Item 1. Business
Background - ----------
The Registrant, DiVall Insured Income Properties 2 Limited Partnership (the "Partnership"), is a limited partnership organized under the Wisconsin Uniform Limited Partnership Act pursuant to an Agreement of Limited Partnership dated as of November 18, 1987, and amended as of November 25, 1987, February 20, 1988, June 21, 1988, February 8, 1993, May 26, 1993 and June 30, 1994 (collectively, the "Partnership Agreement"). As of December 31, 2001, the Partnership consisted of one General Partner and 2,300 Limited Partners owning an aggregate of 46,280.3 Limited Partnership Interests (the "Interests") acquired at a public offering price of $1,000 per Interest before volume discounts. The Interests were sold commencing February 23, 1988, pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration 33-18794) as amended. On June 30, 1989, the former general partners exercised their option to extend the offering period to a date no later than February 22, 1990. On February 22, 1990, the Partnership closed the offering at 46,280.3 Interests ($46,280,300), providing net proceeds to the Partnership after volume discounts and 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, franchisors or franchisees of national, regional and local retail chains under long-term leases. The lessees consist of primarily fast-food, family style, and casual/theme restaurants, but also include a video rental store and a child care center. At December 31, 2001, the Partnership owned 26 properties with specialty leasehold improvements in 10 of these properties, as more fully discussed in Item 2.
Item 2. During the Second Quarter of 1998, the General Partner received the written consent of a majority of the 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 will continue to operate as a going concern.
The Partnership's return on its investment will be derived principally from rental payments received from its lessees. Therefore, the Partnership's return on its investment is largely dependent, among other factors, upon the business success of its lessees. The business success of the Partnership's individual lessees can be adversely affected on three general levels. First, the tenants rely heavily on the management contributions of a few key entrepreneurial owners. The business operations of such entrepreneurial tenants can be adversely affected by death, disability or divorce of a key owner, or by such owner's poor business decisions such as an undercapitalized business expansion. Second, changes in a local market area can adversely affect a lessee's business operation. A local economy can suffer a downturn with high unemployment. Socioeconomic neighborhood changes can affect retail demand at specific sites and traffic patterns may change, or stronger competitors may enter a market. These and other local market factors can potentially adversely affect the lessees of Partnership properties. Finally, despite an individual lessee's solid business plans in a strong local market, the chain concept itself can suffer reversals or changes in management policy which in turn can affect the profitability of operations for Partnership properties. Therefore, there can be no assurance that any specific lessee will have the ability to pay its rent over the entire term of its lease with the Partnership.
Since over 90% of the Partnership's investment in properties and equipment involves restaurant tenants, the restaurant market is the major market segment with a material impact on Partnership operations. It would appear that the management skill and potential operating efficiencies realized by Partnership lessees will be a major ingredient for their future operating success in a very competitive restaurant and food service marketplace.
There is no way to determine, with any certainty, which, if any, tenants will succeed or fail in their business operations over the term of their respective leases with the Partnership. It can be reasonably anticipated
that some lessees will default on future lease payments to the Partnership which will result in the loss of expected lease income for the Partnership. Management will use its best efforts to vigorously pursue collection of any defaulted amounts and to protect the Partnership's assets and future rental income potential by trying to re-lease any properties with rental defaults. External events which could impact the Partnership's liquidity are the entrance of other competitors into the market areas of our tenants; liquidity and working capital needs of the leaseholders; and failure or withdrawal of any of the national franchises held by the Partnership's tenant. Each of these events, alone or in combination, would affect the liquidity level of leaseholders resulting in possible default by the tenant. Since the information regarding plans for future liquidity and expansion of closely held organizations, which are tenants of the Partnership, tend to be of a private and proprietary nature, anticipation of individual liquidity problems is difficult, and prediction of future events is nearly impossible.
A preliminary investigation during 1992 by the Office of the 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, two of 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") 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.
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 the responsibility for daily operations and assets of the Partnerships as well as to develop and execute a plan of restoration to the Partnerships. As reported in the Partnership's report on Form 8-K dated May 26, 1993, effective as of that date, the Limited Partners, by written consent of a majority of interests, elected the Permanent Manager, TPG, as General Partner. Additional results of the solicitation included the approval of the Permanent Manager Agreement ("PMA"), the acceptance of the resignations of the former general partners, amendments to certain provisions of the Partnership Agreement pertaining to general partner interests and compensation, and an amendment of the Partnership Agreement providing for an Advisory Board (the "Board").
The Permanent Manager Agreement - -------------------------------
The PMA was entered into on February 8, 1993, between the Partnership, DiVall 1 (which was dissolved in December 1998), DiVall 3, the now former general partners DiVall and Magnuson, their controlled affiliates, and TPG, naming TPG as the Permanent Manager. The PMA contains provisions allowing the Permanent Manager to submit the PMA, the issue of electing the Permanent Manager as General Partner, and the issue of acceptance of the resignations of the former general partners to a vote of the Limited Partners through a solicitation of written consents.
TPG, as the new General Partner, has been operating and managing the affairs of the Partnership in accordance with the provisions of the PMA and the Partnership Agreement.
Advisory Board - --------------
The concept of the Advisory Board was first introduced by TPG during the solicitation of written consents for the Partnerships and is the only type of oversight body known to exist for similar partnerships at this time. The first Advisory Board was appointed in October 1993, and held its first meeting in November 1993. The four person Advisory Board is empowered to, among other functions, review operational policies and practices, review extraordinary transactions, and advise and serve as an audit committee to the Partnership and the General Partner. The Advisory Board does not have the authority to direct management decisions or policies of the Partnership or remove the General Partner. The powers of the Advisory Board are advisory only. The Advisory Board has full and free access to the Partnership's books and records, and individual Advisory Board members have the right to communicate directly with the Limited Partners
concerning Partnership business. Members of the Advisory Board are compensated $1,500 annually and $500 for each quarterly meeting attended.
The Advisory Board currently consists of a broker dealer representative, William Arnold; and Limited Partners from each of the two remaining Partnerships: Richard Otte and Jesse Small from the Partnership, and Albert Kramer from DiVall 3. For a brief description of each Advisory Board member, refer to Item 10, Directors and Executive Officers of the Registrant.
The Partnership has no employees.
All of the Partnership's business is conducted in the United States.
Item 2. Properties
The Partnership's Properties are leased under long-term leases, generally with terms of approximately 20 years. All leases are triple net which require the tenant to pay all property operating costs including maintenance, repairs, utilities, property taxes, and insurance. A majority of the leases contain percentage rent provisions which require the tenant to pay a specified percentage (6% to 9%) of gross sales above a threshold amount.
The Partnership owned the following Properties (including specialty leasehold improvements for use in some of these properties) as of December 31, 2001:
Footnotes:
(1) Purchase price includes all costs incurred to acquire the property. (2) Purchase price includes cost of specialty leasehold improvements. (3) Renewal option available at tenant's option. (4) Ownership of lessee's interest under a ground lease. The tenant is responsible for payment of all rent obligations under the ground lease.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurants in South Milwaukee and Milwaukee, Wisconsin. Hardee's lease on the South Milwaukee property expired on November 30, 2001 and they were required to continue making rent payments until the lease expiration date. This lease was not renewed, and therefore, Management is actively marketing new leasing for the vacant S. Milwaukee property. 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 Hardee's Food Systems agreed to pay a lease termination fee of $157,000. The former Hardee's - -Milwaukee tenant ceased the payment of rent as of April 30, 2001.
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.
During December 2001, Hardee's Food Systems, Inc. notified Management that it had vacated its restaurant in Hartford, Wisconsin. Hardee's lease on the Hartford property expires on April 30, 2009 and they will be required to continue making rent payments until the lease expiration date or until a lease termination agreement with Management is entered into.
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 terminated and rent income ceased as of December 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, has no rights to the possession of the property. Therefore, Management is in the process of obtaining possession of the property from Fiesta Time, and then Management will 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, monthly rental and Common Area Maintenance (CAM) income ceased as of June 1, 2001.
Management is moving forward with all legal remedies to collect the remaining balance due of approximately $10,000. The entire amount due the Partnership has been reserved. Due to Management's voluntary surrender of the possession and keys of the property to the Ground Lease landlord in June, 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 has withheld the payment of approximately $50,000 in accrued ground lease obligations related to the property. ( See Legal Proceedings in Item 3.
Item 3. Legal Proceedings
The Partnership owned the building occupied by the Mulberry Street Grill restaurant, which was located on a parcel of land where it had entered into a long-term Ground Lease. The 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 in Phoenix, Arizona. The Partnership ceased collecting the former tenant's rent and attempted to return possession of the Phoenix, Arizona property to the Ground Lease Landlord, Centre at 38th Street, L.L.C, ("LLC".) In addition, beginning in May and through December 2001 the Partnership accrued but withheld payment of the ground lease obligations and at December 31, 2001 the total ground lease accrual approximates $50,000. The Ground Lease Landlord, LLC, has released the property to a new tenant and the Partnership has requested notification from the Landlord upon any default of the new tenant.
On June 18, 2001, LLC filed a lawsuit 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 LLC 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 seeks damages for unpaid rent, commissions, improvements, and unspecified other damages exceeding $120,000.
The Partnership and TPG have filed an answer denying any liability to LLC and intends to defend this matter vigorously. 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 to the Ground Lessor, LLC.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market Price and Dividends on the Registrant's Common Equity and Related Stockholder Matters
(a) Although some Interests have been traded, there is no active public market for the Interests, and it is not anticipated that an active public market for the Interests will develop.
(b) As of December 31, 2001 there were 2,300 record holders of Interests in the Partnership.
(c) The Partnership does not pay dividends. However, the Partnership Agreement, provides for distributable net cash receipts of the Partnership to be distributed on a quarterly basis, 99% to the Limited Partners and 1% to the General Partner, subject to the limitations on distributions to the General Partner described in the Partnership Agreement. During 2001 and 2000, $2,180,000 and $2,635,000, respectively, were distributed in the aggregate to the Limited Partners. The General Partner received aggregate distributions of $6,935 and $6,887 in 2001 and 2000, respectively.
Item 6.
Item 6. Selected Financial Data
The Partnership's selected financial data included below has been derived from the Partnership's financial statements. Arthur Andersen LLP's report on the financial statements, for the years ended December 31, 2001 and 2000, is included in this annual report on page 15. The financial data selected below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and with the financial statements and the related notes appearing elsewhere in this annual report.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP (a Wisconsin limited partnership)
December 31, 2001, 2000, 1999, 1998, and 1997
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources: - -------------------------------
Investment Properties and Net Investment in Direct Financing Leases - -------------------------------------------------------------------
The Properties, including equipment held by the Partnership at December 31, 2001, were originally purchased at a price, including acquisition costs, of approximately $22,261,000.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurants in South Milwaukee and Milwaukee, Wisconsin. Hardee's lease on the South Milwaukee property expired on November 30, 2001 and they were required to continue making rent payments until the lease expiration date. This lease was not renewed, and therefore, Management will market the property for lease to a new tenant. 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 payments are scheduled to be received in 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 Note receivable on the balance sheet. Note receivable installment were received in August and October 2001. The remaining installment, which is reflected in the Note receivable on the balance sheet at December 31, 2001, is scheduled to be received in February 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.
During December 2001, Hardee's Food Systems, Inc. notified Management that it had vacated its restaurant in Hartford, Wisconsin. Hardee's lease on the Hartford property expires on April 30, 2009 and they will be required to continue making rent payments until the lease expiration date or until a lease termination agreement with Management is entered into.
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 terminated and rent income ceased as of December 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, has no rights to the possession of the property. Therefore, Management is in the process of obtaining possession of the property from Fiesta Time, and then Management will 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, monthly rental and Common Area Maintenance (CAM) income ceased as of June 1, 2001. Management is moving forward with all legal remedies to collect the remaining balance due of approximately $10,000. The entire amount due the Partnership has been reserved. Due to Management's
attempt to return 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 has withheld the payment of approximately $50,000 in accrued ground lease obligations related to the property. ( See Legal Proceedings in Item 3.)
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 2001, however, rent income has not been collected for January and February of 2002. Management will pursue all legal remedies in relation to the former tenant's past due balance of approximately $17,000, as well as future lease obligations. Management is also seeking a new tenant for the vacated property.
The tenant of the Red Apple Restaurant in Cedar Rapids, Iowa, vacated the property during 1998 and ceased paying rent. Management sold the property during the Fourth Quarter of 1999 for $450,000 at a gain of approximately $26,000.
Phoenix Restaurant Group, Inc. ("Phoenix") did not formally extend its lease on the Denny's property on Camelback Road in Phoenix, Arizona, when it expired on January 30, 1998, but continued to operate the restaurant and pay rent through December 31, 1999. During January 2000, Phoenix notified Management that it had vacated the premises and ceased paying rent. Management entered into a termination agreement with the ground lessor of the property during 2000, which resulted in a one-time payment of $90,000 in exchange for a release of all future obligations. Possession of the property was returned to the ground lessor, resulting in a $153,000 loss in 2000.
During the Fourth Quarter of 2000, Management negotiated the extension of the leases on the ten (10) Wendy's restaurants from original expirations ranging from 2008 to 2009, to new expiration dates of November 2016.
Other Assets - ------------
Cash and cash equivalents, held by the Partnership, totaled approximately $819,000 at December 31, 2001, compared to $752,000 at December 31, 2000. The Partnership designated cash of $485,000 to fund the Fourth Quarter 2001 distributions to Limited Partners paid in February 2002, $112,000 for the payment of year-end accounts payable and accrued expenses, and the remainder represents reserves deemed necessary to allow the Partnership to operate normally. Cash generated through the operations of the Partnership's Properties and sales of 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 Permanent Manager Agreement 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 included in Item 8 of this report.
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.
Property tax receivable at December 31, 2001, in the amount of $31,000 represented 2001 real estate taxes due from the former Hardee's- S. Milwaukee property and new tenant, Omega Restaurants. In addition, 2000 property taxes paid by the Partnership are due from 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 payments were scheduled to be received in 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 Note receivable on the balance sheet in the Second Quarter of 2001. Note receivable installments were received in August and October 2001. The remaining installment, which is reflected in the Note receivable on the balance sheet at December 31, 2001, is scheduled to be received in February 2002.
Deferred charges totaled approximately $286,000 and $263,000, net of amortization, at December 31, 2001 and December 31, 2000, 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. During the Fourth Quarter of 2000, a commission of $190,000 was paid to an affiliate of the General Partner upon the negotiated extension of the leases on the ten (10) Wendy's restaurants. Also, during 2001 deferred charges relating to the former Hardee's- Milwaukee and Mulberry Street Grill properties were written-off.
Liabilities - -----------
Accounts payable and accrued expenses at December 31, 2001, in the amount of $93,000, primarily represented the year-end accruals of auditing, tax and data processing fees, and May through December ground lease rent related to the former Mulberry Street Grill Property.
Property taxes payable at December 31, 2001, in the amount of $25,000, represented 2001 real estate taxes due for the Omega Restaurant property, and the vacant S. Milwaukee, Wisconsin and Twin Falls, Idaho properties.
Due to the Current General Partner amounted to $1,800 at December 31, 2001, representing the General Partner's portion of the Fourth Quarter 2001 distribution.
Partners' Capital: - -----------------
Net income for the year was allocated between the General Partner and the Limited Partners, 1% and 99%, respectively, as provided in the Partnership Agreement as discussed more fully in Note 4 of the financial statements included in Item 8 of this report. 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 included in Item 8 of this report for additional information regarding the reallocation.
Cash distributions paid to the Limited Partners and to the General Partner during 2001 of $2,180,000 and $6,935, respectively, have also been in accordance with the Partnership Agreement. The Fourth Quarter 2001 distribution of $485,000 is scheduled to be paid to the Limited Partners on February 15, 2002.
Results of Operations: - ---------------------
The Partnership reported net income for the year ended December 31, 2001, in the amount of $1,734,000 compared to net income for the years ended December 31, 2000 and 1999, of $1,722,000 and $2,048,000, respectively. Results for all three years were different than would be expected from "normal" operations, primarily because of tenant defaults, non-cash write-offs, ground lease termination fees, real estate taxes on vacant properties, and property valuation costs. Results were also impacted by gains or losses on the disposition of properties and the reversal of a portion of the former general partner receivable write-off. In addition, net income in 2001 included a $157,000 lease termination fee upon the termination of the Hardee's -Milwaukee property in the Second Quarter of 2001.
Revenues - --------
Total revenues were $2,937,000, $2,853,000, and $3,024,000, for the years ended December 31, 2001, 2000, and 1999, respectively. A decrease in fixed rents resulted from tenant turnover, disposal of property, and modified leases. Revenue in 2001 included a $157,0000 lease termination fee upon the termination of the Hardee's- Milwaukee property lease in the second Quarter of 2001. During 1999, a gain of $26,000 was recorded on the sale of the Red Apple Restaurant property, and recoveries totaled $85,000. Recoveries received during 2001 and 2000, totaled $7,000 and $4,000, respectively.
Total revenues should approximate $2,043,000 annually based on leases currently in place. Future revenues may decrease with tenant defaults and/or sales of 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 years ended December 31, 2001, 2000, and 1999, cash expenses amounted to approximately 20%, 21%, and 18%, of total revenues, respectively. Total expenses, including non-cash items, amounted to approximately 41%, 40% and 32%, of total revenues for the years ended December 31, 2001, 2000, and 1999, respectively. Items negatively impacting expenses during the last three years include expenses incurred primarily in relation to non-cash write-offs, and real estate taxes. In addition, during 2001, the Partnership obtained appraisals of all the Partnership properties at a cost of $63,000. Also during 2001, the Partnership incurred the non-cash write-off of the Mulberry Street Grill property resulting in a loss of $157,000. During 2000, the Partnership paid a one-time $90,000 fee to terminate a ground lease. Also during 2000, in connection with the termination, the property was returned to the ground lessor, resulting in a $153,000 loss.
Charge-offs of uncollectible, non-cash disposal of assets, depreciation, and amortization are non-cash items and do not affect current operating cash flow of the Partnership or distributions to the Limited Partners.
Write-offs for uncollectible rents and receivables amounted to $53,500, $6,800, and $3,400, at December 31, 2001, 2000, and 1999, respectively. The write-offs are the result of defaults as well as modifications to several property leases since inception of the Partnership.
The 1999 selling commission was a result of the sale of the Red Apple Restaurant property.
Selected Quarterly Financial Information (unaudited) - ----------------------------------------------------
Quarter Ended March 31, June 30, September 30, December 31, 2001 2001 2001 2001 -------- -------- ------------- ------------ Revenues $606,620 $747,753 $724,089 $858,169
Net Income $324,989 $500,529 $459,624 $448,637 Net Income Per Unit $ 6.95 $ 10.71 $ 9.83 $ 9.60
Quarter Ended March 31, June 30, September 30, December 31, 2000 2000 2000 2000 -------- -------- ------------- ------------ Revenues $583,668 $613,248 $775,092 $881,278
Net Income $353,265 $355,572 $346,275 $666,679 Net Income Per Unit $ 7.56 $ 7.61 $ 7.41 $ 14.25
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 a ctually fix revenues and are not impacted by rising costs of maintenance, insurance, or real estate taxes. Although the majority of the Partnership's leases have percentage rent clauses, revenues from percentage rents represented only 22% of rental income for 2001. 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. 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 will be 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:
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 is recognized, if any.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
None.
Item 8.
Item 8. Financial Statements and Supplementary Data
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP ------------------------------------------------------
(a Wisconsin limited partnership) ---------------------------------
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES -------------------------------------------
Page ----- Report of Independent Public Accountants ................. 15
Balance Sheets, December 31, 2001 and 2000 ................. 16-17
Statements of Income for the Years Ended December 31, 2001, 2000, and 1999 ................. 18
Statements of Partners' Capital for the Years Ended December 31, 2001, 2000, and 1999 ................. 19
Statements of Cash Flows for the Years Ended December 31, 2001, 2000, and 1999 ................. 20
Notes to Financial Statements ................. 21-30
Schedule III--Real Estate and Accumulated Depreciation ................. 37-38
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of Divall Insured Income Properties 2 Limited Partnership:
We have audited the accompanying balance sheets of Divall Insured Income Properties 2 Limited Partnership (the Partnership), as of December 31, 2001 and 2000, and the related statements of income, partners' capital and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Divall Insured Income Properties 2 Limited Partnership, as of December 31, 2001 and 2000, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois March 8, 2002
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
December 31, 2001 and 2000 --------------------------
ASSETS
The accompanying notes are an integral part of these statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
December 31, 2001 and 2000 --------------------------
LIABILITIES AND PARTNERS' CAPITAL
The accompanying notes are an integral part of these statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF INCOME
For the Years Ended December 31, 2001, 2000, and 1999 -----------------------------------------------------
The accompanying notes are an integral part of these statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF PARTNERS' CAPITAL
For the years ended December 31, 2001, 2000 and 1999 ----------------------------------------------------
The accompanying notes are an integral part of these statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2001, 2000, and 1999 -----------------------------------------------------
The accompanying notes are an integral part of these statements
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
1. ORGANIZATION AND BASIS OF ACCOUNTING: ------------------------------------
DiVall Insured Income Properties 2 Limited Partnership (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 escrowed 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, franchisors 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 December 31, 2001, 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 only accrued when the tenant has reached the breakpoint stipulated in the 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 lives of the buildings and improvements. Equipment is depreciated on a straight-line basis over the estimated useful lives of 5 to 7 years.
Deferred charges represent leasing commissions paid when properties are leased and upon 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 follows Statement of Financial Accounting Standards No.121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which requires that all long-lived assets be reviewed for impairment in value whenever changes in circumstances indicate 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 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 will be 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 will continue 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 $7,858,785.
The following represents a reconciliation of net income as stated on the Partnership statements of income to net income for tax reporting purposes:
2. REGULATORY INVESTIGATION: ------------------------
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") 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, and restoration costs and recoveries have been allocated based on the same percentage, Through December 31, 2001, $5,803,000 of recoveries have been received which exceeded the original estimate of $3 million. As a result, in 1996, 1997, 1999, 2000 and 2001, the Partnership has recognized $1,125,000 as income, which represents its share of the excess recovery. There were no restoration activities or recoveries in 1998. The current General Partner continues to pursue recoveries of the misappropriated funds, however, no further significant recoveries are anticipated.
3. INVESTMENT PROPERTIES: ---------------------
As of December 31, 2001, 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, two (2) Hardee's restaurant, two (2) 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) Village Inn restaurant, one (1) Omega restaurant, one (1) Blockbuster Video store, one (1) Sunrise Preschool, and two (2) vacant properties, (which were previously operated as a Fiesta Time restaurant and a Hardee's restaurant.) The 26 properties are located in a total of thirteen (13) states.
During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurants in South Milwaukee and Milwaukee, Wisconsin. Hardee's lease on the South Milwaukee property expired on November 30, 2001 and they were required to continue making rent payments until the lease expiration date. This lease was not renewed, and therefore, Management will market the property for lease to a new tenant. 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 payments are scheduled to be received in 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 Note receivable on the balance sheet in the Second Quarter of 2001. Note receivable installments were received in August and October 2001. The remaining installment, which is reflected in the Note receivable on the balance sheet at December 31, 2001, is scheduled to be received in February 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.
During December 2001, Hardee's Food Systems, Inc. notified Management that it had vacated its restaurant in Hartford, Wisconsin. Hardee's lease on the Hartford property expires on April 30, 2009 and they will be required to continue making rent payments until the lease expiration date or until a lease termination agreement with Management is entered into.
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 terminated and rent income ceased as of December 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, has no rights to the possession of the property. Therefore,
Management is in the process of obtaining possession of the property from Fiesta Time, and then Management will 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, monthly rental and Common Area Maintenance (CAM) income ceased as of June 1, 2001. Management is moving forward with all legal remedies to collect the remaining balance due of approximately $10,000. The entire amount due the Partnership has been reserved. Due to Management's attempt to return 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 has withheld the payment of approximately $50,000 in accrued ground lease obligations related to the property. ( See Legal Proceedings in 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 2001, however, rent income has not been collected for January and February of 2002. Management will pursue all legal remedies in relation to the former tenant's past due balance of approximately $17,000, as well as future lease obligations. Management is also seeking a new tenant for the vacated property.
The tenant of the Red Apple Restaurant in Cedar Rapids, Iowa, vacated the property during 1998 and ceased paying rent. The uncollected rent was written off as uncollectible, because the tenant could not be located. Management sold the property during the Fourth Quarter of 1999 for $450,000 at a gain of approximately $26,000.
The tenant operating a Denny's restaurant on Camelback Road in Phoenix, Arizona, did not formally exercise its option to extend its lease which expired on January 30, 1998, but continued to operate the restaurant and pay rent through December 31, 1999. During January 2000, the tenant notified Management that it had vacated the premises and ceased paying rent. Management entered into a termination agreement with the ground lessor of the property during 2000, which resulted in a one-time payment of $90,000 in exchange for a release of all future obligations. Possession of the property was returned to the ground lessor, resulting in a $153,000 loss in the Third Quarter of 2000.
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 the close of the offering, approximately 75% of the original proceeds was invested in the Partnership's properties.
The current General Partner receives a fee for managing the Partnership equal to 4% of the gross receipts, with a maximum reimbursement for office rent and related office overhead of $25,000 between the three original affiliated Partnerships. Effective March 1, 2001, the minimum management fee and the maximum reimbursement for office rent and overhead increased by 3.4% representing the allowable annual Consumer Price Index adjustment per the Permanent Manager Agreement ("PMA"). For purposes of computing the 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 $55,463 to date on the amounts recovered, which has been offset against the 4% minimum fee.
Prior to December 31, 2001 the Partnership owned two (2) restaurants, Kentucky Fried Chicken and Mulberry Street Grill restaurant, which are located on parcels of land where it has entered into long-term ground leases. One (1) of these leases is paid by the tenant, Kentucky Fried Chicken, and one (1) is paid by the Partnership. The lease paid by the Partnership is considered an operating lease and the lease payments are expensed in the periods to which they apply. The lease requires aggregate minimum annual payments of approximately $72,000 and expires in the year 2008. Due to the Mulberry Street Grill property being vacant, Management is litigating with the ground lessor to terminate the ground lease, which would release the Partnership from its ground lease obligations and would return possession of the property to the ground lessor. Management has withheld payment of the May through December lease obligations totaling approximately $50,000. Due to the ground lessor obtaining it's own tenant, the Partnership wrote-off the net asset value of the vacant Mulberry Street Grill property at a loss of $157,000 in the Fourth Quarter of 2001. In addition, Management has requested notification from the ground lessor upon any default from the new tenant. (See Note 10.)
During the Fourth Quarter of 2000, Management negotiated the extension of the leases on the ten(10) Wendy's restaurants from original expirations ranging from 2008 to 2009, to new expiration dates of November 2016.
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 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.)
Effective June 1, 1993, the Partnership Agreement was amended to (i) change the definition of "Distribution Quarter" to be consistent with calendar quarters, and (ii) change the distribution provisions to subordinate the General Partner's share of distributions from Net Cash Receipts and Net Proceeds, except to the extent necessary for the General Partner to pay its federal and state income taxes on Partnership income allocated to the General Partner. Because these amendments do not adversely affect the rights of the Limited Partners, pursuant to section 10.2 of the Partnership Agreement, the amendments were made by the General Partner without a vote of the Limited Partners.
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 $ 2,042,598 2003 2,001,092 2004 2,030,311 2005 2,040,603 2006 1,964,133 Thereafter 13,131,949 ----------- $23,210,686 ===========
Percentage rentals included in rental income in 2001, 2000, and 1999 were $588,818, $548,180, and $522,924, respectively. The increase in percentage rental income is a result of increased tenant sales.
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: -----------------------------------------
Amounts incurred to the current General Partner for the years ended December 31, 2001, 2000, and 1999, are as follows:
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 escrowed 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 escrowed amounts will be paid to the current General Partner. At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining escrowed 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 escrowed towards the recovery. In lieu of an escrow, 50% of all such disposition fees have been paid directly to a restoration account and then distributed among the three original Partnerships. Fifty percent (50%) of the total amount paid to the recovery was refunded to the current General Partner during 1996 after exceeding 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 December 31, 2001, the Partnership may owe the current General Partner $16,296, which has been reflected as a recovery, if the $6,000,000 recovery level is achieved. Management believes it is unlikely that such a recovery level will be achieved.
8. PMA INDEMNIFICATION TRUST: -------------------------
The Permanent Manager Agreement ("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 December 31, 2001. Funds are invested in U.S. Treasury securities. In addition, $122,167 of earnings have been credited to the Trust as of December 31, 2001. 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 occupied by the Mulberry Street Grill restaurant, which was located on a parcel of land where it had entered into a long-term Ground Lease. The 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 in Phoenix, Arizona. The Partnership ceased collecting the former tenant's rent and attempted to return possession of the Phoenix, Arizona property to the Ground Lease Landlord, Centre at 38th Street, L.L.C, ("LLC".) In addition, beginning in May and through December 2001 the Partnership accrued but withheld payment of the ground lease obligations and at December 31, 2001 the total ground lease accrual approximates $50,000. The Ground Lease Landlord, LLC, has released the property to a new tenant and the Partnership has requested notification from the Landlord upon any default of the new tenant.
On June 18, 2001, LLC filed a lawsuit 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 LLC 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 seeks damages for unpaid rent, commissions, improvements, and unspecified other damages exceeding $120,000.
The Partnership and TPG have filed an answer denying any liability to LLC and intends to defend this matter vigorously. 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 to the Ground Lessor, LLC.
11. SUBSEQUENT EVENTS: -----------------
In February 2002, the Village Inn Restaurant notified Management that its restaurant in Grand Forks, North Dakota was closed and vacated as of February 2002. The lease on the property is set to expire in 2009. Rent income was collected from the tenant through December 2001, however, rent income has not been collected for January and February of 2002. Management will pursue all legal remedies in relation to the former tenant's past due balance of approximately $17,000, as well as future lease obligations. Management is also seeking a new tenant for the vacated property.
In January 2002, the Partnership received the final installment of the Note Receivable due from Hardee's Food Systems in relation to the lease termination agreement executed in the Second Quarter of 2001.
On February 15, 2001, the Partnership made distributions to the Limited Partners of $485,000 amounting to $10.48 per Interest.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
TPG is an Illinois corporation with its principal office at 101 West 11th Street, Suite 1110, Kansas City, Missouri 64105. TPG was elected General Partner by vote of the Limited Partners effective on May 26, 1993. Prior to such date, TPG had been managing the Partnership since February 8, 1993, under the terms of the Permanent Manager Agreement ("PMA"), which remains in effect. TPG also serves as the corporate general partner for DiVall 3. See Items 1 and 13 hereof for additional information about the PMA and the election of TPG as General Partner.
The executive officers and director of the General Partner who control the affairs of the Partnership are as follows:
Bruce A. Provo, Age 51 - President, Founder and Director. Mr. Provo has been involved in the management of real estate and other asset portfolios since 1979. Since he founded the company in 1985, Mr. Provo has been President of TPG. From 1982 to 1986, Mr. Provo served as President and Chief Operating Officer of the North Kansas City Development Company ("NKCDC"), North Kansas City, Missouri. NKCDC was founded in 1903 and the assets of the company were sold in December, 1985 for $102,500,000. NKCDC owned commercial and industrial properties, including an office park and a retail district, as well as apartment complexes, motels, recreational facilities, fast food restaurants, and other properties. NKCDC's holdings consisted of over 100 separate properties and constituted approximately 20% of the privately held real property in North Kansas City, Missouri (a four square mile municipality). Following the sale of the company's real estate, Mr. Provo served as the President, Chief Executive Officer and Liquidating Trustee of NKCDC from 1986 to 1991.
Mr. Provo graduated from Miami University, Oxford, Ohio in 1972 with a B.S. in Accounting. He became a Certified Public Accountant in 1974 and was a manager in the banking and financial services division of Arthur Andersen LLP prior to joining Rubloff Development Corporation in 1979. From 1979 through 1985, Mr. Provo served as Vice President - Finance and then as President of Rubloff Development Corporation. Mr. Provo has previously served on the Board of Directors of the National Realty committee, a legislative "watchdog" organization for the commercial real estate industry headquartered in Washington, DC.
Diane R. Conley, Age 40- Controller- Divall Properties. Ms. Conley joined TPG in November 1986 to become Controller for four limited partnerships managed by TPG. Ms. Conley graduated with a B.S. in Accounting from Rochester Institute of Technology in Rochester, New York in 1984 and became a Certified Public Accountant in 1986. Ms. Conley was an independent auditor with Coopers and Lybrand for three years and supervised audit staff on a variety of engagements. Prior to joining TPG she provided financial consulting services for clients of varied industries.
The Advisory Board, although its members are not "Directors" or "Executive Officers" of the Partnership, provides advisory oversight to management of the Partnership and consists of:
William Arnold - Investment Broker. Mr. Arnold works as a financial planner and investment advisor at his company, Arnold & Company. Mr. Arnold graduated with a Master's Degree from the University of Wisconsin and is a Certified Financial Planner.
Jesse Small - Self Employed. Mr. Small is the President of a small Accounting Firm. In addition to being a CPA, he has a Master's Degree in Economics. Mr. Small is a Limited Partner representing DiVall 2.
Richard W. Otte - Editorial Writer. Mr. Otte is in his seventh year as an Editorial Board Member and editorial writer for The Volusion, a DeLand, Florida, subsidiary of the News-Journal Corporation in Daytona Beach, Florida. Mr. Otte retired in 1988 after 34 years with the Dispatch Printing Co., serving his last eight years as Managing Editor of the Columbus Dispatch and as a member of its Operating Committee. He previously was the executive sports editor of the newspaper in Ohio's capital city. Mr. Otte's 49 years in professional journalism also include news reporting, editing and sports assignments with the Daytona Journal Herald and Springfield News-Sun. Mr. Otte is a Limited Partner representing DiVall 2.
Albert Kramer - Retired. Mr. Kramer is now retired, but previously worked as Tax Litigation Manager for Phillips Petroleum Company. His education includes undergraduate and MBA degrees from Harvard and a J.D. Degree from South Texas College of Law. Mr. Kramer is a Limited Partner representing DiVall 3.
Item 11.
Item 11. Executive Compensation
The Partnership has not paid any "executive compensation" to the corporate General Partner or to the directors and officers of the General Partner. The General Partner's participation in the income of the Partnership is set forth in the Partnership Agreement, which is filed as Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5 hereto. The current General Partner received management fees and expense reimbursements during the year.
See Item 13, below, and Note 6 to the financial statements in Item 8 hereof for further discussion of payments by the Partnership to the General Partner and the former general partners.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) As of December 31, 2001, no one person or group is known by the Partnership to own beneficially more than 5% of the outstanding Interests of the Partnership.
(b) As of December 31, 2001, neither the General Partner nor any of their affiliates owned any Interests in the Partnership.
Item 13.
Item 13. Certain Relationships and Related Transactions
The compensation to be paid to TPG is governed by the Partnership Agreement, as amended by vote of the Limited Partners to reflect the terms of the PMA. TPG's compensation includes a base fee equal to 4% of the Partnership's gross collected receipts, subject to a minimum of $159,000 per year. For this purpose, "gross collected receipts" means all cash revenues arising from operations and reserves of the Partnerships,
including any proceeds recovered with respect to the obligations of the former general partners. The portion of such fee resulting from recoveries from former general partners is designated as restoration fees. TPG is also entitled to reimbursement for office rent and utilities not to exceed $13,250 per year. TPG is entitled to reimbursement of reasonable direct costs and expenses, such as travel, lodging, overnight delivery and postage, but has no right to be reimbursed for administrative expenses such as payroll, payroll taxes, insurance, retirement and other benefits, base phone and fax charges, office furniture and equipment, copier rent, and the like. Between the Partnerships, TPG is entitled to an aggregate minimum base management fee of $300,000 per year and reimbursement for office rent in the maximum amount of $25,000 per year. The Partnership shall only be responsible for its allocable share of such minimum and maximum amounts as indicated above ($159,000 minimum base fee and $13,250 maximum rent reimbursement). TPG is entitled to an annual increase in the minimum base management fee and maximum office overhead reimbursement in an amount not to exceed the percentage increase in the Consumer Price Index ("CPI") for the immediately preceding calendar year. Effective March 1, 2001, the minimum management fee and the maximum reimbursement for office rent and overhead increased by 3.4% representing the allowable annual CPI adjustments. Additionally, TPG is allowed up to one-half of the Competitive Real Estate Commission, not to exceed 3% upon the disposition of assets. The payment of a portion of such fees is subordinated to TPG's success at recovering the funds misappropriated by the former general partners.
The PMA has an expiration date of December 31, 2002, but may be terminated earlier (a) by a vote at any time by a majority in interest of the Limited Partners, (b) upon the dissolution and winding up of the Partnership, (c) upon the entry of an order of a court finding that the Permanent Manager has engaged in fraud or other like misconduct or has shown itself to be incompetent in carrying out its duties under the Partnership Agreement, or (d) upon sixty (60) days written notice from the Permanent Manager to the Limited Partners of the Partnership. Upon termination of the PMA, other than by the voluntary action of TPG, TPG shall be paid a termination fee of one month's Base Fee allocable to the Partnership, subject to a minimum of $13,250. In the event that TPG is terminated by action of a substitute general partner, TPG shall also receive, as part of this termination fee, 4% of any proceeds recovered with respect to the obligations of the former general partners, whenever such proceeds are collected.
Under the PMA, TPG shall be indemnified by the Partnership, DiVall and Magnuson, and their controlled affiliates, and shall be held harmless from all claims of any party to the Partnership Agreement and from any third party including, without limitation, the Limited Partners of the Partnership, for any and all liabilities, damages, costs and expenses, including reasonable attorneys' fees, arising from or related to claims relating to or arising from the PMA or its status as Permanent Manager. The indemnification does not extend to claims arising from fraud or criminal misconduct of TPG as established by court findings. To the extent possible, the Partnership is to provide TPG with appropriate errors and omissions, officers liability or similar insurance coverage, at no cost to TPG. In addition, TPG is granted the right to establish the Trust in an amount, not to exceed $250,000, solely for the purpose of funding such indemnification obligations. Once a determination has been made that no such claims can or will be made against TPG, the balance of the Trust will become unrestricted cash of the Partnership. At December 31, 2001 the Partnership had fully funded the Trust.
The Partnership paid the following fees and reimbursements to management in 2001:
The Provo Group, Inc. ---------------------
Management Fees $192,902 Restoration Fees 278 Leasing Commissions 8,644 Office Overhead Allowance 15,586 Direct Cost Reimbursements 9,690 --------
2001 Total $227,100 ========
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) 1. Financial Statements
The following financial statements of DiVall Insured Income Properties 2 Limited Partnership are included in Part II, Item 8:
Report of Independent Public Accountants
Balance Sheets, December 31, 2001 and 2000
Statements of Income for the Years Ended December 31, 2001, 2000, and
Statements of Partners' Capital for the Years Ended December 31, 2001, 2000, and 1999
Statements of Cash Flows for the Years Ended December 31, 2001, 2000, and 1999
Notes to Financial Statements
2. Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and, therefore, have been omitted.
3. Listing of Exhibits
3.1 Agreement of Limited Partnership dated as of November 18, 1987, amended as of November 25, 1987, and February 20, 1988, filed as Exhibit 3A to Amendment No. 1 to the Partnership's Registration Statement on Form S-11 as filed on February 22, 1988, and incorporated herein by reference.
3.2 Amendments to Amended Agreement of Limited Partnership dated as of June 21, 1988, included as part of Supplement dated August 15, 1988, filed under Rule 424(b)(3), incorporated herein by reference.
3.3. Amendment to Amended Agreement of Limited Partnership dated as of February 8, 1993, filed as Exhibit 3.3 to the Partnership's 10-K for the year ended December 31, 1992, and incorporated herein by reference.
3.4 Amendment to Amended Agreement of Limited Partnership dated as of May 26, 1993, filed as Exhibit 3.4 to the Partnership's 10-K for the year ended December 31, 1993, and incorporated herein by reference.
3.5 Amendment to Amended Agreement of Limited Partnership dated as of June 30, 1994, filed as Exhibit 3.5 to the Partnership's 10-K for the year ended December 31, 1994 and incorporated herein by reference.
10.0 Permanent Manager Agreement filed as an exhibit to the Current Report on Form 8-K dated January 22, 1993, incorporated herein by reference.
99.0 Correspondence to the Limited Partners dated February 15, 2002 regarding the Fourth Quarter 2001 distribution.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 8-K during the fourth quarter of fiscal year 2001.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 2001
(A) Approximates aggregate costs for federal income tax purposes.
(1) This property was written down to its estimated net realizable value of $400,000 at December 31, 1995.
(2) This property was written down to its estimated net realizable value at December 31, 1998
(3) In the Fourth Quarter of 2001 a portion of the land was purchased from the Partnership by the County Commission for utility and maintenance easement.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2001
(B) Reconciliation of "Real Estate and Accumulated Depreciation":
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: /s/Bruce A. Provo ----------------- Bruce A. Provo, President
Date: March 26, 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: March 26, 2002
By: /s/Diane Conley --------------- Diane Conley Controller
Date: March 26, 2002