserve for deferred tax assets was approximately $2 million for the year ended December 31, 1996. DVL believes that its ability to utilize its tax loss carryforward will not be adversely affected by the issuance of stock, stock options and warrants, pursuant to existing agreements with various lenders and with its shareholders, nor the issuance of convertible debentures.
i. PER SHARE DATA: Earnings per share amounts are based upon the weighted average number of common shares and equivalents issued. The dilutive effect of outstanding options and warrants is computed using the treasury stock method.
2. Basis of Presentation and Financial Condition
The accompanying financial statements were prepared on a going concern basis, which assumes that the realization of assets and repayment of liabilities will be in the normal course of business.
During 1996, DVL continued to experience liquidity problems primarily as a result of the limited cash flow generated by its restructured mortgage portfolio, as the mortgage debt service is used to pay senior liens before cash flow on such mortgages is available to DVL. DVL's cash flow provided by current operations is insufficient to meet its cash requirements, and DVL continues to liquidate and/or refinance its assets in order to meet its operating cash flow deficiency. There can be no assurance that the cash flow generated by DVL's potential asset liquidations or refinancings will be sufficient to meet any future operating cash flow deficiencies or future mandatory debt repayments.
DVL has entered into a loan agreement with a new lender that considerably extends DVL's mandatory debt repayments (Note 7). In December 1995, DVL reached an agreement with its final unsettled creditor (Note 7). That settlement resulted in an extraordinary gain on the settlement of indebtedness of $7.4 million in 1996 and gains of $6 million in 1995.
In December 1995, DVL completed its obligations under a 1993 settlement of its class action litigation. The settlement, which was approved by the court in 1993, provided that DVL would issue the plaintiffs (1) 900,000 shares of DVL common stock at a minimum price of $1.50 per share (or notes to cover any deficiency in the event that aggregate market value was less than $1,340,000); (2) $9 million face value of notes due in ten years, with interest at 10% payable in kind for five years, callable after the third year and payable on the tenth year in cash or with DVL common stock equal to 110% of the face value of the notes (valued in 1993 at $3,690,000 by an independent investment banker) and (3) $1.4 million plus interest at 3% from August 16, 1993 and expenses, payable in cash or common stock. In December 1995, DVL issued the 900,000 shares of common stock and as a result of the deficiency in its market value, issued additional notes with the same terms, in the face amount of $1,386,351 (valued at $330,000 by DVL). In payment of the $1.4 million plus interest and expenses, DVL issued 4,017,582 shares of common stock in December 1995.
In the aggregate, DVL issued notes with a face value of $10,386,851. Commencing January 1994, interest on the initial $9 million of notes was imputed based upon DVL's carrying costs of such notes resulting in an effective interest rate of approximately 19%. Beginning October 1, 1995, interest on all of the notes is being imputed based upon an effective interest rate of approximately 16.325%. The settlement resulted in a loss of $6.4 million which was fully provided for in 1992 (Note 11).
In November 1992, DVL, Kenbee and the limited partners of certain affiliated partnerships reached a settlement in the limited partnership class action litigation ("Limited Partner Settlement") and, concurrently with this settlement, DVL reached settlements with a number of its creditors providing for the restructuring of a substantial portion of DVL's defaulted indebtedness and loan guarantees. The Limited Partner Settlement and the related settlements with DVL's creditors, resulted in a) the reaffirmation and the restructuring of the terms of certain of DVL's mortgage loans receivable from affiliated partnerships and similar such partnership mortgages collateralizing DVL's loans due from affiliates, including reductions in payment amounts and interest rates, as well as discounts on the payoff of such loans prior to maturity, b) the replacement of DVL's loans to affiliates collateralized by partnership mortgage loans with the restructured mortgage loans due directly from the partnerships, c) the cancellation of certain of DVL's interim mortgage loans receivable due from affiliated partnerships and a related reduction to DVL's indebtedness through the transfer of substitute assets to certain creditors, d) a restructuring of the payment terms on DVL's indebtedness to other creditors, e) the elimination of DVL's and Kenbee's contingent liabilities to certain partnerships, f) the elimination of certain obligations between Kenbee or DVL
and the partnerships, g) the ratification of the validity and enforceability of loans to limited partners collateralized by limited partnership interests, h) the transfer to DVL of the management of the affiliated partnerships as the general partner (Note 4) and i) the establishment of an independent oversight committee to monitor the management of the affiliated partnerships. In addition, the Limited Partner Settlement established a settlement fund into which DVL is required to deposit a portion of its cash flow received from affiliated partnership mortgages and other loans receivable from affiliated partnerships, as well as a contribution of 5% of DVL's net income subject to certain adjustments in the years 2001 to 2012 (Note 11). Although the Limited Partner Settlement resulted in the reclassification of a substantial portion of DVL's mortgage loan portfolio from non-performing to performing, this reclassification has not resulted, nor is it expected to result in significant income or cash flow on the majority of the restructured mortgages until liens senior to DVL's are fully repaid, as the mortgage debt service is currently used to pay liens senior to DVL's.
DVL's ability to continue as a going concern is dependent upon (1) the sale or refinancing of certain assets to improve its cash position in order to meet operating expenses and mandatory debt payments, (2) the settlement of remaining litigation, (3) the realization of the estimated value of its loan portfolio over an extended period of time rather than the value of the assets on a liquidation basis, (4) the return to profitable operations and (5) availability of additional borrowings. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.
3. Discontinued Operations
During 1993 and 1994, DVL began to pursue an additional business venture involving the acquisition, development and resale of residential real estate. The sales and development of DVL's real estate projects progressed more slowly than DVL originally anticipated and DVL did not have the financial resources to make further investments in its projects. Therefore, in 1994 DVL agreed to transfer its interests in its three remaining projects to the creditors who financed DVL's purchases of such projects in satisfaction of the related non- recourse debts. These activities are reflected as a discontinued operation in these financial statements.
Furthermore, DVL continued to liquidate DVCC's loan portfolio during 1994 and, therefore, DVCC was also accounted for as a discontinued operation in these financial statements. In May 1994, DVCC sold one loan at its carrying value and pledged another loan as collateral for a DVL loan (Note 7). DVCC's remaining assets, net of an additional reserve of $175,000 taken in 1994, were absorbed by DVL, which treated these transactions as the final disposal of DVCC.
4. Loans Receivable
Virtually all of DVL's loans receivable arose out of transactions previously arranged by Kenbee in which affiliated partnerships purchased commercial, office and industrial properties typically leased on a long-term basis to unaffiliated, creditworthy tenants. Each mortgage loan is collateralized by a lien, primarily subordinate to senior liens, on real estate owned by an affiliated partnership. DVL's loan portfolio is comprised of long-term wrap-around and other mortgage loans due from affiliated partnerships; interim second mortgage loans due from affiliated partnerships; a loan due from an unaffiliated party; and loans due from limited partners collateralized by their interests in affiliated partnerships ("Partners' Notes") and are principally pledged to collateralize DVL's indebtedness to NPM (Note 7). DVL's mortgage portfolio includes 36 loans with a net investment of $19,650,000 which are due from affiliated partnerships that own properties leased to Wal- Mart Stores, Inc.
As a result of the Limited Partner Settlement and other settlements, the validity of all of DVL's mortgage portfolio was reaffirmed and virtually all of DVL's loans to Kenbee collateralized by loans due from affiliated partnerships were replaced by the restructured mortgage loans due directly from the partnerships. In many cases, the restructuring of the partnership mortgages called for a reduction in payment terms and interest rates, in order to assure that the partnerships' restructured mortgages are serviced on a current basis from the base rents generated by the properties, and, in all cases, mandatory discounts on the payoffs of the loans prior to maturity. The Limited Partner Settlement also ratified the validity and enforceability of the Partners' Notes
and resulted in the replacement of certain loans due from Kenbee collateralized by Partners' Notes with the loans receivable directly from the limited partners (Note 2).
In 1996, DVL refinanced 19 mortgages which generated approximately $6,000,000 which was used to satisfy existing indebtedness. The amounts obtained or to be obtained from these refinancings were primarily based on the value of the base rents during the period of the base lease term subsequent to the payoff of the existing first mortgages. As a result of DVL's prior and current asset liquidations and refinancings, DVL's asset base available for future liquidations and refinancings has diminished considerably (Note 4(c)).
The Limited Partner Settlement, as well as the settlements with other limited partnerships, resulted in the modification of terms of certain performing mortgage loans receivable from affiliated partnerships which bore interest at effective rates of up to 15% per annum, aggregating $1,466,000 and $3,124,000 at December 31, 1996 and 1995, respectively, and mature through 2027. The effect of the modification on these mortgages on DVL's interest income for 1996 was not material.
In addition, the terms of the loans to Kenbee collateralized by similar loans were restructured and modified. These loans, at the time of the restructuring, bore interest at 3% over DVL's average interest rate for short- term borrowings and matured through 1996. The restructured and modified loans due directly from the partnerships bear interest at stated rates of up to 15.5% and mature through 2031. As of December 31, 1996, the modified loans due directly from the partnerships aggregated $18,242,000 net of underlying mortgages of $38,802,000. Management currently does not anticipate realizing a material amount of interest income over the remaining terms of these modified loans. Had these loans not been in default and had the terms not been modified, interest income relating to these notes would have been approximately $5,000,000 in each of 1996, 1995, and 1994.
Pursuant to certain settlement agreements, DVL replaced certain mortgage loans and loans collateralized by limited partnership interests due from affiliates with similar loans due from unaffiliated parties in 1992 (Note 4(f)).
(a) DVL previously funded certain wrap-around mortgages due from affiliated partnerships, whereby the original principal of the wrap equaled the outstanding balance of an underlying first mortgage loan plus the amount of funds advanced by DVL to the partnership. These loans mature through August 2027, bear interest at effective rates of up to 15% per annum and are collateralized primarily by second mortgages on commercial and industrial properties located in various states. DVL is responsible to make principal and interest payments on the first mortgage loan to the extent received from the borrower and, in certain instances, has the right to refinance or pay off the first mortgage loan and succeed to its seniority. Currently, the partnerships or the tenants are making the underlying mortgage payments directly and DVL is applying such payments to its wrap-around mortgage loans. To the extent that the underlying mortgage payment is less than the wrap-around mortgage payment, the partnership is obligated to pay DVL the balance. These wrap-around loans are reflected net of underlying mortgage loans of $10,947,000 in 1996 and $10,862,000 in 1995, which bear interest at rates ranging from 7.5% to 13.125%, are payable to unaffiliated lenders in monthly installments ranging from $2,000 to $21,000, mature on various dates through August 2011 and are collateralized by liens senior to DVL's liens. See Note 8 for the five year maturities of such underlying loans. These wrap-around loans include three non-performing loans with a net investment aggregating $2,944,000 at December 31, 1996 and four non- performing loans with a net investment aggregating $3,062,000 at December 31, 1995.
(b) DVL's other long-term mortgage loans to affiliated partnerships mature through December 2029, bear interest at effective rates of up to 15% per annum and are collateralized by first mortgages on commercial and industrial properties located in various states. Two of such loans aggregating $1,201,000 in 1996 and $1,320,000 in 1995 arose from DVL's sales of real estate prior to 1980 to Kenbee and affiliated partnerships in which Kenbee is a general partner. DVL realized gains on such sales of $2,280,000 (see Note 1(g) for DVL's income recognition policy). These loans include one non-performing loan with a net investment aggregating $1,119,000 at December 31, 1996 and December 31, 1995.
(c) DVL acquired long-term wrap-around and other mortgage loans to affiliated partnerships pursuant to the Limited Partner Settlement. The principal balance of such loans when acquired in 1992 equaled DVL's net investment in the related loan previously due from Kenbee less specific write- downs of $18,223,000 on certain of these loans based upon the anticipated cash flow to be generated by each loan (Note 5). Although these loans have stated interest rates of up to 15.5%, interest, if any, will be imputed based upon the anticipated cash flow to be generated by each loan. The loans are collateralized by first, second and third mortgages on commercial and industrial properties located in various states and mature through June 2031. DVL subordinated its second mortgage position on sixteen of these loans as part of a refinancing in 1994. The wrap-around loans are reflected net of senior liens of $38,802,000 in 1996 and $33,438,000 in 1995, which bear interest at rates ranging from 7.5% to 14%, are payable to unaffiliated lenders on a zero coupon basis and in monthly installments ranging from $2,000 to $26,000, mature on various dates through January 2012 and are collateralized by liens senior to DVL's liens. The payment of the underlying first mortgages is also being made by the partnerships or tenants as discussed in (a) above. See Note 7 for the five year maturities of such underlying loans.
(d) An interim second mortgage loan to an affiliated partnership generally was equal to the difference between the partnership's purchase price for its property and the amount of a first mortgage provided by an unaffiliated lender. Although the remaining loan bears interest, DVL does not anticipate realizing any income from this loan. This loan is due on demand and is expected to be repaid primarily from the future sale of this property and continues to be non- performing at December 31, 1996.
(e) DVL's mortgage loan due from an unaffiliated entity resulted from the satisfaction of its mortgage loans due from affiliated partnerships. In 1994, DVL received a $1,450,000 loan from Grand Union in partial satisfaction of one of its partnership mortgage loans. This loan bore interest at 9% per annum and required monthly payments of $18,000, with a balloon payment of $1,161,000 due in December 1996. This loan was repaid in 1996.
(f) DVL made loans directly to limited partners to finance up to 80% of their partnership investments. As a result of the Limited Partner Settlement, DVL received loans due from limited partners in 1992 in replacement of loans due from Kenbee collateralized by such Partners' Notes. All such partner loans matured at various dates through December 1995 and bear interest at fixed rates of 15% to 16% and at a variable rates up to 2 1/2% over prime. Certain of the variable rate loans are payable at fixed interest rates, subject to additional interest charges payable upon the maturity of the loan, based on variable interest rates, which are further subject to minimum and maximum levels. All of these loans were non-performing at December 31, 1996 and December 31, 1995.
DVL's commercial mortgage loans, exclusive of its wrap-around mortgages, are collateralized by 7 first mortgages aggregating $7,918,000 and 3 second mortgages aggregating $2,566,000 at December 31, 1996 and by ten first mortgages aggregating $10,840,000 and five second mortgages aggregating $3,097,000 at December 31, 1995. The commercial mortgage loans have prior first or second mortgage liens, principally on a nonrecourse basis, of approximately $3,500,000 and $10,000,000 at December 31, 1996 and 1995, respectively. The principal maturities of DVL's commercial mortgage loan portfolio, excluding wrap-around mortgages, in each of the next five years are $1,240,000 in 1997, $213,000 in 1998, $220,000 in 1999, $231,000 in 2000 and $244,000 in 2001. All such commercial mortgage loans and the wrap-around mortgages are collateralized by liens on commercial and industrial properties located in various states. DVL's commercial mortgage loans and loans collateralized by limited partnership interests have principally the same cost basis for federal income tax and financial reporting purposes, except for certain of the loans acquired from Kenbee pursuant to the Limited Partner Settlement whose basis for federal income tax purposes is greater than for financial reporting purposes by approximately $400,000. Such difference is a result of write offs for income tax purposes greater than for financial statement purposes in 1992 which have been more than offset by (a) interest income being reported for tax purposes using an effective interest rate which is not recognized for financial statement purposes and (b) a reduction in the carrying value based upon cash received for financial reporting purposes, only.
5. Allowance for Losses and Other Reserves
DVL's allowance for loan losses is based upon the value of the collateral underlying each loan in its portfolio. Management's evaluation of such collateral previously resulted in substantial loan write-offs and a substantial allowance for loan losses. The evaluation considered the magnitude of DVL's non-performing loan portfolio, updated internally generated appraisals of certain properties, updated information on certain properties and DVL's anticipated liquidation of loans to meet future mandatory repayment obligations on certain indebtedness, as well as its operating cash flow deficiency (Note 7).
The allowance for losses on DVL's mortgage loan portfolio was calculated by first comparing the appraised value of the property collateralizing a mortgage loan, net of liens senior to DVL's liens, to DVL's net investment in the mortgage loan. For those mortgages which were modified, further losses were provided for by then comparing DVL's net investment in the mortgage loan, less any allowance necessary based upon the appraised value of the property, to the anticipated cash flow to be generated by the terms of the mortgage or the amount anticipated to be received through the liquidation of the mortgage. The partnership properties were valued based upon the cash flow generated by base rents and anticipated percentage rents or base rent escalations to be received by the partnership. The value of partnership properties which are not subject to percentage rents was based upon historical appraisals. Management believes that, generally, the values of such properties have not changed as the tenants, lease terms and timely payment of rent have not changed. When any such changes have occurred, management revalued the property as it reasonably believed appropriate. The value of the partnership properties which are subject to percentage rents was based upon internally generated appraisals. Such appraisals valued the future percentage rents utilizing assumed sales growth percentages of up to 6% annually, based upon each individual store's recent sales history through January 31, 1993. Such appraisals were updated if there were any significant changes in the status of the existing tenancy. Certain other properties were valued based upon management's estimate of the current market value for each specific property using similar procedures. In addition, management provided for a reserve on certain of its mortgages and partnership investments (Note 6) for anticipated losses to be realized as certain of such assets are liquidated to meet DVL's mandatory repayment obligations (Note 7) and its operating cash flow deficiency.
Based upon the ratification of the enforceability and validity of DVL's portfolio of Partners' Notes by the Limited Partner Settlement and the payment experience on such notes, management re-evaluated each note in its portfolio for specific loss reserves. As of December 31, 1996, the notes deemed uncollectible were provided for assuming an estimated residual value of the related partnership investment of approximately 14.5% of the original investment, which reflects management's estimate of the investment's net realizable value.
Management provided for losses of $0, $35,000 and $973,000 in 1996, 1995 and 1994, respectively, in connection with certain litigation and the settlements of claims against it and Kenbee originating from Kenbee's indebtedness to certain creditors. Under previously completed settlement agreements, DVL transferred certain mortgages with a carrying value aggregating $3,007,000 in 1992 and 1991 to the claimants in full satisfaction of the claims against DVL and Kenbee. DVL had guaranteed that such claimants (the "Lender Group") would receive a minimum cash flow from the transferred mortgages of $110,000 per year through 1996 and provided the Lender Group with a contingent note for the reduction in the present value of the transferred mortgages resulting from changes in the terms of such mortgages in connection with the settlement of the limited partner suits. DVL transferred a mortgage to the Lender Group in full settlement of all cash flow requirements and the contingent note. The mortgage had a carrying value of $523,000, which amount had been fully provided for at December 31, 1994.
DVL sold FMF in December 1994 for $837,000 of which $825,000 was financed by DVL with a secured promissory note and subordinated debenture. DVL incurred a $1,181,000 (including $353,000 of overhead allocated by DVL to FMF) loss on its temporary investment in FMF which represents the start-up and operating costs funded by DVL, less the cash received through March 30, 1995 from the sale of FMF. The loss provision included a full reserve for the remaining payments due under the note and debenture as their collectibility was uncertain and DVL had placed no value on the note or debenture. DVL has received $290,000 from the sale of FMF from March 31, 1995 through December 31, 1996 which has been recorded as income and the remaining balance due has been canceled. In December 1995, DVL agreed to issue 250,000 shares of common stock in January 1996 to the prior president of FMF in consideration of an assignment of loans to FMF of approximately $112,000 and his release of all potential claims against DVL. The value of such stock ($31,000) has been offset against the income received from FMF.
6. Investments
Real Estate -----------
At December 31, 1996, DVL's remaining real estate, which is principally pledged to collateralize indebtedness to NPM (Note 8), is leased to two affiliated partnerships under long-term leases at aggregate annual rents of approximately $37,000. At December 31, 1995, one of such leases was in default and DVL provided for a loss of $208,000 based upon the current value of the property. No additional provision was made at December 31, 1996. During 1993, DVL reached an agreement with one of its creditors under which DVL assigned its interest in three of its land leases and the related building improvements to affiliated partnerships (Note 7). The carrying value of the transferred real estate assets aggregated $1,274,000. As part of the agreement, PSC acquired the master lease positions for these properties, which were pledged to the creditor as additional collateral. Information for DVL's remaining properties is as follows:
Affiliated Limited Partnerships -------------------------------
DVL acquired various interests in affiliated partnerships pursuant to the terms of certain settlement agreements. Management originally valued all of these investments at 33% of the original investment amount, the expected recovery for such investments, except for interests acquired in one partnership with an original investment aggregating $2,450,000 which are assigned to one of DVL's creditors and were valued at 40% of their original investment amount based upon the anticipated proceeds through the future sale of the partnership's property. In 1994 and 1996, management provided for a general reserve on these investments to bring the net carrying value down to 25.2% and 14.5%, respectively, of the original investment amount, exclusive of the $2,450,000 discussed above, due to potential anticipated losses upon liquidation of these investments to meet DVL's mandatory repayment requirements and operating cash flow deficiency. (Notes 4,5 and 7). As distributions are received or the investments are disposed of, the carrying value is reduced. No income will be recognized until the anticipated cash flow exceeds the carrying value.
At December 31, 1996, all DVL's investments in affiliated partnerships are pledged to collateralize indebtedness (Note 7).
Other Investments -----------------
In connection with a 1993 settlement of three related partnerships which opted out of the Limited Partner Settlement, DVL received majority limited partnership interests in three new partnerships. These partnerships' sole assets are the restructured partnership mortgage loans on the properties leased to Wal- Mart Stores, Inc. by the three partnerships which opted out. These investments were valued based upon the anticipated cash flow to be generated by the restructured mortgage loans (Notes 4(c) and 5). Management has reserved a total of $400,000 as of December 31, 1996 primarily resulting from a decrease in the value of the underlying collateral of one of the three partnership mortgage loans. As distributions are received or the investments are disposed of, the carrying value is reduced. No income will be recognized until the anticipated cash flow exceeds the carrying value.
7. Short-Term Debt, Long-Term Debt and Loans Payable Underlying Wrap-around Mortgages
DVL's short-term and long-term debt is comprised of the following loans payable to unaffiliated lenders:
(a) In December 1995, DVL reached a settlement with its final unsettled creditor and recognized a gain on the settlement of indebtedness of approximately $6.1 million in 1995. Such debt had been undercollateralized and the settlement eliminated such undercollateralization. The restructured indebtedness required a $400,000 payment at closing and required five quarterly payments totaling $600,000. All of the payments have been made, and DVL recognized additional gains of $7,400,000 in 1996.
(b) During 1995, DVL reduced the portion of its indebtedness which was in default for non-payment of scheduled interest and/or principal by approximately $3.6 million. This reduction resulted from the restructuring of the principal balance, payment terms and interest rate with one creditor. The restructuring agreement was signed in the first quarter of 1995 and closed in the second quarter of 1995. Such restructuring resulted in a gain on the settlement of indebtedness of approximately $1.81 million in the first quarter of 1995 (Note 9).
(c) DVL obtained extensions from two creditors to whom DVL failed to meet various mandatory repayment requirements since December 31, 1994 These loans were repaid from the September 1996 refinancing. (Note 7).
(d) To better enable DVL to resolve its liquidity problems and to meet its certain mandatory repayment requirements, on September 27, 1996, DVL and NPM Capital, LLC ("NPM") closed a loan transaction under a certain Loan Agreement dated March 27, 1996, pursuant to which NPM purchased three loans from three creditors, and agreed to make principal installment payments of up to $600,000 on DVL's obligation to two additional creditors (the "Loan"). The three purchased loans represented an aggregate outstanding balance of $7,501,000. Two of the five loans had negotiated discounts of $2,773,000. The actual amount loaned by NPM at the closing, which included the balances due to the above mentioned creditors, less the realized discount, plus NPM's costs, equaled $5,232,000. Included in the loan balance were NPM's costs (in excess of $175,000) incurred in connection with this transaction, such excess totaled approximately $503,000. In consideration of NPM's loan enabling DVL to avail itself of discounts to existing lenders, and for providing DVL with the extended payment schedule, the principal amount of the loan was increased by $3,150,000. All such funds advanced at the closing were consolidated into a single note with NPM in the amount of $8,382,000. For financial reporting purposes, DVL recognized an extraordinary loss of $880,000 on this transaction.
Under the terms of the NPM loan, the principal balance is payable over six years with interest at the rate of 10.25%. DVL is required to make certain mandatory payments towards the principal balance over the term of the loan. The first such principal reduction of 15% of the original loan, plus additional funds advanced, is due by March 31, 1998. From September 27, 1996 through December 31, 1996, DVL made principal payments from the liquidation of collateral totaling $521,000 which represents approximately 6% of the original principal balance, plus additional funds advanced. DVL is required to pay NPM the cash flow generated from certain of NPM's collateral, but in no event less than accrued interest at a rate of 5% per annum. The initial internal rate of return to NPM on this loan was approximately 27.5%. The initial effective interest rate for financial statement purposes to DVL, including DVL's costs associates with the Loan and the value of the Warrants (described below) was 15%. These rates assumed that payments would be made according to the original payment terms of the Loan. In the event of prepayments, delays in payments or additional fundings under the loan, the internal rate of return and the effective interest rate will increase or decrease, respectively.
In connection with the transactions contemplated by the Loan Agreement in March 1996, DVL and NPO Management LLC ("NPO"), an affiliate of NPM, entered into an Asset Servicing Agreement, pursuant to which NPO is providing DVL with administrative and advisory services relating to the assets of DVL and its affiliated partnerships. In consideration for such services, DVL is required to pay NPO $600,000 per year (with cost of living increases beginning in 1998) over the seven (7) year term of the agreement, subject to early termination under certain conditions. DVL has the right to defer up to $600,000 of such fees, with interest at 15% per annum, for two years and to defer a reduced amount through the third year. DVL had accrued service fees of $372,000 as of December 31, 1996.
In connection with the Loan, affiliates of NPM acquired 1,000,000 shares (the "Shares") of DVL common stock for $200,000 representing approximately 7% of the current outstanding common stock of DVL. An affiliate of NPM also acquired 100 shares of preferred stock for $1,000. In addition, DVL issued to affiliates of NPM 12,911,628 warrants (the "Warrants") which when added to the 1,000,000 shares represent rights to acquire up to 49% of the outstanding common stock of
DVL on a fully diluted basis. Unless certain conditions are met, the Warrants are not exercisable prior to January 1, 1999 without satisfaction of certain conditions and expire December 31, 2007 at a price of $.16 per share. The Warrants were valued for financial statement purposes at $516,000 at the date of issuance and such value resulted in a debt discount to be amortized over the life of the Loan.
During 1996, 1995 and 1994, DVL's settlement and restructuring agreements with certain creditors resulted in net extraordinary gains on the restructuring of indebtedness of $8,349,000, $7,900,000 and $1,935,000, respectively.
The aggregate amount of restructured and other long-term debt and loans payable underlying wrap-around mortgages (Note 5) maturing during the next five years is as follows:
DVL's weighted average short-term borrowing rate for the years ended December 31, 1995 and 1994 were 9.7% and 8.4%, respectively. For 1996, DVL's short-term rate was 16.4% on debt which was outstanding through February 1996. After February 1996, DVL had no further short-term borrowings.
8. Deferred Credits
DVL's deferred credits at December 31, 1996 and 1995 are comprised of deferred gains on the sales of real estate to affiliates. Under the terms of a settlement agreement with one of DVL's creditors (Note 6), certain of these mortgage loans were canceled upon the restructuring of DVL's indebtedness with a different creditor which was completed in the second quarter of 1995 (Note 7). As a result of this restructuring, a substantial portion of the deferred gain on sales of real estate was realized in 1995.
9. Convertible Subordinated Debentures
During 1993, DVL completed a $421,000 private placement of units consisting of one convertible subordinated promissory note and two common stock purchase warrants. The notes bear interest at 12% per annum, mature on April 30, 1997 and are convertible, including accrued interest, into shares of common stock at a price of $1.00 per share at any time prior to maturity. In addition, DVL issued $51,000 of similar such units primarily in connection with the settlement of claims of certain limited partners, which included DVL's acquisition of certain limited partnership interests (Note 7). The convertible notes included in these units bear interest at 10% per annum and mature on April 12, 1997 (Note 12). In March 1996, 282,000 of the $472,000 of the 12% and 10% convertible subordinated debenture holders agreed to waive the payment of interest in cash on the debentures, to eliminate the convertibility feature of the existing debentures and to surrender their existing warrants. In consideration of the above, each debenture holder received shares of DVL stock equal to the number of shares purchasable by the warrants plus shares in payment of interest to be accrued through the maturity of the debenture. The principal balance of these modified debentures will be repaid in April 1997. In addition, during 1996 the holder of $130,000 of these notes redeemed his notes for 200,000 shares of DVL common stock.
10. Stock Option Plans
DVL has elected to follow "Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25") and related interpretations in accounting for its employee stock options. Under APB 25, where the exercise price of DVL's employee stock options equals the market price of the underlying stock on the date of grant, no compensation is recognized.
Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123"). Such information has been determined as if DVL has accounted for its employee stock options under the fair value method of that statement. The effect of applying SFAS No. 123 on 1996 pro forma net income is not necessarily representative of the effects on reported net income for future years due to, among other things: (1) The vesting period of the stock options and the (2) fair value of additional stock options in future years. Had compensation cost for DVL's stock option plans been determined based upon the fair value at the grant date for awards under the plans consistent with the methodology prescribed under SFAS No. 123, DVL's net income in 1996 would have been approximately $3,790,000 and $.24 per share.
DVL's 1996 stock option plan (the "Plan") provides for the grant of options to purchase up to 1,500,000 shares of common stock to officers and key employees of DVL. It also includes automatic grants of 15,000 options to individuals upon their becoming non-employee Directors, as well as for annual grants of 15,000 options to each non-employee director.
All options are non-qualified stock options.
During 1996, employees and a former employee of DVL exchanged 673,131 Stock Appreciation Rights for 673,131 non-qualified stock options. Each of the options was granted at an exercise price of $.21 for a ten year term. The company recorded a charge of $60,000 in connection with this transaction.
As of September 17, 1996, the Company had an option to purchase 15,000 shares to a new non-employee director at $.22 per share for a ten year term.
As of December 31, 1996, there were outstanding 688,131 ten (10) year options. Under the plan, the company has 811,869 options remaining.
11. Commitments, Contingent Liabilities and Legal Proceedings
Commitments and Contingent Liabilities --------------------------------------
As part of DVL's settlement and restructuring agreements, DVL made the following commitments and guarantees: DVL guaranteed that a creditor will receive minimum annual cash flow from 1994 through 2002 totaling $87,000 on a mortgage loan transferred to the creditor; DVL has agreed to pay two creditors additional amounts of up to 80% of the proceeds generated by the collateral pledged to these creditors if any such collateral exists after the restructured loans have been fully satisfied; and DVL has agreed to purchase in 1997 the mortgage loans which were transferred to a creditor during 1992 in satisfaction of DVL's guarantee obligations to such creditor, if the creditor has not received a stated yield based upon the value of the mortgages transferred and has not previously liquidated the mortgages. During 1996, DVL transferred a mortgage with a net carrying value of $230,000 to terminate its agreement to purchase mortgages from such creditor in 1997. Management had previously accrued $300,000 for its obligation to purchase the mortgages in 1997. Management does not anticipate any additional losses on such guarantees or commitments at this time.
Pursuant to the terms of the Limited Partner Settlement, a fund has been established into which DVL is required to deposit 20% of the cash flow received on its mortgage loans from affiliated partnerships net of repayment to existing creditors, 50% of DVL's receipts from certain loans to and general partnership investments in affiliated partnerships and a contribution of 5% of DVL's net income subject to certain adjustments in the years 2001 through 2012. DVL has not provided for losses on such contingencies except where they can be estimated (Note 2).
In April 1994, DVL completed a settlement with a creditor to whom DVL was obligated as a guarantor of an affiliate's indebtedness of approximately $5 million. Pursuant to the settlement, DVL issued 320,000 shares of common stock with a future guaranteed value of $1.50 per share, and paid $275,000 in full satisfaction of the original guarantee. The creditor had the right to put the shares back to DVL and DVL was required to pay the creditor the guaranteed value in installments over twelve months, including a $90,000 payment due in July 1995. This agreement was modified three times to provide for lower payments or extended terms. In the first quarter of 1997, the loan was repaid at par.
Legal and Administrative Proceedings - ------------------------------------
Substantially all of the various litigations brought against DVL, its Board members and certain current and former officers and affiliates by shareholders, banks and others since 1990 have been settled. The following is a summary of the status of all material outstanding cases, as well as cases settled in 1996.
Continuing Litigation ---------------------
(1) A suit entitled DONALD LEVY, ET AL. V. ROGER D. STERN, ET AL. ("LEVY"), originally filed in New Castle County, Delaware on February 13, 1991, on behalf of certain individual shareholders alleged breaches of fiduciary duty of care and candor. The defendants prevailed on a motion for summary judgment and plaintiffs filed an appeal. On appeal, the court reopened discovery for the plaintiffs. Plaintiffs in IN RE DEL-VAL, the shareholder class action case, which settled in 1995 permitted the Plaintiffs in LEVY to participate in their settlement with certain third party defendants. As of March 1997, discovery is continuing.
(2) Federal Insurance Company ("Federal"), which carried DVL's directors and officers insurance policy, declined to cover DVL for any legal costs or liability. DVL commenced an action against its insurance broker and Federal entitled DEL-VAL FINANCIAL CORPORATION, ET AL. V. FEDERAL INSURANCE COMPANY ET AL. ("FEDERAL INSURANCE") on September 23, 1991 in the Supreme Court of the State of New York, County of New York in which DVL alleged negligence against its broker and sought declaratory and injunctive relief against Federal. The New York Court in this matter has held that the Settling Defendants' insurance excluded coverage of these matters. DVL has filed a notice of appeal of that decision.
(3) DVL was named in an action entitled VANGUARD CAPITAL V. KENBEE MANAGEMENT, INC. ET AL. ("VANGUARD"), which was filed on March 21, 1994 in the Superior Court of the State of California, in which Vanguard sought contractual indemnity, equitable indemnity and declaratory relief on certain matters filed against Vanguard in the Superior Court, State of California, by an investor. This action is based on complaints by an investor with a $350,000 investment in an affiliated limited partnership who alleged that the investor's broker sold to her unsuitable investments. DVL defended the case and Vanguard voluntarily dismissed the action without prejudice. On March 22, 1996, the investor in the underlying matter against VANGUARD filed in the Superior Court of Los Angeles, a motion to vacate a NASD Arbitration award made in July 1995 in favor of VANGUARD and has named DVL as a respondent in that Petition.
Settled Litigation ------------------
A) DVL and certain former officers were named as defendants in an action brought by a former employee of Kenbee entitled MICHAEL A. BECKER V. KENBEE MANAGEMENT, INC. ET AL. ("BECKER"), and filed in the Superior Court of New Jersey, Bergen County Law Division on September 22, 1993. In BECKER, plaintiff alleged violations of the New Jersey Law Against Discrimination by Reason of Religious Discrimination, of oral contract not to terminate plaintiff, of an implied promise not to terminate employee for reasons violative of public policy, and for intentional infliction of emotional distress, intentional interference with contractual relations and slander and slander PER SE. A settlement in this matter was completed in March 1996.
B) DVL was named as a defendant in a class action entitled PHILLIP AND CHERYL WEISS V. WINNER'S CIRCLE OF CHICAGO, INC. ET AL. which was filed in the United States District Court for the Northern District of Illinois on April 14, 1995 in which Plaintiffs allege that DVL, as a holder of certain consumer credit contracts issued by Del-Val Capital Corp., a subsidiary of DVL, is subject to claims and defenses against the consumer credit contracts and that DVL aided and abetted violations of the Illinois Consumer Fraud Act. This matter was settled in December 1996 for a nominal payment by DVL.
12. Shareholders' Equity (Deficiency)
As a result of the shareholder class action settlement, DVL issued 4,017,582 shares of common stock in December 1995 (Notes 2 and 11).
DVL issued warrants to purchase 944,000 shares of common stock in connection with the issuance of $472,000 of 12% and 10% convertible subordinated debentures (Note 10). The company recorded a debt discount and allocated $47,000 of the proceeds to the value of the detachable stock warrants. The accumulated amortization of the debt discount aggregated $33,000 and $42,000 at December 31, 1995 and 1996, respectively. The warrants entitle the holder to purchase the company's common stock at an exercise price of $1.00 at any time through their expiration in 1997. In addition, there was $189,000 and $30,000 of accrued interest on the debentures outstanding at December 31, 1995 and 1996, respectively. At December 31, 1996, approximately 1,605,000 shares of the company's common stock were reserved for the conversion of subordinated debentures and exercise of warrants (Note 11).
13. Subsequent Events
(a) In January 1997, DVL issued 50,000 shares of stock to certain unrelated individuals in exchange for 100,000 warrants which such individuals had received in connection with a prior transaction with DVL. In January 1997, DVL issued 150,000 shares of stock to an investment banker for services rendered.
(b) In January and February 1997, DVL paid $1,228,000 to NPM from the proceeds of refinancing activities, of which $1,137,000 was applied to principal on the NPM Loan.
(c) In February 1997, DVL repaid a creditor $1,474,000 in full satisfaction of a loan in the sum of $1,905,000. The payment was made by refinancing that creditors' collateral with a new lender in the sum of $2,000,000. This transaction will result in an extraordinary gain for DVL of $431,000 in the first quarter of 1997.
(d) In February 1997, DVL reached an agreement in principal with another creditor, pursuant to which the creditor agreed to reduce the principal balance of its loan from $2,239,000 to $1,200,000 in exchange for DVL's assignment of a wrap-around mortgage and the transfer of fee title to a second property. Both the mortgage and the property are currently pledged to the creditor as collateral for its loan.
In addition, the creditor agreed that if DVL pays $1,100,000 by June 30, 1997, then the creditor will accept such payment as payment in full for the $1,200,000 remaining balance.
This agreement is subject to final documentation.
(e) In March of 1997, NPM advanced DVL an additional $100,000. This advance, which is not required under the original loan documents, will bear interest at 15% per annum and will be paid pari passu with the original NPM loan.