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 September 30, 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.
<PAGE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
FORM 10-Q - For the Quarterly Period Ended September 30, 1996
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
a) Balance Sheets - September 30, 1996 and
December 31, 1995...........................................3
b) Statements of Operations - Three and Nine Months
Ended September 30, 1996 and 1995...........................4
c) Statements of Changes in Partners' Capital
(Deficit) - Year Ended December 31, 1995
and Nine Months Ended September 30, 1996....................5
d) Statements of Cash Flows - Nine Months
Ended September 30, 1996 and 1995...........................6
e) Notes to Financial Statements...............................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...........14
Part II. Other Information
Item 1. Legal Proceedings.......................................17
Item 5. Other Information.......................................18
Item 6. Exhibits and Reports on Form 8-K........................18
Signature ........................................................19
2
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Part 1. Financial Information
-----------------------------
Item 1. Financial Statements
<TABLE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
BALANCE SHEETS
(Unaudited)
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
ASSETS:
CASH AND CASH EQUIVALENTS $ 27,075,573 $ 25,884,742
MARKETABLE SECURITIES, trading -- 2,356,506
RENT AND OTHER RECEIVABLES, net of allowance
for credit losses of $0 in 1996 and $241,964 in 1995 9,876 8,965
NOTES RECEIVABLE 1,980,828 2,679,486
AIRCRAFT, net of accumulated depreciation of
$100,120,408 in 1996 and $97,407,528 in 1995 66,261,913 76,487,365
AIRCRAFT INVENTORY 169,537 373,483
OTHER ASSETS 29,770 29,770
------------- -------------
$ 95,527,497 $ 107,820,317
============= =============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 79,747 $ 92,511
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 176,870 87,356
SECURITY DEPOSITS 50,000 450,000
MAINTENANCE RESERVES 240,091 179,185
DEFERRED INCOME 642,742 642,742
------------- -------------
Total Liabilities 1,189,450 1,451,794
------------- -------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (1,259,583) (1,139,155)
Limited Partners, 499,997 units
issued and outstanding 95,597,630 107,507,678
------------- -------------
Total Partners' Capital 94,338,047 106,368,523
------------- -------------
$ 95,527,497 $ 107,820,317
============= =============
The accompanying notes are an integral part of these statements.
</TABLE>
3
<PAGE>
<TABLE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF OPERATIONS
(Unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
1996 1995 1996 1995
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Rent from operating leases $ 3,430,000 $ 5,303,518 $10,368,600 $11,356,873
Interest 384,612 457,691 1,168,907 1,210,902
Claims related to lessee defaults -- -- 567,500 --
Other -- 91,093 49,974 310,224
----------- ----------- ----------- -----------
Total Revenues 3,814,612 5,852,302 12,154,981 12,877,999
----------- ----------- ----------- -----------
EXPENSES:
Depreciation 3,309,927 2,992,188 9,329,780 8,704,759
Management fees to general partner 162,500 250,689 486,500 539,568
Provision for credit losses 92,508 -- 192,917 --
Operating 57,997 25,643 210,047 50,115
Administration and other 63,968 79,290 216,296 222,135
----------- ----------- ----------- -----------
Total Expenses 3,686,900 3,347,810 10,435,540 9,516,577
----------- ----------- ----------- -----------
NET INCOME $ 127,712 $ 2,504,492 $ 1,719,441 $ 3,361,422
=========== =========== =========== ===========
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 413,733 $ 150,032 $ 1,254,563 $ 408,574
=========== =========== =========== ===========
NET INCOME (LOSS) ALLOCATED
TO LIMITED PARTNERS $ (286,021) $ 2,354,460 $ 464,878 $ 2,952,848
=========== =========== =========== ===========
NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ (0.57) $ 4.71 $ 0.93 $ 5.90
=========== =========== =========== ===========
The accompanying notes are an integral part of these statements.
</TABLE>
4
<PAGE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
(Unaudited)
Year Ended December 31, 1995 and
Nine Months Ended September 30, 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 1,254,563 464,878 1,719,441
Cash distributions to partners (1,374,991) (12,374,926) (13,749,917)
------------- ------------- -------------
Balance, September 30, 1996 $ (1,259,583) $ 95,597,630 $ 94,338,047
============= ============= =============
The accompanying notes are an integral part of these statements.
5
<PAGE>
<TABLE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
OPERATING ACTIVITIES:
Net income $ 1,719,441 $ 3,361,422
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 9,329,780 8,704,759
Net provision for credit losses (153,323) --
Changes in operating assets and liabilities:
Decrease in marketable securities, trading 2,356,506 --
Decrease in rent and other receivables 241,053 32,878
Increase in other assets -- (55,647)
Decrease in payable to affiliates (12,764) (456,481)
Increase in accounts payable and accrued liabilities 89,514 47,260
Increase (decrease) in security deposits (400,000) 4,293
Increase (decrease) in maintenance reserves 60,906 (146,544)
------------ ------------
Net cash provided by operating activities 13,231,113 11,491,940
------------ ------------
INVESTING ACTIVITIES:
Principal payments on notes receivable 1,505,689 1,534,490
Net proceeds from sale of aircraft inventory 203,946 220,816
------------ ------------
Net cash provided by investing activities 1,709,635 1,755,306
------------ ------------
FINANCING ACTIVITIES:
Cash distributions to partners (13,749,917) (4,166,642)
------------ ------------
Net cash used in financing activities (13,749,917) (4,166,642)
------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS 1,190,831 9,080,604
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 25,884,742 14,662,147
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 27,075,573 $ 23,742,751
============ ============
The accompanying notes are an integral part of these statements.
</TABLE>
6
<PAGE>
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.
7
<PAGE>
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 two quarters of 1996.
As discussed in Note 5, the Partnership completed its evaluation on the airframe
and engines which were returned to the Partnership by Viscount Air Services,
Inc. (Viscount) to determine if a potential re-lease or sale of this equipment
would maximize its economic return to the Partnership. The Partnership estimates
that maintenance and refurbishment costs aggregating approximately $1.6 million
will be required if the Partnership decides to re-lease rather than sell the
aircraft. Alternatively, if the Partnership decides to sell rather than re-lease
the aircraft, such sale would likely be made on an "as is, where is" basis,
without the Partnership incurring substantial maintenance costs. As a result of
this evaluation, the Partnership estimates that a sale of the aircraft on an "as
is, where is" basis would maximize the economic return on the aircraft to the
Partnership. Previous estimates of cash flow for this aircraft were based on the
projected re-lease of the aircraft through its estimated economic life. As a
result of the adjustment to the estimated cash flows, in accordance with SFAS
No. 121, the Partnership recognized an impairment loss of $300,000 for the
aircraft during the third 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. The aggregate
note receivable balance as of September 30, 1996 and December 31, 1995 was
$904,056 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. 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 September 30, 1996 and
December 31, 1995 were $80,074 and $412,166, respectively.
8
<PAGE>
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 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 income for the nine months ended September 30, 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
9
<PAGE>
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.
5. Viscount Default and Bankruptcy Filing
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. In April 1996, GE Capital Aviation Services, Inc. (GECAS), on
behalf of the Partnership, First Security Bank, National Association (formerly
known as First Security Bank of Utah, National Association) (FSB), the
owner/trustee under the Partnership's leases with Viscount (the Leases),
Viscount, certain guarantors of Viscount's indebtedness and others executed in
April 1996 a Compromise of Claims and Stipulation under Section 1110 of the
Bankruptcy Code (the Compromise and Stipulation), which was subsequently
approved by the Bankruptcy Court. The Compromise and Stipulation provided, among
other things, that Viscount rejected the lease of the Partnership's aircraft.
The rejection of the lease gave rise to a prepetition unsecured claim in
Viscount's bankruptcy for breach of contract damages. Notwithstanding Viscount's
rejection of the Partnership's aircraft lease, Viscount continued to possess and
use the Partnership's engine and refused to return various aircraft parts
removed from the Partnership's aircraft.
During 1995, Viscount delivered the Partnership's Boeing 737-200 aircraft to a
repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace, 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. 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. On May 22, 1996, First Security Bank, National Association (formerly
known as First Security Bank of Utah, National Association) (FSB), as
owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to
recover the airframe from BAE Aviation, Inc. and certain creditors alleging
mechanics liens and to determine the validity of the claimed liens.
Pursuant to a stipulated order of the Superior Court entered on July 9, 1996,
FSB filed a bond in the penal sum of $1,371,000 for the benefit of the
lienholders, who subsequently released the aircraft to the Partnership on July
11, 1996. The aircraft was moved to a repair facility in Tucson, Arizona. The
litigation will continue in Superior Court over the validity and amount of the
various liens alleged against the bond.
On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to
recover the engines and parts leased in connection with the Partnership's
aircraft. GECAS and FSB assert that these engines and parts should have been
delivered to FSB pursuant to the Compromise and Stipulation. Viscount paid to
the Partnership $10,000 for the use of the engine during the month of August
1996, and continued through August 1996 to pay maintenance reserves pursuant to
the lease terms.
On September 18, 1996, GECAS (on behalf of the Partnership, Polaris Holding
Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV and
Polaris Aircraft Investors XVIII) (collectively, the Polaris Entities) and
10
<PAGE>
Viscount entered into a Stipulation and Agreement (the Stipulation and
Agreement) by which Viscount agreed to voluntarily return all of the Polaris
Entities' aircraft and engines, turn over possession of the majority of its
aircraft parts inventory, and cooperate with GECAS in the transition of aircraft
equipment and maintenance, in exchange for which, upon Bankruptcy Court approval
of the Stipulation and Agreement, the Polaris Entities would waive their pre-
and post-petition claims against Viscount for amounts due and unpaid.
In accordance with the Stipulation and Agreement, Viscount returned the
Partnership's engine on October 1, 1996 as discussed in Note 10. GECAS, on
behalf of the Polaris Entities, is evaluating the spare parts inventory to which
Viscount relinquished possession in order to determine its condition and value,
the portion allocable to the Partnership, and the Partnership's alternatives for
the use and/or disposition of such parts. A significant portion of the spare
parts inventory is currently in the possession of third party maintenance and
repair facilities with whom GECAS anticipates that it will need to negotiate for
the repair and/or return of these parts.
The Stipulation and Agreement also provides that the Polaris Entities, GECAS and
FSB shall release any and all claims against Viscount, Viscount's bankruptcy
estate, and the property of Viscount's bankruptcy estate, effective upon entry
of a final non-appealable court order approving the Stipulation and Agreement.
The Bankruptcy Court approved the Stipulation and Agreement on October 23, 1996
as discussed in Note 10.
As discussed in the Partnership's June 30, 1996 Form 10-Q, the Partnership
recorded allowances for credit losses of $342,373 for the aggregate unsecured
receivables from Viscount. The line of credit, which was advanced to Viscount in
1994, was, in accordance with the Compromise and Stipulation, secured by certain
of Viscount's trade receivables and spare parts. The Stipulation and Agreement
releases the Partnership's claim against Viscount's trade receivables. As a
result, the Partnership recorded an additional allowance for credit losses of
$92,508 during the third quarter of 1996, representing Viscount's outstanding
balance of the line of credit and accrued interest. Payments received by the
Partnership from the sale of the spare aircraft parts (as discussed above), if
any, will be recorded as revenue when received. The Stipulation and Agreement
provides that, upon entry of a final non-appealable court order approving it,
the Partnership would waive its pre- and post-petition claims against Viscount
for all amounts due and unpaid. As a result, the Partnership considers all
receivables from Viscount to be uncollectible and has written-off, during the
third quarter of 1996, all notes, rents and interest receivable balances from
Viscount.
The Partnership has evaluated the returned airframe and engines for potential
re-lease or sale and estimates that maintenance and refurbishment costs
aggregating approximately $1.6 million will be required to re-lease rather than
sell the airframe and engines. Alternatively, a sale of the airframe and engines
would likely be made on an "as is, where is" basis, without the Partnership
incurring substantial maintenance costs. As a result of this evaluation, the
Partnership estimates that a sale of the airframe and engines on an "as is,
where is" basis would maximize the economic return on the aircraft to the
Partnership. As discussed in Note 1, in accordance with SFAS No. 121, the
Partnership recognized an impairment loss of $300,000 on this aircraft which was
recorded as additional depreciation expense during the third quarter of 1996.
Viscount's failure to perform its financial obligations to the Partnership has
had a material 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 $123,000, which are reflected in
operating expense in the Partnership's statement of operations for the nine
months ended September 30, 1996.
11
<PAGE>
6. Sale of Aircraft to AIA
The Partnership sold one Boeing 727-200 aircraft and hushkit, formerly leased to
Delta Airlines Inc., 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 September 30, 1996, including one
additional principal payment of $410,229 received in May 1995. The note
receivable balance as of September 30, 1996 and December 31, 1995 was $433,088
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 September 30, 1996 was $563,609.
8. Claims Related to Lessee Defaults
As discussed in Item 3 of the Partnership's 1995 Form 10-K, Pan American World
Airways, Inc. (Pan Am) entered into a proposed Stipulation and Order with the
Partnership pursuant to which Pan Am agreed to allow the Partnership $2.5
million as an administrative expense priority claim and $56 million as a general
unsecured claim. In May 1996, the Partnership received from Pan Am a payment of
$567,500 as full satisfaction of the administrative expense priority claim. The
Partnership has recorded this payment as other revenue in claims related to
lessee defaults in the statement of income for the nine months ended September
30, 1996. It cannot be estimated at this time when and if the general unsecured
claim will be paid.
12
<PAGE>
9. 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:
Payments for the
Three Months Ended Payable at
September 30, 1996 September 30, 1996
------------------ ------------------
Aircraft Management Fees $162,000 $ 500
Out-of-Pocket Administrative Expense
Reimbursement 81,190 77,429
Out-of-Pocket Operating and
Remarketing Expense Reimbursement 21,397 1,818
-------- --------
$264,587 $ 79,747
======== ========
10. Subsequent Event
Viscount Stipulation and Agreement - As discussed in Note 5, Viscount returned
the Partnership's engine on October 1, 1996 pursuant to the Stipulation and
Agreement. On October 23, 1996, the Bankruptcy Court approved the Stipulation
and Agreement. The Partnership is currently remarketing the returned airframe
and engines for sale.
13
<PAGE>
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); 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).
One Boeing 737-200 aircraft, previously leased to Viscount Air Services, Inc.
(Viscount) is currently inoperable and requires substantial maintenance work, as
discussed below. The Partnership is currently remarketing this aircraft for
sale. 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. (NWT), in March 1996. The Partnership is currently remarketing the
remaining engine for sale.
Partnership Operations
The Partnership recorded net income of $127,712, or an allocated net loss of
$0.57 per limited partnership unit, for the three months ended September 30,
1996, compared to net income of $2,504,492, or $4.71 per unit, for the same
period in 1995. The Partnership recorded net income of $1,719,441, or $0.93 per
limited partnership unit, for the nine months ended September 30, 1996, compared
to net income of $3,361,422, or $5.90 per unit, for the same period in 1995. The
significant decline in operating results during the three and nine months ended
September 30, 1996, as compared to the same periods in 1995, is primarily the
result of lower rental revenues in 1996, combined with higher operating and
depreciation expenses in 1996. In addition, the Partnership recorded provisions
for credit losses for certain rent, interest and note receivables from Viscount
during the three and nine months ended September 30, 1996, as discussed below.
Rental revenues declined in the three and nine months ended September 30, 1996,
as compared to the same periods in 1995. The lease of one airframe and one
engine from the Boeing 737-200 Combi aircraft to NWT expired in October 1995.
The Partnership did not recognize rental revenue on this aircraft subsequent to
the lease expiration. The airframe and engine were sold in March 1996 as
discussed in Note 7 to the financial statements. In addition, as discussed in
Note 5 to the financial statements, Viscount filed a petition for protection
under Chapter 11 of the United States Bankruptcy Code in January 1996 and
subsequently rejected the Partnership's aircraft lease. Viscount has made only a
nominal engine lease payment to the Partnership during 1996 which was the only
rental revenue recognized by the Partnership on the rejected Viscount lease
subsequent to May 31, 1996. Further affecting the decline in rental revenues in
1996, as compared to 1995, were TWA rental revenues that the Partnership
recognized during the first three quarters of 1995 that had been deferred from
1994, as discussed in Note 4 to the financial statements.
Partially offsetting the decline in rental revenues in 1996, as compared to
1995, in May 1996, the Partnership received from Pan American World Airways,
Inc. (Pan Am) a payment of $567,500 as full satisfaction of the Partnership's
administrative expense priority claim. The Partnership has recorded this payment
as other revenue in claims related to lessee defaults in the statement of income
for the nine months ended September 30, 1996.
14
<PAGE>
The Partnership recorded an allowance for credit losses of $100,409 during the
first quarter of 1996 for certain unpaid rent and accrued interest receivables
from Viscount as a result of Viscount's default on certain obligations due the
Partnership and Viscount's subsequent bankruptcy filing. The Partnership
recorded an allowance for credit losses of $92,508 during the third quarter of
1996 for Viscount's outstanding balance of the line of credit and accrued
interest. In addition, the Partnership recognized legal expenses of
approximately $123,000 related to the Viscount defaults and Chapter 11
bankruptcy filing. These legal costs are included in operating expense in the
Partnership's statement of operations for the nine months ended September 30,
1996.
As discussed in Note 1 to the financial statements, the Partnership recognized
an impairment loss of $300,000 on the aircraft formerly leased to Viscount,
which was recorded as additional depreciation expense during the third quarter
of 1996.
Liquidity and Cash Distributions
Liquidity - The Partnership received all lease payments due from Continental,
Continental Micronesia and TWA and has received all note payments due from
Continental, ALG, Inc. (ALG), American International Airways, Inc. (AIA), and
WestJet Airlines, Ltd. (WestJet).
As discussed in Note 5 to the financial statements and in Part II, Item 1, the
Viscount Stipulation and Agreement specifies, among other things, that the
Partnership waive its pre- and post-petition claims against Viscount for amounts
due and unpaid. As a result, the Partnership recorded an additional allowance
for credit losses of approximately $92,508 during the third quarter of 1996,
representing Viscount's outstanding balance of the line of credit and accrued
interest. In addition, the Partnership currently considers all receivables from
Viscount to be uncollectible and has written-off, during the third quarter of
1996, all notes, rents and interest receivable balances from Viscount.
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 by Continental
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.
The Partnership has received 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 $240,091 as of September 30, 1996.
Payments of $203,946 have been received during the first three quarters 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
15
<PAGE>
aircraft inventory was $169,537 as of September 30, 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 former Viscount aircraft and engine,
including additional legal costs, potential aircraft maintenance, remarketing
and transition costs.
Cash Distributions - Cash distributions to limited partners during the three
months ended September 30, 1996 and 1995 were $4,124,975, or $8.25 per limited
partnership unit and $1,249,993 or $2.50 per unit, respectively. Cash
distributions to limited partners during the nine months ended September 30,
1996 and 1995 were $12,734,926, or $24.75 per limited partnership unit and
$3,749,978 or $7.50 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 former
Viscount aircraft; the receipt of rental payments from TWA, Continental and
Continental Micronesia; the receipt of modification financing payments from
Continental; and the receipt of sales proceeds from AIA and WestJet,
renegotiated promissory note payments from ALG, and payments generated from the
aircraft disassembly process.
TWA Leases
GECAS, on behalf of the Partnership, is negotiating with TWA regarding the
acquisition of noise-suppression devices, commonly known as "hushkits", for 14
of the 18 Partnership aircraft currently on lease to TWA, as well as 14 other
aircraft owned by affiliates of the General Partner and leased to TWA. The
hushkits would recondition the aircraft so as to meet Stage 3 noise level
restrictions, which are discussed in the Partnership's 1995 Annual Report to the
Securities and Exchange Commission on Form 10-K. The anticipated cost of the
hushkit reconditioning is approximately $1.6 million per aircraft, approximately
$300,000 of which will be paid out of the Partnership's cash reserves and the
balance of which will be financed by the engine/hushkit manufacturer over a
6-year period at an interest rate of approximately 10% per year. Such financing
agreements may also require the Partnership to maintain a minimum level of
working capital reserves and, in the event of any shortfall of such minimum
levels, cash distributions may be restricted.
It is anticipated that the leases for the Partnership's 14 aircraft would be
extended for a period of eight years from the date of installation or purchase
of the hushkits, and the rent payable by TWA under the leases would be increased
by an amount sufficient to cover the monthly debt service payments on the
hushkits and fully repay the amount borrowed during the term of the leases. The
loan from the engine/hushkit manufacturer would be non-recourse to the
Partnership and secured by a security interest in the leases.
16
<PAGE>
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) and in Item 1 of Part II of the Partnership's Quarterly
Report to the SEC on Form 10-Q (Form 10-Q) for the periods ended March 31, 1996
and June 30, 1996, 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 - As previously reported,
Viscount exercised its right under the Bankruptcy Code to reject the lease for
the Partnership's B-737-200 aircraft. At the time Viscount rejected its lease,
the aircraft was located at a maintenance facility and had a partially completed
heavy maintenance check. The aircraft has now been returned to the possession of
the Partnership and is at a maintenance facility pending the Partnership's
decision on the disposition of the aircraft. In the meantime, the Partnership is
continuing to pursue its rights in litigation with respect to the maintenance
facility's assertions of non-payment for services.
The Partnership evaluated the aircraft for potential sale or re-lease and
determined that substantial maintenance and refurbishment costs would be
incurred in connection with any release. As a result, the Partnership is
currently remarketing the returned airframe and engines for sale.
On September 18, 1996, GECAS (on behalf of the Partnership and other entities)
and Viscount entered into a Stipulation and Agreement by which Viscount agreed
to voluntarily return aircraft owned by other Polaris entities, turn over
possession of the majority of its aircraft parts inventory, and cooperate with
GECAS in the transition of aircraft equipment and maintenance, in exchange for
which, upon Bankruptcy Court approval of the Stipulation and Agreement, the
Partnership would waive its right to pre- and post-petition claims against
Viscount for amounts due and unpaid.
Other Proceedings - Item 10 in Part III of the Partnership's 1995 Form 10-K and
Item 1 in Part II of the Partnership's Form 10-Q for the periods ended March 31,
1996 and June 30, 1996 discuss 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. Except as discussed below, there
have been no material developments during the period covered by this report with
respect to any of the actions described in Item 10 in Part III of the
Partnership's 1995 Form 10-K and Item 1 in Part II of the Partnership's Form
10-Q for the periods ended March 31, 1996 and June 30, 1996.
Wilson et al. v. Polaris Holding Company et al. - On October 1, 1996, a
complaint was filed in the Superior Court of the State of California for the
County of Sacramento by over 500 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I through VI.
The complaint names 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 Capital Services, Inc., General
17
<PAGE>
Electric Capital Corporation, GE Capital Aviation Services, Inc. and DOES 1-100
as defendants. The Partnership has not been named as a defendant. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, negligence, breach of contract, and breach of fiduciary duty.
The complaint seeks to recover compensatory damages and punitive damages in an
unspecified amount, interest and rescission with respect to the Polaris Aircraft
Income Funds sold to plaintiffs. Defendants time to answer or otherwise respond
to the complaint is November 18, 1996.
B&L Industries, Inc. et al. v. Polaris Holding Company et al. - On August 16,
1996, defendants filed a motion to dismiss plaintiffs' amended complaint. The
motion is returnable on January 16, 1997.
In re Prudential Securities Inc. Limited Partnerships Litigation - The trial,
which was scheduled for November 11, 1996, has not proceeded and no new trial
date has been set.
Item 5. Other Information
James W. Linnan resigned as Director and President of Polaris Investment
Management Corporation effective December 31, 1996. Mr. Linnan's replacement has
not presently been named. Mr. Linnan will continue to serve in those capacities
through the effective date of his resignation.
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
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.
18
<PAGE>
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
November 12, 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)
19
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