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
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SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended November 30, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-25880
ILM II LEASE CORPORATION
------------------------
(Exact name of registrant as specified in its charter)
Virginia 04-3248639
- -------------------------------- -------------------
(State of 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 March 31, 1998: 5,180,952.
Page 1 of 15
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
November 30, 1997 (Unaudited) and August 31, 1997
(In thousands)
ASSETS
<TABLE>
<CAPTION>
November 30 August 31
----------- ---------
<S> <C> <C>
Cash and cash equivalents $2,087 $1,156
Accounts receivable 3 -
Accounts receivable - related party 391 205
Prepaid expenses and other assets 334 403
------ ------
Total current assets 2,815 1,764
Furniture, fixtures and equipment 515 486
Less: accumulated depreciation (93) (70)
------ ------
422 416
Deferred tax asset, net 103 96
------ ------
$3,340 $2,276
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 639 $ 528
Termination fee payable 400 400
Real estate taxes payable -- 199
Accounts payable - related party 1,350 150
Accrued expenses 30 171
Security deposits 9 9
------ ------
Total current liabilities 2,428 1,457
Deferred rent payable 92 100
------ ------
Total liabilities 2,520 1,557
Commitments and Contingencies
Shareholders' Equity:
Common stock, $0.01 par value,
20,000,000 shares authorized
5,180,952 shares issued and outstanding 52 52
Additional paid-in capital 448 448
Retained earnings 320 219
------ ------
Total Shareholder's equity 820 719
------ ------
$3,340 $2,276
====== ======
</TABLE>
See accompanying notes.
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<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands, except per Share amounts)
<TABLE>
<CAPTION>
Three Months Ended
November 30,
---------------------
1997 1996
---- ----
<S> <C> <C>
Revenues
Rental and other income $3,732 $3,576
Interest income 5 10
------ ------
3,737 3,586
Expenses
Master lease rent expense 1,192 1,001
Dietary and food service salaries, wages and expenses 662 659
Administrative salaries, wages and expenses 283 252
Marketing salaries, wages and expenses 167 152
Utilities 269 266
Repairs and maintenance 120 126
Real estate taxes 115 125
Property management fees 205 192
Other property operating expenses 402 382
General and administrative 131 27
Advisory fees -- 18
Depreciation expense 23 7
------ ------
3,569 3,207
------ ------
Income before taxes 168 379
Income tax expense
Current 59 145
Deferred 8 7
------ ------
67 152
------ ------
Net income $ 101 $ 227
====== ======
Basic earnings per share of common stock $ 0.02 $ 0.04
====== ======
</TABLE>
The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.
See accompanying notes.
-3-
<PAGE>
ILM II LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
-------------------- Paid-In Accumulated
Shares Amount Capital Earnings Total
------ ------ ---------- ----------- -----
<S> <C> <C> <C> <C> <C>
Balance At August 31, 1996 5,181 $52 $448 $259 $759
Net income -- -- -- 227 227
----- --- ---- ---- ----
Balance at November 30, 1996 5,181 $52 $448 $486 $986
===== === ==== ==== ====
Balance at August 31, 1997 5,181 $52 $448 $219 $719
Net income -- -- -- 101 101
----- --- ---- ---- ----
Balance at November 30, 1997 5,181 $52 $448 $320 $820
===== === ==== ==== ====
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1997 and 1996 (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Cash flows from operating activities: 1997 1996
---- ----
<S> <C> <C>
Net income $ 101 $ 227
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 23 7
Changes in assets and liabilities:
Accounts receivable 52 (4)
Accounts receivable - affiliate (391) --
Prepaid expenses and other assets 69 24
Deferred tax asset, net (7) 8
Accounts payable and accrued expenses 122 (112)
Accounts payable - affiliates 1,198 7
Real estate taxes payable (199) (203)
Security deposits -- (1)
Deferred rent payable (8) (8)
Income taxes payable -- --
------ ------
Net cash provided by (used in) operating activities 960 (55)
------ ------
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (29) (2)
------ ------
Net cash used in investing activities (29) (2)
------ ------
Net increase (decrease) in cash and cash equivalents 931 (57)
Cash and cash equivalents, beginning of period 1,156 1,591
------ ------
Cash and cash equivalents, end of period $2,087 $1,534
====== ======
Supplemental disclosure:
Cash paid during the period for income taxes $ -- $ --
====== ======
</TABLE>
See accompanying notes.
-5-
<PAGE>
ILM II 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 the
company's 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 period. 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 November 30, 1997 and August 31, 1997 and revenues and
expenses for each of the three-month periods ended November 30, 1997 and 1996.
Actual results could differ from the estimates and assumptions used. Certain
items in the prior period's financial statements have been reclassified to
conform to the current period's presentation.
ILM II Lease Corporation ("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
II Senior Living, Inc., formerly PaineWebber Independent Living Mortgage Inc. II
("ILM II"), to operate six rental housing projects that provide
independent-living and assisted-living services for senior citizens ("the Senior
Housing Facilities") under a master lease agreement. ILM II initially made
mortgage loans to Angeles Housing Concepts, Inc. ("AHC") secured by the Senior
Housing Facilities between July 1990 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 II,
subject to the mortgage loans. Subsequently, the indirect subsidiaries of ILM II
were merged into ILM II Holding, Inc. ("ILM II 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 II 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 II'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 II or its
subsidiaries over an extended period of time could adversely affect ILM II's
status as a REIT. Therefore, ILM II 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 II common stock on
September 1, 1995. Because the Company, which is taxed as a regular C
corporation, is no longer a subsidiary of ILM II, it can receive service-related
income without endangering the REIT status of ILM II.
The Company's sole business is the operation of the Senior Housing
Facilities. The Company initially leased the Senior Housing Facilities from ILM
II Holding, a majority-owned and consolidated affiliate of ILM II 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, 2000
(December 31, 1999 with respect to the Santa Barbara Facility) (see Note 2). The
Company entered into a property management agreement with Capital Senior
Management 2, Inc. of Dallas, Texas ("Capital") to handle the day-to-day
operations of the Senior Housing Facilities. The management agreement with
Capital was executed in July 1996.
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<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
1. General (continued)
-------------------
In November 1996, Lawrence A Cohen, a director of the Company and President,
Chief Executive Officer and Director of ILM II, 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).
2. The Master Lease Agreement
--------------------------
ILM II 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, 2000 (December 31, 1999 with respect to the
Santa Barbara Facility), 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 II Holding are summarized as follows:
<TABLE>
<CAPTION>
Rentable
Name Location Units
- ---- -------- -----
<S> <C> <C>
The Palms Fort Myers, FL 205
Crown Villa Omaha, NE 73
Overland Park Place Overland Park, KS 139
Rio Las Palmas Stockton, CA 164
The Villa at Riverwood St. Louis County, MO 120
Villa Santa Barbara (1) Santa Barbara, CA 125
</TABLE>
(1) The Company operates Villa Santa Barbara under a co-tenancy arrangement
with an affiliated company, ILM I Lease Corporation ("Lease I"). The
Company has entered into an agreement with Lease I regarding such joint
tenancy. Lease I was formed for similar purposes as the Company by an
affiliated REIT, ILM Senior Living, Inc. ("ILM I"), a subsidiary of
which owns 25% of the Villa Santa Barbara property. The portion of the
Senior Housing Facility leased by the Company represents 75% of the
total project. Villa Santa Barbara is 25% owned by ILM Holding Inc. and
75% by ILM II Holding Inc.
During the term of the master lease, the Company is obligated to pay annual
base rent ("Base Rent") for the Senior Housing Facilities. The master lease is a
"triple-net" lease whereby the Lessee pays all operating expanses, 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 ("Additional
Rent"). 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
obligated to pay variable rent ("Variable Rent") for each facility. Such
variable rent is payable quarterly and equals 40% of the excess, if any, of the
aggregate total revenues for the Senior Housing Facilities on an annualized
basis, over $13,021,000. Variable rent amounted to $191,000 for the three months
ended November 30, 1997.
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 Senior Housing
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
-7-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
2. The Master Lease Agreement (continued)
--------------------------------------
California, Florida 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 facility or other sanctions.
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 Senior Management 2, Inc. ("Capital") of
Dallas, Texas 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 II, 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, 2000, which
coincides with the expiration of the master lease agreement between the Company
and ILM II 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, 2000, 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 will be increased
based on the percentage increase in the Consumer Price Index. ILM II has
guaranteed the payment of all fees due to Capital under the terms of the
management agreement.
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 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 II Holding will reimburse the
Company for all costs related to these potential expansions including fees to
Capital Senior Development, Inc. During the quarter ended November 30, 1997,
Capital Senior Development, Inc. earned fees of $40,318 for managing
pre-construction development activities for potential expansions of the Senior
Housing Facilities.
Jeffry R. Dwyer, Secretary and director of the Company, is an employee of
Greenberg Traurig Hoffman Lipoff Rosen & Quentel, which acts as Counsel to the
Company and its affiliates. Greenberg Traurig Hoffman Lipoff Rosen & Quentel
earned fees from the Company of $36,203 for the quarter ended November 30, 1997.
Accounts receivable - related party at November 30, 1997 and August 31, 1997
includes advances of $391,000 and $0, respectively, to ILM II Holding, primarily
for the purchase of land for the expansion of the Senior Housing Facilities.
Accounts payable - related party at November 30, 1997 and August 31, 1997
includes $1,350,000 and $152,000, respectively, for base rent and variable rent
due to ILM II Holding.
4. Legal Proceedings and Contingencies
-----------------------------------
A management agreement between ILM II Holding and Angeles Housing Concepts,
Inc. ("AHC"), which covered the management of all six Senior Housing Facilities,
was assigned to the Company effective September 1, 1995. On July 29, 1996, the
Company and ILM II Holding ("the Companies") terminated the
-8-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited) (continued)
4. Legal Proceedings and Contingencies (continued)
-----------------------------------------------
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 II 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. Due to the
termination of the agreement for cause, no termination fee was paid to AHC.
Subsequent to the termination of the management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic State of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed
with the Virginia District Court an answer in response to the litigation
initiated by the Companies and a counterclaim against ILM II Holding. The
counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests damages which include the payment of a termination fee in the
amount of $750,000, payment of management fees pursuant to the contract from
August 1, 1996 through October 15, 1996, which is the earliest date the
management agreement could have been terminated without cause, and recovery of
attorney's fees and expenses. The aggregate amount of damages against all
parties as requested in AHC's counterclaim exceeds $2,000,000. ILM II 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.
The court initially set a trial date of April 28, 1997 but, at AHC's request,
rescheduled the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the
court issued orders to enter judgment against ILM II and ILM I in the amount of
$1,000,000 ("the "Orders"). In so doing, the court effectively canceled the June
23, 1997 trial date. The Orders do not contain any findings of fact or
conclusions of law. On July 10, 1997, the Company, ILM II, ILM I and ILM I Lease
Corporation 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. Although the eventual outcome of this litigation cannot presently be
determined, a provision of $400,000 for the liabilities which might result to
the Company was recorded as "termination fee payable" at August 31, 1997. The
remaining $600,000 was recorded on the financial statements of Lease I.
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 II Holding by inducing ILM II 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 just begun. At a meeting on February 26,
1997, the Company's Board of Directors concluded that since all of Mr. Cohen's
actions relating to the California litigation were taken either on behalf of the
Company under the direction of the Board or as a PaineWebber Properties
employee, the Company or its affiliates should indemnify Mr. Cohen with respect
to any expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the Boards of the Company and ILM I Lease
Corporation 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. 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.
-9-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
The Company was formed in 1995 by ILM II, a publicly-held, non-traded REIT,
for the purpose of operating six Senior Housing Facilities under the terms of a
master lease agreement. ILM II contributed $500,000 in return for all of the
issued and outstanding shares of the Company's common stock. ILM II had
originally made mortgage loans secured by the Senior Housing Facilities to AHC
between July 1990 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 II, subject to the mortgage
loans. Subsequently, these indirect subsidiaries were merged into ILM II
Holding, which is also a majority-owned subsidiary of ILM II. 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 2, 1995. As discussed further
below, the Agreement with AHC was terminated in July 1996.
ILM II 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 of a REIT, 75% of ILM II'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 II or its
subsidiaries over an extended period of time could adversely affect ILM II's
status as a REIT. Therefore, ILM II 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 II common stock. Because
the Company, which is taxed as a regular C corporation, is no longer a
subsidiary of ILM II, it can receive service-related income without endangering
the REIT status of ILM II. On September 1, 1995, after ILM II 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 II's common stock.
One share of common stock of the Company was issued for each full share of ILM
II's common stock held. No fractional shares were issued. Holders of ILM II's
common stock were not required to pay any cash or other consideration or to
exchange their common stock of ILM II for the common stock of the Company. Prior
to the distribution of the Company's stock, ILM II's shareholders received an
information statement fully describing the Company and the distribution of its
capital stock.
The master lease agreement, which commenced on September 1, 1995, is between
ILM II 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 II Holding, as the Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. If the Company and ILM II Holding decide that any of the Senior
Housing Facilities should be expanded, the master lease agreement between the
Company and ILM II Holding would be amended to include such expansion. During
the initial term of the master lease, which expires on December 31, 2000
(December 31, 1999 with respect to the Santa Barbara Facility), the Company is
obligated to pay annual rent for use of all the Senior Housing Facilities in the
aggregate amount of $3,548,700 for calendar year 1995 (prorated based on the
lease commencement date) and $4,035,600 for calendar year 1996 and each
subsequent year. Beginning 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 $13,021,000. Variable rent expense
related to the first quarter of fiscal 1998 was $191,000.
-10-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
As noted above, the Company's master lease is scheduled to expire on
December 31, 2000. This period coincides with the end of ILM II'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 II provide that the liquidation of ILM II must be completed by no later than
December 31, 2005. Any further renewals of the master lease beyond December 31,
2000 would be subject to negotiation between the Company and ILM II 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 II, there is no assurance that the
Company's operations will continue beyond December 2000.
The Company and ILM II 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 action to its Shareholders. There can be
no assurance that the Company will recommend taking any of the actions which may
be recommended by its investment bankers.
On July 29, 1996, the Company terminated the Agreement with AHC covering six
Senior Housing Facilities leased by the Company (see Note 3 of the Notes to
Consolidated Financial Statements). Subsequent to terminating the property
management agreement, the company retained Capital to be the new manager of the
Senior Housing Facilities pursuant to a management agreement ("Management
Agreement") which commenced on July 29, 1996. Under the terms of the Management
Agreement, Capital will earn a Base Management Fee equal to 4% of the Gross
Operating Revenues of the Senior Housing Facilities, as defined. Capital will
also be eligible to earn and 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 specific base amount. Each August 31, beginning on August 31,
1997, the base amount will be increased annually based on the percentage
increase in the Consumer Price Index. ILM II has guaranteed the payment of all
fees due to Capital under the terms of the Management Agreement.
The six properties which the Company leases from ILM II Holding averaged 94%
occupancy for the quarter ended November 30, 1997. Current annualized operating
income levels are sufficient to cover the base master lease payments at their
current annual level of $4,035,600 and the payment of variable rent which will
remain in effect throughout the remaining term of the lease. 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. Variable rent amounted to $191,000 for the three months ended November
30, 1997.
The Company and ILM II have been pursuing additional steps to increase cash
flow and shareholder value. Several new programs were adopted during fiscal 1997
across the Company's portfolio which are resulting in increased revenues and
cash flow from the properties. These steps include increasing the number of
rentable apartment units as live-in facility managers move from the properties
and increasing rental rates at properties that have maintained high occupancy
levels and are located in strong markets. Another program to increase revenues
and cash flow involves pursuing the potential for future expansions of several
of the facilities which are located in areas that have particularly strong
markets for senior housing. Potential expansion candidates include the
facilities located in Omaha, Nebraska, St. Louis County, Missouri, and Fort
Myers, Florida. As part of this expansion program, approximately three and
one-half acres of land located adjacent to the Omaha facility were acquired by
ILM II Holding during the
-11-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
quarter ended November 30, 1997. In addition, an agreement was obtained to
purchase approximately six acres of land located adjacent to the St. Louis
County facility but, in December 1998 ILM II Holding decided to not pursue the
expansion over the near term and allowed the agreement to expire. The Fort Myers
facility already includes a vacant land parcel of approximately one and one-half
acres which could accommodate an expansion of the existing 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.
Once the pre-construction design process is complete and projected expansion
construction costs are determined, the Company and ILM II Holding will carefully
evaluate the costs and benefits before proceeding with the construction of any
of these expansions. If the Company and ILM II Holding decide to proceed with
any of these expansions, the master lease agreement between the Company and ILM
II Holding will be amended to include such expansion.
Additionally, on December 1997, ILM II Holding purchased for $139,900 a
parcel of vacant land adjacent to the Stockton facility. Although no expansion
of this facility is being considered at this time, control of the property will
provide needed parking spaces and will improve access and marketability.
ILM II Holding is currently negotiating with a major bank to provide a
construction loan facility that, if finalized, would provide up to $15.5 million
to fund the capital costs of these potential expansion programs. The
construction loan facility is expected to be secured by first mortgage of the
Senior Housing Facilities and collateral assignment of the Company's leases of
such Senior Housing Facilities.
At November 30, 1997, the Company had cash and cash equivalents of
$2,087,000. 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
did not pay cash dividends in fiscal 1996 or fiscal 1997. The Company intends to
review this policy during the second half of fiscal 1998 and 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 flow from the Senior Housing Facilities, net
of the master lease payments to ILM II 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.
-12-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Results of Operations
Three Months Ended November 30, 1997 versus Three Months Ended November 30, 1996
Revenues
Total revenues were $3,737,000 for the quarter ended November 30, 1997 compared
to $3,586,000 for the same period of the prior year, representing an increase of
$151,000 or 4.2%. Rental and other income from the Company's senior housing
operations increased $156,000 primarily as a result of improved occupancies and
increased rental rates at certain of the facilities located in strong markets.
Expenses
Total expenses were $3,569,000 for the quarter ended November 30, 1997 compared
to $3,207,000 for the same period in the prior year representing an increase of
$362,000 or 11.3%. This increase was primarily comprised of increases in master
lease rent expense of $191,000, general and administrative expenses of $104,000,
and other minor increases in certain other expenses. The increase in master
lease expense is the result of variable rent payments due under the master lease
agreement which were not due in the comparable period in the prior year. General
and administrative expenses increased principally as a result of the AHC
litigation expenses.
Income Tax Expense
Income tax expense decreased by $85,000 or 56% as compared to the same period in
the prior year as a result of a decrease in income before taxes of $211,000.
Net income
Primarily as a result of the factors noted above, net income decreased from
$227,000 for the quarter ended November 30, 1996 to $101,000 for the quarter
ended November 30, 1997.
-13-
<PAGE>
ILM II 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
-14-
<PAGE>
ILM II 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 II LEASE CORPORATION
------------------------
By: /s/ J. William Sharman, Jr.
----------------------------
J. William Sharman, Jr.
President
Dated: May 1, 1998
-15-
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