================================================================================
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 November 30, 1997
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 March 31, 1998: 5,181,236.
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Page 1 of 18
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
November 30, 1997 (Unaudited) and August 31, 1997
(In thousands)
<TABLE>
<CAPTION>
ASSETS
November 30 August 31
----------- ---------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 5,152 $ 5,030
Building and improvements 29,151 29,151
Furniture, fixtures and equipment 3,815 3,765
-------- --------
38,118 37,946
Less: accumulated depreciation (7,599) (7,280)
-------- --------
30,519 30,666
Cash and cash equivalents 1,491 2,361
Accounts receivable -- related party 1,351 151
Prepaid expenses and other assets 132 77
Deferred rent receivable 92 100
-------- --------
$ 33,585 $ 33,355
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 274 $ 147
Accounts payable -- related party 376 205
-------- --------
Total liabilities 650 352
Preferred shareholders' minority
Interest in subsidiary 118 116
Commitments and Contingencies
Shareholders' equity:
Common stock, $0.01 par value
10,000,000 shares authorized,
5,181,236 shares issued and outstanding 52 52
Additional paid-in capital 44,823 44,823
Accumulated deficit (12,058) (11,988)
-------- --------
Total Shareholders' equity 32,817 32,887
-------- --------
$ 33,585 $ 33,355
======== ========
</TABLE>
See accompanying notes.
-2-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands, except per Share amounts)
<TABLE>
<CAPTION>
Three Months Ended
November 30,
------------------------------
1997 1996
------- ------
<S> <C> <C>
Revenues
Rental income $ 1,192 $1,001
Interest income 22 21
------- ------
1,214 1,022
Expenses
Depreciation and amoritization 319 318
General and administrative 99 70
Directors' compensation 24 9
------- ------
442 397
------- ------
Net income $ 772 $ 625
======= ======
Basic earnings per share of common stock $ 0.15 $ 0.12
======= ======
Cash dividends paid per share of
common stock $0.1625 $0.125
======= ======
</TABLE>
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.
-3-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
----------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
------ ------ ---------- ----------- -----
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1996 5,181 $52 $44,823 $(10,999) $33,876
Cash dividends paid -- -- -- (648) (648)
Net income -- -- -- 625 625
----- --- ------- -------- -------
Shareholders' equity
at November 30, 1996 5,181 $52 $44,823 $(11,990) $33,853
===== === ======= ======== =======
Shareholders' equity
at August 31, 1997 5,181 $52 $44,823 $(11,988) $32,887
Cash dividends paid -- -- -- (842) (842)
Net income -- -- -- 772 772
----- --- ------- -------- -------
Shareholders' equity
at November 30, 1997 5,181 $52 $44,823 $(12,058) $32,817
===== === ======= ======== =======
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 772 $ 625
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 319 318
Preferred stock accrued dividends 2 --
Changes in assets and liabilities:
Accounts receivable - related party (1,200) (2)
Interest and other receivables - 61
Deferred rent receivable 8 8
Prepaid expenses and other assets (55) 4
Accounts payable - affiliates 171 --
Accounts payable and accrued expenses 127 (17)
------- ------
Net cash provided by operating activities 144 997
------- ------
Cash flows from investing activities:
Additions to operating investment properties (172) (59)
------- ------
Net cash used in investing activities (172) (59)
------- ------
Cash flows from financing activities:
Cash dividends paid to shareholders (842) (648)
------- ------
Net cash used in financing activities (842) (648)
------- ------
Net (decrease) increase in cash and cash equivalents (870) 290
Cash and cash equivalents, beginning of period 2,361 1,694
------- -------
Cash and cash equivalents, end of period $ 1,491 $1,984
======= ======
</TABLE>
See accompanying notes.
-5-
<PAGE>
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 November 30, 1997 and August 31, 1997
and revenues and expenses for each of the three month periods ended November 30,
1997 and 1996. Actual results could differ from the estimates and assumptions
used.
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. The Company entered into an exclusivity
agreement (as amended) with AHC and its parent company, Angeles Corporation
("Angeles"), which required AHC to provide the Company with certain specific
opportunities to finance senior housing facilities and set forth the terms and
conditions of the loans which were made. The loan documents under the
aforementioned exclusivity agreement called for interest to be paid on
construction loans at the rate of 13.3% per annum during the construction period
and for base interest to be paid on the permanent loans at the rate of 10.3% per
annum. In addition to the base interest, additional interest was to be paid on
the permanent loans in an amount equal to 10% of the gross revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
exclusivity agreement, additional interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the entire
term of the investments. In the aggregate, the properties securing loans from
the Company did not generate sufficient cash flow to cover the debt service
payments owed to the Company under the amended terms of the exclusivity
agreement. To the extent that the properties did not generate sufficient cash
flow to make the full payments due under the loan documents, the shortfall was
funded by AHC through December 1992. The source of cash to make up these
shortfalls was from specified deficit reserve accounts, which had been funded
from the proceeds of the mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993.
-6-
<PAGE>
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 November 30, 1997 on the preferred stock in ILM II
Holding totaled approximately $7,400.
-7-
<PAGE>
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 schedule 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.
-8-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
2. Operating Investment Properties Subject to Master Lease
-------------------------------------------------------
At November 30, 1997, 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:
<TABLE>
<CAPTION>
Rentable
Name Location Units
- ---- -------- -----
<S> <C> <C>
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
</TABLE>
(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.
The Company consolidates the financial statements of this property on a
proportional basis.
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. The principal
balance on each loan was modified to reflect the estimated fair value of the
related operating property as of April 1, 1994, the date of the transfer of
ownership from AHC. The modified loans, which had an aggregate principal of
$38,144,000 at May 31, 1997 and August 31, 1996, require interest-only payments
on a monthly basis at a rate of 7% from April 1, 1994 through December 1, 1994,
9% for the period from January 1, 1995 through December 31, 1995, 11% for the
period January 1, 1996 through December 31, 1996, 12% for the period January 1,
1997 through December 31, 1997, 13% for the period January 1, 1998 through
December 31, 1998 and 13.5% for the period January 1, 1999 through December 31,
1999 and 14% for the period January 1, 2000 through maturity on December 31,
2000.
In August 1995, each of the Property Companies was merged into ILM II
Holding. As a result, ownership of the Senior Housing Facilities, as well as the
obligation under the loans, is now held by ILM II Holding, and the Property
Companies no longer exist as separate legal entities. Since ILM II Holding is
consolidated with the Company in the accompanying financial statements for
fiscal 1997, the mortgage loans and related interest expense have been
eliminated in consolidation.
Subsequent to the effective date of the Settlement Agreement with AHC, in
order to maximize the potential returns to the existing shareholders while
maintaining the Company's qualification as a REIT under the Internal Revenue
Code, the Company formed a new corporation, Lease 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.
-9-
<PAGE>
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 first quarter of fiscal 1998 was $191,000.
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.
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 November 30,
1997, Capital Senior Development, Inc. earned fees of $40,318 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 $54,304 for the quarter ended November 30, 1997.
Accounts receivable -- related party at November 30, 1997 includes base and
variable rent due from Lease II in accordance with the terms of the master lease
agreement. Accounts receivable -- related party at and August 31, 1997 includes
variable rent due from Lease II. Accounts payable -- related party at November
30, 1997 includes $121,000 due to Lease II for amounts previously advanced by
Lease II to purchase land and $255,475 due to Lease II for amounts advanced by
Lease II for capital improvements to the Senior Housing Facilities, $205,422 of
which was also payable at August 31, 1997.
-10-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited) (continued)
4. Legal Proceedings and Contingencies
-----------------------------------
Angeles Corporation Litigation
------------------------------
Angeles had guaranteed certain of the obligations of AHC under the terms of
the Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, the Company retained a general unsecured claim
against Angeles in the amount of $1,200,658 as part of the bankruptcy
proceedings, but waived all other claims against Angeles, including any amounts
of base and additional interest owed. In addition, the Company maintained a
claim for approximately $408,000 against an affiliate of Angeles which had made
a separate guarantee to the Company. On March 17, 1995, the Bankruptcy Court
handling the Angeles bankruptcy proceedings approved a final settlement of the
Company's outstanding claims against Angeles and its affiliates. Pursuant to the
terms of this settlement, the Company received a cash payment of $1 million on
April 14, 1995 in full satisfaction of the claims, which totaled approximately
$1.6 million. This amount, net of certain related legal expenses, was recorded
as a reduction in the carrying of values of the Company's operating investment
properties.
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.
-11-
<PAGE>
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 December 15, 1997, the Company's Board of Directors declared a quarterly
dividend for the quarter ended November 30, 1997. On January 15, 1998, a
dividend of $0.1875 per share of common stock, totaling approximately $971,000,
was paid to shareholders of record as of December 31, 1997.
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.
-12-
<PAGE>
ILM II SENIOR LIVING, INC.
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 first quarter of fiscal 1998 was $191,000.
-13-
<PAGE>
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 ("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 November 30, 1997 on the Preferred Stock in ILM II
Holding totaled approximately $7,400.
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 four 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 properties
which has 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 the then current estimated market values of the
operating investment properties, a sale at such values prior to the end of the
ten-year holding period 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.
-14-
<PAGE>
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 93% occupancy
as of November 30, 1997. 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 three and one-half acres of land located
adjacent to the Omaha facility were acquired in the first quarter of fiscal 1998
for $160,000. 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 already 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.
-15-
<PAGE>
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 $15.5 million to fund
the capital costs of these potential expansion programs.
At November 30, 1997, the Company had cash and cash equivalents of
$1,491,000. 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.
Results of Operations
For the Three Months Ended November 30, 1997 versus the Three Months Ended
November 30, 1996
Net income increased $147,000 for the three months ended November 30, 1997
as compared to the same period in the prior year, primarily due to the $191,000
variable rent earned pursuant to the master lease agreement. This increase was
offset by a $29,000 increase in general and administrative expense due
principally to increased legal fees, and a $15,000 increase in director's
compensation due to more frequent Board of Director meetings.
-16-
<PAGE>
ILM II SENIOR LIVING, INC.
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
-17-
<PAGE>
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: May 15, 1998
-18-
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