<PAGE>
================================================================================
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, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from _____ to _____.
Commission File Number: 0-25880
-------
ILM II LEASE CORPORATION
(Exact name of registrant as specified in its charter)
VIRGINIA 04-3248639
---------------------- -------------------
(State of organization) (I.R.S. Employer
Identification No.)
1750 Tysons Boulevard, Suite 1200, Tysons Corner, VA 22102
--------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (888) 257-3550
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
----------------------- --------------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock, $.01 Par Value
--------------------------------------
(Title of class)
Indicate by check mark 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 X No .
--- ---
Shares of common stock outstanding as of August 31, 2000: 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
Current Report on Form 8-K Part IV
of registrant dated June 7, 2000
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<PAGE>
ILM II LEASE CORPORATION
2000 FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I Page
------ ----
<S> <C> <C> <C>
Item 1 Business...........................................................................................I-1
Item 2 Properties.........................................................................................I-5
Item 3 Legal Proceedings..................................................................................I-5
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-7
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................................................II-7
Part III
Item 10 Directors and Executive Officers of the Registrant...............................................III-1
Item 11 Executive Compensation...........................................................................III-3
Item 12 Security Ownership of Certain Beneficial Owners and Management...................................III-3
Item 13 Certain Relationships and Related Transactions...................................................III-3
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. Subsequent to the fiscal year end, on November
13, 2000, the ILM II Board of Directors voted to extend the Facilities Lease
Agreement on a month-to-month basis beyond its original expiration date of
December 31, 2000. On November 28, 2000, the Facilities Lease Agreement was
extended through the earlier of the date on which the merger of ILM II with
Capital Senior Living Corporation ("CSLC") is consummated or March 31, 2000, and
on a month-to-month basis thereafter if the merger is not consummated by that
time. 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 CSLC, the corporate parent of Capital, since
1996. Mr. Cohen currently serves as Chief Executive Officer of CSLC. 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 paid annual
base rent for the use of all of the Senior Housing Facilities in the aggregate
amount of $3,995,586 ($4,035,600 in 1999). The reduction in base rent from the
previous year is due to the termination of the Facilities Lease Agreement with
respect to Villa Santa Barbara which was sold by ILM II to CSLC on August 15,
2000. Beginning September 1, 2000, annual base rent will be $3,555,427
(excluding Villa Santa Barbara). The Facilities Lease Agreement is a
"triple-net" lease whereby the Lessee pays all operating expenses, governmental
taxes and assessments, utility charges and insurance premiums, as well as the
costs of all required maintenance, personal property and non-structural repairs
in connection with the operation of the Senior Housing Facilities. ILM II
Holding, as 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 paid 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 through August 15, 2000, when Villa
Santa Barbara was sold. Beginning September 1, 2000, variable rent will be
payable quarterly in an amount equal to 40% of the excess of the aggregate total
revenues over $11,634,000 (excluding Villa Santa Barbara). For the fiscal years
ended August 31, 2000 and 1999, variable rent expense was $1,437,000 and
$1,261,000, respectively.
On February 7, 1999, ILM II entered into an agreement and plan of merger
with CSLC, the corporate parent of Capital, and certain affiliates of CSLC. In
connection with the merger, the Company has received notice from ILM II Holding
indicating that the Facilities Lease Agreement would terminate on the date of
consummation of the pending merger of ILM II and CSLC. 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. Additionally, upon such termination, it
is currently expected that the Company would have nominal value after payment of
expenses and other costs, and the Board accordingly would review the Company's
status and continued existence.
On August 15, 2000, ILM II caused ILM II Holding to terminate the
Facilities Lease Agreement with respect to the Company's 75% leasehold interest
in Villa Santa Barbara and sell the Senior Housing facility to CSLC.
The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, and may be terminated earlier at the election of ILM II
Holding upon sale of ILM II Holding's senior living communities to a
non-affiliated third party. On November 13, 2000, the Facilities Lease Agreement
was extended on a month-to-month basis beyond its original expiration date. On
November 28, 2000, the Facilities Lease Agreement was extended through the
earlier of the date on which the merger of ILM II with CSLC is consummated or
March 31, 2000, and on a month-to-month basis thereafter if the merger is not
consummated by that time.
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, 2000 are
summarized as follows:
<TABLE>
<CAPTION>
Year
Facility Rentable Resident
Property Name and Location (1) Type of Property Built Units (2) Capacities (2)
------------------------------ ---------------- ----- --------- --------------
<S> <C> <C> <C> <C>
The Palms
Fort Myers, FL Senior Housing Facility 1988 205 255
Crown Villa
Omaha, NE Senior Housing Facility 1992 73 73
Overland Park Place
Overland Park, KS Senior Housing Facility 1994 141 153
Rio Las Palmas
Stockton, CA Senior Housing Facility 1988 164 190
The Villa at Riverwood
St. Louis County, MO Senior Housing Facility 1986 120 140
</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) 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, advisors and consultants including Greenberg Traurig, Fleet
Bank, Ernst & Young LLP, and MAVRICC Management Systems, Inc.
There are currently 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 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 CSLC, an affiliate of Capital,
since 1996. Mr. Cohen currently serves as Chief Executive Officer of CSLC. 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 $903,000 and
$980,000 for the years ended August 31, 2000 and 1999, respectively.
I-4
<PAGE>
ILM II LEASE CORPORATION
ITEM 2. PROPERTIES
As of August 31, 2000, the Company has leased the five 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 2000, along
with an average for the year, are presented below for each property:
<TABLE>
<CAPTION>
Average Quarterly Occupancy
-----------------------------------------------------------------------------------------
Fiscal 2000
11/30/99 2/29/00 5/31/00 8/31/00 Average
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
The Palms 89% 92% 92% 90% 91%
Crown Villa 95% 90% 89% 85% 90%
Overland Park Place 94% 93% 92% 95% 94%
Rio Las Palmas 94% 92% 93% 93% 93%
The Villa at Riverwood 88% 88% 84% 85% 86%
</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 then 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, 2000. 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, 2000, the amount advanced to Capital by the Company
and Lease I for Capital's California litigation costs totaled approximately
$563,000. No amounts were advanced during fiscal year 2000.
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, 2000, there were 3,270 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 2000, 1999 and
1998, 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 CSLC, the corporate parent of Capital, and certain affiliates of
CSLC. In connection with the merger, the Company has received notice from ILM II
Holding indicating that the Facilities Lease Agreement would terminate on the
date of consummation of the pending merger of ILM II and CSLC. 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. Additionally, upon
such termination, it is currently expected that the Company would have nominal
value after payment of expenses and other costs, and the Board accordingly would
review the Company's status and continued existence.
On August 15, 2000, ILM II caused ILM II Holding to terminate the
Facilities Lease Agreement with respect to the Company's 75% leasehold interest
in Villa Santa Barbara and sell the Senior Housing facility to CSLC.
The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, and may be terminated earlier at the election of ILM II
Holding upon sale of ILM II Holding's senior living communities to a
non-affiliated third party. On November 13, 2000, the Facilities Lease Agreement
was extended on a month-to-month basis beyond its original expiration date. On
November 28, 2000, the Facilities Lease Agreement was extended through the
earlier of the date on which the merger of ILM II with CSLC is consummated or
March 31, 2000, and on a month-to-month basis thereafter if the merger is not
consummated by that time.
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,
2000 1999 1998
----------- ----------- -----------
<S> <C> <C> <C>
Revenues $ 16,605 $ 16,250 $ 15,524
Income (loss) before income taxes 211 911 (36)
Income tax expense (benefit) 475 342 (14)
----------- ----------- -----------
Net (loss) income $ (264) $ 569 $ (22)
=========== =========== ===========
Net (loss) income per share of common
stock $ (0.05) $ 0.10 $ 0.00
=========== =========== ===========
Total assets $ 2,545 $ 2,770 $ 2,733
=========== =========== ===========
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 paid base rent
for the use of the Senior Housing Facilities in the aggregate amount of
$3,995,586 ($4,035,600 in 1999). The reduction in base rent from the previous
year is due to the termination of the Facilities Lease Agreement with respect to
Villa Santa Barbara which was sold by ILM II to CSLC on August 15, 2000.
Beginning September 1, 2000, annual base rent will be $3,555,427 (excluding
Villa Santa Barbara). The Facilities Lease Agreement 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 paid 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 through August 15, 2000, when Villa Santa
Barbara was sold. Beginning September 1, 2000, variable rent will be payable
quarterly in an amount equal to 40% of the excess of the aggregate total
revenues over $11,634,000 (excluding Villa Santa Barbara). For the fiscal years
ended August 31, 2000 and 1999, variable rent expense was $1,437,000 and
$1,261,000, respectively.
II-3
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, and may be terminated earlier at the election of ILM II
Holding upon sale of ILM II Holding's senior living communities to a
non-affiliated third party. On November 13, 2000, the Facilities Lease Agreement
was extended on a month-to-month basis beyond its original expiration date. On
November 28, 2000, the Facilities Lease Agreement was extended through the
earlier of the date on which the merger of ILM II with CSLC is consummated or
March 31, 2000, and on a month-to-month basis thereafter if the merger is not
consummated by that time.
On July 29, 1996, the Company terminated the management agreement with
AHC covering the then 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 CSLC, an affiliate of Capital, since 1996. Mr. Cohen currently
serves as Chief Executive Officer of CSLC. 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, 2000. 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, 2000, the amount advanced to Capital by the Company
and Lease I for Capital's California litigation costs totaled approximately
$563,000. No amounts were advanced during fiscal year 2000.
Occupancy levels for the five properties which the Company leases from
ILM II Holding (six Senior Housing Facilities in 1999 due to the termination of
the Facilities Lease Agreement with respect to Villa Santa Barbara which was
sold by ILM II to CSLC on August 15, 2000) averaged 91% and 94% for the years
ended August 31, 2000 and 1999, respectively. The Senior Housing Facilities have
generated sufficient net cash flow to cover the base rent payments at their
current level of $3,995,586 during fiscal 2000 ($4,035,600 in 1999 due to the
termination of the Facilities Lease Agreement with respect to Villa Santa
Barbara on August 15, 2000) since the inception of the Company's operations.
Base rent payments of $3,555,427 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, 2000 and
1999, the Company had variable rent expense of $1,437,000 and $1,261,000,
respectively.
II-4
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
At August 31, 2000, the Company had cash and cash equivalents of
$1,894,000 compared to $1,487,000 at August 31, 1999. This increase of $407,000
is primarily attributable to cash flows from the operations of the senior
housing facilities. 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 2000, 1999 and 1998. The Company may or may not determine to pay
cash dividends in the future. Payment of dividends, if any, will be at the
discretion of the Company's Board of Directors and will depend upon such factors
as the Company's financial condition, earnings, anticipated investments and
other relevant factors. The source of future liquidity is expected to be from
operating cash 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.
RESULTS OF OPERATIONS
2000 COMPARED TO 1999
REVENUES. Total revenues were $16,605,000 for the year ended August 31,
2000 compared to $16,250,000 for the year ended August 31, 1999, representing an
increase of $355,000, or 2.2%. Rental and other income from the Company's senior
housing operations increased $330,000 or 2.0%, primarily as a result of
increases in rental rates at certain other facilities located in strong markets.
Interest income increased $25,000 or 138.9%, to $43,000 in fiscal year 2000,
from $18,000 in fiscal year 1999, due to an increase in cash and cash
equivalents experienced throughout most of fiscal year 2000.
EXPENSES. Total expenses were $16,394,000 in fiscal 2000 compared to
$15,339,000 in fiscal 1999, representing an increase of $1,055,000 or 6.9%.
Although overall expenses remained generally comparable, depreciation expense
increased $342,000 or 116.7% due to recognition of changes in remaining useful
lives for certain assets purchased in 2000 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 $136,000 or 2.6% 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 $229,000 or 19.1%; dietary and food service salaries, wages and expenses of
$80,000 or 2.9%; general and administrative of $163,000 or 71.5% due mainly to
increases in Director's & Officer's and property-level insurance of $113,000
over the previous year and minor increases in certain other general &
administrative costs; and a $68,000 or 30.5% increase in professional fees as a
result of increased legal fees.
INCOME TAX EXPENSE. Income tax expense increased $133,000 from a benefit
of $342,000 in fiscal 1999 to expense of $475,000 in fiscal 2000 due to the
Company's recording of a Valuation Allowance against deferred tax assets not
expected to be recovered due to termination of the Facilities Lease Agreement.
NET (LOSS) INCOME. Primarily as a result of the factors discussed above,
net income decreased $833,000 or 146% to net loss of $264,000 in fiscal 2000
from net income of $569,000 in fiscal 1999.
II-5
<PAGE>
ILM II LEASE CORPORATION
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
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.
INFLATION
The Company completed its fifth full year of operations in fiscal 2000.
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-6
<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-7
<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 2000 are as follows:
<TABLE>
<CAPTION>
Dates
Name Office Age of Office
---- ------ --- ---------
<S> <C> <C> <C>
Jeffry R. Dwyer President, Secretary and Director 54 9/13/94*-present
Julien G. Redele Director 65 7/28/98-present
J. William Sharman, Jr. Director 60 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 Director of ILM II and also 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 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 October 15, 1999, the parties entered into a 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 judgment dismissing the action and all non-derivative
claims of the settlement class against the defendants with prejudice.
This litigation was settled at no cost to ILM II and ILM I. As part of
the settlement, CSLC increased its proposed merger consideration
payable to the ILM II and ILM I shareholders and is also responsible
for a total of approximately $1.1 million in plaintiffs' attorneys fees
and expenses if the proposed merger is consummated. If the proposed
merger is not consummated and if ILM II and ILM I were to consummate an
extraordinary transaction with a third party, then ILM II and ILM I
would be responsible for the plaintiffs' attorneys 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, 2000, there was
compliance with all filing requirements applicable to its Officers and Directors
and ten-percent beneficial holders.
III-2
<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
CSLC, 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
through 1997. 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. 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, 2000, 1999 and 1998, PaineWebber earned no management fees.
III-3
<PAGE>
ILM II LEASE CORPORATION
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (continued)
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 CSLC, an
affiliate of Capital, since 1996. Mr. Cohen currently serves as Chief Executive
Officer of CSLC. 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, 2000 and 1999, Capital
earned property management fees from the Company of $903,000 and $980,000,
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, 2000. 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, 2000, the amount advanced to Capital by the Company
and Lease I for Capital's California litigation costs totaled approximately
$563,000. No amounts were advanced during fiscal year 2000.
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, 2000 and 1999, Capital Senior Development, Inc. earned fees
from the Company of $0 and $15,000, 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, 2000 and 1999, Greenberg Traurig
earned fees from the Company of $34,000 and $54,000, respectively.
III-4
<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) The Company filed a Current Report on Form 8-K dated June 7,
2000 reporting that on June 2, 2000, ILM II caused Holding II
to notify the Company that the Facilities Lease Agreement would
terminate on the date of consummation of the pending merger of
the Company with CSLC. Subject to the satisfaction of certain
conditions and the receipt of requisite approvals, consummation
of the merger was expected to occur on or about July 30, 2000
but which, to date, has not occurred and that, if the merger is
not consummated, it is anticipated that the Facilities Lease
Agreement will remain in full force and effect pursuant to its
terms.
(c) Exhibits:
See (a)(3) above.
(d) 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: December 13, 2000
-----------------------------
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.
<TABLE>
<S> <C>
By: /s/ Jeffry R. Dwyer Date: December 13, 2000
------------------------------------------- -------------------------------
Jeffry R. Dwyer
Director
By: /s/ Julien G. Redele Date: December 13, 2000
------------------------------------------- -------------------------------
Julien G. Redele
Director
By: /s/ J. William Sharman, Jr. Date: December 13, 2000
------------------------------------------ -------------------------------
J. William Sharman, Jr.
Director
</TABLE>
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, 2000 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> <C>
ILM II LEASE CORPORATION:
Report of Ernst & Young LLP, Independent Auditors F-2
Balance Sheets as of August 31, 2000 and 1999 F-3
Statements of Operations for the years ended August 31, 2000, 1999 and 1998 F-4
Statements of Changes in Shareholders' Equity for the years ended August 31, F-5
2000, 1999 and 1998
Statements of Cash Flows for the years ended August 31, 2000, 1999 and 1998 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, 2000 and 1999, and the related statements of operations,
shareholders' equity, and cash flows for each of the three years in the period
ended August 31, 2000. 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 auditing standards generally accepted
in the United States. 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, 2000 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended August 31, 2000, in conformity
with accounting principles generally accepted in the United States.
ERNST & YOUNG LLP
Dallas, Texas
October 24, 2000
Except for Note 1, as to which the date is
November 28, 2000
F-2
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
August 31, 2000 and 1999
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
ASSETS
2000 1999
------- -------
<S> <C> <C>
Cash and cash equivalents $ 1,894 $ 1,487
Accounts receivables, net 21 80
Accounts receivable - related party 40 50
Accounts receivable - Capital Senior Living Corporation 39 -
State tax refund receivable 21 21
Prepaid taxes and other assets 58 352
------- -------
Total current assets 2,073 1,990
Furniture, fixtures and equipment 1,604 1,135
Less: accumulated depreciation (1,153) (518)
------- -------
451 617
Deposits 9 9
Deferred tax asset, net 12 154
------- -------
$ 2,545 $ 2,770
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 542 $ 625
Federal income taxes payable 276 226
Real estate taxes payable 305 230
Accounts payable - related party 378 337
Security deposits 36 49
------- -------
Total current liabilities 1,537 1,467
Deferred rent payable 6 37
------- -------
Total liabilities 1,543 1,504
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 502 766
------- -------
Total shareholders' equity 1,002 1,266
------- -------
$ 2,545 $ 2,770
======= =======
</TABLE>
See accompanying notes
F-3
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF OPERATIONS
For the years ended August 31, 2000, 1999 and 1998
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
2000 1999 1998
-------- -------- --------
<S> <C> <C> <C>
REVENUES:
Rental and other income $ 16,562 $ 16,232 $ 15,481
Interest income 43 18 43
-------- -------- --------
16,605 16,250 15,524
EXPENSES:
Facilities lease rent expense 5,401 5,265 4,988
Dietary, salaries, wages and food service expenses 2,820 2,740 2,677
Administrative salaries, wages and expenses 1,425 1,196 1,090
Marketing salaries, wages and expenses 722 705 688
Utilities 1,024 1,062 1,045
Repairs and maintenance 634 636 554
Real estate taxes 603 527 506
Property management fees 903 980 899
Other property operating expenses 1,483 1,433 1,433
General and administrative 391 228 323
Directors compensation 62 51 75
Professional fees 291 223 878
Termination fee expense - - 250
Depreciation expense 635 293 154
-------- -------- --------
16,394 15,339 15,560
-------- -------- --------
Income (loss) before income taxes 211 911 (36)
Income tax expense (benefit):
Current 333 226 -
Deferred 142 116 (14)
-------- -------- --------
475 342 (14)
-------- -------- --------
NET (LOSS) INCOME $ (264) $ 569 $ (22)
======== ======== ========
NET (LOSS) INCOME PER SHARE OF COMMON STOCK $ (0.05) $ 0.10 $ 0.00
======== ======== ========
</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,
2000, 1999 and 1998, 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, 2000, 1999 and 1998
(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, 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
--------- --- ---- ----- -------
Net loss - - - (264) (264)
--------- --- ---- ----- -------
BALANCE AT AUGUST 31, 2000 5,180,952 $52 $448 $ 502 $ 1,002
========= === ==== ===== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the years ended August 31, 2000, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
2000 1999 1998
------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (264) $ 569 $ (22)
Adjustments to reconcile net (loss) income to
net cash provided by operating activities
Depreciation expense 635 293 154
Deferred tax expense (benefit), net 142 116 (14)
Changes in assets and liabilities:
Accounts receivable, net 59 9 (34)
Accounts receivable - related party 10 52 (102)
Accounts receivable- Capital Senior Living Corporation (39)
State tax refund receivable - 137 (158)
Prepaid taxes and other assets 294 (302) 193
Accounts payable and accrued expenses (83) (164) 242
Federal income taxes payable 49 226
Accounts payable - related party 41 50 135
Termination fee payable - (650) 250
Real estate taxes payable 75 21 10
Security deposits (13) 24 8
Deferred rent payable (31) (39) (24)
------- ------- -------
Net cash provided by operating activities 876 342 638
------- ------- -------
Cash flows from investing activity:
Additions to furniture, fixtures and equipment (469) (352) (297)
------- ------- -------
Net cash used in investing activities (469) (352) (297)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 407 (10) 341
Cash and cash equivalents, beginning of period 1,487 1,497 1,156
------- ------- -------
Cash and cash equivalents, end of period $ 1,894 $ 1,487 $ 1,497
======= ======= =======
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for federal income taxes $ 231 $ - $ -
======= ======= =======
Cash paid during the period for state income taxes $ 57 $ 5 $ 116
======= ======= =======
</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. 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 ("CSLC"), the corporate parent of Capital, since
1996. Mr. Cohen currently serves as Chief Executive Officer of CSLC. 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 II entered into an agreement and plan of
merger with CSLC, the corporate parent of Capital, and certain affiliates
of CSLC. In connection with the merger, the Company has received notice
from ILM II Holding indicating that the Facilities Lease Agreement would
terminate on the date of consummation of the pending merger of ILM II and
CSLC. 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. Additionally, upon such termination, it is currently expected
that the Company would have nominal value after payment of expenses and
other costs, and the Board accordingly would review the Company's status
and continued existence.
On August 15, 2000, ILM II caused ILM II Holding to terminate the
Facilities Lease Agreement with respect to the Company's 75% leasehold
interest in Villa Santa Barbara and sell the Senior Housing facility to
CSLC.
The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, and may be terminated earlier at the election of ILM II
Holding upon sale of ILM II Holding's senior living communities to a
non-affiliated third party. On November 13, 2000, the Facilities Lease
Agreement was extended on a month-to-month basis beyond its original
expiration date. On November 28, 2000, the Facilities Lease Agreement was
extended through the earlier of the date on which the merger of ILM II with
CSLC is consummated or March 31, 2000, and on a month-to-month basis
thereafter if the merger is not consummated by that time.
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, 2000 and 1999 and
revenues and expenses for the years ended August 31, 2000, 1999 and 1998.
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, 2000, 1999 and 1998, advertising expenses
were $722,000, $705,000 and $688,000, respectively.
F-8
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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, 2000 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-9
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
3. RELATED PARTY TRANSACTIONS
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 CSLC, an affiliate of Capital, since 1996. Mr.
Cohen currently serves as Chief Executive Officer of CSLC. 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, 2000, 1999 and 1998, Capital
earned property management fees from the Company of $903,000, $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, 2000. 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, 2000, the amount advanced to Capital by the Company and Lease
I for Capital's California litigation costs totaled approximately $563,000.
No amounts were advanced during fiscal year 2000.
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, 2000 and 1999, Capital Senior Development, Inc.
earned fees from the Company of $0 and $15,000, 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, 2000 and 1999, Greenberg Traurig
earned fees from the Company of $32,000 and $54,000, respectively.
F-10
<PAGE>
3. RELATED PARTY TRANSACTIONS (continued)
Accounts receivable - related party at August 31, 2000 and 1999
includes $40,000 and $30,000, respectively, in expense reimbursements due
from Holding II for capital expenditures at the Senior Housing Facilities.
Also included in Accounts receivable - related party at August 31, 1999 is
$20,000 in other reimbursable costs due from ILM II Holding. Accounts
Receivable - Capital Senior Living Corporation at August 31, 2000 includes
amounts due from Capital as part of the final settlement of property-level
receivables and payables at lease termination with respect to the Company's
75% interest in Villa Santa Barbara. Accounts payable - related party at
August 31, 2000 and 1999 primarily includes $356,000 and $337,000,
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-11
<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. The Facilities Lease Agreement
was originally scheduled to expire on December 31, 2000, and may be
terminated earlier at the election of ILM II Holding upon sale of ILM II
Holding's senior living communities to a non-affiliated third party. On
November 13, 2000, the Facilities Lease Agreement was extended on a
month-to-month basis beyond its original expiration date. On November 28,
2000, the Facilities Lease Agreement was extended through the earlier of
the date on which the merger of ILM II with CSLC is consummated or March
31, 2000, and on a month-to-month basis thereafter if the merger is not
consummated by that time. On August 15, 2000, ILM II caused ILM II Holding
to terminate the Facilities Lease Agreement with respect to the Company's
75% leasehold interest in Villa Santa Barbara and sell the Senior Housing
facility to CSLC. 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 at August 31, 2000, are
summarized as follows:
<TABLE>
<CAPTION>
Year
Facility Rentable Resident
Name Location Built Units (1) Capacity (1)
---- -------- ----- --------- ------------
<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
</TABLE>
(1) 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-12
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (continued)
5. THE FACILITIES LEASE AGREEMENT (continued)
Pursuant to the Facilities Lease Agreement, the Company paid annual
base rent for the use of all of the Senior Housing Facilities in the
aggregate amount of $3,995,586 per year ($4,035,600 in 1999). The reduction
in base rent from the previous year is due to the termination of the
Facilities Lease Agreement with respect to Villa Santa Barbara which was
sold by ILM II to CSLC on August 15, 2000. Beginning September 1, 2000,
annual base rent will be $3,555,427 (excluding Villa Santa Barbara). The
Facilities Lease Agreement is a "triple-net" lease whereby the Lessee pays
all operating expenses, governmental taxes and assessments, utility charges
and insurance premiums, as well as the costs of all required maintenance,
personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. ILM II Holding, as 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 paid 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 through August 15,
2000, when Villa Santa Barbara was sold. Beginning September 1, 2000,
variable rent will be payable quarterly in an amount equal to 40% of the
excess of the aggregate total revenues over $11,634,000 (excluding Villa
Santa Barbara). For the fiscal years ended August 31, 2000 and 1999,
variable rent expense was $1,437,000 and $1,261,000, 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-13
<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, 2000. 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, 2000, the amount advanced to Capital by the Company and Lease
I for Capital's California litigation costs totaled approximately $563,000.
No amounts were advanced during fiscal year 2000.
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-14
<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, 2000 and
1999, are comprised of the following amounts (in thousands):
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Deferred tax asset - straight-line rent expense $ 3 $ 15
Deferred tax asset - book over tax depreciation 332 124
Deferred tax asset - book over tax amortization 9 15
---- -----
Gross deferred tax asset 344 154
Valuation allowance (332) -
----- -----
Gross deferred tax asset $ 12 $ 154
===== =====
</TABLE>
The components of income tax expense (benefit) for fiscal 2000, 1999
and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
2000 1999 1998
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal $ 276 $ - $ -
State 57 - -
----- ------ -----
Total current 333 - -
----- ------ -----
Deferred:
Federal 122 293 (12)
State 20 49 (2)
----- ------ -----
Total deferred 142 342 (14)
----- ------ -----
$ 475 $ 342 $ (14)
===== ====== =====
</TABLE>
During the fourth quarter of fiscal year 2000, the Company recorded
income tax expense of $316,802 to record a valuation allowance of $331,745
against deferred tax assets that are not expected to be recovered due to
the termination of the Facilities Lease Agreement.
The reconciliation of income tax computed for fiscal 2000, 1999 and
1998, at U.S. federal statutory rates to income tax expense (benefit) is as
follows (in thousands):
<TABLE>
<CAPTION>
2000 1999 1998
------------------ ---------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Tax at U.S. statutory rates $ 72 34% $293 34% (12) (34%)
State income taxes, net
of federal tax benefit 13 6% 49 6% (2) (6%)
Valuation allowance 332 158% - 0% - 0%
Other 58 27% - 0% - 0%
---- ----- ----- -- ----- ----
$342 225% $342 40% $(14) (40%)
==== ==== ==== === ===== =====
</TABLE>
F-15
