<PAGE>
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED FEBRUARY 29, 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)
<TABLE>
<CAPTION>
VIRGINIA 04-3248639
<S> <C>
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
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 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 February 29, 2000: 5,180,952.
===============================================================================
<PAGE>
ILM II LEASE CORPORATION
INDEX
<TABLE>
<CAPTION>
Part I. Financial Information PAGE
----
Item 1. Financial Statements
<S> <C>
Balance Sheets
February 29, 2000 (Unaudited) and August 31, 1999............................................4
Statements of Income
For the six and three months ended February 29, 2000 and February 28, 1999 (Unaudited).......5
Statements of Changes in Shareholders' Equity
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited)................6
Statements of Cash Flows
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited)................7
Notes to Financial Statements (Unaudited).................................................8-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....12-16
Part II. Other Information...................................................................................17
Item 6. Exhibits and Reports on Form 8-K............................................................17
Signatures....................................................................................................18
</TABLE>
2
<PAGE>
ILM II LEASE CORPORATION
PART I. FINANCIAL INFORMATION
Item I. Financial Statements
(See next page)
3
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
February 29, 2000 (Unaudited) and August 31, 1999
(Dollars in thousands, except per share data)
ASSETS
------
<TABLE>
<CAPTION>
FEBRUARY 29, 2000 AUGUST 31, 1999
----------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 1,790 $1,487
Accounts receivable, net 100 80
Accounts receivable - related party 30 50
Prepaid expenses and other assets 214 352
Tax refund receivable 21 21
--------- ---------
Total current assets 2,155 1,990
Furniture, fixtures and equipment 1,253 1,135
Less: accumulated depreciation (762) (518)
-------- --------
491 617
Deposits 9 9
Deferred tax asset, net 52 154
-------- --------
$2,707 $2,770
====== ======
</TABLE>
LIABILITIES AND SHAREHOLDERS' EQUITY
<TABLE>
<S> <C> <C>
Accounts payable and accrued expenses $ 520 $ 621
Income taxes payable 229 226
Real estate taxes payable 53 230
Accounts payable - related party 404 341
Security deposits 58 49
--------- ---------
Total current liabilities 1,264 1,467
Deferred rent payable 22 37
--------- ---------
Total liabilities 1,286 1,504
Contingencies
Shareholders' equity:
Common stock, $0.01 par value, 20,000,000 shares
authorized 5,180,952 issued and outstanding 52 52
Additional paid-in capital 448 448
Retained earnings 920 766
-------- --------
Total shareholders' equity 1,420 1,266
------- ----------
$2,707 $2,770
====== ======
</TABLE>
See accompanying notes.
4
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the six and three months ended February 29, 2000 and February 28, 1999
(Unaudited) (Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
FEBRUARY 29 FEBRUARY 28 FEBRUARY 29 FEBRUARY 28
2000 1999 2000 1999
REVENUES
<S> <C> <C> <C> <C>
Rental and other income $8,307 $8,122 $4,176 $4,085
Interest income 19 7 10 4
------ ------ ------ ------
8,326 8,129 4,186 4,089
EXPENSES
Master lease rent expense 2,721 2,644 1,369 1,333
Dietary and food service salaries, wages and expenses 1,396 1,366 691 675
Administrative salaries, wages and expenses 640 597 324 315
Marketing salaries, wages and expenses 355 323 178 153
Utilities 512 527 251 254
Repairs and maintenance 308 286 145 156
Real estate taxes 263 262 133 128
Property management fees 526 547 272 323
Other property operating expenses 729 708 364 349
General and administrative 168 118 83 60
Directors compensation 31 27 16 13
Professional fees 177 151 80 (20)
Depreciation expense 244 118 122 72
------ ------ ------ ------
8,070 7,674 4,028 3,811
------ ------ ------ ------
Income before taxes 256 455 158 278
Income tax expense (benefit):
Current - - - -
Deferred 102 182 63 111
------ ------ ------ ------
102 182 63 111
------ ------ ------ ------
NET INCOME $154 $273 $ 95 $ 167
====== ====== ====== ======
Basic earnings per share of common stock $ 0.03 $ 0.05 $0.02 $ 0.03
====== ====== ====== ======
</TABLE>
The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.
See accompanying notes.
5
<PAGE>
ILM II LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
$.01 PAR VALUE PAID-IN RETAINED
--------------
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1998 5,180,952 $ 52 $448 $197 $ 697
Net Income - - - 273 273
-------- -------- ------- ----- -------
Balance at February 28, 1999 5,180,952 $ 52 $448 $470 $ 970
========= ==== ==== ==== =======
Balance at August 31, 1999 5,180,952 $ 52 $448 $766 $ 1,266
Net Income - - - 154 154
--------- ------ ------- ---- -------
Balance at February 29, 2000 5,180,952 $ 52 $448 $920 $1,420
========= ==== ==== ==== ======
</TABLE>
See accompanying notes.
6
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the six months ended February 29, 2000 and February 28, 1999 (Unaudited)
(Dollars In thousands)
<TABLE>
<CAPTION>
Six Months Ended
February 29, February 28,
2000 1999
<S> <C> <C>
Cash flows from operating activities:
Net income $ 154 $ 273
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 244 118
Deferred tax expense (benefit) 102 182
Changes in assets and liabilities:
Accounts receivable, net (20) (56)
Accounts receivable - related party 20 -
Prepaid expenses and other assets 138 2
Tax refund receivable - 131
Accounts payable and accrued expenses (101) (111)
Accounts payable - related party 63 45
Termination fee payable - (650)
Real estate taxes payable (177) (106)
Income taxes payable 4 -
Deferred rent payable (15) (14)
Security deposits, net 9 11
--------- ---------
Net cash provided by operating activities 421 (175)
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (118) (157)
--------- --------
Net cash used in investing activities (118) (157)
Net increase (decrease) in cash and cash equivalents 303 (330)
Cash and cash equivalents, beginning of period 1,487 1,497
------- ---------
Cash and cash equivalents, end of period $ 1,790 $ 1,167
======= ========
SUPPLEMENTAL DISCLOSURE:
- ------------------------
Cash paid during the period for state income taxes $ 1 $ 3
========= =========
</TABLE>
See accompanying notes.
7
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
1. GENERAL
The accompanying financial statements, footnotes and discussions should
be read in conjunction with the financial statements and footnotes
contained in ILM II Lease Corporation's (the "Company") Annual Report on
Form 10-K for the year ended August 31, 1999. In the opinion of management,
the accompanying interim financial statements, which have not been audited,
reflect all adjustments necessary to present fairly the results for the
interim periods. All of the accounting adjustments reflected in the
accompanying interim financial statements are of a normal recurring nature.
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with U.S. generally accepted accounting
principles for interim financial information, which requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosures of contingent assets and liabilities as of
February 29, 2000, and revenues and expenses for each of the six- and
three-month periods ended February 29, 2000 and February 28, 1999. Actual
results may differ from the estimates and assumptions used. Certain numbers
in the prior period's financial statements have been reclassified to
conform to the current period's presentation. The results of operations for
the six- and three-month periods ended February 29, 2000, are not
necessarily indicative of the results to be expected for the year ending
August 31, 2000.
The Company was incorporated on September 12, 1994 under the laws of
the State of Virginia by ILM II Senior Living, Inc., a Virginia finite-life
corporation ("ILM II"), formerly PaineWebber Independent Living Mortgage
Inc. II, to operate six rental housing projects that provide
independent-living and assisted-living services for independent senior
citizens ("the Senior Housing Facilities") under a facilities lease
agreement dated September 1, 1995 (the "Facilities Lease Agreement"),
between the Company, as lessee, and ILM II Holding, Inc. ("ILM II
Holding"), as lessor, and a direct subsidiary of ILM II. The Company's sole
business is the operation of the Senior Housing Facilities.
ILM II made mortgage loans to Angeles Housing Concepts, Inc. ("AHC")
secured by the Senior Housing Facilities between July 1990 and July 1992.
In March 1993, AHC defaulted under the terms of such mortgage loans and in
connection with the settlement of such default, title to the Senior Housing
Facilities was transferred, effective April 1, 1994, to certain indirect
subsidiaries of ILM II, subject to the mortgage loans. Subsequently, these
property-owning subsidiaries were merged into ILM II Holding. As part of
the fiscal 1994 settlement agreement with AHC, AHC was retained as the
property manager for all of the Senior Housing Facilities pursuant to the
terms of a management agreement, which was assigned to the Company as of
September 1, 1995 and subsequently terminated in July 1996. ILM II is a
public company subject to the reporting obligations of the Securities and
Exchange Commission.
In July 1996, following termination of the property management
agreement with AHC, the Company entered into a property management
agreement (the "Management Agreement") with Capital Senior Management 2,
Inc. ("Capital") to handle the day-to-day operations of the Senior Housing
Facilities. Lawrence A. Cohen, who served through July 28, 1998 as a
Director of the Company and President, Chief Executive Officer and Director
of ILM II, has also served in various management capacities at Capital
Senior Living Corporation, an affiliate of Capital, since 1996. Mr. Cohen
currently serves as Chief Executive Officer of Capital Senior Living
Corporation. As a result, the Management Agreement with Capital was
considered a related party transaction (see Note 3) through July 28, 1998.
8
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
AGREEMENT AND PLAN OF MERGER WITH CAPITAL SENIOR LIVING CORPORATION
--------------------------------------------------------------------
On February 7, 1999, ILM II entered into an agreement and plan of
merger, which was amended and restated on October 19, 1999, with Capital
Senior Living Corporation, the corporate parent of Capital, and certain
affiliates of Capital. The agreement presently provides that it may be
terminated if the merger is not consummated by September 30, 2000. In
connection with the merger, ILM II has agreed to cause ILM II Holding to
cancel and terminate the Facilities Lease Agreement immediately prior to
the effective time of the merger. As noted above, the Facilities Lease
Agreement, which is scheduled to expire on December 31, 2000, may be
terminated earlier at the election of the Lessor in connection with the
sale by the Lessor of the Senior Housing Facilities to a non-affiliated
third party, upon 30 days' notice to the Company. Although there can be no
assurance as to whether the merger will be consummated or, if consummated,
as to the timing thereof, the Company's operations would not be expected to
continue beyond the effective time of the merger. As a result of the
proposed merger, it is currently expected that the Company would have
minimal residual value after settlement of expenses and other costs.
2. THE FACILITIES LEASE AGREEMENT
------------------------------
ILM II Holding (the "Lessor") leases the Senior Housing Facilities to
the Company (the "Lessee") pursuant to the Facilities Lease Agreement. Such
lease is scheduled to expire on December 31, 2000 (December 31, 1999 with
respect to the Santa Barbara Facility but was extended on a month-to-month
basis), unless terminated earlier at the election of the Lessor in
connection with the sale by the Lessor of the Senior Housing Facilities to
a non-affiliated third party, upon 30 days' notice to the Company. As noted
above, ILM II has entered into an agreement and plan of merger with Capital
Senior Living Corporation and certain affiliates of Capital, and has agreed
to cause ILM II Holding to cancel and terminate the Facilities Lease
Agreement immediately prior to the effective time of the merger. While
there can be no assurance, consummation of the merger is presently
anticipated in the second or third quarter of calendar year 2000. The lease
is accounted for as an operating lease in the Company's financial
statements.
Descriptions of the properties covered by the Facilities Lease
Agreement between the Company and ILM II Holding are summarized as follows:
<TABLE>
<CAPTION>
Year Facility Rentable Resident
NAME LOCATION BUILT UNITS (2) CAPACITIES (2)
---- -------- ----- --------- --------------
<S> <C> <C> <C> <C>
The Palms Fort Myers, FL 1988 205 255
Crown Villa Omaha, NE 1992 73 73
Overland Park Place Overland Park, KS 1984 141 153
Rio Las Palmas Stockton, CA 1988 164 190
The Villa at Riverwood St. Louis County, MO 1986 120 140
Villa Santa Barbara (1) Santa Barbara, CA 1979 125 125
</TABLE>
(1) The Company operates Villa Santa Barbara under a co-tenancy arrangement
with an affiliated company, ILM I Lease Corporation ("Lease I"). The
Company has entered into an agreement with Lease I regarding such joint
tenancy. Lease I was formed for similar purposes as the Company by an
affiliated company, ILM Senior Living, Inc. ("ILM I"), a subsidiary of
which owns 25% of the Villa Santa Barbara property. The portion of the
Senior Housing Facility leased by the Company represents 75% of the total
project. Villa Santa Barbara is 25% owned by ILM Holding Inc. and 75% by
ILM II Holding, Inc., a direct subsidiary of ILM II, as tenants in
common. Upon the sale of ILM I or ILM II, arrangements would be made to
transfer the Santa Barbara facility to the selling joint tenant (or one
of its subsidiaries). The property was extensively renovated in 1995.
(2) Rentable units represent the number of apartment units and is a measure
commonly used in the real estate industry. Resident capacity equals the
number of bedrooms contained within the apartment units and corresponds
to measures commonly used in the healthcare industry.
9
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. THE FACILITIES LEASE AGREEMENT (CONTINUED)
------------------------------------------
Pursuant to the Facilities Lease Agreement, the Company pays annual base
rent for the use of the Senior Housing Facilities in the aggregate amount of
$4,035,600. The facilities lease is a "triple-net" lease whereby the Lessee pays
all operating expenses, governmental taxes and assessments, utility charges and
insurance premiums, as well as the costs of all required maintenance, personal
property and non-structural repairs in connection with the operation of the
Senior Housing Facilities. ILM II Holding, as Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. Also, any fixed assets of the Company at a Senior Housing Facility
would remain with the Senior Housing Facility at the termination of the lease.
The Company also pays variable rent, on a quarterly basis, for each facility in
an amount equal to 40% of the excess of aggregate total revenues for the Senior
Housing Facilities, on an annualized basis, over $13,021,000. Variable rent was
$718,000 and $368,000 for the six- and three-month periods ended February 29,
2000, respectively, compared to $642,000 and $332,000 for the six- and three-
month periods ended February 28, 1999, respectively.
The Company's use of the properties is limited to use as Senior Housing
Facilities. The Company has responsibility to obtain and maintain all licenses,
certificates and consents needed to use and operate each Senior Housing
Facility, and to use and maintain each Senior Housing Facility in compliance
with all local board of health and other applicable governmental and insurance
regulations. The Senior Housing Facilities located in California, Florida and
Kansas are licensed by such states to provide assisted living services. In
addition, various health and safety regulations and standards, which are
enforced by state and local authorities, apply to the operation of all the
Senior Housing Facilities. Violations of such health and safety standards could
result in fines, penalties, closure of a Senior Housing Facility, or other
sanctions.
3. RELATED PARTY TRANSACTIONS
--------------------------
The Company retained Capital to be the property manager of the Senior
Housing Facilities pursuant to the Management Agreement, which commenced on July
29, 1996. Lawrence A. Cohen, who served through July 28, 1998 as a Director of
the Company and President, Chief Executive Officer and Director of ILM II, has
also served in various management capacities at Capital Senior Living
Corporation, an affiliate of Capital, since 1996. Mr. Cohen currently serves as
Chief Executive Officer of Capital Senior Living Corporation. The Management
Agreement is co-terminous with the Facilities Lease Agreement. If, for any
reason, the Facilities Lease Agreement is extended beyond December 31, 2000, the
scheduled expiration date of the Management Agreement would be extended as well,
but not beyond July 29, 2001. There is no present intention to extend the term
of the Facilities Lease Agreement or the term of the Management Agreement and it
is likely they will be terminated before the end of the term of the Facilities
Lease Agreement (see "Agreement and Plan of Merger with Capital Senior Living
Corporation" in Note 1). Under the terms of the Management Agreement, Capital
earns a base management fee equal to 4% of the gross operating revenues of the
Senior Housing Facilities, as defined. Capital also earns an incentive
management fee equal to 25% of the amount by which the "net cash flow" of the
Senior Housing Facilities, as defined, exceeds a specified base amount. Each
August 31, the base amount is increased based on the percentage increase in the
Consumer Price Index as well as 15% of Senior Housing Facility expansion costs.
ILM II has guaranteed the payment of all fees due to Capital under the terms of
the Management Agreement. For the six- and three-month periods ended February
29, 2000, Capital earned property management fees from the Company of $526,000
and $272,000, respectively, compared to $547,000 and $323,000 for the six- and
three-month periods ended February 28, 1999, respectively.
10
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
3. RELATED PARTY TRANSACTIONS (CONTINUED)
--------------------------------------
On September 18, 1997, the Company entered into an agreement with
Capital Senior Development, Inc., an affiliate of Capital, to manage the
development process for the potential expansions of several of the Senior
Housing Facilities. Capital Senior Development, Inc. would receive a fee
equal to 7% of the total development costs of these potential expansions if
they are pursued. ILM II Holding would also reimburse the Company for all
costs related to these potential expansions including fees to Capital
Senior Development, Inc For the six- and three-month periods ended February
29, 2000, and February 28, 1999, Capital Senior Development, Inc. earned no
fees from the Company for managing pre-construction development activities
for potential expansions of the Senior Housing Facilities.
Jeffry R. Dwyer, Secretary, President and Director of the Company, is a
shareholder of Greenberg Traurig, Counsel to the Company and its affiliates
since 1997. For the six- and three-month periods ended February 29, 2000,
Greenberg Traurig earned fees from the Company of $27,000 and $15,000,
respectively. For the six- and three-month periods ended February 28, 1999,
Greenberg Traurig earned fees from the Company of $22,000 and $20,000,
respectively.
Accounts receivable - related party at February 29, 2000 and August 31,
1999 includes $30,349 expense reimbursement due from ILM II Holding for the
balance of the Ft. Myers roof replacement. Accounts payable - related party
at February 29, 2000 includes $368,000 for variable rent due to ILM II
Holding and $16,000 in accrued legal fees due to Greenberg Traurig, Counsel
to the Company and a related party. At August 31, 1999 accounts payable
related party include $337,000 for variable rent due to ILM II Holding and
$4,000 in accrued legal fees due to Greenberg Traurig, Counsel to the
Company and a related party.
4. LEGAL PROCEEDINGS AND CONTINGENCIES
-----------------------------------
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.
5. CONSTRUCTION LOAN FINANCING
---------------------------
ILM II and the Company have secured a construction loan facility with
a major bank that will provide ILM II with up to $8.8 million to fund the
capital costs of the potential expansion programs. The construction loan
facility is secured by a first mortgage of the Senior Housing Facilities
and collateral assignment of the Company's leases of such properties. The
loan has a three-year term with interest accruing at a rate equal to LIBOR
plus 1.10% or Prime plus 0.5%. The loan term can be extended for an
additional two years beyond its maturity date with monthly payments of
principal and interest on a 25-year amortization schedule. Loan origination
costs in connection with this loan facility are being amortized by ILM II
over the life of the loan.
On June 7, 1999 ILM II borrowed $1,165,000 under the construction
loan facility to fund the pre-construction capital costs, incurred through
April 1999, of the potential expansions of the Senior Housing Facilities,
leaving approximately $7.6 million unused and available. The Company is a
co-borrower on the construction loan.
11
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Facilities Lease Agreement is a "triple-net" lease whereby the Lessee
pays all operating expenses, governmental taxes and assessments, utility charges
and insurance premiums, as well as the costs of all required maintenance,
personal property and non-structural repairs in connection with the operation of
the Senior Housing Facilities. ILM II Holding, as Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. If the Company and ILM II Holding decide that any of the Senior
Housing Facilities should be expanded, the Facilities Lease Agreement between
the Company and ILM II Holding would be amended to include such expansion. The
Facilities Lease Agreement is scheduled to expire on December 31, 2000. Pursuant
to the Facilities Lease Agreement, the Company pays annual base rent for use of
all the Senior Housing Facilities in the aggregate amount of $4,035,600. The
Company also pays variable rent, on a quarterly basis, for each Senior Housing
Facility in an amount equal to 40% of the excess, if any, of the aggregate total
revenues for the Senior Housing Facilities, on an annualized basis, over
$13,021,000. Variable rent was $718,000 and $368,000 for the six-and-three month
periods ended February 29, 2000, respectively, compared to $642,000 and $332,000
for the six- and three-month periods ended February 28, 1999, respectively.
As explained below, ILM II has entered into an agreement and plan of merger with
Capital Senior Living Corporation and certain affiliates of Capital, and has
agreed to cause ILM II Holding to cancel and terminate the Facilities Lease
Agreement immediately prior to the effective time of the merger. Accordingly,
since the Company does not have any current plans to operate or own any other
facilities or engage in any other business outside of its relationship with ILM
I, there is no assurance that the Company's operations will continue beyond the
effective date of the merger. The agreement presently provides that it may be
terminated if the merger is not consummated by September 30, 2000.
AGREEMENT AND PLAN OF MERGER WITH CAPITAL SENIOR LIVING CORPORATION
On February 7, 1999, ILM II entered into an agreement and plan of merger,
which was amended and restated on October 19, 1999, with Capital Senior Living
Corporation, the corporate parent of Capital, and certain affiliates of Capital.
The agreement presently provides that it may be terminated if the merger is not
consummated by September 30, 2000. In connection with the merger, ILM II has
agreed to cause ILM II Holding to cancel and terminate the Facilities Lease
Agreement immediately prior to the effective time of the merger. As noted above,
the Facilities Lease Agreement, which is scheduled to expire on December 31,
2000, may be terminated earlier at the election of the Lessor in connection with
the sale by the Lessor of the Senior Housing Facilities to a non-affiliated
third party, upon 30 days' notice to the Company. Although there can be no
assurance as to whether the merger will be consummated or, if consummated, as to
the timing thereof, the Company's operations would not be expected to continue
beyond the effective time of the merger. As a result of the proposed merger, it
is currently expected that the Company would have minimal residual value after
settlement of expenses and other costs.
LIQUIDITY AND CAPITAL RESOURCES
Occupancy levels for the six properties in which the Company has invested
averaged 92% and 95% for the three-month periods ended February 29, 2000 and
February 28, 1999, respectively. Base rent payments of $4,035,600 will remain in
effect throughout the remaining term of the lease. As noted above, the
Facilities Lease Agreement also provides for the payment of variable rent. The
Senior Housing Facilities are currently generating gross revenues, which are in
excess of the specified threshold in the variable rent calculation. Current
annualized operating income levels are sufficient to cover the Company's base
and variable rent obligations to ILM II Holding.
12
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
At February 29, 2000, the Company had cash and cash equivalents of
$1,790,000 compared to $1,487,000 at August 31, 1999. Remaining amounts of cash
will be used for the Company's working capital requirements. As noted above,
under the terms of the Facilities Lease Agreement, the Lessor is responsible for
major capital improvements and structural repairs to the Senior Housing
Facilities. Consequently, the Company does not have any material commitments for
capital expenditures. Furthermore, the Company does not currently anticipate the
need to engage in any borrowing activities. As a result, substantially all of
the Company's cash flow will be generated from operating activities. The Company
did not pay cash dividends in fiscal years 1999, 1998, and 1997 or for the first
quarter of fiscal year 2000. 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 flows from the Senior Housing Facilities, net of the Facilities
Lease Agreement payments to ILM II Holding, and interest income earned on
invested cash reserves. Such sources of liquidity are expected to be adequate to
meet the Company's operating requirements on both a short-term and long-term
basis.
YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize the year 2000 as a date other than the year 2000. This could
result in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices or engage in similar normal business activities.
Based on ongoing assessments, the Company, through Capital, its property
manager and only significant and material third-party contractor, has developed
a program to modify or replace portions of its software and certain hardware,
which are generally PC-based systems, so that those systems will properly
recognize and utilize dates beyond December 31, 1999. While there can be no
assurance, the Company believes that it has completed all software and hardware
upgrades. The Company presently believes that these modifications and
replacements of existing software and certain hardware will remediate the Year
2000 issue. The costs of Year 2000 remediation have not been material based on
the Company's operations.
The Company has assessed its exposure to operating equipment, and such
exposure is not significant due to the nature of the Company's business.
Management of the Company believes it has an effective program in place to
resolve the Year 2000 issue. However, disruptions in the economy generally
resulting from Year 2000 issues could also adversely affect the Company.
Although the amount of potential liability and lost revenue cannot be reasonably
estimated at this time, in a worst case situation, if Capital, the Company's
only significant and material third-party contractor, were to experience a Year
2000 problem, it is possible that the Company would not receive rental income as
it became due from Senior Living Facility residents. The Company in turn would
fail to pay ILM Holding lease payments as they arise under the master lease, and
ILM Holding in turn would fail to pay ILM I mortgage payments due it. However,
the Company believes that given the nature of its business, such a problem would
be temporary and easily remedied with simple accountings.
13
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
SIX MONTHS ENDED FEBRUARY 29, 2000 VERSUS SIX MONTHS ENDED FEBRUARY 28, 1999
REVENUES
Total revenues were $8,326,000 for the six months ended February 29, 2000
compared to $8,129,000 for the same period of the prior year, representing an
increase of $197,000 or 2.4%. This increase is primarily the result of increased
rental rates at certain of the Company's Senior Housing Facilities located in
strong markets.
EXPENSES
Total expenses were $8,070,000 for the six months ended February 29, 2000
compared to $7,674,000 for the same period in the prior year, representing an
increase of $396,000 or 5.2%. This increase was primarily due to increases in
facilities lease rent expense of $77,000 or 2.9%, administrative salaries and
expenses of $43,000 or 7.2%; repairs and maintenance of $22,000 or 7.7%;
depreciation expense of $125,000 or 105.9%; general and administrative costs of
$52,000 or 44.1%; and professional fees of $26,000 or 17.2%. The increase in
facilities lease rent expense is the result of increased variable rent payments
due under the Facilities Lease Agreement. The increase in depreciation expense
is due to the change in the estimated useful lives of the Company's fixed assets
as a consequence of the expected lease termination date. Pursuant to the terms
of the Facilities Lease Agreement, such assets would revert to ILM Holding upon
lease expiration or termination.
INCOME TAX EXPENSE
Income tax expense decreased overall by $80,000 or 44.0% as compared to the
same period in the prior year, as a result of an decrease in income before taxes
of $199,000 or 77.7%, from $455,000 in 1999 to $256,000 in 2000.
NET INCOME Primarily as a result of the factors noted above, net income
decreased $119,000 or 43.6% to $154,000 for the six months ended February 29,
2000 from net income of $273,000 for the six months ended February 28, 1999.
THREE MONTHS ENDED FEBRUARY 29, 2000 VERSUS THREE MONTHS ENDED FEBRUARY 28, 1999
REVENUES
Total revenues were $4,186,000 for the three months ended February 29, 2000
compared to $4,089,000 for the same period of the prior year, representing an
increase of $97,000 or 2.4%. This increase is primarily the result of increased
rental rates at certain of the Company's Senior Housing Facilities located in
strong markets.
EXPENSES
Total expenses were $4,028,000 for the three months ended February 29,
2000 compared to $3,811,000 for the same period in the prior year, representing
an increase of $217,000 or 5.7%. This increase was primarily due to increases in
facilities lease rent expense of $36,000 or 2.7%; marketing, salaries, wages and
expenses of $25,000 or 16.3%; general and administrative expenses of $23,000 or
38.3%; and depreciation expense of $50,000 or 69.4% offset by decreases in
professional fees of $100,000 or 500%; and property management fees of $51,000
or 15.8% as well as minor increases and decreases in other expenses. The
increase in facilities lease rent expense is the result of increased variable
rent payments due under the Facilities Lease Agreement. The increase in
depreciation expense is due to the change in the estimated useful lives of the
Company's fixed assets as a consequence of the expected lease termination date.
Pursuant to the terms of the Facilities Lease Agreement, such assets would
revert to ILM Holding upon lease expiration or termination.
14
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS (CONTINUED)
INCOME TAX EXPENSE
Income tax expense decreased overall by $48,000 or 43.2% as compared to the
same period in the prior year, as a result of a decrease in income before taxes
of $120,000 or 43.2%, from $278,000 in 1999 to $158,000 in 2000.
NET INCOME
Primarily as a result of the factors noted above, net income decreased
$72,000 or 43.1% to $95,000 for the three months ended February 29, 2000 from
net income of $167,000 for the three months ended February 28, 1999.
15
<PAGE>
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
FORWARD-LOOKING INFORMATION
CERTAIN STATEMENTS INCLUDED IN THIS QUARTERLY REPORT ON FORM 10-Q
("QUARTERLY REPORT") CONSTITUTE "FORWARD-LOOKING STATEMENTS" INTENDED TO QUALIFY
FOR THE SAFE HARBORS FROM LIABILITY ESTABLISHED BY SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND SECTION 21E OF THE
SECURITIES ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). THESE FORWARD-LOOKING
STATEMENTS GENERALLY CAN BE IDENTIFIED AS SUCH BECAUSE THE CONTEXT OF THE
STATEMENT WILL INCLUDE WORDS SUCH AS "BELIEVES," "COULD," "MAY," "SHOULD,"
"ENABLE," "LIKELY," "PROSPECTS," "SEEK," "PREDICTS," "POSSIBLE," "FORECASTS,"
"PROJECTS," "ANTICIPATES," "EXPECTS" AND WORDS OF ANALOGOUS IMPORT AND
CORRELATIVE EXPRESSIONS THEREOF, AS WELL AS STATEMENTS PRECEDED OR OTHERWISE
QUALIFIED BY: "THERE CAN BE NO ASSURANCE" OR "NO ASSURANCE CAN BE GIVEN."
SIMILARLY, STATEMENTS THAT DESCRIBE THE COMPANY'S FUTURE PLANS, OBJECTIVES,
STRATEGIES OR GOALS ALSO ARE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS MAY
ADDRESS FUTURE EVENTS AND CONDITIONS CONCERNING, AMONG OTHER THINGS, THE
COMPANY'S CASH FLOWS, RESULTS OF OPERATIONS AND FINANCIAL CONDITION; THE
CONSUMMATION OF ACQUISITION AND FINANCING TRANSACTIONS AND THE EFFECT THEREOF ON
THE COMPANY'S BUSINESS, ANTICIPATED CAPITAL EXPENDITURES, PROPOSED OPERATING
BUDGETS AND ACCOUNTING RESERVES; LITIGATION; PROPERTY EXPANSION AND DEVELOPMENT
PROGRAMS OR PLANS; REGULATORY MATTERS; AND THE COMPANY'S PLANS, GOALS,
STRATEGIES AND OBJECTIVES FOR FUTURE OPERATIONS AND PERFORMANCE. ANY SUCH
FORWARD-LOOKING STATEMENTS ARE SUBJECT TO VARIOUS RISKS AND UNCERTAINTIES THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED
IN SUCH FORWARD-LOOKING STATEMENTS. SUCH FORWARD-LOOKING STATEMENTS ARE SUBJECT
TO A NUMBER OF ASSUMPTIONS REGARDING, AMONG OTHER THINGS, GENERAL ECONOMIC,
COMPETITIVE AND MARKET CONDITIONS. SUCH ASSUMPTIONS NECESSARILY ARE BASED ON
FACTS AND CONDITIONS AS THEY EXIST AT THE TIME SUCH STATEMENTS ARE MADE, THE
PREDICTION OR ASSESSMENT OF WHICH MAY BE DIFFICULT OR IMPOSSIBLE AND, IN ANY
CASE, BEYOND THE COMPANY'S CONTROL. FURTHER, THE COMPANY'S BUSINESS IS SUBJECT
TO A NUMBER OF RISKS THAT MAY AFFECT ANY SUCH FORWARD-LOOKING STATEMENTS AND
ALSO COULD CAUSE ACTUAL RESULTS OF THE COMPANY TO DIFFER MATERIALLY FROM THOSE
PROJECTED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. ALL FORWARD-LOOKING
STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ARE EXPRESSLY QUALIFIED IN THEIR
ENTIRETY BY THE CAUTIONARY STATEMENTS IN THIS PARAGRAPH. MOREOVER, THE COMPANY
DOES NOT INTEND TO UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS TO REFLECT
ANY CHANGES IN GENERAL ECONOMIC, COMPETITIVE OR MARKET CONDITIONS AND
DEVELOPMENTS BEYOND ITS CONTROL.
READERS OF THIS QUARTERLY REPORT ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE
ON ANY OF THE FORWARD-LOOKING STATEMENTS SET FORTH HEREIN AND THAT ACTUAL FUTURE
RESULTS MAY DIFFER.
16
<PAGE>
ILM II LEASE CORPORATION
PART II-OTHER INFORMATION
ITEM 1. THROUGH 5. NONE
- ------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
- ----------------------------------------
(a) Exhibits: 27. Financial Data Schedule
(b) Reports on Form 8-K: NONE
17
<PAGE>
ILM II LEASE CORPORATION
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
BY: ILM II LEASE CORPORATION
By: /s/ Jeffry R. Dwyer
----------------------------
Jeffry R. Dwyer
President
Dated: APRIL 14, 2000
---------------
18
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<FISCAL-YEAR-END> AUG-31-2000
<PERIOD-END> FEB-29-2000
<CASH> 1,790
<SECURITIES> 0
<RECEIVABLES> 365
<ALLOWANCES> 0
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<CURRENT-ASSETS> 2,155
<PP&E> 1,253
<DEPRECIATION> 762
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0
0
<COMMON> 52
<OTHER-SE> 1,368
<TOTAL-LIABILITY-AND-EQUITY> 2,809
<SALES> 0
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<CGS> 0
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