10-Q 1 ten-q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 33-69996 COMMONWEALTH INCOME & GROWTH FUND II (Exact name of registrant as specified in its charter) Pennsylvania 23-2795120 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 470 John Young Way Suite 300 Exton, PA 19341 (Address, including zip code, of principal executive offices) (610) 594-9600 (Registrant's telephone number including area code) Indicate by check mark whether the registrant (i) 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, and (ii) has been subject to such filing requirements for the past 90 days: YES [X] NO [ ] Commonwealth Income & Growth Fund II Balance Sheets

see accompanying notes to financial statements Commonwealth Income & Growth Fund II Statements of Operations

see accompanying notes to financial statements

see accompanying notes to financial statements Commonwealth Income & Growth Fund II Statements of Cash Flow For the Six Months Ended June 30, 2003 and 2002

see accompanying notes to financial statements NOTES TO FINANCIAL STATEMENTS 1. Business Commonwealth Income & Growth Fund II (the "Partnership") is a limited partnership organized in the Commonwealth of Pennsylvania to acquire, own and lease various types of computer peripheral equipment and other similar capital equipment, which will be leased primarily to U.S. corporations and institutions. Commonwealth Capital Corp ("CCC"), on behalf of the Partnership and other affiliated partnerships, acquires computer equipment subject to associated debt obligations and lease agreements and allocates a participation in the cost, debt and lease revenue to the various partnerships based on certain risk factors. The Partnership's General Partner is Commonwealth Income & Growth Fund, Inc. (the "General Partner"), a Pennsylvania corporation which is an indirect wholly owned subsidiary of CCC. CCC is a member of the Investment Program Association (IPA), Financial Planning Association (FPA), and the Equipment Leasing Association (ELA). Approximately ten years after the commencement of operations, the Partnership intends to sell or otherwise dispose of all of its computer equipment, make final distributions to partners, and to dissolve. Unless sooner terminated, the Partnership will continue until December 31, 2006. 2. Summary of Basis of Presentation Significant Accounting The financial information presented as of Policies any date other than December 31 has been prepared from the books and records without audit. Financial information as of December 31 has been derived from the audited financial statements of the Partnership, but does not include all disclosures required by generally accepted accounting principles. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial information for the periods indicated have been included. For further information regarding the Partnership's accounting policies, refer to the financial statements and related notes included in the Partnership's annual report on Form 10-K for the year ended December 31, 2002. Operating results for the six-month period ended June 30, 2003 are not necessarily indicative of financial results that may be expected for the full year ended December 31, 2003. Revenue Recognition Through June 30, 2003, the Partnership's leasing operations consist substantially of operating leases and seven direct-financing leases. Operating lease revenue is recognized on a monthly basis in accordance with the terms of the lease agreement. Unearned revenue from direct financing agreements is amortized to revenue over the lease term. Gains or losses on the sales of equipment are recognized on the date of the sale agreement. The Partnership reviews a customer's credit history before extending credit and establishes a provision for uncollectible accounts receivable based upon the credit risk of specific customers, historical trends and other information. 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. Long-Lived Assets The Partnership evaluates its long-lived assets when events or circumstances indicate that the value of the asset may not be recoverable. The Partnership determines whether an impairment exists by estimating the undiscounted cash flows to be generated by each asset. If the estimated undiscounted cash flows are less than the carrying value of the asset then an impairment exists. The amount of the impairment is determined based on the difference between the carrying value and the fair value. The fair value is determined based on estimated discounted cash flows to be generated by the asset. As of June 30, 2003, there is no impairment. Depreciation on computer equipment for financial statement purposes is based on the straight-line method over estimated useful lives of four years. Intangible Assets Equipment acquisition costs and deferred expenses, are amortized on a straight-line basis over two- to-four year lives. Unamortized acquisition fees and deferred expenses are charged to amortization expense when the associated leased equipment is sold. Cash and Cash Equivalents The Partnership considers all highly liquid investments with a maturity of three months or less to be cash equivalents. Cash equivalents have been invested in a money market fund investing directly in Treasury obligations. Income Taxes The Partnership is not subject to federal income taxes; instead, any taxable income (loss) is passed through to the partners and included on their respective income tax returns. Taxable income differs from financial statement net income as a result of reporting certain income and expense items for tax purposes in periods other than those used for financial statement purposes, principally relating to depreciation, amortization, and lease income. Offering Costs Offering costs are payments for selling commissions, dealer manager fees, professional fees and other offering expenses relating to the syndication. Selling commissions are 7% of the partners' contributed capital and dealer manager fees are 2% of the partners' contributed capital. These costs have been deducted from partnership capital in the accompanying financial statements. Net Income (Loss) Per Equivalent Limited Partnership Unit The net income (loss) per equivalent limited partnership unit is computed based upon net income (loss) allocated to the limited partners and the weighted average number of equivalent units outstanding during the period. Reimbursable Expenses Reimbursable expenses, which are charged to the Partnership by CCC in connection with the administration and operation of the Partnership, are allocated to the Partnership based upon several factors including, but not limited to, the number of investors, compliance issues, and the number of existing leases. 3. Net Investment in Direct Financing The following lists the components of the net Leases investment in direct financing leases as of June 30, 2003 and December 31, 2002:

The following is a schedule of future minimum rentals on noncancellable direct financing leases at June 30, 2003:

4. Computer The Partnership is the lessor of equipment Equipment under operating leases with periods ranging from 14 to 37 months. In general, the lessee pays associated costs such as repairs and maintenance, insurance and property taxes. The Partnership's share of the computer equipment in which they participate with other partnerships at June 30, 2003 and December 31, 2002 was approximately $1,660,000 and $1,645,000, respectively, which is included in the Partnership's fixed assets on their balance sheet, and the total cost of the equipment shared by the Partnership with other partnerships at June 30, 2003 and December 31, 2002 was approximately $2,813,000 and $2,765,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at June 30, 2003 and December 31, 2002 was approximately $676,000 and $801,000, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at June 30, 2003 and December 31, 2002 related to the equipment shared by the Partnership was approximately $1,137,000 and $1,353,000, respectively. The following is a schedule of future minimum rentals on noncancellable operating leases at June 30, 2003:

5. Related Party Other Receivables Transactions As of June 30, 2003, the Partnership has a non-interest bearing receivable from CCC, a related party to the Partnership, in the amount of approximately $226,000. This receivable, as well as any potential future receivables, was and will be made at the discretion of the General Partner, per the prospectus, and was substantially advanced in 2001. CCC, through its indirect subsidiaries, including the General Partner of the Partnership, earns fees based on revenues and new lease purchases from this fund. CCC intends to repay the receivable via the offsetting of acquisition and debt placement fees, over the next several fiscal years, with a minimum payment of $5,000 per month, commencing January 1, 2003. 6. Notes Payable Notes payable consisted of the following:

7. Supplemental Other noncash activities included in the Cash Flow determination of net loss are as follows: Information Six months ended June 30, 2003 2002 ------------------------------------------------------------------------------- Lease income, net of interest expense on notes payable realized as a result of direct payment of principal by lessee to bank $536,047 $595,229 ------------------------------------------------------------------------------- No interest or principal on notes payable was paid by the Partnership because direct payment was made by lessee to the bank in lieu of collection of lease income and payment of interest and principal by the Partnership. Noncash investing and financing activities include the following: Six months ended June 30, 2003 2002 ------------------------------------------------------------------------------- Net book value of equipment converted to direct financing leases $ 3,346 $ - ------------------------------------------------------------------------------- 8. Litigation In June 2003, the Partnership, through CCC, reached a favorable settlement in a lawsuit against a customer for failure to make monthly lease payments based on the existing lease terms. The settlement did not have a material adverse impact to the financial statements of the Partnership. As of December 31, 2002, the Partnership had recorded a receivable from the customer of approximately $404,000, net of an allowance of approximately $330,000. In July 2003, the Partnership has received approximately $405,000 in proceeds relating to this receivable. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations CRITICAL ACCOUNTING POLICIES Financial Reporting Release No. 60, which was released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Our significant accounting policies are described in Note 1 of the Notes to the Financial Statements. The significant accounting policies that we believe are the most critical to aid in fully understanding our reported financial results include the following: COMPUTER EQUIPMENT Commonwealth Capital Corp, on behalf of the Partnership and other affiliated partnerships, acquires computer equipment subject to associated debt obligations and lease revenue and allocates a participation in the cost, debt and lease revenue to the various partnerships based on certain risk factors. REVENUE RECOGNITION Through June 30, 2003, the Partnership's leasing operations consist substantially of operating leases and seven direct-financing leases. Operating lease revenue is recognized on a monthly basis in accordance with the terms of the lease agreement. Unearned revenue from direct financing agreements is amortized to revenue over the lease term. Gains or losses on the sales of equipment are recognized on the date of the sale agreement. The Partnership reviews a customer's credit history before extending credit and establishes a provision for uncollectible accounts receivable based upon the credit risk of specific customers, historical trends and other information. LONG-LIVED ASSETS The Partnership evaluates its long-lived assets when events or circumstances indicate that the value of the asset may not be recoverable. The Partnership determines whether an impairment exists by estimating the undiscounted cash flows to be generated by each asset. If the estimated undiscounted cash flows are less than the carrying value of the asset then an impairment exists. The amount of the impairment is determined based on the difference between the carrying value and the fair value. Fair value is determined based on estimated discounted cash flows to be generated by the asset. Depreciation on computer equipment for financial statement purposes is based on the straight-line method over estimated useful lives of four years. Liquidity and Capital Resources The Partnership's primary sources of capital for the six months ended June 30, 2003 and June 30, 2002 were from net proceeds received from sale of equipment totaling $382,000 and $122,000, respectively, and cash from operations of $437,000 for the six months ended June 30, 2002. The primary uses of cash for the six months ended June 30, 2003 and June 30, 2002, were for capital expenditures for new equipment totaling $15,000 and $97,000, respectively, the payment of preferred distributions to partners of $289,000 for both periods and operating activities of $23,000 for the six months ended June 30, 2003. For the six month period ended June 30, 2003, the Partnership used cash flows from operating activities of $23,000, which includes net income of $299,000, a gain on sale of equipment totaling $318,000, and depreciation and amortization expenses of $533,000. Other noncash activities included in the determination of net loss include direct payments of lease income by lessees to banks of $536,000. For the six month period ended June 30, 2002, the Partnership generated cash flows from operating activities of $437,000, which includes a net loss of $110,000 and depreciation and amortization expenses of $1,033,000. Other noncash activities included in the determination of net loss include direct payments of lease income by lessees to banks of $595,000. Cash is invested in money market accounts that invest directly in treasury obligations pending the Partnership's use of such funds to purchase additional computer equipment, to pay Partnership expenses or to make distributions to the Partners. In June 2003, the Partnership, through CCC, reached a favorable settlement in a lawsuit against a customer for failure to make monthly lease payments based on the existing lease terms. The settlement did not have a material adverse impact to the financial statements of the Partnership. As of December 31, 2002, the Partnership had recorded a receivable from the customer of approximately $404,000, net of an allowance of approximately $330,000. In July 2003, the Partnership has received approximately $405,000 in proceeds relating to this receivable. As of June 30, 2003, the Partnership has a non-interest bearing receivable from CCC, a related party to the Partnership, in the amount of approximately $226,000. This receivable, as well as any future receivables, was and will be made at the discretion of the General Partner, per the prospectus, and was substantially advanced in 2001. CCC, through its indirect subsidiaries, including the General Partner of the Partnership, earns fees based on revenues and new lease purchases from this fund. CCC intends to repay the receivable via the offsetting of acquisition and debt placement fees, over the next several fiscal years, with a minimum payment of $5,000 per month, commencing January 1, 2003. The Partnership's investment strategy of acquiring computer equipment and generally leasing it under "triple-net leases" to operators who generally meet specified financial standards minimizes the Partnership's operating expenses. As of June 30, 2003, the Partnership had future minimum rentals on non-cancelable operating leases of $553,000 for the balance of the year ending December 31, 2003 and $716,000 thereafter. At June 30, 2003, the outstanding debt was $1,216,000, with interest rates ranging from 5.95% to 9.75%, and will be payable through June 2006. The Partnership's cash from operations is expected to continue to be adequate to cover all operating expenses, liabilities, and preferred distributions to Partners during the next 12-month period. If available Cash Flow or Net Disposition Proceeds are insufficient to cover the Partnership expenses and liabilities on a short and long term basis, the Partnership will attempt to obtain additional funds by disposing of or refinancing Equipment, or by borrowing within its permissible limits. The Partnership may, from time to time, reduce the distributions to its Partners if it deems necessary. Since the Partnership's leases are on a "triple-net" basis, no reserve for maintenance and repairs are deemed necessary. The Partnership's share of the computer equipment in which they participate with other partnerships at June 30, 2003 and December 31, 2002 was approximately $1,660,000 and $1,645,000, respectively, which is included in the Partnership's fixed assets on their balance sheet, and the total cost of the equipment shared by the Partnership with other partnerships at June 30, 2003 and December 31, 2002 was approximately $2,813,000 and $2,765,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at June 30, 2003 and December 31, 2002 was approximately $676,000 and $801,000, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at June 30, 2003 and December 31, 2002 related to the equipment shared by the Partnership was approximately $1,137,000 and $1,353,000, respectively. Results of Operations Three Months Ended June 30, 2003 compared to Three Months Ended June 30, 2002 ----------------------------------------------------------------------------- For the quarter ended June 30, 2003, the Partnership recognized income of $734,000 and expenses of $439,000, resulting in net income of $295,000. For the quarter ended June 30, 2002, the Partnership recognized income of $684,000 and expenses of $717,000, resulting in a net loss of $33,000. Lease income decreased by 40% to $409,000 for the quarter ended June 30, 2003, from $686,000 for the quarter ended June 30, 2002, primarily due to the fact that more lease agreements ended than new lease agreements acquired since the quarter ended June 30, 2002. The Partnership sold computer equipment with a net book value of $56,000 for the quarter ended June 30, 2003, for a net gain of $324,000. The Partnership sold computer equipment with a net book value of $16,000 for the quarter ended June 30, 2002, for a net loss of $2,000. Operating expenses, excluding depreciation, primarily consist of accounting, legal, outside service fees and reimbursement of expenses to CCC for administration and operation of the Partnership. The expense increased 5% to approximately $144,000 for the quarter ended June 30, 2003, from $137,000 for the quarter ended June, 2002, which is primarily attributable to an increase in the amount charged by CCC, a related party, to the Partnership for the administration and operation of approximately $2,000, and an decrease in remarketing fees of approximately $5,000, an increase in accounting fees of approximately $5,000 and an increase in legal fees of approximately $7,000. The equipment management fee is approximately 5% of the gross lease revenue attributable to equipment that is subject to operating leases. The equipment management fee decreased 40% to approximately $20,000 for the quarter ended June 30, 2003, from $34,000 for the quarter ended June 30, 2002, which is consistent with the decrease in lease income. Depreciation and amortization expenses consist of depreciation on computer equipment and amortization of equipment acquisition fees. The expenses decreased 49% to approximately $250,000 for the quarter ended June 30, 2003, from $489,000 for the quarter ended June 30, 2002 due to equipment and acquisition fees being fully depreciated/amortized and not being replaced with as many new purchases. Interest expense decreased 43% to $24,000 for the quarter ended June 30, 2003 from $43,000 for the quarter ended June 30, 2002, primarily due to the decrease in debt relating to the purchase of computer equipment. Six Months Ended June 30, 2003 compared to Six Months Ended June 30, 2002 ------------------------------------------------------------------------- For the six months ended June 30, 2003, the Partnership recognized income of $1,272,000 and expenses of $973,000, resulting in net income of $299,000. For the six months ended June 30, 2002, the Partnership recognized income of $1,390,000 and expenses of $1,500,000, resulting in a net loss of $110,000. Lease income decreased by 31% to $952,000 for the six months ended June 30, 2003, from $1,389,000 for the six months ended June 30, 2002, primarily due to the fact that more lease agreements ended than new lease agreements acquired since the six months ended June 30, 2002. The Partnership sold computer equipment with a net book value of $64,000 for the six months ended June 30, 2003, for a net gain of $318,000. The Partnership sold computer equipment with a net book value of $122,000 for the six months ended June 30, 2002, for a net gain of $1,000. Operating expenses, excluding depreciation, primarily consist of accounting, legal, outside service fees and reimbursement of expenses to CCC for administration and operation of the Partnership. The expense increased 37% to approximately $338,000 for the six months ended June 30, 2003, from $247,000 for the six months ended June, 2002, which is primarily attributable to an increase in the amount charged by CCC, a related party, to the Partnership for the administration and operation of approximately $22,000 and an increase in remarketing fees of approximately $73,000. The equipment management fee is approximately 5% of the gross lease revenue attributable to equipment that is subject to operating leases. The equipment management fee decreased 31% to approximately $48,000 for the six months ended June 30, 2003, from $69,000 for the six months ended June 30, 2002, which is consistent with the decrease in lease income. Depreciation and amortization expenses consist of depreciation on computer equipment and amortization of equipment acquisition fees. The expenses decreased 48% to approximately $533,000 for the six months ended June 30, 2003, from $1,033,000 for the six months ended June 30, 2002 due to equipment and acquisition fees being fully depreciated/amortized and not being replaced with as many new purchases. Interest expense decreased 34% to $54,000 for the six months ended June 30, 2003 from $82,000 for the six months ended June 30, 2002, primarily due to the decrease in debt relating to the purchase of computer equipment. RECENT ACCOUNTING PRONOUNCEMENTS SFAS 150 In May 2003, the FASB issued FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS is applicable immediately for financial instruments entered into or modified after May 31, 2003 and otherwise shall be effective at the beginning of the first interim period beginning after June 15, 2003. The Partnership believes that the adoption of SFAS 150 will not have an impact on its financial position and results of operations. Item 3. Quantitative and Qualitative Disclosures About Market Risk The Partnership believes its exposure to market risk is not material due to the fixed interest rate of its long- term debt and its associated fixed revenue streams. Item 4. Controls and Procedures The Chief Executive Officer and A Financial Officer of the Partnership have conducted a review of the Partnership's disclosure controls and procedures as of June 30, 2003. The Company's disclosure controls and procedures include the Partnership's controls and other procedures designed to ensure that information required to be disclosed in this and other reports filed under the Securities Exchange Act of 1934, as amended (the " Exchange Act") is accumulated and communicated to the Partnership's management, including its chief executive officer and a financial officer, to allow timely decisions regarding required disclosure and to ensure that such information is recorded, processed, summarized and reported with the required time periods. Based upon this review, the Partnership's Chief Executive Officer and the A Financial Officer have concluded that the Partnership's disclosure controls (as defined in pursuant to Rule 13a-14 c promulgated under the Exchange Act) are sufficiently effective to ensure that the information required to be disclosed by the Partnership in the reports it files under the Exchange Act is recorded, processed, summarized and reported with adequate timeliness. Part II: OTHER INFORMATION Commonwealth Income & Growth Fund II Item 1. Legal Proceedings. Commonwealth Capital Corp filed a complaint on December 21, 2001 with Avon Products, Inc. with the Federal District Court of the Eastern District of Pennsylvania, No. 01-C2-6915. The complaint alleges that the defendants illegally purchased/sold leased equipment without the Partnership's authorization, along with suing for late fees on various lease payments. In December 2002, the representatives of CCC, along with representatives from El Camino (the original broker for the Avon lease) and consultants for Avon, met for a reconciliation meeting. This meeting was designed to reconcile all accounting issues (rentals due) related to the Avon lease. A final reconciliation was not submitted by all parties until around February 15, 2003. At that time, CCC reconciled, via payments histories, the amounts owed by each party. A settlement conference with the judge was then scheduled for March 6, 2003. Prior to the conference, CCC submitted their reconciliation of amounts due. At the conference, a reasonable settlement could not be reached on various issues involved in the litigation. Avon was granted another 90 days for discovery. As of December 31, 2002, the Partnership had recorded a receivable from Avon of approximately $404,000, net of an allowance of approximately $330,000. In June 2003, a settlement was reached between all parties. As part of the settlement, title to the equipment was transferred to Avon. In July 2003, the Partnership has received approximately $405,000 in proceeds relating to this receivable. The checks were received on July 3, 2003 and July 14, 2003. Item 2. Changes in Securities. Inapplicable Item 3. Defaults Upon Senior Securities. Inapplicable Item 4. Submission of Matters to a Vote of Securities Holders. Inapplicable Item 5. Other Information. Inapplicable Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: 31.1 THE RULE 15d-14(a) 31.2 THE RULE 15d-14(a) 32.1 SECTION 1350 CERTIFICATION OF CEO 32.2 SECTION 1350 CERTIFICATION OF CFO 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. COMMONWEALTH INCOME & GROWTH FUND II BY: COMMONWEALTH INCOME & GROWTH FUND, INC. General Partner August 12, 2003 By: /s/ George S. Springsteen --------------- -------------------------- Date George S. Springsteen President

COMMONWEALTH INCOME & GROWTH FUND II 10-Q