================================================================================
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, 1998
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-18249
-------
ILM II SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
Virginia 06-1293758
- ----------------------- -----------------------------
(State of organization) (I.R.S. Employer
Identification No.)
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 November 30, 1998: 5,181,236.
================================================================================
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
November 30, 1998 (Unaudited) and August 31, 1998............................................4
Consolidated Statements of Income
For the three month periods ended November 30, 1998 and 1997 (Unaudited).....................5
Consolidated Statements of Changes in Shareholders' Equity
For the three months ended November 30, 1998 and 1997 (Unaudited)............................6
Consolidated Statements of Cash Flows
For the three months ended November 30, 1998 and 1997 (Unaudited)............................7
Notes to Consolidated Financial Statements (Unaudited)....................................8-14
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....15-18
Part II. Other Information
Item 5. Other Information...........................................................................19
Item 6. Exhibits and Reports on Form 8-K............................................................19
Signatures....................................................................................................20
</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
November 30, 1998 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
ASSETS
------
<TABLE>
<CAPTION>
November 30, 1998 August 31, 1998
----------------- ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 5,523 $ 5,518
Building and improvements 27,910 27,726
Furniture, fixtures and equipment 3,815 3,815
-------- --------
37,248 37,059
Less: accumulated depreciation (7,882) (7,599)
-------- --------
29,366 29,460
Unamortized mortgage fees 1,425 1,425
Less: accumulated amortization (1,001) (966)
-------- --------
424 459
Loan origination fees 104 72
Less: accumulated amortization (6) --
-------- --------
98 72
Cash and cash equivalents 1,398 1,896
Accounts receivable - related party 433 273
Prepaid expenses and other assets 133 154
Deferred rent receivable 61 69
-------- --------
$ 31,913 $ 32,383
======== ========
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<TABLE>
<S> <C> <C>
Accounts payable and accrued expenses $ 137 $ 220
-------- -------
137 220
Preferred shareholders' minority
interest in subsidiary 127 125
-------- -------
Total liabilities 264 345
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 (13,226) (12,837)
-------- -------
Total shareholder's equity 31,649 32,038
-------- -------
$ 31,913 $32,383
======== =======
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the three-month periods ended November 30, 1998 and 1997 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
November 30
----------------------
1998 1997
---- ----
<S> <C> <C>
Revenues:
Rental and other Income $1,311 $1,192
Interest Income 18 22
------ ------
1,329 1,158
Expenses:
Depreciation 283 283
Amortization 41 36
Professional fees 172 85
General and administrative 101 14
Directors' compensation 20 24
------ ------
617 442
------ ------
Net income $ 712 $ 772
====== ======
Basic earnings per share of common stock $ 0.14 $ 0.15
====== ======
Cash dividends paid per share of common stock $ 0.21 $ 0.16
====== ======
</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 three months ended November 30, 1998 and 1997 (Unaudited)
(Dollars in thousands, except per share data)
<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, 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
===== ==== ======= ======== ========
Shareholders' equity
at August 31, 1998 5,181 $52 $44,823 $(12,837) $ 32,038
Cash dividends paid -- -- -- (1,101) (1,101)
Net income -- -- -- 712 712
----- ---- ------- -------- --------
Shareholders' equity
at November 30, 1998 5,181 $52 $44,823 $(13,226) $ 31,649
===== ==== ======= ======== ========
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1998 and 1997 (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Three Months Ended
November 30
-------------------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 712 $ 772
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation and amortization expense 324 319
Charitable contribution of subsidiary's preferred stock
and accrued dividends of subsidiary 2 2
Changes in assets and liabilities:
Accounts receivable - related party (160) (1,200)
Deferred rent receivable 8 8
Prepaid expenses and other assets 21 (55)
Accounts payable and accrued expenses (83) 171
Other liabilities -- 127
------- ------
Net cash provided by operating activities 824 144
------- ------
Cash flows used in investing activities:
Additions to operating investment properties (189) (172)
------- ------
Net cash used in investing activities (189) (172)
------- ------
Cash flows used in financing activities:
Loan origination fees (32) --
Cash dividends paid to shareholders (1,101) (842)
------- ------
Net cash used in investing activities (1,133) (842)
------- ------
Net decrease in cash and cash equivalents (498) (870)
Cash and cash equivalents, beginning of period 1,896 2,361
------- ------
Cash and cash equivalents, end of period $ 1,398 $1,491
======= ======
</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 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 November
30, 1998 and August 31, 1998 and revenues and expenses for the three-month
periods ended November 30, 1998 and 1997. Actual results could differ from the
estimates and assumptions used. Operating results for the three months ended
November 30, 1998, are not necessarily indicative of the results that may be
expected for the year ended August 31, 1999.
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 "Prospectus"). The public offering terminated on May 10, 1991 with a total
of 5,181,236 shares issued. The Company received capital contributions of
$51,812,356, of which $200,000 represented the sale of 20,000 shares to an
affiliate at that time, PaineWebber Group, Inc. ("PaineWebber"). For discussion
purposes, PaineWebber will refer to PaineWebber Group, Inc., and all affiliates
that provided services to the Company in the past.
The Company has elected to qualify and be taxed as a Real Estate Investment
Trust ("REIT") under the Internal Revenue Code of 1986, as amended, for each
taxable year of operations.
The Company originally invested the net proceeds of the initial public
offering in six participating mortgage loans secured by senior housing
facilities located in five different states ("Senior Housing Facilities"). All
of the loans made by the Company were originally to Angeles Housing Concepts,
Inc. ("AHC"), a company specializing in the development, acquisition and
operation of Senior Housing Facilities.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. 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.
-8-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
1. General (continued)
-------------------
ILM II Holding holds title to the six Senior Housing Facilities, which
comprise the balance of operating investment properties on the accompanying
consolidated balance sheets, subject to certain mortgage loans payable to the
Company. Such mortgage loans and the related interest expense are eliminated in
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. 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 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
accrued as of November 30, 1998 on the preferred stock in ILM II Holding totaled
approximately $16,280.
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. On September 1, 1995, after the Company received
the required regulatory approval, the Company distributed all of the shares of
capital stock of Lease II to the holders of record of the Company's common stock
and the Senior Housing Facilities were leased to Lease II (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.
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)
1. General (continued)
-------------------
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 independent investment banking firm 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 banking firm. The Boards declined to
seek an immediate sale of the properties because in the Boards' 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 several years prior to their scheduled termination dates.
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 strategic
alternatives to maximize shareholder value and liquidity and have engaged
professional financial and legal advisors to formulate and present plans and
proposals for consideration by the Board. Although no definitive plans,
arrangements or understandings have been agreed to at this time, the Company is
actively reviewing the feasibility of a variety of financial transactions and
proposals, including the reorganization of the ownership of the Senior Housing
Facilities, business combinations with third parties and the sale of the Company
by means of cash and/or stock-for-stock merger. There can be no assurance that
any definitive transaction will be formulated, agreed to or consummated.
-10-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
2. Operating Investment Properties Subject to Master Lease
-------------------------------------------------------
At May 31, 1998, through its consolidated affiliate, 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 master lease
agreement. 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 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 $4,035,600. 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 for
the three-month periods ended November 30, 1998 and 1997 was $310,000 and
$191,000, respectively.
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 to be the property manager of the Senior
Housing Facilities and the Company has guaranteed the payment of all fees due to
Capital under the terms of the Management Agreement which commenced on July 29,
1996. Lawrence A. Cohen, who, through July 28, 1998, served as President, Chief
Executive Officer and Director of the Company and a Director of Lease II, has
also served 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. For the
three-month period ended November 30, 1997, Capital earned property management
fees from Lease II of $205,000.
-11-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
3. Related Party Transactions (continued)
--------------------------------------
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 three-month periods ended
November 30, 1998 and 1997, Capital Senior Development, Inc. earned fees from
Lease II of $0 and $40,000, respectively, for managing pre-construction
development activities for potential expansions of the Senior Housing
Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is a shareholder of
Greenberg Traurig, which began acting as Counsel to the Company and its
affiliates in late fiscal year 1997. For the three-month periods ended November
30, 1998 and 1997, Greenberg Traurig earned fees from the Company of $153,000
and $54,000, respectively.
Accounts receivable - related party at November 30, 1998 includes base and
variable rent due from Lease II in accordance with the terms of the master lease
agreement. Accounts receivable - related party at August 31, 1998 includes
variable rent due from Lease II. There were no accounts payable-related party at
either November 30, 1998 or August 31, 1998.
4. Legal Proceedings and Contingencies
-----------------------------------
Termination of 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 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 date that the 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. The Company had 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 failed to
perform pursuant to its obligations under the management agreement. 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"). 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.
-12-
<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, 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 of at least $2,000,000. On March 4,
1997, the defendants removed the case to Federal District Court in the Central
District of California. At a Board meeting on February 26, 1997, the Company's
Board of Directors concluded that since all of Mr. Cohen's actions relating to
the California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber employee, the Company or its
affiliates should indemnify Mr. Cohen with respect to any expenses arising from
the California litigation, subject to any insurance recoveries for those
expenses. Legal fees paid by Lease I and Lease II on behalf of Mr. Cohen totaled
$228,000 as of November 30, 1998. 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
November 30, 1998, the amount of legal fees either advanced to Capital or
accrued on the financial statements of Lease I and Lease II totaled
approximately $611,000, although the final amount to be reimbursed to Capital
has not yet been determined.
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 and its 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
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. The
Company and ILM I believe that the action is without merit and are vigorously
contesting this action.
Subsequent to the end of the quarter, 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 allegedly injured shareholders without injuring the
Company as a whole.
-13-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
On January 22, 1999, the Feldmann plaintiffs filed an amended complaint,
again purporting to commence a class action. The Company and the Board of
Directors, as well as former Director Cohen, are named as defendants. Outside
counsel is reviewing the allegations of the amended complaint and the Board has
not yet been advised in detail of the planned response. The Board's instructions
to outside counsel to vigorously contest the action remain in place, and we
anticipate that the Company, as well as the individual defendants, will seek an
early opportunity to move to dismiss the action.
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 $24.5
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.
6. Year 2000
---------
The Company relies upon PC-based 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 December 15, 1998, the Company's Board of Directors declared a quarterly
dividend for the quarter ended November 30, 1998. On January 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 December 31, 1998.
-14-
<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. 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. On
September 1, 1995, after the Company received the required regulatory approval,
the Company distributed all of the shares of capital stock of Lease II to the
holders of record of the Company's common stock. 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, 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 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 $4,035,600. 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 equals 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 three-month periods ended November 30, 1998 and 1997 was $310,000 and
$191,000, respectively.
-15-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
The Company completed its restructuring plans by converting ILM II Holding
to a REIT for tax purposes. In connection with these plans, on November 21,
1996, the Company requested that PaineWebber sell all of the stock 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 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 November 30, 1998 on
the Preferred Stock in ILM II Holding totaled approximately $16,280.
The assumption of ownership of the properties through ILM II Holding, which
was organized as a regular C corporation for tax purposes, has resulted in a
possible future tax liability which would be payable upon the ultimate sale of
the properties (the "built-in gain tax"). The amount of such tax would be
calculated based on the lesser of the total net gain realized from the sale
transaction or the portion of the net gain realized upon a final sale which is
attributable to the period during which the properties were held in a C
corporation.
Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM II Holding to a REIT would not be subject to
the built-in gain tax. The built-in gain tax would most likely not be incurred
if the properties were to be held for a period of at least ten years from the
date of the conversion of ILM II Holding to a REIT. However, since the end of
the Company's original anticipated holding period is within three years, the
properties may not be held for an additional ten years. Based on management's
current estimate of the increase in the values of the Senior Housing Facilities
which occurred between April 1994 and January 1996, as supported by independent
appraisals, 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. 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.
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 master lease.
Although, ILM II Holding is not expected to fully fund its scheduled debt
service payments to the Company, the current values of the Senior Housing
Facilities are well in excess of the mortgage principal amounts plus accrued
interest at August 31, 1998. As a result, the Company is expected to recover the
full amount that would be due under the loans upon sale of the Facilities.
-16-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
Occupancy levels for the six properties in which the Company has invested
averaged 95% and 93%, respectively, for the three-month periods ended November
30, 1998 and 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's net operating cash flow is expected to be relatively stable
and predictable due to the master lease structure. 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 Company and Lease II 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; St. Louis County, Missouri;
and Fort Myers, Florida. As part of this expansion program, approximately one
acre of land located adjacent to the Omaha facility was acquired in the first
quarter of fiscal year 1998 for approximately $135,000. In addition, an
agreement was obtained to purchase approximately six acres of land located
adjacent to the St. Louis County facility for approximately $900,000. In
December 1997, the Company decided not to pursue the St. Louis County expansion
and allowed the agreement to expire. 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.
Once the pre-construction design process is complete and projected
expansion costs are determined, the Company will carefully evaluate the costs
and benefits before proceeding with the construction of any of these expansions.
Depending on the extent of any expansions deemed appropriate, such plans could
result in the need for substantial additional capital. The Company has finalized
negotiations with a major bank to provide a construction loan facility that will
would provide the Company with up to $8.8 million to fund the capital costs of
these potential expansion programs. The construction loan facility will be
secured by a first mortgage of the Company's properties and collateral
assignment 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.
At November 30, 1998, the Company had cash and cash equivalents of
$1,398,000. 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.
-17-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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.
The Company relies upon PC-based 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.
Results of Operations
For the Three Months Ended November 30, 1998 versus the Three Months Ended
November 30, 1997
Net income decreased $60,000 for the first quarter ended November 30, 1998
compared to the first quarter ended November 30, 1997. Total revenue was
$1,329,000 representing an increase of $171,000, or 14.8%, compared to the same
period of the prior year. Rental and other income increased $119,000, to
$1,311,000 from $1,192,000, due to increased rental income earned pursuant to
the terms of the master lease agreement. Total expenses increased $175,000, or
39.6%, from $442,000 for the three months ended November 30, 1997 compared to
$617,000 for the three months ended November 30, 1998. This increase in expenses
is primarily attributable to a combined increase in professional fees and
general and administrative expense of $173,000 due to increases in Director's
and Officer's insurance premiums; increased legal fees associated with the
construction loan facility; and financial and advisory professionals who were
engaged to assist the Company.
-18-
<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
-19-
<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: January 28, 1999
----------------
-20-
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-END> NOV-30-1998
<CASH> 1,398
<SECURITIES> 0
<RECEIVABLES> 627
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,025
<PP&E> 36,906
<DEPRECIATION> 7,882
<TOTAL-ASSETS> 31,913
<CURRENT-LIABILITIES> 264
<BONDS> 0
127
0
<COMMON> 52
<OTHER-SE> 31,597
<TOTAL-LIABILITY-AND-EQUITY> 31,913
<SALES> 0
<TOTAL-REVENUES> 1,329
<CGS> 0
<TOTAL-COSTS> 617
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 712
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 712
<EPS-PRIMARY> .14
<EPS-DILUTED> .14
</TABLE>
