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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 November 30, 1998
-----------------
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-18249
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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 November 30, 1998: 7,520,100.
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Page 1 of 20
<PAGE>
ILM SENIOR LIVING, INC.
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page
----
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets
November 30, 1998 (Unaudited) and August 31, 1998............................................4
Consolidated Statements of Income
For the three-month periods ended November 30, 1998 and 1997 (Unaudited).....................5
Consolidated Statements of Changes in Shareholders' Equity
For the three months ended November 30, 1998 and 1997 (Unaudited)............................6
Consolidated Statements of Cash Flows
For the three months ended November 30, 1998 and 1997 (Unaudited)............................7
Notes to Consolidated Financial Statements (Unaudited)....................................8-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....15-17
Part II. Other Information
Item 5. Other Information...........................................................................18
Item 6. Exhibits and Reports on Form 8-K............................................................18
Signatures....................................................................................................19
</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
November 30, 1998 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
------
November 30, 1998 August 31, 1998
----------------- ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,797 $ 4,768
Building and improvements 38,166 38,166
Furniture, fixtures and equipment 4,948 4,948
--------- ---------
47,911 47,882
Less: accumulated depreciation (12,454) (12,131)
--------- ---------
35,457 35,751
Unamortized mortgage fees 2,256 2,256
Less: accumulated amortization (1,993) (1,937)
--------- ---------
263 319
Loan origination fees 204 102
Less: accumulated amortization (17) --
--------- ---------
187 102
Cash and cash equivalents 2,085 2,264
Accounts receivable - related party 369 336
Prepaid expenses and other assets 58 89
Deferred rent receivable 40 49
--------- ---------
$ 38,459 $ 38,910
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable - related party $ 164 $ --
Accounts payable and accrued expenses 157 326
--------- ---------
321 326
Preferred shareholders' minority
interest in subsidiary 127 125
--------- ---------
Total liabilities 448 451
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 (27,775) (27,327)
--------- ---------
Total shareholders' equity 38,011 38,459
--------- ---------
$ 38,459 $ 38,910
========= =========
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three-month periods ended November 30, 1998 and 1997 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
November 30
-----------
<S> <C> <C>
1998 1997
---- ----
Revenues:
Rental and other income $ 1,891 $ 1,782
Interest income 22 28
------- -------
1,913 1,810
Expenses:
Depreciation expense 323 321
Amortization expense 73 56
General and administrative 127 18
Professional fees 220 80
Directors' compensation 20 24
------- -------
763 499
------- -------
Net income $ 1,150 $ 1,311
======= =======
Basic earnings per share of common stock $ 0.15 $ 0.17
======= =======
Cash dividends paid per share of common stock $0.21 $0.19
===== =====
</TABLE>
The above earnings and cash dividends paid per share of common stock are based
upon the 7,520,100 shares outstanding during each period.
See accompanying notes.
-5-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
For the three months ended November 30, 1998 and 1997 (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 -- -- -- (1,410) (1,410)
Net income -- -- -- 1,311 1,311
--------- --- ------- -------- -------
Shareholders' equity
at November 30, 1997 7,520,100 $75 $65,711 $(26,227) $39,559
========= === ======= ======== =======
Shareholders' equity
at August 31, 1998 7,520,100 $75 $65,711 $(27,327) $38,459
Cash dividends paid -- -- -- (1,598) (1,598)
Net income -- -- -- 1,150 1,150
--------- --- ------- -------- -------
Shareholders' equity
at November 30, 1998 7,520,100 $75 $65,711 $(27,775) $38,011
========= === ======= ======== =======
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1998 and 1997 (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
November 30
-----------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,150 $ 1,311
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization expense 396 377
Charitable contribution of subsidiary's preferred
stock and accrued dividends of subsidiary 2 2
Changes in assets and liabilities:
Accounts receivable - related party (33) (1,792)
Prepaid expenses and other assets 31 (29)
Deferred rent receivable 9 9
Loan origination fees (102) --
Accounts payable and accrued expenses (169) 116
Accounts payable - related party 164 476
-------- -------
Net cash provided by operating activities 1,448 470
-------- -------
Cash flows used in investing activities:
Increase in operating investment properties (29) (476)
-------- -------
Net cash used in investing activities (29) (476)
Cash flows used in financing activities:
Cash dividends paid to shareholders (1,598) (1,410)
-------- -------
Net cash used in financing activities (1,598) (1,410)
Net (decrease) increase in cash and cash equivalents (179) 1,416
Cash and cash equivalents, beginning of period 2,264 3,136
-------- -------
Cash and cash equivalents, end of period $ 2,085 $ 1,720
======== =======
</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 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 November 30, 1998 and August 31, 1998 and revenues and
expenses for each of the three-month periods ended November 30, 1998 and
1997. Actual results could differ from the estimates and assumptions used.
Certain reclassifications have been made to prior period numbers in order
to conform to the current year presentation. Operating results for the
three months ended November 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending August 31, 1999.
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 7,520,100 shares issued. The Company received capital
contributions of $75,201,000, of which $201,000 represented the sale of
20,100 shares to an affiliate at that time, PaineWebber Group, Inc.
("PaineWebber"). For discussion purposes, PaineWebber will refer to
PaineWebber Group, Inc. and all affiliates that provided services to the
Company in the past.
The Company has elected to qualify and be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as
amended, for each taxable year of operations.
The Company originally invested the net proceeds of the initial public
offering in eight participating mortgage loans secured by senior housing
facilities located in seven different states ("Senior Housing Facilities").
All of the loans made by the Company were originally to Angeles Housing
Concepts, Inc. ("AHC"), a company specializing in the development,
acquisition and operation of Senior Housing Facilities.
During the quarter ended February 28, 1993, Angeles announced that it
was experiencing liquidity problems that resulted in the inability to meet
its obligations. Subsequent to such announcements, AHC defaulted on the
regularly scheduled mortgage loan payments due to the Company on March 1,
1993. Subsequent to March 1993, payments towards the debt service owed on
the Company's loans were limited to the net cash flow of the operating
investment properties. On May 3, 1993, Angeles filed for reorganization
under a Chapter 11 Federal Bankruptcy petition filed in the State of
California. AHC did not file for reorganization. The Company retained
special counsel and held extensive discussions with AHC concerning the
default status of its loans. During the fourth quarter of fiscal 1993, a
non-binding settlement agreement between the Company, AHC and Angeles was
reached whereby ownership of the properties was transferred from AHC to the
Company or its designated affiliates. Under the terms of the settlement
agreement, the Company released AHC and Angeles from certain obligations
under the loans. On April 27, 1994, each of the properties owned by AHC and
securing the Loans was transferred (collectively, "the Transfers") to
newly-created special purpose corporations affiliated with the Company
(collectively, "the Property Companies"). The Transfers had an effective
date of April 1, 1994 and were made pursuant to the settlement agreement
entered into on February 17, 1994 ("the Settlement Agreement") between the
Company and AHC which had previously been approved by the bankruptcy court
handling the bankruptcy case of Angeles. All of the capital stock of each
Property Company was held by ILM Holding, Inc. ("ILM Holding"), a
-8-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
1. General (continued)
-------------------
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 balance of 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 Company and PaineWebber originally owned
the capital stock of ILM Holding. 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.
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 non-voting, 8% cumulative preferred stock issued to the
Company. The number of authorized shares of preferred and common stock in
ILM Holding were also increased as part of the recapitalization. Following
the recapitalization, the Company made charitable gifts of one share of the
preferred stock in ILM Holding to each of 111 charitable organizations so
that ILM Holding would meet the stock ownership requirements of a REIT as
of January 30, 1997. The preferred stock has a liquidation preference of
$1,000 per share plus any accrued and unpaid dividends. Dividends on the
preferred stock accrue at a rate of 8% per annum on the original $1,000
liquidation preference and are cumulative from the date of issuance. Since
ILM Holding is not expected to have sufficient cash flow in the foreseeable
future to make the required dividend payments, it is anticipated that
dividends will accrue and be paid at liquidation. Cumulative dividends
accrued as of November 30, 1998 on the preferred stock in ILM Holding
totaled approximately $16,280.
As part of the fiscal 1994 settlement agreement with AHC, ILM Holding
retained AHC as the property manager for all of the Senior Housing
Facilities pursuant to the terms of a management agreement. The management
agreement with AHC was terminated in July 1996. Subsequent to the effective
date of the Settlement Agreement with AHC, management investigated and
evaluated the available options for structuring the ownership of the
properties in order to maximize the potential returns to the existing
shareholders while maintaining the Company's qualification as a REIT under
the Internal Revenue Code. As discussed further in Note 2, on September 12,
1994 the Company formed a new subsidiary, ILM I Lease Corporation ("Lease
I"), for 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.
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
-9-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
1. General (continued)
-------------------
Capital Senior Living Corporation, an affiliate of Capital, since November
1996. As a result, through July 28, 1998, Capital was considered a related
party.
On January 10, 1997, at a meeting of the Company's Board of Directors,
PaineWebber recommended the immediate sale of the Senior Housing Facilities
held by the Company and an affiliated entity, ILM II Senior Living, Inc.
("ILM II"), by means of a controlled auction to be conducted by
PaineWebber, at no additional compensation, with PaineWebber offering to
purchase the properties for $127 million, thereby guaranteeing the
Shareholders a "floor" price. The Senior Housing Facilities held by the
Company would represent approximately $75 million of this amount. After
taxes and closing costs, net proceeds to the Company would equal
approximately $71 million or approximately $9.41 per share. PaineWebber
also stated that if it purchased the properties at the specified price and
were then able to resell the properties at a higher price, PaineWebber
would pay any "excess profits" to the Shareholders. To assist the Company
in evaluating PaineWebber's proposal, a disinterested, independent
investment banking firm with expertise in healthcare REITs and
independent/assisted living financings was engaged by the Company and Lease
I as well as by ILM II and its affiliates. Following a comprehensive
analysis, the independent investment banking firm recommended that
PaineWebber's proposal should be declined and that instead investigations
of expansion and restructuring alternatives should be pursued. After
analyzing PaineWebber's proposal and the recommendations and other
information provided by the independent investment banking firm, the Boards
of the Company and ILM II voted unanimously to decline PaineWebber's
proposal and to explore the alternatives recommended by the independent
investment banking firm. The Boards declined to seek an immediate sale of
the properties because, in the Boards' view, the liquidation price would
not reflect the "going concern" values of the Company and ILM II and,
therefore, would not maximize Shareholder value. In addition, the Boards
did not consider it advisable to liquidate the Company and ILM II on the
suggested terms several years prior to their scheduled termination dates.
PaineWebber indicated to the Board in its January 10, 1997 proposal
that it would not wish to continue to serve as advisor to the Company and
its affiliates if the Company declined to accept PaineWebber's proposal.
The Company accepted the resignation of PaineWebber, effective as of June
18, 1997. PaineWebber agreed to continue to provide certain administrative
services to the Company and its affiliates through August 31, 1997,
pursuant to the terms of a transition services agreement entered into with
the Company and its affiliates. The Company and its affiliates also
accepted, effective as of June 18, 1997, the resignations of those Officers
and Directors who were employees of or otherwise affiliated with
PaineWebber.
The Company and Lease I are continuing to review various strategic
alternatives to maximize shareholder value and liquidity and have engaged
professional financial and legal advisors to formulate and present plans
and proposals for consideration by the Board. Although no definitive plans,
arrangements or understandings have been agreed to at this time, the
Company is actively reviewing the feasibility of a variety of financial
transactions and proposals, including the reorganization of the ownership
of the Senior Housing Facilities, business combinations with third parties
and sale of the Company by means of cash and/or stock-for-stock merger.
There can be no assurance that any definitive transaction will be
formulated, agreed to or consummated.
-10-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
2. Operating Investment Properties Subject to Master Lease
-------------------------------------------------------
At November 30, 1998, through its consolidated affiliate, the Company
owned eight Senior Housing Facilities. The name, location and size of the
properties are as set forth below:
<TABLE>
<CAPTION>
Rentable Resident
Name Location Units Capacities
---- -------- ------ ----------
<S> <C> <C> <C>
Independence Village of East Lansing East Lansing, MI 161 162
Independence Village of Winston-Salem Winston-Salem, NC 159 161
Independence Village of Raleigh Raleigh, NC 164 205
Independence Village of Peoria Peoria, IL 165 181
Crown Pointe Apartments Omaha, NE 135 163
Sedgwick Plaza Apartments Wichita, KS 150 170
West Shores Hot Springs, AR 136 166
Villa Santa Barbara (1) Santa Barbara, CA 125 125
</TABLE>
(1) The acquisition of Villa Santa Barbara was financed jointly by the
Company and an affiliated entity, ILM II. All amounts generated from
Villa Santa Barbara are equitably apportioned between the Company,
together with its consolidated subsidiary, and ILM II, together with
its consolidated subsidiary, generally 25% and 75%, respectively. Villa
Santa Barbara is owned 25% by ILM Holding and 75% by ILM II Holding.
Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the existing Shareholders
while maintaining the Company's qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease I, for the
purpose of operating the Senior Housing Facilities under the terms of a
master lease agreement. The master lease agreement, which commenced on
September 1, 1995, is between the Company's consolidated affiliate, ILM
Holding, as owner of the properties and lessor, and Lease I as lessee. The
master lease is a "triple-net" lease whereby the lessee pays all operating
expenses, governmental taxes and assessments, utility charges and insurance
premiums, as well as the costs of all required maintenance, personal
property and non-structural repairs in connection with the operation of the
Senior Housing Facilities. ILM Holding, as the lessor, is responsible for
all major capital improvements and structural repairs to the Senior Housing
Facilities. During the term of the master lease, which expires on December
31, 1999, Lease I is obligated to pay annual base rent for the use of all
of the Facilities in the aggregate amount of $6,364,800 per 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 equals 40% of the excess, if any, of
the aggregate total revenues for the Senior Housing Facilities, on an
annualized basis, over $16,996,000. Variable rental income for the
three-month periods ended November 30, 1998 and 1997 was $276,000 and
$200,000, respectively.
3. Related Party Transactions
--------------------------
Subject to the supervision of the Company's Board of Directors,
assistance in managing the business of the Company was provided by
PaineWebber. As previously discussed in Note 1, PaineWebber resigned
effective as of June 18, 1997.
Lease I has retained Capital 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. 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. For the three-month period ended November 30,
1997, Capital earned property management fees from Lease I of $242,000.
-11-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
3. Related Party Transactions (continued)
--------------------------------------
On September 18, 1997, Lease I entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the
development process for the potential expansion of several of the Senior
Housing Facilities. Capital Senior Development, Inc. will receive a fee
equal to 7% of the total development costs of these expansions if they are
pursued. The Company will reimburse Lease I for all costs related to these
potential expansions including fees to Capital Senior Development, Inc. For
the three-month periods ended November 30, 1998 and 1997, Capital Senior
Development, Inc. earned fees from Lease I of $0 and $96,810, respectively,
for managing pre-construction development activities for potential
expansions of the Senior Housing Facilities.
Jeffry R. Dwyer is a shareholder of Greenberg Traurig, which began
acting as Counsel to the Company and its affiliates in late fiscal 1997.
For the three-month periods ended November 30, 1998 and 1997, Greenberg
Traurig earned fees from the Company of $139,000 and $50,000, respectively.
Accounts receivable - related party at November 30, 1998 and August 31,
1998 represent amounts due from an affiliated company, Lease I, principally
for variable rent.
Accounts payable - related party at November 30, 1998 of $164,000
represents an amount owed to an affiliated company, Lease I. There were no
accounts payable-related party at 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 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 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 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. The Company had guaranteed the
payment of the termination fee at issue in these proceedings to the extent
that any termination fee was deemed payable by the court and in the event
that Lease I failed to perform pursuant to its obligations under the
management agreement. On June 13, 1997 and July 8, 1997, the court issued
orders to enter judgment against the Company and ILM II in the aggregate
amount of $1,000,000 (the "Orders"). 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.
-12-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence
Cohen, 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 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. 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 $228,000 as of November
30, 1998. 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 November 30, 1998, the amount of
legal fees either advanced to Capital or accrued on the financial
statements of Lease I and Lease II totaled approximately $611,000, although
the final amount to be reimbursed to Capital has not yet been determined.
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 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.
-13-
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
Subsequent to the end of the quarter, 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 allegedly injured
shareholders without injuring the Company as a whole.
On January 22, 1999, the Feldmann plaintiffs filed an amended
complaint, again purporting to commence a class action. The Company and the
Board of Directors, as well as former Director Cohen, are named as
defendants. Outside counsel is reviewing the allegations of the amended
complaint and the Board has not yet been advised in detail of the planned
response. The Board's instructions to outside counsel to vigorously contest
the action remain in place, and we anticipate that the Company, as well as
the individual defendants, will seek an early opportunity to move to
dismiss the action.
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.
6. Year 2000
---------
The Company relies upon PC-based systems and does not expect to incur
material costs to transition to Year 2000 compliant systems in its internal
operations. The Company does not expect this project to have a significant
effect on operations. The Company will continue to implement systems and
all new investments are expected to be with Year 2000 compliant software.
7. Subsequent Event
----------------
On December 15, 1998, the Company's Board of Directors declared a
quarterly dividend for the quarter ended November 30, 1998. On January 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 December
31, 1998.
-14-
<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. 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 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 master lease agreement, which commenced on September 1, 1995, is between
the Company's consolidated affiliate, ILM Holding, as owner of the Senior
Housing Facilities and lessor, and Lease I as lessee. The master lease is a
"triple-net" lease whereby the lessee pays all operating expenses, governmental
taxes and assessments, utility charges and insurance premiums, as well as the
costs of all required maintenance, personal property and non-structural repairs
in connection with the operation of the Senior Housing Facilities. ILM Holding,
as the lessor, is responsible for all major capital improvements and structural
repairs to the Senior Housing Facilities. During the initial term of the master
lease, which expires on December 31, 1999, Lease I is obligated to pay annual
base rent for the use of all of the Senior Housing Facilities in the aggregate
amount of $6,364,800. 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 equals 40% of the
excess, if any, of the aggregate total revenues for the Senior Housing
Facilities, on an annualized basis, over $16,996,000. Variable rental income for
the three-month periods ended November 30, 1998 and 1997 was $276,000 and
$200,000, respectively.
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 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
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 part of the recapitalization. Following the
recapitalization, the Company made charitable gifts of one share of
-15-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
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 November 30, 1998 on the
Preferred Stock in ILM Holding totaled approximately $16,280.
The assumption of ownership of the properties through ILM Holding, which was
organized as a regular C corporation for tax purposes, has resulted in a
possible future tax liability which would be payable upon the ultimate sale of
the properties (the "built-in gain tax"). The amount of such tax would be
calculated based on the lesser of the total net gain realized from the sale
transaction or the portion of the net gain realized upon a final sale which is
attributable to the period during which the properties were held in a C
corporation.
Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM Holding to a REIT would not be subject to
the built-in gain tax. The built-in gain tax would most likely not be incurred
if the properties were to be held for a period of at least ten years from the
date of the conversion of ILM Holding to a REIT. However, since the end of the
Company's original anticipated holding period is within two years, the
properties may not be held for an additional ten years. The Board of Directors
may defer the Company's scheduled liquidation date if in the opinion of a
majority of the Directors the disposition of the Company's assets at such time
would result in a material under-realization of the value of such assets;
provided, however, that no such deferral may extend beyond December 31, 2014
absent amendment of the Company's Articles of Incorporation. Based on
management's estimate of the increase in values of the Senior Housing Facilities
which occurred between April 1994 and January 1996, as supported by independent
appraisals, ILM Holding would incur a sizeable tax if the properties were sold.
Based on this increase of values during the time that ILM Holding was operated
as a regular C corporation, a sale within ten years of the date of 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 1998 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 master lease. Although
ILM Holding is not expected to fully fund its scheduled debt service payments to
the Company, the current values of the Senior Housing Facilities are well in
excess of the mortgage principal amounts plus accrued interest at November
30,1998. As a result, the Company is expected to receive the full amount that
would be due under the loans upon sale of the Facilities.
Occupancy levels for the eight properties in which the Company has invested
averaged 95% and 96%, for the three-month periods ended November 30, 1998 and
1997, respectively. The Company's net operating cash flow is expected to be
relatively stable and predictable due to the master lease structure. 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 I 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
-16-
<PAGE>
ILM SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
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.
Once the pre-construction design process is complete and projected expansion
construction costs are determined, the Company will carefully evaluate the costs
and benefits before proceeding with the construction of any of these expansions.
Depending on the extent of any expansions deemed appropriate; such plans could
result in the need for substantial additional capital. The Company 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 these
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.
At November 30, 1998, the Company had cash and cash equivalents of
$2,085,000. Such amounts will be used for the working capital requirements of
the Company, along with the possible investment in the properties owned by ILM
Holding for certain capital improvements and for dividends to the Shareholders.
Future capital improvements could be financed from operations or through
borrowings, depending on the magnitude of the improvements, the availability of
financing and the Company's incremental borrowing rate. The source of future
liquidity and dividends to the Shareholders is expected to be through master
lease payments from Lease I, interest income earned on invested cash reserves
and proceeds from the future sales of the underlying operating investment
properties. Such sources of liquidity are expected to be adequate to meet the
Company's operating requirements on both a short-term and long-term basis. The
Company generally will be obligated to distribute annually at least 95% of its
taxable income to its shareholders in order to continue to qualify as a REIT
under the Internal Revenue Code.
While the Company has potential liabilities pending due to ongoing
litigation against the Company, 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.
The Company relies upon PC-based systems and does not expect to incur
material costs to transition to Year 2000 compliant systems in its internal
operations. The Company does not expect this project to have a significant
effect on operations. The Company will continue to implement systems and all new
investments are expected to be with Year 2000 compliant software.
Results of Operations
Three Months Ended November 30, 1998 versus Three Months Ended November 30, 1997
Net income decreased $161,000 for the first quarter ended November 30, 1998
compared to the first quarter ended November 30, 1997. Total revenue was
$1,913,000 representing an increase of $103,000, or 5.7%, compared to the same
period of the prior year. Rental and other income increased $109,000, to
$1,891,000 from $1,782,000, due to increased rental income earned pursuant to
the terms of the master lease agreement and a cash settlement of $33,000
received for granting the state an easement on the Raleigh property. Total
expenses increased $264,000 from $499,000 at November 30, 1997, to $763,000 for
the three months ended November 30, 1998 or 52.9% increase overall. This
increase is primarily attributable to a combined increase in professional fees
and general and administrative expense of $249,000 due to increases in
Director's and Officer's insurance premiums; increased legal fees associated
with the construction loan facility; and financial and advisory professionals
who were engaged to assist the Company.
-17-
<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: NONE
-18-
<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: January 28, 1999
----------------
-19-
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