-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OhZZozU1tNZTkbPQvE2RunhjmnqECskQ7Q1wrNK+TU/QhJbHRZNYHl3kpIxZ/Gkc 4hiQ3JpuDiCoEjKr/L/d4A== 0000950149-98-000508.txt : 19980327 0000950149-98-000508.hdr.sgml : 19980327 ACCESSION NUMBER: 0000950149-98-000508 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980326 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AIRLEASE LTD CENTRAL INDEX KEY: 0000799033 STANDARD INDUSTRIAL CLASSIFICATION: FINANCE LESSORS [6172] IRS NUMBER: 943008908 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-09259 FILM NUMBER: 98574550 BUSINESS ADDRESS: STREET 1: 733 FRONT ST STREET 2: P.O. BOX 193985 CITY: SAN FRANCISCO STATE: CA ZIP: 94119 BUSINESS PHONE: 4156279289 10-K 1 ANNUAL REPORT FOR THE PERIOD ENDED 12/31/97 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1997 Commission File No. 1-9259 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP (Exact name of registrant as specified in its charter) California 94-3008908 ----------------------- ------------------------------------ (State of Organization) (I.R.S. Employer Identification No.) 555 California Street, Fourth Floor, San Francisco, CA 94104 ------------------------------------------------------ ------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (415) 765-1814 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS: NAME OF EACH EXCHANGE Depositary Units Representing ON WHICH REGISTERED: Limited Partner Interests New York Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Aggregate market value of Depositary Units, held by nonaffiliates of the registrant as of the close of business at March 20, 1998 was $51,514,981.00. 2 TABLE OF CONTENTS Page
PART I ITEM 1. BUSINESS....................................................................................... 3 ITEM 2. PROPERTIES..................................................................................... 14 ITEM 3. LEGAL PROCEEDINGS.............................................................................. 14 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................... 15 ITEM 6. SELECTED FINANCIAL DATA........................................................................ 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................................... 24 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE........... 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT............................................. 24 ITEM 11. EXECUTIVE COMPENSATION......................................................................... 26 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT................................. 26 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS................................................. 27 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.............................. 28 SIGNATURES...................................................................................................... 31 INDEX TO EXHIBITS............................................................................................. A-13
2 3 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 PART I ITEM 1. BUSINESS GENERAL Airlease Ltd., A California Limited Partnership (the "Partnership" or "Airlease"), was formed in 1986. The General Partner of the Partnership (the "General Partner") is Airlease Management Services, Inc., a Delaware corporation. Until October 31, 1996 the General Partner was a wholly owned subsidiary of USL Capital Corporation ("USL Capital"), which in turn was an indirect subsidiary of Ford Motor Company. On October 31, 1996, BA Leasing & Capital Corporation, a California corporation ("BALCAP") purchased the stock of the General Partner from USL Capital and now the General Partner is a wholly owned subsidiary of BALCAP and USL Capital no longer has any affiliation with the Partnership. BALCAP is a wholly owned indirect subsidiary of BankAmerica Corporation. A total of 4,625,000 Depositary Units representing limited Partnership interests ("Units") in the Partnership are outstanding, of which 3,600,000 are held by the public and 1,025,000 are owned by BALCAP and its subsidiaries. The Partnership invests in commercial aircraft and leases the aircraft to others, primarily airlines, pursuant to finance (full payout) or operating leases. PRINCIPAL INVESTMENT OBJECTIVES The business of the Partnership is to acquire and own, either directly or through joint ventures, aircraft and to lease such aircraft primarily to airlines. The Partnership's principal investment objectives are to generate income for quarterly cash distributions to Unitholders and to own a portfolio of leased aircraft. The Partnership's original intent was that until January 1, 2005, it would use a substantial portion of the cash derived from the sale, refinancing or other disposition of aircraft to purchase additional aircraft if attractive investment opportunities were available. 3 4 As previously reported, as part of a plan to mitigate the adverse financial effects of changes in tax law, in 1997 unitholders authorized the General Partner to decide not to make new aircraft investments, to sell aircraft when attractive opportunities arise, to distribute the proceeds and to liquidate the Partnership when all assets are sold. The General Partner will consider whether it is in the best interest of unitholders to cease making new aircraft investments as opportunities arise, in light of market conditions and the Partnership's competitive position. Based on its investment experience and its knowledge of the market, the General Partner believes that attractive investment opportunities like those made by the Partnership in the past probably will not be available. In the event that aircraft are sold and appropriate alternative investments are not available, the Partnership would distribute sale proceeds to unitholders (after repaying debt and establishing appropriate reserves), and this would result in a further reduction of the Partnership's portfolio. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales." AIRCRAFT PORTFOLIO The Partnership's aircraft portfolio consists of narrow-body (single-aisle) twin and tri-jet commercial aircraft which were acquired as used aircraft. Although the Partnership is permitted to do so, the Partnership does not own interests in aircraft which were acquired as new aircraft; nor does the Partnership own any wide-body aircraft, such as the Boeing 747 and MD-11, or any turboprop or prop-fan powered aircraft. 4 5 The following table describes the Partnership's aircraft portfolio at December 31, 1997:
Number & Current Purchase type; year of Ownership Acquired by lease price (in Type of Noise Lessee Delivery Interest Partnership expiration millions) lease compliance(1) - ------ ------------- -------- ----------- ---------- --------- ----- ------------- USAirways 5 MD-82 100% 1986 2001(3) $91.0 Direct Stage III 1981 (2) finance FedEx 1 727-200FH 100% 1987 2006 $18.5(4) Direct Stage III 1979 finance TWA 1 MD-82 100%(5) 1988(5) 2002 $15.8(5) Direct Stage III 1984 finance
(1) See "Government Regulations-Aircraft Noise" below, for a description of laws and regulations governing aircraft noise. (2) The investment tax credits and the accelerated depreciation originally available upon delivery of the aircraft on lease to USAirways, Inc. (formerly USAir, Inc.) ("USAirways") were sold in 1981 pursuant to a tax benefit transfer lease, which terminated November, 1991. See Note 10 of Notes to Financial Statements. (3) US Airways has exercised its option to renew the lease (at the end of the initial twelve year term ending in 1998) for an additional three years at the current quarterly rental. See Note 2 of Notes to Financial Statements. (4) The purchase price includes $6.9 million of conversion costs for the upgrade of the aircraft from a Stage II passenger aircraft to a Stage III freighter. (5) The Partnership originally acquired a 50% interest in this aircraft in 1988 for a purchase price of $10.1 million. On January 31, 1997 the Partnership purchased the remaining 50% interest from USL Capital for a purchase price of $5.7 million. At December 31, 1997, the book value of aircraft by lessee as a percent of total assets was as follows: US Airways, 71.1%; FedEx, 12.7%; and TWA, 14.7%. Revenues by lessee as a percentage of total revenue for 1997 and 1996, respectively, were as follows: US Airways, 73.5% and 57.1%; TWA, 15.2% and 5.3%; FedEx, 5.3% and 4.1%. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" for a further discussion of the Partnership's lessees. 5 6 The Partnership's lessees have the following fair market value renewal options: US Airways has the right to renew its lease as to any of the aircraft for up to three additional renewal terms of one year each at a fair market value rental, provided that the number of aircraft to be returned at the end of any renewal term may not be less than two; Fedex has the right to renew its lease for one six-month term at the current rent payable under the lease, and thereafter for four successive one year terms at a fair market value rental; and TWA has the right to renew its lease for one term of one, two, three or four years at fair market value rentals. COMPETITIVE POSITION OF THE PARTNERSHIP The aircraft leasing industry has become increasingly competitive. In making aircraft investments, leasing aircraft to lessees, and seeking purchasers of aircraft, the Partnership competes with large leasing companies, aircraft manufacturers, airlines and other operators, equipment managers, financial institutions and other parties engaged in leasing, managing, marketing or remarketing aircraft. Affiliates of the General Partner are engaged in many of these businesses and may be deemed to be in competition with the Partnership. There are many large leasing companies which have the financial strength to borrow at very low rates and to obtain significant discounts when purchasing large quantities of aircraft. The lower capital and acquisition costs enjoyed by these large leasing companies permit them to offer airlines lower lease rates than smaller leasing companies can offer. The Partnership does not have the resources to purchase newer aircraft or to purchase aircraft at volume discounts and has only a limited ability to use tax deferrals in its pricing. As previously reported to Unitholders, the Partnership's access to capital is limited. Since all Cash Available from Operations, as defined in the Limited Partnership Agreement, is distributed, there is no build up of equity capital, and acquisitions must be funded from proceeds available when aircraft are sold or from debt. Access to debt is limited because the Partnership's aircraft are being used to collateralize existing borrowings. In general, the Partnership's pricing is uncompetitive for new acquisitions because of its limited sources and high cost of capital. Because of these factors, finding new aircraft investments like those made by the Partnership in the past and that offer an appropriate balance of risk and reward has been difficult. During the past six years the Partnership has made only two aircraft investments, both of which were possible because of special circumstances. In 1996 and 1997, the Partnership sold interests in eight aircraft (a 50% interest in an aircraft on lease to Finnair, a one-third interest in six aircraft on lease to Continental, and a 50% interest in one aircraft leased to Sun Jet International, Inc.) at a profit. See "Disposition of Aircraft" below. However because of the factors described above, the Partnership was unable to reinvest the proceeds in aircraft at an acceptable return, and the General Partner determined that the best use of the net proceeds was to distribute them to Unitholders. These sales and distributions have reduced the size of the Partnership's portfolio. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales." 6 7 EXISTING PARTICIPANTS IN LEASES USL Capital originally participated equally with the Partnership in all aircraft now owned by the Partnership except the aircraft on lease to US Airways (the "US Airways Aircraft"). In April 1993 the Partnership leased two aircraft (held jointly with USL Capital), which were previously off lease, to FedEx. In September 1993 the Partnership exchanged its 50% interest in the two aircraft for a 100% interest in one aircraft and pledged the aircraft and the lease as collateral to obtain funds to upgrade the aircraft from a Stage II passenger aircraft to a Stage III freighter. In January 1997, the Partnership purchased a 50% interest in the TWA Aircraft formerly owned by USL Capital, and now owns a 100% interest in this aircraft. The Sun Jet Aircraft was jointly owned by BALCAP (which purchased USL Capital's interest in this aircraft in 1996) and the Partnership until it was sold on September 29, 1997. DESCRIPTION OF LEASES All aircraft now owned by the Partnership are leased to third parties pursuant to full-payout leases (direct finance). The Partnership owned one aircraft leased to a third party under an operating lease until September 1997 when the aircraft was sold. Generally, operating leases are for a shorter term than full-payout leases and, therefore, it is necessary to remarket the aircraft in order to recover the full investment. Full-payout leases are generally for a longer term and hence provide more predictable revenue than do operating leases. All of the Partnership's leases are net leases, which provide that the lessee will bear the direct operating costs and the risk of physical loss of the aircraft; pay sales, use or other similar taxes relating to the lease or use of the aircraft; maintain the aircraft; indemnify the Partnership-lessor against any liability suffered by the Partnership as the result of any act or omission of the lessee or its agents; maintain casualty insurance in an amount equal to the specific amount set forth in the lease (which may be less than the market value of the aircraft); and maintain liability insurance naming the Partnership as an additional insured with a minimum coverage which the General Partner deems appropriate. In general, substantially all obligations connected with the ownership and operation of the leased aircraft are assumed by the lessee and minimal obligations are imposed upon the Partnership. Default by a lessee may cause the Partnership to incur unanticipated expenses. See "Government Regulation" below. Certain provisions of the Partnership's leases may not be enforceable upon a default by a lessee or in the event of a lessee's bankruptcy. The enforceability of leases will be subject to limitations imposed by Federal, California, or other applicable state law and equitable principles. In order to encourage equipment financing to certain transportation industries, Federal bankruptcy laws traditionally have afforded special treatment to certain lenders or lessors who have provided such financing. Section 1110 ("Section 1110") of the United States Bankruptcy 7 8 Code, as amended (the "Bankruptcy Code"), implements this policy by creating a category of aircraft lenders and lessors whose rights to repossession are substantially improved. If a transaction complies with Section 1110, the transaction is not affected by the automatic stay provisions of the Bankruptcy Code (and thus, the lender or lessor may repossess the equipment), unless within 60 days after commencement of a bankruptcy proceeding the trustee agrees to perform all obligations of the debtor under the agreement or lease and all defaults (except those relating to insolvency or insolvency proceedings) are cured within such 60-day period. One court has recently held that section 1110 does not apply after the 60-day period, and thus the automatic stay may apply after such 60-day period. On October 22, 1994, President Clinton signed into law the Bankruptcy Reform Act of 1994 (the "Reform Act"). The Reform Act made several changes to Section 1110, such that it now protects all transactions involving qualifying equipment, whether the transaction is a lease, conditional sale, purchase money financing or customary refinancing. For equipment first placed in service on or prior to the date of enactment, the requirement that the lender provide purchase money financing continues to apply, but there is a "safe harbor" definition for leases, so that Section 1110 benefits will be available to the lessor without regard to whether or not the lease is ultimately determined to be a "true" lease. This safe harbor is not the exclusive test so that other leases which do not qualify under the safe harbor, but which are true leases, will continue to be covered as leases by Section 1110. The Partnership may not be entitled to the benefits of Section 1110 upon insolvency of a lessee airline under all of its leases. In the past, the Partnership had interests in aircraft leased to operators based outside the United States. It is possible that the Partnership's aircraft could be leased or subleased to foreign airlines. Aircraft on lease to such foreign operators are not registered in the United States and it is not possible to file liens on such foreign aircraft with the Federal Aviation Administration (the "FAA"). Further, in the event of a lessee default or bankruptcy, repossession and claims would be subject to laws other than those of the United States. AIRCRAFT REMARKETING On termination of a lease and return of the aircraft to the Partnership, the Partnership must remarket the aircraft to realize its full investment. Under the Amended and Restated Agreement of Limited Partnership, as amended, the Partnership ("Limited Partnership Agreement"), the remarketing of aircraft may be through a lease or sale. The terms and conditions of any such lease would be determined at the time of the re-lease, and it is possible (although not anticipated at this time) that the lease may not be a net lease. The General Partner will evaluate the risks associated with leases which are not net leases prior to entering into any such lease. The General Partner has not established any standards for lessees to which it will lease aircraft and, as a result, there is no investment restriction prohibiting the Partnership from doing business with any lessee, including "start-up" airlines. However, the General Partner will analyze the credit of a potential lessee and evaluate the aircraft's potential value prior to entering into any lease. 8 9 DISPOSITION OF AIRCRAFT The Partnership's original intent was to dispose of all its aircraft by the year 2011, subject to prevailing market conditions and other factors. However, in 1997 unitholders authorized the General Partner not to make new investments, to sell aircraft when attractive opportunities arise, to distribute the proceeds and to liquidate the Partnership when all assets are sold. See "Principal Investment Objectives" above; and "MANAGEMENT DISCUSSION OF ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales." Under the Limited Partnership Agreement, aircraft may be sold at any time whether or not the aircraft are subject to leases if, in the judgment of the General Partner, it is in the best interest of the Partnership to do so. In March 1996, the Partnership sold its 50% interest in one MD-82 on lease to Finnair to a third party for approximately $6.9 million, resulting in a net gain of approximately $556,000. The Partnership had acquired its interest in this aircraft in April 1992, for approximately $8.5 million. A portion of the sale proceeds were used to pay off the outstanding balance under a non-recourse loan which was collateralized by this aircraft and the balance, after retaining a reserve for liquidity purposes, was distributed to Unitholders. See "Competitive Position of the Partnership" above. The Partnership sold its one-third interest in six 737-200 aircraft on lease to Continental at lease expiration on December 31, 1996, at a sale price of approximately $3.1 million, resulting in a net gain of approximately $1.9 million. The proceeds were distributed to Unitholders in the first quarter of 1997. See "Competitive Position of the Partnership" above. On September 29, 1997 the Partnership sold its one-half ownership interest in a DC9-51 aircraft on lease to Sun Jet International, Inc. The sale price was $1.2 million, resulting in a gain of $393,000 even though the lessee had filed for bankruptcy in June 1997, and had ceased making the rent payments. The proceeds were distributed to Unitholders in the fourth quarter of 1997. See "Competitive Position of the Partnership" above. The Partnership is permitted to sell aircraft to affiliates of the General Partner at the fair market value of the aircraft at the time of sale as established by an independent appraisal. The General Partner will receive a Disposition or Remarketing Fee for any such sale. JOINT VENTURES/GENERAL ARRANGEMENTS Under the Limited Partnership Agreement, the Partnership may enter into joint ventures with third parties to acquire or own aircraft. No such joint ventures presently exist. Generally, each party to a joint venture is jointly responsible for all debts and obligations incurred by the joint venture, and the joint venture will be treated as a single entity by third parties. The 9 10 Partnership may become liable to third parties for obligations of the joint venture in excess of those contemplated by the terms of the joint venture agreement. There can be no assurance that the Partnership will be able to obtain control in any joint ventures, or that, even with such control the Partnership will not be adversely affected by the decisions and actions of the co-venturers. The General Partner attempts to ensure that all such agreements will be fair and reasonable to the Partnership, although joint ventures with affiliates of the General Partner may involve potential conflicts of interest. BORROWING POLICIES Under the Limited Partnership Agreement, the Partnership may borrow funds or assume financing in an aggregate amount equal to less than 50% of the higher of the cost or fair market value at the time of the borrowing of all aircraft owned by the Partnership. The Partnership may exceed such 50% limit for short-term borrowing so long as the General Partner uses its best efforts to comply with such 50% limit within 120 days from the date such indebtedness is incurred or if the borrowed funds are necessary to prevent foreclosure on any Partnership asset. There is no limitation on the amount of such short-term indebtedness. The General Partner is authorized to borrow for working capital purposes and to make distributions. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Liquidity and Capital Resources" and Note 5 of Notes to Financial Statements. MANAGEMENT OF AIRCRAFT PORTFOLIO Aircraft management services are provided by the General Partner and its affiliates. The fees and expenses for these services are reviewed annually and are subject to approval by the Audit Committee of the Partnership. See Note 8 of Notes to Financial Statements. REGISTRATION OF AIRCRAFT; UNITED STATES PERSON Under the Federal Aviation Act, as amended (the "FAA Act"), the operation of an aircraft not registered with the Federal Aviation Administration (the "FAA") in the United States is generally unlawful. Subject to certain limited exceptions, an aircraft may not be registered under the FAA Act unless it is owned by a "citizen of the United States" or a "resident alien" of the United States. In order to attempt to ensure compliance with the citizenship requirements of the FAA Act, the Limited Partnership Agreement requires that all Unitholders (and all transferees of Units) be United States citizens or resident aliens within the meaning of the FAA Act. 10 11 GOVERNMENT REGULATION GENERAL The ownership and operation of aircraft in the United States are strictly regulated by the FAA, which imposes certain minimum restrictions and economic burdens upon the use, maintenance and ownership of aircraft. The FAA Act and FAA regulations contain strict provisions governing various aspects of aircraft ownership and operation, including aircraft inspection and certification, maintenance, equipment requirements, general operating and flight rules, noise levels, certification of personnel and record keeping in connection with aircraft maintenance. FAA policy has given high priority to aviation safety, and a primary objective of FAA regulations is that an aircraft be maintained properly during its service life. FAA regulations establish standards for repairs, periodic overhauls and alterations and require that the owner or operator of an aircraft establish an airworthiness inspection program to be carried out by certified mechanics qualified to perform aircraft repairs. Each aircraft in operation is required to have a Standard Airworthiness Certificate issued by the FAA. MAINTENANCE The Partnership, as the beneficial owner of aircraft, bears the ultimate responsibility for compliance with certain federal regulations. However, under all of the Partnership's aircraft leases, the lessee has the primary obligation to ensure that at all times the use, operation, maintenance and repair of the aircraft are in compliance with all applicable governmental rules and regulations and that the Partnership/lessor is indemnified from loss by the lessee for breach of any of these lessee responsibilities. Changes in government regulations after the Partnership's acquisition of aircraft may increase the cost to, and other burdens on, the Partnership of complying with such regulations. The General Partner monitors the physical condition of the Partnership's aircraft and periodically inspects them to attempt to ensure that the lessees comply with their maintenance and repair obligations under their respective leases. Maintenance is further regulated by the FAA which also monitors compliance. At lease termination, the lessees are required to return the aircraft in airworthy condition. The Partnership may incur unanticipated maintenance expenses if a lessee were to default under a lease and the Partnership were to take possession of the leased aircraft without such maintenance having been completed. If the lessee defaulting is in bankruptcy, the General Partner will file a proof of claim for the required maintenance expenses in the lessee's bankruptcy proceedings and attempt to negotiate payment and reimbursement of a portion of these expenses. The bankruptcy of a lessee could adversely impact the Partnership's ability to recover maintenance expense. From time to time, aircraft manufacturers issue service bulletins and the FAA issues airworthiness directives. These bulletins and directives provide instructions to aircraft operators in the maintenance of aircraft and are intended to prevent the occurrence of accidents arising 11 12 from flaws discovered during maintenance or as the result of aircraft incidents. Compliance with airworthiness directives is mandatory. A formal program to control corrosion in all aircraft is included in the FAA mandatory requirements for maintenance for each type of aircraft. These FAA rules and proposed rules evidence the current approach to aircraft maintenance developed by the manufacturers and supported by the FAA in conjunction with an aircraft industry group. The Partnership may be required to pay for these FAA requirements if a lessee defaults or if necessary to re-lease or sell the aircraft. Trade publications have reported that the FAA is considering issuing an airworthiness directive to remedy potential unsafe conditions in 727 aircraft which were converted from passenger to freight configuration. It has also been reported that the FAA may issue weight restrictions on such aircraft as an interim measure and may require extensive structural changes for the long term. As of February 1, 1998, no such airworthiness directives had been issued. Any such airworthiness directives would apply to the aircraft on lease to FedEx. Under the lease covering this aircraft, FedEx would be required to take the steps necessary to comply with airworthiness directives imposed during the lease term. However, airworthiness directives may affect the residual value of the aircraft or FedEx's decision to exercise fair market value renewal options under the lease. AIRCRAFT NOISE The FAA, through regulations, has categorized certain aircraft types as Stage I, Stage II and Stage III according to the noise level as measured at three designated points. Stage I aircraft create the highest measured noise levels. Aircraft which exceed Stage I noise maximums are no longer allowed to operate from civil airports in the United States. In general, the Aviation Safety and Capacity Act of 1990 bans the operation of Stage II aircraft after December 31, 1999 for aircraft operated within the continental United States. The Act also allows United States airports to impose their own Stage II noise bans before the formal cut-off date, provided that an analysis of the costs and benefits of the restriction is presented and 180 days are allowed for public comment. The Act affects about 2,500 Stage II aircraft operated by United States airlines. Alternatives for operators of Stage II aircraft include hushkitting, re-engining and movement to jurisdictions without mandated noise compliance. Hushkit options are expected to become more plentiful. However, even when certified, there will still be considerable lag time before each program can be brought to maximum production efficiency. See "Aircraft Portfolio" above, for a description of the Partnership's aircraft portfolio. At December 31, 1997, all of the aircraft in the Partnership's portfolio were Stage III aircraft 12 13 ACQUISITION OF ADDITIONAL AIRCRAFT During the past six years the Partnership has made only two aircraft investments. In 1997 unitholders authorized the General Partner to decide not to make new aircraft investments, to sell aircraft when attractive opportunities arise, to distribute the proceeds and to liquidate the Partnership when all assets are sold. See "Principal Investment Objectives" above; and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales." If the Partnership were to acquire additional aircraft, it could do so in many different forms, such as in sale/leaseback transactions, by purchasing interests in existing leases from other lessors, by making loans secured by aircraft or by acquiring or financing leasehold interests in aircraft. The Partnership is permitted to acquire aircraft from affiliates of the General Partner subject to limitations set forth in the Limited Partnership Agreement. Prior to September 30, 1991, the General Partner and USL Capital were required to offer the Partnership a 50% participation interest in certain aircraft leasing investments made by Related Entities, as defined in the Limited Partnership Agreement. After September 30, 1991 and while the General Partner was an affiliate of USL Capital, the General Partner and USL Capital could, but were not obligated to, offer investment opportunities to the Partnership. The Partnership was required to accept suitable opportunities provided that the General Partner and Related Entities made at least 20% (including their investment through ownership of Units and the General Partner's interest) of the total investment made by Related Entities and the Partnership in such transactions. In the event that the Partnership elected not to make or to make only a portion of an investment offered to it by an affiliate, the remaining investment could be made by affiliates of the General Partner or third parties. The General Partner believes that since it is no longer affiliated with USL Capital, the limitation as to making investments with Related Entities should no longer apply and that the Partnership should be able to invest in any aircraft leasing transactions deemed suitable by the General Partner. In determining whether an investment is suitable for the Partnership, the General Partner will consider the following factors: the expected cash flow from the investment and whether existing Unitholders' investment will be diluted; the existing portfolio of the Partnership and the effect of the investment on the diversification of the Partnership's assets; the amount of funds available to finance the investment; the ability of the Partnership to obtain additional funds through debt financing, by issuing Units, or otherwise; the cost of such additional funds and the time needed to obtain such funds; the amount of time available to remove contingencies prior to making the investment; projected Federal income tax effect of the investment; projected residual value, if any; any legal or regulatory restrictions; and other factors deemed relevant by the General Partner. The General Partner and its affiliates are not obligated to make any investment opportunity available to the Partnership, and if any of them are presented with a potential 13 14 investment opportunity, it may be made by any of them without being offered to the Partnership. In addition, in determining which entity should invest in a particular transaction, it may be possible to structure the transaction in various ways to make the acquisition more or less suitable for the Partnership or for the General Partner or its affiliates. FEDERAL INCOME TAXATION The Partnership is considered a publicly traded Partnership ("PTP") under the Revenue Act of 1987 with a special tax status, whereby it has not been subject to federal income taxation. This special tax status was scheduled to expire at the beginning of 1998. However, during 1997 federal and California tax laws were amended to provide that publicly traded Partnerships may elect to continue to be publicly traded and retain their Partnership tax status if they pay a federal tax of 3.5% and state tax of 1% on their annual gross income beginning in January 1998. The Partnership has made an election to pay this tax beginning in 1998. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales." ITEM 2. PROPERTIES The Partnership does not own any real property, and shares office space in the offices of BALCAP and its affiliates. ITEM 3. LEGAL PROCEEDINGS None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 14 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS UNITS OUTSTANDING The Units are traded on the New York Stock Exchange under the symbol FLY. As of February 5, 1998, there were 1,134 holders of record of Units. MARKET PRICE The following chart sets forth the high and low closing prices on the New York Stock Exchange and the trading volume for each of the quarters in the years ended December 31, 1996 and 1997.
Trading Volume Quarter Ended (in thousands) Unit Prices (high-low) - ------------- -------------- ---------------------- March 31, 1996 257 $18 7/8 - $17 June 30, 1996 557 $18 1/4 - $15 September 30, 1996 461 $16 3/4 - $13 1/4 December 31, 1996 298 $16 3/8 - $14 5/8 March 31, 1997 1,104 $17 5/8 - $10 June 30, 1997 757 $12 1/2 - $10 1/4 September 30, 1997 993 $12 1/16 - $9 15/16 December 31, 1997 855 $13 11/16 - $11 1/4
DISTRIBUTIONS TO UNITHOLDERS CASH DISTRIBUTIONS The Partnership makes quarterly cash distributions to Unitholders which are based on Cash Available from Operations (as defined in the Limited Partnership Agreement) and are partially tax sheltered. Information on the tax status of such payments, which is necessary in the preparation of individual tax returns, is prepared and mailed to Unitholders as quickly as practical after the close of each year. The size of the Partnership's portfolio and future aircraft sales will affect distributions. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" -- Tax Position; Future Aircraft 15 16 Purchases/Sales." Distributions declared during 1996, 1997 were as follows:
Record Date Payment Date Per Unit ----------- ------------ -------- March 29, 1996 May 15, 1996 50 cents May 20, 1996 May 31, 1996 80 cents(1) June 28, 1996 August 15, 1996 45 cents September 30, 1996 November 15, 1996 45 cents December 31, 1996 February 14, 1997 45 cents January 15, 1997 January 31, 1997 63 cents(1) March 31, 1997 May 15, 1997 45 cents June 30, 1997 August 15, 1997 45 cents September 30, 1997 November 14, 1997 45 cents October 20, 1997 November 4, 1997 22 cents(1) December 31, 1997 February 13, 1998 45 cents
(1) Special cash distribution from sale proceeds. CASH AVAILABLE FROM OPERATIONS The Partnership distributes all Cash Available from Operations (as defined in the Limited Partnership Agreement). The Partnership is authorized to make distributions from any source, including reserves and borrowed funds. Distributions of Cash Available from Operations are allocated 99% to Unitholders and 1% to the General Partner. The Partnership makes distributions of Cash Available from Operations generally on the fifteenth day of each February, May, August and November to Unitholders of record on the last business day of the calendar quarter preceding payment. 16 17 CASH AVAILABLE FROM SALE OR REFINANCING The Partnership's original intent was that Cash Available From Sale or Refinancing (as defined in the Limited Partnership Agreement) received prior to January 1, 2005 would be retained for use in the Partnership's business, provided that if the General Partner did not believe that attractive investment opportunities exist for the Partnership, the Partnership could distribute Cash Available from Sale or Refinancing. Any Cash Available from Sale or Refinancing received after January 1, 2005 was not to be reinvested but was to be distributed. However, in 1997, unitholders authorized the General Partner to decide not to make new aircraft investments, to sell aircraft when attractive opportunities arise, to distribute the proceeds and to liquidate the Partnership when all assets are sold. See "BUSINESS -- Principal Investment Objectives" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -- Tax Position; Future Aircraft Purchases/Sales". For information as to the sales giving rise to distributions from Cash Available from Sales or Refinancing, see "BUSINESS -- Disposition of Aircraft." TAX ALLOCATIONS Allocations for tax purposes of income, gain, loss deduction, credit and tax preference are made on a monthly basis to Unitholders who owned Units on the first day of each month. Thus, for example, if an aircraft were sold at a gain, that gain would be allocated to Unitholders who owned Units on the first day of the month in which the sale occurred. If proceeds from this sale were distributed to Unitholders, such proceeds would be distributed to Unitholders who owned Units on the record date for such distribution, which, because of notice requirements, likely would not occur in the same month as the sale. In addition, a Unitholder who transfers his or her Units after the commencement of a quarter but prior to the record date for that quarter will be allocated a share of tax items for the first two months of that quarter without any corresponding distribution of Cash Available from Operations for, among other things, payment of any resulting tax. 17 18 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data and other data concerning the Partnership for each of the last five years:
For years ended December 31, (In thousands except per-unit amounts) 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------- OPERATING RESULTS Lease and other income $ 9,210 $ 10,747 $ 12,492 $ 12,538 $ 12,852 Gain on disposition of aircraft 393 2,501 21 -- -- -------------------------------------------------------- Total Revenues 9,603 13,248 12,513 12,538 12,852 -------------------------------------------------------- Interest Expense 2,028 1,830 2,366 2,660 2,557 Depreciation expense 273 1,500 2,129 2,146 2,426 Other expenses 1,820 1,266 1,196 1,401 1,786 -------------------------------------------------------- Total Expenses 4,121 4,596 5,691 6,207 6,769 -------------------------------------------------------- Net income $ 5,482 $ 8,652 $ 6,822 $ 6,331 $ 6,083 -------------------------------------------------------- Net income per unit(1) $ 1.17 $ 1.85 $ 1.46 $ 1.36 $ 1.30 Cash distributions declared per unit(2) $ 2.02 $ 3.28 $ 2.07 $ 1.85 $ 1.69 FINANCIAL POSITION Total Assets $ 82,859 $ 85,130 $103,021 $107,542 $113,967 Long-term obligations $ 19,115 $ 14,071 $ 27,483 $ 29,525 $ 27,940 Total partners' equity $ 61,089 $ 65,042 $ 71,712 $ 74,562 $ 76,874 Limited Partners' equity per unit(1) $ 13.08 $ 13.92 $ 15.35 $ 15.96 $ 16.46
(1) After allocation of the 1% General Partner's interest. (2) Includes special cash distributions of 10 cents per unit in 1995, $1.43 per unit in 1996, of which 63 cents was paid in January 1997 and 22 cents per unit in 1997. 18 19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS LIQUIDITY AND CAPITAL RESOURCES At December 31, 1997, long-term borrowings of $19.1 million represented 16% of the original cost of the aircraft presently owned by the Partnership and 23% of total assets. This debt is outstanding under four long-term, non-recourse debt facilities collateralized by certain aircraft, three of which are at fixed rates and one which is at a floating rate. The adjustable rate loan agreement is due to expire in 1998. The Partnership has entered into an interest rate swap agreement, which limits its risk on the floating rate debt. At December 31, 1997 and 1996, $19.1 million and $14.1 million, respectively, were outstanding under these four facilities. At December 31, 1997, approximately $2.1 million remained available. See Note 5 to Financial Statements. In February 1998, the Partnership obtained a $7.5 million three year, floating rate, revolving loan facility. The loan is collateralized by one aircraft on lease to USAirways. The Partnership intends to use this loan facility for working capital. Total scheduled debt service on the fixed rate loans in 1998 is $6.4 million, and the principal payment on the floating rate loan in 1998 is $1.7 million (the amount outstanding at December 31, 1997). Debt service will be paid primarily from the rental payments received under its aircraft leases. Net cash provided by operating activities was $9.3 million for 1995, $7.3 million for 1996, and $5.1 million for 1997. The decrease in net cash provided from operating activities in 1997 as compared to 1996, is primarily due to reduced rental payments, as a result of the sale of six aircraft in December 1996 and to higher 1997 investor reporting expenses. The decrease in net cash provided from operating activities in 1996 as compared to 1995 is primarily due to reduced rental payments, as a result of the sale of one aircraft in March 1996 and to the scheduled decline in finance lease income in 1996, which is recognized in a manner similar to loan income, as the balance due from lessees declined. Total debt service as a percentage of net cash provided by operating activities was 59.3%, 107%, and 152% for 1995, 1996 and 1997, respectively. The higher 1997 ratio as compared with the 1996 ratio is a result of the decrease in the net cash from operations due to a smaller portfolio, while the debt service (principal and interest) remained at about the same level. Two existing loans secured by four aircraft on lease to USAirways provide for full repayment of the debt by 1998 rather than through the end of the lease term in 2001. Upon repayment of this debt in 1998, net cash provided from operating activities should exceed debt service under the remaining borrowings. In 1996 debt service increased by $2.9 million from the prior year due to the timing of debt service payments. Under the loan documents, if December 31 is not a business day (as was the case in 1995), the loan payment was due in January, causing the debt service to be lower in 1995 and higher in 1996. 19 20 Notes receivable of $236,000, which represented advances under the Partnership's agreement to finance certain aircraft modifications for Continental Airlines ("Continental") were disputed by Continental. In 1997, the notes were written off, when the Partnership determined that pursuing the collection legally would not be cost beneficial. Cash distributions paid by the Partnership were $9.5 million ($2.04 per unit) in 1995, $12.6 million ($2.70 per unit) in 1996, and $12.4 million ($2.65 per unit) in 1997. Distributions paid in 1995 included a special cash distribution of 10 cents per unit made from the proceeds received from the casualty of one aircraft. Distributions paid in 1996 included a special cash distribution of 80 cents per unit made from a portion of the sale proceeds received from the sale of a 50% interest in one MD-82 aircraft. Distributions paid in 1997 included two special cash distributions. The first was a distribution of 63 cents per unit made from the proceeds received from the December 31, 1996 sale of the Partnership's interest in six 737-200 aircraft, and the second was a distribution of 22 cents per unit made from the proceeds received from the September 29, 1997 sale of the Partnership's 50% interest of one DC9-51. Partnership net income was $6.8 million in 1995, $8.7 million in 1996, and $5.5 million in 1997. Pursuant to the Limited Partnership Agreement, the Partnership distributed all Cash Available from Operations and also made special cash distributions, as described above. Since such distributions were in excess of earnings, Partnership equity declined from $65.0 million at December 31, 1996 to $61.1 million at December 31, 1997, and limited partner equity per unit declined from $13.92 to $13.08. From a limited partner perspective, the portion of the distribution in excess of net income constitutes a return of capital. Total cash distribution declared since inception of the Partnership have exceeded total net income by $5.77 per unit. RESULTS OF OPERATIONS In 1995, revenues were earned from seven aircraft subject to finance leases (US Airways, TWA, and FedEx). TWA was on non-accrual status early in 1995, but remitted all past-due amounts by the third quarter. TWA was in bankruptcy for a portion of 1995, and the TWA lease contributed 7% of total 1995 revenues. In 1995, revenues were earned from nine aircraft subject to operating leases (Continental, Finnair, and Sun Jet) from January through May, and eight Aircraft for the balance of the year, reflecting the casualty loss of one aircraft leased to Continental. At year-end 1995, all of the Partnership's lessees were current under their lease agreements and none was in bankruptcy. In 1996, revenues were earned from seven aircraft subject to finance leases (US Airways, TWA, and FedEx). Finance lease income declined from 1995 as the balances due declined. Revenues in 1996 were earned from eight aircraft subject to operating leases (Continental, Finnair, and Sun Jet) from January through March, and seven Aircraft for the balance of the year, reflecting the March sale of the aircraft leased to Finnair. The decline in operating lease rentals is due primarily to the sale of this Aircraft. On December 31, 1996, the operating lease with Continental covering six aircraft expired, and the aircraft were sold on that date. At year-end 20 21 1996, all of the Partnership's lessees were current under their lease agreements and none was in bankruptcy. The sales of the Partnership's interests in aircraft on lease to Finnair and Continental produced gains of $556,000 and $1.9 million, respectively. In 1997, revenues were earned from seven aircraft subject to finance leases (US Airways, TWA, and Fedex). Finance lease income increased from 1996 due to the Partnership's purchase in January 1997 of an additional 50% interest in the MD-82 aircraft on lease to TWA. In 1997 revenues were earned from one aircraft subject to operating lease (Sun Jet). Sun Jet filed for bankruptcy in June 1997, and the 22-year old aircraft was sold in September 1997, at a gain of $393,000. As of December 31, 1997, the Partnership no longer owned interests in any aircraft subject to operating lease treatment. See Note 3 of Notes to Financial Statements. At year-end 1997, all of the Partnership's lessees were current under their lease agreements and none was in bankruptcy. US Airways, the Partnership's major lessee (71.1% of total year-end assets) reported profits of $1.0 billion on revenues of $8.5 billion for 1997, compared with profits of $263 million on revenues of $8.1 billion for 1996. In December 1997, US Airways gave notice electing to extend its lease at the same rental rate until September 2001. FedEx (12.7% of total year-end assets) reported profits of $361 million on revenues of $11.5 billion for 1997 (fiscal year ended May 31, 1997), compared with profits of $308 million on revenues of $10.3 billion for 1996. TWA (14.7% of total year-end assets), reported a net loss of $127 million on revenues of $3.3 billion for 1997, compared with a net loss of $285 million on revenues of $3.6 billion for 1996. For information regarding the percentage of total Partnership assets and revenues represented by aircraft owned and leased by the Partnership, see "Aircraft Portfolio." The Partnership believes that its revenues and income have not been materially affected by inflation and changing prices because its principal items of revenue (rental payments) and expenses (interest) are at fixed long-term rates. Interest expense in 1997 reflects an average interest rate of 9.3%, based on average total outstanding debt of $21.9 million, compared to the average interest rate for 1996 of 8.7%, based on average total outstanding debt of $21 million. Depreciation expense relates to aircraft subject to operating leases and those held for sale or lease. In 1997 depreciation expense decreased by $1.2 million from 1996 due to sales of aircraft subject to operating leases in March 1996, December 1996 and September 1997, as described above. The 1997 investor reporting expenses increased from 1996 by $517,000, primarily due to 21 22 expenses incurred in connection with the solicitation of unitholder consents. In March 1995, the Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which is effective for fiscal years beginning after December 15, 1995. The Partnership adopted the standard January 1, 1996, and the impact on the financial statements was not material. In 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share," and SFAS No. 129, "Disclosure of Information About Capital Structure," which are effective for fiscal years ending after December 15, 1997. SFAS No. 128 establishes standards for computing and presenting earnings per share. The adoption of SFAS No. 128 did not have a material effect on the net income per unit. SFAS No. 129 requires disclosure of the types of securities outstanding and certain rights which these securities have. The adoption of SFAS No. 129 did not require any additional disclosures by the Partnership. In 1997, the Financial Accounting Standards Board also issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" which is effective for years beginning after December 15, 1997. SFAS No. 130 requires reporting comprehensive income in addition to net income when certain revenues, expenses, gains and losses are recorded as a separate component of equity rather than included in net income. The adoption of SFAS No. 130 will not require any change in the format of the financial statements for the Partnership because the Partnership's comprehensive income and net income are the same. SFAS No. 131 requires segment information to be provided using a management reporting approach rather than an industry segment approach. The adoption of SFAS No. 131 will not require the Partnership to provide any additional segment information. TAX POSITION; FUTURE AIRCRAFT SALES/PURCHASES In 1997 the General Partner announced a proposal to mitigate the adverse financial impact of changes in tax law which would have affected the Partnership in 1998. The proposal authorized the General Partner to restrict transferability of units, but provided that the General Partner could take other actions which are in the best interests of the unitholders in the event of a change in tax law. The proposal also authorized the General Partner to decide not to make new aircraft investments, to sell aircraft when attractive opportunities arise, to distribute the proceeds and to liquidate the Partnership when all assets are sold. The proposal was approved by unitholders in August 1997. In August and October 1997 federal and California tax laws, respectively, were amended to provide that publicly traded Partnerships could elect to continue to be publicly traded and retain their Partnership tax status if they pay a federal tax of 3.5% and state tax of 1% on their annual gross income beginning in January 1998. 22 23 After consideration of a number of factors, including the recent tax law changes and the benefits of liquidity, the board of directors of the General Partner unanimously concluded that it is in the best interest of the unitholders for the Partnership to remain a publicly traded Partnership at this time. Accordingly, in January 1998 the Partnership made an election to pay an annual tax at the Partnership level of 4.5% on its gross income beginning in 1998 which would reduce the Partnership's cash flow. As previously reported to unitholders, the General Partner will consider whether it is in the best interest of the Limited Partners to cease making new aircraft investments as opportunities arise, in light of market conditions and the Partnership's competitive position. Based on its investment experience and its knowledge of the market, the General Partner believes that attractive investment opportunities like those made by the Partnership in the past probably will not be available. In the event that aircraft are sold and appropriate alternative investments are not available, the Partnership would distribute sales proceeds to unitholders (after repaying debt and establishing appropriate reserves), and this would result in a further reduction of the Partnership's portfolio. 23 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA The financial statements and Notes to Financial Statements described in Item 14(a) are set forth in Appendix A and are filed as part of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT GENERAL The Partnership has no directors or executive officers. Under the Limited Partnership Agreement, the General Partner has full power and authority in the management and control of the business of the Partnership, subject to certain provisions requiring the consent of the Limited Partners. DIRECTORS AND EXECUTIVE OFFICERS Set forth below is certain information about the directors and executive officers of the General Partner as of March 20, 1998.
POSITION WITH PRINCIPAL OCCUPATION AND NAME GENERAL PARTNER AGE EMPLOYMENT FOR LAST 5 YEARS - --------------------- --------------------- --- ------------------------------------------------------ David B. Gebler Chairman of the 48 Mr. Gebler is Senior Vice President of Bank of America Board, President, National Trust and Savings Association ("Bank of Chief Executive America") and of BALCAP. He has been with BALCAP Officer and a since September 1996. From 1991 to September 1996 he Director was Senior Vice President of the Transportation and Industrial Financing business unit of USL Capital. Mr. Gebler has been President of the General Partner since 1989 and a Director since 1990. Mr. Gebler holds a bachelors degree in mathematics from Clarkson University and graduate degrees in Engineering and Management from the University of Michigan. Richard V. Harris Director 49 Mr. Harris is Executive Vice President of Bank of America and Chairman and President of BALCAP. He was elected President and CEO in 1982, adding the title of Chairman in 1988. He has been a Director of the General Partner since October 1996. Other assignments at Bank of America have included responsibilities for Project Finance and Asset-Backed Finance along with Leasing. Prior to assuming his present responsibilities, Mr. Harris held both transactional and marketing management positions at BankAmerica Leasing. Mr. Harris holds a B.S.E.E. degree in Electrical Engineering from Brigham Young University and a Master of Business Administration degree also from BYU.
24 25
POSITION WITH PRINCIPAL OCCUPATION AND NAME GENERAL PARTNER AGE EMPLOYMENT FOR LAST 5 YEARS - --------------------- --------------------- --- ------------------------------------------------------ William A. Hasler Director 56 Mr. Hasler has been the dean of the Haas School of Business at the University of California at Berkeley since August 1991 and a Director of the General Partner since 1995. From 1984 to 1991, he was vice chairman and director of KPMG Peat Marwick and was responsible for its worldwide consulting business. He is a member of the board of governors of The Pacific Stock Exchange and of the board of directors of The Gap, TCSI, Tenera, Walker Industries, and Aphton Corporation. He serves on a presidential advisory board on critical technologies. He is a 1963 graduate of Pomona College and earned his MBA from Harvard in 1967. Richard P. Powers Director 57 Mr. Powers has been Vice President, Finance and Administration and Chief Financial Officer of CardioGenesis Corporation, a medical device company, since 1996. From 1981 to 1994, he was with Syntex Corporation, a pharmaceutical company, serving as Senior Vice President and Chief Financial Officer of that company from 1986 to 1994. From 1994 to 1996 he served as consultant to various companies, including advising and assisting in the sale of Syntex Corporation to Roche Corporation in 1994. Mr. Powers holds a Bachelor of Science degree in Accounting from Canisius College and a Masters in Business Administration from the University of Rochester. K. Thomas Rose Director 53 Mr. Rose has been Executive Vice President and Chief Operating Officer of BALCAP since 1992, responsible for all non-marketing areas of BALCAP. He also is the chief credit officer for the subsidiaries of BankAmerica Corporation which comprise the leasing group. He has been a Director of the General Partner since October 1996. Prior to his present responsibilities, Mr. Rose was with Security Pacific Leasing Corporation as Executive Vice President - Lease Services since 1973. Mr. Rose holds a B.A. from California State University, Fullerton and a Juris Doctorate degree from Golden Gate University, School of Law. Richard C. Walter Chief Financial 52 Mr. Walter has been Senior Vice President and Officer and a Controller of BALCAP since 1992. He has been a Director director of the General Partner since October 1996. Prior to assuming his present responsibilities at BALCAP, Mr. Walter was with Security Pacific Leasing corporation as Senior Vice President, Financial Adminisrtration since 1973. He holds a Bachelor of Science degree in Business Administration and Accounting from Montana State University.
25 26 ITEM 11. EXECUTIVE COMPENSATION The Partnership does not pay or employ directly any directors or officers. Each of the officers of the General Partner is also an officer or employee of BALCAP and is not separately compensated by the General Partner or the Partnership for services on behalf of the Partnership. Thus, there were no deliberations of the General Partner's Board of Directors with respect to compensation of any officer or employee. The Partnership reimburses the General Partner for fees paid to Directors of the General Partner who are not otherwise affiliated with the General Partner or its affiliates. In 1997, such unaffiliated directors were paid an annual fee of $14,500 and $500 for each meeting attended. The Partnership has not established any plans pursuant to which cash or non-cash compensation has been paid or distributed during the last fiscal year or is proposed to be paid or distributed in the future. The Partnership has not issued or established any options or rights relating to the acquisition of its securities or any plans therefor. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT UNIT OWNERSHIP BY CERTAIN BENEFICIAL OWNERS As of February 28, 1998, the following persons were known to the Partnership to be beneficial owners of more than five percent of the Partnership's equity securities:
Name and Address Amount and Nature of Title of Class of Beneficial Owner Beneficial Ownership Percent of Class -------------- ------------------- -------------------- ---------------- Depositary Units United States Airlease Holding, Inc. 231,250(1) 5% 555 California Street San Francisco, CA 94104(2) Depositary Units BALCAP 793,750(3) 17.2% 555 California Street San Francisco, CA 94104(2)
- ------------ (1) United States Airlease Holding, Inc. ("Holding") reported that it had sole voting and dispositive power over these Units. (2) BALCAP owns all of the outstanding stock of Holding. Therefore, BALCAP may be deemed also to be the indirect beneficial owner of the Units owned by Holding. In addition, BALCAP owns all the outstanding stock of the General Partner. Therefore, BALCAP may be deemed to be the indirect beneficial owner of the 26 27 General Partner's 1% General Partner interest. BALCAP is a wholly owned indirect subsidiary of BankAmerica Corporation. Therefore, BankAmerica Corporation and each BankAmerica Corporation subsidiary which is the direct or indirect parent of BALCAP is also indirectly the beneficial owner of all Units and of the General Partner's 1% General Partner interest owned or deemed owned by BALCAP. (3) BALCAP reported that it had sole voting and dispositive power over these Units. UNIT OWNERSHIP BY MANAGEMENT Set forth below is information regarding interests in the Partnership owned by each director of and all directors and executive officers, as a group, of the General Partner. Unless otherwise noted, each person has sole voting and investment power over all units owned.
Name of Amount and Nature of Title of Class Beneficial Owner Beneficial Ownership Percent of Class -------------- ---------------- -------------------- ---------------- Depositary Units David B. Gebler 700(1) (2) All directors and executive 700(1) (2) officers as a group
- ---------- (1) Includes 200 Units held by Mr. Gebler as custodian for a minor child as to which Mr. Gebler has shared voting and dispositive power and as to which beneficial ownership is disclaimed. (2) Represents less than 1%. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS For a discussion of certain fees, expenses and reimbursements payable and paid to the General Partner and its affiliates by the Partnership, see Note 8 of Notes to Financial Statements. From time to time, the Partnership has borrowed funds from BALCAP, including advances for expense payments. All such borrowings were unsecured and bore interest at a floating rate not exceeding the prime rate. At December 31, 1997 Airlease owed BALCAP $141,000 for such borrowings. For a discussion of certain terms of the Partnership Agreement regarding the Partnership's participation in aircraft leasing investments made by USL Capital and its Related Entities, see "BUSINESS-Acquisition of Additional Aircraft." For a discussion of aircraft held jointly between the Partnership and BALCAP or formerly held jointly between the Partnership and USL Capital, see "BUSINESS-Existing Participants in Leases." 27 28 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) 1. The following financial statements of the Partnership are included in this report as Appendix A: Page
Management's Responsibility for Financial Statements................................... A-1 Independent Auditors' Report........................................................... A-2 Financial Statements: Statements of Income for the Years Ended December 31, 1997, 1996 and 1995 ................................................................ A-3 Balance Sheets, as of December 31, 1997 and 1996.............................. A-4 Statements of Cash Flows for the Years Ended December 31, 1997, 1996 and 1995........................................................... A-5 Statements of Changes in Partners' Equity for the Years Ended December 31, 1997, 1996 and 1995.............................................. A-6 Notes to Financial Statements ......................................................... A-6
Financial statement schedules other than those listed above are omitted because the required information is included in the financial statements or the notes thereto or because of the absence of conditions under which they are required. (b) The Partnership did not file any reports on Form 8-K during the last quarter of the fiscal year ended December 31, 1997. 28 29 (c) Exhibits required by Item 601 of Regulation S-K:
Exhibit No. Description ---------- ----------- 3.1(1) Amended and Restated Agreement of Limited Partnership of Partnership. 3.2(1) Form of Certificate for Limited Partnership Units of Partnership. 3.3(1) Form of Depositary Agreement among Partnership, Chase-Mellon Shareholder Services (formerly Manufacturers Hanover Trust Company), the General Partner and Limited Partners and Assignees holding Depositary Receipts. 3.4(1) Form of Depositary Receipt for Units of Limited Partners' Interest in the Partnership 3.5(2) Amendments to Amended and Restated Partnership Agreement. 4.1(1) Form of Application for Transfer of Depositary Unit. 4.2(2) Loan and Security Agreement dated as of March 20, 1987 between Meridian Trust Company, as Trustee, as Borrower and The World Wing Company Limited, as Lender. 4.3(2) 8.75% Secured Non-recourse Note of Meridian Trust Company dated March 31, 1987 in favor of The World Wing Company Limited. 4.4(2) Instructions and Consent Agreement dated as of March 31, 1987 between the Registrant and The World Wing Company Limited. 10.1(1) Trust Agreement, together with Trust Agreement Supplement No. 1-5, dated as of July 10, 1986, between the Registrant, Meridian Trust Company and the General Partner. 10.3(1) Lease Agreement, together with Lease Supplement Nos. 1-5, dated as of July 10, 1986, between Meridian Trust Company, not in its individual capacity but solely as Trustee, and Pacific Southwest Airlines. 10.40(2) Trust Agreement dated as of August 15, 1988, between Taurus Trust Company, Inc. (formerly Trust Company for USL, Inc.), as Trustee, United States Airlease, Inc., and the Registrant, with respect to aircraft N913TW.
- ----------- (1) Incorporated by reference to the Partnership's Registration Statement on Form S-1 (File No. 33-7985), as amended. (2) Incorporated by reference to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995. 29 30 10.44(3) Aircraft Lease Agreement dated as of April 15, 1993 between Taurus Trust Company, Inc. (formerly Trust Company for USL, Inc.) as Owner Trustee, Lessor, and Federal Express Corporation, Lessee with respect to one (1) Boeing 727-2D4 Aircraft, U.S. Registration No. 362PA (manufacture serial no. 21850). 10.45(2) Trust Agreement dated as of July 27, 1993 among Airlease Ltd., A California Limited Partnership, as Owner Participant, and Taurus Trust Company, Inc. (formerly Trust Company for USL, Inc.) as Trustee, with respect to one (1) Boeing 727-204 Aircraft with FAA Registration No. N362PA leased to Federal Express Corporation. 10.49(4) Assignment and Assumption Agreement dated as of January 31, 1997 between USL Capital Corporation and the Registrant. 10.50(4) Lease, together with Lease Supplement No. 1, dated as of March 15, 1984 between DC-9T-III, Inc., as Lessor, and Trans World Airlines, Inc., as Lessee, with respect to one (1) McDonnell Douglas DC-9-82 Aircraft, as amended by Amendment Agreement dated as of December 15, 1986. 27 Financial Data Schedule
- ---------- (2) Incorporated by reference to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1995. (3) Incorporated by reference to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1993. (4) Incorporated by reference to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1996. 30 31 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 24, 1998. AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP (Registrant) By: Airlease Management Services, Inc., General Partner By: /s/ David B. Gebler ------------------------------------------- David B. Gebler Chairman, Chief Executive Officer and President 31 32 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. For Airlease Management Services, Inc. ("AMSI"), General Partner - ---------------------------------------- /s/ David B. Gebler March 24, 1998 - ------------------------------------------------------------- David B. Gebler Chairman, Chief Executive Officer, President and Director of AMSI /s/ Richard C. Walter March 24, 1998 - ------------------------------------------------------------- Richard C. Walter Chief Financial Officer and Director of AMSI (Principal Financial Officer and Accounting Officer) /s/ Richard V. Harris March 24, 1998 - ------------------------------------------------------------- Richard V. Harris Director of AMSI /s/ K. Thomas Rose March 24, 1998 - ------------------------------------------------------------- K. Thomas Rose Director of AMSI
The foregoing constitute a majority of the members of the Board of Directors of Airlease Management Services, Inc. (the General Partner). 32 33 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS Airlease Management Services, Inc. ("AMSI"), the General Partner of the Partnership was a wholly owned subsidiary of USL Capital Corporation until October 31, 1996, when BA Leasing and Capital Corporation ("BALCAP") purchased 100% of the stock of AMSI. AMSI is responsible for the preparation of the Partnership's financial statements and the other financial information in this report. This responsibility includes maintaining the integrity and objectivity of the financial records and the presentation of the Partnership's financial statements in accordance with generally accepted accounting principles. The General Partner maintains an internal control structure designed to provide, among other things, reasonable assurance that Partnership records include the transactions of its operations in all material respects and to provide protection against significant misuse or loss of Partnership assets. The internal control structure is supported by careful selection and training of financial management personnel, by written procedures that communicate the details of the control structure to the Partnership's activities, and by BALCAP's staff of operating control specialists who conduct reviews of adherence to the Partnership's procedures and policies. The Partnership's financial statements have been audited by Coopers & Lybrand L.L.P., independent auditors for the years ended December 31, 1997, and December 31, 1996. Their audit was conducted in accordance with generally accepted auditing standards which included consideration of the General Partner's internal control structure. The Independent Auditor's Report appears on page A2. The board of directors of the General Partner, acting through its Audit Committee composed solely of directors who are not employees of the General Partner, is responsible for overseeing the General Partner's fulfillment of its responsibilities in the preparation of the Partnership's financial statements and the financial control of its operations. The independent auditors have full and free access to the Audit Committee and meet with it to discuss their audit work, the Partnership's internal controls, and financial reporting matters. /s/ David B. Gebler - ----------------------------------------------- David B. Gebler Chairman, Chief Executive Officer and President Airlease Management Services, Inc. /s/ Richard C. Walter - ----------------------------------------------- Richard C. Walter Chief Financial Officer Airlease Management Services, Inc. A-1 34 INDEPENDENT AUDITORS' REPORT To the Partners of Airlease Ltd., A California Limited Partnership: We have audited the financial statements of Airlease Ltd., A California Limited Partnership (listed in Part IV Item 14(a) of this Form 10-K). These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Partnership as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. /s/ Coopers & Lybrand L.L.P. - ---------------------------- Coopers & Lybrand L.L.P. San Francisco, California January 21, 1998 A-2 35 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP STATEMENTS OF INCOME
For the years ended December 31, (In thousands except per-unit amounts) 1997 1996 1995 - -------------------------------------------------------- -------- -------- -------- REVENUES Finance lease income $ 9,028 $ 8,800 $ 9,455 Operating lease rentals 170 1,798 2,883 Gain on sale of equipment 393 2,501 21 Other income 12 149 154 ------------------------------------ Total revenues 9,603 13,248 12,513 ------------------------------------ EXPENSES Interest 2,028 1,830 2,366 Depreciation - operating leases 273 1,500 2,129 Bad debt expense 228 0 0 Management fee - General Partner 679 740 784 Investor reporting 771 254 258 General and administrative 142 271 154 ------------------------------------ Total expenses 4,121 4,596 5,691 ------------------------------------ NET INCOME $ 5,482 $ 8,652 $ 6,822 ------------------------------------ NET INCOME ALLOCATED TO: GENERAL PARTNER $ 55 $ 87 $ 68 ------------------------------------ Limited partners $ 5,427 $ 8,565 $ 6,754 ------------------------------------ NET INCOME PER LIMITED PARTNERSHIP UNIT $ 1.17 $ 1.85 $ 1.46 ------------------------------------
See notes to financial statements A-3 36 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP BALANCE SHEETS
As of December 31, (IN THOUSANDS EXCEPT UNIT DATA) NOTES 1997 1996 - ---------------------------------------------------------------------------------------------------- ASSETS Cash $ 1 $ 580 Finance leases - net 1 & 2 82,590 83,056 Operating leases - net 1 & 3 0 1,090 Notes receivable 4 & 7 0 236 Prepaid expenses and other assets 268 168 --------------------------- Total Assets $ 82,859 $ 85,130 --------------------------- LIABILITIES AND PARTNERS' EQUITY LIABILITIES: Distribution payable to partners $ 2,102 $ 5,045 Accounts payable and accrued liabilities 553 972 Long-term notes payable 5 19,115 14,071 --------------------------- Total liabilities 21,770 20,088 --------------------------- COMMITMENTS AND CONTINGENCIES 6 PARTNERS' EQUITY: Limited partners (4,625,000 units outstanding) 60,478 64,391 General partner 611 651 --------------------------- Total partners' equity 61,089 65,042 --------------------------- TOTAL LIABILITIES AND PARTNERS' EQUITY $ 82,859 $ 85,130 ---------------------------
See notes to financial statements A-4 37 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS
For the years ended December 31, (In thousands) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 5,482 $ 8,652 $ 6,822 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 273 1,500 2,129 Increase (decrease) in accounts payable and accrued liabilities (390) (518) 231 Decrease (increase) in prepaid expenses and other assets (99) 97 54 Decrease (increase) in accounts receivable 0 111 111 Provision for doubtful account 228 0 0 Gain on disposition of equipment (393) (2,501) (21) -------------------------------------- Net cash provided by operating activities 5,101 7,341 9,326 -------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Aircraft equipment purchase and refurbishment (net of Accrued refurbishment) 0 0 (66) Aircraft equipment purchase (5,732) 0 0 Proceeds from sale of equipment 1,182 10,060 440 Increase (decrease) in notes receivable 8 697 (260) Rental receipts in excess of earned finance lease income 6,219 8,508 2,133 -------------------------------------- Net cash provided by investing activities 1,656 19,265 2,247 -------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Revolving credit borrowing (repayment) - net (1,748) (7,381) 545 Proceeds from issuance of long-term debt 9,000 0 575 Repayment of long-term debt (5,704) (6,031) (3,162) Distributions paid to partners (12,379) (12,614) (9,531) -------------------------------------- Net cash used by financing activities (7,335) (26,026) (11,573) -------------------------------------- Increase (decrease) in cash (579) 580 0 Cash at beginning of year 580 0 0 -------------------------------------- Cash at end of year $ 1 $ 580 $ 0 -------------------------------------- Additional information: Cash paid for interest $ 1,861 $ 2,097 $ 2,052 --------------------------------------
NON - CASH INVESTING ACTIVITY During 1997, unpaid accrued costs were reduced by $28,000 and included in the gain on sale of aircraft. See notes to financial statements A-5 38 AIRLEASE LTD., A CALIFORNIA LIMITED PARTNERSHIP STATEMENTS OF CHANGES IN PARTNERS' EQUITY
For the years ended December 31, 1997, 1996, and 1995 General Limited (In thousands except per-unit amounts) Partner Partners Total - ---------------------------------------------------------------------------------------------------- Balance, December 31, 1994 $ 746 $ 73,816 $ 74,562 Net Income - 1995 68 6,754 6,822 Distributions to partners declared ($2.07 per limited Partnership unit) (97) (9,575) (9,672) - ---------------------------------------------------------------------------------------------------- Balance, December 31, 1995 717 70,995 71,712 Net Income - 1996 87 8,565 8,652 Distributions to partners declared ($3.28 per limited Partnership unit) (153) (15,169) (15,322) - ---------------------------------------------------------------------------------------------------- Balance, December 31, 1996 651 64,391 65,042 Net Income - 1997 55 5,427 5,482 Distributions to partners declared ($2.02 per limited Partnership unit) (95) (9,340) (9,435) - ---------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 $ 611 $ 60,478 $ 61,089 ====================================================================================================
See notes to financial statements NOTES TO FINANCIAL STATEMENTS 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION - Airlease Ltd., A California Limited Partnership (the "Partnership") engages in the business of acquiring, either directly or through joint ventures, commercial jet aircraft, spare or separate engines and related rotable parts ("aircraft") and leasing such aircraft to domestic and foreign airlines and freight carriers. The General Partner is Airlease Management Services, Inc., a wholly owned subsidiary of BA Leasing and Capital Corporation ("BALCAP"). BALCAP holds 793,750 units and United States Airlease Holding, Inc. ("Holding"), a wholly owned subsidiary of BALCAP, holds 231,250 units. An additional 3,600,000 units are publicly held. BASIS OF PRESENTATION - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A-6 39 FINANCE LEASES - Lease agreements, under which the Partnership recovers substantially all its investment from the minimum lease payments are accounted for as finance leases. At lease commencement, the Partnership records the lease receivable, estimated residual value of the leased aircraft, and unearned lease income. The original unearned income is equal to the receivable plus the residual value less the cost of the aircraft (including the acquisition fee paid to an affiliate of the General Partner). The remaining unearned income is recognized as revenue over the lease terms so as to approximate a level rate of return on the investment. OPERATING LEASES - Leases that do not meet the criteria for finance leases are accounted for as operating leases. The Partnership's undivided interests in aircraft subject to operating leases are recorded at cost which includes acquisition fees paid to an affiliate of the General Partner. Aircraft are depreciated over the related lease terms, generally five to nine years on a straight-line basis to an estimated residual value, or over their useful lives for aircraft held for lease or sale, on a straight-line basis to an estimated salvage value. DERIVATIVES - The Partnership accounts for derivatives financial instruments on an accrual basis when the cash flows generated from the hedging instruments fulfill the objectives of the hedge strategy and when there is high correlation between the derivative and the hedged asset or liability. Under accrual accounting interest differentials paid or received under interest rate swap agreements are recognized as adjustments to interest expense over the life of the agreements. Termination gains or losses of such derivatives are amortized to interest expense over the remaining life of the hedged transaction. When a derivative no longer fulfills the high correlation objective, it is accounted for on a mark-to-market basis and termination of such derivatives is recognized immediately in the Statement of Income as a component of interest expense. NET INCOME PER LIMITED PARTNERSHIP UNIT is computed by dividing the net income allocated to the Limited Partners by the weighted average units outstanding (4,625,000). CONCENTRATION OF CREDIT RISK - At December 31, 1997, all seven aircraft owned by the Partnership were leased to commercial airlines and a major freight carrier. 2. FINANCE LEASES The Partnership owns five aircraft, which are leased to US Airways, Inc. US Airways, Inc. has exercised its option to renew the lease for an additional three years at the end of the initial 12-year term (1998). In 1997, 1996, and 1995, leases with US Airways, Inc. resulted in finance lease revenues of $7,058,000, $7,559,000, and $8,007,000, respectively. A sixth aircraft subject to a finance lease expiring in 2002 was held jointly with USL Capital and leased to Trans World Airlines. On January 31, 1997, the Partnership purchased USL Capital's 50% interest in this aircraft for $5.7 million and now holds a 100% interest in the aircraft. A seventh aircraft is leased to FedEx under a 13-year finance lease which expires in 2006. The finance leases at December 31, 1997 and 1996, are summarized as follows (in thousands): A-7 40
1997 1996 -------- -------- Receivable in installments $ 65,727 $ 74,875 Residual valuation 45,500 41,950 Unearned lease income (28,638) (33,769) -------- -------- NET INVESTMENT $ 82,590 $ 83,056 ======== ========
Residual valuation, which is reviewed annually, represents the estimated amount to be received from the disposition of aircraft after lease termination. If necessary, residual adjustments are made which result in an immediate charge to earnings and/or a reduction in earnings over the remaining term of the lease. Finance lease receivables at December 31, 1997 are due in installments of $15,548,000 annually through 2000, $12,589,000 in 2001 and $6,294,000 thereafter. 3. OPERATING LEASES In December 1994, the Partnership leased an aircraft to Sun Jet International, Inc. under a three-year operating lease which expired in 1997. The aircraft had been jointly owned by the Partnership and USL Capital until October 31, 1996, when USL Capital sold its interest to BALCAP. In September 1997 the aircraft was sold for a gain of $393,000. Operating lease revenues to the Partnership were $170,000 in 1997, and $339,000 in 1996 and 1995. The operating leases at December 31, 1997 and 1996 are summarized as follows (in thousands):
1997 1996 -------- -------- Leased aircraft (at cost) $ 0 $ 4,501 Accumulated depreciation 0 (3,411) Rentals receivable 0 0 -------- -------- NET INVESTMENT $ 0 $ 1,090 ======== ========
There will be no future rentals on operating leases after December 31, 1997, as the Partnership no longer owns any aircraft subject to any operating lease. 4. NOTES RECEIVABLE At December 1996, the Partnership had outstanding notes receivable of $236,000 from Continental Airlines for certain aircraft modifications pursuant to the restructured lease agreement on the aircraft. Continental disputed payment of the notes after the aircraft were sold, and the notes were written off in 1997. 5. LONG-TERM NOTES PAYABLE At December 31, 1997 and 1996, the Partnership had outstanding borrowings of $3,589,000 and $8,026,000, respectively, under an 8.75% note payable through September 30, 1998. The note is collateralized by three of the aircraft leased to US Airways, Inc. under a finance lease with no other recourse to the Partnership. The Partnership has a non-recourse revolving variable interest loan facility which is collateralized by one of the aircraft leased to US Airways, Inc. The Partnership may borrow up to $3,888,000, which amount declines through 1998. At December 31, 1997 and 1996, $1,748,000 and $0 were outstanding, respectively. The Partnership has entered into an interest rate swap agreement, which A-8 41 effectively fixes the interest rate at 7.36% on substantially all the borrowing through November 1998. See Note 6. In November 1993, the Partnership entered into a non-recourse fixed interest rate loan facility collateralized by the aircraft leased to FedEx. At December 31, 1997 and 1996, $5,589,000 and $6,045,000, respectively, were outstanding under a 7.4% note payable through 2006. In January 1997, the Partnership entered into a non-recourse fixed rate loan facility collateralized by the aircraft leased to TWA. At December 31, 1997 $8,189,000 was outstanding under a 9.85% note payable through 2002. In February 1998 the Partnership obtained a $7.5 million three-year revolving loan facility. The loan is collateralized by one aircraft on lease to US Airways, Inc. and is guaranteed by the Partnership. The Partnership intends to use the loan facility for working capital. Based upon amounts outstanding at December 31, 1997, the minimum future principal payments on all outstanding long-term notes payable are due as follows (in thousands): 1998 $ 6,867 1999 1,675 2000 1,832 2001 2,007 2002 4,005 Thereafter 2,729 ------- TOTAL $19,115 =======
6. DERIVATIVE FINANCIAL INSTRUMENTS The Partnership holds one derivative financial instrument, which is an interest rate swap agreement used to manage the Partnership's interest rate risk. In September 1997, it was determined that this derivative no longer fulfilled the high correlation objective, and the Partnership began accounting for it on a mark-to-market basis. A loss was recognized immediately in the Statement of Income as a component of interest expense. As of December 31, 1997, a loss of $48,000 was recognized. 7. FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents carrying amounts and fair values of the Partnership's financial instruments at December 31, 1997. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. A-9 42 1997 1997 (In thousands) Carrying Amount Fair Value --------------- ---------- Long-term debt (Note 5) $ 19,115 $ 19,026 Long-term debt (Note 5) Derivatives relating to debt (Note 6) Interest rate swaps-net pay position $ (48) $ (48)
1996 1996 (In thousands) Carrying Amount Fair Value --------------- ---------- Notes receivable (Note 4) $ 236 $ 244 Long-term debt (Note 5) $ 14,071 $ 14,115 Long-term debt (Note 5) Derivatives relating to debt (Note 6) Interest rate swaps-net pay position n/a $ (89)
The carrying amounts presented in the table are included in the balance sheet under the indicated captions. The following notes summarize the major methods and assumption used in estimating the fair values of financial instruments: NOTES RECEIVABLE are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. LONG-TERM DEBT is estimated by discounting the future cash flows using rates that are assumed would be charged to the Partnership for debt with similar terms and remaining maturities. DERIVATIVES are estimated as the amount that the Partnership would receive or pay to terminate the agreements at the reporting date, taking into account current market interest rates and corresponding borrowing spreads. 8. TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES In accordance with the Agreement of Limited Partnership, the General Partner and its affiliates receive expense reimbursement, fees and other compensation for services provided to the Partnership. Amounts earned by the General Partner and affiliates for the years ended December 31, 1997, 1996, and 1995, were as follows (in thousands):
1997 1996 1995 ------ ------ ------ Management fees $ 620 $ 673 $ 718 Disposition and remarketing fees 123 568 65 Acquisition fees 85 Reimbursement of other costs 79 79 79 Reimbursement of interest costs 5 6 39 ------ ------ ------ TOTAL $ 912 $1,326 $ 901 ====== ====== ======
A-10 43 The General Partner was allocated its 1% share of the Partnership net income and cash distributions. Holding and BALCAP, each a limited partner and an affiliate of the General Partner, were also allocated their share of income and cash distributions. 9. FEDERAL INCOME TAX STATUS The Partnership is considered a publicly traded Partnership ("PTP") under the Revenue Act of 1987 with special tax status whereby it was not subject to federal income tax. This special tax status was due to expire beginning in 1998. The Partnership was faced with two major alternatives, either convert to a corporate status and be subject to federal corporate income tax, or de-list the units from the NYSE and thus not be subject to any corporate income tax. In August and October 1997, federal and California tax laws, respectively, were amended to provide that publicly traded Partnerships may elect to continue to be publicly traded and retain their Partnership tax status if they pay a federal tax of 3.5% and state tax of 1% on their annual gross income beginning in January 1998. After authorization from the unitholders and consideration of a number of factors, including the recent tax law changes and the benefits of liquidity, the board of directors of the General Partner unanimously concluded that it is in the best interest of the unitholders for the Partnership to remain a publicly traded Partnership at this time. Accordingly, in January 1998, the Partnership made an election to pay an annual tax at the Partnership level of 4.5% on its gross income beginning in 1998. 10. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING The aircraft on lease to US Airways, Inc. were purchased subject to a tax benefit transfer lease ("TBT") which provided for the transfer of Federal income tax ownership of these aircraft to a tax lessor until 1991. The transfer was accomplished by the sale, for tax purposes only, of the aircraft to the tax lessor for cash and a note and a leaseback of the aircraft for rental payments which equalled the payments on the note. The rental payments resulted in tax deductions and the interest was included in taxable income. In 1991, the TBT lease agreement terminated and the tax attributes transferred under the TBT lease reverted to the Partnership. The difference between the method of accounting for income tax reporting and the method of accounting used in the accompanying financial statements are as follows (in thousands except per unit amounts):
1997 1996 1995 -------- -------- -------- Net income per financial statements: $ 5,482 $ 8,652 $ 6,822 Increases (decreases) resulting from Gain on sale of equipment 482 777 109 Lease rents earned less finance lease income 6,520 5,627 5,207 Depreciation and amortization (5,557) (6,242) (7,949) -------- -------- --------
A-11 44 Income (loss) per income tax method 6,927 8,814 4,189 Allocable to General Partner (69) (88) (42) -------- -------- -------- TAXABLE INCOME (LOSS) ALLOCABLE TO LIMITED PARTNERS $ 6,858 $ 8,726 $ 4,147 Taxable income (loss) per limited Partnership unit after giving effect to taxable income allocable to General Partner (amount based on a unit owned from October 10, 1986) $ 1.48 $ 1.89 $ 0.90 Partner's equity per financial statements $ 61,089 $ 65,042 $ 71,712 Increases (decreases) resulting from Gain on sale of equipment 482 777 109 Lease rents less earned finance lease income 40,420 33,900 28,273 Deferred underwriting discounts and commissions and organization costs 5,351 5,351 5,351 Accumulated depreciation and amortization (56,779) (51,222) (45,089) TBT interest income less TBT rental expense (54,030) (54,030) (54,030) -------- -------- -------- PARTNERS' EQUITY PER INCOME TAX METHOD $ (3,467) $ (182) $ 6,326
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended December 31, 1997 and 1996 (in thousands, except per unit amounts):
1997 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 - ---- -------- ------- -------- ------- Total Revenues $2,358 $2,354 $2,679 $2,212 Net Income $1,167 $1,341 $1,630 $1,344 Net Income Per Limited Partnership Unit $ 0.25 $ 0.28 $ 0.35 $ 0.29 Unit Trading Data: Unit Prices (high-low) on NYSE $17 5/8 - $ 10 $12 1/2 - $10 1/4 12 1/16 - $9 15/16 $13 11/16 - $ 11 1/4 Unit Trading Volumes on NYSE 1,104 757 993 855
1996 MARCH 31 JUNE 30 SEPT. 30 DEC. 31 - ---- -------- ------- -------- ------- Total Revenues $3,431 $2,717 $2,598 $4,502 Net Income $2,171 $1,588 $1,532 $3,361 Net Income Per Limited Partnership Unit $ 0.46 $ 0.34 $ 0.33 $ 0.72 Unit Trading Data: Unit Prices (high-low) on NYSE $18 7/8 - $17 $18 1/4-$15 $16 3/4 - $13 1/4 $16 3/8 - $14 5/8 Unit Trading Volumes on NYSE 257 557 461 298
A-12 45 INDEX TO EXHIBITS
Exhibit No. Description - ----------- ----------- 27. Financial Data Schedule.
A-13 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 DEC-31-1997 1 0 37,089 0 0 1 0 0 82,859 0 19,115 0 0 0 61,089 82,859 9,591 9,603 0 273 1,592 228 2,028 5,482 0 5,482 0 0 0 5,482 1.17 1.17
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