10-Q 1 ten-q.txt FORM 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 MARCH 31, 2005 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 33-89476 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12c-2 of the Act): YES [ ] NO [X] FORM 10-Q MARCH 31, 2005 TABLE OF CONTENTS PART I Item 1. Condensed Financial Statements 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk 14 Item 4. Controls and Procedures 14 PART II Item 1. Legal Proceedings 15 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 15 Item 3. Defaults Upon Senior Securities 15 Item 4. Submission of Matters to a Vote of Securities Holders 15 Item 5. Other Information 15 Item 6. Index to Exhibits Signatures Certifications 2 COMMONWEALTH INCOME & GROWTH FUND II CONDENSED BALANCE SHEETS

see accompanying notes to condensed financial statements 3 COMMONWEALTH INCOME & GROWTH FUND II CONDENSED STATEMENTS OF OPERATIONS

see accompanying notes to condensed financial statements 4 COMMONWEALTH INCOME & GROWTH FUND II CONDENSED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)

see accompanying notes to condensed financial statements 5 COMMONWEALTH INCOME & GROWTH FUND II CONDENSED STATEMENTS OF CASH FLOW FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004

see accompanying notes to condensed financial statements 6 NOTES TO CONDENSED 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 any date other POLICIES 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, 2004. Operating results for the three-month period ended March 31, 2005 are not necessarily indicative of financial results that may be expected for the full year ended December 31, 2005. 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. The Partnership determined that no impairment had occurred during the three months ended March 31, 2005. 7 Depreciation on computer equipment for financial statement purposes is based on the straight-line method over estimated useful lives of four years. 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. 3. NET INVESTMENT IN The following lists the components of the net investment DIRECT FINANCING in direct financing leases as of March 31, 2005 and LEASES December 31, 2004:

The following is a schedule of future minimum rentals on noncancellable direct financing leases at March 31, 2005 Amount ----------- Nine Months Remaining December 31, 2005 $ 56,142 Year Ended December 31, 2006 26,648 ----------- $ 82,790 =========== 4. COMPUTER The Partnership is the lessor of equipment under EQUIPMENT operating leases with periods ranging from 24 to 48 months. In general, the lessee pays associated costs such as repairs and maintenance, insurance and property taxes. Through March 31, 2005, 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. 8 The Partnership's share of the computer equipment in which they participate with other partnerships at March 31, 2005 and December 31, 2004 was approximately $1,281,000 and $1,307,000, respectively, which is included in the Partnership's fixed assets on their balance sheet. The total cost of the equipment shared by the Partnership with other partnerships at March 31, 2005 and December 31, 2004 was approximately $2,131,000 and $2,249,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at March 31, 2005 and December 31, 2004 was approximately $0 and $700, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at March 31, 2005 and December 31, 2004 related to the equipment shared by the Partnership was approximately $0 and $1,000, respectively. The following is a schedule of future minimum rentals on noncancellable operating leases at March 31, 2005: Amount -------------- Nine Months ended December 31, 2005 $ 36,922 Year Ended December 31, 2006 13,563 -------------- $ 50,485 ============== 5. RELATED PARTY REIMBURSABLE EXPENSES TRANSACTIONS The General Partner and its affiliates are entitled to reimbursement by the Partnership for the cost of supplies and services obtained and used by the General Partner in connection with the administration and operation of the Partnership from third parties unaffiliated with the General Partner. In addition, the General Partner and its affiliates are entitled to reimbursement for certain expenses incurred by the General Partner and its affiliates in connection with the administration and operation of the Partnership. During the three months ended March 31, 2005 and 2003, the Partnership recorded $41,000 and $63,000, respectively, for reimbursement of expenses to the General Partner. EQUIPMENT ACQUISITION FEE The General Partner is entitled to be paid an equipment acquisition fee of 4% of the purchase price of each item of equipment purchased as compensation for the negotiation of the acquisition of the equipment and lease thereof or sale under a conditional sales contract. During the three months ended March 31, 2004, equipment acquisition fees of approximately $1,000 were earned by the General Partner. There were no equipment acquisition fees earned by the General Partner during the three months ended March 31, 2005. EQUIPMENT MANAGEMENT FEE The General Partner is entitled to be paid a monthly fee equal to the lesser of (i) the fees which would be charged by an independent third party for similar services for similar equipment 9 or (ii) the sum of (a) 2% of (1) the gross lease revenues attributable to equipment which is subject to full payout net leases which contain net lease provisions plus (2) the purchase price paid on conditional sales contracts as received by the Partnership and (b) 5% of the gross lease revenues attributable to equipment which is subject to operating and capital leases. During the three months ended March 31, 2005 and 2004, equipment management fees of approximately $300 and $12,000, respectively, were earned by the General Partner. EQUIPMENT LIQUIDATION FEE With respect to each item of equipment sold by the General Partner (other than in connection with a conditional sales contract), a fee equal to the lesser of (i) 50% of the competitive equipment sale commission or (ii) 3% of the sales price for such equipment is payable to the General Partner. The payment of such fee is subordinated to the receipt by the limited partners of the net disposition proceeds from such sale in accordance with the Partnership Agreement. Such fee will be reduced to the extent any liquidation or resale fees are paid to unaffiliated parties. During the three months ended March 31, 2005 and March 31, 2004, equipment liquidation fees of approximately $400 and $2,000, respectively, were earned by the General Partner. Notes payable consisted of the following:

These notes are secured by specific computer equipment and are nonrecourse liabilities of the Partnership. Aggregate maturities of notes payable for each of the periods subsequent to March 31, 2005 are as follows: 10 Amount --------- Nine months ended December 31, 2005 $ 50,517 Year ended December 31, 2006 33,066 --------- $ 83,583 --------- 7. SUPPLEMENTAL Other noncash activities included in the determination CASH FLOW of net loss are as follows: INFORMATION Three months ended March 31, 2005 2004 ---------------------------------------------- --------- --------- Lease income, net of interest expense on notes payable realized as a result of direct payment of principal by lessee to bank $ 5,951 $ 183,325 ========= ========= 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: Three months ended March 31, 2005 2004 ------------------------------------------------ --------- --------- Offsetting of receivables from CCC with payables to General Partner $ - $ 53,678 ========= ========= ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES The Partnership's discussion and analysis of its financial condition and results of operations are based upon its financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Partnership to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. The Partnership bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Partnership believes that its critical accounting policies affect its more significant judgments and estimates used in the preparation of its financial statements. 11 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 March 31, 2005, 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. 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 three months ended March 31, 2005 and 2004 were net proceeds received from sale of equipment totaling approximately $13,000 and $53,000, respectively, and the repayment of receivables from CCC of approximately $3,000 and $71,000, respectively. The primary uses of cash for the three months ended March 31, 2005 and 2004 were for cash used in operations of approximately $5,000 and $41,000, respectively, and the payment of preferred distributions to partners of approximately $115,000 for the period ending March 31, 2004. There were no capital expenditures for the periods ending March 31, 2005 and March 31, 2004. For the three month period ended March 31, 2005 and 2004, the Partnership used cash flows from operating activities of approximately $5,000. This includes a net loss of approximately $173,000 and depreciation and amortization expenses of approximately $111,000. Other noncash activities included in the determination of net income include direct payments of lease income by lessees to banks of approximately $6,000. For the three month period ended March 31, 2004, the Partnership used cash flows from operating activities of approximately $41,000, which includes a net loss of approximately $115,000 and depreciation and amortization expenses of approximately $204,000. Other noncash activities included in the determination of net loss include direct payments of lease income by lessees to banks of approximately $183,000. 12 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. 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 March 31, 2005, the Partnership had future minimum rentals on non-cancelable operating leases of $37,000 for the balance of the year ending December 31, 2005 and $14,000 thereafter. As of March 31, 2005, the Partnership had future minimum rentals on noncancellable capital leases of $56,000 for the balance of the year ending December 31, 2005 and $27,000 thereafter. At March 31, 2005, the outstanding debt was $84,000, with interest rates ranging from 5.95% to 6.75%, 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 March 31, 2005 and December 31, 2004 was approximately $1,281,000 and $1,307,000, respectively, which is included in the Partnership's fixed assets on their balance sheet. The total cost of the equipment shared by the Partnership with other partnerships at March 31, 2005 and December 31, 2004 was approximately $2,131,000 and $2,249,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at March 31, 2005 and December 31, 2004 was approximately $0 and $700, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at March 31, 2005 and December 31, 2004 related to the equipment shared by the Partnership was approximately $0 and $1,000, respectively. RESULTS OF OPERATIONS Three Months Ended March 31, 2005 compared to Three Months Ended March 31, 2004 For the quarter ended March 31, 2005, the Partnership recognized income of approximately $29,000 and expenses of approximately $202,000, resulting in a net loss of approximately $173,000. For the quarter ended March 31, 2004, the Partnership recognized income of approximately $233,000 and expenses of approximately $348,000, resulting in a net loss of approximately $115,000. Lease income decreased by 88% to approximately $29,000 for the quarter ended March 31, 2005, from approximately $233,000 for the quarter ended March 31, 2004, primarily due to the fact that more lease agreements ended since the quarter ended March 31, 2004. 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 operating expenses decreased 25% to approximately 13 $83,000 for the quarter ended March 31, 2005, from approximately $111,000 for the quarter ended March 31, 2004, which is primarily attributable to a decrease in the amount charged by CCC, a related party, to the Partnership for the administration and operation of approximately $20,000, and a decrease in professional fees of approximately $12,000. 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 97% to approximately $300 for the quarter ended March 31, 2005, from approximately $12,000 for the quarter ended March 31, 2004, 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 46% to approximately $110,000 for the quarter ended March 31, 2005, from approximately $204,000 for the quarter ended March 31, 2004 due to equipment and acquisition fees being fully depreciated/amortized and not being replaced with new purchases. The Partnership sold computer equipment with a net book value of approximately $19,000 for the quarter ended March 31, 2005, for a net loss of approximately $6,000. The Partnership sold computer equipment with a net book value of approximately $63,000 for the quarter ended March 31, 2004, for a net loss of approximately $10,000. Interest expense decreased 81% to approximately $2,000 for the quarter ended March 31, 2005 from approximately $11,000 for the quarter ended March 31, 2004, primarily due to the decrease in debt relating to the purchase of computer equipment. 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 March 31, 2005. 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. 14 There have been no changes in the General Partner's internal controls or in other factors that could materially affect our disclosure controls and procedures in the quarter ended March 31, 2005, that have materially affected or are reasonably likely to materially affect the General Partner's internal controls over financial reporting. PART II: OTHER INFORMATION COMMONWEALTH INCOME & GROWTH FUND II Item 1. LEGAL PROCEEDINGS. N/A Item 2. CHANGES IN SECURITIES. N/A Item 3. DEFAULTS UPON SENIOR SECURITIES. N/A Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS. N/A Item 5. OTHER INFORMATION. N/A 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 b) Report on Form 8-K: None 15 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 May 16, 2005 By: /s/ George S. Springsteen ------------- ------------------------- Date George S. Springsteen President 16

COMMONWEALTH INCOME & GROWTH FUND II 10-Q