<PAGE>
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 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
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Commission file number 0-17686
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1606834
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 W. 11th Street, Suite 1110, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(816) 421-7444
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report.)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Limited
Partnership
Interests
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting securities held by nonaffiliates
of the Registrant: The aggregate market value of limited partnership interests
held by nonaffiliates is not determinable since there is no public trading
market for the limited partnership interests.
Index to Exhibits located on page: 43 - 44
--------------------
<PAGE>
PART I
ITEM 1. BUSINESS
BACKGROUND
- ----------
The Registrant, DiVall Insured Income Properties 2 Limited Partnership (the
"Partnership"), is a limited partnership organized under the Wisconsin Uniform
Limited Partnership Act pursuant to an Agreement of Limited Partnership dated as
of November 18, 1987, and amended as of November 25, 1987, February 20, 1988,
June 21, 1988, February 8, 1993, May 26, 1993, and June 30, 1994. As of
December 31, 1995, the Partnership consisted of one General Partner and 2,756
Limited Partners owning an aggregate of 46,280.3 Limited Partnership Interests
(the "Interests") acquired at a public offering price of $1,000 per Interest
before volume discounts. The Interests were sold commencing February 23, 1988,
pursuant to a Registration Statement on Form S-11 filed under the Securities Act
of 1933 (Registration 33-18794) as amended. On June 30, 1989, the former
general partners exercised their option to extend the offering period to a date
no later than February 22, 1990. On February 22, 1990, the Partnership closed
the offering at 46,280.3 Interests ($46,280,300), providing net proceeds to the
Partnership after volume discounts and offering costs of $39,358,468.
The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate and recovering
the assets misappropriated by the former general partners and their affiliates.
The misappropriation is more fully discussed under Recent Developments. The
Properties are leased on a triple net basis to, and operated by, franchisors or
franchisees of national, regional, and local retail chains under long-term
leases. The lessees consist primarily of fast-food, family style, and
casual/theme restaurants, but also include a video rental store and a child care
center. At December 31, 1995, the Partnership owned 38 properties with
specialty leasehold improvements in 18 of these properties, as more fully
discussed in Item 2.
Prior to the disposal of the Properties, the Partnership's return on its
investment will be derived principally from rental payments received from its
lessees. Therefore, the Partnership's return on its investment is largely
dependent, among other factors, upon the business success of its lessees. The
business success of the Partnership's individual lessees can be adversely
affected on three general levels. First, the tenants rely heavily on the
management contributions of a few key entrepreneurial owners. The business
operations of such entrepreneurial tenants can be adversely affected by death,
disability or divorce of a key owner, or by such owner's poor business decisions
such as an undercapitalized business expansion. Second, changes in a local
market area can adversely affect a lessee's business operation. A local economy
can suffer a downturn with high unemployment. Socioeconomic neighborhood
changes can affect retail demand at specific sites, and traffic patterns may
change, or stronger competitors may enter a market. These and other local
market factors can potentially adversely affect the lessees of Partnership
properties. Finally, despite an individual lessee's solid business plans in a
strong local market, the chain concept itself can suffer reversals or changes in
management policy which in turn can affect the profitability of operations for
Partnership properties. Therefore, there can be no assurance that any specific
lessee will have the ability to pay its rent over the entire term of its lease
with the Partnership.
Since 95% of the Partnership's investment in properties and equipment involves
restaurant tenants, the restaurant market is the major market segment with a
material impact on Partnership operations. It would appear that the management
skill and potential operating efficiencies realized by Partnership lessees will
be a major ingredient for their future operating success in a very competitive
restaurant and food service marketplace.
2
<PAGE>
There is no way to determine with any certainty which, if any, tenants will
succeed or fail in their business operations over the term of their respective
leases with the Partnership. It can be reasonably anticipated that some lessees
will default on future lease payments to the Partnership which will result in
the loss of expected lease income for the Partnership. Management will use its
best efforts to vigorously pursue collection of any defaulted amounts and to
protect the Partnership assets and future rental income potential by trying to
re-lease any properties with rental defaults. External events which could
impact the Partnership's liquidity are the entrance of other competitors into
the market areas of our tenants; liquidity and working capital needs of the
leaseholders; and failure or withdrawal of any of the national franchises held
by the Partnership's tenant. Each of these events, alone or in combination,
would affect the liquidity level of leaseholders resulting in possible default
by the tenant. Since the information regarding plans for future liquidity and
expansion of closely held organizations, which are tenants of the Partnership,
tend to be of a private and proprietary nature, anticipation of individual
liquidity problems is difficult, and prediction of future events is nearly
impossible.
RECENT DEVELOPMENTS
- -------------------
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 Fund Limited Partnership ("DiVall
1") 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. The aggregate
amount of the misappropriation, related costs and 9% interest accrued since
January 1, 1993, is in excess of $15,700,000, of which $6,353,000 has been
allocated to the Partnership.
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 to
the Partnerships. As reported in the Partnership's report on Form 8-K dated
May 26, 1993, effective as of that date, the Limited Partners, by written
consent of a majority of interests, elected the Permanent Manager, TPG, as
General Partner. Additional results of the solicitation included the approval
of the Permanent Manager Agreement ("PMA"), the acceptance of the resignations
of the former general partners, amendments to certain provisions of the
Partnership Agreement pertaining to general partner interests and compensation,
and an amendment of the Partnership Agreement providing for an Advisory Board
(the "Board").
THE PERMANENT MANAGER AGREEMENT
- -------------------------------
The PMA was entered into on February 8, 1993, between the Partnership, DiVall 1,
DiVall 3, the now former general partners DiVall and Magnuson, their controlled
affiliates, and TPG, naming TPG as the Permanent Manager. The PMA contains
provisions allowing the Permanent Manager to submit the PMA, the issue of
electing the Permanent Manager as General Partner, and the issue of acceptance
of the resignations of the former general partners to a vote of the Limited
Partners through a solicitation of written consents.
TPG, as the new General Partner, has been operating and managing the affairs of
the Partnership in accordance with the provisions of the PMA and the Partnership
Agreement, as amended.
3
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ADVISORY BOARD
- --------------
The concept of the Advisory Board was first introduced by TPG during the
solicitation of written consents for the Partnerships, and is the only type of
oversight body known to exist for similar partnerships at this time. The first
Advisory Board was appointed in October 1993 and held its first meeting in
November 1993. The four person Board is empowered to, among other functions,
review operational policies and practices, review extraordinary transactions,
and advise and serve as an audit committee to the Partnership and the General
Partner. The Advisory Board does not have the authority to direct management
decisions or policies of the Partnership or remove the General Partner. The
powers of the Board are advisory only. The Board has full and free access to
the Partnership's books and records, and individual Board members have the right
to communicate directly with the Limited Partners concerning Partnership
business. Members of the Board will be compensated $3,000 annually and $1,200
for each quarterly meeting attended.
The Board currently consists of a broker dealer representative, D. Todd
Witthoeft of Calton and Associates, Inc. and a Limited Partner from each of the
three Partnerships, Gerhard Zoller from DiVall 1, Michael Bloom from the
Partnership, and Dr. Albert Eschen from DiVall 3. The position of industry
representative was created for approximately a three (3) year period which ended
January 31, 1996. For a brief description of each Board member refer to Item
10, Directors and Executive Officers of the Registrant.
RESTORATION PLAN
- ----------------
TPG, since the commencement of its management of the Partnerships, has been
developing and implementing a strategy (the "Restoration Plan" or "Plan") for
recovering as much of the amounts misappropriated by the former general partners
and their affiliates as possible. The Plan currently focuses on recovery from
the following sources: (a) personal property, (b) promissory notes, (c) land
contracts, (d) litigation, and (e) PMA savings.
A. Personal Property. DiVall and Magnuson appear to have very few
unencumbered personal assets which would materially benefit the
Partnerships. The Partnerships have obtained security interests in
substantially all of DiVall and Magnuson's assets which have been
identified. The security interests include a mortgage on DiVall's
residence and surrounding farm land.
B. Promissory Notes. Pursuant to the PMA, DiVall, Magnuson, and entities
owned by them, granted the Partnership a security interest in certain
promissory notes and mortgages due from other DiVall related entities
(the "Private Partnerships"). Recovery of amounts due under these
notes is being vigorously pursued, but the amount of potential
recovery remains uncertain because many of the Private Partnerships
are currently involved in bankruptcy proceedings. See Item 3, Legal
Proceedings, for additional information regarding the bankruptcy
proceedings of the Private Partnerships.
C. Land Contracts. The Partnerships have been assigned two land
contracts from the Partnership's former general partners. These
contracts were not originally identified nor assigned in connection
with the PMA.
D. Litigation. The Partnerships have initiated lawsuits against the
Partnership's former auditors, former securities counsel, former
general partners and a former affiliate. Refer to Item 3, Legal
Proceedings, and Note 13 to the financial statements included in Item
8 for additional information concerning the settlement of these
lawsuits.
4
<PAGE>
E. PMA Savings. Pursuant to the terms of the PMA, The Provo Group, Inc. is
to account to the former general partners for all of the following
which are avoided or reduced by implementation of the PMA: (i) Fees
payable to the general partner or entities controlled by the general
partner, (ii) brokerage commissions, and (iii) residuals. Under the
PMA, all such savings shall be credited against the amount owed the
Partnership by the former general partners.
Total amounts recovered at December 31, 1995, amounted to $739,000, of which
approximately $301,000 was allocated to the Partnership.
The total amount due the Partnerships from the former general partners and their
affiliates as of December 31, 1995, as a result of the misappropriation of
assets, approximates $15,700,000 which includes the amount of the
misappropriation discovered to date, related costs, and 9% interest accrued
since January 1, 1993.
ITEM 2. PROPERTIES
The Partnership's properties are leased under long-term leases, generally with
terms of approximately 20 years. All leases are triple net which require the
tenant to pay all property operating costs including maintenance, repairs,
utilities, property taxes, and insurance. A majority of the leases contain
percentage rent provisions which require the tenant to pay a specified
percentage (3% to 8%) of gross sales above a threshold amount.
The Partnership owned the following properties (including specialty leasehold
improvements for use in some of these properties) as of December 31, 1995:
<TABLE>
<CAPTION>
Lease
Acquisi- Property Name Purchase Rental Per Expiration Renewal
tion Date & Address Lessee Price (1) Annum Date Options
- --------- --------- ------ --------- ----- ---- -------
<C> <S> <C> <C> <C> <C> <C>
03/11/88 Hallandale Tag Agency Hallandale Auto $ 792,188 $ 30,000 5/31/00 (3)
601 W Hallandale Beach Blvd Tag Agency, Inc.
Hallandale, FL
03/11/88 Miami Subs QSR, Inc. 743,625 30,887 03-31-2016 None
US-1 Near PGA Blvd
Palm Beach, FL
05/09/88 Hardee's Terratron, Inc. 802,750 101,160(6) 04-30-2008 None
662 E Wisconsin Ave
Oconomowoc, WI
06/15/88 Denny's Phoenix Foods, 1,087,137(2) 98,000 08-20-2009 (3)
8801 N 7th St Inc.
Phoenix, AZ
06/15/88 Denny's (4) Phoenix Foods, 520,126(2) 93,000 01-30-1993 (3)
2201 W Camelback Inc.
Phoenix, AZ
07/15/88 Hooter's TWI X, Inc. 1,346,719 95,000 07-14-2008 None
7669 Grapevine Hwy
N Richland Hills, TX
07/22/88 Hardee's (5) Terratron, Inc. 591,038(2) 55,440(6) 07-31-2007 (3)
9400 S 2000 E
Sandy, UT
</TABLE>
5
<PAGE>
<TABLE>
<CAPTION>
Lease
Acquisi- Property Name Purchase Rental Per Expiration Renewal
tion Date & Address Lessee Price (1) Annum Date Options
- --------- --------- ------ --------- ----- ---- -------
<C> <S> <C> <C> <C> <C> <C>
08/01/88 Hardee's Terratron, Inc. 1,091,190(2) 102,000(6) 05-31-2008 None
106 N Chicago Ave
S Milwaukee, WI
08/15/88 Denny's First Foods, Inc. 1,155,965(2) 83,000 08-30-2009 (3)
2360 W Northern Ave
Phoenix, AZ
08/22/88 Hardee's Terratron, Inc. 825,730(2) 77,880(6) 08-31-2008 None
9039 S Redwood
West Jordan, UT
09/09/88 Country Kitchen Vacant 660,156 0 - -
555 33rd Ave
Cedar Rapids, IA
09/19/88 Applebee's Apple South, Inc. 1,579,094(2) 178,800 04-30-2008 None
US Hwy 1 and Port St Lucie Blvd
Port St Lucie, FL
10/10/88 Kentucky Fried Chicken (5) KFC National 451,230 60,000 06-30-2018 None
1014 S St Francis Dr Management Co.
Santa Fe, NM
10/14/88 Applebee's Apple South Inc. 1,348,180(2) 143,040 07-31-2008 None
2114 Union St
Memphis, TN
12/22/88 Wendy's WenSouth Corp. 596,781 76,920 12-31-2008 None
1721 Sam Rittenburg Blvd
Charleston, SC
12/22/88 Wendy's WenSouth Corp. 649,594 86,160 12-31-2008 None
3013 Peach Orchard Rd
Augusta, GA
12/29/88 Popeye's Stillman Mgmt. 580,938 77,280 12-31-2009 None
2562 Western Ave Co., Inc.
Park Forest, IL
02/21/89 Wendy's WenSouth Corp. 776,344 96,780 01-31-2009 None
1901 Whiskey Rd
Aiken, SC
02/21/89 Wendy's WenSouth Corp. 728,813 96,780 01-31-2009 None
1730 Walton Way
Augusta, GA
02/21/89 Wendy's WenSouth Corp. 528,125 70,200 01-31-2009 None
347 Folly Rd
Charleston, SC
02/21/89 Wendy's WenSouth Corp. 580,938 77,280 01-31-2009 None
361 Hwy 17 Bypass
Mount Pleasant, SC
03/14/89 Wendy's WenSouth Corp. 633,750 90,480 01-31-2009 None
1004 Richland Ave
Aiken, SC
</TABLE>
6
<PAGE>
<TABLE>
<CAPTION>
Lease
Acquisi- Property Name Purchase Rental Per Expiration Renewal
tion Date & Address Lessee Price (1) Annum Date Options
- --------- --------- ------ --------- ----- ---- -------
<C> <S> <C> <C> <C> <C> <C>
04/04/89 Denny's Lako's, Inc. 1,029,844 136,800 11-30-2008 None
607 Internatl Speedway
Daytona Beach, FL
04/20/89 Hostetlers, BBQ Hickory Park, Inc. 897,813(2) 55,584 12-31-1997 (3)
4875 Merle Hay
Des Moines, IA
04/28/89 Hardee's Terratron, Inc. 686,563 86,100(6) 04-30-2009 None
1570 E Sumner St
Hartford, WI
05/05/89 Hardee's Terratron, Inc. 940,063(2) 90,540(6) 04-30-2009 None
1265 E Geneva St
Delavan, WI
10/18/89 Hardee's Terratron, Inc. 1,421,983(2) 126,000(6) 04-30-2009 None
4000 S 27th St
Milwaukee, WI
12/28/89 Village Inn Columbia VI, 845,000(2) 84,000 11-30-2009 None
2451 Columbia Rd L.L.C.
Grand Forks, ND
12/29/89 Wendy's WenSouth Corp. 660,156 87,780 12-31-2009 None
1717 Martintown Rd
N Augusta, SC
12/29/89 Wendy's WenSouth Corp. 580,938 77,280 12-31-2009 None
1515 Savannah Hwy
Charleston, SC
12/29/89 Wendy's WenSouth Corp. 633,750 84,120 12-31-2009 None
3869 Washington Rd
Martinez, GA
01/01/90 Sunrise Preschool Sunrise 1,182,735(2) 134,136 05-31-2009 None
4111 E Ray Rd Preschools, Inc.
Phoenix, AZ
01/05/90 Denny's BLR, Inc. 1,025,830 133,380 09-30-2009 None
1820 State Road 44
New Smyrna Beach, FL
01/05/90 Hardee's Terratron, Inc. 1,140,236(2) 105,960(6) 11-30-2009 None
20 N Pioneer Rd
Fond du lac, WI
01/31/90 Blockbuster Video Blockbuster 646,425 94,836 01-31-2001 (3)
336 E 12th St Videos, Inc.
Ogden, UT
03/21/90 Denny's L&H Restaurants, 1,179,501(2) 78,000 04-30-2012 (3)
688 N Blue Lakes Blvd Inc.
Twin Falls, ID
05/02/90 Denny's (4) Phoenix Foods, 514,259(2) 87,000 05-30-1998 (3)
3752 E Ind School Inc.
Phoenix, AZ
</TABLE>
7
<PAGE>
<TABLE>
<CAPTION>
Lease
Acquisi- Property Name Purchase Rental Per Expiration Renewal
tion Date & Address Lessee Price (1) Annum Date Options
- --------- --------- ------ --------- ----- ---- -------
<C> <S> <C> <C> <C> <C> <C>
05/31/90 Applebee's Thomas & King, 1,434,434(2) 135,780 10-31-2009 None
2770 Brice Rd Inc.
Columbus, OH
</TABLE>
Footnotes.
(1) Purchase price includes all costs incurred to acquire the property.
(2) Purchase price includes cost of specialty leasehold improvements.
(3) Renewal options available.
(4) Ownership of lessee's interest under a ground lease. The Partnership is
responsible for payment of all rent obligations under the ground lease.
(5) Ownership of lessee's interest under a ground lease. The tenant is
responsible for payment of all rent obligations under the ground lease.
(6) Rent amount has been reduced for 1996 by a 1-year lease modification
entered into with the tenant.
Terratron, Inc., the lessee of eight (8) Hardee's restaunrants has experienced
sales difficulties over the past two years. Management entered into a one-year
lease modification with the tenant which reduces base rents for 1996 by
approximately $200,000. Additionally, delinquent rent totaling $112,000 was
capitalized into a five (5)-year note accruing interest at 10% per annum. The
amount of rent capitalized was also written off as uncollectible.
ITEM 3. LEGAL PROCEEDINGS
On March 16, 1993, the Partnership, along with DiVall 1 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. The Partnerships have hired
legal counsel under a contingent fee arrangement to prosecute all of the
Partnerships' claims. E & Y filed an Answer denying that it was negligent.
E & Y also filed third-party claims alleging fraud and negligence on the part of
the Partnerships' former securities 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 filed third party claims against KPMG Peat Marwick, the
Partnerships' accountants preceding E&Y. The Partnerships also filed claims
against Magnuson, DiVall, DREIC, Shea, and Quarles & Brady. E & Y's claims
against Ms. Shatrawka and its fraud claims against Quarles & Brady were
voluntarily dismissed.
The trial of the case was scheduled to take place in Iowa County, Wisconsin,
beginning on March 20, 1996. Shortly before trial The Partnerships reached a
resolution of their claims against Quarles & Brady. A resolution of the claims
against Ernst & Young was reached after opening statements. As a result of
8
<PAGE>
these settlements, net proceeds available for deposit in the partnership's
restoration escrow account approximate $900,000.
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 1 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, 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
value of the obligations of the Private Partnerships assigned to the
Partnerships have been at a significant discount to their face amounts, and (ii)
the General Partner interests in such Private Partnerships often have 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 sixteen (16) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $525,000 and notes secured by
subordinated mortgages in the aggregate amount of $625,000. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
9
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Although some interests have been traded, there is no active public
market for limited partnership interests, and it is not anticipated that an
active public market for limited partnership interests will develop.
(b) As of December 31, 1995 there were 2,756 record holders of limited
partnership interests in the Partnership.
(c) The Partnership Agreement, as amended, provides for distributable net
cash receipts of the Partnership to be distributed on a quarterly basis,
99% to the Limited Partners and 1% to the General Partner, subject to the
limitations on distributions to the General Partner described in the
amended Partnership Agreement. During 1995 and 1994, $3,430,000 and
$3,178,000, respectively, were distributed in the aggregate to the Limited
Partners. The General Partner received aggregate distributions of $5,080
and $8,959 in 1995 and 1994, respectively.
ITEM 6. SELECTED FINANCIAL DATA
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
(a Wisconsin limited partnership)
December 31, 1995, 1994, 1993, and 1992
(not covered by Independent Auditor's Report)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
1995 1994 1993 1992
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total Revenue $ 3,932,498 $ 4,190,932 $ 4,133,668 $ 4,196,272
- ------------------------------------------------------------------------------
Net Income (Loss) 1,782,105 2,158,283 804,920 (731,703)
- ------------------------------------------------------------------------------
Net Income (Loss) per
Limited Partner Interest 38.12 46.17 17.19 (14.22)
- ------------------------------------------------------------------------------
Total Assets 27,134,604 29,455,349 31,288,856 33,584,432
- ------------------------------------------------------------------------------
Total Partners' Capital 26,464,478 28,117,453 29,146,593 30,695,089
- ------------------------------------------------------------------------------
Cash Distributions per
Limited Partnership 74.11 68.68 50.76 55.20
Interest
- ------------------------------------------------------------------------------
</TABLE>
(a) The above selected financial data should be read in conjunction with the
financial statements and the related notes appearing elsewhere in this
annual report.
10
<PAGE>
(b) Data prior to 1992 is not shown due to the data being unreliable and a
comparison would not be meaningful. The Partnership's prior auditors
withdrew their report on such financial statements.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
For comparative purposes, it should be noted that the three years presented in
the financial statements reflect the results of management by different general
partners. Until February 8, 1993, the Partnership was under the management of
an interim manager, Barry A. Soble. On February 8, 1993, The Provo Group, Inc.
replaced Mr. Soble as Permanent Manager. On May 26, 1993, TPG was elected as
General Partner as a result of a solicitation of written consents of the Limited
Partners.
LIQUIDITY AND CAPITAL RESOURCES:
- --------------------------------
INVESTMENT PROPERTIES AND NET INVESTMENT IN DIRECT FINANCING LEASES
- -------------------------------------------------------------------
The investment properties, including equipment held by the Partnership at
December 31, 1995, were originally purchased at a price, including acquisition
costs, of approximately $32,890,000.
The former Wendy's restaurant located in Hallandale, Florida, was leased to the
Hallandale Tag Agency during 1995. Rent commenced on December 1, 1995. This
property was written down to its estimated net realizable value of $250,000 at
December 31, 1994.
During the Fourth Quarter of 1994, the tenant of the Arby's restaurant in
Champaign, Illinois notified the Partnership of its intent to exercise an option
to purchase the property for $300,000. This property was written down to the
option price of $300,000 at December 31, 1994. The sale closed during the
Second Quarter of 1995. Management is not aware of any other unfavorable
purchase options.
The tenant of the Country Kitchen restaurant in Cedar Rapids, Iowa vacated the
property during 1995 and ceased paying rent. Management has negotiated a
potential sale of the property and is awaiting lender approval of environmental
reports to close the sale.
Applesouth, the tenant of two Applebee's restaurants in Tennessee and Florida,
notified Management of their intent to exercise an option in their lease to
purchase those properties. The Tennessee property was sold to Applesouth during
January 1996. Due to a dispute over the sale price for the Florida property,
that potential sale is still pending.
Terratron, Inc., the lessee of eight (8) Hardee's restaunrants has experienced
sales difficulties over the past two years. Management entered into a one-year
lease modification with the tenant which reduces base rents for 1996 by
approximately $200,000. Additionally, delinquent rent totaling $112,000 was
capitalized into a five (5)-year note accruing interest at 10% per annum. The
amount of rent capitalized was also written off as uncollectible.
The net investment in direct financing leases, which includes the Partnership's
specialty leasehold improvement leases, amounted to $591,000 at December 31,
1995, compared to $1,268,000 at December 31, 1994. The decrease of $677,000 was
a result of principal and residual payments received during the year as well as
the write-down of residual values to their estimated net realizable value.
11
<PAGE>
OTHER ASSETS
- ------------
Cash and cash equivalents, including cash restricted for real estate taxes and a
certificate of deposit held by the Partnership, was approximately $1,067,000 at
December 31, 1995, compared to $1,651,000 at December 31, 1994. The Partnership
designated cash of $650,000 to fund the Fourth Quarter 1995 distributions to
Limited Partners, $240,000 for the payment of year-end accounts payable and
accrued expenses, and the remainder represents reserves deemed necessary to
allow the Partnership to operate normally. The decrease is primarily due to the
application of a tenant security deposit held in a certificate of deposit at
December 31, 1994, to the balance of its equipment lease. 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, deposited $100,000 in the Trust during 1993 and
completed funding of the Trust with $150,000 during 1994. The provision to
establish the Trust was included in the Permanent Manager Agreement for the
indemnification of TPG, in the absence of fraud or gross negligence, from any
claims or liabilities that may arise from TPG acting as Permanent Manager. The
Trust is owned by the Partnership. For additional information regarding the
Trust refer to Note 11 to the financial statements included in Item 8 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 $3,529,000 at
December 31, 1995. The receivable decreased from the prior year due to $64,000
of recoveries received during the year from the former general partners and
their affiliates along with $1,000 of disposition fees paid to the restoration
fund by the General Partner.
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
$1,880,000 at December 31, 1994, to $2,824,000 at December 31, 1995, and
includes $1,404,000 of cumulative accrued interest.
The current General Partner is vigorously pursuing recovery of the
misappropriated funds from the various sources and initially estimated an
aggregate recovery of $3 million for the Partnerships. As such, 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
probable 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 December 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 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
of the financial statements included in Item 8 of this report. The allocation
is adjusted annually to reflect any changes in the entire misappropriation. The
12
<PAGE>
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 $192,000 due from DiVall 3 with a corresponding reduction reflected in
professional expenses related to the Investigation, former general partner
removal expenses, and interim fund manager fees and expenses. Recoveries
allocated to DiVall 3 have been used to partially repay amounts owed to the
Partnership. At December 31, 1995, the remaining amount due from DiVall 3 for
restoration costs was $74,000.
The Partnership also recorded a receivable due from DiVall 1 in connection with
the DeDan default. The Partnership and DiVall 1 were awarded a Denny's
restaurant located in Phoenix, Arizona, in 1990 as a result of a lawsuit which
the Partnerships brought against DeDan. The Partnership paid cash to DiVall 1
for its share of the property based on an internal valuation by the former
general partners. Current management has evaluated the circumstances
surrounding the transaction and has determined that the estimate of property
value was overstated by the former general partners to enhance reported
earnings. Accordingly, the Partnership recorded a receivable due from DiVall 1
in the amount of $236,000 for its overpayment in 1990, other revenue in the
amount of $11,000, and reduced the investment in the property by $225,000.
During 1994, the total amount due from DiVall 1 was repaid. Refer to Note 12 of
the financial statements included in Item 8 of this report for further
discussion.
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 December 31, 1995.
LIABILITIES
- -----------
During the Fourth Quarter of 1995, the Partnership paid off an equipment note
which had an outstanding balance at December 31, 1994, of $395,000. The funds
used to pay the equipment note were from the prepayment of an equipment lease by
the tenant.
Accounts payable and accrued expenses at December 31, 1995, in the amount of
$267,000, primarily represented the accrual of restoration costs related to the
litigation against the former legal counsel, former auditors and a former
general partner affiliate, along with year-end accruals of legal and auditing
fees.
PARTNERS' CAPITAL
- -----------------
Net income for the year was allocated between the General Partner and the
Limited Partners, 1% and 99%, respectively, as provided in the Partnership
Agreement and the Amendment to the Partnership Agreement, as discussed more
fully in Note 4 of the financial statements included in Item 8 of this report.
The former general partners' deficit capital account balance was reallocated to
the Limited Partners at December 31, 1993. Refer to Note 14 to the financial
statements included in Item 8 of this report for additional information
regarding the reallocation.
Cash distributions paid to the Limited Partners and to the General Partner
during 1995 of $3,430,000 and $5,080, respectively, have also been in accordance
with the amended Partnership Agreement. The Fourth Quarter 1995 distribution,
of $650,000, was paid to the Limited Partners on February 15, 1996.
13
<PAGE>
RESULTS OF OPERATIONS:
- ----------------------
Management believes that the financial results of 1995 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 negative impact on
the 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 year ended December 31, 1995, in the
amount of $1,782,000 compared to net income for the years ended December 31,
1994 and 1993, of $2,158,000 and $805,000 respectively. Results for all three
years 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, tenant defaults, non-cash write-offs, and
real estate taxes on vacant properties. The costs associated witht he
misappropriation increased significantly during 1995 as the lawsuit against the
former general partner accountants and attorneys got closer to trial.
REVENUES
- --------
Total revenues were $3,932,000, $4,191,000, and $4,134,000, for the years ended
December 31, 1995, 1994, and 1993, respectively. A decrease in fixed rents
resulted from tenant turnover and modified leases.
Total revenues should approximate $3,000,000 annually based on leases currently
in place. Future revenues may decrease with tenant defaults and/or sales of
Partnership properties. They may also increase with additional rents due from
tenants, if those tenants experience sales levels which require the payment of
additional rent to the Partnership. The decrease from 1995 to projected 1996
levels is a result of propety sales expected during 1996 as well as the one (1)
year lease modification entered into with Terratron, the tenant of eight (8)
Hardee's restaurants.
EXPENSES
- --------
For the years ended December 31, 1995, 1994, and 1993, cash expenses amounted to
approximately 29%, 27%, and 39%, of total revenues, respectively. Total
expenses, including non-cash items, amounted to approximately 55%, 49%, and 75%,
of total revenues for the years ended December 31, 1995, 1994, and 1993,
respectively. Items negatively impacting expenses during the last three years
include expenses incurred primarily in relation to the misappropriation of
assets by the former general partners and their affiliates, non-cash write offs,
property write-downs, real estate taxes, and equipment losses.
For the years ended December 31, 1995, 1994, and 1993, expenses incurred in
relation to the misappropriated assets amounted to $417,000, $216,000, and
$461,000, 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 $112,000 for the
year ending December 31, 1996.
Additional expenses impacting operating results are the allowance for
uncollectible amounts due from the former general partners and their affiliates,
write-offs of straight-line rent, and write-downs of property to their estimated
net realizable values. All of these items, including depreciation, are non-cash
items and do not affect current operating cash flow of the Partnership or
distributions to the Limited Partners.
Write-offs for uncollectible rents and receivables are non-cash items and
amounted to $112,000, $48,000, and $168,000 at December 31, 1995, 1994, and
1993, respectively. The write-offs are the result of
14
<PAGE>
defaults as well as modifications to several property leases since inception of
the Partnership. Adjustments will generally occur as a result of lease
modifications that affect future increases in rental income previously straight-
lined.
During 1995, the Miami Subs restaurant in Palm Beach, Florida was written down
$255,000 to its estimated net realizable value of $400,000. The poor location
of this property has required lease modifications for the tenant.
During 1994, the Arby's restaurant in Champaign, Illinois, was written down
$34,000 to the purchase option price included in the lease of $300,000. The
tenant notified the Partnership during 1994 of its intent to exercise this
option. The sale took place during the Second Quarter of 1995. The Partnership
also wrote down the carrying value of the former Wendy's in Hallandale, Florida,
in the amount of $310,000 at December 31, 1993, and an additional $136,000 at
December 31, 1994, resulting in a carrying value at December 31, 1994, of
$250,000. The write-down is a non-cash event which management believes more
appropriately reflects the property's estimated net realizable value. The
Partnership re-leased the property in 1995.
Equipment lease terminations created losses during 1993, in the amount of
$224,000. The equipment leases were terminated by several defaulted tenants
from prior years. As a result of these defaults, equipment was written down to
what was considered its fair market value. During 1995, additional write-downs
were taken on the residual values of the remaining equipment leases to more
closely reflect their estimated fair market value.
Real estate tax expenses for the last three years have been inordinately high as
former management allowed these taxes to become delinquent for several years
while interest and penalties accumulated along with new liabilities incurred on
vacant properties and defaulted tenants. The Partnership incurred real estate
taxes on behalf of tenants in the amounts of $30,000, $128,000, and $71,000, for
the years ended December 31, 1995, 1994, and 1993, respectively.
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.
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. Although the majority of the Partnership's leases have percentage
rent clauses, revenues from percentage rents represented only 9% of fixed rental
income for 1995. Percentage rents earned in 1995 were actually 3% higher than
in 1994. If inflation causes operating margins to deteriorate for lessees if
expenses grow faster than revenues, then, inflation may well negatively impact
the portfolio through tenant defaults.
It would be misleading to associate inflation with asset appreciation for real
estate, in general, and the Partnership's portfolio, specifically. Due to the
"triple net" nature of the property leases, asset values generally move
inversely with interest rates.
15
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
------------------------------------------------------
(a Wisconsin limited partnership)
---------------------------------
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
-------------------------------------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants......................... 17
Balance Sheets, December 31, 1995 and 1994....................... 18 - 19
Statements of Income for the Years
Ended December 31, 1995, 1994, and 1993.......................... 20
Statements of Partners' Capital for the
Years Ended December 31, 1995, 1994, and 1993.................... 21
Statements of Cash Flows for the Years
Ended December 31, 1995, 1994, and 1993.......................... 22 - 23
Notes to Financial Statements.................................... 24 - 38
Schedule III--Real Estate and Accumulated
Depreciation..................................................... 45 - 46
</TABLE>
16
<PAGE>
INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of
Divall Insured Income Properties 2 Limited Partnership:
We have audited the accompanying balance sheets of DIVALL INSURED INCOME
PROPERTIES 2 LIMITED PARTNERSHIP (the Partnership) as of December 31, 1995 and
1994 and the related statements of income, partners' capital and cash flows for
each of the three years in the period ended December 31, 1995. These financial
statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Divall Insured Income
Properties 2 Limited Partnership as of December 31, 1995 and 1994, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index of financial
statements is presented for purposes of complying with the Securities and
Exchange Commissions rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 25, 1996
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
--------------------------
ASSETS
<TABLE>
<CAPTION>
December 31, December 31,
1995 1994
------------- -------------
<S> <C> <C>
INVESTMENT PROPERTIES AND
EQUIPMENT:(NOTE 3)
Land $10,027,077 $10,341,226
Buildings 18,153,026 18,449,169
Equipment 669,778 706,228
Accumulated depreciation (5,491,806) (5,001,045)
----------- -----------
Net investment properties and
equipment 23,358,075 24,495,578
----------- -----------
NET INVESTMENT IN DIRECT FINANCING
LEASES:(NOTE 8) 590,527 1,267,553
----------- -----------
OTHER ASSETS:
Cash and cash equivalents 1,005,764 1,349,101
Cash restricted for real estate taxes 61,217 41,694
Certificate of Deposit restricted
for security deposit (NOTE 3) 0 260,000
Cash held in Indemnification Trust
(NOTE 11) 275,231 253,558
Rents and other receivables (net of
allowance of $254,543 in 1995 and
$73,266 in 1994) 459,213 293,614
Due from current General Partner 275 3,215
Deferred rent receivable 296,482 310,229
Due from affiliated partnerships
(NOTE 12) 96,088 102,656
Prepaid insurance 19,631 40,650
Unsecured notes receivable from
lessees 50,000 50,000
----------- -----------
Total other assets 2,263,901 2,704,717
----------- -----------
DUE FROM FORMER AFFILIATES: (NOTES 2
AND 12)
Due from former general partner
affiliates 3,529,205 3,594,605
Allowance for uncollectible amounts
due from former affiliates (2,607,104) (2,607,104)
Restoration cost receivable 2,823,862 1,880,070
Allowance for uncollectible
restoration receivable (2,823,862) (1,880,070)
----------- -----------
Due from former affiliates, net 922,101 987,501
----------- -----------
Total assets $27,134,604 $29,455,349
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
18
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
--------------------------
LIABILITIES AND PARTNERS' CAPITAL
<TABLE>
<CAPTION>
December 31, December 31,
1995 1994
------------- -------------
LIABILITIES:
<S> <C> <C>
Equipment notes payable (NOTE 6) $ 77,255 $ 511,019
Accounts payable and accrued expenses 266,715 184,157
Due to current General Partner 496 1,310
Security deposits 250,577 504,713
Unearned rental income 18,065 25,121
Real estate taxes payable 57,018 111,576
------------ ------------
Total liabilities 670,126 1,337,896
------------ ------------
CONTINGENT LIABILITIES: (NOTE 10 AND 13)
PARTNERS' CAPITAL: (NOTES 1, 4 AND 14)
Former general partners -
Capital contributions 200 200
Cumulative net income 707,313 707,313
Cumulative cash distributions (1,547,742) (1,547,742)
Reallocation of former general
partners' 840,229 840,229
deficit capital to Limited Partners ------------ ------------
0 0
------------ ------------
Current General Partner -
Cumulative net income 47,289 29,468
Cumulative cash distributions (18,245) (13,165)
------------ ------------
29,044 16,303
------------ ------------
Limited Partners (46,280.3 interests
outstanding)
Capital contributions, net of 39,358,468 39,358,468
offering costs
Cumulative net income 11,047,463 9,283,179
Cumulative cash distributions (23,130,268) (19,700,268)
Reallocation of former general (840,229) (840,229)
partners' deficit capital ------------ ------------
26,435,434 28,101,150
------------ ------------
Total partners' capital 26,464,478 28,117,453
------------ ------------
Total liabilities and partners' $ 27,134,604 $ 29,455,349
capital ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
19
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
-----------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
---------- ---------- ----------
REVENUES:
<S> <C> <C> <C> <C>
Rental income(NOTE 5) $3,770,280 $3,868,972 $3,822,228
Interest income on direct financing leases 102,101 98,736 206,555
Other interest income 69,287 109,239 39,099
Net Other income (10,899) 69,323 28,377
Net gain on disposal of assets 1,729 44,662 37,409
---------- ---------- ----------
3,932,498 4,190,932 4,133,668
---------- ---------- ----------
EXPENSES:
Property management and administrative
fees paid to affiliate of former
general partner 0 0
Partnership management fees paid
to current General Partner 164,350 171,256
Disposition fees - Current General Partner 3,000 3,300 3,428
Disposition fees - Restoration 3,000 6,728 0
Restoration fees - Current General Partner 2,616 8,971 0
Selling commissions - Nonaffiliate 9,900 0 0
Appraisal fees 2,500 0 0
Interim fund manager fees and expenses 0 0 37,053
Insurance 48,180 59,103 46,040
General and administrative 103,142 130,208 150,174
Advisory Board fees and expenses 17,351 19,860 5,023
Interest 42,893 113,687 147,133
Real estate taxes 30,203 128,382 71,485
Ground lease payments (NOTE 3) 123,825 123,710 123,507
Expenses incurred due to default by lessee 24,748 9,424 58,960
Professional services 133,189 145,670 162,559
Professional services related to Investigation 417,433 216,474 461,423
General partner removal expenses 0 0 104,968
Loss on equipment lease 72,264 0 223,573
Depreciation 584,352 663,296 755,309
Amortization 804 14,570 20,631
Provision for uncollectible rents and other receivables 111,762 47,883 168,253
Write down of properties to net realizable value 254,881 170,127 310,384
---------- ---------- ----------
2,150,393 2,032,649 3,075,378
---------- ---------- ----------
Income before provision for uncollectible
amounts due from former affiliates 1,782,105 2,158,283
---------- ----------
PROVISION FOR UNCOLLECTIBLE AMOUNTS
DUE FROM FORMER AFFILIATES 0 0 253,370
---------- ---------- ----------
NET INCOME (LOSS) $1,782,105 $2,158,283 $ 804,920
========== ========== ==========
NET INCOME (LOSS) - FORMER GENERAL PARTNERS $ 0 $ 0 $ 1,637
NET INCOME - CURRENT GENERAL PARTNER 17,821 21,583 7,885
NET INCOME (LOSS) - LIMITED PARTNERS 1,764,284 2,136,700 795,398
---------- ---------- ----------
$1,782,105 $2,158,283 $ 804,920
========== ========== ==========
NET INCOME (LOSS) PER LIMITED PARTNERSHIP
INTEREST, based on 46,280.3 Interests outstanding $38.12 $46.17 $17.19
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
20
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
<TABLE>
<CAPTION>
FORMER GENERAL PARTNERS CURRENT GENERAL PARTNER
----------------------------------------------------------------- ----------------------------------
CUMULATIVE CUMULATIVE CUMULATIVE CUMULATIVE
CAPITAL NET CASH NET CASH
CONTRIBUTIONS INCOME DISTRIBUTIONS REALLOCATION TOTAL INCOME DISTRIBUTIONS TOTAL
------------- ---------- ------------- ------------ --------- ---------- ------------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1992 (unaudited) $200 $705,676 $(1,547,742) $ 0 $(841,866) $ 0 $ 0 $ 0
Cash Distributions ($50.76
per limited partnership
interest) (4,206) (4,206)
Net Income 1,637 1,637 7,885 7,885
Reallocation of former
general partners'
deficit capital to the
Limited Partners 840,229 840,229
---- -------- ----------- -------- --------- ------- -------- -------
BALANCE AT DECEMBER 31, 1993 $200 $707,313 $(1,547,742) $840,229 $ 0 $ 7,885 $ (4,206) $ 3,679
Cash Distributions ($68.68
per limited partnership
interest) (8,959) (8,959)
Net Income 21,583 21,583
---- -------- ----------- -------- --------- ------- -------- -------
BALANCE AT DECEMBER 31, 1994 $200 $707,313 $(1,547,742) $840,229 $ 0 $29,468 $(13,165) $16,303
Cash Distributions ($74.11
per limited partnership
interest) (5,080) (5,080)
Net Income 17,821 17,821
---- -------- ----------- -------- --------- ------- -------- -------
BALANCE AT DECEMBER 31, 1995 $200 $707,313 $(1,547,742) $840,229 $ 0 $47,289 $(18,245) $29,044
==== ======== =========== ======== ========= ======= ======== =======
</TABLE>
<TABLE>
<CAPTION>
LIMITED PARTNERS
----------------------------------------------------------------------
CAPITAL
CONTRIBUTIONS, CUMULATIVE CUMULATIVE
NET OF NET (INCOME) CASH
OFFERING COSTS (LOSS) DISTRIBUTION REALLOCATION TOTAL
-------------- ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31,
1992 (unaudited) $39,358,468 $ 6,351,081 $(14,172,594) $ 0 $31,536,955
Cash Distributions ($50.76
per limited partnership
interest) (2,349,210) (2,349,210)
Net Income 795,398 795,398
Reallocation of former
general partners'
deficit capital to the
Limited Partners (840,229) (840,229)
----------- ----------- ------------ --------- -----------
BALANCE AT DECEMBER 31, 1993 $39,358,468 $ 7,146,479 $(16,521,804) $(840,229) $29,142,914
Cash Distributions ($68.68
per limited partnership
interest) (3,178,464) (3,178,464)
Net Income 2,136,700 2,136,700
----------- ----------- ------------ --------- -----------
BALANCE AT DECEMBER 31, 1994 $39,358,468 $ 9,283,179 $(19,700,268) $(840,229) $28,101,150
Cash Distributions ($74.11
per limited partnership
interest) (3,430,000) (3,430,000)
Net Income 1,764,284 1,764,284
----------- ----------- ------------ --------- -----------
BALANCE AT DECEMBER 31, 1995 $39,358,468 $11,047,463 $(23,130,268) $(840,229) $26,435,434
=========== =========== ============ ========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
21
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993
-----------------------------------------------------
<TABLE>
<CAPTION>
1995 1994 1993
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C> <C>
Net income $ 1,782,105 $ 2,158,283 $ 804,920
Adjustments to reconcile net income to net
cash provided by operating activities -
Depreciation and amortization 585,156 677,866 775,940
Provision for uncollectible amounts due from former affiliates 0 0 253,370
Provision for uncollectible rents and other receivables 111,762 47,883 168,253
Property write downs to net realizable value 254,881 170,127 310,384
Net (gain) on disposal of assets (1,729) (44,662) (37,409)
Write-down of equipment leases 72,264 0 223,573
Interest applied to Indemnification Trust account (21,673) (3,558) 0
(Increase) in rents and other receivables (296,921) (138,155) (33,964)
(Deposits) Withdrawals for payment of real estate taxes and CD 240,477 129,358 (431,052)
Decrease in prepaids 21,020 45,406 13,622
(Increase) Decrease in deferred rent receivable 13,747 (10,308) (33,498)
Increase (Decrease) in due to current General Partner (814) (18,072) 19,382
Increase (Decrease) in accounts payable and other 82,558 (6,034) 180,987
(Decrease) in security deposits (254,136) (12,552) (24,873)
Increase (Decrease) in interest payable 0 (5,193) 1,748
Increase (Decrease) in real estate taxes payable (54,558) (53,143) 106,325
(Decrease) in due from former affiliates 0 0 (61,378)
(Decrease) in unearned rental income (7,056) (7,056) (5,506)
----------- ----------- -----------
Net cash from operating activities 2,527,083 2,944,302 2,230,824
----------- ----------- -----------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Principal payments received on direct financing leases 603,956 309,936 429,114
Proceeds from sale of investment properties 300,000 220,000 345,000
Proceeds from condemnation of Texas land 0 0 87,250
Deposit to Indemnification Trust cash account 0 (150,000) (100,000)
Recoveries from former affiliates 65,400 224,272 (19,136)
Payments (to) from affiliated partnerships 29,068 325,868 (203,524)
Principal receipts from unsecured notes 0 15,240 28,931
----------- ----------- -----------
Net cash from (used in) investing activities 998,424 945,316 567,635
----------- ----------- -----------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES:
Cash distributions to Limited Partners (3,430,000) (3,178,464) (2,349,210)
Cash distributions to current General Partner (5,080) (8,959) (4,206)
Principal payments on mortgage notes 0 (493,764) (505,722)
Proceeds from equipment notes 0 0 0
Payments of equipment notes (433,764) (222,665) (202,043)
----------- ----------- -----------
Net cash (used in) financing activities (3,868,844) (3,903,852) (3,061,181)
----------- ----------- -----------
NET (DECREASE) IN CASH AND CASH EQUIVALENTS (343,337) (14,234) (262,722)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,349,101 1,363,335 1,626,057
----------- ----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 1,005,764 $ 1,349,101 $ 1,363,335
=========== =========== ===========
SUPPLEMENTAL DISCLOSURE--cash paid for interest $ 30,203 $ 118,880 $ 145,385
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
22
<PAGE>
Supplemental Information to the Statements of Cash Flows
--------------------------------------------------------
The following significant noncash transactions occurred during the three years
affecting the Partnership's financial statements:
1. The former general partners' deficit capital account balance in the amount
of $840,229 was reallocated to the Limited Partners at December 31, 1993.
The accompanying notes are an integral part of these statements.
23
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1994 AND 1993
1. ORGANIZATION AND BASIS OF ACCOUNTING:
-------------------------------------
DiVall Insured Income Properties 2 Limited Partnership (the "Partnership") was
formed on November 18, 1987, pursuant to the Uniform Limited Partnership Act of
the State of Wisconsin. The initial capital which was contributed during 1987,
consisted of $300, representing aggregate capital contributions of $200 by the
former general partners and $100 by the Initial Limited Partner. The minimum
offering requirements were met and escrowed subscription funds were released to
the Partnership as of April 7, 1988. On January 23, 1989, the former general
partners exercised their option to increase the offering from 25,000 interests
to 50,000 interests and to extend the offering period to a date no later than
August 22, 1989. On June 30, 1989, the general partners exercised their option
to extend the offering period to a date no later than February 22, 1990. The
offering closed on February 22, 1990, at which point 46,280.3 interests had been
sold, resulting in total offering proceeds, net of underwriting compensation and
other offering costs, of $39,358,468.
The Partnership is currently engaged in the business of owning and operating its
investment portfolio (the "Properties") of commercial real estate and recovering
the assets misappropriated by the former general partners and their affiliates.
The Properties are leased on a triple net basis to, and operated by, franchisors
or franchisees of national, regional, and local retail chains under long-term
leases. The lessees consist primarily of fast-food, family style, and
casual/theme restaurants, but also include a video rental store and a child care
center. At December 31, 1995, the Partnership owned 38 properties with
specialty leasehold improvements in 18 of these properties.
Deferred organization costs are amortized over a 60-month period. Deferred
costs on proposed acquisitions are capitalized as a cost of the properties upon
acquisition.
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.
Depreciation of the properties is provided on a straight-line basis over 31.5
years, which is the estimated useful lives of the buildings and improvements.
Equipment is depreciated on a straight-line basis over the estimated useful
lives of 5 to 7 years.
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
24
<PAGE>
vacant, the Partnership makes the appropriate payment to avoid possible
foreclosure of the property. Taxes are accrued in the period in which the
liability is incurred.
Cash and cash equivalents include cash on deposit with financial institutions
and highly liquid temporary investments with initial maturities of 90 days or
less.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities (and disclosure of
contingent assets and liabilities) at the date of the finanacial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Partnership will be dissolved on November 30, 2010, or earlier upon the
prior occurrence of any of the following events: (a) the disposition of all
properties of the Partnership; (b) the written determination by the General
Partner that the Partnership's assets may constitute "plan assets" for purposes
of ERISA; (c) the agreement of Limited Partners owning a majority of the
outstanding interests to dissolve the Partnership; or (d) the dissolution,
bankruptcy, death, withdrawal, or incapacity of the last remaining General
Partner, unless an additional General Partner is elected previously by a
majority of 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, 1995, the tax basis of the Partnership's assets exceeded the
amounts reported in the accompanying financial statements by approximately
$8,700,000.
25
<PAGE>
The following represents a reconciliation of net income as stated on the
Partnership statements of income to net income for tax reporting purposes:
<TABLE>
<CAPTION>
1995 1994 1993
------------ ------------ ------------
<S> <C> <C> <C>
Net income (loss), per statements of income $1,782,105 $2,158,283 $ 804,920
Book to tax depreciation difference (6,450) 17,262 95,692
Book over tax gain from asset disposition (82,904) 0 (105,625)
Straight line rent adjustment 13,747 (10,308) 134,757
Affiliate receivable basis adjustment 0 (19,136) 61,012
Bad debt reserve/expense 111,762 63,733 (211,821)
Real estate tax expense 16,804 (94,368) (62,292)
Minimum rent receivable 0 (188,176) 188,176
Book valuation adjustment of real property 254,881 128,127 341,218
Book valuation adjustment of equipment
leases 50,820 0 0
Other, net (6,437) 22,539 (21,322)
---------- ---------- ----------
Net income(loss) for tax reporting
purposes $2,134,328 $2,077,956 $1,179,715
========== ========== ==========
</TABLE>
2. REGULATORY INVESTIGATION:
-------------------------
A preliminary investigation during 1992 by the Office of Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation") revealed that during at least the four years ended
December 31, 1992, the former general partners of the Partnership, Gary J.
DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial
cash assets of the Partnership and two affiliated publicly registered
partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1") 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 misappropriations, related costs, and 9% interest
accrued since January 1, 1993, is in excess of $15,700,000, of which
approximately $6,353,000 has been attributed to the Partnership and is reflected
as due from former affiliates on the balance sheet at December 31, 1995. The 9%
interest accrued as of December 31, 1995, amounted to approximately $1,404,000
and is not reflected in the accompanying income statement. As of December 31,
1994, approximately $5,475,000 was reflected as due from former affiliates based
on estimated overall misappropriation and related costs of $13,500,000.
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
26
<PAGE>
assume responsibility for daily operations and assets of the Partnerships as
well as to develop and execute a plan of restoration for the Partnerships.
Effective May 26, 1993, the Limited Partners, by written consent of a majority
of interests, elected the Permanent Manager, TPG, as General Partner. TPG
terminated the former general partners by accepting their tendered resignations.
The current General Partner is vigorously pursuing recovery of the
misappropriated funds from the various sources and initially estimated an
aggregate recovery of $3 million for the Partnerships. As such, an allowance
has been established against amounts due from former general partner affiliates
reflecting the current General Partner's best estimate of probable 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 December 31,
1995. Pending the outcome of resolution of all sources of potential recovery,
it is not possible to determine the amount 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 the Partnership assets. All
such transactions identified during the Regulatory Investigation and concurrent
reviews have been reflected in the Partnership's financial statements as of
December 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 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 has elected to record currently certain immaterial errors discovered
during 1993, which relate to prior periods, to assure effective disclosure of
amounts which have otherwise been deemed immaterial in relation to partners'
capital.
27
<PAGE>
3. INVESTMENT PROPERTIES:
----------------------
As of December 31, 1995, the Partnership owned 35 fully constructed fast-food
restaurants, a tag agency, a video store, and a preschool. The properties are
composed of the following: ten (10) Wendy's restaurants, eight (8) Hardee's
restaurants, seven (7) Denny's restaurants, three (3) Applebee's restaurants,
one (1) Popeye's Famous Fried Chicken restaurant, one (1) Country Kitchen
restaurant, one (1) Hooter's restaurant, one (1) Kentucky Fried Chicken
restaurant, one (1) Hostetler's restaurant, one (1) Miami Subs restaurant, one
(1) Village Inn restaurant, one (1) Hallandale Tag Agency, one (1) Blockbuster
Video store, and one (1) Sunrise Preschool. The 38 properties are located in a
total of fourteen (14) states.
From time to time, the Partnership experiences interruptions in rental receipts
due to tenant delinquencies and vacancies. At December 31, 1995, one of the
Partnership's properties was unoccupied. During 1995, the tenant of the Country
Kitchen restaurant in Cedar Rapids, Iowa vacated the property and stopped making
rent payments. Management is negotiating a potential sale of the property.
The total cost of the investment properties and specialty leasehold improvements
includes the original purchase price plus acquisition fees and other capitalized
costs paid to an affiliate of the former general partners.
According to the Partnership Agreement, the former general partners were to
commit 80% of the original offering proceeds to investment in properties. Upon
the close of the offering, approximately 75% of the original proceeds was
invested in the Partnership's properties.
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 amounting to approximately $8,000 through
February 28, 1993. In addition, the former general partner affiliate was
entitled to receive reimbursements of general and administrative costs, either
direct or indirect, amounting to approximately $49,000 during 1993. As a result
of the Investigation, the Partnership engaged a third party as Interim Manager
in October 1992. The Interim Manager received approximately $53,000 during
1993, for management services. 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 gross receipts, with a
maximum reimbursement for 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 the
former general partner 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
28
<PAGE>
the former general partners and their affiliates. TPG has received fees from
the Partnership totaling $11,587 to date on the amounts recovered, which has
been offset against the 4% minimum fee.
The Partnership currently maintains rent insurance policies with terms expiring
in 1996 for 10 of the 39 leased properties. Terms of the rent insurance
policies call for the Partnership to be paid 80% of gross rent due in the event
of nonpayment and vacancy of the property. Under the terms of the original
offering document, rent insurance was originally intended to be obtained on all
leased properties unless the tenant had financial net worth in excess of
$5,000,000. The Partnership did not have sufficient documentation at December
31, 1995 to substantiate whether the uninsured properties had tenants with
adequate net worth at the time the leases were initiated.
At December 31, 1994, the Partnership maintained a $260,000 certificate of
deposit on behalf of Terratron, Inc., a tenant, as a security deposit on an
equipment lease. All interest earned on the certificate of deposit belonged to
the tenant. During the Fourth Quarter of 1995, the tenant applied the balance
of the certificate, including accrued interest, to the equipment lease and
delinquent rents owed on several properties. Management used the funds to pay
off an equipment note which had originally funded the equipment lease.
The tenant of the Partnership's eight (8) Hardee's restaurants has experienced
sales difficulties over the past two years. Management entered into a one-year
lease modification with the tenant for 1996 resulting in a $200,000 decrease in
base rent for the year, and agreed to capitalize delinquent rents totaling
$112,000 into a five-year note earning 10% interest.
The Partnership owns four (4) restaurants located on parcels of land where it
has entered into long-term ground leases. Two (2) of these leases are paid by
the tenant and two (2) are paid by the Partnership. The leases paid by the
Partnership are considered operating leases and the lease payments are expensed
in the periods to which they apply. The lease terms require aggregate minimum
annual payments of approximately $124,000 and expire in the years ranging from
1998 to 2003.
The tenant operating a Denny's restaurant on Camelback Road in Phoenix, Arizona,
has not formally exercised its option to extend its lease which expired on
January 30, 1993, but continues to operate the restaurant and pay rent.
Management is currently negotiating a possible new lease or sale of the property
to the tenant.
Several of the Partnership's property leases contained purchase option
provisions with stated purchase prices in excess of the original cost of the
properties. The Partnership's lease with an Arby's restaurant in Champaign,
Illinois, contained a purchase option with an option price of $300,000. The
Partnership acquired the property at a cost of $389,757. During the Fourth
Quarter of 1994, the tenant notified the Partnership of its intent to exercise
the purchase option. The property was written down to $300,000, the option
price, at December 31, 1994. The sale closed during the Second Quarter of 1995.
The current General Partner is not aware of any additional unfavorable purchase
options in relation to original cost. Applesouth, the tenant of
29
<PAGE>
two Applebee's restaurants, notified Management of its intent to exercise an
option in its lease to purchase those properties. One sale closed in January
1996, resulting in an approximate gain of $400,000. The other sale is pending
due to a dispute over the option price.
4. PARTNERSHIP AGREEMENT:
----------------------
The Partnership Agreement, prior to an amendment effective May 26, 1993,
provided that, for financial reporting and income tax purposes, net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
general partners. The Partnership Agreement also provided for quarterly cash
distributions from Net Cash Receipts, as defined, within 60 days after the last
day of the first full calendar quarter following the date of release of the
subscription funds from escrow, and each calendar quarter thereafter, in which
such funds were available for distribution with respect to such quarter. Such
distributions were to be made 90% to Limited Partners and 10% to the former
general partners, provided, however, that quarterly distributions were to be
cumulative and were not to be made to the former general partners unless and
until each Limited Partner had received a distribution from Net Cash Receipts in
an amount equal to 10% per annum, cumulative simple return on his or her
Adjusted Original Capital, as defined, from the Return Calculation Date, as
defined.
Net Proceeds, as originally defined, were to be distributed as follows: (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation date
including in the calculation of such return all prior distributions of Net Cash
Receipts and any prior distributions of Net Proceeds under this clause; and (c)
then, to Limited Partners, 90% and to the General Partners, 10%, of the
remaining Net Proceeds available for distribution.
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 $1,641 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 13.5% 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
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
30
<PAGE>
to be made 99% to Limited Partners and 1% to the current General Partner
provided, that quarterly distributions will be cumulative and will not be made
to the current General Partner unless and until each Limited Partner has
received a distribution from Net Cash Receipts in an amount equal to 10% per
annum, cumulative simple return on his or her Adjusted Original Capital, as
defined, from the Return Calculation Date, as defined, except to the extent
needed by the General Partner to pay its federal and state income taxes on the
income allocated to them attributable to such year. Distributions paid to the
General Partner are based on the estimated tax liability resulting from
allocated income. Subsequent to the filing of the General Partner's income tax
returns, a true-up with actual distributions is made.
The provisions regarding distribution of Net Proceeds, as defined, were also
amended to provide that Net Proceeds are to be distributed as follows: (a) to
the Limited Partners, an amount equal to 100% of their Adjusted Original
Capital; (b) then, to the Limited Partners, an amount necessary to provide each
Limited Partner a Liquidation Preference equal to a 13.5% per annum, cumulative
simple return on Adjusted Original Capital from the Return Calculation Date
including in the calculation of such return on all prior distributions of Net
Cash Receipts and any prior distributions of Net Proceeds under this clause,
except to the extent needed by the General Partner to pay its federal and state
income tax on the income allocated to its attributable to such year; and (c)
then, to Limited Partners, 99%, and to the General Partner, 1%, of remaining Net
Proceeds available for distribution.
Additionally, per the amendment of the Partnership Agreement dated May 26, 1993,
the total compensation paid to all persons for the sale of the investment
properties shall be limited to a competitive real estate commission, not to
exceed 6% of the contract price for the sale of the property. The General
Partner may receive up to one-half of the competitive real estate commission,
not to exceed 3%, provided that the General Partner provides a substantial
amount of services in the sales effort. It is further provided that a portion
of the amount of such fees payable to the General Partner is subordinated to its
success in recovering the funds misappropriated by the former general partners.
(See Note 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 percentages of gross sales in excess of specified breakpoints.
The lessee is responsible for occupancy costs such as maintenance, insurance,
real estate taxes, and utilities. Accordingly, these amounts are not reflected
in the statements of income except in circumstances where, in management's
opinion, the Partnership will be required to pay such costs to preserve its
assets (i.e., payment of past-due real estate taxes). Management has determined
that the leases are properly classified as operating leases; therefore, rental
income is reported when earned and the cost of the property, excluding the cost
of the land, is depreciated over its estimated useful life.
31
<PAGE>
Aggregate minimum lease payments to be received under the leases for the
Partnership's properties are as follows:
<TABLE>
<S> <C>
Year ending
December 31,
1996 $ 3,048,076
1997 3,221,602
1998 3,123,336
1999 3,156,936
2000 3,153,604
Thereafter 26,571,560
-----------
$42,275,114
===========
</TABLE>
Percentage rentals included in rental income in 1995, 1994, and 1993 were
$719,407, $708,716, and $626,824, respectively. The increase in percentage
rental income is a result of improved sales in various properties subject to
percentage rent.
Eight (8) of the Partnership's properties are leased to Terratron, Inc., a
franchisee of Hardee's restaurants and ten (10) of the properties are leased to
Wensouth, a franchisee of Wendy's restaurants. Terratron base rents accounted
for 22% of total base rents for 1995, and Wensouth accounted for 25% of base
rents for 1995. Due to sales difficulties experienced by Terratron, a one (1)-
year lease modification was made, reducing 1996 base rents by approximately
$200,000. Additionally, delinquent rent totaling $112,000 was capitalized into
a five (5)-year note accruing interest at 10% per annum. The amount of rent
capitalized was also written off as uncollectible at December 31, 1995.
6. EQUIPMENT NOTE PAYABLE:
-----------------------
At December 31, 1995, equipment notes payable consist of the following:
Outstanding
Principal
Balance Interest Rate Maturity Date
----------- ------------- ---------------
$77,255 9.80% September, 1997
In August 1992, the Partnership executed a note payable in the amount of
$190,000 with Norwest Equipment Finance, Incorporated, for equipment placed
in the Denny's restaurant located in Twin Falls, Idaho. The note is
payable in monthly installments of $4,018, including interest at 9.8%
through September 1997. The note is secured by the equipment under a
direct financing lease with an initial cost of $190,000.
32
<PAGE>
Future maturities of the equipment note payable are as follows:
Year ending
December 31,
1996 42,525
1997 34,730
--------
$ 77,255
========
7. TRANSACTIONS WITH FORMER AFFILIATES
AND CURRENT GENERAL PARTNER:
----------------------------
Amounts paid to the former general partners and their affiliates and the current
General Partner for the years ended December 31, 1995, 1994, and 1993, are as
follows. The amounts paid to the Interim Manager during 1993 were for
approximately two (2) months of services.
<TABLE>
<CAPTION>
Former General Partners Amounts Paid
and Interim Manager in 1993
- ------------------- -----------------
<S> <C> <C> <C>
Allocations of salaries and expenses $101,511
Property management fees 7,970
Reimbursement for out-of-pocket expenses 10,221
--------
$119,702
========
Incurred as of Incurred as of Incurred as of
Current General Partner December 31, 1995 December 31, 1994 December 31, 1993
- ----------------------- ----------------- ----------------- -----------------
Management fees $164,350 $171,256 $168,994
Disposition fees 3,000 3,300 3,428
Restoration fees 2,616 8,971 0
Overhead allowance 13,914 13,546 11,042
Reimbursement for out-of-pocket
expenses 19,148 14,268 23,603
Cash distribution 5,080 8,959 4,206
-------- -------- --------
$208,108 $220,300 $211,273
======== ======== ========
</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 comprised of the following as of
December 31, 1995:
<TABLE>
<CAPTION>
<S> <C>
Minimum lease payments receivable $703,198
Estimated residual values of leased
property (non-recourse) 22,364
Acquisition fees, net 804
Less-Unearned income (135,839)
---------
Net investment in direct
financing leases $590,527
========
</TABLE>
33
<PAGE>
<TABLE>
At December 31, 1995, future minimum lease payments for each of the five
succeeding fiscal years are as follows:
<S> <C>
Year ending
December 31,
1996 $ 220,285
1997 196,139
1998 177,791
1999 131,347
---------
$ 725,562
=========
</TABLE>
During 1995, it was determined that the residual values of the equipment leases
were overstated. Accordingly, they were written down to their estimated net
realizable values as of December 31, 1995. The total amount of the write-down
was approximately $72,000.
9. GENERAL AND ADMINISTRATIVE EXPENSES:
------------------------------------
For the years ended December 31, 1995, 1994, and 1993, general and
administrative expenses incurred by the Partnership were as follows:
<TABLE>
<CAPTION>
1995 1994 1993
-------- -------- ---------
<S> <C> <C> <C>
Communication costs $ 60,214 $ 59,923 $ 67,007
Partnership equipment 0 174 22,809
Other administration 23,907 41,107 20,329
Travel costs 5,107 15,458 25,714
Overhead allowance 13,914 13,546 11,042
Moving costs 0 0 3,273
-------- -------- --------
$103,142 $130,208 $150,174
======== ======== ========
</TABLE>
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 is to be escrowed until the aggregate
amount of recovery of the funds misappropriated from the Partnerships by the
former general partners is greater than $4,500,000. Upon reaching such recovery
level, full disposition fees will thereafter be payable and fifty percent (50%)
of the previously 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 December 31, 1995, the Partnership may owe the
current General Partner $24,292, which is currently reflected as a recovery, if
certain specified recovery levels are achieved.
34
<PAGE>
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 December 31, 1995. Funds are invested in U.S. Treasury
securities. In addition, $25,231 of earnings have been credited to the Trust as
of December 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 $192,358 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 $9,785. These amounts
have been offset by $128,555 received from DiVall 3. At December 31, 1995, the
Partnership was owed $73,588 from DiVall 3 for restoration costs.
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 December 31, 1995, the
Partnerships recovered a total of $679,315 from the former general partners and
their
35
<PAGE>
affiliates. Of this amount, the Partnership received its pro-rata share in the
amount of $277,184. Additionally, $60,143, representing 50% of all disposition
fees earned by the General Partner have been paid to the recovery. Of that
amount, $24,292 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.
On March 24, 1994, an affiliated partnership, DiVall 1, 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 DiVall 1 by the former general partners (the "Note") secured by
mortgages on five DiVall 1 properties, and further seeking an injunction against
foreclosure proceedings instituted against a DiVall 1 property located in
Dallas, Texas under a first deed of trust and security agreement given to secure
the Note (the "Foreclosure"). 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 DiVall 1. As of December 31, 1995, DiVall 1
had not paid debt service on the Note. DiVall 1 received a notice of default on
the Note in October 1993, and the Foreclosure Action was filed in February,
1994. As of December 31, 1995, interest in the amount of $174,000 had accrued
but was unpaid on the Note. Interest is accrued at the face rate of the note.
If DiVall 1 loses the case against Boatmen's, additional interest totaling
approximately $190,000, representing the default rate of interest may be due.
Boatmen's has agreed to stay its foreclosure proceedings pending the outcome of
the litigation. Boatmen's answered the complaint and filed a motion for summary
judgment to which DiVall 1 responded. The District Court granted Boatmen's
motion for summary judgement. DiVall 1 appealed and the Eighth Circuit Court of
Appeals reversed the District Court's ruling. The case was sent back to the
District Court for further discovery and trial. Boatmen's has until April 25,
1996 to seek leave to take the Eighth Circuit ruling to the United States
Supreme Court. Pursuant to the Restoration Trust Account procedures described
above, 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.
36
<PAGE>
13. LITIGATION:
-----------
On March 16, 1993, the Partnership, along with DiVall 1 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. The Partnerships
have hired legal counsel under a contingent fee arrangement to prosecute all of
the Partnerships' claims. E & Y filed an Answer denying that it was negligent.
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 filed third party claims against KPMG Peat Marwick, the
Partnerships' accountants preceding E&Y. The Partnerships also filed claims
against Magnuson, DiVall, DREIC, Shea, and Quarles & Brady. E & Y's claims
against Ms. Shatrawka and its fraud claims against Quarles & Brady were
voluntarily dismissed.
The trial of the case was scheduled to take place in Iowa County, Wisconsin,
beginning March 20, 1996. Shortly before trial The Partnerships reached a
resolution of their claims against Quarles & Brady. A resolution of the claims
against Ernst & Young was reached after opening statements. As a result of
these settlements, net proceeds available for deposit in the partnership's
restoration escrow account approximate $900,000.
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
37
<PAGE>
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
value of the obligations of the Private Partnerships assigned to the Partnership
has been at a significant discount to their face amounts, and (ii) the General
Partner interests in such Private Partnerships often have 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 sixteen (16) of the bankruptcies to date have resulted in cash
payments to the Partnerships of a total of $525,000 and notes secured by
subordinated mortgages in the aggregate amount of $625,000. The Partnership is
continuing to vigorously defend its interests in the remaining bankruptcies.
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 a deficit of
$840,229. At December 31, 1993, the former general partners' deficit capital
account balance in the amount of $840,229 was reallocated to the Limited
Partners.
15. SUBSEQUENT EVENTS:
------------------
On February 15, 1996, the Partnership made distributions to the Limited Partners
of $650,000 amounting to $14.05 per limited partnership interest.
On March 14, 1996, the Partnerships reached a resolution of the claims against
Quarles & Brady and on March 22, 1996, a resolution of the claims against Ernst
& Young was reached in relation to the litigation disclosed in Item 3. As a
result of these settlements, net proceeds available for deposit into the
Partnership's restoration escrow account approximate $900,000.
38
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The General Partner of the Partnership is The Provo Group, Inc., an Illinois
corporation ("TPG") with its principal office at 101 West 11th Street, Suite
1110, Kansas City, Missouri 64105. TPG was elected General Partner by vote of
the Limited Partners effective on May 26, 1993. TPG had been managing the
Partnership since February 8, 1993, under the terms of the Permanent Manager
Agreement ("PMA"), which remains in effect. TPG also serves as the corporate
general partner for DiVall 1 and DiVall 3. See Items 1 and 13 hereof for
additional information about the PMA and the election of TPG as General Partner.
The executive officers and director of the General Partner who control the
affairs of the Partnership are as follows:
BRUCE A. PROVO, AGE 45 - PRESIDENT, FOUNDER AND DIRECTOR.
Mr. Provo has been involved in the management of real estate and other
asset portfolios since 1979. Since he founded the company in 1985, Mr.
Provo has been President of TPG. From 1982 to 1986, Mr. Provo served as
President and Chief Operating Officer of the North Kansas City Development
Company ("NKCDC"), North Kansas City, Missouri. NKCDC was founded in 1903
and the assets of the company were sold in December, 1985 for $102,500,000.
NKCDC owned commercial and industrial properties, including an office park
and a retail district, as well as apartment complexes, motels, recreational
facilities, fast food restaurants, and other properties. NKCDC's holdings
consisted of over 100 separate properties and constituted approximately 20%
of the privately held real property in North Kansas City, Missouri (a four
square mile municipality). Following the sale of the company's real
estate, Mr. Provo served as the President, Chief Executive Officer and
Liquidating Trustee of NKCDC from 1986 to 1991.
Mr. Provo graduated from the Miami University, Oxford, Ohio in 1972 with a
B.S. in Accounting. He became a Certified Public Accountant in 1974 and
was a manager in the banking and financial services division of Arthur
Andersen LLP prior to joining Rubloff Development Corporation in 1979.
From 1979 through 1985, Mr. Provo served as Vice President - Finance and
then as President of Rubloff Development Corporation. Mr. Provo has
previously served on the Board of Directors of the National Realty
committee, a legislative "watchdog" organization for the commercial real
estate industry headquartered in Washington, DC.
KRISTIN J. ATKINSON, AGE 33 - VICE PRESIDENT - FINANCE AND ADMINISTRATION.
Ms. Atkinson joined The Provo Group, Inc. in September 1994 to provide
management expertise in the areas of financial controls and management
accounting services for four limited partnerships managed by TPG. Prior to
joining TPG, Ms. Atkinson was Manager of Financial Reporting for Farm &
Home Savings Association, a $4 billion savings and loan association, for
seven years where she was responsible for supervision of the preparation of
internal and external financial documentation, including regulatory
39
<PAGE>
filings for the savings association and its parent company. Ms. Atkinson
graduated Magna Cum Laude with a B.S. in Accounting from Missouri Southern
State College in Joplin, Missouri and worked as an accountant for James P.
Arthus and Company for one year before joining Farm & Home Savings
Association.
BRENDA BLOESCH, AGE 34 - DIRECTOR OF INVESTOR RELATIONS. Ms. Bloesch
joined The Provo Group, Inc. in March 1993, to oversee and provide various
levels of client support for more than 8,000 broker dealers, registered
representatives, custodians and investors. Primarily responsible for all
communications regarding four limited partnerships managed by TPG, Ms.
Bloesch is also involved with database management and partnership
compliance issues. Prior to joining TPG, Ms. Bloesch was Manager of
Investment Services at DiVall Real Estate Investment Corporation ("DREIC")
for four years and Publisher Services Manager at NewsNet, Inc. for five
years. Her role at DREIC allowed Ms. Bloesch to obtain extensive knowledge
of limited partnerships and gain familiarity with the broker and investor
communities. Ms. Bloesch is a graduate of Lock Haven University in Lock
Haven, Pennsylvania, where she received her B.A. in Journalism and Media
Studies.
The Advisory Board, although its members are not "Directors" or "Executive
Officers" of the Partnership, provides advisory oversight to management of the
Partnership and consists of:
D. TODD WITTHOEFT - VICE PRESIDENT OF CALTON ASSOCIATES. Mr.Witthoeft has
been an investment broker for over ten (10) years and was one of the
original founders of Calton and Associates. Mr. Witthoeft serves as part
of the firm's due diligence committee which reviews the structure of public
and private limited partnerships prior to offering to clients. Mr.
Witthoeft has over 400 clients and has taught personal financial planning
courses. Mr. Witthoeft holds the following securities licenses: Options
Principal, Licensed Life Insurance Agent - series 4; General Securities
Representative - series 7; General Securities Principal - series 24; and
State Agent - series 63.
GERHARD ZOLLER - ADVISOR. Mr. Zoller is currently involved in special
training projects at J.H. Findorff & Son, Inc., a leading construction firm
in Wisconsin. Mr. Zoller has worked for this company for 27 years and
served as both President and then Chairman of the Board in more recent
years. Prior business background and experience include positions as
Project Manager, Estimator and Chief Executive. Mr. Zoller has also been
actively managing personal investments for over 25 years including several
real estate limited partnerships. Mr. Zoller is a Limited Partner in
DiVall 1.
MICHAEL M. BLOOM - PRESIDENT OF DAVCON, INC. Mr. Bloom has owned this
multi-state General Contracting firm for 25 years in addition to two (2)
other companies, Bloom Architects and Nordic Springwater, Inc. Mr. Bloom
has been active in the construction industry for the last 27 years and has
served as both a developer and architect. He has been the principal in
charge of projects ranging in size from $100,000 to $10,000,000. Mr. Bloom
has also been the founder of two (2) start up corporations, Intel Security,
Corp. and Nordic Springwater, Inc. Mr. Bloom is a Limited Partner of the
Partnership. Mr. Bloom is presently a member of National Council of
Architectural Registration Boards, American Institute of Architects and
West Jersey Institute of Architects.
ALBERT H. ESCHEN - OPTOMETRIST. Dr. Eschen has been an optometrist for 46
years and is also employed by New York City's Department of Health. Prior
business experience include partnerships or personal investments in Crown
Nursing Home; Coronet Nursing
40
<PAGE>
Home; and Sands Hotel & Casino. Dr. Eschen is currently a member of the
American Optometry Association and is a member of the Board of Directors
Illinois College Alumni Association. Dr. Eschen was past-President of the
Brooklyn Optometric Society and was the first optometrist to be appointed
to New York City's Department of Health. Dr. Eschen is a Limited Partner
of DiVall 3.
ITEM 11. EXECUTIVE COMPENSATION
The Partnership has not paid any "executive compensation" to the corporate
General Partner or to the directors and officers of the General Partner. The
General Partner's participation in the income of the Partnership is set forth in
the Agreement of Limited Partnership and amendments thereto, which are filed as
Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5 hereto. The current General Partner
received management fees and expense reimbursements during the year.
See Item 13, below, and Note 7 to the financial statements in Item 8 hereof for
further discussion of payments by the Partnership to the General Partner and the
former general partners.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
(a) As of December 31, 1995, no one person or group is known by the Partnership
to own beneficially more than 5% of the outstanding interests of the
Partnership.
(b) As of December 31, 1995, neither the General Partner nor any of their
affiliates owned any Limited Partner Interests in the Partnership.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The compensation to be paid to TPG is governed by the Partnership Agreement, as
amended by vote of the Limited Partners to reflect the terms of the PMA. TPG's
compensation includes a base fee equal to 4% of the Partnership's gross
collected receipts, subject to a minimum of $159,000 per year. For this
purpose, "gross collected receipts" means all cash revenues arising from
operations and reserves of the Partnerships, including any proceeds recovered
with respect to the obligations of the former general partners. The portion of
such fee resulting from recoveries from former general partners is designated as
restoration fees. TPG is also entitled to reimbursement for office rent and
utilities not to exceed $13,250 per year. TPG is entitled to reimbursement of
reasonable direct costs and expenses, such as travel, lodging, overnight
delivery and postage, but has no right to be reimbursed for administrative
expenses such as payroll, payroll taxes, insurance, retirement and other
benefits, base phone and fax charges, office furniture and equipment, copier
rent, and the like. Between the three Partnerships, TPG is entitled to an
aggregate minimum base management fee of $300,000 per year and reimbursement for
office rent in the maximum amount of $25,000 per year. The Partnership shall
only be responsible for its allocable share of such minimum and maximum amounts
as indicated above ($159,000 minimum base fee and $13,250 maximum rent
reimbursement). TPG is entitled to an annual increase in the minimum base
management fee and maximum office overhead reimbursement in an amount not to
exceed the percentage increase in the Consumer Price Index ("CPI") for the
immediately preceding calendar year. 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 CPI adjustments.
Additionally, TPG is allowed up to one-half of the Competitive Real Estate
Commission, not to exceed 3% upon the disposition of assets. The payment of a
portion of such fees is subordinated to TPG's success at recovering the funds
misappropriated by the former general partners.
41
<PAGE>
The PMA has an expiration date of December 31, 2002, but may be terminated
earlier (a) by a vote at any time by a majority in interest of the Limited
Partners, (b) upon the dissolution and winding up of the Partnership, (c) upon
the entry of an order of a court finding that the Permanent Manager has engaged
in fraud or other like misconduct or has shown itself to be incompetent in
carrying out its duties under the Partnership Agreement, or (d) upon sixty (60)
days written notice from the Permanent Manager to the Limited Partners of the
Partnership. Upon termination of the PMA, other than by the voluntary action of
TPG, TPG shall be paid a termination fee of one month's Base Fee allocable to
the Partnership, subject to a minimum of $13,250. In the event that TPG is
terminated by action of a substitute general partner, TPG shall also receive, as
part of this termination fee, 4% of any proceeds recovered with respect to the
obligations of the former general partners, whenever such proceeds are
collected.
Under the PMA, TPG shall be indemnified by the Partnership, DiVall and Magnuson,
and their controlled affiliates, and shall be held harmless from all claims of
any party to the Partnership Agreement and from any third party including,
without limitation, the Limited Partners of the Partnership, for any and all
liabilities, damages, costs and expenses, including reasonable attorneys' fees,
arising from or related to claims relating to or arising from the PMA or its
status as Permanent Manager. The indemnification does not extend to claims
arising from fraud or criminal misconduct of TPG as established by court
findings. To the extent possible, the Partnership is to provide TPG with
appropriate errors and omissions, officers liability or similar insurance
coverage, at no cost to TPG. In addition, TPG is granted the right to establish
and segregate Partnership assets in an amount, not to exceed $250,000, solely
for the purpose of funding such indemnification obligations (the
"Indemnification Trust"). Once a determination has been made that no such
claims can or will be made against TPG, the balance of the Indemnification Trust
will become unrestricted cash of the Partnership. At December 31, 1995 the
Partnership had fully funded the Indemnification Trust.
The following fees and reimbursements from the Partnership were paid to
management in 1995:
<TABLE>
<CAPTION>
The Provo Group, Inc.
---------------------
<S> <C>
Management Fees $164,350
Disposition Fees 3,000
Restoration Fees 2,616
Office Overhead Allowance 13,914
Direct Cost Reimbursements 19,148
--------
1995 Total $203,028
========
</TABLE>
42
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following financial statements of DiVall Insured Income Properties
2 Limited Partnership are included in Part II, Item 8:
Report of Independent Public Accountants
Balance Sheets, December 31, 1995 and 1994
Statements of Income for the Years Ended December 31, 1995, 1994, and
1993
Statements of Partners' Capital for the Years Ended December 31, 1995,
1994, and 1993
Statements of Cash Flows for the Years Ended December 31, 1995, 1994,
and 1993
Notes to Financial Statements
2. Financial Statement Schedules
Schedule III - Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not
required under the related instruction or are inapplicable and, therefore,
have been omitted.
3. Listing of Exhibits
3.1 Agreement of Limited Partnership dated as of November 18, 1987,
amended as of November 25, 1987, and February 20, 1988, filed as
Exhibit 3A to Amendment No. 1 to the Partnership's Registration
Statement on Form S-11 as filed on February 22, 1988, and
incorporated herein by reference.
3.2 Amendments to Amended Agreement of Limited Partnership dated as
of June 21, 1988, included as part of Supplement dated August 15,
1988, filed under Rule 424(b)(3), incorporated herein by
reference.
3.3. Amendment to Amended Agreement of Limited Partnership dated as of
February 8, 1993, filed as Exhibit 3.3 to the Partnership's 10-K
for the year ended December 31, 1992, and incorporated herein by
reference.
3.4 Amendment to Amended Agreement of Limited Partnership dated as of
May 26, 1993, filed as Exhibit 3.4 to the Partnership's 10-K for
the year ended December 31, 1993, and incorporated herein by
reference.
43
<PAGE>
3.5 Amendment to Amended Agreement of Limited Partnership dated as of
June 30, 1994, filed as Exhibit 3.5 to the Partnership's 10-K for
the year ended December 31, 1994 and incorporated herein by
reference.
10.0 Permanent Manager Agreement filed as an exhibit to the Current
Report on Form 8-K dated January 22, 1993, incorporated herein by
reference.
27.0 Financial Data Schedule for the years ended December 31, 1995 and
1994.
28.0 Correspondence to the Limited Partners dated February 15, 1996
regarding the Fourth Quarter 1995 distribution.
(b) Reports on Form 8-K:
The Registrant filed no reports on Form 10-K during the fourth quarter of
fiscal year 1995.
44
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1995
<TABLE>
<CAPTION>
GROSS AMOUNT AT WHICH
INITIAL COST TO PARTNERSHIP CARRIED AT END OF YEAR (A)
-------------------------------------- COSTS --------------------------------------
BUILDING CAPITALIZED
AND SUBSEQUENT TO BUILDING AND
PROPERTY ENCUMBRANCES LAND IMPROVEMENTS ACQUISITIONS LAND IMPROVEMENTS TOTAL
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Palm Gardens, Florida (1) $ - $ 495,237 $ 248,388 $ - $ 325,487 $ 163,258 $ 488,745
Hallandale, Florida (2) - 502,578 289,610 - 198,084 147,937 346,021
Oconomowoc, Wisconsin - 290,400 512,350 - 290,400 512,350 802,750
Phoenix, Arizona - 444,224 421,676 - 444,224 421,676 865,900
Phoenix, Arizona - - 295,750 - - 295,750 295,750
N. Richland Hills, Texas - 762,580 584,139 - 662,580 584,139 1,246,719
Sandy City, Utah - - 355,847 - - 355,847 355,847
South Milwaukee, Wisconsin - 274,749 454,064 79,219 274,749 533,283 808,032
Phoenix, Arizona - 482,383 490,343 - 482,383 490,343 972,726
West Jordan, Utah - 274,203 343,704 - 274,203 343,704 617,907
Cedar Rapids, Iowa - 108,125 552,031 - 108,125 552,031 660,156
Port St. Lucie, Florida - 496,519 850,200 - 496,519 850,200 1,346,719
Memphis, Tennessee - 389,255 688,120 - 389,255 688,120 1,077,375
Santa Fe, New Mexico - - 451,230 - - 451,230 451,230
Augusta, Georgia - 215,416 434,178 - 215,416 434,178 649,594
Charleston, South Carolina - 273,619 323,162 - 273,619 323,162 596,781
Park Forest, Illinois - 187,900 393,038 - 187,900 393,038 580,938
Aiken, South Carolina - 402,549 373,795 - 402,549 373,795 776,344
Augusta, Georgia - 332,154 396,659 - 332,154 396,659 728,813
Mt. Pleasant, South Carolina - 286,060 294,878 - 286,060 294,878 580,938
Charleston, South Carolina - 273,625 254,500 - 273,625 254,500 528,125
Aiken, South Carolina - 178,521 455,229 - 178,521 455,229 633,750
Des Moines, Iowa - 164,096 448,529 287,991 164,096 680,902 844,998
Daytona Beach, Florida - 291,356 738,488 - 291,356 738,488 1,029,844
Hartford, Wisconsin - 201,603 484,960 - 201,603 484,960 686,563
Delavan, Wisconsin - 245,718 472,532 - 245,718 472,532 718,250
Milwaukee, Wisconsin - 409,143 600,902 - 409,143 600,902 1,010,045
North Augusta, Georgia - 250,859 409,297 - 250,859 409,297 660,156
Charleston, South Carolina - 286,068 294,870 - 286,068 294,870 580,938
Martinez, Georgia - 266,175 367,575 - 266,175 367,575 633,750
Grand Forks, North Dakota - 172,701 566,674 - 172,701 566,674 739,375
Phoenix, Arizona - - 725,000 - - 500,000 500,000
Phoenix, Arizona - 241,371 843,132 - 241,371 843,132 1,084,503
New Smyrna Beach, Florida - 403,771 622,059 - 403,771 622,059 1,025,830
Ogden, Utah - 194,350 452,075 - 194,350 452,075 646,425
Fond du Lac, Wisconsin - 297,418 552,349 - 297,418 552,349 849,767
Twin Falls, Idaho - 155,269 483,763 60,000 155,269 543,763 699,032
Columbus, Ohio - 351,325 708,141 - 351,326 708,141 1,059,467
--------------------------------------------------------------------------------------------
$ 0 $10,759,673 $18,464,641 $427,210 $10,027,077 $18,153,026 $28,180,103
============================================================================================
</TABLE>
<TABLE>
<CAPTION>
LIFE ON WHICH
DEPRECIATION IN
LATEST STATEMENT
OF OPERATIONS
ACCUMULATED DATE OF DATE IS COMPUTED
PROPERTY DEPRECIATION CONSTRUCTION ACQUIRED (YEARS)
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Palm Gardens, Florida (1) $ 88,744 - 3/11/88 31.5
Hallandale, Florida (2) 97,258 - 3/11/88 31.5
Oconomowoc, Wisconsin 154,063 - 5/9/88 31.5
Phoenix, Arizona 149,185 - 6/15/88 31.5
Phoenix, Arizona 104,634 - 6/15/88 31.5
N. Richland Hills, Texas 171,069 - 7/15/88 31.5
Sandy City, Utah 105,560 - 7/22/88 31.5
South Milwaukee, Wisconsin 153,939 1986 8/1/88 31.5
Phoenix, Arizona 141,677 - 8/15/88 31.5
West Jordan, Utah 97,959 - 8/22/88 31.5
Cedar Rapids, Iowa 157,334 - 9/9/88 31.5
Port St. Lucie, Florida 238,978 - 9/19/88 31.5
Memphis, Tennessee 194,635 - 10/14/88 31.5
Santa Fe, New Mexico 105,068 - 10/10/88 31.5
Augusta, Georgia 116,923 - 12/22/88 31.5
Charleston, South Carolina 87,027 - 12/22/88 31.5
Park Forest, Illinois 105,844 - 12/22/88 31.5
Aiken, South Carolina 99,193 - 2/21/89 31.5
Augusta, Georgia 105,260 - 2/21/89 31.5
Mt. Pleasant, South Carolina 78,251 - 2/21/89 31.5
Charleston, South Carolina 67,536 - 2/21/89 31.5
Aiken, South Carolina 120,803 - 3/14/89 31.5
Des Moines, Iowa 172,653 1989 8/1/89 31.5
Daytona Beach, Florida 201,776 - 4/4/89 31.5
Hartford, Wisconsin 122,969 - 4/28/89 31.5
Delavan, Wisconsin 121,677 - 4/1/89 31.5
Milwaukee, Wisconsin 152,368 - 8/2/89 31.5
North Augusta, Georgia 90,878 - 12/29/89 31.5
Charleston, South Carolina 65,471 - 12/29/89 31.5
Martinez, Georgia 81,614 - 12/29/89 31.5
Grand Forks, North Dakota 125,821 - 12/28/89 31.5
Phoenix, Arizona 116,742 - 1/1/90 31.5
Phoenix, Arizona 187,204 - 1/1/90 31.5
New Smyrna Beach, Florida 138,118 - 1/5/90 31.5
Ogden, Utah 129,246 - 1/31/90 31.5
Fond du Lac, Wisconsin 122,640 - 1/5/90 31.5
Twin Falls, Idaho 108,666 - 3/21/90 31.5
Columbus, Ohio 143,245 - 6/1/90 31.5
----------
$4,822,028
==========
</TABLE>
(1) This property was written down to its estimated net realizable value of
$400,000 at December 31, 1995.
(2) This property was written down to its estimated net realizable value of
$250,000 at December 31, 1994.
45
<PAGE>
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1995
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended Year Ended
------------------ ------------------ ------------------ -----------------
Investment in Real Estate December 31, 1995 December 31, 1994 Accumulated Depreciation December 31, 1995 December 31, 1994
- ------------------------- ------------------ ------------------ ------------------------ ------------------ -----------------
<S> <C> <C> <C> <C> <C>
Balance at beginning of $28,790,395 $29,135,861 Balance at beginning of $4,336,437 $3,778,412
year year
Deletions: Additions charged to 542,731 558,015
Due to disposition (355,411) (175,339) costs and expenses
Due to property write-downs (254,881) (170,127) Deletion due to real (57,140) 0
estate disposition
----------- ----------- ---------- ----------
Balance at end of year $28,180,103 $28,790,395 Balance at end of year $4,822,028 $4,336,437
=========== =========== ========== ==========
</TABLE>
46
<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 PROPERTIES 2 LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: /s/Bruce A. Provo
--------------------------------------------
Bruce A. Provo, President
Date: March 29, 1996
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: March 29, 1996
By: /s/Kristin J. Atkinson
-------------------------------------------
Kristin J. Atkinson
Vice President - Finance and Administration
Date: March 29, 1996
47
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DECEMBER
31,1995 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1995 DEC-31-1994
<PERIOD-START> JAN-01-1995 JAN-01-1994
<PERIOD-END> DEC-31-1995 DEC-31-1994
<CASH> 1,066,981 1,650,795
<SECURITIES> 275,231 253,558
<RECEIVABLES> 8,119,826 7,615,858
<ALLOWANCES> 5,685,509 4,560,440
<INVENTORY> 0 0
<CURRENT-ASSETS> 3,776,529 4,959,771
<PP&E> 28,849,881 29,496,623
<DEPRECIATION> 5,491,806 5,001,045
<TOTAL-ASSETS> 27,134,604 29,455,349
<CURRENT-LIABILITIES> 592,871 826,877
<BONDS> 77,255 511,019
<COMMON> 0 0
0 0
0 0
<OTHER-SE> 26,464,478 28,117,453
<TOTAL-LIABILITY-AND-EQUITY> 27,134,604 29,455,349
<SALES> 3,872,381 3,967,708
<TOTAL-REVENUES> 3,932,498 4,190,932
<CGS> 0 0
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 1,668,593 1,700,952
<LOSS-PROVISION> 438,907 218,010
<INTEREST-EXPENSE> 42,893 113,687
<INCOME-PRETAX> 1,782,105 2,158,283
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 1,782,105 2,158,283
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,782,105 2,158,283
<EPS-PRIMARY> 38.12 46.17
<EPS-DILUTED> 38.12 46.17
</TABLE>
