-----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, LlhsYhCrjjs8IJwEcYYjkIDF6WguwaXSLLP/fbPJk2jnXKMnLQdeLW3oJrlgSzq7 Z11NV+JvYH4AcJUOjSV6/w== 0000932091-97-000004.txt : 19970423 0000932091-97-000004.hdr.sgml : 19970423 ACCESSION NUMBER: 0000932091-97-000004 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970228 FILED AS OF DATE: 19970421 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ILM I LEASE CORP CENTRAL INDEX KEY: 0000932091 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 043248637 STATE OF INCORPORATION: VA FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25878 FILM NUMBER: 97584496 BUSINESS ADDRESS: STREET 1: 265 FRANKLIN ST STREET 2: 15TH FL CITY: BOSTON STATE: MA ZIP: 02110 BUSINESS PHONE: 6174398118 MAIL ADDRESS: STREET 1: 265 FRANKLIN ST STREET 2: 15TH FL CITY: BOSTON STATE: MA ZIP: 02110 10-Q 1 THIS IS A 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------------------- FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended February 28, 1997 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from to . Commission File Number : 0-25878 ILM I LEASE CORPORATION (Exact name of registrant as specified in its charter) Virginia 04-3248637 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 265 Franklin Street, Boston, MA 02110 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (800) 225-1174 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . ---- Shares on common stock outstanding as of February 28, 1997: 7,519,430. The aggregate sales price of the shares sold was $700,000. This does not reflect market value. There is no current market for these shares. ILM I LEASE CORPORATION BALANCE SHEET February 28, 1997 and August 31, 1996 (Unaudited) (In thousands) ASSETS February 28 August 31 ----------- --------- Cash and cash equivalents $ 2,003 $ 2,185 Accounts receivable 46 77 Prepaid expenses and other assets 115 267 -------- -------- Total current assets 2,164 2,529 Furniture, fixtures and equipment 385 261 Less: accumulated depreciation (42) (19) -------- --------- 343 242 Deferred tax asset, net 8 26 -------- -------- $ 2,515 $ 2,797 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses $ 470 $ 863 Real estate taxes payable 359 300 Accounts payable - affiliates 292 445 Security deposits 5 5 -------- -------- Total current liabilities 1,126 1,613 Deferred rent payable 104 123 -------- -------- Total liabilities 1,230 1,736 Shareholders' equity 1,285 1,061 -------- -------- $ 2,515 $ 2,797 ======== ======== See accompanying notes. ILM I LEASE CORPORATION STATEMENTS OF INCOME For the three and six months ended February 28, 1997 and February 29, 1996 (Unaudited) (In thousands, except per share amounts) Three Months Ended Six Months Ended February 28/29, February 28/29, 1997 1996 1997 1996 ---- ---- ---- ---- Revenues: Rental and other income $ 4,426 $ 4,311 $ 8,826 $ 8,540 Interest income 16 18 38 25 ------- -------- ------- -------- 4,442 4,329 8,864 8,565 Expenses: Master lease rent expense 1,653 1,582 3,235 3,164 Dietary salaries, wages and food service expenses 822 792 1,651 1,529 Administrative salaries, wages and expenses 310 301 596 554 Marketing salaries, wages and expenses 230 209 437 433 Utilities 226 223 429 414 Repairs and maintenance 160 173 312 316 Real estate taxes 209 201 423 400 Property management fees 208 237 415 470 Other property operating expenses 388 386 758 707 General and administrative 146 24 177 54 Advisory fees 22 21 44 42 Depreciation expense 14 - 23 - ------- ------- ------- ------- 4,388 4,149 8,500 8,083 ------- ------- ------- ------- Income before taxes 54 180 364 482 Income tax expense (benefit): Current 6 78 121 238 Deferred 10 (6) 19 (45) ------- ------- ------- ------- 16 72 140 193 ------- ------- ------- ------- Net income $ 38 $ 108 $ 224 $ 289 ======= ======= ======= ======= Earnings per share of common stock $0.01 $0.01 $0.03 $0.04 ===== ===== ===== ===== The above earnings per share of common stock is based upon the 7,519,430 shares outstanding for each period. See accompanying notes. ILM I LEASE CORPORATION STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY For the six months ended February 28, 1997 and February 29, 1996 (Unaudited) (In thousands)
Common Stock Additional $.01 Par Value Paid-in Accumulated Shares Amount Capital Earnings Total ------ ------ ------- -------- ----- Balance at August 31, 1995 15 $ - $ 1 $ (1) $ - Issuance of common stock 7,504 75 624 - 699 Net income - - - 289 289 ----- ------- ------ ------ ------- Balance at February 29, 1996 7,519 $ 75 $ 625 $ 288 $ 988 ===== ======= ======= ======= ======= Balance at August 31, 1996 7,519 $ 75 $ 625 $ 361 $ 1,061 Net income - - - 224 224 ----- ------- ------ ------- ------- Balance at February 28, 1997 7,519 $ 75 $ 625 $ 585 $ 1,285 ====== ======= ======= ======= =======
See accompanying notes. ILM I LEASE CORPORATION STATEMENTS OF CASH FLOWS For the six months ended February 28, 1997 and February 29, 1996 (Unaudited) Increase (Decrease) in Cash and Cash Equivalents (In thousands) 1997 1996 ---- ---- Cash flows from operating activities: Net income $ 224 $ 289 Adjustments to reconcile net income to net cash (used in) provided by operating activities Depreciation expense 23 - Changes in assets and liabilities: Accounts receivable 31 (35) Prepaid expenses and other assets 152 (13) Deferred tax asset, net 18 45 Accounts payable and accrued expenses (394) 461 Accounts payable - affiliates (152) 21 Real estate taxes payable 59 229 Deferred rent payable (19) 141 Income taxes payable - 193 ------- ------- Total adjustments (282) 1,042 ------- ------- Net cash (used in) provided by operating activities (58) 1,331 Cash flows from investing activities: Additions to furniture, fixtures and equipment (124) - ------- -------- Net cash used in investing activities (124) - Cash flows from financing activities: Proceeds from issuance of common stock - 699 ------- ------- Net cash provided by financing activities - 699 -------- ------- Net (decrease) increase in cash and cash equivalents (182) 2,030 Cash and cash equivalents, beginning of period 2,185 - -------- ------- Cash and cash equivalents, end of period $ 2,003 $ 2,030 ======== ======= Supplemental disclosure: Cash paid during the period for income taxes $ 110 $ - ======== ======= See accompanying notes. ILM I LEASE CORPORATION NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. General The accompanying financial statements, footnotes and discussions should be read in conjunction with the financial statements and footnotes contained in the Company's Annual Report for the year ended August 31, 1996. In the opinion of management, the accompanying financial statements, which have not been audited, reflect all adjustments necessary to present fairly the results for the interim period. All of the accounting adjustments reflected in the accompanying interim financial statements are of a normal recurring nature. The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of February 28, 1997 and August 31, 1996 and revenues and expenses for each of the three and six-month periods ended February 28, 1997 and February 29, 1996. Actual results could differ from the estimates and assumptions used. The Company was formed by PaineWebber Independent Living Mortgage Fund, Inc. ("ILM") to operate eight rental housing projects for independent senior citizens ("the Senior Housing Facilities") under a master lease arrangement. ILM has elected to be taxed as a Real Estate Investment Trust ("REIT") under the Internal Revenue Code of 1986, as amended ("the Code"), for each taxable year of operations. In order to maintain its status as a REIT, 75% of ILM's annual gross income must be Qualified Rental Income as defined by the Code. The rent paid by the residents of the Facilities likely would not be deemed to be Qualified Rental Income because of the extent of services provided to residents. Consequently, the operation of the Facilities by ILM or its subsidiaries over an extended period of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the Company to operate the Senior Housing Facilities, and by means of a distribution, transferred the ownership of the common stock of the Company to the holders of ILM common stock on September 1, 1995. Because the Company, which is taxed as a regular C corporation, is no longer a subsidiary of ILM, it can receive service-related income without endangering the REIT status of ILM. At a meeting of the ILM Board on January 10, 1997, the Advisor recommended the immediate sale of the senior housing facilities held by ILM and an affiliated entity, PaineWebber Independent Living Mortgage Inc. II ("ILM2"), by means of a controlled auction to be conducted by PaineWebber, at no additional compensation, with PaineWebber offering to purchase the properties for a specified price, thereby guaranteeing the shareholders a "floor" price. The Advisor also stated that if PaineWebber purchased the properties at the specified price and were then able to resell the properties at a higher price, PaineWebber would pay any "excess profits" to the shareholders. To assist the Company and ILM in evaluating the Advisor's proposal, a disinterested, independent investment banker with expertise in healthcare REITs and independent/assisted living financings was engaged. Following a comprehensive analysis, the investment banker recommended that ILM decline the Advisor's proposal and instead investigate expansion and restructuring alternatives. The Company and ILM are presently analyzing the Advisor's proposal and the recommendations and other information provided by the independent investment banker. In addition, the Company and ILM are reviewing various restructuring alternatives. The Company and ILM are analyzing a merger of ILM with ILM Holding and are also considering possibly merging ILM with ILM2 and the Company with ILM II Lease Corporation. In addition, ILM is exploring listing its shares on an exchange or, alternatively, having them trade through NASDAQ. The Company has not fully evaluated any of these alternatives and is not in a position at this time to recommend any actions to the shareholders. There can be no assurance that the Company will recommend taking any of such actions. 2. The Master Lease Agreement The Company's sole business is the operation of the Senior Housing Facilities. The Company has leased the Senior Housing Facilities from ILM Holding, Inc. ("ILM Holding"), a majority-owned and consolidated subsidiary of ILM which currently holds title to the Facilities, pursuant to a master lease which commenced on September 1, 1995 and expires on December 31, 1999. The Company has entered into a property management agreement with Capital Senior Management 2, Inc. of Dallas, Texas ("Capital") to handle the day-to-day operations of the Senior Housing Facilities. The management contract with Capital was executed in July 1996. In November 1996, Lawrence A. Cohen, a Director of the Company and President, Chief Executive Officer and Director of ILM, also became Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation, an affiliate of Capital. As a result, the management contract with Capital is considered a related party transaction (see Note 3). Descriptions of the properties covered by the master lease between the Company and ILM Holding are summarized as follows: Rentable Date of Name Location Units (1) Construction (2) ---- -------- --------- ---------------- Independence Village of East Lansing East Lansing, MI 159 May 1989 Independence Village of Winston-Salem Winston-Salem, NC 156 February 1989 Independence Village of Raleigh Raleigh, NC 163 March 1991 Independence Village of Peoria Peoria, IL 164 November 1990 Crown Pointe Apartments Omaha, NE 133 August 1985 Sedgwick Plaza Apartments Wichita, KS 150 May 1985 West Shores Hot Springs, AR 134 June 1987 Villa Santa Barbara (3) Santa Barbara, CA 123 June 1979
(1)Represents rentable units as of April 1, 1994, the effective date of the transfer of ownership to ILM Holding. Rentable units exclude manager units, assistant manager units and other units converted to non-rental usage. These unit counts will be updated upon the completion of the new property management team's current program of placing non-rental units back into service. (2) Date initial construction was completed. (3)The Company operates Villa Santa Barbara under a co-tenancy arrangement with an affiliated company, ILM II Lease Corporation. The Company has entered into an agreement with ILM II Lease Corporation regarding such joint tenancy. ILM II Lease Corporation was formed for similar purposes as the Company by an affiliated REIT, PaineWebber Independent Living Mortgage Inc. II, whose subsidiary owns a portion of the Villa Santa Barbara property. The portion of the Facility leased by the Company represents 25% of the total project. Terms of the Master Lease Agreement ----------------------------------- During the term of the master lease, the Company is obligated to pay annual base rent ("Base Rent") for the Facilities. For calendar year 1995, the annual Base Rent was $5,886,000 (prorated according to the date of commencement of the master lease), allocated as follows: $896,156 for the Michigan Facility, $566,914 for the Winston-Salem, North Carolina Facility, $1,017,659 for the Raleigh, North Carolina Facility, $892,600 for the Illinois Facility, $893,918 for the Nebraska Facility, $855,702 for the Kansas Facility, $623,984 for the Arkansas Facility, and $139,067 for the California Facility. For calendar year 1996 and subsequent years, the annual Base Rent will be $6,364,800, allocated as follows: $969,054 for the Michigan Facility, $613,030 for the Winston-Salem, North Carolina Facility, $1,100,441 for the Raleigh, North Carolina Facility, $965,209 for the Illinois Facility, $966,634 for the Nebraska Facility, $925,310 for the Kansas Facility, $674,742 for the Arkansas Facility, and $150,380 for the California Facility. The master lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities ("Additional Rent"). ILM Holding, as the Lessor, is responsible for major capital improvements and structural repairs to the Senior Housing Facilities. In addition, beginning in the second quarter of fiscal 1997 and for the remainder of the lease term, the Company is also obligated to pay variable rent ("Variable Rent") for each Facility. Such Variable Rent is payable quarterly and equals 40% of the excess, if any, of the aggregate total revenues for the Facilities, on an annualized basis, over $16,996,000. Variable rent amounted to $71,000 for the three months ended February 28, 1997. Under the master lease, the Company's use of the Facilities is limited to use as a Senior Housing Facility unless the Lessor's consent to some other use is obtained. The Company has responsibility to obtain and maintain all licenses, certificates and consents needed to use and operate each Facility, and to use and maintain each Facility in compliance with all local board of health and other applicable governmental and insurance regulations. The Facilities located in Arkansas, California and Kansas are licensed by such states to provide assisted living services. Also, various health and safety regulations and standards which are enforced by state and local authorities apply to the operation of all of the Facilities. Violations of such health and safety standards could result in fines, penalties, closure of a Facility or other sanctions. 3. Related Party Transactions The Advisor receives a base fee in an amount equal to 0.5% of the Gross Operating Revenues of the Facilities operated by the Company as compensation for its services. This fee amounted to $44,000 and $42,000 for the six-month periods ended February 28, 1997 and February 29, 1996, respectively. In addition, an affiliate of the Advisor is entitled to reimbursement for expenses incurred in providing certain financial, accounting and investor communication services to the Company. Included in general and administrative expenses for the six months ended February 28, 1997 and February 29, 1996 is $39,000 and $40,000, respectively, representing reimbursements to this affiliate of the Advisor for providing such services to the Company. The Company has retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas to be the property manager of the Senior Housing Facilities pursuant to a Management Agreement which commenced on July 29, 1996. The initial term of the Management Agreement expires on December 31, 1999, which coincides with the expiration of the master lease agreement between the Company and ILM Holding described in Note 2. Under the terms of the Management Agreement, in the event that the master lease agreement is extended beyond December 31, 1999, the Management Agreement will be extended as well, but not beyond July 29, 2001. Effective in November 1996, Lawrence A. Cohen, a Director of the Company and President, Chief Executive Officer and Director of ILM, was also named Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation, an affiliate of Capital. Under the terms of the Management Agreement, Capital earns a Base Management Fee equal to 4% of the Gross Operating Revenues of the Senior Housing Facilities, as defined. Capital is also be eligible to earn an Incentive Management Fee equal to 25% of the amount by which the average monthly Net Cash Flow of the Senior Housing Facilities, as defined, for the twelve month period ending on the last day of each calendar month exceeds a specified Base Amount. Each August 31, beginning on August 31, 1997, the Base Amount will be increased based on the percentage increase in the Consumer Price Index. ILM has guaranteed the payment of all fees due to Capital under the terms of the Management Agreement. Capital earned total management fees of $415,000 for the six months ended February 28, 1997. Accounts payable - affiliates at February 28, 1997 and August 31, 1996 includes advances of $195,000 and $348,000, respectively, received from ILM Holding, primarily for the purchase of personal property to operate the Senior Housing Facilities. The remaining balance of accounts payable - affiliates at February 28, 1997 consists of management fees payable to Capital of $75,000 and advisory fees payable to the Advisor of $22,000. The remaining balance of accounts payable - affiliates at August 31, 1996 consists of management fees of $76,000 payable to Capital and advisory fees payable to the Advisor of $21,000. 4. Contingencies A management agreement between ILM Holding and Angeles Housing Concepts, Inc. ("AHC") which covered the management of all eight Senior Housing Facilities was assigned to the Company effective September 1, 1995. On July 29, 1996, the Company and ILM Holding ("the Companies") terminated the property management agreement with AHC. The management agreement was terminated for cause pursuant to the terms of the contract. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. The Company and ILM Holding allege, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. Due to the termination of the agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the management agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of California. The filing was challenged by the Companies, and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed an Answer with the Virginia District Court in response to the litigation initiated by the Companies and a Counterclaim against ILM Holding. The Counterclaim alleges that the management agreement was wrongfully terminated for cause and requests damages which include the payment of a termination fee in the amount of $1,250,000, payment of management fees pursuant to the contract from August 1, 1996 through October 15, 1996, and recovery of attorney's fees and expenses. ILM has guaranteed the payment of the termination fee at issue in these proceedings to the extent that any termination fee is deemed payable by the court and in the event that the Company fails to perform pursuant to its contractual obligations. The discovery process is currently underway. The court initially set a trial date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for June 23, 1997. The Companies intend to diligently prosecute the case and to vigorously defend the counterclaims made by AHC. The eventual outcome of this termination dispute cannot presently be determined. Accordingly, no provision for any liability which might result from the outcome of this matter has been recorded in the accompanying financial statements. On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of California against Capital, Lawrence Cohen, and others alleging that the defendants intentionally interfered with AHC's property management agreement with ILM Holding by inducing ILM Holding to terminate the agreement (the "California litigation"). The complaint seeks damages of at least $2,000,000. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber Properties employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should advance up to $20,000 to pay reasonable legal fees and expenses incurred by Capital in the California litigation. The defendants intend to vigorously defend the claims made against them in the California litigation. The eventual outcome of this litigation cannot presently be determined and, accordingly, no provision for any liability has been recorded in the accompanying financial statements. 5. Federal Income Taxes The Company is taxable as a regular C corporation and, therefore, its income is subject to tax at the federal and state levels. The Company reports on a calendar year for tax purposes. Income taxes at the appropriate statutory rates have been provided for in the accompanying financial statements. Deferred income tax expense (benefit) reflects the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The Company's deferred tax assets and liabilities as of February 28, 1997 and August 31, 1996 are comprised of the following amounts (in thousands): February 28 August 31 ----------- --------- Deferred tax asset - straight-line rent expense $ 42 $ 49 Deferred tax liability - tax over book amortization 34 23 ------- ------ Net deferred tax asset $ 8 $ 26 ======= ====== The components of income tax expense (benefit) for the three and six months ended February 28, 1997 and February 29, 1996 are as follows (in thousands): Three Months Ended Six Months Ended February 28/29, February 28/29, ------------------- -------------------- 1997 1996 1997 1996 ---- ---- ---- ---- Current: Federal $ 4 $ 65 $ 102 $ 202 State 2 13 19 36 -------- -------- ------- ------ Total current 6 78 121 238 -------- -------- ------- ------ Deferred: Federal 9 (4) 16 (38) State 1 (2) 3 (7) -------- -------- ------- ------ Total deferred 10 (6) 19 (45) -------- -------- ------ ------ $ 16 $ 72 $ 140 $ 193 ======= ======== ====== ====== The reconciliation of income tax computed at U.S. federal statutory rates to income tax expense for the six months ended February 28, 1997 and February 29, 1996 is as follows (in thousands): 1997 1996 ---- ---- Tax at U.S. statutory rates $ 118 34% $ 164 34% State income taxes, net of federal tax benefit 22 6% 29 6% ----- --- ------ --- $ 140 40% $ 193 40% ===== === ====== === ILM I LEASE CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources - ------------------------------- ILM I Lease Corporation (the "Company") was formed by PaineWebber Independent Living Mortgage Fund, Inc. ("ILM"), a publicly-held, non-traded Real Estate Investment Trust ("REIT"), for the purpose of operating eight Senior Housing Facilities under the terms of a master lease agreement. ILM contributed $700,000 in return for all of the issued and outstanding shares of the Company's common stock. ILM has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended ("the Code"), for each taxable year of operations. In order to maintain its status as a REIT, 75% of ILM's annual gross income must be Qualified Rental Income as defined by the Code. The rent paid by the residents of the Facilities likely would not be deemed to be Qualified Rental Income because of the extent of services provided to residents. Consequently, the operation of the Facilities by ILM or its subsidiaries over an extended period of time could adversely affect ILM's status as a REIT. Therefore, ILM formed the Company to operate the Facilities, and by means of a distribution, transferred the ownership of the common stock of the Company to the holders of ILM common stock on September 1, 1995. Because the Company, which is taxed as a regular C corporation, is no longer a subsidiary of ILM, it can receive service-related income without endangering the REIT status of ILM. The Company's sole business is the operation of the Senior Housing Facilities. The Company has leased the Senior Housing Facilities from ILM Holding, Inc. ("ILM Holding"), a majority-owned and consolidated subsidiary of ILM which currently holds title to the Facilities, pursuant to a master lease which commenced on September 1, 1995 and expires on December 31, 1999. The master lease is a "triple-net" lease whereby the Lessee pays all operating expenses, governmental taxes and assessments, utility charges and insurance premiums, as well as the costs of all required maintenance, personal property and non-structural repairs in connection with the operation of the Senior Housing Facilities. ILM Holding, as the Lessor, is responsible for major capital improvements and structural repairs to the Senior Housing Facilities. During the initial term of the master lease, the Company is obligated to pay annual base rent for the use of all of the Facilities in the aggregate amount of $5,886,000 for calendar year 1995 (prorated based on the lease commencement date) and $6,364,800 for calendar year 1996 and each subsequent year. Beginning in the second quarter of fiscal 1997 and for the remainder of the lease term, the Company is also obligated to pay variable rent for each Facility. Such variable rent is payable quarterly and equals 40% of the excess, if any, of the aggregate total revenues for the Facilities, on an annualized basis, over $16,996,000. Variable rent amounted to $71,000 for the three months ended February 28, 1997. On July 29, 1996, the Company and ILM Holding ("the Companies") terminated the property management agreement with AHC covering the eight Senior Housing Facilities leased by the Company. The management agreement was terminated for cause pursuant to the terms of the contract. Simultaneously with the termination of the management agreement, the Companies, together with certain affiliated entities, filed suit against AHC in the United States District Court for the Eastern District of Virginia for breach of contract, breach of fiduciary duty and fraud. The Company and ILM Holding allege, among other things, that AHC willfully performed actions specifically in violation of the management agreement and that such actions caused damages to the Companies. Due to the termination of the agreement for cause, no termination fee was paid to AHC. Subsequent to the termination of the management agreement, AHC filed for protection under Chapter 11 of the U.S. Bankruptcy Code in its domestic state of California. The filing was challenged by the Companies, and the Bankruptcy Court dismissed AHC's case effective October 15, 1996. In November 1996, AHC filed an Answer with the Virginia District Court in response to the litigation initiated by the Companies and a Counterclaim against ILM Holding. The Counterclaim alleges that the management agreement was wrongfully terminated for cause and requests damages which include the payment of a termination fee in the amount of $1,250,000, payment of management fees pursuant to the contract from August 1, 1996 through October 15, 1996, and recovery of attorney's fees and expenses. ILM has guaranteed the payment of the termination fee at issue in these proceedings to the extent that any termination fee is deemed payable by the court and in the event that the Company fails to perform pursuant to its contractual obligations. The discovery process is currently underway. The court initially set a trial date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for June 23, 1997. The Companies intend to diligently prosecute the case and to vigorously defend the counterclaims made by AHC. The eventual outcome of this termination dispute cannot presently be determined. Accordingly, no provision for any liability which might result from the outcome of this matter has been recorded in the accompanying financial statements. Subsequent to terminating the management agreement with AHC, the Company retained Capital Senior Management 2, Inc. ("Capital") of Dallas, Texas to be the new manager of the Senior Housing Facilities pursuant to a Management Agreement which commenced on July 29, 1996. The initial term of the Management Agreement expires on December 31, 1999, which coincides with the expiration of the master lease agreement between the Company and ILM Holding described above. Under the terms of the Management Agreement, in the event that the master lease agreement is extended beyond December 31, 1999, the Management Agreement will be extended as well, but not beyond July 29, 2001. Effective in November 1996, Lawrence A. Cohen, a Director of the Company and President, Chief Executive Officer and Director of ILM, was also named Vice Chairman and Chief Financial Officer of Capital Senior Living Corporation, an affiliate of Capital. Under the terms of the Agreement, Capital earns a Base Management Fee equal to 4% of the Gross Operating Revenues of the Senior Housing Facilities, as defined. Capital is also eligible to earn an Incentive Management Fee equal to 25% of the amount by which the average monthly Net Cash Flow of the Senior Housing Facilities, as defined, for the twelve month period ending on the last day of each calendar month exceeds a specified Base Amount. Each August 31, beginning on August 31, 1997, the Base Amount will be increased based on the percentage increase in the Consumer Price Index. ILM has guaranteed the payment of all fees due to Capital under the terms of the Management Agreement. On February 4, 1997, AHC filed a Complaint in the Superior Court of the State of California against Capital, Lawrence Cohen, and others alleging that the defendants intentionally interfered with AHC's property management agreement with ILM Holding by inducing ILM Holding to terminate the agreement (the "California litigation"). The complaint seeks damages of at least $2,000,000. At a Board meeting on February 26, 1997, the Company's Board of Directors concluded that since all of Mr. Cohen's actions relating to the California litigation were taken either on behalf of the Company under the direction of the Board or as a PaineWebber Properties employee, the Company or its affiliates should indemnify Mr. Cohen with respect to any expenses arising from the California litigation, subject to any insurance recoveries for those expenses. The Company's Board also concluded that, subject to certain conditions, the Company or its affiliates should advance up to $20,000 to pay reasonable legal fees and expenses incurred by Capital in the California litigation. The defendants intend to vigorously defend the claims made against them in the California litigation. The eventual outcome of this litigation cannot presently be determined and, accordingly, no provision for any liability has been recorded in the accompanying financial statements. The eight properties which the Company leases from ILM Holding averaged 92% occupancy for the quarter ended February 28, 1997. Current annualized operating income levels are sufficient to cover the base master lease payments at their current annual level of $6,364,800, which will remain in effect throughout the remaining term of the lease. As noted above, the master lease also provides for the payment of variable rent beginning in December 1996. The Senior Housing Facilities are currently generating gross revenues which are in excess of the specified threshold in the variable rent calculation, as discussed further above. Variable rent amounted to $71,000 for the three months ended February 28, 1997. Further improvements in operating income levels are expected upon the successful implementation of several new programs by the new property management company. At many properties, the management company has increased the number of rentable units by asking the facility managers to move off site. The increased rental revenue is expected to more than offset any additional costs of housing the managers and providing 24-hour coverage at the front desk. The live-in assistant manager positions at several properties are also being eliminated, which will increase the number of rentable units. In addition, the management company is in the process of implementing new marketing plans at several of the properties and increasing rental rates at properties that have maintained high occupancy levels and are located in strong markets. Property improvements to be paid for by the Company during fiscal 1997 include dining room and lobby refurbishments at the Winston-Salem facility. Fiscal 1997 capital expenditure plans to be funded by ILM include an ongoing program to replace air-conditioning units at the Santa Barbara facility and a program to upgrade the overall appearance of the Sedgwick Plaza property. ILM is also investigating the potential for future expansions of several of the facilities which are located in areas that have particularly strong markets for senior housing. As discussed in the Annual Report, the road adjacent to the Raleigh facility is being improved, and the county Department of Transportation has requested a temporary construction easement on the property. Although the easement does not directly affect the operation of the facility, it has resulted in the removal of several trees that provided a buffer between the building and the road. To date, the facility's management team has been able to work with the Department of Transportation and the local power company to minimize the removal of trees as the road construction work progresses. Once the road work is completed, negotiations with the city to secure a settlement that will pay for any required changes to the property's landscape buffer will be finalized. At a meeting of the ILM Board on January 10, 1997, the Advisor recommended the immediate sale of the senior housing facilities held by ILM and an affiliated entity, PaineWebber Independent Living Mortgage Inc. II ("ILM2"), by means of a controlled auction to be conducted by PaineWebber, at no additional compensation, with PaineWebber offering to purchase the properties for a specified price, thereby guaranteeing the shareholders a "floor" price. The Advisor also stated that if PaineWebber purchased the properties at the specified price and were then able to resell the properties at a higher price, PaineWebber would pay any "excess profits" to the shareholders. To assist the Company and ILM in evaluating the Advisor's proposal, a disinterested, independent investment banker with expertise in healthcare REITs and independent/assisted living financings was engaged. Following a comprehensive analysis, the investment banker recommended that ILM decline the Advisor's proposal and instead investigate expansion and restructuring alternatives. The Company and ILM are presently analyzing the Advisor's proposal and the recommendations and other information provided by the independent investment banker. In addition, the Company and ILM are reviewing various restructuring alternatives. The Company and ILM are analyzing a merger of ILM with ILM Holding and are also considering possibly merging ILM with ILM2 and the Company with ILM II Lease Corporation. In addition, ILM is exploring listing its shares on an exchange or, alternatively, having them trade through NASDAQ. The Company has not fully evaluated any of these alternatives and is not in a position at this time to recommend any actions to its shareholders. There can be no assurance that the Company will recommend taking any of such actions. At February 28, 1997, the Company had cash and cash equivalents of $2,003,000. Such amounts will be used for the Company's working capital requirements. As noted above, under the terms of the master lease the Lessor is responsible for major capital improvements and structural repairs to the Senior Housing Facilities. Consequently, the Company does not have any material commitments for capital expenditures. Furthermore, the Company does not currently anticipate the need to engage in any borrowing activities. As a result, substantially all of the Company's cash flow will be generated from operating activities. The Company did not pay cash dividends in fiscal 1996. The Company intends to review this policy during the second half of fiscal 1997 and may or may not determine to pay cash dividends in the future. Payment of dividends, if any, will be at the discretion of the Company's Board of Directors and will depend upon such factors as the Company's financial condition, earnings, anticipated investments and other relevant factors. The source of future liquidity is expected to be from operating cash flow from the Senior Housing Facilities, net of the master lease payments to ILM Holding, and interest income earned on invested cash reserves. Such sources of liquidity are expected to be adequate to meet the Company's operating requirements on both a short-term and long-term basis. Results of Operations Three Months Ended February 28, 1997 - ------------------------------------ The Company's net income decreased by $70,000 for the three months ended February 28, 1997 when compared to the same period in the prior year. The decrease in net income is primarily the result of an increase in operating expenses of $239,000. The increase in operating expenses was mainly due to increases in master lease rent and general and administrative of $71,000 and $122,000, respectively. In addition, costs were higher in the areas of dietary and marketing expenses for the three months ended February 28, 1997. Master lease rent expense increased due to additional variable rent accrued effective for the second quarter of fiscal 1997 per the Master Lease Agreement. General and administrative expenses increased largely due to an increase in legal fees attributable mainly to the ongoing AHC litigation referred to above. The increases in operating expenses were partially offset by an increase in rental income from the Senior Housing Facilities of $115,000. The increase in rental income is due to a slight increase in the portfolio's average occupancy level from 90% for the fiscal quarter ended February 1996 to 92% for the fiscal quarter ended February 1997, as well as increases in rental rates at certain of the facilities located in strong markets. Six Months Ended February 28, 1997 - ---------------------------------- The Company's net income decreased by $65,000 for the six months ended February 28, 1997 when compared to the same period in the prior year. The decrease in net income is primarily the result of an increase in operating expenses of $417,000. The increase in operating expenses was mainly due to higher costs in the areas of dietary, rent and general and administrative expenses for the six months ended February 28, 1997. Dietary salaries, wages and food service expense increased by $122,000 primarily due to an improvement in the portfolio occupancy level compared to the same period in the prior year. Master lease rent expense increased by $71,000 due to additional variable rent accrued effective for the second quarter of fiscal 1997 per the Master Lease Agreement. General and administrative expenses increased by $123,000 largely due to an increase in legal fees, attributable mainly to the ongoing AHC litigation referred to above. The increases in operating expenses were partially offset by an increase in rental income from the Senior Housing Facilities of $286,000. The increase in rental income is due to a slight increase in the portfolio's average occupancy level from 89% for the six months ended February 1996 to 92% for the six months ended February 1997, as well as increases in rental rates at certain of the facilities located in strong markets. PART II Other Information Item 1. Legal Proceedings The status of the litigation involving the Company, ILM Holding, Inc. and Angeles Housing Concepts, Inc. remains unchanged from what was reported in the Company's Annual Report on Form 10-K for the year ended August 31, 1996. The discovery process is currently underway. The court initially set a trial date of April 28, 1997 but, at AHC's request, recently rescheduled the trial for June 23, 1997. Item 2. through 5. NONE Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: NONE (b) Reports on Form 8-K: NONE ILM I LEASE CORPORATION SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. By: ILM LEASE CORPORATION By: /s/ Timothy J. Medlock ---------------------- Timothy J. Medlock Treasurer Dated: April 17, 1997 EX-27 2 ARTICLE 5 FDS FOR THE YEAR ENDED 8/31/97
5 This schedule contains summary financial information extracted from the Partnership's audited financial statements for the six months ended February 28, 1997 and is qualified in its entirety by reference to such financial statements. 1,000 6-MOS AUG-31-1997 FEB-28-1997 2,003 0 46 0 0 2,164 385 42 2,515 1,126 0 0 0 700 585 2,515 0 8,864 0 8,500 0 0 0 364 140 224 0 0 0 224 0.03 0.03
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