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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended February 28, 1999
OR
_ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-18942
ILM II SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
Virginia 06-1293758
- ----------------------- --------------------
(State of organization) (I.R.S. Employer
Identification No.)
8180 Greensboro Drive, Suite 850, McLean, VA 22102
- --------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (888) 357-3550
-----------------
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 February 28, 1999: 5,181,236.
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Page 1 of 21
<PAGE>
ILM II SENIOR LIVING, INC
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets
February 28, 1999 (Unaudited) and August 31, 1998............................................4
Consolidated Statements of Income
For the three months and six months ended February 28, 1999 and 1998 (Unaudited).............5
Consolidated Statements of Changes in Shareholders' Equity
For the six months ended February 28, 1999 and 1998 (Unaudited)..............................6
Consolidated Statements of Cash Flows
For the six months ended February 28, 1999 and 1998 (Unaudited)..............................7
Notes to Consolidated Financial Statements (Unaudited)....................................8-13
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....14-19
Part II. Other Information
Item 5. Other Information...........................................................................20
Item 6. Exhibits and Reports on Form 8-K............................................................20
Signatures....................................................................................................21
</TABLE>
-2-
<PAGE>
ILM II SENIOR LIVING, INC
Part I. Financial Information
Item I. Financial Statements
(see next page)
-3-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
February 28, 1999 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
ASSETS
<TABLE>
<CAPTION>
February 28, 1999 August 31, 1998
----------------- ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 5,528 $ 5,518
Building and improvements 27,910 27,726
Furniture, fixtures and equipment 3,815 3,815
---------- ---------
37,253 37,059
Less: accumulated depreciation (8,165) (7,599)
---------- ---------
29,088 29,460
Unamortized mortgage fees 1,425 1,425
Less: accumulated amortization (1,037) (966)
---------- ---------
388 459
Loan origination fees 143 72
Less: accumulated amortization (19) -
---------- ---------
124 72
Cash and cash equivalents 1,262 1,896
Accounts receivable - related party 319 273
Prepaid expenses and other assets 112 154
Deferred rent receivable 53 69
---------- ---------
$ 31,346 $ 32,383
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 347 $ 220
Contingencies
Preferred shareholders' minority
interest in subsidiary 130 125
---------- ----------
Total liabilities 477 345
Shareholders' equity:
Common stock, $0.01 par value,
12,500,000 shares authorized
5,181,236 issued and outstanding 52 52
Additional paid-in capital 44,823 44,823
Accumulated deficit (14,006) (12,837)
--------- ---------
Total shareholder's equity 30,869 32,038
--------- ---------
$ 31,346 $ 32,383
========= =========
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the six-month and three-month periods ended February 28, 1999 and 1998
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
February 28, February 28,
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Rental income $2,644 $2,446 $1,333 $1,254
Interest income 31 43 13 22
------ ------ ------ ------
2,675 2,489 1,346 1,276
Expenses
Depreciation expense 566 566 283 283
Amortization expense 90 71 49 36
General and administrative 177 57 76 42
Professional fees 762 190 590 106
Directors' compensation 47 58 27 34
------ ------ ------ ------
1,642 942 1,025 501
------ ------ ------ ------
Net Income $1,033 $1,547 $321 $775
====== ====== ==== ====
Basic earnings per share of common stock $0.20 $0.30 $ 0.06 $ 0.15
===== ===== ====== ======
Cash dividends paid per share of common stock $0.43 $0.35 $ 0.21 $ 0.19
===== ===== ====== ======
</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.
-5-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Common Stock Additional
$.01 Par Value Paid-In Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1997 5,181,236 $52 $44,823 $(11,988) $ 32,887
Cash dividends paid - - - (1,813) (1,813)
Net income - - - 1,547 1,547
--------- --- ------- -------- --------
Shareholders' equity
at February 28, 1998 5,181,236 $ 52 $44,823 $(12,254) $ 32,621
========= ==== ======= ========= ========
Shareholders' equity
at August 31, 1998 5,181,236 $ 52 $44,823 $(12,837) $32,038
Cash dividends paid - - - (2,202) (2,202)
Net income - - - 1,033 1,033
--------- --- ------- -------- --------
Shareholders' equity
at February 28, 1999 5,181,236 $ 52 $44,823 $(14,006) $ 30,869
========= ==== ======= ========= ========
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
February 28,
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,033 $ 1,547
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense 656 637
Changes in assets and liabilities:
Accounts receivable - related party (46) (417)
Prepaid expenses and other assets 42 (44)
Deferred rent receivable 16 8
Accounts payable and accrued expenses 127 17
Accounts payable - related party -- (155)
Preferred shareholders' minority interest 5 4
------- -------
Net cash provided by operating activities 1,833 1,597
Cash flows from investing activities:
Additions to operating investment properties (194) (372)
------- -------
Net cash used in investing activities (194) (372)
Cash flows from financing activities:
Loan origination fees paid (71) --
Cash dividends paid to shareholders (2,202) (1,813)
------- -------
Net cash used in financing activities (2,273) (1,813)
------- -------
Net decrease in cash and cash equivalents (634) (588)
Cash and cash equivalents, beginning of period 1,896 2,361
------- -------
Cash and cash equivalents, end of period $ 1,262 $ 1,773
======= ======-
</TABLE>
See accompanying notes.
-7-
<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 ILM II Senior Living, Inc.'s (the
"Company") Annual Report on Form 10-K for the year ended August 31, 1998. 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 periods. 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 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 February 28, 1999 and revenues and expenses for each of the six- and
three-month periods ended February 28, 1999 and 1998. Actual results could
differ from the estimates and assumptions used. Certain numbers in the prior
period's financial statements have been reclassified to conform to the current
period's presentation. The results of operations for the six- and three-month
periods ended February 28, 1999, are not necessarily indicative of the results
that may be expected for the year ended August 31, 1999.
The Company was incorporated on February 5, 1990 under the laws of the
State of Virginia as a Virginia finite-life corporation, formerly PaineWebber
Independent Mortgage Inc. II. On September 12, 1990, the Company sold to the
public in a registered initial offering 5,181,236 shares of common stock, $.01
par value. The Company received capital contributions of $51,812,356, of which
$200,000 represented the sale of 20,000 shares to an affiliate at that time,
PaineWebber Group, Inc. ("PaineWebber"). For discussion purposes, PaineWebber
will refer to PaineWebber Group, Inc., and all affiliates that provided services
to the Company in the past.
The Company 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"), as mortgagor, a company specializing in the development,
acquisition and operation of Senior Housing Facilities and guaranteed by AHC's
corporate parent, Angeles Corporation ("Angeles").
ILM II Holding, Inc. ("ILM II Holding"), a majority-owned subsidiary of the
Company, now holds title to the six Senior Housing Facilities, which comprise
the balance of the operating investment properties on the accompanying
consolidated balance sheets, subject to certain mortgage loans payable to the
Company. Such mortgage loans and the related interest expense are eliminated in
the consolidation of the financial statements of the Company.
The Company made charitable gifts of one share of the preferred stock in
ILM II Holding to each of 111 charitable organizations so that ILM II Holding
would meet the stock ownership requirements of a REIT as of January 30, 1997.
The preferred stock has a liquidation preference of $1,000 per share plus any
accrued and unpaid dividends. Dividends on the preferred stock accrue at a rate
of 8% per annum on the original $1,000 liquidation preference and are cumulative
from the date of issuance. Since ILM II Holding is not expected to have
sufficient cash flow in the foreseeable future to make the required dividend
payments, it is anticipated that dividends will accrue and be paid at
liquidation of ILM II Holding. Cumulative dividends accrued as of February 28,
1999 on the preferred stock in ILM II Holding totaled approximately $18,500.
-8-
<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, in order to maximize the potential returns to the
Company's existing Shareholders while maintaining the Company's qualification as
a REIT under the Internal Revenue Code, the Company formed a new corporation,
ILM II Lease Corporation ("Lease II"), for the purpose of operating the Senior
Housing Facilities under the terms of a facilities lease agreement (the
"Facilities Lease Agreement"). All of the shares of capital stock of Lease II
were distributed to the holders of record of the Company's common stock and the
Senior Housing Facilities were leased to Lease II (see Note 2 for a description
of the Facilities Lease Agreement). Lease II is a public company subject to the
reporting obligations of the Securities and Exchange Commission. All
responsibility for the day-to-day management of the Senior Housing Facilities,
including administration of the property management agreement with AHC, was
transferred to Lease II. On July 29, 1996, the management agreement with AHC was
terminated and Lease II retained Capital Senior Management 2, Inc. ("Capital")
to be the new property manager of its Senior Housing Facilities pursuant to a
management agreement (the "Management Agreement"). Lawrence A. Cohen, who,
through July 28, 1998, served as President, Chief Executive Officer and Director
of the Company and a Director of Lease II has also served as Vice Chairman and
Chief Financial Officer of Capital Senior Living Corporation, an affiliate of
Capital, since November 1996. As a result, through July 28, 1998, Capital was
considered a related party.
-9-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
2. Operating Investment Properties Subject to Facilities Lease Agreement
At May 31, 1998, through its consolidated subsidiary, the Company owned six
Senior Housing Facilities. The name, location and size of the properties are as
set forth below:
<TABLE>
<CAPTION>
Rentable Resident
Name Location Units Capacity
- ---- -------- ----- --------
<S> <C> <C> <C>
The Palms Fort Myers, FL 205 255
Crown Villa Omaha, NE 73 73
Overland Park Place Overland Park, KS 141 153
Rio Las Palmas Stockton, CA 164 190
The Villa at Riverwood St. Louis County, MO 120 140
Villa Santa Barbara (1) Santa Barbara, CA 125 125
</TABLE>
(1) The acquisition of Villa Santa Barbara was financed jointly by the Company
and an affiliated entity, ILM I. All amounts generated from the operations
of Villa Santa Barbara are equitably apportioned between the Company,
together with its consolidated subsidiary, and ILM I, together with its
consolidated subsidiary, generally 75% and 25%, respectively. Villa Santa
Barbara is owned 75% by ILM II Holding and 25% by ILM I Holding, Inc.
Subsequent to the effective date of the Settlement Agreement with AHC, in
order to maximize the potential returns to the existing Shareholders while
maintaining the Company's qualification as a REIT under the Internal Revenue
Code, the Company formed a new corporation, Lease II, for the purpose of
operating the Senior Housing Facilities under the terms of a Facilities Lease
Agreement dated September 1, 1995 between the Company's consolidated affiliate,
ILM II Holding, as owner of the properties and lessor (the "Lessor"), and Lease
II as lessee (the "Lessee"). The facilities lease is a "triple-net" lease
whereby the Lessee pays all operating expenses, governmental taxes and
assessments, utility charges and insurance premiums, as well as the costs of all
required maintenance, personal property and non-structural repairs in connection
with the operation of the Senior Housing Facilities. ILM II Holding, as Lessor,
is responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the term of the Facilities Lease Agreement,
which expires on December 31, 2000 (December 31, 1999 with respect to the Santa
Barbara facility), unless earlier terminated at the election of the Lessor in
connection with the sale by the Lessor of the Senior Housing Facilities to a
non-affiliated third party upon 30 days' notice to the Company. Lease II pays
annual base rent for the use of all of the Facilities in the aggregate amount of
$4,035,600 per year. Lease II also pays variable rent, on a quarterly basis, for
each Senior Housing Facility in an amount equal to 40% of the excess of the
aggregate total revenues for the Senior Housing Facilities, on an annualized
basis, over $13,021,000. Variable rent was $642,000 and $332,000 for the six-
and three-month periods ended February 28, 1999, respectively, compared to
$436,000 and $245,000, for the six- and three-month periods ended February 28,
1998, respectively.
Recent Developments
On February 7, 1999, the Company entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of Capital,
and certain affiliates of Capital. Consummation of the merger is presently
anticipated in October 1999. In connection with the merger, the Company has
agreed to cause ILM II Holding to cancel and terminate the Facilities Lease
Agreement with Lease II immediately prior to the effective time of the merger.
There can be no assurance as to whether the merger will be consummated or, if
consummated, as to the timing thereof. As noted above, the Facilities Lease
Agreement, which is scheduled to expire on December 31, 2000, may be terminated
earlier at the election of the Lessor in connection with the sale by the Lessor
of the Senior Housing Facilities to a non-affiliated third party. As a result,
Lease II would have little "going concern" value. There can be no assurance as
to whether the merger will be consummated or, if consummated, as to the timing
thereof.
-10-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
3. Related Party Transactions
Subject to the supervision of the Company's Board of Directors, assistance
in managing the business of the Company was provided by PaineWebber. As
discussed in the Company's Annual Report on Form 10-K, PaineWebber resigned
effective as of June 18, 1997.
Lease II has retained Capital to be the property manager of the Senior
Housing Facilities and the Company has guaranteed the payment of all fees due to
Capital pursuant to the Management Agreement which commenced on July 29, 1996.
Lawrence A. Cohen, who served through July 28, 1998 as President, Chief
Executive Officer and Director of the Company and a Director of Lease II, has
also served as Vice Chairman and Chief Financial Officer of Capital Senior
Living Corporation, an affiliate of Capital, since November 1996. For the six-
and three-month periods ended February 28, 1999, Capital earned property
management fees from the Company of $546,700 and $323,063, respectively,
compared to $444,000 and $239,000, for the six- and three-month periods ended
February 28, 1998, respectively.
On September 18, 1997, Lease II entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the development
process for the potential expansion of several of the Senior Housing Facilities.
Capital Senior Development, Inc. will receive a fee equal to 7% of the total
development costs of these expansions if they are pursued. The Company will
reimburse Lease II for all costs related to these potential expansions including
fees to Capital Senior Development, Inc. For the six- and three-month periods
ended February 28, 1999, Capital Senior Development, Inc. earned fees from Lease
II of $0 and $0, respectively, compared to $99,000 and $59,000 for the six- and
three-month periods ended February 28, 1998, respectively, for managing
pre-construction development activities for potential expansions of the Senior
Housing Facilities.
Jeffry R. Dwyer is a shareholder of Greenberg Traurig, Counsel to the
Company and its affiliates since 1997. For the six-month periods ended February
28, 1999 and 1998, Greenburg Traurig earned fees from the Company of $351,651
and $119,000, respectively. For the three-month periods ended February 28, 1999
and 1998, Greenberg Traurig earned fees from the Company of $246,480 and
$65,000, respectively.
Accounts receivable - related party at February 28, 1999 and August 31,
1998 includes variable rent due from Lease II. There were no accounts
payable-related party at either February 28, 1999 or August 31, 1998.
4. Legal Proceedings and Contingencies
Termination of Management Contract with AHC
On July 29, 1996, Lease II and ILM II Holding ("the Companies") terminated
a property management agreement with AHC covering the six Senior Housing
Facilities leased by Lease II from ILM II Holding. The management agreement was
terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the
agreement. Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against AHC in
the United States District Court for the Eastern District of Virginia for breach
of contract, breach of fiduciary duty and fraud. The Companies alleged that AHC
willfully performed actions specifically in violation of the management
agreement and that such actions caused damages to the Companies.
Due to the termination of the agreement for cause, no termination fee was
paid to AHC. Subsequent to the termination of the management agreement, AHC
filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its
domestic State of California. The filing was challenged by the Companies, and
the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
November 1996, AHC filed with the Virginia District Court an answer in response
to the litigation initiated by the Companies and a counterclaim against ILM II
Holding. The counterclaim alleged that the 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
-11-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
date that 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 exceeded $2,000,000. On June 13, 1997 and July 8, 1997, the court
issued orders to enter judgment against the Company and ILM I in the amount of
$1,000,000. The orders did not contain any findings of fact or conclusions of
law. On July 10, 1997, the Company, ILM I, Lease I and Lease II filed a notice
of appeal to the United States Court of Appeals for the Fourth Circuit from the
orders.
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence Cohen,
who, through July 28, 1998, was President, Chief Executive Officer and a
Director of the Company; and others alleging that the defendants intentionally
interfered with AHC's property management agreement (the "California
litigation"). The complaint sought damages in the amount of at least $2,000,000.
On March 4, 1997, the defendants removed the case to Federal District Court for
the Central District of California. At a Board meeting on February 26, 1997, the
Company's Board of Directors concluded that since all of Mr. Cohen's actions
relating to the California litigation were taken either on behalf of the Company
under the direction of the Board or as a PaineWebber employee, the Company or
its affiliates should indemnify Mr. Cohen with respect to any expenses arising
from the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$239,000 as of February 28, 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 in the
California litigation. Subsequently, the Boards of Directors of Lease I and
Lease II voted to increase the maximum amount of the advance to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in the
California litigation. On February 2, 1998, the amount to be advanced to Capital
was increased to include 75% of the California litigation legal fees and costs
incurred by Capital for December 1997 and January 1998, plus 75% of such legal
fees and costs incurred by Capital thereafter, not to exceed $500,000. At
February 28, 1999, the amount of legal fees either advanced to Capital or
accrued on the financial statements of Lease I and Lease II totaled
approximately $619,000.
On August 18, 1998, the Company and its affiliates along with Capital and
its affiliates entered into a settlement agreement with AHC. Lease I and Lease
II agreed to pay $1,625,000 and Capital and its affiliates agreed to pay
$625,000 to AHC in settlement of all claims, including those related to the
Virginia litigation and the California litigation. The Company and its
affiliates also entered into an agreement with Capital and its affiliates to
mutually release each other from all claims that any such parties, may have
against each other, other than any claims under the property management
agreements. 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 Lease II paying $650,000 and Lease I paying $975,000.
Other Litigation
On May 8, 1998 Andrew A. Feldman and Jeri Feldman, as Trustees for the
Andrew A. & Jeri Feldman Revocable Trust dated September 18, 1990, commenced a
purported class action on behalf of that trust and all other shareholders of the
Company and ILM I in the Supreme Court of the State of New York, County of New
-12-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
York against the Company, ILM I and the Directors of both corporations. The
class action complaint alleges that the Directors engaged in wasteful and
oppressive conduct and breached fiduciary duties in preventing the sale or
liquidation of the assets of the Company and ILM I, diverting certain of their
assets and changing the nature of the Company and ILM I. The complaint seeks
damages in an unspecified amount, punitive damages, the judicial dissolution of
the Company and ILM I, an order requiring the Directors to take all steps to
maximize Shareholder value, including either an auction or liquidation, and
rescinding certain agreements, and attorney's fees. On July 8, 1998, the Company
joined with all other defendants to dismiss the complaint on all counts.
In an oral ruling from the bench on December 8, 1998, the Court granted the
Company's dismissal motion in part and gave the plaintiffs leave to amend their
complaint. In sum, the Court accepted the Company's position that all claims
relating to so-called "derivative" actions were filed improperly and were
dismissed. In addition, the Court dismissed common law claims for punitive
damages, but allowed plaintiffs 30 days to allege any claims, which may have
injured shareholders without injuring the Company as a whole.
On January 22, 1999, the Feldman plaintiffs filed an amended complaint,
again purporting to commence a class action, and adding claims under Section
10(b) and 20(a) of the Securities and Exchange Act of 1934 and Rule 10b-5
promulgated thereunder. Even before the Company and the Board of Directors
responded to that amended complaint, the Feldman plaintiffs moved for leave to
file a second amended complaint to add claims directed at enjoining the
announced potential merger with Capital Senior Living Corporation and,
alternatively, for compensatory and punitive damages. At a hearing held on March
4, 1999 relating to the motion for leave to file that second amended complaint
and to expedite discovery, the Court granted leave to amend and set a schedule
for discovery leading to a trial (if necessary) in Summer 1999. The plaintiffs
have requested documents and depositions of certain current and former
Directors. The Company and the Board of Directors anticipate filing a motion to
dismiss the second amended complaint in April 1999 and to continue to contest
the action vigorously.
5. Construction Loan Financing
The Company has finalized negotiations with a major bank to provide a
construction loan facility that will provide the Company with up to $8.8 million
to fund the capital costs of the potential expansion programs. The construction
loan facility will be secured by a first mortgage of the Company's properties
and collateral assignment of the Company's leases of such properties. The loan
will have a three-year term with interest accruing at a rate equal to LIBOR plus
1.10% or Prime plus 0.5%. The loan term could be extended for an additional two
years beyond its maturity date with monthly payments of principal and interest
on a 25-year amortization schedule. Loan origination costs in connection with
this loan facility are being amortized over the life of the loan.
6. Year 2000
The Company relies upon PC-based computer systems and does not expect to
incur material costs to transition to Year 2000 compliant systems in its
internal operations. The Company does not expect this project to have a
significant effect on operations. The Company will continue to implement systems
and all new investments are expected to be with Year 2000 compliant software.
7. Subsequent Event
On March 15, 1999, the Company's Board of Directors declared a quarterly
dividend for the three-month period ended February 28, 1999. On April 15, 1999,
a dividend of $0.2125 per share of common stock, totaling approximately
$1,101,000, was paid to Shareholders of record as of March 31, 1999.
-13-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
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. 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 Facilities Lease Agreement. As of
August 31, 1995, Lease II, which is taxable as a so-called "C" corporation and
not as a REIT, was a wholly owned subsidiary of the Company. On September 1,
1995 the Company, after receiving the required regulatory approval, distributed
all of the shares of capital stock of Lease II to the holders of record of the
Company's common stock.
The Facilities Lease Agreement is between the Company's consolidated
affiliate, ILM II Holding, as owner of the Senior Housing Facilities and Lessor,
and Lease II as Lessee. The facilities lease is a "triple-net" lease whereby the
Lessee pays all operating expenses, governmental taxes and assessments, utility
charges and insurance premiums, as well as the costs of all required
maintenance, personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. ILM II Holding, as the Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. Pursuant to the Facilities Lease Agreement, which
expires on December 31, 2000 (December 31, 1999 with respect to the Santa
Barbara property), Lease II pays annual base rent for the use of all the Senior
Housing Facilities in the aggregate amount of $4,035,600. Lease II also pays
variable rent, on a quarterly basis, for each Senior Housing Facility in an
amount equal to 40% of the excess, if any, of the aggregate total revenues for
the Senior Housing Facilities, on an annualized basis, over $13,021,000.
Variable rental income for the six- and three-month periods ended February 28,
1999 was $642,000 and $332,000, respectively, compared to $456,000 and $245,000,
for the six- and three-month periods ended February 28, 1998, respectively.
The Company completed its restructuring plans by qualifying ILM II Holding
as a REIT for Federal 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 non-voting, 8% cumulative preferred stock issued to the Company.
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
-14-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
General (continued)
liquidation preference of $1,000 per share plus any accrued and unpaid
dividends. Dividends on the Preferred Stock accrue at a rate of 8% per annum on
the original $1,000 liquidation preference and are cumulative from the date of
issuance. Since ILM II Holding is not expected to have sufficient cash flow in
the foreseeable future to make the required dividend payments, it is anticipated
that dividends will accrue and be paid at liquidation. Cumulative dividends in
arrears as of February 28, 1999 on the Preferred Stock in ILM II Holding totaled
approximately $18,500.
The assumption of ownership of the properties through ILM II Holding, which
was organized as a so-called "C" corporation for tax purposes, has resulted in a
possible future tax liability which would be payable upon the ultimate sale of
the properties (the "built-in gain tax"). The amount of such tax would be
calculated based on the lesser of the total net gain realized from the sale
transaction or the portion of the net gain realized upon a final sale which is
attributable to the period during which the properties were held in a C
corporation.
Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM II Holding to a REIT would not be subject to
the built-in gain tax. The built-in gain tax would most likely not be incurred
if the properties were to be held for a period of at least ten years from the
date of the conversion of ILM II Holding to a REIT. However, since the end of
the Company's original anticipated holding period is within three years, the
properties may not be held for an additional ten years. The Board of Directors
may defer the Company's scheduled liquidation date if in the opinion of a
majority of the Directors the disposition of the Company's assets at such time
would result in a material under-realization of the value of such assets;
provided, however, that no such deferral may extend beyond December 31, 2014
absent amendment of the Company's Articles of Incorporation. Based on
management's current estimate of the increase in values of the Senior Housing
Facilities which occurred between April 1994 and January 1996, as supported by
independent appraisals, ILM II Holding would incur a sizable tax if the
properties were sold. Based on this increase in values during the time ILM II
Holding was operated as a regular C corporation, a sale within ten years of the
date of the conversion of ILM II Holding to a REIT could result in a built-in
gain tax of as much as $2.3 million.
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 1999 to (i) meet its obligations to make the
debt service payments due under the loans, and (ii) pay for capital improvements
and structural repairs in accordance with the terms of the Facilities Lease
Agreement. Although, ILM II Holding is not expected to fully fund its scheduled
debt service payments to the Company, the estimated current values of the Senior
Housing Facilities are well in excess of the mortgage principal amounts plus
accrued interest at February 28, 1999. As a result, the Company is expected to
recover the full amount that would be due under the loans upon sale of the
Facilities.
Recent Developments
On February 7, 1999, the Company entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of Capital,
and certain affiliates of Capital. Consummation of the merger is presently
anticipated in October 1999. In connection with the merger, the Company has
agreed to cause ILM II Holding to cancel and terminate the Facilities Lease
Agreement with Lease II immediately prior to the effective time of the merger.
There can be no assurance as to whether the merger will be consummated or, if
consummated, as to the timing thereof. As noted above, the Facilities Lease
Agreement, which is scheduled to expire on December 31, 2000, may be terminated
earlier at the election of the Lessor in connection with the sale by the Lessor
of the Senior Housing Facilities to a non-affiliated third party. As a result,
Lease II would have little "going concern" value. There can be no assurance as
to whether the merger will be consummated or, if consummated, as to the timing
thereof.
-15-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources
Occupancy levels for the six properties in which the Company has invested
averaged 94% and 96% for the three-month periods ended February 28, 1999 and
1998, respectively. The Company's net operating cash flow is expected to be
relatively stable and predictable due to the structure of the Facilities Lease
Agreement. The annual base rental payments owed to ILM II Holding are $4,035,600
and will remain at that level for the remainder of the lease term. In addition,
the Senior Housing Facilities are currently generating gross revenues which are
in excess of the specified threshold in the variable rent calculation, as
discussed further above, which became effective in January 1997.
The City of Stockton has announced plans to build a railroad underpass on
the street located immediately adjacent to Rio Las Palmas in Stockton,
California. The City plans to use a portion of the Rio Las Palmas property for a
temporary bypass during the expected 18-month construction process. Although
this road construction would not directly affect facility operations, it would
eliminate several parking spaces and result in increased noise and traffic
during the construction period while the traffic is re-routed closer to the
facility. Negotiations with the City are currently underway to minimize any
disruption to the operations of Rio Las Palmas and to secure a settlement that
will pay for any damages.
The Company and ILM I have been pursuing the potential for future expansion
of several of the facilities which are located in areas that have particularly
strong markets for senior housing. Potential expansion candidates include the
facilities located in Omaha, Nebraska; and Fort Myers, Florida. As part of this
expansion program, approximately one acre of land located adjacent to the Omaha
facility was acquired in the first quarter of fiscal year 1998 for approximately
$135,000. The Fort Myers facility includes a vacant parcel of approximately one
and one-half acres which could accommodate an expansion of the existing facility
or the construction of a new free-standing facility. Preliminary feasibility
evaluations have been completed for all of these potential expansions and
pre-construction design and construction-cost evaluations are underway for
expansions of the facilities located in Omaha and Fort Myers. Additionally, in
December 1997, ILM II Holding purchased a one-half acre parcel of land adjacent
to the Stockton facility for approximately $136,000. Although no expansion of
this facility is being considered at this time, this additional land will
provide needed parking spaces and improved access to the existing facility as
well as future expansion potential.
The Company has finalized negotiations with a major bank to provide a
construction loan facility that would provide the Company with up to $8.8
million to fund the capital costs of these potential expansion programs. The
construction loan facility would be secured by a first mortgage of the Company's
properties 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 could be extended for an additional
two years beyond its maturity date with monthly payments of principal and
interest on a 25-year amortization schedule.
At February 28, 1999, the Company had cash and cash equivalents of
$1,262,000 compared to $1,896,000 at August 31, 1998. 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 facilities lease payments from Lease II,
interest income earned on invested cash reserves and proceeds from the future
sales of the underlying operating investment properties. Such sources of
liquidity are expected to be adequate to meet the Company's operating
requirements on both a short-term and long-term basis. The Company generally
will be obligated to distribute annually at least 95% of its taxable income to
its Shareholders in order to continue to qualify as a REIT under the Internal
Revenue Code.
-16-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
While the Company has potential liabilities pending due to ongoing
litigation against the Company, the eventual outcome of this litigation cannot
presently be determined. The Company will vigorously defend against all claims
made against it and, at this time, it is not certain that the Company will have
ultimate responsibility for any such claims.
Year 2000
The Company relies upon PC-based computer systems and does not expect to
incur material costs to transition to Year 2000 compliant systems in its
internal operations. The Company does not expect this project to have a
significant effect on operations. The Company will continue to implement systems
and all new investments are expected to be with Year 2000 compliant software.
Market Risk
The Company believes its market risk is immaterial.
-17-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
For the Six Months Ended February 28, 1999 versus the Six Months Ended February
28, 1998
Net income decreased $514,000 to $1,033,000 for the six-month period ended
February 28, 1999 compared to $1,547,000 for the six-month period ended February
28, 1998. Total revenue was $2,675,000 representing an increase of $186,000, or
7.5%, compared to the same period of the prior year. Rental and other income
increased $198,000, to $2,644,000 for the six-month period ended February 28,
1999, compared to $2,446,000 for the six-month period ended February 28, 1998,
due to increased rental income earned pursuant to the terms of the Facilities
Lease Agreement. Total expenses increased $700,000, or 74.3%, to $1,642,000 for
the six-month period ended February 28, 1999, compared to $942,000 for the
six-month period ended February 28, 1998. This increase in expenses is primarily
attributable to increased professional fees due to increased legal, financial
and advisory professionals who were engaged to assist the Company with the
proposed agreement and plan of merger with Capital Senior Living Corporation, as
discussed in Note 2 to the financial statements, and increased legal fees
associated with the construction loan facility. The $120,000 increase in General
and Administrative expenses to $177.000 for the six-month period ended February
28, 1999, compared to $57,000 for the same period last year, is due to a variety
of factors including increased Director and Officer insurance costs of $62,000;
increased printing costs of $30,000 for the annual and quarterly reports which
were completed earlier in the current year when compared to the previous year;
$32,000 in state tax payments; and minor increases and decreases in other
general and administrative costs. Directors' Compensation decreased $11,000, or
19%, due to a decrease in the number of Board members.
For the Three Months Ended February 28, 1999 versus the Three Months Ended
February 28, 1998
Net income decreased $454,000 to $321,000 for the second quarter ended
February 28, 1999 compared to $775,000 for the second quarter ended February 28,
1998. Total revenue was $1,346,000 representing an increase of $70,000, or 5.5%,
compared to the same period of the prior year. Rental and other income increased
$79,000, to $1,333,000 for the quarter ended February 28, 1999, compared to
$1,254,000 for the quarter ended February 28, 1998, due to increased rental
income earned pursuant to the terms of the Facilities Lease Agreement. Total
expenses increased $524,000, or 104.6%, to $1,025,000 for the three-month period
ended February 28, 1999, compared to $501,000 for the three-month period ended
February 28, 1998. This increase in expenses is primarily attributable to
increased legal fees associated with the construction loan facility and
increased legal and professional fees associated with the Company's proposed
agreement and plan of merger with Capital Senior Living Corporation, as
discussed in Note 2 to the financial statements. The $34,000 increase in General
and Administrative expenses to $76,000 for the quarter ended February 28, 1999,
compared to $42,000 for the same period last year, is due to a variety of
factors including increased Director and Officer insurance costs of $11,000;
increased printing costs of $16,000 for the annual and quarterly reports which
were completed earlier in the current year when compared to the previous year;
and $7,000 in state tax payments. Directors' Compensation decreased $11,000, or
19%, due to a decrease in the number of Board members.
-18-
<PAGE>
ILM II SENIOR LIVING, INC.
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.
-19-
<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: The Company filed a Current Report on Form 8-K dated
February 7, 1999 reporting that the Company had entered into an Agreement
and Plan of Merger with Capital Senior Living Corporation.
-20-
<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/ J. William Sharman, Jr.
----------------------------
J. William Sharman, Jr.
President and Director
Dated: April 12, 1999
-21-
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