10-Q 1 d10q.txt FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (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, 2001 ----------------------- OR [_] 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 0-17686 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP (Exact name of registrant as specified in its charter) Wisconsin 39-1606834 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 W. 11th Street, Suite 1110, Kansas City, Missouri 64105 (Address of principal executive offices, including zip code) (816) 421-7444 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Interests Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or 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 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP BALANCE SHEETS March 31, 2001 and December 31, 2000 ------------------------------------ ASSETS
(Unaudited) March 31, December 31, 2001 2000 ----------- ----------- INVESTMENT PROPERTIES AND EQUIPMENT: (Note 3) Land $ 7,298,596 $ 7,298,596 Buildings 11,902,463 11,902,463 Equipment 669,778 669,778 Accumulated depreciation (5,781,080) (5,694,980) ----------- ----------- Net investment properties and equipment 14,089,757 14,175,857 ----------- ----------- OTHER ASSETS: Cash and cash equivalents 1,025,117 7 52,060 Cash held in Indemnification Trust (Note 8) 362,183 356,153 Rents and other receivables 116,156 530,379 Deferred rent receivable 103,508 105,684 Prepaid insurance 11,264 16,091 Deferred charges 270,711 263,407 ----------- ----------- Total other assets 1,888,939 2,023,774 ----------- ----------- Total assets $15,978,696 $16,199,631 =========== ===========
The accompanying notes are an integral part of these statements. 2 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP BALANCE SHEETS March 31, 2001 and December 31, 2000 ------------------------------------ LIABILITIES AND PARTNERS' CAPITAL
(Unaudited) March 31, December 31, 2001 2000 ------------ ------------ LIABILITIES: Accounts payable and accrued expenses $ 36,213 $ 40,059 Due to current General Partner 1,300 2,667 Security deposits 117,850 117,850 Unearned rental income 120,995 85,407 ------------ ------------ Total liabilities 276,358 245,983 ------------ ------------ CONTINGENT LIABILITIES: (Note 7) PARTNERS' CAPITAL: (Notes 1, 4 and 9) Current General Partner - Cumulative net income 158,088 154,838 Cumulative cash distributions (65,306) (64,006) ------------ ------------ 92,782 90,832 ------------ ------------ Limited Partners (46,280.3 interests outstanding) Capital contributions, net of offering costs 39,358,468 39,358,468 Cumulative net income 22,016,585 21,694,845 Cumulative cash distributions (44,925,268) (44,350,268) Reallocation of former general partners' deficit capital (840,229) (840,229) ------------ ------------ 15,609,556 15,862,816 ------------ ------------ Total partners' capital 15,702,338 15,953,648 ------------ ------------ Total liabilities and partners' capital $ 15,978,696 $ 16,199,631 ============ ============
The accompanying notes are an integral part of these statements. 3 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP STATEMENTS OF INCOME (Unaudited) -----------
Three Months Ended March 31, ---------------------------- 2001 2000 -------- -------- REVENUES: Rental income (Note 5) $589,482 $566,813 Interest income 14,173 15,197 Recovery of amounts previously written off 2,781 1,391 Other income 185 267 -------- -------- 606,621 583,668 -------- -------- EXPENSES: Partnership management fees (Note 6) 47,386 46,235 Restoration fees (Note 6) 111 56 Insurance 4,827 4,375 General and administrative 29,835 21,258 Advisory Board fees and expenses 4,275 4,017 Ground lease payments (Note 3) 16,852 31,372 Professional services 89,110 31,664 Depreciation 86,100 88,098 Amortization 3,135 3,328 -------- -------- 281,631 230,403 -------- -------- NET INCOME $324,990 $353,265 ======== ======== NET INCOME - CURRENT GENERAL PARTNER $ 3,250 $ 3,533 NET INCOME - LIMITED PARTNERS 321,740 349,732 -------- -------- $324,990 $353,265 ======== ======== NET INCOME (LOSS) PER LIMITED PARTNERSHIP INTEREST, based on 46,280.3 Interests outstanding $ 6.95 $ 7.56 ======== ========
The accompanying notes are an integral part of these statements. 4 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS (Unaudited) -----------
Three Months Ended March 31, ----------------------------- 2001 2000 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 324,990 $ 353,265 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 89,235 91,426 Recovery of amounts previously written off (2,781) (1,391) Interest applied to Indemnification Trust account (6,030) (4,321) Decrease in rents and other receivables 414,223 398,130 Decrease in prepaids 4,827 4,122 Decrease in deferred rent receivable 2,176 8,419 (Decrease) in due to current General Partner (1,367) (190) (Decrease) in accounts payable and other (3,846) (15,527) Increase in real estate taxes payable 0 13,867 Increase/(Decrease) in unearned rental income 35,588 (16,460) ---------- ---------- Net cash from operating activities 857,015 831,340 ---------- ---------- CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES: Payment of Deferred Leasing Commissions (10,439) 0 Recoveries from former affiliates 2,781 1,391 ---------- ---------- Net cash (used in) from investing activities (7,658) 1,391 ---------- ---------- CASH FLOWS (USED IN) FINANCING ACTIVITIES: Cash distributions to Limited Partners (575,000) (985,000) Cash distributions to current General Partner (1,300) (1,414) ---------- ---------- Net cash (used in) financing activities (576,300) (986,414) ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 273,057 (153,683) CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 752,060 1,387,306 ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $1,025,117 $1,233,623 ========== ==========
The accompanying notes are an integral part of these statements. 5 DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS These unaudited interim financial statements should be read in conjunction with DiVall Insured Income Properties 2 Limited Partnership's (the "Partnership") 2000 annual audited financial statements within Form 10-K. These unaudited financial statements include all adjustments which are, in the opinion of management, necessary to present a fair statement of financial position as of March 31, 2001, and the results of operations for the three-month periods ended March 31, 2001, and 2000, and cash flows for the three-month periods ended March 31, 2001 and 2000. Results of operations for the periods are not necessarily indicative of the results to be expected for the full year. 1. ORGANIZATION AND BASIS OF ACCOUNTING: ------------------------------------- The Partnership was formed on November 18, 1987, pursuant to the Uniform Limited Partnership Act of the State of Wisconsin. The initial capital which was contributed during 1987, consisted of $300, representing aggregate capital contributions of $200 by the former general partners and $100 by the Initial Limited Partner. The minimum offering requirements were met and escrow subscription funds were released to the Partnership as of April 7, 1988. On January 23, 1989, the former general partners exercised their option to increase the offering from 25,000 interests to 50,000 interests and to extend the offering period to a date no later than August 22, 1989. On June 30, 1989, the general partners exercised their option to extend the offering period to a date no later than February 22, 1990. The offering closed on February 22, 1990, at which point 46,280.3 interests had been sold, resulting in total offering proceeds, net of underwriting compensation and other offering costs, of $39,358,468. The Partnership is currently engaged in the business of owning and operating its investment portfolio (the "Properties") of commercial real estate. The Properties are leased on a triple net basis to, and operated by, franchisers or franchisees of national, regional, and local retail chains under long-term leases. The lessees consist primarily of fast-food, family style, and casual/theme restaurants, but also include a video rental store and a child care center. At March 31, 2001, the Partnership owned 25 properties with specialty leasehold improvements in 12 of these properties. Rental revenue from investment properties is recognized on the straight-line basis over the life of the respective lease. Percentage rents are recorded when the tenant has reached the breakpoint stipulated in its lease. The Partnership considers its operations to be in only one segment and therefore no segment disclosure is made. Depreciation of the properties is provided on a straight-line basis over 31.5 years, which is the estimated useful lives of the buildings and improvements. Equipment is depreciated on a straight-line basis over the estimated useful lives of 5 to 7 years. Deferred charges consist of leasing commissions paid when properties are leased to tenants and the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the life of the lease. Real estate taxes on the Partnership's investment properties are the responsibility of the tenant. However, when a tenant fails to make the required tax payments or when a property becomes vacant, the Partnership makes the appropriate payment to avoid possible foreclosure of the property. Taxes are accrued in the period in which the liability is incurred. Cash and cash equivalents include cash on deposit with financial institutions and highly liquid temporary 6 investments with initial maturities of 90 days or less. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (and disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Partnership follows Statement of Financial Accounting Standards No.121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed of, which requires that all long-lived assets be reviewed for impairment in value whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Partnership will be dissolved on November 30, 2010, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all properties of the Partnership; (b) the written determination by the General Partner that the Partnership's assets may constitute "plan assets" for purposes of ERISA; (c) the agreement of Limited Partners owning a majority of the outstanding interests to dissolve the Partnership; or (d) the dissolution, bankruptcy, death, withdrawal, or incapacity of the last remaining General Partner, unless an additional General Partner is elected previously by a majority in interest of the Limited Partners. During the Second Quarter of 1998, the General Partner received the consent of the Limited Partners to liquidate the Partnership's assets and dissolve the Partnership. However, a buyer was not found for the Partnership's assets, and no current liquidation or dissolution plans are in effect. Management plans to continue normal operations for the Partnership for the foreseeable future. No provision for Federal income taxes has been made, as any liability for such taxes would be that of the individual partners rather than the Partnership. At December 31, 2000, the tax basis of the Partnership's assets exceeded the amounts reported in the accompanying financial statements by approximately $8,318,000. 2. REGULATORY INVESTIGATION: ------------------------- A preliminary investigation during 1992 by the Office of Commissioner of Securities for the State of Wisconsin and the Securities and Exchange Commission (the "Investigation") revealed that during at least the four years ended December 31, 1992, the former general partners of the Partnership, Gary J. DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial cash assets of the Partnership and two affiliated publicly registered partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1") (dissolved effective December 31, 1998) and DiVall Income Properties 3 Limited Partnership ("DiVall 3") (collectively the "Partnerships") to various other entities previously sponsored by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers were in violation of the respective Partnership Agreements and resulted, in part, from material weaknesses in the internal control system of the Partnerships. Subsequent to discovery, and in response to the regulatory inquiries, a third- party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed (effective February 8, 1993) to assume responsibility for daily operations and assets of the Partnerships as well as to develop and execute a plan of restoration for the Partnerships. Effective May 26, 1993, the Limited Partners, by written consent of a majority of interests, elected the Permanent Manager, TPG, as General Partner. TPG terminated the former general partners by accepting their tendered resignations. In 1993, the current General Partner estimated an aggregate recovery of $3 million for the Partnerships. At that time, an allowance was established against amounts due from former general partners and their affiliates reflecting the estimated $3 million receivable. This net receivable was allocated among the Partnerships based on each Partnership's pro rata share of the total misappropriation. Through March 31, 2001, $5,794,000 of recoveries have been received which exceeded the original estimate of $3 million. As a result, since 1996, the Partnership has recognized $1,120,000 as income, which represents its share of the excess recovery. No further significant recoveries are anticipated. 3. INVESTMENT PROPERTIES: ---------------------- 7 As of March 31, 2001, the Partnership owned 25 fully constructed fast-food restaurants, a video store, and a preschool. The properties are comprised of the following: ten (10) Wendy's restaurants, four (4) Hardee's restaurants, two (2) Denny's restaurants, one (1) Fiesta Time restaurant, one (1) Mulberry Street Grill restaurant, one (1) Applebee's restaurant, one (1) Popeye's Famous Fried Chicken restaurant, one (1) Hooter's restaurant, one (1) Kentucky Fried Chicken restaurant, one (1) Hostettler's restaurant, one (1) Miami Subs restaurant, one (1) Village Inn restaurant, one (1) Blockbuster Video store, and one (1) Sunrise Preschool. The 25 properties are located in a total of thirteen (13) states. The tenant operating a Denny's restaurant on Camelback Road in Phoenix, Arizona, did not formally exercise its option to extend its lease which expired on January 30, 1998, but continued to operate the restaurant and pay rent through December 31, 1999. During January 2000, the tenant notified Management that it had vacated the premises and ceased paying rent. Management entered into a termination agreement with the ground lessor of the property during the Third Quarter of 2000, which resulted in a one-time payment of $90,000 in exchange for a release of all future obligations. Possession of the property was returned to the ground lessor, resulting in $153,000 loss. During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurants in South Milwaukee and Milwaukee, Wisconsin. Hardee's lease on the South Milwaukee property expires on November 30, 2001 and they will be required to continue making rent payments until that time or until a lease termination agreement is entered into. Management will market the property for lease to a new tenant. Hardee's lease on the Milwaukee property does not expire until 2009, and Hardee's is required to continue making rent payments until that time or until a lease termination agreement is entered into. Management will market the property for sale or re-lease. The Blockbuster Video Store lease expired on January 31, 2001. However, in the First Quarter of 2001, Management negotiated a five (5) year lease extension to January 31, 2006. A commission of $10,000 was paid to an unaffiliated leasing agent upon the negotiated extension of the lease. During the Fourth Quarter of 2000, Management negotiated the extension of the leases on the ten (10) Wendy's restaurants from original expirations ranging from 2008 to 2009, to new expirations dates of November 2016. A commission of $190,000 was paid to an affiliate of the General Partner upon the negotiated extension of the leases. The Partnership owns two (2) restaurants, Kentucky Fried Chicken and Mulberry Street Grill restaurant, which are located on parcels of land where it has entered into long-term ground leases. One (1) of these leases is paid by the tenant, Kentucky Fried Chicken, and one (1) is paid by the Partnership. The lease paid by the Partnership is considered an operating lease and the lease payments are expensed in the periods to which they apply. The lease terms require aggregate minimum annual payments of approximately $67,000 and expire in the year 2008. The total cost of the investment properties and specialty leasehold improvements includes the original purchase price plus acquisition fees and other capitalized costs paid to an affiliate of the former general partners. According to the Partnership Agreement, the former general partners were to commit 80% of the original offering proceeds to investment in properties. Upon full investment of the net proceeds of the offering, approximately 75% of the original proceeds was invested in the Partnership's properties. The current General Partner receives a fee for managing the Partnership equal to 4% of gross receipts, with a maximum reimbursement for office rent and related office overhead of $25,000 between the three original affiliated Partnerships as provided in the Permanent Manager Agreement ("PMA"). Effective March 1, 2001, the minimum management fee and the maximum reimbursement for office rent and overhead increased by 3.4% representing the allowable annual Consumer Price Index adjustment per the PMA. For purposes of computing the 4% overall fee, gross receipts includes amounts recovered in connection with the misappropriation of assets by the former general partners and their affiliates. TPG has received fees from the Partnership totaling $55,296 to date on the amounts recovered, which has been offset against the 4% minimum fee. 8 Several of the Partnership's property leases contain purchase option provisions with stated purchase prices in excess of the original cost of the properties. The current General Partner is not aware of any unfavorable purchase options in relation to original cost. 4. PARTNERSHIP AGREEMENT: ---------------------- The Partnership Agreement, prior to an amendment effective May 26, 1993, provided that, for financial reporting and income tax purposes, net profits or losses from operations were allocated 90% to the Limited Partners and 10% to the general partners. The Partnership Agreement also provided for quarterly cash distributions from Net Cash Receipts, as defined, within 60 days after the last day of the first full calendar quarter following the date of release of the subscription funds from escrow, and each calendar quarter thereafter, in which such funds were available for distribution with respect to such quarter. Such distributions were to be made 90% to Limited Partners and 10% to the former general partners, provided, however, that quarterly distributions were to be cumulative and were not to be made to the former general partners unless and until each Limited Partner had received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined. Net Proceeds, as originally defined, were to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation date including in the calculation of such return all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause; and (c) then, to Limited Partners, 90% and to the General Partners, 10%, of the remaining Net Proceeds available for distribution. On May 26, 1993, pursuant to the results of a solicitation of written consents from the Limited Partners, the Partnership Agreement was amended to replace the former general partners and amend various sections of the agreement. The former general partners were replaced as General Partner by The Provo Group, Inc., an Illinois corporation. Under the terms of the amendment, net profits or losses from operations are allocated 99% to the Limited Partners and 1% to the current General Partner. The amendment also provided for distributions from Net Cash Receipts to be made 99% to Limited Partners and 1% to the current General Partner provided, that quarterly distributions will be cumulative and will not be made to the current General Partner unless and until each Limited Partner has received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined, except to the extent needed by the General Partner to pay its federal and state income taxes on the income allocated to them attributable to such year. Distributions paid to the General Partner are based on the estimated tax liability resulting from allocated income. Subsequent to the filing of the General Partner's income tax returns, a true-up with actual distributions is made. The provisions regarding distribution of Net Proceeds, as defined, were also amended to provide that Net Proceeds are to be distributed as follows: (a) to the Limited Partners, an amount equal to 100% of their Adjusted Original Capital; (b) then, to the Limited Partners, an amount necessary to provide each Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative simple return on Adjusted Original Capital from the Return Calculation Date including in the calculation of such return on all prior distributions of Net Cash Receipts and any prior distributions of Net Proceeds under this clause, except to the extent needed by the General Partner to pay its federal and state income tax on the income allocated to its attributable to such year; and (c) then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net Proceeds available for distribution. Additionally, per the amendment of the Partnership Agreement dated May 26, 1993, the total compensation paid to all persons for the sale of the investment properties shall be limited to a competitive real estate commission, not to exceed 6% of the contract price for the sale of the property. The General Partner may receive up to one-half of the competitive real estate commission, not to exceed 3%, provided that the General Partner provides a substantial amount of services in the sales effort. It is further provided that a portion of the amount of such fees payable to the General Partner is subordinated to its success in recovering the funds misappropriated by the former general partners. (See Note 7.) 9 5. LEASES: ------- Lease terms for the majority of the investment properties are 20 years from their inception. The leases generally provide for minimum rents and additional rents based upon percentages of gross sales in excess of specified breakpoints. The lessee is responsible for occupancy costs such as maintenance, insurance, real estate taxes, and utilities. Accordingly, these amounts are not reflected in the statements of income except in circumstances where, in management's opinion, the Partnership will be required to pay such costs to preserve its assets (i.e., payment of past-due real estate taxes). Management has determined that the leases are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the property, excluding the cost of the land, is depreciated over its estimated useful life. Aggregate minimum lease payments to be received under the leases for the Partnership's properties are as follows: Year ending December 31, 2001 $ 2,118,563 2002 2,098,296 2003 2,050,756 2004 2,074,663 2005 2,085,617 Thereafter 15,627,591 ----------- $26,055,486 =========== Ten (10) of the properties are leased to Wensouth Orlando, a franchisee of Wendy's restaurants. Wensouth base rents accounted for 37% of total base rents for 2000. 6. TRANSACTIONS WITH CURRENT GENERAL PARTNER: ------------------------------------------ Amounts paid to the current General Partner for the three-month periods ended March 31, 2001 and 2000 are as follows. Incurred as of Incurred as of Current General Partner March 31, 2001 March 31, 2000 ----------------------- -------------- -------------- Management fees $47,386 $46,235 Restoration fees 111 56 Overhead allowance 3,832 3,735 Reimbursement for out-of-pocket expenses 4,137 4,186 Cash distribution 1,300 1,414 ------- ------- $56,766 $55,626 ======= ======= 7. CONTINGENT LIABILITIES: ----------------------- According to the Partnership Agreement, as amended, the current General Partner may receive a disposition fee not to exceed 3% of the contract price of the sale of investment properties. Fifty percent (50%) of all such disposition fees earned by the current General Partner is to be in escrow until the aggregate amount of recovery of the funds misappropriated from the Partnerships by the former general partners is greater than $4,500,000. Upon reaching such recovery level, full disposition fees will thereafter be payable and fifty percent (50%) of the previously escrow amounts will be paid to the current General Partner. At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining escrow 10 disposition fees shall be paid to the current General Partner. If such levels of recovery are not achieved, the current General Partner will contribute the amounts in escrow towards the recovery. In lieu of an escrow, 50% of all such disposition fees have been paid directly to the restoration account and then distributed among the three Partnerships. Fifty percent (50%) of the total amount paid to the recovery was refunded to the current General Partner during March 1996 after surpassing the recovery level of $4,500,000. The remaining amount allocated to the Partnership may be owed to the current General Partner if the $6,000,000 recovery level is met. As of March 31, 2001, the Partnership may owe the current General Partner $16,296, which is currently reflected as a recovery, if the $6,000,000 recovery level is achieved, which is considered unlikely. 8. PMA INDEMNIFICATION TRUST: -------------------------- The PMA provides that the Permanent Manager will be indemnified from any claims or expenses arising out of or relating to the Permanent Manager serving in such capacity or as substitute general partner, so long as such claims do not arise from fraudulent or criminal misconduct by the Permanent Manager. The PMA provides that the Partnership fund this indemnification obligation by establishing a reserve of up to $250,000 of Partnership assets which would not be subject to the claims of the Partnership's creditors. An Indemnification Trust ("Trust") serving such purposes has been established at United Missouri Bank, N.A. The Trust has been fully funded with Partnership assets as of March 31, 2001. Funds are invested in U.S. Treasury securities. In addition, $112,183 of earnings have been credited to the Trust as of March 31, 2001. The rights of the Permanent Manager to the Trust shall be terminated upon the earliest to occur of the following events: (i) the written release by the Permanent Manager of any and all interest in the Trust; (ii) the expiration of the longest statute of limitations relating to a potential claim which might be brought against the Permanent Manager and which is subject to indemnification; or (iii) a determination by a court of competent jurisdiction that the Permanent Manager shall have no liability to any person with respect to a claim which is subject to indemnification under the PMA. At such time as the indemnity provisions expire or the full indemnity is paid, any funds remaining in the Trust will revert back to the general funds of the Partnership. 9. FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS: ------------------------------------------ The capital account balance of the former general partners as of May 26, 1993, the date of their removal as general partners pursuant to the results of a solicitation of written consents from the Limited Partners, was a deficit of $840,229. At December 31, 1993, the former general partners' deficit capital account balance in the amount of $840,229 was reallocated to the Limited Partners. 10. SUBSEQUENT EVENTS: ------------------ On May 15, 2001, the Partnership will make distributions to the Limited Partners for the First Quarter of 2001 of $540,000 amounting to approximately $11.67 per limited partnership interest. During April 2001, Mulberry Street Grill Restaurant notified Management of its intent to close and vacate its restaurant in Phoenix, Arizona. The lease on the property expires in 2007 and they will be required to continue making rent payments until that time or until a lease termination agreement is entered into. Management is moving forward with all legal remedies. 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources: -------------------------------- Investment Properties --------------------- The investment properties, including equipment held by the Partnership at March 31, 2001, were originally purchased at a price, including acquisition costs, of approximately $23,295,000. The tenant operating a Denny's restaurant on Camelback Road in Phoenix, Arizona, did not formally exercise its option to extend its lease which expired on January 30, 1998, but continued to operate the restaurant and pay rent through December 31, 1999. During January 2000, the tenant notified Management that it had vacated the premises and ceased paying rent. Management entered into a termination agreement with the ground lessor of the property during the Third Quarter of 2000, which resulted in a one-time payment of $90,000 in exchange for a release of all future obligations. Possession of the property was returned to the ground lessor, resulting in $153,000 loss. During April 2001, Mulberry Street Grill Restaurant notified Management of its intent to close and vacate its restaurant in Phoenix, Arizona. The lease on the property expires in 2007 and they will be required to continue making rent payments until that time or until a lease termination agreement is entered into. Management is moving forward with all legal remedies. During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurants in South Milwaukee and Milwaukee, Wisconsin. Hardee's lease on the South Milwaukee property expires on November 30, 2001 and they will be required to continue making rent payments until that time or until a lease termination agreement is entered into. Management will market the property for lease to a new tenant. Hardee's lease on the Milwaukee property does not expire until 2009, and Hardee's is required to continue making rent payments until that time or until a lease termination agreement is entered into. Management will market the property for sale or re-lease. The Blockbuster Video Store lease expired on January 31, 2001. However, in the First Quarter of 2001, Management negotiated a five (5) year extension to January 31, 2006. A commission of $10,000 was paid to an unaffiliated leasing agent upon the negotiated extension of the lease. During the Fourth Quarter of 2000, Management negotiated the extension of the leases on the ten (10) Wendy's restaurants from original expirations ranging from 2008 to 2009, to new expirations dates of November 2016. Other Assets ------------ Cash and cash equivalents were approximately $1,025,000 at March 31, 2001, compared to $752,000 at December 31, 2000. The Partnership designated cash of $540,000 to fund the First Quarter 2001 distributions to Limited Partners, $431,000 for the payment of accounts payable and accrued expenses, and the remainder represents reserves deemed necessary to allow the Partnership to operate normally. Cash generated through the operations of the Partnership's investment properties and sales of investment properties will provide the sources for future fund liquidity and Limited Partner distributions. The Partnership established an Indemnification Trust (the "Trust") during the Fourth Quarter of 1993, deposited $100,000 in the Trust during 1993 and completed funding of the Trust with $150,000 during 12 1994. The provision to establish the Trust was included in the PMA for the indemnification of TPG, in the absence of fraud or gross negligence, from any claims or liabilities that may arise from TPG acting as Permanent Manager. The Trust is owned by the Partnership. For additional information regarding the Trust refer to Note 8 to the financial statements. Deferred charges totaled approximately $271,000 and $263,000, net of amortization, at March 31, 2001 and December 31, 2000, respectively. Deferred charges represent leasing commissions paid when properties are leased or upon the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the life of the lease. During the First Quarter of 2001, a commission of $10,000 was paid to an unaffiliated leasing agent upon the negotiated extension of the lease with Blockbuster Video. During the Fourth Quarter of 2000, a commission of $190,000 was paid to an affiliate of the General Partner upon the negotiated extension of the leases on the ten (10) Wendy's restaurants. Liabilities ----------- Accounts payable and accrued expenses at March 31, 2001, in the amount of $36,000, primarily represent the accrual of auditing fees. Due to the Current General Partner amounted to $1,300 at March 31, 2001, representing the General Partner's portion of the First Quarter 2001 distribution. Partners' Capital ----------------- Net income for the quarter was allocated between the General Partner and the Limited Partners, 1% and 99%, respectively, as provided in the Partnership Agreement and the Amendment to the Partnership Agreement, as discussed more fully in Note 4 of the financial statements. The former general partners' deficit capital account balance was reallocated to the Limited Partners at December 31, 1993. Refer to Note 9 to the financial statements for additional information regarding the reallocation. Cash distributions paid to the Limited Partners and to the General Partner during 2001 of $575,000 and $1,300, respectively, have also been in accordance with the amended Partnership Agreement. The First Quarter 2001 distribution of $540,000 will be paid to the Limited Partners on May 15, 2001. Results of Operations: ---------------------- The Partnership reported net income for the quarter ended March 31, 2001, in the amount of $325,000 compared to net income for the quarter ended March 31, 2000, of $353,000. Revenues -------- Total revenues were $607,000 and $584,000, for the quarters ended March 31, 2001 and 2000, respectively. Total revenues should approximate $2,100,000 annually, based on leases currently in place. Future revenues may decrease with tenant defaults and/or sales of Partnership properties. They may also increase with additional rents due from tenants, if those tenants experience sales levels which require the payment of additional rent to the Partnership. 13 Expenses -------- For the quarters ended March 31, 2001 and 2000, cash expenses amounted to approximately 32% and 24%, of total revenues, respectively. Total expenses, including non-cash items, amounted to approximately 46% and 39%, of total revenues for the quarters ended March 31, 2001 and 2000, respectively. The increase in total expenses is primarily due to appraisals being performed in the First Quarter of 2001 on all the Partnership properties. Inflation: ---------- Inflation has a minimal effect on operating earnings and related cash flows from a portfolio of triple net leases. By their nature, such leases actually fix revenues and are not impacted by rising costs of maintenance, insurance, or real estate taxes. If inflation causes operating margins to deteriorate for lessees if expenses grow faster than revenues, then, inflation may well negatively impact the portfolio through tenant defaults. It would be misleading to associate inflation with asset appreciation for real estate, in general, and the Partnership's portfolio, specifically. Due to the "triple net" nature of the property leases, asset values generally move inversely with interest rates. Item 3. Quantitative and Qualitative Disclosure About Market Risk None. 14 PART II - OTHER INFORMATION Items 1 - 5. Not Applicable. Item 6. Exhibits and Reports on Form 8-K (a) Listing of Exhibits: 99.0 Correspondence to the Limited Partners dated May 15, 2001, regarding the First Quarter 2001 distribution. (b) Reports on Form 8-K: The Registrant filed no reports on Form 8-K during the first quarter of fiscal year 2001. 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized. DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP By: The Provo Group, Inc., General Partner By: /s/ Bruce A. Provo, ----------------------------------------------- Bruce A. Provo, President Date: May 15, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: The Provo Group, Inc., General Partner By: /s/ Bruce A. Provo ------------------------------------------------- Bruce A. Provo, President Date: May 15, 2001 By: /s/ Diane R. Conley -------------------------------------------------- Diane R. Conley Controller Date: May 15, 2001 16