================================================================================
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
---
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended May 31, 1998
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-18249
-------
ILM SENIOR LIVING, INC.
-----------------------
(Exact name of registrant as specified in its charter)
Virginia 04-3042283
- ----------------------- -------------------
(State of organization) (I.R.S. Employer
Identification No.)
28 State Street, Suite 1100, Boston, MA 02109
- --------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (888) 257-3550
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ---------------------- ----------------
Shares of Common Stock None
Securities registered pursuant to Section 12(g) of the Act:
SHARES OF COMMON STOCK
----------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes No X
--- ---
Shares of common stock outstanding as of May 31, 1998: 7,520,100.
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Page 1 of 19
<PAGE>
ILM SENIOR LIVING, INC.
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page
----
<S> <C> <C>
Item 1. Financial Statements
Consolidated Balance Sheets
May 31, 1998 (Unaudited) and August 31, 1997....................................................4
Consolidated Statements of Income
For the nine- and three-month periods ended May 31, 1998 and 1997 (Unaudited)...................5
Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended May 31, 1998 and 1997 (Unaudited).....................................6
Consolidated Statements of Cash Flows
For the nine months ended May 31, 1998 and 1997 (Unaudited).....................................7
Notes to Consolidated Financial Statements (Unaudited).......................................8-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......14-16
Part II. Other Information
Item 5. Other Information..............................................................................17
Item 6. Exhibits and Reports on Form 8-K...............................................................17
Signatures......................................................................................................18
</TABLE>
-2-
<PAGE>
ILM SENIOR LIVING, INC.
Part I. Financial Information
- ------------------------------
Item 1. Financial Statements
(see next page)
-3-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
May 31, 1998 (Unaudited) and August 31, 1997
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS
------
May 31, 1998 August 31, 1997
------------ ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,625 $ 3,792
Building and improvements 38,166 38,147
Furniture, fixtures and equipment 4,948 4,948
-------- --------
47,739 46,887
Less: accumulated depreciation (11,806) (10,844)
-------- --------
35,933 36,043
Unamortized mortgage fees 2,256 2,256
Less: accumulated amortization (1,881) (1,712)
------- -------
375 544
Cash and cash equivalents 1,258 3,136
Accounts receivable - related party 1,824 116
Prepaid expenses and other assets 64 108
Deferred rent receivable 58 86
-------- --------
$ 39,512 $ 40,033
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 198 $ 166
Accounts payable - related party 205 93
-------- --------
403 259
Preferred shareholders' minority
interest in subsidiary 122 116
-------- --------
Total liabilities 525 375
Shareholders' equity:
Common stock, $0.01 par value,
10,000,000 Shares authorized,
7,520,100 shares issued and outstanding 75 75
Additional paid-in capital 65,711 65,711
Accumulated deficit (26,799) (26,128)
-------- --------
Total shareholders' equity 38,987 39,658
-------- --------
$ 39,512 $ 40,033
======== ========
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the nine- and three-month periods ended May 31, 1998 and 1997 (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
May 31 May 31
------ ------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Rental income $5,397 $4,945 $1,814 $1,710
Interest income 67 117 11 42
------ ------ ------ ------
5,464 5,062 1,825 1,752
Expenses:
Depreciation expense 962 1,139 321 380
Deferred amortization expense 169 -- 56 --
Management fees -- 66 -- 22
Termination fee -- 600 -- 600
General and administrative 495 664 231 281
Directors' compensation 91 57 30 33
------ ------ ------ ------
1,717 2,526 638 1,316
------ ------ ------ ------
Net income $3,747 $2,536 $1,187 $ 436
====== ====== ====== ======
Basic earnings per share of common stock $ 0.50 $ 0.34 $ 0.16 $ 0.06
====== ====== ====== ======
Cash dividends paid per share of common stock $ 0.59 $ 0.55 $ 0.20 $ 0.19
====== ====== ====== ======
</TABLE>
The above earnings and cash dividends paid per share of common stock are
based upon the 7,520,100 shares outstanding during each period.
See accompanying notes.
-5-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended May 31, 1998 and 1997 (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1996 7,520 $75 $65,711 $(24,418) $41,368
Cash dividends paid -- -- -- (4,136) (4,136)
Net income -- -- -- 2,536 2,536
----- --- ------- -------- -------
Shareholders' equity
at May 31, 1997 7,520 $75 $65,711 $(26,018) $39,768
===== === ======= ======== =======
Shareholders' equity
at August 31, 1997 7,520 $75 $65,711 $(26,128) $39,658
Cash dividends paid -- -- -- (4,418) (4,418)
Net income -- -- -- 3,747 3,747
----- --- ------- -------- -------
Shareholders' equity
at May 31, 1998 7,520 $75 $65,711 $(26,799) $38,987
===== === ======= ======== =======
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended May 31, 1998 and 1997 (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended
May 31
------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,747 $ 2,536
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization expense 1,131 1,139
Charitable contribution of preferred stock in ILM Holding -- 111
Preferred shareholders' minority interest 6 --
Changes in assets and liabilities:
Interest and other receivables -- 152
Accounts receivable - related party (1,708) 47
Prepaid expenses and other assets 44 (52)
Deferred rent receivable 28 28
Accounts payable and accrued expenses 32 190
Accounts payable - related party 112 1
Accrued termination fee payable - 600
------- -------
Total adjustments (355) 2,216
------- -------
Net cash provided by operating activities 3,392 4,752
------- -------
Cash flows from investing activities:
Increase in operating investment properties (852) (16)
------- -------
Net cash used in investing activities (852) (16)
Cash flows from financing activities:
Cash dividends paid to shareholders (4,418) (4,136)
------- -------
Net cash used in financing activities (4,418) (4,136)
Net (decrease) increase in cash and cash equivalents (1,878) 600
Cash and cash equivalents, beginning of period 3,136 3,010
------- -------
Cash and cash equivalents, end of period $ 1,258 $ 3,610
======= =======
</TABLE>
See accompanying notes.
-7-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
1. General
-------
The accompanying consolidated financial statements, footnotes and
discussions should be read in conjunction with the consolidated financial
statements and footnotes contained in ILM Senior Living, Inc.'s ("the Company")
Annual Report for the year ended August 31, 1997. In the opinion of management,
the accompanying interim consolidated financial statements, which have not been
audited, reflect all adjustments necessary to present fairly the results for the
interim periods. All of the accounting adjustments reflected in the accompanying
interim consolidated financial statements are of a normal recurring nature.
The accompanying consolidated financial statements have been prepared on the
accrual basis of accounting in accordance with generally accepted accounting
principles, which requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of May 31, 1998 and August 31, 1997 and
revenues and expenses for each of the nine- and three-month periods ended May
31, 1998 and August 31, 1997. Actual results could differ from the estimates and
assumptions used. Certain reclassifications have been made to prior period
numbers in order to conform to the current year presentation.
The Company, formerly PaineWebber Independent Living Mortgage Fund, Inc.,
was organized as a corporation on March 6, 1989 under the laws of the State of
Virginia. On June 21, 1989, the Company commenced a public offering of up to
10,000,000 shares of its common stock at $10 per share, pursuant to the final
prospectus as amended, incorporated into a Registration Statement filed on Form
S-11 under the Securities Act of 1933 (Registration Statement No. 33-27653). The
public offering terminated on July 21, 1989 with a total of 7,520,100 shares
issued. The Company received capital contributions of $75,201,000, of which
$201,000 represented the sale of 20,100 shares to an affiliate at that time,
PaineWebber Group, Inc. ("PaineWebber"). For discussion purposes, PaineWebber
will refer to PaineWebber Group, Inc. and all affiliates that provided services
to the Company in the past.
The Company has elected to qualify and be taxed as a Real Estate Investment
Trust ("REIT") under the Internal Revenue Code of 1986, as amended, for each
taxable year of operations.
The Company originally invested the net proceeds of the initial public
offering in eight participating mortgage loans secured by senior housing
facilities located in seven different states ("Senior Housing Facilities"). All
of the loans made by the Company were originally to Angeles Housing Concepts,
Inc. ("AHC"), a company specializing in the development, acquisition and
operation of senior housing facilities.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments towards the debt service owed on the Company's loans
were limited to the net cash flow of the operating investment properties. On May
3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the State of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between the Company, AHC and Angeles
was reached whereby ownership of the properties was transferred from AHC to the
Company or its designated affiliates. Under the terms of the settlement
agreement, the Company released AHC and Angeles from certain obligations under
the loans. On April 27, 1994, each of the properties owned by AHC and securing
the Loans was transferred (collectively, "the Transfers") to newly-created
special purpose corporations affiliated with the Company (collectively, "the
Property Companies"). The Transfers had an effective date of April 1, 1994 and
were made pursuant to the settlement agreement entered into on February 17, 1994
("the Settlement Agreement") between the Company and AHC which had previously
been approved by the bankruptcy court handling the bankruptcy case of Angeles.
All of the capital stock of each Property Company was held by ILM Holding, Inc.
("ILM Holding"), a Virginia corporation. In August 1995, each of the Property
Companies merged into ILM Holding, which is majority owned by the Company. As a
result, ownership of the Senior Housing Facilities is now held by ILM Holding
and the Property Companies no longer exist as separate legal entities.
-8-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
1. General (continued)
-------------------
ILM Holding holds title to eight Senior Housing Facilities, which comprise
the operating investment properties on the accompanying consolidated balance
sheets, subject to certain mortgage loans payable to the Company. Such mortgage
loans and the related interest expense are eliminated in consolidation. The
capital stock of ILM Holding was originally owned by the Company and
PaineWebber. ILM Holding had issued 100 Shares of Series A Preferred Stock to
the Company in return for a capital contribution in the amount of $693,000 and
had issued 10,000 shares of common stock to PaineWebber in return for a capital
contribution in the amount of $7,000. The common stock represented approximately
99 percent of the voting power and 1 percent of the economic interest in ILM
Holding, while the preferred stock represented approximately 1 percent of the
voting power and 99 percent of the economic interest in ILM Holding.
The Company completed its restructuring plans by converting ILM Holding to
a REIT for tax purposes. In connection with these plans, on November 21, 1996,
the Company requested that PaineWebber sell all of the stock held in ILM Holding
to the Company for a price equal to the fair market value of the 1% economic
interest in ILM Holding represented by the common stock. On January 10, 1997,
this transfer of the common stock of ILM Holding was completed at an agreed upon
fair value of $46,000. The accompanying consolidated financial statements
include the operations of ILM Holding as if control had been obtained by the
Company as of September 1, 1996. With this transfer completed, effective January
23, 1997, ILM Holding recapitalized its common stock and preferred stock by
replacing the outstanding shares with 50,000 shares of new common stock and 275
shares of a new class of nonvoting, 8% cumulative preferred stock issued to the
Company. The number of authorized shares of preferred and common stock in ILM
Holding were also increased as part of the recapitalization. Following the
recapitalization, the Company made charitable gifts of one share of the
preferred stock in ILM Holding to each of 111 charitable organizations so that
ILM Holding would meet the stock ownership requirements of a REIT as of January
30, 1997. The preferred stock has a liquidation preference of $1,000 per share
plus any accrued and unpaid dividends. Dividends on the preferred stock accrue
at a rate of 8% per annum on the original $1,000 liquidation preference and are
cumulative from the date of issuance. Since ILM Holding is not expected to have
sufficient cash flow in the foreseeable future to make the required dividend
payments, it is anticipated that dividends will accrue and be paid at
liquidation. Cumulative dividends accrued as of May 31, 1998 on the preferred
stock in ILM Holding totaled approximately $11,840.
As part of the fiscal 1994 settlement agreement with AHC, ILM Holding
retained AHC as the property manager for all of the Senior Housing Facilities
pursuant to the terms of a management agreement. The management agreement with
AHC was terminated in July 1996. Subsequent to the effective date of the
Settlement Agreement with AHC, management investigated and evaluated the
available options for structuring the ownership of the properties in order to
maximize the potential returns to the existing shareholders while maintaining
the Company's qualification as a REIT under the Internal Revenue Code. As
discussed further in Note 2, on September 12, 1994 the Company formed a new
subsidiary, ILM I Lease Corporation ("Lease I"), for the purpose of operating
the Senior Housing Facilities. All of the shares of capital stock in Lease I
were distributed to the holders of record of the Company's common stock and the
Senior Housing Facilities were leased to Lease I effective September 1, 1995
(see Note 2 for a description of the master lease agreement). Lease I is a
public company subject to the reporting obligations of the Securities and
Exchange Commission.
-9-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
1. General (continued)
-------------------
At a meeting of the Company's Board of Directors on January 10, 1997,
PaineWebber recommended the immediate sale of the Senior Housing Facilities held
by the Company and an affiliated entity, ILM II Senior Living, Inc. ("ILM II"),
by means of a controlled auction to be conducted by PaineWebber, at no
additional compensation, with PaineWebber offering to purchase the properties
for $127 million, thereby guaranteeing the Shareholders a "floor" price. The
Senior Housing Facilities held by the Company would represent approximately $75
million of this amount. After taxes and closing costs, net proceeds to the
Company would equal approximately $71 million or approximately $9.41 per share.
PaineWebber also stated that if it purchased the properties at the specified
price and were then able to resell the properties at a higher price, PaineWebber
would pay any "excess profits" to the Shareholders. To assist the Company in
evaluating PaineWebber's proposal, a disinterested, independent investment
banking firm with expertise in healthcare REITs and independent/assisted living
financings was engaged by the Company and Lease I as well as by ILM II and its
affiliates. Following a comprehensive analysis, the independent investment
banking firm recommended that PaineWebber's proposal should be declined and that
instead investigations of expansion and restructuring alternatives should be
pursued. After analyzing PaineWebber's proposal and the recommendations and
other information provided by the independent investment banker, the Boards of
the Company and ILM II voted unanimously to decline PaineWebber's proposal and
to explore the alternatives recommended by the independent investment banking
firm. The Boards declined to seek an immediate sale of the properties because,
in the Boards' view, the liquidation price would not reflect the "going concern"
values of the Company and ILM II and, therefore, would not maximize shareholder
value. In addition, the Boards did not consider it advisable to liquidate the
Company and ILM II on the suggested terms several years prior to their scheduled
termination dates.
PaineWebber indicated to the Board in its January 10, 1997 proposal that it
would not wish to continue to serve as advisor to the Company and its affiliates
if the Company declined to accept PaineWebber's proposal. The Company accepted
the resignation of PaineWebber, effective as of June 18, 1997. PaineWebber
agreed to continue to provide certain administrative services to the Company and
its affiliates through August 31, 1997, pursuant to the terms of a transition
services agreement entered into with the Company and its affiliates. The Company
and its affiliates also accepted, effective as of June 18, 1997, the
resignations of those officers and directors who were employees of or otherwise
affiliated with PaineWebber.
The Company and Lease I are continuing to review various restructuring
alternatives that could further increase shareholder value and liquidity. The
Company and Lease I are considering a merger of the Company with ILM II and
Lease I with ILM II Lease Corporation ("Lease II"), as well as other business
combinations. An independent investment banking firm has been retained by the
Company and its affiliates to assist in analyzing these strategic alternatives.
The Company has not fully evaluated any of these alternatives and is not in a
position at this time to recommend any actions to the shareholders. There can be
no assurance that the Company will recommend taking any of the actions
identified above or any others which may be recommended by its investment
bankers.
-10-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
2. Operating Investment Properties Subject to Master Lease
-------------------------------------------------------
At May 31, 1998, through its consolidated affiliate, the Company owned
eight Senior Housing Facilities. The name, location and size of the properties
are as set forth below:
<TABLE>
<CAPTION>
Rentable Resident
Name Location Units Capacities
- ---- -------- ------ ----------
<S> <C> <C> <C>
Independence Village of East Lansing East Lansing, MI 161 162
Independence Village of Winston-Salem Winston-Salem, NC 159 161
Independence Village of Raleigh Raleigh, NC 164 205
Independence Village of Peoria Peoria, IL 165 181
Crown Pointe Apartments Omaha, NE 135 163
Sedgwick Plaza Apartments Wichita, KS 150 170
West Shores Hot Springs, AR 136 166
Villa Santa Barbara (1) Santa Barbara, CA 125 125
</TABLE>
(1) The acquisition of Villa Santa Barbara was financed jointly by the
Company and an affiliated entity, ILM II. All amounts generated from
Villa Santa Barbara are equitably apportioned between the Company,
together with its consolidated subsidiary, and ILM II, together with
its consolidated subsidiary, generally 25% and 75%, respectively. Villa
Santa Barbara is owned 25% by ILM Holding and 75% by ILM II Holding.
Subsequent to the effective date of the Settlement Agreement with AHC, in
order to maximize the potential returns to the existing shareholders while
maintaining the Company's qualification as a REIT under the Internal Revenue
Code, the Company formed a new corporation, Lease I, for the purpose of
operating the Senior Housing Facilities under the terms of a master lease
agreement. The master lease agreement, which commenced on September 1, 1995, is
between the Company's consolidated affiliate, ILM Holding, as owner of the
properties and lessor, and Lease I as lessee. The master lease is a "triple-net"
lease whereby the lessee pays all operating expenses, governmental taxes and
assessments, utility charges and insurance premiums, as well as the costs of all
required maintenance, personal property and non-structural repairs in connection
with the operation of the Senior Housing Facilities. ILM Holding, as the lessor,
is responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the initial term of the master lease, which
expires on December 31, 1999, Lease I is obligated to pay annual base rent for
the use of all of the Facilities in the aggregate amount of $6,364,800. Lease I
is also obligated to pay variable rent for each Senior Housing Facility. Such
variable rent is payable quarterly and is equal to 40% of the excess, if any, of
the aggregate total revenues for the Senior Housing Facilities, on an annualized
basis, over $16,996,000. Variable rental income for the nine- and three-month
periods ended May 31, 1998 was $651,026 and $232,270, respectively. This
compares to variable rent of approximately $199,000 and $128,000 for the nine-
and three-month periods ended May 31, 1997, respectively.
3. Related Party Transactions
--------------------------
Subject to the supervision of the Company's Board of Directors, assistance
in managing the business of the Company was provided by PaineWebber. As
previously discussed in Note 1, PaineWebber resigned effective as of June 18,
1997.
Lease I has retained Capital Senior Management 2, Inc. ("Capital") of
Dallas, Texas to be the property manager of the Senior Housing Facilities and
the Company has guaranteed the payment of all fees due to Capital under the
terms of the management agreement which commenced on July 29, 1996. In November,
1996, Lawrence A. Cohen, President, Chief Executive Officer and Director of the
Company and a Director of Lease I, was also named Vice Chairman and Chief
Financial Officer of Capital Senior Living Corporation, an affiliate of Capital.
For the nine- and three-month periods ended May 31, 1998, Capital earned
property management fees from Lease I of $741,000 and $258,000, respectively.
This compares to $637,000 and $222,000 for the nine- and three-month periods
ended May 31, 1997, respectively.
-11-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
3. Related Party Transactions (continued)
--------------------------------------
On September 18, 1997, Lease I entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the development
process for the potential expansion of several of the Senior Housing Facilities.
Capital Senior Development, Inc. will receive a fee equal to 7% of the total
development costs of these expansions if they are pursued. The Company will
reimburse Lease I for all costs related to these potential expansions including
fees to Capital Senior Development, Inc. For the nine- and three-month periods
ended May 31, 1998, Capital Senior Development, Inc. earned fees from Lease I of
$212,465 and $82,616, respectively, for managing pre-construction development
activities for potential expansions of the Senior Housing Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is an employee of
Greenberg Traurig Hoffman Lipoff Rosen & Quentel, which began acting as Counsel
to the Company and its affiliates in late fiscal 1997. For the nine- and
three-month periods ended May 31, 1998, Greenberg Traurig Hoffman Lipoff Rosen &
Quentel earned fees from the Company of $167,696 and $89,722, respectively.
Accounts receivable - related party at May 31, 1998 includes base and
variable rent due from Lease I in accordance with the terms of the master lease
agreement. Accounts receivable - related party at August 31, 1997 includes
variable rent due from Lease I. Accounts payable - related party at May 31, 1998
includes approximately $205,000 due to Lease I for amounts advanced by Lease I
to fund facility expansion costs. At August 31, 1997, $93,000 was payable to
Lease I for amounts advanced by Lease I for capital improvements to the Senior
Housing Facilities.
4. Legal Proceedings and Contingencies
-----------------------------------
On July 29, 1996, Lease I and ILM Holding ("the Companies") terminated a
property management agreement with AHC covering the eight Senior Housing
Facilities leased by Lease I from ILM Holding. The management agreement was
terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the
agreement. Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against AHC in
the United States District Court for the Eastern District of Virginia for breach
of contract, breach of fiduciary duty and fraud. The Companies allege, among
other things, that AHC willfully performed actions specifically in violation of
the management agreement and that such actions caused damages to the Companies.
Due to the termination of the agreement for cause, no termination fee was paid
to AHC. Subsequent to the termination of the management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed
with the Virginia District Court an answer in response to the litigation
initiated by the Companies and a counterclaim against ILM Holding. The
counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests damages which include the payment of a termination fee in the
amount of $1,250,000, payment of management fees pursuant to the contract from
August 1, 1996 through October 15, 1996, which is the earliest date the
Management Agreement could have been terminated without cause, and recovery of
attorneys' fees and expenses.
The aggregate amount of damages against all parties as requested in AHC's
counterclaim exceeds $2,000,000. The Company has guaranteed the payment of the
termination fee at issue in these proceedings to the extent that any termination
fee is deemed payable by the court and in the event that Lease I fails to
perform pursuant to its obligations under the Management Agreement. On June 13,
1997 and July 8, 1997, the court issued orders to enter judgment against the
Company and ILM II in the aggregate amount of $1,000,000 (the "Orders"). In so
doing, the court effectively canceled the June 23, 1997 trial date. The Orders
do not contain any findings of fact or conclusion of law. On July 10, 1997, the
Company, ILM II, Lease I and Lease II filed a notice of appeal to the United
States Court of Appeals for the Fourth Circuit from the Orders. The Company
intends to diligently pursue the appeal. The eventual outcome of this litigation
cannot presently be determined. However, a provision of $600,000 for the
liability which might result to the Company was recorded in the financial
statements of Lease I at August 31, 1997. The remaining $400,000 was recorded in
the financial statements of Lease II. No provision for any liability has been
recorded on the accompanying consolidated financial statements.
-12-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against Capital, the new property manager, Lawrence Cohen,
and others alleging that the defendants intentionally interfered with AHC's
property management agreement (the "California litigation"). The complaint seeks
damages of at least $2,000,000. On March 4, 1997, the defendants removed the
case to Federal District Court in the Central District of California. Trial in
the action is expected to occur in 1998 and discovery has begun. At a meeting on
February 26, 1997, the Company's Board of Directors concluded that since all of
Mr. Cohen's actions relating to the California litigation were taken either on
behalf of the Company under the direction of the Board or as a PaineWebber
employee, the Company or its affiliates should indemnify Mr. Cohen with respect
to any expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital and its
affiliates in the California litigation. Subsequently, the boards of directors
of Lease I and Lease II voted to increase the maximum amount of the advance to
$100,000. By the end of November 1997, Capital had incurred $100,000 of legal
expenses in the California litigation. On February 2, 1998, the amount to be
advanced to Capital was increased to include 75% of the California litigation
legal fees and costs incurred by Capital for December 1997 and January 1998,
plus 75% of such legal fees and costs incurred by Capital thereafter, not to
exceed $500,000. As of May 31, 1998, the amount advanced to Capital by Lease I
and Lease II totaled approximately $335,000. The defendants intend to vigorously
defend the claims made against them in the California litigation. The eventual
outcome of this litigation cannot presently be determined and, accordingly, no
provision for any liability has been recorded in the accompanying financial
statements.
On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a
purported class action on behalf of that trust and all other shareholders of the
Company and ILM II in the Supreme Court of the State of New York, County of New
York against the Company, ILM II and the directors of both corporations. The
class action complaint alleges that the directors engaged in wasteful and
oppressive conduct and breached fiduciary duties in preventing the sale or
liquidation of the assets of the Company and ILM II, diverting certain of their
assets and changing the nature of the Company and ILM II. The complaint seeks
damages in an unspecified amount, punitive damages, the judicial dissolution of
the Company and ILM II, an order requiring the directors to take all steps to
maximize shareholder value, including either an auction or liquidation, and
rescinding certain agreements, and attorney's fees. On July 8, 1998, the Company
joined with all other defendants to dismiss the complaint on all counts. The
Company and ILM II believe that the action is without merit and are vigorously
contesting this action.
5. Subsequent Event
----------------
On June 15, 1998, the Company's Board of Directors declared a quarterly
dividend for the quarter ended May 31, 1998. On July 15, 1998, a dividend of
$0.20 per share of common stock, totaling approximately $1,504,000, was paid to
shareholders of record as of June 30, 1998.
-13-
<PAGE>
ILM SENIOR LIVING, INC.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Company offered shares of its common stock to the public from June 21,
1989 to July 21, 1989 pursuant to a Registration Statement filed under the
Securities Act of 1933. Capital contributions of $75,201,000 were received by
the Company (including $201,000 contributed by PaineWebber) and, after deducting
selling expenses and offering costs and allowing for adequate cash reserves,
approximately $62.8 million was available to be invested in participating first
mortgage loans secured by Senior Housing Facilities. The Company originally
invested the net proceeds of the initial public offering in eight participation
mortgage loans secured by Senior Housing Facilities located in seven different
states. All of the loans made by the Company were originally with AHC. As
previously reported, AHC defaulted on the scheduled mortgage loan payments due
to the Company on March 1, 1993. Its parent company, Angeles, subsequently filed
for bankruptcy. In fiscal 1994, a Settlement Agreement was executed whereby
ownership of the properties was transferred from AHC to certain designated
affiliates of the Company which were majority owned by the Company.
Subsequently, these affiliates were merged into ILM Holding, which is majority
owned by the Company. ILM Holding holds title to the eight Senior Housing
Facilities which comprise the balance of operating investment properties in the
accompanying consolidated balance sheets, subject to certain mortgage loans
payable to the Company. As part of the fiscal 1994 Settlement Agreement with
AHC, ILM Holding retained AHC as the property manager for all of the Senior
Housing Facilities pursuant to the terms of the Agreement. As discussed further
below, the Agreement with AHC was terminated in July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC, in
order to maximize the potential returns to the Company's existing Shareholders
while maintaining its qualification as a REIT under the Internal Revenue Code,
the Company formed a new corporation, Lease I, for the purpose of operating the
Senior Housing Facilities under the terms of a master lease agreement. During
1995, the Company distributed all of the shares of capital stock of Lease I to
the holders of record of the Company's common stock. Lease I is a public company
subject to the reporting obligations of the Securities and Exchange Commission.
The master lease agreement, which commenced on September 1, 1995, was
initially between the Company's consolidated affiliate, ILM Holding, as owner of
the Senior Housing Facilities and lessor, and Lease I as lessee. The master
lease is a "triple-net" lease whereby the lessee pays all operating expenses,
governmental taxes and assessments, utility charges and insurance premiums, as
well as the costs of all required maintenance, personal property and
non-structural repairs in connection with the operation of the Senior Housing
Facilities. ILM Holding, as the lessor, is responsible for all major capital
improvements and structural repairs to the Senior Housing Facilities. During the
initial term of the master lease, which expires on December 31, 1999, Lease I is
obligated to pay annual base rent for the use of all of the Senior Housing
Facilities in the aggregate amount of $6,364,800. Lease I is also obligated to
pay variable rent for each Senior Housing Facility. Such variable rent is
payable quarterly and equals 40% of the excess, if any, of the aggregate total
revenues for the Senior Housing Facilities, on an annualized basis, over
$16,996,000. Variable rent for the nine- and three-month periods ended May 31,
1998 was $651,026 and $232,270, respectively. This compares to variable rent of
approximately $199,000 and $128,000 for the nine- and three-month periods ended
May 31, 1997, respectively.
The Company completed its restructuring plans by converting ILM Holding to a
real estate investment trust ("REIT") for tax purposes. In connection with these
plans, on November 21, 1996 the Company requested that PaineWebber sell all of
its stock in ILM Holding to the Company for a price equal to the fair market
value of the 1% economic interest in ILM Holding represented by the common
stock. On January 10, 1997, this transfer of the common stock of ILM Holding was
completed at an agreed upon fair value of $46,000. With this transfer completed,
effective January 23, 1997, ILM Holding recapitalized its common stock and
preferred stock by replacing the outstanding shares with 50,000 shares of new
common stock and 275 shares of nonvoting, 8% cumulative preferred stock issued
to the Company (the "Preferred Stock"). The number of authorized shares of
preferred stock and common stock in ILM Holding were also increased as part of
the recapitalization. Following the recapitalization, the Company made
charitable gifts of one share of the Preferred Stock in ILM Holding to each of
111 charitable organizations so that ILM Holding would meet the stock ownership
requirements of a REIT as of January 30, 1997. The Preferred Stock has a
liquidation preference of $1,000 per share plus any accrued and unpaid
dividends. Dividends on the Preferred Stock accrue at a rate of 8% per annum on
the original $1,000 liquidation preference and
-14-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
are cumulative from the date of issuance. Since ILM Holding is not expected to
have sufficient cash flow in the foreseeable future to make the required
dividend payments, it is anticipated that dividends will accrue and be paid at
liquidation. Cumulative dividends in arrears as of May 31, 1998 on the Preferred
Stock in ILM Holding totaled approximately $11,840.
The assumption of ownership of the properties through ILM Holding, which was
organized as a regular C corporation for tax purposes, has resulted in a
possible future tax liability which would be payable upon the ultimate sale of
the properties (the "built-in gain tax"). The amount of such tax would be
calculated based on the lesser of the total net gain realized from the sale
transaction or the portion of the net gain realized upon a final sale which is
attributable to the period during which the properties were held in a C
corporation. Any future appreciation in the value of the Senior Housing
Facilities subsequent to the conversion of ILM Holding to a REIT would not be
subject to the built-in gain tax. The built-in gain tax would most likely not be
incurred if the properties were to be held for a period of at least ten years
from the date of the conversion of ILM Holding to a REIT. However, since the end
of the Company's original anticipated holding period is within two years, the
properties may not be held for an additional ten years. The Board of Directors
may defer the Company's scheduled liquidation date if in the opinion of a
majority of the Directors the disposition of the Company's assets at such time
would result in a material under-realization of the value of such assets;
provided, however, that no such deferral may extend beyond December 31, 2014
absent amendment of the Company's Articles of Incorporation. Based on
management's estimate of the increase in values of the Senior Housing Facilities
which occurred between April 1994 and January 1996, as supported by independent
appraisals, ILM Holding would incur a sizeable tax if the properties were sold.
Based on this increase of values during the time that ILM Holding was operated
as a regular C corporation, a sale within ten years of the date of conversion to
a REIT could result in a built-in gain tax of as much as $2.9 million.
Because the ownership of the assets of ILM Holding was expected to be
transferred to the Company or its wholly-owned subsidiary, ILM Holding was
capitalized with funds to provide it with working capital only for a limited
period of time. At the present time, ILM Holding is not expected to have
sufficient cash flow during fiscal 1998 to (i) meet its obligations to make the
debt service payments due under the loans, (ii) pay for capital improvements and
structural repairs in accordance with the terms of the master lease, and (iii)
pay for costs that may be incurred in defending AHC's counterclaim against ILM
Holding. As a result, ILM I is not expected to receive the full amount that
would be due under the loans.
Occupancy levels for the eight properties in which the Company has invested
averaged 95% and 96%, respectively, for the nine- and three-month periods ended
May 31, 1998. The Company's net operating cash flow is expected to be relatively
stable and predictable now that the master lease structure is in place. The
annual base rental payments owed to ILM Holding are $6,364,800 and will remain
at that level for the remainder of the lease term. In addition, the Senior
Housing Facilities are currently generating gross revenues which are in excess
of the specified threshold in the variable rent calculation, as discussed
further above, which became effective in January 1997.
The Company and Lease I have been pursuing the potential for future
expansion of several of the facilities which are located in areas that have
particularly strong markets for senior housing. Potential expansion candidates
include the facilities located in Raleigh, North Carolina; East Lansing,
Michigan; Omaha, Nebraska; Peoria, Illinois; and Hot Springs, Arkansas. As part
of this expansion program, approximately two acres of land located adjacent to
the East Lansing facility and approximately two and one-half acres of land
located adjacent to the Omaha facility were acquired in the first quarter of
fiscal 1998 for approximately $200,000 and $265,000, respectively. In addition,
an agreement was obtained to purchase approximately five acres of land located
adjacent to the Peoria facility for approximately $600,000. In May 1998, the
Company decided not to pursue the Peoria expansion over the near term and
allowed the agreement to expire. The Hot Springs facility includes a vacant
parcel of approximately two acres which could accommodate an expansion of the
existing facility or the construction of a new free-standing facility.
Preliminary feasibility evaluations have been completed for all of these
potential expansions and pre-construction design and construction-cost
evaluations are underway for expansions of the facilities located in Raleigh and
Omaha.
-15-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
Once the pre-construction design process is complete and projected expansion
construction costs are determined, the Company will carefully evaluate the costs
and benefits before proceeding with the construction of any of these expansions.
Depending on the extent of any expansions deemed appropriate, such plans
could result in the need for substantial additional capital. The Company is
currently negotiating with a major bank to provide a construction loan facility
that, if finalized, would provide the Company with up to $24.5 million to fund
the capital costs of these potential expansion programs. The loan facility is
expected to close by fiscal year end.
At May 31, 1998, the Company had cash and cash equivalents of $1,258,000.
Such amounts will be used for the working capital requirements of the Company,
along with the possible investment in the properties owned by ILM Holding for
certain capital improvements, and for dividends to the shareholders. Future
capital improvements could be financed from operations or through borrowings,
depending on the magnitude of the improvements, the availability of financing
and the Company's incremental borrowing rate. The source of future liquidity and
dividends to the shareholders is expected to be through master lease payments
from Lease I, interest income earned on invested cash reserves and proceeds from
the future sales of the underlying operating investment properties. Such sources
of liquidity are expected to be adequate to meet the Company's operating
requirements on both a short-term and long-term basis. The Company generally
will be obligated to distribute annually at least 95% of its taxable income to
its shareholders in order to continue to qualify as a REIT under the Internal
Revenue Code.
While the Company has potential liabilities pending due to ongoing
litigation against the Company, or for which the Company is a guarantor, the
eventual outcome of this litigation and the extent of obligations under the
guarantee cannot presently be determined. The court order in the Virginia AHC
litigation equals an aggregate of $1 million, the California litigation by AHC
seeks at least $2 million, and the purported class action litigation seeks
damages of an unspecified amount. As discussed in Note 4, Legal Proceedings and
Contingencies, the Company and Lease I have agreed to indemnify Mr. Cohen and
Lease I has agreed to advance funds to Capital to pay reasonable legal fees and
expenses in the California litigation. The Company will vigorously defend
against all claims made against it and, at this time, it is not certain that the
Company will have ultimate responsibility for any such claims.
The Company relies upon PC-based systems and does not expect to incur
material costs to transition to Year 2000 compliant systems in its internal
operations. The Company does not expect this project to have a significant
effect on operations. The Company will continue to implement systems and all new
investments are expected to be with Year 2000 compliant software.
Results of Operations
Nine Months Ended May 31, 1998 versus Nine Months Ended May 31, 1997
After giving effect to a $600,000 audit adjustment at August 31, 1997, which was
not reflected in the May 1997 income statement, net income increased $611,000
for the nine months ended May 31, 1998 as compared to the same period in the
prior year. This increase was primarily due to the $452,000 increase in rental
income earned pursuant to the master lease agreement.. It was also due to a net
decrease in expense of $209,000 including a $169,000 reduction in general and
administrative expense due to reductions in advisory fees and reimbursable costs
from the same period last year. A $34,000 increase in directors' compensation
was due to more frequent Board of Director meetings.
Three Months Ended May 31, 1998 versus Three Months Ended May 31, 1997
After giving effect to a $600,000 audit adjustment at August 31, 1997, which was
not reflected in the May 1997 income statement, net income increased $151,000
for the three months ended May 31, 1998, as compared to the same period in the
prior year. This increase was primarily due to an increase in variable rent
earned pursuant to the master lease agreement. General and administrative
expenses decreased $50,000 overall.
-16-
<PAGE>
ILM SENIOR LIVING, INC.
PART II
Other Information
Item 1. through 4. NONE
- ------------------
Item 5. Other Information
- -------------------------
On June 4, 1998, an unsolicited tender offer was filed on Schedule 14D-1 to
purchase up to 700,000 outstanding shares of the Company's common stock
representing approximately 9.3% of the outstanding shares at $7.00 per share. On
June 17, 1998, the Company filed a response on Schedule 14D-9, which response
was amended on July 7, 1998, stating that the Company's Board of Directors
unanimously concluded that the offer is inadequate and not in the best interests
of the Company and its shareholders. Accordingly, the Board unanimously
recommended that the Company's shareholders reject the offer and not tender
their shares.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits: 27. Financial Data Schedule
(b) Reports on Form 8-K: NONE
-17-
<PAGE>
ILM SENIOR LIVING, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
By: ILM SENIOR LIVING, INC.
By: /s/ Lawrence A. Cohen
---------------------
Lawrence A. Cohen
President
Dated: July 15, 1998
-18-
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