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 March 31, 2002
-------------------
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_____
-----
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION: Page
----
Item 1. Financial Statements
Statement of Financial Position
at March 31, 2002 and December 31, 2001 3
Statement of Operations
for the three months ended March 31, 2002 and 2001 4
Statement of Cash Flows
for the three months ended March 31, 2002 and 2001 5
Notes to the Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 17
PART II. OTHER INFORMATION:
Item 1 - 6 18
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
MARCH 31, 2002 AND DECEMBER 31, 2001
(UNAUDITED)
March 31, December 31,
2002 2001
-------------- --------------
ASSETS
Cash and cash equivalents $ 5,243,983 $ 3,907,407
Rents receivable, net of allowance of $49,163 and $43,919
at March 31, 2002 and December 31, 2001, respectively 29,091 60,747
Accounts receivable - affiliate 4,382 984
Other assets 32,894 4,859
Interest receivable - loan, net of allowance of $590,772
at March 31, 2002 and December 31, 2001 - -
Loan receivable, net of allowance of $318,500
at March 31, 2002 and December 31, 2001 3,321,500 3,321,500
Net investment in sales-type lease - 17,755
Equipment at cost, net of accumulated depreciation
of $2,650,672 and $2,585,327 at March 31, 2002
and December 31, 2001, respectively 2,146,442 2,211,787
-------------- --------------
Total assets $ 10,778,292 $ 9,525,039
============== ==============
LIABILITIES AND PARTNERS' CAPITAL
Notes payable $ 984,248 $ 1,038,675
Accrued interest 6,693 6,611
Accrued liabilities 510,487 666,106
Accrued liabilities - affiliate 26,967 22,888
-------------- --------------
Total liabilities 1,528,395 1,734,280
-------------- --------------
Partners' capital (deficit):
General Partner (2,532,962) (2,605,919)
Limited Partnership interests
(2,714,647 Units; initial purchase price of $25 each) 11,782,859 10,396,678
-------------- --------------
Total partners' capital 9,249,897 7,790,759
-------------- --------------
Total liabilities and partners' capital $ 10,778,292 $ 9,525,039
============== ==============
The accompanying notes are an integral part of these financial statements.
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(UNAUDITED)
2002 2001
... ------------ ------------
INCOME
Operating lease revenue $ 86,195 $ 155,995
Sales-type lease revenue - 3,351
Interest income 18,651 30,121
Interest income - loan - 144,686
Other income 1,562,774 -
------------- -------------
Total income 1,667,620 334,153
------------- -------------
EXPENSES
Depreciation 65,345 65,346
Interest expense 19,178 17,393
Equipment management fees - affiliate 6,046 10,750
Bad debt expense 22,999 -
Operating expenses - affiliate 94,914 141,432
------------- -------------
Total expenses 208,482 234,921
------------- -------------
Net income $ 1,459,138 $ 99,232
============= =============
Net income per limited partnership unit $ 0.51 $ 0.03
============= =============
Cash distributions declared
per limited partnership unit $ - $ -
============= =============
The accompanying notes are an integral part of these financial statements.
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001
(UNAUDITED)
2002 2001
... ------------ ------------
CASH FLOWS PROVIDED BY (USED IN) OPERATING ACTIVITIES
Net income $ 1,459,138 $ 99,232
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation 65,345 65,346
Bad debt expense 22,999 -
Sales-type lease revenue - (3,351)
Changes in assets and liabilities:
Rents receivable 26,412 116,820
Accounts receivable - affiliate (3,398) (36,717)
Other assets (28,035) (24,087)
Interest receivable - loan - (144,686)
Collections on net investment in sales-type lease - 58,995
Accrued interest 82 (7,043)
Accrued liabilities (155,619) (178,102)
Accrued liabilities - affiliate 4,079 7,913
Deferred rental income - 24,848
-------------- --------------
Net cash provided by (used in) operating activities 1,391,003 (20,832)
-------------- --------------
CASH FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES
Proceeds from notes payable - 505,028
Principal payments - notes payable (54,427) (220,340)
-------------- --------------
Net cash provided by (used in) financing activities (54,427) 284,688
-------------- --------------
Net increase (decrease) in cash and cash equivalents 1,336,576 263,856
Cash and cash equivalents at beginning of period 3,907,407 2,827,385
-------------- --------------
Cash and cash equivalents at end of period $ 5,243,983 $ 3,091,241
============== ==============
SUPPLEMENTAL INFORMATION
Cash paid during the period for interest $ 19,096 $ 24,436
============== ==============
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITY:
In February 2001, the Partnership refinanced certain indebtedness and accrued
interest in the amount of $706,831.
The accompanying notes are an integral part of these financial statements.
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
MARCH 31, 2002
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
- -----------------------------------
The financial statements presented herein are prepared in conformity with
generally accepted accounting principles 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 generally
accepted accounting principles for complete financial statements and,
accordingly, the accompanying financial statements should be read in conjunction
with the financial statements and related footnotes presented in the 2001 Annual
Report (Form 10-K) of AIRFUND II International Limited Partnership (the
"Partnership"). Except as disclosed herein, there has been no material change
to the information presented in the footnotes to the 2001 Annual Report included
in Form 10-K.
In the opinion of management, all adjustments (consisting of normal and
recurring adjustments) considered necessary to present fairly the financial
position at March 31, 2002 and December 31, 2001 and results of operations for
the three month periods ended March 31, 2002 and 2001 have been made and are
reflected.
NOTE 2 - 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, wholly owned by 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.
Future minimum rents for operating leases of $766,487 are due as follows:
For the year ending March 31, 2003 $349,861
2004 294,089
2005 122,537
--------
... Total $766,487
========
NOTE 3 - EQUIPMENT
- ---------------------
The following is a summary of equipment owned by the Partnership at March 31,
2002. Remaining Lease Term (Months), as used below, represents the number of
months remaining from March 31, 2002 under contracted lease terms. A Remaining
Lease Term equal to zero reflects equipment held for sale or re-lease.
... Remaining
... Lease Term Equipment
Equipment Type (Months) at Cost
- ---------------------------------------------- ----------- ------------
One McDonnell Douglas MD-82 0 $ 2,078,640
One McDonnell Douglas MD-82
(Aerovias de Mexico S.A. de C.V) 29 2,078,640
One Boeing 737-2H4 (Air Slovakia) 5 639,834
------------
Total equipment cost - 4,797,114
Accumulated depreciation - (2,650,672)
------------
Equipment, net of accumulated depreciation - $ 2,146,442
============
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.
Certain of the Partnership's aircraft and the related lease payment streams were
used to secure the Partnership's term loans with third-party lenders. The
preceding summary includes leveraged equipment having an original cost of
approximately $2,079,000 and a net book value of approximately $1,078,000 at
March 31, 2002.
The Partnership entered into a three-year lease agreement with Air Slovakia for
its proportionate interest in a Boeing 737-2H4 aircraft, effective September
2000. In accordance with a lease amendment executed in January 2002, the lease
term was revised and the lease will terminate in August 2002. The total
payments due under the amended lease approximate the total payments remaining
under the original lease.
The summary above includes aircraft held for re-lease or sale with an original
proportionate cost of approximately $2,079,000 and a net book value of
approximately $907,000, which represents the McDonnell Douglas MD-82 aircraft
returned in April 2001. The General Partner is actively seeking the sale or
re-lease of this aircraft.
NOTE 4 - LOAN RECEIVABLE
- ----------------------------
On March 8, 2000, the Partnership and 10 affiliated partnerships (the
''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, an unrelated 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 6 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 Partnerships as collateral. Echelon Residential Holdings
has no material business interests other than those connected with the real
estate properties owned by Echelon Residential LLC.
During the second quarter of 2001, the General Partner determined that
recoverability of the loan receivable had been impaired and at June 30, 2001
recorded an impairment of $318,500, reflecting the General Partner's current
assessment of the amount of loss that is likely to be incurred by the
Partnership. In addition to the write-down recorded at June 30, 2001, the
Partnership reserved all accrued interest of $590,772 recorded on the loan
receivable from inception through March 31, 2001 and ceased accruing interest on
its loan receivable from Echelon Residential Holdings, effective April 1, 2001.
The summarized unaudited financial information for Echelon Residential Holdings
as of and for the quarters ended March 31, 2002 and 2001 is as follows:
2002 2001
------------- ------------
Total assets $ 89,635,923 $72,861,183
Total liabilities $100,468,976 $76,780,082
Minority interest $ 1,507,536 $ 1,906,448
Total deficit $(12,340,589) $(5,825,347)
Total revenues $ 3,559,971 $ 1,063,439
Total expenses, minority interest
and equity in loss of unconsolidated
joint venture $ 5,358,501 $ 3,096,648
Net loss $ (1,798,530) $(2,033,209)
NOTE 5 - NET INVESTMENT IN SALES-TYPE LEASE
- --------------------------------------------------
The Partnership's net investment in a sales-type lease was 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 was to transfer to
Royal Aviation Inc. at the expiration of the lease term in January 2002. For
the quarter ended March 31, 2001, the Partnership recognized sales-type lease
revenue of $3,351 from this lease.
In the fourth quarter of 2001, Royal Aviation Inc. declared bankruptcy and as a
result, has defaulted on this conditional sales agreement. The General Partner
is continuing to negotiate for the return of the aircraft. As of March 31,
2002, the Partnership has written-down the remaining balance of the
Partnership's investment in the sales-type lease. The write-down was based on
the comparison of the net estimated fair value of the Partnership's interest in
the aircraft and the Partnership's net investment in the sales-type lease. The
write-down recorded in the three months ended March 31, 2002 was $17,755.
NOTE 6 - 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 three month periods ended March 31,
2002 and 2001, which were paid or accrued by the Partnership to EFG or its
Affiliates, are as follows:
2002 2001
-------- --------
Equipment management fees $ 6,046 $ 10,750
Administrative charges 26,283 13,965
Reimbursable operating expenses
due to third parties 68,631 127,467
-------- --------
Total $100,960 $152,182
======== ========
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 March 31, 2002, the Partnership was owed $4,382 by EFG for such funds. These
funds were remitted to the Partnership in April 2002.
The discussion of the loan to Echelon Residential Holdings in Note 4 above is
incorporated herein by reference.
NOTE 7 - NOTE PAYABLE
- -------------------------
The Partnership has a note payable outstanding at March 31, 2002 in the amount
of $984,248. 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.
Management believes that the carrying amount of the note payable approximates
fair value at March 31, 2002 based on its experience and understanding of the
market for instruments with similar terms.
The annual maturities of the note payable are as follows:
For the year ending March 31, 2003 $ 228,055
2004 244,702
2005 511,491
-----------
... Total $ 984,248
===========
NOTE 8 - LEGAL PROCEEDINGS
- ------------------------------
Action involving Rosenblum, et al.
- --------------------------------------
As described more fully in the Partnership's Annual Report on Form 10-K for the
year ended December 31, 2001, the Partnership is a Nominal Defendant along with
ten affiliated partnerships (collectively, the "Partnerships") in a Class Action
Lawsuit, Leonard Rosenblum, et al. v. Equis Financial Group Limited Partnership,
-----------------------------------------------------------------------
et al., the outcome of which could significantly alter the nature of the
- -------
Partnership's organization and its future business operations.
- ------
The Defendant's and Plaintiff's Counsel have reached agreement on a Revised
Stipulation of Settlement (the "Revised Settlement"). As part of the Revised
Settlement, EFG has agreed to buy the loans made by the Partnerships to Echelon
Residential Holdings for an aggregate of $32 million plus interest at 7.5% per
annum, if they are not repaid prior to or at their scheduled maturity date of
September 8, 2002. The Revised Settlement also provides for the liquidation of
the Partnerships' assets, a cash distribution and the dissolution of the
Partnerships including the liquidation and dissolution of this Partnership. The
court held a hearing on March 1, 2002 to consider the Revised Settlement. After
the hearing, the court issued an order preliminarily approving the Revised
Settlement and providing for the mailing of notice to the Operating Partnership
Sub-Class of a hearing on June 7, 2002 to determine whether the settlement on
the terms and conditions set forth in the Revised Settlement is fair, reasonable
and adequate and should be finally approved by the court and a final judgment
entered in the matter.
Action involving Transmeridian Airlines
- ------------------------------------------
As described more fully in the Partnership's Annual Report on Form 10-K for the
year ended December 31, 2001, the Partnership and certain affiliated investment
programs (collectively, the "Plaintiffs), were involved with certain litigation
with Transmeridian Airlines ("Transmeridian"), and Atkinson & Mullen Travel,
Inc., and Apple Vacations, West, Inc., both d/b/a Apple Vacations ("Apple").
As of March 13, 2002, the parties settled all claims involved in these lawsuits.
The material terms of settlement provide: (i) in exchange for payment of
$2,100,000 from Apple to the Plaintiffs all claims arising from or related to
the lawsuits are dismissed with prejudice; (ii) the Plaintiffs shall have
Allowed Claims against the bankruptcy estate of Transmeridian in the aggregate
amount of $2,700,000; (iii) the Plaintiffs will be paid $400,000 from the
insurance proceeds relating to the aircraft loss; and (iv) each of the parties
will receive mutual releases of all claims and counterclaims.
The Partnership has received and recorded approximately $1,563,000 in the first
quarter of 2002, as its share of the $2,100,000 payment. The Partnership has
not yet received or recorded its share of the $400,000 from the insurance
proceeds. In addition, the Partnership recognized $969,686 as income in the
fourth quarter of 2001 that had been held in escrow pending the resolution of
the litigation.
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, 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 unintentionally may have engaged,
or may in the future engage, in an activity or activities that may be construed
to fall within the scope of the 1940 Act. The General Partner has been engaged
in discussions with the staff of the Securities and Exchange Commission ("SEC")
regarding whether or not the Partnership may be an inadvertent investment
company as a consequence of the above-referenced loan. In a letter dated May
10, 2001, the staff of the SEC informed the general partner that the staff
believes that the Partnership and seven of its affiliated partnerships are
unregistered investment companies as defined in Section 3(a)(1)(C) of the 1940
Act. 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. The
General Partner has consulted counsel and believes that the Partnership is not
an investment company. If the Partnership were determined to be an unregistered
investment company, its business would be adversely affected. The General
Partner has determined to take action to resolve the Partnership's status under
the 1940 Act by means that may include disposing or acquiring certain assets
that it might not otherwise dispose or acquire.
As part of the Revised Settlement, EFG has agreed to buy the loans made by the
Partnerships to Echelon Residential Holdings for an aggregate of $32 million
plus interest at 7.5% per annum, if they are not repaid prior to or at their
scheduled maturity date of September 8, 2002. The Revised Settlement also
provides for the liquidation of the Partnerships' assets, a cash distribution
and the dissolution of the Partnerships including the liquidation and
dissolution of this Partnership. The court held a hearing on March 1, 2002 to
consider the Revised Settlement. After the hearing, the court issued an order
preliminarily approving the Revised Settlement and providing for the mailing of
notice to the Operating Partnership Sub-Class of a hearing on June 7, 2002 to
determine whether the settlement on the terms and conditions set forth in the
Revised Settlement is fair, reasonable and adequate and should be finally
approved by the court and a final judgment entered in the matter.
While there can be no assurance that the Revised Settlement will receive final
Court approval and be effected, if it is, the assets of the Partnership will be
liquidated and the Partnership dissolved. The dissolution of the Partnership
may resolve its status under the 1940 Act. In the absence of a final settlement
approved by the Court, the Defendants intend to defend vigorously against the
claims asserted in the Class Action Lawsuit.
Overview
- --------
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 March 31, 2002, the Partnership's equipment portfolio included proportionate
ownership interests in three aircraft, two of which were on lease at that date.
In April 2001, the lease term for one of these aircraft expired and the aircraft
was returned by the lessee and remains off lease. 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 conditional sales agreement related to its
interest in an aircraft and defaulted on the sale in 2001, see discussion below.
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. 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.
Critical Accounting Policies and Estimates
- ----------------------------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires the General Partner to make
estimates and assumptions that affect the amounts reported in the financial
statements. On a regular basis, the General Partner reviews these estimates and
assumptions including those related to revenue recognition, asset lives and
depreciation, allowance for doubtful accounts, allowance for loan loss,
impairment of long-lived assets and contingencies. These estimates are based on
the General Partner's historical experience and on various other assumptions
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions. The General
Partner believes, however, that the estimates, including those for the
above-listed items, are reasonable.
The General Partner believes the following critical accounting policies, among
others, are subject to significant judgments and estimates used in the
preparation of these financial statements:
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 Partnership's leases are accounted for as operating
leases and are noncancellable. Rents received prior to their due dates are
deferred. 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.
Asset lives and depreciation method: The Partnership's primary business involves
- ------------------------------------
the purchase and subsequent lease of long-lived equipment. The Partnership's
depreciation policy is intended to allocate the cost of equipment over the
period during which it produces economic benefit. The principal period of
economic benefit is considered to correspond to each asset's primary lease term,
which generally represents the period of greatest revenue potential for each
asset. Accordingly, to the extent that an asset is held on primary lease term,
the Partnership depreciates the difference between (i) the cost of the asset and
(ii) the estimated residual value of the asset on a straight-line basis over
such term. For purposes of this policy, estimated residual values represent
estimates of equipment values at the date of the primary lease expiration. To
the extent that an asset is held beyond its primary lease term, the Partnership
continues to depreciate the remaining net book value of the asset on a
straight-line basis over the asset's remaining economic life.
Allowance for doubtful accounts: The Partnership maintains allowances for
- -----------------------------------
doubtful accounts for estimated losses resulting from the inability of the
- -----
lessees to make the lease payments required under the contracted lease
- -----
agreements. These estimates are primarily based on the amount of time that has
- -----
elapsed since the related payments were due as well as specific knowledge
related to the ability of the lessees to make the required payments. If the
financial condition of the Partnership's lessees were to deteriorate, additional
allowances could be required that would increase expenses. Conversely, if the
financial condition of the lessees were to improve or if legal remedies to
collect past due amounts were successful, the allowance for doubtful accounts
could be reduced, thereby decreasing expenses.
Allowance for loan losses: The Partnership periodically evaluates the
- -----------------------------
collectibility of its loan's contractual principal and interest and the
- ---------
existence of loan impairment indicators, including contemporaneous economic
- --------
conditions, situations which could affect the borrower's ability to repay its
- ----
obligation, the estimated value of the underlying collateral, and other relevant
- --
factors. Real estate values are discounted using a present value methodology
over the period between the financial reporting date and the estimated
disposition date of each property. A loan is considered to be impaired when,
based on current information and events, it is probable that the Partnership
will be unable to collect all amounts due according to the contractual terms of
the loan agreement, which includes both principal and interest. A provision for
loan losses is charged to earnings based on the judgment of the General Partner
of the amount necessary to maintain the allowance for loan losses at a level
adequate to absorb probable losses.
Impairment of long-lived assets: On a regular basis, the General Partner
- -----------------------------------
reviews the net carrying value of equipment to determine whether it can be
- ------
recovered from undiscounted future cash flows. Adjustments to reduce the net
- -----
carrying value of equipment are recorded in those instances where estimated net
- --
realizable value is considered to be less than net carrying value. Inherent in
the Partnership's estimate of net realizable values are assumptions regarding
estimated future cash flows. If these assumptions or estimates change in the
future, the Partnership could be required to record impairment charges for these
assets.
Contingencies and litigation: The Partnership is subject to legal proceedings
- -------------------------------
involving ordinary and routine claims related to its business. In addition, the
Partnership is also involved in a class action lawsuit. The ultimate legal and
financial liability with respect to such matters cannot be estimated with
certainty and requires the use of estimates in recording liabilities for
potential litigation settlements. Estimates for losses from litigation are made
after consultation with outside counsel. If estimates of potential losses
increase or the related facts and circumstances change in the future, the
Partnership may be required to adjust amounts recorded in its financial
statements.
Results of Operations
- -----------------------
For the three months ended March 31, 2002, the Partnership recognized operating
lease revenue of $86,195 compared to $155,995 for the same period in 2001. The
decrease in operating lease revenue from 2001 to 2002 resulted from lease term
expirations. In the future, operating lease revenue is expected to decline due
to lease term expirations and aircraft sales.
The Boeing 737-2H4 aircraft, in which the Partnership holds an ownership
interest, was re-leased in September 2000 to Air Slovakia BWJ Ltd., with a lease
term expiring in September 2003. In January 2002, this lease was amended,
including revising the lease expiration date to August 2002. The Partnership
recognized operating lease revenue of $12,673 and $29,498 for the quarters ended
March 31, 2002 and 2001, respectively.
A McDonnell Douglas MD-82 aircraft, in which the Partnership holds an ownership
interest, 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 73,522 related to this aircraft during each of the three month
periods ended March 31, 2002 and 2001.
A second McDonnell-Douglas MD-82 aircraft, in which the Partnership holds a
proportionate interest, was leased to Finnair OY though April 2001. In April
2001, the lessee returned the aircraft, which the General Partner is attempting
to remarket.
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
stored in the warehouse from January 2000 through the date of the conditional
sale in October 2000. The title to the aircraft was to transfer to Royal
Aviation Inc., at the expiration of the lease term in January 2002. In the
fourth quarter of 2001, Royal Aviation Inc. declared bankruptcy and as a result,
has defaulted on the conditional sales agreement. The General Partner is
negotiating for the return of the aircraft. As of March 31, 2002, the
Partnership has written-down the remaining balance of the Partnership's
investment in the sales-type lease. The write-down was based on the comparison
of estimated fair value of the Partnership's interest in the aircraft and the
Partnership's net investment in the sales-type lease. The write-down recorded
in the three months ended March 31, 2002 was $17,755. For the three months
ended March 31, 2001, the Partnership recognized sales-type lease revenue of
$3,351.
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 months ended March 31, 2002 was $18,651 compared
to $174,807 for the same period in 2001. Interest income is typically generated
from temporary investment of rental receipts and equipment sale proceeds in
short-term instruments and interest earned on the loan receivable from Echelon
Residential Holdings. 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.
Interest income included $144,686 for the three months ended March 31, 2001,
earned on the loan receivable from Echelon Residential Holdings. The
Partnership ceased accruing interest on this loan, effective April 1, 2001. See
further discussion below.
In the fourth quarter of 2001, a court judgment was entered in favor of the
Partnership and certain affiliates related to the litigation with Transmeridian
Airlines. The Partnership received settlement proceeds of approximately
$1,563,000 from the defendants in March 2002, which was recognized as other
income in the first quarter of 2002.
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 any future gain or loss reported in the financial
statements may not necessarily be indicative of the total residual value the
Partnership achieved from leasing the aircraft.
For the three months ended March 31, 2002 and 2001, the Partnership incurred
interest expense of $19,178 and $17,393, respectively. 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 $6,046 and $10,750, respectively, during the periods ended
March 31, 2002 and 2001. Management fees are based on 5% of gross lease revenue
generated by leases and 2% of gross revenue generated by full payout leases.
Bad debt expense was $22,999 for the quarter ended March 31, 2002 including the
write-down of the remaining balance of the Partnership's investment in the
sales-type lease. The write-down was based on the comparison of estimated fair
value of the Partnership's interest in the aircraft and the Partnership's net
investment in the sales-type lease.
Operating expenses were $94,914 and $141,432 for the three months ended March
31, 2002 and 2001, respectively. During the quarter ended March 31, 2001,
operating expenses included approximately $27,000 related to the Class Action
Lawsuit. 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.
Depreciation expense was $65,345 for the three months ended March 31, 2002
compared to $65,346 for the same period in 2001.
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 $1,391,003 and a net cash outflow of $20,832 for the three months
ended March 31, 2002 and 2001, respectively. The cash inflow in 2002 is
primarily the result of the receipt of approximately $1,563,000 of litigation
settlement proceeds. 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. In the future, the amount of cash from interest income
is expected to fluctuate as a result of changing interest rates and the level of
cash available for investment, among other factors. The loan to Echelon
Residential Holdings and accrued interest thereon are due in full at maturity on
September 8, 2002.
At March 31, 2002, the Partnership was due aggregate future minimum lease
payments of $766,487 from contractual operating lease agreements, a portion of
which will be used to amortize the principal balance of notes payable of
$984,248. 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 currently are attempting to remarket the aircraft that is 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. In accordance with the Partnership's investment objectives and the
terms of its Partnership Agreement, the Partnership generally sells its
aircraft as the related leases expire. Additionally, the Partnership sells, on
a selective basis, aircraft before the expiration of the related lease.
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.
During the second quarter of 2001, the General Partner determined that
recoverability of the loan receivable had been impaired and at June 30, 2001
recorded an impairment of $318,500, reflecting the General Partner's current
assessment of the amount of loss that is likely to be incurred by the
Partnership. In addition to the write-down recorded at June 30, 2001, the
Partnership reserved all accrued interest of $590,772 recorded on the loan
receivable through March 31, 2001 and has ceased accruing interest on its loan
receivable from Echelon Residential Holdings, effective April 1, 2001.
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 periodically evaluates the collectibility of
the loan's contractual principal and interest and the existence of loan
impairment indicators.
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. In the near
term, the amount of cash used for debt payments will be consistent with the
quarter ended March 31, 2002. Subsequently, the amount of cash used will
decrease as the principal balance of the note payable is reduced through the
collection and application of rents. In addition, the Partnership has a balloon
payment obligation as discussed below.
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 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 $706,831 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 another aircraft 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.
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 March 31, 2002, 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. In January 2002, this lease was amended, including
revising the lease expiration date to August 2002. The remaining two aircraft
in the Partnership's portfolio already are Stage 3 compliant. The lease term
associated with one of the McDonnell Douglas MD-82 aircraft expired in 2001 and
the aircraft is currently off lease.
Recent changes in the 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 its commercial jet aircraft. Currently, all of the commercial
jet aircraft in which the Partnership has a proportionate ownership interest are
subject to contracted lease agreements except one McDonnell Douglas MD-82
aircraft, 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.
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).
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
component of the cumulative difference between financial statement income or
loss and tax income or loss results from different depreciation policies for
book and tax purposes.
For financial reporting purposes, the General Partner has accumulated a capital
deficit at March 31, 2002. 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, 2001, the
General Partner had a positive tax capital account balance.
The Partnership is a Nominal Defendant in a Class Action Lawsuit. 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 March 31, 2002, 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 during the quarter ended March
31, 2002 was not material.
The Partnership's loan to Echelon Residential Holdings matures on September 8,
2002 and currently earns interest at a fixed annual rate of 18% with interest
due at maturity (see discussion above). 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 in
the quarter ended March 31, 2002 was not material.
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
. Response:
. Refer to Note 8 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
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: May 14, 2002
--------------
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:
Michael J. Butterfield
Treasurer of AFG Aircraft Management Corporation
(Duly Authorized Officer and
Principal Financial and Accounting Officer)
Date: