-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PLx1faFbFFt88VeNPd8ewBtU3D4wDk+ejzhPqpfil2EVcqa9YsnI+LEMR4wc5A1l Hsqa5JNT3GoLfq8cnw68MA== 0000912057-99-007589.txt : 19991130 0000912057-99-007589.hdr.sgml : 19991130 ACCESSION NUMBER: 0000912057-99-007589 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990831 FILED AS OF DATE: 19991129 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILM II SENIOR LIVING INC /VA CENTRAL INDEX KEY: 0000861880 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 061293758 STATE OF INCORPORATION: VA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-18942 FILM NUMBER: 99765545 BUSINESS ADDRESS: STREET 1: 8180 GREENSBORO DRIVE STREET 2: STE 850 CITY: MCLEAN STATE: VA ZIP: 22102 BUSINESS PHONE: 8883573550 MAIL ADDRESS: STREET 1: 1300 CONNECTICUT AVE NW STREET 2: STE 1000 CITY: WASHINGTON STATE: DC ZIP: 20036 FORMER COMPANY: FORMER CONFORMED NAME: PAINE WEBBER INDEPENDENT LIVING MORTGAGE INC II DATE OF NAME CHANGE: 19971103 FORMER COMPANY: FORMER CONFORMED NAME: ILM II SENIOR LIVING INC DATE OF NAME CHANGE: 19970905 FORMER COMPANY: FORMER CONFORMED NAME: PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC II DATE OF NAME CHANGE: 19930511 10-K 1 10-K ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K __X__ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR FISCAL YEAR ENDED: AUGUST 31, 1999 OR _____ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from to . ----- ----- Commission File Number: 0-18942 ------- ILM II SENIOR LIVING, INC. (Exact name of registrant as specified in its charter) VIRGINIA 06-1293758 - ----------------------- ---------------- (State of organization) (I.R.S. Employer Identification No.) 8180 Greensboro Drive, Suite 850, McLean, VA 22102 - -------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: 888-257-3550 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange 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. X --- Indicate by check mark whether the registrant (1) has filed all reports 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, 1999: 5,181,236. The aggregate sales price of the shares sold was $51,812,356. This does not reflect market value. There is no current market for these shares. DOCUMENTS INCORPORATED BY REFERENCE DOCUMENTS Form 10-K Reference - ------------------------------- ------------------- Prospectus of registrant dated Parts II, Part IV August 8, 1990, as supplemented [33 Act filing #33-33857] Current Report on Form 8-K Part IV of registrant dated October 21, 1999 ================================================================================
ILM II SENIOR LIVING, INC. 1999 FORM 10-K TABLE OF CONTENTS PART I PAGE Item 1 Business.............................................................................I-1 Item 2 Properties...........................................................................I-6 Item 3 Legal Proceedings....................................................................I-6 Item 4 Submission of Matters to a Vote of Security Holders..................................I-9 PART II Item 5 Market for the Registrant's Shares and Related Stockholder Matters..............................................................II-1 Item 6 Selected Financial Data.............................................................II-2 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................II-3 Item 8 Financial Statements and Supplementary Data.........................................II-9 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.........................................................II-9 PART III Item 10 Directors and Executive Officers of the Registrant.................................III-1 Item 11 Executive Compensation.............................................................III-2 Item 12 Security Ownership of Certain Beneficial Owners and Management.....................III-2 Item 13 Certain Relationships and Related Transactions.....................................III-3 PART IV Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.....................IV-1 Signatures ....................................................................................IV-2 Index to Exhibits ....................................................................................IV-3 Financial Statements and Supplementary Data........................................................F-1 to F-23
ILM II SENIOR LIVING, INC. PART I ITEM 1. BUSINESS ILM II Senior Living, Inc. (the "Company") was incorporated on February 5, 1990 under the laws of the State of Virginia as a Virginia finite-life corporation, formerly PaineWebber Independent Mortgage Inc. II, for the purpose of making construction and participating mortgage loans secured by rental housing complexes for independent senior citizens ("Senior Housing Facilities"). On September 12, 1990, the Company sold to the public in a registered initial offering pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration Statement No. 33-33857), 5,181,236 shares of common stock, $.01 par value. The Company received capital contributions of $51,812,356, of which $200,000 represented the sale of 20,000 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 six participating mortgage loans secured by senior housing facilities located in five 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, and guaranteed by AHC's corporate parent, Angeles Corporation ("Angeles"). During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on the Company's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. The Company retained special counsel and held extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding settlement agreement between the Company, AHC and Angeles was reached whereby ownership of the 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 II Holding, Inc. ("ILM II Holding"), a Virginia corporation. In August 1995, each of the Property Companies merged into ILM II Holding which is now a subsidiary of the Company. As a result, ownership of the Senior Housing Facilities is now held by ILM II Holding, and the Property Companies no longer exist as separate legal entities. I-1 ILM II SENIOR LIVING, INC. ITEM 1. BUSINESS (CONTINUED) ILM II Holding, Inc. ("ILM II Holding"), a majority-owned subsidiary of the Company, now holds title to the six Senior Housing Facilities, which comprise the balance of the operating investment properties on the accompanying consolidated balance sheets, subject to certain mortgage loans payable to the Company. Such mortgage loans and the related interest expense are eliminated in the consolidation of the financial statements of the Company. The capital stock of ILM II Holding was originally owned by the Company and PaineWebber. ILM II Holding had issued 100 shares of Series A Preferred Stock to the Company in return for a capital contribution in the amount of $495,000 and had issued 10,000 shares of common stock to PaineWebber in return for a capital contribution in the amount of $5,000. The common stock represented approximately 99 percent of the voting power and 1 percent of the economic interest in ILM II Holding, while the preferred stock represented approximately 1 percent of the voting power and 99 percent of the economic interest in ILM II Holding. The Company completed its restructuring plans by converting ILM II 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 II Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM II Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM II Holding was completed at an agreed upon fair value of $40,000, representing a $35,000 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 II 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 II 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 II Holding to each of 111 charitable organizations so that ILM II 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 II 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 II Holding to the charitable organizations at the amount of the initial liquidation preference of $111,000. Such amount is included in general and administrative expenses in the accompanying consolidated statement of income for the year ended August 31, 1997. Cumulative dividends accrued as of August 31, 1999 and 1998, on the Preferred Stock in ILM II Holding totaled $23,000 and $14,000, respectively. I-2 ILM II SENIOR LIVING, INC. ITEM 1. BUSINESS (CONTINUED) As part of the fiscal 1994 Settlement Agreement with AHC, ILM II Holding retained AHC as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement. The management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, in order to maximize the potential returns to the Company's existing Shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code, the Company formed a new corporation, ILM II Lease Corporation ("Lease II"), for the purpose of operating the Senior Housing Facilities under the terms of a facilities lease agreement (the "Facilities Lease Agreement"). All of the shares of capital stock of Lease II were distributed to the holders of record of the Company's common stock and the Senior Housing Facilities were leased to Lease II effective September 1, 1995. Lease II is a public company subject to the reporting obligations of the Securities and Exchange Commission. All responsibility for the day-to-day management of the Senior Housing Facilities, including administration of the property management agreement with AHC, was transferred to Lease II. On July 29, 1996, the management agreement with AHC was terminated and Lease II retained Capital Senior Management 2, Inc. ("Capital") to be the new property manager of its Senior Housing Facilities pursuant to a management agreement (the "Management Agreement"). Lawrence A. Cohen, who, through July 28, 1998, served as President, Chief Executive Officer and Director of the Company and a Director of Lease II, has also served in various management capacities at Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer of Capital Senior Living Corporation. As a result, through July 28, 1998, Capital was considered a related party. RECENT DEVELOPMENTS On February 7, 1999, the Company entered into an agreement and plan of merger, which was amended and restated on October 19, 1999, with Capital Senior Living Corporation, the corporate parent of Capital, and certain affiliates of Capital. If the merger is consummated, the Shareholders of the Company will receive all-cash merger consideration of approximately $14.47 per share. Consummation of this transaction will require, among other things, the affirmative vote of the holders of not less than 66-2/3% of the Company's outstanding common stock. While there can be no assurance, consummation of the merger is presently anticipated in the first quarter of calendar year 2000. In connection with the merger, the Company has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement with Lease II immediately prior to the effective time of the merger. As noted above, the Facilities Lease Agreement, which is scheduled to expire on December 31, 2000, may be terminated earlier at the election of the Lessor in connection with the sale by the Lessor of the Senior Housing Facilities to a non-affiliated third party. As a result of the proposed merger, Lease II would have little "going concern" value. There can be no assurance as to whether the merger will be consummated or, if consummated, as to the timing thereof. I-3 ILM II SENIOR LIVING, INC. ITEM 1. BUSINESS (CONTINUED) At August 31, 1999, through its consolidated subsidiary, the Company owned eight Senior Housing Facilities. The Company's investments as of August 31, 1999 are described below:
Year Property Name Date of Facility Rentable Resident and Location (1) Type of Property Investment Built Units (3) Capacities (3) - --------------------- ---------------- ---------- ----- --------- -------------- The Palms Fort Myers, FL Senior Housing Facility 7/18/90 1988 205 255 Crown Villa Omaha, NE Senior Housing Facility 4/25/91 1992 73 73 Overland Park Place Overland Park, KS Senior Housing Facility 4/9/92 1984 141 153 Rio Las Palmas Stockton, CA Senior Housing Facility 5/14/92 1988 164 190 The Villa at Riverwood St. Louis County, MO Senior Housing Facility 5/29/92 1986 120 140 Villa Santa Barbara (2) Santa Barbara, CA Senior Housing Facility 7/13/92 1979 125 125
(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 I. All amounts generated from the operations of Villa Santa Barbara are equitably apportioned between the Company, together with its consolidated subsidiary, and ILM I, together with its consolidated subsidiary, generally 75% and 25%, respectively. Villa Santa Barbara is owned 75% by ILM II Holding and 25% by ILM Holding, Inc. as tenants in common. Upon the sale of ILM I or the Company, arrangements would be made to transfer the Santa Barbara facility to the non-selling joint tenant (or one of its subsidiaries). The property was extensively renovated in 1995. (3) Rentable units represent the number of apartment units and is a measure commonly used in the real estate industry. Resident capacity equals the number of bedrooms contained within the apartment units and corresponds to measures commonly used in the healthcare industry. The facilities lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM II Holding, as Lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. During the term of the Facilities Lease Agreement, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara facility), unless earlier terminated at the election of the Lessor in connection with the sale by the Lessor of the Senior Housing Facilities to a non-affiliated third party upon 30 days' notice to the Company, Lease II pays annual base rent for the use of all of the Facilities in the aggregate amount of $4,035,600 per year. Lease II also pays variable rent, on a quarterly basis, for each Senior Housing Facility in an amount equal to 40% of the excess of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. For the years ended August 31, 1999 and 1998, variable rental income was $1,261,000 and $984,000, respectively. I-4 ILM II SENIOR LIVING, INC. ITEM 1. BUSINESS (CONTINUED) 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 the 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 net proceeds of any sale transactions are expected to be distributed to the Shareholders, so that the Company will, in effect, be self-liquidating. Through June 18, 1997, and subject to the supervision of the Company's Board of Directors, assistance in the management of the business of the Company was provided by PaineWebber. PaineWebber resigned from this position effective as of June 18, 1997, although PaineWebber agreed to provide certain administrative services to the Company and its affiliates through August 31, 1997. Through the date of its resignation, PaineWebber performed the day-to-day operations of the Company and acted as the investment advisor and consultant for the Company. PaineWebber provided cash management, accounting, tax preparation, financial reporting, investor communications and relations as well as asset management services to the Company. These services are now being provided to the Company, subject to the supervision of the Company's Board of Directors, by various companies and consultants including Cohen & Steers, Greenberg Traurig, Fleet Bank, Ernst & Young LLP and MAVRICC Management Systems, Inc. There are currently three Directors of the Company, none of whom are affiliates of PaineWebber or Capital. The Directors are subject to removal by the vote of the holders of a majority of the outstanding shares of Company common stock. The terms of transactions between the Company and PaineWebber, and similar disclosures with respect to relationships of other related parties which provide services to the Company, are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions. I-5 ILM II SENIOR LIVING, INC. ITEM 2. PROPERTIES As of August 31, 1999, the Company has interests in the six operating properties referred to under Item 1 above, to which reference is made for the description, name and location of such properties. Average occupancy levels for each fiscal quarter during 1999, along with an average for the year are presented below for each property:
Average Quarterly Occupancy -------------------------------------------------------------------------- Fiscal 1999 11/30/98 2/28/99 5/31/99 8/31/99 Average -------- ------- ------- ------- ----------- The Palms 94% 93% 91% 89% 92% Crown Villa 96% 97% 93% 94% 95% Overland Park Place 98% 97% 95% 95% 96% Rio Las Palmas 92% 92% 91% 92% 92% The Villa at Riverwood 97% 93% 86% 87% 91% Villa Santa Barbara 97% 99% 97% 97% 98%
ITEM 3. LEGAL PROCEEDINGS TERMINATION OF MANAGEMENT CONTRACT WITH AHC On July 29, 1996, Lease II and ILM II Holding (collectively for this Item 3, the "Companies") terminated a property management agreement with AHC covering the six Senior Housing Facilities leased by Lease II from ILM II Holding. The management agreement was terminated for "cause" pursuant to the contract. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. The Companies alleged, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. Due to the termination of the management agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the management agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic State of California. The filing was challenged by the Companies, and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed with the Virginia District Court an answer in response to the litigation initiated by the Companies and a counterclaim against ILM II Holding. The counterclaim alleged that the management agreement was wrongfully terminated for cause and requested damages which include the payment of the termination fee in the amount of $750,000, payment of management fees pursuant to the management agreement from August 1, 1996 through October 15, 1996, which is the earliest date that the management agreement could have been terminated without cause, and recovery of attorney's fees and expenses. The aggregate amount of damages against all parties as requested in AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997, the court issued orders to enter judgment against the Company and ILM I in the amount of $1,000,000. The orders did not contain any findings of fact or conclusions of law. On July 10, 1997, the Company, ILM I, Lease I and Lease II filed a notice of appeal to the United States Court of Appeals for the Fourth Circuit from the orders. I-6 ILM II SENIOR LIVING, INC. ITEM 3. LEGAL PROCEEDINGS (CONTINUED) On February 4, 1997, AHC filed a complaint in the Superior Court of the State of California against Capital, the new property manager; Lawrence A. Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and Director of the Company; and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint sought damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to Federal District Court in the Central District of California. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should pay reasonable legal fees and expenses incurred by Capital in the California litigation. As August 31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees totaled approximately $563,000. On August 18, 1998, the Company and its affiliates along with Capital and its affiliates entered into a settlement agreement with AHC. Lease I and Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay $625,000 to AHC in settlement of all claims including those related to the Virginia litigation and the California litigation. The Company and its affiliates also entered into an agreement with Capital and its affiliates to mutually release each other from all claims that any such parties may have against each other, other than any claims under the property management agreements. On September 4, 1998, the full settlement amounts were paid to AHC and its affiliates with Lease I paying $975,000 and Lease II paying $650,000. I-7 ILM II SENIOR LIVING, INC. ITEM 3. LEGAL PROCEEDINGS (CONTINUED) OTHER LITIGATION On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a purported class action on behalf of that trust and all other shareholders of the Company and ILM I in the Supreme Court of the State of New York, County of New York naming the Company, ILM I and their Directors as defendants. The class action complaint alleged that the Directors engaged in wasteful and oppressive conduct and breached fiduciary duties in preventing the sale or liquidation of the assets of the Company and ILM I, diverting certain of their assets. The complaint sought compensatory damages in an unspecified amount, punitive damages, the judicial dissolution of the Company and ILM I, an order requiring the Directors to take all steps to maximize Shareholder value, including either an auction or liquidation, and rescinding certain agreements, and attorney's fees. On July 8, 1998, the Company and its co-defendants moved to dismiss the complaint on all counts. On December 8, 1998, the Court granted the Company's dismissal motion in part but afforded the plaintiffs leave to amend their complaint. In doing so, the Court accepted the Company's position that all claims relating to the derivative actions were filed improperly. In addition, the Court dismissed common law claims for punitive damages, but allowed plaintiffs to amend their claims to assert claims alleging that the defendants injured shareholders without injuring the Company as a whole. On January 22, 1999, the Feldman plaintiffs filed an amended complaint, again purporting to commence a class action, and adding claims under Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Even before the Company and the Board of Directors responded to that amended complaint, the Feldman plaintiffs moved for leave to file a second amended complaint to add claims directed at enjoining the announced potential merger with Capital Senior Living Corporation and, alternatively, for compensatory and punitive damages. At a hearing held on March 4, 1999 relating to the motion for leave to file that second amended complaint and to expedite discovery, the Court granted leave to amend and set a schedule for discovery leading to a trial (if necessary) in the summer of 1999. On March 9, 1999, the Feldman plaintiffs filed a second amended complaint, which included claims for injunctive relief and, in the alternative, damages in an unspecified amount. In response to the Company's motion to dismiss the second amended complaint filed by the plaintiffs, on June 7, 1999 the Court issued an order dismissing the plaintiffs' federal security claims but denying the motion to dismiss plaintiffs' claims for breach of fiduciary duty and judicial dissolution, which motion was addressed to the pleadings and not to the merits of the action. On June 21, 1999, the Company and its co-defendants answered the second amended complaint and denied any and all liability and moved for reconsideration of the portion of the Court's June 7, 1999 order denying their motion to dismiss. In response to discovery requests, the Company, ILM I and others produced documents to the plaintiffs and depositions of current and former directors and others were taken. Discovery was completed as of July 1, 1999. On July 2, 1999, the parties to this action came to an agreement-in-principle to settle the action. On August 3, 1999, the parties entered into a Stipulation of Settlement and on August 11, 1999, the Court signed an order preliminarily approving the Stipulation and providing for notice of the Stipulation to the proposed settlement class. On September 30, 1999, the Court conducted a hearing and on October 4, 1999 issued an order certifying a settlement class and approving the proposed settlement as fair, reasonable and adequate, subject to the condition that certain modifications be made to the Stipulation of Settlement and any related documents filed with the Court on or before October 15, 1999. I-8 ILM II SENIOR LIVING, INC. ITEM 3. LEGAL PROCEEDINGS (CONTINUED) On October 15, 1999, the parties entered into a revised Stipulation of Settlement and filed it with the Court, which approved the settlement, by order dated October 21, 1999. In issuing that order the Court entered a final judgment dismissing the action and all non-derivative claims of the settlement class against the defendants with prejudice. In its October 4th order, the Court also denied the application by plaintiffs' counsel for payment of attorneys' fees and expenses, without prejudice to renewal within 14 days upon reapplication therefor. On or about October 14, 1999, plaintiffs' counsel reapplied to the Court for fees and expenses. A hearing was held November 5, 1999, in which the Court granted the application for attorney's fees in the amount of $950,000 and costs in the amount of $182,000. Under the Stipulation, if the proposed merger is consummated, Capital Senior Living Corporation is responsible for payment of such attorney's fees and expenses sought under this application, and if the proposed merger with Capital Senior Living Corporation is not consummated and ILM I and the Company enter into a transaction having similar effect to the merger with a third party, then ILM I and the Company are responsible for such fees and expenses. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. I-9 ILM II SENIOR LIVING, INC. PART II ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED STOCKHOLDER MATTERS During the public offering period, which commenced August 8, 1990 and ended May 10, 1991, the selling price of the shares of common stock was $10 per share. At August 31, 1999 there were 3,015 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 that the Company does not violate certain share accumulation restrictions imposed by the Internal Revenue Code on REITs. The Company makes quarterly distributions, payable within 45 days after the end of each fiscal quarter, to Shareholders of record on the record date for such quarter as determined by the Directors. The Company intends to make distributions to Shareholders in an amount equal to at least 95% of its taxable income in order to continue to qualify as a REIT. Reference is made to Item 6 below for the amount of cash dividends paid per share of common stock during fiscal 1999. On June 4, 1998, an unsolicited tender offer was filed on Schedule 14D-1 to purchase up to 500,000 outstanding shares of the Company's common stock representing approximately 9.65% of the outstanding shares at $7.00 per share. On June 11, 1998, the offer was increased to $8.00 per share. On June 17, 1998, the Company filed a response on Schedule 14D-9, which response was amended on July 7, 1998, stating that the Company's Board of Directors unanimously concluded that the offer is inadequate and not in the best interests of the Company and its Shareholders. Accordingly, the Board unanimously recommended that the Company's Shareholders reject the offer and not tender their shares. On February 7, 1999, the Company entered into an agreement and plan of merger, which was amended and restated on October 19, 1999, with Capital Senior Living Corporation, the corporate parent of Capital, and certain affiliates of Capital. If the merger is consummated, the Shareholders of the Company will receive all-cash merger consideration of approximately $14.47 per share. Consummation of this transaction will require, among other things, the affirmative vote of the holders of not less than 66-2/3% of the Company's outstanding common stock. While there can be no assurance, consummation of the merger is presently anticipated in the first quarter of calendar year 2000. In connection with the merger, the Company has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement with Lease II immediately prior to the effective time of the merger. As noted above, the Facilities Lease Agreement, which is scheduled to expire on December 31, 2000, may be terminated earlier at the election of the Lessor in connection with the sale by the Lessor of the Senior Housing Facilities to a non-affiliated third party. As a result of the proposed merger, Lease II would have little "going concern" value. There can be no assurance as to whether the merger will be consummated or, if consummated, as to the timing thereof. II-1 ILM II SENIOR LIVING, INC. ITEM 6. SELECTED FINANCIAL DATA
ILM II SENIOR LIVING, INC. For the years ended August 31, 1999, 1998, 1997, 1996 and 1995 (Dollars in thousands, except per share data) 1999 1998 1997(1) 1996 1995 ---- ---- -------- ---- ---- Revenues $5,321 $ 5,065 $ 4,515 $ 46 $ 87 Operating income (loss) 1,697 2,907 2,184 (587) (877) Equity in income from properties securing mortgage loans - - - 2,674 2,308 ----------- ----------- ------------ --------- --------- Net income $1,697 $ 2,907 $ 2,184 $ 2,087 $ 1,431 ====== ======== ======== ======== ======== Earnings per share of common stock $ 0.32 $ 0.56 $ 0.42 $ 0.40 $ 0.27 ========== ========= ========= ========= ========= Cash dividends paid per share of common stock $ 0.85 $ 0.73 $ 0.61 $ 0.50 $ 0.43 ========== ========= ========= ========= ========= August 31 ----------------------------------------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Total assets $31,376 $32,383 $33,355 $33,973 $35,052 ======= ======= ======= ======= ======= Shares outstanding 5,181,236 5,181,236 5,181,236 5,181,236 5,181,236
(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 ILM II 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 September 12, 1990 to May 10, 1991 pursuant to a Registration Statement filed under the Securities Act of 1933. Capital contributions of $51,812,356 were received by the Company (including $200,000 contributed by PaineWebber) and, after deducting selling expenses and offering costs and allowing for adequate cash reserves, approximately $42.9 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 six participating mortgage loans secured by Senior Housing Facilities located in five 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 Senior Housing Facilities was transferred from AHC to certain designated affiliates of the Company which were majority owned by the Company. Subsequently, these affiliates were merged into ILM II Holding which is now a subsidiary of the Company. ILM II Holding holds title to the six Senior Housing Facilities which comprise the balance of operating investment properties in the accompanying consolidated balance sheets, subject to certain mortgage loans payable to the Company. Such mortgage loans and the related interest expense are eliminated in the consolidation of the financial statements of the Company. As part of the fiscal 1994 Settlement Agreement with AHC, ILM II 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 below, the management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, in order to maximize the potential returns to the Company's existing Shareholders while maintaining its qualification as a REIT under the Internal Revenue Code, the Company formed a new corporation, Lease II, for the purpose of operating the Senior Housing Facilities under the terms of a Facilities Lease Agreement. As of August 31, 1995, Lease II, which is taxable as a so-called "C" corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On September 1, 1995, after the Company received the required regulatory approval, it distributed all of the shares of capital stock of Lease II to the holders of record of the Company's common stock. One share of common stock of Lease II was issued for each full share of the Company's common stock held. Prior to the distribution, the Company capitalized Lease II with $500,000 from its existing cash reserves, which was an amount estimated to provide Lease II with necessary working capital. The Facilities Lease Agreement is between the Company's consolidated affiliate, ILM II Holding, as owner of the properties and Lessor, and Lease II as Lessee. The facilities lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM II Holding, as the Lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. Pursuant to the Facilities Lease Agreement, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara property), Lease II pays annual base rent for the use of all of the Senior Housing Facilities in the aggregate amount $4,035,600. Lease II also pays variable rent, on a quarterly basis, for each Senior Housing Facility in an amount equal to 40% of the excess, if any, of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. Variable rental income related to fiscal years 1999 and 1998 was $1,261,000 and $984,000, respectively. The assumption of ownership of the Senior Housing Facilities through ILM II Holding, which was a so-called "C" corporation for tax purposes at the time of the assumption, may result in a possible future tax liability which would be payable upon the ultimate sale of the Senior Housing Facilities (the "built-in gain tax"). The amount of such tax would be calculated based on the lesser of the total net gain realized from the sale transaction or the portion of the net gain realized upon a final sale which is attributable to the period during which the Senior Housing Facilities were held by a C corporation. II-3 ILM II 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 II 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 II Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM II Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM II Holding was completed at an agreed upon fair value of $40,000. With this transfer completed, effective January 23, 1997, ILM II 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 II 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 II Holding to each of 111 charitable organizations so that ILM II 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 are cumulative from the date of issuance. Since ILM II 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 II Holding to the charitable organizations at the amount of the initial liquidation preference of $111,000. Such amount is included in general and administrative expense in the accompanying consolidated statement of income for the year ended August 31, 1997. Cumulative dividends accrued as of August 31, 1999 and 1998, on the preferred stock in ILM II Holding totaled approximately $23,000 and $14,000, respectively. Any future appreciation in the value of the Senior Housing Facilities subsequent to the conversion of ILM II 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 II Holding to a REIT. However, since the end of the Company's original anticipated holding period as defined in the Articles of Incorporation is December 31, 2001, the properties may not be held for an additional ten years. Based on management's current estimate of the increase in the 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 II Holding to a REIT could result in a built-in gain tax of as much as $2.3 million, which could be reduced by approximately $1.4 million using available net operating loss carryforwards of ILM II Holding of approximately $4.2 million. To avoid this built-in gain tax, the Directors are prepared at the appropriate time to recommend to the Shareholders an amendment to the Articles of Incorporation to extend the Company's scheduled liquidation date. ILM II 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 7% from April 1, 1994 through December 1, 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, 1999 through December 31, 1999 and 14% for the period January 1, 2000 through maturity. Since ILM II Holding is consolidated with the Company in the accompanying consolidated financial statements for fiscal years 1999 and 1998, the mortgage loans and related interest expense have been eliminated in consolidation. II-4 ILM II SENIOR LIVING, INC. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Because the ownership of the assets of ILM II Holding was expected to be transferred to the Company or its wholly-owned subsidiary, ILM II Holding was capitalized with funds to provide it with working capital only for a limited period of time. At the present time, ILM II Holding is not expected to have sufficient cash flow during fiscal year 2000 to (i) meet its obligations to make the debt service payments due under the loans and (ii) pay for capital improvements and structural repairs in accordance with the terms of the Facilities Lease Agreement. Although ILM II Holding is not expected to fully fund its scheduled debt service payments to the Company, the current values of the Senior Housing Facilities are well in excess of the mortgage principal amounts plus accrued interest at August 31, 1999. As a result, the Company is expected to recover the full amount that would be due under the loans upon the sale of the Senior Housing Facilities. Lease II has retained Capital to be the property manager of the Senior Housing Facilities and the Company has guaranteed payment of all fees due to Capital pursuant to the Management Agreement which commenced on July 29, 1996. Lawrence A. Cohen, who, through July 28, 1998, served as President, Chief Executive Officer and Director of the Company and a Director of Lease II, has also served in various management capacities at Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer of Capital Senior Living Corporation. As a result, through July 28, 1998, Capital was considered a related party. Under the terms of the Management Agreement, Capital earns a base management fee equal to 4% of the gross operating revenues of the Senior Housing Facilities, as defined. Capital also earns an incentive management fee equal to 25% of the amount by which the average monthly net cash flow of the Senior Housing Facilities, as defined, for the twelve- month period ending on the last day of each calendar month during the term of the Management Agreement exceeds a specified base amount. Each August 31, beginning on August 31, 1997, the base amount is increased based on the percentage increase in the Consumer Price Index as well as 15% of Senior Housing Facility expansion costs. On February 4, 1997, AHC filed a complaint in the Superior Court of the State of California against Capital, the new property manager; Lawrence A. Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and Director of the Company; and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint sought damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to Federal District Court in the Central District of California. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should pay reasonable legal fees and expenses incurred by Capital in the California litigation. As August 31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees totaled approximately $563,000. II-5 ILM II SENIOR LIVING, INC. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) The six Senior Housing Facilities in which the Company has invested averaged 94% and 96% occupancy for the fiscal years ended August 31, 1999 and 1998, respectively. The Company's net operating cash flow is expected to be relatively stable and predictable due to the structure of the Facilities Lease Agreement. The annual base rental payments owed to ILM II Holding are $4,035,600 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 II Holding received variable rent payments in fiscal 1999 and 1998 in the amounts of $1,261,000 and $984,000, respectively. As a result of the status of the Company's net operating cash flow under the current Facilities Lease Agreement, the Company increased its quarterly dividend payment from $.1625 per share to $.1875 per share effective with the dividend paid in January 1998 for the quarter ended November 30, 1997. The Company increased its quarterly dividend payment to $0.2125 per share effective with the dividend paid on October 15, 1998, for the quarter ended August 31, 1998. The Company and ILM I have been pursuing the potential for future expansion of several of the Senior Housing Facilities which are located in areas that have particularly strong markets for senior housing to increase cash flow and shareholder value. Potential expansion candidates include the facilities located in Omaha, Nebraska; St. Louis County, Missouri; and Fort Myers, Florida. During fiscal year 1999, approximately one acre of land located adjacent to the Omaha facility was acquired for approximately $135,000 and during fiscal year 1998, a one-half acre parcel of vacant land adjacent to the Stockton facility was purchased for approximately $136,000. Also included in Land on the accompanying consolidated balance sheets are significant pre-construction design and planning costs incurred at existing facilities for possible future expansions. Although no expansion of the Stockton facility is being considered at this time, the additional land will provide needed parking spaces and improved access to the existing facility as well as future expansion potential. The Fort Myers facility includes a vacant land parcel of approximately one and one-half acres, which could accommodate an expansion of the existing facility. Preliminary feasibility evaluations have been completed for all of these potential expansions and pre-construction design and construction-cost evaluations are underway for expansions of the facilities located in Omaha and Fort Myers. Once the pre-construction design process is complete and projected expansion construction costs are determined, the Company will carefully evaluate the costs and benefits before proceeding with the construction of any of these expansions. Depending on the extent of any expansions deemed appropriate, such plans would result in the need for substantial capital. The Company secured a construction loan facility with a major bank that provides the Company with up to $8.8 million to fund the capital costs of the potential expansion programs. The construction loan facility is secured by a first mortgage of the Senior Housing Facilities and collateral assignment of the Company's leases of such Senior Housing Facilities. The loan expires December 31, 2000, with possible extensions through September 29, 2003. Principal is due at expiration. Interest is payable at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. Loan origination costs in connection with this loan facility are being amortized over the life of the loan. On June 7, 1999, the Company borrowed approximately $1.2 million under the construction loan facility to fund the pre-construction capital costs incurred through April 1999, of the potential expansions of the Senior Housing Facilities. As of August 31, 1999, approximately $7.6 million of the construction loan facility is unused and available. II-6 ILM II SENIOR LIVING, INC. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) At August 31, 1999, the Company had cash and cash equivalents of $1,913,000 compared to $1,896,000 at August 31, 1998. The increase in cash of approximately $17,000 is primarily due to borrowing of approximately $1.2 million under the construction loan facility offset by costs incurred due to the potential merger transaction with Capital Senior Living Corporation. Such amounts will be used for the working capital requirements of the Company, along with the possible investment in the 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 facilities lease payments from Lease II, interest income earned on invested cash reserves and proceeds from the future sales of the underlying operating investment properties. Such sources of liquidity are expected to be adequate to meet the Company's operating requirements on both a short-term and long-term basis. The Company generally will be obligated to distribute annually at least 95% of its taxable income to its Shareholders in order to continue to qualify as a REIT under the Internal Revenue Code. While the Company has potential liabilities pending due to ongoing litigation against the Company, the eventual outcome of this litigation cannot presently be determined. The Company will vigorously defend against all claims made against it and, at this time, it is not certain that the Company will have ultimate responsibility for any such claims. YEAR 2000 The 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 II would not receive rental income as it became due from Senior Living Facility residents. Lease II in turn would fail to pay ILM II Holding lease payments as they arise under the master lease, and ILM II Holding in turn would fail to pay the Company mortgage payments due it. However, the Company believes that given the nature of its business, such problem would be temporary and easily remediable with a simple accounting. MARKET RISK The Company believes its market risk is immaterial. II-7 ILM II SENIOR LIVING, INC. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) RESULTS OF OPERATIONS 1999 COMPARED TO 1998 Net income decreased $1,210,000, or 41.6%, to $1,697,000 for the fiscal year ended August 31, 1999, compared to $2,907,000 for the fiscal year ended August 31, 1998. Total revenue was $5,321,000 for fiscal year 1999, representing an increase in revenue of $256,000, or 5.1%, compared to total revenue of $5,065,000 for fiscal year 1998. Rental and other income increased $277,000, or 5.6%, to $5,265,000 from $4,988,000 last year, due to increased rental income earned pursuant to the terms of the Facilities Lease Agreement. Interest income decreased $21,000, or 27.3%, to $56,000 for the year ended August 31, 1999, compared to $77,000 for the same period last year, primarily due to a decrease in cash and cash equivalents throughout most of fiscal year 1999. Total expenses increased $1,466,000, or 67.9%, to $3,624,000 for the fiscal year ended August 31, 1999, compared to $2,158,000 for the fiscal year ended August 31, 1998. This increase in expenses is primarily attributable to increased professional fees of $1,238,000, or 229.3%, due to increased legal, financial and advisory professionals who were engaged to assist the Company with the proposed agreement and plan of merger with Capital Senior Living Corporation, as discussed in Note 1 to the financial statements, and increased legal fees associated with finalizing the construction loan facility. General and administrative expenses increased $122,000 to $344,000, or 55.0%, for the fiscal year ended August 31, 1999, compared to $222,000 for the same period last year, due to a variety of factors including increased Director and Officer insurance costs of $87,000; increased printing costs of $58,000 primarily due to the potential merger transaction with Capital Senior Living Corporation; offset by a $58,000 decrease in postage and mailing costs and minor increases and decreases in other general and administrative costs. Directors' compensation decreased $28,000, or 25.2%, due to a decrease in the number of Board members. 1998 COMPARED TO 1997 Net income increased $723,000, or 33.1%, to $2,907,000 for the fiscal year ended August 31, 1998, compared to $2,184,000 for the fiscal year ended August 31, 1997. Total revenue was $5,065,000 for fiscal year 1998, representing an increase in revenue of $550,000, or 12.2%, compared to total revenue of $4,515,000 for fiscal year 1997. Rental and other income increased $572,000, or 13.0%, to $4,988,000 from $4,416,000 last year, due to increased rental income earned pursuant to the terms of the Facilities Lease Agreement. Interest income decreased $22,000, or 22.2%, to $77,000 for the twelve-months ended August 31, 1998, compared to $99,000 for the same period last year, as a result of a decrease in the average balances of cash and cash equivalents in fiscal year 1998 versus fiscal year 1997. Total expenses decreased $173,000, or 7.4%, to $2,158,000 for the fiscal year ended August 31, 1998, compared to $2,331,000 for the fiscal year ended August 31, 1997. This decrease in expenses was primarily attributable to a decrease in general and administrative expenses of $341,000, or 60.6%, due, in part, to reductions in advisory fees, reimbursable costs and ILM II Holding restructuring costs as well as the elimination of; offset by an increase in professional fees of $232,000, or 75.3%, associated with restructuring advice provided by the independent investment banking firm and increased legal fees. Directors' compensation increased $29,000, or 35.4%, as a result of more frequent Board of Directors meetings. INFLATION The Company completed its seventh full year of operations in fiscal 1999. The effects of inflation and changes in prices on the Company's operating results to date have not been significant. Inflation in future periods is likely to cause increases in the Company's expenses, which may be partially offset by increases in revenues from the Company's investments in the Senior Housing Facilities. Under the terms of the facilities lease, as discussed further above, the Company, through its consolidated affiliate, ILM II 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 ILM II 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 ILM II SENIOR LIVING, INC. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT There are currently three Directors of the Company. The Directors are subject to removal by the vote of the holders of a majority of the outstanding shares. The directors are responsible for the general policies of the Company, but they are not required to personally conduct the business of the Company in their capacities as Directors. (a) and (b) The names and ages of the Directors and Executive Officers of the Company during fiscal 1999 are as follows:
Name Office Age Dates of Office ---- ------ --- --------------- J. William Sharman, Jr. President and Director 59 6/9/89** - present Jeffry R. Dwyer Secretary and Director 53 6/9/89* - present Carl J. Schramm Director 53 12/5/96 - present
* The date of incorporation of the Company. ** The date of incorporation of the Company as Director; July 28, 1998 as President. (c) There is no family relationship among any of the Directors or Officers. All of the 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 1990 and and was appointed President, succeeding Mr. Cohen, on July 28, 1998. Mr. Sharman is the Chairman of the Board and Chief Executive Officer 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 a President and Director of ILM I, 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 1990. 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 I and President, Secretary and Director of Lease I and Lease II. Mr. Dwyer has written several law review articles and a major treatise on real estate financing and has taught Real Estate Planning as an Adjunct Professor at the Georgetown University Law Center. Mr. Dwyer graduated from Georgetown University and received his law degree from the Georgetown University Law Center. III-1 ILM II 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 I. (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 described in Item 3. (f) Compliance With Exchange Act Filing Requirements: The Securities Exchange Act of 1934 requires the officers and directors of the Company, and persons who own more than ten percent of the Company's outstanding common stock, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten-percent beneficial holders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file. Based solely on its review of the copies of such forms received by it, the Company believes that, during the year ended August 31, 1999, there was compliance with all filing requirements applicable to its officers and directors and ten-percent beneficial holders. ITEM 11. EXECUTIVE COMPENSATION The Company's Directors each receive an annual fee of $12,000 (except for J. William Sharman, Jr., President and Director, who receives $27,000) plus $500 for attending each Board of Directors meeting and reimbursement for expenses incurred in attending meetings and as a result of other work performed for the Company. Officers of the Company are not compensated. Jeffry R. Dwyer is a shareholder of and receives compensation from Greenberg Traurig, which acts as Counsel to the Company and its affiliates. The former officers of the Company who were also officers of PaineWebber received compensation from PaineWebber which indirectly related to services to the Company because the Company was required to pay certain fees to PaineWebber as described in Item 13. When PaineWebber resigned as advisor to the Companies, the former officers resigned effective the same date, therefore no services were provided by such persons subsequent to June 18, 1997. Lawrence A. Cohen, who was President, Chief Executive Officer and a Director of the Company until July 28, 1998, also received compensation from Capital Senior Living Corporation, an affiliate of Capital, a related party through July 28, 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) As of the date hereof, no person of record owns or is known by the Company to own beneficially more than five percent of the outstanding shares of common stock of the Company. (b) The Directors and Officers of the Company do not have any direct or indirect ownership of shares (c) There exists no arrangement, known to the Company, the operation of which may at a subsequent date result in a change in control of the Company. III-2 ILM II SENIOR LIVING, INC. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Subject to the supervision of the Company's Board of Directors, assistance with the management of the business of the Company was provided by PaineWebber. PaineWebber received fees and compensation determined on a agreed-upon basis, in consideration of various services performed in connection with the sale of the shares, the management of the Company and the acquisition, management and disposition of the Company's investments. The type of compensation to be paid by the Company to PaineWebber under the terms of the advisory agreement was as follows. (i) Under the former advisory agreement, PaineWebber had specific management responsibilities; to perform day-to-day operations of the Company and to act as the investment advisor and consultant for the Company in connection with general policy and investment decisions. PaineWebber received an annual base fee and an incentive fee of 0.25% and 0.25%, respectively, of the capital contributions of the Company, as defined, as compensation for such services. Incentive Fees are subordinated to Shareholders' receipt of distributions of net cash sufficient to provide a return equal to 10% per annum. For the years ended August 31, 1999, 1998 and 1997, PaineWebber earned base management fees totaling $0, $0 and $103,000, respectively. Payment of incentive management fees was suspended effective April 15, 1993 in conjunction with a reduction in the Company's quarterly dividend payments. (ii) For its services in finding and recommending investments, PaineWebber received mortgage placement fees equal to 2% of the capital contributions. Mortgage placement fees of approximately $1,000,000 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 $425,141 were earned by PaineWebber during the Company's investment acquisition period. Such fees have been capitalized and are included in the cost of the operating investment properties on the accompanying consolidated balance sheet. (iv) In connection with the construction of Senior Housing Facilities, PaineWebber received a fee, paid directly by AHC, equal to 1% of the principal amount of each construction loan for administering construction loans made by the Company. Such fees received by PaineWebber totaled $431,000 during the Company's investment acquisition period. (v) Under the former advisory agreement, PaineWebber was entitled to receive 1% of disposition proceeds, as defined, until the shareholders received dividends of net cash equal to their adjusted capital investments, as defined, plus a 12% non-compounded annual return on their adjusted capital investments; all disposition proceeds thereafter until PaineWebber received an aggregate of 5% of disposition proceeds; and, thereafter, 5% of disposition proceeds. PaineWebber was reimbursed for their direct expenses relating to the offering of shares, the administration of the Company and the acquisition and operations of the Company's real estate investments. Included in general and administrative expenses on the accompanying statements of income for the years ended August 31, 1999, 1997 and 1996 is $0, $118,000 and $107,000, respectively, representing reimbursements to PaineWebber for providing certain financial, accounting and investor communication services to the Company. Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provided cash management services with respect to the Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. During fiscal 1999, 1998 and 1997, Mitchell Hutchins earned $0, $0 and $5,000 (included in general and administrative expenses) for managing the Company's cash assets, respectively. III-3 ILM II SENIOR LIVING, INC. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED) 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 II 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 II, has also served in various management capacities at Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer and Acting Chief Financial Officer of Capital Senior Living Corporation. As a result, through July 28, 1998, Capital was considered a related party. For the years ended August 31, 1999 and 1998, Capital earned property management fees from Lease II of $980,000 and $899,000, respectively. On February 4, 1997, AHC filed a complaint in the Superior Court of the State of California against Capital, the new property manager; Lawrence A. Cohen, who, through July 28, 1998, was President, Chief Executive Officer and Director of the Company; and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint sought damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to Federal District Court in the Central District of California. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should pay reasonable legal fees and expenses incurred by Capital in the California litigation. As August 31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees totaled approximately $563,000. On September 18, 1997, Lease II 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 II for all costs related to these potential expansions including fees to Capital Senior Development, Inc. For the years ended August 31, 1999 and 1998, Capital Senior Development, Inc. earned fees from the Company of $15,000 and $73,000, respectively, for managing pre-construction development activities for potential expansions of the Senior Housing Facilities. Jeffry R. Dwyer, Secretary and Director of the Company, is a shareholder of Greenberg Traurig, Counsel to the Company and its affiliates since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig earned fees from the Company of $1,168,000 and $233,000, respectively. III-4 ILM II SENIOR LIVING, INC. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: (1) and (2) Financial Statements and Schedules: The response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements and Financial Statement Schedules at page F-1. (3) EXHIBITS: The exhibits listed on the accompanying index to exhibits at page IV-3 are filed as part of this Report. (b) The Company filed a Current Report on Form 8-K dated October 21, 1999 announcing that the Company had entered into an amended and restated agreement and plan of merger with Capital Senior Living Corporation. The Company filed a Current Report on Form 8-K dated August 13, 1999 announcing that a Stipulation of Settlement was reached in the Feldman litigation. The Company filed a Current Report on Form 8-K dated February 7, 1999 reporting that the Company entered into an Agreement and Plan of Merger with Capital Senior Living Corporation. (c) Exhibits: See (a) (3) above. (d) Financial Statement Schedules: The response to this portion of Item 14 is submitted as a separate section of this report. See Index to Financial Statements and Financial Statement Schedules at page F-1. IV-1 ILM II 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 II SENIOR LIVING, INC. By:. /s/ J. William Sharman, Jr. ----------------------------------------- J. William Sharman, Jr. President and Chief Executive Officer Dated: NOVEMBER 23, 1999 ----------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company in the capacity and on the dates indicated. By: /s/ J. William Sharman, Jr. Date: November 23, 1999 ---------------------------------- ----------------------- J. William Sharman, Jr. Director By: /s/ Jeffry R. Dwyer Date: November 23, 1999 ---------------------------------- ---------------------- Director By: /s/ Carl J. Schramm Date: November 22, 1999 ---------------------------------- ---------------------- Carl J. Schramm Director IV-2 ILM II SENIOR LIVING, INC. ANNUAL REPORT ON FORM 10-K ITEM 14(a)(3) ILM II SENIOR LIVING, INC. INDEX TO EXHIBITS
PAGE NUMBER IN THE REPORT OR EXHIBIT NO. DESCRIPTION OF DOCUMENT OTHER REFERENCE - ----------------------------- ----------------------------------------- -------------------------------------- (3) and (4) Prospectus of the Registrant dated Filed with the Commission pursuant to August 8, 1990, as supplemented, with Rule 424(c) and incorporated herein particular reference to the Restated by reference. Certificate and Agreement of Limited Partnership. (10) Material contracts previously filed as Filed with the Commission pursuant to exhibits to registration statements and Section 13 or 15(d) of the Securities amendments thereto of the registrant Exchange Act of 1934 and incorporated together with all such contracts filed herein by reference. as exhibits of previously filed Forms 8-K and Forms 10-K are hereby incorporated herein by reference. Contracts regarding retention by ILM II Filed as Exhibits 1 and 2 to the Lease Corporation of Capital Senior Current Report on Form 8-K dated Management 2, Inc., as property manager. July 18, 1996 and incorporated herein by reference. (13) Annual Reports to Stockholders No Annual Report for the year ended August 31, 1999 has been sent to the Stockholders. An Annual Report will be sent to the Stockholders subsequent to this filing. (27) Financial Data Schedule Filed as the last page of EDGAR submission following the Financial Statements and Financial Statement Schedules required by Item 14.
IV-3 ILM II SENIOR LIVING, INC. ANNUAL REPORT ON FORM 10-K ITEM 14(a)(1) AND (2) AND 14(d) ILM II SENIOR LIVING, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
ILM II SENIOR LIVING, INC.: REFERENCE Report of Independent Auditors F-2 Consolidated Balance Sheets as of August 31, 1999 and 1998 F-3 Consolidated Statements of Income for the years ended August 31, 1999, 1998 and 1997 F-4 Consolidated Statements of Changes in Shareholders' Equity for the years ended August 31, 1999, 1998 and 1997 F-5 Consolidated Statements of Cash Flows for the years ended August 31, 1999, 1998 and 1997 F-6 Notes to Consolidated Financial Statements F-7 SCHEDULE: Schedule III - Real Estate and Accumulated Depreciation F-21
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 ILM II SENIOR LIVING, INC. REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Shareholders of ILM II Senior Living, Inc. We have audited the accompanying consolidated balance sheets of ILM II Senior Living, Inc. and subsidiary, as of August 31, 1999 and 1998, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended August 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on 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 II Senior Living, Inc. and subsidiary, at August 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended August 31, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Dallas, Texas October 22, 1999 except for Note 5, as to which the date is November 5, 1999 F-2 ILM II SENIOR LIVING, INC. CONSOLIDATED BALANCE SHEETS August 31, 1999 and 1998 (Dollars in thousands, except per share data)
ASSETS 1999 1998 ------------ ----------- Operating investment properties, at cost: Land $ 5,664 $ 5,518 Building and improvements 27,957 27,726 Furniture, fixtures and equipment 3,815 3,815 --------- ---------- 37,436 37,059 Less: accumulated depreciation (8,834) (7,599) 28,602 29,460 Mortgage placement fees 1,425 1,425 Less: accumulated amortization (1,108) (966) --------- ---------- 317 459 Loan origination fees 144 72 Less: accumulated amortization (42) - --------- ---------- 102 72 Cash and cash equivalents 1,913 1,896 Accounts receivable - related party 337 273 Prepaid expenses and other assets 68 154 Deferred rent receivable 37 69 --------- ---------- $ 31,376 $ 32,383 ======== =========
LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses $ 219 $ 171 Accounts payable - related party 527 49 Construction loan payable 1,165 - Preferred shareholders' minority interest in consolidated subsidiary 134 125 ---------- --------- Total liabilities 2,045 345 Commitments and contingencies Shareholders' equity: Common stock, $0.01 par value, 12,500,000 shares authorized, 5,181,236 shares issued and outstanding 52 52 Additional paid-in capital 44,823 44,823 Accumulated deficit (15,544) (12,837) -------- -------- Total shareholders' equity 29,331 32,038 -------- -------- $ 31,376 $ 32,383 ======== ========
See accompanying notes. F-3 ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF INCOME For the years ended August 31, 1999, 1998, and 1997 (Dollars in thousands, except per share data)
1999 1998 1997 ---------- ---------- ---------- REVENUES: Rental and other income $5,265 $4,988 $4,416 Interest income 56 77 99 --------- --------- --------- 5,321 5,065 4,515 EXPENSES: Depreciation expense 1,235 1,142 1,132 Amortization expense 184 143 143 Management fees 103 - - General and administrative 344 222 563 Professional fees 1,778 540 308 Director compensation 83 111 82 --------- --------- --------- 3,624 2,158 2,331 --------- --------- --------- NET INCOME $1,697 $2,907 $2,184 ====== ====== ====== Earnings per share of common stock $ 0.32 $0.56 $0.42 ====== ===== ===== Cash dividends paid per share of common stock $ 0.85 $0.73 $0.61 ====== ===== =====
The above earnings and cash dividends paid per share of common stock are based upon the 5,181,236 shares outstanding during the year. See accompanying notes. F-4 ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the years ended August 31, 1999, 1998 and 1997 (Dollars in thousands, except per share data)
COMMON STOCK $.01 PAR VALUE ADDITIONAL ------------------------ PAID-IN ACCUMULATED SHARES AMOUNT CAPITAL DEFICIT TOTAL ------ ------ ----------- ----------- ----- SHAREHOLDERS' EQUITY AT AUGUST 31, 1996 5,181,236 $52 $44,823 $(10,999) $33,876 Cash dividends paid - - - (3,173) (3,173) Net income - - - 2,184 2,184 ----------- --------- --------- ---------- --------- SHAREHOLDERS' EQUITY AT AUGUST 31, 1997 5,181,236 52 44,823 (11,988) 32,887 Cash dividends paid - - - (3,756) (3,756) Net income - - - 2,907 2,907 ----------- -------- --------- ---------- --------- SHAREHOLDERS' EQUITY AT AUGUST 31, 1998 5,181,236 52 44,823 (12,837) 32,038 Cash dividends paid - - - (4,404) (4,404) Net income - - - 1,697 1,697 ----------- -------- --------- ---------- --------- SHAREHOLDERS' EQUITY AT AUGUST 31, 1999 5,181,236 $52 $44,823 $(15,544) $29,331 =========== ======== ========= ========== =========
See accompanying notes. F-5 ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended August 31, 1999, 1998, and 1997 (In thousands)
1999 1998 1997 ---------- ------------ ------------ Cash flows from operating activities: Net income $ 1,697 $ 2,907 $ 2,184 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 1,419 1,285 1,275 Charitable contribution of subsidiary's preferred stock and accrued dividends 9 9 116 Changes in assets and liabilities: Interest and other receivables - - 178 Accounts receivable - related party (64) (122) 74 Prepaid expenses and other assets 86 (77) (68) Deferred rent receivable 32 31 31 Accounts payable - related party 478 (205) 173 Accounts payable and accrued expenses 48 73 82 -------- ---------- ---------- Net cash provided by operating activities 3,705 3,901 4,045 -------- ---------- ---------- Cash flows (used in) provided by investing activities: ILM II Holding acquired cash balance - - 245 Additions to operating investment properties (377) (538) (205) --------- ----------- ----------- Net cash (used in) provided by investing activities (377) (538) 40 --------- ----------- ---------- Cash flows used in financing activities: Loan origination fees paid (72) (72) - Proceeds from construction loan facility 1,165 - - Cash dividends paid to shareholders (4,404) (3,756) (3,173) --------- ----------- ----------- Net cash used in financing activities (3,311) (3,828) (3,173) --------- ----------- ----------- Net increase (decrease) in cash and cash equivalents 17 (465) 912 Cash and cash equivalents, beginning of year 1,896 2,361 1,449 -------- ---------- ---------- Cash and cash equivalents, end of year $ 1,913 $ 1,896 $ 2,361 ======== ========== ========== Cash paid for state income taxes $ 42 $ 4 $ - ========= ========== ========== Cash paid for interest $ 11 $ - $ - ========= ========== ==========
See accompanying notes. F-6 ILM II SENIOR LIVING, INC. Notes to Financial Statements 1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION ILM II Senior Living, Inc. (the "Company), formerly PaineWebber Independent Mortgage Fund, Inc. II, was organized as a corporation on February 5, 1990 under the laws of the State of Virginia. On September 12, 1990, 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. 33-33857), (the "Prospectus"). The public offering terminated on May 10, 1991 with a total of 5,181,236 shares issued. The Company received capital contributions of $51,812,356, of which $200,000 represented the sale of 20,000 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 six participating mortgage loans secured by senior housing facilities ("Senior Housing Facilities") located in five states. 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 and guaranteed by AHC's corporate parent, Angeles Corporation ("Angeles"). During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on the Company's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. The Company retained special counsel and held extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding Settlement Agreement between the Company, AHC and Angeles was reached whereby ownership of the Senior Housing Facilities would be transferred from AHC to the Company or its designated affiliates. Under the terms of the Settlement Agreement, the Company would release AHC and Angeles from certain obligations under the loans. On April 27, 1994, each of the Senior Housing Facilities owned by AHC and securing the loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with the Company (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994 and were made pursuant to the Settlement Agreement entered into on February 17, 1994 ("the Settlement Agreement") between the Company and AHC which had previously been approved by the bankruptcy court handling the bankruptcy case of Angeles. All of the capital stock of each Property Company was held by ILM II Holding, Inc. ("ILM II Holding"), a Virginia corporation. In August 1995, each of the Property Companies merged into ILM II Holding which is now a subsidiary of the Company. As a result, ownership of the Senior Housing Facilities is now held by ILM II Holding, and the Property Companies no longer exist as separate legal entities. ILM II Holding now holds title to the six 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 the consolidation of the financial statements of the Company. The capital stock of ILM II Holding was originally owned by the Company and PaineWebber. ILM II Holding had issued 100 shares of Series A Preferred Stock to the Company in return for a capital contribution in the amount of $495,000 and had issued 10,000 shares of common stock to PaineWebber in return for a capital contribution in the amount of $5,000. The common stock represented approximately 99 percent of the voting power and 1 percent of the economic interest in ILM II Holding, while the preferred stock represented approximately 1 percent of the voting power and 99 percent of the economic interest in ILM II Holding. F-7 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED) The Company completed its restructuring plans by converting ILM II 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 II Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM II Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM II Holding was completed at an agreed upon fair value of $40,000, representing a $35,000 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 II 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 "Preferred Stock"). The number of authorized shares of preferred and common stock in ILM II 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 II Holding to each of 111 charitable organizations so that ILM II 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 II 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 II 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, 1999 and 1998, on the preferred stock in ILM II Holding totaled approximately $23,000 and $14,000, respectively. As part of the fiscal 1994 Settlement Agreement with AHC, ILM II 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 II Lease Corporation ("Lease II"), 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 II to the holders of record of the Company's common stock. The Senior Housing Facilities were leased to Lease II effective September 1, 1995 (see Note 4 for a description of the Facilities Lease Agreement). Lease II is a public company subject to the reporting obligations of the Securities and Exchange Commission. F-8 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 1. NATURE OF OPERATIONS, RESTRUCTURING, AND BASIS OF PRESENTATION (CONTINUED) On February 7, 1999, the Company entered into an agreement and plan of merger, which was amended and restated on October 19, 1999, with Capital Senior Living Corporation, the corporate parent of Capital, and certain affiliates of Capital. If the merger is consummated, the Shareholders of the Company will receive all-cash merger consideration of approximately $14.47 per share. Consummation of this transaction will require, among other things, the affirmative vote of the holders of not less than 66-2/3% of the Company's outstanding common stock. While there can be no assurance, consummation of the merger is presently anticipated in the first quarter of calendar year 2000. In connection with the merger, the Company has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement with Lease II immediately prior to the effective time of the merger. As noted above, the Facilities Lease Agreement, which is scheduled to expire on December 31, 2000, may be terminated earlier at the election of the Lessor in connection with the sale by the Lessor of the Senior Housing Facilities to a non-affiliated third party. There can be no assurance as to whether the merger will be consummated or, if consummated, as to the timing thereof. F-9 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of August 31, 1999 and 1998 and revenues and expenses for each of the three years in the period ended August 31, 1999. Actual results could differ from the estimates and assumptions used. The Company's significant accounting policies are summarized as follows: A. BASIS OF PRESENTATION The operating cycle in the real estate industry is longer than one year and the distinction between current and non-current is of little relevance. Accordingly, the accompanying consolidated balance sheets are presented in an unclassified format. Effective January 10, 1997, the Company purchased the remaining common shares held by PaineWebber of ILM II Holding which provided the Company with 100% majority voting control, for $40,000 which is included in general and administrative expense for the year ended August 31, 1997. The accompanying financial statements include the financial statements of the Company and ILM II Holding. The results of operations of ILM II Holding have been included in the consolidated results of operations of the Company since September 1, 1996. All intercompany balances and transactions have been eliminated in consolidation. B. INCOME TAXES The Company has elected to qualify and to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, for each taxable year of operations. As a REIT, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby effectively subjecting the distributed net taxable income of the Company to taxation at the shareholder level only, provided it distributes at least 95% of its taxable income and meets certain other requirements for qualifying as a real estate investment trust. In connection with the settlement agreement described in Note 1, the Company, through ILM II Holding, obtained title to the Senior Housing Facilities securing its mortgage loan investments. To retain REIT status, the Company must ensure that 75% of its annual gross income is received from qualified sources. Under the original investment structure, interest income from the Company's mortgage loans was a qualified source. The Senior Housing Facilities that are now owned by a subsidiary of the Company provide residents with more services, such as meals, activities, assisted living, etc., than are customary for ordinary residential apartment properties. As a result, a significant portion of the rents paid by the residents includes income for the increased level of services received by them. Consequently, the rents paid by the residents likely would not be qualified rents for REIT qualification 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 facilities 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 II, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to Lease II effective September 1, 1995 (see Note 4 for a description of the Facilities Lease Agreement). F-10 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The assumption of ownership of the Senior Housing Facilities through ILM II Holding, which was organized as a so-called "C" corporation for tax purposes, has resulted in a possible future tax liability which would be payable upon the ultimate sale of the Senior Housing Facilities (the "built-in gain tax"). The amount of such tax would be calculated based on the lesser of the total net gain realized from the sale transaction or the portion of the net gain realized upon a final sale which is attributable to the period during which the Senior Housing Facilities were held by a C corporation. The Company completed its restructuring plans by converting ILM II 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 II 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 II Holding to a REIT. However, since the end of the Company's original anticipated holding period as defined in the Articles of Incorporation is December 31, 2001, the Senior Housing Facilities might not be held for an additional 10 years. Based on management's estimate of the increase in the 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 II Holding to a REIT could result in a built-in gain tax of as much as $2.3 million, which could be reduced by approximately $1.4 million using available net operating loss carryforwards of ILM II Holding of approximately $4.2 million. The Company's consolidated subsidiary, ILM II Holding, has incurred losses for tax purposes since inception. Neither the Company nor ILM II Holding is likely to be able to use these losses to offset future tax liabilities other than the built-in gain tax above. Accordingly, no income tax benefit is reflected in these consolidated financial statements. The Company reports on a calendar year basis for income tax purposes. All distributions during calendar years 1999, 1998 and 1997 were ordinary taxable dividends. C. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include all highly liquid investments with original maturities of 90 days or less. D. OPERATING INVESTMENT PROPERTIES Operating investment properties are carried at the lower of cost, reduced by accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the owner's investment through expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its current market value, as determined on a discounted basis. None of the operating investment properties were held for sale as of August 31, 1999 or 1998. Depreciation expense is provided on a straight-line basis using an estimated useful life of 40 years for the buildings and improvements and five years for the furniture, fixtures and equipment. F-11 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The Company reviews the carrying value of a long-lived asset if facts and circumstances suggest that it may be impaired or that the amortization period may need to be changed. The Company considers external factors relating to the long-lived asset, including occupancy trends, local market developments, changes in payments, and other publicly available information. If these external factors indicate the long-lived asset will not be recoverable, based upon undiscounted cash flows of the long-lived asset over its remaining life, the carrying value of the long-lived asset will be reduced by the estimated shortfall of discounted cash flows. The Company does not believe there are any indicators that would require an adjustment to the carrying value of its long-lived assets or their remaining useful lives as of August 31, 1999. Mortgage placement fees at August 31, 1999 of $1,425,000 were incurred by the Company and these fees are included in the accompanying consolidated balance sheets. Accumulated amortization of mortgage placement fees at August 31, 1999 and 1998 was $1,108,000 and $966,000, respectively. At August 31, 1999 and 1998, loan origination fees of $144,000 and $72,000 relating to the construction loan facility (see Note 6) are included on the accompanying consolidated balance sheet. These fees are being amortized to expense on a straight-line basis over the term of the loan. Accumulated amortization at August 31, 1999 and 1998 was $42,000 and $0, respectively. Capitalized interest at August 31, 1999 and 1998 was $17,000 and $0, respectively. E. RENTAL REVENUES In fiscal years 1999 and 1998, rental revenues consist of payments due from Lease II under the terms of the Facilities Lease Agreement described in Note 4. Base rental income under the facilities 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, 1999 and 1998 represents the difference between rental income on a straight-line basis and rental income received under the terms of the facilities lease. 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 maturity of such instrument. F-12 ILM II SENIOR LIVING, INC. Notes to 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 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 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 advisory agreement, PaineWebber had specific management responsibilities; to perform day-to-day operations of the Company and to act as the investment advisor and consultant for the Company in connection with general policy and investment decisions. PaineWebber received an annual base fee and an incentive fee of 0.25% and 0.25%, respectively, of the capital contributions of the Company, as defined, as compensation for such services. Incentive fees are subordinated to shareholders' receipt of distributions of net cash sufficient to provide a return equal to 10% per annum. For the years ended August 31, 1999, 1998 and 1997, PaineWebber earned base management fees totaling $0, $0 and $103,000, respectively. Payment of incentive management fees was suspended effective April 15, 1993 in conjunction with a reduction in the Company's quarterly dividend payments. (ii) For its services in finding and recommending investments, PaineWebber received mortgage placement fees equal to 2% of the capital contributions. Mortgage placement fees of approximately $1,000,000 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 the loan amounts. Loan servicing fees totaling $425,000 were earned by PaineWebber during the Company's investment due diligence period. Such fees have been capitalized and are included in the cost of the operating investment properties on the accompanying consolidated balance sheets. (iv) PaineWebber was entitled to receive 1% of disposition proceeds, as defined, until the shareholders have received dividends of net cash equal to their adjusted capital investments, as defined, plus a 12% non-compounded annual return on their adjusted capital investments; all disposition proceeds thereafter until PaineWebber has received an aggregate of 5% of disposition proceeds; and, thereafter, 5% of disposition proceeds. PaineWebber was reimbursed for its direct expenses relating to the offering of shares, the administration of the Company and the acquisition and operations of the Company's real estate investments. Included in general and administrative expenses on the accompanying statements of income for the years ended August 31, 1999, 1998 and 1997 is $0, $0 and $118,000, respectively, representing reimbursements to PaineWebber for providing certain financial, accounting and investor communication services to the Company. Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provided cash management services with respect to the Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. During fiscal years 1999, 1998 and 1997, Mitchell Hutchins earned $0, $0 and $5,000 (included in general and administrative expenses) for managing the Company's cash assets, respectively. F-13 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 3. RELATED PARTY TRANSACTIONS (CONTINUED) Lease II has retained Capital to be the property manager of the Senior Housing Facilities and the Company has guaranteed the payment of all fees due to Capital pursuant to a Management Agreement which commenced on July 29, 1996. Lawrence A. Cohen, who, through July 28, 1998, served as President, Chief Executive Officer and Director of the Company and a Director of Lease II, has also served in various management capacities at Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer of Capital Senior Living Corporation. As a result, through July 28, 1998, Capital was considered a related party. For the years ended August 31, 1999 and 1998, Capital earned property management fees from Lease II of $980,000 and $899,000, respectively. On February 4, 1997, AHC filed a complaint in the Superior Court of the State of California against Capital, the new property manager; Lawrence A. Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and Director of the Company; and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint sought damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to Federal District Court in the Central District of California. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should pay reasonable legal fees and expenses incurred by Capital in the California litigation. As of August 31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees totaled approximately $563,000. On September 18, 1997, Lease II 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 II for all costs related to these potential expansions including fees to Capital Senior Development, Inc. For the years ended August 31, 1999 and 1998, Capital Senior Development, Inc. earned fees from the Company of $15,000 and $73,000, respectively, for managing pre-construction development activities for potential expansions of the Senior Housing Facilities. Jeffry R. Dwyer, Secretary and Director of the Company, is a shareholder of Greenberg Traurig, Counsel to the Company and its affiliates since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig received fees from the Company of $1,168,000 and $224,000, respectively. Accounts receivable - related party at August 31, 1999 and 1998 represents amounts due from an affiliated company, Lease II, for variable rent. Accounts payable - related party at August 31, 1999, includes $50,000 of expense reimbursements payable to Lease II; $194,000 in variable rent received from Lease II in advance; and $283,000 in unbilled legal fees due to Greenberg Traurig, Counsel to the Company and its affiliates and a related party, as described above. Accounts payable - related party at August 31, 1998 includes $49,000 in unbilled legal fees that were due to Greenberg Traurig and subsequently paid during fiscal year 1999. F-14 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE As of August 31, 1999, the Company, through its consolidated affiliate, owned six 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:
Year Rentable Resident Facility Date of Name Location Units (3) Capacities(3) Built Investment (1) ---- -------- --------- ------------- ----- -------------- The Palms Fort Myers, FL 205 255 205 7/18/90 Crown Villa Omaha, NE 73 73 73 4/25/91 Overland Park Place Overland Park, KS 141 153 141 4/9/92 Rio Las Palmas Stockton, CA 164 190 164 5/14/92 The Villa at Riverwood St. Louis County, MO 120 140 120 5/29/92 Villa Santa Barbara (2) Santa Barbara, CA 125 125 125 7/13/92
(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 I. All amounts generated from the operations of Villa Santa Barbara are equitably apportioned between the Company, together with its consolidated subsidiary, and ILM I, together with its consolidated subsidiary, generally 75% and 25%, respectively. The financial position, results of operations and cash flows presented in these consolidated financial statements include only the 75% allocable portion of the Company's interest in the Santa Barbara Facility. Villa Santa Barbara is owned 75% by ILM II Holding and 25% by ILM Holding, Inc. as tenants in common. (3) Rentable units represent the number of apartment units and is a measure commonly used in the real estate industry. Resident capacity equals the number of bedrooms contained within the apartment units and corresponds to measures commonly used in the healthcare industry. The cost basis of the operating investment properties reflects amounts funded under the Company's participating mortgage loans less certain guaranty payments received from AHC in excess of the net cash flow of the Senior Housing Facilities under the terms of the Exclusivity Agreement with the Company. The transfer of ownership of the Senior Housing Facilities from AHC in fiscal 1994 resulted in no gain or loss recognition by the Company for financial reporting purposes. In accordance with generally accepted accounting principles, the Company had always accounted for its investments in acquisition and construction loans under the equity method, as if such investments were equity interests in a joint venture. Accordingly, the carrying values of such investments were reduced from inception by non-cash depreciation charges and by payments from AHC, prior to the default in fiscal 1993, in excess of the net cash flow generated by the Senior Housing Facilities received pursuant to the guaranty agreement between the Company and AHC. As a result of this accounting treatment, the carrying values of the Company's investments 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 F-15 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE (CONTINUED) 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 7% from April 1, 1994 through December 1, 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, 1999 through December 31, 1999 and 14% for the period January 1, 2000 through maturity. In August 1995, each of the Property Companies was merged into ILM II Holding. As a result, ownership of the Senior Housing Facilities, as well as the obligation under the loans, is now held by ILM II Holding, and the Property Companies no longer exist as separate legal entities. Since ILM II Holding is consolidated with the Company in the accompanying financial statements for fiscal 1999 and 1998, the mortgage loans and related interest expense have been eliminated in consolidation. Subsequent to the effective date of the Settlement Agreement with AHC, in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code, the Company formed a new corporation, Lease II, for the purpose of operating the Senior Housing Facilities under the terms of a Facilities Lease Agreement. As of August 31, 1995, Lease II, which is taxable as a so-called `C" corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On September 1, 1995, after the Company received the required regulatory approval, it distributed all of the shares of capital stock of Lease II to the holders of record of the Company's common stock. One share of common stock of Lease II was issued for each full share of the Company's common stock held. Prior to the distribution, the Company capitalized Lease II with $500,000 from its existing cash reserves, which was an amount estimated to provide Lease II with necessary working capital. The Facilities Lease Agreement is between the Company's consolidated subsidiary, ILM II Holding, as owner of the Senior Housing Facilities and Lessor, and Lease II as Lessee. The Lessor has the right to terminate the Facilities Lease Agreement as to any property sold by the Lessor as of the date of such sale. The Facilities Lease Agreement is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM II Holding, as Lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. During the term of the Facilities Lease Agreement, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara facility), unless earlier terminated at the election of the Lessor in connection with the sale by the Lessor of the Senior Housing Facilities to a non-affiliated third party upon 30 days' notice to the Company, Lease II pays annual base rent for the use of all of the Facilities in the aggregate amount of $4,035,600 per year. Lease II also pays variable rent, on a quarterly basis, for each Senior Housing Facility in an amount equal to 40% of the excess of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. For the years ended August 31, 1999 and 1998, variable rental income was $1,261,000 and $984,000, respectively. F-16 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 4. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE (CONTINUED) Condensed balance sheets as of August 31, 1999 and 1998, and condensed statements of operations for the years ended August 31, 1999 and 1998 of Lease II are as follows (in thousands):
ASSETS 1999 1998 ---------- ----------- Current assets $1,990 $1,896 Furniture, fixtures, and equipment, net 617 558 Other assets 163 279 ---------- ---------- $2,770 $2,733 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities $1,467 $1,960 Other liabilities 37 76 Shareholders' equity 1,266 697 ---------- ---------- $2,770 $2,733 ========== ========== STATEMENT OF OPERATIONS Revenues $16,250 $15,524 Operating expenses 15,339 15,560 Income tax expense (benefit) 342 (14) ---------- ---------- Net income (loss) $ 569 $ (22) ========== ==========
5. LEGAL PROCEEDINGS AND CONTINGENCIES TERMINATION OF MANAGEMENT CONTRACT WITH AHC On July 29, 1996, Lease II and ILM II Holding (collectively for this Item 3, the "Companies") terminated a property management agreement with AHC covering the six Senior Housing Facilities leased by Lease II from ILM II Holding. The management agreement was terminated for "cause" pursuant to the contract. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. The Companies alleged, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. F-17 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED) Due to the termination of the management agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the management agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of California. The filing was challenged by the Companies, and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed with the Virginia District Court an answer in response to the litigation initiated by the Companies and a counterclaim against ILM II Holding. The counterclaim alleged that the management agreement was wrongfully terminated for cause and requested damages which include the payment of the termination fee in the amount of $750,000, 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. On June 13, 1997 and July 8, 1997, the court issued orders to enter judgment against the Company and ILM I in the amount of $1,000,000. The orders did not contain any findings of fact or conclusions of law. On July 10, 1997, the Company, ILM I, 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 A. Cohen, who, through July 28, 1998, was President, Chief Executive Officer, and Director of the Company; and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint sought damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to Federal District Court in the Central District of California. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled $229,000 as of August 31, 1999. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should pay reasonable legal fees and expenses incurred by Capital in the California litigation. As August 31, 1999, the amount advanced to Capital by Lease I and Lease II for legal fees totaled approximately $563,000. On August 18, 1998, the Company and its affiliates along with Capital and its affiliates entered into a settlement agreement with AHC. Lease I and Lease II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay $625,000 to AHC in settlement of all claims including those related to the Virginia litigation and the California litigation. The Company and its affiliates also entered into an agreement with Capital and its affiliates to mutually release each other from all claims that any such parties may have against each other, other than any claims under the property management agreements. On September 4, 1998, the full settlement amounts were paid to AHC and its affiliates with Lease I paying $975,000 and Lease II paying $650,000. F-18 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED) OTHER LITIGATION On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a purported class action on behalf of that trust and all other shareholders of the Company and ILM I in the Supreme Court of the State of New York, County of New York naming the Company, ILM I and their Directors as defendants. The class action complaint alleged that the Directors engaged in wasteful and oppressive conduct and breached fiduciary duties in preventing the sale or liquidation of the assets of the Company and ILM I, diverting certain of their assets. The complaint sought compensatory damages in an unspecified amount, punitive damages, the judicial dissolution of the Company and ILM I, an order requiring the Directors to take all steps to maximize Shareholder value, including either an auction or liquidation, and rescinding certain agreements, and attorney's fees. On July 8, 1998, the Company and its co-defendants moved to dismiss the complaint on all counts. On December 8, 1998, the Court granted the Company's dismissal motion in part but afforded the plaintiffs leave to amend their complaint. In doing so, the Court accepted the Company's position that all claims relating to the derivative actions were filed improperly. In addition, the Court dismissed common law claims for punitive damages, but allowed plaintiffs to amend their claims to assert claims alleging that the defendants injured shareholders without injuring the Company as a whole. On January 22, 1999, the Feldman plaintiffs filed an amended complaint, again purporting to commence a class action, and adding claims under Section 10(b) and 20(a) of the Securities and Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Even before the Company and the Board of Directors responded to that amended complaint, the Feldman plaintiffs moved for leave to file a second amended complaint to add claims directed at enjoining the announced potential merger with Capital Senior Living Corporation and, alternatively, for compensatory and punitive damages. At a hearing held on March 4, 1999 relating to the motion for leave to file that second amended complaint and to expedite discovery, the Court granted leave to amend and set a schedule for discovery leading to a trial (if necessary) in the summer of 1999. On March 9, 1999, the Feldman plaintiffs filed a second amended complaint, which included claims for injunctive relief and, in the alternative, damages in an unspecified amount. In response to the Company's motion to dismiss the second amended complaint, on June 7, 1999 the Court issued an order dismissing the plaintiffs' federal security claims but denying the motion to dismiss plaintiffs' claims for breach of fiduciary duty and judicial dissolution, which motion was addressed to the pleadings and not to the merits of the action. On June 21, 1999, the Company and its co-defendants answered the second amended complaint and denied any and all liability and moved for reconsideration of the portion of the Court's June 7, 1999 order denying their motion to dismiss. In response to discovery requests, the Company, ILM I and others produced documents to the plaintiffs and depositions of current and former directors and others were taken. Discovery was completed as of July 1, 1999. On July 2, 1999, the parties to this action came to an agreement-in-principle to settle the action. On August 3, 1999, the parties entered into a Stipulation of Settlement and on August 11, 1999, the Court signed an order preliminarily approving the Stipulation and providing for notice of the Stipulation to the proposed settlement class. On September 30, 1999, the Court conducted a hearing and on October 4, 1999 issued an order certifying a settlement class and approving the proposed settlement as fair, reasonable and adequate, subject to the condition that certain modifications be made to the Stipulation of Settlement and any related documents filed with the Court on or before October 15, 1999. F-19 ILM II SENIOR LIVING, INC. Notes to Financial Statements (continued) 5. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED) On October 15, 1999, the parties entered into a revised Stipulation of Settlement and filed it with the Court, which approved the settlement, by order dated October 21, 1999. In issuing that order the Court entered a final judgment dismissing the action and all non-derivative claims of the settlement class against the defendants with prejudice. In its October 4th order, the Court also denied the application by plaintiffs' counsel for payment of attorneys' fees and expenses, without prejudice to renewal within 14 days upon reapplication therefor. On or about October 14, 1999, plaintiffs' counsel reapplied to the Court for fees and expenses. A hearing was held November 5, 1999, in which the Court granted the application for attorney's fees in the amount of $950,000 and costs in the amount of $182,000. Under the Stipulation, if the proposed merger is consummated, Capital Senior Living Corporation is responsible for payment of such attorney's fees and expenses sought under this application, and if the proposed merger with Capital Senior Living Corporation is not consummated and ILM I and the Company enter into a transaction having similar effect to the merger with a third party, then ILM I and the Company are responsible for such fees and expenses. 6. CONSTRUCTION LOAN FINANCING During 1999 the Company secured a construction loan facility with a major bank that provides the Company with up to $8.8 million to fund the capital costs of the potential expansion programs. The construction loan facility is secured by a first mortgage of the Senior Housing Facilities and collateral assignment of the Company's leases of such properties. The loan expires December 31, 2000, with possible extensions through September 29, 2003. Principal is due upon expiration. Interest is payable monthly at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. Amounts outstanding under the loan at August 31, 1999, were approximately $1.2 million. Loan origination fees of $144,000 were paid at August 31, 1999, in connection with this loan facility and are being amortized over the life of the loan. 7. SUBSEQUENT EVENT On September 15, 1999, the Company's Board of Directors declared a quarterly dividend for the quarter ended August 31, 1999. On October 15, 1999, a dividend of $0.2125 per share of common stock, totaling $1,101,000, was paid to the Shareholders of record as of September 30, 1999. F-20 SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION ILM II SENIOR LIVING, INC. CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION August 31, 1999 (Amounts in thousands)
Initial Cost to Gross Amount at Which Carried at The Company (2) End of Year -------------------- -------------------------------------- Costs Capitalized (Removed Subsequent to) Acquisition of Buildings & Buildings & Buildings & Unamortized Description Encumbrances(1) Land Improvements Improvements(3) Land Improvements(5) Mortgage Fees(5) Total - ----------- --------------- ---- ------------ --------------- ---- --------------- ---------------- ----- CONGREGATE CARE FACILITIES: Fort Myers, $8,700 $1,075 $11,233 $(3,268) $1,227 $ 7,825 $ 412 $ 9,464 Florida Omaha, Nebraska 4,950 400 5,043 (1,054) 543 3,840 183 4,566 Overland Park, Kansas 7,850 672 6,787 22 656 6,647 251 7,554 Stockton, California 5,700 1,507 5,628 (443) 1,644 5,014 240 6,898 St. Louis County, 5,850 292 4,488 74 298 4,436 161 4,895 Missouri Santa Barbara, California 5,094 1,160 4,322 (197) 1,150 4,010 178 5,338 ------- ------ ------- -------- ------ ------- ------ ------- $38,144 $5,106 $37,501 $(4,866) $5,664 $31,772 $1,425 $38,861 ======= ====== ======= ======== ====== ======= ====== =======
Life on Which Depreciation Accumulated Accumulated Date of Date in Latest Income Statement Depreciation(5) Amortization(5) Construction Acquired is Computed --------------- --------------- ------------ -------- -------------------------- Fort Myers, $(2,291) $(366) 1988 7/18/90 5-40 yrs. Florida Omaha, Nebraska (1,134) (137) 1992 4/25/91 5-40 yrs. Overland Park, Kansas (1,685) (186) 1984 4/9/92 5-40 yrs. Stockton, California (1,401) (175) 1988 5/14/92 5-40 yrs. St. Louis County, Missouri (1,257) (117) 1985 5/29/92 5-40 yrs. Santa Barbara, California (1,067) (127) 1979 7/13/92 5-40 yrs. -------- -------- $(8,834) $(1,108) ======== ========
(1) Encumbrances represent first mortgage loans between ILM II 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 of the Exclusivity Agreement as discussed further in Notes 1 and 4 to the Consolidated Financial Statements and costs incurred relating to capitalized interest. (4) The aggregate cost of real estate owned at August 31, 1999 for Federal income tax purposes is approximately $39,975,000. (5) Certain numbers have been reclassified to conform to the current year's presentation. F-21 SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION ILM II SENIOR LIVING, INC. AND SUBSIDIARY SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION (continued) August 31, 1999 (Amounts in thousands)
1999 1998 1997 ---- ---- ---- (5) Reconciliation of real estate owned: Balance at beginning of period $38,484 $37,946 $37,471 Acquisitions and improvements - year ended 8/31/99 377 - - Acquisitions and improvements - year ended 8/31/98 - 538 - Acquisitions and improvements - year ended 8/31/97 - - 205 Balance at end of period $38,861 $38,484 $37,946 ======= ======= ======= (6) Reconciliation of accumulated depreciation and amortization: Balance at beginning of period $ 8,565 $ 7,280 $ 6,005 Depreciation and amortization expense - year ended 8/31/99 1,377 - - Depreciation and amortization expense - year ended 8/31/98 - 1,285 - Depreciation and amortization expense - year ended 8/31/97 - - 1,275 Balance at end of period $ 9,942 8,565 $ 7,280 ======= ======= =======
F-22 EX-27 2 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF AUGUST 31, 1999, AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR ENDED AUGUST 31, 1999. 1,000 12-MOS AUG-31-1999 AUG-31-1999 1,913 0 442 0 0 2,355 37,436 8,834 31,376 746 0 0 134 52 29,279 31,376 5,265 5,321 0 3,624 0 0 0 1,697 0 1,697 0 0 0 1,697 .32 .32
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