-----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, WaP9+Sk9rP7NbG4fQ29BgL/awO4+cleCxfOOLroQUbp8F98InPWIzwPwdibf1jEI ME1jsvTqU2fyqigrES8dmw== 0001047469-99-027569.txt : 19990716 0001047469-99-027569.hdr.sgml : 19990716 ACCESSION NUMBER: 0001047469-99-027569 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990531 FILED AS OF DATE: 19990715 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILM II LEASE CORP CENTRAL INDEX KEY: 0000932092 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 043248639 STATE OF INCORPORATION: VA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-25880 FILM NUMBER: 99664849 BUSINESS ADDRESS: STREET 1: 28 STATE STREET SUITE 1100 CITY: BOSTON STATE: MA ZIP: 02109 BUSINESS PHONE: 8882573550 MAIL ADDRESS: STREET 1: 28 STATE STREET SUITE 1100 CITY: BOSTON STATE: MA ZIP: 02109 10-Q 1 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 MAY 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: 0-25880 ------- ILM II LEASE CORPORATION ------------------------ (Exact name of registrant as specified in its charter) VIRGINIA 04-3248639 - ------------------------------- --------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) 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 - ------------------- ------------------------ None None Securities registered pursuant to Section 12(g) of the Act: Shares of Common Stock $.01 Par Value ------------------------------------- (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ____No _X__ Shares of common stock outstanding as of May 31, 1999: 5,180,952. =============================================================================== Page 1 of 19 ILM II LEASE CORPORATION INDEX Part I. Financial Information Page ---- Item 1. Financial Statements Balance Sheets May 31, 1999 (Unaudited) and August 31, 1998.................................................4 Statements of Income For the nine months and three months ended May 31, 1999 and 1998 (Unaudited).................5 Statements of Changes in Shareholders' Equity For the nine months ended May 31, 1999 and 1998 (Unaudited)..................................6 Statements of Cash Flows For the nine months ended May 31, 1999 and 1998 (Unaudited)..................................7 Notes to Financial Statements (Unaudited).................................................8-12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....13-17 Part II. Other Information...................................................................................18 Item 6. Exhibits and Reports on Form 8-K............................................................18 Signatures....................................................................................................18
-2- ILM II LEASE CORPORATION PART I. FINANCIAL INFORMATION Item I. Financial Statements (See next page) -3- ILM II LEASE CORPORATION BALANCE SHEETS May 31, 1999 (Unaudited) and August 31, 1998 (Dollars in thousands, except per share data) ASSETS
MAY 31, 1999 AUGUST 31, 1998 ------------ --------------- Cash and cash equivalents $ 1,363 $1,497 Accounts receivable, net 162 89 Accounts receivable - related party 102 102 Prepaid expenses and other assets 66 50 Tax refund receivable 27 158 --------- ------- Total current assets 1,720 1,896 Furniture, fixtures and equipment 1,010 783 Less: accumulated depreciation (424) (225) -------- -------- 586 558 Deposits 9 9 Deferred tax asset, net 25 270 -------- -------- $2,340 $2,733 -------- -------- -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses $ 742 $ 789 Termination fee payable - 650 Real estate taxes payable 116 209 Accounts payable - related party 321 287 Security deposits 42 25 --------- --------- Total current liabilities 1,221 1,960 Deferred rent payable 54 76 --------- --------- Total liabilities 1,275 2,036 Shareholders' equity: Common stock, $0.01 par value, 20,000,000 shares authorized 5,180,952 issued and outstanding 52 52 Additional paid-in capital 448 448 Retained earnings 565 197 -------- -------- Total shareholders' equity 1,065 697 -------- -------- $2,340 $2,733 -------- -------- -------- --------
See accompanying notes. -4- ILM II LEASE CORPORATION STATEMENTS OF INCOME For the nine months and three months ended May 31, 1999 and 1998 (Unaudited) (Dollars in thousands, except per share data)
NINE MONTHS ENDED THREE MONTHS ENDED MAY 31, MAY 31, 1999 1998 1999 1998 ---- ---- ---- ---- REVENUES: Rental and other income $12,130 $11,508 $4,008 $ 3,908 Interest income 12 32 4 19 ---------- ---------- -------- --------- 12,142 11,540 4,012 3,927 EXPENSES: Facilities lease rent expense 3,947 3,700 1,302 1,262 Dietary salaries, wages and food service expenses 2,050 1,989 685 670 Administrative salaries, wages and expenses 888 750 291 180 Marketing salaries, wages and expenses 513 514 191 182 Utilities 772 770 245 248 Repairs and maintenance 447 392 162 141 Real estate taxes 394 435 131 127 Property management fees 773 684 225 240 Other property operating expenses 1,074 1,058 366 364 General and administrative expenses 187 199 82 92 Directors compensation 39 56 12 22 Professional fees 245 588 81 261 Depreciation expense 199 64 81 21 ---------- ---------- -------- --------- 11,528 11,199 3,854 3,810 ---------- ---------- -------- --------- Income before taxes 614 341 158 117 Income tax expense: Current - 113 - (122) Deferred 246 23 63 169 ---------- ---------- -------- --------- 246 136 63 47 ---------- ---------- -------- --------- NET INCOME $ 368 $ 205 $ 95 $ 70 ---------- ---------- -------- --------- ---------- ---------- -------- --------- Basic earnings per share of common stock $ 0.07 $ 0.04 $ 0.01 $ 0.01 ---------- ---------- -------- --------- ---------- ---------- -------- ---------
The above earnings per share of common stock is based upon the 5,180,952 shares outstanding for each period. See accompanying notes. -5- ILM II LEASE CORPORATION STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the nine months ended May 31, 1999 and 1998 (Unaudited) (Dollars in thousands, except per share data)
COMMON STOCK ADDITIONAL $.01 PAR VALUE PAID-IN RETAINED SHARES AMOUNT CAPITAL EARNINGS TOTAL Balance at August 31, 1997 5,180,952 $ 52 $448 $219 $ 719 Net Income - - - 205 205 --------- ----- ----- ----- ------ Balance at May 31, 1998 5,180,952 $ 52 $448 $424 $ 924 --------- ----- ----- ----- ------ --------- ----- ----- ----- ------ Balance at August 31, 1998 5,180,952 $ 52 $448 $197 $ 697 Net Income - - - 368 368 --------- ----- ----- ----- ------ Balance at May 31, 1999 5,180,952 $ 52 $448 $565 $1,065 --------- ----- ----- ----- ------ --------- ----- ----- ----- ------
See accompanying notes. -6- ILM II LEASE CORPORATION STATEMENTS OF CASH FLOWS For the nine months ended May 31, 1999 and 1998 (Unaudited) (Dollars In thousands)
NINE MONTHS ENDED MAY 31, 1998 1999 Cash flows from operating activities: Net income $ 368 $205 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation expense 199 64 Deferred tax expense (benefit) 245 (137) Changes in assets and liabilities: Accounts receivable, net (73) 53 Accounts receivable - related party - (121) Prepaid expenses and other assets (16) 254 Tax refund receivable 131 - Accounts payable and accrued expenses (47) (40) Accounts payable - related party 34 1,118 Termination fee payable (650) - Real estate taxes payable (93) (82) Income taxes payable - 139 Deferred rent payable (22) (24) Security deposits, net 17 (2) ------ ------ Net cash provided by operating activities 93 1,427 Cash flows from investing activities: Additions to furniture, fixtures and equipment (227) (167) ------ ------ Net cash used in investing activities (227) (167) Net (decrease) increase in cash and cash equivalents (134) 1,260 Cash and cash equivalents, beginning of period 1,497 1,156 ------ ------ Cash and cash equivalents, end of period $1,363 $ 2,416 ------ ------ ------ ------ SUPPLEMENTAL DISCLOSURE: Cash paid during the period for state income taxes $ 3 $ - ------ ------ ------ ------
See accompanying notes. -7- ILM II LEASE CORPORATION Notes to Financial Statements (Unaudited) 1. GENERAL The accompanying financial statements, footnotes and discussions should be read in conjunction with the financial statements and footnotes contained in ILM II Lease Corporation's (the "Company") Annual Report on Form 10-K for the year ended August 31, 1998. In the opinion of management, the accompanying interim financial statements, which have not been audited, reflect all adjustments necessary to present fairly the results for the interim periods. All of the accounting adjustments reflected in the accompanying interim financial statements are of a normal recurring nature. The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles for interim financial information, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of May 31, 1999, and revenues and expenses for each of the nine- and three-month periods ended May 31, 1999 and 1998. Actual results may 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. The results of operations for the nine- and three-month periods ended May 31, 1999, are not necessarily indicative of the results to be expected for the year ended August 31, 1999. The Company was incorporated on September 12, 1994 under the laws of the State of Virginia by ILM II Senior Living, Inc., a Virginia finite-life corporation ("ILM II"), formerly PaineWebber Independent Living Mortgage Inc. II, to operate six rental housing projects that provide independent-living and assisted-living services for independent senior citizens ("the Senior Housing Facilities") under a facilities lease agreement dated September 1, 1995 (the "Facilities Lease Agreement"), between the Company, as lessee, and ILM II Holding, Inc. ("ILM II Holding"), as lessor, and a direct subsidiary of the ILM II. The Company's sole business is the operation of the Senior Housing Facilities. ILM II made mortgage loans to Angeles Housing Concepts, Inc. ("AHC") secured by the Senior Housing Facilities between July 1990 and July 1992. In March 1993, AHC defaulted under the terms of such mortgage loans and in connection with the settlement of such default, title to the Senior Housing Facilities was transferred, effective April 1, 1994, to certain indirect subsidiaries of ILM II, subject to the mortgage loans. Subsequently, these property-owning subsidiaries were merged into ILM II Holding. As part of the fiscal 1994 settlement agreement with AHC, AHC was retained as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement, which was assigned to the Company as of September 1, 1995 and subsequently terminated in July 1996. ILM II is a public company subject to the reporting obligations of the Securities and Exchange Commission. In July 1996, following termination of the property management agreement with AHC, the Company entered into a property management agreement (the "Management Agreement") with Capital Senior Management 2, Inc. ("Capital") to handle the day-to-day operations of the Senior Housing Facilities. Lawrence A. Cohen, who served through July 28, 1998 as a Director of the Company and President, Chief Executive Officer and Director of ILM 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, the Management Agreement with Capital was considered a related party transaction (see Note 3) through July 28, 1998. -8- ILM II LEASE CORPORATION Notes to Financial Statements (Unaudited) (continued) 2. THE FACILITIES LEASE AGREEMENT ILM II Holding (the "Lessor") leases the Senior Housing Facilities to the Company (the "Lessee") pursuant to the Facilities Lease Agreement. Such lease is scheduled to expire on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara Facility), unless 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, upon 30 days' notice to the Company. As noted below in Recent Developments, ILM II has entered into an agreement and plan of merger with Capital Senior Living Corporation and certain affiliates of Capital, and has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement immediately prior to the effective time of the merger. While there can be no assurance, consummation of the merger is presently anticipated by the end of calendar year 1999. The lease is accounted for as an operating lease in the Company's financial statements. Descriptions of the properties covered by the Facilities Lease Agreement between the Company and ILM II Holding are summarized as follows:
YEAR FACILITY RENTABLE RESIDENT NAME LOCATION BUILT UNITS CAPACITIES ---- -------- ----- ----- ---------- The Palms Fort Myers, FL 1988 205 255 Crown Villa Omaha, NE 1992 73 73 Overland Park Place Overland Park, KS 1984 141 153 Rio Las Palmas Stockton, CA 1988 164 190 The Villa at Riverwood St. Louis County, MO 1986 120 140 Villa Santa Barbara (1) Santa Barbara, CA 1979 125 125
(1) The Company operates Villa Santa Barbara under a co-tenancy arrangement with an affiliated company, ILM I Lease Corporation ("Lease I"). The Company has entered into an agreement with Lease I regarding such joint tenancy. Lease I was formed for similar purposes as the Company by an affiliated company, ILM Senior Living, Inc. ("ILM I"), a subsidiary of which owns 25% of the Villa Santa Barbara property. The portion of the Senior Housing Facility leased by the Company represents 75% of the total project. Villa Santa Barbara is 25% owned by ILM Holding Inc. and 75% by ILM II Holding, Inc., a direct subsidiary of ILM II. Upon the sale of ILM I or ILM II, arrangements would be made to transfer the Santa Barbara facility to the non-selling joint tenant (or one of its subsidiaries). The property was extensively renovated in 1995. Pursuant to the Facilities Lease Agreement, the Company pays annual base rent for the use of the Senior Housing Facilities in the aggregate amount of $4,035,600. 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. Also, any fixed assets of the Company at a Senior Housing Facility would remain with the Senior Housing Facility at the termination of the lease. The Company also pays variable rent, on a quarterly basis, for each facility in an amount equal to 40% of the excess of aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $13,021,000. Variable rent was $943,000 and $301,000 for the nine- and three-month periods ended May 31, 1999, respectively, compared to $697,000 and $261,000 for the nine- and three-month periods ended May 31, 1998, respectively. The Company's use of the properties is limited to use as Senior Housing Facilities. The Company has responsibility to obtain and maintain all licenses, certificates and consents needed to use and operate each Senior Housing Facility, and to use and maintain each Senior Housing Facility in compliance with all local board of health and other applicable governmental and insurance regulations. The Senior Housing Facilities -9- ILM II LEASE CORPORATION Notes to Financial Statements (Unaudited) (continued) 2. THE FACILITIES LEASE AGREEMENT (CONTINUED) located in California, Florida and Kansas are licensed by such states to provide assisted living services. In addition, various health and safety regulations and standards, which are enforced by state and local authorities, apply to the operation of all the Senior Housing Facilities. Violations of such health and safety standards could result in fines, penalties, closure of a Senior Housing Facility, or other sanctions. RECENT DEVELOPMENTS On February 7, 1999, ILM II entered into an agreement and plan of merger with Capital Senior Living Corporation, the corporate parent of Capital, and certain affiliates of Capital. While there can be no assurance, consummation of the merger is presently anticipated by the end of calendar year 1999. In connection with the merger, ILM II has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement 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, upon 30 days' notice to the Company. Although there can be no assurance as to whether the merger will be consummated or, if consummated, as to the timing thereof, the Company's operations would not be expected to continue beyond the effective time of the merger. 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 the Company's Annual Report on Form 10-K for the year ended August 31, 1998, PaineWebber resigned effective as of June 18, 1997. The Company has retained Capital to be the property manager of the Senior Housing Facilities pursuant to the Management Agreement, which commenced on July 29, 1996. Lawrence A. Cohen, who served through July 28, 1998 as a Director of the Company and President, Chief Executive Officer and Director of ILM 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. The Management Agreement is co-terminous with the Facilities Lease Agreement. If, for any reason, the Facilities Lease Agreement is extended beyond December 31, 2000, the scheduled expiration date of the Management Agreement would be extended as well, but not beyond July 29, 2001. There is no present intention to extend the term of the Facilities Lease Agreement or the term of the Management Agreement and it is likely they will be terminated before the end of the term of the Facilities Lease Agreement (see "Recent Developments" in Note 2). Under the terms of the Management Agreement, Capital earns a base management fee equal to 4% of the gross operating revenues of the Senior Housing Facilities, as defined. Capital also earns an incentive management fee equal to 25% of the amount by which the "net cash flow" of the Senior Housing Facilities, as defined, exceeds a specified base amount. Each August 31, 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. ILM II has guaranteed the payment of all fees due to Capital under the terms of the Management Agreement. For the nine- and three-month periods ended May 31, 1999, Capital earned property management fees from the Company of $773,000 and $225,000, respectively, compared to $684,000 and $240,000, for the nine- and three-month periods ended May 31, 1998, respectively. On September 18, 1997, the Company 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. would receive a fee equal to 7% of the total development costs of these potential expansions if they are pursued. ILM II Holding would also reimburse the Company for all costs related to these potential expansions including fees to Capital Senior Development, Inc. For the nine- -10- ILM II LEASE CORPORATION Notes to Financial Statements (Unaudited) (continued) 3. RELATED PARTY TRANSACTIONS (CONTINUED) and three-month periods ended May 31, 1999, Capital Senior Development, Inc. earned no fees from the Company compared to fees of $73,000 and $14,000 earned for the nine- and three-month periods ended May 31, 1998, respectively, for managing pre-construction development activities for potential expansions of the Senior Housing Facilities. Jeffry R. Dwyer, Secretary, President and Director of the Company, is a shareholder of Greenberg Traurig, Counsel to the Company and its affiliates since 1997. For the nine- and three-month periods ended May 31, 1999, Greenburg Traurig earned fees from the Company of $54,000 and $0, respectively. For the nine-and three-month periods ended May 31, 1998, Greenberg Traurig earned fees from the Company of $115,000 and $56,000, respectively. Accounts receivable - related party at May 31, 1999 and August 31, 1998 includes an expense reimbursement payable to the Company from Lease I in the amount of $102,000. Accounts payable - related party at May 31, 1999 and August 31, 1998 includes $301,000 and $287,000, respectively, for variable rent due to ILM II Holding. 4. LEGAL PROCEEDINGS AND CONTINGENCIES A property management agreement between ILM II Holding and AHC, which covered the management of all six Senior Housing Facilities, was assigned to the Company effective September 1, 1995. On July 29, 1996, the Company and ILM II Holding ("the Companies") terminated the property management agreement with AHC for "cause" pursuant to the terms of 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 Company and ILM II Holding alleged, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. Due to the termination of the agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic State of California. The Companies challenged the filing, 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 included 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 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 ILM II and ILM I in the aggregate 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, ILM II, and Lease I 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, Lawrence Cohen, who, through July 28, 1998 was a Director of the Company and President, Chief Executive Officer and Director of ILM II, 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 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 -11- ILM II LEASE CORPORATION Notes to Financial Statements (Unaudited) (continued) 4. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED) recoveries for those expenses. Legal fees paid by the Company and Lease I on behalf of Mr. Cohen totaled $239,000 as of May 31, 1999. 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 and its affiliates in the California litigation. Subsequently, the Boards of Directors of the Company and Lease I voted to increase the maximum amount of the advance to $100,000. By the end of November 1997, Capital had incurred $100,000 of legal expenses in the California litigation. On February 2, 1998, the amount to be advanced to Capital was increased to include 75% of the California litigation legal fees and costs incurred by Capital for December 1997 and January 1998, plus 75% of such legal fees and costs incurred by Capital thereafter, not to exceed $500,000. By May 31, 1999, $226,000 of legal fees had been either advanced or accrued in the Company's financial statements and $339,000 of legal fees have been either advanced or accrued in Lease I's financial statements for Capital's California litigation costs. On August 18, 1998, the Company and its affiliates along with Capital and its affiliates entered into a settlement agreement with AHC. The Company and Lease I agreed to pay $1,625,000 and Capital and its affiliates agreed to pay $625,000 to AHC in settlement of all claims, including those related to the Virginia litigation and the California litigation. The Company and its affiliates also entered into an agreement with Capital and its affiliates to mutually release each other from all claims that any such parties may have against each other, other than any claims under the property management agreements. The Company's Board of Directors believed that settling the AHC litigation was a prudent course of action because the settlement amount represented a small percentage of the increases in cash flow and value achieved for the Company and its affiliates over the past two years. On September 4, 1998, the full settlement amounts were paid to AHC and its affiliates with the Company paying $650,000 and Lease I paying $975,000 to AHC and its affiliates. The Company has pending claims incurred in the normal course of business which, in the opinion of the Company's Board of Directors, will not have a material effect on the financial statements of the Company. 5. CONSTRUCTION LOAN FINANCING The Company has secured a construction loan facility with a major bank that will provide ILM II 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 has a three-year term with interest accruing at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. The loan term can be extended for an additional two years beyond its maturity date with monthly payments of principal and interest on a 25-year amortization schedule. Loan origination costs in connection with this loan facility are being amortized by ILM II over the life of the loan. On June 7, 1999 ILM II borrowed $1,165,000 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, leaving approximately $7.6 million unused and available. The Company is a co-borrower on the construction loan. -12- ILM II LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL 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. If the Company and ILM II Holding decide that any of the Senior Housing Facilities should be expanded, the Facilities Lease Agreement between the Company and ILM II Holding would be amended to include such expansion. Pursuant to the Facilities Lease Agreement, the Company pays annual base rent for use of all the Senior Housing Facilities in the aggregate amount of $4,035,600. The Company 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 rent was $943,000 and $301,000 for the nine- and three-month periods ended May 31, 1999, respectively, compared to $697,000 and $261,000 for the nine- and three-month periods ended May 31, 1998, respectively. The Facilities Lease Agreement is scheduled to expire on December 31, 2000 (December 31, 1999, with respect to Santa Barbara). Accordingly, since the Company does not have any current plans to operate or own any other facilities or engage in any other business outside of its relationship with ILM II, there is no assurance that the Company's operations will continue beyond December 2000. Moreover, the Facilities Lease Agreement is subject to termination at any time by ILM II Holding upon 30 days' notice to the Company in connection with the sale to a non-affiliated third party of the Senior Housing Facilities. RECENT DEVELOPMENTS On February 7, 1999, ILM II entered into an agreement and plan of merger with Capital Senior Living Corporation, the corporate parent of Capital, and certain affiliates of Capital. While there can be no assurance, consummation of the merger is presently anticipated by the end of calendar year 1999. In connection with the merger, ILM II has agreed to cause ILM II Holding to cancel and terminate the Facilities Lease Agreement 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, upon 30 days' notice to the Company. Although there can be no assurance as to whether the merger will be consummated or, if consummated, as to the timing thereof, the Company's operations would not be expected to continue beyond the effective time of the merger. LIQUIDITY AND CAPITAL RESOURCES Occupancy levels for the six properties in which the Company has invested averaged 94% and 92% for the nine-and three-month periods ended May 31, 1999, respectively, compared to 94% and 95% for the nine- and three-month periods ended May 31, 1998, respectively. Base rent payments of $4,035,600 will remain in effect throughout the remaining term of the lease. As noted above, the Facilities Lease Agreement also provides for the payment of variable rent. The Senior Housing Facilities are currently generating gross revenues, which are in excess of the specified threshold in the variable rent calculation. Current annualized operating income levels are sufficient to cover the Company's base and variable rent obligations to ILM II Holding. At May 31, 1999, the Company had cash and cash equivalents of $1,363,000 compared to $1,497,000 at August 31, 1998. The decrease of $134,000 is primarily attributable to the September 4, 1998 payment of the AHC litigation settlement of $650,000 (see Note 4) offset by other cash flows provided by operating activities. Remaining amounts of cash will be used for the Company's working capital requirements. As noted above, under the terms of the Facilities Lease Agreement, the Lessor is responsible for major capital improvements and structural repairs to the -13- ILM II LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) Senior Housing Facilities. Consequently, the Company does not have any material commitments for capital expenditures. Furthermore, the Company does not currently anticipate the need to engage in any borrowing activities. As a result, substantially all of the Company's cash flow will be generated from operating activities. The Company did not pay cash dividends in fiscal years 1998 and 1997 or for the first, second and third quarter of fiscal 1999. Payment of dividends, if any, will be at the discretion of the Company's Board of Directors and will depend upon such factors as the Company's financial condition, earnings, anticipated investments and other relevant factors. The source of future liquidity is expected to be from operating cash flows from the Senior Housing Facilities, net of the Facilities Lease Agreement payments to ILM II Holding, and interest income earned on invested cash reserves. 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. 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. Based on ongoing assessments, the Company, through Capital, its property manager, has developed a program to modify or replace portions of its software and certain hardware, which are generally PC-based systems, so that those systems will properly recognize and utilize dates beyond December 31, 1999. While there can be no assurance, as of May 31, 1999, the Company believes that it substantially completed all software and hardware upgrades as of December 31, 1998. The Company believes that these modifications and replacements of existing software and certain hardware will mitigate the Year 2000 issue. However, if such modifications and replacements are not completed timely, the Year 2000 issue could have a material impact on the operations of the Company. The costs of Year 2000 remediation are not expected to be material based on the Company's operations. 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 the Company would not receive rental income as it became due from Senior Living Facility residents. The Company 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 ILM II mortgage payments due it. However, the Company believes that given the nature of its business, such problem would be temporary and is easily remedied with simple accountings. -14- ILM II LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF OPERATIONS NINE MONTHS ENDED MAY 31, 1999 VERSUS Nine MONTHS ENDED MAY 31, 1998 REVENUES Total revenues were $12,142,000 for the nine months ended May 31, 1999 compared to $11,540,000 for the same period of the prior year, representing an increase of $602,000 or 5.2%. This increase is primarily the result of increased rental rates at certain of the Company's Senior Housing Facilities located in strong markets. EXPENSES Total expenses were $11,528,000 for the nine months ended May 31, 1999 compared to $11,199,000 for the same period in the prior year, representing an increase of $329,000 or 2.9%. This increase was primarily due to increases in facilities lease rent expense of $247,000, administrative salaries and expenses of $138,000; depreciation expense of $135,000; and property management fees of $89,000, offset by a $343,000 decrease in professional fees as a result of settling the AHC litigation as well as minor increases and decreases in certain other expenses. The increase in facilities lease rent expense is the result of increased variable rent payments due under the Facilities Lease Agreement. The increase in depreciation expense is due to the change in the estimated useful lives of the Company's fixed assets as a consequence of the expected lease termination date of December 31, 2000, as such assets are not subject to repurchase by ILM II Holding. The increase in property management fees is attributable to higher incentive management fees earned by the property manager as a result of improved performance at the Senior Housing Facilities. INCOME TAX EXPENSE Income tax expense increased overall by $110,000 as compared to the same period in the prior year, as a result of an increase in income before taxes of $273,000. NET INCOME Primarily as a result of the factors noted above, net income increased $163,000 to $368,000 for the nine months ended May 31, 1999 from net income of $205,000 for the nine months ended May 31, 1998. THREE MONTHS ENDED MAY 31, 1999 VERSUS THREE MONTHS ENDED MAY 31, 1998 REVENUES Total revenues were $4,012,000 for the quarter ended May 31, 1999 compared to $3,927,000 for the same period of the prior year, representing an increase of $85,000 or 2.2%. This increase is primarily the result of increased rental rates at certain of the Company's Senior Housing Facilities located in strong markets. EXPENSES Total expenses were $3,854,000 for the quarter ended May 31, 1999 compared to $3,810,000 for the same period in the prior year, representing an increase of $44,000 or 1.2%. This increase was principally comprised of increases in administrative salaries and expenses of $111,000; depreciation expense of $60,000; and facilities lease rent expense of $40,000; offset by significant decreases in professional fees of $180,000 as a result of settling the AHC litigation. The increase in depreciation expense is due to the change in the estimated useful lives of the Company's fixed assets as a consequence of the expected lease termination date of December 31, 1999, as such assets are not subject to repurchase by ILM II Holding. The increase in facilities lease rent expense is the result of increased variable rent payments due under the Facilities Lease Agreement. -15- ILM II LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) RESULTS OF OPERATIONS (CONTINUED) INCOME TAX EXPENSE Income tax expense increased overall by $16,000 as compared to the same period in the prior year, as a result of an increase in income before taxes of $41,000. NET INCOME Primarily as a result of the factors noted above, net income increased $25,000 to $95,000 for the quarter ended May 31, 1999 from net income of $70,000 for the quarter ended May 31, 1998. -16- ILM II LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) FORWARD-LOOKING INFORMATION CERTAIN STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q ("QUARTERLY 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 QUARTERLY 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 QUARTERLY 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. -17- ILM II LEASE CORPORATION PART II-OTHER INFORMATION ITEM 1. THROUGH 5. NONE ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 27. Financial Data Schedule (b) Reports on Form 8-K: NONE -18- ILM II LEASE CORPORATION 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. By: ILM II LEASE CORPORATION By: /s/ Jeffry R. Dwyer --------------------- Jeffry R. Dwyer President Dated: July 15, 1999 -------------- -19- EX-27 2 EXHIBIT 27
5 9-MOS AUG-31-1999 MAY-31-1999 1,363 0 357 0 0 1,720 1,010 424 2,340 1,221 0 0 0 52 1,013 2,340 0 12,142 0 11,528 0 0 0 614 246 368 0 0 0 368 .07 .07
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