<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 NOVEMBER 30, 1998
-----------------
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____to____.
Commission File Number: 0-25880
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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 November 30, 1998: 5,180,952.
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Page 1 of 19
<PAGE>
ILM II LEASE CORPORATION
INDEX
Part I. Financial Information PAGE
----
Item 1. Financial Statements
Balance Sheets
November 30, 1998 (Unaudited) and August 31, 1998................3
Statements of Income
For the three-month periods ended November 30, 1998
and 1997 (Unaudited).............................................4
Statements of Changes in Shareholders' Equity
For the three months ended November 30, 1998
and 1997 (Unaudited).............................................5
Statements of Cash Flows
For the three months ended November 30, 1998
and 1997 (Unaudited).............................................6
Notes to Financial Statements (Unaudited).......................7-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................13-16
Part II. Other Information..................................................17
Item 6. Exhibits and Reports on Form 8-K...........................17
Signatures...................................................................18
-2-
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
November 30, 1998 (Unaudited) and August 31, 1998
(Dollars In thousands, except per share amounts)
<TABLE>
<CAPTION>
ASSETS
------
NOVEMBER 30, 1998 AUGUST 31, 1998
----------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 881 $1,497
Accounts receivable, net 173 89
Accounts receivable - related party 102 102
Prepaid expenses and other assets 73 50
Tax refund receivable 3 158
------- --------
Total current assets 1,262 1,896
Furniture, fixtures and equipment 854 783
Less: accumulated depreciation (271) (225)
------- --------
583 558
Deposits 9 9
Deferred tax asset 198 270
-------- --------
$2,052 $2,733
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 701 $ 789
Termination fee payable - 650
Real estate taxes payable 3 209
Accounts payable - related party 447 287
Security deposits 29 25
--------- ---------
Total current liabilities 1,180 1,960
Deferred rent payable 69 76
--------- ---------
Total liabilities 1,249 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 303 197
-------- --------
Total shareholders' equity 803 697
-------- --------
$2,052 $2,733
====== ======
</TABLE>
See accompanying notes.
-3-
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the three-month periods ended November 30, 1998 and 1997 (Unaudited)
(Dollars In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
NOVEMBER 30
-----------
1998 1997
<S> ---- ----
REVENUES: <C> <C>
Rental and other income $4,037 $3,732
Interest income 3 5
------ ------
4,040 3,737
----- -----
EXPENSES:
Facilities lease rent expense 1,311 1,192
Dietary salaries, wages and food service expenses 691 662
Administrative salaries, wages and expenses 282 283
Marketing salaries, wages and expenses 170 167
Utilities 274 269
Repairs and maintenance 129 120
Real estate taxes 134 115
Property management fees 224 205
Other property operating expenses 359 352
General and administrative expenses 64 43
Directors compensation 13 16
Professional fees 165 122
Depreciation expense 46 23
----- -----
3,862 3,569
----- -----
Income before taxes 178 168
Income tax expense:
Current - 59
Deferred 72 8
----- -----
72 67
----- -----
NET INCOME $ 106 $ 101
===== =====
Basic earnings per share of common stock $0.02 $0.02
===== =====
</TABLE>
The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.
See accompanying notes.
-4-
<PAGE>
ILM II LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the three months ended November 30, 1998 and 1997 (Unaudited)
(Dollars In thousands, except per share data)
<TABLE>
<CAPTION>
Common Stock 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 - - - 101 101
--------- --- ---- ---- ----
Balance at November 30, 1997 5,180,952 $52 $448 $320 $820
========= === ==== ==== ====
Balance at August 31, 1998 5,180,952 $52 $448 $197 $697
Net income - - - 106 106
--------- --- ---- ---- ----
Balance at November 30, 1998 5,180,952 $52 $448 $303 $803
========= === ==== ==== ====
</TABLE>
See accompanying notes.
-5-
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1998 and 1997 (Unaudited)
(Dollars In thousands)
<TABLE>
<CAPTION>
Three Months Ended
NOVEMBER 30
-----------
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 106 $ 101
Adjustments to reconcile net income to
net cash provided by (used in) operating activities:
Depreciation expense 46 23
Deferred tax expense (benefit) 72 (7)
Changes in assets and liabilities:
Accounts receivable, net (84) 52
Accounts receivable - related party - (391)
Prepaid expenses and other assets (23) 69
Tax refund receivable 125 -
Accounts payable and accrued expenses (88) 122
Accounts payable - related party 160 1,198
Termination fee payable (650) -
Real estate taxes payable (206) (199)
Security deposits 4 -
Deferred rent payable (7) (8)
-------- -------
Net cash (used in) provided by operating activities (545) 960
-------- -------
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (71) (29)
------- ------
Net cash used in investing activities (71) (29)
------- ------
Net increase (decrease) in cash and cash equivalents (616) 931
Cash and cash equivalents, beginning of period 1,497 1,156
------ ------
Cash and cash equivalents, end of period $ 881 $2,087
====== ======
Supplemental Disclosure:
- ------------------------
Cash paid during the period for state income taxes $ - $ -
========= =========
</TABLE>
See accompanying notes.
-6-
<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 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 U.S. 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, 1998 and August 31,
1998, and revenues and expenses for the three-month periods ended November
30, 1998 and 1997. Actual results could differ from the estimates and
assumptions used. 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 three-month period ended
November 30, 1998, are not necessarily indicative of the results to be
expected for the full year.
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 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 Company. The Company's sole business is the
operations 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. The Company 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, through July 28, 1998, the Management Agreement with
Capital was considered a related party transaction (see Note 3).
-7-
<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 earlier terminated at the
election of the Lessor in connection with the sale by the Lessor of the
Senior Housing Facilities to a non-affiliated third party, upon 30 days'
notice to the Company. 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>
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.
-8-
<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 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 expense amounted to
$310,000 and $191,000 for the three-month periods ended November 30, 1998
and 1997, 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. 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.
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. 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.
-9-
<PAGE>
ILM II 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 the Company's Annual Report,
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 (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 "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 three-month periods ended November 30, 1998 and 1997, Capital earned
property management fees from the Company of $224,000 and $205,000,
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 the Senior Housing
Facilities. Capital Senior Development, Inc. would receive a fee equal to
7% of the total development costs of these potential expansions including
fees to Capital Senior Development, Inc. For the three-month periods ended
November 30, 1998 and 1997, Capital Senior Development, Inc. earned fees
from the Company of $0 and $40,000, respectively for managing
pre-construction development activities for potential expansions of the
Senior Housing Facilities.
Jeffry R. Dwyer, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the three-month periods ended November 30, 1998 and 1997,
Greenberg Traurig earned fees from the Company of $34,000 and $36,000,
respectively.
Accounts receivable - related party at November 30, 1998 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 November 30, 1998
and August 31, 1998 includes $447,000 and $152,000, respectively, for base
rent and 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. 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 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.
-10-
<PAGE>
ILM II 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 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 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. ILM II had guaranteed the
payment of the termination fee at issue in these proceedings to the extent
that any termination fee would be deemed payable by the court and in the
event that the Company failed to perform pursuant to its contractual
obligations. 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"). 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 I filed a notice of appeal to the United States Court of Appeals for
the Fourth Circuit from the orders.
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 agreement
with ILM II Holding by inducing ILM II Holding to terminate the agreement
(the "California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a Board meeting on
February 26, 1997, the Company's Board of Directors concluded that since
all of Mr. Cohen's actions relating to the California litigation were taken
either on behalf of the Company under the direction of the Board or as a
PaineWebber employee, the Company or its affiliates should indemnify Mr.
Cohen with respect to any expenses arising from the California litigation,
subject to any insurance recoveries for those expenses. Legal fees paid by
the Company and Lease I on behalf of Mr. Cohen totaled $228,000 as of
November 30, 1998. The Company's Board also concluded that, subject to
certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital and
its affiliates in the California litigation. Subsequently, the Boards 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. At November 30, 1998, $293,553
of legal fees have been either advanced or accrued in the Company's
financial statements and $317,000 of legal fees have been either advances
or accrued in Lease I's financial statements for Capital's litigation
costs, although the final amount to be reimbursed to Capital has not yet
been determined.
On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. 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.
-11-
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
5. SUBSEQUENT EVENT
----------------
On February 11, 1999, the Company's Board of Directors elected Jeffry
R. Dwyer to the office of Chief Operating Officer.
-12-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS
GENERAL
The Facilities Lease Agreement 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. For the three-month period ended
November 30, 1998 and 1997, variable rent expense was $310,000 and
$191,000, respectively.
The Facilities Lease Agreement is scheduled to expire on December 31,
2000 (December 31, 1999, with respect to Santa Barbara). This period
coincides with the present corporate finite-life of ILM II. 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. 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 96% and 94%, respectively, for the three-month
periods ended November 30, 1998 and 1997. 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 November 30, 1998, the Company had cash and cash equivalents of
$881,000 compared to $1,497,000 at August 31, 1998. The decrease of
$616,000 is primarily attributable to the September 4, 1998, payment of the
AHC litigation settlement of $650,000 (see Note 4). Remaining amounts of
cash will be used for the Company's working capital requirements. As noted
above, under the terms of the Facilities Lease Agreement, 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. 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 1998, 1997 or 1996.
-13-
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
The Company intends to review this policy during fiscal 1999 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 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 November 30,
1998, the Company believes that it will substantially complete 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 CONDITIONAND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
THREE MONTHS ENDED NOVEMBER 30, 1998 VERSUS THREE MONTHS ENDED NOVEMBER 30,
1997
REVENUES
Total revenues were $4,040,000 for the quarter ended November 30, 1998
compared to $3,737,000 for the same period of the prior year, representing
an increase of $303,000, or 8.1%, primarily as a result of improved
occupancies and increased rental rates at certain of the facilities located
in strong markets.
EXPENSES
Total expenses were $3,862,000 for the quarter ended November 30, 1998
compared to $3,569,000 for the same period of the prior year representing
an increase of $293,000 or 8.2%. This increase was primarily attributable
to an increase in Facilities lease rent expense of $119,000 or 10%. The
increase in Facilities lease rent expense is the result of variable rent
payments due under the Facilities Lease Agreement. General and
administrative expenses increased $21,000 or 48.8%, principally as a result
of the AHC litigation expenses. Depreciation expense increased $23,000 or
100% when compared to the quarter ended November 30, 1997, due to changes
in the remaining useful life of assets purchased in 1997 and prior to
conform to the lease termination date, as such assets are not subject to
repurchase by ILM II Holding.
INCOME TAX EXPENSE
Income tax expense increased by $5,000 or 7.5% as compared to the same
period in the prior year as a result of an increase in income before taxes
of $10,000 or 5.6%.
NET INCOME
Primarily as a result of the factors noted above, net income increased
$5,000 or 5%, to $106,000 for the quarter ended November 30, 1998 from net
income of $101,000 for the quarter ended November 30, 1997.
-15-
<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 BE," "SHOULD," "ENABLE," "LIKELY TO," "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.
-16-
<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
-17-
<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
Chief Operating Officer
(Principal Accounting Officer)
Dated: NOVEMBER 12, 1999
-----------------
-18-
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<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1998
<PERIOD-END> NOV-30-1998
<CASH> 881
<SECURITIES> 0
<RECEIVABLES> 381
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,262
<PP&E> 854
<DEPRECIATION> 271
<TOTAL-ASSETS> 2,052
<CURRENT-LIABILITIES> 1,180
<BONDS> 0
0
0
<COMMON> 500
<OTHER-SE> 303
<TOTAL-LIABILITY-AND-EQUITY> 2,052
<SALES> 0
<TOTAL-REVENUES> 4,040
<CGS> 0
<TOTAL-COSTS> 3,862
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 178
<INCOME-TAX> 72
<INCOME-CONTINUING> 106
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 106
<EPS-BASIC> .02
<EPS-DILUTED> .02
</TABLE>
