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, 1998
--------------------------------------------------
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 .
--- ---
This document consists of 25 pages.
<PAGE>
Pegasus Aircraft Partners II, L.P.
Quarterly Report on Form 10-Q for the
Quarter Ended September 30, 1998
Table of Contents
-----------------
Page
----
Part I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Balance Sheets - September 30, 1998
and December 31, 1997 3
Statements of Income for the three
months ended September 30, 1998
and 1997 4
Statements of Income for the nine
months ended September 30, 1998
and 1997 5
Statements of Partners' Equity for the
nine months ended September 30, 1998
and 1997 6
Statements of Cash Flows for the nine
months ended September 30, 1998 and
1997 7
Notes to Financial Statements 9
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 15
Part II OTHER INFORMATION
Item 1.Legal Proceedings 22
Item 5.Other Information 22
Item 6.Exhibits and Reports on Form 8-K 23
Signature 24
2
<PAGE>
Part I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
--------------------
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
BALANCE SHEETS -- SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
----------------------------------------------------------
(unaudited)
1998 1997
---- ----
(in thousands, except unit data)
ASSETS
------
Cash and cash equivalents $ 5,004 $ 5,705
Rent and other receivables, net 449 444
Aircraft, net (Note 2) 47,439 52,098
Other assets 817 26
-------- --------
Total Assets $ 53,709 $ 58,273
======== ========
LIABILITIES AND PARTNERS' EQUITY
--------------------------------
LIABILITIES:
Lease settlement reserve $ -- $ 3,000
Accounts payable and accrued expenses 134 123
Payable to affiliates (Note 3) 612 211
Maintenance reserves collected 1,499 591
Notes payable 10,000 4,751
Deferred income and deposits 1,618 2,584
Distributions payable to partners 2,914 2,943
Accrued interest payable 79 --
-------- --------
Total Liabilities 16,856 14,203
-------- --------
COMMITMENTS (Note 5)
PARTNERS' EQUITY:
General Partners (842) (1,008)
Limited Partners (7,255,000 units outstanding) 37,695 45,078
-------- --------
Total Partners' Equity 36,853 44,070
-------- --------
Total Liabilities and Partners' Equity $ 53,709 $ 58,273
======== ========
The accompanying notes are an integral part
of these financial statements.
3
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
STATEMENTS OF INCOME
--------------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
------------------------------------------------------
(unaudited)
1998 1997
---- ----
(in thousands, except unit data
and per unit amounts)
REVENUE:
Rentals from operating leases $ 3,225 $ 3,213
Interest 49 95
Other income 13 --
Gain on sale of engine 241 --
---------- ----------
3,528 3,308
---------- ----------
EXPENSES:
Depreciation and amortization 2,106 1,900
Write-downs 97 --
Management and re-lease fees (Note 3) 274 259
Interest 240 111
General and administrative (Note 3) 65 69
Direct lease 76 76
---------- ----------
2,858 2,415
---------- ----------
NET INCOME $ 670 $ 893
========== ==========
NET INCOME ALLOCATED:
To the General Partners $ 245 $ 9
To the Limited Partners 425 884
---------- ----------
$ 670 $ 893
========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .06 $ .12
========== ==========
WEIGHTED AVERAGE NUMBER OF LIMITED
PARTNERSHIP UNITS OUTSTANDING 7,255,000 7,255,000
========== ==========
The accompanying notes are an integral part
of these financial statements.
4
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
STATEMENTS OF INCOME
--------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
-----------------------------------------------------
(unaudited)
1998 1997
---- ----
(in thousands, except unit data
and per unit amounts)
REVENUE:
Rentals from operating leases $ 9,449 $ 8,981
Interest 145 396
Other income 134 --
Gain on sale of engine 241 --
---------- ----------
9,969 9,377
---------- ----------
EXPENSES:
Depreciation and amortization 6,152 5,219
Write-downs 477 --
Management and re-lease fees (Note 3) 763 718
Interest 533 342
General and administrative (Note 3) 244 251
Direct lease 223 304
---------- ----------
8,392 6,834
---------- ----------
NET INCOME $ 1,577 $ 2,543
========== ==========
NET INCOME ALLOCATED:
To the General Partners $ 254 $ 25
To the Limited Partners 1,323 2,518
---------- ----------
$ 1,577 $ 2,543
========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .18 $ .35
========== ==========
WEIGHTED AVERAGE NUMBER OF LIMITED
PARTNERSHIP UNITS OUTSTANDING 7,255,000 7,255,000
========== ==========
The accompanying notes are an integral part
of these financial statements.
5
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
STATEMENTS OF PARTNERS' EQUITY
------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
-----------------------------------------------------
(unaudited)
General Limited
Partners Partners Total
-------- -------- -----
(in thousands)
Balance, January 1, 1998 $ (1,008) $ 45,078 $ 44,070
Net income 254 1,323 1,577
Distributions to partners declared (88) (8,706) (8,794)
-------- -------- --------
Balance, September 30, 1998 $ (842) $ 37,695 $ 36,853
======== ======== ========
Balance, January 1, 1997 $ (904) $ 55,444 $ 54,540
Net income 25 2,518 2,543
Distributions to partners declared (88) (8,706) (8,794)
-------- -------- --------
Balance, September 30, 1997 $ (967) $ 49,256 $ 48,289
======== ======== ========
The accompanying notes are an integral part
of these financial statements.
6
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
STATEMENTS OF CASH FLOWS
------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
-----------------------------------------------------
(unaudited)
1998 1997
---- ----
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,577 $ 2,543
Adjustments to reconcile net income to net
cash provided by operating activities:
Gain on sale of engine and equipment (254) --
Depreciation and amortization 6,152 5,219
Write-downs 477 --
Change in assets and liabilities:
Rent and other receivables (232) (139)
Other assets (1) (10)
Accounts payable and accrued expenses 11 28
Payable to affiliates 401 (258)
Accrued interest payable 79 --
Deferred income and deposits (223) (1,150)
Maintenance reserves collected 908 439
------- -------
Net cash provided by operating activities 8,895 6,672
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit for aircraft modifications (790) --
Capitalized aircraft improvements (7,012) (4,793)
Proceeds from the sale of equipment 1,553 --
Repayment of advances by lessees 227 262
------- -------
Net cash used in investing activities (6,022) (4,531)
------- -------
The accompanying notes are an integral part
of these financial statements.
7
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
STATEMENTS OF CASH FLOWS (Continued)
------------------------------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
-----------------------------------------------------
(unaudited)
1998 1997
---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Security deposits -- 196
Transfer from restricted cash -- 2,275
Application of maintenance reserves
payable to restore aircraft -- (2,275)
Proceeds from note payable 5,249 --
Cash distributions paid to partners (8,823) (8,779)
-------- --------
Net cash used in financing activities (3,574) (8,583)
-------- --------
NET DECREASE IN CASH AND
CASH EQUIVALENTS (701) (6,442)
CASH AND CASH EQUIVALENTS
AT BEGINNING OF PERIOD 5,705 12,831
-------- --------
CASH AND CASH EQUIVALENTS
AT END OF PERIOD $ 5,004 $ 6,389
======== ========
SUPPLEMENTAL INFORMATION:
Interest paid $ 447 $ 343
======== ========
The accompanying notes are an integral part
of these financial statements.
8
<PAGE>
PEGASUS AIRCRAFT PARTNERS II, L.P.
----------------------------------
NOTES TO FINANCIAL STATEMENTS
-----------------------------
SEPTEMBER 30, 1998
------------------
(unaudited)
1. GENERAL
-------
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and in accordance with instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of the General Partners, all adjustments
necessary for a fair presentation have been included. Certain reclassifications
have been made to the 1997 financial statements to conform to the 1998
presentation. For further information, refer to the financial statements and
footnotes thereto included in the Partnership's annual report on Form 10-K for
the year ended December 31, 1997. (Operating results for the three and nine
month periods ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ended December 31, 1998.)
New Accounting Pronouncement: In March 1998 the Partnership adopted
SFAS No. 130, "Reporting Comprehensive Income", which establishes standards for
the reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Comprehensive income is defined as
the change in equity of a business enterprise during a period from transactions
and other events and circumstances arising from non-owner sources. The adoption
of this pronouncement did not impact the reporting of the Partnership's results
of operations.
New Accounting Pronouncement: In June 1998, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). FAS
133 is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999 (January 1, 2000 for the Partnership). FAS 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction and, if it is, the type of hedge
transaction. The adoption of this pronouncement is not expected to impact the
Partnership's earnings or statement of financial position.
9
<PAGE>
2. AIRCRAFT
--------
The Partnership's net investment in aircraft as of September 30, 1998
and December 31, 1997 consisted of the following (in thousands):
1998 1997
---- ----
Aircraft on operating leases, at cost $ 108,150 $ 103,990
Less: Accumulated depreciation (60,004) (55,513)
Write-downs (8,058) (8,143)
--------- ---------
$ 40,088 $ 40,334
--------- ---------
Aircraft held for lease, at cost $ 46,744 $ 46,934
Less: Accumulated depreciation (18,959) (18,839)
Write-downs (20,434) (16,331)
--------- ---------
$ 7,351 $ 11,764
--------- ---------
Aircraft, net $ 47,439 $ 52,098
========= =========
Write-downs, for aircraft held for lease, at cost, includes in part,
$14.4 million of amounts which were received in cash as advanced rental payments
or as payments in lieu of aircraft meeting return conditions related to the
early return of the Airbus A-300 and Lockheed L-1011 aircraft, by the lessees.
This amount also includes the estimated value of two Boeing 727-200 aircraft
which were received in partial settlement of the A-300 lease as well as certain
reserves for maintenance.
Continental Airline Leases: The Partnership owns a McDonnell Douglas
DC-10-10 aircraft which was subject to an operating lease with Continental
Micronesia providing for rentals of $150,000 per month through June 30, 1998.
The Partnership and Continental have signed a lease amendment that extends the
lease from July 1, 1998 through September 15, 1999 at a monthly lease rate of
$138,500.
Upon the expiration of the extended lease, the Partnership will convert
the aircraft to a freighter pursuant to an aircraft modification agreement for
delivery to Emery Worldwide Airlines Inc. ("Emery"). The Partnership and Emery
have signed a lease which provides for 84 months rent at $218,000 per month. The
lease also provides a two-year renewal option at $200,000 per month, and three
additional two-year renewal options at the then fair market rental. Emery has
provided a security deposit aggregating $218,000 at September 30, 1998. The
Partnership provided a deposit of $790,000 to the third party modification
center which will perform the conversion and this amount is included in other
assets on the balance sheet as of September 30, 1998. The current workscope
under the aircraft modification agreement requires the investment of
approximately $8.0 million, subject to escalation, by the Partnership. The
Partnership also estimates expending another $1.0 million to meet the lease
delivery conditions.
The lease of the Boeing 727-200 advanced aircraft leased to Continental
expired January 31, 1998 and the aircraft was returned to the Partnership. The
Partnership and Continental continue discussing each party's obligation with
respect to the return condition of the aircraft under the lease. The Partnership
has entered into a lease of the aircraft for a term of four years to TNT
10
<PAGE>
Transport International B.V. ("TNT") a foreign cargo carrier and has converted
the aircraft to cargo configuration, including a low gross weight hushkit. (See
TNT discussion below).
TNT Transport International B.V.: In June 1998 the Partnership
delivered a Boeing 727-200 advanced aircraft formerly leased to Continental to a
European freight carrier, TNT Transport International B.V. ("TNT") for a lease
term of four years. The lease provides for monthly rentals of $123,500 (subject
to a reduction of approximately 10% after two years if TNT exercises an option
to extend the lease for an additional two years beyond the original expiration
date) and airframe and landing gear reserves aggregating $85 per flight hour.
TNT has contracted with a third party service provider for maintenance of the
engines. TNT has provided a $150,000 security deposit. TNT also has the right to
extend the lease for an additional two years at the end of the initial lease
term (if the above option is not exercised) at $95,000 per month.
The Partnership has invested approximately $7.8 million for a low gross
weight hushkit and cargo conversion of the aircraft, and the purchase of three
JT8D-7B engines. The Partnership received cash proceeds of $1,050,000 for the
sale of the JT8D-15 engines from this aircraft, which resulted in a $60,000
loss. In the third quarter of 1998, due to the conversion of this aircraft to a
freighter, the Partnership wrote-off the remaining net book value of the
interior, determined through a third party appraisal, which resulted in an
impairment expense of $57,000. The work was performed and certain of the
aircraft parts were provided by companies affiliated with the Managing General
Partner or its President and Director.
Airbus A-300 Aircraft: In December 1997, the Partnership leased, on a
short-term (six month minimum) basis, one of the CF6-50C2 engines from the
Airbus A-300 aircraft to Viacao Aerea Sao Paulo S.A. ("VASP"), a Brazilian
carrier, for rents of $2,200 per day, plus maintenance reserves of $225 per
engine hour or cycle, whichever is greater. The Partnership and VASP extended
the lease to December 1998. The Partnership is continues to re-market this
aircraft for lease or sale.
During June 1998, the Partnership entered into an Engine Exchange
Agreement and Bill of Sale with an affiliate of the Managing General Partner.
Pursuant to this agreement, the Partnership received cash in the amount of
$190,000 and a General Electric CF6-50C2 engine in exchange for a General
Electric CF6-50C2 engine from the Airbus A-300 aircraft. The amount of the
payment was determined through a third party appraisal of the engines.
Lockheed L-1011 Aircraft: At September 30, 1998 the L-1011 aircraft had
an estimated market value and book value of approximately $1.7 million. During
the third quarter of 1998, the Partnership reclassified the $3,000,000 return
condition settlement and the $743,000 unearned portion of the L-1011 lease
prepayment, as an additional write-down. In addition, in the first quarter of
1998 a write-down of $360,000 was taken to reflect the estimated market value of
the aircraft. The Partnership is currently in discussions for the sale of the
Lockheed L-1011 aircraft to an unrelated party.
Falcon Air Express, Inc.: In 1996, the Partnership entered into a lease
agreement with Falcon Air Express, Inc. ("Falcon"), a charter airline, with
11
<PAGE>
respect to the 727-200 non-advanced aircraft formerly leased to Kiwi
International Airlines, Inc. ("Kiwi") providing rentals of $95,000 per month
through March 1, 2002.
In September 1998, the Partnership received cash proceeds of $300,000
and realized a gain of $241,000, on the sale of an engine that had been
dismantled and stored, since the return of this aircraft by Kiwi in 1996.
Capital Cargo International Airlines, Inc.: In 1997, the Partnership
entered into a lease agreement with Capital Cargo International Airlines, Inc.
("Capital"), a start-up freight carrier, with respect to the Boeing 727-200
advanced aircraft formerly leased to Kiwi, for a term of approximately eight
years. As part of the original lease the Partnership agreed to hushkit the
aircraft at a budgeted cost of approximately $2,500,000 on or before its 1999
"C" check, at which time the lease rate increases from $105,000 per month to
$139,000 per month. Capital Cargo has requested that the hushkit be delivered by
early December.
Shortly after delivery of the aircraft to Capital in 1997, one of the
engines failed. In August 1998, the Partnership reached an agreement with the
lessee, in which the Partnership shared in the cost to overhaul the engine on
this aircraft. The Partnership's share of the overhaul was $266,000.
3. TRANSACTIONS WITH AFFILIATES
----------------------------
Base 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 a total of $48,000
and $133,000 of base management fees during the three and nine months ended
September 30, 1998, respectively.
Incentive Management Fees. 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 a total of $138,000
and $378,000 of incentive management fees during the three and nine months ended
September 30, 1998, 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 a total of $88,000 and $252,000 of re-lease fees during
the three and nine months ended September 30, 1998, respectively.
All of the above fees are subordinated to the limited partners
receiving an 8% annual non-cumulative return based upon original contributed
capital, as adjusted per the Partnership agreement.
12
<PAGE>
Income and losses generally will be allocated 99% to the Limited
Partners and 1% to the General Partners. Upon the sale of aircraft, gain
generally will be allocated, first to the General Partners in an amount equal to
the difference between their capital contributions and 1.01% of the aggregate
capital contributions of the Limited Partners, and then, 99% to the Limited
Partners and 1% to the General Partners.
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
during the nine months ended September 30, 1998 and was payable to the
Administrative General Partner.
During the nine months ended September 30, 1998 the Partnership paid
$1,297,000 to a maintenance facility affiliated with the Managing General
Partner for work performed on certain aircraft, including the cargo conversion.
The Partnership also paid $1,882,000 for aircraft parts to a company owned by
the President and Director of the Managing General Partner and two former
officers and directors. In the third quarter of 1998, the Partnership received a
$13,000 cash payment for spare parts sold on consignment by this affiliated
aircraft parts company.
During June 1998, the Partnership entered into an Engine Exchange
Agreement and Bill of Sale with an affiliate of the Managing General Partner.
Pursuant to this agreement the Partnership received cash in the amount of
$190,000 and a General Electric CF6-50C2 engine in exchange for a General
Electric CF6-50C2 engine from the Airbus A-300 aircraft. The amount of the
payment was determined through a third party appraisal of the engines.
During September 1998, the Partnership finalized a transaction with the
Managing General Partner, for the acquisition of a JT8D-7B engine owned by the
Managing General Partner which was installed on the Boeing 727-200 aircraft
leased to TNT, in conjunction with the conversion of this aircraft to a
freighter. Under the terms of the transaction, the Partnership received a
JT8D-7B engine and $530,000 cash from the Managing General Partner, in exchange
for a $250,000 payment and two JT8D-15 engines removed from the Partnership's
Boeing 727-200 aircraft.
4. LITIGATION
----------
The Partnership, along with the Managing General Partner,
Administrative General Partner and PaineWebber Incorporated, had been named as a
defendant in a lawsuit entitled Paul Mallia, et al. v. PaineWebber, Inc., et
al., pending before the United States District Court for the Southern District
of New York, and relating to the sale and sponsorship of various limited
partnership investments, including the Partnership and an affiliated partnership
("the Pegasus Partnerships"). The complaint asserts claims under the Racketeer
Influenced and Corrupt Organizations Act, as well as state law claims for 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, on behalf of those investors who
bought interests in the Pegasus Partnerships and in other limited partnerships
and investments. The plaintiffs seek unspecified damages, including attorneys'
13
<PAGE>
fees, reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages. The Managing General Partner, Administrative
General Partner and the Pegasus Partnerships have been dismissed as defendants.
Under certain circumstances PaineWebber Incorporated can seek indemnification
from the Partnership. As a result, it cannot be determined at this time the
impact, if any, of the litigation on the Partnership.
The Partnership has filed a claim in the Bankruptcy Court for unpaid
rents and other damages related to the rejection by Kiwi of the leases. Given
the sale of Kiwi's assets as approved by the Court, it is unlikely that the
Partnership will obtain any recovery.
5. COMMITMENTS
-----------
Upon the expiration of the extended lease with Continental, as
discussed in Note 2, the Partnership will convert the McDonnell Douglas DC-10-10
aircraft to a freighter pursuant to an aircraft modification agreement for
delivery to Emery Worldwide Airlines, Inc. ("Emery"). The Partnership and Emery
have signed a lease agreement which provides for 84 months rent at $218,000 per
month, and three additional two-year renewal options at the then fair market
rental. Emery has provided a security deposit aggregating $218,000. The
Partnership paid a deposit of $790,000 to the third party modification center,
which is included in other assets on the balance sheet as of September 30, 1998.
The current workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million, subject to price escalation. The
Partnership estimates expending an additional $1.0 million to meet the delivery
conditions under the lease with Emery.
The Partnership is committed to fund the hushkit for the Boeing 727-200
advanced aircraft leased to Capital Cargo International Airlines, Inc.
("Capital"), which is expected to cost approximately $2,500,000. This aircraft
is scheduled for a "C" Check in December 1998, at which time it will also be
hushkitted.
In all, the Partnership has estimated commitments of $12 million. The
Partnership has drawn all available funds under its $10 million borrowing
facility and the principal balance at September 30, 1998 is $10 million. The
Limited Partnership Agreement permits the Partnership to borrow up to 35% (or
$50,785,000) of the original offering proceeds. The Partnership has commenced
discussions with the lender to increase the amount available under the borrowing
facility. However, there can be no assurance that the Partnership will have
sufficient collateral to be able to obtain additional borrowings. The
Partnership may have to utilize cash from operations to finance such
commitments, thus potentially reducing distributions to partners.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
This report may contain, in addition to historical information,
forward-looking statements that include risks and other uncertainties. The
Partnership's actual results may differ materially from those anticipated in
these forward-looking statements. Factors that might cause such a difference
include those discussed below, as well as general economic and business
conditions, competition and other factors discussed elsewhere in this report.
The Partnership undertakes no obligation to release publicly any revisions to
these forward-looking statements to reflect events or circumstances after the
date hereof or to reflect the occurrence of anticipated or unanticipated events.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The Partnership owns and manages a diversified portfolio of commercial
aircraft and makes quarterly distributions to the partners of net cash flow
generated by operations. In certain situations, the Partnership may retain cash
flow from operations to finance authorized capital expenditures.
The Partnership invests working capital and cash flow from operations
prior to its distribution to the partners in short-term, highly liquid
investments or a fund that invests in such instruments. At September 30, 1998,
the Partnership's unrestricted cash and cash equivalents of $5,004,000 was
primarily invested in such a fund. This amount was $701,000 less than the
Partnership's unrestricted cash and equivalents at December 31, 1997 of
$5,705,000. This decrease in unrestricted cash was attributable to the amount by
which cash distribution to partners and capitalized aircraft improvements
exceeded cash generated by operating activities, collection of advances to
lessees, proceeds from notes payable, and the unapplied maintenance reserves
during the nine months ended September 30, 1998.
Rent and other receivables, net, increased $5,000 from $444,000 at
December 31, 1997 to $449,000 at September 30, 1998. This increase resulted
primarily from Falcon Air Express, Inc. ("Falcon"), falling three months in
arrears with respect to their scheduled lease payments, as of September 30,
1998. (See Falcon discussion below). This delinquency was partially offset by
the continued repayment of the advances by TWA.
TWA, which had been expected to post a profit, reported a loss for the
third quarter of 1998, which is typically the best quarter of the year for
airlines due to summer travel. Although TWA had a cash position of $314 million
at September 30, 1998, given TWA's historical financial difficulties, the third
quarter loss is of concern. A default or deferral of lease payments on the part
of TWA, (or a continuing default by Falcon, discussed below) or any other
lessee, may affect quarterly distributions. TWA accounted for 17% of the
Partnership's lease revenue in the third quarter of 1998.
At September 30, 1998, Falcon was in arrears with respect to scheduled
rent payments, for a total of $285,000, which is reflected in Rent and Other
Receivables and $137,000 in arrears with respect to maintenance reserve
payments. Falcon has indicated they are close to finalizing a line of credit
which would enable them to bring their payments current. If Falcon is
unsuccessful in closing such a line of credit, the Partnership would evaluate
15
<PAGE>
all of its rights including repossession and remarketing of the aircraft. If the
Partnership remarkets the aircraft, there can be no assurance as to the ability
to do so, the time it would take and the lease rate that might be acheived.
The Partnership's leases with TWA for the Lockheed L-1011 and McDonnell
Douglas MD-82 aircraft were modified and extended during 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, 1998,
the total balance of the advances to TWA aggregated approximately $15,000.
Other assets increased $791,000 from $26,000 at December 31, 1997 to
$817,000 at September 30, 1998. This increase is primarily due to the payment of
a deposit, to a third party, to secure a facility for the modifications to the
DC10-10 to convert it to a cargo aircraft in late 1999.
The payable to affiliates increased $401,000 to $612,000 at September
30, 1998 from $211,000 at December 31, 1997. The increase was predominantly due
to fees for the fourth quarter of 1997, and the first quarter of 1998, which
were expensed but unpaid at September 30, 1998.
Deferred rental income and deposits were $1,618,000 at September 30,
1998 as compared to $2,584,000 at December 31, 1997. The decrease was primarily
attributable to the recognition of amounts previously received in connection
with the A-300 Lease Settlement and the L-1011 Lease Prepayment. Also
contributing to the decrease, was the reclassification of the unearned portion
of the L-1011 lease prepayment, to additional impairment on the L-1011 aircraft,
in the third quarter of 1998. The Partnership is currently in discussions for
the sale of the Lockheed L-1011 aircraft to an unrelated party. The Partnership
continues to re-market for lease or sale, the A-300 aircraft which is currently
off lease.
During the three months ended September 30, 1998, the Partnership paid
cash distributions pertaining to the second quarter of 1998. The quarterly
distribution represented an annualized rate equal to 8.0% of contributed capital
($.40 per Unit).
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 amount of recent distributions has exceeded
cash generated from operations for the particular quarter and the Partnership
has utilized cash generated in prior periods to achieve the level of
distributions made. The distribution for the third quarter of 1998 was paid in
October, 1998 at an annualized rate equal to 8.0% of contributed capital ($.40
per Unit).
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 77% of
16
<PAGE>
the cash distributions paid to the partners for the quarter ended September 30,
1998 constituted a return of capital. Also, based on the amount of net income
reported by the Partnership for accounting purposes, approximately 83% of the
cash distributions paid to the partners from the inception of the Partnership
through September 30, 1998 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.
The L-1011 and the A-300 aircraft remained off-lease during 1998. In
early 1998, the Partnership received informal offers to sell both these
aircraft. Based upon the offers received, the Partnership recognized write-downs
aggregating approximately $1.4 million to recognize the decrease in value of
these aircraft at December 31, 1997. Additionally, the Partnership provided a
write-down of $360,000 with respect to the L-1011 aircraft in the first quarter
of 1998 and during the third quarter of 1998, the Partnership reclassified the
$3,000,000 return condition settlement and the $743,000 unearned portion of the
L-1011 lease prepayment, as an adjustment to the carrying value of the aircraft.
If the aircraft are sold, the Partnership may elect either to utilize such
proceeds, for capital or maintenance expenditures or distributions to the
limited partners.
Continental Micronesia agreed to extend the lease of the DC10-10 for an
additional fifteen months (through September 15, 1999) at a lease rate of
$138,500 per month. Upon the expiration of the extended lease, the Partnership
will convert the aircraft to a freighter pursuant to an aircraft modification
agreement with a third party for ultimate delivery to Emery Worldwide Airlines
Inc. ("Emery"). The Partnership and Emery have signed an 84 month lease, which
provides for rents of $218,000 per month. The lease also provides a two-year
renewal at a monthly lease rate of $200,000, followed by three additional
two-year renewal options at the then fair market rental. Emery provided a
security deposit of $218,000 at September 30, 1998. The current workscope under
the aircraft modification agreement requires the investment of approximately
$8.0 million, subject to escalation, by the Partnership. The Partnership also
estimates expending an additional $1.0 million to meet the lease delivery
conditions. Additionally, the Partnership is committed to fund the hushkit for
the Boeing 727 leased to Capital Cargo International, Inc. ("Capital"), which is
expected to cost approximately $2,500,000.
In early 1998, Continental returned one 727-200 ADV aircraft, the lease
of which expired January 31, 1998. The Partnership and Continental continue
discussing each party's obligation with respect to the return condition of the
aircraft under the lease. If unsuccessful at achieving an agreed settlement, the
Partnership may need to institute litigation against Continental. The ultimate
resolution is unknown at this time.
In all, the Partnership has estimated commitments of $12 million. The
Partnership has drawn all available funds under its $10 million borrowing
facility and the principal balance at September 30, 1998 is $10 million. The
Limited Partnership Agreement permits the Partnership to borrow up to 35% (or
$50,785,000) of the original offering proceeds. The Partnership has commenced
discussions with the lender to increase the amount available under the borrowing
facility. However, there can be no assurance that the Partnership will have
17
<PAGE>
sufficient collateral to be able to obtain additional borrowings. The
Partnership may have to utilize cash from operations to finance such
commitments, thus potentially reducing distributions to partners.
Litigation
- ----------
See Note 4 "Litigation" for an update on certain legal proceedings.
RESULTS OF OPERATIONS
- ---------------------
The Partnership's net income was $670,000 and $1,577,000 for the
quarter and nine months ended September 30, 1998 (the "1998 Quarter" and "1998
Period", respectively) as compared to $893,000 and $2,543,000 for the quarter
and nine months ended September 30, 1997 (the "1997 Quarter" and "1997 Period",
respectively).
The Partnership's net income for the 1998 Period and 1998 Quarter
decreased as compared to the 1997 Period and 1997 Quarter principally due to the
write-downs of the interior and engines of the Boeing 727-200 aircraft and the
L-1011 aircraft based upon current market conditions. Increased interest expense
related to the additional draw down on the note payable and increased
depreciation expense due to the 1997 and 1998 capitalized aircraft improvements,
also contributed to the decrease in net income.
Net Income allocated to the Limited Partners for the 1998 Quarter and
1998 Period declined disproportionately to the decline in net income due to the
allocation, to the General Partners, of the gain on the sale of an engine (see
Note 3).
Rental revenue increased by $12,000 or 1% in the 1998 Quarter, and
$468,000 or 52% in the 1998 Period as compared to the 1997 Quarter and 1997
Period. Rental revenue increased during the 1998 Period principally due to the
rental income attributable to the Falcon lease, Capital lease and the A-300
engine lease with Viacao Aerea Sao Paulo S.A., all of which were off-lease for
all or a portion of the 1997 Period. These were partially off set by the absence
of amortization of the L-1011 deferred income in the second and third quarter of
1998.
Interest income decreased $46,000 and $251,000, or 48%, and 63%,
respectively, for the 1998 Quarter and 1998 Period in comparison to the 1997
Quarter and 1997 Period. This was due to a decrease in cash reserves for
expenditures throughout 1997 and 1998, for capitalized aircraft improvements,
and for the continued reduction in advances due from lessees due to their
scheduled repayments.
During the 1998 Period, the Partnership realized a gain of $116,000,
which is included in Other Income, representing the difference between the
amount realized and the book value of the Partnership's claim in the 1991
Continental bankruptcy.
In September 1998, the Partnership realized a gain of $241,000, on the
sale of an engine that had been dismantled and stored, since the return of the
Boeing 727-200 aircraft by Kiwi in 1996.
Depreciation and amortization expense increased $206,000 and $933,000,
or 11%, and 18%, respectively, for the 1998 Quarter and 1998 Period in
comparison to the 1997 Quarter and 1997 Period, respectively. This is due
primarily to the depreciation associated with the Falcon and Capital aircraft
18
<PAGE>
(including capitalized aircraft improvements made in 1997) which were off-lease
for a substantial portion of the 1997 Period. Additionally, capitalized
improvements to the TNT and Capital aircraft were depreciated for the entire
1998 Quarter. The Partnership does not recognize depreciation on off-lease
aircraft.
During the first quarter of 1998, the Partnership provided for a
write-down aggregating $360,000 relating to the value of the L-1011 aircraft. No
such amount was provided in the first quarter of 1997. Additionally, during the
second quarter of 1998, the Partnership provided for a $20,000 write-down in
connection with the sale of a JT8D-15 engine from the Boeing 727-200 advanced
aircraft leased to TNT Transport International B.V. ("TNT"). During September
1998, the Partnership finalized a transaction with the Managing General Partner,
for the acquisition of a JT8D-7B engine which was installed on the Boeing
727-200 aircraft, leased to TNT, in conjunction with the conversion of this
aircraft to a freighter. The Partnership received a JT8D-7B engine and $530,000
cash from the Managing General Partner, in exchange for a $250,000 payment and
two JT8D-15 engines. The Partnership provided for a $40,000 write-down in
connection the sale of the two JT8D-15 engines. Also during the third quarter of
1998, due to the conversion of this aircraft to a freighter, the Partnership
wrote-off the remaining net book value of the interior, determined through a
third party appraisal, which resulted in a write-down of $57,000.
Shortly after delivery of the aircraft to Capital Cargo International,
Inc. in 1997, one of the engines failed. In August 1998, the Partnership reached
an agreement with the lessee, in which the Partnership would share in the cost
to overhaul the engine on this aircraft. The Partnership's share of the overhaul
was $266,000.
Management and re-lease fees increased by $15,000 and $45,000 or 6% and
6%, respectively, for the 1998 Quarter and 1998 Period in comparison to the 1997
Quarter and 1997 Period. This is primarily due to the increase in rental income
for the 1998 Quarter and the 1998 Period, which serves as the basis upon which
management and re-lease fees are calculated.
Interest expense for the 1998 Quarter and 1998 Period increased by
$129,000 and $191,000 or 116%, and 56%, respectively, in comparison to the 1997
Quarter and 1997 Period due to an increase in the note payable.
General and administrative expenses decreased by $4,000 and $7,000 or
6%, and 3%, respectively, in the 1998 Quarter and 1998 Period. This decrease is
primarily due to a decrease in legal fees, partially offset by the increase in
accrued audit and tax fees.
Direct lease expenses remained consistent in the 1998 Quarter, but
decreased $81,000 or 27% in the 1998 Period, respectively, as compared to the
1997 Quarter and 1997 Period, primarily due to the Kiwi related expenses
incurred in the 1997 Period. (There were no such items in the 1998 Period.)
19
<PAGE>
IMPACT OF YEAR 2000 ISSUE
- -------------------------
The Year 2000 issue is the result of computer programs being written
using two digits rather than four digits to define the applicable year. This
could result in a failure of the information technology systems (IT systems) and
other equipment containing imbedded technology (non-IT systems) in the Year
2000, causing disruption of operation of the Partnership, its lessees or
vendors.
The Partnership does not own its own software, but is reliant upon
software owned by the General Partners or third party vendors. The General
Partners and third party vendors are either currently Year 2000 compliant or
have instituted plans to be so.
The plan for addressing third party critical dependencies includes:
identification of third party critical dependencies including lessees, vendors
and financial institutions; circulation to all applicable third parties of a
written request for their plans and progress in addressing the Year 2000 issue;
evaluation of responses; and development of contingency plans to address risks
of non-compliance by third parties. The Partnership has completed the
identification of critical dependencies and the circulation for requests for
Year 2000 compliance status.
The costs associated with addressing the Year 2000 issue, including
developing and implementing the above stated plan will be nominal and will be
expensed as incurred.
While the Partnership expects to have no interruption of operations as
a result of internal IT and non-IT systems, uncertainties remain about the
affect of third party critical dependencies who are not Year 2000 compliant.
The Partnership is not aware of any significant Year 2000 systems
issues with respect to the airworthiness of aircraft, however, should such an
issue result in Airworthiness Directives or other manufacturer recommended
maintenance, the implementation and the majority of the cost of such
implementation would be the responsibility of the aircraft lessee. Any resulting
costs to the Partnership cannot be estimated at this time.
Non-compliance on the part of a lessee could result in lost revenue for
the lessee and an inability to make lease payments to the Partnership.
Non-compliance by the lessee's financial institution could also affect the
ability to process lease payments. The Partnership has attempted to mitigate
such risks by inquiring of each lessee about its Year 2000 plans, including
whether they have addressed the issue with their financial institution.
The Partnership's lessees face the potential risk of non-compliance by
the air traffic control systems throughout the world. A disruption in the
operations of some or all of the air traffic control systems may cause
disruption to the operations of the Partnership's lessees, which may adversely
affect their ability to generate revenue.
A worst case scenario would be that a number of lessees are unable to
operate and generate revenues and as a result unable to make lease payments. The
Partnership is unable to estimate the likelihood or the magnitude of the
20
<PAGE>
resulting lost revenue at this time. Should this occur, the Partnership would
attempt to repossess aircraft from non-compliant lessees and place the aircraft
with compliant lessees. No assurances can be given that the Partnership would be
able to re-lease such aircraft at favorable terms or at all. If a significant
number of aircraft could not be re-leased at favorable terms or at all, or their
re-lease is delayed, the Partnership's business, financial condition and results
of operations would be adversely affected.
21
<PAGE>
Part II. OTHER INFORMATION
-----------------
Item 1. Legal Proceedings
-----------------
The Partnership, along with the Managing General Partner, Administrative General
Partner and PaineWebber Incorporated, had been named as a defendant in a lawsuit
entitled Paul Mallia, et al. v. PaineWebber, Inc., et al., pending before the
United States District Court for the Southern District of New York, and relating
to the sale and sponsorship of various limited partnership investments,
including the Partnership and an affiliated partnership ("the Pegasus
Partnerships"). The complaint asserts claims under the Racketeer Influenced and
Corrupt Organizations Act, as well as state law claims for 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, on behalf of those investors who bought
interests in the Pegasus Partnerships and in other limited partnerships and
investments. The plaintiffs seek unspecified damages, including attorneys' fees,
reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages. The Managing General Partner, Administrative
General Partner and the Pegasus Partnerships have been dismissed as defendants.
Under certain circumstances PaineWebber Incorporated can seek indemnification
from the Partnership. As a result, it cannot be determined at this time the
impact, if any, of the litigation on the Partnership.
The Partnership has filed a claim in the Bankruptcy Court for unpaid rents and
other damages related to the rejection, by Kiwi, of the lease. Given the sale of
Kiwi's assets as approved by the Court, it is unlikely that the Partnership will
obtain any recovery.
Item 5. Other Information
-----------------
On October 20, 1998 Paul L. Novello, Vice President, Chief Financial Officer,
Secretary and Treasurer of the Administrative General Partner resigned.
On October 20, 1998 Carmine Fusco was named Vice President, Secretary, Treasurer
and Chief Financial and Accounting Officer of the Administrative General
Partner.
Carmine Fusco, age 30, is Vice President, Secretary, Treasurer and Chief
Financial and Accounting Officer of the Administrative General Partner, he also
serves as an Assistant Vice President within the Private Investments Department
of PaineWebber Incorporated. Mr. Fusco had previously been employed as a
Financial Valuation Consultant in the Business Valuation Group of Deloitte &
Touche, LLP from January 1997 to August 1998. He was employed as a Commodity
Fund Analyst in the Managed Futures Department of Dean Witter Reynolds
Incorporated, from October 1994 to November 1995. Prior to joining Dean Witter,
Mr. Fusco was a Mutual Fund Accountant with the Bank of New York Company
Incorporated. He received his Bachelor of Science degree in Accounting and
Finance in May 1991 from Rider University and a Master of Business
Administration from Seton Hall University in June 1996.
22
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits and Reports to be files:
27. Financial Data Schedule (in electronic format only).
(b) Reports on Form 8-K
The Partnership did not file a report on Form 8-K during the
third quarter of the fiscal year ending December 31, 1998.
23
<PAGE>
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 12, 1998 By: /s/ Carmine Fusco
-----------------
Carmine Fusco
Vice President, Secretary,
Treasurer and Chief Financial and
Accounting Officer
24
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMTION EXTRACTED FROM FORM 10-Q FOR
THE PERIOD ENDED SEPTEMBER 30, 1998 OF PEGASUS AIRCRAFT PARTNERS II, LP AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 5,004,000
<SECURITIES> 0
<RECEIVABLES> 1,089,000
<ALLOWANCES> 640,000
<INVENTORY> 0
<CURRENT-ASSETS> 6,270,000
<PP&E> 154,894,000
<DEPRECIATION> 107,455,000 <F3>
<TOTAL-ASSETS> 53,709,000
<CURRENT-LIABILITIES> 6,856,000
<BONDS> 10,000,000
0
0
<COMMON> 0
<OTHER-SE> 36,853,000 <F2>
<TOTAL-LIABILITY-AND-EQUITY> 53,709,000
<SALES> 0
<TOTAL-REVENUES> 9,969,000
<CGS> 0
<TOTAL-COSTS> 7,615,000
<OTHER-EXPENSES> 244,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 533,000
<INCOME-PRETAX> 1,577,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,577,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,577,000
<EPS-PRIMARY> .22 <F1>
<EPS-DILUTED> 0
<FN>
<F1>REPRESENTS NET INCOME PER LIMITED PARTNERSHIP UNIT OUTSTANDING.
<F2>REPRESENTS AGGREGATE PARTNERSHIP CAPITAL.
<F3>INCLUDES PROVISIONS FOR WRITEDOWNS AND CERTAIN OTHER RESERVES.
</FN>
</TABLE>
