<PAGE> 1
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________ to _______________
Commission file number 0-18387
Pegasus Aircraft Partners II, L.P.
(Exact name of registrant as specified in its charter)
Delaware 84-1111757
(State of organization) (IRS Employer
Identification No.)
Four Embarcadero Center 35th Floor
San Francisco, California 94111
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (415) 434-3900
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 (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|.
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Pegasus Aircraft Partners II, L.P.
Quarterly Report on Form 10-Q for the
Quarter Ended September 30, 1996
Table of Contents
<TABLE>
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Page
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<S> <C> <C> <C>
Part I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 2
Balance Sheets - September 30, 1996
and December 31, 1995 2
Statements of Income for the three
months ended September 30, 1996
and 1995 3
Statements of Income for the nine
months ended September 30, 1996
and 1995 4
Statements of Partners' Equity for the
nine months ended September 30, 1996
and 1995 5
Statements of Cash Flows for the nine
months ended September 30, 1996 and
1995 6
Notes to Financial Statements 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 16
Part II OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 3. Exhibits and Reports on Form 8-K 23
</TABLE>
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Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
PEGASUS AIRCRAFT PARTNERS II, L.P.
BALANCE SHEETS -- SEPTEMBER 30, 1996 AND DECEMBER 31, 1995
(unaudited)
<TABLE>
<CAPTION>
1996 1995
-------- --------
(in thousands,
except unit data)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 8,832 $ 11,955
Restricted cash 2,487 2,104
Rent and other receivables (Note 5) 895 2,557
Aircraft, net (Notes 2, 4 and 5) 57,282 63,482
Other assets 68 701
-------- --------
Total Assets $ 69,564 $ 80,799
======== ========
LIABILITIES AND PARTNERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 112 $ 148
Payable to affiliates (Note 3) 661 893
Interest payable 34 46
Maintenance payable (Note 5) 2,487 2,104
Notes payable 5,199 6,638
Deferred income 1,883 4,672
Distributions payable to partners 2,974 2,931
-------- --------
Total Liabilities 13,350 17,432
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 3, 4, 5 and 6)
PARTNERS' EQUITY:
General Partners (888) (816)
Limited Partners (7,255,000 units outstanding) 57,102 64,183
-------- --------
Total Partners' Equity 56,214 63,367
-------- --------
Total Liabilities and Partners' Equity $ 69,564 $ 80,799
======== ========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
2
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(unaudited)
<TABLE>
<CAPTION>
1996 1995
---------- ----------
(in thousands, except unit
data and per unit amounts)
<S> <C> <C>
REVENUE:
Rentals from operating leases $ 3,961 $ 3,356
Interest 160 143
---------- ----------
4,121 3,499
---------- ----------
EXPENSES:
Provision for bad debts (Note 5) 640 --
Loss in value Kiwi stock (Note 5) 119 --
Depreciation and amortization 2,703 2,341
Management and re-lease fees (Note 3) 268 265
Interest expense 156 189
General and administrative (Note 3) 69 72
Direct lease 59 71
---------- ----------
4,014 2,938
---------- ----------
NET INCOME $ 107 $ 561
========== ==========
NET INCOME ALLOCATED:
To the General Partners $ 1 $ 6
To the Limited Partners 106 555
---------- ----------
$ 107 $ 561
========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .01 $ .08
========== ==========
WEIGHTED AVERAGE NUMBER OF LIMITED
PARTNERSHIP UNITS OUTSTANDING 7,255,000 7,255,000
========== ==========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
3
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(unaudited)
<TABLE>
<CAPTION>
1996 1995
---------- ----------
(in thousands, except unit
data and per unit amounts)
<S> <C> <C>
REVENUE:
Rentals from operating leases $ 11,815 $ 10,257
Interest 563 426
---------- ----------
12,378 10,683
---------- ----------
EXPENSES:
Provision for bad debts (Note 5) 640 --
Loss in value Kiwi stock (Note 5) 155 --
Depreciation and amortization 8,113 7,023
Management and re-lease fees (Note 3) 850 784
Interest expense 506 616
General and administrative (Note 3) 227 218
Direct lease 246 164
---------- ----------
10,737 8,805
---------- ----------
NET INCOME $ 1,641 $ 1,878
========== ==========
NET INCOME ALLOCATED:
To the General Partners $ 16 $ 19
To the Limited Partners 1,625 1,859
---------- ----------
$ 1,641 $ 1,878
========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .22 $ .26
========== ==========
WEIGHTED AVERAGE NUMBER OF LIMITED
PARTNERSHIP UNITS OUTSTANDING 7,255,000 7,255,000
========== ==========
</TABLE>
The accompanying notes are an integral
part of these financial statements.
4
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF PARTNERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(unaudited)
<TABLE>
<CAPTION>
General Limited
Partners Partners Total
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Balance, January 1, 1996 $ (816) $ 64,183 $ 63,367
Net income 16 1,625 1,641
Distributions to partners declared (88) (8,706) (8,794)
-------- -------- --------
Balance, September 30, 1996 $ (888) $ 57,102 $ 56,214
======== ======== ========
Balance, January 1, 1995 $ (719) $ 73,792 $ 73,073
Net income 19 1,859 1,878
Distributions to partners declared (88) (8,706) (8,794)
-------- -------- --------
Balance, September 30, 1995 $ (788) $ 66,945 $ 66,157
======== ======== ========
</TABLE>
The accompanying notes are an integral part
of these financial statements.
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
(unaudited)
<TABLE>
<CAPTION>
1996 1995
-------- --------
(in thousands)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,641 $ 1,878
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 8,113 7,023
Provision for bad debts 640 --
Loss arising from securities received
in a leasing transaction 155 --
Change in assets and liabilities:
Rent and other receivables 684 (138)
Other assets 35 34
Accounts payable and accrued expenses (77) 12
Payable to affiliates (232) 291
Interest payable (12) (1)
Deferred income and deposits (2,346) (100)
-------- --------
Net cash provided by operating activities 8,601 8,999
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized aircraft improvements (1,913) (16)
Advances to lessees -- (353)
Repayment of advances by lessees 338 322
Accounts payable arising from
capitalized aircraft improvements 41 100
-------- --------
Net cash (used in) provided by investing activities (1,534) 53
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Transfers from restricted cash, net -- 381
Repayment of notes payable (1,439) (264)
Cash distributions paid to partners (8,751) (8,794)
-------- --------
Net cash used in financing activities (10,190) (8,677)
-------- --------
NET (DECREASE) INCREASE IN CASH AND
CASH EQUIVALENTS (3,123) 375
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 11,955 4,513
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 8,832 $ 4,888
======== ========
Supplemental schedule of cash flow information:
Interest paid $ 518 $ 617
======== ========
</TABLE>
The accompanying notes are an integral part
of these financial statements
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PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
(unaudited)
1. GENERAL
The accompanying unaudited interim financial statements include all
adjustments (consisting solely of normal recurring adjustments) which are, in
the opinion of the General Partners, necessary to fairly present the financial
position of the Partnership as of September 30, 1996 and the results of its
operations, changes in partners' equity and cash flows for the nine months then
ended.
These financial statements should be read in conjunction with the
Significant Accounting Policies and other Notes to Financial Statements included
in the Partnership's annual audited financial statements for the year ended
December 31, 1995.
Certain amounts in the 1995 financial statements presented herein have been
reclassified to conform to the classifications used in 1996.
2. AIRCRAFT
The Partnership's net investment in aircraft as of September 30, 1996 and
December 31, 1995 consisted of the following (in thousands):
<TABLE>
<CAPTION>
1996 1995
-------- --------
<S> <C> <C>
Aircraft on operating leases $116,354 $114,460
Less: Accumulated depreciation (53,888) (45,775)
Provision for decline in market
value of aircraft (12,246) (12,246)
-------- --------
$ 50,220 $ 56,439
Aircraft held for lease (A-300 Aircraft) $ 28,747 $ 28,728
Less: Accumulated depreciation (11,013) (11,013)
Amounts received including value
of aircraft in Lease Settlement accounted
for under the cost recovery method (10,115) (10,115)
Reserves for maintenance (557) (557)
-------- --------
7,062 7,043
-------- --------
Aircraft, net $ 57,282 $ 63,482
======== ========
</TABLE>
7
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3. TRANSACTIONS WITH AFFILIATES
Management Fees The General Partners are entitled to receive a quarterly
subordinated base management fee in an amount generally equal to 1.5% of gross
aircraft rentals, net of re-lease fees paid. Of this amount, 1.0% is payable to
the Managing General Partner and 0.5% is payable to the Administrative General
Partner. The General Partners earned $53,000 and $169,000 of base management
fees during the quarter and nine months ended September 30, 1996, respectively.
The General Partners also are entitled to receive a quarterly subordinated
incentive management fee in an amount equal to 4.5% of quarterly cash flow and
sales proceeds (net of resale fees), of which 2.5% is payable to the Managing
General Partner and 2.0% is payable to the Administrative General Partner. The
General Partners earned $160,000 and $490,000 of incentive management fees
during the quarter and nine months ended September 30, 1996, respectively.
Re-lease Fees The General Partners are entitled to receive a quarterly
subordinated fee for re-leasing aircraft or renewing a lease in an amount equal
to 3.5% of the gross rentals from such re-lease or renewal for each quarter for
which such payment is made. Of this amount, 2.5% is payable to the Managing
General Partner and 1.0% is payable to the Administrative General Partner. The
General Partners earned $55,000 and $191,000 of re-lease fees during the quarter
and nine months ended September 30, 1996, respectively.
All of the above fees are subordinated to the limited partners receiving an
8% annual non-cumulative return based upon original, contributed capital. The
Partnership did not accrue any fees related to the Kiwi rent for which a
provision for bad debts was provided at September 30, 1996.
Accountable General and Administrative Expenses The General Partners are
entitled to reimbursement of certain expenses paid on behalf of the Partnership
which are incurred in connection with the administration and management of the
Partnership. Such reimbursable expenses amounted to $19,000 and $56,000 during
the quarter and nine months ended September 30, 1996, respectively, all of which
was payable to the Administrative General Partner.
During 1996 and 1995, the Administrative General Partner deferred the
receipt of management fees and re-lease fees earned beginning January 1, 1995.
As part of the proposed class action settlement (See Note 5, "Litigation" these
management and re-lease fees as well as all future fees and cash distributions
earned by the Administrative General Partner have been assigned by an affiliate
to an escrow account for the benefit of class members. In September 1996, the
Partnership paid $445,000 to the Administrative General Partner pursuant to such
assignment.
In the nine months ended September 30, 1996, the Partnership purchased
certain equipment and parts relating to the A-300 aircraft and the hushkitting
of the 727 non-advanced aircraft from a company owned by the three directors of
the Managing General Partner in the amount of $75,000. Additionally, the
Partnership paid $29,000 to a licensed
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maintenance provider in which affiliates of the Managing General Partners have
an equity interest.
4. AIRCRAFT LEASES
a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental, originally
scheduled to expire on May 31, 1997, with rents of $252,000 per month.
Continental also has three two-year renewal options, with rent payable during
the first two such renewal periods at the lesser of the then fair market rental
value or the rental rate during the initial term, and during the third such
renewal period at the then fair market rental rate. In addition, the lessee has
a right of first refusal to purchase or re-lease the aircraft after the last
renewal period on the same terms as those included in any bona fide offer made
to the Partnership by a third party. This lease was modified in 1995 as
discussed below.
During September 1989, the Partnership acquired a Boeing 727-200
non-advanced aircraft for a total purchase price of $6,116,000, subject to an
operating lease with Continental. This aircraft was returned during
Continental's bankruptcy and subsequently leased to Kiwi (see discussion of Kiwi
below).
During August 1990, the Partnership acquired an Airbus Industrie Model
A300-B4-103 ("A-300") aircraft for a total purchase price of $28,070,000,
subject to an operating lease with Continental, originally scheduled to expire
on December 29, 2000 and with monthly, in advance, rentals of $312,000.
In January 1995, Continental announced that it was grounding its fleet of
Airbus Industrie A-300 aircraft, including the A-300 aircraft leased to it by
the Partnership, and notified the Partnership of its intention to return the
aircraft to the Partnership. Continental paid $150,000 of the $312,000 monthly
rental payment due in February through May 1995. The Partnership did not accrue
as rental revenue the difference between the amount due and the amount paid by
Continental for such months. Continental took the A-300 out of service in May
1995, and the Partnership prepared the aircraft for delivery in June 1995 to a
new lessee, Akdeniz Air Mediterranean, Inc. ("Akdeniz") based in Turkey.
In June 1995, the Partnership executed a lease of the A-300 aircraft to
Akdeniz for a scheduled term of four years, under which Akdeniz subsequently
defaulted. The Partnership recovered the A-300 aircraft, returned it to FAA
registry, and is currently remarketing it. The Partnership estimates that it
will spend approximately $1.4 million for a scheduled heavy maintenance check
that will be required prior to delivery of the aircraft to a new lessee. The
Partnership received $557,000 from Continental pursuant to the A-300 Settlement
discussed below which will be applied towards such maintenance.
On November 15, 1995, the Partnership reached an agreement with Continental
regarding the settlement of its lease obligations under the A-300 lease ("A-300
Lease Settlement"), which also included a restructuring of the DC-10-10 Aircraft
lease ("DC-10 Restructuring").
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Under the terms of the A-300 Lease Settlement, the Partnership received a
cash payment of approximately $3,721,000, including approximately $325,000 as
reimbursement for certain integration and transaction expenses, and (i) title to
a Boeing 727-200 advanced aircraft subject to lease with Continental for a term
of approximately 26 months at a lease rate of $85,000 per month and (ii) title
to a second Boeing 727-200 advanced aircraft subject to a lease with Continental
for a term of approximately 42 months at a lease rate of $85,000 per month.
Additionally, the Partnership received approximately $557,000 as an economic
settlement in lieu of Continental performing certain maintenance work and the
aircraft meeting certain return conditions required by the lease.
Under the DC-10 Restructuring the Partnership received approximately
$3,100,000, the lease expiration date was changed from May 31, 1997 to October
31, 1996 and the monthly lease payments were reduced from $252,000 to $135,000
effective September 15, 1995. All other terms and conditions of the DC-10-10
lease remain unchanged. Continental and the Partnership have reached an
agreement in principle to extend the lease for a term of approximately 18 months
at a lease rate of approximately $150,000 per month. The agreement in principal
is subject to documentation and certain terms. Continental continues to use the
aircraft and made the November 1996 rental payment.
Continental did not make the monthly rental payments due under the three
leases with the Partnership on December 1, 1990 and filed for Chapter 11
bankruptcy protection on December 3, 1990. The Partnership entered into various
lease modifications and financing arrangements with Continental as a result of
the bankruptcy. At September 30, 1996, the Partnership had aircraft modification
advances outstanding from Continental totaling $139,000, which are being repaid
monthly with interest.
b. Trans World Airlines Leases During December 1989, the Partnership
acquired a McDonnell Douglas MD-82 aircraft for a total purchase price of
$20,763,000, subject to an operating lease with TWA, which was originally
scheduled to expire on April 13, 1993, but was amended and extended until
November 1, 1998 with monthly, in advance, rental payments of $185,000. As
described below, this lease was further extended to November 2004 during TWA's
prepackaged bankruptcy in 1995.
Upon execution of the lease amendment, the Partnership reimbursed TWA for
$225,000 of capital improvements which were made to the aircraft and advanced
$750,000 to TWA to finance certain major maintenance procedures, which is being
repaid over the remaining lease term, in monthly installments with interest at a
fixed rate of 9.70%. At September 30, 1996, the balance of the receivable was
$331,000. All 1996 repayments of advances have been made by TWA as scheduled.
During January 1990, the Partnership acquired a Lockheed L-1011 aircraft
for a total purchase price of $17,555,000, subject to an operating lease with
TWA, originally scheduled to expire on June 30, 1993. The lease was amended and
extended to October 1, 1998 with rental payments payable monthly, in advance, at
the rate of $130,000.
Upon execution of the lease amendment, the Partnership reimbursed TWA for
$225,000 of capital improvements which were made to the aircraft and advanced
$550,000 to TWA to finance certain major maintenance procedures, which is being
repaid
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over the remaining lease term in monthly installments with interest at 9.68%. At
September 30, 1996, the balance of the receivable was $236,000. All 1996
repayments of advances have been made by TWA as scheduled.
In mid-October 1994, because of operating and financial problems, TWA
announced that it would seek a global restructuring of its capital by offering
common stock for its debt securities, preferred stock obligations and lease
deferrals negotiated with aircraft lessors such as the Partnership ("Exchange
Offer") with the objective of an orderly financial reorganization through a
prepackaged bankruptcy filing. In conjunction with this restructuring, TWA and
the Partnership agreed ("TWA Agreement") to a deferral of 50% of the rent
scheduled for November 1994, and 75% of the rent scheduled from December 1994 to
April 1995 for the MD-82 aircraft (50% of the December 1994 through April 1995
rent with respect to the L-1011 aircraft) followed by a return to the original
payment schedule. Under the terms of the TWA Agreement all rents deferred during
the November 1994 to April 1995 period are to be repaid with interest at 12%
from the date of deferral over an 18-month period, the repayments of which
commenced May 1, 1995. Deferred rent pursuant to the TWA Agreement of $77,000
and $736,000 was included in rents and other receivables in the balance sheets
as of September 30, 1996 and December 31, 1995, respectively. Additionally, TWA
and the Partnership agreed to extend the lease of the MD-82 aircraft six years
beyond the scheduled expiration date (to November 2004) at the current lease
rate of $185,000 per month. On June 30, 1995, TWA filed its prepackaged
reorganization plan under Chapter 11 of the U.S. Bankruptcy Code. On August 23,
1995 the reorganization plan which included the foregoing lease modification was
confirmed by the Bankruptcy Court and TWA emerged from bankruptcy. TWA has made
all rental payments, advance repayments and payments of deferred rent when due.
However, there can be no assurance that it will be able to meet its obligations
in the future.
In mid-1996, as part of its fleet restructuring, TWA offered to return the
L-1011 aircraft it leases from the Partnership. The lease, which provided for
monthly rental of $130,000, was originally scheduled to expire in September
1998. TWA agreed to pay the Partnership $2,846,000, which represents rents due
under the remaining term of the lease, discounted at 5% plus $3,000,000 as an
economic settlement for non-compliance with certain lease return conditions. The
lease was terminated, the aircraft was returned and the amounts aggregating
$5,846,000 were paid on October 16, 1996. The Partnership is reviewing
alternatives for the use of the proceeds received, including the use of the
economic settlement to purchase an additional aircraft or engines. It is likely
that the Partnership will lease the engines that were a part of the L-1011
separately and sell the airframe for parts.
The L-1011 aircraft was originally purchased in 1990 for $18,205,000
(including related fees) and had a net book value of $6,176,000 at September 30,
1996.
c. Aeromexico Leases During July 1992, the Partnership re-leased two
McDonnell Douglas DC-9-31 aircraft previously leased to Midway Airlines Inc. to
Aerovias de Mexico, S.A. de C.V. ("Aeromexico"). The leases are operating leases
that require quarterly rental payments, in advance, in the amount of $234,000
per aircraft. The terms of the leases expire on July 6, 1997 and July 23, 1997.
Aeromexico has the right to
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renew the leases for up to five consecutive one-year renewal periods for the
then fair market rental value.
The DC-9-31 aircraft had originally been acquired in April and March 1990
for purchase prices aggregating $14,295,000. At the time the Partnership
repossessed these two aircraft from Midway, the aircraft were in need of
substantial maintenance work. As a precondition to accepting the aircraft for
lease, Aeromexico required the Partnership to complete the needed maintenance
procedures and also to make certain capital improvements to the aircraft. The
Partnership incurred approximately $5.5 million in completing these maintenance
procedures and capital improvements.
In October 1994, Aeromexico failed to make the quarterly in advance rental
payments for both aircraft. Aeromexico announced it was having financial and
operating problems and, in response, made significant management changes and
began to develop a revised business plan. Aeromexico agreed to and paid monthly
rental payments equal to the monthly equivalent rent ($78,000 per aircraft)
beginning November 1994 in return for a four-month standstill agreement
("Standstill Agreement") from lessors and lenders, including the Partnership,
not to pursue their rights and remedies with respect to Aeromexico's failure to
pay rent and other debt due in October 1994. The Standstill Agreement was
extended an additional three months to allow Aeromexico to complete a financial
restructuring. Aeromexico made all of its monthly rental payments due and repaid
the October 1994 rent with interest.
USAir Lease During March 1989, the Partnership acquired one-half of the
beneficial interest in a trust ("Trust") which is the owner/lessor of a
McDonnell Douglas MD-81 aircraft ("USAir Aircraft") for a total purchase price
of $10,041,000. The remaining one-half interest in the trust is owned by Pegasus
Aircraft Partners II, L.P., an affiliated partnership. The aircraft is subject
to an operating lease with USAir, Inc. ("USAir") the term of which ends on June
1, 1998. The lease may be terminated subject to the lessee's guarantee that the
partnership will receive contractually defined minimum termination values upon
remarketing of the aircraft. Rental payments are payable quarterly, in arrears,
at a rate of $304,000 (for the Partnership's one-half interest in the aircraft).
The lease provided for one three-year renewal option, at the same quarterly
rental rate. If the lease is not renewed for the first renewal period, the
lessee must make a termination payment of $1,113,000 to the Partnership. The
lessee also has three additional one-year renewal options at fair market rental
rates. The lessee may elect to purchase at it fair market value at the end of
any renewal term. The USAir Aircraft was purchased subject to a tax benefit
transfer lease ("TBT Lease") which provided for the transfer of certain tax
benefits to a tax lessor. The Trust as owner and tax lessor under the TBT Lease,
has agreed to indemnify the tax lessor for the loss of the tax benefits in
certain circumstances and posted a letter of credit to secure the obligation
under such indemnification. Under the operating lease, USAir has assumed all
obligations, liabilities and indemnities of the Trust to the tax lessor and has
indemnified the Trust for its obligations to the tax lessor except those arising
from breaches by the Trust of convenants under the operating lease.
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5. KIWI BANKRUPTCY
The Partnership leased its two Boeing 727-200 aircraft, to Kiwi
International Air Lines, Inc. ("Kiwi"). The aircraft were originally purchased
in 1989 (non-advanced) and 1990 (advanced) for purchase prices of $6,261,000 and
$10,748,000 respectively (including related fees). The leases are operating
leases which require monthly rental payments, in advance, in the amounts of
$60,000 (Non-advanced) and $115,000 (Advanced). The terms of the leases were
originally scheduled to expire on April 15, 1998 and June 30, 1998,
respectively. In 1995, the leases were amended and extended to December 31,
1999. Kiwi is also obligated to make monthly payments of $250 per flight hour
for maintenance reserve funds administered by the Partnership. During the terms
of the leases Kiwi can request that the aircraft be hushkitted to obtain Stage 3
noise abatement for which the lease term will be reset to five years with lease
payments increasing to amortize the cost of the hushkitting at the rate of
approximately 2% per month. Alternatively, the Partnership can deem the
hushkitting economically unfeasible at which point Kiwi can terminate the leases
and return the aircraft. An affiliated partnership and affiliates of the
Managing General Partner also own aircraft leased to Kiwi.
In connection with the delivery of the aircraft the Partnership expended
$2,228,000 with respect to the 727 Advanced aircraft, of which $971,000 was
capitalized and $1,257,000 represented maintenance costs which were paid out of
funds received in a maintenance settlement with the prior lessee. Capitalized
improvements of $743,000 were made with respect to the non-advanced aircraft.
The Partnership also received Kiwi stock and rights to warrants in
connection with these leasing transactions. The Partnership is subject to
significant restrictions on its ability to dispose of these securities. Based
upon the price at which Kiwi sold similar securities to unrelated third parties,
the Partnership originally recorded the securities at a value of $600,000. The
securities were valued at $1,000 at September 30, 1996.
During 1994, the Partnership funded approximately $633,000 of costs related
to maintenance of the Kiwi aircraft, including compliance with certain FAA
airworthiness directives, $308,000 of which was scheduled to be repaid by Kiwi
over a one-year period. In March 1996 Kiwi signed a promissory note ("Bellyskin
Note") scheduling the repayment of this amount, with interest from February 1996
at 12% per annum, over eighteen months which began June 1, 1996.
In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft. The purchase price was funded out of cash reserves
previously generated.
In June 1996, Kiwi agreed with the FAA to ground 25% of its fleet due to
certain pilot training handbook deficiencies. In August 1996, Kiwi and the FAA
resolved the deficiencies and Kiwi returned to full capacity. In addition to the
FAA grounding, Kiwi was also negatively impacted by the market reaction to the
ValuJet incident and as a result, did not meet its financial goals. In July
1996, an outside institutional investor contributed $4,000,000 in return for a
convertible note due in March 1997, for up to 32% of Kiwi's common stock and two
seats on Kiwi's Board of Directors. The investor has options to invest an
additional $6,000,000 in convertible preferred stock which expires in
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March 1997. Existing shareholders (including directors and employees) were to be
given the opportunity to make additional investments.
Kiwi requested and was granted by the Partnership a deferral of its August
1996 rental and July 1996 maintenance payments for the advanced aircraft and the
July rental and June maintenance reserves with respect to the non-advanced
aircraft. Kiwi was also unable to make its September rental and August
maintenance payments for each aircraft and was placed in default by the
Partnership.
In late September, Kiwi proposed a restructuring of its obligations with
certain creditors, including the Partnership, which the Partnership was
reviewing. On September 30, 1996, Kiwi filed a voluntary petition for
reorganization under Chapter 11 of the Federal Bankruptcy Code ("Bankruptcy
Code") and has not made any subsequent payments. Generally, under Section 1110
of the Bankruptcy Code, Kiwi has sixty days from the filing to cure all
arrearages with respect to an aircraft lease or return the aircraft. The Kiwi
leases account for approximately 17% of the Partnership's rental receipts and
the aircraft had net book values aggregating approximately $8,300,000 (including
the hushkit). Additionally the unpaid balance of the Bellyskin Note, plus
interest was $290,000 at September 30, 1996. The Partnership currently holds
maintenance deposits aggregating approximately $2.4 million, which the
Partnership believes will not be sufficient to complete work required on the
aircraft and the related engines to meet lease return conditions and make the
aircraft marketable. The Parthership would fund any shortfall from operations
or a borrowing facility. Kiwi indicated that it is going to reduce its fleet in
the short term, and it is likely that Kiwi will return one or both of the
Partnership's aircraft. Further, Kiwi announced that, absent debtor in
possession financing, it may cease operations. On Tuesday October 15,1996, Kiwi
ceased scheduled flight operations while still exploring financial
alternatives. Kiwi has filed a motion to reject both leases which will be heard
on November 15, 1996. It is likely that the Partnership will incur significant
costs to re-lease the aircraft. Further, while the Partnership has commenced
remarketing activities, there could be a significant delay before the aircraft
are redeployed. The Partnership provided an allowance for bad debts in the
amount of $640,000 in respect of amounts due at September 30, 1996. The long
term impact of the Kiwi bankruptcy on the Partnership's ability to realize upon
the value of its aircraft is not determinable at this time.
6. LITIGATION
In November 1994, a series of purported class actions (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York concerning PaineWebber Incorporated sale and
sponsorship of various limited partnership investments, including those offered
by the Partnership. The lawsuits were brought against PaineWebber Incorporated
and Paine Webber Group, Inc. (together, "PaineWebber"), among others, by
allegedly dissatisfied partnership investors. In March 1995, after the actions
were consolidated under the title In re: PaineWebber Limited Partnerships
Litigation, the plaintiffs amended their complaint to assert claims against a
variety of other defendants, including Air Transport Leasing, Inc., an affiliate
of
14
<PAGE> 16
PaineWebber and the Administrative General Partner in the Partnership
("Administrative General Partner").
The amended complaint in the New York Limited Partnership Actions alleged,
among other things, that, in connection with the sale of interests in Pegasus
Aircraft Partners II, L.P., PaineWebber and the Administrative General Partners
(1) failed to provide adequate disclosure of the risks involved with each
partnership; (2) made false and misleading representations about the safety of
the investments and the partnership's anticipated performance; and (3) marketed
the partnership to investors for whom such investments were not suitable. The
plaintiffs also alleged that following the sale of the partnership investments
PaineWebber and the Administrative General Partner misrepresented financial
information about the partnership's value and performance. The amended complaint
alleged that PaineWebber and the Administrative General Partner violated the
Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal
securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and other income derived by PaineWebber from the
limited partnerships. In addition, the plaintiffs also sought treble damages
under RICO.
On May 30, 1995, the US District Court certified class action treatment of
the plaintiffs' claims in the New York Limited Partnership Actions.
In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties have
agreed to settle the case. Pursuant to that memorandum of understanding,
PaineWebber irrevocably deposited $125 million into an escrow fund under the
supervision of the United States District Court for the Southern District of New
York "District Court" to be used to resolve the litigation. On July 17, 1996,
the District Court granted preliminary approval of the proposed settlement of
the class action litigation. As part of the class action settlement, PaineWebber
agreed to pay $125 million and additional consideration to class members. A
final hearing on the proposed settlement is scheduled to continue in November
1996.
In April 1995, two investors in the Pegasus limited partnerships filed a
purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert M. Jacobson, et al. v. PaineWebber, Inc., et al., making
allegations substantially similar to those in the New York Limited Partnership
Actions, but limited in subject matter to the sale of the Pegasus partnerships,
and without a RICO claim. The plaintiffs in the Jacobson case simultaneously
remained as participants in the New York Limited Partnership Actions, and are
challenging the proposed settlement of these cases. The Illinois case has been
dismissed.
Three actions were filed in the District Court for Brazoria County, Texas,
relating to the sale and sponsorship of interests in the Partnership and an
affiliated partnership. The complaints make state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act.
15
<PAGE> 17
The plaintiffs seek unspecified damages, including attorneys' fees,
reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages under the Texas Deceptive Trade Practices Act. All
three actions have been removed to federal court and two have been transferred
to the United States District Court for the Southern District of New York and
consolidated under the title, Mallia vs. PaineWebber, Inc. The third action has
been dismissed with the consent of the parties on the grounds that it is
duplicative of the two actions now before the federal court in New York.
In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchases of various limited partnership interests. The complaint
alleges, among other things, that PaineWebber and its related entities committed
fraud and misrepresentation and breached fiduciary duties allegedly owed to the
plaintiffs by selling or promoting limited partnership investments that were
unsuitable for the plaintiffs and by overstating the benefits, understating the
risks and failing to state material facts concerning the investments. The
complaint seeks compensatory damages of $15 million plus punitive damages. In
September 1996, the California Superior Court dismissed many of the plaintiffs'
claims as barred by the applicable statutes of limitation.
In June 1996, counsel for the Abbate plaintiffs instituted two additional
actions containing allegations nearly identical to those set forth in Abbate.
Bandrowski v. PaineWebber Incorporated, et al. was filed in California Superior
Court and Barstad v. Paine Webber Incorporated, et al. was filed in Arizona
Superior Court. Collectively, the two additional actions are brought by
approximately 50 plaintiffs and seek compensatory damages of approximately $4
million plus punitive damages.
Under certain limited circumstances, pursuant to the Partnership Agreement
and other contractual obligations, PaineWebber and its affiliates, including the
Administrative General Partner could be entitled to indemnification from the
Partnership for expenses and liabilities in connection with the Mallia, Abbate,
Bandrowski and Barstad actions. The General Partners are unable to determine the
effect, if any, of these actions on the Partnership's financial statements taken
as a whole.
16
<PAGE> 18
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
LIQUIDITY AND CAPITAL RESOURCES
The Partnership invests working capital and cash flow from operations prior
to its distribution to the partners in short-term, highly liquid investments. At
September 30, 1996, the Partnership's unrestricted cash and cash equivalents of
$8,832,000 was primarily invested in commercial paper. This amount was
$3,123,000 less than the Partnership's unrestricted cash and equivalents at
December 31, 1995 of $11,955,000. This decrease in unrestricted cash was equal
to the amount by which the combined total of the quarterly cash distributions
paid to the partners during the nine months, the required principal payments on
the Partnership's debt, and capitalized expenditures for aircraft (primarily
the purchase of the hush kit for $1.9 million) exceeded cash provided by
operating activities plus the collection of amounts previously advanced to
lessees during the nine months ended September 30, 1996.
Restricted cash increased $383,000 from $2,104,000 at December 31, 1995 to
$2,487,000 at September 30, 1996. During 1993, the Partnership leased two Boeing
727-200 aircraft to Kiwi. Under the terms of the leases, Kiwi is obligated to
make monthly payments to maintenance reserve funds administered by the
Partnership. The Partnership is obligated to reimburse Kiwi for specified
maintenance costs out of the reserve funds, upon submission of appropriate
evidence documenting the maintenance costs incurred by Kiwi. This amount is
reflected on the balance sheet both as restricted cash and as maintenance
payable. (See discussion below regarding Kiwi and Footnote 5, "Kiwi
Bankruptcy".)
Rent and other receivables, net, decreased $1,662,000 from $2,557,000 at
December 31, 1995 to $895,000 at September 30, 1996. This decrease resulted
primarily from the continued repayment of advances and deferrals with
Continental, TWA and Kiwi. However, Partnership collections were impacted by the
Kiwi bankruptcy and the Partnership provided an allowance for bad debts totaling
$640,000 with respect to two months rent plus the Bellyskin Note and related
interest which were outstanding at September 30, 1996.
The Partnership entered into various lease modifications and financing
arrangements with Continental as a result of its December 1990 bankruptcy. At
September 30, 1996, the Partnership had aircraft modification advances
outstanding from Continental totaling $139,000, which are being repaid monthly
with interest.
As part of TWA's January 1991 bankruptcy filing, the Partnership's leases
with TWA for the Lockheed L-1011 and McDonnell Douglas MD-82 aircraft were
modified and extended in April 1993. Upon execution of the lease amendments, the
Partnership advanced $1,300,000 to TWA to finance certain major maintenance
procedures which had been performed on the two aircraft. TWA agreed to repay
these amounts to the Partnership over the applicable remaining lease terms in
equal monthly installments with interest at a fixed rate of 450 basis points
over the equivalent term U.S. Treasury obligations (9.68% and 9.70% for the
initial advances). At September 30, 1996, the balance of the advances to TWA
aggregated $567,000.
17
<PAGE> 19
Other assets decreased $633,000 from $701,000 at December 31, 1995 to
$68,000 at September 30, 1996. The Partnership received Kiwi stock and rights to
warrants in connection with the leasing of the two Boeing 727-200 aircraft to
Kiwi. The Partnership is subject to significant restrictions on its ability to
dispose of these securities and has no current plans to dispose of the
securities. Based upon the price at which Kiwi sold similar securities to
unrelated third parties, the Partnership recorded the securities at a value of
$600,000 and began recognizing the associated income ratably over the lease
terms. Through September 30, 1994, the Partnership recognized $156,000 of income
with respect to such securities. The Partnership recognized a loss of $155,000
in the 1996 Period and removed $599,000 from the books relating to its interest
in the Kiwi stock, as a result of the Kiwi bankruptcy. (See below for discussion
of deferred income.).
The payable to affiliates decreased $232,000 from $893,000 at December 31,
1995 to $661,000 at September 30, 1996. The decrease was attributable primarily
to the payment during the quarter ended September 30, 1996 to the Administrative
General Partner of amounts previously deferred (See Note 3 "Transactions with
Affiliates").
In order to finance expenditures made during 1992 and 1993 for the
maintenance work and the capital improvements to the aircraft leased to
Aeromexico and Kiwi and re-leased to TWA, as well as the various advances to
Continental and TWA, the Partnership established two loan facilities which
permit the Partnership to borrow up to $10.5 million. Borrowings, up to the
amounts expended, were made when needed to fund Partnership operations or
distributions. At September 30, 1996, the Partnership borrowings, net of
repayments, totaled $5,199,000. The Partnership will incur additional borrowings
if necessary to fund future advances to lessees as required to finance
modification enhancements (such as hushkitting) if such investment is necessary
to maintain or enhance the value of the Partnership's assets. In July 1996, the
Partnership entered into an agreement in principle with an unaffiliated third
party lender to refinance a portion of the outstanding debt. Under the terms of
the agreement in principle, the commitment would be for an aggregated
$10,000,000, the commitment period would be for a term of three years, the
interest rate would be reduced to prime plus 1% and there would be no principal
payment due until the maturity date (the expiration of the three year commitment
period).
Deferred income was $1,883,000 at September 30, 1996 as compared to
$4,672,000 at December 31, 1995. The decrease was primarily attributable to the
recognition of amounts previously received in connection with the A-300 Lease
Settlement and the DC-10 Restructuring. Additionally, the Partnership removed
$444,000 of deferred income from the books during the 1996 Period ultimately
based upon the Kiwi bankruptcy. As described above, the difference between the
$599,000 of other assets (see above) and the deferred income of $444,000 related
to the Kiwi stock totaling $155,000 was recognized as a loss during the 1996
Period.
The amount of each distribution will be determined on a quarterly basis
after an evaluation of the Partnership's operating results and its current and
expected financial position. The distribution for the second quarter of 1996 was
paid on July 25, 1996 at an annualized rate equal to 8.0% of contributed capital
($.40 per Unit). The distribution for the third quarter of 1996 was paid in
October 1996 at the same rate.
18
<PAGE> 20
Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital or both. The portion of
each cash distribution by a partnership which exceeds its net income for the
fiscal period may be deemed a return of capital. Based on the amount of net
income reported by the Partnership for accounting purposes, approximately 96% of
the cash distributions paid to the partners for the three months ended September
30, 1996 (approximately 81% for the nine months then ended) constituted a return
of capital. Also, based on the amount of net income reported by the Partnership
for accounting purposes, approximately 82% of the cash distributions paid to the
partners from the inception of the Partnership through September 30, 1996
constituted a return of capital. However, the total actual return on capital
over the Partnership's life can only be determined at the termination of the
Partnership after all cash flows, including proceeds from the sale of the
aircraft, have been realized.
As described above, Kiwi filed a voluntary petition for bankruptcy under
Chapter 11 of the US Bankruptcy Code. Kiwi has ceased scheduled flight
operations and requires significant debtor in possession financing in order to
commence revenue service. Kiwi has filed a motion to reject both leases which
will be heard on November 15, 1996. The Partnership believes that the cost to
refurbish the aircraft to meet return conditions and make the aircraft
remarketable will exceed the maintenance reserves held. The Parthership would
fund any shortfall from operations or a borrowing facility. Additionally, it
may take significant time to redeploy the aircraft. The Kiwi leases represented
approximately 17% of the Partnership's rental receipts. The Partnership
continues to actively remarket the A-300, which is currently off lease. The
A-300 will require a heavy maintenance check in connection with its remarketing
and the work required is estimated to cost $1,400,000. As part of the A-300
Settlement, the Partnership received $557,000 settlement in lieu of Continental
meeting certain return conditions required by the lease which was accounted for
as a reserve for maintenance and will be utilized to fund a portion of such
maintenance. It is anticipated the Partnership will utilize a portion of the
operating reserves to fund the balance of work required. Additionally, the
lease of the DC-10-10 will expire in October 1996, unless renewed. The
Partnerships liquidity was enhanced by the October 1996 lease prepayment by
TWA. Because of fleet restructuring, TWA voluntarily returned the L-1011
aircraft to the Partnership and paid the Partnership $5,846,000 which
represented the present value of the remaining payments due under the lease,
discounted at 5% and a settlement for non-compliance with lease return
conditions. The Partnership may utilize the settlement payment to purchase a
new aircraft or upgrade existing aircraft. Further, it is likely that the
Partnership will sell the L-1011 airframe and lease the engines. However, until
and if the Kiwi aircraft and A-300 are remarketed, the Partnership's cash from
operations will be less than its current distribution rate. The Partnership
will utilize cash generated in previous periods, as well as the L-1011 lease
prepayment, to subsidize distributions to partners.
RESULTS OF OPERATIONS
The Partnership's net income was $107,000 and $1,641,000 for the quarter
and nine months ended September 30, 1996 ("1996 Quarter" and "1995 Period",
19
<PAGE> 21
respectively) as compared to $561,000 and $1,878,000 for the quarter and nine
months ended September 30, 1995 ("1995 Quarter" and "1995 Period",
respectively).
The decrease in the Partnership's net income for the 1996 Quarter was
attributable to the provision for bad debts and loss in value of Kiwi stock
which aggregated $759,000 and the increase in depreciation attributable to the
DC-10-10 aircraft (discussed below) partially offset by the recognition of
income during the quarter with respect to the A-300 Lease Settlement (including
the income associated with the two 727 aircraft received in connection with the
settlement) and the DC-10 Restructuring (See "Liquidity and Capital Resources"
and Footnote 4 to the Financial Statements, "Aircraft Leases" for a discussion
of Continental.).
Rental income increased by $605,000 and $1,558,000, or 18% and 15% in the
1996 Quarter and 1996 Period, respectively, as compared to the 1995 Quarter and
1995 Period which reflects the difference between the income recognized with
respect to the A-300 Lease Settlement (including the rent associated with the
two 727 aircraft received in the settlement) and DC-10 Restructuring in the 1996
Quarter and the rents recognized in the 1995 Quarter, which included the
DC-10-10 rentals at the original lease rate and the rents recognized under the
A-300 Lease under which rentals of $312,000 were recognized in January 1995 and
reduced rents ($150,000 per month) were recognized in February through May 1995.
Interest income increased $17,000 and $137,000, or 12% and 32%, for the
1996 Quarter and 1996 Period, in comparison to the 1995 Quarter and 1995 Period,
respectively. This increase was primarily attributable to the interest income
earned with respect to the cash reserves held by the Partnership during the 1996
Quarter and 1996 Period (substantially provided by the A-300 Lease Settlement
and DC 10-10 Restructuring discussed above).
Depreciation and amortization expense increased $362,000 and $1,090,000, or
15% and 16%, for the 1996 Quarter and 1996 Period in comparison to the 1995
Quarter and 1995 Period, respectively. The increase was attributable to the
increase in depreciation relating to the DC 10-10 aircraft (based upon a change
in estimate of the aircraft's end of lease residual value) as well as the
depreciation relating to the two 727 aircraft received in the A-300 Lease
Settlement, which were not in place in the 1995 Quarter and 1995 Period, offset
by a reduction in depreciation expense with respect to the A-300 which was off
lease during the 1996 Quarter and 1996 Period (thus no depreciation was
recognized).
Management and re-lease fees for the 1996 Quarter and 1996 Period,
increased by $3,000 and $66,000 or 1% and 8%, respectively, in comparison to the
1995 Quarter and 1995 Period primarily because of the increases in rental income
and net income adjusted for depreciation which serve as the bases upon which
management fees are calculated.
Interest expense for the 1996 Quarter and 1996 Period, decreased by $33,000
and $110,000 or 18% and 18% in comparison to the 1995 Quarter and 1995 Period,
primarily because of a decrease in interest rates which affected the variable
rate note as well as a reduction in the principal outstanding.
20
<PAGE> 22
General and administrative expenses decreased by $3,000 but increased by
$9,000 or (4%) and 4% during the 1996 Quarter and 1996 Period respectively, as
compared to the 1995 Quarter and 1995 Period which was consistent with the
Partnership's level of operations.
Direct lease expenses decreased by $12,000, but increased by $82,000 in the
1996 Quarter and 1996 Period, or (17%) and 50% as compared to the 1995 Quarter
and 1995 Period, respectively, due primarily to an increase in insurance
premiums as well as certain storage costs and technical consulting costs related
to the A-300 aircraft which was off lease during the 1996 Quarter and 1996
Period.
At September 30, 1996 the Partnership provided an allowance for bad debts
in the amount of $640,000 which represented rents, advances (Bellyskin Note) and
related interest due from Kiwi (See Footnote 5, "Kiwi Bankruptcy").
Additionally, at September 30, 1996, the Partnership recognized a loss of
$155,000 ($119,000 was recognized in the 1996 Quarter) with respect to Kiwi
securities received in prior transactions. The securities will be carried at a
nominal value (See Footnote 5, "Kiwi Bankruptcy").
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<PAGE> 23
Part II. OTHER INFORMATION
Item 3. Legal Proceedings
In November 1994, a series of purported class actions (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York concerning PaineWebber Incorporated sale and
sponsorship of various limited partnership investments, including those offered
by the Partnership. The lawsuits were brought against PaineWebber Incorporated
and Paine Webber Group, Inc. (together, "PaineWebber"), among others, by
allegedly dissatisfied partnership investors. In March 1995, after the actions
were consolidated under the title In re: PaineWebber Limited Partnerships
Litigation, the plaintiffs amended their complaint to assert claims against a
variety of other defendants, including Air Transport Leasing, Inc., an affiliate
of PaineWebber and the Administrative General Partner in the Partnership
("Administrative General Partner").
The amended complaint in the New York Limited Partnership Actions alleged,
among other things, that, in connection with the sale of interests in Pegasus
Aircraft Partners II, L.P., PaineWebber and the Administrative General Partners
(1) failed to provide adequate disclosure of the risks involved with each
partnership; (2) made false and misleading representations about the safety of
the investments and the partnership's anticipated performance; and (3) marketed
the partnership to investors for whom such investments were not suitable. The
plaintiffs also alleged that following the sale of the partnership investments
PaineWebber and the Administrative General Partner misrepresented financial
information about the partnership's value and performance. The amended complaint
alleged that PaineWebber and the Administrative General Partner violated the
Racketeer Influenced and Corrupt Organizations Act ("RICO") and the federal
securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and other income derived by PaineWebber from the
limited partnerships. In addition, the plaintiffs also sought treble damages
under RICO.
On May 30, 1995, the US District Court certified class action treatment of
the plaintiffs' claims in the New York Limited Partnership Actions.
In January 1996, PaineWebber signed a memorandum of understanding with the
plaintiffs in the class action outlining the terms under which the parties have
agreed to settle the case. Pursuant to that memorandum of understanding,
PaineWebber irrevocably deposited $125 million into an escrow fund under the
supervision of the United States District Court for the Southern District of New
York "District Court: to be used to resolve the litigation. On July 17, 1996,
the District Court granted preliminary approval of the proposed settlement of
the class action litigation. As part of the class action settlement, PaineWebber
agreed to pay $125 million and additional consideration to class members. A
final hearing on the proposed settlement is scheduled to continue in November
1996.
In April 1995, two investors in the Pegasus limited partnerships filed a
purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert
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<PAGE> 24
M. Jacobson, et al. v. PaineWebber, Inc., et al., making allegations
substantially similar to those in the New York Limited Partnership Actions, but
limited in subject matter to the sale of the Pegasus partnerships, and without a
RICO claim. The plaintiffs in the Jacobson case simultaneously remained as
participants in the New York Limited Partnership Actions, and are challenging
the proposed settlement of these cases. The Illinois case has been dismissed.
Three actions were filed in the District Court for Brazoria County, Texas,
relating to the sale and sponsorship of interests in the Partnership and an
affiliated partnership. The complaints make state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act. The plaintiffs seek
unspecified damages, including attorneys' fees, reimbursement for all sums
invested by them in the partnerships, exemplary damages, and treble damages
under the Texas Deceptive Trade Practices Act. All three actions have been
removed to federal court and two have been transferred to the United States
District Court for the Southern District of New York and consolidated under the
title, Mallia vs. PaineWebber, Inc. The third action has been dismissed with the
consent of the parties on the grounds that it is duplicative of the two actions
now before the federal court in New York.
In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchases of various limited partnership interests. The complaint
alleges, among other things, that PaineWebber and its related entities committed
fraud and misrepresentation and breached fiduciary duties allegedly owed to the
plaintiffs by selling or promoting limited partnership investments that were
unsuitable for the plaintiffs and by overstating the benefits, understating the
risks and failing to state material facts concerning the investments. The
complaint seeks compensatory damages of $15 million plus punitive damages. In
September 1996, the California Superior Court dismissed many of the plaintiffs'
claims as barred by the applicable statutes of limitation.
In June 1996, counsel for the Abbate plaintiffs instituted two additional
actions containing allegations nearly identical to those set forth in Abbate.
Bandrowski v. PaineWebber Incorporated, et al. was filed in California Superior
Court and Barstad v. Paine Webber Incorporated, et al. was filed in Arizona
Superior Court. Collectively, the two additional actions are brought by
approximately 50 plaintiffs and seek compensatory damages of approximately $4
million plus punitive damages.
Under certain limited circumstances, pursuant to the Partnership Agreement
and other contractual obligations, PaineWebber and its affiliates, including the
Administrative General Partner could be entitled to indemnification from the
Partnership for expenses and liabilities in connection with Mallia, Abbate
Bandrowski and Barstad actions. The General Partners are unable to determine the
effect, if any, of these actions on the Partnership's financial statements taken
as a whole.
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<PAGE> 25
Item 4. Exhibits and Reports on Form 8-K
(a) None
(b) The Partnership did not file any Form 8-K during the third
quarter of the fiscal year ending December 31, 1996.
SIGNATURE
Pursuant to the requirements 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.
Pegasus Aircraft Partners II, L.P.
(Registrant)
By: Air Transport Leasing, Inc.
A General Partner
Date: November 7, 1996 By: /s/ Joseph P. Ciavarella
------------------------
Joseph P. Ciavarella
Vice President, Treasurer
and Chief Financial
and Accounting Officer
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<PAGE> 26
Kiwi International Air Lines Leases During March and May 1993, the
Partnership leased its two Boeing 727-200 aircraft, which were previously leased
to Continental (727 Non-Advanced Aircraft) and Dan-Air Services Limited
("Dan-Air") ("727 Advanced Aircraft") to Kiwi International Air Lines, Inc.
("Kiwi"). The leases are operating leases which require monthly rental payments,
in advance, in the amounts of $60,000 (Non-advanced) and $115,000 (Advanced).
The terms of the leases were originally scheduled to expire on April 15, 1998
and June 30, 1998, respectively. During the terms of the leases Kiwi can request
that the aircraft be hushkitted to obtain Stage 3 noise abatement for which the
lease term will be reset to five years with lease payments increasing to
amortize the cost of the hushkitting at the rate of approximately 2% per month.
Alternatively, the Partnership can deem the hushkitting economically infeasible
at which point Kiwi can terminate the leases and return the aircraft. The
original leases also had an annual one month rent abatement feature, which would
extend the term of the leases by a month for each year Kiwi opted for the
abatement. Under the original terms, Kiwi had two one-year renewal options, with
rent payable at the then current fair market rental rate.
The Partnership also received Kiwi stock and rights to warrants in
connection with these leasing transactions. The Partnership is subject to
significant restrictions on its ability to dispose of these securities. Based
upon the price at which Kiwi sold similar securities to unrelated third parties,
the Partnership recorded the securities at a value of $600,000 and is
recognizing the associated income ratably over the lease terms. Of the $600,000,
$81,000 and $75,000 were recognized as income during 1994 and 1993,
respectively. Because of concerns discussed below, the Partnership stopped
amortizing such income in the fourth quarter of 1994. In July 1996, Kiwi
received proceeds from an outsider investor in return for a convertible note.
(See discussion below) Based upon the valuation of Kiwi's stock, the Partnership
reduced its investment in Kiwi stock from $600,000 to $120,000, reduced deferred
income by $444,000 and charged $36,000 to operations during the quarter ended
September 30, 1996.
Kiwi is also obligated to make monthly payments of $250 per flight hour for
maintenance reserve funds administered by the Partnership. The Partnership is
obligated to reimburse Kiwi for specified maintenance costs out of the reserve
funds, upon submission of appropriate evidence documenting the maintenance costs
incurred by Kiwi.
In connection with the delivery of the aircraft the Partnership expended
$2,228,000 with respect to the 727 Advanced aircraft, of which $971,000 was
capitalized and $1,257,000 represented maintenance costs which were paid out of
funds received in a maintenance settlement with Dan-Air.
During 1994, the Partnership funded approximately $633,000 of costs related
to maintenance of the Kiwi aircraft, including compliance with certain FAA
airworthiness directives, $308,000 of which was scheduled to be repaid by Kiwi
over a one-year period. In March 1996 Kiwi signed a promissory note ("Bellyskin
Note") scheduling the repayment of this amount, with interest from February 1996
at 12% per annum, over eighteen months which began June 1, 1996.
Kiwi, as a start-up airline, had continued liquidity concerns that were
worsened by operating problems in early 1995. Kiwi made significant management
changes and has
26
<PAGE> 27
sought to rationalize costs and raise capital. Kiwi elected to defer January
1995 rent under the previously described rental abatement feature of the
original leases, and did not make the rental payments due in February and March
1995 and did not make maintenance reserve deposits due in those months.
The Partnership and Kiwi executed lease amendments that modified the lease
terms that enabled Kiwi to defer February's and half of March's rent in 1995.
Pursuant to the lease amendments, the deferred rent was repaid over a nine-month
period with 12% interest, which began July 1, 1995. Kiwi did not make payments
towards the maintenance reserves for February, March and April 1995 but funded
or is obligated to fund the related maintenance work in its entirety as it
becomes due. Pursuant to the lease amendments, each of the leases was extended
to December 1999. The lease amendments removed the rental abatement feature of
the original leases.
Based upon the composition of its fleet and FAA mandated deadlines for
compliance with Stage 3 noise reduction standards, Kiwi and the Partnership have
entered into discussions to hushkit one or both of the 727 aircraft leased to it
by December 31, 1996. If the Partnership elected to complete such work, it is
anticipated that it would be funded from operating reserves and borrowings. It
is estimated that this upgrade would cost $1.9 million for the non-advanced
aircraft and $3 million for the advanced aircraft. If the Partnership elected
not to complete such work, Kiwi could terminate the leases. See Item 2,
"Management's Discussion And Analysis Of Financial Condition And Results Of
Operations", for a discussion of capital requirements.
At September 30, 1996, the Partnership held maintenance deposits
aggregating $2,381,000 with respect to the Kiwi aircraft which is included in
restricted cash on the balance sheet. Kiwi made its February and May 1996
payments late and has requested a deferral of its July 1996 maintenance reserve
payments and the Bellyskin Note payments and its July 1996 rental payment
relative to the 727 non-advanced aircraft and the August payment for the 727
Advanced aircraft. Kiwi is to repay the deferred rent and Bellyskin Note
installment over nine months at 12% interest starting in October 1996 and make
up the deficiency in maintenance reserve payments at the next scheduled
maintenance checks. In June 1996, Kiwi agreed with the FAA to ground 25% of its
fleet due to certain pilot training manual deficiencies. Kiwi is working towards
satisfying the FAA and has returned two of the four aircraft grounded to active
status. Additionally, in July 1996, an outside institutional investor
contributed $4,000,000 in return for a convertible note due in March 1997, for
up to 32% of Kiwi's common stock and two seats on Kiwi's Board of Directors. The
investor has options to invest the additional $6,000,000 in convertible
preferred stock which expires in March 1997. Existing shareholders are also
making or being given an opportunity to make additional investments. Kiwi's
ability to make timely lease and maintenance reserve payments is uncertain due
to its long-term liquidity, capital and market concerns.
27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
Form 10-Q for the quarter and nine months ended September 30, 1996 for
Pegasus Aircraft Partners II, L.P. and is qualified in its entirety by
reference to such Form 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 8,832,000
<SECURITIES> 0
<RECEIVABLES> 1,535,000
<ALLOWANCES> (640,000)
<INVENTORY> 0
<CURRENT-ASSETS> 12,282,000
<PP&E> 145,101,000
<DEPRECIATION> (87,819,000)<F3>
<TOTAL-ASSETS> 69,564,000
<CURRENT-LIABILITIES> 11,467,000<F4>
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 56,214,000<F2>
<TOTAL-LIABILITY-AND-EQUITY> 69,564,000
<SALES> 11,815,000
<TOTAL-REVENUES> 12,378,000
<CGS> 0
<TOTAL-COSTS> 9,364,000
<OTHER-EXPENSES> 227,000
<LOSS-PROVISION> 640,000
<INTEREST-EXPENSE> 506,000
<INCOME-PRETAX> 1,641,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,641,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,641,000
<EPS-PRIMARY> .22<F1>
<EPS-DILUTED> 0
<FN>
<F1> Income per Unit of limited partnership interest outstanding for the nine
months ended September 30, 1996.
<F2> Represents partners capital plus accumulated earnings and distributions to
partners.
<F3> Includes allowances for decline in market value of aircraft.
<F4> Includes Notes Payable.
</FN>
</TABLE>
