-----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, A+EzM6Wz8T26EEXEF5nirYxB1UIvg1zRazjP7XnknJYdiYvuvh4FeN0HuTLrmal1 9ZK8VPt/LbUMpbcdNPgg/Q== 0001029869-98-000858.txt : 19980702 0001029869-98-000858.hdr.sgml : 19980702 ACCESSION NUMBER: 0001029869-98-000858 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980228 FILED AS OF DATE: 19980701 SROS: NONE 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-Q SEC ACT: SEC FILE NUMBER: 000-18942 FILM NUMBER: 98658868 BUSINESS ADDRESS: STREET 1: 1300 CONNECTICUT AVE NW STREET 2: STE 1000 CITY: WASHINGTON STATE: DC ZIP: 20036 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-Q 1 ILM II SENIOR LIVING, INC. FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q _X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended February 28, 1998 OR __ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from ____to____. Commission File Number: 0-18249 ILM 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.) 28 State Street, Suite 1100, Boston, MA 02109 - ------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code (888) 257-3550 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered - -------------------- -------------------------- Shares of Common Stock None Securities registered pursuant to Section 12(g) of the Act: SHARES OF COMMON STOCK ---------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ___ No _X_ Shares of common stock outstanding as of February 28, 1998: 5,181,236. ================================================================================ Page 1 of 21 ILM II SENIOR LIVING, INC. -------------------------- INDEX Part I. Financial Information - ------------------------------- Item 1. Financial Statements Consolidated Balance Sheets February 28, 1998 (Unaudited) and August 31, 1997 Consolidated Statements of Income For the three- and six-month periods ended February 28, 1998 and 1997 (Unaudited) Consolidated Statements of Changes in Shareholders' Equity For the three- and six-month periods ended February 28, 1998 and 1997 (Unaudited) Consolidated Statements of Cash Flows For the three- and six-month periods ended February 28, 1998 and 1997 (Unaudited) Notes to Consolidated Financial Statements (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Part II. Other Information - ---------------------------- Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Signatures -2- ILM II SENIOR LIVING, INC. Part I. Financial Information - ------------------------------- Item 1. Financial Statements (see next page) -3- ILM II SENIOR LIVING, INC. CONSOLIDATED BALANCE SHEETS February 28, 1998 (Unaudited) and August 31, 1997 (In thousands, except per share amounts) ASSETS ------
February 28, 1998 August 31, 1997 ----------------- --------------- Operating investment properties, at cost: Land $5,352 $5,030 Building and improvements 27,726 27,726 Furniture, fixtures and equipment 3,815 3,765 ----- ----- 36,893 36,521 Less: accumulated depreciation (7,023) (6,457) ------- ------- 29,870 30,064 Unamortized mortgage fees 1,425 1,425 Less: Accumulated Amortization (894) (823) ----- ----- 531 602 Cash and cash equivalents 1,773 2,361 Accounts receivable - related party 568 151 Prepaid expenses and other assets 121 77 Deferred rent receivable 92 100 ------- -------- $32,955 $33,355 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------- Accounts payable and accrued expenses $164 $147 Accounts payable - related party 50 205 ------- --------- 214 352 Preferred shareholders' minority interest in subsidiary 120 116 ------- --------- Total liabilities 334 468 Shareholders' Equity Common stock, $0.01 par value, 12,500,000 shares authorized 5,181,236 issued and outstanding 52 52 Additional paid-in capital 44,823 44,823 Accumulated deficit (12,254) (11,988) -------- -------- Total Shareholder's equity 32,621 32,887 -------- -------- $32,955 $33,355 ======== ========
See accompanying notes. -4- ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF INCOME For the three- and six-month periods ended February 28, 1998 and 1997 (Unaudited) (In thousands, except per share amounts)
Six Months Ended Three Months Ended February 28 February 28 ----------- ----------- 1998 1997 1998 1997 ---- ---- ---- ---- Revenues Rental Income $2,446 $2,133 $1,254 $1,132 Interest Income 43 44 22 23 ------ -------- -------- ------- $2,489 $2,177 1,276 1,155 Expenses Depreciation and amortization expense 637 636 319 318 Management fees - 65 - 33 General and administrative 247 186 148 148 Directors' compensation 58 24 34 15 ------ -------- -------- -------- 942 911 501 514 Net Income $1,547 $1,266 $775 $641 ====== ====== ==== ==== Basic earnings per share of common stock $0.30 $0.24 $0.15 $0.12 ===== ===== ===== ===== Cash dividends paid per share of common stock $0.35 $0.29 $0.19 $0.16 ===== ===== ===== =====
The above earnings and cash dividends paid per share of common stock are based upon the 5,181,236 shares outstanding for each period. See accompanying notes. -5- ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the three- and six- month periods ended February 28, 1998 and 1997 (Unaudited) (In thousands, except per share amounts)
Common Stock $.01 Par Value Additional -------------- Paid-In Accumulated Shares Amount Capital Deficit Total ------ ----- ---------- ----------- ----- Shareholders' equity at August 31, 1996 5,181 $52 $44,823 $(10,999) $33,876 Cash dividends paid -- -- -- (1,490) (1,490) Net Income -- -- -- 1,266 1,266 ------ ---- -------- -------- ------- Shareholders' equity at February 28, 1997 5,181 $52 $44,823 $(11,223) $33,652 ===== === ======= ========= ======= Shareholders' equity at August 31, 1997 5,181 $52 $44,823 $(11,988) $32,887 Cash dividends paid -- -- -- (1,813) (1,813) Net income -- -- -- 1,547 1,547 ------ ---- ------- -------- ------- Shareholders' equity at February 28, 1998 5,181 $52 $44,823 $(12,254) $32,621 ===== === ======= ========= =======
See accompanying notes. -6- ILM II SENIOR LIVING, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS For the six months ended February 28, 1998 and 1997 (Unaudited) (In thousands, except per share amounts)
1998 1997 ---- ---- Cash flows from operating activities: Net income $1,547 $1,266 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization expense 637 636 Charitable Contribution of Preferred Stock in ILM Holding -- 111 Changes in assets and liabilities: Accounts receivable - related party (417) (8) Interest and other receivables -- (23) Deferred rent receivable 8 16 Prepaid expenses and other assets (44) (22) Accounts payable - affiliates (155) -- Accounts payable and accrued expenses 17 10 Preferred shareholder's minority interest 4 -- ------- -------- - Total adjustments 50 720 ------- -------- Net cash provided by operating activities $1,597 1,986 Cash flows from investing activities: Funding of initial working capital to ILM II Lease Corporation -- -- Additions to operating investment properties (372) (23) ------- -------- Net cash used in investing activities (372) (23) Cash flows from financing activities: Cash dividends paid to shareholders (1,813) (1,490) ------- -------- Net (decrease) increase in cash and cash equivalents (588) 473 Cash and cash equivalents, beginning of period 2,361 1,694 ------- ------- Cash and cash equivalents, end of period $1,773 $2,167 ======= =======
See accompanying notes. -7- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) 1. General ------- The accompanying consolidated financial statements, footnotes and discussions should be read in conjunction with the consolidated financial statements and footnotes contained in the Company's Annual Report for the year ended August 31, 1997. In the opinion of management, the accompanying interim consolidated financial statements, which have not been audited, reflect all adjustments necessary to present fairly the results for the interim period. All of the accounting adjustments reflected in the accompanying interim consolidated financial statements are of a normal recurring nature. The accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of February 28, 1998 and August 31, 1997 and revenues and expenses for each of the six- and three-month periods ended February 28, 1998 and 1997. Actual results could differ from the estimates and assumptions used. Certain numbers in the prior period's financial statements have been reclassified to conform to the current period's presentation. ILM II Senior Living, Inc. (the "Company"), formerly PaineWebber Independent Mortgage 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 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. 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 different states ("Senior Housing Facilities"). All of the loans made by the Company were originally to Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of senior housing facilities. During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. -8- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) 1. General (continued) ------------------- 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 was transferred from AHC to the Company or its designated affiliates. Under the terms of the settlement agreement, the Company released AHC and Angeles from certain obligations under the loans. On April 27, 1994, each of the properties owned by AHC and securing the Loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with the Company (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994 and were made pursuant to the settlement agreement entered into on February 17, 1994 ("the Settlement Agreement") between the Company and AHC which had previously been approved by the bankruptcy court handling the bankruptcy case of Angeles. All of the capital stock of each Property Company was held by ILM II Holding, Inc. ("ILM II Holding"), a Virginia corporation. In August 1995, each of the Property Companies merged into ILM II Holding, which is majority owned by 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 holds title to the six Senior Housing Facilities, which comprise 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 consolidation. 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. 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. The accompanying consolidated financial statements include the operations of ILM II Holding as if control had been obtained by the Company as of September 1, 1996. 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 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. Cumulative dividends accrued as of February 28, 1998 on the preferred stock in ILM II Holding totaled approximately $9,620. -9- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) (continued) 1. General (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, management investigated and evaluated the available options for structuring the ownership of the properties in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code. As discussed further in Note 2, on September 12, 1994 the Company formed a new subsidiary, ILM II Lease Corporation ("Lease II"), for the purpose of operating the Senior Housing Facilities. All of the shares of capital stock in 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 (see Note 2 for a description of the master lease agreement). Lease II is a public company subject to the reporting obligations of the Securities and Exchange Commission. At a meeting of the Company's Board of Directors on January 10, 1997, PaineWebber recommended the immediate sale of the Senior Housing Facilities held by the Company and an affiliated entity, ILM Senior Living, Inc. ("ILM I"), by means of a controlled auction to be conducted by PaineWebber with PaineWebber offering to purchase the properties for $127 million, thereby guaranteeing the Shareholders a "floor" price. The Senior Housing Facilities held by the Company would represent approximately $52 million of this amount. After taxes and closing costs, net proceeds to the Company would equal approximately $48 million or approximately $9.36 per share. PaineWebber also stated that if it purchased the properties at the specified price and were then able to resell the properties at a higher price, PaineWebber would pay any "excess profits" to the Shareholders. To assist the Company in evaluating PaineWebber's proposal, a disinterested, independent investment banking firm with expertise in healthcare REIT's and independent/assisted living financings was engaged by the Company and Lease II, as well as by ILM I and its affiliates. Following a comprehensive analysis, the investment banker recommended that PaineWebber's proposal should be declined and that, instead, investigations of expansion and restructuring alternatives should be pursued. After analyzing PaineWebber's proposal and the recommendations and other information provided by the independent investment banking firm, the Boards of the Company and ILM I voted unanimously to decline PaineWebber's proposal and to explore the alternatives recommended by the independent investment banker. The Boards declined to seek an immediate sale of the properties because in the Board's view, the liquidation price would not reflect the "going concern" values of the Company and ILM I and, therefore, would not maximize Shareholder value. In addition, the Boards did not consider it advisable to liquidate the Company and ILM I on the suggested terms three years prior to their scheduled termination date. PaineWebber indicated to the Board in its January 10, 1997 proposal that it would not wish to continue to serve as advisor to the Company and its affiliates if the Company declined to accept PaineWebber's proposal. The Company accepted the resignation of PaineWebber, effective as of June 18, 1997. PaineWebber agreed to continue to provide certain administrative services to the Company and its affiliates through August 31, 1997, pursuant to the terms of a transition services agreement entered into with the Company and its affiliates. The Company and its affiliates also accepted, effective as of June 18, 1997, the resignations of those officers and directors who were employees of or otherwise affiliated with PaineWebber. The Company and Lease II are continuing to review various restructuring alternatives that could further increase Shareholder value and liquidity. The Company and Lease II are considering a merger of the Company with ILM I and Lease II with ILM I Lease Corporation ("Lease I") as well as other business combinations. An independent investment banking firm has been retained by the Company to assist in analyzing these strategic alternatives. The Company has not fully evaluated any of these alternatives and is not in a position at this time to recommend any actions to the Shareholders. There can be no assurances that the Company will recommend taking any of the actions which may be recommended by its investment bankers. -10- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) (continued) 2. Operating Investment Properties Subject to Master Lease -------------------------------------------------------- At February 28, 1998, through its consolidated affiliate, the Company owned six Senior Housing Facilities. The accompanying financial statements include the Company's investments in six Senior Housing Facilities. The name, location and size of the properties are as set forth below: Rentable Name Location Units - ---- -------- ----- The Palms Fort Myers, FL 205 Units Crown Villa Omaha, NE 73 Units Overland Park lace Overland Park, KS 139 Units Rio Las Palmas Stockton, CA 164 Units The Villa at Riverwood St. Louis County, MO 120 Units Villa Santa Barbara (1) Santa Barbara, CA 125 Units (1) The acquisition of Villa Santa Barbara was financed jointly by the Company and an affiliated entity, ILM I. All amounts generated from 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 25% by ILM Holding and 75% by ILM II Holding. As discussed in Note 1, ILM II Holding holds title to each Senior Housing Facility subject to a first mortgage loan payable to the Company. Since ILM II Holding is consolidated with the Company in the accompanying financial statements, 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 master lease agreement. As of August 31, 1995, Lease II, which is taxable as a regular C corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On September 1, 1995, after the Company received the required regulatory approval, it distributed all of the shares of capital stock of Lease 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. Lease II is a public company subject to the reporting obligations of the Securities and Exchange Commission. -11- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) (continued) 2. Operating Investment Properties Subject to Master Lease (continued) ------------------------------------------------------------------- The master lease agreement, which commenced on September 1, 1995, is between the Company's consolidated affiliate, ILM II Holding, as owner of the properties and lessor, and Lease II as lessee. The master lease is a "triple-net" lease whereby the lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM II Holding, as lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. During the initial term of the master lease, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara Facility), the lessor has the right to terminate the master lease as to any property sold by the lessor as of the date of such sale. During the initial term of the master lease, Lease II is obligated to pay annual base rent for the use of all of the Senior Housing Facilities in the aggregate amount of $3,548,700 for calendar year 1995 (prorated based on the commencement date of the lease) and $4,035,600 for calendar year 1996 and each subsequent year. Beginning in January 1997 and for the remainder of the lease term, Lease II is also obligated to pay variable rent for each Senior Housing Facility. Such variable rent is payable quarterly and is equal to 40% of the excess, if any, of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. Variable rental income related to the second quarter of fiscal 1998 was $244,898. 3. Related Party Transactions --------------------------- Subject to the supervision of the Company's Board of Directors, assistance in managing the business of the Company was provided by PaineWebber. As previously discussed in Note 1, PaineWebber resigned effective as of June 18, 1997. Lease II has retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas 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. In November, 1996, Lawrence A. Cohen, President, Chief Executive Officer and Director of the Company and a Director of Lease II, was also named Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation, an affiliate of Capital. For the quarter ended February 28, 1998, Capital earned property management fees of $238,615. 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 expansions 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. During the quarter ended February 28,1998, Capital Senior Development, Inc. earned fees of $58,900 for managing pre-construction development activities for potential expansions of the Senior Housing Facilities. Jeffry R. Dwyer, Secretary and director of the Company, is an employee of Greenberg Traurig Hoffman Lipoff Rosen & Quentel, which acts as Counsel to the Company and its affiliates. Greenberg Traurig Hoffman Lipoff Rosen & Quentel earned fees from the Company of $64,755 for the quarter ended February 28,1998. Accounts receivable - related party at February 28,1998 includes base and variable rent due from Lease II in accordance with the terms of the master lease agreement. Accounts receivable - related party at August 31, 1997 includes variable rent due from Lease II. Accounts payable - related party at February 28,1998, includes $49,883 due to Lease II for amounts advanced by Lease II to purchase land. At August 31, 1997, $205,422 was payable to Lease II for amounts advanced by Lease II for capital improvements to the Senior Housing Facilities. -12- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) (continued) 4. Legal Proceedings and Contingencies ----------------------------------- Termination of Management Contract with AHC -------------------------------------------- On July 29, 1996, Lease II and ILM II Holding ("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 Sections 1.05 (a) (i) (iii) and (iv) of the agreement. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. The Companies allege, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. Due to the termination of the agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the management agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of California. The filing was challenged by the Companies, and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed with the Virginia District Court an answer in response to the litigation initiated by the Companies and a counterclaim against ILM II Holding. The counterclaim alleges that the management agreement was wrongfully terminated for cause and requests damages which include the payment of a termination fee in the amount of $750,000, payment of management fees pursuant to the contract from August 1, 1996 through October 15, 1996, which is the earliest date the Management Agreement could have been terminated without cause, and recovery of attorneys' fees and expenses. The aggregate amount of damages against all parties as requested in AHC's counterclaim exceeds $2,000,000. The Company has guaranteed the payment of the termination fee at issue in these proceedings to the extent that any termination fee is deemed payable by the court and in the event that Lease II fails to perform pursuant to its obligations under the Management Agreement. The court initially set a trial date of April 28, 1997 but, at AHC's request, rescheduled the trial for June 23, 1997. 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"). In so doing, the court effectively canceled the June 23, 1997 trial date. The Orders do 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. The Company intends to diligently pursue the appeal. The eventual outcome of this litigation cannot presently be determined. However, a provision of $400,000 for the liability which might result to the Company was recorded in the financial statements of Lease II at August 31, 1997. The remaining $600,000 was recorded in the financial statements of Lease I. -13- ILM II SENIOR LIVING, INC. Notes to Consolidated Financial Statements (Unaudited) (continued) 4. Legal Proceedings and Contingencies (continued) ----------------------------------------------- On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of California against Capital Senior Management 2 Inc., ("Capital"), the new property manager, Lawrence Cohen, and others alleging that the defendants intentionally interfered with AHC's property management agreement (the "California litigation"). The complaint seeks 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. Trial in the action is expected to occur in 1998 and discovery has begun. At a 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 Properties 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. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should advance up to $20,000 to pay reasonable legal fees and expenses incurred by Capital in the California litigation. Subsequently, the boards of directors of Lease I and Lease II voted to increase the maximum amount of the advance to $100,000. By the end of November 1997, Capital had incurred $100,000 of legal expenses in the California litigation. On February 2, 1998, the amount to be advanced was increased to include 75% of the California litigation legal fees and costs incurred by Capital for December 1997 and January 1998, plus 75% of such legal fees and costs incurred by Capital, thereafter not to exceed $500,000. The defendants intend to vigorously defend the claims made against them in the California litigation. The eventual outcome of this litigation cannot presently be determined and, accordingly, no provision for any liability has been recorded in the accompanying financial statements. 5. Subsequent Events ----------------- On March 13, 1998, the Company's Board of Directors declared a quarterly dividend for the quarter ended February 28, 1998. On April 15, 1998, a dividend of $0.1875 per share of common stock, totaling approximately $971,000, was paid to shareholders of record as of March 31, 1998. On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the Andrew A. & Jeri Feldman Revocable Trust dated 9/18/90, 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 against the Company, ILM I and the directors of both corporations. The class action complaint alleges that the directors engaged in wasteful and oppressive conduct and breached fiduciary duties in preventing the sale or liquidation of the assets of the Company and ILM I, diverting certain of their assets and changing the nature of the Company and ILM I. The complaint seeks 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. The Company, ILM I and the directors have not yet been required to respond to the complaint in this action. The Company and ILM I believe that the action is without merit and intend vigorously to contest this action. -14- ILM II SENIOR LIVING, INC. Item 2. 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 different states. All of the loans made by the Company were originally with AHC. As previously reported, AHC defaulted on the scheduled mortgage loan payments due to the Company on March 1, 1993. Its parent company, Angeles, subsequently filed for bankruptcy. In fiscal 1994, a Settlement Agreement was executed whereby ownership of the properties was transferred from AHC to certain designated affiliates of the Company which were majority owned by the Company. Subsequently, these affiliates were merged into ILM II Holding, which is majority owned by 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 consolidation. 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 the Agreement. As discussed further below, the Agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, in order to maximize the potential returns to the Company's existing Shareholders while maintaining its qualification as a REIT under the Internal Revenue Code, the Company formed a new corporation, Lease II, for the purpose of operating the Senior Housing Facilities under the terms of a master lease agreement. As of August 31, 1995, Lease II, which is taxable as a regular C corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On September 1, 1995, after the Company received the required regulatory approval, it distributed all of the shares of capital stock of Lease 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. Lease II is a public company subject to the reporting obligations of the Securities and Exchange Commission. The master lease agreement, which commenced on September 1, 1995, was initially between the Company's consolidated affiliate, ILM II Holding, as owner of the Senior Housing Facilities and lessor, and Lease II as lessee. The master lease is a "triple-net" lease whereby the lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM II Holding, as the lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. During the initial term of the master lease, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara property), Lease II is obligated to pay annual base rent for the use of all the Senior Housing Facilities in the aggregate amount of $3,548,700 for calendar year 1995 (prorated based on the lease commencement date) and $4,035,600 for calendar year 1996 and each subsequent year. Beginning in January 1997 and for the remainder of the lease term, Lease II is also obligated to pay variable rent for each Senior Housing Facility. Such variable rent will be payable quarterly and will equal 40% of the excess, if any, of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. Variable rental income related to the second quarter of fiscal 1998 was $244,898. -15- ILM II SENIOR LIVING, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Liquidity and Capital Resources (continued) The Company completed its restructuring plans by converting ILM II Holding to a real estate investment trust ("REIT") for tax purposes. In connection with these plans, on November 21, 1996 the Company requested that PaineWebber sell all of its stock in ILM 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 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 nonvoting, 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 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. Cumulative dividends in arrears as of February 28, 1998 on the Preferred Stock in ILM II Holding totaled approximately $9,620. The assumption of ownership of the properties through ILM II Holding, which was organized as a regular C corporation for tax purposes, has resulted in a possible future tax liability which would be payable upon the ultimate sale of the properties (the "built-in gain tax"). The amount of such tax would be calculated based on the lesser of the total net gain realized from the sale transaction or the portion of the net gain realized upon a final sale which is attributable to the period during which the properties were held in a C corporation. Any future appreciation in the value of the Senior Housing Facilities subsequent to the conversion of ILM 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 is within three years, the properties are not expected to 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, ILM II Holding would incur a sizable tax if the properties were sold. Based on this increase in values during the time ILM II Holding was operated as a regular C corporation, a sale within ten years of the date of conversion to a REIT could result in a built-in gain tax of as much as $2.3 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. Following the termination of its advisor relationship with PaineWebber (See "Note 1. to Notes to Consolidated Financial Statements"), the Company and Lease II commenced a further review of various restructuring alternatives that could further increase Shareholder value and liquidity. The Company and Lease II are analyzing a merger of the Company with ILM I and Lease II with Lease I as well as other business combinations. An independent investment banking firm has been retained by the Company and its affiliates to assist in analyzing these strategic alternatives. The Company has not fully evaluated any of these alternatives and is not in a position at this time to recommend any actions to the Shareholders. There can be no assurances that the Company will recommend taking any of the actions which may be recommended by its investment advisors. -16- ILM II SENIOR LIVING, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Liquidity and Capital Resources (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 1998 to (i) meet its obligations to make the debt service payments due under the loans, (ii) pay for capital improvements and structural repairs in accordance with the terms of the master lease, and (iii) pay for costs that may be incurred in defending AHC's counterclaim against ILM II Holding. As a result, ILM II is not expected to receive the full amount that would be due under the loans. Lease II retained Capital Senior Management 2, Inc., ("Capital") to be the property manager of its Senior Housing Facilities pursuant to a Management Agreement which commenced on July 29, 1996. 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 is also eligible to earn 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 will be increased annually based on the percentage increase in the Consumer Price Index. The Company has guaranteed the payment of all fees due to Capital under the terms of the Management Agreement. The six properties in which the Company has invested averaged 95% occupancy for the quarter ended February 28, 1998. The Company's net operating cash flow is expected to be relatively stable and predictable now that the master lease structure is in place. The annual base rental payments owed to ILM II Holding increased to $4,035,600 effective January 1, 1996 and will remain at that level for the remainder of the lease term. In addition, the Senior Housing Facilities are currently generating gross revenues which are in excess of the specified threshold in the variable rent calculation, as discussed further above, which became effective in January 1997. The Company and Lease II have been pursuing additional steps to increase Shareholder value. Several new programs were adopted during fiscal 1997 across the Company's portfolio which are resulting in increased revenues and cash flow from the properties. These steps include increasing the number of rentable apartment units as live-in facility managers move from the properties and increasing rental rates at properties that have maintained high occupancy levels and are located in strong markets. Another program to increase revenues and cash flow involves pursuing the potential for future expansions of several of the facilities which are located in areas that have particularly strong markets for senior housing. Potential expansion candidates include the facilities located in Omaha, Nebraska; St. Louis County, Missouri; and Fort Myers, Florida. As part of this expansion program, approximately one acre of land located adjacent to the Omaha facility was acquired in the first quarter of fiscal 1998 for approximately $135,000. In addition, an agreement was obtained to purchase approximately six acres of land located adjacent to the St. Louis County facility for approximately $900,000. In December 1998 the Company decided to not pursue the expansion over the near term and allowed the agreement to expire. The Fort Meyers facility includes a vacant parcel of approximately one and one-half acres which could accommodate an expansion of the existing facility or the construction of a new free-standing facility. Preliminary feasibility evaluations have been completed for all of these potential expansions and pre-construction design and construction-cost evaluations are underway for expansions of the facilities located in Omaha and Fort Meyers. 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. -17- ILM II SENIOR LIVING, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Liquidity and Capital Resources (continued) Depending on the extent of any expansions deemed appropriate, such plans could result in the need for substantial additional capital. The Company is currently negotiating with a major bank to provide a construction loan facility that, if finalized, would provide the Company with up to $8.8 million to fund the capital costs of these potential expansion programs. Additionally, in December 1997 ILM II Holding purchased, for approximately $140,000, a parcel of vacant land adjacent to the Stockton facility. Although no expansion of this facility is being considered at this time, this additional land will provide needed parking spaces and improved access to the existing facility. At February 28, 1998, the Company had cash and cash equivalents of $1,773,000. Such amounts will be used for the working capital requirements of the Company, along with the possible investment in the properties owned by ILM II Holding for certain capital improvements, and for dividends to the Shareholders. Future capital improvements could be financed from operations or through borrowings, depending on the magnitude of the improvements, the availability of financing and the Company's incremental borrowing rate. The source of future liquidity and dividends to the Shareholders is expected to be through master lease payments from Lease 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, or for which the Company is a guarantor, the eventual outcome of this litigation cannot presently be determined. The court order in the Virginia AHC litigation equals $1 million, the California litigation by AHC seeks at least $2 million, and the purported class action litigation seeks damages in an unspecified amount. As discussed in Note 4. Legal Proceedings and Contingencies, the Company and Lease II have agreed to indemnify Mr. Cohen and Lease II has agreed to advance funds to Capital to pay reasonable legal fees and expenses in the California litigation. 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. Results of Operations For the Six Months Ended February 28,1998 versus the Six Months Ended February 28, 1997 Net income increased $281,000 for the six months ended February 28, 1998 as compared to the same period in the prior year, primarily due to variable rent earned pursuant to the master lease agreement. This increase was offset by a $61,000 increase in general and administrative expense due principally to increased legal fees, and a $34,000 increase in director's compensation due to more frequent Board of Director meetings. For the Three Months Ended February 28, 1998 versus the Three Months Ended February 28, 1997 Net income increased $134,000 for the three months ended February 28, 1998 as compared to the same period in the prior year. This increase was offset by a $19,000 increase in director's compensation due to more frequent Board of Director meetings. -18- ILM II SENIOR LIVING, INC. PART II Other Information Item 1. through 4. NONE - ------------------ Item 5. Other Information - -------------------------- 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 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. Item 6. Exhibits and Reports on Form 8-K - ----------------------------------------- (a) Exhibits: 27. Financial Data Schedule (b) Reports on Form 8-K: NONE -19- ILM II SENIOR LIVING, INC. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. By: ILM II SENIOR LIVING, INC. By: /s/ Lawrence A. Cohen --------------------------------- Lawrence A. Cohen President Dated: June 15, 1998 -20- EX-27 2 FINANCIAL DATA SCHEDULE
5 6-MOS AUG-31-1997 FEB-28-1998 1,773 0 781 0 0 2,554 38,318 7,917 32,955 214 0 120 0 56 32,621 32,955 0 2,489 0 942 0 0 0 1,547 0 0 0 0 0 1,547 .30 .30
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