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 February 28, 1997
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 (800) 225-1174
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 February 28, 1997: 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
February 28, 1997 and August 31, 1996 (Unaudited)
(In thousands)
ASSETS
February 28 August 31
------------ ---------
Operating investment properties, at cost:
Land $ 5,030 $ 5,030
Building and improvements 28,969 28,946
Furniture, fixtures and equipment 3,765 3,765
--------- ---------
37,764 37,741
Less: accumulated depreciation (6,641) (6,005)
--------- ---------
31,123 31,736
Cash and cash equivalents 2,167 1,694
Interest and other receivables 204 181
Accounts receivable - related party 233 225
Prepaid expenses and other assets 31 9
Deferred rent receivable 115 131
--------- ---------
$ 33,873 $ 33,976
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 78 $ 68
Accounts payable - affiliates 32 32
Minority interest in ILM Holding 111 -
Shareholders' equity 33,652 33,876
---------- ---------
$ 33,873 $ 33,976
========== =========
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF INCOME
For the three and six months ended February 28, 1997 and February 29, 1996
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
February 28/29, February 28/29,
--------------------- --------------------
1997 1996 1997 1996
---- ---- ---- ----
Revenues:
Rental income $ 1,132 $ 1,001 $ 2,133 $ 2,002
Interest income 23 14 44 29
-------- -------- ------- -------
1,155 1,015 2,177 2,031
Expenses:
Depreciation expense 318 318 636 636
Management fees 33 33 65 65
General and administrative 148 106 186 309
Directors' compensation 15 6 24 12
-------- -------- ------- -------
514 463 911 1,022
-------- -------- ------- -------
Net income $ 641 $ 552 $ 1,266 $ 1,009
======== ======== ======= =======
Earnings per share of
common stock $0.12 $0.11 $0.24 $0.19
===== ===== ===== =====
Cash dividends paid per
share of common stock $0.16 $0.13 $0.29 $0.25
===== ===== ===== =====
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 six months ended February 28, 1997 and February 29, 1996 (Unaudited)
(In thousands)
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
Shareholders' equity
at August 31, 1995 5,181 $ 52 $44,823 $(9,995) $34,880
Cash dividends paid - - - (1,296) (1,296)
Distribution of
stock in ILM II
Lease Corporation - - - (500) (500)
Net income - - - 1,009 1,009
----- ----- ------- -------- -------
Shareholders' equity
at February 29, 1996 5,181 $ 52 $44,823 $(10,782) $34,093
===== ===== ======= ======== =======
Shareholders' equity
at August 31, 1996 5,181 $ 52 $44,823 $(10,999) $33,876
Cash dividends paid - - - (1,490) (1,490)
Net income - - - 1,266 1,266
---- ----- ------- -------- -------
Shareholders' equity
at February 28, 1997 5,181 $ 52 $44,823 $(11,223) $33,652
===== ====== ======= ======== =======
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1997 and February 29, 1996 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
1997 1996
---- ----
Cash flows from operating activities:
Net income $ 1,266 $ 1,009
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense 636 636
Charitable contribution of preferred stock
in ILM Holding 111 -
Changes in assets and liabilities:
Accounts receivable - related party (8) 74
Interest and other receivables (23) 43
Deferred rent receivable 16 (146)
Prepaid expenses and other assets (22) 119
Accounts payable - affiliates - (45)
Accounts payable and accrued expenses 10 (582)
-------- -------
Total adjustments 720 99
-------- -------
Net cash provided by operating activities 1,986 1,108
Cash flows from investing activities:
Funding of initial working
capital to ILM II Lease Corporation - (500)
Additions to operating investment properties (23) (125)
-------- -------
Net cash used in investing activities (23) (625)
Cash flows from financing activities:
Cash dividends paid to shareholders (1,490) (1,296)
-------- -------
Net increase (decrease) in cash and cash equivalents 473 (813)
Cash and cash equivalents, beginning of period 1,694 2,409
-------- -------
Cash and cash equivalents, end of period $ 2,167 $ 1,596
======== =======
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
Notes to Consolidated Financial Statements
(Unaudited)
1. General
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, 1996. 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.
The accompanying consolidated 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 February 28, 1997
and August 31, 1996 and revenues and expenses for each of the three and six
month periods ended February 28, 1997 and February 29, 1996. Actual results
could differ from the estimates and assumptions used.
As discussed in the Company's Annual Report, the accompanying financial
statements reflect the consolidated financial position, results of
operations and cash flows of the Company and ILM II Holding, Inc. ("ILM
Holding"). ILM Holding holds title to the six Senior Housing Facilities
which comprise the balance of operating investment properties on the
accompanying consolidated balance sheets, subject to certain mortgage loans
payable to the Company. Such mortgage loans and the related interest
expense are eliminated in consolidation. The capital stock of ILM Holding
was originally owned by the Company and PWP Holding, Inc. ("PWP Holding"),
a wholly owned subsidiary of PaineWebber Properties Incorporated ("PWPI"),
which is an affiliate of the Advisor. ILM Holding had issued 100 shares of
Series A Preferred Stock to the Company in return for a capital
contribution in the amount of $495,000 and had issued 10,000 shares of
Common Stock to PWP Holding in return for a capital contribution in the
amount of $5,000. The common stock represented approximately 99 percent of
the voting power and 1 percent of the economic interest in ILM Holding,
while the preferred stock represented approximately 1 percent of the voting
power and 99 percent of the economic interest in ILM Holding.
As discussed further in the Annual Report, 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. Subsequent to the
end of the first quarter, 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 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. The
Company has recorded the contribution of the preferred stock in ILM Holding
to the charitable organizations at the amount of the initial Liquidation
Preference of $111,000. Such amount is included in general and
administrative expenses on the accompanying statements of income for the
three and six months ended February 28, 1997.
At a Board meeting on January 10, 1997, the Company's Advisor recommended
the immediate sale of the senior housing facilities held by the Company and
an affiliated entity, PaineWebber Independent Living Mortgage Fund, Inc.
("ILM1"), by means of a controlled auction to be conducted by PaineWebber,
at no additional compensation, with PaineWebber offering to purchase the
properties for a specified price, 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 II 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 a
comprehensive analysis, the investment banker recommended that the Company
decline the Advisor's proposal and instead investigate expansion and
restructuring alternatives. The Company and ILM II Lease Corporation are
presently analyzing the Advisor's proposal and the recommendations and
other information provided by the independent investment banker.
In addition, the Company and ILM II Lease Corporation are reviewing
various restructuring alternatives that could further increase shareholder
value and liquidity. The Company and ILM II Lease Corporation are analyzing
a merger of the Company with ILM Holding and are also considering possibly
merging the Company with ILM1 and ILM II Lease Corporation with ILM I Lease
Corporation. In addition, the Company is exploring listing its shares on an
exchange or, alternatively, having them trade through NASDAQ. 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.
2. Operating Investment Properties Subject to Master Lease
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:
<TABLE>
Rentable Date of
Name Location Units (1) Investment (2)
---- -------- --------- --------------
<S> <C> <C> <C>
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 Riverwood St. Louis County, MO 119 Units 5/29/92
Villa Santa Barbara (3) Santa Barbara, CA 123 Units 7/13/92
</TABLE>
(1)Represents rentable units as of April 1, 1994, the effective date of
the transfer of ownership to ILM Holding. Rentable units exclude manager
units, assistant manager units and other units converted to non-rental
usage. These unit counts will be updated upon the completion of the new
property management team's current program of placing non-rental units
back into service.
(2)Represents the date of the Company's original mortgage loan to Angeles
Housing Concepts, Inc. ("AHC"). See the further discussion in the
Annual Report.
(3)The acquisition of the Santa Barbara Facility was financed jointly by
the Company and ILM1. All amounts generated from Villa Santa Barbara
are equitably apportioned between the Company, together with its
consolidated subsidiary, and ILM1, together with its consolidated
subsidiary, generally 75% and 25%, respectively.
As discussed in Note 1, ILM Holding holds title to each Senior Housing
Facility subject to a first mortgage loan payable to the Company. The
principal balance on each loan was modified to reflect the estimated fair
value of the related operating property as of April 1, 1994, the date of the
transfer of ownership from AHC. The modified loans, which had an aggregate
principal balance of $38,144,000 at February 28, 1997 and August 31, 1996,
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 on December 31, 2000.
As discussed further in the Annual Report, effective September 1, 1995 the
properties were leased to a newly formed company, ILM II Lease Corporation,
pursuant to the terms of a master lease which covers all of the Senior
Housing Facilities. 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. The master
lease agreement is between ILM Holding, as owner and Lessor of the
properties, 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),
$4,035,600 for calendar years 1996 through 1999 and $3,555,427 for calendar
year 2000 (reflects rent reduction attributable to termination of lease for
Villa Santa Barbara on December 31, 1999). Beginning in the second quarter
of fiscal 1997, and for each fiscal quarter 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 such fiscal quarter over
$3,255,250. The Company earned variable rent of $131,000 for the three
months ended February 28, 1997. 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, personal property and non-structural repairs in
connection with the operation of the Facilities. The Lessor, as the owner of
the Facilities, is responsible for major capital improvements and structural
repairs to the Facilities.
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 filings with the United States Securities
and Exchange Commission are as follows (in thousands):
Three Months Ended Six Months Ended
February 28/29, February 28/29,
------------------ ------------------
1997 1996 1997 1996
---- ---- ---- ----
Rental income $3,582 $3,233 $7,158 $6,398
Expenses:
Property management fees 188 178 380 353
Property operating expenses 1,907 1,764 3,744 3,343
Real estate taxes 129 179 254 352
------ ------ ------ ------
2,224 2,121 4,378 4,048
------ ------ ------ ------
$1,358 $1,112 $2,780 $2,350
====== ====== ====== ======
3. Related Party Transactions
Accounts receivable - related party at February 28, 1997 and August 31,
1996 includes advances made to ILM II Lease Corporation primarily for the
purchase of personal property to operate the Senior Housing Facilities.
Accounts receivable - related party at February 28, 1997 also includes
additional variable rent due from ILM II Lease Corporation in accordance with
the terms of the Master Lease Agreement.
The Advisor to the Company earned management fees of $65,000 for each of
the six-month periods ended February 28, 1997 and February 29, 1996. Accounts
payable - affiliates at both February 28, 1997 and August 31, 1996 consists
of management fees of $32,000 payable to the Advisor.
Included in general and administrative expenses for the six months ended
February 28, 1997 and February 29, 1996 is $59,000 and $55,000, 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 six months
ended February 28, 1997 and February 29, 1996 is $2,000 and $4,000,
respectively, representing fees earned by an affiliate, Mitchell Hutchins
Institutional Investors, Inc., for managing the Company's cash assets.
4. Contingencies
On July 29, 1996, ILM II Lease Corporation and ILM Holding ("the
Companies") terminated a property management agreement with AHC covering the
six Senior Housing Facilities leased by ILM II 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 II Lease
Corporation and ILM Holding allege, among other things, that AHC willfully
performed actions specifically in violation of the management agreement and
that such actions caused damages to the Companies. Due to the termination of
the agreement for cause, no termination fee was paid to AHC. Subsequent to
the termination of the 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 a termination fee
in the amount of $750,000, payment of management fees pursuant to the
contract from August 1, 1996 through October 15, 1996, and recovery of
attorney's fees and expenses. The Company has guaranteed the payment of the
termination fee at issue in these proceedings to the extent that any
termination fee is deemed payable by the court and in the event that ILM II
Lease Corporation fails to perform pursuant to its obligations under the
management agreement. The Companies intend to diligently prosecute the case
and to vigorously defend the counterclaims made by AHC. The discovery process
is currently underway. The court initially set a trial date of April 28, 1997
but, at AHC's request, recently rescheduled the trial for June 23, 1997. 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 II Lease Corporation 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. The initial term of the Management Agreement expires on December 31,
2000, which coincides with the expiration of the master lease agreement
between ILM Holding and ILM II Lease Corporation described in Note 2. Under
the terms of the Management Agreement, in the event that the master lease
agreement is extended beyond December 31, 2000, the Management Agreement will
be extended as well, but not beyond July 29, 2001. 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. Under the terms
of the Management Agreement, Capital earns a Base Management Fee equal to 4%
of the Gross Operating Revenues of the Senior Housing Facilities, as defined.
Capital is also 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 based on the
percentage increase in the Consumer Price Index. The Company has guaranteed
the payment of all fees due to Capital under the terms of the Management
Agreement in the event that ILM II Lease Corporation fails to perform
pursuant to its obligations. In conjunction with the execution of this
Management Agreement, the Company entered into an agreement with Capital
which specifies that if the Company chooses to sell the Senior Housing
Facilities during the term of the agreement, Capital has the right to present
first and last offers to purchase the Facilities. Notwithstanding such right,
the Company may determine, at any time and in its sole discretion, not to
engage in a sale transaction or to accept any offer received whether from
Capital or a third party.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, and others alleging that
the defendants intentionally interfered with AHC's property management
agreement (the "California litigation"). The complaint seeks damages of at
least $2,000,000. 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. 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.
As discussed in more detail in the Annual Report, the Company and its
Advisor have been involved in certain shareholder-related litigation. 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).
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 are expected to be received in April 1997. Based on
the settlement agreements discussed above covering all of the outstanding
shareholder litigation, 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.
<PAGE>
5. Subsequent Events
On March 14, 1997, the Company's Board of Directors declared a quarterly
dividend for the quarter ended February 28, 1997. On April 15, 1997, a
dividend of $0.1625 per share of common stock, totalling approximately
$842,000, will be paid to shareholders of record as of March 31, 1997.
<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, 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, 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. 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. The master lease agreement is between the Company's
consolidated subsidiary, ILM II Holding, Inc. ("ILM Holding") as owner and
Lessor of the properties, 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 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), $4,035,600 for calendar
years 1996 through 1999 and $3,555,427 for calendar year 2000 (reflects rent
reduction attributable to termination of lease for Villa Santa Barbara on
December 31, 1999). Beginning in the second quarter of fiscal 1997, and for each
fiscal quarter 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 such fiscal quarter over $3,255,250. The Company earned variable
rent of $131,000 for the three months ended February 28, 1997. 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, personal property and non-structural repairs
in connection with the operation of the Facilities. The Lessor, as the owner of
the Facilities, is responsible for major capital improvements and structural
repairs to the Facilities.
As discussed further in the Annual Report, 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. Subsequent to the end of the first quarter, 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 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. The Company has recorded the contribution of the preferred
stock in ILM Holding to the charitable organizations at the amount of the
initial Liquidation Preference of $111,000. Such amount is included in general
and administrative expenses on the accompanying statements of income for the
three and six months ended February 28, 1997.
At a Board meeting on January 10, 1997, the Company's Advisor recommended the
immediate sale of the senior housing facilities held by the Company and an
affiliated entity, PaineWebber Independent Living Mortgage Fund, Inc. ("ILM1"),
by means of a controlled auction to be conducted by PaineWebber, at no
additional compensation, with PaineWebber offering to purchase the properties
for a specified price, 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 II Lease Corporation in evaluating the Advisor's proposal, a
disinterested, independent investment banker with expertise in healthcare REITs
and independent/assisted living financings was engaged. Following a
comprehensive analysis, the investment banker recommended that the Company
decline the Advisor's proposal and instead investigate expansion and
restructuring alternatives. The Company and ILM II Lease Corporation are
presently analyzing the Advisor's proposal and the recommendations and other
information provided by the independent investment banker.
The Company and ILM II Lease Corporation are also considering additional
steps to increase shareholder value and liquidity. Several new programs have
recently been adopted across the Company's portfolio which are expected to
increase revenues and cash flow from the properties. These include increasing
the number of rentable apartment units as live-in facility managers move from
the properties and increasing rental rates at properties that have maintained
high occupancy levels and are located in strong markets. Another program to
increase revenues and cash flow involves investigating the potential for future
expansions of several of the facilities which are located in areas that have
particularly strong markets for senior housing.
In addition, the Company and ILM II Lease Corporation are reviewing various
restructuring alternatives that could further increase shareholder value and
liquidity. The Company and ILM II Lease Corporation are analyzing a merger of
the Company with ILM Holding and are also considering possibly merging the
Company with ILM1 and ILM II Lease Corporation with ILM I Lease Corporation. In
addition, the Company is exploring listing its shares on an exchange or,
alternatively, having them trade through NASDAQ. 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 assumption of ownership of the properties through ILM Holding, which was
organized as 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 in a C
corporation. Any future appreciation in the value of the Senior Housing
Facilities subsequent to the conversion of ILM Holding to a REIT will 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. Based on management's
estimate of the increase in the values of the properties which occurred since
April 1994, as supported by independent appraisals, a sale of the properties at
their estimated market 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.
On July 29, 1996, ILM II Lease Corporation and ILM Holding ("the Companies")
terminated the property management agreement with Angeles Housing Concepts, Inc.
("AHC") covering the six Senior Housing Facilities leased by ILM II 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 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 II Lease Corporation and ILM
Holding allege, among other things, that AHC willfully performed actions
specifically in violation of the management agreement and that such actions
caused damages to the Companies. Due to the termination of the agreement for
cause, no termination fee was paid to AHC. Subsequent to the termination of the
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 a termination fee in the amount of $750,000, payment of
management fees pursuant to the contract from August 1, 1996 through October 15,
1996, and recovery of attorney's fees and expenses. The Company has guaranteed
the payment of the termination fee at issue in these proceedings to the extent
that any termination fee is deemed payable by the court and in the event that
ILM II Lease Corporation fails to perform pursuant to its obligations under the
management agreement. The Companies intend to diligently prosecute the case and
to vigorously defend the counterclaims made by AHC. The discovery process is
currently underway. The court initially set a trial date of April 28, 1997 but,
at AHC's request, recently rescheduled the trial for June 23, 1997. 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 II Lease Corporation 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.
The initial term of the Management Agreement expires on December 31, 2000, which
coincides with the expiration of the master lease agreement described above
between ILM Holding and ILM II Lease Corporation. Under the terms of the
Management Agreement, in the event that the master lease agreement is extended
beyond December 31, 2000, the Management Agreement will be extended as well, but
not beyond July 29, 2001. 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. Under the terms of the Management Agreement, Capital
earns a Base Management Fee equal to 4% of the Gross Operating Revenues of the
Senior Housing Facilities, as defined. Capital is also 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 based on the percentage increase in the Consumer Price Index. The
Company has guaranteed the payment of all fees due to Capital under the terms of
the Management Agreement in the event that ILM II Lease Corporation fails to
perform pursuant to its obligations. In conjunction with the execution of this
Management Agreement, the Company entered into an agreement with Capital which
specifies that if the Company chooses to sell the Senior Housing Facilities
during the term of the agreement, Capital has the right to present first and
last offers to purchase the Facilities. Notwithstanding such right, the Company
may determine, at any time and in its sole discretion, not to engage in a sale
transaction or to accept any offer received whether from Capital or a third
party.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the State
of California against Capital, Lawrence Cohen, and others alleging that the
defendants intentionally interfered with AHC's property management agreement
(the "California litigation"). The complaint seeks damages of at least
$2,000,000. 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. 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.
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 $4,035,600 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 in excess of the specified threshold in the variable rent calculation,
as discussed further above, which became effective on December 1, 1996. As a
result of the status of the Company's net operating cash flow under the current
master lease arrangement, the Company increased its quarterly dividend payment
from $0.125 per share to $0.1625 per share effective with the dividend paid in
January 1997 for the quarter ended November 30, 1996. This increase raises the
dividend payment to the equivalent of a 6.5% 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. The fiscal
1997 capital expenditure plans include an ongoing program to replace
air-conditioning units at the Santa Barbara facility, as well as planned roof
repairs at Overland Park Place and The Palms. In addition, as discussed in the
Annual Report, the Company has been investigating the potential to expand
certain facilities that are located in strong markets. Specifically, the
investigation has focused on the facilities located in Fort Myers and Omaha. The
Board of Directors has concluded that obtaining control of adjacent land for
future expansion purposes could add significant value to these properties. In
addition, the Board also believes that pursuing potential expansion
opportunities could yield substantial increases in cash flow and value.
Management is currently reviewing the feasibility of purchasing vacant land
which is adjacent to the Omaha facility. The Fort Myers facility already
includes approximately 1.5 acres of developable land which was purchased in 1995
and added to the original 4.5 acre site. This excess land could potentially
accommodate a sizable expansion of the existing facility. A comprehensive
cost-benefit analysis of any potential expansion program will be prepared and
evaluated before any expansion decision is made. Depending on the extent of any
expansions deemed appropriate, such plans could result in the need for
substantial capital.
At February 28, 1997, the Company had cash and cash equivalents of
$2,167,000. 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 or from possible future equity offerings depending on the market.
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. At the present time, the Company's consolidated
subsidiary, ILM Holding, is not expected to have sufficient cash flow during
fiscal 1997 to (i) meet its obligations to make the debt service payments due to
the Company under the mortgage loans, (ii) pay for capital improvements and
structural repairs in accordance with the terms of its master lease with ILM II
Lease Corporation and (iii) pay for costs that may be incurred in defending
AHC's counterclaim against ILM Holding, as discussed further above. If ILM
Holding's liquidity problem is not resolved through the Company's completion of
its restructuring plans or otherwise, ILM Holding may not be able to make
payments on the mortgage loans to the Company in the amounts required by the
applicable loan agreements. 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 February 28, 1997
- ------------------------------------
Net income increased by $89,000 for the three months ended February 28, 1997,
when compared to the same period in the prior year. The increase in net income
was mainly due to an increase in rental income of $131,000. Rental income for
the three months ended February 28, 1997 increased due to the accrual of
additional rent effective December 1, 1996 in accordance with the terms of the
Master Lease Agreement, as discussed further above. The increase in rental
income was partially offset by an increase of $42,000 in general and
administrative expenses. The increase in general and administrative expenses is
primarily due to the charitable contribution expense associated with the
recapitalization of ILM Holding, as described above.
Six Months Ended February 28, 1997
- ----------------------------------
Net income increased by $257,000 for the six months ended February 28, 1997
when compared to the same period in the prior year. The increase in net income
was mainly due to a decrease in general and administrative expenses of $123,000
and an increase in rental income of $131,000. Despite the inclusion of the
charitable contribution expense described above, general and administrative
expenses for the six months ended February 28, 1997 decreased mainly due to
certain expenses incurred in the prior year related to the inception of the
master lease agreement. Rental income increased for the six months ended
February 28, 1997 due to the accrual of additional rent effective December 1,
1996 in accordance with the terms of the Master Lease Agreement, as discussed
further 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. On July 17, 1996, PaineWebber and
the class plaintiffs submitted a definitive settlement agreement which 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. 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 are expected
to be received in April 1997. Based on the settlement agreements discussed above
covering all of the outstanding shareholder litigation, 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.
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: April 17, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Partnership's audited financial statements for the six months ended February 28,
1997 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-END> FEB-28-1997
<CASH> 2,167
<SECURITIES> 0
<RECEIVABLES> 437
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,635
<PP&E> 37,764
<DEPRECIATION> 6,641
<TOTAL-ASSETS> 33,873
<CURRENT-LIABILITIES> 110
<BONDS> 0
0
0
<COMMON> 44,875
<OTHER-SE> (11,223)
<TOTAL-LIABILITY-AND-EQUITY> 33,873
<SALES> 0
<TOTAL-REVENUES> 2,177
<CGS> 0
<TOTAL-COSTS> 911
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<INCOME-PRETAX> 1,266
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</TABLE>
