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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR FISCAL YEAR ENDED: AUGUST 31, 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
ILM II SENIOR LIVING, INC.
(Exact name of registrant as specified in its charter)
Virginia 06-1293758
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(State of organization) (I.R.S. Employer
Identification No.)
28 State Street, Suite 1100, Boston, MA 02109
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(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: 888-257-3550
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
- ------------------- ---------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock $.01 Par Value
(Title of class)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
-
Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes No X
- -
Shares of common stock outstanding as of August 31, 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.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
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Prospectus of registrant dated Parts II, Part IV
August 8, 1990, as supplemented [33 Act filing #33-33857]
Current Report on Form 8-K Part IV
of registrant dated July 18, 1997
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<PAGE>
ILM II SENIOR LIVING, INC.
1997 FORM 10-K
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Part I Page
- ------ ----
<S> <C> <C> <C>
Item 1 Business.............................................................I-1
Item 2 Properties...........................................................I-6
Item 3 Legal Proceedings....................................................I-7
Item 4 Submission of Matters to a Vote of Security Holders..................I-7
Part II
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Item 5 Market for the Registrant's Shares and Related
Stockholder Matters...............................................II-1
Item 6 Selected Financial Data.............................................II-2
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................II-3
Item 8 Financial Statements and Supplementary Data.........................II-7
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..........................................II-7
Part III
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Item 10 Directors and Executive Officers of the Registrant.................III-1
Item 11 Executive Compensation.............................................III-2
Item 12 Security Ownership of Certain Beneficial Owners and Management.....III-3
Item 13 Certain Relationships and Related Transactions.....................III-3
Part IV
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Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K.....IV-1
Signatures ....................................................................IV-2
Index to Exhibits ....................................................................IV-3
Financial Statements and Supplementary Data....................................F-1 to F-33
</TABLE>
<PAGE>
PART I
------
Item 1. Business
ILM II Senior Living, Inc. (the "Company") is a finite-life corporation
organized on February 5, 1990 in the Commonwealth of Virginia for the purpose of
making construction and participating mortgage loans secured by rental housing
complexes for independent senior citizens ("Senior Housing Facilities"). On
September 12, 1990, the Company commenced a public offering of up to 10,000,000
shares of common stock pursuant to the final prospectus as amended incorporated
into a Registration Statement filed on Form S-11 under the Securities Act of
1933 (Registration Statement No. 33-33857), (the "Prospectus"). On May 10, 1991,
the public offering terminated. The Company issued 5,181,236 shares,
representing capital contributions of $51,812,356, of which $200,000 represented
the sale of 20,000 shares to an affiliate at that time, PaineWebber Group, Inc.
("PaineWebber"). For discussion purposes, PaineWebber will refer to PaineWebber
Group, Inc. and all affiliates that provided services to the Company in the
past. The Company has elected to qualify and be taxed as a Real Estate
Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended,
for each taxable year of operations. As a REIT, the Company is allowed a
deduction for the amount of dividends paid to shareholders of the Company
("Shareholders"), thereby effectively subjecting the distributed net income of
the Company to taxation at the shareholder level only. In order to qualify as a
REIT, the Company must distribute at least 95% of its taxable income on an
annual basis and meet certain other requirements.
The Company originally invested the net proceeds of the initial public
offering in six participating mortgage loans secured by Senior Housing
Facilities located in five different states. All of the loans made by the
Company were originally to Angeles Housing Concepts, Inc. ("AHC"), a company
specializing in the development, acquisition and operation of Senior Housing
Facilities. The Company entered into an exclusivity agreement (as amended), with
AHC and its parent company, Angeles Corporation ("Angeles"), which required AHC
to provide the Company with certain specific opportunities to finance Senior
Housing Facilities and set forth the terms and conditions of the loans which
were made. The loan documents under the aforementioned Exclusivity Agreement
called for interest to be paid on construction loans at the rate of 13.3% per
annum during the construction period and for base interest to be paid on the
permanent loans at the rate of 10.3% per annum. In addition to the Base
Interest, additional interest was to be paid on the permanent loans in an amount
equal to 10% of the gross revenues of the Senior Housing Facilities, as defined.
Under the terms of the amended Exclusivity Agreement, additional interest was to
be no less than 3% of the aggregate principal amount of all permanent loans
outstanding for the entire term of the investments. In the aggregate, the
properties securing loans from the Company did not generate sufficient cash flow
to cover the debt service payments owed to the Company under the amended terms
of the Exclusivity Agreement. To the extent that the properties did not generate
sufficient cash flow to make the full payments due under the loan documents, the
shortfall was funded by AHC through December 1992. The source of cash to make up
these shortfalls was from specified deficit reserve accounts, which had been
funded from the proceeds of the mortgage loans, and from contributions by
Angeles.
During the quarter ended February 28, 1993, Angeles announced that it
was experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between the Company, AHC and Angeles
was reached whereby ownership of the properties would be transferred from AHC to
the Company or its designated affiliates. Under the terms of the settlement
agreement, the Company would release AHC and Angeles from certain obligations
under the loans. On April 27, 1994, each of the properties owned by AHC and
securing the loans was transferred (collectively, "the Transfers") to newly
created special purpose corporations affiliated with the Company (collectively,
"the Property Companies"). The Transfers had an effective date of April 1, 1994
and were made pursuant to the Settlement Agreement entered into on February 17,
1994 ("the Settlement Agreement") between the Company and AHC which had
previously been approved by the bankruptcy court handling the bankruptcy case of
Angeles. All of
I-1
<PAGE>
Item 1. Business (continued)
the capital stock of each Property Company was held by ILM II Holding, Inc.
("ILM II Holding") a subsidiary, a Virginia corporation. In August 1995, each of
the Property Companies merged into ILM II Holding which is majority owned by the
Company. As a result, ownership of the Senior Housing Facilities is now held by
ILM II Holding, and the Property Companies no longer exist as separate legal
entities. As part of the Settlement Agreement, ILM II Holding retained AHC as
the property manager for all of the Senior Housing Facilities pursuant to the
terms of a management agreement (the "Agreement").
Subsequent to the effective date of the Settlement Agreement with AHC,
management investigated and evaluated the available options for structuring the
ownership of the properties in order to maximize the potential returns to the
existing Shareholders, while maintaining the Company's qualification as a REIT
under the Internal Revenue Code. To retain REIT status, the Company must ensure
that 75% of its annual gross income is received from qualified sources. Under
the original investment structure, interest income from the Company's mortgage
loans was a qualified source. The properties that are now owned by a subsidiary
of the Company are Senior Housing Facilities that provide residents with more
services, such as meals, activities, assisted living, etc., than are customary
for ordinary residential apartment properties. As a result, a significant
portion of the rents paid by the residents includes income for the increased
level of services received by them. Consequently, the rents paid by the
residents likely would not be qualified rents for REIT qualification purposes if
received directly by the Company. Therefore, if the Company received such rents
directly, it could lose REIT status and be taxed as a regular corporation. After
extensive review, the Board of Directors determined that it would be in the best
interests of the Shareholders for the Company to retain REIT status and master
lease the properties to a shareholder-owned operating company. As discussed
further in Item 7, on September 12, 1994, the Company formed a new subsidiary,
ILM II Lease Corporation ("Lease II"), for the purpose of operating the Senior
Housing Facilities. The Senior Housing Facilities were leased to Lease II
effective September 1, 1995. See Item 7 for a description of the master lease
agreement.
As discussed further in Item 7, the Agreement with AHC was terminated in
July 1996 and Capital Senior Management 2, Inc. ("Capital") was engaged as the
new property manager on July 29, 1996. In November 1996, Lawrence A. Cohen,
President, Chief Executive Officer and Director of the Company became Vice
Chairman and Chief Financial Officer of Capital Senior Living Corporation, an
affiliate of Capital. As a result, the management agreement (the "Management
Agreement") with Capital is considered a related party transaction (see Item
13).
ILM II 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 II Holding was originally owned by the
Company and PaineWebber. ILM II 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 PaineWebber
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 II Holding, while the preferred stock represented
approximately 1 percent of the voting power and 99 percent of the economic
interest in ILM II Holding.
The Company completed its restructuring plans by converting ILM II
Holding to a REIT for tax purposes. In connection with these plans, on November
21, 1996 the Company requested that PaineWebber sell all of the stock held in
ILM II Holding to the Company for a price equal to the fair market value of the
1% economic interest in ILM II Holding represented by the common stock. On
January 10, 1997, this transfer of the common stock of ILM II Holding was
completed at an agreed upon fair value of $40,000. With this transfer completed,
effective January 23, 1997 ILM II 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 Preferred Stock"). The number of authorized
shares of preferred and common stock in ILM II 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 II Holding to each
of 111 charitable organizations so that ILM II 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
I-2
<PAGE>
Item 1. Business (continued)
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 II 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 recorded the
contribution of the Preferred Stock in ILM II 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 in the
accompanying consolidated statement of income for the year ended August 31,
1997. Cumulative dividends accrued as of August 31, 1997 on the Preferred Stock
in ILM II Holding totaled $5,180.
At a meeting of the Company's Board of Directors on January 10, 1997,
PaineWebber recommended the immediate sale of the Senior Housing Facilities held
by the Company and an affiliated entity, ILM Senior Living, Inc. ("ILM I"). ILM
I is also a finite-life corporation organized for the purpose of making
construction and participating mortgage loans secured by Senior Housing
Facilities. The recommended sale would transpire by means of a controlled
auction to be conducted by PaineWebber, at no additional compensation, with
PaineWebber offering to purchase the Senior Living Facilities held by the
Company and ILM I for $127 million, thereby guaranteeing the Shareholders a
"floor" price. The Senior Housing Facilities held by the Company would represent
approximately $52 million of this amount. After taxes and closing costs, net
proceeds to the Company would equal approximately $48 million or approximately
$9.36 per share. PaineWebber also stated that if it purchased the Senior Housing
Facilities held by the Company and ILM I 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 in evaluating
PaineWebber's proposal, a disinterested, independent investment banking firm
with expertise in healthcare REITs and independent/assisted living financings
was engaged by the Company, Lease II, and ILM I and its affiliates. Following a
comprehensive analysis, the investment banker recommended that PaineWebber's
proposal should be declined and that instead investigation of expansion and
restructuring alternatives should be pursued. After analyzing PaineWebber's
proposal and the recommendations and other information provided by the
independent investment banker, the Boards of the Company and ILM I voted
unanimously to decline PaineWebber's proposal and to explore the alternatives
recommended by the independent investment banker. The Boards declined to seek an
immediate sale of the properties because, in the Boards' view, the liquidation
price would not reflect the "going concern" values of the Company and ILM I and,
therefore, would not maximize shareholder value. In addition, the Boards did not
consider it advisable to liquidate the Company and ILM I on the suggested terms
three years prior to their scheduled termination date.
PaineWebber indicated to the Board in its January 10, 1997 proposal that
it would not wish to continue to serve as advisor to the Company and its
affiliates if the Company declined to accept PaineWebber's proposal. The Company
accepted the resignation of PaineWebber, effective as of June 18, 1997.
PaineWebber continued to provide certain administrative services to the Company
and its affiliates through August 31, 1997, pursuant to the terms of a
transition services agreement entered into with the Company and its affiliates.
The Company and its affiliates also accepted, effective as of June 18, 1997, the
resignations of those officers and directors who were employees of or otherwise
affiliated with PaineWebber.
The Company and Lease II are considering a merger of the Company with
ILM I, a merger of Lease II with ILM I Lease Corporation ("Lease I") and other
business combinations. 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 the actions identified above or any others which may be
recommended by its investment bankers.
I-3
<PAGE>
Item 1. Business (continued)
The Company's investments as of August 31, 1997 are described below:
<TABLE>
<CAPTION>
Property Name Date of
and Location (1) Type of Property Investment Size
- --------------------- ---------------- ---------- ----
<S> <C> <C> <C>
The Palms
Fort Myers, FL Senior Facility Housing 7/18/90 205 Units
Crown Villa
Omaha, NE Senior Facility Housing 4/25/91 73 Units
Overland Park Place
Overland Park, KS Senior Facility Housing 4/9/92 140 Units
Rio Las Palmas
Stockton, CA Senior Facility Housing 5/14/92 164 Units
The Villa at Riverwood
St. Louis County, MO Senior Facility Housing 5/29/92 120 Units
Villa Santa Barbara (2)
Santa Barbara, CA Senior Facility Housing 7/13/92 125 Units
</TABLE>
(1) See Note 4 to the consolidated financial statements filed with this Annual
Report for a description of the agreements through which the Company has
acquired these real estate investments.
(2) The acquisition and improvement of the Santa Barbara facility was jointly
financed by the Company and ILM I. Any amounts generated by the operations
of the Santa Barbara property are equitably apportioned between the
Company, together with its consolidated affiliate, and ILM I, together with
its consolidated affiliate (generally 75% and 25%, respectively).
The Senior Housing Facilities are subject to competition from similar
properties in the vicinities in which they are located. The properties are
located in areas with significant senior citizen populations and, as a result,
there are, and will likely continue to be a variety of competing projects aimed
at attracting senior residents. Such projects will generally compete on the
basis of rental rates, services, amenities and location. The Company has no real
estate investments located outside the United States. The Company is engaged
solely in the business of real estate investment. Therefore, presentation of the
information about industry segments is not applicable.
The Company originally expected to liquidate its investments after a
period of approximately ten years, although under the terms of its
organizational documents property sales may occur at earlier or later dates. The
net proceeds of any sale transactions are expected to be distributed to the
Shareholders, so that the Company will, in effect, be self-liquidating.
Through June 18, 1997, and subject to the supervision of the Company's
Board of Directors, assistance in the management of the business of the Company
was provided by PaineWebber. PaineWebber resigned from this position effective
as of June 18, 1997, although PaineWebber agreed to provide certain
administrative services to the Company and its affiliates through August 31,
1997. Through the date of its resignation, PaineWebber performed the day-to-day
operations of the Company and acted as the investment advisor and consultant for
the Company. PaineWebber provided cash management, accounting, tax preparation,
financial reporting, investor communications and relations as well as asset
management services to the Company. These services are now being provided to the
Company, subject to the supervision of the Company's Board of Directors, by
various companies and consultants including Fleet Bank, Ernst & Young LLP,
MAVRICC Management Systems, Inc. and Capital Senior Living, Inc. In
I-4
<PAGE>
Item 1. Business (continued)
addition, C. David Carlson, who was a Vice President of the Company until the
date of PaineWebber's resignation and a Vice President of PaineWebber through
October 1997, where he served as Portfolio Manager to the Company, now serves as
a consultant to the Company. The resignation of PaineWebber is discussed further
at Item 7 below.
There are currently five directors of the Company, none of whom are
affiliates of PaineWebber. The directors are subject to removal by the vote of
the holders of a majority of the outstanding shares of Company common stock. The
directors are responsible for the general policies of the Company, but they are
not required to personally conduct the business of the Company in their
capacities as directors.
The terms of transactions between the Company and PaineWebber, and
similar disclosures with respect to relationships of the current advisor and the
Company, are set forth in Items 11 and 13 below to which reference is hereby
made for a description of such terms and transactions.
I-5
<PAGE>
Item 2. Properties
As of August 31, 1997, the Company has interests in the six operating
properties referred to under Item 1 above, to which reference is made for the
description, name and location of such properties.
Average occupancy figures for each fiscal quarter during 1997, along
with an average for the year, are presented below for each property:
<TABLE>
<CAPTION>
Percent Leased At
------------------------------------------------------------
Fiscal 1997
11/30/96 2/28/97 5/31/97 8/31/97 Average
-------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
The Palms 99% 98% 96% 94% 97%
Crown Villa 97% 97% 98% 97% 97%
Overland Park Place 96% 94% 93% 98% 95%
Rio Las Palmas 92% 85% 82% 84% 86%
The Villa at Riverwood 99% 96% 93% 92% 95%
Villa Santa Barbara 87% 92% 92% 94% 91%
</TABLE>
I-6
<PAGE>
Item 3. Legal Proceedings
On July 29, 1996, Lease II and ILM II Holding (collectively for this
Item 3, the "Companies") terminated the Agreement with AHC covering the six
Senior Housing Facilities leased by the Companies. Such Agreement was terminated
for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the Agreement.
Simultaneously with the termination of the Agreement, the Companies, together
with certain affiliated entities, filed suit against AHC in the United States
District Court for the Eastern District of Virginia for breach of contract,
breach of fiduciary duty and fraud. The Companies allege that AHC willfully
performed actions specifically in violation of the Agreement and that such
actions caused damages to the Companies. Due to the termination of the Agreement
for cause, no termination fee was paid to AHC. Subsequent to the termination of
the Agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy
Code in its domestic state of California. The 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 II Holding. The counterclaim alleges that the Agreement was wrongfully
terminated for cause and requests damages which include the payment of the
termination fee in the amount of $750,000, payment of management fees pursuant
to the Agreement from August 1, 1996 through October 15, 1996, which is the
earliest date that the Agreement could have been terminated without cause, and
recovery of attorney's fees and expenses. The aggregate amount of damages
against all parties as requested in AHC's counterclaim exceeds $2,000,000. 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 Lease II fails to perform pursuant to its
obligations under the Agreement. The court initially set a trial date of April
28, 1997 but, at AHC's request, rescheduled the trial for June 23, 1997. On June
13, 1997 and July 8, 1997, the court issued orders to enter judgment against the
Company and ILM I in the amount of $1,000,000 (the "Orders"). In so doing, the
court effectively canceled the June 23, 1997 trial date. The Orders do not
contain any findings of fact or conclusions of law. On July 10, 1997, the
Company, ILM I, Lease I and Lease II filed a notice of appeal to the United
States Court of Appeals for the Fourth Circuit from the Orders. The Company
intends to diligently prosecute the appeal. The eventual outcome of this
litigation cannot presently be determined.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against an affiliate of Capital, Lawrence A. Cohen, and
others alleging that the defendants intentionally interfered with AHC's
Agreement (the "California litigation"). The complaint seeks damages of at least
$2,000,000. On March 4, 1997, the defendants moved the case to Federal District
Court in the Central District of California. Trial in the action is expected to
occur in 1998 and discovery has just begun. At a Board meeting on February 26,
1997, the Company's Board of Directors concluded that since all of Mr. Cohen's
actions relating to the California litigation were taken either on behalf of the
Company under the direction of the Board or as a PaineWebber employee, the
Company or its affiliates should indemnify Mr. Cohen with respect to any
expenses arising from the California litigation, subject to any insurance
recoveries for those expenses. The Company's Board also concluded that, subject
to certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the boards of directors of Lease I and
Lease II voted to increase the maximum amount of the advance to Capital to
$100,000. By the end of November 1997, Capital had incurred $100,000 of legal
expenses in the California litigation. On February 2, 1998, the amount to be
advanced to Capital was increased to include 75% of the California litigation
legal fees and cost incurred by Capital for December 1997 and January 1998, plus
75% of such legal fees and cost incurred by Capital thereafter, not to exceed
$500,000. The defendants intend to vigorously defend the claims made against
them in the California litigation. The eventual outcome of this litigation
cannot presently be determined and, accordingly, no provision for any liability
has been recorded in the accompanying consolidated financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
None.
I-7
<PAGE>
PART II
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Item 5. Market for the Registrant's Shares and Related Stockholder Matters
During the public offering period, which commenced August 8, 1990 and
ended May 10, 1991, the selling price of the shares of common stock was $10 per
share. At August 31, 1997 there were 3,356 record holders of the Company's
shares. There is no public market for the resale of the shares, and it is not
anticipated that a public market will develop. While shares of the Company were
designed for long-term holding, they may possibly be traded through a secondary
market resale. The shares do not trade on an established exchange and the only
market that has developed is an informal secondary market; therefore little
resale activity occurs. Although PaineWebber and others may endeavor to assist
Shareholders desiring to sell their shares by attempting to match requests to
sell shares with requests to purchase shares, such transfers are not expected to
be frequent. In addition, the Company's Articles of Incorporation restrict
ownership of more than 9.8% of the Company's outstanding shares by one investor.
These restrictions are designed to ensure that the Company does not violate
certain share accumulation restrictions imposed by the Internal Revenue Code on
REITs.
The Company has a Distribution Reinvestment Plan designed to enable
Shareholders to have their dividends from the Company invested in additional
shares of the Company's common stock. The terms of the Plan are outlined in
detail in the Prospectus, a copy of which Prospectus is incorporated herein by
reference.
The Company makes quarterly distributions, payable within 45 days after
the end of each fiscal quarter, to Shareholders of record on the record date for
such quarter as determined by the Directors. The Company intends to make
distributions to Shareholders in an amount equal to at least 95% of its taxable
income in order to continue to qualify as a REIT. Reference is made to Item 6
below for the amount of cash dividends paid per share of common stock during
fiscal 1997.
II-1
<PAGE>
Item 6. Selected Financial Data
ILM II Senior Living, Inc.
For the years ended August 31, 1997, 1996, 1995, 1994 and 1993
(in thousands except per share data)
<TABLE>
<CAPTION>
For the years ended August 31,
-----------------------------------------------------------------
1997(1) 1996 1995 1994 1993
------- ----- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $ 4,515 $ 46 $ 87 $ 72 $ 211
Operating income (loss) $ 2,184 $ (587) $ (877) $ (769) $ (457)
Gain on sale of Treasury Note - - - - $ 87
Equity in income from
properties securing
mortgage loans $ - $ 2,674 $ 2,308 $ 1,957 $ 567
Net income $ 2,184 $ 2,087 $ 1,431 $ 1,188 $ 197
Earnings per
share of common stock $ 0.42 $ 0.40 $ 0.27 $ 0.23 $ 0.04
Cash dividends paid
per share of common stock $ 0.61 $ 0.50 $ 0.43 $ 0.40 $ 0.70
Total assets $33,355 $33,973 $35,052 $35,382 $36,234
Shares outstanding 5,181,236 5,181,236 5,181,236 5,181,236 5,181,236
</TABLE>
(1) As a result of certain restructuring plans which the Company began to
implement during fiscal 1995 (see Item 7), the financial position and
results of operations of the combined operating investment properties in
which the Company has invested have been presented on a consolidated
basis in the Company's financial statements beginning in fiscal 1997.
Prior to fiscal 1997, the Company had accounted for its interests in
such properties under the equity method as a result of the Company not
holding majority voting control of ILM Holding.
The above selected financial data should be read in conjunction with the
consolidated financial statements and related notes to the consolidated
financial statements appearing in item 14(a) of this annual report.
II-2
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Liquidity and Capital Resources
The Company offered shares of its common stock to the public from
September 12, 1990 to May 10, 1991 pursuant to a Registration Statement filed
under the Securities Act of 1933. Capital contributions of $51,812,356 were
received by the Company (including $200,000 contributed by PaineWebber) and,
after deducting selling expenses and offering costs and allowing for adequate
cash reserves, approximately $42.9 million was available to be invested in
participating first mortgage loans secured by Senior Housing Facilities. The
Company originally invested the net proceeds of the initial public offering in
six participating mortgage loans secured by Senior Housing Facilities located in
five different states. All of the loans made by the Company were originally with
AHC. As previously reported, AHC defaulted on the regularly scheduled mortgage
loan payments due to the Company on March 1, 1993. Its parent company, Angeles,
subsequently filed for bankruptcy. In fiscal 1994, a Settlement Agreement was
executed whereby ownership of the properties was transferred from AHC to certain
designated affiliates of the Company which were only majority owned by the
Company. Subsequently, these affiliates were merged into ILM II Holding which is
only majority owned by the Company. ILM II Holding holds title to the six Senior
Housing Facilities which comprise the balance of operating investment properties
in 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 part of the fiscal 1994 Settlement
Agreement with AHC, ILM II Holding retained AHC as the property manager for all
of the Senior Housing Facilities pursuant to the terms of the Agreement. As
discussed further below, the Agreement with AHC was terminated in July 1996.
Subsequent to the effective date of the Settlement Agreement with AHC,
in order to maximize the potential returns to the Company's existing
Shareholders while maintaining its qualification as a REIT under the Internal
Revenue Code, the Company formed a new corporation, Lease II, for the purpose of
operating the Senior Housing Facilities under the terms of a master lease
agreement. As of August 31, 1995, Lease II, 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 Lease II to the holders of
record of the Company's common stock. One share of common stock of Lease II was
issued for each full share of the Company's common stock held. Prior to the
distribution, the Company capitalized Lease II with $500,000 from its existing
cash reserves, which was an amount estimated to provide Lease II with necessary
working capital. The master lease agreement, which commenced on September 1,
1995, was initially between the Company's consolidated affiliate, ILM II
Holding, as owner of the properties and lessor, and Lease II as lessee. The
master Lease Is a "triple-net" lease whereby the lessee pays all operating
expenses, governmental taxes and assessments, utility charges and insurance
premiums, as well as the costs of all required maintenance, personal property
and non-structural repairs in connection with the operation of the Senior
Housing Facilities. ILM II Holding, as the lessor, is responsible for all major
capital improvements and structural repairs to the Senior Housing Facilities.
During the initial term of the master lease, which expires on December 31, 2000
(December 31, 1999 with respect to the Santa Barbara property), Lease II is
obligated to pay annual base rent for the use of all of the Senior Housing
Facilities in the aggregate amount of $3,548,700 for calendar year 1995
(prorated based on the lease commencement date) and $4,035,600 for calendar year
1996 and each subsequent year. Beginning in January 1997 and for the remainder
of the lease term, Lease II is also obligated to pay variable rent for each
Senior Housing Facility. Such variable rent will be payable quarterly and will
equal 40% of the excess, if any, of the aggregate total revenues for the Senior
Housing Facilities, on an annualized basis, over $13,021,000. Variable rental
income related to fiscal year 1997 was $411,857.
The assumption of ownership of the properties through ILM II Holding,
which was a regular C corporation for tax purposes at the time of the
assumption, may result in a possible future tax liability which would be payable
upon the ultimate sale of the properties (the "built-in gain tax"). The amount
of such tax would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain realized upon
a final sale which is attributable to the period during which the properties
were held by a C corporation. The Company completed its restructuring plans by
converting ILM II Holding to a REIT for tax purposes. In connection with these
plans, on November 21, 1996, the Company requested that PaineWebber sell all of
the stock held in ILM II Holding to the Company for a price equal to the fair
market value of the 1% economic interest in ILM II Holding represented
II-3
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
by the common stock. On January 10, 1997, this transfer of the common stock of
ILM II Holding was completed at an agreed upon fair value of $40,000. With this
transfer completed, effective January 23, 1997 ILM II 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 Preferred Stock issued to the
Company. The number of authorized shares of Preferred Stock and common stock in
ILM II 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 II 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 II
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 recorded the contribution of the
Preferred Stock in ILM II 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 in the accompanying consolidated statement
of income for the year ended August 31, 1997. Cumulative dividends accrued as of
August 31, 1997 on the Preferred Stock in ILM II Holding totaled $5,180.
Any future appreciation in the value of the Senior Housing Facilities
subsequent to the conversion of ILM II 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 II Holding to a REIT. However, since the end of
the Company's original anticipated holding period is less than 4 years away, the
properties are not expected to be held for an additional 10 years. Based on
management's estimate of the increase in the values of the properties which
occurred between April 1994 and January 1996, as supported by independent
appraisals, ILM II Holding would incur a sizable tax if the properties were
sold. Based on the then estimated market values of the operating investment
properties, a sale at such values prior to the end of the 10-year holding period
could result in a built-in gain tax of as much as $2.3 million. To avoid this
built-in gain tax, the Directors are prepared at the appropriate time to
recommend to the shareholders an amendment to the Articles of Incorporation to
extend the Company's scheduled liquidation date.
Following the termination of its advisor relationship with PaineWebber
(See "Item 1. Business"), the Company and Lease II commenced a further review of
various restructuring alternatives that could further increase shareholder value
and liquidity. The Company and Lease II are considering a merger of the Company
with ILM I, a merger of Lease II with ILM I Lease Corporation ("Lease I") and
other business combinations. 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 the actions identified above or any others which may be
recommended by its investment bankers.
ILM II Holding has acquired the respective operating properties subject
to, and assumed the obligations under, the mortgage loans payable to the
Company, pursuant to the Settlement Agreement with AHC. The principal balance of
each loan was modified to reflect the estimated fair value of the related
operating property as of the date of the transfer of ownership. The modified
loans require interest-only payments on a monthly basis at a rate of 7% from
April 1, 1994 through December 1, 1994, 9% for the period from January 1 through
December 31, 1995, 11% for the period January 1 through December 31, 1996, 12%
for the period January 1 through December 31, 1997, 13% for the period January 1
through December 31, 1998, 13.5% for the period January 1, 1999 through December
31, 1999 and 14% for the period January 1, 2000 through maturity. Since ILM II
Holding is consolidated with the Company in the accompanying consolidated
financial statements for fiscal year 1997, the mortgage loans and related
interest expense have been eliminated in consolidation. Because the ownership of
the assets of ILM II Holding was expected to be transferred to the Company or
its wholly owned subsidiary, ILM II Holding was capitalized with funds to
provide it with working capital only for a limited period of time. At the
present time, ILM II Holding is not expected to have sufficient cash flow during
fiscal 1998 to (i) meet its obligations to make the debt service payments due
under the loans, (ii) pay for capital improvements and structural repairs in
accordance with the
II-4
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
terms of the master lease, and (iii) pay for costs that may be incurred in
defending AHC's counterclaim against ILM II Holding. For information concerning
outstanding litigation between the Company and its former property manager, see
"Part 1, Item 3, Legal Proceedings".
Lease II retained Capital to be the new property manager of its Senior
Housing Facilities pursuant to a Management Agreement which commenced on July
29, 1996. 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 during the term of the Management Agreement
exceeds a specified base amount. Each August 31, beginning on August 31, 1997,
the base amount will be increased annually based on the percentage increase in
the Consumer Price Index. The Company has guaranteed the payment of all fees due
to Capital under the terms of the Management Agreement.
The six properties in which the Company has invested averaged 93%
occupancy as of August 31, 1997. As previously reported, a property renovation
and assisted living conversion program was in progress at Villa Santa Barbara
during fiscal years 1996 and 1995. The total cost of the renovation program was
approximately $1.2 million, which has been funded 75% by the Company and 25% by
ILM I from funds previously reserved for such improvements. Leasing gains at
Villa Santa Barbara were slowed by delays in completing the capital improvements
and in obtaining the required regulatory licensing to begin leasing the new
assisted living units. During the quarter ended February 28, 1996, all
renovations were completed and during the quarter ended May 31, 1996, Lease II
received the required assisted living licenses. Villa Santa Barbara averaged 94%
occupancy as of August 31, 1997.
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 II 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 in January
1997. Accordingly, ILM II Holding received variable rent payments in fiscal 1997
in the amount of $411,857. 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. As noted above, ILM II Holding, as lessor, is responsible for
major capital improvements and structural repairs to the Senior Housing
Facilities. The fiscal 1997 capital expenditure plans included 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.
The Company and Lease II have been pursuing additional steps to increase
Shareholder value. Several new programs were adopted during fiscal 1997 across
the Company's portfolio which are resulting in increased revenues and cash flow
from the properties. These steps 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 pursuing the potential for future expansions of several of the
facilities which are located in areas that have particularly strong markets for
senior housing. Potential expansion candidates include the facilities located in
Omaha, Nebraska; St. Louis County, Missouri; and Fort Myers, Florida. As part of
this expansion program, approximately three and one-half acres of land located
adjacent to the Omaha facility were acquired subsequent to the fiscal year end
for $400,000. In addition, an agreement has been obtained to purchase
approximately six acres of land located adjacent to the St. Louis County
facility for approximately $900,000 and closing is expected to occur during
fiscal 1998, contingent on due diligence activities. The Fort Myers facility
already includes a vacant parcel of approximately one and one-half acres which
could accommodate an expansion of the existing facility or the construction of a
new free-standing facility. Preliminary feasibility evaluations have been
completed for all of these potential expansions and pre-construction design and
construction-cost evaluations are underway for expansions of the facilities
located in Omaha and Fort Myers. Once the pre-construction design process is
complete and projected
II-5
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
expansion construction costs are determined, the Company will carefully evaluate
the costs and benefits before proceeding with the construction of any of these
expansions. Depending on the extent of any expansions deemed appropriate, such
plans could result in the need for substantial capital. The Company is currently
negotiating with a major bank to provide a construction loan facility that, when
finalized, will provide the Company with up to $17.5 million to fund the capital
costs of these potential expansion programs. The construction loan facility is
expected to be secured by a first mortgage of the Company's properties and
collateral assignment of the Company's leases of such properties. The loan is
also expected to have a three-year term with interest accruing at a rate equal
to LIBOR plus 1.10% or Prime plus 0.5%. It is currently anticipated that the
loan term could be extended for an additional two years beyond its maturity date
with monthly payments of principal and interest on a 25-year amortization
schedule.
At August 31, 1997, the Company had cash and cash equivalents of
$2,361,000. 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 Lease II, interest income
earned on invested cash reserves and proceeds from the future sales of the
underlying operating investment properties. Such sources of liquidity are
expected to be adequate to meet the Company's operating requirements on both a
short-term and long-term basis. The Company generally will be obligated to
distribute annually at least 95% of its taxable income to its Shareholders in
order to continue to qualify as a REIT under the Internal Revenue Code.
Results of Operations
1997 Compared to 1996
Net income increased by $97,000 for fiscal 1997 compared to 1996.
Revenue increased by $4,469,000 of which $4,416,000 was due to the consolidation
of ILM II Holding in 1997 including an improvement in master lease rentals of
$412,000 from the property leases owing to improved overall occupancies and
revenues of the lessee. Interest income increased $53,000 as a result of an
increase in the average balances of cash and cash equivalents in 1997 versus
1996. General and administrative and professional fee expenses increased
$392,000 of which $242,000 of the increase was due, in part, to expenses
associated with purchasing the remaining controlling interest in ILM II Holding,
increased expenses associated with higher AHC litigation expenses and the
expense of restructuring cost studies carried out by the independent investment
banker. The remaining $151,000 increase in general and administrative and
professional fee expenses is due to the consolidation of ILM II Holding in 1997
which includes $116,000 associated with the charitable contribution of ILM II
Holdings' Preferred Stock. Director compensation also increased in the current
year by $58,000, due to an increase in the number of directors and meetings.
Depreciation expense increased $1,274,000 due to the consolidation of ILM II
Holding in 1997. Equity in income of properties securing mortgage loans
decreased by $2,674,000 as a result of the consolidation of ILM II Holding in
1997.
1996 Compared to 1995
Net income increased by $656,000 for fiscal 1996 when compared to the
prior year. A primary reason for this increase in net income is the commencement
of the master lease between the Company's equity investee, ILM II Holding, and
Lease II effective September 1, 1995, as discussed further above and in the
notes to the accompanying financial statements. ILM II Holding now receives
master lease rental income from Lease II rather than the revenues from the
individual tenants of the Senior Housing Facilities. In addition, under the
terms of the master lease, all property operating expenses are now the
responsibility of the lessee. The master lease rental income earned by ILM II
Holding during fiscal 1996 was $305,000 more than the excess of rental income
earned from the Senior Housing Facilities over property management fees and
property operating expenses during the prior year. In addition, management and
advisory fees incurred by ILM II Holding decreased as the advisory fees charged
in 1995 and prior years was no longer applicable upon commencement of the master
lease.
II-6
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
The Company's operating loss decreased as a result of decreases in
professional fees, general and administrative expense, insurance expense and
amortization expense. Professional fees decreased by $295,000 as a result of the
significant amount of legal and tax advisory services incurred in the prior year
in connection with the evaluation, selection and implementation of the master
lease property ownership structure described above. Amortization expense
decreased by $6,000 as organization costs became fully amortized during 1995.
A decrease of $41,000 in interest income partially offset the favorable
changes to operating loss described above. Interest income decreased due to a
decline in the average amount of cash and cash equivalents outstanding when
compared to the prior year.
Other
The City of Stockton has announced plans to build a railroad underpass
on the street located immediately adjacent to Rio Las Palmas in Stockton,
California. The City plans to use a portion of the Rio Las Palmas property for a
temporary bypass during the expected 18-month construction process. Although
this road construction would not directly affect facility operations, it would
eliminate several parking spaces and would result in increased noise and traffic
during the construction period while the traffic is re-routed closer to the
facility. Negotiations with the City are currently underway to minimize any
disruption to the operations Rio Las Palmas and to secure a settlement that will
pay for any damages.
Inflation
The Company completed its sixth full year of operations in fiscal 1997.
The effects of inflation and changes in prices on the Company's operating
results to date have not been significant.
Inflation in future periods is likely to cause increases in the
Company's expenses, which may be partially offset by increases in revenues from
the Company's investments in the Senior Housing Facilities. Under the terms of
the master lease, as discussed further above, the Company, through its
consolidated affiliate, ILM II Holding, earned additional rental income based on
increases in the gross revenues of the related operating properties beginning in
January 1997. Such gross revenues may tend to rise with inflation since the
rental rates on the tenant leases, which are short-term in nature, can be
adjusted to keep pace with inflation as market conditions allow.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements and supplementary data are
included under Item 14 of this annual report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
II-7
<PAGE>
PART III
--------
Item 10. Directors and Executive Officers of the Registrant
There are currently five directors of the Company. The directors are
subject to removal by the vote of the holders of a majority of the outstanding
shares. The directors are responsible for the general policies of the Company,
but they are not required to personally conduct the business of the Company in
their capacities as directors.
(a) and (b) The names and ages of the directors and executive
officers of the Company are as follows:
Date
elected
Name Office Age to Office
- ---- ------ --- ---------
Lawrence A. Cohen President, Chief Executive Officer
and Director 44 5/15/91
Jeffry R. Dwyer Secretary and Director 51 2/12/90*
J. William Sharman, Jr. Director 57 2/12/90*
Carl J. Schramm Director 51 12/5/96
Julien G. Redele' Director 62 12/5/96
* The date of incorporation of the Company.
(c) There is no family relationship among any of the directors or
officers. All of the directors and officers of the Company have been
elected to serve until the Company's next annual meeting.
(d) The business experience of each of the current directors and
executive officers of the Company is as follows:
Lawrence A. Cohen has served as President, Chief Executive Officer and
Director of the Company since 1991. Mr. Cohen is also Vice Chairman and Chief
Financial Officer of Capital Senior Living Corporation, an affiliate of Capital,
which is the company that was contracted by Lease II in July 1996 to perform
property management services for the Senior Housing Facilities in which the
Company has invested. Mr. Cohen joined Capital Senior Living Corporation in
November 1996. Mr. Cohen was President and Chief Executive Officer of
PaineWebber Properties Incorporated until August 1996. Mr. Cohen joined
PaineWebber in January 1989 as its Executive Vice President and Director of
Marketing and Sales. Mr. Cohen is also a member of the board of directors of
Lease I and Lease II and President, Chief Executive Officer and Director of ILM
I. Mr. Cohen received his LL.M (in Taxation) from New York University School of
Law and his J.D. degree from St. John's University School of Law. Mr. Cohen
received his B.B.A. degree in accounting from George Washington University. He
is a member of the New York Bar and is a Certified Public Accountant.
Jeffry R. Dwyer has served as Secretary and a Director of the Company
since its inception in 1990. Mr. Dwyer has been a shareholder of the law firm of
Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quental, P.A. since June 1997. In
May 1997, Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quental, P.A. began
acting as Counsel to the Company. From 1993 to 1997 Mr. Dwyer was a partner with
the law firm of Akin, Gump, Strauss, Hauer & Feld in the District of Columbia.
Prior to joining Akin, Gump, Strauss, Hauer & Feld, Mr. Dwyer was a partner with
the law firm of Morrison & Foerster from 1989 to 1993. Mr. Dwyer also presently
serves as Secretary and a director of ILM I, Lease I and Lease II. Mr. Dwyer has
written several law review articles and a major treatise on real estate
financing and has taught Real Estate Planning as an Adjunct Professor at the
Georgetown University Law Center. Mr. Dwyer graduated from Georgetown University
and received his law degree from the Georgetown University Law Center.
III-1
<PAGE>
Item 10. Directors and Executive Officers of the Registrant (continued)
J. William Sharman, Jr. has served as a Director of the Company since
its inception in 1990. Mr. Sharman is the Chairman of the Board and Chief
Executive Officer of Lancaster Hotels and Resorts, Inc., a hotel management
company, and Bayou Equities, Inc., a hotel development company. Mr. Sharman
served for ten years as Chairman of the Board and President of The Lancaster
Group, Inc., a real estate development firm based in Houston, Texas, which is
the predecessor of Lancaster Hotel Management, L.C. and Bayou Equities, Inc. Mr.
Sharman serves as a Director of Small Luxury Hotels, Ltd. of the United Kingdom,
an international hotel marketing and reservations firm, and also serves on the
Board of Trustees of St. Edwards University in Austin, Texas. Mr. Sharman also
presently serves as a Director of ILM I, and President and Director of Lease I
and Lease II. He has a Bachelor of Science degree in Civil Engineering from the
University of Notre Dame.
Carl J. Schramm was appointed to fill a newly created seat on the
Company's Board of Directors as of December 5, 1996. Mr. Schramm is President of
Greenspring Advisors, Inc., a consulting and investment advisory firm serving
clients in the managed care, health insurance and health information industries.
From 1993 to 1995, Mr. Schramm served as Executive Vice President of Fortis,
Inc., a diversified insurance and financial services company. From 1987 through
1992, Mr. Schramm was President of the Health Insurance Association of America,
the national trade association of commercial health underwriters. Mr. Schramm
currently serves on the boards of HCIA, Inc., LifeRate Systems, Inc., the
Rochdale Insurance Group, Physician Health Corporation and Madison Information
Technologies. Mr. Schramm holds a Ph.D. in Economics from the University of
Wisconsin and received his J.D. from Georgetown University. Mr. Schramm also
presently serves as a Director of ILM I.
Julien G. Redele was appointed to fill a newly created seat on the
Company's Board of Directors as of December 5, 1996. Mr. Redele is one of the
original founders of SFRE, Inc., a Dutch owned real estate investment and
development firm which has served since 1963 as advisor to Dutch institutional,
corporate and individual investors active in the United States. Mr. Redele
serves as a Director of the Island Preservation Partnership. Mr. Redele attended
Westersingel Business School, Rotterdam, where he studied economics, law and
finance. Mr. Redele also presently serves as a Director of ILM I.
(e) None of the directors and officers was involved in legal proceedings
which are material to an evaluation of his or her ability or
integrity as a director or officer other than that described in "Part
I, Item 3, Legal Proceedings" regarding Lawrence A. Cohen.
(f) Compliance With Exchange Act Filing Requirements: The Securities
Exchange Act of 1934 requires the officers and directors of the
Company, and persons who own more than ten percent of the Company's
outstanding common stock, to file certain reports of ownership and
changes in ownership with the Securities and Exchange Commission.
Officers, directors and ten-percent beneficial holders are required
by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file.
Based solely on its review of the copies of such forms received by it,
the Company believes that, during the year ended August 31, 1997, there was
compliance with all filing requirements applicable to its officers and directors
and ten-percent beneficial holders.
Item 11. Executive Compensation
The Company's Independent Directors each receive an annual fee of
$12,000 plus $500 for attending each board of directors meeting and
reimbursement for expenses incurred in attending meetings and as a result of
other work performed for the Company. Officers of the Company are not
compensated. Lawrence A. Cohen is an employee of Capital Senior Living
Corporation, an affiliate of Capital, and in his employee agreement with Capital
Senior Living Corporation it states that without Capital Senior Living
Corporation's prior consent he can spend only a limited amount of time on
non-Capital Senior Living Corporation activities. Capital Senior Living
Corporation has consented to Mr. Cohen serving as President and Chief Executive
Officer of the Company and ILM I. Jeffry R. Dwyer is an employee of Greenberg,
Traurig, Hoffman, Lipoff, Rosen & Quental, P.A., which acts as Counsel to the
III-2
<PAGE>
Item 11. Executive Compensation (continued)
Company. The former officers of the Company who were also officers of
PaineWebber received compensation from PaineWebber which indirectly related to
services to the Company because the Company was required to pay certain fees to
PaineWebber as described in Item 13. When PaineWebber resigned as advisor to the
Companies, the former officers resigned effective the same date, therefore no
services were provided by such persons subsequent to June 18, 1997.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) As of the date hereof, no person of record owns or is known by the
Registrant to own beneficially more than five percent of the
outstanding shares of common stock of the Company.
(b) The following table sets forth the ownership of shares owned directly
or indirectly by the Directors and principal officers of the Company
as of August 31, 1997:
Amount
Beneficially Percent
Title of Class Name of Beneficial Owner Owned of Class
- -------------- ------------------------ ------------ --------
Shares of Lawrence A. Cohen 540 Shares Less than 1%
Common Stock,
$0.01 par value
Shares of All Directors and Officers of 540 Shares Less than 1%
Common Stock, the Company, as a group
$0.01 par value
(c) There exists no arrangement, known to the Company, the operation of
which may at a subsequent date result in a change in control of the
Company.
Item 13. Certain Relationships and Related Transactions
Through June 18, 1997 (see Item 1), and subject to the supervision of
the Company's Board of Directors, assistance with the management of the business
of the Company was provided by PaineWebber.
For its services in finding and recommending investments, PaineWebber
received a mortgage placement fee equal to 2% of the capital contributions of
the Company. Mortgage placement fees totaling $1,036,248 were earned by
PaineWebber during the Company's investment acquisition period. In connection
with construction loans, a construction loan administration fee of 1% of each
construction loan was paid by AHC to PaineWebber for administering such loan. In
connection with acquisition loans, a due diligence fee of 1% of the principal
amount of each such loan was paid by AHC to PaineWebber for conducting due
diligence activities. Loan administration and due diligence fees totaling
$425,141 were paid to PaineWebber during the Company's investment acquisition
period from 1989 to 1992.
Under the former advisory agreement, PaineWebber was entitled to receive
1% of the disposition proceeds, as defined, until the Shareholders have received
dividends of net cash equal to their adjusted capital investments, as defined,
plus 12% non-compounded annual return on their adjusted capital investments, as
defined, all disposition proceeds thereafter until PaineWebber has received an
aggregate of 5% of disposition proceeds; and, thereafter, 5% of disposition
proceeds.
Under the former advisory agreement, PaineWebber had specific management
responsibilities; to perform day-to-day operations of the Company and to act as
the investment advisor and consultant for the Company in connection with general
policy and investment decisions. PaineWebber received an annual base fee and an
Incentive Fee of 0.25% and 0.25%, respectively, of the capital contributions of
the Company, as defined, as compensation for
III-3
<PAGE>
Item 13. Certain Relationships and Related Transactions (continued)
such services. Incentive fees are subordinated to Shareholders' receipt of
distributions of net cash sufficient to provide a return equal to 10% per annum.
PaineWebber earned base management fees totaling $103,000, $130,000, and
$130,000 for the years ended August 31, 1997, 1996, and 1995, respectively.
Payment of incentive management fees was suspended effective April 15, 1993, in
conjunction with a reduction in the Company's quarterly dividend payments.
PaineWebber was reimbursed for direct expenses relating to the offering
of shares of Company common stock, the administration of the Company and the
acquisition and operations of the Company's real estate investments.
PaineWebber performed certain accounting, tax preparation, securities
law compliance, and investor communications and relations services for the
Company. Total costs incurred by PaineWebber in providing these services are
allocated among several entities, including the Company. Included in general and
administrative expenses on the accompanying consolidated statements of income
for the years ended August 31, 1997, 1996, and 1995, are $118,000, $107,000, and
$121,000, respectively, representing reimbursements to PaineWebber for providing
such services to the Company.
Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins")
provided cash management services with respect to the Company's cash assets.
Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc.,
an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned
$5,000, $6,000, and $3,000 (included in general and administrative expenses) for
managing the Company's cash assets during fiscal 1997, 1996, and 1995,
respectively. Fees charged by Mitchell Hutchins are based on a percentage of
invested cash reserves which varies based on the total amount of invested cash
which Mitchell Hutchins manages on behalf of PaineWebber.
The advisory relationship with PaineWebber ceased on June 18, 1997;
therefore the payment of advisory fees ceased as of that date. Other services,
such as accounting, compliance, investor communications and relations, and cash
management services ceased on August 31, 1997; therefore, the Company was not
obligated to pay service fees past August 31, 1997 to PaineWebber or Mitchell
Hutchins.
Lawrence A. Cohen is an employee of Capital Senior Living Corporation,
an affiliate of Capital (See "Item 11. Executive Compensation").
Jeffry R. Dwyer is an employee of Greenberg, Traurig, Hoffman, Lipoff,
Rosen & Quental, P.A., which acts as Counsel to the Company and its affiliates.
Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quental, received fees from the
Company of $57,000 for the year ended August 31, 1997.
III-4
<PAGE>
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1) and (2) Financial Statements and Schedules:
The response to this portion of Item 14 is
submitted as a separate section of this report. See
Index to Financial Statements and Financial
Statement Schedules at page F-1.
(3) Exhibits:
The exhibits listed on the accompanying index to
exhibits at page IV-3 are filed as part of this
Report.
(b) The Company filed a Current Report on Form S-K dated August 14,
1997 reporting the Company's name change.
(c) Exhibits:
See (a)(3) above.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is
submitted as a separate section of this report. See
Index to Financial Statements and Financial
Statement Schedules at page F-1.
IV-1
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ILM II Senior Living, Inc.
By: /s/Lawrence A. Cohen
-------------------------------
Lawrence A. Cohen
President and Chief Executive Officer
Dated:____________
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Company in the
capacity and on the dates indicated.
By: /s/ Lawrence A. Cohen Date:
------------------------------ ------------------------------
Lawrence A. Cohen
Director
By: /s/ Jeffry R. Dwyer Date:
------------------------------ ------------------------------
Jeffry R. Dwyer
Director
By: /s/ J. William Sharman, Jr. Date:
------------------------------ ------------------------------
J. William Sharman, Jr.
Director
By: /s/ Carl J. Schramm Date:
------------------------------ ------------------------------
Carl J. Schramm
Director
By: /s/ Julien G. Redele' Date:
------------------------------ ------------------------------
Julien G. Redele'
Director
IV-2
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(3)
ILM II SENIOR LIVING, INC.
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Page Number in the Report or
Exhibit No. Description of Document Other Reference
- ----------- ---------------------------------- ------------------------------
<S> <C> <C>
(3) and (4) Prospectus of the Registrant dated Filed with the Commission
August 8, 1990, as supplemented, pursuant to Rule 424(c) and
with particular reference to the incorporated herein by
Restated Certificate and reference.
Agreement of Limited Partnership.
(10) Material contracts previously Filed with the Commission
filed as exhibits to registration pursuant to Section 13 or
statements and amendments thereto 15(d) of the Securities
of the registrant together with Exchange Act of 1934 and
all such contracts filed as incorporated herein by
exhibits of previously filed reference.
Forms 8-K and Forms 10-K are
hereby incorporated herein by
reference.
Contracts regarding retention by Filed as Exhibits 1 and 2
to ILM II Lease Corporation of the Current Report on Form
Capital Senior Management 2, 8-K dated July 18, 1996 and
Inc., as property manager. incorporated herein by
reference.
(13) Annual Reports to Stockholders No Annual Report for the year
ended August 31, 1997 has
been sent to the Stockholders.
An Annual Report will be sent to the
Stockholders subsequent to this filing.
(27) Financial Data Schedule Filed as the last page of
EDGAR submission following
the Financial Statements and
Financial Statement Schedules
required by Item 14.
</TABLE>
IV-3
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(1) and (2) and 14(d)
ILM II SENIOR LIVING, INC.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Reference
---------
<S> <C>
ILM II Senior Living, Inc.
Report of independent auditors F-2
Consolidated balance sheets as of August 31, 1997 and 1996 F-3
Consolidated statements of income for the years ended August 31, 1997,
1996 and 1995 F-4
Consolidated statements of changes in shareholders' equity for the
years ended August 31, 1997, 1996 and 1995 F-5
Consolidated statements of cash flows for the years ended August 31,
1997, 1996 and 1995 F-6
Notes to consolidated financial statements F-7
ILM II Holding, Inc.
Report of independent auditors F-19
Balance sheet as of August 31, 1996 F-20
Statements of operations for the year ended August 31, 1996, the
two month period ended August 31, 1995 and the year ended June
30, 1995 F-21
Statements of changes in shareholders' for the year ended August 31,
1996, the two month period ended August 31, 1995 and the year ended
June 30, 1995 F-22
Statements of cash flows for the year ended August 31, 1996, the two
month period ended August 31, 1995 and the year ended June 30, 1995 F-23
Notes to financial statements F-24
Schedule
Schedule III - Real Estate and Accumulated Depreciation F-31
</TABLE>
Other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements, including the notes thereto.
F-1
<PAGE>
REPORT OF ERNST & YOUNG, LLP INDEPENDENT AUDITORS
The Shareholders of
ILM II Senior Living, Inc.
We have audited the accompanying consolidated balance sheets of ILM II
Senior Living, Inc. and subsidiary, as of August 31, 1997 and 1996, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended August 31, 1997. Our
audits also included the financial statement schedule listed in the Index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
ILM II Senior Living, Inc. and subsidiary, at August 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended August 31, 1997, in conformity with generally
accepted accounting principles. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
ERNST & YOUNG LLP
Dallas, Texas
December 12, 1997
F-2
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED BALANCE SHEETS
August 31, 1997 and 1996
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Operating investment properties, at cost:
Land 5,030 -
Building and improvements 29,151 -
Furniture, fixtures and equipment 3,765 -
-------- --------
37,946 -
Less: accumulated depreciation and amortization (7,280) -
-------- --------
30,666 -
Investment in and mortgage loans to ILM II Holding, Inc. - 32,173
Cash and cash equivalents 2,361 1,449
Interest and other receivables - 350
Accounts receivable - related party 151 -
Prepaid expenses and other assets 77 1
Deferred rent receivable 100 -
-------- --------
$ 33,355 $ 33,973
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 147 $ 65
Accounts payable - related party 205 32
-------- --------
352 97
Total liabilities
Minority interest in consolidated subsidiary 116 -
Commitments and contingencies
Shareholders' equity:
Common stock, $0.01 par value, 12,500,000 shares authorized,
5,181,236 shares issued and outstanding 52 52
Additional paid-in capital 44,823 44,823
Accumulated deficit (11,988) (10,999)
-------- --------
Total shareholders' equity 32,887 33,876
-------- --------
$ 33,355 $ 33,973
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF INCOME For the years
ended August 31, 1997, 1996 and 1995
(In thousands, except per share amounts)
1997 1996 1995
---- ---- ----
Revenues:
Rental and other income $ 4,416 $ - $ -
Interest income earned
on cash equivalents 99 46 87
------- ------- -------
4,515 46 87
Expenses:
Depreciation and amortization 1,275 - 6
Management and advisory fees 103 130 130
General and administrative 563 246 276
Professional fees 308 233 528
Director compensation 82 24 24
------- ------- -------
2,331 633 964
------- ------- -------
Operating income (loss) 2,184 (587) (877)
Equity in income of properties securing
mortgage loans - 2,674 2,308
------- ------- -------
Net income $ 2,184 $ 2,087 $ 1,431
======= ======= =======
Earnings per share of common stock $ 0.42 $ 0.40 $ 0.27
======= ======= =======
Cash dividends paid per share
of common stock $ 0.61 $ 0.50 $ 0.43
======= ======= =======
The above earnings and cash dividends paid per share of common stock are
based upon the 5,181,236 shares outstanding during each year.
See accompanying notes.
F-4
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For
the years ended August 31, 1997, 1996 and 1995
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock
$.01 Par Value Additional
-------------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
------ ------ ---------- ----------- -----
<S> <C> <C> <C> <C> <C>
Shareholders' equity
at August 31, 1994 5,181,236 $52 $44,823 $ (9,648) $35,227
Cash dividends paid - - - (2,202) (2,202)
Net income - - - 1,431 1,431
Adjustment to
eliminate reporting
lag for combined
facilities'
operations - - - 424 424
---------------- ------------------- ---------- ----------
Shareholders' equity
at August 31, 1995 5,181,236 52 44,823 (9,995) 34,880
Cash dividends paid - - - (2,591) (2,591)
Distribution of
stock in ILM II
Lease Corporation - - - (500) (500)
Net income - - - 2,087 2,087
---------------- ------------------- ---------- ---------
Shareholders' equity
at August 31, 1996 5,181,236 52 44,823 (10,999) 33,876
Cash dividends paid - - - (3,173) (3,173)
Net income - - - 2,184 2,184
--------------- ------------------- ---------- ---------
Shareholders' equity
at August 31, 1997 5,181,236 $52 $44,823 $(11,988) $32,887
========= === ======= ======== =======
</TABLE>
See accompanying notes.
F-5
<PAGE>
ILM II SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS For the years
ended August 31, 1997, 1996 and 1995
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 2,184 $ 2,087 $ 1,431
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Equity in income of properties securing
mortgage loans - (2,674) (2,308)
Depreciation 1,132 - -
Amortization 143 - -
Charitable contribution of subsidiary's
preferred stock and accrued dividends 116 - -
Changes in assets and liabilities:
Interest and other receivables 178 (318) (29)
Accounts receivable - related party 74 156 (143)
Prepaid expenses and other assets (68) 7 (8)
Deferred rent receivable 31 - -
Accounts payable - affiliates 173 (25) (2)
Accounts payable and accrued expenses 82 (50) 17
------- ------- -------
Net cash provided by
operating activities 4,045 (817) (1,036)
------- ------- -------
Cash flows from investing activities:
Funding of initial working capital to
ILM II Lease Corporation - (500) -
Net proceeds from settlement of claims with
Angeles Corporation and affiliates - - 948
Additional fundings of construction loans - (320) (587)
Contractual payments received under
mortgage loans to ILM II Holding, Inc. - 3,998 3,176
Additions to operating investment properties (205) - -
ILM II Holding acquired cash balance 245 - -
------- ------- -------
Net cash provided by
investing activities 40 3,178 3,537
------- ------- -------
Cash flows from financing activities:
Cash dividends paid to shareholders (3,173) (2,591) (2,202)
------- ------- -------
Net cash used in financing activities (3,173) (2,591) (2,202)
------- ------- -------
Net increase (decrease) in cash and
cash equivalents 912 (230) 299
Cash and cash equivalents, beginning of year 1,449 1,679 1,380
------- ------- -------
Cash and cash equivalents, end of year $ 2,361 $ 1,449 $ 1,679
======= ======= =======
Cash paid for state income taxes $ - $ 3 $ 3
======= ======= =======
</TABLE>
See accompanying notes.
F-6
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements
1. Nature of Operations, Restructuring, and Basis of Presentation
ILM II Senior Living, Inc. formerly PaineWebber Independent
Mortgage Fund, Inc. II (the "Company") was organized as a corporation on
February 5, 1990 under the laws of the State of Virginia. On September
12, 1990, the Company commenced a public offering of up to 10,000,000
shares of its common stock at $10 per share, pursuant to the final
prospectus as amended incorporated into a Registration Statement filed
on Form S-11 under the Securities Act of 1933 (Registration Statement
No. 33-33857), (the "Prospectus"). The public offering terminated on May
10, 1991 with a total of 5,181,236 shares issued. The Company received
capital contributions of $51,812,356, of which $200,000 represented the
sale of 20,000 shares to an affiliate at that time, PaineWebber Group,
Inc. ("PaineWebber"). For discussion purposes, PaineWebber will refer to
PaineWebber Group, Inc. and all affiliates that provided services to the
Company in the past. The Company has elected to qualify and be taxed as
a Real Estate Investment Trust ("REIT") under the Internal Revenue Code
of 1986, as amended, for each taxable year of operations (see Note 2).
The Company originally invested the net proceeds of the initial
public offering in six participating mortgage loans secured by senior
housing facilities located in five different states ("Senior Housing
Facilities"). All of the loans made by the Company were originally to
Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the
development, acquisition and operation of senior housing facilities. The
Company entered into an exclusivity agreement (as amended) with AHC and
its parent company, Angeles Corporation ("Angeles"), which required AHC
to provide the Company with certain specific opportunities to finance
senior housing facilities and set forth the terms and conditions of the
loans which were made. The loan documents under the aforementioned
exclusivity agreement called for interest to be paid on construction
loans at the rate of 13.3% per annum during the construction period and
for base interest to be paid on the permanent loans at the rate of 10.3%
per annum. In addition to the base interest, additional interest was to
be paid on the permanent loans in an amount equal to 10% of the gross
revenues of the Senior Housing Facilities, as defined. Under the terms
of the amended exclusivity agreement, additional interest was to be no
less than 3% of the aggregate principal amount of all permanent loans
outstanding for the entire term of the investments. In the aggregate,
the properties securing loans from the Company did not generate
sufficient cash flow to cover the debt service payments owed to the
Company under the amended terms of the exclusivity agreement. To the
extent that the properties did not generate sufficient cash flow to make
the full payments due under the loan documents, the shortfall was funded
by AHC through December 1992. The source of cash to make up these
shortfalls was from specified deficit reserve accounts, which had been
funded from the proceeds of the mortgage loans, and from contributions
by Angeles.
During the quarter ended February 28, 1993, Angeles announced
that it was experiencing liquidity problems that resulted in the
inability to meet its obligations. Subsequent to such announcements, AHC
defaulted on the regularly scheduled mortgage loan payments due to the
Company on March 1, 1993. Subsequent to March 1993, payments toward the
debt service owed on the Company's loans were limited to the net cash
flow of the operating investment properties. On May 3, 1993, Angeles
filed for reorganization under a Chapter 11 Federal Bankruptcy petition
filed in the state of California. AHC did not file for reorganization.
The Company retained special counsel and held extensive discussions with
AHC concerning the default status of its loans. During the fourth
quarter of fiscal 1993, a non-binding settlement agreement between the
Company, AHC and Angeles was reached whereby ownership of the properties
would be transferred from AHC to the Company or its designated
affiliates. Under the terms of the settlement agreement, the Company
would release AHC and Angeles from certain obligations under the loans.
On April 27, 1994, each of the properties owned by AHC and securing the
Loans was transferred (collectively, "the Transfers") to newly-created
special purpose corporations affiliated with the Company (collectively,
"the Property Companies"). The Transfers had an effective date of April
1, 1994 and were made pursuant to the Settlement Agreement entered into
on February 17, 1994 ("the Settlement Agreement") between the Company
and AHC which had previously been approved by the bankruptcy court
handling the bankruptcy
F-7
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations, Restructuring, and Basis of Presentation
(continued)
case of Angeles. All of the capital stock of each Property Company was
held by ILM II Holding, Inc. ("ILM II Holding"), a Virginia corporation.
In August 1995, each of the Property Companies merged into ILM II
Holding which is majority owned by the Company. As a result, ownership
of the Senior Housing Facilities is now held by ILM II Holding, and the
Property Companies no longer exist as separate legal entities.
ILM II 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 II Holding was originally owned by the Company and PaineWebber. ILM
II 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 PaineWebber 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 II Holding, while the preferred stock
represented approximately 1 percent of the voting power and 99 percent
of the economic interest in ILM II Holding.
The Company completed its restructuring plans by converting ILM
II Holding to a REIT for tax purposes. In connection with these plans,
on November 21, 1996 the Company requested that PaineWebber sell all of
the stock held in ILM II Holding to the Company for a price equal to the
fair market value of the 1% economic interest in ILM II Holding
represented by the common stock. On January 10, 1997, this transfer of
the common stock of ILM II Holding was completed at an agreed upon fair
value of $40,000. With this transfer completed, effective January 23,
1997 ILM II 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 II 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
II Holding to each of 111 charitable organizations so that ILM II
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 II 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 recorded the contribution of the preferred stock in ILM II
Holding to the charitable organizations at the amount of the initial
liquidation preference of $111,000. Such amount is included in general
and administrative expense on the accompanying income statement for the
year ended August 31, 1997. Cumulative dividends accrued as of August
31, 1997 on the preferred stock in ILM II Holding totaled approximately
$5,180.
As part of the fiscal 1994 settlement agreement with AHC, ILM II
Holding retained AHC as the property manager for all of the Senior
Housing Facilities pursuant to the terms of a management agreement. As
discussed further in Note 5, the management agreement with AHC was
terminated in July 1996. Subsequent to the effective date of the
Settlement Agreement with AHC, management investigated and evaluated the
available options for structuring the ownership of the properties in
order to maximize the potential returns to the existing shareholders
while maintaining the Company's qualification as a REIT under the
Internal Revenue Code (see Note 2). As discussed further in Note 4, on
September 12, 1994 the Company formed a new subsidiary, ILM II Lease
Corporation ("Lease II"), for the purpose of operating the Senior
Housing Facilities. The Senior Housing Facilities were leased to Lease
II effective September 1, 1995 (see Note 4 for a description of the
master lease agreement). Lease II is a public company subject to the
reporting obligations of the Securities and Exchange Commission.
F-8
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
1. Nature of Operations, Restructuring, and Basis of Presentation
(continued)
At a meeting of the Company's Board of Directors on January 10,
1997, PaineWebber recommended the immediate sale of the Senior Housing
Facilities held by the Company and an affiliated entity, ILM Senior
Living, Inc. ("ILM I"), by means of a controlled auction to be conducted
by PaineWebber with PaineWebber offering to purchase the properties for
$127 million, thereby guaranteeing the shareholders a "floor" price. The
Senior Housing Facilities held by the Company would represent
approximately $52 million of this amount. After taxes and closing costs,
net proceeds to the Company would equal approximately $48 million or
approximately $9.36 per share. PaineWebber also stated that if it
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 in
evaluating PaineWebber's proposal, a disinterested, independent
investment banking firm with expertise in healthcare REITs and
independent/assisted living financings was engaged by the Company, Lease
II, and ILM I and its affiliates. Following a comprehensive analysis,
the investment banker recommended that PaineWebber's proposal should be
declined and that, instead, investigations of expansion and
restructuring alternatives should be pursued. After analyzing
PaineWebber's proposal and the recommendations and other information
provided by the independent investment banker, the Boards of the Company
and ILM I voted unanimously to decline PaineWebber's proposal and to
explore the alternatives recommended by the independent investment
banker. The Boards declined to seek an immediate sale of the properties
because, in the Boards' view, the liquidation price would not reflect
the "going concern" values of the Company and ILM I and, therefore,
would not maximize Shareholder value. In addition, the Boards did not
consider it advisable to liquidate the Company and ILM I on the
suggested terms three years prior to their scheduled termination date.
PaineWebber had indicated to the Board in its January 10, 1997,
proposal that it would not wish to continue to serve as advisor to the
Company and its affiliates if the Company declined to accept
PaineWebber's proposal. The Company accepted the resignation of
PaineWebber, effective as of June 18, 1997. PaineWebber agreed to
continue to provide certain administrative services to the Company and
its affiliates through August 31, 1997, pursuant to the terms of a
transition services agreement entered into with the Company and its
affiliates. The Company and its affiliates also accepted, effective as
of June 18, 1997, the resignations of those officers and directors who
were employees of or otherwise affiliated with PaineWebber.
In addition, the Company and Lease II are continuing to review
various restructuring alternatives that could further increase
shareholder value and liquidity. The Company and Lease II are
considering a merger of the Company with ILM I, a merger of Lease II
with ILM I Lease Corporation ("Lease I"), a related entity, and other
business combinations. 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 the actions identified above or any others
which may be recommended by its investment bankers.
F-9
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
2. Use of Estimates and Summary of Significant Accounting Policies
The accompanying financial statements have been prepared on the
accrual basis of accounting in accordance with generally accepted
accounting principles which requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities
and disclosures of contingent assets and liabilities as of August 31,
1997 and 1996 and revenues and expenses for each of the three years in
the period ended August 31, 1997. Actual results could differ from the
estimates and assumptions used.
The Company's significant accounting policies are summarized as
follows:
A. BASIS OF PRESENTATION
The operating cycle in the real estate industry is longer than
one year and the distinction between current and non-current is
of little relevance. Accordingly, the accompanying consolidated
balance sheet is presented in an unclassified format.
The accompanying financial statements include the financial
statements of the Company and ILM II Holding. All intercompany
balances and transactions have been eliminated in consolidation.
Effective January 10, 1997, the Company purchased the remaining
common shares held by PaineWebber of ILM II Holding which
provided the Company with 100% majority voting control, for
$40,000 which is included in general and administrative expense
for the year ended August 31, 1997. Accordingly, the accounts of
ILM II Holding have been consolidated with those of the Company
as though this controlling interest had been acquired at
September 1, 1996. The accompanying financial statements for
fiscal years 1996 and prior were restated to account for the
Company's investment in ILM II Holding using the equity method.
Under the equity method, the Company's investment in ILM II
Holding is carried at cost, including the face amount of the
mortgage loans, adjusted for the Company's share of ILM II
Holding's earnings, losses and distributions.
B. INCOME TAXES
The Company has elected to qualify and to be taxed as a REIT
under the Internal Revenue Code of 1986, as amended, for each
taxable year of operations. As a REIT, the Company is allowed a
deduction for the amount of dividends paid to its shareholders,
thereby effectively subjecting the distributed net taxable income
of the Company to taxation at the shareholder level only,
provided it distributes at least 95% of its taxable income and
meets certain other requirements for qualifying as a real estate
investment trust. In connection with the settlement agreement
described in Note 1, the Company, through ILM II Holding,
obtained title to the properties securing its mortgage loan
investments. To retain REIT status, the Company must ensure that
75% of its annual gross income is received from qualified
sources. Under the original investment structure, interest income
from the Company's mortgage loans was a qualified source. The
properties that are now owned by an affiliate of the Company are
Senior Housing Facilities that provide residents with more
services, such as meals, activities, assisted living, etc., than
are customary for ordinary residential apartment properties. As a
result, a significant portion of the rents paid by the residents
includes income for the increased level of services received by
them. Consequently, the rents paid by the residents likely would
not be qualified rents for REIT qualification purposes if
received directly by the Company. Therefore, if the Company
received such rents directly, it could lose REIT status and be
taxed as a regular corporation. After extensive review, the Board
of Directors determined that it would be in the best interests of
the shareholders for the Company to retain REIT status and master
lease the properties to a shareholder-owned operating company. As
discussed further in Note 4, on
F-10
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
2. Use of Estimates and Summary of Significant Accounting Policies
(continued)
September 12, 1994 the Company formed a new subsidiary, Lease II,
for the purpose of operating the Senior Housing Facilities. The
Senior Housing Facilities were leased to Lease II effective
September 1, 1995 (see Note 4 for a description of the master
lease agreement).
The assumption of ownership of the properties through ILM II
Holding, which was a regular C corporation for tax purposes at
the time of assumption, has resulted in a possible future tax
liability which would be payable upon the ultimate sale of the
properties (the "built-in gain tax"). The amount of such tax
would be calculated based on the lesser of the total net gain
realized from the sale transaction or the portion of the net gain
realized upon a final sale which is attributable to the period
during which the properties were held by a C corporation. The
Company completed its restructuring plans by converting ILM II
Holding to a REIT for tax purposes. Any future appreciation in
the value of the Senior Housing Facilities subsequent to the
conversion of ILM II 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 II
Holding to a REIT. However, since the end of the Company's
original anticipated holding period is less than 4 years away,
the properties are not expected to be held for an additional 10
years. Based on management's estimate of the increase in the
values of the properties which occurred between April 1994 and
January 1996, as supported by independent appraisals, ILM II
Holding would incur a sizable tax if the properties were sold.
Based on the then estimated market values of the operating
investment properties, a sale at such values prior to the end of
the 10-year holding period could result in a built-in gain tax of
as much as $2.3 million. To avoid this built-in gain tax, the
directors are prepared at the appropriate time to recommend to
the shareholders an amendment to the Articles of Incorporation to
extend the Company's scheduled liquidation date.
The Company's consolidated affiliate, ILM II Holding, has
incurred losses for tax purposes since inception. Neither the
Company nor ILM II Holding is likely to be able to use these
losses to offset future tax liabilities. Accordingly, no income
tax benefit is reflected in these consolidated financial
statements.
The Company reports on a calendar year basis for income tax
purposes. All distributions during calendar years 1997 and 1996
were ordinary taxable dividends. During calendar 1995, the
Company distributed $0.45 per share in cash and $0.14 per share
in shares of Lease II. The tax status of these dividends amounted
to an ordinary taxable dividend of approximately $0.41 per share
and a tax free return of capital of approximately $0.18 per
share. All distributions during calendar 1996 were ordinary
taxable dividends.
C. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents
include all highly liquid investments with original maturities of
90 days or less.
D. OPERATING INVESTMENT PROPERTIES
Operating investment properties are carried at the lower of cost,
reduced by accumulated depreciation, or net realizable value. The
net realizable value of a property held for long-term investment
purposes is measured by the recoverability of the owner's
investment through expected future cash flows on an undiscounted
basis, which may exceed the property's current market value.
F-11
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
2. Use of Estimates and Summary of Significant Accounting Policies
(continued)
The net realizable value of a property held for sale approximates
its current market value, as determined on a discounted basis.
None of the operating investment properties were held for sale as
of August 31, 1997 or 1996. Depreciation expense is provided on a
straight-line basis using an estimated useful life of 40 years
for the buildings and improvements and five years for the
furniture, fixtures and equipment.
The Company reviews the carrying value of a long-lived asset if
facts and circumstances suggest that it may be impaired or that
the amortization period may need to be changed. The Company
considers external factors relating to the long-lived asset,
including occupancy trends, local market developments, changes in
payments, and other publicly available information. If these
external factors indicate the long-lived asset will not be
recoverable, based upon undiscounted cash flows of the long-lived
asset over its remaining life, the carrying value of the
long-lived asset will be reduced by the estimated shortfall of
discounted cash flows. The Company does not believe there are any
indicators that would require an adjustment to the carrying value
of its long-lived assets or their remaining useful lives as of
August 31, 1997.
Loan placement fees of $1,424,850 were incurred by the Company
and are included in operating investment properties in the
accompanying balance sheet. Accumulated amortization at August
31, 1997, is $823,233.
E. RENTAL REVENUES
In fiscal year 1997, rental revenues consist of payments due from
Lease II under the terms of the master lease described in Note 4.
Base rental income under the master Lease Is recognized on a
straight-line basis over the term of the lease. Deferred rent
receivable on the balance sheet as of August 31, 1997 represents
the difference between rental income on a straight-line basis and
rental income received under the terms of the master lease.
F. FAIR VALUE DISCLOSURES
FASB Statement No. 107, "Disclosures about Fair Value of
Financial Instruments" ("SFAS 107"), requires disclosure of fair
value information about financial instruments, whether or not
recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value
or other valuation techniques. SFAS 107 excludes certain
financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the
Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the
balance sheet for cash and cash equivalents approximates its fair
value due to the short-term maturities of such instruments.
Accounts receivable - related party: The carrying amount reported
on the balance sheet for accounts receivable - related party
approximates its fair value due to the short-term maturity of
such instrument.
F-12
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
3. The Advisory Agreement and Related Party Transactions
Subject to the supervision of the Company's Board of Directors,
the business of the Company was managed by PaineWebber. As previously
discussed in Note 1, PaineWebber resigned effective as of June 18, 1997.
PaineWebber and its affiliates received fees and compensation
determined on an agreed-upon basis, in consideration of various services
performed in connection with the sale of the shares, the management of
the Company and the acquisition, management and disposition of the
Company's investments. The type of compensation to be paid by the
Company to PaineWebber under the terms of the advisory agreement was as
follows.
(i) Under the advisory agreement, PaineWebber has specific management
responsibilities; to perform day-to-day operations of the Company
and to act as the investment advisor and consultant for the
Company in connection with general policy and investment
decisions. PaineWebber received an annual base fee and an
incentive fee of 0.25% and 0.25%, respectively, of the capital
contributions of the Company, as defined, as compensation for
such services. Incentive fees are subordinated to shareholders'
receipt of distributions of net cash sufficient to provide a
return equal to 10% per annum. PaineWebber earned base management
fees totaling $103,000 for the year ended August 31, 1997, and
$130,000 for each of the years ended August 31, 1996 and 1995.
Payment of incentive management fees was suspended effective
April 15, 1993 in conjunction with a reduction in the Company's
quarterly dividend payments.
(ii) For its services in finding and recommending investments,
PaineWebber received mortgage placement fees equal to 2% of the
capital contributions. Mortgage placement fees totaling
$1,036,000 were earned by PaineWebber during the Company's
investment acquisition period. Such fees have been capitalized
and are included in the cost of the operating investment
properties on the accompanying consolidated balance sheets.
(iii) For its administrative services with respect to all loans,
PaineWebber received, directly from AHC, construction loan
administration or due diligence fees equal to 1% of the loan
amounts. Loan administration and due diligence fees totaling
$425,141 were earned by PaineWebber during the Company's
investment due diligence period.
(iv) PaineWebber was entitled to receive 1% of disposition proceeds,
as defined, until the shareholders have received dividends of net
cash equal to their adjusted capital investments, as defined,
plus a 12% non-compounded annual return on their adjusted capital
investments; all disposition proceeds thereafter until
PaineWebber has received an aggregate of 5% of disposition
proceeds; and, thereafter, 5% of disposition proceeds.
AHC received a research and analysis fee in connection with the
offering equal to 1% of the capital contributions for identifying and
analyzing development and acquisition opportunities for Senior Housing
Facilities and for reimbursements of certain expenses associated with
those activities. The research and analysis fee paid to AHC totaled
$518,123 and is included in offering costs on the accompanying
consolidated balance sheets.
AHC received an investment fee for providing the Company with the
opportunity to invest the available proceeds of the offering in loans.
The investment fee is an amount equal to 0.75% of the offering proceeds,
and was payable on the date of the Initial Closing. AHC earned
investment fees totaling $388,603 which are included in the cost of the
operating investment properties on the accompanying consolidated balance
sheets.
F-13
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
3. The Advisory Agreement and Related Party Transactions (continued)
PaineWebber was reimbursed for their direct expenses relating to
the offering of shares, the administration of the Company and the
acquisition and operations of the Company's real estate investments.
Included in general and administrative expenses on the accompanying
statements of income for the years ended August 31, 1997, 1996 and 1995
is $118,000, $107,000 and $121,000, respectively, representing
reimbursements to PaineWebber for providing certain financial,
accounting and investor communication services to the Company.
Mitchell Hutchins Institutional Investors, Inc. ("Mitchell
Hutchins") provides cash management services with respect to the
Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell
Hutchins Asset Management, Inc., an independently operated subsidiary of
PaineWebber. Mitchell Hutchins earned $5,000, $6,000 and $3,000
(included in general and administrative expenses) for managing the
Company's cash assets during fiscal 1997, 1996 and 1995, respectively.
Jeffry R. Dwyer is an employee of Greenberg, Traurig, Hoffman,
Lipoff, Rosen & Quental, P.A., which acts as Counsel to the Company and
its affiliates. Greenberg, Traurig, Hoffman, Lipoff, Rosen & Quental,
P.A., received fees from the Company of $57,000 for the year ended
August 31, 1997.
Accounts receivable - related party at August 31, 1997 represent
amounts due from Lease II for variable rents.
Accounts payable - related party at August 31, 1997 represents
amounts owed to Lease II for property improvements made on the Company's
behalf.
4. Operating Investment Properties Subject to Master Lease
As of August 31, 1997 and 1996, the Company, through its
consolidated affiliate, owned 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>
<CAPTION>
Date of
Name Location Rentable Units Investment (1)
---- -------- -------------- --------------
<S> <C> <C> <C>
The Palms Fort Myers, FL 205 Units 7/18/90
Crown Villa Omaha, NE 73 Units 4/25/91
Overland Park Place Overland Park, KS 140 Units 4/9/92
Rio Las Palmas Stockton, CA 164 Units 5/14/92
The Villa at St. Louis County, MO 120 Units 5/29/92
Riverwood
Villa Santa Barbara, CA 125 Units 7/13/92
Santa Barbara (2)
</TABLE>
(1) Represents the date of the Company's original mortgage loan to
Angeles Housing Concepts, Inc. (see Note 1).
F-14
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
4. Operating Investment Properties Subject to Master Lease (continued)
(2) The acquisition of the Santa Barbara Facility was financed
jointly by the Company and an affiliated entity, ILM I. All
amounts generated from the operations of Villa Santa Barbara are
equitably apportioned between the Company, together with its
consolidated affiliate, and ILM I, together with its consolidated
affiliate, generally 75% and 25%, respectively. The financial
position, results of operations and cash flows presented in these
consolidated financial statements include only the 75% allocable
portion of the Company's interest in the Santa Barbara Facility.
Villa Santa Barbara is owned 75% by ILM II Holding and 25% by ILM
I Holding, Inc.
The cost basis of the operating investment properties reflects
amounts funded under the Company's participating mortgage loans less
certain guaranty payments received from AHC in excess of the net cash
flow of the Facilities under the terms of the Exclusivity Agreement with
the Company. The transfer of ownership of the Senior Housing Facilities
from AHC in fiscal 1994 resulted in no gain or loss recognition by the
Company for financial reporting purposes. As discussed in Note 1, in
accordance with generally accepted accounting principles, the Company
had always accounted for its investments in acquisition and construction
loans under the equity method, as if such investments were equity
interests in a joint venture. Accordingly, the carrying values of such
investments were reduced from inception by non-cash depreciation charges
and by payments from AHC, prior to the default in fiscal 1993, in excess
of the net cash flow generated by the Senior Housing Facilities received
pursuant to the guaranty agreement between the Company and AHC. As a
result of this accounting treatment, the carrying values of the
Company's investments had been reduced below management's estimate of
the fair market value of the Senior Housing Facilities as of the
effective date of the transfer of ownership. For federal income tax
purposes, the investments had always been carried at the contractually
stated principal balances of the participating mortgage loans. For tax
purposes only, a loss was recognized by the Company in 1994 in the
amount by which the stated principal balances of the loans were reduced
as of the date of the transfer of ownership.
As discussed in Note 1, effective April 1, 1994 each Property
Company acquired the respective operating property subject to, and
assumed the obligations, under the mortgage loan payable to the Company,
pursuant to the Settlement Agreement with AHC. The principal balance on
each loan was modified to reflect the estimated fair value of the
related operating property as of the date of the transfer of ownership.
The modified loans require interest-only payments on a monthly basis at
a rate of 7% from April 1, 1994 through December 1, 1994, 9% for the
period from January 1 through December 31, 1995, 11% for the period
January 1 through December 31, 1996, 12% for the period January 1
through December 31, 1997, 13% for the period January 1 through December
31, 1998, 13.5% for the period January 1, 1999 through December 31, 1999
and 14% for the period January 1, 2000 through maturity. In August 1995,
each of the Property Companies was merged into ILM II Holding. As a
result, ownership of the Senior Housing Facilities, as well as the
obligation under the loans, is now held by ILM II Holding, and the
Property Companies no longer exist as separate legal entities. Since ILM
II Holding is consolidated with the Company in the accompanying
financial statements for fiscal 1997, the mortgage loans and related
interest expense have been eliminated in consolidation.
Subsequent to the effective date of the Settlement Agreement with
AHC, in order to maximize the potential returns to the existing
shareholders while maintaining the Company's qualification as a REIT
under the Internal Revenue Code, the Company formed a new corporation,
Lease II, for the purpose of operating the Senior Housing Facilities
under the terms of a master lease agreement. As of August 31, 1995,
Lease II, 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 Lease II to the
holders of record of the Company's common stock. One share of common
stock of Lease II was issued for each full share of the Company's common
F-15
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
4. Operating Investment Properties Subject to Master Lease (continued)
stock held. Prior to the distribution, the Company capitalized Lease II
with $500,000 from its existing cash reserves, which was an amount
estimated to provide Lease II with necessary working capital. The master
lease agreement, which commenced on September 1, 1995, is between the
Company's consolidated affiliate, ILM II Holding, as owner of the
properties and lessor, and Lease II as lessee. The master lease is a
"triple-net" lease whereby the lessee pays all operating expenses,
governmental taxes and assessments, utility charges and insurance
premiums, as well as the costs of all required maintenance, personal
property and non-structural repairs in connection with the operation of
the Senior Housing Facilities. ILM II Holding, as the lessor, is
responsible for all major capital improvements and structural repairs to
the Senior Housing Facilities. During the initial term of the master
lease, which expires on December 31, 2000 (December 31, 1999 with
respect to the Santa Barbara Facility). 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,
Lease II is obligated to pay annual base rent for the use of all of the
Senior Housing Facilities in the aggregate amount of $3,548,700 for
calendar year 1995 (prorated based on the commencement date of the
lease) and $4,035,600 for calendar year 1996 and each subsequent year.
Beginning in January 1997 and for the remainder of the lease term, Lease
II is also obligated to pay variable rent for each Senior Housing
Facility. Such variable rent is payable quarterly and is equal to 40% of
the excess, if any, of the aggregate total revenues for the Senior
Housing Facilities, on an annualized basis, over $13,021,000. Variable
rental income related to fiscal year 1997 was $411,857.
A condensed balance sheet as of August 31, 1997, and condensed
statement of operations for the year ended August 31, 1997, of Lease II
are as follows:
Assets
Current assets $ 1,614
Furniture, fixtures, and equipment 416
Other assets 96
---------
$ 2,126
=========
Liabilities and shareholders' equity
Current liabilities $ 1,307
Other liabilities 100
Shareholders' equity 719
---------
$ 2,126
=========
Statement of operations
Revenues $ 14,433
Operating expenses 14,500
Income tax expense benefit (27)
---------
Net loss $ (40)
=========
F-16
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
5. Legal Proceedings and Contingencies
Angeles Corporation Litigation
Angeles had guaranteed certain of the obligations of AHC under
the terms of the Exclusivity Agreement described in Note 1. Under the
terms of the Settlement Agreement discussed in Note 1, the Company
retained a general unsecured claim against Angeles in the amount of
$1,200,658 as part of the bankruptcy proceedings, but waived all other
claims against Angeles, including any amounts of base and additional
interest owed. In addition, the Company maintained a claim for
approximately $408,000 against an affiliate of Angeles which had made a
separate guaranty to the Company. On March 17, 1995, the Bankruptcy
Court handling the Angeles bankruptcy proceedings approved a final
settlement of the Company's outstanding claims against Angeles and its
affiliates. Pursuant to the terms of this settlement, the Company
received a cash payment of $1 million on April 14, 1995 in full
satisfaction of the claims, which totaled approximately $1.6 million.
This amount, net of certain related legal expenses, was recorded as a
reduction in the carrying values of the Company's operating investment
properties.
Termination of Management Contract with AHC
On July 29, 1996, Lease II and ILM II Holding ("the Companies")
terminated the property management agreement ("Agreement") with AHC
covering the six Senior Housing Facilities leased by the Companies. The
Agreement was terminated for cause pursuant to Sections 1.05 (a) (i),
(iii) and (iv) of the agreement. Simultaneously with the termination of
the Agreement, the Companies, together with certain affiliated entities,
filed suit against AHC in the United States District Court for the
Eastern District of Virginia for breach of contract, breach of fiduciary
duty and fraud. The Companies allege that AHC willfully performed
actions specifically in violation of the Agreement and that such actions
caused damages to the Companies. Due to the termination of the Agreement
for cause, no termination fee was paid to AHC. Subsequent to the
termination of the Agreement, AHC filed for protection under Chapter 11
of the U.S. Bankruptcy Code in its domestic state of California. The
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 II
Holding. The counterclaim alleges that the Agreement was wrongfully
terminated for cause and requests damages which include the payment of
the termination fee in the amount of $750,000, payment of management
fees pursuant to the contract from August 1, 1996 through October 15,
1996, which is the earliest date that the Agreement could have been
terminated without cause, and recovery of attorney's fees and expenses.
The aggregate amount of damages against all parties as requested
in AHC's counterclaim exceeds $2,000,000. 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 Lease II fails to perform pursuant to its obligations
under the Agreement. The court initially set a trial date of April 28,
1997 but, at AHC's request, rescheduled the trial for June 23, 1997. On
June 13, 1997 and July 8, 1997, the court issued orders to enter
judgment against the Company and ILM I in the amount of $1,000,000 (the
"Orders"). In so doing, the court effectively canceled the June 23,
1997, trial date. The Orders do not contain any findings of fact or
conclusions of law. On July 10, 1997, the Company, ILM I, Lease I and
Lease II filed a notice of appeal to the United States Court of Appeals
for the Fourth Circuit from the Orders. The Company intends to
diligently prosecute the appeal. The eventual outcome of this litigation
cannot presently be determined. However, provision of $400,000 for the
liability which might result to the Company from the Order has been
recorded in the financial statements of Lease II, with the remaining
$600,000 recorded by Lease I.
F-17
<PAGE>
ILM II SENIOR LIVING, INC.
Notes to Consolidated Financial Statements (continued)
5. Legal Proceedings and Contingencies (continued)
On February 4, 1997, AHC filed a Complaint in the Superior Court
of the State of California against Capital Senior Management 2, Inc.
("Capital"), Lawrence Cohen, and others alleging that the defendants
intentionally interfered with AHC's property Agreement (the "California
litigation"). The complaint seeks damages of at least $2,000,000. On
March 4, 1997, the defendants removed the case to federal district court
in the Central District of California. Trial in the action has been set
for January 13, 1998, and discovery has just begun. At a Board meeting
on February 26, 1997, the Company's Board of Directors concluded that
since all of Mr. Cohen's actions relating to the California litigation
were taken either on behalf of the Company under the direction of the
Board or as a PaineWebber employee, the Company or its affiliates should
indemnify Mr. Cohen with respect to any expenses arising from the
California litigation, subject to any insurance recoveries for those
expenses. The Company's Board also concluded that, subject to certain
conditions, the Company or its affiliates should advance up to $20,000
to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. Subsequently, the boards of directors of Lease I
and Lease II voted to increase the maximum amount of the advance to
$100,000. By the end of November 1997, Capital had incurred $100,000 of
legal expenses in the California litigation. 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 consolidated financial statements.
Lease II has retained Capital to be the manager of the Senior
Housing Facilities pursuant to a management agreement which commenced on
July 29, 1996. Under the terms of the agreement, Capital will earn a
base management fee equal to 4% of the gross operating revenues of the
Senior Housing Facilities, as defined. Capital will also be eligible to
earn an incentive management fee equal to 25% of the amount by which the
average monthly net cash flow of the Senior Housing Facilities, as
defined, for the twelve month period ending on the last day of each
calendar month exceeds a specified base amount. Each August 31,
beginning on August 31, 1997, the base amount will be increased annually
based on the percentage increase in the consumer price index. The
Company has guaranteed the payment of all fees due to Capital under the
terms of the management agreement.
6. Subsequent Events
On September 30, 1997, the Company's Board of Directors declared
a quarterly dividend for the quarter ended August 31, 1997. On October
15, 1997, a dividend of $0.1625 per share of common stock, totaling
$841,952 was made to shareholders of record as of September 30, 1997. On
December 8, 1997, a dividend of $0.1875 per share of common stock was
declared for shareholders of record as of December 15, 1997.
F-18
<PAGE>
REPORT OF ERNST & YOUNG, LLP INDEPENDENT AUDITORS
The Shareholders of
ILM II Senior Living, Inc.
We have audited the accompanying consolidated balance sheets of ILM II Holding,
Inc., (the "Company"), as of August 31, 1996 and 1995, and the related
statements of operations, changes in shareholders' deficit, and cash flows for
the year ended August 31, 1996, the two month period ended August 31, 1995 and
the year ended June 30, 1995. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ILM II Holding, Inc., at August
31, 1996, and the results of its operations and its cash flows for the year
ended August 31, 1996, the two-month period ended August 31, 1995, and the year
ended June 30, 1995, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Boston, Massachusetts
December 10, 1996
F-19
<PAGE>
ILM II HOLDING, INC.
BALANCE SHEET
August 31, 1996
(In thousands, except per share amounts)
ASSETS
1996
----
Operating investment properties, at cost:
Land $ 5,030
Building and improvements 25,714
Furniture, fixtures and equipment 3,964
--------
34,708
Less: accumulated depreciation (2,768)
31,940
Cash and cash equivalents 245
Accounts receivable -
Accounts receivable - related party 225
Deferred rent receivable 131
Prepaid expenses and other assets 33
--------
$32,574
LIABILITIES AND SHAREHOLDERS' EQUITY
Mortgages payable $34,006
Accounts payable - related party -
Accounts payable and accrued expenses 3
========
Total liabilities 34,009
========
Commitments and contingencies
Shareholders' deficit:
Preferred stock,( Series A, $1 par value, 100 shares
authorized, shares issued and outstanding) 1
Common stock,($1 par value, 10,000 shares
authorized, shares issued and outstanding)
10
Additional paid-in capital 489
Accumulated deficit (1,935)
Total shareholders' equity (1,435)
========
$32,574
========
See accompanying notes.
F-20
<PAGE>
ILM II HOLDING, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
For the two
For the year month period For the year
ended August 31, ended August 31, ended June 30,
1996 1995 1995
------------------ ------------------ ------------------
<S> <C> <C> <C>
Revenues:
Rental income $ 4,004 $2,036 $11,789
Interest income earned
on cash equivalents 13 - 5
Expenses:
Property operating - 1,406 8,114
Depreciation 1,127 196 1,170
Interest 3,998 518 3,033
Management advisory fees - 10 59
General and administrative 73 - -
--------------------------------------------------------
5,198 2,130 12,376
--------------------------------------------------------
Net loss (1,181) (94) (582)
========================================================
Loss per share of common
stock $(118.10) $(9.40) $(58.20)
========================================================
</TABLE>
See accompanying notes.
F-21
<PAGE>
ILM II HOLDING, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the
year ended August 31, 1996, the two-month period ended
August 31, 1995 and the year ended June 30, 1995
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Common Stock Preferred Stock
$.01 Par Value $.01 Par Value Additional
---------------- -------------- Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit Total
------ ------ ------ ----- ---------- ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
Shareholders' equity
at June 30, 1994 10,000 $ 10 100 $ 1 $ 489 $ (78) $ 422
Net loss - - - - - (582) (582)
------ ------- --- ------- ------- ------- -------
Shareholders' equity
at June 30, 1995 10,000 10 100 1 489 (660) (160)
Net loss - - - - - (94) (94)
------ ------- --- ------- ------- ------- -------
Shareholders' equity
at August 31, 1995 10,000 10 100 1 489 (754) (254)
Net loss - - - - - (1,181) (1,181)
------ ------- --- ------- ------- ------- -------
Shareholders' deficit
at August 31, 1996 10,000 $ 10 100 $ 1 $ 489 $(1,935) $(1,435)
====== ======= === ======= ======= ======= =======
</TABLE>
See accompanying notes.
F-22
<PAGE>
ILM II HOLDING, INC.
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the two
For the year month period For the year
ended August 31, ended ended
1996 August 31, 1995 June 30, 1995
------------------ ----------------- --------------
<S> <C> <C> <C>
Operating activities: $ 245 $ 811 $ 942
Net loss $(1,181) $ (94) $(582)
Adjustments to reconcile net income to
net cash used in operating activities:
Depreciation 1,127 196 1,170
Changes in operating assets and
liabilities:
Accounts receivable 13 17 (30)
Accounts receivable - related party (37) 33 663
Other assets 7 27 89
Deferred rent receivable (131) - -
Accounts payable - related party (83) - -
Accounts payable and accrued (498) (235) (360)
expenses
---------------------------------------------------
Total adjustments 398 38 1,532
---------------------------------------------------
Net cash used in operating activities (783) (56) 950
---------------------------------------------------
Investing activities:
Additions to operating investment
properties (103) (319) (1,189)
---------------------------------------------------
Net cash used in investing activities (103) (319) (1,189)
---------------------------------------------------
Financing activities:
Advances under mortgage notes 320 64 523
---------------------------------------------------
Net cash provided by financing
activities 320 64 523
---------------------------------------------------
Net increase (decrease) in cash and
cash equivalents at end of period (566) (131) 284
Cash and cash equivalents at beginning
of year 811 942 658
===================================================
Cash and cash equivalents at end of year $ 245 $ 811 $ 942
===================================================
</TABLE>
See accompanying notes.
F-23
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements
1. Nature of Operations, Restructuring, and Basis of Presentation
ILM II Senior Living, Inc. formerly PaineWebber Independent Living Mortgage,
Inc. II ("ILM II"), invested in six participating mortgage loans secured by
Senior Housing Facilities located in five different states. All of the loans
made by ILM II were originally with Angeles Housing Concepts, Inc. ("AHC"), a
company specializing in the development, acquisition, and operation of senior
housing facilities. ILM II entered into an Exclusivity Agreement with AHC and
its parent company, Angeles Corporation ("Angeles"), which required AHC to
provide ILM II with certain specific opportunities to finance Senior Housing
Facilities and set forth the terms and conditions of the loans which were made.
The loan documents under the aforementioned Exclusivity Agreement called for
interest to be paid on construction loans at the rate of 13.3% per annum during
the construction period and for Base Interest to be paid on the permanent loans
at the rate of 10.3% per annum. In addition to the Base Interest, Additional
Interest was to be payable on the permanent loans in an amount equal to 10% of
the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms
of the amended Exclusivity Agreement, Additional Interest was to be no less than
3% of the aggregate principal amount of all permanent loans outstanding for the
entire term of the investments. In the aggregate, the properties securing loans
from ILM II did not generate sufficient cash flow to cover the debt service
payments owed to ILM II under the amended terms of the Exclusivity Agreement. To
the extent that the properties did not generate sufficient cash flow to make the
full payments due under the loan documents, the shortfall was funded by AHC
through December 1992. The source of cash to make up these shortfalls was from
specified deficit reserve accounts, which had been funded from the proceeds of
the mortgage loans, and from contributions by Angeles.
During the quarter ended February 28, 1993, Angeles announced that it was
experiencing liquidity problems that resulted in the inability to meet its
obligations. Subsequent to such announcements, AHC defaulted on the regularly
scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent
to March 1993, payments toward the debt service owed on the Company's loans were
limited to the net cash flow of the operating investment properties. On May 3,
1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy
petition filed in the state of California. AHC did not file for reorganization.
ILM II retained special counsel and held extensive discussions with AHC
concerning the default status of its loans. During the fourth quarter of fiscal
1993, a non-binding settlement agreement between ILM II, AHC and Angeles was
reached whereby ownership of the properties would be transferred from AHC to ILM
II or its designated affiliates. Under the terms of the Settlement Agreement,
ILM II released AHC and Angeles from certain obligations under the loans. On
April 27, 1994, each of the properties owned by AHC and securing the Loans was
transferred (collectively, "the Transfers") to newly-created special purpose
corporations affiliated with ILM II (collectively, "the Property Companies").
The Transfers had an effective date of April 1, 1994 and were made pursuant to
the Settlement Agreement entered into on February 17, 1994 ("the Settlement
Agreement") between ILM II and AHC which had previously been approved by the
bankruptcy court handling the bankruptcy case of Angeles. All of the capital
stock of each Property Company was held by ILM II Holding, Inc. (the "Company"),
a Virginia corporation. In August 1995, each of the Property Companies merged
into the Company. As a result, ownership of the Senior Housing Facilities is now
held by the Company, and the Property Companies no longer exist as separate
legal entities. The capital stock of the Company is owned by ILM II and PWP
Holding, Inc., ("PWP Holding"), a wholly-owned subsidiary of PaineWebber
Properties Incorporated ("PWPI"). PWPI is a wholly-owned subsidiary of
PaineWebber Incorporated, which is a wholly-owned subsidiary of PaineWebber
Group, Inc. ("PaineWebber").
As part of the fiscal 1994 Settlement Agreement with AHC, the Company retained
AHC as the property manager for all of the Senior Housing Facilities pursuant to
the terms of a management agreement. As discussed further in Note 8, the
management agreement with AHC was terminated in July 1996. Subsequent to the
effective date of the Settlement Agreement with AHC, management investigated and
evaluated the available options for structuring the ownership of the properties
in order to maximize the potential returns to the existing shareholders while
maintaining the Company's qualification as a REIT under the Internal Revenue
Code. On September 12, 1994, ILM II formed a new subsidiary, ILM II Lease
Corporation, for the purpose of operating the Senior Housing Facilities. The
Senior Housing Facilities were leased to ILM II Lease Corporation effective
September 1, 1995 (see Note 7 for a description of the master lease agreement).
ILM II Lease Corporation is a public company subject to the reporting
obligations of the Securities and Exchange Commission.
F-24
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
2. Use of Estimates and Summary of Significant Accounting Policies
The accompanying financial statements have been prepared on the accrual basis of
accounting in accordance with generally accepted accounting principles which
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities as of August 31, 1996 and 1995 and revenues and expenses for the
years ended August 31, 1996, the two-month period ended August 31, 1995, and the
year ended June 30, 1995. Actual results could differ from the estimates and
assumptions used.
In 1995, in connection with the restructuring of property ownership described
above, the Company changed its fiscal year end from June 30 to August 31.
The Company's significant accounting policies are summarized as follows:
A. BASIS OF PRESENTATION
The operating cycle in the real estate industry is longer than one year
and the distinction between current and non-current is of little
relevance. Accordingly, the accompanying balance sheets are presented in
an unclassified format. The Company includes its interest in the Villa
Santa Barbara property on a proportional basis in the accompanying
financial statements due to its joint tenancy agreement and 75% interest
in the property.
B. INCOME TAXES
For purposes of filing federal tax returns, the financial statements of
the Company are consolidated with those of ILM II. The Company has
incurred losses for tax purposes since inception. Neither ILM II no the
Company is likely to be able to use these losses to offset future tax
liabilities. Accordingly, no income tax benefit is reflected in these
financial statements.
C. CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents, include
all highly liquid investments with original maturities of 90 days or
less.
D. FAIR VALUE DISCLOSURES
FASB Statement No. 107, "Disclosures about Fair Value of Financial
Instruments" ("SFAS 107"), requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance
sheet, for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. SFAS 107
excludes certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate fair value
amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported on the balance
sheet for cash and cash equivalents approximates its fair value due to
the short-term notice of such instruments.
Accounts receivable - related party: The carrying amount reported on the
balance sheet for accounts receivable - related party approximates its
fair value due to the short-term notice of such instrument.
F-25
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
2. Use of Estimates and Summary of Significant Accounting Policies (continued)
Accounts payable - related party: The carrying amount reported on the
balance sheet for accounts payable - related party approximates its fair
value due to the short-term notice of such instruments.
Mortgages payable: Due to the unique nature of the debt arrangement as
described in Note 5, management is unable to determine the fair value of
mortgages payable without incurring excessive costs.
E. OPERATING INVESTMENT PROPERTIES
Operating investment properties are carried at the lower of cost,
reduced by accumulated depreciation, or net realizable value. The net
realizable value of a property held for long-term investment purposes is
measured by the recoverability of the owner's investment through
expected future cash flows on an undiscounted basis, which may exceed
the property's current market value. The net realizable value of a
property held for sale approximates its current market value, as
determined on a discounted basis. None of the operating investment
properties were held for sale as of August 31, 1996 or 1995.
Depreciation expense is provided on a straight-line basis using an
estimated useful life of 40 years for the buildings and improvements and
5 years for the furniture, fixtures and equipment.
The Company reviews the carrying value of a long-lived asset if facts
and circumstances suggest that it may be impaired or that the
amortization period may need to be changed. The company considers
external factors relating to the long-lived asset, including occupancy
trends, local market developments, changes in payments, and other
publicly available information. If these external factors indicate the
long-lived asset will not be recoverable, based upon undiscounted cash
flows of the long-lived asset over its remaining life, the carrying
value of the long-lived asset will be reduced by the estimated shortfall
of discounted cash flows. The Company does not believe there are any
indicators that would require an adjustment to the carrying value of its
long-lived assets or their remaining useful lives as of August 31, 1996.
F. RENTAL REVENUES
In fiscal year 1995, rental income consisted of payments due on the
individual tenant leases at the Senior Housing Facilities. Units at the
Senior Housing Facilities are generally rented for terms of twelve
months or less. The base rent charged varies depending on the unit size,
with added fees collected for more than one occupant per unit and for
assisted living services. Included in the amount of base rent charged
are certain meals, housekeeping, medical and social services provided to
the residents of each Facility. In fiscal 1996, rental revenues consist
of payments due from LIM II Lease Corporation under the terms of the
master lease described in Note 7. Base rental income under the master
lease is recognized on a straight-line basis over the term of the lease.
Deferred rent receivable on the balance sheet as of August 31, 1996
represents the difference between rental income on a straight-line basis
and rental income received under the terms of the master lease.
G. NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board issued Statement No. 128,
Earnings per Share, and Statement No. 130, Reporting Comprehensive
Income and Statement No. 131, Disclosures about Segments of an
Enterprise and Related Information, all effective for fiscal 1998.
Statement No. 128 requires changes to the calculation of earnings per
share. Statement No. 130 requires reporting and display of comprehensive
income and its components in the financial statements. Statement No. 131
requires reporting about operating segments and other disclosures about
the business in its annual and interim financial statements. The Company
does not believe adoption of these new Statements will have a material
impact on its financial statements.
F-26
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
3. The Advisory Agreement and Related Party Transactions
Subject to the supervision of ILM II's Board of Directors, the business of ILM
II and the Company is managed by PaineWebber ILM Advisor, L.P. (the "Advisor"),
a limited partnership comprised of ILM REIT Advisor, Inc., a Virginia
corporation, and Properties Associates, L.P. ("PA"), a Virginia limited
partnership. ILM REIT Advisor, Inc., is a wholly-owned subsidiary of PaineWebber
Properties Incorporated ("PWPI"). In addition, the limited partners and holders
of assignee interest of PA are, or have been, officers of PWPI. PWPI is a
wholly-owned subsidiary of PaineWebber Incorporated ("PWI"). PWI is a
wholly-owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The Advisor
and its affiliates receive fees and compensation determined on an agreed-upon
basis, in consideration of various services performed in connection with the
sale of the shares, the management of ILM II and the acquisition, management and
disposition of ILM II's investments.
Management advisory fees for the two-month period ended August 31, 1995 and the
year ended June 30, 1995 were earned by an affiliate of PWPI for its
administration and supervision of the day-to-day operations of the Company. Such
fees were equal to 0.5% of the Gross Operating Revenues of the Senior Housing
Facilities. These management advisory fees were no longer charged to the Company
effective September 1, 1995, upon the commencement of the master lease described
in Note 7. Accounts payable - related party at August 31, 1995, represents the
Company's outstanding liability for these fees at that date.
Accounts receivable - related party at August 31, 1996, represents advances in
the amount of $225,000 made to ILM II Lease Corporation (see Note 7) primarily
for the purchase of personal property to operate the Senior Housing Facilities.
4. Operating Properties
Descriptions of the Company's operating properties are summarized below:
The Palms, Fort Myers, Florida
In July 1990, ILM II acquired a loan with respect to an existing
204-unit Senior Housing Facility known as The Palms, located in Fort
Myers, Florida. Construction of the Senior Housing Facility, which was
99% leased as of August 31, 1996, was completed in October 1988.
Crown Villa, Omaha, Nebraska
In April 1991, ILM II acquired a loan with respect to a recently
completed 73-unit Senior Housing Facility known as Crown Villa, located
in Omaha, Nebraska. Construction of the Senior Housing Facility, was
completed in January 1992. As of August 31, 1996, the project was 99%
leased.
Overland Park Place, Overland Park, Kansas
In April 1992, ILM II acquired a loan with respect to an existing
137-unit Senior Housing Facility known as Overland Park Place, located
in Overland Park, Kansas. Construction of the Senior Housing Facility,
was completed in June 1984. As of August 31, 1996, the project was 91%
leased.
Rio Las Palmas, Stockton, California
In May 1992, ILM II acquired a loan with respect to an existing 162-unit
Senior Housing Facility known as Rio Las Palmas, located in Stockton,
California. Construction of the Senior Housing Facility was completed in
June 1985. As of August 31, 1996, the project was 40% leased.
F-27
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
4. Operating Properties (continued)
The Villa at Riverwood, St. Louis County, Missouri
In May 1992, ILM II acquired a loan with respect to an existing 119-unit
Senior Housing Facility known as The Villa at Riverwood, located in St.
Louis Country, Missouri. Construction of the Senior Housing Facility,
was completed in June 1985. As of August 31, 1996, the project was 94%
leased.
Villa Santa Barbara, Santa Barbara, California
In July 1992, ILM II acquired a loan with respect to an existing
123-unit Senior Housing Facility known as Villa Santa Barbara, located
in Santa Barbara, California. The acquisition and improvement of the
facility was financed by the aforementioned loan and another loan from
an affiliated company, PaineWebber Independent Living Mortgage Fund,
Inc. (ILM). Any amounts due from Angeles Housing with regard to the
mortgage loans on the Santa Barbara property will be equitably
apportioned between ILM II and ILM (generally 75% to ILM II and 25% to
ILM). ILM II and ILM have entered into an Intercreditor Agreement to set
forth their respective rights and entitlements under the loan documents.
Construction of the Senior Housing Facility was completed in 1979. As of
August 31, 1996, the project was 81% leased. During the first quarter of
fiscal 1994, ILM II committed to release a portion of the funds set
aside for capital improvements at Villa Santa Barbara in order to
improve the marketability of the property. With the formal execution of
the Settlement Agreement completed, the planned improvement program is
now moving forward toward completion. ILM II's financing of such a
program is expected to total approximately $1 million, which it will
fund from available uninvested offering proceeds.
5. Mortgage Loans
The Company's operating properties were acquired subject to the participating
mortgage loans payable to ILM II. The principal balance of each loan was
modified to reflect the estimated fair value of the related operating property
as of the date of the Tansfers. The modified Loans require interest-only
payments on a monthly basis at a rate of 7% from April 1, 1994 through December
31, 1994, 9% for the period January 1 through December 31, 1995, 11% for the
period January 1 through December 31, 1996, 12% for the period January 1 through
December 31, 1997, 13% for the period January 1 through December 31, 1998, 13.5%
for the period January 1 through December 31, 1999 and 14% for the period
January 1, 2000 through maturity, on December 31, 2000.
F-28
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
5. Mortgage Loans (continued)
The following loans were outstanding at August 31, 1996 and 1995.
August 31,
Property Pledged as Collateral 1996 1995 Date of Loan
- ----------------------------------- --------- ---------- ------------
The Palms $8,700,00 $8,700,000 7/18/90
Fort Myers, FL
Crown Villa 4,950,000 4,950,000 4/25/91
Omaha, NE
Overland Park Place 7,850,000 7,850,000 4/9/92
Overland Park, KS
Rio Las Palmas 5,700,000 5,700,000 5/14/92
Stockton, CA
The Villa at Riverwood 5,858,000 5,850,000 5/29/92
St. Louis County, MO
Villa Santa Barbara 5,094,000 4,774,000 7/13/92
Santa Barbara, CA
$38,144,000 $37,824,000
Less discount (4,138,000) (4,138,000)
---------- -----------
$34,006,000 $33,686,000
=========== ===========
A discount was recorded on the long-term debt in the amount by which the
modified principal amount of the loans exceeded the historical cost basis of the
properties at the time of the Transfers.
6. Shareholders' Equity
The Company has issued 100 shares of Series A Preferred Stock to ILM II in
return for a capital contribution in the amount of $495,000. The holders of the
Series A Preferred Stock are entitled to one vote for each share of Preferred
Stock held. In addition, the holders of the Series A Preferred Stock are
entitled to receive, when and if declared by the Board of Directors, dividends
and distributions in an amount per share equal to the product of 0.1 and 99% of
the total amount of dividends and distributions made to all shareholders. The
Company has also issued 10,000 shares of common stock to PWP Holding in return
for a capital contribution in the amount of $5,000. The holders of the common
stock are entitled to one vote for each share of common stock held. The holders
of the common Stock are entitled to receive, when and if declared by the Board
of Directors, dividends and distributions in an amount per share equal to the
product of 0.001 and 1% of the total amount of dividends and distributions made
to all shareholders.
7. Lease Arrangements
Beginning September 1, 1995, the Senior Housing Facilities were leased to ILM II
Lease Corporation under a master lease agreement. The master lease agreement, is
initially between the Company, as owner of the properties and Lessor and ILM II
Lease Corporation as Lessee. The master lease is a "triple-net" lease whereby
the Lessee pays all operating, expenses, governmental taxes and assessments,
utility charges and insurance premiums, as well as the costs of all required
maintenance, personal property and non-structural repairs in connection with the
operation of the Senior Housing Facilities. The Company, as the Lessor, is
responsible for all major capital improvements and structural repairs to the
Senior Housing Facilities. During the initial term of the master lease, which
expires on
F-29
<PAGE>
ILM II HOLDING, INC.
Notes to Consolidated Financial Statements (continued)
7. Lease Arrangements (continued)
December 31, 2000 (December 31, 1999 with respect to the Santa Barbara
property), 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 lease commencement date) and $4,035,600 for
calendar year 1996 and each subsequent year. Beginning in January 1997, and for
the remainder of the lease term, ILM I Lease Corporation will also be obligated
to pay variable rent for each Senior Housing Facility. Such variable rent will
be payable quarterly and will equal 40% of the excess, if any, of the aggregate
total revenues for the Senior Housing Facilities, on an annualized basis, over
$13,021,000.
A condensed balance sheet as of August 31, 1996, and summary of operations for
the year then ended of ILM II Lease Corporation are as follows:
Assets
Current assets $ 1,714
Furniture, fixtures and equipment 183
Other assets 38
--------
$ 1,935
========
Current liabilities $ 1,045
Other non-current liabilities 131
Shareholders' equity 759
--------
$ 1,935
========
Summary of Operations
Revenues $13,201
Operating expenses 8,764
Master lease expense 4,004
Income tax expense 173
-------
Net income $ 260
=======
8. Legal Proceedings and Contingencies
Angeles Corporation Litigation
Angeles had guaranteed certain of the obligations of AHC under the terms of the
Exclusivity Agreement described in Note 1. Under the terms of the Settlement
Agreement discussed in Note 1, ILM II retained a general unsecured claim against
Angeles in the amount of $1,200,658 as part of the bankruptcy proceedings, but
waived all other claims against Angeles, including any amounts of base and
additional interest owed. In addition, ILM II maintained a claim for
approximately $408,000 against an affiliate of Angeles which had made a separate
guaranty to ILM II. On March 17, 1995, the Bankruptcy Court handling the Angeles
bankruptcy proceedings approved a final settlement of ILM II's outstanding
claims against Angeles and its affiliates. Pursuant to the terms of this
settlement, ILM II received a cash payment of $1 million on April 14, 1995, in
full satisfaction of the claims, which totaled approximately $1.6 million. This
amount, net of certain related legal expenses, was recorded as a reduction in
the carrying values of ILM II's operating investment properties.
F-30
<PAGE>
Schedule III - Real Estate and Accumulated Depreciation
ILM II SENIOR LIVING, INC. AND SUBSIDIARY
SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION
August 31, 1997
(Amounts in thousands)
<TABLE>
<CAPTION>
Costs Capitalized
Initial Cost to (Removed
The Company (2) Subsequen to)
---------------------- Acquisition of
Buildings & Buildings &
Description Encumbrances (1) Land Improvements Improvements (3)
- ------------------ --------------- ---- ------------ ----------------
<S> <C> <C> <C> <C>
CONGREGATE CARE FACILITIES:
Fort Myers, FL $ 8,700 $1,075 $11,233 $(3,268)
Omaha, NE 4,950 400 5,043 (1,054)
Overland Park, KS 7,850 672 6,787 22
Stockton, CA 5,700 1,507 5,628 (443)
St. Louis County, 5,850 292 4,488 74
MO
Santa Barbara, CA 5,094 1,160 4,322 (197)
------- ------ -------- --------
$38,144 $5,106 $37,501 $(4,866)
======= ====== ======== ========
</TABLE>
<TABLE>
<CAPTION>
Life on
Which
Gross Amount at Which Carried Depreciation
at End of Year in Latest
------------------------------ Income
Buildings & Accumulated Date of Date Statement
Description Land Improvements Total Depreciation Construction Acquired is Computed
- ----------------- ---- ------------ ----- ------------ ------------ -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
CONGREGATE CARE FACILITIES:
Fort Myers, FL $1,058 $ 8,002 $ 9,060 $(2,135) 1988 7/18/90 5-40 yrs.
Omaha, NE 390 4,002 4,392 (888) 1992 4/25/91 5-40 yrs.
Overland Park, KS 656 6,898 7,554 (1,371) 1984 4/9/92 5-40 yrs.
Stockton, CA 1,496 5,241 6,737 (1,124) 1988 5/14/92 5-40 yrs.
St. Louis County, 280 4,585 4,865 (967) 1985 5/29/92 5-40 yrs.
MO
Santa Barbara, CA 1,150 4,188 5,338 (795) 1979 7/13/92 5-40 yrs.
------ ------- ------- --------
$5,030 $32,916 $37,946 $(7,280)
====== ======= ======= ========
</TABLE>
(1) Encumbrances represent first mortgage loans between ILM II Holding, as
mortgagor, and the Company, as mortgagee. Such loans are eliminated in
consolidation in the accompanying consolidated financial statements (see
Note 4).
(2) Initial cost to the Company represents the aggregate advances made by the
Company on the loans secured by the facilities which were made to AHC
prior to the default and foreclosure actions described in Notes 1 and 4 to
the Consolidated Financial Statements.
(3) Costs removed subsequent to acquisition reflect the guaranty payments
received by the Company from AHC under the terms on the Exclusivity
Agreement as discussed further in Notes 1 and 4 to the consolidated
financial statements.
(4) The aggregate cost of real estate owned at August 31, 1997 for federal
income tax purposes is approximately $39,077,000.
F-31
<PAGE>
Schedule III - Real Estate and Accumulated Depreciation
ILM II SENIOR LIVING, INC. AND SUBSIDIARY
SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION (continued)
August 31, 1997
(Amounts in thousands)
(5) Reconciliation of real estate owned:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Balance at beginning of period $ 37,741 $ 37,638 $ 37,247
Acquisitions and improvements - 12 months ended 8/31/97 205 - -
Acquisitions and improvements - 12 months ended 8/31/96 - 103 -
Acquisitions and improvements - 12 months ended 6/30/95 - - 1,200
Improvements - 2 months ended 8/31/95 - - 139
Net proceeds from full satisfaction
of claims against Angeles Corporation -
and affiliates - - (948)
--------- --------- ----------
Balance at end of period $ 37,946 $ 37,741 $ 37,638
========= ========= =========
(6) Reconciliation of accumulated depreciation:
Balance at beginning of period $ 6,005 $ 4,736 $ 3,233
Depreciation expense - 12 months ended 8/31/97 1,274 - -
Depreciation expense - 12 months ended 8/31/96 - 1,269 -
Depreciation expense - 12 months ended 6/30/95 - - 1,307
Depreciation expense - 2 months ended 8/31/95 - - 196
---------- ---------- ----------
Balance at end of period $ 7,280 $ 6,005 $ 4,736
========== ========== ==========
</TABLE>
F-32
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-END> AUG-31-1997
<CASH> 2,361
<SECURITIES> 0
<RECEIVABLES> 251
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,689
<PP&E> 37,946
<DEPRECIATION> 7,280
<TOTAL-ASSETS> 33,355
<CURRENT-LIABILITIES> 352
<BONDS> 0
0
116
<COMMON> 52
<OTHER-SE> 32,835
<TOTAL-LIABILITY-AND-EQUITY> 33,355
<SALES> 4,416
<TOTAL-REVENUES> 4,515
<CGS> 0
<TOTAL-COSTS> 2,331
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,184
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,184
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,184
<EPS-PRIMARY> .42
<EPS-DILUTED> .42
<FN>
This schedule contains summary financial information extracted from the
consolidated balance sheet as of August 31, 1997, and the consolidated statement
of income for the year ended August 31, 1997.
</FN>
</TABLE>
