10-Q 1 tenq.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, 2002 ( ) 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 Income

see accompanying notes to financial statements Commonwealth Income & Growth Fund II Statements of Partners' Capital

see accompanying notes to financial statements Commonwealth Income & Growth Fund II Statements of Cash Flow For the Six Months Ended June 30, 2002 and 2001

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, 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. 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 Commonwealth Capital Corp. 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, 2001. Operating results for the six-month period ended June 30, 2002 are not necessarily indicative of financial results that may be expected for the full year ended December 31, 2002. Revenue Recognition Through June 30, 2002, the Partnership has only entered into operating leases. Lease revenue is recognized on a monthly basis in accordance with the terms of the operating lease agreements. 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, 2002, 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 are charged to amortization expense when the associated leased equipment is sold. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of six months or less to be cash equivalents. At June 30, 2002, cash equivalents were 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. 3. Computer The Partnership is the lessor of equipment under operating Equipment leases with periods ranging from 24 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, 2002 and December 31, 2001 was approximately $3,211,000 and $2,969,000, 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, 2002 and December 31, 2001 was approximately $6,294,000 and $5,526,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at June 30, 2002 and December 31, 2001 was approximately $1,429,000 and $1,581,000, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at June 30, 2002 and December 31, 2001 related to the equipment shared by the Partnership was approximately $2,478,000 and $4,895,000, respectively. The following is a schedule of future minimum rentals on noncancellable operating leases at June 30, 2002: Amount -------------------------------------------------------- Six Months ended December 31, 2002 $ 794,000 Year Ended December 31, 2003 1,338,000 Year Ended December 31, 2004 774,000 Year Ended December 31, 2005 16,000 -------------------------------------------------------- $2,922,000 ======================================================== 4. Related Party Other Receivables Transactions At June 30, 2002, the Partnership has a receivable from Commonwealth Capital Corp ("CCC"), a related party to the Partnership, in the amount of approximately $301,000. CCC, thru its indirect subsidiaries, including the General Partner of the Partnership, earns fees based on revenues and new lease purchases from this fund and other funds. This is a non-interest bearing receivable that CCC plans to repay over the next two and a half fiscal years from acquisition and debt placement fees earned by the General Partner of the Partnership. For the six months ended June 30, 2002, CCC has repaid approximately $14,000 to the Partnership. 5. Notes Payable Notes payable consisted of the following:

6. Supplemental Other noncash activities included in the determination of Cash Flow net loss are as follows: Information =============================================================================== Six months ended June 30, 2002 2002 2001 ---------------------------------------------------------------------------- Lease income, net of interest expense on notes payable realized as a result of direct payment of principal by lessee to bank $ 595,229 $ 690,687 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, 2002 2002 2001 ----------------------------------------------------------------------------- Debt assumed in connection with purchase of computer equipment $ 503,623 $ 55,631 ============================================================================= 7. Litigation The Partnership, through Commonwealth Capital Corp, has initiated a lawsuit against a customer, for approximately $750,000 in addition to ongoing monthly rentals, for failure to make monthly lease payments on the existing terms. Management believes that the Partnership will prevail in this matter. The outstanding receivable is approximately $499,000, which the Partnership believes is fully collectible. The Partnership received a rental payment during the second quarter of 2002 from the above-mentioned broker relating to a July 2001 invoice, for approximately $37,000. During June, 2002, in connection with the above matter, the Partnership filed for Summary Judgment against an unrelated third party broker to collect payments of approximately $307,500 made by Avon Products, Inc. to this broker. The Partnership anticipates a scheduled court date sometime in the third quarter of 2002 in connection with the Summary Judgment. 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 Consolidated 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, 2002, the Partnership has only entered into operating leases. Lease revenue is recognized on a monthly basis in accordance with the terms of the operating lease agreements. 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, 2002 and 2001 were from cash from operations of $322,000 and $807,000, respectively, and net proceeds received from sale of equipment totaling $122,000 for the period ending June 30, 2002 and $119,000 for the period ending June 30, 2001. The primary use of cash for the six months ended June 30, 2002 and 2001, was for capital expenditures for new equipment totaling $97,000 and $147,000, and the payment of preferred distributions to partners for the six months ended June 30, 2002 and 2001 of $173,000 and $462,000, respectively. For the six month period ended June 30, 2002, the Partnership generated cash flows from operating activities of $322,000, 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. For the six month period ended June 30, 2001, the Partnership generated cash flows from operating activities of $807,000, which includes net income of $87,000, a gain on sale of equipment totaling $72,000, and depreciation and amortization expenses of $1,280,000. Other noncash activities included in the determination of net income include direct payments of lease income by lessees to banks of $691,000. 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. At June 30, 2002, the Partnership had approximately $171,000 invested in these money market accounts. Included in accounts receivable is approximately $499,000 of receivables from Avon Products Inc., in which the Partnership has initiated a lawsuit. Management believes we will collect in full the balance due to the Partnership, therefore, no reserves have been booked. During June, 2002, in connection with the above matter, the Partnership filed for Summary Judgment against an unrelated third party broker to collect payments of approximately $307,500 made by Avon Products, Inc. to this broker. The Partnership anticipates a scheduled court date sometime in the third quarter of 2002 in connection with the Summary Judgment. Revenue from the Avon Products, Inc. lease approximates to 15% of the revenues for the six months ended June 30, 2002 and 2001. At June 30, 2002, the Partnership has a receivable from Commonwealth Capital Corp ("CCC"), a related party to the Partnership, in the amount of approximately $301,000. CCC, thru its indirect subsidiaries, including the General Partner of the Partnership, earns fees based on revenues and new lease purchases from this fund and other funds. This is a non-interest bearing receivable that CCC plans to repay over the next two an a half fiscal years from acquisition and debt placement fees earned by the General Partner of the Partnership. For the six months ended June 30, 2002, CCC has repaid approximately $14,000 to the Partnership. 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, 2002, the Partnership had future minimum rentals on non-cancelable operating leases of $794,000 for the balance of the year ending December 31, 2002 and $2,128,000 thereafter. At June 30, 2002, the outstanding debt was $2,289,000, with interest rates ranging from 6.25% to 9.75%, and will be payable through April 2005. 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, 2002 and December 31, 2001 was approximately $3,211,000 and $2,969,000, 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, 2002 and December 31, 2001 was approximately $6,294,000 and $5,526,000, respectively. The Partnership's share of the outstanding debt associated with this equipment at June 30, 2002 and December 31, 2001 was approximately $1,429,000 and $1,581,000, respectively, which is included in the Partnership's liabilities on the balance sheet, and the total outstanding debt at June 30, 2002 and December 31, 2001 related to the equipment shared by the Partnership was approximately $2,478,000 and $4,895,000, respectively. Results of Operations Three Months Ended June 30, 2002 compared to Three Months Ended June 30, 2001 ----------------------------------------------------------------------------- For the quarter ended June 30, 2002, the Partnership recognized income of $685,000 and expenses of $717,000, resulting in a net loss of $32,000. For the quarter ended June 30, 2001, the Partnership recognized income of $844,000 and expenses of $627,000, resulting in net income of $217,000. Lease income decreased by 8% to $686,000 for the quarter ended June 30, 2002, from $746,000 for the quarter ended June 30, 2001, primarily due to the fact that more lease agreements ended than new lease agreements acquired since the quarter ended June 30, 2001. Operating expenses, excluding depreciation, primarily consist of accounting, legal, and outside service fees. The expense increased 136% to approximately $137,000 for the quarter ended June 30, 2002, from $58,000 for the quarter ended June 30, 2001, 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 $17,000, and an increase in remarketing fees of $28,000, an increase in promotions/advertising of $2,000, an increase in outside services of $5,000, an increase in recruiting fees of $3,000, an increase in insurance of $5,000, an increase in due diligence of $11,000, an increase in postage of $3,000, an increase in supplies of $2,000, and an increase in equipment shipping cost of $3,000. 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 8% to approximately $34,000 for the quarter ended June 30, 2002, from $37,000 for the quarter ended June 30, 2001, 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 4% to approximately $489,000 for the quarter ended June 30, 2002, from $508,000 for the quarter ended June 30, 2001 due to equipment and acquisition fees being fully depreciated/amortized and not being replaced with as many new purchases. The partnership recorded bad debt expenses of approximately $14,000 related to disputed accounts receivables balances for the quarter ended June 30, 2002. 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. The Partnership sold computer equipment with a net book value of $10,000 for the quarter ended June 30, 2001, for a net gain of $96,000. Interest expense increased 75% to $43,000 for the quarter ended June 30, 2002 from $25,000 for the quarter ended June 30, 2001, primarily due to the acquisitions of new computer leases and the outstanding debt associated with it. Six Months Ended June 30, 2002 compared to Six Months Ended June 30, 2001 ------------------------------------------------------------------------- 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. For the six months ended June 30, 2001, the Partnership recognized income of $1,654,000 and expenses of $1,567,000, resulting in net income of $87,000. Lease income decreased by 12% to $1,389,000 for the six months ended June 30, 2002, from $1,576,000 for the six months ended June 30, 2001, primarily due to the fact that more lease agreements ended than new lease agreements acquired since the six months ended June 30, 2001. Operating expenses, excluding depreciation, primarily consist of accounting, legal, and outside service fees. The expense increased 61% to approximately $247,000 for the six months ended June 30, 2002, from $153,000 for the six months ended June 30, 2001, 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 $34,000, and an increase in remarketing fees of $30,000, an increase in promotions/advertising of $2,000, an increase in legal fees of $8,000, an increase in due diligence of $11,000, an increase in equipment shipping cost of $4,000, and an increase in marketing of approximately $5,000. 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 11% to approximately $70,000 for the six months ended June 30, 2002, from $79,000 for the six months ended June 30, 2001, 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 19% to approximately $1,033,000 for the six months ended June 30, 2002, from $1,280,000 for the six months ended June 30, 2001 due to equipment and acquisition fees being fully depreciated/amortized and not being replaced with as many new purchases. The partnership recorded bad debt expenses of approximately $68,000 related to disputed accounts receivables balances for the six months ended June 30, 2002. 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 $300. The Partnership sold computer equipment with a net book value of $47,000 for the six months ended June 30, 2001, for a net gain of $72,000. Interest expense increased 48% to $82,000 for the six months ended June 30, 2002 from $55,000 for the six months ended June 30, 2001, primarily due to the acquisitions of new computer leases and the outstanding debt associated with it. RECENT ACCOUNTING PRONOUNCEMENTS SFAS 145 In April 2002, the FASB issued SFAS No. 145, "Recission of FASB statements No. 4, 44 and 64, Amendment of FASB statement No. 13, and Technical Corrections" ("SFAS 145"). FASB No. 4 required that gains and losses from extinguishments of debt that were included in the determination of net income be aggregated and, if material, be classified as an extraordinary item, net of related income tax. Effective January 1, 2003, pursuant to SFAS 145, the treatment of debt is to be included in "Other Income" in the Financial Statements. SFAS 145 has no affect on our financial statements at this time. Part II: OTHER INFORMATION Commonwealth Income & Growth Fund II Item 1. Legal Proceedings. On or about December 21, 2001, a complaint captioned Commonwealth Capital Corp V. Avon Products, Inc. was filed by Commonwealth Capital Corp against Avon Products Inc. with the Federal District Court of the Eastern District of Pennsylvania, No. 01-CV-6915. The initial claim is approximately $750,000, plus ongoing monthly rentals of approximately $37,000 per month. The complaint alleges that the named defendant has failed to make monthly payments on the existing lease terms. The case is still in discovery and no court date has been set. On or about April 26, 2002, the Federal District Court of the Eastern District of Pennsylvania has denied Avon's request for Summary Judgment to join two brokers in the above-mentioned lawsuit. On or about June 15, 2002, in connection with the above matter, the Partnership filed for Summary Judgment against an unrelated third party broker to collect payments of approximately $410,000 made by Avon Products, Inc. to this broker. The Partnership anticipates a scheduled court date sometime in the third quarter of 2002 in connection with the Summary Judgment. 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: 1. SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Commonwealth Income & Growth Fund II, (the "Company") on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, George S. Springsteen, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ George S. Springsteen ------------------------- George S. Springsteen Chief Executive Officer August 19, 2002 In connection with the Quarterly Report of Commonwealth Income & Growth Fund II, (the "Company") on Form 10-Q for the period ending June 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Salvatore R. Barila, Controller of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Salvatore R. Barila ----------------------- Salvatore R. Barila Controller August 19, 2002 b) Report on Form 8-K: None Item 7.A 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. 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 19, 2002 By: /s/ George S. Springsteen --------------- ------------------------------ Date George S. Springsteen President

COMMONWEALTH INCOME & GROWTH FUND II 10-Q