- -------------------------------------------------------------------------------- U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------ FORM 10-QSB ------------------ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2005 ------------------ Commission file number 0-11973 CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP Organized pursuant to the Laws of the State of Maryland ------------------ Internal Revenue Service - Employer Identification No. 52-1321492 11200 Rockville Pike, Rockville, Maryland 20852 (301) 468-9200 ------------------ 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 | | - -------------------------------------------------------------------------------- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP INDEX TO FORM 10-QSB FOR THE QUARTER ENDED SEPTEMBER 30, 2005 Page ---- Part I - FINANCIAL INFORMATION Item 1. Financial Statements Balance Sheets - September 30, 2005 and December 31, 2004..................... 1 Statements of Operations and Accumulated Losses - for the three and nine months ended September 30, 2005 and 2004 ...................................................... 2 Statements of Cash Flows - for the nine months ended September 30, 2005 and 2004........ 3 Notes to Financial Statements - September 30, 2005 and 2004.................................. 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................... 14 Item 3. Controls and Procedures.......................................... 18 Part II - OTHER INFORMATION Item 3. Defaults Upon Senior Securities.................................. 18 Item 5. Other Information................................................ 19 Item 6. Exhibits......................................................... 20 Signature................................................................. 21 Part I. FINANCIAL INFORMATION Item 1. Financial Statements CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP BALANCE SHEETS ASSETS September 30, December 31, 2005 2004 ------------ ------------ (Unaudited) Investment in partnerships held for sale .......................................... $ 1,628,784 $ 1,491,380 Cash and cash equivalents ......................................................... 4,242,683 15,311,566 Sales proceeds receivable ......................................................... 472,612 832,879 Other assets ...................................................................... 368 572 ------------ ------------ Total assets ................................................................... $ 6,344,447 $ 17,636,397 ============ ============ LIABILITIES AND PARTNERS' CAPITAL Due on investments in partnerships ................................................ $ 1,400,000 $ 1,400,000 Accrued interest payable .......................................................... 2,846,762 2,752,262 Accounts payable and accrued expenses ............................................. 184,280 138,537 Disposition fees payable to related party ......................................... -- 1,210,408 ------------ ------------ Total liabilities .............................................................. 4,431,042 5,501,207 ------------ ------------ 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 ......................................... (25,765,791) (15,293,973) Offering costs ................................................................ (5,278,980) (5,278,980) Accumulated losses ............................................................ (17,058,824) (17,308,857) ------------ ------------ Total partners' capital ..................................................... 1,913,405 12,135,190 ------------ ------------ Total liabilities and partners' capital ..................................... $ 6,344,447 $ 17,636,397 ============ ============ 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, ---------------------------- ---------------------------- 2005 2004 2005 2004 ------------ ------------ ------------ ------------ Share of income from partnerships ............... $ 139,366 $ 159,852 $ 486,675 $ 1,228,378 ------------ ------------ ------------ ------------ Other revenue and expenses: Revenue: Interest and other .......................... 32,361 9,080 94,083 17,816 ------------ ------------ ------------ ------------ Expenses: Interest .................................... 31,500 31,500 94,500 94,500 General and administrative .................. 105,060 74,170 296,300 243,827 Management fee .............................. 62,499 62,499 187,497 187,497 Professional fees ........................... 25,495 35,625 119,816 106,875 Amortization of deferred costs .............. -- 3,521 -- 10,564 ------------ ------------ ------------ ------------ 224,554 207,315 698,113 643,263 ------------ ------------ ------------ ------------ Total other revenue and expenses .......... (192,193) (198,235) (604,030) (625,447) ------------ ------------ ------------ ------------ (Loss) income before gain on disposition of investment in partnerships .................... (52,827) (38,383) (117,355) 602,931 (Loss) gain on disposition of investments in partnerships, net of disposition fees ...... (6,510) -- 367,388 -- ------------ ------------ ------------ ------------ Net (loss) income ............................... (59,337) (38,383) 250,033 602,931 Accumulated losses, beginning of period ......... (16,999,487) (28,492,375) (17,308,857) (29,133,689) ------------ ------------ ------------ ------------ Accumulated losses, end of period ............... $(17,058,824) $(28,530,758) $(17,058,824) $(28,530,758) ============ ============ ============ ============ Net (loss) income allocated to General Partners (1.51%) ................... $ (896) $ (580) $ 3,776 $ 9,104 ============ ============ ============ ============ Net (loss) income allocated to Initial and Special Limited Partners (1.49%) $ (884) $ (572) $ 3,725 $ 8,984 ============ ============ ============ ============ Net (loss) income allocated to Additional Limited Partners (97%) .......... $ (57,557) $ (37,231) $ 242,532 $ 584,843 ============ ============ ============ ============ Net (loss) income per unit of Additional Limited Partner Interest, based on 49,910 units outstanding ............. $ (1.15) $ (0.75) $ 4.86 $ 11.72 ============ ============ ============ ============ 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, ---------------------------- 2005 2004 ------------ ------------ Cash flows from operating activities: Net income ................................................................... $ 250,033 $ 602,931 Adjustments to reconcile net income to net cash used in operating activities: Share of income from partnerships .......................................... (486,675) (1,228,378) Gain on distribution of investments in partnerships, net of disposition fees (255,043) -- Additional gain on disposition of investment in partnerships ............... (112,345) -- Loss on sale proceeds receivable ........................................... 15,733 -- Amortization of deferred costs ............................................. -- 10,564 Changes in assets and liabilities: Decrease (increase) in other assets ...................................... 204 (93) Increase in accrued interest receivable on advances ...................... (1,122) -- Increase in accrued interest payable ..................................... 94,500 94,500 Increase (decrease) in accounts payable and accrued expenses ............. 45,743 (1,372) ------------ ------------ Net cash used in operating activities .................................. (448,972) (521,848) ------------ ------------ Cash flows from investing activities: Receipt of distributions from partnerships ................................... 350,393 1,165,200 Proceeds from disposition of investment in partnership ....................... 1,012,685 -- Collection of sale proceeds receivable ....................................... 456,879 -- Additional proceeds from disposition of investment in partnership ............ -- 591 Payment of disposition fees to related party ................................. (1,968,050) -- ------------ ------------ Net cash (used in) provided by investing activities .................... (148,093) 1,165,791 ------------ ------------ Cash flows used in financing activities: Distribution to Additional Limited Partners .................................. (9,867,848) -- Tax distribution on behalf of Additional Limited Partners .................... (603,970) -- ------------ ------------ Net cash used in financing activities .................................. (10,471,818) -- ------------ ------------ Net (decrease) increase in cash and cash equivalents ........................... (11,068,883) 643,943 Cash and cash equivalents, beginning of period ................................. 15,311,566 2,979,778 ------------ ------------ Cash and cash equivalents, end of period ....................................... $ 4,242,683 $ 3,623,721 ============ ============ The accompanying notes are an integral part of these financial statements. -3- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (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, 2005, and the results of its operations for the three and nine months ended September 30, 2005 and 2004, and its cash flows for the nine months ended September 30, 2005 and 2004. The results of operations for the interim periods ended September 30, 2005, 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 (US GAAP) 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 US GAAP 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, 2004. 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 Local Partnerships in which the Partnership invested were formed by individuals or entities unrelated to the Partnership or its affiliates. The Partnership purchased limited partner interests in existing, operating partnerships with unaffiliated managing general partners. An affiliate of the Managing General Partner also purchased a general partner interest in the majority of the Local Partnerships. Neither the Partnership nor the affiliate of the Managing General Partner received development fees at or near the time of investment. The Managing General Partner has evaluated the Local Partnerships in which the Partnership is invested and has determined that the equity holders as a group held sufficient equity at risk in the operating Local Partnerships and the equity investors have the characteristics of controlling financial interest in accordance with the provisions of FIN 46-R. The Managing General Partner has therefore determined that the investments in Local Partnerships 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, and mailed it to Limited Partners to solicit consents for approval of the following: -4- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 2. PLAN OF LIQUIDATION AND DISSOLUTION - Continued (1) The sale of all of the Partnership's assets and the dissolution of the Partnership pursuant to a Plan of Liquidation and Dissolution, and the amendment of the Partnership's Limited Partnership Agreement to permit the Managing General Partner, CRI, to be eligible to 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 (a "Disposition Fee"); (2) The amendment of the Partnership's Limited Partnership Agreement to permit CRI to be eligible to 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 [March 22, 2004], 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 (the "Partnership Liquidation Fee"); and (3) To authorize the Managing General Partner, in its sole discretion, to elect to extend the period during which Consents of Limited Partners may be solicited and voted, but not beyond sixty (60) days from the date that the Consent Solicitation Statement was sent to the Limited Partners. The matters for which consent was solicited are collectively referred to as the "Liquidation." The record date for voting was December 31, 2003, and the final voting deadline was March 22, 2004. A tabulation of votes received by the voting deadline follows. FOR AGAINST ABSTAIN TOTAL ------------------ ------------------ ------------------- ------------------- Units of Units of Units of Units of limited limited limited limited partner partner partner partner Description interest Percent interest Percent interest Percent Interest Percent - ----------- -------- ------- -------- ------- -------- ------- -------- ------- Sale, dissolution and Disposition Fee 28,699 57.6% 1,264 2.5% 268 0.5% 30,231 60.6% $500,000 Partnership Liquidation Fee 25,841 51.8% 3,546 7.1% 844 1.7% 30,231 60.6% Extension of solicitation period 27,975 56.1% 1,767 3.5% 489 1.0% 30,231 60.6% There can be no assurance that the Liquidation will be completed pursuant to the Plan of Liquidation and Dissolution. -5- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO 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 8, 2005, principal and accrued interest of $1,400,000 and $2,861,002, respectively, were due. In conjunction with the approved Plan of Liquidation and Dissolution of the Partnership, the Managing General Partner is currently negotiating the sale of the property related to Westgate. The sale is scheduled to close in the second quarter of 2006. The noteholders have agreed to accept the proceeds of such sale as a discounted payoff of the purchase money note's principal and accrued interest. The discounted payoff would result in cancellation of indebtedness income to the Limited Partners, which would be taxed at a federal tax rate of up to 35 percent. There can be no assurance that a sale of Westgate and discounted payoff of the purchase money note will occur. Interest expense on the Partnership's Westgate purchase money note for each of the three and nine month periods ended September 30, 2005 and 2004, was $31,500 and $94,500 respectively. The accrued interest payable on the purchase money note of $2,846,762 and $2,752,262 as of September 30, 2005 and December 31, 2004, respectively, is in default. Due to the possible sale of the property related to Westgate, the Partnership's basis in the Local Partnership, along with the net unamortized amount of acquisition fees and property purchase costs, which totaled $472,395 and $486,187 as of September 30, 2005 and December 31, 2004, respectively, has been reclassified to investment in partnerships held for sale in the accompanying balance sheets. b. Advance to Local Partnership ---------------------------- Four Winds West --------------- In October 2004, the Partnership advanced $25,000 to Four Winds West Company, Ltd., (Four Winds West) to assist with current cash requirements. For financial reporting purposes, the Partnership reduced this advance to zero as of December 31, 2004, as a result of losses at the related Local Partnership level. c. Completed sales --------------- Arrowhead --------- On November 17, 2004, the Partnership's interest in Arrowhead Apartments Associates (Arrowhead) was sold. Gross cash proceeds received by the Partnership totaled $1,156,495. The sale resulted in net gain on disposition of investment in partnerships of $698,210 for financial statement purposes and in total gain of $6,082,297 for federal tax purposes in 2004. In accordance with the terms of the Partnership Agreement, in December 2004 the Managing General Partner was paid a disposition fee of $432,824 related to the sale. The fee was netted against the related gain on disposition of investment in partnerships. In 2005, the Partnership accrued $85,298 for additional cash proceeds expected to be received upon the release of escrow reserves, of which fifty percent was received in August 2005. The remaining $42,649, held in escrow is due to be released upon the anniversary date of November 17, 2005. -6- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Mercy Terrace ------------- On June 6, 2005, the Partnership's interest in Mercy Terrace Associates (Mercy Terrace) was sold. Gross proceeds received by the Partnership totaled $1,012,685. The sale resulted in net gain on disposition of investment in partnerships of $255,043 for financial statement purposes and in total gain of $7,155,425 for federal tax purposes in 2005. In accordance with the terms of the Partnership Agreement, in June 2005 the Managing General Partner was paid a disposition fee of $757,642 related to the sale. The fee was netted against the related gain on disposition of investment in partnerships. Moorings -------- On November 17, 2004, the Partnership's interest in Moorings Apartments Associates (Moorings) was sold. Gross cash proceeds received by the Partnership totaled $366,943. The sale resulted in net loss on disposition of investment in partnerships of $120,694 for financial statement purposes and in total gain of $6,216,291 for federal tax purposes in 2004. In accordance with the terms of the Partnership Agreement, in December 2004 the Managing General Partner was paid a disposition fee of $462,417 related to the sale. In 2005 the Partnership accrued $27,047 for additional cash proceeds expected to be received upon the release of escrow reserves, of which fifty percent was received in August 2005. The remaining $13,523 held in escrow is due to be released upon the anniversary date of November 17, 2005. Country Place I --------------- On December 29, 2004, the Partnership's interest in Blackburn Limited Partnership (Country Place I) was sold. Gross cash proceeds received by the Partnership in 2004 totaled $6,821,935. In addition, at December 31, 2004, the Partnership accrued $504,604 for cash proceeds to be received in 2005 upon the release of escrow reserves, which were posted as security for the purchaser to claim any monetary damages as a result of any breach of the representations and warranties made by the seller within one year after closing. The sale resulted in net gain on disposition of investment in partnerships of $6,565,858 for financial statement purposes and in total gain of $11,060,421 for federal tax purposes in 2004. In accordance with the terms of the Partnership agreement, in January 2005 the Managing General Partner was paid a disposition fee of $743,366 related to the sale. The fee was accrued and netted against the related gain on disposition of investment in partnerships at December 31, 2004. In August 2005, fifty percent of the escrow reserves were released. The remaining $252,302 held in escrow is due to be released upon the anniversary date of December 29, 2005. -7- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Country Place II ---------------- On December 29, 2004, the Partnership's interest in Second Blackburn Limited Partnership (Country Place II) was sold. Gross cash proceeds received by the Partnership in 2004 totaled $4,438,748. In addition, at December 31, 2004, the Partnership accrued $328,275 for cash proceeds to be received in 2005 upon the release of escrow reserves, which were posted as security for the purchaser to claim any monetary damages as a result of any breach of representations and warranties made by the seller within one year after closing. The sale resulted in net gain on disposition of investment in partnerships of $4,288,096 for financial statement purposes and in total gain of $6,846,454 for federal tax purposes in 2004. In accordance with the terms of the Partnership agreement, in January 2005 the Managing General Partner was paid a disposition fee of $467,042 related to the sale. The fee was accrued and netted against the related gain on disposition of investment in partnerships at December 31, 2004. In August 2005, fifty percent of the escrowed reserves were released. The remaining $164,138 held in escrow is due to be released upon the anniversary date of December 29, 2005. d. Assets held for sale -------------------- Chevy Chase ----------- In December 2004, a contract for the sale of the property owned by Chevy Chase Park, Ltd. (Chevy Chase) was signed. The property is currently scheduled to be sold by the end of November 2005. The Partnership's basis in the Local Partnership, along with net unamortized acquisition fees and property purchase costs, which totaled $1,143,822 and $992,626 as of September 30, 2005 and December 31, 2004, respectively, has been reclassified to investments in partnerships held for sale in the accompanying balance sheets. Posada Vallarta --------------- The Partnership recently approved the sale of the property owned by Posada Associates Limited Partnership (Posada Vallarta). The sale is scheduled to close in the fourth quarter of 2005. There is no assurance that a sale of the property will occur. Westgate -------- The Partnership's basis in Westgate, along with the net unamortized amount of acquisition fees and property purchase costs are disclosed in Note 3.a., above. -8- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued Four Winds West, Golden Acres, Orangewood Plaza, ------------------------------------------------ and Troy Manor -------------- In accordance with its approved Plan of Liquidation and Dissolution, the Partnership is actively marketing its remaining four investments in the following Local Partnerships: 1) Four Winds West Company, Ltd. (Four Winds West) 2) Chowchilla Elderly Associates, Ltd. (Golden Acres) 3) Orangewood Plaza Limited Partnership (Orangewood Plaza) 4) Troy Apartments Ltd. (Troy Manor) The Partnership's net unamortized amount of acquisition fees and property purchase costs relating to Four Winds West, which totaled $12,567 at both September 30, 2005 and December 31, 2004, has been reclassified to investment in partnerships held for sale in the accompanying balance sheets. There is no assurance that the sale of any or all of these four investments will occur. -9- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued e. Summarized financial information -------------------------------- Combined statements of operations for the seven and twelve Local Partnerships in which the Partnership was invested as of September 30, 2005 and 2004, respectively, 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). 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. COMBINED STATEMENTS OF OPERATIONS (Unaudited) For the three months ended September 30, ----------------------------------------------------------- 2005 2004 ----------------------------------------------------------- Equity Equity Method Suspended Method Suspended ---------- ---------- ---------- ---------- Number of Local Partnerships 2 5 4 8 = = = = Revenue: Rental $ 560,950 $ 799,228 $1,525,216 $2,512,053 Other 13,192 89,407 58,648 72,673 ---------- ---------- ---------- ---------- Total revenue 574,142 888,635 1,583,864 2,584,726 ---------- ---------- ---------- ---------- Expenses: Operating 355,564 462,565 675,334 1,532,367 Interest (10,446) 293,148 213,732 943,914 Depreciation and amortization 89,232 192,454 205,573 447,683 ---------- ---------- ---------- ---------- Total expenses 434,350 948,167 1,094,639 2,923,964 ---------- ---------- ---------- ---------- Net income (loss) $ 139,792 $ (59,532) $ 489,225 $ (339,238) ========== ========== ========== ========== Cash distributions $ -- $ -- $ -- $ -- ========== ========== ========== ========== Cash distributions recorded as reduction of investments in partnerships $ -- $ -- $ -- $ -- ========== ========== ========== ========== Cash distributions recorded as income $ -- $ -- $ -- $ -- Partnership's share of Local Partnership net income 139,366 -- 159,440 -- Miscellaneous -- -- -- 412 ----------------------------------------------------------- Share of income from partnerships $139,366 $159,852 ======== ======== -10- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 3. INVESTMENTS IN AND ADVANCES TO PARTNERSHIPS - Continued For the nine months ended September 30, ------------------------------------------------------------ 2005 2004 ------------------------ -------------------------- Equity Equity Method Suspended Method Suspended ---------- ---------- ---------- ----------- Number of Local Partnerships 2 5 4 8 = = = = Revenue: Rental $1,704,555 $2,397,683 $4,481,492 $ 7,536,164 Other 36,491 268,221 124,031 218,019 ---------- ---------- ---------- ----------- Total revenue 1,741,046 2,665,904 4,605,523 7,754,183 ---------- ---------- ---------- ----------- Expenses: Operating 1,094,196 1,387,694 2,321,255 4,597,103 Interest (31,337) 879,443 641,192 2,831,746 Depreciation and amortization 267,697 577,363 616,722 1,343,056 ---------- ---------- ---------- ----------- Total expenses 1,330,556 2,844,500 3,579,169 8,771,905 ---------- ---------- ---------- ----------- Net income (loss) $ 410,490 $ (178,596) $1,026,354 $(1,017,722) ========== ========== ========== =========== Cash distributions $ 273,327 $ 77,066 (1) $ 986,287 $ 178,913 ========== ========== ========== =========== Cash distributions recorded as reduction of investments in partnerships $ 273,327 $ -- $ 957,414 $ -- ========== ========== ========== =========== Cash distributions recorded as income $ -- $ 77,066 (1) $ 28,873 $ 178,913 Partnership's share of Local Partnership net income 409,609 -- 1,020,001 -- Miscellaneous -- -- -- 591 ------------------------------------------------------------ Share of income from partnerships $486,675 $1,228,378 ======== ========== (1) Includes Mercy Terrace sold June 2005. 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, 2005 and 2004, the Partnership's share of cumulative losses to date for the five of the seven and eight of the twelve Local Partnerships, respectively, exceeded the amount of the Partnership's investments in those Local Partnerships by $9,488,093 and $21,236,242, 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. -11- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (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 $52,896 and $192,866 for the three and nine month periods ended September 30, 2005, respectively, and $55,584 and $176,440 for the three and nine month periods ended September 30, 2004, 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 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, 2005 and 2004, and $187,497 for each of the nine month periods ended September 30, 2005 and 2004. 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. In accordance with the terms of the amended Partnership Agreement, in December 2004 the Managing General Partner was paid disposition fees of $895,241 related to the sales of Arrowhead and Moorings, which were netted against the related gain on disposition of investment in partnerships at December 31, 2004. In January 2005, the Managing General Partner was paid disposition fees in the amount of $1,210,408 related to the sales of Country Place I and II in December 2004, which were accrued and netted against the related gain on disposition of investments in partnerships at December 31, 2004. In June 2005, the Managing General Partner was paid a disposition fee of $757,642 related to the sale of Mercy Terrace, which was netted against the related gain on disposition of investments in partnerships. -12- CAPITAL REALTY INVESTORS-II LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS September 30, 2005 and 2004 (Unaudited) 5. CASH DISTRIBUTIONS On January 31, 2005, the Partnership made a cash distribution of $9,582,720 ($192 per Unit) to Additional Limited Partners who were holders of record as of December 31, 2004. The distribution consisted of proceeds received from the sales of the Partnership's interests in Arrowhead, Moorings, Country Place I and Country Place II. On April 7, 2005, the Partnership made a tax distribution of $603,970 (approximately $17.50 per Unit) on behalf of Additional Limited Partners who are not residents of Maryland. On July 12, 2005, the Partnership made a cash distribution of $285,128 ($17.50 per Unit) to Additional Limited Partners who were holders of record and Maryland residents as of December 31, 2004. The distributions consisted of proceeds from the sale of Country Place I and Country Place II. # # # -13- 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, 2004. 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 five 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 Local Partnerships in which the Partnership invested were formed by individuals or entities unrelated to the Partnership or its affiliates. The Partnership purchased limited partner interests in existing, operating partnerships with unaffiliated managing general partners. An affiliate of the Managing General Partner also purchased a general partner interest in the majority of the Local Partnerships. Neither the Partnership nor the affiliate of the Managing General Partner received development fees at or near the time of investment. The Managing General Partner has evaluated the Local Partnerships in which the Partnership is invested and has determined that the equity holders as a group held sufficient equity at risk in the operating Local Partnerships and the equity investors have the characteristics of controlling financial interest in accordance with the provisions of FIN 46-R. The Managing General Partner has therefore determined that the investments in Local Partnerships 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 (57.6%) voted "for" such sale and dissolution. See Note 3 of the notes to financial statements contained in Part I, Item 1, hereof, for additional information concerning the sale of the Partnership's limited partner interests in four Local Partnerships in 2004. -14- 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 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. 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, at this time. 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. -15- 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. Chevy Chase Park, Ltd. (Chevy Chase) has a Section 8 HAP contract covering 100% of its apartment units which expired in September 2000. The Section 8 HAP contract has been renewed annually. The property owned by Chevy Chase is scheduled to be sold by the end of November 2005. As of September 30, 2005, the carrying amount of the Partnership's investments in Local Partnerships with Section 8 HAP contracts expiring in the next 12 months was $1,119,637. The Managing General Partner continues to seek strategies to deal with affordable housing requirements. 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 $4,242,683 as of September 30, 2005, 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 8, 2005, there were no material commitments for capital expenditures. The Managing General Partner currently intends to retain all of the Partnership's remaining undistributed cash for operating cash reserves pending further distributions under its Plan of Liquidation and Dissolution. The Partnership's remaining obligation with respect to its investment in Westgate Limited Dividend Housing Association (Westgate), in the form of a nonrecourse purchase money note which matured September 1, 2003, has a principal balance of $1,400,000 plus accrued interest of $2,846,762 as of September 30, 2005, and is payable in full upon the earliest of: (I) sale or refinancing of the respective Local Partnership's rental property; (ii) payment in full of the respective Local Partnership's permanent loan; or (iii) maturity. The purchase money note, which is nonrecourse to the Partnership, is secured by the Partnership's interest in the Westgate Local Partnership, which owns Westgate. The underlying property does not have sufficient appreciation and equity to enable the Partnership to pay the purchase money note's principal and accrued interest. In conjunction with the approved Plan of Liquidation and Dissolution of the Partnership, the Managing General Partner is actively marketing Westgate for sale. The noteholders have agreed to accept the proceeds of such sale as a discounted payoff of the purchase money note's principal and accrued interest. The discounted payoff would result in cancellation of indebtedness income to the Limited Partners, which would be taxed at a federal tax rate of up to 35 percent. There can be no assurance that a sale of Westgate and discounted payoff of the purchase money note will occur. -16- 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 of Unit Holders for the liquidation of the Partnership. (See Note 2 of the notes to financial statements contained in Part I, Item 1, hereof.) 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, 2005, the receipt of distributions from Local Partnerships was adequate to support operating cash requirements. Cash and cash equivalents decreased $11,068,883 during the nine month period ended September 30, 2005, primarily as a result of distributions to Additional Limited Partners in January 2005 and July 2005, and a tax distribution made on behalf of the Additional Limited Partners in April 2005 and the payment of an accrued disposition fee. On January 31, 2005, the Partnership made a cash distribution of $9,582,720 ($192 per Unit) to Additional Limited Partners who were holders of record as of December 31, 2004. The distribution consisted of proceeds received from the sales of the Partnership's interests in Arrowhead Apartments Associates (Arrowhead), Moorings Apartments Associates (Moorings), Blackburn Limited Partnership (Country Place I) and Second Blackburn Limited Partnership (Country Place II). On April 7, 2005, the Partnership made a tax distribution of $603,970 (approximately $17.50 per Unit) on behalf of Additional Limited Partners who are not residents of Maryland. On July 12, 2005, the Partnership made a cash distribution of $285,128 ($17.50 per Unit) to Additional Limited Partners who were holders of record and Maryland residents as of December 31, 2004. The distributions consisted of proceeds from the sale of Country Place I and Country Place II. Results of Operations --------------------- The Partnership's net loss for the three month period ended September 30, 2005, increased from the corresponding period in 2004, primarily due to a decrease in share of income from partnerships and increases in general and administrative expenses and loss on disposition of investments in partnerships, partially offset by an increase in interest revenue and decreases in professional fees and amortization of deferred costs. Share of income from partnerships decreased in 2005 primarily due to lower other income at one property. General and administrative expenses increased primarily due to higher reimbursed payroll costs and expenses against escrow reserves relating to the sales of Country Place I and Country Place II. Loss on disposition of investments in partnerships is due to adjustments in escrow reserve amounts receivable relating to the sales of Arrowhead and Moorings. Interest revenue increased in 2005 due to higher interest rates. Professional fees decreased primarily due to lower legal expenses in 2005. Amortization of deferred costs decreased to zero since all of the Partnership's investments in Local Partnerships had been reclassified to investment in partnerships held for sale by the end of 2004. The Partnership's net income for the nine month period ended September 30, 2005, decreased from the corresponding period in 2004, primarily due to a decrease in share of income from partnerships and increases in general and administrative expenses and professional fees, partially offset by an increase in interest revenue, a decrease in amortization of deferred cost and gain on disposition of investments in partnerships. Share of income from partnership decreased in 2005 primarily due to the sales of the Partnership's interests in four Local Partnerships during 2004. General and administrative expenses increased due to higher reimbursed payroll costs and expenses against escrow reserves, partially offset by lower printing costs. Professional fees increased due to higher audit costs, partially offset by lower legal expenses due to proxy costs incurred in 2004, but not in 2005. Amortization of deferred costs decreased as discussed above. The increase in gain on disposition of investment in partnerships relates to the sales of the Partnership's interests in Arrowhead, Mercy Terrace and Moorings as discussed in Note 3.c., above. -17- Part I. FINANCIAL INFORMATION Item 2. Management's Discussion Analysis of Financial Condition and Results of Operations - Continued 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, 2005 did not include losses of $56,630 and $169,892, respectively, compared to excluded losses of $332,129 and $996,393 for the three and nine month periods ended September 30, 2004, respectively. No other significant changes in the Partnership's operations have taken place during the nine month period ended September 30, 2005. Item 3. Controls and Procedures In October 2005, 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 2005 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. -18- Part II. OTHER INFORMATION Item 5. Other Information a. There has not been any information required to be disclosed in a report on Form 8-K during the quarter ended September 30, 2005, but not reported, whether or not otherwise required by this Form 10-QSB at September 30, 2005. b. 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 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. Aside from its Limited Partner interests in the Partnership, 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. Aside from its Limited Partner interests in the Partnership, Peachtree is unaffiliated with the Partnership or the Managing General Partner. The price offered was determined solely at the discretion of Peachtree and does not necessarily represent the fair market value of each Unit. In its Definitive Proxy Statement, dated February 4, 2004, the Managing General Partner recommended that Limited Partners reject the unregistered tender offer because it viewed the offer price as inadequate. Cash Distribution ----------------- On January 31, 2005, the Partnership made a cash distribution of $9,582,720 ($192 per Unit) to Additional Limited Partners who were holders of record as of December 31, 2004. The distribution consisted of proceeds received from the sales of the Partnership's interests in Arrowhead, Moorings, Country Place I and Country Place II. On April 7, 2005, the Partnership made a tax distribution of $603,970 (approximately $17.50 per Unit) on behalf of Additional Limited Partners who are not residents of Maryland. On July 12, 2005, the Partnership made a cash distribution of $285,128 ($17.50 per Unit) to Additional Limited Partners who were holders of record and Maryland residents as of December 31, 2004. The distributions consisted of proceeds from the sale of Country Place I and Country Place II. -19- Part II. OTHER INFORMATION Item 6. 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.) All other Items are not applicable. -20- 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 8, 2005 by: /s/ H. William Willoughby - ---------------- ------------------------------------ DATE H. William Willoughby, Director, President, Secretary, Principal Financial Officer and Principal Accounting Officer -21-