AIRFUND II International Limited Partnership
Annual Report to the Partners, December 31, 2000
Dear Investor:
We are pleased to provide the 2000 Annual Report for AIRFUND II International
Limited Partnership which contains important information concerning the recent
operating results and current financial position of your investment program.
Please refer to the index on the following page for a listing of information
contained in this report.
If you have any questions about your investment program or, if you would like a
copy of Form 10-K for this program, please contact our Investor Services
Representatives at 1-800-247-3863.
Very truly yours,
/s/ GEOFFREY A. MACDONALD
Geoffrey A. MacDonald
Chairman and Co-founder
AIRFUND II International Limited Partnership
INDEX TO ANNUAL REPORT TO THE PARTNERS
PAGE
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SELECTED FINANCIAL DATA................................................. 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................... 3-8
FINANCIAL STATEMENTS:
Report of Independent Auditors.......................................... 9
Statement of Financial Position
at December 31, 2000 and 1999........................................... 10
Statement of Operations
for the years ended December 31, 2000, 1999 and 1998.................... 11
Statement of Changes in Partners' Capital
for the years ended December 31, 2000, 1999 and 1998.................... 12
Statement of Cash Flows
for the years ended December 31, 2000, 1999 and 1998.................... 13
Notes to the Financial Statements....................................... 14-28
ADDITIONAL FINANCIAL INFORMATION:
Schedule of Excess (Deficiency) of Total Cash
Generated to Cost of Equipment Disposed................................. 29
Statement of Cash and Distributable
Cash From Operations, Sales and Refinancings............................ 30
Schedule of Costs Reimbursed to the General Partner
and its Affiliates as Required by Section 10.4 of the Amended
and Restated Agreement and Certificate of Limited Partnership........... 31
SELECTED FINANCIAL DATA
The following data should be read in conjunction with Management's
Discussion and Analysis of Financial Condition and Results of Operations and the
financial statements.
For each of the years in the five year period ended December 31, 2000:
SUMMARY OF
OPERATIONS 2000 1999 1998 1997 1996
- ------------------------------------------- ------------ ------------ ------------ ------------ ------------
Operating and sales-type lease revenue .... $ 556,906 $ 1,841,170 $ 3,130,704 $ 3,224,618 $ 4,706,774
Interest Income ........................... $ 202,930 $ 267,788 $ 158,844 $ 110,635 $ 265,820
Net income (loss) ......................... $ 176,226 $ 1,892,009 $ (1,208,085) $ (1,762,752) $ (3,649,940)
Per Unit:
Net income (loss) .................... $ 0.06 $ 0.66 $ (0.42) $ (0.62) $ (1.28)
Cash distributions declared .......... $ -- $ -- $ -- $ -- $ 2.25
FINANCIAL POSITION
- -------------------------------------------
Total assets .............................. $ 9,250,375 $ 9,112,479 $ 8,076,569 $ 9,765,106 $ 13,163,812
Total long-term obligations ............... $ 906,869 $ 981,775 $ 1,896,665 $ 2,677,520 $ 3,419,785
Partners' capital ......................... $ 7,700,277 $ 7,524,051 $ 5,632,042 $ 6,840,127 $ 8,602,879
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR
ENDED DECEMBER 31, 1999 AND THE YEAR ENDED DECEMBER 31, 1999
COMPARED TO THE YEAR ENDED DECEMBER 31, 1998
Certain statements in this annual 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 equipment, and the performance of the
Partnership's non-equipment assets.
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. Currently, all of the aircraft in the
Partnership's original portfolio have been re-leased, renewed, exchanged for
other aircraft, or sold. At December 31, 2000, the Partnership's equipment
portfolio included proportionate ownership interests in three aircraft and two
aircraft engines. 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.
The Investment Company Act of 1940 (the "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
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
Act. If the Partnership were to be determined to be an investment company, its
business would be adversely affected. If necessary, the Partnership intends to
avoid being deemed an investment company by disposing of or acquiring certain
assets that it might not otherwise dispose of or acquire.
RESULTS OF OPERATIONS
For the year ended December 31, 2000, the Partnership recognized operating
lease revenue of $554,415 compared to $1,841,170 and $3,130,704 for the years
ended December 31, 1999 and 1998, respectively. The decrease in lease revenue
from 1999 to 2000 resulted primarily from the expiration of lease terms related
to the Partnership's interest in three Boeing 737-2H4 aircraft and a McDonnell
Douglas MD-82 aircraft, as discussed below, and the sales of the Partnership's
Boeing 727-208 ADV aircraft and its Boeing 727-251 ADV aircraft in April 1999
and May 2000, respectively. The decrease in lease revenue from 1998 to 1999
resulted primarily to the non-payment of rents by the lessee of the
Partnership's Lockheed L-1011-100 aircraft and the lessee's subsequent
liquidation (see below), the non-payment of rents by the lessee of the
Partnership's Boeing 727-251 ADV aircraft (see below) and the sale of the Boeing
727-208 ADV aircraft and the Partnership's interest in a Lockheed L-1011-50
aircraft in April 1998. The amount of operating lease revenues in the near term
will increase due to the re-lease of both the McDonnell Douglas MD-82 aircraft
and one of the Boeing 737-2H4 aircraft in September 2000. Subsequently,
operating lease revenue is expected to decline due to lease term expiration and
aircraft sales. See discussion below related to the Partnership's sales-type
lease revenue for the year ended December 31, 2000.
At December 31, 2000, the Partnership's equipment portfolio included assets
in which the Partnership holds a proportionate ownership interest. In such
cases, the remaining interests are owned by an affiliated equipment
3
leasing program sponsored by Equis Financial Group Limited Partnership ("EFG").
Proportionate equipment ownership enabled the Partnership to further diversify
its equipment portfolio at inception by participating in the ownership of
selected assets, thereby reducing the general levels of risk which could have
resulted from a concentration in any single equipment type, industry or lessee.
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 equipment.
The lease terms related to the three Boeing 737-2H4 aircraft, in which the
Partnership held a proportionate interest, expired on December 31, 1999 and the
aircraft were stored pending their remarketing. In July 2000, one of the Boeing
737-2H4 aircraft was sold, resulting in $255,645 of proceeds and a net gain, for
financial statement purposes, of $43,102. In September 2000, a second Boeing
737-2H4 aircraft was re-leased, with a lease term expiring in September 2003.
Under the terms of this re-lease agreement, the Partnership will receive rents
of approximately $350,000 over the term of the lease. The Partnership entered
into a conditional sales agreement to sell its interest in the remaining Boeing
737-2H4 aircraft as described below.
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. Under the terms of this re-lease
agreement, the Partnership will receive rents of approximately $1,176,358 over
the term of the lease. The remaining McDonnell Douglas MD-82 aircraft, in which
the Partnership owns an ownership interest, is currently on lease to Finnair OY
through April 2001.
Interest income for the year ended December 31, 2000 was $202,930 compared
to $267,788 and $158,844 for the years ended December 31, 1999 and 1998,
respectively. Interest income is typically generated from temporary investments
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. On March 8, 2000, the Partnership utilized $3,640,000 of
available cash for a loan to Echelon Residential Holdings. The loan is presented
in the accompanying financial statements 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", and
therefore the Partnership does not recognize interest income related to this
loan. (See further discussion included in Note 4 to the financial statements
herein).
Other income for the year ended December 31, 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.
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. 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 year ended December 31, 2000, the
Partnership recorded a net gain on sale of equipment, for financial statement
purposes, of $91,471 for the Partnership's proportional interest in the aircraft
and recognized sales-type lease revenue of $2,491.
The Partnership's Boeing 727-251 ADV aircraft was damaged in an on-ground
accident in October 1998 while being leased on a month-to-month basis by
Transmeridian Airlines, Inc. ("Transmeridian"). In September 1999, Transmeridian
ceased paying rent with respect to this aircraft. See Note 9 to the accompanying
financial statements for details regarding legal action undertaken by the
Partnership related to this situation. In May 2000, the Partnership sold the
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 year ended December 31, 2000.
The Partnership recognized lease revenue of $70,000, $560,000, and $876,667
related to this aircraft during the years ended December 31, 2000, 1999 and
1998, respectively.
In April 1999, the Partnership sold its Boeing 727-208 ADV aircraft,
previously leased to American Trans Air, Inc. ("ATA"), to the lessee for net
proceeds of $3,109,500. The aircraft was fully depreciated at the time of sale,
resulting in a net gain, for financial statement purposes, of $3,109,500. The
Partnership recognized lease revenue of approximately $246,000 and $762,000
related to this aircraft for the year ended December 31, 1999 and 1998,
respectively.
4
In August 1998, Classic Airways Limited ("Classic") ceased paying rent with
respect to the Partnership's Lockheed L-1011-100 jet aircraft. In October 1998,
Classic filed for receivership in the United Kingdom ("UK") and was placed in
liquidation (see further discussion below). The Partnership earned lease revenue
in the amount of approximately $320,000 related to this aircraft during the year
ended December 31, 1998.
On April 29, 1998, at the expiration of the aircraft's lease term, the
Partnership sold its proportional interest in a Lockheed L-1011-50 aircraft to
the lessee for net proceeds of $553,699. The Partnership's interest in the
aircraft had a net book value of $426,434 at the time of sale, resulting in the
recognition of a net gain on sale, for financial statement purposes, of
$127,265.
It cannot be determined whether future sales of aircraft will result in a
net gain or a net loss to the Partnership, as such transactions will be
dependent upon the condition and type of aircraft being sold and their
marketability at the time of sale. In addition, the amount of gain or loss
reported for financial statement purposes is partly a function of the amount of
accumulated depreciation associated with the equipment being sold.
The ultimate realization of residual value for any aircraft will be
dependent upon many factors, including EFG's ability to sell and re-lease the
aircraft. Changes in market conditions, industry trends, technological advances,
and other events could converge to enhance or detract from asset values at any
given time. EFG attempts to monitor these changes and the airline industry 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 for 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.
Interest expense was $103,919, $120,701 and $200,679 for the years ended
December 31, 2000, 1999 and 1998, respectively. Interest expense in near term
will increase as a result of the Partnership's debt refinancing in February
2001. (See Note 11 to the financial statements.) Subsequently, interest expense
will decline as the principal balance of notes payable is reduced through the
application of rent receipts to outstanding debt. See additional discussion
below regarding the refinancing of the debt in 2001.
Management fees of $29,913, 92,059, and 156,535 for the years ended
December 31, 2000, 1999 and 1998, respectively. Management fees are based on 5%
of gross lease revenue generated by operating leases and 2% of gross lease
revenue generated by full payout leases.
Operating expenses were $1,061,428, $2,059,346 and $1,815,947 for the years
ended December 31, 2000, 1999 and 1998, respectively. In 2000 and 1999, the
Partnership accrued approximately $149,000 and $201,000, respectively, for the
reconfiguration costs and completion of a D-Check incurred to facilitate the
remarketing of the McDonnell Douglas MD-82 aircraft released in September 2000.
In 2000, the Partnership also accrued approximately $201,000 for a required
D-check for a second McDonnell Douglas MD-82 aircraft. In addition, the
Partnership incurred legal fees in connection with the lease-related litigation
described in Note 9 to the financial statements. Operating expenses in the year
ended December 31, 1999 include engine leasing costs of $984,000 incurred
related to the aircraft leased to Transmeridian and legal costs related to the
Partnership's ongoing litigation. In addition, the operating expenses in 1998
also included legal costs incurred in connection with legal proceedings related
to Northwest Airlines, Inc. and Classic. Operating expenses in 2000, 1999 and
1998 also included approximately $41,000, $50,000 and $332,000, respectively,
related to the Class Action Lawsuit described in Note 9 to the financial
statements. Other operating expenses consist principally of professional service
costs, such as audit and legal fees, as well as insurance, printing,
distribution and other remarketing expenses. Depreciation expense was $297,611,
$1,054,343, and $2,451,737 for the years ended December 31, 2000, 1999, and
1998, respectively.
For the year ended December 31, 2000, the Partnership's share of losses in
Echelon Residential Holdings was $276,289. This loss is reflected on the
Statement of Operations as "Partnership's share of unconsolidated real estate
venture's loss." See further discussion below.
5
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 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 outflow of
$182,996 in 2000 and net cash inflows of $99,270 and $1,550,424 in 1999 and
1998, respectively. Overall, expenses associated with rental activities, such as
management fees, and net cash flow from operating activities will decline as the
Partnership remarket 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. The amount of future interest income is expected to fluctuate as a result
of changing interest rates and the level of cash available for investment, among
other factors.
Cash realized from aircraft disposal transactions is reported under
investing activities on the accompanying Statement of Cash Flows. For the year
ended December 31, 2000, the Partnership realized net cash proceeds of
$1,005,645 related to its Boeing 737-2H4 and 727-251 ADV aircraft. In 1999, the
Partnership received sales proceeds of $3,109,500 related to its Boeing 727-208
ADV aircraft formerly leased to ATA. During the year ended December 31, 1998,
the Partnership sold its interest in a Lockheed L-1011-50 aircraft and realized
net cash proceeds of $553,699. 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 December 31, 2000, the Partnership was due aggregate future minimum
lease payments of $1,708,411 from contractual operating and sales-type lease
agreements (see Notes 2 and 5 to the financial statements), a portion of which
will be used to amortize the principal balance of notes payable of $906,869 (see
Note 7 to the financial statements). At the expiration of the individual lease
terms underlying the Partnership's future minimum lease payments, the
Partnership will sell its aircraft or enter re-lease or renewal agreements when
considered advantageous by the General Partner and EFG. Such future remarketing
activities will result in the realization of additional cash inflows in the form
of sale proceeds or rents from renewals and 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 August 1998, a lessee of the Partnership, Classic, ceased paying rent to
the Partnership with respect to a Lockheed L-1011-100 Aircraft (the "Aircraft")
and the Partnership terminated the lease. Classic then filed for receivership in
the United Kingdom ("UK") and was placed in liquidation. Prior to its
liquidation, Classic had incurred and failed to pay significant airport ground
fees to BAA plc, Eurocontrol, and CAA (collectively, the "Airport Authorities").
Classic's failure to pay such charges resulted in detention of the Aircraft by
BAA plc. The total of ground fees and expenses asserted by the Airport
Authorities, which continued to accrue after the detention began, exceeded
$1,500,000 at November 30, 1999. Prior to that date, the General Partner had
attempted to reach a negotiated settlement with the Airport Authorities so that
the Aircraft could be returned to the Partnership. Those negotiations were
unsuccessful and the General Partner determined that the amount of fees owed to
the Airport Authorities was in excess of the Aircraft's value and, therefore, it
would not be in the Partnership's best interests to pay these fees.
BAA plc obtained a judgment from a UK Court entitling it to sell the
aircraft to satisfy the unpaid charges and, on December 8, 1999, the Aircraft
was sold at auction. It is believed that the sale price was insufficient to
satisfy the aggregate fees owed to the Airport Authorities. Accordingly, the
Partnership will not realize any portion of the sale proceeds obtained by BAA
plc nor any future residual value from the Aircraft. Notwithstanding the
foregoing, the Partnership held the Aircraft's records, which were sold for
$55,000 in 2000. In addition, the Partnership retains two engines that had been
removed from the Aircraft for maintenance prior to Classic's liquidation. The
General Partner is attempting to remarket these engines. At the date of
Classic's liquidation, the Partnership had accrued $160,000 of rental income
which had not been collected from Classic and all of which was written off as
uncollectible in the third quarter of 1998. The Aircraft, including the two
engines that were removed for maintenance, had been fully depreciated prior to
the auction by BAA plc. Subsequent to the auction, the Aircraft (except for the
two engines) was written off by the Partnership.
6
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 4 to the Partnership's financial statements herein,
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. 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 and 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
Partnership's Statement of Cash Flows. The corresponding note agreements are
recourse only to the specific equipment financed and to the minimum rental
payments contracted to be received during the debt amortization periods (which
generally coincides with the lease terms). As rental payments are collected, a
portion of all of the rental payments is used to repay associated indebtedness.
In the near term, the amount of cash used to repay debt obligations will
increase due to the refinancing discussed below. Subsequently the amount of cash
used will decline as the principal balance of notes payable is reduced through
the collection and application of rents.
In February 2000, the Partnership and certain affiliated investment
programs (collectively, the "Programs") refinanced the indebtedness, which
matured in January 2000 associated with a McDonnell Douglas MD-82 aircraft
re-leased in September 2000. In addition to refinancing the existing
indebtedness of $3,370,000, the Programs received additional debt proceeds of
$1,350,000 required to perform a D-Check on the aircraft. The Partnership
received $201,247 from such proceeds. The note had a fluctuating interest rate
based on LIBOR plus a margin with interest payments due monthly. The
Partnership's aggregate share of the refinanced and new indebtedness was
$701,062, which matured in August 2000. The Partnership paid interest-only on
the debt throughout 2000. In February 2001, the Programs refinanced the
outstanding indebtedness and accrued interest related to this 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 $706,831 used to repay the existing
indebtedness on the
7
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 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.
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 December 31, 2000, 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. These aircraft have lease terms
expiring in April 2001 and September 2004, respectively.
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). 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
treatments for book and tax purposes related to the real estate venture.
For financial reporting purposes, the General Partner has accumulated a
capital deficit at December 31, 2000. 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.
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 is a Nominal Defendant in a Class Action Lawsuit described
in Note 9 to the accompanying financial statements. The proposed settlement to
that lawsuit, if effected, will 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 adjudicated.
8
REPORT OF INDEPENDENT AUDITORS
To the Partners of AIRFUND II International Limited Partnership:
We have audited the accompanying statements of financial position of AIRFUND II
International Limited Partnership, as of December 31, 2000 and 1999, and the
related statements of operations, changes in partners' capital, and cash flows
for each of the three years in the period ended December 31, 2000. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The consolidated financial statements of Echelon Residential
Holdings LLC, (a limited liability company to which the Partnership has loaned
$3,640,000), have been audited by other auditors whose report has been furnished
to us; insofar as our opinion on the financial statements relates to data
included for Echelon Residential Holdings LLC, it is based solely on their
report.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of AIRFUND II International Limited Partnership at
December 31, 2000 and 1999, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 2000, in conformity
with accounting principles generally accepted in the United States.
Our audits were conducted for the purpose of forming an opinion on the basic
financial statements taken as a whole. The Additional Financial Information
identified in the Index to Annual Report to the Partners is presented for
purposes of additional analysis and is not a required part of the basic
financial statements. Such information has been subjected to the auditing
procedures applied in our audits of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
/s/ ERNST & YOUNG LLP
Tampa, Florida
March 30, 2001
9
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
DECEMBER 31, 2000 AND 1999
2000 1999
------------ ------------
ASSETS
Cash and cash equivalents .............................. $ 2,827,385 $ 5,719,642
Rents receivable ....................................... 116,820 --
Accounts receivable - affiliate ........................ 33,452 1,476
Other assets ........................................... 24,508 31,742
Investment in real estate venture ...................... 3,363,711 --
Net investment in sales-type lease ..................... 240,330 --
Equipment at cost, net of accumulated
depreciation of $8,152,945 and $18,449,875
at December 31, 2000 and 1999, respectively ........ 2,644,169 3,359,619
------------ ------------
Total assets ................................... $ 9,250,375 $ 9,112,479
============ ============
LIABILITIES AND PARTNERS' CAPITAL
Notes payable .......................................... $ 906,869 $ 981,775
Accrued interest ....................................... 7,161 13,356
Accrued liabilities .................................... 591,617 463,324
Accrued liabilities - affiliate ........................ 17,207 78,593
Deferred rental income ................................. 27,244 51,380
------------ ------------
Total liabilities .............................. 1,550,098 1,588,428
------------ ------------
Partners' capital (deficit):
General Partner .................................... (2,610,443) (2,619,254)
Limited Partnership Interests (2,714,647 Units;
initial purchase price of $25 each) ............... 10,310,720 10,143,305
------------ ------------
Total partners' capital ........................ 7,700,277 7,524,051
------------ ------------
Total liabilities and partners' capital ........ $ 9,250,375 $ 9,112,479
============ ============
The accompanying notes are an integral part of these financial statements.
10
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
----------- ----------- -----------
Income:
Operating lease revenue .................. $ 554,415 $ 1,841,170 $ 3,130,704
Sales-type lease revenue ................. 2,491 -- --
Interest income .......................... 202,930 267,788 158,844
Other income ............................. 300,977 -- --
Gain on sale of equipment ................ 884,573 3,109,500 127,265
----------- ----------- -----------
Total income ......................... 1,945,386 5,218,458 3,416,813
----------- ----------- -----------
Expenses:
Depreciation ............................. 297,611 1,054,343 2,451,737
Interest expense ......................... 103,919 120,701 200,679
Equipment management fees - .............. 29,913 92,059 156,535
affiliate
Operating expenses - affiliate ........... 1,061,428 2,059,346 1,815,947
Partnership's share of unconsolidated
real estate venture's loss ........... 276,289 -- --
----------- ----------- -----------
Total expenses ....................... 1,769,160 3,326,449 4,624,898
----------- ----------- -----------
Net income (loss) ............................. $ 176,226 $ 1,892,009 $(1,208,085)
=========== =========== ===========
Net income (loss)
per limited partnership unit ............. $ 0.06 $ 0.66 $ (0.42)
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
11
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
GENERAL RECOGNIZED OWNERS
PARTNER ------------------------------
AMOUNT UNITS AMOUNT TOTAL
------------ ------------ ------------ ------------
Balance at December 31, 1997 .... $ (2,653,450) 2,714,647 $ 9,493,577 $ 6,840,127
Net loss - 1998 ............. (60,404) -- (1,147,681) (1,208,085)
------------ ------------ ------------ ------------
Balance at December 31, 1998 .... (2,713,854) 2,714,647 8,345,896 5,632,042
Net income - 1999 ........... 94,600 -- 1,797,409 1,892,009
------------ ------------ ------------ ------------
Balance at December 31, 1999 .... (2,619,254) 2,714,647 10,143,305 7,524,051
Net income - 2000 .......... 8,811 -- 167,415 176,226
------------ ------------ ------------ ------------
Balance at December 31, 2000 .... $ (2,610,443) 2,714,647 $ 10,310,720 $ 7,700,277
============ ============ ============ ============
The accompanying notes are an integral part of these financial statements.
12
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
2000 1999 1998
----------- ----------- -----------
Cash flows provided by (used in) operating activities:
Net income (loss) ............................................... $ 176,226 $ 1,892,009 $(1,208,085)
Adjustments to reconcile net income (loss)
to net cash (used in) provided by operating activities:
Depreciation ............................................... 297,611 1,054,343 2,451,737
Sales-type lease revenue ................................... (2,491) -- --
Gain on sale of equipment .................................. (884,573) (3,109,500) (127,265)
Partnership's share of unconsolidated
real estate venture's loss ............................. 276,289 -- --
Changes in assets and liabilities:
Decrease (increase) in:
Rents receivable ........................................ (116,820) 39,933 25,187
Accounts receivable - affiliate ......................... (31,976) 69,702 234,181
Other assets ............................................ 7,234 93,992 (125,734)
Collections on net investment in sales-type lease ....... 58,928 -- --
Increase (decrease) in:
Accrued interest ........................................ (6,195) (11,770) (4,492)
Accrued liabilities ..................................... 128,293 4,839 450,235
Accrued liabilities - affiliate ......................... (61,386) 62,339 (26,270)
Deferred rental income .................................. (24,136) 3,383 (119,070)
----------- ----------- -----------
Net cash (used in) provided by operating activities .... (182,996) 99,270 1,550,424
----------- ----------- -----------
Cash flows provided by (used in) investing activities:
Proceeds from equipment sales .............................. 1,005,645 3,109,500 553,699
Investment in real estate venture .......................... (3,640,000) -- --
----------- ----------- -----------
Net cash (used in) provided by investing activities .... (2,634,355) 3,109,500 553,699
----------- ----------- -----------
Cash flows provided by (used in) financing activities:
Proceeds from notes payable ................................ 201,247 -- --
Principal payments - notes payable ......................... (276,153) (914,890) (780,855)
----------- ----------- -----------
Net cash used in financing activities .................. (74,906) (914,890) (780,855)
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents ............ (2,892,257) 2,293,880 1,323,268
Cash and cash equivalents at beginning of year .................. 5,719,642 3,425,762 2,102,494
----------- ----------- -----------
Cash and cash equivalents at end of year ........................ $ 2,827,385 $ 5,719,642 $ 3,425,762
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest ..................... $ 110,114 $ 132,471 $ 205,171
=========== =========== ===========
Supplemental disclosure of non-cash financing activities:
Equipment sold on sales-type lease.......................... $ 296,767 $ -- $ --
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
13
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
DECEMBER 31, 2000
NOTE 1 - ORGANIZATION AND PARTNERSHIP MATTERS
AIRFUND II International Limited Partnership (the "Partnership") was
organized as a limited partnership under the Massachusetts Uniform Limited
Partnership Act (the "Uniform Act") on July 20, 1989 for the purpose of
acquiring and leasing to third parties a specified portfolio of used commercial
aircraft. Partners' capital initially consisted of contributions of $1,000 from
the General Partner (AFG Aircraft Management Corporation, a Massachusetts
corporation) and $100 from the Initial Limited Partner (AFG Assignor
Corporation, a Massachusetts corporation). The Partnership issued 2,714,647
units, representing assignments of limited partnership interests (the "Units"),
to 4,192 investors. Unitholders and Limited Partners (other than the Initial
Limited Partner) are collectively referred to as Recognized Owners. The General
Partner is an affiliate of Equis Financial Group Limited Partnership (formerly
known as American Finance Group), a Massachusetts limited partnership ("EFG").
The common stock of the General Partner is owned by AF/AIP Programs Limited
Partnership. EFG and a wholly owned affiliate are the 99% limited partners and
AFG Programs, Inc., a Massachusetts corporation that is wholly-owned by Geoffrey
A. MacDonald, is the 1% general partner. The General Partner is not required to
make any other capital contributions to the Partnership except as may be
required under the Uniform Act and Section 6.1(b) of the Amended and Restated
Agreement and Certificate of Limited Partnership (the "Restated Agreement, as
amended").
EFG is a Massachusetts partnership formerly known as American Finance Group
("AFG"). AFG was established in 1988 as a Massachusetts general partnership and
succeeded American Finance Group, Inc., a Massachusetts corporation organized in
1980. EFG and its subsidiaries (collectively, the "Company") are engaged in
various aspects of the equipment leasing business, including EFG's role as
Equipment Manager or Advisor to the Partnership and several other
direct-participation equipment leasing programs sponsored or co-sponsored by EFG
(the "Other Investment Programs"). The Company arranges to broker or originate
equipment leases, acts as remarketing agent and asset manager, and provides
leasing support services, such as billing, collecting, and asset tracking.
The general partner of EFG, with a 1% controlling interest, is Equis
Corporation, a Massachusetts corporation owned and controlled entirely by Gary
D. Engle, its President, Chief Executive Officer and sole Director. Equis
Corporation also owns a controlling 1% general partner interest in EFG's 99%
limited partner, GDE Acquisition Limited Partnership ("GDE LP"). Equis
Corporation and GDE LP were established in December 1994 by Mr. Engle for the
sole purpose of acquiring the business of AFG.
In January 1996, the Company sold certain assets of AFG relating primarily
to the business of originating new leases, and the name "American Finance
Group," and its acronym, to a third party. AFG changed its name to Equis
Financial Group Limited Partnership after the sale was concluded. Pursuant to
terms of the sale agreements, EFG specifically reserved the rights to continue
using the name American Finance Group and its acronym in connection with the
Partnership and the Other Investment Programs and to continue managing all
assets owned by the Partnership and the Other Investment Programs.
In 1990, EFG assigned its Equipment Management Agreement with the
Partnership to AF/AIP Programs Limited Partnership, and AF/AIP Programs Limited
Partnership entered into an identical management agreement with EFG.
On June 28, 1991, the Offering of Units of the Partnership was concluded.
The Partnership issued an aggregate of 2,714,647 Units in six Interim Closings
during the period May 17, 1990 through June 28, 1991. The initial purchase of
the aircraft and the associated lease commitments occurred on May 18, 1990.
Additional purchases of aircraft (or proportionate interests in aircraft)
occurred subsequent to each Closing. The six Interim Closings which occurred in
1990 and 1991 and the associated Units issued, purchase price and number of
investors who became Recognized Owners of the Partnership are summarized below.
14
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
RECOGNIZED
CLOSING DATE UNITS ISSUED PURCHASE PRICE OWNERS
------------ ------------ -------------- -----------
May 17, 1990 ................ 1,725,100 $43,127,500 2,600
August 2, 1990 .............. 317,986 7,949,650 494
October 1, 1990 ............. 159,510 3,987,750 251
December 27, 1990 ........... 246,845 6,171,125 398
February 15, 1991 ........... 112,796 2,819,900 173
June 28, 1991 ............... 152,410 3,810,250 276
----------- ----------- -----------
Totals .... 2,714,647 $67,866,175 4,192
=========== =========== ===========
Pursuant to the Restated Agreement, as amended, distributions of
Distributable Cash From Operations and Distributable Cash From Sales or
Refinancings of the Partnership shall be made as follows: Prior to Payout, (i)
Distributable Cash From Operations will be distributed 95% to the Recognized
Owners and 5% to the General Partner and (ii) Distributable Cash From Sales or
Refinancings shall be distributed 99% to the Recognized Owners and 1% to the
General Partner. After Payout, (i) all Distributions will be distributed 99% to
the General Partner and 1% to the Recognized Owners until the General Partner
has received an amount equal to 5% of all Distributions made by the Partnership
and (ii) thereafter, all Distributions will be made 90% to the Recognized Owners
and 10% to the General Partner.
Under the terms of a Management Agreement between the Partnership and EFG,
management services are provided by EFG to the Partnership at fees which the
General Partner believes to be competitive for similar services (see Note 6).
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH
The Partnership considers liquid investment instruments purchased with a
maturity of three months or less to be cash equivalents. From time to time, the
Partnership invests excess cash with large institutional banks in federal agency
discount notes and in repurchase agreements with overnight maturities. Under the
terms of the agreements, title to the underlying securities passes to the
Partnership. The securities underlying the agreements are book entry securities.
At December 31, 2000, the Partnership had $2,710,280 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.
REVENUE RECOGNITION
Effective January 1, 2000, the Partnership adopted the provisions of
Securities Exchange Commission Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" ("SAB No. 101"). SAB No. 101 provides
guidance for the recognition, presentation and disclosure of revenue in
financial statements. The adoption of SAB No. 101 had no impact on the
Partnership's financial statements.
Rents are payable to the Partnership monthly, quarterly or semi-annually
and no significant amounts are calculated on factors other than the passage of
time. 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 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 regarding the Class Action Lawsuit. Future minimum
rents are $1,472,431 are due as follows:
15
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
For the year ending December 31, 2001.......... $ 491,543
2002.......... 412,079
2003.......... 372,749
2004.......... 196,060
-----------
Total......... $ 1,472,431
===========
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 $255,407 are due in the year ending December 31,
2001.
Revenue from major individual lessees which accounted for 10% or more of
lease revenue during the years ended December 31, 2000, 1999 and 1998 is as
follows:
2000 1999 1998
-------- -------- --------
Finnair OY ........................ $346,949 $634,658 $639,923
Aerovias de Mexico S.A. de C.V .... $ 92,311 $ -- $ --
Transmeridian Airlines, Inc. ...... $ 70,000 $560,000 $876,667
Southwest Airlines, Inc. .......... $ -- $380,699 $377,568
American Trans Air, Inc. .......... $ -- $245,533 $762,000
Classic Airways Limited ........... $ -- $ -- $319,960
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
EQUIPMENT ON LEASE
All aircraft were acquired from EFG or one of its Affiliates. Equipment
Cost means the actual cost paid by the Partnership to acquire the aircraft,
including acquisition fees. Equipment cost reflects the actual price paid for
the aircraft by EFG or the Affiliate plus all actual costs incurred by EFG or
the Affiliate while carrying the aircraft less the amount of all rents received
by EFG or the Affiliate prior to selling the aircraft.
DEPRECIATION
The Partnership's depreciation policy is intended to allocate the cost of
aircraft over the period during which they produce economic benefit. The
principal period of economic benefit is considered to correspond to each
aircraft's primary lease term, which term generally represents the period of
greatest revenue potential for each aircraft. Accordingly, to the extent that an
aircraft is held on primary lease term, the Partnership depreciates the
difference between (i) the cost of the aircraft and (ii) the estimated residual
value of the aircraft on a straight-line basis over such term. For purposes of
this policy, estimated residual values represent estimates of aircraft values at
the date of primary lease expiration. To the extent that an aircraft is held
beyond its primary lease term, the Partnership continues to depreciate the
remaining net book value of the aircraft on a straight-line basis over the
aircraft's remaining economic life. Periodically, the General Partner evaluates
the net carrying value of equipment to determine whether it exceeds estimated
net realizable value. 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.
16
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
The ultimate realization of residual value for any type of aircraft is
dependent upon many factors, including EFG's ability to sell and re-lease
aircraft. Changing market conditions, industry trends, technological advances,
and many other events can converge to enhance or detract from asset values at
any given time.
REAL ESTATE LOAN
The Partnership accounts for the loan to a real estate company using the
guidance set forth in the Third Notice to Practitioners by the American
Institute of Certified Public Accountants ("AICPA") in February 1986 entitled
"ADC Arrangements" (the "Third Notice"). The Partnership has evaluated this loan
and has determined that real estate accounting is appropriate. This
determination affects the Partnership's balance sheet classification of the loan
and the recognition of revenues derived therefrom. The Third Notice was issued
to address those real estate acquisition, development and construction
arrangements where a lender has virtually the same risk and potential rewards as
those of owners or joint ventures. Emerging Issues Task Force ("EITF") 86-21,
"Application of the AICPA Notice to Practitioners regarding Acquisition,
Development and Construction Arrangements to Acquisition of an Operating
Property" expanded the applicability of the Third Notice to entities other than
financial institutions.
Based on the applicability of the Third Notice, EITF 86-21 and
consideration of the economic substance of the transaction, 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 the real estate company under the equity method of accounting.
NET INVESTMENT IN SALES-TYPE LEASE
For leases that qualify as sales-type leases, the Partnership recognizes
profit or loss at lease inception to the extent the fair value of the property
leased differs from the carrying value. For balance sheet purposes, the
aggregate lease payments receivable are recorded on the balance sheet net of
unearned income as net investment in sales-type lease. Unearned income is
recognized as sales-type lease revenue over the lease term using the interest
method.
IMPAIRMENT OF LONG-LIVED ASSETS
The carrying value of long-lived assets including equipment and the real
estate loan will be reviewed for impairment whenever events or changes in
circumstances indicate that the recorded value cannot be recovered from
undiscounted future cash flows.
ACCRUED LIABILITIES - AFFILIATE
Unpaid operating expenses paid by EFG on behalf of the Partnership and
accrued but unpaid administrative charges and management fees are reported as
Accrued Liabilities - Affiliate (see Note 6).
CONTINGENCIES
It is the Partnership's policy to recognize a liability for goods and
services during the period when the goods or services are received. To the
extent that the Partnership has a contingent liability, meaning generally a
liability the payment of which is subject to the outcome of a future event, the
Partnership recognizes a liability in accordance with Statement of Financial
Accounting Standards No. 5 "Accounting for Contingencies" ("SFAS No. 5"). SFAS
No. 5 requires the recognition of contingent liabilities when the amount of
liability can be reasonably estimated and the liability is probable.
The Partnership is a Nominal Defendant in a Class Action Lawsuit. In 1998,
a settlement proposal to resolve that litigation was negotiated and remains
pending (see Note 9). The Partnership's estimated exposure for costs anticipated
to be incurred in pursuing the settlement proposal is approximately $423,000
consisting principally of legal fees and other professional service costs. These
costs are expected to be incurred regardless of whether the proposed settlement
ultimately is effected and, therefore, the Partnership expensed approximately
$332,000 of these costs in 1998 following the Court's approval of the settlement
plan. The cost estimate is subject to change and is monitored by the General
Partner based upon the progress of the settlement proposal and other pertinent
information. As a result, the Partnership accrued and expensed additional
amounts of approximately $41,000 and $50,000 for such costs during 2000 and
1999, respectively.
17
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
ALLOCATION OF PROFITS AND LOSSES
For financial statement purposes, net income or loss is allocated to each
Partner according to their respective ownership percentages (95% to the
Recognized Owners and 5% to the General Partner). See Note 8 concerning
allocation of income or loss for income tax purposes.
NET INCOME (LOSS) PER UNIT
Net income (loss) per unit is based on 2,714,647 Units outstanding during
each of the three years in the period ended December 31, 2000 and computed after
allocation of the General Partner's 5% share of net income (loss).
PROVISION FOR INCOME TAXES
No provision or benefit from income taxes is included in the accompanying
financial statements. The Partners are responsible for reporting their
proportionate shares of the Partnership's taxable income or loss and other tax
attributes on their separate tax returns.
NOTE 3 - EQUIPMENT
The following is a summary of equipment owned by the Partnership at
December 31, 2000. Remaining Lease Term (Months), as used below, represents the
number of months remaining from December 31, 2000 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 LOCATION
- ------------------------------------------------------ --------------- ----------------- -----------------
Two Rolls Royce aircraft engines...................... 0 $ 6,000,000 Warehouse
One McDonnell Douglas MD-82 (Finnair)................. 4 2,078,640 Foreign
One McDonnell Douglas MD-82
(Aerovias de Mexico S.A. de C.V)...................... 44 2,078,640 Foreign
One Boeing 737-2H4 (Air Slovakia)..................... 32 639,834 Foreign
-----------------
Total equipment cost................................ 10,797,114
Accumulated depreciation............................ 8,152,945
-----------------
Equipment, net of accumulated depreciation.......... $ 2,644,169
=================
The cost of each of the Partnership's aircraft represents 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 aggregate original cost
of approximately $4,157,000 and a net book value of approximately $2,446,000 at
December 31, 2000. (See Note 7).
The Partnership entered into a three-year release agreement with Air
Slovakia for its proportionate interest in a Boeing 737-2H4 aircraft, effective
September 2000. Under the terms of this agreement, the Partnership will receive
rents of approximately $350,000 over the term of the lease. The Partnership
entered into a four-year re-lease agreement with Aerovias de Mexico, S.A. de
C.V. for its proportionate interest in a McDonnell Douglas MD-82 aircraft,
effective September 2000. Under the terms of this agreement, the Partnership
will receive rents of approximately $1,176,000 over the term of the lease.
18
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Generally, the costs associated with maintaining, insuring and operating
the Partnership's aircraft are incurred by the respective lessees pursuant to
terms specified in their individual lease agreements with the Partnership.
However, the Partnership has purchased supplemental insurance coverage to reduce
the economic risk arising from certain losses. Specifically, the Partnership is
insured under supplemental policies for "Aircraft Hull Total Loss Only" and
"Aircraft Hull Total Loss Only War and Other Perils."
As aircraft are sold to third parties, or otherwise disposed of, the
Partnership recognizes a gain or loss equal to the difference between the net
book value of the aircraft at the time of sale or disposition and the proceeds
realized upon sale or disposition. The ultimate realization of estimated
residual value in the aircraft is dependent upon, among other things, EFG's
ability to maximize proceeds from selling or re-leasing the aircraft. At
December 31, 2000, all of the Partnership's aircraft were subject to contracted
lease agreements, except the Rolls Royce aircraft engines, which were
warehoused. The General Partner is attempting to remarket these engines.
NOTE 4 - 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 participation in the loan is $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 for ADC Arrangements
as described in Note 2, Real Estate Loans, in the Partnership's financial
statements as of and for the year ended December 31, 2000. The loan is accounted
for as an investment in real estate venture and is presented net of the
Partnership's share of losses in Echelon Residential Holdings. For the period
ended December 31, 2000, the Partnership's share of losses in Echelon
Residential Holdings was $276,289 and is reflected on the Statement of
Operations as "Partnership's share of unconsolidated real estate venture's
loss."
19
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
The summarized financial information for Echelon Residential Holdings as of
December 31, 2000 and for the period March 8, 2000 (commencement of operations)
through December 31, 2000 is as follows:
Total assets......................................... $ 68,580,891
Total liabilities.................................... $ 70,183,162
Minority interest.................................... $ 2,257,367
Total deficit ....................................... $ (3,859,638)
Total revenues....................................... $ 5,230,212
Total expenses, minority interest and equity
in loss of unconsolidated joint venture............ $ 11,936,238
Net loss............................................. $ (6,706,026)
NOTE 5 - 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 year ended December 31, 2000, the Partnership
recorded a net gain on sale of equipment, for financial statement purposes, of
$91,471 for the Partnership's proportional interest in the aircraft and
recognized sales-type lease revenue of $2,491. The net book value of equipment
sold on sales-type lease totaled $296,767, which was a non-cash transaction. The
components of the net investment in the sales-type lease are as follows:
Total minimum lease payments to be received .... $255,407
Less: Unearned income ......................... 15,077
--------
Total .............. $240,330
========
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 each of the three years in
the period ended December 31, 2000, which were paid or accrued by the
Partnership to EFG or its Affiliates, are as follows:
2000 1999 1998
---------- ---------- ----------
Equipment management fees ........... $ 29,913 $ 92,059 $ 156,535
Administrative charges .............. 72,967 71,699 53,676
Reimbursable operating expenses
due to third parties ........... 988,461 1,987,647 1,762,271
---------- ---------- ----------
Total ....... $1,091,341 $2,151,405 $1,972,482
========== ========== ==========
As provided under the terms of the Management Agreement, EFG is compensated
for its services to the Partnership. Such services include acquisition and
management of equipment. For acquisition services, EFG was compensated by an
amount equal to 3.07% of Equipment Base Price paid by the Partnership. For
management services, EFG is compensated by an amount equal to 5% of gross
operating lease rental revenue and 2% of gross full payout lease rental revenue
received by the Partnership. Both acquisition and management fees are subject to
certain limitations defined in the Management Agreement.
20
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Administrative charges represent amounts owed to EFG, pursuant to Section
10.4 of Restated Agreement, as amended, for persons employed by EFG who are
engaged in providing administrative services to the Partnership. Reimbursable
operating expenses due to third parties represent costs paid by EFG on behalf of
the Partnership which are reimbursed to EFG at actual cost.
All aircraft were purchased from EFG or one of its Affiliates. The
Partnership's acquisition cost was determined by the method described in Note 2,
Equipment on Lease.
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 December 31, 2000, the Partnership was owed $33,452 by EFG for such funds and
the interest thereon. These funds were remitted to the Partnership in January
2001.
An affiliate of the General Partner owns Units in the Partnership as
follows:
--------------------------------------------- -------------------------- ------------------------
NUMBER OF PERCENT OF TOTAL
AFFILIATE UNITS OWNED OUTSTANDING UNITS
--------------------------------------------- -------------------------- ------------------------
Old North Capital Limited Partnership 40,000 1.47%
--------------------------------------------- -------------------------- ------------------------
Old North Capital Limited Partnership ("ONC") is a Massachusetts limited
partnership formed in 1995. The general partner of ONC is controlled by Gary D.
Engle and the limited partnership interests of ONC are owned by Semele Group
Inc. ("Semele"). Gary D. Engle is Chairman and Chief Executive Officer of
Semele.
NOTE 7 - NOTES PAYABLE
Notes payable at December 31, 2000 consisted of two installment notes
payable to banks of $906,869. One installment note bears an interest rate of
8.225% and the other bears a fluctuating interest rate based on LIBOR
(approximately 6.7% at December 31, 2000) plus a margin. Both of the
installment notes are non-recourse and are collateralized by the equipment and
assignment of the related lease payments. The Partnership had a balloon payment
obligation due at the expiration of the lease term related to the aircraft
leased to Finnair OY. This indebtedness was due to mature in 2001. In addition,
the Partnership had a balloon payment obligation of $701,062, which matured in
August 2000. The Partnership paid interest-only on this debt through 2000 and in
February 2001, the Partnership and certain affiliated investment programs
refinanced this indebtedness and repaid the outstanding indebtedness related to
the Finnair OY aircraft. See Note 11, "Subsequent Event", regarding this
refinancing.
Management believes that the carrying amount of notes payable approximates
fair value at December 31, 2000 based on its experience and understanding of the
market for instruments with similar terms.
The annual maturities of the installment notes payable at December 31,
2000, reflecting the maturity of the notes in consideration of the February 2001
refinancing discussed in Note 11, "Subsequent Event", are as follows:
For the year ending December 31, 2001....... $ 109,728
2002....... 143,640
2003....... 143,640
2004....... 511,861
---------
Total....... $ 906,869
=========
21
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
NOTE 8 - INCOME TAXES
The Partnership is not a taxable entity for federal income tax purposes.
Accordingly, no provision for income taxes has been recorded in the accounts of
the Partnership.
For financial statement purposes, the Partnership allocates net income or
loss to each class of partner according to their respective ownership
percentages (95% to the Recognized Owners and 5% to the General Partner). This
convention differs from the income or loss allocation requirements for income
tax and Dissolution Event purposes as delineated in the Restated Agreement, as
amended. For income tax reporting purposes, the Partnership allocates net income
or loss in accordance with such agreement. The Restated Agreement, as amended,
requires that upon 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 following is a reconciliation between net income (loss) reported for
financial statement and federal income tax reporting purposes for the years
ended December 31, 2000, 1999 and 1998:
2000 1999 1998
----------- ----------- -----------
Net income (loss) ............................. $ 176,226 $ 1,892,009 $(1,208,085)
Financial statement depreciation in
excess of (less than) tax depreciation .... (56,850) 673,872 (713,082)
Deferred rental income ...................... (24,136) 3,383 (119,070)
Interest income - real estate venture ....... 444,512 -- --
Partnership's share of unconsolidated
real estate venture's loss .................. 276,289 -- --
Other ....................................... 318,871 64,000 362,435
----------- ----------- -----------
Net income (loss) for federal income
tax reporting purposes .................... $ 1,134,912 $ 2,633,264 $(1,677,802)
=========== =========== ===========
The principal component of "Other" consists of the difference between the
tax gain or loss on aircraft disposals and the financial statement gain or loss
on aircraft disposals. It also includes reversal of certain maintenance
reserves.
The following is a reconciliation between partners' capital reported for
financial statement and federal income tax reporting purposes for the years
ended December 31, 2000 and 1999:
2000 1999
------------ ------------
Partners' capital .............................................. $ 7,700,277 $ 7,524,051
Add back selling commissions and organization
and offering costs ...................................... 7,085,240 7,085,240
Cumulative difference between federal income tax
and financial statement income (loss) ................... 21,568 (937,118)
------------ ------------
Partners' capital for federal income tax reporting purposes .... $ 14,807,085 $ 13,672,173
============ ============
The cumulative difference between federal income tax and financial
statement income (loss) represents a timing difference.
22
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
NOTE 9 - LEGAL PROCEEDINGS
In January 1998, certain plaintiffs (the "Plaintiffs") filed a class and
derivative action, captioned LEONARD ROSENBLUM, ET AL. V. EQUIS FINANCIAL GROUP
LIMITED PARTNERSHIP, ET AL., in the United States District Court for the
Southern District of Florida (the "Court") on behalf of a proposed class of
investors in 28 equipment leasing programs sponsored by EFG, including the
Partnership (collectively, the "Nominal Defendants"), against EFG and a number
of its affiliates, including the General Partner, as defendants (collectively,
the "Defendants"). Certain of the Plaintiffs, on or about June 24, 1997, had
filed an earlier derivative action, captioned LEONARD ROSENBLUM, ET AL. V. EQUIS
FINANCIAL GROUP LIMITED PARTNERSHIP, ET AL., in the Superior Court of the
Commonwealth of Massachusetts on behalf of the Nominal Defendants against the
Defendants. Both actions are referred to herein collectively as the "Class
Action Lawsuit".
The Plaintiffs have asserted, among other things, claims against the
Defendants on behalf of the Nominal Defendants for violations of the Securities
Exchange Act of 1934, common law fraud, breach of contract, breach of fiduciary
duty, and violations of the partnership or trust agreements that govern each of
the Nominal Defendants. The Defendants have denied, and continue to deny, that
any of them have committed or threatened to commit any violations of law or
breached any fiduciary duties to the Plaintiffs or the Nominal Defendants.
On July 16, 1998, counsel for the Defendants and the Plaintiffs executed a
Stipulation of Settlement setting forth terms pursuant to which a settlement of
the Class Action Lawsuit is intended to be achieved and which, among other
things, is expected to reduce the burdens and expenses attendant to continuing
litigation. The Stipulation of Settlement was preliminarily approved by the
Court on August 20, 1998 when the Court issued its "Order Preliminarily
Approving Settlement, Conditionally Certifying Settlement Class and Providing
for Notice of, and Hearing on, the Proposed Settlement" (the "August 20 Order").
On March 12, 1999, counsel for the Plaintiffs and the Defendants entered
into an amended stipulation of settlement (the "Amended Stipulation") which was
filed with the Court on March 12, 1999. The Amended Stipulation was
preliminarily approved by the Court by its "Modified Order Preliminarily
Approving Settlement, Conditionally Certifying Settlement Class and Providing
For Notice of, and Hearing On, the Proposed Settlement" dated March 22, 1999
(the "March 22 Order"). The Amended Stipulation, among other things, divided the
Class Action Lawsuit into two separate sub-classes that could be settled
individually. On May 26, 1999, the Court issued an Order and Final Judgment
approving settlement of one of the sub-classes. Settlement of the second
sub-class, involving the Partnership and 10 affiliated partnerships
(collectively referred to as the "Exchange Partnerships"), remains pending due,
in part, to the complexity of the proposed settlement pertaining to this class.
In February 2000, counsel for the Plaintiffs and the Defendants entered
into a second amended stipulation of settlement (the "Second Amended
Stipulation") which modified certain of the settlement terms contained in the
Amended Stipulation. The Second Amended Stipulation was preliminarily approved
by the Court by its "Second Modified Order Preliminarily Approving Settlement,
Conditionally Certifying Settlement Class and Providing For Notice of, and
Hearing On, the Proposed Settlement" dated March 6, 2000 (the "March 2000
Order"). Prior to issuing a final order approving the settlement of the second
sub-class involving the Partnership, the Court will hold a fairness hearing that
will be open to all interested parties and permit any party to object to the
settlement. The investors of the Partnership and all other plaintiff sub-class
members will receive a Notice of Settlement and other information pertinent to
the settlement of their claims that will be mailed to them in advance of the
fairness hearing.
The settlement of the second sub-class is premised on the consolidation of
the Exchange Partnerships' net assets (the "Consolidation"), subject to certain
conditions, into a single successor company ("Newco"). Under the proposed
Consolidation, the partners of the Exchange Partnerships would receive both
common stock in Newco and a cash distribution; and thereupon the Exchange
Partnerships would be dissolved. In addition, EFG would contribute certain
management contracts, operations personnel, and business opportunities to Newco
and cancel its current management contracts with all of the Exchange
Partnerships. Newco would operate principally as a
23
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
finance company and would use its best efforts to list its shares on the NASDAQ
National Market or another national exchange or market as soon after the
Consolidation as Newco deems that market conditions and its business operations
are suitable for listing its shares and Newco has satisfied all necessary
regulatory and listing requirements. The potential benefits and risks of the
Consolidation will be presented in a Solicitation Statement that will be mailed
to all of the partners of the Exchange Partnerships as soon as the associated
regulatory review process is completed and at least 60 days prior to the
fairness hearing. A preliminary Solicitation Statement was filed with the
Securities and Exchange Commission on August 24, 1998 and remains pending. Class
members will be notified of the actual fairness hearing date when it is
confirmed.
One of the principal objectives of the Consolidation is to create a company
that would have the potential to generate more value for the benefit of existing
limited partners than other alternatives, including continuing the Partnership's
customary business operations until all of its assets are disposed in the
ordinary course of business. To facilitate the realization of this objective,
the Amended Stipulation provided, among other things, that commencing March 22,
1999, the Exchange Partnerships could collectively invest up to 40% of the total
aggregate net asset values of all of the Exchange Partnerships in any
investment, including additional equipment and other business activities that
the general partners of the Exchange Partnerships and EFG reasonably believed to
be consistent with the anticipated business interests and objectives of Newco,
subject to certain limitations. The Second Amended Stipulation, among other
things, quantified the 40% limitation using a whole dollar amount of $32 million
in the aggregate.
On March 8, 2000, the Exchange Partnerships collectively made a $32 million
loan as permitted by the Second Amended Stipulation approved by the Court. The
Partnership's portion of the aggregate loan is $3,640,000. The loan consists of
a term loan to Echelon Residential Holdings, a newly-formed real estate company
that is owned by several independent investors and, in his individual capacity,
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. 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. The
loan has a term of 30 months maturing on September 8, 2002 and bears interest at
the annual rate of 14% for the first 24 months and 18% for the final six months
of the term. Interest accrues and compounds monthly but is not payable until
maturity. Echelon Residential Holdings has pledged its membership interests in
Echelon Residential LLC to the Exchange Partnerships as collateral for the loan.
In the absence of the Court's authorization to enter into new investment
activities, the Partnership's Restated Agreement, as amended, would not permit
such activities without the approval of limited partners owning a majority of
the Partnership's outstanding Units. Consistent with the Amended Stipulation,
the Second Amended Stipulation provides terms for unwinding any new investment
transactions in the event that the Consolidation is not effected or the
Partnership objects to its participation in the Consolidation.
The Second Amended Stipulation, as well as the Amended Stipulation and the
original Stipulation of Settlement, prescribe certain conditions necessary to
effect a final settlement, including providing the partners of the Exchange
Partnerships with the opportunity to object to the participation of their
partnership in the Consolidation. Assuming the proposed settlement is effected
according to present terms, the Partnership's share of legal fees and expenses
related to the Class Action Lawsuit and the Consolidation is estimated to be
approximately $423,000, of which approximately $332,000 was accrued and expensed
by the Partnership in 1998 and additional amounts of approximately $41,000 and
$50,000 was accrued and expensed in 2000 and 1999, respectively.
While the Court's August 20 Order enjoined certain class members, including
all of the partners of the Partnership, from transferring, selling, assigning,
giving, pledging, hypothecating, or otherwise disposing of any Units pending the
Court's final determination of whether the settlement should be approved, the
March 22 Order permitted the partners to transfer Units to family members or as
a result of the divorce, disability or death of the
24
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
partner. No other transfers are permitted pending the Court's final
determination of whether the settlement should be approved. The provision of the
August 20 Order which enjoined the General Partners of the Exchange Partnerships
from, among other things, recording any transfers not in accordance with the
Court's order remains effective.
There can be no assurance that settlement of the sub-class involving the
Exchange Partnerships will receive final Court approval and be effected. There
also can be no assurance that all or any of the Exchange Partnerships will
participate in the Consolidation because if limited partners owning more than
one-third of the outstanding Units of a partnership object to the Consolidation,
then that partnership will be excluded from the Consolidation. Notwithstanding
the extent of delays experienced thus far in achieving a final settlement of the
Class Action Lawsuit with respect to the Exchange Partnerships, the General
Partner and its affiliates, in consultation with counsel, continue to feel that
there is a reasonable basis to believe that a final settlement of the sub-class
involving the Exchange Partnerships ultimately will be achieved. However, 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.
Neither the General Partner nor its affiliates can predict with any degree of
certainty the cost of continuing litigation to the Partnership or the ultimate
outcome.
In addition to the foregoing, the Partnership is a party to other lawsuits
that have arisen out of the conduct of its business, principally involving
disputes or disagreements with lessees over lease terms and conditions as
described below:
FIRST ACTION INVOLVING TRANSMERIDIAN AIRLINES
On October 11, 1996, Prime Air Inc. d/b/a Transmeridian Airlines (the
"Plaintiff") filed an action in the 61st Judicial District Court of Harris
County, Texas (the "Court") entitled PRIME AIR, INC. D/B/A TRANSMERIDIAN
AIRLINES V. INVESTORS ASSET HOLDING CORP. ("IAHC"), AS TRUSTEE FOR AIRFUND II
INTERNATIONAL LIMITED PARTNERSHIP, PLM INTERNATIONAL ("PLM"), AND NAVCOM
AVIATION, INC. (collectively, the "Defendants"). In that action, the Plaintiff
claimed damages of more than $3 million for alleged breach of contract, fraud,
civil conspiracy, tortious interference of business relations, negligent
misrepresentation, negligence and gross negligence, and punitive damages against
the Defendants in connection with Transmeridian's lease of a Boeing 727-251 ADV
jet aircraft from the Partnership. On November 7, 1996, PLM removed the action
to United States District Court for the Southern District of Texas. On February
14, 1997, the Defendants answered the Plaintiff's Complaint denying the
allegations made therein and asserting various defenses.
On July 31, 1998, the Court granted IAHC's motion to strike Plaintiff's
fraud and negligent misrepresentation claims due to failure to plead with
particularity. Extensive discovery was conducted on the merits of Plaintiff's
claims. The Plaintiff, at one point, provided an expert report seeking
approximately $30 million in damages. The Plaintiff later provided a revised
expert report claiming actual damages of approximately $8.5 million and
Plaintiff continued to seek punitive damages and both pre-judgment and
post-judgment interest. On March 18, 1999, the Court entered summary judgment in
favor of IAHC and PLM on all remaining claims. The Plaintiff subsequently filed
a motion to alter or amend the judgment, or in the alternative, to certify the
Court's Order for Interlocutory Appeal. On April 30, 1999, the Court declined to
alter or amend its judgment and entered final judgment in favor of IAHC and PLM
on all remaining claims. The Plaintiff appealed to the United States Court of
Appeals for the 5th Circuit. The Court of Appeals denied Transmeridian's appeal,
affirmed the District Court's judgement in IAHC's favor, and subsequently denied
Transmeridian's request for rehearing. Transmeridian has not sought further
review of the District Court's judgment. There have been, however, subsequent
proceedings in the District Court on IAHC's request for the assessment of costs
in the amount of approximately $35,000.
In connection with this litigation, the Partnership has incurred
substantial legal fees, exceeding $1 million. An action seeking recovery of
these costs was filed on behalf of the Partnership in November 1999. See
"Indemnity action against Transmeridian Airlines and Apple Vacations" described
below.
25
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
SECOND ACTION INVOLVING TRANSMERIDIAN AIRLINES
On November 9, 1998, Investors Asset Holding Corp., as Trustee for the
Partnership (the "Plaintiff"), filed an action in Superior Court of the
Commonwealth of Massachusetts in Suffolk County against Prime Air, Inc. d/b/a
Transmeridian Airlines ("Transmeridian"), Atkinson & Mullen Travel, Inc., and
Apple Vacations, West, Inc., both d/b/a Apple Vacations, asserting various
causes of action for declaratory judgment and breach of contract. The action
subsequently was removed to United States District Court for the District of
Massachusetts. The Plaintiff filed an Amended Complaint asserting claims for
breaches of contract and covenant of good faith and fair dealing against
Transmeridian and breach of guaranty against Apple Vacations.
In October 1998, an aircraft leased by Transmeridian (being the same
aircraft in the above-referenced "First action involving Transmeridian
Airlines") was damaged in an on-ground accident at the Caracas, Venezuela
airport. The cost to repair the aircraft was estimated to be at least $350,000.
In addition, the Partnership had to lease two substitute engines at a cost of
$82,000 per month. During the year ended December 31, 1999, the Partnership
incurred total engine lease costs of $984,000. This was partially offset by
lease rents paid by Transmeridian of $560,000 during the same period. However,
as of September 11, 1999, Transmeridian ceased paying rent on this aircraft. The
Plaintiff alleges that Transmeridian, among other things, has impeded the
Partnership's ability to terminate the two engine lease contracts between the
Partnership and a third party. The Plaintiff intends to pursue insurance
coverage and also to enforce written guarantees issued by Apple Vacations that
absolutely and unconditionally guarantee Transmeridian's performance under the
lease and is seeking recovery of all costs, lost revenue and monetary damages in
connection with this matter. On September 22, 2000, Transmeridian file a
petition for bankruptcy reorganization under Chapter 11 of the Bankruptcy Code
in the Bankruptcy Court for the Northern District of Georgia in Atlanta (the
"Bankruptcy Court"). This filling automatically stayed all pending litigation
against Transmeridian, including this action. The bankruptcy filings indicate
Transmeridian has at least $24 million in debt. In January 2001, Transmeridian
filed a reorganization plan and disclosure statement indicating that little if
any money will be available for distribution to unsecured creditors like the
Plaintiff. Moreover, Transmeridian's bankruptcy counsel has indicated recently
that he intends to file an adversary proceeding in the bankruptcy court seeking
the turn over to Transmeridian the proceeds of certain insurance policies (in
the amount of approximately $800,000) that insured the Plaintiffs' aircraft
against damage. Plaintiffs contend that all or most of these insurance proceeds
should be paid to them and intend to contest vigorously any effort to cause
these insurance proceeds to be paid to Transmeridian. Plaintiffs' counsel has
recently initiated discussions with Transmeridian's counsel concerning
settlement of the claims against Transmeridian and the dispute over the
insurance proceeds. No assurances can be given that a settlement will be
reached.
On March 2, 2001, Plaintiffs' counsel filed a motion in the Bankruptcy
Court asking the Court to lift the automatic stay of this Massachusetts
proceeding so that it may proceed to final judgment. The Bankruptcy Court has
scheduled a hearing on this motion for April 10, 2001. Transmeridian's
bankruptcy counsel has indicated that he is considering asking the court to move
this Massachusetts action to Georgia and consolidate it with the bankruptcy
proceeding. The General Partner cannot predict the outcome of its motion for
relief from stay or Transmeridian's efforts to transfer venue of the
Massachusetts action. Notwithstanding the Transmeridian bankruptcy, the General
Partner plans to vigorously pursue enforcement of the written guarantees issued
by Apple Vacations; however, it is too early to predict the Plaintiff's
likelihood of success.
INDEMNITY ACTION AGAINST TRANSMERIDIAN AIRLINES AND APPLE VACATIONS
On November 12, 1999, Investors Asset Holding Corp. ("IAHC"), as trustee
for the Partnership, filed an action against Transmeridian Airlines (f/k/a Prime
Air, Inc.) and Atkinson & Mullen Travel, Inc. (d/b/a Apple Vacations) under
Civil Action No. H-99-3804 in the United States District Court for the Southern
District of Texas, Houston Division, seeking recovery of attorneys' fees and
related costs incurred in defending the action described above under the heading
"First action involving Transmeridian Airlines." The present suit seeks recovery
of expenses pursuant to the indemnification provisions of the lease agreement
under which Transmeridian leased the Boeing 727-251 aircraft. Currently, the
amount being sought is over $1 million. On September 1, 2000, IHAC filed with
the Court a motion for partial summary judgment, seeking judgment on liability
(i.e. that Transmeridian and Apple
26
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Vacations are liable under the lease agreements and guarantees). IHAC also filed
a motion for leave to join in this litigation an affiliate of Apple's, Apple
Vacations, West, inc., which also gave written guarantees of Transmeridian's
performance under the lease agreements. On September 22, 2000, however,
Transmeridian filed a petition for bankruptcy reorganization under Chapter 11 of
the Bankruptcy Code in the Bankruptcy Court for the Northern District of Georgia
in Atlanta (the "Bankruptcy Court"). See "Second action involving Transmeridian
Airlines" above. On January 10, 2001, the Bankruptcy Court granted IHAC's motion
for relief from the automatic stay so that this litigation may be pursued
through to final judgment. Transmeridian's counsel in this action then filed a
motion to withdraw its appearance on behalf of Transmeridian. The U.S. District
Court allowed that motion on March 6, 2001, and gave Transmeridian 60 days in
which to secure replacement counsel. Within 20 days of the entry of replacement
counsel, Transmeridian is required to file its opposition to IHAC's motion for
partial summary judgment. The U.S. District Court also allowed IHAC's motion to
join Apple Vacations, West, Inc. as a defendant in this action.
The Plaintiffs' counsel has recently initiated discussions with
Transmeridian's counsel concerning settlement of the claims against
Transmeridian. No assurances can be given that a settlement will be reached. The
General Partner cannot predict the outcome of this suit.
ACTION INVOLVING NORTHWEST AIRLINES, INC.
On September 22, 1995, Investors Asset Holding Corp. and First Security
Bank, N.A., trustees of the Partnership and certain affiliated investment
programs (collectively, the "Plaintiffs"), filed an action in United States
District Court for the District of Massachusetts against a lessee of the
Partnership, Northwest Airlines, Inc. ("Northwest"). The Complaint alleges that
Northwest did not fulfill its maintenance and return obligations under its Lease
Agreements with the Plaintiffs and seeks declaratory judgment concerning
Northwest's obligations and monetary damages. Northwest filed an Answer to the
Plaintiffs' Complaint and a motion to transfer the venue of this proceeding to
Minnesota. The Court denied Northwest's motion. On June 29, 1998, a United
States Magistrate Judge recommended entry of partial summary judgment in favor
of the Plaintiffs. Northwest appealed this decision. On April 15, 1999, the
United States District Court Judge adopted the Magistrate Judge's recommendation
and entered partial summary judgment in favor of the Plaintiffs on their claims
for declaratory judgment. The parties then undertook a second phase of
discovery, focused on damages. This second phase of damages is scheduled to
conclude in April 2001 with the completion of depositions of the parties'
experts. In February 2001, the District Court also denied summary judgment on
certain of the Plaintiffs' other claims, including their tort claims for
conversion. If no settlement is reached, the Plaintiffs will proceed to trial
for an assessment of damages. No firm trial date has been established at this
time; however, if a trial should become necessary, it is not expected to occur
before June 2001. The General Partner believes that the Plaintiff's claims
ultimately will prevail and that the Partnership's financial position will not
be adversely affected by the outcome of this action.
27
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
NOTE 10 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended December 31, 2000 and 1999:
THREE MONTHS ENDED
----------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, TOTAL
--------- -------- ------------- ------------ -----
2000
----
Total operating and sales-type
lease revenue ..................... $ 09,420 $ 148,602 $ 106,446 $ 192,438 $ 556,906
Net (loss) income ................. (4,476) 920,669 (402,587) (337,380) 176,226
Net income (loss) per
limited partnership unit ........ -- 0.32 (0.14) (0.12) 0.06
1999
----
Total lease revenue ............... $ 708,129 $ 482,218 $ 393,846 $ 256,977 $1,841,170
Net (loss) income ................. (111,725) 2,915,743 (142,229) (769,780) 1,892,009
Net (loss) income per
limited partnership unit ........ (0.04) 1.02 (0.05) (0.27) 0.66
The Partnership's net income in the three months ended June 30, 2000 is
primarily the result of the sale of a Boeing 727-251 ADV aircraft, which
resulted in a net gain, for financial statement purposes of $750,000.
The Partnership's net income in the three months ended in June 30, 1999 is
primarily the result of the sale of a Boeing 727-251 ADV aircrat which resulted
in a net gain, for financial statement purposes of $3,109,500.
NOTE 11 - SUBSEQUENT EVENT
In February 2001, the Partnership and certain affiliated investment
programs (collectively "the Programs") refinanced the outstanding indebtedness
and accrued interest related to an 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 the aircraft 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.
28
ADDITIONAL FINANCIAL INFORMATION
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
SCHEDULE OF EXCESS (DEFICIENCY) OF TOTAL CASH GENERATED TO COST
OF EQUIPMENT DISPOSED
FOR THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
The Partnership classifies all rents from leasing aircraft as lease
revenue. Upon expiration of the primary lease terms, aircraft may be sold,
rented on a month-to-month basis or re-leased for a defined period under a new
or extended lease agreement. The proceeds generated from selling or re-leasing
the aircraft, in addition to any month-to-month revenue, represent the total
residual value realized for each aircraft. Therefore, the financial statement
gain or loss, which reflects the difference between the net book value of the
aircraft at the time of sale or disposition and the proceeds realized upon sale
or disposition may not reflect the aggregate residual proceeds realized by the
Partnership for such aircraft.
The following is a summary of cash excess (deficiency) associated with the
aircraft dispositions which occurred in the years ended December 31, 2000, 1999
and 1998.
2000 1999 1998
----------- ----------- -----------
Rents earned prior to disposal of aircraft ............. $10,868,406 $25,196,334 $ 4,150,170
Sale proceeds realized upon disposition of aircraft .... 1,005,645 3,109,500 553,699
----------- ----------- -----------
Total cash generated from rents
and aircraft sale proceeds ............................. 11,874,051 28,305,834 4,703,869
Original acquisition cost of aircraft disposed ......... 10,372,547 23,572,848 5,248,872
----------- ----------- -----------
Excess (deficiency) of total cash generated
to the cost of the aircraft disposed ................... $ 1,501,504 $ 4,732,986 $ (545,003)
=========== =========== ===========
29
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH AND DISTRIBUTABLE CASH FROM OPERATIONS,
SALES AND REFINANCINGS
FOR THE YEAR ENDED DECEMBER 31, 2000
SALES AND
OPERATIONS REFINANCINGS TOTAL
----------- ----------- -----------
Net income (loss) .................................. $ (616,876) $ 793,102 $ 176,226
Add:
Depreciation .................................. 297,611 -- 297,611
Collections on net investment in
sales-type lease ............................ 58,928 -- 58,928
Management fees ............................... 29,913 -- 29,913
Book value of disposed equipment .............. -- 212,543 212,543
Partnership's share of unconsolidated
real estate venture's loss .................... 276,289 -- 276,289
Less:
Non-cash gain on sales-type lease ............. (91,471) -- (91,471)
Sales-type lease revenue ...................... (2,491) -- (2,491)
Principal repayment of notes payable .......... (18,251) (257,902) (276,153)
----------- ----------- -----------
Cash from (used in) operations, sales
and refinancings .............................. (66,348) 747,743 681,395
Less:
Management fees ............................... (29,913) -- (29,913)
----------- ----------- -----------
Distributable cash from (used in)
operations, sales and refinancings ............ (96,261) 747,743 651,482
Other sources and uses of cash:
Cash and cash equivalents
at beginning of year .......................... -- 5,719,642 5,719,642
Net change in receivables and accruals ........ (104,986) -- (104,986)
Proceeds from notes payable ................... 201,247 -- 201,247
Investment in real estate venture ............. -- (3,640,000) (3,640,000)
----------- ----------- -----------
Cash and cash equivalents at end of year ........... $ -- $ 2,827,385 $ 2,827,385
=========== =========== ===========
30
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
SCHEDULE OF COSTS REIMBURSED TO THE
GENERAL PARTNER AND ITS AFFILIATES AS REQUIRED
BY SECTION 10.4 OF THE AMENDED AND RESTATED
AGREEMENT AND CERTIFICATE OF LIMITED PARTNERSHIP
FOR THE YEAR ENDED DECEMBER 31, 2000
For the year ended December 31, 2000, the Partnership reimbursed the
General Partner and its Affiliates for the following costs:
Operating expenses $ 994,521
31