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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
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Commission file number 0-11973
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
Organized pursuant to the Laws of the State of Maryland
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Internal Revenue Service - Employer Identification No. 52-1321492
11200 Rockville Pike, Rockville, Maryland 20852
(301) 468-9200
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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 o
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CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
INDEX TO FORM 10-QSB
FOR THE QUARTER ENDED JUNE 30, 2004
Page
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets
- June 30, 2004 and December 31, 2003........................... 1
Statements of Operations and Accumulated Losses
- for the three and six months ended June 30, 2004 and 2003..... 2
Statements of Cash Flows
- for the six months ended June 30, 2004 and 2003............... 3
Notes to Financial Statements
- June 30, 2004 and 2003........................................ 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 10
Item 3. Controls and Procedures........................................... 14
Part II - OTHER INFORMATION
Item 3. Defaults Upon Senior Securities................................... 14
Item 5. Other Information................................................. 14
Item 6. Exhibits and Reports on Form 8-K.................................. 15
Signature.................................................................. 16
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
BALANCE SHEETS
ASSETS
June 30, December 31,
2004 2003
------------ ------------
(Unaudited)
Investments in partnerships ....................................................... $ 815,640 $ 854,495
Investment in partnership held for transfer ....................................... 450,230 508,229
Cash and cash equivalents ......................................................... 3,758,867 2,979,778
Acquisition fees, principally paid to related parties,
net of accumulated amortization of $124,201 and $121,219, respectively .......... 54,686 57,667
Property purchase costs,
net of accumulated amortization of $165,635 and $161,573, respectively .......... 78,037 82,098
Other assets ...................................................................... 84 40
------------ ------------
Total assets ................................................................... $ 5,157,544 $ 4,482,307
============ ============
LIABILITIES AND PARTNERS' CAPITAL
Due on investments in partnerships ................................................ $ 1,400,000 $ 1,400,000
Accrued interest payable .......................................................... 2,689,262 2,626,262
Accounts payable and accrued expenses ............................................. 116,610 145,687
------------ ------------
Total liabilities .............................................................. 4,205,872 4,171,949
------------ ------------
Commitments and contingencies
Partners' capital:
Capital paid in:
General Partners .............................................................. 2,000 2,000
Limited Partners .............................................................. 50,015,000 50,015,000
------------ ------------
50,017,000 50,017,000
Less:
Accumulated distributions to partners ......................................... (15,293,973) (15,293,973)
Offering costs ................................................................ (5,278,980) (5,278,980)
Accumulated losses ............................................................ (28,492,375) (29,133,689)
------------ ------------
Total partners' capital ..................................................... 951,672 310,358
------------ ------------
Total liabilities and partners' capital ..................................... $ 5,157,544 $ 4,482,307
============ ============
The accompanying notes are an integral part
of these financial statements.
-1-
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
STATEMENTS OF OPERATIONS
AND ACCUMULATED LOSSES
(Unaudited)
For the three months ended For the six months ended
June 30, June 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Share of income from partnerships ............... $ 835,537 $ 595,893 $ 1,068,527 $ 1,005,613
------------ ------------ ------------ ------------
Other revenue and expenses:
Revenue:
Interest .................................... 4,613 8,696 8,737 16,157
Gain from extinguishment of debt ............ -- -- -- 670,099
------------ ------------ ------------ ------------
4,613 8,696 8,737 686,256
------------ ------------ ------------ ------------
Expenses:
Interest .................................... 31,500 31,500 63,000 63,000
General and administrative .................. 87,686 63,554 169,659 140,670
Management fee .............................. 62,499 62,499 124,998 124,998
Professional fees ........................... 35,625 33,250 71,250 56,500
Amortization of deferred costs .............. 3,202 6,298 7,043 12,595
------------ ------------ ------------ ------------
220,512 197,101 435,950 397,763
------------ ------------ ------------ ------------
Total other revenue and expenses .......... (215,899) (188,405) (427,213) 288,493
------------ ------------ ------------ ------------
Net income ...................................... 619,638 407,488 641,314 1,294,106
Accumulated losses, beginning of period ......... (29,112,013) (29,234,683) (29,133,689) (30,121,301)
------------ ------------ ------------ ------------
Accumulated losses, end of period ............... $(28,492,375) $(28,827,195) $(28,492,375) $(28,827,195)
============ ============ ============ ============
Net income allocated
to General Partners (1.51%) ................... $ 9,357 $ 6,153 $ 9,684 $ 19,541
============ ============ ============ ============
Net income allocated
to Initial and Special Limited Partners (1.49%) $ 9,233 $ 6,072 $ 9,556 $ 19,282
============ ============ ============ ============
Net income allocated
to Additional Limited Partners (97%) .......... $ 601,048 $ 395,263 $ 622,074 $ 1,255,283
============ ============ ============ ============
Net income per unit of Additional Limited Partner
Interest, based on 49,910 units outstanding ... $ 12.04 $ 7.92 $ 12.46 $ 25.15
============ ============ ============ ============
The accompanying notes are an integral part
of these financial statements.
-2-
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
STATEMENTS OF CASH FLOWS
(Unaudited)
For the six months ended
June 30,
--------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net income .......................................................... $ 641,314 $ 1,294,106
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Share of income from partnerships ................................. (1,068,527) (1,005,613)
Gain from extinguishment of debt .................................. -- (670,099)
Amortization of deferred costs .................................... 7,043 12,595
Changes in assets and liabilities:
(Increase) decrease in other assets ............................. (44) 335,774
Increase in accrued interest payable ............................ 63,000 63,000
Decrease in accounts payable and accrued expenses ............... (29,077) (20,376)
----------- -----------
Net cash (used in) provided by operating activities ........... (386,291) 9,387
----------- -----------
Cash flows from investing activities:
Receipt of distributions from partnerships .......................... 1,165,200 942,435
Additional proceeds from disposition of investment in partnership ... 180 1,043
----------- -----------
Net cash provided by investing activities ..................... 1,165,380 943,478
----------- -----------
Net increase in cash and cash equivalents ............................. 779,089 952,865
Cash and cash equivalents, beginning of period ........................ 2,979,778 3,420,489
----------- -----------
Cash and cash equivalents, end of period .............................. $ 3,758,867 $ 4,373,354
=========== ===========
The accompanying notes are an integral part
of these financial statements.
-3-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
1. BASIS OF PRESENTATION
In the opinion of C.R.I., Inc. (CRI), the Managing General Partner, the
accompanying unaudited financial statements reflect all adjustments, consisting
of normal recurring accruals, necessary for a fair presentation of the financial
position of Capital Realty Investors-II Limited Partnership (the Partnership) as
of June 30, 2004, and the results of its operations for the three and six months
ended June 30, 2004 and 2003, and its cash flows for the six months ended June
30, 2004 and 2003. The results of operations for the interim periods ended June
30, 2004, are not necessarily indicative of the results to be expected for the
full year.
The accompanying unaudited financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America and with the instructions to Form 10-QSB. Certain information and
accounting policies and footnote disclosures normally included in financial
statements prepared in conformity with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
instructions. These condensed financial statements should be read in conjunction
with the financial statements and notes thereto included in the Partnership's
annual report on Form 10-KSB at December 31, 2003.
On February 4, 2004, the Partnership filed a Definitive Proxy Statement,
pursuant to Section 14(a) of the Securities Exchange Act of 1934, to solicit
consent for, among other things, the sale of all of the Partnership's assets and
the dissolution of the Partnership pursuant to a Plan of Liquidation and
Dissolution. As of the voting deadline, March 22, 2004, the holders of 28,699
units of limited partner interest (57.5%) voted "for" such sale and dissolution,
and the Managing General Partner began to proceed accordingly.
The Partnership received an unsolicited offer from Equity Resource
Investments, LLC (ERI) to purchase the Partnership's limited partner interests
in all 12 Local Partnerships, and to purchase the general partner interests in
the Local Partnerships held by affiliates of the Managing General Partner (CRI).
On July 1, 2004, ERI, the Partnership and CRI signed a non-binding Letter of
Intent, in which ERI agreed in principle that it and/or its affiliated entities
or assignees would purchase all of the ownership interests of the Partnership in
the Local Partnerships for approximately $21,000,000, and all of the general
partner interests held by affiliates of CRI for approximately $800,000, subject
to the terms and conditions of one or more definitive acquisition agreements to
be negotiated and entered into among the parties. Closing would then be
scheduled after successful completion of an inspection period, receipt of all
necessary third party and governmental and regulatory approvals, and the
satisfaction of all other respective conditions to closing. On July 2, 2004, ERI
filed a Schedule 13D with the Securities and Exchange Commission (SEC) regarding
the offer. If the offer results in a definitive acquisition agreement, the
Partnership will disclose its terms in a Form 8-K filing with the SEC. Due to
the non-binding nature of the Letter of Intent, and the complexity of the terms
to be negotiated, the Partnership has not reclassified its basis in the Local
Partnerships to investments in partnerships held for sale in the accompanying
balance sheet at June 30, 2004. There can be no assurance that the sale to ERI
will be consummated and closed.
-4-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
1. BASIS OF PRESENTATION - Continued
In December 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 (revised December 2003) (FIN 46-R), Consolidation of
Variable Interest Entities. FIN 46-R clarifies the application of Accounting
Research Bulletin 51, Consolidated Financial Statements, for certain entities
that do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties
or in which equity investors do not have the characteristics of a controlling
financial interest ("variable interest entities"). Variable interest entities
within the scope of FIN 46-R will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. The Partnership
must apply the provisions of FIN 46-R to all entities subject to FIN 46-R no
later than the end of the first reporting period that ends after December 15,
2004 (as of December 31, 2004, for the Partnership). The Managing General
Partner is in the process of determining what impact, if any, the adoption of
the provisions of FIN 46-R will have upon the Partnership's financial condition
and results of operations related to the Partnership's investments in limited
partnerships (Local Partnerships), and has complied with the disclosure
requirements of FIN 46-R in these financial statements. As of June 30, 2004, the
Partnership's maximum loss exposure related to its investments in partnerships
is limited to the remaining balance of $1,265,870.
2. INVESTMENTS IN PARTNERSHIPS
a. Due on investments in partnerships and accrued interest payable
---------------------------------------------------------------
Westgate
--------
The Partnership defaulted on its one remaining purchase money note, related
to Westgate Limited Dividend Housing Association (Westgate), on September 1,
2003, when the note (as extended) matured and was not paid. The default amount
included principal and accrued interest of $1,400,000 and $2,584,492,
respectively. As of August 6, 2004, principal and accrued interest of $1,400,000
and $2,701,517, respectively, were due. In September 2003, the Managing General
Partner offered to tender the Partnership's interest in Westgate to the purchase
money noteholders, in full satisfaction of the principal and accrued interest
balances due on the purchase money note. The trustee for the noteholders has
acknowledged receipt of the Managing General Partner's offer, but indicated that
it might take several months to obtain a response from the numerous noteholders.
No response has been received to date. There is no assurance that the
noteholders will accept the offer, or what other course of action the
noteholders might choose to pursue.
The Partnership's inability to pay the Westgate purchase money note
principal and accrued interest balance when due, and the resulting uncertainty
regarding the Partnership's continued ownership interest in Westgate, does not
adversely impact the Partnership's financial condition because the purchase
money note is nonrecourse and secured solely by the Partnership's interest in
Westgate. Therefore, even though the Partnership's investment in Westgate has
not produced sufficient value to satisfy the related purchase money note, the
Partnership's exposure to loss is limited because the amount of the nonrecourse
indebtedness of the matured purchase money note exceeds the carrying amount of
the investment in Westgate. Thus, even a complete loss of the Partnership's
interest in Westgate would not have a material adverse impact on the financial
condition of the Partnership. In the event of a foreclosure or other transfer of
the Partnership's interest, the excess of the nonrecourse indebtedness over the
carrying amount of the Partnership's investment in Westgate will result in a
taxable gain. This gain will be taxable to Limited Partners at a federal tax
rate of up to 25.0%, as it will reflect recapture of depreciation deductions
claimed in prior years. Additionally, the Partnership would lose its investment
in Westgate and, likewise, its share of any future cash distributed by Westgate
from rental operations, mortgage debt refinancings, or the sale of the real
estate.
-5-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
2. INVESTMENTS IN PARTNERSHIPS - Continued
Interest expense on the Partnership's Westgate purchase money note for each
of the three and six month periods ended June 30, 2004 and 2003, was $31,500 and
$63,000, respectively. The accrued interest payable on the purchase money note
of $2,689,262 and $2,626,262 as of June 30, 2004, and December 31, 2003,
respectively, is in default.
Due to the possible transfer of the Partnership's interest in Westgate to
the noteholders, the Partnership's basis in the Local Partnership, along with
the net unamortized acquisition fees and property purchase costs, which totaled
$450,230 and $508,229 as of June 30, 2004 and December 31, 2003, respectively,
has been reclassified to investment in partnership held for transfer in the
accompanying balance sheets.
b. Summarized financial information
--------------------------------
Combined statements of operations for the 12 Local Partnerships in which
the Partnership was invested as of June 30, 2004 and 2003, follow. The combined
statements have been compiled from information supplied by the management agents
of the projects and are unaudited. The information for each of the periods is
presented separately for those Local Partnerships which have positive or zero
investment basis (equity method), and for those Local Partnerships which have
cumulative losses in excess of the amount of the Partnership's investments in
those Local Partnerships (equity method suspended). Appended after the combined
statements is information concerning the Partnership's share of income from
partnerships related to cash distributions recorded as income, and related to
the Partnership's share of income from Local Partnerships.
-6-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
2. INVESTMENTS IN PARTNERSHIPS - Continued
COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended
June 30,
------------------------------------------------------------
2004 2003
------------------------- -------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- ----------
Number of Local Partnerships 4 8 4 8
= = = =
Revenue:
Rental $1,490,872 $2,512,057 $1,479,329 $2,477,768
Other 15,956 72,674 34,961 102,654
---------- ---------- ---------- ----------
Total revenue 1,506,828 2,584,731 1,514,290 2,580,422
---------- ---------- ---------- ----------
Expenses:
Operating 761,456 1,532,369 765,142 1,510,770
Interest 213,730 943,917 216,195 942,107
Depreciation and amortization 205,575 447,688 200,139 439,379
---------- ---------- ---------- ----------
Total expenses 1,180,761 2,923,974 1,181,476 2,892,256
---------- ---------- ---------- ----------
Net income (loss) $ 326,067 $ (339,243) $ 332,814 $ (311,834)
========== ========== ========== ==========
Cash distributions $ 986,287 $ 155,778 $ 680,502 $ 40,490
========== ========== ========== ==========
Cash distributions recorded
as reduction of investments
in partnerships $ 631,353 $ -- $ 458,190 $ --
========== ========== ========== ==========
Cash distributions recorded
as income $ 354,934 $ 155,778 $ 222,312 $ 40,490
Partnership's share of
Local Partnership net income 324,645 -- 332,255 --
Miscellaneous -- 180 -- 836
------------------------- -------------------------
Share of income from partnerships $835,537 $595,893
======== ========
-7-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
2. INVESTMENTS IN PARTNERSHIPS - Continued
For the six months ended
June 30,
-----------------------------------------------------------
2004 2003
-----------------------------------------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- ----------
Number of Local Partnerships 4 8 4 8
= = = =
Revenue:
Rental $2,956,276 $5,024,112 $2,903,809 $4,955,539
Other 65,384 145,347 67,539 205,308
---------- ---------- ---------- ----------
Total revenue 3,021,660 5,169,459 2,971,348 5,160,847
---------- ---------- ---------- ----------
Expenses:
Operating 1,645,921 3,064,736 1,616,059 3,021,540
Interest 427,461 1,887,834 432,391 1,884,215
Depreciation and amortization 411,149 895,373 400,278 878,758
---------- ---------- ---------- ----------
Total expenses 2,484,531 5,847,943 2,448,728 5,784,513
---------- ---------- ---------- ----------
Net income (loss) $ 537,129 $ (678,484) $ 522,620 $ (623,666)
========== ========== ========== ==========
Cash distributions $ 986,287 $ 178,913 $ 680,502 $ 261,933
========== ========== ========== ==========
Cash distributions recorded
as reduction of investments
in partnerships $ 631,353 $ -- $ 458,190 $ --
========== ========== ========== ==========
Cash distributions recorded
as income $ 354,934 $ 178,913 $ 222,312 $ 261,933
Partnership's share of Local
Partnership net income 534,500 -- 520,325 --
Miscellaneous -- 180 -- 1,043
-------------------------- --------------------------
Share of income from partnerships $1,068,527 $1,005,613
========== ==========
All of the cash distributions recorded as income are included in share of
income from partnerships on the statements of operations for the respective
periods, and are recorded as cash receipts on the respective balance sheets. As
of June 30, 2004 and 2003, the Partnership's share of cumulative losses to date
for eight of the 12 Local Partnerships exceeded the amount of the Partnership's
investments in those Local Partnerships by $20,904,113 and $19,521,290,
respectively. As the Partnership has no further obligation to advance funds or
provide financing to these Local Partnerships, the excess losses have not been
reflected in the accompanying financial statements.
-8-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
June 30, 2004 and 2003
(Unaudited)
3. RELATED PARTY TRANSACTIONS
In accordance with the terms of the Partnership Agreement, the Partnership
is obligated to reimburse the Managing General Partner for its direct expenses
in connection with managing the Partnership. The Partnership paid $56,562 and
$120,856 for the three and six month periods ended June 30, 2004, respectively,
and $60,939 and $119,153 for the three and six month periods ended June 30,
2003, respectively, to the Managing General Partner as direct reimbursement of
expenses incurred on behalf of the Partnership. Such expenses are included in
the accompanying statements of operations as general and administrative
expenses.
In accordance with the terms of the Partnership Agreement, the Partnership
is obligated to pay the Managing General Partner an annual incentive management
fee (Management Fee) after all other expenses of the Partnership are paid. The
Partnership paid the Managing General Partner a Management Fee of $62,499 for
each of the three month periods ended June 30, 2004 and 2003, and $124,998 for
each of the six month periods ended June 30, 2004 and 2003.
In accordance with the terms of a Definitive Proxy Statement for the
Liquidation and Dissolution of the Partnership, which was approved on March 22,
2004, by holders of a majority of the Units of Limited Partner Interest, the
Managing General Partner may receive property disposition fees from the
Partnership on the same basis as such fees may currently be paid to Local
General Partners, real estate brokers or other third party intermediaries
employed to sell Partnership properties, to the extent that CRI markets and
sells the Partnership's properties instead of such persons. In addition, the
Managing General Partner may receive a partnership liquidation fee in the amount
of $500,000, payable only if the Managing General Partner is successful in
liquidating all of the Partnership's investments within 36 months from the date
the liquidation is approved, in recognition that one or more of the properties
in which the Partnership holds an interest might not be saleable to parties not
affiliated with the respective Local Partnership due to the amount and/or terms
of their current indebtedness. See Note 1 above for additional information
concerning an unsolicited offer and non-binding Letter of Intent for the
purchase of the investment portfolio in its entirety.
# # #
-9-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations
Capital Realty Investors-II Limited Partnership's (the Partnership)
Management's Discussion and Analysis of Financial Condition and Results of
Operations section is based on the financial statements, and contains
information that may be considered forward looking, including statements
regarding the effect of governmental regulations. Actual results may differ
materially from those described in the forward looking statements and will be
affected by a variety of factors including national and local economic
conditions, the general level of interest rates, governmental regulations
affecting the Partnership and interpretations of those regulations, the
competitive environment in which the Partnership operates, and the availability
of working capital.
Critical Accounting Policies
----------------------------
The Partnership has disclosed its selection and application of significant
accounting policies in Note 1 of the notes to financial statements included in
the Partnership's annual report on Form 10-KSB at December 31, 2003. The
Partnership accounts for its investments in partnerships (Local Partnerships) by
the equity method because the Partnership is a limited partner in the Local
Partnerships. As such, the Partnership has no control over the selection and
application of accounting policies, or the use of estimates, by the Local
Partnerships. Environmental and operational trends, events and uncertainties
that might affect the properties owned by the Local Partnerships would not
necessarily have a significant impact on the Partnership's application of the
equity method of accounting, since the equity method has been suspended for
eight Local Partnerships in which the Partnership's investment balances have
been reduced to zero.
New Accounting Pronouncement
----------------------------
In December 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 (revised December 2003) (FIN 46-R), Consolidation of
Variable Interest Entities. FIN 46-R clarifies the application of Accounting
Research Bulletin 51, Consolidated Financial Statements, for certain entities
that do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other parties
or in which equity investors do not have the characteristics of a controlling
financial interest ("variable interest entities"). Variable interest entities
within the scope of FIN 46-R will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. The Partnership
must apply the provisions of FIN 46-R to all entities subject to FIN 46-R no
later than the end of the first reporting period that ends after December 15,
2004 (as of December 31, 2004, for the Partnership). The Managing General
Partner is in the process of determining what impact, if any, the adoption of
the provisions of FIN 46-R will have on the Partnership's financial condition
and results of operations related to the Partnership's investments in limited
partnerships (Local Partnerships).
General
-------
On February 4, 2004, the Partnership filed a Definitive Proxy Statement,
pursuant to Section 14(a) of the Securities Exchange Act of 1934, to solicit
consent for, among other things, the sale of all of the Partnership's assets and
the dissolution of the Partnership pursuant to a Plan of Liquidation and
Dissolution. As of the voting deadline, March 22, 2004, the holders of 28,699
units of limited partner interest (57.5%) voted "for" such sale and dissolution.
See Notes 1 and 3 of the notes to financial statements contained in Part I, Item
1, hereof, for additional information concerning an unsolicited offer and
non-binding Letter of Intent for the purchase of the investment portfolio in its
entirety. There can be no assurance that the sale will be consummated and
closed.
-10-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
Some of the rental properties owned by the Local Partnerships are financed
by state housing agencies. The Managing General Partner has sold or refinanced,
and will continue to sell or refinance, certain properties pursuant to programs
developed by these agencies. These programs may include opportunities to sell a
property to a qualifying purchaser who would agree to maintain the property as
low to moderate income housing, or to refinance a property, or to obtain
supplemental financing. The Managing General Partner continues to monitor
certain state housing agency programs, and/or programs provided by certain
lenders, to ascertain whether the properties would qualify within the parameters
of a given program and whether these programs would provide an appropriate
economic benefit to the Limited Partners of the Partnership.
Some of the rental properties owned by the Local Partnerships are dependent
on the receipt of project-based Section 8 Rental Housing Assistance Payments
(HAP) provided by the U.S. Department of Housing and Urban Development (HUD)
pursuant to Section 8 HAP contracts. Current legislation allows all expired
Section 8 HAP contracts with rents at less than 100% of fair market rents to be
renewed for up to one year. Expiring Section 8 HAP contracts with rents that
exceed 100% of fair market rents could be renewed for up to one year, but at
rents reduced to 100% of fair market rents (Mark-to-Market). All expiring
Section 8 HAP contracts with rents exceeding comparable market rents, and
properties with mortgage loans insured by the Federal Housing Administration
(FHA), became subject to the Mark-to-Market legislation.
Mark-to-Market (M2M) implementation will reduce rental income at properties
that are currently subsidized at higher-than-market rental rates, and will
therefore lower cash flow available to meet mortgage payments and operating
expenses. In some instances, a property will be able to meet its existing debt
service payments after the reduction in rental income. In this case, the
property may enter the M2M "Lite" program, which would not require a debt
restructuring. In the remaining instances, the affected property may undergo
debt restructuring according to terms determined by an individual property and
operations evaluation. This would involve reducing the first mortgage loan
balance to an amount supportable by the property's operations, taking into
account the property's operating expenses and reduced income. The balance of the
amount written down from the first mortgage loan would be converted to a
non-performing but accruing (soft) second mortgage loan. When the existing first
mortgage loan is bifurcated into a first and second mortgage loan, the newly
created second mortgage loan will accrue interest at a below-market rate. The
Internal Revenue Service issued a ruling in July 1998, that concluded that the
below-market rate of interest would not generate additional ordinary income.
Each property subject to M2M will be affected in a different manner, and it is
difficult to predict the exact form of restructuring, or potential tax
liabilities to the Limited Partners. All properties, upon entering the M2M
program (excluding M2M Lite), are required to enter into an agreement
restricting the property's use to affordable housing for 30 years.
Finally, under HUD's "Mark-up-to-Market" program, properties with expiring
Section 8 HAP contracts that are located in high-rent areas as defined by HUD
are eligible for rent increases which would be necessary to bring Section 8 HAP
contract rents in line with market rate rents. For properties that enter the
program and have interest rate subsidized FHA loans, the rents are adjusted to
take into account the benefits the property is already receiving from the
below-market interest rate by means of a HUD-determined adjustment factor. The
purpose of this program is to provide incentives to owners of properties with
expiring Section 8 HAP contracts not to convert these properties to market rate
housing.
In return for receiving market rate rents under Mark-up-to-Market, the
property owner must enter into a five year conditional Section 8 HAP contract
with HUD, subject to the annual availability of funding by Congress. In
addition, property owners who enter into the Mark-up-to- Market program may
receive increased cash flow as the limited dividend will be increased in an
amount equal to the increase in gross rental revenues.
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Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
Mercy Terrace Associates (Mercy Terrace) had a Section 8 HAP contract
covering 100% of its apartment units which expired in November 2003. The Local
Managing General Partner has entered Mercy Terrace into the Mark-to-Market
program. It is not known at this time what adjustments, if any, will be made to
the rental amounts or the mortgage loan, as the Local Managing General Partner
continues to negotiate these issues with HUD. Four Winds West Company Ltd. (Four
Winds) has a Section 8 HAP contract covering 100% of its apartment units which
expires in October 2004. Four Winds anticipates a one-year renewal of its
Section 8 HAP contract at expiration. Posada Associates Limited Partnership
(Posada Vallarta) has a Section 8 HAP contract covering 21% of its apartment
units which expires in February 2005. Posada Vallarta anticipates a one-year
renewal of its Section 8 HAP contract at expiration. As of June 30, 2004, the
carrying amount of the Partnership's investments in Local Partnerships with
Section 8 HAP contracts expiring in the next 12 months was $0.
The Managing General Partner continues to seek strategies to deal with
affordable housing policy. While the Managing General Partner cannot predict the
outcome for any particular property at this time, the Managing General Partner
will continue to work with the Local Partnerships to develop strategies that
maximize the benefits to investors.
Financial Condition/Liquidity
-----------------------------
The Partnership's liquidity, with unrestricted cash resources of $3,758,867
as of June 30, 2004, along with anticipated future cash distributions from the
Local Partnerships, is expected to be adequate to meet its current and
anticipated operating cash needs. As of August 6, 2004, there were no material
commitments for capital expenditures. The Managing General Partner currently
intends to retain all of the Partnership's remaining undistributed cash pending
resolution of the Partnership's remaining purchase money note and related
accrued interest, for its Plan of Liquidation and Dissolution, and for operating
cash reserves.
The Partnership's remaining obligation with respect to its investment in
Local Partnerships, in the form of a nonrecourse purchase money note having a
principal balance of $1,400,000 plus accrued interest of $2,689,262 as of June
30, 2004, matured on September 1, 2003, and was not paid. The purchase money
note, which is nonrecourse to the Partnership, is secured solely by the
Partnership's interest in the related Local Partnership, Westgate Tower Limited
Dividend Housing Association (Westgate). Since the Partnership's investment in
Westgate has not produced sufficient value to satisfy the purchase money note,
the Managing General Partner offered to tender the Partnership's interest in
Westgate to the purchase money noteholders. See the notes to financial
statements for additional information concerning this purchase money note.
The Partnership's inability to pay the Westgate purchase money note
principal and accrued interest balance when due, and the resulting uncertainty
regarding the Partnership's continued ownership interest in Westgate, does not
adversely impact the Partnership's financial condition because the purchase
money note is nonrecourse and secured solely by the Partnership's interest in
Westgate. Therefore, even though the Partnership's investment in Westgate has
not produced sufficient value to satisfy the related purchase money note, the
Partnership's exposure to loss is limited because the amount of the nonrecourse
indebtedness of the matured purchase money note exceeds the carrying amount of
the investment in Westgate. Thus, even a complete loss of the Partnership's
interest in Westgate would not have a material adverse impact on the financial
condition of the Partnership. In the event of a foreclosure or other transfer of
the Partnership's interest, the excess of the nonrecourse indebtedness over the
carrying amount of the Partnership's investment in Westgate will result in a
taxable gain. This gain will be taxable to Limited Partners at a federal tax
rate of up to 25.0%, as it will reflect recapture of depreciation deductions
claimed in prior years. Additionally, the Partnership would lose its investment
in Westgate and, likewise, its share of any future cash distributed by Westgate
from rental operations, mortgage debt refinancings, or the sale of the real
estate. The Partnership received no cash distributions from Westgate during 2003
and through August 6, 2004; thus in the event of a foreclosure or other transfer
of the Partnership's interest, there would be no material adverse impact on the
cash liquidity of the Partnership.
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Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
The Managing General Partner has received consent from a majority in
interest of the Limited Partners for the liquidation of the Partnership. It is
anticipated that the Partnership's obligation, discussed above, would be retired
in conjunction with such liquidation. There can be no assurance that the
liquidation will be completed pursuant to the Plan of Liquidation and
Dissolution.
The Partnership closely monitors its cash flow and liquidity position in an
effort to ensure that sufficient cash is available for operating requirements.
For the six month period ended June 30, 2004, the receipt of distributions from
Local Partnerships was adequate to support operating cash requirements. Cash and
cash equivalents increased $779,089 during the six month period ended June 30,
2004, primarily as a result of the receipt of distributions from partnerships
exceeding cash used in operating activities. The primary use of cash in
operating activities was to pay management and professional fees, and general
and administrative expenses.
Results of Operations
---------------------
The Partnership's net income for the three month period ended June 30,
2004, increased from the corresponding period in 2003, primarily due to an
increase in share of income from partnerships and a nominal decrease in
amortization of deferred costs, partially offset by an increase in general and
administrative expenses related to higher reimbursed payroll costs, a decrease
in interest revenue due to lower cash and cash equivalent balances and declining
interest rates, and a nominal increase in professional fees. The increase in
share of income from partnerships was primarily due to a higher amount of cash
distributions recorded as income in the 2004 period.
The Partnership's net income for the six month period ended June 30, 2004,
decreased from the corresponding period in 2004, primarily due to gain from
extinguishment of debt related to the transfer of one Local Partnership in 2003,
and by an increase in general and administrative expenses, as discussed above,
an increase in professional legal fees, and by a decrease in interest revenue,
also as discussed above. Partially offsetting the decrease in net income were an
increase in share of income from partnerships, as discussed above, and a nominal
decrease in amortization of deferred costs.
For financial reporting purposes, the Partnership, as a limited partner in
the Local Partnerships, does not record losses from the Local Partnerships in
excess of its investment to the extent that the Partnership has no further
obligation to advance funds or provide financing to the Local Partnerships. As a
result, the Partnership's share of income from partnerships for the three and
six month periods ended June 30, 2004 did not include losses of $332,133 and
$664,264, respectively, compared to excluded losses of $314,831 and $629,660 for
the three and six month periods ended June 30, 2003, respectively.
No other significant changes in the Partnership's operations have taken
place during the six month period ended June 30, 2004.
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Part I. FINANCIAL INFORMATION
Item 3. Controls and Procedures
In July 2004, representatives of the Managing General Partner of the
Partnership carried out an evaluation of the effectiveness of the design and
operation of the Partnership's disclosure controls and procedures, pursuant to
Exchange Act Rules 13a-15 and 15d-15. The Managing General Partner does not
expect that the Partnership's disclosure controls and procedures will prevent
all error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable 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 have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Over time,
controls may become inadequate because of changes in conditions, or the degree
of compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected. Based on the July 2004 evaluation,
and subject to the foregoing, the Principal Executive Officer and Principal
Financial Officer concluded that the Partnership's disclosure controls and
procedures are effective as of the end of the period covered by this report to
alert them in a timely manner to any material information relating to the
Partnership that must be included in the Partnership's periodic SEC filings, and
particularly during the period in which this report is being prepared. In
addition, there have been no significant changes in the Partnership's internal
control over financial reporting that occurred during the Partnership's most
recent fiscal quarter that have materially affected, or are reasonably likely to
materially affect, the Partnership's internal control over financial reporting.
Part II. OTHER INFORMATION
Item 3. Defaults Upon Senior Securities
See Note 2.a. of the notes to financial statements contained in Part I,
Item 1, hereof, for information concerning the Partnership's default on one
purchase money note.
Item 5. Other Information
There is no established market for the purchase and sale of units of
additional limited partner interest (Units) in the Partnership, although various
informal secondary market services exist. Due to the limited markets, however,
investors may be unable to sell or otherwise dispose of their Units.
Registered Tender Offers
------------------------
On January 23, 2004, Equity Resource Fund XXII (Equity) initiated a
registered tender offer to purchase up to 5,000 of the outstanding Units in the
Partnership at a price of $175 per Unit; the offer, as extended, expired March
23, 2004. Equity is unaffiliated with the Partnership or the Managing General
Partner. The price offered was determined solely at the discretion of Equity and
does not necessarily represent the fair market value of each Unit.
In response to the registered tender offer, on February 4, 2004, the
Managing General Partner filed Schedule 14D-9. In that filing, the Managing
General Partner recommended that Limited Partners reject the offer because it
viewed the offer price as inadequate.
-14-
Part II. OTHER INFORMATION
Item 5. Other Information - Continued
Unregistered Tender Offers
--------------------------
On January 26, 2004, Peachtree Partners (Peachtree) initiated an
unregistered tender offer to purchase up to 4.9% (including 1,525 Units or 3.1%
already owned by affiliates) of the outstanding Units in the Partnership at a
price of $175 per Unit less a transfer fee of $100 per investor; the offer
expired March 23, 2004. On March 14, 2003, Peachtree initiated an unregistered
tender offer to purchase an unspecified number of the outstanding Units in the
Partnership at a price of $100 per Unit; the offer expired April 18, 2003.
Peachtree is unaffiliated with the Partnership or the Managing General Partner.
The prices offered were determined solely at the discretion of Peachtree and do
not necessarily represent the fair market value of each Unit.
The Managing General Partner did not express any opinion and remained
neutral toward the 2003 unregistered tender offer for the purchase of Units
described above, and in its Definitive Proxy Statement, dated February 4, 2004,
recommended that Limited Partners reject the 2004 unregistered tender offer
because it viewed the offer price as inadequate.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit No. Description
31.1 Certification of Principal Executive Officer, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer, pursuant
to 18 U.S.C. Section 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
32 Certification of Principal Executive
Officer and Principal Financial Officer,
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99 Schedule 13D, dated July 2, 2004. (Incorporated by
reference thereto.)
b. No reports on Form 8-K were filed with the Commission during the
quarter ended June 30, 2004.
All other Items are not applicable.
-15-
SIGNATURE
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.
CAPITAL REALTY INVESTORS-II LIMITED
PARTNERSHIP
----------------------------------------------
(Registrant)
by: C.R.I., Inc.
-----------------------------------------
Managing General Partner
August 6, 2004 by: /s/ Michael J. Tuszka
- -------------- ------------------------------------
DATE Michael J. Tuszka
Vice President
and Chief Accounting Officer
(Principal Financial Officer
and Principal Accounting Officer)
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