UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THEx SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1996 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-17691 Krupp Insured Plus-III Limited Partnership Massachusetts 04 - 3007489 (State or other jurisdiction of (IRS employer incorporation or organization) identification no.) 470 Atlantic Avenue, Boston, Massachusetts 02210 (Address of principal executive offices) (Zip Code) (617) 423-2233 (Registrant's telephone number, including area code) 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 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 PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, including those identified herein. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP BALANCE SHEETS ASSETS June 30, December 31, 1996 1995 Participating Insured Mortgages ("PIMs") (Note 2) $151,043,449 $151,465,652 Mortgage-Backed Securities and insured mortgages ("MBS")(Note 3) 34,185,042 36,693,963 Total mortgage investments 185,228,491 188,159,615 Cash and cash equivalents 4,511,531 3,433,885 Interest receivable and other assets 1,284,605 1,924,402 Prepaid acquisition expenses and fees, net of accumulated amortization of $6,681,531 and $6,091,012, respectively 5,649,532 6,240,051 Prepaid participation servicing fees, net of accumulated amortization of $2,270,498 and $2,084,200, respectively 1,816,034 2,002,332 Total assets $198,490,193 $201,760,285 LIABILITIES AND PARTNERS' EQUITY Liabilities $ 9,019 $ 14,756 Partners' equity (deficit) (Note 4): Limited Partners 198,448,621 200,575,459 (12,770,261 Limited Partner interests outstanding) General Partners (131,618) (102,556) Unrealized gain on MBS 164,171 1,272,626 Total Partners' equity 198,481,174 201,745,529 Total liabilities and Partners' equity $198,490,193 $201,760,285 The accompanying notes are an integral part of the financial statements. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP STATEMENTS OF INCOME For the Three Months For the Six Months Ended June 30, Ended June 30, 1996 1995 1996 1995 Revenues: Interest income - PIMs: Base interest $2,916,924 $3,095,380 $5,837,998 $6,139,329 Participation interest - 435,077 - 435,077 Interest income - MBS 684,368 727,278 1,382,770 1,444,302 Interest income - other 55,176 53,329 102,346 100,333 Total revenues 3,656,468 4,311,064 7,323,114 8,119,041 Expenses: Asset management fee to an affiliate 345,779 352,879 693,281 703,117 Expense reimbursements to affiliates 38,912 50,142 85,897 100,916 Amortization of prepaid expenses and fees 388,408 405,609 776,817 811,219 General and administrative 22,534 49,588 60,666 79,823 Total expenses 795,633 858,218 1,616,661 1,695,075 Net income $2,860,835 $3,452,846 $5,706,453 $6,423,966 Allocation of net income (Note 4): Limited Partners $2,775,010 $3,349,261 $5,535,25 $6,231,247 Average net income per Limited Partner interest (12,770,261 Limited Partner interests outstanding) $ .21 $ .26 $ .43 $ .49 General Partners $ 85,825 $ 103,585 $ 171,194 $ 192,719 The accompanying notes are an integral part of the financial statements. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS For the Six Months Ended June 30, 1996 1995 Operating activities: Net income $ 5,706,453 $ 6,423,966 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of prepaid expenses and fees 776,817 811,219 Changes in assets and liabilities: Decrease in interest receivable and other assets 639,797 118,939 Increase (decrease) in liabilities (5,737) 8,308 Net cash provided by operating activities 7,117,330 7,362,432 Investing activities: Principal collections on PIMs 422,203 447,829 Principal collections on MBS 1,400,466 855,780 Investment in MBS - (312,391) Net cash provided by investing activities 1,822,669 991,218 Financing activity: Distributions (7,862,353) (7,864,182) Net increase in cash and cash equivalents 1,077,646 489,468 Cash and cash equivalents, beginning of period 3,433,885 3,257,180 Cash and cash equivalents, end of period $ 4,511,531 $ 3,746,648 The accompanying notes are an integral part of the financial statements. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS 1. Accounting Policies Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted in this report on Form 10-Q pursuant to the Rules and Regulations of the Securities and Exchange Commission. However, in the opinion of the general partners, Krupp Plus Corporation and Mortgage Services Partners Limited Partnership, (collectively the "General Partners") of Krupp Insured Plus-III Limited Partnership (the "Partnership"), the disclosures contained in this report are adequate to make the information presented not misleading. See Notes to Financial Statements included in the Partnership's Form 10-K for the year ended December 31, 1995 for additional information relevant to significant accounting policies followed by the Partnership. In the opinion of the General Partners of the Partnership, the accompanying unaudited financial statements reflect all adjustments (consisting of only normal recurring accruals) necessary to present fairly the Partnership's financial position as of June 30, 1996, its results of operations for the three and six months ended June 30, 1996 and 1995, and its cash flows for the six months ended June 30, 1996 and 1995. The results of operations for the three and six months ended June 30, 1996 are not necessarily indicative of the results which may be expected for the full year. See Management's Discussion and Analysis of Financial Condition and Results of Operations included in this report. 2. PIMs During May 1996, the Partnership entered into an agreement with the borrower of the Sundance Apartments PIM that reduces the interest paid monthly by the borrower by 1% per annum and modifies the participation features. In addition, under the modified terms, the borrower may prepay the first mortgage loan without incurring any prepayment penalty and will not have to pay any additional interest accumulated prior to the modification date. Under the agreement, the Partnership will be entitled to 25% of the surplus cash generated by the operations of the property on an annual basis beginning with the surplus cash calculation for the year ended December 31, 1997. In the event of a sale or refinancing, the Partnership will be entitled to 25% of the net sale proceeds or, in the case of a refinancing, the greater of: (i) 25% of the net refinancing proceeds or (ii) a payment equal to 1% of the then- outstanding first mortgage loan balance. Net sale proceeds and net refinancing proceeds are net of certain amounts due the borrower or affiliates of the borrower. Upon the maturity or accelerated maturity of the PIM the Partnership will be entitled to 25% of the difference between the value of the property less: (i) the unpaid balance of the first mortgage loan and (ii) certain amounts due the borrower or affiliates of the borrower. At June 30, 1996, the Partnership s PIM portfolio has a fair value of approximately $150,011,000 and gross unrealized gains and losses of approximately $910,000 and $1,942,000, respectively. The PIM portfolio has maturities ranging from 1999 to 2032. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS, Continued 3. MBS At June 30, 1996, the Partnership's MBS portfolio has an amortized cost of approximately $34,020,871 and gross unrealized gains and losses of approximately $514,404 and $350,233, respectively. The Partnership's MBS have maturities ranging from 2010 to 2035. 4. Changes in Partners' Equity A summary of changes in Partners' Equity for the six months ended June 30, 1996 is as follows: Total Limited General Unrealized Partners' Partners Partners Gain Equity Balance at December 31, 1995 $200,575,459 $(102,556) $1,272,626 $201,745,529 Net income 5,535,259 171,194 - 5,706,453 Distributions (7,662,097) (200,256) - (7,862,353) Decrease in unrealized gain on MBS - - (1,108,455) (1,108,455) Balance at June 30, 1996 $198,448,621 $(131,618) $ 164,171 $198,481,174 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements including those concerning Management s expectations regarding the future financial performance and future events. These forward-looking statements involve significant risk and uncertainties, including those described herein. Actual results may differ materially from those anticipated by such forward-looking statements. Liquidity and Capital Resources The most significant demand on the Partnership's liquidity is quarterly distributions paid to investors of approximately $3.9 million. Funds used for investor distributions come from interest received on the PIMs, MBS, cash and cash equivalents net of operating expenses, and certain principal collections received on the PIMs and MBS. The Partnership funds a portion of the distribution from principal collections causing the capital resources of the Partnership to continually decrease. As the capital resources decrease, the total cash inflows to the Partnership will also decrease which will result in periodic downward adjustments to the quarterly distributions paid to investors. The General Partners periodically review the distribution rate to determine whether an adjustment to the distribution rate is necessary based on projected future cash flows. In general, the General Partners try to set a distribution rate that provides for level quarterly distributions of cash available for distribution. To the extent quarterly distributions differ from the cash available for distribution the General Partners may adjust the distribution rate or distribute funds through a special distribution. During May 1996, the Partnership entered into an agreement with the borrower of the Sundance Apartments PIM that reduces the monthly interest paid by the borrower by 1% per annum and modifies the participation features. The modification will reduce the monthly cash flow of the Partnership, but will not materially affect the Partnership s liquidity. During the second quarter, the borrower of the Friendly Hills PIM notified the Partnership of its intention to prepay that PIM in August 1996. In addition to the outstanding principal balance of approximately $11.3 million, the Partnership will receive a prepayment penalty of approximately $1,013,000 and all Shared Income and Minimum Additional interest due. The Partnership will use the proceeds from this prepayment to fund a special distribution of $.97 per Limited Partner interest during August 1996. Based on current projections, the General Partners believe the Partnership can maintain the current distribution rate for the foreseeable future following the prepayment of the Friendly Hills PIM and the subsequent special distribution to investors. For the first five years of the PIMs the borrowers are prohibited from prepaying. For the second five years, the borrower can prepay the loan incurring a prepayment penalty. The Partnership has the option of calling certain PIMs by accelerating their maturity if the loans are not prepaid by the tenth year after permanent funding. The Partnership will determine the merits of exercising the call option for each PIM as economic conditions warrant. Such factors as the condition of the asset, local market conditions, interest rates and available financing will have an impact on this decision. Assessment of Credit Risk The Partnership's investments in mortgages are guaranteed or insured by the Federal National Mortgage Association ( FNMA ), the Federal Home Loan Mortgage Corporation ( FHLMC ), the Government National Mortgage Association ( GNMA ) and the Department of Housing and Urban Development ( HUD ) and therefore the certainty of their cash flows and the risk of material loss of the amounts invested depends on the creditworthiness of these entities. FNMA is a federally chartered private corporation that guarantees obligations originated under its programs. FHLMC is a federally chartered corporation that guarantees obligations originated under its programs and is wholly-owned by the twelve Federal Home Loan Banks. These obligations are not guaranteed by the U.S. Government or the Federal Home Loan Bank Board. GNMA guarantees the full and timely payment of principal and basic interest on the securities it issues, which represent interests in pooled mortgages insured by HUD. Obligations insured by HUD, an agency of the U.S. Government, are backed by the full faith and credit of the U.S. Government. Distributable Cash Flow and Net Cash Proceeds from Capital Transactions Shown below is the calculation of Distributable Cash Flow and Net Cash Proceeds from Capital Transactions as defined in Section 17 of the Partnership Agreement and the source of cash distributions for the six months ended June 30, 1996 and the period from inception through June 30, 1996. The General Partners provide certain of the information below to meet requirements of the Partnership Agreement and because they believe that it is an appropriate supplemental measure of operating performance. However, Distributable Cash Flow and Net Cash Proceeds from Capital Transactions should not be considered by the reader as a substitute to net income as an indicator of the Partnership's operating performance or to cash flows as a measure of liquidity. (Amounts in thousands except per Unit amounts) Six Months Ended Inception to June 30, 1996 June 30, 1996 Distributable Cash Flow: Income for tax purposes $ 6,626 $103,721 Items not requiring or (not providing) the use of operating funds: Amortization of prepaid expenses, fees and organization costs 409 6,478 Acquisition expenses paid from offering proceeds charged to operations - 184 Shared appreciation income - (800) Gain on sale of MBS - (253) Total Distributable Cash Flow ("DCF") $ 7,035 $109,330 Limited Partners Share of DCF $ 6,824 $106,050 Limited Partners Share of DCF per Limited Partner interests ( Unit ) $ .53 8.30 (b) General Partners Share of DCF $ 211 $ 3,280 Net Proceeds from Capital Transactions: Principal collections and prepayments (including Shared Appreciation Income) on PIMs $ 422 $ 18,260 Principal collections and sales proceeds on MBS (including gain on sale) 1,400 61,944 Reinvestment of MBS and PIM principal collections - (41,960) Total Net Proceeds from Capital Transactions $ 1,822 $ 38,244 Cash available for distribution (DCF plus proceeds from Capital transactions) $ 8,857 $147,574 Distributions: Limited Partners $ 7,662 (a) $142,422 (a) Limited Partners Average per Unit $ .60 (a) $ 11.15 (a)(b) General Partners $ 211 (a) $ 3,280 (a) Total Distributions $ 7,873 $145,702 (a) Includes an estimate of the distribution to be paid in August 1996. (b) Limited Partners average per Unit return of capital as of August 1996 is $2.85 [$11.15 - $8.30]. Return of capital represents that portion of distribution which is not funded from DCF such as proceeds from the sale of assets and substantially all of the principal collections received from MBS and PIMs. Operations The following discussion relates to the operations of the Partnership during the three and six months ended June 30, 1996 and 1995 (Amounts in thousands): For the Three Months For the Six Months Ended June 30, Ended June 30, 1996 1995 1996 1995 Interest income on PIMs: Base interest $2,917 $3,095 $5,838 $6,139 Participation interest 393 435 552 435 Interest income on MBS 685 727 1,383 1,444 Other interest income 55 53 102 100 Partnership expenses (408) (452) (840) (883) Distributable Cash Flow 3,642 3,858 7,035 7,235 Decrease in accrued participation income (393) - (552) - Amortization of prepaid fees and expenses (389) (405) (777) (811) Net income $2,860 $3,453 $5,706 $6,424 Operations, Continued Net income decreased by approximately $593,000 and $718,000 for the three and six months ended June 30, 1996, respectively, as compared to the corresponding periods in 1995 due primarily to lower interest income on PIMs. Base interest income on PIMs decreased in 1996 as compared to 1995 due primarily to the interest rate reduction on the Royal Palm Apartments PIM in December 1995. Although participation interest income earned decreased $435,000 for the three and six months ended June 30, 1996 as compared to the three and six months ended June 30, 1995, participation interest income accrued for 1996 will improve as a result of the Friendly Hills Apartments PIM prepayment expected in August. KRUPP INSURED PLUS-III LIMITED PARTNERSHIP PART II - OTHER INFORMATION Item 1. Legal Proceedings Response: None Item 2. Changes in Securities Response: None Item 3. Defaults upon Senior Securities Response: None Item 4. Submission of Matters to a Vote Security Holders Response: None Item 5. Other information Response: None Item 6. Exhibits and Reports on Form 8-K Exhibits (10.1) Modification agreement dated May 23, 1996 by and between Sundance Associates II, Ltd. and Krupp Insured Plus-III Limited Partnership. Reports on Form 8-K Response: None SIGNATURE Pursuant to the requirements 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. Krupp Insured Plus-III Limited Partnership (Registrant) BY: /s/Robert A. Barrows Robert A. Barrows Treasurer and Chief Accounting Officer of Krupp Plus Corporation, a General Partner. DATE: July 25, 1996