AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
ANNUAL REPORT TO THE PARTNERS, DECEMBER 31, 1998
AIRFUND 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, 1998 and 1997............................................. 10
Statement of Operations for the years ended December 31, 1998, 1997 and 1996.............................. 11
Statement of Changes in Partners Capital for the years ended December 31, 1998, 1997 and 1996............. 12
Statement of Cash Flows for the years ended December 31, 1998, 1997 and 1996.............................. 13
Notes to the Financial Statements......................................................................... 14-22
ADDITIONAL FINANCIAL INFORMATION:
Schedule of Excess (Deficiency) of Total Cash Generated to Cost of Equipment Disposed..................... 23
Statement of Cash and Distributable Cash From Operations, Sales and Refinancings.......................... 24
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................................... 25
1
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 five years in the period ended December 31, 1998:
SUMMARY OF
OPERATIONS 1998 1997 1996 1995 1994
- ------------------------------------- ------------- ------------- ------------- ------------- -------------
Lease revenue........................ $ 3,604,643 $ 3,858,270 $ 4,346,218 $ 4,588,609 $ 5,166,392
Net income (loss).................... $ 431,323 $ 49,656 $ 4,360,899 $ (2,283,720) $ (1,463,495)
Per Unit:
Net income (loss).................. $ 0.13 $ 0.02 $ 1.36 $ (0.71) $ (0.46)
Cash distributions declared........ $ -- $ -- $ 1.56 $ 1.00 $ 1.25
FINANCIAL POSITION
- -------------------------------------
Total assets......................... $ 17,906,024 $ 19,864,413 $ 23,700,585 $ 16,888,606 $ 17,961,111
Total long-term obligations.......... $ 6,279,100 $ 8,864,307 $ 11,321,769 $ 4,742,968 $ --
Partners' capital.................... $ 11,075,621 $ 10,644,298 $ 10,594,642 $ 11,233,743 $ 16,717,463
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR
ENDED DECEMBER 31, 1997 AND THE YEAR ENDED DECEMBER 31, 1997
COMPARED TO THE YEAR ENDED DECEMBER 31, 1996
Certain statements in this annual report of AIRFUND 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 important 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 7 to the accompanying
financial statements, the collection of all rents due under the Partnership's
lease agreements and remarketing of the Partnership's equipment.
YEAR 2000 ISSUE
The Year 2000 Issue generally refers to the capacity of computer programming
logic to correctly identify the calendar year. Many companies utilize computer
programs or hardware with date sensitive software or embedded chips that could
interpret dates ending in "00" as the year 1900 rather than the year 2000. In
certain cases, such errors could result in system failures or miscalculations
that disrupt the operations of the affected businesses. The Partnership uses
information systems provided by EFG and has no information systems of its own.
EFG has adopted a plan to address the Year 2000 Issue that consists of four
phases: assessment, remediation, testing, and implementation and has elected to
utilize principally internal resources to perform all phases. EFG completed
substantially all of its Year 2000 project by December 31, 1998 at an aggregate
cost of less than $50,000 and at a di minimus cost to the Partnership. Remaining
items are expected to be minor and be completed by March 31, 1999. All costs
incurred in connection with EFG's Year 2000 project have been expensed as
incurred.
EFG's primary information software was coded by IBM at the point of original
design to use a four-digit field to identify calendar year. All of the
Partnership's lease billings, cash receipts and equipment remarketing processes
are performed using this proprietary software. In addition, EFG has gathered
information about the Year 2000 readiness of significant vendors and third party
servicers and continues to monitor developments in this area. All of EFG's
peripheral computer technologies, such as its network operating system and
third-party software applications, including payroll, depreciation processing,
and electronic banking, have been evaluated for potential programming changes
and have required only minor modifications to function properly with respect to
dates in the year 2000 and thereafter. EFG understands that each of its and the
Partnership's significant vendors and third-party servicers are in the process,
or have completed the process, of making their systems Year 2000 compliant.
Substantially all parties queried have indicated that their systems would be
Year 2000 compliant by the end of 1998.
Presently, EFG is not aware of any outside customer with a Year 2000 Issue
that would have a material effect on the Partnership's results of operations,
liquidity, or financial position. The Partnership's equipment leases were
structured as triple net leases, meaning that the lessees are responsible for,
among other things, (i) maintaining and servicing all equipment during the lease
term, (ii) ensuring that all equipment functions properly and is returned in
good condition, normal wear and tear excepted, and (iii) insuring the assets
against casualty and other events of loss. Non-compliance with lease terms on
the part of a lessee, including failure to address Year 2000 Issues could result
in lost revenues and impairment of residual values of the Partnership's
equipment assets under a worst-case scenario.
EFG believes that its Year 2000 compliance plan will be effective in
resolving all material Year 2000 risks in a timely manner and that the Year 2000
Issue will not pose significant operational problems with
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
respect to its computer systems or result in a system failure or disruption of
its or the Partnership's business operations. However, EFG has no means of
ensuring that all customers, vendors and third-party servicers will conform
ultimately to Year 2000 standards. The effect of this risk to the Partnership is
not determinable.
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. Upon its inception in 1989, the Partnership
purchased three used commercial jet aircraft and a proportionate interest in a
fourth aircraft, which were leased by major carriers, engaged in passenger
transportation. Initially, each aircraft generated rental revenues pursuant to
primary-term lease agreements. In 1991, one of the Partnership's original
aircraft was sold to a third party and a portion of the sale proceeds was
reinvested in a proportionate interest in another aircraft. Subsequently, all of
the aircraft in the Partnership's original portfolio have been re-leased,
renewed, exchanged for other aircraft or sold (see below). At December 31, 1998,
the Partnership owned a proportionate interest in five aircraft. All of the
Partnership's aircraft are currently on lease. Upon expiration of the lease
agreements, each aircraft will be re-leased or sold depending on prevailing
market conditions and the assessment of such conditions by EFG to obtain the
most advantageous economic benefit. 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 7 to the accompanying financial statements. Pursuant to the
Restated Agreement, as amended, the Partnership is scheduled to be dissolved by
December 31, 2004.
RESULTS OF OPERATIONS
For year ended December 31, 1998, the Partnership recognized lease revenue
of $3,604,643 compared to $3,858,270 and $4,346,218 for the years ended December
31, 1997 and 1996, respectively. The decrease in lease revenue from 1997 to 1998
reflects the sale, at the expiration of the aircraft's lease term on April 1998,
of the Partnership's interest in a Lockheed L-1011-50 aircraft to the lessee,
Air Lease Limited (see discussion below). The Partnership recognized aggregate
lease revenue related to the Lockheed L-1011-50 aircraft of $236,004, $489,609
and $462,676 in 1998, 1997 and 1996, respectively. The decrease in lease revenue
from 1996 to 1997 resulted from the expiration of the leases related to the
Lockheed L-1011-50 aircraft during 1996 and the sale of two Boeing 727-251
Advanced aircraft also in 1996. These decreases in 1997 were partially offset by
the re-lease of the Lockheed L-1011-50 aircraft effective April 1997 and the
Partnership's aircraft exchange (discussed below), which was concluded in the
first quarter of 1996. As a result of the aircraft exchange, the Partnership
replaced its ownership interest in a Boeing 747-SP aircraft (the "United
Aircraft") having aggregate quarterly lease revenues of $495,360, with interests
in five other aircraft; three Boeing 737 aircraft leased by Southwest Airlines,
Inc. (the "Southwest Aircraft"), and two McDonnell Douglas MD-82 aircraft leased
by Finnair OY (the "Finnair Aircraft") having aggregate quarterly lease revenues
of $842,160. Due to the conclusion of this transaction late in the first quarter
of 1996, 1997 was the first year the Partnership recognized a full year's
revenue related to its interests in all five of these replacement aircraft.
On April 29, 1998, at the expiration of the aircraft's lease term, the
Partnership sold its interest in a Lockheed L-1011-50 aircraft to Aer Lease
Limited ("Aer Lease"). The Partnership realized net proceeds of $846,300 from
the sale of this aircraft. The Partnership's interest in the aircraft had a net
book value of $658,282 at the time of sale, resulting in the recognition of a
net gain on sale, for financial statement purposes, of $188,018 during the year
ending December 31, 1998.
4
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Previously, the former lessee, Cathay Pacific Airways, Ltd returned the
Lockheed L-1011-50 aircraft to the Partnership on June 30, 1996, at the
expiration of the last of several lease extensions. Upon return of the aircraft,
the aircraft underwent heavy maintenance which cost the Partnership
approximately $570,000, the majority of which was expensed during 1996. The
Partnership subsequently entered into a new 1-year lease agreement with Aer
Lease at a base rent to the Partnership of $60,450 per month, beginning April
27, 1997. The demand for Lockheed L-1011 aircraft was weak, limited principally
to air cargo carriers and operators of passenger charters. Several major
airlines reduced their commitment to the Lockheed L-1011 aircraft. Such
circumstances inhibited the remarketing of the Partnership's Lockheed L-1011-50
aircraft and required the Partnership to refurbish the aircraft to meet the
needs of Aer Lease.
During July 1996, the Partnership sold a Boeing 727-251 Advanced jet
aircraft with an original cost and net book value of $9,520,359 and $426,560,
respectively, to the existing lessee Northwest Airlines, Inc. ("Northwest"). In
connection with this sale, the Partnership realized sale proceeds of $3,210,000
which resulted in a net gain, for financial statement purposes, of $2,783,440.
The Partnership also realized lease termination rents of $180,000 relating to
this sale as the aircraft was sold prior to the expiration of the related lease
term. During November 1996, the Partnership sold a second Boeing 727-251
Advanced jet aircraft with an original cost and net book value of $9,520,359 and
$261,697, respectively, to the existing lessee. In connection with this sale,
the Partnership realized sale proceeds of $3,454,313 which resulted in a net
gain, for financial statement purposes, of $3,192,616. In 1996, the Partnership
recognized aggregate lease revenue of $1,200,000 related to these two aircraft,
prior to their respective sales.
The Partnership holds a proportionate ownership interest in the Southwest
and Finnair Aircraft, discussed above. 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 (see Note 3 to the financial statements).
Interest income for the year ended December 31, 1998 was $165,479 compared
to $130,552 and $261,557 for the years ended December 31, 1997 and 1996,
respectively. Interest income is typically generated from temporary investments
of rental receipts and equipment sale proceeds in short-term instruments.
Interest income in 1996 included $130,268 earned on cash held in a
special-purpose escrow account in connection with the like-kind exchange
transactions and also reflected a temporary increase in the Partnership's cash
available for investment resulting from the receipt of sale proceeds associated
with the Northwest aircraft.
Depreciation expense was $2,152,360, $2,501,988 and $3,065,516 for the years
ended December 31, 1998, 1997 and 1996, respectively. The Partnership also
recorded a write-down of aircraft carrying values, representing impairments,
during the year ended December 31, 1996. The resulting charge, $967,200 ($0.30
per limited partnership unit) was based on a comparison of estimated net
realizable values and corresponding carrying values for the Partnership's
aircraft.
Net realizable values were estimated based on (i) third-party appraisals of
the Partnership's aircraft and (ii) EFG's assessment of prevailing market
conditions for similar aircraft. In recent years, market values for certain
models of used commercial jet aircraft have deteriorated. Consistent price
competition and other pressures within the airline industry have inhibited
sustained profitability for many carriers. Most major airlines have had to
re-evaluate their aircraft fleets and operating strategies. Aircraft condition,
age, passenger capacity, distance capability, fuel efficiency, and other factors
influence market demand and market values for passenger jet aircraft. The
write-down in 1996 resulted from the deterioration in the market value of the
Partnership's interest in the Lockheed L-1011-50 aircraft.
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Notwithstanding the foregoing, the ultimate realization of residual value
for any aircraft is 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. Accordingly, EFG will attempt to monitor
changes in 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 upon final disposition of each aircraft is
comprised of all primary lease term revenues 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.
During 1998, 1997 and 1996, the Partnership incurred interest expense of
$664,418, $890,289 and $874,683 respectively. Interest expense resulted from
financing obtained from third-party lenders in connection with the Southwest
Aircraft and the Finnair Aircraft, described above. The financing of the
Southwest and Finnair Aircraft occurred in December 1995 and March 1996,
respectively. Interest expense in future years is expected to decline as the
principal balance of notes payable is reduced through the application of rent
receipts to outstanding debt.
Management fees were 5% of lease revenue in 1998, 1997, and 1996 and will
not change as a percentage of lease revenue in future periods.
Operating expenses were $529,807, $353,976 and $1,098,222 for the years
ended December 31, 1998, 1997 and 1996, respectively. During the year ended
December 31, 1998, the Partnership incurred or accrued $336,500 for certain
legal and administrative expenses related to the Class Action Lawsuit described
in Note 7 to the accompanying financial statements. In 1996, operating expenses
included heavy maintenance costs incurred and accrued in connection with the
Partnership's interest in the Lockhead L-1011-50 aircraft and legal expenses and
broker fees incurred in connection with the like-kind exchange transactions (see
discussion below). Other operating expenses consist principally of
administrative charges, professional service costs, such as audit and other
legal fees, as well as insurance, printing, distribution and other remarketing
expenses.
LIQUIDITY AND CAPITAL RESOURCES AND DISCUSSION OF CASH FLOWS
The Partnership by its nature is a limited life entity. As an equipment
leasing program, the Partnership's principal operating activities generally
derive from aircraft rental transactions. Accordingly, the Partnership's
principal source of cash from operations is generally provided by the collection
of periodic rents. These cash inflows are used to satisfy debt service
obligations associated with leveraged leases, and to pay management fees and
operating costs. Operating activities generated net cash inflows of $2,608,602,
$2,001,652 and $3,806,235 in 1998, 1997 and 1996, respectively. The sales of the
Partnership's interest in the Lockheed L-1011-50 and the two Boeing 727-251
Advanced aircraft have caused an overall decline in the Partnership's lease
revenue and corresponding sources of operating cash from 1996 to 1998. This
decline has been partially offset by an increase in rents generated in
connection with the Southwest Aircraft and the Finnair Aircraft subsequent to
1996. Overall, expenses associated with rental activities, such as management
fees, and net cash flow from operating activities will decline as the
Partnership remarkets its aircraft. 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.
6
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cash expended for equipment acquisitions and cash realized from asset
disposal transactions are reported under investing activities on the
accompanying Statement of Cash Flows. During year ended December 31, 1998, the
Partnership realized $846,300 in proceeds from the sale of its interest in the
Lockheed L-1011-50 aircraft. In 1996, the Partnership realized $6,664,313 in
proceeds from the sale of the two Boeing 727-251 Advanced aircraft. There were
no aircraft sales in 1997. 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 aircraft's
condition and age, and future market conditions. In 1996, the Partnership
completed the replacement of the United Aircraft with a 49.17% ownership
interest in the Finnair Aircraft at a total cost to the Partnership of
$13,762,438. To acquire the ownership interest in the Finnair Aircraft, the
Partnership paid $4,601,325 in cash and obtained financing of $9,161,113 from a
third-party lender. The Partnership utilized $4,360,599 (classified as
Contractual Right Equipment at December 31,1995) which had been deposited into a
special purpose escrow account through a third party exchange agent pending the
completion of the aircraft exchange. The balance of $240,726 was expended from
the Partnership's cash reserves. The remaining ownership interest of 50.83% in
the Finnair Aircraft is held by affiliated equipment leasing programs sponsored
by EFG. The like-kind exchange, involving the United, Southwest and Finnair
Aircraft, was undertaken, in part, to mitigate the Partnership's economic risk
resulting from the United Aircraft being returned to the Partnership upon its
lease expiration in April 1996 and remaining off-lease for an extended period.
The exchange enabled the Partnership to replace a specialized aircraft with
other aircraft, which are used more widely in the industry, and also to
significantly extend its rental stream with two creditworthy lessees. There were
no aircraft acquisitions in 1998 and 1997.
At December 31, 1998, the Partnership was due aggregate future minimum lease
payments of $4,782,888 from contractual lease agreements (see Note 2 to the
financial statements), a portion of which will be used to amortize the principal
balance of notes payable of $6,279,100 (see Note 5 to the financial statements).
At the expiration of the individual primary lease terms underlying the
Partnership's future minimum lease payments, the Partnership will sell the
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. Accordingly, as the terms of the
currently existing contractual lease agreements expire, the cash flows of the
Partnership will become less predictable. In addition, the Partnership will need
cash outflows to satisfy interest on indebtedness and to pay management fees and
operating expenses.
As described in Results of Operations, the Partnership obtained long-term
financing in connection with the like-kind exchange transactions involving the
Southwest Aircraft and the Finnair Aircraft. 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 period. As
rental payments are collected, a portion or all of the rental payment will be
used to repay principal and interest. The Partnership also has balloon payment
obligations at the expiration of the primary lease term related to the Finnair
Aircraft of $4,671,150. All of the Partnership's indebtedness matures in the
year ended December 31, 1999.
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
7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
other things, operating costs and potential expenditures, such as refurbishment
costs to remarket equipment upon lease expiration. Liquidity is especially
important as the Partnership matures and sells equipment, because the remaining
equipment base 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 air worthiness 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. Individually,
these repairs can cost in excess of $1 million and, collectively; they could
require the disbursement of several million dollars, depending upon the extent
of refurbishment. In addition, the Partnership's equipment portfolio includes an
interest in three Stage 2 aircraft having scheduled lease expiration dates of
December 31, 1999. These aircraft are prohibited from operating in the United
States after December 31, 1999 unless they are retro-fitted with hush-kits to
meet Stage 3 noise regulations promulgated by the Federal Aviation
Administration. The cost to hush-kit an aircraft, such as the Partnership's
Boeing 737s, can approach $2 million. Although the Partnership is not required
to retro-fit its aircraft with hush-kits, insufficient liquidity could
jeopardize the re-marketing of these aircraft and risk their disposal at a
depressed value at a time when a better economic return would be realized from
refurbishing the aircraft and re-leasing them to another user. Collectively, the
aggregation of the Partnership's potential liquidity needs related to aircraft
and other working capital requirements could be significant. Accordingly, the
General Partner has maintained significant cash reserves within the Partnership
in order to minimize the risk of a liquidity shortage.
Finally, the Partnership is a Nominal Defendant in a Class Action Lawsuit
described in Note 7 to the accompanying financial statements. A preliminary
settlement agreement will allow the Partnership to invest in new equipment or
other activities, subject to certain limitations, effective March 22, 1999. To
the extent that the Partnership continues to own aircraft investments that could
require capital reserves, the General Partner does not anticipate that the
Partnership will invest in new assets, regardless of its authority to do so.
Until the Class Action Lawsuit is adjudicated, the General Partner does not
expect to declare any distributions to the Partners. In addition, the proposed
settlement, if effected, will materially change the future organizational
structure and business interests of the Partnership, as well as its cash
distribution policies. See Note 7 to the accompanying financial statements.
Cash distributions to the General Partner and Recognized Owners are declared
and generally paid within fifteen days following the end of each calendar
quarter. The payment of such distributions is presented as a component of
financing activities. Cash distributions paid to the Recognized Owners consist
of both a return of and a return on capital. To the extent that cash
distributions consist of Cash From Sales or Refinancings, substantially all of
such cash distributions should be viewed as a return of capital. Cash
distributions do not represent and are not indicative of yield on investment.
Actual yield on investment cannot be determined with any certainty until
conclusion of the Partnership and will be dependent upon the collection of all
future contracted rents, the generation of renewal and/or re-lease rents, and
the residual value realized for each aircraft at its disposal date. No
distributions were declared in either 1997 or 1998.
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
8
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
comparison to financial reporting purposes (generally referred to as permanent
or timing differences; see Note 6 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. Such items consist of the cumulative difference between
income or loss for tax purposes and financial statement income or loss and the
difference between distributions (declared vs. paid) for income tax and
financial reporting purposes, if any. The principal component of the cumulative
difference between financial statement income or loss and tax income or loss
results from different depreciation policies for book and tax purposes.
For financial reporting purposes, the General Partner has accumulated a
capital deficit at December 31, 1998. 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 Amended and Restated
Agreement and Certificate of Limited Partnership, 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, 1998, the
General Partner had a positive tax capital account balance.
The future liquidity of the Partnership will be influenced by, among other
factors, prospective market conditions, aircraft refurbishment requirements
(discussed above), the ability of EFG to manage and remarket the aircraft, and
many other events and circumstances, that could enhance or detract from
individual aircraft yields and the collective performance of the Partnership's
aircraft portfolio. However, the outcome of the Class Action Lawsuit described
in Note 7 to the accompanying financial statements will be the principal factor
in determining the future of the Partnership's operations.
9
REPORT OF INDEPENDENT AUDITORS
To the Partners of AIRFUND International Limited Partnership:
We have audited the accompanying statements of financial position of AIRFUND
International Limited Partnership, as of December 31, 1998 and 1997, 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, 1998. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of AIRFUND International
Limited Partnership at December 31, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
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.
ERNST & YOUNG LLP
Boston, Massachusetts
March 10, 1999
10
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
DECEMBER 31, 1998 AND 1997
1998 1997
------------- -------------
ASSETS
Cash and cash equivalents.......................................................... $ 3,540,736 $ 2,671,041
Rents receivable................................................................... 104,184 --
Accounts receivable--affiliate..................................................... -- 121,626
Equipment at cost, net of accumulated depreciation of $5,857,207 and $10,923,789 at
December 31, 1998 and 1997, respectively......................................... 14,261,104 17,071,746
------------- -------------
Total assets................................................................... $ 17,906,024 $ 19,864,413
------------- -------------
------------- -------------
LIABILITIES AND PARTNERS' CAPITAL
Notes payable...................................................................... $ 6,279,100 $ 8,864,307
Accrued interest................................................................... 83,223 98,052
Accrued liabilities................................................................ 288,500 8,250
Accrued liabilities--affiliate..................................................... 20,698 36,219
Deferred rental income............................................................. 158,882 213,287
------------- -------------
Total liabilities.............................................................. 6,830,403 9,220,115
------------- -------------
Partners' capital (deficit):
General Partner.................................................................. (1,145,215) (1,166,781)
Limited Partnership Interests (3,040,000 Units; initial purchase price of $25
each).......................................................................... 12,220,836 11,811,079
------------- -------------
Total partners' capital........................................................ 11,075,621 10,644,298
------------- -------------
Total liabilities and partners' capital........................................ $ 17,906,024 $ 19,864,413
------------- -------------
------------- -------------
The accompanying notes are an integral part of
these financial statements.
11
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------ ------------ -------------
Income:
Lease revenue....................................................... $ 3,604,643 $ 3,858,270 $ 4,346,218
Interest income..................................................... 165,479 130,552 261,557
Gain on sale of equipment........................................... 188,018 -- 5,976,056
------------ ------------ -------------
Total income...................................................... 3,958,140 3,988,822 10,583,831
------------ ------------ -------------
Expenses:
Depreciation........................................................ 2,152,360 2,501,988 3,065,516
Write-down of equipment............................................. -- -- 967,200
Interest expense.................................................... 664,418 890,289 874,683
Equipment management fees--affiliate................................ 180,232 192,913 217,311
Operating expenses--affiliate....................................... 529,807 353,976 1,098,222
------------ ------------ -------------
Total expenses.................................................... 3,526,817 3,939,166 6,222,932
------------ ------------ -------------
Net income............................................................ $ 431,323 $ 49,656 $ 4,360,899
------------ ------------ -------------
------------ ------------ -------------
Net income per limited partnership unit............................... $ 0.13 $ 0.02 $ 1.36
------------ ------------ -------------
------------ ------------ -------------
Cash distributions declared per limited partnership unit.............. $ -- $ -- $ 1.56
------------ ------------ -------------
------------ ------------ -------------
The accompanying notes are an integral part of
these financial statements.
12
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CHANGES IN PARTNERS' CAPITAL
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
GENERAL RECOGNIZED OWNERS
PARTNER -------------------------
AMOUNT UNITS AMOUNT TOTAL
------------- ---------- ------------- -------------
Balance at December 31, 1995........................... $ (1,137,309) 3,040,000 $ 12,371,052 $ 11,233,743
Net income--1996..................................... 218,045 -- 4,142,854 4,360,899
Cash distributions declared.......................... (250,000) -- (4,750,000) (5,000,000)
------------- ---------- ------------- -------------
Balance at December 31, 1996........................... (1,169,264) 3,040,000 11,763,906 10,594,642
Net income--1997..................................... 2,483 -- 47,173 49,656
------------- ---------- ------------- -------------
Balance at December 31, 1997........................... (1,166,781) 3,040,000 11,811,079 10,644,298
Net income--1998..................................... 21,566 -- 409,757 431,323
------------- ---------- ------------- -------------
Balance at December 31, 1998........................... $ (1,145,215) 3,040,000 $ 12,220,836 $ 11,075,621
------------- ---------- ------------- -------------
------------- ---------- ------------- -------------
The accompanying notes are an integral part of
these financial statements.
13
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------- ------------- -------------
Cash flows from (used in) operating activities:
Net income........................................................... $ 431,323 $ 49,656 $ 4,360,899
Adjustments to reconcile net income to net cash from operating
activities:
Depreciation................................................... 2,152,360 2,501,988 3,065,516
Write-down of equipment........................................ -- -- 967,200
Gain on sale of equipment...................................... (188,018) -- (5,976,056)
Changes in assets and liabilities:
Decrease (increase) in:
Rents receivable................................................. (104,184) -- 562,594
Accounts receivable--affiliate................................... 121,626 (121,626) 353,803
Increase (decrease) in:
Accrued interest................................................. (14,829) (20,888) 55,372
Accrued liabilities.............................................. 280,250 (434,150) 401,873
Accrued liabilities--affiliate................................... (15,521) (27,711) (7,731)
Deferred rental income........................................... (54,405) 54,383 22,765
------------- ------------- -------------
Net cash from operating activities............................. 2,608,602 2,001,652 3,806,235
------------- ------------- -------------
Cash flows from (used in) investing activities:
Purchase of equipment.............................................. -- -- (240,726)
Proceeds from equipment sales...................................... 846,300 -- 6,664,313
------------- ------------- -------------
Net cash from investing activities............................. 846,300 -- 6,423,587
------------- ------------- -------------
Cash flows used in financing activities:
Principal payments--notes payable.................................. (2,585,207) (2,457,462) (2,582,312)
Distributions paid................................................. -- (1,000,000) (4,600,000)
------------- ------------- -------------
Net cash used in financing activities.......................... (2,585,207) (3,457,462) (7,182,312)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents................. 869,695 (1,455,810) 3,047,510
Cash and cash equivalents at beginning of year....................... 2,671,041 4,126,851 1,079,341
------------- ------------- -------------
Cash and cash equivalents at end of year............................. $ 3,540,736 $ 2,671,041 $ 4,126,851
------------- ------------- -------------
------------- ------------- -------------
Supplemental disclosure of cash flow information:
Cash paid during the year for interest............................. $ 679,247 $ 911,177 $ 819,311
------------- ------------- -------------
------------- ------------- -------------
Supplemental disclosure of non-cash investing and financing activities:
See Note 3 to the Financial Statements.
The accompanying notes are an integral part of
these financial statements.
14
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
NOTE 1-- ORGANIZATION AND PARTNERSHIP MATTERS
AIRFUND International Limited Partnership (the "Partnership") was organized
as a limited partnership under the Massachusetts Uniform Limited Partnership Act
(the "Uniform Act") on January 31, 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). On July 26, 1989, the Partnership issued 3,040,000 units
representing assignments of limited partnership interests (the "Units") to 4,147
investors. Unit holders 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, of
which EFG and a wholly-owned affiliate are the 99% limited partners and AFG
Programs, Inc., a Massachusetts corporation which is wholly-owned by Geoffrey A.
MacDonald, is the 1% general partner. The capital contribution of the General
Partner, in consideration of its general partner interests, was $1,000. The
General Partner is not required to make any other capital contributions 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.
Significant operations commenced July 27, 1989 when the Partnership made its
initial equipment purchase. Pursuant to the Restated Agreement, as amended,
Distributable Cash From Operations and
15
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Distributable Cash From Sales or Refinancings will be allocated 95% to the
Recognized Owners and 5% to the General Partner for the life of the Partnership.
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 4).
NOTE 2-- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
STATEMENT OF CASH FLOWS
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 reverse 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, 1998, the Partnership had $3,431,400 invested in
federal agency discount notes and in reverse repurchase agreements secured by
U.S. Treasury Bills or interests in U.S. Government securities.
REVENUE RECOGNITION
Rents are payable to the Partnership monthly and quarterly and no
significant amounts are calculated on factors other than the passage of time.
All leases are accounted for as operating leases and are noncancellable. Rents
received prior to their due dates are deferred. Future minimum rents of
$4,782,888 are due as follows:
For the year ending December 31, 1999............................... $ 3,363,406
2000............................... 1,156,422
2001............................... 263,060
-----------
Total $ 4,782,888
-----------
-----------
In December 1998, the Partnership and the other affiliated leasing programs
owning interests in two McDonnell Douglas MD-82 aircraft entered into lease
extension agreements with Finnair OY. The lease extensions, effective upon the
expiration of the existing primary lease terms on April 28, 1999, extended the
leases for nine months and two years, respectively. In aggregate, these lease
extensions will provide additional lease revenue of approximately $2,899,000 to
the Partnership.
16
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Revenue from major individual lessees which accounted for 10% or more of
lease revenue during the years ended December 31, 1998, 1997 and 1996 is as
follows:
1998 1997 1996
------------ ------------ ------------
Finnair OY.............................................................. $ 2,118,431 $ 2,118,453 $ 1,433,334
(Two MD-82)
Southwest Airlines, Inc................................................. $ 1,250,208 $ 1,250,208 $ 1,250,208
(Three Boeing 737-2H4)
Aer Lease Limited....................................................... $ -- $ 489,609 $ --
(One Lockheed L-1011-50)
Northwest Airlines, Inc................................................. $ -- $ -- $ 1,200,000
(Two Boeing 727-251 ADV)
Cathay Pacific Airways Limited.......................................... $ -- $ -- $ 462,676
(One Lockheed L-1011-50)
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 reflect 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, for the Lockhead L-1011-50 aircraft, the
amount of all interim 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 each aircraft to determine whether it exceeds
estimated net realizable value. Adjustments to reduce the net carrying value of
aircraft are recorded in those instances where estimated net realizable value is
considered to be less than net carrying value. Such adjustments are reflected
separately on the accompanying Statement of Operations as Write-Down of
Equipment.
The ultimate realization of residual value for any type of equipment is
dependent upon many factors, including EFG's ability to sell and re-lease
equipment. Changing market conditions, industry trends,
17
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
technological advances, and many other events can converge to enhance or detract
from asset values at any given time.
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 4).
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 6 concerning
allocation of income or loss for income tax purposes.
NET INCOME (LOSS) AND CASH DISTRIBUTIONS PER UNIT
Net income (loss) and cash distributions per Unit are based on 3,040,000
Units outstanding during each of the three years in the period ended December
31, 1998 and computed after allocation of the General Partner's 5% share of net
income (loss) and cash distributions.
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 tax returns.
NOTE 3-- EQUIPMENT
The following is a summary of equipment owned by the Partnership at December
31, 1998. Remaining Lease Term (Months), as used below, represents the number of
months remaining from December 31, 1998 under contracted lease terms. 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 McDonnell-Douglas MD-82 (Finnair) 13-28 $ 13,762,438 Foreign
Three Boeing 737-2H4 (Southwest) 12 6,355,873 TX
-------------
Total equipment cost 20,118,311
Accumulated depreciation (5,857,207)
-------------
Equipment, net of accumulated depreciation $ 14,261,104
-------------
-------------
18
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
The cost of the three Boeing 737-2H4 aircraft and the two McDonnell-Douglas
MD-82 aircraft represent proportionate ownership interests. The remaining
interests are owned by other affiliated partnerships sponsored by EFG. All
Partnerships individually report, in proportion to their respective ownership
interests, their respective shares of assets, liabilities, revenues, and
expenses associated with the aircraft.
In 1996, the Partnership completed the replacement of the United Aircraft
with a 49.17% ownership interest in two MD-82 aircraft leased to Finnair OY (the
"Finnair Aircraft") at a total cost to the Partnership of $13,762,438. To
acquire the ownership interest in the Finnair Aircraft, the Partnership paid
$4,601,325 in cash and obtained financing of $9,161,113 from a third-party
lender. The Partnership's utilized $4,360,599 (classified as Contractual Right
for Equipment at December 31, 1995) which had been deposited into a
special-purpose escrow account through a third party exchange agent pending the
completion of the aircraft exchange. The balance of $240,726 was expended from
the Partnership's cash reserves. The remaining ownership interests of 50.83% in
the Finnair Aircraft are held by affiliated equipment leasing programs sponsored
by EFG.
All of the remaining aircraft and related lease payment streams were used to
secure term loans with third-party lenders. Such leveraged aircraft had an
original cost of approximately $20,118,000 and a net book value of approximately
$14,261,000 at December 31, 1998 (see Note 5).
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 upon the
expiration of the primary lease terms.
During 1996, the Partnership recorded a write-down of aircraft carrying
values, representing impairments related to the Partnership's interest in the
Lockheed L-1011-50 aircraft, which was sold in April 1998. The resulting charge
of $967,200 ($0.30 per limited partnership unit) was based on a comparison of
estimated net realizable values and corresponding carrying values for the
Partnership's aircraft.
NOTE 4-- 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
19
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
the three years in the period ended December 31, 1998, which were paid or
accrued by the Partnership to EFG or its Affiliates, are as follows:
1998 1997 1996
---------- ---------- ------------
Equipment management fees.................................................. $ 180,232 $ 192,913 $ 217,311
Administrative charges..................................................... 53,004 49,788 28,376
Reimbursable operating expenses due to third parties....................... 476,803 304,188 1,069,846
---------- ---------- ------------
Total................................................................ $ 710,039 $ 546,889 $ 1,315,533
---------- ---------- ------------
---------- ---------- ------------
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 1.6% 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 revenues and 2% of gross full payout lease rental
revenues received by the Partnership. Both acquisition and management fees are
subject to certain limitations defined in the Management Agreement.
Administrative charges represent amounts owed to EFG, pursuant to Section
10.4(c) of the 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 equipment was purchased from EFG or one of its Affiliates. The
Partnership's Purchase Price was determined by the method described in Note 2,
Equipment on Lease.
All rents and proceeds from the sale of aircraft are paid directly to EFG.
EFG temporarily deposits collected funds in a separate interest-bearing escrow
account prior to remittance to the Partnership.
Certain affiliates of the General Partner own Units in the Partnership as
follows:
NUMBER OF PERCENT OF TOTAL
AFFILIATE UNITS OWNED OUTSTANDING UNITS
- --------------------------------------------------------------------------------- ------------ -------------------
Old North Capital Limited Partnership............................................ 205,040 6.74%
Old North Capital Limited Partnership ("ONC") is a Massachusetts limited
partnership formed in 1995 and an affiliate of EFG. The general partner of ONC
is controlled by Gary D. Engle. In addition, the limited partnership interests
of ONC are owned by Semele Group, Inc. ("Semele"). Gary D. Engle is Chairman and
CEO of Semele.
NOTE 5-- NOTES PAYABLE
Notes payable at December 31, 1998 consisted of installment notes payable to
banks of $6,279,100. All of the installment notes are non-recourse, with
interest rates ranging between 8.65% and 8.89% and are collateralized by the
equipment and assignment of the related lease payments. All of the notes were
originated in connection with the Southwest Aircraft and the Finnair Aircraft.
The installment notes related to the Southwest Aircraft will be fully amortized
by noncancellable rents. The Partnership has a balloon payment obligation at the
expiration of the primary lease term related to the Finnair Aircraft of
$4,671,150. The carrying amount of notes payable approximates fair value at
December 31, 1998.
All of the Partnership's installment notes payable mature during the year
ending December 31, 1999.
20
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
NOTE 6-- 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). The
allocation of net income or loss for financial statement purposes differs from
the net income or loss allocation requirements for income tax and Dissolution
Event purposes, as delineated in the Restated Agreement, as amended. For income
tax purposes, the Partnership allocates net income or net loss in accordance
with the provisions of 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, 1998, the General Partner had a positive tax capital account
balance.
The following is a reconciliation between net income reported for financial
statement and federal income tax reporting purposes for the years ended December
31, 1998, 1997 and 1996:
1998 1997 1996
----------- ----------- ------------
Net income................................................................ $ 431,323 $ 49,656 $ 4,360,899
Tax depreciation in excess of financial statement depreciation.......... (487,526) (551,768) (1,654,141)
Write-down of equipment................................................. -- -- 967,200
Deferred rental income.................................................. (54,405) 54,383 22,765
Other................................................................... (760,951) (424,651) (1,333,616)
----------- ----------- ------------
Net income (loss) for federal income tax reporting purposes............... $ (871,559) $ (872,380) $ 2,363,107
----------- ----------- ------------
----------- ----------- ------------
The principal component of "Other" consists of the difference between the
tax gain or loss on aircraft disposals and the financial statement gain on
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, 1998 and 1997:
1998 1997
------------- -------------
Partners' capital.................................................................. $ 11,075,621 $ 10,644,298
Add back selling commissions and organization and offering costs................. 7,975,000 7,975,000
Cumulative difference between federal income tax and financial statement income
(loss)......................................................................... (6,750,404) (5,447,522)
------------- -------------
Partners' capital for federal income tax reporting purposes........................ $ 12,300,217 $ 13,171,776
------------- -------------
------------- -------------
The cumulative difference between federal income tax and financial statement
income (loss) represents a timing difference.
NOTE 7-- 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
21
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
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 based upon and superseded a
Memorandum of Understanding between the parties dated March 9, 1998 which
outlined the terms of a possible settlement. The Stipulation of Settlement was
filed with the Court on July 23, 1998 and 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").
Prior to issuing a final order, 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 class
members in the Class Action Lawsuit 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. Since first executing the
Stipulation of Settlement, the Court has scheduled two fairness hearings, the
first on December 11, 1998 and the second on March 19, 1999, each of which was
postponed because of delays in finalizing certain information materials that are
subject to regulatory review prior to being distributed to investors.
On March 15, 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 15, 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, divides the
Class Action Lawsuit into two separate sub-classes that can be settled
individually. This revision is expected to expedite the settlement of one
sub-class by the middle of 1999. However, the second sub-class, involving the
Partnership and 10 affiliated partnerships (collectively referred to as the
"Exchange Partnerships"), is expected to remain pending for a longer period due,
in part, to the complexity of the proposed settlement pertaining to this class.
Specifically, 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
22
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Exchange Partnerships. Newco would operate as a finance company specializing in
the acquisition, financing and servicing of equipment leases for its own account
and for the account of others on a contract basis. Newco also 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 provides, among other things, that commencing March 22,
1999, the Exchange Partnerships may 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 believe to
be consistent with the anticipated business interests and objectives of Newco,
subject to certain limitations, including that the Exchange Partnerships retain
sufficient cash balances to pay their respective shares of the cash distribution
referenced above in connection with the proposed Consolidation.
In the absence of the Court's authorization to enter into such activities,
the Partnership's Restated Agreement, as amended, would not permit new
investment activities without the approval of limited partners owning a majority
of the Partnership's outstanding Units. Accordingly, to the extent that the
Partnership invests in new equipment, the Manager (being EFG) will (i) defer,
until the earlier of the effective date of the Consolidation or December 31,
1999, any acquisition fees resulting therefrom and (ii) limit its management
fees on all such assets to 2% of rental income. In the event that the
Consolidation is consummated, all such acquisition and management fees will be
paid to Newco. To the extent that the Partnership invests in other business
activities not consisting of equipment acquisitions, the Manager will forego any
acquisition fees and management fees related to such investments. In the event
that the Partnership has acquired new investments, but the Partnership does not
participate in the Consolidation, Newco will acquire such new investments for an
amount equal to the Partnership's net equity investment plus an annualized
return thereon of 7.5%. Finally, in the event that the Partnership has acquired
new investments and the Consolidation is not effected, the General Partner will
use its best efforts to divest all such new investments in an orderly and timely
fashion and the Manager will cancel or return to the Partnership any acquisition
or management fees resulting from such new investments.
The Amended Stipulation and previous Stipulation of Settlement prescribe
certain conditions necessary to effecting final settlements, 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 is estimated to be
approximately $81,400, all of which was accrued and expensed by the Partnership
in 1998. In addition, the Partnership's share of fees and expenses related to
the proposed Consolidation is estimated to be approximately $255,100, all of
which was accrued and expensed by the Partnership in 1998.
23
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
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 permits the partners to transfer Units to family members or as a
result of the divorce, disability or death of the 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 either sub-class of the Class
Action Lawsuit 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. The General Partner and its
affiliates, in consultation with counsel, concur that there is a reasonable
basis to believe that final settlements of each sub-class will be achieved.
However, in the absence of final settlements 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.
24
ADDITIONAL FINANCIAL INFORMATION
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
SCHEDULE OF EXCESS (DEFICIENCY) OF TOTAL CASH GENERATED TO COST
OF EQUIPMENT DISPOSED
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
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, 1998 and
1996. There were no aircraft disposals during the year ended December 31, 1997.
1998 1996
------------ -------------
Rents earned prior to disposal of aircraft........................................... $ 6,064,972 $ 17,831,499
Sale proceeds realized upon disposition of aircraft.................................. 846,300 6,664,313
------------ -------------
Total cash generated from rents and aircraft sale proceeds........................... 6,911,272 24,495,812
Original acquisition cost of aircraft disposed....................................... 7,877,224 19,040,719
------------ -------------
Excess (deficiency) of total cash generated to cost of aircraft disposed............. $ (965,952) $ 5,455,093
------------ -------------
------------ -------------
25
AIRFUND INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH AND DISTRIBUTABLE CASH FROM OPERATIONS,
SALES AND REFINANCINGS
FOR THE YEAR ENDED DECEMBER 31, 1998
SALES AND
OPERATIONS REFINANCINGS TOTAL
------------- ------------ -------------
Net income............................................................ $ 243,305 $ 188,018 $ 431,323
Add:
Depreciation........................................................ 2,152,360 -- 2,152,360
Management fees..................................................... 180,232 -- 180,232
Book value of disposed equipment.................................... -- 658,282 658,282
Less:
Principal repayment of notes payable................................ (2,585,207) -- (2,585,207)
------------- ------------ -------------
Cash from operations, sales and refinancings........................ (9,310) 846,300 836,990
Less:
Management fees..................................................... (180,232) -- (180,232)
------------- ------------ -------------
Distributable cash from operations, sales and refinancings.......... (189,542) 846,300 656,758
Other sources and uses of cash:
Cash at beginning of year........................................... 1,606,728 1,064,313 2,671,041
Net change in receivable and accruals............................... 212,937 -- 212,937
------------- ------------ -------------
Cash at end of year................................................... $ 1,630,123 $ 1,910,613 $ 3,540,736
------------- ------------ -------------
------------- ------------ -------------
26
AIRFUND 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
DECEMBER 31, 1998
For the year ended December 31, 1998, the Partnership reimbursed the General
Partner and its Affiliates for the following costs:
Operating expenses................................................ $ 262,053
27