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, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from to .
Commission File Number: 0-25880
ILM II LEASE CORPORATION
(Exact name of registrant as specified in its charter)
Virginia 04-3248639
(State of organization) (I.R.S.Employer
Identification No.)
265 Franklin Street, Boston, Massachusetts 02110
- ---------------------------------------------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (800) 342-5797
--------------
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
None None
Securities registered pursuant to Section 12(g) of the Act:
Shares of Common Stock, $.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 required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ______
Shares of common stock outstanding as of August 31, 1996: 5,180,952. The
aggregate sales price of the shares sold was $500,000. This does not reflect
market value. There is no current market for these shares.
DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-K Reference
Registration Statement on Form 10 of registrant Part IV
dated July 20, 1995, as supplemented
Current Report on Form 8-K
of registrant dated July 29, 1996 Part IV
<PAGE>
ILM II LEASE CORPORATION
1996 FORM 10-K
TABLE OF CONTENTS
Part I Page
Item 1 Business I-1
Item 2 Properties I-3
Item 3 Legal Proceedings I-3
Item 4 Submission of Matters to a Vote of Security Holders I-3
Part II
Item 5 Market for the Registrant's Shares and Related
Stockholder Matters II-1
Item 6 Selected Financial Data II-1
Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations II-2
Item 8 Financial Statements and Supplementary Data II-4
Item 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure II-4
Part III
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
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-12
<PAGE>
PART I
Item 1. Business
ILM II Lease Corporation (the "Company") was formed by PaineWebber
Independent Living Mortgage Inc. II ("ILM"), a publicly-held, non-traded Real
Estate Investment Trust ("REIT"), for the purpose of operating six Senior
Housing Facilities under the terms of a master lease agreement. ILM contributed
$500,000 in return for all of the issued and outstanding shares of the Company's
common stock. ILM had originally made mortgage loans secured by the Facilities
to Angeles Housing Concepts, Inc. ("AHC") between July 1990 and July 1992. In
March 1993, AHC defaulted under the terms of such mortgage loans and in
connection with the settlement of such default, title to the Facilities was
transferred, effective April 1, 1994, to certain majority-owned, indirect
subsidiaries of ILM, subject to the mortgage loans. Subsequently, the indirect
subsidiaries of ILM were merged into ILM II Holding, Inc. ("ILM Holding"). As
part of the fiscal 1994 settlement agreement with AHC, AHC was retained as the
property manager for all of the Senior Housing Facilities pursuant to the terms
of a management agreement which was assigned to the Company as of September 1,
1995. As discussed further in Item 7, the management agreement with AHC was
terminated in July 1996.
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. 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. On September 1, 1995, after ILM received the
required regulatory approval, it distributed all of the outstanding shares of
capital stock of the Company to the holders of record of ILM's common stock. One
share of common stock of the Company was issued for each full share of ILM's
common stock held. No fractional shares were issued. Holders of ILM's common
stock were not required to pay any cash or other consideration or to exchange
their common stock of ILM for the common stock of the Company. Prior to the
distribution of the Company's stock, ILM's shareholders received an information
statement fully describing the Company and the distribution of its capital
stock.
The master lease agreement, which commenced on September 1, 1995, is
between ILM Holding, as owner of the properties and Lessor, and the Company, 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 Holding, as the Lessor, is responsible for all
major capital improvements and structural repairs to the Senior Housing
Facilities. ILM Holding, as the Lessor, is responsible for all 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 Company 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, the
Company will also be obligated to pay variable rent for each Facility. Such
variable rent will be payable quarterly and will equal 40% of the excess, if
any, of the aggregate total revenues for the Facilities, on an annualized basis,
over $13,021,000.
The facilities which the Company has leased as of August 31, 1996 are
described below:
Property Name
and Location (1) Type of Property Size
- ---------------- ---------------- ----
The Palms
Fort Myers, FL Senior Housing Facility 204 Units
<PAGE>
Property Name
and Location (1) Type of Property Size
- ---------------- ---------------- ----
Crown Villa
Omaha, NE Senior Housing Facility 73 Units
Overland Park Place
Overland Park, KS Senior Housing Facility 137 Units
Rio Las Palmas
Stockton, CA Senior Housing Facility 162 Units
The Villa at Riverwood
St. Louis County, MO Senior Housing Facility 119 Units
Villa Santa Barbara (2)
Santa Barbara, CA Senior Housing Facility 123 Units
(1) See Notes to the Financial Statements filed with this Annual Report for a
description of the agreements through which the Company has leased these
facilities.
(2) The Santa Barbara facility is jointly leased by the Company and an
affiliated company, ILM I Lease Corporation. The Company and ILM I Lease
Corporation have entered into a joint tenancy agreement which governs the
operation of the property and the apportionment of revenues and expenses
between the parties. Any amounts generated by the operations of the Santa
Barbara property are equitably apportioned between the Company and ILM I
Lease Corporation (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's sole
business is the operation of the Facilities. Therefore, presentation of
information about industry segments is not applicable.
Subject to the supervision of and pursuant to the general policies set by
the Company's Board of Directors, assistance in managing the business of the
Company is provided by PaineWebber Lease Advisor, L.P. (the "Advisor"), a
limited partnership comprised of ILM Lease Advisor, Inc., as the general partner
and Properties Associates, L.P., as the limited partner. ILM Lease Advisor, Inc.
is a wholly owned subsidiary of PaineWebber Properties Incorporated ("PWPI").
The partners of the Advisor are affiliates of PaineWebber Incorporated ("PWI")
and PaineWebber Group, Inc. ("PaineWebber").
There currently are three directors of the Company, none of whom are an
affiliate of the Advisor. 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.
The terms of transactions between the Company and the Advisor and its
affiliates are set forth in Items 11 and 13 below to which reference is hereby
made for a description of such terms and transactions. As discussed further in
Item 7, the Company has retained Capital Senior Management 2, Inc. of Dallas,
Texas ("Capital"), to be the new manager 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, became Vice Chairman and Chief Financial Officer of
Capital Senior Living Corp., an affiliate of Capital. As a result, the
management contract with Capital is considered a related party transaction (see
Item 13).
<PAGE>
Item 2. Properties
As of August 31, 1996, the Company has leased the six operating properties
referred to under Item 1 above to which reference is made for the description,
name and location of such properties.
Occupancy figures for each fiscal quarter during 1996, along with an
average for the year, are presented below for each property:
Percent Leased At
------------------------------------------------
Fiscal
1996
11/30/95 2/29/96 5/31/96 8/31/96 Average
-------- ------- ------- ------- -------
The Palms 99% 100% 99% 99% 99%
Crown Villa 98% 97% 96% 99% 98%
Overland Park Place 98% 95% 91% 91% 94%
Rio Las Palmas 75% 79% 85% 90% 82%
The Villa at Riverwood 95% 95% 93% 94% 94%
Villa Santa Barbara 59% 64% 69% 81% 68%
Item 3. Legal Proceedings
On July 29, 1996, the Company and ILM II Holding, Inc. ("the Companies")
terminated the property management agreement with Angeles Housing Concepts, Inc.
("AHC") covering the six senior housing facilities leased by the Company. The
management agreement was terminated for cause pursuant to Sections 1.05 (a) (i),
(iii) and (iv) of the agreement. Simultaneously with the termination of the
management agreement, the Companies, together with certain affiliated entities,
filed suit against AHC in the United States District Court for the Eastern
District of Virginia for breach of contract, breach of fiduciary duty and fraud.
The Company and ILM Holding allege that AHC willfully performed actions
specifically in violation of the management agreement and that such actions
caused damages to the Companies. Due to the termination of the agreement for
cause, no termination fee was paid to AHC. Subsequent to the termination of the
management agreement, AHC filed for protection under Chapter 11 of the U.S.
Bankruptcy Code in its domestic state of California. The filing was challenged
by the Companies, and the Bankruptcy Court dismissed AHC's case effective
October 15, 1996. In November 1996, AHC filed with the Virginia District Court
an Answer in response to the litigation initiated by the Companies and a
Counterclaim against ILM Holding. The Counterclaim alleges that the management
agreement was wrongfully terminated for cause and requests damages which include
the payment of 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 management agreement could have been
terminated without cause, and recovery of attorney's fees and expenses.
PaineWebber Independent Living Mortgage Inc. II guaranteed the payment of the
termination fee at issue in these proceedings. The Companies intend to
diligently prosecute the case and to vigorously defend the counterclaims made by
AHC. The eventual outcome of this termination dispute cannot presently be
determined.
Item 4. Submission of Matters to a Vote of Security Holders
None.
<PAGE>
PART II
Item 5. Market for the Registrant's Shares and Related Stockholder Matters
Prior to September 1, 1995, the Company was a wholly-owned subsidiary of
ILM. Pursuant to a Reorganization and Distribution Agreement, ILM capitalized
the Company with $500,000, an amount estimated to provide the Company with
necessary working capital. On September 1, 1995, Mavricc Management Systems,
Inc., as the distribution agent, caused to be issued on the stock records of the
Company the distributed Common Stock of the Company, in uncertificated form, to
the holders of record of ILM common stock at the close of business on July 14,
1995. One share of the Company's Common Stock was distributed for each
outstanding share of ILM Common Stock. No certificates or scrip representing
fractional shares of the Company's Common Stock were issued to holders of ILM
common stock as part of the distribution. In lieu of receiving fractional
shares, each holder of ILM common stock who would otherwise have been entitled
to receive a fractional share of the Company's Common Stock received a cash
payment equivalent to $0.14 per share for such fractional interest. At August
31, 1996, there were 3,578 record holders of the Company's shares.
The Company did not pay cash dividends in fiscal 1996. The Company intends
to review this policy during 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.
Item 6. Selected Financial Data
ILM II Lease Corporation
(In thousands, except per share data)
Period from
September 12, 1994
For the year ended (date of inception)
August 31, 1996 through August 31, 1995
--------------- -----------------------
Revenues $13,201 $ -
Income (loss) before income taxes $ 433 $ (1)
Income tax expense $ 173 -
Net income (loss) $ 260 $ (1)
Net income (loss) per share
of common stock $ 0.05 $ (0.07)
Total assets $ 1,935 -
The above selected financial data should be read in conjunction with the
financial statements and related notes appearing elsewhere in this Annual
Report.
The above net income (loss) per share of common stock is based upon the
weighted average number of shares outstanding for the year ended August 31, 1996
and the period September 12, 1994 (inception) through August 31, 1995 (5,180,952
and 15,000, respectively).
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity and Capital Resources
ILM II Lease Corporation (the "Company") was formed by PaineWebber
Independent Living Mortgage Inc. II ("ILM"), a publicly-held, non-traded Real
Estate Investment Trust ("REIT"), for the purpose of operating six Senior
Housing Facilities under the terms of a master lease agreement. ILM contributed
$500,000 in return for all of the issued and outstanding shares of the Company's
common stock. ILM had originally made mortgage loans secured by the Facilities
to Angeles Housing Concepts, Inc. ("AHC") between July 1990 and July 1992. In
March 1993, AHC defaulted under the terms of such mortgage loans and in
connection with the settlement of such default, title to the Facilities was
transferred, effective April 1, 1994, to certain majority-owned, indirect
subsidiaries of ILM, subject to the mortgage loans. Subsequently, these indirect
subsidiaries were merged into ILM II Holding, Inc. ("ILM Holding") which is also
a majority-owned subsidiary of ILM. As part of the fiscal 1994 settlement
agreement with AHC, AHC was retained as the property manager for the Senior
Housing Facilities pursuant to the terms of a management agreement which was
assigned to the Company as of September 1, 1995. As discussed further below, the
management agreement with AHC was terminated in July 1996.
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. 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. On September 1, 1995, after ILM received the
required regulatory approval, it distributed all of the outstanding shares of
capital stock of the Company to the holders of record of ILM's common stock. One
share of common stock of the Company was issued for each full share of ILM's
common stock held. No fractional shares were issued. Holders of ILM's common
stock were not required to pay any cash or other consideration or to exchange
their common stock of ILM for the common stock of the Company. Prior to the
distribution of the Company's stock, ILM's shareholders received an information
statement fully describing the Company and the distribution of its capital
stock.
The master lease agreement, which commenced on September 1, 1995, is
between ILM Holding, as owner of the properties and Lessor, and the Company, 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 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 Company 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, the Company will also be obligated to pay variable rent for
each Facility. Such variable rent will be payable quarterly and will equal 40%
of the excess, if any, of the aggregate total revenues for the Facilities, on an
annualized basis, over $13,021,000.
At the present time, ILM Holding is not expected to have sufficient cash
flow during fiscal 1997 to (i) meet its obligations to make the debt service
payments due under its mortgage loans with ILM, (ii) pay for capital
improvements and structural repairs in accordance with the terms of the master
lease, and (iii) pay for costs that may be incured in defending AHC's
Counterclaim against ILM Holding, as discussed further below. If ILM Holding is
unable to complete its restructuring plans, as described in the information
statement referred to above, due to PWPI's refusal to cause PWP Holding to sell
to ILM its voting stock in ILM Holding, ILM Holding may be unable to perform its
obligations under the master lease.
As noted above, the Company's master lease is scheduled to expire on
December 31, 2000. This period coincides with the end of ILM's expected holding
period for its investments in the Facilities. While such holding period is
subject to change, the current Articles of Incorporation of ILM provide that the
liquidation of ILM must be completed by no later than December 31, 2005. Any
further renewals of the master lease beyond December 2000 would be subject to
negotiation between the Company and ILM and its consolidated affiliate.
Accordingly, since the Company does not have any current plans to operate or own
any other facilities or engage in any other business outside of its relationship
with ILM, there are no assurances that the Company's operations will continue
beyond December 2000.
On July 29, 1996, the Company and ILM Holding ("the Companies") terminated
the property management agreement with AHC covering the six 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 that AHC willfully performed
actions specifically in violation of the management agreement and that such
actions caused damages to the Companies. Due to the termination of the agreement
for cause, no termination fee was paid to AHC. Subsequent to the termination of
the management agreement, AHC filed for protection under Chapter 11 of the U.S.
Bankruptcy Code in its domestic state of California. The filing was challenged
by the Companies, and the Bankruptcy Court dismissed AHC's case effective
October 15, 1996. In November 1996, AHC filed with the Virginia District Court
an Answer in response to the litigation initiated by the Companies and a
Counterclaim against ILM Holding. The Counterclaim alleges that the management
agreement was wrongfully terminated for cause and requests damages which include
the payment of 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 management agreement could have been
terminated without cause, and recovery of attorney's fees and expenses. ILM
guaranteed the payment of the termination fee at issue in these proceedings. The
Companies intend to diligently prosecute the case and to vigorously defend the
counterclaims made by AHC. The eventual outcome of this termination dispute
cannot presently be determined. Accordingly, no provision for any liability
which might result from the 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. 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. ILM has guaranteed the payment of all fees due to
Capital under the terms of the Management Agreement.
The six properties which the Company leases from ILM Holding averaged 93%
occupancy as of August 31, 1996. The Facilities generated sufficient net cash
flow to cover the master lease rental obligation during the initial year of the
Company's operation. In addition, current annualized operating income levels are
sufficient to cover the base master lease payments at their current annualized
level of $4,035,600, 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 January 1997. The Senior Housing Facilities are
currently generating gross revenues which are slightly in excess of the
specified threshold in the variable rent calculation, as discussed further
above. Accordingly, the Company expects that it will owe variable rent payments
to ILM Holding in fiscal 1997. Further improvement in operating income levels is
expected upon the lease-up of the Villa Santa Barbara property. A property
renovation and assisted-living conversion program has been in progress at Villa
Santa Barbara for the past two years. Phase one of the renovations at the Santa
Barbara Facility, which was completed during fiscal 1995, included renovation of
the lobby, dining room, library, activities room, television and game room and
the laundry rooms. Phase two of the renovation program, which was substantially
completed during the first quarter of fiscal 1996, involved interior unit
improvements, hallway upgrades and the conversion of existing studio units to
assisted living units. The total cost of the renovation program was
approximately $1.2 million, which has been funded 75% by ILM and 25% by an
affiliated company, PaineWebber Independent Living Mortgage Fund, Inc., from
funds previously reserved for such improvements. Leasing gains at Santa Barbara
have been slowed by delays in completing the capital improvements and in
obtaining the required regulatory licensing to begin leasing the new assisted
living units. During the quarter ended May 31, 1996, the Company received the
required assisted living licenses. Leasing of the 38 new assisted living units
is now well underway. Overall occupancy of Villa Santa Barbara averaged 81% for
the fourth quarter of fiscal 1996. The Company, together with ILM and its
consolidated affiliate, is currently investigating the potential for expansion
of the assisted living capacities at properties in other markets where demand
for assisted living units is particularly high.
At August 31, 1996, the Company had cash and cash equivalents of
$1,591,000. 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 any major capital improvements or 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 fiscal 1997, subsequent to the
commencement of the variable rent payments discussed further above, 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
1996 Compared to 1995
Prior to the commencement of the master lease agreement on September 1,
1995, the Company had no significant operating activities. As a result, the
comparison of fiscal 1996 results to any prior period is not relevant.
Inflation
The Company completed its first full year of operations in fiscal 1996.
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 tenant
leases at the Senior Housing Facilities. Rental 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.
As noted above, under the terms of the master lease agreement between the
Company and ILM II Holding, Inc., the Company is obligated to pay variable rent,
in addition to the base rent owed, in an amount equal to 40% of the excess of
total revenues from the Facilities over a specified base amount. Accordingly, to
the extent that the total revenues are in excess of this threshold, a portion of
the increase in revenues would be payable to the Lessor.
Item 8. Financial Statements and Supplementary Data
The 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.
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Registrant
There currently are three directors of the Company, none of whom are an
affiliate of the Advisor. 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
---- ------ --- ---------
John B. Watts III President and Director 43 9/13/94 *
Lawrence A. Cohen Director 43 9/13/94 *
Jeffry R. Dwyer Director 50 9/13/94 *
David F. Brooks Vice President and Secretary 54 9/13/94 *
Timothy J. Medlock Treasurer 35 9/13/94 *
Valda M. Webster Kreie Assistant Secretary 45 9/13/94 *
* The date of incorporation of the Company.
(c) ILM Lease Advisor, Inc., the general partner of the Advisor, assists
the directors and officers of the Company in the management and control of
the Company's affairs. ILM Lease Advisor, Inc. is a wholly-owned subsidiary
of PaineWebber Properties Incorporated ("PWPI"). The principal executive
officers of ILM Lease Advisor, Inc. are as follows:
Name Office Age
---- ------ ---
Bruce J. Rubin President and Chief Executive Officer 37
David F. Brooks Vice President and Secretary 54
Timothy J. Medlock Vice President and Treasurer 35
Valda M. Webster Kreie Assistant Secretary 45
(d) There is no family relationship among any of the foregoing directors or
officers. All of the foregoing directors and officers of the Company have been
elected to serve until the Company's next annual meeting.
(e) The business experience of each of the directors and executive
officers of the Company is as follows:
John B. Watts III is President and Director of the Company. He is also
President and Director of ILM I Lease Corporation. Mr. Watts was a Senior
Vice President of PWPI from June 1988 to August 1996. Mr. Watts has had over
17 years of experience in acquisitions, dispositions and finance of real
estate. He received degrees of Bachelor of Architecture, Bachelor of Arts
and Master of Business Administration from the University of Arkansas.
Lawrence A. Cohen is a Director of the Company. Mr. Cohen is also Vice
Chairman and Chief Financial Officer of Capital Senior Living Corp., an
affiliate of Capital Senior Management 2, Inc., which is the company that was
contracted by the Company in July 1996 to perform property management services
for the Senior Housing Facilities. Mr. Cohen joined Capital Senior Living
Corp. in November 1996. Mr. Cohen was President and Chief Executive Officer
of PWPI until August 1996. Mr. Cohen is also a member of the board of
directors of ILM, PaineWebber Independent Living Mortgage Fund, Inc. (ILM1),
ILM I Lease Corporation and Retail Property Investors, Inc. (RPI). 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 is a Director of the Company. Mr. Dwyer is a partner
with the law firm of Akin, Gump, Straus, Hauer & Feld in the District of
Columbia, which he joined in 1993. Prior to joining Akin, Gump, Straus, Hauer
& Feld, Mr. Dwyer was a partner with the law firm of Morrison & Foerster from
1989 to 1993. Immediately prior to joining Morrison & Foerster, Mr. Dwyer was
a partner with the law firm of Lane & Edson. Mr. Dwyer also presently serves
as a director of ILM, ILM1 and ILM I Lease Corporation. Mr. Dwyer has written
several books on real estate financing and 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.
Bruce J. Rubin was named President and Chief Executive Officer of PWPI in
August 1996. Mr. Rubin joined PaineWebber Real Estate Investment Banking in
November 1995 as a Senior Vice President. Prior to joining PaineWebber, Mr.
Rubin was employed by Kidder, Peabody and served as President for KP Realty
Advisers, Inc. Prior to his association with Kidder, Mr. Rubin was a Senior
Vice President and Director of Direct Investments at Smith Barney Shearson.
Prior thereto, Mr. Rubin was a First Vice President and a real estate workout
specialist at Shearson Lehman Brothers. Prior to joining Shearson Lehman
Brothers in 1989, Mr. Rubin practiced law in the Real Estate Group at Willkie
Farr & Gallagher. Mr. Rubin is a graduate of Stanford University and Stanford
Law School.
David F. Brooks is Vice President and Secretary of the Company and First
Vice President and Assistant Treasurer of PWPI which Mr. Brooks joined in March
1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property
Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant
Treasurer of Capital for Real Estate, which provided real estate investment,
asset management and consulting services.
Timothy J. Medlock is Treasurer of the Company and a Vice President and
Treasurer of PWPI which he joined in 1986. From 1986 to August of 1989, Mr.
Medlock served as the Controller. From 1983 to 1986, Mr. Medlock was associated
with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in
1983 and received his Masters in Accounting from New York University in 1985.
Valda M. Webster Kreie is Assistant Secretary of the Company and a Vice
President of PWPI. Ms. Kreie joined PWPI in 1989 as an Assistant Vice
President. From 1981 to 1987, Ms. Kreie was the Contract and Title Attorney
for Santa Fe Minerals, Inc. in Tulsa, Oklahoma. Ms. Kreie graduated from
Oklahoma State University in 1978 and received her law degree from The
University of Tulsa College of Law in 1981. Ms. Kreie is a licensed attorney
in Massachusetts and Oklahoma and a licensed real estate broker in
Massachusetts.
(f) 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.
(g) 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, 1996, all filing
requirements applicable to its officers and directors and ten-percent beneficial
holders were complied with.
Item 11. Executive Compensation
The Company's independent directors are entitled to receive total annual
compensation of $9,000 plus reimbursement for expenses incurred in attending
meetings and as a result of other work performed for the Company. With the
exception of John B. Watts III beginning in August 1996, the officers of the
Company are also officers of PWPI and receive compensation from PWPI which
indirectly relates to services to the Company. In addition, the Company is
required to pay certain fees to the Advisor as described in Item 13.
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 Directors and officers of the Company do not have any direct or
indirect ownership of shares of the Company's common stock as of the date
hereof.
(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
Subject to the supervision of and pursuant to the general policies set by
the Company's Board of Directors, assistance in managing the business of the
Company is provided by PaineWebber Lease Advisor, L.P. (the "Advisor"), a
limited partnership comprised of ILM Lease Advisor, Inc., a Virginia
corporation, and Properties Associates, L.P.("PA"), a Virginia limited
partnership. ILM Lease Advisor, Inc. is a wholly owned subsidiary of PaineWebber
Properties Incorporated ("PWPI"). The sole general partner of Properties
Associates, L.P. is PAM, Inc., which is a wholly-owned subsidiary of PWPI. In
addition, the limited partners and holders of certain assignee interests 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").
Under the Advisory Agreement, the Advisor 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. The Advisor will receive a fee in an amount
equal to 0.5% of the gross operating revenue of the facilities. The Advisor
earned management fees totalling $66,000 for the year ended August 31, 1996. The
Advisor and its affiliates are reimbursed for their direct expenses relating to
the administration of the Company.
An affiliate of the Advisor performs certain accounting, tax preparation,
securities law compliance and investor communications and relations services for
the Company. Total costs incurred by this affiliate in providing these services
are allocated among several entities, including the Company. Included in general
and administrative expenses on the accompanying statement of income for the year
ended August 31, 1996 is $55,000, representing reimbursements to this affiliate
for providing such services to the Company.
The Company retained Capital Senior Management 2, Inc. ("Capital") of
Dallas, Texas to be the manager of the senior housing facilities pursuant to a
Management Agreement which commenced on July 29, 1996. In November 1996,
Lawrence A. Cohen, a director of the Company and President, Chief Executive
Officer and Director of ILM, became Vice Chairman and Chief Financial Officer of
Capital's parent company. As a result, the management contract with Capital is
considered a related party transaction. 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. ILM has guaranteed the payment of all fees due to
Capital under the terms of the Management Agreement. Capital earned total
management fees of $60,000 for August 1996 which is included in accounts payable
- - affiliates on the accompanying balance sheet as of August 31, 1996.
<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 8-K dated July 29, 1996
reporting the termination of the property management agreement
with Angeles Housing Concepts, Inc. and the retention of Capital
Senior Management 2, Inc. as the new property manager.
(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.
<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 LEASE CORPORATION
By: /s/ John B. Watts III
-----------------------
John B. Watts III
President
By: /s/ Timothy J. Medlock
------------------------
Timothy J. Medlock
Treasurer
(functioning as chief financial
and accounting officer)
Dated: December 13, 1996
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: December 13, 1996
------------------------------- -----------------
Lawrence A. Cohen
Director
By:/s/ Jeffry R. Dwyer Date: December 13, 1996
------------------------------- -----------------
Jeffry R. Dwyer
Director
By:/s/ John B. Watts III Date: December 13, 1996
------------------------------- -----------------
John B. Watts III
Director
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(3)
ILM II LEASE CORPORATION
INDEX TO EXHIBITS
Page Number in the Report
Exhibit No. Description of Document or Other Reference
- ----------- ------------------------ ------------------
(3) and (4) Registration Statement on Form 10 Filed with the Commission
of the Registrant dated July 20, 1995, pursuant to Rule 424(c)
as supplemented. and incorporated herein
by reference.
(10) Contracts regarding retention of Capital Filed as Exhibits 1 and 2
Senior Management 2, Inc. as property to Current Report on
manager Form 8-K date July 29,
1996 and incorporated
herein by reference.
(13) Annual Reports to Shareholders No Annual Report for the
year ended August 31,
1996 has been sent to the
Shareholders. An Annual
Report will be sent to
the Shareholders
subsequent to this filing.
(27) Financial Data Schedule Filed as last page of
EDGAR submission following
the Financial Statements
and Financial Statement
Schedule required by
Item 14.
<PAGE>
ANNUAL REPORT ON FORM 10-K
Item 14(a)(1) and (2) and 14(d)
ILM II LEASE CORPORATION
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Reference
---------
ILM I Lease Corporation:
Report of independent auditors F-2
Balance sheets as of August 31, 1996 and 1995 F-3
Statements of operations for the year ended August 31, 1996
and the period September 12, 1994 (inception) to August 31, 1995 F-4
Statements of changes in shareholders' equity for the year ended
August 31, 1996 and the period September 12, 1994 (inception)
to August 31, 1995 F-5
Statements of cash flows for the year ended August 31, 1996 and
the period September 12, 1994 (inception) to August 31, 1995 F-6
Notes to financial statements F-7
Financial statement 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 financial statements, including the notes thereto.
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Shareholders of
ILM II Lease Corporation:
We have audited the accompanying balance sheets of ILM II Lease Corporation
as of August 31, 1996 and 1995, and the related statements of operations,
changes in shareholders' equity, and cash flows for the year ended August 31,
1996 and the period September 12, 1994 (inception) to August 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audit 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 audit provides 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 Lease Corporation at
August 31, 1996 and 1995, and the results of its operations and its cash flows
for the year ended August 31, 1996 and the period September 12, 1994 (inception)
to August 31, 1995 in conformity with generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
---------------------
ERNST & YOUNG LLP
Boston, Massachusetts
December 13, 1996
<PAGE>
ILM II LEASE CORPORATION
BALANCE SHEETS
August 31, 1996 and 1995
(In thousands, except per share amounts)
ASSETS
1996 1995
---- ----
Cash and cash equivalents $ 1,591 $ -
Accounts receivable 5 -
Prepaid expenses and other assets 118 -
-------- ------
Total current assets 1,714 -
Furniture, fixtures and equipment 197 -
Less: accumulated depreciation (14) -
-------- -------
183 -
Deferred tax asset, net 38 -
-------- ------
$ 1,935 $ -
======== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses $ 503 $ -
Real estate taxes payable 203 -
Accounts payable - affiliates 327 -
Security deposits 12 -
-------- ------
Total current liabilities 1,045 -
Deferred rent payable 131 -
-------- ------
Total liabilities 1,176 -
Shareholders' equity:
Common stock, $0.01 par value,
20,000,000 shares authorized,
5,180,952 shares issued and outstanding
(15,000 shares issued and outstanding in 1995) 52 -
Additional paid-in capital 448 1
Retained earnings (deficit) 259 (1)
-------- -------
Total shareholders' equity 759 -
-------- -------
$ 1,935 $ -
======== =======
See accompanying notes.
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF OPERATIONS
For the year ended August 31, 1996 and the period
September 12, 1994 (inception) to August 31, 1995
(In thousands, except per share amounts)
1996 1995
---- ----
Revenues:
Rental and other income $ 13,163 $ -
Interest income 38 -
-------- ------
13,201 -
Expenses:
Master lease rent expense 4,004 -
Dietary salaries, wages and food
service expenses 2,409 -
Administrative salaries, wages
and expenses 1,061 -
Marketing salaries, wages and expenses 684 -
Utilities 1,008 -
Repairs and maintenance 597 -
Real estate taxes 508 -
Property management fees 720 -
Other property operating expenses 1,412 -
General and administrative 285 1
Advisory fees 66 -
Depreciation expense 14 -
-------- ------
12,768 1
-------- ------
Income (loss) before taxes 433 (1)
Income tax expense (benefit):
Current 211 -
Deferred (38) -
----------- ------
173 -
---------- ------
Net income (loss) $ 260 $ (1)
========= ======
Net income (loss) per share of
common stock $0.05 $(0.07)
===== ======
The above net income (loss) per share of common stock is based upon the weighted
average number of shares outstanding for the year ended August 31, 1996 and the
period September 12, 1994 (inception) to August 31, 1995 (5,180,952 and 15,000,
respectively).
See accompanying notes.
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the year ended August 31, 1996 and the period
September 12, 1994 (inception) to August 31, 1995
(In thousands, except per share amounts)
Common Stock Additional Retained
$.01 Par Value Paid-in Earnings
Shares Amount Capital (Deficit) Total
------ ------ ------- --------- -----
Balance at September 12, 1994 - $ - $ - $ - $ -
Issuance of common stock 15,000 - 1 - 1
Net loss - - - (1) (1)
---------- ----- ------ ------ -----
Balance at August 31, 1995 15,000 - 1 (1) -
Issuance of common stock 5,165,952 52 447 - 499
Net income - - - 260 260
---------- ----- ------ ------ ----
Balance at August 31, 1996 5,180,952 $ 52 $ 448 $ 259 $759
========= ===== ====== ====== ====
See accompanying notes.
<PAGE>
ILM II LEASE CORPORATION
STATEMENTS OF CASH FLOWS
For the year ended August 31, 1996 and the period
September 12, 1994 (inception) to August 31, 1995
Increase (Decrease) in Cash and Cash Equivalents
(In thousands)
1996 1995
---- ----
Cash flows from operating activities:
Net income (loss) $ 260 $ (1)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities
Depreciation expense 14 -
Changes in assets and liabilities:
Accounts receivable (5) -
Prepaid expenses and other assets (118) -
Deferred tax asset, net (38) -
Accounts payable and accrued expenses 503 -
Accounts payable - affiliates 327 -
Real estate taxes payable 203 -
Security deposits 12 -
Deferred rent payable 131 -
--------- ------
Total adjustments 1,029 -
--------- ------
Net cash provided by (used in) operating
activities 1,289 (1)
Cash flows from investing activities:
Additions to furniture, fixtures and equipment (197) -
--------- ------
Net cash used in investing activities (197) -
Cash flows from financing activities:
Proceeds from issuance of common stock 499 1
--------- ------
Net cash provided by financing activities 499 1
--------- ------
Net increase in cash and cash equivalents 1,591 -
Cash and cash equivalents, beginning of period - -
--------- ------
Cash and cash equivalents, end of period $ 1,591 $ -
========= ======
Supplemental disclosure:
Cash paid during the period for income taxes $ 220 $ -
========= ======
See accompanying notes.
<PAGE>
ILM II LEASE CORPORATION
Notes to Financial Statements
1. Organization and Nature of Operations
ILM II Lease Corporation ("the Company") was organized as a corporation on
September 12, 1994 under the laws of the state of Virginia. Through August
31, 1995, the Company had no significant operations. The Company was formed
by PaineWebber Independent Living Mortgage Inc. II (ILM) to operate six
rental housing projects for independent senior citizens ("the Senior Housing
Facilities") under a master lease arrangement. ILM initially made mortgage
loans to Angeles Housing Concepts, Inc. ("AHC") secured by the Facilities
between July 1990 and July 1992. In March 1993, AHC defaulted under the terms
of such mortgage loans and in connection with the settlement of such default,
title to the Senior Housing Facilities was transferred, effective April 1,
1994, to certain majority-owned, indirect subsidiaries of ILM, subject to the
mortgage loans. Subsequently, the indirect subsidiaries of ILM were merged
into ILM II Holding, Inc. ("ILM Holding"). As part of the fiscal 1994
settlement agreement with AHC, AHC was retained as the property manager for
all of the Senior Housing Facilities pursuant to the terms of a management
agreement which was assigned to the Company as of September 1, 1995. As
discussed further in Note 6, the management agreement with AHC was terminated
in July 1996. 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 (see Note 4). 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 operations of the Senior Housing
Facilities. The Company has initially leased the Senior Housing Facilities
from ILM Holding, a majority-owned and consolidated affiliate 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, 2000 (December 31,
1999 with respect to the Santa Barbara Facility) (see Note 5). 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, became Vice Chairman and Chief Financial Officer of Capital Senior
Living Corp., an affiliate of Capital. As a result, the management contract
with Capital is considered a related party transaction (see Note 3).
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 require 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 year ended August 31, 1996 and the period from September
12, 1994 (date of inception) to August 31, 1995. Actual results could differ
from the estimates and assumptions used.
Furniture, fixtures and equipment are carried at the lower of cost,
reduced by accumulated depreciation, or fair value in accordance with FAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets To Be Disposed Of." Depreciation expense is provided on a
straight-line basis using an estimated useful life of 3 years.
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.
The Company rents the Facilities from ILM Holding pursuant to a multi-year
operating lease. Rent expense is recognized on a straight-line basis over the
term of the lease agreement. Deferred rent payable represents the difference
between rent expense recognized on a straight-line basis and cash paid for
rent pursuant to the terms of the lease agreement.
The Company's policy is to expense all advertising costs as incurred.
The cash and cash equivalents, receivables, accounts payable and accrued
liabilities appearing on the accompanying balance sheets represent financial
instruments for purposes of Statement of Financial Accounting Standards No.
107, "Disclosures about Fair Value of Financial Instruments." The carrying
amount of these assets and liabilities approximates their fair value as of
August 31, 1996 due to the short-term maturities of these instruments.
Income tax expense is provided for using the liability method as
prescribed by Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes."
For purposes of reporting cash flows, cash and cash equivalents include
all highly liquid investments with original maturities of 90 days or less.
3. Related Party Transactions
The Company has entered into an Advisory Agreement with PaineWebber Lease
Advisor, L.P. ("the Advisor"), a Virginia limited partnership comprised of
ILM Lease Advisor, Inc. as the general partner and Properties Associates,
L.P. as the limited partner. ILM Lease Advisor, Inc. is a wholly-owned
subsidiary of PaineWebber Properties Incorporated ("PWPI"). The sole general
partner of Properties Associates, L.P. is PAM, Inc., which is a wholly-owned
subsidiary of PWPI. In addition, the limited partners and holders of certain
assignee interests of PA are or have been officers of PWPI. PWPI is a
wholly-owned subsidiary of PaineWebber Incorporated ("PWI"), which is a
subsidiary of Paine Webber Group, Inc. ("PaineWebber"). Subject to the
supervision of and pursuant to the general policies set by the Company's
Board of Directors, assistance in the managing of the business of the Company
is provided by the Advisor. Under the Advisory Agreement, the Company engages
the Advisor and the Advisor agrees to use its best efforts to manage the
day-to-day affairs and operations of the Company and to provide
administrative services and facilities appropriate for such management. The
specific duties of the Advisor under the Advisory Agreement include
recommending selections of providers of professional and specialized services
and handling other managerial functions with respect to the Facilities. The
Advisor is also obligated to provide office and clerical facilities adequate
for the Company's operations and to provide, or obtain others to provide,
accounting, custodial, funds collection and payment, stockholder
communications, legal and other services necessary in connection with the
Company's operations. The Advisory Agreement also obligates the Advisor to
handle or arrange for the handling of the Company's financial and other
records.
Either party may terminate the Advisory Agreement at any time on or after
January 1, 1996 on 90 days notice, and the Company may terminate the Advisory
Agreement for cause at any time. 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 $66,000
for the year ended August 31, 1996. 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 year ended August 31,
1996 is $55,000, representing reimbursements to this affiliate of the Advisor
for providing such services to the Company. In performing its services under
the Advisory Agreement, the Advisor is required to pay certain employment
expenses of its personnel, certain expenses of employees and agents of the
Advisor and of directors, officers and employees of the Company who are also
employees of the Advisor or its affiliates, and certain of its overhead and
miscellaneous administrative expenses relating to performance of its
functions under the Advisory Agreement. The Company is responsible for
reimbursing out-of-pocket expenses of directors, officers and employees of
the Company incurred by them exclusively in such capacity and for all other
costs of its operations.
ILM II Lease Corporation 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. As discussed in Note 1, a director of the Company became an officer and
director of Capital Senior Living Corp., an affiliate of Capital, subsequent
to the commencement of the management agreement. Under the Management
Agreement, Capital generally is required to perform all operational functions
necessary to operate the Facilities other than certain administrative
functions. The functions performed by Capital include periodic reporting to
and coordinating with the Company, leasing the individual units in the
Facilities, maintaining bank accounts, maintaining books and records,
advertising and marketing the Facilities, hiring and supervising on-site
personnel, and performing maintenance. 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. PaineWebber Independent Living Mortgage
Fund, Inc. has guaranteed the payment of all fees due to Capital under the
terms of the Management Agreement. Capital earned total management fees of
$60,000 for August 1996 which is included in accounts payable - affiliates on
the accompanying balance sheet as of August 31, 1996.
Accounts payable - affiliates at August 31, 1996 also includes advances of
$225,000 received from ILM Holding, primarily for the purchase of personal
property to operate the Senior Housing Facilities.
4. Capital Stock
Prior to September 1, 1995, the Company was a wholly-owned subsidiary of
ILM. Pursuant to a Reorganization and Distribution Agreement, ILM capitalized
the Company with $500,000, an amount estimated to provide the Company with
necessary working capital. On September 1, 1995, Mavricc Management Systems,
Inc., as the distribution agent, caused to be issued on the stock records of
the Company the distributed Common Stock of the Company, in uncertificated
form, to the holders of record of ILM common stock at the close of business
on July 14, 1995. One share of the Company's Common Stock was distributed for
each outstanding share of ILM Common Stock. No certificates or scrip
representing fractional shares of the Company's Common Stock were issued to
holders of ILM common stock as part of the distribution. In lieu of receiving
fractional shares, each holder of ILM common stock who would otherwise have
been entitled to receive a fractional share of the Company's Common Stock
received a cash payment equivalent to $0.14 per share for such fractional
interest.
5. The Master Lease Agreement
ILM Holding (the "Lessor") has leased the Senior Housing Facilities to the
Company (the "Lessee") pursuant to a master lease which commenced on
September 1, 1995. Under the terms of the master lease, which has a scheduled
expiration date of 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 Facility sold as of the date of such sale. The master lease
is accounted for as an operating lease in the Company's financial statements.
Descriptions of the properties covered by the master lease between the
Company and ILM Holding are summarized as follows:
Rentable Date of
Name Location Units Construction (1)
---- -------- ----- ----------------
The Palms Fort Myers, FL 204 October 1988
Crown Villa Omaha, NE 73 January 1992
Overland Park Place Overland Park, KS 137 June 1984
Rio Las Palmas Stockton, CA 162 June 1988
The Villa at Riverwood St. Louis County, MO 119 June 1985
Villa Santa Barbara (2) Santa Barbara, CA 123 June 1979
(1)Date initial construction was completed.
(2)The Company operates Villa Santa Barbara under a co-tenancy
arrangement with an affiliated company, ILM I Lease Corporation.
The Company has entered into an agreement with ILM I Lease
Corporation regarding such joint tenancy. ILM I Lease Corporation
was formed for similar purposes as the Company by an affiliated
REIT, PaineWebber Independent Living Mortgage Fund, Inc., whose
indirect subsidiary owns a portion of the Villa Santa Barbara
property. The portion of the Facility leased by the Company
represents 75% 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 $3,548,700 (prorated according to the date of
commencement of the master lease), allocated as follows: $849,836 for the
Florida Facility, $541,010 for the Nebraska Facility, $720,252 for the Kansas
Facility, $591,429 for the Stockton, California Facility, $423,933 for the
Missouri Facility and $422,240 for the Santa Barbara, California Facility.
For calendar year 1996 and subsequent years, the annual Base Rent will be
$4,035,600, allocated as follows: $966,439 for the Florida Facility, $615,240
for the Nebraska Facility, $819,074 for the Kansas Facility, $672,576 for the
Stockton, California Facility, $482,098 for the Missouri Facility and
$480,173 for the Santa Barbara, 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 all major capital improvements and structural repairs to the Senior
Housing Facilities. In addition, beginning in January 1997 and for the
remainder of the lease term, the Company will also be obligated to pay
variable rent ("Variable Rent") for each Facility. Such Variable Rent will be
payable quarterly and will equal 40% of the excess, if any, of the aggregate
total revenues for the Facilities, on an annualized basis, over $13,021,000.
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 California, Florida 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.
6. Contingencies
A management agreement between ILM Holding and AHC which covered the
management of all six 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 that AHC willfully performed actions specifically in
violation of the management agreement and that such actions caused damages to
the Companies. Due to the termination of the agreement for cause, no
termination fee was paid to AHC. Subsequent to the termination of the
management agreement, AHC filed for protection under Chapter 11 of the U.S.
Bankruptcy Code in its domestic state of California. The filing was
challenged by the Companies, and the Bankruptcy Court dismissed AHC's case
effective October 15, 1996. In November 1996, AHC filed with the Virginia
District Court an Answer in response to the litigation initiated by the
Companies and a Counterclaim against ILM Holding. The Counterclaim alleges
that the management agreement was wrongfully terminated for cause and
requests damages which include the payment of 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
management agreement could have been terminated without cause, and recovery
of attorney's fees and expenses. ILM guaranteed the payment of the
termination fee at issue in these proceedings. The Companies intend to
diligently prosecute the case and to vigorously defend the counterclaims made
by AHC. The eventual outcome of this termination dispute cannot presently be
determined. Accordingly, no provision for any liability which might result
from the outcome of this matter has been recorded in the accompanying
financial statements.
7. 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 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 August 31, 1996 are
comprised of the following amounts (in thousands):
Deferred tax asset - straight-line rent expense $ 53
Deferred tax liability - tax over book amortization 15
-------
Net deferred tax asset $ 38
=======
The components of income tax expense (benefit) for fiscal 1996 are as
follows (in thousands):
Current:
Federal $ 179
State 32
--------
Total current 211
--------
Deferred:
Federal (32)
State (6)
--------
Total deferred (38)
--------
$ 173
========
<PAGE>
The reconciliation of income tax computed at U.S. federal statutory
rates to income tax expense is as follows (in thousands):
Tax at U.S. statutory rates $ 147 34%
State income taxes, net
of federal tax benefit 26 6%
------- ---
$ 173 40%
======= ===
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Partnership's audited financial statements for the year ended August 31, 1996
and is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> AUG-31-1996
<PERIOD-END> AUG-31-1996
<CASH> 1,591
<SECURITIES> 0
<RECEIVABLES> 5
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,714
<PP&E> 197
<DEPRECIATION> (14)
<TOTAL-ASSETS> 1,935
<CURRENT-LIABILITIES> 1,045
<BONDS> 0
0
0
<COMMON> 500
<OTHER-SE> 259
<TOTAL-LIABILITY-AND-EQUITY> 1,935
<SALES> 0
<TOTAL-REVENUES> 13,201
<CGS> 0
<TOTAL-COSTS> 12,768
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 433
<INCOME-TAX> 173
<INCOME-CONTINUING> 260
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 260
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
