UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from___to___
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Commission File No. 33-2794
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POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
State of Organization: California
IRS Employer Identification No. 94-2985086
201 Mission Street, 27th Floor, San Francisco, California 94105
Telephone - (415) 284-7400
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, and (2) has been subject to such filing
requirements for the past 90 days.
Yes_X_ No___
This document consists of 19 pages.
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
FORM 10-Q - For the Quarterly Period Ended March 31, 1996
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
a) Balance Sheets - March 31, 1996 and
December 31, 1995................................................3
b) Statements of Operations - Three Months Ended
March 31, 1996 and 1995..........................................4
c) Statements of Changes in Partners' Capital
(Deficit) - Year Ended December 31, 1995
and Three Months Ended March 31, 1996............................5
d) Statements of Cash Flows - Three Months
Ended March 31, 1996 and 1995....................................6
e) Notes to Financial Statements....................................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations................13
Part II. Other Information
Item 1. Legal Proceedings............................................16
Item 6. Exhibits and Reports on Form 8-K.............................18
Signature.............................................................19
2
Part 1. Financial Information
-----------------------------
Item 1. Financial Statements
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
BALANCE SHEETS
(Unaudited)
March 31, December 31,
1996 1995
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 27,457,989 $ 25,884,742
MARKETABLE SECURITIES, trading -- 2,356,506
RENT AND OTHER RECEIVABLES, net of
allowance for credit losses of $342,373 in 1996
and $241,964 in 1995 18,803 8,965
NOTES RECEIVABLE 2,988,372 2,679,486
AIRCRAFT, net of accumulated depreciation of
$93,800,555 in 1996 and $97,407,528 in 1995 72,581,766 76,487,365
AIRCRAFT INVENTORY 337,622 373,483
OTHER ASSETS 29,770 29,770
------------- -------------
$ 103,414,322 $ 107,820,317
============= =============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 75,172 $ 92,511
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 103,153 87,356
SECURITY DEPOSITS 75,000 450,000
MAINTENANCE RESERVES 179,185 179,185
DEFERRED INCOME 642,742 642,742
------------- -------------
Total Liabilities 1,075,252 1,451,794
------------- -------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (1,179,491) (1,139,155)
Limited Partners, 499,997 units
issued and outstanding 103,518,561 107,507,678
------------- -------------
Total Partners' Capital 102,339,070 106,368,523
------------- -------------
$ 103,414,322 $ 107,820,317
============= =============
The accompanying notes are an integral part of these statements.
3
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31,
----------------------------
1996 1995
---- ----
REVENUES:
Rent from operating leases $ 3,518,600 $ 1,633,500
Interest 392,225 289,964
Other 49,974 218,171
----------- -----------
Total Revenues 3,960,799 2,141,635
----------- -----------
EXPENSES:
Depreciation 3,009,927 2,920,383
Management fees to general partner 162,000 79,425
Provision for credit losses 100,409 --
Operating 75,502 14,023
Administration and other 59,108 60,053
----------- -----------
Total Expenses 3,406,946 3,073,884
----------- -----------
NET INCOME (LOSS) $ 553,853 $ (932,249)
=========== ===========
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 417,995 $ 115,664
=========== ===========
NET INCOME (LOSS) ALLOCATED
TO LIMITED PARTNERS $ 135,858 $(1,047,913)
=========== ===========
NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ 0.27 $ (2.10)
=========== ===========
The accompanying notes are an integral part of these statements.
4
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
(Unaudited)
Year Ended December 31, 1995 and
Three Months Ended March 31, 1996
---------------------------------
General Limited
Partner Partners Total
------- -------- -----
Balance, December 31, 1994 $ (1,119,868) $ 109,410,169 $ 108,290,301
Net income 744,597 4,972,468 5,717,065
Cash distributions to partners (763,884) (6,874,959) (7,638,843)
------------- ------------- -------------
Balance, December 31, 1995 (1,139,155) 107,507,678 106,368,523
Net income 417,995 135,858 553,853
Cash distributions to partners (458,331) (4,124,975) (4,583,306)
------------- ------------- -------------
Balance, March 31, 1996 $ (1,179,491) $ 103,518,561 $ 102,339,070
============= ============= =============
The accompanying notes are an integral part of these statements.
5
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,
----------------------------
1996 1995
---- ----
OPERATING ACTIVITIES:
Net income (loss) $ 553,853 $ (932,249)
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation 3,009,927 2,920,383
Provision for credit losses 100,409 -
Changes in operating assets and liabilities:
Decrease in marketable securities, trading 2,356,506 -
Decrease (increase) in rent and other
receivables (110,247) 64,925
Decrease in payable to affiliates (17,339) (658,537)
Increase in accounts payable and accrued
liabilities 15,797 26,446
Increase (decrease) in security deposits (375,000) 1,367
Increase in maintenance reserves - 47,984
----------- -----------
Net cash provided by operating activities 5,533,906 1,470,319
----------- -----------
INVESTING ACTIVITIES:
Principal payments on notes receivable 586,786 467,521
Net proceeds from sale of aircraft inventory 35,861 17,663
----------- -----------
Net cash provided by investing activities 622,647 485,184
----------- -----------
FINANCING ACTIVITIES:
Cash distributions to partners (4,583,306) (1,388,881)
----------- -----------
Net cash used in financing activities (4,583,306) (1,388,881)
----------- -----------
CHANGES IN CASH AND CASH
EQUIVALENTS 1,573,247 566,622
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 25,884,742 14,662,147
----------- -----------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $27,457,989 $15,228,769
=========== ===========
The accompanying notes are an integral part of these statements.
6
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Accounting Principles and Policies
In the opinion of management, the financial statements presented herein include
all adjustments, consisting only of normal recurring items, necessary to
summarize fairly Polaris Aircraft Income Fund II's (the Partnership's) financial
position and results of operations. The financial statements have been prepared
in accordance with the instructions of the Quarterly Report to the Securities
and Exchange Commission (SEC) Form 10-Q and do not include all of the
information and note disclosures required by generally accepted accounting
principles. These statements should be read in conjunction with the financial
statements and notes thereto for the years ended December 31, 1995, 1994, and
1993 included in the Partnership's 1995 Annual Report to the SEC on Form 10-K
(Form 10-K).
Aircraft and Depreciation - The aircraft are recorded at cost, which includes
acquisition costs. Depreciation to an estimated residual value is computed using
the straight-line method over the estimated economic life of the aircraft which
was originally estimated to be 30 years from the date of manufacture.
Depreciation in the year of acquisition was calculated based upon the number of
days that the aircraft were in service.
The Partnership periodically reviews the estimated realizability of the residual
values at the projected end of each aircraft's economic life based on estimated
residual values obtained from independent parties which provide current and
future estimated aircraft values by aircraft type. For any downward adjustment
in estimated residual value or decrease in the projected remaining economic
life, the depreciation expense over the projected remaining economic life of the
aircraft is increased.
If the projected net cash flow for each aircraft (projected rental revenue, net
of management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, an impairment
loss is recognized. Pursuant to Statement of Financial Accounting Standards
(SFAS) No. 121, as discussed below, measurement of an impairment loss will be
based on the "fair value" of the asset as defined in the statement.
Capitalized Costs - Aircraft modification and maintenance costs which are
determined to increase the value or extend the useful life of the aircraft are
capitalized and amortized using the straight-line method over the estimated
useful life of the improvement. These costs are also subject to periodic
evaluation as discussed above.
Financial Accounting Pronouncements - SFAS No. 107, "Disclosures about Fair
Value of Financial Instruments," requires the Partnership to disclose the fair
value of financial instruments. Cash and cash equivalents are stated at cost,
which approximates fair value. Marketable Securities, trading (Note 4) were
carried at fair value, which was determined based on quoted market prices. The
fair value of the Partnership's notes receivable is estimated by discounting
future estimated cash flows using current interest rates at which similar loans
would be made to borrowers with similar credit ratings and remaining maturities.
The carrying value of the note receivable from Continental Airlines, Inc.
(Continental) discussed in Note 2, the note receivable from ALG, Inc. (ALG)
discussed in Note 3, the note receivable from American International Airways,
Inc. (AIA) discussed in Note 6, and the note receivable from Westjet Airlines,
Ltd. (Westjet) discussed in Note 7 approximate their estimated fair value. The
7
carrying value of the line of credit note receivable from Viscount Air Services,
Inc. (Viscount) discussed in Note 5 approximates its estimated fair value as
this note is guaranteed by certain affiliates of Viscount. The carrying value of
the rents receivable from Viscount is zero due to a recorded allowance for
credit losses equal to the balance of the outstanding rents. As of March 31,
1996 and December 31, 1995, the estimated fair value of the rents receivable
from Viscount was also zero.
The Partnership adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," as of January 1,
1996. This statement requires that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Partnership estimates that this pronouncement will
not have a material impact on the Partnership's financial position or results of
operations unless events or circumstances change that would cause projected net
cash flows to be adjusted. No impairment loss was recognized by the Partnership
during the first quarter of 1996.
2. Continental and Continental Micronesia, Inc. (Continental Micronesia) Cost
Sharing Agreements
In accordance with the Continental and Continental Micronesia cost-sharing
agreements as discussed in the Form 10-K, in January 1994, the Partnership
financed $2,177,533 to Continental and Continental Micronesia for new image
modifications, which is being repaid with interest over the lease terms of the
three aircraft. The Partnership has received all scheduled principal and
interest payments due from Continental and Continental Micronesia through
September 30, 1995. The aggregate note receivable balance as of March 31, 1996
and December 31, 1995 was $1,163,785 and $1,289,328, respectively.
3. Promissory Note from ALG
One hushkit set from the aircraft formerly leased to Pan Am was sold in January
1993 to ALG for $1,750,000, which resulted in a gain of $259,809 in 1993. ALG
paid cash for a portion of the sales price and issued an 11% interest-bearing
promissory note for the balance of $1,132,363, which specified 23 equal monthly
payments and a balloon payment of $897,932 due in January 1995. ALG paid to the
Partnership $19,138 of the balloon payment in January 1995, originating an event
of default under the note. The Partnership and ALG subsequently restructured the
terms of the promissory note. The renegotiated terms specify payment by ALG of
the note balance with interest at a rate of 13% per annum with one lump sum
payment in January 1995 of $254,733, eleven monthly payments of $25,600
beginning in February 1995, and a balloon payment in January 1996 of $416,631.
In January 1996, the Partnership and ALG once again restructured the terms of
the promissory note. The renegotiated terms specify payment by ALG of the note
balance with interest at a rate of 13% per annum with a lump sum payment in
January 1996 of $135,258 and eleven payments of $27,272 beginning in February
1996 through December 1996. ALG is current on the renegotiated payments. The
note receivable balances as of March 31, 1996 and December 31, 1995 were
$232,663 and $412,166, respectively.
4. Trans World Airlines, Inc. (TWA) Reorganization
As discussed in the Form 10-K, the Partnership renegotiated the TWA leases after
TWA defaulted under its leases with the Partnership during 1991. The
renegotiated agreement stipulated that the Partnership share in the costs of
certain Airworthiness Directives after TWA successfully reorganized. Pursuant
8
to this cost-sharing agreement, since TWA emerged from its reorganization
proceedings in 1993, expenses totaling $6.3 million ($2.7 million in 1993 and
$3.6 million in 1994) have been offset against rental payments. Under the terms
of the TWA cost-sharing agreement, TWA may offset up to an additional $2.7
million against rental payments, subject to annual limitations, over the
remaining lease terms of the aircraft.
In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, GE Capital Aviation
Services, Inc. (GECAS) negotiated a standstill arrangement, as set forth in a
letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for
the 46 aircraft that are managed by GECAS, 18 of which are owned by the
Partnership. As required by its terms, the Deferral Agreement (which has since
been amended as discussed below) was approved by Polaris Investment Management
Corporation (PIMC) on behalf of the Partnership with respect to the
Partnership's aircraft.
The Deferral Agreement provided for (i) a moratorium on all the rent due to the
Partnership in November 1994 and on 75% of the rents due to the Partnership from
December 1994 through March 1995, and (ii) all of the deferred rents, together
with interest thereon, to be repaid in monthly installments beginning in May
1995 and ending in December 1995. The repayment schedule was subsequently
accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not
recognize either the $1.575 million rental amount deferred in 1994 or the $2.025
million rental amount deferred during the first quarter of 1995 as rental
revenue until the deferred rents were received. The deferred rents were paid in
full by October 1995.
In consideration for the partial rent moratorium described above, TWA agreed to
make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom
GECAS provides management services and who agreed to the Deferral Agreement. The
Partnership received $218,171 in January 1995 as its pro-rata share of such
payment by TWA. This amount was recognized as other revenue in the accompanying
statement of operations for the three months ended March 31, 1995. In addition,
TWA agreed to issue warrants to the Partnership for TWA Common Stock.
In order to resolve certain issues that arose after the execution of the
Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27,
1995, pursuant to which they agreed to amend certain provisions of the Deferral
Agreement (as so amended, the Amended Deferral Agreement). The effect of the
Amended Deferral Agreement, which was approved by PIMC with respect to the
Partnership's aircraft, is that TWA, in addition to agreeing to repay the
deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable
in warrants, the number of which was determined by a formula) in consideration
for the aircraft owners' agreement to defer rent under the Deferral Agreement,
and, (ii) to the extent the market value of the warrants is less than the
payment amount, to supply maintenance services to the aircraft owners having a
value equal to such deficiency. The payment amount was determined by subtracting
certain maintenance reimbursements owed to TWA by certain aircraft owners,
including the Partnership, from the aggregate amount of deferred rents. The
amount of such maintenance reimbursement has not been finally determined.
The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995. The Partnership exercised the warrants on December
29, 1995 for the strike price of $0.01 per share. The fair market value of the
TWA stock at December 31, 1995 of $2,356,506 is reflected in the accompanying
December 31, 1995 balance sheet. The Partnership sold the TWA Common Stock by
February 1996, net of broker commissions, for $2,406,479 and recognized a gain
on trading securities of $49,974 during the first quarter of 1996.
9
5. Viscount Default and Bankruptcy Filing
As discussed in the Form 10-K, in July 1994, the Partnership entered into a
restructuring agreement with Viscount to defer certain rents due the Partnership
which aggregated $196,800; to extend a line of credit to Viscount for a total of
$127,000 to be used primarily for maintenance expenses relating to the
Partnership's aircraft; and to give the Partnership the option to acquire
approximately 0.6% of the issued and outstanding shares of Viscount stock as of
July 26, 1994 for an option price of approximately $91,000. It was not
practicable to estimate the fair value of the stock options as of March 31,
1996, as they are not publicly traded, although Viscount's recent bankruptcy
filing (as discussed below) would have an adverse impact on the value of the
stock options, if any.
The deferred rents, which were being repaid by Viscount with interest at a rate
of 6% per annum over the remaining terms of the leases, were recognized as
revenue in the period earned. The unpaid balances of the deferred rents as of
March 31, 1996 and December 31, 1995, before the allowance for credit losses as
discussed below, was $130,511. The line of credit, which was advanced to
Viscount during 1994, was being repaid by Viscount over a 30- month period,
beginning in January 1995, with interest at a rate of 11.53% per annum. The line
of credit balance, which is reflected in notes receivable in the March 31, 1996
and December 31, 1995 balance sheets, was $88,641.
During 1995, the Partnership had been in discussions with Viscount to
restructure additional existing financial obligations of Viscount to the
Partnership. While such discussions were underway, Viscount had undertaken to
pay in full, by the end of each month, beginning in June 1995, the current
month's obligations by making partial periodic payments during that month.
Viscount is presently in default on its financial obligations to the
Partnership. On December 13, 1995, the Partnership issued a notice of default to
Viscount demanding, within 10 days, full payment of all delinquent amounts due
the Partnership. On January 9, 1996, Viscount was notified that the Partnership
had elected to terminate the lease (which is disputed by Viscount) and the
Partnership demanded return of the aircraft. On January 24, 1996, Viscount filed
a petition for protection under Chapter 11 of the United States Bankruptcy Code
in the United States Bankruptcy Court in Tucson, Arizona. Legal counsel has been
retained and the general partner is evaluating the rights, remedies and courses
of action available to the Partnership with respect to Viscount's default and
bankruptcy filing. The Partnership has received no additional payments from
Viscount during the first quarter of 1996. As a result of Viscount's defaults
and Chapter 11 bankruptcy filing, the Partnership may incur additional legal
costs and maintenance, remarketing and transition costs related to the
Partnership's aircraft and engines, which cannot be estimated at this time. The
outcome of Viscount's Chapter 11 proceeding cannot be predicted.
During 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance
facility located in Arizona, to perform a heavy maintenance check on the
aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000
from maintenance reserves and cash reserves for this aircraft as progress
payments on this maintenance check. Work on the maintenance check was suspended
prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace
asserts that Viscount owes it approximately $866,000 for work done on the
aircraft, which is in addition to the approximately $565,000 already paid by the
Partnership from maintenance reserves. The aircraft is currently in the
possession of Tucson Aerospace and it may assert a lien against the aircraft to
secure payment of its claim. In addition, a third party vendor, who claims it
provided personnel to work on the aircraft, is asserting a claim against Tucson
Aerospace and a lien against the aircraft in the amount of $720,000. Another
third-party vendor, who claims it provided inspectors, is claiming $185,000 from
Tucson Aerospace. The Partnership has been in discussions with the various
10
parties to resolve these disputes and is currently evaluating all of its
options, including alternative procedures to obtain repossession of this
aircraft.
One of the Partnership's Boeing 737-200 commercial jet aircraft was on lease to
Viscount prior to the lease termination notification. As of March 31, 1996, the
Partnership's aggregate rent, maintenance reserve, loan and interest receivable
from Viscount was approximately $466,000. All amounts due from Viscount may be
affected by Viscount's filing for protection under Chapter 11.
The balance of the line of credit advanced to Viscount in 1994 of $88,641 at
March 31, 1996 and December 31, 1995, plus accrued interest, is guaranteed by
certain affiliates of the principal shareholder of Viscount. An allowance for
credit losses has not been provided for this note. The Partnership has recorded
an allowance for credit losses for the remaining unsecured receivable balances
from Viscount for the aggregate of the unpaid rents, outstanding deferred rent
balance and accrued interest of $342,373 as of March 31, 1996. Viscount's
failure to perform on its financial obligations with the Partnership is expected
to have an adverse effect on the Partnership's financial position. Note 9
contains an additional discussion of the Viscount situation subsequent to March
31, 1996.
6. Sale of Aircraft to AIA
The Partnership sold one Boeing 727-200 aircraft and hushkit, formerly leased to
Delta Airlines Inc. (Delta), to AIA in February 1995 for a sales price of
$1,771,805. The Partnership recorded no gain or loss on the sale as the sales
price equaled the net book value of the aircraft and hushkit. The Partnership
agreed to accept payment of the sales price in 36 monthly installments of
$55,000, with interest at a rate of 7.5% per annum, beginning in March 1995. The
Partnership recorded a note receivable for the sales price and has received all
scheduled principal and interest payments due from AIA through March 31, 1996,
including one additional principal payment of $410,229 received in May 1995. The
note receivable balance as of March 31, 1996 and December 31, 1995 was $740,096
and $889,351, respectively.
7. Sale of Boeing 737-200 Combi Airframe and Engine
In March 1996, the Partnership sold the airframe and one engine from the Boeing
737-200 Combi Aircraft, formerly on lease to Northwest Territorial Airways,
Ltd., to Westjet. The security deposit of approximately $88,000 received from
Westjet in December 1995 was applied to the sales price of approximately
$896,000. The Partnership recorded no gain or loss on the sale as the sales
price equaled the net book value of the airframe and engine. The Partnership
agreed to accept payment of the balance of the sales price in 22 monthly
installments, with interest at a rate of 10% per annum, beginning in March 1996.
Westjet is current on its scheduled payments to the Partnership. The note
receivable balance as of March 31, 1996 was $763,187.
8. Related Parties
Under the Limited Partnership Agreement, the Partnership paid or agreed to pay
the following amounts for the current quarter to the general partner, PIMC, in
connection with services rendered or payments made on behalf of the Partnership:
11
Payments for
Three Months Ended Payable at
March 31, 1996 March 31, 1996
-------------- --------------
Aircraft Management Fees $162,000 $ --
Out-of-Pocket Administrative Expense
Reimbursement 97,624 63,209
Out-of-Pocket Operating and
Remarketing Expense Reimbursement 38,526 11,963
-------- --------
$298,150 $ 75,172
======== ========
9. Subsequent Event
Viscount Chapter 11 Bankruptcy - On or about April 15, 1996, GE Capital Aviation
Services, Inc. (GECAS), on behalf of Polaris Holding Company, Polaris Aircraft
Income Fund I, Polaris Aircraft Income Fund IV, and Polaris Aircraft Investors
XVIII (collectively, Polaris Entities), First Security Bank of Utah, National
Association, the owner/trustee under a number of the leases, Viscount, and other
parties executed a Compromise of Claims and Stipulation under Section 1110 of
the United States Bankruptcy Code (the Compromise and Stipulation). The
Compromise and Stipulation, which remains subject to court approval, provides,
among other things that Viscount will reject the lease of the Partnership's
aircraft. The rejection of the lease will give rise to a prepetition unsecured
claim in Viscount's bankruptcy for breach of contract damages. In addition,
Viscount has agreed to cooperate with the Partnership in recovering possession
of the aircraft from Tucson Aerospace, where it had been undergoing certain
maintenance checks. Various liens have been asserted against the aircraft and
the claims of such lienholders have not yet been settled or resolved.
The Compromise and Stipulation also provides that Viscount will deliver to the
Partnership an interest bearing note (the Aircraft Note), having administrative
priority status, in an amount equal to the net present value of all rent due
under the lease of aircraft from April 1, 1996 through the date that is four
calendar months from the date possession of the Partnership's aircraft is
delivered to GECAS on behalf of the Partnership. In any month in which the
Partnership receives rent for the use of the aircraft, the principal amount of
the Aircraft Note shall be reduced by the amount of such rent received, not to
exceed $45,000 per month. The Aircraft Note will mature on November 30, 1997,
with any remaining principal then becoming due and payable by Viscount. In
addition, the Compromise and Stipulation provides that: (i) an assignment from
certain of Viscount's guarantors under the Restructuring and Loan Agreement
(Loan Agreement), dated July 20, 1994, of security interests in Viscount assets
that will provide further security for Viscount's indebtedness to the
Partnership under the Loan Agreement; (ii) a release by Viscount of claims
against GECAS, the Partnership and the Polaris Entities; and (iii) a release by
GECAS the Partnership and the Polaris Entities of Viscount's guarantors with
respect to the Loan Agreement (the guarantor's collateral for the obligations on
the line of credit are being substituted by the assignments referenced in (i)
above).
A hearing to consider approval of the Compromise and Stipulation has been
scheduled for May 14, 1996. The Partnership's claim for rejection damages under
the lease and amounts due under the Loan Agreement will be treated under
Viscount's plan of reorganization, which must be filed by June 30, 1996, and
confirmed by September 30, 1996.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Polaris Aircraft Income Fund II (the Partnership) owns a portfolio of 22 used
commercial jet aircraft, one spare engine and certain inventoried aircraft parts
out of its original portfolio of 30 aircraft. The portfolio consists of 17
McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft
leased to Trans World Airlines, Inc. (TWA); one Boeing 737-200 aircraft,
previously leased to Viscount Air Services, Inc. (Viscount) which has filed for
Chapter 11 bankruptcy protection in January 1996, as discussed below, is
currently in the possession of Tucson Aerospace, a maintenance facility located
in Arizona; two Boeing 727-200 Advanced aircraft leased to Continental
Micronesia, Inc. (Continental Micronesia); and one Boeing 727-200 Advanced
aircraft leased to Continental Airlines, Inc. (Continental). The Partnership
transferred six Boeing 727-200 aircraft, previously leased to Pan American World
Airways, Inc., to aircraft inventory in 1992. These aircraft have been
disassembled for sale of their component parts. The Partnership sold one Boeing
727-200 aircraft, formerly leased to Delta Airlines, Inc., in February 1995. The
Partnership sold the airframe and one engine from the Boeing 737-200 Combi
aircraft, formerly leased to Northwest Territorial Airways, Ltd., in March 1996
as discussed below. The Partnership is currently remarketing the remaining
engine for sale.
Partnership Operations
The Partnership recorded net income of $553,853, or $0.27 per limited
partnership unit, for the three months ended March 31, 1996, compared to a net
loss of $932,249, or $2.10 per unit, for the same period in 1995. The net loss
for the three months ended March 31, 1995 resulted primarily from a decrease in
rental revenue recognized during the first three months of 1995 on the
Partnership's leases with TWA. In December 1994, GE Capital Aviation Services,
Inc. (GECAS) negotiated a standstill agreement with TWA. That agreement provided
for a deferral of the rent due the Partnership in November 1994 and 75% of the
rents due the Partnership from December 1994 through March 1995. The Partnership
did not recognize the deferred rent as rental revenue until it was received,
including $2,025,000 deferred in the first three months of 1995.
In consideration for the rent deferral, TWA agreed to make a lump sum payment of
$1,000,000 to GECAS for the TWA lessors for whom GECAS provides management
services and who agreed to the Deferral Agreement. The Partnership received
$218,171 in January 1995 as its pro-rata share of such payment by TWA. This
amount was recognized as other revenue in the first quarter of 1995. In
addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock.
The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995 and exercised the warrants on December 29, 1995. The
Partnership sold the TWA Common Stock by February 1996, net of broker
commissions, for $2,406,479 and recognized a gain on trading securities of
$49,974 during the first quarter of 1996.
Liquidity and Cash Distributions
Liquidity - The Partnership received all lease payments due from Continental,
Continental Micronesia and TWA. As discussed above, the Partnership received
from TWA warrants to purchase 227,133 shares of TWA Common Stock in
consideration for the rent deferral. The Partnership exercised the warrants in
1995 and sold the TWA Common Stock in the first quarter of 1996, net of broker
commissions, for $2,406,479.
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As discussed below, prior to January 1, 1996, the Partnership had been in
discussions with Viscount to restructure certain of Viscount's existing
financial obligations to the Partnership. While such discussions were underway,
Viscount had undertaken to pay in full, by the end of each month, beginning in
June 1995, the current month's obligations by making partial periodic payments
during that month. Viscount is presently in default on its financial obligations
to the Partnership, and as discussed below, the aircraft Viscount was leasing is
currently in the possession of a maintenance facility located in Arizona. On
January 24, 1996, Viscount filed a petition for protection under Chapter 11 of
the United States Bankruptcy Code in the United States Bankruptcy Court in
Tucson, Arizona. Legal counsel has been retained and the general partner is
evaluating the rights, remedies and courses of action available to the
Partnership with respect to Viscount's default and bankruptcy filing. All
amounts due from Viscount may be affected by Viscount's filing for protection
under Chapter 11.
As of March 31, 1996, Viscount's defaults with the Partnership aggregated
approximately $570,000. Viscount's failure to perform on its financial
obligations with the Partnership is expected to have an adverse effect on the
Partnership's financial position. As a result of Viscount's defaults and Chapter
11 bankruptcy filing, the Partnership has incurred legal costs of approximately
$49,000 and may incur maintenance, remarketing, transition and additional legal
costs related to the Partnership's aircraft. A further discussion of the
Viscount situation is included in the Legal Proceedings section (Part II, Item
1).
As discussed in Note 4 to the financial statements, the Partnership agreed to
share in the cost of meeting certain Airworthiness Directives (ADs) with TWA. In
accordance with the cost- sharing agreement, TWA may offset up to an additional
$2.7 million against rental payments, subject to annual limitations, over the
remaining lease terms.
As specified in the Partnership's leases with Continental Micronesia and
Continental, in January 1994, the Partnership reimbursed Continental (partially
on behalf of its affiliate Continental Micronesia) an aggregate of $1.8 million
for cockpit modifications and $742,325 for C-check labor and parts for the three
aircraft. In addition, in January 1994, the Partnership financed an aggregate of
$2,177,533 for new image modifications, which is being repaid with interest over
the terms of the aircraft leases. The leases with Continental and Continental
Micronesia also stipulate that the Partnership share in the cost of meeting
certain ADs, which cannot be estimated at this time.
ALG, Inc. (ALG) was scheduled to pay the Partnership a balloon payment of
$416,631 in January 1996 on their promissory note. ALG did not pay the balloon
payment due in January 1996 and the Partnership and ALG restructured the terms
of the promissory note. The renegotiated terms specify payment by ALG of the
note balance with interest at a rate of 13% per annum with one lump sum payment
in January 1996 of $135,258 and eleven payments of $27,272 beginning in February
1996 through December 1996. ALG is current on the renegotiated payments.
The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA
in February 1995 as previously discussed. The agreement with AIA specifies
payment of the sales price in 36 monthly installments of $55,000 beginning in
March 1995. The Partnership has received all scheduled payments due from AIA.
In March 1996, the Partnership sold the airframe and one engine from its Boeing
737-200 Combi aircraft to Westjet Airlines, Ltd. (Westjet). The Partnership
received a security deposit of approximately $88,000 from Westjet in December
1995 which was applied to the sales price of approximately $896,000. The
Partnership agreed to accept payment of the balance of the sales price in 22
monthly installments, with interest at a rate of 10% per annum beginning in
March 1996. The Partnership has received all scheduled payments from Westjet.
14
The Partnership receives maintenance reserve payments from certain of its
lessees that may be reimbursed to the lessee or applied against certain costs
incurred by the Partnership for maintenance work performed on the Partnership's
aircraft, as specified in the leases. Maintenance reserve balances, if any,
remaining at the termination of the lease may be used by the Partnership to
offset future maintenance expenses or recognized as revenue. The net maintenance
reserves balances aggregate $179,185 as of March 31, 1996.
Payments of $35,861 have been received during the first quarter of 1996 from the
sale of inventoried parts from the six disassembled aircraft and have been
applied against aircraft inventory. The net book value of the Partnership's
aircraft inventory was $337,622 as of March 31, 1996. The Partnership is
retaining cash reserves to meet obligations under the TWA, Continental and
Continental Micronesia lease agreements and to cover the costs that the
Partnership may incur relating to the Viscount default and bankruptcy filing,
including additional legal costs, potential aircraft maintenance, remarketing
and transition costs.
Cash Distributions - Cash distributions to limited partners during the three
months ended March 31, 1996 and 1995 were $4,124,975, or $8.25 per limited
partnership unit and $1,249,993 or $2.50 per unit, respectively. The timing and
amount of future cash distributions are not yet known and will depend on the
Partnership's future cash requirements including the costs that will be incurred
relating to the Viscount default and bankruptcy; the receipt of rental payments
from TWA, Continental and Continental Micronesia; the receipt of modification
financing payments from Continental and Continental Micronesia; and the receipt
of sales proceeds from AIA and Westjet, renegotiated promissory note payments
from ALG, payments generated from the aircraft disassembly process, and current
and delinquent lease and loan payments from Viscount.
15
Part II. Other Information
Item 1. Legal Proceedings
As discussed in Item 3 of Part I of Polaris Aircraft Income Fund II's (the
Partnership) 1995 Annual Report to the Securities and Exchange Commission (SEC)
on Form 10-K (Form 10-K), there are a number of pending legal actions or
proceedings involving the Partnership. Except as described below, there have
been no material developments with respect to any such actions or proceedings
during the period covered by this report.
Viscount Air Services, Inc. (Viscount) Bankruptcy - On January 24, 1996,
Viscount filed a petition for protection under Chapter 11 of the United States
Bankruptcy Code in the United States Bankruptcy Court for the District of
Arizona. The Partnership leases one aircraft to Viscount. In addition, Polaris
Holding Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund
IV, and Polaris Aircraft Investors XVIII (collectively, Polaris Entities) lease
a total of nine other aircraft and a spare engine to Viscount. GE Capital
Aviation Services, Inc. (GECAS), on behalf of the Partnership and the Polaris
Entities, delivered a letter of termination to Viscount prepetition, notifying
Viscount of the termination of the aircraft and engine leases. Viscount disputes
the effectiveness of the termination and currently has possession of the
aircraft and engines. Pursuant to various agreements between Viscount and the
Polaris Entities, the aggregate outstanding obligations between Viscount and the
Polaris Entities is estimated to be approximately $11.5 million, of which
approximately $570,000 represents indebtedness to the Partnership.
As of March 31, 1996, Viscount was in default of its obligations under the lease
in the approximate amount of $351,000. In addition, Viscount is indebted to the
Partnership under a Restructuring and Loan Agreement (Loan Agreement), dated
July 20, 1994, for amounts related to a line of credit and deferred rent
obligations under the lease. As of March 31, 1996, Viscount was indebted to the
Partnership in the approximate amount of $88,000 on the line of credit and
$131,000 on deferred rent obligations. Viscount's total outstanding obligations
to the Partnership as of March 31, 1996, is approximately $570,000.
On or about April 15, 1996, GECAS, on behalf of the Polaris Entities, First
Security Bank of Utah, National Association, the owner/trustee under a number of
the leases, Viscount, and other parties executed a Compromise of Claims and
Stipulation under Section 1110 of the United States Bankruptcy Code (the
Compromise and Stipulation). The Compromise and Stipulation, which remains
subject to court approval, provides, among other things that Viscount will
reject the lease of the Partnership's aircraft. The rejection of the lease will
give rise to a prepetition unsecured claim in Viscount's bankruptcy for breach
of contract damages. In addition, Viscount has agreed to cooperate with the
Partnership in recovering possession of the aircraft from Tucson Aerospace,
where it had been undergoing certain maintenance checks. Various liens have been
asserted against the aircraft that have not yet been settled or resolved.
The Compromise and Stipulation also provides that Viscount will deliver to the
Partnership an interest bearing note (the Aircraft Note), having administrative
priority status, in an amount equal to the net present value of all rent due
under the lease of aircraft from April 1, 1996 through the date that is four
calendar months from the date possession of the Partnership's aircraft is
delivered to GECAS on behalf of the Partnership. In any month in which the
Partnership receives rent for the use of the aircraft, the principal amount of
the Aircraft Note shall be reduced by the amount of such rent received, not to
exceed $45,000 per month. The Aircraft Note will mature on November 30, 1997,
with any remaining principal then becoming due and payable by Viscount. In
addition, the Compromise and Stipulation provides that: (i) an assignment from
certain of Viscount's guarantors under the Loan Agreement of security interests
in Viscount assets that will provide further security for Viscount's
indebtedness to the Partnership under the Loan Agreement; (ii) a release by
Viscount of claims against GECAS, the Partnership and the Polaris Entities; and
(iii) a release by GECAS the Partnership and the Polaris Entities of Viscount's
16
guarantors with respect to the Loan Agreement (the guarantor's collateral for
the obligations on the line of credit are being substituted by the assignments
referenced in (i) above).
A hearing to consider approval of the Compromise and Stipulation has been
scheduled for May 14, 1996. The Partnership's claim for rejection damages under
the lease and amounts due under the Loan Agreement will be addressed under
Viscount's plan of reorganization, which must be filed by June 30, 1996, and
confirmed by September 30, 1996.
Other Proceedings - Item 10 in Part III of the Partnership's 1995 Form 10-K
discusses certain actions which have been filed against Polaris Investment
Management Corporation and others in connection with the sale of interests in
the Partnership and the management of the Partnership. With the exception of
Novak, et al v. Polaris Holding Company, et al, (which has been dismissed as
discussed in Item 10 of the Partnership's 1995 Form 10-K) where the Partnership
was named as a defendant for procedural purposes, the Partnership is not a party
to these actions. There have been no material developments with respect to any
of the actions described therein during the period covered by this report, but
the following new proceedings have been commenced.
In or around December 1994, a complaint entitled John J. Jones, Jr. v.
Prudential Securities Incorporated et al., was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company and General Electric
Capital Corporation. Plaintiff alleges claims of tort, breach of fiduciary duty
in tort, contract and quasi-contract, violation of sections of the Louisiana
Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement
and solicitation of purchases arising out of the public offering of Polaris
Aircraft Income Fund III. Plaintiff seeks compensatory damages, attorneys' fees,
interest, costs and general relief. The Partnership is not named as a defendant
in this action.
On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v.
General Electric Company, et al., was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint named as defendants General
Electric Company and General Electric Capital Corporation. Plaintiffs allege
claims of tort, breach of fiduciary duty in tort, contract and quasi-contract,
violation of sections of the Louisiana Blue Sky Law and violation of the
Louisiana Civil Code concerning the inducement and solicitation of purchases
arising out of the public offering of Polaris Aircraft Income Funds III and IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief. The Partnership is not named as a defendant in this action.
On or about April 9, 1996, a summons and First Amended Complaint entitled Sara
J. Bishop, et al. v. Kidder Peabody & Co., et al. was filed in the Superior
Court of the State of California, County of Sacramento, by over one hundred
individual plaintiffs who purchased limited partnership units in Polaris
Aircraft Income Funds III, IV, V and VI and other limited partnerships sold by
Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP
Realty Advisors, Inc., Polaris Holding Company, Polaris Aircraft Leasing
Corporation, Polaris Investment Management Corporation, Polaris Securities
Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc.,
General Electric Company, General Electric Financial Services, Inc., General
Electric Capital Corporation, General Electric Credit Corporation and DOES 1-100
as defendants. The complaint alleges violations of state common law, including
fraud, negligent misrepresentation, breach of fiduciary duty, and violations of
the rules of the National Association of Securities Dealers. The complaint seeks
to recover compensatory damages and punitive damages in an unspecified amount,
17
interest, and rescission with respect to the Polaris Aircraft Income Funds
III-VI and all other limited partnerships alleged to have been sold by Kidder
Peabody to the plaintiffs. The Partnership is not named as a defendant in this
action.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
27. Financial Data Schedule (Filed electronically only)
b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter for
which this report is filed.
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SIGNATURE
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.
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
(Registrant)
By: Polaris Investment
Management Corporation,
General Partner
May 8, 1996 By: /S/Marc A. Meiches
- --------------------------- ------------------
Mark A. Meiches
Chief Financial Officer
(principal financial officer and
principal accounting officer of
Polaris Investment Management
Corporation, General Partner of
the Registrant)
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