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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 September 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 | |
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CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
INDEX TO FORM 10-QSB
FOR THE QUARTER ENDED SEPTEMBER 30, 2004
Page
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Balance Sheets
- September 30, 2004 and December 31, 2003................... 1
Statements of Operations and Accumulated Losses
- for the three and nine months ended September 30, 2004
and 2003................................................... 2
Statements of Cash Flows
- for the nine months ended September 30, 2004 and 2003...... 3
Notes to Financial Statements
- September 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. xhibits........................................................ 16
Signature............................................................... 17
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
BALANCE SHEETS
ASSETS
September 30, December 31,
2004 2003
------------ ------------
(Unaudited)
Investments in partnerships ....................................................... $ 954,086 $ 854,495
Investment in partnerships held for sale or transfer .............................. 551,106 508,229
Cash and cash equivalents ......................................................... 3,623,721 2,979,778
Acquisition fees, principally paid to related parties,
net of accumulated amortization of $53,358 and $121,219, respectively ........... 23,091 57,667
Property purchase costs,
net of accumulated amortization of $56,520 and $161,573, respectively ........... 26,229 82,098
Other assets ...................................................................... 133 40
------------ ------------
Total assets ................................................................... $ 5,178,366 $ 4,482,307
============ ============
LIABILITIES AND PARTNERS' CAPITAL
Due on investments in partnerships ................................................ $ 1,400,000 $ 1,400,000
Accrued interest payable .......................................................... 2,720,762 2,626,262
Accounts payable and accrued expenses ............................................. 144,315 145,687
------------ ------------
Total liabilities .............................................................. 4,265,077 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 ............................................................ (28,530,758) (29,133,689)
------------ ------------
Total partners' capital ..................................................... 913,289 310,358
------------ ------------
Total liabilities and partners' capital ..................................... $ 5,178,366 $ 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 nine months ended
September 30, September 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Share of income from partnerships ............... $ 159,852 $ 221,192 $ 1,228,378 $ 1,226,805
------------ ------------ ------------ ------------
Other revenue and expenses:
Revenue:
Interest .................................... 9,080 6,336 17,816 22,493
Gain from extinguishment of debt ............ -- -- -- 670,099
------------ ------------ ------------ ------------
9,080 6,336 17,816 692,592
------------ ------------ ------------ ------------
Expenses:
Interest .................................... 31,500 31,500 94,500 94,500
General and administrative .................. 74,170 66,520 243,827 207,190
Management fee .............................. 62,499 62,499 187,497 187,497
Professional fees ........................... 35,625 23,250 106,875 79,750
Amortization of deferred costs .............. 3,521 6,138 10,564 18,733
------------ ------------ ------------ ------------
207,315 189,907 643,263 587,670
------------ ------------ ------------ ------------
Total other revenue and expenses .......... (198,235) (183,571) (625,447) 104,922
------------ ------------ ------------ ------------
Net (loss) income ............................... (38,383) 37,621 602,931 1,331,727
Accumulated losses, beginning of period ......... (28,492,375) (28,827,195) (29,133,689) (30,121,301)
------------ ------------ ------------ ------------
Accumulated losses, end of period ............... $(28,530,758) $(28,789,574) $(28,530,758) $(28,789,574)
============ ============ ============ ============
Net (loss) income allocated
to General Partners (1.51%) ................... $ (580) $ 568 $ 9,104 $ 20,109
============ ============ ============ ============
Net (loss) income allocated
to Initial and Special Limited Partners (1.49%) $ (572) $ 561 $ 8,984 $ 19,843
============ ============ ============ ============
Net (loss) income allocated
to Additional Limited Partners (97%) .......... $ (37,231) $ 36,492 $ 584,843 $ 1,291,775
============ ============ ============ ============
Net (loss) income per unit of Additional Limited
Partner Interest, based on 49,910 units
outstanding ................................... $ (0.75) $ 0.73 $ 11.72 $ 25.88
============ ============ ============ ============
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 nine months ended
September 30,
--------------------------
2004 2003
----------- -----------
Cash flows from operating activities:
Net income .................................................................. $ 602,931 $ 1,331,727
Adjustments to reconcile net income to net cash used in operating activities:
Share of income from partnerships ......................................... (1,228,378) (1,226,805)
Gain from extinguishment of debt .......................................... -- (670,099)
Amortization of deferred costs ............................................ 10,564 18,733
Changes in assets and liabilities:
(Increase) decrease in other assets ..................................... (93) 335,778
Increase in accrued interest payable .................................... 94,500 94,500
(Decrease) increase in accounts payable and accrued expenses ............ (1,372) 2,724
----------- -----------
Net cash used in operating activities ................................. (521,848) (113,442)
----------- -----------
Cash flows from investing activities:
Receipt of distributions from partnerships .................................. 1,165,200 1,200,394
Additional proceeds from disposition of investment in partnership ........... 591 1,043
----------- -----------
Net cash provided by investing activities ............................. 1,165,791 1,201,437
----------- -----------
Net increase in cash and cash equivalents ..................................... 643,943 1,087,995
Cash and cash equivalents, beginning of period ................................ 2,979,778 3,420,489
----------- -----------
Cash and cash equivalents, end of period ...................................... $ 3,623,721 $ 4,508,484
=========== ===========
The accompanying notes are an integral part
of these financial statements.
-3-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 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 September 30, 2004, and the results of its operations for the three and nine
month periods ended September 30, 2004 and 2003, and its cash flows for the nine
month periods ended September 30, 2004 and 2003. The results of operations for
the interim periods ended September 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.
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 Managing
General Partner has evaluated the Partnership's investments in partnerships and
has determined that they are not variable interest entities subject to
consolidation by the Partnership under the provisions of FIN 46-R.
2. PLAN OF LIQUIDATION AND DISSOLUTION
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.
-4-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2004 and 2003
(Unaudited)
2. PLAN OF LIQUIDATION AND DISSOLUTION - Continued
The Partnership received an 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. On September 15, 2004, four definitive acquisition agreements were
signed in which ERI agreed to purchase the Partnership's limited partner
interests in Arrowhead Apartments Associates (Arrowhead), Blackburn Limited
Partnership (Country Place I), Second Blackburn Limited Partnership (Country
Place II) and Moorings Apartment Associates (Moorings) on or about December 1,
2004, for a total of approximately $13,750,000, and all of the general partner
interests held by affiliates of CRI for approximately $797,000. Each sale is
conditioned on the closing of the other three sales of the Partnership's limited
partner interests. There can be no assurance that a sale of the Partnership's
limited partner interests will occur. Due to the impending sale of the
Partnership's limited partner interests in Arrowhead, Country Place I, Country
Place II, and Moorings, the Partnership's basis in each of these four Local
Partnerships, along with the net unamortized amount of acquisition fees and
property purchase costs, which totaled $25,461, $21,994, $11,885 and $25,220,
respectively, at September 30, 2004, has been reclassified to investments in
partnerships held for sale or transfer in the accompanying balance sheet at that
date.
On October 29, 2004, the Partnership and ERI agreed that they could not
come to terms for the sale of the Partnership's interests in the remaining eight
Local Partnerships, so they formally terminated the Letter of Intent as to those
interests.
3. 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 November 11, 2004, principal and accrued interest of
$1,400,000 and $2,732,585, 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. In the
fall of 2003, the trustee for the noteholders 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 as of November 11, 2004. There is no assurance that the noteholders
will accept the offer, or what other course of action the noteholders might
choose to pursue.
-5-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2004 and 2003
(Unaudited)
3. INVESTMENTS IN PARTNERSHIPS - Continued
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.
Interest expense on the Partnership's Westgate purchase money note was
$31,500 for each of the three month periods ended September 30, 2004 and 2003,
and $94,500 for each of the nine month periods ended September 30, 2004 and
2003. The accrued interest payable on the purchase money note of $2,720,762 and
$2,626,262 as of September 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 amount of acquisition fees and property purchase costs,
which totaled $466,546 and $508,229 as of September 30, 2004 and December 31,
2003, respectively, has been reclassified to investment in partnerships held for
sale or 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 September 30, 2004 and 2003, follow. The
combined statements have been compiled from information supplied by the
management agents of the properties and are unaudited. The information for each
of the periods is presented separately for those Local Partnerships which have
positive 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). Certain
reclassifications have been made to the 2003 amounts to conform them to the 2004
presentation. 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
September 30, 2004 and 2003
(Unaudited)
3. INVESTMENTS IN PARTNERSHIPS - Continued
COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months ended
September 30,
-----------------------------------------------------------
2004 2003
-----------------------------------------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- ----------
Number of Local Partnerships 4 8 4 8
= = = =
Revenue:
Rental $1,525,216 $2,512,053 $1,451,382 $2,482,867
Other 58,648 72,673 78,796 102,719
---------- ---------- ---------- ----------
Total revenue 1,583,864 2,584,726 1,530,178 2,585,586
---------- ---------- ---------- ----------
Expenses:
Operating 675,334 1,532,367 732,006 1,534,178
Interest 213,732 943,914 216,195 942,108
Depreciation and amortization 205,573 447,683 200,136 439,376
---------- ---------- ---------- ----------
Total expenses 1,094,639 2,923,964 1,148,337 2,915,662
---------- ---------- ---------- ----------
Net income (loss) $ 489,225 $ (339,238) $ 381,841 $ (330,076)
========== ========== ========== ==========
Cash distributions $ -- $ -- $ 199,980 $ 57,980
========== ========== ========== ==========
Cash distributions recorded
as reduction of investments
in partnerships $ -- $ -- $ 199,980 $ --
========== ========== ========== ==========
Cash distributions recorded
as income $ -- $ -- $ -- $ 57,980
Partnership's share of
Local Partnership net income 159,440 -- 163,212 --
Miscellaneous -- 412 -- --
-----------------------------------------------------------
Share of income from partnerships $159,852 $221,192
======== ========
-7-
CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP
NOTES TO FINANCIAL STATEMENTS
September 30, 2004 and 2003
(Unaudited)
3. INVESTMENTS IN PARTNERSHIPS - Continued
COMBINED STATEMENTS OF OPERATIONS
(Unaudited)
For the nine months ended
September 30,
---------------------------------------------------------
2004 2003
------------------------ ------------------------
Equity Equity
Method Suspended Method Suspended
---------- ---------- ---------- ----------
Number of Local Partnerships 4 8 4 8
= = = =
Revenue:
Rental $4,481,492 $ 7,536,164 $4,355,191 $7,438,406
Other 124,031 218,019 146,335 308,027
---------- ----------- ---------- ----------
Total revenue 4,605,523 7,754,183 4,501,526 7,746,433
---------- ----------- ---------- ----------
Expenses:
Operating 2,321,255 4,597,103 2,348,065 4,555,718
Interest 641,192 2,831,746 648,586 2,826,323
Depreciation and amortization 616,722 1,343,056 600,414 1,318,134
---------- ----------- ---------- ----------
Total expenses 3,579,169 8,771,905 3,597,065 8,700,175
---------- ----------- ---------- ----------
Net income (loss) $1,026,354 $(1,017,722) $ 904,461 $ (953,742)
========== =========== ========== ==========
Cash distributions $ 986,287 $ 178,913 $ 880,481 $ 319,913
========== =========== ========== ==========
Cash distributions recorded
as reduction of investments
in partnerships $ 957,414 $ -- $ 874,039 $ --
========== =========== ========== ==========
Cash distributions recorded
as income $ 28,873 $ 178,913 $ 6,442 $ 319,913
Partnership's share of Local
Partnership net income 1,020,001 -- 899,407 --
Miscellaneous -- 591 -- 1,043
------------------------- -------------------------
Share of income from partnerships $1,228,378 $1,226,805
========== ==========
Cash distributions received from Local Partnerships which have investment
basis (equity method) are recorded as a reduction of investments in partnerships
and as cash receipts on the respective balance sheets. Cash distributions
received from Local Partnerships which have cumulative losses in excess of the
amount of the Partnership's investments in those Local Partnerships (equity
method suspended) are recorded as share of income from partnerships on the
respective statements of operations and as cash receipts on the respective
balance sheets. As of September 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
$21,236,242 and $19,844,126, 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
September 30, 2004 and 2003
(Unaudited)
4. 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 $55,584 and
$176,440 for the three and nine month periods ended September 30, 2004,
respectively, and $54,397 and $173,550 for the three and nine month periods
ended September 30, 2003, respectively, to the Managing General Partner as
direct reimbursement of expenses incurred on behalf of the Partnership. Such
expenses are included in general and administrative expenses in the accompanying
statements of operations.
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 September 30, 2004 and 2003, and $187,497
for each of the nine month periods ended September 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 2 above for additional information
concerning an unsolicited offer to purchase the Partnership's interests in four
Local Partnerships.
# # #
-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 which have cumulative losses in excess of the amount of
the Partnership's investments in those Local Partnerships.
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 Managing
General Partner has evaluated the Partnership's investments in partnerships and
has determined that they are not variable interest entities subject to
consolidation by the Partnership under the provisions of FIN 46-R.
Plan of Liquidation and Dissolution
-----------------------------------
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 2 and 4 of the notes to financial statements contained in Part I, Item
1, hereof, for additional information concerning an offer to purchase the
Partnership's limited partner interests in four Local Partnerships. There can be
no assurance that the sale of the Partnership's limited partner interests in
four Local Partnerships will occur.
-10-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
General
-------
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.
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Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
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.
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 entered Mercy Terrace into the Mark-up-to-Market
program at that time. The Section 8 HAP contract will be renewed annually. Four
Winds West Company Ltd. (Four Winds) has a Section 8 HAP contract covering 100%
of its apartment units which expires in October 2005. 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.
Chevy Chase Park, Ltd. (Chevy Chase) has a Section 8 HAP contract covering 100%
of its apartment units which expires in September 2005. Chevy Chase anticipates
a one-year renewal of its Section 8 HAP contract at expiration. As of September
30, 2004, the carrying amount of the Partnership's investments in two Local
Partnerships with Section 8 HAP contracts expiring in the next 12 months was
$953,855.
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 $3,623,721
as of September 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 November 11, 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 $2,720,762 as of
September 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
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Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
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 November 11, 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.
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 nine month period ended September 30, 2004, the receipt of distributions
from Local Partnerships was adequate to support operating cash requirements.
Cash and cash equivalents increased $643,943 during the nine month period ended
September 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 recognized net loss of $38,383 for the three month period
ended September 30, 2004, compared to net income of $37,621 for the
corresponding period in 2003, primarily due to a decrease in share of income
from partnerships, and also due to increases in professional legal fees and
general and administrative expenses, partially offset by a nominal increase in
interest revenue and a nominal decrease in amortization of deferred costs.
The Partnership's net income for the nine month period ended September 30,
2004, decreased $728,796 from the corresponding period in 2003, primarily due to
gain from extinguishment of debt related to the transfer of one Local
Partnership in 2003, and also due to an increase in general and administrative
expenses related to the Partnership's Definitive Proxy Statement and higher
reimbursed payroll costs, an increase in professional legal fees and a nominal
decrease in interest revenue. Partially offsetting the decrease in net income
was a nominal increase in share of income from partnerships and a 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
nine month periods ended September 30, 2004 did not include losses of $332,129
and $996,393, respectively, compared to excluded losses of $332,684 and $962,344
for the three and nine month periods ended September 30, 2003, respectively.
Distributions of $0 and $178,913, received from zero and five Local Partnerships
during the three and nine month periods ended September 30, 2004, respectively,
and which have cumulative losses in excess of the Partnership's investments in
the Local Partnerships (equity method suspended), were recorded as increases in
the Partnership's share of income from partnerships when received, compared to
distributions of $57,980 and $319,913, received from six Local Partnerships
during the three and nine month periods ended September 30, 2003, respectively.
-13-
Part I. FINANCIAL INFORMATION
Item 2. Management's Discussion Analysis of Financial Condition
and Results of Operations - Continued
No other significant changes in the Partnership's operations have taken
place during the nine month period ended September 30, 2004.
Item 3. Controls and Procedures
In October 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 October 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 3.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
a. 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.
-14-
Part II. OTHER INFORMATION
Item 5. Other Information - Continued
Registered Tender Offer
-----------------------
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.
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.
b. On September 17, 2004, the Partnership filed a Current Report on Form
8-K, dated September 15, 2004, to report that, on September 15, 2004,
the Partnership and two of its affiliates had entered into material
definitive agreements not made in the ordinary course of business. The
definitive agreements consisted of four Purchase and Sale Agreements
with affiliates of Equity Resource Investments, LLC, to sell their
partnership interests in four of the twelve partnerships in which the
Partnership currently holds interests. The sales are in furtherance of
the liquidation of the Partnership pursuant to a consent solicitation
approved by a majority in interest of the Partnership's limited
partners in March 2004.
-15-
Part II. OTHER INFORMATION
Item 6. Exhibits
Exhibit No. Description
---------- -----------
10.1
Purchase and Sale Agreement, dated September 15, 2004, for
the sale of 100% of the partnership interests in Arrowhead
Apartments Associates.
10.2 Purchase and Sale Agreement, dated September 15, 2004, for
the sale of 100% of the partnership interests in Blackburn
Limited Partnership.
10.3 Purchase and Sale Agreement, dated September 15, 2004, for
the sale of 100% of the partnership interests in Second
Blackburn Limited Partnership.
10.4 Purchase and Sale Agreement, dated September 15, 2004, for
the sale of 100% of the partnership interests in Moorings
Apartments Associates.
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.)
All other Items are not applicable.
-16-
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
November 11, 2004 by: /s/ Michael J. Tuszka
- ----------------- ------------------------------------
DATE Michael J. Tuszka
Vice President
and Chief Accounting Officer
(Principal Financial Officer
and Principal Accounting Officer)
-17-