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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 February 28, 1999
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
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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.)
8180 Greensboro Drive, Suite 850, McLean, VA 22102
- -------------------------------------------- ----------
(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
- ------------------- ------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares Of Common Stock $.01 Par Value
-------------------------------------
(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 February 28, 1999: 7,520,100.
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Page 1 of 20
<PAGE>
ILM SENIOR LIVING, INC.
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
February 28, 1999 (Unaudited) and August 31, 1998............................................ 4
Consolidated Statements of Income
For the three months and six months ended February 28, 1999 and 1998 (Unaudited)............ 5
Consolidated Statements of Changes in Shareholders' Equity
For the six months ended February 28, 1999 and 1998 (Unaudited).............................. 6
Consolidated Statements of Cash Flows
For the six months ended February 28, 1999 and 1998 (Unaudited).............................. 7
Notes to Consolidated Financial Statements (Unaudited).................................... 8-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.... 14-18
Part II. Other Information
Item 5. Other Information........................................................................... 19
Item 6. Exhibits and Reports on Form 8-K ........................................................... 19
Signatures.................................................................................................... 20
</TABLE>
-2-
<PAGE>
ILM SENIOR LIVING, INC
Part I. Financial Information
Item I. Financial Statements
(See next page)
-3-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
February 28, 1999 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
------
February 28, 1999 August 31, 1998
----------------- ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,865 $ 4,768
Building and improvements 38,166 38,166
Furniture, fixtures and equipment 4,948 4,948
-------- --------
47,979 47,882
Less: accumulated depreciation (12,774) (12,131)
-------- --------
35,205 35,751
Unamortized mortgage fees 2,256 2,256
Less: accumulated amortization (2,050) (1,937)
-------- --------
206 319
Loan origination fees 270 102
Less: accumulated amortization (34) --
-------- --------
236 102
Cash and cash equivalents 1,519 2,264
Accounts receivable - related party 289 336
Prepaid expenses and other assets 27 89
Deferred rent receivable 31 49
-------- --------
$ 37,513 $ 38,910
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 459 $ 326
Preferred shareholders' minority
interest in subsidiary 130 125
-------- --------
Total liabilities 589 451
Contingencies
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 (28,862) (27,327)
-------- --------
Total shareholders' equity 36,924 38,459
-------- --------
$ 37,513 $ 38,910
======== ========
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three months and six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
February 28, February 28,
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Rental and other income $3,761 $3,583 $1,870 $1,800
Interest income 39 56 17 28
------ ------ ------ ------
3,800 3,639 1,887 1,828
Expenses
Depreciation expense 643 642 320 321
Amortization expense 147 112 74 56
General and administrative 256 66 129 44
Professional fees 1,044 199 824 123
Directors' compensation 49 61 29 37
------ ------ ------ ------
2,139 1,080 1,376 581
------ ------ ----- ------
Net Income $1,661 $2,559 $ 511 $1,247
====== ====== ====== ======
Basic earnings per share of common stock $ 0.22 $ 0.34 $ 0.07 $ 0.17
====== ====== ====== ======
Cash dividends paid per share of common stock $ 0.42 $ 0.39 $ 0.21 $ 0.20
====== ====== ====== ======
</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 six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
<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, 1997 7,520,100 $ 75 $65,711 $(26,128) $ 39,658
Cash dividends paid -- -- -- (2,914) (2,914)
Net income -- -- -- 2,559 2,559
--------- ---- ------- -------- --------
Shareholders' equity
at February 28, 1998 7,520,100 $ 75 $65,711 $(26,483) $ 39,303
========= ==== ======= ======== ========
Shareholders' equity
at August 31, 1998 7,520,100 $ 75 $65,711 $(27,327) $ 38,459
Cash dividends paid -- -- -- (3,196) (3,196)
Net income -- -- -- 1,661 1,661
--------- ---- ------- -------- --------
Shareholders' equity
at February 28, 1999 7,520,100 $ 75 $65,711 $(28,862) $ 36,924
========= ==== ======= ======== ========
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
February 28,
------------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,661 $ 2,559
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization expense 790 754
Charitable contribution of subsidiary's preferred
stock and accrued dividends of subsidiary 5 4
Changes in assets and liabilities:
Accounts receivable - related party 47 (633)
Prepaid expenses and other assets 62 84
Deferred rent receivable 18 18
Accounts payable and accrued expenses -- (7)
Accounts payable - related party 133 --
------- -------
Net cash provided by operating activities 2,716 2,779
------- -------
Cash flows used in investing activities:
Additions to operating investment properties (97) (730)
------- --------
Net cash used in investing activities (97) (730)
Cash flows used in financing activities:
Loan origination fees paid (168) --
Cash dividends paid to shareholders (3,196) (2,914)
------- -------
Net cash used in financing activities (3,364) (2,914)
------- -------
Net decrease in cash and cash equivalents (745) (865)
Cash and cash equivalents, beginning of period 2,264 3,136
------- -------
Cash and cash equivalents, end of period $ 1,519 $ 2,271
======= =======
</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 on Form 10-K for the fiscal year ended August 31,
1998. 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 U.S. generally
accepted accounting principles for interim financial information, 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 February 28, 1999 and revenues and expenses
for each of the six- and three-month periods ended February 28, 1999 and
1998. Actual results may differ from the estimates and assumptions used.
Certain numbers in the prior period's financial statements have been
reclassified to conform to the current period's presentation. The results
of operations for the six- and three-month periods ended February 28, 1999,
are not necessarily indicative of the results that may be expected for the
year ending August 31, 1999.
The Company was incorporated on March 6, 1989 under the laws of the
State of Virginia as a Virginia finite-life corporation, formerly
PaineWebber Independent Mortgage Fund, Inc. On June 21, 1989, the Company
sold to the public in a registered initial offering 7,520,100 shares of
common stock, $.01 par value. 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 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"), as mortgagor, a company specializing in the
development, acquisition and operation of Senior Housing Facilities and
guaranteed by AHC's corporate parent, Angeles Corporation ("Angeles").
ILM Holding, Inc. ("ILM Holding"), a majority-owned subsidiary of the
Company, now holds title to the eight Senior Housing Facilities, which
comprise the balance of 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 the consolidation of the financial statements of
the Company.
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 of ILM Holding. Cumulative dividends
accrued as of February 28, 1999 on the preferred stock in ILM Holding
totaled approximately $18,500.
-8-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
1. General (continued)
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, 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, ILM I Lease Corporation ("Lease I"), for the
purpose of operating the Senior Housing Facilities under the terms of a
facilities lease agreement (the "Facilities Lease Agreement"). 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 Facilities Lease Agreement). Lease I is a public company subject to
the reporting obligations of the Securities and Exchange Commission. All
responsibility for the day-to-day management of the Senior Housing
Facilities, including administration of the property management agreement
with AHC, was transferred to Lease I. On July 29, 1996, the management
agreement with AHC was terminated and Lease I retained Capital Senior
Management 2, Inc. ("Capital") to be the new property manager of its Senior
Housing Facilities pursuant to a management agreement (the "Management
Agreement"). Lawrence A. Cohen, who, through July 28, 1998, served as
President, Chief Executive Officer and Director of the Company and a
Director of Lease I has also served as Vice Chairman and Chief Financial
Officer of Capital Senior Living Corporation, an affiliate of Capital,
since November 1996. As a result, through July 28, 1998, Capital was
considered a related party.
-9-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
2. Operating Investment Properties Subject to Facilities Lease Agreement
At February 28, 1999, through its consolidated subsidiary, 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 166 183
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
Facilities Lease Agreement dated September 1, 1995 between the Company's
consolidated affiliate, ILM Holding, as owner of the properties and lessor
(the "Lessor"), and Lease I as lessee (the "Lessee"). The facilities 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 term of the Facilities Lease Agreement, which is
scheduled to expire on December 31, 1999, unless terminated earlier at the
election of the Lessor in connection with the sale by the Lessor of the
Senior Housing Facilities to a non-affiliated third party upon 30 days'
notice to the Company. Lease I pays annual base rent for the use of all of
the Facilities in the aggregate amount of $6,364,800 per year. Lease I also
pays variable rent, on a quarterly basis, for each facility in an amount
equal to 40% of the excess of aggregate total revenues for the Senior
Housing Facilities, on an annualized basis, over $16,996,000. Variable rent
was $564,000 and $288,000 for the six- and three-month periods ended
February 28, 1999, respectively, compared to $418,000 and $218,000 for the
six- and three-month periods ended February 28, 1998, respectively.
Recent Developments
On February 7, 1999, the Company entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of
Capital, and certain affiliates of Capital. Consummation of the merger is
presently anticipated in October 1999. In connection with the merger, the
Company has agreed to cause ILM Holding to cancel and terminate the
Facilities Lease Agreement with Lease I immediately prior to the effective
time of the merger. As noted above, the Facilities Lease Agreement, which
is scheduled to expire on December 31, 1999, may be terminated earlier at
the election of the Lessor in connection with the sale by the Lessor of the
Senior Housing Facilities to a non-affiliated third party. As a result,
Lease I would have little "going concern" value. There can be no assurance
as to whether the merger will be consummated or, if consummated, as to the
timing thereof.
-10-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
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 discussed in the Company's Annual Report on Form 10-K for
the year ended August 31, 1998, PaineWebber resigned effective as of June
18, 1997.
Lease I has retained Capital to be the property manager of the Senior
Housing Facilities and the Company has guaranteed the payment of all fees
due to Capital pursuant to the Management Agreement which commenced on July
29, 1996. Lawrence A. Cohen, who served through July 28, 1998 as President,
Chief Executive Officer and Director of the Company and a Director of Lease
I, has also served as Vice Chairman and Chief Financial Officer of Capital
Senior Living Corporation, an affiliate of Capital, since November 1996.
For the six-month periods ended February 28, 1999 and 1998, Capital earned
property management fees from Lease I of $537,000, and $484,000,
respectively. For the three-month periods ended February 28, 1999 and 1998,
Capital earned property management fees from Lease I of $277,000 and
$241,634, respectively.
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.
During fiscal 1999, Capital Senior Development, Inc. earned no fees from
Lease I, compared to fees of $226,659 and $129,849 earned for the six- and
three-month periods ended February 28, 1998, respectively, for managing
pre-construction development activities for potential expansions of the
Senior Housing Facilities.
Jeffry R. Dwyer is a shareholder of Greenberg Traurig, Counsel to the
Company and its affiliates since 1997. For the six-month periods ended
February 28, 1999 and 1998, Greenberg Traurig earned fees from the Company
of $426,000 and $102,533, respectively. For the three-month periods ended
February 28, 1999 and 1998, Greenberg Traurig earned fees from the Company
of $287,000 and $52,189, respectively.
Accounts receivable - related party at February 28, 1999 and August 31,
1998 represent amounts due from an affiliated company, Lease I, principally
for variable rent. There were no accounts payable - related party at
February 28, 1999 and August 31, 1998.
4. Legal Proceedings and Contingencies
Termination of Management 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 the terms of the contract.
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 alleged 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
-11-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
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 alleged that the management agreement was wrongfully terminated
for cause and requested damages which included 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 exceeded $2,000,000. 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 did not contain any findings
of fact or conclusions 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.
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, who, through July 28, 1998, was President, Chief Executive Officer
and a Director of the Company; and others alleging that the defendants
intentionally interfered with AHC's property management agreement (the
"California litigation"). The complaint sought damages in the amount of at
least $2,000,000. On March 4, 1997, the defendants removed the case to
Federal District Court for the Central District of California. At a Board
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. Legal
fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as
of February 28, 1999. 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. As of February 28, 1999, the amount of legal fees either advanced
to Capital or accrued on the financial statements of Lease I and Lease II
totaled approximately $619,000.
On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. Lease I and
Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to
pay $625,000 to AHC in settlement of all claims including those related to
the Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties may have
against each other, other than any claims under the property management
agreements. The Company's Board of Directors believed that settling the AHC
litigation was a prudent course of action because the settlement amount
represented a small percentage of the increase in cash flow and value
achieved for the Company and its affiliates over the past two years.
On September 4, 1998, the full settlement amounts were paid to AHC and
its affiliates with Lease I paying $975,000 and Lease II paying $650,000.
Other Litigation
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
-12-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
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.
In an oral ruling from the bench on December 8, 1998, the Court granted
the Company's dismissal motion in part and gave the plaintiffs leave to
amend their complaint. In sum, the Court accepted the Company's position
that all claims relating to so-called "derivative" actions were filed
improperly and were dismissed. In addition, the Court dismissed common law
claims for punitive damages, but allowed plaintiffs 30 days to allege any
claims, which may have injured shareholders without injuring the Company as
a whole.
On January 22, 1999, the Feldman plaintiffs filed an amended complaint,
again purporting to commence a class action, and adding claims under
Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 and Rule
10b-5 promulgated thereunder. Even before the Company and the Board of
Directors responded to that amended complaint, the Feldman plaintiffs moved
for leave to file a second amended complaint to add claims directed at
enjoining the announced potential merger with Capital Senior Living
Corporation and, alternatively, for compensatory and punitive damages. At a
hearing held on March 4, 1999 relating to the motion for leave to file that
second amended complaint and to expedite discovery, the Court granted leave
to amend and set a schedule for discovery leading to a trial (if necessary)
in Summer 1999. The plaintiffs have requested documents and depositions of
certain current and former Directors. The Company and the Board of
Directors anticipate filing a motion to dismiss the second amended
complaint in April 1999 and to continue to contest the action vigorously.
5. Construction Loan Financing
The Company has finalized negotiations with a major bank to provide a
construction loan facility that will provide the Company with up to $24.5
million to fund the capital costs of the potential expansion programs. The
construction loan facility will be secured by a first mortgage of the
Company's properties and collateral assignment of the Company's leases of
such properties. The loan will have a three-year term with interest
accruing at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. The loan
term could be extended for an additional two years beyond its maturity date
with monthly payments of principal and interest on a 25-year amortization
schedule. Loan origination costs in connection with this loan facility are
being amortized over the life of the loan.
6. Year 2000
The Company relies upon PC-based computer 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.
7. Subsequent Event
On March 15, 1999, the Company's Board of Directors declared a
quarterly dividend for the three-month period ended February 28, 1999. On
April 15, 1999, a dividend of $0.2125 per share of common stock, totaling
approximately $1,598,000, was paid to Shareholders of record as of March
31, 1999.
-13-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
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 Facilities Lease Agreement. As of
August 31, 1995, Lease I, which is taxable as a so-called "C" corporation and
not as a REIT, was a wholly-owned subsidiary of the Company. On September 1,
1995 the Company, after receiving the required regulatory approval, 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 existing cash reserves, which was
an amount estimated to provide Lease I with necessary working capital.
The Facilities Lease Agreement is between the Company's consolidated
affiliate, ILM Holding, as owner of the Senior Housing Facilities and Lessor,
and Lease I as Lessee. The facilities 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. Pursuant to the Facilities Lease Agreement, which
expires on December 31, 1999, Lease I pays annual base rent for the use of all
of the Senior Housing Facilities in the aggregate amount of $6,364,800. Lease I
also pays variable rent, on a quarterly basis, for each Senior Housing Facility
in an amount 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 six- and three-month periods ended February 28,
1999 was $564,000 and $288,000, respectively, compared to variable rental income
of $418,000 and $218,000 for the six- and three-month periods ended February 28,
1998, respectively.
The Company completed its restructuring plans by qualifying ILM Holding as a
REIT for Federal 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
-14-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General (continued)
new common stock and 275 shares of non-voting, 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 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 February 28, 1999 on the Preferred Stock in ILM Holding totaled
approximately $18,500.
The assumption of ownership of the properties through ILM Holding, which
was organized as a so-called "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 the
conversion of ILM Holding 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. At the present time, ILM Holding is not expected to have sufficient cash
flow during fiscal 1999 to (i) meet its obligations to make the debt service
payments due under the loans and (ii) pay for capital improvements and
structural repairs in accordance with the terms of the Facilities Lease
Agreement. Although ILM Holding is not expected to fully fund its scheduled debt
service payments to the Company, the estimated current values of the Senior
Housing Facilities are well in excess of the mortgage principal amounts plus
accrued interest at February 28, 1999. As a result, the Company is expected to
receive the full amount that would be due under the loans upon sale of the
Facilities.
Recent Developments
On February 7, 1999, the Company entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of Capital,
and certain affiliates of Capital. Consummation of the merger is presently
anticipated in October 1999. In connection with the merger, the Company has
agreed to cause ILM Holding to cancel and terminate the Facilities Lease
Agreement with Lease I immediately prior to the effective time of the merger. As
noted above, the Facilities Lease Agreement, which is scheduled to expire on
December 31, 1999, may be terminated earlier at the election of the Lessor in
connection with the sale by the Lessor of the Senior Housing Facilities to a
non-affiliated third party. As a result, Lease I would have little "going
concern" value. There can be no assurance as to whether the merger will be
consummated or, if consummated, as to the timing thereof.
-15-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
Occupancy levels for the eight properties in which the Company has invested
averaged 95% and 95%, for the three-month periods ended February 28, 1999 and
1998, respectively. The Company's net operating cash flow is expected to be
relatively stable and predictable due to the structure of the Facilities Lease
Agreement. 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 ILM II have been pursuing the potential for future
expansion to increase cash flow and shareholder value. Potential expansion
candidates include the facilities located in Raleigh, North Carolina, East
Lansing, Michigan, Omaha, Nebraska, Peoria, Illinois and Hot Springs, Arkansas.
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 by ILM Holding during the quarter ended November 30,
1997. In addition, an agreement has been obtained by ILM Holding to purchase
approximately five acres of land located adjacent to the Peoria facility. The
Hot Springs facility already includes a vacant land 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.
The Company has finalized negotiations with a major bank to provide a
construction loan facility that would provide the Company with up to $24.5
million to fund the capital costs of these potential expansion programs. The
construction loan facility would be secured by a first mortgage of the Company's
properties and collateral assignment of the Company's leases of such properties.
The loan has a three-year term with interest accruing at a rate equal to LIBOR
plus 1.10% or Prime plus 0.5%. The loan term could be extended for an additional
two years beyond its maturity date with monthly payments of principal and
interest on a 25-year amortization schedule.
At February 28, 1999, the Company had cash and cash equivalents of
$1,519,000 compared to $2,264,000 at August 31, 1998. 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 facilities 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, the eventual outcome of this litigation cannot
presently be determined. 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.
Year 2000
The Company relies upon PC-based computer 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.
-16-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Market Risk
The Company believes its market risk is immaterial.
Results of Operations
Six Months Ended February 28, 1999 versus Six Months Ended February 28, 1998
Net income decreased $898,000 to $1,661,000 for the six-month period ended
February 28, 1999 compared to $2,559,000 for the six-month period ended February
28, 1998. Total revenue was $3,800,000 representing an increase of $161,000, or
4.4%, compared to $3,639,000 for the same period of the prior year. Rental and
other income increased $178,000, or 5.0%, to $3,761,000 from $3,583,000, due to
increased rental income earned pursuant to the terms of the Facilities Lease
Agreement. Total expenses increased $1,059,000, or 98.1%, to $2,139,000 for the
six-month period ended February 28, 1999, compared to $1,080,000 for the
six-month period ended February 28, 1998. This increase in expenses is primarily
attributable to an increase in professional fees due to increased legal,
financial and advisory professionals who were engaged to assist the Company with
the proposed agreement and plan of merger with Capital Senior Living
Corporation, as discussed in Note 2 to the financial statements and increased
legal fees associated with the construction loan facility. The $190,000 increase
in General and Administrative expenses to $256,000, for the six-month period
ended February 28, 1999, compared to $66,000 for the same period last year, was
due to a variety of factors including increased Director and Officer insurance
costs of $109,000; increased printing costs of $39,000 for the annual and
quarterly reports which were completed earlier in the current year when compared
to the previous year; $38,000 in state tax payments which were incurred
principally during the most recent quarter; and minor increases and decreases in
other general and administrative costs. Directors' Compensation decreased
$12,000, or 19.7%, due to a decrease in the number of Board members.
Three Months Ended February 28, 1999 versus Three Months Ended February 28, 1998
Net income decreased $736,000, or 59%, to $511,000 for the second quarter
ended February 28, 1999 compared to $1,247,000 for the second quarter ended
February 28, 1998. Total revenue was $1,887,000 representing an increase of
$59,000 , or 3.2%, compared to $1,828,000 for the same period of the prior year.
Rental and other income increased $70,000, or 3.9%, to $1,870,000 from
$1,800,000, due to increased rental income earned pursuant to the terms of the
Facilities Lease Agreement. Total expenses increased $795,000, or 136.8%, to
$1,376,000 for the quarter ended February 28, 1999 compared to $581,000 for the
quarter ended February 28, 1998. This increase in expenses is primarily
attributable to an increase in professional fees due to an legal, financial and
advisory professionals who were engaged to assist the Company with the proposed
agreement and plan of merger with Capital Senior Living Corporation, as
discussed in Note 2 to the financial statements; and increased legal fees
associated with the construction loan facility. The $85,000 increase in General
and Administrative expenses to $129,000, for the second quarter ended February
28, 1999, compared to $44,000 for the same period last year, was due to a
variety of factors including increased Director and Officer insurance costs of
$32,000; increased printing costs of $20,000 for the annual and quarterly
reports which were completed earlier in the current year when compared to the
previous year; $23,000 in state tax payments; and minor increases and decreases
in other general and administrative costs. Directors' Compensation decreased
$9,000, or 21.6%, due to a decrease in the number of Board members.
-17-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Information
Certain statements included in this Quarterly Report on Form 10-Q
("Quarterly Report") constitute "forward-looking statements" intended to qualify
for the safe harbors from liability established by Section 27A of the Securities
Act of 1933, as amended (the "Securities Act"), and Section 21E of the
Securities Act of 1934, as amended (the "Exchange Act"). These forward-looking
statements generally can be identified as such because the context of the
statement will include words such as "believes," "could," "may," "should,"
"enable," "likely," "prospects," "seek," "predicts," "possible," "forecasts,"
"projects," "anticipates," "expects" and words of analogous import and
correlative expressions thereof, as well as statements preceded or otherwise
qualified by: "there can be no assurance" or "no assurance can be given."
Similarly, statements that describe the Company's future plans, objectives,
strategies or goals also are forward-looking statements. Such statements may
address future events and conditions concerning, among other things, the
Company's cash flows, results of operations and financial condition; the
consummation of acquisition and financing transactions and the effect thereof on
the Company's business, anticipated capital expenditures, proposed operating
budgets and accounting reserves; litigation; property expansion and development
programs or plans; regulatory matters; and the Company's plans, goals,
strategies and objectives for future operations and performance. Any such
forward-looking statements are subject to various risks and uncertainties that
could cause actual results to differ materially from those expressed or implied
in such forward-looking statements. Such forward-looking statements are subject
to a number of assumptions regarding, among other things, general economic,
competitive and market conditions. Such assumptions necessarily are based on
facts and conditions as they exist at the time such statements are made, the
prediction or assessment of which may be difficult or impossible and, in any
case, beyond the Company's control. Further, the Company's business is subject
to a number of risks that may affect any such forward-looking statements and
also could cause actual results of the Company to differ materially from those
projected or implied by such forward-looking statements. All forward-looking
statements contained in this Quarterly Report are expressly qualified in their
entirety by the cautionary statements in this paragraph. Moreover, the Company
does not intend to update or revise any forward-looking statements to reflect
any changes in general economic, competitive or market conditions and
developments beyond its control.
Readers of this Quarterly Report are cautioned not to place undue reliance
on any of the forward-looking statements set forth herein and the Company makes
absolutely no promises, guarantees, representations or warranties as to the
accuracy thereof.
-18-
<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 Schedule
(b) Reports on Form 8-K: The Company filed a Current Report on Form 8-K dated
February 7, 1999 reporting that the Company had entered into an Agreement
and Plan of Merger with Capital Senior Living Corporation.
-19-
<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/ J. William Sharman, Jr.
----------------------------
J. William Sharman, Jr.
President and Director
Dated: April 12, 1999
-20-
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