10-Q 1 d10q.txt FORM 10-Q FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2001 --------------------------------------- OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------------- --------------- Commission file number 0-20253 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP (Exact name of registrant as specified in its charter) Wisconsin 39-1660958 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 W. 11th St., Suite 1110, Kansas City, Missouri 64105 (Address of principal executive offices, including zip code) (816) 421-7444 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Interests Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --------- --------- PART I - FINANCIAL INFORMATION Item 1. Financial Statements DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP BALANCE SHEETS September 30, 2001 and December 31, 2000 ---------------------------------------- ASSETS

The accompanying notes are an integral part of these statements. 2 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP LIABILITIES AND PARTNERS' CAPITAL September 30, 2001 and December 31, 2000 ----------------------------------------

The accompanying notes are an integral part of these statements. 3 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP STATEMENTS OF INCOME (Unaudited) -----------

The accompanying notes are an integral part of these statements. 4 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS (Unaudited) -----------

The accompanying notes are an integral part of these statements. 5 DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS These unaudited interim financial statements should be read in conjunction with DiVall Income Properties 3 Limited Partnership's (the "Partnership") 2000 annual audited financial statements within Form 10-K. These unaudited financial statements include all adjustments which are, in the opinion of management, necessary to present a fair statement of financial position as of September 30, 2001, and the results of operations for the three and nine-month periods ended September 30, 2001, and 2000, and cash flows for the nine-month periods ended September 30, 2001 and 2000. Results of operations for the periods are not necessarily indicative of the results to be expected for the full year. 1. ORGANIZATION AND BASIS OF ACCOUNTING: ------------------------------------- The Partnership was formed on December 12, 1989, pursuant to the Uniform Limited Partnership Act of the State of Wisconsin. The initial capital which was contributed during 1989, consisted of $300, representing aggregate capital contributions of $200 by the former general partners and $100 by the Initial Limited Partner. The Partnership initially offered two classes of Limited Partnership interests for sale: Distribution interests ("D-interests") and Retention interests ("R-interests"). Each class was offered at a price (before volume discounts) of $1,000 per interest. The Partnership offered the two classes of interests simultaneously up to an aggregate of 25,000 interests. The minimum offering requirements for the D-interests were met and escrow subscription funds were released to the Partnership as of July 13, 1990. The offering closed on April 23, 1992, at which point 17,102.52 D-interests had been issued, resulting in aggregate proceeds, net of discounts and offering costs, of $14,408,872. The minimum offering requirements for R-interests were not met. During 1991, 680.9 R-interests were converted to D-interests and were reflected as Partnership issuances in 1991. The Partnership is currently engaged in the business of owning and operating its investment portfolio (the "Properties") of commercial real estate. The Properties are leased on a triple net basis to, and operated by, franchisers or franchisees of national, regional and local retail chains under long-term leases. The lessees consist of fast-food, family style, and casual/theme restaurants. At September 30, 2001, the Partnership owned five (5) properties and specialty leasehold improvements for use in all five (5) of the Properties. 6 Rental revenue from investment properties is recognized on the straight-line basis over the life of the respective lease. Percentage rents are recorded when the tenant has reached the breakpoint stipulated in its lease. The Partnership considers its operations to be in only one segment and therefore no segment disclosure is made. Depreciation of the properties is provided on a straight-line basis over 31.5 years, which is the estimated useful lives of the buildings and improvements. Deferred charges consist of leasing commissions paid when properties are leased and upon the negotiated extension of a lease. Leasing commissions are capitalized and amortized over the life of the lease. Real estate taxes on the Partnership's investment properties are the responsibility of the tenant. However, when a tenant fails to make the required tax payments or when a property becomes vacant, the Partnership makes the appropriate payment to avoid possible foreclosure of the property. Taxes are accrued in the period for which the liability is incurred. Cash and cash equivalents include cash on deposit in financial institutions and highly liquid temporary investments with initial maturities of 90 days or less. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities (and disclosure of contingent assets and liabilities) at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Partnership follows Statement of Financial Accounting Standards No.121 ("SFAS 121"), Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which requires that all long-lived assets be reviewed for impairment in value whenever changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Partnership will be dissolved on December 1, 2015, or earlier upon the prior occurrence of any of the following events: (a) the disposition of all interests in real estate and other Partnership assets; (b) the decision by Majority Vote (as defined in the Amended Agreement of Limited Partnership ("Partnership Agreement")) of the Limited Partners to dissolve the Partnership or to compel the sale of all or substantially all of the Partnership's assets; (c) the failure to elect a successor General Partner within six months after removal of the last remaining General Partner; or (d) the date of the death or the effective date of dissolution, removal, withdrawal, bankruptcy, or incompetency of the last remaining General Partner, unless the Partnership is continued by vote of all Limited Partners and a replacement General Partner is previously elected by a majority of the Limited Partners. During the Second Quarter of 1998, the General Partner received the consent of the Limited Partners to liquidate the Partnership's assets and dissolve the Partnership. However, a buyer was not found for the Partnership's assets, and no current liquidation or dissolution plans are in effect. Management plans to continue normal operations for the Partnership for the foreseeable future. 7 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, 2000, the tax basis of the Partnership's assets exceeded the amounts reported in the accompanying financial statements by approximately $3,224,000. 2. REGULATORY INVESTIGATION: ------------------------ A preliminary investigation during 1992 by the Office of the Commissioner of Securities for the State of Wisconsin and the Securities and Exchange Commission (the "Investigation") revealed that during at least the three years ended December 31, 1992, the former general partners of the Partnership, Gary J. DiVall ("DiVall") and Paul E. Magnuson ("Magnuson") had transferred substantial cash assets of the Partnership and two affiliated publicly registered partnerships, DiVall Insured Income Fund Limited Partnership ("DiVall 1") (dissolved effective December 31, 1998) and DiVall Insured Income Properties 2 Limited Partnership ("DiVall 2") (collectively the "Partnerships") to various other entities previously sponsored by or otherwise affiliated with DiVall and Magnuson. The unauthorized transfers were in violation of the respective Partnership Agreements and resulted, in part, from material weaknesses in the internal control system of the Partnerships. Subsequent to discovery, and in response to the regulatory inquiries, a third-party Permanent Manager, The Provo Group, Inc. ("TPG"), was appointed (effective February 8, 1993) to assume responsibility for daily operations and assets of the Partnerships as well as to develop and execute a plan of restoration for the Partnerships. Effective May 26, 1993, the Limited Partners, by written consent of a majority of interests, elected the Permanent Manager, TPG, as General Partner. TPG terminated the former general partners by accepting their tendered resignations. In 1993, the current General Partner estimated an aggregate recovery of $3 million for the Partnerships. At that time, an allowance was established against amounts due from former general partners and their affiliates reflecting the estimated $3 million receivable. This net receivable was allocated among the Partnerships based on each Partnership's pro rata share of the total misappropriation. Through September 30, 2001, $5,797,000 of recoveries have been received which exceeded the original estimate of $3 million. As a result, since 1996, the Partnership has recognized $1,302,000 as income, which represents its share of the excess recovery. The current General Partner continues to pursue recoveries of the misappropriated funds, however no further significant recoveries are anticipated. 3. INVESTMENT PROPERTIES: --------------------- As of September 30, 2001, the Partnership owned four (4) fast-food restaurants comprised of: one (1) Hardee's restaurant, one (1) Applebee's restaurant, and two (2) Denny's restaurants; and one (1) vacant property, which was previously operated as a Hardee's restaurant. The five (5) properties are located in three (3) states. The Denny's property in Englewood, Colorado is located on a parcel of land where the Partnership has entered into a long-term ground lease. The lease payments are made by the tenant of the property. During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurant in Oak Creek, Wisconsin. The lease on the property was not set to expire until 2010. In the Second Quarter of 2001, a lease termination agreement was executed and the tenant ceased the payment of rent 8 as of April 30, 2001. Hardee's Food Systems will pay a lease termination fee of approximately two (2) years rent or $181,000. The payments are scheduled to be received in four (4) equal installments of $45,250. The first payment was received in May 2001 upon the execution of the agreement, and the subsequent installments were reflected as Note receivable on the balance sheet. The first Note receivable installment was received in August 2001. The remaining installments, which are reflected in the Note receivable on the balance sheet at September 30, 2001, are scheduled to be received in November 2001 and February 2002. Management is actively marketing new leasing for the vacant property. The total cost of the investment properties includes the original purchase price plus acquisition fees and other capitalized costs paid to an affiliate of the former general partners. According to the Partnership Agreement, the former general partners were to commit 82% of the original offering proceeds to the acquisition of investment properties. Upon full investment of the net proceeds of the offering, approximately 57% of the original offering proceeds was invested in the Partnership's properties. The current General Partner receives a fee for managing the Partnership equal to 4% of gross receipts, with a maximum reimbursement for office rent and related overhead of $25,000 between the three original affiliated Partnerships as provided in the Permanent Manager Agreement ("PMA"). On May 26, 1993, the Permanent Manager, TPG, replaced the former general partners as the new General Partner, as provided for in an amendment to the Partnership Agreement dated May 26, 1993. Pursuant to amendments to the Partnership Agreement, TPG continues to provide management services for the same fee structure as provided in the PMA mentioned above. Effective March 1, 2001, the minimum management fee and the maximum reimbursement for office rent and overhead increased by 3.4% representing the allowable annual Consumer Price Index adjustment per the PMA. For purposes of computing the 4% overall fee, gross receipts includes amounts recovered in connection with the misappropriation of assets by the former general partners and their affiliates. TPG has received fees from the Partnership totaling $88,561 to date on the amounts recovered, which has been offset against the 4% minimum fee. Several of the Partnership's property leases contain purchase option provisions with stated purchase prices in excess of the original cost of the properties. The current General Partner is unaware of any unfavorable purchase options in relation to original cost. 4. PARTNERSHIP AGREEMENT: --------------------- The Partnership Agreement, prior to an amendment effective May 26, 1993, provided that, for financial reporting and income tax purposes, net profits or losses from operations were allocated 90% to the Limited Partners and 10% to the former general partners. The Partnership Agreement also provided that Net Cash Receipts, as defined, would be distributed 90% to the Limited Partners and 10% to the former general partners, except that distributions to the former general partners in excess of 1% in any calendar year would be subordinated to distributions to the Limited Partners in an amount equal to their Original Property Distribution Preference, as defined. Net proceeds, as defined, were to be distributed as follows: (a) 1% to the General Partners and 99% to the Limited Partners, until distributions to the Limited Partners equal their Original Capital, as defined, plus their Original Property Liquidation Preference, as defined, and (b) the remainder 90% to the Limited 9 Partners and 10% to the General Partners. Such distributions were to be made as soon as practicable following the sale, financing or refinancing of an original property. On May 26, 1993, pursuant to the results of a solicitation of written consents from the Limited Partners, the Partnership Agreement was amended to replace the former general partners and amend various sections of the agreement. The former general partners were replaced as General Partner, by The Provo Group, Inc., an Illinois corporation. Under the terms of the amendment, net profits or losses from operations are allocated 99% to the Limited Partners and 1% to the current General Partner. The amendment also provided for distributions from Net Cash Receipts to be made 99% to the Limited Partners and 1% to its current General Partner. Pursuant to the amendments to the Partnership Agreement effective June 30, 1994, distributions of Net Cash Receipts will not be made to the General Partner unless and until each Limited Partner has received a distribution from Net Cash Receipts in an amount equal to 10% per annum, cumulative simple return on his or her Adjusted Original Capital, as defined, from the Return Calculation Date, as defined, except to the extent needed by the General Partner to pay its federal and state income taxes on the income allocated to it attributable in such year. Distributions paid to the General Partner are based on the estimated tax liability as a result of allocated income. Subsequent to the filing of the General Partner's income tax returns, a true-up of actual distributions is made. Net proceeds, as defined, were also amended to be distributed 1% to the current General Partner and 99% to the Limited Partners. Additionally, as per the amendment of the Partnership Agreement dated May 26, 1993, the total compensation paid to all persons for the sale of the investment properties shall be limited to a competitive real estate commission, not to exceed 6% of the contract price for the sale of the property. The General Partner may receive up to one-half of the competitive real estate commission, not to exceed 3%, provided that the General Partner provides a substantial amount of services in the sales effort. It is further provided that a portion of the amount of such fees payable to the General Partner is subordinated to its success at recovering the funds misappropriated by the former general partners. (See Note 7.) Effective June 1, 1993, the Partnership Agreement was amended to (i) change the definition of "Distribution Quarter" to be consistent with calendar quarters, and (ii) change the distribution provisions to subordinate the General Partner's share of distributions from Net Cash Receipts and Net Proceeds, except to the extent necessary for the General Partner to pay its federal and state income taxes on Partnership income allocated to the General Partner. Because these amendments do not adversely affect the rights of the Limited Partners, pursuant to section 10.2 of the Partnership Agreement, the amendments were made by the General Partner without a vote of the Limited Partners. 5. LEASES: ------ Lease terms for the investment properties are 20 years from their inception. The leases provide for minimum rents and additional rents based upon percentages of gross sales in excess of specified breakpoints. The lessee is responsible for occupancy costs such as maintenance, insurance, real estate taxes, and utilities. Accordingly, these amounts are not reflected in the statements of income, except in circumstances where, in management's opinion, the Partnership will be required to pay such costs to preserve assets (i.e., payment of past-due real estate taxes). Management has determined that the leases are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the property, excluding the cost of the land, is depreciated over its estimated useful life. 10 Aggregate minimum lease payments to be received under the leases for the Partnership's properties are as follows: Year ending December 31, 2001 $350,713 2002 321,380 2003 321,380 2004 321,380 2005 321,380 Thereafter 1,524,531 ---------- $3,160,764 ========== Two (2) of the Partnership's properties are leased to a Denny's franchisee. Base rent from these properties amounted to approximately 28% of total base rent in 2000. Prior to May 1, 2001 two (2) of the Partnership's properties were leased to Hardee's Food Systems, Inc. Base rent from these properties amounted to approximately 44% of total base rents in 2000. The original offering document allowed the Partnership to lease its properties to a single tenant as long as the properties so leased do not constitute; in the aggregate, more than 20% of the aggregate gross proceeds of the offering. Prior to May 1, 2001, the Partnership leased two (2) of its properties to Hardee's Food Systems, Inc., which constituted 21% of the aggregate gross proceeds in 2000. 6. TRANSACTIONS WITH CURRENT GENERAL PARTNER: ----------------------------------------- Amounts paid to the current General Partner for the quarters ended September 30, 2001 and 2000, are as follows: Current General Partner Incurred as of Incurred as of ----------------------- September 30, September 30, ------------ ------------ 2001 2000 ---- ---- Management fees $51,652 $50,159 Restoration fees 193 107 Cash distribution 1,174 587 Overhead allowance 4,183 4,056 Reimbursement for out-of-pocket expenses 1,795 2,215 ------- ------- $58,997 $57,124 ======= ======= 7. CONTINGENT LIABILITIES: ---------------------- According to the Partnership Agreement, the current General Partner may receive a disposition fee not to exceed 3% of the contract price of the sale of investment properties. Fifty percent (50%) of all such 11 disposition fees earned by the current General Partner is to be in escrow until the aggregate amount of recovery of the funds misappropriated from the Partnerships by the former general partners is greater than $4,500,000. Upon reaching such recovery level, full disposition fees will thereafter be payable and fifty percent (50%) of the previously escrowed amounts will be paid to the current General Partner. At such time as the recovery exceeds $6,000,000 in the aggregate, the remaining escrowed disposition fees shall be paid to the current General Partner. If such levels of recovery are not achieved, the current General Partner will contribute the amounts in escrow towards the recovery. In lieu of an escrow, 50% of all such disposition fees have been paid directly to the restoration account and then distributed among the three Partnerships. After surpassing the $4,500,000 recovery level during March 1996, 50% of the amounts previously in escrow were refunded to the current General Partner. The remaining amount allocated to the Partnerships may be owed to the current General Partner if the $6,000,000 recovery level is met. As of September 30, 2001, the Partnership may owe the current General Partner $18,862, which is currently reflected as a recovery, if the $6,000,000 recovery level is achieved, which is unlikely. 8. PMA INDEMNIFICATION TRUST: ------------------------- The PMA provides that the Permanent Manager will be indemnified from any claims or expenses arising out of or relating to the Permanent Manager serving in such capacity or as substitute general partner, so long as such claims do not arise from fraudulent or criminal misconduct by the Permanent Manager. The PMA provides that the Partnership fund this indemnification obligation by establishing a reserve of up to $250,000 of Partnership assets which would not be subject to the claims of the Partnership's creditors. An Indemnification Trust ("Trust") serving such purposes has been established at United Missouri Bank, N.A. The Trust has been fully funded with Partnership assets as of September 30, 2001. Funds are invested in U.S. Treasury securities. In addition, interest totaling $102,894 has been credited to the Trust as of September 30, 2001. The rights of the Permanent Manager to the Trust shall be terminated upon the earliest to occur of the following events: (i) the written release by the Permanent Manager of any and all interest in the Trust; (ii) the expiration of the longest statute of limitations relating to a potential claim which might be brought against the Permanent Manager and which is subject to indemnification; or (iii) a determination by a court of competent jurisdiction that the Permanent Manager shall have no liability to any person with respect to a claim which is subject to indemnification under the PMA. At such time as the indemnity provisions expire or the full indemnity is paid, any funds remaining in the Trust will revert back to the general funds of the Partnership. 9. FORMER GENERAL PARTNERS' CAPITAL ACCOUNTS: ----------------------------------------- The capital account balance of the former general partners as of May 26, 1993, the date of their removal as general partners pursuant to the results of a solicitation of written consents from the Limited Partners, was a deficit of $265,491. At December 31, 1993, the former general partners' deficit capital account balance in the amount of $265,491 was reallocated to the Limited Partners. 10. SUBSEQUENT EVENTS: ----------------- On November 15, 2001, the Partnership will make a distribution to the Limited Partners for the Third Quarter 2001 of $80,000 amounting to approximately $4.68 per limited partnership interest. 12 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources: ------------------------------- Investment Properties and Net Investment in Direct Financing Leases ------------------------------------------------------------------- The investment properties, including equipment held by the Partnership at September 30, 2001, were originally purchased at a price, including acquisition costs, of approximately $6,091,000. During March 2001, Hardee's Food Systems, Inc. notified Management of its intent to close its restaurant in Oak Creek, Wisconsin. The lease on the property was not set to expire until 2010. In the Second Quarter of 2001, a lease termination agreement was executed and the tenant ceased the payment of rent as of April 30, 2001. Management is actively marketing new leasing for the vacant property. Other Assets ------------ Cash and cash equivalents were $268,000 at September 30, 2001, compared to $252,000 at December 31, 2000. The Partnership designated cash of $80,000 to fund the Third Quarter 2001 distributions to Limited Partners; $41,000 for the payment of accounts payable and accrued expenses; and the remainder represents reserves deemed necessary to allow the Partnership to operate normally. Cash generated through the operations of the Partnership's investment properties and sales of investment properties will provide the sources for future fund liquidity and Limited Partner distributions. The Partnership established an Indemnification Trust (the "Trust") during the Fourth Quarter of 1993 and deposited $130,000 in the Trust during 1994, $100,000 during 1995, and $20,000 during 1996. The provision to establish the Trust was included in the PMA for the indemnification of TPG, in the absence of fraud or gross negligence, from any claims or liabilities that may arise from TPG acting as Permanent Manager. The Trust is owned by the Partnership. For additional information regarding the Trust, refer to Note 8 to the financial statements. Property taxes escrow at September 30, 2001, in the amount of approximately $9,500, represented four (4) months of 2001 real estate taxes for the vacant Hardee's- Oak Creek property paid by Hardee's Food Systems, Inc. upon the lease termination agreement with Management. The Note receivable balance at September 30, 2001 was $90,500. In the Second Quarter of 2001, a lease termination agreement was executed with Hardee's Food Systems upon the closing of its restaurant in Oak Creek, Wisconsin. Hardee's Food Systems will pay a lease termination fee of approximately two (2) years rent or $181,000. The payments are scheduled to be received in four equal (4) installments of $45,250. The first payment was received in May 2001 upon the execution of the agreement, and the subsequent installments were reflected as Note receivable on the balance sheet. The first Note receivable installment was received in August 2001. The remaining installments, which are reflected in the Note receivable on the balance sheet at September 30, 2001,are scheduled to be received in November 2001 and February 2002. Liabilities ----------- 13 Accounts payable and accrued expenses at September 30, 2001, in the amount of $26,000, primarily represented the accrual of auditing fees. Property taxes payable at September 30, 2001, in the amount of $9,500, represented four (4) months of 2001 real estate taxes for the vacant Hardee's- Oak Creek property paid by Hardee's Food Systems, Inc. upon the lease termination agreement with Management. Partners' Capital ----------------- Net income for the quarter was allocated between the General Partner and the Limited Partners, 1% and 99%, respectively, as provided in the Partnership Agreement and the Amendment to the Partnership Agreement, as discussed more fully in Note 4 of the financial statements. The former general partners' capital account balance was reallocated to the Limited Partners at December 31, 1993. Refer to Note 9 to the financial statements for additional information regarding the reallocation. Cash distributions paid to the Limited Partners and to the General Partner during 2001, of $230,000 and $1,174, respectively, have also been made in accordance with the amended Partnership Agreement. The Third Quarter 2001 distribution of $80,000 will be paid to the Limited Partners on November 15, 2001. Results of Operations: --------------------- The Partnership reported net income for the quarter ended September 30, 2001, in the amount of $30,000 compared to net income for the quarter ended September 30, 2000 of $57,000. Net income for the nine months ended September 30, 2001 and 2000 totaled $294,000 and $147,000, respectively. Revenues -------- Total revenues were $85,000, and $111,000, for the quarters ended September 30, 2001, and 2000, respectively, and were $476,000 and $332,000 for the nine months ended September 30, 2001 and 2000, respectively. As of May 1, 2001 total revenues, should approximate $320,000 annually or $80,000 quarterly, based on leases currently in place. Future revenues may decrease with tenant defaults and/or sales of Partnership properties. They may also increase with additional rents due from tenants, if those tenants experience sales levels which require the payment of additional rent to the Partnership. The fluctuation in the 2001 Third Quarter revenues is due primarily to decreased rental income upon the lease termination of Hardee's- Oak Creek as of April 30, 2001. The increase in revenues in 2001 is primarily due to the $181,000 lease termination fee charged to Hardee's Food Systems, Inc. in the Second Quarter upon the termination of the Hardee's- Oak Creek lease. Expenses -------- For the quarters ended September 30, 2001 and 2000, cash expenses amounted to approximately 46% and 34% of total revenues, respectively. For the nine months ended September 30, 2001 and 2000, cash expenses totaled 27% and 41% of total revenues, respectively. Total expenses, including non-cash items, amounted to 65% and 49% of total revenues for the quarters ended September 30, 2001 and 2000, respectively, and totaled 38% and 56% of total revenues for the nine months ended September 30, 2001 and 2000, respectively. The fluctuation in the Third Quarter of 2001 is due primarily to decreased rental 14 income upon the lease termination of Hardee's- Oak Creek as of April 30, 2001. The fluctuation in 2001 is due to the increase in revenues, primarily due to the $181,000 lease termination fee. Inflation: --------- Inflation has a minimal effect on operating earnings and related cash flows from a portfolio of triple net leases. By their nature, such leases actually fix revenues and are not impacted by rising costs of maintenance, insurance, or real estate taxes. If inflation causes operating margins to deteriorate for lessees if expenses grow faster than revenues, then, inflation may well negatively impact the portfolio through tenant defaults. It would be misleading to associate inflation with asset appreciation for real estate, in general, and the Partnership's portfolio, specifically. Due to the "triple net" nature of the property leases, asset values generally move inversely with interest rates. Item 3. Quantitative and Qualitative Disclosure About Market Risk None. 15 PART II - OTHER INFORMATION Items 1 - 5. Not Applicable. Item 6. Exhibits and Reports on Form 8-K (a) Listing of Exhibits: 99.0 Correspondence to the Limited Partners dated November 15, 2001, regarding the Third Quarter 2001 distribution. (b) Report on Form 8-K: The Registrant filed no reports on Form 8-K during the first quarter of fiscal year 2001. 16 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, thereto duly authorized. DIVALL INCOME PROPERTIES 3 LIMITED PARTNERSHIP By: The Provo Group, Inc., General Partner By: /s/Bruce A. Provo --------------------------------------------- Bruce A. Provo, President Date: November 12, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. By: The Provo Group, Inc., General Partner By: /s/Bruce A. Provo --------------------------------------------- Bruce A. Provo, President Date: November 12, 2001 By: /s/Diane R. Conley --------------------------------------- Diane R. Conley Controller Date: November 12, 2001 17

DIVALL INCOME PROPERTIES 3 L P 10-Q