Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended June 30, 2003

OR

For the transition period from                                 to                                 

Commission file number 0-17876

WELLS REAL ESTATE FUND II-OW

(Exact name of registrant as specified in its charter)

(Former name, former address, and former fiscal year, if changed since last report)

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 ¨

Table of Contents

FORM 10-Q

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

TABLE OF CONTENTS

2

Table of Contents

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

BALANCE SHEETS

See accompanying notes

3

Table of Contents

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

STATEMENTS OF LOSS

See accompanying notes

4

Table of Contents

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

STATEMENTS OF PARTNERS’ CAPITAL 

FOR THE YEAR ENDED DECEMBER 31, 2002 

AND SIX MONTHS ENDED JUNE 30, 2003 (UNAUDITED)

See accompanying notes

5

Table of Contents

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

STATEMENTS OF CASH FLOWS

See accompanying notes

6

Table of Contents

WELLS REAL ESTATE FUND II-OW

(A Georgia Public Limited Partnership)

CONDENSED NOTES TO FINANCIAL STATEMENTS

JUNE 30, 2003 (unaudited)

(a)  General

Wells Real Estate Fund II-OW (the “Partnership”) is a Georgia public limited partnership with Leo F. Wells, III and Wells Capital, Inc. (“Wells Capital”), a Georgia corporation, serving as its general partners (the “General Partners”). The Partnership was formed on October 13, 1987 for the purpose of acquiring, developing, constructing, owning, operating, improving, leasing, and managing income-producing properties for investment purposes. The Partnership has two classes of limited partnership interests, Class A and Class B units. Limited partners may vote to, among other things, (a) amend the partnership agreement, subject to certain limitations; (b) change the business purpose or investment objectives of the Partnership; and (c) remove a general partner. A majority vote on any of the above described matters will bind the Partnership without the concurrence of the General Partners. Each limited partnership unit has equal voting rights regardless of class.

On November 6, 1987, the Partnership commenced a public offering of its limited partnership units pursuant to a Registration Statement filed on Form S-11 under the Securities Act of 1933. The Partnership terminated its offering on September 7, 1988, upon receiving gross offering proceeds of $1,922,000 for 7,688 Class A and Class B limited partner units at $250 per unit from 219 limited partners.

The Partnership owns interests in all of its real estate assets through a joint venture with Wells Real Estate Fund II (“Fund II and Fund II-OW”) which owns interests in real estate assets both directly and through joint ventures with other Wells Real Estate Funds. As of June 30, 2003, the Partnership owned interests in the following five properties through the affiliated joint ventures (the “Joint Ventures”) listed below:

7

Table of Contents

On October 1, 2001, Fund I, II, II-OW, VI and VII Associates, a joint venture among the Partnership, Fund II and Fund II-OW, Wells Real Estate Fund VI, L.P., and Wells Real Estate Fund VII, L.P. sold the Cherokee Commons property to an unrelated third party for a gross sales price of $8,660,000. The Cherokee Commons property is a retail shopping center located in Cherokee County, Georgia. Fund I, II, II-OW, VI and VII Associates was liquidated in the fourth quarter of 2002, and approximately $239,800 in net sales proceeds was allocated to the Partnership as a result of this sale.

On April 7, 2003, Fund I-II Tucker Associates sold the retail portion of Heritage Place, which comprises approximately 30% of the total premises. The retail portion of Heritage Place was sold for a gross sales price of $3,400,000, resulting in a gain of approximately $293,000, net of selling expenses of approximately $158,000. Of this gain, the Partnership recognized approximately $7,000 through equity income (loss) of Joint Venture. The partnership was allocated approximately $81,000 in net sales proceeds as a result of this sale.

Each of the above properties was acquired on an all cash basis. For further information regarding the foregoing Joint Ventures and properties, refer to the report filed for the Partnership on Form 10-K for the year ended December 31, 2002.

(b)  Basis of Presentation

The financial statements of the Partnership have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, including the instructions to Form 10-Q and Article 10 of Regulation S-X, and in accordance with such rules and regulations, do not include all of the information and footnotes required by accounting principles generally accepted in the United States (“GAAP”) for complete financial statements. The quarterly statements included herein have not been examined by independent auditors. However, in the opinion of the General Partners, the statements for the unaudited interim periods presented include all adjustments that are of a normal and recurring nature and necessary to fairly present the results for such periods. Results for interim periods are not necessarily indicative of full year results. For further information, refer to the financial statements and footnotes included in the Partnership’s Form 10-K for the year ended December 31, 2002.

(c)  Allocations of Net Income, Net Loss and Gain on Sale

For the purposes of determining allocations per the partnership agreement, net income is defined generally as net income recognized by the Partnership, excluding deductions for depreciation and amortization. Net income, as defined, of the Partnership will be allocated each year in the same proportions that net cash from operations is distributed to the limited partners holding Class A Units and the General Partners. To the extent the Partnership’s net income in any year exceeds net cash from operations, it will be allocated 99% to the limited partners and 1% to the General Partners.

Net loss, depreciation, and amortization deductions for each fiscal year are allocated as follows: (a) 99% to the limited partners holding Class B Units and 1% to the General Partners until their capital accounts are reduced to zero; (b) then to any partner having a positive balance in his/her capital account in an amount not to exceed such positive balance; and (c) thereafter to the General Partners.

Gain on the sale or exchange of the Partnership’s properties will be allocated as follows: (a) first to partners having negative capital accounts, if any, until all negative capital accounts have been restored to zero; (b) then to the limited partners in proportion to and to the extent of the excess of (i) each limited partner’s adjusted Capital Contribution, plus a cumulative 12% per annum return on his/her adjusted Capital Contribution, less the sum of all prior distributions of cash flow from operations previously made to such limited partner, over (ii) such limited partner’s capital account balance as of the sale date, subject to the requirement to initially allocate gain on sale to limited partners holding Class B Units until they have been allocated an amount equal to the net cash available for distribution previously received by limited partners holding Class A Units on a per unit basis; (c) then to the

8

Table of Contents

General Partners in proportion to and to the extent of the excess of (i) each general partner’s adjusted Capital Contribution, over (ii) such General Partner’s capital account balance as of the sale date; and (d) thereafter 85% to the limited partners and 15% to the General Partners.

(d)  Distributions of Net Cash From Operations

Cash available for distribution is distributed on a cumulative non-compounded basis to limited partners quarterly. In accordance with the partnership agreement, distributions are paid first to limited partners holding Class A Units until they have received an 8% per annum return on their adjusted Capital Contributions, as defined. Cash available for distribution is then distributed to limited partners holding Class B Units until they have received an 8% per annum return on their adjusted Capital Contributions, as defined. Excess cash available for distribution will be distributed to the General Partners until each has received 10% of total distributions to limited partners for the year. Thereafter, cash available for distribution is distributed 90% to the limited partners and 10% to the General Partners.

(a)  Basis of Presentation

The Partnership does not have control over the operations of the Joint Ventures described above; however, it does exercise significant influence. Accordingly, the Partnership’s investment in its Joint Ventures are recorded using the equity method of accounting, whereby original investments are recorded at cost and subsequently adjusted for contributions, distributions and net income (loss) attributable to the Partnership. For further information, refer to the report filed for the Partnership on Form 10-K for the year ended December 31, 2002.

(b)  Summary of Operations

The following information summarizes the operations of the Joint Venture for the three months and six months ended June 30, 2003 and 2002, respectively:

9

Table of Contents

(c)  Summary of Operations

The following information summarizes the operations of the Joint Ventures in which the Partnership holds interests through its ownership in Fund II-II-OW Associates for the three months and six months ended June 30, 2003 and 2002, respectively:

(d)  Summary of Operations

The following information summarizes the operations of the joint venture in which the Partnership holds an interest through its ownership in Fund II-III Associates for the three months and six months ended June 30, 2003 and June 30, 2002, respectively:

10

Table of Contents

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities,” which clarifies the application of Accounting Research Bulletin (ARB) No. 51, “Consolidated Financial Statements,” relating to consolidation of certain entities. FIN 46 requires the identification of the Partnership’s participation in variable interest entities (“VIEs”), which are defined as entities with a level of invested equity that is not sufficient to fund future activities to permit them to operate on a stand-alone basis, or whose equity holders lack certain characteristics of a controlling financial interest. For entities identified as VIEs, FIN 46 sets forth a model to evaluate potential consolidation based on an assessment of which party to the VIE, if any, bears a majority of the exposure to its expected losses, or stands to gain from a majority of its expected returns. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. FIN 46 also sets forth certain disclosures regarding interests in VIEs that are deemed significant, even if consolidation is not required. As the Joint Ventures do not fall under the definition of VIEs provided above, the Partnership does not believe that the adoption of FIN 46 will result in the consolidation of any previously unconsolidated entities.

In August 2001, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (effective beginning January 1, 2002) was issued. SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of and supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of.” Among other factors, SFAS No. 144 establishes criteria beyond that previously specified in SFAS No. 121 to determine when a long-lived asset is to be considered held for sale. We believe that the adoption of SFAS No. 144 will not have a significant impact on the Partnership’s financial statements.

(a)  Management and Leasing Fees

Wells Management Company, Inc. (“Wells Management”), an affiliate of the General Partners, is entitled to compensation for the management and leasing of the Partnership’s properties owned through Joint Ventures equal to (a) 3% of the gross revenues for management and 3% of the gross revenues for leasing (aggregate maximum of 6%) plus a separate fee for the one-time lease-up of newly constructed properties in an amount not to exceed the fee customarily charged in arm’s-length transactions by others rendering similar services in the same geographic area for similar properties or (b) in the case of commercial properties which are leased on a long-term net basis (ten or more years), 1% of the gross revenues except for initial leasing fees equal to 3% of the gross revenues over the first five years of the lease term. The properties in which the Partnership owns an interest generated management and leasing fees payable to Wells Management of $48,929 and $39,026 for the three months ended June 30, 2003 and 2002, respectively, and $86,051 and $78,624 for the six months ended June 30, 2003 and 2002, respectively.

(b)  Administration Reimbursements

Wells Capital, Inc. and its affiliates perform certain administrative services for the Partnership, such as accounting and other partnership administration, and incurs the related expenses. Such expenses are allocated among the various Wells Real Estate Funds based on time spent on each fund by individual administrative personnel. The Partnership and its Joint Venture reimbursed $24,858 and $17,555 for the three months ended June 30, 2003 and 2002, respectively, and $55,504 and $35,629 for the six months ended June 30, 2003 and 2002, respectively, to Wells Capital, Inc. and its affiliates for these services and expenses.

(c)  Conflicts of Interest

The General Partners of the Partnership are also general partners of other Wells Real Estate Funds. As such, there may exist conflicts of interest where the General Partners in their capacity as general partners of other

11

Table of Contents

Wells Real Estate Funds may be in competition with the Partnership in connection with property acquisitions or for tenants in similar geographic markets.

The following discussion and analysis should be read in conjunction with the Partnership’s accompanying financial statements and notes thereto.

(a)  Forward Looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and 21E of the Securities Exchange Act of 1934, including discussion and analysis of the financial condition of the Partnership, anticipated capital expenditures required to complete certain projects, amounts of cash distributions anticipated to be distributed to limited partners in the future and certain other matters. Readers of this report should be aware that there are various factors that could cause actual results to differ materially from any forward-looking statements made in this report, including lease-up risks, inability to obtain new tenants upon the expiration of existing leases, and the potential need to fund tenant improvements, leasing commissions or other capital expenditures or lease-up costs out of operating cash flows or sales proceeds.

(b)  Results of Operations

Gross Revenues

Gross revenues of the Partnership were relatively stable at $76 and $0 for the three months ended June 30, 2003 and 2002, respectively, and $76 and $0 for the six months ended June 30, 2003 and 2002, respectively.

Equity In Loss of Joint Venture

Gross Revenues of Joint Venture

Gross revenues of the Joint Venture in which the Partnership holds an interest through its interest in the Joint Venture increased in 2003, as compared to 2002, primarily due to a significant increase in occupancy for Boeing at the Atrium, partially offset by (i) the sale of the retail portion of Heritage Place which closed in April 2003, and (ii) a reduction in interest income earned by Fund I, II, II-OW, VI and VII Associates as a result of liquidating this joint venture during the fourth quarter of 2002.

Expenses of Joint Venture

The expenses of the Joint Venture in which the Partnership holds an interest through its interest in the Joint Venture increased in 2003, as compared to 2002, primarily as a result of (i) the aforementioned increase in occupancy of Boeing at the Atrium, and (ii) an increase in administrative costs incurred partially in response to new regulatory requirements. We anticipate additional increases related to the implementation of new reporting regulations during the second half of 2003.

As a result, equity in loss of Joint Venture decreased from $(16,946) for the three months ended June 30, 2002 to $(3,351) for the three months ended June 30, 2003, and from $(39,090) and for the six months ended June 30, 2002 to $(9,311) for the six months ended June 30, 2003.

Expenses

Expenses of the Partnership, consisting primarily of equity in loss of Joint Venture (which essentially means the Partnership’s share of the net income or loss of the Joint Ventures in which the Partnership has invested and owns an equity interest), were $3,351 and $16,946 for the three months ended June 30, 2003 and 2002, respectively, and $9,311 and $39,090 for the six months ended June 30, 2003 and 2002, respectively. The 2003

12

Table of Contents

decrease from 2002 resulted primarily from the corresponding change in equity in loss of Joint Venture, which was further described above.

Net Loss

As a result, net loss of the Partnership was $(3,275) and $(16,946) for the three months ended June 30, 2003 and 2002, respectively, and $(9,235) and $(39,090) for the six months ended June 30, 2003 and 2002, respectively.

(c)  Liquidity and Capital Resources

Cash Flows From Operating Activities

Net cash flows from operating activities remained fairly stable at $(1,090) for the six months ended June 30, 2003, as compared to $(573) for the six months ended June 30, 2002.

Cash Flows From Investing Activities

Net cash flows from investing activities was $(15,903) and $35,732 for the six months ended June 30, 2003 and 2002, respectively. The 2003 decrease from 2002 resulted primarily from the Joint Ventures reserving funds in order to fund the remaining tenant improvements for Boeing at the Atrium and future anticipated capital expenditures and leasing costs anticipated in connection with the re-leasing of the Louis Rose Building, which was vacant as of June 30, 2003. In addition, we anticipate reserving funds in the future to fund tenant improvements for the Holcomb Bridge Property, as described in “Capital Resources” below.

Distributions

No distributions of operating cash flow were paid to the limited partners holding Class A Units during either the second quarter of 2003 or the second quarter of 2002 in order to reserve cash flows to fund future tenant improvements and leasing costs for Fund II-III-VI-VII Associates and the Louis Rose Building. Funds were also reserved in the second quarter of 2002 to fund the tenant improvements and leasing costs of Boeing at the Atrium, which is now at 100% occupancy. The General Partners anticipate that distributions per unit to limited partners holding Class A Units will be reinstated upon re-leasing the Louis Rose Building and funding all related re-leasing costs. No distributions were made to limited partners holding Class B Units.

Sales Proceeds

Rather than distributing to the limited partners, the Partnership’s share of the net proceeds generated from the sales of the Cherokee Commons property and the retail portion of the Heritage Place property is being held in reserve as the General Partners continue to evaluate the capital needs of the existing properties in which the Partnership holds an interest in consideration of the best interests of the limited partners.

Capital Resources

The Partnership is an investment vehicle formed for the purpose of acquiring, owning, and operating income-producing real properties and has invested all of its funds available for investment. Accordingly, it is unlikely that the Partnership will acquire interests in any additional properties. During the fourth quarter of 2002, American Trust Bancorp entered into a 10-year lease agreement for approximately 13,000 square feet of the Holcomb Bridge Property at an estimated cost of $207,000 for tenant improvements and leasing costs. In connection therewith, Fund II-III-VI-VII Associates has funded approximately $40,000 of leasing costs in the second quarter of 2003 and anticipates funding tenant improvements and leasing costs of approximately $167,000 during the third quarter of 2003, of which approximately $1,000 would be attributable to the Partnership.

(d)  Related-Party Transactions

The Partnership and the Joint Ventures have entered into agreements with Wells Capital, Inc. and its affiliates, whereby the Partnership or the Joint Ventures pay certain fees or reimbursements to Wells Capital, Inc.

13

Table of Contents

or its affiliates for property management and leasing fees, and reimbursement of operating and administrative costs. See Note 4 to the Partnership’s financial statements included in this report for a discussion of the various related party transactions, agreements and fees.

(e)  Inflation

The real estate market has not been affected significantly by inflation in the past three years due to the relatively low inflation rate. However, there are provisions in the majority of tenant leases, which would protect the Partnership from the impact of inflation. These provisions include reimbursement billings for operating expense pass-through charges, real estate tax and insurance reimbursements on a per square foot basis, or in some cases, annual reimbursement of operating expenses above a certain per square foot allowance. There is no assurance, however, that the Partnership would be able to replace existing leases with new leases at higher base rental rates.

(f)  Application of Critical Accounting Policies

The Partnership’s accounting policies have been established to conform with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If management’s judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied; thus, resulting in a different presentation of the financial statements. Additionally, other companies may utilize different estimates that may impact comparability of the Partnership’s results of operations to those of companies in similar businesses.

Below is a discussion of the accounting policies that management considers to be critical in that they may require complex judgment in their application or require estimates about matters that are inherently uncertain.

Investment in Real Estate Assets

Management is required to make subjective assessments as to the useful lives of its depreciable assets. Management considers the period of future benefit of the asset to determine the appropriate useful lives. These assessments have a direct impact on net income. The estimated useful lives of the Joint Venture’s assets by class are as follows:

In the event that management uses inappropriate useful lives or methods for depreciation, the Partnership’s net income would be misstated.

Valuation of Real Estate Assets

Management continually monitors events and changes in circumstances that could indicate that the carrying amounts of the real estate assets in which the Partnership has an ownership interest, either directly or through investments in Joint Ventures, may not be recoverable. When indicators of potential impairment are present which indicate that the carrying amounts of real estate assets may not be recoverable, management assesses the recoverability of the real estate assets by determining whether the carrying value of the real estate assets will be recovered through the undiscounted future operating cash flows expected from the use of the asset and its eventual disposition. In the event that such expected undiscounted future cash flows do not exceed the carrying value, management adjusts the real estate assets to the fair value and recognizes an impairment loss. Management

14

Table of Contents

has determined that there has been no impairment in the carrying value of real estate assets held by the Partnership to date.

Projections of expected future cash flows requires management to estimate future market rental income amounts subsequent to the expiration of current lease agreements, property operating expenses, discount rates, the number of months it takes to re-lease the property, and the number of years the property is held for investment. The use of inappropriate assumptions in the future cash flow analysis would result in an incorrect assessment of the property’s future cash flows and fair value, and could result in the overstatement of the carrying value of real estate assets held by the Joint Ventures and net income of the Partnership.

Since the Partnership does not borrow any money, make any foreign investments or invest in any market risk-sensitive instruments, it is not subject to risks relating to interest rates, foreign current exchange rate fluctuations, or the other market risks contemplated by Item 305 of Regulation S-K.

ITEM  4.    CONTROLS AND PROCEDURES

The Partnership carried out an evaluation, under the supervision and with the participation of management of Wells Capital, Inc., the corporate general partner of the Partnership, including the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Partnership’s disclosure controls and procedures as of the end of the period covered by this report pursuant to the Securities Exchange Act of 1934. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that the Partnership’s disclosure controls and procedures were effective.

There were no significant changes in the Partnership’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Partnership’s internal control over financial reporting.

(THE REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK)

15

Table of Contents

PART II.    OTHER INFORMATION

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

16

Table of Contents

EXHIBIT INDEX

TO

SECOND QUARTER FORM 10-Q

OF

WELLS REAL ESTATE FUND II-OW

17