================================================================================
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 November 30, 1997
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 Secti on 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 March 31, 1998: 7,520,100.
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Page 1 of 18
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
November 30, 1997 (Unaudited) and August 31, 1997
(In thousands)
<TABLE>
<CAPTION>
ASSETS
November 30 August 31
----------- ---------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,249 $ 3,792
Building and improvements 40,403 40,403
Furniture, fixtures and equipment 4,967 4,948
-------- --------
49,619 49,143
Less: accumulated depreciation (12,933) (12,556)
--------- --------
36,686 36,587
Cash and cash equivalents 1,720 3,136
Accounts receivable -- related party 1,908 116
Prepaid expenses and other assets 137 108
Deferred rent receivable 77 86
-------- --------
$ 40,528 $ 40,033
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 282 $ 166
Accounts Payable -- related party 569 93
-------- --------
851 259
Total Liabilities
Preferred shareholder's minority
Interest in subsidiary 118 116
Commitments and Contingencies
Shareholder's 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 (26,227) (26,128)
-------- --------
Total Shareholders' equity 39,559 39,658
-------- --------
$ 40,528 $ 40,033
======== ========
</TABLE>
See accompanying notes.
-2-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands, except per Share amounts)
<TABLE>
<CAPTION>
Three Months Ended
November 30,
-----------------
1997 1996
------- ------
<S> <C> <C>
Revenues
Rental income $ 1,782 $1,582
Interest income 28 37
------- ------
1,810 1,619
Expenses
Depreciation and amoritization 377 380
General and administrative 98 81
Directors' compensation 24 9
------- ------
499 470
------- ------
Net income $ 1,311 $1,149
======= ======
Basic earnings per share of common stock $ 0.17 $ 0.15
======= ======
Cash dividends paid per share of
common stock $0.1875 $0.175
======= ======
</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.
-3-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands)
<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 -- -- -- (1,316) (1,316)
Net income -- -- -- 1,149 1,149
----- --- ------- --------- -------
Shareholders' equity
at November 30, 1996 7,520 $75 $65,711 $(24,585) $41,201
===== === ======= ========= =======
Shareholders' equity
at August 31, 1997 7,520 $75 $65,711 ($26,128) $39,658
Cash dividends paid -- -- -- (1,410) (1,410)
Net income -- -- -- 1,311 1,311
----- --- ------- -------- -------
Shareholders' equity
at November 30, 1997 7,520 $75 $65,711 ($26,227) $39,559
===== === ======= ========= =======
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1997 and 1996 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $1,311 $1,149
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 377 380
Preferred stock accrued dividends 2 --
Changes in assets and liabilities:
Interest and other receivables -- 46
Accounts receivable - related party (1,792) (8)
Prepaid expenses (29) 6
Deferred rent receivable 9 9
Accounts payable and accrued expenses 116 (23)
Accounts payable - affiliates 476 -
------- -------
Net cash provided by operating activities 470 1,559
------- -------
Cash flows from investing activities:
Additions to operating investment properties (476) (38)
------- -------
Net cash used in investing activities (476) (38)
Cash flows from financing activities:
Cash dividends paid to shareholders (1,410) (1,316)
------- -------
Net cash used in financing activities (1,410) (1,316)
------- -------
Net (decrease) increase in cash and cash equivalents (1,416) 205
Cash and cash equivalents, beginning of period 3,136 3,010
------- -------
Cash and cash equivalents, end of period $1,720 $3,215
======= =======
</TABLE>
See accompanying notes.
-5-
<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 the Company's 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 period. 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 require management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of November 30, 1997 and August 31, 1997
and revenues and expenses for each of the three month periods ended November 30,
1997 and 1996. Actual results could differ from the estimates and assumptions
used.
ILM Senior Living, Inc. (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. The Company entered into an exclusivity
agreement (as amended) with AHC and its parent company, Angeles Corporation
("Angeles"), which required AHC to provide the Company with certain specific
opportunities to finance senior housing facilities and set forth the terms and
conditions of the loans which were made. The loan documents under the
aforementioned exclusivity agreement called for interest to be paid on
construction loans at the rate of 13% per annum during the construction period
and for base interest to be paid on the permanent loans at the rate of 10% per
annum. In addition to the base interest, additional interest was to be paid on
the permanent loans in an amount equal to 10% of the gross revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
exclusivity agreement, additional interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the entire
term of the investments. In the aggregate, the properties securing loans from
the Company did not generate sufficient cash flow to cover the debt service
payments owed to the Company under the amended terms of the exclusivity
agreement. To the extent that the properties did not generate sufficient cash
flow to make the full payments due under the loan documents, the shortfall was
funded by AHC through December 1992. The source of cash to make up these
shortfalls was from specified deficit reserve accounts, which had been funded
from the proceeds of the mortgage loans, and from contributions by Angeles.
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
-6-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
1. General (continued)
-------------------
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.
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 will
accrue at a rate of 8% per annum on the original $1,000 liquidation preference
and will be 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 November 30, 1997 on the
preferred stock in ILM Holding totaled approximately $7,400.
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
-7-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
1. General (continued)
-------------------
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.
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 investment banker
recommended that PaineWebber's proposal should be declined and that instead
investigations of expansion and restructuring alternatives should be pursued.
After analyzing PaineWebbers' 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 three years prior to their scheduled
termination date.
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.
-8-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
2. Operating Investment Properties Subject to Master Lease
-------------------------------------------------------
At November 30, 1997, 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
Name Location Units
- ---- -------- -----
<S> <C> <C>
Independence Village of East Lansing East Lansing, MI 161
Independence Village of Winston-Salem Winston-Salem, NC 159
Independence Village of Raleigh Raleigh, NC 164
Independence Village of Peoria Peoria, IL 165
Crown Pointe Apartments Omaha, NE 135
Sedgwick Plaza Apartments Wichita, KS 150
West Shores Hot Springs, AR 136
Villa Santa Barbara (1) Santa Barbara, CA 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.
The Company consolidates the financial statements of this property on a
proportional basis.
As discussed in Note 1, ILM Holding holds title to each Senior Housing
Facility subject to a first mortgage loan payable to the Company. The principal
balance on each loan was modified to reflect the estimated fair value of the
related operating property as of April 1, 1994, the date of the transfer of
ownership from AHC. The modified loans, which have an aggregate principal
balance of $54,998,000 require interest-only payments on a monthly basis at a
rate of 9.5% from April 1, 1994 through December 1, 1994, 11% for the period
from January 1, 1995 through December 31, 1995, 12.5% for the period January 1,
1996 through December 31, 1996, 13.5% for the period January 1, 1997 through
December 31, 1997, 14% for the period January 1, 1998 through December 31, 1998
and 14.5% for the period January 1, 1999 through maturity on December 31, 1999.
In August 1995, each of the Property Companies was merged into ILM Holding.
As a result, ownership of the Senior Housing Facilities, as well as the
obligation under the loans, is now held by ILM Holding, and the Property
Companies no longer exist as separate legal entities. Since ILM Holding is
consolidated with the Company in the accompanying financial statements for
fiscal 1997, the mortgage loans and related interest expense have been
eliminated in consolidation.
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. As of August 31, 1995, Lease I, which is taxable as a regular C
corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On
September 1, 1995, after the Company received the required regulatory approval,
it distributed all of the shares of capital stock of Lease I to the holders of
record of the Company's common stock. One share of common stock of Lease I was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease I with $700,000 from its existing
cash reserves, which was an amount estimated to provide Lease I with necessary
working capital. 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)
2. Operating Investment Properties Subject to Master Lease (continued)
-------------------------------------------------------------------
The master lease agreement, which commenced on September 1, 1995, is
initially 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
$5,886,000 for calendar year 1995 (prorated based on the lease commencement
date) and $6,364,800 for calendar year 1996 and each subsequent year. Beginning
in January 1997 and for the remainder of the lease term, 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 related to the first quarter of
fiscal 1998 was $200,000.
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.
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 expansions 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. During the quarter ended November 30,
1997, Capital Senior Development, Inc. earned fees of $96,810 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 acts as Counsel to the
Company and its affiliates. Greenberg Traurig Hoffman Lipoff Rosen & Quentel
earned fees from the Company of $50,344 for the quarter ended November 30, 1997.
Accounts receivable -- related party at November 30, 1997 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 November
30, 1997 includes $457,708 due to Lease I for amounts previously advanced by
Lease I to purchase land and $111,804 due to Lease I for amounts advanced by
Lease I for capital improvements to the Senior Housing Facilities, $93,000 of
which was also payable at August 31, 1997
-10-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
4. Legal Proceedings and Contingencies
-----------------------------------
Angeles Corporation Litigation
------------------------------
Angeles had guaranteed certain of the obligations of AHC under the terms of
the Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, the Company retained a general unsecured claim
against Angeles in the amount of $1,513,935 as part of the bankruptcy
proceedings, but waived all other claims against Angeles, including any amounts
of base and additional interest owed. In addition, the Company maintained a
claim for approximately $592,000 against an affiliate of Angeles which had made
a separate guarantee to the Company. On March 17, 1995, the Bankruptcy Court
handling the Angeles bankruptcy proceedings approved a final settlement of the
Company's outstanding claims against Angeles and its affiliates. Pursuant to the
terms of this settlement, the Company received a cash payment of $1.5 million on
April 14, 1995 in full satisfaction of the claims, which totaled approximately
$2.1 million. This amount, net of certain related legal expenses, was recorded
as a reduction in the carrying values of the operating investment properties.
Termination of Contract with AHC
--------------------------------
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. The court
initially set a trial date of April 28, 1997 but, at AHC's request, rescheduled
the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the court issued
orders to enter judgment against the Company and ILM II in the 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.
-11-
<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 Senior Management 2, Inc., ("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 Properties 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 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. 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.
5. Subsequent Events
-----------------
On December 15, 1997, the Company's Board of Directors declared a quarterly
dividend for the quarter ended November 30, 1997. On January 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 December 31, 1997.
On March 13, 1998, the Company's Board of Directors declared a quarterly
dividend for the quarter ended February 28, 1998. On April 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 March 31, 1998.
On March 24, 1998, a fire occurred at the Senior Housing Facility located
in East Lansing Michigan. The damage to the building will be repaired with
proceeds from the facility's insurance. The cost of the building repairs has
been estimated at approximately $400,000.
-12-
<PAGE>
ILM SENIOR LIVING, INC.
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. Such mortgage loans and the related interest expense are
eliminated in consolidation. 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. As of
August 31, 1995, Lease I, which is taxable as a regular C corporation and not as
a REIT, was a wholly owned subsidiary of the Company. On September 1, 1995,
after the Company received the required regulatory approval, it distributed all
of the shares of capital stock of Lease I to the holders of record of the
Company's common stock. One share of common stock of Lease I was issued for each
full share of the Company's common stock held. Prior to the distribution, the
Company capitalized Lease I with $700,000 from its existing cash reserves, which
was an amount estimated to provide Lease I with necessary working capital. 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 $5,886,000 for calendar year 1995
(prorated based on the lease commencement date) and $6,364,800 for calendar year
1996 and each subsequent year. Beginning in January 1997 and for the remainder
of the lease term, Lease I is also obligated to pay variable rent for each
Senior Housing Facility. Such variable rent will be payable quarterly and will
equal 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 related to the first quarter of fiscal 1998 was $200,000.
-13-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
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 will accrue at a rate of 8% per
annum on the original $1,000 liquidation preference and will be 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 November 30, 1997 on the Preferred Stock in ILM
Holding totaled approximately $7,400.
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 three years, the
properties are not expected to 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 properties 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 the
then current estimated market values of the operating investment properties, a
sale at such values prior to the end of the ten-year holding period could result
in a built-in gain tax of as much as $2.9 million.
Following the termination of its advisory relationship with PaineWebber (see
"Note 1 to Notes to Consolidated Financial Statements"), the Company and Lease I
commenced a further review of various restructuring alternatives that could
further increase Shareholder value and liquidity. The Company and Lease I are
analyzing a merger of the Company with ILM II and Lease I with 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 which may be recommended by its investment bankers.
-14-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
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.
Lease I retained Capital Senior Management 2, Inc., "Capital", as the
property manager of its Senior Housing Facilities pursuant to a Management
Agreement which commenced on July 29, 1996. Under the terms of the Management
Agreement, Capital earns a base management fee equal to 4% of the gross
operating revenues of the Senior Housing Facilities, as defined. Capital is also
eligible to earn an incentive management fee equal to 25% of the amount by which
the average monthly net cash flow of the Senior Housing Facilities, as defined,
for the twelve-month period ending on the last day of each calendar month during
the term of the Management Agreement exceeds a specified base amount. Each
August 31, beginning on August 31, 1997, the base amount will be increased
annually based on the percentage increase in the Consumer Price Index. The
Company has guaranteed the payment of all fees due to Capital under the terms of
the Management Agreement.
The eight properties in which the Company has invested averaged 96%
occupancy as of November 30, 1997. 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
increased to $6,364,800 effective January 1, 1996 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 additional steps to increase
Shareholder value. Several new programs were adopted during fiscal 1997 across
the Company's portfolio which are resulting in increased revenues and cash flow
from the properties. These steps include increasing the number of rentable
apartment units as live-in facility managers move from the properties and
increasing rental rates at properties that have maintained high occupancy levels
and are located in strong markets. Another program to increase revenues and cash
flow involves pursing the potential for future expansions 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 Raleigh facility were
acquired for $450,000 during the year ended August 31, 1997. In addition,
approximately two acres of land located adjacent to the East Lansing facility
and approximately three and one-half acres of land located adjacent to the Omaha
facility were acquired in the first quarter of fiscal 1998 for $200,000 and
$240,000 respectively. In addition, an agreement has been obtained to purchase
approximately five acres of land located adjacent to the Peoria facility for
approximately $600,000 and closing is expected to occur during fiscal 1998,
contingent on due diligence activities. The Hot Springs facility already
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. Once the pre-construction design process is complete and projected
-15-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
expansion construction costs are determined, the Company will 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.
At November 30, 1997, the Company had cash and cash equivalents of
$1,720,000. 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.
Results of Operations
Three Months Ended November 30, 1997 versus Three Months Ended November 30, 1996
Net income increased $162,000 for the three months ended November 30, 1997 as
compared to the same period in the prior year, primarily due to the $200,000
variable rent earned pursuant to the master lease agreement. This increase was
offset by a $17,000 increase in general and administrative expense due
principally to increased legal fees and a $15,000 increase in directors'
compensation due to more frequent Board of Director meetings.
-16-
<PAGE>
ILM SENIOR LIVING, INC.
PART II
Other Information
Item 1. Through 5. NONE
- ------------------
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits: 27. Financial Data Scheduled
(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: May 15, 1998
-18-
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