FORM 10-QSB--QUARTERLY OR TRANSITIONAL REPORT UNDER SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
QUARTERLY OR TRANSITIONAL REPORT
U.S. Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1999
[ ] TRANSITION REPORT PURSUANT TO 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from to
Commission file number 0-14483
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
(Exact name of small business issuer as specified in its charter)
Delaware 62-1207077
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
55 Beattie Place, P.O. Box 1089
Greenville, South Carolina 29602
(Address of principal executive offices)
(864) 239-1000
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
a)
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
CONSOLIDATED BALANCE SHEET
(in thousands, except unit data)
(Unaudited)
March 31, 1999
Assets
Cash and cash equivalents $ 1,180
Receivables and deposits, net of $61
for doubtful accounts 673
Restricted escrows 597
Other assets 511
Investment properties:
Land $ 2,878
Buildings and related personal property 42,906
45,784
Less accumulated depreciation (23,609) 22,175
$ 25,136
Liabilities and Partners' Deficit
Liabilities
Accounts payable $ 153
Tenant security deposit liabilities 186
Accrued property taxes 660
Other liabilities 585
Mortgage notes payable 26,060
Partners' Deficit
General partners' $ (485)
Limited partners' (1,224.25 units issued
and outstanding) (2,023) (2,508)
$ 25,136
See Accompanying Notes to Consolidated Financial Statements
b)
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except unit data)
(Unaudited)
Three Months Ended
March 31,
1999 1998
Revenues:
Rental income $ 2,147 $ 1,911
Other income 185 183
Total revenues 2,332 2,094
Expenses:
Operating 1,033 961
General and administrative 88 81
Depreciation 519 495
Interest 563 567
Property taxes 191 198
Loss on disposal of property -- 164
Total expenses 2,394 2,466
Net loss $ (62) $ (372)
Net loss allocated to general
partners (2%) $ (1) $ (7)
Net loss allocated to limited
partners (98%) (61) (365)
$ (62) $ (372)
Net loss per limited partnership unit $ (49.83) $(298.14)
See Accompanying Notes to Consolidated Financial Statements
c)
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' DEFICIT
(in thousands, except unit data)
(Unaudited)
Limited
Partnership General Limited
Units Partners Partners' Total
Original capital contributions 1,224.25 $ 1 $24,485 $24,486
Partners' deficit at
December 31, 1998 1,224.25 $(484) $(1,962) $(2,446)
Net loss for the three months
ended March 31, 1999 -- (1) (61) (62)
Partners' deficit at
March 31, 1999 1,224.25 $(485) $(2,023) $(2,508)
See Accompanying Notes to Consolidated Financial Statements
d)
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
Three Months Ended
March 31,
1999 1998
Cash flows from operating activities:
Net loss $ (62) $ (372)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation 519 495
Amortization of discounts, loan costs
and leasing commissions 59 56
Loss on disposal of property -- 164
Change in accounts:
Receivables and deposits 141 374
Other assets (56) 38
Accounts payable (81) (77)
Tenant security deposit liabilities (2) 3
Accrued property taxes (37) (164)
Other liabilities 87 24
Net cash provided by operating activities 568 541
Cash flows from investing activities:
Property improvements and replacements (179) (339)
Net withdrawals from restricted escrows 15 22
Net cash used in investing activities (164) (317)
Cash flows from financing activities:
Payments on mortgage notes payable (195) (181)
Net cash used in financing activities (195) (181)
Net increase in cash and cash equivalents 209 43
Cash and cash equivalents at beginning of period 971 885
Cash and cash equivalents at end of period $1,180 $ 928
Supplemental disclosure of cash flow information:
Cash paid for interest $ 498 $ 514
See Accompanying Notes to Consolidated Financial Statements
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Davidson
Diversified Real Estate II, L.P. (the "Registrant" or "Partnership") have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Item 310(b)
of Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of Davidson Diversified Properties, Inc.
("Managing General Partner"), all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three month period ended March 31, 1999, are not
necessarily indicative of the results that may be expected for the fiscal year
ending December 31, 1999. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Partnership's annual
report on Form 10-KSB for the fiscal year ended December 31, 1998.
Principles of Consolidation
The consolidated financial statements include all the accounts of the
Partnership and its three 99.9% owned partnerships. The Managing General
Partner of the consolidated partnerships is Davidson Diversified Properties,
Inc. Davidson Diversified Properties, Inc. may be removed by the Registrant;
therefore, the consolidated partnerships are controlled and consolidated by the
Registrant. All significant interpartnership balances have been eliminated.
NOTE B - TRANSFER OF CONTROL
Pursuant to a series of transactions which closed on October 1, 1998 and
February 26, 1999, Insignia Financial Group, Inc. and Insignia Properties Trust
merged into Apartment Investment and Management Company, a publicly traded real
estate investment trust ("AIMCO"), with AIMCO being the surviving corporation
(the "Insignia Merger"). As a result, AIMCO acquired 100% ownership interest in
the Managing General Partner. The Managing General Partner does not believe
that this transaction will have a material effect on the affairs and operations
of the Partnership.
NOTE C - TRANSACTIONS WITH AFFILIATED PARTIES
The Partnership has no employees and is dependent on the Managing General
Partner and its affiliates for the management and administration of all
partnership activities. The Partnership Agreement provides for certain payments
to affiliates for services and as reimbursement of certain expenses incurred by
affiliates on behalf of the Partnership. The following transactions with the
Managing General Partner and affiliates were incurred during the three month
periods ended March 31, 1999 and 1998:
1999 1998
(in thousands)
Property management fees (included in operating
expense) $104 $107
Reimbursement for services of affiliates, (included
in operating and general and administrative
expense and investment properties) (1) 61 105
Due to affiliates 203 --
(1) Included in "reimbursement for services of affiliates" for the three months
ended March 31, 1998, is approximately $50,000 in reimbursements for
construction oversight costs. There were no such costs incurred for the
three months ended March 31, 1999.
Additionally, the Partnership paid approximately $2,000 during the three months
ended March 31, 1998 to an affiliate of the Managing General Partner for lease
commissions at the Partnership's commercial property. No lease commissions were
paid to an affiliate during the three months ended March 31, 1999. These lease
commissions are included in other assets and are amortized over the terms of the
respective leases.
During the three months ended March 31, 1999 and 1998, affiliates of the
Managing General Partner were entitled to receive 5% of gross receipts from all
of the Registrant's residential properties for providing property management
services. The Registrant paid to such affiliates $104,000 and $97,000 for the
three months ended March 31, 1999 and 1998 respectively. For the three months
ended March 31, 1998, affiliates of the Managing General Partner were entitled
to varying percentages of gross receipts from the Registrant's commercial
property for providing property management services. The Registrant paid to
such affiliates $10,000 for the three months ended March 31, 1998. No fees were
paid for the three months ended March 31, 1999 as these services were provided
by an unrelated party effective October 1, 1998.
An affiliate of the Managing General Partner was entitled to receive
reimbursement of accountable administrative expenses amounting to approximately
$61,000 and $105,000 for the three months ended March 31, 1999 and 1998,
respectively. The current fees and a portion of the prior years fees for the
whole year were not able to be paid due to the Partnership's cashflow.
Accordingly, as of March 31, 1999, a liability of $203,000 exists and is
reflected in other liabilities.
On September 26, 1997, an affiliate of the Managing General Partner purchased
Lehman Brothers' class "D" subordinated bonds of SASCO, 1992-M1. These bonds
are secured by 55 multi-family apartment mortgage loan pairs held in Trust,
including Big Walnut Apartments and Greensprings Manor Apartments owned by the
Partnership.
NOTE D - SEGMENT REPORTING
Description of the types of products and services from which the reportable
segment derives its revenue:
The Partnership has two reportable segments: residential properties and
commercial properties. The Partnership's residential property segment consists
of four apartment complexes located in Ohio, Kentucky, Tennessee, and Indiana.
The Partnership rents apartment units to tenants for terms that are typically
twelve months or less. The commercial property segment consists of a retail
shopping center located in Murfreesboro, Tennessee. This property leases space
mainly to name brand outlet clothing stores at terms ranging from nine months to
four years.
Measurement of segment profit or loss:
The Partnership evaluates performance based on net income. The accounting
policies of the reportable segments are the same as those described in the
summary of significant accounting policies described in the Partnership's annual
report on Form 10-KSB for the year ended December 31, 1998.
Factors management used to identify the enterprise's reportable segment:
The Partnership's two reportable segments are investment properties that offer
different products and services. The reportable segments are each managed
separately because they provide distinct services with different types of
products and customers.
Segment information for the three months ended March 31, 1999 and 1998 is shown
in the tables below. The "Other" column includes partnership administration
related items and income and expense not allocated to reportable segments.
1999 RESIDENTIAL COMMERCIAL OTHER TOTAL
Rental income $1,933 $ 214 $ -- $ 2,147
Other income 133 48 4 185
Interest expense 513 41 9 563
Depreciation 426 93 -- 519
General and administrative
expense -- -- 88 88
Segment profit (loss) 80 (49) (93) (62)
Total assets 21,076 3,470 590 25,136
Capital expenditures for
investment properties 171 8 -- 179
1998 RESIDENTIAL COMMERCIAL OTHER TOTAL
Rental income $ 1,717 $ 194 $ -- $ 1,911
Other income 135 42 6 183
Interest expense 524 43 -- 567
Depreciation 402 93 -- 495
General and administrative
expense -- -- 81 81
Loss on disposal of property (164) -- -- (164)
Segment loss (226) (71) (75) (372)
Total assets 21,508 3,684 600 25,792
Capital expenditures for
investment properties 335 4 -- 339
NOTE E - LEGAL PROCEEDINGS
In March 1998, several putative unit holders of limited partnership units of the
Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia
Financial Group, Inc., et al. in the Superior Court of the State of California
for the County of San Mateo. The plaintiffs named as defendants, among others,
the Partnership, the Managing General Partner and several of their affiliated
partnerships and corporate entities. The complaint purports to assert claims on
behalf of a class of limited partners and derivatively on behalf of a number of
limited partnerships (including the Partnership) which are named as nominal
defendants, challenging the acquisition by Insignia Financial Group, Inc.
("Insignia") and entities which were, at one time, affiliates of Insignia
("Insignia Affiliates") of interests in certain general partner entities, past
tender offers by Insignia Affiliates to acquire limited partnership units, the
management of partnerships by Insignia Affiliates as well as a recently
announced agreement between Insignia and Apartment Investment and Management
Company ("AIMCO"). The complaint seeks monetary damages and equitable relief,
including judicial dissolution of the Partnership. On June 25, 1998, the
Managing General Partner filed a motion seeking dismissal of the action. In lieu
of responding to the motion, the plaintiffs filed an amended complaint. The
Managing General Partner has filed demurrers to the amended complaint which were
heard during February 1999. No ruling on such demurrers has been received. The
Managing General Partner does not anticipate that costs associated with this
case, if any, will be material to the Partnership's overall operations.
On July 30, 1998, certain entities claiming to own limited partnership interests
in certain limited partnerships whose general partners were, at the time,
affiliates of Insignia filed a complaint entitled EVEREST PROPERTIES, LLC. V.
INSIGNIA FINANCIAL GROUP, INC., ET AL. in the Superior Court of the State of
California, county of Los Angeles. The action involves 44 real estate limited
partnerships (including the Partnership) in which the plaintiffs allegedly own
interests and which Insignia Affiliates allegedly manage or control (the
"Subject Partnerships"). This case was settled on March 3, 1999. The
Partnership is responsible for a portion of the settlement costs. The expense
will not have a material effect on the Partnership's overall operations.
The Partnership is unaware of any other pending or outstanding litigation that
is not of a routine nature arising in the ordinary course of business.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The matters discussed in this Form 10-QSB contain certain forward-looking
statements and involve risks and uncertainties (including changing market
conditions, competitive and regulatory matters, etc.) detailed in the
disclosures contained in this Form 10-QSB and the other filings with the
Securities and Exchange Commission made by the Registrant from time to time.
The discussion of the Registrant's business and results of operations, including
forward-looking statements pertaining to such matters, does not take into
account the effects of any changes to the Registrant's business and results of
operation. Accordingly, actual results could differ materially from those
projected in the forward-looking statements as a result of a number of factors,
including those identified herein.
The Partnership's investment properties consist of four apartment complexes and
one commercial property. The following table sets forth the average occupancy
of the properties for the three months ended March 31, 1999 and 1998:
Average Occupancy
1999 1998
Big Walnut Apartments 91% 95%
Columbus, Ohio
LaFontenay I & II Apartments 91% 89%
Louisville, Kentucky
The Trails Apartments 94% 90%
Nashville, Tennessee
Greensprings Manor Apartments 94% 83%
Indianapolis, Indiana
Shoppes At River Rock 78% 66%
(Formerly Outlet's Ltd. Mall)
Murfreesboro, Tennessee
The Managing General Partner attributes the decrease in occupancy at Big Walnut
Apartments to deferred maintenance that needs to be performed at the property.
The Managing General Partner has budgeted capital improvements for 1999 to help
improve the property. The increase in occupancy at The Trails Apartments and
Greensprings Manor Apartments is attributed to an aggressive and effective
marketing campaign during the last part of 1998 and into the first quarter of
1999. The increase in occupancy at Shoppes at River Rock is attributed to new
tenants moving in during the three months ended March 31, 1999. For the three
months ended March 31, 1998, the property had a low occupancy rate due to the
loss of a major tenant in 1997. Management is continuing to explore alternative
concepts for repositioning the shopping center in an attempt to fill its
vacancies and improve occupancy.
Results of Operations
The Partnership's net loss for the three months ended March 31, 1999 was
approximately $62,000 as compared to approximately $372,000 for the three months
ended March 31, 1998. The decrease in net loss was due to an increase in total
revenues and a decrease in total expenses. The increase in total revenues is
due to an increase in rental income. The increase in rental income was due to
an increase in average rental rates at all of the Partnership's residential
properties and an increase in average occupancy at four of the properties which
was partially offset by a decrease in average occupancy at Big Walnut Apartments
as noted above.
Expenses decreased primarily due to the fact that no loss was recognized during
the first quarter of 1999 as was recognized during the first quarter of 1998.
During the first quarter of 1998 a loss on disposal of property at LaFontenay I
& II Apartments was recognized due to the write-off of the undepreciated value
of roofs that were replaced during the first quarter of 1998. Partially
offsetting the decrease was an increase in operating expense. The increase in
operating expense is attributable to an increase in employees' salaries and an
increase in snow removal expense at all of the residential properties. The
increase in operating expense was also attributable to an increase in merchant
associates dues at Shoppes at River Rock as the result of the increase in
occupancy as discussed above. The increase in operating expense was partially
offset by a decrease in insurance premiums at all properties and insurance
proceeds received at Big Walnut Apartments. The insurance proceeds were
proceeds from water damage incurred due to structural deficiencies at Big Walnut
Apartments. Additional expenses are expected to be incurred in the next few
months as repairs are made to correct the structural problems with Big Walnut's
roofs.
Depreciation expense increased due to the capital improvements performed for the
three months ended March 31, 1999 and throughout 1998. General and
administrative expense increased slightly as a result of an increase in legal
costs, which include the Partnership's portion of settlement costs paid in March
1999 as described in "Part II, Item 1. Legal Proceedings". Included in general
and administrative expenses at both March 31, 1999 and 1998 are management
reimbursements to the Managing General Partner allowed under the Partnership
Agreement. In addition, costs associated with the quarterly communications with
investors and regulatory agencies and the annual audit required by the
Partnership Agreement are also included.
As part of the ongoing business plan of the Partnership, the Managing General
Partner monitors the rental market environment of each of its investment
properties to assess the feasibility of increasing rents, maintaining or
increasing occupancy levels and protecting the Partnership from increases in
expenses. As part of this plan, the Managing General Partner attempts to
protect the Partnership from the burden of inflation-related increases in
expenses by increasing rents and maintaining a high overall occupancy level.
However, due to changing market conditions, which can result in the use of
rental concessions and rental reductions to offset softening market conditions,
there is no guarantee that the Managing General Partner will be able to sustain
such a plan.
Liquidity and Capital Resources
At March 31, 1999, the Partnership had cash and cash equivalents of
approximately $1,180,000 as compared to approximately $928,000 at March 31,
1998. Cash and cash equivalents increased approximately $209,000 for the three
months ended March 31, 1999 from the Partnership's year end, primarily due to
approximately $568,000 of cash provided by operating activities, which was
partially offset by approximately $164,000 of cash used in investing activities
and approximately $195,000 of cash used in financing activities. Cash used in
financing activities consisted of payments of principal made on the mortgages
encumbering the Partnership's properties. Cash used in investing activities
consisted of property improvements and replacements, slightly offset by net
withdrawals from escrow accounts maintained by the mortgage lender. The
Partnership invests its working capital reserves in money market accounts.
The sufficiency of existing liquid assets to meet future liquidity and capital
expenditure requirements is directly related to the level of capital
expenditures required at the various properties to adequately maintain the
physical assets and other operating needs of the Partnership and to comply with
Federal, state, and local legal and regulatory requirements. Capital
improvements planned for each of the Registrant's properties are detailed below.
Big Walnut Apartments
Based on a report received from an independent third party consultant analyzing
necessary exterior improvements and estimates made by the Managing General
Partner on interior improvements, it is estimated that the property requires
approximately $634,000 of capital improvements over the near term. The property
has budgeted, but is not limited to, capital improvements of approximately
$633,000 for 1999, including HVAC, roofing, and electrical improvements. As of
March 31, 1999, approximately $13,000 has been incurred consisting primarily of
appliance and floor covering replacements.
LaFontenay I&II Apartments
Based on a report received from an independent third party consultant analyzing
necessary exterior improvements and estimates made by the Managing General
Partner on interior improvements, it is estimated that the property requires
approximately $295,000 of capital improvements over the near term. The property
has budgeted, but is not limited to, capital improvements of approximately
$400,000 for 1999, including parking lot repair, roofing, and floor covering
replacements. As of March 31, 1999, approximately $68,000 has been incurred
consisting primarily of roof replacements, appliance and floor covering
replacements and exterior and interior building improvements.
The Trails
Based on a report received from an independent third party consultant analyzing
necessary exterior improvements and estimates made by the Managing General
Partner on interior improvements, it is estimated that the property requires
approximately $267,000 of capital improvements over the near term. The property
has budgeted, but is not limited to, capital improvements of approximately
$304,000 for 1999, including landscaping, electrical, and HVAC improvements. As
of March 31, 1999, approximately $32,000 has been incurred consisting primarily
of clubhouse renovations and interior building improvements.
Greensprings Manor
Based on a report received from an independent third party consultant analyzing
necessary exterior improvements and estimates made by the Managing General
Partner on interior improvements, it is estimated that the property requires
approximately $693,000 of capital improvements over the near term. The property
has budgeted, but is not limited to, capital improvements of approximately
$693,000 for 1999, including roofing repairs, gutters and down spouts, and
exterior painting. As of March 31, 1999, approximately $58,000 has been incurred
consisting primarily of appliance and floor covering replacement and interior
building improvements.
Shoppes At River Rock
Based on a report received from an independent third party consultant analyzing
necessary exterior improvements and estimates made by the Managing General
Partner on interior improvements, it is estimated that the property requires
approximately $977,000 of capital improvements over the near term. The property
has budgeted, but is not limited to, capital improvements of approximately
$249,000 for 1999, including roof replacements, curb and gutter repairs. As of
March 31, 1999, approximately $8,000 has been incurred consisting primarily of
interior building improvements.
The additional capital expenditures will be incurred only if cash is available
from operations or from Partnership reserves. To the extent that such budgeted
capital improvements are completed, the Registrant's distributable cash flow, if
any, may be adversely affected at least in the short term.
The Registrant's current assets are thought to be sufficient for any near-term
needs (exclusive of capital improvements) of the Registrant. The mortgage
indebtedness of approximately $26,060,000, net of discount, is amortized over
varying periods with required balloon payments ranging from January 15, 2000 to
December 1, 2009. The Managing General Partner will attempt to refinance such
indebtedness and/or sell the properties prior to such maturity date. If the
properties cannot be refinanced or sold for a sufficient amount, the Registrant
will risk losing such properties through foreclosure.
No cash distributions were made during the three months ended March 31, 1999 or
1998. The Registrant's distribution policy is reviewed on a quarterly basis.
Future cash distributions will depend on the levels of net cash generated from
operations, the availability of cash reserves, and the timing of debt
maturities, refinancings and/or property sales. There can be no assurance,
however, that the Registrant will generate sufficient funds from operations
after planned capital expenditures to permit further distributions to its
partners in 1999 or subsequent periods.
Potential Tender Offer
On October 1, 1998, Insignia Financial Group, Inc. merged into AIMCO, a real
estate investment trust, whose Class A Common Shares are listed on the New York
Stock Exchange. As a result of such merger, AIMCO and AIMCO Properties, L.P., a
Delaware limited partnership and the operating partnership of AIMCO ("AIMCO OP")
acquired indirect control of the Managing General Partner. AIMCO and its
affiliates currently own 13.886% of the limited partnership interests in the
Partnership. AIMCO is presently considering whether it will engage in an
exchange offer for additional limited partnership interests in the Partnership.
There is a substantial likelihood that, within a short period of time, AIMCO OP
will offer to acquire limited partnership interests in the Partnership for cash
or preferred units or common units of limited partnerships interests in AIMCO
OP. While such an exchange offer is possible, no definite plans exist as to when
or whether to commence such an exchange offer, or as to the terms of any such
exchange offer, and it is possible that none will occur.
A registration statement relating to these securities has been filed with the
Securities and Exchange Commission but has not yet become effective. These
securities may not be sold nor may offers to buy be accepted prior to the time
the registration statement becomes effective. This Form 10-QSB shall not
constitute an offer to sell or the solicitation of an offer to buy nor shall
there be any sale of these securities in any state in which such offer,
solicitation or sale would be unlawful prior to the registration or
qualification under the securities laws of any such state.
Year 2000 Compliance
General Description of the Year 2000 Issue and the Nature and Effects of the
Year 2000 on Information Technology (IT) and Non-IT Systems
The Year 2000 issue is the result of computer programs being written using two
digits rather than four digits to define the applicable year. The Partnership
is dependent upon the General Partner and its affiliates for management and
administrative services ("Managing Agent"). Any of the computer programs or
hardware that have date-sensitive software or embedded chips may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
Over the past two years, the Managing Agent has determined that it will be
required to modify or replace significant portions of its software and certain
hardware so that those systems will properly utilize dates beyond December 31,
1999. The Managing Agent presently believes that with modifications or
replacements of existing software and certain hardware, the Year 2000 issue can
be mitigated. However, if such modifications and replacements are not made, or
not completed in time, the Year 2000 issue could have a material impact on the
operations of the Partnership.
The Managing Agent's plan to resolve Year 2000 issues involves four phases:
assessment, remediation, testing, and implementation. To date, the Managing
Agent has fully completed its assessment of all the information systems that
could be significantly affected by the Year 2000, and has begun the remediation,
testing and implementation phases on both hardware and software systems.
Assessments are continuing in regards to embedded systems. The status of each
is detailed below.
Status of Progress in Becoming Year 2000 Compliant, Including Timetable for
Completion of Each Remaining Phase
Computer Hardware:
During 1997 and 1998, the Managing Agent identified all of the computer systems
at risk and formulated a plan to repair or replace each of the affected systems.
In August 1998, the mainframe system used by the Managing Agent became fully
functional. In addition to the mainframe, PC-based network servers, routers and
desktop PCs were analyzed for compliance. The Managing Agent has begun to
replace each of the non-compliant network connections and desktop PCs and, as of
March 31, 1999, had completed approximately 75% of this effort.
The total cost to the Managing Agent to replace the PC-based network servers,
routers and desktop PCs is expected to be approximately $1.5 million of which
$1.3 million has been incurred to date. The remaining network connections and
desktop PCs are expected to be upgraded to Year 2000 compliant systems by July
31, 1999.
Computer Software:
The Managing Agent utilizes a combination of off-the-shelf, commercially
available software programs as well as custom-written programs that are designed
to fit specific needs. Both of these types of programs were studied, and
implementation plans written and executed with the intent of repairing or
replacing any non-compliant software programs.
During 1998, the Managing Agent began converting the existing property
management and rent collection systems to its management properties Year 2000
compliant systems. The estimated additional costs to convert such systems at
all properties, is $200,000, and the implementation and the testing process is
expected to be completed by July 31, 1999.
The final software area is the office software and server operating systems.
The Managing Agent has upgraded all non-compliant office software systems on
each PC and has upgraded 80% of the server operating systems. The remaining
server operating systems are planned to be upgraded to be Year 2000 compliant by
July 31, 1999.
Operating Equipment:
The Managing Agent has operating equipment, primarily at the property sites,
which needed to be evaluated for Year 2000 compliance. In September 1997, the
Managing Agent began taking a census and inventory of embedded systems
(including those devices that use time to control systems and machines at
specific properties, for example elevators, heating, ventilating, and air
conditioning systems, security and alarm systems, etc.).
The Managing Agent has chosen to focus its attention mainly upon security
systems, elevators, heating, ventilating and air conditioning systems, telephone
systems and switches, and sprinkler systems. While this area is the most
difficult to fully research adequately, management has not yet found any major
non-compliance issues that put the Managing Agent at risk financially or
operationally. The Managing Agent intends to have a third-party conduct an
audit of these systems and report their findings by July 31, 1999.
Any of the above operating equipment that has been found to be non-compliant to
date has been replaced or repaired. To date, these have consisted only of
security systems and phone systems. As of March 31, 1999 the Managing Agent has
evaluated approximately 86% of the operating equipment for the Year 2000
compliance.
The total cost incurred for all properties managed by the Managing Agent as of
March 31, 1999 to replace or repair the operating equipment was approximately
$400,000. The Managing Agent estimates the cost to replace or repair any
remaining operating equipment is approximately $325,000, which is expected to be
completed by August 30, 1999.
The Managing Agent continues to have "awareness campaigns" throughout the
organization designed to raise awareness and report any possible compliance
issues regarding operating equipment within its enterprise.
Nature and Level of Importance of Third Parties and Their Exposure to the Year
2000
The Managing Agent continues to conduct surveys of its banking and other vendor
relationships to assess risks regarding their Year 2000 readiness. The Managing
Agent has banking relationships with three major financial institutions, all of
which have indicated their compliance efforts will be complete before May 1999.
The Managing Agent has updated data transmission standards with two of the three
financial institutions. The Managing Agent's contingency plan in this regard is
to move accounts from any institution that cannot be certified Year 2000
compliant by June 1, 1999.
The Partnership does not rely heavily on any single vendor for goods and
services, and does not have significant suppliers and subcontractors who share
information systems (external agent). To date the Partnership is not aware of
any external agent with a Year 2000 compliance issue that would materially
impact the Partnership's results of operations, liquidity, or capital resources.
However, the Partnership has no means of ensuring that external agents will be
Year 2000 compliant.
The Managing Agent does not believe that the inability of external agents to
complete their Year 2000 remediation process in a timely manner will have a
material impact on the financial position or results of operations of the
Partnership. However, the effect of non-compliance by external agents is not
readily determinable.
Costs to Address Year 2000
The total cost of the Year 2000 project to the Managing Agent is estimated at
$3.5 million and is being funded from operating cash flows. To date, the
Managing Agent has incurred approximately $2.8 million ($0.6 million expensed
and $2.2 million capitalized for new systems and equipment) related to all
phases of the Year 2000 project. Of the total remaining project costs,
approximately $0.5 million is attributable to the purchase of new software and
operating equipment, which will be capitalized. The remaining $0.2 million
relates to repair of hardware and software and will be expensed as incurred.
The Partnership's portion of these costs are not material.
Risks Associated with the Year 2000
The Managing Agent believes it has an effective program in place to resolve the
Year 2000 issue in a timely manner. As noted above, the Managing Agent has not
yet completed all necessary phases of the Year 2000 program. In the event that
the Managing Agent does not complete any additional phases, certain worst case
scenarios could occur. The worst case scenarios could include elevators,
security and heating, ventilating and air conditioning systems that read
incorrect dates and operate with incorrect schedules (e.g., elevators will
operate on Monday as if it were Sunday). Although such a change would be
annoying to residents, it is not business critical.
In addition, disruptions in the economy generally resulting from Year 2000
issues could also adversely affect the Partnership. The Partnership could be
subject to litigation for, among other things, computer system failures,
equipment shutdowns or failure to properly date business records. The amount of
potential liability and lost revenue cannot be reasonably estimated at this
time.
Contingency Plans Associated with the Year 2000
The Managing Agent has contingency plans for certain critical applications and
is working on such plans for others. These contingency plans involve, among
other actions, manual workarounds and selecting new relationships for such
activities as banking relationships and elevator operating systems.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 1998, several putative unit holders of limited partnership units of the
Partnership commenced an action entitled Rosalie Nuanes, et al. v. Insignia
Financial Group, Inc., et al. in the Superior Court of the State of California
for the County of San Mateo. The plaintiffs named as defendants, among others,
the Partnership, the Managing General Partner and several of their affiliated
partnerships and corporate entities. The complaint purports to assert claims on
behalf of a class of limited partners and derivatively on behalf of a number of
limited partnerships (including the Partnership) which are named as nominal
defendants, challenging the acquisition by Insignia Financial Group, Inc.
("Insignia") and entities which were, at one time, affiliates of Insignia
("Insignia Affiliates") of interests in certain general partner entities, past
tender offers by Insignia Affiliates to acquire limited partnership units, the
management of partnerships by Insignia Affiliates as well as a recently
announced agreement between Insignia and Apartment Investment and Management
Company ("AIMCO"). The complaint seeks monetary damages and equitable relief,
including judicial dissolution of the Partnership. On June 25, 1998, the
Managing General Partner filed a motion seeking dismissal of the action. In lieu
of responding to the motion, the plaintiffs filed an amended complaint. The
Managing General Partner has filed demurrers to the amended complaint which were
heard during February 1999. No ruling on such demurrers has been received. The
Managing General Partner does not anticipate that costs associated with this
case, if any, will be material to the Partnership's overall operations.
On July 30, 1998, certain entities claiming to own limited partnership interests
in certain limited partnerships whose general partners were, at the time,
affiliates of Insignia filed a complaint entitled Everest Properties, LLC, v.
Insignia Financial Group, Inc., et. al. in the Superior Court of the State of
California, County of Los Angeles. The action involves 44 real estate limited
partnerships (including the Partnership) in which the plaintiffs allegedly own
interests and which Insignia Affiliates allegedly manage or control (the
"Subject Partnerships"). This case was settled on March 3, 1999. The
Partnership is responsible for a portion of the settlement costs. The expense
will not have a material effect on the Partnership's overall operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits:
Exhibit 27, Financial Data Schedule, is filed as an exhibit to this report.
b) Reports on Form 8-K:
None filed during the three months ended March 31, 1999.
SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
DAVIDSON DIVERSIFIED REAL ESTATE II, L.P.
By: Davidson Diversified Properties, Inc.,
Managing General Partner
By: /s/Patrick J. Foye
Patrick J. Foye
Executive Vice President
By: /s/Carla R. Stoner
Carla R. Stoner
Senior Vice President
Finance and Administration
Date: May 12, 1999