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 June 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 20 pages.
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POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
FORM 10-Q - For the Quarterly Period Ended June 30, 1996
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
a) Balance Sheets - June 30, 1996 and
December 31, 1995.......................................... 3
b) Statements of Income - Three and Six Months
Ended June 30, 1996 and 1995............................... 4
c) Statements of Changes in Partners' Capital
(Deficit) - Year Ended December 31, 1995
and Six Months Ended June 30, 1996......................... 5
d) Statements of Cash Flows - Six Months
Ended June 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 6. Exhibits and Reports on Form 8-K....................... 19
Signature ....................................................... 20
2
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Part 1. Financial Information
-----------------------------
Item 1. Financial Statements
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
BALANCE SHEETS
(Unaudited)
June 30, December 31,
1996 1995
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 27,563,478 $ 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 16,428 8,965
NOTES RECEIVABLE 2,516,775 2,679,486
AIRCRAFT, net of accumulated depreciation of
$96,810,481 in 1996 and $97,407,528 in 1995 69,571,840 76,487,365
AIRCRAFT INVENTORY 248,290 373,483
OTHER ASSETS 29,770 29,770
------------- -------------
$ 99,946,581 $ 107,820,317
============= =============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 74,325 $ 92,511
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 162,416 87,356
SECURITY DEPOSITS 75,000 450,000
MAINTENANCE RESERVES 198,458 179,185
DEFERRED INCOME 642,742 642,742
------------- -------------
Total Liabilities 1,152,941 1,451,794
------------- -------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (1,214,986) (1,139,155)
Limited Partners, 499,997 units
issued and outstanding 100,008,626 107,507,678
------------- -------------
Total Partners' Capital 98,793,640 106,368,523
------------- -------------
$ 99,946,581 $ 107,820,317
============= =============
The accompanying notes are an integral part of these statements.
3
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POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1996 1995 1996 1995
---- ---- ---- ----
REVENUES:
Rent from operating leases $3,420,000 $4,419,855 $6,938,600 $6,053,355
Interest 392,070 463,247 784,295 753,211
Claims related to lessee defaults 567,500 -- 567,500 --
Other -- 960 49,974 219,131
---------- ---------- ---------- ----------
Total Revenues 4,379,570 4,884,062 8,340,369 7,025,697
---------- ---------- ---------- ----------
EXPENSES:
Depreciation 3,009,926 2,792,188 6,019,853 5,712,571
Management fees to general partner 162,000 209,454 324,000 288,879
Provision for credit losses -- -- 100,409 --
Operating 76,548 10,449 152,050 24,472
Administration and other 93,220 82,792 152,328 142,845
---------- ---------- ---------- ----------
Total Expenses 3,341,694 3,094,883 6,748,640 6,168,767
---------- ---------- ---------- ----------
NET INCOME $1,037,876 $1,789,179 $1,591,729 $ 856,930
========== ========== ========== ==========
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 422,835 $ 142,878 $ 840,830 $ 258,542
========== ========== ========== ==========
NET INCOME ALLOCATED
TO LIMITED PARTNERS $ 615,041 $1,646,301 $ 750,899 $ 598,388
========== ========== ========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ 1.23 $ 3.29 $ 1.50 $ 1.19
========== ========== ========== ==========
The accompanying notes are an integral part of these statements.
4
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POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
(Unaudited)
Year Ended December 31, 1995 and
Six Months Ended June 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 840,830 750,899 1,591,729
Cash distributions to partners (916,661) (8,249,951) (9,166,612)
------------- ------------- -------------
Balance, June 30, 1996 $ (1,214,986) $ 100,008,626 $ 98,793,640
============= ============= =============
The accompanying notes are an integral part of these statements.
5
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POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
-------------------------
1996 1995
---- ----
OPERATING ACTIVITIES:
Net income $ 1,591,729 $ 856,930
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 6,019,853 5,712,571
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 (107,872) 17,151
Decrease in payable to affiliates (18,186) (628,286)
Increase in accounts payable and accrued
liabilities 75,060 36,375
Increase (decrease) in security deposits (375,000) 2,838
Increase in maintenance reserves 19,273 98,369
------------ ------------
Net cash provided by operating activities 9,661,772 6,095,948
------------ ------------
INVESTING ACTIVITIES:
Principal payments on notes receivable 1,058,383 1,198,947
Net proceeds from sale of aircraft inventory 125,193 100,361
------------ ------------
Net cash provided by investing activities 1,183,576 1,299,308
------------ ------------
FINANCING ACTIVITIES:
Cash distributions to partners (9,166,612) (2,777,761)
------------ ------------
Net cash used in financing activities (9,166,612) (2,777,761)
------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS 1,678,736 4,617,495
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 25,884,742 14,662,147
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 27,563,478 $ 19,279,642
============ ============
The accompanying notes are an integral part of these statements.
6
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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
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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 secured by certain of Viscount's trade receivables and spare parts.
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 June 30, 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 two quarters 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 June 30, 1996 and December 31, 1995 was $1,035,382
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 June 30, 1996 and
December 31, 1995 were $157,602 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 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.
8
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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 six months ended June 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
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
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5. Viscount Default and Bankruptcy Filing
As discussed in the Form 10-K, in July 1994, the Partnership entered into a
Restructuring and Loan Agreement (Loan Agreement) with Viscount. During 1995,
the Partnership had been in discussions with Viscount to restructure additional
existing financial obligations of Viscount to the Partnership. Viscount
subsequently defaulted on its financial obligations to the Partnership and on
December 13, 1995, the Partnership issued a notice of default to Viscount. On
January 9, 1996, Viscount was notified that the Partnership had elected to
terminate the lease and the Partnership demanded return of the aircraft.
Viscount disputed the lease termination. 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.
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.
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), FSB, 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), which was approved by the Bankruptcy Court on May 14, 1996. The
Compromise and Stipulation, provides, among other things that Viscount rejected
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. Notwithstanding Viscount's rejection of the Partnership's
aircraft lease, Viscount continues to possess and use the Partnership's engine
and has refused to return various aircraft parts removed from the Partnership's
aircraft.
The Compromise and Stipulation also provides for Viscount to 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,
dated July 20, 1994 (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 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).
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The Partnership's claim for rejection damages under the lease and amounts due
under the Loan Agreement are addressed under Viscount's proposed plan of
reorganization, which was filed with the Bankruptcy Court on July 1, 1996 as
discussed in Note 10 and in Part II, Item 1, and must be confirmed by September
30, 1996, pursuant to the Compromise and Stipulation.
As of June 30, 1996, the Partnership's aggregate rent, maintenance reserve, loan
and interest receivable from Viscount was approximately $575,000. All amounts
due from Viscount may be affected by Viscount's filing for protection under
Chapter 11. The balance of the Loan Agreement line of credit advanced to
Viscount in 1994 of $88,641 at June 30, 1996 and December 31, 1995, plus accrued
interest, is secured by certain of Viscount's trade receivables and spare parts.
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 approximately
$342,000 as of June 30, 1996.
Viscount's failure to perform on its financial obligations with the Partnership
has 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 $92,000, which are reflected in operating
expense in the Partnership's statement of income for the six months ended June
30, 1996. The Partnership may incur maintenance, remarketing, transition and
additional legal costs related to the Partnership's aircraft, which cannot be
estimated at this time. The outcome of Viscount's Chapter 11 proceeding cannot
be predicted.
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 June 30, 1996, including one additional
principal payment of $410,229 received in May 1995. The note receivable balance
as of June 30, 1996 and December 31, 1995 was $588,027 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 June 30, 1996 was $647,123.
11
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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 three and six months ended
June 30, 1996. It cannot be estimated at this time when and if the general
unsecured claim will be paid.
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
Three Months Ended Payable at
June 30, 1996 June 30, 1996
------------- -------------
Aircraft Management Fees $162,000 $ --
Out-of-Pocket Administrative Expense
Reimbursement 71,282 73,663
Out-of-Pocket Operating and
Remarketing Expense Reimbursement 40,062 662
-------- --------
$273,344 $ 74,325
======== ========
10. Subsequent Events
On July 1, 1996, Viscount filed its bankruptcy disclosure statement and proposed
plan of reorganization, which sets forth Viscount's proposed treatment for
restructuring and satisfying the claims of all of its creditors. The plan of
reorganization contemplates a capital investment of between $2.5 million and $9
million from an outside source. A hearing date of August 29, 1996 has been set
to consider the sufficiency of disclosure contained in the disclosure statement;
however, counsel for Viscount has indicated that Viscount likely will amend the
disclosure statement and plan prior to any such hearing. The Partnership is
presently evaluating the disclosure statement and plan.
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 (Note 5), who subsequently released the aircraft to the Partnership
on July 11, 1996. The aircraft was moved to a repair facility in Tucson, Arizona
for completion of a "D" check. 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 Order. Viscount alleges that it
cannot return the engines and parts without impairing its operations and has no
12
<PAGE>
legal obligation to do so. A hearing has been scheduled for August 29, 1996 to
consider the motion of GECAS and FSB to recover the engine and certain aircraft
parts. Pending the hearing, Viscount has agreed to pay the Partnership $10,000
for the use of the engine during the month of August, and will continue to pay
maintenance reserves pursuant to the lease terms. Discussions are proceeding
with Viscount in an effort to resolve these issues prior to the scheduled
hearing.
13
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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.
The Partnership is currently remarketing the remaining engine for sale.
Partnership Operations
The Partnership recorded net income of $1,037,876, or $1.23 per limited
partnership unit, for the three months ended June 30, 1996, compared to net
income of $1,789,179, or $3.29 per unit, for the same period in 1995. The
Partnership recorded net income of $1,591,729, or $1.50 per limited partnership
unit, for the six months ended June 30, 1996, compared to net income of
$856,930, or $1.19 per unit, for the same period in 1995. Operating results for
the six months ended June 30, 1995 were negatively impacted by 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. TWA repaid the
deferred rent in full from May 1995 through October 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.
As discussed in Note 8 to the financial statements, 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 three and six months ended
June 30, 1996.
14
<PAGE>
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 no lease or loan payments to the Partnership during the first six months of
1996. The Partnership has recorded an allowance for credit losses aggregating
$100,409 during the first quarter of 1996 for unpaid rents and accrued interest
recognized during the first quarter of 1996. The Partnership has not recognized
rental revenue on the rejected Viscount lease subsequent to May 31, 1996. As a
result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership
has incurred legal costs of approximately $92,000, which are reflected in
operating expense in the Partnership's statement of income for the six months
ended June 30, 1996.
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 that time. The airframe and engine were sold in
March 1996 as discussed in Note 7 to the financial statements.
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 above, in January 1996, Viscount filed a petition for protection
under Chapter 11 of the United States Bankruptcy Code. As of June 30, 1996,
Viscount's defaults with the Partnership aggregated approximately $575,000.
Viscount's failure to perform on its financial obligations with the Partnership
has an adverse effect on the Partnership's financial position. As a result of
Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership 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 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 $198,458 as of June 30, 1996.
15
<PAGE>
Payments of $125,193 have been received during the first two 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
aircraft inventory was $248,290 as of June 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 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 June 30, 1996 and 1995 were $4,124,975, or $8.25 per limited
partnership unit and $1,249,992 or $2.50 per unit, respectively. Cash
distributions to limited partners during the six months ended June 30, 1996 and
1995 were $8,249,951, or $16.50 per limited partnership unit and $2,499,985 or
$5.00 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
the receipt of sales proceeds from AIA and WestJet, renegotiated promissory note
payments from ALG, payments generated from the aircraft disassembly process, and
delinquent lease and loan payments from Viscount.
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.
It is anticipated that the leases for these 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 period ended March 31, 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.
Pan American Airways, Inc. (Pan Am) - On or about May 16, 1996, the Partnership
received a payment of $567,500, representing full satisfaction of the
Partnership's $2.5 million administrative priority claim.
Trans World Airlines, Inc. (TWA) - On May 2, 1996, the United States Bankruptcy
Court for the Northern District of California issued a notice of final decree
declaring that the estate of TWA had been fully administered and that TWA's
proceedings under Chapter 11 of the United States Bankruptcy Code was closed.
Viscount Air Services, Inc. (Viscount) Bankruptcy - On April 15, 1996, GE
Capital Aviation Services, Inc. (GECAS), as agent for 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, certain guarantors of Viscount's indebtedness and others
executed that certain Compromise of Claims and Stipulation under Section 1110 of
the Bankruptcy Code (the Compromise and Stipulation), the key terms of which as
they affect the Partnership were disclosed in the Partnership's Form 10-Q for
the period ended March 31, 1996. On May 14, 1996, the Bankruptcy Court entered
its Order Granting Debtor's Motion: (1) To Approve and Authorize Compromise and
Settlement; (2) To Approve Section 1110 Stipulation; (3) To Authorize
Post-Petition Financing; and (4) To Approve Rejection of an Aircraft Lease
(Compromise Order), approving the Compromise and Stipulation.
The Compromise Order authorized Viscount to reject its lease with the
Partnership of the aircraft bearing registration no. N306VA (306 Aircraft). The
306 Aircraft was located at a repair facility operated by BAE Aviation, Inc.,
d/b/a Tucson Aerospace. On May 22, 1996, FSB, as owner/trustee, filed suit in
the Superior Court of Arizona in Pima County, Case No. C313027, 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 defendants, and the defendants
released the aircraft on July 11, 1996. The aircraft was moved to a repair
facility at Hamilton Aviation in Tucson, Arizona for completion of a "C" check.
The litigation will continue in Superior Court over the validity and amount of
the defendants' various liens alleged against the bond.
Notwithstanding Viscount's rejection of the 306 Aircraft lease, Viscount
continues to possess and use the Partnership's engine and has refused to return
various aircraft parts removed from the 306 Aircraft. 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 306 Aircraft. GECAS and FSB assert that
these engines and parts should have been delivered to FSB pursuant to the
Compromise Order. Viscount alleges that it cannot return the engines and parts
without impairing its operations and has no legal obligation to do so. A hearing
has been scheduled for August 29, 1996 to consider the motion of GECAS and FSB
to recover the engine and certain aircraft parts. Pending the hearing, Viscount
17
<PAGE>
has agreed to pay the Partnership $10,000 for the use of the engine during the
month of August, and will continue to pay maintenance reserves pursuant to the
lease terms. Discussions are proceeding with Viscount in an effort to resolve
these issues prior to the scheduled hearing.
On July 1, 1996, Viscount filed its bankruptcy disclosure statement and proposed
plan of reorganization, which sets forth Viscount's proposed treatment for
restructuring and satisfying the claims of all of its creditors. The plan of
reorganization contemplates a capital investment of between $2.5 million and $9
million from an outside source. A hearing date of August 29, 1996 has been set
to consider the sufficiency of disclosure contained in the disclosure statement;
however, counsel for Viscount has indicated that Viscount likely will amend the
disclosure statement and plan prior to any such hearing. The Partnership is
presently evaluating the disclosure statement and plan.
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 period ended March 31,
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 with respect to any of the actions described therein during the
period covered by this report.
Bishop v. Kidder Peabody & Co., Incorporated et al. - On June 18, 1996,
defendants filed a motion to transfer venue from Sacramento to San Francisco
County. The Court subsequently denied the motion.
Weisl et al. v. Polaris Holding Company et al. - On April 25, 1996, the
Appellate Division for the First Department affirmed the trial court's order
which had dismissed most of plaintiffs' claims.
In re Prudential Securities Inc. Limited Partnerships Litigation - On June 5,
1996, the Court certified a class with respect to claims against Polaris Holding
Company, one of its former officers, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, and Polaris Securities Corporation.
The class is comprised of all investors who purchased securities in any of
Polaris Aircraft Income Funds I through VI during the period from January 1985
until January 29, 1991, regardless of which brokerage firm the investor
purchased from. Excepted from the class are those investors who settled in the
SEC/Prudential settlement or otherwise opted for arbitration pursuant to the
settlement and any investor who has previously released the Polaris defendants
through any other settlement. On June 10, 1996, the Court issued an opinion
denying summary judgment to Polaris on plaintiffs' Section 1964(c) and (d) RICO
claims and state causes of action, and granting summary judgment to Polaris on
plaintiffs' 1964(a) RICO claims and the New Jersey State RICO claims. On August
5, 1996, the Court signed an order providing for notice to be given to the class
members. The case has been set for trial on November 11, 1996.
18
<PAGE>
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.
19
<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
August 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)
20
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