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, 1997
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 18 pages.
<PAGE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
FORM 10-Q - For the Quarterly Period Ended June 30, 1997
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
a) Balance Sheets - June 30, 1997 and
December 31, 1996......................................... 3
b) Statements of Income - Three and Six Months
Ended June 30, 1997 and 1996.............................. 4
c) Statements of Changes in Partners' Capital
(Deficit) - Year Ended December 31, 1996
and Six Months Ended June 30, 1997........................ 5
d) Statements of Cash Flows - Six Months
Ended June 30, 1997 and 1996.............................. 6
e) Notes to Financial Statements............................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.......... 11
Part II. Other Information
Item 1. Legal Proceedings...................................... 16
Item 6. Exhibits and Reports on Form 8-K....................... 17
Signature ....................................................... 18
2
<PAGE>
Part 1. Financial Information
Item 1. Financial Statements
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
BALANCE SHEETS
(Unaudited)
June 30, December 31,
1997 1996
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 21,547,044 $ 22,224,813
RENT AND OTHER RECEIVABLES 1,107,843 6,648
NOTES RECEIVABLE 12,175,703 1,522,956
AIRCRAFT, net of accumulated depreciation of
$65,980,962 in 1997 and $120,260,981 in 1996 49,382,347 63,638,062
AIRCRAFT INVENTORY 17,979 113,248
OTHER ASSETS 8,032 117,015
------------ ------------
$ 84,238,948 $ 87,622,742
============ ============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 296,541 $ 66,631
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 565,765 209,781
SECURITY DEPOSITS 50,000 116,000
MAINTENANCE RESERVES -- 223,528
DEFERRED INCOME -- 597,915
NOTES PAYABLE 17,734,198 14,193,178
------------ ------------
Total Liabilities 18,646,504 15,407,033
------------ ------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (1,547,172) (1,480,858)
Limited Partners, 499,997 units
issued and outstanding 67,139,616 73,696,567
------------ ------------
Total Partners' Capital 65,592,444 72,215,709
------------ ------------
$ 84,238,948 $ 87,622,742
============ ============
The accompanying notes are an integral part of these statements.
3
<PAGE>
<TABLE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF INCOME
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------- --------
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
Rent from operating leases $ 4,132,342 $ 3,420,000 $ 8,500,720 $ 6,938,600
Interest 388,262 392,070 690,339 784,295
Claims related to lessee defaults -- 567,500 -- 567,500
Loss on sale of aircraft -- -- (26,079) --
Other 88,414 -- 802,443 49,974
------------ ------------ ------------ -----------
Total Revenues 4,609,018 4,379,570 9,967,423 8,340,369
------------ ------------ ------------ -----------
EXPENSES:
Depreciation 2,971,322 3,009,926 6,069,438 6,019,853
Management fees to general partner 157,284 162,000 366,703 324,000
Provision for credit losses -- -- -- 100,409
Operating 37,035 76,548 81,927 152,050
Interest 440,119 -- 851,985 --
Administration and other 113,267 93,220 192,911 152,328
------------ ------------ ------------ -----------
Total Expenses 3,719,027 3,341,694 7,562,964 6,748,640
------------ ------------ ------------ -----------
NET INCOME $ 889,991 $ 1,037,876 $ 2,404,459 $ 1,591,729
============ ============ ============ ===========
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 508,848 $ 422,835 $ 836,459 $ 840,830
============ ============ ============ ===========
NET INCOME ALLOCATED
TO LIMITED PARTNERS $ 381,143 $ 615,041 $ 1,568,000 $ 750,899
============ ============ ============ ===========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ 0.76 $ 1.23 $ 3.13 $ 1.50
============ ============ ============ ===========
The accompanying notes are an integral part of these statements.
4
</TABLE>
<PAGE>
<TABLE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
(Unaudited)
<CAPTION>
Year Ended December 31, 1996 and
Six Months Ended June 30, 1997
------------------------------
General Limited
Partner Partners Total
------- -------- -----
<S> <C> <C> <C>
Balance, December 31, 1995 $ (1,139,155) $ 107,507,678 $ 106,368,523
Net income (loss) 1,602,730 (16,311,216) (14,708,486)
Cash distributions to partners (1,944,433) (17,499,895) (19,444,328)
------------- -------------- --------------
Balance, December 31, 1996 (1,480,858) 73,696,567 72,215,709
Net income 836,459 1,568,000 2,404,459
Cash distributions to partners (902,773) (8,124,951) (9,027,724)
------------- -------------- --------------
Balance, June 30, 1997 $ (1,547,172) $ 67,139,616 $ 65,592,444
============== ============== ==============
The accompanying notes are an integral part of these statements.
5
</TABLE>
<PAGE>
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended June 30,
-------------------------
1997 1996
---- ----
OPERATING ACTIVITIES:
Net income $ 2,404,459 $ 1,591,729
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation 6,069,438 6,019,853
Loss on sale of aircraft 26,079 --
Provision for credit losses -- 100,409
Changes in operating assets and liabilities,
net of effect of sale of aircraft:
Decrease in marketable securities, trading -- 2,356,506
Increase in rent and other receivables (1,082,360) (107,872)
Decrease in other assets 108,983 --
Increase (decrease) in payable to affiliates 229,910 (18,186)
Increase in accounts payable and accrued
liabilities 290,584 75,060
Decrease in security deposits (66,000) (375,000)
Decrease (increase) in maintenance reserves (6,453) 19,273
Decrease in deferred income (597,915) --
------------ ------------
Net cash provided by operating activities 7,376,725 9,661,772
------------ ------------
INVESTING ACTIVITIES:
Increase in aircraft capitalized costs (4,784,633) --
Principal payments on notes receivable 622,403 1,058,383
Proceeds from sale of aircraft 2,500,238 --
Payments to Purchaser related to sale of aircraft (1,001,067) --
Net proceeds from sale of aircraft inventory 95,269 125,193
------------ ------------
Net cash provided by (used in) investing
activities (2,567,790) 1,183,576
------------ ------------
FINANCING ACTIVITIES:
Increase in notes payable 3,884,633 --
Principal payments on notes payable (343,613) --
Cash distributions to partners (9,027,724) (9,166,612)
------------ ------------
Net cash used in financing activities (5,486,704) (9,166,612)
------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS (677,769) 1,678,736
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 22,224,813 25,884,742
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 21,547,044 $ 27,563,478
============ ============
The accompanying notes are an integral part of these statements.
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, 1996, 1995, and
1994 included in the Partnership's 1996 Annual Report to the SEC on Form 10-K
(Form 10-K).
2. Sale of Boeing 737-200 Aircraft
On January 30, 1997, one Boeing 737-200 formerly on lease to Viscount Air
Services, Inc. (Viscount), was sold to American Aircarriers Support,
Inc.(American Aircarriers) on an "as-is, where-is" basis for $660,000 cash. In
addition, the Partnership retained maintenance reserves from the previous lessee
of $217,075, that had been held by the Partnership, which were recognized as
additional sale proceeds. A net loss of $26,079 was recorded on the sale of the
aircraft.
3. TWA Lease Extension
GECAS, on behalf of the Partnership, negotiated with TransWorld Airlines, Inc.
(TWA) for the acquisition of noise-suppression devices, commonly known as
"hushkits," for the 14 Partnership aircraft currently on lease to TWA, as well
as 18 other aircraft owned by affiliates of Polaris Investment Management
Corporation (PIMC) and leased to TWA. Hushkit installation was completed on 11
of the Partnership's aircraft in November 1996. Installation of hushkits on the
remaining three aircraft was completed during February 1997.
The aggregate cost of the hushkit reconditioning for the 3 aircraft was
$4,784,633 or approximately $1.6 million per aircraft, which was capitalized by
the Partnership during 1997. The Partnership paid $900,000 of the aggregate
hushkit cost and the balance of $3,884,633 was financed by UT Finance
Corporation (UT Finance), a wholly owned subsidiary of United Technologies
Corporation, of which a division is Pratt and Whitney Group, the hushkit
manufacturer, over a 6-year period at an interest rate of approximately 10% per
annum.
The rent payable by TWA under the leases has been increased by an amount
sufficient to cover the monthly debt service payments on the hushkits and fully
repay, during the term of the TWA leases, the amount borrowed. The loan from UT
Finance is non-recourse to the Partnership and secured by a security interest in
the lease receivables. The leases for these 3 aircraft were extended for a
period of eight years until February 2005.
7
<PAGE>
4. Sale of Aircraft to Triton
On May 28, 1997, Polaris Investment Management Corporation (the "General
Partner" or "PIMC"), on behalf of the Partnership, executed definitive
documentation for the purchase of 7 of the Partnership's 21 remaining aircraft
(the "Aircraft") and certain of its notes receivables by Triton Aviation
Services II LLC, a special purpose company (the "Purchaser"). The closings for
the purchase of the 7 Aircraft occurred from May 28, 1997 to June 16, 1997. The
Purchaser is managed by Triton Aviation Services, Ltd. ("Triton Aviation"or the
"Manager"), a privately held aircraft leasing company which was formed in 1996
by Triton Investments, Ltd., a company which has been in the marine cargo
container leasing business for 17 years and is diversifying its portfolio by
leasing commercial aircraft. Each Aircraft was sold subject to the existing
leases.
The Terms of the Transaction - The total contract purchase price (the "Purchase
Price") to the Purchaser is $13,988,000 which is allocable to the Aircraft and
to certain notes receivable by the Partnership. The Purchaser paid into an
escrow account $1,575,888 of the Purchase Price in cash upon the closing of the
first aircraft and delivered a promissory note (the "Promissory Note") for the
balance of $12,412,112. The Partnership received payment of $1,575,888 from the
escrow account on June 24, 1997.
The Promissory Note is due in 28 quarterly installments of principal and
interest commencing June 30, 1997 in the amount of $608,772 over a period of
seven years bearing interest at a rate of 12% per annum with a balloon principal
payment in the amount of $2,262,866 due on March 31, 2004. The Purchaser has the
right to voluntarily prepay the Promissory Note in whole or in part at any time
without penalty. In addition, the Promissory Note is subject to mandatory
partial prepayment in certain specified instances. The Purchaser is current on
its Promissory Note obligation.
Under the terms of the transaction, the Purchaser's assets, which are limited to
the Aircraft, including any income or proceeds therefrom, and any funds made
available to Purchaser under the working capital line described below constitute
the sole source of payments under the Promissory Note. Although no security
interest over the Aircraft or the leases is granted in favor of the Partnership,
the equity interests in the Purchaser have been pledged to the Partnership. In
connection with that pledge, the Purchaser is prohibited from incurring
indebtedness other than (i) the Promissory Note; (ii) deferred taxes not yet due
and payable; (iii) indebtedness incurred to hushkit Aircraft owned by the
Purchaser; (iv) demand loans to another SPC (defined below) at a market rate of
interest; and (v) debt to trade creditors incurred in the ordinary course of
business. In addition, the Purchaser undertakes to keep the Aircraft and leases
free of any lien, security interest or other encumbrance other than (i) inchoate
taxes and materialmen's liens and the like, (ii) in the event that the Purchaser
elects to install hushkits on any Aircraft, secured debt to the extent of the
full cost of such hushkit and other hushkits acquired with proceeds from the
same loan facility; (iii) liens lessees are customarily permitted to incur that
are required to be removed. The Purchaser has the right to sell any of the
Aircraft without the consent of the Partnership, except that the Partnership's
consent would be required in the event that the sale price is less than the
portion of the outstanding balance of the Promissory Note which is allocable to
the Aircraft in question and the Purchaser does not have sufficient funds to
make up the difference. In the event that any of the Aircraft are sold by the
Purchaser, the Promissory Note is subject to a mandatory prepayment of the
portion of the Promissory Note which is allocable to the Aircraft sold.
Under the terms of the transaction, the Purchaser's Manager has undertaken to
make available a working capital line to the Purchaser of up to approximately
$1,222,000 to fund operating obligations of the Purchaser. This working capital
line is guaranteed by Triton Investments, Ltd., the parent of the Purchaser's
Manager and such guarantor provided the Partnership with a copy of its most
recent balance sheet showing a consolidated net worth (net of minority
interests) of at least $150-million at December 31, 1996. Provided that the
Purchaser is not in default in making payments due under the Promissory Note to
the Partnership, the Purchaser is permitted to dividend to its equity owners an
amount not to exceed approximately $33,000 per month. The Purchaser may
distribute additional dividends to the equity owners to the extent of the
8
<PAGE>
working capital advances made by the Purchaser's Manager provided that the
working capital line available to the Purchaser will be deemed increased to the
extent of such dividends.
Under the purchase agreement, the Purchaser purchased the Aircraft effective as
of April 1, 1997 notwithstanding the actual closing dates. The utilization of an
effective date facilitated the determination of rent and other allocations
between the parties. The Purchaser has the right to receive all income and
proceeds, including rents and receivables, from the Aircraft accruing from and
after April 1, 1997, and the Promissory Note commenced bearing interest as of
April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold
subject to the existing leases.
Neither PIMC nor GECAS will receive a sales commission in connection with the
transaction. In addition, PIMC will not be paid a management fee with respect to
the collection of the Promissory Note or on any rents accruing from or after
April 1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of
its affiliates holds any interest in Triton Aviation or any of Triton Aviation's
affiliates. John Flynn, the current President of Triton Aviation, was a Polaris
executive until May 1996 and has over 15 years experience in the commercial
aviation industry. At the time Mr. Flynn was employed at PIMC, he had no
affiliation with Triton Aviation or its affiliates.
Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris
Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold
certain aircraft assets to separate special purpose companies under common
management with the Purchaser (collectively, together with the Purchaser, the
"SPC's") on terms similar to those set forth above, with the exception of the
Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.
The Accounting Treatment of the Transaction - In accordance with generally
accepted accounting principles (GAAP), the Partnership recognized rental income
up until the closing date for each aircraft which occurred from May 28, 1997 to
June 16, 1997. However, under the terms of the transaction, the Purchaser was
entitled to receive payment of the rents, receivables and other income accruing
from April 1, 1997. As a result, the Partnership made payments to the Purchaser
in the amount of the rents, receivables and other income due and received from
April 1, 1997 to the closing date of $1,001,067, which is included in rent from
operating leases and interest income. For financial reporting purposes, the cash
down payment portion of the sales proceeds of $1,575,888 has been adjusted by
the following: income and proceeds, including rents and receivables from the
effective date of April 1, 1997 to the closing date, interest due on the cash
portion of the purchase price, interest on the Promissory Note from the
effective date of April 1, 1997 to the closing date and estimated selling costs.
As a result of these GAAP adjustments, the net adjusted sales price recorded by
the Partnership, including the Promissory Note, was $13,205,140.
The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 have been classified as aircraft held for sale from that date until the
actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $749,373 during the three months ended June 30,
1997. This adjustment to the net carrying value of the aircraft held for sale is
included in depreciation and amortization expense on the statement of operations
for the three and six months ended June 30, 1997.
9
<PAGE>
5. 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, 1997 June 30, 1997
------------- -------------
Aircraft Management Fees $ 115,666 $ 124,027
Out-of-Pocket Administrative and Selling
Expense Reimbursement 111,226 166,928
Out-of-Pocket Operating Expense
Reimbursement 7,480 5,586
---------- ----------
$ 234,372 $ 296,541
========== ==========
6. Subsequent Event
In July 1997, the Partnership received its $935,000 rental payment from TWA that
was due on June 27, 1997. This amount was included in rent and other receivables
on the balance sheet at June 30, 1997.
10
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
At June 30, 1997, Polaris Aircraft Income Fund II (the Partnership) owned a
portfolio of 14 used commercial jet aircraft and certain inventoried aircraft
parts out of its original portfolio of 30 aircraft. The portfolio consists of 14
McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA).
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. Of its original
portfolio, the Partnership sold one Boeing 727-200 aircraft in February 1995,
one Boeing 737-200 Combi aircraft in March 1996, and one Boeing 737-200 aircraft
in January 1997. During the second quarter of 1997, the Partnership sold 3
McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft
leased to 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).
REMARKETING UPDATE
Sale of Boeing 737-200 Aircraft
On January 30, 1997, one Boeing 737-200 formerly on lease to Viscount, was sold
to American Aircarriers Support, Inc.(American Aircarriers) on an "as-is,
where-is" basis for $660,000 cash. In addition, the Partnership retained
maintenance reserves from the previous lessee of $217,075, that had been held by
the Partnership, which were recognized as additional sale proceeds. A net loss
of $26,079 was recorded on the sale of the aircraft.
TWA Lease Extension
GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of
noise-suppression devices, commonly known as "hushkits," for the 14 Partnership
aircraft currently on lease to TWA, as well as 18 other aircraft owned by
affiliates of Polaris Investment Management Corporation (PIMC) and leased to
TWA. Hushkit installation was completed on 11 of the Partnership's aircraft in
November 1996. Installation of hushkits on the remaining three aircraft was
completed during February 1997.
The aggregate cost of the hushkit reconditioning completed in February 1997 for
the 3 aircraft was $4,784,633 or approximately $1.6 million per aircraft, which
was capitalized by the Partnership during 1997. The Partnership paid $900,000 of
the aggregate hushkit cost and the balance of $3,884,633 was financed by UT
Finance Corporation (UT Finance), a wholly owned subsidiary of United
Technologies Corporation, of which a division is Pratt and Whitney Group, the
hushkit manufacturer, over a 6-year period at an interest rate of approximately
10% per annum.
The rent payable by TWA under the leases has been increased by an amount
sufficient to cover the monthly debt service payments on the hushkits and fully
repay, during the term of the TWA leases, the amount borrowed. The loan from UT
Finance is non-recourse to the Partnership and secured by a security interest in
the lease receivables. The leases for these 3 aircraft were extended for a
period of eight years until February 2005.
Sale of Aircraft to Triton
On May 28, 1997, Polaris Investment Management Corporation (the "General
Partner" or "PIMC"), on behalf of the Partnership, executed definitive
documentation for the purchase of 7 of the Partnership's 21 remaining aircraft
(the "Aircraft") and certain of its notes receivables by Triton Aviation
Services II LLC, a special purpose company (the "Purchaser" or "Triton"). The
11
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closings for the purchase of the 7 Aircraft occurred from May 28, 1997 to June
16, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton
Aviation" or the "Manager"), a privately held aircraft leasing company which was
formed in 1996 by Triton Investments, Ltd., a company which has been in the
marine cargo container leasing business for 17 years and is diversifying its
portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the
existing leases.
The General Partner's Decision to Approve the Transaction - In determining
whether the transaction was in the best interests of the Partnership and its
unitholders, the General Partner evaluated, among other things, the risks and
significant expenses associated with continuing to own and remarket the Aircraft
(many of which were subject to leases that were nearing expiration). The General
Partner determined that such a strategy could require the Partnership to expend
a significant portion of its cash reserves for remarketing and that there was a
substantial risk that this strategy could result in the Partnership having to
reduce or even suspend future cash distributions to limited partners. The
General Partner concluded that the opportunity to sell the Aircraft at an
attractive price would be beneficial in the present market where demand for
Stage II aircraft is relatively strong rather than attempting to sell the
aircraft "one-by-one" over the coming years when the demand for such Aircraft
might be weaker. During the months of intense negotiations, GE Capital Aviation
Services, Inc. ("GECAS"), which provides aircraft marketing and management
services to the General Partner, sought to obtain the best price and terms
available for these Stage II aircraft given the aircraft market and the
conditions and types of planes owned by the Partnership. Both the General
Partner and GECAS approved the sale terms of the Aircraft (as described below)
as being in the best interest of the Partnership and its unit holders because
both believe that this transaction will optimize the potential cash
distributions to be paid to limited partners. To ensure that no better offer
could be obtained, the terms of the transaction negotiated by GECAS included a
"market-out" provision that permitted the Partnership to elect to accept an
offer for all (but not less than all) of the assets to be sold by it to the
Purchaser on terms which it deemed more favorable, with the ability of the
Purchaser to match the offer or decline to match the offer and be entitled to be
compensated in an amount equal to 1 1/2% of the Purchaser's proposed purchase
price. The Partnership did not receive any other offers and, accordingly, the
General Partner believes that a valid market check has occurred confirming that
the terms of this transaction were the most beneficial that could have been
obtained.
The Terms of the Transaction - The total contract purchase price (the "Purchase
Price") to the Purchaser is $13,988,000 which is allocable to the Aircraft and
to certain notes receivable by the Partnership. The Purchaser paid into an
escrow account $1,575,888 of the Purchase Price in cash upon the closing of the
first aircraft and delivered a promissory note (the "Promissory Note") for the
balance of $12,412,112. The Partnership received payment of $1,575,888 from the
escrow account on June 24, 1997.
The Promissory Note is due in 28 quarterly installments of principal and
interest commencing June 30, 1997 in the amount of $608,772 over a period of
seven years bearing interest at a rate of 12% per annum with a balloon principal
payment in the amount of $2,262,866 due on March 31, 2004. The Purchaser has the
right to voluntarily prepay the Promissory Note in whole or in part at any time
without penalty. In addition, the Promissory Note is subject to mandatory
partial prepayment in certain specified instances. The Purchaser is current on
its Promissory Note obligation.
Under the terms of the transaction, the Purchaser's assets, which are limited to
the Aircraft, including any income or proceeds therefrom, and any funds made
available to Purchaser under the working capital line described below constitute
the sole source of payments under the Promissory Note. Although no security
interest over the Aircraft or the leases is granted in favor of the Partnership,
the equity interests in the Purchaser have been pledged to the Partnership. In
connection with that pledge, the Purchaser is prohibited from incurring
indebtedness other than (i) the Promissory Note; (ii) deferred taxes not yet due
and payable; (iii) indebtedness incurred to hushkit Aircraft owned by the
Purchaser; (iv) demand loans to another SPC (defined below) at a market rate of
interest; and (v) debt to trade creditors incurred in the ordinary course of
12
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business. In addition, the Purchaser undertakes to keep the Aircraft and leases
free of any lien, security interest or other encumbrance other than (i) inchoate
taxes and materialmen's liens and the like, (ii) in the event that the Purchaser
elects to install hushkits on any Aircraft, secured debt to the extent of the
full cost of such hushkit and other hushkits acquired with proceeds from the
same loan facility; (iii) liens lessees are customarily permitted to incur that
are required to be removed. The Purchaser has the right to sell any of the
Aircraft without the consent of the Partnership, except that the Partnership's
consent would be required in the event that the sale price is less than the
portion of the outstanding balance of the Promissory Note which is allocable to
the Aircraft in question and the Purchaser does not have sufficient funds to
make up the difference. In the event that any of the Aircraft are sold by the
Purchaser, the Promissory Note is subject to a mandatory prepayment of the
portion of the Promissory Note which is allocable to the Aircraft sold.
Under the terms of the transaction, the Purchaser's Manager has undertaken to
make available a working capital line to the Purchaser of up to approximately
$1,222,000 to fund operating obligations of the Purchaser. This working capital
line is guaranteed by Triton Investments, Ltd., the parent of the Purchaser's
Manager and such guarantor provided the Partnership with a copy of its most
recent balance sheet showing a consolidated net worth (net of minority
interests) of at least $150-million at December 31, 1996. Provided that the
Purchaser is not in default in making payments due under the Promissory Note to
the Partnership, the Purchaser is permitted to dividend to its equity owners an
amount not to exceed approximately $33,000 per month. The Purchaser may
distribute additional dividends to the equity owners to the extent of the
working capital advances made by the Purchaser's Manager provided that the
working capital line available to the Purchaser will be deemed increased to the
extent of such dividends.
Under the purchase agreement, the Purchaser purchased the Aircraft effective as
of April 1, 1997 notwithstanding the actual closing dates. The utilization of an
effective date facilitated the determination of rent and other allocations
between the parties. The Purchaser has the right to receive all income and
proceeds, including rents and receivables, from the Aircraft accruing from and
after April 1, 1997, and the Promissory Note commenced bearing interest as of
April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold
subject to the existing leases.
Neither PIMC nor GECAS will receive a sales commission in connection with the
transaction. In addition, PIMC will not be paid a management fee with respect to
the collection of the Promissory Note or on any rents accruing from or after
April 1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of
its affiliates holds any interest in Triton Aviation or any of Triton Aviation's
affiliates. John Flynn, the current President of Triton Aviation, was a Polaris
executive until May 1996 and has over 15 years experience in the commercial
aviation industry. At the time Mr. Flynn was employed at PIMC, he had no
affiliation with Triton Aviation or its affiliates.
Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris
Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold
certain aircraft assets to separate special purpose companies under common
management with the Purchaser (collectively, together with the Purchaser, the
"SPC's") on terms similar to those set forth above, with the exception of the
Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.
The Accounting Treatment of the Transaction - In accordance with generally
accepted accounting principles (GAAP), the Partnership recognized rental income
up until the closing date for each aircraft which occurred from May 28, 1997 to
June 16, 1997. However, under the terms of the transaction, the Purchaser was
entitled to receive payment of the rents, receivables and other income accruing
from April 1, 1997. As a result, the Partnership made payments to the Purchaser
in the amount of the rents, receivables and other income due and received from
April 1, 1997 to the closing date of $1,001,067, which is included in rent from
operating leases and interest income. For financial reporting purposes, the cash
down payment portion of the sales proceeds of $1,575,888 has been adjusted by
the following: income and proceeds, including rents and receivables from the
effective date of April 1, 1997 to the closing date, interest due on the cash
13
<PAGE>
portion of the purchase price, interest on the Promissory Note from the
effective date of April 1, 1997 to the closing date and estimated selling costs.
As a result of these GAAP adjustments, the net adjusted sales price recorded by
the Partnership, including the Promissory Note, was $13,205,140.
The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 have been classified as aircraft held for sale from that date until the
actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $749,373 during the three months ended June 30,
1997. This adjustment to the net carrying value of the aircraft held for sale is
included in depreciation and amortization expense on the statement of operations
for the three and six months ended June 30, 1997.
PARTNERSHIP OPERATIONS
The Partnership recorded net income of $889,991, or $0.76 per limited
partnership unit, for the three months ended June 30, 1997, compared to net
income of $1,037,876, or $1.23 per limited partnership unit, for the three
months ended June 30, 1996. The Partnership recorded net income of $2,404,459,
or $3.13 per limited partnership unit, for the six months ended June 30, 1997,
compared to net income of $1,591,729, or $1.50 per limited partnership unit, for
the six months ended June 30, 1996.
Rental revenues, net of related management fees, increased during the three and
six months ended June 30, 1997 compared to the same periods in 1996. This
increase was primarily the result of an increase in rental revenues from TWA. In
November 1996 and February 1997, installation of hushkits was completed on the
14 aircraft leased to TWA and the leases were extended for eight years. The rent
payable by TWA under the leases has been increased by an amount sufficient to
cover the monthly debt service payments on the hushkits and fully repay, during
the term of the TWA leases, the amount borrowed. The Partnership recorded
$440,119 and $851,985 in interest expense on the amount borrowed to finance the
hushkits during the three and six months ended June 30, 1997, respectively.
The Partnership recorded an increase in other income during the six months ended
June 30, 1997. This increase in other income was the result of the receipt of
$802,443 related to amounts due under the TWA maintenance credit and rent
deferral agreement.
Partially offsetting the increase in 1997 net income was a net loss recorded on
the sale of the Boeing 737- 200 aircraft to American Aircarriers for $660,000
cash in January 1997. In addition, the Partnership retained maintenance reserves
from the previous lessee of $217,075, which were recognized as additional sale
proceeds. A net loss of $26,079 was recorded on the sale of the aircraft.
In consideration for a rent deferral, 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.
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.
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. The Partnership recorded an allowance for credit losses
aggregating $100,409 during the first quarter of 1996 for unpaid rents and
14
<PAGE>
accrued interest recognized during the first quarter of 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 Partnership's balance sheet shows an increase in rent and other receivables
at June 30, 1997, as compared to December 31, 1996. This increase in rent and
other receivables was the result of certain rental payments due from TWA at the
end of June 1997 that were subsequently received by the Partnership in July
1997.
The decrease in the deferred income balance at June 30, 1997 is attributable to
differences between the payments due and the rental income earned on the TWA
leases for the 14 Partnership aircraft currently on lease to TWA that were
extended in 1996 and 1997. For income recognition purposes, the Partnership
recognizes rental income over the life of the lease in equal monthly amounts. As
a result, the difference between rental income earned and the rental payments
due is recognized as deferred income. The rental income earned on the TWA leases
during the six months ended June 30, 1997 exceeded the rental payments due from
TWA, causing a decrease in the deferred income balance.
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),
WestJet Airlines, Ltd. (WestJet) and Triton Aviation Services II LLC. As
discussed above, the Partnership received from TWA warrants to purchase 227,133
shares of TWA Common Stock in consideration for a rent deferral. The Partnership
exercised the warrants in 1995 and sold the TWA Common Stock in the first
quarter of 1996, net of broker commissions, for $2,406,479.
In July 1997, the Partnership received its $935,000 rental payment from TWA that
was due on June 27, 1997. This amount was included in rent and other receivables
on the balance sheet at June 30, 1997.
Payments of $95,270 and $125,193 have been received during the first two
quarters of 1997 and 1996, respectively, 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 $17,979 as of
June 30, 1997.
PIMC has determined that the Partnership maintain cash reserves as a prudent
measure to insure that the Partnership has available funds in the event that the
aircraft presently on lease to TWA require remarketing, the Purchaser defaults
under the Promissory Note, and for other contingencies including expenses of the
Partnership. The Partnership's cash reserves will be monitored and may be
revised from time to time as further information becomes available in the
future.
Cash Distributions - Cash distributions to limited partners during the three
months ended June 30, 1997 and 1996 were $4,999,970, or $10 per limited
partnership unit and $4,124,975, or $8.25 per unit, respectively. Cash
distributions to limited partners during the six months ended June 30, 1997 and
1996 were $8,124,951, or $16.25 per limited partnership unit and $8,249,951, or
$16.50 per unit, respectively.
In accordance with the Limited Partnership Agreement, cash distributions are to
be allocated 90% to the limited partners and the 10% to the general partner. In
July 1997, the Partnership made a cash distribution to limited partners of
$3,799,977 ($7.60 per limited partnership unit) and $422,220 to the general
partner. The timing and amount of future cash distributions are not yet known
and will depend on the Partnership's future cash requirements including expenses
of the Partnership as previously discussed in the Liquidity section; the receipt
of rental payments from TWA; the receipt of note payments from Triton; and
payments generated from the aircraft disassembly process.
15
<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) 1996 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, 1997,
there are a number of pending legal actions or proceedings involving the
Partnership. Except as discussed 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 - A trustee has been appointed
to administer Viscount's bankruptcy. On June 27, 1997, the Bankruptcy Court
heard oral argument on a hearing concerning confirmation of a liquidity Chapter
11 plan.
As discussed in the Partnership's 1996 Form 10-K, First Security Bank, National
Association (FSB), the owner/trustee under the Partnership's leases with
Viscount, is involved in litigation with BAE Aviation, Inc., dba Tucson
Aerospace, STS Services, Inc. and Piping Design Services, Inc., dba PDS
Technical Services, which assert mechanics' liens over an airframe for the
aircraft bearing registration no. N306VA (the "306 Aircraft") belonging to the
Partnership. After FSB filed a bond in the penal amount of $1,300,000, the
claimants in the action released the aircraft and filed a claim against the
bond. On July 7, 1997, cross-motions for summary judgment were briefed, argued
to the Superior Court and taken under advisement.
After recovering the airframe for the 306 Aircraft, the Partnership sold the
airframe in January of 1997. In the course of delivering the airframe, GE
Capital Aviation Services, Inc. (GECAS) determined that a painter, Thomas Cook,
was holding the right elevator at his shop due to an unpaid bill incurred in
connection with work on the 306 Aircraft by BAE Aviation, Inc. under contract to
Viscount, then the lessee of the 306 Aircraft. After Mr. Cook refused the
Partnership's demand for possession of the elevator, FSB, as owner trustee,
filed a lawsuit in the Superior Court of Arizona in Pima County, Case No. 318585
on March 20, 1997 against Mr. Cook and Hamilton Aviation, Inc., where his shop
is located, to recover possession. On July 7, 1997, the Superior Court heard
oral argument on motions for summary judgment and took the matter under
advisement.
Equity Resources, Inc., et al. v. Polaris Investment Management Corporation, et
al. - On May 12, 1997, plaintiffs appealed the Superior Court's denial of their
motion seeking to enjoin the sale by the Partnership of certain of its aircraft
and notes receivable. On May 15, 1997, the Appellate Court denied plaintiffs'
appeal. On May 19, 1997, plaintiffs appealed the Superior Court's denial of
their motion to the Supreme Court of Massachusetts. The Supreme Court of
Massachusetts denied plaintiffs' appeal on May 29, 1997. On May 23, 1997, the
defendants filed a motion to dismiss the action.
Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about
June 18, 1997, a purported class action entitled Ron Wallace v. Polaris
Investment Management Corporation, et al. was filed on behalf of the unitholders
of Polaris Aircraft Income Funds II through VI in the Superior Court of the
State of California, County of San Francisco. The complaint names each of
Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services,
Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, certain executives of PIMC and GECAS and
John E. Flynn, a former PIMC executive, as defendants. The complaint alleges
that defendants committed a breach of their fiduciary duties with respect to the
Sale Transaction involving the Partnership as described in Item 2, under the
caption "Remarketing Update -- Sale of Aircraft to Triton."
16
<PAGE>
Other Proceedings - Item 10 in Part III of the Partnership's 1996 Form 10-K and
Item 1 in Part II of the Partnership's Form 10-Q for the period ended March 31,
1997 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 the Partnership's 1996 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.
The following actions have been settled pursuant to a settlement agreement
entered into on June 6, 1997:
- - Thelma Abrams, et al. v. Polaris Holding Company, et al.
- - Sara J. Bishop, et al. v. Kidder, Peabody & Co. Incorporated, et al.
- - Elphick, et al. v. Kidder, Peabody & Co. Incorporated, et al.
- - Janet K. Johnson, et al. v. Polaris Holding Company, et al.
- - Wayne W. Kuntz, et al. v. Polaris Holding Company, et al.
- - Joyce H. McDevitt, et al. v. Polaris Holding Company, et al.
- - Mary Grant Tarrer, et al. v. Kidder, Peabody & Co. Incorporated, et al.
- - Harry R. Wilson, et al. v. Polaris Holding Company, et al.
- - George Zicos, et al. v. Polaris Holding Company, et al.
- - Michael J. Ouellette, et al. v. Kidder, Peabody & Co. Incorporated, et al.;
Thelma A. Rolph, et al. v. Polaris Holding Company, et al.; Carl L. Self, et al.
v. Polaris Holding Company, et al. - On or about March 21, 1997, three
complaints were filed in the Superior Court of the State of California, County
of Sacramento naming as defendants Kidder, Peabody & Company, Incorporated,
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, General Electric Capital Corporation, GE
Capital Aviation Services and Does 1-100. The first complaint, entitled Michael
J. Ouellette, et al. v. Kidder Peabody & Co., et al., was filed by over 50
individual plaintiffs who purchased limited partnership units in one or more of
Polaris Aircraft Income Funds I-VI. The second complaint, entitled Thelma A.
Rolph, et al. v. Polaris Holding Company, et al., was filed by over 500
individual plaintiffs who purchased limited partnership units in one or more of
Polaris Aircraft Income Funds I-VI. The third complaint, entitled Carl L. Self,
et al. v. Polaris Holding Company, et al., was filed by over 500 individual
plaintiffs who purchased limited partnership units in one or more of Polaris
Aircraft Income Funds I-VI. Each complaint alleges violations of state common
law, including fraud, negligent misrepresentation and breach of fiduciary duty,
and violations of the rules of the National Association of Securities Dealers,
Inc. Each complaint seeks to recover compensatory damages and punitive damages
in an unspecified amount, interest and rescission with respect to Polaris
Aircraft Income Funds I-VI and all other limited partnerships alleged to have
been sold by Kidder Peabody to the plaintiffs.
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
A Current Report on Form 8-K, dated May 28, 1997, reporting the sale of
assets under Item 2 was filed on June 12, 1997.
17
<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 12, 1997 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)
18
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> JUN-30-1997
<CASH> 21547044
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