<PAGE>
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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 29, 2000
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.)
1750 Tysons Boulevard, Suite 1200, Tysons Corner, 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 X No
---- -----
Shares of common stock outstanding as of February 29, 2000: 5,181,236.
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<PAGE>
ILM II SENIOR LIVING, INC
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page
----
<S> <C>
Item 1. Financial Statements
Consolidated Balance Sheets
February 29, 2000 (Unaudited) and August 31, 1999............................................4
Consolidated Statements of Income
For the six months and three months ended February 29, 2000 and
February 28, 1999 (Unaudited)................................................................5
Consolidated Statements of Changes in Shareholders' Equity
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited).................6
Consolidated Statements of Cash Flows
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited).................7
Notes to Consolidated Financial Statements (Unaudited)....................................8-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....13-19
Part II. Other Information
Item 5. Other Information...........................................................................20
Item 6. Exhibits and Reports on Form 8-K............................................................20
Signatures....................................................................................................21
</TABLE>
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<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 29, 2000 (Unaudited) and August 31, 1999
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
February 29, 2000 August 31, 1999
----------------- ---------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 5,777 $ 5,664
Building and improvements 27,998 27,957
Furniture, fixtures and equipment 3,815 3,815
-------- --------
37,590 37,436
Less: accumulated depreciation (9,429) (8,834)
-------- --------
28,161 28,602
Unamortized mortgage fees 1,425 1,425
Less: accumulated amortization (1,179) (1,108)
-------- --------
246 317
Loan origination fees 144 144
Less: accumulated amortization (59) (42)
-------- --------
85 102
Cash and cash equivalents 965 1,913
Accounts receivable - related party 388 337
Prepaid expenses and other assets 105 68
Deferred rent receivable 22 37
-------- --------
$ 29,972 $ 31,376
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 97 $ 219
Accounts payable-related party 130 527
Construction loan payable 1,165 1,165
Preferred shareholders' minority
Interest in subsidiary 138 134
-------- --------
Total liabilities 1,530 2,045
Contingencies
Shareholders' equity:
Common stock, $0.01 par value,
12,500,000 shares authorized
5,181,236 shares issued and outstanding 52 52
Additional paid-in capital 44,823 44,823
Accumulated deficit (16,433) (15,544)
-------- --------
Total shareholder's equity 28,442 29,331
-------- --------
$ 29,972 $ 31,376
======== ========
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME
For the six months and three months ended February 29, 2000 and
February 28, 1999 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
February 29 February 28 February 29 February 28
2000 1999 2000 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES
Rental income $2,721 $2,644 $1,369 $1,333
Interest income 25 31 11 13
------ ------ ------ ------
2,746 2,675 1,380 1,346
EXPENSES
Depreciation expense 595 566 298 283
Amortization expense 88 90 40 49
General and administrative 122 177 68 76
Professional fees 585 762 279 590
Directors' compensation 43 47 23 27
------ ------ ------ ------
1,433 1,642 708 1,025
------ ------ ------ ------
NET INCOME $1,313 $1,033 $ 672 $ 321
====== ====== ====== ======
Basic earnings per share of common stock $ 0.25 $ 0.20 $ 0.13 $ 0.06
====== ====== ====== ======
Cash dividends paid per share of common stock $ 0.43 $ 0.43 $ 0.21 $ 0.21
====== ====== ====== ======
</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 29, 2000 and February 28, 1999 (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, 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
========= ========= ========= ========= =========
Shareholders' equity
at August 31, 1999 5,181,236 $ 52 $ 44,823 $ (15,544) $ 29,331
Cash dividends paid -- -- -- (2,202) (2,202)
Net income -- -- -- 1,313 1,313
--------- --------- --------- --------- ---------
Shareholders' equity
at February 29, 2000 5,181,236 $ 52 $ 44,823 $ (16,433) $ 28,442
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
------------------------------
February 29, February 28,
2000 1999
------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,313 $ 1,033
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense 683 656
Changes in assets and liabilities:
Accounts receivable - related party (51) (46)
Prepaid expenses and other assets (37) 42
Deferred rent receivable 15 16
Accounts payable and accrued expenses (122) 127
Accounts payable - related party (397) --
Preferred shareholders' minority interest 4 5
------- -------
Net cash provided by operating activities 1,408 1,833
Cash flows from investing activities:
Additions to operating investment properties (154) (194)
------- -------
Net cash used in investing activities (154) (194)
Cash flows from financing activities:
Loan origination fees paid -- (71)
Cash dividends paid to shareholders (2,202) (2,202)
------- -------
Net cash used in financing activities (2,202) (2,273)
------- -------
Net decrease in cash and cash equivalents (948) (634)
Cash and cash equivalents, beginning of period 1,913 1,896
------- -------
Cash and cash equivalents, end of period $ 965 $ 1,262
======= =======
</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 ILM II Senior Living, Inc.'s (the
"Company") Annual Report on Form 10-K for the year ended August 31, 1999.
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 29, 2000 and revenues and expenses
for each of the six- and three-month periods ended February 29, 2000 and
February 28, 1999. 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 29, 2000, are not necessarily indicative of the
results that may be expected for the year ending August 31, 2000.
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, the term "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 nine 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 29, 2000 on the preferred stock
in ILM II Holding totaled approximately $27,000.
-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 in various management capacities at Capital Senior Living
Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently
serves as Chief Executive Officer of Capital Senior Living Corporation. As
a result, through July 28, 1998, Capital was considered a related party.
AGREEMENT AND PLAN OF MERGER WITH CAPITAL SENIOR LIVING CORPORATION
On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital
Senior Living Corporation, the corporate parent of Capital, and certain
affiliates of Capital. If the merger is consummated, the Shareholders of
the Company will receive all-cash merger consideration of approximately
$14.47 per share. Consummation of this transaction will require, among
other things, the affirmative vote of the holders of not less than 66-2/3%
of the Company's outstanding common stock. The agreement presently provides
that it may be terminated if the merger is not consummated by September 30,
2000. 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. 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. Although the pending merger agreement
remains operative and in full force and effect, Capital has communicated
certain proposed modifications to the pending transaction which have not
been agreed to in principle or otherwise by the Company. The Company
presently is in discussions with Capital regarding the pending merger
transaction and is considering potential modifications thereto including
a reduced merger consideration. There can be no assurance as to whether the
merger will be consummated or, if consummated, as to the timing thereof.
-9-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
2. OPERATING INVESTMENT PROPERTIES SUBJECT TO FACILITIES LEASE AGREEMENT
At February 29, 2000, 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>
Year Facility Rentable Resident
Name Location Built Units (2) Capacity (2)
---- -------- ----- --------- ------------
<S> <C> <C> <C> <C>
The Palms Fort Myers, FL 1988 205 255
Crown Villa Omaha, NE 1992 73 73
Overland Park Place Overland Park, KS 1984 141 153
Rio Las Palmas Stockton, CA 1988 164 190
The Villa at Riverwood St. Louis County, MO 1986 120 140
Villa Santa Barbara (1) Santa Barbara, CA 1979 125 125
</TABLE>
(1) The acquisition of Villa Santa Barbara was financed jointly by the Company
and an affiliated entity, ILM Senior Living, Inc. ("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 Holding, Inc. as tenants in common. Upon the sale of ILM I or
the Company, arrangements would be made to transfer the Santa Barbara
facility to the selling joint tenant (or one of its subsidiaries). The
property was extensively renovated in 1995.
(2) Rentable units represent the number of apartment units and is a measure
commonly used in the real estate industry. Resident capacity equals the
number of bedrooms contained within the apartment units and corresponds to
measures commonly used in the healthcare industry.
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 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 $719,000 and $368,000 for the six-
and three-month periods ended February 29, 2000, respectively, compared to
$642,000 and $332,000, for the six- and three-month periods ended February 28,
1999, respectively.
-10-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
3. RELATED PARTY TRANSACTIONS
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, through July 28, 1998, served as
President, Chief Executive Officer and Director of the Company and a
Director of Lease II, has also served in various management capacities at
Capital Senior Living Corporation, an affiliate of Capital, since 1996. As
a result, through July 28, 1998, Capital was considered a related party.
Mr. Cohen currently serves as Chief Executive Officer of Capital Senior
Living Corporation For the six- and three-month periods ended February 29,
2000, Capital earned property management fees from the Company of $525,516
and $272,310, respectively, compared to $546,700 and $323,063, for the six-
and three-month periods ended February 28, 1999, 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 29, 2000 and February 28,
1999, Capital Senior Development, Inc. earned no fees from Lease II 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, Counsel to the Company and its affiliates
since 1997. For the six-month periods ended February 29, 2000 and February
28, 1999, Greenberg Traurig earned fees from the Company of $293,150 and
$221,299, respectively. For the three-month periods ended February 29, 2000
and February 28, 1999, Greenberg Traurig earned fees from the Company of
$219,789 and $172,437.
Accounts receivable - related party at February 29, 2000 and August 31,
1999 includes variable rent due from Lease II. Accounts payable-related
party at February 29, 2000 includes accrued legal fees due to Greenberg
Traurig, Counsel to the Company and its affiliate and a related party, as
described above. At August 31, 1999, Accounts payable-related party
includes $50,000 of expense reimbusements payable to Lease II; $194,000 in
variable rent received from Lease II in advance; and $283,000 of accrued
legal fees due to Greenberg Traurig, Counsel to the Company and its
affiliate and a related party, as described above.
-11-
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (Unaudited)
(continued)
4. LEGAL PROCEEDINGS AND CONTINGENCIES
FELDMAN 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 naming the Company, ILM I and their Directors
as defendants. The class action complaint alleged 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. The complaint sought compensatory
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 October 15, 1999, the parties entered into a Stipulation of
Settlement and filed it with the Court, which approved the settlement, by
order dated October 21, 1999. In issuing that order the Court entered a
final judgment dismissing the action and all non-derivative claims of the
settlement class against the defendants with prejudice. This litigation was
settled at no cost to the Company and ILM I. As part of the settlement,
Capital Senior Living Corporation increased its proposed merger
consideration payable to the Company and ILM I shareholders to all-cash
amounts of $14.47 and $12.90 per share, respectively, and is also
responsible for a total of approximately $1.1 million in plaintiffs'
attorneys fees and expenses if the proposed merger is consummated. If the
proposed merger is not consummated and if the Company and ILM I were to
consummate an extraordinary transaction with a third party, then the
Company and ILM I would be responsible for the plaintiffs' attorneys fees
and expenses.
5. CONSTRUCTION LOAN FINANCING
During 1999 the Company secured a construction loan facility with a
major bank that provides the Company with up to $8.8 million to fund the
capital costs of potential expansion programs. The construction loan
facility is secured by a first mortgage of the Senior Housing Facilities
and collateral assignment of the Company's leases of such properties. The
loan expires on December 31, 2000, with possible extensions through
September 29, 2003. Principal is due upon expiration. Interest is payable
monthly at a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. Amounts
outstanding under the loan at February 29, 2000, were approximately $1.2
million. Loan origination fees of $144,000 were paid in connection with
this loan facility and are being amortized over the life of the loan.
Capitalized interest at February 29, 2000, and August 31, 1999, was $58,020
and $17,387, respectively.
6. SUBSEQUENT EVENT
On March 20, 2000, the Company's Board of Directors declared a
quarterly dividend for the three-month period ended February 29, 2000. On
April 17, 2000, a dividend of $0.2125 per share of common stock, totaling
approximately $1,101,000, will be paid to Shareholders of record as of
March 31, 2000.
-12-
<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 but has been extended on a month-to-month basis), 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 29, 2000 was $642,000 and $332,000,
respectively, compared to $642,000 and $332,000, for the six- and three-month
periods ended February 28, 1999, 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, representing a $35,000 increase in fair
value. This increase in fair value is based on the increase in values of the
Senior Housing Facilities which occurred between April 1994 and January 1996, as
supported by independent appraisals.
-13-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
GENERAL (CONTINUED)
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. It is anticipated that dividends will accrue and be paid at
liquidation. Cumulative dividends in arrears as of February 29, 2000 on the
Preferred Stock in ILM II Holding totaled approximately $27,000.
The assumption of ownership of the Senior Housing Facilities 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 Senior Living Facilities (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 as defined in the Articles of
Incorporation is December 31, 2001, 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, a sale of the Senior
Housing Facilities 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, which could be reduced by approximately $1.4 million using available
net operating loss carryforwards of ILM II Holding of approximately $4.2
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 year 2000 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 29, 2000. As a result, the
Company is expected to recover the full amount that would be due under the loans
upon sale of the Senior Housing Facilities.
-14-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
GENERAL (CONTINUED)
AGREEMENT AND PLAN OF MERGER WITH CAPITAL SENIOR LIVING CORPORATION
On February 7, 1999, the Company entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital
Senior Living Corporation, the corporate parent of Capital, and certain
affiliates of Capital. If the merger is consummated, the Shareholders of the
Company will receive all-cash merger consideration of approximately $14.47
per share. Consummation of this transaction will require, among other things,
the affirmative vote of the holders of not less than 66-2/3% of the Company's
outstanding common stock. The agreement presently provides that it may be
terminated if the merger is not consummated by September 30, 2000. 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. 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. Although the pending merger agreement remains operative and in full
force and effect, Capital has communicated certain proposed modifications to
the pending transaction which have not been agreed to in principle or
otherwise by the Company. The Company presently is in discussions with
Capital regarding the pending merger transaction and is considering potential
modifications thereto including a reduced merger consideration. 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 92% and 95% for three months ended February 29, 2000 and February 28,
1999, 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 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, 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 secured a construction loan facility with a major bank that
provides the Company with up to $8.8 million to fund the capital costs of the
potential expansion programs. The construction loan facility is secured by a
first mortgage of the Senior Housing Facilities and collateral assignment of the
Company's leases of such Senior Housing Facilities. The loan expires December
31, 2000, with possible extensions through September 29, 2003. Principal is due
at expiration. Interest is payable at a rate equal to LIBOR plus 1.10% or Prime
plus 0.5%. Loan origination costs in connection with this loan facility are
being amortized over the life of the loan.
On June 7, 1999, the Company borrowed approximately $1.2 million under the
construction loan facility to fund the pre-construction capital costs incurred
through April 1999, of the potential expansions of the Senior Housing
Facilities. As of February 29, 2000, approximately $7.6 million of the
construction loan facility is unused and available.
At February 29, 2000, the Company had cash and cash equivalents of $965,000
compared to $1,913,000 at August 31, 1999. Remaining cash 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.
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.
-16-
<PAGE>
ILM II SENIOR LIVING, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize the year 2000 as a date other than the year 2000. This could
result in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.
The Company has assessed its exposure to operating equipment, and such
exposure is not significant due to the nature of the Company's business.
The Company is not aware of any external agent with a Year 2000 issue that
would materially impact the Company's results of operations, liquidity or
capital resources. However, the Company has no means of determining whether or
ensuring those external agents will be Year 2000 ready. The inability of
external agents to complete their Year 2000 resolution process in a timely
fashion could impact the Company.
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. As noted above, the Company
believes that it has completed all necessary phases of its Year 2000 program.
However, disruptions in the economy generally resulting from Year 2000 issues
could also adversely affect the Company. Although the amount of potential
liability and lost revenue cannot be reasonably estimated at this time, in a
worst case situation, if Capital, Lease II's only significant and material
third-party contractor, were to experience a Year 2000 problem, it is likely
that Lease II would not receive rental income as it became due from Senior
Living Facility residents. Lease II in turn would fail to pay ILM II Holding
lease payments as they arise under the master lease, and ILM II Holding in turn
would fail to pay the Company mortgage payments due it. However, the Company
believes that given the nature of its business, such problem would be temporary
and easily remedied with a simple accounting.
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 29, 2000 VERSUS THE SIX MONTHS ENDED
FEBRUARY 28, 1999
Net income increased $280,000 or 27.1% to $1,313,000 for the six-month
period ended February 29, 2000 compared to $1,033,000 for the six-month period
ended February 28, 1999. Total revenue was $2,746,000 representing an increase
of $71,000, or 2.7%, compared to the same period of the prior year. Rental and
other income increased $77,000 or 2.9%, to $2,721,000 for the six-month period
ended February 29, 2000, compared to $2,644,000 for the six-month period ended
February 28, 1999 due to increased rental income earned pursuant to the terms of
the Facilities Lease Agreement. Total expenses decreased $209,000, or 12.7%, to
$1,433,000 for the six-month period ended February 29, 2000, compared to
$1,642,000 for the six-month period ended February 28, 1999. This overall
decrease in expenses is primarily attributable to a $177,000 or 23.2% decrease
in professional fees due to a decrease in the use of financial and advisory
professionals who were engaged to assist the Company with the agreement and plan
of merger with Capital Senior Living Corporation (as discussed in Note 1 to the
financial statements) as well as decreased legal fees associated with the
construction loan facility. The $55,000 or 31.1% decrease in general and
administrative expenses to $122,000 for the six-month period ended February 29,
2000, from $177,000 for the same period last year, is due to a variety of
factors including decreased Director and Officer insurance costs of $12,000 or
17.3%; decreased printing costs of $25,000 or 78.9% for the annual and quarterly
reports which were completed timely, distributing incurred costs more evenly
when compared to the previous year; and a $23,000 or 58.8% decrease in state tax
payments; and minor increases and decreases in other general and administrative
costs.
FOR THE THREE MONTHS ENDED FEBRUARY 29, 2000 VERSUS THE THREE MONTHS ENDED
FEBRUARY 28, 1999
Net income increased $351,000 or 109.3% to $672,000 for the second
quarter ended February 29, 2000 compared to $321,000 for the second quarter
ended February 28, 1999. Total revenue was $1,380,000 representing an increase
of $34,000 or 2.5%, compared to the same period of the prior year. Rental and
other income increased $36,000 or 2.7%, to $1,369,000 for the quarter ended
February 29, 2000, compared to $1,333,000 for the quarter ended February 28,
1999, due to increased rental income earned pursuant to the terms of the
Facilities Lease Agreement. Total expenses decreased $317,000, or 30.9%, to
$708,000 for the three-month period ended February 29, 2000, compared to
$1,025,000 for the three-month period ended February 28, 1999. This decrease in
expenses is primarily attributable to a $311,000 or 52.7% decrease in
professional fees due to a decrease in the use of financial and advisory
professionals who were engaged to assist the Company with the agreement and plan
of merger with Capital Senior Living Corporation (as discussed in Note 1 to the
financial statements) as well as decreased legal fees associated with the
construction loan facility. The $8,000 or 10.5% decrease in general and
administrative expenses to $68,000 for the quarter ended February 29, 2000,
compared to $76,000 for the same period last year, is due to a variety of
factors including decreased printing costs of $15,000 or 71.5% for the annual
and quarterly reports which were completed timely, distributing incurred costs
more evenly when compared to the previous year; and a $13,000 or 85% decrease in
state tax payments which were offset by minor increases and decreases in other
general and administrative costs.
-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 THAT ACTUAL FUTURE
RESULTS MAY DIFFER.
-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: NONE
-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 14, 2000
--------------
-21-
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