UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A No. 1
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED: AUGUST 31, 1996
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: 0-18249
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PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
(now known as ILM Senior Living, Inc.)
(Exact name of registrant as specified in its charter)
Virginia 04-3042283
- ----------------------- ------------------------------------
(State of organization) (I.R.S. Employer Identification No.)
1285 Avenue of the Americas, New York, New York 10104
- -------------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (212) 713-4264
----------------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each
exchange on
Title of each class which registered
- ------------------- ----------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock, $.01 Par Value
(Title of class)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ---
Shares of common stock outstanding as of August 31, 1996: 7,520,100 (20,100 of
which were initially sold to an affiliate). The aggregate sales price of the
shares sold was $75,201,000 ($201,000 for the 20,100 shares sold to an
affiliate). This does not reflect market value. There is no current market for
these shares.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
- ------------------------------- Parts II and IV
Prospectus of registrant dated
August 8, 1990, as supplemented
Current Report on Form 8-K Part IV
of registrant dated July 29, 1996
<PAGE>
PART I
Item 1. Business (Amended to note that the Company is no longer advised by
affiliates of PaineWebber Group, Inc. and to add disclosures regarding
restrictions on the Company's borrowing ability)
PaineWebber Independent Living Mortgage Fund, Inc. (the "Company") is a
finite-life corporation organized on March 6, 1989 in the Commonwealth of
Virginia for the purpose of making construction and participating mortgage loans
secured by rental housing complexes for independent senior citizens ("Senior
Housing Facilities"). On June 21, 1989, the Company commenced a public offering
of up to 10,000,000 shares of common stock pursuant to a Registration Statement
filed on Form S-11 under the Securities Act of 1933 (Registration Statement No.
33-27653). On July 21, 1989, the public offering terminated. The Company issued
7,520,100 shares, representing capital contributions of $75,201,000, of which
$201,000 represented the sale of 20,100 shares to an affiliate, PaineWebber
Group, Inc. ("PaineWebber"). As of November 1, 1996, PaineWebber and its
affiliates held 165,344 shares of the Company's common stock. The Company has
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. As a REIT, the Company is allowed a deduction for the amount of
dividends paid to its shareholders, thereby effectively subjecting the
distributed net income of the Company to taxation at the shareholder level only.
In order to qualify as a REIT, the Company must distribute at least 95% of its
taxable income on an annual basis and meet certain other requirements.
The Company originally invested the net proceeds of the initial public offering
in eight participating mortgage loans secured by Senior Housing Facilities
located in seven different states. All of the loans made by the Company were
originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing
in the development, acquisition and operation of Senior Housing Facilities. The
Company entered into an Exclusivity Agreement with AHC and its parent company,
Angeles Corporation ("Angeles"), which required AHC to provide the Company with
certain specific opportunities to finance Senior Housing Facilities and set
forth the terms and conditions of the loans which were made. The loan documents
under the aforementioned Exclusivity Agreement called for interest to be paid on
construction loans at the rate of 13% per annum during the construction period
and for Base Interest to be paid on the permanent loans at the rate of 10% per
annum. In addition to the Base Interest, Additional Interest was to be payable
on the permanent loans in an amount equal to 10% of the Gross Revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
Exclusivity Agreement, Additional Interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the entire
term of the investments. In the aggregate, the properties securing loans from
the Company did not generate sufficient cash flow to cover the debt service
payments owed to the Company under the amended terms of the Exclusivity
Agreement. To the extent that the properties did not generate sufficient cash
flow to make the full payments due under the loan documents, the shortfall was
funded by AHC through December 1992. The source of cash to make up these
shortfalls was from specified deficit reserve accounts, which had been funded
from the proceeds of the mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between the Company, AHC and Angeles
was reached whereby ownership of the properties would be transferred from AHC to
the Company or its designated affiliates. Under the terms of the Settlement
Agreement, the Company released AHC and Angeles from certain obligations under
the loans. On April 27, 1994, each of the properties owned by AHC and securing
the Loans was transferred (collectively, "the Transfers") to newly-created
special purpose corporations affiliated with the Company (collectively, "the
Property Companies"). The Transfers had an effective date of April 1, 1994 and
were made pursuant to the Settlement Agreement entered into on February 17, 1994
("the Settlement Agreement") between the Company and AHC which had previously
been approved by the bankruptcy court handling the bankruptcy case of Angeles.
All of the capital stock of each Property Company was held by ILM Holding, Inc.
("ILM Holding"), a Virginia corporation. In August 1995, each of the Property
Companies merged into ILM Holding. As a result,
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<PAGE>
ownership of the Senior Housing Facilities is now held by ILM Holding, and the
Property Companies no longer exist as separate legal entities. Through January
10, 1997, the capital stock of ILM Holding was owned by the Company and PWP
Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber
Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of
PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber
Group, Inc. ("PaineWebber"). The Company held substantially all of the economic
ownership in ILM Holding, while PWP Holding held voting control. As discussed
further under Item 7, on November 21, 1996 the Company requested that PWPI cause
PWP Holding to sell all of the stock held by PWP Holding in ILM Holding to the
Company for a price equal to the fair market value of the 1% economic interest
in ILM Holding represented by the common stock. On January 10, 1997, this
transfer of the common stock of ILM Holding was completed at an agreed upon fair
value of $46,000.
As part of the fiscal 1994 settlement agreement with AHC, ILM Holding retained
AHC as the property manager for all of the Senior Housing Facilities pursuant to
the terms of a management agreement. As discussed further in Item 7, the
management agreement with AHC was terminated in July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC,
management investigated and evaluated the available options for structuring the
ownership of the properties 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. To retain REIT status, the Company must ensure
that 75% of its annual gross income is received from qualified sources. Under
the original investment structure, interest income from the Company's mortgage
loans was a qualified source. The properties that are now owned by an affiliate
of the Company are Senior Housing Facilities that provide tenants with more
services, such as meals, activities, assisted living, etc., than are customary
for ordinary residential apartment properties. As a result, a significant
portion of the rents paid by the tenants includes income for the increased level
of services received by them. Consequently, the rents paid by the tenants likely
would not be qualified rents for REIT qualification purposes if received
directly by the Company. Therefore, if the Company received such rents directly,
it could lose REIT status and be taxed as a regular corporation. After extensive
review, the Board of Directors determined that it would be in the best interests
of the shareholders for the Company to retain REIT status and master lease the
properties to a shareholder-owned operating company. As discussed further in
Item 7, on September 12, 1994 the Company formed a new subsidiary, ILM I Lease
Corporation, for the purpose of operating the Senior Housing Facilities. The
Senior Housing Facilities were leased to ILM I Lease Corporation effective
September 1, 1995 (see Item 7 for a description of the master lease agreement).
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<PAGE>
The Company's investments as of August 31, 1996 are described below:
<TABLE>
<CAPTION>
Property Name Date of
and Location (1) Type of Property Investment Size
- ---------------- ---------------- ---------- ----
<S> <C> <C> <C>
Independence Village of Winston-Salem Senior Housing Facility 6/29/89 156 Units
Winston-Salem, NC
Independence Village of East Lansing Senior Housing Facility 6/29/89 159 Units
East Lansing, MI
Independence Village of Raleigh Senior Housing Facility 12/18/89 163 Units
Raleigh, NC
Independence Village of Peoria Senior Housing Facility 12/18/89 164 Units
Peoria, IL
Crown Pointe Apartments Senior Housing Facility 2/14/89 133 Units
Omaha, NE
Sedgwick Plaza Apartments Senior Housing Facility 2/14/89 150 Units
Wichita, KS
West Shores Senior Housing Facility 12/14/90 134 Units
Hot Springs, AR
Villa Santa Barbara (2) Senior Housing Facility 7/13/92 123 Units
Santa Barbara, CA
</TABLE>
(1) See Notes to the Financial Statements filed with this Annual Report for a
description of the agreements through which the Company has acquired these
real estate investments.
(2) The acquisition and improvement of the Santa Barbara facility was jointly
financed by the Company and an affiliated company, PaineWebber Independent
Living Mortgage Inc. II (ILM2). Any amounts generated by the operations of
the Santa Barbara property are equitably apportioned between the Company,
together with its consolidated affiliate, and ILM2, together with its
consolidated affiliate (generally 25% and 75%, respectively).
The Senior Housing Facilities are subject to competition from similar properties
in the vicinities in which they are located. The properties are located in areas
with significant senior citizen populations and, as a result, there are, and
will likely continue to be, a variety of competing projects aimed at attracting
senior residents. Such projects will generally compete on the basis of rental
rates, services, amenities and location. The Company has no real estate
investments located outside the United States. The Company is engaged solely in
the business of real estate investment. Therefore, presentation of information
about industry segments is not applicable.
The Company originally expected to liquidate its investments after a period of
approximately ten years, although under the terms of its organizational
documents property sales may occur at earlier or later dates. The Board of
Directors may defer the Company's scheduled liquidation date, if in the opinion
of a majority of the Directors, the disposition of the Company's assets at such
time would result in a material under-realization of the value of such assets;
provided, however, that no such deferral may extend beyond December 31, 2004.
The net proceeds of any sale transactions are expected to be distributed to the
Shareholders, so that the Company will, in effect, be self-liquidating.
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<PAGE>
Under certain circumstances it may be advantageous for the Company to borrow
funds to meet its investment objectives and maximize return to shareholders. The
Company's bylaws provide that the Company may not incur indebtedness if, after
giving effect to the incurrence of debt thereof, aggregated indebtedness,
secured and unsecured, would exceed 300% of the Company's net assets on a
consolidated basis, as calculated at the end of each calendar quarter in
accordance with generally accepted accounting principles.
In addition to the foregoing, the Company may incur indebtedness in order to
prevent default under loans or to discharge them entirely if this becomes
necessary to protect the Company's investment. This may occur if foreclosure
proceedings are instituted by the holder of a mortgage interest which is senior
to that held by the Company, although the Company does not anticipate entering
into loans that are subject to such senior mortgage interests. In addition, the
Company may incur indebtedness in order to assist in the operation of any
property acquired by the Company as a result of a default on a loan made by the
Company secured by the property to protect such loan.
Through June 18, 1997 and subject to the supervision of the Company's Board of
Directors, assistance in the management of the business of the Company was
provided by PaineWebber ILM Advisor, L.P. (the "Advisor"), a limited partnership
comprised of ILM REIT Advisor, Inc., a Virginia corporation, and Properties
Associates, L.P., a Virginia limited partnership. ILM REIT Advisor, Inc. is a
wholly owned subsidiary of PWPI. The partners of the Advisor are affiliates of
PWI and PaineWebber.
As discussed further in Item 7, the Company has accepted the resignation of the
Advisor, effective as of June 18, 1997. The Advisor agreed to continue to
provide certain administrative services to the Company and its affiliates
through August 31, 1997, pursuant to the terms of a transition services
agreement entered into with the Company and its affiliates. The Company and its
affiliates have also accepted, effective as of June 18, 1997, the resignations
of those officers and directors who are employees of or otherwise affiliated
with the Advisor or its affiliates. Subsequent to resignation of the Advisor and
affiliated persons, the Board of Directors engaged a former employee of PWPI as
a consultant to assist in the management of the Company. The Company is
currently evaluating various strategic alternatives, including the possibility
of becoming self-managed.
Subsequently to June 18, 1997, there are five directors of the Company, none of
whom is an affiliate of the Advisor. The directors are subject to removal by the
vote of the holders of a majority of the outstanding shares. The directors are
responsible for the general policies of the Company, but they are not required
to personally conduct the business of the Company in their capacities as
directors.
The terms of transactions between the Company and the Advisor and its affiliates
are set forth in Items 11 and 13 below to which reference is hereby made for a
description of such terms and transactions.
Effective August 14, 1997, the name of the Company was changed to ILM Senior
Living, Inc.
Item 3. Legal Proceedings (Amended to update the status of litigation since the
date of the original filing.)
On July 29, 1996, ILM I Lease Corporation and ILM Holding, Inc. ("the
Companies") terminated the property management agreement with Angeles Housing
Concepts, Inc. ("AHC") covering the eight senior housing facilities leased by
ILM I Lease Corporation from ILM Holding, Inc., the Company's consolidated
affiliate. The management agreement was terminated for cause pursuant to
Sections 1.05 (a) (i), (iii) and (iv) of the agreement. 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. ILM I Lease Corporation and ILM Holding, Inc. allege 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 management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed
with the Virginia District Court an Answer in response to the litigation
initiated by the Companies and a Counterclaim against ILM Holding, Inc. The
Counterclaim alleges that
I - 4
<PAGE>
the management agreement was wrongfully terminated for cause and requests
damages which include the payment of the termination fee in the amount of
$1,250,000, payment of management fees pursuant to the contract from August 1,
1996 through October 15, 1996, which is the earliest date that the management
agreement could have been terminated without cause, and recovery of attorney's
fees and expenses. PaineWebber Independent Living Mortgage Fund, Inc. guaranteed
the payment of the termination fee at issue in these proceedings. The court
initially set a trial date of April 28, 1997 but, at AHC's request, rescheduled
the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the court issued
Orders purporting to enter judgment against the Company and ILM2 in the amount
of $1,000,000. In so doing, the court effectively canceled the June 23, 1997
trial date. The Orders did not contain any findings of fact or conclusions of
law. On July 10, 1997, the Company, PaineWebber Independent Living Mortgage Inc.
II (ILM II), ILM I Lease Corporation and ILM II Lease Corporation filed a notice
of appeal to the United State Court of Appeals for the Fourth Circuit. The
Company intends to diligently prosecute the appeal. The eventual outcome of this
litigation cannot presently be determined. However, as reported in the Company's
report on Form 10-Q for the quarter ended May 31, 1997, the Company has recorded
a provision in the amount of $600,000 for the liability which might result from
the court's orders.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of
California against Capital, Lawrence Cohen, President, Chief Executive Officer,
and a director of the Company and others alleging that the defendants
intentionally interfered with AHC's property management agreement. The complaint
seeks 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. Trial
in the action has been set for January 13, 1998 and discovery has just begun. At
a Board meeting on February 26, 1997, the Company's Board of Directors concluded
that since all of Mr. Cohen's actions relating to the California litigation were
taken either on behalf of the Company under the direction of the Board or as a
PaineWebber Properties 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. 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 in the California litigation. Subsequently, the Boards of Directors
of ILM I Lease Corporation and ILM II Lease Corporation voted to increase the
maximum amount of the advance to $100,000. The defendants intend to vigorously
defend the claims made against them in the California litigation. The eventual
outcome of this litigation cannot presently be determined and, accordingly, no
provision for any liability has been recorded in the accompanying financial
statements.
In November 1994, a series of purported class actions (the "New York Limited
Partnership Actions") were filed in the United States District Court for the
Southern District of New York concerning PaineWebber Incorporated's sale and
sponsorship of various limited partnership interests and common stock, including
the securities offered by the Company. The lawsuits were brought against
PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"),
among others, by allegedly dissatisfied investors. In March 1995, after the
actions were consolidated under the title In re PaineWebber Limited Partnership
Litigation, the plaintiffs amended their complaint to assert claims against a
variety of other defendants, including PaineWebber Properties Incorporated
("PWPI"), an affiliate of PaineWebber and the parent company of the general
partner of the Advisor to the Company. On May 30, 1995, the court certified
class action treatment of the claims asserted in the litigation.
The amended complaint in the New York Limited Partnership Actions alleged that,
in connection with the sale of common stock of the Company, the defendants (1)
failed to provide adequate disclosure of the risks involved; (2) made false and
misleading representations about the safety of the investments and the Company's
anticipated performance; and (3) marketed the Company to investors for whom such
investments were not suitable. The plaintiffs, who purported to be suing on
behalf of all persons who invested in the Company also alleged that following
the issuance of the Company's stock, the defendants misrepresented financial
information about the Company's value and performance. The amended complaint
alleged that the defendants violated the Racketeer Influenced and Corrupt
Organizations Act ("RICO") and the federal securities laws. The plaintiffs
sought unspecified damages, including reimbursement for all sums invested by
them in the Company's stock, as well as disgorgement of all fees and other
income derived by PaineWebber from the Company. In addition, the plaintiffs also
sought treble damages under RICO.
In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties have
agreed to settle the case. Pursuant to that memorandum of understanding,
PaineWebber irrevocably deposited $125 million into an escrow fund under the
supervision of the United States District Court for the
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<PAGE>
Southern District of New York to be used to resolve the litigation in accordance
with a definitive settlement agreement and a plan of allocation. On July 17,
1996, PaineWebber and the class plaintiffs submitted a definitive settlement
agreement which has been preliminarily approved by the court and provides for
the complete resolution of the class action litigation, including releases in
favor of the Company and PWPI, and the allocation of the $125 million settlement
fund among investors in the various partnerships and REITs at issue in the case.
As part of the settlement, PaineWebber also agreed to provide class members with
certain financial guarantees relating to some of the partnerships and REITs. The
details of the settlement are described in a notice mailed directly to class
members at the direction of the court. A final hearing on the fairness of the
proposed settlement was held in December 1996, and in March 1997 the court
announced its final approval of the settlement. The release of the agreed upon
settlement proceeds had been delayed pending the resolution of an appeal of the
settlement agreement by two of the plaintiff class members. In July, 1997, the
United States Court of Appeals for the Second Circuit upheld the settlement over
the objections of the two class members. As part of the settlement agreement,
PaineWebber agreed not to seek indemnification from the related partnerships and
REITs at issue in the litigation (including the Company)for any amounts it is
required to pay under the settlement.
In February 1996, approximately 150 plaintiffs filed an action entitled Abbate
v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiffs'
purchases of various limited partnership investments and REIT stocks, including
those offered by the Company. The complaint alleges, among other things, that
PaineWebber and its related entities committed fraud and misrepresentation and
breached fiduciary duties allegedly owed to the plaintiffs by selling or
promoting limited partnership and REIT investments that were unsuitable for the
plaintiffs and by overstating the benefits, understating the risks and failing
to state material facts concerning the investments. The complaint seeks
compensatory damages of $15 million plus punitive damages. In September 1996,
the court dismissed many of the plaintiffs' claims as barred by applicable
securities arbitration regulations.
In June 1996, approximately 50 plaintiffs filed an action entitled Bandrowski v.
PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiff's
purchases of various limited partnership interests and REIT stocks, including
those offered by the Company. The complaint is substantially similar to the
complaint in the Abbate action described above, and seeks compensatory damages
of $3.4 million plus punitive damages.
In July 1996, approximately 15 plaintiffs filed an action entitled Barstad v.
PaineWebber Inc. in Maricopa County, Arizona Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiffs'
purchases of various limited partnership interests and REIT stocks, including
those offered by the Company. The complaint is substantially similar to the
complaint in the Abbate action described above, and seeks compensatory damages
of $752,000 plus punitive damages.
In December 1996. PaineWebber agreed to settle the Abbate, Bandrowski and
Barstad actions. Final releases and dismissals with regard to these actions were
received during fiscal 1997.
Based on these settlement agreements which cover all of the outstanding
shareholder litigation, management does not expect that the resolution of the
shareholder matters will have a material impact on the Company's financial
statements, taken as a whole.
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<PAGE>
PART II
Item 6. Selected Financial Data (Amended to be consistent with amended financial
statements included in Item 14)
PaineWebber Independent Living Mortgage Fund, Inc.
For the years ended August 31, 1996, 1995, 1994, 1993 and 1992
(in thousands except per unit data)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 129 $ 174 $ 85 $ 166 $ 228
Operating loss $ (641) $ (954) $ (918) $ (611) $ (621)
Gain on sale of Treasury Note- -- -- -- $ 82 --
Equity in income
from properties securing
mortgage loans. $ 4,756 $ 5,053 $ 3,822 $ 2,671 $ 822
Net income $ 4,115 $ 4,099 $ 2,904 $ 2,142 $ 201
Earnings per
share of common
stock $ 0.55 $ 0.54 $ 0.39 $ 0.28 $ 0.03
Cash dividends paid
per share of common
stock $ 0.70 $ 0.71 $ 0.40 $ 0.70 $ 1.00
Total assets $41,451 $43,489 $43,580 $43,776 $46,859
</TABLE>
The above selected financial data should be read in conjunction with the
financial statements and related notes appearing elsewhere in this Annual
Report.
The above earnings and cash dividends paid per share of common stock are based
upon the 7,520,100 shares outstanding during each year.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (Amended to be consistent with amended financial statements
included in Item 14, to reflect changes in ownership subsequent to the original
filing, and to note the resignation of the Advisor effective June 18, 1997.)
Liquidity and Capital Resources
The Company offered shares of its common stock to the public from June 21, 1989
to July 21, 1989 pursuant to a Registration Statement filed under the Securities
Act of 1933. Capital contributions of $75,201,000 were received by the Company
(including $201,000 contributed by PaineWebber Group, Inc.) and, after deducting
selling expenses and offering costs and allowing for adequate cash reserves,
approximately $62.8 million was available to be invested in participating first
mortgage loans secured by Senior Housing Facilities. The Company originally
invested the net proceeds of the initial public offering in eight participating
mortgage loans secured by Senior Housing Facilities located in
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<PAGE>
seven different states. All of the loans made by the Company were originally
with Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the
development, acquisition and operation of Senior Housing Facilities. As
previously reported, AHC defaulted on the regularly scheduled mortgage loan
payments due to the Company on March 1, 1993 as a result of the financial
problems of its parent company, Angeles Corporation ("Angeles"), which
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. Subsequently, these affiliates were merged
into ILM Holding, Inc. ("ILM Holding"). Through January 10, 1997, the capital
stock of ILM Holding was owned by the Company and PWP Holding, Inc. ("PWP
Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated
("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which
is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The
Company held substantially all of the economic ownership in ILM Holding, while
PWP Holding held voting control. As discussed further under Item 7, on November
21, 1996 the Company requested that PWPI cause PWP Holding to sell all of the
stock held by PWP Holding in ILM Holding to the Company for a price equal to the
fair market value of the 1% economic interest in ILM Holding represented by the
common stock. On January 10, 1997, this transfer of the common stock of ILM
Holding was completed at an agreed upon fair value of $46,000. As part of the
fiscal 1994 settlement agreement with AHC, ILM Holding retained AHC as the
property manager for all of the Senior Housing Facilities pursuant to the terms
of a management agreement. As discussed further below, 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 existing shareholders while maintaining
the Company's qualification as a REIT under the Internal Revenue Code, the
Company formed a new corporation, ILM I Lease Corporation, for the purpose of
operating the Senior Housing Facilities under the terms of a master lease
agreement. As of August 31, 1995, ILM I Lease Corporation, which is taxable as a
regular C Corporation and not as a REIT, was a wholly-owned subsidiary of the
Company. On September 1, 1995, after the Company received the required
regulatory approval, it distributed all of the shares of capital stock of ILM I
Lease Corporation to the holders of record of the Company's common stock. One
share of common stock of ILM I Lease Corporation was issued for each full share
of the Company's common stock held. Prior to the distribution, the Company
capitalized ILM I Lease Corporation with $700,000 from its existing cash
reserves, which was an amount estimated to provide ILM I Lease Corporation with
necessary working capital. The master lease agreement, which commenced on
September 1, 1995, is initially between the Company's equity investee, ILM
Holding, as owner of the properties and Lessor, and ILM I Lease Corporation as
Lessee. The master 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 Holding, as the Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. During the initial term of the master lease, which expires on
December 31, 1999, ILM I Lease Corporation is obligated to pay annual base rent
for the use of all of the Facilities in the aggregate amount of $5,886,000 for
calendar year 1995 (prorated based on the lease commencement date) and
$6,364,800 for calendar year 1996 and each subsequent year. Beginning in January
1997 and for the remainder of the lease term, ILM I Lease Corporation will also
be obligated to pay variable rent for each Facility. Such variable rent will be
payable quarterly and will equal 40% of the excess, if any, of the aggregate
total revenues for the Facilities, on an annualized basis, over $16,996,000.
The assumption of ownership of the properties through ILM Holding has resulted
in a possible future tax liability which would be payable upon the ultimate sale
of the properties (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 by a C
corporation. The final phase of the Company's restructuring plans involves the
conversion of ILM Holding to a REIT for tax purposes. Certain changes to the
ownership structure of ILM Holding which are necessary in order for ILM Holding
to qualify as a REIT under the Internal Revenue Code are expected to be made in
time for ILM Holding to elect REIT status in conjunction with the filing of its
calendar 1996 federal tax return. Any future appreciation in the value of the
Senior Housing Facilities subsequent to the conversion of ILM 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 10 years from the date of the conversion of ILM Holding to a REIT.
However, since the end of the Company's original anticipated holding period is
less than 4 years away, the properties are not expected to be held for an
additional 10 years. The Board of Directors may defer the Company's scheduled
liquidation date, if in the opinion of a majority of
II - 2
<PAGE>
the Directors, the disposition of the Company's assets at such time would result
in a material under-realization of the value of such assets; provided, however,
that no such deferral may extend beyond December 31, 2004. Based on management's
current estimate of the increase in the values of the properties which has
occurred since April 1994, as supported by independent appraisals, ILM Holding
would incur a sizable tax if the properties were sold. Based on these current
estimated market values of the operating investment properties, a sale at such
values prior to the end of the 10-year holding period could result in a built-in
gain tax of as much as $2.9 million. As the holder of a 99% economic interest in
ILM Holding, the burden of this built-in gain tax would be primarily borne by
the Company.
On July 29, 1996, ILM I Lease Corporation and ILM Holding ("the Companies")
terminated the property management agreement with AHC covering the eight senior
housing facilities leased by ILM I Lease Corporation from ILM Holding. The
management agreement was terminated for cause pursuant to the terms of the
contract. Simultaneously with the termination of the management agreement, the
Companies, together with certain affiliated entities, filed suit against AHC in
the United States District Court for the Eastern District of Virginia for breach
of contract, breach of fiduciary duty and fraud. ILM I Lease Corporation and ILM
Holding allege 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 management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed
with the Virginia District Court an Answer in response to the litigation
initiated by the Companies and a Counterclaim against ILM Holding. The
Counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests damages which include the payment of the termination fee in
the amount of $1,250,000, payment of management fees pursuant to the contract
from August 1, 1996 through October 15, 1996, which is the earliest date that
the management agreement could have been terminated without cause, and recovery
of attorney's fees and expenses. PaineWebber Independent Living Mortgage Fund,
Inc. guaranteed the payment of the termination fee at issue in these
proceedings. The court initially set a trial date of April 28, 1997 but, at
AHC's request, rescheduled the trial for June 23, 1997. On June 13, 1997 and
July 8, 1997, the court issued Orders purporting to enter judgment against the
Company and ILM II in the amount of $1,000,000. In so doing, the court
effectively canceled the June 23, 1997 trial date. The Orders did not contain
any findings of fact or conclusions of law. On July 10, 1997, the Company, ILM
II, ILM I Lease Corporation and ILM II Lease Corporation filed a notice of
appeal to the United States Court of Appeals for the Fourth Circuit. The Company
intends to diligently prosecute the appeal. The eventual outcome of this
litigation cannot presently be determined. However, as reported in the Company's
report on Form 10-Q for the quarter ended May 31, 1997, the Company has recorded
a provision in the amount of $600,000 for the liability which might result from
the court's Orders.
ILM I Lease Corporation has retained Capital Senior Management 2, Inc.
("Capital") of Dallas, Texas to be the new manager of the Senior Housing
Facilities pursuant to a Management Agreement which commenced on July 29, 1996.
Under the terms of the Agreement, Capital will earn a Base Management Fee equal
to 4% of the Gross Operating Revenues of the Senior Housing Facilities, as
defined. Capital will also be eligible to earn an Incentive Management Fee equal
to 25% of the amount by which the average monthly Net Cash Flow of the Senior
Housing Facilities, as defined, for the twelve month period ending on the last
day of each calendar month exceeds a specified Base Amount. Each August 31,
beginning on August 31, 1997, the Base Amount will be increased annually based
on the percentage increase in the Consumer Price Index. PaineWebber Independent
Living Mortgage Fund, Inc. has guaranteed the payment of all fees due to Capital
under the terms of the Management Agreement.
The Company has been attempting to continue its restructuring plans by
converting ILM Holding to a real estate investment trust ("REIT") for tax
purposes. In connection with these plans, on November 21, 1996 the Company
requested that PWPI cause PWP Holding to sell all of the stock held by PWP
Holding in ILM Holding to the Company for a price equal to the fair market value
of the 1% economic interest in ILM Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM Holding was completed
at an agreed upon fair value of $40,000. With this transfer completed, effective
January 23, 1997 ILM 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 a new class of nonvoting, 8% cumulative preferred stock issued to
the Company. The number of authorized shares of preferred and common stock in
ILM 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 Holding to each of 111 charitable organizations
II - 3
<PAGE>
so that ILM 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
will accrue at a rate of 8% per annum on the original $1,000 Liquidation
Preference and will be cumulative from the date of issuance. Since ILM Holding
is not expected to have sufficient cash flow in the foreseeable future to make
the required dividend payments, it is anticipated that dividends will accrue and
be paid at liquidation.
At a Board meeting on January 10, 1997, the Advisor at that point in time
recommended the immediate sale of the senior housing facilities held by the
Company and an affiliated entity, PaineWebber Independent Living Mortgage Inc.
II ("ILM II"), by means of a controlled auction to be conducted by PaineWebber,
at no additional compensation, with PaineWebber offering to purchase the
properties for $127 million, thereby guaranteeing the shareholders a "floor"
price. The Advisor also stated that if PaineWebber purchased the properties at
the specified price and were then able to resell the properties at a higher
price, PaineWebber would pay any "excess profits" to the shareholders. To assist
the Company and ILM I Lease Corporation (see Note 2) in evaluating the Advisor's
proposal, a disinterested, independent investment banker with expertise in
healthcare REITs and independent/assisted living financings was engaged.
Following comprehensive analysis, the investment banker recommended that the
Company decline the Advisor's proposal and instead investigate expansion and
restructuring alternatives. After analyzing the Advisor's proposal and the
recommendations and other information provided by the independent investment
banker, the Boards of the Company and ILM II voted unanimously to decline the
Advisor's proposal and to explore the alternatives recommended by the
independent investment banker. The Boards declined to seek an immediate sale of
the properties because, in the Boards' view, the liquidation price would not
reflect the "going concern" value of the Company and ILM II and, therefore,
would not maximize shareholder value. In addition, the Boards did not consider
it advisable to liquidate the Company and ILM II on the suggested terms three
years prior to their scheduled termination date.
The Advisor had indicated to the Board in its January 10, 1997 proposal that it
would not wish to continue to serve as advisor to the Company and its affiliates
if the Company declined to accept the Advisor's proposal. The Company has
accepted the resignation of the Advisor, effective as of June 18, 1997. The
Advisor has agreed to continue to provide certain administrative services to the
Company and its affiliates through August 31, 1997, pursuant to the terms of a
transition services agreement entered into with the Company and its affiliates.
The Company and its affiliates have also accepted, effective as of June 18,
1997, the resignations of those officers and directors who are employees of or
otherwise affiliated with the Advisor or its affiliates. Subsequent to
resignation of the Advisor and affiliated persons, the Board of Directors
engaged a former employee of PWPI as a consultant to assist in the management of
the Company. The Company is currently evaluating various strategic alternatives,
including the possibility of becoming self-managed.
In addition, the Company and ILM I Lease Corporation are continuing to review
various restructuring alternatives that could further increase shareholder value
and liquidity. The Company and ILM I Lease Corporation are analyzing a merger of
the Company with ILM Holding and are also considering possibly merging the
Company with ILM II and ILM I Lease Corporation with ILM II Lease Corporation.
In addition, the Company is exploring listing its shares on an exchange or,
alternatively, having them trade through NASDAQ. The independent investment
banker is also in the process of developing a new reorganization proposal. The
Company has not fully evaluated any of these alternatives and is not in a
position at this time to recommend any actions to the shareholders. There can be
no assurance that the Company will recommend taking any of such actions.
The eight properties in which the Company has invested averaged 92% occupancy as
of August 31, 1996. As previously reported, a property renovation and
assisted-living conversion program has been in progress at Villa Santa Barbara
for the past two years. Phase one of the renovations at the Santa Barbara
facility, which was completed during fiscal 1995, included renovation of the
lobby, dining room, library, activities room, television and game room and the
laundry rooms. Phase two of the renovation program, which was substantially
completed during the first quarter of fiscal 1996, involved interior unit
improvements, hallway upgrades and the conversion of existing studio units to
assisted living units. The total cost of the renovation program was
approximately $1.2 million, which has been funded 25% by the Company and 75% by
PaineWebber Independent Living Mortgage Inc. II ("ILM II") from funds previously
reserved for such improvements. Leasing gains at Villa Santa Barbara have been
slowed by delays in completing the capital improvements and in obtaining the
required regulatory licensing to begin leasing the new assisted living units.
During the quarter ended May 31, 1996, ILM I Lease Corporation received the
required assisted living licenses. Leasing
II - 4
<PAGE>
of the 38 new assisted living units is now well underway. Overall occupancy of
Villa Santa Barbara averaged 81% for the fourth quarter of fiscal 1996.
The road adjacent to the Raleigh facility is being improved, and the county
Department of Transportation has requested a temporary construction easement on
the property. Although the easement will not directly affect the operation of
the facility, it will likely result in the removal of several trees that
currently provide a buffer between the building and the road. Negotiations are
currently underway to minimize the removal of trees and to secure a settlement
from the county that will pay for installing a new landscape buffer upon the
completion of the roadway construction.
The Company's net operating cash flow is expected to be relatively stable and
predictable now that the master lease structure is in place. The annual base
rental payments owed to ILM Holding increased to $6,364,800 effective January 1,
1996 and will remain at that level for the remainder of the lease term. In
addition, the Senior Housing Facilities are currently generating gross revenues
which are slightly in excess of the specified threshold in the variable rent
calculation, as discussed further above, which becomes effective in January
1997. Accordingly, the Company expects that ILM Holding will receive variable
rent payments in fiscal 1997. As a result of the status of the Company's net
operating cash flow under the current master lease arrangement, the Company is
expected to be able to increase its quarterly dividend payment from $0.175 per
share to $0.1875 per share effective with the dividend to be paid in January
1997 for the quarter ended November 30, 1996. This expected increase would raise
the dividend payment to the equivalent of a 7.5% annual return on the original
offering price of the Company's common stock. As noted above, ILM Holding, as
Lessor, is responsible for major capital improvements and structural repairs to
the Senior Housing Facilities. Management is currently reviewing with the new
property management team annual operating budgets and capital expenditure plans,
which include an ongoing program to replace air-conditioning units at the Santa
Barbara facility and a potential program to upgrade the overall appearance of
the Winston-Salem property. In addition, management plans to continue its
investigation of the potential for the expansion of the assisted living
capacities of the properties in certain markets where demand for assisted living
units is particularly high. Depending on the extent of any assisted living
expansions deemed appropriate, such plans could result in the need for
substantial capital improvement funds.
As reported in the Company's report on Form 10-Q for the quarter ended May 31,
1997, the Company's Board of Directors has concluded that obtaining control of
adjacent land for future expansion purposes could add significant value to the
East Lansing, Raleigh, Omaha and Hot Springs properties. During 1997, the
Company entered into agreements to purchase land adjacent to the East Lansing,
Raleigh and Omaha properties. In addition, the Company is in the process of
obtaining a credit facility of up to $25 million from a major bank which can be
used to fund its expansion plans.
At August 31, 1996, the Company had cash and cash equivalents of $2,610,000.
Such amounts will be used for the working capital requirements of the Company,
along with the possible investment in the properties owned by the Company's
consolidated affiliate for certain capital improvements, and for dividends to
the shareholders. 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 master lease payments from ILM I Lease Corporation, 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 95% of its taxable income to its Shareholders in
order to continue to qualify as a REIT under the Internal Revenue Code.
Results of Operations
1996 Compared to 1995
Net income increased by $16,000 for fiscal 1996 when compared to the prior year.
The primary reasons for this increase in net income is a decrease in
professional fees incurred during fiscal 1996 net of a decrease in the Company's
equity in the income of ILM Holding. Professional fees decreased by $318,000 as
a result of the significant amount of legal and tax advisory services incurred
in the prior year in connection with the evaluation, selection and
implementation of the master lease property ownership structure described above.
The Company's equity investee, ILM Holding, now receives
II - 5
<PAGE>
master lease rental income from ILM I Lease Corporation rather than the revenues
from the individual tenants of the Senior Housing Facilities. In addition, under
the terms of the master lease, all property operating expenses are now the
responsibility of the Lessee. The master lease rental income earned by ILM
Holding during fiscal 1996 was $395,000 less than the excess of rental income
earned from the Senior Housing Facilities over property operating expenses and
property management fees during the prior year. In addition, a decrease in
interest income of $45,000 also partially offset the improvement in net income
in fiscal 1996. Interest income decreased due to a decline in the average amount
of cash and cash equivalents outstanding when compared to the prior year. The
decline in outstanding cash reserves was primarily the result of the Company's
funding of the $700,000 initial working capital investment in ILM I Lease
Corporation on September 1, 1995.
1995 Compared to 1994
Operating loss increased from $918,000 to $954,000 due to an increase in
professional fees mainly as a result of certain legal and tax advisory services
required in connection with the evaluation, selection and implementation of the
master lease property ownership structure described above. The increase in
professional fees was offset by an increase in interest income earned on cash
equivalents which resulted from higher average cash balances.
The Company's equity in income of ILM Holding increased by $1,231,000 as ILM
Holding generated rental revenues of $16,239,000 for fiscal 1995, as compared to
$14,771,000 for the prior year. This increase of $1,468,000, or 10%, along with
a decrease in depreciation and amortization of $234,000, were the primary
reasons that the Company's net income improved from $2,904,000 for fiscal 1994
to $4,099,000 for fiscal 1995. The increase in rental revenues was mainly the
result of an increase in effective rental rates at certain of the Facilities.
Overall portfolio occupancy increased slightly from an average of 87% for fiscal
1994 to 89% for fiscal 1995. The biggest leasing gains were achieved at the
Winston-Salem and Raleigh properties. Average occupancy at Winston-Salem
improved to 84% for fiscal 1995 from an average level of 65% for the prior year.
Likewise, average occupancy at Raleigh increased to 98% from 89% over the same
period. The occupancy level at the Peoria property dropped during fiscal 1995 to
an average of 82% from a level of 88% for the prior year, and the occupancy
level at Sedgwick Plaza declined to 86% for fiscal 1995 from an average of 93%
in fiscal 1994. Occupancy levels at Crown Pointe, East Lansing and West Shores
remained relatively steady, in the mid-to-high 90% range during both years.
However, revenues were up at these stabilized properties because management was
able to implement rental rate increases while maintaining stable occupancy
levels. Occupancy and rental revenues were relatively unchanged at Villa Santa
Barbara due to the pending status of the property's assisted living license, as
discussed further above. Depreciation expense decreased due to the full year
effect of the change in the cost basis of the Facilities upon the transfer of
ownership of the Facilities which occurred in April 1994, as discussed further
in the Notes to Financial Statements accompanying this Annual Report.
Property operating expenses increased by $300,000, or 4%, for fiscal 1995,
partially offsetting the improvement in revenues. The increase in property
operating expenses was primarily attributable to higher variable food service,
housekeeping, activities and assisted living costs associated with the overall
increase in the portfolio occupancy level. However, the change in property
operating expenses also reflected a decrease in marketing costs at certain of
the Facilities that had achieved stabilized occupancy levels and the effects of
certain operating efficiencies implemented at most of the Facilities subsequent
to the transfer of ownership. Management and advisory fees incurred by ILM
Holding increased by $82,000 as a result of the advisory agreement between ILM
Holding and an affiliate of PWPI. Such agreement, which was effective from April
1, 1994 through August 31, 1995, called for fees equal to 0.5% of the Gross
Operating Revenues of the Facilities in return for certain administrative
services.
1994 Compared to 1993
- ---------------------
The Transfers of the Senior Housing Facilities from AHC to the Property
Companies in fiscal 1994 resulted in no gain or loss recognition by the Company
for financial reporting purposes. As previously reported, under generally
accepted accounting principles, the Company has always accounted for its
investments in acquisition and construction loans under the equity method, as
if such investments were equity interests in a joint venture. Accordingly, the
carrying values of such investments have been reduced since inception by
non-cash depreciation charges and by payments from AHC, prior to the default in
fiscal 1993, in excess of the net cash flow generated by the Senior Housing
II - 6
<PAGE>
Facilities received pursuant to the guaranty agreement between the Company and
AHC. As a result of this accounting treatment, the carrying values of the
Company's investments had been reduced below management's estimate of the fair
market value of the Senior Housing Facilities as of the effective date of the
Transfers. Accordingly, for financial reporting purposes the Company has
continued to employ its historical cost basis in accounting for these
investments subsequent to the Transfers and has continued to record its share
of the operating results of the properties in its statement of income. For
federal income tax purposes, the investments have always been carried at the
contractually stated principal balances of the Loans. For tax purposes only, a
loss will be recognized by the Company in 1994 in the amount by which the
stated principal balances of the Loans were reduced as of the date of the
Transfers.
Net income increased by approximately $762,000 for fiscal 1994, when
compared to fiscal 1993, primarily as a result of an increase of approximately
$1,151,000 in equity in the income from the properties securing the Company's
acquisition and construction loans. This increase is generally the result of
increased occupancy and increased rental income at most of the Senior Housing
Facilities. Overall portfolio occupancy increased to 89% as of August 31, 1994
from its level of 85% one year earlier. In addition, several properties which
have reached stabilized occupancy levels have successfully implemented rental
rate increases on all units. A decrease in the aggregate depreciation expense
recognized for all of the Facilities also contributed to the improvement in the
net operating results of the properties securing the Company's acquisition and
construction loans in fiscal 1994. The decrease in depreciation expense is
primarily attributable to the change in the depreciable basis of the fixed
assets which occurred upon the transfer of the properties from AHC to the
Property Companies. The Property Companies recorded the depreciable basis of the
properties based on the historical cost basis of the Company's investments in
the operating properties as of April 1, 1994. Such basis was significantly lower
than the historical cost basis of AHC, mainly due to the reduction in basis
recognized by the Company as a result of payments made by AHC pursuant to its
guaranty agreement with the Company. As noted above, the Company's net
historical cost basis was lower than management's estimate of the fair market
value of the investment properties as of the effective date of the Transfers.
The favorable change in the operating results of the Senior Housing Facilities
was partially offset by an increase in the Company's operating loss of
approximately $307,000. This increase in operating loss was primarily the result
of a decrease of approximately $81,000 in interest and other income, an increase
in professional fees of approximately $214,000 and an increase in general and
administrative expenses of approximately $73,000. The decrease in interest and
other income was partly due to the disposition in fiscal 1993 of the investment
in a U.S. Treasury Note which yielded a significantly higher rate of return than
the return on short-term money-market investments. The disposition of the
investment in the U.S. Treasury Note also resulted in a gain of approximately
$82,000 in fiscal 1993. The decrease in interest income can also be attributed
to a decline in the average outstanding balance of the Company's cash and cash
equivalents during fiscal 1994. The increase in professional fees expenses was
mainly the result of increased legal costs related to the AHC loan defaults and
management's efforts to protect the Company's interest in the underlying
collateral. The increase in general and administrative expenses was also
primarily due to additional costs incurred in connection with the AHC loan
defaults.
A decline in management fees of approximately $77,000 in the current year
also contributed to the increase in net income. Management fee expense decreased
due to the reduction in the quarterly dividend, beginning with the quarter ended
February 28, 1993, from $0.25 per share to $0.10 per share. The dividend
reduction, resulting from the circumstances described above with respect to the
loan defaults, reduced the shareholders' rate of return on original
shareholders' equity to below 10% per annum. Accordingly, the Advisor has not
earned any incentive management fees since the first quarter of fiscal 1993.
Item 8. Financial Statements and Supplementary Data (Amended as described under
Item 14.)
The financial statements and supplementary data are included under Item 14 of
this Annual Report.
II - 7
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant (Amended to note
resignation of the Advisor and affiliated persons effective June 18, 1997.)
Effective after June 18, 1997, there are five directors of the Company, none of
whom is an affiliate of the Advisor. The directors are subject to removal by the
vote of the holders of a majority of the outstanding shares. The directors are
responsible for the general policies of the Company, but they are not required
to personally conduct the business of the Company in their capacities as
directors.
(a) and (b) The names and ages of the directors and executive officers of the
Company are as follows:
<TABLE>
<CAPTION>
Date
elected
Name Office Age to Office
---- ------ --- ---------
<S> <C> <C> <C>
Lawrence A. Cohen President, Chief Executive
Officer and Director 43 5/15/91
Jeffry R. Dwyer Director 50 2/12/90*
J. William Sharman, Jr. Director 56 2/12/90*
Carl J. Schramm Director 50 12/5/96
Julien G. Redele' Director 61 12/5/96
Walter V. Arnold** Senior Vice President, Chief
Financial Officer
and Treasurer 49 2/12/90*
James A. Snyder** Senior Vice President 51 7/06/92
C. David Carlson** Vice President 48 12/11/95
Dorothy F. Haughey** Secretary 70 2/12/90*
</TABLE>
* The date of incorporation of the Company.
** The Company has accepted the resignation of the Advisor effective as of June
18, 1997. The Advisor has agreed to continue to provide certain administrative
services to the Company and its affiliates through August 31, 1997, pursuant to
the terms of a transition services agreement entered into with the Company and
its affiliates. The Company and its affiliates have also accepted, effective as
of June 18, 1997, the resignations of those officers and directors who are
employees of or otherwise affiliated with the Advisor or its affiliates.
(c) Through June 18, 1997, ILM REIT Advisor, Inc., the general partner of the
Advisor, assisted the directors and officers of the Company in the management
and control of the Company's affairs. ILM REIT Advisor, Inc. was a wholly-owned
subsidiary of PaineWebber Properties Incorporated ("PWPI"). The principal
executive officers of ILM REIT Advisor, Inc. were as follows:
Name Office Age
---- ------ ---
Bruce J. Rubin President and Chief Executive Officer 37
Walter V. Arnold Senior Vice President, Chief
Financial Officer and Treasurer 49
James A. Snyder Senior Vice President 51
C. David Carlson Vice President 48
(d) There is no family relationship among any of the foregoing directors or
officers. All of the foregoing directors and officers of the Company have been
elected to serve until the Company's next annual meeting.
III - 1
<PAGE>
(e) The business experience of each of the directors and executive officers of
the Company and ILM REIT Advisor, Inc. is as follows:
Lawrence A. Cohen has served as President, Chief Executive Officer and Director
of the Company since 1991. Mr. Cohen is also Vice Chairman and Chief Financial
Officer of Capital Senior Living Corp., an affiliate of Capital Senior
Management 2, Inc., which is the company that was contracted by ILM I Lease
Corporation in July 1996 to perform property management services for the Senior
Housing Facilities in which the Company has invested. Mr. Cohen joined Capital
Senior Living Corp. in November 1996. Mr. Cohen was President and Chief
Executive Officer of PWPI until August 1996. Mr. Cohen joined PWPI in January
1989 as its Executive Vice President and Director of Marketing and Sales. Mr.
Cohen is also a member of the board of directors of PaineWebber Independent
Living Mortgage Inc. II (ILM II), ILM I Lease Corporation, ILM II Lease
Corporation and Retail Property Investors, Inc. (RPI). Mr. Cohen received his
LL.M (in Taxation) from New York University School of Law and his J.D. degree
from St. John's University School of Law. Mr. Cohen received his B.B.A. degree
in accounting from George Washington University. He is a member of the New York
Bar and is a Certified Public Accountant.
Jeffry R. Dwyer has served as a director of the Company since its inception in
1990. Mr. Dwyer is a partner with the law firm of Akin, Gump, Straus, Hauer &
Feld in the District of Columbia, which he joined in 1993. Prior to joining
Akin, Gump, Straus, Hauer & Feld, Mr. Dwyer was a partner with the law firm of
Morrison & Foerster from 1989 to 1993. Immediately prior to joining Morrison &
Foerster, Mr. Dwyer was a partner with the law firm of Lane & Edson. Mr. Dwyer
also presently serves as a director of ILM II, ILM I Lease Corporation and ILM
II Lease Corporation. Mr. Dwyer has written several books on real estate
financing and taught Real Estate Planning as an Adjunct Professor at the
Georgetown University Law Center. Mr. Dwyer graduated from Georgetown University
and received his law degree from the Georgetown University Law Center.
J. William Sharman, Jr. has served as a director of the Company since its
inception in 1990. Mr. Sharman is the Chairman of the Board and President of
Lancaster Hotel Management, L.C., a hotel management company, and Bayou
Equities, Inc., a hotel development company. Mr. Sharman served for ten years as
Chairman of the Board and President of The Lancaster Group, Inc., a real estate
development firm based in Houston, Texas, which is the predecessor of Lancaster
Hotel Management, L.C. and Bayou Equities, Inc. Mr. Sharman is Vice Chairman of
Small Luxury Hotels, Ltd. of the United Kingdom, an international hotel
marketing and reservations firm. Mr. Sharman also presently serves as a director
of ILMI and RPI. He has a Bachelor of Science degree in Civil Engineering from
the University of Notre Dame.
Carl J. Schramm was appointed to fill a newly created seat on the Company's
Board of Directors as of December 5, 1996. Mr. Schramm is President of
Greenspring Advisors, Inc., a consulting and investment advisory firm serving
clients in the managed care, health insurance and health information industries.
From 1993 to 1995, Mr. Schramm served as Executive Vice President of Fortis,
Inc., a diversified insurance and financial services company. From 1987 through
1992, Mr. Schramm was President of the Health Insurance Association of America,
the national trade association of commercial health underwriters. Mr. Schramm
currently serves on the boards of HCIA, Inc., LifeRate Systems, Inc., the
Rochdale Insurance Group, Physicians Health Corporation and Madison Information
Technologies. Mr. Schramm holds a Ph.D. in Economics from the University of
Wisconsin and received his J.D. from Georgetown University.
Julien G. Redele' was appointed to fill a newly created seat on the Company's
Board of Directors as of December 5, 1996. Mr. Redele' is one of the original
founders of SFRE, Inc., a Dutch owned real estate investment and development
firm which has served since 1963 as advisor to Dutch institutional, corporate
and individual investors active in the United States. Mr. Redele' serves as a
director of the Island Preservation Partnership. Mr. Redele' attended
Westersingel Business School, Rotterdam, where he studied economics, law and
finance.
Bruce J. Rubin was named President and Chief Executive Officer of PWPI in August
1996. Mr. Rubin joined PaineWebber Real Estate Investment Banking in November
1995 as a Senior Vice President. Prior to joining PaineWebber, Mr. Rubin was
employed by Kidder, Peabody and served as President for KP Realty Advisers, Inc.
Prior to his association with Kidder, Mr. Rubin was a Senior Vice President and
Director of Direct Investments at Smith Barney Shearson. Prior thereto, Mr.
Rubin was a First Vice President and a real estate workout specialist at
Shearson
III - 2
<PAGE>
Lehman Brothers. Prior to joining Shearson Lehman Brothers in 1989, Mr. Rubin
practiced law in the Real Estate Group at Willkie Farr & Gallagher. Mr. Rubin is
a graduate of Stanford University and Stanford Law School.
Walter V. Arnold was a Senior Vice President, Chief Financial Officer and
Treasurer of the Company and is Senior Vice President and Chief Financial
Officer of PWPI which he joined in October 1985. Mr. Arnold joined PWI in 1983
with the acquisition of Rotan Mosle, Inc. where he had been First Vice President
and Controller since 1978, and where he continued until joining PWPI. Mr. Arnold
is a Certified Public Accountant licensed in the state of Texas.
James A. Snyder was a Senior Vice President of the Company and is a Senior Vice
President of PWPI. Mr. Snyder re-joined PWPI in July 1992 having served
previously as an officer of PWPI from July 1980 to August 1987. From January
1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation, where
he served as the Vice President of Asset Sales prior to re-joining PWPI. From
February 1989 to October 1990, he was President of Kan Am Investors, Inc., a
real estate investment company. During the period August 1987 to February 1989,
Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast
Regional Management Inc., a real estate development company.
C. David Carlson was a Vice President of the Company and a Vice President of
PWPI which he joined in December 1995. From 1987 through 1995, Mr. Carlson was
an officer in Belmont Properties, Inc., a Boston-based real estate investment,
development and advisory firm. Mr. Carlson graduated from the University of
Minnesota in 1977 and received a Master of Science in Real Estate Development
degree from the Massachusetts Institute of Technology in 1986. In 1997, Mr.
Carlson left PWPI and currently serves as a consultant to the Company.
Dorothy F. Haughey was Secretary of the Company and is Assistant Secretary of
PaineWebber and Secretary of PWI and PWPI. Ms. Haughey joined PaineWebber in
1962.
(f) None of the directors and officers was involved in legal proceedings which
are material to an evaluation of his or her ability or integrity as a director
or officer.
(g) Compliance With Exchange Act Filing Requirements: The Securities Exchange
Act of 1934 requires the officers and directors of the Company, and persons who
own more than ten percent of the Company's outstanding common stock, to file
certain reports of ownership and changes in ownership with the Securities and
Exchange Commission. Officers, directors and ten-percent beneficial holders are
required by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file.
Based solely on its review of the copies of such forms received by it, the
Company believes that, during the year ended August 31, 1996, all filing
requirements applicable to its officers and directors and ten-percent beneficial
holders were complied with.
Item 13. Certain Relationships and Related Transactions (Amended to reflect the
resignation of the Advisor effective June 18, 1997.)
Through June 18, 1997 (see Item 10) and subject to the supervision of the
Company's Board of Directors, assistance with the management of the business of
the Company was provided by PaineWebber ILM Advisor, L.P. (the "Advisor"), a
limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation,
and Properties Associates, L.P. ("PA"), a Virginia limited partnership. ILM REIT
Advisor, Inc. is a wholly owned subsidiary of PaineWebber Properties
Incorporated ("PWPI"). In addition, the limited partners and holders of certain
assignee interests of PA are or have been also officers of PWPI. PWPI is a
wholly owned subsidiary of PaineWebber Incorporated ("PWI"). PWI is a wholly
owned subsidiary of PaineWebber Group Inc., ("PaineWebber").
For its services in finding and recommending investments, PWPI received a
mortgage placement fee equity to 2% of the capital contributions of the company.
Mortgage placement fees totaling $1,036,248 were earned by PWPI during the
Company's investment acquisition period. In connection with construction loans,
a construction loan administration fee of 1% of each construction loan was paid
by AHC to PWPI or its affiliates for administering such loan. In connection with
acquisition loans, a due diligence fee of 1% of the principal amount of each
such loan was paid by AHC to PWPI for
III - 3
<PAGE>
conducting due diligence activities. Loan administration and due diligence fees
totaling $425,141 were paid to PWPI during the Company's investment acquisition
period.
AHC received an investment fee for providing the Company with the opportunity to
invest the available proceeds of the offering in loans. The investment fee is an
amount equal to 0.75% of the offering proceeds, and was payable on the date of
the Initial Closing. Investment fees earned by AHC totaled $388,603.
AHC received a research and analysis fee in connection with the offering equal
to 1% of the capital contributions for identifying and analyzing development and
acquisition opportunities for Senior Housing Facilities and for reimbursements
of certain expenses associated with those activities. The research and analysis
fee paid to AHC totaled $518,123.
The Advisor was entitled to receive 1% of Disposition Proceeds, as defined,
until the shareholders have received dividends of Net Cash equal to their
Adjusted Capital Investments, as defined, plus a 12% non-compounded annual
return on their Adjusted Capital Investments; all Disposition Proceeds
thereafter until the Advisor has received an aggregate of 5% of Disposition
Proceeds; and, thereafter, 5% of Disposition Proceeds.
Under the Advisory Agreement, the Advisor had specific management
responsibilities; to perform day-to-day operations of the Company and to act as
the investment advisor and consultant for the Company in connection with general
policy and investment decisions. The Advisor will receive an annual Base Fee and
an Incentive Fee of 0.25% and 0.25%, respectively, of the capital contributions
of the Company, as defined, as compensation for such services. Incentive Fees
are subordinated to shareholders' receipt of distributions of net cash
sufficient to provide a return equal to 10% per annum. The Advisor earned base
management fees totaling $130,000 for the year ended August 31, 1996. Payment of
incentive management fees was suspended effective April 15, 1993 in conjunction
with a reduction in the Company's quarterly dividend payments.
The Advisor and its affiliates were reimbursed for their direct expenses
relating to the offering of Shares, the administration of the Company and the
acquisition and operations of the Company's real estate investments.
An affiliate of the Advisor performs certain accounting, tax preparation,
securities law compliance and investor communications and relations services for
the Company. Total costs incurred by this affiliate in providing these services
are allocated among several entities, including the Company. Included in general
and administrative expenses on the accompanying statement of income for the year
ended August 31, 1996 is $107,000, representing reimbursements to this affiliate
for providing such services to the Company.
Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provided
cash management services with respect to the Company's cash assets. Mitchell
Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an
independently operated subsidiary of PaineWebber. Mitchell Hutchins earned
$6,000 (included in general and administrative expenses) for managing the
Company's cash assets during fiscal 1996. Fees charged by Mitchell Hutchins are
based on a percentage of invested cash reserves which varies based on the total
amount of invested cash which Mitchell Hutchins manages on behalf of PWPI.
III - 4
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(Amended to account for the Company's investment in ILM Holding, Inc. using the
equity method, to clarify the Company's obligation under its guaranty related to
the Angeles termination fee litigation, to include an unaudited footnote
regarding events subsequent to the date of the independent auditors report, and
to include the separate financial statements of ILM Holding, Inc.)
(a) The following documents are filed as part of this report:
(1) and (2) Financial Statements and Schedules:
The response to this portion of Item 14 is submitted as a
separate section of this report. See Index to Financial
Statements and Financial Statement Schedules at page F-1.
(3) Exhibits:
The exhibits listed on the accompanying index to exhibits at page
IV-3 are filed as part of this Report.
(b) The Company filed a Current Report on Form 8-K dated July 29, 1996
reporting the termination by ILM I Lease Corporation of the property
management agreement with Angeles Housing Concepts, Inc. and the
retention of Capital Senior Management 2, Inc. as the new property
manager.
(c) Exhibits:
See (a)(3) above.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is submitted as a separate
section of this report. See Index to Financial Statements and
Financial Statement Schedules at page F-1.
IV - 1
<PAGE>
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.
PAINEWEBBER INDEPENDENT
LIVING MORTGAGE FUND, INC.
By: /s/ Lawrence A. Cohen
Lawrence A. Cohen
President and Chief Executive
Officer
Dated: November 7, 1997
IV - 2
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(3)
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Page Number in the
Exhibit No. Description of Document Report or Other Reference
- ----------- ----------------------- -------------------------
<S> <C> <C>
(3) and (4) Prospectus of the Registrant dated June 9, 1989, Filed with the
as supplemented, with particular reference to the Commission pursuant to
Restated Certificates and Agreement of Limited Rule 424c and
Partnership. incorporated herein
by reference.
(10) Material contracts previously filed as exhibits to Filed with the
registration statements and amendments thereto Commission pursuant to
of the registrant together with all such contracts Section 13 or 15d of the
filed as exhibits of previously filed Form 8-K and Securities Exchange
Forms 10-K are hereby incorporated by reference. Act of 1934 and
incorporated herein by
reference.
Contracts regarding retention by ILM I Lease Filed as exhibits 1 and 2
Corporation of Capital Senior Management 2, Inc., to the Current Report on
as property manager. Form 8-K dated July 29,
1996 and incorporated
herein by reference.
(13) Annual Reports to Stockholders No Annual Reports for
the year ended August 31,
1996 has been sent to the
Stockholders. An Annual Report
will be sent to the Stockholders
subsequent to this filing.
(27) Financial Data Schedule Filed as the last page of
EDGAR submission
following the Financial
Statements and Financial
Statement Schedule
required by Item 14.
</TABLE>
IV - 3
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(1) and (2) and 14(d)
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Reference
PaineWebber Independent Living Mortgage Fund, Inc.:
Report of independent auditors F-2
Balance sheets as of August 31, 1996 and 1995 F-3
Statements of income for the years ended
August 31, 1996, 1995 and 1994 F-4
Statements of changes in shareholders' equity
for the years ended August 31, 1996, 1995 and 1994 F-5
Statements of cash flows for the years ended
August 31, 1996, 1995 and 1994 F-6
Notes to financial statements F-7
ILM Holding, Inc.
Report of independent auditors F-23
Balance sheets as of August 31, 1996 and 1995 F-24
Statements of income for the year ended
August 31, 1996, the two month period ended
August 31, 1995 and the year ended June 30, 1995 F-25
Statements of changes in shareholders' equity
for the year ended August 31, 1996, the two
month period ended August 31, 1995 and the
year ended June 30, 1995 F-26
Statements of cash flows for the year ended
August 31, 1996, the two month period
ended August 31, 1995 and the year ended
June 30, 1995 F-27
Notes to financial statements F-28
Schedule III - Real Estate and Accumulated Depreciation F-36
Other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the financial
statements, including the notes thereto.
F - 1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Shareholders of
PaineWebber Independent Living Mortgage Fund, Inc.
We have audited the accompanying balance sheets of PaineWebber Independent
Living Mortgage Fund, Inc. as of August 31, 1996 and 1995, and the related
statements of income, changes in shareholders' equity, and cash flows for each
of the three years in the period ended August 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of PaineWebber Independent
Living Mortgage Fund, Inc. at August 31, 1996 and 1995, and the results of its
operations and its cash flows for each of the three years in the period ended
August 31, 1996, in conformity with generally accepted accounting principles.
As described in Note 2, the financial statements as of August 31, 1996 and
1995 and for each of the three years ended August 31, 1996 have been restated to
account for the Company's investment in and construction loans to ILM Holding,
Inc. on the equity method.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Boston, Massachusetts
December 10, 1996
Except for Note 2 to which
the date is September 30, 1997
F - 2
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
BALANCE SHEETS
August 31, 1996 and 1995
(In thousands)
<TABLE>
<CAPTION>
1996 1995
-------------- -------------
<S> <C> <C>
ASSETS
Real estate investments -
Investment in and construction loans to ILM Holding, Inc. $38,477 $39,737
Cash and cash equivalents 2,610 3,565
Interest and other receivables 353 175
Prepaid expenses and other assets 11 12
-------------- -------------
$41,451 $43,489
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable - affiliates 22 144
Accounts payable and accrued expenses 61 128
-------------- -------------
Total liabilities 83 272
Shareholders' equity:
Common stock, $0.01 par value,
10,000,000 shares authorized,
7,520,100 shares issued and outstanding 75 75
Additional paid-in capital (net of offering costs) 65,711 65,711
Accumulated deficit (24,418) (22,569)
-------------- -------------
Total shareholders' equity 41,368 43,217
-------------- -------------
$41,451 $43,489
============== =============
</TABLE>
See accompanying notes.
F - 3
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
STATEMENTS OF INCOME
For the years ended August 31, 1996, 1995 and 1994
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
1996 1995 1994
------------- ------------ ------------
<S> <C> <C> <C>
Revenues:
Interest income earned
on cash equivalents $ 129 $ 174 $ 85
Expenses:
Management fees 88 89 94
General and administrative 313 340 356
Insurance expense 30 42 48
Professional fees 315 633 477
Director compensation 24 24 24
Amortization expense -- -- 4
------------- ------------ -----------
770 1,128 1,003
------------- ------------ ------------
Operating loss (641) (954) (918)
Equity in income of properties securing
construction loans 4,756 5,053 3,822
------------- ----------- ------------
Net income: $4,115 $4,099 $2,904
============= ============ ============
Earnings per share of common stock $ 0.55 $ 0.54 $ 0.39
============= ============ ============
Cash dividends paid per share
of common stock $ 0.70 $ 0.71 $ 0.40
============= ============ ============
</TABLE>
The above earnings and cash dividends paid per share of common stock are
based upon the 7,520,100 shares outstanding during each year.
See accompanying notes.
F - 4
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the years ended August 31, 1996, 1995 and 1994
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Deficit Total
------------- ------------ --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1993 7,520,100 $75 $65,711 $(22,233) $43,553
Cash dividends paid - - - (3,008) (3,008)
Net income - - - 2,904 2,904
------------- --------- --------------- ---------------- ---------------
Shareholders' equity
at August 31, 1994 7,520,100 75 65,711 (22,337) 43,449
Cash dividends paid - - - (5,302) (5,302)
Net income - - - 4,099 4,099
Adjustment to eliminate
reporting lag for combined
facilities' operations (Note 4) - - - 971 971
------------- --------- --------------- ---------------- ---------------
Shareholders' equity
at August 31, 1995 7,520,100 75 65,711 (22,569) 43,217
Cash dividends paid - - - (5,264) (5,264)
Distribution of stock in ILM I
Lease Corporation (Note 4) - - - (700) (700)
Net income - - - 4,115 4,115
------------- --------- --------------- ---------------- ---------------
Shareholders' equity
at August 31, 1996 7,520,100 $75 $65,711 $(24,418) $41,368
============= ========= =============== ================ ===============
</TABLE>
See accompanying notes.
F - 5
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
STATEMENTS OF CASH FLOWS
For the years ended August 31, 1996, 1995 and 1994
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
<TABLE>
<CAPTION>
1996 1995 1994
------------ ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $4,115 $4,099 $2,904
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in income of properties securing construction loans (4,756) (5,053) (3,822)
Amortization expense - - 4
Changes in assets and liabilities:
Interest and other receivables (178) (167) 29
Prepaid expenses and other assets 1 (12) 43
Accounts payable - affiliates (122) 119 (130)
Accounts payable and accrued expenses (67) 21 39
------------ ----------- -----------
Total adjustments (5,122) (5,092) (3,837)
------------ ----------- -----------
Net cash used in operating activities (1,007) (993) (933)
Cash flows from investing activities
Initial investment in ILM I Lease Corporation (700) - -
Net proceeds from full satisfaction of claims against Angeles
Corporation and affiliates - 1,422 -
Additional fundings of construction loans (106) (170) (939)
Contractual payments received from
construction loans 6,122 6,310 4,379
------------ ----------- -----------
Net cash provided by investing activities 5,316 7,562 3,440
Cash flows from financing activities:
Cash dividends paid to shareholders (5,264) (5,302) (3,008)
------------ ----------- -----------
Net cash used in financing activities (5,264) (5,302) (3,008)
------------ ----------- -----------
Net (decrease) increase in cash and cash equivalents (955) 1,267 (501)
Cash and cash equivalents, beginning of year 3,565 2,298 2,799
------------ ----------- -----------
Cash and cash equivalents, end of year $2,610 $3,565 $2,298
============ =========== ===========
</TABLE>
See accompanying notes.
F - 6
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC.
Notes to Financial Statements
1. Nature of Operations
PaineWebber Independent Living Mortgage Fund, Inc. (the "Company") was organized
as a corporation on March 6, 1989 under the laws of the State of Virginia. On
June 21, 1989 the Company commenced a public offering of up to 10,000,000 shares
of its common stock at $10 per share, pursuant to a Registration Statement filed
on Form S-11 under the Securities Act of 1933 (Registration Statement No.
33-27653). The public offering terminated on July 21, 1989 with a total of
7,520,100 shares issued. The Company received capital contributions of
$75,201,000, of which $201,000 represented the sale of 20,100 shares to an
affiliate, Paine Webber Group, Inc. ("PaineWebber"). As of November 1, 1996,
PaineWebber and its affiliates held 165,344 shares of the Company's common
stock. The Company has 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 (see Note 2).
The Company originally invested the net proceeds of the initial public offering
in eight participating mortgage loans secured by Senior Housing Facilities
located in seven different states. All of the loans made by the Company were
originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing
in the development, acquisition and operation of Senior Housing Facilities. The
Company entered into an Exclusivity Agreement with AHC and its parent company,
Angeles Corporation ("Angeles"), which required AHC to provide the Company with
certain specific opportunities to finance Senior Housing Facilities and set
forth the terms and conditions of the loans which were made. The loan documents
under the aforementioned Exclusivity Agreement called for interest to be paid on
construction loans at the rate of 13% per annum during the construction period
and for Base Interest to be paid on the permanent loans at the rate of 10% per
annum. In addition to the Base Interest, Additional Interest was to be payable
on the permanent loans in an amount equal to 10% of the Gross Revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
Exclusivity Agreement, Additional Interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the entire
term of the investments. In the aggregate, the properties securing loans from
the Company did not generate sufficient cash flow to cover the debt service
payments owed to the Company under the amended terms of the Exclusivity
Agreement. To the extent that the properties did not generate sufficient cash
flow to make the full payments due under the loan documents, the shortfall was
funded by AHC through December 1992. The source of cash to make up these
shortfalls was from specified deficit reserve accounts, which had been funded
from the proceeds of the mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between the Company, AHC and Angeles
was reached whereby ownership of the properties would be transferred from AHC to
the Company or its designated affiliates. Under the terms of the Settlement
Agreement, the Company released AHC and Angeles from certain obligations under
the loans. On April 27, 1994, each of the properties owned by AHC and securing
the Loans was transferred (collectively, "the Transfers") to newly-created
special purpose corporations affiliated with the Company (collectively, "the
Property Companies"). The Transfers had an effective date of April 1, 1994 and
were made pursuant to the Settlement Agreement entered into on February 17, 1994
("the Settlement Agreement") between the Company and AHC which had previously
been approved by the bankruptcy court handling the bankruptcy case of Angeles.
All of the capital stock of each Property Company was held by ILM Holding, Inc.
("ILM Holding"), a Virginia corporation. In August 1995, each of the Property
Companies merged into ILM Holding. As a result, ownership of the Senior Housing
Facilities is now held by ILM Holding, and the Property Companies no longer
exist as separate legal entities. The capital stock of ILM Holding is owned by
the Company and
F - 7
<PAGE>
PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber
Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of
PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber
Group, Inc. ("PaineWebber").
The Company holds substantially all of the economic ownership in ILM Holding,
while PWP Holding holds voting control. ILM Holding issued 100 shares of Series
A Preferred Stock to the Company in return for a capital contribution in the
amount of $693,000 and issued 10,000 shares of Common Stock to PWP Holding in
return for a capital contribution in the amount of $7,000. The holders of the
Series A Preferred Stock are entitled to one vote for each share of Preferred
Stock held. In addition, the holders of the Series A Preferred Stock are
entitled to receive, when and if declared by the Board of Directors, dividends
and distributions in an aggregate amount equal to 99% of the total amount of
dividends and distributions made to all shareholders. The holders of the Common
Stock are entitled to one vote for each share of Common Stock held. The holders
of the Common Stock are entitled to receive, when and if declared by the Board
of Directors, dividends and distributions in an aggregate amount equal to 1% of
the total amount of dividends and distributions made to all shareholders. As
part of the fiscal 1994 settlement agreement with AHC, ILM Holding retained AHC
as the property manager for all of the Senior Housing Facilities pursuant to the
terms of a management agreement. As discussed further in Note 5, the management
agreement with AHC was terminated in July 1996. Subsequent to the effective date
of the Settlement Agreement with AHC, management investigated and evaluated the
available options for structuring the ownership of the properties 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 (see Note
2). As discussed further in Note 4, on September 12, 1994 the Company formed a
new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior
Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease
Corporation effective September 1, 1995 (see Note 4 for a description of the
master lease agreement).
2. Change in Accounting Principle
The financial position and results of operations of ILM Holding were previously
consolidated with those of the Company for financial reporting purposes because
the Company has substantially all of the economic ownership in ILM Holding.
However, because the Company does not hold majority voting control, it
determined that accounting for its investment in ILM Holding using the equity
method would be more appropriate. As a result, the accompanying financial
statements have been restated to account for the Company's investment in ILM
Holding using the equity method. Under the equity method, the Company's
investment in ILM Holding is carried at cost, including the face amount of the
mortgage loans, adjusted for the Company's share of ILM Holding's earnings,
losses and distributions.
3. Use of Estimates and Summary of Significant Accounting Policies
The accompanying financial statements have been prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles which
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 August 31, 1996 and 1995 and revenues and expenses for each of
the three years in the period ended August 31, 1996. Actual results could differ
from the estimates and assumptions used.
F - 8
<PAGE>
A. BASIS OF PRESENTATION
The operating cycle in the real estate industry is longer than one
year and the distinction between current and non-current is of little
relevance. Accordingly, the accompanying consolidated balance is
presented in an unclassified format.
B. INCOME TAXES
The Company has elected to qualify and to be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as
amended, for each taxable year of operations. As a REIT, the Company
is allowed a deduction for the amount of dividends paid to its
shareholders, thereby effectively subjecting the distributed net
taxable income of the Company to taxation at the shareholder level
only, provided it distributes at least 95% of its taxable income and
meets certain other requirements for qualifying as a real estate
investment trust. In connection with the settlement agreement
described in Note 1, the Company, through its consolidated affiliate,
obtained title to the properties securing its mortgage loan
investments. To retain REIT status, the Company must ensure that 75%
of its annual gross income is received from qualified sources. Under
the original investment structure, interest income from the Company's
mortgage loans was a qualified source. The properties that are now
owned by an affiliate of the Company are Senior Housing Facilities
that provide tenants with more services, such as meals, activities,
assisted living, etc., than are customary for ordinary residential
apartment properties. As a result, a significant portion of the rents
paid by the tenants includes income for the increased level of
services received by them. Consequently, the rents paid by the tenants
likely would not be qualified rents for REIT qualification purposes if
received directly by the Company. Therefore, if the Company received
such rents directly, it could lose REIT status and be taxed as a
regular corporation. After extensive review, the Board of Directors
determined that it would be in the best interests of the shareholders
for the Company to retain REIT status and master lease the properties
to a shareholder-owned operating company. As discussed further in Note
4, on September 12, 1994 the Company formed a new subsidiary, ILM I
Lease Corporation, for the purpose of operating the Senior Housing
Facilities. The Senior Housing Facilities were leased to ILM I Lease
Corporation effective September 1, 1995 (see Note 4 for a description
of the master lease agreement).
The assumption of ownership of the properties through ILM Holding,
which is presently a regular C corporation for tax purposes, has
resulted in a possible future tax liability which would be payable
upon the ultimate sale of the properties (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 by in a C corporation.
The final phase of the Company's restructuring plans involves the
conversion of ILM Holding to a REIT for tax purposes. Certain changes
to the ownership structure of ILM Holding which are necessary in order
for ILM Holding to qualify as a REIT under the Internal Revenue Code
are expected to be made in time for ILM Holding to elect REIT status
in conjunction with the filing of its calendar 1996 federal tax
return. Any future appreciation in the value of the Senior Housing
Facilities subsequent to the conversion of ILM 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 10 years from the date of the conversion of ILM
Holding to a REIT. However, since the end of the Company's original
anticipated holding period is less than 4 years away, the properties
are not expected to be held for an additional 10 years. The Board of
Directors may defer the Company's scheduled liquidation date, if in
the opinion of a majority of the Directors, the disposition of the
Company's assets at such time would result in a material
under-realization of the value of such assets; provided, however, that
no such deferral may extend beyond December 31, 2004. Based on
management's current estimate of the increase in the values of the
properties which has occurred since April 1994, as supported by
independent appraisals, ILM Holding would incur a sizable tax if the
properties were sold. Based on these current estimated market values
of the operating investment properties, a sale at such values prior to
the end of the 10-year holding period could result in a built-in gain
tax of as much as $2.9 million. As the holder of a 99% economic
interest in ILM Holding, the burden of this built-in gain tax would be
primarily borne by the Company.
F - 9
<PAGE>
The Company's affiliate, ILM Holding, has incurred losses for tax
purposes since inception. Neither the Company nor ILM Holding is
likely to be able to use these losses to offset future tax
liabilities. Accordingly, no income tax benefit is reflected in these
consolidated financial statements.
The Company reports on a calendar year basis for income tax purposes.
During calendar 1995, the Company distributed $0.78 per share in cash
and $0.15 per share in shares of ILM I Lease Corporation. The tax
status of these dividends amounted to an ordinary taxable dividend of
approximately $0.64 per share and a tax free return of capital of
approximately $0.29 per share. The Company anticipates that all
distributions during calendar 1996 will be ordinary taxable dividends.
C. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents
include all highly liquid investments with original maturities of 90
days or less.
D. OFFERING COSTS
Offering costs consist primarily of selling commissions and other
costs such as printing and mailing costs, legal fees, filing fees and
other marketing costs associated with the offering of shares. Selling
commissions were equal to 8% of the gross proceeds raised through the
public offering. Commissions totaling $6,000,000 were paid to PWI in
connection with the sale of shares. All of the offering costs are
shown as a reduction of shareholders' equity.
E. FAIR VALUE DISCLOSURES
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("SFAS 107"), requires disclosure of fair value
information about financial instruments, whether or not recognized in
the balance sheet, for which it is practicable to estimate that value.
In cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques.
SFAS 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying
value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the balance
sheet for cash and cash equivalents approximates its fair value due to
the short-term maturities of such instruments.
Accounts payable - affiliates: The carrying amount reported on the
balance sheet for accounts payable affiliates approximates its fair
value due to the short-term maturity of such instrument.
4. The Advisory Agreement and Related Party Transactions
Subject to the supervision of the Company's Board of Directors, assistance in
managing the business of the Company is provided by PaineWebber ILM Advisor,
L.P. (the "Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc.,
a Virginia corporation, and Properties Associates, L.P. ("PA"), a Virginia
limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of
PaineWebber Properties Incorporated ("PWPI"). In addition, the limited partners
and holders of assignee interests of PA are or have been officers of PWPI. PWPI
is a wholly owned subsidiary of PaineWebber Incorporated ("PWI"). PWI is a
wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber").
The Advisor and its affiliates receive fees and compensation determined on an
agreed-upon basis, in consideration of various services performed in connection
with the sale of the shares, the management of the Company and the
F - 10
<PAGE>
acquisition, management and disposition of the Company's investments. The type
of compensation to be paid by the Company to the Advisor and its affiliates
under the terms of the Advisory Agreement is as follows:
1. Under the Advisory Agreement, the Advisor has specific management
responsibilities; to perform day-to-day operations of the Company and
to act as the investment advisor and consultant for the Company in
connection with general policy and investment decisions. The Advisor
will receive an annual Base Fee and an Incentive Fee of 0.15% and
0.45%, respectively, of the Gross Assets of the Company, as defined,
as compensation for such services. Incentive Fees are subordinated to
shareholders' receipt of distributions of net cash sufficient to
provide a return equal to 10% per annum. The Advisor earned base
management fees totaling $88,000, $89,000 and $94,000 for the years
ended August 31, and 1994, respectively. Payment of incentive
management fees was suspended effective April 15, 1993 in conjunction
with a reduction in the Company's quarterly dividend payments.
2. For its services in finding and recommending investments, PWPI
received mortgage placement fees equal to 2% of the capital
contributions. Mortgage placement fees totaling $1,504,000 were earned
by PWPI during the Company's investment acquisition period. Such fees
have been capitalized and are included in the cost of the operating
investment properties on the accompanying consolidated balance sheet.
3. For its administrative services with respect to all loans, PWPI
received loan servicing fees equal to 1% of capital contributions.
Loan servicing fees totaling $752,010 were earned by PWPI during the
Company's investment acquisition period. Such fees have been
capitalized and are included in the cost of the operating investment
properties on the accompanying consolidated balance sheet.
4. In connection with the construction of Senior Housing Facilities, PWPI
received a fee, paid directly by AHC, equal to 1% of the principal
amount of each construction loan for administering construction loans
made by the Company. Such fees received by PWPI totaled $431,000
during the Company's investment acquisition period.
5. The Advisor will be entitled to receive 1% of Disposition Proceeds, as
defined, until the shareholders have received dividends of Net Cash
equal to their Adjusted Capital Investments, as defined, plus a 12%
non-compounded annual return on their Adjusted Capital Investments,
all Disposition Proceeds thereafter until the Advisor has received an
aggregate of 5% of Disposition Proceeds; and, thereafter, 5% of
Disposition Proceeds.
Included in management and advisory fees for the year ended August 31, 1995 are
advisory fees of $114,000 earned by an affiliate of PWPI for its administration
and supervision of the day-to-day operations of ILM Holding. Such fees were
equal to 0.5% of the Gross Operating Revenues of the Senior Housing Facilities.
These advisory fees were no longer charged to ILM Holding effective September 1,
1995 upon the commencement of the master lease described in Note 4.
The Advisor and its affiliates are reimbursed for their direct expenses relating
to the offering of Shares, the administration of the Company and the acquisition
and operations of the Company's real estate investments. Included in general and
administrative expenses on the accompanying statements of income for the years
ended August 31, 1996, 1995 and 1994 is $142,000, $166,000 and $175,000,
respectively, representing reimbursements to an affiliate of the Advisor for
providing certain financial, accounting and investor communication services to
the Company.
Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provides
cash management services with respect to the Company's cash assets. Mitchell
Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an
independently operated subsidiary of PaineWebber. Mitchell Hutchins earned
$13,000, $4,000 and $7,000 (included in general and administrative expenses) for
managing the Company's cash assets during fiscal 1996, 1995 and 1994,
respectively.
Accounts payable - affiliates at August 31, 1996 consists of management fees of
$22,000 owed to the Advisor for the quarter ended August 31, 1996. Accounts
payable - affiliates at August 31, 1995 includes management fees of $22,000 owed
to the Advisor for the quarter ended August 31, 1995, $4,000 of out-of-pocket
expense reimbursements payable to
F - 11
<PAGE>
PWPI and $84,000 payable to an affiliated company, PaineWebber Independent
Living Mortgage Inc. II (ILM2), for advances made by ILM2 on behalf of the
Company to the Villa Santa Barbara Senior Housing Facility.
5. Investment in ILM Holding, Inc.
The Company had made certain mortgage loans (collectively, "the Loans") to
Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the
development, acquisition and operation of Senior Housing Facilities. The Company
entered into an Exclusivity Agreement with AHC and its parent company, Angeles
Corporation ("Angeles"), which required AHC to provide the Company with certain
specific opportunities to finance Senior Housing Facilities and set forth the
terms and conditions of the loans which were made. The Company's loans were
secured by first mortgages on the Senior Housing Facilities and a security
interest in all tangible personal property. During the quarter ended February
28, 1993, Angeles announced that it was experiencing liquidity problems that had
resulted in the inability to meet its obligations. Subsequent to such
announcements, AHC defaulted on the regularly scheduled mortgage loan payments
due to the Company on March 1, 1993. Subsequent to March 1993, payments toward
the debt service owed on the Company's loans were limited to the net cash flow
of the operating investment properties. On May 3, 1993, Angeles filed for
reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state
of California. AHC did not file for reorganization. During fiscal 1993 and
continuing in fiscal 1994, the Company retained special counsel and had
extensive discussions with AHC concerning the default status of its loans.
During the fourth quarter of fiscal 1993, a non-binding settlement agreement
between the Company, AHC and Angeles was reached whereby title to ownership of
the properties would be transferred from AHC to the Company.
On April 27, 1994, each of the properties owned by AHC and securing the Loans
was transferred (collectively, "the Transfers") to newly-created special purpose
corporations affiliated with the Company (collectively, "the Property
Companies"). The Transfers had an effective date of April 1, 1994. The Transfers
were made pursuant to the Settlement Agreement entered into on February 17, 1994
("the Settlement Agreement") between the Company and AHC, and previously
approved by the bankruptcy court handling the bankruptcy case of Angeles.
Conveyance documents relating to the Transfers were placed in escrow on February
17, 1994 pending the completion of certain due diligence procedures. This due
diligence process included the setting up of appropriate entities to take title
to the individual properties as well as the completion of the licensing
requirements for each facility. On April 27, 1994, the due diligence process was
completed, escrow was broken and the Transfers were effected. Under the terms of
the Settlement Agreement, the Company released AHC and Angeles from certain
obligations under the Loans.
All of the capital stock of each Property Company is held by ILM Holding, Inc.
("ILM Holding"), a newly-formed Virginia corporation. The capital stock of ILM
Holding is owned by the Company and PWP Holding, Inc. ("PWP Holding"), a
wholly-owned subsidiary of PWPI. The Company holds substantially all of the
economic ownership in ILM Holding, while PWP Holding holds voting control. ILM
Holding has issued 100 shares of Series A Preferred Stock to the Company in
return for a capital contribution in the amount of $693,000. The holders of the
Series A Preferred Stock are entitled to one vote for each share of Preferred
Stock held. In addition, the holders of the Series A Preferred Stock are
entitled to receive, when and if declared by the Board of Directors, dividends
and distributions in an amount per share equal to the product of 0.1 and 99% of
the total amount of dividends and distributions made to all shareholders. ILM
Holding has also issued 10,000 shares of Common Stock to PWP Holding in return
for a capital contribution in the amount of $7,000. The holders of the Common
Stock are entitled to one vote for each share of Common Stock held. The holders
of the Common Stock are entitled to receive, when and if declared by the Board
of Directors, dividends and distributions in an amount per share equal to the
product of 0.001 and 1% of the total amount of dividends and distributions made
to all shareholders.
Each Property Company acquired the respective operating property subject to, and
assumed the obligations under, the Loan payable to the Company. The principal
balance of each Loan was modified to reflect the estimated fair value of the
related operating property as of the date of the Transfers. The modified Loans
require interest-only payments on a monthly basis at a rate of 9.5% from April
1, 1994 through December 31, 1994, 11% for the period January 1 through December
31, 1995, 12.5% for the period January 1 through December 31, 1996, 13.5% for
the period January 1 through December 31, 1997, 14% for the period January 1
through December 31, 1998, and 14.5% for the period January 1, 1999 through
maturity, on December 31, 1999.
F - 12
<PAGE>
Management expects the property ownership structure described above to be in
place only temporarily. Since the time that the Company reached agreement with
AHC regarding the terms of the Settlement Agreement, management has been
investigating and evaluating the available options for structuring the ownership
of the properties in order to maximize the potential returns to the existing
shareholders while maintaining the Company's qualification as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code. The Board of
Directors has identified what it believes is the best structure to accomplish
these objectives, and the Company is in the process of implementing that
structure as of the date of this report.
Certain changes to the presentation of the Company's financial position and
results of operations will be required once the aforementioned permanent
property ownership structure is effected. The Transfers of the Senior Housing
Facilities from AHC to the Property Companies in fiscal 1994 resulted in no gain
or loss recognition by the Company for financial reporting purposes. As stated
above, under generally accepted accounting principles, the Company has always
accounted for its investments in acquisition and construction loans under the
equity method, as if such investments were equity interests in a joint venture.
Accordingly, the carrying values of such investments have been reduced since
inception by non-cash depreciation charges and by payments from AHC, prior to
the default in fiscal 1993, in excess of the net cash flow generated by the
Senior Housing Facilities received pursuant to the guaranty agreement between
the Company and AHC. As a result of this accounting treatment, the carrying
values of the Company's investments had been reduced below management's estimate
of the fair market value of the Senior Housing Facilities as of the effective
date of the Transfers. Accordingly, for financial reporting purposes the Company
has continued to employ its historical cost basis in accounting for these
investments subsequent to the Transfers and has continued to record its share of
the operating results of the properties in its statement of income. For federal
income tax purposes, the investments have always been carried at the
contractually stated principal balances of the Loans. For tax purposes only, a
loss will be recognized by the Company in 1994 in the amount by which the stated
principal balances of the Loans were reduced as of the date of the Transfers
(see discussion below).
Based on the initial economic structure of the loan transactions and the
expected future allocations of cash flows between the Company and AHC,
management originally estimated that the Company's allocable share of the
earnings or losses of the properties securing the loan investments was
approximately 90% of the total earnings or losses (including depreciation
expense) of such properties. As a result of the loan defaults and the Settlement
Agreement discussed further above, management believes that the initial economic
structure of the Company's investments has changed and, accordingly, the Company
has recognized 100% of the earnings or losses of the underlying operating
properties in the accompanying income statements for fiscal 1994 and are
reported within Investment In and Construction Loans to ILM Holding, Inc. on the
accompanying balance sheet.
F - 13
<PAGE>
The following mortgage loans were outstanding at August 31, 1996 and 1995:
<TABLE>
<CAPTION>
Property
Pledged Date of
as Collateral 8/31/96 8/31/95 Loans
------------- ------- ------- -----
<S> <C> <C> <C>
Independence $8,950,000 $8,950,000 6/29/89
Village of
East Lansing, MI
Independence 5,750,000 5,750,000 6/29/89
Village of
Winston-Salem, NC
Independence 8,350,000 8,350,000 4/29/91
Village of
Raleigh, NC
Independence 8,350,000 8,350,000 11/30/90
Village of
Peoria, IL
Crown Pointe 8,200,000 8,200,000 2/14/90
Apartments
Omaha, NE
Sedgwick Plaza 8,350,000 8,350,000 2/14/90
Apartments
Wichita, KS
West Shores 5,350,000 5,350,000 12/14/90
Hot Springs, AR
Villa Santa Barbara
Santa Barbara, CA 1,698,000 1,592,000 7/13/92
------------ ------------
54,998,000 54,892,000
Less discount (14,607,000) (14,607,000)
------------ ------------
$40,391,000 $40,285,000
============ ============
</TABLE>
A discount was recorded on the long-term debt in the amount by which the
modified principal amount of the loans exceeded the historical cost basis of the
properties at the time of the Transfers.
Descriptions of the properties financed by the Company's loans are summarized
below:
Independence Village of East Lansing
------------------------------------
In June 1989, the Company acquired a Loan with respect to a 159-unit
Senior Housing Facility known as Independence Village of East Lansing
located in East Lansing, Michigan. Construction of the Senior Housing
Facility, which was 91% leased as of August 31, 1996, was completed in
May, 1989.
F - 14
<PAGE>
Independence Village of Winston-Salem
-------------------------------------
In June 1989, the Company acquired a loan with respect to a 156-unit
Senior Housing Facility known as Independence Village of Winston-Salem
located in Winston-Salem, North Carolina. Construction of the Senior
Housing Facility, which was 93% leased as of August 31, 1996, was
completed in February, 1989.
Independence Village of Raleigh
-------------------------------
In December 1989, the Company acquired a loan with respect to a
163-unit Senior Housing Facility, known as Independence Village of
Raleigh, located in Raleigh, North Carolina. The original closing of
the construction loan occurred on December 18, 1989. Construction of
the Senior Housing Facility, which was 98% leased as of August 31,
1996, was completed in March, 1991. The Company's investment was
converted from a construction loan to a permanent loan effective April
29, 1991.
Independence Village of Peoria
------------------------------
In December 1989, the Company acquired a loan with respect to a
164-unit Senior Housing Facility known as Independence Village of
Peoria located in Peoria, Illinois. The original closing of the
construction loan occurred on December 18, 1989. Construction of the
Senior Housing Facility, which was 91% leased as of August 31, 1996,
was completed in November, 1990. The Company's investment was converted
from a construction loan to a permanent loan effective November 30,
1990.
Crown Pointe
------------
In February 1990, the Company acquired a loan with respect to an
existing 133-unit Senior Housing Facility known as Crown Pointe
Apartments located in Omaha, Nebraska. The Senior Housing Facility,
which was 99% leased as of August 31, 1996, was opened in August of
1985.
Sedgwick Plaza
--------------
In February 1990, the Company acquired a loan with respect to an
existing 150-unit Senior Housing Facility known as Sedgwick Plaza
Apartments located in Wichita, Kansas. The Senior Housing Facility,
which was 83% leased as of August 31, 1996, was opened in May of 1985.
West Shores
-----------
In December 1990, the Company acquired a loan with respect to an
existing 134-unit Senior Housing Facility known as West Shores located
in Hot Springs, Arkansas. The Senior Housing Facility, which was 94%
leased as of August 31, 1996, was opened in June of 1987.
Santa Barbara
-------------
In July 1992, the Company acquired an A&C Loan with respect to an
existing 123-unit Senior Housing Facility known as Villa Santa Barbara
located in Santa Barbara, California. The acquisition and improvement
of the facility was financed by the aforementioned loan and another
loan from an affiliated company, PaineWebber Independent Living
Mortgage Inc. II (ILM2). Any amounts due from the borrower with regard
to the mortgage loans on the Santa Barbara property will be equitably
apportioned between the Company and ILM2 (generally 25% to the Company
and 75% to ILM2). The Company and ILM2 have entered into a
Intercreditor Agreement to set forth their respective rights and
entitlements under the loan documents. The Senior Housing Facility,
which was 81% leased as of August 31, 1996, was opened in June of 1979.
F - 15
<PAGE>
Other Information Regarding Mortgage Loans:
The Settlement Agreement calls for AHC to be retained in a property management
capacity under a contract covering the operating properties (the "Management
Contract"). The terms of the Management Contract provide that AHC will receive a
base management fee (the "Base Management Fee") equal to 5.5% of Gross Operating
Revenues, as defined. In addition, AHC is eligible to earn additional
compensation through a 25% participation in excess cash flow or sale or
refinancing proceeds above specified levels. The thresholds at which AHC would
begin to participate in excess cash flow or sale or refinancing proceeds have
been set at levels which provide that the Company would receive all amounts to
which it was originally entitled under the terms of the Exclusivity Agreement on
a cumulative basis before such participation begins. The Property Companies have
the right to terminate the Management Contract for cause at any time and can
terminate the agreement without cause upon 30 days' written notice to AHC. The
Property Companies can also terminate the Management Contract immediately if
certain current executive officers of AHC do not remain in their present
capacities. Furthermore, the Property Companies have the option of terminating
the Management Contract any time after December 31, 1994 by giving 30 days'
written notice following any fiscal quarter for which the net operating income
level of each operating property fails to equal or exceed certain specified
levels. If the Management Contract were terminated on or before June 30, 1995,
without cause or because the specified executive officers failed to remain
employed by AHC, AHC would be entitled to receive a termination fee equal to 24
months Base Management Fee calculated based on annualized Gross Operating
Revenue for the three calendar months immediately preceding such termination.
Under these circumstances the termination fee declines to 18 months Base
Management Fee after June 30, 1995 and to 12 months Base Management Fee after
June 30, 1996. If the Management Contract is terminated because the net
operating income levels are below the specified amounts, the termination fees
described above would be subject to reduction to between 75% and 0% of the
applicable amount depending on the magnitude of the net income shortfall. The
Company has guaranteed payment of the termination fee.
Condensed balance sheets of ILM Holding, Inc. as of August 31, 1996 and 1995 are
presented as follows:
Assets
------
<TABLE>
<CAPTION>
August 31, 1996 August 31, 1995
--------------- ---------------
<S> <C> <C>
Current
Assets $ 1,104 $ 1,861
Operating Investment Properties, net 38,214 39,323
--------- ---------
$39,318 $41,184
========= =========
Liabilities and Shareholders' Equity (Deficit)
----------------------------------------------
Current liabilities $ 588 $ 835
Long term debt 40,391 40,285
Shareholders' equity (deficit) (1,661) 64
--------- ---------
$ 39,318 $41,184
========= =========
F - 16
<PAGE>
Reconciliation of Company's Investment
--------------------------------------
Company's share of capital at August 31, 1996 (1,661)
Excess basis due to investment in and
construction loans to ILM Holding, Inc. (1) 584
Company's share of investee's current liabilities
and long-term debt 40,976
Permanent difference due to settlement of claims
with Angeles Corporation and affiliates (2) (1,422)
---------
Investment in and construction loans to ILM
Holding, Inc. $ 38,477
=========
</TABLE>
(1) The Company's investment in and construction loans to ILM Holding, Inc.
includes amounts representing acquisition fees and other expenses incurred
by the Company in connection with the acquisition of the construction loans
encumbering the ILM Holding, Inc. properties. Excess basis is being
amortized over the term of the loans.
(2) As described in Note 5 under Angeles Corporation Litigation.
Summarized operations of the investment properties securing the Company's A&C
Loans for the year ended August 31, 1996, the two months ended August 31, 1995,
and the years ended June 30, 1995 and 1994 are as follows:
Condensed Summary of Operations
-------------------------------
<TABLE>
<CAPTION>
Year ended Two months ended Year ended Year ended
August 31, 1996 August 31, 1995 June 30, 1995 June 30, 1994
--------------- --------------- ------------- -------------
<S> <C> <C> <C> <C>
Revenues $ 6,344 $2,753 $16,264 $14,774
Operating Expenses - 1,542 9,541 9,138
Depreciation expense 1,290 227 1,364 1,589
Interest expense 6,707 1,046 5,673 7,090
Management advisory fees - 13 81 -
General and administrative 72 - - -
--------- ------- -------- --------
Net loss $(1,725) $ (75) $ (395) $(3,043)
======== ======= ======== ========
Company's share of loss $(1,725) $ (75) $ (395) $(3,043)
Borrowers' share of loss - - - -
--------- ------- ------- --------
$(1,725) $ (75) $ (395) $(3,043)
========= ======= ======== ========
Reconciliation of Company's Share of Income
- -------------------------------------------
Company's share of loss
as shown above $(1,725) $ (75) $ (395) $(3,043)
Interest on mortgage loans issued
by the Company 6,707 1,046 5,673 7,090
Amortization of excess basis (226) - (225) (225)
-------- ------- -------- --------
Equity in income from properties
mortgage loans $ 4,756 $ 971 $ 5,053 $ 3,822
======== ======= ======== ========
</TABLE>
F - 17
<PAGE>
As discussed earlier, on September 12, 1994 the Company formed a new subsidiary,
ILM I Lease Corporation, for the purpose of operating the Senior Housing
Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation
effective September 1, 1995 (see Item 7 for a description of the master lease
agreement). A condensed balances sheet as of August 31, 1996 and summary of
operations for the year then ended of ILM I Lease Corporation are as follows:
Assets
------
August 31, 1996
---------------
Current Assets $2,529
Furniture, fixtures and equipment 242
Other non-current assets 26
------
$2,797
======
Liabilities and Shareholders' Equity
------------------------------------
Current liabilities $1,613
Other non-current liabilities 123
Shareholders' equity 1,061
------
$2,797
======
Summary of Operations
---------------------
Year ended
August 31, 1996
---------------
Revenues $17,285
Operating expenses 16,682
Income tax expense 241
-------
Net income $ 362
=======
6. Legal Proceedings and Contingencies
Angeles Corporation Litigation
Angeles had guaranteed certain of the obligations of AHC under the terms of the
Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, the Company retained a general unsecured claim
against Angeles in the amount of $1,513,935 as part of the bankruptcy
proceedings, but waived all other claims against Angeles, including any amounts
of base and additional interest owed. In addition, the Company maintained a
claim for approximately $592,000 against an affiliate of Angeles which had made
a separate guaranty to the Company. On March 17, 1995, the Bankruptcy Court
handling the Angeles bankruptcy proceedings approved a final settlement of the
Company's outstanding claims against Angeles and its affiliates. Pursuant to the
terms of this settlement, the Company received a cash payment of $1.5 million on
April 14, 1995 in full satisfaction of the claims, which totaled approximately
$2.1 million. This amount, net of certain related legal expenses, was recorded
as a reduction in the carrying values of the operating investment properties.
F - 18
<PAGE>
Termination of Management Contract with AHC
On July 29, 1996, ILM I Lease Corporation and ILM Holding, Inc. ("the
Companies") terminated the property management agreement with AHC covering the
eight senior housing facilities leased by ILM I Lease Corporation from ILM
Holding, the Company's consolidated affiliate. The management agreement was
terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the
agreement. 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. ILM I Lease Corporation and ILM
Holding allege 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 management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed
with the Virginia District Court an Answer in response to the litigation
initiated by the Companies and a Counterclaim against ILM Holding. The
Counterclaim alleges that the management agreement was wrongfully terminated for
cause and requests damages which include the payment of the termination fee in
the amount of $1,250,000, payment of management fees pursuant to the contract
from August 1, 1996 through October 15, 1996, which is the earliest date that
the management agreement could have been terminated without cause, and recovery
of attorney's fees and expenses. In the event ILM I Lease Corporation cannot
perform its obligation to pay such amounts, PaineWebber Independent Living
Mortgage Fund, Inc. guaranteed the payment of any termination fee the court
deems to be owed as a result of these proceedings; however, management believes
that ILM I Lease Corporation has the ability to perform under the terms of the
management agreement in the event of an unfavorable outcome to this litigation
and the probability of PaineWebber Independent Living Mortgage Inc. II incurring
a loss under the terms of its guaranty is remote. The Companies intend to
diligently prosecute the case and to vigorously defend the counterclaims made by
AHC. The eventual outcome of this termination dispute cannot presently be
determined. Accordingly, no provision for any liability which might result from
the Company's guaranty of the termination fee has been recorded in the
accompanying financial statements.
ILM I Lease Corporation has retained Capital Senior Management 2, Inc.
("Capital") of Dallas, Texas to be the new manager of the Senior Housing
Facilities pursuant to a Management Agreement which commenced on July 29, 1996.
Under the terms of the Agreement, Capital will earn a Base Management Fee equal
to 4% of the Gross Operating Revenues of the Senior Housing Facilities, as
defined. Capital will also be eligible to earn an Incentive Management Fee equal
to 25% of the amount by which the average monthly Net Cash Flow of the Senior
Housing Facilities, as defined, for the twelve month period ending on the last
day of each calendar month exceeds a specified Base Amount. Each August 31,
beginning on August 31, 1997, the Base Amount will be increased annually based
on the percentage increase in the Consumer Price Index. PaineWebber Independent
Living Mortgage Fund, Inc. has guaranteed the payment of all fees due to Capital
under the terms of the Management Agreement.
Effective in November, 1996 Lawrence A. Cohen , President, Chief Executive
Officer and Director of the Company, was also named Vice Chairman and Chief
Financial Officer of Capital Senior Living Corporation, an affiliate of Capital.
Shareholder Matters
In November 1994, a series of purported class actions (the "New York Limited
Partnership Actions") were filed in the United States District Court for the
Southern District of New York concerning PaineWebber Incorporated's sale and
sponsorship of various limited partnership interests and common stock, including
the securities offered by the Company. The lawsuits were brought against
PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"),
among others, by allegedly dissatisfied investors. In March 1995, after the
actions were consolidated under the title In re PaineWebber Limited Partnership
Litigation, the plaintiffs amended their complaint to assert claims against a
variety of other defendants, including PaineWebber Properties Incorporated
("PWPI"), an affiliate of PaineWebber and the parent company of the general
partner of the Advisor to the Company. On May 30, 1995, the court certified
class action treatment of the claims asserted in the litigation.
F - 19
<PAGE>
The amended complaint in the New York Limited Partnership Actions alleged that,
in connection with the sale of common stock of the Company, the defendants (1)
failed to provide adequate disclosure of the risks involved; (2) made false and
misleading representations about the safety of the investments and the Company's
anticipated performance; and (3) marketed the Company to investors for whom such
investments were not suitable. The plaintiffs, who purported to be suing on
behalf of all persons who invested in the Company also alleged that following
the issuance of the Company's stock, the defendants misrepresented financial
information about the Company's value and performance. The amended complaint
alleged that the defendants violated the Racketeer Influenced and Corrupt
Organizations Act ("RICO") and the federal securities laws. The plaintiffs
sought unspecified damages, including reimbursement for all sums invested by
them in the Company's stock, as well as disgorgement of all fees and other
income derived by PaineWebber from the Company. In addition, the plaintiffs also
sought treble damages under RICO.
In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties have
agreed to settle the case. Pursuant to that memorandum of understanding,
PaineWebber irrevocably deposited $125 million into an escrow fund under the
supervision of the United States District Court for the Southern District of New
York to be used to resolve the litigation in accordance with a definitive
settlement agreement and a plan of allocation. On July 17, 1996, PaineWebber and
the class plaintiffs submitted a definitive settlement agreement which has been
preliminarily approved by the court and provides for the complete resolution of
the class action litigation, including releases in favor of the Company and
PWPI, and the allocation of the $125 million settlement fund among investors in
the various partnerships and REITs at issue in the case. As part of the
settlement, PaineWebber also agreed to provide class members with certain
financial guarantees relating to some of the partnerships and REITs. The details
of the settlement are described in a notice mailed directly to class members at
the direction of the court. A final hearing on the fairness of the proposed
settlement is scheduled to continue in December 1996.
In February 1996, approximately 150 plaintiffs filed an action entitled Abbate
v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiffs'
purchases of various limited partnership investments and REIT stocks, including
those offered by the Company. The complaint alleges, among other things, that
PaineWebber and its related entities committed fraud and misrepresentation and
breached fiduciary duties allegedly owed to the plaintiffs by selling or
promoting limited partnership and REIT investments that were unsuitable for the
plaintiffs and by overstating the benefits, understating the risks and failing
to state material facts concerning the investments. The complaint seeks
compensatory damages of $15 million plus punitive damages. In September 1996,
the court dismissed many of the plaintiffs' claims as barred by applicable
securities arbitration regulations.
In June 1996, approximately 50 plaintiffs filed an action entitled Bandrowski v.
PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiff's
purchases of various limited partnership interests and REIT stocks, including
those offered by the Company. The complaint is substantially similar to the
complaint in the Abbate action described above, and seeks compensatory damages
of $3.4 million plus punitive damages.
In July 1996, approximately 15 plaintiffs filed an action entitled Barstad v.
PaineWebber Inc. in Maricopa County, Arizona Superior Court against PaineWebber
Incorporated and various affiliated entities concerning the plaintiffs'
purchases of various limited partnership interests and REIT stocks, including
those offered by the Company. The complaint is substantially similar to the
complaint in the Abbate action described above, and seeks compensatory damages
of $752,000 plus punitive damages.
With respect to the Abbate, Bandrowski and Barstad actions described above, the
defendants' time to move against or answer the complaints has not yet expired.
In all cases, PaineWebber intends to vigorously contest the allegations of the
actions. However, the eventual outcome of this litigation and the potential
impact, if any, on the Company's shareholders cannot be determined at the
present time. Mediation hearings on the Abbate, Bandrowski and Barstad actions
are currently scheduled to be held in December 1996.
F - 20
<PAGE>
Under certain limited circumstances, pursuant to the Advisor Agreement with the
Advisor and other contractual obligations, PaineWebber affiliates could be
entitled to indemnification for expenses and liabilities in connection with the
shareholder litigation matters described above. However, PaineWebber has agreed
not to seek indemnification for any amounts it is required to pay in connection
with the settlement of the New York Limited Partnership Actions. At the present
time, neither PaineWebber nor management can estimate the impact, if any, of any
of the potential indemnification claims on the Company's financial statements,
taken as a whole. Accordingly, no provision for any liability which could result
from the eventual outcome of these matters has been made in the accompanying
financial statements.
7. Subsequent Events
On September 15, 1996, the Company's Board of Directors declared a quarterly
dividend for the quarter ended August 31, 1996. On October 15, 1996, a dividend
of $0.175 per share of common stock, totaling $1,316,000, was made to
shareholders of record as of September 30, 1996. On December 13, 1996, the Board
of Directors declared a quarterly dividend for the quarter ended November 30,
1996. On January 15, 1997, a dividend of $0.1875 per share of common stock,
totaling $1,410,000, will be made to shareholders of record as of January 2,
1997.
8. Events (unaudited) Subsequent to December 10, 1996
The Company has been attempting to continue its restructuring plans by
converting ILM Holding to a real estate investment trust ("REIT") for tax
purposes. In connection with these plans, on November 21, 1996 the Company
requested that PWPI cause PWP Holding to sell all of the stock held by PWP
Holding in ILM Holding to the Company for a price equal to the fair market value
of the 1% economic interest in ILM Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM Holding was completed
at an agreed upon fair value of $46,000. With this transfer completed, effective
January 23, 1997 ILM 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 a new class of nonvoting, 8% cumulative preferred stock issued to
the Company. The number of authorized shares of preferred and common stock in
ILM 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 Holding to each of 111 charitable organizations so that
ILM 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 will
accrue at a rate of 8% per annum on the original $1,000 Liquidation Preference
and will be cumulative from the date of issuance. Since ILM Holding is not
expected to have sufficient cash flow in the foreseeable future to make the
required dividend payments, it is anticipated that dividends will accrue and be
paid at liquidation.
With regard to the litigation described in Note 5 under "Termination of
Management Contract with AHC," the court initially set a trial date of April 28,
1997 but, at AHC's request, recently rescheduled the trial for June 23, 1997. On
June 13, 1997 and July 8, 1997, the court issued Orders purporting to enter
judgment against the Company and ILM II in the amount of $1,000,000. In so
doing, the court effectively canceled the June 23, 1997 trial date. The Orders
do not contain any findings of fact or conclusions of law. On July 10, 1997, the
Company, ILM II, ILM I Lease Corporation and ILM II Lease Corporation filed a
notice of appeal to the United State Court of Appeals for the Fourth Circuit
from the Orders. The Company intends to diligently prosecute the appeal. The
eventual outcome of this litigation cannot presently be determined. However, as
reported in the Company's report on Form 10-Q for the quarter ended May 31,
1997, the Company has recorded a provision in the amount of $600,000 for the
liability which might result from the court's Orders.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of
California against Capital, Lawrence Cohen, President, Chief Executive Officer
and a director of the Company, and others alleging that the defendants
intentionally interfered with AHC's property management agreement. The complaint
seeks 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. Trial
in the action has been set for January 13, 1998 and discovery has just begun. At
a Board meeting on February 26, 1997, the Company's Board of Directors concluded
that since all of Mr. Cohen's actions relating to the California litigation were
taken either on behalf of the Company under the direction of the Board or as a
PaineWebber Properties employee, the Company or its affiliates should indemnify
Mr. Cohen with respect to any expenses arising
F - 21
<PAGE>
from the California litigation, subject to any insurance recoveries for those
expenses. 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 in the California
litigation. Subsequently, the boards of directors of ILM I Lease Corporation and
ILM II Lease Corporation voted to increase the maximum amount of the advance to
$100,000. The defendants intend to vigorously defend the claims made against
them in the California litigation. The eventual outcome of this litigation
cannot presently be determined and, accordingly, no provision for any liability
has been recorded in the accompanying financial statements.
With regard to the litigation described in Note 5 under "Shareholder Matters,"
in March 1997, the United States District Court for the Southern District of New
York announced its final approval of the proposed settlement of the New York
Limited Partnership Actions (see the Annual Report for further information). The
release of the agreed upon settlement proceeds had been delayed pending the
resolution of an appeal of the settlement agreement by two of the plaintiff
class members. In July, 1997, the United States Court of Appeals for the Second
Circuit upheld the settlement over the objections of the two class members. As
part of the settlement agreement, PaineWebber has agreed not to seek
indemnification from the related partnerships and real estate investment trusts
at issue in the litigation (including the Company) for any amounts that it is
required to pay under the settlement. In addition, in December 1996 PaineWebber
agreed to settle the Abbate, Bandrowski and Barstad actions discussed further in
the Annual Report. Final releases and dismissals with regard to these actions
were received during fiscal 1997. Based on these settlement agreements which
cover all of the outstanding shareholder litigation, and notwithstanding the
appeal of the class action settlement referred to above, management does not
expect that the resolution of these matters will have a material impact on the
Company's financial statements, taken as a whole.
F - 22
<PAGE>
Report of Independent Auditors
The Shareholders of
ILM Holding, Inc.
We have audited the accompanying balance sheets of ILM Holding, Inc. (the
"Company"), as of August 31, 1996 and 1995 and the related statements of
operations, changes in shareholders' deficit and cash flows for the year ended
August 31, 1996, the two month period ended August 31, 1995 and the year ended
June 30, 1995. Our audits also included the financial statement schedule listed
in the Index at Item 14(a). These financial statements and schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ILM Holding, Inc. at August 31,
1996 and 1995, and the results of its operations and its cash flows for the year
ended August 31, 1996, the two month period ended August 31, 1995 and the year
ended June 30, 1995 in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/S/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Boston, Massachusetts
December 10, 1996
F - 23
<PAGE>
ILM HOLDING, INC.
BALANCE SHEETS
August 31, 1996 and 1995
(In thousands, except per share amounts)
Assets
------
<TABLE>
<CAPTION>
1996 1995
--------------------------------------
<S> <C> <C>
Operating investment properties, at cost:
Land $ 3,352 $ 3,352
Building and improvements 33,105 32,924
Furniture, fixtures and equipment 4,948 4,948
--------------------------------------
41,405 41,224
Less accumulated depreciation (3,191) (1,901)
--------------------------------------
38,214 39,323
Cash and cash equivalents 400 1,505
Interest and other receivable - 11
Accounts receivable - related party 348 -
Deferred rent receivable 123 -
Other assets 233 345
--------------------------------------
$39,318 $41,184
======================================
Liabilities & Shareholders' Equity (Deficit)
--------------------------------------------
Mortgages payable $40,391 $40,285
Accounts payable - related party 585 311
Accounts payable and accrued expenses 3 524
--------------------------------------
Total liabilities 40,979 41,120
Shareholders' equity (deficit):
Preferred stock (Series A, $1 par value, 100 shares
authorized, issued and outstanding) 1 1
Common stock ($1 par value, 10,000 shares
authorized, issued and outstanding) 10 10
Additional paid-in capital 689 689
Accumulated deficit (2,361) (636)
--------------------------------------
Total shareholders' equity (deficit) (1,661) 64
--------------------------------------
$39,318 $41,184
======================================
</TABLE>
See accompanying notes.
F - 24
<PAGE>
ILM HOLDING, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the two month
For the year ended period ended For the year ended
August 31, 1996 August 31, 1995 June 30, 1995
--------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Rental income $ 6,328 $2,747 $16,239
Interest income earned
on cash equivalents 16 6 25
Expenses:
Property Operating - 1,542 9,541
Depreciation 1,290 227 1,364
Interest 6,707 1,046 5,673
Management advisory fees - 13 81
Other 72 - -
--------------------------------------------------------------------
8,069 2,822 16,659
--------------------------------------------------------------------
Net loss $ (1,725) $ (75) $ (395)
====================================================================
Loss per share of
common stock $(172.50) $(7.50) $(39.50)
====================================================================
</TABLE>
See accompanying notes.
F - 25
<PAGE>
ILM HOLDING, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
For the year ended August 31, 1996, the two month period ended
August 31, 1995 and the year ended June 30, 1995
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock Preferred Stock
$.01 Par Value $.01 Par Value Additional
------------------------- ---------------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------ ------ ------ ------ ----------- ------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Shareholders' equity
at June 30, 1994 10,000 $10 100 $1 $689 $ (166) $ 534
Net loss - - - - - (395) (395)
---------- ---------- --------- ---------- ---------- ------------- --------
Shareholders' deficit
at June 30, 1995 10,000 10 100 1 689 (561) 139
Net loss - - - - - (75) (75)
---------- ---------- --------- ---------- ---------- ------------- --------
Shareholders' deficit
at August 31, 1995 10,000 10 100 1 689 (636) 64
Net loss - - - - - (1,725) (1,725)
---------- ---------- --------- ---------- ---------- ------------- --------
Shareholders' deficit
at August 31, 1996 10,000 $10 100 $1 $689 $(2,361) $(1,661)
========== ========== ========= ========== ========== ============= ========
</TABLE>
See accompanying notes.
F - 26
<PAGE>
ILM HOLDING, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the two month
For the year ended period ended For the year ended
August 31, 1996 August 31, 1995 June 30, 1995
-------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net loss $(1,725) $ (75) $ (395)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 1,290 227 1,364
Changes in operating assets and liabilities:
Interest and other receivable 11 (11) 3
Accounts receivable - related party (348) - 568
Deferred rent receivable (123) - -
Other assets 112 21 60
Accounts payable - related party 274 (137) (1,158)
Accounts payable and accrued liabilities (521) (357) 148
-------------------------------------------------------------------
Total adjustments 695 (257) 985
-------------------------------------------------------------------
Net cash provided by (used for) operating
activities (1,030) (332) 590
-------------------------------------------------------------------
Investing activities:
Investment in properties (181) (131) (771)
-------------------------------------------------------------------
Net cash used for investing activities (181) (131) (771)
-------------------------------------------------------------------
Financing activities:
Borrowings under mortgage notes 106 21 174
-------------------------------------------------------------------
Net cash provided by financing activities 106 21 174
-------------------------------------------------------------------
Net decrease in cash and cash equivalents
at end of period (1,105) (442) (7)
Cash and cash equivalents at beginning of year 1,505 1,947 1,954
-------------------------------------------------------------------
Cash and cash equivalents at end of year 400 1,505 1,947
===================================================================
</TABLE>
See accompanying notes.
F - 27
<PAGE>
1. Nature of Operations and Basis of Presentation
PaineWebber Independent Living Mortgage Fund, Inc. ("ILM") invested in eight
participating mortgage loans secured by Senior Housing Facilities located in
seven different states. All of the loans made by ILM were originally with
Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the
development, acquisition and operation of Senior Housing Facilities. ILM entered
into an Exclusivity Agreement with AHC and its parent company, Angeles
Corporation ("Angeles"), which required AHC to provide ILM with certain specific
opportunities to finance Senior Housing Facilities and set forth the terms and
conditions of the loans which were made. The loan documents under the
aforementioned Exclusivity Agreement called for interest to be paid on
construction loans at the rate of 13.3% per annum during the construction period
and for Base Interest to be paid on the permanent loans at the rate of 10.3% per
annum. In addition to the Base Interest, Additional Interest was to be payable
on the permanent loans in an amount equal to 10% of the Gross Revenues of the
Senior Housing Facilities, as defined. Under the terms of the amended
Exclusivity Agreement, Additional Interest was to be no less than 3% of the
aggregate principal amount of all permanent loans outstanding for the entire
term of the investments. In the aggregate, the properties securing loans from
ILM did not generate sufficient cash flow to cover the debt service payments
owed to ILM under the amended terms of the Exclusivity Agreement. To the extent
that the properties did not generate sufficient cash flow to make the full
payments due under the loan documents, the shortfall was funded by AHC through
December 1992. The source of cash to make up these shortfalls was from specified
deficit reserve accounts, which had been funded from the proceeds of the
mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to ILM on March 1, 1993. Subsequent to
March 1993, payments toward the debt service owed on ILM's loans were limited to
the net cash flow of the operating investment properties. On May 3, 1993,
Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition
filed in the state of California. AHC did not file for reorganization. ILM
retained special counsel and held extensive discussions with AHC concerning the
default status of its loans. During the fourth quarter of fiscal 1993, a
non-binding settlement agreement between ILM, AHC and Angeles was reached
whereby ownership of the properties would be transferred from AHC to ILM or its
designated affiliates. Under the terms of the Settlement Agreement, ILM released
AHC and Angeles from certain obligations under the loans. On April 27, 1994,
each of the properties owned by AHC and securing the Loans was transferred
(collectively, "the Transfers") to newly-created special purpose corporations
affiliated with ILM (collectively, "the Property Companies"). The Transfers had
an effective date of April 1, 1994 and were made pursuant to the Settlement
Agreement entered into on February 17, 1994 ("the Settlement Agreement") between
ILM and AHC which had previously been approved by the bankruptcy court handling
the bankruptcy case of Angeles. All of the capital stock of each Property
Company was held by ILM Holding, Inc. (the "Company"), a Virginia corporation.
In August 1995, each of the Property Companies merged into the Company. As a
result, ownership of the Senior Housing Facilities is now held by the Company,
and the Property Companies no longer exist as separate legal entities. The
capital stock of the Company is owned by ILM and PWP Holding, Inc. ("PWP
Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated
("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which
is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber").
As part of the fiscal 1994 settlement agreement with AHC, the Company retained
AHC as the property manager for all of the Senior Housing Facilities pursuant to
the terms of a management agreement. As discussed further in Note 8, the
management agreement with AHC was terminated in July 1996. Subsequent to the
effective date of the Settlement Agreement with AHC, management investigated and
evaluated the available options for structuring the ownership of the properties
in order to maximize the potential returns to the existing shareholders while
maintaining ILM's qualification as a REIT under the Internal Revenue Code. On
September 12, 1994, ILM formed a new subsidiary, ILM I Lease Corporation, for
the purpose of operating the Senior Housing Facilities. The Senior Housing
Facilities were leased to ILM I Lease Corporation effective September 1, 1995
(see Note 4 for a description of the master lease agreement).
2. Use of Estimates and Summary of Significant Accounting Policies
The accompanying financial statements have been prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles which
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 August 31, 1996 and 1995 and revenues and expenses for the
year ended August 31, 1996, the two month period ended August 31, 1995, and the
year ended June 30, 1995. Actual results could differ from the estimates and
assumptions used.
F - 28
<PAGE>
In 1995, in connection with the restructuring of property ownership described
above, the Company changed its fiscal year end from June 30 to August 31.
The Company's significant accounting policies are summarized as follows:
A. BASIS OF PRESENTATION
The operating cycle in the real estate industry is longer than one year
and the distinction between current and non-current is of little
relevance. Accordingly, the accompanying balance sheets are presented in
an unclassified format.
B. INCOME TAXES
For purposes of filing federal tax returns, the financial statements of
the Company are consolidated with those of ILM. The Company, has
incurred losses for tax purposes since inception. Neither ILM nor the
Company is likely to be able to use these losses to offset future tax
liabilities. Accordingly, no income tax benefit is reflected in these
financial statements.
C. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include
all highly liquid investments with original maturities of 90 days or
less.
D. FAIR VALUE DISCLOSURES
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("SFAS 107"), requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance
sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. SFAS 107
excludes certain financial instruments and all non-financial instruments
from its disclosure requirements. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the balance
sheet for cash and cash equivalents approximates its fair value due to
the short-term maturities of such instruments.
Accounts receivable - related party: The carrying amount reported on the
balance sheet for accounts receivable - related party approximates its
fair value due to the short-term maturity of such instrument.
Accounts payable - related party: The carrying amount reported on the
balance sheet for accounts payable related party approximates its fair
value due to the short-term maturity of such instrument.
Mortgages payable: Due to the unique nature of the debt arrangement as
described in Note 5, management is unable to determine the fair value of
mortgages payable without incurring excessive costs.
F - 29
<PAGE>
E. OPERATING INVESTMENT PROPERTIES
Operating investment properties are carried at the lower of cost,
reduced by accumulated depreciation, or net realizable value. The net
realizable value of a property held for long-term investment purposes is
measured by the recoverability of the owner's investment through
expected future cash flows on an undiscounted basis, which may exceed
the property's current market value. The net realizable value of a
property held for sale approximates its current market value as
determined on a discounted basis. None of the operating investment
properties were held for sale as of August 31, 1996 or 1995.
Depreciation expense is provided on a straight-line basis using an
estimated useful life of 40 years for the buildings and improvements and
5 years for the furniture, fixtures and equipment.
The Company has reviewed FAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," which is
effective for financial statements for years beginning after December
15, 1995, and believes this new pronouncement will not have a material
effect on the Company's financial statements.
F. RENTAL REVENUES
In fiscal 1995 rental income consisted of payments due on the individual
tenant leases at the Senior Housing Facilities. Units at the Facilities
are generally rented for terms of twelve months or less. The base rent
charged varies depending on the unit size, with added fees collected for
more than one occupant per unit and for assisted living services.
Included in the amount of base rent charged are certain meals,
housekeeping, medical and social services provided to the residents of
each Facility. In fiscal 1996, rental revenues consist of payments due
from ILM I Lease Corporation under the terms of the master lease
described in Note 7. Base rental income under the master lease is
recognized on a straight-line basis over the term of the lease. Deferred
rent receivable on the balance sheet as of August 31, 1996 represents
the difference between rental income on a straight-line basis and rental
income received under the terms of the master lease
3. The Advisory Agreement and Related Party Transactions
Subject to the supervision of the ILM's Board of Directors, the business of ILM
and the Company is managed by PaineWebber ILM Advisor, L.P. (the "Advisor"), a
limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation,
and Properties Associates, L.P. ("PA"), a Virginia limited partnership. ILM REIT
Advisor, Inc. is a wholly owned subsidiary of PaineWebber Properties
Incorporated ("PWPI"). In addition, the limited partners and holders of assignee
interest of PA are or have been officers of PWPI. PWPI is a wholly owned
subsidiary of PaineWebber Incorporated ("PWI"). PWI is a wholly owned subsidiary
of PaineWebber Group, Inc. ("PaineWebber"). The Advisor and its affiliates
received fees and compensation determined on an agreed-upon basis, in
consideration of various services performed in connection with the sale of the
shares, the management of ILM and the Company, and the acquisition, management
and disposition of ILM's investments.
Management advisory fees for the two month period ended August 31, 1995 and the
year ended June 30, 1995 were earned by an affiliate of PWPI for its
administration and supervision of the day-to-day operations of the Company. Such
fees were equal to 0.5% of the Gross Operating Revenues of the Senior Housing
Facilities. These management advisory fees were no longer charged to the Company
effective September 1, 1995 upon the commencement of the master lease described
in Note 7.
Accounts payable - related party at August 31, 1995 consists primarily of the
Company's outstanding liability for management advisory fees to date and amounts
payable to an affiliated company for advances made on behalf of the Company to
the Villa Santa Barbara Senior Housing Facility. Accounts payable - related
party at August 31, 1996 represents outstanding interest under the Company's
mortgage loans payable to ILM (see note 5).
Accounts receivable - related party at August 31, 1996 represents advances made
to ILM I Lease Corporation (see Note 7) primarily for the purchase of personal
property to operate the Senior Housing Facilities.
F - 30
<PAGE>
4. Operating Properties
Descriptions of the properties financed by the Company's loans are summarized
below:
Independence Village of East Lansing
------------------------------------
In June 1989, ILM acquired a loan with respect to a 159-unit Senior
Housing Facility known as Independence Village of East Lansing located
in East Lansing, Michigan. Construction of the Senior Housing Facility,
which was 91% leased as of August 31, 1996, was completed in May, 1989.
Independence Village of Winston-Salem
-------------------------------------
In June 1989, ILM acquired a loan with respect to a 156-unit Senior
Housing Facility known as Independence Village of Winston-Salem located
in Winston-Salem, North Carolina. Construction of the Senior Housing
Facility, which was 93% leased as of August 31, 1996, was completed in
February, 1989.
Independence Village of Raleigh
-------------------------------
In December 1989, ILM acquired a loan with respect to a 163-unit Senior
Housing Facility, known as Independence Village of Raleigh, located in
Raleigh, North Carolina. The original closing of the construction loan
occurred on December 18, 1989. Construction of the Senior Housing
Facility, which was 98% leased as of August 31, 1996, was completed in
March, 1991. ILM's investment was converted from a construction loan to
a permanent loan effective April 29, 1991.
Independence Village of Peoria
------------------------------
In December 1989, ILM acquired a loan with respect to a 164-unit Senior
Housing Facility known as Independence Village of Peoria located in
Peoria, Illinois. The original closing of the construction loan
occurred on December 18, 1989. Construction of the Senior Housing
Facility, which was 91% leased as of August 31, 1996, was completed in
November, 1990. ILM's investment was converted from a construction loan
to a permanent loan effective November 30, 1990.
F - 31
<PAGE>
Crown Pointe
------------
In February 1990, ILM acquired a loan with respect to an existing
133-unit Senior Housing Facility known as Crown Pointe Apartments
located in Omaha, Nebraska. The Senior Housing Facility, which was 99%
leased as of August 31, 1996, was opened in August of 1985.
Sedgwick Plaza
--------------
In February 1990, ILM acquired an loan with respect to an existing
150-unit Senior Housing Facility known as Sedgwick Plaza Apartments
located in Wichita, Kansas. The Senior Housing Facility, which was 83%
leased as of August 31, 1996, was opened in May of 1985.
West Shores
-----------
In December 1990, ILM acquired a loan with respect to an existing
134-unit Senior Housing Facility known as West Shores located in Hot
Springs, Arkansas. The Senior Housing Facility, which was 94% leased as
of August 31, 1996, was opened in June of 1987.
Santa Barbara
-------------
In July 1992, ILM acquired a loan with respect to an existing 123-unit
Senior Housing Facility known as Villa Santa Barbara located in Santa
Barbara, California. The acquisition and improvement of the facility
was financed by the aforementioned loan and another loan from an
affiliated company, PaineWebber Independent Living Mortgage Inc. II
(ILM2). Any amounts due from the borrower with regard to the mortgage
loans on the Santa Barbara property will be equitably apportioned
between ILM and ILM2 (generally 25% to ILM and 75% to ILM2). ILM and
ILM2 have entered into a Intercreditor Agreement to set forth their
respective rights and entitlements under the loan documents. During the
first quarter of fiscal 1994, ILM committed to release a portion of the
funds set aside for capital improvements at Villa Santa Barbara in
order to improve the marketability of that property. With the formal
execution of the Settlement Agreement completed, the planned
improvement program is now moving forward toward completion. ILM's
financing of such a program is expected to total approximately
$350,000, which it will fund from available uninvested offering
proceeds. The Senior Housing Facility, which was 81% leased as of
August 31, 1996, was opened in June of 1979.
5. Mortgage Loans
The Company's operating properties were acquired subject to the participating
mortgage loans payable to ILM. The principal balance of each loan was modified
to reflect the estimated fair value of the related operating property as of the
date of the Transfers. The modified Loans require interest-only payments on a
monthly basis at a rate of 7% from April 1, 1994 through December 31, 1994, 9%
for the period January 1 through December 31, 1995, 11% for the period January 1
through December 31, 1996, 12% for the period January 1 through December 31,
1997, 13% for the period January 1 through December 31, 1998, 13.5% for the
period January 1 through December 31, 1999 and 14% for the period January 1,
2000 through maturity, on December 31, 2000.
F - 32
<PAGE>
The following loans were outstanding at August 31, 1996 and 1995:
<TABLE>
<CAPTION>
Property
Pledged August 31, August 31, Date of
as Collateral 1996 1995 Loan
------------- ---- ---- ----
<S> <C> <C> <C>
Independence $ 8,950,000 $ 8,950,000 6/29/89
Village of
East Lansing, MI
Independence $ 5,750,000 $ 5,750,000 6/29/89
Village of
Winston-Salem, NC
Independence 8,350,000 8,350,000 4/29/91
Village of
Raleigh, NC
Independence 8,350,000 8,350,000 11/30/90
Village of
Peoria, IL
Crown Pointe 8,200,000 8,200,000 2/14/90
Apartments
Omaha, NE
Sedgwick Plaza 8,350,000 8,350,000 2/14/90
Apartments
Wichita, KS
West Shores 5,350,000 5,350,000 12/14/90
Hot Springs, AR
Villa Santa Barbara 1,698,000 1,592,000 7/13/92
Santa Barbara, CA
----------------- -----------------
$ 54,998,000 $ 54,892,000
Less discount (14,607,000) (14,607,000)
----------------- -----------------
$ 40,391,000 $ 40,285,000
================= =================
</TABLE>
A discount was recorded on the long-term debt in the amount by which the
modified principal amount of the loans exceeded the historical cost basis of the
properties at the time of the Transfers.
6. Stockholders' Equity
The Company has issued 100 shares of Series A Preferred Stock to ILM in return
for a capital contribution in the amount of $693,000. The holders of the Series
A Preferred Stock are entitled to one vote for each share of Preferred Stock
held. In addition, the holders of the Series A Preferred Stock are entitled to
receive, when and if declared by the Board of Directors, dividends and
distributions in an amount per share equal to the product of 0.1 and 99% of the
total amount of dividends and distributions made to all shareholders. The
Company has also issued 10,000 shares of Common Stock to PWP Holding in return
for a capital contribution in the amount of $7,000. The holders of the Common
Stock are entitled to one vote for each share of Common Stock held. The holders
of the Common Stock are entitled to receive, when and if declared by the Board
of Directors, dividends and distributions in an amount per share equal to the
product of 0.001 and 1% of the total amount of dividends and distributions made
to all shareholders.
F - 33
<PAGE>
7. Lease Arrangements
Beginning September 31, 1995, the Senior Housing Facilities were leased to ILM I
Lease Corporation under a master lease agreement. The master lease agreement is
initially between the Company, as owner of the properties and Lessor, and ILM I
Lease Corporation as Lessee. The master 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. The Company, as the Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the initial term of the master lease, which
expires on December 31, 2000 (December 31, 1999 with respect to the Santa
Barbara property), ILM I Lease Corporation is obligated to pay annual base rent
for the use of all of the Senior Housing Facilities in the aggregate amount of
$5,886,000 for calendar year 1995 (prorated based on the lease commencement
date) and $6,364,800 for calendar year 1996 and each subsequent year. Beginning
in January 1997 and for the remainder of the lease term, ILM I Lease Corporation
will also be obligated to pay variable rent for each Senior Housing Facility.
Such variable rent will be payable quarterly and will equal 40% of the excess,
if any, of the aggregate total revenues for the Senior Housing Facilities, on an
annualized basis, over $16,996,000.
A condensed balance sheet as of August 31, 1996 and summary of operations for
the year then ended of ILM I Lease Corporation are as follows:
Assets
------
August 31, 1996
---------------
Current Assets $2,529
Furniture, fixtures and equipment 242
Other non-current assets 26
-------
$2,797
=======
Liabilities and Shareholders' Equity
------------------------------------
Current liabilities $1,613
Other non-current liabilities 123
Shareholders' equity 1,061
-------
$2,797
=======
Summary of Operations
---------------------
Year ended
August 31, 1996
---------------
Revenues $17,285
Operating expenses 16,682
Income tax expense 241
--------
Net income $ 362
========
F - 34
<PAGE>
8. Legal Proceedings and Contingencies
Angeles Corporation Litigation
Angeles had guaranteed certain of the obligations of AHC under the terms of the
Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, ILM retained a general unsecured claim against
Angeles in the amount of $1,200,658 as part of the bankruptcy proceedings, but
waived all other claims against Angeles, including any amounts of base and
additional interest owed. In addition, ILM maintained a claim for approximately
$408,000 against an affiliate of Angeles which had made a separate guaranty to
ILM. On March 17, 1995, the Bankruptcy Court handling the Angeles bankruptcy
proceedings approved a final settlement of ILM's outstanding claims against
Angeles and its affiliates. Pursuant to the terms of this settlement, ILM
received a cash payment of $1 million on April 14, 1995 in full satisfaction of
the claims, which totaled approximately $1.6 million. This amount, net of
certain related legal expenses, was recorded as a reduction in the carrying
values of ILM's operating investment roperties.
F - 35
<PAGE>
Schedule III - Real Estate and Accumulated Depreciation
- -------------------------------------------------------
ILM HOLDING, INC.
SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
August 31, 1996
(Amounts in thousands)
<TABLE>
<CAPTION>
Costs
Capitalized
Initial Cost to (Removed) Gross Amount at Which Carried at
II.M (2) Subsequent to End of Year
------------------------- Acquisition ------------------------------------
Buildings & Buildings & Buildings & Accumulated
Depreciation Encumbrances (1) Land Improvements Improvements Land Improvements Total Depreciation
- ------------------ ----------------- ---------- ------------- ----------------- ---------- ------------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
East Lansing,
Michigan $ 8,950 $ 334 $ 4,759 $ (25) $ 334 $ 4,734 $ 5,068 $ 533
Winston-Salem
North Carolina 5,750 337 3,827 (20) 337 3,807 4,144 501
Raleigh,
North Carolina 8,350 741 5,791 (31) 741 5,760 6,501 530
Peoria,
Illinois 8,350 426 5,990 (31) 426 5,959 6,385 517
Omaha,
Nebraska 8,200 447 6,323 (33) 447 6,290 6,737 517
Wichita,
Kansas 8,350 367 4,093 (21) 367 4,072 4,439 370
Hot Springs,
Arkansas 5,350 301 1,764 24 301 1,788 2,089 156
Santa Barbara 1,698 399 733 (38) 399 695 1,094 67
California ------- ------- -------- -------- ------- -------- -------- -------
$54,998 $ 3,352 $ 33,280 $ (175) $ 3,352 $ 33,105 $ 36,457 $ 3,191
======= ======= ======== ======== ======= ======== ======== =======
Life on Which
Depreciation
in Latest
Income
Date of Date Statement
Depreciation Construction Acquired (2) is Computed
- ------------------ -------------- ------------- -------------
<S> <C> <C> <C>
East Lansing,
Michigan 1989 4/1/94 5 - 40 yrs
Winston-Salem
North Carolina 1989 4/1/94 5 - 40 yrs
Raleigh,
North Carolina 1991 4/1/94 5 - 40 yrs
Peoria,
Illinois 1990 4/1/94 5 - 40 yrs
Omaha,
Nebraska 1985 4/1/94 5 - 40 yrs
Wichita,
Kansas 1985 4/1/94 5 - 40 yrs
Hot Springs,
Arkansas 1987 4/1/94 5 - 40 yrs
Santa Barbara
California 1979 4/1/94 5 - 40 yrs
</TABLE>
(1) Encumbrances represent first mortgage loans between the Company, as
mortgagor, and PaineWebber Independent Living Mortgage Fund, Inc., as
mortgagee.
(2) Initial cost to the Company represents the cost at which the Facilities
were transferred to the Company effective April 1, 1994 pursuant to the
Settlement Agreement entered into between the Company and AHC as described
in the Notes to the Financial Statements.
(3) The aggregate cost of real estate owned at August 31, 1996 for Federal
income tax purposes is approximately $55,969,000.
F-36
<PAGE>
Schedule III - Real Estate and Accumulated Depreciation
- -------------------------------------------------------
ILM HOLDING, INC.
SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
August 31, 1996
(Amounts in thousands)
(5) Reconciliation of real estate owned:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Balance at beginning of period $ 36,276 $ 35,374
Acquisitions and improvements - 12 months ended 8/31/96 181 -
Acquisitions and improvements - 12 months ended 6/30/95 - 771
Improvements - 3 months ended 6/30/94 - -
Improvements - 2 months ended 8/31/95 - 131
----------- ------------
Balance at end of period $ 36,457 $ 36,276
=========== ============
(6) Reconciliation of accumulated depreciation:
Balance at beginning of period $ 1,901 $ 310
Depreciation expense - 12 months ended 8/31/96 1,290 -
Depreciation expense - 12 months ended 6/30/95 - 1,364
Depreciation expense - 3 months ended 6/30/94 - -
Depreciation expense - 2 months ended 8/31/95 - 227
----------- ------------
Balance at end of period $ 3,191 $ 1,901
=========== ============
</TABLE>
F-37
