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 ("BA Leasing & Capital"), a wholly owned indirect subsidiary of BankAmerica Corporation, purchased the stock of the General Partner from USL Capital and the General Partner became a wholly owned subsidiary of BA Leasing & Capital. On September 29, 1999, BA Leasing & Capital merged into Banc of America Leasing and Capital, LLC, a Delaware limited liability company ("BALCAP"). BALCAP is also a wholly owned indirect subsidiary of BankAmerica Corporation. A total of 4,625,000 Depository 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.
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 will 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.
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.
The following table describes the Partnership's aircraft portfolio at December 31, 1999:
At December 31, 1999, the book value of aircraft by lessee as a percent of total assets was as follows: US Airways, 71.7%; FedEx, 13%; and TWA, 14.9%. Revenues by lessee as a percentage of total revenue for 1999 and 1998, respectively, were as follows: US Airways, 77.1% and 77.4%; TWA, 17.2% and 17.0%; and FedEx, 5.7% and 5.6%.
See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" for a further discussion of the Partnership's lessees.
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 most of 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.
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.
DESCRIPTION OF LEASES
All aircraft now owned by the Partnership are leased to third parties pursuant to full-payout (direct finance) leases. 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 fair 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 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 is eligible under Section 1110, the right of the lender or lessor to take possession of the equipment upon default is not affected by the automatic stay provisions of the Bankruptcy Code, 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 or 30 days after the default. 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, the President signed 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 ("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.
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.
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. If party to a joint venture, the 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 4 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 6 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.
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 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.
In January 1999 the FAA issued an airworthiness directive setting payload weight limitations on the Boeing 727 aircraft which were converted from passenger to freight configuration. The directive requires extensive structural modifications to strengthen the aircraft's floor, if the aircraft is to continue to operate under the existing payload limits. If these modifications are not performed, the directive sets substantially reduced payload limits. This airworthiness directive applies to the aircraft on lease to FedEx. Under the lease covering this aircraft, FedEx is 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. Stage I and Stage II aircraft are no longer allowed to operate from civil airports in the United States.
See "Aircraft Portfolio" above, for a description of the Partnership's aircraft portfolio. At December 31, 1999, all of the aircraft in the Partnership's portfolio were Stage III aircraft
ACQUISITION OF ADDITIONAL AIRCRAFT
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.
Not withstanding the above, 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 ("Related Entities") 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 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 PTPs may elect to continue to be publicly traded and retain their Partnership tax status if they pay a federal tax of 3.5% and a California state tax of 1% on their respective annual gross income beginning in January 1998. The Partnership made an election to pay this tax beginning in 1998.
EMPLOYEES
The Partnership has no employees. See "DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - General" below. Employees of the General Partner Provide services on behalf of the Partnership.
ITEM 2.
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.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II -------
ITEM 5.
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 23, 2000, there were 1,011 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, 1998 and 1999.
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. Form time to time the Partnership also has made cash distributions from Cash Available from Sale or Refinancing (as defined in the Limited Partnership Agreement.) 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.
Distributions declared during 1998 and 1999 were as follows:
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.
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." 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.
ITEM 6.
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:
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The information set forth below and elsewhere in this Annual Report on Form 10-K contains certain forward-looking statements, which reflect the current view of the Partnership with respect to future events and financial performance. The words "expect", "intend", "believe", "anticipate", "likely" and "will" and similar expressions generally identify forward-looking statements. These statements are subject to certain risks and uncertainties, which could cause actual results and events to differ materially from those anticipated in the forward-looking statements.
Factors that could cause the Partnership's actual results to differ from current expectations include, among others, changes in the aircraft or aircraft leasing market, economic downturn in the airline industry, default by lessees under leases causing the Partnership to incur uncontemplated expenses or not to receive rental income as and when expected, changes in interest rates and legislative or regulatory changes that adversely affect the value of aircraft.
LIQUIDITY AND CAPITAL RESOURCES
The Partnership presently has three long-term debt facilities. At December 31, 1999, the following amounts were outstanding: $4.6 million on a 7.4% non-recourse note collateralized by one aircraft leased to FedEx; $3.7 million on a 9.35% non-recourse note collateralized by one aircraft on lease to Trans World Airlines; and $1.8 million on a long-term variable rate revolving loan facility guaranteed by the Partnership and collateralized by two aircraft on lease to US Airways. At December 31, 1999 and 1998, $10.1 million and $14.5 million, respectively, was outstanding under the Partnership's loan facilities. At December 31, 1999 approximately $5.9 million remained available under the revolving loan facility.
Long-term borrowings at December 31, 1999 represented 8.3% of the original cost of the aircraft presently owned by the Partnership, including capital expenditures for upgrades. The terms of the Partnership Agreement permit debt to be at a level not exceeding 50% of such cost.
Total scheduled debt service (principal and interest) on the fixed loans in 2000 is $2.7 million, and the principal payment on the floating loan in 2000 is projected to be $0.7 million (if no purchase or sale of aircraft or any unforeseen business events occur). Debt service will be paid primarily from the rental payments received under aircraft leases.
Net cash provided by operating activities was $5.1 million for 1997, $5.3 million for 1998, and $4.1 million for 1999. Aside from the cash flow activity associated with taxes payable, the net cash flow provided by operating activities showed moderate decreases over the three-year period. The decrease was due to reduced rentals as a result of a smaller portfolio.
Total debt service on the fixed loans as a percentage of net cash provided by operating activities was 152%, 166%, and 78% for 1997, 1998 and 1999, respectively. However, cash flow from operating activities does not fully reflect cash receipts from lease payments. When the excess of rental receipts above finance lease income is added to cash flow from operating activities, the ratios become 68%, 71%, and 26%, respectively. The lower 1999 ratio as compared with 1998 and 1997 reflects a greater rate of debt repayment, while the cash received from lease rentals remained about the same for each year of the three-year period. The higher 1998 ratio as compared with 1997 primarily reflects the $2 million early principal pay-down of a fixed loan in 1998. The pay-down was mainly financed by the variable line of credit.
Cash distributions paid by the Partnership were $12.4 million ($2.65 per unit) in 1997, $7.8 million ($1.68 per unit) in 1998, and $7.7 million ($1.64 per unit) in 1999. Distributions paid in 1997 included two special cash distributions. The first, was a distribution of 63 cents per unit made with 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 with the proceeds received from the September 29, 1997 sale of the Partnership's 50% interest of one DC9-51. There were no special cash distributions paid in either 1998 or 1999.
Partnership net income was $5.5 million in 1997, $4.9 million in 1998, and $4.7 million in 1999. The decline in net income from 1997 to 1998 primarily reflects the imposition of federal taxation at the Partnership level, and the decline from 1998 to 1999 is due to a smaller asset base. 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 $58.3 million at December 31, 1998 to $55.3 million at December 31, 1999, and limited partner equity per unit declined from $12.48 to $11.85. From a limited partner perspective, the portion of the distribution in excess of net income constitutes a return of capital. Total cash distributions declared since inception of the Partnership have exceeded total net income by $6.94 per unit.
RESULTS OF OPERATIONS
- ---- In 1997, revenues were earned from seven aircraft subject to finance leases (US Airways, TWA, and Fedex). In 1997 revenues were also earned from one aircraft subject to an 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 leases. At year-end 1997, all of the Partnership's lessees were current under their lease agreements and none was in bankruptcy.
1998 vs. 1997 - ------------- In 1998, all revenues were earned from aircraft subject to finance leases. The revenue reduction in 1998 as compared with 1997 is primarily due to the scheduled decline in finance lease income as the asset base declined. In addition, in 1997 the Partnership earned revenue from an aircraft on an operating lease and from a gain on sale of such aircraft. No such revenues were earned in 1998. At year-end 1998, all the Partnership's lessees were current under their lease agreements and none was in bankruptcy.
1999 vs. 1998 - -------------
In 1999, all revenues were earned from aircraft subject to finance leases. The revenue reduction in 1999 as compared with 1998 is primarily due to the scheduled decline in finance lease income as the balances due from the lessees declined.
US Airways, the Partnership's major lessee (72% of total 1999 year-end assets) reported profits of $197 million on revenues of $8.6 billion for 1999, compared with profits of $538 million on revenues of $8.7 billion for 1998.
FedEx (13% of total 1999 year-end assets) reported profits of $631 million on revenues of $16.8 billion for 1999 (fiscal year ended May 31, 1999), compared with profits of $503 million on revenues of $15.9 billion for 1998.
TWA (15% of total 1999 year-end assets) reported a net loss of $353 million on revenues of $3.3 billion for 1999, compared with a net loss of $120 million on revenues of $3.3 billion for 1998.
For information regarding the percentage of total Partnership assets and revenues represented by aircraft owned and leased by the Partnership, see "BUSINESS--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 a majority of its expenses (interest) are at fixed long-term rates.
Expenses in 1999 were $2.9 million or $620,000 lower than the 1998 expenses of $3.5 million. The decline in expenses is primarily due to lower interest expense in 1999 as a result of the Partnership's reduced debt balances. Debt balances declined from $14.5 million at December 31, 1998 to $10.1 million at December 31, 1999.
YEAR 2000 ISSUE
The year 2000 issue results from older computer programs using two, rather than four digits to define a year, thus the programs do not recognize a year that begins with "20" rather than the familiar "19." If not corrected, many computer applications could fail or create erroneous results.
Since the Partnership's operations consist primarily of collecting periodic lease payments on a limited number of leases and making periodic debt payments and distributions to its partners, the General Partner believes that the Partnership's exposure to the Year 2000 problem is limited to the software programs and services it obtains from suppliers and vendors. The Partnership's
leases and loans are supported by amortization schedules generated at the inception of these transactions, generally making the tracking of payments and recording of income and interest expense a manual process and thus independent of computer software.
The Partnership relies on third parties ("external relationships") such as banks, financial intermediaries, and tax services to facilitate certain business transactions. The Partnership reviewed the impact of these external relationships on its business during 1999 and concluded that the two most critical service providers were: the provider of the tax service that generates the K1 tax statements to be used by our limited partners to complete their tax returns and the stock transfer agent that facilitates the public trading of the Partnership's units. In 1999, the Partnership contacted both vendors and were advised that their systems were Year 2000 compliant.
The Partnership believes that due to its minimal reliance on computer software to conduct its internal day to day transactions processing, the Year 2000 ongoing costs are negligible.
The year 2000 compliance of each of the Partnership's lessees is available from reports filed by the lessees with the Securities and Exchange Commission.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Partnership's assets consist of aircraft subject to leases accounted for as financing leases, and thus consist of a future stream of fixed rental payments and a residual interest in the aircraft. See Note 2 to Financial Statements for information as to finance lease receivables. At December 31, 1999, the Partnership had long-term fixed-rate notes payable of $8,309,000 and a revolving variable rate loan facility with $1,783,000 outstanding and approximately $5,937,000 of credit available. See Note 4 to Financial Statements for information as to minimum future principal payments due and the interest rates applicable to the notes and revolving credit facility. Since the rental payments under its leases are fixed, but a portion of its liabilities are based on a variable interest rate, the assets and liabilities of the Partnership are not perfectly hedged and the Partnership bears some risk of interest rate fluctuations. Since a portion of its debt under the revolving credit facility is for variable working capital needs, the General Partner believes that the risk of interest fluctuations is appropriate under the circumstances.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY 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.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III --------
ITEM 10.
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 February 28, 2000. As used below, "BALCAP" refers both to BALCAP and to BA Leasing & Capital prior to its merger into BALCAP in September 1999.
ITEM 11.
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 1999, such unaffiliated directors were paid an annual fee of $14,500 plus $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.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
UNIT OWNERSHIP BY CERTAIN BENEFICIAL OWNERS
As of February 28, 2000, the following persons were known to the Partnership to be beneficial owners of more than five percent of the Partnership's equity securities:
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.
ITEM 13.
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 6 of Notes to Financial Statements. From time to time, the Partnership has borrowed funds from BALCAP or BA Leasing & Capital, 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, 1999 Airlease owed BALCAP $129,439 for such borrowings.
For a discussion of certain terms of the Limited 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 formerly held jointly between the Partnership and USL Capital, see "BUSINESS- Participants in Leases."
PART IV ------- ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) 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 and A-3
Financial Statements:
Statements of Income for the Years Ended December 31, 1999, 1998 and 1997 A-4
Balance Sheets, as of December 31, 1999 and 1998 A-5
Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 A-6
Statements of Changes in Partners' Equity for the Years Ended December 31, 1999, 1998 and 1997 A-7
Notes to Financial Statements A-7
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, 1999.
(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 Meridian Trust Company and the General Partner.
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.
- --------------------
(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.
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).
10.49(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.
10.51(5) Loan agreement secured by two aircraft leased to US Airways dated as of December 22, 1997, amended and restated as of December 15, 1998, 6 between Meridian Trust Company, as Trustee, as Borrower and Credit Lyonnais/PK AIRFINANCE, as Lender.
27 Financial Data Schedule
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(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.
(5) Incorporated by reference to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1998.
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 10, 2000.
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
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 10, 2000 - ---------------------------------------- David B. Gebler Chairman, Chief Executive Officer, President and Director of AMSI
/s/ RICHARD C. WALTER March 10, 2000 - ---------------------------------------- Richard C. Walter Chief Financial Officer and Director of AMSI (Principal Financial Officer and Accounting Officer)
/s/ RICHARD V. HARRIS March 10, 2000 - ---------------------------------------- Richard V. Harris Director of AMSI
/s/ K. THOMAS ROSE March 10, 2000 - ---------------------------------------- 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).
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Airlease Management Services, Inc. ("AMSI"), the General Partner of the Partnership 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 staff of operating control specialists of Banc of America Leasing and Capital, LLC., which owns 100% of the stock of AMSI, who conduct reviews of adherence to the Partnership's procedures and policies.
The Partnership's financial statements have been audited by Ernst & Young L.L.P., independent auditors for the year ended December 31, 1999 and 1998, and by Coopers & Lybrand L.L.P., independent auditors for the years ended December 31, 1997. Their audits were conducted in accordance with generally accepted auditing standards which included consideration of the General Partner's internal control structure. The Independent Auditor's Reports appears on page A-2 and A-3.
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
REPORT OF INDEPENDENT AUDITORS
To the Partners of Airlease Ltd., A California Limited Partnership:
We have audited the accompanying balance sheets of Airlease Ltd. as of December 31, 1999 and 1998 and the related statements of income, changes in Partners'equity, and cash flows for each of the two years in the period ended December 31, 1999. 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. The financial statements of Airlease Ltd. for the years ended December 31, 1997, were audited by other auditors whose report dated January 21, 1998, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Airlease Ltd. at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG L.L.P. - ------------------------ Ernst & Young L.L.P. San Francisco, California January 31, 2000
A-2
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 14(A) of this form 10-K for the year ended December 31, 1997. 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 audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the results of the partnership's operations and its cash flows for the year ended December 31, 1997, in conformity with generally accepted accounting principles.
/s/ COOPERS AND LYBRAND L.L.P. - ------------------------------ Coopers & Lybrand L.L.P. San Francisco, California January 21, 1998
A-3
A-4
A-5
A-6
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 Banc of America Leasing and Capital LLC. ("BALCAP"). BALCAP also holds 793,750 limited partnership units and United States Airlease Holding, Inc. ("Holding"), a wholly owned subsidiary of BALCAP, holds 231,250 limited partnership 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-7
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 term 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 derivative 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 a 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 an adjustment 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).
2. FINANCE LEASES
As of December 31, 1999, the partnership owns seven aircraft, which are all leased under finance leases. Five of the aircraft are leased to US Airways, Inc. In 1998, at the end of the initial 12-year term, US Airways, Inc. exercised its option to renew the lease for an additional three years, which renewal period was included in the original lease term for accounting under the generally accepted accounting principals. In 1999, 1998, and 1997, leases with US Airways, Inc. resulted in finance lease revenues of $5,873,000, $6,498,000, and $7,058,000, respectively.
The sixth aircraft, wholly owned by the partnership since January 31, 1997 when it purchased USL Capital's 50% interest in this aircraft for $5.7 million, is leased to Trans World Airlines (TWA) under a finance lease expiring in 2002. In 1999, 1998, and 1997 this lease with TWA, resulted in finance lease income of $1,310,000, $1,432,000, and $1,463,000, respectively.
The seventh aircraft is leased to Federal Express Corporation (FedEx) under a 13-year finance lease which expires in 2006. In 1999, 1998, and 1997 this lease with FedEx resulted in finance lease income of $431,000, $470,000, and $507,000, respectively.
The finance leases at December 31, 1999 and 1998, are summarized as follows (in thousands):
A-8
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, 1999 are due in installments of $15,748,000 in 2000, $12,589,000 in 2001, $1,710,000 in 2002, $1,310,000 in 2003, and $3,276,000 thereafter.
3. OPERATING LEASES
At December 31, 1999, the partnership did not own any aircraft subject to an operating lease. The last aircraft that was subject to an operating lease was sold in September 1997.
4. LONG-TERM NOTES PAYABLE
As of December 31, 1999 and 1998 long-term notes payable included the following:
A 7.4% non-recourse loan facility collateralized by the aircraft leased to FedEx, due in semi-annual installments of $451,000 through April 2006. At December 31, 1999 and 1998, $4,569,000 and $5,098,000, were outstanding, respectively.
A 9.35% non-recourse loan facility collateralized by the aircraft leased to TWA, due in monthly installments of $150,000 through March 2002. At December 31, 1999 and 1998, $3,740,000 and $5,150,000, were outstanding, respectively. During 1998, the partnership renegotiated the terms of the 9.35% loan facility. As part of the re-negotiation, the partnership was able to prepay $2.0 million in principal and reduce the interest rate 50 basis points from 9.85% to 9.35%.
A $7.5 million three-year revolving loan facility obtained in February 1998. The facility was initially collateralized by one aircraft on lease to US Airways, Inc., was guaranteed by the partnership, and bore an interest rate of three-month Libor plus 225 basis points. In December 1998, this loan facility was expanded by $5.0 million and the variable interest rate was lowered to 212.50 basis points over the three-month Libor when another aircraft leased to US Airways was added as additional collateral. At December 31, 1999 $1,783,000 was outstanding and approximately $5,937,000 was available under this facility. At December 31, 1998, $4,257,000 was outstanding.
A-9
Based upon amounts outstanding at December 31, 1999, the minimum future principal payments on all outstanding fixed-rate long-term notes payable are due as follows (in thousands):
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table presents carrying amounts and fair values of the partnership's financial instruments at December 31, 1999 and 1998. 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.
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 assumptions used in estimating the fair values of financial instruments:
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.
6. 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.
A-10
Amounts earned by the general partner and affiliates for the years ended December 31, 1999, 1998, and 1997, were as follows (in thousands):
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.
7. FEDERAL INCOME TAX STATUS
The Partnership is considered a publicly traded partnership ("PTP") under the Revenue Act of 1987. Under that Act, the partnership was not subject to federal income tax as a partnership until 1998. Effective January 1, 1998, PTP's were required to choose to retain PTP status and be subjected to federal income tax as a corporation or to delist their units thereby removing themselves from the scope of the PTP rules. Faced with these alternatives, the Partnership initially recommended that its units be delisted.
In August 1997, federal tax laws were amended to provide PTP's a third alternative. Under these amended laws, PTP's are allowed to continue to be publicly traded during 1998 and subsequent years without becoming subject to corporate income tax if they elect to pay a 3.5% federal tax on gross income.
The board of directors of the General Partner unanimously concluded, after authorization from the unitholders and consideration of a number of factors, including the 1997 tax law changes and the benefits of liquidity, that is was in the best interests of the unitholders for the partnership to remain publicly traded at that time. Accordingly, in January 1998 the partnership made an election to pay the annual gross income tax at the partnership level.
8. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING (ANAUDITED)
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.
A-11
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):
9. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of the quarterly results of operations for the years ended December 31, 1999 and 1998 (in thousands, except per unit amounts):
A-12
A-13
INDEX TO EXHIBITS
Exhibit No. Description
27. Financial Data Schedule.
A-14