<PAGE>
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED: AUGUST 31, 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 .
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Commission File Number: 0-25880
ILM II LEASE CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 04-3248639
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(State of organization) (I.R.S. Employer
Identification No.)
8180 Greensboro Drive, Suite 850, McLean, VA 22102
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (888) 257-3550
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. X
---
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 August 31, 1999: 5,180,952. The
aggregate sales price of the shares sold was $500,000. This does not reflect
market value. There is no current market for these shares.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
- ---------------------------------------------- -------------------
Registration Statement on Form 10 of registrant Part III, Part IV
dated July 20, 1995, as supplemented
Part IV
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<PAGE>
ILM II LEASE CORPORATION
1999 FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I PAGE
<S> <C>
Item 1 Business...............................................................................I-1
Item 2 Properties.............................................................................I-5
Item 3 Legal Proceedings......................................................................I-6
Item 4 Submission of Matters to a Vote of Security Holders....................................I-6
PART II
Item 5 Market for the Registrant's Shares and Related
Stockholder Matters....................................................................II-1
Item 6 Selected Financial Data................................................................II-2
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations.............................................................II-3
Item 8 Financial Statements and Supplementary Data............................................II-8
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...........................................................II-8
PART III
Item 10 Directors and Executive Officers of the Registrant.....................................III-1
Item 11 Executive Compensation.................................................................III-4
Item 12 Security Ownership of Certain Beneficial Owners and Management.........................III-4
Item 13 Certain Relationships and Related Transactions.........................................III-4
PART IV
Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K........................IV-1
Signatures..........................................................................................IV-2
Index to Exhibits...................................................................................IV-3
Financial Statements and Supplementary Data........................................................F1-F15
</TABLE>
<PAGE>
ILM II LEASE CORPORATION
PART I
ITEM 1. BUSINESS
ILM II Lease Corporation (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 the terms of 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 ILM II. The Company's
sole business is the operation of the Senior Housing Facilities.
ILM II contributed $500,000 to the Company 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
Angeles Housing Concepts, Inc. ("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, the indirect subsidiaries of ILM II were merged into ILM
II Holding. As part of the fiscal 1994 settlement agreement with AHC (the
"Settlement Agreement"), ILM II Holding retained AHC 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. As discussed further in Item 7, the agreement with AHC was terminated
in July 1996. ILM II is a public company subject to the reporting obligations
of the Securities and Exchange Commission.
ILM II has elected to qualify and be taxed as a REIT under the
Internal Revenue Code of 1986, as amended ("the Code"), for each taxable year
of operations. In order to maintain its status as a REIT, 75% of ILM 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 so-called "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.
ILM II Holding (the "Lessor"), a majority-owned subsidiary of ILM
II, 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. 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. While there can be no assurance,
consummation of the merger is presently anticipated in the first quarter of
calendar year 2000. The lease is accounted for as an operating lease in the
Company's financial statements.
I-1
<PAGE>
ILM II LEASE CORPORATION
ITEM 1. BUSINESS (CONTINUED)
In July 1996, the Company terminated the property management
agreement with AHC, and 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 in various management capacities at Capital Senior Living
Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves
as Chief Executive Officer of Capital Senior Living Corporation. As a result,
the Management Agreement with Capital was considered a related party
transaction through July 28, 1998.
Pursuant to the Facilities Lease Agreement, the Company pays annual
base rent for the use of all 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 the 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 Senior Housing Facility in an
amount equal to 40% of the excess of the aggregate total revenues for the
Senior Housing Facilities, on an annualized basis, over $13,021,000. For the
fiscal years ended August 31, 1999 and 1998, variable rent expense was
$1,261,000 and $984,000, respectively.
On February 7, 1999, ILM I entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of
Capital, and certain affiliates of Capital. 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.
I-2
<PAGE>
ILM II LEASE CORPORATION
ITEM 1. BUSINESS (CONTINUED)
Descriptions of the properties covered by the Facilities Lease
Agreement between the Company and ILM II Holding as of August 31, 1999 are
summarized as follows:
<TABLE>
<CAPTION>
Year
Facility Rentable Resident
Property Name and Location (1) Type of Property Built Units (3) Capacities (3)
- ------------------------------ ---------------- ----- --------- --------------
<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 (2)
Santa Barbara, CA Senior Housing Facility 1979 125 125
</TABLE>
(1) See Notes to the financial statements filed with this annual report for
a description of the agreements through which the Company has leased
these facilities.
(2) 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.
(3) 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.
The Senior Housing Facilities are subject to competition from similar
properties in the vicinities in which they are located. The properties are
located in areas with significant senior citizen populations and, as a result
there are, and will likely continue to be, a variety of competing projects aimed
at attracting senior residents. Such projects will generally compete on the
basis of rental rates, services, amenities and location. The Company has no real
estate investments located outside the United States. The Company's sole
business is the operation of the Senior Housing Facilities. Therefore,
presentation of information about industry segments is not applicable.
I-3
<PAGE>
ILM II LEASE CORPORATION
ITEM 1. BUSINESS (CONTINUED)
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.
Through June 18, 1997, and subject to the supervision of and
pursuant to the general policies set by the Company's Board of Directors,
assistance in managing the business of the Company was provided by
PaineWebber Lease Advisors, L.P. ("PaineWebber"). For discussion purposes,
PaineWebber will refer to PaineWebber Lease Advisors, L.P. and all affiliates
of PaineWebber that provided services to the Company in the past. PaineWebber
resigned from this position effective as of June 18, 1997. PaineWebber agreed
to perform certain administrative services for the Company and its affiliates
through August 31, 1997. Through the date of its resignation, PaineWebber
performed the day-to-day operations of the Company and acted as the
investment advisor and consultant for the Company. PaineWebber provided cash
management, accounting, tax preparation, financial reporting, investor
communications and relations as well as asset management services to the
Company. These services are now being provided to the Company, subject to the
supervision of the Company's Board of Directors, by various companies and
consultants including Greenberg Traurig, Fleet Bank, Ernst & Young LLP, and
MAVRICC Management Systems, Inc.
There are currently three Directors of the Company, none of whom are
affiliates of PaineWebber or the property management company. The Directors
are subject to removal by the vote of the holders of a majority of the
outstanding shares of the Company's common stock.
The terms of transactions between the Company and PaineWebber and
similar disclosures with respect to relationships of other related parties
which provide services to the Company are set forth in Items 11 and 13 below
to which reference is hereby made for a description of such terms and
transactions.
As discussed further in Item 7, on July 29, 1996, the Company
terminated the property management agreement with AHC and retained Capital to
be the property manager of the Senior Housing Facilities, and ILM II has
guaranteed the payment of all fees due to Capital under the terms of the
Management Agreement. 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 in various management capacities at Capital Senior
Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently
serves as Chief Executive Officer of Capital Senior Living Corporation. As a
result, through July 28, 1998, Capital was considered a related party (see
Item 13). Capital earned property management fees from Lease II of $980,000
and $899,000 for the years ended August 31, 1999 and 1998, respectively.
I-4
<PAGE>
ILM II LEASE CORPORATION
ITEM 2. PROPERTIES
As of August 31, 1999, the Company has leased the six operating
properties referred to under Item 1 to which reference is made for the
description, name and location of such properties.
Average occupancy levels for each fiscal quarter during 1999, along
with an average for the year, are presented below for each property:
<TABLE>
<CAPTION>
Average Quarterly Occupancy
-----------------------------------------------------------------------------------------
Fiscal 1999
11/30/98 2/28/99 5/31/99 8/31/99 Average
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
The Palms 94% 93% 91% 89% 92%
Crown Villa 96% 97% 93% 94% 95%
Overland Park Place 98% 97% 95% 95% 96%
Rio Las Palmas 92% 92% 91% 92% 92%
The Villa at Riverwood 97% 93% 86% 87% 91%
Villa Santa Barbara 97% 99% 97% 97% 98%
</TABLE>
ITEM 3. LEGAL PROCEEDINGS
On July 29, 1996, the Company and ILM II Holding (collectively for
this Item 3, the "Companies") terminated a property management agreement with
AHC which covered the six Senior Housing Facilities leased by the Company
from ILM II Holding. The management agreement with AHC was terminated for
cause pursuant to 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 Companies alleged, among other things, that AHC willfully
performed actions specifically in violation of the agreement and that such
actions caused damages to the Companies.
Due to the termination of the management 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 alleged
that the management agreement was wrongfully terminated for cause and
requested damages which included the payment of the 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 that the
management agreement could have been terminated without cause, and recovery
of attorneys' fees and expenses.
I-5
<PAGE>
ILM II LEASE CORPORATION
ITEM 3. LEGAL PROCEEDINGS (CONTINUED)
The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997,
the court issued orders to enter judgment against ILM I and ILM II in the
amount of $1,000,000. 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, the new property manager; Lawrence
A. 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 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 $229,000 as of August
31, 1999. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should pay reasonable legal fees
and expenses incurred by Capital in the California litigation. At August 31,
1999, the amount advanced to Capital by the Company and Lease I for Capital's
California litigation costs totaled approximately $563,000.
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. 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.
The Company has pending claims incurred in the normal course of
business which, in the opinion of the Company's Board of Directors, will not
have a material effect on the financial statements of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
I-6
<PAGE>
ILM II LEASE CORPORATION
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S SHARES AND RELATED STOCKHOLDER MATTERS
Prior to September 1, 1995, the Company was a wholly-owned
subsidiary of ILM II. Pursuant to a reorganization and distribution
agreement, ILM II capitalized the Company with $500,000, an amount estimated
to provide the Company with necessary working capital. On September 1, 1995,
MAVRICC Management Systems, Inc., as the distribution agent, caused to be
issued on the stock records of the Company the distributed common stock of
the Company, in uncertificated form, to the holders of record of ILM II
common stock at the close of business on July 14, 1995. One share of the
Company's common stock was distributed for each outstanding share of ILM II
common stock. No certificates or scrip representing fractional shares of the
Company's common stock were issued to holders of ILM II common stock as part
of the distribution. In lieu of receiving fractional shares, each holder of
ILM II common stock who would otherwise have been entitled to receive a
fractional share of the Company's common stock received a cash payment
equivalent to $0.14 per share for such fractional interest. At August 31,
1999, there were 3,282 record holders of the Company's shares. The shares do
not trade on an established exchange and the only market that has developed
is a secondary market; therefore, little resale activity occurs. Although
PaineWebber and others may endeavor to assist Shareholders desiring to sell
their shares by attempting to match requests to sell shares with requests to
purchase shares, such transfers are not expected to be frequent.
The Company did not pay cash dividends in fiscal years 1999, 1998
and 1997, and may or may not determine to pay cash dividends in the future.
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. While there can be no assurance,
consummation of the merger is presently anticipated in the first quarter of
calendar year 2000. 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.
II-1
<PAGE>
ILM II LEASE CORPORATION
ITEM 6. SELECTED FINANCIAL DATA
ILM II LEASE CORPORATION
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
For the year ended August 31,
1999 1998 1997
--------------------- --------------------- --------------------
<S> <C> <C> <C>
Revenues $16,250 $15,524 $14,433
Income (loss) before income taxes 911 (36) (67)
Income tax expense (benefit) 342 (14) (27)
---------------- -------------- ---------------
Net income (loss) $ 569 $ (22) $ (40)
---------------- -------------- ---------------
---------------- -------------- ---------------
Net income (loss) per share of common
stock $ 0.10 $ 0.00 $(0.01)
---------------- -------------- ---------------
---------------- -------------- ---------------
Total assets $ 2,770 $ 2,733 $ 2,126
---------------- -------------- ---------------
---------------- -------------- ---------------
Shares outstanding 5,180,952 5,180,952 5,180,952
</TABLE>
The above selected financial data should be read in conjunction with
the financial statements and related notes appearing in Item 14 in this annual
report.
II-2
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. 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 Facilities 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
property-owning subsidiaries of ILM II 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, ILM II Holding retained AHC as the property
manager for the Senior Housing Facilities pursuant to the terms of a
management agreement which was assigned to the Company as of September 1,
1995. As discussed further below, the management agreement with AHC was
terminated in July 1996.
ILM II has elected to qualify and be taxed as a REIT under the
Internal Revenue Code of 1986, as amended ("the Code"), for each taxable year
of operations. In order to maintain its status as a REIT, 75% of ILM 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
so-called "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.
Pursuant to the Facilities Lease Agreement, the Company pays 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 Company,
as 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 Senior Housing Facility in an amount equal to 40% of the
excess of the aggregate total revenues for the Senior Housing Facilities, on
an annualized basis, over $13,021,000. For the fiscal years ended August 31,
1999 and 1998, variable rent expense was $1,261,000 and $984,000,
respectively.
As noted above, the Company's Facilities Lease Agreement is
scheduled to expire on December 31, 2000. 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 Facilities Lease Agreement may be terminated earlier, however, by ILM II
Holding upon 30 days' notice to the Company in connection with a sale to a
non-affiliated third party of the Senior Housing Facilities.
II-3
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
On July 29, 1996, the Company terminated the management agreement
with AHC covering six Senior Housing Facilities leased by the Company (see
"Item 3. Legal Proceedings") and retained Capital to be the manager of the
Senior Housing Facilities. ILM II has guaranteed payment of all fees due to
Capital under the terms of the Management Agreement. 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 in various
management capacities at Capital Senior Living Corporation, an affiliate of
Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer
and Acting Chief Financial Officer of Capital Senior Living Corporation. As a
result, the Management Agreement with Capital was considered a related party
transaction through July 28, 1998. 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, as well as
an incentive management fee equal to 25% of the amount by which net cash flow
of the Senior Housing Facilities, as defined, exceeds a specified base
amount. Each August 31, beginning on August 31, 1997, the base amount is
increased based on the percentage increase in the Consumer Price Index as
well as 15% of facility expansion costs.
On February 4, 1997, AHC filed a complaint in the Superior Court of
the State of California against Capital, the new property manager; Lawrence
A. 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 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 $229,000 as of August
31, 1999. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should pay reasonable legal fees
and expenses incurred by Capital in the California litigation. At August 31,
1999, the amount advanced to Capital by the Company and Lease I for Capital's
California litigation costs totaled approximately $563,000.
Occupancy levels for the six properties which the Company leases
from ILM II Holding averaged 94% and 96% for the years ended August 31, 1999
and 1998, respectively. The Senior Housing Facilities have generated
sufficient net cash flow to cover the base rent payments at their current
level of $4,035,600 per year since the inception of the Company's operations.
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 beginning in January 1997. 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. In fiscal
years ended August 31, 1999 and 1998, the Company had variable rent expense
of $1,261,000 and $984,000, respectively.
At August 31, 1999, the Company had cash and cash equivalents of
$1,487,000 compared to $1,497,000 at August 31, 1998. This decrease of
$10,000 is primarily attributable to the September 4, 1998, payment of the
AHC litigation settlement of $650,000 and increased investment in capital
improvements, offset by other cash flows provided by operating activities. 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 years
1999, 1998 and 1997. The Company may or may not determine to pay cash
dividends in the future. Payment of dividends, if any, will be at the
discretion of the Company's Board of Directors and will depend upon
II-4
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 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 August 31, 1999, the Company
believes that it substantially completed all software and hardware upgrades.
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.
II-5
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
RESULTS OF OPERATIONS
1999 COMPARED TO 1998
REVENUES. Total revenues were $16,250,000 for the year ended August
31, 1999 compared to $15,524,000 for the year ended August 31, 1998,
representing an increase of $726,000, or 4.7%. Rental and other income from
the Company's senior housing operations increased $751,000 or 4.9%, primarily
as a result of increases in rental rates at certain other facilities located
in strong markets. Interest income decreased $25,000 or 58.1%, to $18,000 in
fiscal year 1999, compared to $43,000 in fiscal year 1998, primarily due to a
decrease in cash and cash equivalents experienced throughout most of fiscal
year 1999.
EXPENSES. Total expenses were $15,339,000 in fiscal 1999 compared to
$15,560,000 in fiscal 1998, representing a decrease of $221,000 or 1.4%.
Although overall expenses remained generally comparable, depreciation expense
increased $139,000 or 90.3% due to recognition of changes in remaining useful
lives for certain assets purchased in 1999 and prior to conform to the lease
expiration date, as such assets are not subject to repurchase by ILM II
Holding. Facilities Lease Agreement rent expense increased $277,000 or 5.6%
as the result of the increase in variable rents due under the Facilities
Lease Agreement. Other increases in expense included administrative salaries,
wages and expenses of $106,000 or 9.7%; repairs and maintenance of $82,000 or
14.8%; property management fees of $81,000 or 9.0%; and minor increases in
certain other expenses. These increases were offset by a $250,000 or 100%
decrease in Termination fee expense and a $655,000 or 74.6% decrease in
Professional fees as a result of reduced legal fees subsequent to the AHC
litigation settlement. General and administrative costs decreased $95,000 or
29.4% while Director's Compensation decreased $24,000 or 32.0% as a result of
fewer Board of Directors meetings.
INCOME TAX EXPENSE. Income tax expense increased $356,000 from a
benefit of $14,000 in fiscal 1998 to expense of $342,000 in fiscal 1999.
NET INCOME (LOSS). Primarily as a result of the factors discussed
above, net income increased $591,000 or to net income of $569,000 in fiscal
1999 from a net loss of $22,000 in fiscal 1998.
II-6
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
1998 COMPARED TO 1997
REVENUES. Total revenues were $15,524,000 for the year ended August 31,
1998 compared to $14,433,000 for the year ended August 31, 1997, representing an
increase of $1,091,000, or 7.6%. Rental and other income from the Company's
senior housing operations increased $1,087,000 primarily as a result of improved
occupancies in all markets and increases in rental rates at certain other
facilities located in strong markets.
EXPENSES. Total expenses were $15,560,000 in fiscal 1998 compared to
$14,500,000 in fiscal 1997, representing an increase of $1,060,000, or 7.3%.
This increase was principally comprised of increases in Facilities Lease
Agreement rent expense of $572,000; marketing salaries, wages and expenses of
$31,000; repairs and maintenance of $23,000; property management fees of
$192,000; and general and administrative expenses of $701,000. These increases
in expenses were offset by decreases in dietary and food service salaries, wages
and expenses of $25,000; administrative salaries, wages and expenses of
$138,000; other property operating expenses of $175,000; termination fee expense
of $150,000 (see "Item 3, Legal Proceedings"); advisory fees of $58,000; and
minor decreases in certain other expenses. The increase in Facilities Lease
Agreement expense is the result of the increase in variable rents due under the
Facilities Lease Agreement. General and administrative expense increased as a
result of higher AHC litigation expenses in fiscal 1998. The increases in other
operating costs cited above were the result of higher operating levels
associated with improved occupancies. In addition, total charges to depreciation
expense in fiscal 1998 include additional depreciation expense of $36,000 in
recognition of changes in the remaining useful life for certain assets purchased
in fiscal 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 benefit decreased from $27,000 in fiscal
1997 to a $14,000 benefit in fiscal 1998. The fiscal 1997 deferred tax provision
reflects a reclassification of $160,000 of current tax expense in fiscal 1997,
which was ultimately determined to be deductible in fiscal 1998.
NET INCOME (LOSS). Primarily as a result of the factors discussed above,
net loss decreased from a net loss of $40,000 in fiscal 1997 to a net loss of
$22,000 in fiscal 1998.
INFLATION
The Company completed its fourth full year of operations in fiscal
1999. The effects of inflation and changes in prices on the Company's
operating results to date have not been significant. Inflation in future
periods is likely to cause increases in the Company's expenses, which may be
partially offset by increases in revenues from the tenant leases at the
Senior Housing Facilities. Rental revenues may tend to rise with inflation
since the rental rates on the tenant leases, which are short-term in nature,
can be adjusted to keep pace with inflation as market conditions allow. As
noted above, under the terms of the Facilities Lease Agreement between the
Company and ILM II Holding, the Company is obligated to pay variable rent, in
addition to the base rent owed, in an amount equal to 40% of the excess of
total revenues from the Senior Housing Facilities over a specified base
amount. Accordingly, to the extent that the total revenues are in excess of
this threshold, a portion of the increase in revenues would be payable to ILM
II Holding.
II-7
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
FORWARD-LOOKING INFORMATION
CERTAIN STATEMENTS INCLUDED IN THIS ANNUAL REPORT ON FORM 10-K
("ANNUAL 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 ANNUAL 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 ANNUAL 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are included under Item
14 of this annual report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
II-8
<PAGE>
ILM II LEASE CORPORATION
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There currently are three Directors of the Company. The Directors
are subject to removal by the vote of the holders of a majority of the
outstanding shares of the Company's common stock. The Directors are
responsible for the general policies of the Company, but they are not
required to personally conduct the business of the Company in their
capacities as Directors.
(a) and (b) The names and ages of the Directors and Executive
Officers of the Company during fiscal 1999 are as follows:
<TABLE>
<CAPTION>
Dates
Name Office Age Of Office
----- ------- --- ----------
<S> <C> <C> <C>
Jeffry R. Dwyer President, Secretary and Director 53 9/13/94*-present
Julien G. Redele Director 64 7/28/98-present
J. William Sharman, Jr. Director 59 9/18/97-present
</TABLE>
* The date of incorporation of the Company.
(c) There is no family relationship among any of the foregoing
Directors or Officers. All of the foregoing Directors and Officers of
the Company have been elected to serve until the Company's next annual
meeting.
(d) The business experience of each of the Directors and Executive
Officers of the Company is as follows:
JEFFRY R. DWYER is President, Secretary and Director of the
Company. Mr. Dwyer has served as President of the Company since March 9,
1999. Mr. Dwyer has been a shareholder of Greenberg Traurig, which has
provided legal services to the Company and its affiliates since June 1997.
From 1993 to 1997 Mr. Dwyer was a partner with the law firm of Akin, Gump,
Strauss, Hauer & Feld in the District of Columbia. Prior to joining Akin,
Gump, Strauss, Hauer & Feld, Mr. Dwyer was a partner with the law firm of
Morrison & Foerster from 1989 to 1993. Mr. Dwyer also presently serves as
Secretary and a Director of ILM I and ILM II and also serves as President,
Secretary and Director of Lease I. Mr. Dwyer has written several law review
articles and a major treatise on real estate financing and taught Real Estate
Planning as an Adjunct Professor at the Georgetown University Law Center.
Mr. Dwyer graduated from Georgetown University and received his law degree
from the Georgetown University Law Center.
JULIEN G. REDELE is a Director and served as President of the
Company from July 28, 1998 through March 9, 1999. Mr. Redele' is one of the
original founders of SFRE, Inc., a Dutch owned real estate investment and
development firm which has served since 1963 as advisor to Dutch
institutional, corporate and individual investors active in the United
States. Mr. Redele serves as a Director of the Island Preservation
Partnership. Mr. Redele attended Westersingel Business School, Rotterdam,
where he studied economics, law and finance. Mr. Redele' also presently
serves as Director of Lease I.
J. WILLIAM SHARMAN, JR. is a Director and served as President of the
Company from September 18, 1997 through July 28, 1998. Mr. Sharman also
presently serves as a Director of Lease I. Mr. Sharman is the Chairman of the
Board and CEO of Lancaster Hotels and Resorts, Inc., a hotel management
company. Mr. Sharman served for ten years as Chairman of the Board and
President of the Lancaster Group, Inc., a real estate development firm based
III-1
<PAGE>
ILM II LEASE CORPORATION
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)
in Houston, Texas, which is the predecessor of Lancaster Hotel Management,
L.C. and Bayou Equities, Inc. Mr. Sharman serves as a Director of Small
Luxury Hotels, Ltd. of the United Kingdom, an international hotel marketing
and reservations firm, and also serves on the Board of Trustees of St.
Edwards University in Austin, Texas. Mr. Sharman also presently serves as
President and Director of ILM I and ILM II. He has a Bachelor of Science
degree from the University of Notre Dame.
(e) Except for the Feldman litigation as discussed below, none
of the current Directors and Officers was involved in legal proceedings
which are material to an evaluation of his or her ability or integrity
as a Director or Officer. On May 8, 1998, Andrew A. Feldman and Jeri
Feldman, as Trustees for the Andrew A. & Jeri Feldman Revocable Trust
dated September 18, 1990, commenced a purported class action on behalf
of that trust and all other shareholders of ILM I and ILM II
(affiliates of the Company, as previously discussed) in the Supreme
Court of the State of New York, County of New York, naming as
defendants ILM I, ILM II and Lawrence A. Cohen, Jeffry R. Dwyer, Julien
G. Redele, Carl J. Schramm and J. William Sharman, Jr. as the directors
of both corporations. The class action complaint alleged that the
directors engaged in wasteful and oppressive conduct and breached
fiduciary duties in preventing the sale or liquidation of the assets of
ILM I and ILM II, diverting certain of their assets. The complaint
sought compensatory damages in an unspecified amount, punitive damages,
the judicial dissolution of ILM I and ILM II, an order requiring the
directors to take all steps to maximize shareholder value, including
either an auction or liquidation, and rescinding certain agreements,
and attorney's fees. On July 8, 1998, the defendants moved to dismiss
the complaint on all counts.
On December 8, 1998, the Court granted the defendants'
dismissal motion in part but afforded the plaintiffs leave to amend
their complaint. In doing so, the Court accepted the defendants'
position that all claims relating to the derivative actions were filed
improperly. In addition, the Court dismissed common law claims for
punitive damages, but allowed plaintiffs to amend their claims to
assert claims alleging that the defendants injured shareholders without
injuring ILM I and ILM II as a whole.
On January 22, 1999, the Feldman plaintiffs filed an amended
complaint, again purporting to commence a class action, and adding
claims under Section 10(b) and 20(a) of the Securities and Exchange Act
of 1934 and Rule 10b-5 promulgated thereunder. Even before the
defendants responded to that amended complaint, the Feldman plaintiffs
moved for leave to file a second amended complaint to add claims
directed at enjoining the announced potential merger on ILM I and ILM
II with Capital Senior Living Corporation and, alternatively, for
compensatory and punitive damages. At a hearing held on March 4, 1999
relating to the motion for leave to file that second amended complaint
and to expedite discovery, the Court granted leave to amend and set a
schedule for discovery leading to a trial (if necessary) in the summer
of 1999.
On March 9, 1999, the Feldman plaintiffs filed a second
amended complaint, which included claims for injunctive relief and, in
the alternative, damages in an unspecified amount. In response to the
defendants' motion to dismiss the second amended complaint, on June 7,
1999 the Court issued an order dismissing the plaintiffs' federal
security claims but denying the motion to dismiss plaintiffs' claims
for breach of fiduciary duty and judicial dissolution, which motion was
addressed to the pleadings and not to the merits of the action.
III-2
<PAGE>
ILM II LEASE CORPORATION
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (CONTINUED)
On June 21, 1999, the defendants answered the second amended
complaint and denied any and all liability and moved for
reconsideration of the portion of the Court's June 7, 1999 order
denying their motion to dismiss. In response to discovery requests, ILM
I, ILM II and others produced documents to the plaintiffs and
depositions of current and former directors and others were taken.
Discovery was completed as of July 1, 1999.
On July 2, 1999, the parties to this action came to an
agreement-in-principle to settle the action. On August 3, 1999, the
parties entered into a Stipulation of Settlement and on August 11,
1999, the Court signed an order preliminarily approving the Stipulation
and providing for notice of the Stipulation to the
proposed settlement class.
On September 30, 1999, the Court conducted a hearing and on
October 4, 1999 issued an order certifying a settlement class and
approving the proposed settlement as fair, reasonable and adequate,
subject to the condition that certain modifications be made to the
Stipulation of Settlement and any related documents filed with the
Court on or before October 15, 1999.
On October 15, 1999, the parties entered into a revised
Stipulation of Settlement and filed it with the Court, which approved
the settlement, by order dated October 21, 1999. In issuing that order
the Court entered a final judgement dismissing the action and all
non-derivative claims of the settlement class against the defendants
with prejudice. In its October 4th order, the Court also denied the
application by plaintiffs' counsel for payment of attorneys' fees and
expenses, without prejudice to renewal within 14 days upon
reapplication therefor. On or about October 14, 1999, plaintiffs'
counsel reapplied to the Court for fees and expenses. A hearing was
held November 5, 1999, in which the Court granted the application for
attorney's fees in the amount of $950,000 and costs in the amount of
$182,000. Under the Stipulation, if the proposed merger is consummated,
Capital Senior Living Corporation is responsible for payment of such
attorney's fees and expenses sought under this application, and if the
proposed merger with Capital Senior Living Corporation is not
consummated and if ILM I and ILM II enter into a transaction having
similar effect to the merger with a third party, then ILM I and ILM II
are responsible for such fees and expenses.
(f) Compliance With Exchange Act Filing Requirements: The
Securities Exchange Act of 1934 requires the Officers and Directors of
the Company, and persons who own more than ten percent of the Company's
outstanding common stock, to file certain reports of ownership and
changes in ownership with the Securities and Exchange Commission.
Officers, Directors and ten-percent beneficial holders are required by
SEC regulations to furnish the Company with copies of all Section 16(a)
forms they file.
Based solely on its review of the copies of such forms received by it,
the Company believes that, during the year ended August 31, 1999, there was
compliance with all filing requirements applicable to its Officers and Directors
and ten-percent beneficial holders.
III-3
<PAGE>
ILM II LEASE CORPORATION
ITEM 11. EXECUTIVE COMPENSATION
The Company's Directors each receive annual compensation of $12,000
plus $500 for attending each Board of Directors meeting and reimbursement for
expenses incurred in attending meetings and as a result of other work
performed for the Company. Officers of the Company are not compensated.
Jeffry R. Dwyer receives compensation from and is a shareholder of Greenberg
Traurig, which acts as Counsel to the Company and its affiliates. The former
Officers of the Company who were also Officers of PaineWebber received
compensation from PaineWebber which indirectly related to services to the
Company because the Company was required to pay certain fees to PaineWebber
as described in Item 13. When PaineWebber resigned as advisor to the Company,
the former officers resigned effective the same date, therefore no services
were provided by such persons subsequent to June 18, 1997. Lawrence A. Cohen,
who was a Director of the Company until July 28, 1998, received compensation
from and was an employee of Capital Senior Living Corporation, an affiliate
of Capital, a related party through July 28, 1998.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) As of the date hereof, no person of record owns or is known by the
Company to own beneficially more than five percent of the outstanding
shares of common stock of the Company.
(b) The Directors and Officers of the Company do not have any direct or
indirect ownership of shares of the Company's common stock as of the
date hereof.
(c) There exists no arrangement, known to the Company, the operation of
which may at a subsequent date result in a change in control of the
Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED 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 Item 1, PaineWebber resigned effective June 18, 1997.
Under the advisory agreement, PaineWebber had specific management
responsibilities; to perform day-to-day operations of the Company and to act as
the investment advisor and consultant for the Company in connection with general
policy and investment decisions. PaineWebber received a fee in an amount equal
to 0.5% of the gross operating revenue of the facilities. For the years ended
August 31, 1999, 1998 and 1997, PaineWebber earned management fees totaling $0,
$0 and $58,000, respectively. PaineWebber was reimbursed for direct expenses
relating to the administration of the Company. PaineWebber performed certain
accounting, tax preparation, securities law compliance and investor
communications and relations services for the Company. Included in general and
administrative expenses on the accompanying statements of income for the years
ended August 31, 1999, 1998 and 1997 are $0, $0 and $59,000, respectively,
representing reimbursements to PaineWebber for providing such services to the
Company. As discussed in Items 1 and 7, the Company, ILM I, ILM II, and their
affiliates accepted the resignation of PaineWebber effective as of June 18,
1997. The Company, ILM I, ILM II, and their affiliates and PaineWebber entered
into a transition services agreement pursuant to which PaineWebber would
continue to provide certain administrative services to the Company, ILM I, ILM
II, and their affiliates through August 31, 1997.
III-4
<PAGE>
ILM II LEASE CORPORATION
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
The advisory relationship with PaineWebber ceased on June 18, 1997;
therefore, the payment of advisory fees ceased as of that date. Other
services, such as accounting, compliance, investor communications and
relations, and cash management services ceased on August 31, 1997; therefore,
the Company was not obligated to pay service fees past August 31, 1997 to
PaineWebber.
The Company retained Capital to be the property manager of the
Senior Housing Facilities pursuant to a Management Agreement which commenced
on July 29, 1996. As discussed in Note 1, 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 in various
management capacities at Capital Senior Living Corporation, an affiliate of
Capital, since 1996. Mr. Cohen currently serves as Chief Executive Officer
and Acting Chief Financial Officer of Capital Senior Living Corporation.
Under the Management Agreement, Capital generally is required to perform all
operational functions necessary to operate the Senior Housing Facilities
other than certain administrative functions. The functions performed by
Capital include periodic reporting to and coordination with the Company,
leasing the individual units in the Senior Housing Facilities maintaining
bank accounts, maintaining books and records, advertising and marketing the
Senior Housing Facilities, hiring and supervising on-site personnel, and
performing maintenance. 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, beginning on August 31, 1997, the base amount is increased based
on the percentage increase in the Consumer Price Index as well as 15% of
Facility expansion costs. ILM II has guaranteed the payment of all fees due
to Capital under the terms of the Management Agreement. For the years ended
August 31, 1999 and 1998, Capital earned property management fees from the
Company of $980,000 and $899,000, respectively.
On February 4, 1997, AHC filed a complaint in the Superior Court of
the State of California against Capital, the new property manager; Lawrence
A. 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 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 $229,000 as of August
31, 1999. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should pay reasonable legal fees
and expenses incurred by Capital in the California litigation. At August 31,
1999, the amount advanced to Capital by the Company and Lease I for Capital's
California litigation costs totaled approximately $563,000.
III-5
<PAGE>
ILM II LEASE CORPORATION
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (CONTINUED)
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. For
the years ended August 31, 1999 and 1998, Capital Senior Development, Inc.
earned fees from the Company of $15,000 and $73,000, respectively, for
managing pre-construction development activities for potential expansions of
the Senior Housing Facilities.
Jeffry R. Dwyer, President, Secretary and Director of the Company,
is a shareholder of Greenberg Traurig, Counsel to the Company and its
affiliates since 1997. For the years ended August 31, 1999 and 1998,
Greenberg Traurig earned fees from the Company of $54,000 and $153,000,
respectively.
III-6
<PAGE>
ILM II LEASE CORPORATION
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(1) and (2) FINANCIAL STATEMENTS AND SCHEDULES:
The response to this portion of Item 14 is
submitted as a separate section of
this report. See Index to Financial Statements
and Financial Statement Schedules at page F-1.
(3) EXHIBITS:
The exhibits listed on the accompanying
index to exhibits at page IV-3 are filed as
part of this Report.
(b) Exhibits:
See (a)(3) above.
(c) Financial Statement Schedules:
The response to this portion of Item 14 is
submitted as a separate section of this report. See
Index to Financial Statements and Financial
Statement Schedules at page F-1.
IV-1
<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.
ILM II LEASE CORPORATION
By: /s/ Jeffry R. Dwyer
-----------------------
Jeffry R. Dwyer
President
(Principal Accounting Officer)
Dated: November 23, 1999
-----------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Company in the capacity and on the dates indicated.
By: /s/ Jeffry R. Dwyer Date: November 23, 1999
--------------------------------------------- -----------------
Jeffry R. Dwyer
Director
By: /s/ Julien G. Redele Date: November 22, 1999
------------------------------------------- -----------------
Julien G. Redele
Director
By: /s/ J. William Sharman, Jr. Date: November 23, 1999
--------------------------------------------- -----------------
J. William Sharman, Jr.
Director
IV-2
<PAGE>
ILM II LEASE CORPORATION
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(3)
ILM II LEASE CORPORATION
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
PAGE NUMBER IN THE REPORT
EXHIBIT NO. DESCRIPTION OF DOCUMENT OR OTHER REFERENCE
----------- ----------------------- --------------------------
<S> <C> <C>
(3) and (4) Registration Statement on Form 10 Filed with the Commission
of the Registrant dated July 20, 1995, pursuant to Rule 424(c) and
as supplemented incorporated herein by reference
(13) Annual Reports to Shareholders No Annual Report for the year
ended August 31, 1999 has been
sent to the Shareholders. An
Annual Report will be sent to the
Shareholders subsequent to this
filing.
(27) Financial Data Schedule Filed as last page of EDGAR
submission following the
Financial Statements and
Financial Statement Schedule
required by Item 14.
</TABLE>
IV-3
<PAGE>
ILM II LEASE CORPORATION
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1) AND (2) AND 14(d)
ILM II LEASE CORPORATION
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
REFERENCE
---------
<S> <C>
ILM II LEASE CORPORATION:
Report of Ernst & Young LLP, Independent Auditors F-2
Balance Sheets as of August 31, 1999 and 1998 F-3
Statements of Operations for the years ended August 31, 1999, 1998 and 1997 F-4
Statements of Changes in Shareholders' Equity for the years ended August 31, F-5
1999, 1998 and 1997
Statements of Cash Flows for the years ended August 31, 1999, 1998 and 1997 F-6
Notes to Financial Statements F-7
</TABLE>
Financial statement schedules have been omitted since the required
information is not present or not present in amounts sufficient to require
submission of the schedule, or because the information required is included
in the financial statements, including the notes thereto.
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Shareholders of
ILM II Lease Corporation:
We have audited the accompanying balance sheets of ILM II Lease Corporation
as of August 31, 1999 and 1998, and the related statements of operations,
changes in shareholders' equity, and cash flows for each of the three years
in the period ended August 31, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assisting the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ILM II Lease Corporation at
August 31, 1999 and 1998, and the results of its operations and its cash
flows for each of the three years in the period ended August 31, 1999, in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas
October 22, 1999
F-2
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
August 31, 1999 and 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
------
1999 1998
------------ ----------
<S> <C> <C>
Cash and cash equivalents $1,487 $1,497
Accounts receivables, net 80 89
Accounts receivable - related party 50 102
Prepaid taxes and other assets 352 50
Tax refund receivable 21 158
------ -------
Total current assets 1,990 1,896
Furniture, fixtures and equipment 1,135 783
Less: accumulated depreciation (518) (225)
----- --------
617 558
Deposits 9 9
Deferred tax asset, net 154 270
-------- --------
$2,770 $2,733
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Accounts payable and accrued expenses $ 625 $ 789
Income taxes payable 226 --
Termination fee payable -- 650
Real estate taxes payable 230 209
Accounts payable - related party 337 287
Security deposits 49 25
-------- --------
Total current liabilities 1,467 1,960
Deferred rent payable 37 76
-------- --------
Total liabilities 1,504 2,036
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 766 197
-------- --------
Total shareholders' equity 1,266 697
----- --------
$ 2,770 $ 2,733
========= =======
</TABLE>
See accompanying notes.
F-3
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF OPERATIONS
For the years ended August 31, 1999, 1998 and 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
REVENUES:
Rental and other income $ 16,232 $ 15,481 $ 14,394
Interest income 18 43 39
--------- --------- ---------
16,250 15,524 14,433
EXPENSES:
Facilities lease rent expense 5,265 4,988 4,416
Dietary, salaries, wages and food service expenses 2,740 2,677 2,702
Administrative salaries, wages and expenses 1,196 1,090 1,228
Marketing salaries, wages and expenses 705 688 657
Utilities 1,062 1,045 1,051
Repairs and maintenance 636 554 531
Real estate taxes 527 506 511
Property management fees 980 899 707
Other property operating expenses 1,433 1,433 1,389
General and administrative 228 323 216
Directors compensation 51 75 31
Professional fees 223 878 547
Termination fee expense - 250 400
Advisory fees - - 58
Depreciation expense 293 154 56
-------- -------- ---------
15,339 15,560 14,500
-------- -------- ---------
Income (loss) before income taxes 911 (36) (67)
Income tax expense (benefit):
Current 226 - 191
Deferred 116 (14) (218)
-------- -------- ---------
342 (14) (27)
-------- -------- ---------
NET INCOME (LOSS) $ 569 $ (22) $ (40)
-------- -------- ---------
-------- -------- ---------
NET INCOME (LOSS) PER SHARE OF COMMON STOCK $ 0.10 $ 0.00 $ (0.01)
-------- -------- ---------
-------- -------- ---------
</TABLE>
The above net income (loss) per share of common stock is based upon the
weighted average number of shares outstanding for the year ended August 31,
1999, 1998 and 1997, of 5,180,952.
See accompanying notes.
F-4
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended August 31, 1999, 1998 and 1997
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
------------------------------- Paid-in Retained
Shares Amount Capital Earnings Total
------------- ------------- ------------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
BALANCE AT AUGUST 31, 1996 5,180,952 $ 52 $448 $259 $ 759
Net loss - - - (40) (40)
----------- --------- ------- -------- ---------
BALANCE AT AUGUST 31, 1997 5,180,952 52 448 219 719
Net loss - - - (22) (22)
----------- --------- ------- -------- ---------
BALANCE AT AUGUST 31, 1998 5,180,952 52 448 197 697
Net income - - - 569 569
----------- --------- ------- -------- ---------
BALANCE AT AUGUST 31, 1999 5,180,952 $ 52 $ 448 $766 $1,266
----------- --------- ------- -------- ---------
----------- --------- ------- -------- ---------
</TABLE>
See accompanying notes.
F-5
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the years ended August 31, 1999, 1998 and 1997
(In thousands)
<TABLE>
<CAPTION>
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 569 $ (22) $ (40)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities
Depreciation expense 293 154 56
Deferred tax expense (benefit), net 116 (14) (218)
Changes in assets and liabilities:
Accounts receivable, net 9 (34) 5
Accounts receivable - related party 52 (102) (55)
Tax refund receivable 137 (158) -
Prepaid taxes and other assets (302) 193 (125)
Accounts payable and accrued expenses (164) 242 196
Income taxes payable 226
Accounts payable - related party 50 135 (327)
Termination fee payable (650) 250 400
Real estate taxes payable 21 10 (4)
Security deposits 24 8 (3)
Deferred rent payable (39) (24) (31)
------------- ------------- -------------
Net cash provided by (used in) operating activities 342 638 (146)
------------- ------------- -------------
Cash flows from investing activity:
Additions to furniture, fixtures and equipment (352) (297) (289)
------------- ------------- -------------
Net cash used in investing activities (352) (297) (289)
------------- ------------- -------------
Net (decrease) increase in cash and cash equivalents (10) 341 (435)
Cash and cash equivalents, beginning of period 1,497 1,156 1,591
------------- ------------- -------------
Cash and cash equivalents, end of period $ 1,487 $ 1,497 $ 1,156
------------- ------------- -------------
------------- ------------- -------------
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for state income taxes $ 5 $ 116 $ 288
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
See accompanying notes.
F-6
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements
1. ORGANIZATION, RESTRUCTURING, AND NATURE OF OPERATIONS
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. ("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. 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 which was assigned to the Company as of
September 1, 1995. As discussed further in Note 6, the management agreement
with AHC was terminated in July 1996.
ILM II has elected to qualify and 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 (see Note 4). Because the Company, which
is taxed as a so-called "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 operations of the Senior Housing
Facilities. The Company leases the Senior Housing Facilities from ILM II
Holding, which is now a subsidiary of ILM II that holds title to the Senior
Housing Facilities, pursuant to a Facilities Lease Agreement. Such lease is
scheduled to expire on December 31, 2000 (December 31, 1999 with respect to
the Santa Barbara Facility) (see Note 5), unless terminated earlier at the
election of the Lessor in connection with the sale of the Senior Housing
Facilities to a non-affiliated third party, upon 30 days' notice to the
Company. 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.
While there can be no assurance, consummation of the merger is presently
anticipated in the first quarter of calendar year 2000. The lease is
accounted for as an operating lease in the Company's financial statements.
In July 1996, following the 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 in various management capacities at Capital
Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen
currently serves as Chief Executive Officer and Acting Chief Financial
Officer of Capital Senior Living Corporation. As a result, the Management
Agreement with Capital was considered a related party transaction through
July 28, 1998 (see Note 3).
F-7
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
1. ORGANIZATION, RESTRUCTURING, AND NATURE OF OPERATIONS (CONTINUED)
On February 7, 1999, ILM I entered into an agreement and plan of merger
with Capital Senior Living Corporation, the corporate parent of Capital,
and certain affiliates of Capital. 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.
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 August 31, 1999 and 1998 and
revenues and expenses for the years ended August 31, 1999, 1998 and 1997.
Actual results could differ from the estimates and assumptions used.
Furniture, fixtures and equipment are carried at the lower of cost,
reduced by accumulated depreciation, or fair value in accordance with FAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets To Be Disposed Of." Depreciation expense was provided on
a straight-line basis using an estimated useful life of 3 to 5 years
through fiscal year 1997. In 1998, the Company changed the estimated useful
lives of its assets to the lease termination date of December 31, 2000, as
such assets are not subject to repurchase by ILM II Holding. For fiscal
year 1998, this increased depreciation expense by $36,000.
Units at the Senior Housing Facilities are generally rented for terms
of twelve months or less. The base rent charged varies depending on the
unit size, with added fees collected for more than one occupant per unit
and for assisted living services. Included in the amount of base rent
charged are certain meals, housekeeping, medical and social services
provided to the residents of each Senior Housing Facility.
The Company rents the Senior Housing Facilities from ILM II Holding
pursuant to a multi-year operating lease. Rent expense is recognized on a
straight-line basis over the term of the lease agreement. Deferred rent
payable represents the difference between rent expense recognized on a
straight-line basis and cash paid for rent pursuant to the terms of the
lease agreement.
The Company's policy is to expense all advertising costs as incurred.
For the years ended August 31, 1999, 1998 and 1997, advertising expenses
were $705,000, $688,000 and $657,000, respectively.
The cash and cash equivalents, receivables, accounts payable and
accrued liabilities appearing on the accompanying balance sheets represent
financial instruments for purposes of Statement of Financial Accounting
Standards No. 107, "Disclosures about Fair Value of Financial Instruments."
The carrying amount of these assets and liabilities approximates their fair
value as of August 31, 1999 due to the short-term nature of these
instruments.
Income tax expense is provided for using the liability method as
prescribed by Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes."
For purposes of reporting cash flows, cash and cash equivalents include
all highly liquid investments with original maturities of 90 days or less.
F-8
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS
The Company entered into an advisory agreement (the "Advisory
Agreement") with PaineWebber Lease Advisor, L.P. For discussion purposes,
PaineWebber Lease Advisors L.P. and all affiliates of PaineWebber will be
collectively referred to as PaineWebber ("PaineWebber"). PaineWebber served
in this capacity through June 18, 1997. Subject to the supervision of and
pursuant to the general policies set by the Company's Board of Directors,
assistance in the managing of the business of the Company was provided by
PaineWebber. Under the Advisory Agreement, the Company engaged PaineWebber
and PaineWebber agreed to use its best efforts to manage the day-to-day
affairs and operations of the Company and to provide administrative
services and facilities appropriate for such management. The specific
duties of PaineWebber under the Advisory Agreement included recommending
selections of providers of professional and specialized services and
handling other managerial functions with respect to the Senior Housing
Facilities. PaineWebber was also obligated to provide office and clerical
facilities adequate for the Company's operations and to provide, or obtain
others to provide, accounting, custodial, funds collection and payment,
stockholder communications, legal and other services necessary in
connection with the Company's operations. The Advisory Agreement also
obligated PaineWebber to handle or arrange for the handling of the
Company's financial and other records.
PaineWebber received a base fee in an amount equal to 0.5% of the gross
operating revenues of the Senior Housing Facilities operated by the Company
as compensation for its services. This fee amounted to $0, $0 and $58,000
for the years ended August 31, 1999, 1998 and 1997, respectively. In
addition, PaineWebber is entitled to reimbursement for expenses incurred in
providing certain financial, accounting and investor communication services
to the Company. Included in general and administrative expense for the year
ended August 31, 1999, 1998 and 1997, are $0, $0 and $59,000, respectively,
representing reimbursements to PaineWebber for providing such services to
the Company. In performing its services under the Advisory Agreement,
PaineWebber was required to pay certain employment expenses of its
personnel, certain expenses of employees and agents of PaineWebber and of
directors, officers and employees of the Company who are also employees of
PaineWebber or its affiliates, and certain of its overhead and
miscellaneous administrative expenses relating to performance of its
functions under the Advisory Agreement. The Company was responsible for
reimbursing out-of-pocket expenses of directors, officers and employees of
the Company incurred by them exclusively in such capacity and for all other
costs of its operations.
The Company retained Capital to be the property manager of the Senior
Housing Facilities pursuant to a Management Agreement which commenced on
July 29, 1996. As discussed in Note 1, 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 in various
management capacities at Capital Senior Living Corporation, an affiliate of
Capital, since 1996. Mr. Cohen currently serves as Chief Executive of
Capital Senior Living Corporation. Under the Management Agreement, Capital
generally is required to perform all operational functions necessary to
operate the Senior Housing Facilities other than certain administrative
functions. The functions performed by Capital include periodic reporting to
and coordinating with the Company, leasing the individual units in the
Senior Housing Facilities, maintaining bank accounts, maintaining books and
records, advertising and marketing the Senior Housing Facilities, hiring
and supervising on-site personnel, and performing maintenance. 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,
beginning on August 31, 1997, the base amount is increased based on the
percentage increase in the Consumer Price Index as well as 15% of Facility
expansion costs. ILM II has guaranteed the payment of all fees due to
Capital under the terms of the Management Agreement. For the years ended
August 31, 1999, 1998 and 1997, Capital earned property management fees
from the Company of $980,000, $899,000 and $707,000, respectively.
F-9
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, the new property manager; Lawrence A.
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 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 $229,000 as of
August 31, 1999. The Company's Board also concluded that, subject to
certain conditions, the Company or its affiliates should pay reasonable
legal fees and expenses incurred by Capital in the California litigation.
At August 31, 1999, the amount advanced to Capital by the Company and Lease
I for Capital's California litigation costs totaled approximately $563,000.
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. For
the years ended August 31, 1999 and 1998, Capital Senior Development, Inc.
earned fees from the Company of $15,000 and $73,000, respectively, for
managing pre-construction development activities for potential expansions
of the Senior Housing Facilities.
Jeffry R. Dwyer, President, Secretary and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the years ended August 31, 1999 and 1998, Greenberg Traurig
earned fees from the Company of $54,000 and $153,000, respectively.
Accounts receivable - related party at August 31, 1999 includes $30,349
expense reimbursement due from ILM II Holding for the balance of the Ft.
Myers roof replacement and $20,000 in other reimbursable costs due from ILM
II Holding. Accounts receivable - related party at August 31, 1998 is an
insurance refund due to the Company from Lease I in the amount of $102,000
which was reimbursed to the Company during fiscal 1999. Accounts payable -
related party at August 31, 1999 and 1998 includes $337,000 and $287,000,
respectively, for variable rent due to ILM II Holding.
4. CAPITAL STOCK
Prior to September 1, 1995, the Company was a wholly-owned subsidiary
of ILM II. Pursuant to a reorganization and distribution agreement, ILM II
capitalized the Company with $500,000, an amount estimated to provide the
Company with necessary working capital. On September 1, 1995, MAVRICC
Management Systems, Inc., as the distribution agent, caused to be issued on
the stock records of the Company the distributed Common Stock of the
Company, in uncertificated form, to the holders of record of ILM II Common
Stock at the close of business on July 14, 1995. One share of the Company's
Common Stock was distributed for each outstanding share of ILM II Common
Stock. No certificates or scrip representing fractional shares of the
Company's Common Stock were issued to holders of ILM II Common Stock as
part of the distribution. In lieu of receiving fractional shares, each
holder of ILM II Common Stock who would otherwise have been entitled to
receive a fractional share of the Company's Common Stock received a cash
payment equivalent to $0.14 per share for such fractional interest.
F-10
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
5. THE FACILITIES LEASE AGREEMENT
ILM II Holding (the "Lessor"), a majority-owned subsidiary of ILM II,
leases the Senior Housing Facilities to the Company (the "Lessee"),
pursuant to a 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 of the Senior Housing Facilities to a
non-affiliated third party, upon 30 days' notice to the Company. 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. While there can be
no assurance, consummation of the merger is presently anticipated in the
first quarter of calendar year 2000. 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
Name Location Built Units (2) Capacity (2)
---- -------- ----- --------- ------------
<S> <C> <C> <C> <C>
The Palms Fort Myers, FL 1988 205 255
Crown Villa Omaha, NE 1992 73 73
Overland Park Place Overland Park, KS 1984 141 153
Rio Las Palmas Stockton, CA 1988 164 190
The Villa at Riverwood St. Louis County, MO 1986 120 140
Villa Santa Barbara (1) Santa Barbara, CA 1979 125 125
</TABLE>
(1) The 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.
F-11
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
5. THE FACILITIES LEASE AGREEMENT (CONTINUED)
Pursuant to the Facilities Lease Agreement, the Company pays annual
base rent for the use of all 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 the 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 Senior
Housing Facility in an amount equal to 40% of the excess of the aggregate
total revenues for the Senior Housing Facilities, on an annualized basis,
over $13,021,000. For the fiscal years ended August 31, 1999 and 1998,
variable rent expense was $1,261,000 and $984,000, respectively.
The Company's use of the properties is limited to use as a Senior
Housing Facility. The Company has responsibility to obtain and maintain all
licenses, certificates and consents needed to use and operate each
Facility, and to use and maintain each Senior Housing Facility in
compliance with all local board of health and other applicable governmental
and insurance regulations. The Senior Housing Facilities located in
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 of 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.
6. LEGAL PROCEEDINGS AND CONTINGENCIES
A 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 agreement and that such actions caused damages to the
Companies.
Due to the termination of the management 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 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 alleged that the
agreement was wrongfully terminated for cause and requested damages which
include the payment of the 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 that the management
agreement could have been terminated without cause, and recovery of
attorney's fees and expenses.
F-12
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
6. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
The aggregate amount of damages against all parties as requested in
AHC's counterclaim exceeded $2,000,000. On June 13, 1997 and July 8, 1997,
the court issued orders to enter judgment against ILM I and ILM II in the
amount of $1,000,000. 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, the new property manager; Lawrence A.
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 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 $229,000 as of
August 31, 1999. The Company's Board also concluded that, subject to
certain conditions, the Company or its affiliates should pay reasonable
legal fees and expenses incurred by Capital in the California litigation.
At August 31, 1999, the amount advanced to Capital by the Company and Lease
I for Capital's California litigation costs totaled approximately $563,000.
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. 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.
The Company has pending claims incurred in the normal course of
business which, in the opinion of the Company's management, will not have
a material effect on the financial statements of the Company.
F-13
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
7. FEDERAL INCOME TAXES
The Company is taxable as a so-called "C" corporation and, therefore,
its income is subject to tax at the federal and state levels. The Company
reports on a calendar year for tax purposes. Income taxes at the
appropriate statutory rates have been provided for in the accompanying
financial statements.
Deferred income tax benefit reflects the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
The Company's deferred tax assets and liabilities as of August 31, 1999 and
1998, are comprised of the following amounts (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Deferred tax asset - straight-line rent expense $ 15 $28
Deferred tax asset - book over tax depreciation 124 44
Deferred tax asset - book over tax amortization 15 30
Net operating loss carryforward - 168
----- -----
Net deferred tax asset $154 $270
----- -----
----- -----
</TABLE>
The components of income tax expense (benefit) for fiscal 1999, 1998
and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- -------
<S> <C> <C> <C>
Current:
Federal $ - $ - $ 162
State - - 29
--------- --------- -------
Total current - - 191
--------- --------- -------
Deferred:
Federal 293 (12) (185)
State 49 (2) (33)
--------- --------- -------
Total deferred 342 (14) (218)
--------- --------- -------
$342 $(14) $ (27)
--------- --------- -------
--------- --------- -------
</TABLE>
The reconciliation of income tax computed for fiscal 1999, 1998 and
1997, at U.S. federal statutory rates to income tax expense (benefit) is as
follows (in thousands):
<TABLE>
<CAPTION>
1999 1998 1997
------------------ ---------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Tax at U.S. statutory rates $293 34% (12) (34%) $(23) (34%)
State income taxes, net
of federal tax benefit 49 6% (2) (6%) (4) (6%)
---- --- ----- ----- ----- -----
$342 40% $(14) (40%) $(27) (40%)
==== === ===== ===== ===== =====
</TABLE>
F-14
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE
SHEET AS OF AUGUST 31, 1999 AND THE STATEMENT OF INCOME FOR THE PERIOD ENDED
AUGUST 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1999
<PERIOD-END> AUG-31-1999
<CASH> 1,487
<SECURITIES> 0
<RECEIVABLES> 503
<ALLOWANCES> 5
<INVENTORY> 0
<CURRENT-ASSETS> 1,990
<PP&E> 1,135
<DEPRECIATION> 518
<TOTAL-ASSETS> 2,770
<CURRENT-LIABILITIES> 1,467
<BONDS> 0
0
0
<COMMON> 52
<OTHER-SE> 1,214
<TOTAL-LIABILITY-AND-EQUITY> 2,770
<SALES> 0
<TOTAL-REVENUES> 16,250
<CGS> 0
<TOTAL-COSTS> 15,339
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 911
<INCOME-TAX> 342
<INCOME-CONTINUING> 569
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 569
<EPS-BASIC> .10
<EPS-DILUTED> .10
</TABLE>
