<PAGE>
ILM SENIOR LIVING, INC.
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
___ SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED: AUGUST 31, 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
ILM SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
Virginia 04-3042283
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(State of organization) (I.R.S. Employer
Identification No.)
8180 Greensboro Drive, Suite 850, McLean, Virginia 22102
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(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 which
Title of each class registered
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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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
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.
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Shares of common stock outstanding as of August 31, 1999: 7,520,100. The
aggregate sales price of the shares sold was $75,201,000. This does not reflect
market value. There is no current market for these shares.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
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Prospectus of registrant dated Part II, Part IV
June 9, 1989, as supplemented
[33 Act filing #33-27653]
Current Report on Form 8-K of Part IV
Registrant dated October 21, 1999
===============================================================================
<PAGE>
ILM SENIOR LIVING, INC.
1999 FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I Page
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<S> <C> <C> <C>
Item 1 Business..................................................................I-1
Item 2 Properties................................................................I-6
Item 3 Legal Proceedings.........................................................I-6
Item 4 Submission of Matters to a Vote of Security Holders.......................I-8
PART II
Item 5 Market for the Registrant's Shares and Related
Stockholder Matters..................................................II-1
Item 6 Selected Financial Data..................................................II-2
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................II-3
Item 8 Financial Statements and Supplementary Data..............................II-9
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................II-9
PART III
Item 10 Directors and Executive Officers of the Registrant......................III-1
Item 11 Executive Compensation..................................................III-2
Item 12 Security Ownership of Certain Beneficial Owners and Management..........III-2
Item 13 Certain Relationships and Related Transactions..........................III-3
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K..........IV-1
Signatures .........................................................................IV-2
Index to Exhibits .........................................................................IV-3
Financial Statements and Supplementary Data..................................................F1-F23
</TABLE>
<PAGE>
ILM SENIOR LIVING, INC.
PART I
ITEM 1. BUSINESS
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ILM Senior Living, Inc. (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., for the
purpose of making construction and participating mortgage loans secured by
rental housing complexes for independent senior citizens ("Senior Housing
Facilities"). On June 21, 1989, the Company sold to the public in a registered
initial offering pursuant to a Registration Statement filed on Form S-11 under
the Securities Act of 1933 (Registration Statement No. 33-27653), 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 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. As a REIT, the Company is allowed a
deduction for the amount of dividends paid to shareholders of the Company
("Shareholders"), thereby effectively subjecting the distributed net income of
the Company to taxation at the shareholder level only. In order to qualify as a
REIT, the Company must distribute at least 95% of its taxable income on an
annual basis and meet certain other requirements.
The Company originally invested the net proceeds of the initial public
offering in eight participating mortgage loans secured by senior housing
facilities ("Senior Housing Facilities") located in seven states. 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").
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 toward 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 Senior Housing Facilities would be
transferred from AHC to the Company or its designated affiliates. Under the
terms of the Settlement Agreement, the Company would release AHC and Angeles
from certain obligations under the loans. On April 27, 1994, each of the Senior
Housing Facilities owned by AHC and securing the loans was transferred
(collectively, "the Transfers") to newly-created special purpose corporations
affiliated with the Company (collectively, "the Property Companies"). The
Transfers had an effective date of April 1, 1994 and were made pursuant to the
Settlement Agreement entered into on February 17, 1994 ("the Settlement
Agreement") between the Company and AHC which had previously been approved by
the bankruptcy court handling the bankruptcy case of Angeles. All of the capital
stock of each Property Company was held by ILM Holding, Inc. ("ILM Holding"), a
Virginia corporation. In August 1995, each of the Property Companies merged into
ILM Holding, which is now a subsidiary of 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.
I-1
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
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ILM Holding, Inc., 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 capital stock of ILM Holding was
originally owned by the Company and PaineWebber. ILM Holding had issued 100
shares of Series A Preferred Stock to the Company in return for a capital
contribution in the amount of $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 effective for calendar year 1996. 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, representing a
$39,000 increase in fair value. This increase in fair value is based on the
increase in values of the Senior Housing Facilities which occurred between April
1994 and January 1996, as supported by independent appraisals.
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 "Preferred
Stock"). 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. The Company recorded the contribution of the Preferred Stock in ILM
Holding to the charitable organizations at the amount of the initial liquidation
preference of $111,000. Such amount is included in general and administrative
expense in the accompanying consolidated statement of income for the year ended
August 31, 1997. Cumulative dividends accrued as of August 31, 1999 and 1998, on
the Preferred Stock in ILM Holding totaled $23,000 and $14,000, respectively.
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.
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 in various management capacities at Capital Senior
Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen
I-2
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
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currently serves as Chief Executive Officer of Capital Senior Living
Corporation. As a result, through July 28, 1998, Capital was considered a
related party.
RECENT DEVELOPMENTS
On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital Senior
Living Corporation, the corporate parent of Capital, and certain affiliates of
Capital. If the merger is consummated, the Shareholders of the Company will
receive all-cash merger consideration of approximately $12.90 per share.
Consummation of this transaction will require, among other things, the
affirmative vote of the holders of not less than 66-2/3% of the Company's
outstanding common stock. While there can be no assurance, consummation of the
merger is presently anticipated in the first quarter of calendar year 2000. 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 was extended on a month-to-month basis on November 16, 1999 beyond its
original expiration date of December 31, 1999. There can be no assurance as to
whether the merger will be consummated or, if consummated, as to the timing
thereof.
I-3
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
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At August 31, 1999, through its consolidated subsidiary, the Company owned
eight Senior Housing Facilities. The Company's investments as of August 31, 1999
are described below:
<TABLE>
<CAPTION>
Year
Date of Facility Rentable Resident
PROPERTY NAME AND LOCATION (1) TYPE OF PROPERTY INVESTMENT BUILT UNITS (3) CAPACITIES(3)
------------------------------ ---------------- ---------- ----- --------- -------------
<S> <C> <C> <C> <C> <C>
Independence Village of Winston-Salem Senior Housing 6/29/89 1989 159 161
Winston-Salem, NC Facility
Independence Village of East Lansing Senior Housing 6/29/89 1989 161 162
East Lansing, MI Facility
Independence Village of Raleigh Senior Housing 4/29/91 1991 164 205
Raleigh, NC Facility
Independence Village of Peoria Senior Housing 11/30/90 1990 166 183
Peoria, IL Facility
Crown Pointe Apartments Senior Housing 2/14/90 1984 135 163
Omaha, NE Facility
Sedgwick Plaza Apartments Senior Housing 2/14/90 1984 150 170
Wichita, KS Facility
West Shores Senior Housing 12/14/90 1986 136 166
Hot Springs, AR Facility
Villa Santa Barbara (2) Senior Housing 7/13/92 1979 125 125
Santa Barbara, CA Facility
</TABLE>
(1) See Note 4 to the consolidated financial statements filed with this
annual report for a description of the agreements through which the
Company has acquired these real estate investments.
(2) 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 as tenants in common. Upon the sale of the Company or ILM II,
arrangements would be made to transfer the Santa Barbara facility to
the non-selling joint tenant (or one of its subsidiaries). The
property was extensively renovated in 1995.
(3) Rentable units represent the number of apartment units and is a measure
commonly used in the real estate industry. Resident capacity equals the
number of bedrooms contained within the apartment units and corresponds
to measures commonly used in the healthcare industry.
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
I-4
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
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Housing Facilities. During the term of the Facilities Lease Agreement, which was
extended on a month-to-month basis on November 16, 1999 beyond its original
expiration date of December 31, 1999, 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. For the fiscal years ended
August 31, 1999 and 1998, variable rent was $1,164,000 and $894,000,
respectively.
The Senior Housing Facilities are subject to competition from similar
properties in the vicinities in which they are located. The Senior Housing
Facilities are located in areas with significant senior citizen populations and,
as a result, there are, and will likely continue to be, a variety of competing
projects aimed at attracting senior residents. Such projects will generally
compete on the basis of rental rates, services, amenities and location. The
Company has no real estate investments located outside the United States. The
Company is engaged solely in the business of real estate investment. Therefore,
presentation of information about industry segments is not applicable.
The Company originally expected to liquidate its investments after a
period of approximately ten years, although under the terms of its
organizational documents property sales may occur at earlier or later dates. 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. Because the Directors believe that disposition of the Company's assets by
December 31, 1999, would result in such under-realization, and because the
merger with Capital Senior Living Corporation is presently anticipated to occur
in the first quarter of calendar year 2000, on November 16, 1999, the Company's
Board of Directors voted to extend the term of the Company on a month-to-month
basis. If the merger does not occur, the Company's Board of Directors presently
expects to extend the term of the Company until December 31, 2001. On November
16, 1999, the Company's Board of Directors also voted to cause ILM Holding to
extend the Facilities Lease Agreement with Lease I on a month-to-month basis.
The net proceeds of any sale transactions are expected to be distributed to the
Shareholders, so that the Company will, in effect, be self-liquidating.
Through June 18, 1997 and subject to the supervision of the Company's
Board of Directors, assistance in the management of the business of the Company
was provided by PaineWebber. PaineWebber resigned from this position effective
as of June 18, 1997, although PaineWebber agreed to provide certain
administrative services to the Company and its affiliates through August 31,
1997. Through the date of its resignation, PaineWebber performed the day-to-day
operations of the Company and acted as the investment advisor and consultant for
the Company. PaineWebber provided cash management, accounting, tax preparation,
financial reporting, investor communications and relations as well as asset
management services to the Company. These services are now being provided to the
Company, subject to the supervision of the Company's Board of Directors, by
various companies and consultants including Cohen & Steers, Greenberg Traurig,
Fleet Bank, Ernst & Young LLP and MAVRICC Management Systems, Inc.
There are currently three Directors of the Company, none of whom are
affiliates of PaineWebber or Capital. The Directors are subject to removal by
the vote of the holders of a majority of the outstanding shares of Company
common stock.
The terms of transactions between the Company and PaineWebber, and
similar disclosures with respect to relationships of other related parties which
provide services to the Company are set forth in Items 11 and 13 below to which
reference is hereby made for a description of such terms and transactions.
I-5
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 2. PROPERTIES
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As of August 31, 1999, the Company has interests in the eight operating
properties referred to under Item 1 above, to which reference is made for the
description, name and location of such properties.
Average occupancy levels for each fiscal quarter during 1999 along with
an average for the year are presented below for each property:
<TABLE>
<CAPTION>
AVERAGE QUARTERLY OCCUPANCY
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Fiscal 1999
11/30/98 2/28/99 5/31/99 8/31/99 AVERAGE
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<S> <C> <C> <C> <C> <C>
Independence Village
of Winston-Salem 92% 94% 93% 96% 94%
Independence Village
of East Lansing 94% 89% 87% 87% 89%
Independence Village of Raleigh 95% 94% 95% 97% 95%
Independence Village of Peoria 98% 98% 98% 95% 97%
Crown Pointe Apartments 98% 98% 96% 93% 96%
Sedgwick Plaza Apartments 94% 91% 89% 87% 90%
West Shores 97% 94% 97% 97% 96%
Villa Santa Barbara 97% 99% 97% 97% 98%
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
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TERMINATION OF MANAGEMENT CONTRACT WITH AHC
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On July 29, 1996, Lease I and ILM Holding (collectively for this Item
3, 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 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 management 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 the
termination fee in the amount of $1,250,000, payment of management fees pursuant
to the management agreement from August 1, 1996 through October 15, 1996, which
is the earliest date that the management agreement could have been terminated
without cause, and recovery of attorneys' fees and expenses.
I-6
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
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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
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 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
$229,000 as of August 31, 1999. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000.
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. 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 naming the Company, ILM II and their Directors as defendants. The class
action complaint alleged 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. The
complaint sought compensatory 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 and its co-defendants moved to dismiss the
complaint on all counts.
On December 8, 1998, the Court granted the Company's dismissal motion
in part but afforded the plaintiffs leave to amend their complaint. In doing so,
the Court accepted the Company's position that all claims relating to the
derivative actions were filed improperly. In addition, the Court dismissed
common law claims for punitive damages, but allowed plaintiffs to amend their
claims to assert claims alleging that the defendants 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
I-7
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
- --------------------------------------
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 the summer of 1999.
On March 9, 1999, the Feldman plaintiffs filed a second amended
complaint, which included claims for injunctive relief and, in the alternative,
damages in an unspecified amount. In response to the Company's motion to dismiss
the second amended complaint filed by the plaintiffs, on June 7, 1999 the Court
issued an order dismissing the plaintiffs' federal security claims but denying
the motion to dismiss plaintiffs' claims for breach of fiduciary duty and
judicial dissolution, which motion was addressed to the pleadings and not to the
merits of the action.
On June 21, 1999, the Company and its co-defendants answered the second
amended complaint and denied any and all liability and moved for reconsideration
of the portion of the Court's June 7, 1999 order denying their motion to
dismiss. In response to discovery requests, the Company, ILM II and others
produced documents to the plaintiffs and depositions of current and former
directors and others were taken. Discovery was completed as of July 1, 1999.
On July 2, 1999, the parties to this action came to an
agreement-in-principle to settle the action. On August 3, 1999, the parties
entered into a Stipulation of Settlement and on August 11, 1999, the Court
signed an order preliminarily approving the Stipulation and providing for notice
of the Stipulation to the proposed settlement class.
On September 30, 1999, the Court conducted a hearing and on October 4,
1999 issued an order certifying a settlement class and approving the proposed
settlement as fair, reasonable and adequate, subject to the condition that
certain modifications be made to the Stipulation of Settlement and any related
documents filed with the Court on or before October 15, 1999.
On October 15, 1999, the parties entered into a revised Stipulation of
Settlement and filed it with the Court, which approved the settlement, by order
dated October 21, 1999. In issuing that order the Court entered a final judgment
dismissing the action and all non-derivative claims of the settlement class
against the defendants with prejudice. In its October 4th order, the Court also
denied the application by plaintiffs' counsel for payment of attorneys' fees and
expenses, without prejudice to renewal within 14 days upon reapplication
therefor. On or about October 14, 1999, plaintiffs' counsel reapplied to the
Court for fees and expenses. A hearing was held November 5, 1999, in which the
Court granted the application for attorney's fees in the amount of $950,000 and
costs in the amount of $182,000. Under the Stipulation, if the proposed merger
is consummated, Capital Senior Living Corporation is responsible for payment of
such attorney's fees and expenses sought under this application, and if the
proposed merger with Capital Senior Living Corporation is not consummated and if
the Company and ILM II enter into a transaction having similar effect to the
merger with a third party, then the Company and ILM II are responsible for such
fees and expenses.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
None.
I-8
<PAGE>
ILM SENIOR LIVING, INC.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED STOCKHOLDER MATTERS
- ---------------------------------------------------------------------------
During the public offering period, which commenced on June 21, 1989 and
ended on July 21, 1989, the selling price of the shares of common stock was $10
per share. At August 31, 1999, there were 4,509 record holders of the Company's
shares. There is no public market for the resale of the shares, and it is not
anticipated that a public market will develop. While shares of the Company were
designed for long-term holding, they may possibly be traded through a secondary
market resale. The shares do not trade on an established exchange and the only
market that has developed is an informal secondary market; therefore, little
resale activity occurs. Although PaineWebber and others may endeavor to assist
Shareholders desiring to sell their shares by attempting to match requests to
sell shares with requests to purchase shares, such transfers are not expected to
be frequent. In addition, the Company's Articles of Incorporation restrict
ownership of more than 9.8% of the Company's outstanding shares by one investor.
These restrictions are designed to ensure the Company does not violate certain
share accumulation restrictions imposed by the Internal Revenue Code on REITs.
The Company makes quarterly distributions, payable within 45 days after
the end of each fiscal quarter, to Shareholders of record on the record date for
such quarter as determined by the Directors. The Company intends to make
distributions to shareholders in an amount equal to at least 95% of its taxable
income in order to continue to qualify as a REIT. Reference is made to Item 6
below for the amount of cash dividends paid per share of common stock during
fiscal 1999.
On June 4, 1998, an unsolicited tender offer was filed on Schedule
14D-1 to purchase up to 700,000 outstanding shares of the Company's common stock
representing approximately 9.3% of the outstanding shares at $7.00 per share. On
June 11, 1998, the offer was increased to $8.00 per share. On June 17, 1998, the
Company filed a response on Schedule 14D-9, which response was amended on July
7, 1998, stating that the Company's Board of Directors unanimously concluded
that the offer is inadequate and not in the best interests of the Company and
its shareholders. Accordingly, the Board unanimously recommended that the
Company's Shareholders reject the offer and not tender their shares.
On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital Senior
Living Corporation, the corporate parent of Capital, and certain affiliates of
Capital. If the merger is consummated, the Shareholders of the Company will
receive all-cash merger consideration of approximately $12.90 per share.
Consummation of this transaction will require, among other things, the
affirmative vote of the holders of not less than 66-2/3% of the Company's
outstanding common stock. While there can be no assurance, consummation of the
merger is presently anticipated in the first quarter of calendar year 2000. 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. The Facilities Lease Agreement was
extended on a month-to-month basis on November 16, 1999 beyond its original
expiration date of December 31, 1999. There can be no assurance as to whether
the merger will be consummated or, if consummated, as to the timing thereof.
II-1
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------
ILM SENIOR LIVING, INC.
For the years ended August 31, 1999, 1998, 1997, 1996 and 1995
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997(1) 1996 1995
---- ---- ------- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 7,597 $ 7,320 $ 6,805 $ 129 $ 174
Operating income (loss) 2,961 4,723 3,834 (641) (954)
Equity in income from properties
securing mortgage loans -- -- -- 4,756 5,053
-------- -------- -------- -------- --------
Net income $ 2,961 $ 4,723 $ 3,834 $ 4,115 $ 4,099
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Earnings per share of common stock $ 0.39 $ 0.63 $ 0.51 $ 0.55 $ 0.54
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Cash dividends paid
per share of common stock $ 0.85 $ 0.79 $ 0.74 $ 0.70 $ 0.71
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 31
---------
1999 1998 1997 1996 1995
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Total assets $ 37,962 $ 38,910 $ 40,033 $ 41,451 $ 3,489
======== ======== ========= ========= =======
SHARES OUTSTANDING 7,520,100 7,520,100 7,520,100 7,520,100 7,520,100
</TABLE>
(1) As a result of certain restructuring plans which the Company began to
implement during fiscal 1995 (see Item 7), the financial position and
results of operations of the combined operating investment properties
in which the Company has invested have been presented on a
consolidated basis in the Company's financial statements beginning in
fiscal 1997. Prior to fiscal 1997, the Company had accounted for its
interests in such properties under the equity method as a result of
the Company not holding majority voting control of ILM Holding.
The above selected financial data should be read in conjunction with the
consolidated financial statements and related notes to the consolidated
financial statements appearing in item 14(a) of this annual report.
II-2
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. 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 participating
mortgage loans secured by Senior Housing Facilities located in seven states. All
of the loans made by the Company were originally with AHC. AHC defaulted on the
regularly 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 Senior Housing
Facilities 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 now a subsidiary of the Company. ILM
Holding holds title to the eight Senior Housing Facilities which comprise the
balance of operating investment properties in the accompanying consolidated
balance sheets, subject to certain mortgage loans payable to the Company. Such
mortgage loans and the related interest expense are eliminated in the
consolidation of the financial statements of 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
management agreement. As discussed further below, 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, 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, after the Company received the required regulatory approval,
it distributed all of the shares of capital stock of Lease I to the holders of
record of the Company's common stock. One share of common stock of Lease I was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease I with $700,000 from its existing
cash reserves, which was an amount estimated to provide Lease I with necessary
working capital.
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 was
extended on a month-to-month basis on November 16, 1999 beyond its original
expiration date of 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 related to fiscal years 1999 and 1998 was
$1,164,000 and $894,000, respectively.
The assumption of ownership of the Senior Housing Facilities through
ILM Holding, which was a so-called "C" corporation for tax purposes at the time
of assumption, has resulted in a possible future tax liability which would be
payable upon the ultimate sale of the Senior Housing Facilities (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 Senior Housing Facilities were held by a C corporation.
II-3
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
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 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. 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 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. The Company recorded the contribution of the Preferred Stock in ILM
Holding to the charitable organizations at the amount of the initial liquidation
preference of $111,000. Such amount is included in general and administrative
expense in the accompanying consolidated statements of income for the year ended
August 31, 1997. Cumulative dividends accrued as of August 31, 1999 and 1998, on
the Preferred Stock in ILM Holding totaled $23,000 and $14,000, respectively.
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 Senior Housing Facilities 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 one year,
the Senior Housing Facilities 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. On November
16, 1999, the Company's Board of Directors voted to extend the term of the
Company and the Facilities Lease Agreement with Lease I on a month-to-month
basis commencing December 31, 1999. 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 Senior Housing Facilities 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, which could be reduced by $2.45 million using available net operating
loss carryforwards of ILM Holding of approximately $7.2 million.
ILM Holding has acquired the respective operating properties subject
to, and assumed the obligations under, the mortgage loans payable to the
Company, pursuant to the 1997 Settlement Agreement with AHC. The principal
balance of each loan was modified to reflect the estimated fair value of the
related operating property as of the date of the transfer of ownership. The
modified loans require interest-only payments on a monthly basis at a rate of
9.5% from April 1, 1994 through December 1, 1994, 11% for the period January 1
through December 31, 1995, 12.5% for the period January 1 through December 31,
1996, 13.5% for the period January 1 through December 31, 1997, 14% for the
period January 1 through December 31, 1998 and 14.5% for the period January 1,
1999 through maturity. Since ILM Holding is consolidated with the Company in the
accompanying consolidated financial statements for fiscal years 1999 and 1998,
the mortgage loans and related interest expense have been eliminated in
consolidation.
Because the ownership of the assets of ILM Holding was expected to be
transferred to the Company or its wholly-owned subsidiary, ILM Holding was
capitalized with funds to provide it with working capital only for a limited
period of time. At the present time, ILM Holding is not expected to have
sufficient cash flow during fiscal year 2000 to (i) meet its obligations to make
the debt service payments due under the loans and (ii) pay for capital
II-4
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
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 current values of the
Senior Housing Facilities are well in excess of the mortgage principal amounts
plus accrued interest at August 31, 1999. As a result, the Company is expected
to recover the full amount that would be due under the loans upon the sale of
the Senior Housing Facilities.
Lease I has retained Capital to be the property manager of the Senior
Housing Facilities and the Company has guaranteed payment of all fees due to
Capital pursuant to 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 in various management capacities at Capital Senior Living
Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as
Chief Executive Officer of Capital Senior Living Corporation. As a result,
through July 28, 1998, Capital was considered a related party. Under the terms
of the Management Agreement, Capital earns a base management fee equal to 4% of
the gross operating revenues of the Senior Housing Facilities, as defined.
Capital also earns an incentive management fee equal to 25% of the amount by
which the net cash flow of the Senior Housing Facilities, as defined, exceeds a
specified base amount. Each August 31, beginning on August 31, 1997, the base
amount is increased based on the percentage increase in the Consumer Price Index
as well as 15% of Senior Housing Facility expansion costs.
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
$229,000 as of August 31, 1999. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000.
The eight Senior Housing Facilities in which the Company has invested
averaged 94% and 96% occupancy for the fiscal years ended August 31, 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. Accordingly,
ILM Holding received variable rent payments in fiscal 1999 and 1998 in the
amounts of $1,164,000 and $894,000, respectively. As a result of the status of
the Company's net operating cash flow under the current Facilities Lease
Agreement, the Company increased its quarterly dividend payment from $0.1875 per
share to $0.20 per share effective with the dividend paid in January 1998 for
the quarter ended November 30, 1997. The Company increased its quarterly
dividend payment to $0.2125 per share effective with the dividend paid on
October 15, 1998 for the quarter ended August 31, 1998.
The Company and ILM II have been pursuing the potential for future
expansion of several of the Senior Housing Facilities which are located in areas
that have particularly strong markets for senior housing 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. During fiscal year 1997,
approximately two acres of land adjacent to the Raleigh facility were purchased
and during fiscal 1998, approximately two acres of land located adjacent to the
East Lansing facility and approximately two and one-half
II-5
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
acres of land located adjacent to the Omaha facility were acquired by ILM
Holding. Also included in Land on the accompanying consolidated balance sheets
are significant pre-construction design and planning costs incurred at existing
facilities for possible future expansions. The Hot Springs facility includes a
vacant parcel of approximately two acres which could accommodate an expansion of
the existing facility or the construction of a new free-standing facility.
Preliminary feasibility evaluations have been completed for all of these
potential expansions and pre-construction design and construction cost
evaluations are underway for expansions of the facilities located in Raleigh and
Omaha.
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 would result in the need for substantial capital.
The Company secured a construction loan facility with a major bank that
provides the Company with up to $24.5 million to fund the capital costs of the
potential expansion programs. The construction loan facility is secured by a
first mortgage of the Senior Housing Facilities and collateral assignment of the
Company's leases of such Senior Housing Facilities. The loan expires December
31, 2000, with possible extensions through September 29, 2003. Principal is due
at expiration. Interest is payable monthly at a rate equal to LIBOR plus 1.10%
or Prime plus 0.5%. Loan origination costs in connection with this loan facility
are being amortized over the life of the loan.
On June 7, 1999, the Company borrowed approximately $2.1 million under
the construction loan facility to fund the pre-construction capital costs
incurred through April 1999 of the potential expansions of the Senior Housing
Facilities. As of August 31, 1999, approximately $22.4 million of the
construction loan facility is unused and available.
At August 31, 1999, the Company had cash and cash equivalents of
$2,615,000 compared to $2,264,000 at August 31, 1998. The increase in cash of
approximately $351,000 is primarily due to borrowing of approximately $2.1
million under the construction loan facility offset by costs incurred due to the
potential merger transaction with Capital Senior Living Corporation. Such
amounts will be used for the working capital requirements of the Company, along
with the possible investment in the Senior Housing Facilities 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 lease 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.
II-6
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
YEAR 2000
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize the year 2000 as a date other than the year 2000.
This could result in a system failure or miscalculations causing disruptions of
operations including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
The Company has assessed its exposure to operating equipment, and
such exposure is not significant due to the nature of the Company's business.
The Company is not aware of any external agent with a Year 2000 issue
that would materially impact the Company's results of operations, liquidity or
capital resources. However, the Company has no means of determining whether or
ensuring those external agents will be Year 2000 ready. The inability of
external agents to complete their Year 2000 resolution process in a timely
fashion could impact the Company.
Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. As noted above, the Company
has substantially completed all necessary phases of its Year 2000 program. In
addition, disruptions in the economy generally resulting from Year 2000 issues
could also adversely affect the Company. Although the amount of potential
liability and lost revenue cannot be reasonably estimated at this time, in a
worst case situation, if Capital, the Company's most significant third party
contractor, were to experience a year 2000 problem, it is likely that Lease I
would not receive rental income as it became due from Senior Living Facility
residents. Lease I in turn would fail to pay ILM Holding lease payments as they
arise under the master lease, and ILM Holding in turn would fail to pay the
Company mortgage payments due it. However, the Company believes that given the
nature of its business, such problem would be temporary and easily remediable
with a simple accounting.
MARKET RISK
The Company believes its market risk is immaterial.
II-7
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
RESULTS OF OPERATIONS
1999 COMPARED TO 1998
- ---------------------
Net income decreased $1,762,000, or 37.3%, to $2,961,000 for the fiscal
year ended August 31, 1999, compared to $4,723,000 for the fiscal year ended
August 31, 1998. Total revenue was $7,597,000 for fiscal year 1999, representing
an increase in revenue of $277,000, or 3.8%, compared to total revenue of
$7,320,000 for fiscal year 1998. Interest income decreased $26,000, or 26.5%, to
$72,000 for the year ended August 31, 1999, compared to $98,000 for the same
period last year, primarily due to a decrease in cash and cash equivalents
throughout most of fiscal year 1999. Rental and other income increased $303,000,
or 4.2%, to $7,525,000 from $7,222,000 last year, primarily due to increased
rental income earned pursuant to the terms of the Facilities Lease Agreement.
Total expenses increased $2,039,000, or 78.5%, to $4,636,000 for the fiscal year
ended August 31, 1999, compared to $2,597,000 for the fiscal year ended August
31, 1998. This increase in expenses was primarily attributable to an increase in
professional fees of $1,719,000, or 255.0%, 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 1 to the financial statements, and increased legal fees
associated with finalizing the construction loan facility. General and
administrative expenses increased $265,000 to $559,000, or 90.1%, for the fiscal
year ended August 31, 1999, compared to $294,000 for the same period last year,
due to a variety of factors including increased Director and Officer insurance
costs of $147,000; increased printing costs of $149,000 due to the potential
merger transaction with Capital Senior Living Corporation, offset by a $64,000
decrease in postage and mailing costs and minor increases and decreases in other
general and administrative costs. Directors' compensation decreased $29,000, or
25.0%, due to a decrease in the number of Board members.
1998 COMPARED TO 1997
- ---------------------
Net income increased $889,000, or 23.2%, to $4,723,000 for the fiscal
year ended August 31, 1998, compared to $3,834,000 for the fiscal year ended
August 31, 1997. Total revenue was $7,320,000 for fiscal year 1998, representing
an increase in revenue of $515,000, or 7.6%, compared to total revenue of
$6,805,000 for fiscal year 1997. Interest income decreased $64,000, or 39.5%, to
$98,000 for the twelve-months ended August 31, 1998, compared to $162,000 for
the same period last year, primarily due to a decrease in cash and cash
equivalents. Rental and other income increased $579,000, or 8.7%, to $7,222,000
from $6,643,000 last year, primarily due to increased rental income earned
pursuant to the terms of the Facilities Lease Agreement. Total expenses
decreased $374,000, or 12.6%, to $2,597,000 for the fiscal year ended August 31,
1998, compared to $2,971,000 for the fiscal year ended August 31, 1997. This
decrease in expenses was primarily attributable to a decrease in general and
administrative expenses of $572,000, or 66.1%, due in part, to reductions in
advisory fees, reimbursable costs and ILM Holding restructuring costs; offset by
an increase in professional fees of $229,000, or 51.5%, associated with
restructuring advice provided by the independent investment banking firm and
increased legal fees. Directors' compensation increased $34,000, or 41.5%, as a
result of more frequent Board of Directors meetings.
INFLATION
- ---------
The Company completed its tenth full year of operations in fiscal 1999.
The effects of inflation and changes in prices on the Company's operating
results to date have not been significant. Inflation in future periods is likely
to cause increases in the Company's expenses, which may be partially offset by
increases in revenues from the Company's investments in the Senior Housing
Facilities. Under the terms of the Facilities Lease Agreement, as discussed
further above, the Company, through its consolidated affiliate, ILM Holding,
earned additional rental income based on increases in the gross revenues of the
related operating properties beginning in January 1997. Such gross revenues may
tend to rise with inflation since the rental rates on the tenant leases, which
are short-term in nature, can be adjusted to keep pace with inflation as market
conditions allow.
II-8
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- -------------------------------------------------------------------------------
FORWARD-LOOKING INFORMATION
CERTAIN STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K ("ANNUAL
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 ANNUAL 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 ANNUAL 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The consolidated financial statements and supplementary data are
included under Item 14 of this annual report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- -----------------------------------------------------------------------
None.
II-9
<PAGE>
ILM SENIOR LIVING, INC.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
There are currently three Directors of the Company. The Directors are
subject to removal by the vote of the holders of a majority of the outstanding
shares. The Directors are responsible for the general policies of the Company,
but they are not required to personally conduct the business of the Company in
their capacities as Directors.
(a) and (b) the names and ages of the Directors and Executive Officers
of the Company during fiscal 1999 are as follows:
<TABLE>
<CAPTION>
NAME OFFICE AGE DATES OF OFFICE
<S> <C> <C> <C>
J. William Sharman, Jr President and Director 59 6/9/89 **-present
Jeffry R. Dwyer Secretary and Director 53 6/9/89*-present
Carl J. Schramm Director 53 12/5/96-present
</TABLE>
* The date of incorporation of the Company.
**The date of incorporation of the Company as Director; 7/28/98 as
President.
(c) There is no family relationship among any of the current
Directors or Officers. All of the current Directors and Officers of
the Company have been elected to serve until the Company's next annual
meeting.
(d) The business experience of each of the Directors and Executive
Officers of the Company is as follows:
J. WILLIAM SHARMAN, JR. has served as a Director of the Company since
its inception in 1989 and was appointed President, succeeding Mr. Cohen, on July
28, 1998. Mr. Sharman is the Chairman of the Board and CEO of Lancaster Hotels
and Resorts, Inc., a hotel management company, Mr. Sharman served for ten years
as Chairman of the Board and President of The Lancaster Group, Inc., a real
estate development firm based in Houston, Texas, which is the predecessor of
Lancaster Hotel Management, L.C. and Bayou Equities, Inc. Mr. Sharman serves as
a Director of Small Luxury Hotels, Ltd. of the United Kingdom, an international
hotel marketing and reservations firm, and also serves on the Board of Trustees
of St. Edwards University in Austin, Texas. Mr. Sharman also presently serves as
President and Director of ILM II and Director of Lease I and Lease II. He has a
Bachelor of Science degree from the University of Notre Dame.
JEFFRY R. DWYER has served as Secretary and a Director of the Company
since its inception in 1989. Mr. Dwyer has been a shareholder of the law firm of
Greenberg Traurig since June 1997. In May 1997, Greenberg Traurig began acting
as Counsel to the Company and its affiliates. From 1993 to 1997, Mr. Dwyer was a
partner with the law firm of Akin, Gump, Strauss, Hauer & Feld in the District
of Columbia. Prior to joining Akin, Gump, Strauss, Hauer & Feld, Mr. Dwyer was a
partner with the law firm of Morrison & Foerster from 1989 to 1993. Mr. Dwyer
also presently serves as Secretary and a Director of ILM II and President,
Secretary and a Director of Lease I and Lease II. Mr. Dwyer has written several
law review articles and a major treatise on real estate financing and has taught
Real Estate Planning as an Adjunct Professor at the Georgetown University Law
Center. Mr. Dwyer graduated from Georgetown University and received his law
degree from the Georgetown University Law Center.
III-1
<PAGE>
ILM SENIOR LIVING, INC.
PART III
--------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)
- ------------------------------------------------------------------------
CARL J. SCHRAMM was appointed to fill a newly created seat on the
Company's Board of Directors as of December 5, 1996. Mr. Schramm is President of
Greenspring Advisors, Inc., a consulting and investment advisory firm serving
clients in the managed care, health insurance and health information industries.
From 1993 to 1995, Mr. Schramm served as Executive Vice President of Fortis,
Inc., a diversified insurance and financial services company. From 1987 through
1992, Mr. Schramm was President of the Health Insurance Association of America,
the national trade association of commercial health underwriters. Mr. Schramm
currently serves on the boards of HCIA, Inc., the Rochdale Insurance Group,
Health Process Management and Post Acute Care, L.L.C. Mr. Schramm holds a Ph.D.
in Economics from the University of Wisconsin and received his J.D. from
Georgetown University. Mr. Schramm also presently serves as a Director of ILM
II.
(e) None of the current Directors and Officers were involved in legal
proceedings which are material to an evaluation of his or her ability
or integrity as a Director or Officer except for the Feldman litigation
as explained in Item 3.
(f) Compliance With Exchange Act Filing Requirements: The Securities
Exchange Act of 1934 requires the Officers and Directors of the
Company, and persons who own more than ten percent of the Company's
outstanding common stock, to file certain reports of ownership and
changes in ownership with the Securities and Exchange Commission.
Officers, Directors and ten-percent beneficial holders are required by
SEC regulations to furnish the Company with copies of all Section 16(a)
forms they file.
Based solely on its review of the copies of such forms received by it,
the Company believes that, during the year ended August 31, 1999, there was
compliance with all filing requirements applicable to its Officers and Directors
and ten-percent beneficial holders.
ITEM 11. EXECUTIVE COMPENSATION
- -------------------------------
The Company's Directors each receive an annual fee of $12,000 (except
for J. William Sharman, Jr., President and Director, who receives $27,000) plus
$500 for attending each Board of Directors meeting and reimbursement for
expenses incurred in attending meetings and as a result of other work performed
for the Company. Officers of the Company are not compensated. Jeffry R. Dwyer is
a shareholder of and receives compensation from Greenberg Traurig, which acts as
Counsel to the Company and its affiliates. The former Officers of the Company
who were also Officers of PaineWebber received compensation from PaineWebber
which indirectly related to services to the Company because the Company was
required to pay certain fees to PaineWebber as described in Item 13. When
PaineWebber resigned as advisor to the Companies the former Officers resigned
effective the same date, therefore, no services were provided by such persons
subsequent to June 18, 1997. Lawrence A. Cohen, who was President, Chief
Executive Officer and a Director of the Company until July 28, 1998, also
received compensation from Capital Senior Living Corporation, an affiliate of
Capital, a related party through July 28, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
(a) As of the date hereof, no person of record owns or is known by the
Company to own beneficially more than five percent of the outstanding
shares of common stock of the Company.
(b) The Directors and Officers of the Company do not have any direct or
indirect ownership of shares of the Company's common stock as of the
date hereof.
(c) There exists no arrangement, known to the Company, the operation of
which may at a subsequent date result in a change in control of the
Company.
III-2
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED 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, PaineWebber resigned effective as of June 18, 1997.
PaineWebber received fees and compensation determined on an agreed-upon
basis, in consideration of various services performed in connection with the
sale of the shares, the management of the Company and the acquisition,
management and disposition of the Company's investments. The type of
compensation to be paid by the Company to PaineWebber under the terms of the
advisory agreement was as follows.
(i) Under the former advisory agreement, PaineWebber had specific
management responsibilities; to perform day-to-day operations of the
Company and to act as the investment advisor and consultant for the
Company in connection with general policy and investment decisions.
PaineWebber received an annual base fee and an incentive fee of 0.25%
and 0.25%, respectively, of the capital contributions of the Company,
as defined, as compensation for such services. Incentive Fees are
subordinated to Shareholders' receipt of distributions of net cash
sufficient to provide a return equal to 10% per annum. For the years
ended August 31, 1999, 1998 and 1997, PaineWebber earned base
management fees totaling $0, $0 and $70,000, respectively. Payment of
incentive management fees was suspended effective April 15, 1993 in
conjunction with a reduction in the Company's quarterly dividend
payments.
(ii) For its services in finding and recommending investments, PaineWebber
received mortgage placement fees equal to 2% of the capital
contributions. Mortgage placement fees totaling $1,504,000 were earned
by PaineWebber during the Company's investment acquisition period. Such
fees have been capitalized and are included in the cost of the
operating investment properties on the accompanying consolidated
balance sheet.
(iii) For its administrative services with respect to all loans, PaineWebber
received loan servicing fees equal to 1% of capital contributions. Loan
servicing fees totaling $752,010 were earned by PaineWebber during the
Company's investment acquisition period. Such fees have been
capitalized and are included in the cost of the operating investment
properties on the accompanying consolidated balance sheet.
(iv) In connection with the construction of Senior Housing Facilities,
PaineWebber received a fee, paid directly by AHC, equal to 1% of the
principal amount of each construction loan for administering
construction loans made by the Company. Such fees received by
PaineWebber totaled $431,000 during the Company's investment
acquisition period.
(v) Under the former advisory agreement, PaineWebber was entitled to
receive 1% of disposition proceeds, as defined, until the shareholders
received dividends of net cash equal to their adjusted capital
investments, as defined, plus a 12% non-compounded annual return on
their adjusted capital investments; all disposition proceeds thereafter
until PaineWebber received an aggregate of 5% of disposition proceeds;
and, thereafter, 5% of disposition proceeds.
PaineWebber was reimbursed for their direct expenses relating to the
offering of shares, the administration of the Company and the acquisition and
operations of the Company's real estate investments. Included in general and
administrative expenses on the accompanying statements of income for the years
ended August 31, 1999, 1998 and 1997, is $0, $0 and $155,000, respectively,
representing reimbursements to PaineWebber for providing certain financial,
accounting and investor communication services to the Company.
Mitchell Hutchins Institutional Investors, Inc.
("Mitchell Hutchins") provided cash management services with respect to the
Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins
Asset Management, Inc., an independently operated subsidiary of PaineWebber.
During fiscal years 1999, 1998 and 1997,
III-3
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
- --------------------------------------------------------------------
Mitchell Hutchins earned $0, $0 and $9,000 (included in general and
administrative expenses) for managing the Company's cash assets, respectively.
The advisory relationship with PaineWebber ceased on June 18, 1997;
therefore the payment of advisory fees ceased as of that date. Other services,
such as accounting, compliance, investor communications and relations, and cash
management services ceased on August 31, 1997; therefore, the Company was not
obligated to pay service fees past August 31, 1997 to PaineWebber or Mitchell
Hutchins.
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 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 in various management capacities at Capital Senior
Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently
serves as Chief Executive Officer and Acting Chief Financial Officer of Capital
Senior Living Corporation. As a result, through July 28, 1998, Capital was
considered a related party. For the years ended August 31, 1999 and 1998,
Capital earned property management fees from Lease I of $1,011,000 and $919,000,
respectively.
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
$229,000 as of August 31, 1999. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should pay reasonable legal
fees and expenses incurred by Capital in the California litigation. As of August
31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees
totaled approximately $563,000.
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 years ended August 31, 1999 and
1998, Capital Senior Development, Inc. earned fees from the Company of $41,000
and $212,000, respectively, for managing pre-construction development activities
for potential expansions of the Senior Housing Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig
earned fees from the Company of $1,315,000 and $214,000, respectively.
III-4
<PAGE>
ILM SENIOR LIVING, INC.
PART IV
----------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- ------------------------------------------------------------------------
(a) The following documents are filed as part of this report:
(1) and (2) FINANCIAL STATEMENTS AND SCHEDULES:
The response to this portion of Item 14 is
submitted as a separate section of this report.
See Index to Financial Statements and Financial
Statement Schedules at page F-1.
(3) EXHIBITS:
The exhibits listed on the accompanying index to
exhibits at page IV-3 are filed as part of this
Report.
(b) The Company filed a Current Report on Form 8-K dated October
21, 1999 announcing that the Company had entered into an
amended and restated agreement and plan of merger with
Capital Senior Living Corporation.
The Company filed a Current Report on Form 8-K dated August
13, 1999 announcing that a Stipulation of Settlement was
reached in the Feldman litigation.
The Company filed a Current Report on Form 8-K dated February
7, 1999 reporting that the Company entered into an Agreement
and Plan of Merger with Capital Senior Living Corporation.
(c) Exhibits:
See (a) (3) above.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is submitted
as a separate section of this report. See Index to
Financial Statements and Financial Statement
Schedules at page F-1.
IV-1
<PAGE>
ILM SENIOR LIVING, INC.
SIGNATURES
------------
Pursuant to the requirements of Section 13 or 15(d) 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.
ILM SENIOR LIVING, INC.
By: /S/ J. William Sharman, Jr.
----------------------------
J. William Sharman, Jr.
President and Chief Executive
Officer
Dated: November 23, 1999
-----------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company in the
capacity and on the dates indicated.
<TABLE>
<S> <C>
By: /S/ J. WILLIAM SHARMAN Date: NOVEMBER 23, 1999
------------------------ -----------------
J. William Sharman, Jr.
Director
By: /S/ JEFFRY R. DWYER Date: NOVEMBER 23, 1999
------------------------- -----------------
Jeffry R. Dwyer
Director
By: /S/ CARL J. SCHRAMM Date: NOVEMBER 22, 1999
------------------------- -----------------
Carl J. Schramm
Director
</TABLE>
IV-2
<PAGE>
ILM SENIOR LIVING, INC.
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(3)
ILM SENIOR LIVING, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
PAGE NUMBER IN THE REPORT
EXHIBIT NO. DESCRIPTION OF DOCUMENT OR OTHER REFERENCE
- ------------------------------------- -------------------------------------- -----------------------------------
<S> <C> <C>
(3) and (4) Prospectus of the Registrant dated Filed with the Commission
June 9, 1989, as supplemented. pursuant to Rule 424(c) and
incorporated herein by reference.
(10) Material contracts previously filed Filed with the Commission
as exhibits to registration pursuant to Section 13 or 15(d)
statements and amendments thereto of of the Securities Exchange Act of
the registrant together with all 1934 and incorporated herein by
such contracts filed as exhibits of reference.
previously filed Forms 8-K and Forms
10-K are hereby incorporated herein
by reference.
Contracts regarding retention by ILM Filed as Exhibits 1 and 2 to
I Lease Corporation of Capital the Current Report on Form
Senior Management 2, Inc., as 8-K dated July 18, 1996 and
property manager. incorporated herein by
reference.
(13) Annual Reports to Stockholders No Annual Report for the year
ended August 31, 1999 has been
sent to the Stockholders. An
Annual Report will be sent to the
Stockholders subsequent to this
filing.
(27) Financial Data Schedule Filed as the last page of EDGAR
submission following the
Financial Statements and
Financial Statement Schedules
required by Item 14.
</TABLE>
IV-3
<PAGE>
ILM SENIOR LIVING, INC.
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1) AND (2) AND 14(d)
ILM SENIOR LIVING, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
REFERENCE
---------
ILM SENIOR LIVING, INC.:
<S> <C>
Report of Independent Auditors F-2
Consolidated Balance Sheets as of August 31, 1999 and 1998 F-3
Consolidated Statements of Income for the years ended August 31, 1999, 1998 and 1997 F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended August 31, 1999,
1998 and 1997 F-5
Consolidated Statements of Cash Flows for the years ended August 31, 1999, 1998 and 1997 F-6
Notes to Consolidated Financial Statements F-7
SCHEDULE:
Schedule III - Real Estate and Accumulated Depreciation F-21
</TABLE>
Other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements, including the notes thereto.
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Shareholders of
ILM Senior Living, Inc.:
We have audited the accompanying consolidated balance sheets of ILM Senior
Living, Inc. and subsidiary as of August 31, 1999 and 1998, and the related
consolidated statements of income, changes in shareholders' equity, and cash
flows for each of the three years in the period ended August 31, 1999. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion of these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ILM Senior Living, Inc. and subsidiary at August 31, 1999 and 1998, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended August 31, 1999, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Dallas, Texas
October 22, 1999,
except for Notes 5 and 1, as to which the date is
November 5 and 16, 1999, respectively
F-2
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
August 31, 1999 and 1998
(Dollars in thousands, except per share data)
ASSETS
--------
<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,921 $ 4,768
Building and improvements 38,197 38,166
Furniture, fixtures and equipment 4,948 4,948
-------- --------
48,066 47,882
Less: accumulated depreciation (13,417) (12,131)
-------- --------
34,649 35,751
Mortgage placement fees 2,256 2,256
Less: accumulated amortization (2,163) (1,937)
-------- --------
93 319
Loan origination fees 272 102
Less: accumulated amortization (85) --
-------- --------
187 102
Cash and cash equivalents 2,615 2,264
Accounts receivable - related party 306 336
Prepaid expenses and other assets 100 89
Deferred rent receivable 12 49
-------- --------
$ 37,962 $ 38,910
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses 365 259
Accounts payable - related party 343 67
Construction loan payable 2,093 --
Preferred shareholders' minority
interest in consolidated subsidiary
Total liabilities 134 125
-------- --------
2,935 451
Commitments and 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 (30,759) (27,327)
-------- --------
Total shareholders' equity $ 35,027 38,459
-------- --------
$ 37,962 38,910
-------- --------
-------- --------
</TABLE>
See accompanying notes.
F-3
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended August 31, 1999, 1998, and 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- -------
<S> <C> <C> <C>
REVENUES:
Rental and other income $7,525 $7,222 $6,643
Interest income 72 98 162
------ ------ ------
7,597 7,320 6,805
EXPENSES:
Depreciation expense 1,286 1,287 1,282
Amortization expense 311 226 226
Management fees - - 70
General and administrative 559 294 866
Professional fees 2,393 674 445
Directors' compensation 87 116 82
------ ------ ------
4,636 2,597 2,971
------ ------ ------
NET INCOME $2,961 $4,723 $3,834
------ ------ ------
------ ------ ------
Earnings per share of common stock $ 0.39 $ 0.63 $ 0.51
------ ------ ------
------ ------ ------
Cash dividends paid per share of common stock $ 0.85 $ 0.79 $ 0.74
------ ------ ------
------ ------ ------
</TABLE>
The above earnings and cash dividends paid per share of common stock are
based upon the 7,520,100 shares outstanding during the year.
See accompanying notes.
F-4
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended August 31, 1999, 1998 and 1997
(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, 1996 7,520,100 $ 75 $ 65,711 $ (24,418) $ 41,368
Cash dividends paid -- -- -- (5,544) (5,544)
Net income -- -- -- 3,834 3,834
--------- ----- --------- --------- ---------
SHAREHOLDERS' EQUITY AT
AUGUST 31, 1997 7,520,100 75 65,711 (26,128) 39,658
Cash dividends paid -- -- -- (5,922) (5,922)
Net income -- -- -- 4,723 4,723
--------- ----- --------- --------- ---------
SHAREHOLDERS' EQUITY AT
AUGUST 31, 1998 7,520,100 75 65,711 (27,327) 38,459
Cash dividends paid -- -- -- (6,393) (6,393)
Net income -- -- -- 2,961 2,961
--------- ----- --------- --------- ---------
SHAREHOLDERS' EQUITY AT
AUGUST 31, 1999 7,520,100 $ 75 $ 65,711 $ (30,759) $ 35,027
--------- ----- --------- --------- ---------
--------- ----- --------- --------- ---------
</TABLE>
See accompanying notes.
F-5
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended August 31, 1999, 1998, and 1997
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,961 $ 4,723 $ 3,834
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 1,597 1,513 1,508
Charitable contribution of subsidiary's
preferred stock and accrued dividends 9 9 116
Changes in assets and liabilities:
Interest and other receivables -- -- 397
Accounts receivable - related party 30 (220) 232
Prepaid expenses and other assets (11) 18 (97)
Deferred rent receivable 37 37 37
Accounts payable - related party 276 (93) 71
Accounts payable and accrued expenses 106 160 105
------- ------- -------
Net cash provided by operating
activities 5,005 6,147 6,203
------- ------- -------
Cash flows used in investing activities:
ILM Holding acquired cash balance -- -- 400
Additions to operating investment properties (184) (995) (533)
------- ------- -------
Net cash used in investing activities (184) (995) (133)
------- ------- -------
Cash flows used in financing activities:
Loan origination fees paid (170) (102) --
Proceeds from construction loan facility 2,093 -- --
Cash dividends paid to shareholders (6,393) (5,922) (5,544)
------- ------- -------
Net cash used in financing activities (4,470) (6,024) (5,544)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 351 (872) 526
Cash and cash equivalents, beginning of year 2,264 3,136 2,610
------- ------- -------
Cash and cash equivalents, end of year $ 2,615 $ 2,264 $ 3,136
------- ------- -------
------- ------- -------
Cash paid for state income taxes $ 42 $ 13 $ --
------- ------- -------
------- ------- -------
Cash paid for interest $ 20 $ -- $ --
------- ------- -------
------- ------- -------
</TABLE>
See accompanying notes.
F-6
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements
August 31, 1999
1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION
--------------------------------------------------------------
ILM Senior Living, Inc. (the "Company"), formerly PaineWebber
Independent Living Mortgage Fund, Inc., was organized as a corporation on
March 6, 1989 under the laws of the State of Virginia. On June 21, 1989,
the Company commenced a public offering of up to 10,000,000 shares of its
common stock at $10 per share, pursuant to the final prospectus, as
amended, incorporated into a Registration Statement filed on Form S-11
under the Securities Act of 1933 (Registration Statement No. 33-27653) (the
"Prospectus"). The public offering terminated on July 21, 1989 with a total
of 7,520,100 shares issued. The Company received capital contributions of
$75,201,000, of which $201,000 represented the sale of 20,100 shares to an
affiliate at that time, PaineWebber Group, Inc. ("PaineWebber"). For
discussion purposes, PaineWebber will refer to PaineWebber Group, Inc. and
all affiliates that provided services to the Company in the past.
The Company has elected to qualify and be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as
amended, for each taxable year of operations (see Note 2).
The Company originally invested the net proceeds of the initial public
offering in eight participating mortgage loans secured by senior housing
facilities ("Senior Housing Facilities") located in seven states. 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").
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 toward 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 Senior Housing Facilities would be
transferred from AHC to the Company or its designated affiliates. Under the
terms of the Settlement Agreement, the Company would release AHC and
Angeles from certain obligations under the loans. On April 27, 1994, each
of the Senior Housing Facilities owned by AHC and securing the loans was
transferred (collectively, "the Transfers") to newly-created special
purpose corporations affiliated with the Company (collectively, "the
Property Companies"). The Transfers had an effective date of April 1, 1994
and were made pursuant to the Settlement Agreement entered into on February
17, 1994 ("the Settlement Agreement") between the Company and AHC which had
previously been approved by the bankruptcy court handling the bankruptcy
case of Angeles. All of the capital stock of each Property Company was held
by ILM Holding, Inc. ("ILM Holding"), a Virginia corporation. In August
1995, each of the Property Companies merged into ILM Holding, which is now
a subsidiary of 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 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 capital stock of ILM Holding was originally owned by the
Company and PaineWebber. ILM Holding had issued 100 shares of Series A
Preferred Stock to the Company in return for a capital contribution in the
amount of $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.
F-7
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED)
---------------------------------------------------------------------------
The Company completed its restructuring plans by converting ILM Holding
to a REIT for tax purposes effective for calendar year 1996. 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, representing a $39,000 increase in fair value. This
increase in fair value is based on the increase in values of the Senior
Housing Facilities which occurred between April 1994 and January 1996, as
supported by independent appraisals.
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 "Preferred Stock"). 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. The Company recorded the contribution of the Preferred
Stock in ILM Holding to the charitable organizations at the amount of the
initial liquidation preference of $111,000. Such amount is included in
general and administrative expense in the accompanying consolidated
statement of income for the year ended August 31, 1997. Cumulative
dividends accrued as of August 31, 1999 and 1998, on the Preferred Stock in
ILM Holding totaled $23,000 and $14,000, respectively.
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. As discussed
further in Note 5, 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 Senior Housing Facilities 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 (see Note 2). As discussed further in Note 4, on September 12,
1994, the Company formed a new subsidiary, ILM I Lease Corporation ("Lease
I"), for the purpose of operating the Senior Housing Facilities. On
September 1, 1995, after the Company received the required regulatory
approval, the Company distributed all of the shares of capital stock of
Lease I to the holders of record of the Company's common stock. The Senior
Housing Facilities were leased to Lease I effective September 1, 1995 (see
Note 4 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.
On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital
Senior Living Corporation, the corporate parent of Capital, and certain
affiliates of Capital. If the merger is consummated, the Shareholders of
the Company will receive all-cash merger consideration of approximately
$12.90 per share. Consummation of this transaction will require, among
other things, the affirmative vote of the holders of not less than 66-2/3%
of the Company's outstanding common stock. While there can be no assurance,
consummation of the merger is presently anticipated in the
F-8
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED)
--------------------------------------------------------------------------
first quarter of calendar year 2000. 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. The Facilities Lease Agreement was extended on a
month-to-month basis on November 16, 1999 beyond its original expiration
date of December 31, 1999. There can be no assurance as to whether the
merger will be consummated or, if consummated, as to the timing thereof.
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
---------------------------------------------------------------
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with generally accepted accounting
principles which requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of August 31, 1999 and 1998 and
revenues and expenses for each of the three years in the period ended
August 31, 1999. Actual results could differ from the estimates and
assumptions used.
The Company's significant accounting policies are summarized as follows:
A. BASIS OF PRESENTATION
The operating cycle in the real estate industry is longer than one year and
the distinction between current and non-current is of little relevance.
Accordingly, the accompanying consolidated balance sheets are presented in
an unclassified format.
Effective January 10, 1997, the Company purchased the remaining common
shares held by PaineWebber of ILM Holding, which provided the Company with
100% majority voting control, for $46,000 which is included in general and
administrative expense for the year ended August 31, 1997.
The accompanying consolidated financial statements include the financial
statements of the Company and ILM Holding. The results of operations of ILM
Holding have been included in the consolidated results of operations of the
Company since September 1, 1996. All intercompany balances and transactions
have been eliminated in consolidation.
B. INCOME TAXES
The Company has elected to qualify and to be taxed as a REIT under the
Internal Revenue Code of 1986, as amended, for each taxable year of
operations. As a REIT, the Company is allowed a deduction for the amount of
dividends paid to its shareholders, thereby effectively subjecting the
distributed net taxable income of the Company to taxation at the
shareholder level only, provided it distributes at least 95% of its taxable
income and meets certain other requirements for qualifying as a real estate
investment trust. In connection with the Settlement Agreement described in
Note 1, the Company, through ILM Holding, obtained title to the Senior
Housing Facilities securing its mortgage loan investments. To retain REIT
status, the Company must ensure that 75% of its annual gross income is
received from qualified sources. Under the original investment structure,
interest income from the Company's mortgage loans was a qualified source.
The Senior Housing Facilities that are now owned by a subsidiary of the
Company provide residents with more services, such as meals, activities,
assisted living, etc., than are customary for ordinary residential
apartment properties. As a result, a significant portion of the rents paid
by the residents includes income for the increased level of services
received by them. Consequently, the rents paid by the residents likely
would not be qualified rents for REIT qualification
F-9
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
--------------------------------------------------------------------------
purposes if received directly by the Company. Therefore, if the Company
received such rents directly, it could lose REIT status and be taxed as a
regular corporation. After extensive review, the Board of Directors
determined that it would be in the best interests of the Shareholders for
the Company to retain REIT status and master lease the Senior Housing
Facilities to a shareholder-owned operating company. As discussed further
in Note 4, on September 12, 1994 the Company formed a new subsidiary, Lease
I, for the purpose of operating the Senior Housing Facilities. The Senior
Housing Facilities were leased to Lease I effective September 1, 1995 (see
Note 4 for a description of the Facilities Lease Agreement).
The assumption of ownership of the Senior Housing Facilities 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 Senior Housing Facilities (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 Senior Housing Facilities were held by a C
corporation. The Company completed its restructuring plans by converting
ILM Holding to a REIT for tax purposes effective for calendar year 1996.
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 Senior Housing Facilities were to be held for a period of
at least 10 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 one year, the Senior Housing Facilities might not be held for an
additional 10 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. Because the Directors believe that disposition of the Company's
assets by December 31, 1999, would result in such under-realization, and
because the merger with Capital Senior Living Corporation is presently
anticipated to occur in the first quarter of calendar year 2000, on
November 16, 1999, the Company's Board of Directors voted to extend the
term of the Company on a month-to-month basis. If the merger does not
occur, the Company's Board of Directors presently expects to extend the
term of the Company until December 31, 2001. On November 16, 1999, the
Company's Board of Directors also voted to cause ILM Holding to extend the
Facilities Lease Agreement with Lease I on a month-to-month basis. Based on
management's estimate of the increase in the values of the Senior Housing
Facilities which occurred between April 1994 and January 1, 1996, as
supported by independent appraisals, a sale of the Senior Housing
Facilities 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,
which could be reduced by approximately $2.45 million using available net
operating loss carryforwards of ILM Holding of approximately $7.2 million.
The Company's consolidated subsidiary, ILM Holding, has incurred losses for
tax purposes since inception. Neither the Company nor ILM Holding is likely
to be able to use these losses to offset future tax liabilities, other than
the built-in gain above. Accordingly, no income tax benefit is reflected in
these consolidated financial statements.
The Company reports on a calendar year basis for income tax purposes. All
distributions during calendar years 1999, 1998 and 1997 were ordinary
taxable dividends.
C. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include all
highly liquid investments with original maturities of 90 days or less.
F-10
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
--------------------------------------------------------------------------
D. OPERATING INVESTMENT PROPERTIES
Operating investment properties are carried at the lower of cost, reduced
by accumulated depreciation, or net realizable value. The net realizable
value of a property held for long-term investment purposes is measured by
the recoverability of the owner's investment through expected future cash
flows on an undiscounted basis, which may exceed the property's current
market value. The net realizable value of a property held for sale
approximates its current market value, as determined on a discounted basis.
None of the operating investment properties were held for sale as of August
31, 1999 or 1998. Depreciation expense is provided on a straight-line basis
using an estimated useful life of 5 to 40 years for the buildings and
improvements and 5 years for the furniture, fixtures and equipment.
The Company reviews the carrying value of a long-lived asset if facts and
circumstances suggest that it may be impaired or that the amortization
period may need to be changed. The Company considers external factors
relating to the long-lived asset, including occupancy trends, local market
developments, changes in payments, and other publicly available
information. If these external factors indicate the long-lived asset will
not be recoverable, based upon undiscounted cash flows of the long-lived
asset over its remaining life, the carrying value of the long-lived asset
will be reduced by the estimated shortfall of discounted cash flows. The
Company does not believe there are any indicators that would require an
adjustment to the carrying value of its long-lived assets or their
remaining useful lives as of August 31, 1999.
Mortgage placement fees through August 31, 1999 of $2,256,000 were incurred
by the Company and these fees are included in the accompanying balance
sheets. Accumulated amortization of mortgage fees at August 31, 1999 and
1998, were $2,163,000 and $1,937,000, respectively. At August 31, 1999 and
1998, loan origination fees of $272,000 and $102,000 relating to the
construction loan facility (see Note 6) are included on the accompanying
consolidated balance sheet. These fees are being amortized on a
straight-line basis over the term of the loan. Accumulated amortization at
August 31, 1999 and 1998 was $85,000 and $0, respectively. Capitalized
interest for 1999 and 1998 was $31,000 and $0, respectively.
E. RENTAL REVENUES
In fiscal years 1999 and 1998, rental revenues consist of payments due from
Lease I under the terms of the Facilities Lease Agreement described in Note
4. Base rental income under the Facilities Lease Agreement is recognized on
a straight-line basis over the term of the lease. Deferred rent receivable
on the balance sheet as of August 31, 1999 and 1998 represents the
difference between rental income on a straight-line basis and rental income
received under the terms of the Facilities Lease Agreement.
F. FAIR VALUE DISCLOSURES
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("SFAS 107"), requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance
sheet, for which it is practicable to estimate that value. In cases where
quoted market prices are not available, fair values are based on estimates
using present value or other valuation techniques. SFAS 107 excludes
certain financial instruments and all non-financial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
F-11
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
--------------------------------------------------------------------------
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amount reported on the balance
sheet for cash and cash equivalents approximates its fair value due to the
short-term maturities of such instruments.
ACCOUNTS RECEIVABLE - RELATED PARTY: The carrying amount reported on the
balance sheet for accounts receivable - related party approximates its fair
value due to the short-term nature of such instrument.
F-12
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements
August 31, 1999
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. PaineWebber resigned effective as of June 18, 1997.
PaineWebber received fees and compensation determined on a agreed-upon
basis, in consideration of various services performed in connection with
the sale of the shares, the management of the Company and the acquisition,
management and disposition of the Company's investments. The type of
compensation to be paid by the Company to PaineWebber under the terms of
the advisory agreement was as follows.
(i) Under the former advisory agreement, PaineWebber had specific
management responsibilities; to perform day-to-day operations of the
Company and to act as the investment advisor and consultant for the
Company in connection with general policy and investment decisions.
PaineWebber received an annual base fee and an incentive fee of 0.25%
and 0.25%, respectively, of the capital contributions of the Company,
as defined, as compensation for such services. Incentive fees are
subordinated to Shareholders' receipt of distributions of net cash
sufficient to provide a return equal to 10% per annum. For the years
ended August 31, 1999, 1998 and 1997, PaineWebber earned base
management fees totaling $0, $0 and $70,000, respectively. Payment of
incentive management fees was suspended effective April 15, 1993 in
conjunction with a reduction in the Company's quarterly dividend
payments.
(ii) For its services in finding and recommending investments, PaineWebber
received mortgage placement fees equal to 2% of the capital
contributions. Mortgage placement fees totaling $1,504,000 were earned
by PaineWebber during the Company's investment acquisition period. Such
fees have been capitalized and are included in the cost of the
operating investment properties on the accompanying consolidated
balance sheets.
(iii) For its administrative services with respect to all loans, PaineWebber
received loan servicing fees equal to 1% of loan amounts. Loan
servicing fees totaling $752,000 were earned by PaineWebber during the
Company's investment acquisition period. Such fees have been
capitalized and are included in the cost of the operating investment
properties on the accompanying consolidated balance sheets.
(iv) PaineWebber was entitled to receive 1% of disposition proceeds, as
defined, until the shareholders have received dividends of net cash
equal to their adjusted capital investments, as defined, plus a 12%
non-compounded annual return on their adjusted capital investments; all
disposition proceeds thereafter until PaineWebber received an aggregate
of 5% of disposition proceeds; and, thereafter, 5% of disposition
proceeds.
PaineWebber was reimbursed for its direct expenses relating to the
offering of shares, the administration of the Company and the acquisition
and operations of the Company's real estate investments. Included in
general and administrative expenses on the accompanying statements of
income for the years ended August 31, 1999, 1998 and 1997 is $0, $0 and
$155,000, respectively, representing reimbursements to PaineWebber for
providing certain financial, accounting and investor communication services
to the Company.
Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins")
provided cash management services with respect to the Company's cash
assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset
Management, Inc., an independently operated subsidiary of PaineWebber.
During fiscal 1999, 1998 and 1997, Mitchell Hutchins earned $0, $0 and
$9,000, (included in general and administrative expenses) for managing the
Company's cash assets, respectively.
F-13
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
3. RELATED PARTY TRANSACTIONS (CONTINUED)
--------------------------------------
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 a 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 in various management capacities at
Capital Senior Living Corporation since 1996. Mr. Cohen currently serves as
Chief Executive Officer of Capital Senior Living Corporation. As a result,
through July 28, 1998, Capital was considered a related party. For the
years ended August 31, 1999 and 1998, Capital earned property management
fees from Lease I of $1,011,000 and $919,000, respectively.
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 $229,000 as of August
31, 1999. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should pay reasonable legal fees
and expenses incurred by Capital in the California litigation. As of August
31, 1999, the amount advanced to Capital by Lease I and Lease II for legal
fees totaled approximately $563,000.
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 years ended August 31, 1999 and 1998, Capital Senior Development, Inc.
earned fees from the Company of $41,000 and $212,000, respectively, for
managing pre-construction development activities for potential expansions
of the Senior Housing Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig
earned fees from the Company of $1,315,000 and $214,000, respectively.
Accounts receivable - related party at August 31, 1999 and 1998
represent amounts due from an affiliated company, Lease I, for variable
rent. Accounts payable - related party at August 31, 1999 and 1998
represent unbilled legal fees due to Greenberg Traurig, Counsel to the
Company and its affiliates and a related party, as described above.
F-14
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE AGREEMENT
---------------------------------------------------------------------
At August 31, 1999, through its consolidated subsidiary, the Company
owned eight Senior Housing Facilities. The name, location and size of the
Senior Housing Facilities and the date that the Company made its initial
investment in such assets are as set forth below:
<TABLE>
<CAPTION>
Year
Rentable Resident Facility Date of
NAME LOCATION UNITS (3) CAPACITIES(3) BUILT INVESTMENT(1)
- ---- -------- --------- ------------- ----- -------------
<S> <C> <C> <C> <C> <C>
Independence Village of East Lansing, MI 161 162 1989 6/29/89
East Lansing
Independence Village of Winston-Salem, NC 159 161 1989 6/29/89
Winston-Salem
Independence Village of Raleigh, NC 164 205 1991 4/29/91
Raleigh
Independence Village of Peoria, IL 165 181 1990 11/30/90
Peoria
Crown Pointe Apartments Omaha, NE 135 163 1984 2/14/90
Sedgwick Plaza Apartments Wichita, KS 150 170 1984 2/14/90
West Shores Hot Springs, AR 136 166 1986 12/14/90
Villa Santa Barbara (2) Santa Barbara, CA 125 125 1979 7/13/92
</TABLE>
(1) Represents the date of the Company's original mortgage loan to Angeles
Housing Concepts , Inc. (see Note 1).
(2) The acquisition of the Santa Barbara Facility 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. The financial position,
results of operations and cash flows include only the 25% allocable portion
of the Company's interest in the Santa Barbara Facility. Villa Santa Barbara
is owned 25% by ILM Holding and 75% by ILM II Holding, Inc. as tenants in
common.
(3) Rentable units represent the number of apartment units and is a measure
commonly used in the real estate industry. Resident capacity equals the
number of bedrooms contained within the apartment units and corresponds to
measures commonly used in the healthcare industry.
The cost basis of the operating investment properties reflects amounts
funded under the Company's participating mortgage loans less certain
guaranty payments received from AHC in excess of the net cash flow of the
Senior Housing Facilities under the terms of the Exclusivity Agreement with
the Company. The transfer of ownership of the Senior Housing Facilities
from AHC in fiscal 1994 resulted in no gain or loss recognition by the
Company for financial reporting purposes. In accordance with generally
accepted accounting principles, the Company had always accounted for its
investments in acquisition and construction loans under the equity method,
as if such investments were equity interests in a joint venture.
Accordingly, the carrying values of such investments were reduced from
inception by non-cash depreciation charges and by payments from AHC, prior
to the default in fiscal 1993, in excess of the net cash flow generated by
the Senior Housing Facilities received
F-15
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE AGREEMENT
(CONTINUED)
---------------------------------------------------------------------
pursuant to the guaranty agreement between the Company and AHC. As a result
of this accounting treatment, the carrying values of the Company's
investment had been reduced below management's estimate of the fair market
value of the Senior Housing Facilities as of the effective date of the
transfer of ownership. For federal income tax purposes, the investments had
always been carried at the contractually stated principal balances of the
participating mortgage loans. For tax purposes only, a loss was recognized
by the Company in 1994 in the amount by which the stated principal balances
of the loans were reduced as of the date of the transfer of ownership.
As discussed in Note 1, effective April 1, 1994 each Property Company
acquired the respective operating property subject to, and assumed the
obligations under, the mortgage loan payable to the Company, pursuant to
the Settlement Agreement with AHC. The principal balance on each loan was
modified to reflect the estimated fair value of the related operating
property as of the date of the transfer of ownership. The modified loans
require interest-only payments on a monthly basis at a rate of 9.5% from
April 1, 1994 through December 1, 1994, 11% for the period January 1
through December 31, 1995, 12.5% for the period January 1 through December
31, 1996, 13.5% for the period January 1 through December 31, 1997, 14% for
the period January 1 through December 31, 1998 and 14.5% for the period
January 1, 1999 through maturity. In August 1995, each of the Property
Companies was merged into ILM Holding. As a result, ownership of the Senior
Housing Facilities, as well as the obligation under the loans, is now held
by ILM Holding, and the Property Companies no longer exist as separate
legal entities. Since ILM Holding is consolidated with the Company in the
accompanying financial statements for fiscal 1999 and 1998, the mortgage
loans and related interest expense have been eliminated in consolidation.
Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the existing shareholders
while maintaining the Company's qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease I, for the
purpose of operating the Senior Housing Facilities under the terms of a
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, after the
Company received the required regulatory approval, it distributed all of
the shares of capital stock of Lease I to the holders of record of the
Company's common stock. One share of common stock of Lease I was issued for
each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease I with $700,000 from its
existing cash reserves, which was an amount estimated to provide Lease I
with necessary working capital.
The Facilities Lease Agreement is between the Company's consolidated
subsidiary, ILM Holding, as owner of the Senior Housing Facilities and
Lessor, and Lease I as Lessee. The Lessor has the right to terminate the
Facilities Lease Agreement as to any property sold by the Lessor as of the
date of such sale. The Facilities Lease Agreement 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 Facilities Lease Agreement, which was extended in November 1999
beyond its original expiration date of December 31, 1999, Lease I pays
annual base rent for the use of all of the Facilities in the aggregate
amount of $6,364,800. 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 rental income related to
fiscal years 1999 and 1998 was $1,164,000 and $894,000, respectively.
F-16
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE AGREEMENT
(CONTINUED)
----------------------------------------------------------------------
Condensed balance sheets as of August 31, 1999 and 1998, and condensed
statements of operations for the years ended August 31, 1999 and 1998 (in
thousands), of Lease I are as follows:
<TABLE>
<CAPTION>
ASSETS 1999 1998
---------- -----------
<S> <C> <C>
Current assets $ 1,447 $ 2,225
Furniture, fixtures, and equipment, net 356 609
Other assets 92 364
-------- --------
$ 1,895 $ 3,198
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 1,370 $ 2,756
Other liabilities 12 49
Shareholders' equity 513 393
-------- --------
$ 1,895 $ 3,198
-------- --------
-------- --------
STATEMENT OF OPERATIONS
Revenues $ 19,923 $ 19,294
Operating expenses 19,530 19,729
Income tax expense (benefit) (273) (54)
-------- --------
Net income (loss) $ 120 $ (381)
-------- --------
-------- --------
</TABLE>
5. 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 Companies. 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 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 management 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 that the management agreement
could have been terminated without cause, and recovery of attorney's fees
and expenses.
F-17
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
-----------------------------------------------
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 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 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 $229,000 as of August
31, 1999. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should pay reasonable legal fees
and expenses incurred by Capital in the California litigation. As of August
31, 1999, the amount advanced to Capital by Lease I and Lease II for legal
fees totaled approximately $563,000.
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. 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.
F-18
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
-----------------------------------------------
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 naming the Company, ILM II and their Directors
as defendants. The class action complaint alleged 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. The complaint sought compensatory
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 and its co-defendants moved to dismiss the
complaint on all counts.
On December 8, 1998, the Court granted the Company's dismissal
motion in part but afforded the plaintiffs leave to amend their complaint.
In doing so, the Court accepted the Company's position that all claims
relating to the derivative actions were filed improperly. In addition, the
Court dismissed common law claims for punitive damages, but allowed
plaintiffs to amend their claims to assert claims alleging that the
defendants 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 the summer of 1999.
On March 9, 1999, the Feldman plaintiffs filed a second amended
complaint, which included claims for injunctive relief and, in the
alternative, damages in an unspecified amount. In response to the Company's
motion to dismiss the second amended complaint, on June 7, 1999 the Court
issued an order dismissing the plaintiffs' federal security claims but
denying the motion to dismiss plaintiffs' claims for breach of fiduciary
duty and judicial dissolution, which motion was addressed to the pleadings
and not to the merits of the action.
On June 21, 1999, the Company and its co-defendants answered the
second amended complaint and denied any and all liability and moved for
reconsideration of the portion of the Court's June 7, 1999 order denying
their motion to dismiss. In response to discovery requests, the Company,
ILM II and others produced documents to the plaintiffs and depositions of
current and former directors and others were taken. Discovery was completed
as of July 1, 1999.
On July 2, 1999, the parties to this action came to an
agreement-in-principle to settle the action. On August 3, 1999, the parties
entered into a Stipulation of Settlement and on August 11, 1999, the Court
signed an order preliminarily approving the Stipulation and providing for
notice of the Stipulation to the proposed settlement class.
On September 30, 1999, the Court conducted a hearing and on
October 4, 1999 issued an order certifying a settlement class and approving
the proposed settlement as fair, reasonable and adequate, subject to the
condition that certain modifications be made to the Stipulation of
Settlement and any related documents filed with the Court on or before
October 15, 1999.
F-19
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
August 31, 1999
5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
-----------------------------------------------
.
On October 15, 1999, the parties entered into a revised Stipulation of
Settlement and filed it with the Court, which approved the settlement, by
order dated October 21, 1999. In issuing that order the Court entered a
final judgment dismissing the action and all non-derivative claims of the
settlement class against the defendants with prejudice. In its October 4th
order, the Court also denied the application by plaintiffs' counsel for
payment of attorneys' fees and expenses, without prejudice to renewal
within 14 days upon reapplication therefor. On or about October 14, 1999,
plaintiffs' counsel reapplied to the Court for fees and expenses. A hearing
was held November 5, 1999, in which the Court granted the application for
attorney's fees in the amount of $950,000 and costs in the amount of
$182,000. Under the Stipulation, if the proposed merger is consummated,
Capital Senior Living Corporation is responsible for payment of such
attorney's fees and expenses sought under this application, and if the
proposed merger is not consummated and if the Company and ILM II enter into
a transaction having similar effect to the merger with a third party, then
the company and ILM II are responsible for such fees and expenses.
6. CONSTRUCTION LOAN FINANCING
During 1999, the Company secured a construction loan facility with a
major bank that provides the Company with up to $24.5 million to fund the
capital costs of the potential expansion programs. The construction loan
facility is secured by a first mortgage of the Senior Housing Facilities
and collateral assignment of the Company's leases of such properties. The
loan expires December 31, 2000, with possible extensions through September
29, 2003. Principal is due at expiration. Interest is payable monthly at a
rate equal to LIBOR plus 1.10% or Prime plus 0.5%. Amounts outstanding
under the loan at August 31, 1999, were approximately $2.1 million. Loan
origination fees of $272,000 were paid in connection with this loan
facility and are being amortized over the term of the loan.
7. SUBSEQUENT EVENT
On September 15, 1999, the Company's Board of Directors declared a
quarterly dividend for the quarter ended August 31, 1999. On October 15,
1999, a dividend of $0.2125 per share of common stock, totaling $1,598,000,
was paid to the Shareholders of record as of September 30, 1999.
F-20
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements
August 31, 1999
Schedule III - Real Estate and Accumulated Depreciation
ILM SENIOR LIVING, INC.
CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
August 31, 1999
(Amounts in thousands)
<TABLE>
<CAPTION>
Initial Cost to Gross Amount at Which Carried
ILM (2) At End of Year
--------------- Cost -----------------------------
Capitalized
(Removed
Subsequent to)
Acquisition of
Buildings & Buildings & Buildings & Unamortized
DESCRIPTION ENCUMBRANCES LAND IMPROVEMENTS IMPROVEMENTS (3) LAND IMPROVEMENTS MORTGAGE FEES (5) TOTAL
- ----------- ------------- ---- ------------ ---------------- ---- ------------- ----------------- -----
(1) (5)
--- ---
CONGREGATE CARE FACILITIES:
<S> <C> <C> <C> <C> <C> <C> <C> <C>
East Lansing,
Michigan $ 8,950 $ 422 $ 9,251 $ (2,881) $ 558 $ 6,138 $ 345 $ 7,041
Winston-Salem,
North Carolina 5,750 520 8,883 (3,881) 337 4,855 336 5,528
Raleigh,
North Carolina 8,350 1,021 10,992 (3,414) 1,378 7,455 429 9,262
Peoria,
Illinois 8,350 524 10,867 (2,831) 492 7,736 408 8,636
Omaha,
Nebraska 8,200 430 8,092 521 1,029 8,315 305 9,649
Wichita,
Kansas 8,350 388 5,381 174 367 5,379 207 5,953
Hot Springs,
Arkansas 5,350 290 3,187 (736) 361 2,339 125 2,825
Santa Barbara,
California 1,698 387 1,086 (63) 399 928 101 1,428
- ---------------------- -------- -------- -------- -------- -------- -------- -------- -------
$ 54,998 $ 3,982 $ 57,739 $(13,111) $4,921 $ 43,145 $ 2,256 $50,322
-------- -------- -------- -------- -------- -------- -------- -------
-------- -------- -------- -------- -------- -------- -------- -------
</TABLE>
<TABLE>
<CAPTION>
Life on
Which
Depreciation
in Latest
Income
Statement
IS COMPUTED
Accumulated Accumulated Date of Date ---------------
DESCRIPTION DEPRECIATION (5) AMORTIZATION (5) CONSTRUCTION ACQUIRED
- ----------- ------------------ -------------- ------------ --------
<S> <C> <C> <C> <C> <C>
CONGREGATE CARE FACILITIES:
East Lansing,
Michigan $(2,042) $(350) 1989 6/29/89 5-40 yrs.
Winston-Salem,
North Carolina (1,938) (339) 1989 6/29/89 5-40 yrs.
Raleigh,
North Carolina (2,210) (412) 1991 4/29/91 5-40 yrs.
Peoria,
Illinois (2,173) (389) 1990 11/30/90 5-40 yrs.
Omaha,
Nebraska (2,136) (292) 1985 2/14/90 5-40 yrs.
Wichita,
Kansas (1,716) (198) 1985 2/14/90 5-40 yrs.
Hot Springs,
Arkansas (781) (111) 1987 12/14/90 5-40 yrs.
Santa Barbara,
California (421) (72) 1979 7/13/92 5-40 yrs.
- ------------------ -------- --------
$(13,417) $(2,163)
-------- --------
-------- --------
</TABLE>
(1) Encumbrances represent first mortgage loans between ILM Holding as
mortgagor and the Company as mortgagee. Such loans are eliminated in
consolidation in the accompanying Consolidated Financial Statements
(see Note 4).
(2) Initial cost to the Company represents the aggregate advances made by
the Company on the loans secured by the Facilities which were made to
AHC prior to the default and foreclosure actions described in Notes 1
and 4 to the Consolidated Financial Statements and costs incurred
relating to capitalized interest.
(3) Costs removed subsequent to acquisition reflect the guaranty payments
received by the Company from AHC under the terms on the Exclusivity
Agreement as discussed further in Notes 1 and 4 to the Consolidated
Financial Statements.
(4) The aggregate cost of real estate owned at August 31, 1999 for Federal
income tax purposes is approximately $57,621,000.
(5) Certain numbers have been reclassified to conform to the current year's
presentation.
F-21
<PAGE>
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
ILM SENIOR LIVING, INC. AND SUBSIDIARY
CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION (continued)
August 31, 1999
(Amounts in thousands)
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
(5) Reconciliation of real estate owned:
Balance at beginning of period $50,138 $49,143 $48,610
Acquisitions and improvements - year ended 8/31/99 184 -- --
Acquisitions and improvements - year ended 8/31/98 -- 995 --
Acquisitions and improvements - year ended 8/31/97 -- -- 533
------- ------- -------
Balance at end of period $50,322 $50,138 $49,143
------- ------- -------
------- ------- -------
(6) Reconciliation of accumulated depreciation and amortization:
Balance at beginning of period $14,069 $12,556 $11,048
Depreciation and amortization expense - year ended 8/31/99 1,511
Depreciation and amortization expense - year ended 8/31/98 -- 1,513 --
Depreciation and amortization expense - year ended 8/31/97 -- -- 1,508
------- ------- -------
Balance at end of period $15,580 $14,069 $12,556
------- ------- -------
------- ------- -------
</TABLE>
F-22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF AUGUST 31, 1999, AND THE CONSOLIDATED
STATEMENT OF INCOME FOR THE YEAR ENDED AUGUST 31, 1999.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1999
<PERIOD-END> AUG-31-1999
<CASH> 2,615
<SECURITIES> 0
<RECEIVABLES> 428
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 3,033
<PP&E> 48,035
<DEPRECIATION> 13,417
<TOTAL-ASSETS> 37,931
<CURRENT-LIABILITIES> 708
<BONDS> 0
0
134
<COMMON> 75
<OTHER-SE> 34,921
<TOTAL-LIABILITY-AND-EQUITY> 37,931
<SALES> 7,525
<TOTAL-REVENUES> 7,597
<CGS> 0
<TOTAL-COSTS> 4,636
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 31
<INCOME-PRETAX> 2,930
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,930
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,930
<EPS-BASIC> .38
<EPS-DILUTED> .38
</TABLE>
