<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 MAY 31, 2001
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: 0-18942
ILM II SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
Virginia 06-1293758
- --------------------- -----------------------
(State of organization) (I.R.S. Employer
Identification No.)
1750 Tysons Boulevard, Suite 1200, Tysons Corner, Va 22102
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(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
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Shares of common stock outstanding as of May 31, 2001: 5,181,236
Page 1 of 28
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<Page>
<Table>
<Caption>
ILM II SENIOR LIVING, INC
INDEX
Part I. Financial Information PAGE
----
Item 1. Financial Statements
Consolidated Balance Sheets
May 31, 2001 (Unaudited) and August 31, 2000.................................................4
Consolidated Statements of Operations
For the nine months and three months ended May 31, 2001 and 2000 (Unaudited).................5
Consolidated Statements of Changes in Shareholders' Equity
For the nine months ended May 31, 2001 and 2000 (Unaudited)..................................6
Consolidated Statements of Cash Flows
For the nine months ended May 31, 2001 and 2000 (Unaudited)..................................7
Notes to Consolidated Financial Statements (Unaudited)....................................8-17
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....18-25
Part II. Other Information
Item 5. Other Information...........................................................................26
Item 6. Exhibits and Reports on Form 8-K............................................................27
Signatures....................................................................................................28
</Table>
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<Page>
ILM II SENIOR LIVING, INC
PART I. FINANCIAL INFORMATION
Item I. Financial Statements
(see next page)
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<Page>
CONSOLIDATED BALANCE SHEETS
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May 31, 2001 (Unaudited) and August 31, 2000
(Dollars in thousands, except per share data)
<Table>
<Caption>
Assets May 31, 2001 August 31, 2000
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Operating investment properties, at cost:
Land $ 4,593 $ 4,522
Building and improvements 24,247 24,190
Furniture, fixtures and equipment 3,856 3,856
------------------------------------
32,696 32,568
Less: accumulated depreciation (9,706) (8,813)
------------------------------------
22,990 23,755
Unamortized mortgage fees 1,247 1,247
Less: accumulated amortization (1,199) (1,106)
------------------------------------
48 141
Loan origination fees 144 144
Less: accumulated amortization (144) (84)
------------------------------------
-- 60
Cash and cash equivalents 1,395 11,258
Accounts receivable--related party 237 376
Prepaid expenses and other assets 18 15
Deferred rent receivable -- 6
------------------------------------
$ 24,688 $ 35,611
====================================
Liabilities and Shareholders' Equity
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Accounts payable and accrued expenses $ 173 $ 121
Accounts payable--related party 617 40
Construction loan payable -- 570
Preferred shareholders' minority interest in subsidiary 149 143
------------------------------------
Total liabilities 939 874
Contingencies
Shareholders' equity:
Common stock, $0.01 par value,
12,500,000 shares authorized
5,181,236 shares issued and outstanding 52 52
Additional paid-in capital 44,823 44,823
Accumulated deficit (21,126) (10,138)
------------------------------------
Total shareholder's equity 23,749 34,737
------------------------------------
$ 24,688 $ 35,611
====================================
</Table>
See accompanying notes.
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PAGE 7
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CONSOLIDATED STATEMENTS OF OPERATIONS
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For the nine months and three months ended May 31, 2001 and 2000 (Unaudited)
(Dollars in thousands, except per share data)
<Table>
<Caption>
Nine Months Ended Three Months Ended
May 31, May 31, May 31, May 31,
----------------------- -----------------------
2001 2000 2001 2000
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Revenues
Rental income $3,419 $4,084 $1,126 $1,364
Interest income 162 32 17 7
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3,581 4,116 1,143 1,371
Expenses
Depreciation expense 893 893 298 298
Amortization expense 153 137 65 48
General and administrative 400 202 125 82
Professional fees 1,577 1,022 490 362
Directors' compensation 73 70 25 27
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3,096 2,324 1,003 817
-----------------------------------------------------
Net Income $ 485 $1,792 $ 140 $ 554
=====================================================
Basic earnings per share of common
stock $ 0.09 $ 0.35 $ 0.03 $ 0.11
=====================================================
Cash dividends paid per share of common
stock $ 2.21 $ 0.64 $ 0.16 $ 0.21
=====================================================
</Table>
The above earnings and cash dividends paid per share of common stock are based
upon the 5,181,236 shares outstanding for each period.
See accompanying notes.
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PAGE 8
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
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For the nine months ended May 31, 2001 and 2000 (Unaudited)
(Dollars in thousands, except per share data)
<Table>
<Caption>
Common Stock
$.01 Par Value Additional
-------------------- Paid-In Accumulated
Shares Amount Capital Deficit Total
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Shareholders' equity at
August 31, 1999 5,181,236 $52 $44,823 $(15,544) $ 29,331
Cash dividends paid -- -- -- (3,303) (3,303)
Net income -- -- -- 1,792 1,792
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Shareholders' equity at May
31, 2000 5,181,236 $52 $44,823 $(17,055) $ 27,820
===========================================================
Shareholders' equity at
August 31, 2000 5,181,236 $52 $44,823 $(10,138) $ 34,737
Cash dividends paid -- -- -- (11,473) (11,473)
Net income -- -- -- 485 485
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Shareholders' equity at May
31, 2001 5,181,236 $52 $44,823 $(21,126) $ 23,749
===========================================================
</Table>
See accompanying notes.
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PAGE 9
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CONSOLIDATED STATEMENTS OF CASH FLOWS
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For the nine months ended May 31, 2001 and 2000 (Unaudited)
(Dollars in thousands)
<Table>
<Caption>
Nine Months Ended
May 31, May 31,
----------------------
2001 2000
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Cash flows from operating activities:
Net income $ 485 $ 1,792
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization expense 1,046 1,030
Changes in assets and liabilities:
Accounts receivable--related party 139 (46)
Prepaid expenses and other assets (3) (15)
Deferred rent receivable 6 23
Accounts payable and accrued expenses 52 (140)
Accounts payable--related party 577 (398)
Preferred shareholders' minority interest 6 7
----------------------
Net cash provided by operating activities 2,308 2,253
Cash flows from investing activity:
Additions to operating investment properties (128) (242)
----------------------
Net cash used in investing activity (128) (242)
Cash flows from financing activity:
Repayment of Construction Loan Payable to CSLC (570) --
Cash dividends paid to shareholders (11,473) (3,303)
----------------------
Net cash used in financing activity (12,043) (3,303)
Net decrease in cash and cash equivalents (9,863) (1,292)
Cash and cash equivalents, beginning of period 11,258 1,913
----------------------
Cash and cash equivalents, end of period $ 1,395 $ 621
======================
Supplemental disclosure:
Cash paid during the period for construction loan interest $ 28 $ 64
======================
</Table>
See accompanying notes.
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PAGE 10
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Notes to Consolidated Financial Statements (Unaudited)
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1. General
The accompanying consolidated financial statements, footnotes and discussions
should be read in conjunction with the consolidated financial statements and
footnotes contained in ILM II Senior Living, Inc.'s (the "Company") Annual
Report on Form 10-K for the year ended August 31, 2000. In the opinion of
management, the accompanying interim consolidated 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 consolidated financial statements are of a normal
recurring nature.
The accompanying consolidated financial statements have been prepared on the
accrual basis of accounting in accordance with accounting principles generally
accepted in the United States of America 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 May 31, 2001, and revenues and expenses for each of the
nine- and three-month periods ended May 31, 2001 and 2000. Actual results could
differ from the estimates and assumptions used. Certain numbers in the prior
period's financial statements have been reclassified to conform to the current
period's presentation. The results of operations for the nine-month period ended
May 31, 2001, are not necessarily indicative of the results that may be expected
for the year ending August 31, 2001.
The Company was incorporated on February 5, 1990 under the laws of the State of
Virginia as a Virginia finite-life corporation, formerly PaineWebber Independent
Mortgage Inc. II. On September 12, 1990, the Company sold to the public in a
registered initial offering 5,181,236 shares of common stock, $.01 par value.
The Company received capital contributions of $51,812,356, of which $200,000
represented the sale of 20,000 shares to an affiliate at that time, PaineWebber
Group, Inc. ("PaineWebber"). For discussion purposes, the term "PaineWebber"
will refer to PaineWebber Group, Inc., and all affiliates that provided services
to the Company in the past.
The Company elected to qualify and be taxed as a Real Estate Investment Trust
("REIT") under the Internal Revenue Code of 1986, as amended, for each taxable
year of operations.
The Company originally invested the net proceeds of the initial public offering
in six participating mortgage loans collateralized by senior housing facilities
located in five different states ("Senior Housing Facilities"). All of the loans
made by the Company were originally to Angeles Housing Concepts, Inc. ("AHC"),
as mortgagor, a company specializing in the
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PAGE 11
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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development, acquisition and operation of Senior Housing Facilities and
guaranteed by AHC's corporate parent, Angeles Corporation ("Angeles").
ILM II Holding, Inc. ("ILM II Holding"), a majority-owned subsidiary of the
Company, now holds title to the five remaining Senior Housing Facilities which
comprise the balance of the operating investment properties on the accompanying
consolidated balance sheets, subject to certain mortgage loans payable to the
Company. Such mortgage loans and the related interest expense are eliminated in
the consolidation of the financial statements of the Company.
The Company made charitable gifts of one share of the preferred stock in ILM II
Holding to each of 111 charitable organizations so that ILM II Holding would
meet the stock ownership requirements of a REIT as of January 30, 1997. The
preferred stock has a liquidation preference of $1,000 per share plus any
accrued and unpaid dividends. Dividends on the preferred stock accrue at a rate
of 8% per annum on the original $1,000 liquidation preference and are cumulative
from the date of issuance. It is anticipated that dividends will accrue and be
paid at liquidation of ILM II Holding. Cumulative dividends accrued as of
May 31, 2001 on the preferred stock in ILM II Holding totaled approximately
$38,000.
As part of the fiscal 1994 Settlement Agreement with AHC, ILM II Holding
retained AHC as the property manager for all of the Senior Housing Facilities
pursuant to the terms of a management agreement. The management agreement with
AHC was terminated in July 1996. Subsequent to the effective date of the
settlement agreement with AHC, in order to maximize the potential returns to the
Company's existing Shareholders while maintaining the Company's qualification as
a REIT under the Internal Revenue Code, the Company formed a new corporation,
ILM II Lease Corporation ("Lease II"), for the purpose of operating the Senior
Housing Facilities under the terms of a facilities lease agreement (the
"Facilities Lease Agreement"). All of the shares of capital stock of Lease II
were distributed to the holders of record of the Company's common stock and the
Senior Housing Facilities were leased to Lease II (see Note 2 for a description
of the Facilities Lease Agreement). Lease II is a public company subject to the
reporting obligations of the Securities and Exchange Commission. All
responsibility for the day-to-day management of the Senior Housing Facilities,
including administration of the property management agreement with AHC, was
transferred to Lease II. On July 29, 1996, the management agreement with AHC was
terminated and Lease II retained Capital Senior Management 2, Inc. ("Capital")
to be the new property manager of its Senior Housing Facilities pursuant to a
management agreement (the "Management Agreement").
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PAGE 12
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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Terminated Agreement and Plan of Merger with Capital Senior Living Corporation
("CSLC")
On February 7, 1999, the Company entered into an agreement and plan of merger,
which was amended and restated on October 19, 1999, as subsequently amended,
with CSLC and certain affiliates of CSLC.
On June 22, 2000, holders of more than two-thirds of the outstanding shares of
the Company's common stock voted in favor of approval of the proposed Agreement
and Plan of Merger.
On August 15, 2000, the Company caused ILM II Holding to complete the sale of
its 75% co-tenancy interest in its senior living facility located in Santa
Barbara, California ("Villa Santa Barbara"), to CSLC for $10,143,750. In
consideration for the sale, the Company received $9,543,750 in cash and CSLC
contributed $600,000 toward the Company's outstanding construction loan debt and
assumed certain then current transaction expenses of the Company in connection
with the previously announced proposed merger. The remaining 25% co-tenancy
interest in Villa Santa Barbara was formerly owned by ILM Holding, Inc.
("Holding I"), a subsidiary of ILM Senior Living, Inc. ("ILM I") and was
transferred to CSLC at the time the merger between ILM I and CSLC was
consummated. A gain on the sale of approximately $6,160,000 was recognized in
the consolidated statement of income for the year ended August 31, 2000. It is
anticipated that this gain will result in a built-in gain tax which would be
reduced by available net operating loss carryforwards from the period when the
Company's subsidiary was a so-called "C" Corporation (prior to the Company's
conversion of its subsidiary to a REIT for the year 1996).
On February 8, 2001, the Company received notice from CSLC terminating the
merger agreement. CSLC stated in its termination letter that it terminated the
merger agreement because of its concerns relating to the Company's claimed
election in 1996 to defer built-in gain taxes upon conversion of ILM II Holding
from a "C" Corporation to a REIT. As previously reported in the Company's public
filings, the Company claimed this election based upon the advice of its outside
tax accountants, has operated since 1996 under the belief that such election was
validly perfected, and pursued administrative relief with the Internal Revenue
Service to ensure the availability of the Company's election to defer such
corporate level built-in gain taxes. On May 8, 2001, the Internal Revenue
Service notified the Company that it granted the requested administrative relief
in this matter and, accordingly, the built-in gain tax has been deferred.
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PAGE 13
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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On November 13, 2000, the Company's 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
the Company with CSLC was consummated or March 31, 2001, and on a month-to-month
basis thereafter if the merger was not consummated by that time. Although there
can be no assurance, the Facilities Lease Agreement is expected to continue on a
month-to-month basis.
2. Operating Investment Properties Subject to Facilities Lease Agreement
At May 31, 2001, through its consolidated subsidiary, the Company owned five
Senior Housing Facilities. The name, location and size of the properties are as
set forth below:
<Table>
<Caption>
YEAR FACILITY RENTABLE RESIDENT
NAME LOCATION BUILT UNITS (1) CAPACITY (1)
- --------------------------------------------------------------------------------------
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.
Subsequent to the effective date of the Settlement Agreement with AHC, in order
to maximize the potential returns to the existing Shareholders while maintaining
the Company's qualification as a REIT under the Internal Revenue Code, the
Company formed a new corporation, Lease II, for the purpose of operating the
Senior Housing Facilities under the terms of a Facilities Lease Agreement dated
September 1, 1995 between the Company's consolidated affiliate, ILM II Holding,
as owner of the properties and lessor (the "Lessor"), and Lease II as lessee
(the "Lessee"). 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. The Facilities Lease Agreement was originally scheduled to expire on
December 31, 2000, unless earlier terminated at the election of the
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PAGE 14
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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Lessor in connection with the sale by the Lessor of the Senior Housing
Facilities to a non-affiliated third party but on November 13, 2000, was
extended beyond its original expiration date on a month-to-month basis. On
November 28, 2000, the Facilities Lease Agreement was extended through the
earlier of the date on which the merger of the Company with CSLC is consummated
or March 31, 2001, and on a month-to-month basis thereafter if the merger is not
consummated by that time. Because the merger was terminated prior to March 31,
2001, the Facilities Lease Agreement will continue on a month-to-month basis
until the properties are liquidated or December 31, 2001, whichever comes first.
During fiscal year 2000, Lease II 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 per year in 1999). The reduction in base rent from the previous year
was due to the sale of Villa Santa Barbara on August 15, 2000. Beginning
September 1, 2000, annual base rent is $3,555,427 (excluding Villa Santa
Barbara). Lease II also pays variable rent, on a quarterly basis, for each
Senior Housing Facility in an amount equal to 40% of the excess of the aggregate
total revenues for the Senior Housing Facilities, on an annualized basis, over
$11,634,000. Variable rent was $759,000 and $237,000 for the nine- and
three-month periods ended May 31, 2001, respectively, compared to $1,081,000 and
$363,000 for the nine- and three-month periods ended May 31, 2000, respectively.
Lease II has retained Capital to be the property manager of the Senior Housing
Facilities and the Company has guaranteed the payment of all fees due to Capital
pursuant to a Management Agreement which commenced on July 29, 1996. For the
nine- and three-month periods ended May 31, 2001, Capital earned property
management fees from Lease II of $558,000 and $149,000, respectively. For the
nine- and three-month periods ended May 31, 2000, Capital earned property
management fees from Lease II of $738,707 and $213,191, respectively.
On September 18, 1997, Lease II entered into an agreement with Capital Senior
Development, Inc., an affiliate of Capital, to manage the development process
for the potential expansion of several 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. The Company will reimburse Lease
II for all costs related to these potential expansions including fees to Capital
Senior Development, Inc. For the nine- and three-month periods ended May 31,
2001, and 2000, Capital Senior Development, Inc. earned no fees from Lease II
for managing pre-construction development activities for potential expansions of
the Senior Housing Facilities.
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PAGE 15
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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3. Related Party Transactions
Jeffry R. Dwyer, Secretary and Director of the Company, is a shareholder of
Greenberg Traurig, Counsel to the Company and its affiliates since 1997. For the
nine- and three-month periods ended May 31, 2001, Greenberg Traurig earned fees
from the Company of $991,000 and $411,000, respectively. For the nine- and
three-month periods ended May 31, 2000, Greenberg Traurig earned fees from the
Company of $603,000 and $231,000.
ACCOUNTS RECEIVABLE--RELATED PARTY at May 31, 2001 and August 31, 2000, includes
variable rent due from Lease II. ACCOUNTS PAYABLE--RELATED PARTY at May 31,
2001, includes accrued legal fees due to Greenberg Traurig, Counsel to the
Company and its affiliate and a related party, as described above. At
August 31, 2000, ACCOUNTS PAYABLE--RELATED PARTY includes $40,000 of expense
reimbursements payable to Lease II.
4. Legal Proceedings and Contingencies
Feldman Litigation
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 the
Company and ILM I in the Supreme Court of the State of New York, County of New
York naming the Company, ILM I and their Directors as defendants. The class
action complaint alleged various theories of redress and a broad range of
damages.
On October 15, 1999, the parties entered into a Stipulation of Settlement that
was filed with the Court and approved 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 the Company and ILM I. As
part of the settlement, CSLC increased its proposed merger consideration payable
to the Company and ILM I shareholders and was also responsible for a total of
approximately $1.1 million (approximately 40% of which is allocable to the
Company) in plaintiffs' attorneys fees and expenses upon consummation of the
proposed merger. If the proposed merger was not consummated and if the Company
and ILM I were to consummate an extraordinary transaction with a third party,
then the Company and ILM I would be responsible for the plaintiffs' attorneys
fees and expenses.
On August 15, 2000, the merger of ILM I with CSLC was consummated and on
February 28, 2001, CSLC terminated the proposed merger with the Company. Because
of these events and based upon the Stipulation of Settlement, if the Company was
to consummate an
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PAGE 16
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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extraordinary transaction with a third party, the Company would be responsible
for the Company's share of the plaintiff"s attorney's fees and expenses.
Built-in Gain Tax
The assumption of ownership of the Senior Housing Facilities through ILM II
Holding, which was organized as a so-called "C" corporation for tax purposes,
has resulted in a possible future tax liability which would be payable upon the
ultimate sale of the Senior Living Facilities (the "built-in gain tax"). The
amount of such tax would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain realized upon
a final sale which is attributable to the period during which the properties
were held in a "C" corporation.
Any future appreciation in the value of the Senior Housing Facilities subsequent
to the conversion of ILM II Holding to a REIT would not be subject to the
built-in gain tax. The built-in gain tax would most likely not be incurred if
the properties were to be held for a period of at least ten years from the date
of the conversion of ILM II Holding to a REIT. However, since the end of the
Company's original anticipated holding period as defined in the Articles of
Incorporation is December 31, 2001, the properties may not be held for an
additional ten years. Based on management's current estimate of the increase in
the values of the Senior Housing Facilities which occurred between April 1994
and January 1996, as supported by independent appraisals, a sale of the Senior
Housing Facilities within ten years of the date of the conversion of ILM II
Holding to a REIT could result in a built-in gain tax of as much as
$2.5 million, which could be reduced by approximately $270,000, using available
net operating loss carryforwards of ILM II Holding of $780,000 that were
incurred prior to its conversion to REIT status. ILM II Holding also has net
operating losses that were incurred after its conversion to REIT status of
approximately $4.2 million. The sale of the Company's interest in Villa Santa
Barbara resulted in the recognition of a built-in gain of approximately
$600,000, which was offset by pre-conversion net operating losses. As of
August 31, 2000, the potential built-in gain tax relating to the Senior Housing
Facilities is as much as $2.3 million, which could be further reduced by
approximately $50,000, using the remaining available pre-conversion net
operating loss carryforwards of ILM II Holding of approximately $150,000. To
avoid this built-in gain tax, the Directors have recommended to the Shareholders
an amendment to the Articles of Incorporation to extend the Company's scheduled
liquidation date. Based in part upon advice from the Company's outside tax
accountants, commencing in 1996, the Company has acted as though it had made an
election in its 1996 tax return to allow the Company to avoid a corporate level
tax upon conversion of ILM II Holding from a "C" Corporation to a REIT. Because
proof of a formal
- --------------------------------------------------------------------------------
PAGE 17
<Page>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
- --------------------------------------------------------------------------------
election had not then been obtained, the Company pursued administrative relief
with the Internal Revenue Service to ensure the availability of the benefits of
this election. On May 8, 2001, the Internal Revenue Service notified the Company
that it granted the requested administrative relief in this matter and,
accordingly, the built-in gain tax has been deferred.
5. Construction Loan Financing
During 1999 the Company obtained a construction loan facility with a major bank
that provided the Company with up to $8.8 million to fund the capital costs of
potential expansion programs. The construction loan facility was collateralized
by a first mortgage of the Senior Housing Facilities and collateral assignment
of the Company's leases of such properties. The loan was scheduled to expire on
December 31, 2000, with possible extensions through September 29, 2003.
Principal was due at expiration. Interest was payable monthly at a rate equal to
LIBOR plus 1.10% or Prime plus 0.5%.
On June 7, 1999, the Company borrowed approximately $1.2 million 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. On August 16, 2000, the Company repaid approximately $600,000 of
principal on the construction loan facility in connection with the sale of Villa
Santa Barbara and the lender sold the remaining loan to CSLC. As part of this
transaction, the Company agreed that the term of the loan would not be extended
beyond December 31, 2000. On November 28, 2000, the Company and CSLC agreed that
the maturity date of the loan would be extended until the date on which the
merger of the Company with CSLC was consummated or the date on which the merger
agreement was terminated, whichever occurred first. On February 28, 2001, CSLC
terminated the proposed merger with the Company, and on April 3, 2001, the
remaining principal balance plus accrued interest was repaid in full. Amounts
outstanding under the loan at May 31, 2001, and August 31, 2000, were $0 and
$570,000, respectively. Loan origination fees of $144,000 were paid in
connection with this loan facility and were being amortized over the life of the
loan. On April 3, 2001, unamortized loan origination fees totaling $29,867 were
amortized to expense with repayment of the loan. Capitalized interest at
May 31, 2001, and August 31, 2000, was $107,059 and $79,310, respectively.
6. Subsequent Event
In June 2001, the Company's Board of Directors declared a quarterly dividend for
the three-month period ended May 31, 2001. On July 16, 2001, a dividend of
$0.1622 per share of common stock, totaling approximately $840,000 will be paid
to Shareholders of record as of June 30, 2001.
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PAGE 18
<Page>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
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General
The Company offered shares of its common stock to the public from September 12,
1990 to May 10, 1991 pursuant to a Registration Statement filed under the
Securities Act of 1933, as amended. Capital contributions of $51,812,356 were
received by the Company (including $200,000 contributed by PaineWebber) and,
after deducting selling expenses and offering costs and allowing for adequate
cash reserves, approximately $42.9 million was available to be invested in
participating first mortgage loans collateralized by Senior Housing Facilities.
The Company originally invested the net proceeds of the initial public offering
in six participating mortgage loans collateralized by Senior Housing Facilities
located in five different states. All of the loans made by the Company were
originally with AHC. As previously reported, AHC defaulted on the scheduled
mortgage loan payments due to the Company on March 1, 1993. Its parent company,
Angeles, subsequently filed for bankruptcy. In fiscal 1994, a Settlement
Agreement was executed whereby ownership of the properties was transferred from
AHC to certain designated affiliates of the Company which were majority owned by
the Company. Subsequently, these affiliates were merged into ILM II Holding,
which is majority owned by the Company. ILM II Holding holds title to the five
remaining Senior Housing Facilities which comprise the balance of operating
investment properties in the accompanying consolidated balance sheets, subject
to certain mortgage loans payable to the Company. As part of the fiscal 1994
Settlement Agreement with AHC, ILM II Holding retained AHC as the property
manager for all of the Senior Housing Facilities pursuant to the terms of the
Agreement. As discussed further below, the Agreement with AHC was terminated in
July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC, in order
to maximize the potential returns to the Company's existing Shareholders while
maintaining its qualification as a REIT under the Internal Revenue Code, the
Company formed a new corporation, Lease II, for the purpose of operating the
Senior Housing Facilities under the terms of a Facilities Lease Agreement. As of
August 31, 1995, Lease II, which is taxable as a so-called "C" corporation and
not as a REIT, was a wholly owned subsidiary of the Company. On September 1,
1995 the Company, after receiving the required regulatory approval, distributed
all of the shares of capital stock of Lease II to the holders of record of the
Company's common stock.
The Facilities Lease Agreement is between the Company's consolidated affiliate,
ILM II Holding, as owner of the Senior Housing Facilities and Lessor, and Lease
II as Lessee. The facilities lease is a "triple-net" lease whereby the Lessee
pays all operating expenses,
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
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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. The
Facilities Lease Agreement was originally scheduled to expire on December 31,
2000, unless earlier terminated at the election of the Lessor in connection with
the sale by the Lessor of the Senior Housing Facilities to a non-affiliated
third party but on November 13, 2000, was extended beyond its original
expiration date on a month-to-month basis. On November 28, 2000, the Facilities
Lease Agreement was extended though the earlier of the date on which the merger
of the Company with CSLC was consummated or March 31, 2001, and on a
month-to-month basis thereafter if the merger was not consummated by that time.
As discussed fully under the "Agreement and Plan of Merger with Capital Senior
Living Corporation" below, the merger was terminated by CSLC prior to March 31,
2001, and, although there can be no assurance, the Facilities Lease Agreement is
expected to continue on a month-to-month basis. During fiscal year 2000, Lease
II paid annual base rent for the use of all the Senior Housing Facilities in the
aggregate amount of $3,995,586 per year ($4,035,600 per year in 1999). The
reduction in base rent from the previous year is due to the sale of Villa Santa
Barbara on August 15, 2000. Beginning on September 1, 2000, annual base rent is
$3,555,427 (excluding Villa Santa Barbara). Lease II also paid 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 $11,634,000. Variable rental income for
the nine- and three-month periods ended May 31, 2001, was $759,000 and $237,000,
respectively, compared to $1,081,000 and $363,000 for the nine- and three-month
periods ended May 31, 2000, respectively.
The Company completed its restructuring plans by qualifying ILM II Holding as a
REIT for Federal tax purposes. In connection with these plans, on November 21,
1996, the Company requested that PaineWebber sell all of its stock in ILM II
Holding to the Company for a price equal to the fair market value of the 1%
economic interest in ILM II Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM II Holding was
completed at an agreed upon fair value of $40,000, representing a $35,000
increase in fair value. This increase in fair value is based on the increase in
values of the Senior Housing Facilities which occurred between April 1994 and
January 1996, as supported by independent appraisals.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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With this transfer completed, effective January 23, 1997, ILM II Holding
recapitalized its common stock and preferred stock by replacing the outstanding
shares with 50,000 shares of new common stock and 275 shares of non-voting, 8%
cumulative preferred stock issued to the Company. The number of authorized
shares of preferred stock and common stock in ILM II Holding were also increased
as part of the recapitalization. Following the recapitalization, the Company
made charitable gifts of one share of the Preferred Stock in ILM II Holding to
each of 111 charitable organizations so that ILM II Holding would meet the stock
ownership requirements of a REIT as of January 30, 1997. The Preferred Stock has
a liquidation preference of $1,000 per share plus any accrued and unpaid
dividends. Dividends on the Preferred Stock accrue at a rate of 8% per annum on
the original $1,000 liquidation preference and are cumulative from the date of
issuance. It is anticipated that dividends will accrue and be paid at
liquidation. Cumulative dividends in arrears as of May 31, 2001, on the
Preferred Stock in ILM II Holding totaled approximately $38,000.
The assumption of ownership of the Senior Housing Facilities through ILM II
Holding, which was organized as a so-called "C" corporation for tax purposes,
has resulted in a possible future tax liability which would be payable upon the
ultimate sale of the Senior Living Facilities (the "built-in gain tax"). The
amount of such tax would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain realized upon
a final sale which is attributable to the period during which the properties
were held in a "C" corporation.
Any future appreciation in the value of the Senior Housing Facilities subsequent
to the conversion of ILM II Holding to a REIT would not be subject to the
built-in gain tax. The built-in gain tax would most likely not be incurred if
the properties were to be held for a period of at least ten years from the date
of the conversion of ILM II Holding to a REIT. However, since the end of the
Company's original anticipated holding period as defined in the Articles of
Incorporation is December 31, 2001, the properties may not be held for an
additional ten years. Based on management's current estimate of the increase in
the values of the Senior Housing Facilities which occurred between April 1994
and January 1996, as supported by independent appraisals, a sale of the Senior
Housing Facilities within ten years of the date of the conversion of ILM II
Holding to a REIT could result in a built-in gain tax of as much as
$2.5 million, which could be reduced by approximately $270,000, using available
net operating loss carryforwards of ILM II Holding of $780,000 that were
incurred prior to its conversion to REIT status. ILM II Holding also has net
operating losses that were incurred after its conversion to REIT status of
approximately $4.2 million. The sale of the Company's
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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interest in Villa Santa Barbara resulted in the recognition of a built-in gain
of approximately $600,000, which was offset by pre-conversion net operating
losses. As of August 31, 2000, the potential built-in gain tax relating to the
Senior Housing Facilities is as much as $2.3 million, which could be further
reduced by approximately $50,000, using the remaining available pre-conversion
net operating loss carryforwards of ILM II Holding of approximately $150,000. To
avoid this built-in gain tax, the Directors have recommended to the Shareholders
an amendment to the Articles of Incorporation to extend the Company's scheduled
liquidation date. Based upon advice from the Company's financial advisors,
commencing in 1996, the Company has acted as though it had made an election in
its 1996 tax return to allow the Company to avoid a corporate level built-in
gain tax upon conversion of ILM II Holding from a "C" Corporation to a REIT.
Because proof of a formal election had not then been obtained, the Company
pursued administrative relief with the Internal Revenue Service to ensure the
availability of the benefits of this election. On May 8, 2001, the Internal
Revenue Service notified the Company that it granted the requested
administrative relief in this matter and, accordingly, the built-in gain tax has
been deferred.
Because the ownership of the assets of ILM II Holding was expected to be
transferred to the Company or its wholly-owned subsidiary, ILM II Holding was
capitalized with funds to provide it with working capital only for a limited
period of time. At the present time, ILM II Holding is not expected to have
sufficient cash flow during fiscal year 2001 to (i) meet its obligations to make
the debt service payments due under the loans, and (ii) pay for capital
improvements and structural repairs in accordance with the terms of the
Facilities Lease Agreement. Although ILM II Holding is not expected to fully
fund its scheduled debt service payments to the Company, the estimated current
values of the Senior Housing Facilities are well in excess of the mortgage
principal amounts plus accrued interest at May 31, 2001. As a result, the
Company is expected to recover the full amount that would be due under the loans
upon sale of the Senior Housing Facilities.
Terminated Agreement and Plan of Merger with Capital Senior Living Corporation
On February 7, 1999, the Company entered into an agreement and plan of merger,
which was amended and restated on October 19, 1999, as subsequently amended,
with CSLC and certain affiliates of CSLC.
On June 22, 2000, holders of more than two-thirds of the outstanding shares of
the Company's common stock voted in favor of approval of the proposed Agreement
and Plan of Merger.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
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On August 15, 2000, the Company caused ILM II Holding to complete the sale of
its 75% co-tenancy interest in its senior living facility located in Santa
Barbara, California ("Villa Santa Barbara"), to CSLC for $10,143,750. In
consideration for the sale, the Company received $9,543,750 in cash and CSLC
contributed $600,000 toward the Company's outstanding construction loan debt and
assumed certain then current transaction expenses of the Company in connection
with the previously announced proposed merger. The remaining 25% co-tenancy
interest in Villa Santa Barbara was formerly owned by ILM Holding, Inc.
("Holding I"), a subsidiary of ILM Senior Living, Inc. ("ILM I") and was
transferred to CSLC at the time the merger between ILM I and CSLC was
consummated. A gain on the sale of approximately $6,160,000 has been recognized
in the accompanying consolidated statement of income for the year ended
August 31, 2000. It is anticipated that this gain will result in a built-in gain
tax which would be reduced by available net operating loss carryforwards from
the period when the Company's subsidiary was a so-called "C" Corporation (prior
to the Company's conversion of its subsidiary to a REIT for the year 1996).
On February 8, 2001, the Company received notice from CSLC terminating the
merger agreement. CSLC stated in its termination letter that it terminated the
merger agreement because of its concerns relating to the Company's claimed
election in 1996 to defer built-in gain taxes upon conversion of ILM II Holding
from a "C" Corporation to a REIT. As previously reported in the Company's public
filings, the Company claimed this election based upon the advice of its outside
tax accountants; has operated since 1996 under the belief that such election was
validly perfected; and pursued administrative relief with the Internal Revenue
Service to ensure the availability of the Company's election to defer such
corporate level built-in gain taxes. On May 8, 2001, the Internal Revenue
Service notified the Company that it granted the requested administrative relief
in this matter and, accordingly, the built-in gain tax has been deferred.
As noted above, the Facilities Lease Agreement, which was scheduled to expire on
December 31, 2000, was extended through the earlier of the date on which the
merger of the Company with CSLC was consummated or March 31, 2001, and on a
month-to-month basis thereafter if the merger was not consummated by that time.
Although there can be no assurance, the Facilities Lease Agreement is expected
to continue on a month-to-month basis.
Liquidity and Capital Resources
Occupancy levels for the five remaining properties in which the Company has
invested averaged 85% and 91% for the three months ended May 31, 2001 and 2000,
respectively.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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The Company's net operating cash flow is expected to be relatively stable and
predictable due to the structure of the Facilities Lease Agreement. Beginning
September 1, 2000, the annual base rental payments owed to ILM II Holding
(excluding Villa Santa Barbara) are $3,555,427 and will remain at that level for
the remainder of the lease term, including any month-to-month extensions. In
addition, the Senior Housing Facilities are currently generating gross revenues
which are in excess of the specified threshold in the variable rent calculation,
as discussed further above, which became effective in January 1997.
The Company had been pursuing the potential for future expansion of several of
the Senior Housing Facilities which are located in areas that had particularly
strong markets for senior housing to increase cash flow and shareholder value.
Potential expansion candidates include the facilities located in Omaha,
Nebraska; St. Louis County, Missouri; and Fort Myers, Florida. As part of this
expansion program, during fiscal year 1999, approximately one acre of land
located adjacent to the Omaha facility was acquired for approximately $135,000.
The Fort Myers facility includes a vacant parcel of approximately one and
one-half acres which could accommodate an expansion of the existing facility or
the construction of a new free-standing facility. Preliminary feasibility
evaluations have been completed for all of these potential expansions and
pre-construction design and construction-cost evaluations have been completed
for expansions of the facilities located in Omaha and Fort Myers.
To date, no construction has been started and expansion plans had been
temporarily suspended. The Company will carefully evaluate the costs and
benefits before proceeding with the construction of any of these expansions.
Depending on the extent of any expansions deemed appropriate, such plans would
result in the need for substantial capital.
During 1999, the Company secured a construction loan facility with a major bank
that provided the Company with up to $8.8 million to fund the capital costs of
the potential expansion programs. The construction loan facility was secured by
a first mortgage of the Senior Housing Facilities and collateral assignment of
the Company's leases of such Senior Housing Facilities. The loan was scheduled
to expire on December 31, 2000, with possible extensions through September 29,
2003. Principal was due at expiration. Interest was payable at a rate equal to
LIBOR plus 1.10% or Prime plus 0.5%. Loan origination costs in connection with
this loan facility were being amortized over the life of the loan.
On June 7, 1999, the Company borrowed approximately $1.2 million 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. On August 16, 2000, the Company
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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repaid approximately $600,000 of principal on the construction loan facility and
the lender sold the loan to CSLC. As part of the transaction, the Company agreed
that the term of the loan would not be extended beyond December 31, 2000. On
November 28, 2000, the Company and CSLC agreed that the maturity date of the
loan would be extended until the date on which the merger of the Company with
CSLC was consummated or the date on which the merger agreement was terminated,
whichever occurred first. On February 8, 2001, CSLC terminated the proposed
merger with the Company, and on April 3, 2001, the remaining principal balance
plus accrued interest was repaid in full. Amounts outstanding under the loan at
May 31, 2001, and August 31, 2000, were $0 and $570,000, respectively.
At May 31, 2001, the Company had cash and cash equivalents of $1,395,000
compared to $11,258,000 at August 31, 2000. Remaining cash amounts will be used
for the working capital requirements of the Company, along with the possible
investment in the properties owned by ILM II Holding for certain capital
improvements, and for dividends to the Shareholders. On December 15, 2000, a
special distribution of $1.89 per share was paid to Shareholders of record as of
November 1, 2000, distributing net proceeds from the sale of the Company's
investment in Villa Santa Barbara. On January 15, 2001, the Company paid a
quarterly dividend of $0.1622 per share to Shareholders of record as of
December 15, 2000, and on April 16, 2001, the Company paid a quarterly dividend
of $0.1622 per share to Shareholders of record as of March 30, 2001. Future
capital improvements could be financed from operations or through borrowings,
depending on the magnitude of the improvements, the availability of financing
and the Company's incremental borrowing rate. The source of future liquidity and
dividends to the Shareholders is expected to be through facilities lease
payments from Lease II, interest income earned on invested cash reserves and
proceeds from the future sales of the underlying operating investment
properties. 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. The
Company generally will be obligated to distribute annually at least 90% of its
taxable income to its Shareholders in order to continue to qualify as a REIT
under the Internal Revenue Code.
While the Company has potential liabilities pending due to ongoing litigation
against the Company, the eventual outcome of this litigation cannot presently be
determined. The Company will vigorously defend against all claims made against
it and, at this time, it is not certain that the Company will have ultimate
responsibility for any such claims.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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Market Risk
The Company believes its market risk is immaterial.
Results of Operations
FOR THE NINE MONTHS ENDED MAY 31, 2001 VERSUS THE NINE MONTHS ENDED MAY 31, 2000
Net income decreased $1,307,000 or 72.9% from income of $1,792,000 for the
nine-month period ended May 31, 2000 compared to income of $485,000 for the
nine-month period ended May 31, 2001. Total revenue was $3,581,000 representing
a decrease of $535,000, or 13.0%, compared to the same period of the prior year.
Rental income decreased $665,000 or 16.3%, to $3,419,000 for the nine-month
period ended May 31, 2001, compared to $4,084,000 for the nine-month period
ended May 31, 2001, due to decreased rental income earned pursuant to the terms
of the Facilities Lease Agreement and primarily as a result of the sale of Villa
Santa Barbara. Total expenses increased $772,000, or 33.2%, to $3,096,000 for
the nine-month period ended May 31, 2001, compared to $2,324,000 for the
nine-month period ended May 31, 2001. This overall increase in expenses is
primarily attributable to a $555,000 or 54.3% increase in professional fees due
to increased legal fees associated with the agreement and plan of merger with
CSLC (as discussed in Note 1 to the financial statements). The $198,000 or 98.0%
increase in general and administrative expenses to $400,000 for the nine-month
period ended May 31, 2001, from $202,000 for the same period last year, is due
to a variety of factors including increased Director and Officer insurance costs
of $155,000 or 153.8%; investor servicing costs of $31,000 or 283.6%; and
portfolio communications of $42,000 or 2818.1%. These increases were offset by a
$29,000 or 79.7% decrease in postage and mailing costs and minor increases and
decreases in other costs.
FOR THE THREE MONTHS ENDED MAY 31, 2001, VERSUS THE THREE MONTHS ENDED
MAY 31,2000
Net income decreased $414,000 or 74.7% to $140,000 for the third quarter ended
May 31, 2001, compared to $554,000 for the third quarter ended May 31, 2000.
Total revenue was $1,143,000 representing a decrease of $228,000 or 16.6%,
compared to the same period of the prior year. Rental income decreased $238,000
or 17.4%, to $1,126,000 for the quarter ended May 31, 2001, compared to
$1,364,000 for the quarter ended May 31, 2000, due to decreased rental income
earned subsequent to the sale of Villa Santa Barbara and pursuant to the terms
of the Facilities Lease Agreement. Total expenses increased $186,000, or 22.8%,
to $1,003,000 for the three-month period ended May 31, 2001, compared to
$817,000 for the three-month period ended May 31, 2000. This increase in
expenses is primarily attributable to a $128,000 or 35.4% increase in
professional fees due to increased use of financial and advisory professionals
who were engaged to assist the Company with the agreement and
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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plan of merger with CSLC (as discussed in Note 1 to the financial statements) as
well as the sale of Villa Santa Barbara. The $43,000 or 52.4% increase in
general and administrative expenses to $125,000 for the three-month period ended
May 31, 2001, from $82,000 for the same period last year, is due to a variety of
factors including investor servicing costs of $12,000 or 226.3%; and portfolio
communications of $42,000 or 4083.1%. These increases in expenses were
accompanied by minor increases and decreases in other expenses as well.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
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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.
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Part II--Other Information
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Item 1. through 4. NONE
Item 5. Other Information
The Company's Board of Directors has, on Schedule 14A filed with the Securities
and Exchange Commission on July 6, 2001, recommended to the Company's
shareholders that the Company's Articles of Incorporation be amended to extend
the Company's finite-life existence until December 31, 2008. The Articles of
Incorporation currently provide for the automatic termination of the Company's
finite-life existence on December 31, 2001.
In view of the impending termination deadline and the failure to consummate a
merger with Capital Senior Living Corporation, the Company thought it was
prudent to conduct a "market check" and authorized management to work
expeditiously with the Company's legal and financial advisors to identify
prospective purchasers of the Company's capital stock or assets (by means of
merger, strategic business combination, tender offer or sale of the Company's
senior living properties) and to elicit bona fide offers for transactions to be
consummated on or prior to December 31, 2001 which would maximize current
shareholder value. After having reviewed expressions of interest received from
seven prospective purchasers (of 26 prospective purchasers contacted), the
Company pursued what it considered to be the most attractive potential
opportunity and highest offer--a major real estate investment fund's interest in
acquiring substantially all of the Company's assets for a purchase price of
$50.5 million, subject to adjustment for the assumption of pre-closing
liabilities. After several meetings and conversations between the purchaser and
the Company and after the Company considered its alternatives, it determined
that continuation of discussions or negotiations with this potential purchaser
was unlikely to result in a transaction which would maximize current shareholder
value because the proposed purchase price, after adjustment for the Company's
liabilities, transaction costs and taxes, would likely result in a lower net per
share consideration payable to the Company's shareholders.
Although the Company is no longer actively soliciting proposals from additional
prospective purchasers, the Company is continuing to explore with its financial
and legal advisors strategic alternatives to maximize current shareholder value
(and will duly consider any bona fide offers which are received regarding the
acquisition of the Company or its assets) and believes that, although there can
be no assurance that such transactions would be entered into or consummated in
the near-term, if at all, such transactions are more likely to be identified and
accomplished in a stronger industry environment and healthier overall domestic
economy.
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PART II--OTHER INFORMATION
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One alternative to a sale transaction being studied, on a preliminary basis, by
the Company at this time is a leveraged financing transaction whereby the
Company would seek to obtain first mortgage loans secured by all or
substantially all of the Company's assets, a portion of the net proceeds from
which could be made available to the Company's shareholders in the form of an
extraordinary distribution or used to purchase the outstanding Common Stock by
means of self-tender offer or otherwise. The Company has engaged in preliminary
discussions to date with several prospective lending sources to assess the
viability of obtaining this type of mortgage financing and the intended use of
net proceeds as described above. There can be no assurance that such a
transaction would be entered into or consummated or, if consummated, as to the
timing thereof.
The Company further believes that extending the Company's finite-life existence
could assist in the avoidance of the corporate level built-in gains tax
assessment upon a sale of the Company's senior living properties or capital
stock. Based upon applicable law, the built-in gains tax would most likely not
be assessed if the Company's senior living properties were held for a period of
at least 10 years (i.e., until 2006) from the date of conversion of ILM II's
subsidiary to a REIT.
If the finite-life existence of the Company is not extended and the Company is
unable to consummate an extraordinary corporate transaction by December 31,
2001, the Company will be required to liquidate its senior living properties on
that date.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None
(b) Reports on Form 8-K: None
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ILM II SENIOR LIVING, INC.
SIGNATURES
Pursuant to the requirements 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 SENIOR LIVING, INC.
By: /s/ J. William Sharman, Jr.
-------------------------------------
J. William Sharman, Jr.
President and Director
Dated: JULY 12, 2001
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