-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, D9uNbRN5nElEqggWwZTnsMH49IGSsYkV8boCZ8b69x8abOGy+AWU25ETsE4w/EoT i6JIwubbVbCGI5OywWU1Aw== 0001029869-97-001447.txt : 19971216 0001029869-97-001447.hdr.sgml : 19971216 ACCESSION NUMBER: 0001029869-97-001447 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19960831 FILED AS OF DATE: 19971215 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILM SENIOR LIVING INC /VA CENTRAL INDEX KEY: 0000847414 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 043042283 STATE OF INCORPORATION: VA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-18249 FILM NUMBER: 97738338 BUSINESS ADDRESS: STREET 1: 1300 CONNECTICUT AVE NW STREET 2: STE 1000 CITY: WASHINGTON STATE: DC ZIP: 20036 MAIL ADDRESS: STREET 1: 1300 CONNECTICUT AVE NW STREET 2: STE 1000 CITY: WASHINGTON STATE: DC ZIP: 20036 FORMER COMPANY: FORMER CONFORMED NAME: PAINE WEBBER INDEPENDENT LIVING MORTGAGE FUND INC DATE OF NAME CHANGE: 19971103 FORMER COMPANY: FORMER CONFORMED NAME: ILM SENIOR LIVING INC DATE OF NAME CHANGE: 19970905 FORMER COMPANY: FORMER CONFORMED NAME: PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND INC DATE OF NAME CHANGE: 19920703 10-K/A 1 PAINEWEBBER FORM 10-K/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K/A No. 1 [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: 0-18249 ------- PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. (now known as ILM Senior Living, Inc.) (Exact name of registrant as specified in its charter) Virginia 04-3042283 - ----------------------- ------------------------------------ (State of organization) (I.R.S. Employer Identification No.) 1285 Avenue of the Americas, New York, New York 10104 - ------------------------------------------------------------------------------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (212) 713-4264 ---------------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered - ------------------- ---------------- None None Securities registered pursuant to Section 12(g) of the Act: Shares of Common Stock, $.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: 7,520,100 (20,100 of which were initially sold to an affiliate). The aggregate sales price of the shares sold was $75,201,000 ($201,000 for the 20,100 shares sold to an affiliate). This does not reflect market value. There is no current market for these shares. DOCUMENTS INCORPORATED BY REFERENCE Documents Form 10-K Reference - ------------------------------- Parts II and IV Prospectus of registrant dated August 8, 1990, as supplemented Current Report on Form 8-K Part IV of registrant dated July 29, 1996 PART I Item 1. Business (Amended to note that the Company is no longer advised by affiliates of PaineWebber Group, Inc. and to add disclosures regarding restrictions on the Company's borrowing ability) PaineWebber Independent Living Mortgage Fund, Inc. (the "Company") is a finite-life corporation organized on March 6, 1989 in the Commonwealth of Virginia for the purpose of making construction and participating mortgage loans secured by rental housing complexes for independent senior citizens ("Senior Housing Facilities"). On June 21, 1989, the Company commenced a public offering of up to 10,000,000 shares of common stock pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration Statement No. 33-27653). On July 21, 1989, the public offering terminated. The Company issued 7,520,100 shares, representing capital contributions of $75,201,000, of which $201,000 represented the sale of 20,100 shares to an affiliate, PaineWebber Group, Inc. ("PaineWebber"). As of November 1, 1996, PaineWebber and its affiliates held 165,344 shares of the Company's common stock. The Company has elected to qualify and be taxed as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended, for each taxable year of operations. As a REIT, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby effectively subjecting the distributed net income of the Company to taxation at the shareholder level only. In order to qualify as a REIT, the Company must distribute at least 95% of its taxable income on an annual basis and meet certain other requirements. The Company originally invested the net proceeds of the initial public offering in eight participating mortgage loans secured by Senior Housing Facilities located in seven different states. All of the loans made by the Company were originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of Senior Housing Facilities. The Company entered into an Exclusivity Agreement with AHC and its parent company, Angeles Corporation ("Angeles"), which required AHC to provide the Company with certain specific opportunities to finance Senior Housing Facilities and set forth the terms and conditions of the loans which were made. The loan documents under the aforementioned Exclusivity Agreement called for interest to be paid on construction loans at the rate of 13% per annum during the construction period and for Base Interest to be paid on the permanent loans at the rate of 10% per annum. In addition to the Base Interest, Additional Interest was to be payable on the permanent loans in an amount equal to 10% of the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms of the amended Exclusivity Agreement, Additional Interest was to be no less than 3% of the aggregate principal amount of all permanent loans outstanding for the entire term of the investments. In the aggregate, the properties securing loans from the Company did not generate sufficient cash flow to cover the debt service payments owed to the Company under the amended terms of the Exclusivity Agreement. To the extent that the properties did not generate sufficient cash flow to make the full payments due under the loan documents, the shortfall was funded by AHC through December 1992. The source of cash to make up these shortfalls was from specified deficit reserve accounts, which had been funded from the proceeds of the mortgage loans, and from contributions by Angeles. During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on the Company's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. The Company retained special counsel and held extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding settlement agreement between the Company, AHC and Angeles was reached whereby ownership of the properties would be transferred from AHC to the Company or its designated affiliates. Under the terms of the Settlement Agreement, the Company released AHC and Angeles from certain obligations under the loans. On April 27, 1994, each of the properties owned by AHC and securing the Loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with the Company (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994 and were made pursuant to the Settlement Agreement entered into on February 17, 1994 ("the Settlement Agreement") between the Company and AHC which had previously been approved by the bankruptcy court handling the bankruptcy case of Angeles. All of the capital stock of each Property Company was held by ILM Holding, Inc. ("ILM Holding"), a Virginia corporation. In August 1995, each of the Property Companies merged into ILM Holding. As a result, I - 1 ownership of the Senior Housing Facilities is now held by ILM Holding, and the Property Companies no longer exist as separate legal entities. Through January 10, 1997, the capital stock of ILM Holding was owned by the Company and PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The Company held substantially all of the economic ownership in ILM Holding, while PWP Holding held voting control. As discussed further under Item 7, on November 21, 1996 the Company requested that PWPI cause PWP Holding to sell all of the stock held by PWP Holding in ILM Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM Holding was completed at an agreed upon fair value of $46,000. As part of the fiscal 1994 settlement agreement with AHC, ILM Holding retained AHC as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement. As discussed further in Item 7, the management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, management investigated and evaluated the available options for structuring the ownership of the properties in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code. To retain REIT status, the Company must ensure that 75% of its annual gross income is received from qualified sources. Under the original investment structure, interest income from the Company's mortgage loans was a qualified source. The properties that are now owned by an affiliate of the Company are Senior Housing Facilities that provide tenants with more services, such as meals, activities, assisted living, etc., than are customary for ordinary residential apartment properties. As a result, a significant portion of the rents paid by the tenants includes income for the increased level of services received by them. Consequently, the rents paid by the tenants likely would not be qualified rents for REIT qualification purposes if received directly by the Company. Therefore, if the Company received such rents directly, it could lose REIT status and be taxed as a regular corporation. After extensive review, the Board of Directors determined that it would be in the best interests of the shareholders for the Company to retain REIT status and master lease the properties to a shareholder-owned operating company. As discussed further in Item 7, on September 12, 1994 the Company formed a new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation effective September 1, 1995 (see Item 7 for a description of the master lease agreement). I - 2 The Company's investments as of August 31, 1996 are described below:
Property Name Date of and Location (1) Type of Property Investment Size - ---------------- ---------------- ---------- ---- Independence Village of Winston-Salem Senior Housing Facility 6/29/89 156 Units Winston-Salem, NC Independence Village of East Lansing Senior Housing Facility 6/29/89 159 Units East Lansing, MI Independence Village of Raleigh Senior Housing Facility 12/18/89 163 Units Raleigh, NC Independence Village of Peoria Senior Housing Facility 12/18/89 164 Units Peoria, IL Crown Pointe Apartments Senior Housing Facility 2/14/89 133 Units Omaha, NE Sedgwick Plaza Apartments Senior Housing Facility 2/14/89 150 Units Wichita, KS West Shores Senior Housing Facility 12/14/90 134 Units Hot Springs, AR Villa Santa Barbara (2) Senior Housing Facility 7/13/92 123 Units Santa Barbara, CA
(1) See Notes to the Financial Statements filed with this Annual Report for a description of the agreements through which the Company has acquired these real estate investments. (2) The acquisition and improvement of the Santa Barbara facility was jointly financed by the Company and an affiliated company, PaineWebber Independent Living Mortgage Inc. II (ILM2). Any amounts generated by the operations of the Santa Barbara property are equitably apportioned between the Company, together with its consolidated affiliate, and ILM2, together with its consolidated affiliate (generally 25% and 75%, respectively). The Senior Housing Facilities are subject to competition from similar properties in the vicinities in which they are located. The properties are located in areas with significant senior citizen populations and, as a result, there are, and will likely continue to be, a variety of competing projects aimed at attracting senior residents. Such projects will generally compete on the basis of rental rates, services, amenities and location. The Company has no real estate investments located outside the United States. The Company is engaged solely in the business of real estate investment. Therefore, presentation of information about industry segments is not applicable. The Company originally expected to liquidate its investments after a period of approximately ten years, although under the terms of its organizational documents property sales may occur at earlier or later dates. The Board of Directors may defer the Company's scheduled liquidation date, if in the opinion of a majority of the Directors, the disposition of the Company's assets at such time would result in a material under-realization of the value of such assets; provided, however, that no such deferral may extend beyond December 31, 2004. The net proceeds of any sale transactions are expected to be distributed to the Shareholders, so that the Company will, in effect, be self-liquidating. I - 3 Under certain circumstances it may be advantageous for the Company to borrow funds to meet its investment objectives and maximize return to shareholders. The Company's bylaws provide that the Company may not incur indebtedness if, after giving effect to the incurrence of debt thereof, aggregated indebtedness, secured and unsecured, would exceed 300% of the Company's net assets on a consolidated basis, as calculated at the end of each calendar quarter in accordance with generally accepted accounting principles. In addition to the foregoing, the Company may incur indebtedness in order to prevent default under loans or to discharge them entirely if this becomes necessary to protect the Company's investment. This may occur if foreclosure proceedings are instituted by the holder of a mortgage interest which is senior to that held by the Company, although the Company does not anticipate entering into loans that are subject to such senior mortgage interests. In addition, the Company may incur indebtedness in order to assist in the operation of any property acquired by the Company as a result of a default on a loan made by the Company secured by the property to protect such loan. Through June 18, 1997 and subject to the supervision of the Company's Board of Directors, assistance in the management of the business of the Company was provided by PaineWebber ILM Advisor, L.P. (the "Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation, and Properties Associates, L.P., a Virginia limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of PWPI. The partners of the Advisor are affiliates of PWI and PaineWebber. As discussed further in Item 7, the Company has accepted the resignation of the Advisor, effective as of June 18, 1997. The Advisor agreed to continue to provide certain administrative services to the Company and its affiliates through August 31, 1997, pursuant to the terms of a transition services agreement entered into with the Company and its affiliates. The Company and its affiliates have also accepted, effective as of June 18, 1997, the resignations of those officers and directors who are employees of or otherwise affiliated with the Advisor or its affiliates. Subsequent to resignation of the Advisor and affiliated persons, the Board of Directors engaged a former employee of PWPI as a consultant to assist in the management of the Company. The Company is currently evaluating various strategic alternatives, including the possibility of becoming self-managed. Subsequently to June 18, 1997, there are five directors of the Company, none of whom is 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. Effective August 14, 1997, the name of the Company was changed to ILM Senior Living, Inc. Item 3. Legal Proceedings (Amended to update the status of litigation since the date of the original filing.) On July 29, 1996, ILM I Lease Corporation and ILM Holding, Inc. ("the Companies") terminated the property management agreement with Angeles Housing Concepts, Inc. ("AHC") covering the eight senior housing facilities leased by ILM I Lease Corporation from ILM Holding, Inc., the Company's consolidated affiliate. The management agreement was terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the agreement. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. ILM I Lease Corporation and ILM Holding, Inc. 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, Inc. The Counterclaim alleges that I - 4 the management agreement was wrongfully terminated for cause and requests damages which include the payment of the 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, 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 Fund, Inc. guaranteed the payment of the termination fee at issue in these proceedings. The court initially set a trial date of April 28, 1997 but, at AHC's request, rescheduled the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the court issued Orders purporting to enter judgment against the Company and ILM2 in the amount of $1,000,000. In so doing, the court effectively canceled the June 23, 1997 trial date. The Orders did not contain any findings of fact or conclusions of law. On July 10, 1997, the Company, PaineWebber Independent Living Mortgage Inc. II (ILM II), ILM I Lease Corporation and ILM II Lease Corporation filed a notice of appeal to the United State Court of Appeals for the Fourth Circuit. The Company intends to diligently prosecute the appeal. The eventual outcome of this litigation cannot presently be determined. However, as reported in the Company's report on Form 10-Q for the quarter ended May 31, 1997, the Company has recorded a provision in the amount of $600,000 for the liability which might result from the court's orders. On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of California against Capital, Lawrence Cohen, President, Chief Executive Officer, and a director of the Company and others alleging that the defendants intentionally interfered with AHC's property management agreement. The complaint seeks damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to federal district court in the Central District of California. Trial in the action has been set for January 13, 1998 and discovery has just begun. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber 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. Subsequently, the Boards of Directors of ILM I Lease Corporation and ILM II Lease Corporation voted to increase the maximum amount of the advance to $100,000. The defendants intend to vigorously defend the claims made against them in the California litigation. The eventual outcome of this litigation cannot presently be determined and, accordingly, no provision for any liability has been recorded in the accompanying financial statements. In November 1994, a series of purported class actions (the "New York Limited Partnership Actions") were filed in the United States District Court for the Southern District of New York concerning PaineWebber Incorporated's sale and sponsorship of various limited partnership interests and common stock, including the securities offered by the Company. The lawsuits were brought against PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"), among others, by allegedly dissatisfied investors. In March 1995, after the actions were consolidated under the title In re PaineWebber Limited Partnership Litigation, the plaintiffs amended their complaint to assert claims against a variety of other defendants, including PaineWebber Properties Incorporated ("PWPI"), an affiliate of PaineWebber and the parent company of the general partner of the Advisor to the Company. On May 30, 1995, the court certified class action treatment of the claims asserted in the litigation. The amended complaint in the New York Limited Partnership Actions alleged that, in connection with the sale of common stock of the Company, the defendants (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Company's anticipated performance; and (3) marketed the Company to investors for whom such investments were not suitable. The plaintiffs, who purported to be suing on behalf of all persons who invested in the Company also alleged that following the issuance of the Company's stock, the defendants misrepresented financial information about the Company's value and performance. The amended complaint alleged that the defendants violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal securities laws. The plaintiffs sought unspecified damages, including reimbursement for all sums invested by them in the Company's stock, as well as disgorgement of all fees and other income derived by PaineWebber from the Company. In addition, the plaintiffs also sought treble damages under RICO. In January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the I - 5 Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and a plan of allocation. On July 17, 1996, PaineWebber and the class plaintiffs submitted a definitive settlement agreement which has been preliminarily approved by the court and provides for the complete resolution of the class action litigation, including releases in favor of the Company and PWPI, and the allocation of the $125 million settlement fund among investors in the various partnerships and REITs at issue in the case. As part of the settlement, PaineWebber also agreed to provide class members with certain financial guarantees relating to some of the partnerships and REITs. The details of the settlement are described in a notice mailed directly to class members at the direction of the court. A final hearing on the fairness of the proposed settlement was held in December 1996, and in March 1997 the court announced its final approval of the settlement. The release of the agreed upon settlement proceeds had been delayed pending the resolution of an appeal of the settlement agreement by two of the plaintiff class members. In July, 1997, the United States Court of Appeals for the Second Circuit upheld the settlement over the objections of the two class members. As part of the settlement agreement, PaineWebber agreed not to seek indemnification from the related partnerships and REITs at issue in the litigation (including the Company)for any amounts it is required to pay under the settlement. In February 1996, approximately 150 plaintiffs filed an action entitled Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership investments and REIT stocks, including those offered by the Company. The complaint alleges, among other things, that PaineWebber and its related entities committed fraud and misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs by selling or promoting limited partnership and REIT investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint seeks compensatory damages of $15 million plus punitive damages. In September 1996, the court dismissed many of the plaintiffs' claims as barred by applicable securities arbitration regulations. In June 1996, approximately 50 plaintiffs filed an action entitled Bandrowski v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiff's purchases of various limited partnership interests and REIT stocks, including those offered by the Company. The complaint is substantially similar to the complaint in the Abbate action described above, and seeks compensatory damages of $3.4 million plus punitive damages. In July 1996, approximately 15 plaintiffs filed an action entitled Barstad v. PaineWebber Inc. in Maricopa County, Arizona Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership interests and REIT stocks, including those offered by the Company. The complaint is substantially similar to the complaint in the Abbate action described above, and seeks compensatory damages of $752,000 plus punitive damages. In December 1996. PaineWebber agreed to settle the Abbate, Bandrowski and Barstad actions. Final releases and dismissals with regard to these actions were received during fiscal 1997. Based on these settlement agreements which cover all of the outstanding shareholder litigation, management does not expect that the resolution of the shareholder matters will have a material impact on the Company's financial statements, taken as a whole. I - 6 PART II Item 6. Selected Financial Data (Amended to be consistent with amended financial statements included in Item 14) PaineWebber Independent Living Mortgage Fund, Inc. For the years ended August 31, 1996, 1995, 1994, 1993 and 1992 (in thousands except per unit data)
1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Revenues $ 129 $ 174 $ 85 $ 166 $ 228 Operating loss $ (641) $ (954) $ (918) $ (611) $ (621) Gain on sale of Treasury Note- -- -- -- $ 82 -- Equity in income from properties securing mortgage loans. $ 4,756 $ 5,053 $ 3,822 $ 2,671 $ 822 Net income $ 4,115 $ 4,099 $ 2,904 $ 2,142 $ 201 Earnings per share of common stock $ 0.55 $ 0.54 $ 0.39 $ 0.28 $ 0.03 Cash dividends paid per share of common stock $ 0.70 $ 0.71 $ 0.40 $ 0.70 $ 1.00 Total assets $41,451 $43,489 $43,580 $43,776 $46,859
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 earnings and cash dividends paid per share of common stock are based upon the 7,520,100 shares outstanding during each year. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (Amended to be consistent with amended financial statements included in Item 14, to reflect changes in ownership subsequent to the original filing, and to note the resignation of the Advisor effective June 18, 1997.) Liquidity and Capital Resources The Company offered shares of its common stock to the public from June 21, 1989 to July 21, 1989 pursuant to a Registration Statement filed under the Securities Act of 1933. Capital contributions of $75,201,000 were received by the Company (including $201,000 contributed by PaineWebber Group, Inc.) and, after deducting selling expenses and offering costs and allowing for adequate cash reserves, approximately $62.8 million was available to be invested in participating first mortgage loans secured by Senior Housing Facilities. The Company originally invested the net proceeds of the initial public offering in eight participating mortgage loans secured by Senior Housing Facilities located in II - 1 seven different states. All of the loans made by the Company were originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of Senior Housing Facilities. As previously reported, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993 as a result of the financial problems of its parent company, Angeles Corporation ("Angeles"), which subsequently filed for bankruptcy. In fiscal 1994, a settlement agreement was executed whereby ownership of the properties was transferred from AHC to certain designated affiliates of the Company. Subsequently, these affiliates were merged into ILM Holding, Inc. ("ILM Holding"). Through January 10, 1997, the capital stock of ILM Holding was owned by the Company and PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The Company held substantially all of the economic ownership in ILM Holding, while PWP Holding held voting control. As discussed further under Item 7, on November 21, 1996 the Company requested that PWPI cause PWP Holding to sell all of the stock held by PWP Holding in ILM Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM Holding was completed at an agreed upon fair value of $46,000. As part of the fiscal 1994 settlement agreement with AHC, ILM Holding retained AHC as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement. As discussed further below, the management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code, the Company formed a new corporation, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities under the terms of a master lease agreement. As of August 31, 1995, ILM I Lease Corporation, which is taxable as a regular C Corporation and not as a REIT, was a wholly-owned subsidiary of the Company. On September 1, 1995, after the Company received the required regulatory approval, it distributed all of the shares of capital stock of ILM I Lease Corporation to the holders of record of the Company's common stock. One share of common stock of ILM I Lease Corporation was issued for each full share of the Company's common stock held. Prior to the distribution, the Company capitalized ILM I Lease Corporation with $700,000 from its existing cash reserves, which was an amount estimated to provide ILM I Lease Corporation with necessary working capital. The master lease agreement, which commenced on September 1, 1995, is initially between the Company's equity investee, ILM Holding, as owner of the properties and Lessor, and ILM I Lease Corporation as Lessee. The master lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. 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, 1999, ILM I Lease Corporation 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 January 1997 and for the remainder of the lease term, ILM I Lease Corporation 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 $16,996,000. The assumption of ownership of the properties through ILM Holding has resulted in a possible future tax liability which would be payable upon the ultimate sale of the properties (the "built-in gain tax"). The amount of such tax would be calculated based on the lesser of the total net gain realized from the sale transaction or the portion of the net gain realized upon a final sale which is attributable to the period during which the properties were held by a C corporation. The final phase of the Company's restructuring plans involves the conversion of ILM Holding to a REIT for tax purposes. Certain changes to the ownership structure of ILM Holding which are necessary in order for ILM Holding to qualify as a REIT under the Internal Revenue Code are expected to be made in time for ILM Holding to elect REIT status in conjunction with the filing of its calendar 1996 federal tax return. Any future appreciation in the value of the Senior Housing Facilities subsequent to the conversion of ILM Holding to a REIT would not be subject to the built-in gain tax. The built-in gain tax would most likely not be incurred if the properties were to be held for a period of at least 10 years from the date of the conversion of ILM Holding to a REIT. However, since the end of the Company's original anticipated holding period is less than 4 years away, the properties are not expected to be held for an additional 10 years. The Board of Directors may defer the Company's scheduled liquidation date, if in the opinion of a majority of II - 2 the Directors, the disposition of the Company's assets at such time would result in a material under-realization of the value of such assets; provided, however, that no such deferral may extend beyond December 31, 2004. Based on management's current estimate of the increase in the values of the properties which has occurred since April 1994, as supported by independent appraisals, ILM Holding would incur a sizable tax if the properties were sold. Based on these current estimated market values of the operating investment properties, a sale at such values prior to the end of the 10-year holding period could result in a built-in gain tax of as much as $2.9 million. As the holder of a 99% economic interest in ILM Holding, the burden of this built-in gain tax would be primarily borne by the Company. On July 29, 1996, ILM I Lease Corporation and ILM Holding ("the Companies") terminated the property management agreement with AHC covering the eight senior housing facilities leased by ILM I Lease Corporation from ILM Holding. The management agreement was terminated for cause pursuant to the terms of the contract. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. ILM I Lease Corporation 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 $1,250,000, 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 Fund, Inc. guaranteed the payment of the termination fee at issue in these proceedings. The court initially set a trial date of April 28, 1997 but, at AHC's request, rescheduled the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the court issued Orders purporting to enter judgment against the Company and ILM II in the amount of $1,000,000. In so doing, the court effectively canceled the June 23, 1997 trial date. The Orders did not contain any findings of fact or conclusions of law. On July 10, 1997, the Company, ILM II, ILM I Lease Corporation and ILM II Lease Corporation filed a notice of appeal to the United States Court of Appeals for the Fourth Circuit. The Company intends to diligently prosecute the appeal. The eventual outcome of this litigation cannot presently be determined. However, as reported in the Company's report on Form 10-Q for the quarter ended May 31, 1997, the Company has recorded a provision in the amount of $600,000 for the liability which might result from the court's Orders. ILM I Lease Corporation has retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas to be the new manager of the Senior Housing Facilities pursuant to a Management Agreement which commenced on July 29, 1996. 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. The Company has been attempting to continue its restructuring plans by converting ILM Holding to a real estate investment trust ("REIT") for tax purposes. In connection with these plans, on November 21, 1996 the Company requested that PWPI cause PWP Holding to sell all of the stock held by PWP Holding in ILM Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM Holding was completed at an agreed upon fair value of $40,000. With this transfer completed, effective January 23, 1997 ILM Holding recapitalized its common stock and preferred stock by replacing the outstanding shares with 50,000 shares of new common stock and 275 shares of a new class of nonvoting, 8% cumulative preferred stock issued to the Company. The number of authorized shares of preferred and common stock in ILM Holding were also increased as part of the recapitalization. Following the recapitalization, the Company made charitable gifts of one share of the preferred stock in ILM Holding to each of 111 charitable organizations II - 3 so that ILM Holding would meet the stock ownership requirements of a REIT as of January 30, 1997. The preferred stock has a Liquidation Preference of $1,000 per share plus any accrued and unpaid dividends. Dividends on the preferred stock will accrue at a rate of 8% per annum on the original $1,000 Liquidation Preference and will be cumulative from the date of issuance. Since ILM Holding is not expected to have sufficient cash flow in the foreseeable future to make the required dividend payments, it is anticipated that dividends will accrue and be paid at liquidation. At a Board meeting on January 10, 1997, the Advisor at that point in time recommended the immediate sale of the senior housing facilities held by the Company and an affiliated entity, PaineWebber Independent Living Mortgage Inc. II ("ILM II"), by means of a controlled auction to be conducted by PaineWebber, at no additional compensation, with PaineWebber offering to purchase the properties for $127 million, 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 I Lease Corporation (see Note 2) in evaluating the Advisor's proposal, a disinterested, independent investment banker with expertise in healthcare REITs and independent/assisted living financings was engaged. Following comprehensive analysis, the investment banker recommended that the Company decline the Advisor's proposal and instead investigate expansion and restructuring alternatives. After analyzing the Advisor's proposal and the recommendations and other information provided by the independent investment banker, the Boards of the Company and ILM II voted unanimously to decline the Advisor's proposal and to explore the alternatives recommended by the independent investment banker. The Boards declined to seek an immediate sale of the properties because, in the Boards' view, the liquidation price would not reflect the "going concern" value of the Company and ILM II and, therefore, would not maximize shareholder value. In addition, the Boards did not consider it advisable to liquidate the Company and ILM II on the suggested terms three years prior to their scheduled termination date. The Advisor had indicated to the Board in its January 10, 1997 proposal that it would not wish to continue to serve as advisor to the Company and its affiliates if the Company declined to accept the Advisor's proposal. The Company has accepted the resignation of the Advisor, effective as of June 18, 1997. The Advisor has agreed to continue to provide certain administrative services to the Company and its affiliates through August 31, 1997, pursuant to the terms of a transition services agreement entered into with the Company and its affiliates. The Company and its affiliates have also accepted, effective as of June 18, 1997, the resignations of those officers and directors who are employees of or otherwise affiliated with the Advisor or its affiliates. Subsequent to resignation of the Advisor and affiliated persons, the Board of Directors engaged a former employee of PWPI as a consultant to assist in the management of the Company. The Company is currently evaluating various strategic alternatives, including the possibility of becoming self-managed. In addition, the Company and ILM I Lease Corporation are continuing to review various restructuring alternatives that could further increase shareholder value and liquidity. The Company and ILM I Lease Corporation are analyzing a merger of the Company with ILM Holding and are also considering possibly merging the Company with ILM II and ILM I Lease Corporation with ILM II Lease Corporation. In addition, the Company is exploring listing its shares on an exchange or, alternatively, having them trade through NASDAQ. The independent investment banker is also in the process of developing a new reorganization proposal. The Company has not fully evaluated any of these alternatives and is not in a position at this time to recommend any actions to the shareholders. There can be no assurance that the Company will recommend taking any of such actions. The eight properties in which the Company has invested averaged 92% occupancy as of August 31, 1996. As previously reported, 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 25% by the Company and 75% by PaineWebber Independent Living Mortgage Inc. II ("ILM II") from funds previously reserved for such improvements. Leasing gains at Villa 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, ILM I Lease Corporation received the required assisted living licenses. Leasing II - 4 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 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 will not directly affect the operation of the facility, it will likely result in the removal of several trees that currently provide a buffer between the building and the road. Negotiations are currently underway to minimize the removal of trees and to secure a settlement from the county that will pay for installing a new landscape buffer upon the completion of the roadway construction. The Company's net operating cash flow is expected to be relatively stable and predictable now that the master lease structure is in place. The annual base rental payments owed to ILM Holding increased to $6,364,800 effective January 1, 1996 and will remain at that level for the remainder of the lease term. In addition, the Senior Housing Facilities are currently generating gross revenues which are slightly in excess of the specified threshold in the variable rent calculation, as discussed further above, which becomes effective in January 1997. Accordingly, the Company expects that ILM Holding will receive variable rent payments in fiscal 1997. As a result of the status of the Company's net operating cash flow under the current master lease arrangement, the Company is expected to be able to increase its quarterly dividend payment from $0.175 per share to $0.1875 per share effective with the dividend to be paid in January 1997 for the quarter ended November 30, 1996. This expected increase would raise the dividend payment to the equivalent of a 7.5% annual return on the original offering price of the Company's common stock. As noted above, ILM Holding, as Lessor, is responsible for major capital improvements and structural repairs to the Senior Housing Facilities. Management is currently reviewing with the new property management team annual operating budgets and capital expenditure plans, which include an ongoing program to replace air-conditioning units at the Santa Barbara facility and a potential program to upgrade the overall appearance of the Winston-Salem property. In addition, management plans to continue its investigation of the potential for the expansion of the assisted living capacities of the properties in certain markets where demand for assisted living units is particularly high. Depending on the extent of any assisted living expansions deemed appropriate, such plans could result in the need for substantial capital improvement funds. As reported in the Company's report on Form 10-Q for the quarter ended May 31, 1997, the Company's Board of Directors has concluded that obtaining control of adjacent land for future expansion purposes could add significant value to the East Lansing, Raleigh, Omaha and Hot Springs properties. During 1997, the Company entered into agreements to purchase land adjacent to the East Lansing, Raleigh and Omaha properties. In addition, the Company is in the process of obtaining a credit facility of up to $25 million from a major bank which can be used to fund its expansion plans. At August 31, 1996, the Company had cash and cash equivalents of $2,610,000. Such amounts will be used for the working capital requirements of the Company, along with the possible investment in the properties owned by the Company's consolidated affiliate for certain capital improvements, and for dividends to the shareholders. Future capital improvements could be financed from operations or through borrowings, depending on the magnitude of the improvements, the availability of financing and the Company's incremental borrowing rate. The source of future liquidity and dividends to the shareholders is expected to be through master lease payments from ILM I Lease Corporation, interest income earned on invested cash reserves and proceeds from the future sales of the underlying operating investment properties. Such sources of liquidity are expected to be adequate to meet the Company's operating requirements on both a short-term and long-term basis. The Company generally will be obligated to distribute annually at least 95% of its taxable income to its Shareholders in order to continue to qualify as a REIT under the Internal Revenue Code. Results of Operations 1996 Compared to 1995 Net income increased by $16,000 for fiscal 1996 when compared to the prior year. The primary reasons for this increase in net income is a decrease in professional fees incurred during fiscal 1996 net of a decrease in the Company's equity in the income of ILM Holding. Professional fees decreased by $318,000 as a result of the significant amount of legal and tax advisory services incurred in the prior year in connection with the evaluation, selection and implementation of the master lease property ownership structure described above. The Company's equity investee, ILM Holding, now receives II - 5 master lease rental income from ILM I Lease Corporation rather than the revenues from the individual tenants of the Senior Housing Facilities. In addition, under the terms of the master lease, all property operating expenses are now the responsibility of the Lessee. The master lease rental income earned by ILM Holding during fiscal 1996 was $395,000 less than the excess of rental income earned from the Senior Housing Facilities over property operating expenses and property management fees during the prior year. In addition, a decrease in interest income of $45,000 also partially offset the improvement in net income in fiscal 1996. Interest income decreased due to a decline in the average amount of cash and cash equivalents outstanding when compared to the prior year. The decline in outstanding cash reserves was primarily the result of the Company's funding of the $700,000 initial working capital investment in ILM I Lease Corporation on September 1, 1995. 1995 Compared to 1994 Operating loss increased from $918,000 to $954,000 due to an increase in professional fees mainly as a result of certain legal and tax advisory services required in connection with the evaluation, selection and implementation of the master lease property ownership structure described above. The increase in professional fees was offset by an increase in interest income earned on cash equivalents which resulted from higher average cash balances. The Company's equity in income of ILM Holding increased by $1,231,000 as ILM Holding generated rental revenues of $16,239,000 for fiscal 1995, as compared to $14,771,000 for the prior year. This increase of $1,468,000, or 10%, along with a decrease in depreciation and amortization of $234,000, were the primary reasons that the Company's net income improved from $2,904,000 for fiscal 1994 to $4,099,000 for fiscal 1995. The increase in rental revenues was mainly the result of an increase in effective rental rates at certain of the Facilities. Overall portfolio occupancy increased slightly from an average of 87% for fiscal 1994 to 89% for fiscal 1995. The biggest leasing gains were achieved at the Winston-Salem and Raleigh properties. Average occupancy at Winston-Salem improved to 84% for fiscal 1995 from an average level of 65% for the prior year. Likewise, average occupancy at Raleigh increased to 98% from 89% over the same period. The occupancy level at the Peoria property dropped during fiscal 1995 to an average of 82% from a level of 88% for the prior year, and the occupancy level at Sedgwick Plaza declined to 86% for fiscal 1995 from an average of 93% in fiscal 1994. Occupancy levels at Crown Pointe, East Lansing and West Shores remained relatively steady, in the mid-to-high 90% range during both years. However, revenues were up at these stabilized properties because management was able to implement rental rate increases while maintaining stable occupancy levels. Occupancy and rental revenues were relatively unchanged at Villa Santa Barbara due to the pending status of the property's assisted living license, as discussed further above. Depreciation expense decreased due to the full year effect of the change in the cost basis of the Facilities upon the transfer of ownership of the Facilities which occurred in April 1994, as discussed further in the Notes to Financial Statements accompanying this Annual Report. Property operating expenses increased by $300,000, or 4%, for fiscal 1995, partially offsetting the improvement in revenues. The increase in property operating expenses was primarily attributable to higher variable food service, housekeeping, activities and assisted living costs associated with the overall increase in the portfolio occupancy level. However, the change in property operating expenses also reflected a decrease in marketing costs at certain of the Facilities that had achieved stabilized occupancy levels and the effects of certain operating efficiencies implemented at most of the Facilities subsequent to the transfer of ownership. Management and advisory fees incurred by ILM Holding increased by $82,000 as a result of the advisory agreement between ILM Holding and an affiliate of PWPI. Such agreement, which was effective from April 1, 1994 through August 31, 1995, called for fees equal to 0.5% of the Gross Operating Revenues of the Facilities in return for certain administrative services. 1994 Compared to 1993 - --------------------- The Transfers of the Senior Housing Facilities from AHC to the Property Companies in fiscal 1994 resulted in no gain or loss recognition by the Company for financial reporting purposes. As previously reported, under generally accepted accounting principles, the Company has always accounted for its investments in acquisition and construction loans under the equity method, as if such investments were equity interests in a joint venture. Accordingly, the carrying values of such investments have been reduced since inception by non-cash depreciation charges and by payments from AHC, prior to the default in fiscal 1993, in excess of the net cash flow generated by the Senior Housing II - 6 Facilities received pursuant to the guaranty agreement between the Company and AHC. As a result of this accounting treatment, the carrying values of the Company's investments had been reduced below management's estimate of the fair market value of the Senior Housing Facilities as of the effective date of the Transfers. Accordingly, for financial reporting purposes the Company has continued to employ its historical cost basis in accounting for these investments subsequent to the Transfers and has continued to record its share of the operating results of the properties in its statement of income. For federal income tax purposes, the investments have always been carried at the contractually stated principal balances of the Loans. For tax purposes only, a loss will be recognized by the Company in 1994 in the amount by which the stated principal balances of the Loans were reduced as of the date of the Transfers. Net income increased by approximately $762,000 for fiscal 1994, when compared to fiscal 1993, primarily as a result of an increase of approximately $1,151,000 in equity in the income from the properties securing the Company's acquisition and construction loans. This increase is generally the result of increased occupancy and increased rental income at most of the Senior Housing Facilities. Overall portfolio occupancy increased to 89% as of August 31, 1994 from its level of 85% one year earlier. In addition, several properties which have reached stabilized occupancy levels have successfully implemented rental rate increases on all units. A decrease in the aggregate depreciation expense recognized for all of the Facilities also contributed to the improvement in the net operating results of the properties securing the Company's acquisition and construction loans in fiscal 1994. The decrease in depreciation expense is primarily attributable to the change in the depreciable basis of the fixed assets which occurred upon the transfer of the properties from AHC to the Property Companies. The Property Companies recorded the depreciable basis of the properties based on the historical cost basis of the Company's investments in the operating properties as of April 1, 1994. Such basis was significantly lower than the historical cost basis of AHC, mainly due to the reduction in basis recognized by the Company as a result of payments made by AHC pursuant to its guaranty agreement with the Company. As noted above, the Company's net historical cost basis was lower than management's estimate of the fair market value of the investment properties as of the effective date of the Transfers. The favorable change in the operating results of the Senior Housing Facilities was partially offset by an increase in the Company's operating loss of approximately $307,000. This increase in operating loss was primarily the result of a decrease of approximately $81,000 in interest and other income, an increase in professional fees of approximately $214,000 and an increase in general and administrative expenses of approximately $73,000. The decrease in interest and other income was partly due to the disposition in fiscal 1993 of the investment in a U.S. Treasury Note which yielded a significantly higher rate of return than the return on short-term money-market investments. The disposition of the investment in the U.S. Treasury Note also resulted in a gain of approximately $82,000 in fiscal 1993. The decrease in interest income can also be attributed to a decline in the average outstanding balance of the Company's cash and cash equivalents during fiscal 1994. The increase in professional fees expenses was mainly the result of increased legal costs related to the AHC loan defaults and management's efforts to protect the Company's interest in the underlying collateral. The increase in general and administrative expenses was also primarily due to additional costs incurred in connection with the AHC loan defaults. A decline in management fees of approximately $77,000 in the current year also contributed to the increase in net income. Management fee expense decreased due to the reduction in the quarterly dividend, beginning with the quarter ended February 28, 1993, from $0.25 per share to $0.10 per share. The dividend reduction, resulting from the circumstances described above with respect to the loan defaults, reduced the shareholders' rate of return on original shareholders' equity to below 10% per annum. Accordingly, the Advisor has not earned any incentive management fees since the first quarter of fiscal 1993. Item 8. Financial Statements and Supplementary Data (Amended as described under Item 14.) The financial statements and supplementary data are included under Item 14 of this Annual Report. II - 7 PART III Item 10. Directors and Executive Officers of the Registrant (Amended to note resignation of the Advisor and affiliated persons effective June 18, 1997.) Effective after June 18, 1997, there are five directors of the Company, none of whom is 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 ---- ------ --- --------- Lawrence A. Cohen President, Chief Executive Officer and Director 43 5/15/91 Jeffry R. Dwyer Director 50 2/12/90* J. William Sharman, Jr. Director 56 2/12/90* Carl J. Schramm Director 50 12/5/96 Julien G. Redele' Director 61 12/5/96 Walter V. Arnold** Senior Vice President, Chief Financial Officer and Treasurer 49 2/12/90* James A. Snyder** Senior Vice President 51 7/06/92 C. David Carlson** Vice President 48 12/11/95 Dorothy F. Haughey** Secretary 70 2/12/90*
* The date of incorporation of the Company. ** The Company has accepted the resignation of the Advisor effective as of June 18, 1997. The Advisor has agreed to continue to provide certain administrative services to the Company and its affiliates through August 31, 1997, pursuant to the terms of a transition services agreement entered into with the Company and its affiliates. The Company and its affiliates have also accepted, effective as of June 18, 1997, the resignations of those officers and directors who are employees of or otherwise affiliated with the Advisor or its affiliates. (c) Through June 18, 1997, ILM REIT Advisor, Inc., the general partner of the Advisor, assisted the directors and officers of the Company in the management and control of the Company's affairs. ILM REIT Advisor, Inc. was a wholly-owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). The principal executive officers of ILM REIT Advisor, Inc. were as follows: Name Office Age ---- ------ --- Bruce J. Rubin President and Chief Executive Officer 37 Walter V. Arnold Senior Vice President, Chief Financial Officer and Treasurer 49 James A. Snyder Senior Vice President 51 C. David Carlson Vice President 48 (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. III - 1 (e) The business experience of each of the directors and executive officers of the Company and ILM REIT Advisor, Inc. is as follows: Lawrence A. Cohen has served as President, Chief Executive Officer and Director of the Company since 1991. Mr. Cohen is also Vice Chairman and Chief Financial Officer of Capital Senior Living Corp., an affiliate of Capital Senior Management 2, Inc., which is the company that was contracted by ILM I Lease Corporation in July 1996 to perform property management services for the Senior Housing Facilities in which the Company has invested. Mr. Cohen joined Capital Senior Living Corp. in November 1996. Mr. Cohen was President and Chief Executive Officer of PWPI until August 1996. Mr. Cohen joined PWPI in January 1989 as its Executive Vice President and Director of Marketing and Sales. Mr. Cohen is also a member of the board of directors of PaineWebber Independent Living Mortgage Inc. II (ILM II), ILM I Lease Corporation, ILM II 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 has served as a director of the Company since its inception in 1990. 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 II, ILM I Lease Corporation and ILM II 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. J. William Sharman, Jr. has served as a director of the Company since its inception in 1990. Mr. Sharman is the Chairman of the Board and President of Lancaster Hotel Management, L.C., a hotel management company, and Bayou Equities, Inc., a hotel development company. Mr. Sharman served for ten years as Chairman of the Board and President of The Lancaster Group, Inc., a real estate development firm based in Houston, Texas, which is the predecessor of Lancaster Hotel Management, L.C. and Bayou Equities, Inc. Mr. Sharman is Vice Chairman of Small Luxury Hotels, Ltd. of the United Kingdom, an international hotel marketing and reservations firm. Mr. Sharman also presently serves as a director of ILMI and RPI. He has a Bachelor of Science degree in Civil Engineering from the University of Notre Dame. Carl J. Schramm was appointed to fill a newly created seat on the Company's Board of Directors as of December 5, 1996. Mr. Schramm is President of Greenspring Advisors, Inc., a consulting and investment advisory firm serving clients in the managed care, health insurance and health information industries. From 1993 to 1995, Mr. Schramm served as Executive Vice President of Fortis, Inc., a diversified insurance and financial services company. From 1987 through 1992, Mr. Schramm was President of the Health Insurance Association of America, the national trade association of commercial health underwriters. Mr. Schramm currently serves on the boards of HCIA, Inc., LifeRate Systems, Inc., the Rochdale Insurance Group, Physicians Health Corporation and Madison Information Technologies. Mr. Schramm holds a Ph.D. in Economics from the University of Wisconsin and received his J.D. from Georgetown University. Julien G. Redele' was appointed to fill a newly created seat on the Company's Board of Directors as of December 5, 1996. Mr. Redele' is one of the original founders of SFRE, Inc., a Dutch owned real estate investment and development firm which has served since 1963 as advisor to Dutch institutional, corporate and individual investors active in the United States. Mr. Redele' serves as a director of the Island Preservation Partnership. Mr. Redele' attended Westersingel Business School, Rotterdam, where he studied economics, law and finance. 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 III - 2 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. Walter V. Arnold was a Senior Vice President, Chief Financial Officer and Treasurer of the Company and is Senior Vice President and Chief Financial Officer of PWPI which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining PWPI. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas. James A. Snyder was a Senior Vice President of the Company and is a Senior Vice President of PWPI. Mr. Snyder re-joined PWPI in July 1992 having served previously as an officer of PWPI from July 1980 to August 1987. From January 1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation, where he served as the Vice President of Asset Sales prior to re-joining PWPI. From February 1989 to October 1990, he was President of Kan Am Investors, Inc., a real estate investment company. During the period August 1987 to February 1989, Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast Regional Management Inc., a real estate development company. C. David Carlson was a Vice President of the Company and a Vice President of PWPI which he joined in December 1995. From 1987 through 1995, Mr. Carlson was an officer in Belmont Properties, Inc., a Boston-based real estate investment, development and advisory firm. Mr. Carlson graduated from the University of Minnesota in 1977 and received a Master of Science in Real Estate Development degree from the Massachusetts Institute of Technology in 1986. In 1997, Mr. Carlson left PWPI and currently serves as a consultant to the Company. Dorothy F. Haughey was Secretary of the Company and is Assistant Secretary of PaineWebber and Secretary of PWI and PWPI. Ms. Haughey joined PaineWebber in 1962. (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 13. Certain Relationships and Related Transactions (Amended to reflect the resignation of the Advisor effective June 18, 1997.) Through June 18, 1997 (see Item 10) and subject to the supervision of the Company's Board of Directors, assistance with the management of the business of the Company was provided by PaineWebber ILM Advisor, L.P. (the "Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation, and Properties Associates, L.P. ("PA"), a Virginia limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). In addition, the limited partners and holders of certain assignee interests of PA are or have been also officers of PWPI. PWPI is a wholly owned subsidiary of PaineWebber Incorporated ("PWI"). PWI is a wholly owned subsidiary of PaineWebber Group Inc., ("PaineWebber"). For its services in finding and recommending investments, PWPI received a mortgage placement fee equity to 2% of the capital contributions of the company. Mortgage placement fees totaling $1,036,248 were earned by PWPI during the Company's investment acquisition period. In connection with construction loans, a construction loan administration fee of 1% of each construction loan was paid by AHC to PWPI or its affiliates for administering such loan. In connection with acquisition loans, a due diligence fee of 1% of the principal amount of each such loan was paid by AHC to PWPI for III - 3 conducting due diligence activities. Loan administration and due diligence fees totaling $425,141 were paid to PWPI during the Company's investment acquisition period. AHC received an investment fee for providing the Company with the opportunity to invest the available proceeds of the offering in loans. The investment fee is an amount equal to 0.75% of the offering proceeds, and was payable on the date of the Initial Closing. Investment fees earned by AHC totaled $388,603. AHC received a research and analysis fee in connection with the offering equal to 1% of the capital contributions for identifying and analyzing development and acquisition opportunities for Senior Housing Facilities and for reimbursements of certain expenses associated with those activities. The research and analysis fee paid to AHC totaled $518,123. The Advisor was entitled to receive 1% of Disposition Proceeds, as defined, until the shareholders have received dividends of Net Cash equal to their Adjusted Capital Investments, as defined, plus a 12% non-compounded annual return on their Adjusted Capital Investments; all Disposition Proceeds thereafter until the Advisor has received an aggregate of 5% of Disposition Proceeds; and, thereafter, 5% of Disposition Proceeds. Under the Advisory Agreement, the Advisor had specific management responsibilities; to perform day-to-day operations of the Company and to act as the investment advisor and consultant for the Company in connection with general policy and investment decisions. The Advisor will receive an annual Base Fee and an Incentive Fee of 0.25% and 0.25%, respectively, of the capital contributions of the Company, as defined, as compensation for such services. Incentive Fees are subordinated to shareholders' receipt of distributions of net cash sufficient to provide a return equal to 10% per annum. The Advisor earned base management fees totaling $130,000 for the year ended August 31, 1996. Payment of incentive management fees was suspended effective April 15, 1993 in conjunction with a reduction in the Company's quarterly dividend payments. The Advisor and its affiliates were reimbursed for their direct expenses relating to the offering of Shares, the administration of the Company and the acquisition and operations of the Company's real estate investments. 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 $107,000, representing reimbursements to this affiliate for providing such services to the Company. Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provided cash management services with respect to the Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned $6,000 (included in general and administrative expenses) for managing the Company's cash assets during fiscal 1996. Fees charged by Mitchell Hutchins are based on a percentage of invested cash reserves which varies based on the total amount of invested cash which Mitchell Hutchins manages on behalf of PWPI. III - 4 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Amended to account for the Company's investment in ILM Holding, Inc. using the equity method, to clarify the Company's obligation under its guaranty related to the Angeles termination fee litigation, to include an unaudited footnote regarding events subsequent to the date of the independent auditors report, and to include the separate financial statements of ILM Holding, Inc.) (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 by ILM I Lease Corporation 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. IV - 1 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. PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. By: /s/ Lawrence A. Cohen Lawrence A. Cohen President and Chief Executive Officer Dated: November 7, 1997 IV - 2 ANNUAL REPORT ON FORM 10-K Item 14(a)(3) PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. INDEX TO EXHIBITS
Page Number in the Exhibit No. Description of Document Report or Other Reference - ----------- ----------------------- ------------------------- (3) and (4) Prospectus of the Registrant dated June 9, 1989, Filed with the as supplemented, with particular reference to the Commission pursuant to Restated Certificates and Agreement of Limited Rule 424c and Partnership. incorporated herein by reference. (10) Material contracts previously filed as exhibits to Filed with the registration statements and amendments thereto Commission pursuant to of the registrant together with all such contracts Section 13 or 15d of the filed as exhibits of previously filed Form 8-K and Securities Exchange Forms 10-K are hereby incorporated by reference. Act of 1934 and incorporated herein by reference. Contracts regarding retention by ILM I Lease Filed as exhibits 1 and 2 Corporation of Capital Senior Management 2, Inc., to the Current Report on as property manager. Form 8-K dated July 29, 1996 and incorporated herein by reference. (13) Annual Reports to Stockholders No Annual Reports for the year ended August 31, 1996 has been sent to the Stockholders. An Annual Report will be sent to the Stockholders subsequent to this filing. (27) Financial Data Schedule Filed as the last page of EDGAR submission following the Financial Statements and Financial Statement Schedule required by Item 14.
IV - 3 ANNUAL REPORT ON FORM 10-K Item 14(a)(1) and (2) and 14(d) PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES Reference PaineWebber Independent Living Mortgage Fund, Inc.: Report of independent auditors F-2 Balance sheets as of August 31, 1996 and 1995 F-3 Statements of income for the years ended August 31, 1996, 1995 and 1994 F-4 Statements of changes in shareholders' equity for the years ended August 31, 1996, 1995 and 1994 F-5 Statements of cash flows for the years ended August 31, 1996, 1995 and 1994 F-6 Notes to financial statements F-7 ILM Holding, Inc. Report of independent auditors F-23 Balance sheets as of August 31, 1996 and 1995 F-24 Statements of income for the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995 F-25 Statements of changes in shareholders' equity for the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995 F-26 Statements of cash flows for the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995 F-27 Notes to financial statements F-28 Schedule III - Real Estate and Accumulated Depreciation F-36 Other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements, including the notes thereto. F - 1 REPORT OF INDEPENDENT AUDITORS The Shareholders of PaineWebber Independent Living Mortgage Fund, Inc. We have audited the accompanying balance sheets of PaineWebber Independent Living Mortgage Fund, Inc. as of August 31, 1996 and 1995, and the related statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended August 31, 1996. 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 audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PaineWebber Independent Living Mortgage Fund, Inc. at August 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended August 31, 1996, in conformity with generally accepted accounting principles. As described in Note 2, the financial statements as of August 31, 1996 and 1995 and for each of the three years ended August 31, 1996 have been restated to account for the Company's investment in and construction loans to ILM Holding, Inc. on the equity method. /s/ ERNST & YOUNG LLP ERNST & YOUNG LLP Boston, Massachusetts December 10, 1996 Except for Note 2 to which the date is September 30, 1997 F - 2 PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. BALANCE SHEETS August 31, 1996 and 1995 (In thousands)
1996 1995 -------------- ------------- ASSETS Real estate investments - Investment in and construction loans to ILM Holding, Inc. $38,477 $39,737 Cash and cash equivalents 2,610 3,565 Interest and other receivables 353 175 Prepaid expenses and other assets 11 12 -------------- ------------- $41,451 $43,489 ============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable - affiliates 22 144 Accounts payable and accrued expenses 61 128 -------------- ------------- Total liabilities 83 272 Shareholders' equity: Common stock, $0.01 par value, 10,000,000 shares authorized, 7,520,100 shares issued and outstanding 75 75 Additional paid-in capital (net of offering costs) 65,711 65,711 Accumulated deficit (24,418) (22,569) -------------- ------------- Total shareholders' equity 41,368 43,217 -------------- ------------- $41,451 $43,489 ============== =============
See accompanying notes. F - 3 PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. STATEMENTS OF INCOME For the years ended August 31, 1996, 1995 and 1994 (In thousands, except per share amounts)
1996 1995 1994 ------------- ------------ ------------ Revenues: Interest income earned on cash equivalents $ 129 $ 174 $ 85 Expenses: Management fees 88 89 94 General and administrative 313 340 356 Insurance expense 30 42 48 Professional fees 315 633 477 Director compensation 24 24 24 Amortization expense -- -- 4 ------------- ------------ ----------- 770 1,128 1,003 ------------- ------------ ------------ Operating loss (641) (954) (918) Equity in income of properties securing construction loans 4,756 5,053 3,822 ------------- ----------- ------------ Net income: $4,115 $4,099 $2,904 ============= ============ ============ Earnings per share of common stock $ 0.55 $ 0.54 $ 0.39 ============= ============ ============ Cash dividends paid per share of common stock $ 0.70 $ 0.71 $ 0.40 ============= ============ ============
The above earnings and cash dividends paid per share of common stock are based upon the 7,520,100 shares outstanding during each year. See accompanying notes. F - 4 PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the years ended August 31, 1996, 1995 and 1994 (In thousands, except per share amounts)
Common Stock Additional $.01 Par Value Paid-in Accumulated Shares Amount Capital Deficit Total ------------- ------------ --------------- -------------- --------------- Shareholders' equity at August 31, 1993 7,520,100 $75 $65,711 $(22,233) $43,553 Cash dividends paid - - - (3,008) (3,008) Net income - - - 2,904 2,904 ------------- --------- --------------- ---------------- --------------- Shareholders' equity at August 31, 1994 7,520,100 75 65,711 (22,337) 43,449 Cash dividends paid - - - (5,302) (5,302) Net income - - - 4,099 4,099 Adjustment to eliminate reporting lag for combined facilities' operations (Note 4) - - - 971 971 ------------- --------- --------------- ---------------- --------------- Shareholders' equity at August 31, 1995 7,520,100 75 65,711 (22,569) 43,217 Cash dividends paid - - - (5,264) (5,264) Distribution of stock in ILM I Lease Corporation (Note 4) - - - (700) (700) Net income - - - 4,115 4,115 ------------- --------- --------------- ---------------- --------------- Shareholders' equity at August 31, 1996 7,520,100 $75 $65,711 $(24,418) $41,368 ============= ========= =============== ================ ===============
See accompanying notes. F - 5 PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. STATEMENTS OF CASH FLOWS For the years ended August 31, 1996, 1995 and 1994 Increase (Decrease) in Cash and Cash Equivalents (In thousands)
1996 1995 1994 ------------ ----------- ----------- Cash flows from operating activities: Net income $4,115 $4,099 $2,904 Adjustments to reconcile net income to net cash provided by operating activities: Equity in income of properties securing construction loans (4,756) (5,053) (3,822) Amortization expense - - 4 Changes in assets and liabilities: Interest and other receivables (178) (167) 29 Prepaid expenses and other assets 1 (12) 43 Accounts payable - affiliates (122) 119 (130) Accounts payable and accrued expenses (67) 21 39 ------------ ----------- ----------- Total adjustments (5,122) (5,092) (3,837) ------------ ----------- ----------- Net cash used in operating activities (1,007) (993) (933) Cash flows from investing activities Initial investment in ILM I Lease Corporation (700) - - Net proceeds from full satisfaction of claims against Angeles Corporation and affiliates - 1,422 - Additional fundings of construction loans (106) (170) (939) Contractual payments received from construction loans 6,122 6,310 4,379 ------------ ----------- ----------- Net cash provided by investing activities 5,316 7,562 3,440 Cash flows from financing activities: Cash dividends paid to shareholders (5,264) (5,302) (3,008) ------------ ----------- ----------- Net cash used in financing activities (5,264) (5,302) (3,008) ------------ ----------- ----------- Net (decrease) increase in cash and cash equivalents (955) 1,267 (501) Cash and cash equivalents, beginning of year 3,565 2,298 2,799 ------------ ----------- ----------- Cash and cash equivalents, end of year $2,610 $3,565 $2,298 ============ =========== ===========
See accompanying notes. F - 6 PAINEWEBBER INDEPENDENT LIVING MORTGAGE FUND, INC. Notes to Financial Statements 1. Nature of Operations PaineWebber Independent Living Mortgage Fund, Inc. (the "Company") was organized as a corporation on March 6, 1989 under the laws of the State of Virginia. On June 21, 1989 the Company commenced a public offering of up to 10,000,000 shares of its common stock at $10 per share, pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933 (Registration Statement No. 33-27653). The public offering terminated on July 21, 1989 with a total of 7,520,100 shares issued. The Company received capital contributions of $75,201,000, of which $201,000 represented the sale of 20,100 shares to an affiliate, Paine Webber Group, Inc. ("PaineWebber"). As of November 1, 1996, PaineWebber and its affiliates held 165,344 shares of the Company's common stock. The Company has elected to qualify and be taxed as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended, for each taxable year of operations (see Note 2). The Company originally invested the net proceeds of the initial public offering in eight participating mortgage loans secured by Senior Housing Facilities located in seven different states. All of the loans made by the Company were originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of Senior Housing Facilities. The Company entered into an Exclusivity Agreement with AHC and its parent company, Angeles Corporation ("Angeles"), which required AHC to provide the Company with certain specific opportunities to finance Senior Housing Facilities and set forth the terms and conditions of the loans which were made. The loan documents under the aforementioned Exclusivity Agreement called for interest to be paid on construction loans at the rate of 13% per annum during the construction period and for Base Interest to be paid on the permanent loans at the rate of 10% per annum. In addition to the Base Interest, Additional Interest was to be payable on the permanent loans in an amount equal to 10% of the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms of the amended Exclusivity Agreement, Additional Interest was to be no less than 3% of the aggregate principal amount of all permanent loans outstanding for the entire term of the investments. In the aggregate, the properties securing loans from the Company did not generate sufficient cash flow to cover the debt service payments owed to the Company under the amended terms of the Exclusivity Agreement. To the extent that the properties did not generate sufficient cash flow to make the full payments due under the loan documents, the shortfall was funded by AHC through December 1992. The source of cash to make up these shortfalls was from specified deficit reserve accounts, which had been funded from the proceeds of the mortgage loans, and from contributions by Angeles. During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on the Company's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. The Company retained special counsel and held extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding settlement agreement between the Company, AHC and Angeles was reached whereby ownership of the properties would be transferred from AHC to the Company or its designated affiliates. Under the terms of the Settlement Agreement, the Company released AHC and Angeles from certain obligations under the loans. On April 27, 1994, each of the properties owned by AHC and securing the Loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with the Company (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994 and were made pursuant to the Settlement Agreement entered into on February 17, 1994 ("the Settlement Agreement") between the Company and AHC which had previously been approved by the bankruptcy court handling the bankruptcy case of Angeles. All of the capital stock of each Property Company was held by ILM Holding, Inc. ("ILM Holding"), a Virginia corporation. In August 1995, each of the Property Companies merged into ILM Holding. As a result, ownership of the Senior Housing Facilities is now held by ILM Holding, and the Property Companies no longer exist as separate legal entities. The capital stock of ILM Holding is owned by the Company and F - 7 PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The Company holds substantially all of the economic ownership in ILM Holding, while PWP Holding holds voting control. ILM Holding issued 100 shares of Series A Preferred Stock to the Company in return for a capital contribution in the amount of $693,000 and issued 10,000 shares of Common Stock to PWP Holding in return for a capital contribution in the amount of $7,000. The holders of the Series A Preferred Stock are entitled to one vote for each share of Preferred Stock held. In addition, the holders of the Series A Preferred Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an aggregate amount equal to 99% of the total amount of dividends and distributions made to all shareholders. The holders of the Common Stock are entitled to one vote for each share of Common Stock held. The holders of the Common Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an aggregate amount equal to 1% of the total amount of dividends and distributions made to all shareholders. As part of the fiscal 1994 settlement agreement with AHC, ILM Holding retained AHC as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement. As discussed further in Note 5, the management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, management investigated and evaluated the available options for structuring the ownership of the properties in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a REIT under the Internal Revenue Code (see Note 2). As discussed further in Note 4, on September 12, 1994 the Company formed a new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation effective September 1, 1995 (see Note 4 for a description of the master lease agreement). 2. Change in Accounting Principle The financial position and results of operations of ILM Holding were previously consolidated with those of the Company for financial reporting purposes because the Company has substantially all of the economic ownership in ILM Holding. However, because the Company does not hold majority voting control, it determined that accounting for its investment in ILM Holding using the equity method would be more appropriate. As a result, the accompanying financial statements have been restated to account for the Company's investment in ILM Holding using the equity method. Under the equity method, the Company's investment in ILM Holding is carried at cost, including the face amount of the mortgage loans, adjusted for the Company's share of ILM Holding's earnings, losses and distributions. 3. Use of Estimates and Summary of Significant Accounting Policies The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of August 31, 1996 and 1995 and revenues and expenses for each of the three years in the period ended August 31, 1996. Actual results could differ from the estimates and assumptions used. F - 8 A. BASIS OF PRESENTATION The operating cycle in the real estate industry is longer than one year and the distinction between current and non-current is of little relevance. Accordingly, the accompanying consolidated balance is presented in an unclassified format. B. INCOME TAXES The Company has elected to qualify and to be taxed as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended, for each taxable year of operations. As a REIT, the Company is allowed a deduction for the amount of dividends paid to its shareholders, thereby effectively subjecting the distributed net taxable income of the Company to taxation at the shareholder level only, provided it distributes at least 95% of its taxable income and meets certain other requirements for qualifying as a real estate investment trust. In connection with the settlement agreement described in Note 1, the Company, through its consolidated affiliate, obtained title to the properties securing its mortgage loan investments. To retain REIT status, the Company must ensure that 75% of its annual gross income is received from qualified sources. Under the original investment structure, interest income from the Company's mortgage loans was a qualified source. The properties that are now owned by an affiliate of the Company are Senior Housing Facilities that provide tenants with more services, such as meals, activities, assisted living, etc., than are customary for ordinary residential apartment properties. As a result, a significant portion of the rents paid by the tenants includes income for the increased level of services received by them. Consequently, the rents paid by the tenants likely would not be qualified rents for REIT qualification purposes if received directly by the Company. Therefore, if the Company received such rents directly, it could lose REIT status and be taxed as a regular corporation. After extensive review, the Board of Directors determined that it would be in the best interests of the shareholders for the Company to retain REIT status and master lease the properties to a shareholder-owned operating company. As discussed further in Note 4, on September 12, 1994 the Company formed a new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation effective September 1, 1995 (see Note 4 for a description of the master lease agreement). The assumption of ownership of the properties through ILM Holding, which is presently a regular C corporation for tax purposes, has resulted in a possible future tax liability which would be payable upon the ultimate sale of the properties (the "built-in gain tax"). The amount of such tax would be calculated based on the lesser of the total net gain realized from the sale transaction or the portion of the net gain realized upon a final sale which is attributable to the period during which the properties were held by in a C corporation. The final phase of the Company's restructuring plans involves the conversion of ILM Holding to a REIT for tax purposes. Certain changes to the ownership structure of ILM Holding which are necessary in order for ILM Holding to qualify as a REIT under the Internal Revenue Code are expected to be made in time for ILM Holding to elect REIT status in conjunction with the filing of its calendar 1996 federal tax return. Any future appreciation in the value of the Senior Housing Facilities subsequent to the conversion of ILM Holding to a REIT would not be subject to the built-in gain tax. The built-in gain tax would most likely not be incurred if the properties were to be held for a period of at least 10 years from the date of the conversion of ILM Holding to a REIT. However, since the end of the Company's original anticipated holding period is less than 4 years away, the properties are not expected to be held for an additional 10 years. The Board of Directors may defer the Company's scheduled liquidation date, if in the opinion of a majority of the Directors, the disposition of the Company's assets at such time would result in a material under-realization of the value of such assets; provided, however, that no such deferral may extend beyond December 31, 2004. Based on management's current estimate of the increase in the values of the properties which has occurred since April 1994, as supported by independent appraisals, ILM Holding would incur a sizable tax if the properties were sold. Based on these current estimated market values of the operating investment properties, a sale at such values prior to the end of the 10-year holding period could result in a built-in gain tax of as much as $2.9 million. As the holder of a 99% economic interest in ILM Holding, the burden of this built-in gain tax would be primarily borne by the Company. F - 9 The Company's affiliate, ILM Holding, has incurred losses for tax purposes since inception. Neither the Company nor ILM Holding is likely to be able to use these losses to offset future tax liabilities. Accordingly, no income tax benefit is reflected in these consolidated financial statements. The Company reports on a calendar year basis for income tax purposes. During calendar 1995, the Company distributed $0.78 per share in cash and $0.15 per share in shares of ILM I Lease Corporation. The tax status of these dividends amounted to an ordinary taxable dividend of approximately $0.64 per share and a tax free return of capital of approximately $0.29 per share. The Company anticipates that all distributions during calendar 1996 will be ordinary taxable dividends. C. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include all highly liquid investments with original maturities of 90 days or less. D. OFFERING COSTS Offering costs consist primarily of selling commissions and other costs such as printing and mailing costs, legal fees, filing fees and other marketing costs associated with the offering of shares. Selling commissions were equal to 8% of the gross proceeds raised through the public offering. Commissions totaling $6,000,000 were paid to PWI in connection with the sale of shares. All of the offering costs are shown as a reduction of shareholders' equity. E. FAIR VALUE DISCLOSURES FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS 107"), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amount reported on the balance sheet for cash and cash equivalents approximates its fair value due to the short-term maturities of such instruments. Accounts payable - affiliates: The carrying amount reported on the balance sheet for accounts payable affiliates approximates its fair value due to the short-term maturity of such instrument. 4. The Advisory Agreement and Related Party Transactions Subject to the supervision of the Company's Board of Directors, assistance in managing the business of the Company is provided by PaineWebber ILM Advisor, L.P. (the "Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation, and Properties Associates, L.P. ("PA"), a Virginia limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). In addition, the limited partners and holders of assignee 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"). The Advisor and its affiliates receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the shares, the management of the Company and the F - 10 acquisition, management and disposition of the Company's investments. The type of compensation to be paid by the Company to the Advisor and its affiliates under the terms of the Advisory Agreement is as follows: 1. 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 an annual Base Fee and an Incentive Fee of 0.15% and 0.45%, respectively, of the Gross Assets of the Company, as defined, as compensation for such services. Incentive Fees are subordinated to shareholders' receipt of distributions of net cash sufficient to provide a return equal to 10% per annum. The Advisor earned base management fees totaling $88,000, $89,000 and $94,000 for the years ended August 31, and 1994, respectively. Payment of incentive management fees was suspended effective April 15, 1993 in conjunction with a reduction in the Company's quarterly dividend payments. 2. For its services in finding and recommending investments, PWPI received mortgage placement fees equal to 2% of the capital contributions. Mortgage placement fees totaling $1,504,000 were earned by PWPI during the Company's investment acquisition period. Such fees have been capitalized and are included in the cost of the operating investment properties on the accompanying consolidated balance sheet. 3. For its administrative services with respect to all loans, PWPI received loan servicing fees equal to 1% of capital contributions. Loan servicing fees totaling $752,010 were earned by PWPI during the Company's investment acquisition period. Such fees have been capitalized and are included in the cost of the operating investment properties on the accompanying consolidated balance sheet. 4. In connection with the construction of Senior Housing Facilities, PWPI received a fee, paid directly by AHC, equal to 1% of the principal amount of each construction loan for administering construction loans made by the Company. Such fees received by PWPI totaled $431,000 during the Company's investment acquisition period. 5. The Advisor will be entitled to receive 1% of Disposition Proceeds, as defined, until the shareholders have received dividends of Net Cash equal to their Adjusted Capital Investments, as defined, plus a 12% non-compounded annual return on their Adjusted Capital Investments, all Disposition Proceeds thereafter until the Advisor has received an aggregate of 5% of Disposition Proceeds; and, thereafter, 5% of Disposition Proceeds. Included in management and advisory fees for the year ended August 31, 1995 are advisory fees of $114,000 earned by an affiliate of PWPI for its administration and supervision of the day-to-day operations of ILM Holding. Such fees were equal to 0.5% of the Gross Operating Revenues of the Senior Housing Facilities. These advisory fees were no longer charged to ILM Holding effective September 1, 1995 upon the commencement of the master lease described in Note 4. The Advisor and its affiliates are reimbursed for their direct expenses relating to the offering of Shares, the administration of the Company and the acquisition and operations of the Company's real estate investments. Included in general and administrative expenses on the accompanying statements of income for the years ended August 31, 1996, 1995 and 1994 is $142,000, $166,000 and $175,000, respectively, representing reimbursements to an affiliate of the Advisor for providing certain financial, accounting and investor communication services to the Company. Mitchell Hutchins Institutional Investors, Inc. ("Mitchell Hutchins") provides cash management services with respect to the Company's cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned $13,000, $4,000 and $7,000 (included in general and administrative expenses) for managing the Company's cash assets during fiscal 1996, 1995 and 1994, respectively. Accounts payable - affiliates at August 31, 1996 consists of management fees of $22,000 owed to the Advisor for the quarter ended August 31, 1996. Accounts payable - affiliates at August 31, 1995 includes management fees of $22,000 owed to the Advisor for the quarter ended August 31, 1995, $4,000 of out-of-pocket expense reimbursements payable to F - 11 PWPI and $84,000 payable to an affiliated company, PaineWebber Independent Living Mortgage Inc. II (ILM2), for advances made by ILM2 on behalf of the Company to the Villa Santa Barbara Senior Housing Facility. 5. Investment in ILM Holding, Inc. The Company had made certain mortgage loans (collectively, "the Loans") to Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of Senior Housing Facilities. The Company entered into an Exclusivity Agreement with AHC and its parent company, Angeles Corporation ("Angeles"), which required AHC to provide the Company with certain specific opportunities to finance Senior Housing Facilities and set forth the terms and conditions of the loans which were made. The Company's loans were secured by first mortgages on the Senior Housing Facilities and a security interest in all tangible personal property. During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that had resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to the Company on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on the Company's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. During fiscal 1993 and continuing in fiscal 1994, the Company retained special counsel and had extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding settlement agreement between the Company, AHC and Angeles was reached whereby title to ownership of the properties would be transferred from AHC to the Company. On April 27, 1994, each of the properties owned by AHC and securing the Loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with the Company (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994. The Transfers were made pursuant to the Settlement Agreement entered into on February 17, 1994 ("the Settlement Agreement") between the Company and AHC, and previously approved by the bankruptcy court handling the bankruptcy case of Angeles. Conveyance documents relating to the Transfers were placed in escrow on February 17, 1994 pending the completion of certain due diligence procedures. This due diligence process included the setting up of appropriate entities to take title to the individual properties as well as the completion of the licensing requirements for each facility. On April 27, 1994, the due diligence process was completed, escrow was broken and the Transfers were effected. Under the terms of the Settlement Agreement, the Company released AHC and Angeles from certain obligations under the Loans. All of the capital stock of each Property Company is held by ILM Holding, Inc. ("ILM Holding"), a newly-formed Virginia corporation. The capital stock of ILM Holding is owned by the Company and PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PWPI. The Company holds substantially all of the economic ownership in ILM Holding, while PWP Holding holds voting control. ILM Holding has issued 100 shares of Series A Preferred Stock to the Company in return for a capital contribution in the amount of $693,000. The holders of the Series A Preferred Stock are entitled to one vote for each share of Preferred Stock held. In addition, the holders of the Series A Preferred Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an amount per share equal to the product of 0.1 and 99% of the total amount of dividends and distributions made to all shareholders. ILM Holding has also issued 10,000 shares of Common Stock to PWP Holding in return for a capital contribution in the amount of $7,000. The holders of the Common Stock are entitled to one vote for each share of Common Stock held. The holders of the Common Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an amount per share equal to the product of 0.001 and 1% of the total amount of dividends and distributions made to all shareholders. Each Property Company acquired the respective operating property subject to, and assumed the obligations under, the Loan payable to the Company. The principal balance of each Loan was modified to reflect the estimated fair value of the related operating property as of the date of the Transfers. The modified Loans require interest-only payments on a monthly basis at a rate of 9.5% from April 1, 1994 through December 31, 1994, 11% for the period January 1 through December 31, 1995, 12.5% for the period January 1 through December 31, 1996, 13.5% for the period January 1 through December 31, 1997, 14% for the period January 1 through December 31, 1998, and 14.5% for the period January 1, 1999 through maturity, on December 31, 1999. F - 12 Management expects the property ownership structure described above to be in place only temporarily. Since the time that the Company reached agreement with AHC regarding the terms of the Settlement Agreement, management has been investigating and evaluating the available options for structuring the ownership of the properties in order to maximize the potential returns to the existing shareholders while maintaining the Company's qualification as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code. The Board of Directors has identified what it believes is the best structure to accomplish these objectives, and the Company is in the process of implementing that structure as of the date of this report. Certain changes to the presentation of the Company's financial position and results of operations will be required once the aforementioned permanent property ownership structure is effected. The Transfers of the Senior Housing Facilities from AHC to the Property Companies in fiscal 1994 resulted in no gain or loss recognition by the Company for financial reporting purposes. As stated above, under generally accepted accounting principles, the Company has always accounted for its investments in acquisition and construction loans under the equity method, as if such investments were equity interests in a joint venture. Accordingly, the carrying values of such investments have been reduced since inception by non-cash depreciation charges and by payments from AHC, prior to the default in fiscal 1993, in excess of the net cash flow generated by the Senior Housing Facilities received pursuant to the guaranty agreement between the Company and AHC. As a result of this accounting treatment, the carrying values of the Company's investments had been reduced below management's estimate of the fair market value of the Senior Housing Facilities as of the effective date of the Transfers. Accordingly, for financial reporting purposes the Company has continued to employ its historical cost basis in accounting for these investments subsequent to the Transfers and has continued to record its share of the operating results of the properties in its statement of income. For federal income tax purposes, the investments have always been carried at the contractually stated principal balances of the Loans. For tax purposes only, a loss will be recognized by the Company in 1994 in the amount by which the stated principal balances of the Loans were reduced as of the date of the Transfers (see discussion below). Based on the initial economic structure of the loan transactions and the expected future allocations of cash flows between the Company and AHC, management originally estimated that the Company's allocable share of the earnings or losses of the properties securing the loan investments was approximately 90% of the total earnings or losses (including depreciation expense) of such properties. As a result of the loan defaults and the Settlement Agreement discussed further above, management believes that the initial economic structure of the Company's investments has changed and, accordingly, the Company has recognized 100% of the earnings or losses of the underlying operating properties in the accompanying income statements for fiscal 1994 and are reported within Investment In and Construction Loans to ILM Holding, Inc. on the accompanying balance sheet. F - 13 The following mortgage loans were outstanding at August 31, 1996 and 1995:
Property Pledged Date of as Collateral 8/31/96 8/31/95 Loans ------------- ------- ------- ----- Independence $8,950,000 $8,950,000 6/29/89 Village of East Lansing, MI Independence 5,750,000 5,750,000 6/29/89 Village of Winston-Salem, NC Independence 8,350,000 8,350,000 4/29/91 Village of Raleigh, NC Independence 8,350,000 8,350,000 11/30/90 Village of Peoria, IL Crown Pointe 8,200,000 8,200,000 2/14/90 Apartments Omaha, NE Sedgwick Plaza 8,350,000 8,350,000 2/14/90 Apartments Wichita, KS West Shores 5,350,000 5,350,000 12/14/90 Hot Springs, AR Villa Santa Barbara Santa Barbara, CA 1,698,000 1,592,000 7/13/92 ------------ ------------ 54,998,000 54,892,000 Less discount (14,607,000) (14,607,000) ------------ ------------ $40,391,000 $40,285,000 ============ ============
A discount was recorded on the long-term debt in the amount by which the modified principal amount of the loans exceeded the historical cost basis of the properties at the time of the Transfers. Descriptions of the properties financed by the Company's loans are summarized below: Independence Village of East Lansing ------------------------------------ In June 1989, the Company acquired a Loan with respect to a 159-unit Senior Housing Facility known as Independence Village of East Lansing located in East Lansing, Michigan. Construction of the Senior Housing Facility, which was 91% leased as of August 31, 1996, was completed in May, 1989. F - 14 Independence Village of Winston-Salem ------------------------------------- In June 1989, the Company acquired a loan with respect to a 156-unit Senior Housing Facility known as Independence Village of Winston-Salem located in Winston-Salem, North Carolina. Construction of the Senior Housing Facility, which was 93% leased as of August 31, 1996, was completed in February, 1989. Independence Village of Raleigh ------------------------------- In December 1989, the Company acquired a loan with respect to a 163-unit Senior Housing Facility, known as Independence Village of Raleigh, located in Raleigh, North Carolina. The original closing of the construction loan occurred on December 18, 1989. Construction of the Senior Housing Facility, which was 98% leased as of August 31, 1996, was completed in March, 1991. The Company's investment was converted from a construction loan to a permanent loan effective April 29, 1991. Independence Village of Peoria ------------------------------ In December 1989, the Company acquired a loan with respect to a 164-unit Senior Housing Facility known as Independence Village of Peoria located in Peoria, Illinois. The original closing of the construction loan occurred on December 18, 1989. Construction of the Senior Housing Facility, which was 91% leased as of August 31, 1996, was completed in November, 1990. The Company's investment was converted from a construction loan to a permanent loan effective November 30, 1990. Crown Pointe ------------ In February 1990, the Company acquired a loan with respect to an existing 133-unit Senior Housing Facility known as Crown Pointe Apartments located in Omaha, Nebraska. The Senior Housing Facility, which was 99% leased as of August 31, 1996, was opened in August of 1985. Sedgwick Plaza -------------- In February 1990, the Company acquired a loan with respect to an existing 150-unit Senior Housing Facility known as Sedgwick Plaza Apartments located in Wichita, Kansas. The Senior Housing Facility, which was 83% leased as of August 31, 1996, was opened in May of 1985. West Shores ----------- In December 1990, the Company acquired a loan with respect to an existing 134-unit Senior Housing Facility known as West Shores located in Hot Springs, Arkansas. The Senior Housing Facility, which was 94% leased as of August 31, 1996, was opened in June of 1987. Santa Barbara ------------- In July 1992, the Company acquired an A&C Loan with respect to an existing 123-unit Senior Housing Facility known as Villa Santa Barbara located in Santa Barbara, California. The acquisition and improvement of the facility was financed by the aforementioned loan and another loan from an affiliated company, PaineWebber Independent Living Mortgage Inc. II (ILM2). Any amounts due from the borrower with regard to the mortgage loans on the Santa Barbara property will be equitably apportioned between the Company and ILM2 (generally 25% to the Company and 75% to ILM2). The Company and ILM2 have entered into a Intercreditor Agreement to set forth their respective rights and entitlements under the loan documents. The Senior Housing Facility, which was 81% leased as of August 31, 1996, was opened in June of 1979. F - 15 Other Information Regarding Mortgage Loans: The Settlement Agreement calls for AHC to be retained in a property management capacity under a contract covering the operating properties (the "Management Contract"). The terms of the Management Contract provide that AHC will receive a base management fee (the "Base Management Fee") equal to 5.5% of Gross Operating Revenues, as defined. In addition, AHC is eligible to earn additional compensation through a 25% participation in excess cash flow or sale or refinancing proceeds above specified levels. The thresholds at which AHC would begin to participate in excess cash flow or sale or refinancing proceeds have been set at levels which provide that the Company would receive all amounts to which it was originally entitled under the terms of the Exclusivity Agreement on a cumulative basis before such participation begins. The Property Companies have the right to terminate the Management Contract for cause at any time and can terminate the agreement without cause upon 30 days' written notice to AHC. The Property Companies can also terminate the Management Contract immediately if certain current executive officers of AHC do not remain in their present capacities. Furthermore, the Property Companies have the option of terminating the Management Contract any time after December 31, 1994 by giving 30 days' written notice following any fiscal quarter for which the net operating income level of each operating property fails to equal or exceed certain specified levels. If the Management Contract were terminated on or before June 30, 1995, without cause or because the specified executive officers failed to remain employed by AHC, AHC would be entitled to receive a termination fee equal to 24 months Base Management Fee calculated based on annualized Gross Operating Revenue for the three calendar months immediately preceding such termination. Under these circumstances the termination fee declines to 18 months Base Management Fee after June 30, 1995 and to 12 months Base Management Fee after June 30, 1996. If the Management Contract is terminated because the net operating income levels are below the specified amounts, the termination fees described above would be subject to reduction to between 75% and 0% of the applicable amount depending on the magnitude of the net income shortfall. The Company has guaranteed payment of the termination fee. Condensed balance sheets of ILM Holding, Inc. as of August 31, 1996 and 1995 are presented as follows: Assets ------
August 31, 1996 August 31, 1995 --------------- --------------- Current Assets $ 1,104 $ 1,861 Operating Investment Properties, net 38,214 39,323 --------- --------- $39,318 $41,184 ========= ========= Liabilities and Shareholders' Equity (Deficit) ---------------------------------------------- Current liabilities $ 588 $ 835 Long term debt 40,391 40,285 Shareholders' equity (deficit) (1,661) 64 --------- --------- $ 39,318 $41,184 ========= ========= F - 16 Reconciliation of Company's Investment -------------------------------------- Company's share of capital at August 31, 1996 (1,661) Excess basis due to investment in and construction loans to ILM Holding, Inc. (1) 584 Company's share of investee's current liabilities and long-term debt 40,976 Permanent difference due to settlement of claims with Angeles Corporation and affiliates (2) (1,422) --------- Investment in and construction loans to ILM Holding, Inc. $ 38,477 =========
(1) The Company's investment in and construction loans to ILM Holding, Inc. includes amounts representing acquisition fees and other expenses incurred by the Company in connection with the acquisition of the construction loans encumbering the ILM Holding, Inc. properties. Excess basis is being amortized over the term of the loans. (2) As described in Note 5 under Angeles Corporation Litigation. Summarized operations of the investment properties securing the Company's A&C Loans for the year ended August 31, 1996, the two months ended August 31, 1995, and the years ended June 30, 1995 and 1994 are as follows: Condensed Summary of Operations -------------------------------
Year ended Two months ended Year ended Year ended August 31, 1996 August 31, 1995 June 30, 1995 June 30, 1994 --------------- --------------- ------------- ------------- Revenues $ 6,344 $2,753 $16,264 $14,774 Operating Expenses - 1,542 9,541 9,138 Depreciation expense 1,290 227 1,364 1,589 Interest expense 6,707 1,046 5,673 7,090 Management advisory fees - 13 81 - General and administrative 72 - - - --------- ------- -------- -------- Net loss $(1,725) $ (75) $ (395) $(3,043) ======== ======= ======== ======== Company's share of loss $(1,725) $ (75) $ (395) $(3,043) Borrowers' share of loss - - - - --------- ------- ------- -------- $(1,725) $ (75) $ (395) $(3,043) ========= ======= ======== ======== Reconciliation of Company's Share of Income - ------------------------------------------- Company's share of loss as shown above $(1,725) $ (75) $ (395) $(3,043) Interest on mortgage loans issued by the Company 6,707 1,046 5,673 7,090 Amortization of excess basis (226) - (225) (225) -------- ------- -------- -------- Equity in income from properties mortgage loans $ 4,756 $ 971 $ 5,053 $ 3,822 ======== ======= ======== ========
F - 17 As discussed earlier, on September 12, 1994 the Company formed a new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation effective September 1, 1995 (see Item 7 for a description of the master lease agreement). A condensed balances sheet as of August 31, 1996 and summary of operations for the year then ended of ILM I Lease Corporation are as follows: Assets ------ August 31, 1996 --------------- Current Assets $2,529 Furniture, fixtures and equipment 242 Other non-current assets 26 ------ $2,797 ====== Liabilities and Shareholders' Equity ------------------------------------ Current liabilities $1,613 Other non-current liabilities 123 Shareholders' equity 1,061 ------ $2,797 ====== Summary of Operations --------------------- Year ended August 31, 1996 --------------- Revenues $17,285 Operating expenses 16,682 Income tax expense 241 ------- Net income $ 362 ======= 6. Legal Proceedings and Contingencies Angeles Corporation Litigation Angeles had guaranteed certain of the obligations of AHC under the terms of the Exclusivity Agreement described in Note 1. Under the terms of the Settlement Agreement discussed in Note 1, the Company retained a general unsecured claim against Angeles in the amount of $1,513,935 as part of the bankruptcy proceedings, but waived all other claims against Angeles, including any amounts of base and additional interest owed. In addition, the Company maintained a claim for approximately $592,000 against an affiliate of Angeles which had made a separate guaranty to the Company. On March 17, 1995, the Bankruptcy Court handling the Angeles bankruptcy proceedings approved a final settlement of the Company's outstanding claims against Angeles and its affiliates. Pursuant to the terms of this settlement, the Company received a cash payment of $1.5 million on April 14, 1995 in full satisfaction of the claims, which totaled approximately $2.1 million. This amount, net of certain related legal expenses, was recorded as a reduction in the carrying values of the operating investment properties. F - 18 Termination of Management Contract with AHC On July 29, 1996, ILM I Lease Corporation and ILM Holding, Inc. ("the Companies") terminated the property management agreement with AHC covering the eight senior housing facilities leased by ILM I Lease Corporation from ILM Holding, the Company's consolidated affiliate. The management agreement was terminated for cause pursuant to Sections 1.05 (a) (i), (iii) and (iv) of the agreement. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. ILM I Lease Corporation 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 $1,250,000, 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. In the event ILM I Lease Corporation cannot perform its obligation to pay such amounts, PaineWebber Independent Living Mortgage Fund, Inc. guaranteed the payment of any termination fee the court deems to be owed as a result of these proceedings; however, management believes that ILM I Lease Corporation has the ability to perform under the terms of the management agreement in the event of an unfavorable outcome to this litigation and the probability of PaineWebber Independent Living Mortgage Inc. II incurring a loss under the terms of its guaranty is remote. The Companies intend to diligently prosecute the case and to vigorously defend the counterclaims made by AHC. The eventual outcome of this termination dispute cannot presently be determined. Accordingly, no provision for any liability which might result from the Company's guaranty of the termination fee has been recorded in the accompanying financial statements. ILM I Lease Corporation has retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas to be the new manager of the Senior Housing Facilities pursuant to a Management Agreement which commenced on July 29, 1996. 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. Effective in November, 1996 Lawrence A. Cohen , President, Chief Executive Officer and Director of the Company, was also named Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation, an affiliate of Capital. Shareholder Matters In November 1994, a series of purported class actions (the "New York Limited Partnership Actions") were filed in the United States District Court for the Southern District of New York concerning PaineWebber Incorporated's sale and sponsorship of various limited partnership interests and common stock, including the securities offered by the Company. The lawsuits were brought against PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"), among others, by allegedly dissatisfied investors. In March 1995, after the actions were consolidated under the title In re PaineWebber Limited Partnership Litigation, the plaintiffs amended their complaint to assert claims against a variety of other defendants, including PaineWebber Properties Incorporated ("PWPI"), an affiliate of PaineWebber and the parent company of the general partner of the Advisor to the Company. On May 30, 1995, the court certified class action treatment of the claims asserted in the litigation. F - 19 The amended complaint in the New York Limited Partnership Actions alleged that, in connection with the sale of common stock of the Company, the defendants (1) failed to provide adequate disclosure of the risks involved; (2) made false and misleading representations about the safety of the investments and the Company's anticipated performance; and (3) marketed the Company to investors for whom such investments were not suitable. The plaintiffs, who purported to be suing on behalf of all persons who invested in the Company also alleged that following the issuance of the Company's stock, the defendants misrepresented financial information about the Company's value and performance. The amended complaint alleged that the defendants violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal securities laws. The plaintiffs sought unspecified damages, including reimbursement for all sums invested by them in the Company's stock, as well as disgorgement of all fees and other income derived by PaineWebber from the Company. In addition, the plaintiffs also sought treble damages under RICO. In January 1996, PaineWebber signed a memorandum of understanding with the plaintiffs in the class action outlining the terms under which the parties have agreed to settle the case. Pursuant to that memorandum of understanding, PaineWebber irrevocably deposited $125 million into an escrow fund under the supervision of the United States District Court for the Southern District of New York to be used to resolve the litigation in accordance with a definitive settlement agreement and a plan of allocation. On July 17, 1996, PaineWebber and the class plaintiffs submitted a definitive settlement agreement which has been preliminarily approved by the court and provides for the complete resolution of the class action litigation, including releases in favor of the Company and PWPI, and the allocation of the $125 million settlement fund among investors in the various partnerships and REITs at issue in the case. As part of the settlement, PaineWebber also agreed to provide class members with certain financial guarantees relating to some of the partnerships and REITs. The details of the settlement are described in a notice mailed directly to class members at the direction of the court. A final hearing on the fairness of the proposed settlement is scheduled to continue in December 1996. In February 1996, approximately 150 plaintiffs filed an action entitled Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership investments and REIT stocks, including those offered by the Company. The complaint alleges, among other things, that PaineWebber and its related entities committed fraud and misrepresentation and breached fiduciary duties allegedly owed to the plaintiffs by selling or promoting limited partnership and REIT investments that were unsuitable for the plaintiffs and by overstating the benefits, understating the risks and failing to state material facts concerning the investments. The complaint seeks compensatory damages of $15 million plus punitive damages. In September 1996, the court dismissed many of the plaintiffs' claims as barred by applicable securities arbitration regulations. In June 1996, approximately 50 plaintiffs filed an action entitled Bandrowski v. PaineWebber Inc. in Sacramento, California Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiff's purchases of various limited partnership interests and REIT stocks, including those offered by the Company. The complaint is substantially similar to the complaint in the Abbate action described above, and seeks compensatory damages of $3.4 million plus punitive damages. In July 1996, approximately 15 plaintiffs filed an action entitled Barstad v. PaineWebber Inc. in Maricopa County, Arizona Superior Court against PaineWebber Incorporated and various affiliated entities concerning the plaintiffs' purchases of various limited partnership interests and REIT stocks, including those offered by the Company. The complaint is substantially similar to the complaint in the Abbate action described above, and seeks compensatory damages of $752,000 plus punitive damages. With respect to the Abbate, Bandrowski and Barstad actions described above, the defendants' time to move against or answer the complaints has not yet expired. In all cases, PaineWebber intends to vigorously contest the allegations of the actions. However, the eventual outcome of this litigation and the potential impact, if any, on the Company's shareholders cannot be determined at the present time. Mediation hearings on the Abbate, Bandrowski and Barstad actions are currently scheduled to be held in December 1996. F - 20 Under certain limited circumstances, pursuant to the Advisor Agreement with the Advisor and other contractual obligations, PaineWebber affiliates could be entitled to indemnification for expenses and liabilities in connection with the shareholder litigation matters described above. However, PaineWebber has agreed not to seek indemnification for any amounts it is required to pay in connection with the settlement of the New York Limited Partnership Actions. At the present time, neither PaineWebber nor management can estimate the impact, if any, of any of the potential indemnification claims on the Company's financial statements, taken as a whole. Accordingly, no provision for any liability which could result from the eventual outcome of these matters has been made in the accompanying financial statements. 7. Subsequent Events On September 15, 1996, the Company's Board of Directors declared a quarterly dividend for the quarter ended August 31, 1996. On October 15, 1996, a dividend of $0.175 per share of common stock, totaling $1,316,000, was made to shareholders of record as of September 30, 1996. On December 13, 1996, the Board of Directors declared a quarterly dividend for the quarter ended November 30, 1996. On January 15, 1997, a dividend of $0.1875 per share of common stock, totaling $1,410,000, will be made to shareholders of record as of January 2, 1997. 8. Events (unaudited) Subsequent to December 10, 1996 The Company has been attempting to continue its restructuring plans by converting ILM Holding to a real estate investment trust ("REIT") for tax purposes. In connection with these plans, on November 21, 1996 the Company requested that PWPI cause PWP Holding to sell all of the stock held by PWP Holding in ILM Holding to the Company for a price equal to the fair market value of the 1% economic interest in ILM Holding represented by the common stock. On January 10, 1997, this transfer of the common stock of ILM Holding was completed at an agreed upon fair value of $46,000. With this transfer completed, effective January 23, 1997 ILM Holding recapitalized its common stock and preferred stock by replacing the outstanding shares with 50,000 shares of new common stock and 275 shares of a new class of nonvoting, 8% cumulative preferred stock issued to the Company. The number of authorized shares of preferred and common stock in ILM Holding were also increased as part of the recapitalization. Following the recapitalization, the Company made charitable gifts of one share of the preferred stock in ILM Holding to each of 111 charitable organizations so that ILM Holding would meet the stock ownership requirements of a REIT as of January 30, 1997. The preferred stock has a Liquidation Preference of $1,000 per share plus any accrued and unpaid dividends. Dividends on the preferred stock will accrue at a rate of 8% per annum on the original $1,000 Liquidation Preference and will be cumulative from the date of issuance. Since ILM Holding is not expected to have sufficient cash flow in the foreseeable future to make the required dividend payments, it is anticipated that dividends will accrue and be paid at liquidation. With regard to the litigation described in Note 5 under "Termination of Management Contract with AHC," the court initially set a trial date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for June 23, 1997. On June 13, 1997 and July 8, 1997, the court issued Orders purporting to enter judgment against the Company and ILM II in the amount of $1,000,000. In so doing, the court effectively canceled the June 23, 1997 trial date. The Orders do not contain any findings of fact or conclusions of law. On July 10, 1997, the Company, ILM II, ILM I Lease Corporation and ILM II Lease Corporation filed a notice of appeal to the United State Court of Appeals for the Fourth Circuit from the Orders. The Company intends to diligently prosecute the appeal. The eventual outcome of this litigation cannot presently be determined. However, as reported in the Company's report on Form 10-Q for the quarter ended May 31, 1997, the Company has recorded a provision in the amount of $600,000 for the liability which might result from the court's Orders. On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of California against Capital, Lawrence Cohen, President, Chief Executive Officer and a director of the Company, and others alleging that the defendants intentionally interfered with AHC's property management agreement. The complaint seeks damages of at least $2,000,000. On March 4, 1997, the defendants removed the case to federal district court in the Central District of California. Trial in the action has been set for January 13, 1998 and discovery has just begun. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber Properties employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising F - 21 from the California litigation, subject to any insurance recoveries for those expenses. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should advance up to $20,000 to pay reasonable legal fees and expenses incurred by Capital in the California litigation. Subsequently, the boards of directors of ILM I Lease Corporation and ILM II Lease Corporation voted to increase the maximum amount of the advance to $100,000. The defendants intend to vigorously defend the claims made against them in the California litigation. The eventual outcome of this litigation cannot presently be determined and, accordingly, no provision for any liability has been recorded in the accompanying financial statements. With regard to the litigation described in Note 5 under "Shareholder Matters," in March 1997, the United States District Court for the Southern District of New York announced its final approval of the proposed settlement of the New York Limited Partnership Actions (see the Annual Report for further information). The release of the agreed upon settlement proceeds had been delayed pending the resolution of an appeal of the settlement agreement by two of the plaintiff class members. In July, 1997, the United States Court of Appeals for the Second Circuit upheld the settlement over the objections of the two class members. As part of the settlement agreement, PaineWebber has agreed not to seek indemnification from the related partnerships and real estate investment trusts at issue in the litigation (including the Company) for any amounts that it is required to pay under the settlement. In addition, in December 1996 PaineWebber agreed to settle the Abbate, Bandrowski and Barstad actions discussed further in the Annual Report. Final releases and dismissals with regard to these actions were received during fiscal 1997. Based on these settlement agreements which cover all of the outstanding shareholder litigation, and notwithstanding the appeal of the class action settlement referred to above, management does not expect that the resolution of these matters will have a material impact on the Company's financial statements, taken as a whole. F - 22 Report of Independent Auditors The Shareholders of ILM Holding, Inc. We have audited the accompanying balance sheets of ILM Holding, Inc. (the "Company"), as of August 31, 1996 and 1995 and the related statements of operations, changes in shareholders' deficit and cash flows for the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of ILM Holding, Inc. at August 31, 1996 and 1995, and the results of its operations and its cash flows for the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /S/ ERNST & YOUNG LLP ERNST & YOUNG LLP Boston, Massachusetts December 10, 1996 F - 23 ILM HOLDING, INC. BALANCE SHEETS August 31, 1996 and 1995 (In thousands, except per share amounts) Assets ------
1996 1995 -------------------------------------- Operating investment properties, at cost: Land $ 3,352 $ 3,352 Building and improvements 33,105 32,924 Furniture, fixtures and equipment 4,948 4,948 -------------------------------------- 41,405 41,224 Less accumulated depreciation (3,191) (1,901) -------------------------------------- 38,214 39,323 Cash and cash equivalents 400 1,505 Interest and other receivable - 11 Accounts receivable - related party 348 - Deferred rent receivable 123 - Other assets 233 345 -------------------------------------- $39,318 $41,184 ====================================== Liabilities & Shareholders' Equity (Deficit) -------------------------------------------- Mortgages payable $40,391 $40,285 Accounts payable - related party 585 311 Accounts payable and accrued expenses 3 524 -------------------------------------- Total liabilities 40,979 41,120 Shareholders' equity (deficit): Preferred stock (Series A, $1 par value, 100 shares authorized, issued and outstanding) 1 1 Common stock ($1 par value, 10,000 shares authorized, issued and outstanding) 10 10 Additional paid-in capital 689 689 Accumulated deficit (2,361) (636) -------------------------------------- Total shareholders' equity (deficit) (1,661) 64 -------------------------------------- $39,318 $41,184 ======================================
See accompanying notes. F - 24 ILM HOLDING, INC. STATEMENTS OF OPERATIONS (In thousands, except per share amounts)
For the two month For the year ended period ended For the year ended August 31, 1996 August 31, 1995 June 30, 1995 -------------------------------------------------------------------- Revenues: Rental income $ 6,328 $2,747 $16,239 Interest income earned on cash equivalents 16 6 25 Expenses: Property Operating - 1,542 9,541 Depreciation 1,290 227 1,364 Interest 6,707 1,046 5,673 Management advisory fees - 13 81 Other 72 - - -------------------------------------------------------------------- 8,069 2,822 16,659 -------------------------------------------------------------------- Net loss $ (1,725) $ (75) $ (395) ==================================================================== Loss per share of common stock $(172.50) $(7.50) $(39.50) ====================================================================
See accompanying notes. F - 25 ILM HOLDING, INC. STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT) For the year ended August 31, 1996, the two month period ended August 31, 1995 and the year ended June 30, 1995 (In thousands, except per share amounts)
Common Stock Preferred Stock $.01 Par Value $.01 Par Value Additional ------------------------- ---------------------- Paid-in Accumulated Shares Amount Shares Amount Capital Deficit Total ------ ------ ------ ------ ----------- ------------- ---------- Shareholders' equity at June 30, 1994 10,000 $10 100 $1 $689 $ (166) $ 534 Net loss - - - - - (395) (395) ---------- ---------- --------- ---------- ---------- ------------- -------- Shareholders' deficit at June 30, 1995 10,000 10 100 1 689 (561) 139 Net loss - - - - - (75) (75) ---------- ---------- --------- ---------- ---------- ------------- -------- Shareholders' deficit at August 31, 1995 10,000 10 100 1 689 (636) 64 Net loss - - - - - (1,725) (1,725) ---------- ---------- --------- ---------- ---------- ------------- -------- Shareholders' deficit at August 31, 1996 10,000 $10 100 $1 $689 $(2,361) $(1,661) ========== ========== ========= ========== ========== ============= ========
See accompanying notes. F - 26 ILM HOLDING, INC. STATEMENTS OF CASH FLOWS (In thousands)
For the two month For the year ended period ended For the year ended August 31, 1996 August 31, 1995 June 30, 1995 ------------------------------------------------------------------- Operating activities: Net loss $(1,725) $ (75) $ (395) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,290 227 1,364 Changes in operating assets and liabilities: Interest and other receivable 11 (11) 3 Accounts receivable - related party (348) - 568 Deferred rent receivable (123) - - Other assets 112 21 60 Accounts payable - related party 274 (137) (1,158) Accounts payable and accrued liabilities (521) (357) 148 ------------------------------------------------------------------- Total adjustments 695 (257) 985 ------------------------------------------------------------------- Net cash provided by (used for) operating activities (1,030) (332) 590 ------------------------------------------------------------------- Investing activities: Investment in properties (181) (131) (771) ------------------------------------------------------------------- Net cash used for investing activities (181) (131) (771) ------------------------------------------------------------------- Financing activities: Borrowings under mortgage notes 106 21 174 ------------------------------------------------------------------- Net cash provided by financing activities 106 21 174 ------------------------------------------------------------------- Net decrease in cash and cash equivalents at end of period (1,105) (442) (7) Cash and cash equivalents at beginning of year 1,505 1,947 1,954 ------------------------------------------------------------------- Cash and cash equivalents at end of year 400 1,505 1,947 ===================================================================
See accompanying notes. F - 27 1. Nature of Operations and Basis of Presentation PaineWebber Independent Living Mortgage Fund, Inc. ("ILM") invested in eight participating mortgage loans secured by Senior Housing Facilities located in seven different states. All of the loans made by ILM were originally with Angeles Housing Concepts, Inc. ("AHC"), a company specializing in the development, acquisition and operation of Senior Housing Facilities. ILM entered into an Exclusivity Agreement with AHC and its parent company, Angeles Corporation ("Angeles"), which required AHC to provide ILM with certain specific opportunities to finance Senior Housing Facilities and set forth the terms and conditions of the loans which were made. The loan documents under the aforementioned Exclusivity Agreement called for interest to be paid on construction loans at the rate of 13.3% per annum during the construction period and for Base Interest to be paid on the permanent loans at the rate of 10.3% per annum. In addition to the Base Interest, Additional Interest was to be payable on the permanent loans in an amount equal to 10% of the Gross Revenues of the Senior Housing Facilities, as defined. Under the terms of the amended Exclusivity Agreement, Additional Interest was to be no less than 3% of the aggregate principal amount of all permanent loans outstanding for the entire term of the investments. In the aggregate, the properties securing loans from ILM did not generate sufficient cash flow to cover the debt service payments owed to ILM under the amended terms of the Exclusivity Agreement. To the extent that the properties did not generate sufficient cash flow to make the full payments due under the loan documents, the shortfall was funded by AHC through December 1992. The source of cash to make up these shortfalls was from specified deficit reserve accounts, which had been funded from the proceeds of the mortgage loans, and from contributions by Angeles. During the quarter ended February 28, 1993, Angeles announced that it was experiencing liquidity problems that resulted in the inability to meet its obligations. Subsequent to such announcements, AHC defaulted on the regularly scheduled mortgage loan payments due to ILM on March 1, 1993. Subsequent to March 1993, payments toward the debt service owed on ILM's loans were limited to the net cash flow of the operating investment properties. On May 3, 1993, Angeles filed for reorganization under a Chapter 11 Federal Bankruptcy petition filed in the state of California. AHC did not file for reorganization. ILM retained special counsel and held extensive discussions with AHC concerning the default status of its loans. During the fourth quarter of fiscal 1993, a non-binding settlement agreement between ILM, AHC and Angeles was reached whereby ownership of the properties would be transferred from AHC to ILM or its designated affiliates. Under the terms of the Settlement Agreement, ILM released AHC and Angeles from certain obligations under the loans. On April 27, 1994, each of the properties owned by AHC and securing the Loans was transferred (collectively, "the Transfers") to newly-created special purpose corporations affiliated with ILM (collectively, "the Property Companies"). The Transfers had an effective date of April 1, 1994 and were made pursuant to the Settlement Agreement entered into on February 17, 1994 ("the Settlement Agreement") between ILM and AHC which had previously been approved by the bankruptcy court handling the bankruptcy case of Angeles. All of the capital stock of each Property Company was held by ILM Holding, Inc. (the "Company"), a Virginia corporation. In August 1995, each of the Property Companies merged into the Company. As a result, ownership of the Senior Housing Facilities is now held by the Company, and the Property Companies no longer exist as separate legal entities. The capital stock of the Company is owned by ILM and PWP Holding, Inc. ("PWP Holding"), a wholly-owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). PWPI is a wholly owned subsidiary of PaineWebber Incorporated, which is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). As part of the fiscal 1994 settlement agreement with AHC, the Company retained AHC as the property manager for all of the Senior Housing Facilities pursuant to the terms of a management agreement. As discussed further in Note 8, the management agreement with AHC was terminated in July 1996. Subsequent to the effective date of the Settlement Agreement with AHC, management investigated and evaluated the available options for structuring the ownership of the properties in order to maximize the potential returns to the existing shareholders while maintaining ILM's qualification as a REIT under the Internal Revenue Code. On September 12, 1994, ILM formed a new subsidiary, ILM I Lease Corporation, for the purpose of operating the Senior Housing Facilities. The Senior Housing Facilities were leased to ILM I Lease Corporation effective September 1, 1995 (see Note 4 for a description of the master lease agreement). 2. Use of Estimates and Summary of Significant Accounting Policies The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of August 31, 1996 and 1995 and revenues and expenses for the year ended August 31, 1996, the two month period ended August 31, 1995, and the year ended June 30, 1995. Actual results could differ from the estimates and assumptions used. F - 28 In 1995, in connection with the restructuring of property ownership described above, the Company changed its fiscal year end from June 30 to August 31. The Company's significant accounting policies are summarized as follows: A. BASIS OF PRESENTATION The operating cycle in the real estate industry is longer than one year and the distinction between current and non-current is of little relevance. Accordingly, the accompanying balance sheets are presented in an unclassified format. B. INCOME TAXES For purposes of filing federal tax returns, the financial statements of the Company are consolidated with those of ILM. The Company, has incurred losses for tax purposes since inception. Neither ILM nor the Company is likely to be able to use these losses to offset future tax liabilities. Accordingly, no income tax benefit is reflected in these financial statements. C. CASH AND CASH EQUIVALENTS For purposes of reporting cash flows, cash and cash equivalents include all highly liquid investments with original maturities of 90 days or less. D. FAIR VALUE DISCLOSURES FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments" ("SFAS 107"), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. SFAS 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amount reported on the balance sheet for cash and cash equivalents approximates its fair value due to the short-term maturities of such instruments. Accounts receivable - related party: The carrying amount reported on the balance sheet for accounts receivable - related party approximates its fair value due to the short-term maturity of such instrument. Accounts payable - related party: The carrying amount reported on the balance sheet for accounts payable related party approximates its fair value due to the short-term maturity of such instrument. Mortgages payable: Due to the unique nature of the debt arrangement as described in Note 5, management is unable to determine the fair value of mortgages payable without incurring excessive costs. F - 29 E. OPERATING INVESTMENT PROPERTIES Operating investment properties are carried at the lower of cost, reduced by accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the owner's investment through expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its current market value as determined on a discounted basis. None of the operating investment properties were held for sale as of August 31, 1996 or 1995. Depreciation expense is provided on a straight-line basis using an estimated useful life of 40 years for the buildings and improvements and 5 years for the furniture, fixtures and equipment. The Company has reviewed FAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of," which is effective for financial statements for years beginning after December 15, 1995, and believes this new pronouncement will not have a material effect on the Company's financial statements. F. RENTAL REVENUES In fiscal 1995 rental income consisted of payments due on the individual tenant leases at the Senior Housing Facilities. Units at the Facilities are generally rented for terms of twelve months or less. The base rent charged varies depending on the unit size, with added fees collected for more than one occupant per unit and for assisted living services. Included in the amount of base rent charged are certain meals, housekeeping, medical and social services provided to the residents of each Facility. In fiscal 1996, rental revenues consist of payments due from ILM I Lease Corporation under the terms of the master lease described in Note 7. Base rental income under the master lease is recognized on a straight-line basis over the term of the lease. Deferred rent receivable on the balance sheet as of August 31, 1996 represents the difference between rental income on a straight-line basis and rental income received under the terms of the master lease 3. The Advisory Agreement and Related Party Transactions Subject to the supervision of the ILM's Board of Directors, the business of ILM and the Company is managed by PaineWebber ILM Advisor, L.P. (the "Advisor"), a limited partnership comprised of ILM REIT Advisor, Inc., a Virginia corporation, and Properties Associates, L.P. ("PA"), a Virginia limited partnership. ILM REIT Advisor, Inc. is a wholly owned subsidiary of PaineWebber Properties Incorporated ("PWPI"). In addition, the limited partners and holders of assignee interest of PA are or have been officers of PWPI. PWPI is a wholly owned subsidiary of PaineWebber Incorporated ("PWI"). PWI is a wholly owned subsidiary of PaineWebber Group, Inc. ("PaineWebber"). The Advisor and its affiliates received fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the shares, the management of ILM and the Company, and the acquisition, management and disposition of ILM's investments. Management advisory fees for the two month period ended August 31, 1995 and the year ended June 30, 1995 were earned by an affiliate of PWPI for its administration and supervision of the day-to-day operations of the Company. Such fees were equal to 0.5% of the Gross Operating Revenues of the Senior Housing Facilities. These management advisory fees were no longer charged to the Company effective September 1, 1995 upon the commencement of the master lease described in Note 7. Accounts payable - related party at August 31, 1995 consists primarily of the Company's outstanding liability for management advisory fees to date and amounts payable to an affiliated company for advances made on behalf of the Company to the Villa Santa Barbara Senior Housing Facility. Accounts payable - related party at August 31, 1996 represents outstanding interest under the Company's mortgage loans payable to ILM (see note 5). Accounts receivable - related party at August 31, 1996 represents advances made to ILM I Lease Corporation (see Note 7) primarily for the purchase of personal property to operate the Senior Housing Facilities. F - 30 4. Operating Properties Descriptions of the properties financed by the Company's loans are summarized below: Independence Village of East Lansing ------------------------------------ In June 1989, ILM acquired a loan with respect to a 159-unit Senior Housing Facility known as Independence Village of East Lansing located in East Lansing, Michigan. Construction of the Senior Housing Facility, which was 91% leased as of August 31, 1996, was completed in May, 1989. Independence Village of Winston-Salem ------------------------------------- In June 1989, ILM acquired a loan with respect to a 156-unit Senior Housing Facility known as Independence Village of Winston-Salem located in Winston-Salem, North Carolina. Construction of the Senior Housing Facility, which was 93% leased as of August 31, 1996, was completed in February, 1989. Independence Village of Raleigh ------------------------------- In December 1989, ILM acquired a loan with respect to a 163-unit Senior Housing Facility, known as Independence Village of Raleigh, located in Raleigh, North Carolina. The original closing of the construction loan occurred on December 18, 1989. Construction of the Senior Housing Facility, which was 98% leased as of August 31, 1996, was completed in March, 1991. ILM's investment was converted from a construction loan to a permanent loan effective April 29, 1991. Independence Village of Peoria ------------------------------ In December 1989, ILM acquired a loan with respect to a 164-unit Senior Housing Facility known as Independence Village of Peoria located in Peoria, Illinois. The original closing of the construction loan occurred on December 18, 1989. Construction of the Senior Housing Facility, which was 91% leased as of August 31, 1996, was completed in November, 1990. ILM's investment was converted from a construction loan to a permanent loan effective November 30, 1990. F - 31 Crown Pointe ------------ In February 1990, ILM acquired a loan with respect to an existing 133-unit Senior Housing Facility known as Crown Pointe Apartments located in Omaha, Nebraska. The Senior Housing Facility, which was 99% leased as of August 31, 1996, was opened in August of 1985. Sedgwick Plaza -------------- In February 1990, ILM acquired an loan with respect to an existing 150-unit Senior Housing Facility known as Sedgwick Plaza Apartments located in Wichita, Kansas. The Senior Housing Facility, which was 83% leased as of August 31, 1996, was opened in May of 1985. West Shores ----------- In December 1990, ILM acquired a loan with respect to an existing 134-unit Senior Housing Facility known as West Shores located in Hot Springs, Arkansas. The Senior Housing Facility, which was 94% leased as of August 31, 1996, was opened in June of 1987. Santa Barbara ------------- In July 1992, ILM acquired a loan with respect to an existing 123-unit Senior Housing Facility known as Villa Santa Barbara located in Santa Barbara, California. The acquisition and improvement of the facility was financed by the aforementioned loan and another loan from an affiliated company, PaineWebber Independent Living Mortgage Inc. II (ILM2). Any amounts due from the borrower with regard to the mortgage loans on the Santa Barbara property will be equitably apportioned between ILM and ILM2 (generally 25% to ILM and 75% to ILM2). ILM and ILM2 have entered into a Intercreditor Agreement to set forth their respective rights and entitlements under the loan documents. During the first quarter of fiscal 1994, ILM committed to release a portion of the funds set aside for capital improvements at Villa Santa Barbara in order to improve the marketability of that property. With the formal execution of the Settlement Agreement completed, the planned improvement program is now moving forward toward completion. ILM's financing of such a program is expected to total approximately $350,000, which it will fund from available uninvested offering proceeds. The Senior Housing Facility, which was 81% leased as of August 31, 1996, was opened in June of 1979. 5. Mortgage Loans The Company's operating properties were acquired subject to the participating mortgage loans payable to ILM. The principal balance of each loan was modified to reflect the estimated fair value of the related operating property as of the date of the Transfers. The modified Loans require interest-only payments on a monthly basis at a rate of 7% from April 1, 1994 through December 31, 1994, 9% for the period January 1 through December 31, 1995, 11% for the period January 1 through December 31, 1996, 12% for the period January 1 through December 31, 1997, 13% for the period January 1 through December 31, 1998, 13.5% for the period January 1 through December 31, 1999 and 14% for the period January 1, 2000 through maturity, on December 31, 2000. F - 32 The following loans were outstanding at August 31, 1996 and 1995:
Property Pledged August 31, August 31, Date of as Collateral 1996 1995 Loan ------------- ---- ---- ---- Independence $ 8,950,000 $ 8,950,000 6/29/89 Village of East Lansing, MI Independence $ 5,750,000 $ 5,750,000 6/29/89 Village of Winston-Salem, NC Independence 8,350,000 8,350,000 4/29/91 Village of Raleigh, NC Independence 8,350,000 8,350,000 11/30/90 Village of Peoria, IL Crown Pointe 8,200,000 8,200,000 2/14/90 Apartments Omaha, NE Sedgwick Plaza 8,350,000 8,350,000 2/14/90 Apartments Wichita, KS West Shores 5,350,000 5,350,000 12/14/90 Hot Springs, AR Villa Santa Barbara 1,698,000 1,592,000 7/13/92 Santa Barbara, CA ----------------- ----------------- $ 54,998,000 $ 54,892,000 Less discount (14,607,000) (14,607,000) ----------------- ----------------- $ 40,391,000 $ 40,285,000 ================= =================
A discount was recorded on the long-term debt in the amount by which the modified principal amount of the loans exceeded the historical cost basis of the properties at the time of the Transfers. 6. Stockholders' Equity The Company has issued 100 shares of Series A Preferred Stock to ILM in return for a capital contribution in the amount of $693,000. The holders of the Series A Preferred Stock are entitled to one vote for each share of Preferred Stock held. In addition, the holders of the Series A Preferred Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an amount per share equal to the product of 0.1 and 99% of the total amount of dividends and distributions made to all shareholders. The Company has also issued 10,000 shares of Common Stock to PWP Holding in return for a capital contribution in the amount of $7,000. The holders of the Common Stock are entitled to one vote for each share of Common Stock held. The holders of the Common Stock are entitled to receive, when and if declared by the Board of Directors, dividends and distributions in an amount per share equal to the product of 0.001 and 1% of the total amount of dividends and distributions made to all shareholders. F - 33 7. Lease Arrangements Beginning September 31, 1995, the Senior Housing Facilities were leased to ILM I Lease Corporation under a master lease agreement. The master lease agreement is initially between the Company, as owner of the properties and Lessor, and ILM I Lease Corporation as Lessee. The master lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. The Company, as the Lessor, is responsible for all major capital improvements and structural repairs to the Senior Housing Facilities. During the initial term of the master lease, which expires on December 31, 2000 (December 31, 1999 with respect to the Santa Barbara property), ILM I Lease Corporation is obligated to pay annual base rent for the use of all of the Senior Housing 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 January 1997 and for the remainder of the lease term, ILM I Lease Corporation will also be obligated to pay variable rent for each Senior Housing Facility. Such variable rent will be payable quarterly and will equal 40% of the excess, if any, of the aggregate total revenues for the Senior Housing Facilities, on an annualized basis, over $16,996,000. A condensed balance sheet as of August 31, 1996 and summary of operations for the year then ended of ILM I Lease Corporation are as follows: Assets ------ August 31, 1996 --------------- Current Assets $2,529 Furniture, fixtures and equipment 242 Other non-current assets 26 ------- $2,797 ======= Liabilities and Shareholders' Equity ------------------------------------ Current liabilities $1,613 Other non-current liabilities 123 Shareholders' equity 1,061 ------- $2,797 ======= Summary of Operations --------------------- Year ended August 31, 1996 --------------- Revenues $17,285 Operating expenses 16,682 Income tax expense 241 -------- Net income $ 362 ======== F - 34 8. Legal Proceedings and Contingencies Angeles Corporation Litigation Angeles had guaranteed certain of the obligations of AHC under the terms of the Exclusivity Agreement described in Note 1. Under the terms of the Settlement Agreement discussed in Note 1, ILM retained a general unsecured claim against Angeles in the amount of $1,200,658 as part of the bankruptcy proceedings, but waived all other claims against Angeles, including any amounts of base and additional interest owed. In addition, ILM maintained a claim for approximately $408,000 against an affiliate of Angeles which had made a separate guaranty to ILM. On March 17, 1995, the Bankruptcy Court handling the Angeles bankruptcy proceedings approved a final settlement of ILM's outstanding claims against Angeles and its affiliates. Pursuant to the terms of this settlement, ILM received a cash payment of $1 million on April 14, 1995 in full satisfaction of the claims, which totaled approximately $1.6 million. This amount, net of certain related legal expenses, was recorded as a reduction in the carrying values of ILM's operating investment roperties. F - 35 Schedule III - Real Estate and Accumulated Depreciation - ------------------------------------------------------- ILM HOLDING, INC. SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION August 31, 1996 (Amounts in thousands)
Costs Capitalized Initial Cost to (Removed) Gross Amount at Which Carried at II.M (2) Subsequent to End of Year ------------------------- Acquisition ------------------------------------ Buildings & Buildings & Buildings & Accumulated Depreciation Encumbrances (1) Land Improvements Improvements Land Improvements Total Depreciation - ------------------ ----------------- ---------- ------------- ----------------- ---------- ------------- ---------- ------------- East Lansing, Michigan $ 8,950 $ 334 $ 4,759 $ (25) $ 334 $ 4,734 $ 5,068 $ 533 Winston-Salem North Carolina 5,750 337 3,827 (20) 337 3,807 4,144 501 Raleigh, North Carolina 8,350 741 5,791 (31) 741 5,760 6,501 530 Peoria, Illinois 8,350 426 5,990 (31) 426 5,959 6,385 517 Omaha, Nebraska 8,200 447 6,323 (33) 447 6,290 6,737 517 Wichita, Kansas 8,350 367 4,093 (21) 367 4,072 4,439 370 Hot Springs, Arkansas 5,350 301 1,764 24 301 1,788 2,089 156 Santa Barbara 1,698 399 733 (38) 399 695 1,094 67 California ------- ------- -------- -------- ------- -------- -------- ------- $54,998 $ 3,352 $ 33,280 $ (175) $ 3,352 $ 33,105 $ 36,457 $ 3,191 ======= ======= ======== ======== ======= ======== ======== ======= Life on Which Depreciation in Latest Income Date of Date Statement Depreciation Construction Acquired (2) is Computed - ------------------ -------------- ------------- ------------- East Lansing, Michigan 1989 4/1/94 5 - 40 yrs Winston-Salem North Carolina 1989 4/1/94 5 - 40 yrs Raleigh, North Carolina 1991 4/1/94 5 - 40 yrs Peoria, Illinois 1990 4/1/94 5 - 40 yrs Omaha, Nebraska 1985 4/1/94 5 - 40 yrs Wichita, Kansas 1985 4/1/94 5 - 40 yrs Hot Springs, Arkansas 1987 4/1/94 5 - 40 yrs Santa Barbara California 1979 4/1/94 5 - 40 yrs
(1) Encumbrances represent first mortgage loans between the Company, as mortgagor, and PaineWebber Independent Living Mortgage Fund, Inc., as mortgagee. (2) Initial cost to the Company represents the cost at which the Facilities were transferred to the Company effective April 1, 1994 pursuant to the Settlement Agreement entered into between the Company and AHC as described in the Notes to the Financial Statements. (3) The aggregate cost of real estate owned at August 31, 1996 for Federal income tax purposes is approximately $55,969,000. F-36 Schedule III - Real Estate and Accumulated Depreciation - ------------------------------------------------------- ILM HOLDING, INC. SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION August 31, 1996 (Amounts in thousands) (5) Reconciliation of real estate owned:
1996 1995 Balance at beginning of period $ 36,276 $ 35,374 Acquisitions and improvements - 12 months ended 8/31/96 181 - Acquisitions and improvements - 12 months ended 6/30/95 - 771 Improvements - 3 months ended 6/30/94 - - Improvements - 2 months ended 8/31/95 - 131 ----------- ------------ Balance at end of period $ 36,457 $ 36,276 =========== ============ (6) Reconciliation of accumulated depreciation: Balance at beginning of period $ 1,901 $ 310 Depreciation expense - 12 months ended 8/31/96 1,290 - Depreciation expense - 12 months ended 6/30/95 - 1,364 Depreciation expense - 3 months ended 6/30/94 - - Depreciation expense - 2 months ended 8/31/95 - 227 ----------- ------------ Balance at end of period $ 3,191 $ 1,901 =========== ============
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