FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 For Quarter Ended: September 30, 1996 Commission file number: 33-28988 DBSI PACIFIC INCOME & GROWTH FUND - II, A Real Estate Limited Partnership State of Organization: Idaho Employer ID #: 82-0428903 1070 N. Curtis Rd., Suite 270, Boise, Idaho 83706 Telephone number: (208) 322-5858 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) Yes [X] No [ ] (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] FORM 10-Q File Number: 33-28988 PART I - FINANCIAL INFORMATION Item 1 - Financial Statements Included herein on pages 5-10 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Included herein on page 3-4 DBSI PACIFIC INCOME & GROWTH FUND - II A Real Estate Limited Partnership General Partners' Discussion and Analysis of Financial Condition and Results of Operations September 30, 1996 Liquidity and Capital Resources The Partnership has generated funds primarily from the sale and operation of rental properties and to a lesser extent from interest on savings and certificates of deposit. Because of the favorable market, the Partnership sold Dakota Station on June 5, 1996, Talisman Apartments on September 27, 1996, and Sorrento View on October 16, 1996. As the Seattle real estate market improves the Partnership anticipates selling the remaining property. Funds are used for rental property operating expenses, distributions to partners, debt service, fixed asset replacements, capital improvements, management and professional fees. The general partners believe that the Partnership has the liquidity and capital resources to meet all of its known obligations and commitments. The cash and cash equivalents position of the Partnership at September 30, 1996 represented approximately $1,843,000 including approximately $44,000 for tax, insurance and replacements reserves and approximately $1,799,000 operating cash primarily from the sale of Dakota Station and Talisman. The Partnership has no external sources of liquidity and no outstanding capital commitments. Cash deposits earned interest of approximately 4.0%. Cash Flow and Operations For the nine months ended September 30, 1996 and 1995, the Partnership generated $360,833 and $219,388 of cash flow from operating activities. The following adjustments should be made to the 1996 annualized cash flow for Weatherstone and Sorrento View in order to compare the first year pro forma funds from operations as found in the supplements to the offering prospectus. First, mortgage interest payments of $59,573 for Sorrento View Apartments should be added to cash flow since the pro forma statements anticipated no mortgage loan on this property. Second, changes in operating assets and liabilities of $159,103 should reduce cash flow to reflect the ongoing funds generated from operations. Cash flow should also be reduced for principal payments of $17,103 and for normal fixed asset purchases of $120,978. Finally cash flow should be decreased $25,918 to eliminate Dakota Station, Talisman, and partnership activity. After the above adjustments, the remaining properties combined annualized funds from operations reached 30% of the pro forma amount. Total revenue increased from $1,750,652 to $2,620,490 for third quarter 1995 compared to 1996. Real estate operating expense increased from $1,937,354 to $1,967,221 for third quarter 1995 to third quarter 1996. The general partner has contracted with Pinnacle Realty Management Company for management of Weatherstone. On June 5, 1996, the Partnership sold Dakota Station Apartments to unrelated individual parties for $2,080,000. The Partnership received $1,967,380 from the sale less mortgage repayment and interest of $790,512, commissions to unrelated parties of $51,975, closing costs of $4,962, a credit to buyer of $12,425 and a loan prepayment penalty of $43,258. The Partnership purchased the property in November 1990 for $1,765,000 and at the time of sale it had asset carrying costs of $1,542,371 ($1,855,486 cost basis less accumulated depreciation of $313,115). The Partnership realized a gain of $425,009 on the sale ($1,967,380 proceeds received less adjusted basis of $1,542,371). Had this sale occurred on January 1, 1996 the rental income of the partnership would have decreased by approximately $95,000, net income would have increased by approximately $2,000 for the six months ended June 30, 1996, and net income from sales would have decreased by approximately $425,000. On September 27, 1996, the Partnership sold Talisman Apartments to unrelated individual parties for $4,300,000. The Partnership received $759,323 from the sale after commissions to unrelated parties of $107,500, closing costs of $11,307, a credit to buyer of $95,757, excise tax of $76,112, and an all inclusive promissory note of $3,250,000. The buyer must make monthly payments of $26,050 at the rate of 8.25% for two years, the same amount at 8.25% for two years and then $26,345 monthly at 8.75% until due on November 15, 20001 (or the date of payment of the underlying first mortgage if sooner). The note payments equal or exceed the payment required on the underlying first mortgage. Payments not received within ten days incur a 5% penalty. The Partnership remains liable under the first mortgage until paid in November 2001. The Partnership purchased the property in October 1991 for $4,100,000 and at the time of sale it had asset carrying costs of $3,574,655 ($4,238,228 cost basis less accumulated depreciation of $663,573). The Partnership realized a gain of $434,668 on the sale ($3,250,000 promissory note plus $759,323 net proceeds less adjusted basis of $3,574,655). Had this sale occurred on January 1, 1996 partnership revenue would have decreased by approximately $464,000, net income would have increased by approximately $123,000 for the nine months ended September 30, 1996, and net income from sales would have decreased by approximately $435,000. On October 16, 1996, the Partnership sold Sorrento View Apartments to unrelated individual parties for $4,020,000. The Partnership received proceeds of approximately $3,896,000 from the sale less loan repayment of $945,156, commissions to unrelated parties of $80,400, closing costs of approximately $10,000 and a prepayment penalty of $33,905. The Partnership purchased the property in November 1990 for $3,400,000 and at the time of sale it had fixed asset carrying costs of approximately $2,854,000 ($3,548,000 cost basis less accumulated depreciation of $694,000). The Partnership realized a gain of approximately $1,042,000 on the sale ($3,896,000 proceeds received less adjusted basis of $2,854,000). The Partnership distributed $208,545 to the partners during the first nine months of 1996 from current operations. The Partnership net income after depreciation for the nine months ended September 30, 1996 was $825,424; therefore, on a GAAP basis, all cash distributions are from net income. Per $1,000 invested (on the basis of a $1,000 investment made at the inception of the escrow and offering) distributions have been made in the following amounts: escrow period - $58; November 1990 through May 1995 - $18 per quarter; August 1995 through August 1996 - $7.50 per quarter, for total distributions of approximately $439. DBSI PACIFIC INCOME & GROWTH FUND - II A REAL ESTATE LIMITED PARTNERSHIP (an Idaho limited partnership) BALANCE SHEETS ASSETS September 30, 1996 December 31, 1995 __________________ _________________ Rental property: Land $935,000 $1,527,400 Buildings and improvements 7,407,174 12,461,311 Furniture and fixtures 798,898 1,007,792 _________ _________ 9,132,072 14,996,503 Less accumulated depreciation (1,756,275) (2,372,813) __________ __________ 7,375,797 12,623,690 Cash and cash equivalents 1,798,867 41,572 Accounts receivable 4,175 7,229 Prepaid expenses 3,352 12,166 Reserves 43,893 41,010 Tenant security deposits 23,539 84,015 Intangible costs (net) (Note 4) 58,044 118,736 Note receivable (Note 2) 3,250,000 __________ __________ Total assets $12,557,667 $12,928,418 LIABILITIES AND CAPITAL Accounts payable $231,581 $43,624 Interest payable 37,855 75,466 Taxes payable 11,889 10,052 Security deposits payable 34,762 50,550 Note payable affiliate (Note 3) 120,500 Mortgages payable (Note 2) 7,604,511 8,435,881 _________ _________ Total liabilities 7,920,598 8,736,073 _________ _________ Partners' capital 4,637,069 4,192,345 __________ __________ Total liabilities and capital $12,557,667 $12,928,418 <FN> The Accompanying Notes are an Integral Part of these Financial Statements DBSI PACIFIC INCOME & GROWTH FUND - II A REAL ESTATE LIMITED PARTNERSHIP (an Idaho limited partnership) STATEMENTS OF OPERATIONS Nine Months Ended Nine Months Ended REVENUES September 30, 1996 September 30, 1995 __________________ __________________ Tenant rent $1,666,982 $1,693,156 Interest income 15,035 2,324 Other income 78,796 55,172 Gain on sale of rental property (Note 5) 859,677 _________ _________ 2,620,490 1,750,652 EXPENSES Interest 572,302 612,376 Depreciation 337,882 359,010 Property tax and insurance 152,072 176,976 Maintenance and repairs 333,864 208,178 Utilities 239,602 202,739 Administrative 137,150 165,861 Management fees 69,244 73,144 On-site manager 104,484 116,985 Amortization 20,621 22,085 _________ _________ 1,967,221 1,937,354 _________ _________ Net loss $653,269 ($186,702) STATEMENTS OF PARTNERS' CAPITAL Nine months ended Nine months ended September 30, 1996 September 30, 1995 __________________ __________________ Beginning capital $4,192,345 $4,887,928 Distributions (208,545) (410,958) Net loss 653,269 (186,702) __________ __________ Ending capital $4,637,069 $4,290,268 <FN> The Accompanying Notes are an Integral Part of these Financial Statements DBSI PACIFIC INCOME & GROWTH FUND - II A REAL ESTATE LIMITED PARTNERSHIP (an Idaho limited partnership) STATEMENTS OF CASH FLOWS CASH FLOWS FROM Nine Months Ended Nine Months Ended OPERATING ACTIVITIES September 30, 1996 September 30, 1995 __________________ __________________ Net income (loss) $653,269 ($186,702) Adjustments to reconcile net income to cash flows from operating activities Depreciation and amortization 358,503 381,095 Gain on sale of rental property (859,677) Changes in operating assets and liabilities Accounts receivable 3,053 7,543 Prepaid expenses 8,814 8,875 Tenant security deposits 60,476 Accounts payable 187,957 (35,485) Interest payable (37,611) 4,482 Taxes payable 1,837 51,926 Tenant security deposits payable (15,788) (12,346) ________ ________ Net cash provided by operating activities 360,833 219,388 CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of rental property 2,726,703 Rental property purchases (166,943) (86,668) Decrease (increase) in reserves (2,883) (44,396) __________ _________ Net used in investing activities 2,556,877 (131,064) CASH FLOWS FROM FINANCING ACTIVITIES Decrease in intangible costs 6,230 Proceeds from (payments on) note payable to affiliate (120,500) 120,500 Principal payments on loans (831,370) (51,769) Distributions to partners (208,545) (410,958) _________ _________ Net cash used in financing activities (1,160,415) (335,997) Net increase (decrease) in cash and cash equivalents 1,757,295 (247,672) Cash and cash equivalents at beginning of period 41,572 294,265 _______ _______ Cash and cash equivalents at end of period $1,798,867 $46,593 <FN> The Accompanying Notes are an Integral Part of these Financial Statements DBSI PACIFIC INCOME & GROWTH FUND - II A REAL ESTATE LIMITED PARTNERSHIP (an Idaho limited partnership) NOTES TO UNAUDITED FINANCIAL STATEMENTS For the Nine months ended September 30, 1996 and 1995 1. SUMMARY OF PARTNERSHIP ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES Partnership Organization. DBSI Pacific Income & Growth Fund - II A Real Estate Limited Partnership, was formed on May 17, 1989 with general partners DBSI Housing Inc., an Idaho corporation, and DBSI Realty Partners, an Idaho general partnership. The Partnership was in the development stage through January 9, 1990 and in the offering stage through December 31, 1991. The business purpose of the Partnership is to acquire and operate leveraged multi-family housing projects in the Western United States and sell them when market prices are advantageous. The partnership agreement provides that the Partnership will be dissolved no later than December 31, 2039, unless sooner terminated as provided in the agreement. The Partnership acquired three properties during 1990: Weatherstone Apartments, an existing 138-unit project located in Silverdale, (Kitsap County) Washington; Sorrento View Apartments, an existing 80-unit project, and Dakota Station Apartments, an existing 40-unit project, both located in the Beaverton/Tigard (Portland), Oregon metropolitan area. In October 1991 the Partnership purchased a fourth property, Talisman Apartments, an existing 96-unit project located in Olympia, Washington. The Partnership sold Dakota Station on June 5, 1996, Talisman on September 27, 1996, and Sorrento View on October 16, 1996. Operating profits and losses exclusive of losses from the sale or disposition of Partnership properties, and cash distributions, are allocated 98% to limited partners and 2% to general partners. After the limited partners have received distributions equal to a 7% annual return on their capital contributions the general partners receive additional distributions equal to 5% of total distributions. Proceeds from sale or refinancing are to be distributed, generally, 100% to the limited partners until they have received cumulative distributions equal to their capital contributions, then 85% to the limited partners and 15% to the general partners. However, the limited partners must receive cumulative distributions from operations and sale or refinancing proceeds equal to their capital contributions plus a 10% per annum return thereon before the general partners receive any sale or refinancing proceeds. Significant Accounting Policies. The balance sheets include only those assets, liabilities, and partners' capital which relate to the business of the Partnership and do not include any assets, liabilities, revenues or expenses attributable to the partners' activities. No partners receive salaries from the Partnership for services. No provision has been made for federal and state income taxes since these taxes are the personal responsibility of the partners. Rental property is recorded at cost. Depreciation is computed for all assets over their estimated useful lives as follows: buildings and structural improvements, 15 to 32 years; furniture and fixtures, 5 to 12 years. Expenditures for maintenance and repairs are charged to operating expenses as incurred. The cost and accumulated depreciation of assets sold or otherwise retired are removed from the accounts and gain or loss on disposition is included in the results of operations. Mortgage loan fees are amortized over the estimated life of the mortgage notes. Cash and cash equivalents include cash in banks (except for security deposits and reserve bank accounts). Reserves consist of bank deposits for repairs and replacements, property taxes, insurance, and Partnership reserves. The estimated fair value of cash and cash equivalents, accounts payable and long-term debt approximates their carrying amounts. The preparation of the Partnership's 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. The Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, requires management to review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. This statement is effective for the Partnership's fiscal year end December 31, 1996. The Partnership's existing accounting policies are such that this pronouncement is not expected to have a material effect on the Company's financial position or results of operations. 2. MORTGAGES PAYABLE A mortgage payable of $3,875,000 to Pacific First Federal Savings Bank was used in the purchase of Weatherstone Apartments in March, 1990. The balance of $3,762,352 as of September 30, 1996 and $3,784,957 as of September 30, 1995 bears interest at 9.875% and requires monthly payments of $32,942 through April 1, 2000 when the remaining balance of approximately $3,660,621 is due. In October, 1991, the Partnership purchased Talisman Apartments by executing a mortgage loan in the amount of $3,000,000. The mortgage note in the current amount of $2,899,261 and a balance of $2,924,161 as of September 30, 1995 is held by the State of Washington, State Investment Board, and requires payments of $26,050 monthly with interest charged at 9.875%. The entire balance of the loan is due in ten years (November, 2001) when the approximate balance will be $2,722,795. The loan may not be prepaid during the first five years of the loan period. During the second five years of the loan period it may be prepaid subject to the greater of a yield maintenance prepayment penalty or a minimum 2% prepayment penalty. The Partnership received on the sale of Talisman an all inclusive promissory note which has a principle sum of $3,250,000 and requires monthly payments of $26,050 commencing on October 27, 1996 at a rate of 8.25%. Beginning November 1998 the rate increases to 8.5% and increases again to 8.75% in November 2000 with monthly payments of $26,345. The remaining principle of approximately $3,001,000 and accrued interest is payable in full on November 15, 2001 at approximately the same time the first mortgage is due. The Partnership has filed a security position on the Talisman Apartments under the note and in case of default has an immediate right to take over management and collect rents. A first deed of trust loan of approximately $998,000 to Canada Life Assurance Company was renegotiated for Sorrento Apartments after a reduction of $886,000 to the principal was made from operating capital on May 11, 1993. The loan requires monthly payments of $7,996 with interest charged at 8.375%, current amount due as of September 30, 1996 is $942,898 with a balance of $959,132 as of September 30, 1995. The loan in the amount of $941,483 was paid in full on October 16, 1996 with a $33,905 prepayment penalty when Sorrento View was sold. An 8.25% $800,000 loan from Canada Life Assurance Co. secured by the Dakota Station Apartments was obtained on April 28, 1994 to finance six to eighteen additional units at Weatherstone Apartments. The loan was for five years with a 25 year amortization. The loan required monthly payments of $6,308 and the balance as of June 5, 1996 was $779,341. The mortgage was paid in full with a $43,248 prepayment penalty when Dakota Station was sold. 3. LOAN PAYABLE The Partnership borrowed $120,500 in 1995 from an affiliate of the General Partner. This loan bears interest at the General Partner's bank borrowing rate of prime plus 1.5% (9 as of June 30, 1996). The loan proceeds provided funds for short term operating cash flow needs of the Seattle area projects and to enable the Partnership to maintain the first quarter 1995 distribution rate following the lower operating cash flow from these properties. The loan was repaid on June 28, 1996 from the proceeds of the sale of Dakota Station. 4. INTANGIBLE COSTS Intangible assets and cumulative amortization at September 30, 1996 amount to $165,218 of loan costs related to outstanding loans and $107,174 of accumulated amortization related to these fees. The net value of intangible costs is $58,044. 5. SALES OF RENTAL PROPERTY AND SUBSEQUENT EVENT On June 5, 1996, the Partnership sold Dakota Station Apartments to unrelated individual parties for $2,080,000. The Partnership received $1,967,380 from the sale less mortgage repayment of $790,512, commissions to unrelated parties of $51,975, closing costs of $4,962, a credit to buyer of $12,425 and a loan prepayment penalty of $43,258. The Partnership purchased the property in November 1990 for $1,765,000 and at the time of sale it had asset carrying costs of $1,542,371 ($1,855,486 cost basis less accumulated depreciation of $313,115). The Partnership realized a gain of $425,009 on the sale ($1,967,380 proceeds received less adjusted basis of $1,542,371). On September 27, 1996, the Partnership sold Talisman Apartments to unrelated individual parties for $4,300,000. The Partnership received $759,323 from the sale after commissions to unrelated parties of $107,500, closing costs of $11,307, a credit to buyer of $95,757, excise tax of $76,112, and an all inclusive promissory note of $3,250,000. (See note 2) The note requires monthly payments of $26,050.26 at the rate of 8.25%. The Partnership purchased the property in October 1991 for $4,100,000 and at the time of sale it had asset carrying costs of $3,574,655 ($4,238,228 cost basis less accumulated depreciation of $663,573). The Partnership realized a gain of $434,668 on the sale ($3,250,000 promissory note plus $759,323 net proceeds less adjusted basis of $3,574,655). The Partnership remains liable under the mortgage until paid in November 2001. On October 16, 1996, the Partnership sold Sorrento View Apartments to unrelated individual parties for $4,020,000. The Partnership received proceeds of approximately $3,896,000 from the sale less loan repayment of $945,156, commissions to unrelated parties of $80,400, closing costs of approximately $10,000 and a prepayment penalty of $33,905. The Partnership purchased the property in November 1990 for $3,400,000 and at the time of sale it had fixed asset carrying costs of approximately $2,854,000 ($3,548,000 cost basis less accumulated depreciation of $694,000). The Partnership realized a gain of approximately $1,042,000 on the sale ($3,896,000 proceeds received less adjusted basis of $2,854,000). 6. NET INCOME (LOSS) FROM RENTAL PROPERTIES The following schedule details separate rental property activity for the six months ended June 30, 1996: ________________________________________________________________________ Weatherstone Talisman Sorrento Dakota Apts Apts View Apts Station Apts Partnership Total ________________________________________________________________________ REVENUES Tenant rent $662,967 $454,204 $433,495 $116,316 $1,666,982 Interest income 296 246 784 289 $13,420 15,035 Other income 39,572 9,936 21,879 5,409 2,000 78,796 Income from sale of rental property 859,677 859,677 ________________________________________________________________________ 702,835 464,386 456,158 122,014 875,097 2,620,490 EXPENSES Interest 279,376 191,550 59,573 33,591 8,212 572,302 Depreciation 135,000 90,438 86,310 26,134 337,882 Tax and insurance 43,009 55,204 39,683 14,176 152,072 Maintenance 170,257 97,375 46,217 20,015 333,864 Utilities 109,669 64,590 49,508 15,835 239,602 Administration 52,419 37,030 22,047 4,814 20,840 137,150 Management fees 23,413 16,912 21,523 7,396 69,244 On-site manager 40,146 34,073 26,341 3,924 104,484 Amortization 20,621 20,621 _______________________________________________________________________ 853,289 587,172 351,202 125,885 49,673 1,967,221 _______________________________________________________________________ Net income (loss) ($150,454) ($122,786) $104,956 ($3,871) $825,424 $653,269 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. DBSI PACIFIC INCOME & GROWTH FUND - II A Real Estate Limited Partnership by _________________________ Date ____________________ Douglas L. Swenson, President of DBSI Housing Inc., general partner of DBSI PACIFIC INCOME & GROWTH FUND - II A Real Estate Limited Partnership by _________________________ Date ____________________ Charles E. Hassard, Secretary-Treasurer and principal financial officer of DBSI Housing Inc., the Idaho corporation that is a general partner and principal financial officer of DBSI PACIFIC INCOME & GROWTH FUND - II A Real Estate Limited Partnership