-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GLbDES5aLh5vLmRFR8zM4ndqZx+STuz3v2UOyENBVCehBf4VfzTN4waAwJvFIXJh zgG+vSQtG4w1nQ6hApwVRA== 0000711642-99-000165.txt : 19990806 0000711642-99-000165.hdr.sgml : 19990806 ACCESSION NUMBER: 0000711642-99-000165 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990805 FILER: COMPANY DATA: COMPANY CONFORMED NAME: DAVIDSON DIVERSIFIED REAL ESTATE II LIMITED PARTNERSHIP CENTRAL INDEX KEY: 0000750258 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE [6500] IRS NUMBER: 621207077 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-14483 FILM NUMBER: 99678180 BUSINESS ADDRESS: STREET 1: 1873 SOUTH BELLAIRE STREET STREET 2: 17TH FLOOR CITY: DENVER STATE: CO ZIP: 80222 BUSINESS PHONE: 3037578101 MAIL ADDRESS: STREET 1: 1873 SOUTH BELLAIRE STREET STREET 2: 17TH FLOOR CITY: DENVER STATE: CO ZIP: 80222 FORMER COMPANY: FORMER CONFORMED NAME: FREEMAN DIVERSIFIED REAL ESTATE II LP DATE OF NAME CHANGE: 19910501 10QSB 1 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 June 30, 1999 [ ] 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 (IRS 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 (in thousands, except unit data) (Unaudited) June 30, 1999 Assets Cash and cash equivalents $ 1,186 Receivables and deposits, net of $119 for doubtful accounts 645 Restricted escrows 542 Other assets 487 Investment properties: Land $ 2,878 Buildings and related personal property 43,200 46,078 Less accumulated depreciation (24,123) 21,955 $ 24,815 Liabilities and Partners' Deficit Liabilities Accounts payable $ 236 Tenant security deposit liabilities 187 Accrued property taxes 505 Other liabilities 592 Mortgage notes payable 25,903 Partners' Deficit General partners' $ (487) Limited partners' (1,224.25 units issued and outstanding) (2,121) (2,608) $ 24,815 See Accompanying Notes to Consolidated Financial Statements b) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except unit data) (Unaudited) Three Months Ended Six Months Ended June 30, June 30, 1999 1998 1999 1998 Revenues: Rental income $ 2,021 $ 2,055 $ 4,168 $ 3,966 Other income 189 198 374 381 Gain on casualty event -- 216 -- 216 Total revenues 2,210 2,469 4,542 4,563 Expenses: Operating 1,045 1,147 2,078 2,108 General and administrative 75 87 163 168 Depreciation 514 502 1,033 997 Interest 543 563 1,106 1,130 Property taxes 133 199 324 397 Loss on disposal of property -- 17 -- 181 Total expenses 2,310 2,515 4,704 4,981 Net loss $ (100) $ (46) $ (162) $ (418) Net loss allocated to general partners (2%) $ (2) $ (1) $ (3) $ (8) Net loss allocated to limited partners (98%) (98) (45) (159) (410) $ (100) $ (46) $ (162) $ (418) Net loss per limited partnership unit $ (80.05) $ (36.76) $(129.88) $(334.90) See Accompanying Notes to Consolidated Financial Statements c) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT (in thousands, except unit data) (Unaudited) Limited Partnership General Limited Units Partners Partners' Total Original capital contributions 1,224.25 $ 1 $24,485 $24,486 Partners' deficit at December 31, 1998 1,224.25 $(484) $(1,962) $(2,446) Net loss for the six months ended June 30, 1999 -- (3) (159) (162) Partners' deficit at June 30, 1999 1,224.25 $(487) $(2,121) $(2,608) See Accompanying Notes to Consolidated Financial Statements d) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited) Six Months Ended June 30, 1999 1998 Cash flows from operating activities: Net loss $ (162) $ (418) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 1,033 997 Amortization of discounts, loan costs and leasing commissions 121 111 Loss on disposal of property -- 181 Gain on casualty event -- (216) Change in accounts: Receivables and deposits 169 304 Other assets (54) 29 Accounts payable 2 250 Tenant security deposit liabilities (1) (3) Accrued property taxes (192) (163) Other liabilities 94 55 Net cash provided by operating activities 1,010 1,127 Cash flows from investing activities: Property improvements and replacements (473) (1,048) Net withdrawals from (deposits to) restricted escrows 70 (35) Net insurance proceeds from casualty event -- 225 Net cash used in investing activities (403) (858) Cash flows from financing activities: Payments on mortgage notes payable (392) (366) Net cash used in financing activities (392) (366) Net increase (decrease) in cash and cash equivalents 215 (97) Cash and cash equivalents at beginning of period 971 885 Cash and cash equivalents at end of period $ 1,186 $ 788 Supplemental disclosure of cash flow information: Cash paid for interest $ 992 $ 1,023 See Accompanying Notes to Consolidated Financial Statements 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 "Registrant" or "Partnership") 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. ("Managing General Partner"), all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 1999, are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 1999. 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, 1998. Principles of Consolidation The consolidated financial statements include all the accounts of the Partnership and its three 99.9% owned partnerships. The Managing General Partner of the consolidated partnerships is Davidson Diversified Properties, Inc. Davidson Diversified Properties, Inc. may be removed by the Registrant; therefore, the consolidated partnerships are controlled and consolidated by the Registrant. All significant interpartnership balances have been eliminated. NOTE B - TRANSFER OF CONTROL Pursuant to a series of transactions which closed on October 1, 1998 and February 26, 1999, Insignia Financial Group, Inc. and Insignia Properties Trust merged into Apartment Investment and Management Company ("AIMCO"), a publicly traded real estate investment trust with AIMCO being the surviving corporation (the "Insignia Merger"). As a result, AIMCO acquired 100% ownership interest in the Managing General Partner. The Managing General Partner does not believe that this transaction will have a material effect on the affairs and operations of the Partnership. NOTE C - 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 certain payments to affiliates for services and as reimbursement of certain expenses incurred by affiliates on behalf of the Partnership. The following payments were paid or accrued to the Managing General Partner and affiliates during the six months ended June 30, 1999 and 1998: 1999 1998 (in thousands) Property management fees (included in operating expense) $207 $215 Reimbursement for services of affiliates, (included in operating and general and administrative expense and investment properties) (1) 114 197 Due to affiliate 226 20 (1) Included in "Reimbursement for services of affiliates" for the six months ended June 30, 1999 and 1998, is approximately $30,000 and $78,000, respectively, in reimbursements for construction oversight costs. Additionally, the Partnership paid approximately $2,000, during the six months ended June 30, 1998 to an affiliate of the Managing General Partner for lease commissions at the Partnership's commercial property. These lease commissions are included in other assets and are amortized over the terms of the respective leases. No lease commissions were paid to an affiliate during the six months ended June 30, 1999. During the six months ended June 30, 1999 and 1998, affiliates of the Managing General Partner were entitled to receive 5% of gross receipts from all of the Registrant's residential properties for providing property management services. The Registrant paid to such affiliates approximately $207,000 and $195,000 for the six months ended June 30, 1999 and 1998, respectively. For the six months ended June 30, 1998, affiliates of the Managing General Partner were entitled to varying percentages of gross receipts from the Registrant's commercial property for providing property management services. The Registrant paid to such affiliates approximately $20,000 for the six months ended June 30, 1998. No fees were paid for the six months ended June 30, 1999 as these services were provided by an unrelated party effective October 1, 1998. An affiliate of the Managing General Partner was entitled to receive reimbursement of accountable administrative expenses amounting to approximately $114,000 and $197,000 for the six months ended June 30, 1999 and 1998, respectively. The current fees and a portion of the prior years fees for the whole year were not able to be paid due to the Partnership's cashflow. Accordingly, as of June 30, 1999, a liability of approximatley $226,000 exists and is reflected in other liabilities. On September 26, 1997, an affiliate of the Managing General Partner purchased Lehman Brothers' class "D" subordinated bonds of SASCO, 1992-M1. These bonds are secured by 55 multi-family apartment mortgage loan pairs held in Trust, including Big Walnut Apartments and Greensprings Manor Apartments owned by the Partnership. NOTE D - SEGMENT REPORTING Description of the types of products and services from which the reportable segment derives its revenue: The Partnership has two reportable segments: residential properties and commercial properties. The Partnership's residential property segment consists of four apartment complexes located in Ohio, Kentucky, Tennessee, and Indiana. The Partnership rents apartment units to tenants for terms that are typically twelve months or less. The commercial property segment consists of a retail shopping center located in Murfreesboro, Tennessee. This property leases space mainly to name brand outlet clothing stores at terms ranging from nine months to four years. Measurement of segment profit or loss: The Partnership evaluates performance based on net income. The accounting policies of the reportable segments are the same as those of the Partnership as described in the Partnership's annual report on Form 10-KSB for the year ended December 31, 1998. Factors management used to identify the enterprise's reportable segment: The Partnership's two reportable segments are investment properties that offer different products and services. The reportable segments are each managed separately because they provide distinct services with different types of products and customers. Segment information for the six months ended June 30, 1999 and 1998 is shown in the tables below. The "Other" column includes partnership administration related items and income and expense not allocated to reportable segments. 1999 RESIDENTIAL COMMERCIAL OTHER TOTAL Rental income $3,828 $ 340 $ -- $ 4,168 Other income 277 89 8 374 Interest expense 1,024 82 -- 1,106 Depreciation 864 169 -- 1,033 General and administrative expense -- -- 163 163 Segment profit (loss) 59 (66) (155) (162) Total assets 20,858 3,381 576 24,815 Capital expenditures for investment properties 462 11 -- 473 1998 RESIDENTIAL COMMERCIAL OTHER TOTAL Rental income $ 3,487 $ 479 $ -- $ 3,966 Other income 274 96 11 381 Interest expense 1,044 86 -- 1,130 Depreciation 810 187 -- 997 General and administrative expense -- -- 168 168 Gain on casualty event 216 -- -- 216 Loss on disposal of property 181 -- -- 181 Segment loss (171) (90) (157) (418) Total assets 21,784 3,681 487 25,952 Capital expenditures for investment properties 1,044 4 -- 1,048 NOTE E - CASUALTY EVENT In December 1997, a fire destroyed one building at The Trails Apartments. As a result, the asset and related accumulated depreciation were written off in 1997. At December 31, 1997, the proceeds received on the casualty approximated the loss on write-off of the fire-damaged asset, with the difference of approximately $9,000 being recorded as an insurance receivable. Therefore, no gain or loss relating to this fire was recognized in 1997. At June 30, 1998, reconstruction of the destroyed building was ongoing, with the costs reflected in investment properties as construction-in-process. The Partnership recognized a casualty gain of approximately $216,000 in 1998, with insurance proceeds received totaling $225,000. NOTE F - 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. in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, the Managing General Partner and several of their affiliated partnerships and corporate entities. The complaint 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 the acquisition by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia ("Insignia Affiliates") of interests in certain general partner entities, past tender offers by Insignia Affiliates to acquire limited partnership units, the management of partnerships by Insignia Affiliates as well as a recently announced agreement between Insignia and Apartment Investment and Management Company ("AIMCO"). The complaint seeks 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 has filed demurrers to the amended complaint which were heard during February 1999. No ruling on such demurrers has been received. The Managing General Partner does not anticipate that costs associated with this case, if any, 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 OR 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 the other filings with the Securities and Exchange Commission made by the Registrant from time to time. The discussions 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 and one commercial property. The following table sets forth the average occupancy of the properties for the six months ended June 30, 1999 and 1998: Average Occupancy 1999 1998 Big Walnut Apartments 91% 94% Columbus, Ohio LaFontenay I & II Apartments 91% 90% Louisville, Kentucky The Trails Apartments 94% 91% Nashville, Tennessee Greensprings Manor Apartments 93% 84% Indianapolis, Indiana Shoppes At River Rock 75% 66% (Formerly Outlet's Ltd. Mall) Murfreesboro, Tennessee The Managing General Partner attributes the decrease in occupancy at Big Walnut Apartments to deferred maintenance that needs to be performed at the property. The Managing General Partner has budgeted capital improvements for 1999 to help improve the property. The increase in occupancy at The Trails Apartments and Greensprings Manor Apartments is attributed to an aggressive and effective marketing campaign during the last part of 1998 and into the first and second quarters of 1999. The increase in occupancy at Shoppes at River Rock is attributed to new tenants moving in during the six months ended June 30, 1999. For the six months ended June 30, 1998, the property had a low occupancy rate due to the loss of a major tenant in 1997. Management is continuing to explore alternative concepts for repositioning the shopping center in an attempt to fill its vacancies and improve occupancy. Results of Operations The Registrant's net loss for the three and six months ended June 30, 1999 was approximately $100,000 and $162,000, respectively, as compared to approximately $46,000 and $418,000 for the three and six months ended June 30, 1998. The increase in net loss for the three months ended June 30, 1999 was due to a decrease in total revenue, offset by a decrease in total expenses. Total revenue decreased primarily due to the fact that no gain or casualty event was recognized during the second quarter of 1999 as was recognized during the second quarter of 1998. During the second quarter of 1998 a gain on casualty event was recognized as a result of fire damage at The Trails Apartments. The decrease in net loss for the six months ended June 30, 1999 was due to a decrease in total expense, which was offset by a decrease in total revenue. The decrease in total revenue is the result of the decrease in casualty gain as discussed above. The decrease in casualty gain was offset by an increase in rental income. Rental income increased primarily due to an increase in average rental rates at all five of the Registrant's investment properties and to the increase in occupancy at LaFontenay I & II Apartments, The Trails Apartments, Greenspring Manor Apartments and Shoppes At River Rock as discussed above which more than offset the decrease in occupancy at Big Walnut Apartments. Total expenses decreased primarily due to the fact that no loss on disposal of property was recognized during the three and six months ended June 30, 1999 as was recognized during the three and six months ended June 30, 1998 and to a lesser extent due to decreases in operation, general and administrative, interest, and property expenses. During 1998 a loss on disposal of property at LaFontenay I & II Apartments was recognized due to the write-off of the undepreciated value of roofs that were replaced and a loss on disposal of property at The Trials Apartments was recognized due to the write-off to the undepreciated value of the building destroyed by fire. Also, contributing to the decrease in expenses, was insurance proceeds received during 1999 from water damage incurred due to structural deficiencies at Big Walnut Apartments and insurance proceeds received from storm damage at LaFontenay I & II Apartments. Additional expenses are expected to be incurred in the next few months as repairs are made at Big Walnut Apartments and LaFontenay I & II Apartments. Property taxes decreased due primarily to a decrease in the assessment value of Shoppes at River Rock and The Trails. The decrease in general and administrative expense is primarily attributable to a decrease in general partners reimbursement fees, which was offset by an increase in legal fees. Legal fees increased as a result of the settlement of an outstanding litigation case in the first quarter of 1999. Also included in general and administrative expenses were costs associated with the quarterly and annual communications with investors and regulatory agencies and the annual audit required by the Partnership Agreement. As part of the ongoing business plan of the Partnership, the Managing General Partner monitors the rental market environment of each of its investment properties to assess the feasibility of increasing rents, maintaining or increasing occupancy levels and protecting the Partnership from increases in expenses. 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 June 30, 1999, the Partnership had cash and cash equivalents of approximately $1,186,000 as compared to approximately $788,000 at June 30, 1998. Cash and cash equivalents increased approximately $215,000 for the six months ended June 30, 1999 from the Partnership's year end, primarily due to approximately $1,010,000 of cash provided by operating activities, which was partially offset by approximately $403,000 of cash used in investing activities and approximately $392,000 of cash used in financing activities. Cash used in financing activities consisted of payments of principal made on the mortgages encumbering the Partnership's properties. Cash used in investing activities consisted of property improvements and replacements, offset by net withdrawals from escrow accounts maintained by the mortgage lender. The Partnership invests its working capital reserves in money market 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 Based on a report received from an independent third party consultant analyzing necessary exterior improvements and estimates made by the Managing General Partner on interior improvements, it is estimated that the property requires approximately $634,000 of capital improvements over the next few years. The property has budgeted, but is not limited to, capital improvements of approximately $633,000 for 1999 which include certain of the required improvements and consist of HVAC, roofing, and electrical improvements. As of June 30, 1999, approximately $53,000 has been incurred consisting primarily of appliance and floor covering replacements, pool repairs, and roof replacement. LaFontenay I&II Apartments Based on a report received from an independent third party consultant analyzing necessary exterior improvements and estimates made by the Managing General Partner on interior improvements, it is estimated that the property requires approximately $295,000 of capital improvements over the next few years. The property has budgeted, but is not limited to, capital improvements of approximately $400,000 for 1999 which include certain of the required improvements and consist of parking lot repair, landscaping, exterior building improvements, roofing, and floor covering replacements. As of June 30, 1999, approximately $218,000 has been incurred consisting primarily of roof replacements, appliance and floor covering replacements and exterior and interior building improvements, and landscaping. The Trails Based on a report received from an independent third party consultant analyzing necessary exterior improvements and estimates made by the Managing General Partner on interior improvements, it is estimated that the property requires approximately $267,000 of capital improvements over the next few years. The property has budgeted, but is not limited to, capital improvements of approximately $304,000 for 1999 which include certain of the required improvements and consist of landscaping, electrical, clubhouse renovations, and HVAC improvements. As of June 30, 1999, approximately $66,000 has been incurred consisting primarily of clubhouse renovations and interior building improvements. Greensprings Manor Based on a report received from an independent third party consultant analyzing necessary exterior improvements and estimates made by the Managing General Partner on interior improvements, it is estimated that the property requires approximately $693,000 of capital improvements over the next few years. The property has budgeted, but is not limited to, capital improvements of approximately $693,000 for 1999, which include certain of the required improvements and consist of roofing repairs, gutters and down spouts, appliance and floor covering replacements and parking lot improvements, and exterior painting. As of June 30, 1999, approximately $125,000 has been incurred consisting primarily of appliance and floor covering replacement and interior and exterior building improvements, and land and parking lot improvements. Shoppes At River Rock Based on a report received from an independent third party consultant analyzing necessary exterior improvements and estimates made by the Managing General Partner on interior improvements, it is estimated that the property requires approximately $977,000 of capital improvements over the next few years. The property has budgeted, but is not limited to, capital improvements of approximately $249,000 for 1999 which include certain of the required improvements and consist of roof replacements, curb and gutter repairs. As of June 30, 1999, approximately $11,000 has been incurred consisting primarily of interior building improvements and gutter repairs. 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 $25,903,000, net of discount, is amortized over varying periods with required balloon payments ranging from January 15, 2000 to December 1, 2009. The Managing General Partner will attempt to refinance such indebtedness and/or sell the properties prior to such maturity date. If the properties cannot be refinanced or sold for a sufficient amount, the Registrant may risk losing such properties through foreclosure. No cash distributions were made during the six months ended June 30, 1999 or 1998. The Registrant's distribution policy is reviewed on a semi-annual 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. There can be no assurance, however, that the Registrant will generate sufficient funds from operations after planned capital expenditures to permit further distributions to its partners in 1999 or subsequent periods. Year 2000 Compliance General Description of the Year 2000 Issue and the Nature and Effects of the Year 2000 on Information Technology (IT) and Non-IT Systems The Year 2000 issue is the result of computer programs being written using two digits rather than four digits to define the applicable year. The Partnership is dependent upon the Managing General Partner and its affiliates for management and administrative services ("Managing Agent"). Any of the computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Over the past two years, the Managing Agent has determined that it will be required to modify or replace significant portions of its software and certain hardware so that those systems will properly utilize dates beyond December 31, 1999. The Managing Agent presently believes that with modifications or replacements of existing software and certain hardware, the Year 2000 issue can be mitigated. However, if such modifications and replacements are not made, or not completed in time, the Year 2000 issue could have a material impact on the operations of the Partnership. The Managing Agent's plan to resolve Year 2000 issues involves four phases: assessment, remediation, testing, and implementation. To date, the Managing Agent has fully completed its assessment of all the information systems that could be significantly affected by the Year 2000, and has begun the remediation, testing and implementation phases on both hardware and software systems. Assessments are continuing in regards to embedded systems. The status of each is detailed below. Status of Progress in Becoming Year 2000 Compliant, Including Timetable for Completion of Each Remaining Phase Computer Hardware: During 1997 and 1998, the Managing Agent identified all of the computer systems at risk and formulated a plan to repair or replace each of the affected systems. In August 1998, the main computer system used by the Managing Agent became fully functional. In addition to the main computer system, PC-based network servers, routers and desktop PCs were analyzed for compliance. The Managing Agent has begun to replace each of the non-compliant network connections and desktop PCs and, as of June 30, 1999, had completed approximately 90% of this effort. The total cost to the Managing Agent to replace the PC-based network servers, routers and desktop PCs is expected to be approximately $1.5 million of which $1.3 million has been incurred to date. The remaining network connections and desktop PCs are expected to be upgraded to Year 2000 compliant systems by September 30, 1999. The completion of this process is scheduled to coincide with the release of a compliant version of the Managing Agent's operating system. Computer Software: The Managing Agent utilizes a combination of off-the-shelf, commercially available software programs as well as custom-written programs that are designed to fit specific needs. Both of these types of programs were studied, and implementation plans written and executed with the intent of repairing or replacing any non-compliant software programs. In April, 1999 the Managing Agent embarked on a data center consolidation project that unifies its core financial systems under its Year 2000 compliant system. The estimated completion date for this project is October, 1999. During 1998, the Managing Agent began converting the existing property management and rent collection systems to its management properties Year 2000 compliant systems. The estimated additional costs to convert such systems at all properties, is $200,000, and the implementation and testing process was completed in June, 1999. The final software area is the office software and server operating systems. The Managing Agent has upgraded all non-compliant office software systems on each PC and has upgraded 90% of the server operating systems. The remaining server operating systems are planned to be upgraded to be Year 2000 compliant by September, 1999. The completion of this process is scheduled to coincide with the release of a compliant version of the Managing Agent's operating system. Operating Equipment: The Managing Agent has operating equipment, primarily at the property sites, which needed to be evaluated for Year 2000 compliance. In September 1997, the Managing Agent began taking a census and inventory of embedded systems (including those devices that use time to control systems and machines at specific properties, for example elevators, heating, ventilating, and air conditioning systems, security and alarm systems, etc.). The Managing Agent has chosen to focus its attention mainly upon security systems, elevators, heating, ventilating and air conditioning systems, telephone systems and switches, and sprinkler systems. While this area is the most difficult to fully research adequately, management has not yet found any major non-compliance issues that put the Managing Agent at risk financially or operationally. A pre-assessment of the properties by the Managing Agent has indicated no Year 2000 issues. A complete, formal assessment of all the properties by the Managing Agent is in process and will be completed in September, 1999. Any operating equipment that is found non-compliant will be repaired or replaced. The total cost incurred for all properties managed by the Managing Agent as of June 30, 1999 to replace or repair the operating equipment was approximately $75,000. The Managing Agent estimates the cost to replace or repair any remaining operating equipment is approximately $125,000. The Managing Agent continues to have "awareness campaigns" throughout the organization designed to raise awareness and report any possible compliance issues regarding operating equipment within its enterprise. Nature and Level of Importance of Third Parties and Their Exposure to the Year 2000 The Managing Agent continues to conduct surveys of its banking and other vendor relationships to assess risks regarding their Year 2000 readiness. The Managing Agent has banking relationships with three major financial institutions, all of which have indicated their compliance efforts will be complete before July, 1999. The Managing Agent has updated data transmission standards with all of the financial institutions. The Managing Agent's contingency plan in this regard is to move accounts from any institution that cannot be certified Year 2000 compliant by September 1, 1999. The Partnership does not rely heavily on any single vendor for goods and services, and does not have significant suppliers and subcontractors who share information systems (external agent). To date the Partnership is not aware of any external agent with a Year 2000 compliance issue that would materially impact the Partnership's results of operations, liquidity, or capital resources. However, the Partnership has no means of ensuring that external agents will be Year 2000 compliant. The Managing Agent does not believe that the inability of external agents to complete their Year 2000 remediation process in a timely manner will have a material impact on the financial position or results of operations of the Partnership. However, the effect of non-compliance by external agents is not readily determinable. Costs to Address Year 2000 The total cost of the Year 2000 project to the Managing Agent is estimated at $3.5 million and is being funded from operating cash flows. To date, the Managing Agent has incurred approximately $2.9 million ($0.7 million expensed and $2.2 million capitalized for new systems and equipment) related to all phases of the Year 2000 project. Of the total remaining project costs, approximately $0.5 million is attributable to the purchase of new software and operating equipment, which will be capitalized. The remaining $0.2 million relates to repair of hardware and software and will be expensed as incurred. The Partnership's portion of these costs are not material. Risks Associated with the Year 2000 The Managing Agent believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, the Managing Agent has not yet completed all necessary phases of the Year 2000 program. In the event that the Managing Agent does not complete any additional phases, certain worst case scenarios could occur. The worst case scenarios could include elevators, security and heating, ventilating and air conditioning systems that read incorrect dates and operate with incorrect schedules (e.g., elevators will operate on Monday as if it were Sunday). Although such a change would be annoying to residents, it is not business critical. In addition, disruptions in the economy generally resulting from Year 2000 issues could also adversely affect the Partnership. The Partnership could be subject to litigation for, among other things, computer system failures, equipment shutdowns or failure to properly date business records. The amount of potential liability and lost revenue cannot be reasonably estimated at this time. Contingency Plans Associated with the Year 2000 The Managing Agent has contingency plans for certain critical applications and is working on such plans for others. These contingency plans involve, among other actions, manual workarounds and selecting new relationships for such activities as banking relationships and elevator operating systems. 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. in the Superior Court of the State of California for the County of San Mateo. The plaintiffs named as defendants, among others, the Partnership, the Managing General Partner and several of their affiliated partnerships and corporate entities. The complaint 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 the acquisition by Insignia Financial Group, Inc. ("Insignia") and entities which were, at one time, affiliates of Insignia ("Insignia Affiliates") of interests in certain general partner entities, past tender offers by Insignia Affiliates to acquire limited partnership units, the management of partnerships by Insignia Affiliates as well as a recently announced agreement between Insignia and Apartment Investment and Management Company ("AIMCO"). The complaint seeks 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 has filed demurrers to the amended complaint which were heard during February 1999. No ruling on such demurrers has been received. The Managing General Partner does not anticipate that costs associated with this case, if any, will be material to the Partnership's overall operations. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits: Exhibit 27, Financial Data Schedule, is filed as an exhibit to this report. b) Reports on Form 8-K: None filed during the quarter ended June 30, 1999. 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., Managing General Partner By: /s/Patrick J. Foye Patrick J. Foye Executive Vice President By: /s/Carla R. Stoner Carla R. Stoner Senior Vice President Finance and Administration Date: EX-27 2
5 This schedule contains summary financial information extracted from Davidson Diversified Real Estate II, L.P. Second Quarter 10-QSB and is qualified in its entirety by reference to such 10-QSB filing. 0000750258 DAVIDSON DIVERSIFIED REAL ESTATE II L.P. 1,000 6-MOS DEC-31-1999 JUN-30-1999 1,186 0 645 0 0 0 46,078 24,123 24,815 0 25,903 0 0 0 (2,608) 24,815 0 4,542 0 0 4,704 0 1,106 0 0 0 0 0 0 (162) (129.88) 0 Registrant has an unclassified balance sheet. Multiplier is 1.
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