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FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
-------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________to
Commission file number 0-17686
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
Wisconsin 39-1606834
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 W. 11th Street, Suite 1110, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(816) 421-7444
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Limited
Partnership Interests
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 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
---
1
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
June 30, 2002 and December 31, 2001
------------------------------------
ASSETS
(Unaudited)
June 30, December 31,
2002 2001
----------- ------------
INVESTMENT PROPERTIES AND EQUIPMENT: (Note 3)
Land $ 7,264,553 $ 7,296,406
Buildings 10,906,597 11,561,307
Property held for sale 686,563 0
Equipment 669,778 669,778
Accumulated depreciation (6,022,194) (5,854,938)
----------- -----------
Net investment properties and equipment 13,505,297 13,672,553
OTHER ASSETS:
Cash and cash equivalents 903,596 818,606
Cash held in Indemnification Trust (Note 8) 375,447 372,167
Property tax escrow 0 7,875
Rents and other receivables (Net of allowance of
$102,001 and $39,636, respectively) 116,283 546,771
Property tax receivable 8,293 30,977
Deferred rent receivable 107,751 105,633
Prepaid insurance 8,814 22,035
Deferred charges 279,459 286,067
Note receivable (Note 3) 0 39,250
----------- -----------
Total other asset 1,799,643 2,229,381
Total assets $15,304,940 $15,901,934
=========== ===========
The accompanying notes are an integral part of these statements.
2
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
June 30, 2002 and December 31, 2001
-----------------------------------
LIABILITIES AND PARTNERS' CAPITAL
(Unaudited) December 31,
June 30, 2001
2002 ----
----
LIABILITIES:
Accounts payable and accrued expenses $130,167 $92,802
Property taxes payable 0 25,105
Due to General Partner 1,297 1,795
Security deposits 109,017 109,017
Unearned rental income 41,988 172,723
------- -------
Total liabilities 282,469 401,442
------- -------
CONTINGENT LIABILITIES: (Note 7)
PARTNERS' CAPITAL: (Notes 1, 4 and 9)
Current General Partner -
Cumulative net income
177,266 172,176
Cumulative cash distributions (72,977) (70,941)
------- -------
104,289 101,235
Limited Partners (46,280.3 interests outstanding)
Capital contributions, net of offering costs 39,358,468 39,358,468
Cumulative net income 23,915,211 23,411,286
Cumulative cash distributions (47,515,268) (46,530,268)
Reallocation of former general partners' deficit capital (840,229) (840,229)
--------- ---------
14,918,182 15,399,257
---------- ----------
Total partners' capital 15,022,471 15,500,492
Total liabilities and partners' capital $15,304,940 $15,901,934
=========== ===========
The accompanying notes are an integral part of these statements.
3
DIVALL INSURED
INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF INCOME
(Unaudited)
-----------
Three Months Ended Six Months Ended
---------------------- --------------------
June 30, June 30,
-------- --------
2001 2002 2001 2002
---- ---- ---- ----
REVENUES:
Rental income (Note 5) $527,523 $577,644 $1,033,908 $1,167,126
Interest income 4,659 11,584 8,672 25,757
Lease termination fee (Note 3) 0 157,000 0 157,000
Recovery of amount previously written off 232 1,391 232 4,172
Other income 0 134 8,059 318
- --- ----- ---
532,414 747,753 1,050,871 1,354,373
------- ------- --------- ---------
EXPENSES:
Partnership management fees (Note 6) 49,911 48,505 98,925 95,891
Insurance 6,611 6,827 13,221 9,655
General and administrative 26,716 25,408 47,562 46,743
Advisory Board fees and expenses 2,188 2,188 5,924 6,462
Write-off non-collectible receivables 56,352 7,561 58,369 15,561
Ground lease payments (Note 3) 0 18,951 0 35,803
Expenses incurred due to default by lessee 5,239 1,205 5,944 1,205
Professional services 42,914 38,476 92,910 130,086
Restoration fees (Note 6) 9 56 9 167
Judgment expense (Note 10) 45,128 0 45,128 0
Depreciation 83,021 86,100 167,256 172,200
Amortization 3,304 11,947 6,608 15,082
----- ------ ----- ------
321,393 247,224 541,856 528,855
------- ------- ------- -------
NET INCOME $211,021 $500,529 $509,015 $825,518
======== ======== ======== ========
NET INCOME - CURRENT GENERAL PARTNER $2,110 $5,005 $5,090 $8,255
NET INCOME - LIMITED PARTNERS 208,911 495,524 503,925 817,263
------- ------- ------- -------
$211,021 $500,529 $509,015 $825,518
======== ======== ======== ========
NET INCOME PER LIMITED PARTNERSHIP
INTEREST, based on 46,280.3 Interests outstanding $4.51 $10.71 $10.89 $17.66
===== ====== ====== ======
The accompanying notes are an integral part of these statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(Unaudited)
-----------
Six Months Ended June 30,
-------------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $509,015 $825,518
Adjustments to reconcile net income to net
cash from operating activities -
Depreciation and amortization 173,864 187,282
Recovery of amounts previously written off (232) (4,172)
Provision from non-collectible rents and receivables 58,369 15,561
Interest applied to Indemnification Trust account (3,280) (9,622)
Lease termination fee 0 (117,750)
Decrease/(Increase) in property tax escrow 7,875 (7,875)
Decrease in rents and other receivables 394,803 434,071
Decrease in prepaid assets 13,221 9,655
(Increase) in deferred rent receivable (2,118) (3,780)
(Decrease) in due to current General Partner (498) (665)
Increase in accounts payable and other accrued expenses 12,260 52,821
(Decrease) in unearned rental income (130,735) (43,342)
--------- --------
Net cash from operating activities 1,344,702 1,032,544
--------- ---------
CASH FLOWS (USED IN) FROM INVESTING ACTIVITIES:
Note receivable 39,250 0
Payment of deferred leasing commissions 0 (69,509)
Recoveries from former affiliates 232 4,172
--- -----
Net cash (used in) from investing activities 39,482 (65,537)
------ --------
CASH FLOWS (USED IN) FINANCING ACTIVITIES:
Cash distributions to Limited Partners (985,000) (1,115,000)
Cash distributions to current General Partner (2,036) (2,8.35)
------- -------
Net cash (used in) financing activities (987,036) (1,118,302)
--------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 84,990 161,063
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 818,606 752,060
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $903,596 $913,123
======== ========
The accompanying notes are an integral part of these statements.
5
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
These unaudited interim financial statements should be read in conjunction with
DiVall Insured Income Properties 2 Limited Partnership' (the "Partnership") 2001
annual audited financial statements within Form 10-K.
These unaudited financial statements include all adjustments, which are, in the
opinion of management, necessary to present a fair statement of financial
position as of June 30, 2002, and the results of operations for the three and
six-month periods ended June 30, 2002, and 2001, and cash flows for the
three-month periods ended June 30, 2002 and 2001. Results of operations for the
periods are not necessarily indicative of the results to be expected for the
full year.
1. ORGANIZATION AND BASIS OF ACCOUNTING:
-------------------------------------
The Partnership was formed on November 18, 1987, pursuant to the Uniform Limited
Partnership Act of the State of Wisconsin. The initial capital, which was
contributed during 1987, consisted of $300, representing aggregate capital
contributions of $200 by the former general partners and $100 by the Initial
Limited Partner. The minimum offering requirements were met and escrow
subscription funds were released to the Partnership as of April 7, 1988. On
January 23, 1989, the former general partners exercised their option to increase
the offering from 25,000 interests to 50,000 interests and to extend the
offering period to a date no later than August 22, 1989. On June 30, 1989, the
general partners exercised their option to extend the offering period to a date
no later than February 22, 1990. The offering closed on February 22, 1990, at
which point 46,280.3 interests had been sold, resulting in total offering
proceeds, net of underwriting compensation and other offering costs, of
$39,358,468.
The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate. The
Properties are leased on a triple net basis to, and operated by, franchisers or
franchisees of national, regional, and local retail chains under long-term
leases. The lessees consist primarily of fast-food, family style, and
casual/theme restaurants, but also include a video rental store and a child care
center. At June 30, 2002, the Partnership owned 26 properties with specialty
leasehold improvements in 10 of these properties.
Rental revenue from investment properties is recognized on the straight-line
basis over the life of the respective lease. Percentage rents are recorded when
the tenant has reached the breakpoint stipulated in its lease.
The Partnership considers its operations to be in only one segment and therefore
no segment disclosure is made. Depreciation of the properties is provided on a
straight-line basis over 31.5 years, which is the estimated useful life of the
buildings and improvements. Equipment is depreciated on a straight-line basis
over the estimated useful lives of 5 to 7 years.
6
Deferred charges consist of leasing commissions paid when properties are leased
to tenants and the negotiated extension of a lease. Leasing commissions are
capitalized and amortized over the life of the lease.
Real estate taxes on the Partnership's investment properties are the
responsibility of the tenant. However, when a tenant fails to make the required
tax payments or when a property becomes vacant, the Partnership makes the
appropriate payment to avoid possible foreclosure of the property. Taxes are
accrued in the period in which the liability is incurred.
Cash and cash equivalents include cash on deposit with financial institutions
and highly liquid temporary investments with initial maturities of 90 days or
less.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities (and disclosure of
contingent assets and liabilities) at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Partnership previously followed Statement of Financial Accounting Standards
No.121 ("FAS 121"), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of", which required that all long-lived assets
be reviewed for impairment in value whenever changes in circumstances indicated
that the carrying amount of an asset may not be recoverable. In October 2001,
Statement of Financial Accounting Standards No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("FAS 144") was issued. FAS 144
supercedes FAS 121. FAS 144 primarily addresses issues relating to the
implementation of FAS 121 and develops a single accounting model for long-lived
assets to be disposed of, whether previously held and used or newly acquired.
The provisions of FAS 144 became effective for fiscal years beginning after
December 15, 2001. The Company adopted FAS 144 on January 1, 2002 with no impact
on financial statements.
The Partnership will be dissolved on November 30, 2010, or earlier upon the
prior occurrence of any of the following events: (a) the disposition of all
properties of the Partnership; (b) the written determination by the General
Partner that the Partnership's assets may constitute "plan assets" for purposes
of ERISA; (c) the agreement of Limited Partners owning a majority of the
outstanding interests to dissolve the Partnership; or (d) the dissolution,
bankruptcy, death, withdrawal, or incapacity of the last remaining General
Partner, unless an additional General Partner is elected previously by a
majority of the Limited Partners. During the Second Quarter of 1998, the General
Partner received the consent of the Limited Partners to liquidate the
Partnership=s assets and dissolve the Partnership. No buyer was identified for
the Partnership's assets, and Management continued normal operations. During the
Second Quarter of 2001, another consent letter was sent to Limited Partners. The
General Partner did not receive majority approval to sell the assets of the
Partnership for purposes of liquidation. The Partnership, therefore, continued
to operate as a going concern.
No provision for Federal income taxes has been made, as any liability for such
taxes would be that of the individual partners rather than the Partnership. At
December 31, 2001, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$7,859,000.
2. REGULATORY INVESTIGATION:
-------------------------
7
A preliminary investigation during 1992 by the Office of Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation") revealed that during at least the four years ended
December 31, 1992, the former general partners of the Partnership, Gary J.
DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial
cash assets of the Partnership and two affiliated publicly registered
partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1")
(dissolved effective December 31, 1998) and DiVall Income Properties 3 Limited
Partnership ("DiVall 3") (collectively the "Partnerships") to various other
entities previously sponsored by or otherwise affiliated with DiVall and
Magnuson. The unauthorized transfers were in violation of the respective
Partnership Agreements and resulted, in part, from material weaknesses in the
internal control system of the Partnerships.
Subsequent to discovery, and in response to the regulatory inquiries, a
third-party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed
(effective February 8, 1993) to assume responsibility for daily operations and
assets of the Partnerships as well as to develop and execute a plan of
restoration for the Partnerships. Effective May 26, 1993, the Limited Partners,
by written consent of a majority of interests, elected the Permanent Manager,
TPG, as General Partner. TPG terminated the former general partners by accepting
their tendered resignations.
In 1993, the current General Partner estimated an aggregate recovery of $3
million for the Partnerships. At that time, an allowance was established against
amounts due from former general partners and their affiliates reflecting the
estimated $3 million receivable. This net receivable was allocated among the
Partnerships based on each Partnership's pro rata share of the total
misappropriation. Through June 30, 2002, $5,804,000 of recoveries has been
received which exceeded the original estimate of $3 million. As a result, since
1996, the Partnership has recognized $1,125,000 as income, which represents its
share of the excess recovery. No further significant recoveries are anticipated.
3. INVESTMENT PROPERTIES:
----------------------
As of June 30, 2002, the Partnership owned 24 fully constructed fast-food
restaurants, a video store, and a preschool. The properties are composed of the
following: ten (10) Wendy's restaurants, one (1) Denny's restaurants, one (1)
Applebee's restaurant, one (1) Popeye's Famous Fried Chicken restaurant, one (1)
Hooter's restaurant, one (1) Kentucky Fried Chicken restaurant, one (1)
Hostetler's restaurant, one (1) Miami Subs restaurant, one (1) Omega restaurant,
one (1) Blockbuster Video store, one (1) Sunrise Preschool, and six (6) vacant
properties, (which were previously operated as a Village Inn restaurant, a
Fiesta Time restaurant, one (1) Denny's restaurants, and three (3) Hardee's
restaurants.) The 26 properties are located in a total of thirteen (13) states.
During the Second Quarter of 2002, Management entered a contract to sell the
vacant Hardee's restaurant in Hartford, Wisconsin in July 2002 at a sales price
of $618,000. The net asset value of the property at June 30, 2002 was
approximately $470,000. The Partnership intends to pay TPG a sales commission
upon the sale amounting to $18,500. No commissions are to be paid to
unaffiliated brokers by the Partnership. During December 2001, Hardee's Food
Systems, Inc. had notified Management that it had vacated its restaurant in
Hartford, Wisconsin. Hardee's lease on the Hartford property was set to expire
on April 30, 2009 and they will be required to continue making rent payments
until the sale date.
8
During the Second Quarter of 2002, Mountain Range Restaurants, the sub-lessee of
the Denny's- N. 7th Street property in Phoenix, Arizona, notified Management
that it would vacate the property at the end of May 2002. During the Fourth
Quarter of 2001, the Bankruptcy court granted the motion of Lessee, Phoenix
Restaurant Group, Inc. ("Phoenix"), to reject the lease with the Partnership at
the Phoenix, Arizona location. Following the rejection of this lease by Phoenix,
the Mountain Range Restaurants declined the Partnership's offer to lease the
property directly to them. Therefore, the property was vacated and rent ceased
as of May 31, 2002. Management intends to market the property for lease or sale.
During March 2002, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in Fond du Lac, Wisconsin in April 2002. Hardee's lease
on the Fond du Lac property is set to expire on September 30, 2009 and they will
be required to continue making rent payments until the lease expiration date or
until a lease termination agreement is entered into.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in South Milwaukee, Wisconsin. Hardee's lease on the
South Milwaukee property expired on November 30, 2001 and they continued making
rent payments until the lease expiration date. This lease was not renewed, and
therefore, Management continues to market the property for sale or lease to a
new operator.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in Milwaukee, Wisconsin. The Hardee's lease on the
Milwaukee property was not set to expire until 2009. In the Second Quarter of
2001, a lease termination agreement was executed and the tenant ceased the
payment of rent as of April 30, 2001. Hardee's Food Systems agreed to pay a
lease termination fee of approximately two (2) years rent or $157,000. The
payment schedule included four (4) equal installments of $39,250. The first
payment was received in May 2001 upon the execution of the agreement, and the
subsequent installments were reflected as a Note receivable on the balance sheet
in the Second Quarter of 2001. The second and third Note receivable installments
were received in August and October 2001. The final installment, which is
reflected as a Note receivable on the balance sheet at December 31, 2001, was
received in January 2002.
During May 2001, Management negotiated the re-lease of the former
Hardee's-Milwaukee, Wisconsin property to Omega Restaurant in June 2001 and rent
income commenced in October 2001. Commissions of $50,000 and $9,000 were paid to
an unaffiliated leasing agent and to an affiliate of the General Partner,
respectively, upon the execution of the new lease in the Second Quarter of 2001.
The Blockbuster Video Store lease expired on January 31, 2001. However, in the
First Quarter of 2001, Management negotiated a five (5) year lease extension to
January 31, 2006. A commission of $10,000 was paid to an unaffiliated leasing
agent upon the negotiated extension of the lease.
During the Fourth Quarter of 2001, the Bankruptcy court granted the motion of
Phoenix Restaurant Group, Inc. ("Phoenix") to reject the lease with the
Partnership at the Twin Falls, Idaho location. Although Phoenix's lease on the
Twin Falls property expires on April 30, 2012, due to bankruptcy proceedings of
Phoenix, the lease was rejected and rent income ceased in the Fourth Quarter of
2001. The remaining balance due the Partnership of approximately $29,000 from
the former tenant has been reserved. This amount is included in the
Partnership's filing for damages in Bankruptcy court of approximately $85,000,
or one year's rent, although it is uncertain whether the amount will be
collectible. In addition, since Phoenix rejected the lease, its subtenant,
Fiesta Time, is
9
not entitled to possession of the property. Therefore, Management is in the
process of evicting and obtaining possession of the property from Fiesta Time,
after which Management intends to market the property for lease or sale.
During April 2001, the sub-tenant AMF Corporation ("AMF") notified Management of
its intent to close and vacate its Mulberry Street Grill restaurant in Phoenix,
Arizona. Although the lease on the property expires in 2007, monthly rental and
Common Area Maintenance (CAM) income ceased as of June 1, 2001. Management is
moving forward with legal remedies to collect the balances due from AMF. The
past due rent amount of $10,000 has been reserved. Due to Management's return of
possession of the property to the Ground Lease landlord, the net asset value of
the property was written-off in the Fourth Quarter of 2001, resulting in a loss
of $157,000. As of December 31, 2001 the Partnership had withheld the May
through December 2001 accrued ground lease obligations totaling approximately
$50,000 related to the property. In the Second Quarter of 2001, the Ground Lease
landlord filed suit against the Partnership and TPG (as General Partner) seeking
possession of the property and damages for breach of the Ground Lease. In April
2002, an additional $43,000 was accrued as payable to the Ground Lease landlord,
due to the Court's granting a summary judgment of $93,000 against the
Partnership. (See Legal Proceedings in Part II. - Item 1 and Note 10.)
During October 2001, the Village Inn Restaurant notified Management of its
intent to close and vacate its restaurant in Grand Forks, North Dakota within
the next few months. The lease on the property expires in 2009. In February
2002, Management was notified Village Inn had closed and vacated the restaurant.
Rent income was collected from the tenant through December 2001, however; rent
income has not been collected for January through June of 2002. In addition, in
March 2002, the Partnership paid the properties' first installment of 2001 real
estate taxes. Management will pursue all legal remedies in relation to the
former tenant's past due balance of approximately $58,000, as well as future
lease and other obligations. Management is also seeking a new tenant for the
vacated property. Management anticipates that the Partnership will incur
approximately $27,000 to replace the roof on the property in the Third Quarter
of 2002. Other repairs may also be needed, however, specifics and amounts are
not known as of the end of the Second Quarter.
As of June 30, 2002 the Partnership owns one (1) restaurant, Kentucky Fried
Chicken, which is located on a parcel of land where it has entered into a
long-term ground lease. Tenant, Kentucky Fried Chicken pays the lease
obligations under the ground lease.
The total cost of the investment properties and specialty leasehold improvements
includes the original purchase price plus acquisition fees and other capitalized
costs paid to an affiliate of the former general partners.
According to the Partnership Agreement, the former general partners were to
commit 80% of the original offering proceeds to investment in properties. Upon
full investment of the net proceeds of the offering, approximately 75% of the
original proceeds were invested in the Partnership's properties.
The current General Partner receives a fee for managing the Partnership equal to
4% of gross receipts, with a maximum reimbursement for office rent and related
office overhead of $25,000 between the three original affiliated Partnerships as
provided in the Permanent Manager Agreement ("PMA"). Effective March 1, 2002,
the minimum management fee and the maximum reimbursement for office rent and
overhead increased by 2.8%, representing the allowable annual Consumer Price
Index adjustment per the PMA. For purposes of computing the
10
4% overall fee, gross receipts includes amounts recovered in connection with the
misappropriation of assets by the former general partners and their affiliates.
TPG has received fees from the Partnership totaling $55,481 to date on the
amounts recovered. The fees received from the Partnership on the amounts
recovered reduce the 4% minimum fee by that same amount.
Several of the Partnership's property leases contain purchase option provisions
with stated purchase prices in excess of the original cost of the properties.
The current General Partner is not aware of any unfavorable purchase options in
relation to original cost.
4. PARTNERSHIP AGREEMENT:
----------------------
The Partnership Agreement, prior to an amendment effective May 26, 1993,
provided that, for financial reporting and income tax purposes, net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
general partners. The Partnership Agreement also provided for quarterly cash
distributions from Net Cash Receipts, as defined, within 60 days after the last
day of the first full calendar quarter following the date of release of the
subscription funds from escrow, and each calendar quarter thereafter, in which
such funds were available for distribution with respect to such quarter. Such
distributions were to be made 90% to Limited Partners and 10% to the former
general partners, provided, however, that quarterly distributions were to be
cumulative and were not to be made to the former general partners unless and
until each Limited Partner had received a distribution from Net Cash Receipts in
an amount equal to 10% per annum, cumulative simple return on his or her
Adjusted Original Capital, as defined, from the Return Calculation Date, as
defined.
Net Proceeds, as originally defined, were to be distributed as follows: (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation date
including in the calculation of such return all prior distributions of Net Cash
Receipts and any prior distributions of Net Proceeds under this clause; and (c)
then, to Limited Partners, 90% and to the General Partners, 10%, of the
remaining Net Proceeds available for distribution.
On May 26, 1993, pursuant to the results of a solicitation of written consents
from the Limited Partners, the Partnership Agreement was amended to replace the
former general partners and amend various sections of the agreement. The former
general partners were replaced as General Partner by The Provo Group, Inc., an
Illinois corporation. Under the terms of the amendment, net profits or losses
from operations are allocated 99% to the Limited Partners and 1% to the current
General Partner. The amendment also provided for distributions from Net Cash
Receipts to be made 99% to Limited Partners and 1% to the current General
Partner provided, that quarterly distributions will be cumulative and will not
be made to the current General Partner unless and until each Limited Partner has
received a distribution from Net Cash Receipts in an amount equal to 10% per
annum, cumulative simple return on his or her Adjusted Original Capital, as
defined, from the Return Calculation Date, as defined, except to the extent
needed by the General Partner to pay its federal and state income taxes on the
income allocated to it attributable to such year. Distributions paid to the
General Partner are based on the estimated tax liability resulting from
allocated income. Subsequent to the filing of the General Partner's income tax
returns, a true up with actual distributions is made.
The provisions regarding distribution of Net Proceeds, as defined, were also
amended to provide that Net Proceeds are to be distributed as follows: (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
11
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation Date
including in the calculation of such return on all prior distributions of Net
Cash Receipts and any prior distributions of Net Proceeds under this clause,
except to the extent needed by the General Partner to pay its federal and state
income tax on the income allocated to its attributable to such year; and (c)
then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net
Proceeds available for distribution.
Additionally, per the amendment of the Partnership Agreement dated May 26, 1993,
the total compensation paid to all persons for the sale of the investment
properties shall be limited to a competitive real estate commission, not to
exceed 6% of the contract price for the sale of the property. The General
Partner may receive up to one-half of the competitive real estate commission,
not to exceed 3%, provided that the General Partner provides a substantial
amount of services in the sales effort. It is further provided that a portion of
the amount of such fees payable to the General Partner is subordinated to its
success in recovering the funds misappropriated by the former general partners.
(See Note 7.)
5. LEASES:
------
Lease terms for the majority of the investment properties are 20 years from
their inception. The leases generally provide for minimum rents and additional
rents based upon percentages of gross sales in excess of specified breakpoints.
The lessee is responsible for occupancy costs such as maintenance, insurance,
real estate taxes, and utilities. Accordingly, these amounts are not reflected
in the statements of income except in circumstances where, in management's
opinion, the Partnership will be required to pay such costs to preserve its
assets (i.e., payment of past-due real estate taxes). Management has determined
that the leases are properly classified as operating leases; therefore, rental
income is reported when earned and the cost of the property, excluding the cost
of the land, is depreciated over its estimated useful life.
Aggregate minimum lease payments to be received under the leases for the
Partnership's properties are as follows:
Year ending December 31,
2002 $1,963,431
2003 1,847,092
2004 1,876,311
2005 1,886,603
2006 1,810,133
Thereafter 12,742,616
----------
$22,126,186
===========
Ten (10) of the properties are leased to Wensouth Orlando, a franchisee of
Wendy's restaurants. Wensouth base rents accounted for 40% of total base rents
for 2001.
6. TRANSACTIONS WITH CURRENT GENERAL PARTNER:
-----------------------------------------
12
Amounts paid to the current General Partner for the three-month periods ended
June 30, 2002 and 2001 are as follows.
Incurred as of Incurred as of
Current General Partner June 30,2002 June 30, 2001
- ----------------------- -------------- --------------
Management fees $98,925 $95,981
Restoration fees 9 167
Overhead allowance 7,982 7,750
Reimbursement for out-of-pocket expenses 3,702 4,796
Leasing Commissions 0 8,644
Cash distribution 2,036 3,302
-------- --------
$112,654 $120,640
======== ========
7. CONTINGENT LIABILITIES:
----------------------
According to the Partnership Agreement, as amended, the current General
Partner may receive a disposition fee not to exceed 3% of the contract price
of the sale of investment properties. Fifty percent (50%) of all such
disposition fees earned by the current General Partner is to be in escrow
until the aggregate amount of recovery of the funds misappropriated from the
Partnerships by the former general partners is greater than $4,500,000. Upon
reaching such recovery level, full disposition fees will thereafter be payable
and fifty percent (50%) of the previously escrow amounts will be paid to the
current General Partner. At such time as the recovery exceeds $6,000,000 in
the aggregate, the remaining escrow disposition fees shall be paid to the
current General Partner. If such levels of recovery are not achieved, the
current General Partner will contribute the amounts in escrow towards the
recovery. In lieu of an escrow, 50% of all such disposition fees have been
paid directly to the restoration account and then distributed among the three
Partnerships. Fifty percent (50%) of the total amount paid to the recovery was
refunded to the current General Partner during March 1996 after surpassing the
recovery level of $4,500,000. The remaining amount allocated to the
Partnership may be owed to the current General Partner if the $6,000,000
recovery level is met. As of June 30, 2002, the Partnership may owe the
current General Partner $16,296, which is currently reflected as a recovery,
if the $6,000,000 recovery level is achieved, which is considered unlikely.
8. PMA INDEMNIFICATION TRUST:
-------------------------
The PMA provides that the Permanent Manager will be indemnified from any
claims or expenses arising out of or relating to the Permanent Manager serving
in such capacity or as substitute general partner, so long as such claims do
not arise from fraudulent or criminal misconduct by the Permanent Manager. The
PMA provides that the Partnership fund this indemnification obligation by
establishing a reserve of up to $250,000 of Partnership assets which would not
be subject to the claims of the Partnership's creditors. An Indemnification
Trust ("Trust") serving such purposes has been established at United Missouri
Bank, N.A. The Trust has been fully funded with Partnership assets as of June
30, 2002. Funds are invested in U.S. Treasury securities. In addition,
$125,447 of
13
earnings has been credited to the Trust as of June 30, 2002. The rights of the
Permanent Manager to the Trust shall be terminated upon the earliest to occur of
the following events: (i) the written release by the Permanent Manager of any
and all interest in the Trust; (ii) the expiration of the longest statute of
limitations relating to a potential claim which might be brought against the
Permanent Manager and which is subject to indemnification; or (iii) a
determination by a court of competent jurisdiction that the Permanent Manager
shall have no liability to any person with respect to a claim which is subject
to indemnification under the PMA. At such time as the indemnity provisions
expire or the full indemnity is paid, any funds remaining in the Trust will
revert back to the general funds of the Partnership.
9. FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS:
-----------------------------------------
The capital account balance of the former general partners as of May 26, 1993,
the date of their removal as general partners pursuant to the results of a
solicitation of written consents from the Limited Partners, was a deficit of
$840,229. At December 31, 1993, the former general partners' deficit capital
account balance in the amount of $840,229 was reallocated to the Limited
Partners.
10. LEGAL PROCEEDINGS:
-----------------
The Partnership owned the building in Phoenix, Arizona occupied by the Mulberry
Street Grill restaurant, which was located on a parcel of land, leased to the
Partnership pursuant to a long-term ground lease (the "Ground Lease.") The
Ground Lease was considered an operating lease and the lease payments were paid
by the Partnership and expensed in the periods to which they applied. During the
Second Quarter of 2001, sub-tenant AMF Corporation ("AMF") notified Management
of its intent to close its Mulberry Street Grill restaurant. Although the
sub-lease had not expired, since such notification the Partnership has received
no rent from the former tenant and has returned possession of the Phoenix,
Arizona property to the Ground Lease Landlord, Centre at 38th Street, L.L.C,
("Centre".) Beginning in May and through December 2001 the Partnership accrued
but withheld payment of the ground lease obligations, and on March 31, 2002 and
December 31, 2001 the total ground lease accrual approximated $50,000. Centre
has re-leased the property to a new tenant.
On June 18, 2001, Centre filed a lawsuit (the "Complaint") in the Maricopa
County Superior Court, against the Partnership and TPG. The Complaint alleges
that the Partnership is a tenant under a Ground Lease with Centre and that the
Partnership has defaulted on its obligations under that lease. The suit names
TPG as a defendant because TPG is the Partnership's general partner. The
Complaint sought damages for unpaid rent, commissions, improvements, and
unspecified other damages exceeding $120,000.
The Partnership and TPG filed an answer denying any liability to Centre. In
addition, the Partnership has filed a third-party complaint against the original
tenant, National Restaurant Group, ("National Restaurant"), L.L.C., and its
sub-tenant AMF. In the third-party complaint, the Partnership alleges that
National Restaurant and AMF are liable to the Partnership for breach of the
subleases and any damages for which the Partnership may be held liable pursuant
to the Ground Lease. Currently National Restaurant has filed for bankruptcy and
the Partnership has not been successful in locating AMF.
On April 10, 2002 the Maricopa County Superior Court granted the motion for
summary judgment against the Partnership and TPG. The Court awarded damages to
Centre as of April 10, 2002 in the amount of $93,000.
14
As of March 31, 2002 the Partnership had accrued $50,000 in ground lease
obligations payable to Centre and the remaining summary judgment balance of
$43,000 was accrued in April 2002.
On June 20, 2002 the Partnership and TPG filed the Notice of Appeal with respect
to such judgment and are waiting for the Court of Appeals to set a schedule for
filing briefs in support of the appeal. In order to prevent Centre from
enforcing the judgment, an approximately $140,000 bond application was filed in
July 2002. The bond premium is anticipated to be approximately $1,600. By law,
the amount of the bond must be sufficient to cover the amount of the judgment,
plus interest, and any additional costs that may be incurred during the appeal.
11. SUBSEQUENT EVENTS:
-----------------
On August 15, 2002, the Partnership is scheduled to make distributions to the
Limited Partners for the Second Quarter of 2002 of $360,000 amounting to
approximately $7.78 per limited partnership interest.
The Hardee's- Hartford sale was not consummated in late July 2002 as Management
anticipated. The closing date is presently projected for August 2002 at a sale
price of $618,000. The net asset value of the property at June 30, 2002 was
approximately $470,000. The Partnership intends to pay an approximately $18,500
sales commission to TPG upon the sale. No commissions are to be paid to
unaffiliated brokers by the Partnership.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Liquidity and Capital Resources:
- -------------------------------
Investment Properties
- ---------------------
The investment properties, including equipment held by the Partnership at June
30, 2002, were originally purchased at a price, including acquisition costs, of
approximately $22,261,000.
During the Second Quarter of 2002, Management entered a contract to sell the
vacant Hardee's restaurant in Hartford, Wisconsin in July 2002 at a sales price
of $618,000. The net asset value of the property at June 30, 2002 was
approximately $470,000. The Partnership intends to pay TPG a sales commission
upon the sale amounting to $18,500. No commissions are to be paid to
unaffiliated brokers by the Partnership. During December 2001, Hardee's Food
Systems, Inc. had notified Management that it had vacated its restaurant in
Hartford, Wisconsin. Hardee's lease on the Hartford property was set to expire
on April 30, 2009 and they will be required to continue making rent payments
until the sale date.
During the Second Quarter of 2002, Mountain Range Restaurants, the sub-lessee of
the Denny's- N. 7th Street property in Phoenix, Arizona, notified Management
that it would vacate the property at the end of May 2002. During the Fourth
Quarter of 2001, the Bankruptcy court granted the motion of Lessee, Phoenix
Restaurant Group, Inc. ("Phoenix"), to reject the lease with the Partnership at
the Phoenix, Arizona location. Following the rejection of this lease by Phoenix,
Mountain Range Restaurants declined the Partnership's offer to lease the
15
property directly to them. Therefore, the property was vacated and rent ceased
as of May 31, 2002. Management will market the property for lease or sale.
During March 2002, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in Fond du Lac, Wisconsin in April 2002. Hardee's lease
on the Fond du Lac property is set to expire on September 30, 2009 and they will
be required to continue making rent payments until the lease expiration date or
until a lease termination agreement is entered into.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in South Milwaukee, Wisconsin. Hardee's lease on the
South Milwaukee property expired on November 30, 2001 and they continued making
rent payments until the lease expiration date. This lease was not renewed, and
therefore, Management continues to market the property for sale or lease to a
new operator.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent
to close its restaurant in Milwaukee, Wisconsin. The Hardee's lease on the
Milwaukee property was not set to expire until 2009. In the Second Quarter of
2001, Hardee's Food Systems agreed to pay a lease termination fee of
approximately two (2) years rent or $157,000. The payment schedule included four
(4) equal installments of $39,250. The first payment was received in May 2001
upon the execution of the agreement, and the subsequent installments were
reflected as a Note receivable on the balance sheet. The second and third Note
receivable installments were received in August and October 2001. The final
installment, which is reflected as a Note receivable on the balance sheet at
December 31, 2001, was received in January 2002.
During May 2001, Management negotiated the re-lease of the former Hardee's-
Milwaukee, Wisconsin property to Omega Restaurants, Inc. The ten (10) year lease
is set to expire in 2011. The new tenant took possession of the property in June
2001 and rent income commenced in October 2001. Commissions of $50,000 and
$9,000 were paid to an unaffiliated leasing agent and to an affiliate of the
General Partner, respectively, upon the execution of the new lease.
The Blockbuster Video Store lease expired on January 31, 2001. However, in the
First Quarter of 2001, Management negotiated a five (5) year lease extension to
January 31, 2006. A commission of $10,000 was paid to an unaffiliated leasing
agent upon the negotiated extension of the lease.
During the Fourth Quarter of 2001, the Bankruptcy court granted the motion of
Phoenix Restaurant Group, Inc. ("Phoenix") to reject the lease with the
Partnership at the Twin Falls, Idaho location. Although Phoenix's lease on the
Twin Falls property expires on April 30, 2012, due to bankruptcy proceedings of
Phoenix, the lease was rejected and rent income ceased in the Fourth Quarter of
2001. The remaining balance due the Partnership of approximately $29,000 from
the former tenant has been reserved. This amount is included in the
Partnership's filing for damages in Bankruptcy court of approximately $85,000,
or one year's rent, although it is uncertain whether the amount will be
collectible. In addition, since Phoenix rejected the lease, its subtenant,
Fiesta Time, is not entitled to possession of the property. Therefore,
Management is in the process of obtaining possession of the property from Fiesta
Time, after which Management intends to market the property for lease or sale.
During April 2001, the sub-tenant AMF Corporation notified Management of its
intent to close and vacate its Mulberry Street Grill restaurant in Phoenix,
Arizona. Although the lease on the property expires in 2007,
16
monthly rental and Common Area Maintenance (CAM) income ceased as of June 1,
2001. Management is moving forward with legal remedies to collect the balances
due from AMF. The past due rent amount of $10,000 has been reserved. Due to
Management's return of possession of the property to the Ground Lease landlord,
the net asset value of the property was written-off in the Fourth Quarter of
2001, resulting in a loss of $157,000. As of March 31, 2002 the Partnership has
withheld the payment of approximately $50,000 in accrued ground lease
obligations related to the property. In April 2002, an additional $43,000 was
accrued as payable to the Ground Lease landlord due to the Court's granting of a
summary judgment against the Partnership. (See Legal Proceedings in Part II-
Item 1 and Note 10.)
During October 2001, the Village Inn Restaurant notified Management of its
intent to close and vacate its restaurant in Grand Forks, North Dakota within
the next few months. The lease on the property expires in 2009. In February
2002, Management was notified Village Inn had closed and vacated its restaurant
in Grand Forks. Rent income was collected from the tenant through December of
2001; however, rent income has not been collected for January through June of
2002. In addition, in March 2002, the Partnership paid the properties' first
installment of 2001 real estate taxes. Management will pursue all legal remedies
in relation to the former tenant's past due balance of approximately $58,000, as
well as future lease and other obligations. Management is also seeking a new
tenant for the vacated property. Management anticipates that the Partnership
will incur approximately $27,000 to replace the roof on the property in the
Third Quarter of 2002. Other repairs may also be needed, however, specifics and
amounts are not known as of the end of the Second Quarter.
Other Assets
- ------------
Cash and cash equivalents were approximately $904,000 at June 30, 2002, compared
to $818,606 at December 31, 2001. The Partnership designated cash of $360,000 to
fund the Second Quarter 2002 distributions to Limited Partners, $491,000 for the
payment of accounts payable, accrued expenses, and future distributions. The
remainder represents reserves deemed necessary to allow the Partnership to
operate normally.
Cash generated through the operations of the Partnership's investment properties
and sales of investment properties will provide the sources for future fund
liquidity and Limited Partner distributions.
The Partnership established an Indemnification Trust (the "Trust") during the
Fourth Quarter of 1993, deposited $100,000 in the Trust during 1993 and
completed funding of the Trust with $150,000 during 1994. The provision to
establish the Trust was included in the PMA for the indemnification of TPG, in
the absence of fraud or gross negligence, from any claims or liabilities that
may arise from TPG acting as Permanent Manager. The Trust is owned by the
Partnership. For additional information regarding the Trust refer to Note 8 to
the financial statements.
Rents and other receivables amounted to $116,280 (net of allowance of $102,000)
as of June 30, 2002. The tenant Popeye's- Park Forest is delinquent on its
January 2002 percentage rent billing for 2001. Management intends to pursue
legal remedies in relation to the collection of the tenant's percentage rent
past due balance of approximately $72,000.
17
Property tax escrow at December 31, 2001, in the amount of $7,875, represented
four (4) months of 2001 real estate taxes for the former Hardee's- Milwaukee
tenant paid by Hardee's Food Systems, Inc. upon the lease termination agreement
with Management. The property taxes were paid by the Partnership in January
2002.
Property tax receivable at June 30, 2002, in the amount of $8,300 represented
2001 property taxes paid by the Partnership, which are due from the tenant of
the vacant Village Inn property. Property tax receivable at December 31, 2001,
in the amount of $31,000 represented 2001 real estate taxes due from the tenant
of the Hardee's- S. Milwaukee property and new tenant, Omega Restaurants and
2000 property taxes due from the tenant of the Village Inn property.
The Note receivable balance at December 31, 2001 was $39,250. In the Second
Quarter of 2001, a lease termination agreement was executed with Hardee's Food
Systems upon the closing of its restaurant in Milwaukee, Wisconsin. Hardee's
Food Systems agreed to pay a lease termination fee of approximately two (2)
years rent or $157,000. The payment schedule included four (4) equal
installments of $39,250. The first payment was received in May 2001 upon the
execution of the agreement, and the subsequent installments were reflected as a
Note receivable on the balance sheet. The second and third Note receivable
installments were received in August and October 2001. The final installment,
which is reflected as a Note receivable on the balance sheet at December 31,
2001, was received in January 2002.
Deferred charges totaled approximately $279,460 and $286,000, net of
amortization, at June 30, 2002 and December 31, 2001, respectively. Deferred
charges represent leasing commissions paid when properties are leased or upon
the negotiated extension of a lease. Leasing commissions are capitalized and
amortized over the life of the lease. During the Second Quarter of 2001,
commissions of $50,000 and $9,000 were paid to an unaffiliated leasing agent and
to an affiliate of the General Partner, respectively, upon the execution of the
new Omega Restaurant lease. During the First Quarter of 2001, a commission of
$10,000 was paid to an unaffiliated leasing agent upon the negotiated extension
of the lease with Blockbuster Video. Also, during the Second Quarter and Fourth
Quarters of 2001 deferred charges relating to the former Hardee's-Milwaukee and
Mulberry Street Grill properties, respectively, were written-off.
Liabilities
- -----------
Accounts payable and accrued expenses at June 30, 2002, in the amount of
$130,000, primarily represent the accrual of auditing, tax, legal and data
processing fees, and the summary judgment related to the former Mulberry Street
Grill property.
Due to the Current General Partner amounted to $1,297 at June 30, 2002, of which
$844 represents the General Partner's Second Quarter 2002 distribution.
18
Partners' Capital
- -----------------
Net income for the quarter was allocated between the General Partner and the
Limited Partners, 1% and 99%, respectively, as provided in the Partnership
Agreement and the Amendment to the Partnership Agreement, as discussed more
fully in Note 4 of the financial statements. The former general partners'
deficit capital account balance was reallocated to the Limited Partners at
December 31, 1993. Refer to Note 9 to the financial statements for additional
information regarding the reallocation.
Cash distributions paid to the Limited Partners and to the General Partner
during 2002 of $985,000 and $2,036, respectively, have also been in accordance
with the amended Partnership Agreement. The Second Quarter 2002 distribution of
$360,000 is scheduled to be paid to the Limited Partners on August 15, 2002.
Results of Operations:
- ---------------------
The Partnership reported net income for the quarter ended June 30, 2002, in the
amount of $211,000 compared to net income for the quarter ended June 30, 2001,
of $501,000. For the six months ended June 30, 2002 and 2001, net income totaled
$509,000 and $826,000, respectively. The decrease in net income revenue in 2002
is due primarily to decreased rental income, relating to the expired lease of
the Hardee's-S. Milwaukee property in the Fourth Quarter of 2001, the
bankruptcy rejection of the Denny's-Twin Falls lease and the non-cash disposal
of the former Mulberry Street Grill Restaurant in the Fourth Quarter of 2001.
The decrease in net income in 2002 is also due to the summary judgment related
to the former Mulberry Street Grill property, the write-off of non-collectible
receivables, and increased legal expenditures due to tenant defaults, eviction
proceedings at the Twin Falls property and court proceedings related to the
former Mulberry Street Grill property. In addition, the Partnership's charged a
lease termination fee of $157,000 in the Second Quarter of 2001 due to the
termination of the Hardee's-Milwaukee lease, which is a non-recurring charge.
Revenues
- --------
Total revenues were $532,000 and $748,000, for the quarters ended June 30, 2002
and 2001, respectively, and were $1,051,000 and $1,354,000, for the six months
ended June 30, 2002 and 2001, respectively The decrease in revenue in 2002 is
due primarily to decreased rental income, upon the expired lease of the
Hardee's-S. Milwaukee property in the Fourth Quarter of 2001, the bankruptcy
rejection of the Denny's-Twin Falls lease and the non-cash disposal of the
former Mulberry Street Grill Restaurant in the Fourth Quarter of 2001. In
addition, the Partnership charged a lease termination fee of $157,000 in the
Second Quarter of 2001 due to the termination of the Hardee's-Milwaukee lease,
which is a non-recurring charge.
As of June 1, 2002 total revenues should approximate $1,963,000 annually, based
on leases currently in place.
19
Future revenues may decrease with tenant defaults and/or sales of Partnership
properties. They may also increase with additional rents due from tenants, if
those tenants experience sales levels, which require the payment of additional
rent to the Partnership.
Expenses
- --------
For the quarters ended June 30, 2002 and 2001, cash expenses amounted to
approximately 34% and 20%, of total revenues, respectively. For the six months
ended June 30, 2002 and 2001, cash expenses totaled 29% and 25%, respectively.
Total expenses, including non-cash items, amounted to approximately 60% and 33%,
of total revenues for the quarters ended June 30, 2002 and 2001, respectively,
and totaled 52% and 39% for the six months ended June 30, 2002 and 2001,
respectively.
The increase in expenditures in 2002 is due to the Second Quarter 2001 summary
judgment accrual related to the former Mulberry Street Grill property, the
write-off of non-collectible receivables, and increased legal expenditures due
to tenant defaults, eviction proceedings at the Twin Falls property and court
proceedings related to the former Mulberry Street Grill property. Total
expenditures in 2001 included non-recurring appraisals, which were performed in
the First Quarter of 2001 on all the Partnership properties, and ground lease
obligations relating to the former Mulberry Street Grill Restaurant.
Inflation:
- ---------
Inflation has a minimal effect on operating earnings and related cash flows from
a portfolio of triple net leases. By their nature, such leases actually fix
revenues and are not impacted by rising costs of maintenance, insurance, or real
estate taxes. If inflation causes operating margins to deteriorate for lessees
if expenses grow faster than revenues, then, inflation may well negatively
impact the portfolio through tenant defaults.
It would be misleading to associate inflation with asset appreciation for real
estate, in general, and the Partnership's portfolio, specifically. Due to the
"triple net" nature of the property leases, asset values generally move
inversely with interest rates.
New Accounting Pronouncement:
- ----------------------------
In October 2001, Statement of Financial Accounting Standards No. 144 "Accounting
for the Impairment or Disposal of Long-Lived Assets" (FAS 144) was issued. The
FAS 144 supercedes Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be disposed of" (FAS 121). FAS 144 primarily addresses issues relating to the
implementation of FAS 121 and develops a single accounting model for long-lived
assets to be disposed of, whether previously held and used or newly acquired.
The provisions of FAS 144 are effective for fiscal years beginning after
December 15, 2001. The Company adopted FAS 144 on January 1, 2002 with no impact
on financial statements.
Critical Accounting Policies:
- ----------------------------
The Partnership believes that its most significant accounting policies deal
with:
20
Depreciation methods and lives--Depreciation of the properties is provided on a
straight-line basis over 31.5 years, which is the estimated useful life of the
buildings and improvements. While the Partnership believes these are the
appropriate lives and methods, use of different lives and methods could result
in different impacts on net income. Additionally, the value of real estate is
typically based on market conditions and property performance, so depreciated
book value of real estate may not reflect the market value of real estate
assets.
Revenue recognition--Rental revenue from investment properties is recognized on
the straight-line basis over the life of the respective lease. Percentage rents
are accrued only when the tenant has reached the breakpoint stipulated in the
lease.
The Partnership periodically reviews its long-lived assets, primarily real
estate, for impairment whenever events or changes in circumstances indicate that
the carrying amount of such assets may not be recoverable. The Partnership's
review involves comparing current and future operating performance of the
assets, the most significant of which is undiscounted operating cash flows, to
the carrying value of the assets. Based on this analysis, a provision for
possible loss to write down the asset to its fair value is recognized, if any.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
None.
21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Partnership owned the building in Phoenix, Arizona occupied by the Mulberry
Street Grill restaurant, which was located on a parcel of land leased to the
Partnership pursuant to a long-term ground lease ("Ground Lease.") The Ground
Lease was considered an operating lease and the lease payments were paid by the
Partnership and expensed in the periods to which they applied. During the Second
Quarter of 2001, sub-tenant AMF Corporation ("AMF") notified Management of its
intent to close its Mulberry Street Grill restaurant. Although the sub-lease had
not expired, since such notification the Partnership has received no rent from
the former tenant and has returned possession of the Phoenix, Arizona property
to the Ground Lease Landlord, Centre at 38th Street, L.L.C, ("Centre".)
Beginning in May and through December 2001 the Partnership accrued but withheld
payment of the ground lease obligations, and on March 31, 2002 and December 31,
2001 the total ground lease accrual approximated $50,000. Centre has re-leased
the property to a new tenant.
On June 18, 2001, Centre filed a lawsuit (the "Complaint") in the Maricopa
County Superior Court, against the Partnership and TPG. The Complaint alleges
that the Partnership is a tenant under a Ground Lease with Centre and that the
Partnership has defaulted on its obligations under that lease. The suit names
TPG as a defendant because TPG is the Partnership's general partner. The
Complaint sought damages for unpaid rent, commissions, improvements, and
unspecified other damages exceeding $120,000.
The Partnership and TPG filed an answer denying any liability to Centre. In
addition, the Partnership has filed a third-party complaint against the original
tenant, National Restaurant Group, ("National Restaurant"), Centre, and its
sub-tenant AMF. In the third-party complaint, the Partnership alleges that
National Restaurant and AMF are liable to the Partnership for breach of the
subleases and any damages for which the Partnership may be held liable pursuant
to the Ground Lease. Currently National Restaurant has filed for bankruptcy and
the Partnership has not been successful in locating AMF.
On April 10, 2002 the Maricopa County Superior Court granted the motion for
summary judgment against the Partnership and TPG. The Court awarded damages to
Centre as of April 10, 2002 in the amount of $93,000. As of March 31, 2002 the
Partnership had accrued $50,000 in ground lease obligations payable to Centre
and the remaining summary judgment balance of $43,000 was accrued in April 2002.
In June 2002 the Partnership and TPG filed the Notice of Appeal with respect to
such judgment and are waiting for the Court of Appeals to set a schedule for
filing briefs in support of the appeal. In order to prevent Centre from
enforcing the judgment, an approximately $140,000 bond application was filed in
July 2002. The bond premium is anticipated to approximately $2,600. By law, the
amount of the bond must be sufficient to cover the amount of the judgment, plus
interest, and any additional costs that may be incurred during the appeal.
Items 2 - 4.
Not Applicable.
22
Item 5. Other Information
Registrant's interim financial statements in this Form 10-Q have not been
reviewed by an independent public accountant due to the wind-down of Arthur
Andersen's business. See Item 4 to Registrant's Form 8-K, filed August 14, 2002,
and incorporated herein by reference. Registrant will amend this form 10-Q to
contain a review by an independent public accountant as soon as Registrant
engages this accountant.
Item 6. Exhibits and Reports on Form 8-K
(a) Listing of Exhibits:
99.0 Correspondence to the Limited Partners dated August 15, 2002,
regarding the Second Quarter 2002 distribution.
99.1 Certification of Periodic Financial Report Pursuant to 18 U.S.C.
Section 1350.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 8-K during the second quarter of
fiscal year 2002.
23
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, there unto duly authorized.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: /s/Bruce A. Provo
-----------------
Bruce A. Provo, President
Date: August 14, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
By: The Provo Group, Inc., General Partner
By: /s/Bruce A. Provo
-----------------
Bruce A. Provo, President
Date: August 14, 2002
By: /s/Bruce A. Provo
------------------
Bruce A. Provo, Chief Executive Officer and
Chief Financial Officer
Date: August 14, 2002
24