UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2001
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to .
--------
Commission File No. 0-19137
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
--------------------------------------------
(Exact name of registrant as specified in its charter)
Massachusetts 04-3057290
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
88 Broad Street, Boston, MA 02110
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 854-5800
-------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
-----
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes No
1
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION: Page
----
Item 1. Financial Statements
Statement of Financial Position
at June 30, 2001 and December 31, 2000 3
Statement of Operations
for the three and six months ended June 30, 2001 and 2000 4
Statement of Cash Flows
for the six months ended June 30, 2001 and 2000 5
Notes to the Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
PART II. OTHER INFORMATION:
Item 1 - 6 20
2
3
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
JUNE 30, 2001 AND DECEMBER 31, 2000
(UNAUDITED)
June 30, December 31,
2001 2000
ASSETS
Cash and cash equivalents $ 3,208,739 $ 2,827,385
Rents receivable 4,857 116,820
Accounts receivable - affiliate 137,655 33,452
Other assets 34,016 24,508
Investment in real estate venture 3,205,202 3,363,711
Net investment in sales-type lease 129,043 240,330
Equipment at cost, net of accumulated depreciation
of $8,408,636 and $8,152,945 at June 30, 2001
and December 31, 2000, respectively 2,388,478 2,644,169
------------ --------------
Total assets $ 9,107,990 $ 9,250,375
============ ==============
LIABILITIES AND PARTNERS' CAPITAL
Notes payable $ 1,142,265 $ 906,869
Accrued interest 7,525 7,161
Accrued liabilities 613,396 591,617
Accrued liabilities - affiliate 30,061 17,207
Deferred rental income - 27,244
------------ --------------
Total liabilities 1,793,247 1,550,098
------------ --------------
Partners' capital (deficit):
General Partner (2,629,720) (2,610,443)
Limited Partnership Interests
(2,714,647 Units; initial purchase price of $25 each) 9,944,463 10,310,720
------------ --------------
Total partners' capital 7,314,743 7,700,277
------------ --------------
Total liabilities and partners' capital $ 9,107,990 $ 9,250,375
============ ==============
The accompanying notes are an integral part of these financial statements.
3
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000
(UNAUDITED)
For the three months ended For the six months ended
June 30, June 30,
2001 2000 2001 2000
INCOME
Operating lease revenue $ 155,113 $ 148,602 $ 311,108 $ 258,022
Sales-type lease revenue 3,351 - 6,702 -
Interest income 38,022 37,238 68,143 104,174
Gain on sale of equipment - 750,000 - 750,000
Other income 29,000 245,977 29,000 300,977
---------- ---------- ---------- ----------
Total income 225,486 1,181,817 414,953 1,413,173
---------- ---------- ---------- ----------
EXPENSES
Depreciation 65,345 79,837 130,691 159,674
Write-down of equipment 125,000 - 125,000 -
Interest expense 31,637 23,388 49,030 54,073
Equipment management fees - affiliate 10,705 7,430 21,455 12,901
Operating expenses - affiliate 174,370 130,718 315,802 246,995
Partnership's share of unconsolidated
real estate venture's loss 83,806 19,775 158,509 23,337
---------- ---------- ---------- ----------
Total expenses 490,863 261,148 800,487 496,980
---------- ---------- ---------- ----------
Net income (loss) $(265,377) $ 920,669 $(385,534) $ 916,193
========== ========== ========== ==========
Net income (loss) per limited partnership unit $ (0.09) $ 0.32 $ (0.13) $ 0.32
========== ========== ========== ==========
Cash distributions declared
per limited partnership unit $ -- $ -- $ -- $ --
========== ========== ========== ==========
The accompanying notes are an integral part of these financial statements.
4
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000
(UNAUDITED)
2001 2000
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income (loss) $ (385,534) $ 916,193
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 130,691 159,674
Write-down of equipment 125,000 -
Gain on sale of equipment - (750,000)
Sales-type lease revenue (6,702) -
Partnership's share of unconsolidated
real estate venture's loss 158,509 23,337
Changes in assets and liabilities:
Rents receivable 111,963 -
Accounts receivable - affiliate (104,203) (1,684)
Other assets (9,508) 31,742
Collections on net investment in sales-type lease 117,989 -
Accrued interest 364 (4,493)
Accrued liabilities 21,779 (237,144)
Accrued liabilities - affiliate 12,854 (68,572)
Deferred rental income (27,244) (25,775)
----------- ------------
Net cash provided by operating activities 145,958 43,278
----------- ------------
CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES
Proceeds from equipment sales - 750,000
Investment in real estate venture - (3,640,000)
----------- ------------
Net cash provided by (used in) investing activities - (2,890,000)
----------- ------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Proceeds from notes payable 505,028 201,247
Principal payments - notes payable (269,632) (130,205)
----------- ------------
Net cash provided by financing activities 235,396 71,042
----------- ------------
Net increase (decrease) in cash and cash equivalents 381,354 (2,775,680)
Cash and cash equivalents at beginning of period 2,827,385 5,719,642
----------- ------------
Cash and cash equivalents at end of period $3,208,739 $ 2,943,962
=========== ============
SUPPLEMENTAL INFORMATION
Cash paid during the period for interest $ 48,666 $ 58,566
=========== ============
See Note 8 to the financial statements regarding the refinancing of the
Partnership's notes payable in February 2001.
The accompanying notes are an integral part of these financial statements.
5
------
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
- -----------------------------------
The financial statements presented herein are prepared in conformity with
accounting principles generally accepted in the United States for interim
financial reporting and the instructions for preparing Form 10-Q under Rule
10-01 of Regulation S-X of the Securities and Exchange Commission and are
unaudited. As such, these financial statements do not include all information
and footnote disclosures required under accounting principles generally accepted
in the United States for complete financial statements and, accordingly, the
accompanying financial statements should be read in conjunction with the
footnotes presented in the 2000 Annual Report. Except as disclosed herein,
there has been no material change to the information presented in the footnotes
to the 2000 Annual Report.
In the opinion of management, all adjustments (consisting of normal and
recurring adjustments) considered necessary to present fairly the financial
position at June 30, 2001 and December 31, 2000 and results of operations for
the three and six month periods ended June 30, 2001 and 2000 have been made and
are reflected. Operating results for the six months ended June 30, 2001 are not
necessarily indicative of the results that may be expected for the entire year.
NOTE 2 - CASH
- ----------------
At June 30, 2001, AIRFUND II International Limited Partnership (the
"Partnership") had $3,109,515 invested in federal agency discount notes,
repurchase agreements secured by U.S. Treasury Bills or interests in U.S.
Government securities, or other highly liquid overnight investments.
NOTE 3 - REVENUE RECOGNITION
- --------------------------------
Rents are payable to the Partnership monthly or quarterly and no significant
amounts are calculated on factors other than the passage of time. The majority
of the leases are accounted for as operating leases and are noncancellable.
Rents received prior to their due dates are deferred. In certain instances, the
Partnership may enter renewal or re-lease agreements which expire beyond the
Partnership's anticipated dissolution date. This circumstance is not expected
to prevent the orderly wind-up of the Partnership's business activities as the
General Partner and Equis Financial Group Limited Partnership ("EFG") would seek
to sell the then-remaining equipment assets either to the lessee or to a third
party, taking into consideration the amount of future noncancellable rental
payments associated with the attendant lease agreements. See also Note 9 to the
financial statements regarding the Class Action Lawsuit. Future minimum rents
for operating leases of $1,186,927 are due as follows:
For the year ending June 30, 2002 $ 412,079
2003 412,079
2004 313,754
2005 49,015
----------
. Total $1,186,927
==========
Lease payments for the sales-type lease are due monthly and the related revenue
is recognized by a method, which produces a constant periodic rate of return on
the outstanding investment in the lease. Future minimum lease payments for the
sales-type lease of $137,418 are due through the date of the lease expiration in
January 2002.
6
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS - (CONTINUED)
JUNE 30, 2001
(UNAUDITED)
NOTE 4 - EQUIPMENT
- ---------------------
The following is a summary of equipment owned by the Partnership at June 30,
2001. Remaining Lease Term (Months), as used below, represents the number of
months remaining from June 30, 2001 under contracted lease terms. A Remaining
Lease Term equal to zero reflects equipment held for sale or re-lease. In the
opinion of EFG, the acquisition cost of the equipment did not exceed its fair
market value.
Remaining
Lease
Term Equipment
Equipment Type (Months) at Cost
- ------------------------------------------------ ---------- ------------
Two Rolls Royce aircraft engines (Off Lease) 0 $ 6,000,000
One McDonnell-Douglas MD-82
(Aerovias de Mexico S.A. de C.V.) 38 2,078,640
One McDonnell-Douglas MD-82 (Off Lease) 0 2,078,640
One Boeing 737-2H4 (Air Slovakia) 26 639,834
------------
Total equipment cost . 10,797,114
Accumulated depreciation . (8,408,636)
------------
Equipment, net of accumulated depreciation . $ 2,388,478
============
The costs of each of the Partnership's aircraft represent proportionate
ownership interests. The remaining interests are owned by other affiliated
partnerships sponsored by EFG. All partnerships individually report, in
proportion to their respective ownership interests, their respective shares of
assets, liabilities, revenues, and expenses associated with the aircraft.
One of the Partnership's aircraft and the related lease payment streams secures
the Partnership's loan with a third-party lender (see Note 8). The preceding
summary includes leveraged equipment having an original cost of approximately
$2,079,000 and a net book value of approximately $1,165,000 at June 30, 2001.
The Rolls Royce aircraft engines were fully depreciated prior to December 31,
2000.
At June 30, 2001, a McDonnell Douglas MD-82 aircraft previously leased to
Finnair OY and the Partnership's Rolls Royce aircraft engines were off lease.
The Partnership's interest in this aircraft had an original cost of
approximately $2,079,000 and a net book value of approximately $1,040,000 at
June 30, 2001. The aircraft engines had a cost of $6,000,000 and have been
fully depreciated. The General Partner is attempting to remarket this aircraft
and the Rolls Royce aircraft engines.
The Partnership accounts for impairment of long-lived assets in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"
which was issued in March 1995. SFAS No. 121 requires that long-lived assets be
reviewed for impairment whenever events or changes in circumstances indicate
that the net book value of the assets may not be recoverable from undiscounted
future cash flows. During the three months ended June 30, 2001, the Partnership
recorded a write-down of equipment, representing an impairment to the carrying
value of the Partnership's interest in the McDonnell Douglas MD-82 aircraft
discussed above. The resulting charge of $125,000 was based on a comparison of
estimated fair value and carrying value of the Partnership's interest in the
aircraft.
7
======
NOTE 5 - INVESTMENT IN REAL ESTATE VENTURE
- -------------------------------------------------
On March 8, 2000, the Partnership and 10 affiliated partnerships (the ''Exchange
Partnerships'') collectively loaned $32 million to Echelon Residential Holdings
LLC (''Echelon Residential Holdings''), a newly formed real estate company.
Echelon Residential Holdings is owned by several investors, including James A.
Coyne, Executive Vice President of EFG. In addition, certain affiliates of the
General Partner made loans to Echelon Residential Holdings in their individual
capacities.
The Partnership's original loan was $3,640,000. Echelon Residential Holdings,
through a wholly-owned subsidiary (Echelon Residential LLC), used the loan
proceeds to acquire various real estate assets from Echelon International
Corporation, a Florida-based real estate company. The loan has a term of 30
months, maturing on September 8, 2002, and an annual interest rate of 14% for
the first 24 months and 18% for the final six months. Interest accrues and
compounds monthly and is payable at maturity. In connection with the
transaction, Echelon Residential Holdings has pledged a security interest in all
of its right, title and interest in and to its membership interests in Echelon
Residential LLC to the Exchange Partnerships as collateral.
The loan is presented, in accordance with the guidance set forth in the Third
Notice to Practitioners by the American Institute of Certified Public
Accountants in February 1986 entitled "ADC Arrangements", as an investment in
real estate venture and is presented net of the Partnership's share of losses in
Echelon Residential Holdings. The Partnership is allocated its proportionate
share of the unconsolidated real estate venture's net income or loss, adjusted
for interest on the ADC arrangements, based on the balance of its ADC
arrangement in relation to the real estate venture's total equity and notes
payable, including the ADC arrangements. For the six month periods ended June
30, 2001 and 2000, the Partnership's share of losses in Echelon Residential
Holdings were $158,509 and $23,337, respectively, and are reflected on the
Statement of Operations as ''Partnership's share of unconsolidated real estate
venture's loss."
The Partnership took into consideration the following characteristics of the
loan in determining that the loan should be accounted for as an investment in a
real estate venture: (i) the Exchange Partnerships who made the loans
collectively have provided substantially all of the necessary funds to acquire
the underlying properties without taking title to such properties, (ii) by
virtue of a pledged security interest in the wholly owned subsidiary of Echelon
Residential Holdings that holds title to the properties, the Partnership's loan
is secured only by the underlying properties, (iii) Echelon Residential Holdings
will only repay the Partnership at maturity, including all interest accrued on
the loan through maturity, (iv) it is expected that Echelon Residential Holdings
can only repay the loan through sales of undeveloped and developed property; and
(v) the structure of the loan (i.e. no payments due until maturity) makes it
unlikely that the properties will be taken in foreclosure as a result of
delinquency.
8
The summarized financial information for Echelon Residential Holdings as of and
for the periods ended June 30, 2001 and 2000, respectively, is as follows:
(Unaudited)
As of and for the periods ended
June 30,
2001 2000
------------ ------------
Total assets $79,159,776 $54,704,360
Total liabilities $85,455,528 $48,386,270
Minority interest $ 1,782,982 $ 2,527,750
Total equity (deficit) $(8,078,734) $ 3,790,340
Total revenues $ 1,705,679 $ 905,751
Total expenses, minority interest
and equity in loss of unconsolidated
joint venture $ 5,924,774 $ 2,593,700
Net loss $(4,219,095) $(1,687,949)
NOTE 6 - NET INVESTMENT IN SALES-TYPE LEASE
- --------------------------------------------------
The Partnership's net investment in a sales-type lease is the result of the
conditional sale of the Partnership's proportionate interest in a Boeing 737
aircraft executed in October 2000. The title to the aircraft transfers to Royal
Aviation Inc., at the expiration of the lease term. The sale of the aircraft
has been recorded by the Partnership as a sales-type lease, with a lease term
expiring in January 2002. For the three and six month periods ended June 30,
2001, the Partnership recognized sales-type lease revenue of $3,351 and $6,702,
respectively, from this lease. At June 30, 2001, the components of the net
investment in the sales-type lease are as follows:
Total minimum lease payments to be received $137,418
Less: Unearned income 8,375
--------
Total $129,043
========
Unearned income is being amortized to revenue over the lease term, expiring in
January 2002.
9
- ------
NOTE 7 - RELATED PARTY TRANSACTIONS
- ----------------------------------------
All operating expenses incurred by the Partnership are paid by EFG on behalf of
the Partnership and EFG is reimbursed at its actual cost for such expenditures.
Fees and other costs incurred during the six month periods ended June 30, 2001
and 2000, which were paid or accrued by the Partnership to EFG or its
Affiliates, are as follows:
2001 2000
-------- --------
Equipment management fees $ 21,455 $ 12,901
Administrative charges 27,930 25,213
Reimbursable operating expenses
due to third parties 287,872 221,782
-------- --------
Total $337,257 $259,896
======== ========
All rents and the proceeds from the sale of equipment are paid directly to
either EFG or to a lender. EFG temporarily deposits collected funds in a
separate interest-bearing escrow account prior to remittance to the Partnership.
At June 30, 2001, the Partnership was owed $137,655 by EFG for such funds. These
funds were remitted to the Partnership in July 2001.
The discussion of the loan to Echelon Residential Holdings in Note 5 above is
incorporated herein by reference.
NOTE 8 - NOTE PAYABLE
- -------------------------
The Partnership has one note payable outstanding at June 30, 2001 in the amount
of $1,142,265. This installment note is non-recourse and is collateralized by
Partnership's interest in an aircraft leased to Aerovias de Mexico, S. A. de
C.V. and assignment of the related lease payments. This indebtedness bears a
fixed interest rate of 7.65%, principal is amortized monthly and the Partnership
has a balloon payment obligation at the expiration of the lease term of $404,138
in September 2004.
In February 2001, the Partnership and certain affiliated investment programs
(collectively "the Programs") refinanced the outstanding indebtedness and
accrued interest related to the aircraft on lease to Aerovias de Mexico, S.A. de
C.V. In addition to refinancing the Programs' total existing indebtedness and
accrued interest of $4,758,845, the Programs received additional debt proceeds
of $3,400,177. The Partnership's aggregate share of the refinanced and new
indebtedness was $1,211,860 including $706,832 used to repay the existing
indebtedness on the refinanced aircraft. The Partnership used a portion of its
share of the additional proceeds of $505,028 to repay the outstanding balance of
the indebtedness and accrued interest related to the aircraft then on lease to
Finnair OY of $130,852 and certain aircraft reconfiguration costs that the
Partnership had accrued at December 31, 2000.
Management believes that the carrying amount of the note payable approximates
fair value at June 30, 2001 based on its experience and understanding of the
market for instruments with similar terms.
10
The annual maturities of the note payable are as follows:
For the year ending June 30, 2002 $ 214,125
2003 231,100
2004 249,412
2005 447,628
----------
. Total $1,142,265
==========
NOTE 9 - LEGAL PROCEEDINGS
- ------------------------------
As described more fully in the Partnership's Annual Report on Form 10-K for the
year ended December 31, 2000, the Partnership is a Nominal Defendant in a Class
Action Lawsuit, the outcome of which could significantly alter the nature of the
Partnership's organization and its future business operations.
On March 12, 2001, after a status conference and hearing, the Court issued an
order that required the parties, no later than May 15, 2001, to advise the Court
on (a) whether the Securities and Exchange Commission ("SEC") had completed its
review of the solicitation statement and related materials submitted to the SEC
in connection with the proposed settlement, and (b) whether the parties
requested the Court to schedule a hearing for final approval of the proposed
settlement or were withdrawing the proposed settlement from judicial
consideration and resuming the litigation of the Plaintiffs' claims.
On May 11, 2001, the general partners of the partnerships that are nominal
defendants in the Class Action Lawsuit received a letter dated May 10, 2001 from
the Associate Director and Chief Counsel of the Division of Investment
Management of the SEC informing the general partners that the staff of the
Division believes that American Income Partners V-A Limited Partnership,
American Income Partners V-B Limited Partnership, American Income Partners V-C
Limited Partnership, American Income Partners V-D Limited Partnership, American
Income Fund I-A, American Income Fund I-B, American Income Fund I-E and AIRFUND
II International Limited Partnership (the "Designated Partnerships") are
investment companies as defined in Section 3(a)(1)(c) of the Investment Company
Act of 1940, as amended (the "1940 Act"). The SEC staff noted that Section 7 of
the 1940 Act makes it unlawful for an unregistered investment company to offer
or sell or purchase any security or engage in any business in interstate
commerce. Accordingly, Section 7 would prohibit any partnership that is an
unregistered investment company from engaging in any business in interstate
commerce, except transactions that are merely incidental to its dissolution.
The letter also stated that the Division is considering enforcement action with
respect to this matter. Noting that the parties to the Class Action Lawsuit
were scheduled to appear before the court in the near future to consider a
proposed settlement, and that the SEC staff's views, as expressed in the letter,
are relevant to the specific matters that will be considered by the court at the
hearing, the SEC staff submitted the letter to the court for its consideration.
The general partners have consulted with counsel who specializes in the 1940 Act
and, based on counsel's advice, do not believe that the Partnership or the other
Designated Partnerships are investment companies within the meaning of the 1940
Act. Counsel has corresponded and met with the SEC staff to address the issues
concerning the Designated Partnerships' status under the 1940 Act. However,
their status is unresolved and there is a risk that the Division of Investment
Management may commence enforcement action against the Partnership and the other
Designated Partnerships with respect to this matter.
11
Plaintiffs' Counsel and Defendants' Counsel each filed status reports in
response to the Court's order on May 15, 2001. The Court held a hearing on May
28, 2001 at which Plaintiffs' Counsel requested that the case be put back on a
litigation track anticipating his filing a motion for class certification and
discovery leading to the setting of a trial date. Defendants' Counsel requested
that the Court address the issue of whether or not the 1940 Act applies to the
Designated Partnerships and the consolidation under the proposed settlement. The
Court permitted Plaintiffs' Counsel to submit a timetable for discovery and
trial and at the same time encouraged the parties to continue to work together
with the SEC in an effort to consummate the proposed settlement. Subsequently,
the Court scheduled a status conference for February 22, 2002 and a trial date
of March 4, 2002.
12
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations.
- ---------------
Certain statements in this quarterly report of AIRFUND II International Limited
Partnership (the "Partnership") that are not historical fact constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and are subject to a variety of risks and
uncertainties. There are a number of factors that could cause actual results to
differ materially from those expressed in any forward-looking statements made
herein. These factors include, but are not limited to, the outcome of the Class
Action Lawsuit described in Note 9 to the accompanying financial statements, the
remarketing of the Partnership's aircraft and the performance of the
Partnership's non-aircraft assets.
The Investment Company Act of 1940 (the "1940 Act") places restrictions on the
capital structure and business activities of companies registered thereunder.
The Partnership has active business operations in the financial services
industry, including equipment leasing and the loan to Echelon Residential
Holdings LLC ("Echelon Residential Holdings"). The Partnership does not intend
to engage in investment activities in a manner or to an extent that would
require the Partnership to register as an investment company under the 1940 Act.
However, it is possible that the Partnership may unintentionally engage in an
activity or activities that may be construed to fall within the scope of the
1940 Act. If the Partnership were determined to be an unregistered investment
company, its business would be adversely affected. The 1940 Act, among other
things, prohibits an unregistered investment company from offering securities
for sale or engaging in any business in interstate commerce and, consequently,
leases and contracts entered into by partnerships that are unregistered
investment companies may be voidable. If necessary, the Partnership intends to
avoid being deemed an investment company by disposing or acquiring certain
assets that it might not otherwise dispose or acquire.
On May 11, 2001, the general partners of the partnerships that are nominal
defendants in the Class Action Lawsuit received a letter dated May 10, 2001 from
the Associate Director and Chief Counsel of the Division of Investment
Management of the SEC informing the general partners that the staff of the
Division believes that American Income Partners V-A Limited Partnership,
American Income Partners V-B Limited Partnership, American Income Partners V-C
Limited Partnership, American Income Partners V-D Limited Partnership, American
Income Fund I-A, American Income Fund I-B, American Income Fund I-E and AIRFUND
II International Limited Partnership (the "Designated Partnerships") are
investment companies as defined in Section 3(a)(1)(c) of the 1940 Act. The
letter also stated that the Division is considering enforcement action with
respect to this matter. Noting that the parties to the Class Action Lawsuit
were scheduled to appear before the court in the near future to consider a
proposed settlement, and that the SEC staff's views, as expressed in the letter,
are relevant to the specific matters that will be considered by the court at the
hearing, the SEC staff submitted the letter to the court for its consideration.
The general partners have consulted with counsel who specializes in the 1940 Act
and, based on counsel's advice, do not believe that the Partnership or the other
Designated Partnerships are investment companies within the meaning of the 1940
Act. Counsel has corresponded and met with the SEC staff to address the issues
concerning the Designated Partnerships' status under the 1940 Act. However,
their status is unresolved and there is a risk that the Division of Investment
Management may commence enforcement action against the Partnership and the other
Designated Partnerships with respect to this matter.
13
Plaintiffs' Counsel and Defendants' Counsel each filed status reports in
response to the Court's order on May 15, 2001. The Court held a hearing on May
28, 2001 at which Plaintiffs' Counsel requested that the case be put back on a
litigation track anticipating his filing a motion for class certification and
discovery leading to the setting of a trial date. Defendants' Counsel requested
that the Court address the issue of whether or not the 1940 Act applies to the
Designated Partnerships and the consolidation under the proposed settlement. The
Court permitted Plaintiffs' Counsel to submit a timetable for discovery and
trial and at the same time encouraged the parties to continue to work together
with the SEC in an effort to consummate the proposed settlement. See Note 9 to
the financial statements for additional discussion.
Three and six months ended June 30, 2001 compared to the three and six months
- --------------------------------------------------------------------------------
ended June 30, 2000:
- -----------------------
As an equipment leasing partnership, the Partnership was organized to acquire
and lease a portfolio of commercial jet aircraft subject to lease agreements
with third parties. During 1990 and 1991, the Partnership purchased four
commercial jet aircraft and a proportionate interest in two additional aircraft,
which were leased by major carriers, engaged in passenger transportation.
Initially, each aircraft generated rental revenue pursuant to primary-term lease
agreements. Subsequently, all of the aircraft in the Partnership's original
portfolio have been re-leased, renewed, exchanged for other aircraft, or sold.
At June 30, 2001, the Partnership's equipment portfolio included proportionate
ownership interests in three aircraft, two of which were on lease at that date.
The Partnership also has two aircraft engines, which were off lease at June 30,
2001. In April 2001, the lease term for one of the aircraft expired and the
aircraft was returned by the lessee (see discussion below). The aircraft off
lease and the remaining aircraft, upon expiration of their lease agreements,
will be re-leased or sold depending on prevailing market conditions. In
addition, in 2000 the Partnership entered into a conditional sales agreement
related to its interest in an aircraft. Presently, the Partnership is a Nominal
Defendant in a Class Action Lawsuit, the outcome of which could significantly
alter the nature of the Partnership's organization and its future business
operations. (See Note 9 to the accompanying financial statements.) Pursuant to
the Amended and Restated Agreement and Certificate of Limited Partnership (the
"Restated Agreement, as amended"), the Partnership is scheduled to be dissolved
by December 31, 2005.
Results of Operations
- -----------------------
For the three and six month periods ended June 30, 2001, the Partnership
recognized operating lease revenue of $155,113 and $311,108, respectively,
compared to $148,602 and $258,022, respectively, for the same periods in 2000.
The net increase in operating lease revenue from 2000 to 2001 resulted from the
revenue from the re-lease of certain of the Partnership's aircraft partially
offset by an aircraft lease expiration, as discussed below. In the future,
operating lease revenue is expected to decline due to lease term expirations and
aircraft sales.
The lease term associated with a Boeing 737-2H4, in which the Partnership holds
an ownership interest, expired in December 1999. The aircraft was re-leased in
September 2000 to Air Slovakia BWJ, Ltd., with a lease term expiring in
September 2003. The Partnership recognized operating lease revenue of $58,995
for the six month period ended June 30, 2001 related to this aircraft.
The lease term associated with a McDonnell Douglas MD-82 aircraft, in which the
Partnership holds an ownership interest, expired in January 2000. The aircraft
was re-leased in September 2000 to Aerovias de Mexico S.A. de C.V., with a lease
term expiring in September 2004. The Partnership recognized lease revenue of
$147,044 and $29,095 related to this aircraft during the six month periods ended
June 30, 2001 and 2000, respectively.
The General Partner is attempting to remarket the second McDonnell Douglas MD-82
aircraft, in which the Partnership holds an ownership interest. This lease term
associated with this aircraft expired in April 2001 and the aircraft is
currently off lease. The Partnership recognized operating lease revenue of
$105,068 and $158,927 related to this aircraft during the six month periods
ended June 30, 2001 and 2000, respectively.
14
In October 2000, the Partnership and certain of its affiliates executed a
conditional sales agreement with Royal Aviation Inc. for the sale of the
Partnership's interest in a Boeing 737-2H4 aircraft. This aircraft had been off
lease from January 2000 through the date of the conditional sale in October
2000. The title to the aircraft transfers to Royal Aviation Inc., at the
expiration of the lease term. The sale of the aircraft has been recorded by the
Partnership as a sales-type lease, with a lease term expiring in January 2002.
For the three and six month period ended June 30, 2001, the Partnership
recognized sales-type lease revenue of $3,351 and $6,702, respectively.
The Partnership's aircraft interests represent proportionate ownership
interests. In such cases, the remaining interests are owned by an affiliated
equipment leasing program sponsored by Equis Financial Group Limited Partnership
("EFG"). The Partnership and each affiliate individually report, in proportion
to their respective ownership interests, their respective shares of assets,
liabilities, revenues, and expenses associated with the aircraft.
Interest income for the three and six month periods ended June 30, 2001 was
$38,022 and $68,143, respectively, compared to $37,238 and $104,174,
respectively, for the same periods in 2000. Interest income is typically
generated from temporary investment of rental receipts and equipment sale
proceeds in short-term instruments. The amount of future interest income is
expected to fluctuate as a result of changing interest rates and the amount of
cash available for investment, among other factors.
Other income for the three and six months ended June 30, 2000, reflects the
receipt of $245,977 of unused aircraft maintenance reserves related to a sold
aircraft and $55,000 for the sale of certain aircraft records, respectively.
In May 2000, the Partnership sold its Boeing 727-251 ADV aircraft to a
third-party for proceeds of $750,000. This aircraft was fully depreciated at
the time of sale, resulting in a net gain, for financial statement purposes, of
$750,000 for the three and six months ended June 30, 2000.
The ultimate realization of residual value for the Partnership's aircraft will
be dependent upon many factors, including EFG's ability to sell and re-lease the
aircraft. Changing market conditions, industry trends, technological advances,
and many other events can converge to enhance or detract from aircraft values at
any given time. EFG attempts to monitor these changes and the airline industry
in general in order to identify opportunities which may be advantageous to the
Partnership and which will maximize total cash returns for each aircraft.
The total economic value realized upon final disposition of each aircraft is
comprised of all primary lease term revenue generated from that aircraft,
together with its residual value. The latter consists of cash proceeds realized
upon the aircraft's sale in addition to all other cash receipts obtained from
renting the aircraft on a re-lease, renewal or month-to-month basis.
Consequently, the amount of gain or loss reported in the financial statements is
not necessarily indicative of the total residual value the Partnership achieved
from leasing the aircraft.
For the three and six month period ended June 30, 2001, the Partnership incurred
interest expense of $31,637 and $49,030, respectively, compared to $23,388 and
$54,073 for the same periods in 2000. In the future, interest expense will
decline as the principal balance of the note payable is reduced through the
application of rent receipts to the outstanding debt.
Management fees were $10,705 and $21,455, respectively, for the three and six
month periods ended June 30, 2001 and $7,430 and $12,901, respectively, for the
same periods in 2000.
Operating expenses were $174,370 and $315,802 for the three and six month
periods ended June 30, 2001, respectively, compared to $130,718 and $246,995 for
the same periods in 2000. In 2001, operating expenses included approximately
$59,000 related to the Class Action Lawsuit discussed in Note 9 to the financial
statements herein. Other operating expenses consist principally of
administrative charges, professional service costs, such as audit and other
legal fees, as well as insurance, printing, distribution and remarketing
expenses. In certain cases, equipment storage or repairs and maintenance costs
may be incurred in connection with equipment being remarketed.
15
Depreciation expense was $65,345 and $130,691, respectively, for the three and
six month periods ended June 30, 2001 compared to $79,837 and $159,674,
respectively, for the same periods in 2000. During the three months ended June
30, 2001, the Partnership also recorded a write-down of equipment, representing
an impairment to the carrying value of the Partnership's interest in a McDonnell
Douglas MD-82 aircraft returned in April 2001 and currently off lease. The
resulting charge of $125,000 was based on a comparison of estimated fair value
and carrying value of the Partnership's interest in the aircraft. The estimate
of the fair value was based on (i) information provided by a third-party
aircraft broker and (ii) EFG's assessment of prevailing market conditions for
similar aircraft. Aircraft condition, age, passenger capacity, distance
capability, fuel efficiency, and other factors influence market demand and
market values for passenger jet aircraft.
For the three and six month periods ended June 30, 2001, the Partnership's share
of losses in Echelon Residential Holdings were $83,806 and $158,509,
respectively, compared to $19,775 and $23,337 for the same periods in 2000. The
losses are reflected in the Statement of Operations as "Partnership's share of
unconsolidated real estate venture's loss". See further discussion below.
Liquidity and Capital Resources and Discussion of Cash Flows
- --------------------------------------------------------------------
The Partnership by its nature is a limited life entity. The Partnership's
principal operating activities derive from aircraft rental transactions.
Accordingly, the Partnership's principal source of cash from operations is
provided by the collection of periodic rents. These cash inflows are used to
satisfy debt service obligations associated with leveraged leases, and to pay
management fees and operating costs. Operating activities generated a net cash
inflow of $145,958 and $43,278 for the six months ended June 30, 2001 and 2000,
respectively. Overall, expenses associated with rental activities, such as
management fees, and net cash flow from operating activities will decline as the
Partnership remarkets its aircraft. The Partnership, however, may continue to
incur significant costs to facilitate the successful remarketing of its aircraft
in the future. Ultimately, the Partnership will dispose of all aircraft under
lease. This will occur principally through sale transactions whereby each
aircraft will be sold to the existing lessee or to a third party. Generally,
this will occur upon expiration of each aircraft's primary or renewal/re-lease
term.
Cash realized for asset disposal transactions is reported under investing
activities on the accompanying Statement of Cash Flows. For the six months
ended June 30, 2000, the Partnership realized $750,000 in equipment sales
proceeds. There were no equipment sales in the six months ended June 30, 2001.
Future inflows of cash from aircraft disposals will vary in timing and amount
and will be influenced by many factors including, but not limited to, the
frequency and timing of lease expirations, the type of aircraft being sold,
their condition and age, and future market conditions.
At June 30, 2001, the Partnership was due aggregate future minimum lease
payments of $1,324,345 from contractual operating and sales-type lease
agreements (see Note 3 to the financial statements), a portion of which will be
used to amortize the principal balance of the note payable of $1,142,265 (see
Note 8 to the financial statements). At the expiration of the individual lease
term underlying the Partnership's future minimum lease payments, the Partnership
will sell the aircraft or enter into a re-lease or renewal agreement when
considered by advantageous by the General Partner or EFG. In addition, the
General Partner and EFG are attempting to remarket the McDonnell-Douglas MD-82
aircraft and the two aircraft engines that are currently off lease. Such
remarketing activities will result in the realization of additional cash inflows
in the form of sale proceeds or rents from renewals or re-leases, the timing and
extent of which cannot be predicted with certainty. This is because the timing
and extent of remarketing events often is dependent upon the needs and interests
of the existing lessees. Some lessees may choose to renew their lease
contracts, while others may elect to return the aircraft. In the latter
instances, the aircraft could be re-leased to another lessee or sold to a third
party.
16
In connection with a preliminary settlement agreement for a Class Action Lawsuit
described in Note 9 to the financial statements, the court permitted the
Partnership to invest in any new investment, including but not limited to new
equipment or other business activities, subject to certain limitations. On March
8, 2000, the Partnership loaned $3,640,000 to a newly formed real estate
company, Echelon Residential Holdings, to finance the acquisition of real estate
assets by that company. Echelon Residential Holdings, through a wholly owned
subsidiary ("Echelon Residential LLC"), used the loan proceeds, along with the
loan proceeds from similar loans by ten affiliated partnerships representing $32
million in the aggregate, to acquire various real estate assets from Echelon
International Corporation, an independent Florida-based real estate company.
Echelon Residential Holding's interest in Echelon Residential LLC is pledged
pursuant to a pledge agreement to the partnerships as collateral for the loans.
The loan has a term of 30 months, maturing on September 8, 2002, and an annual
interest rate of 14% for the first 24 months and 18% for the final six months.
Interest accrues and compounds monthly and is payable at maturity.
As discussed in Note 5 to the Partnership's financial statements, the loan is
considered to be an investment in a real estate venture for accounting purposes.
In accordance with the provisions of Statement of Position No. 78-9, "Accounting
for Investments in Real Estate Ventures", the Partnership reports its share of
income or loss of Echelon Residential Holdings under the equity method of
accounting.
The loan made by the Partnership to Echelon Residential Holdings is, and will
continue to be, subject to various risks, including the risk of default by
Echelon Residential Holdings, which could require the Partnership to foreclose
under the pledge agreement on its interests in Echelon Residential LLC. The
ability of Echelon Residential Holdings to make loan payments and the amount the
Partnership may realize after a default would be dependent upon the risks
generally associated with the real estate lending business including, without
limitation, the existence of senior financing or other liens on the properties,
general or local economic conditions, property values, the sale of properties,
interest rates, real estate taxes, other operating expenses, the supply and
demand for properties involved, zoning and environmental laws and regulations,
rent control laws and other governmental rules. A default by Echelon
Residential Holdings could have a material adverse effect on the future cash
flow and operating results of the Partnership.
The Restated Agreement, as amended, prohibits the Partnership from making loans
to the General Partner or its affiliates. Since the acquisition of the several
parcels of real estate from the owner had to occur prior to the admission of
certain independent third parties as equity owners, Echelon Residential Holdings
and its wholly owned subsidiary, Echelon Residential LLC, were formed in
anticipation of their admission. The General Partner agreed to an officer of
the Manager serving as the initial equity holder of Echelon Residential Holdings
and as an unpaid manager of Echelon Residential Holdings. The officer made a
$185,465 equity investment in Echelon Residential Holdings. His return on his
equity investment is restricted to the same rate of return as the partnerships
realize on their loans. There is a risk that the court may object to the
general partner's action in structuring the loan in this way since the officer
may be deemed an affiliate and the loans in violation of the prohibition against
loans to affiliates and the court's statement in its order permitting New
Investments that all other provisions of the Partnership Agreements governing
the investment objectives and policies of the Partnership shall remain in full
force and effect. The court may require the partnerships to restructure or
divest the loan.
The Partnership obtained long-term financing in connection with certain
aircraft. The origination of such indebtedness and the subsequent repayments of
principal are reported as components of financing activities in the accompanying
Statement of Cash Flows. The Partnership's outstanding loan agreement is
recourse only to the specific aircraft financed and to the minimum rental
payments contracted to be received during the debt amortization period (which
coincides with the lease term). As rental payments are collected, a portion or
all of the rental payment is used to repay associated indebtedness. See Note 8
to the financial statements for the annual maturities of the note payable. In
addition, the Partnership has a balloon payment obligation as discussed below.
17
In February 2001, the Partnership's and certain affiliated investment programs
collectively, (the "Programs") refinanced the outstanding indebtedness and
accrued interest related to the aircraft. In addition to refinancing the
Programs' total existing indebtedness and accrued interest of $4,758,845, the
Programs received additional debt proceeds of $3,400,177. The Partnership's
aggregate share of the refinanced and new indebtedness was $1,211,860 including
$706,832 used to repay the existing indebtedness on the refinanced aircraft.
The Partnership used a portion of its share of the additional proceeds of
$505,028 to repay the outstanding balance of the indebtedness and accrued
interest related to the aircraft then on lease to Finnair OY of $130,852 and
certain aircraft reconfiguration costs that the Partnership had accrued at
December 31, 2000. The new indebtedness bears a fixed interest rate of 7.65%,
principal is amortized monthly and the Partnership has a balloon payment
obligation at the expiration of the lease term of $404,138 in September 2004.
In the six months ended June 30, 2000, the Partnership refinanced the
indebtedness associated with the same aircraft and in addition to refinancing
the existing indebtedness, received additional debt proceeds of $201,247.
There are no formal restrictions under the Restated Agreement, as amended, that
materially limit the Partnership's ability to pay cash distributions, except
that the General Partner may suspend or limit cash distributions to ensure that
the Partnership maintains sufficient working capital reserves to cover, among
other things, operating costs and potential expenditures, such as refurbishment
costs to remarket aircraft upon lease expiration. In addition to the need for
funds in connection with the Class Action Lawsuit, liquidity is especially
important as the Partnership matures and sells aircraft, because the remaining
aircraft portfolio consists of fewer revenue-producing assets that are available
to cover prospective cash disbursements. Insufficient liquidity could inhibit
the Partnership's ability to sustain its operations or maximize the realization
of proceeds from remarketing its remaining aircraft.
The management and remarketing of aircraft can involve, among other things,
significant costs and lengthy remarketing initiatives. Although the
Partnership's lessees are required to maintain the aircraft during the period of
lease contract, repair, maintenance, and/or refurbishment costs at lease
expiration can be substantial. For example, an aircraft that is returned to the
Partnership meeting minimum airworthiness standards, such as flight hours or
engine cycles, nonetheless may require heavy maintenance in order to bring its
engines, airframe and other hardware up to standards that will permit its
prospective use in commercial air transportation.
At June 30, 2001, the Partnership's equipment portfolio included ownership
interests in three commercial jet aircraft, one of which is a Boeing 737
aircraft. The Boeing 737 aircraft is a Stage 2 aircraft, meaning that it is
prohibited from operating in the United States unless it is retro-fitted with
hush-kits to meet Stage 3 noise regulations promulgated by the Federal Aviation
Administration. During 2000, the aircraft was re-leased to Air Slovakia BWJ,
Ltd. through September 2003.The remaining two aircraft in the Partnership's
portfolio already are Stage 3 compliant. One of these aircraft has a lease term
expiring in September 2004 and the remaining aircraft is currently off lease.
Recent changes in economic condition of the airline industry have adversely
affected the demand for and market values for commercial jet aircraft. These
changes could adversely affect the operations of the Partnership and the
residual value of the commercial jet aircraft. Currently, all of commercial jet
aircraft in which the Partnership has a proportionate ownership interest are
subject to contracted lease agreements except one McDonnell Douglas MD-82, which
was returned to the General Partner upon its lease expiration in April 2001.
The General Partner is attempting to remarket this aircraft.
In any given year, it is possible that Recognized Owners will be allocated
taxable income in excess of distributed cash. This discrepancy between tax
obligations and cash distributions may or may not continue in the future, and
cash may or may not be available for distribution to the Recognized Owners
adequate to cover any tax obligation.
18
The Partnership's capital account balances for federal income tax and for
financial reporting purposes are different primarily due to differing treatments
of income and expense items for income tax purposes in comparison to financial
reporting purposes (generally referred to as permanent or timing differences;
see Note 8 to the financial statements presented in the Partnership's 2000
Annual Report). For instance, selling commissions and organization and offering
costs pertaining to syndication of the Partnership's limited partnership units
are not deductible for federal income tax purposes, but are recorded as a
reduction of partners' capital for financial reporting purposes. Therefore,
such differences are permanent differences between capital accounts for
financial reporting and federal income tax purposes. Other differences between
the bases of capital accounts for federal income tax and financial reporting
purposes occur due to timing differences consisting of the cumulative difference
between income or loss for tax purposes and financial statement income or loss.
The principal components of the cumulative difference between financial
statement income or loss and tax income or loss result from different
depreciation policies for book and tax purposes and different treatment for book
and tax purposes related to the real estate venture.
For financial reporting purposes, the General Partner has accumulated a capital
deficit at June 30, 2001. This is the result of aggregate cash distributions to
the General Partner being in excess of its capital contribution of $1,000 and
its allocation of financial statement net income or loss. Ultimately, the
existence of a capital deficit for the General Partner for financial reporting
purposes is not indicative of any further capital obligations to the Partnership
by the General Partner. The Restated Agreement, as amended, requires that upon
the dissolution of the Partnership, the General Partner will be required to
contribute to the Partnership an amount equal to any negative balance, which may
exist in the General Partner's tax capital account. At December 31, 2000, the
General Partner had a positive tax capital account balance.
The Partnership is a Nominal Defendant in a Class Action Lawsuit described in
Note 9 to the accompanying financial statements. The settlement or adjudication
of that lawsuit may materially change the future organizational structure and
business interests of the Partnership, as well as its cash distribution
policies. In addition, the General Partner will continue to suspend the payment
of quarterly cash distributions pending final resolution of the Class Action
Lawsuit. Accordingly, future cash distributions are not expected to be paid
until the Class Action Lawsuit is settled or adjudicated.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
- --------------------------------------------------------------------------
The Partnership's financial statements include financial instruments that are
exposed to interest rate risks.
The Partnership has one note payable outstanding at June 30, 2001, which bears a
fixed interest rate of 7.65%. The fair market value of fixed interest rate debt
may be adversely impacted due to a decrease in interest rates. The effect of
interest rate fluctuations on the Partnership in the six months ended June 30,
2001 was not material.
The Partnership's acquisition, development and construction loan to Echelon
Residential Holdings matures on September 8, 2002 and earns interest at a fixed
annual rate of 14% for the first 24 months and a fixed annual rate of 18% for
the last 6 months of the loan. Investments earning a fixed rate of interest may
have their fair market value adversely impacted due to a rise in interest rates.
The effect of interest rate fluctuations on the Partnership for the six months
ended June 30, 2001 was not material.
19
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
. Response:
. Refer to Note 9 to the financial statements herein.
Item 2. Changes in Securities
. Response: None
Item 3. Defaults upon Senior Securities
. Response: None
Item 4. Submission of Matters to a Vote of Security Holders
. Response: None
Item 5. Other Information
. Response: None
Item 6(a). Exhibits
. Response: None
Item 6(b). Reports on Form 8-K
. Response: None
20
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AIRFUND II International Limited Partnership
By: AFG Aircraft Management Corporation, a
Massachusetts corporation and the General
Partner of the Registrant.
By: /s/ Michael J. Butterfield
----------------------------
Michael J. Butterfield
Treasurer of AFG Aircraft Management Corporation
(Duly Authorized Officer and
Principal Financial and Accounting Officer)
Date: August 14, 2001
-----------------
21