<PAGE>
FORM 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
-----------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ___________________
Commission file number 0-20253
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
WISCONSIN 39-1660958
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
101 W. 11th St., Suite 1110, Kansas City, Missouri 64105
(Address of principal executive offices, including zip code)
(816) 421-7444
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Limited
Partnership Interests
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
------ ------
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
BALANCE SHEETS
MARCH 31, 1996 AND DECEMBER 31, 1995
------------------------------------
ASSETS
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1996 1995
------------ -------------
<S> <C> <C>
INVESTMENT PROPERTIES: (NOTE 3)
Land $ 2,085,836 $ 2,085,836
Buildings and improvements 3,766,226 3,766,226
Accumulated depreciation (673,773) (644,443)
----------- -----------
Net investment properties 5,178,289 5,207,619
----------- -----------
NET INVESTMENT IN DIRECT FINANCING LEASES: (NOTE 7) 893,207 976,461
----------- -----------
OTHER ASSETS:
Cash and cash equivalents 481,581 312,290
Cash restricted for real estate taxes 85 42,799
Cash held in Indemnification Trust (NOTE 10) 265,856 242,725
Restoration escrow account 826,160 0
Rents and other receivables (net of allowance of $45,730 in 1995) 39,958 27,955
Due from current General Partner 0 792
Deferred rent receivable 42,846 42,904
Notes receivable 73,040 79,001
Prepaid assets 2,482 1,902
----------- -----------
Total other assets 1,732,008 750,368
----------- -----------
DUE FROM FORMER AFFILIATES: (NOTE 2)
Due from former general partner affiliates 2,288,194 4,084,424
Allowance for uncollectible amounts due from former affiliates (2,288,194) (3,017,285)
Restoration cost receivable 4,111,392 3,252,676
Allowance for uncollectible restoration receivable (4,111,392) (3,252,676)
----------- -----------
Due from former affiliates, net
0 1,067,139
Total assets ----------- -----------
$ 7,803,504 $ 8,001,587
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
2
<PAGE>
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
LIABILITIES AND PARTNERS' CAPITAL
MARCH 31, 1996 AND DECEMBER 31, 1995
------------------------------------
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
1996 1995
------------ -------------
<S> <C> <C>
LIABILITIES:
Accounts payable and accrued expenses $ 147,070 $ 251,948
Due to affiliated partnerships (NOTE 11) 0 201,912
Due to current General Partner 637 0
Security deposits 103,181 103,181
Real estate taxes payable 2,671 3,184
----------- -----------
Total liabilities 253,559 560,225
----------- -----------
CONTINGENET LIABILITIES: (NOTE 9)
PARTNER'S CAPITAL: (NOTES 1, 4 AND 13)
Former general partners -
Capital contributions 200 200
Cumulative net loss (195,015) (195,015)
Cumulative cash distributions (70,676) (70,676)
Reallocation of former general partners' deficit
capital to Limited Partners 265,491 265,491
----------- -----------
0 0
----------- -----------
Current General Partner -
Cumulative net income (loss) 4,017 2,425
Cumulative cash distributions (2,070) (1,433)
----------- -----------
1,947 992
----------- -----------
Limited Partners (17,102.52 interests outstanding)
Capital contributions, net of offering costs 14,408,872 14,408,872
Cumulative net loss (1,357,399) (1,515,027)
Cumulative cash distributions (5,237,984) (5,187,984)
Reallocation of former general partners' deficit capital (265,491) (265,491)
----------- -----------
7,547,998 7,440,370
----------- -----------
Total partners' capital 7,549,945 7,441,362
----------- -----------
Total liabilities and partners' capital $ 7,803,504 $ 8,001,587
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE>
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
STATEMENTS OF INCOME
(UNAUDITED)
-----------
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1996 1995
------------- -------------
<S> <C> <C>
REVENUES:
Rental income $170,578 $182,726
Interest income on direct financing leases 27,053 17,388
Interest income 8,053 29,860
Other income 277 847
Recovery of amounts previously written off 729,091 0
-------- --------
935,052 230,821
-------- --------
EXPENSES:
Partnership management fees 15,170 14,275
Restoration fees 52,335 492
Insurance 1,268 1,032
General and administrative (NOTE 8) 8,930 9,330
Advisory board fees and expenses 4,942 5,636
Interest 0 1,760
Professional services 13,187 21,045
Professional services related to investigation 650,670 42,199
Depreciation 29,330 29,330
Amortization 0 3,783
-------- --------
775,832 128,882
-------- --------
NET INCOME $159,220 $101,939
======== ========
NET INCOME - GENERAL PARTNER $ 1,592 $ 1,019
NET INCOME - LIMITED PARTNERS 157,628 100,920
-------- --------
$159,220 $101,939
======== ========
NET INCOME PER LIMITED PARTNERSHIP
INTEREST, based on 17,102.52 interests outstanding $9.22 $5.90
===== =====
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE>
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(UNAUDITED)
-----------
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
1996 1995
--------------- -------------
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES:
Net income $ 159,220 $ 101,939
Adjustments to reconcile net income to net cash from (used in)
operating activities -
Depreciation and amortization 29,330 33,113
Recovery of amounts previously written off (729,091) 0
Interest applied to Indemnification Trust Account (3,131) (2,036)
(Increase) in rents, other receivables and prepaid assets (11,791) (29,752)
(Increase)/Decrease in deferred rent receivable 58 (1,291)
Deposits applied for real estate taxes 42,714 42,414
(Decrease) in accounts payable and accrued expenses (104,878) (12,104)
Increase in due to General Partner 637 50
(Decrease) in real estate taxes payable (513) (42,319)
---------- ---------
Net cash provided from operating activities
617,445 90,014
---------- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES:
Principal payments received on direct financing leases 83,254 72,626
Deposit to Indemnification Trust Account (20,000) (25,000)
Deposit to restoration escrow account (826,160) 0
Recoveries from former affiliates 1,796,230 12,296
Principal receipts from note 5,961 0
---------- ---------
Net cash provided from investing activities
1,039,285 59,922
---------- ---------
CASH FLOWS (USED IN) FINANCING ACTIVITIES:
Principal payments on mortgage note 0 (22,240)
Payments of amounts due to affiliated partnerships (201,912) (11,804)
Cash distributions to General Partner (637) (408)
Cash distributions to Limited Partners (50,000) (160,000)
---------- ---------
Net cash (used in) financing activities
(252,549) (194,452)
---------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 169,291 (44,516)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 312,290 382,605
---------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 481,581 $ 338,089
========== =========
SUPPLEMENTAL DISCLOSURE--cash paid for interest $ 0 $ 1,760
========== =========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE>
DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF ACCOUNTING:
-------------------------------------
DiVall Income Properties 3 Limited Partnership (the "Partnership") was formed on
December 12, 1989, pursuant to the Uniform Limited Partnership Act of the State
of Wisconsin. The initial capital which was contributed during 1989, consisted
of $300, representing aggregate capital contributions of $200 by the former
general partners and $100 by the Initial Limited Partner.
The Partnership initially offered two classes of Limited Partnership interests
for sale: Distribution interests ("D-interests") and Retention interests
("R-interests"). Each class was offered at a price (before volume discounts) of
$1,000 per interest. The Partnership offered the two classes of interests
simultaneously up to an aggregate of 25,000 interests.
The minimum offering requirements for the D-interests were met and escrowed
subscription funds were released to the Partnership as of July 13, 1990. The
offering closed on April 23, 1992, at which point 17,102.52 D-interests had been
issued, resulting in aggregate proceeds, net of discounts and offering costs, of
$14,408,872.
The minimum offering requirements for R-interests were not met. During 1991,
680.9 R-interests were converted to D-interests and were reflected as
Partnership issuances in 1991.
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 of fast-food, family style, and casual/theme
restaurants. At March 31, 1996, the Partnership owned seven (7) properties and
specialty leasehold improvements for use in all seven (7) of the Properties.
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.
Real estate taxes on the Partnership's investment properties are the
responsibility of the tenant. However, when a tenant fails to make the required
tax payments or when a property becomes vacant, the Partnership makes the
appropriate payment to avoid possible foreclosure of the property. Taxes are
accrued in the period for which the liability is incurred.
Cash and cash equivalents include cash on deposit in financial institutions and
highly liquid temporary investments with initial maturities of 90 days or less.
6
<PAGE>
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities (and disclosure of
contingent assets and liabilities) at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
The Partnership will be dissolved on December 1, 2015, or earlier upon the prior
occurrence of any of the following events: (a) the disposition of all interests
in real estate and other Partnership assets; (b) the decision by Majority Vote
of the Limited Partners to dissolve the Partnership or to compel the sale of all
or substantially all of the Partnership's assets; (c) the failure to elect a
successor General Partner within six months after removal of the last remaining
General Partner; or (d) the date of the death or the effective date of
dissolution, removal, withdrawal, bankruptcy, or incompetency of the last
remaining General Partner, unless the Partnership is continued by vote of all
Limited Partners and a replacement General Partner is previously elected 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
$3,100,000.
2. REGULATORY INVESTIGATION:
-------------------------
A preliminary investigation during 1992 by the Office of the Commissioner of
Securities for the State of Wisconsin and the Securities and Exchange Commission
(the "Investigation") revealed that during at least the three 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 Insured Income Properties 2 Limited Partnership ("DiVall 2")
(collectively the "Partnerships") to various other entities previously sponsored
by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers
were in violation of the respective Partnership Agreements and resulted, in
part, from material weaknesses in the internal control system of the
Partnerships. The aggregate amount of the misappropriation, related costs, and
9% interest accrued since January 1, 1993, is in excess of $13,700,000, of which
approximately $6,400,000 has been attributed to the Partnership and is reflected
as due from former affiliates on the balance sheet at March 31, 1996. The 9%
interest accrued as of March 31, 1996, amounted to approximately $1,762,000 and
is not reflected in the accompanying income statement. As of December 31, 1995,
$7,337,000 was reflected as due from former affiliates based on an estimated
overall misappropriation and related costs of $15,700,000. Permanent Manager
Agreement ("PMA") savings, representing cost savings to the Partnerships as a
result of the implementation of the PMA, are not credited against the due from
former affiliates account on the financial statements of 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 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.
7
<PAGE>
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, of which approximately
$1.4 million was allocated to the Partnership. 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 Partnership's allowance was reduced by
approximately $729,000 at March 31, 1996 as a result of recoveries received in
excess of the original estimate. Pending resolution of all sources of potential
recovery, it is not possible to determine the amount that will ultimately be
recovered.
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
the former general partners during the three years ended December 31, 1992,
which initially either were not recorded on the books and records of the
Partnership or were improperly recorded and characterized. Such transactions
included unsupported disbursements or improper disbursements under the terms of
the Partnership Agreement and the encumbrance of Partnership assets. All such
transactions identified during the regulatory Investigation and concurrent
reviews have been reflected in the Partnership's financial statements as of
March 31, 1996.
3. INVESTMENT PROPERTIES:
----------------------
As of March 31, 1996, the Partnership owned seven (7) fast-food restaurants
comprised of: three (3) Hardee's restaurants, one (1) Applebee's restaurant,
and three (3) Denny's restaurants. The seven (7) properties are located in five
(5) states.
The total cost of the investment properties 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 82% of the original offering proceeds to the acquisition of investment
properties. Upon full investment of the net proceeds of the offering,
approximately 57% of the original offering 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 $2,000 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 $12,000 through February 28,
1993. As a result of the Investigation, the Partnership engaged a third party
as Interim Manager in October 1992. The Interim Manager received approximately
$19,000 through February 28, 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
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 partners as the new General Partner, as
provided for in an amendment to the Partnership
8
<PAGE>
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, 1996, the
minimum management fee and the maximum reimbursement for office rent and
overhead increased by 2.8% representing the allowable annual Consumer Price
Index adjustment per the PMA. For purposes of computing the 4% overall fee,
gross receipts includes amounts recovered in connection with the
misappropriation of assets by the former general partners and their affiliates.
TPG has received fees from the Partnership totaling $65,746 to date on the
amounts recovered, which has been offset against the 4% minimum fee.
Several of the Partnership's property leases contain purchase option provisions
with stated purchase prices in excess of the original cost of the properties.
The current General Partner is unaware of any unfavorable purchase options in
relation to original cost.
4. PARTNERSHIP AGREEMENT:
----------------------
The Partnership Agreement, prior to an amendment effective May 26, 1993,
provided that, for financial reporting and income tax purposes, net profits or
losses from operations were allocated 90% to the Limited Partners and 10% to the
former general partners. The Partnership Agreement also provided that Net Cash
Receipts, as defined, would be distributed 90% to the Limited Partners and 10%
to the former general partners, except that distributions to the former general
partners in excess of 1% in any calendar year would be subordinated to
distributions to the Limited Partners in an amount equal to their Original
Property Distribution Preference, as defined.
Net proceeds, as defined, were to be distributed as follows: (a) 1% to the
General Partners and 99% to the Limited Partners, until distributions to the
Limited Partners equal their Original Capital, as defined, plus their Original
Property Liquidation Preference, as defined, and (b) the remainder 90% to the
Limited Partners and 10% to the General Partners. Such distributions were to be
made as soon as practicable following the sale, financing or refinancing of an
original property.
On May 26, 1993, pursuant to the results of a solicitation of written consents
from the Limited Partners, the Partnership Agreement was amended to replace the
former general partners and amend various sections of the agreement. The former
general partners were replaced as General Partner, by The Provo Group, Inc., an
Illinois Corporation. Under the terms of the amendment, net profits or losses
from operations are allocated 99% to the Limited Partners and 1% to the current
General Partner. The amendment also provided for distributions from Net Cash
Receipts to be made 99% to the Limited Partners and 1% to its current General
Partner. Pursuant to the amendments to the Partnership Agreement effective June
30, 1994, distributions of Net Cash Receipts will not be made to the 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 incomes taxes on the income allocated to it attributable to
such year. Distributions paid to the General Partner are based on the estimated
tax liability as a result of allocated income. Subsequent to the filing of the
General Partner's income tax returns, a true-up of actual distributions is made.
Net proceeds, as defined, was also amended to be distributed 1% to the current
General Partner and 99% to the Limited Partners.
9
<PAGE>
Additionally, as per the amendment of the Partnership Agreement dated May 26,
1993, the total compensation paid to all persons for the sale of the investment
properties shall be limited to a competitive real estate commission, not to
exceed 6% of the contract price for the sale of the property. The General
Partner may receive up to one-half of the competitive real estate commission,
not to exceed 3%, provided that the General Partner provides a substantial
amount of services in the sales effort. It is further provided that a portion
of the amount of such fees payable to the General Partner is subordinated to its
success at recovering the funds misappropriated by the former general partners.
(See Note 10.)
Effective June 1, 1993, the Partnership Agreement was amended to (i) change the
definition of "Distribution Quarter" to be consistent with calendar quarters,
and (ii) change the distribution provisions to subordinate the General Partner's
share of distributions from Net Cash Receipts and Net Proceeds, except to the
extent necessary for the General Partner to pay its federal and state income
taxes on Partnership income allocated to the General Partner. Because these
amendments do not adversely affect the rights of the Limited Partners, pursuant
to section 10.2 of the Partnership Agreement, the amendments were made by the
General Partner without a vote of the Limited Partners.
5. LEASES:
-------
Lease terms for the investment properties are 20 years from their inception.
The leases 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 assets (i.e., payment of past-due
real estate taxes). Management has determined that the leases are properly
classified as operating leases; therefore, rental income is reported when earned
and the cost of the property, excluding the cost of the land, is depreciated
over its estimated useful life.
Aggregate minimum lease payments to be received under the leases for the
Partnership's properties are as follows:
<TABLE>
<CAPTION>
Year ending
December 31,
<S> <C>
1996 $ 670,900
1997 742,860
1998 742,860
1999 742,860
2000 742,860
Thereafter 7,175,975
-----------
$10,818,315
===========
</TABLE>
Three (3) of the Partnership's properties are leased to a Denny's franchise.
Base rent from these properties amounted to approximately 34% of total base rent
in 1995.
The original offering document required the Partnership to lease its properties
to a single tenant as long as the properties so leased do not constitute; in the
aggregate, more than 20% of the aggregate gross proceeds of the offering. As of
March 31, 1996, the Partnership has leased two of its properties to Terratron,
Inc., which constitute 21% of the aggregate gross proceeds. Due to sales
difficulties in the
10
<PAGE>
stores leased by Terratron, a one (1) year lease modification was entered into
with the tenant, reducing 1996 base rents by approximately $85,000.
Additionally, delinquent rents totaling $46,000 were capitalized into a five (5)
year note accruing interest at 10% per annum. The amount of the rent
capitalized was written off as uncollectible at December 31, 1995.
6. TRANSACTIONS WITH CURRENT GENERAL PARTNER:
------------------------------------------
Amounts paid to the current General Partner for the quarters ended March 31,
1996 and 1995, are as follow:
<TABLE>
<CAPTION>
Incurred as of Incurred as of
Current General Partner March 31, 1996 March 31, 1995
- - ----------------------- -------------- --------------
<S> <C> <C>
Management fees $15,170 $14,275
Restoration fees 52,335 492
Cash distribution 637 408
Overhead allowance 1,264 1,231
Reimbursement for out-of-pocket expenses 1,826 1,484
------- -------
$71,232 $17,890
======= =======
</TABLE>
7. 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
March 31, 1996:
<TABLE>
<S> <C>
Minimum lease payments receivable $ 981,138
Estimated residual values of leased
property (non-recourse) 73,728
Less - Unearned income (161,659)
---------
Net investment in direct financing leases $ 893,207
=========
</TABLE>
Scheduled future minimum lease payments are as follows:
<TABLE>
<S> <C>
Year ending
December 31,
1996 $ 333,035
1997 312,561
1998 225,470
1999 183,800
----------
$1,054,866
==========
</TABLE>
11
<PAGE>
During 1995, it was determined that the residual amounts of the leases were
overstated. Accordingly a write-down of residual amounts to their estimated net
realizable values was recorded. The total amount of the write-down was
approximately $96,000.
8. GENERAL AND ADMINISTRATIVE EXPENSES:
------------------------------------
For the quarters ended March 31, 1996 and 1995, general and administrative
expenses incurred by the Partnership were as follows:
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1996 1995
------------- -------------
<S> <C> <C>
Communication costs $4,650 $5,088
Overhead allowance 1,264 1,231
Income tax expense 0 1,725
Other administration 3,016 1,286
------ ------
$8,930 $9,330
====== ======
</TABLE>
9. 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. After surpassing the $4,500,000
recovery level during March 1996, 50% of the amounts previously escrowed was
refunded to the current General Partner. The remaining amount allocated to the
Partnerships may be owed to the current General Partner if the $6,000,000
recovery level is met. As of March 31, 1996, the Partnership may owe the
current General Partner $18,862, which is currently reflected as a recovery, if
the $6,000,000 recovery level is achieved.
10. 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
12
<PAGE>
to the claims of the Partnership's creditors. An Indemnification Trust
("Trust") serving such purposes has been established at United Missouri Bank,
N.A. The Trust has been fully funded with Partnership assets as of March 31,
1996. Funds are invested in U.S. Treasury securities. In addition, interest
totaling $15,855 has been credited to the Trust as of March 31, 1996. 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.
11. 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 owed $295,053 and $192,359 to DiVall 1 and
DiVall 2, respectively, for amounts paid on its behalf. Amounts recovered from
former general partner affiliates have been used to partially repay the amounts
due to DiVall 1 and DiVall 2. At December 31, 1995, the remaining amounts due
to DiVall 1 and DiVall 2 totaled $105,824 and $73,588, respectively. Such
amounts are reflected on the balance sheet as due to affiliated partnerships.
These amount were fully repaid during March 1996 from recoveries received.
Recoveries realized by the Partnerships are being distributed to each respective
partnership on the same basis as the restoration costs are currently being
allocated, adjusted for any future changes in the entire misappropriation, as a
result of the continuing investigation. Any available recovery funds are being
utilized first to satisfy amounts due other partnerships for amounts advanced
under prior allocation methods. As of March 31, 1996, the Partnerships
recovered a total of approximately $4,541,000 from the former general partners
and their affiliates. Of this amount, the Partnership received its pro-rata
share in the amount of $2,117,000. Additionally, $40,347, representing 25% of
all disposition fees earned by the General Partner, have been paid to the
recovery. Of that amount, $18,862 was allocated to the Partnership and is
contingently payable to the General Partner upon achievement of the final
recovery level 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
13
<PAGE>
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 March 31, 1996, 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 March 31, 1996, interest in the amount of $187,000 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 $204,000,
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. 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.
12. LITIGATION:
-----------
On March 16, 1993, the Partnership, along with DiVall 1 and DiVall 2 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 requested the payment of damages
in the amount of $9,000,000, plus interest, attorneys fees and costs, and
whatever additional relief the court deemed just and proper. The Partnerships
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. 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 of
14
<PAGE>
DREIC and former Director of Fund Management of 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 these
settlements, net proceeds deposited in the Partnership's restoration escrow
account totaled approximately $826,000.
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 2. 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 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 $537,000 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.
13. 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
$265,491. At December 31, 1993, the former general partners' deficit capital
account balance in the amount of $265,491 was reallocated to the Limited
Partners.
15
<PAGE>
14. SUBSEQUENT EVENTS:
------------------
On May 15, 1996, the Partnership made a distribution to the Limited Partners for
the First Quarter 1996 of $175,000 amounting to approximately $10.23 per limited
partnership interest.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES:
- - --------------------------------
INVESTMENT PROPERTIES AND NET INVESTMENT IN DIRECT FINANCING LEASES
- - -------------------------------------------------------------------
The investment properties, including equipment held by the Partnership at March
31, 1996, were originally purchased at a price, including acquisition costs, of
approximately $5,869,000.
The net investment in direct financing leases, which includes the Partnership's
specialty leasehold improvement leases, amounted to $893,000 at March 31, 1996,
compared to $976,000 at December 31, 1995. The decrease of $83,000 was a result
of principal payments received during the quarter.
OTHER ASSETS
- - ------------
Cash and cash equivalents, including cash restricted for real estate taxes held
by the Partnership, were $482,000 at March 31, 1996, compared to $355,000 at
December 31, 1995. The Partnership designated cash of $175,000 to fund the First
Quarter 1996 distributions to Limited Partners; $155,000 for the payment of
accounts payable and accrued expenses; and the remainder represents reserves
deemed necessary to allow the Partnership to operate normally. Cash generated
through the operations of the Partnership's investment properties, 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.
A Restoration Escrow account was established during the First Quarter of 1996,
and $826,000, representing the net proceeds to the partnership from the
settlement of the Ernst & Young and Quarles & Brady litigation, was deposited to
the account. For information regarding the settlement refer to PART II, Item 1
of this report.
The Partnership established an Indemnification Trust (the "Trust") during the
Fourth Quarter of 1993 and deposited $130,000 in the Trust during 1994, $100,000
during 1995, and $20,000 during 1996. 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.
16
<PAGE>
DUE FROM FORMER AFFILIATES, ALLOWANCE FOR UNCOLLECTIBLE AMOUNTS DUE FROM FORMER
AFFILIATES AND DUE TO AFFILIATED PARTNERSHIPS
Due from former affiliates represented misappropriated assets due from the
former general partners and their affiliates in the amount of $2,288,000 at
March 31, 1996. The receivable decreased from December 31, 1995, due to
$1,796,000 of recoveries received during the quarter from the former general
partners and their affiliates, including the settlement received in the
litigation against the Partnerships' former accountants and attorneys.
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 $3,253,000 at December 31, 1995 to
$4,111,000 at March 31, 1996, and includes $1,762,000 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, of which approximately
$1.4 million was allocated to the Partnership. 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 Partnership's allowance was reduced by
approximately $729,000 at March 31, 1996 due to recoveries received in excess of
the original estimate. Pending the outcome of litigation and other matters
affecting the sources of potential recovery, it is not possible to determine the
amount that will ultimately be recovered.
The restoration costs are allocated among the Partnerships based on each
Partnership's respective share of the misappropriation as discussed in Note 12
to the financial statements. The allocation is adjusted periodically to reflect
any changes in the entire misappropriation. The Partnership's percentage of the
allocation was increased in 1993. Consequently, the Partnership had not been
paying its pro rata share of the costs. Accordingly, the Partnership recorded
payables at December 31, 1993, in the amount of $295,000 and $192,000, due to
DiVall 1 and DiVall 2, respectively, with corresponding amounts reflected as
professional expenses related to the Investigation. Recoveries allocated to the
Partnership have been used to repay the amounts owed to DiVall 1 and DiVall 2.
At December 31, 1995, the remaining amounts due to DiVall 1 and DiVall 2 for
restoration costs totaled $106,000 and $74,000, respectively. During March 1996,
these amounts were fully repaid from recoveries received.
As a result of the misappropriation and material weaknesses in the internal
control structure of the Partnership prior to February 8, 1993, there can be no
assurance that all transactions recorded by the Partnership prior to February 8,
1993, were appropriate transactions of the Partnership and properly reflected in
the accompanying financial statements of the Partnership or that all
transactions of the Partnership prior to February 8, 1993, including improper
and unsupported transactions, have been identified and reflected in the
accompanying financial statements of the Partnership as of March 31, 1996.
17
<PAGE>
LIABILITIES
- - -----------
Accounts payable and accrued expenses at March 31, 1996, in the amount of
$147,000, primarily represented the accrual of legal and auditing fees.
PARTNERS' CAPITAL
- - -----------------
Net income for the quarter was allocated between the General Partner and the
Limited Partners, 1% and 99%, respectively, as provided in the Partnership
Agreement and the Amendment to the Partnership Agreement, as discussed more
fully in Note 4 of the financial statements. The former general partners'
capital account balance was reallocated to the Limited Partners at December 31,
1993. Refer to Note 14 to the financial statements for additional information
regarding the reallocation.
Cash distributions paid to the Limited Partners and to the General Partner
during 1996, of $50,000 and $637, respectively, have also been made in
accordance with the amended Partnership Agreement. The First Quarter 1996
distribution of $175,000 was paid to the Limited Partners on May 15, 1996.
RESULTS OF OPERATIONS:
- - ----------------------
Management believes that the financial results 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 financial
results. Some of these events will continue to have a negative impact on the
Partnership in the future. However, the settlement of litigation against the
Partnership's former accountants and attorneys should result in operating
results going forward which more closely represent "normal" operations than what
has been experienced during the past three years.
The Partnership reported net income for the quarter ended March 31, 1996, in the
amount of $159,000 compared to net income for the quarter ended March 31, 1995
of $102,000. Results for both periods were less than would be expected from
"normal" operations, primarily because of costs associated with misappropriation
of assets by the former general partners and their affiliates. These costs
increased significantly during 1996 as the lawsuit against the former general
partner accountants and attorneys got closer to trial and as a result of
contigent fee payments made upon settlements of the litigation.
REVENUES
- - --------
Total revenues were $935,000, and $231,000, for the quarters ended March 31,
1996, and 1995, respectively. The increase in income in 1996 is attributable to
the recovery of amounts from the Partnerships' former accountants and attorneys
which had been previously been written-off.
Total revenues should approximate $750,000 annually or $187,000 quarterly,
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 primarily a result of the one (1) year
lease modification entered into with Terratron, the tenant of two (2) of the
Partnership's Hardee's restaurants.
18
<PAGE>
EXPENSES
- - --------
For the quarters ended March 31, 1996 and 1995, cash expenses amounted to
approximately 80% and 41% of total revenues, respectively. Total expenses,
including non-cash items, amounted to 83% and 56% of total revenues for the
quarters ended March 31, 1996 and 1995, respectively. Items negatively impacting
expenses during the First Quarter of 1996, are expenses incurred primarily in
relation to the misappropriation of assets by the former general partners and
their affiliates.
For the quarters ended March 31, 1996 and 1995, expenses incurred in relation to
the misappropriated assets amounted to $651,000 and $42,000, respectively. These
costs increased significantly during the first quarter of 1996 due to the
payment of contingent fees and litigation expenses in relation to the settlement
of litigation against the Partnerships' former accountants and attorneys. Future
expenses incurred in relation to the misappropriation should have a minimal
impact on the Partnership.
As noted above, management believes the Partnership's operations have yet to
stabilize to what could be considered normal, due to the negative impact of the
costs related to the recovery of the misappropriated assets. However, these
"recovery costs" should be minimized in the future.
INFLATION:
- - ----------
Inflation has a minimal effect on operating earnings and related cash flows from
a portfolio of triple net leases. By their nature, such leases actually fix
revenues and are not impacted by rising costs of maintenance, insurance, or real
estate taxes. If inflation causes operating margins to deteriorate for lessees
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.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On March 16, 1993, the Partnership, along with DiVall 1 and DiVall 2 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 requested the payment of damages
in the amount of $9,000,000, plus interest, attorneys fees
19
<PAGE>
and costs, and whatever additional relief the court deemed just and proper. The
Partnerships 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 Qualres & 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 these
settlements, net proceeds deposited in the Partnership's restoration escrow
account totaled approximately $826,000.
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 was 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 2. 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
20
<PAGE>
have resulted in cash payments to the Partnerships of a total of $537,000 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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Listing of Exhibits:
28.0 Correspondence to the Limited Partners dated May 15, 1996, regarding
the First Quarter 1996 distribution.
(b) Report on Form 8-K:
The Registrant filed no reports on Form 8-K during the first quarter of
fiscal year 1996.
21
<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 INCOME PROPERTIES 3 LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: __________________________________________________
Bruce A. Provo, President
Date: May 14, 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: __________________________________________________
Bruce A. Provo, President
Date: May 14, 1996
By: __________________________________________________
Kristin J. Atkinson
Vice President - Finance and Administration
Date: May 14, 1996
22
<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 INCOME PROPERTIES 3 LIMITED PARTNERSHIP
By: The Provo Group, Inc., General Partner
By: /s/Bruce A. Provo
---------------------------------------------
Bruce A. Provo, President
Date: May 14, 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: May 14, 1996
By: /s/Kristin J. Atkinson
--------------------------------------------
Kristin J. Atkinson
Vice President - Finance and Administration
Date: May 14, 1996
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from the
March 31, 1996 Form 10-Q and is qualified in its entirety by reference to such
financial statements.</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 1,307,826
<SECURITIES> 265,856
<RECEIVABLES> 7,451,119
<ALLOWANCES> 6,399,586
<INVENTORY> 0
<CURRENT-ASSETS> 2,625,215
<PP&E> 5,852,062
<DEPRECIATION> 673,773
<TOTAL-ASSETS> 7,803,504
<CURRENT-LIABILITIES> 253,559
<BONDS> 0
<COMMON> 0
0
0
<OTHER-SE> 7,549,945
<TOTAL-LIABILITY-AND-EQUITY> 7,803,504
<SALES> 197,631
<TOTAL-REVENUES> 935,052
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 775,832
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 159,220
<INCOME-TAX> 0
<INCOME-CONTINUING> 159,220
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 159,220
<EPS-PRIMARY> 9.22
<EPS-DILUTED> 9.22
</TABLE>
<PAGE>
May 15, 1996
RE: FIRST QUARTER 1996 CORRESPONDENCE
DIVALL INCOME PROPERTIES 3, L.P. (THE "PARTNERSHIP")
Dear Limited Partner:
===============================
FIRST QUARTER 1996 HIGHLIGHTS
. During the First Quarter of 1996, we SETTLED our lawsuit
with QUARLES & BRADY and ERNST & YOUNG, the
Partnership's former attorneys and accountants.
(Refer to "Restoration Highlights" for more details.)
===============================
FIRST QUARTER 1996 "DISTRIBUTION" HIGHLIGHTS
. 5.6% (approx.) annualized return on . $175,000 "total" amount distributed
$12,562,000 ("net" remaining initial for the FIRST QUARTER 1996 which was
investment). according to budget.
. $10.23 per unit (approx.) for the . $396.00 "total" per unit (approx.)
FIRST QUARTER 1996 from both cash distributed SINCE INCEPTION from both
flow from operations and "net" cash cash flow from operations and "net"
activity from financing and cash activity from financing and
investing activities. investing activities.
(NOTE: ORIGINAL UNITS WERE PURCHASED FOR $1,000/UNIT.)
<PAGE>
DiVall Income Properties 3, L.P.
May 15, 1996
Page 2
===============================
STATEMENTS OF INCOME AND CASH FLOW HIGHLIGHTS
. 9.7% increase in RENTAL INCOME from . Investigation and Restoration costs
projections. in the amount of $651,000 (related to
the trial and settlement with QUARLES
. 83% increase in OPERATING EXPENSES & BRADY and ERNST & YOUNG) were
from projections primarily due to recorded in March. A portion of
contingent legal fees paid upon these costs had been budgeted to
settlement with Quarles & Brady and occur in April due to initial
Ernst & Young. projections of the anticipated length
of the March 1996 trial. (See
. The Partnership paid $179,000 to its "Restoration Highlights" for
affiliated partnerships for additional information.)
previously advanced restoration
costs.
===============================
PROPERTY HIGHLIGHTS
VACANCIES
---------
. There were no vacancies at March 31, 1996.
RENTS RECEIVABLE
----------------
. Terratron, Inc., tenant of the . Midland Food Systems, Inc., tenant
HARDEE'S RESTAURANTS IN WISCONSIN of the HARDEE'S restaurant (Wahoo,
was delinquent in the amount of NE) is experiencing cash flow
$7,300 for "catchup" real estate problems related to sales and legal
taxes and percentage rents scheduled difficulties. This tenant is
to be paid during the quarter. Poor delinquent in the total amount of
sales from a weak national "concept" $22,000 for scheduled rent,
remains the issue with respect to equipment leases, and sales tax.
this tenant's cash flow problems. We have agreed to Midland's request
We continue to work with Terratron to commence payments (including
to assure compliance with the terms catch-up) on July 1, 1996 with
of a modified rental agreement for delinquencies cured by year-end.
1996.
<PAGE>
DiVall Income Properties 3, L.P.
May 15, 1996
Page 3
===============================
RESTORATION HIGHLIGHTS
. Recoveries received during the FIRST . "Total" recoveries received TO DATE
QUARTER 1996 totalled $1,796,000 for the Partnership amount to
(approx.) for the Partnership. approximately $2,136,000.
. As previously communicated, the . With respect to the DiVall "PRIVATE"
Partnership and its affiliated Partnerships, we would like to
partnerships settled with QUARLES & finalize all remaining settlements
BRADY (Q&B) and ERNST & YOUNG (E&Y) with the bankruptcy courts as quickly
during the First Quarter of 1996. as possible.
The "NET" recoveries (less fees Although we have no control of the
and expenses paid upon timetable for these proceedings, we
settlement) from this lawsuit continue to monitor closely and
are currently in a separate negotiate settlements as they arise.
bank account.
We are pleased with the results We currently have only a few
of the settlement because it remaining settlements pending.
allowed us to recapture not
only the cost of the litigation
but also all expenses
associated with the
investigation and former
general partner removal.
. Earlier this year, DiVall Insured Income Fund, L.P. (DiVall 1) WON its appeal
in the Eighth Circuit Federal Court of Appeals in St. Louis, Missouri against
Boatmen's First National Bank of Kansas City ("BOATMEN'S"). The FDIC and
Boatmen's did not pursue their option to obtain a ruling by the U.S. Supreme
Court - which means the case will now go back to the lower courts for trial.
For purposes of summarizing background information regarding this lawsuit,
please note the following:
<PAGE>
DiVall Income Properties 3, L.P.
May 15, 1996
Page 4
===============================
RESTORATION HIGHLIGHTS (CONT'D)
. During 1993, it was discovered that the former general partners borrowed
$600,000 IN DIVALL 1'S NAME during or before 1991 from Metro North State Bank
(now "BOATMEN'S"). Not only were the proceeds never received by DiVall 1 --
but, this loan was secured by mortgages on FIVE (5) of DiVall 1's properties.
. At the time of discovery, . On March 24, 1994, DiVall 1 formally
all three partnerships disputed the loan by filing a
included the diversion complaint against BOATMEN'S. Since
of the BOATMEN'S loan that time, various summary judgments
proceeds as part of the and appeals have occurred resulting
"total" misappropriation in the final stage of discovery and
-- meaning all expenses TRIAL -- which is expected to begin
and recoveries of this this FALL.
litigation are shared by
the Partnership and its
affiliated partnerships.
. Former general partner, Gary . Former general partner, Paul E.
J. DiVall pleaded "NO- Magnuson has NOT formally responded
CONTEST" to criminal charges to criminal charges brought against
brought against him by the him by the Wisconsin Attorney
Wisconsin Attorney General's General's Office.
Office.
. At this time we are unaware of any "criminal" charges made by the
Wisconsin Attorney General's Office against any other agent of the
former general partners.
===============================
RETURN OF CAPITAL
The following table has been updated to illustrate the breakdown of
distributions since the Partnership's first quarterly distribution, for the
period ended September 30, 1990 through March 31, 1996.
<PAGE>
DiVall Income Properties 3, L.P.
May 15, 1996
Page 5
===============================
RETURN OF CAPITAL (CONT'D)
================================================================================
DISTRIBUTION CAPITAL
------------ -------
ANALYSIS BALANCE
-------- -------
Original Capital Balance - $17,102,520
Cash Flow From Operations Since Inception $ 871,974 -
Total Distributions Since Inception (5,412,983) -
-----------
(Return) of Capital $(4,541,009) (4,451,009)
=========== -----------
"NET" REMAINING INITIAL INVESTMENT
BY ORIGINAL PARTNERS - $12,561,511
===========
================================================================================
(NOTE: For a more individualized discussion of return of capital contact
Investor Relations.)
===============================
QUESTIONS & ANSWERS
1. WHEN WILL THE "NET" PROCEEDS FROM THE Q&B AND E&Y SETTLEMENT BE DISTRIBUTED
TO LIMITED PARTNERS?
. We anticipate releasing the "net" settlement proceeds in accordance with
our historical allocation percentages and including the payout with the
Partnership's Second Quarter Distribution scheduled to be mailed on
August 15, 1996.
2. HAS THERE BEEN ANY DECISION MADE REGARDING THE PARTNERSHIP'S LIQUIDATION
ALTERNATIVES OR THE POSSIBILITY OF REPOSITIONING ITS ASSETS?
. We recently met with the Advisory Board to continue our discussions
regarding future alternatives for the Partnership - no decisions have
been made at this time.
There are various operating issues management would like resolve for the
Partnership prior to any plans for dissolution or repositioning assets.
<PAGE>
DiVall Income Properties 3, L.P.
May 15, 1996
Page 6
===============================
QUESTIONS & ANSWERS (CONT'D)
3. WHAT IS TPG'S POLICY FOR RECEIVING NOTIFICATION OF ADDRESS CHANGES FROM
LIMITED PARTNERS?
. It is our policy that all Limited Partner address changes* be submitted
in writing to our Investor Relations Department.
(*NOTE: Any change in a Limited Partner's distribution or correspondence
address should be sent to Investor Relations NO LATER THAN THREE (3)
WEEKS before each scheduled distribution mailing date to insure that the
change will be processed prior to check printing and label processing.)
As always, if you have any questions or need additional information, please
contact Investor Relations at 1-800-547-7686 or 1-608-829-2992. All written
inquiries may be mailed or faxed to:
THE PROVO GROUP, INC.
Post Office Box 2137
Madison, Wisconsin 53701-2137
(FAX 608-829-2996)
Sincerely,
THE PROVO GROUP, INC.
By: /s/ Brenda Bloesch By: /s/ Kristin Atkinson
------------------------------ ---------------------------------
Brenda Bloesch Kristin Atkinson
Director of Investor Relations V.P. - Finance and Administration
Enclosures
<PAGE>
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------------------------------------
DIVALL INCOME PROPERTIES 3 L.P.
STATEMENTS OF INCOME AND CASH FLOW CHANGES
FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1996
- - -------------------------------------------------------------------------------------------------------------
PROJECTED ACTUAL VARIANCE
-----------------------------------------
1ST 1ST
QUARTER QUARTER BETTER
3/31/96 3/31/96 (WORSE)
--------- --------- ---------
<S> <C> <C> <C>
OPERATING REVENUES
Rental income $155,537 $170,578 $15,041
Direct financing interest 27,050 27,052 2
Interest income 10,005 8,053 (1,952)
Recovery of amounts previously written off 0 729,091 729,091
Other income 0 277 277
--------- --------- ---------
TOTAL OPERATING REVENUES $192,592 $935,051 $742,459
--------- --------- ---------
OPERATING EXPENSES
Insurance $1,252 $1,268 ($16)
Management fees 15,180 15,170 10
Restoration fees 0 52,335 (52,335)
Overhead allowance 1,267 1,264 3
Advisory Board 5,250 4,942 308
Administrative 8,019 7,665 354
Professional services 170 263 (93)
Auditing 20,000 12,383 7,617
Legal 900 541 359
Defaulted tenants 300 0 300
--------- --------- ---------
TOTAL OPERATING EXPENSES $52,338 $95,831 ($43,493)
--------- --------- ---------
INVESTIGATION AND RESTORATION EXPENSES $72,697 $650,670 ($577,973)
--------- --------- ---------
NON-OPERATING EXPENSES
Depreciation $29,331 $29,330 $1
--------- --------- ---------
TOTAL NON-OPERATING EXPENSES $29,331 $29,330 $1
--------- --------- ---------
TOTAL EXPENSES $154,366 $775,831 ($621,465)
--------- --------- ---------
NET INCOME $38,226 $159,220 $120,994
OPERATING CASH RECONCILIATION: VARIANCE
---------
Depreciation and amortization 29,331 29,330 (1)
Recovery of amounts previously written off 0 (729,091) (729,091)
(Increase) Decrease in current assets 38,839 (18,377) (57,216)
Increase (Decrease) in current liabilities (97,475) (124,367) (26,892)
Advance from/(to) future cash flows for current distributions (5,000) 0 5,000
Increase in cash reserved for payables 94,000 0 (94,000)
--------- --------- ---------
Net Cash Provided From Operating Activities $97,921 ($683,285) ($781,206)
--------- --------- ---------
CASH FLOWS FROM (USED IN) INVESTING
AND FINANCING ACTIVITIES
Payments to affiliated partnerships 0 (179,421) (179,421)
Recoveries from former G.P. affiliates 0 1,796,230 1,796,230
Principal received on equipment leases 92,109 83,254 (8,855)
Cash invested in restoration escrow account 0 (826,160) (826,160)
Investment in PMA Indemnity (20,000) (20,000) 0
Principal payments received on notes receivable 5,960 5,959 (1)
--------- --------- ---------
Net Cash Provided from Investing And Financing
Activities $78,069 $859,862 $781,793
--------- --------- ---------
Total Cash Flow For Quarter $175,990 $176,577 $587
Cash Balance Beginning of Period 312,290 355,090 42,800
Less 4th quarter distributions paid 2/96 (50,000) (50,000) 0
Change in cash reserved for payables or distributions (89,000) 0 89,000
--------- --------- ---------
Cash Balance End of Period $349,280 $481,667 $132,387
Cash reserved for 1st quarter L.P. distributions (175,000) (175,000) 0
Cash reserved for future distributions (5,000) 0 5,000
Cash reserved for payment of payables (36,000) (155,000) (119,000)
--------- --------- ---------
Unrestricted Cash Balance End of Period $133,280 $151,667 $18,387
========= ========= =========
<PAGE>
- - -------------------------------------------------------------------------------------------------------------
PROJECTED ACTUAL VARIANCE
-----------------------------------------
* Quarterly Distribution $175,000 $175,000 $0
Mailing Date 5/16/96 (enclosed) -
- - -------------------------------------------------------------------------------------------------------------
</TABLE>
* Refer to distribution letter for detail of quarterly distribution.
<PAGE>
<TABLE>
<CAPTION>
PROJECTIONS FOR DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP
DISCUSSION PURPOSES 1996 PROPERTY SUMMARY
AND RELATED ESTIMATED RECEIPTS
PORTFOLIO (Note 1)
--------------------------------- -----------------------------------------------
REAL ESTATE EQUIPMENT
--------------------------------- -----------------------------------------------
ANNUAL LEASE ANNUAL
- - ------------------------------- BASE % EXPIRATION LEASE %
CONCEPT LOCATION COST RENT YIELD DATE COST RECEIPTS RETURN
- - ------------------------------- --------------------------------- -----------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
APPLEBEE'S PITTSBURGH, PA 891,333 116,040 13.02% 290,469 0.00%
" " 58,094 0.00%
DENNY'S CO SPRINGS, CO 580,183 77,460 13.35% 05/31/97 210,976 53,520 25.37%
DENNY'S ENGLEWOOD, CO 213,211 35,880 16.83% 06/30/96 210,976 48,000 22.75%
DENNY'S SANFORD, FL 1,136,433 140,340 12.35% 04/30/96 263,720 49,000 18.58%
" " 07/31/96 79,116 20,000 25.28%
HARDEE'S (3) ST. FRANCIS, WI 1,194,381 117,000 9.80% 12/31/99 (2) 369,688 74,008 20.02%
" " 12/31/99 (2) 84,500 17,852 21.13%
HARDEE'S (3) OAK CREEK, WI 1,341,906 117,000 8.72% 12/31/99 (2) 482,078 109,622 22.74%
" " 12/31/99 (2) 105,488 23,987 22.74%
HARDEE'S WAHOO, NE 511,616 68,280 13.35% 06/30/97 290,468 59,140 20.36%
- - ------------------------------- --------------------------------- -----------------------------------------------
- - ------------------------------- --------------------------------- --------------------------------
PORTFOLIO TOTALS (7 Properties) 5,869,063 672,000 11.45% 2,445,573 455,129 18.61%
- - ------------------------------- --------------------------------- --------------------------------
</TABLE>
<TABLE>
<CAPTION>
---------------------------------------------
ORIGINAL CAPITAL $17,102,520
NET DISTRIBUTION OF
CAPITAL SINCE
INCEPTION $4,541,009
-------------
CURRENT EQUITY $12,561,511
-------------
---------------------------------------------
------------------------------------- ------------------
TOTALS TOTAL %
------------------------------------- ON $12,561,511
- - ------------------------------- ANNUAL % EQUITY
CONCEPT LOCATION COST RECEIPTS RETURN RAISE
- - ------------------------------- ------------------------------------- ------------------
<S> <C> <C> <C> <C> <C>
APPLEBEE'S PITTSBURGH, PA 1,239,896 116,040 9.36%
" "
DENNY'S CO SPRINGS, CO 791,159 130,980 16.56%
DENNY'S ENGLEWOOD, CO 424,187 83,880 19.77%
DENNY'S SANFORD, FL 1,479,269 209,340 14.15%
" "
HARDEE'S (3) ST. FRANCIS, WI 1,648,569 208,860 12.67%
" "
HARDEE'S (3) OAK CREEK, WI 1,929,472 250,609 12.99%
" "
HARDEE'S WAHOO, NE 802,084 127,420 15.89%
- - ------------------------------- ------------------------------------- ------------------
- - ------------------------------- ------------------------------------- ------------------
PORTFOLIO TOTALS (7 Properties) 8,314,636 1,127,129 13.56% 8.97%
- - ------------------------------- ------------------------------------- ------------------
</TABLE>
Note 1: This property summary includes only current property and equipment held
by the Partnership. Equipment lease receipts shown include a return of
capital.
2: The lease was modified effective January 1, 1996 amortizing the
remaining balance over four years at a rate of 10% per annum.
3: A one-year lease modification was entered into with this tenant,
reducing 1996 base rent by approximately $70,000.
