4 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the fiscal year ended Commission File Number December 31, 1997 33-4682 CAPITAL BUILDERS DEVELOPMENT PROPERTIES II, A CALIFORNIA LIMITED PARTNERSHIP (Exact name of registrant as specified in its charter) California 77-0111643 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 4700 Roseville Road, Suite 206, North Highlands, California 95660 (Address of principal executive offices) Zip Code Registrant's telephone number, including area code: (916)331-8080 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Limited Partnership Units Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. X Yes No As of December 31, 1997 the aggregate Limited Partnership Units held by nonaffiliates of the registrant was 23,030. There is no market for the Units. Documents Incorporated by Reference Limited Partnership Agreement dated February 6, 1986, filed as Exhibit 3.3, and the Amendment to the Limited Partnership Agreement dated May 22, 1986 filed as Exhibit 3.4 to Registration Statement No. 33-4682 of Capital Builders Development Properties II, A California Limited Partnership, are hereby incorporated by reference into Part IV of this Form 10K. PART I ITEM 1. BUSINESS (a) General Development of Business Capital Builders Development Properties II (the "Partnership") is a publicly held limited partnership organized under the provisions of the California Revised Limited Partnership Act pursuant to the Limited Partnership Agreement dated February 6, 1986, as amended (the "Agreement"). The Partnership commenced on May 22, 1986 and shall continue in full force and be effective until December 31, 2021 unless dissolved sooner by certain events as described in the Agreement. The Managing General Partner is Capital Builders, Inc., a California Corporation (CB). The Associate General Partners are the sole shareholder, President and Director of CB, and four founders of CB. On October 6, 1986 the Partnership sold 2,407 Limited Partnership Units for a total of $1,203,500. From October 6, 1986, through May 21, 1988, the Partnership sold an additional 20,623 Units for a total of 23,030 Units. On May 21, 1988, the Partnership was closed to capital raising activity with a total of $11,515,000 proceeds raised from the offering. The General Partners have contributed capital in the amount of $1,000 to the Partnership for a 1% interest in the profits, losses, tax credits and distributions of the Partnership. (b) Financial Information about Industry Segments The Partnership is in the business of real estate development and is not a significant factor in its industry. The Partnership's investment properties are located near major urban areas and, accordingly, compete not only with similar properties in their immediate areas but with hundreds of properties throughout the urban areas. Such competition is primarily on the basis of locations, rents, services and amenities. In addition, the Partnership competes with significant numbers of individuals and organizations (including similar partnerships, real estate investment trusts and financial institutions) with respect to the purchase and sale of land, primarily on the basis of the prices and terms of such transactions. (c) Narrative Description of the Business The Partnership's business objective is to complete the development of its existing land with light industrial and office buildings for lease and eventual sale. The primary investment objective of the Partnership is to realize capital appreciation from the sale of the Properties developed by it some three to five years after such Properties have been placed in service. A secondary investment objective is to generate cash from the leasing of Partnership Properties pending their sale for distribution to the Limited Partners, although it is not presently anticipated that the amount of such cash available for distribution to the Limited Partners will be significant. Since the Partnership has not sold its investment properties, it has not achieved its investment goals as yet. Although investor returns cannot be accurately determined until the investment properties are sold, due to the additional time required to lease up the investment properties, the decline in real estate values during the California recession, it is anticipated that ultimate returns will be less than initially projected. Funds obtained by the Partnership from the sale of Limited Partnership Units have been used to acquire equity interest in one piece of land for development and a 40% equity interest in another for development in accordance with its investment objective. On April 10, 1987, the Partnership entered into a joint venture called Capital Builders Roseville Venture ("JV") with Capital Builders Development Properties ("CBDP"), a California limited partnership. The Partnership and CBDP are affiliates as they have the same General Partner, but there are no direct transactions between the respective Partnerships. The Partnership contributed $900,000 resulting in a 40% interest in the profits, losses and cash distributions of the JV. CB, the Managing General Partner of the Partnership, had the same rights and obligations with respect to the JV's operations and management as it could exercise as Managing General Partner of the Partnership. The JV was dissolved as of May 1, 1997 when the Partnership purchased the remaining 60% interest in the JV. The acquisition of the real estate is consistent with the Partnership objectives which are to acquire, develop, hold, maintain, lease, sell, or otherwise dispose of real property within the Western United States (including the states of California, Oregon, Washington, Arizona, Nevada, New Mexico, Utah, Colorado, Hawaii, and Alaska), including without limitation, the acquisition of undeveloped land for development and construction of research and development, light industrial, commercial/retail, or office buildings thereon, and the acquisition of partially completed commercial real property developments for completion of development. Although the Associate General Partners, Officers, and Directors of the Managing General Partners are experienced in real property operation and management, they also may utilize independent advisors, agents, and workers, in addition to the Partnership employees, to assist them in the operation, leasing, maintenance and improvement of the Partnership's properties. The Partnership has no full time employees but is managed by CB, the Managing General Partner. ITEM 2. PROPERTIES The Partnership owns 100% equity interest in two properties, Highlands 80 Commerce Center ("H80") and Capital Professional Center ("CPC"). H80 is a three phase development. Phase I is a 109,000 square foot office/industrial project consisting of five multi-tenant buildings. Phase II consists of approximately 45,921 square feet of two, one-story light industrial/office space buildings and Phase III consists of one 29,000 square foot office building. The Partnership is currently proceeding with the development of Phase II, in which one building consisting of 26,141 square feet was completed in early 1997. The remaining 19,780 square foot building of Phase II was completed by February 1998. Remaining Phase II shell development costs are estimated to be approximately $46,000. Funds for these improvements will come from existing cash reserves, property income, and additional borrowings. CPC is a 40,400 square foot office project consisting of two multi-tenant buildings which are completely developed and have achieved a stabilized occupancy. Additional information about the individual properties follows: H80 CPC Ownership Percentage: 100% 100% Acquisition Date: April 30, 1987Apr 10, 1987 - 40% Ownership May 1, 1997 - 60% Ownership Location: North Highlands, CaliforniaRoseville, California Present Monthly Effective Average Base Rent Per Square Foot: $0.84 $1.55 Square Footage Mix: Office 21,966 40,397 Industrial 113,259 Leased Occupancy at December 31: 1997 75% 100% 1996 78% 95% 1995 86% 95% 1994 84% 100% 1993 77% 96% Current Year Depreciation: $288,181 $138,709 Method of Depreciation: Straight Line Straight Line Depreciation Life: 40 Years 40 Years Bldg. Improvements Bldg. Improvements Life of Lease Life of Lease Tenant Improvements Tenant Improvements Total cost: $9,685,154 $4,807,887 Encumbrances: $5,542,668 $3,407,704 Additional information about the individual properties follows: (continued) Tenant occupying more H80 CPC than 10% of square footage and nature of None Coldwell Banker (Residential business: (Real Estate Brokerage) First American Title Ins. Co. USA Properties (Real Estate Developer) H80 and CPC are subject to encumbrances which are more fully described under Note 6 of the Partnership's financial statements included under Item 8 which is incorporated herein by reference. Both properties are being leased to a wide variety of tenants in a diversity of industries. Leases are typically three to five years in term and provide for free rent periods, at inception, equal to approximately one-half a month per year of lease term. Some leases contain options to extend the term of the lease. The Partnership's investment properties are located in major urban areas and, therefore, must compete with properties of greater and lesser quality. Such competition is based primarily on rent, location, services and amenities. The properties are suitable for their current and anticipated use. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S LIMITED PARTNERSHIP INTERESTS AND RELATED SECURITY HOLDER MATTERS There is no public trading market for the Partnership's Limited Partnership Units and it is not anticipated that a public trading market will develop. Furthermore, the Partnership Agreement prohibits Limited Partners from transferring Limited Partnership Interests if such transfers would result in the dissolution of the Partnership for tax purposes under Section 708 of the Internal Revenue Code. As of December 31, 1997, there were 1,715 holders and 23,030 Limited Partnership Units outstanding. ITEM 6. SELECTED FINANCIAL DATA The following constitutes a summary of selected consolidated financial data for the following periods (000's omitted except net loss per Limited Partnership Unit): 1997 1996 1995 1994 1993 Revenues $1,728 $1,224 $1,208 $1,089 $1,079 Net Loss ($217) ($268) ($583) ($697) ($1,173) Net Loss per Limited Partnership Unit($9.33) ($11.54) ($25.05) ($29.97) ($50.41) Total Assets $13,077 $9,953 $9,934 $8,910 $9,441 Notes and Loans Payable$8,950 $4,928 $4,986 $3,577 $3,598 (See ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA) ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The Partnership commenced operations on May 22, 1986 upon the sale of the minimum number of Limited Partnership Units. The Partnership's initial source of cash was from the sale of Limited Partnership Units. Through the offering of Units, the Partnership raised $11,515,000 (represented by 23,030 Limited Partnership Units). Cash generated from the sale of Limited Partnership Units was used to acquire land and for the development of a mixed use commercial project and a 40% interest in a commercial office project. The Partnership's primary current sources of cash are from cash reserves, property rental income and construction financing. As of December 31, 1997, the Partnership had $254,626 in cash reserves. It is the Partnership's investment goal to utilize existing capital resources for continued leasing operations (tenant improvements and leasing commissions) and further development of its investment properties. The Partnership is currently proceeding with the development of Phase II, consisting of approximately 45,921 square feet of two, one-story Light Industrial/Office space buildings. One building of Phase II consisting of 26,141 square feet was completed, and the remaining 19,780 square foot building was completed by February 1998. During December 31, 1997, net cash used in investing activities ($1,007,701) was primarily the result of costs incurred for the shell construction for Highlands 80 Phase II, tenant improvements for the 11,657 square foot lease at Highlands 80 Phase II, tenant improvement costs incurred for lease roll-overs at Highlands 80 Phase I, and lease renewals at Capital Professional Center. These costs were primarily funded with a new construction loan which provided $677,059 in loan proceeds. The construction loan provides for future loan draws of $1,602,941 for additional shell and tenant improvement construction costs for Phase II. Management anticipates additional tenant improvement costs for Highlands 80 Phase I in the amount of $129,000 and additional Highlands 80 Phase II development and tenant improvement costs of $897,266 to be incurred within the next 12 months. These costs, along with additional leasing commissions, are expected to be funded from existing cash reserves, property income, and additional borrowings. The Partnership's ability to maintain or improve cash flow is dependent upon its ability to maintain and improve the occupancy of its investment properties. The Partnership's financial resources appear to be adequate to meet current year's obligations and no adverse change in liquidity is foreseen. Results of Operations 1997 vs 1996 The Partnership's total revenues increased by $504,199 (41.2%) in fiscal year 1997 compared to 1996. Total expenses increased by $512,579 (36.4%) in fiscal year 1997 compared to 1996. In addition, the loss on the investment in joint venture decreased by $59,839 (72.4%) in 1997 compared to 1996, all resulting in a decrease in net loss of $51,459 (19.2%). The increase in revenues is primarily due to the Partnership's acquisition of the remaining 60% interest of Capital Builders Roseville Venture (Capital Professional Center). Since the purchase on May 1, 1997, property income earned by Capital Professional Center has been fully recognized by the Partnership. Prior to the purchase, the Partnership recognized only a 40% share of net income (loss) from Capital Professional Center as income/(loss) in Joint Venture. As of the purchase date of May 1, 1997 to December 31, 1997, rental income of $506,743 was recognized from Capital Professional Center. While Capital Professional Center has achieved and maintained an average stabilized occupancy of 96%, Highlands 80 has only maintained an average 75% occupancy during 1997. It is management's opinion that Highlands 80's lack of lease-up was due to a temporary stall in tenant demand for space in the Sacramento sub-market in which Highlands 80 is located. Management anticipates that demand will increase during 1998 and that substantial lease-up will occur at Highlands 80. Expenses increased for the fiscal year 1997 compared to 1996, primarily due to the net effect of: a) The purchase of the 60% interest in Capital Builders Roseville Venture, resulting in an increase in total expenses of $484,260, representing expenses of Capital Professional Center during the Partnership's 100% ownership for the period, May 1, 1997 through December 31, 1997. b) $18,376 (12.24%) increase in repairs and maintenance from Highlands 80 due to major landscape and parking lot repairs of Phase I, and an increase in landscape maintenance for the newly developed Phase II. 1996 vs 1995 The Partnership's total revenues increased by $15,982 (1.3%) in fiscal year 1996 compared to 1995. Total expenses exclusive of depreciation also increased by $77,828 (7.9%), while depreciation expense decreased by $297,560 (46.4%) in fiscal year 1996 compared to 1995. In addition, the loss on the investment in joint venture decreased by $78,610 in 1996 compared to 1995, all resulting in a decrease in net loss of $314,324 (53.9%) from fiscal year 1996 to 1995. The increase in revenues is primarily due to a $35,000 settlement for past due rent which had been written-off in 1994. The Sacramento market in which the property is located is continuing to improve. Vacancy factors are beginning to decline, while market rents are starting to increase. During the last quarter of 1996, Highlands 80 recognized a temporary decline in occupancy due to a large tenant downsizing. Expenses, exclusive of depreciation, increased for the fiscal year 1996 compared to 1995, due to the net effect of : a) $37,565 (15.7%) increase in operating expenses due to the recognition of $16,944 in bad debt expense, an increase of project manager supervision costs associated with the development of Phase II, plus an increase in marketing costs associated with Phase II, b) $4,574 (2.9%) decrease in repairs and maintenance due to the re-carpeting and repainting of the office building's common area performed during 1995, which exceeded the cost of repainting the entire project during 1996, c) $8,189 (12.4%) increase in property taxes due to a tax refund received in 1995 as a result of a reduction in the property's assessed value, d) $15,541 (3.9%) increase in interest costs due to an increase in the average outstanding loan balance during 1996 (the additional loan proceeds have and will continue to be used to fund additional Phase II improvements, see Liquidity and Capital Resources for further discussion), and e) $21,107 (16.6%) increase in general and administrative costs due to an increase in investor services, and legal fees. Total expenses including depreciation decreased by $219,732 (13.5%) for the fiscal year 1996 compared to 1995. The decrease was primarily due to a decrease in depreciation expense of $297,560 (46.4%). The reduction of depreciation was the result of tenant improvement costs that were amortized during 1995, became fully amortized during the last quarter of 1995 and the first quarter of 1996. Many of the suites with fully amortized improvements were either re-leased or their leases renewed without requiring any major tenant improvement `, therefore reducing the recorded amount of amortization taken during fiscal year 1996. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Number INDEPENDENT AUDITORS' REPORT 10 FINANCIAL STATEMENTS 11 BALANCE SHEETS AS OF DECEMBER 31, 1997 AND 1996 STATEMENTS OF OPERATIONS 12 FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 STATEMENTS OF PARTNERS' EQUITY 13 FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 STATEMENTS OF CASH FLOWS 14 FOR THE YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 NOTES TO FINANCIAL STATEMENTS 15-22 SUPPLEMENTAL SCHEDULES SCHEDULE III 26 REAL ESTATE AND ACCUMULATED DEPRECIATION Financial schedules not included have been omitted because of the absence of conditions under which they are required or because the information is included elsewhere in this report. Independent Auditors' Report The Partners Capital Builders Development Properties II: We have audited the accompanying balance sheets of Capital Builders Development Properties II, a California Limited Partnership, as of December 31, 1997 and 1996, and the related statements of operations, partners' equity and cash flows for each of the years in the three-year period ended December 31, 1997. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Capital Builders Development Properties II as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Sacramento, California KPMG Peat Marwick LLP February 4, 1998 PART 1 - FINANCIAL INFORMATION Capital Builders Development Properties II (A California Limited Partnership) BALANCE SHEETS December 31 December 31 1997 1996 ASSETS Cash and cash equivalents $254,626 $701,828 Accounts receivable, net 163,738 68,724 Due from joint venture - - - - 1,514,788 Investment property, at cost, Net of accumulated depreciation of $2,061,160 and $1,426,812 at December 31, 1997 and 1996, respectively 12,431,881 7,485,543 Lease commissions, net of accumulated amortization of $179,388 and $52,498 at December 31, 1997 and 1996, respectively 162,386 78,635 Other assets, net of accumulated amortization of $34,606 and $3,885 at December 31, 1997 and 1996, respectively 64,587 103,815 Total assets $13,077,218 $9,953,333 LIABILITIES AND PARTNERS' EQUITY Notes payable $8,950,372 $4,928,442 Accounts payable and accrued liabilities 127,777 158,405 Tenant deposits 93,690 48,995 Share of joint venture deficit - - - - 695,094 Total liabilities 9,171,839 5,830,936 Commitments and contingencies Partners' Equity: General Partners (56,777) (54,607) Limited Partners 3,962,156 4,177,004 Total Partners' equity 3,905,379 4,122,397 Total liabilities and Partners' equity $13,077,218 $9,953,333 See accompanying notes to the financial statements. Capital Builders Development Properties II (A California Limited Partnership) STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997 1996 1995 Revenues Rental and other income $1,599,917 $1,101,978 $1,051,084 Interest income 128,237 121,977 156,889 Total revenues 1,728,154 1,223,955 1,207,973 Expenses Operating expenses 368,434 276,165 238,600 Repairs and maintenance 236,623 150,718 155,292 Property taxes 108,220 74,323 66,134 Interest 620,946 416,264 400,723 General and administrative 157,160 148,543 127,436 Depreciation and amortization 430,983 343,774 641,334 Total expenses 1,922,366 1,409,787 1,629,519 Loss before joint venture interest (194,212) (185,832) (421,546) Loss on investment in joint venture (22,806) (82,645) (161,255) Net loss (217,018) (268,477) (582,801) Allocated to General Partners (2,170) (2,685) (5,828) Allocated to Limited Partners ($214,848) ($265,792) ($576,973) Net loss per Limited Partnership Unit ($9.33) ($11.54) ($25.05) Average Units outstanding 23,030 23,030 23,030 See accompanying notes to the financial statements. Capital Builders Development Properties II (A California Limited Partnership) STATEMENTS OF PARTNERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 Total General Limited Partners' Partners Partners Equity Balance at December 31, 1994 ($46,094)$5,019,769$4,973,675 Net Loss (5,828) (576,973) (582,801) Balance at December 31, 1995 (51,922) 4,442,796 4,390,874 Net loss (2,685) (265,792) (268,477) Balance at December 31, 1996 (54,607) 4,177,004 4,122,397 Net loss (2,170) (214,848) (217,018) Balance at December 31, 1997 ($56,777)$3,962,156$3,905,379 See accompanying notes to the financial statements. Capital Builders Development Properties II (A California Limited Partnership) STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997 1996 1995 Cash flows from operating activities: Net loss ($217,018) ($268,477) ($582,801) Adjustments to reconcile net loss to cash flow (used in) provided by operating activities: Depreciation and amortization 430,983 343,774 641,334 Equity in losses of Joint Venture 22,806 82,645 161,255 Uncollected interest earned from Joint Venture (114,046) - - - - (115,684) Changes in operating assets and liabilities: (Increase)/Decrease in accounts receivable (60,266) 74,902 8,514 Increase in leasing commissions (88,736) (35,091) (28,785) Decrease/(Increase) in other assets 9,204 (2,654) (119,160) Increase in accounts payable and accrued liabilities 2,444 85,171 554 Decrease in tenant deposits (6,845) (5,507) (558) Net cash (used in) provided by operating activities (21,474) 274,763 (35,331) Cash flows from investing activities: Proceeds from (Investment in) securities - - - - 1,214,118 (1,214,118) Acquisition of remaining joint venture interest, net of cash acquired (14,380) - - - - - - - - Increase in advances to joint venture - - - - (225,000) (105,000) Improvements to investment properties (993,321) (1,091,548) (133,530) Distributions from joint venture - - - - 124,480 36,400 Net cash (used in) provided by investing activities (1,007,701) 22,050 (1,416,248) Cash flows from financing activities: Proceeds from issuance of debt 677,059 - - - - 1,433,740 Payments of debt (95,086) (57,932) (24,306) Net cash provided by (used in) financing activities 581,973 (57,932) 1,409,434 Net (decrease)/increase in cash & cash equivalents (447,202) 238,881 (42,145) Cash and cash equivalents, beginning of period 701,828 462,947 505,092 Cash and cash equivalents, end of period $254,626 $701,828 $462,947 Supplemental Disclosure of Acquisition of Remaining 60% Joint Venture Interest Fair Value of Assets Acquired $5,095,204 - - - - - - - - Fair Value of Liabilities to outside parties (3,439,957) - - - - - - - - Fair Value of Affiliate Loan (1,570,134) - - - - - - - - Net Equity $85,113 - - - - - - - - Cash paid for 60% interest in Joint Venture 51,068 - - - - - - - - Cash Acquired (36,688) - - - - - - - - Net cash paid for acquisition $14,380 - - - - - - - - Cash Paid for Interest $584,613 $416,264 $400,723 See accompanying notes to the financial statements. Capital Builders Development Properties II (A California Limited Partnership) NOTES TO FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND ORGANIZATION A summary of the significant accounting policies applied in the preparation of the accompanying financial statements follows: Basis of Accounting The financial statements of Capital Builders Development Properties II (The "Partnership") are prepared on the accrual basis of accounting and therefore revenue is recorded as earned and costs and expenses are recorded as incurred. Organization Capital Builders Development Properties II, a California Limited Partnership, is owned under the laws of the State of California. The Managing General Partner is Capital Builders, Inc., a California corporation (CB). The Partnership is in the business of real estate development and is not a significant factor in its industry. The Partnership's investment properties are located near major urban areas and, accordingly, compete not only with similar properties in their immediate areas but with hundreds of properties throughout the urban areas. Such competition is primarily on the basis of locations, rents, services and amenities. In addition, the Partnership competes with significant numbers of individuals and organizations (including similar companies, real estate investment trusts and financial institutions) with respect to the purchase and sale of land, primarily on the basis of the prices and terms of such transactions. Investment Properties Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. The Partnership's investment property consists of commercial land, buildings and leasehold improvements that are carried net of accumulated depreciation. Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives of three to forty years. The straight-line method of depreciation is followed for financial reporting purposes. Other Assets Included in other assets are loan fees. Loan fees are amortized over the life of the related note. Lease Commissions Lease commissions are being amortized over the related lease terms. Income Taxes The Partnership has no provision for income taxes since all income or losses are reported separately on the individual Partners' tax returns. Investment in Joint Venture Equity investments of 20% to 50% are accounted for by the equity method. Under this method, the investments are recorded at initial cost and increased or decreased for the Partnership's share of income and losses, and decreased for distributions (See Note 5). Revenue Recognition Rental income is recognized on a straight-line basis over the life of the lease, which may differ from the scheduled rental payments. Net Loss per Limited Partnership Unit The net loss per Limited Partnership Unit is computed based on the weighted average number of Units outstanding during the year of 23,030 in 1997, 1996 and 1995. Statement of Cash Flows For purposes of the statement of cash flows, the Partnership considers all short-term investments with a maturity, at date of purchase, of three months or less to be cash equivalents. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. NOTE 2 - RELATED PARTY EXPENSE REIMBURSEMENT AND FEE ARRANGEMENT The Managing General Partner (Capital Builders, Inc.) and the Associate General Partners are entitled to reimbursement of expenses incurred on behalf of the Partnership and certain fees from the Partnership. These fees include: a portion of the sales commissions payable by the Partnership with respect to the sale of the Partnership Units; an acquisition fee of up to 12.5% of gross proceeds from the sale of the Partnership Units; a property management fee up to 6% of gross rental revenues realized by the Partnership with respect to its properties; a subordinated real estate commission of up to 3% of the gross sales price of the properties; and a subordinated 25% share of the Partnership's distributions of cash from sales or refinancing. The property management fee currently being charged is 5% of gross rental revenues collected. All acquisition fees and expenses, all underwriting commissions, and all offering and organizational expenses which can be paid are limited to 20% of the gross proceeds from sales of Partnership Units provided the Partnership incurs no borrowing to develop its properties. However, these fees may increase to a maximum of 33% of the gross offering proceeds based upon the total acquisition and development costs, including borrowing. Since the formation of the Partnership, 27.5% of these fees were paid to the Partnership's related parties, leaving a remaining maximum of 5.5% ($633,325) of the gross offering proceeds. The ultimate amount of these costs will be determined once the properties are fully developed and leveraged. The total management fees paid to the Managing General Partner were $78,045, $52,947 and $51,310 for the years ended December 31, 1997, 1996 and 1995, respectively, while total reimbursement of expenses was $201,441, $176,641 and $151,877, respectively. The Managing General Partner will reduce its future participation in proceeds from sales by an amount equal to the loss on the abandonment of option fees in 1988 ($110,000) and interest on the amount at a rate equal to that of the borrowed funds rate as determined by construction or permanent funds utilized by the Partnership. NOTE 3 - INVESTMENT PROPERTY The components of the investment property account at December 31, are as follows: 1997 1996 Land $4,053,799 $2,622,014 Building and Improvements 9,111,111 5,449,418 Tenant Improvements 1,328,131 840,923 Investment property, at cost 14,493,041 8,912,355 Less: accumulated depreciation and amortization (2,061,160) (1,426,812) Investment property, net $12,431,881 $7,485,543 NOTE 4 - DUE FROM JOINT VENTURE The receivable represents funds advanced to Capital Builders Roseville Venture. Amounts outstanding earned interest at 8.95%, approximately the same rate paid for other borrowings. The Note receivable was settled in connection with the purchase of Capital Builders Development Properties' 60% joint venture interest. See Note 5 for further discussion. NOTE 5 - INVESTMENT IN JOINT VENTURE The investment in joint venture represents a 40% interest in a joint venture with Capital Builders Development Properties (CBDP), a related partnership with the same general partner. In May 1997, the Partnership purchased the remaining 60% interest in the joint venture. The purchase was completed after an independent valuation of the joint venture property, Capital Professional Center. The Partnership acquired CBDP's 60% interest for $51,068 in cash, which was based on CBDP's 60% interest in the joint venture's net assets. The acquisition has been accounted for using the purchase method of accounting, and accordingly, the operating results of Capital Professional Center have been included in the Partnership's Statement of Operations since the May 1, 1997 acquisition. The purchase price was allocated based on the estimated fair values of the net assets at the date of acquisition. As the purchase price approximated the estimated fair value of the net assets acquired, no goodwill was recorded. A summary of balance sheet financial information of Capital Builders Roseville Venture as of December 31, 1996 is as follows: Assets Cash $ 23,657 Accounts receivable 33,437 Investment property 3,163,465 Other assets 102,995 Total Assets $ 3,323,554 Liabilities and Equity Accounts payable and accrued liabilities$ 37,292 Tenant security deposits 53,611 Note payable 3,455,591 Loan payable to affiliate 1,514,788 Partners' Equity/(Deficit) Capital, CBDP (1,042,634) Capital, CBDP II (695,094) Total Liabilities and Partner's Equity/(Deficit)$ 3,323,554 A summary of operating information of Capital Builders Roseville Venture follows: For the Four Months For the Years Ended April 30, Ended December 31, 1997 1996 1995 Total Revenue $ 242,630 $ 671,525 $612,670 Total Expenses 299,645 878,136 1,015,807 Net (Loss) ($ 57,015) ($ 206,611) ($403,137) Capital Builders Development Properties II Share of Net Loss ($22,806) ($82,645) ($161,255) The 1997 Net Loss from Capital Builders Roseville Venture represents activity prior to the May 1, 1997 purchase. The purchase did not generate any sales commissions, transaction fees, changes in management compensation, or any other direct or indirect benefit to General Partner. NOTE 6 - NOTES PAYABLE Notes Payable consist of the following at:December 31, 1997 December 31, 1996 A mini-permanent loan of $5,000,000 with a fixed 8.95% interest rate. The loan requires monthly principal and interest payments of $41,789 which is sufficient to amortize the loan over 25 years. The loan is due October 1, 2002. The note is collateralized by a First Deed Of Trust on Highlands 80 Phase I land, buildings and improvements. $4,865,609 $4,928,442 A construction loan of $2,280,000 with a variable interest rate of prime plus 1.5% (10% as of December 31, 1997). The loan requires monthly interest only payments, and is due March 1, 1999. The note provides for future draws of $1,602,941 for shell and tenant improvement construction costs and leasing commissions for future lease- up of Phase II. The note is collateralized by a First Deed of Trust on Highlands 80 Phase II land, buildings and improvements. 677,059 - - - - - A mini-permanent loan with a fixed interest rate of 8.24% and requiring monthly principal and interest payments of $27,541, which is sufficient to amortize the loan over 25 years. The loan is due January 1, 2001. The note is collateralized by a First Deed Of Trust on Capital Professional Center's land, buildings and improvements. $3,407,704 - - - - - Total Notes Payable $8,950,372 $4,928,442 Scheduled principal payments during 1998, 1999, 2000, 2001 and 2002 are $120,711, $808,629, $143,348, $3,327,894, and $4,549,790, respectively. NOTE 7 - LEASES The Partnership leases its properties under long term noncancelable operating leases to various tenants. The facilities are leased through agreements for rents based on the square footage leased. Minimum annual base rental payments under these leases for the years ended December 31 are as follows: 1998 $1,455,787 1999 936,657 2000 591,186 2001 442,581 2002 172,825 Total $3,599,036 NOTE 8 - RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING A reconciliation of the financial statement method of accounting to the Federal income tax method of accounting for the years ended December 31 are as follows: 1997 1996 1995 Net loss - financial ($217,018) (268,477) (582,801) Adjustments resulting from: Book to tax difference in depreciation and amortization (76,317) 236,810 452,864 Net loss - tax method ($293,335) (31,667) (129,937) Partners' equity - financial $3,905,379 4,122,397 4,390,874 Increases resulting from: Book to tax difference in depreciation and amortization and valuation allowance 2,784,844 2,861,161 2,624,351 Selling expenses for Partnership units 1,713,666 1,713,666 1,713,666 Partners' equity - tax $8,403,889 8,697,224 8,728,891 Taxable loss per Limited Partnership unit after giving effect to the taxable loss allocated to the General Partner ($12.60) (1.36) (5.59) NOTE 9- FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Partnership in estimating its fair value disclosures for financial instruments. Cash and cash equivalents The carrying amount approximates fair value because of the short maturity of these instruments. Note payable The fair value of the Partnership's Notes Payable are estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Partnership for debt of the same remaining maturities. The estimated fair values of the Partnership's financial instruments as of December 31, are as follows: 1997 1996 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value Assets Cash and cash equivalents $ 254,626 $254,626 $701,828 $701,828 Due from joint venture - - - - - - - - $1,514,788 (A) Liabilities Note payable $4,865,609 $4,865,609 $4,928,442 $4,928,442 Note payable $677,059 $677,059 - - - - - - - - Note payable $3,407,704 $3,407,704 - - - - - - - - (A) It is not practicable to determine the fair value of the Due from joint venture due to the related party nature of the arrangement. NOTE 10 - COMMITMENTS AND CONTINGENCIES The Partnership is involved in litigation arising in the normal course of its business. In the opinion of management, the Partnership's recovery or liability if any, under any pending litigation would not materially affect its financial condition or operations. NOTE 11 - PROSPECTIVE ACCOUNTING PRONOUNCEMENTS Reporting Comprehensive Income In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 130, Reporting Comprehensive Income. SFAS No. 130 is effective for interim and annual periods beginning after December 15, 1997 and is to be applied retroactively to all periods presented. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. It does not, however, specify when to recognize or how to measure items that make up comprehensive income. SFAS No. 130 was issued to address concerns over the practice of reporting elements of comprehensive income directly in equity. This Statement requires all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed in equal prominence with the other financial statements. It does not require a specific format for that financial statement but requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement. Enterprises are required to classify items of "other comprehensive income" by their nature in the financial statement and display the balance of other comprehensive income separately in the equity section of a statement of financial position. It does not require per share amounts of comprehensive income to be disclosed. Management does not expect that adoption of SFAS No. 130 will have a material impact on the Partnership's financial statements. Financial Reporting for Segments of a Business Enterprise In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS No. 131 is effective for interim and annual periods beginning after December 15, 1997 and is to be applied retroactively to all periods presented. SFAS No. 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. SFAS No. 131 supersedes SFAS No. 14, Financial Reporting for Segments of a Business Enterprise, but retains the requirement to report information about major customers. Management does not expect that adoption of SFAS No. 131 will have a material impact on the Partnership's financial statements. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE NONE PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Partnership has no directors. The Partnership is managed by Capital Builders, Inc. ("CB"), the Managing General Partner. The following are the names and other information relating to the Managing General Partner. No expiration date has been set for the term during which the Managing General Partner is to serve. MANAGING GENERAL PARTNER The Partnership is being managed by CB, the Managing General Partner. CB is a California corporation organized in May 1978, with its executive offices at 4700 Roseville Road, Suite 206, North Highlands, California 95660 (telephone number 916-331- 8080). To date, CB has organized ten partnerships to engage in commercial real estate development. As the General Partner, CB may be responsible for certain liabilities that a partnership it manages is unable to pay. In addition, CB, in the normal course of business, has guaranteed certain debt obligations of the Partnerships it sponsored aggregating $3,521,000. The officers, directors, and key personnel of CB are as follows: Name Office Michael J. Metzger President and Director Mark J. Leggio Director Ellen Wilcox Director Michael J. Metzger: Mr. Metzger, 52, is responsible for the general management of CB. Mr. Metzger assumed responsibility for the management of CB in December 1986. He was formerly the Executive Vice President of The Elder-Nelson Company (EN) and its subsidiary, the Elder-Nelson Equities Corporation - affiliated companies which provided underwriting and administrative services to CB. Prior to joining EN in 1977, Mr. Metzger was Partner/General Manager for two years in his family's real estate contracting, development and syndication business. Mr. Metzger has also had five years of experience in manufacturing management and served as an Army Officer for four years. Mr. Metzger holds a B.S. degree in Business and Industrial Management as well as licenses in Real Estate, Securities and Insurance. Ellen Wilcox: Ellen Wilcox is the Owner/Manager of Wilcox Financial Services, a Registered Investment Advisor in San Carlos CA. She is licensed in General Securities and Insurance through Linsco/Private Ledger, an NASD Registered Broker/Dealer. As an Investment Advisor and Broker, Ms. Wilcox provides a full range of investment products and services to individuals and small business owners. She has been actively providing such services since 1986. Ms. Wilcox teaches classes on retirement planning, investment strategies, and basic money management. She is a popular speaker and lecturer on financial topics, has authored many published articles, and has appeared on several radio shows. Mark J. Leggio: Mark Leggio is the Owner of Mark J. Leggio, CPA. He provides tax accounting and business consultation services to a wide variety of small and mid-size businesses. In addition, he is the founding shareholder and chief financial officer of Green Planet Juicery, Inc., located in the Sacramento area. From 1978 to 1995 he worked for KPMG Peat Marwick and was a partner when he left. Mr. Leggio holds a Bachelor of Science degree in Accounting from the University of Southern California, where he graduated cum laude. ITEM 11. EXECUTIVE COMPENSATION The Partnership does not have any officers or employees and, therefore, does not pay compensation to such persons. The Partnership's business is conducted by the Managing General Partner which is entitled under Article IV of the Partnership Agreement to receive underwriting commissions, acquisition fees, property management fees, subordinated real estate commission, share of distribution and an interest in the Partnership. The Managing General Partner's fees totaled $78,045 in 1997, consisting entirely of property management fees which are calculated as 5% of gross rental revenues collected. In addition to the fees described above, the General Partner is entitled to reimbursement for out of pocket expenses incurred on behalf of the Partnership. Such expenses aggregated $201,441 in 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The Managing General Partner contributed $1,000 to the Partnership Capital accounts, however, no securities were issued in respect thereof. No person is known to the Partnership to own beneficially more than 5% of the Units. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Partnership agreement (see Part IV, Item 14(a)(4) Exhibits) which was executed in 1985, authorized the compensation set forth below to be paid to the Managing General Partner and to affiliates of the Managing General Partner. During the year ended December 31, 1997, the Managing General Partner and/or its affiliate received $201,441 for reimbursement of administrative services and $78,045 for property management and administrative fees. PART IV ITEM 14. EXHIBITS FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K EXHIBIT NUMBER EXHIBIT (a) 1,2 See Item 8 of this Form 10-K for the Consolidated Financial Statements of the Partnership, Notes thereto, and Supplementary Schedules. An index to Financial Statements and Schedules is included and incorporated herein by reference. 4 Limited Partnership Agreement dated February 6, 1986 filed as exhibit 3.3 and the Amendment to the Limited Partnership Agreement dated May 22, 1986, filed as exhibit 3.4 to Registration Statement No. 2-96042 of Capital Builders Development Properties II, a California Limited Partnership are hereby incorporated by reference. 11 Statement regarding computation of per Unit earnings is not included because the computation can be clearly determined from the material contained in this report. (b) Reports on Form 8-K The Partnership filed an 8-K dated November 11, 1992. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Capital Builders Development Properties II a California Limited Partnership By CAPITAL BUILDERS, INC., The Managing General Partner, For and On Behalf of the Capital Builders Development Properties II A California Limited Partnership President Michael J. Metzger Date Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. Signature Title Date Associate General Michael J. Metzger Partner; President and Director of Capital Builders, Inc. ("CB") Chief Financial Kenneth L. Buckler Officer of CB SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT. The Partnership has not sent an annual report or proxy statements to the Limited Partners and does not intend to send a proxy statement to the Limited Partners. The Partnership will send the Limited Partners an annual report and will furnish the Commission with copies of the annual report on or before April 30, 1998. Capital Builders Development Properties II A California Limited Partnership and Subsidiary SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATIO N 12/31/97 Column A Column B Column C Column D Column E Cost Captialized Description Encumbrance Initial Subsequent Gross Carrying Amount s Cost to at End of Period Acquistion Carrying Buildings & Land (1) Improvement Costs Land(1) Improvement Total (1) s(1) s(1) Commercial Office Bldg. Highlands $5,542,668 $2,115,148 $7,519,782 $50,225 $2,622,014 $7,063,140 $9,685,154 80 Roseville $ 3,407,704 986,715 3,370,588 89,326 1,431,785 3,376,102 4,807,887 Commercial $8,950,372 $3,101,863 $10,890,370 $139,551 $4,053,799 $10,439,242 $14,493,041 Office Bldg. Column E Total 1995 1996 1997 Balance at $8,831,186 $8,168,305 $8,912,355 beginning of period Additions 133,530 1,091,548 5,747,656 Deletions (2) (796,411) (347,498) (166,970) Balance at $8,168,305 $8,912,355 $14,493,041 end of period Column A Column F Column G Column H Column I Accumulated Date of Date Depreciatio n Description Depreciatio Constructio Acquired Life n n Commercial Office Bldg. Highlands $1,548,023 1987 1987 40 Years 80 (Bldg) Roseville 1987 1987 40 Years 513,137 (Bldg) Commercial $2,061,160 Life of Office Lease Bldg. (Tenant Imp.) Column F Total 1996 1996 1997 Balance at $1,716,603 $1,474,003 $1,426,812 beginning of period Additions (3) (3) 553,811 300,307 801,318 Deletions (2) (796,411) (347,498) (166,970) Balance at $1,474,003 $1,426,812 $2,061,160 end of period 1) Valuation allowance for possible investment loss of $469,000 at December 31, 1995 was charged against the cost basis of the land and building and improvments on a pro rata basis in accordance with the provisions of SFAS No. 121 which was adopted on January 1, 1996. 2) Deletions represent the write- off of fully amortized tenant improvement costs. 3) On May 1, 1997 the Partnership purchased the remaining 60% interest in the Capital Builders Roseville Venture from CBDP I. The acquistion has been accounted for using the purchase method of accounting.