<PAGE>
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, 1995
--------------------------------------------
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 0-16722
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
WISCONSIN 36-6845083
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 West 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 No X
------- -------
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
BALANCE SHEETS
MARCH 31, 1995 AND DECEMBER 31, 1994
ASSETS
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1995 1994
------------ -------------
<S> <C> <C>
INVESTMENT PROPERTIES AND EQUIPMENT: (NOTE 3)
Land $ 7,358,073 $ 7,358,073
Buildings and improvements 12,070,525 12,070,525
Equipment 246,896 246,896
Accumulated depreciation (3,807,765) (3,712,602)
----------- -----------
Net investment properties and equipment 15,867,729 15,962,892
----------- -----------
NET INVESTMENT IN DIRECT FINANCING LEASES: (NOTE 8) 292,387 303,811
----------- -----------
OTHER ASSETS:
Cash and cash equivalents 536,676 1,169,554
Cash restricted for real estate taxes 56,405 6,910
Cash held in Indemnification Trust (NOTE 11) 255,822 191,798
Rents and other receivables (net of allowance of
$151,629 in 1995 and $151,161 in 1994) 121,991 68,303
Deferred rent receivable 111,993 108,024
Due from current General Partner 133 0
Due from affiliated partnerships (NOTE 12) 142,353 149,435
Prepaid insurance 10,548 7,878
Unsecured notes receivable from lessees 2,245 5,270
Deferred loan costs (net of accumulated
amortization of $52,416 in 1995 and $51,753
in 1994) 6,618 7,281
----------- -----------
Total other assets 1,244,784 1,714,453
----------- -----------
DUE FROM FORMER AFFILIATES:(NOTE 2)
Due from former general partner affiliates 1,141,066 1,144,448
Allowance for uncollectible amounts due from
former affiliates (830,051) (830,051)
Restoration cost receivable 657,431 606,430
Allowance for uncollectible restoration receivable (657,431) (606,430)
----------- -----------
Due from former affiliates, net 311,015 314,397
----------- -----------
Total assets $17,715,915 $18,295,553
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE>
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
LIABILITIES AND PARTNERS' CAPITAL
MARCH 31, 1995 AND DECEMBER 31, 1994
------------------------------------
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1995 1994
------------- ------------
<S> <C> <C>
LIABILITIES:
Mortgage notes payable (NOTE 6) $ 1,153,680 $ 1,155,528
Accounts payable and accrued expenses 38,717 43,787
Payable to tenant 0 144,000
Due to current General Partner 1,150 1,673
Accrued interest payable 133,972 121,026
Security deposits 125,410 125,410
Real estate taxes payable 56,405 132,946
Unearned rental income 24,000 0
------------ ------------
Total liabilities 1,533,334 1,724,370
------------ ------------
CONTINGENT LIABILITIES: (NOTES 10 AND 14)
PARTNERS' CAPITAL:(NOTES 1, 4 AND 14)
Former general partners -
Capital contributions 100 100
Cumulative net income 789,806 789,806
Cumulative cash distributions 0 0
Reallocation of former general partners'
capital to Limited Partners (789,906) (789,906)
------------ ------------
0 0
------------ ------------
Current General Partner -
Cumulative net income 22,406 19,530
Cumulative cash distributions (9,668) (8,518)
------------ ------------
12,738 11,012
------------ ------------
Limited Partners (25,000 interests outstanding) -
Capital contributions, net of offering costs 22,270,578 22,270,578
Cumulative net income 9,376,100 9,091,428
Cumulative cash distributions (16,266,741) (15,591,741)
Reallocation of former
general partners' capital 789,906 789,906
------------ ------------
16,169,843 16,560,171
------------ ------------
Total partners' capital 16,182,581 16,571,183
------------ ------------
Total liabilities and partners' capital $ 17,715,915 $ 18,295,553
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
1995 1994
-------- --------
<S> <C> <C>
REVENUES:
Rental income $490,815 $553,094
Interest income on direct financing leases 7,507 8,590
Interest income 9,585 2,937
Other Income 1,127 31,118
-------- --------
509,034 595,739
-------- --------
EXPENSES:
Partnership management fees paid
to current General Partner 21,626 25,809
Restoration fees - current General Partner 135 606
Insurance 5,556 11,344
General and administrative(NOTE 9) 14,304 14,847
Interest 27,371 58,599
Real estate taxes, including interest and penalties 0 2,682
Expenses incurred due to default by lessee 967 0
Professional services 39,959 33,520
Professional services related to Investigation 11,608 29,425
Advisory board fees and expenses 4,133 5,772
Depreciation 95,163 108,141
Amortization 662 1,807
-------- --------
221,484 292,552
-------- --------
NET INCOME $287,550 $303,187
======== ========
NET INCOME - CURRENT GENERAL PARTNER $ 2,876 $ 3,032
NET INCOME - LIMITED PARTNERS 284,674 300,155
-------- --------
$287,550 $303,187
======== ========
NET INCOME PER LIMITED PARTNERSHIP INTEREST,
based on 25,000 interests outstanding $11.39 $12.01
====== ======
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended March 31,
1995 1994
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 287,550 $ 303,187
Adjustments to reconcile net income to net
cash provided by operating activities -
Depreciation and amortization 95,825 109,948
Interest applied to Indemnification Trust Account (4,024) 0
Increase in unearned rental income 24,000 14,706
(Increase)/Decrease in rents and other receivables (53,822) 45,228
(Increase) in long-term rent receivable (3,969) 0
(Deposits)/Withdrawals for payment of real estate taxes (49,495) 20,468
(Increase)/Decrease in prepaid expenses (2,670) 11,344
(Decrease) in accounts payable and accrued expenses (5,069) (32,300)
(Decrease) in payable to tenant (144,000) 0
Increase/(Decrease) in due to current General Partner (523) 3,224
Increase in accrued interest payable 12,945 0
(Decrease) in real estate taxes payable (76,542) (53,465)
---------- ---------
Net cash provided from operating activities 80,206 422,340
---------- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Deposit to Indemnification Trust cash account (60,000) 0
Payments from affiliated partnerships 7,082 28,137
Recoveries from former affiliates 3,382 15,705
Principal payments received on direct financing leases 11,424 10,340
Principal receipts on notes receivable 3,026 9,187
---------- ---------
Net cash from (used in) investing activities (35,086) 63,369
---------- ---------
CASH FLOWS (USED IN) FINANCING ACTIVITIES:
Principal payments on mortgage notes (1,848) (14,605)
Cash distributions to Limited Partners (675,000) (450,000)
Cash distributions to current General Partner (1,150) (1,618)
---------- ---------
Net cash (used in) financing activities (677,998) (466,223)
---------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (632,878) 19,486
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,169,554 664,475
---------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 536,676 $ 683,961
========== =========
SUPPLEMENTAL DISCLOSURE--cash paid for interest $ 14,426 $ 58,599
========== =========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF ACCOUNTING:
-------------------------------------
DiVall Insured Income Fund Limited Partnership (the "Partnership") was formed on
November 29, 1985, pursuant to the Uniform Limited Partnership Act of the State
of Wisconsin. The initial capital which was contributed during 1986, consisted
of $110, representing aggregate capital contributions of $100 by the former
general partners and $10 by the Initial Limited Partner. The Partnership
initially offered 15,000 additional limited partnership interests ("Interests")
at $1,000 per Interest. Subsequently, the former general partners exercised
their option to increase the offering to 25,000 Interests. The offering closed
on March 16, 1988 at which point 25,000 Interests had been sold, resulting in
the receipt by the Partnership of offering proceeds of $22,270,578, net of
offering costs and after volume discounts.
Rental revenue from investment properties is recognized on the straight-line
basis over the life of the respective lease. Revenue from direct financing
leases is recognized at level rates of return over the term of the lease.
Prior to 1992, depreciation of the properties was provided on a straight-line
basis over estimated useful lives of 20 to 25 years which generally approximated
the lease terms. Beginning January 1, 1992, the Partnership prospectively
revised the remaining lives of its properties to 31.5 years which management
believes is a better representation of the estimated useful lives of the
buildings and improvements. Equipment is depreciated on a straight-line basis
over the estimated useful lives of 5 years.
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 in financial institutions and
highly liquid temporary investments with initial maturities of 90 days or less.
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 the
purposes of ERISA; (c) the agreement of Limited Partners owning a majority of
the outstanding interests to dissolve the Partnership; or (d) the bankruptcy or
termination of the existing General Partner, unless an additional General
Partner is previously elected by the Limited Partners.
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, 1994, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$4,000,000.
6
<PAGE>
2. REGULATORY INVESTIGATION:
-------------------------
A preliminary investigation during 1992 by the Office of the 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, two of 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 Properties 2 Limited Partnership
("DiVall 2") 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. The aggregate amount of the misappropriation, related costs, and
9% interest accrued since January 1, 1993, is in excess of $13,900,000, of which
approximately $1,798,000 has been attributed to the Partnership and is reflected
as due from former affiliates on the balance sheet at March 31, 1995. The 9%
interest accrued as of March 31, 1995, amounted to approximately $323,000 and is
not reflected in the accompanying income statement. As of December 31, 1994,
$1,751,000 was reflected as due from former affiliates based on the estimated
overall misappropriation and related costs of $13,500,000. As of December 31,
1994, PMA savings representing cost savings to the Partnerships as a result of
the implementation of the Permanent Manager Agreement, are estimated to
approximate $565,000, of which approximately $43,000 is attributed to the
Partnership. PMA savings are not credited against the due from former
affiliates account on the financial statements 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 the 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.
The current General Partner intends to vigorously pursue recovery of the
misappropriated funds from the various sources and initially estimated a range
of recovery with an estimated floor of $3 million for the Partnerships.
Accordingly, an allowance has been established against amounts due from former
general partner affiliates reflecting the current General Partner's best
estimate of potential loss from misappropriated amounts. This allowance has
been allocated among the Partnerships based on each Partnership's pro rata share
of the total misappropriation. The amount of the allowance was unchanged at
March 31, 1995. Pending the outcome of the litigation and other matters
affecting the sources of potential recovery, it is not possible to determine the
amount, if any, that will ultimately be recovered. The ultimate recovery will
likely be for an amount different than the current estimate.
As mentioned above, material weaknesses were identified in the Partnership's
internal control structure. The internal control structure was not adequate to
assure that all transactions of the Partnership were properly recorded and
reflected in the books and records and financial statements of the Partnership.
Significant transactions affecting the Partnership were apparently initiated by
DiVall and Magnuson during at least the four years ended December 31, 1992,
which initially either were not recorded on the books and records of the
Partnership or were improperly recorded and characterized. Such transactions
included unsupported disbursements or improper disbursements under the terms of
the Partnership Agreement and the encumbrance of Partnership assets. All
transactions identified during the regulatory Investigation and concurrent
reviews have been reflected in the Partnership's financial statements as of
March 31, 1995. Because of the significance of the weaknesses in the internal
control structure, there could be no certainty that all improper and unsupported
transactions were identified and recorded and reflected in the Partnership's
financial statements as of December 31, 1992. Accordingly, the Partnership's
auditors were unable to render an opinion on the financial statements for the
year ended December 31, 1992. Financial statements for prior periods, including
1991 and certain prior years and
7
<PAGE>
quarterly reports as of September 30, 1992, and certain prior quarters, do not
properly reflect such transactions, but have not been restated due to the
impracticality and uncertainty in attempting to make such restatements.
Correspondingly, management elected to record in the period discovered certain
immaterial errors discovered during 1993 which related to prior periods, to
assure effective disclosure of amounts which have otherwise been deemed
immaterial in relation to partners' capital.
3. INVESTMENT PROPERTIES:
----------------------
As of March 31, 1995, the Partnership owned 22 fully constructed fast-food
restaurants and a parcel of undeveloped land. The restaurants are comprised of
the following: two (2) Chi Chi's Mexican restaurants, four (4) Taco Cabana
restaurants, six (6) Denny's restaurants, seven (7) Popeye's Famous Fried
Chicken restaurants, one (1) Hardee's restaurant, one (1) former Porterhouse
restaurant, and one (1) future Fazoli's restaurant. The 22 properties are
located in seven (7) states.
The undeveloped land is located in Colorado Springs, Colorado, and was
originally purchased in contemplation of constructing and leasing a Rocky
Rococo's restaurant. The land was purchased from a former affiliate of the
Partnership in 1987. As part of the purchase, the former affiliate agreed to
reimburse the Partnership for any costs to carry the property while the land
remained unimproved and nonearning. The construction never commenced and the
former affiliate has not fully reimbursed the Partnership for its costs. The
unreimbursed costs include guaranteed monthly rent, real estate taxes,
insurance, and additional items required to maintain the property. At March 31,
1995 and December 31, 1994, these costs totalled approximately $184,000 and
$169,000, respectively, and are not reflected in the Partnership's financial
statements. Management is currently negotiating a contract to sell the
undeveloped parcel. The land was originally purchased for $356,549 and has an
adjusted carrying value at March 31, 1995, of $250,000 which approximates the
estimated net realizable value.
From time to time, the Partnership experiences interruptions in rental receipts
due to tenant delinquencies and vacancies. During March 1994, the Partnership's
Happy Joe's restaurant located in Des Moines, Iowa, became vacant. Management
executed a new lease on the property during February 1995 with Fazoli's
restaurant. In September 1994, the Partnership's Denny's restaurant in Hopkins,
Minnesota, was closed by the tenant. However, the tenant continues to pay rent
and has executed a lease with a sub-tenant. During January 1995, the
Partnership evicted the tenant and took possession of the Porterhouse restaurant
in Chicago, Illinois. The tenant in this property has been delinquent and in
bankruptcy throughout 1994. Management has listed the property for re-lease.
The total cost of the investment properties and equipment includes the original
purchase price plus acquisition fees and other capitalized costs paid to a
former affiliate of the general partners.
Prior to 1992, depreciation of the properties was provided on a straight-line
basis over estimated useful lives of 20 to 25 years which generally approximated
the lease terms. Beginning January 1, 1992, the Partnership prospectively
revised the remaining lives of its properties to 31.5 years which management
believes is a better representation of the estimated useful lives of the
buildings and improvements.
The Partnership's investment properties had been managed by an affiliate of the
former general partners pursuant to a management agreement which provided for a
fee equal to 1% of gross receipts. In addition, the former general partner
affiliate was entitled to receive reimbursements of general and administrative
costs, either direct or indirect. As a result of the Investigation, the
Partnership engaged a third party as Interim Manager in October 1992.
Subsequent to the appointment of the Permanent Manager, effective February 8,
1993, these services were being provided by the Permanent Manager for an overall
fee equal to 4% of the gross receipts, with a maximum reimbursement for the
office rent and related office overhead of $25,000 between the three affiliated
Partnerships as provided in the Permanent Manager Agreement ("PMA"). On May 26,
1993, the Permanent Manager, TPG, replaced
8
<PAGE>
the former general partners as the new General Partner as provided for in an
amendment to the Partnership Agreement dated May 26, 1993. Pursuant to
amendments to the Partnership Agreement, TPG continues to provide management
services for the same fee structure as provided in the PMA mentioned above.
Effective March 1, 1995, the minimum management fee and the maximum
reimbursement for office rent and overhead increased by 2.7%, 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
$2,991 to date on the amounts recovered.
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 unaware 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 would 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,
as defined, in an amount equal to 10.5% 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 14% per annum, cumulative simple return thereon 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
of this clause, and (c) then, to Limited Partners, 88%, and to the General
Partners, 12%, of remaining Net Proceeds available for distribution.
Under the terms of the Partnership Agreement, the General Partners were
obligated to create and contribute to an escrow fund an amount equal to 25% of
Net Cash Receipts distributed to the General Partners. At December 31, 1993,
the General Partner had contributed $1,974 to the fund. The fund was to be used
to repurchase interests of Limited Partners that exhibited hardship, at the
determination of the General Partner, and for distributions to the Limited
Partners upon final dissolution of the Partnership to permit the Limited
Partners to receive an amount equal to their Liquidation Preference of 14% per
annum. During 1994, it was determined that the amounts being funded to the
escrow fund were immaterial, and the fund was eliminated. Amounts paid to the
escrow fund were returned to the Partnership.
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 the 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
9
<PAGE>
a distribution from Net Cash Receipts in an amount equal to 10.5% 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 it 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 of 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 14% per annum, cumulative simple return therein 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 except to the extent needed by the General Partner to pay its
federal and state income tax on the income allocated to it 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 at recovering the funds misappropriated by the former general partners.
(See Note 10.)
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 a percentage of gross sales in excess of specified sales
levels. 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:
<TABLE>
<CAPTION>
Year ending
December 31,
<S> <C>
1995 1,671,784
1996 1,671,784
1997 1,671,784
1998 1,633,700
1999 1,635,900
Thereafter 13,294,258
-----------
$21,579,210
===========
</TABLE>
10
<PAGE>
6. MORTGAGE NOTES PAYABLE:
-----------------------
At March 31, 1995, mortgage notes payable consist of the following:
<TABLE>
<CAPTION>
Outstanding
Principal Balance Interest Rate Maturity Date
----------------- -------------- ----------------
<S> <C> <C>
a. 296,519 prime + 2.5% September, 1997
b. 257,161 9.5% September, 1997
c. 600,000 prime + 2.0% August, 1992
----------
$1,153,680
==========
</TABLE>
a. In September 1992, the Partnership entered into a promissory note
agreement with Riverside Bank, Minnesota, in the amount of $310,000.
The note bears interest at the referenced prime rate, as defined, plus
2.5%. Principal and interest are paid in monthly installments of
$3,285 until September 1997, when all outstanding amounts are due.
The note is secured by a mortgage on a Denny's restaurant located in
Hopkins, Minnesota, with a net book value at March 31, 1995 of
$653,048. The proceeds of the note were used to convert a Rocky
Rococo restaurant to a Denny's restaurant.
b. In September 1992, the Partnership entered into a loan agreement with
Bank One, Beaver Dam, Wisconsin, in the amount of $270,000. The loan
bears interest at 9.5% and is payable in monthly installments of
$2,520 through September 1997, with a lump-sum amount of $239,747 due
at that time. The loan is secured by a mortgage on a Denny's
restaurant located in Beaver Dam, Wisconsin, with a net book value at
March 31, 1995, of $504,838. The proceeds of the loan were used to
convert a Rocky Rococo restaurant to a Denny's restaurant.
c. During the Investigation, discussed in Note 2, it was discovered that
the former general partners borrowed $600,000 during or before 1991
from Metro North State Bank in Missouri (now Boatmen's First National
Bank of Kansas City) secured by mortgages on five (5) Partnership
properties. The mortgage note bears interest at the referenced prime
rate, as defined, plus 2% and was due August 15, 1992. The proceeds
of the note were not received by the Partnership and, accordingly, a
corresponding amount due from former affiliates was recorded in 1992.
As of March 31, 1995, the Partnership has not paid debt service on
this note. Management has met with representatives of the bank and
has disputed the obligation. The Partnership received a notice of
default on this note in October 1993 and an action of foreclosure was
filed in February 1994 on one of the Partnership's properties located
in Dallas, Texas, with a net book value of $1,220,977 at March 31,
1995. See Note 13 for further discussion of litigation concerning
this note. Interest in the amount of $134,000 was accrued, but
unpaid, as of March 31, 1995.
Scheduled maturities of all notes payable, with the exception of the
$600,000 note payable mentioned above, are as follows:
<TABLE>
<CAPTION>
Year Ending
December 31,
<S> <C>
1995 $ 12,114
1996 15,261
1997 526,305
--------
$553,680
========
</TABLE>
11
<PAGE>
7. TRANSACTIONS WITH FORMER AFFILIATES AND CURRENT GENERAL PARTNER:
----------------------------------------------------------------
Amounts paid to the current General Partner for the three months ended March 31,
1995 and 1994, are as follows:
<TABLE>
<CAPTION>
Incurred as of Unpaid at Incurred as of
Current General Partner March 31, 1995 March 31, 1995 March 31, 1994
- - - - - ----------------------- -------------- -------------- --------------
<S> <C> <C> <C>
Management fees $21,625 $ (135) $25,809
Restoration fees 135 0 606
Overhead allowance 1,813 0 1,794
Reimbursement for out-of-pocket expenses 2,183 0 792
Cash distribution 1,150 1,150 1,618
------- ------ -------
$26,906 $1,015 $30,619
======= ====== =======
</TABLE>
8. NET INVESTMENT IN DIRECT FINANCING LEASES:
------------------------------------------
The net investment in direct financing leases which includes the Partnership's
specialty leasehold improvement leases, is composed of the following as of
March 31, 1995:
<TABLE>
<S> <C>
Minimum lease payments receivable $371,187
Less - Unearned income (78,800)
--------
Net investment in direct financing leases $292,387
========
</TABLE>
Scheduled future minimum lease payments are as follows:
<TABLE>
<CAPTION>
Year ending
December 31,
<S> <C>
1995 $ 56,790
1996 75,720
1997 75,720
1998 75,720
1999 75,720
Thereafter 11,517
--------
$371,187
========
</TABLE>
9. GENERAL AND ADMINISTRATIVE EXPENSES:
------------------------------------
For the three months ended March 31, 1995 and 1994, general and administrative
expenses incurred by the Partnership were as follows:
<TABLE>
<CAPTION>
1995 1994
------- -------
<S> <C> <C>
Communication costs $ 7,607 $ 7,934
Travel costs 400 2,060
Overhead allowance 1,813 1,794
Other administration 1,119 3,059
Income tax expense 3,365 0
------- -------
$14,304 $14,847
======= =======
</TABLE>
12
<PAGE>
10. 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 are to be escrowed until the aggregate
amount of recovery for 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 escrowed amounts will be paid to the current General Partner.
At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining
escrowed 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 escrowed 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. The amount allocated to the
Partnership may be owed to the current General Partner if the above noted
recovery levels are met. As of March 31, 1995, the Partnership may owe the
current General Partner $7,349, which is currently reflected as a recovery, if
certain specified recovery levels are achieved.
11. PMA INDEMNIFICATION TRUST:
--------------------------
The Permanent Manager Agreement ("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, 1995. Funds are invested in U.S. Treasury
securities. In addition, interest totaling $5,822 has been credited to the
Trust as of March 31, 1995. 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.
12. RESTORATION TRUST ACCOUNT; EXPENSE ALLOCATIONS; AND RELATED
-----------------------------------------------------------
INTER-PARTNERSHIP RECEIVABLES:
------------------------------
Restoration costs represent expenses incurred by the Partnership in relation to
the misappropriated assets by the former general partners and their affiliates.
These costs are allocated among the Partnerships based on each partnership's
respective share of the entire misappropriation, as currently quantified. The
amount of misappropriation for each partnership is adjusted annually to reflect
new discoveries and more accurate quantification of amounts based on the
continuing Investigation. Such adjustments will result in periodic adjustments
to prior allocations of recovery costs to reflect updated information.
Consequently, previous payments for restoration expenses may not be consistent
with modified allocations. Based on modified allocations adjusted as of
December 31, 1993, the Partnership was owed $295,053 from DiVall 3 for amounts
paid on its behalf. Such amounts are reflected on the balance sheet as due from
affiliated partnerships. During 1994, the Partnership made an additional
adjustment increasing the amount due from DiVall 3 by $5,346. These amounts
have been offset by $158,046 received from DiVall 3. At March 31, 1995, the
Partnership was owed $142,353 from DiVall 3.
When recoveries are realized by the Partnerships, the amounts received are
distributed to each respective partnership on the same basis as the restoration
costs are currently being allocated. Additionally, any available recovery funds
have been utilized first to satisfy amounts due other partnerships for amounts
advanced under prior allocation methods. As of March 31, 1995, the
13
<PAGE>
Partnerships recovered a total of $546,695 from the former general partners and
their affiliates. Of this amount, the Partnership received its pro-rata share
in the amount of $67,441. Additionally, $57,143, representing 50% of all
disposition fees earned by the General Partner have been paid to the recovery.
Of that amount, $7,349 was allocated to the Partnership and is contingently
payable to the General Partner upon achievement of certain recovery levels as
described in Note 10.
The PMA contemplated that the Permanent Manager could establish a separate and
distinct Restoration Trust Fund which would hold all recoveries until a final
independent adjudication by a court of competent jurisdiction or vote of the
Limited Partners ratified the allocation of proceeds to each respective
partnership. Management has concluded that a fair and reasonable interim
accounting for recovery proceeds can be accomplished at the partnership level in
a manner similar to restoration costs which are paid directly by the
Partnerships. Management reserves the right to cause the final allocation of
such costs and recoveries to be determined either by a vote of the Limited
Partners or a court of competent jurisdiction. Potential sources of recoveries
include third party litigation, promissory notes, land contracts, and personal
assets of the former general partners and their affiliates.
13. LITIGATION:
-----------
On March 16, 1993, the Partnership, along with DiVall 2 and DiVall 3, initiated
a lawsuit against Ernst & Young LLP ("E & Y"), a certified public accounting
firm, in the Circuit Court of Dane County, Wisconsin in connection with the
audits of the Partnerships performed by E & Y for the years 1989, 1990 and 1991.
The Complaint filed in said lawsuit alleges, among other things, that Defendant
E & Y, was negligent in its audit work for the Partnerships by failing to
exercise ordinary care and failing to adhere to professional standards in the
following areas: reviewing, understanding, and auditing of compliance with the
Partnership Agreements; evaluation of the adequacy of internal controls;
identification of audit risks; selection and implementation of audit procedures
to address audit risks; identification of related party transactions;
compilation of sufficient evidential matters; resolution of improper transfers
and allocations; disclosure of related party transactions; and exercise of
appropriate audit skepticism. The Partnerships request the payment of damages
in the amount of $9,000,000, plus interest, attorneys fees and costs, and
whatever additional relief the court deems just and proper. E & Y filed an
Answer denying that it was negligent, and discovery is in process.
E & Y also filed third-party claims alleging fraud and negligence on the part of
the Partnerships' former law firm, Quarles & Brady. Additionally, E & Y also
filed third-party claims against Paul Magnuson, Gary DiVall, an affiliate of the
former general partners, DiVall Real Estate Investment Corporation ("DREIC"),
David Shea ("Shea") (former Acquisitions Director of DREIC), and Lisa Shatrawka
(former Controller for DREIC and former Director of Fund Management with TPG).
In turn, Quarles & Brady has filed third-party claims against KPMG Peat Marwick,
the predecessor accountants to E & Y. The Partnerships have filed claims
against Magnuson, DiVall, DREIC, Shea, and Quarles & Brady. E&Y's claims
against Ms. Shatrawka were recently voluntarily dismissed.
The Partnerships have hired legal counsel under a contingent fee arrangement to
prosecute all of the Partnerships' claims. Because the spouse of a partner at
Quarles & Brady is a judge in Dane County, it was recently determined that the
case will be heard before a judge who sits in neighboring Iowa County.
As part of the Permanent Manager Agreement, DiVall, Magnuson, and entities owned
by them, granted the Partnership a security interest in certain promissory notes
and mortgages from other DiVall related entities (the "Private Partnerships").
In the aggregate, the face amount of these notes were equal to a minimum of
$8,264,932. In addition, DiVall, Magnuson, and related entities owned by them,
granted the Partnership a security interest in their general partner interests
in the Private Partnerships. The foregoing security interests were to secure
the repayment of the funds which were diverted by DiVall and Magnuson from the
Partnership. The Partnership shares such security interests with DiVall 2 and
DiVall 3. These promissory notes and mortgages are not recorded on the balance
sheets of the Partnerships, but are recorded as recoveries on a cash basis upon
settlement.
14
<PAGE>
On July 23, 1993, nineteen (19) of the Private Partnerships sought the
protection of the Bankruptcy Court in the Eastern District of Wisconsin. Seven
(7) of these bankruptcies were voluntary and twelve (12) of these bankruptcies
were involuntary. Several of the Private Partnerships seeking bankruptcy owe
promissory notes to DiVall, Magnuson, or entities owned by them, in which the
Partnership has a security interest. These cases were subsequently transferred
to the Western District Bankruptcy Court located in Madison, Wisconsin.
The Partnership's experience in those bankruptcy cases that have concluded,
either through the approval of Plans of Reorganization, dismissal of the
bankruptcies, settlements or a combination of the foregoing, is that (i) the
collectibility of the obligations of the Private Partnerships assigned to the
Partnership has been significantly reduced and (ii) the value of the General
Partner interests in such Private Partnerships is often of little economic
value. The Partnership's recoveries in these bankruptcies have, to date, been
on a steeply discounted basis. Management anticipates that the recoveries in
the remaining unresolved bankruptcies are likely to also be on a deeply
discounted basis.
Plans of reorganization have been filed in some of the bankruptcies, and
settlement agreements in many of the Private Partnerships have been reached.
Settlements in nine (9) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $515,000 and notes secured by
subordinated mortgages in the aggregate amount of $275,000. The Partnership is
continuing to vigorously defend its interests in the remaining bankruptcies.
On March 24, 1994, the Partnership filed a complaint in the United States
District Court for the Western District of Missouri against Boatmen's First
National Bank of Kansas City ("Boatmen's") seeking a declaratory judgment that
Boatmen's has no right or interest in a promissory note executed in the name of
the Partnership by the former general partners (the "Note") secured by mortgages
on five Partnership properties, and further seeking an injunction against
foreclosure proceedings instituted against a Partnership property located in
Dallas, Texas, under a first deed of trust and security agreement given to
secure the Note (the "Foreclosure"). As further described in Note 6, the former
general partners borrowed $600,000 during or before 1991 from Metro North State
Bank (now Boatmen's). The proceeds of the Note were not received by the
Partnership. As of March 31, 1995, the Partnership had not paid debt service on
the Note. The Partnership received a notice of default on the Note in October
1993 and the Foreclosure Action was filed in February 1994. As of March 31,
1995, interest in the amount of $134,000 was accrued, but unpaid, on the Note.
Boatmen's has agreed to stay its foreclosure proceedings. Boatmen's answered
the complaint and filed a motion for summary judgment to which the Partnership
responded. Boatmen's motion for summary judgment was granted. The Partnership
has appealed the summary judgment to the United States Court of Appeals for the
Eighth Circuit and briefs have been filed. Pursuant to the Restoration Trust
Account procedures described in Note 12, all of the Partnerships are sharing the
expenses of this litigation and any recoveries resulting effectively from the
partial or full cancellation of the alleged indebtedness will be allocated among
the three Partnerships on the same basis as the restoration costs are currently
being allocated via appropriate payments by the Partnership to its affiliated
Partnerships.
14. 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 $789,906.
Because any amount payable to the former general partners with respect to their
capital accounts is subject to (a) the satisfaction of certain preferential
return requirements for the Limited Partners (See Note 4); and (b) the
assignment of such amounts to the Partnerships with respect to the amounts due
to the Partnerships from the former general partners, payment to the former
general partners with respect to their capital account balances as of May 26,
1993, is highly remote. In the unlikely event that the Partnership would owe
the former general partners any residual amount, such amounts would be due the
restoration fund for the benefit of all the Partnerships, and therefore
represent a contingent liability. At December 31, 1993, the former general
partners' capital account balance in the amount of $789,906 was reallocated to
the Limited Partners.
15
<PAGE>
15. SUBSEQUENT EVENTS:
------------------
On May 15, 1995, the Partnership made distributions to the Limited Partners of
$285,000 amounting to $11.40 per limited partnership interest.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
- - - - - --------------------------------
INVESTMENT PROPERTIES AND NET INVESTMENT IN DIRECT FINANCING LEASES
- - - - - -------------------------------------------------------------------
The investment properties, including equipment held by the Partnership at March
31, 1995, were originally purchased at a price, including acquisition costs, of
approximately $20,136,000.
The Partnership did not sell any investment properties during the first quarter
of 1995. However, the Partnership is currently negotiating a possible sale of
the vacant land in Colorado Springs, Colorado. The Partnership executed a lease
on the former Happy Joe's restaurant in Des Moines, Iowa during February 1995
and is pursuing various lease options for the Porterhouse restaurant in Chicago,
Illinois.
The net investment in direct financing leases, which includes the Partnership's
specialty leasehold improvement leases, amounted to $292,000 at March 31, 1995,
compared to $304,000 at December 31, 1994. The decrease of $12,000 was a result
of principal payments received during the quarter.
OTHER ASSETS
- - - - - ------------
Cash and cash equivalents, including cash restricted for real estate taxes held
by the Partnership, were $593,000 at March 31, 1995, compared to $1,176,000 at
December 31, 1994. The decrease is primarily due to the fourth quarter 1994
distribution in the amount of $675,000 paid to the Limited Partners during the
first quarter of 1995. The Partnership designated cash of $285,000 to fund the
First Quarter 1995 distributions to Limited Partners, $180,000 for the payment
of quarter-end accounts payable and accrued expenses, and the remainder
represents reserves deemed necessary to allow the Partnership to operate
normally, should any significant unforseen costs occur. Cash generated through
the operations of the Partnership's investment properties, sales of investment
properties and any recoveries of misappropriated funds by the former general
partners 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 and deposited $100,000 in the Trust during 1993 and
$90,000 during 1994. The provision to establish the Trust was included in the
Permanent Manager Agreement for the indemnification of The Provo Group, Inc.
(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. The Partnership completed the funding of the Trust
with an additional $60,000 during the First Quarter of 1995. For additional
information regarding the Trust, refer to Note 11 to the financial statements
included in Item 1 of this report.
DUE FROM AFFILIATED PARTNERSHIPS, DUE FROM FORMER AFFILIATES, ALLOWANCE FOR
- - - - - ---------------------------------------------------------------------------
UNCOLLECTIBLE AMOUNTS DUE FROM FORMER AFFILIATES, AND DEFERRED INCOME
- - - - - ---------------------------------------------------------------------
Due from former affiliates represented misappropriated assets due from the
former general partners and their affiliates in the amount of $1,141,000 at
March 31, 1995. The receivable decreased from December 31, 1994, due to $3,000
of recoveries received during the quarter from the former general partners and
their affiliates.
The Partnership maintains a record of costs incurred in identifying or
recovering the misappropriated assets. These amounts are expensed when
incurred, and then, recorded on the balance sheet as a restoration cost
receivable with a corresponding allowance for such receivable deemed
uncollectible. These costs are considered due from the former general partners
and their affiliates. Interest has been accrued on the misappropriated funds
since January 1, 1993, at a rate of 9% per annum and has been included in the
restoration cost receivable. The receivable increased from approximately
$606,000 at December 31, 1994, to $657,000 at March 31, 1995, and includes
$323,000 of cumulative accrued interest.
16
<PAGE>
The current General Partner intends to vigorously pursue recovery of the
misappropriated funds from the various sources and initially estimated a range
of recovery with an estimated floor of $3 million for the Partnerships.
Accordingly, an allowance has been established against amounts due from the
former general partners and their affiliates reflecting the current General
Partner's original estimate of potential loss from misappropriated amounts.
This allowance has been allocated among the Partnerships based on each
Partnership's pro rata share of the total misappropriation. The amount of the
allowance was unchanged at March 31, 1995. Pending the outcome of litigation
and other matters affecting the sources of potential recovery, it is not
possible to determine the amount that will ultimately be recovered. The
ultimate recovery may differ from the current estimate.
The restoration costs are allocated among the Partnerships based on each
Partnership's respective share of the misappropriation as discussed in Note 12
to the financial statements included in Item 1 of this report. The allocation
is adjusted annually to reflect any changes in the entire misappropriation. The
Partnership's percentage of the allocation was reduced in 1993. Consequently,
the Partnership had been paying more than its pro rata share of the costs.
Accordingly, the Partnership recorded a receivable at December 31, 1993, in the
amount of $295,000, due from DiVall 3 with a corresponding reduction reflected
in professional expenses relating to the Investigation, general partner removal
expenses, and interim fund manager fees and expenses. During 1994 and 1995,
recoveries allocated to DiVall 3 were used to partially repay amounts owed to
the Partnership. At March 31, 1995, the remaining amount due from DiVall 3 was
$142,000.
As a result of the misappropriation and material weaknesses in the internal
control structure of the Partnership prior to February 8, 1993, there can be no
assurance that all transactions recorded by the Partnership prior to February 8,
1993, were appropriate transactions of the Partnership and properly reflected in
the accompanying financial statements of the Partnership or that all
transactions of the Partnership prior to February 8, 1993, including improper
and unsupported transactions, have been identified and reflected in the
accompanying financial statements of the Partnership as of March 31, 1995.
LIABILITIES
- - - - - -----------
Accounts payable and accrued expenses at March 31, 1995, amounted to
approximately $39,000. The majority of this balance represented quarter-end
accruals of legal and auditing fees.
Payable to Tenant of $144,000 at December 31, 1994, represents a portion of the
monthly payments received from a tenant which must be refunded to them, due to
their not achieving specified sales goals. This amount was returned to the
tenant during January, 1995.
Real estate taxes payable amounted to $56,000 at March 31, 1995, compared to
$133,000 at December 31, 1994. The decrease is primarily a result of amounts
accrued for 1994 taxes on vacant properties which were paid during the first
quarter of 1995.
PARTNERS' CAPITAL
- - - - - -----------------
Net income for the quarter was allocated between the current 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 included in Item 1 of this report.
The former general partners' capital account balance was reallocated to the
Limited Partners at December 31, 1993. Refer to Note 14 to the financial
statements included in Item 1 of this report for additional information
regarding the reallocation.
Cash distributions paid to the Limited Partners and to the current General
Partner during 1995 of $675,000 and $1,150, respectively, have also been made in
accordance with the amended Partnership Agreement. The First Quarter 1995
distribution of $285,000 was paid to the Limited Partners on May 15, 1995.
RESULTS OF OPERATIONS:
- - - - - ----------------------
Management believes that the financial results of the quarter are not indicative
of "normal" Partnership operations. There are many events which occurred since
the discovery of the misappropriations in 1992 which have had a
17
<PAGE>
negative impact on financial results. Some of these events will continue to
have a negative impact on the Partnership in the future.
The Partnership reported net income for the quarter ended March 31, 1995, in the
amount of $288,000 compared to $303,000 for the quarter ended March 31, 1994.
Results for both periods were less than would be expected from "normal"
operations, primarily because of costs associated with the misappropriation of
assets by the former general partners and their affiliates.
REVENUES
- - - - - --------
Total revenues were $509,000, and $596,000 for the quarters ended March 31, 1995
and 1994, respectively. Revenue decreased from 1994 to 1995, primarily due to
the sale of three (3) Wendy's restaurants in Florida during the fourth quarter
of 1994. Additionally, during the first quarter of 1994, a $31,000 expense
accrual from the prior year was reversed and credited to other income.
Based on leases currently in place on the remaining owned properties, total
revenues should approximate $1,950,000 annually or $487,500 quarterly. 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.
EXPENSES
- - - - - --------
For the quarters ended March 31, 1995 and 1994, cash expenses amounted to
approximately 25% and 31% of total revenues, respectively. Total expenses,
including non-cash items, amounted to approximately 44% and 49% of total
revenues for the quarters ended March 31, 1995 and 1994, respectively. Items
negatively impacting expenses during the periods include expenses incurred
primarily in relation to the misappropriation of assets by the former general
partners and their affiliates, interest expense, and real estate taxes.
For the quarters ended March 31, 1995 and 1994, expenses incurred in relation to
the misappropriated assets amounted to $12,000 and $29,000, respectively.
Future expenses incurred in relation to the misappropriation will continue to
have a negative impact on the Partnership. Management has estimated that these
expenses will approximate $65,000 for the year ending December 31, 1995.
Interest expense for the first quarter of 1995 amounted to $27,000 compared to
$59,000 for the same period in 1994. Three notes repaid during November 1994,
had a favorable affect on interest expense during 1995.
As noted above, management believes the Partnership's operations have yet to
stabilize to what could be considered normal, due to the negative impact of the
costs related to the recovery of the misappropriated assets. However, these
"recovery costs" are being minimized currently as indicated by the comparative
results of the Partnership's statements of income, and will continue to be
minimized in the future.
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,
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, the assets of the Partnership's
portfolio should perform more like marketable bonds. In other words, asset
values generally move inversely with interest rates.
18
<PAGE>
PART II - OTHER INFORMATION
ITEM 2. LEGAL PROCEEDINGS
On March 16, 1993, the Partnership, along with DiVall 2 and DiVall 3 initiated a
lawsuit against Ernst & Young LLP ("E & Y"), a certified public accounting firm,
in the Circuit Court of Dane County, Wisconsin, in connection with the audits of
the Partnerships performed by E & Y for the years 1989, 1990 and 1991. The
Complaint filed in said lawsuit alleges, among other things, that Defendant E &
Y was negligent in its audit work for the Partnerships by failing to exercise
ordinary care and failing to adhere to professional standards in the following
areas: reviewing, understanding, and auditing of compliance in regards to the
Partnership Agreements; evaluation of the adequacy of internal controls;
identification of audit risks; selection and implementation of audit procedures
to address audit risks; identification of related party transactions;
compilation of sufficient evidential matters; resolution of improper transfers
and allocations; disclosure of related party transactions; and exercise of
appropriate audit skepticism. The Partnerships request the payment of damages
in the amount of $9,000,000, plus interest, attorneys fees and costs, and
whatever additional relief the court deems just and proper. E & Y filed an
Answer denying that it was negligent, and discovery is in process.
E & Y also filed third-party claims alleging fraud and negligence on the part of
the Partnerships' former law firm, Quarles & Brady. E & Y also filed third-
party claims against Paul Magnuson, Gary DiVall, an affiliate of the former
general partners, DiVall Real Estate Investment Corporation ("DREIC"), David
Shea ("Shea") (former Acquisitions Director for DREIC), and Lisa Shatrawka
(former Controller for DREIC and former Director of Fund Management with TPG).
In turn, Quarles & Brady has filed third party claims against KPMG Peat Marwick,
the predecessor accountants to E&Y. The Partnerships have filed claims against
Magnuson, DiVall, DREIC, Shea, and Quarles & Brady. E&Y's claims against Ms.
Shatrawka were recently voluntarily dismissed.
The Partnerships have hired legal counsel under a contingent fee arrangement to
prosecute all of the Partnerships' claims. Because the spouse of a partner at
Quarles & Brady is a judge in Dane County, it was recently determined that the
case will be heard before a judge who sits in neighboring Iowa County.
As part of the Permanent Manager Agreement, DiVall, Magnuson, and entities owned
by them, granted the Partnership a security interest in certain promissory notes
and mortgages from other DiVall related entities (the "Private Partnerships").
In the aggregate, the face amount of these notes were equal to a minimum of
$8,264,932. In addition, DiVall, Magnuson, and related entities owned by them,
granted the Partnership a security interest in their general partner interests
in the Private Partnerships. The foregoing security interests were to secure
the repayment of the funds which were diverted by DiVall and Magnuson from the
Partnership. The Partnership shares such security interests with DiVall 2 and
DiVall 3. These promissory notes and mortgages are not recorded on the balance
sheets of the Partnerships, but are recorded as recoveries on a cash basis upon
settlement.
On July 23, 1993, nineteen (19) of the Private Partnerships sought the
protection of the Bankruptcy Court in the Eastern District of Wisconsin. Seven
(7) of these bankruptcies were voluntary and twelve (12) of these bankruptcies
were involuntary. Several of the Private Partnerships seeking bankruptcy owe
promissory notes to DiVall, Magnuson, or entities owned by them, in which the
Partnership has a security interest. These cases were subsequently transferred
to the Western District Bankruptcy Court located in Madison.
The Partnership's experience in those bankruptcy cases that have concluded,
either through the approval of Plans of Reorganization, dismissal of the
bankruptcies, settlements or a combination of the foregoing, is that (i) the
collectibility of the obligations of the Private Partnerships assigned to the
Partnership has been significantly reduced and (ii) the value of the General
Partner interests in such Private Partnerships is often of little economic
value. The Partnership's recoveries in these bankruptcies have, to date, been
on a steeply discounted basis. Management anticipates that the recoveries in
the remaining unresolved bankruptcies are likely to also be on a deeply
discounted basis.
Plans of reorganization have been filed in some of the bankruptcies, and
settlement agreements in many of the Private Partnerships have been reached.
Settlements in nine (9) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $515,000 and notes secured by
subordinated mortgages in the aggregate
19
<PAGE>
amount of $275,000. The Partnership is continuing to vigorously defend its
interests in the remaining bankruptcies.
The Partnerships have been named as defendants in certain foreclosure actions
brought in state courts in Wisconsin. In each of these actions, the plaintiff
seeks to foreclose on real property owned by one of the Private Partnerships.
The Partnerships were named as subordinate lienholders on the properties. It is
believed that none of these cases constitute a claim against the individual
Public Partnerships. However, if the foreclosures are successful, the Private
Partnerships' interest in the underlying real estate may be extinguished,
rendering individual obligations to the Partnerships uncollectible. Such a
foreclosure has occurred in one instance, and is pending in at least one other
situation.
The Partnership is also pursuing collection actions against former tenants of
the Partnership and/or guarantors of former tenants of the Partnership arising
from defaults on their leases. Although the Partnership believes its claims are
valid, it is currently unknown whether the Partnerships will receive favorable
verdicts or whether any such verdicts will ultimately prove collectible.
On March 24, 1994, the Partnership filed a complaint in the United States
District Court for the Western District of Missouri against Boatmen's First
National Bank of Kansas City ("Boatmen's") seeking a declaratory judgment that
Boatmen's has no right or interest in a promissory note executed in the name of
the Partnership by the former general partners (the "Note") secured by mortgages
on five Partnership properties, and further seeking an injunction against
foreclosure proceedings instituted against a Partnership property located in
Dallas, Texas, under a first deed of trust and security agreement given to
secure the Note (the "Foreclosure"). As further described in Note 6 to the
Financial Statements included in Part I, Item 1 of this report, the former
general partners borrowed $600,000 during or before 1991 from Metro North State
Bank (now Boatmen's). The proceeds of the Note were not received by the
Partnership. As of March 31, 1995, the Partnership had not paid debt service on
the Note. The Partnership received a notice of default on the Note in October
1993, and the Foreclosure Action was filed in February 1994. As of March 31,
1995, interest in the amount of $134,000 had been accrued, but was unpaid on the
Note. Boatmen's has agreed to stay its foreclosure proceedings. Boatmen's
answered the complaint and filed a motion for summary judgment to which the
Partnership responded. Boatmen's motion for summary judgment was granted. The
Partnership has appealed the summary judgment to the United States Court of
Appeals for the Eighth Circuit and briefs have been filed. Pursuant to the
Restoration Trust Account procedures described in Note 12 to the Financial
Statements, included in Part I, Item 1 of this report, all of the Partnerships
are sharing the expenses of this litigation and any recoveries resulting
effectively from the partial or full cancellation of the alleged indebtedness
will be allocated among the three Partnerships on the same basis as the
restoration costs are currently being allocated via appropriate payments by the
Partnership to its affiliated Partnerships.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Listing of Exhibits:
28.0 Correspondence to the Limited Partners dated May 15, 1995 regarding
the first quarter 1995 distributions.
(b) Report on Form 8-K:
The Registrant filed no reports on Form 8-K during the first quarter of
fiscal year 1995.
20
<PAGE>
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, thereunto duly authorized.
DIVALL INSURED INCOME FUND LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: /s/ Bruce A. Provo
-------------------------------------------------
Bruce A. Provo, President
Date: May 15, 1995
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, 1995
By: /s/ Kristin J. Atkinson
----------------------------------
Kristin J. Atkinson
(Principal Financial and Accounting Officer)
Date: May 15, 1995
21
<PAGE>
May 15, 1995
RE: DIVALL INSURED INCOME FUND LP (THE "PARTNERSHIP")
FIRST QUARTER 1995 DISTRIBUTION CORRESPONDENCE
Dear Limited Partner:
Enclosed please find the following:
1. Your First Quarter 1995 distribution check amounting to approximately
$11.40 per unit representing both cash flow from operations as well as
"net" cash activity from financing and investing activities, as
presented on the Statements of Income and Cash Flow Changes;
2. Statements of Income and Cash Flow Changes for the three month period
ended March 31, 1995;
3. Property Summary with current updates as of March 31, 1995; and
4. Projected Statements of Income and Cash Flow Changes for the remaining
1995 quarterly periods.
FIRST QUARTER 1995 DISTRIBUTION
The Partnership is distributing $285,000 which represents $45,000 less than
projected for the period ended March 31, 1995. This decrease is primarily due
to a multi-store tenant's delinquency in rental income.
The $285,000 total distribution paid for the first quarter represents a
4.89% annualized return on the Partnership's "NET" REMAINING INITIAL INVESTMENT
of approximately $23,297,000 as shown on page 4.
STATEMENTS OF INCOME AND CASH FLOW CHANGES
The enclosed Statements of Income and Cash Flow Changes present results of
operations and related changes in cash flow for the first quarter ended March
31, 1995. The Partnership had net income of $288,000 which was $29,000 more than
projected for the three month period ended March 31, 1995, based on revenues of
$509,000 and expenses of $221,000.
The most significant cash flow variances from our projections are as
follows:
1. The Partnership had an increase in rents receivable in the amount of
$52,000. These delinquent rents, which included percentage rents,
were due from one (1) specific tenant with multiple stores.
<PAGE>
Letter to Limited Partners in DiVall Insured Income Fund LP
May 15, 1995
Page 2
2. Although there was an increase in rents receivable from a "delinquent"
tenant, the Partnership's rental income on an overall basis was
$22,000 higher than budgeted which was primarily due to receiving
higher percentage rents than planned from "non-delinquent" tenants.
Additionally, the Partnership received approximately $6,000 more than
was projected from other income. The increase in other income was
comprised of a gain on the sale of the Happy Joe's restaurant
equipment; registration transfer fees; and an accrual of a tenant's
late rent fees.
3. Partnership "operating expenses" were slightly higher than budgeted
this quarter as a result of legal fees related to specific tenant or
property issues as well as a final alignment of 1994 partnership audit
costs.
It should be noted that the Partnership's "investigation and
restoration expenses" were lower than budgeted for the three-month
period ended March 31, 1995.
4. The Partnership recovered a total of $3,400 in misappropriated monies
from the former general partners and their affiliates during the first
quarter.
The Partnership also received $7,000 from an affiliated partnership
for previously advanced restoration costs.
5. At March 31, 1995, the Partnership had an interest accrual (a non-cash
item that does not impact distributions) of $13,000 on the mortgage
note currently held at Boatmen's First National Bank of Kansas City,
Missouri.
Litigation continues between the Partnership and Boatmen's regarding
the Partnership's claim that it never received the original loan
proceeds from a mortgage note with a face amount of $600,000. The
decision to accrue the interest, but withhold payments until the
dispute is settled, remains the same. We are currently appealing the
matter with the 8th District Federal Court of Appeals in St. Louis,
Missouri.
Although operating revenues were higher than budgeted during the first
quarter, the higher operating expenses combined with a tenant's delinquent rent
from several stores prevented the Partnership from meeting its budgeted
distributions for the quarter.
PROPERTY SUMMARY
VACANCIES
At March 31, 1995, the Partnership had one (1) vacancy; the Porterhouse in
Chicago, Illinois.
Porterhouse: Chicago, Illinois
- - - - - -------------------------------
The Partnership took possession of this property in January 1995, as a
result of a past history of delinquency and bankruptcy issues. We currently
have a pending lease offer for this property.
<PAGE>
Letter to Limited Partners in DiVall Insured Income Fund LP
May 15, 1995
Page 3
RENTS RECEIVABLE
At March 31, 1995, the Partnership had rents receivable of approximately
$70,000 due from Bysom Enterprises, Inc. (tenant of seven (7) Popeye's
restaurants located in Chicago, Illinois). This receivable represents a $49,000
increase since year-end.
The receivable issue was exacerbated by poor sales during the winter months
of 1994 and 1995. We anticipate receiving a catch-up payment in May or June of
this year. However, we intend to invoke all our legal remedies during the
second quarter.
OTHER PROPERTY MATTERS
Colorado Land
- - - - - -------------
The Partnership has received an offer to purchase this land for $225,000.
The purchase offer is currently being negotiated between parties.
Former Denny's: Hopkins, Minnesota
- - - - - -----------------------------------
During the quarter, the Partnership signed a sub-lease with Buffalo Wings
(BW-3) restaurant. Although this former Denny's was a poor performer, the
Partnership did not experience any interruption of rent. Buffalo Wings (BW-3)
began rent payments on April 1, 1995.
Former Happy Joe's: Des Moines, Iowa
- - - - - -------------------------------------
The Partnership signed a lease with Fazoli's restaurant during the first
quarter. This property had been vacant since March 1994. Our future monthly
fixed rent (expected to commence by June of 1995) will approximate $3,800
compared with the former Happy Joe's $3,300 monthly rental payments.
Hardee's, Fond du Lac, Wisconsin
- - - - - --------------------------------
The tenant of this property, Terratron, Inc., experienced significant sales
difficulties throughout 1994 in addition to the anticipated normal "drop" in
sales that occurred during the winter months of 1995. The Partnership has
worked with this tenant in the past to accommodate the timing of their seasonal
cash flows.
During January and February of this year, a portion of the tenant's
scheduled rent payments were deferred by mutual agreement. In March, as agreed,
Terratron began "catching up" on the amounts deferred and a payment schedule
reflecting a total "catch-up" by September of 1995 has been approved. We
continue to work with this tenant very closely.
<PAGE>
Letter to Limited Partners in DiVall Insured Income Fund LP
May 15, 1995
Page 4
ADVISORY BOARD
The seventh Advisory Board meeting was held on May 2 and 3, 1995.
Representatives from Arthur Andersen & Co. and Popham, Haik, Schnobrich &
Kaufman, Ltd. were also in attendance at this meeting. Primary topics of
discussion included Former GP Affiliate Litigation; 1994 10-K's; 1994 Net Unit
Valuations; Overview of Funds; Results of Fund Operations for the First Quarter
of 1995; Property Disposition Updates; Restoration Updates; Partnership
Combination/Liquidation Alternatives; and Advisory Board Member Selection
Process.
RESTORATION
During the First Quarter of 1995, we continued to monitor the bankruptcy
proceedings of the DiVall "Private" Partnerships. The major focus of our
attention continues to relate to the litigation against Ernst & Young, Quarles &
Brady and Peat Marwick, the Partnerships' former auditors and attorneys. At the
request of a new judge from a different jurisdiction, THE TRIAL DATE FOR THIS
LAWSUIT HAS BEEN MOVED TO JANUARY 1996.
The Partnerships (DiVall Insured Income Fund LP, DiVall Insured Income
Properties 2 LP and DiVall Income Properties 3 LP) collected a combined total of
$26,300 during the First Quarter of 1995.
RETURN OF CAPITAL
The following table has been updated to illustrate the breakdown of
distributions since the Partnership's first quarterly distribution, for the
period ended December 31, 1986 through March 31, 1995.
<TABLE>
<CAPTION>
DISTRIBUTION CAPITAL
ANALYSIS BALANCE
------------- ------------
<S> <C> <C>
Original Capital Balance - $25,000,000
Cash Flow From Operations Since Inception $ 14,849,362 -
Distributions Since Inception (16,551,740) -
------------
(Return) of Capital $ (1,702,378) (1,702,378)
============ -----------
"NET" REMAINING INITIAL INVESTMENT
BY ORIGINAL PARTNERS - $23,297,622
===========
</TABLE>
<PAGE>
Letter to Limited Partners in DiVall Insured Income Fund LP
May 15, 1995
Page 5
QUESTION & ANSWER
1. HAS THERE BEEN ANY DECISION MADE AS TO WHEN THE PARTNERSHIP WILL BE
DISSOLVED OR WILL OFFER LIQUIDATION ALTERNATIVES TO THE LIMITED
PARTNERS?
As we indicated above, during our past Advisory Board meeting we
discussed partnership combination and liquidation alternatives for the
Partnerships (DiVall Insured Income Fund LP, DiVall Insured Income
Properties 2 LP, and DiVall Income Properties 3 LP).
At this point in time there has been no decision made with respect to
this issue, primarily due to the valuation uncertainties surrounding
our litigation against the Partnerships' former auditors and
attorneys.
We anticipate communicating more detailed information to you in 1996
on these matters.
Your next scheduled distribution correspondence for the Second Quarter of
1995 will be mailed on August 15, 1995. If you have any questions or need
additional information, please call Investor Relations at 1-800-547-7686 or 1-
608-829-2992.
Sincerely,
THE PROVO GROUP, INC.
By:____________________________________
Brenda Bloesch
Director of Investor Relations
By:____________________________________
Kristin J. Atkinson
Director of Finance
Enclosures
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1994
<PERIOD-START> JAN-01-1995
<PERIOD-END> MAR-31-1995
<CASH> 593,081
<SECURITIES> 255,822
<RECEIVABLES> 2,638,394
<ALLOWANCES> 1,639,111
<INVENTORY> 0
<CURRENT-ASSETS> 1,848,186
<PP&E> 19,675,494
<DEPRECIATION> 3,807,765
<TOTAL-ASSETS> 17,715,915
<CURRENT-LIABILITIES> 379,654
<BONDS> 1,153,680
<COMMON> 0
0
0
<OTHER-SE> 16,182,581
<TOTAL-LIABILITY-AND-EQUITY> 17,715,915
<SALES> 498,322
<TOTAL-REVENUES> 509,034
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 194,113
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 27,371
<INCOME-PRETAX> 287,550
<INCOME-TAX> 0
<INCOME-CONTINUING> 287,550
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 287,550
<EPS-PRIMARY> 11.39
<EPS-DILUTED> 11.39
</TABLE>
