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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended February 28, 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
(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.)
28 State Street, Suite 1100, Boston, MA 02109
(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 ____No _X__
Shares of common stock outstanding as of February 28, 1999: 5,180,952.
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Page 1 of 19
ILM II LEASE CORPORATION
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
Balance Sheets
February 28, 1999 (Unaudited) and August 31, 1998............................................4
Statements of Income
For the six months and three months ended February 28, 1999 and 1998 (Unaudited).............5
Statements of Changes in Shareholders' Equity
For the six months ended February 28, 1999 and 1998 (Unaudited)..............................6
Statements of Cash Flows
For the six months ended February 28, 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)
3
ILM II LEASE CORPORATION
BALANCE SHEETS
February 28, 1999 (Unaudited) and August 31, 1998
(Dollars in thousands, except per share data)
ASSETS
February 28, 1999 August 31, 1998
----------------- ---------------
Cash and cash equivalents $ 1,167 $1,497
Accounts receivable, net 145 89
Accounts receivable - related party 102 102
Prepaid expenses and other assets 48 50
Tax refund receivable 27 158
--------- -------
Total current assets 1,489 1,896
Furniture, fixtures and equipment 939 783
Less: accumulated depreciation (344) (225)
-------- --------
595 558
Deposits 9 9
Deferred tax asset, net 88 270
-------- --------
$2,181 $2,733
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 678 $ 789
Termination fee payable - 650
Real estate taxes payable 103 209
Accounts payable - related party 332 287
Security deposits 36 25
--------- ---------
Total current liabilities 1,149 1,960
Deferred rent payable 62 76
--------- ---------
Total liabilities 1,211 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 470 197
-------- --------
Total shareholders' equity 970 697
-------- --------
$2,181 $2,733
====== ======
See accompanying notes.
4
ILM II LEASE CORPORATION
STATEMENTS OF INCOME
For the six months and three months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
Six Months Ended Three Months Ended
February 28, February 28,
1999 1998 1999 1998
---- ---- ---- ----
Revenues:
Rental and other income $8,122 $7,600 $4,085 $3,868
Interest income 7 12 4 7
------ ------ ------ ------
8,129 7,612 4,089 3,875
Expenses:
Facilities lease rent expense 2,644 2,446 1,333 1,254
Dietary salaries, wages and food service expenses 1,366 1,320 675 657
Administrative salaries, wages and expenses 597 570 315 287
Marketing salaries, wages and expenses 323 332 153 165
Utilities 527 522 254 253
Repairs and maintenance 286 251 156 131
Real estate taxes 262 308 128 125
Property management fees 547 444 323 239
Other property operating expenses 708 694 349 349
General and administrative expenses 118 106 60 57
Directors compensation 27 34 13 18
Professional fees 151 316 (20) 194
Depreciation expense 118 44 72 21
------ ------ ------ ------
7,674 7,387 3,811 3,750
------ ------ ------ ------
Income before taxes 455 225 278 125
Income tax expense:
Current - 235 - 50
Deferred 182 (145) 111 -
------ ------ ------ ------
182 90 111 50
------ ------ ------ ------
Net income $273 $135 $167 $ 75
====== ===== ====== ======
Basic earnings per share of common stock $ 0.05 $0.03 $ 0.03 $ 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 six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars in thousands, except per share data)
Common Stock Additional
$.01 Par Value Paid-In Retained
Shares Amount Capital Earnings Total
------ ------ ------- -------- -----
Balance at August 31, 1997 5,180,952 $ 52 $448 $219 $719
Net Income - - - 135 135
--------- ---- ---- ---- ----
-
Balance at February 28, 1998 5,180,952 $ 52 $448 $354 $ 854
========= ==== ==== ==== =====
Balance at August 31, 1998 5,180,952 $ 52 $448 $197 $ 697
Net Income - - - 273 273
--------- ---- ---- ---- ----
Balance at February 28, 1999 5,180,952 $ 52 $448 $470 $ 970
========= ==== ==== ==== =====
See accompanying notes.
6
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1999 and 1998 (Unaudited)
(Dollars In thousands)
Six Months Ended
February 28,
1999 1998
---- ----
Cash flows from operating activities:
Net income $ 273 $ 135
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Depreciation expense 118 44
Deferred tax expense (benefit) 182 (145)
Changes in assets and liabilities:
Accounts receivable, net (56) 54
Accounts receivable - related party -- (64)
Prepaid expenses and other assets 2 241
Tax refund receivable 131 --
Accounts payable and accrued expenses (111) 44
Accounts payable - related party 45 429
Termination fee payable (650) --
Real estate taxes payable (106) (96)
Income taxes payable -- 101
Deferred rent payable (14) --
Security deposits, net 11 (7)
Net cash (used in) provided by operating activities (175) 736
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (157) (68)
------- -------
Net cash used in investing activities (157) (68)
Net (decrease) increase in cash and cash equivalents (330)
668
Cash and cash equivalents, beginning of period 1,497 1,156
------- -------
Cash and cash equivalents, end of period $ 1,167 $ 1,824
======= =======
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 February
28, 1999, and revenues and expenses for each of the six- and three-month periods
ended February 28, 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 six- and three-month periods ended February 28,
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 as
Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation,
an affiliate of Capital, since November 1996. 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. Consummation of
the merger is presently anticipated in October 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:
Rentable Resident
Name Location Units Capacity
- ---- -------- ----- --------
The Palms Fort Myers, FL 205 255
Crown Villa Omaha, NE 73 73
Overland Park Place Overland Park, KS 141 153
Rio Las Palmas Stockton, CA 164 190
The Villa at Riverwood St. Louis County, MO 120 140
Villa Santa Barbara (1) Santa Barbara, CA 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.
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).
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
$642,000 and $332,000 for the six- and three-month periods ended February 28,
1999, respectively, compared to $436,000 and $245,000 for the six- and
three-month periods ended February 28, 1998, respectively.
The Company's use of the properties is limited to use as Senior Housing
Facilities. The Company has responsibility to obtain and maintain all licenses,
certificates and consents needed to use and operate each Senior Housing
Facility, and to use and maintain each Senior Housing Facility in compliance
with all local board of health and other applicable governmental and insurance
regulations. The Senior Housing Facilities located in California, Florida and
Kansas are licensed by such states to provide assisted living services. In
addition, various health and safety regulations and standards, which are
enforced by state and local authorities,
9
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
2. The Facilities Lease Agreement (continued)
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. Consummation of the merger is presently
anticipated in October 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 as well as President, Chief Executive Officer and Director of ILM
II, has also served as Vice Chairman and Chief Financial Officer of Capital
Senior Living Corporation, an affiliate of Capital, since November 1996. 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 six- and
three-month periods ended February 28, 1999, Capital earned property management
fees from the Company of $547,000 and $323,000, respectively, compared to
$444,000 and $239,000, for the six- and three-month periods ended February 28,
1998, respectively.
On September 18, 1997, the Company entered into an agreement with Capital
Senior Development, Inc., an affiliate of Capital, to manage the development
process for the potential expansions of several of the Senior Housing
Facilities. Capital Senior Development, Inc. would receive a fee equal to 7% of
the total development costs of these potential expansions if they are pursued.
ILM II Holding would also reimburse the Company for all costs related to these
potential expansions including fees to Capital Senior Development, Inc. For the
six- and three-month periods ended February 28, 1999, Capital Senior
Development, Inc. earned no fees from the Company compared to fees of $99,000
and $59,000 earned for the six- and three-month periods ended
10
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
3. Related Party Transactions (continued)
February 28, 1998, respectively, for managing pre-construction development
activities for potential expansions of the Senior Housing Facilities.
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
six- and three-month periods ended February 28, 1999, Greenburg Traurig earned
fees from the Company of $22,000 and $20,000, respectively. For the six- and
three-month periods ended February 28, 1998, Greenberg Traurig earned fees from
the Company of $69,000 and $33,000, respectively.
Accounts receivable - related party at February 28, 1999 and August 31,
1998 includes an insurance refund due to the Company from Lease I in the amount
of $102,140. Accounts payable - related party at February 28, 1999 and August
31, 1998 includes $332,000 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.
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
11
ILM II LEASE CORPORATION
Notes to Financial Statements (Unaudited)
(continued)
4. Legal Proceedings and Contingencies (continued)
recoveries for those expenses. Legal fees paid by the Company and Lease I on
behalf of Mr. Cohen totaled $239,000 as of February 28, 1999. The Company's
Board also concluded that, subject to certain conditions, the Company or its
affiliates should advance up to $20,000 to pay reasonable 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
February 28, 1999, $209,000 of legal fees had been either advanced or accrued in
the Company's financial statements and $313,000 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.
5. Construction Loan Financing
The Company has finalized negotiations with a major bank to provide a
construction loan facility that will provide ILM II with up to $8.8 million to
fund the capital costs of these potential expansion programs. The construction
loan facility will be secured by a first mortgage of ILM II's properties and
collateral assignment of the Company's leases of such properties. The loan will
have a three-year term with interest accruing at a rate equal to LIBOR plus
1.10% or Prime plus 0.5%. The loan term could be extended for an additional two
years beyond its maturity date with monthly payments of principal and interest
on a 25-year amortization schedule.
6. Subsequent Event
On March 9, 1999, Jeffry R. Dwyer was elected President of the Company and
Lease I.
12
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
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. 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 $642,000 and $332,000 for the six-
and three-month periods ended February 28, 1999, respectively, compared to
$436,000 and $245,000 for the six- and three-month periods ended February 28,
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. Consummation of the merger is presently
anticipated in October 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 which the Company leases from ILM II
Holding averaged 95% and 95% for the three months ended February 28, 1999 and
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.
At February 28, 1999, the Company had cash and cash equivalents of
$1,167,000 compared to $1,497,000 at August 31, 1998. The decrease of $330,000
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, 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
13
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
Company did not pay cash dividends in fiscal years 1998 and 1997 or for the
first and second 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 Company relies upon PC-based computer systems and does not expect to
incur material costs to transition to Year 2000 compliant systems in its
internal operations. The Company does not expect this project to have a
significant effect on operations. The Company will continue to implement systems
and all new investments are expected to be with Year 2000 compliant software.
14
ILM II LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)
Results of Operations
Six Months Ended February 28, 1999 versus Six Months Ended February 28, 1998
Revenues
Total revenues were $8,129,000 for the six months ended February 28, 1999
compared to $7,612,000 for the same period of the prior year, representing an
increase of $517,000 or 6.8%. This increase is the result of increased rental
rates at certain of the Company's Senior Housing Facilities located in strong
markets.
Expenses
Total expenses were $7,674,000 for the six months ended February 28, 1999
compared to $7,387,000 for the same period in the prior year, representing an
increase of $287,000 or 3.9%. This increase was primarily due to increases in
Facilities Lease rent expense of $198,000, property management fees of $103,000,
and depreciation expense of $74,000, offset by a $165,000 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 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. 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.
Income Tax Expense
Income tax expense increased overall by $92,000 as compared to the same
period in the prior year, as a result of an increase in income before taxes of
$230,000.
Net Income
Primarily as a result of the factors noted above, net income decreased
$138,000 to net income of $273,000 for the six months ended February 28, 1999
from net income of $135,000 for the six months ended February 28, 1998.
Three Months Ended February 28, 1999 versus Three Months Ended February 28, 1998
Revenues
Total revenues were $4,089,000 for the quarter ended February 28, 1999
compared to $3,875,000 for the same period of the prior year, representing an
increase of $214,000 or 5.5%. This increase is the result of increased rental
rates at certain of the Company's Senior Housing Facilities located in strong
markets.
Expenses
Total expenses were $3,811,000 for the quarter ended February 28, 1999
compared to $3,750,000 for the same period in the prior year, representing an
increase of $61,000 or 1.6%. This increase was principally comprised of
increases in Facilities Lease rent expense of $79,000; property management fees
of $84,000 and depreciation expense of $51,000 offset by significant decreases
in professional fees of $214,000 as a result of settling the AHC litigation as
well as a $209,000 decrease in general and administrative expense due to changes
in estimated liabilities at August 31, 1997, that were reduced in 1998. The
increase in Facilities Lease rent expense is the result of increased variable
rent payments due under the Facilities Lease Agreement. 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. 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 Holding.
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 $61,000 as compared to the same
period in the prior year, as a result of an increase in income before taxes of
$153,000.
Net Income
Primarily as a result of the factors noted above, net income increased
$92,000 to net income of $167,000 for the quarter ended February 28, 1999 from
net income of $75,000 for the quarter ended February 28, 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: April 14, 1999
19