<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________________________ TO
___________________________
FOR QUARTER ENDED SEPTEMBER 30, 1998 COMMISSION FILE NO. 0-19137
------------------------
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3057290
(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
88 BROAD STREET, BOSTON, MA 02110
(Address of principal executive offices) (Zip Code)
(617) 854-5800
Registrant's telephone number, including area code
(Former name, former address and former fiscal year, if changed since last
report.)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90 days Yes / / No / /
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<PAGE>
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Statement of Financial Position
at September 30, 1998 and December 31, 1997................................................. 3
Statement of Operations
for the three and nine months ended September 30, 1998 and 1997............................. 4
Statement of Cash Flows
for the nine months ended September 30, 1998 and 1997....................................... 5
Notes to the Financial Statements............................................................... 6-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................................................... 11-17
PART II. OTHER INFORMATION:
Items 1 - 6......................................................................................... 18
</TABLE>
2
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF FINANCIAL POSITION
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- -------------
<S> <C> <C>
<CAPTION>
ASSETS
<S> <C> <C>
Cash and cash equivalents........................................................... $ 3,487,037 $ 2,102,494
Rents receivable.................................................................... 86,599 65,120
Accounts receivable--affiliate...................................................... 64,678 305,359
Equipment at cost, net of accumulated depreciation of
$40,894,051 and $43,339,081 at September 30, 1998
and December 31, 1997, respectively............................................... 4,488,291 7,292,133
------------- -------------
Total assets.................................................................. $ 8,126,605 $ 9,765,106
------------- -------------
------------- -------------
<CAPTION>
LIABILITIES AND PARTNERS' CAPITAL
<S> <C> <C>
Notes payable....................................................................... $ 2,105,147 $ 2,677,520
Accrued interest.................................................................... 27,569 29,618
Accrued liabilities................................................................. 404,000 8,250
Accrued liabilities--affiliate...................................................... 68,518 42,524
Deferred rental income.............................................................. 49,774 167,067
------------- -------------
Total liabilities............................................................. 2,655,008 2,924,979
------------- -------------
Partners' capital (deficit):
General Partner................................................................... (2,721,876) (2,653,450)
Limited Partnership Interests
(2,714,647 Units; initial purchase price of $25 each)............................. 8,193,473 9,493,577
------------- -------------
Total partners' capital....................................................... 5,471,597 6,840,127
------------- -------------
Total liabilities and partners' capital....................................... $ 8,126,605 $ 9,765,106
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
3
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
--------------------------- -----------------------------
1998 1997 1998 1997
------------ ------------- ------------- --------------
<S> <C> <C> <C> <C>
Income:
Lease revenue.................................. $ 737,647 $ 803,499 $ 2,457,641 $ 2,262,996
Interest income................................ 49,992 26,926 117,967 80,935
Gain on sale of equipment...................... -- -- 127,265 --
------------ ------------- ------------- --------------
Total income................................. 787,639 830,425 2,702,873 2,343,931
------------ ------------- ------------- --------------
Expenses:
Depreciation................................... 768,387 844,338 2,377,409 2,533,013
Interest expense............................... 47,996 65,234 157,233 207,852
Equipment management fees--affiliate........... 36,882 40,175 122,882 113,150
Operating expenses--affiliate.................. 617,389 539,280 1,413,879 997,416
------------ ------------- ------------- --------------
Total expenses............................... 1,470,654 1,489,027 4,071,403 3,851,431
------------ ------------- ------------- --------------
Net loss........................................... $ (683,015) $ (658,602) $ (1,368,530) $ (1,507,500)
------------ ------------- ------------- --------------
------------ ------------- ------------- --------------
Net loss per limited partnership unit.............. $ (0.24) $ (0.23) $ (0.48) $ (0.53)
------------ ------------- ------------- --------------
------------ ------------- ------------- --------------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
4
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
STATEMENT OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Cash flows from (used in) operating activities:
Net loss............................................................................ $ (1,368,530) $ (1,507,500)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation.................................................................... 2,377,409 2,533,013
Gain on sale of equipment....................................................... (127,265) --
Changes in assets and liabilities
Decrease (increase) in:
rents receivable................................................................ (21,479) (39,931)
accounts receivable--affiliate.................................................. 240,681 (38,926)
Increase (decrease) in:
accrued interest................................................................ (2,049) 912
accrued liabilities............................................................. 395,750 (206,034)
accrued liabilities--affiliate.................................................. 25,994 (464,732)
deferred rental income.......................................................... (117,293) 37,367
------------- -------------
Net cash from operating activities............................................ 1,403,218 314,169
------------- -------------
Cash flows from investing activities:
Proceeds from equipment sale...................................................... 553,698 --
------------- -------------
Net cash from investing activities............................................ 553,698 --
------------- -------------
Cash flows used in financing activities:
Principal payments--notes payable................................................. (572,373) (524,715)
------------- -------------
Net cash used in financing activities......................................... (572,373) (524,715)
------------- -------------
Net increase (decrease) in cash and cash equivalents................................ 1,384,543 (210,546)
Cash and cash equivalents at beginning of period.................................... 2,102,494 2,347,762
------------- -------------
Cash and cash equivalents at end of period.......................................... $ 3,487,037 $ 2,137,216
------------- -------------
------------- -------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest.......................................... $ 159,282 $ 206,940
------------- -------------
------------- -------------
</TABLE>
The accompanying notes are an integral part
of these financial statements.
5
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
NOTE 1--BASIS OF PRESENTATION
The financial statements presented herein are prepared in conformity with
generally accepted accounting principles and the instructions for preparing Form
10-Q under Rule 10-01 of Regulation S-X of the Securities and Exchange
Commission and are unaudited. As such, these financial statements do not include
all information and footnote disclosures required under generally accepted
accounting principles for complete financial statements and, accordingly, the
accompanying financial statements should be read in conjunction with the
footnotes presented in the 1997 Annual Report. Except as disclosed herein, there
has been no material change to the information presented in the footnotes to the
1997 Annual Report.
In the opinion of management, all adjustments (consisting of normal and
recurring adjustments) considered necessary to present fairly the financial
position at September 30, 1998 and December 31, 1997 and results of operations
for the three and nine months ended September 30, 1998 and 1997 have been made
and are reflected.
NOTE 2--CASH
At September 30, 1998, the Partnership had $3,363,561 invested in federal
agency discount notes and in reverse repurchase agreements secured by U.S.
Treasury Bills or interests in U.S. Government securities.
NOTE 3--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
$1,061,305 are due as follows:
<TABLE>
<S> <C> <C>
For the year ending September 30, 1999.......................... $ 935,449
2000.......................... 125,856
----------
Total......................... $1,061,305
----------
----------
</TABLE>
During the third quarter of 1998, Classic Airways Limited ("Classic"), a
lessee of the Partnership, ceased paying rents related to the Partnership's
Lockheed L-1011-100 aircraft. In October 1998, Classic was placed in
liquidation. The Partnership's future minimum rents exclude $2,240,000 scheduled
to be received from Classic under the existing lease agreement at September 30,
1998 (see Note 7 for additional information).
NOTE 4--EQUIPMENT
The following is a summary of equipment owned by the Partnership at
September 30, 1998. Remaining Lease Term (Months), as used below, represents the
number of months remaining from September 30, 1998 under contracted lease terms.
In the opinion of Equis Financial Group Limited Partnership ("EFG"), the
acquisition cost of the equipment did not exceed its fair market value.
6
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
<TABLE>
<CAPTION>
REMAINING
LEASE
TERM EQUIPMENT
EQUIPMENT TYPE (MONTHS) AT COST
- - -------------------------------------------------------------- --------------- --------------
<S> <C> <C>
One Lockheed L-1011-100 (Classic)............................. 28(a) $ 16,644,138
One Boeing 727-208 ADV (ATA).................................. 4 12,928,710
One Boeing 727-251 ADV (Transmeridian)........................ 1 9,732,714
Two McDonnell-Douglas MD-82 (Finnair)......................... 7 4,157,280
Three Boeing 737-2H4 (Southwest).............................. 15 1,919,500
--------------
Total equipment cost ........................................................ 45,382,342
Accumulated depreciation .................................................... (40,894,051)
--------------
Equipment, net of accumulated depreciation .................................. $ 4,488,291
--------------
--------------
</TABLE>
(a) see Note 3 for additional information regarding this lease.
The costs of the two McDonnell-Douglas MD-82 aircraft, and the three Boeing
737-2H4 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.
American Trans Air, Inc. has given the Partnership an irrevocable notice of
its intention to purchase the Partnership's Boeing 727-208 ADV aircraft for $3.3
million at the expiration of its existing lease term in January 1999, pursuant
to a purchase option contained in the lease agreement. The aircraft had a net
book value of $12,255 at September 30, 1998.
NOTE 5--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 nine month
periods ended September 30, 1998 and 1997, which were paid or accrued by the
Partnership to EFG or its Affiliates, are as follows:
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Equipment management fees..................... $ 122,882 $ 113,150
Administrative charges........................ 40,257 36,885
Reimbursable operating expenses
due to third parties.......................... 1,373,622 960,531
------------
Total......................................... $ 1,536,761 $ 1,110,566
------------
------------
</TABLE>
All rents and 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 September 30, 1998, the Partnership was owed $64,678 by EFG for such funds
and the interest thereon. These funds were remitted to the Partnership in
October 1998.
7
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
NOTE 6--NOTES PAYABLE
Notes payable at September 30, 1998 consisted of installment notes payable
to banks of $2,105,147. 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. 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 $1,411,035. The carrying
amount of notes payable approximates fair value at September 30, 1998.
The annual maturities of the installment notes payable are as follows:
<TABLE>
<S> <C> <C>
For the year ending September 30, 1999.......................... $1,981,529
2000.......................... 123,618
------------------------------ ----------
Total......................... $2,105,147
------------------------------ ----------
------------------------------ ----------
</TABLE>
NOTE 7--LEGAL PROCEEDINGS
On or about January 15, 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 the 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 supersedes 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. On August 20, 1998, 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"). The Court's August 20 Order enjoined certain class members,
including all of the partners of the Partnership, from transferring, selling,
assigning, giving, pledging, hypothesizing, or otherwise disposing of any Units
pending the Court's final determination of whether the settlement should be
approved. Similarly, the August 20
8
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
Order enjoined the General Partner of the Partnership (and the general partners
of certain affiliated partnerships) from, among other things, recording any such
transfers.
The Stipulation of Settlement, as preliminarily approved by the Court,
contemplates various changes that, if effected, would alter the future
operations of the Nominal Defendants. With respect to the Partnership and 10
affiliated partnerships (hereafter referred to as the "Exchange Partnerships"),
the Stipulation of Settlement provides for the restructuring of their respective
business operations into a single successor company whose securities would be
listed and traded on a national securities exchange. The partners of the
Exchange Partnerships would receive both common stock in the new company and a
cash distribution in exchange for their existing partnership interests. Such a
transaction would, among other things, allow for the consolidation of the
Partnership's operating expenses with other similarly organized equipment
leasing programs. The Stipulation of Settlement prescribes certain conditions
necessary to effecting the settlement, including providing the partners of the
Exchange Partnerships with the opportunity to object to the participation of
their partnership in the restructuring.
A preliminary Solicitation Statement, describing, among other things, the
various terms of settlement, was filed with the Securities and Exchange
Commission on August 25, 1998. Upon completion of the review process, a
definitive Solicitation Statement will be distributed to all of the partners of
the Exchange Partnerships to enable them to vote on the restructuring. Prior to
the settlement becoming final, the Court will hold a hearing on the settlement
that will be open to all interested parties. The Court has scheduled a hearing
date for December 11, 1998. Currently, it is anticipated that a request for
extension will be filed with the Court to permit sufficient time to complete the
regulatory review process and print and mail the definitive Solicitation
Statement. Class members will be notified of the final hearing date in advance.
There can be no assurance that the outcome of the voting by the partners of
the Exchange Partnerships, including the Partnership, will result in all or any
of the Exchange Partnerships, including the Partnership, being included in the
proposed restructuring. There also can be no assurance that a settlement,
including the restructuring, will be approved by the Court and effected. The
General Partner and its affiliates, in consultation with counsel, concur that
there is a reasonable basis to believe that a final settlement 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. The General Partner and its affiliates cannot predict with any
degree of certainty the ultimate outcome of such litigation.
During the third quarter of 1998, Classic ceased paying rents to the
Partnership with respect to the L-1011-100 and was served formal notice of
default of its lease obligations by the Partnership. Subsequently, Classic filed
for receivership in the United Kingdom and was placed in liquidation in October
1998. Due to the financial situation of Classic, the L-1011-100 was grounded and
incurred significant airport charges owed to each of BAA plc, Eurocontrol and
CAA (the "Airport Authorities") in the United Kingdom. The failure of Classic to
pay such charges resulted in the Airport Authorities exercising their powers of
detention over the L-1011-100. The General Partner, on behalf of the
Partnership, is negotiating with the Airport Authorities to resolve the issue of
the unpaid charges and to allow the Partnership to remove the aircraft.
Currently, the General Partner is not able to determine the ultimate outcome of
its claim or the extent of any related losses that the Partnership may incur.
During the three months ended September 30, 1998, the Partnership lost lease
revenues of $160,000 pertaining to this aircraft. In addition, the Partnership
accrued expenses of $75,000 during the three months ended September 30, 1998 for
legal costs in connection with this matter. The Partnership ultimately intends
to recover the aircraft and remarket it to another third party.
9
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
NOTES TO THE FINANCIAL STATEMENTS
(CONTINUED)
On November 9, 1998, Investors Asset Holding Corp. ("IAHC"), as Trustee for
the Partnership, filed an action in the 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.
IAHC is seeking a declaration that Transmeridian has breached the lease
agreement that the Partnership entered into with Transmeridian to lease the
Partnership's Boeing 727-251 ADV aircraft (the "Aircraft") by failing and
refusing to repair the substantial damage caused to the airframe of the Aircraft
as the result of an on-ground accident at the airport in Caracas, Venezuela in
October 1998. Transmeridian's breach is impeding the Partnership's ability to
sell the Aircraft and its ability to return two of the Aircraft's engines, which
the Partnership currently leases from a third party. In addition, the
Partnership seeks to enforce written guaranties issued by Apple Vacations that
absolutely and unconditionally guarantee Transmeridian's performance under the
lease agreement. Thus, Apple Vacations is liable to the Partnership for any harm
it suffers as a result of Transmeridian's breaches. At present, it is not
possible to determine the outcome of this matter.
In a separate action filed in October 1996, Transmeridian filed suit against
IAHC, as trustee for the Partnership. This suit remains pending (see Note 7 to
the financial statements contained in the 1997 Annual Report for additional
detail).
10
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this quarterly report of AIRFUND II International
Limited Partnership (the "Partnership") that are not historical fact constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 and are subject to a variety of risks and
uncertainties. There are a number of 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, and the ability of Equis Financial Group Limited
Partnership (formerly American Finance Group) ("EFG") to collect all rents due
under the attendant lease agreements and successfully remarket the Partnership's
equipment upon the expiration of such leases.
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. Presently, EFG
anticipates completing its Year 2000 project by December 31, 1998 at a di
minimus cost to the Partnership. Aggregate costs for the entire project are
anticipated to be less than $50,000, all of which will 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 are expected to require only minor modifications to function properly with
respect to dates in the year 2000 and thereafter. Moreover, 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 will 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. However, non-compliance on the part of a lessee could, under a worse
case scenario, result in lost revenues to the Partnership.
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 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.
11
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO THE THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 1997
OVERVIEW
As an equipment leasing partnership, the Partnership was organized to
acquire and lease a portfolio of commercial jet aircraft subject to lease
agreements with third parties. During 1990 and 1991, the Partnership purchased
four commercial jet aircraft and a proportionate interest in two additional
aircraft which were leased by major carriers engaged in passenger
transportation. Initially, each aircraft generated rental revenue pursuant to
primary-term lease agreements. Subsequently, all of the aircraft in the
Partnership's original portfolio have been re-leased, renewed, exchanged for
other aircraft or sold. At September 30, 1998, the Partnership owned three
aircraft and proportionate interests in five additional aircraft, all of which
were on lease (see below for discussion regarding the lease of the Partnership's
Lockheed L-1011-100 aircraft). Upon expiration of the current 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 the Class Action Lawsuit could alter
the nature of the Partnership's organization and its future business operations.
See Note 7 to the accompanying financial statements.
RESULTS OF OPERATIONS
For the three and nine months ended September 30, 1998, the Partnership
recognized lease revenue of $737,647 and $2,457,641, respectively, compared to
$803,499 and $2,262,996 for the same periods in 1997. The increase in lease
revenue in the nine months ended September 30, 1998 compared to the same period
in 1997 resulted primarily from the re-lease of the Partnership's L-1011-100
aircraft to Classic Airways Limited ("Classic") commencing in the fourth quarter
of 1997 (see discussion below). Such increase was partially offset by a
reduction in lease revenue resulting from the sale of the Partnership's interest
in a Lockheed L-1011-50 aircraft in April 1998 to Aer Lease Limited ("Aer
Lease") and a scheduled reduction in the base rent payable under the lease
agreement related to the Partnership's Boeing 727-251 ADV aircraft (see
discussion below). The lease agreement with Aer Lease provided for base rent to
the Partnership of $39,550 per month beginning April 27, 1997. In 1997, prior to
the commencement of this 1-year lease, this aircraft was undergoing heavy
maintenance and was not on lease. On April 29, 1998, at the expiration of the
aircraft's lease term, the Partnership sold its interest in this aircraft to Aer
Lease for net proceeds of $553,698. The Partnership's interest in the aircraft
had a net book value of $426,433 at the time of sale, resulting in a net gain,
for financial statement purposes, of $127,265. There were no other equipment
sales during either of the nine month periods ending September 30, 1998 and
1997.
The three Boeing 737-2H4 aircraft in which the Partnership holds a
proportionate interest (the "Southwest Aircraft") are currently on lease to
Southwest Airlines, Inc. These leases are scheduled to expire on December 31,
1999 and provide lease revenue of $31,464 per month to the Partnership.
Additionally, the two McDonnell-Douglas MD-82 aircraft, in which the Partnership
holds a proportionate interest (the "Finnair Aircraft"), are currently on lease
to Finnair OY. These leases are scheduled to expire on April 28, 1999 and
provide lease revenue of $159,981 per quarter to the Partnership.
The Partnership entered into an agreement with Classic to lease the
Partnership's Lockheed L-1011-100 aircraft for a period of three years with a
base rent of $80,000 per month, effective November 1, 1997. Due to certain
refurbishments required to be performed by Classic, the Partnership agreed to
12
<PAGE>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
defer rents required under the attendant lease agreement for the three month
period ended March 31, 1998. The lease agreement was therefore extended three
months through January 31, 2001. The Partnership recognized lease revenue in the
amount of $320,000 related to this aircraft during the nine months ended
September 30, 1998 (see additional discussion below). During the nine months
ended September 30, 1997, this aircraft was off lease, undergoing certain
maintenance prior to being placed in storage until it was re-leased to Classic.
During the third quarter of 1998, Classic ceased paying rents to the
Partnership with respect to the L-1011-100 and was served formal notice of
default of its lease obligations by the Partnership. Subsequently, Classic filed
for receivership in the United Kingdom and was placed in liquidation in October
1998. Due to the financial situation of Classic, the L-1011-100 was grounded and
incurred significant airport charges owed to each of BAA plc, Eurocontrol and
CAA (the "Airport Authorities") in the United Kingdom. The failure of Classic to
pay such charges resulted in the Airport Authorities exercising their powers of
detention over the L-1011-100. The General Partner, on behalf of the
Partnership, is negotiating with the Airport Authorities to resolve the issue of
the unpaid charges and to allow the Partnership to remove the aircraft.
Currently, the General Partner is not able to determine the ultimate outcome of
its claim or the extent of any related losses that the Partnership may incur.
During the three months ended September 30, 1998, the Partnership lost lease
revenues of $160,000 pertaining to this aircraft. In addition, the Partnership
accrued expenses of $75,000 during the three months ended September 30, 1998 for
legal costs in connection with this matter. The Partnership ultimately intends
to recover the aircraft and remarket it to another third party.
The Partnership's Boeing 727-208 ADV aircraft is under a two year renewal
agreement with American Trans Air, Inc. The renewal agreement, scheduled to
expire in January 1999, provides lease revenue of $63,500 per month to the
Partnership. The Partnership recognized lease revenue of $571,500 from this
aircraft for each of the nine month periods ended September 30, 1997 and 1998
(see additional discussion below). The Partnership's Boeing 727-251 ADV
aircraft, is under a 26 month re-lease agreement with Transmeridian Airlines,
Inc. which commenced on September 11, 1996. The Partnership recognized lease
revenue from this aircraft of $643,333 and $720,000 for the nine months ended
September 30, 1998 and 1997, respectively. In the future, the Partnership's
aggregate lease revenue is expected to decline due to the Classic situation and
the expiration of the lease terms related to the Partnership's remaining
aircraft.
At September 30, 1998, the Partnership held a proportionate ownership
interest in the Southwest and Finnair Aircraft (see Note 4 to the financial
statements). 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.
The ultimate realization of residual value for aircraft is dependent upon
many factors, including EFG's ability to sell and re-lease the aircraft.
Changing market conditions, industry trends, technological advances, and many
other events can converge to enhance or detract from asset values at any given
time. EFG attempts to monitor these 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 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
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AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
in the financial statements is not necessarily indicative of the total residual
value the Partnership achieved from leasing the aircraft.
Interest income for the three and nine months ended September 30, 1998 was
$49,992 and $117,967, respectively, compared to $26,926 and $80,935 for the same
periods in 1997. Interest income is typically generated from temporary
investments of rental receipts and equipment sale proceeds in short-term
instruments.
For the three and nine months ending September 30, 1998, the Partnership
incurred interest expense of $47,996 and $157,233, respectively, compared to
$65,234 and $207,852 for the same periods in 1997. Interest expense in future
periods will continue 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 during each of the periods ended
September 30, 1998 and 1997, and will not change as a percentage of lease
revenue in future periods.
Operating expenses consist principally of administrative charges,
professional service costs, such as audit and legal fees, as well as insurance,
printing, distribution and remarketing expenses. Operating expenses were
$617,389 and $1,413,879 for the three and nine months ended September 30, 1998,
respectively, compared to $539,280 and $997,416 for the same periods in 1997.
During the nine months ended September 30, 1998, the Partnership incurred or
accrued approximately $334,000 for certain legal and administrative expenses
related to the Class Action Lawsuit described in Note 7 to the accompanying
financial statements. Additionally, the increase in operating expenses from 1997
to 1998 was due to legal costs incurred in connection with the legal proceedings
related to Northwest Airlines, Inc. and Transmeridian Airlines, Inc. (refer to
Note 7 in the 1997 Annual Report), engine leasing costs, legal costs incurred
with the Classic matter and certain remarketing costs. In 1997, significant
operating expenses were incurred in connection with the refurbishment of the
L-1011-50 aircraft, in which the Partnership held an interest, to meet the needs
of Aer Lease. The amount of future operating expenses cannot be predicted with
certainty; however, such expenses are usually higher during the acquisition and
liquidation phases of a partnership. Other fluctuations will occur in relation
to the volume and timing of aircraft remarketing activities. Depreciation
expense was $768,387 and $2,377,409 for the three and nine months ended
September 30, 1998 compared to $844,338 and $2,533,013 for the same periods in
1997.
LIQUIDITY AND CAPITAL RESOURCES AND DISCUSSION OF CASH FLOWS
The Partnership by its nature is a limited life entity which was established
for specific purposes described in the preceding "Overview". As an equipment
leasing program, the Partnership's principal operating activities derive from
aircraft rental transactions. Accordingly, the Partnership's principal source of
cash from operations is provided by the collection of periodic rents. These cash
inflows are used to satisfy debt service obligations associated with leveraged
leases, and to pay management fees and operating costs. Operating activities
generated net cash inflows of $1,403,218 for the nine months ended September 30,
1998 compared to $314,169 for the same period in 1997 Overall, expenses
associated with rental activities, such as management fees, and net cash flow
from operating activities decline as the Partnership remarkets its aircraft.
Conversely, the Partnership may incur increased costs to insure the successful
remarketing of these 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.
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AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
Cash realized from aircraft disposal transactions is reported under
investing activities on the accompanying Statement of Cash Flows. For the nine
months ended September 30,1998, the Partnership realized net cash proceeds of
$553,698. No aircraft sales occurred during the corresponding period in 1997.
Such proceeds related to the sale, to Aer Lease, of the Partnership's interest
in the L-1011-50 aircraft. 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.
American Trans Air, Inc. has given the Partnership an irrevocable notice of
its intention to purchase the Partnership's Boeing 727-208 ADV aircraft for $3.3
million at the expiration of its existing lease term in January 1999, pursuant
to a purchase option contained in the lease agreement. The aircraft had a net
book value of $12,255 at September 30, 1998. The Partnership's ability to
remarket its Boeing 727-251 ADV aircraft is being impeded due to Transmeridian
Airlines' failure and refusal to repair the substantial damage caused to the
airframe of this aircraft as the result of an on-ground accident at the airport
in Caracas, Venezuela in October 1998. See Note 7 to the accompanying financial
statements for details regarding legal action undertaken by the Partnership
related to this situation. The Partnership also ultimately intends to recover
the aircraft on lease to Classic and remarket it to another third party.
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 6 to the financial statements presented in the Partnership's 1997
Annual Report). For instance, selling commissions, 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,
the difference between distributions (declared vs. paid) for income tax and
financial reporting purposes, and the treatment of unrealized gains or losses on
investment securities, if any, for book and tax purposes. 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 September 30, 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, 1997, the
General Partner had a negative tax capital account balance of approximately
$811,000.
At September 30, 1998, the Partnership had aggregate future minimum lease
payments of $1,061,305 from contractual lease agreements (see Note 3 to the
financial statements), a portion of which will be used to amortize the principal
balance of notes payable of $2,105,147 (see Note 6 to the financial statements).
At the expiration of the individual primary and renewal lease terms underlying
the Partnership's future
15
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AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
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 aircraft 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 is often
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 have cash
outflows to satisfy interest on indebtedness and to pay management fees and
operating expenses. The Partnership may also be required to expend funds to
refurbish or otherwise improve the aircraft being remarketed in order to make
them more desirable to a potential lessee or purchaser. Ultimately, the
Partnership is expected to meet its future disbursement obligations and to
distribute any excess of cash inflows over cash outflows to the Partners in
accordance with the Amended and Restated Agreement and Certificate of Limited
Partnership. However, several factors, including month-to-month lease
extensions, lessee defaults, aircraft casualty events, and early lease
terminations could alter the timing and amount of the Partnership's anticipated
cash flows as described herein and in the accompanying financial statements and
result in fluctuations to the Partnership's periodic cash distribution payments.
Further, the outcome of the Class Action Lawsuit described above could effect
the ability of the Partnership to collect all of its contracted future minimum
lease payments and remarketing proceeds, as well as the amount and timing of
future cash distributions to the Partners.
The Partnership obtained long-term financing in connection with like-kind
exchange transactions involving the Southwest Aircraft and the Finnair Aircraft.
The corresponding note agreements are recourse only to the specific aircraft
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 a balloon payment obligation at the expiration of the primary lease
term related to the Finnair Aircraft of $1,411,035.
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. Future market conditions, technological changes, the
ability of EFG to manage and remarket the aircraft, and many other events and
circumstances, could enhance or detract from individual asset yields and the
collective performance of the Partnership's aircraft portfolio.
Overall, the future liquidity of the Partnership will be influenced by the
outcome of the Class Action Lawsuit described in Note 7 to the accompanying
financial statements. The General Partner anticipates that cash proceeds
resulting from upon the collection of contractual rents and the outcome of
residual activities will satisfy the Partnership's future expense obligations.
However, the amount of cash available for distribution in future periods is
expected to fluctuate widely as the General Partner attempts to remarket the
Partnership's aircraft and possibly upgrade certain aircraft to meet the
standards of potential successor lessees.
16
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AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART I. FINANCIAL INFORMATION
The Partnership has incurred significant heavy maintenance costs in recent
years in connection with its aircraft remarketing efforts. It is important to
note that all of the Partnership's lease agreements are scheduled to expire by
the end of 1999 and therefore the Partnership will be required to maintain
sufficient liquidity to address future remarketing costs, including potential
modifications to the Partnership's aircraft in order to sell or re-lease the
aircraft at an attractive price. Accordingly, the General Partner expects to
continue to suspend the declaration of future cash distributions pending further
developments in the remarketing requirements for the Partnership's remaining
aircraft.
17
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AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
FORM 10-Q
PART II. OTHER INFORMATION
<TABLE>
<CAPTION>
<S> <C>
Item 1. Legal Proceedings
Response:
Refer to Note 7 to the financial statements herein.
Item 2. Changes in Securities
Response: None
Item 3. Defaults upon Senior Securities
Response: None
Item 4. Submission of Matters to a Vote of Security Holders
Response: None
Item 5. Other Information
Response: None
Item 6(a). Exhibits
Response: None
Item 6(b). Reports on Form 8-K
Response: None
</TABLE>
18
<PAGE>
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on behalf of the registrant and in the capacity and
on the date indicated.
<TABLE>
<S> <C> <C>
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
By: AFG Aircraft Management Corporation, a
Massachusetts corporation and the General
Partner of the Registrant.
By: /s/ MICHAEL J. BUTTERFIELD
------------------------------------------------
Michael J. Butterfield
Treasurer of AFG Aircraft Management Corporation
(Duly Authorized Officer and
Principal Accounting Officer)
Date: November 13, 1998
---------------------------------------------------------
By: /s/ GARY ROMANO
------------------------------------------------
Gary M. Romano
Clerk of AFG Aircraft Management Corporation
(Duly Authorized Officer and
Principal Financial Officer)
Date: November 13, 1998
---------------------------------------------------------
</TABLE>
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 14,331,637
<SECURITIES> 0
<RECEIVABLES> 2,492,702
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 16,824,339
<PP&E> 107,551,097
<DEPRECIATION> 44,587,747
<TOTAL-ASSETS> 79,787,689
<CURRENT-LIABILITIES> 1,182,535
<BONDS> 36,507,192
0
0
<COMMON> 0
<OTHER-SE> 42,097,962
<TOTAL-LIABILITY-AND-EQUITY> 79,787,689
<SALES> 0
<TOTAL-REVENUES> 14,984,315
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 9,550,130
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,652,655
<INCOME-PRETAX> 2,781,530
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,781,530
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,781,530
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
