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 November 30, 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
None 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 November 30, 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
November 30, 1996 and August 31, 1996 (Unaudited)
(In thousands)
ASSETS
November 30 August 31
----------- ---------
Operating investment properties, at cost:
Land $ 5,030 $ 5,030
Building and improvements 29,005 28,946
Furniture, fixtures and equipment 3,765 3,765
--------- ---------
37,800 37,741
Less: accumulated depreciation (6,323) (6,005)
--------- ---------
31,477 31,736
Cash and cash equivalents 1,984 1,694
Interest and other receivables 120 181
Accounts receivable - related party 227 225
Prepaid expenses and other assets 5 9
Deferred rent receivable 123 131
--------- ---------
$ 33,936 $ 33,976
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 51 $ 68
Accounts payable - affiliates 32 32
Shareholders' equity 33,853 33,876
---------- ---------
$ 33,936 $ 33,976
========= =========
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended November 30, 1996 and 1995 (Unaudited)
(In thousands, except per share amounts)
1996 1995
---- ----
Revenues:
Rental income $ 1,001 $ 1,001
Interest income 21 15
-------- -------
1,022 1,016
Expenses:
Depreciation expense 318 329
Management fees 32 32
General and administrative 38 203
Directors' compensation 9 6
-------- -------
397 570
-------- -------
Net income $ 625 $ 446
======== =======
Earnings per share of common stock $0.12 $0.09
===== =====
Cash dividends paid per share of
common stock $0.125 $0.125
====== ======
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 three months ended November 30, 1996 and 1995 (Unaudited)
(In thousands)
<TABLE>
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ------- ------- -----
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1995 5,181 $ 52 $44,823 $ (9,995) $34,880
Cash dividends paid - - - (648) (648)
Distribution of
stock in ILM II
Lease Corporation - - - (500) (500)
Net income - - - 446 446
----- ----- ------- -------- --------
Shareholders' equity
at November 30, 1995 5,181 $ 52 $44,823 $(10,697) $ 34,178
===== ===== ======= ======== ========
Shareholders' equity
at August 31, 1996 5,181 $ 52 $44,823 $(10,999) $ 33,876
Cash dividends paid - - - (648) (648)
Net income - - - 625 625
----- ----- ------- -------- --------
Shareholders' equity
at November 30, 1996 5,181 $ 52 $44,823 $(11,022) $ 33,853
===== ===== ======= ======== ========
</TABLE>
See accompanying notes.
<PAGE>
PAINEWEBBER INDEPENDENT LIVING MORTGAGE INC. II
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended November 30, 1996 and 1995 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
1996 1995
---- ----
Cash flows from operating activities:
Net income $ 625 $ 446
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense 318 329
Changes in assets and liabilities:
Accounts receivable - related party (2) 74
Interest and other receivables 61 (91)
Prepaid expenses and other assets 4 118
Deferred rent receivable 8 (114)
Accounts payable - affiliates - (45)
Accounts payable and accrued expenses (17) (316)
-------- --------
Total adjustments 372 (45)
-------- --------
Net cash provided by operating activities 997 401
-------- --------
Cash flows from investing activities:
Funding of initial working
capital to ILM II Lease Corporation - (500)
Additions to operating investment properties (59) (89)
-------- --------
Net cash used in investing activities (59) (589)
-------- --------
Cash flows from financing activities:
Cash dividends paid to shareholders (648) (648)
-------- --------
Net increase (decrease) in cash and cash equivalents 290 (836)
Cash and cash equivalents, beginning of period 1,694 2,409
-------- --------
Cash and cash equivalents, end of period $ 1,984 $ 1,573
======== ========
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 November 30, 1996
and August 31, 1996 and revenues and expenses for each of the three month
periods ended November 30, 1996 and 1995. 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. As of November 30, 1996, the
capital stock of ILM Holding was owned by the Company and PWP Holding, Inc.
("PWP Holding"), a wholly owned subsidiary of PaineWebber Properties
Incorporated ("PWPI"), 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 represents approximately 99
percent of the voting power and 1 percent of the economic interest in ILM
Holding, while the preferred stock represents 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, ILM Holding is expected to be recapitalized
such that the outstanding common stock and preferred stock will be replaced
with 50,000 shares of new common stock and 275 shares of a new class of
nonvoting, cumulative 8% preferred stock issued to the Company. Following
the recapitalization, and prior to January 30, 1997, the Company is
expected to make a charitable gift of one share of the preferred stock to
each of up to 125 charitable organizations or other entities and
individuals so that ILM Holding will meet the stock ownership requirements
of a REIT. Dividends on the preferred stock will be cumulative from the
date of issuance. The preferred stock will have a Liquidation Preference of
$1,000 per share plus accrued and unpaid dividends. 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.
<PAGE>
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 Investment (1)
---- -------- ----- --------------
<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 (2) Santa Barbara, CA 123 Units 7/13/92
</TABLE>
(1) Represents the date of the Company's original mortgage loan to Angeles
Housing Concepts, Inc. (see discussion in the Annual Report).
(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 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 November 30, 1996 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 initially 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 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,
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 Three Months Ended
11/30/96 11/30/95
-------- --------
Rental income $ 3,576 $3,165
Expenses:
Property management fees 192 175
Property operating expenses 1,837 1,631
Real estate taxes 125 123
------- ------
2,154 1,929
------- ------
$ 1,422 $1,236
======= ======
3. Related Party Transactions
Accounts receivable - related party at November 30, 1996 and August 31,
1996 represents advances made to ILM II Lease Corporation primarily for the
purchase of personal property to operate the Senior Housing Facilities.
The Advisor to the Company and its consolidated affiliate earned
management fees of $32,000 for each of the three-month periods ended November
30, 1996 and 1995. Accounts payable - affiliates at both November 30, 1996
and August 31, 1996 consists of management fees of $32,000 payable to the
Advisor.
Included in general and administrative expenses for the three months ended
November 30, 1996 and 1995 is $30,000 and $25,000, 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 three months
ended November 30, 1996 and 1995 is $2,000 and $3,000, 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. The Companies intend to
diligently prosecute the case and to vigorously defend the counterclaims made
by AHC. The eventual outcome of this termination dispute cannot presently be
determined. Accordingly, no provision for any liability which might result
from the Company's guaranty of the termination fee has been recorded in the
accompanying financial statements.
ILM II Lease Corporation has retained Capital Senior Management 2, Inc.
("Capital") of Dallas, Texas to be the new manager of the Senior Housing
Facilities pursuant to a Management Agreement which commenced on July 29,
1996. 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 Agreement, Capital will earn a Base Management Fee equal to 4% of the
Gross Operating Revenues of the Senior Housing Facilities, as defined.
Capital will also be eligible to earn an Incentive Management Fee equal to
25% of the amount by which the average monthly Net Cash Flow of the Senior
Housing Facilities, as defined, for the twelve month period ending on the
last day of each calendar month exceeds a specified Base Amount. Each August
31, beginning on August 31, 1997, the Base Amount will be increased 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 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.
As discussed in more detail in the Annual Report, the Company and its
Advisor are involved in certain shareholder-related litigation. At the
present time, management cannot estimate the impact, if any, that the
resolution of these matters may have on the Company's financial statements,
taken as a whole.
5. Subsequent Events
On December 9, 1996, the Company's Board of Directors declared a quarterly
dividend for the quarter ended November 30, 1996. On January 15, 1997, a
dividend of $0.1625 per share of common stock, totalling $842,000, was paid
to shareholders of record as of January 2, 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. 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
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 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, 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.
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. The final phase of the Company's restructuring plans involves the
conversion of ILM Holding to a REIT for tax purposes. Certain changes to the
ownership structure of ILM Holding described further below, and which are
necessary in order for ILM Holding to qualify as a REIT under the Internal
Revenue Code, are expected to be made in time for ILM Holding to elect REIT
status in conjunction with the filing of its calendar 1996 federal tax return.
Any future appreciation in the value of the Senior Housing Facilities subsequent
to the conversion of ILM Holding to a REIT would not be subject to the built-in
gain tax. The built-in gain tax would most likely not be incurred if the
properties were to be held for a period of at least 10 years from the date of
the conversion of ILM Holding to a REIT. 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, a sale of the properties at their
current 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.
In connection with the conversion of ILM Holding to a REIT, 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
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, ILM Holding is expected to be
recapitalized such that the outstanding common stock and preferred stock will be
replaced with 50,000 shares of new common stock and 275 shares of a new class of
nonvoting, cumulative 8% preferred stock issued to the Company. Following the
recapitalization, and prior to January 30, 1997, the Company is expected to make
a charitable gift of one share of the preferred stock to each of up to 125
charitable organizations or other entities and individuals so that ILM Holding
will meet the stock ownership requirements of a REIT. Dividends on the preferred
stock will be cumulative from the date of issuance. The preferred stock will
have a Liquidation Preference of $1,000 per share plus accrued and unpaid
dividends. 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.
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. The Companies
intend to diligently prosecute the case and to vigorously defend the
counterclaims made by AHC. The eventual outcome of this termination dispute
cannot presently be determined. Accordingly, no provision for any liability
which might result from the Company's guaranty of the termination fee has been
recorded in the accompanying financial statements.
ILM II Lease Corporation has retained Capital Senior Management 2, Inc.
("Capital") of Dallas, Texas to be the new manager of the Senior Housing
Facilities pursuant to a Management Agreement which commenced on July 29, 1996.
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 Agreement, Capital will earn a
Base Management Fee equal to 4% of the Gross Operating Revenues of the Senior
Housing Facilities, as defined. Capital will also be eligible to earn an
Incentive Management Fee equal to 25% of the amount by which the average monthly
Net Cash Flow of the Senior Housing Facilities, as defined, for the twelve month
period ending on the last day of each calendar month exceeds a specified Base
Amount. Each August 31, beginning on August 31, 1997, the Base Amount will be
increased 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 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.
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 becomes effective in January 1997.
Accordingly, the Company expects that ILM Holding will receive variable rent
payments in fiscal 1997. As a result of the status of the Company's net
operating cash flow under the current master lease arrangement, the Company has
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. Management
is currently reviewing with the new property management team annual operating
budgets and capital expenditure plans which include an ongoing program to
replace air-conditioning units at the Santa Barbara facility, as well as planned
roof repairs at Overland Park Place and The Palms. In addition, the Company is
investigating the potential to acquire adjacent land and to expand several
facilities that are located in strong markets. Depending on the extent of any
expansions deemed appropriate, such plans could result in the need for
substantial capital.
At November 30, 1996, the Company had cash and cash equivalents of
$1,984,000. Such amounts will be used for the working capital requirements of
the Company, along with the possible investment in the properties owned by the
Company's consolidated affiliate for certain capital improvements, and for
dividends to the shareholders. Future capital improvements could be financed
from operations or through borrowings, depending on the magnitude of the
improvements, the availability of financing and the Company's incremental
borrowing rate. The source of future liquidity and dividends to the shareholders
is expected to be through master lease payments from ILM 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 November 30, 1996
Net income increased by $179,000 for the three months ended November 30,
1996, 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
$165,000. General and administrative expenses decreased mainly due to a
reduction in professional fees. Professional fees declined primarily as a result
of certain non-recurring legal expenses incurred during the prior period in
connection with the restructuring of the Company and the spin off of ILM II
Lease Corporation, as discussed further above. A small increase in interest
income and a slight decline in depreciation expense also contributed to the
improvement in net income for the current three-month period.
<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 has been
preliminarily approved by the court and provides for the complete resolution of
the class action litigation, including releases in favor of the Company and
PWPI, and the allocation of the $125 million settlement fund among investors in
the various partnerships and REITs at issue in the case. As part of the
settlement, PaineWebber also agreed to provide class members with certain
financial guarantees relating to some of the partnerships and REITs. The details
of the settlement are described in a notice mailed directly to class members at
the direction of the court. A final hearing on the fairness of the proposed
settlement was held in December 1996, and a ruling by the court as a result of
this final hearing is currently pending.
Mediation with respect to the Abbate, Bandrowski and Barstad actions
described in the Company's Annual Report was held in December 1996. As a result
of such mediation, a tentative settlement between PaineWebber and the plaintiffs
was reached which would provide for complete resolution of all three actions.
PaineWebber anticipates that releases and dismissals with regard to these
actions will be received by February 1997.
Under certain limited circumstances, pursuant to the Advisor Agreement with
the Advisor and other contractual obligations, PaineWebber affiliates could be
entitled to indemnification for expenses and liabilities in connection with the
shareholder litigation matters described above. However, PaineWebber has agreed
not to seek indemnification for any amounts it is required to pay in connection
with the settlement of the New York Limited Partnership Actions. At the present
time, neither PaineWebber nor management of the Company can estimate the impact,
if any, of any of the potential 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.
PAINEWEBBER INDEPENDENT LIVING
By: MORTGAGE INC. II
By: /s/ Walter V. Arnold
--------------------
Walter V. Arnold
Senior Vice President, Chief
Financial Officer and Treasurer
Dated: January 17, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Partnership's audited financial statements for the quarter ended November 30,
1996 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-END> NOV-30-1996
<CASH> 1,984
<SECURITIES> 0
<RECEIVABLES> 347
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,336
<PP&E> 37,800
<DEPRECIATION> (6,323)
<TOTAL-ASSETS> 33,936
<CURRENT-LIABILITIES> 83
<BONDS> 0
0
0
<COMMON> 44,875
<OTHER-SE> (11,022)
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 1,022
<CGS> 0
<TOTAL-COSTS> 397
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 625
<INCOME-TAX> 0
<INCOME-CONTINUING> 625
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 625
<EPS-PRIMARY> 0.12
<EPS-DILUTED> 0.12
</TABLE>
