ITEM 1: BUSINESS
GENERAL
Commonwealth Income and Growth Fund II (the "Partnership") was formed on January 13, 1995, under the Pennsylvania Revised Uniform Limited Partnership Act. The Partnership began offering $15,000,000 of Units of Limited Partnership ("Units") to the public on May 12, 1995 (the "Offerings"). On September 22, 1995, $2,521,380 in subscriptions from investors was released by the escrow agent and 126,118 Units were admitted as Limited Partners of the Partnership. The Partnership terminated its offering of Units on May 12, 1997, with 461,817 Units ($9,235,185) admitted as Limited Partners of the Partnership.
See "The Glossary" below for the definition of capitalized terms not otherwise defined in the text of this report.
PRINCIPAL INVESTMENT OBJECTIVES
The Partnership was formed for the purpose of acquiring various types of Equipment, including computer peripheral and other similar capital equipment. The Partnership utilized the net proceeds of the Offering to purchase IBM and IBM compatible computer peripheral and other similar capital equipment. The Partnership utilizes Retained Proceeds and debt financing (not to exceed 30% of the aggregate cost of the Equipment owned or subject to Conditional Sales Contract by the Partnership at the time the debt is incurred) to purchase additional Equipment. The Partnership acquires and leases Equipment principally to U.S. corporations and other institutions pursuant to Operating Leases. The Partnership retains the flexibility to enter into Full Payout Net Leases and Conditional Sales Contracts, but has not done so.
The Partnership's principal investment objectives are to;
(a) acquire, lease and sell Equipment to generate revenues from operations sufficient to provide quarterly cash distributions to Limited Partners;
(b) preserve and protect Limited Partners' capital;
(c) use a portion of Cash Flow and Net Disposition Proceeds derived from the sale, refinancing or other disposition of Equipment to purchase additional Equipment; and
(d) refinance, sell or otherwise dispose of Equipment in a manner that will maximize the proceeds to the Partnership.
THERE CAN BE NO ASSURANCE THAT ANY OF THESE OBJECTIVES WILL BE ATTAINED.
Limited Partners do not have the right to vote on or otherwise approve or disapprove any particular investment to be made by the Partnership.
Although the Partnership has acquired predominately new Equipment, the Partnership may purchase used Equipment. Generally, Equipment is acquired from manufacturers, distributors, leasing companies, agents, owner-users, owner-lessors, and other suppliers upon terms that vary depending upon the Equipment and supplier involved. Manufacturers and distributors usually furnish a limited warranty against defects in material and workmanship and some purchase agreements for Equipment provide for service and replacement of parts during a limited period. Equipment purchases are also made through lease brokers and on an ad hoc basis to meet the needs of a particular lessee.
As of December 31, 2000, all Equipment purchased by the Partnership is subject to an Operating Lease or an Operating Lease was entered into with a third party when the Partnership acquired an item of Equipment. The Partnership may also engage in sale/leaseback transactions, pursuant to which the Partnership would purchase Equipment from companies that would then immediately lease the Equipment from the Partnership. The Partnership may also purchase Equipment which is leased under Full Payout Net Leases or sold under Conditional Sales Contracts at the time of acquisition or the Partnership may enter into a Full Payout Net Lease or Conditional Sales Contract with a third party when the Partnership acquires an item of Equipment.
The Partnership may enter into arrangements with one or more manufacturers pursuant to which the Partnership purchases from such manufacturers Equipment that has previously been leased directly by the manufacturer to third parties ("vendor leasing agreements"). The Partnership and manufacturers may agree to nonrecourse loans to the Partnership from the manufacturers to finance the acquisition of Equipment secured by the Equipment and the receivables due to the manufacturers from users of such Equipment. It is expected that the manufacturers of Equipment will provide maintenance, remarketing and other services for the Equipment subject to such agreements. As of December 31, 2000, the Partnership has not entered into any such agreements.
The General Partner has the discretion consistent with its fiduciary duty to change the investment objectives of the Partnership if it determines that such a change is in the best interest of the Limited Partners and so long as such a change is consistent with the Partnership Agreement. The General Partner will notify the Limited Partners if it makes such a determination to change the Partnership's investment objectives.
TYPES OF EQUIPMENT
COMPUTER PERIPHERAL EQUIPMENT. Computer peripheral equipment consists of devices used to convey information into and out of a central processing unit (or "mainframe") of a computer system, such as tape drives, disk drives, tape controllers, disk controllers, printers, terminals and related control units, all of which are in some way related to the process of storing, retrieving, and processing information by computer.
The Partnership acquires primarily IBM manufactured or IBM compatible equipment. The General Partner believes that dealing in IBM or IBM compatible equipment is particularly advantageous because of the large IBM customer base, policy of supporting users with software and maintenance services and the large amount of IBM and IBM compatible equipment in the marketplace.
Computer technology has developed rapidly in recent years and is expected to continue to do so. Technological advances have permitted continued reductions in the cost of computer processing capacity, thereby permitting applications not economically feasible a few years ago. Much of the older IBM and IBM compatible computer peripheral equipment has not been retired from service, because software is generally interchangeable between older and newer equipment, and older equipment is capable of performing many of the same functions as newer equipment. The General Partner believes that historically values of peripheral equipment have been affected less dramatically by changes in technology than have the values of central processing units. An equipment user who upgrades to a more advanced central processor generally can continue to use his existing peripheral equipment. Peripheral equipment nevertheless is subject to declines in value as new, improved models are developed and become available. Technological advances and other factors, discussed below in Management Discussion and Analysis, have at times caused dramatic reduction in the market prices of older models of IBM and IBM compatible computer peripheral equipment from the prices at which they were originally introduced.
OTHER EQUIPMENT-RESTRICTIONS. The Partnership acquires computer peripheral equipment, such as tape drives, disk drives, tape controllers, disk controllers, printers, terminals and related control units, all of which are in some way related to the process of storing, retrieving and processing information by computer. The General Partner is also authorized, but does not presently intend, to cause the Partnership to invest in non-IBM compatible computer peripheral, data processing, telecommunication or medical
technology equipment. The Partnership may not invest in any of such other types of Equipment (i) to the extent that the purchase price of such Equipment, together with the aggregate Purchase Price of all such other types of Equipment then owned by the Partnership, is in excess of 25% of the total cost of all of the assets of the Partnership at the time of the Partnership's commitment to invest therein and (ii) unless the General Partner determines that such purchase is in the best economic interest of the Partnership at the time of the purchase and, in the case of non-IBM compatible peripheral Equipment, that such Equipment is comparable in quality to similar IBM or IBM compatible Equipment. There can be no assurance that any Equipment investments can be found which meet this standard. Accordingly, there can be no assurance that investments of this type will be made by the Partnership.
DIVERSIFICATION
Diversification is generally desirable to minimize the effects of changes in specific industries, local economic conditions or similar risks. However, the extent of the Partnership's diversification, in the aggregate and within each category of Equipment, depends in part upon the financing which can be assumed by the Partnership or borrowed from third parties on satisfactory terms. The Partnership's policy not to borrow on a recourse basis will further limit its financing options. Diversification also depends on the availability of various types of Equipment. As of December 31, 2000, the Partnership has acquired a diversified Equipment portfolio, which it has leased to 23 different companies located throughout the United States. Approximately 20% of the Equipment acquired by the Partnership consists of Printers. Approximately another 36% of the Equipment acquired by the Partnership consists of Workstations. Approximately 13% of the Equipment acquired by the Partnership consists of tape storage. Approximately 19% of the Equipment acquired by the Partnership consists of Escon drivers. Approximately 7% of the Equipment acquired by the Partnership consists of communication controllers. Approximately 5% of the Equipment acquired by the Partnership consists of routers. During the operational stage of the Partnership, the Partnership may not at any one point in time to lease (or sell pursuant to a Conditional Sales Contract) more than 25% of the Equipment to a single Person or Affiliated group of Persons.
DESCRIPTION OF LEASES
The Partnership to date has purchased, and in the future intends to continue to purchase only Equipment that is subject to a lease or for which a lease or similar agreement will be entered into contemporaneously with the consummation of the Partnership's acquisition of the Equipment. The General Partner to date has leased and in the future intends to lease most of the Equipment purchased by the Partnership to third parties pursuant to Operating Leases. Operating Leases are relatively short-term (12 to 48 month) leases under which the aggregate noncancellable rental payments during the original term of the lease are not sufficient to permit the lessor to recover the purchase price of the subject Equipment. The Equipment may also be leased pursuant to Full Payout Net Leases. Full Payout Net Leases are leases under which the aggregate noncancellable rental payments during the original term of the lease are at least sufficient to recover the purchase price of the subject Equipment. It is anticipated that the Partnership will enter into few, if any, Full Payout net Leases. The General Partner may also enter into Conditional Sales Contracts for Equipment. A Conditional Sales Contract generally provides that the noncancellable payments to the seller over the term of the contract are sufficient to recover the investment in such Equipment and to provide a return on such investment. Under a Conditional Sales Contract, the seller reserves title to, and retain a security interest in, the Equipment until the Purchase Price of the Equipment is paid. As of December 31, 2000, the Partnership has not entered into any Full Payout Net Leases or Conditional Sales Contracts for Equipment and does not presently intend to do so.
In general, the terms of the Partnership's leases, whether the Equipment is leased pursuant to an Operating lease or a Full Payout Net Lease, depend upon a variety of factors, including: the desirability of each type of lease from both an investment and a tax point of view; the relative demand among lessees for Operating or Full Payout Net Leases; the type and use of Equipment and its anticipated residual value; the business of
the lessee and its credit rating; the availability and cost of financing; regulatory considerations; the accounting treatment of the lease sought by the lessee or the Partnership; and competitive factors.
An Operating Lease generally represents a greater risk to the Partnership than a Full Payout Net Lease, because in order to recover the purchase price of the subject Equipment and earn a return on such investment, it is necessary to renew or extend the Operating Lease, lease the Equipment to a third party at the end of the original lease term, or sell the Equipment. On the other hand, the term of an Operating Lease is generally much shorter than the term of a Full Payout Net Lease, and the lessor is thus afforded an opportunity under an Operating Lease to re-lease or sell the subject Equipment at an earlier stage of the Equipment's life cycle than under a Full Payout Net Lease. Also, the annual rental payments received under an Operating Lease are ordinarily higher than those received under a Full Payout Net Lease.
The Partnership's policy is to generally enter into "triple net leases" (or the equivalent, in the case of a Conditional Sales Contract) which typically provide that the lessee or some other party bear the risk of physical loss of the Equipment; pay taxes relating to the lease or use of the Equipment; maintain the Equipment; indemnify the Partnership-lessor against any liability suffered by the Partnership as the result of any act or omission of the lessee or its agents; maintain casualty insurance in an amount equal to the greater of the full value of the Equipment and a specified amount set forth in the lease; and maintain liability insurance naming the Partnership as an additional insured with a minimum coverage which the General Partner deems appropriate. In addition, the Partnership may purchase "umbrella" insurance policies to cover excess liability and casualty losses, to the extent deemed practicable and advisable by the General Partner. As of December 31, 2000, all leases that have been entered into are "triple net leases".
The General Partner has not established any standards for lessees to whom it will lease Equipment and, as a result, there is not an investment restriction prohibiting the Partnership from doing business with any lessees. However, a credit analysis of all potential lessees is undertaken by the General Partner to determine the lessee's ability to make payments under the proposed lease. The General Partner may refuse to enter into an agreement with a potential lessee based on the outcome of the credit analysis.
The terms and conditions of the Partnership's leases, or Conditional Sales Contracts, are each determined by negotiation and may impose substantial obligations upon the Partnership. Where the Partnership assumes maintenance or service obligations, the General Partner generally causes the Partnership to enter into separate maintenance or service agreements with manufacturers or certified maintenance organizations to provide such services. Such agreements generally require annual or more frequent adjustment of service fees. As of December 31, 2000, the Partnership has not entered into any such agreements.
BORROWING POLICIES
The General Partner, at its discretion, may cause the Partnership to incur debt in the maximum aggregate amount of 30% of the aggregate cost of the Equipment owned, or subject to Conditional Sales Contract (except that the Partnership may not incur any indebtedness to acquire Equipment until the net proceeds of the Offering are fully invested, or committed to investment, in Equipment). The Partnership will incur only non-recourse debt, which is secured by Equipment and lease income there from. Such leveraging permits the Partnership to increase the aggregate amount of its depreciable assets, and, as a result, potentially increases both its lease revenues and its federal income tax deductions above those levels, which would be achieved without leveraging. There is no limit on the amount of debt that may be incurred in connection with the acquisition of any single item of Equipment. Any debt incurred is fully amortized over the term of the initial lease or Conditional Sales Contract to which the Equipment securing the debt is subject. The precise amount borrowed by the Partnership depends on a number of factors, including the types of Equipment acquired by the Partnership; the creditworthiness of the lessee; the availability of suitable financing; and prevailing interest rates. The Partnership is flexible in the degree of leverage it employs, within the permissible limit. There can be no assurance that credit will be available to the Partnership in the amount or at the time desired or on terms considered reasonable by the General Partner. As of December 31, 2000, the aggregate non-recourse debt outstanding of $1,665,816 was 14% of the aggregate cost of the Equipment owned.
The Partnership may continue to purchase some items of Equipment without leverage. If the Partnership purchases an item of Equipment without leverage and thereafter suitable financing becomes available, it may then obtain the financing, secure the financing with the purchased Equipment to the extent practicable and invest any proceeds from such financing in additional items of Equipment, or it may distribute some or all of such proceeds to the Limited Partners. Any such later financing will be on terms consistent with the terms applicable to borrowings generally. As of December 31, 2000, the Partnership has not exercised this option.
After the net proceeds of the offering are fully invested in Equipment, the General Partner plans to continue to cause the Partnership to borrow funds, to the fullest extent practicable, at interest rates fixed at the time of borrowing. However, the Partnership may borrow funds at rates, which vary with the "prime" or "base" rate. If lease revenues were fixed, a rise in the "prime" or "base" rate would increase borrowing costs and reduce the amount of the Partnership's income and cash available for distribution. Therefore, the General Partner is permitted to borrow funds to purchase Equipment at fluctuating rates only if the lease for such Equipment provides for fluctuating rental payments calculated on a similar basis.
Any additional debt incurred by the Partnership must be non-recourse. Non-recourse debt, in the context of the business to be conducted by the Partnership, means that the lender providing the funds can look for security only to the Equipment pledged as security and the proceeds derived from leasing or selling such Equipment. Neither the Partnership nor any Partner (including the General Partner) would be liable for repayment of any non-recourse debt.
Loan agreements may also require that the Partnership maintain certain reserves or compensating balances and may impose other obligations upon the Partnership. Moreover, since a significant portion of the Partnership's revenues from the leasing of Equipment will be reserved for repayment of debt, the use of financing reduces the cash, which might otherwise be available for distributions until the debt has been repaid and may reduce the Partnership's Cash Flow over a substantial portion of the Partnership's operating life. As of December 31, 2000, no such agreements existed.
The General Partner and any of its Affiliates may, but are not required to, make loans to the Partnership on a short-term basis. If the General Partner or any of its Affiliates makes such a short-term loan to the Partnership, the General Partner of Affiliate may not charge interest at a rate greater that the interest rate charged by unrelated lenders on comparable loans for the same purpose in the same locality. In no event is the Partnership required to pay interest on any such loan at an annual rate greater than three percent over the "prime rate' from time to time announced by PNC Bank, Philadelphia, Pennsylvania ("PNC Bank"). All payments of principal and interest on any financing provided by the General Partner or any of its affiliates are due and payable by the Partnership within 12 months after the date of the loan.
REFINANCING POLICIES
Subject to the limitations set forth in "Borrowing Policies" above, the Partnership may refinance its debt from time to time. With respect to a particular item of Equipment, the General Partner will take into consideration such factors as the amount of appreciation in value, if any, to be realized, the possible risks of continued ownership, and the anticipated advantages to be obtained for the Partnership, as compared to selling such Equipment. As of December 31, 2000, the Partnership has not refinanced any of its debt.
Refinancing, if achievable, may permit the Partnership to retain an item of Equipment and at the same time to generate additional funds for reinvestment in additional Equipment or for distribution to the Limited Partners.
LIQUIDATION POLICIES
The General Partner intends to cause the Partnership to begin disposing of its Equipment in approximately January 2006. Notwithstanding the Partnership's objective to sell all of its assets and dissolve by December 31, 2006, the General Partner may at any time cause the Partnership to dispose of all its
Equipment and, dissolve the Partnership upon the approval of Limited Partners holding a Majority in Interest of Units.
Particular items of Equipment may be sold at any time if, in the judgment of the General Partner, it is in the best interest of the Partnership to do so. The determination of whether particular items of Partnership Equipment should be sold or otherwise disposed of is made by the General Partner after consideration of all relevant factors (including prevailing general economic conditions, lessee demand, the General Partner's views of current and future market conditions, the cash requirements of the Partnership, potential capital appreciation, cash flow and federal income tax considerations), with a view toward achieving the principal investment objectives of the Partnership. As partial payment for Equipment sold, the Partnership may receive purchase money obligations secured by liens on such Equipment. Subject to the General Partner's discretion the Partnership may extend beyond December 31, 2006, if deemed beneficial to the Partnership.
MANAGEMENT OF EQUIPMENT
Equipment management services for the Partnership's Equipment is provided by the General Partner and its Affiliates and by persons employed by the General Partner. Such services will consist of collection of income from the Equipment, negotiation and review of leases, Conditional Sales Contracts and sales agreements, releasing and leasing-related services, payment of operating expenses, periodic physical inspections and market surveys, servicing indebtedness secured by Equipment, general supervision of lessees to assure that they are properly utilizing and operating Equipment, providing related services with respect to Equipment, supervising, monitoring and reviewing services performed by others in respect to Equipment and preparing monthly Equipment operating statements and related reports.
COMPETITION
The equipment leasing industry is highly competitive. The Partnership competes with leasing companies, equipment manufacturers and their affiliated financing companies, distributors and entities similar to the Partnership (including other programs sponsored by the General Partner), some of which have greater financial resources than the Partnership and more experience in the equipment leasing business than the General Partner. Other leasing companies and equipment manufacturers, their affiliated financing companies and distributors may be in a position to offer equipment to prospective lessees on financial terms, which are more favorable than those, which the Partnership can offer. They may also be in a position to offer trade-in privileges, software, maintenance contracts and other services, which the Partnership may not be able to offer. Equipment manufacturers and distributors may offer to sell equipment on terms (such as liberal financing terms and exchange privileges), which will afford benefits to the purchaser similar to those obtained through leases. As a result of the advantages, which certain of its competitors may have, the Partnership may find it necessary to lease its Equipment on a less favorable basis than certain of its competitors.
The computer peripheral equipment industry is extremely competitive. Competitive factors include pricing, technological innovation and methods of financing. Certain manufacturer-lessors maintain advantages through patent protection, where applicable, and through a policy that combines service and hardware with payment accomplished through a single periodic charge.
The dominant firm in the computer marketplace is International Business Machines Corporation, and its subsidiary IBM Credit Corporation is the dominant force in the leasing of IBM equipment. Because of IBM's substantial resources and dominant position, revolutionary changes with respect to computer systems, pricing, marketing practices, technological innovation and the availability of new and attractive financing plans could occur at any time. Significant action in any of these areas by IBM or IBM Credit Corporation might materially adversely affect the Partnership's business or the other manufacturers with whom the General Partner might negotiate purchase and other agreements. Any adverse effect on these manufacturers could be reflected in the overall return realized by the Partnership on equipment from those manufacturers of from IBM.
INVESTMENTS
As of March 29, 2001, the Partnership has purchased the following Equipment:
RESERVES
Because the Partnership's leases are on a "triple-net" basis, no permanent reserve for maintenance and repairs will be established from the Offering proceeds. However, the General Partner, in its sole discretion, may retain a portion of the Cash Flow and Net Disposition Proceeds available to the Partnership for maintenance, repairs and working capital. There are no limitations on the amount of Cash Flow and Net Disposition Proceeds that may be retained as reserves. Since no reserve will be established if available Cash Flow of the Partnership is insufficient to cover the Partnership's operating expenses and liabilities, it may be necessary for the Partnership to obtain additional funds by refinancing its Equipment or borrowing.
GENERAL RESTRICTIONS
Under the Partnership Agreement, the Partnership is not permitted, among other things, to:
(a) invest in junior trust deeds unless received in connection with the sale of an item of Equipment in an aggregate amount which does not exceed 30% of the assets of the Partnership on the date of the investment;
(b) invest in or underwrite the securities of other issuers;
(c) acquire any Equipment for Units;
(d) issue senior securities (except that the issuance to lenders of notes or other evidences of indebtedness in connection with the financing or refinancing of Equipment or the Partnership's business shall not be deemed to be the issuance of senior securities);
(e) make loans to any Person, including the General Partner or any of its Affiliates, except to the extent a Conditional Sales Contract constitutes a loan;
(f) sell or lease any Equipment to, lease any Equipment from, or enter into any sale-leaseback transactions with, the General Partner or any of its Affiliates; or
(g) give the General Partner or any of its Affiliates an exclusive right or employment to sell the Partnership's Equipment.
The General Partner has also agreed in the Partnership Agreement to use its best efforts to assure that the Partnership shall not be deemed an "investment company" as such term is detained in the Investment Company Act of 1940.
The General Partner and its Affiliates may engage in other activities, whether or not competitive with the Partnership. The Partnership Agreement provides, however, that neither the General Partner nor any of its Affiliates may receive any rebate or "give up" in connection with the Partnership's activities or participate in reciprocal business arrangements that circumvent the restrictions in the Partnership Agreement against dealings with Affiliates.
EMPLOYEES
The Partnership has no employees and receives administrative and other services from the General Partner, which has 12 employees as of December 31, 2000.
ITEM 2:
ITEM 2: PROPERTIES
NOT APPLICABLE
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS
NOT APPLICABLE
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NOT APPLICABLE
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
There is no public market for the Units nor is it anticipated that one will develop. As of December 31, 2000, there were 501 holders of Units. The Units are not listed on any exchange or permitted to trade on any over-the-counter market. In addition, there are substantial restrictions on the transferability of Units.
GENERAL LIMITATIONS
Units cannot be transferred without the consent of the General Partner, which may be withheld in its absolute discretion. The General Partner monitors transfers of Units in an effort to ensure that all transfers are within certain safe harbors promulgated by the IRS to furnish guidance regarding publicly traded partnerships. These safe harbors limit the number of transfers that can occur in any one year. The General Partner intends to cause the Partnership to comply with the safe harbor that permits nonexempt transfers and redemptions of Units of up to five percent of the total outstanding interest in the Partnership's capital or profits in any one year.
REDEMPTION PROVISION
Upon the conclusion of the 30-month period following the termination of the Offering, the Partnership may, at the sole discretion of the General Partner, repurchase a number of the outstanding Units. After such 30 month period, on a semi-annual basis, the General Partner, at its discretion, will establish an amount for redemption, generally not to exceed two percent of the outstanding Units per year, subject to the General Partner's good faith determination that such redemptions will not (a) cause the Partnership to be taxed as a corporation under Section 7704 of the Code or (b) impair the capital or operations of the Partnership. (The Partnership may redeem Units in excess of the two percent limitation if, in the good faith judgment of the General Partner, the conditions imposed in the preceding sentence would remain satisfied.) The redemption price for Units will be 105% of the selling Limited Partner's Adjusted Capital Contributions attributable to the Units for sale. Following the determination of the annual redemption amount, redemptions will occur on a semi-annual basis and all requests for redemption, which must be made in writing, must be on file as of the Record Date in which the redemption is to occur. The General Partner will maintain a master list of requests for redemption with priority being given to Units owned by estates, followed by IRAs and Qualified Plans. All other requests will be considered in the order received. Redemption requests made by or on behalf of Limited Partners who are not affiliated with the General Partner or its Affiliates will be given priority over those made by Limited Partners who are affiliated with
the General Partner or its Affiliates. All redemption requests will remain in effect until and unless canceled, in writing, by the requesting Limited Partner(s).
The Partnership will accept redemption requests beginning 30 months following the termination of the Offering. There will be no limitations on the period of time that a redemption request may be pending prior to its being granted. Limited Partners will not be required to hold their interest in the Partnership for any specified period prior to their making a redemption request.
In order to make a redemption request, Limited Partners will be required to advise the General Partner in writing of such request. Upon receipt of such notification, the Partnership will provide detailed forms and instructions to complete the request.
EXEMPT TRANSFERS
The following six categories of transfers are exempt transfers for purposes of calculating the volume limitations imposed by the IRS and will generally be permitted by the General Partner:
(1) transfers in which the basis of the Unit in the hands of the transferee is determined, in whole or in part, by reference to its basis in the hands of the transferor (for example, Units acquired by corporations in certain reorganizations, contributions to capital, gifts of Units, Units contributed to another partnership, and no liquidating as well as liquidating distributions by a parent partnership to its partners of interests in a sub partnership);
(2) transfers at death;
(3) transfers between members of a family (which include brothers and sisters, spouse, ancestors, and lineal descendants);
(4) transfers resulting from the issuance of Units by the Partnership in exchange for cash, property, or services;
(5) transfers resulting from distributions from Qualified Plans; and
(6) any transfer by a Limited Partner in one or more transactions during any 30-day period of Units representing in the aggregate more than five percent of the total outstanding interests in capital or profits of the Partnership.
ADDITIONAL RESTRICTIONS ON TRANSFER
Limited Partners who wish to transfer their Units to a new beneficial owner are required to pay the Partnership up to $50 for each transfer to cover the Partnership's cost of processing the transfer application and take such other actions and execute such other documents as may be reasonably requested by the General Partner. There is no charge for re-registration of a certificate in the event of a marriage, divorce, death, or trust so long as the transfer is not a result of a sale of the Units.
In addition, the following restrictions apply to each transfer: (i) no transfer may be made if it would cause 25% or more of the outstanding Units to be owned by benefit plans; and (ii) no transfer is permitted unless the transferee obtains such governmental approvals as may reasonably be required by the General Partner, including without limitation, the written consents of the Pennsylvania Securities Commissioner and of any other state securities agency or commission having jurisdiction over the transfer.
ALLOCATION AND DISTRIBUTION BETWEEN THE GENERAL PARTNER AND THE LIMITED PARTNERS
Cash distributions, if any, are made quarterly on March 31, June 30, September 30 and December 31, of each year. Distributions are made 99% to the Limited Partners and one percent to the General Partner until the Limited Partners have received an amount equal to their Capital Contributions plus the Priority Return; thereafter, cash distributions will be made 90% to Limited Partners and 10% to the General Partner. Distributions made in connection with the liquidation of the Partnership or a Partner's Units will be made in accordance with the Partner's positive Capital Account balance as determined under the Partnership Agreement and Treasury Regulations.
The Priority Return is calculated on the Limited Partners' Adjusted Capital Contributions for their Units. The Adjusted Capital Contributions will initially be equal to the amount paid by the Limited Partners for their Units. If distributions at any time exceed the Priority Return, the excess will reduce the Adjusted Capital Contributions, decreasing the base on which the Priority Return is calculated.
If the proceeds resulting from the sale of any Equipment are reinvested in Equipment, sufficient cash will be distributed to the Partners to pay the additional federal income tax resulting from such sale for a Partner in a 39.6% federal income tax bracket or, if lower, the maximum federal income tax rate in effect for individuals for such taxable year.
Generally, the General Partner is allocated Net Profits equal to its cash distributions (but not less than one percent of Net Profits) and the balance is allocated to the Limited Partners. Net Profits arising from transactions in connection with the termination or liquidation of the Partnership are allocated in the following order: (1) First, to each Partner in an amount equal to the negative amount, if any, of his Capital Account; (2) Second, an amount equal to the excess of the proceeds which would be distributed to the Partners based on the Operating Distributions to the Partners over the aggregate Capital Accounts of all the Partners, to the Partners in proportion to their respective shares of such excess, and (3) Third, with respect to any remaining Net Profits, to the Partners in the same proportions as if the distributions were Operating Distributions. Net Losses, if any, are in all cases allocated 99% to the Limited Partners and one percent to the General Partner.
Net Profits and Net Losses are computed without taking into account, in each taxable year of the Partnership, any items of income, gain, loss or deduction required to be specially allocated pursuant to Section 704(b) of the Code and the Treasury Regulation promulgated there under. No Limited Partner is required to contribute cash to the capital of the Partnership in order to restore a closing Capital Account deficit, and the General Partner has only a limited deficit restoration obligation under the Partnership Agreement.
Quarterly distributions in the following amounts were declared and paid to the Limited Partners during 2000, 1999, and 1998.
QUARTER ENDED 2000 1999 1998 - --------------------------------------------------------------------------------
March 31 $228,600 $230,908 $230,908
June 30 228,599 230,908 230,908
September 30 228,625 230,908 230,908
December 31 228,600 190,049 230,910 ------------------------------------------
$914,424 $882,773 $923,634 ==========================================
ALLOCATIONS AND DISTRIBUTIONS AMONG THE LIMITED PARTNERS
Except during the Offering Period, Cash Available for Distribution, which is allocable to the Limited Partners, is apportioned among and distributed to them solely with reference to the number of Units owned by each as of the Record Date for each such distribution. During the Offering Period, Cash Available for Distribution which is allocable to the Limited Partners was apportioned among and distributed to them with reference to both (i) the number of Units owned by each as of each Record Date and (ii) the number of
days since the previous Record Date (or, in the case of the first Record Date, the commencement of the Offering Period) that the Limited Partner owned the Units.
After the Offering Period, Net Profits, Net Losses and Cash Available for Distribution allocable to the Limited Partners is apportioned among them in accordance with the number of Units owned by each. A different convention was utilized during the Offering Period, whereby Net Profits and Net Losses allocable to Limited Partners were apportioned among them in the ratio which the product of the number of Units owned by a Limited Partner multiplied by the number of days in which the Limited Partner owns such Units during the period bears to the sum of such products for all Limited Partners.
In addition, where a Limited Partner transfers Units during a taxable year, the Limited Partner may be allocated Net Profits for a period for which such Limited Partner does not receive a corresponding cash distribution.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA
The following table sets forth, in summary form, selected financial data for the Partnership for each of the five years in the period ended December 31, 2000. This table is qualified in its entirely by the more detailed information and certain of the financial statements presented elsewhere in this report, and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and related notes thereto included herein.
Net loss per unit is computed based upon net loss allocated to the Limited Partners and the weighted average number of equivalent Limited Partners' Units outstanding during the year. Cash distribution per Unit is computed based upon distributions allocated to the Limited Partners and the weighted average number of equivalent Limited Partners' Units outstanding during the year.
ITEM 7:
ITEM 7: MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Partnership satisfied its minimum offering requirements and commenced operations on September 22, 1995.
The Partnership's primary sources of capital for the years ended December 31, 2000, 1999 and 1998 were from cash from operations of $857,000, $1,081,000, and $1,924,000 respectively. The primary uses of cash for the years ended December 31, 2000, 1999, and 1998, were for capital expenditures for new equipment totaling $98,000, $255,000, and $1,702,000, the payment of acquisition fees of $33,000, $57,000, and $223,000 and the payment of distributions to partners totaling $924,000, $892,000, and $933,000 respectively.
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 December 31, 2000, and 1999 the Partnership had approximately $263,000, and $52,000, respectively, invested in these money market accounts.
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. Future minimum rentals on noncancellable operating leases decreased by 36% in December 31, 2000 from December 31, 1999, due to computer equipment leases with expirations in 2000. As of December 31, 2000, the Partnership had future minimum rentals on noncancellable operating leases of $1,343,000 for the year ended 2001 and $664,000 thereafter. During 2000 and 1999, the Partnership incurred debt in connection with the purchase of computer equipment totaling $721,000 and $1,150,000, respectively. At December 31, 2000, the outstanding debt was $1,666,000, with interest rates ranging from 6.35% to 9.75% and will be payable through December 2003. The Partnership intends to continue purchasing additional computer equipment with existing cash, as well as when future cash becomes available. In addition, the Partnership may incur debt in purchasing computer equipment in the future.
The Partnership's cash flow 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 also 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.
For the year ended December 31, 2000, the Partnership generated cash flow from operating activities of $857,000, which includes net loss of $369,000 reduced by depreciation and amortization expenses of $3,680,000. Other noncash activities included in the determination of net income include direct payments of lease income by lessees to banks of $2,382,000.
RESULTS OF OPERATIONS
For the years ended December 31, 2000, 1999 and 1998, the Partnership recognized income of $4,117,000, $4,625,000 and $4,246,000 and expenses of $4,486,000, $5,004,000 and $4,679,000, resulting in a net loss of $369,000, for the year ended December 31, 2000, $379,000 for the year ended December 31, 1999, and a net loss of $434,000 for the year ended December 31, 1998.
Lease income decreased by 11% in 2000 from 1999 primarily due to operating leases that matured in 2000. In 2000 the partnership expended approximately $98,000 in cash and assumed debt of $721,000 to acquire 41 additional leases.
Interest income decreased to $11,000 for the year ended December 31, 2000 from $27,000 for the year ended December 31, 1999, and $33,000 for the year ended December 31, 1998 as a result of cash being used to purchase additional computer equipment and pay Limited Partners' distributions.
Operating expenses, excluding depreciation, consist of accounting, legal, outside service fees and reimbursement of expenses to Com Cap Corp., a related party (see Item 10), for administration and operation of the Partnership. The increase to $241,000 during the year ended December 31, 2000 from $233,000 during the year ended December 31, 1999 is attributable to reimbursable expenses in connection with the administration and operation of the Partnership charged by Com Cap Corp.
The equipment management fee is approximated 5% of the gross lease revenue attributable to equipment that is subject to operating leases. The equipment management fee decreased to $222,000 during the year ended December 31, 2000 from $230,000 during the year ended December 31, 1999 and increased from $211,000, during the year ended December 31, 1998, which is consistent with the change in lease income.
Depreciation and amortization expenses consist of depreciation on computer equipment, amortization of organization costs (for 1999 and 1998 only), equipment acquisition fees and debt placement fees. The decrease to $3,517,000 during the year ended December 31, 2000 from $3,977,000 and $3,909,000 during the year ended December 31, 1999 and 1998, respectively, is attributable to the decrease in the computer equipment portfolio being leased.
In 2000, the Partnership recorded Bad Debt Expense of $45,000 as a result of management's analysis that certain amounts receivable were deemed uncollectible.
The Partnership sold computer equipment with a net book value of $569,000 during the year ended December 31, 2000, for a net loss of $138,000 and in the year ended December 31, 2000, the Partnership sold equipment with a net book value of $57,000 for a net loss of $8,000.
The Partnership identified specific computer equipment and associated equipment acquisition costs, which were reevaluated due to technological changes. The Partnership determined that no impairment had occurred for the year ended December 31, 2000. In 1999 and 1998 the Partnership determined that the carrying amount of certain assets was greater than the undiscounted cash flows to be generated by these assets and therefore recorded a charge of $181,000 and $428,000 to depreciation expense to record the assets at their estimated fair value in the year ended December 31, 1999 and 1998, respectively.
NET LOSS
As a result of the above factors, net loss decreased to $369,000 in 2000 from $379,000 and $434,000, in 1999 and 1998, respectively.
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.
ITEM 8:
ITEM 8: FINANCIAL STATEMENTS
See financial statements commencing in Part IV Item 14.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On December 14, 2000 the Partnership informed the accounting firm of Ernst & Young LLP ("E&Y") that the Partnership would not retain it to audit the Partnership's financial statements for the year ended December 31, 2000. E&Y had been the Partnerships' principal accountants since the fiscal year ended December 31, 1995. The report of E&Y on the financial statements of the Partnership for the two most recent fiscal years did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles. The partnership has had no disagreements with its former principal accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which disagreements, if not resolved to the satisfaction of the former accountants, would have caused it to make reference to the subject matter of disagreements in connection with its report relating to the audits for the fiscal years ended December 31, 1999 and 1998 or during the period from January 1, 2000 to December 14, 2000.
The Partnership's decision not to retain E&Y was not based on the expectation that any disagreement would arise in connection with the audit of its financial statements for the year ended December 31, 2000. The decision not to retain E&Y was made by the Partnership's Board of Directors.
On December 13, 2000 the Partnership approved the accounting firm of BDO Seidman LLP as its principal accountants.
PART III
ITEM 10:
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
GENERAL
The General Partner, a wholly owned subsidiary of Commonwealth of Delaware, Inc., a Delaware corporation, which is in turn a wholly-owned subsidiary of Commonwealth Capital Corp., a Pennsylvania corporation ("Com Cap Corp."), was incorporated in Pennsylvania on August 26, 1993. The General Partner also acts as the General Partner for Commonwealth Income and Growth Fund I and Commonwealth Income and Growth Fund II. The principal business office of the General Partner is 1160 West Swedesford Road, Suite 340, Berwyn, PA 19312, and its telephone number is 610-647-6800. The General Partner manages and controls the affairs of the Partnership and has sole responsibility for all aspects of the Partnership's operations. The officers of the General Partner devote such time to the affairs of the Partnership as in the opinion of the General Partner is necessary to enable it to perform its function as General Partner. The officers of the General Partner are not required to spend their full time in meeting their obligations to the Partnership.
The directors and officers of the General Partner and key employees of Com Cap Corp. are as follows:
NAME TITLE - ---- -----
George S. Springsteen Chairman of the Board of Directors and President of the General Partner and Com Cap Corp.
Kimberly A. MacDougall Executive Vice President, Chief Operating Officer and Secretary of the General Partner and Com Cap Corp.
Henry J. Abbott Vice President and Portfolio Manager of Com Cap Corp.
Salvatore R. Barila Assistant Vice President and Controller of the General Partner and Com Cap Corp.
John A. Conboy III Assistant Vice President and Accounting Manager of the General Partner and Com Cap Corp.
Dorothy A. Ferguson Assistant Vice President of Com Cap Corp.
George S. Springsteen, age 66, is President of both Com Cap Corp. and the General Partner. Mr. Springsteen is also President of the general partners or controlling entities of several prior programs sponsored by Com Cap Corp. with objectives similar to the Partnership's. He has been the sole shareholder and director of Com Cap Corp. since its formation in 1978. From 1971 to 1978, Mr. Springsteen was involved in the computer leasing business of Granite Computer Corporation. Mr. Springsteen served as Vice President of Marketing, in addition to other capacities, and managed a portfolio of approximately $120,000,000 of IBM computers and peripherals. In 1978, Granite Computer Corporation sold its equipment portfolio and left the equipment leasing business. Mr. Springsteen acquired a portion of Granite's portfolio, client base, employees and corporate offices in Jenkintown, Pennsylvania. The new company began operations as Com Cap Corp. in May of 1978. Mr. Springsteen received a Bachelor of Science degree from the University of Delaware in 1957.
Kimberly A. MacDougall, age 41, wife of George Springsteen, is Executive Vice President, Chief Operating Officer and Secretary of Com Cap Corp. and the General Partner and joined Com Cap Corp. in 1997. She is also the President of Commonwealth Capital Securities Corp. From 1980 to 1997, Ms. MacDougall was employed with Wheat First Butcher Singer, a broker/dealer headquartered in Richmond, Virginia. While at Wheat First Butcher Singer, Ms. MacDougall, Senior Vice President, served as Marketing Manager for the Direct Investments Department, with over $450,000,000 of investments under management in real estate,
equipment leasing and energy-related industries. Ms. MacDougall holds Series 7, 63 and 39 NASD licenses and is a member of the Equipment Leasing Association, Investment Partnership Association, and International Association for Financial Planning.
Henry J. Abbott, age 49, is Vice President and Portfolio Manager of Com Cap Corp. and has been employed by Com Cap Corp. since 1998. Mr. Abbot has been active in the commercial lending industry, working primarily on asset-backed transactions for more than twenty-seven years. Prior to joining Com Cap Corp. Mr. Abbott was a founding partner of Westwood Capital LLC, in New York. Prior to that, as Senior Vice President for IBJ Schroder Leasing Corporation where Mr. Abbott managed a group specializing in providing operating lease financing programs in the high technology sector. Mr. Abbott brings extensive knowledge and experience in all facets of asset-backed financing and has successfully managed $1.5 billion of secured transactions. Mr. Abbott attended St. John's University. Mr. Abbott is a member of the Equipment Leasing Association.
Salvatore R. Barila, age 30, is Controller of the General Partner and Com Cap Corp. and certain of its subsidiaries where he has been employed since 2000. From 1992 to 2000, Mr. Barila was employed as Corporate Accounting Manager of RCG Information Technology, Inc. Mr. Barila received a BS degree in Accounting from Pace University in 1992. Mr. Barila is a member of the Equipment leasing Association.
John A. Conboy III, age 54, is Assistant Vice President and Accounting Manager of the General Partner and Com Cap Corp. and certain of its subsidiaries where he has been employed since 1999. From 1965 to 1996, Mr. Conboy was employed as a Manager of Accounting Operations of Consolidated Rail Corporation. Mr. Conboy received a BS/BA degree in Accounting and Business Administration from the University of Phoenix in 1994. Mr. Conboy is a member of the Equipment Leasing Association.
Dorothy A. Ferguson, age 58, is Assistant Vice President of Com Cap Corp. and has been employed by Com Cap Corp. since 1995. She brought with her over 20 years experience in commercial banking and finance. Prior to joining Commonwealth, she held positions as a Banking Officer and Administrative Assistant to the Chairman of a large Philadelphia based bank, as well as Executive Secretary to the CEO of an international manufacturing management group.
The directors and officers of the General Partner are required to spend only such time on the Partnership's affairs as is necessary in the sole discretion of the directors of the General Partner for the proper conduct of the Partnership's business. A substantial amount of time of such directors and officers is expected to be spent on matters unrelated to the Partnership, particularly after the Partnership's investments have been selected. Under certain circumstances, such directors and officers are entitled to indemnification from the Partnership.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION
The following table summarizes the types, amounts and recipients of compensation to be paid by the Partnership directly or indirectly to the General Partner and its Affiliates. Some of these fees are paid regardless of the success or profitability of the Partnership's operations and investments. While such compensation and fees were established by the General Partner and are not based on arm's-length negotiations, the General Partner believes that such compensation and fees are comparable to those which would be charged by an unaffiliated entity or entities for similar services. The Partnership Agreement limits the liability of the General Partner and its Affiliates to the Partnership and the Limited Partners and provides indemnification to the General Partner and its Affiliates under certain circumstances.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
NOT APPLICABLE
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Partnership is subject to various conflicts of interest arising out of its relationships with the General Partner and its Affiliates. These conflicts include the following:
COMPETITION WITH GENERAL PARTNER AND AFFILIATES: COMPETITION FOR MANAGEMENT'S TIME
The General Partner and its Affiliate sponsor other investor programs, which are in potential competition with the Partnership in connection with the purchase of Equipment as well as opportunities to lease and sell such Equipment. Competition for Equipment has occurred and is likely to occur in the future. The General Partner and its Affiliates may also form additional investor programs, which may be competitive with the Partnership.
If one or more investor programs and the Partnership are in a position to acquire the same Equipment, the General Partner will determine which program will purchase the Equipment based upon the objectives of each and the suitability of the acquisition in light of those objectives. The General Partner will generally afford priority to the program or entity that has had funds available to purchase Equipment for the longest period of time. If one or more investor programs and the Partnership are in a position to enter into lease with the same lessee or sell Equipment to the same purchaser, the General Partner will generally afford priority to the Equipment which has been available for lease or sale for the longest period of time.
Certain senior executives of the General Partner and its Affiliates also serve as officers and directors of the other programs and are required to apportion their time among these entities. The Partnership is, therefore, in competition with the other programs for the attention and management time of the General Partner and Affiliates. The officers and directors of the General Partner are not required to devote all or substantially all of their time to the affairs of the Partnership.
ACQUISITIONS
Com Cap Corp. and the General Partner or other Affiliates of the General Partner may acquire Equipment for the Partnership provided that (i) the Partnership has insufficient funds at the time the Equipment is acquired, (ii) the acquisition is in the best interest of the partnership and (iii) no benefit to the General Partner or its Affiliates arises from the acquisition except for compensation paid to Com Cap Corp., the General Partner or such other Affiliate as disclosed in this Report. Com Cap Corp., the General Partner or their Affiliates will not hold Equipment for more than 60 days prior to transfer to the Partnership. If sufficient funds become available to the Partnership within such 60 day period, such Equipment may be resold to the Partnership for a price not in excess of the sum of the cost of the Equipment to such entity and any accountable Acquisition Expenses payable to third parties which are incurred by such entity and interest on the Purchase Price from the date of purchase to the date of transfer to the Partnership. Com Cap Corp., the General Partner or such other Affiliate will retain any rent or other payments received for the Equipment, and bear all expenses and liabilities, other than accountable Acquisition Expenses payable to third parties with respect to such Equipment, for all periods prior to the acquisition of the Equipment by the Partnership. Except as described above, there will be no sales of Equipment to or from any Affiliate of Com Cap Corp.
In certain instances, the Partnership may find it necessary, in connection with the ordering and acquisition of Equipment, to make advances to manufacturers or vendors with funds borrowed from the General Partner for such purpose. The Partnership does not borrow money from the General Partner or any of its Affiliates with a term in excess of twelve months. Interest is paid on loans or advances (in the form of deposits with manufacturers or vendors of Equipment or otherwise) from the General Partner of its Affiliates from their own funds at a rate equal to that which would be charged by third party financing institutions on comparable loans from the same purpose in the same geographic area, but in no event in excess of the General Partner's or Affiliate's own cost of funds. In addition, if the General Partner or its Affiliates borrow money and loan or advance it on a short-term basis to or on behalf of the Partnership, the
General Partnership than that which the General Partner or such Affiliates are paying. The Partnership does not loan money to any Person including the General Partner or its Affiliates except to the extent that a Conditional Sales Contract constitutes a loan.
If the General Partner or any of its Affiliates purchases Equipment in its own name and with its own funds in order to facilitate ultimate purchase by the Partnership, the purchaser is entitled to receive interest on the funds expended for such purchase on behalf of the Partnership. Simple interest on any such temporary purchases is charged on a floating rate basis not in excess of three percent over the "prime rate" from time to time announced by PNC Bank, from the date of initial acquisition to the date of repayment by the Partnership/ownership transfer.
The Partnership does not invest in equipment Limited Partnerships, general partnerships or joint ventures, except that (a) the Partnership may invest in general partnerships or joint ventures with persons other that equipment Programs formed by the General Partner or its Affiliates, which partnerships or joint ventures own specific equipment; provided that (i) the Partnership has or acquires a controlling interest in such ventures or partnerships, (ii) the non-controlling interest is owned by a non-Affiliated, and (iii) the are no duplicate fees; and (b) the Partnership may invest in joint venture arrangements with other equipment Programs formed by the General Partner or its Affiliates if such action is in the best interest of all Programs and if all the following conditions are met: (i) all the Programs have substantially identical investment objectives; (ii) there are no duplicate fees; (iii) the sponsor compensation is substantially identical in each Program; (iv) the Partnership has a right of first refusal to buy another Program's interest in a joint venture if the other Program wishes to sell equipment held in the joint venture; (v) the investment of each Program is on substantially the same terms and conditions; and (vi) the joint venture is formed either for the purpose of effecting appropriated diversification for the Programs or for the purpose of relieving the General Partner or its Affiliates from a commitment entered into pursuant to certain provisions of the Partnership Agreement.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K
(a) (1) Financial Statements.
Commonwealth Income & Growth Fund II
Reports of Independent Certified Public Accountants
Balance Sheets as of December 31, 2000 and 1999
Statements of Operations for each of the three years ended December 31, 2000, 1999, and 1998.
Statements of Partners' Capital for each of the three years ended December 31, 2000, 1999 and 1998.
Statements of Cash Flows for each of the three years ended December 31, 2000, 1999 and 1998.
Notes to Financial Statements
Commonwealth Income & Growth Fund, Inc.
Report of Independent Auditors
Balance Sheet as of February 29, 2000
Notes to Balance Sheet
Commonwealth Capital Corp.
Report of Independent Auditors
Consolidated Balance Sheet as of February 29, 2000
Notes to Consolidated Balance Sheet
(a) (2) Schedules.
Schedules are omitted because they are not applicable, not required, or because the required information is included in the financial statements and notes thereto.
(a) (3) Exhibits. * 3.1 Certificate of Limited Partnership **3.2 Agreement of Limited Partnership **10.1 Agency Agreement dated as of May 12, 1995 by and among the Partnership, the General Partner and Wheat First Securities, Inc.
* Incorporated by reference from the Partnership's Registration Statement on Form S-1 (Registration No. 33-89476)
** Incorporated by reference for the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995.
(b) Reports on Form 8-K
On December 15, 2000, the partnership filed Form 8-K indicating on Item 4, the registrant changed certifying accountants.
The Board of Directors of the Company approved the engagement of BDO Seidman, LLP, at 1700 Market Street, Philadelphia, PA 19103-3592, as its independent auditors for the fiscal year ended December 31, 2000. This is to replace the firm of Ernst & Young LLP, who were dismissed as auditors of the Company. The audit committee of the Board of Directors approved the change in auditors on December 13, 2000.
COMMONWEALTH INCOME & GROWTH FUND II
CONTENTS
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REPORTS OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 3-4
FINANCIAL STATEMENTS Balance sheets 5-6 Statements of operations 7 Statements of partners' capital 8 Statements of cash flows 9-10
NOTES TO FINANCIAL STATEMENTS 11-22
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Partners Commonwealth Income & Growth Fund II Berwyn, Pennsylvania
We have audited the accompanying balance sheet of Commonwealth Income & Growth Fund II as of December 31, 2000, and the related statements of operations, partners' capital, and cash flows for the year ended December 31, 2000. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Commonwealth Income & Growth Fund II at December 31, 2000, and the results of its operations and its cash flows for the year ended December 31, 2000, in conformity with generally accepted accounting principles in the United States.
/s/ BDO Seidman, LLP
Philadelphia, Pennsylvania April 3, 2001
Report of Independent Auditors
The Partners Commonwealth Income & Growth Fund II
We have audited the accompanying balance sheets of Commonwealth Income & Growth Fund II as of December 31, 1999, and the related statements of operations, partners' capital, and cash flows for each of the two years in the period ended December 31, 1999. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Commonwealth Income & Growth Fund II at December 31, 1999, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania March 24, 2000
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COMMONWEALTH INCOME & GROWTH FUND II
BALANCE SHEETS
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
COMMONWEALTH INCOME & GROWTH FUND II
STATEMENTS OF OPERATIONS
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
COMMONWEALTH INCOME & GROWTH FUND II
STATEMENTS OF PARTNERS' CAPITAL
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
COMMONWEALTH INCOME & GROWTH FUND II
STATEMENTS OF CASH FLOWS
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COMMONWEALTH INCOME & GROWTH FUND II
STATEMENTS OF CASH FLOWS
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SEE ACCOMPANYING NOTES TO FINANCIAL STATEMENTS.
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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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. 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.
Allocations of income and distributions of cash are based on the Partnership's Limited Partnership Agreement (the "Agreement"). The various allocations under the Agreement prevent any limited partner's capital account from being reduced below zero and ensure the capital accounts reflect the anticipated sharing ratios of cash distributions, as defined in the Agreement. During 2000, annual cash distributions to limited partners were made at a rate of 9.9% of their original contributed capital. During 1999, annual cash distributions to limited partners were made at a rate of 9.5% of their original contributed capital. During 1998, annual cash distributions to limited partners were made at a rate of 10% of their original contributed capital. Distributions during 2000 reflect an annual return of capital in the amount of approximately $1.98 per limited partnership unit for units, which were outstanding for the entire year. Distributions during 1999 reflect an annual return of capital in the amount of approximately $1.90 per limited partnership unit for units, which were outstanding for the entire year. Distributions during 1998 reflect an annual return of capital in the amount of approximately $2.00 per limited partnership unit for units which were outstanding for the entire year.
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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2. SUMMARY OF REVENUE RECOGNITION SIGNIFICANT ACCOUNTING Through December 31, 2000, the Partnership POLICIES 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.
During 2000, 1999 and 1998, the Partnership identified specific computer equipment and associated equipment acquisition costs, which were reevaluated due to technological changes. In 2000, the Partnership determined that no impairment had occurred. In 1999 and 1998, the Partnership determined that the carrying amount of certain assets was greater than the undiscounted cash flows to be generated by these assets. The Partnership recorded charges of $181,000 and $428,000 in the fourth quarter of 1999 and 1998,
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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respectively, to record the assets at their estimated fair value. Such amounts have been included in depreciation expense in the accompanying financial statements.
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-five 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 three months or less to be cash equivalents. At December 31, 2000 and 1999, 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
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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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 are deducted from partnership capital in the accompanying financial statements.
NET LOSS PER EQUIVALENT LIMITED PARTNERSHIP UNIT
The net loss per equivalent limited partnership unit is computed based upon net loss allocated to the limited partners and the weighted average number of limited partners' equivalent units outstanding during the year.
3. COMPUTER The Partnership is the lessor of equipment EQUIPMENT under operating leases with periods ranging from 22 to 48 months. In general, associated costs such as repairs and maintenance, insurance and property taxes are paid by the lessee. Typically, at the end of the operating lease periods, the lessees continue to lease the equipment on a month- to-month basis.
The following is a schedule of future minimum rentals on noncancelable operating leases at December 31, 2000:
Lease income from one lessee, exceeding 10% of lease revenue, represented 11% of lease income for the year ended December 31, 2000. Lease income from three lessees, each exceeding 10% of total lease income, aggregated 40% of lease income for the year ended December 31, 1999. Lease income from four lessees, each exceeding 10% of total lease income, aggregated 55% of lease income for the year ended December 31, 1998.
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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As of December 31, 2000, four lessees comprised approximately 85% of the Partnership's accounts receivable.
4. RELATED PARTY ORGANIZATIONAL FEE TRANSACTIONS The General Partner is entitled to be paid an Organizational Fee equal to three percent of the first $10,000,000 of Limited Partners' Capital Contributions and two percent of the Limited Partners' Capital Contributions in excess of $10,000,000, as compensation for the organization of the Partnership. No organizational fees were paid during 2000, 1999 and 1998.
REIMBURSEMENT OF EXPENSES
The General Partner and its affiliates are entitled to reimbursement by the Partnership for the cost of goods, supplies or 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 2000, 1999 and 1998, the Partnership recorded $91,000, $84,000 and $72,000, 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. The fee was paid upon each closing of the Offering with respect to the equipment to be purchased by the Partnership with the net proceeds for the Offering available for investment in equipment. If the Partnership acquires equipment in an amount exceeding the net proceeds of the Offering available for investment in equipment, the fee will be paid when such equipment is
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
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acquired. During 2000, 1999 and 1998, equipment acquisition fees of approximately $33,000, $57,000 and $223,000, respectively, were paid to the General Partner.
DEBT PLACEMENT FEE
As compensation for arranging term debt to finance the acquisition of equipment by the Partnership, the General Partner is paid a fee equal to 1% of such indebtedness; provided, however, that such fee shall be reduced to the extent the Partnership incurs such fees to third parties, unaffiliated with the General Partner or the lender, with respect to such indebtedness and no such fee will be paid with respect to borrowings from the General Partner or its affiliates. During 2000, 1999 and 1998, debt placement fees of approximately $7,000, $12,000 and $40,000, respectively, were paid to the General Partner. No debt placement fee was paid to the General Partner.
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 or (ii) the sum of (a) two percent 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 leases. During 2000, 1999 and 1998, equipment management fees of approximately $222,000, $230,000 and $211,000, respectively, were paid to the General Partner as determined pursuant to section (ii) above.
RELEASE FEE
As compensation for providing releasing services for any equipment for which the General Partner has, following the
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
expiration of, or default under, the most recent lease or conditional sales contract, arranged a subsequent lease or conditional sales contract for the use of such equipment to a lessee or other party, other than the current or most recent lessee or other operator of such equipment or its affiliates ("Release"), the General Partner shall receive, on a monthly basis, a Release Fee equal to the lesser of (a) the fees which would be charged by an independent third party for comparable services for comparable equipment or (b) two percent of gross lease revenues derived from such Release. There were no such fees paid to the General Partner in 2000, 1999 and 1998.
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) three percent 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. There were no such fees paid to the General Partner in 2000, 1999 and 1998.
5. NOTES PAYABLE Notes payable consisted of the following:
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
These notes are secured by specific computer equipment and are nonrecourse liabilities of the Partnership. Aggregate maturities of notes payable for each of the three years subsequent to December 31, 2000 are as follows:
6. SUPPLEMENTAL Other noncash activities included in the CASH FLOW determination of net loss are as follows: INFORMATION
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.
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
Noncash investing and financing activities include the following:
7. RECONCILIATION OF NET (LOSS) REPORTED FOR FINANCIAL REPORTING PURPOSES TO TAXABLE (LOSS) INCOME ON THE FEDERAL PARTNERSHIP RETURN
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
8. QUARTERLY RESULTS Summarized quarterly financial data for the OF OPERATION years ended December 31, 2000 and 1999 is as (UNAUDITED) follows:
COMMONWEALTH INCOME & GROWTH FUND II
NOTES TO FINANCIAL STATEMENTS
================================================================================
Net (loss) for the quarters ended March 31, 2000, June 30, 2000 and September 30, 2000 decreased by approximately $47,000, $54,000 and $30,000, respectively, due to decreases in the gain (loss) on sale of computer equipment. The partnership will file new quarterly reports to reflect these changes. The cumulative gain or loss on sale of equipment is included in revenues or costs as appropriate.
Net income (loss) for the quarter ended September 30, 1999 decreased by approximately $50,000 due to a decrease in the gain (loss) on sale of computer equipment.
* Restated for the first, second and third quarters for the year ended December 31, 2000 and the third quarter 1999.
9. FOURTH QUARTER During the fourth quarter of 2000, the ADJUSTMENTS Partnership recorded bad debts of approximately $45,000.
COMMONWEALTH INCOME & GROWTH FUND, INC. (An Indirect Wholly-Owned Subsidiary of Commonwealth Capital Corp.)
BALANCE SHEET
FEBRUARY 29, 2000
COMMONWEALTH INCOME & GROWTH FUND, INC. (An Indirect Wholly-Owned Subsidiary of Commonwealth Capital Corp.)
FEBRUARY 29, 2000
PAGE ----
INDEPENDENT AUDITOR'S REPORT 1
BALANCE SHEET 2
NOTES TO BALANCE SHEET 3
INDEPENDENT AUDITOR'S REPORT
Stockholder Commonwealth Income & Growth Fund, Inc.
We have audited the accompanying balance sheet of COMMONWEALTH INCOME & GROWTH FUND, INC. (An indirect wholly-owned subsidiary of Commonwealth Capital Corp.) as of February 29, 2000. This balance sheet is the responsibility of the Company's management. Our responsibility is to express an opinion on this balance sheet based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the balance sheet is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the balance sheet. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the balance sheet referred to above presents fairly, in all material respects, the financial position of Commonwealth Income & Growth Fund, Inc. as of February 29, 2000, in conformity with generally accepted accounting principles.
Fishbein & Company, P.C.
Elkins Park, Pennsylvania May 22, 2000
COMMONWEALTH INCOME & GROWTH FUND, INC (An Indirect Wholly-Owned Subsidiary of Commonwealth Capital Corp.)
BALANCE SHEET FEBRUARY 29, 2000
ASSETS
Cash $ 500
Investment in Partnerships 3,000 -----------
$ 3,500 -----------
LIABILITIES AND STOCKHOLDER'S EQUITY
LIABILITIES Accrued expenses $ 200 Due to parent 468 Due to income funds 1,732 -----------
2,400 -----------
STOCKHOLDER'S EQUITY Common stock -- No par value Authorized 1,000 shares Issued and outstanding 100 shares 1,000 Additional paid -- in capital 1,000,100 -----------
1,001,100 Less note receivable (1,000,000) -----------
1,100 -----------
$ 3,500 -----------
See notes to balance sheet.
COMMONWEALTH INCOME & GROWTH FUND, INC. (An Indirect Wholly-Owned Subsidiary of Commonwealth Capital Corp.)
NOTES TO BALANCE SHEET FEBRUARY 29, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Nature of Business
Commonwealth Income & Growth Fund, Inc. (the company) is a wholly-owned subsidiary of Commonwealth of Delaware, Inc. which is a wholly-owned subsidiary of Commonwealth Capital Corp. (CCC). The company is the sole General Partner of Commonwealth Income & Growth Fund I, Commonwealth Income & Growth Fund II, and Commonwealth Income & Growth Fund III, all Pennsylvania limited partnerships (the "Partnerships").
CCC has provided additional capital by means of a non-interest bearing demand note in the amount of $1,000,000, so that the company will at all times have a net worth (which includes the net equity of the Company and the demand note receivable from CCC) of at least $1,000,000. The note receivable is reflected on the accompanying balance sheet as a reduction of the Company's equity.
The Company's operations are included in the consolidated federal income tax return of CCC.
b. Use of Estimates
The preparation of the balance sheet 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. Actual results could differ from those estimates.
2. INVESTMENT IN PARTNERSHIPS
The Company contributed $3,000 in cash to the Partnerships for its general partner interests. The Company may, at its sole discretion, purchase a limited partnership interest in the Partnerships ("Units") for an additional capital contribution of $20 per Unit with a minimum investment of 125 units.
3. RELATED PARTY TRANSACTIONS
The Company and its affiliates receive substantial fees and compensation in connection with the offering of Units and the management of the Partnerships' assets.
See notes to balance sheet.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS FEBRUARY 29, 2000
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS FEBRUARY 29, 2000
PAGE ---- INDEPENDENT AUDITOR'S REPORT 1
CONSOLIDATED FINANCIAL STATEMENTS Balance sheets 2 Statements of operations and retained earnings 3 Statements of cash flows 4 Notes to financial statements 5 - 11
INDEPENDENT AUDITOR'S REPORT
Stockholder Commonwealth Capital Corp.
We have audited the accompanying consolidated balance sheets of COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES as of February 29, 2000 and February 28, 1999, and the related consolidated statements of operations and retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Commonwealth Capital Corp. and Subsidiaries as of February 29, 2000 and February 28, 1999, and the consolidated results of their operations and their consolidated cash flows for the years then ended in conformity with generally accepted accounting principles.
Fishbein & Company, P.C.
Elkins Park, Pennsylvania May 22, 2000
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS
See notes to consolidated financial statements.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
1. NATURE OF BUSINESS
Commonwealth Capital Corp., through its wholly-owned subsidiary, Commonwealth of Delaware, Inc. (CDI), primarily leases various types of computer peripheral equipment and related equipment to U.S. corporations and institutions. Certain wholly-owned subsidiaries of CDI were formed for the purpose of functioning as general partners/managing trustees which own a 1% interest in limited partnerships/trusts (the "Income Funds") which were organized to acquire, own, and act as lessor with respect to certain computer equipment. CDI's subsidiaries include Commonwealth Capital Fund 1987-I, Inc., Commonwealth Capital Fund 1988-I, Inc., Commonwealth Capital Fund No. 3, Inc., Commonwealth Capital Fund No. 4, Inc., Commonwealth Capital Fund V, Inc., Commonwealth Capital Private Fund-I, Inc., Commonwealth Capital Fund VI, Inc., Commonwealth Capital Fund VII, Inc., Commonwealth Capital Private Fund - II, Inc., Commonwealth Capital Trustee VIII, Inc., Commonwealth Capital Trustee IX, Inc., Commonwealth Capital Trustee X, Inc., Commonwealth Capital Private Fund-III, Inc., Commonwealth Income & Growth Fund, Inc., Commonwealth Capital Private Fund IV, Inc., Commonwealth Capital Private Fund V, Inc., and Commonwealth Capital Private Fund VI, Inc. (collectively the "General Partner Subsidiaries"), Commonwealth Capital Securities Corp., Garden State Facilities Funding, Inc. (GSFF), and Commonwealth Capital Delaware Trustee, Inc.
The Company is dependent on the compensation it receives from the Income Funds. This compensation may be reduced due to the financial performance of each Income Fund. There are certain Income Funds that have deferred the payment of fees to the Company, because distributions to the limited partners were reduced because of their financial performance. If the financial performance of additional Income Funds deteriorates and the distributions to the limited partners are reduced, there is no assurance that the Company would be able to continue to collect fees for services provided.
Commission income is earned by Commonwealth Capital Securities Corp., which sells units of its affiliated partnerships through broker-dealer firms to their respective customers throughout the United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, CDI, and CDI's subsidiaries (the Company) (see Note 1). All significant intercompany transactions and balances have been eliminated. The balance sheets are presented on an unclassified basis in accordance with leasing industry practice.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
b. 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.
c. Cash and Cash Equivalents
The Company maintains its cash balances in several financial institutions. The balances in each institution are insured (up to $100,000) by the Federal Deposit Insurance Corporation or the Securities Investor Protection Corporation. At times, the balances may exceed federally insured limits. The Company has not experienced any losses in such accounts, and believes it is not exposed to any significant credit risk on cash.
The Company considers all highly-liquid investments purchased with a maturity of three months or less to be cash equivalents. At February 29, 2000 and February 28, 1999, cash equivalents consist of a money market fund which invests in U.S. Treasury obligations.
d. Investment in Income Funds
The Company accounts for its 1% interests in the Income Funds by the equity method. In 1999 and 1998, certain Income Funds had liabilities in excess of their assets. As the Company is obligated to fund any liabilities in excess of assets, the Company has reduced its investment in Income Funds and recorded a Due to Income Funds of $61,255 and $63,382 at February 29, 2000 and February 28, 1999, of which ($2,127) and $17,269 was incurred during the years ended February 29, 2000 and February 28, 1999, respectively. Financial information of the Income Funds as of December 31, 1999 and 1998, is as follows:
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
d. Investment in Income Funds (Continued)
The Company has guaranteed the performance of certain nonmonetary obligations of the General Partner Subsidiaries to the respective Income Funds, primarily the responsibility for management of the Income Funds. In addition, the Company is responsible for certain capital funding requirements of the General Partner Subsidiaries which it satisfies through noninterest-bearing demand notes. Such notes total approximately $4,166,000 at February 29, 2000 and February 28, 1999, and have been eliminated in consolidation.
Fee income earned by the Company from the Income Funds consists of: (1) equipment acquisition fees (4% (as defined) of the purchase price of all equipment purchased by the Income Funds), (2) debt placement fees (1% of the cost of equipment financed by the Income Funds), (3) sales fees (3% of the gross proceeds of equipment sold by the Income Funds), and (4) equipment management fees (3% - 5% (as defined) of the gross operating lease revenues of the Income Funds). Ongoing acquisition fees and equipment management fees may be increased as an indirect result of company loans.
Approximately 58% and 76% of fee income for the years ended February 29, 2000 and February 28, 1999, was from three Income Funds.
e. Office Furniture and Equipment
Office furniture and equipment are stated at cost. Depreciation is provided using the declining balance method over the estimated useful lives of the assets (ranging from 5 to 7 years).
f. Deferred Offering Costs
Deferred offering costs represent amounts incurred by the Company for the organization of an Income Fund. These costs are recovered from the Income Fund through fees as cash proceeds are raised through the sale of Limited Partnership Units during the offering period or, if necessary, the future operations of the Income Fund. Deferred offering costs at February 29, 2000 and February 28, 1999, relate to an Income Fund whose offering period expires in July, 2000.
g. Revenue Recognition
The Company recognizes fees as earned in accordance with the various Limited Partnership and Trust Agreements. The Company recognizes commission income and brokerage fee expense on an accrual basis based on the trade date of the underlying customer transactions. Interest income on minimum lease payments receivable is recognized as earned.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
h. Income Taxes
Deferred income taxes are provided as necessary for temporary differences between the financial and tax bases of investment in Income Funds and office furniture and equipment. The tax basis of investment in income funds differs from financial reporting due to temporary differences associated with ownership of general partnership interests in the various Income Funds. Also, for income tax reporting, the cost of property and equipment is being recovered using the methods and lives prescribed by the Internal Revenue Code.
Deferred income tax assets are also recognized for net operating losses and investment tax credit carryforwards that are available to offset future income taxes. A valuation allowance is provided as necessary to reduce the deferred income tax assets to the amount that is more likely than not to be realized.
3. LEASE COMMITMENTS
GSFF acted as lessor in a series of lease purchase transactions whereby the underlying assets were funded by investors through certificates of participation in the lease payments. All of GSFF's rights as lessor were assigned to a third-party agent which administers the collection of rentals paid by the lessee. The obligations under the certificates are nonrecourse to GSFF. Accordingly, any reduction in the minimum lease payments receivable for uncollectible accounts would result in an equal reduction of the nonrecourse obligations. Amounts outstanding at February 29, 2000 and February 28, 1999, under these leases and certificates of participation are $4,715,000 and $5,260,000, respectively, and are reflected as minimum lease payments receivable and nonrecourse obligations in the accompanying balance sheets. The certificates mature at various dates through 2011. The Company recognized interest income and interest expense in connection with these leases of $358,828 and $395,375 for the years ended February 29, 2000 and February 28, 1999, respectively.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
3. LEASE COMMITMENTS (Continued)
Future minimum lease payments to be received as of February 29, 2000, are as follows:
The Company leases an automobile, certain office equipment and office space under noncancelable operating leases expiring in various dates through 2004. Rent expense under all operating leases was approximately $155,000 and $174,000 for the years ended February 29, 2000 and February 28, 1999, respectively. Future minimum lease payments under noncancelable operating leases as of February 29, 2000, are as follows:
4. PROFIT SHARING PLAN
The Company has a profit sharing plan which covers substantially all of its employees. Contributions to the plan may be made at the discretion of management. No contributions to the plan were made or accrued for the years ended February 29, 2000 and February 28, 1999.
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
5. RELATED PARTY TRANSACTIONS
For the year ended February 28, 1999, certain of the General Partner Subsidiaries agreed to waive or forgive the related Income Funds' obligations to pay certain equipment management fees in the amount of $28,907. Accordingly, fee income from Income Funds is reflected net of these amounts. No fees were waived or forgiven for the year ended February 29, 2000.
6. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return.
The Company has net operating loss carryforwards of approximately $639,000 and investment tax credit carryforwards of approximately $109,000 available to reduce future federal income taxes. If not used, the carryforwards will expire as follows:
The Company also has net operating loss carryforwards of approximately $3,758,000 available to reduce future Pennsylvania state income taxes. If not used, the carryforwards will expire as follows:
COMMONWEALTH CAPITAL CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FEBRUARY 29, 2000
6. INCOME TAXES (Continued)
At February 29, 2000 and February 28, 1999, the cumulative temporary differences resulted in net deferred tax assets or liabilities consisting primarily of:
The valuation allowance was increased by $146,000 and $29,000, respectively, for the years ended February 29, 2000 and February 28, 1999.
7. SUPPLEMENTAL CASH FLOW INFORMATION
Other noncash activities associated with lease transactions: