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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 March 31, 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.
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PEGASUS AIRCRAFT PARTNERS II, L.P.
QUARTERLY REPORT ON FORM 10-Q FOR THE
QUARTER ENDED MARCH 31, 1998
TABLE OF CONTENTS
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PAGE
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Part I FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited) 2
Balance Sheets - March 31, 1998 and
December 31, 1997 2
Statements of Income for the three months
ended March 31, 1998 and 1997 3
Statements of Partners' Equity for the three
months ended March 31, 1998 and 1997 4
Statements of Cash Flows for the three months
ended March 31, 1998 and 1997 5
Notes to Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 3. Exhibits and Reports on Form 8-K 20
</TABLE>
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEGASUS AIRCRAFT PARTNERS II, L.P.
BALANCE SHEETS -- MARCH 31, 1998 AND DECEMBER 31, 1997
(unaudited)
<TABLE>
<CAPTION>
1998 1997
---- ----
(IN THOUSANDS,
EXCEPT UNIT DATA)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 4,737 $ 5,705
Rent and other receivables, net (Note 4) 396 444
Aircraft, net (Notes 2, 4, 5 and 6) 50,389 52,098
Other assets (Note 6) 810 26
-------- --------
Total Assets $ 56,332 $ 58,273
======== ========
LIABILITIES AND PARTNERS' EQUITY
LIABILITIES:
Lease settlement reserve $ 3,000 $ 3,000
Accounts payable and accrued expenses 143 123
Payable to affiliates (Note 3) 453 211
Maintenance reserves payable 812 591
Notes payable 4,751 4,751
Deferred rental income and deposits 2,506 2,584
Distributions payable to partners 2,913 2,943
Accrued Interest Payable 37 --
-------- --------
Total Liabilities 14,615 14,203
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 3, 4, 5 and 6)
PARTNERS' EQUITY:
General Partners (1,031) (1,008)
Limited Partners (7,255,000 units outstanding) 42,748 45,078
-------- --------
Total Partners' Equity 41,717 44,070
-------- --------
Total Liabilities and Partners' Equity' $ 56,332 $ 58,273
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(unaudited)
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<CAPTION>
1998 1997
---- ----
(IN THOUSANDS,
EXCEPT UNIT DATA
AND PER UNIT AMOUNTS)
<S> <C> <C>
REVENUE:
Rentals from operating leases $ 3,327 $ 2,763
Interest 55 153
Other Income 116 --
---------- ----------
3,498 2,916
---------- ----------
EXPENSES:
Depreciation and amortization 2,050 1,533
Writedowns (Note 5) 360 --
Management and re-lease fees (Note 3) 250 220
Interest 119 115
General and administrative (Note 3) 74 99
Direct lease 67 72
---------- ----------
2,920 2,039
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NET INCOME $ 578 $ 877
========== ==========
NET INCOME ALLOCATED:
To the General Partners $ 6 $ 9
To the Limited Partners 572 868
---------- ----------
$ 578 $ 877
========== ==========
NET INCOME PER LIMITED PARTNERSHIP UNIT $ .08 $ .12
========== ==========
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.
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PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF PARTNERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 1998 AND MARCH 31,1997
(unaudited)
<TABLE>
<CAPTION>
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
-------- -------- -----
(IN THOUSANDS)
<S> <C> <C> <C>
Balance, January 1, 1998 $(1,008) $ 45,078 $ 44,070
Net income 6 572 578
Distributions to partners declared (29) (2,902) (2,931)
------- -------- --------
Balance, March 31, 1998 ($1,031) $ 42,748 $ 41,717
======= ======== ========
Balance, January 1, 1997 $ (904) $ 55,444 $ 54,540
Net income 9 868 877
Distributions to partners declared (29) (2,902) (2,931)
------- -------- --------
Balance, March 31, 1997 $ (924) $ 53,410 $ 52,486
======= ======== ========
</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 THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(unaudited)
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<CAPTION>
1998 1997
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(IN THOUSANDS)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 578 $ 877
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,050 1,533
Writedowns 360 --
Change in assets and liabilities:
Rent and other receivables (23) (35)
Other assets 6 (31)
Accounts payable and accrued expenses 20 60
Payable to affiliates 242 19
Interest payable 37 40
Deferred rental income and deposits (337) (241)
Unrestricted maintenance reserves collected 221 --
--------- --------
Net cash provided by operating activities 3,154 2,222
-------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Deposit for aircraft modification (790) --
Capitalized aircraft improvements (701) (785)
Repayment of advances by lessees 71 85
---------- ---------
Net cash used in investing activities (1,420) (700)
-------- --------
</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 THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(continued)
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<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Security deposit 259 --
Transfer from restricted cash -- 2,275
Application of maintenance reserves
payable to restore aircraft -- (1,060)
Cash distributions paid to partners (2,961) (2,917)
-------- ---------
Net cash used in financing activities (2,702) (1,702)
-------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (968) (180)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 5,705 12,831
------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 4,737 $12,651
======= =======
Supplemental schedule of cash flow information:
Interest paid $ 80 $ 75
========== ===========
</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
MARCH 31, 1998
(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 March 31, 1998 and the results of its
operations, changes in partners' equity and cash flows for the three 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, 1997.
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 nonowner sources. The adoption
of this pronouncement did not impact the reporting of the Partnership's results
of operations.
2. AIRCRAFT
The Partnership's net investment in aircraft as of March 31, 1998 and
December 31, 1997 consisted of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997
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<S> <C> <C>
Aircraft on operating leases $ 99,885 $ 103,990
Less: Accumulated depreciation (55,733) (55,513)
Writedowns (8,143) (8,143)
-------- ---------
$ 36,009 $ 40,334
-------- ---------
Aircraft held for lease $ 51,740 $ 46,934
Less: Accumulated depreciation (20,669) (18,839)
Writedowns (6,019) (5,659)
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)
-------- ---------
14,380 11,764
-------- ---------
Aircraft, net $ 50,389 $ 52,098
======== =========
</TABLE>
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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. 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 $42,000 of base management fees during the three months
ended March 31, 1998.
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 $129,000 of incentive management fees
during the three months ended March 31, 1998.
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 $79,000 of re-lease fees during the three months ended
March 31, 1998.
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 three months ended March 31, 1998, all of which was payable to the
Administrative General Partner.
During the quarter ended March 31, 1998, the Partnership paid $457,000
to a maintenance facility affiliated with the Managing General Partner for work
performed on certain aircraft, including the cargo conversion. The Partnership
also paid $267,000 for aircraft parts to a company owned by the President and
Director of the Managing General Partner and two former officers and directors.
4. AIRCRAFT LEASES
Continental Airline 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. This lease was
modified in 1995 and 1996 as discussed below and at March 31, 1998, the aircraft
was subject to a lease scheduled to expire on June 30, 1998 which provided for
rentals of $150,000 per month.
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 to the Partnership
during Continental's bankruptcy, remarketed to Kiwi (and recovered from Kiwi,
after Kiwi filed for bankruptcy in late 1996) and was delivered in March 1997 to
Falcon Air Express Inc. (see discussion below).
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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 rentals, in advance, of $312,000.
In January 1995, Continental announced that it was grounding its fleet
of Airbus 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 aircraft was prepared 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 defaulted. The
Partnership recovered the A-300 aircraft and is currently remarketing it. The
Partnership estimates that it would cost approximately $2.5 million for a
scheduled heavy maintenance check, modifications and FAA mandated work 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. However, during the
quarter ended March 31, 1998 the Partnership determined that the market
conditions for this type of aircraft the recovery of its investment plus any
incremental investment would be problematic and the Partnership began
entertaining purchase offers. At December 31, 1997 the Partnership provided a
writedown of $1.1 million to reflect a current informal purchase offer for the
airframe plus the appraised value of the engines. Additionally, in late
December, 1997, the Partnership leased, on a short-term (six months) basis, one
of the engines from the A-300 to Viacao Aerea Sao Paulo S/A ("VASP") a Brazilian
carrier for rents of $2,200 per day plus maintenance reserves.
On November 15, 1995, the Partnership reached an agreement with
Continental regarding the settlement for the 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").
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 for the Akdeniz
remarket, and (i) title to a Boeing 727-200 advanced aircraft subject to a lease
with Continental for a term of approximately 26 months at a lease rate of
$85,000 per month. ("Continental 727 No. 1") (ii) title to a second Boeing
727-200 advanced aircraft subject to a lease with Continental for a term of 42
months at a lease rate of $85,000 per month ("Continental 727 No. 2").
Additionally, the Partnership received approximately $557,000 as an economic
settlement in lieu of Continental performing certain maintenance work and
meeting the return conditions required by the A-300 lease. The lease of the
Continental 727 No. 1 expired January 31, 1998 and the aircraft was returned to
the Partnership. The Partnership and Continental are currently discussing each
party's compliance with the return condition of the aircraft and the related
liability as well as Continental's compliance with the lease. The Partnership
entered into an agreement in principle to lease the aircraft for a term of four
years to TNT
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Transport International B.V. ("TNT") a foreign cargo carrier and
has begun to convert the aircraft to cargo configuration at a budgeted cost of
approximately $4,500,000, including a low gross weight hushkit.
Under the DC-10 Restructuring the Partnership received approximately
$3,100,000 in cash, 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 remained unchanged. During 1996, Continental and the Partnership
reached an agreement to extend the lease of the DC-10 aircraft to June 30, 1998
at a lease rate of $150,000 per month. The Partnership and Continental entered
into an agreement in principle to extend the lease of the DC-10 aircraft for a
term of approximately 15 months beyond the scheduled expiration date at $138,500
per month. (See Item 2, Management's Discussion of and Analysis of Financial
Condition and Results of Operations and Footnote 6, "Commitments", for further
discussion of the Partnership's plans for this aircraft.)
Continental 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, all of which have
been repaid as of January 1998.
Trans World Airlines, Inc. 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 rental payments, in advance, 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 1993 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 in monthly installments through November 1998 with interest at a
fixed rate of 9.70%. At March 31, 1998, the balance of the receivable was
$99,000. All 1998 payments to date have been made by TWA.
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 in monthly installments through October 1998 with interest at
9.68%. At March 31, 1998, the balance of the receivable was $69,000. All 1998
repayments of advances have been made by TWA.
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
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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. All
rents deferred during the November 1994 to April 1995 period were repaid with
interest at 12% from the date of deferral over an 18-month period which
commenced May 1, 1995. 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 US
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. TWA has narrowed its losses and improved its
liquidity although it has yet to achieve sustained profitability. 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 returned the
L-1011 aircraft it leased from the Partnership. The lease, which provided for
monthly rentals of $130,000, was originally scheduled to expire in September
1998. In connection with the return of the L-1011 aircraft, TWA paid the
Partnership $2,846,000, which represented rents due under the remaining term of
the lease, discounted at 5% ("L-1011 Lease Prepayment") plus $3,000,000 as an
economic settlement for noncompliance with certain lease return conditions. The
lease was terminated, the aircraft was returned and $5,846,000 was received on
October 16, 1996. While the Partnership's L-1011 has been advertised for lease
and the Managing General partner has made inquiries of potential lessees, there
has been little interest in the aircraft on the part of potential lessees. Given
the number of L-1011s that are currently available for lease or purchase and the
fact that the Partnership's L-1011 requires a significant maintenance check, the
General Partners believe it is likely that the Partnership will seek to sell the
aircraft and engines. 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.
At March 31,1998 the L-1011 aircraft had an economic value of
approximately $1.7 million (net book value of $5.5 million adjusted for the $3
million economic settlement accounted for on the cost recovery basis and the
unearned portion of the L-1011 Lease Prepayment reflected as deferred income at
March 31, 1998 and a writedown of $300,000 to reflect the current estimated
market value of the aircraft).
Aeromexico Leases: During July 1992, the Partnership re-leased two
McDonnell Douglas DC-9-31 aircraft previously leased to and repossessed from
Midway Airlines Inc. ("Midway") to Aerovias de Mexico, S.A. de C.V.
("Aeromexico") for terms of approximately five years. The leases, which
originally provided for quarterly rentals in advance of $234,000, were scheduled
to expire in July 1997; one lease was extended to October 31, 1999 (with
Aeromexico given the right, subject to notice to extend to February 2000) and
one of which was extended to February 2000, each at a rate of $75,000 per month.
The DC-9-31 aircraft had originally been acquired in March and April
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
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certain capital improvements to the aircraft. The Partnership incurred
approximately $5.5 million in completing these maintenance procedures and
capital improvements prior to delivery of the aircraft to Aeromexico.
US Airways Group Inc. ("USAIR"): During September 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 for a total purchase price of
$10,041,000. The remaining one-half interest in the Trust is owned by Pegasus
Aircraft Partners, L.P., an affiliated partnership. The aircraft is subject to
an operating lease with USAir, which is scheduled to expire on June 1, 2001
pursuant to the renewal option exercised by USAir in 1997. Rental payments are
payable quarterly, in arrears, at the rate of $304,000 (for the Partnership's
one-half interest in the aircraft). The lessee also has three additional
one-year renewal options at fair market rental rates. The lessee may elect to
purchase the aircraft at its then fair market value at the end of any renewal
term.
The aircraft was purchased subject to a tax benefit transfer lease
("TBT lease") which provided for the transfer of the investment tax credits and
depreciation deductions with respect to the aircraft to a tax lessor. Under the
TBT lease, the Trust, as the owner of the aircraft and the tax lessee under the
TBT lease, has agreed to indemnify the tax lessor if certain anticipated tax
benefits are lost by the tax lessee as a result of, among other things, acts or
omissions by the Trust, breach of covenants by the Trust under the TBT lease,
loss or damage to the aircraft or use of the aircraft outside the United States.
The TBT lease requires that a letter of credit be posted to collateralize this
obligation. The Partnership shares in one-half of the annual cost of the letter
of credit and is obligated for one-half of any calls on the letter of credit.
The letter of credit has a current face amount of approximately $1.2
million. The letter of credit agreement originally obligated the Partnership to
deposit $35,000 per quarter (beginning on June 1, 1992) as cash collateral to
collateralize the Partnership's obligation under the letter of credit agreement.
In July 1995, the Partnership consummated an agreement with the issuer of the
letter of credit under which the issuer released its interest in the cash in the
cash collateral account and eliminated the requirement for future deposits to
such account.
Under the operating lease, the lessee, USAir, has assumed all
liabilities, indemnities and obligations of the Trust to the tax lessor under
the TBT lease and has agreed to indemnify the Trust for any liability, indemnity
or obligation to the tax lessor under the TBT lease except for liability
resulting from breaches by the Trust of covenants under the operating lease.
USAir has not posted a letter of credit to collateralize this obligation. As a
result of the foregoing, if the tax lessor draws on the letter of credit as a
result of action by the lessee, the Partnership and Pegasus Aircraft Partners,
L.P. through the trust will be responsible for the loss to the tax lessor until
and if the lessee performs under its indemnification. There also have been no
calls on the letter of credit through March 31, 1998.
The tax lessor is entitled to call on the letter of credit whether its
loss of tax benefits is caused by Pegasus Aircraft Partners, L.P. or the
Partnership. Pegasus Aircraft Partners, L.P. and the Partnership have agreed to
indemnify each other for any loss occasioned by the acts of the other.
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Kiwi International Air Lines, Inc Bankruptcy: In 1993, the Partnership
leased its two Boeing 727-200 aircraft to 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
were operating leases which required monthly rental payments, in advance, in the
amounts of $60,000 (Non-advanced) and $115,000 (Advanced) (collectively, the
"Kiwi Leases"). The Kiwi Leases were originally scheduled to expire on April 15,
1998 and June 30, 1998, respectively. In 1996, the Kiwi Leases were amended and
extended to December 31, 1999. Kiwi was also obligated to make monthly payments
of $250 per flight hour for maintenance reserve funds administered and held by
the Partnership. An affiliated partnership and affiliates of the Managing
General Partner also own aircraft which were leased to Kiwi.
In connection with the delivery of the aircraft to Kiwi 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. 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
approximately $1,000 at March 31, 1998 and December 31, 1997 (see Kiwi
bankruptcy discussion below).
During 1994, the Partnership funded approximately $633,000 of costs
primarily related to 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 over eighteen months which began June 1, 1996, with
interest from February 1997 at 12% per annum.
In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft for which Kiwi was to pay an increased lease rate over
an extended lease term. The hushkit purchase price was funded out of cash
reserves previously generated.
During 1996, in part because of the grounding of certain Kiwi aircraft
by the FAA as the result of pilot handbook deficiencies and the market reaction
to the ValuJet incident, Kiwi did not meet its financial goals. 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.
On September 30, 1996, Kiwi filed a voluntary petition for
reorganization under Chapter 11 of the Federal Bankruptcy Code ("Bankruptcy
Code") and did not make any subsequent payments. The Kiwi Leases accounted for
approximately 11% of the Partnership's rental revenue in 1996 and the aircraft
had net book values aggregating approximately $8,100,000 (including the
hushkit), at December 31, 1996 (excluding the cost of the heavy maintenance
check being completed prior to delivery to Falcon Air Express Inc. discussed
below). Additionally, the unpaid balance of the Bellyskin Note, plus interest,
was
14
<PAGE> 15
$290,000 at that time. On October 15, 1996, Kiwi ceased scheduled flight
operations and rejected both leases as of November 15, 1996. The Partnership
provided an allowance for bad debts in the amount of $640,000 with respect of
amounts due at September 30, 1996 and did not record any revenue beyond that
date. The Partnership recovered the aircraft in late 1996 and prepared them for
delivery to new lessees, Falcon Air Express, Inc. and Capital Cargo
International Airlines, Inc. as discussed below. The Partnership filed claims in
Kiwi's bankruptcy for all unpaid items and rejection damages. In April 1997, the
Partnership won a summary judgment in Bankruptcy Court permitting the use of the
previously collected maintenance reserves ($2.3 million). The Partnership
reclassified the collected reserves from restricted cash to cash and cash
equivalents and applied such amounts against expenditures incurred to make the
aircraft leasable. In July 1997, the Bankruptcy Court approved a proposal
submitted by a group that includes certain of the parties that had provided
debtor-in-possession financing to purchase the assets of Kiwi. Based upon the
approved purchase price, it is likely that the Partnership will have little or
no recovery of its bankruptcy claims.
Falcon Air Express, Inc. lease: In December 1996, the Partnership
entered into a lease agreement with Falcon Air Express, Inc. ("Falcon"), a
charter airline, with respect to the 727-200 non-advanced aircraft formerly
leased to Kiwi. The lease is for a term of 60 months and provides for a monthly
rental of $95,000. Falcon provided a security deposit of $95,000. The lease also
requires Falcon to fund, on a monthly basis, maintenance reserves of $317 per
flight hour. In connection with the delivery of the aircraft, the Partnership
completed a heavy maintenance check on the aircraft, including certain
modifications at a cost of approximately $2,700,000, $600,000 of which was
expended in 1996. The Partnership also purchased an engine at a cost of $760,000
prior to delivery of the aircraft and spent approximately $700,000 with respect
to maintenance work on one engine returned by Kiwi. The aircraft was delivered
to Falcon in March 1997. Maintenance reserves previously collected from Kiwi of
approximately $1,104,000 were applied to such costs to restore the aircraft.
Capital Cargo International Airlines, Inc. lease: In January 1997, the
Partnership entered into an agreement in principle with Capital Cargo
International Airlines, Inc. ("Capital"), a start-up freight carrier, with
respect to the 727-200 advanced aircraft formerly leased to Kiwi. The
Partnership agreed to finance the conversion of the aircraft to a freighter and
complete a C-check (totaling approximately $2.4 million). The Capital Cargo
Lease ("Capital Cargo Lease") is for a term of approximately eight years and
provides for an initial monthly lease rate of $105,000 per month. The Capital
Cargo Lease requires the Partnership to hushkit the aircraft on or before its
1999 C-check visit at its own expense (approximately $3 million) at which time
the lease rate increases to $139,000 per month. The Capital Lease requires
Capital to fund maintenance reserves monthly at a rate of $377 per flight hour.
Capital provided a security deposit of $50,000 and is obligated to add $17,000
per month to the security deposit during the lease term until the deposit totals
$220,000. The lease was executed and the aircraft was delivered to Capital in
July 1997.
In July 1997, in connection with the delivery of the aircraft to
Capital, the Partnership purchased two JT8D-15 engines from an unaffiliated
third party for cash of $1,550,000 plus two JT8D-15 engine cores returned with
the aircraft by Kiwi. Maintenance reserves previously collected from Kiwi of
$1,144,000 were applied to such costs to restore the aircraft.
15
<PAGE> 16
5. COMMITMENTS
In the fourth quarter of 1997, the Partnership entered into discussions
regarding the lease of the DC 10-10 aircraft, the lease of which is scheduled to
expire on June 30, 1998. Continental Micronesia agreed in principle to extend
the lease for an additional fifteen months (through September 30, 1999) at a
rate of $138,500 per month. Upon the expiration of the extended lease, the
Partnership would 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 an agreement in principle which provides
for a lease of 84 months with rent of $218,000 per month. The lease also
provides a two-year renewal 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 March 31, 1998. The Partnership provided a
deposit of $790,000 to the third party modification center, which included other
assets and the balance sheet as of March 31, 1998.
The workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million. Additionally, the Partnership is
committed in 1999, to fund the hushkit for the 727 leased to Capital, which is
expected to cost approximately $3 million. The Partnership currently has $5.2
million available under its borrowing facility (see Note 6 "Contingencies").
6. CONTINGENCIES
In early 1998, Continental returned one 727-200 ADV aircraft the lease
of which expired January 31, 1998. The Partnership and Continental continue to
discuss Continental's compliance with return conditions required by the lease.
Continental believes that the airframe exceeded return conditions and that the
engines met the aggregate return condition requirements; the Partnership
believes that the engines failed to meet return conditions and agree generally
regarding the airframe. The ultimate resolution is unknown at this time. The
Partnership entered into an agreement in principle to deliver this aircraft to
TNT Transport International B.V. for a term of approximately four years and
agreed to convert the aircraft to cargo configuration and hushkit the engines at
a budgeted cost of approximately $4.5 million. In all, the Partnership has
capital commitments of $15.5 million and has commenced discussions with its
lender to increase the amounts available under the existing borrowing facility.
16
<PAGE> 17
To the extent that the Partnership is unable to increase its loan
facilities or obtain additional borrowings, the Partnership may have to utilize
cash from operation to finance these obligations, potentially reducing
distributions to partners.
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 March 31, 1998, the Partnership's unrestricted cash and cash
equivalents of $4,737,000 was primarily invested in commercial paper. This
amount was $968,000 less than the Partnership's unrestricted cash and
equivalents at December 31, 1997 of $5,705,000. 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 quarter and capitalized
expenditures and maintenance deposits for aircraft exceeded cash provided by
operating activities plus the collection of amounts previously advanced to
lessees, (See Footnote 4, "Aircraft" and Footnote 5 "Litigation") during the
three months ended March 31, 1998.
Rent and other receivables, net, decreased $48,000 from $444,000 at
December 31, 1997 to $396,000 at March 31, 1998. This decrease resulted
primarily from the continued repayment of advances by Continental (fully paid)
and TWA.
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 has 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 March 31, 1998, the
balance of the advances to TWA aggregated $99,000.
Other assets increased $784,000 from $26,000 at December 31, 1997 to
$810,000 at March 31, 1998. This increase was primarily from the deposit made to
the modifications center with respect to DC 10-10 freight conversion (See Item
1, Financial).
The payable to affiliates increased $242,000 from $211,000 at December
31, 1997 to $453,000 at March 31, 1998 due principally to fees for the fourth
quarter of 1997 which were unpaid at March 31, 1998.
Deferred rental income and deposits was $2,506,000 at March 31, 1998 as
compared to $2,584,000 at December 31, 1997. The decrease was primarily
attributable to the recognition of amounts previously received in connection
with the A-300 Lease Settlement and the L-1011 Lease Prepayment, partially
offset by the collection of security deposits from TNT and Emery.
17
<PAGE> 18
During the three months ended March 31, 1998, the Partnership paid cash
distributions pertaining to the fourth quarter of (except the amount due to the
Administrative General Partner which remains unpaid). The quarterly distribution
represented an annualized rate equal to 8.0% of contributed capital ($.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 distribution for the first quarter of 1998 was
paid on April 25, 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 80% of
the cash distributions paid to the partners for the three months ended March 31,
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 March 31, 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 Partnership owns and manages a diversified portfolio of leased
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.
During 1997, the Partnership invested $7.6 million in capitalized
aircraft improvements and maintenance checks, of which $2.3 million was funded
by the application of maintenance reserves collected from Kiwi in prior periods.
During 1997, the Partnership delivered one 727-200 aircraft to Falcon and a
second to Capital Cargo. The L-1011 aircraft and the A-300 remained off-lease
during 1997. In early 1998, the Partnership received informal offers to purchase
these aircraft. Based upon the offers received, the Partnership recognized
writedowns aggregating approximately $1.4 million to recognize the decrease in
value of these aircraft at December 31, 1997. Additionally, at March 31, 1998
the Partnership provided a writedown of $300,000 with respect to the L-1011
aircraft. There can be no assurance that either offer will result in the
consummation of a sale. However, if the aircraft are sold, the Partnership may
utilize such proceeds, to the extent permitted under the Partnership Agreement,
to invest (along with the $3,000,000 L-1011 return condition settlement received
in 1996) in additional used aircraft subject to lease or may distribute such
amounts to partners.
In the fourth quarter of 1997, the Partnership entered into discussions
with the lessee regarding the DC 10-10 aircraft, the lease of which is scheduled
to expire on June 30, 1998. Continental Micronesia agreed in principle to extend
the lease for an additional fifteen months (through September 30, 1999) at a
lease rate of $138,500 per month. Upon the expiration of the extended lease, the
Partnership would 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 an agreement in principle which provides
18
<PAGE> 19
for a lease of 84 months with rent 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 March 31, 1998.
The workscope under the aircraft modification agreement requires the
investment of approximately $8.0 million by the Partnership. Additionally, the
Partnership is committed to fund in 1999 the hushkit for the 727 leased to
Capital, which is expected to cost approximately $3 million. In early 1998,
Continental returned one 727-200 ADV aircraft, the lease of which expired
January 31, 1998. The Partnership and Continental are discussing each party's
compliance with return conditions required by the lease. Continental's position
is that the airframe exceeded return condition requirements and that the
engines met the aggregate return condition requirements; the Partnership
believes that the engines failed to meet return conditions and agree generally
regarding the airframe. The ultimate resolution is unknown at this time. The
Partnership entered into an agreement in principle to deliver this aircraft to
TNT Transport International B.V. for a term of approximately four years. In
conjunction with the agreement in principle, the Partnership agreed to convert
the aircraft to cargo configuration and hushkit the engines at a budgeted cost
of approximately $4.5 million. In all the Partnership has capital commitments
of $15.5 million. The Partnership currently has $5.2 million available under
its $10 million borrowing facility. The Partnership is permitted to borrow up
to 35% of the original offering proceeds ($50,785,000). 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 be able to obtain additional borrowings. The Partnership may have to
utilize cash from operations to finance such cost, thus potentially reducing
distributions to partners.
RESULTS OF OPERATIONS
The Partnership's net income was $578,000 for the three months ended
March 31, 1998 ("1998 Quarter") as compared to $877,000 for the quarter ended
March 31, 1997 ("1997 Quarter").
The Partnership's net income for the 1998 Quarter decreased as compared
to the 1997 Quarter principally due to the writedown related to the L-1011
aircraft based upon current market conditions; further the increase in rental
income was offset by a corresponding increase in depreciation.
Rental income increased by $564,000, or 20% in the 1998 Quarter as
compared to the 1997 Quarter, principally due to the rental income attributable
to the Falcon, Capital Air Cargo and the A-300 engine leased to VASP, all of
which were off-lease for all or substantially all of the 1997 Period.
Interest income decreased $98,000, or 64%, for the 1998 Quarter in
comparison to the 1997 Quarter, due to a decrease in cash reserves due to
expenditures throughout 1997 for capitalized aircraft improvements as well as
the continued reduction in advances due from lessees due to their scheduled
repayments.
During the 1998 Quarter, the Partnership realized a gain of $116,000
representing the difference between the book value of the Partnership's claim in
the Continental bankruptcy and the amount realized.
19
<PAGE> 20
Depreciation and amortization expense increased $517,000, or 34%, for
the 1998 Quarter in comparison to the 1997 Quarter due primarily to the
depreciation associated with the Falcon and Capital aircraft (including
capitalized aircraft improvements made in 1997) which were off-lease for all or
substantially all of the 1997 Quarter. The Partnership does not recognize
depreciation on off-lease aircraft.
During the 1998 Quarter, the Partnership provided for writedowns
aggregating $360,000 to recognize the impairment of the value of certain
aircraft. No such amounts were provided in the 1997 Quarter.
Management and re-lease fees for the 1998 Quarter increased by $30,000
or 14% in comparison to the 1997 Quarter primarily because of the increases in
rental income and net income adjusted for depreciation which serve as the bases
upon which management and re-lease fees are calculated.
Interest expense for the 1998 Quarter increased by $4,000 or 3% in
comparison to the 1997 Quarter due to a slight increase in the interest rate.
General and administrative expenses decreased by $25,000 or 25% in the
1998 Quarter as compared to the 1997 Quarter due to a decrease in the level of
certain administrative expenses which was consistent with the level of
operations.
Direct lease expenses decreased by $5,000 or 7% in the 1998 Quarter as
compared to the 1997 Quarter due primarily to the Kiwi related expenses incurred
in the 1997 Quarter. (There were no such items in the 1998 Quarter.)
PART II. OTHER INFORMATION
ITEM 3. LEGAL PROCEEDINGS
None.
20
<PAGE> 21
ITEM 4. EXHIBITS AND REPORTS ON FORM 8-K
(a) None
(b) The Partnership did not file any reports on Form 8-K during
the first quarter of the fiscal year ending December 31, 1998.
21
<PAGE> 22
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: May 15, 1998 By: /s/ Joseph P. Ciavarella
Joseph P. Ciavarella
Vice President, Treasurer
and Chief Financial
and Accounting Officer
22
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1998 FOR PEGASUS AIRCRAFT PARTNERS II LP AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM 10-Q.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 4,737,000
<SECURITIES> 0
<RECEIVABLES> 1,036,000
<ALLOWANCES> (640,000)
<INVENTORY> 0
<CURRENT-ASSETS> 5,153,000
<PP&E> 151,625,000
<DEPRECIATION> (101,236,000)<F3>
<TOTAL-ASSETS> 56,332,000
<CURRENT-LIABILITIES> 7,358,000
<BONDS> 4,751,000
0
0
<COMMON> 0
<OTHER-SE> 41,717,000<F2>
<TOTAL-LIABILITY-AND-EQUITY> 56,332,000
<SALES> 0
<TOTAL-REVENUES> 3,498,000
<CGS> 0
<TOTAL-COSTS> 2,727,000
<OTHER-EXPENSES> 74,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 119,000
<INCOME-PRETAX> 578,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 578,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 578,000
<EPS-PRIMARY> .08<F1>
<EPS-DILUTED> 0
<FN>
<F1>Income per unit of limited partnership interest.
<F2>Includes partners capital and accumulated earnings and distribution to
partners.
<F3>Includes allowance for equipment.
</FN>
</TABLE>
