-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KWlpJOIsFcHLb7NqXXQ6yGMdBYTTdYB/W5v9Z3cD4+T3/jJ4+unZqjDysx9zQLZY Xo6pX2iuaxTpOHjU80bhHw== 0000789895-96-000003.txt : 19960813 0000789895-96-000003.hdr.sgml : 19960813 ACCESSION NUMBER: 0000789895-96-000003 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960630 FILED AS OF DATE: 19960812 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: POLARIS AIRCRAFT INCOME FUND II CENTRAL INDEX KEY: 0000789895 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EQUIPMENT RENTAL & LEASING, NEC [7359] IRS NUMBER: 942985086 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 033-02794 FILM NUMBER: 96608988 BUSINESS ADDRESS: STREET 1: 201 MISSION ST STREET 2: 27TH FL CITY: SAN FRANCISCO STATE: CA ZIP: 94105 BUSINESS PHONE: 4152847440 MAIL ADDRESS: STREET 1: 201 MISSION ST STREET 2: 27TH FL CITY: SAN FRANCISCO STATE: CA ZIP: 94105 10-Q 1 JUNE 30, 1996 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------------- FORM 10-Q ---------------------- _X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 1996 OR ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___ to ___ ---------------------- Commission File No. 33-2794 ---------------------- POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership State of Organization: California IRS Employer Identification No. 94-2985086 201 Mission Street, 27th Floor, San Francisco, California 94105 Telephone - (415) 284-7400 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes _X_ No___ This document consists of 20 pages. POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership FORM 10-Q - For the Quarterly Period Ended June 30, 1996 INDEX Part I. Financial Information Page Item 1. Financial Statements a) Balance Sheets - June 30, 1996 and December 31, 1995.......................................... 3 b) Statements of Income - Three and Six Months Ended June 30, 1996 and 1995............................... 4 c) Statements of Changes in Partners' Capital (Deficit) - Year Ended December 31, 1995 and Six Months Ended June 30, 1996......................... 5 d) Statements of Cash Flows - Six Months Ended June 30, 1996 and 1995............................... 6 e) Notes to Financial Statements.............................. 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 14 Part II. Other Information Item 1. Legal Proceedings...................................... 17 Item 6. Exhibits and Reports on Form 8-K....................... 19 Signature ....................................................... 20 2 Part 1. Financial Information ----------------------------- Item 1. Financial Statements POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership BALANCE SHEETS (Unaudited) June 30, December 31, 1996 1995 ---- ---- ASSETS: CASH AND CASH EQUIVALENTS $ 27,563,478 $ 25,884,742 MARKETABLE SECURITIES, trading -- 2,356,506 RENT AND OTHER RECEIVABLES, net of allowance for credit losses of $342,373 in 1996 and $241,964 in 1995 16,428 8,965 NOTES RECEIVABLE 2,516,775 2,679,486 AIRCRAFT, net of accumulated depreciation of $96,810,481 in 1996 and $97,407,528 in 1995 69,571,840 76,487,365 AIRCRAFT INVENTORY 248,290 373,483 OTHER ASSETS 29,770 29,770 ------------- ------------- $ 99,946,581 $ 107,820,317 ============= ============= LIABILITIES AND PARTNERS' CAPITAL (DEFICIT): PAYABLE TO AFFILIATES $ 74,325 $ 92,511 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 162,416 87,356 SECURITY DEPOSITS 75,000 450,000 MAINTENANCE RESERVES 198,458 179,185 DEFERRED INCOME 642,742 642,742 ------------- ------------- Total Liabilities 1,152,941 1,451,794 ------------- ------------- PARTNERS' CAPITAL (DEFICIT): General Partner (1,214,986) (1,139,155) Limited Partners, 499,997 units issued and outstanding 100,008,626 107,507,678 ------------- ------------- Total Partners' Capital 98,793,640 106,368,523 ------------- ------------- $ 99,946,581 $ 107,820,317 ============= ============= The accompanying notes are an integral part of these statements. 3 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF INCOME (Unaudited) Three Months Ended Six Months Ended June 30, June 30, -------- -------- 1996 1995 1996 1995 ---- ---- ---- ---- REVENUES: Rent from operating leases $3,420,000 $4,419,855 $6,938,600 $6,053,355 Interest 392,070 463,247 784,295 753,211 Claims related to lessee defaults 567,500 -- 567,500 -- Other -- 960 49,974 219,131 ---------- ---------- ---------- ---------- Total Revenues 4,379,570 4,884,062 8,340,369 7,025,697 ---------- ---------- ---------- ---------- EXPENSES: Depreciation 3,009,926 2,792,188 6,019,853 5,712,571 Management fees to general partner 162,000 209,454 324,000 288,879 Provision for credit losses -- -- 100,409 -- Operating 76,548 10,449 152,050 24,472 Administration and other 93,220 82,792 152,328 142,845 ---------- ---------- ---------- ---------- Total Expenses 3,341,694 3,094,883 6,748,640 6,168,767 ---------- ---------- ---------- ---------- NET INCOME $1,037,876 $1,789,179 $1,591,729 $ 856,930 ========== ========== ========== ========== NET INCOME ALLOCATED TO THE GENERAL PARTNER $ 422,835 $ 142,878 $ 840,830 $ 258,542 ========== ========== ========== ========== NET INCOME ALLOCATED TO LIMITED PARTNERS $ 615,041 $1,646,301 $ 750,899 $ 598,388 ========== ========== ========== ========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 1.23 $ 3.29 $ 1.50 $ 1.19 ========== ========== ========== ========== The accompanying notes are an integral part of these statements. 4 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) (Unaudited) Year Ended December 31, 1995 and Six Months Ended June 30, 1996 ------------------------------ General Limited Partner Partners Total ------- -------- ----- Balance, December 31, 1994 $ (1,119,868) $ 109,410,169 $ 108,290,301 Net income 744,597 4,972,468 5,717,065 Cash distributions to partners (763,884) (6,874,959) (7,638,843) ------------- ------------- ------------- Balance, December 31, 1995 (1,139,155) 107,507,678 106,368,523 Net income 840,830 750,899 1,591,729 Cash distributions to partners (916,661) (8,249,951) (9,166,612) ------------- ------------- ------------- Balance, June 30, 1996 $ (1,214,986) $ 100,008,626 $ 98,793,640 ============= ============= ============= The accompanying notes are an integral part of these statements. 5 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, ------------------------- 1996 1995 ---- ---- OPERATING ACTIVITIES: Net income $ 1,591,729 $ 856,930 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 6,019,853 5,712,571 Provision for credit losses 100,409 -- Changes in operating assets and liabilities: Decrease in marketable securities, trading 2,356,506 -- Decrease (increase) in rent and other receivables (107,872) 17,151 Decrease in payable to affiliates (18,186) (628,286) Increase in accounts payable and accrued liabilities 75,060 36,375 Increase (decrease) in security deposits (375,000) 2,838 Increase in maintenance reserves 19,273 98,369 ------------ ------------ Net cash provided by operating activities 9,661,772 6,095,948 ------------ ------------ INVESTING ACTIVITIES: Principal payments on notes receivable 1,058,383 1,198,947 Net proceeds from sale of aircraft inventory 125,193 100,361 ------------ ------------ Net cash provided by investing activities 1,183,576 1,299,308 ------------ ------------ FINANCING ACTIVITIES: Cash distributions to partners (9,166,612) (2,777,761) ------------ ------------ Net cash used in financing activities (9,166,612) (2,777,761) ------------ ------------ CHANGES IN CASH AND CASH EQUIVALENTS 1,678,736 4,617,495 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 25,884,742 14,662,147 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 27,563,478 $ 19,279,642 ============ ============ The accompanying notes are an integral part of these statements. 6 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. Accounting Principles and Policies In the opinion of management, the financial statements presented herein include all adjustments, consisting only of normal recurring items, necessary to summarize fairly Polaris Aircraft Income Fund II's (the Partnership's) financial position and results of operations. The financial statements have been prepared in accordance with the instructions of the Quarterly Report to the Securities and Exchange Commission (SEC) Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles. These statements should be read in conjunction with the financial statements and notes thereto for the years ended December 31, 1995, 1994, and 1993 included in the Partnership's 1995 Annual Report to the SEC on Form 10-K (Form 10-K). Aircraft and Depreciation - The aircraft are recorded at cost, which includes acquisition costs. Depreciation to an estimated residual value is computed using the straight-line method over the estimated economic life of the aircraft which was originally estimated to be 30 years from the date of manufacture. Depreciation in the year of acquisition was calculated based upon the number of days that the aircraft were in service. The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased. If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, an impairment loss is recognized. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 121, as discussed below, measurement of an impairment loss will be based on the "fair value" of the asset as defined in the statement. Capitalized Costs - Aircraft modification and maintenance costs which are determined to increase the value or extend the useful life of the aircraft are capitalized and amortized using the straight-line method over the estimated useful life of the improvement. These costs are also subject to periodic evaluation as discussed above. Financial Accounting Pronouncements - SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires the Partnership to disclose the fair value of financial instruments. Cash and cash equivalents are stated at cost, which approximates fair value. Marketable Securities, trading (Note 4) were carried at fair value, which was determined based on quoted market prices. The fair value of the Partnership's notes receivable is estimated by discounting future estimated cash flows using current interest rates at which similar loans would be made to borrowers with similar credit ratings and remaining maturities. The carrying value of the note receivable from Continental Airlines, Inc. (Continental) discussed in Note 2, the note receivable from ALG, Inc. (ALG) discussed in Note 3, the note receivable from American International Airways, Inc. (AIA) discussed in Note 6, and the note receivable from WestJet Airlines, Ltd. (WestJet) discussed in Note 7 approximate their estimated fair value. The 7 carrying value of the line of credit note receivable from Viscount Air Services, Inc. (Viscount) discussed in Note 5 approximates its estimated fair value as this note is secured by certain of Viscount's trade receivables and spare parts. The carrying value of the rents receivable from Viscount is zero due to a recorded allowance for credit losses equal to the balance of the outstanding rents. As of June 30, 1996 and December 31, 1995, the estimated fair value of the rents receivable from Viscount was also zero. The Partnership adopted SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," as of January 1, 1996. This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Partnership estimates that this pronouncement will not have a material impact on the Partnership's financial position or results of operations unless events or circumstances change that would cause projected net cash flows to be adjusted. No impairment loss was recognized by the Partnership during the first two quarters of 1996. 2. Continental and Continental Micronesia, Inc. (Continental Micronesia) Cost Sharing Agreements In accordance with the Continental and Continental Micronesia cost-sharing agreements as discussed in the Form 10-K, in January 1994, the Partnership financed $2,177,533 to Continental and Continental Micronesia for new image modifications, which is being repaid with interest over the lease terms of the three aircraft. The Partnership has received all scheduled principal and interest payments due from Continental and Continental Micronesia. The aggregate note receivable balance as of June 30, 1996 and December 31, 1995 was $1,035,382 and $1,289,328, respectively. 3. Promissory Note from ALG One hushkit set from the aircraft formerly leased to Pan Am was sold in January 1993 to ALG for $1,750,000. ALG paid cash for a portion of the sales price and issued an 11% interest-bearing promissory note for the balance of $1,132,363, which specified 23 equal monthly payments and a balloon payment of $897,932 due in January 1995. ALG paid to the Partnership $19,138 of the balloon payment in January 1995, originating an event of default under the note. The Partnership and ALG subsequently restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1995 of $254,733, eleven monthly payments of $25,600 beginning in February 1995, and a balloon payment in January 1996 of $416,631. In January 1996, the Partnership and ALG once again restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with a lump sum payment in January 1996 of $135,258 and eleven payments of $27,272 beginning in February 1996 through December 1996. ALG is current on the renegotiated payments. The note receivable balances as of June 30, 1996 and December 31, 1995 were $157,602 and $412,166, respectively. 4. Trans World Airlines, Inc. (TWA) Reorganization As discussed in the Form 10-K, the Partnership renegotiated the TWA leases after TWA defaulted under its leases with the Partnership during 1991. The renegotiated agreement stipulated that the Partnership share in the costs of certain Airworthiness Directives after TWA successfully reorganized. Pursuant to this cost-sharing agreement, since TWA emerged from its reorganization proceedings in 1993, expenses totaling $6.3 million ($2.7 million in 1993 and $3.6 million in 1994) have been offset against rental payments. Under the terms of the TWA cost-sharing agreement, TWA may offset up to an additional $2.7 million against rental payments, subject to annual limitations, over the remaining lease terms of the aircraft. 8 In October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GE Capital Aviation Services, Inc. (GECAS) negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by GECAS, 18 of which are owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by Polaris Investment Management Corporation (PIMC) on behalf of the Partnership with respect to the Partnership's aircraft. The Deferral Agreement provided for (i) a moratorium on all the rent due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not recognize either the $1.575 million rental amount deferred in 1994 or the $2.025 million rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The deferred rents were paid in full by October 1995. In consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its pro-rata share of such payment by TWA. This amount was recognized as other revenue in the accompanying statement of income for the six months ended June 30, 1995. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock. In order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by a formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents. The amount of such maintenance reimbursement has not been finally determined. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share. The fair market value of the TWA stock at December 31, 1995 of $2,356,506 is reflected in the accompanying December 31, 1995 balance sheet. The Partnership sold the TWA Common Stock by February 1996, net of broker commissions, for $2,406,479 and recognized a gain on trading securities of $49,974 during the first quarter of 1996. 9 5. Viscount Default and Bankruptcy Filing As discussed in the Form 10-K, in July 1994, the Partnership entered into a Restructuring and Loan Agreement (Loan Agreement) with Viscount. During 1995, the Partnership had been in discussions with Viscount to restructure additional existing financial obligations of Viscount to the Partnership. Viscount subsequently defaulted on its financial obligations to the Partnership and on December 13, 1995, the Partnership issued a notice of default to Viscount. On January 9, 1996, Viscount was notified that the Partnership had elected to terminate the lease and the Partnership demanded return of the aircraft. Viscount disputed the lease termination. On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in Tucson, Arizona. During 1995, Viscount delivered the Partnership's Boeing 737-200 aircraft to a repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace, located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft, which is in addition to the approximately $565,000 already paid by the Partnership from maintenance reserves. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third-party vendor, who claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. On May 22, 1996, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), as owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to recover the airframe from BAE Aviation, Inc. and certain creditors alleging mechanics liens and to determine the validity of the claimed liens. On or about April 15, 1996, GE Capital Aviation Services, Inc. (GECAS), on behalf of Polaris Holding Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, and Polaris Aircraft Investors XVIII (collectively, Polaris Entities), FSB, the owner/trustee under a number of the leases, Viscount, and other parties executed a Compromise of Claims and Stipulation under Section 1110 of the United States Bankruptcy Code (the Compromise and Stipulation), which was approved by the Bankruptcy Court on May 14, 1996. The Compromise and Stipulation, provides, among other things that Viscount rejected the lease of the Partnership's aircraft. The rejection of the lease will give rise to a prepetition unsecured claim in Viscount's bankruptcy for breach of contract damages. Notwithstanding Viscount's rejection of the Partnership's aircraft lease, Viscount continues to possess and use the Partnership's engine and has refused to return various aircraft parts removed from the Partnership's aircraft. The Compromise and Stipulation also provides for Viscount to deliver to the Partnership an interest bearing note (the Aircraft Note), having administrative priority status, in an amount equal to the net present value of all rent due under the lease of aircraft from April 1, 1996 through the date that is four calendar months from the date possession of the Partnership's aircraft is delivered to GECAS on behalf of the Partnership. In any month in which the Partnership receives rent for the use of the aircraft, the principal amount of the Aircraft Note shall be reduced by the amount of such rent received, not to exceed $45,000 per month. The Aircraft Note will mature on November 30, 1997, with any remaining principal then becoming due and payable by Viscount. In addition, the Compromise and Stipulation provides that: (i) an assignment from certain of Viscount's guarantors under the Restructuring and Loan Agreement, dated July 20, 1994 (Loan Agreement), of security interests in Viscount assets that will provide further security for Viscount's indebtedness to the Partnership under the Loan Agreement; (ii) a release by Viscount of claims against GECAS, the Partnership and the Polaris Entities; and (iii) a release by GECAS, the Partnership and the Polaris Entities of Viscount's guarantors with respect to the Loan Agreement (the guarantor's collateral for the obligations on the line of credit are being substituted by the assignments referenced in (i) above). 10 The Partnership's claim for rejection damages under the lease and amounts due under the Loan Agreement are addressed under Viscount's proposed plan of reorganization, which was filed with the Bankruptcy Court on July 1, 1996 as discussed in Note 10 and in Part II, Item 1, and must be confirmed by September 30, 1996, pursuant to the Compromise and Stipulation. As of June 30, 1996, the Partnership's aggregate rent, maintenance reserve, loan and interest receivable from Viscount was approximately $575,000. All amounts due from Viscount may be affected by Viscount's filing for protection under Chapter 11. The balance of the Loan Agreement line of credit advanced to Viscount in 1994 of $88,641 at June 30, 1996 and December 31, 1995, plus accrued interest, is secured by certain of Viscount's trade receivables and spare parts. An allowance for credit losses has not been provided for this note. The Partnership has recorded an allowance for credit losses for the remaining unsecured receivable balances from Viscount for the aggregate of the unpaid rents, outstanding deferred rent balance and accrued interest of approximately $342,000 as of June 30, 1996. Viscount's failure to perform on its financial obligations with the Partnership has an adverse effect on the Partnership's financial position. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership has incurred legal costs of approximately $92,000, which are reflected in operating expense in the Partnership's statement of income for the six months ended June 30, 1996. The Partnership may incur maintenance, remarketing, transition and additional legal costs related to the Partnership's aircraft, which cannot be estimated at this time. The outcome of Viscount's Chapter 11 proceeding cannot be predicted. 6. Sale of Aircraft to AIA The Partnership sold one Boeing 727-200 aircraft and hushkit, formerly leased to Delta Airlines Inc., to AIA in February 1995 for a sales price of $1,771,805. The Partnership recorded no gain or loss on the sale as the sales price equaled the net book value of the aircraft and hushkit. The Partnership agreed to accept payment of the sales price in 36 monthly installments of $55,000, with interest at a rate of 7.5% per annum, beginning in March 1995. The Partnership recorded a note receivable for the sales price and has received all scheduled principal and interest payments due from AIA through June 30, 1996, including one additional principal payment of $410,229 received in May 1995. The note receivable balance as of June 30, 1996 and December 31, 1995 was $588,027 and $889,351, respectively. 7. Sale of Boeing 737-200 Combi Airframe and Engine In March 1996, the Partnership sold the airframe and one engine from the Boeing 737-200 Combi Aircraft, formerly on lease to Northwest Territorial Airways, Ltd., to WestJet. The security deposit of approximately $88,000 received from WestJet in December 1995 was applied to the sales price of approximately $896,000. The Partnership recorded no gain or loss on the sale as the sales price equaled the net book value of the airframe and engine. The Partnership agreed to accept payment of the balance of the sales price in 22 monthly installments, with interest at a rate of 10% per annum, beginning in March 1996. WestJet is current on its scheduled payments to the Partnership. The note receivable balance as of June 30, 1996 was $647,123. 11 8. Claims Related to Lessee Defaults As discussed in Item 3 of the Partnership's 1995 Form 10-K, Pan American World Airways, Inc. (Pan Am) entered into a proposed Stipulation and Order with the Partnership pursuant to which Pan Am agreed to allow the Partnership $2.5 million as an administrative expense priority claim and $56 million as a general unsecured claim. In May 1996, the Partnership received from Pan Am a payment of $567,500 as full satisfaction of the administrative expense priority claim. The Partnership has recorded this payment as other revenue in claims related to lessee defaults in the statement of income for the three and six months ended June 30, 1996. It cannot be estimated at this time when and if the general unsecured claim will be paid. 9. Related Parties Under the Limited Partnership Agreement, the Partnership paid or agreed to pay the following amounts for the current quarter to the general partner, PIMC, in connection with services rendered or payments made on behalf of the Partnership: Payments for Three Months Ended Payable at June 30, 1996 June 30, 1996 ------------- ------------- Aircraft Management Fees $162,000 $ -- Out-of-Pocket Administrative Expense Reimbursement 71,282 73,663 Out-of-Pocket Operating and Remarketing Expense Reimbursement 40,062 662 -------- -------- $273,344 $ 74,325 ======== ======== 10. Subsequent Events On July 1, 1996, Viscount filed its bankruptcy disclosure statement and proposed plan of reorganization, which sets forth Viscount's proposed treatment for restructuring and satisfying the claims of all of its creditors. The plan of reorganization contemplates a capital investment of between $2.5 million and $9 million from an outside source. A hearing date of August 29, 1996 has been set to consider the sufficiency of disclosure contained in the disclosure statement; however, counsel for Viscount has indicated that Viscount likely will amend the disclosure statement and plan prior to any such hearing. The Partnership is presently evaluating the disclosure statement and plan. Pursuant to a stipulated order of the Superior Court entered on July 9, 1996, FSB filed a bond in the penal sum of $1,371,000 for the benefit of the lienholders (Note 5), who subsequently released the aircraft to the Partnership on July 11, 1996. The aircraft was moved to a repair facility in Tucson, Arizona for completion of a "D" check. The litigation will continue in Superior Court over the validity and amount of the various liens alleged against the bond. On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to recover the engines and parts leased in connection with the Partnership's aircraft. GECAS and FSB assert that these engines and parts should have been delivered to FSB pursuant to the Compromise Order. Viscount alleges that it cannot return the engines and parts without impairing its operations and has no 12 legal obligation to do so. A hearing has been scheduled for August 29, 1996 to consider the motion of GECAS and FSB to recover the engine and certain aircraft parts. Pending the hearing, Viscount has agreed to pay the Partnership $10,000 for the use of the engine during the month of August, and will continue to pay maintenance reserves pursuant to the lease terms. Discussions are proceeding with Viscount in an effort to resolve these issues prior to the scheduled hearing. 13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Polaris Aircraft Income Fund II (the Partnership) owns a portfolio of 22 used commercial jet aircraft, one spare engine and certain inventoried aircraft parts out of its original portfolio of 30 aircraft. The portfolio consists of 17 McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft leased to Trans World Airlines, Inc. (TWA); one Boeing 737-200 aircraft, previously leased to Viscount Air Services, Inc. (Viscount) which has filed for Chapter 11 bankruptcy protection in January 1996, as discussed below, is currently in the possession of Tucson Aerospace, a maintenance facility located in Arizona; two Boeing 727-200 Advanced aircraft leased to Continental Micronesia, Inc. (Continental Micronesia); and one Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental). The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan American World Airways, Inc., to aircraft inventory in 1992. These aircraft have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft, formerly leased to Delta Airlines, Inc., in February 1995. The Partnership sold the airframe and one engine from the Boeing 737-200 Combi aircraft, formerly leased to Northwest Territorial Airways, Ltd., in March 1996. The Partnership is currently remarketing the remaining engine for sale. Partnership Operations The Partnership recorded net income of $1,037,876, or $1.23 per limited partnership unit, for the three months ended June 30, 1996, compared to net income of $1,789,179, or $3.29 per unit, for the same period in 1995. The Partnership recorded net income of $1,591,729, or $1.50 per limited partnership unit, for the six months ended June 30, 1996, compared to net income of $856,930, or $1.19 per unit, for the same period in 1995. Operating results for the six months ended June 30, 1995 were negatively impacted by a decrease in rental revenue recognized during the first three months of 1995 on the Partnership's leases with TWA. In December 1994, GE Capital Aviation Services, Inc. (GECAS) negotiated a standstill agreement with TWA. That agreement provided for a deferral of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995. The Partnership did not recognize the deferred rent as rental revenue until it was received, including $2,025,000 deferred in the first three months of 1995. TWA repaid the deferred rent in full from May 1995 through October 1995. In consideration for the rent deferral, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its pro-rata share of such payment by TWA. This amount was recognized as other revenue in the first quarter of 1995. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and exercised the warrants on December 29, 1995. The Partnership sold the TWA Common Stock by February 1996, net of broker commissions, for $2,406,479 and recognized a gain on trading securities of $49,974 during the first quarter of 1996. As discussed in Note 8 to the financial statements, in May 1996, the Partnership received from Pan American World Airways, Inc. (Pan Am) a payment of $567,500 as full satisfaction of the Partnership's administrative expense priority claim. The Partnership has recorded this payment as other revenue in claims related to lessee defaults in the statement of income for the three and six months ended June 30, 1996. 14 As discussed in Note 5 to the financial statements, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in January 1996 and subsequently rejected the Partnership's aircraft lease. Viscount has made no lease or loan payments to the Partnership during the first six months of 1996. The Partnership has recorded an allowance for credit losses aggregating $100,409 during the first quarter of 1996 for unpaid rents and accrued interest recognized during the first quarter of 1996. The Partnership has not recognized rental revenue on the rejected Viscount lease subsequent to May 31, 1996. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership has incurred legal costs of approximately $92,000, which are reflected in operating expense in the Partnership's statement of income for the six months ended June 30, 1996. The lease of one airframe and one engine from the Boeing 737-200 Combi aircraft to NWT expired in October 1995. The Partnership did not recognize rental revenue on this aircraft subsequent to that time. The airframe and engine were sold in March 1996 as discussed in Note 7 to the financial statements. Liquidity and Cash Distributions Liquidity - The Partnership received all lease payments due from Continental, Continental Micronesia and TWA and has received all note payments due from Continental, ALG, Inc. (ALG), American International Airways, Inc. (AIA), and WestJet Airlines, Ltd. (WestJet). As discussed above, in January 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code. As of June 30, 1996, Viscount's defaults with the Partnership aggregated approximately $575,000. Viscount's failure to perform on its financial obligations with the Partnership has an adverse effect on the Partnership's financial position. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership may incur maintenance, remarketing, transition and additional legal costs related to the Partnership's aircraft. A further discussion of the Viscount situation is included in the Legal Proceedings section (Part II, Item 1). As discussed in Note 4 to the financial statements, the Partnership agreed to share in the cost of meeting certain Airworthiness Directives (ADs) with TWA. In accordance with the cost-sharing agreement, TWA may offset up to an additional $2.7 million against rental payments, subject to annual limitations, over the remaining lease terms. As specified in the Partnership's leases with Continental Micronesia and Continental, in January 1994, the Partnership reimbursed Continental (partially on behalf of its affiliate Continental Micronesia) an aggregate of $1.8 million for cockpit modifications and $742,325 for C-check labor and parts for the three aircraft. In addition, in January 1994, the Partnership financed an aggregate of $2,177,533 for new image modifications, which is being repaid by Continental with interest over the terms of the aircraft leases. The leases with Continental and Continental Micronesia also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time. The Partnership has received maintenance reserve payments from certain of its lessees that may be reimbursed to the lessee or applied against certain costs incurred by the Partnership for maintenance work performed on the Partnership's aircraft, as specified in the leases. Maintenance reserve balances, if any, remaining at the termination of the lease may be used by the Partnership to offset future maintenance expenses or recognized as revenue. The net maintenance reserves balances aggregate $198,458 as of June 30, 1996. 15 Payments of $125,193 have been received during the first two quarters of 1996 from the sale of inventoried parts from the six disassembled aircraft and have been applied against aircraft inventory. The net book value of the Partnership's aircraft inventory was $248,290 as of June 30, 1996. The Partnership is retaining cash reserves to meet obligations under the TWA, Continental and Continental Micronesia lease agreements and to cover the costs that the Partnership may incur relating to the Viscount default and bankruptcy filing, including additional legal costs, potential aircraft maintenance, remarketing and transition costs. Cash Distributions - Cash distributions to limited partners during the three months ended June 30, 1996 and 1995 were $4,124,975, or $8.25 per limited partnership unit and $1,249,992 or $2.50 per unit, respectively. Cash distributions to limited partners during the six months ended June 30, 1996 and 1995 were $8,249,951, or $16.50 per limited partnership unit and $2,499,985 or $5.00 per unit, respectively. The timing and amount of future cash distributions are not yet known and will depend on the Partnership's future cash requirements including the costs that will be incurred relating to the Viscount default and bankruptcy; the receipt of rental payments from TWA, Continental and Continental Micronesia; the receipt of modification financing payments from Continental; and the receipt of sales proceeds from AIA and WestJet, renegotiated promissory note payments from ALG, payments generated from the aircraft disassembly process, and delinquent lease and loan payments from Viscount. TWA Leases GECAS, on behalf of the Partnership, is negotiating with TWA regarding the acquisition of noise-suppression devices, commonly known as "hushkits", for 14 of the 18 Partnership aircraft currently on lease to TWA, as well as 14 other aircraft owned by affiliates of the General Partner and leased to TWA. The hushkits would recondition the aircraft so as to meet Stage 3 noise level restrictions, which are discussed in the Partnership's 1995 Annual Report to the Securities and Exchange Commission on Form 10-K. The anticipated cost of the hushkit reconditioning is approximately $1.6 million per aircraft, approximately $300,000 of which will be paid out of the Partnership's cash reserves and the balance of which will be financed by the engine/hushkit manufacturer over a 6-year period at an interest rate of approximately 10% per year. It is anticipated that the leases for these 14 aircraft would be extended for a period of eight years from the date of installation or purchase of the hushkits, and the rent payable by TWA under the leases would be increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay the amount borrowed during the term of the leases. The loan from the engine/hushkit manufacturer would be non-recourse to the Partnership and secured by a security interest in the leases. 16 Part II. Other Information -------------------------- Item 1. Legal Proceedings As discussed in Item 3 of Part I of Polaris Aircraft Income Fund II's (the Partnership) 1995 Annual Report to the Securities and Exchange Commission (SEC) on Form 10-K (Form 10-K) and in Item 1 of Part II of the Partnership's Quarterly Report to the SEC on Form 10-Q (Form 10-Q) for the period ended March 31, 1996, there are a number of pending legal actions or proceedings involving the Partnership. Except as described below, there have been no material developments with respect to any such actions or proceedings during the period covered by this report. Pan American Airways, Inc. (Pan Am) - On or about May 16, 1996, the Partnership received a payment of $567,500, representing full satisfaction of the Partnership's $2.5 million administrative priority claim. Trans World Airlines, Inc. (TWA) - On May 2, 1996, the United States Bankruptcy Court for the Northern District of California issued a notice of final decree declaring that the estate of TWA had been fully administered and that TWA's proceedings under Chapter 11 of the United States Bankruptcy Code was closed. Viscount Air Services, Inc. (Viscount) Bankruptcy - On April 15, 1996, GE Capital Aviation Services, Inc. (GECAS), as agent for the Partnership, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), the owner/trustee under the Partnership's leases with Viscount, certain guarantors of Viscount's indebtedness and others executed that certain Compromise of Claims and Stipulation under Section 1110 of the Bankruptcy Code (the Compromise and Stipulation), the key terms of which as they affect the Partnership were disclosed in the Partnership's Form 10-Q for the period ended March 31, 1996. On May 14, 1996, the Bankruptcy Court entered its Order Granting Debtor's Motion: (1) To Approve and Authorize Compromise and Settlement; (2) To Approve Section 1110 Stipulation; (3) To Authorize Post-Petition Financing; and (4) To Approve Rejection of an Aircraft Lease (Compromise Order), approving the Compromise and Stipulation. The Compromise Order authorized Viscount to reject its lease with the Partnership of the aircraft bearing registration no. N306VA (306 Aircraft). The 306 Aircraft was located at a repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace. On May 22, 1996, FSB, as owner/trustee, filed suit in the Superior Court of Arizona in Pima County, Case No. C313027, to recover the airframe from BAE Aviation, Inc. and certain creditors alleging mechanics liens and to determine the validity of the claimed liens. Pursuant to a stipulated order of the Superior Court entered on July 9, 1996, FSB filed a bond in the penal sum of $1,371,000 for the benefit of defendants, and the defendants released the aircraft on July 11, 1996. The aircraft was moved to a repair facility at Hamilton Aviation in Tucson, Arizona for completion of a "C" check. The litigation will continue in Superior Court over the validity and amount of the defendants' various liens alleged against the bond. Notwithstanding Viscount's rejection of the 306 Aircraft lease, Viscount continues to possess and use the Partnership's engine and has refused to return various aircraft parts removed from the 306 Aircraft. On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to recover the engines and parts leased in connection with the 306 Aircraft. GECAS and FSB assert that these engines and parts should have been delivered to FSB pursuant to the Compromise Order. Viscount alleges that it cannot return the engines and parts without impairing its operations and has no legal obligation to do so. A hearing has been scheduled for August 29, 1996 to consider the motion of GECAS and FSB to recover the engine and certain aircraft parts. Pending the hearing, Viscount 17 has agreed to pay the Partnership $10,000 for the use of the engine during the month of August, and will continue to pay maintenance reserves pursuant to the lease terms. Discussions are proceeding with Viscount in an effort to resolve these issues prior to the scheduled hearing. On July 1, 1996, Viscount filed its bankruptcy disclosure statement and proposed plan of reorganization, which sets forth Viscount's proposed treatment for restructuring and satisfying the claims of all of its creditors. The plan of reorganization contemplates a capital investment of between $2.5 million and $9 million from an outside source. A hearing date of August 29, 1996 has been set to consider the sufficiency of disclosure contained in the disclosure statement; however, counsel for Viscount has indicated that Viscount likely will amend the disclosure statement and plan prior to any such hearing. The Partnership is presently evaluating the disclosure statement and plan. Other Proceedings - Item 10 in Part III of the Partnership's 1995 Form 10-K and Item 1 in Part II of the Partnership's Form 10-Q for the period ended March 31, 1996 discuss certain actions which have been filed against Polaris Investment Management Corporation and others in connection with the sale of interests in the Partnership and the management of the Partnership. With the exception of Novak, et al v. Polaris Holding Company, et al, (which has been dismissed, as discussed in Item 10 of the Partnership's 1995 Form 10-K) where the Partnership was named as a defendant for procedural purposes, the Partnership is not a party to these actions. Except as discussed below, there have been no material developments with respect to any of the actions described therein during the period covered by this report. Bishop v. Kidder Peabody & Co., Incorporated et al. - On June 18, 1996, defendants filed a motion to transfer venue from Sacramento to San Francisco County. The Court subsequently denied the motion. Weisl et al. v. Polaris Holding Company et al. - On April 25, 1996, the Appellate Division for the First Department affirmed the trial court's order which had dismissed most of plaintiffs' claims. In re Prudential Securities Inc. Limited Partnerships Litigation - On June 5, 1996, the Court certified a class with respect to claims against Polaris Holding Company, one of its former officers, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, and Polaris Securities Corporation. The class is comprised of all investors who purchased securities in any of Polaris Aircraft Income Funds I through VI during the period from January 1985 until January 29, 1991, regardless of which brokerage firm the investor purchased from. Excepted from the class are those investors who settled in the SEC/Prudential settlement or otherwise opted for arbitration pursuant to the settlement and any investor who has previously released the Polaris defendants through any other settlement. On June 10, 1996, the Court issued an opinion denying summary judgment to Polaris on plaintiffs' Section 1964(c) and (d) RICO claims and state causes of action, and granting summary judgment to Polaris on plaintiffs' 1964(a) RICO claims and the New Jersey State RICO claims. On August 5, 1996, the Court signed an order providing for notice to be given to the class members. The case has been set for trial on November 11, 1996. 18 Item 6. Exhibits and Reports on Form 8-K a) Exhibits (numbered in accordance with Item 601 of Regulation S-K) 27. Financial Data Schedule (Filed electronically only) b) Reports on Form 8-K No reports on Form 8-K were filed by the Registrant during the quarter for which this report is filed. 19 SIGNATURE Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership (Registrant) By: Polaris Investment Management Corporation, General Partner August 8, 1996 By: /S/Marc A. Meiches - ------------------------------ -------------------------------- Mark A. Meiches Chief Financial Officer (principal financial officer and principal accounting officer of Polaris Investment Management Corporation, General Partner of the Registrant) 20 EX-27 2
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