-----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, M1rs0h04Vi+mWweAgZohMhME/7cbJItbnKrMaukUd2Ss9gwpPb0/c8aJ87ymXbBa gv53KEZSjXOVshOhL+GsTQ== 0000711642-99-000267.txt : 19991115 0000711642-99-000267.hdr.sgml : 19991115 ACCESSION NUMBER: 0000711642-99-000267 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 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: 99746945 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 September 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 (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) September 30, 1999 Assets Cash and cash equivalents $ 1,387 Receivables and deposits, net of $135 for doubtful accounts 739 Restricted escrows 542 Other assets 490 Investment properties: Land $ 2,878 Buildings and related personal property 42,909 45,787 Less accumulated depreciation (24,601) 21,186 $ 24,344 Liabilities and Partners' Deficit Liabilities Accounts payable $ 508 Tenant security deposit liabilities 181 Accrued property taxes 687 Other liabilities 593 Mortgage notes payable 25,744 Partners' Deficit General partners $ (502) Limited partners (1224.25 units issued and outstanding) (2,867) (3,369) $ 24,344 See Accompanying Notes to Consolidated Financial Statements b) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (in thousands, except unit data) Three Months Ended Nine Months Ended September 30, September 30, 1999 1998 1999 1998 Revenues: Rental income $ 2,065 $ 2,032 $ 6,233 $ 5,998 Other income 148 184 522 565 Gain on casualty event -- -- -- 216 Total revenues 2,213 2,216 6,755 6,779 Expenses: Operating 1,012 1,314 3,090 3,422 General and administrative 85 86 248 254 Depreciation 478 498 1,511 1,495 Interest 555 559 1,661 1,689 Property taxes 184 198 508 595 Impairment loss on property held for investment 660 -- 660 -- Loss on disposal of property -- 17 -- 198 Total expenses 2,974 2,672 7,678 7,653 Net loss $ (761) $ (456) $ (923) $ (874) Net loss allocated to general partners (2%) (15) (9) (18) (17) Net loss allocated to limited partners (98%) (746) (447) (905) (857) $ (761) $ (456) $ (923) $ (874) Net loss per limited partnership unit $(609.35) $(365.12) $(739.23) $(700.02) See Accompanying Notes to Consolidated Financial Statements c) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT (Unaudited) Limited Partnership General Limited Units Partner 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 nine months ended September 30, 1999 -- (18) (905) (923) Partners' deficit at September 30, 1999 1,224.25 $ (502) $(2,867) $(3,369) See Accompanying Notes to Consolidated Financial Statements d) DAVIDSON DIVERSIFIED REAL ESTATE II, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) Nine Months Ended September 30, 1999 1998 Cash flows from operating activities: Net loss $ (923) $ (874) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation 1,511 1,495 Amortization of discounts, loan costs and leasing commissions 180 168 Impairment loss on property held for investment 660 -- Loss on disposal of property -- 198 Gain on casualty event -- (216) Change in accounts: Receivables and deposits 75 127 Other assets (76) (54) Accounts payable 274 140 Tenant security deposit liabilities (7) (2) Accrued property taxes (10) 35 Other liabilities 95 136 Net cash provided by operating activities 1,779 1,153 Cash flows used in investing activities: Property improvements and replacements (842) (1,291) Net withdrawals from restricted escrows 70 228 Net insurance proceeds from casualty event -- 225 Net cash used in investing activities (772) (838) Cash flows from financing activities: Payments on mortgage notes payable (591) (555) Net increase (decrease) in cash and cash equivalents 416 (240) Cash and cash equivalents at beginning of period 971 885 Cash and cash equivalents at end of period $ 1,387 $ 645 Supplemental disclosure of cash flow information: Cash paid for interest $ 1,491 $ 1,528 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 and nine month periods ended September 30, 1999 are not necessarily indicative of the results that may be expected for the 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 Registrant's 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 inter-partnership 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 nine months ended September 30, 1999 and 1998: 1999 1998 (in thousands) Property management fees (included in operating expenses) $308 $323 Reimbursement for services of affiliates (included in general and administrative expenses, other assets and investment properties) 173 309 Due to affiliates 226 81 During the nine months ended September 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 $308,000 and $292,000 for the nine months ended September 30, 1999 and 1998, respectively. For the nine months ended September 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 $31,000 for the nine months ended September 30, 1998. No such fees were paid for the nine months ended September 30, 1999 as these services were provided by an unrelated third party effective October 1, 1998. An affiliate of the Managing General Partner was entitled to receive reimbursement of accountable administrative expenses amounting to approximately $135,000 and $178,000 for the nine months ended September 30, 1999 and 1998, respectively. A portion of both the current fees and the prior year fees were not able to be paid due to the Partnership's cash flow. Accordingly, as of September 30, 1999, a liability of approximately $226,000 exists and is reflected in other liabilities. Also included in reimbursements for services for the nine months ended September 30, 1999 and 1998, is approximately $38,000 and $91,000, respectively, in reimbursements for construction oversight costs. Additionally, the Partnership paid approximately $40,000, during the nine months ended September 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 nine months ended September 30, 1999. 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. During September 1998, an affiliate of the Managing General Partner (the "Purchaser") commenced a tender offer for limited partnership interests in the Partnership. The Purchaser offered to purchase up to 400 of the outstanding units of limited partnership interest in the Partnership at $6,000 per Unit, net to the seller in cash. During November 1998, the tender offer was completed and the Purchaser acquired 135.5 units of limited partnership interest at $6,000 per Unit in the Partnership or approximately 11.07% of the total outstanding units. As a result, AIMCO and its affiliates currently own 170.0 units of limited partnership interest in the Partnership representing 13.89% of the total outstanding units. It is possible that AIMCO or its affiliate will make one or more additional offers to acquire additional limited partnership interests in the Partnership for cash or in exchange for units in the operating partnership of AIMCO. During August 1999, AIMCO Properties, L.P., an affiliate of the General Partner commenced a tender offer to purchase up to 479.03 (approximately 39.12% of the total outstanding units) units of limited partnership interest in the Partnership for a purchase price of $2,899 per unit. The offer expired on September 16, 1999. Pursuant to the offer, AIMCO Properties, L.P. acquired 34.5 units. As a result AIMCO and its affiliates currently own 197.5 units of limited partnership interest in the Partnership representing approximately 16.13% of the total outstanding units. It is possible that AIMCO or its affiliates will make one or more additional offers to acquire additional limited partnership interests in the Partnership for cash or in exchange for units in the operating partnership of AIMCO. (See "Note G - Legal Proceedings). 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 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 segment 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 nine months ended September 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 the reportable segment. 1999 RESIDENTIAL COMMERCIAL OTHER TOTALS (in thousands) Rental income $ 5,711 $ 522 $ -- $ 6,233 Other income 392 118 12 522 Interest expense 1,538 123 -- 1,661 Depreciation 1,257 254 -- 1,511 General and administrative expense -- -- 248 248 Impairment loss on property held for investment -- 660 -- 660 Segment profit (loss) 96 (783) (236) (923) Total assets 21,113 2,632 599 24,344 Capital expenditures for investment properties 831 11 -- 842 1998 RESIDENTIAL COMMERCIAL OTHER TOTALS (in thousands) Rental income $ 5,287 $ 711 $ -- $ 5,998 Other income 401 147 17 565 Interest expense 1,561 128 -- 1,689 Depreciation 1,215 280 -- 1,495 General and administrative expense -- -- 254 254 Gain on casualty event 216 -- -- 216 Loss on disposal of property 198 -- -- 198 Segment loss (519) (118) (237) (874) Total assets 21,410 3,677 428 25,515 Capital expenditures for investment properties 1,291 -- -- 1,291 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 - IMPAIRMENT LOSS ON PROPERTY HELD FOR INVESTMENT In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Partnership records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. During the three months ended September 30, 1999, the Partnership determined that the Shoppes at River Rock located in Murfreesboro, Tennessee with a carrying value of approximately $2,988,000, was impaired and its value was written down by approximately $660,000 to reflect its fair value at September 30, 1999 of approximately $2,328,000. The fair value was based upon current economic conditions and projected future operational cash flows. NOTE G - 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 and the Insignia Merger (see "Note B - Transfer of Control"). 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 have 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 ("Stipulation"), settling claims, subject to final court approval, on behalf of the Partnership and all limited partners who own units as of November 3, 1999. The Court has preliminarily approved the Settlement and scheduled a final approval hearing for December 10, 1999. In exchange for a release of all claims, the Stipulation provides that, among other things, an affiliate of the Managing General Partner will make tender offers for all outstanding limited partnership interests in 49 partnerships, including the Registrant, subject to the terms and conditions set forth in the Stipulation, and has agreed to establish a reserve to pay an additional amount in settlement to qualifying class members (the "Settlement Fund"). At the final approval hearing, Plaintiffs' counsel will make an application for attorneys' fees and reimbursement of expenses, to be paid in part by the partnerships and in part from the Settlement Fund. The Managing General Partner does not anticipate that costs associated with this case 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 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 nine months ended September 30, 1999 and 1998: Average Occupancy 1999 1998 Big Walnut Apartments Columbus, Ohio 92% 94% LaFontenay I & II Apartments Louisville, Kentucky 92% 92% The Trails Apartments Nashville, Tennessee 95% 92% Greensprings Manor Apartments Indianapolis, Indiana 91% 85% Shoppes At River Rock (Formerly Outlet's Ltd. Mall) Murfreesboro, Tennessee 71% 68% The Managing General Partner attributes the increase in occupancy at The Trails Apartments and Greensprings Manor Apartments to an aggressive and effective marketing campaign during the last part of 1998 and into the first three quarters of 1999. The increase in occupancy at Shoppes at River Rock is attributed to new tenants moving in during the nine months ended September 30, 1999. The Partnership entered into a contract to sell Shoppes at River Rock to an unaffiliated third party. The sale, which is conditioned upon the purchaser completing its due diligence review of the property and other customary conditions, is expected to close, if at all, prior to year end. There can be no assurances, however, that the sale will be consummated, or if consummated, on what terms or in what time frame. Results of Operations The Registrant's net loss for the three and nine months ended September 30, 1999 was approximately $761,000 and $923,000, respectively, as compared to approximately $456,000 and $874,000 for the three and nine months ended September 30, 1998. The increase in net loss for the three and nine months ended September 30, 1999 was due to an increase in total expenses, and a decrease in total revenues. Total revenues decreased primarily due to the fact that no gain on casualty event was recognized during the nine months ended September 30, 1999 as was recognized during the nine months ended September 30, 1998. During 1998 a gain on casualty event was recognized as a result of fire damage at The Trails Apartments. 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 The Trails Apartments, Greensprings Manor Apartments and Shoppes At River Rock as discussed above, which more than offset the slight decrease in occupancy at Big Walnut Apartments. Total expenses increased for both the three and nine month periods ended September 30, 1999 primarily due to the recognition of an impairment loss on property held for investment. This loss was recognized due to the impairment of the Shoppes at River Rock; therefore, its value was written down by approximately $660,000 to reflect its fair value at September 30, 1999. The fair value was based upon current economic conditions and projected future operational cash flows. The increase in loss on property held for investment was partially offset by decreases in operating and property tax expense and a reduction in loss on disposal of property during 1999. In addition such increase was offset during the three months ended September 30, 1999 by a decrease in depreciation 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 Trails Apartments was recognized due to the write-off of 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. Operating expenses decreased as a result of a decrease in insurance expense and repairs and maintenance expenses. The decrease in insurance expense is the result of lower premiums due to a change in the policy carrier for the residential properties. The decrease in repairs and maintenance is due to the completion in 1998 of roof repairs at Big Walnut. Property taxes decreased due primarily to a decrease in the assessment value of Shoppes at River Rock and The Trails. General and administrative expense remained stable due primarily 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 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 September 30, 1999, the Partnership had cash and cash equivalents of approximately $1,387,000 as compared to approximately $645,000 at September 30, 1998. Cash and cash equivalents increased approximately $416,000 for the nine months ended September 30, 1999 from the Partnership's year end, primarily due to approximately $1,779,000 of cash provided by operating activities which was partially offset by approximately $772,000 of cash used in investing activities and approximately $591,000 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, partially 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, pool improvements, floor covering replacements and electrical improvements. As of September 30, 1999, approximately $76,000 has been incurred consisting primarily of appliance and floor covering replacement, pool improvements, and roof replacement. These improvements were funded from Partnership reserves and operations. 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 upgrades, landscaping, exterior building improvements, roofing, and floor covering replacements. As of September 30, 1999, approximately $384,000 has been incurred consisting primarily of roof replacements, appliance and floor covering replacements and exterior and interior building improvements, and landscaping. These improvements were funded from Partnership reserves and operations. 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, appliance and floor covering replacements and HVAC improvements. As of September 30, 1999, approximately $94,000 has been incurred consisting primarily of interior building improvements, appliance and floor covering replacements. These improvements were funded from Partnership operations. 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 roof replacements, gutters and down spouts, appliance and floor covering replacements and parking lot improvements, and exterior building enhancements. As of September 30, 1999, approximately $277,000 has been incurred consisting primarily of appliance and floor covering replacements, interior and exterior building improvements, and land and parking lot improvements. These improvements were funded from Partnership operations. 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 September 30, 1999, approximately $11,000 has been incurred consisting primarily of interior building improvements and gutter replacements. These improvements were funded from Partnership operations. The Partnership recently entered into a contract to sell Shoppes at River Rock to an unaffiliated third party. The sale, which is conditioned upon the purchaser completing its due diligence review of the property and other customary conditions, is expected to close, if at all, prior to year end. There can be no assurances, however, that the sale will be consummated, or it consummated, on what terms or in what time frame. 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 $25,744, net of discount, is amortized over 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 property cannot be refinanced or sold for a sufficient amount, the Registrant will risk losing such property through foreclosure. No cash distributions were made during the nine months ended September 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, refinancing 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 distributions to its partners in 1999 or subsequent periods. Tender Offer During August 1999, AIMCO Properties, L.P., an affiliate of the General Partner commenced a tender offer to purchase up to 479.03 (approximately 39.12% of the total outstanding units) units of limited partnership interest in the Partnership for a purchase price of $2,899 per unit. The offer expired on September 16, 1999. Pursuant to the offer, AIMCO Properties, L.P. acquired 34.5 units. As a result AIMCO and its affiliates currently own 197.5 units of limited partnership interest in the Partnership representing approximately 16.13% of the total outstanding units. It is possible that AIMCO or its affiliates will make one or more additional offers to acquire additional limited partnership interests in the Partnership for cash or in exchange for units in the operating partnership of AIMCO. (See "Item 1. Financial Statements, Note G - Legal Proceedings"). 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 September 30, 1999, had virtually completed 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. 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 virtually all of the server operating systems. 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 virtually no Year 2000 issues. A complete, formal assessment of all the properties by the Managing Agent was virtually completed by September 30, 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 September 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 has banking relationships with three major financial institutions, all of which have designated their compliance. The Managing Agent has updated data transmission standards with all of the financial institutions. All financial institutions have communicated that they are Year 2000 compliant and accordingly no accounts were required to be moved from the existing financial institutions. 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 expenses 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 and the Insignia Merger (see "Part I _ Financial Information, Item 1. Financial Statements, Note B _ Transfer of Control"). 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 have 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 ("Stipulation"), settling claims, subject to final court approval, on behalf of the Partnership and all limited partners who own units as of November 3, 1999. The Court has preliminarily approved the Settlement and scheduled a final approval hearing for December 10, 1999. In exchange for a release of all claims, the Stipulation provides that, among other things, an affiliate of the Managing General Partner will make tender offers for all outstanding limited partnership interests in 49 partnerships, including the Registrant, subject to the terms and conditions set forth in the Stipulation, and has agreed to establish a reserve to pay an additional amount in settlement to qualifying class members (the "Settlement Fund"). At the final approval hearing, Plaintiffs' counsel will make an application for attorneys' fees and reimbursement of expenses, to be paid in part by the partnerships and in part from the Settlement Fund. The Managing General Partner does not anticipate that costs associated with this case will be material to the Partnership's overall operations. The Managing General Partner does not anticipate that costs associated with this case 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 September 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. 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: November 10, 1999 EX-27 2
5 This schedule contains summary financial information extracted from Davidson Diversified Real Estate II, L.P. Third 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 9-MOS DEC-31-1999 SEP-30-1999 1,387 0 739 0 0 0 45,787 24,601 24,344 0 25,744 0 0 0 (3,369) 24,344 0 6,755 0 0 7,678 0 1,661 0 0 0 0 0 0 (923) (739.23) 0 Registrant has an unclassified balance sheet. Multiplier is 1.
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