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:
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
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.
</LEGEND>
<CIK> 0000750258
<NAME> DAVIDSON DIVERSIFIED REAL ESTATE II L.P.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,186
<SECURITIES> 0
<RECEIVABLES> 645
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0<F1>
<PP&E> 46,078
<DEPRECIATION> 24,123
<TOTAL-ASSETS> 24,815
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 25,903
0
0
<COMMON> 0
<OTHER-SE> (2,608)
<TOTAL-LIABILITY-AND-EQUITY> 24,815
<SALES> 0
<TOTAL-REVENUES> 4,542
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 4,704
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,106
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (162)
<EPS-BASIC> (129.88)<F2>
<EPS-DILUTED> 0
<FN>
<F1>Registrant has an unclassified balance sheet.
<F2>Multiplier is 1.
</FN>
</TABLE>
