UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended February 28, 1997
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to .
Commission File Number : 0-25878
ILM I LEASE CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 04-3248637
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
265 Franklin Street, Boston, MA 02110
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 225-1174
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X . No .
----
Shares on common stock outstanding as of February 28, 1997: 7,519,430. The
aggregate sales price of the shares sold was $700,000. This does not reflect
market value. There is no current market for these shares.
<PAGE>
ILM I LEASE CORPORATION
BALANCE SHEET
February 28, 1997 and August 31, 1996 (Unaudited)
(In thousands)
ASSETS
February 28 August 31
----------- ---------
Cash and cash equivalents $ 2,003 $ 2,185
Accounts receivable 46 77
Prepaid expenses and other assets 115 267
-------- --------
Total current assets 2,164 2,529
Furniture, fixtures and equipment 385 261
Less: accumulated depreciation (42) (19)
-------- ---------
343 242
Deferred tax asset, net 8 26
-------- --------
$ 2,515 $ 2,797
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 470 $ 863
Real estate taxes payable 359 300
Accounts payable - affiliates 292 445
Security deposits 5 5
-------- --------
Total current liabilities 1,126 1,613
Deferred rent payable 104 123
-------- --------
Total liabilities 1,230 1,736
Shareholders' equity 1,285 1,061
-------- --------
$ 2,515 $ 2,797
======== ========
See accompanying notes.
<PAGE>
ILM I LEASE CORPORATION
STATEMENTS OF INCOME
For the three and six months ended February 28, 1997 and February 29, 1996
(Unaudited)
(In thousands, except per share amounts)
Three Months Ended Six Months Ended
February 28/29, February 28/29,
1997 1996 1997 1996
---- ---- ---- ----
Revenues:
Rental and other income $ 4,426 $ 4,311 $ 8,826 $ 8,540
Interest income 16 18 38 25
------- -------- ------- --------
4,442 4,329 8,864 8,565
Expenses:
Master lease rent expense 1,653 1,582 3,235 3,164
Dietary salaries, wages
and food service expenses 822 792 1,651 1,529
Administrative salaries, wages
and expenses 310 301 596 554
Marketing salaries, wages
and expenses 230 209 437 433
Utilities 226 223 429 414
Repairs and maintenance 160 173 312 316
Real estate taxes 209 201 423 400
Property management fees 208 237 415 470
Other property operating expenses 388 386 758 707
General and administrative 146 24 177 54
Advisory fees 22 21 44 42
Depreciation expense 14 - 23 -
------- ------- ------- -------
4,388 4,149 8,500 8,083
------- ------- ------- -------
Income before taxes 54 180 364 482
Income tax expense (benefit):
Current 6 78 121 238
Deferred 10 (6) 19 (45)
------- ------- ------- -------
16 72 140 193
------- ------- ------- -------
Net income $ 38 $ 108 $ 224 $ 289
======= ======= ======= =======
Earnings per share of
common stock $0.01 $0.01 $0.03 $0.04
===== ===== ===== =====
The above earnings per share of common stock is based upon the 7,519,430 shares
outstanding for each period.
See accompanying notes.
<PAGE>
ILM I LEASE CORPORATION
STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended February 28, 1997 and February 29, 1996 (Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Common Stock Additional
$.01 Par Value Paid-in Accumulated
Shares Amount Capital Earnings Total
------ ------ ------- -------- -----
<S> <C> <C> <C> <C> <C>
Balance at August 31, 1995 15 $ - $ 1 $ (1) $ -
Issuance of common stock 7,504 75 624 - 699
Net income - - - 289 289
----- ------- ------ ------ -------
Balance at February 29, 1996 7,519 $ 75 $ 625 $ 288 $ 988
===== ======= ======= ======= =======
Balance at August 31, 1996 7,519 $ 75 $ 625 $ 361 $ 1,061
Net income - - - 224 224
----- ------- ------ ------- -------
Balance at February 28, 1997 7,519 $ 75 $ 625 $ 585 $ 1,285
====== ======= ======= ======= =======
</TABLE>
See accompanying notes.
<PAGE>
ILM I LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the six months ended February 28, 1997 and February 29, 1996 (Unaudited)
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
1997 1996
---- ----
Cash flows from operating activities:
Net income $ 224 $ 289
Adjustments to reconcile net income to
net cash (used in) provided by operating activities
Depreciation expense 23 -
Changes in assets and liabilities:
Accounts receivable 31 (35)
Prepaid expenses and other assets 152 (13)
Deferred tax asset, net 18 45
Accounts payable and accrued expenses (394) 461
Accounts payable - affiliates (152) 21
Real estate taxes payable 59 229
Deferred rent payable (19) 141
Income taxes payable - 193
------- -------
Total adjustments (282) 1,042
------- -------
Net cash (used in) provided by
operating activities (58) 1,331
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (124) -
------- --------
Net cash used in investing activities (124) -
Cash flows from financing activities:
Proceeds from issuance of common stock - 699
------- -------
Net cash provided by financing activities - 699
-------- -------
Net (decrease) increase in cash and cash equivalents (182) 2,030
Cash and cash equivalents, beginning of period 2,185 -
-------- -------
Cash and cash equivalents, end of period $ 2,003 $ 2,030
======== =======
Supplemental disclosure:
Cash paid during the period for income taxes $ 110 $ -
======== =======
See accompanying notes.
<PAGE>
ILM I LEASE CORPORATION
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. General
The accompanying financial statements, footnotes and discussions should be
read in conjunction with the financial statements and footnotes contained in
the Company's Annual Report for the year ended August 31, 1996. In the
opinion of management, the accompanying financial statements, which have not
been audited, reflect all adjustments necessary to present fairly the results
for the interim period. All of the accounting adjustments reflected in the
accompanying interim financial statements are of a normal recurring nature.
The accompanying financial statements have been prepared on the accrual
basis of accounting in accordance with generally accepted accounting
principles which requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of February 28, 1997 and August 31, 1996
and revenues and expenses for each of the three and six-month periods ended
February 28, 1997 and February 29, 1996. Actual results could differ from the
estimates and assumptions used.
The Company was formed by PaineWebber Independent Living Mortgage Fund,
Inc. ("ILM") to operate eight rental housing projects for independent senior
citizens ("the Senior Housing Facilities") under a master lease arrangement.
ILM has elected to be taxed as a Real Estate Investment Trust ("REIT") under
the Internal Revenue Code of 1986, as amended ("the Code"), for each taxable
year of operations. In order to maintain its status as a REIT, 75% of ILM's
annual gross income must be Qualified Rental Income as defined by the Code.
The rent paid by the residents of the Facilities likely would not be deemed
to be Qualified Rental Income because of the extent of services provided to
residents. Consequently, the operation of the Facilities by ILM or its
subsidiaries over an extended period of time could adversely affect ILM's
status as a REIT. Therefore, ILM formed the Company to operate the Senior
Housing Facilities, and by means of a distribution, transferred the ownership
of the common stock of the Company to the holders of ILM common stock on
September 1, 1995. Because the Company, which is taxed as a regular C
corporation, is no longer a subsidiary of ILM, it can receive service-related
income without endangering the REIT status of ILM.
At a meeting of the ILM Board on January 10, 1997, the Advisor
recommended the immediate sale of the senior housing facilities held by ILM
and an affiliated entity, PaineWebber Independent Living Mortgage Inc. II
("ILM2"), by means of a controlled auction to be conducted by PaineWebber, at
no additional compensation, with PaineWebber offering to purchase the
properties for a specified price, thereby guaranteeing the shareholders a
"floor" price. The Advisor also stated that if PaineWebber purchased the
properties at the specified price and were then able to resell the properties
at a higher price, PaineWebber would pay any "excess profits" to the
shareholders. To assist the Company and ILM in evaluating the Advisor's
proposal, a disinterested, independent investment banker with expertise in
healthcare REITs and independent/assisted living financings was engaged.
Following a comprehensive analysis, the investment banker recommended that
ILM decline the Advisor's proposal and instead investigate expansion and
restructuring alternatives. The Company and ILM are presently analyzing the
Advisor's proposal and the recommendations and other information provided by
the independent investment banker.
In addition, the Company and ILM are reviewing various restructuring
alternatives. The Company and ILM are analyzing a merger of ILM with ILM
Holding and are also considering possibly merging ILM with ILM2 and the
Company with ILM II Lease Corporation. In addition, ILM is exploring listing
its shares on an exchange or, alternatively, having them trade through
NASDAQ. The Company has not fully evaluated any of these alternatives and is
not in a position at this time to recommend any actions to the shareholders.
There can be no assurance that the Company will recommend taking any of such
actions.
<PAGE>
2. The Master Lease Agreement
The Company's sole business is the operation of the Senior Housing
Facilities. The Company has leased the Senior Housing Facilities from ILM
Holding, Inc. ("ILM Holding"), a majority-owned and consolidated subsidiary
of ILM which currently holds title to the Facilities, pursuant to a master
lease which commenced on September 1, 1995 and expires on December 31, 1999.
The Company has entered into a property management agreement with Capital
Senior Management 2, Inc. of Dallas, Texas ("Capital") to handle the
day-to-day operations of the Senior Housing Facilities. The management
contract with Capital was executed in July 1996. In November 1996, Lawrence
A. Cohen, a Director of the Company and President, Chief Executive Officer
and Director of ILM, also became Vice Chairman and Chief Financial Officer of
Capital Senior Living Corporation, an affiliate of Capital. As a result, the
management contract with Capital is considered a related party transaction
(see Note 3).
Descriptions of the properties covered by the master lease between the
Company and ILM Holding are summarized as follows:
<TABLE>
Rentable Date of
Name Location Units (1) Construction (2)
---- -------- --------- ----------------
<S> <C> <C> <C>
Independence Village of East Lansing East Lansing, MI 159 May 1989
Independence Village of Winston-Salem Winston-Salem, NC 156 February 1989
Independence Village of Raleigh Raleigh, NC 163 March 1991
Independence Village of Peoria Peoria, IL 164 November 1990
Crown Pointe Apartments Omaha, NE 133 August 1985
Sedgwick Plaza Apartments Wichita, KS 150 May 1985
West Shores Hot Springs, AR 134 June 1987
Villa Santa Barbara (3) Santa Barbara, CA 123 June 1979
</TABLE>
(1)Represents rentable units as of April 1, 1994, the effective date of
the transfer of ownership to ILM Holding. Rentable units exclude
manager units, assistant manager units and other units converted to
non-rental usage. These unit counts will be updated upon the completion
of the new property management team's current program of placing
non-rental units back into service.
(2) Date initial construction was completed.
(3)The Company operates Villa Santa Barbara under a co-tenancy arrangement
with an affiliated company, ILM II Lease Corporation. The Company has
entered into an agreement with ILM II Lease Corporation regarding such
joint tenancy. ILM II Lease Corporation was formed for similar purposes
as the Company by an affiliated REIT, PaineWebber Independent Living
Mortgage Inc. II, whose subsidiary owns a portion of the Villa Santa
Barbara property. The portion of the Facility leased by the Company
represents 25% of the total project.
Terms of the Master Lease Agreement
-----------------------------------
During the term of the master lease, the Company is obligated to pay
annual base rent ("Base Rent") for the Facilities. For calendar year 1995,
the annual Base Rent was $5,886,000 (prorated according to the date of
commencement of the master lease), allocated as follows: $896,156 for the
Michigan Facility, $566,914 for the Winston-Salem, North Carolina Facility,
$1,017,659 for the Raleigh, North Carolina Facility, $892,600 for the
Illinois Facility, $893,918 for the Nebraska Facility, $855,702 for the
Kansas Facility, $623,984 for the Arkansas Facility, and $139,067 for the
California Facility. For calendar year 1996 and subsequent years, the annual
Base Rent will be $6,364,800, allocated as follows: $969,054 for the Michigan
Facility, $613,030 for the Winston-Salem, North Carolina Facility, $1,100,441
for the Raleigh, North Carolina Facility, $965,209 for the Illinois Facility,
$966,634 for the Nebraska Facility, $925,310 for the Kansas Facility,
$674,742 for the Arkansas Facility, and $150,380 for the California Facility.
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 ("Additional Rent"). ILM Holding, as the
Lessor, is responsible for major capital improvements and structural repairs
to the Senior Housing Facilities. In addition, beginning in the second
quarter of fiscal 1997 and for the remainder of the lease term, the Company
is also obligated to pay variable rent ("Variable Rent") for each Facility.
Such Variable Rent is payable quarterly and equals 40% of the excess, if any,
of the aggregate total revenues for the Facilities, on an annualized basis,
over $16,996,000. Variable rent amounted to $71,000 for the three months
ended February 28, 1997.
<PAGE>
Under the master lease, the Company's use of the Facilities is limited to
use as a Senior Housing Facility unless the Lessor's consent to some other
use is obtained. The Company has responsibility to obtain and maintain all
licenses, certificates and consents needed to use and operate each Facility,
and to use and maintain each Facility in compliance with all local board of
health and other applicable governmental and insurance regulations. The
Facilities located in Arkansas, California and Kansas are licensed by such
states to provide assisted living services. Also, various health and safety
regulations and standards which are enforced by state and local authorities
apply to the operation of all of the Facilities. Violations of such health
and safety standards could result in fines, penalties, closure of a Facility
or other sanctions.
3. Related Party Transactions
The Advisor receives a base fee in an amount equal to 0.5% of the Gross
Operating Revenues of the Facilities operated by the Company as compensation
for its services. This fee amounted to $44,000 and $42,000 for the six-month
periods ended February 28, 1997 and February 29, 1996, respectively. In
addition, an affiliate of the Advisor is entitled to reimbursement for
expenses incurred in providing certain financial, accounting and investor
communication services to the Company. Included in general and administrative
expenses for the six months ended February 28, 1997 and February 29, 1996 is
$39,000 and $40,000, respectively, representing reimbursements to this
affiliate of the Advisor for providing such services to the Company.
The Company has retained Capital Senior Management 2, Inc. ("Capital") of
Dallas, Texas to be the property manager of the Senior Housing Facilities
pursuant to a Management Agreement which commenced on July 29, 1996. The
initial term of the Management Agreement expires on December 31, 1999, which
coincides with the expiration of the master lease agreement between the
Company and ILM Holding described in Note 2. Under the terms of the
Management Agreement, in the event that the master lease agreement is
extended beyond December 31, 1999, the Management Agreement will be extended
as well, but not beyond July 29, 2001. Effective in November 1996, Lawrence
A. Cohen, a Director of the Company and President, Chief Executive Officer
and Director of ILM, was also named Vice Chairman and Chief Financial Officer
of Capital Senior Living Corporation, an affiliate of Capital. Under the
terms of the Management Agreement, Capital earns a Base Management Fee equal
to 4% of the Gross Operating Revenues of the Senior Housing Facilities, as
defined. Capital is also be eligible to earn an Incentive Management Fee
equal to 25% of the amount by which the average monthly Net Cash Flow of the
Senior Housing Facilities, as defined, for the twelve month period ending on
the last day of each calendar month exceeds a specified Base Amount. Each
August 31, beginning on August 31, 1997, the Base Amount will be increased
based on the percentage increase in the Consumer Price Index. ILM has
guaranteed the payment of all fees due to Capital under the terms of the
Management Agreement. Capital earned total management fees of $415,000 for
the six months ended February 28, 1997.
Accounts payable - affiliates at February 28, 1997 and August 31, 1996
includes advances of $195,000 and $348,000, respectively, received from ILM
Holding, primarily for the purchase of personal property to operate the
Senior Housing Facilities. The remaining balance of accounts payable -
affiliates at February 28, 1997 consists of management fees payable to
Capital of $75,000 and advisory fees payable to the Advisor of $22,000. The
remaining balance of accounts payable - affiliates at August 31, 1996
consists of management fees of $76,000 payable to Capital and advisory fees
payable to the Advisor of $21,000.
4. Contingencies
A management agreement between ILM Holding and Angeles Housing Concepts,
Inc. ("AHC") which covered the management of all eight Senior Housing
Facilities was assigned to the Company effective September 1, 1995. On July
29, 1996, the Company and ILM Holding ("the Companies") terminated the
property management agreement with AHC. The management agreement was
terminated for cause pursuant to the terms of the contract. Simultaneously
with the termination of the management agreement, the Companies, together
with certain affiliated entities, filed suit against AHC in the United States
District Court for the Eastern District of Virginia for breach of contract,
breach of fiduciary duty and fraud. The Company and ILM Holding allege, among
other things, that AHC willfully performed actions specifically in violation
of the management agreement and that such actions caused damages to the
Companies. Due to the termination of the agreement for cause, no termination
fee was paid to AHC. Subsequent to the termination of the management
agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy
Code in its domestic state of California. The filing was challenged by the
Companies, and the Bankruptcy Court dismissed AHC's case effective October
15, 1996. In November 1996, AHC filed an Answer with the Virginia District
Court in response to the litigation initiated by the Companies and a
Counterclaim against ILM Holding. The Counterclaim alleges that the
management agreement was wrongfully terminated for cause and requests damages
which include the payment of a termination fee in the amount of $1,250,000,
payment of management fees pursuant to the contract from August 1, 1996
through October 15, 1996, and recovery of attorney's fees and expenses. ILM
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 the Company fails to perform pursuant to its
contractual obligations. The discovery process is currently underway. The
court initially set a trial date of April 28, 1997 but, at AHC's request,
recently rescheduled the trial for June 23, 1997. The Companies intend to
diligently prosecute the case and to vigorously defend the counterclaims made
by AHC. The eventual outcome of this termination dispute cannot presently be
determined. Accordingly, no provision for any liability which might result
from the outcome of this matter has been recorded in the accompanying
financial statements.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, and others alleging that
the defendants intentionally interfered with AHC's property management
agreement with ILM Holding by inducing ILM Holding to terminate the agreement
(the "California litigation"). The complaint seeks damages of at least
$2,000,000. At a Board meeting on February 26, 1997, the Company's Board of
Directors concluded that since all of Mr. Cohen's actions relating to the
California litigation were taken either on behalf of the Company under the
direction of the Board or as a PaineWebber Properties employee, the Company
or its affiliates should indemnify Mr. Cohen with respect to any expenses
arising from the California litigation, subject to any insurance recoveries
for those expenses. The Company's Board also concluded that, subject to
certain conditions, the Company or its affiliates should advance up to
$20,000 to pay reasonable legal fees and expenses incurred by Capital in the
California litigation. The defendants intend to vigorously defend the claims
made against them in the California litigation. The eventual outcome of this
litigation cannot presently be determined and, accordingly, no provision for
any liability has been recorded in the accompanying financial statements.
5. Federal Income Taxes
The Company is taxable as a regular C corporation and, therefore, its
income is subject to tax at the federal and state levels. The Company reports
on a calendar year for tax purposes. Income taxes at the appropriate
statutory rates have been provided for in the accompanying financial
statements.
Deferred income tax expense (benefit) reflects the net tax effects of
temporary differences between the carrying amounts of assets and liabilities
for financial reporting purposes and the amounts used for income tax
purposes. The Company's deferred tax assets and liabilities as of February
28, 1997 and August 31, 1996 are comprised of the following amounts (in
thousands):
February 28 August 31
----------- ---------
Deferred tax asset - straight-line
rent expense $ 42 $ 49
Deferred tax liability - tax over
book amortization 34 23
------- ------
Net deferred tax asset $ 8 $ 26
======= ======
The components of income tax expense (benefit) for the three and six
months ended February 28, 1997 and February 29, 1996 are as follows (in
thousands):
Three Months Ended Six Months Ended
February 28/29, February 28/29,
------------------- --------------------
1997 1996 1997 1996
---- ---- ---- ----
Current:
Federal $ 4 $ 65 $ 102 $ 202
State 2 13 19 36
-------- -------- ------- ------
Total current 6 78 121 238
-------- -------- ------- ------
Deferred:
Federal 9 (4) 16 (38)
State 1 (2) 3 (7)
-------- -------- ------- ------
Total deferred 10 (6) 19 (45)
-------- -------- ------ ------
$ 16 $ 72 $ 140 $ 193
======= ======== ====== ======
<PAGE>
The reconciliation of income tax computed at U.S. federal statutory rates
to income tax expense for the six months ended February 28, 1997 and February
29, 1996 is as follows (in thousands):
1997 1996
---- ----
Tax at U.S. statutory rates $ 118 34% $ 164 34%
State income taxes, net
of federal tax benefit 22 6% 29 6%
----- --- ------ ---
$ 140 40% $ 193 40%
===== === ====== ===
<PAGE>
ILM I LEASE CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Liquidity and Capital Resources
- -------------------------------
ILM I Lease Corporation (the "Company") was formed by PaineWebber
Independent Living Mortgage Fund, Inc. ("ILM"), a publicly-held, non-traded Real
Estate Investment Trust ("REIT"), for the purpose of operating eight Senior
Housing Facilities under the terms of a master lease agreement. ILM contributed
$700,000 in return for all of the issued and outstanding shares of the Company's
common stock. ILM has elected to be taxed as a REIT under the Internal Revenue
Code of 1986, as amended ("the Code"), for each taxable year of operations. In
order to maintain its status as a REIT, 75% of ILM's annual gross income must be
Qualified Rental Income as defined by the Code. The rent paid by the residents
of the Facilities likely would not be deemed to be Qualified Rental Income
because of the extent of services provided to residents. Consequently, the
operation of the Facilities by ILM or its subsidiaries over an extended period
of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the
Company to operate the Facilities, and by means of a distribution, transferred
the ownership of the common stock of the Company to the holders of ILM common
stock on September 1, 1995. Because the Company, which is taxed as a regular C
corporation, is no longer a subsidiary of ILM, it can receive service-related
income without endangering the REIT status of ILM.
The Company's sole business is the operation of the Senior Housing
Facilities. The Company has leased the Senior Housing Facilities from ILM
Holding, Inc. ("ILM Holding"), a majority-owned and consolidated subsidiary of
ILM which currently holds title to the Facilities, pursuant to a master lease
which commenced on September 1, 1995 and expires on December 31, 1999. The
master lease is a "triple-net" lease whereby the Lessee pays all operating
expenses, governmental taxes and assessments, utility charges and insurance
premiums, as well as the costs of all required maintenance, personal property
and non-structural repairs in connection with the operation of the Senior
Housing Facilities. ILM Holding, as the Lessor, is responsible for major capital
improvements and structural repairs to the Senior Housing Facilities. During the
initial term of the master lease, the Company is obligated to pay annual base
rent for the use of all of the Facilities in the aggregate amount of $5,886,000
for calendar year 1995 (prorated based on the lease commencement date) and
$6,364,800 for calendar year 1996 and each subsequent year. Beginning in the
second quarter of fiscal 1997 and for the remainder of the lease term, the
Company is also obligated to pay variable rent for each Facility. Such variable
rent is payable quarterly and equals 40% of the excess, if any, of the aggregate
total revenues for the Facilities, on an annualized basis, over $16,996,000.
Variable rent amounted to $71,000 for the three months ended February 28, 1997.
On July 29, 1996, the Company and ILM Holding ("the Companies") terminated
the property management agreement with AHC covering the eight Senior Housing
Facilities leased by the Company. The management agreement was terminated for
cause pursuant to the terms of the contract. Simultaneously with the termination
of the management agreement, the Companies, together with certain affiliated
entities, filed suit against AHC in the United States District Court for the
Eastern District of Virginia for breach of contract, breach of fiduciary duty
and fraud. The Company and ILM Holding allege, among other things, that AHC
willfully performed actions specifically in violation of the management
agreement and that such actions caused damages to the Companies. Due to the
termination of the agreement for cause, no termination fee was paid to AHC.
Subsequent to the termination of the management agreement, AHC filed for
protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of
California. The filing was challenged by the Companies, and the Bankruptcy Court
dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed an
Answer with the Virginia District Court in response to the litigation initiated
by the Companies and a Counterclaim against ILM Holding. The Counterclaim
alleges that the management agreement was wrongfully terminated for cause and
requests damages which include the payment of a termination fee in the amount of
$1,250,000, payment of management fees pursuant to the contract from August 1,
1996 through October 15, 1996, and recovery of attorney's fees and expenses. ILM
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 the Company fails to perform pursuant to its contractual obligations.
The discovery process is currently underway. The court initially set a trial
date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for
June 23, 1997. The Companies intend to diligently prosecute the case and to
vigorously defend the counterclaims made by AHC. The eventual outcome of this
termination dispute cannot presently be determined. Accordingly, no provision
for any liability which might result from the outcome of this matter has been
recorded in the accompanying financial statements.
Subsequent to terminating the management agreement with AHC, the Company
retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas to be
the new manager of the Senior Housing Facilities pursuant to a Management
Agreement which commenced on July 29, 1996. The initial term of the Management
Agreement expires on December 31, 1999, which coincides with the expiration of
the master lease agreement between the Company and ILM Holding described above.
Under the terms of the Management Agreement, in the event that the master lease
agreement is extended beyond December 31, 1999, the Management Agreement will be
extended as well, but not beyond July 29, 2001. Effective in November 1996,
Lawrence A. Cohen, a Director of the Company and President, Chief Executive
Officer and Director of ILM, was also named Vice Chairman and Chief Financial
Officer of Capital Senior Living Corporation, an affiliate of Capital. Under the
terms of the Agreement, Capital earns a Base Management Fee equal to 4% of the
Gross Operating Revenues of the Senior Housing Facilities, as defined. Capital
is also eligible to earn an Incentive Management Fee equal to 25% of the amount
by which the average monthly Net Cash Flow of the Senior Housing Facilities, as
defined, for the twelve month period ending on the last day of each calendar
month exceeds a specified Base Amount. Each August 31, beginning on August 31,
1997, the Base Amount will be increased based on the percentage increase in the
Consumer Price Index. ILM has guaranteed the payment of all fees due to Capital
under the terms of the Management Agreement.
On February 4, 1997, AHC filed a Complaint in the Superior Court of the
State of California against Capital, Lawrence Cohen, and others alleging that
the defendants intentionally interfered with AHC's property management agreement
with ILM Holding by inducing ILM Holding to terminate the agreement (the
"California litigation"). The complaint seeks damages of at least $2,000,000. At
a Board meeting on February 26, 1997, the Company's Board of Directors concluded
that since all of Mr. Cohen's actions relating to the California litigation were
taken either on behalf of the Company under the direction of the Board or as a
PaineWebber Properties employee, the Company or its affiliates should indemnify
Mr. Cohen with respect to any expenses arising from the California litigation,
subject to any insurance recoveries for those expenses. The Company's Board also
concluded that, subject to certain conditions, the Company or its affiliates
should advance up to $20,000 to pay reasonable legal fees and expenses incurred
by Capital in the California litigation. The defendants intend to vigorously
defend the claims made against them in the California litigation. The eventual
outcome of this litigation cannot presently be determined and, accordingly, no
provision for any liability has been recorded in the accompanying financial
statements.
The eight properties which the Company leases from ILM Holding averaged
92% occupancy for the quarter ended February 28, 1997. Current annualized
operating income levels are sufficient to cover the base master lease payments
at their current annual level of $6,364,800, which will remain in effect
throughout the remaining term of the lease. As noted above, the master lease
also provides for the payment of variable rent beginning in December 1996. 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. Variable rent amounted to $71,000 for the three months ended
February 28, 1997. Further improvements in operating income levels are expected
upon the successful implementation of several new programs by the new property
management company. At many properties, the management company has increased the
number of rentable units by asking the facility managers to move off site. The
increased rental revenue is expected to more than offset any additional costs of
housing the managers and providing 24-hour coverage at the front desk. The
live-in assistant manager positions at several properties are also being
eliminated, which will increase the number of rentable units. In addition, the
management company is in the process of implementing new marketing plans at
several of the properties and increasing rental rates at properties that have
maintained high occupancy levels and are located in strong markets. Property
improvements to be paid for by the Company during fiscal 1997 include dining
room and lobby refurbishments at the Winston-Salem facility. Fiscal 1997 capital
expenditure plans to be funded by ILM include an ongoing program to replace
air-conditioning units at the Santa Barbara facility and a program to upgrade
the overall appearance of the Sedgwick Plaza property. ILM is also investigating
the potential for future expansions of several of the facilities which are
located in areas that have particularly strong markets for senior housing.
As discussed in the Annual Report, the road adjacent to the Raleigh
facility is being improved, and the county Department of Transportation has
requested a temporary construction easement on the property. Although the
easement does not directly affect the operation of the facility, it has resulted
in the removal of several trees that provided a buffer between the building and
the road. To date, the facility's management team has been able to work with the
Department of Transportation and the local power company to minimize the removal
of trees as the road construction work progresses. Once the road work is
completed, negotiations with the city to secure a settlement that will pay for
any required changes to the property's landscape buffer will be finalized.
At a meeting of the ILM Board on January 10, 1997, the Advisor
recommended the immediate sale of the senior housing facilities held by ILM and
an affiliated entity, PaineWebber Independent Living Mortgage Inc. II ("ILM2"),
by means of a controlled auction to be conducted by PaineWebber, at no
additional compensation, with PaineWebber offering to purchase the properties
for a specified price, thereby guaranteeing the shareholders a "floor" price.
The Advisor also stated that if PaineWebber purchased the properties at the
specified price and were then able to resell the properties at a higher price,
PaineWebber would pay any "excess profits" to the shareholders. To assist the
Company and ILM in evaluating the Advisor's proposal, a disinterested,
independent investment banker with expertise in healthcare REITs and
independent/assisted living financings was engaged. Following a comprehensive
analysis, the investment banker recommended that ILM decline the Advisor's
proposal and instead investigate expansion and restructuring alternatives. The
Company and ILM are presently analyzing the Advisor's proposal and the
recommendations and other information provided by the independent investment
banker.
In addition, the Company and ILM are reviewing various restructuring
alternatives. The Company and ILM are analyzing a merger of ILM with ILM Holding
and are also considering possibly merging ILM with ILM2 and the Company with ILM
II Lease Corporation. In addition, ILM is exploring listing its shares on an
exchange or, alternatively, having them trade through NASDAQ. The Company has
not fully evaluated any of these alternatives and is not in a position at this
time to recommend any actions to its shareholders. There can be no assurance
that the Company will recommend taking any of such actions.
At February 28, 1997, the Company had cash and cash equivalents of
$2,003,000. Such amounts will be used for the Company's working capital
requirements. As noted above, under the terms of the master lease the Lessor is
responsible for major capital improvements and structural repairs to the Senior
Housing Facilities. Consequently, the Company does not have any material
commitments for capital expenditures. Furthermore, the Company does not
currently anticipate the need to engage in any borrowing activities. As a
result, substantially all of the Company's cash flow will be generated from
operating activities. The Company did not pay cash dividends in fiscal 1996. The
Company intends to review this policy during the second half of fiscal 1997 and
may or may not determine to pay cash dividends in the future. Payment of
dividends, if any, will be at the discretion of the Company's Board of Directors
and will depend upon such factors as the Company's financial condition,
earnings, anticipated investments and other relevant factors. The source of
future liquidity is expected to be from operating cash flow from the Senior
Housing Facilities, net of the master lease payments to ILM Holding, and
interest income earned on invested cash reserves. 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.
Results of Operations
Three Months Ended February 28, 1997
- ------------------------------------
The Company's net income decreased by $70,000 for the three months ended
February 28, 1997 when compared to the same period in the prior year. The
decrease in net income is primarily the result of an increase in operating
expenses of $239,000. The increase in operating expenses was mainly due to
increases in master lease rent and general and administrative of $71,000 and
$122,000, respectively. In addition, costs were higher in the areas of dietary
and marketing expenses for the three months ended February 28, 1997. Master
lease rent expense increased due to additional variable rent accrued effective
for the second quarter of fiscal 1997 per the Master Lease Agreement. General
and administrative expenses increased largely due to an increase in legal fees
attributable mainly to the ongoing AHC litigation referred to above. The
increases in operating expenses were partially offset by an increase in rental
income from the Senior Housing Facilities of $115,000. The increase in rental
income is due to a slight increase in the portfolio's average occupancy level
from 90% for the fiscal quarter ended February 1996 to 92% for the fiscal
quarter ended February 1997, as well as increases in rental rates at certain of
the facilities located in strong markets.
Six Months Ended February 28, 1997
- ----------------------------------
The Company's net income decreased by $65,000 for the six months ended
February 28, 1997 when compared to the same period in the prior year. The
decrease in net income is primarily the result of an increase in operating
expenses of $417,000. The increase in operating expenses was mainly due to
higher costs in the areas of dietary, rent and general and administrative
expenses for the six months ended February 28, 1997. Dietary salaries, wages and
food service expense increased by $122,000 primarily due to an improvement in
the portfolio occupancy level compared to the same period in the prior year.
Master lease rent expense increased by $71,000 due to additional variable rent
accrued effective for the second quarter of fiscal 1997 per the Master Lease
Agreement. General and administrative expenses increased by $123,000 largely due
to an increase in legal fees, attributable mainly to the ongoing AHC litigation
referred to above. The increases in operating expenses were partially offset by
an increase in rental income from the Senior Housing Facilities of $286,000. The
increase in rental income is due to a slight increase in the portfolio's average
occupancy level from 89% for the six months ended February 1996 to 92% for the
six months ended February 1997, as well as increases in rental rates at certain
of the facilities located in strong markets.
<PAGE>
PART II
Other Information
Item 1. Legal Proceedings
The status of the litigation involving the Company, ILM Holding, Inc. and
Angeles Housing Concepts, Inc. remains unchanged from what was reported in the
Company's Annual Report on Form 10-K for the year ended August 31, 1996. The
discovery process is currently underway. The court initially set a trial date of
April 28, 1997 but, at AHC's request, recently rescheduled the trial for June
23, 1997.
Item 2. through 5. NONE
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: NONE
(b) Reports on Form 8-K: NONE
<PAGE>
ILM I LEASE CORPORATION
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.
By: ILM LEASE CORPORATION
By: /s/ Timothy J. Medlock
----------------------
Timothy J. Medlock
Treasurer
Dated: April 17, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Partnership's audited financial statements for the six months ended February 28,
1997 and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> AUG-31-1997
<PERIOD-END> FEB-28-1997
<CASH> 2,003
<SECURITIES> 0
<RECEIVABLES> 46
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 2,164
<PP&E> 385
<DEPRECIATION> 42
<TOTAL-ASSETS> 2,515
<CURRENT-LIABILITIES> 1,126
<BONDS> 0
0
0
<COMMON> 700
<OTHER-SE> 585
<TOTAL-LIABILITY-AND-EQUITY> 2,515
<SALES> 0
<TOTAL-REVENUES> 8,864
<CGS> 0
<TOTAL-COSTS> 8,500
<OTHER-EXPENSES> 0
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<INCOME-PRETAX> 364
<INCOME-TAX> 140
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</TABLE>
