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 a Certificate of Limited Partnership dated as of November 20, 1987, and governed by a Limited Partnership Agreement, as amended from time to time (collectively, the “Partnership Agreement”). The Partnership is managed by its general partner, The Provo Group, Inc. (“TPG” or the “General Partner”). As of December 31, 2017, the Partnership had 1,296 limited partners owning an aggregate of 46,280.3 Limited Partnership Interests (the “Interests”).
The Partnership is engaged in the business of owning and operating its investment portfolio of commercial real estate properties (each a “Property” and collectively, the “Properties”). At December 31, 2017, the Partnership owned 11 Properties, located in a total of four states. 10 of the Properties are leased on a triple net basis primarily to, and operated by, franchisees of national, regional and local fast food, family style, and casual/theme restaurants under long-term leases.
At December 31, 2017, eight of the 11 Properties were (and continue to be) leased to three Wendy’s franchisees, with five of the Properties being leased to Wendgusta, LLC (“Wendgusta”), two of the Properties being leased to Wendcharles I, LLC (“Wendcharles I”), and one of the Properties being leased to Wendcharles II, LLC (“Wendcharles II”). An additional Property was leased to Wendgusta until its lease expired on November 6, 2016; this Property is currently vacant. Operating base rents from these eight leases during the year ended December 31, 2017 comprised approximately 77% of the total 2017 operating base rents. During the year ended December 31, 2017, additional percentage rents were also generated from these eight Wendy’s properties and totaled $595,399. Additionally, those eight Properties exceeded 72% of the Partnership’s total Properties, both by historical asset value and number. As a result of the previously reported lease extension notices received by the Partnership in January 2017, all eight of the Properties that are currently leased to Wendy’s franchisees now feature a lease expiration date of November 6, 2026.
See Properties under Item 2 below for the table of all Properties and lease expirations and a discussion of Properties with significant developments during the year ended December 31, 2017.
During the process of leasing the Properties, the Partnership may experience competition from owners and managers of other properties. As a result, in connection with negotiating tenant leases, along with recognizing market conditions, the General Partner may offer rental concessions, or other inducements, which may have an adverse impact on the results of the Partnership’s operations. The Partnership is also in competition with sellers of similar properties to locate suitable purchasers for its Properties.
The Partnership Agreement specifies that the Partnership is scheduled to be dissolved on November 30, 2020, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all its Properties; (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.
On February 15, 2018, the Partnership announced that the General Partner intends to seek affirmative consent from the limited partners to sell the Partnership’s assets, including all the Properties, and liquidate the Partnership. The proposed sale of assets, liquidation and dissolution is expected to be completed by December 31, 2018, and it requires affirmative consents from limited partners owning a majority of the outstanding Interests. Affirmative consents will be sought by a consent solicitation statement that the Partnership expects to file with the Securities and Exchange Commission by April 2018.
The Permanent Manager Agreement
The Permanent Manager Agreement (“PMA”) was entered into on February 8, 1993, between the Partnership, DiVall 1 (which was dissolved in December 1998), DiVall 3 (which was dissolved in December 2003), the now former general partners, Gary J. DiVall and Paul E. Magnuson, their controlled affiliates, and TPG, naming TPG as the Permanent Manager. The PMA contains provisions allowing TPG to submit to the PMA, election of TPG 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 General Partner, has been operating and managing the affairs of the Partnership in accordance with the provisions of the PMA and the Partnership Agreement since February 8, 1993.
Effective January 1, 2017, the PMA was renewed by the General Partner for a two-year period ending December 31, 2018. The PMA can be terminated earlier (a) by a vote at any time by a majority 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 TPG 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 60 days’ written notice from TPG to the limited partners of the Partnership.
Advisory Board
The concept of the Advisory Board was first introduced by TPG during the solicitation of written consents seeking to elect TPG as the General Partner. The first Advisory Board was established in October 1993. Among other functions, the three-person Advisory Board has the following rights and duties: to review operational policies and practices; to review extraordinary transactions; to review internal financial controls and practices; and to review the performance of the independent auditors of the Partnership. The Advisory Board’s powers are advisory only and the Advisory Board does not have the authority to direct management decisions or policies of the Partnership or remove the General Partner. The Advisory Board has full and free access to the Partnership’s books and records, and individual Advisory Board members have the right to communicate directly with the limited partners concerning Partnership business. Members of the Advisory Board are compensated $1,500 annually and $500 for each quarterly meeting attended.
The Advisory Board currently consists of a broker dealer representative, William Arnold; and limited partners of the Partnership: Jesse Small and Albert Kramer. For a brief description of each Advisory Board member, refer to Item 10, Directors and Executive Officers of the Registrant.
No Employees; Location of Business Operations
The Partnership has no employees.
All of the Partnership’s business is conducted in the United States.
Available Information
The Partnership is required to file with the SEC annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, along with any related amendments and supplements to these periodic and current reports. The SEC maintains a website containing these reports and other information regarding our electronic filings at www.sec.gov. These reports may also be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Further information about the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330.
We also make these reports and other information available either on or through our Internet Website at www.divallproperties.com as soon as reasonably practicable after such reports are available. Please note that any internet addresses provided in this Annual Report on Form 10-K are for information purposes only and are not intended to be hyperlinks. Accordingly, no information found and/or provided at such internet addresses is intended or deemed to be incorporated by reference herein.
Item 1A.
Item 1A. Risk Factors
As a smaller reporting company, the Partnership is not required to disclose risk factors in its annual report on Form 10-K.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
out of 11 Properties are leased to franchisees of national, regional and local fast food, family style and casual/theme restaurants. The eleventh Property was leased to a Wendy’s franchisee until its lease expired in November 2016; this Property is currently vacant.
Original lease terms for the leased Properties are generally five to 20 years from their inception. 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 (five percent to eight percent) of gross sales above a threshold amount. None of the Properties are mortgaged. The Partnership owns the buildings and land, and all improvements for all the Properties, except for the Property leased to the franchisee of a Kentucky Fried Chicken restaurant (“KFC”) in Santa Fe, New Mexico. KFC is located on land where the Partnership has entered into a long-term ground lease, as lessee, which is set to expire on June 30, 2018. Although the Partnership has the option to extend the ground lease for two additional ten year periods, the Partnership does not expect to exercise its option to extend this ground lease. The Partnership owns all improvements constructed on the land (including the building and improvements) until the termination of the ground lease, at which time all constructed improvements will become the land owner’s property.
The Partnership owned the following Properties as of March 23, 2018:
Footnotes:
(1) Purchase price includes all costs incurred by the Partnership to acquire the Property.
(2) The tenant has the option to extend the lease an additional period of five years.
(3) The tenant has the option to extend the lease one additional period of five years.
(4) Ownership of lessee’s interest is under a ground lease. The tenant is responsible for payment of all rent obligations under the ground lease.
(5) One of the 11 Properties owned as of December 31, 2017 was leased to Wendcharles II. Since more than 72% of the Properties, both by historical asset value and number are leased to Wendy’s franchisees the financial status of the tenant may be considered relevant to investors. At the request of the Partnership, Wendcharles II provided it with a copy of its reviewed financial statements for the fiscal years ended December 31, 2017 and December 25, 2016. Those reviewed financial statements are attached to this Annual Report on Form 10-K as Exhibit 99.2.
(6) Five of the 11 Properties owned as of December 31, 2017 were leased to Wendgusta. Since more than 72% of the Properties, both by historical asset value and number, are leased to Wendy’s franchisees, the financial status of the tenant may be considered relevant to investors. At the request of the Partnership, Wendgusta provided it with a copy of its reviewed financial statements for the fiscal years ended December 31, 2017 and December 25, 2016. Those reviewed financial statements are attached to this Annual Report on Form 10-K as Exhibit 99.0.
(7) Two of the 11 Properties owned by the Partnership as of December 31, 2017 were leased to Wendcharles I. Since more than 72% of the Properties, both by historical asset value and number, are leased to Wendy’s franchisees, the financial status of the tenant may be considered relevant to investors. At the request of the Partnership, Wendcharles I provided it with a copy of its reviewed financial statements for the fiscal years ended December 31, 2017 and December 25, 2016. Those reviewed financial statements are attached to this Annual Report on Form 10-K as Exhibit 99.1.
(8) The lease for this Property expired on November 6, 2016.
The following summarizes significant developments, by property, for Properties with such developments.
Wendy’s Franchisees - Lease Extension Notices
In January 2017, the Partnership received lease extension notices relating to seven of the eight Properties that are leased to Wendy’s franchisees. Pursuant to such notices, each of Wendgusta, LLC, Wendcharles I, LLC and Wendcharles II, LLC exercised the option in their respective property leases to renew such lease for five years beyond the prior expiration date of November 6, 2021. As a result, all eight of the Properties that are leased to Wendy’s franchisees now feature a lease expiration date of November 6, 2026.
Applebee’s - Columbus, OH Property
Effective September 1, 2017, the tenant for the Property operated as an Applebee’s restaurant signed a ten year lease renewal for that Property. The new lease expiration date is August 31, 2027. The lease for that Property now provides for a monthly rent of $11,500 and a percentage rent of 6% over $2,300,000 in annual sales. The lease now also includes a single option to extend the lease for an additional five years. If the extension option is exercised, monthly rent during that period will be $13,915 and the percentage rent breakpoint of 6% will be for over $2,500,000 in annual sales.
Other Property Information
Property taxes, general maintenance, insurance and ground rent on the Properties are the responsibility of the respective tenants. However, when a tenant fails to make the required tax payments or when a property becomes vacant (such as the Martinez, GA property, previously operated as a Wendy’s restaurant), the Partnership makes the appropriate property tax payments to avoid possible foreclosure of the property. During a property vacancy, the Partnership pays for insurance and maintenance related to the vacant property.
Such taxes, insurance and ground rent are accrued in the period in which the liability is incurred. The Partnership owns one restaurant located on a parcel of land where it has entered into a long-term ground lease, as lessee, which is set to expire on June 30, 2018. The Partnership has the option to extend the ground lease for two additional ten year periods. The Partnership owns all improvements constructed on the land (including the building and improvements) until the termination of the ground lease, at which time all constructed improvements will become the land owner’s property. The tenant, KFC, is responsible for the $3,400 per month ground lease payment per the terms of its lease with the Partnership.
Item 3.
Item 3. Legal Proceedings
As of the date of this report there are no material pending legal proceedings to which the Partnership is a party.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market Price and Dividends on the Registrant’s Common Equity and Related Stockholder Matters
(a) Although from time to time some Interests have been traded, there is no active public market for the Interests, and it is not anticipated that an active public market for the Interests will develop.
(b) As of March 23, 2018, there were 1,245 record holders of Interests.
(c) The Partnership does not pay dividends. However, the Partnership Agreement provides for net income and loss of the Partnership to be allocated on a quarterly basis, 99% to the limited partners and 1% to the General Partner. The Partnership Agreement provides for the distribution of net cash receipts and net proceeds to the limited partners and General Partner on a quarterly basis, subject to the limitations on distributions to the General Partner described in the Partnership Agreement. See Note 3 to the financial statements for further information. During 2017 and 2016, $760,000 and $970,000, respectively, were distributed in the aggregate to the limited partners. The General Partner received aggregate distributions of $2,751 and $3,006 in 2017 and 2016, respectively.
(d) The Partnership has no equity compensation plans under which equity securities of the Partnership have been issued or are reserved for issuance.
Item 6.
Item 6. Selected Financial Data
Not Applicable.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT
This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements are not historical facts but are the intent, belief or current expectations of the Partnership’s management based on its knowledge and understanding of the business and industry. Words such as “may,” “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “would,” “could,” “should” and variations of these words and similar expressions are intended to identify forward-looking statements. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these expectations will prove to have been correct. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, some of which are beyond our control, are difficult to predict and could cause actual results to differ materially from those expressed or forecasted in the forward-looking statements.
Examples of forward-looking statements include, but are not limited to, statements we make regarding:
● our ability to consummate the proposed sale of assets and liquidation of the Partnership;
● the expected timing and effects of the proposed sale of assets and liquidation;
● our expectations regarding financial condition or results of operations in any future period;
● our future sources of, and needs for, liquidity and capital resources;
● our expectations regarding economic and business conditions;
● our business strategies and our ability to grow our business;
● our decisions and policies with respect to the potential retention or disposition of one or more Properties;
● our ability to collect rents on our leases;
● our ability to maintain relationships with our tenants, and when necessary identify new tenants; and
● our future capital expenditures.
Forward-looking statements may ultimately differ materially from the actual results. The Partnership cautions readers not to place undue reliance on forward-looking statements, which reflect management’s view only as of the date of this Form 10-K. All subsequent written and oral forward-looking statements attributable to the Partnership, or persons acting on the Partnership’s behalf, are expressly qualified in their entirety by this cautionary statement. Management undertakes no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results. Factors that could cause actual results to differ materially from any forward-looking statements made in this Form 10-K include, without limitation, changes in general economic conditions, changes in real estate conditions, including without limitation, decreases in valuations of real properties, increases in property taxes, and lack of suitable buyers and offers for the Properties and other factors that could result in our inability to realize full value for limited partners upon disposition of the Partnership’s assets, lease-up risks, ability of tenants to fulfill their obligations to the Partnership under existing leases, sales levels of tenants whose leases include a percentage rent component, adverse changes to the restaurant market, entrance of competitors to the Partnership’s lessees in markets in which the Properties are located, inability to obtain new tenants upon the expiration of existing leases, the potential need to fund tenant improvements or other capital expenditures out of operating cash flows, and such other factors and uncertainties described from time to time in our filings with the Securities and Exchange Commission (the “SEC”).
Critical Accounting Policies and Estimates
The following discussion and analysis of financial condition and results of operations is based upon the Partnership’s financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires persons performing the functions of the Partnership’s management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including investment impairment. These estimates are based on the General Partner’s historical industry experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.
The Partnership believes that its most significant accounting policies pertain to:
Depreciation methods and lives- Depreciation of the properties is provided on a straight-line basis over the estimated useful life of the buildings and improvements. While the Partnership believes these are the appropriate lives and methods, use of different lives and methods could result in different impacts on net income. Additionally, the value of real estate is typically based on market conditions and property performance. As a result, depreciated book value of real estate may not reflect the market value of real estate assets.
Revenue recognition- Rental revenue from investment properties is recognized on the straight-line basis over the life of the respective lease when collectability is assured. Percentage rents are accrued only when the tenant has reached the sales breakpoint stipulated in the lease.
Impairment-The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, if deemed necessary, a provision for possible loss is recognized.
Recent Developments
On February 15, 2018, the Partnership announced that the General Partner intends to seek affirmative consent from the limited partners to sell the Partnership’s assets, including all the Properties, and liquidate the Partnership. The proposed sale of assets and liquidation is expected to be completed by December 31, 2018, and it requires affirmative consents from limited partners owning a majority of the outstanding Interests. Affirmative consents will be sought by a consent solicitation statement that the Partnership expects to file with the SEC by April 2018.
Investment Properties
As of December 31, 2017, the Partnership owned 11 Properties, each currently containing a fully constructed fast-food or casual restaurant. One Property is located on a parcel of land which is subject to a ground lease (see Item 2 above). The current tenants are franchisees of casual restaurants and as a result the following are operated at the Properties: eight Wendy’s restaurants, an Applebee’s restaurant, and a KFC restaurant. The Property in Martinez, GA is vacant and, as of December 15, 2016, this Property has been held for sale. The Properties are located in a total of four states.
Property taxes, general maintenance, insurance and ground rent on the Properties are the responsibility of the respective tenants. A more detailed discussion of tax payments, insurance and ground rent is provided in Item 2, and incorporated herein by this reference.
There were no building improvements capitalized during 2017 or 2016.
In accordance with Financial Accounting Standards Board (“FASB”) guidance for “Accounting for the Impairment or Disposal of Long-Lived Assets”, current and historical results from operations for disposed properties and assets classified as held for sale are reclassified separately as discontinued operations. The guidance also requires the adjustment to carrying value of properties due to impairment in an attempt to reflect appropriate market values.
Further Information
A summary of significant developments as of December 31, 2017, by property, for properties with such developments, can be found in Item 2, Properties.
Net Income
Net income for the fiscal years ended December 31, 2017 and 2016 were $687,499 and $751,253, respectively. Net income per Interest for the fiscal years ended December 31, 2017 and 2016 were $14.71 and $16.07, respectively.
Net income for the fiscal years ended December 31, 2017 and 2016 included the results from both operations and discontinued operations. Assets disposed of, or deemed to be classified as held for sale, require the reclassification of current and previous years’ operations to discontinued operations in accordance with GAAP applicable to “Accounting for the Impairment or Disposal of Long Lived Assets”. As such, prior year operating results for those properties considered as held for sale or properties no longer considered for sale have been reclassified to conform to the current year presentation without effecting total net income. When Properties are considered held for sale, depreciation of the properties is discontinued, and the properties are valued at the lower of the depreciated cost or fair value, less costs to dispose.
Results of Operations
Net income from continuing operations for the fiscal years ended December 31, 2017 and 2016 were $703,481 and $688,279, respectively. See the paragraphs below for further information as to variances in individual operating income and expense items.
Fiscal year ended December 31, 2017 as compared to fiscal year ended December 31, 2016:
Operating Rental Income: Operating rental income for the fiscal years ended December 31, 2017 and 2016 was $1.484 and $1.461 million, respectively. The rental income was comprised of monthly lease obligations per the tenant leases, and percentage rents obligations related to operating tenants who had reached their sales breakpoint. The slight increase in 2017 compared to 2016 is due to the continued increase in reported sales for tenants who had reached their sales breakpoint stipulated in their respective leases.
Management expects total base operating rental income to be approximately $828,000 for the 2018 fiscal year based on operating leases currently in place. Future operating rental income has the potential to either decrease or increase. Future operating rental income may decrease with a tenant default and/or we may reclassify certain additional properties as properties held for sale. Future operating rental income may also increase with additional rents due from tenants, if those tenants experience increased sales levels, which require the payment of additional rent to the Partnership. Operating percentage rents included in operating rental income in the fiscal years ended December 31, 2017 and 2016 were $595,399 and $581,324, respectively. Management expects percentage rents for the fiscal year ending December 31, 2018 to be comparable to those received in 2017 due to the expected continued increase in sales from the tenants operating Wendy’s restaurants.
Partnership Management Fees Expense: Partnership management fees expense for the fiscal years ended December 31, 2017 and 2016 were $270,110 and $267,246, respectively. The General Partner receives a fee for managing the Partnership, and this fee changes each year based on the Consumer Price Index. See Note 5, Transactions with General Partner and Its Affiliates, for further information.
Insurance Expense: Insurance expense for the fiscal years ended December 31, 2017 and 2016 was approximately $6,000. Insurance expense was comprised of general liability insurance. Each tenant is responsible for insurance protection and the Partnership only purchases property insurance for an individual property if the tenant cannot provide proof of insurance protection or due to a property vacancy. For the fiscal year ending December 31, 2018, management expects operating insurance expense to again be approximately $6,000. This amount could increase upon a property insurance default or vacancy by a tenant or an increase in the general liability insurance premium for the 2018/2019 insurance year, which is expected to be paid in the fourth quarter of 2018.
General and Administrative Expense: General and administrative expenses for the fiscal years ended December 31, 2017 and 2016 were $61,356 and $59,631, respectively. General and administrative expenses were comprised of management expense, state/city registration and annual report filing fees, office supplies and printing costs, outside storage expenses, copy/fax costs, postage and shipping expenses, long-distance telephone expenses, website fees, bank fees and state income tax expenses. Total operating general and administrative expenses for the fiscal year ended December 31, 2017 were higher than in the fiscal year ended December 31, 2016, primarily due to increased income tax expense and registration/filing fees. Management expects the total operating general and administrative expenses for the fiscal year ending December 31, 2018 to be marginally higher than for the fiscal year ended December 31, 2017 due to an expected increase in postage and printing costs.
Professional Services: Professional services expenses for the fiscal years ended December 31, 2017 and 2016 were $282,927 and $285,421, respectively. Professional service expenses were primarily comprised of investor relations data processing, investor mailings processing, website design, legal, auditing and tax preparation fees, electronic tax filings, and SEC report conversion and processing fees. The General Partner anticipates that total professional services expenses for the fiscal year ending December 31, 2018 will be higher than incurred for the fiscal year ended December 31, 2017 as a result of higher investor relations, title search and legal fees that are expected in connection with the proposed sale of assets, liquidation and dissolution of the Partnership.
Note Receivable Interest Income: Note receivable interest income for the fiscal years ended December 31, 2017 and 2016 was $0 and $2,093, respectively. The interest income was comprised of interest associated with the Buyers Note, which was paid in full as of November 1, 2016. See Note 9 Note Receivable for further information regarding the Buyers Note.
Results of Discontinued Operations
In accordance with FASB guidance for “Accounting for the Impairment or Disposal of Long Lived Assets”, discontinued operations represent the operations of properties disposed of or classified as held for sale as well as any gain or loss recognized in their disposition. During the fiscal years ended December 31, 2017 and 2016, the Partnership recognized (loss) income from discontinued operations of ($15,982) and $62,974, respectively. The (loss) income from discontinued operations was attributable to the Martinez, GA property which has been held for sale as of December 15, 2016 and was vacant throughout the 2017 fiscal year. See the components of discontinued operations included in the statements of income for the years ended December 31, 2017 and 2016 in Note 2 Investment Properties and Property Held for Sale.
The General Partner anticipates that there will be approximately $15,000 in discontinued operations expenditures in 2018 because the Martinez, GA Property is classified as property held for sale.
Cash Flow Analysis
Net cash flows provided by continuing operating activities for the fiscal years ended December 31, 2017 and 2016 were $727,167 and $794,968, respectively. Cash flows from operating activities was lower in 2017 primarily due to unusually high payments of leasing commissions, as compared to historic leasing commissions paid in previous years, related to the eight lease extensions during the 2017 calendar year. Cash (used in) provided from discontinued operations for the fiscal years ended December 31, 2017 and 2016 were ($15,982) and $75,980, respectively
Property impairment write-downs, depreciation and amortization are non-cash items and do not affect the current operating cash flow of the Partnership or distributions to the limited partners.
Cash flows (used in) provided from investing activities for the fiscal years ended December 31, 2017 and 2016 were ($3,129) and $55,636, respectively. The 2016 amounts were comprised entirely of note receivable principal payments and earnings from the indemnification trust account. The 2017 amounts were comprised entirely of earnings from the indemnification trust account.
For the fiscal year ended December 31, 2017, cash flows used in financing activities were $762,751 and consisted of aggregate limited partner distributions of $760,000 and General Partner distributions of $2,751. For the fiscal year ended December 31, 2016, cash flows used in financing activities were $973,006 and consisted of aggregate limited partner distributions of $970,000 and General Partner distributions of $3,006. Both limited partner and General Partner distributions have been, and will continue to be, made in accordance with the Partnership Agreement. Management anticipates that aggregate limited partner distributions will be approximately $750,000 during 2018, but this will increase to the extent that proceeds are received from the previously announced proposed sale of the Partnership’s assets.
Liquidity and Capital Resources
The Partnership’s cash balance was $145,674 at December 31, 2017. Cash of $100,000 was used to fund the fourth quarter of 2017 aggregate distribution paid to limited partners in February of 2018. Cash of approximately $30,000 is anticipated to be used in 2018 for the payment of quarter-end accrued liabilities which are included in the balance sheets. The remainder represents amounts deemed necessary to allow the Partnership to operate normally.
The Partnership’s principal demands for funds historically have been, and are expected to continue to be, for the payment of operating expenses and distributions. Management anticipates that cash generated through the operations of the Properties and potential sales of Properties will primarily provide the sources for future fund liquidity and limited partner distributions. During the process of leasing the Properties, the Partnership may experience competition from owners and managers of other similarly situated properties. As a result, in connection with negotiating tenant leases, along with recognizing market conditions, management may offer rental concessions, or other inducements, which may have an adverse impact on the results of the Partnership’s operations. The Partnership is also in competition with sellers of similar properties to locate suitable purchasers for its Properties. The two primary liquidity risks in the absence of mortgage debt are the Partnership’s inability to collect rent receivables and near- term or chronic property vacancies. The amount of cash to be distributed to our limited partners is determined by the General Partner and is dependent on a number of factors, including funds available for payment of distributions, capital expenditures, and taxable income recognition matching, which is primarily attributable to percentage rents and property sales.
As of December 31, 2017 and 2016, the Properties were leased 91%. In addition, the Partnership collected 100% of its base rent from current operating tenants for the fiscal years ended December 31, 2017 and 2016, which we believe is a good indication of overall tenant quality and stability. The only lease set to expire during 2018 is the ground lease in Palo Alto, NM. The Partnership does not expect to renew this ground lease, and the General Partner is expected to explore strategic options with respect to this Property. In January 2017, the Partnership received lease extension notices relating to seven of the eight Properties that are leased to Wendy’s franchisees. Pursuant to such notices, each of Wendgusta, LLC, Wendcharles I, LLC and Wendcharles II, LLC exercised the option in their respective property leases to renew such lease for five years beyond the prior expiration date of November 6, 2021. As a result, all eight of the Properties that are leased to Wendy’s franchisees now feature a lease expiration date of November 6, 2026. See Item 2, Properties for further information regarding Properties with significant developments.
Eight of the 11 Properties are operated as Wendy’s fast food restaurants and are franchises of the international Wendy’s Company. An additional Property was operated as a Wendy’s restaurant until its lease expired on November 6, 2016. Operating base rents from these eight leases comprised approximately 77% of the total 2017 operating base rents included in operating rental income of the Partnership. During the year ended December 31, 2017, additional percentage rents totaled $595,399, all of which were unbilled and were accrued in relation to the Properties operated as Wendy’s restaurants. Therefore, during 2017, the Partnership generated approximately 86% of its total operating revenues from those eight Properties.
The Partnership’s return on its investment historically has been, and is expected to continue to be, derived principally from rental payments received from its lessees. Therefore, the Partnership’s return on its investment historically is largely dependent upon the business success of its lessees. The business success of the Partnership’s individual lessees can be adversely affected on at least 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 the Properties. Finally, despite an individual lessee’s solid business plans in a strong local market, the franchise concept itself can suffer reversals or changes in management policy, which in turn can affect the profitability of operations. An overall economic recession is another factor that could affect the relative success of a lessee’s business. 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 the Properties are leased to restaurant tenants, the restaurant market is the major market segment with a material impact on Partnership operations. The success of customer marketing and the operating effectiveness of the Partnership’s lessee’s, will impact the Partnership’s future operating success in a very competitive restaurant and food service marketplace.
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. Economic volatility, either locally or nationally, may affect a lessee’s operational activity and its ability to meet lease obligations. Based on past experience, 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. The General Partner will use its best efforts to vigorously pursue collection of any defaulted amounts and to protect the Partnership’s 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, include the entrance of other competitors into the market areas of our tenants; liquidity and working capital needs of the lessees; and failure or withdrawal of any of the national franchises operated by the Partnership’s tenants. Each of these events, alone or in combination, would affect the liquidity level of the lessees resulting in possible default by a 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.
The credit environment has continued to be difficult for certain borrowers. Fortunately, the Partnership has limited exposure to the credit markets, as the Partnership has no mortgage debt. The General Partner believes that the Partnership’s liquid assets have been deposited with creditworthy financial institutions. However, the economic environment at any time and any lack of available credit could delay or inhibit the General Partner’s ability to dispose of any of the Properties, or cause management to feel compelled to dispose of Properties for a lower than anticipated return. As a result, the General Partner continues to maintain an objective to preserve capital and sustain property values while from time to time disposing of certain of the Properties as appropriate.
Off-Balance Sheet Arrangements
The Partnership does not have any off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Disposition Policies
In deciding whether to sell a Property, management considers factors such as potential capital appreciation or depreciation, market and economic conditions and the general strength of the real estate market, cash flow and federal income tax considerations, including possible adverse federal income tax consequences to the limited partners. The General Partner may exercise its discretion as to whether and when to sell a Property, and there is no obligation to sell any of the Properties at any particular time, except upon Partnership dissolution currently scheduled for November 30, 2020 pursuant to the Partnership Agreement, or if limited partners holding a majority of the Interests vote to liquidate and dissolve the Partnership in response to a formal consent solicitation to liquidate the Partnership.
Inflation
To the extent that tenants can pass through commodity inflation in their sales prices, the Partnership will benefit from additional percentage rent from increased sales. The majority of the Partnership’s leases have percentage rental clauses. Revenues from operating percentage rentals represented 40% of operating rental income for the fiscal year ended December 31, 2017, and 39% of operating rental income for the fiscal years ended December 31, 2016. If, however, inflation causes sales to decrease, operating margins to deteriorate for lessees, or if expenses grow faster than revenues, then, inflation may well negatively impact the portfolio through tenant defaults.
Due to the “triple-net” nature of the property leases, asset values generally move inversely with interest rates.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Partnership is not subject to market risk as defined by Item 305 of Regulation S-K.
Item 8.
Item 8. Financial Statements and Supplementary Data
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
(A Wisconsin limited partnership)
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Report of Independent Registered Public Accounting Firm
Third Avenue
14TH Floor
New York, NY 10022
212.838.5100
212.838.2676/ Fax
www.rbsmllp.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Management and the Advisory Board
DiVall Insured Income Properties 2 Limited Partnership
Opinion on the Financial Statements
We have audited the accompanying balance sheets of DiVall Insured Income Properties 2 Limited Partnership (the “Company”) as of December 31, 2017 and 2016, and the related statements of income, partners’ capital, and cash flows for each of the years in the two-year period ended December 31, 2017, and the related notes and schedules (collectively referred to as the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Emphasis of Matter
The Partnership is scheduled to be dissolved on November 30, 2020, or earlier upon the prior occurrence of some events, as described in Note 1 to the accompanying financial statement.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company’s auditor since 2014.
New York, New York
March 23, 2018
New York, NY Washington DC Mumbai & Pune, India San Francisco, CA Las Vegas, NV Beijing, China Athens, Greece
Member: ANTEA Alliance with offices in major cities worldwide
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
December 31, 2017 and 2016
ASSETS
The accompanying notes are an integral part of these financial statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
BALANCE SHEETS
December 31, 2017 and 2016
LIABILITIES AND PARTNERS’ CAPITAL
The accompanying notes are an integral part of these financial statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF INCOME
For the Years Ended December 31, 2017 and 2016
The accompanying notes are an integral part of these financial statement
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF PARTNERS’ CAPITAL
For the years ended December 31, 2017 and 2016
The accompanying notes are an integral part of these financial statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2017 and 2016
The accompanying notes are an integral part of these financial statements.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2017 AND 2016
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:
DiVall Insured Income Properties 2 Limited Partnership (the “Partnership”) was formed on November 20, 1987, pursuant to the Uniform Limited Partnership Act of the State of Wisconsin. The initial capital, contributed during 1987, consisted of $300, representing aggregate capital contributions of $200 by the former general partners and $100 by the initial Limited Partner. A subsequent offering of limited partnership interests (closed on February 22, 1990, with 46,280.3 limited partnership interests (“Interests”) having been sold in that offering, resulting in total proceeds to the Partnership, 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 of commercial real estate properties (the “Properties”). The Properties are leased on a triple net basis primarily to, and operated by, franchisors or franchisees of national, regional, and local retail chains under primarily long-term leases. The lessees are fast food, family style, and casual/theme restaurants. As of December 31, 2017, the Partnership owned 11 Properties, which are located in a total of four states.
The Partnership is scheduled to be dissolved on November 30, 2020, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all its Properties; (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 limited partner 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. During the second and third quarters of the nine odd numbered years from 2001 through 2017, consent solicitations were circulated to the Partnership’s limited partners which, if approved by the limited partners, would have authorized the General Partner to initiate the potential sale of all of the Properties and the dissolution of the Partnership (each a “Consent”). Limited partners owning a majority of the outstanding Interests did not vote in favor of any of the Consents. Therefore, the Partnership continues to operate as a going concern.
Significant Accounting Policies
Rental revenue from the Properties is recognized on the straight-line basis over the term of the respective lease. Percentage rents are only accrued when the tenant has reached the sales breakpoint stipulated in the lease.
Rents and other receivables are comprised of billed but uncollected amounts due for monthly rents and other charges, and amounts due for scheduled rent increases for which rentals have been earned and will be collected in the future under the terms of the leases. Receivables are recorded at management’s estimate of the amounts that will be collected.
As of December 31, 2017 and 2016 there were no values for allowance for doubtful accounts based on an analysis of specific accounts and historical experience.
The Partnership considers its operations to be in only one segment, the operation of a portfolio of commercial real estate leased on a triple net basis, and therefore no segment disclosure is made.
Depreciation of the Properties is provided on a straight-line basis over the estimated useful lives of the buildings and improvements.
Deferred charges represent leasing commissions paid when the Properties are leased and upon the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the term of the lease. As of December 31, 2017 and 2016, accumulated amortization amounted to $33,843 and $186,850, respectively. Fully amortized deferred charges of $183,021, including related accumulated amortization, were removed from the balance sheets as of December 31, 2016.
Deferred tenant award proceeds escrow represents the portion of the award proceeds from the sale of the portion of the Mt. Pleasant, South Carolina property that are being paid to the tenant ratably over 99 months beginning August 1, 2013.
The Partnership generally maintains cash in federally insured accounts which, at times, may exceed federally insured limits. The Partnership has not experienced any losses in such accounts and does not believe it is exposed to any significant credit risk.
Financial instruments that potentially subject the Partnership to significant concentrations of credit risk consist primarily of cash investments and leases. As of December 31, 2017, eight of the Partnership’s 11 Properties are leased to three significant tenants, Wendgusta, LLC (“Wendgusta”), Wendcharles I, LLC (“Wendcharles I”) and Wendcharles II, LLC (“Wendcharles II”), all three of whom are Wendy’s restaurant franchisees. The property lease(s) for these three tenants comprised approximately 52%, 17% and 9%, respectively, of the Partnership’s total 2017 operating base rents reflected for the fiscal year ended December 31, 2017.
The preparation of financial statements in conformity with GAAP 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.
Assets disposed of or deemed to be classified as held for sale require the reclassification of current and previous years’ operations to discontinued operations in accordance with GAAP applicable to “Accounting for the Impairment or Disposal of Long Lived Assets”. As such, prior year operating results for those properties considered as held for sale or properties no longer considered for sale have been reclassified to conform to the current year presentation without affecting total income. When properties are considered held for sale, depreciation of the properties is discontinued, and the properties are valued at the lower of the depreciated cost or fair value, less costs to dispose. If circumstances arise that were previously considered unlikely, and, as a result, the property previously classified as held for sale is no longer to be sold, the property is reclassified as held and used. Such property is measured at the lower of its carrying amount (adjusted for any depreciation and amortization expense that would have been recognized had the property been continuously classified as held and used) or fair value at the date of the subsequent decision not to sell.
Assets are classified as held for sale, generally, when all criteria within GAAP applicable to “Accounting for the Impairment or Disposal of Long Lived Assets” have been met.
The Partnership periodically reviews its long-lived assets, primarily real estate, for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The Partnership’s review involves comparing current and future operating performance of the assets, the most significant of which is undiscounted operating cash flows, to the carrying value of the assets. Based on this analysis, a provision for possible loss is recognized, if any. There were no adjustments to carrying values for the fiscal years ended December 31, 2017 and 2016.
The Financial Accounting Standards Board (“FASB”) guidance on “Fair Value Measurements and Disclosure”, defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. The adoption of the provisions of this FASB issuance, with respect to nonrecurring fair value measurements of nonfinancial assets and liabilities, including (but not limited to) the valuation of reporting units for the purpose of assessing goodwill impairment and the valuation of property and equipment when assessing long-lived asset impairment, did not have a material impact on how the Partnership estimated its fair value measurements but did result in increased disclosures about fair value measurements in the Partnership’s financial statements as of and for the years ended December 31, 2017 and 2016. See Note 10 for further disclosure.
GAAP applicable to disclosure about fair value of financial instruments requires entities to disclose the fair value of all financial assets and liabilities for which it is practicable to estimate. Fair value is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The General Partner believes that the carrying value of the Partnership’s assets (exclusive of the Properties) and liabilities approximate fair value due to the relatively short maturity of these instruments.
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, 2017, the tax basis of the Partnership’s assets exceeded the amounts reported in the December 31, 2017 financial statements by approximately $6,696,215.
The following represents an unaudited reconciliation of net income as stated on the Partnership statements of income to net income for tax reporting purposes:
The Partnership is not subject to federal income tax because its income and losses are includable in the tax returns of its partners, but may be subject to certain state taxes. FASB has provided guidance for how uncertain tax positions should be recognized, measured, disclosed and presented in the financial statements. This requires the evaluation of tax positions taken or expected to be taken in the course of preparing the entity’s tax returns to determine whether the tax positions are more-likely-than-not to be sustained when challenged or when examined by the applicable taxing authority. Management has determined that there were no material uncertain income tax positions. Tax returns filed by the Partnership generally are subject to examination by U.S. and state taxing authorities for the years ended after December 31, 2014.
Ohio - Commercial Activates Tax CAT
The Commercial Activity Tax (CAT) is an annual tax imposed on the privilege of doing business in Ohio, measured by gross receipts from business activities in Ohio. Businesses with Ohio taxable gross receipts of $150,000.00 per calendar year are subject to the CAT tax. Such “taxable gross receipts”, include I) gross rents and royalties from real property located in Ohio, and 2) gross receipts from the sale of real property located in Ohio. For calendar years 2006 and thereafter, the first $1 million in taxable gross receipts are taxed at $150, thereafter at a rate of 0.2600%. For tax years prior to December 31, 2013, there is an annual minimum tax (AMT) of$150.00. Since the Partnership has not had gross receipts in excess of $150,000 for the periods ended December 31, 2017and 2016, the CAT tax is not applicable to the Company for the periods indicated.
2. INVESTMENT PROPERTIES AND PROPERTY HELD FOR SALE:
The total cost of the Properties includes the original purchase price plus acquisition fees and other capitalized costs paid to an affiliate of the former general partners of the Partnership.
As of December 31, 2017, the Partnership owned 11 Properties that contained fully constructed fast-food/casual dining restaurant facilities. The following are operated by tenants at the Properties: eight separate Wendy’s restaurants, an Applebee’s restaurant, and a KFC restaurant. Following its lease expiration on November 6, 2016, the Martinez, GA Property is vacant. The 11 Properties are located in a total of four states.
A summary of significant developments as of December 31, 2017, by Property, for Properties with such developments, can be found in Item 2, Properties.
Discontinued Operations
During the fiscal years ended December 31, 2017 and 2016, the Partnership recognized (loss) income from discontinued operations of ($15,982) and $62,974, respectively. The income or (loss) from discontinued operations was attributable to the vacant Martinez, GA Property held for sale as of December 15, 2016 and that was vacant throughout the fiscal year ended December 31, 2017.
The components of property held for sale in the balance sheets as of December 31, 2017 and 2016 are outlined below:
The components of discontinued operations included in the statements of income for the years ended December 31, 2017 and 2016 are outlined below:
3. PARTNERSHIP AGREEMENT:
The Limited Partnership Agreement, as amended from time to time (collectively, the “Partnership Agreement”) was amended, effective as of November 9, 2009, to extend the term of the Partnership to November 30, 2020, or until dissolution prior thereto pursuant to the consent of the majority of the outstanding limited partnership interests.
Under the terms of the Partnership Agreement net profits or losses from operations are allocated 99% to the limited partners and 1% to the current General Partner. The November 9, 2009 amendment also provided for distributions from Net Cash Receipts, as defined, to be made 99% to limited partners and 1% to the current General Partner, provided that quarterly distributions are cumulative and are not to 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 it attributable to such year.
The provisions regarding distribution of Net Proceeds, as defined, 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 it attributable to such year; and (c) then, to limited partners, 99%, and to the General Partner, 1%, of remaining Net Proceeds available for distribution.
4. LEASES:
Original lease terms for the majority of the leased Properties were generally five to 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 the General Partner’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 on a straight-line basis and the cost of the property, excluding the cost of the land, is depreciated over its estimated useful life.
As of December 31, 2017, the aggregate minimum operating lease payments to be received under the current operating leases for the Properties are as follows:
5. TRANSACTIONS WITH GENERAL PARTNER AND ITS AFFILIATES:
Pursuant to the terms of the Permanent Manager Agreement (the “PMA”) executed in 1993 and renewed for an additional two-year term as of January 1, 2017, the General Partner receives a Base Fee for managing the Partnership equal to four percent of gross receipts, subject to an initial annual minimum amount of $159,000. The PMA also provides that the Partnership is responsible for reimbursement of the General Partner for office rent and related office overhead (“Expenses”) up to an initial annual maximum of $13,250. Both the Base Fee and Expense reimbursement are subject to annual Consumer Price Index based adjustments. Effective March 1, 2017, the minimum annual Base Fee and the maximum Expense reimbursement increased by 1.26% from the prior year, which represents the allowable annual Consumer Price Index adjustment per the PMA. Therefore, as of March 1, 2017, the minimum monthly Base Fee paid by the Partnership was raised to $22,556 and the maximum monthly Expense reimbursement was increased to $1,820.
For purposes of computing the four percent overall fees, gross receipts include amounts recovered in connection with the misappropriation of assets by the former general partners and their affiliates. The fees received from the Partnership on the amounts recovered reduce the four percent minimum fee by that same amount.
Amounts paid and/or accrued to the General Partner and its affiliates for the years ended December 31, 2017 and 2016, are as follows:
At December 31, 2017 and 2016, $1,238 and $1,242, respectively, were the distributions payable to the General Partner.
6. TRANSACTIONS WITH OWNERS WITH GREATER THAN TEN PERCENT BENEFICIAL INTERESTS:
As of December 31, 2017, an Advisory Board Member, Jesse Small, beneficially owns greater than ten percent of the Partnership’s outstanding limited partnership interests. Amounts paid to Mr. Small for the fiscal years ended December 31, 2017 and 2016 are as follows:
At December 31, 2017 and 2016, there were no outstanding Advisory Board fees accrued and payable to Mr. Small.
7. CONTINGENT LIABILITIES:
According to the Partnership Agreement, TPG, as General Partner of the Partnership, may receive a disposition fee not to exceed three percent of the contract price on the sale of the properties of the Partnership and two affiliated publicly registered limited partnerships, DiVall Insured Income Fund Limited Partnership (“DiVall 1”), which was dissolved December 1998, and DiVall Income Properties 3 Limited Partnership, which was dissolved in December 2003 (“DiVall 3”), and together with the Partnership and DiVall 1, the “three original partnerships”). In addition, fifty percent of all such disposition fees earned by TPG were to be escrowed until the aggregate amount of recovery of the funds misappropriated from the three original partnerships by the former general partners was greater than $4,500,000. Upon reaching such recovery level, full disposition fees would thereafter be payable and fifty percent of the previously escrowed amounts would be paid to TPG. At such time as the recovery exceeded $6,000,000 in the aggregate, the remaining escrowed disposition fees were to be paid to TPG. If such levels of recovery were not achieved, TPG would contribute the amounts escrowed toward the recovery until the three original partnerships were made whole. In lieu of a disposition fee escrow, fifty percent of all such disposition fees previously discussed were paid directly to a restoration account and then distributed among the three original partnerships; whereby the three original partnerships recorded the recoveries as income. After the recovery level of $4,500,000 was exceeded, fifty percent of the total disposition fee amount paid to the three original partnerships recovery through the restoration account (in lieu of the disposition fee escrow) was refunded to TPG during March 1996. The remaining fifty percent amount allocated to the Partnership through the restoration account, and which was previously reflected as Partnership recovery income, may be owed to TPG if the $6,000,000 recovery level is met. As of December 31, 2017, the Partnership may owe TPG $16,296 if the $6,000,000 recovery level is achieved. TPG does not expect any future refund, as it is uncertain that such a $6,000,000 recovery level will be achieved.
8. PMA INDEMNIFICATION TRUST:
The PMA provides that TPG will be indemnified from any claims or expenses arising out of, or relating to, TPG serving as the General Partner, so long as such claims do not arise from fraudulent or criminal misconduct by TPG. 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 corpus of the Trust has been fully funded with Partnership assets. Funds are invested in U.S. Treasury securities. In addition, $207,821 of earnings has been credited to the Trust as of December 31, 2017. The rights of TPG to the Trust will be terminated upon the earliest to occur of the following events: (i) the written release by TPG 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 TPG and which is subject to indemnification; or (iii) a determination by a court of competent jurisdiction that TPG shall have no liability to any person with respect to a claim which is subject to indemnification under the PMA. At such time as the indemnity provisions expire or the full indemnity is paid, any funds remaining in the Trust will revert back to the general funds of the Partnership.
9. NOTE RECEIVABLE:
In 2009, the Partnership sold the Panda Buffet restaurant property located in Grand Forks, ND (“Panda Buffet”) for $450,000. The buyer paid $150,000 at closing with the remaining balance of $300,000 being delivered in the form of a promissory note (“Buyers Note”) to the Partnership. The maturity date of the Buyers Note was extended twice, and, as of the final maturity date of November 1, 2016, the Buyers Note was paid in full. A mortgage release was issued to the buyer. During the year ended December 31, 2016, payments received by the Partnership under the Buyers Note totaled $57,157 in principal and $2,093 in interest.
10. FAIR VALUE DISCLOSURES
The Partnership has determined the fair value based on hierarchy that gives the highest priority to quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Inputs are broadly defined as assumptions market participants would use in pricing an asset or liability. The three levels of the fair value hierarchy under the accounting principle are described below:
Level 1. Quoted prices in active markets for identical assets or liabilities.
Level 2. Quoted prices for similar investments in active markets, quoted prices for identical or similar investments in markets that are not active, and inputs other than quoted prices that are observable for the investment.
Level 3. Unobservable inputs for which there is little, if any, market activity for the investment. The inputs into the determination of fair value are based upon the best information in the circumstances and may require significant management judgment or estimation and the use of discounted cash flow models to value the investment.
The fair value hierarchy is based on the lowest level of input that is significant to the fair value measurements. The Partnership’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.
The Partnership assesses the levels of the Investments at each measurement date, and transfers between levels are recognized on the actual date of the event or change in circumstances that caused the transfer in accordance with the Partnership’s accounting policy regarding the recognition of transfers between levels of the fair value hierarchy. For the years ended December 31, 2017 and 2016, there were no such transfers.
11. SUBSEQUENT EVENTS
On February 15, 2018, the Partnership made a distribution to the limited partners of $100,000 in the aggregate, which amounted to $2.16 per Interest.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Control and Procedures
Controls and Procedures
As of December 31, 2017, the Partnership’s management, including the persons performing the functions of principal executive officer and principal financial officer, have concluded that the Partnership’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report were effective based on the evaluation of these controls and procedures as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 under the Exchange Act.
Management’s Report on Internal Control over Financial Reporting
The Partnership’s management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act). The Partnership’s management assessed the effectiveness of the internal control over financial reporting as of December 31, 2017. In making this assessment, the Partnership’s management used the criteria set forth in the original Framework issued in 2013, by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. The Partnership’s management has concluded that, as of December 31, 2017, the internal control over financial reporting is effective based on these criteria. Further, there were no changes in the Partnership’s internal control over financial reporting during the three months ended December 31, 2017, that have materially affected, or are reasonably likely to materially affect, the Partnership’s internal control over financial reporting.
The Partnership’s management does not expect that the disclosure controls and procedures or the internal control over financial reporting will prevent all error and misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
This Annual Report on Form 10-K does not include an attestation report of the Partnership’s registered public accounting firm regarding internal control over financial reporting. As a non-accelerated filer, management’s report was not subject to attestation by the Partnership’s registered public accounting firm pursuant to rules in the Dodd Frank Act that permit the Partnership to provide only management’s report in this Annual Report on Form 10-K.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The Partnership itself does not have any employees, executive officers or directors and, therefore, has no board committees.
The General Partner of the Partnership is TPG. TPG’s principal office is located at 1100 Main Street, Suite 1830, Kansas City, Missouri 64105. TPG was elected General Partner by vote of the Limited Partners effective on May 26, 1993. Prior to such date, TPG had been managing the Partnership since February 8, 1993, under the terms of the PMA, which remains in effect. See Items 1 and 13 hereof for additional information about the PMA and the election of TPG as General Partner.
The executive officer and director of the General Partner who controls the affairs of the Partnership is:
Bruce A. Provo, Age 67 - President, Founder and Director, TPG.
Mr. Provo has been involved in the management of real estate and other asset portfolios since 1979. TPG was founded by Mr. Provo in 1985 and he has served as its President since its formation. TPG’s focus has been to provide professional real estate services to outside clients. Since the founding of TPG in 1985, Mr. Provo has also founded various entities engaged in unique businesses such as Rescue Services, Owner Representation, Asset Management, Managed Financial and Accounting Systems, Investments, and Virtual Resort Services. The entities are generally grouped under an informal umbrella known as The Provo Group of Companies. Since TPG was appointed General Partner to the Partnership in 1993, Mr. Provo has been primarily responsible for making management, leasing and disposition decisions on behalf of the Partnership.
From 1982 to 1986, Mr. Provo also 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 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.
The members of the Advisory Board of the Partnership are identified below. The Advisory Board provides guidance to management of the Partnership; however, it does not have the express power or authority to oversee and direct the operations of the Partnership and its members are not deemed “Directors” or “Executive Officers” of the Partnership.
William Arnold - Investment Broker. Mr. Arnold works as an independent financial planner, real estate broker and investment advisor. Mr. Arnold received a MSLA Master of Science Landscape Architecture from the University of Wisconsin and is a Certified Financial Planner. Mr. Arnold is a part of the brokerage community and the Partnership believes that as an Advisory Board member, he generally represents the views of the brokerage community.
Jesse Small - CPA. Mr. Small has been a tax and business consultant in Hallandale, FL for more than 30 years. Mr. Small has a Master’s Degree in Economics. Mr. Small is a Limited Partner, and the Partnership believes that as an Advisory Board member, he generally represents the views of Limited Partners. During the past five years after retiring from the accounting profession, Mr. Small has been developing property on the east and west coast of Florida.
Albert Kramer - Retired. Mr. Kramer is now retired, but previously worked as Tax Litigation Manager for Phillips Petroleum Company, now known as ConocoPhillips. His education includes undergraduate and MBA degrees from Harvard and a J.D. Degree from South Texas College of Law. Mr. Kramer is a Limited Partner, and the Partnership believes that as an Advisory Board member he generally represents the views of Limited Partners.
Code of Ethics
The Partnership has no executive officers or any employees and, accordingly, has not adopted a formal code of ethics.
Mr. Provo and TPG require that all personnel, including all employees, officers and directors of TPG: engage in honest and ethical conduct; ensure full, fair, accurate, timely and understandable disclosure; comply with all applicable governmental laws, rules and regulations; and report to Mr. Provo any deviation from these principles. Because TPG has two employees (including Mr. Provo), and because Mr. Provo is the ultimate decision maker in all instances, TPG has not adopted a formal code of ethics. Mr. Provo, as Chief Executive Officer and Chairman of the Board of Directors of TPG, negotiates and resolves all conflicts to the best of his ability and determines appropriate actions if necessary to deter violations and promote accountability, consistent with his fiduciary obligations to TPG and the fiduciary obligations of TPG to the Partnership.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires the officers and directors of TPG, and persons who own 10% or more of the Interests, to report their beneficial ownership of such Interests to the SEC. Their initial reports are required to be filed using the SEC’s Form 3, and they are required to report subsequent purchases, sales, and other changes using the SEC’s Form 4, which must be filed within two business days of most transactions. Officers, directors, and persons owning more than 10% of the Interests are required by SEC regulations to furnish the Partnership with copies of all of reports they file pursuant to Section 16(a).
As of December 31, 2017, Jesse Small was a beneficial owner of more than 10% of the outstanding Partnership Interests. One Form 4, which reported one transaction effected during 2017, was filed late by Mr. Small in 2017.
Item 11.
Item 11. Executive Compensation
The Partnership has not paid any executive compensation to the General Partner or to the directors and officers of the General Partner. The person that performs the role of principal financial officer of the Partnership is a consultant to the General Partner and receives fees from the General Partner (but not directly from the Partnership) pursuant to that relationship. The General Partner’s participation in the income of the Partnership is set forth in the Partnership Agreement, as amended. The General Partner received management fees and expense reimbursements during the year.
See Item 13, below, and Note 5 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. The principal executive officer of the General Partner is not directly compensated by the Partnership for controlling the affairs of the Partnership.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
(a) The following table sets forth certain information with respect to such beneficial ownership of the Partnership as of March 23, 2018. Based on information known to the Partnership and filed with the SEC, the following persons are known to beneficially own 5% or more of the outstanding Interests as follows:
(1) Based on 46,280.3 Interests outstanding as of March 23, 2018.
(b) As of March 23, 2018, the General Partner and the person who performs the functions of the principal executive officer of the General Partner did not beneficially own any Interests.
(c) Management knows of no contractual arrangements, the operation or the terms of which may at a subsequent date result in a change of control of the Partnership, except for provisions in the PMA.
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence
Pursuant to the terms of the PMA, the General Partner receives a Base Fee for managing the Partnership equal to four percent of gross receipts, subject to a $159,000 minimum, annually. The PMA also provides that the Partnership is responsible for reimbursement for office rent and related office overhead (“Expenses”) up to a maximum of $13,250 annually. Both the Base Fee and Expense reimbursement are subject to annual Consumer Price Index based adjustments. Effective March 1, 2017, the minimum annual Base Fee and the maximum Expense reimbursement increased by 1.26% from the prior year, which represents the allowable annual Consumer Price Index adjustment per the PMA. Therefore, as of March 1, 2017, the minimum monthly Base Fee paid by the Partnership was raised to $22,556 and the maximum monthly Expense reimbursement was raised to $1,820.
Additionally, TPG, or its affiliates, are allowed up to one-half of the commissions customarily charged by other brokers in arm’s-length sales transactions involving comparable properties in the same geographic area, but such TPG commissions are not to exceed three percent of the contract price on the sale of an investment property. The payment of a portion of such fees is subordinated to TPG’s success at recovering the funds misappropriated by the former general partners. See Note 7 to the financial statements for further information.
The PMA had an original expiration date of December 31, 2002. The term of the PMA has been extended multiple times and is currently set to expire on December 31, 2018. The PMA can 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 TPG 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 TPG to the Limited Partners of the Partnership. Upon termination of the PMA, other than by the voluntary action of TPG, TPG will 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 will be indemnified by the Partnership, DiVall and Magnuson, and their controlled affiliates, and 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, officer’s liability or similar insurance coverage, at no cost to TPG. In addition, TPG was granted the right to establish an Indemnification Trust in an original amount, not to exceed $250,000, solely for the purpose of funding such indemnification obligations. Once a determination has been made that no such claims can or will be made against TPG, the balance of the Trust will become unrestricted property of the Partnership. The corpus of the Trust has been fully funded with Partnership assets.
Advisory Board Member Independence
Although not “directors” or “officers” of the Partnership, the Partnership does evaluate whether the members of the Advisory Board are “independent” by evaluating whether each member has any relationships or has engaged in any transactions that, in the opinion of the General Partner, would interfere with any Advisory Board member’s exercise of independent judgment with respect to matters concerning the Partnership. As a part of this evaluation the General Partner considers, among other things, transactions and relationships between any member of the Advisory Board or any member of his family and the Partnership. The General Partner believes that each of Messrs. Arnold, Small and Kramer are “independent”.
The Partnership paid and/or accrued the following to the General Partner and its affiliates in 2017 and 2016:
Item 14.
Item 14. Principal Accountant Firm Fees and Services
RBSM, LLP serves as the Partnership’s independent registered public accountants.
Audit Fees
Aggregate billings during the fiscal years ended December 31, 2017 and 2016, for audit and interim review services provided to the Partnership by its principal accounting firm, RBSM, LLP, amounted to $47,400 and $48,350, respectively.
Audit-Related Fees
For the fiscal years ended December 31, 2017 and 2016, RBSM, LLP did not perform any assurance and related services that were reasonably related to the performance of the audit or interim reviews.
Tax Fees
Tax compliance services billed during the fiscal years ended December 31, 2017 and 2016 were $26,650 and $26,000, respectively, provided by RSM US, LLP (“RSM”).
All Other Fees
For the fiscal years ended December 31, 2017 and 2016, neither RSM nor RBSM, LLP performed any management consulting or other services for the Partnership.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedule
(a) 1. Financial Statements
The following financial statements of DiVall Insured Income Properties 2 Limited Partnership are included in Part II, Item 8 of this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Balance Sheets at December 31, 2017 and 2016
Statements of Income for the Years Ended December 31, 2017 and 2016
Statements of Partners’ Capital for the Years Ended December 31, 2017 and 2016
Statements of Cash Flows for the Years Ended December 31, 2017 and 2016
Notes to Financial Statements
2. Financial Statement Schedule
Schedule III - Investment Properties and Accumulated Depreciation, December 31, 2017
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.
10.0 Permanent Manager Agreement filed as an exhibit to the Current Report on Form 8-K dated January 22, 1993, Commission File 33-18794, and incorporated herein by reference.
31.1 Sarbanes Oxley Section 302 Certifications.
31.2 Sarbanes Oxley Section 302 Certifications.
32.1 Certification of Periodic Financial Report Pursuant to 18 U.S.C. Section 1350.
99.0
Reviewed Financial Statements of Wendgusta, LLC for the fiscal years ended December 31, 2017 and December 25, 2016 prepared by Vrona & Van Schuyler, CPAs, PLLC.
99.1 Reviewed Financial Statements of Wendcharles I, LLC for the fiscal years ended December 31, 2017 and December 25, 2016 prepared by Vrona &Van Schuyler, CPAs, PLLC.
99.2 Reviewed Financial Statements of Wendcharles II, LLC for the fiscal years ended December 31, 2017 and December 25, 2016 prepared by Vrona &Van Schuyler, CPAs, PLLC.
The following materials from the Partnership’s Annual Report on Form 10-K for the year ended, formatted in XBRL (Extensible Business Reporting Language): (i) Balance Sheets at December 31, 2017 and December 31, 2016, (ii) Statements of Income for the years ended December 31, 2017 and 2016, (iii) Statement of Cash Flows for the years ended December 31, 2017 and 2016, and (v) Notes to the Financial Statements.
Item 16. Form 10-K Summary
None.
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
SCHEDULE III - INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2017
(1) In the Fourth Quarter of 2001, a portion of the land was purchased from the Partnership by the County Commission for utility and maintenance easement.
(2) In the Third Quarter of 2013, a portion of the land was sold to the City of Charleston for right of way purposes.
(3) In the Fourth Quarter of 2016, the property was classified as held for sale
DIVALL INSURED INCOME PROPERTIES 2 LIMITED PARTNERSHIP
SCHEDULE III - INVESTMENT PROPERTIES AND ACCUMULATED DEPRECIATION
DECEMBER 31, 2017
(B) Reconciliation of “Investment Properties and Accumulated Depreciation”:
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, L.P.
By: /s/ Bruce A. Provo
President, Chief Executive Officer and Director of
The Provo Group, Inc., the General Partner of the Partnership
(principal executive officer of the registrant)
By: /s/ Lynette L. DeRose
Chief Financial Officer of the Partnership
(principal financial officer and principal accounting officer of the registrant)
By:
THE PROVO GROUP, INC., General Partner
By: /s/ Bruce A. Provo
President, Chief Executive Officer and
Director of The Provo Group, Inc., the
General Partner of the Partnership
(principal executive officer of the registrant)
Dated: [March 23, 2018]
Pursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By: /s/ Bruce A. Provo
President, Chief Executive Officer and Director of
The Provo Group, Inc., the General Partner
of the Partnership
By: /s/ Caroline E. Provo
Director of The Provo Group, Inc., the General
Partner of the Partnership
Date: [March 23, 2018]