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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED: AUGUST 31, 1998
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from _____ to _____.
Commission File Number: 0-18249
ILM SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA 04-3042283
- ----------------------- --------------------
(State of organization) (I.R.S. Employer
Identification No.)
8180 Greensboro Drive, Suite 850, McLean, Virginia 22102
- --------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 888-257-3550
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- -------------------------- -------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
SHARES OF COMMON STOCK $.01 PAR VALUE
(Title of class)
Indicate by check mark 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/A. 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 .
--- ---
Shares of common stock outstanding as of August 31, 1998: 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/A REFERENCE
- ------------------------------------- -----------------------
Prospectus of registrant dated Part II, Part IV
June 9, 1989, as supplemented
[33 Act filing #33-27653]
Current Report on Form 8-K Part IV
of registrant dated August 21, 1998
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<PAGE>
ILM SENIOR LIVING, INC.
1998 FORM 10-K/A
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I PAGE
<S> <C> <C> <C>
Item 1 Business............................................................................I-1
Item 2 Properties..........................................................................I-6
Item 3 Legal Proceedings...................................................................I-7
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-3
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-F35
</TABLE>
<PAGE>
ILM SENIOR LIVING, INC.
PART I
ITEM 1. BUSINESS
ILM Senior Living, Inc. (the "Company") is a finite-life corporation
organized on March 6, 1989 in the Commonwealth of Virginia 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 commenced a public offering of up to 10,000,000 shares of
common stock 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"). On July 21, 1989, the
public offering terminated. The Company issued 7,520,100 shares, representing
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 located in seven different states ("Senior Housing Facilities"). All
of the loans made by the Company were originally to Angeles Housing Concepts,
Inc. ("AHC"), a company specializing in the development, acquisition and
operation of Senior Housing Facilities.
The Company entered into an exclusivity agreement (as amended) with AHC
and its parent company, Angeles Corporation ("Angeles"), which required AHC to
provide the Company with certain specific opportunities to finance Senior
Housing Facilities and set forth the terms and conditions of the loans which
were made. The loan documents under the aforementioned exclusivity agreement
called for interest to be paid on construction loans at the rate of 13% per
annum during the construction period and for base interest to be paid on the
permanent loans at the rate of 10% per annum. In addition to the base interest,
additional interest was to be paid on the permanent loans in an amount equal to
10% of the gross revenues of the Senior Housing Facilities, as defined. Under
the terms of the amended exclusivity agreement, additional interest was to be no
less than 3% of the aggregate principal amount of all permanent loans
outstanding for the entire term of the investments. In the aggregate, the
properties securing loans from the Company did not generate sufficient cash flow
to cover the debt service payments owed to the Company under the amended terms
of the exclusivity agreement. To the extent that the properties did not generate
sufficient cash flow to make the full payments due under the loan documents, the
shortfall was funded by AHC through December 1992. The source of cash to make up
these shortfalls was from specified deficit reserve accounts, which had been
funded from the proceeds of the mortgage loans, and from contributions by
Angeles.
During the quarter ended February 28, 1993, Angeles announced that it
was experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments 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 properties 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
I-1
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
obligations under the loans. On April 27, 1994, each of the properties owned by
AHC and securing the loans was transferred (collectively, "the Transfers") to
newly-created special purpose corporations affiliated with the Company
(collectively, "the Property Companies"). The Transfers had an effective date of
April 1, 1994 and were made pursuant to the settlement agreement entered into on
February 17, 1994 ("the Settlement Agreement") between the Company and AHC which
had previously been approved by the bankruptcy court handling the bankruptcy
case of Angeles. All of the capital stock of each Property Company was held by
ILM Holding, Inc. ("ILM Holding"), a Virginia corporation. In August 1995, each
of the Property Companies merged into ILM Holding, which is majority owned by
the Company. As a result, ownership of the Senior Housing Facilities is now held
by ILM Holding, and the Property Companies no longer exist as separate legal
entities.
As part of the fiscal 1994 Settlement Agreement with AHC, ILM Holding
retained AHC as the property manager for all of the Senior Housing Facilities
pursuant to the terms of a management agreement. The management agreement with
AHC was terminated in July 1996. Subsequent to the effective date of the
Settlement Agreement with AHC, management investigated and evaluated the
available options for structuring the ownership of the properties in order to
maximize the potential returns to the existing shareholders while maintaining
the Company's qualifications as a REIT under the Internal Revenue Code. On
September 12, 1994, the Company formed a new subsidiary, ILM I Lease Corporation
("Lease I"), for the purpose of operating the Senior Housing Facilities. All of
the shares of capital stock in Lease I were distributed to the holders of record
of the Company's common stock and the Senior Housing Facilities were leased to
Lease I effective September 1, 1995.
All responsibility for 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 property manager of its Senior Housing Facilities
pursuant to a management agreement (the "Management Agreement") which commenced
on July 29, 1996. Lawrence A. Cohen, who, through July 28, 1998 served as
President, Chief Executive Officer and Director of the Company and a Director of
Lease I, has also served as Vice Chairman and Chief Financial Officer of Capital
Senior Living, Inc., an affiliate of Capital, since November 1996. 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 Facility expansion costs. The Company has guaranteed the
payment of all fees due to Capital under the terms of the management agreement.
Lease I is a public company subject to the reporting obligations of the
Securities and Exchange Commission.
ILM Holding holds title to the eight Senior Housing Facilities which
comprise the balance of operating investment properties on the accompanying
consolidated balance sheets, subject to certain mortgage loans payable to the
Company. Such mortgage loans and the related interest expense are eliminated in
consolidation. The capital stock of ILM Holding was originally owned by the
Company and PaineWebber. ILM Holding had issued 100 shares of Series A Preferred
Stock to the Company in return for a capital contribution in the amount of
$693,000 and had issued 10,000 shares of common stock to PaineWebber in return
for a capital contribution in the amount of $7,000 on March 25, 1994. 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
I-2
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
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 will
accrue at a rate of 8% per annum on the original $1,000 liquidation preference
and will be cumulative from the date of issuance. Since ILM Holding is not
expected to have sufficient cash flow in the foreseeable future to make the
required dividend payments, it is anticipated that dividends will accrue and be
paid at liquidation. 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, 1998 on the Preferred Stock in ILM Holding totaled $14,000.
At a meeting of the Company's Board of Directors on January 10, 1997,
PaineWebber recommended the immediate sale of the Senior Housing Facilities held
by the Company and an affiliated entity, ILM II Senior Living, Inc. ("ILM II"),
by means of a controlled auction to be conducted by PaineWebber, at no
additional compensation, with PaineWebber offering to purchase the properties
for $127 million, thereby guaranteeing the Shareholders a "floor" price. The
Senior Housing Facilities held by the Company would represent approximately $75
million of this amount. After taxes and closing costs, net proceeds to the
Company would equal approximately $71 million or approximately $9.41 per share.
PaineWebber also stated that if it purchased the properties at the specified
price and were then able to resell the properties at a higher price, PaineWebber
would pay any "excess profits" to the Shareholders. To assist the Company in
evaluating PaineWebber's proposal, NatWest Securities, a disinterested,
independent investment banking firm with expertise in healthcare REIT's and
independent/assisted living financings was engaged by the Company and Lease I as
well as by ILM II and its affiliates. Following a comprehensive analysis, the
independent investment banking firm recommended that PaineWebber's proposal
should be declined and that instead investigations of expansion and
restructuring alternatives should be pursued. After analyzing PaineWebber's
proposal and the recommendations and other information provided by the
independent investment banking firm, the Boards of the Company and ILM II voted
unanimously to decline PaineWebber's proposal and to explore the alternatives
recommended by the independent investment banking firm. The Boards declined to
seek an immediate sale of the properties because, in the Boards' view, the
liquidation price would not reflect the "going concern" values of the Company
and ILM II and, therefore, would not maximize shareholder value. In addition,
the Boards did not consider it advisable to liquidate the Company and ILM II on
the suggested terms several years prior to their scheduled termination dates.
PaineWebber indicated to the Board in its January 10, 1997 proposal
that it would not wish to continue to serve as advisor to the Company and its
affiliates if the Company declined to accept PaineWebber's proposal. The Company
accepted the resignation of PaineWebber, effective as of June 18, 1997.
PaineWebber agreed to continue to provide certain administrative services to the
Company and it affiliates through August 31, 1997, pursuant to the terms of a
transition services agreement entered into with the Company and its affiliates.
The Company and its affiliates also accepted, effective as of June 18, 1997, the
resignations of those Officers and Directors who were employees of or otherwise
affiliated with PaineWebber.
I-3
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
The Company and Lease I are continuing to review various strategic
alternatives to maximize shareholder value and liquidity and have engaged
professional financial and legal advisors to formulate and present plans and
proposals for consideration by the Board. Although no definitive plans,
arrangements or understandings have been agreed to at this time, the Company is
actively reviewing the feasibility of a variety of financial transactions, and
proposals, including the reorganization of the ownership of the Senior Housing
Facilities, business combinations with third parties and the sale of the Company
by means of cash and or stock-for-stock merger. There can be no assurance that
any definitive transaction will be formulated, agreed to or consummated.
The Company's investments as of August 31, 1998 are described below:
<TABLE>
<CAPTION>
Year
Property Name Date of Facility Rentable Resident
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 165 181
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 represents 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 unit and
corresponds to measures commonly used in the healthcare industry.
I-4
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 1. BUSINESS (CONTINUED)
The master lease is a "triple-net" lease whereby the lessee pays all
operating expenses, governmental taxes and assessments, utility charges and
insurance premiums, as well as the costs of all required maintenance, personal
property and non-structural repairs in connection with the operation of the
Senior Housing Facilities. ILM Holding, as the lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. During the initial term of the master lease, which expires on
December 31, 1999, Lease I is obligated to pay annual base rent for the use of
all of the facilities in the aggregate amount of $6,364,800. Lease I is also
obligated to pay variable rent for each Senior Housing Facility. Such variable
rent is payable quarterly and is equal to 40% of the excess, if any, of the
aggregate total revenues for the Senior Housing Facilities, on an annualized
basis, over $16,996,000. Variable rental income for the years ended August 31,
1998 and 1997 was $894,000 and $315,000, respectively.
The Senior Housing Facilities are subject to competition from similar
properties in the vicinities in which they are located. The properties 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. 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 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
As of August 31, 1998, 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 1998 along with
an average for the year are presented below for each property:
<TABLE>
<CAPTION>
Average Quarterly Occupancy
-------------------------------------------------------------------------------
Fiscal 1998
11/30/97 2/28/98 5/31/98 8/31/98 Average
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Independence Village
of Winston-Salem 96% 95% 94% 92% 94%
Independence Village
of East Lansing 93% 95% 94% 94% 94%
Independence Village of Raleigh 96% 97% 98% 96% 97%
Independence Village of Peoria 99% 99% 98% 99% 99%
Crown Pointe Apartments 98% 99% 98% 96% 98%
Sedgwick Plaza Apartments 91% 90% 89% 91% 90%
West Shores 95% 93% 98% 97% 96%
Villa Santa Barbara 96% 97% 95% 96% 96%
</TABLE>
I-6
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 3. LEGAL PROCEEDINGS
TERMINATION OF MANAGEMENT CONTRACT WITH AHC
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 Sections 1.05 (a) (i),
(iii) and (iv) of the agreement. Simultaneously with the termination of the
management agreement, the Companies, together with certain affiliated entities,
filed suit against AHC in the United States District Court for the Eastern
District of Virginia for breach of contract, breach of fiduciary duty and fraud.
The Companies alleged, among other things, that AHC willfully performed actions
specifically in violation of the management agreement and that such actions
caused damages to the Companies. Due to the termination of the agreement for
cause, no termination fee was paid to AHC. Subsequent to the termination of the
management agreement, AHC filed for protection under Chapter 11 of the U.S.
Bankruptcy Code in its domestic state of California. The filing was challenged
by the Companies, and the Bankruptcy Court dismissed AHC's case effective
October 15, 1996. In November 1996, AHC filed with the Virginia District Court
an answer in response to the litigation initiated by the Companies and a
counterclaim against ILM II Holding. The counterclaim alleged that the agreement
was wrongfully terminated for cause and requested damages which include the
payment of the termination fee in the amount of $1,250,000, payment of
management fees pursuant to the agreement from August 1, 1996 through October
15, 1996, which is the earliest date that the agreement could have been
terminated without cause, and recovery of attorney's fees and expenses.
The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. The Company had guaranteed the payment
of the termination fee at issue in these proceedings to the extent that any
termination fee was deemed payable by the court and in the event that Lease I
failed to perform pursuant to its obligations under the management agreement. On
June 13, 1997 and July 8, 1997, the court issued orders to enter judgment
against the Company and ILM II in the amount of $1,000,000 (the "Orders"). The
Orders did not contain any findings of fact or conclusions of law. On July 10,
1997, the Company, ILM II, Lease I and Lease II filed a notice of appeal to the
United States Court of Appeals for the Fourth Circuit from the Orders.
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
$227,000 as of August 31, 1998. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the Boards of Directors of Lease I and
Lease II voted to increase the maximum amount of the advance to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in the
California litigation. On February 2, 1998, the amount to be advanced to Capital
was increased to include 75% of the California litigation legal fees and costs
incurred by Capital for December 1997 and January 1998, plus 75% of such legal
fees and costs incurred by Capital thereafter, not to exceed $500,000. At August
31, 1998, the amount of legal fees either advanced to Capital or accrued on the
financial statements of Lease I and Lease II totaled approximately $519,000,
although the final amount to be reimbursed to Capital has not yet been
determined.
I-7
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. Lease I and
Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay
$625,000 to AHC in settlement of all claims including those related to the
Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties may have
against each other, other than any claims under the property management
agreements. The Company's Board of Directors feels that settling the AHC
litigation is a prudent course of action because the settlement amount
represents a small percentage of the increases in cash flow and value achieved
for the Company and its affiliates over the past two years.
Due to the Order, $1,000,000 had been recorded as a liability by Lease
I and Lease II at the end of fiscal year 1997. At August 31, 1997, a provision
of $600,000 for the liability which might have resulted to the Company had been
recorded in the financial statements of Lease I, with the remaining $400,000
provision recorded by Lease II. Due to the final settlement agreement, the 1997
provisions were increased by $625,000 at August 31, 1998 with an additional
$375,000 recorded on the financial statements of Lease I and the remaining
$250,000 recorded on the financial statements of Lease II. Subsequent to the end
of the fiscal year, on September 4, 1998, the full settlement amounts were paid
to AHC and its affiliates.
OTHER LITIGATION
On May 8, 1998, Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a
purported class action on behalf of that trust and all other shareholders of the
Company and ILM II in the Supreme Court of the State of New York, County of New
York against the Company, ILM II and the Directors of both corporations. The
class action complaint alleges that the Directors engaged in wasteful and
oppressive conduct and breached fiduciary duties in preventing the sale or
liquidation of the assets of the Company and ILM II, diverting certain of their
assets and changing the nature of the Company and ILM II. The complaint seeks
damages in an unspecified amount, punitive damages, the judicial dissolution of
the Company and ILM II, an order requiring the Directors to take all steps to
maximize shareholder value, including either an auction or liquidation, and
rescinding certain agreements, and attorney's fees. On July 8, 1998, the Company
joined with all other defendants to dismiss the complaint on all counts.
Subsequent to the end of the fiscal year, in an oral ruling from the
bench on December 8, 1998, the Court granted the Company's dismissal motion in
part and gave the plaintiffs leave to amend their complaint. In sum, the Court
accepted the Company's position that all claims relating to so-called
"derivative" actions were filed improperly and were properly dismissed. In
addition, the Court dismissed common law claims for punitive damages, but
allowed plaintiffs 30 days to allege any claims which allegedly injured
shareholders without injuring the Company as a whole. The Board doubts that such
a cause of action could be alleged and continues to believe that this lawsuit is
meritless. The Board has directed outside counsel to continue vigorously
contesting the action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on July 28, 1998, J. William
Sharman, Jr., Jeffry R. Dwyer and Carl J. Schramm were elected to serve as
Directors of the Company until the 1999 Annual Meeting and designation of Ernst
& Young LLP as auditors for the fiscal year ending August 31, 1998, was
ratified. J. William Sharman, Jr., and Jeffry R. Dwyer have served as Directors
since ILM Senior Living, Inc.'s inception. Carl J. Schramm has served as a
Director since December 1996.
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, 1998, there were 4,719 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 1998.
On June 4, 1998, an unsolicited tender offer was filed on Schedule
14D-1 to purchase up to 700,000 outstanding shares of the Company's common stock
representing approximately 9.3% of the outstanding shares at $7.00 per share. On
June 17, 1998, the Company filed a response on Schedule 14D-9, which response
was amended on July 7, 1998, stating that the Company's Board of Directors
unanimously concluded that the offer is inadequate and not in the best interests
of the Company and its shareholders. Accordingly, the Board unanimously
recommended that the Company's Shareholders reject the offer and not tender
their shares.
II-1
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 6. SELECTED FINANCIAL DATA
ILM SENIOR LIVING, INC.
For the years ended August 31, 1998, 1997, 1996, 1995 and 1994
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997 (1) 1996 1995 1994
---- -------- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 7,320 $ 6,805 $ 129 $ 174 $ 85
Operating income (loss) $ 4,723 $ 3,834 $ (641) $ (954) $ (918)
Equity in income from properties
securing mortgage loans -- -- $ 4,756 $ 5,053 $ 3,822
Net income $ 4,723 $ 3,834 $ 4,115 $ 4,099 $ 2,904
=========== =========== =========== =========== ===========
Earnings per share of common stock $ 0.63 $ 0.51 $ 0.55 $ 0.54 $ 0.39
=========== =========== =========== =========== ===========
Cash dividends paid
per share of common stock $ 0.79 $ 0.74 $ 0.70 $ 0.71 $ 0.40
=========== =========== =========== =========== ===========
Total assets $ 38,910 $ 40,033 $ 41,451 $ 43,489 $ 43,580
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 different
states. All of the loans made by the Company were originally with AHC. As
previously reported, 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 properties was transferred from AHC to certain
designated affiliates of the Company which were only majority owned by the
Company. Subsequently, these affiliates were merged into ILM Holding which is
majority owned by the Company. ILM Holding holds title to the eight Senior
Housing Facilities which comprise the balance of operating investment properties
in the accompanying consolidated balance sheets, subject to certain mortgage
loans payable to the Company. Such mortgage loans and the related interest
expense are eliminated in consolidation. As part of the fiscal 1994 Settlement
Agreement with AHC, ILM Holding retained AHC as the property manager for all of
the Senior Housing Facilities pursuant to the terms of the Agreement. As
discussed further below, the Agreement with AHC was terminated in July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the Company's existing
Shareholders while maintaining its qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease I, for the purpose of
operating the Senior Housing Facilities under the terms of a master lease
agreement. As of August 31, 1995, Lease I, which is taxable as a regular C
corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On
September 1, 1995, after the Company received the required regulatory approval,
it distributed all of the shares of capital stock of Lease I to the holders of
record of the Company's common stock. One share of common stock of Lease I was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease I with $700,000 from its existing
cash reserves, which was an amount estimated to provide Lease I with necessary
working capital.
The master lease agreement, which commenced on September 1, 1995, is
between the Company's consolidated affiliate, ILM Holding, as owner of the
properties and lessor, and Lease I as lessee. The master lease is a "triple-net"
lease whereby the lessee pays all operating expenses, governmental taxes and
assessments, utility charges and insurance premiums, as well as the costs of all
required maintenance, personal property and non-structural repairs in connection
with the operation of the Senior Housing Facilities. ILM Holding, as the lessor,
is responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the initial term of the master lease, which
expires on December 31, 1999, Lease I is obligated to pay annual base rent for
the use of all of the Senior Housing Facilities in the aggregate amount of
$6,364,800 per year. Beginning in January 1997 and for the remainder of the
lease term, Lease I is also obligated to pay variable rent for each Senior
Housing Facility. Such variable rent is payable quarterly and equals 40% of the
excess, if any, of the aggregate total revenues for the Senior Housing
Facilities, on an annualized basis, over $16,996,000. Variable rental income
related to fiscal years 1998 and 1997 was $894,000 and $315,000, respectively.
The assumption of ownership of the properties through ILM Holding,
which was a regular C corporation for tax purposes at the time of assumption,
may result in a possible future tax liability which would be payable upon the
ultimate sale of the properties (the "built-in gain tax"). The amount of such
tax would be calculated based on the lesser of the total net gain realized from
the sale transaction or the portion of the net gain realized upon a final sale
which is attributable to the period during which the properties were held 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 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. 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, 1998, on the Preferred Stock
in ILM Holding totaled $14,000.
Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM Holding to a REIT would not be subject to
the built-in gain tax. The built-in gain tax would most likely not be incurred
if the properties were to be held for a period of at least ten years from the
date of the conversion of ILM Holding to a REIT. However, since the end of the
Company's original anticipated holding period is within two years, the
properties may not be held for an additional ten years. The Board of Directors
may defer the Company's scheduled liquidation date if in the opinion of a
majority of the Directors the disposition of the Company's assets at such time
would result in a material under-realization of the value of such assets;
provided, however, that no such deferral may extend beyond December 31, 2014,
absent amendment of the Company's Articles of Incorporation. Based on
management's estimate of the increase in values of the Senior Housing Facilities
which occurred between April 1994 and January 1996, as supported by independent
appraisals, 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.
The Company and Lease I are continuing to review various strategic
alternatives to maximize shareholder value and liquidity and have engaged
professional financial and legal advisors to formulate and present plans and
proposals for consideration by the Board. Although no definitive plans,
arrangements or understandings have been agreed to at this time, the Company is
actively reviewing the feasibility of a variety of financial transactions, and
proposals, including the reorganization of the ownership of the Senior Housing
Facilities, business combinations with third parties and the sale of the Company
by means of cash and or stock-for-stock merger. There can be no assurance that
any definitive transaction will be formulated, agreed to or consummated.
II-4
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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 from
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
1998 and 1997, 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 1999 to (i) meet its obligations to make the
debt service payments due under the loans and (ii) pay for capital improvements
and structural repairs in accordance with the terms of the master lease.
Although ILM Holding is not expected to fully fund its scheduled debt service
payments to the Company, the current values of the Senior Housing Facilities are
well in excess of the mortgage principal amounts plus accrued interest at August
31, 1998. As a result, the Company is expected to recover the full amount that
would be due under the loans upon the sale of the Facilities.
Lease I retained Capital to be the property manager of its Senior
Housing Facilities 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 as Vice Chairman and Chief Financial Officer of Capital Senior
Living, Inc., an affiliate of Capital, since November 1996. 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 Facility expansion costs. The Company has guaranteed the payment of
all fees due to Capital under the terms of the Management Agreement.
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
$227,000 as of August 31, 1998. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the Boards of Directors of Lease I and
Lease II voted to increase the maximum amount of the advance to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in the
California litigation. On February 2, 1998, the amount to be advanced to Capital
was increased to include 75% of the California litigation legal fees and costs
incurred by Capital for December 1997 and January 1998, plus 75% of such legal
fees and costs incurred by Capital thereafter, not to exceed $500,000. At August
31, 1998, the amount of legal fees either advanced to Capital or accrued on the
financial statements of Lease I and Lease II totaled approximately $519,000,
although the final amount to be reimbursed to Capital has not yet been
determined.
II-5
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The eight properties in which the Company has invested averaged 96%
occupancy for the year ended August 31, 1998. The road adjacent to the Raleigh
facility is being improved, and the County Department of Transportation
requested a temporary construction easement on the property. Although the
easement will not directly affect the operation of the facility, it resulted in
the removal of several trees that provided a buffer between the building and the
road. During fiscal year 1998, the Company reached a settlement with the County
in the amount of $33,000 which will cover the cost of installing a new landscape
buffer upon completion of the roadway construction.
The Company's net operating cash flow is expected to be relatively
stable and predictable due to the master lease structure. The annual base rental
payments owed to ILM Holding are $6,364,800 and will remain at that level for
the remainder of the lease term. In addition, the Senior Housing Facilities are
currently generating gross revenues which are in excess of the specified
threshold in the variable rent calculation, as discussed further above, which
became effective in January 1997. Accordingly, ILM Holding received variable
rent payments in fiscal 1998 and 1997 in the amounts of $894,000 and $315,000,
respectively. As a result of the status of the Company's net operating cash flow
under the current master lease arrangement, 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.
Subsequent to fiscal year end, 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. As noted above, ILM Holding, as
lessor, is responsible for major capital improvements and structural repairs to
the Senior Housing Facilities.
The Company and Lease I have been pursuing the potential for future
expansion of several of the facilities which are located in areas that have
particularly strong markets for senior housing. Potential expansion candidates
include the facilities located in Raleigh, North Carolina; East Lansing,
Michigan; Omaha, Nebraska; Peoria, Illinois; and Hot Springs, Arkansas. As part
of this expansion program, approximately two acres of land located adjacent to
the East Lansing facility and approximately two and one-half acres of land
located adjacent to the Omaha facility were acquired in the first quarter of
fiscal year 1998 for approximately $200,000 and $265,000, respectively. Also
included in Land on the accompanying consolidated balance sheet are significant
costs incurred at existing facilities for possible future expansions. In
addition, an agreement was obtained to purchase approximately five acres of land
located adjacent to the Peoria facility for approximately $600,000. 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 freestanding facility. Preliminary feasibility evaluations have been
completed for all of these potential expansions except Peoria and
pre-construction design and construction-cost evaluations are underway for
expansions of the facilities located in Raleigh and Omaha.
Once the pre-construction design process is complete and projected
expansion construction costs are determined, the Company will carefully evaluate
the costs and benefits before proceeding with the construction of any of these
expansions. Depending on the extent of any expansions deemed appropriate, such
plans could result in the need for substantial capital. The Company has
finalized negotiations with a major bank to provide a construction loan facility
that will provide the Company with up to $24.5 million to fund the capital costs
of these potential expansion programs. The construction loan facility will be
secured by a first mortgage of the Company's properties and collateral
assignment of the Company's leases of such properties. The loan will have a
three-year term with interest accruing at a rate equal to LIBOR plus 1.10% or
Prime plus 0.5%. The loan term could be extended for an additional two years
beyond its maturity date with monthly payments of principal and interest on a
25-year amortization schedule.
At August 31, 1998, the Company had cash and cash equivalents of
$2,264,000. Such amounts will be used for the working capital requirements of
the Company, along with the possible investment in the properties owned by the
Company's consolidated affiliate for certain capital improvements and for
dividends to the Shareholders. Future capital improvements could be financed
from operations or through borrowings, depending on the magnitude of the
improvements, the availability of financing and the Company's incremental
borrowing rate. The source of future liquidity and dividends to the Shareholders
is expected to be through master lease
II-6
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
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.
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.
RESULT OF OPERATIONS
1998 COMPARED TO 1997
Net income was $4,723,000 representing an increase of $889,000 or 23.2%
for fiscal year 1998 compared to 1997. Total revenue was $7,320,000 representing
an increase of $515,000 or 7.6% over the prior year. Rental and other income
increased $579,000 or 8.7% as a result of increased rental income earned
pursuant to the terms of the master lease agreement. Interest income decreased
$64,000 or 39.5% as a result of a decrease in the average balances of cash and
cash equivalents in 1998 versus 1997. Total expenses were $2,597,000
representing a decrease of $374,000 or 12.6% for fiscal year 1998 when compared
to 1997. General and administrative expenses decreased $572,000 or 66.1% due, in
part, to reductions in advisory fees, reimbursable costs and ILM Holding
restructuring costs of the prior year. This decrease in expenses was offset by a
$229,000 or 51.5% increase in professional fees associated with restructuring
advice provided by the independent investment banking firm and increased legal
fees
II-7
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
as well as a $34,000 or 41.5% increase in Director's compensation as a result of
more frequent Board of Directors meetings.
1997 COMPARED TO 1996
Net income was $3,834,000 representing a decrease of $281,000 or 6.8%
for fiscal year 1997 compared to 1996. Total revenue was $6,805,000 representing
an increase of $6,676,000 or 5,175.2% from the previous fiscal year, of which
$6,643,000 or 99.5% was due to the consolidation of ILM Holding in 1997
including an improvement in master lease rentals of $315,000 from the property
leases owing to improved overall occupancies and revenues of the lessee and the
inclusion of variable rent payments for the year ended August 31, 1997. Interest
income increased $33,000 or 25.6% as a result of increased average balances of
cash and cash equivalents in 1997 versus 1996. Total expenses were $2,971,000
representing an increase of $2,201,000 or 285.8% when compared to 1996. General
and administrative and professional fee expenses increased $653,000 or 99.2%, of
which $469,000 of the increase was due, in part, to expenses associated with
purchasing the remaining controlling interest in ILM Holding, increased expenses
associated with higher legal expenses and the expense of restructuring studies
carried out by the independent investment banking firm. The remaining $184,000
increase in general and administrative and professional fee expenses is due to
the consolidation of ILM Holding in 1997 which includes $116,000 associated with
the charitable contribution in ILM Holding's Preferred Stock. Director
compensation also increased in the current year by $58,000 or 241.7% due to an
increase in the number of Directors and meetings. Depreciation and amortization
expense increased $1,508,000 or 100% due to the consolidation of ILM Holding in
1997. Equity in income properties securing mortgage loans decreased by
$4,756,000 or 100% as a result of the consolidation of ILM Holding in 1997.
INFLATION
The Company completed its ninth full year of operations in fiscal 1998.
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 master lease, 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 1998 are as follows:
<TABLE>
<CAPTION>
NAME OFFICE AGE DATES OF OFFICE
<S> <C> <C> <C>
J. William Sharman, Jr. President and Director 58 6/9/89 **-present
Jeffry R. Dwyer Secretary and Director 52 6/9/89*-present
Carl J. Schramm Director 52 12/5/96-present
Lawrence A. Cohen President, CEO and Director 45 5/15/91-7/28/98
Julien G. Redele Director 63 12/5/96-7/28/98
</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, 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.
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.
LAWRENCE A. COHEN served as President, Chief Executive Officer and
Director of the Company from 1991 until July 28, 1998. In November 1996, he also
became Vice Chairman and Chief Financial Officer of Capital Senior Living
Corporation, an affiliate of Capital, which is the company that was contracted
by Lease I in July 1996 to perform property management services for the Senior
Housing Facilities in which the Company has invested. Mr. Cohen was President
and Chief Executive Officer of PaineWebber Properties Incorporated until August
1996. Mr. Cohen joined PaineWebber in January 1989 as its Executive Vice
President and Director of Marketing and Sales. Mr. Cohen had also been a
Director of Lease I and Lease II and President, Chief Executive Officer and
Director of ILM II until July 28, 1998. Mr. Cohen received his LL.M. (in
Taxation) from New York University School of Law and his J.D. degree from St.
John's University School of Law. Mr. Cohen received his B.B.A. degree in
accounting from George Washington University. He is a member of the New York Bar
and is a Certified Public Accountant.
JULIEN G. REDELE was a Director of the Company until July 28, 1998. He
had been appointed to fill a newly created seat on the Company's Board of
Directors as of December 5, 1996. Mr. Redele is one of the original founders of
SFRE, Inc., a Dutch-owned real estate investment and development firm which has
served since 1963 as advisor to Dutch institutional, corporate and individual
investors active in the United States. Mr. Redele serves as a Director of the
Island Preservation Partnership. Mr. Redele attended Westersingel Business
School, Rotterdam, where he studied economics, law and finance. Mr. Redele now
serves as President and Director of Lease I and Lease II and as Vice President
and Director of ILM Holding and ILM II Holding.
(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, 1998, 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
III-2
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 11. EXECUTIVE COMPENSATION (CONTINUED)
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.
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
Registrant 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.
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 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% annum. PaineWebber earned
base management fees totaling $0, $70,000 and $88,000 for the years
ended August 31, 1998, 1997 and 1996, 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.
III-3
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
(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, 1998, 1997 and 1996 is $0, $155,000 and $142,000, 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. Mitchell Hutchins earned
$0, $9,000 and $6,000 (included in general and administrative expenses) for
managing the Company's cash assets during fiscal 1998, 1997 and 1996,
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 under the terms of the management agreement which commenced on July
29, 1996. Lawrence A. Cohen, who, through July 28, 1998, served as President,
Chief Executive Officer and Director of the Company and a Director of Lease I,
has also served as Vice Chairman and Chief Financial Officer of Capital Senior
Living Corporation, an affiliate of Capital, since November 1996. As a result,
through July 28, 1998, Capital was considered a related party. Capital earned
property management fees from Lease I of $919,000 and $841,000 for the years
ended August 31, 1998 and 1997, 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
$227,000 as of August 31, 1998. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the Boards of Directors of Lease I and
Lease II voted to increase the maximum amount of the advance to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in the
III-4
<PAGE>
ILM SENIOR LIVING, INC.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
California litigation. On February 2, 1998, the amount to be advanced to Capital
was increased to include 75% of the California litigation legal fees and costs
incurred by Capital for December 1997 and January 1998, plus 75% of such legal
fees and costs incurred by Capital thereafter, not to exceed $500,000. At August
31, 1998, the amount of legal fees either advanced to Capital or accrued on the
financial statements of Lease I and Lease II totaled approximately $519,000,
although the final amount to be reimbursed to Capital has not yet been
determined
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, 1998 and
1997, Capital Senior Development, Inc. earned fees from the Company of $212,000
and $0, 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, which began acting as Counsel to the Company
and its affiliates in late fiscal year 1997. Greenberg Traurig earned fees from
the Company of $214,000 and $46,000 for the years ended August 31, 1998 and
1997, respectively.
III-5
<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 August
21, 1998 reporting the Company's settlement of the AHC
litigation.
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.
On June 17, 1998, the Company filed a response to the
unsolicited tender offer 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.
The Company filed a Current Report on Form 8-K dated August
14, 1997 reporting the Company's name change.
(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
Dated: NOVEMBER 16, 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.
By: /s/ J. William Sharman, Jr. Date: November 16, 1999
-------------------------------- ------------------------------
J. William Sharman, Jr.
Director
By: /s/ Jeffrey R. Dwyer Date: November 12, 1999
--------------------------------- ------------------------------
Jeffry R. Dwyer
Director
By: /s/ Carl J. Schramm Date: November 16, 1999
--------------------------------- ------------------------------
Carl J. Schramm
Director
IV-2
<PAGE>
ILM SENIOR LIVING, INC.
ANNUAL REPORT ON FORM 10-K/A
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 ommission
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 Senior the Current Report on Form
Management 2, Inc., as property manager. 8-K dated July 18, 1996 and
incorporated herein by reference.
(13) Annual Reports to Stockholders No Annual Report for the year
ended August 31, 1998 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/A
ITEM 14(a)(1) AND (2) AND 14(d)
ILM SENIOR LIVING, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
REFERENCE
<S> <C>
ILM SENIOR LIVING, INC.:
Report of Independent Auditors F-2
Consolidated Balance Sheets as of August 31, 1998 and 1997 F-3
Consolidated Statements of Income for the years ended August 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Changes in Shareholders' Equity for the years ended August 31, 1998,
1997 and 1996 F-5
Consolidated Statements of Cash Flows for the years ended August 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-7
ILM HOLDING, INC.:
Report of Independent Auditors F-20
Balance Sheet as of August 31, 1996 F-21
Statements of Operations for the year ended August 31, 1996 F-22
Statements of Changes in Shareholders' Equity for the year ended August 31, 1996 F-23
Statements of Cash Flows for the year ended August 31, 1996 F-24
Notes to Financial Statements F-25
SCHEDULE:
Schedule III - Real Estate and Accumulated Depreciation F-33
</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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended August 31, 1998, 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 13, 1998
F-2
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
August 31, 1998 and 1997
(Dollars in thousands, except per share data)
ASSETS
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 4,768 $ 3,792
Building and improvements 38,166 38,147
Furniture, fixtures and equipment 4,948 4,948
-------- --------
47,882 46,887
Less: accumulated depreciation (12,131) (10,844)
-------- --------
35,751 36,043
Real estate investments:
Unamortized mortgage fees 2,256 2,256
Less: accumulated amortization (1,938) (1,712)
-------- --------
318 544
Loan origination fees 102 --
Cash and cash equivalents 2,264 3,136
Accounts receivable - related party 336 116
Prepaid expenses and other assets 90 108
Deferred rent receivable 49 86
-------- --------
$ 38,910 $ 40,033
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable - related party $ -- $ 93
Accounts payable and accrued expenses 326 166
-------- --------
326 259
Preferred shareholders'
minority interest in consolidated subsidiary 125 116
-------- --------
Total liabilities 451 375
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 (27,327) (26,128)
-------- --------
Total shareholders' equity 38,459 39,658
-------- --------
$ 38,910 $ 40,033
-------- --------
-------- --------
</TABLE>
See accompanying notes.
F-3
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the years ended August 31, 1998, 1997, and 1996
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1998 1997 1996
--------- ---------- ----------
<S> <C> <C> <C>
REVENUES:
Rental and other income $7,222 $6,643 $ -
Interest income earned on cash equivalents 98 162 129
-------- -------- ---------
7,320 6,805 129
EXPENSES:
Depreciation 1,287 1,282 -
Amortization 226 226 -
Management fees - 70 88
General and administrative 294 866 343
Professional fees 674 445 315
Director compensation 116 82 24
-------- -------- ---------
2,597 2,971 770
-------- -------- ---------
Operating income (loss) 4,723 3,834 (641)
Equity in income of properties securing mortgage loans - - 4,756
-------- -------- ---------
NET INCOME $4,723 $3,834 $4,115
-------- -------- ---------
-------- -------- ---------
Earnings per share of common stock $0.63 $0.51 $0.55
-------- -------- --------
-------- -------- ---------
Cash dividends paid per share of common stock $0.79 $0.74 $0.70
-------- -------- ---------
-------- -------- ---------
</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, 1998, 1997 and 1996
(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, 1995 7,520,100 $ 75 $ 65,711 $ (22,569) $ 43,217
Cash dividends paid -- -- -- (5,264) (5,264)
Distribution of stock in ILM Lease
Corporation -- -- -- (700) (700)
Net income -- -- 4,115 4,115
--------- --------- --------- --------- ---------
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
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See accompanying notes.
F-5
<PAGE>
ILM SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended August 31, 1998, 1997, and 1996
(In thousands)
<TABLE>
<CAPTION>
1998 1997 1996
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 4,723 $ 3,834 $ 4,115
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Equity in income of properties securing mortgage
loans -- -- (4,756)
Depreciation and amortization 1,513 1,508 --
Charitable contribution of subsidiary's
preferred stock and accrued dividends 9 116 --
Changes in assets and liabilities:
Interest and other receivables -- 397 (178)
Accounts receivable - related party (220) 232 --
Prepaid expenses and other assets 18 (97) 1
Deferred rent receivable 37 37 --
Accounts payable - related party (93) 71 (122)
Accounts payable and accrued expenses 160 105 (67)
------- ------- -------
Net cash provided by (used in) operating
activities 6,147 6,203 (1,007)
------- ------- -------
Cash flows (used in) from investing activities:
Initial investment in ILM I Lease Corporation -- -- (700)
Additional fundings of construction loans -- -- (106)
Contractual payments received on mortgage loans -- -- 6,122
ILM Holding acquired cash balance -- 400 --
Additions to operating investment properties (995) (533) --
------- ------- -------
Net cash (used in) provided by investing
activities (995) (133) 5,316
------- ------- -------
Cash flows used in financing activities:
Loan origination fees (102) -- --
Cash dividends paid to shareholders (5,922) (5,544) (5,264)
------- ------- -------
Net cash used in financing activities (6,024) (5,544) (5,264)
------- ------- -------
Net increase (decrease) in cash and cash equivalents (872) 526 (955)
Cash and cash equivalents, beginning of year 3,136 2,610 3,565
------- ------- -------
Cash and cash equivalents, end of year $ 2,264 $ 3,136 $ 2,610
------- ------- -------
------- ------- -------
Cash paid for state income taxes $ 13 $ -- $ 3
------- ------- -------
------- ------- -------
</TABLE>
See accompanying notes.
F-6
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
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 located in seven different states ("Senior Housing Facilities").
All of the loans made by the Company were originally to Angeles Housing
Concepts, Inc. ("AHC"), a company specializing in the development,
acquisition and operation of senior housing facilities.
The Company entered into an exclusivity agreement, as amended, with
AHC and its parent company, Angeles Corporation ("Angeles"), which required
AHC to provide the Company with certain specific opportunities to finance
senior housing facilities and set forth the terms and conditions of the
loans which were made. The loan documents under the aforementioned
exclusivity agreement called for interest to be paid on construction loans
at the rate of 13% per annum during the construction period and for base
interest to be paid on the permanent loans at the rate of 10% per annum. In
addition to the base interest, additional interest was to be paid on the
permanent loans in an amount equal to 10% of the gross revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
exclusivity agreement, additional interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the
entire term of the investments. In the aggregate, the properties securing
loans from the Company did not generate sufficient cash flow to cover the
debt service payments owed to the Company under the amended terms of the
exclusivity agreement. To the extent that the properties did not generate
sufficient cash flow to make the full payments due under the loan
documents, the shortfall was funded by AHC through December 1992. The
source of cash to make up these shortfalls was from specified deficit
reserve accounts, which had been funded from the proceeds of the mortgage
loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the
regularly scheduled mortgage loan payments due to the Company on March 1,
1993. Subsequent to March 1993, payments 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 properties 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
properties owned by AHC and securing the loans was transferred
(collectively, "the Transfers") to newly-created special purpose
corporations affiliated with the Company (collectively, "the Property
Companies"). The Transfers had an effective date of April 1, 1994 and were
made pursuant to the settlement agreement entered into on February 17, 1994
("the Settlement Agreement") between the Company and AHC which had
previously been approved by the bankruptcy court handling the bankruptcy
case of Angeles. All of the capital stock of each Property Company was held
by ILM Holding, Inc. ("ILM Holding"), a Virginia corporation. In August
1995,
F-7
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED)
each of the Property Companies merged into ILM Holding which is majority
owned by the Company. As a result, ownership of the Senior Housing
Facilities is now held by ILM Holding, and the Property Companies no longer
exist as separate legal entities.
ILM Holding holds title to the eight Senior Housing Facilities which
comprise the balance of operating investment properties on the accompanying
consolidated balance sheets, subject to certain mortgage loans payable to
the Company. Such mortgage loans and the related interest expense are
eliminated in consolidation. The capital stock of ILM Holding was
originally owned by the Company and PaineWebber. ILM Holding had issued 100
shares of Series A Preferred Stock to the Company in return for a capital
contribution in the amount of $693,000 and had issued 10,000 shares of
common stock to PaineWebber in return for a capital contribution in the
amount of $7,000. The common stock represented approximately 99 percent of
the voting power and 1 percent of the economic interest in ILM Holding,
while the preferred stock represented approximately 1 percent of the voting
power and 99 percent of the economic interest in ILM Holding.
The Company completed its restructuring plans by converting ILM
Holding to a REIT for tax purposes. In connection with these plans, on
November 21, 1996, the Company requested that PaineWebber sell all of the
stock held in ILM Holding to the Company for a price equal to the fair
market value of the 1% economic interest in ILM Holding represented by the
common stock. On January 10, 1997, this transfer of the common stock of ILM
Holding was completed at an agreed upon fair value of $46,000. With this
transfer completed, effective January 23, 1997, ILM Holding recapitalized
its common stock and preferred stock by replacing the outstanding shares
with 50,000 shares of new common stock and 275 shares of a new class of
nonvoting, 8% cumulative preferred stock issued to the Company. The number
of authorized shares of preferred and common stock in ILM Holding were also
increased as part of the recapitalization. Following the recapitalization,
the Company made charitable gifts of one share of the preferred stock in
ILM Holding to each of 111 charitable organizations so that ILM Holding
would meet the stock ownership requirements of a REIT as of January 30,
1997. The preferred stock has a liquidation preference of $1,000 per share
plus any accrued and unpaid dividends. Dividends on the preferred stock
will accrue at a rate of 8% per annum on the original $1,000 liquidation
preference and will be cumulative from the date of issuance. Since ILM
Holding is not expected to have sufficient cash flow in the foreseeable
future to make the required dividend payments, it is anticipated that
dividends will accrue and be paid at liquidation. 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 on
the accompanying income statement for the year ended August 31, 1997.
Cumulative dividends accrued as of August 31, 1998 and 1997 on the
preferred stock in ILM Holding totaled approximately $14,000 and $5,000,
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 properties in order to maximize the
potential returns to the existing shareholders while maintaining the
Company's qualification as a REIT under the Internal Revenue Code (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 master lease agreement). Lease I is a public company subject to the
reporting obligations of the Securities and Exchange Commission.
F-8
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED)
At a meeting of the Company's Board of Directors on January 10, 1997,
PaineWebber recommended the immediate sale of the Senior Housing Facilities
held by the Company and an affiliated entity, ILM II Senior Living, Inc.
("ILM II"), by means of a controlled auction to be conducted by
PaineWebber, at no additional compensation, with PaineWebber offering to
purchase the properties for $127 million, thereby guaranteeing the
shareholders a "floor" price. The Senior Housing Facilities held by the
Company would represent approximately $75 million of this amount. After
taxes and closing costs, net proceeds to the Company would equal
approximately $71 million or approximately $9.41 per share. PaineWebber
also stated that if it purchased the properties at the specified price and
were then able to resell the properties at a higher price, PaineWebber
would pay any "excess profits" to the Shareholders. To assist the Company
in evaluating PaineWebber's proposal, a disinterested, independent
investment banking firm with expertise in healthcare REITs and
independent/assisted living financings was engaged by the Company and Lease
I as well as by ILM II and its affiliates. Following a comprehensive
analysis, the investment banking firm recommended that PaineWebber's
proposal should be declined and that instead investigations of expansion
and restructuring alternatives should be pursued. After analyzing
PaineWebber's proposal and the recommendations and other information
provided by the independent investment banking firm, the Boards of the
Company and ILM II voted unanimously to decline PaineWebber's proposal and
to explore the alternatives recommended by the independent investment
banking firm. The Boards declined to seek an immediate sale of the
properties because, in the Boards' view, the liquidation price would not
reflect the "going concern" values of the Company and ILM II and,
therefore, would not maximize Shareholder value. In addition, the Boards
did not consider it advisable to liquidate the Company and ILM II on the
suggested terms several years prior to their scheduled termination date.
PaineWebber indicated to the Board in its January 10, 1997 proposal
that it would not wish to continue to serve as advisor to the Company and
its affiliates if the Company declined to accept PaineWebber's proposal.
The Company accepted the resignation of PaineWebber, effective as of June
18, 1997. PaineWebber agreed to continue to provide certain administrative
services to the Company and its affiliates through August 31, 1997,
pursuant to the terms of a transition services agreement entered into with
the Company and its affiliates. The Company and its affiliates also
accepted, effective as of June 18, 1997, the resignations of those officers
and directors who were employees of or otherwise affiliated with
PaineWebber.
The Company and Lease I are continuing to review various strategic
alternatives to maximize shareholder value and liquidity and have engaged
professional financial and legal advisors to formulate and present plans
and proposals for consideration by the Board. Although no definitive plans,
arrangements or understandings have been agreed to at this time, the
Company is actively reviewing the feasibility of a variety of financial
transactions, and proposals, including the reorganization of the ownership
of the Senior Housing Facilities, business combinations with third parties
and the sale of the Company by means of cash and or stock-for-stock merger.
There can be no assurance that any definitive transaction will be
formulated, agreed to or consummated.
F-9
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
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 estimate and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of August 31, 1998 and 1997 and
revenues and expenses for each of the three years in the period ended
August 31, 1998. 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 sheet is presented in an
unclassified format.
The accompanying financial statements include the financial statements of
the Company and ILM Holding. All intercompany balances and transactions
have been eliminated in consolidation.
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. Accordingly, the
accounts of ILM Holding have been consolidated with those of the Company as
though this controlling interest had been acquired at September 1, 1996.
The accompanying financial statements for fiscal year 1996 account for the
Company's investment in ILM Holding using the equity method. Under the
equity method, the Company's investment in ILM Holding is carried at cost,
including the face amount of the mortgage loans, adjusted for the Company's
share of ILM Holding's earnings, losses, and distributions.
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 properties 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 properties that are now owned by an affiliate of the Company are
Senior Housing Facilities that 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 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
properties 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 master lease agreement).
F-10
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The assumption of ownership of the properties through ILM Holding, which
was a regular C corporation for tax purposes at the time of assumption,
resulted in a possible future tax liability which would be payable upon the
ultimate sale of the properties (the "built-in gain tax"). The amount of
such tax would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain realized
upon a final sale which is attributable to the period during which the
properties were held 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 properties 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 two years, the properties 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. Based on management's estimate of the increase in the values of the
properties 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.
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.
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 1998, 1997 and 1996 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.
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, 1998 or 1997. Depreciation expense is provided on a straight-line basis
using an estimated useful life of 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, 1998.
F-11
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Loan placement fees of $2,256,000 were incurred by the Company at its
formation and these fees are included in the accompanying balance sheet.
Accumulated amortization at August 31, 1998 and 1997, is $1,937,000 and
$1,712,000, respectively. Loan origination fees relating to the
construction loan financing (see Note 6.) will be amortized on the
straight-line method.
E. RENTAL REVENUES
In fiscal years 1998 and 1997, rental revenues consist of payments due from
Lease I under the terms of the master lease described in Note 4. Base
rental income under the master lease is recognized on a straight-line basis
over the term of the lease. Deferred rent receivable on the balance sheet
as of August 31, 1998 and 1997 represents the difference between rental
income on a straight-line basis and rental income received under the terms
of the master lease.
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 nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
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.
G. NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 130,
Reporting Comprehensive Income and Statement No. 131, Disclosures about
Segments of an Enterprise and Related Information all effective for fiscal
1998. Statement No. 130 requires reporting and display of comprehensive
income and its components in the financial statements. Statement No. 131
requires reporting about operating segments and other disclosures about the
business in its annual and interim financial statements. The Company does
not believe adoption of these new Statements will have a material impact on
its financial statements.
F-12
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS
Subject to the supervision of the Company's Board of Directors,
assistance in managing the business of the Company was provided by
PaineWebber. As previously discussed in Note 1, 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% annum. PaineWebber earned
base management fees totaling $0, $70,000 and $88,000 for the years
ended August 31, 1998, 1997 and 1996, 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 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, 1998, 1997 and 1996 is $0, $155,000
and $142,000, respectively, representing reimbursements to PaineWebber for
providing certain financial, accounting and investor communication services
to the Company.
F-13
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
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.
Mitchell Hutchins earned $0, $9,000 and $13,000, (included in general and
administrative expenses) for managing the Company's cash assets during
fiscal 1998, 1997 and 1996, respectively.
Lease I has retained Capital Senior Management, 2, Inc. ("Capital") to
be the property manager of the Senior Housing Facilities, and the Company
has guaranteed the payment of all fees due to Capital under the terms of
the management agreement which commenced on July 29, 1996. Lawrence A.
Cohen, who, through July 28, 1998, served as President, Chief Executive
Officer and Director of the Company and a Director of Lease I, has also
served as Vice Chairman and Chief Financial Officer of Capital Senior
Living Corporation, an affiliate of Capital, since November 1996. As a
result, through July 28, 1998, Capital was considered a related party.
Capital earned property management fees from Lease I of $919,000 and
$841,000 for the years ended August 31, 1998 and 1997, 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 $227,000 as of August
31, 1998. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should advance up to $20,000 to
pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the Boards of Directors of Lease I and
Lease II voted to increase the maximum amount of the advance to $100,000.
By the end of November 1997, Capital had incurred $100,000 of legal
expenses in the California litigation. On February 2, 1998, the amount to
be advanced to Capital was increased to include 75% of the California
litigation legal fees and costs incurred by Capital for December 1997 and
January 1998, plus 75% of such legal fees and costs incurred byCapital
thereafter, not to exceed $500,000. At August 31, 1998, the amount of legal
fees either advanced to Capital or accrued on the financial statements of
Lease I and Lease II totaled approximately $519,000, although the final
amount to be reimbursed to Capital has not yet been determined.
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, 1998 and 1997, Capital Senior Development, Inc.
earned fees from the Company of $212,000 and $0, 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, which began acting as Counsel to the
Company and its affiliates in late fiscal year 1997. Greenberg Traurig
earned fees from the Company of $214,000 and $46,000 for the years ended
August 31, 1998 and 1997, respectively.
F-14
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
Accounts receivable - related party at August 31, 1998 and 1997
represent amounts due from an affiliated company, Lease I, for variable
rent.
Accounts payable - related party at August 31, 1997 represents amounts
owed to an affiliated company, Lease I, for property improvements made on
the Company's behalf; there were no accounts payable - related party at
August 31, 1998.
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO MASTER LEASE
As of August 31, 1998 the Company, through its consolidated affiliate,
owned eight Senior Housing Facilities. The name, location and size of the
properties 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 East Lansing, MI 161 162 1989 6/29/89
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 represents 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 unit 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
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
F-15
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO MASTER LEASE (CONTINUED)
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 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 from 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 1998 and 1997, the mortgage
loans and related interest expense have been eliminated in consolidation.
Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the existing shareholders
while maintaining the Company's qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease I, for the
purpose of operating the Senior Housing Facilities under the terms of a
master lease agreement. As of August 31, 1995, Lease I, which is taxable as
a regular C corporation and not as a REIT, was a wholly-owned subsidiary of
the Company. On September 1, 1995, after the Company received the required
regulatory approval, it distributed all of the shares of capital stock of
Lease I to the holders of record of the Company's common stock. One share
of common stock of Lease I was issued for each full share of the Company's
common stock held. Prior to the distribution, the Company capitalized Lease
I with $700,000 from its existing cash reserves, which was an amount
estimated to provide Lease I with necessary working capital. The master
lease agreement, which commenced on September 1, 1995, is between the
Company's consolidated subsidiary, ILM Holding, as owner of the properties
and lessor, and Lease I as lessee. The lessor has the right to terminate
the master lease as to any property sold by the lessor as of the date of
such sale. The master lease is a "triple-net" lease whereby the lessee pays
all operating expenses, governmental taxes and assessments, utility charges
and insurance premiums, as well as the costs of all required maintenance,
personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. ILM Holding, as the lessor, is
responsible for all major capital improvements and structural repairs to
the Senior Housing Facilities. During the initial term of the master lease,
which expires on December 31, 1999, Lease I is obligated to pay annual base
rent for the use of all of the Facilities in the aggregate amount of
$6,364,800 for calendar year 1996 and each subsequent year. Beginning in
January 1997 and for the remainder of the lease term, Lease I is also
obligated to pay variable rent for each Facility. Such variable rent is
payable quarterly and is equal to 40% of the excess, if any, of the
aggregate total revenues for the Facilities, on an annualized basis, over
$16,996,000. Variable rental income related to fiscal years 1998 and 1997
was $894,000 and $315,000, respectively.
F-16
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
4. OPERATING INVESTMENT PROPERTIES SUBJECT TO MASTER LEASE (CONTINUED)
Condensed balance sheets as of August 31, 1998 and 1997, and condensed
statements of operations for the years ended August 31, 1998 and 1997, of
Lease I are as follows:
<TABLE>
<CAPTION>
ASSETS 1998 1997
---------- ----------
<S> <C> <C>
Current assets $ 2,225 $ 1,825
Furniture, fixtures, and equipment, net 609 498
Other assets 364 310
--------- --------
$ 3,198 $ 2,633
--------- --------
--------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 2,756 $ 1,773
Other liabilities 49 86
Shareholders' equity 393 774
--------- ---------
$ 3,198 $ 2,633
-------- --------
-------- --------
STATEMENT OF OPERATIONS
Revenues $ 19,294 $18,121
Operating expenses 19,729 18,600
Income tax expense (benefit) (54) (192)
--------- --------
Net loss $ (381) $ (287)
--------- ---------
--------- ---------
</TABLE>
5. LEGAL PROCEEDINGS AND CONTINGENCIES
ANGELES CORPORATION LITIGATION
Angeles had guaranteed certain of the obligations of AHC under the
terms of the Exclusivity Agreement described in Note 1. Under the terms of
the Settlement Agreement discussed in Note 1, the Company retained a
general unsecured claim against Angeles in the amount of $1,514,000 as part
of the bankruptcy proceedings, but waived all other claims against Angeles,
including any amounts of base and additional interest owed. In addition,
the Company maintained a claim for approximately $592,000 against an
affiliate of Angeles which had made a separate guaranty to the Company. On
March 17, 1995, the Bankruptcy Court handling the Angeles bankruptcy
proceedings approved a final settlement of the Company's outstanding claims
against Angeles and its affiliates. Pursuant to the terms of this
settlement, the Company received a cash payment of $1.5 million on April
14, 1995 in full satisfaction of the claims, which totaled approximately
$2.1 million. This amount, net of certain related legal expenses, was
recorded as a reduction in the carrying values of the operating investment
properties.
TERMINATION OF 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
F-17
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
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
5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
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.
The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. The Company had guaranteed the
payment of the termination fee at issue in these proceedings to the extent
that any termination fee was deemed payable by the court and in the event
that Lease I failed to perform pursuant to its obligations under the
management agreement. On June 13, 1997 and July 8, 1997, the court issued
orders to enter judgment against the Company and ILM II in the amount of
$1,000,000 (the "Orders"). The Orders did not contain any findings of fact
or conclusions of law. On July 10, 1997, the Company, ILM II, Lease I and
Lease II filed a notice of appeal to the United States Court of Appeals for
the Fourth Circuit from the Orders.
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital Senior Management 2, Inc. ("Capital")
of Dallas, Texas, Lawrence Cohen, and others alleging that the defendants
intentionally interfered with AHC's 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 $227,068 as of August 31, 1998. The
Company's Board also concluded that, subject to certain conditions, the
Company or its affiliates should advance up to $20,000 to pay reasonable
legal fees and expenses incurred by Capital in the California litigation.
Subsequently, the Boards of Directors of Lease I and Lease II voted to
increase the maximum amount of the advance to Capital to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in
the California litigation. On February 2, 1998, the amount to be advanced
to Capital was increased to include 75% of the California litigation legal
fees and costs incurred by Capital for December 1997 and January 1998, plus
75% of such legal fees and costs incurred by Capital thereafter, not to
exceed $500,000. At August 31, 1998, legal expense of $519,000 in total has
been either advanced or accrued in the financial statements of Lease I and
Lease II for Capital's California litigation costs, although the final
amount to be reimbursed to Capital has not yet been determined.
On August 18, 1998, the Company and its affiliates, along with Capital
and its affiliates, entered into a settlement agreement with AHC. Lease I
and Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed
to pay $625,000 to AHC in settlement of all claims including those related
to the Virginia litigation and the California litigation. The Company and
its affiliates also entered into an agreement with Capital and its
affiliates to mutually release each other from all claims that any such
parties may have against each other, other than any claims under the
property management agreements. The Company's Board of Directors believe
that settling the AHC litigation is a prudent course of action because the
settlement amount represents a small percentage of the increases in cash
flow and value achieved for the Company and its affiliates over the past
two years. At August 31, 1997, a provision of $600,000 for the liability
which might have resulted to the Company had been recorded in the financial
statements of Lease I, with the remaining $400,000 provision recorded by
F-18
<PAGE>
ILM SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
Lease II. Due to the final settlement agreement, the 1997 provisions were
increased by $625,000 at August 31, 1998, with an additional $375,000
recorded in the financial statements of Lease I and the remaining $250,000
5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
recorded in the financial statements of Lease II. Subsequent to the end of
the fiscal year, on September 4, 1998, the full settlement amounts were
paid to AHC and its affiliates.
OTHER LITIGATION
On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990,
commenced a purported class action on behalf of that trust and all other
shareholders of the Company and ILM II in the Supreme Court of the State of
New York, County of New York against the Company, ILM II and the Directors
of both corporations. The class action complaint alleges that the Directors
engaged in wasteful and oppressive conduct and breached fiduciary duties in
preventing the sale or liquidation of the assets of the Company and ILM II,
diverting certain of their assets and changing the nature of the Company
and ILM II. The complaint seeks damages in an unspecified amount, punitive
damages, the judicial dissolution of the Company and ILM II, an order
requiring the Directors to take all steps to maximize shareholder value,
including either an auction or liquidation, and rescinding certain
agreements, and attorney's fees. On July 8, 1998, the Company joined with
all other defendants to dismiss the complaint on all counts.
Subsequent to the end of the fiscal year, in an oral ruling from the
bench on December 8, 1998, the Court granted the Company's dismissal motion
in part and gave the plaintiffs leave to amend their complaint. In sum, the
Court accepted the Company's position that all claims relating to so-called
"derivative" actions were filed improperly and were properly dismissed. In
addition, the Court dismissed common law claims for punitive damages, but
allowed plaintiffs 30 days to allege any claims which allegedly injured
shareholders without injuring the Company as a whole. The Board doubts that
such a cause of action could be alleged and continues to believe that this
lawsuit is meritless. The Board has directed outside counsel to continue
vigorously contesting the action.
6. CONSTRUCTION LOAN FINANCING
The Company has finalized negotiations with a major bank to provide a
construction loan facility that will provide the Company with up to $24.5
million to fund the capital costs of these potential expansion programs.
The construction loan facility will be secured by a first mortgage of the
Company's properties and collateral assignment of the Company's leases of
such properties. The loan will have a three-year term with interest
accruing at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. The loan
term could be extended for an additional two years beyond its maturity date
with monthly payments of principal and interest on a 25-year amortization
schedule.
7. SUBSEQUENT EVENTS
On September 15, 1998, the Company's Board of Directors declared a
quarterly dividend for the quarter ended August 31, 1998. On October 15,
1998, a dividend of $0.2125 per share of common stock, totaling $1,598,000,
will be made to the shareholders of record as of September 30, 1998.
F-19
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Shareholders of
ILM Senior Living, Inc.
We have audited the accompanying balance sheet of ILM Holding, Inc. (the
"Company"), as of August 31, 1996, and the related statements of operations,
changes in shareholders' equity (deficit) and cash flows for the year ended
August 31, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ILM Holding, Inc., at August
31, 1996, and the results of its operations and its cash flows for the year
ended August 31, 1996, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Boston, Massachusetts
December 10, 1996
F-20
<PAGE>
ILM HOLDING, INC.
BALANCE SHEET
August 31, 1996
(Dollars in thousands, except per share amounts)
ASSETS
<TABLE>
<S> <C>
Operating investment properties, at cost:
Land $ 3,352
Building and improvements 33,105
Furniture, fixtures and equipment 4,948
--------
41,405
Less accumulated depreciation (3,191)
--------
38,214
Cash and cash equivalents 400
Accounts receivable - related party 348
Deferred rent receivable 123
Other assets 233
--------
$ 39,318
--------
--------
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Mortgages payable $ 40,391
Accounts payable - related party 585
Accounts payable and accrued expenses 3
--------
Total liabilities 40,979
Commitments and contingencies
Shareholders' equity (deficit):
Preferred stock (Series A, $1 par value, 100 shares
authorized, issued and outstanding) 1
Common stock ($1 par value, 10,000 shares
authorized, issued and outstanding) 10
Additional paid-in capital 689
Accumulated deficit (2,361)
--------
Total shareholders' equity (deficit) (1,661)
--------
$ 39,318
--------
--------
</TABLE>
See accompanying notes.
F-21
<PAGE>
ILM HOLDING, INC.
STATEMENT OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
AUGUST 31, 1996
-------
<S> <C>
REVENUES:
Rental income $ 6,328
Interest income earned
on cash equivalents 16
-------
6,344
EXPENSES:
Depreciation 1,290
Interest 6,707
Other 72
-------
8,069
NET LOSS $(1,725)
-------
-------
Loss per share of
common stock $(172.50)
-------
-------
</TABLE>
See accompanying notes.
F-22
<PAGE>
ILM HOLDING, INC.
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(DEFICIT) For the year ended August 31, 1996
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK
$.01 PAR VALUE $.01 PAR VALUE ADDITIONAL
----------------------- ------------------------ PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- --------- ---------- ---------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Shareholders' equity at
August 31, 1995 10,000 10 100 $1 $689 $ (636) $ 64
Net loss -- -- --- -- -- (1,725) (1,725)
--------- --------- ---------- ---------- ---------- ------------- ---------
Shareholders' equity
(deficit) at
August 31, 1996 10,000 $10 100 $1 $689 $(2,361) $(1,661)
--------- --------- ---------- ---------- ---------- ------------- ---------
--------- --------- ---------- ---------- ---------- ------------- ---------
</TABLE>
See accompanying notes.
F-23
<PAGE>
ILM HOLDING, INC.
STATEMENT OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
AUGUST 31, 1996
----------------------
OPERATING ACTIVITIES:
<S> <C>
Net loss $(1,725)
Adjustments to reconcile net income to net cash used
in operating activities:
Depreciation 1,290
Changes in operating assets and liabilities:
Interest and other receivables 11
Accounts receivable - related party (348)
Deferred rent receivable (123)
Other assets 112
Accounts payable - related party 274
Accounts payable and accrued liabilities (521)
-------
Total adjustments 695
-------
Net cash used in operating activities (1,030)
-------
INVESTING ACTIVITIES:
Investment in properties (181)
-------
Net cash used for investing activities (181)
-------
FINANCING ACTIVITIES:
Borrowings under mortgage notes 106
-------
Net cash provided by financing activities 106
-------
Net decrease in cash and cash equivalents
at end of period (1,105)
Cash and cash equivalents at beginning of year 1,505
-------
Cash and cash equivalents at end of year $ 400
-------
-------
</TABLE>
F-24
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
August 31, 1996
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
ILM Senior Living, Inc., formerly PaineWebber Independent Living Mortgage Fund,
Inc. ("ILM I"), invested in eight participating mortgage loans secured by Senior
Housing Facilities located in seven different states. All of the loans made by
ILM I were originally with Angeles Housing Concepts, Inc. ("AHC"), a company
specializing in the development, acquisition and operation of Senior Housing
Facilities. ILM I entered into an Exclusivity Agreement with AHC and its parent
company, Angeles Corporation ("Angeles"), which required AHC to provide the
Company with certain specific opportunities to finance Senior Housing Facilities
and set forth the terms and conditions of the loans which were made. The loan
documents under the aforementioned Exclusivity Agreement called for interest to
be paid on construction loans at the rate of 13.3% per annum during the
construction period and for Base Interest to be paid on the permanent loans at
the rate of 10.3% per annum. In addition to the Base Interest, Additional
Interest was to be payable on the permanent loans in an amount equal to 10% of
the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms
of the amended Exclusivity Agreement, Additional Interest was to be no less than
3% of the aggregate principal amount of all permanent loans outstanding for the
entire term of the investments. In the aggregate, the properties securing loans
from ILM I did not generate sufficient cash flow to cover the debt service
payments owed to ILM I under the amended terms of the Exclusivity Agreement. To
the extent that the properties did not generate sufficient cash flow to make the
full payments due under the loan documents, the shortfall was funded by AHC
through December 1992. The source of cash to make up these shortfalls was from
specified deficit reserve accounts, which had been funded from the proceeds of
the mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to ILM I on March 1, 1993. Subsequent to
March 1993, payments toward the debt service owed on ILM I'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. ILM I
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 ILM I, AHC and Angeles was reached
whereby ownership of the properties would be transferred from AHC to ILM I or
its designated affiliates. Under the terms of the Settlement Agreement, ILM I
released AHC and Angeles from certain obligations under the loans. On April 27,
1994, each of the properties owned by AHC and securing the Loans was transferred
(collectively, "the Transfers") to newly-created special purpose corporations
affiliated with ILM I (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
ILM I 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. (the "Company"), a Virginia
corporation. In August 1995, each of the Property Companies merged into the
Company. As a result, ownership of the Senior Housing Facilities is now held by
the Company, and the Property Companies no longer exists as separate legal
entities. The capital stock of the Company is owned by ILM and PWP Holding, Inc.
("PWP Holding"), a wholly-owned subsidiary of PaineWebber Properties
Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber
Incorporated, which is a wholly owned subsidiary of PaineWebber Group, Inc.
("PaineWebber").
F-25
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
1. NATURE OF OPERATIONS AND BASIS OF PRESENTATION (CONTINUED)
As part of the fiscal 1994 settlement agreement with AHC, the Company
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 8, the management agreement with AHC was terminated in July
1996. Subsequent to the effective date of the Settlement Agreement with
AHC, management investigated and evaluated the available options for
structuring the ownership of the properties in order to maximize the
potential returns to the existing shareholders while maintaining ILM's
qualification as a REIT under the Internal Revenue Code. On September 12,
1994, ILM I formed a new subsidiary, ILM I Lease Corporation, for the
purpose of operating the Senior Housing Facilities. The Senior Housing
Facilities were leased to ILM I Lease Corporation effective September 1,
1995 (see Note 4 for a description of the master lease agreement). ILM I
Lease Corporation is a public company subject to the reporting obligations
of the Securities and Exchange Commission.
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, 1996 and 1995 and
revenues and expenses for the year ended August 31, 1996.
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 balance sheets are presented in an
unclassified format. The Company includes its interest in the Santa Barbara
property on a proportional basis in the accompanying financial statements
due to its joint tenancy agreement with a related party and 25% interest in
the property.
B. INCOME TAXES
For purposes of filing federal tax returns, the financial statements of the
Company are consolidated with those of ILM I. The Company has incurred
losses for tax purposes since inception. Neither ILM I nor the Company is
likely to be able to use these losses to offset future tax liabilities.
Accordingly, no income tax benefit is reflected in these financial
statements.
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.
D. 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-26
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
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 of the
balance sheet for accounts receivable - related party approximates its fair
value due to the short-term nature of such instruments.
ACCOUNTS PAYABLE - RELATED PARTY: The carrying amount reported on the
balance sheet for accounts payable related party approximates its fair
value due to the short-term nature of such instrument.
MORTGAGES PAYABLE: Due to the unique nature of the debt arrangement as
described in Note 5, management is unable to determine the fair value of
mortgages payable without incurring excessive costs.
E. 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, 1996. Depreciation expense is provided on a straight-line basis using
an estimated useful life of 40 years for the buildings and improvements and
five 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, 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, 1996.
F. RENTAL REVENUES
Rental revenues consist of payments due from ILM I Lease Corporation under
the terms of the master lease described in Note 7. Base rental income under
the master lease is recognized on a straight-line basis over the term of
the lease. Deferred rent receivable on the balance sheet as of August 31,
1996 represents the difference between rental income on a straight-line
basis and rental income received under the terms of the master lease.
F-27
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
3. THE ADVISORY AGREEMENT AND RELATED PARTY TRANSACTIONS
Subject to the supervision of the ILM I's Board of Directors, the business
of ILM I and the Company is managed by PaineWebber ILM Advisor, L.P. (the
"Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc., a
Virginia corporation, and Properties Associates, L.P. ("PA"), a Virginia
limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of
PaineWebber Properties Incorporated ("PWPI"). In addition, the limited
partners and holders of assignee interest of PA are or have been officers
of PWPI. PWPI is a wholly owned subsidiary of PaineWebber Incorporated
("PWI"). PWI is a wholly owned subsidiary of PaineWebber Group, Inc.
("PaineWebber"). The Advisor and its affiliates 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 ILM I and the Company, and the acquisition, management and
disposition of ILM I's investments.
Accounts payable - related party at August 31, 1996 represents outstanding
interest under the Company's mortgage loans payable to ILM I (see Note 5).
Accounts receivable - related party at August 31, 1996 represents advances
made to ILM I Lease Corporation (see Note 7) primarily for the purchase of
personal property to operate the Senior Housing Facilities.
4. OPERATING PROPERTIES
Descriptions of the properties financed by the Company's loans are
summarized below:
INDEPENDENCE VILLAGE OF EAST LANSING
In June 1989, ILM I acquired a loan with respect to a 159-unit Senior
Housing Facility known as Independence Village of East Lansing located in
East Lansing, Michigan. Construction of the Senior Housing Facility, which
was 91% leased as of August 31, 1996, was completed in May, 1989.
INDEPENDENCE VILLAGE OF WINSTON-SALEM
In June 1989, ILM I acquired a loan with respect to a 156-unit Senior
Housing Facility known as Independence Village of Winston-Salem located in
Winston-Salem, North Carolina. Construction of the Senior Housing Facility,
which was 93% leased as of August 31, 1996, was completed in February,
1989.
INDEPENDENCE VILLAGE OF RALEIGH
In December 1989, ILM I acquired a loan with respect to a 163-unit Senior
Housing Facility, known as Independence Village of Raleigh, located in
Raleigh, North Carolina. The original closing of the construction loan
occurred on December 18, 1989. Construction of the Senior Housing Facility,
which was 98% leased as of August 31, 1996, was completed in March, 1991.
ILM I's investment was converted from a construction loan to a permanent
loan effective April 29, 1991.
F-28
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
4. OPERATING PROPERTIES (CONTINUED)
INDEPENDENCE VILLAGE OF PEORIA
In December 1989, ILM I acquired a loan with respect to a 164-unit Senior
Housing Facility known as Independence Village of Peoria located in Peoria,
Illinois. The original closing of the construction loan occurred on
December 18, 1989. Construction of the Senior Housing Facility, which was
91% leased as of August 31, 1996, was completed in November, 1990. ILM I's
investment was converted from a construction loan to a permanent loan
effective November 30, 1990.
CROWN POINTE
In February 1990, ILM I acquired a loan with respect to an existing
133-unit Senior Housing Facility known as Crown Pointe Apartments located
in Omaha, Nebraska. The Senior Housing Facility, which was 99% leased as of
August 31, 1996, was opened in August of 1985.
SEDGWICK PLAZA
In February 1990, ILM I acquired a loan with respect to an existing
150-unit Senior Housing Facility known as Sedgwick Plaza Apartments located
in Wichita, Kansas. The Senior Housing Facility, which was 83% leased as of
August 31, 1996, was opened in May of 1985.
WEST SHORES
In December 1990, ILM I acquired a loan with respect to an existing
134-unit Senior Housing Facility known as West Shores located in Hot
Springs, Arkansas. The Senior Housing Facility, which was 94% leased as of
August 31, 1996, was opened in June of 1987.
SANTA BARBARA
In July 1992, ILM I acquired a loan with respect to an existing 123-unit
Senior Housing Facility known as Villa Santa Barbara located in Santa
Barbara, California. The acquisition and improvement of the facility was
financed by the aforementioned loan and another loan from an affiliated
company, PaineWebber Independent Living Mortgage Inc. II (ILM II). Any
amounts due from the borrower with regard to the mortgage loans on the
Santa Barbara property will be equitably apportioned between ILM I and ILM
II (generally 25% to ILM I and 75% to ILM II). ILM I and ILM II have
entered into an Intercreditor Agreement to set forth their respective
rights and entitlements under the loan documents. During the first quarter
of fiscal 1994, ILM I committed to release a portion of the funds set aside
for capital improvements at Villa Santa Barbara in order to improve the
marketability of that property. With the formal execution of the Settlement
Agreement completed, the planned improvement program is now moving forward
toward completion. ILM I's financing of such a program is expected to total
approximately $350,000, which it will fund from available uninvested
offering proceeds. The Senior Housing Facility, which was 81% leased as of
August 31, 1996, was opened in June of 1979.
F-29
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
5. MORTGAGE LOANS
The Company's operating properties were acquired subject to the participating
mortgage loans payable to ILM I. 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 Transfers. The modified loans require interest-only
payments on a monthly basis at a rate of 7% from April 1, 1994 through
December 31, 1994, 9% for the period January 1 through December 31, 1995, 11%
for the period January 1 through December 31, 1996, 12% for the period January
1 through December 31, 1997, 13% for the period January 1 through December 31,
1998, 13.5% for the period January 1 through December 31, 1999 and 14% for the
period January 1, 2000 through maturity, on December 31, 2000.
The following loans were outstanding at August 31, 1996:
<TABLE>
<CAPTION>
August 31, Date of
Property Pledged as Collateral 1996 Loan
- ------------------------------ ---- ----
<S> <C> <C> <C>
Independence Village of East Lansing, MI $ 8,950,000 6/29/89
Independence Village of Winston-Salem, NC 5,750,000 6/29/89
Independence Village of Raleigh, NC 8,350,000 4/29/91
Independence Village of Peoria, IL 8,350,000 11/30/90
Crown Pointe Apartments, Omaha, NE 8,200,000 2/14/90
Sedgwick Plaza Apartments, Wichita, KS 8,350,000 2/14/90
West Shores, Hot Springs, AR 5,350,000 12/14/90
Villa Santa Barbara, Santa Barbara, CA 1,698,000 7/13/92
--------------
54,998,000
Less discount (14,607,000)
--------------
$ 40,391,000
--------------
--------------
</TABLE>
A discount was recorded on the long-term debt in the amount by which the
modified principal amount of the loans exceeded the historical cost basis of the
properties at the time of the Transfers.
6. SHAREHOLDERS' EQUITY
The Company has issued 100 shares of Series A Preferred Stock to ILM I in return
for a capital contribution in the amount of $693,000. The holders of the Series
A Preferred Stock are entitled to one vote for each share of Preferred Stock
held. In addition, the holders of the Series A Preferred Stock are entitled to
receive, when and if declared by the Board of Directors, dividends and
distributions in an amount per share equal to the product of 0.1 and 99% of the
total amount of dividends and distributions made to all shareholders. The
Company has also issued 10,000 shares of Common Stock to PWP Holding in return
for a capital contribution in the amount of $7,000. The holders of the Common
Stock are entitled to one vote for each share of Common Stock held. The holders
of the Common Stock are entitled to receive, when and if declared by the Board
of Directors, dividends and distributions in an amount per share equal to the
product of 0.001 and 1% of the total amount of dividends and distributions made
to all shareholders.
F-30
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
7. LEASE ARRANGEMENTS
Beginning September 1, 1995, the Senior Housing Facilities were leased to ILM I
Lease Corporation under a master lease agreement. The master lease agreement is
initially between the Company, as owner of the properties and Lessor, and ILM I
Lease Corporation as Lessee. The master lease is a "triple-net" lease whereby
the Lessee pays all operating expenses, governmental taxes and assessments,
utility charges and insurance premiums, as well as the costs of all required
maintenance, personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. The Company, as the Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the initial term of the master lease, which
expires on December 31, 2000 (December 31, 1999 with respect to the Santa
Barbara property), ILM I Lease Corporation is obligated to pay annual base rent
for the use of all of the Senior Housing Facilities in the aggregate amount of
$5,886,000 for calendar year 1995 (prorated based on the lease commencement
date) and $6,364,800 for calendar year 1996 and each subsequent year. Beginning
in January 1997 and for the remainder of the lease term, ILM I Lease Corporation
will also be obligated to pay variable rent for each Senior Housing Facility.
Such variable rent will be payable quarterly and will equal 40% of the excess,
if any, of the aggregate total revenues for the Senior Housing Facilities, on an
annualized basis, over $16,996,000.
A condensed balance sheet as of August 31, 1996 and summary of operations for
the year then ended of ILM I Lease Corporation are as follows:
<TABLE>
<S> <C>
ASSETS
Current assets $2,529
Furniture, fixtures and equipment 242
Other non-current assets 26
-----------
$2,797
-----------
-----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $1,613
Other non-current liabilities 123
Shareholders' equity 1,061
-----------
$2,797
-----------
-----------
SUMMARY OF OPERATIONS
Revenues $17,285
Operating expenses 16,682
Income tax expense 241
-----------
Net income $ 362
-----------
-----------
</TABLE>
F-31
<PAGE>
ILM HOLDING, INC.
Notes to Financial Statements
8. LEGAL PROCEEDINGS AND CONTINGENCIES
ANGELES CORPORATION LITIGATION
Angeles had guaranteed certain of the obligations of AHC under the terms of the
Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, ILM I retained a general unsecured claim against
Angeles in the amount of $1,200,658 as part of the bankruptcy proceedings, but
waived all other claims against Angeles, including any amounts of base and
additional interest owed. In addition, ILM I maintained a claim for
approximately $408,000 against an affiliate of Angeles which had made a separate
guaranty to ILM I. On March 17, 1995, the Bankruptcy Court handling the Angeles
bankruptcy proceedings approved a final settlement of ILM I's outstanding claims
against Angeles and its affiliates. Pursuant to the terms of this settlement,
ILM I received a cash payment of $1 million on April 14, 1995 in full
satisfaction of the claims, which totaled approximately $1.6 million. This
amount, net of certain related legal expenses, was recorded as a reduction in
the carrying values of ILM I's operating investment properties.
F-32
<PAGE>
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
ILM SENIOR LIVING, INC.
CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
August 31, 1998
(Amounts in thousands)
<TABLE>
<CAPTION>
Initial Cost to Gross Amount at Which Carried
ILM (2) At End of Year
Costs Capitalized
(Removed Subsequent
to) Acquisition
Buildings & of Buildings & Buildings & Unamortized
Description Encumbrances (1) Land Improvements Improvements (3) Land Improvements (5) Mortgage Fees (5) Total
- ----------- ---------------- ---- ------------ ---------------- ---- --------------- -----------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CONGREGATE CARE FACILITIES:
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) 1,346 7,439 429 9,214
Peoria,
Illinois 8,350 524 10,867 (2,831) 490 7,736 408 8,634
Omaha,
Nebraska 8,200 430 8,092 521 910 8,300 305 9,515
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) $ 4,768 $ 43,114 $ 2,256 $ 50,138
-------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- --------
</TABLE>
<TABLE>
<CAPTION>
Life on Which
Depreciation
in Latest
Income
Accumulated Accumulated Date of Date Statement
Depreciation (5) Amortization (5) Construction acquired is Computed
----------------- ---------------- ------------ -------- -----------
<S> <C> <C> <C> <C> <C>
East Lansing,
Michigan $ (1,883) $ (316) 1989 6/29/89 5-40 yrs.
Winston-Salem,
North Carolina (1,777) (305) 1989 6/29/89 5-40 yrs.
Raleigh,
North Carolina (2,049) (369) 1991 4/29/91 5-40 yrs.
Peoria,
Illinois (2,012) (349) 1990 11/30/90 5-40 yrs.
Omaha,
Nebraska (1,975) (261) 1985 2/14/90 5-40 yrs.
Wichita,
Kansas (1,555) (177) 1985 2/14/90 5-40 yrs.
Hot Springs,
Arkansas (620) (99) 1987 12/14/90 5-40 yrs.
Santa Barbara,
California (260) (62) 1979 7/13/92 5-40 yrs.
-------- -------- ----------- ----------- -----------
$ (12,131) $ (1,938)
---------- ----------
---------- ----------
</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.
(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, 1998 for Federal
income tax purposes is approximately $57,468,000.
(5) Certain numbers have been reclassified to conform to the current year's
presentation.
F-33
<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, 1998
(Amounts in thousands)
(5) Reconciliation of real estate owned:
<TABLE>
<CAPTION>
1998 1997 1996
<S> <C> <C> <C>
Balance at beginning of period $ 49,143 $48,610 $ 48,428
Acquisitions and improvements - 12 months ended 8/31/98 995 - -
Acquisitions and improvements - 12 months ended 8/31/97 - 533 -
Acquisitions and improvements - 12 months ended 8/31/96 - - 182
-------- ------- --------
Balance at end of period $50,138 $49,143 $ 48,610
======= ======= ========
(6) Reconciliation of accumulated depreciation and amortization:
Balance at beginning of period $ 12,556 $11,048 $ 9,532
Depreciation and amortization expense - 12 months ended 8/31/98 1,513 - -
Depreciation and amortization expense - 12 months ended 8/31/97 - 1,508 -
Depreciation and amortization expense - 12 months ended 8/31/96 - - 1,516
-------- ------- --------
Balance at end of period $14,069 $12,556 $ 11,048
======== ======= ========
</TABLE>
F-34
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
consolidated balance sheet as of August 31, 1998, and the consolidated statement
of income for the year ended August 31, 1998.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-END> AUG-31-1998
<CASH> 2,264
<SECURITIES> 0
<RECEIVABLES> 474
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,738
<PP&E> 47,882
<DEPRECIATION> 12,131
<TOTAL-ASSETS> 38,910
<CURRENT-LIABILITIES> 326
<BONDS> 0
0
125
<COMMON> 75
<OTHER-SE> 38,384
<TOTAL-LIABILITY-AND-EQUITY> 38,910
<SALES> 7,222
<TOTAL-REVENUES> 7,320
<CGS> 0
<TOTAL-COSTS> 2,597
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4,723
<INCOME-TAX> 0
<INCOME-CONTINUING> 4,723
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,723
<EPS-BASIC> .63
<EPS-DILUTED> .63
</TABLE>
