<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[XX] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended JUNE 30, 1999
------------------------------------------------
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 June 30, 1999 Commission File No. 0-19137
AIRFUND II INTERNATIONAL LIMITED PARTNERSHIP
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3057290
- ------------------------------- ------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
88 BROAD STREET, BOSTON, MA 02110
- ------------------------------- ------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (617) 854-5800
----------------------------
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court 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 / /
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I. FINANCIAL INFORMATION:
Item 1. Financial Statements
Statement of Financial Position
at June 30, 1999 and December 31, 1998 3
Statement of Operations
for the three and six months ended June 30, 1999 and 1998 4
Statement of Cash Flows
for the six months ended June 30, 1999 and 1998 5
Notes to the Financial Statements 6-12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-18
PART II. OTHER INFORMATION:
Items 1 - 6 19
</TABLE>
2
<PAGE>
AIRFUND II International Limited Partnership
STATEMENT OF FINANCIAL POSITION
June 30, 1999 and December 31, 1998
(Unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 6,313,774 $ 3,425,762
Rents receivable 31,464 39,933
Accounts receivable - affiliate 71,010 71,178
Other assets 82,000 125,734
Equipment at cost, net of accumulated depreciation of
$28,454,694 and $40,968,380 at June 30, 1999
and December 31, 1998, respectively 3,998,938 4,413,962
------------ -------------
Total assets $ 10,497,186 $ 8,076,569
------------ -------------
------------ -------------
LIABILITIES AND PARTNERS' CAPITAL
Notes payable $ 1,466,338 $ 1,896,665
Accrued interest 18,566 25,126
Accrued liabilities 436,445 458,485
Accrued liabilities - affiliate 88,397 16,254
Deferred rental income 51,380 47,997
------------ -------------
Total liabilities 2,061,126 2,444,527
------------ -------------
Partners' capital (deficit):
General Partner (2,573,653) (2,713,854)
Limited Partnership Interests
(2,714,647 Units; initial purchase price of $25 each) 11,009,713 8,345,896
------------ -------------
Total partners' capital 8,436,060 5,632,042
------------ -------------
Total liabilities and partners' capital $ 10,497,186 $ 8,076,569
------------ -------------
------------ -------------
</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 six months ended June 30, 1999 and 1998
(Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Income:
Lease revenue $ 482,218 $ 937,552 $ 1,190,347 $ 1,719,994
Interest income 59,656 35,911 98,074 67,975
Gain on sale of equipment 3,109,500 127,265 3,109,500 127,265
----------- ----------- ----------- -----------
Total income 3,651,374 1,100,728 4,397,921 1,915,234
----------- ----------- ----------- -----------
Expenses:
Depreciation 154,375 768,736 415,024 1,609,022
Interest expense 32,536 52,434 71,333 109,237
Equipment management fees - affiliate 24,111 46,878 59,517 86,000
Operating expenses - affiliate 524,609 655,246 1,048,029 796,490
----------- ----------- ----------- -----------
Total expenses 735,631 1,523,294 1,593,903 2,600,749
----------- ----------- ----------- -----------
Net income (loss) $ 2,915,743 $ (422,566) $ 2,804,018 $ (685,515)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Net income (loss)
per limited partnership unit $ 1.02 $ (0.15) $ 0.98 $ (0.24)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</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 six months ended June 30, 1999 and 1998
(Unaudited)
<TABLE>
<CAPTION>
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from (used in) operating activities:
Net income (loss) $ 2,804,018 $ (685,515)
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Depreciation 415,024 1,609,022
Gain on sale of equipment (3,109,500) (127,265)
Changes in assets and liabilities Decrease (increase) in:
Rents receivable 8,469 (6,834)
Accounts receivable - affiliate 168 91,188
Other assets 43,734 --
Increase (decrease) in:
Accrued interest (6,560) 4,357
Accrued liabilities (22,040) 316,414
Accrued liabilities - affiliate 72,143 15,324
Deferred rental income 3,383 (90,628)
------------ ------------
Net cash from operating activities 208,839 1,126,063
------------ ------------
Cash flows from investing activities:
Proceeds from equipment sales 3,109,500 553,699
------------ ------------
Net cash from investing activities 3,109,500 553,699
------------ ------------
Cash flows used in financing activities:
Principal payments - notes payable (430,327) (340,937)
------------ ------------
Net cash used in financing activities (430,327) (340,937)
------------ ------------
Net increase in cash and cash equivalents 2,888,012 1,338,825
Cash and cash equivalents at beginning of period 3,425,762 2,102,494
------------ ------------
Cash and cash equivalents at end of period $ 6,313,774 $ 3,441,319
------------ ------------
------------ ------------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 77,893 $ 104,880
------------ ------------
------------ ------------
</TABLE>
The accompanying notes are an integral
part of these financial statements.
5
<PAGE>
AIRFUND II International Limited Partnership
Notes to the Financial Statements
June 30, 1999
(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 1998 Annual Report. Except as disclosed herein, there
has been no material change to the information presented in the footnotes to the
1998 Annual Report.
In the opinion of management, all adjustments (consisting of normal and
recurring adjustments) considered necessary to present fairly the financial
position at June 30, 1999 and December 31, 1998 and results of operations for
the three and six month periods ended June 30, 1999 and 1998 have been made and
are reflected.
NOTE 2 - CASH AND CASH EQUIVALENTS
At June 30, 1999, the Partnership had $6,200,136 invested in federal agency
discount notes, repurchase agreements secured by U.S. Treasury Bills or
interests in U.S. Government securities, or other highly liquid overnight
investments.
NOTE 3 - REVENUE RECOGNITION
Rents are payable to the Partnership monthly 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 $936,474
are due as follows:
<TABLE>
<S> <C>
For the year ending June 30, 2000 $ 698,083
2001 238,391
--------------
Total $ 936,474
--------------
--------------
</TABLE>
In December 1998, the Partnership and certain 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 $876,000 to
the Partnership over the terms of the leases.
NOTE 4 - EQUIPMENT
The following is a summary of equipment owned by the Partnership at June
30, 1999. Remaining Lease Term (Months), as used below, represents the number of
months remaining from June 30, 1999 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 0 $ 16,644,138
One Boeing 727-251 ADV (Transmeridian) 0 9,732,714
Two McDonnell-Douglas MD-82 (Finnair) 7-22 4,157,280
Three Boeing 737-2H4 (Southwest) 6 1,919,500
---------------
Total equipment cost 32,453,632
Accumulated depreciation (28,454,694)
---------------
Equipment, net of accumulated depreciation $ 3,998,938
---------------
---------------
</TABLE>
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.
Certain of the equipment and related lease payment streams were used to
secure term loans with third-party lenders. The preceding summary includes
leveraged equipment having an original cost of $6,076,780 and a net book value
of $3,998,938 at June 30, 1999 (see Note 6).
At June 30, 1999, the Partnership's Boeing 727-251 ADV jet aircraft was
held for sale. The Partnership's Lockheed L-1011-100 jet aircraft was being
detained in the United Kingdom as a result of the lessee's failure to pay
various airport ground fees. Each of these aircraft was fully depreciated at
June 30, 1999. See Note 7 for additional discussion regarding each aircraft.
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 six month periods
ended June 30, 1999 and 1998, which were paid or accrued by the Partnership to
EFG or its Affiliates, are as follows:
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Equipment management fees $ 59,517 $ 86,000
Administrative charges 46,517 26,838
Reimbursable operating expenses
due to third parties 1,001,512 769,652
------------ ------------
Total $ 1,107,546 $ 882,490
------------ ------------
------------ ------------
</TABLE>
All rents and proceeds from the sale of equipment are paid directly to EFG.
EFG temporarily deposits collected funds in a separate interest-bearing escrow
account prior to remittance to the Partnership. At June 30,
7
<PAGE>
AIRFUND II International Limited Partnership
Notes to the Financial Statements
(Continued)
1999, the Partnership was owed $71,010 by EFG for such funds and the interest
thereon. These funds were remitted to the Partnership in July 1999.
Administrative charges represent amounts owed to EFG, pursuant to Section
10.4 of the Amended and Restated Agreement and Certificate of Limited
Partnership (the "Restated Agreement, as amended"), for persons employed by EFG
who are engaged in providing administrative services to the Partnership.
Administrative charges and reimbursable operating expenses for the six months
ended June 30, 1999 include adjustments for 1998 actual costs of approximately
$13,000 and $10,000, respectively.
NOTE 6 - NOTES PAYABLE
Notes payable at June 30, 1999 consisted of installment notes payable to
banks of $1,466,338. The installment notes are non-recourse, with interest rates
ranging between 8.09% and 8.65% 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 balloon payment obligations at the
expiration of the renewal lease terms related to the aircraft on lease to
Finnair OY of $499,815 and $133,261. This indebtedness matures in January 2000
and April 2001, respectively. The carrying amount of notes payable approximates
fair value at June 30, 1999.
The annual maturities of the installment notes payable are as follows:
<TABLE>
<S> <C>
For the year ending June 30, 2000 $ 1,114,582
2001 351,756
--------------
Total $ 1,466,338
--------------
--------------
</TABLE>
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 equipment leasing programs sponsored by EFG, including the
Partnership (collectively, the "Nominal Defendants"), against EFG and a number
of its affiliates, including the General Partner, as defendants (collectively,
the "Defendants"). Certain of the Plaintiffs, on or about June 24, 1997, had
filed an earlier derivative action, captioned LEONARD ROSENBLUM, ET AL. V. EQUIS
FINANCIAL GROUP LIMITED PARTNERSHIP, ET AL., in the Superior Court of the
Commonwealth of Massachusetts on behalf of the Nominal Defendants against the
Defendants. Both actions are referred to herein collectively as the "Class
Action Lawsuit".
The Plaintiffs have asserted, among other things, claims against the
Defendants on behalf of the Nominal Defendants for violations of the Securities
Exchange Act of 1934, common law fraud, breach of contract, breach of fiduciary
duty, and violations of the partnership or trust agreements that govern each of
the Nominal Defendants. The Defendants have denied, and continue to deny, that
any of them have committed or threatened to commit any violations of law or
breached any fiduciary duties to the Plaintiffs or the Nominal Defendants.
On July 16, 1998, counsel for the Defendants and the Plaintiffs executed a
Stipulation of Settlement setting forth terms pursuant to which a settlement of
the Class Action Lawsuit is intended to be achieved and which, among other
things, is expected to reduce the burdens and expenses attendant to continuing
litigation. The Stipulation of Settlement was preliminarily approved by the
Court on August 20, 1998 when the Court issued its
8
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AIRFUND II International Limited Partnership
Notes to the Financial Statements
(Continued)
"Order Preliminarily Approving Settlement, Conditionally Certifying Settlement
Class and Providing for Notice of, and Hearing on, the Proposed Settlement" (the
"August 20 Order").
On March 12, 1999, counsel for the Plaintiffs and the Defendants entered
into an amended stipulation of settlement (the "Amended Stipulation") which was
filed with the Court on March 12, 1999. The Amended Stipulation was
preliminarily approved by the Court by its "Modified Order Preliminarily
Approving Settlement, Conditionally Certifying Settlement Class and Providing
For Notice of, and Hearing On, the Proposed Settlement" dated March 22, 1999
(the "March 22 Order"). The Amended Stipulation, among other things, divides the
Class Action Lawsuit into two separate sub-classes that can be settled
individually. On May 26, 1999, the Court issued an Order and Final Judgment
approving settlement of one of the sub-classes. Settlement of the second
sub-class, involving the Partnership and 10 affiliated partnerships
(collectively referred to as the "Exchange Partnerships"), is expected to remain
pending for a longer period due, in part, to the complexity of the proposed
settlement pertaining to this class. Prior to issuing a final order approving
the settlement of the second sub-class involving the Partnership, the Court will
hold a fairness hearing that will be open to all interested parties and permit
any party to object to the settlement. The investors of the Partnership and all
other plaintiff sub-class members will receive a Notice of Settlement and other
information pertinent to the settlement of their claims that will be mailed to
them in advance of the fairness hearing.
The settlement of the second sub-class is premised on the consolidation of
the Exchange Partnerships' net assets (the "Consolidation"), subject to certain
conditions, into a single successor company ("Newco"). Under the proposed
Consolidation, the partners of the Exchange Partnerships would receive both
common stock in Newco and a cash distribution; and thereupon the Exchange
Partnerships would be dissolved. In addition, EFG would contribute certain
management contracts, operations personnel, and business opportunities to Newco
and cancel its current management contracts with all of the Exchange
Partnerships. Newco would operate 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
9
<PAGE>
AIRFUND II International Limited Partnership
Notes to the Financial Statements
(Continued)
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. To date, the General Partner has not authorized new investment
activities involving the Partnership.
The Amended Stipulation and previous Stipulation of Settlement prescribe
certain conditions necessary to effecting a final settlement, including
providing the partners of the Exchange Partnerships with the opportunity to
object to the participation of their partnership in the Consolidation. Assuming
the proposed settlement is effected according to present terms, the
Partnership's share of legal fees and expenses related to the Class Action
Lawsuit is estimated to be approximately $76,000 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 $256,000, all of which also was accrued and expensed by the
Partnership in 1998.
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 the sub-class involving the
Exchange Partnerships will receive final Court approval and be effected. There
also can be no assurance that all or any of the Exchange Partnerships will
participate in the Consolidation because if limited partners owning more than
one-third of the outstanding Units of a partnership object to the Consolidation,
then that partnership will be excluded from the Consolidation. The General
Partner and its affiliates, in consultation with counsel, concur that there is a
reasonable basis to believe that a final settlement of the sub-class involving
the Exchange Partnerships will be achieved. However, in the absence of a final
settlement approved by the Court, the Defendants intend to defend vigorously
against the claims asserted in the Class Action Lawsuit. Neither the General
Partner nor its affiliates can predict with any degree of certainty the cost of
continuing litigation to the Partnership or the ultimate outcome.
In addition to the foregoing, the Partnership is a party to other lawsuits
that have arisen out of the conduct of its business, principally involving
disputes or disagreements with lessees over lease terms and conditions. Refer to
the Partnership's Annual Report on Form 10-K for the year ended December 31,
1998 for a description of these matters. The following are updates to the
Partnership's prior disclosures on Form 10-K for 1998:
FIRST ACTION INVOLVING TRANSMERIDIAN AIRLINES
On October 11, 1996, Prime Air Inc. d/b/a Transmeridian Airlines (the
"Plaintiff") filed an action in the 61st Judicial District Court of Harris
County, Texas (the "Court") entitled PRIME AIR, INC. D/B/A TRANSMERIDIAN
AIRLINES V. INVESTORS ASSET HOLDING CORP. ("IAHC"), AS TRUSTEE FOR AIRFUND II
INTERNATIONAL LIMITED PARTNERSHIP, PLM INTERNATIONAL ("PLM"), AND NAVCOM
AVIATION, INC. (collectively, the "Defendants"). In that action, the Plaintiff
claimed damages of more than $3 million for alleged breach of contract, fraud,
civil conspiracy, tortious interference of business relations, negligent
misrepresentation, negligence and gross negligence, and punitive damages against
the Defendants in connection with Transmeridian's lease of a Boeing 727-251 ADV
jet aircraft
10
<PAGE>
AIRFUND II International Limited Partnership
Notes to the Financial Statements
(Continued)
from the Partnership. On November 7, 1996, PLM removed the action
to United States District Court for the Southern District of Texas. On February
14, 1997, the Defendants answered the Plaintiff's Complaint denying the
allegations made therein and asserting various defenses.
On July 31, 1998, the Court granted IAHC's motion to strike Plaintiff's
fraud and negligent misrepresentation claims due to failure to plead with
particularity. Extensive discovery was conducted on the merits of Plaintiff's
claims. The Plaintiff provided a revised expert report claiming actual damages
of approximately $8.5 million and Plaintiff continued to seek punitive damages
and both pre-judgment and post-judgment interest. On March 18, 1999, the Court
entered summary judgment in favor of IAHC and PLM on all remaining claims. The
Plaintiff subsequently filed a motion to alter or amend the judgment, or in the
alternative, to certify the Court's Order for Interlocutory Appeal. On April 30,
1999, the Court declined to alter or amend its judgment and entered final
judgment in favor of IAHC and PLM on all remaining claims. The Plaintiff has
filed a notice of appeal and Plaintiff's brief is due to be filed in the Court
of Appeals by August 27, 1999. The General Partner believes that the Plaintiff's
claims are without merit and will continue to defend this action vigorously.
While there is no certainty as to the outcome of this litigation, the General
Partner, in consultation with counsel, believes that there is a reasonable basis
to believe that the summary judgments already granted will be upheld under
appeal. Therefore, the General Partner does not believe that the outcome of this
litigation will adversely affect the Partnership's financial position.
SECOND ACTION INVOLVING TRANSMERIDIAN AIRLINES
On November 9, 1998, Investors Asset Holding Corp., as Trustee for the
Partnership (the "Plaintiff"), filed an action in Superior Court of the
Commonwealth of Massachusetts in Suffolk County against Prime Air, Inc. d/b/a
Transmeridian Airlines ("Transmeridian"), Atkinson & Mullen Travel, Inc., and
Apple Vacations, West, Inc., both d/b/a Apple Vacations, asserting various
causes of action for declaratory judgment and breach of contract. The action
subsequently was removed to United States District Court for the District of
Massachusetts. The Plaintiff has filed an Amended Complaint asserting claims for
breaches of contract and covenant of good faith and fair dealing against
Transmeridian and breach of guaranty against Apple Vacations.
In October 1998, an aircraft leased by Transmeridian (being the same
aircraft in the above-referenced "First action involving Transmeridian
Airlines") was damaged in an on-ground accident at the Caracas, Venezuela
airport. The aircraft currently is undergoing repairs at a repair facility in
Louisiana. The cost to repair the aircraft is estimated to be at least $350,000.
In addition, the Partnership has had to lease two substitute engines at a cost
of $82,000 per month. During the six months ended June 30, 1999, the Partnership
incurred total engine lease costs of $492,000. This was partially offset by
lease rents paid by Transmeridian of $420,000 during the same period. The
Plaintiff alleges that Transmeridian, among other things, has impeded the
Partnership's ability to terminate the two engine lease contracts between the
Partnership and a third party. The Plaintiff intends to pursue insurance
coverage and also to enforce written guarantees issued by Apple Vacations that
absolutely and unconditionally guarantee Transmeridian's performance under the
lease and is seeking recovery of all costs, lost revenue and monetary damages in
connection with this matter. Discovery is ongoing and a trial date has been
tentatively scheduled for April 17, 2000. The General Partner plans to
vigorously pursue this action; however, it is too early to predict the
Plaintiff's likelihood of success.
ACTION INVOLVING NORTHWEST AIRLINES, INC.
On September 22, 1995, Investors Asset Holding Corp. and First Security
Bank, N.A., trustees of the Partnership and certain affiliated investment
programs (collectively, the "Plaintiffs"), filed an action in United States
District Court for the District of Massachusetts against a lessee of the
Partnership, Northwest Airlines, Inc. ("Northwest"). The Complaint alleges that
Northwest did not fulfill its maintenance obligations under its Lease Agreements
with the Plaintiffs and seeks declaratory judgment concerning Northwest's
obligations and monetary damages. Northwest filed an Answer to the Plaintiffs'
Complaint and a motion to transfer the venue of this
11
<PAGE>
AIRFUND II International Limited Partnership
Notes to the Financial Statements
(Continued)
proceeding to Minnesota. The Court denied Northwest's motion. On June 29, 1998,
a United States Magistrate Judge recommended entry of partial summary judgment
in favor of the Plaintiffs. Northwest appealed this decision. On April 15, 1999,
the United States District Court Judge adopted the Magistrate Judge's
recommendation and entered partial summary judgment in favor of the Plaintiffs.
The General Partner believes that the Plaintiff's claims ultimately will prevail
and that the Partnership's financial position will not be adversely affected by
the outcome of this action.
ACTION INVOLVING CLASSIC AIRWAYS LIMITED
In August 1998, a lessee of the Partnership, Classic Airways Limited
("Classic"), ceased paying rent to the Partnership with respect to an L-1011-100
aircraft. In October 1998, Classic filed for receivership in the United Kingdom
("UK") and was placed in liquidation. Prior to its liquidation, Classic had
incurred and failed to pay significant airport ground fees to BAA plc,
Eurocontrol, and CAA (collectively, the "Airport Authorities"). The failure of
Classic to pay such charges resulted in detention of the aircraft by the Airport
Authorities. In addition, BAA plc has continued to charge incremental ground
fees and expenses to the aircraft and has continued to detain the aircraft
pending collection of such amounts, which totaled approximately $1,500,000 at
June 30, 1999. Under UK law, the Airport Authorities have the right not only to
detain the aircraft, but to sell the aircraft at auction in order to satisfy
their outstanding fees. The General Partner engaged counsel to represent the
Partnership's interests in the UK and initially had hoped to reach a settlement
with the Airport Authorities. After extensive litigation and failed
negotiations, BAA plc obtained a judgment from UK Court entitling it to sell the
aircraft to satisfy the unpaid charges. At this time, the total amount of such
charges exceeds the anticipated value of the aircraft to BAA plc, if it were to
sell the aircraft at auction. Although BAA plc has custody of the aircraft, the
Partnership holds the aircraft's records, without which the aircraft has only
limited market value. Based upon prior negotiations, the Partnership had accrued
and expensed approximately $167,000 to cover the cost of settling the airport
charges, all of which was recorded in the fourth quarter of 1998. At the date of
Classic's liquidation, the Partnership had accrued $160,000 of rental income
which had not been collected from Classic and all of which was written-off as
uncollectible in the third quarter of 1998. At this time, the General Partner
does not believe that the Partnership's best economic interests would be served
by paying the accumulated ground fees to the Airport Authorities because such
fees are greater than the aircraft's expected market value. The consequence of
this position is that BAA plc may sell the aircraft at auction in order to
recover a portion of its fees. This aircraft was fully depreciated at June 30,
1999. The General Partner does not expect that any funds are likely to be
recovered from Classic in connection with this matter.
12
<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 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 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 Equis Financial Group Limited
Partnership (formerly American Finance Group) ("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 has completed substantially all of its Year 2000 project at an aggregate
cost of less than $50,000 and at a di minimus cost to the Partnership. All costs
incurred in connection with EFG's Year 2000 project have been expensed as
incurred.
EFG's primary information software was coded by a third party 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 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 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.
13
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART I. FINANCIAL INFORMATION
THREE AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO THE THREE AND SIX MONTHS
ENDED JUNE 30, 1998:
As an equipment leasing partnership, the Partnership was organized to
acquire and lease a portfolio of commercial jet aircraft subject to lease
agreements with third parties. During 1990 and 1991, the Partnership purchased
four commercial jet aircraft and a proportionate interest in two additional
aircraft which were leased by major carriers engaged in passenger
transportation. Initially, each aircraft generated rental revenue pursuant to
primary-term lease agreements. Subsequently, all of the aircraft in the
Partnership's original portfolio have been re-leased, renewed, exchanged for
other aircraft, or sold. At June 30, 1999, the Partnership owned two aircraft
and proportionate interests in five additional aircraft. Upon expiration of the
current lease agreements, the 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. See below for discussion related
to the detention of one of the Partnership's aircraft in the United Kingdom. In
addition, 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, 2005.
RESULTS OF OPERATIONS
For the three and six months ended June 30, 1999, the Partnership
recognized lease revenue of $482,218 and $1,190,347, respectively, compared to
$937,552 and $1,719,994 for the same periods in 1998. The decrease in lease
revenue from 1998 to 1999 was due primarily to the non-payment of rents by the
lessee of the Partnership's Lockheed L-1011-100 aircraft and that lessee's
subsequent liquidation (see discussion below), the sale of the Partnership's
Boeing 727-208 ADV aircraft in April 1999, and the sale of the Partnership's
interest in a Lockheed L-1011-50 aircraft in April 1998. In the future, the
Partnership's aggregate lease revenue is scheduled to decline due to the
expiration of the lease terms related to the Partnership's remaining aircraft
and the ultimate sale of its aircraft.
In April 1999, the Partnership sold its Boeing 727-208 ADV aircraft,
previously leased to American Trans Air, Inc. ("ATA"), to the lessee for net
proceeds of $3,109,500. The aircraft was fully depreciated at the time of sale,
resulting in a net gain, for financial statement purposes, of $3,109,500. The
Partnership recognized lease revenue of approximately $246,000 and $381,000
related to this aircraft for the six months ended June 30, 1999 and 1998,
respectively.
In August 1998, Classic Airways Limited ("Classic") ceased paying rent with
respect to the Partnership's Lockheed L-1011-100 jet aircraft. In October 1998,
Classic filed for receivership in the United Kingdom ("UK") and was placed in
liquidation (see further discussion below). The Partnership earned lease revenue
in the amount of approximately $240,000 related to this aircraft during the six
months ended June 30, 1998.
In April 1998, the Partnership sold its proportionate interest in a
Lockheed L-1011-50 aircraft to Aer Lease Limited ("Aer Lease") for net proceeds
of $553,699. The Partnership's interest in the aircraft had a net book value of
$426,434 at the time of disposal, resulting in a net gain for financial
statement purposes, of $127,265. The Partnership recognized aggregate lease
revenue of approximately $159,000 related to this aircraft during the six months
ended June 30, 1998.
The three Boeing 737-2H4 aircraft in which the Partnership holds a
proportionate ownership interest are currently on lease to Southwest Airlines,
Inc. (the "Southwest Aircraft"). These leases are scheduled to expire in
December 1999 and collectively provide lease revenue of $94,392 per quarter to
the Partnership. Additionally, the two McDonnell-Douglas MD-82 aircraft in which
the Partnership holds a proportionate interest are currently on lease to Finnair
OY (the "Finnair Aircraft"). These leases, which were renewed upon the
expiration of the primary lease terms in April 1999, are now scheduled to expire
in January 2000 and April 2001 and generate lease revenue of $79,990 and $79,464
per quarter to the Partnership, respectively.
14
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART I. FINANCIAL INFORMATION
The Partnership's Boeing 727-251 ADV aircraft was damaged in an on-ground
accident in October 1998 (see below) and is being leased on a month-to-month
basis by Transmeridian Airlines, Inc. ("Transmeridian"). Currently, this lease
generates lease revenue of $210,000 per quarter to the Partnership.
At June 30, 1999, the Partnership held proportionate ownership interests in
the Southwest Aircraft and the 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.
Interest income for the three and six months ended June 30, 1999 was
$59,656 and $98,074, respectively, compared to $35,911 and $67,975 for the same
periods in 1998. Interest income is typically generated from temporary
investments of rental receipts and equipment sale proceeds in short-term
instruments.
For the three and six months ended June 30, 1999, the Partnership incurred
interest expense of $32,536 and $71,333, respectively, compared to $52,434 and
$109,237 for the same periods in 1998. Interest expense resulted from financing
obtained from third-party lenders in connection with the acquisition of the
Southwest Aircraft and the Finnair Aircraft. 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.
The ultimate realization of residual value for any aircraft will be
dependent upon many factors, including EFG's ability to sell and re-lease the
aircraft. Changes in market conditions, industry trends, technological advances,
and other events could converge to enhance or detract from asset values at any
given time. EFG attempts to monitor these changes and the airline industry in
order to identify opportunities which may be advantageous to the Partnership and
which will maximize total cash returns for each aircraft.
The total economic value realized for each aircraft is comprised of all
primary lease term revenue generated from that aircraft, together with its
residual value. The latter consists of cash proceeds realized upon the
aircraft's sale in addition to all other cash receipts obtained from renting the
aircraft on a re-lease, renewal or month-to-month basis. Consequently, the
amount of gain or loss reported in the financial statements is not necessarily
indicative of the total residual value the Partnership achieved from leasing the
aircraft.
Operating expenses were $524,609 and $1,048,029 for the three and six
months ended June 30, 1999, respectively, compared to $655,246 and $796,490 for
the same periods in 1998. Operating expenses in 1999 include engine leasing
costs of $492,000 incurred related to the aircraft leased to Transmeridian and
legal costs related to the Partnership's ongoing litigation (refer to Note 7 to
the financial statements). In 1999, operating expenses also include an
adjustment for 1998 actual administrative charges and third party costs of
approximately $23,000. During 1998, the Partnership accrued $332,000 for certain
legal and Consolidation expenses related to the Class Action Lawsuit described
in Note 7 to the financial statements. Other operating expenses consist
principally of professional service costs, such as audit and other legal fees,
as well as insurance, printing, distribution and other remarketing expenses.
Depreciation expense was $154,375 and $415,024 for the three and six months
ended June 30, 1999 compared to $768,736 and $1,609,022 for the same periods in
1998. Management fees were 5% of lease revenue during each of the three and six
month periods ended June 30, 1999 and 1998.
LIQUIDITY AND CAPITAL RESOURCES AND DISCUSSION OF CASH FLOWS
The Partnership by its nature is a limited life entity. As an aircraft
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
15
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART I. FINANCIAL INFORMATION
operating costs. Operating activities generated net cash inflows of $208,839 and
$1,126,063 for the six months ended June 30, 1999 and 1998, respectively. Future
renewal, re-lease and aircraft sales activities will continue to cause a decline
in the Partnership's lease revenues and corresponding sources of operating cash.
Overall, expenses associated with rental activities, such as management fees,
and net cash flow from operating activities will decline as the Partnership
remarkets its aircraft. The Partnership, however, may incur increased costs to
facilitate the successful remarketing of its aircraft in the future. Ultimately,
the Partnership will dispose of all aircraft under lease. This will occur
principally through sale transactions whereby each aircraft will be sold to the
existing lessee or to a third party. Generally, this will occur upon expiration
of each aircraft's primary or renewal/re-lease term.
Cash realized from aircraft disposal transactions is reported under
investing activities on the accompanying Statement of Cash Flows. In 1999, the
Partnership received sales proceeds of $3,109,500 related to the Partnership's
Boeing 727-208 ADV aircraft formerly leased to ATA. For the six months ended
June 30, 1998, the Partnership realized net cash proceeds of $553,699 from the
sale of the Partnership's interest in an 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.
At June 30, 1999, the Partnership was due aggregate future minimum lease
payments of $936,474 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 $1,466,338 (see Note 6 to the financial statements).
At the expiration of the individual lease terms underlying the Partnership's
future minimum lease payments, the Partnership will sell its aircraft or enter
re-lease or renewal agreements when considered advantageous by the General
Partner and EFG. Such future remarketing activities will result in the
realization of additional cash inflows in the form of 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 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.
The Partnership's ability to remarket its Boeing 727-251 ADV aircraft
leased by Transmeridian has been impeded by 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 financial statements for details
regarding legal action undertaken by the Partnership related to this situation.
In August 1998, Classic, which leased the Partnership's L-1011-100
aircraft, ceased paying rent. In October 1998, Classic filed for receivership in
the United Kingdom ("UK") and was placed in liquidation. Prior to its
liquidation, Classic had incurred and failed to pay significant airport ground
fees to BAA plc, Eurocontrol, and CAA (collectively, the "Airport Authorities").
The failure of Classic to pay such charges resulted in detention of the aircraft
by the Airport Authorities. In addition, BAA plc has continued to charge
incremental ground fees and expenses to the aircraft and has continued to detain
the aircraft pending collection of such amounts, which totaled approximately
$1,500,000 at June 30, 1999. Under UK law, the Airport Authorities have the
right not only to detain the aircraft, but to sell the aircraft at auction in
order to satisfy their outstanding fees. The General Partner engaged counsel to
represent the Partnership's interests in the UK and initially had hoped to reach
a settlement with the Airport Authorities. After extensive litigation and failed
negotiations, BAA plc obtained a judgment from UK Court entitling it to sell the
aircraft to satisfy the unpaid charges. At this time, the total amount of such
charges exceeds the anticipated value of the aircraft to BAA plc, if it were to
sell the aircraft at auction. Although BAA plc has custody of the aircraft, the
Partnership holds the aircraft's records, without which the aircraft has only
limited market value. Based upon prior negotiations, the Partnership had accrued
and expensed approximately
16
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART I. FINANCIAL INFORMATION
$167,000 to cover the cost of settling the airport charges, all of which was
recorded in the fourth quarter of 1998. At the date of Classic's liquidation,
the Partnership had accrued $160,000 of rental income which had not been
collected from Classic and all of which was written-off as uncollectible in the
third quarter of 1998. At this time, the General Partner does not believe that
the Partnership's best economic interests would be served by paying the
accumulated ground fees to the Airport Authorities because such fees are greater
than the aircraft's expected market value. The consequence of this position is
that BAA plc may sell the aircraft at auction in order to recover a portion of
its fees. This aircraft was fully depreciated at June 30, 1999. The General
Partner does not expect that any funds are likely to be recovered from Classic
in connection with this matter.
The Partnership obtained long-term financing in connection with 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, they are used to repay principal and interest.
In December 1998, the Partnership and certain affiliated investment
programs owning interests in two McDonnell Douglas MD-82 aircraft (collectively,
the "Programs") 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 $876,000 to the Partnership over the terms of the
leases.
On April 29, 1999, the Programs entered into agreements with a third-party
lender to extend the maturity dates of the Programs' indebtedness related to the
Finnair Aircraft. Consistent with the extension terms of the lease agreements
related to the Finnair Aircraft discussed above, the maturity dates of the
indebtedness were extended to January 2000 and April 2001, respectively. The
Partnership has balloon payment obligations of $499,815 and $133,261 related to
this indebtedness that is due on the respective maturity dates.
There are no formal restrictions under the Restated Agreement, as amended,
that materially limit the Partnership's ability to pay cash distributions,
except that the General Partner may suspend or limit cash distributions to
ensure that the Partnership maintains sufficient working capital reserves to
cover, among other things, operating costs and potential expenditures, such as
refurbishment costs to remarket 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 airworthiness standards, such as
flight hours or engine cycles, nonetheless may require heavy maintenance in
order to bring its engines, airframe and other hardware up to standards that
will permit its prospective use in commercial air transportation. 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
one Stage 2 aircraft as well as proportionate ownership interests in three other
Stage 2 aircraft. 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 727s and 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 remarketing 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
17
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART I. FINANCIAL INFORMATION
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
court order has allowed 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 reinstate 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 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 for either of the six
months ended June 30, 1999 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 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 1998
Annual Report). For instance, selling commissions and organization and offering
costs pertaining to syndication of the Partnership's limited partnership units
are not deductible for federal income tax purposes, but are recorded as a
reduction of partners' capital for financial reporting purposes. Therefore, such
differences are permanent differences between capital accounts for financial
reporting and federal income tax purposes. Other differences between the bases
of capital accounts for federal income tax and financial reporting purposes
occur due to timing differences. 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 June 30, 1999. This is the result of aggregate cash
distributions to the General Partner being in excess of its capital contribution
of $1,000 and its allocation of financial statement net income or loss.
Ultimately, the existence of a capital deficit for the General Partner for
financial reporting purposes is not indicative of any further capital
obligations to the Partnership by the General Partner. The Restated Agreement,
as amended, requires that upon the dissolution of the Partnership, the General
Partner will be required to contribute to the Partnership an amount equal to any
negative balance which may exist in the General Partner's tax capital account.
At December 31, 1998, the General Partner had a negative tax capital account
balance of approximately $828,000.
The future liquidity of the Partnership will be influenced by, among other
factors, prospective market conditions, aircraft refurbishment requirements, the
ability of EFG to manage and remarket the Partnership's 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.
18
<PAGE>
AIRFUND II International Limited Partnership
FORM 10-Q
PART II. OTHER INFORMATION
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
19
<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.
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: August 13, 1999
-----------------------------------------------
By: /s/ Gary Romano
-----------------------------------------------
Gary M. Romano
Clerk of AFG Aircraft Management Corporation
(Duly Authorized Officer and
Principal Financial Officer)
Date: August 13, 1999
-----------------------------------------------
20
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<PAGE>
<ARTICLE> 5
<CIK> 0000853937
<NAME> AIRFUND II
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 6,313,774
<SECURITIES> 0
<RECEIVABLES> 102,474
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,183,412
<PP&E> 32,453,632
<DEPRECIATION> (28,454,694)
<TOTAL-ASSETS> 10,497,186
<CURRENT-LIABILITIES> 594,788
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 8,436,060
<TOTAL-LIABILITY-AND-EQUITY> 10,497,186
<SALES> 0
<TOTAL-REVENUES> 4,397,921
<CGS> 0
<TOTAL-COSTS> 1,522,570
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 71,333
<INCOME-PRETAX> 2,804,018
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,804,018
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,804,018
<EPS-BASIC> 0
<EPS-DILUTED> 0
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