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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q/A
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
-- SECURITIES EXCHANGE ACT OF 1934
FOR QUARTERLY PERIOD ENDED MAY 31, 1999
OR
__ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from ____ to ____.
Commission File Number: 0-25880
ILM II LEASE CORPORATION
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(Exact name of registrant as specified in its charter)
Virginia 04-3248639
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8180 GREENSBORO DRIVE, SUITE 850, MCLEAN, VA 22102
- -------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (888) 257-3550
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
- ------------------- -----------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares Of Common Stock $.01 Par Value
-------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes ____No _X__
Shares of common stock outstanding as of May 31, 1999: 5,180,952.
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Page 1 of 20
ILM II LEASE CORPORATION
INDEX
Part I. Financial Information PAGE
Item 1. Financial Statements
Balance Sheets
May 31, 1999 (Unaudited) and August 31, 1998.................................................4
Statements of Income
For the nine months and three months ended May 31, 1999 and 1998 (Unaudited).................5
Statements of Changes in Shareholders' Equity
For the nine months ended May 31, 1999 and 1998 (Unaudited)..................................6
Statements of Cash Flows
For the nine months ended May 31, 1999 and 1998 (Unaudited)..................................7
Notes to Financial Statements (Unaudited).................................................8-12
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....13-17
Part II. Other Information...................................................................................18
Item 6. Exhibits and Reports on Form 8-K............................................................18
Signatures....................................................................................................18
-2-
ILM II LEASE CORPORATION
PART I. FINANCIAL INFORMATION
Item I. Financial Statements
(See next page)
ILM II LEASE CORPORATION
BALANCE SHEETS May 31, 1999
(Unaudited) and August 31, 1998 (Dollars in
thousands, except per share data)
ASSETS
May 31, 1999 August 31, 1998
------------ ---------------
Cash and cash equivalents $ 1,363 $1,497
Accounts receivable, net 162 89
Accounts receivable - related party 102 102
Prepaid expenses and other assets 66 50
Tax refund receivable 27 158
--------- -------
Total current assets 1,720 1,896
Furniture, fixtures and equipment 1,010 783
Less: accumulated depreciation (424) (225)
--------- -------
586 558
Deposits 9 9
Deferred tax asset, net 25 270
--------- -------
$2,340 $2,733
========= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 742 $ 789
Termination fee payable - 650
Real estate taxes payable 116 209
Accounts payable - related party 321 287
Security deposits 42 25
--------- -------
Total current liabilities 1,221 1,960
Deferred rent payable 54 76
--------- -------
Total liabilities 1,275 2,036
Shareholders' equity:
Common stock, $0.01 par value, 20,000,000 shares
authorized 5,180,952 issued and outstanding 52 52
Additional paid-in capital 448 448
Retained earnings 565 197
--------- -------
Total shareholders' equity 1,065 697
--------- -------
$2,340 $2,733
========= =======
See accompanying notes.
-4-
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the nine months and three months ended May 31, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
Nine Months Ended Three Months Ended
May 31, May 31,
------- -------
1999 1998 1999 1998
---- ---- ---- ----
REVENUES:
Rental and other income $12,130 $11,508 $4,008 $ 3,908
Interest income 12 32 4 19
-------- ------- ------ -------
12,142 11,540 4,012 3,927
EXPENSES:
Facilities lease rent expense 3,947 3,700 1,302 1,262
Dietary salaries, wages and food service expenses 2,050 1,989 685 670
Administrative salaries, wages and expenses 888 750 291 180
Marketing salaries, wages and expenses 513 514 191 182
Utilities 772 770 245 248
Repairs and maintenance 447 392 162 141
Real estate taxes 394 435 131 127
Property management fees 773 684 225 240
Other property operating expenses 1,074 1,058 366 364
General and administrative expenses 187 199 82 92
Directors compensation 39 56 12 22
Professional fees 245 588 81 261
Depreciation expense 199 64 81 21
-------- ------- ------ -------
11,528 11,199 3,854 3,810
-------- ------- ------ -------
Income before taxes 614 341 158 117
Income tax expense:
Current - 113 - (122)
Deferred 246 23 63 169
-------- ------- ------ -------
246 136 63 47
-------- ------- ------ -------
136
NET INCOME $ 368 $ 205 $ 95 $ 70
======== ====== ====== ======
Basic earnings per share of common stock $ 0.07 $ 0.04 $ 0.01 $ 0.01
======== ====== ====== ======
The above earnings per share of common stock is based upon the 5,180,952 shares
outstanding for each period.
See accompanying notes.
-5-
ILM II LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended May 31, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
Common Stock
$.01 PAR VALUE Additional
-------------- Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ------- -------- -----
Balance at August 31, 1997 5,180,952 $ 52 $448 $219 $ 719
Net Income - - - 205 205
--------- ---- ---- ---- ------
Balance at May 31, 1998 5,180,952 $ 52 $448 $424 $ 924
========= ==== ==== ==== =======
Balance at August 31, 1998 5,180,952 $ 52 $448 $197 $ 697
Net Income - - 368 368
--------- ---- ---- ---- ------
-
Balance at May 31, 1999 5,180,952 $ 52 $448 $565 $1,065
========= ==== ==== ==== ======
See accompanying notes.
-6-
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the nine months ended May 31, 1999 and 1998 (Unaudited)
(Dollars In thousands)
Nine Months Ended
May 31,
-------
1999 1998
----- ----
Cash flows from operating activities:
Net income $368 $ 205
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation expense 199 64
Deferred tax expense (benefit) 245 (137)
Changes in assets and liabilities:
Accounts receivable, net (73) 53
Accounts receivable - related party - (121)
Prepaid expenses and other assets (16) 254
Tax refund receivable 131 -
Accounts payable and accrued expenses (47) (40)
Accounts payable - related party 34 1,118
Termination fee payable (650) -
Real estate taxes payable (93) (82)
Income taxes payable - 139
Deferred rent payable (22) (24)
Security deposits, net 17 (2)
------ ------
Net cash provided by operating activities 93 1,427
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (227) (167)
------ ------
Net cash used in investing activities (227) (167)
Net (decrease) increase in cash and cash equivalents (134) 1,260
Cash and cash equivalents, beginning of period 1,497 1,156
------ ------
Cash and cash equivalents, end of period $1,363 $2,416
====== ======
SUPPLEMENTAL DISCLOSURE:
Cash paid during the period for state income taxes $ 3 $ -
====== ======
See accompanying notes.
-7-
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
1. GENERAL
The accompanying financial statements, footnotes and discussions should
be read in conjunction with the financial statements and footnotes
contained in ILM II Lease Corporation's (the "Company") Annual Report on
Form 10-K for the year ended August 31, 1998. In the opinion of management,
the accompanying interim financial statements, which have not been audited,
reflect all adjustments necessary to present fairly the results for the
interim 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
May 31, 1999, and revenues and expenses for each of the nine- and
three-month periods ended May 31, 1999 and 1998. 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 nine- and
three-month periods ended May 31, 1999, are not necessarily indicative of
the results to be expected for the year ended August 31, 1999.
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 the 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 and Acting Chief Financial
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-
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. THE FACILITIES LEASE AGREEMENT
ILM II Holding (the "Lessor") leases the Senior Housing Facilities to
the Company (the "Lessee") pursuant to the Facilities Lease Agreement. Such
lease is scheduled to expire on December 31, 2000 (December 31, 1999 with
respect to the Santa Barbara Facility), unless 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 below in Recent Developments, 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 by the
end of calendar 1999. 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:
Year Facility Rentable Resident
Name Location Built Units (2) Capacities (2)
---- -------- ----- --------- --------------
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
(1) The Company operates Villa Santa Barbara under a co-tenancy
arrangement with an affiliated company, ILM I Lease Corporation ("Lease
I"). The Company has entered into an agreement with Lease I regarding
such joint tenancy. Lease I was formed for similar purposes as the
Company by an affiliated company, ILM Senior Living, Inc. ("ILM I"), a
subsidiary of which owns 25% of the Villa Santa Barbara property. The
portion of the Senior Housing Facility leased by the Company represents
75% of the total project. Villa Santa Barbara is 25% owned by ILM Holding
Inc. and 75% by ILM II Holding, Inc., a direct subsidiary of ILM II, as
tenants in common. Upon the sale of ILM I or ILM II, arrangements would
be made to transfer the Santa Barbara facility to the non-selling joint
tenant (or one of its subsidiaries). The property was extensively
renovated in 1995.
(2) Rentable units represent the number of apartment units and is a
measure commonly used in the real estate industry. Resident capacity
equals the number of bedrooms contained within the apartment units and
corresponds to measures commonly used in the healthcare industry.
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 $943,000 and $301,000 for the nine- and three-month periods ended
May 31, 1999, respectively, compared to $697,000 and $261,000 for the
nine- and three-month periods ended May 31, 1998, respectively.
-9-
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. THE FACILITIES LEASE AGREEMENT (CONTINUED)
The Company's use of the properties is limited to use as Senior Housing
Facilities. The Company has responsibility to obtain and maintain all
licenses, certificates and consents needed to use and operate each Senior
Housing Facility, and to use and maintain each Senior Housing Facility in
compliance with all local board of health and other applicable governmental
and insurance regulations. The Senior Housing Facilities located in
California, Florida and Kansas are licensed by such states to provide
assisted living services. In addition, various health and safety
regulations and standards, which are enforced by state and local
authorities, apply to the operation of all the Senior Housing Facilities.
Violations of such health and safety standards could result in fines,
penalties, closure of a Senior Housing Facility, or other sanctions.
RECENT DEVELOPMENTS
On February 7, 1999, ILM II entered into an agreement and plan of
merger with Capital Senior Living Corporation, the corporate parent of
Capital, and certain affiliates of Capital. While there can be no assurance,
consummation of the merger is presently anticipated by the end of calendar
1999. In connection with the merger, ILM II has agreed to cause ILM II
Holding to cancel and terminate the Facilities Lease Agreement immediately
prior to the effective time of the merger. 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.
3. RELATED PARTY TRANSACTIONS
Subject to the supervision of the Company's Board of Directors,
assistance in managing the business of the Company was provided by
PaineWebber. As previously discussed in the Company's Annual Report on Form
10-K for the year ended August 31, 1998, PaineWebber resigned effective as
of June 18, 1997.
The Company has retained Capital to be the property manager of the
Senior Housing Facilities pursuant to the Management Agreement, which
commenced on July 29, 1996. Lawrence A. Cohen, who served through July 28,
1998 as a Director of the Company and President, Chief Executive Officer
and Director of ILM II, has also served in various management capacities at
Capital Senior Living Corporation, an affiliate of Capital, since 1996. Mr.
Cohen currently serves as Chief Executive Officer and Acting Chief
Financial Officer of Capital Senior Living Corporation. 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 "Recent
Developments" in Note 2). Under the terms of the Management Agreement,
Capital earns a base management fee equal to 4% of the gross operating
revenues of the Senior Housing Facilities, as defined. Capital also earns
an incentive management fee equal to 25% of the amount by which the "net
cash flow" of the Senior Housing Facilities, as defined, exceeds a
specified base amount. Each August 31, the base amount is increased based
on the percentage increase in the Consumer Price Index as well as 15% of
Senior Housing Facility expansion costs. ILM II has guaranteed the payment
of all fees due to Capital under the terms of the Management Agreement. For
the nine- and three-month periods ended May 31, 1999, Capital earned
property management fees from the Company of $773,000 and $225,000,
respectively, compared to $684,000 and $240,000, for the nine- and
three-month periods ended May 31, 1998, respectively.
-10-
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 nine- and three-month periods ended May
31, 1999, Capital Senior Development, Inc. earned no fees from the Company
compared to fees of $73,000 and $14,000 earned for the nine- and
three-month periods ended May 31, 1998, respectively, 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 nine- and three-month periods ended May 31, 1999,
Greenburg Traurig earned fees from the Company of $54,000 and $0,
respectively. For the nine- and three-month periods ended May 31, 1998,
Greenberg Traurig earned fees from the Company of $115,000 and $56,000,
respectively.
Accounts receivable - related party at May 31, 1999 and August 31, 1998
includes an expense reimbursement payable to the Company from Lease I in
the amount of $102,000. Accounts payable - related party at May 31, 1999
and August 31, 1998 includes $301,000 and $287,000, respectively, for
variable rent due to ILM II Holding.
4. LEGAL PROCEEDINGS AND CONTINGENCIES
A property management agreement between ILM II Holding and AHC, which
covered the management of all six Senior Housing Facilities, was assigned
to the Company effective September 1, 1995. On July 29, 1996, the Company
and ILM II Holding ("the Companies") terminated the property management
agreement with AHC for "cause" pursuant to the terms of the contract.
Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against
AHC in the United States District Court for the Eastern District of
Virginia for breach of contract, breach of fiduciary duty and fraud. The
Company and ILM II Holding alleged, among other things, that AHC willfully
performed actions specifically in violation of the management agreement and
that such actions caused damages to the Companies.
Due to the termination of the agreement for cause, no termination fee
was paid to AHC. Subsequent to the termination of the agreement, AHC filed
for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic
State of California. The Companies challenged the filing, and the
Bankruptcy Court dismissed AHC's case effective October 15, 1996. In
November 1996, AHC filed with the Virginia District Court an answer in
response to the litigation initiated by the Companies and a counterclaim
against ILM II Holding. The counterclaim alleged that the management
agreement was wrongfully terminated for cause and requested damages, which
included the payment of a termination fee in the amount of $750,000,
payment of management fees pursuant to the contract from August 1, 1996
through October 15, 1996, which is the earliest date the management
agreement could have been terminated without cause, and recovery of
attorney's fees and expenses. The aggregate amount of damages against all
parties as requested in AHC's counterclaim exceeded $2,000,000. On June 13,
1997 and July 8, 1997, the court issued orders to enter judgment against
ILM II and ILM I in the aggregate amount of $1,000,000. The orders did not
contain any findings of fact or conclusions of law. On July 10, 1997, the
Company, ILM I, ILM II, and Lease I filed a notice of appeal to the United
States Court of Appeals for the Fourth Circuit from the orders.
-11-
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
4. LEGAL PROCEEDINGS AND CONTINGENCIES (CONTINUED)
On February 4, 1997, AHC filed a complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, who, through July 28,
1998 was a Director of the Company and President, Chief Executive Officer
and Director of ILM II, and others alleging that the defendants
intentionally interfered with AHC's property management agreement (the
"California litigation"). The complaint sought damages of at least
$2,000,000. On March 4, 1997, the defendants removed the case to Federal
District Court in the Central District of California. At a meeting on
February 26, 1997, the Company's Board of Directors concluded that since
all of Mr. Cohen's actions relating to the California litigation were taken
either on behalf of the Company under the direction of the Board or as a
PaineWebber employee, the Company or its affiliates should indemnify Mr.
Cohen with respect to any expenses arising from the California litigation,
subject to any insurance recoveries for those expenses. Legal fees paid by
the Company and Lease I on behalf of Mr. Cohen totaled $239,000 as of May
31, 1999. The Company's Board also concluded that, subject legal fees and
expenses incurred by Capital and its affiliates in the California
litigation. Subsequently, the Boards of Directors of the Company and Lease
I voted to increase the maximum amount of the advance to $100,000. By the
end of November 1997, Capital had incurred $100,000 of legal expenses in
the California litigation. On February 2, 1998, the amount to be advanced
to Capital was increased to include 75% of the California litigation legal
fees and costs incurred by Capital for December 1997 and January 1998, plus
75% of such legal fees and costs incurred by Capital thereafter, not to
exceed $500,000. By May 31, 1999, $226,000 of legal fees had been either
advanced or accrued in the Company's financial statements and $339,000 of
legal fees have been either advanced or accrued in Lease I's financial
statements for Capital's California litigation costs.
On August 18, 1998, the Company and its affiliates along with Capital
and its affiliates entered into a settlement agreement with AHC. The
Company and Lease I agreed to pay $1,625,000 and Capital and its
affiliates agreed to pay $625,000 to AHC in settlement of all claims,
including those related to the Virginia litigation and the California
litigation. The Company and its affiliates also entered into an
agreement with Capital and its affiliates to mutually release each other
from all claims that any such parties may have against each other, other
than any claims under the property management agreements. The Company's
Board of Directors believed that settling the AHC litigation was a
prudent course of action because the settlement amount represented a
small percentage of the increases in cash flow and value achieved for
the Company and its affiliates over the past two years.
On September 4, 1998, the full settlement amounts were paid to AHC
and its affiliates with the Company paying $650,000 and Lease I paying
$975,000 to AHC and its affiliates.
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
The Company has 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.
-12-
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. 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
$943,000 and $301,000 for the nine-and three-month periods ended May 31,
1999, respectively, compared to $697,000 and $261,000 for the nine- and
three-month periods ended May 31, 1998, respectively.
The Facilities Lease Agreement is scheduled to expire on December 31,
2000 (December 31, 1999, with respect to Santa Barbara). Accordingly, since
the Company does not have any current plans to operate or own any other
facilities or engage in any other business outside of its relationship with
ILM II, there is no assurance that the Company's operations will continue
beyond December 2000. Moreover, the Facilities Lease Agreement is subject to
termination at any time by ILM II Holding upon 30 days' notice to the Company
in connection with the sale to a non-affiliated third party of the Senior
Housing Facilities.
RECENT DEVELOPMENTS
On February 7, 1999, ILM II entered into an agreement and plan of merger
with Capital Senior Living Corporation, the corporate parent of Capital, and
certain affiliates of Capital. While there can be no assurance, consummation
of the merger is presently anticipated by the end of calendar 1999. In
connection with the merger, ILM II has agreed to cause ILM II Holding to
cancel and terminate the Facilities Lease Agreement immediately prior to the
effective time of the merger. 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.
LIQUIDITY AND CAPITAL RESOURCES
Occupancy levels for the six properties in which the Company has invested
averaged 94% and 92% for the nine- and three-month periods ended May 31,
1999, respectively, compared to 94% and 95% for the nine- and three-month
periods ended May 31, 1998, 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.
-13-
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
At May 31, 1999, the Company had cash and cash equivalents of
$1,363,000 compared to $1,497,000 at August 31, 1998. The decrease of
$134,000 is primarily attributable to the September 4, 1998 payment of the
AHC litigation settlement of $650,000 (see Note 4) offset by other cash flows
provided by operating activities. 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 1998 and 1997 or for the first,
second and third quarter of fiscal 1999. Payment of dividends, if any, will
be at the discretion of the Company's Board of Directors and will depend upon
such factors as the Company's financial condition, earnings, anticipated
investments and other relevant factors. The source of future liquidity is
expected to be from operating cash flows from the Senior Housing Facilities,
net of the Facilities Lease Agreement payments to ILM II Holding, and
interest income earned on invested cash reserves. Such sources of liquidity
are expected to be adequate to meet the Company's operating requirements on
both a short-term and long-term basis.
YEAR 2000
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize the year 2000 as a date other than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary
inability to process transactions, send invoices or engage in similar normal
business activities.
Based on ongoing assessments, the Company, through Capital, its property
manager, has developed a program to modify or replace portions of its
software and certain hardware, which are generally PC-based systems, so that
those systems will properly recognize and utilize dates beyond December 31,
1999. While there can be no assurance, as of May 31, 1999, the Company
believes that it substantially completed all software and hardware upgrades
as of December 31, 1998. The Company believes that these modifications and
replacements of existing software and certain hardware will mitigate the Year
2000 issue. However, if such modifications and replacements are not completed
timely, the Year 2000 issue could have a material impact on the operations of
the Company. The costs of Year 2000 remediation are not expected to be
material based on the Company's operations.
The Company has assessed its exposure to operating equipment, and such
exposure is not significant due to the nature of the Company's business.
The Company is not aware of any external agent with a Year 2000 issue
that would materially impact the Company's results of operations, liquidity
or capital resources. However, the Company has no means of determining
whether or ensuring those external agents will be Year 2000 ready. The
inability of external agents to complete their Year 2000 resolution process
in a timely fashion could impact the Company.
Management of the Company believes it has an effective program in place
to resolve the Year 2000 issue in a timely manner. As noted above, the
Company has substantially completed all necessary phases of its Year 2000
program. In addition, disruptions in the economy generally resulting from
Year 2000 issues could also adversely affect the Company. Although the amount
of potential liability and lost revenue cannot be reasonably estimated at
this time, in a worst case situation, if Capital, the Company's most
significant third party contractor, were to experience a year 2000 problem,
it is likely that the Company would not receive rental income as it became
due from Senior Living Facility residents. The Company in turn would fail to
pay ILM II Holding lease payments as they arise under the master lease, and
ILM II Holding in turn would fail to pay ILM II mortgage payments due it.
However, the Company believes that given the nature of its business, such
problem would be temporary and is easily remedied with simple accountings.
-14-
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
RESULTS OF OPERATIONS
NINE MONTHS ENDED MAY 31, 1999 VERSUS Nine MONTHS ENDED MAY 31, 1998
REVENUES
Total revenues were $12,142,000 for the nine months ended May 31, 1999
compared to $11,540,000 for the same period of the prior year, representing
an increase of $602,000 or 5.2%. 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 $11,528,000 for the nine months ended May 31, 1999
compared to $11,199,000 for the same period in the prior year, representing
an increase of $329,000 or 2.9%. This increase was primarily due to increases
in facilities lease rent expense of $247,000 or 6.7%, administrative salaries
and expenses of $138,000 or 18.4%; depreciation expense of $135,000 or
210.9%; and property management fees of $89,000 OR 13%, offset by a $343,000
or 58.3% decrease in professional fees as a result of settling the AHC
litigation as well as minor increases and decreases in certain 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 of December 31, 2000, as such assets are not subject
to repurchase by ILM II Holding. The increase in property management fees is
attributable to higher incentive management fees earned by the property
manager as a result of improved performance at the Senior Housing Facilities.
INCOME TAX EXPENSE
Income tax expense increased overall by $110,000 or 80.9% as compared to
the same period in the prior year, as a result of an increase in income
before taxes of $273,000 or 44.5%, from $341,000 in 1998 to $614,000 in 1999.
NET INCOME
Primarily as a result of the factors noted above, net income increased
$163,000 pr 79.5% to $368,000 for the nine months ended May 31, 1999 from net
income of $205,000 for the nine months ended May 31, 1998.
THREE MONTHS ENDED MAY 31, 1999 VERSUS THREE MONTHS ENDED MAY 31, 1998
REVENUES
Total revenues were $4,012,000 for the quarter ended May 31, 1999
compared to $3,927,000 for the same period of the prior year, representing an
increase of $85,000 or 2.2%. 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 $3,854,000 for the quarter ended May 31, 1999
compared to $3,810,000 for the same period in the prior year, representing an
increase of $44,000 or 1.2%. This increase was principally comprised of
increases in administrative salaries and expenses of $111,000 or 61.7%;
depreciation expense of $60,000 or 285.7%; and facilities lease rent expense
of $40,000 or 3.2%; offset by significant decreases in professional fees of
$180,000 or 69% as a result of settling the AHC litigation. 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 of December 31, 1999, as such assets are not subject to repurchase by
ILM II Holding. The increase in facilities lease rent expense is the result
of increased variable rent payments due under the Facilities Lease Agreement.
-15-
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 increased overall by $16,000 or 34% as compared to the
same period in the prior year, as a result of an increase in income before
taxes of $41,000 or 35%.
NET INCOME
Primarily as a result of the factors noted above, net income increased
$25,000 or 33% to $95,000 for the quarter ended May 31, 1999 from net income
of $70,000 for the quarter ended May 31, 1998.
-16-
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 THE
COMPANY MAKES ABSOLUTELY NO PROMISES, GUARANTEES, REPRESENTATIONS OR
WARRANTIES AS TO THE ACCURACY THEREOF.
-17-
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
-18-
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: November 12, 1999
------------------
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