<PAGE>
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------------
FORM 10-Q/A
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED FEBRUARY 28, 1999
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____ to ____.
Commission File Number: 0-25880
ILM II LEASE CORPORATION
(Exact name of registrant as specified in its charter)
VIRGINIA 04-3248639
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8180 GREENSBORO DRIVE, SUITE 850, MCLEAN, VA 22102
- --------------------------------------------- -----------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (888) 257-3550
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
TITLE OF EACH CLASS which registered
- ------------------- -------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
SHARES OF COMMON STOCK $.01 PAR VALUE
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes ___No _X__
Shares of common stock outstanding as of February 28, 1999: 5,180,952.
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Page 1 of 20
<PAGE>
ILM II LEASE CORPORATION
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information PAGE
<S> <C> <C>
Item 1. Financial Statements
Balance Sheets
February 28, 1999 (Unaudited) and August 31, 1998............................................4
Statements of Income
For the six months and three months ended February 28, 1999 and 1998 (Unaudited)............5
Statements of Changes in Shareholders' Equity
For the six months ended February 28, 1999 and 1998 (Unaudited)..............................6
Statements of Cash Flows
For the six months ended February 28, 1999 and 1998 (Unaudited)..............................7
Notes to Financial Statements (Unaudited).................................................8-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....13-17
Part II. Other Information...................................................................................18
Item 6. Exhibits and Reports on Form 8-K............................................................18
Signatures....................................................................................................19
</TABLE>
-2-
<PAGE>
ILM II LEASE CORPORATION
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C>
Item I. Financial Statements
(See next page)
</TABLE>
-3-
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
February 28, 1999 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
ASSETS
<TABLE>
<CAPTION>
FEBRUARY 28, 1999 AUGUST 31, 1998
----------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 1,167 $1,497
Accounts receivable, net 145 89
Accounts receivable - related party 102 102
Prepaid expenses and other assets 48 50
Tax refund receivable 27 158
------- -------
Total current assets 1,489 1,896
Furniture, fixtures and equipment 939 783
Less: accumulated depreciation (344) (225)
------- ------
595 558
Deposits 9 9
Deferred tax asset, net 88 270
------ ------
$2,181 $2,733
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 678 $ 789
Termination fee payable - 650
Real estate taxes payable 103 209
Accounts payable - related party 332 287
Security deposits 36 25
------ ------
Total current liabilities 1,149 1,960
Deferred rent payable 62 76
------ ------
Total liabilities 1,211 2,036
Shareholders' equity:
Common stock, $0.01 par value, 20,000,000 shares
authorized 5,180,952 issued and outstanding 52 52
Additional paid-in capital 448 448
Retained earnings 470 197
------ ------
Total shareholders' equity 970 697
------ ------
$2,181 $2,733
====== ======
</TABLE>
See accompanying notes.
-4-
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the six months and three months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
February 28, February 28,
------------ ------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Rental and other income $8,122 $7,600 $4,085 $3,868
Interest income 7 12 4 7
-------- ------ -------- --------
8,129 7,612 4,089 3,875
EXPENSES:
Facilities lease rent expense 2,644 2,446 1,333 1,254
Dietary salaries, wages and food service expenses 1,366 1,320 675 657
Administrative salaries, wages and expenses 597 570 315 287
Marketing salaries, wages and expenses 323 332 153 165
Utilities 527 522 254 253
Repairs and maintenance 286 251 156 131
Real estate taxes 262 308 128 125
Property management fees 547 444 323 239
Other property operating expenses 708 694 349 349
General and administrative expenses 118 106 60 57
Directors compensation 27 34 13 18
Professional fees 151 316 (20) 194
Depreciation expense 118 44 72 21
------ ----- ----- -----
7,674 7,387 3,811 3,750
----- ----- ----- -----
Income before taxes 455 225 278 125
Income tax expense:
Current - 235 - 50
Deferred 182 (145) 111 -
--- ----- --- -----
182 90 111 50
--- ----- --- -----
NET INCOME $ 273 $ 135 $ 167 $ 75
====== ====== ====== =====
Basic earnings per share of common stock $ 0.05 $ 0.03 $ 0.03 $0.01
====== ====== ====== =====
</TABLE>
The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.
See accompanying notes.
-5-
<PAGE>
ILM II LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended February 28, 1999 and 1998 Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Common Stock Additional
$.01 PAR VALUE Paid-In Retained
Shares Amount Capital Earnings Total
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1997 5,180,952 $ 52 $448 $219 $ 719
Net Income - - - 135 135
--------- ----- ------ ---- -----
Balance at February 28, 1998 5,180,952 $ 52 $448 $354 $ 854
========= ===== ====== ==== =====
Balance at August 31, 1998 5,180,952 $ 52 $448 $197 $ 697
Net Income - - - 273 273
--------- ----- ------ ---- -----
Balance at February 28, 1999 5,180,952 $ 52 $448 $470 $ 970
========= ===== ====== ==== =====
</TABLE>
See accompanying notes.
-6-
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
FEBRUARY 28,
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 273 $ 135
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation expense 118 44
Deferred tax expense (benefit) 182 (145)
Changes in assets and liabilities:
Accounts receivable, net (56) 54
Accounts receivable - related party - (64)
Prepaid expenses and other assets 2 241
Tax refund receivable 131 -
Accounts payable and accrued expenses (111) 44
Accounts payable - related party 45 429
Termination fee payable (650) -
Real estate taxes payable (106) (96)
Income taxes payable - 101
Deferred rent payable (14) -
Security deposits, net 11 (7)
--- ---
Net cash (used in) provided by operating activities (175) 736
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (157) (68)
---- ----
Net cash used in investing activities (157) (68)
Net (decrease) increase in cash and cash equivalents (330) 668
Cash and cash equivalents, beginning of period 1,497 1,156
----- -----
Cash and cash equivalents, end of period $1,167 $1,824
====== ======
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for state income taxes $ 3 $ -
====== ======
</TABLE>
See accompanying notes.
-7-
<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 ILM II Lease Corporation's (the "Company") Annual Report on
Form 10-K for the year ended August 31, 1998. 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 U.S. generally accepted accounting
principles for interim financial information, which requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities as of
February 28, 1999, and revenues and expenses for each of the six- and
three-month periods ended February 28, 1999 and 1998. Actual results may
differ from the estimates and assumptions used. Certain numbers in the
prior period's financial statements have been reclassified to conform to
the current period's presentation. The results of operations for the six-
and three-month periods ended February 28, 1999, are not necessarily
indicative of the results to be expected for the year ended August 31,
1999.
The Company was incorporated on September 12, 1994 under the laws of
the State of Virginia by ILM II Senior Living, Inc., a Virginia finite-life
corporation ("ILM II"), formerly PaineWebber Independent Living Mortgage
Inc. II, to operate six rental housing projects that provide
independent-living and assisted-living services for independent senior
citizens ("the Senior Housing Facilities") under a facilities lease
agreement dated September 1, 1995 (the "Facilities Lease Agreement"),
between the Company, as lessee, and ILM II Holding, Inc. ("ILM II
Holding"), as lessor, and a direct subsidiary of the ILM II. The Company's
sole business is the operation of the Senior Housing Facilities. ILM II
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 indirect
subsidiaries of ILM II, subject to the mortgage loans. Subsequently, these
property-owning subsidiaries were merged into 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, which was assigned to the Company as of
September 1, 1995 and subsequently terminated in July 1996. ILM II is a
public company subject to the reporting obligations of the Securities and
Exchange Commission.
In July 1996, following termination of the property management
agreement with AHC, the Company entered into a property management
agreement (the "Management Agreement") with Capital Senior Management 2,
Inc. ("Capital") to handle the day-to-day operations of the Senior Housing
Facilities. Lawrence A. Cohen, who served through July 28, 1998 as a
Director of the Company and President, Chief Executive Officer and Director
of ILM II, has also served as Vice Chairman and Chief Financial Officer of
Capital Senior Living Corporation, an affiliate of Capital, since November
1996. As a result, the Management Agreement with Capital was considered a
related party transaction (see Note 3) through July 28, 1998.
-8-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. THE FACILITIES LEASE AGREEMENT
ILM II Holding (the "Lessor") leases the Senior Housing Facilities to
the Company (the "Lessee") pursuant to the Facilities Lease Agreement. Such
lease is scheduled to expire on December 31, 2000 (December 31, 1999 with
respect to the Santa Barbara Facility), unless 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, upon 30 days'
notice to the Company. As noted below in Recent Developments, ILM II has
entered into an agreement and plan of merger with Capital Senior Living
Corporation and certain affiliates of Capital, and has agreed to cause ILM
II Holding to cancel and terminate the Facilities Lease Agreement
immediately prior to the effective time of the merger. Consummation of the
merger is presently anticipated in October 1999. The lease is accounted for
as an operating lease in the Company's financial statements.
Descriptions of the properties covered by the Facilities Lease
Agreement between the Company and ILM II Holding are summarized as follows:
<TABLE>
<CAPTION>
Year
Facility Rentable Resident
Property Name and Location Type Of Property Built Units (2) Capacities (2)
- --------------------------- ---------------- ----- --------- --------------
<S> <C> <C> <C> <C>
The Palms
Fort Myers, FL Senior Housing Facility 1988 205 255
Crown Villa
Omaha, NE Senior Housing Facility 1992 73 73
Overland Park Place
Overland Park, KS Senior Housing Facility 1994 141 153
Rio Las Palmas
Stockton, CA Senior Housing Facility 1988 164 190
The Villa at Riverwood
St. Louis County, MO Senior Housing Facility 1986 120 140
Villa Santa Barbara (1)
Santa Barbara, CA Senior Housing Facility 1979 125 125
</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 company, 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., a direct subsidiary of ILM II, as
tenants in common. Upon the sale of ILM I or ILM II, arrangements would
be made to transfer the Santa Barbara facility to the non-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.
-9-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. THE FACILITIES LEASE AGREEMENT (CONTINUED)
Pursuant to the Facilities Lease Agreement, the Company pays annual
base rent for the use of the Senior Housing Facilities in the aggregate
amount of $4,035,600. 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. Also, any fixed assets
of the Company at a Senior Housing Facility would remain with the Senior
Housing Facility at the termination of the lease. The Company also pays
variable rent, on a quarterly basis, for each facility in an amount equal
to 40% of the excess of aggregate total revenues for the Senior Housing
Facilities, on an annualized basis, over $13,021,000. Variable rent was
$642,000 and $332,000 for the six- and three-month periods ended February
28, 1999, respectively, compared to $436,000 and $245,000 for the six- and
three-month periods ended February 28, 1998, respectively.
The Company's use of the properties is limited to use as Senior Housing
Facilities. 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
California, Florida and Kansas are licensed by such states to provide
assisted living services. In addition, 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.
RECENT DEVELOPMENTS
On February 7, 1999, ILM II entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of
Capital, and certain affiliates of Capital. Consummation of the merger is
presently anticipated in October 1999. In connection with the merger, ILM
II has agreed to cause ILM II Holding to cancel and terminate the
Facilities Lease Agreement 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, upon 30 days' notice to
the Company. Although there can be no assurance as to whether the merger
will be consummated or, if consummated, as to the timing thereof, the
Company's operations would not be expected to continue beyond the effective
time of the merger.
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 the Company's Annual Report on Form
10-K for the year ended August 31, 1998, 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 the Management Agreement, which
commenced on July 29, 1996. Lawrence A. Cohen, who served through July 28,
1998 as a Director of the Company as well as President, Chief Executive
Officer and Director of ILM II, has also served as Vice Chairman and Chief
Financial Officer of Capital Senior Living Corporation, an affiliate of
Capital, since November 1996. The Management Agreement is co-terminous with
the Facilities Lease Agreement. If, for any reason, the Facilities Lease
Agreement is extended beyond December 31, 2000, the scheduled expiration
date of the Management Agreement would be extended as well, but not beyond
July 29, 2001. There is no present intention to extend the term of the
Facilities Lease Agreement or the term of the Management Agreement and it
is likely they will be terminated before the end of the term of the
Facilities Lease Agreement (see "Recent Developments" in Note 2). 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 also earns an incentive management fee
equal to 25% of the amount by which the
-10-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
"net cash flow" of the Senior Housing Facilities, as defined, exceeds a
specified base amount. Each August 31, the base amount is increased based
on the percentage increase in the Consumer Price Index as well as 15% of
Senior Housing Facility expansion costs. ILM II has guaranteed the payment
of all fees due to Capital under the terms of the Management Agreement. For
the six- and three-month periods ended February 28, 1999, Capital earned
property management fees from the Company of $547,000 and $323,000,
respectively, compared to $444,000 and $239,000, for the six- and
three-month periods ended February 28, 1998, 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. would receive a
fee equal to 7% of the total development costs of these potential
expansions if they are pursued. ILM II Holding would also reimburse the
Company for all costs related to these potential expansions including fees
to Capital Senior Development, Inc. For the six- and three-month periods
ended February 28, 1999, Capital Senior Development, Inc. earned no fees
from the Company compared to fees of $99,000 and $59,000 earned for the
six- and three-month periods ended February 28, 1998, respectively, for
managing pre-construction development activities for potential expansions
of the Senior Housing Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the six- and three-month periods ended February 28, 1999,
Greenburg Traurig earned fees from the Company of $22,000 and $20,000,
respectively. For the six- and three-month periods ended February 28, 1998,
Greenberg Traurig earned fees from the Company of $69,000 and $33,000,
respectively.
Accounts receivable - related party at February 28, 1999 and August 31,
1998 includes an insurance refund due to the Company from Lease I in the
amount of $102,140. Accounts payable - related party at February 28, 1999
and August 31, 1998 includes $332,000 and $287,000, respectively, for
variable rent due to ILM II Holding.
4. LEGAL PROCEEDINGS AND CONTINGENCIES
A property management agreement between ILM II Holding and 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 property management
agreement with AHC 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 alleged, 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 agreement, AHC filed
for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic
State of California. The Companies challenged the filing, and the
Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
November 1996, AHC filed with the Virginia District Court an answer in
response to the litigation initiated by the Companies and a counterclaim
against ILM II Holding. The counterclaim alleged that the management
agreement was wrongfully terminated for cause and requested damages, which
included the payment of a termination fee in the amount of $750,000,
payment of management fees pursuant to the contract from August 1, 1996
through October 15, 1996, which is the earliest date 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 II and ILM I in the aggregate amount of $1,000,000. The orders did not
contain any findings of fact or conclusions of law. On July 10, 1997, the
Company, ILM I, ILM II, and Lease I filed a notice of appeal to the United
States Court of Appeals for the Fourth Circuit from the orders.
-11-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
4. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, who, through July 28,
1998 was a Director of the Company and President, Chief Executive Officer
and Director of ILM II, and others alleging that the defendants
intentionally interfered with AHC's property management agreement (the
"California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a 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 financial recoveries for those expenses. Legal
fees paid by the Company and Lease I on behalf of Mr. Cohen totaled
$239,000 as of February 28, 1999. The Company's Board also concluded that,
subject to certain conditions, legal fees and expenses incurred by Capital
and its affiliates in the California litigation. Subsequently, the Boards
of Directors of the Company and Lease I 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. By February
28, 1999, $209,000 of legal fees had been either advanced or accrued in the
Company's financial statements and $313,000 of legal fees have been either
advanced or accrued in Lease I's financial statements for Capital's
California litigation costs.
On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. The
Company and Lease I agreed to pay $1,625,000 and Capital and its affiliates
agreed to pay $625,000 to AHC in settlement of all claims, including those
related to the Virginia litigation and the California litigation. The
Company and its affiliates also entered into an agreement with Capital
and its affiliates to mutually release each other from all claims that
any such parties may have against each other, other than any claims
under the property management agreements. The Company's Board of
Directors believed that settling the AHC litigation was a prudent course
of action because the settlement amount represented a small percentage
of the increases in cash flow and value achieved for the Company and its
affiliates over the past two years.
On September 4, 1998, the full settlement amounts were paid to AHC and
its affiliates with the Company paying $650,000 and Lease I paying $975,000
to AHC and its affiliates.
5. CONSTRUCTION LOAN FINANCING
The Company has finalized negotiations with a major bank to provide a
construction loan facility that will provide ILM II with up to $8.8 million
to fund the capital costs of these potential expansion programs. The
construction loan facility will be secured by a first mortgage of ILM II's
properties and collateral assignment of the Company's leases of such
properties. The loan will have a three-year term with interest accruing at
a rate equal to LIBOR plus 1.10% or Prime plus 0.5%. The loan term could be
extended for an additional two years beyond its maturity date with monthly
payments of principal and interest on a 25-year amortization schedule.
6. SUBSEQUENT EVENT
On March 9, 1999, Jeffry R. Dwyer was elected President of the
Company and Lease I.
-12-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
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. If the Company and ILM II Holding decide
that any of the Senior Housing Facilities should be expanded, the
Facilities Lease Agreement between the Company and ILM II Holding would be
amended to include such expansion. Pursuant to the Facilities Lease
Agreement, the Company pays annual base rent for use of all the Senior
Housing Facilities in the aggregate amount of $4,035,600. The Company 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 rent was $642,000 and $332,000 for the six- and
three-month periods ended February 28, 1999, respectively, compared to
$436,000 and $245,000 for the six- and three-month periods ended February
28, 1998, respectively.
The Facilities Lease Agreement is scheduled to expire on December 31,
2000 (December 31, 1999, with respect to Santa Barbara). 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. Moreover, the Facilities Lease Agreement is subject
to termination at any time by ILM II Holding upon 30 days' notice to the
Company in connection with the sale to a non-affiliated third party of the
Senior Housing Facilities.
RECENT DEVELOPMENTS
On February 7, 1999, ILM II entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of
Capital, and certain affiliates of Capital. Consummation of the merger is
presently anticipated in October 1999. In connection with the merger, ILM
II has agreed to cause ILM II Holding to cancel and terminate the
Facilities Lease Agreement 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, upon 30 days' notice to
the Company. Although there can be no assurance as to whether the merger
will be consummated or, if consummated, as to the timing thereof, the
Company's operations would not be expected to continue beyond the effective
time of the merger.
LIQUIDITY AND CAPITAL RESOURCES
Occupancy levels for the six properties which the Company leases from
ILM II Holding averaged 95% and 95% for the three months ended February 28,
1999 and 1998, respectively. Base rent payments of $4,035,600 will remain in
effect throughout the remaining term of the lease. As noted above, the
Facilities Lease Agreement also provides for the payment of variable rent.
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 II Holding.
At February 28, 1999, the Company had cash and cash equivalents of
$1,167,000 compared to $1,497,000 at August 31, 1998. The decrease of
$330,000 is primarily attributable to the September 4, 1998 payment of the
AHC litigation settlement of $650,000 (see Note 4) offset by other cash
flows provided by operating activities. Remaining amounts of cash will be
used for the Company's working capital requirements. As noted above, under
the terms of the facilities 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
-13-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
for capital expenditures. Furthermore, the Company does not currently
anticipate the need to engage in any borrowing activities. As a result,
substantially all of the Company's cash flow will be generated from
operating activities. The Company did not pay cash dividends in fiscal
years 1998 and 1997 or for the first and second quarter of fiscal 1999.
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 Facilities Lease
Agreement 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.
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.
Based on ongoing assessments, the Company, through Capital, its
property manager, has developed a program to modify or replace portions of
its software and certain hardware, which are generally PC-based systems, so
that those systems will properly recognize and utilize dates beyond
December 31, 1999. While there can be no assurance, as of May 31, 1999, the
Company believes that it substantially completed all software and hardware
upgrades as of December 31, 1998. The Company believes that these
modifications and replacements of existing software and certain hardware
will mitigate the Year 2000 issue. However, if such modifications and
replacements are not completed timely, the Year 2000 issue could have a
material impact on the operations of the Company. The costs of Year 2000
remediation are not expected to be material based on the Company's
operations.
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 has substantially completed all necessary phases of its Year 2000
program. In addition, 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, the
Company's most significant third party contractor, were to experience a
year 2000 problem, it is likely that the Company would not receive rental
income as it became due from Senior Living Facility residents. The Company
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 ILM II
mortgage payments due it. However, the Company believes that given the
nature of its business, such problem would be temporary and is easily
remedied with a simple accounting.
-14-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
SIX MONTHS ENDED FEBRUARY 28, 1999 VERSUS Six MONTHS ENDED FEBRUARY 28, 1998
REVENUES
Total revenues were $8,129,000 for the six months ended February 28,
1999 compared to $7,612,000 for the same period of the prior year,
representing an increase of $517,000 or 6.8%. This increase is the result
of increased rental rates at certain of the Company's Senior Housing
Facilities located in strong markets.
EXPENSES
Total expenses were $7,674,000 for the six months ended February 28,
1999 compared to $7,387,000 for the same period in the prior year,
representing an increase of $287,000 or 3.9%. This increase was primarily
due to increases in Facilities Lease rent expense of $198,000 or 8.1%;
property management fees of $103,000 or 23.2%; and depreciation expense of
$74,000 or 168.2%, offset by a $165,000 or 52.2% decrease in professional
fees as a result of settling the AHC litigation as well as minor increases
and decreases in certain other expenses. The increase in Facilities Lease
rent expense is the result of increased variable rent payments due under
the Facilities Lease Agreement. The increase in property management fees is
attributable to higher incentive management fees earned by the property
manager as a result of improved performance at the Senior Housing
Facilities. The increase in depreciation expense is due to the change in
the estimated useful lives of the Company's fixed assets as a consequence
of the expected lease termination date of December 31, 2000, as such assets
are not subject to repurchase by ILM II Holding.
INCOME TAX EXPENSE
Income tax expense increased overall by $92,000 or 102.2% as compared to
the same period in the prior year, as a result of an increase in income
before taxes of $230,000 or 50.5%.
NET INCOME
Primarily as a result of the factors noted above, net income increased
$138,000 or 102.2%, to net income of $273,000 for the six months ended
February 28, 1999 from net income of $135,000 for the six months ended
February 28, 1998.
THREE MONTHS ENDED FEBRUARY 28, 1999 VERSUS THREE MONTHS ENDED FEBRUARY
28, 1998
REVENUES
Total revenues were $4,089,000 for the quarter ended February 28, 1999
compared to $3,875,000 for the same period of the prior year, representing
an increase of $214,000 or 5.5%. This increase is the result of increased
rental rates at certain of the Company's Senior Housing Facilities located
in strong markets.
EXPENSES
Total expenses were $3,811,000 for the quarter ended February 28, 1999
compared to $3,750,000 for the same period in the prior year, representing
an increase of $61,000 or 1.6%. This increase was principally comprised of
increases in Facilities Lease rent expense of $79,000 or 6.3%; property
management fees of $84,000 or 35.1%; and depreciation expense of $51,000 or
242.9%, offset by significant decreases in professional fees of $214,000 or
110.3% as a result of settling the AHC litigation as well as a $209,000 or
98% decrease in general and administrative expense due to changes in
estimated liabilities at August 31, 1997, that were reduced in 1998. The
increase in Facilities Lease rent expense is the result of increased
variable rent payments due under the Facilities Lease Agreement. The
increase in property management fees is attributable to higher incentive
management fees earned by the property manager as a result of improved
performance at the Senior Housing Facilities. The increase in depreciation
expense is due to the change in the estimated useful lives of the Company's
fixed assets as a consequence of the expected lease termination date of
December 31, 1999, as such assets are not subject to repurchase by ILM
Holding.
-15-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS (CONTINUED)
INCOME TAX EXPENSE
Income tax expense increased overall by $61,000 or 122%, as compared to
the same period in the prior year, as a result of an increase in income
before taxes of $153,000 or 122.4%.
NET INCOME
Primarily as a result of the factors noted above, net income increased
$92,000 or 122.7% to net income of $167,000 for the quarter ended February
28, 1999 from net income of $75,000 for the quarter ended February 28,
1998.
-16-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FORWARD-LOOKING INFORMATION
CERTAIN STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q
("QUARTERLY REPORT") CONSTITUTE "FORWARD-LOOKING STATEMENTS" INTENDED TO
QUALIFY FOR THE SAFE HARBORS FROM LIABILITY ESTABLISHED BY SECTION 27A OF
THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION
21E OF THE SECURITIES ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE
FORWARD-LOOKING STATEMENTS GENERALLY CAN BE IDENTIFIED AS SUCH BECAUSE THE
CONTEXT OF THE STATEMENT WILL INCLUDE WORDS SUCH AS "BELIEVES," "COULD,"
"MAY," "SHOULD," "ENABLE," "LIKELY," "PROSPECTS," "SEEK," "PREDICTS,"
"POSSIBLE," "FORECASTS," "PROJECTS," "ANTICIPATES," "EXPECTS" AND WORDS OF
ANALOGOUS IMPORT AND CORRELATIVE EXPRESSIONS THEREOF, AS WELL AS STATEMENTS
PRECEDED OR OTHERWISE QUALIFIED BY: "THERE CAN BE NO ASSURANCE" OR "NO
ASSURANCE CAN BE GIVEN." SIMILARLY, STATEMENTS THAT DESCRIBE THE COMPANY'S
FUTURE PLANS, OBJECTIVES, STRATEGIES OR GOALS ALSO ARE FORWARD-LOOKING
STATEMENTS. SUCH STATEMENTS MAY ADDRESS FUTURE EVENTS AND CONDITIONS
CONCERNING, AMONG OTHER THINGS, THE COMPANY'S CASH FLOWS, RESULTS OF
OPERATIONS AND FINANCIAL CONDITION; THE CONSUMMATION OF ACQUISITION AND
FINANCING TRANSACTIONS AND THE EFFECT THEREOF ON THE COMPANY'S BUSINESS,
ANTICIPATED CAPITAL EXPENDITURES, PROPOSED OPERATING BUDGETS AND ACCOUNTING
RESERVES; LITIGATION; PROPERTY EXPANSION AND DEVELOPMENT PROGRAMS OR PLANS;
REGULATORY MATTERS; AND THE COMPANY'S PLANS, GOALS, STRATEGIES AND
OBJECTIVES FOR FUTURE OPERATIONS AND PERFORMANCE. ANY SUCH FORWARD-LOOKING
STATEMENTS ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED IN SUCH
FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT TO
A NUMBER OF ASSUMPTIONS REGARDING, AMONG OTHER THINGS, GENERAL ECONOMIC,
COMPETITIVE AND MARKET CONDITIONS. SUCH ASSUMPTIONS NECESSARILY ARE BASED
ON FACTS AND CONDITIONS AS THEY EXIST AT THE TIME SUCH STATEMENTS ARE MADE,
THE PREDICTION OR ASSESSMENT OF WHICH MAY BE DIFFICULT OR IMPOSSIBLE AND,
IN ANY CASE, BEYOND THE COMPANY'S CONTROL. FURTHER, THE COMPANY'S BUSINESS
IS SUBJECT TO A NUMBER OF RISKS THAT MAY AFFECT ANY SUCH FORWARD-LOOKING
STATEMENTS AND ALSO COULD CAUSE ACTUAL RESULTS OF THE COMPANY TO DIFFER
MATERIALLY FROM THOSE PROJECTED OR IMPLIED BY SUCH FORWARD-LOOKING
STATEMENTS. ALL FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY
REPORT ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE CAUTIONARY
STATEMENTS IN THIS PARAGRAPH. MOREOVER, THE COMPANY DOES NOT INTEND TO
UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT ANY CHANGES IN
GENERAL ECONOMIC, COMPETITIVE OR MARKET CONDITIONS AND DEVELOPMENTS BEYOND
ITS CONTROL.
READERS OF THIS QUARTERLY REPORT ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON ANY OF THE FORWARD-LOOKING STATEMENTS SET FORTH HEREIN AND THE
COMPANY MAKES ABSOLUTELY NO PROMISES, GUARANTEES, REPRESENTATIONS OR
WARRANTIES AS TO THE ACCURACY THEREOF.
-17-
<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
-18-
<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/ JEFFRY R. DWYER
---------------------------
Jeffry R. Dwyer
President
Dated: NOVEMBER 12, 1999
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