10QSB 1 ddre2.txt DDRE2 FORM 10-QSB--QUARTERLY OR TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Quarterly or Transitional Report U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-QSB (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________to _________ Commission file number 0-14483 Davidson Diversified Real Estate II, L.P. (Exact name of small business issuer as specified in its charter) Delaware 62-1207077 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 55 Beattie Place, P.O. Box 1089 Greenville, South Carolina 29602 (Address of principal executive offices) (864) 239-1000 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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___ PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS a) Davidson Diversified Real Estate II, L.P. CONSOLIDATED BALANCE SHEET (Unaudited) (in thousands, except unit data) March 31, 2002
Assets Cash and cash equivalents $ 772 Receivables and deposits 257 Restricted escrows 269 Other assets 670 Investment properties: Land $ 2,603 Buildings and related personal property 47,761 50,364 Less accumulated depreciation (25,833) 24,531 $ 26,499 Liabilities and Partners' Deficit Liabilities Accounts payable $ 329 Tenant security deposit liabilities 147 Accrued property taxes 398 Other liabilities 430 Due to an affiliate 6,790 Mortgage notes payable 25,984 Partners' Deficit General partners $ (587) Limited partners (1,224.25 units issued and outstanding) (6,992) (7,579) $ 26,499 See Accompanying Notes to Consolidated Financial Statements
b) Davidson Diversified Real Estate II, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in thousands, except per unit data)
Three Months Ended March 31, 2002 2001 Revenues: Rental income $ 1,566 $ 1,547 Other income 168 174 Total revenues 1,734 1,721 Expenses: Operating 771 869 General and administrative 90 88 Depreciation 497 493 Interest 398 534 Property taxes 114 113 Total expenses 1,870 2,097 Loss before extraordinary item (136) (376) Extraordinary loss on early extinguishment of debt (Note C) -- (554) Net loss $ (136) $ (930) Net loss allocated to general partners (2%) $ (3) $ (19) Net loss allocated to limited partners (98%) (133) (911) $ (136) $ (930) Per limited partnership unit: Loss before extraordinary item $(108.64) $(300.59) Loss on early extinguishment of debt -- (443.54) Net loss $(108.64) $(744.13) See Accompanying Notes to Consolidated Financial Statements
c) Davidson Diversified Real Estate II, L.P. CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT (Unaudited) (in thousands, except unit data)
Limited Partnership General Limited Units Partners Partners Total Original capital contributions 1,224.25 $ 1 $24,485 $24,486 Partners' deficit at December 31, 2001 1,224.25 $ (584) $(6,859) $(7,443) Net loss for the three months ended March 31, 2002 -- (3) (133) (136) Partners' deficit at March 31, 2002 1,224.25 $ (587) $(6,992) $(7,579) See Accompanying Notes to Consolidated Financial Statements
d) Davidson Diversified Real Estate II, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands)
Three Months Ended March 31, 2002 2001 Cash flows from operating activities: Net loss $ (136) $ (930) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation 497 493 Amortization of discounts and loan costs 91 62 Extraordinary loss on early extinguishment of debt -- 554 Change in accounts: Receivables and deposits (64) (139) Other assets (107) (144) Accounts payable (387) (197) Tenant security deposit liabilities 8 4 Accrued property taxes (58) (30) Due to affiliate 276 109 Other liabilities 73 (135) Net cash provided by (used in) operating activities 193 (353) Cash flows from investing activities: Property improvements and replacements (2,917) (237) Net (deposits to) withdrawals from restricted escrows (39) 308 Net cash (used in) provided by investing activities (2,956) 71 Cash flows from financing activities: Advances from Managing General Partner 1,200 3,847 Payments on mortgage notes payable (126) (116) Proceeds from mortgage note payable 1,737 5,065 Repayment of mortgage note payable -- (7,812) Prepayment penalty -- (359) Loan costs paid (19) (417) Net cash provided by financing activities 2,792 208 Net increase (decrease) in cash and cash equivalents 29 (74) Cash and cash equivalents at beginning of period 743 1,130 Cash and cash equivalents at end of period $ 772 $ 1,056 Supplemental disclosure of cash flow information: Cash paid for interest $ 394 $ 338 Supplemental disclosure of non-cash activity: Property improvements and replacements in accounts payable $ -- $ 27 At December 31, 2001 approximately $850,000 of property improvements and replacements were included in accounts payable and are included in property improvements and replacements at March 31, 2002. See Accompanying Notes to Consolidated Financial Statements
e) Davidson Diversified Real Estate II, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note A - Basis of Presentation The accompanying unaudited consolidated financial statements of Davidson Diversified Real Estate II, L.P. (the "Partnership" or "Registrant") have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of Davidson Diversified Properties, Inc. (the "Managing General Partner"), all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. For further information, refer to the consolidated financial statements and footnotes thereto included in the Partnership's Annual Report on Form 10-KSB for the fiscal year ended December 31, 2001. The Managing General Partner is a subsidiary of Apartment Investment and Management Company ("AIMCO"), a publicly traded real estate investment trust. Certain reclassifications have been made to the 2001 balances to conform to the 2002 presentation. Note B - Transactions with Affiliated Parties The Partnership has no employees and is dependent on the Managing General Partner and its affiliates for the management and administration of all Partnership activities. The Partnership Agreement provides for (i) certain payments to affiliates for services and (ii) reimbursement of certain expenses incurred by affiliates on behalf of the Partnership. During the three months ended March 31, 2002 and 2001, affiliates of the Managing General Partner were entitled to receive 5% of gross receipts from all of the Registrant's properties for providing property management services. The Registrant paid to such affiliates approximately $87,000 and $88,000 during the three months ended March 31, 2002 and 2001, respectively, which is included in operating expenses. An affiliate of the Managing General Partner received reimbursement of accountable administrative expenses amounting to approximately $628,000 and $65,000 during the three months ended March 31, 2002 and 2001, respectively, which is included in general and administrative expenses and investment properties. Included in these amounts are fees related to construction management services provided by an affiliate of the Managing General Partner of approximately $559,000 for the three months ended March 31, 2002. There were no construction management service fees paid or accrued during the three months ended March 31, 2001. The construction management fees are calculated based on a percentage of additions to investment properties. In accordance with the Partnership Agreement, the Managing General Partner has advanced the Partnership funds to cover operational expenses and to assist in the closing of the refinancing required at Reflections Apartments. At March 31, 2002, the amount of the outstanding loans and accrued interest to cover operational expenses was approximately $3,065,000 and the amount of the outstanding loan and accrued interest to assist the refinancing was approximately $3,725,000. Both amounts are included in Due to affiliate on the accompanying consolidated balance sheet. Interest is charged at prime plus 1%. Interest expense was approximately $83,000 and $109,000 for the three months ended March 31, 2002 and 2001, respectively. The Partnership accrued a real estate commission of $18,000 as a result of the sale of Shoppes at River Rock due to the Managing General Partner during the year ended December 31, 1999 which is included in other liabilities in the accompanying consolidated balance sheet. Payment of this commission is subordinate to the limited partners receiving their original invested capital plus a cumulative non-compounded annual return of 8% on their adjusted invested capital. Beginning in 2001, the Partnership began insuring its properties up to certain limits through coverage provided by AIMCO which is generally self-insured for a portion of losses and liabilities related to workers compensation, property casualty and vehicle liability. The Partnership insures its properties above the AIMCO limits through insurance policies obtained by AIMCO from insurers unaffiliated with the Managing General Partner. During the three months ended March 31, 2002 and 2001, the Partnership was charged by AIMCO and its affiliates approximately $105,000 and $116,000, respectively, for insurance coverage and fees associated with policy claims administration which is included in operating expenses. Note C - Refinancing of Mortgage Note Payable On January 16, 2001, the mortgages encumbering Reflections Apartments were refinanced in order to finance the rehabilitation of the property. The maximum new loan amount is $13,600,000. Effective January 16, 2001, the lender made an initial advance of $5,040,000. Prior to the initial advance, the Managing General Partner loaned the Partnership approximately $3,673,000 in order for the Partnership to close the refinancing of the property. This amount will be repaid from the further refinancing that will occur after the completion of the rehabilitation project, estimated to be September 2002. During the year ended December 31, 2001, the lender advanced Reflections Apartments an additional amount of approximately $3,845,000 and during the three months ended March 31, 2002 the lender advanced Reflections Apartments an additional $1,737,000. Subsequent advances of up to $2,978,000 will also be made to cover renovation work that is needed at the property. The new loan matures in January 2004, with 2 one-year extension options. Interest payments started in February 2001 based on LIBOR plus 280 basis points (4.63% at March 31, 2002). Due to the rehabilitation project, approximately $174,000 and $43,000 of the interest expense for the three months ended March 31, 2002 and 2001, respectively, was capitalized. During December 2001, the Partnership adjusted the accumulated expenditures used in calculating capitalized interest which resulted in an overall decrease in fourth quarter 2001 interest expense of approximately $190,000. The impact on the first quarter of 2001 was an increase in interest expense of approximately $28,000. In addition, monthly cash flow payments will be made to the lender until the anticipated completion date of the renovations. If any amount remains from these advances on the completion date of the renovation, it will be applied to the principal balance. Principal payments will begin in February 2003, and monthly deposits into a replacement reserve will be required. In connection with the refinancing, the Partnership incurred loan costs of approximately $469,000 during the year ended December 31, 2001. Additional loan costs of approximately $19,000 were incurred during the three months ended March 31, 2002. These loan costs are included in other assets in the accompanying consolidated balance sheet and are being amortized over the life of the mortgage. In connection with the refinancing, the assets and liabilities of the property were transferred from one subsidiary, Big Walnut L.P., to a newly formed subsidiary, AIMCO Greensprings L.P. The loan is collateralized by the property as well as the interest of both the Partnership and Davidson Diversified Properties, Inc. in AIMCO Greensprings L.P. The new mortgage replaced a first mortgage of approximately $7,518,000 and a second mortgage of approximately $294,000. The Partnership recognized an extraordinary loss on the early extinguishment of debt of approximately $554,000 consisting of a prepayment penalty of approximately $359,000 and the write-off of unamortized loan costs and mortgage discounts of approximately $195,000. Note D - Legal Proceedings In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purports to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) which are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs seek monetary damages and equitable relief, including judicial dissolution of the Partnership. On June 25, 1998, the Managing General Partner filed a motion seeking dismissal of the action. In lieu of responding to the motion, the plaintiffs filed an amended complaint. The Managing General Partner filed demurrers to the amended complaint which were heard February 1999. Pending the ruling on such demurrers, settlement negotiations commenced. On November 2, 1999, the parties executed and filed a Stipulation of Settlement, settling claims, subject to court approval, on behalf of the Partnership and all limited partners who owned units as of November 3, 1999. Preliminary approval of the settlement was obtained on November 3, 1999 from the Court, at which time the Court set a final approval hearing for December 10, 1999. Prior to the December 10, 1999 hearing, the Court received various objections to the settlement, including a challenge to the Court's preliminary approval based upon the alleged lack of authority of prior lead counsel to enter the settlement. On December 14, 1999, the Managing General Partner and its affiliates terminated the proposed settlement. In February 2000, counsel for some of the named plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who negotiated the settlement. On June 27, 2000, the Court entered an order disqualifying them from the case and an appeal was taken from the order on October 5, 2000. On December 4, 2000, the Court appointed the law firm of Lieff Cabraser Heimann & Bernstein LLP as new lead counsel for plaintiffs and the putative class. Plaintiffs filed a third amended complaint on January 19, 2001. On March 2, 2001, the Managing General Partner and its affiliates filed a demurrer to the third amended complaint. On May 14, 2001, the Court heard the demurrer to the third amended complaint. On July 10, 2001, the Court issued an order sustaining defendants' demurrer on certain grounds. On July 20, 2001, Plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer. On September 7, 2001, Plaintiffs filed a fourth amended class and derivative action complaint. On September 12, 2001, the Court denied Plaintiffs' motion for reconsideration. On October 5, 2001, the Managing General Partner and affiliated defendants filed a demurrer to the fourth amended complaint, which was heard on December 11, 2001. On February 2, 2002, the Court served its order granting in part the demurrer. The Court has dismissed without leave to amend certain of the plaintiffs' claims. On February 11, 2002, plaintiffs filed a motion seeking to certify a putative class comprised of all non-affiliated persons who own or have owned units in the partnerships. The Managing General Partner and affiliated defendants oppose the motion. On April 29, 2002, the Court heard argument on the motion and ordered further briefing after which time the matter will be taken under submission. The Court has set the matter for trial in January 2003. During the third quarter of 2001, a complaint (the "Heller action") was filed against the same defendants that are named in the Nuanes action, captioned Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed a first amended complaint. The first amended complaint in the Heller action is brought as a purported derivative action, and asserts claims for among other things breach of fiduciary duty; unfair competition; conversion, unjust enrichment; and judicial dissolution. Plaintiffs in the Nuanes action filed a motion to consolidate the Heller action with the Nuanes action and stated that the Heller action was filed in order to preserve the derivative claims that were dismissed without leave to amend in the Nuanes action by the Court order dated July 10, 2001. On October 5, 2001, the Managing General Partner and affiliated defendants moved to strike the first amended complaint in its entirety for violating the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer in the Nuanes action, or alternatively, to strike certain portions of the complaint based on the statute of limitations. Other defendants in the action demurred to the fourth amended complaint, and, alternatively, moved to strike the complaint. On December 11, 2001, the court heard argument on the motions and took the matters under submission. On February 4, 2002, the Court served notice of its order granting defendants' motion to strike the Heller complaint as a violation of its July 10, 2001 order in the Nuanes action. On March 27, 2002, the plaintiffs filed a notice appealing the order striking the complaint. The Managing General Partner does not anticipate that any costs, whether legal or settlement costs, associated with these cases will be material to the Partnership's overall operations. The Partnership is unaware of any other pending or outstanding litigation that is not of a routine nature arising in the ordinary course of business. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF PLAN OF OPERATION The matters discussed in this Form 10-QSB contain certain forward-looking statements and involve risks and uncertainties (including changing market conditions, competitive and regulatory matters, etc.) detailed in the disclosures contained in this Form 10-QSB and other filings with the Securities and Exchange Commission made by the Registrant from time to time. The discussion of the Registrant's business and results of operations, including forward-looking statements pertaining to such matters, does not take into account the effects of any changes to the Registrant's business and results of operation. Accordingly, actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including those identified herein. The Partnership's investment properties consist of four apartment complexes. The following table sets forth the average occupancy of the properties for the three months ended March 31, 2002 and 2001: Average Occupancy 2002 2001 Big Walnut Apartments Columbus, Ohio (1) 97% 82% LaFontenay I & II Apartments Louisville, Kentucky (2) 85% 89% The Trails Apartments Nashville, Tennessee 93% 93% Reflections Apartments Indianapolis, Indiana (3) 35% 42% (1) The Managing General Partner attributes the increase in occupancy at Big Walnut Apartments to an improved job market and reduced average rental rates. (2) The Managing General Partner attributes the decrease in occupancy at LaFontenay I & II Apartments to poor market conditions and tenants buying homes due to low interest rates. (3) The Managing General Partner attributes the decrease in occupancy at Reflections Apartments to construction at the property. The property is currently undergoing a major renovation project to enhance the appearance of the property to attract desirable tenants. At March 31, 2002 47.25% of the units cannot be rented due to the rehabilitation. Results of Operations The Registrant's net loss for the three months ended March 31, 2002, was approximately $136,000 compared to a net loss of approximately $930,000 for the three months ended March 31, 2001. The decrease in net loss was partially due to the extraordinary loss from the early extinguishment of debt related to the refinancing of Reflections Apartments in January 2001 (see discussion in "Liquidity and Capital Resources"). The loss before the extraordinary item was approximately $136,000 for the three months ended March 31, 2002 as compared to approximately $376,000 for the three months ended March 31, 2001. The decrease in loss before the extraordinary item is due to a decrease in total expenses and, to a lesser extent, an increase in total revenues. Total expenses decreased due to decreases in operating and interest expenses. Operating expense decreased primarily due to decreases in contract courtesy patrol expense and operating costs capitalized as part of the renovation project at Reflections which were offset by an increase in utility expense primarily at Reflections Apartments. Interest expense decreased due to the new financing at Reflections Apartments with variable rate interest that is lower than the 7.6% rate on the old mortgage and to a portion of the interest on the debt at Reflections being capitalized as part of the renovation project. In addition, interest on advances from the Managing General Partner decreased due to a lower average interest rate. These decreases were partially offset by increased loan cost amortization at Reflections Apartments. Included in general and administrative expenses are reimbursements to the Managing General Partner allowed under the Partnership Agreement associated with its management of the Partnership. Costs associated with the quarterly and annual communications with investors and regulatory agencies and the annual audit required by the Partnership Agreement are also included in general and administrative expenses. Total revenues increased due to an increase in rental income which was partially offset by a decrease in other income for the three months ended March 31, 2002. Rental income increased due to an increase in occupancy at Big Walnut Apartments and an increase in the average rental rate at Reflections which were partially offset by decreases in occupancy at Reflections and Lafontenay Apartments. Other income decreased due to a decrease in utility reimbursements at Lafontenay Apartments, reduced laundry income at Reflections, LaFontenay and The Trails Apartments and reduced interest income due to lower average cash balances in interest bearing accounts partially offset by an increase in utility reimbursements at Big Walnut and The Trails Apartments. As part of the ongoing business plan of the Partnership, the Managing General Partner monitors the rental market environment of the investment properties to assess the feasibility of increasing rents, maintaining or increasing occupancy levels and protecting the Partnership from increases in expense. As part of this plan, the Managing General Partner attempts to protect the Partnership from the burden of inflation-related increases in expenses by increasing rents and maintaining a high overall occupancy level. However, due to changing market conditions, which can result in the use of rental concessions and rental reductions to offset softening market conditions, there is no guarantee that the Managing General Partner will be able to sustain such a plan. Liquidity and Capital Resources At March 31, 2002, the Partnership had cash and cash equivalents of approximately $772,000 as compared to approximately $1,056,000 at March 31, 2001. Cash and cash equivalents increased approximately $29,000 since December 31, 2001 primarily due to approximately $2,792,000 of cash provided by financing activities and approximately $193,000 of cash provided by operating activities partially offset by approximately $2,956,000 of cash used in investing activities. Cash provided by financing activities consisted of advances from the Managing General Partner and additional proceeds from refinancing the mortgage note encumbering Reflections Apartments partially offset by principal payments on the mortgages encumbering the Partnership's properties and additional loan costs paid. Cash used in investing activities consisted of property improvements and replacements and net deposits to restricted escrow accounts. The Partnership invests its working capital reserves in interest bearing accounts. The sufficiency of existing liquid assets to meet future liquidity and capital expenditure requirements is directly related to the level of capital expenditures required at the various properties to adequately maintain the physical assets and other operating needs of the Partnership and to comply with Federal, state, and local legal and regulatory requirements. Capital improvements planned for each of the Registrant's properties are detailed below. Big Walnut Apartments: The property has budgeted, but is not limited to, capital improvements of approximately $125,000 during 2002 which consists of structural improvements, appliance replacements, and floor covering replacements. The Partnership has completed approximately $31,000 in capital expenditures at Big Walnut Apartments as of March 31, 2002 consisting primarily of floor covering replacements. These improvements were funded primarily from operating cash flow. LaFontenay I & II Apartments: The property has budgeted, but is not limited to, capital improvements of approximately $84,000 during 2002 which consists of floor covering and appliance replacements, painting and HVAC replacements. The Partnership has completed approximately $56,000 in capital expenditures at LaFontenay I & II Apartments as of March 31, 2002, consisting primarily of roof replacements, natural gas enhancements, plumbing fixtures and floor covering replacements. These improvements were funded from operating cash flow and replacement reserves. The Trails: The property has budgeted, but is not limited to, capital improvements of approximately $82,000 during 2002 which consists of swimming pool improvements, floor covering, appliance and water heater replacements and major landscaping. The Partnership has completed approximately $10,000 in capital expenditures at The Trails Apartments as of March 31, 2002, consisting primarily of floor covering replacements. These improvements were funded from operating cash flow. Reflections: In January 2001, the Managing General Partner refinanced the mortgage encumbering this property. The proceeds are being used to fund the rehabilitation project for this property with an anticipated completion in September 2002. The Managing General Partner is currently evaluating the capital spending required to complete the rehabilitation project during 2002. The Partnership has completed approximately $1,970,000 in capital expenditures at Reflections Apartments during the three months ended March 31, 2002, consisting primarily of architect and consultant fees, development services, furniture and fixtures, and structural improvements. These improvements were funded primarily from refinancing proceeds and operating cash flow. The additional capital expenditures will be incurred only if cash is available from operations or from Partnership reserves. To the extent that such budgeted capital improvements are completed, the Registrant's distributable cash flow, if any, may be adversely affected at least in the short term. The Registrant's current assets are thought to be sufficient for any near-term needs (exclusive of capital improvements) of the Registrant. The mortgage indebtedness of approximately $25,984,000, net of discount, is amortized over varying periods with required balloon payments ranging from November 15, 2002 to December 1, 2009. The Managing General Partner will attempt to refinance such indebtedness and/or sell the properties prior to such maturity dates. If the properties cannot be refinanced or sold for a sufficient amount, the Registrant will risk losing such properties through foreclosure. On January 16, 2001, the mortgages encumbering Reflections Apartments were refinanced in order to finance the rehabilitation of the property. The maximum new loan amount is $13,600,000. Effective January 16, 2001, the lender made an initial advance of $5,040,000. Prior to the initial advance, the Managing General Partner loaned the Partnership approximately $3,673,000 in order for the Partnership to close the refinancing of the property. This amount will be repaid from the further refinancing that will occur after the completion of the rehabilitation project, estimated to be September 2002. During the year ended December 31, 2001, the lender advanced Reflections Apartments an additional amount of approximately $3,845,000 and during the three months ended March 31, 2002 the lender advanced Reflections Apartments an additional $1,737,000. Subsequent advances of up to $2,978,000 will also be made to cover renovation work that is needed at the property. The new loan matures in January 2004, with 2 one-year extension options. Interest payments started in February 2001 based on LIBOR plus 280 basis points (4.63% at March 31, 2002). Due to the rehabilitation project, approximately $174,000 and $43,000 of the interest expense for the three months ended March 31, 2002 and 2001, respectively, was capitalized. In addition, monthly cash flow payments will be made to the lender until the anticipated completion date of the renovations. If any amount remains from these advances on the completion date of the renovation, it will be applied to the principal balance. Principal payments will begin in February 2003, and monthly deposits into a replacement reserve will be required. In connection with the refinancing, the Partnership incurred loan costs of approximately $469,000 during the year ended December 31, 2001. Additional loan costs of approximately $19,000 were incurred during the three months ended March 31, 2002. These loan costs are included in other assets in the accompanying consolidated balance sheet and are being amortized over the life of the mortgage. In connection with the refinancing, the assets and liabilities of the property were transferred from one subsidiary, Big Walnut L.P., to a newly formed subsidiary, AIMCO Greensprings L.P. The loan is collateralized by the property as well as the interest of both the Partnership and Davidson Diversified Properties, Inc. in AIMCO Greensprings L.P. The new mortgage replaced a first mortgage of approximately $7,518,000 and a second mortgage of approximately $294,000. The Partnership recognized an extraordinary loss on the early extinguishment of debt of approximately $554,000 consisting of a prepayment penalty of approximately $359,000 and the write-off of unamortized loan costs and mortgage discounts of approximately $195,000. Pursuant to the Partnership Agreement, the term of the Partnership is scheduled to expire on December 31, 2008. Accordingly, prior to such date the Partnership will need to either sell its investment properties or extend the term of the Partnership. No cash distributions were made during the three months ended March 31, 2002 or 2001. The Registrant's cash available for distribution is reviewed on a monthly basis. Future cash distributions will depend on the levels of net cash generated from operations, the availability of cash reserves, and the timing of debt maturities, refinancings and/or property sales. In light of the rehabilitation project at Reflections and the significant amounts accrued to the Managing General Partner at March 31, 2002, it is not anticipated that the Partnership will make distributions in the foreseeable future. In addition, the Partnership may be restricted from making distributions by the requirement to deposit net operating income (as defined in the mortgage note) into the reserve account until the reserve account is funded in an amount equal to a minimum of $400 and a maximum of $1,000 per apartment unit for Big Walnut Apartments for a total of approximately $100,000 to $251,000. As of March 31, 2002, the reserve account balance was approximately $251,000 for Big Walnut Apartments. In addition to its indirect ownership of the managing and associate general partner interest in the Partnership, AIMCO and its affiliates currently own 610.25 limited partnership units in the Partnership representing 49.85% of the outstanding units. A number of these units were acquired pursuant to tender offers made by AIMCO or its affiliates. It is possible that AIMCO or its affiliates will acquire additional limited partnership interests in the Partnership for cash or in exchange for units in the operating partnership of AIMCO either through private purchases or tender offers. Under the Partnership Agreement, unitholders holding a majority of the units are entitled to take action with respect to a variety of matters which would include voting on certain amendments to the Partnership Agreement and voting to remove the Managing General Partner. As a result of its ownership of 49.85% of the outstanding units, AIMCO is in a position to significantly influence all voting decisions with respect to the Registrant. When voting on matters, AIMCO would in all likelihood vote the units it acquired in a manner favorable to the interest of the Managing General Partner because of its affiliation with the Managing General Partner. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In March 1998, several putative unit holders of limited partnership units of the Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia Financial Group, Inc., et al. (the "Nuanes action") in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, its Managing General Partner and several of their affiliated partnerships and corporate entities. The action purports to assert claims on behalf of a class of limited partners and derivatively on behalf of a number of limited partnerships (including the Partnership) which are named as nominal defendants, challenging, among other things, the acquisition of interests in certain Managing General Partner entities by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia; past tender offers by the Insignia affiliates to acquire limited partnership units; management of the partnerships by the Insignia affiliates; and the series of transactions which closed on October 1, 1998 and February 26, 1999 whereby Insignia and Insignia Properties Trust, respectively, were merged into AIMCO. The plaintiffs seek monetary damages and equitable relief, including judicial dissolution of the Partnership. On June 25, 1998, the Managing General Partner filed a motion seeking dismissal of the action. In lieu of responding to the motion, the plaintiffs filed an amended complaint. The Managing General Partner filed demurrers to the amended complaint which were heard February 1999. Pending the ruling on such demurrers, settlement negotiations commenced. On November 2, 1999, the parties executed and filed a Stipulation of Settlement, settling claims, subject to court approval, on behalf of the Partnership and all limited partners who owned units as of November 3, 1999. Preliminary approval of the settlement was obtained on November 3, 1999 from the Court, at which time the Court set a final approval hearing for December 10, 1999. Prior to the December 10, 1999 hearing, the Court received various objections to the settlement, including a challenge to the Court's preliminary approval based upon the alleged lack of authority of prior lead counsel to enter the settlement. On December 14, 1999, the Managing General Partner and its affiliates terminated the proposed settlement. In February 2000, counsel for some of the named plaintiffs filed a motion to disqualify plaintiff's lead and liaison counsel who negotiated the settlement. On June 27, 2000, the Court entered an order disqualifying them from the case and an appeal was taken from the order on October 5, 2000. On December 4, 2000, the Court appointed the law firm of Lieff Cabraser Heimann & Bernstein LLP as new lead counsel for plaintiffs and the putative class. Plaintiffs filed a third amended complaint on January 19, 2001. On March 2, 2001, the Managing General Partner and its affiliates filed a demurrer to the third amended complaint. On May 14, 2001, the Court heard the demurrer to the third amended complaint. On July 10, 2001, the Court issued an order sustaining defendants' demurrer on certain grounds. On July 20, 2001, Plaintiffs filed a motion for reconsideration of the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer. On September 7, 2001, Plaintiffs filed a fourth amended class and derivative action complaint. On September 12, 2001, the Court denied Plaintiffs' motion for reconsideration. On October 5, 2001, the Managing General Partner and affiliated defendants filed a demurrer to the fourth amended complaint, which was heard on December 11, 2001. On February 2, 2002, the Court served its order granting in part the demurrer. The Court has dismissed without leave to amend certain of the plaintiffs' claims. On February 11, 2002, plaintiffs filed a motion seeking to certify a putative class comprised of all non-affiliated persons who own or have owned units in the partnerships. The Managing General Partner and affiliated defendants oppose the motion. On April 29, 2002, the Court heard argument on the motion and ordered further briefing after which time the matter will be taken under submission. The Court has set the matter for trial in January 2003. During the third quarter of 2001, a complaint (the "Heller action") was filed against the same defendants that are named in the Nuanes action, captioned Heller v. Insignia Financial Group. On or about August 6, 2001, plaintiffs filed a first amended complaint. The first amended complaint in the Heller action is brought as a purported derivative action, and asserts claims for among other things breach of fiduciary duty; unfair competition; conversion, unjust enrichment; and judicial dissolution. Plaintiffs in the Nuanes action filed a motion to consolidate the Heller action with the Nuanes action and stated that the Heller action was filed in order to preserve the derivative claims that were dismissed without leave to amend in the Nuanes action by the Court order dated July 10, 2001. On October 5, 2001, the Managing General Partner and affiliated defendants moved to strike the first amended complaint in its entirety for violating the Court's July 10, 2001 order granting in part and denying in part defendants' demurrer in the Nuanes action, or alternatively, to strike certain portions of the complaint based on the statute of limitations. Other defendants in the action demurred to the fourth amended complaint, and, alternatively, moved to strike the complaint. On December 11, 2001, the court heard argument on the motions and took the matters under submission. On February 4, 2002, the Court served notice of its order granting defendants' motion to strike the Heller complaint as a violation of its July 10, 2001 order in the Nuanes action. On March 27, 2002, the plaintiffs filed a notice appealing the order striking the complaint. The Managing General Partner does not anticipate that any costs, whether legal or settlement costs, associated with these cases will be material to the Partnership's overall operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits None. b) Reports on Form 8-K: None filed during the quarter ended March 31, 2002. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. By: Davidson Diversified Properties, Inc. Its Managing General Partner By: /s/Patrick J. Foye Patrick J. Foye Executive Vice President By: /s/Martha L. Long Martha L. Long Senior Vice President and Controller Date: