UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended May 31, 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: 0-18942
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
(Exact name of registrant as specified in its charter)
Virginia 06-1293758
(State of organization) (I.R.S.Employer
Identification No.)
1285 Avenue of the Americas, New York, New York 10019
(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
Shares of Common Stocks None
Securities registered pursuant to Section 12(g) of the Act:
SHARES OF COMMON STOCK
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
Shares of common stock outstanding as of May 31, 1996: 5,181,236. The
aggregate sales price of the shares sold was $51,812,356. This does not
reflect market value. There is no current market for these shares.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED BALANCE SHEETS
May 31, 1996 and August 31, 1995
(Unaudited)
(In thousands)
ASSETS
May 31 August 31
------ ---------
Operating investment properties, at cost:
Land $ 5,030 $ 5,030
Building and improvements 28,932 28,843
Furniture, fixtures and equipment 3,879 3,765
--------- ---------
37,841 37,638
Less: accumulated depreciation (5,706) (4,736)
--------- ----------
32,135 32,902
Cash and cash equivalents 1,541 2,409
Interest and other receivables 147 46
Accounts receivable - affiliates 3 74
Prepaid expenses and other assets 10 121
--------- ---------
$ 33,836 $ 35,552
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 49 $ 615
Accounts payable - affiliates 32 57
Shareholders' equity 33,755 34,880
---------- ---------
$ 33,836 $ 35,552
========== =========
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF INCOME
For the three and nine months ended May 31, 1996 and 1995
(In Thousands, except per Share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
May 31, May 31,
------------------ ------------------
1995 1995
1996 (As restated) 1996 (As restated)
---- ------------ ---- -----------
Revenues:
Rental income $ 1,008 $ 2,936 $ 2,864 $ 8,806
Interest income 12 25 41 61
-------- -------- -------- --------
1,020 2,961 2,905 8,867
Expenses:
Property operating expenses - 2,053 - 6,068
Depreciation expense 312 318 970 954
Management and advisory fees 32 47 97 141
General and administrative 147 55 502 255
Directors' compensation 6 6 18 18
-------- -------- -------- --------
497 2,479 1,587 7,436
-------- -------- -------- --------
Net income $ 523 $ 482 $ 1,318 $ 1,431
========= ======== ======== ========
Earnings per share of
common stock $0.10 $0.10 $0.25 $0.28
===== ===== ===== =====
Cash dividends paid per share of
common stock $0.13 $0.10 $0.38 $0.30
===== ===== ===== =====
The above earnings and cash dividends paid per share of common stock are
based upon the 5,181,236 shares outstanding for each period.
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended May 31, 1996 and 1995 (Unaudited)
(In Thousands)
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- -------- -----
Shareholders' equity
at August 31, 1994 5,181 $ 52 $44,823 $(9,649) $35,226
Cash dividends paid - - - (1,554) (1,554)
Net income - - - 1,431 1,431
----- ------ ------- -------- -------
Shareholders' equity
at May 31, 1995 5,181 $ 52 $44,823 $(9,772) $35,103
===== ====== ======= ======= =======
Shareholders' equity
at August 31, 1995 5,181 $ 52 $44,823 $(9,995) $34,880
Cash dividends paid - - - (1,943) (1,943)
Distribution of
stock in ILM II
Lease Corporation - - - (500) (500)
Net income - - - 1,318 1,318
----- ------ ------- -------- -------
Shareholders' equity
at May 31, 1996 5,181 $ 52 $44,823 $(11,120) $33,755
===== ====== ======= ======== =======
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended May 31, 1996 and 1995 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In Thousands)
1995
1996 (As restated)
---- ------------
Cash flows from operating activities:
Net income $ 1,318 $ 1,431
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense 970 954
Changes in assets and liabilities:
Accounts receivable - affiliate 71 (7)
Interest and other receivables (101) -
Prepaid expenses and other assets 111 (9)
Accounts payable - affiliates (25) 73
Accounts payable and accrued expenses (566) (24)
--------- --------
Total adjustments 460 987
--------- --------
Net cash provided by operating activities 1,778 2,418
--------- --------
Cash flows from investing activities:
Funding of initial working
capital to ILM II Lease Corporation (500) -
Additions to operating investment properties (203) (1,085)
Net proceeds from settlement of claims with
Angeles Corporation and affiliates - 948
--------- --------
Net cash used in investing activities (703) (137)
--------- --------
Cash flows from financing activities:
Cash dividends paid to shareholders (1,943) (1,554)
--------- ---------
Net (decrease) increase in cash and cash equivalents (868) 727
Cash and cash equivalents, beginning of period 2,409 1,380
--------- --------
Cash and cash equivalents, end of period $ 1,541 $ 2,107
========= =========
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
Notes to Consolidated Financial Statements
(Unaudited)
1. Organization and Basis of Presentation
The accompanying consolidated financial statements, footnotes and
discussions should be read in conjunction with the consolidated financial
statements and footnotes contained in the Company's Annual Report for the
year ended August 31, 1995.
In the opinion of management, the accompanying consolidated financial
statements, which have not been audited, reflect all adjustments necessary to
present fairly the results for the interim period. All of the accounting
adjustments reflected in the accompanying interim financial statements are of
a normal recurring nature.
As discussed in the Company's Annual Report, the Company was formed for
the purpose of investing in a portfolio of participating mortgage loans
secured by rental housing complexes for independent senior citizens ("Senior
Housing Facilities"). The Company invested the net proceeds of the initial
public offering in six participating mortgage loans secured by Senior Housing
Facilities located in five different states. All loans made by the Company
were originally made to Angeles Housing Concepts, Inc. ("AHC") for its use in
developing, acquiring and operating the six 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 it set forth the terms and conditions of the loans which were
made. 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 original terms of the Exclusivity Agreement, which
called for minimum base and additional interest payments equal to 13.3% per
annum. 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 for these
fundings was from pre-established deficit reserve accounts and contributions
from Angeles. 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. Subsequently, AHC defaulted on the
regularly scheduled mortgage loan payments due to the Company on March 1,
1993. Subsequent to the payment defaults, on May 3, 1993, Angeles filed for
reorganization under a Chapter 11 Federal Bankruptcy petition filed in the
state of California.
In June 1993, a non-binding settlement agreement between the Company, AHC
and Angeles was reached which involved the transfer of title to ownership of
the properties from AHC to the Company or its designated affiliates. On April
27, 1994, ownership of each of the Facilities securing the loans from the
Company was transferred (collectively, "the Transfers") to newly-created
special purpose corporations affiliated with the Company ("the Property
Companies"). All of the capital stock of each Property Company was held by
ILM II Holding, Inc. ("ILM Holding"), a Virginia corporation. The capital
stock of ILM Holding is owned by the Company and PWP Holding, Inc. ("PWP
Holding"), a wholly owned subsidiary of PaineWebber Properties Incorporated,
which is an affiliate of the Advisor. 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 $495,000 and
issued 10,000 shares of Common Stock to PWP Holding in return for a capital
contribution in the amount of $5,000. The Transfers had an effective date of
April 1, 1994. The Transfers were made pursuant to a final Settlement
Agreement entered into on February 17, 1994 ("the Settlement Agreement")
between the Company, AHC and Angeles, and previously approved by the
bankruptcy court handling the Angeles bankruptcy proceedings. Concurrent with
the Transfers, the mortgage loans from the Company, which were assumed by the
Property Companies, were modified (see Note 2). In addition to providing for
the transfer of title to the properties to the Company, the Settlement
Agreement called for AHC to be retained in a property management capacity
under a contract covering all of the Senior Housing Facilities (see Note 3).
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. 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. Despite the additional
costs associated with the master leases of the properties, the Directors
believed that this alternative would maximize potential shareholder returns
and allow the greatest flexibility to provide future liquidity to
shareholders.
In connection with the Company's restructuring plans, 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. In addition, on
September 12, 1994, the Company formed a new subsidiary, ILM II Lease
Corporation, for the purpose of operating the Senior Housing Facilities under
the terms of a master lease agreement. ILM II Lease Corporation, which is
taxable as a regular C Corporation and not as a REIT, was a wholly owned
subsidiary of the Company as of August 31, 1995. On September 1, 1995, the
Company distributed all of the shares of capital stock of ILM II Lease
Corporation to the holders of record of the Company's common stock. Prior to
the distribution on September 1, 1995, the Company capitalized ILM II Lease
Corporation with $500,000 from its existing cash reserves, which was an
amount estimated to provide ILM II Lease Corporation with necessary working
capital.
In prior years, the Company had accounted for its investments in mortgage
loans as investments in acquisition and construction loans under the equity
method because the loans met certain accounting criteria which require that
participating mortgage loans with certain characteristics be accounted for as
joint ventures. Such accounting criteria are meant to apply to lending
arrangements which have essentially the same risks and potential rewards for
the lender as would exist in a joint venture partnership. The final phase of
the Company's restructuring plans involves either the liquidation of ILM
Holding and the transfer of ownership of the Senior Housing Facilities to the
Company or its wholly-owned subsidiary or the conversion of ILM Holding to a
REIT for tax purposes. As a result of these plans, which are expected to be
finalized during fiscal 1996, the financial position, results of operations
and cash flows of ILM Holding are presented on a consolidated basis with the
Company as of and for the nine months ended May 31, 1996. The prior year
financial statements have been restated to present the combined Facilities on
a consolidated basis in order for the statements to be comparable to the
current year presentation. Such restatement does not affect the net income or
net shareholders' equity amounts previously reported. All material
intercompany balances and transactions have been eliminated in consolidation.
The Company's policy had been to record its equity in the earnings or losses
of the properties based on financial information of the properties which was
two months in arrears to that of the Company. As a result of the
restructuring of the property ownership discussed above, the Company
eliminated this reporting lag as of the end of fiscal 1995.
<PAGE>
2. Operating Investment Properties
The accompanying financial statements include the Company's investments in
six Senior Housing Facilities. The name, location and size of the properties
and the date that the Company made its initial investment in such assets are
as set forth below:
Rentable Date of
Name Location Units Investment (1)
---- -------- ------- --------------
The Palms Fort Myers, FL 204 Units 7/18/90
Crown Villa Omaha, NE 73 Units 4/25/91
Overland Park Place Overland Park, KS 137 Units 4/9/92
Rio Las Palmas Stockton, CA 162 Units 5/14/92
The Villa at St. Louis County, MO 119 Units 5/29/92
Riverwood
Villa Santa
Barbara (2) Santa Barbara, CA 123 Units 7/13/92
(1)Represents the date of the Company's original mortgage loan to Angeles
Housing Concepts, Inc. (see Note 1).
(2)The acquisition of the Santa Barbara Facility was financed jointly by
the Company and an affiliated entity, PaineWebber Independent Living
Mortgage Fund, Inc. ("ILM1"). All amounts generated from Villa Santa
Barbara are equitably apportioned between the Company, together with its
consolidated affiliate, and ILM1, together with its consolidated
affiliate, generally 75% and 25%, respectively.
As discussed in Note 1, effective April 1, 1994 each Property Company
acquired the respective operating property subject to, and assumed the
obligations under the mortgage loan payable to the Company, pursuant to the
Settlement Agreement described in Note 1. The principal balance on 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 1, 1994, 9% for the period from 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, 1999 through
December 31, 1999 and 14% for the period January 1, 2000 through maturity.
In August 1995, each of the Property Companies was merged into ILM Holding.
As a result, ownership of the Senior Housing Facilities, as well as the
obligation under the loans, is now held by ILM Holding and the Property
Companies no longer exist as separate legal entities. Since ILM Holding is
consolidated with the Company in the accompanying financial statements, the
mortgage loans and related interest income and expense have been eliminated
in consolidation.
As discussed in Note 1, effective September 1, 1995, the properties are
subject to a master lease with a newly formed company, ILM II Lease
Corporation. The master lease agreement is initially between ILM Holding, as
owner of the properties and Lessor, and ILM II Lease Corporation, as Lessee.
The master lease is a "triple-net" lease with an original fixed term
expiring December 31, 2000 (December 31, 1999 with respect to the Santa
Barbara property). The Lessor has the right to terminate the master lease as
to any property sold by the Lessor as of the date of such sale. During the
initial term of the master lease, ILM II Lease Corporation is obligated to
pay annual base rent for the use of all of the Facilities in the aggregate
amount of $3,548,700 for calendar year 1995 (prorated based on the
commencement date of the lease) and $4,035,600 for calendar year 1996 and
each subsequent year. Beginning in fiscal 1997, and for each fiscal year
thereafter, ILM II Lease Corporation will also be obligated to pay variable
rent for each Facility. Such variable rent will be equal to 40% of the
excess, if any, of the aggregate total revenues for the Facilities for
fiscal 1997 or such subsequent fiscal year over $13,021,000. In addition, as
the Lessee, ILM II Lease Corporation is responsible for paying all
governmental taxes and assessments, utility charges, and insurance premiums,
as well as the costs of all required maintenance and non-structural repairs
to the Facilities. The Lessor, as the owner of the Facilities, is
responsible for all capital improvements and structural repairs to the
Facilities.
For the three and nine months ended May 31, 1996, rental income on the
accompanying income statement reflects the rental payments due under the
terms of the master lease agreement. For the same periods in the prior year,
rental income reflects the rental payments due under the terms of the
individual tenant leases. Property operating expenses in the prior periods
reflect the day-to-day costs of operating the Facilities, including the
management fees payable to AHC, in addition to the real estate taxes
associated with the ownership of the operating properties. As noted above,
under the terms of the master lease all such costs are now the
responsibility of the Lessee.
Combined summarized operating results of the Company's operating
investment properties reflecting the rental income earned on individual
tenant leases and the property operating expenses as reported by ILM II
Lease Corporation in its quarterly filing with the United States Securities
and Exchange Commission are as follows (in thousands):
Three Months Ended Nine Months Ended
5/31/96 5/31/96
------- -------
Rental income $ 3,304 $ 9,702
Expenses:
Property management fees 181 534
Property operating expenses 1,670 5,013
Real estate taxes and
insurance 198 550
---------- ----------
2,049 6,097
---------- ---------
$ 1,255 $ 3,605
========== =========
3. Management Agreement
Management of the Facilities has been provided by AHC from, and in certain
cases prior to, the date that the original mortgage loans were made by the
Company (see Note 1). In connection with the Settlement Agreement described
in Note 1, AHC was retained in a property management capacity under a
contract with an original expiration date of December 31, 1995. The contract
is automatically renewable for successive one-year periods through December
31, 2000, subject to certain limitations described further below. The terms
of the management contract provide that AHC will receive a base management
fee equal to 5.5% of Gross Operating Revenues of the Senior Housing
Facilities, as defined. In addition, under the original terms of the
contract, AHC was eligible to earn additional compensation through a 25%
participation in excess cash flow or sale or refinancing proceeds above
certain specified levels. The thresholds at which AHC would begin to
participate in excess cash flow or sale or refinancing proceeds were set at
levels which provided 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 began. During the first quarter
of fiscal 1996, the Company reached an agreement with AHC regarding certain
modifications to the management agreement. In return for making the contract
non-cancellable, except for cause, for a one-year period, AHC agreed to
waive its rights to any additional compensation to which it might be
entitled through the participation interest described above. In addition,
the parties agreed to fix the termination fee due to AHC if the agreement is
terminated without cause prior to December 31, 2000. Prior to such
agreement, the termination fee was calculated based on a percentage of Gross
Operating Revenues of the Senior Housing Facilities for a specified number
of months which varied depending on the date of termination and the
achievement of certain minimum net operating income levels. Subsequent to
this amendment, the management agreement may be terminated without cause
upon 30 days' written notice subsequent to September 15, 1996. The contract
may be terminated immediately for cause, which includes failure to meet
certain minimum occupancy and rental rate thresholds. If the agreement is
terminated without cause prior to December 31, 2000, AHC would be due a
termination fee of $750,000. As explained in Note 2, effective September 1,
1995, the obligations to pay AHC under the terms of the management agreement
were transferred to ILM II Lease Corporation. However, the Company has
guaranteed the payment of the termination fee described above.
4. Related Party Transactions
Accounts receivable - affiliate consists of amounts due from an affiliated
company for disbursements made by the Company on behalf of its affiliate
related to the Villa Santa Barbara property which the two companies jointly
financed (see Note 2).
The advisors to the Company and its consolidated affiliate earned
management and advisor fees of $97,000 and $141,000 for the nine-month
periods ended May 31, 1996 and 1995, respectively. Accounts payable
affiliates at both May 31, 1996 and August 31, 1995 includes management fees
of $32,000 payable to the Advisor. Accounts payable - affiliates at August
31, 1995 also includes reimbursements of out-of-pocket expenses of $25,000
payable to PWPI.
Included in general and administrative expenses for the nine months ended
May 31, 1996 and 1995 is $85,000 and $89,000, respectively, representing
reimbursements to an affiliate of the Advisor for providing certain
financial, accounting and investor communication services to the Company.
Also included in general and administrative expenses for the nine months
ended May 31, 1996 and 1995 is $4,000 and $3,000, respectively, representing
fees earned by Mitchell Hutchins Institutional Investors, Inc.
for managing the Company's cash assets.
5. Subsequent Events
On June 14, 1996, the Company's Board of Directors declared a quarterly
dividend for the quarter ended May 31, 1996. On July 15, 1996, a dividend of
$0.125 per share of common stock, totalling $648,000, will be paid to
shareholders of record as of June 28, 1996.
6. Contingencies
The Company is involved in certain legal actions. At the present time,
management is unable to estimate the impact, if any, that these matters may
have on the Company's financial statements, taken as a whole.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
As described further in the Company's Annual Report for fiscal 1995, the
Company implemented a plan effective September 1, 1995 which involved master
leasing the Senior Housing Facilities to a shareholder-owned operating company.
As discussed further in the Annual Report, the Board of Directors believed that
such a master lease structure was the best alternative to preserve the Company's
REIT status, maximize potential shareholder returns and allow for the greatest
flexibility to provide future liquidity to shareholders.
In connection with the Company's restructuring plans, in September 1994,
the Company formed a new corporation, ILM II 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 II Lease Corporation, which is taxable as
a regular C corporation and not as a REIT, was a wholly-owned subsidiary of the
Company. Subsequent to year-end, on September 1, 1995, after the Company
received the required regulatory approval, it distributed all of the shares of
capital stock of ILM II Lease Corporation to the holders of record of the
Company's common stock. One share of common stock of ILM II Lease Corporation
was issued for each full share of the Company's common stock held. Holders of
the Company's common stock were not required to pay any cash or other
consideration or to exchange their common stock of the Company for the common
stock of ILM II Lease Corporation. The distribution of the capital stock of ILM
II Lease Corporation did not affect the number of shares of the Company's common
stock outstanding. Prior to the distribution, the Company capitalized ILM II
Lease Corporation with $500,000 from its existing cash reserves, which was an
amount estimated to provide ILM II Lease Corporation with necessary working
capital. Prior to the distribution of the ILM II Lease Corporation stock, the
Company's shareholders received an information statement fully describing ILM II
Lease Corporation and the distribution of its capital stock.
The master lease agreement is initially between the Company's consolidated
affiliate, ILM II Holding, Inc. ("ILM Holding") as owner of the properties and
Lessor, and ILM II Lease Corporation as Lessee. The master lease is a
"triple-net" lease with an original fixed term expiring December 31, 2000
(December 31, 1999 with respect to the Santa Barbara property). The Lessor has
the right to terminate the master lease as to any property sold by the Lessor as
of the date of such sale. During the initial term of the master lease, ILM II
Lease Corporation is obligated to pay annual base rent for the use of all of the
Facilities in monthly installments of $295,725 for calendar year 1995 and
monthly installments of $336,300 for calendar year 1996 and each subsequent
year. Beginning in fiscal 1997, and for each fiscal year thereafter, ILM II
Lease Corporation will also be obligated to pay variable rent to the Lessor for
each Facility. Such variable rent will be equal to 40% of the excess, if any, of
the aggregate total revenues for the Facilities for fiscal 1997 or such
subsequent fiscal year over $13,021,000. In addition, as the Lessee, ILM II
Lease Corporation is responsible for paying all governmental taxes and
assessments, utility charges, and insurance premiums, as well as the costs of
all required maintenance and non-structural repairs to the Facilities. The
Lessor, as the owner of the Facilities, is responsible for all capital
improvements and structural repairs to the Facilities.
The Company currently plans to hold its investments in the Senior Housing
Facilities for long-term investment purposes. At the present time, the outlook
for the senior housing industry is excellent. Increasing numbers of seniors and
the high incidence of seniors requiring assistance with daily living have
substantially increased the demand for senior housing and assisted-living
services. Management expects that this trend will continue for the foreseeable
future. The resulting potential for attractive returns appears to be causing
real estate buyers to seek acquisition opportunities for a limited pool of
available properties which has caused market values for existing properties to
increase. Demand would appear to be particularly high for Senior Housing
Facilities with assisted living units, which the Company has at certain of its
properties. At some point in this typical real estate market cycle, expected
returns become high enough to justify the construction of new facilities which
will result in the addition of supply to the market. At such time, values could
be expected to plateau and possibly decline. With the current expected return
characteristics and the continued availability of favorable financing terms,
some market observers are predicting a significant increase in development
activity in the senior housing segment over the course of the next 5-to-10
years. In certain of the Company's markets, capital investment in the
construction of new competing senior housing properties has increased noticeably
in recent months. Management will continue to monitor market dynamics in trying
to determine the optimal time to sell the Company's assets. Management continues
to analyze the potential impact on overall shareholder returns of leveraging the
portfolio of properties with mortgage debt and distributing the financing
proceeds to the shareholders in the near term. Management expects to complete
its analysis and formalize its strategic plans for the Company during 1996.
As a result of assuming ownership of the properties through ILM Holding, a
regular C corporation for tax purposes, the Company, as a REIT, has 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 the C corporation. The REIT
would most likely not incur a built-in gain tax if it were to hold the
properties for a period of at least 10 years from the date of transfer from the
C corporation. However, since the end of the Company's original anticipated
holding period is only 5 years away, the Company is not expected to hold the
properties 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, 2005. 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, the Company
would expect to incur a sizable tax if the properties were sold in the near
term. Based on these current estimated market values, 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 $2.3 million. The final phase of the Company's restructuring
plans involves either the liquidation of ILM Holding and the transfer of
ownership of the Senior Housing Facilities to the Company or its wholly-owned
subsidiary or the conversion of ILM Holding to a REIT for tax purposes. Any
future appreciation in the value of the assets subsequent to the transfer of
ownership from ILM Holding to the Company or the conversion of ILM Holding to a
REIT would not be subject to the built-in gain tax.
The six properties in which the Company has invested averaged 90%
occupancy for the quarter ended May 31, 1996. As previously reported, a property
renovation and assisted-living conversion program has been in progress at Villa
Santa Barbara for the past 21 months. 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 in 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 75% by the Company and 25% by
PaineWebber Independent Living Mortgage Fund, Inc. (ILM1) from funds previously
reserved for such improvements. Leasing gains at 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, the Company received the required assisted living
licenses. Leasing of the 38 new assisted living units is now underway. Overall
occupancy of Villa Santa Barbara had increased to 79% as of the end of the third
quarter.
Management of the Facilities has been provided by AHC from, and in certain
cases prior to, the date that the original mortgage loans were made by the
Company. In connection with the Settlement Agreement described in Note 1 to the
accompanying financial statements, AHC was retained in a property management
capacity under a contract with an original expiration date of December 31, 1995.
The contract is automatically renewable for successive one-year periods through
December 31, 2000, subject to certain limitations. The terms of the management
contract provide that AHC will receive a base management fee equal to 5.5% of
Gross Operating Revenues of the Senior Housing Facilities, as defined. In
addition, under the original terms of the contract, AHC was eligible to earn
additional compensation through a 25% participation in excess cash flow or sale
or refinancing proceeds above certain specified levels. The thresholds at which
AHC would begin to participate in excess cash flow or sale or refinancing
proceeds were set at levels which provided 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 began. During the
first quarter of fiscal 1996, the Company reached an agreement with AHC
regarding certain modifications to the management agreement. In return for
making the contract non-cancellable, except for cause, for a one-year period,
AHC agreed to waive its rights to any additional compensation to which it might
be entitled through the participation interest described above. In addition, the
parties agreed to fix the termination fee due to AHC if the agreement is
terminated without cause prior to December 31, 2000 at a flat amount. Prior to
such agreement, the termination fee was calculated based on a percentage of
Gross Operating Revenues of the Senior Housing Facilities for a specified number
of months which varied depending on the date of termination and the achievement
of certain minimum net operating income levels. The management agreement may be
terminated without cause upon 30 days' written notice subsequent to September
15, 1996. The contract may be terminated immediately for cause, which includes
failure to meet certain minimum occupancy and rental rate thresholds. If the
agreement is terminated without cause prior to December 31, 2000, AHC would be
due a termination fee of $750,000. Effective September 1, 1995, the obligations
to pay AHC under the terms of the management agreement were transferred to ILM
II Lease Corporation. However, the Company has guaranteed the payment of the
termination fee described above.
At May 31, 1996, the Company and its consolidated affiliate had cash and
cash equivalents of $1,541,000. Such amounts will be used for the working
capital requirements of the Company, along with the possible investment in the
Senior Housing Facilities for certain capital improvements and for dividends to
the Shareholders. Although the Company, through its consolidated affiliate, has
taken title to the operating properties, its liquidity needs are not expected to
be significantly different in the near term. The Company had already set aside
funds to pay for initial identified capital improvement programs at certain of
the Senior Housing Facilities. 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 II 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
Three Months Ended May 31, 1996
As a result of the restructuring of the Company, as discussed further above
and in the notes to the accompanying financial statements, the Company now
receives master lease income from ILM II 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 the Company during the current quarter was $125,000 more than the excess of
rental income earned from the Senior Housing Facilities over property operating
expenses during the same period in the prior year. The Company's net income
increased by $41,000 for the three months ended May 31, 1996, as compared to the
same period in the prior year. The increase in net income can be attributed
mainly to the increase in master lease rental income referred to above. The
increase in master lease rental income was partially offset by an increase in
general and administrative expenses of $92,000. General and administrative
expenses increased for the third quarter of fiscal 1996 mainly due to an
increase in professional fees. Professional fees increased primarily due to
legal expenses incurred in connection with the restructuring of the Company, as
discussed above.
Nine Months Ended May 31, 1996
The master lease rental income earned by the Company during the nine months
ended May 31, 1996 was $126,000 more than the excess of rental income earned
from the Senior Housing Facilities over property operating expenses during the
same period in the prior year. Despite this improvement, the Company's net
income decreased by $113,000 for the nine months ended May 31, 1996. The
decrease in net income can be attributed mainly to an increase in general and
administrative expenses of $247,000. General and administrative expenses
increased primarily due to an increase in professional fees. Professional fees
increased primarily due to legal expenses incurred in connection with the
restructuring of the Company, as discussed above.
<PAGE>
PART II
Other Information
Item 1. Legal Proceedings
As previously disclosed, the Company's management was named as a
defendant in a class action lawsuit against PaineWebber Incorporated
("PaineWebber") and a number of its affiliates relating to PaineWebber's sale of
70 direct investment offerings, including the offering of interests in the
various limited partnership investments and REIT stocks, including those offered
by the Company. 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 which the parties
expect to submit to the court for its consideration and approval within the next
several months. Until a definitive settlement and plan of allocation is approved
by the court, there can be no assurance what, if any, payment or non-monetary
benefits will be made available to shareholders in Independent Living Mortgage
Inc. II.
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. The
eventual outcome of this litigation and the potential impact, if any, on the
Company's shareholders cannot be determined at the present time.
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
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 $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.
Under certain limited circumstances, pursuant to the Partnership
Agreement and other contractual obligations, PaineWebber affiliates could be
entitled to indemnification for expenses and liabilities in connection with this
litigation. At the present time, the General Partners cannot estimate the
impact, if any, of these indemnification claims on the Company's financial
statements, taken as a whole.
Item 2. through 5. NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: NONE
(b) Reports on Form 8-K: NONE
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
By: PAINEWEBBER INDEPENDENT LIVING
MORTGAGE INC. II
By: /s/ Walter V. Arnold
Walter V. Arnold
Senior Vice President, Chief
Financial Officer and Treasurer
Dated: July 9, 1996
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Partnership's audited financial statements for the quarter ended May 31, 1996
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> AUG-31-1996
<PERIOD-END> MAY-31-1996
<CASH> 1,541
<SECURITIES> 0
<RECEIVABLES> 150
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,701
<PP&E> 37,841
<DEPRECIATION> 5,706
<TOTAL-ASSETS> 33,836
<CURRENT-LIABILITIES> 81
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 33,755
<TOTAL-LIABILITY-AND-EQUITY> 33,836
<SALES> 0
<TOTAL-REVENUES> 2,905
<CGS> 0
<TOTAL-COSTS> 1,587
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,318
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,318
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,318
<EPS-PRIMARY> 0.25
<EPS-DILUTED> 0.25
</TABLE>
