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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 May 31, 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: 0-25878
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ILM I LEASE CORPORATION
-----------------------
(Exact name of registrant as specified in its charter)
Virginia 04-3248637
- -------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
28 State Street, Suite 1100, Boston, MA 02109
- --------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code (888) 257-3550
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes No X
--- ---
Shares of common stock outstanding as of May 31, 1998: 7,519,430.
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Page 1 of 17
<PAGE>
ILM I LEASE CORPORATION
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information Page
----
<S> <C> <C> <C>
Item 1. Financial Statements
Balance Sheets
May 31, 1998 (Unaudited) and August 31, 1997....................................................4
Statements of Income
For the nine- and three-month periods ended May 31, 1998 and 1997 (Unaudited)...................5
Statements of Changes in Shareholders' Equity
For the nine months ended May 31, 1998 and 1997 (Unaudited).....................................6
Statements of Cash Flows
For the nine months ended May 31, 1998 and 1997 (Unaudited).....................................7
Notes to Financial Statements (Unaudited)....................................................8-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........12-14
Part II. Other Information.......................................................................................15
Item 6. Exhibits and Reports on Form 8-K................................................................15
Signatures.......................................................................................................16
</TABLE>
-2-
<PAGE>
ILM I LEASE CORPORATION
Part I. Financial Information
- ------------------------------
Item 1. Financial Statements
(see next page)
-3-
<PAGE>
ILM I LEASE CORPORATION
BALANCE SHEETS
May 31, 1998 (Unaudited) and August 31, 1997
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS
------
May 31, 1998 August 31, 1997
------------ ---------------
<S> <C> <C>
Cash and cash equivalents $3,190 $1,473
Accounts receivable - related party 206 93
Accounts receivable 17 --
Prepaid expenses and other assets 72 499
------ ------
Total current assets 3,485 2,065
Furniture, fixtures and equipment 854 591
Less: accumulated depreciation (171) (93)
------ ------
683 498
Deferred tax asset 278 70
------ ------
$4,446 $2,633
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 612 $ 882
Termination fee payable 600 600
Real estate taxes payable 372 170
Accounts payable - related party 1,838 116
Security deposits 6 5
------ ------
Total current liabilities 3,428 1,773
Deferred rent payable 58 86
------ ------
Total liabilities 3,486 1,859
Shareholders' equity:
Common stock, $0.01 par value,
20,000,000 shares authorized
7,519,430 issued and outstanding 75 75
Additional paid-in capital 625 625
Retained earnings 260 74
------ ------
Total shareholders' equity 960 774
------ ------
$4,446 $2,633
====== ======
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM I LEASE CORPORATION
STATEMENTS OF INCOME
For the nine- and three-month periods ended May 31, 1998 and 1997 (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
May 31 May 31
------ ------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues:
Rental and other income $14,375 $13,394 $4,830 $ 4,568
Interest income 48 62 28 24
------- ------- ------ -------
14,423 13,456 4,858 4,592
Expenses:
Master lease rent expense 5,397 4,945 1,814 1,710
Dietary and food service salaries, wages and expenses 2,657 2,532 895 881
Administrative salaries, wages and expenses 896 918 256 322
Marketing salaries, wages and expenses 636 653 206 216
Utilities 595 620 196 191
Repairs and maintenance 472 475 162 163
Real estate taxes 676 616 205 193
Property management fees 742 637 258 222
Other property operating expenses 1,102 1,108 374 350
General and administrative 861 615 404 438
Advisory fees -- 67 -- 23
Depreciation expense 78 37 26 14
------- ------- ------ -------
14,112 13,223 4,796 4,723
------- ------- ------ -------
Income (loss) before taxes 311 233 62 (131)
Income tax expense (benefit):
Current 33 65 (40) (61)
Deferred 92 28 65 9
------- ------- ------ -------
125 93 25 (52)
------- ------- ------ -------
Net income (loss) $ 186 $ 140 $ 37 $ (79)
======= ======= ====== =======
Basic earnings (loss) per share of common stock $ 0.02 $ 0.02 $ 0.00 $ (0.01)
======= ======= ====== =======
</TABLE>
The above earnings per share of common stock is based upon the 7,519,430 shares
outstanding for each period.
See accompanying notes.
-5-
<PAGE>
ILM I LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended May 31, 1998 and
1997 (Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
--------------------- Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1996 7,519 $75 $625 $361 $1,061
Net income -- -- -- 140 140
----- --- ---- ---- ------
Balance at May 31, 1997 7,519 $75 $625 $501 $1,201
===== === ==== ==== ======
Balance at August 31, 1997 7,519 $75 $625 $ 74 $ 774
Net income -- -- -- 186 186
----- --- ---- ---- ------
Balance at May 31, 1998 7,519 $75 $625 $260 $ 960
===== === ==== ==== ======
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM I LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the nine months ended May 31, 1998 and 1997 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------
May 31
------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $186 $140
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 78 37
Deferred taxes, net (208) 28
Changes in assets and liabilities:
Accounts receivable - related party (113) --
Accounts receivable (17) (168)
Prepaid expenses and other assets 427 118
Accounts payable and accrued expenses (270) 20
Accounts payable - affiliates 1,722 (50)
Real estate taxes payable 202 45
Deferred rent payable (28) (28)
Security deposits 1 --
------ ------
Total Adjustments 1,794 2
------ ------
Net cash provided by operating activities 1,980 142
------ ------
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (263) (173)
------ ------
Net cash used in investing activities (263) (173)
------ ------
Net increase (decrease) in cash and cash equivalents 1,717 (31)
Cash and cash equivalents, beginning of period 1,473 2,185
------ ------
Cash and cash equivalents, end of period $3,190 $2,154
====== ======
Supplemental disclosure:
Cash paid during the period for income taxes $ -- $ 110
====== ======
</TABLE>
See accompanying notes.
-7-
<PAGE>
ILM I LEASE CORPORATION
Notes to Financial Statements (Unaudited)
1. General
-------
The accompanying financial statements, footnotes and discussions should be
read in conjunction with the financial statements and footnotes contained in ILM
I Lease Corporation's ("the Company") Annual Report for the year ended August
31, 1997. In the opinion of management, the accompanying interim financial
statements, which have not been audited, reflect all adjustments necessary to
present fairly the results for the interim periods. All of the accounting
adjustments reflected in the accompanying interim financial statements are of a
normal recurring nature.
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with generally accepted accounting principles,
which require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities as of May 31, 1998 and August 31, 1997 and revenues and expenses
for each of the nine- and three-month periods ended May 31, 1998 and 1997.
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 Company was organized as a corporation on September 12, 1994 under the
laws of the State of Virginia. Through August 31, 1995, the Company had no
significant operations. The Company was formed by ILM Senior Living, Inc. ("ILM
I"), formerly PaineWebber Independent Mortgage Fund, Inc., to operate eight
rental housing projects that provide independent-living and assisted-living
services for independent senior citizens ("the Senior Housing Facilities") under
a master lease arrangement. ILM I initially made mortgage loans to Angeles
Housing Concepts, Inc. ("AHC") secured by the Senior Housing Facilities between
June 1989 and July 1992. In March 1993, AHC defaulted under the terms of such
mortgage loans and in connection with the settlement of such default, title to
the Senior Housing Facilities was transferred, effective April 1, 1994, to
certain majority-owned, indirect subsidiaries of ILM I, subject to the mortgage
loans. Subsequently, the indirect subsidiaries of ILM I were merged into ILM
Holding, Inc. ("ILM Holding"). As part of the fiscal 1994 settlement agreement
with AHC, AHC was retained as the property manager for all of the Senior Housing
Facilities pursuant to the terms of a management agreement (the "Agreement"),
which was assigned to the Company as of September 1, 1995. The Agreement with
AHC was terminated in July 1996.
ILM I has elected to be taxed as a Real Estate Investment Trust ("REIT")
under the Internal Revenue Code of 1986, as amended ("the Code"), for each
taxable year of operations. In order to maintain its status as a REIT, 75% of
ILM I's annual gross income must be qualified rental income as defined by the
Code. The rent paid by the residents of the Senior Housing Facilities likely
would not be deemed to be qualified rental income because of the extent of
services provided to residents. Consequently, the operation of the Senior
Housing Facilities by ILM I or its subsidiaries over an extended period of time
could adversely affect ILM I's status as a REIT. Therefore, ILM I formed the
Company to operate the Senior Housing Facilities, and by means of a
distribution, transferred the ownership of the common stock of the Company to
the holders of ILM I common stock on September 1, 1995. Because the Company,
which is taxed as a regular C corporation, is no longer a subsidiary of ILM I,
it can receive service-related income without endangering the REIT status of ILM
I.
The Company's sole business is the operation of the Senior Housing
Facilities. The Company leases the Senior Housing Facilities from ILM Holding, a
majority-owned and consolidated affiliate of ILM I, which currently holds title
to the Senior Housing Facilities, pursuant to a master lease which commenced on
September 1, 1995 and expires on December 31, 1999 (see Note 2). In July, 1996,
the Company entered into a property management agreement with Capital Senior
Management 2, Inc. ("Capital") of Dallas, Texas to handle the day-to-day
operation of the Senior Housing Facilities. In November 1996, Lawrence A. Cohen,
a director of the Company and President, Chief Executive Officer and Director of
ILM I, became Vice Chairman and Chief Financial Officer of Capital Senior Living
Corporation, an affiliate of Capital. As a result, the management agreement with
Capital is considered a related party transaction (see Note 3).
-8-
<PAGE>
ILM I LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
2. The Master Lease Agreement
--------------------------
ILM Holding (the "Lessor") has leased the Senior Housing Facilities to the
Company (the "Lessee") pursuant to a master lease which commenced on September
1, 1995. Under the terms of the master lease, which has a scheduled expiration
date of December 31, 1999, the Lessor has the right to terminate the master
lease as to any Senior Housing Facility sold as of the date of such sale. The
master lease is accounted for as an operating lease in the Company's financial
statements.
Descriptions of the properties covered by the master lease between the
Company and ILM Holding are summarized as follows:
<TABLE>
<CAPTION>
Rentable Resident
Name Location Units Capacities
- ---- -------- ----- ----------
<S> <C> <C> <C>
Independence Village of East Lansing East Lansing, MI 161 162
Independence Village of Winston-Salem Winston-Salem, NC 159 161
Independence Village of Raleigh Raleigh, NC 164 205
Independence Village of Peoria Peoria, IL 165 181
Crown Point Apartments Omaha, NE 135 163
Sedgwick Plaza Apartments Wichita, KS 150 170
West Shores Hot Springs, AR 136 166
Villa Santa Barbara (1) Santa Barbara, CA 125 125
</TABLE>
(1) The Company operates Villa Santa Barbara under a co-tenancy arrangement
with an affiliated company, ILM II Lease Corporation ("Lease II"). The
Company has entered into an agreement with Lease II regarding such
joint tenancy. Lease II was formed for similar purposes as the Company
by an affiliated REIT, ILM II Senior Living, Inc. ("ILM II"), a
subsidiary of which owns a portion of the Villa Santa Barbara property.
The portion of the Senior Housing Facility leased by the Company
represents 25% of the total project. Villa Santa Barbara is 25% owned
by ILM Holding and 75% by ILM II Holding, Inc., a majority-owned and
consolidated subsidiary of ILM II.
During the term of the master lease, the Company is obligated to pay annual
base rent for the Senior Housing Facilities. 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. The Lessor is responsible
for major capital improvements and structural repairs to the Senior Housing
Facilities. In addition, beginning in the second quarter of fiscal 1997 and for
the remainder of the lease term, the Company is also obligated to pay variable
rent for each facility. Variable rent is payable quarterly and equals 40% of the
excess of aggregate total revenues for the Senior Housing Facilities, on an
annualized basis, over $16,996,000. Variable rent amounted to $651,026 and
$232,270 for the nine- and three-month periods ended May 31, 1998, respectively.
This compares to variable rent of approximately $199,000 and $128,000 for the
nine- and three-month periods ended May 31, 1997, respectively.
Under the master lease, the Company's use of the properties is limited to
use as Senior Housing Facilities unless the Lessor's consent to some other use
is obtained. The Company has responsibility to obtain and maintain all licenses,
certificates and consents needed to use and operate each facility, and to use
and maintain each Senior Housing Facility in compliance with all local board of
health and other applicable governmental and insurance regulations. The Senior
Housing Facilities located in Arkansas, California and Kansas are licensed by
such states to provide assisted living services. Also, various health and safety
regulations and standards, which are enforced by state and local authorities,
apply to the operation of all the Senior Housing Facilities. Violations of such
health and safety standards could result in fines, penalties, closure of a
Senior Housing Facility, or other sanctions.
-9-
<PAGE>
ILM I LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
3. Related Party Transactions
--------------------------
Subject to the supervision of the Company's Board of Directors, assistance
in managing the business of the Company was provided by PaineWebber. As
previously discussed in Note 1, PaineWebber resigned effective as of June 18,
1997.
The Company has retained Capital to be the property manager of the Senior
Housing Facilities pursuant to a management agreement which commenced on July
29, 1996. In November 1996, Lawrence A. Cohen, a Director of the Company and
President, Chief Executive Officer and Director of ILM I, was also named Vice
Chairman and Chief Financial Officer of Capital Senior Living Corporation, an
affiliate of Capital. The initial term of the management agreement expires on
December 31, 1999, which coincides with the expiration of the master lease
agreement between the Company and ILM Holding described in Note 2. Under the
terms of the management agreement, in the event that the master lease agreement
is extended beyond December 31, 1999, the management agreement will be extended
as well, but not beyond July 29, 2001. Under the terms of the management
agreement, Capital earns a base management fee equal to 4% of the gross
operating revenues of the Senior Housing Facilities, as defined. Capital is also
eligible to earn an incentive management fee equal to 25% of the amount by which
the average monthly net cash flow of the Senior Housing Facilities, as defined,
for the twelve-month period ending on the last day of each calendar month
exceeds a specified base amount. Each August 31, beginning on August 31, 1997,
the base amount is increased based on the percentage increase in the Consumer
Price Index as well as 15% of facility expansion costs. ILM I has guaranteed the
payment of all fees due to Capital under the terms of the management agreement.
For the nine- and three-month periods ended May 31, 1998, Capital earned
property management fees from the Company of $742,000 and $258,000,
respectively. This compares to $637,000 and $222,000 for the nine- and
three-month periods ended May 31, 1997, respectively.
On September 18, 1997, the Company entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the development
process for the potential expansions of several of the Senior Housing
Facilities. Capital Senior Development, Inc. will receive a fee equal to 7% of
the total development costs of these expansions if they are pursued. ILM Holding
will reimburse the Company for all costs related to these potential expansions
including fees to Capital Senior Development, Inc. For the nine- and three-month
periods ended May 31, 1998, Capital Senior Development, Inc. earned fees from
the Company of $212,465 and $82,616, 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 an employee of
Greenberg Traurig Hoffman Lipoff Rosen & Quentel, which began acting as Counsel
to the Company and its affiliates in late fiscal 1997. For the nine- and
three-month periods ended May 31, 1998, Greenberg Traurig Hoffman Lipoff Rosen &
Quentel earned fees from the Company of $115,794 and $63,811, respectively.
Accounts receivable - related party at May 31, 1998 and August 31, 1997
includes advances of $205,871, and $93,000, respectively, to ILM Holding,
primarily to fund facility expansion costs. Accounts payable - related party at
May 31, 1998 and August 31, 1997 consists principally of base rent and variable
rent payable to ILM Holding of $1,823,474 and $116,000, respectively, and
expense reimbursement payable to Lease II of $15,000 and $0, respectively.
4. Legal Proceedings and Contingencies
-----------------------------------
A management agreement between ILM Holding and Angeles Housing Concepts,
Inc. ("AHC"), which covered the management of all eight Senior Housing
Facilities, was assigned to the Company effective September 1, 1995. On July 29,
1996, the Company and ILM Holding ("the Companies") terminated the property
management agreement with AHC. The management agreement was terminated for cause
pursuant to the terms of the contract. Simultaneously with the termination of
the management agreement, the Companies, together with certain affiliated
entities, filed suit against AHC in the United States District Court for the
Eastern District of Virginia for breach of contract, breach of fiduciary duty
and fraud. The Company and ILM Holding allege, among other things, that AHC
willfully performed actions specifically in violation of the management
agreement and that such actions caused damages to the Companies.
-10-
<PAGE>
ILM I LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
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 Holding. The
counterclaim alleged that the management agreement was wrongfully terminated for
cause and requests damages, which include the payment of a termination fee in
the amount of $1,250,000, payment of management fees pursuant to the contract
from August 1, 1996 through October 15, 1996, which is the earliest date the
management agreement could have been terminated without cause, and recovery of
attorney's fees and expenses. The aggregate amount of damages against all
parties as requested in AHC's counterclaim exceeded $2,000,000. On June 13, 1997
and July 8, 1997, the court issued orders to enter judgment against ILM I and
ILM II in the aggregate amount of $1,000,000 ("the Orders"). In so doing, the
court effectively canceled the June 23, 1997 trial date. The Orders do not
contain any findings of fact or conclusions of law. On July 10, 1997, the
Company, ILM I, ILM II, and Lease II filed a notice of appeal to the United
States Court of Appeals for the Fourth Circuit from the Orders. The Company
intends to diligently pursue the appeal. The eventual outcome of this litigation
cannot presently be determined. However, provision of $600,000 for the liability
which might result to the Company was recorded as "termination fee payable" at
May 31, 1998 and August 31, 1997. The remaining $400,000 was recorded on the
financial statements of Lease II. ILM I has guaranteed the payment of the
termination fee at issue in these proceedings to the extent that any termination
fee is deemed payable by the court and in the event that the Company fails to
perform pursuant to its contractual obligations.
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, and others alleging that
the defendants intentionally interfered with AHC's property management agreement
with ILM Holding by inducing ILM Holding to terminate the management agreement
(the "California litigation"). The complaint seeks damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. Trial in the action is
expected during 1998 and discovery has begun. At a meeting on February 26, 1997,
the Company's Board of Directors concluded that since all of Mr. Cohen's actions
relating to the California litigation were taken either on behalf of the Company
under the direction of the Board or as a PaineWebber employee, the Company or
its affiliates should indemnify Mr. Cohen with respect to any expenses arising
from the California litigation, subject to any insurance recoveries for those
expenses. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should advance up to $20,000 to pay
reasonable legal fees and expenses incurred by Capital and its affiliates in the
California litigation. Subsequently, the Boards of the Company 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. As of May
31, 1998, the amount advanced to Capital by the Company and Lease II totaled
approximately $335,000. The defendants intend to vigorously defend the claims
made against them in the California litigation. The eventual outcome of this
litigation cannot presently be determined and, accordingly, no provision for any
liability has been recorded in the accompanying financial statements.
-11-
<PAGE>
ILM I LEASE CORPORATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Company was formed in 1995 by ILM I, a publicly-held, non-traded REIT,
for the purpose of operating eight Senior Housing Facilities under the terms of
a master lease agreement. ILM I contributed $700,000 in return for all of the
issued and outstanding shares of the Company's common stock. ILM I had
originally made mortgage loans secured by the Senior Housing Facilities to AHC
between June 1989 and July 1992. In March 1993, AHC defaulted under the terms of
such mortgage loans and in connection with the settlement of such default, title
to the Senior Housing Facilities was transferred, effective April 1, 1994, to
certain majority-owned, indirect subsidiaries of ILM I, subject to the mortgage
loans. Subsequently, these indirect subsidiaries were merged into ILM Holding,
which is also a majority-owned subsidiary of ILM I. As part of the fiscal 1994
settlement agreement with AHC, AHC was retained as the property manager for the
Senior Housing Facilities pursuant to the terms of an agreement which was
assigned to the Company as of September 1, 1995. As discussed further below, the
agreement with AHC was terminated in July 1996.
ILM I has elected to be taxed as a REIT under the Internal Revenue Code of
1986, as amended ("the Code"), for each taxable year of operations. In order to
maintain its status as a REIT, 75% of ILM I's annual gross income must be
qualified rental income as defined by the Code. The rent paid by the residents
of the Senior Housing Facilities likely would not be deemed to be qualified
rental income because of the extent of services provided to residents.
Consequently, the operation of the Senior Housing Facilities by ILM I or its
subsidiaries over an extended period of time could adversely affect ILM I's
status as a REIT. Therefore, ILM I formed the Company to operate the Senior
Housing Facilities, and by means of a distribution, transferred the ownership of
the common stock of the Company to the holders of ILM I common stock. Because
the Company, which is taxed as a regular C corporation, is no longer a
subsidiary of ILM I, it can receive service-related income without endangering
the REIT status of ILM I. On September 1, 1995, after ILM I received the
required regulatory approval, it distributed all of the outstanding shares of
capital stock of the Company to the holders of record of ILM I's common stock.
The master lease agreement, which commenced on September 1, 1995, is between
ILM Holding, as owner of the properties and lessor, and the Company, 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 Holding, as the lessor, is responsible for all major
capital improvements and structural repairs to the Senior Housing Facilities. If
the Company and ILM Holding decide that any of the Senior Housing Facilities
should be expanded, the master lease agreement between the Company and ILM
Holding would be amended to include such expansion. During the initial term of
the master lease, which expires on December 31, 1999, the Company is obligated
to pay annual base rent for the use of all the Senior Housing Facilities in the
aggregate amount of $6,364,800. Beginning in January 1997 and for the remainder
of the lease term, the Company is also obligated to pay variable rent for each
Senior Housing Facility. Such variable rent is payable quarterly and will equal
40% of the excess, if any, of the aggregate total revenues for the Senior
Housing Facilities, on an annualized basis, over $16,996,000. For the nine- and
three-month periods ended May 31, 1998, variable rent expense was $651,026 and
$232,270, respectively. This compares to variable rent of approximately $199,000
and $128,000 for the nine- and three-month periods ended May 31, 1997,
respectively.
As noted above, the Company's master lease is scheduled to expire on
December 31, 1999. This period coincides with the end of ILM I's expected
holding period for its investments in the Senior Housing Facilities. While such
holding period is subject to change, the current Articles of Incorporation of
ILM I provide that the liquidation of ILM I must be completed by no later than
December 31, 2014. Any further renewals of the master lease beyond December 1999
would be subject to negotiation between the Company and ILM I and its
consolidated affiliate. Accordingly, since the Company does not have any current
plans to operate or own any other facilities or engage in any other business
outside of its relationship with ILM I, there is no assurance that the Company's
operations will continue beyond December 1999.
The Company and ILM I continue to review various restructuring alternatives.
An independent investment banking firm has been retained by the Company and its
affiliates to assist in reviewing these strategic alternatives. The Company has
not fully evaluated any of these alternatives and is not in a position at this
time to recommend any actions to the shareholders. There can be no assurance
that the Company will recommend taking any of the actions which may be
recommended by its investment bankers.
-12-
<PAGE>
ILM I LEASE CORPORATION
MANAGEMENTS'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources (continued)
Occupancy levels for the eight properties which the Company leases from ILM
Holding averaged 95% and 96%, respectively, for the nine- and three-month
periods ended May 31, 1998. Base master lease payments of $6,364,800, will
remain in effect throughout the remaining term of the lease. As noted above, the
master lease also provides for the payment of variable rent and the Senior
Housing Facilities are currently generating gross revenues which are in excess
of the specified threshold in the variable rent calculation. Current annualized
operating income levels are sufficient to cover the Company's base and variable
rent obligations to ILM Holding.
The Company and ILM I have been pursuing the potential for future expansion
of several of the facilities which are located in areas that have particularly
strong markets for senior housing. Potential expansion candidates include the
facilities located in Raleigh, North Carolina, East Lansing, Michigan, Omaha,
Nebraska, Peoria, Illinois and Hot Springs, Arkansas. Approximately two acres of
land located adjacent to the East Lansing facility and approximately
two-and-one-half acres of land located adjacent to the Omaha facility were
acquired by ILM Holding during the quarter ended November 30, 1997. In addition,
an agreement has been obtained by ILM Holding to purchase approximately five
acres of land located adjacent to the Peoria facility. In May 1998, the Company
and ILM Holding decided not to pursue the Peoria expansion over the near term
and allowed the agreement to expire. The Hot Springs facility already includes a
vacant land parcel of approximately two 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 Raleigh and
Omaha.
Once the pre-construction design process is complete and projected expansion
construction costs are determined, the Company and ILM Holding will carefully
evaluate the costs and benefits before proceeding with the construction of any
of these expansions. If the Company and ILM Holding decide to proceed with any
of these expansions, the master lease agreement between the Company and ILM
Holding will be amended to include such expansions. ILM Holding is currently
negotiating with a major bank to provide a construction loan facility that, if
finalized, would provide up to $24.5 million to fund the capital costs of these
potential expansion programs.
At May 31, 1998, the Company had cash and cash equivalents of $3,190,000.
Such amounts will be used for the Company's working capital requirements. As
noted above, under the terms of the master lease, the Lessor is responsible for
major capital improvements and structural repairs to the Senior Housing
Facilities. Consequently, the Company does not have any material commitments for
capital expenditures. Furthermore, the Company does not currently anticipate the
need to engage in any borrowing activities. The Company has not paid cash
dividends in fiscal 1996, 1997 or 1998. The Company may or may not determine to
pay cash dividends in the future. Payment of dividends, if any, will be at the
discretion of the Company's Board of Directors and will depend upon such factors
as the Company's financial condition, earnings, anticipated investments and
other relevant factors. The source of future liquidity is expected to be from
operating cash flows from the Senior Housing Facilities, net of the master lease
payments to ILM Holding, and interest income earned on invested cash reserves.
Such sources of liquidity are expected to be adequate to meet the Company's
operating requirements on both a short-term and long-term basis.
While the Company has potential liabilities pending due to ongoing
litigation against the Company, or for which the Company is a guarantor, the
eventual outcome of this litigation cannot presently be determined. The court
order in the Virginia AHC litigation equals $1 million and the California
litigation by AHC seeks at least $2 million. As discussed in Note 4, Legal
Proceedings and Contingencies, the Company and Lease II have agreed to indemnify
Mr. Cohen and to advance funds to Capital to pay reasonable legal fees and
expenses in the California litigation. Amounts are being advanced 60% by the
Company and 40% by Lease II based on their relative sizes and the identity of
the issues. 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.
-13-
<PAGE>
ILM I LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Results of Operations
Nine Months Ended May 31, 1998 versus Nine Months Ended May 31, 1997
Revenues
Total revenues were $14,423,000 for the nine months ended May 31, 1998
compared to $13,456,000 for the same period of the prior year, representing an
increase of $967,000 or 7.2%. Rental and other income from the Company's Senior
Housing Facilities operations increased $981,000 primarily as a result of
improved occupancies and increased rental rates at certain of the facilities
located in strong markets.
Expenses
Total expenses were $14,112,000 for the nine months ended May 31, 1998
compared to $13,223,000 for the same period in the prior year, representing an
increase of $889,000 or 6.7%. This increase was principally comprised of
increases in master lease expense of $452,000, dietary and food service
salaries, wages and expenses of $125,000, general and administrative expenses of
$246,000, and property management fees of $105,000, offset by minor decreases in
certain other expenses. The increase in master lease expense is the result of
variable rent payments due under the master lease agreement. General and
administrative expenses increased principally as a result of the AHC litigation
expenses.
Income Tax Expense
Income tax expense increased overall by $32,000 or 34% as compared to the
same period in the prior year, as a result of an increase in income before taxes
of $78,000.
Net Income
Primarily as a result of the factors noted above, net income increased from
$140,000 for the nine-month period ended May 31, 1997 to $186,000 for the nine-
month period ended May 31, 1998.
Results of Operations
Three Months Ended May 31, 1998 versus Three Months Ended May 31, 1997
Revenues
Total revenues were $4,858,000 for the quarter ended May 31, 1998 compared
to $4,592,000 for the same period of the prior year, representing an increase of
$266,000 or 5.8%. Rental and other income from the Company's Senior Housing
Facilities operations increased $262,000, primarily as a result of improved
occupancies and increased rental rates at certain of the facilities located in
strong markets.
Expenses
Total expenses were $4,796,000 for the quarter ended May 31, 1998 compared
to $4,723,000 for the same period in the prior year, representing an increase of
$73,000 or 1.5%. This increase was principally comprised of increases in master
lease expense of $104,000 and property management fees of $36,000, offset by
minor decreases in certain other expenses. The increase in master lease expense
is the result of variable rent payments due under the master lease agreement.
Income Tax Expense
Income tax expense increased overall by $77,000 as compared to the same
period in the prior year, as a result of an increase in income of $193,000.
Net Income
Primarily as a result of the factors noted above, net income increased from
a net loss of $79,000 for the quarter ended May 31, 1997 to net income of
$37,000 for the quarter ended May 31, 1998.
-14-
<PAGE>
ILM I LEASE CORPORATION
PART II
Other Information
Item 1. through 5. NONE
- ------------------
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits: 27. Financial Data Schedule
(b) Reports on Form 8-K: NONE
-15-
<PAGE>
ILM I LEASE CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
By: ILM I LEASE CORPORATION
By: /s/ J. William Sharman, Jr.
---------------------------
J. William Sharman, Jr.
President
Dated: July 15, 1998
-16-
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