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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (Fee Required)
For the fiscal year ended December 31, 1995
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from to
Commission File No. 33-2794
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
--------------------------------
(Exact name of registrant as specified in its charter)
California 94-2985086
---------- ----------
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
201 Mission Street, 27th Floor, San Francisco, California 94105
- ----------------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (415) 284-7400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Units of Limited Partnership Interest
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 ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
No formal market exists for the units of limited partnership interest and
therefore there exists no aggregate market value at December 31, 1995.
Documents incorporated by reference: None
This document consists of 54 pages.
PART I
Item 1. Business
The principal objectives of Polaris Aircraft Income Fund II, A California
Limited Partnership (PAIF-II or the Partnership), are to purchase and lease used
commercial jet aircraft in order to provide quarterly distributions of cash from
operations, to maximize the residual values of aircraft upon sale and to protect
Partnership capital through experienced management and diversification. PAIF-II
was organized as a California limited partnership on June 27, 1984 and will
terminate no later than December 2010.
PAIF-II has many competitors in the aircraft leasing market, including airlines,
aircraft leasing companies, other limited partnerships, banks and several other
types of financial institutions. This market is highly competitive and there is
no single competitor who has a significant influence on the industry. In
addition to other competitors, the general partner, Polaris Investment
Management Corporation (PIMC), and its affiliates, including GE Capital Aviation
Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris
Holding Company (PHC) and General Electric Capital Corporation (GE Capital),
acquire, lease, finance, sell and remarket aircraft for their own accounts and
for existing aircraft and aircraft leasing programs managed by them. Further,
GECAS provides a significant range of management services to GPA Group plc, a
public limited company organized in Ireland, together with its consolidated
subsidiaries (GPA), which acquires, leases and sells aircraft. Accordingly, in
seeking to re-lease and sell its aircraft, the Partnership may be in competition
with the general partner, its affiliates, and GPA.
A brief description of the aircraft owned by the Partnership is set forth in
Item 2. The following table describes certain material terms of the
Partnership's leases to Trans World Airlines, Inc. (TWA), Viscount Air Services,
Inc. (Viscount), Continental Micronesia, Inc. (Continental Micronesia) and
Continental Airlines, Inc. (Continental) as of December 31, 1995. As discussed
in Items 7 and 8, Viscount defaulted on certain payments due to the Partnership.
Viscount was then notified on January 9, 1996 that the Partnership had elected
to terminate the lease (which is disputed by Viscount). Viscount subsequently
filed a petition for protection under Chapter 11 of the United States Bankruptcy
Code (Items 3, 7 and 8) and the Partnership's aircraft is currently in the
possession of Tucson Aerospace, a maintenance facility located in Arizona, as
discussed below. Viscount's ultimate compliance or non-compliance with end of
lease maintenance return conditions may require the Partnership to evaluate
whether a sale or a re-lease of the Partnership's aircraft would be most
beneficial for the Partnership's unit holders. As a result of Viscount's
defaults and Chapter 11 bankruptcy filing, the Partnership may incur
maintenance, remarketing, transition and legal costs related to the
Partnership's aircraft.
Scheduled
Number of Lease
Lessee Aircraft Type Aircraft Expiration Renewal Options
- ------ ------------- -------- ---------- ---------------
TWA McDonnell Douglas DC-9-30 16 2/98 (1) none
McDonnell Douglas DC-9-40 1 11/98 (1) none
McDonnell Douglas DC-9-30 1 11/98 (1) none
Viscount Boeing 737-200 1 11/97 (2) none
Continental Boeing 727-200 Advanced 1 4/98 (3) none
Continental
Micronesia Boeing 727-200 Advanced 2 4/98 (4) none
2
(1) TWA may specify a lease expiration date for each aircraft up to six
months before the date shown, provided the average date for the 16
aircraft is February 1998, and the average expiration date for the
remaining two aircraft is November 1998. The TWA leases were modified
in 1991. The leases for the 16 aircraft were extended for an
aggregate of 75 months beyond the initial lease expiration date in
November 1991 at approximately 46% of the original lease rates. The
leases for the remaining two aircraft were extended for 72 months
beyond the initial lease expiration dates in November 1992 at
approximately 42% of the original lease rates. The Partnership also
agreed to share in the costs of certain Airworthiness Directives
(ADs). If such costs are incurred by TWA, they will be credited
against rental payments, subject to annual limitations with a maximum
of $500,000 per aircraft over the lease terms.
As discussed in Item 7, in October 1994, TWA notified its creditors,
including the Partnership, of a proposed restructuring of its debt.
Subsequently, GECAS negotiated a standstill agreement with TWA which
was approved on behalf of the Partnership by PIMC. That agreement
provided for a moratorium of the rent due the Partnership in November
1994 and 75% of the rents due the Partnership from December 1994
through March 1995. The deferred rents, which aggregated $3.6
million, plus interest were repaid in monthly installments beginning
in May 1995 through October 1995. The Partnership received as
consideration for the agreement $218,071 and warrants for TWA Common
Stock (Item 7).
(2) This aircraft was previously on lease to SABA Airlines, S.A. (SABA).
The lease rate to Viscount was approximately 56% of the prior lease
rate. Items 3, 7 and 8 contain additional discussions of the Viscount
default, lease termination notification and Viscount's subsequent
bankruptcy filing.
During 1995, Viscount delivered the aircraft to Tucson Aerospace, a
maintenance facility 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. The aircraft is currently in the possession of Tucson
Aerospace and it may assert a lien against the aircraft to secure
payment of its claim. 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, which claims it
provided inspectors, is claiming $185,000 from Tucson Aerospace. The
Partnership has been in discussions with the various parties to
resolve these disputes and is currently evaluating all of its
options, including alternative procedures to obtain repossession of
this aircraft.
(3) This aircraft, previously on lease to Alaska Airlines, Inc. (Alaska),
was leased to Continental in April 1993. The lease rate is
approximately 55% of the prior lease rate. The lease stipulates that
Continental may assign the lease to its affiliate Continental
Micronesia under certain conditions. The lease also stipulates that
the Partnership will reimburse costs for cockpit modifications up to
$600,000, C-check labor costs up to $300,000 and the actual cost of
C-check parts for the aircraft. In addition, the Partnership will
provide financing up to $815,000 for new image modifications to be
repaid with interest over the lease term. In accordance with the cost
sharing agreement, in January 1994, the Partnership reimbursed
Continental $600,000 for cockpit modifications and $338,189 for
C-check labor and parts. In addition, the Partnership financed
3
$719,784 for new image modifications, which is being repaid with
interest over the lease term of the aircraft. The lease also
stipulates that the Partnership share in the cost of meeting certain
ADs, which cannot be estimated at this time.
(4) These two aircraft, previously on lease to Alaska, were leased to
Continental Micronesia in May and June 1993. The lease rates are
approximately 55% of the prior lease rates. The leases stipulate that
the Partnership will reimburse costs for cockpit modifications up to
$600,000 per aircraft, C-check labor costs up to $300,000 for one of
the aircraft and the actual cost of C-check parts for one of the
aircraft. In addition, the Partnership will provide financing up to
$815,000 for new image modifications to be repaid with interest over
the lease term for each aircraft. In accordance with the cost sharing
agreement, in January 1994, the Partnership reimbursed Continental
(on behalf of its affiliate Continental Micronesia) $1.2 million for
cockpit modifications and $404,136 for C-check labor and parts. In
addition, the Partnership financed $1,457,749 for new image
modifications, which is being repaid with interest over the lease
terms of the aircraft. The leases also stipulate that the Partnership
share in the cost of meeting certain ADs, which cannot be estimated
at this time.
The Partnership transferred six Boeing 727-200 aircraft, formerly leased to Pan
American World Airways, Inc. (Pan Am), to aircraft inventory in 1992. These
aircraft were disassembled for sale of their component parts as discussed in
Note 5 to the financial statements (Item 8). The Partnership sold one Boeing
727-200 aircraft equipped with a hushkit (described below), formerly leased to
Delta Airlines, Inc. (Delta), to American International Airways, Inc. (AIA) in
February 1995 as discussed in Item 7.
The lease of one Boeing 737-200 Combi aircraft to Northwest Territorial Airways,
Ltd. (NWT) expired in October 1995. As specified in the lease, NWT was required
to perform certain maintenance work on the aircraft prior to its return. NWT
returned the aircraft without performing the required maintenance work, which
constituted a default under the lease. The Partnership and NWT subsequently
reached an agreement by which NWT paid to the Partnership in December 1995
approximately $457,000 and the Partnership was entitled to retain NWT's security
deposit of approximately $101,000 in lieu of NWT's performing the required
maintenance work on the aircraft. The airframe and one engine from this aircraft
were subsequently sold to Westjet Airlines, Ltd. (Westjet) in March 1996 as
discussed in Items 7 and 8. The Partnership is currently remarketing the
remaining engine for sale.
Industry-wide, approximately 475 commercial aircraft are currently available for
sale or lease, approximately 125 less than a year ago. From 1991 through 1994,
depressed demand for air travel limited airline expansion plans, with new
aircraft orders and scheduled deliveries being canceled or substantially
deferred. As profitability declined, many airlines took action to downsize or
liquidate assets and some airlines were forced to file for bankruptcy
protection. Following two years of good traffic growth accompanied by rising
yields, this trend is improving with new aircraft orders last year exceeding
deliveries for the first time since 1990. To date, this recovery has mainly
benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which
are now being upgraded with noise suppression hardware, commonly known as
"hushkits," which, when installed on the aircraft, bring Stage 2 aircraft into
compliance with Federal Aviation Administration (FAA) Stage 3 noise restrictions
as discussed in the Industry Update section of Item 7. Older Stage 2
narrow-bodies have shown marginal signs of recovery. The Partnership has been
forced to adjust its estimates of the residual values realizable from its
aircraft and aircraft inventory, which resulted in an increase in depreciation
expense, as discussed in Items 7 and 8. A discussion of the current market
condition for the type of aircraft owned by the Partnership follows:
4
Boeing 727-200 Advanced - The Boeing 727 was the first tri-jet introduced into
commercial service. The Boeing 727 is a short- to medium-range jet used for
trips of up to 1,500 nautical miles. In 1972, Boeing introduced the Boeing
727-200 Advanced model, a higher gross weight version with increased fuel
capacity as compared with the non-advanced model. Hushkits which bring the
Boeing 727-200 Advanced into compliance with FAA Stage 3 noise restrictions, are
now available at an average cost of approximately $2.6 million per aircraft.
Hushkits may not be cost effective on all aircraft due to the age of some of the
aircraft and the time required to fully amortize the additional investment.
Certain ADs applicable to all models of the Boeing 727 have been issued to
prevent fatigue cracks and control corrosion as discussed in Item 7. The market
for this type of aircraft, as for all Stage 2 narrowbody aircraft, has improved
over the previous year.
Boeing 737-200 - The Boeing 737-200 aircraft was introduced in 1967 and 150 were
delivered from 1967 through 1971. This two-engine, two-pilot aircraft provides
operators with 107 to 130 seats, meeting their requirements for economical lift
in the 1,100 nautical mile range. Hushkits which bring Boeing 737-200 aircraft
into compliance with FAA Stage 3 noise restrictions, are now available at a cost
of approximately $1.5 million per aircraft. Hushkits may not be cost effective
on all aircraft due to the age of some of the aircraft and the time required to
fully amortize the additional investment. Certain ADs applicable to all models
of the Boeing 737 have been issued to prevent fatigue cracks and control
corrosion as discussed in Item 7. The market for this type of aircraft, as for
all Stage 2 narrowbody aircraft, has improved over the previous year.
McDonnell Douglas DC-9-30/40 - The McDonnell Douglas DC-9-30/40 is a short- to
medium-range twin-engine jet that was introduced in 1967. Providing reliable,
inexpensive lift, these aircraft fill thin niche markets, mostly in the United
States. Hushkits are available to bring these aircraft into compliance with
Stage 3 requirements at a cost of approximately $1.7 million per aircraft.
Hushkits may not be cost effective on all aircraft due to the age of some of the
aircraft and the time required to fully amortize the additional investment.
Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent
fatigue cracks and control corrosion as discussed in Item 7. The market for this
type of aircraft, as for all Stage 2 narrowbody aircraft, has improved over the
previous year.
The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control and structural inspection
and modification as discussed in the Industry Update section of Item 7.
Item 2. Properties
PAIF-II owns 17 McDonnell Douglas DC-9-30 and one McDonnell Douglas DC-9-40
aircraft leased to TWA, one Boeing 727-200 Advanced aircraft leased to
Continental, two Boeing 727-200 Advanced aircraft leased to Continental
Micronesia and one Boeing 737-200 aircraft currently in the possession of Tucson
Aerospace, a maintenance facility located in Arizona, as discussed in Items 1, 7
and 8. The Partnership's entire fleet consists of Stage 2 aircraft. All leases
are operating leases. The Partnership transferred six Boeing 727-200 aircraft,
previously leased to Pan Am, to aircraft inventory in 1992. These aircraft,
which are not included in the following table, have been disassembled for sale
of their component parts. The Partnership sold one Boeing 727-200 aircraft
equipped with a hushkit in February 1995. The Partnership sold the airframe and
5
one engine from the Boeing 737-200 Combi aircraft in March 1996. The Partnership
is currently remarketing the remaining engine for sale or lease.
The following table describes the Partnership's current aircraft portfolio in
greater detail:
Year of Cycles
Aircraft Type Serial Number Manufacture As of 11/30/95 (1)
- ------------- ------------- ----------- ------------------
Boeing 727-200 Advanced 21426 1977 31,219
Boeing 727-200 Advanced 21427 1977 29,839
Boeing 727-200 Advanced 21947 1979 26,478
Boeing 737-200 19609 1968 63,364
McDonnell Douglas DC-9-30 47082 1967 74,237
McDonnell Douglas DC-9-30 47096 1967 74,827
McDonnell Douglas DC-9-30 47135 1968 75,617
McDonnell Douglas DC-9-30 47137 1968 74,503
McDonnell Douglas DC-9-30 47249 1968 80,841
McDonnell Douglas DC-9-30 47251 1968 78,987
McDonnell Douglas DC-9-30 47343 1969 77,813
McDonnell Douglas DC-9-30 47345 1969 76,153
McDonnell Douglas DC-9-30 47411 1969 73,554
McDonnell Douglas DC-9-30 47412 1969 73,532
McDonnell Douglas DC-9-30 47027 1967 79,456
McDonnell Douglas DC-9-30 47107 1968 79,422
McDonnell Douglas DC-9-30 47108 1968 76,136
McDonnell Douglas DC-9-30 47174 1968 76,809
McDonnell Douglas DC-9-30 47324 1969 73,349
McDonnell Douglas DC-9-30 47357 1969 73,009
McDonnell Douglas DC-9-30 47734 1977 43,628
McDonnell Douglas DC-9-40 47617 1975 42,691
(1) Cycle information as of 12/31/95 is not yet available.
Item 3. Legal Proceedings
Braniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition
under Chapter 11 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the Middle District of Florida, Orlando Division. On
September 26, 1990 the Partnership filed a proof of claim to recover unpaid rent
and other damages, and on November 27, 1990, the Partnership filed a proof of
administrative claim to recover damages for detention of aircraft,
non-compliance with court orders and post-petition use of engines as well as
liquidated damages. On July 27, 1992, the Bankruptcy Court approved a
stipulation embodying a settlement among the Partnership, the Braniff creditor
committees and Braniff in which it was agreed that the Partnership would be
allowed an administrative claim in the bankruptcy proceeding of approximately
$230,769. The Partnership has received a check from the bankruptcy estate in
full payment of the allowed administrative claim, subject, however, to the
requirement of the stipulation that 25% of such proceeds be held in a separate,
interest-bearing account pending notification by Braniff that all the allowed
administrative claims have been satisfied. In the third quarter of 1994, the
Partnership was authorized to release one-half of the 25% portion of the
Partnership's administrative claim segregated pursuant to the stipulation
approved in 1992. At the end of 1994, the Partnership was advised that the
6
remaining one-half balance of the 25% segregated portion of the administrative
claim payment could be released. As the final disposition of the Partnership's
claim in the Bankruptcy proceedings, the Partnership was permitted by the
Bankruptcy Court to exchange a portion of its unsecured claim for Braniff's
right (commonly referred to as a "Stage 2 Base Level right") under the FAA noise
regulations to operate one Stage 2 aircraft and has been allowed a net remaining
unsecured claim of $769,231 in the proceedings. The unsecured claim will not be
recorded as revenue by the Partnership until it is received. It cannot be
estimated at this time when and if this claim will be paid.
Pan American World Airways, Inc. (Pan Am) - As discussed in the Partnership's
1990 and 1991 Forms 10-K, Pan Am commenced reorganization proceedings under
Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy
Court for the Southern District of New York on January 8, 1991. On November 8,
1991, the Partnership filed a proof a claim in Pan Am's bankruptcy proceeding to
recover damages for lost rent and for Pan Am's failure to meet return conditions
with respect to the Partnership's aircraft on lease to Pan Am. Pan Am's
reorganization under Chapter 11 was ultimately unsuccessful, and Pan Am ceased
operations in December 1991. On July 10, 1995, 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. This Stipulation and Order was
approved by the Bankruptcy Court, at a hearing held on August 17, 1995. The
claims will not be recorded as revenue by the Partnership until they are
received. It cannot be estimated at this time when and if these claims will be
paid.
Trans World Airlines, Inc. (TWA) - On June 30, 1995, TWA filed a reorganization
proceeding under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Eastern District of Missouri. Immediately before
the filing, the Partnership and TWA entered into an Amended Deferral Agreement,
pursuant to which TWA agreed to bring lease rents current over a period of
several months and to confirm all of its leases with the Partnership. As agreed,
TWA proposed a plan of reorganization in which, among other things, it confirmed
all of its leases with the Partnership, and the plan was confirmed by the
Bankruptcy Court on August 4, 1995. TWA has emerged from its bankruptcy
proceeding and has repaid all outstanding rent deferrals in accordance with its
commitment to the Partnership and in accordance with its plan of reorganization.
TWA has since remained current on all of its payment obligations to the
Partnership.
Viscount Air Services, Inc. (Viscount) Bankruptcy - 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 for the District of
Arizona. Polaris Holding Company, the Partnership, Polaris Aircraft Income Fund
II, Polaris Aircraft Income Fund IV, and Polaris Aircraft Investors XVIII
(collectively, Polaris Entities) lease a total of ten aircraft and two spare
engines to Viscount. The aggregate outstanding obligations of Viscount to the
Polaris Entities is approximately $11.0 million. GE Capital Aviation Services,
Inc. (GECAS), as agent for the Polaris Entities, terminated the aircraft and
engine leases pre-petition, but Viscount disputes the effectiveness of the
termination and currently has possession of the aircraft and engines, with the
exception of the Partnership's aircraft, which is currently in the possession of
Tucson Aerospace, a maintenance facility located in Arizona. GECAS and Viscount
are currently negotiating to determine if they can resolve their differences by
agreement. The outcome of this Chapter 11 proceeding cannot be predicted.
Kepford, et al. v. Prudential Securities, et al. - On April 13, 1994, an action
entitled Kepford, et al. v. Prudential Securities, Inc. was filed in the
District Court of Harris County, Texas. The complaint names Polaris Investment
Management Corporation, Polaris Securities Corporation, Polaris Holding Company,
Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income
7
Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV,
Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General
Electric Capital Corporation, Prudential Securities, Inc., Prudential Insurance
Company of America and James J. Darr, as defendants. Certain defendants were
served with a summons and original petition on or about May 2, 1994. Plaintiffs'
original petition alleges that defendants violated the Texas Securities Act, the
Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act of
1933 and committed common law fraud, fraud in the inducement, negligent
misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by
misrepresenting and failing to disclose material facts in connection with the
sale of limited partnership units in the Partnership and the other Polaris
Aircraft Income Funds. Plaintiffs seek, among other things, an award of
compensatory damages in an unspecified amount plus interest thereon, and double
and treble damages under the Texas Deceptive Trade Practices Act.
Certain defendants, including Polaris Investment Management Corporation and the
Partnership, filed a general denial on June 29, 1994 and a motion for summary
judgment on June 17, 1994 on the basis that the statute of limitations has
expired. On June 29, 1994 and July 14, 1994, respectively, plaintiffs filed
their first amended original petition and second amended original petition, both
of which added plaintiffs. On July 18, 1994, plaintiffs filed their response and
opposition to defendants' motion for partial summary judgment and also moved for
a continuance on the motion for partial summary judgment. On August 11, 1994,
after plaintiffs again amended their petition to add numerous plaintiffs, the
defendants withdrew their summary judgment motion and motion to stay discovery,
without prejudice to refiling these motions at a later date.
Riskind, et al. v. Prudential Securities, Inc., et al. - An action entitled
Riskind, et al. v. Prudential Securities, Inc., et al. has been filed in the
District Court of the 165 Judicial District, Maverick County, Texas. This action
is on behalf of over 3,000 individual investors who purchased units in "various
Polaris Aircraft Income Funds," including the Partnership. The Partnership and
Polaris Investment Management Corporation received service of plaintiffs' second
amended original petition and, on June 13, 1994, filed an original answer
containing a general denial.
The second amended original petition names the Partnership, Polaris Investment
Management Corporation, Prudential Securities, Inc. and others as defendants and
alleges that these defendants violated the Texas Securities Act and the Texas
Deceptive Trade Practices Act and committed common law fraud, fraud in the
inducement, negligent misrepresentation, negligent breach of fiduciary duty and
civil conspiracy by misrepresenting and failing to disclose material facts in
connection with the sale of limited partnership units in the Partnership and the
other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an
award of compensatory damages in an unspecified amount plus interest thereon,
and double and treble damages under the Texas Deceptive Trade Practices Act.
Kidder, Peabody & Co. was added as an additional defendant by virtue of an
Intervenor's Amended Plea in Intervention filed on or about April 7, 1995.
Prudential Securities, Inc. reached a settlement with the plaintiffs. The trial
of the claims of one plaintiff, Robert W. Wilson, against Polaris Aircraft
Income Funds I-VI, Polaris Investment Management Corporation and various
affiliates of Polaris Investment Management Corporation, including General
Electric Capital Corporation, was commenced on July 10, 1995. On July 26, 1995,
the jury returned a verdict in favor of the defendants on all counts. Subsequent
to this verdict, all of the defendants (with the exception of Prudential
Securities, Inc., which had previously settled) entered into a settlement with
the plaintiffs. None of the Polaris Aircraft Income Funds were required to
contribute to this settlement.
Howland, et al. v. Polaris Holding Company, et al. - On or about February 4,
1994, a purported class action entitled Howland, et al. v. Polaris Holding
8
Company, et al. was filed in the United States District Court for the District
of Arizona on behalf of investors in Polaris Aircraft Income Funds I-VI. The
complaint names each of Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing
Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft
Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund
V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation,
Prudential Securities, Inc., Prudential Securities Group, Inc., Prudential
Insurance Company of America, George W. Ball, Robert J. Sherman, James J. Darr,
Paul J. Proscia, Frank W. Giordano, William A. Pittman, Joseph H. Quinn, Joe W.
Defur, James M. Kelso and Brian J. Martin, as defendants. The complaint alleges
that defendants violated federal RICO statutes, committed negligent
misrepresentations, and breached their fiduciary duties by misrepresenting and
failing to disclose material facts in connection with the sale of limited
partnership units in the Partnership and the other Polaris Aircraft Income
Funds. Plaintiffs seek, among other things, an accounting of all monies invested
by plaintiffs and the class and the uses made thereof by defendants, an award of
compensatory, punitive and treble damages in unspecified amounts plus interest
thereon, rescission, attorneys' fees and costs. On August 3, 1994, the action
was transferred to the Multi-District Litigation in the Southern District of New
York entitled In re Prudential Securities Limited Partnerships Litigation,
discussed in Part III, Item 10 below.
Mary C. Scott v. Prudential Securities Inc. et al. - On or around August 15,
1995, a complaint entitled Mary C. Scott v. Prudential Securities Inc. et al.
was filed in the Court of Common Pleas, County of Summit, Ohio. The complaint
names as defendants Prudential Securities Inc., the Partnership, Polaris
Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft
Income Fund VI, P-Bache/A.G. Spanos Genesis Income Partners LP 1,
Prudential-Bache Properties, Inc., A.G. Spanos Residential Partners - 86,
Polaris Securities Corporation and Robert Bryan Fitzpatrick. Plaintiff alleges
claims of fraud and violation of Ohio securities law arising out of the public
offerings of the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft
Income Fund IV, Polaris Aircraft Income Fund VI, and P-Bache/A.G. Spanos Genesis
Income Partners LP 1. Plaintiff seeks compensatory damages, general,
consequential and incidental damages, punitive damages, rescission, costs,
attorneys' fees and other and further relief as the Court deems just and proper.
On September 15, 1995, defendants removed this action to the United States
District Court, Eastern District of Ohio. On September 18, 1995, defendants
sought the transfer of this action to the Multi-District Litigation and sought a
stay of all proceedings by the district court, which stay was granted on
September 25, 1995. The Judicial Panel transferred this action to the
Multi-District Litigation on or about February 7, 1996.
Other Proceedings - Part III, Item 10 discusses certain other actions which have
been filed against the general partner in connection with certain public
offerings, including that of the Partnership. With the exception of Novak, et al
v. Polaris Holding Company, et al, where the Partnership is named as a
defendant, the Partnership is not a party to these actions. In Novak, a
derivative action, the Partnership is named as a defendant for procedural
purposes but the plaintiffs in such lawsuit do not seek an award from the
Partnership.
Item 4. Submission of Matters to a Vote of Security Holders
None.
9
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
a) Polaris Aircraft Income Fund II's (PAIF-II or the Partnership)
limited partnership interests (Units) are not publicly traded.
Currently there is no market for PAIF-II's Units and it is unlikely
that any market will develop.
b) Number of Security Holders:
Number of Record Holders
Title of Class as of December 31, 1995
----------------------------- ------------------------
Limited Partnership Interest: 16,426
General Partnership Interest: 1
c) Dividends:
The Partnership distributed cash to partners on a quarterly basis
beginning July 1986. Cash distributions to limited partners during
1995 and 1994 totaled $6,874,959 and $12,499,925, respectively. Cash
distributions per limited partnership unit were $13.75 and $25.00 in
1995 and 1994, respectively.
10
Item 6. Selected Financial Data
For the years ended December 31,
--------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Revenues $ 21,093,341 $ 14,443,902 $ 15,558,866 $ 17,990,196 $ 29,673,077
Net Income (Loss) 5,717,065 (3,217,172) 48,114 (1,709,007) (1,596,956)
Net Income (Loss)
Allocated to Limited
Partners 4,972,468 (4,434,868) (952,261) (2,941,785) (3,330,801)
Net Income (Loss) per
Limited Partnership Unit 9.94 (8.87) (1.91) (5.88) (6.66)
Cash Distributions per
Limited Partnership
Unit 13.75 25.00 20.00 25.00 35.00
Amount of Cash
Distributions Included
Above Representing
a Return of Capital on
a Generally Accepted
Accounting Principle
Basis per Limited
Partnership Unit* 13.75 25.00 20.00 25.00 35.00
Total Assets 107,820,317 110,568,377 129,706,547 141,436,928 155,052,097
Partners' Capital 106,368,523 108,290,301 125,396,279 136,459,209 152,057,022
* The portion of such distributions which represents a return of capital on an
economic basis will depend in part on the residual sale value of the
Partnership's aircraft and thus will not be ultimately determinable until the
Partnership disposes of its aircraft. However, such portion may be significant
and may equal, exceed or be smaller than the amount shown in the above table.
11
Item 7. 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 and in
Items 3 and 8, 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. (Delta), in
February 1995 as discussed below. The Partnership sold the airframe and one
engine from the Boeing 737-200 Combi aircraft, formerly leased to Northwest
Territorial Airways, Ltd. (NWT), in March 1996 as discussed below. The
Partnership is currently remarketing the remaining engine for sale.
Remarketing Update
Sale of Boeing 727-200 Aircraft - The Partnership sold one Boeing 727-200
aircraft equipped with a hushkit, formerly leased to Delta, to AIA in February
1995 for a sales price of approximately $1.77 million. 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.
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 NWT, to Westjet Airlines, Ltd. (Westjet). The
Partnership is currently remarketing the remaining engine for sale or lease. 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
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.
Partnership Operations
The Partnership recorded net income of $5,717,065, or $9.94 per limited
partnership unit for the year ended December 31, 1995, compared a net loss of
$3,217,172, or $8.87 per limited partnership unit and net income of $48,114, or
an allocated net loss of $1.91 per limited partnership unit, for the years ended
December 31, 1994 and 1993, respectively. The net loss in 1994 resulted
primarily from a decrease in rental revenue recognized from the Partnership's
leases with TWA combined with maintenance expenses incurred from the TWA leases.
Further impacting the decline in operating results in 1994 as compared to 1993,
depreciation expense was substantially increased in 1994 for declines in the
estimated realizable values of the Partnership's aircraft and aircraft
inventory, as discussed later in the Industry Update section. The significant
improvement in operating results in 1995 was primarily the result of
substantially increased revenues combined with lower operating expenses in 1995
as compared to 1994.
12
Rental revenues, net of related management fees, declined during 1994 as
compared to 1993 primarily as a result of a decrease in rental revenue
recognized in 1994 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 rental amount deferred
in 1994 of $1,575,000 as rental revenue until it was received in 1995. The
Partnership has received from TWA all scheduled rent payments beginning in April
1995 and all scheduled deferred rental payments beginning in May 1995 through
October 1995, including interest at a rate of 12% per annum. The increase in
rental revenues in 1995, as compared to 1994, was partially offset by a
provision for credit losses of $241,964 recorded in 1995 for certain rent,
deferred rent and accrued interest receivables from Viscount as discussed below.
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 share of such payment by TWA. This amount was
recognized as other revenue in 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 has
recognized the net warrant value as of the date of receipt of $1,772,206 as
revenue in 1995. The Partnership exercised the warrants on December 29, 1995 for
the strike price of $0.01 per share and has recognized a gain on the value of
the warrants of $582,028 in 1995. In addition, the Partnership recognized as
other revenue in 1995 payments received from NWT aggregating approximately
$647,000 in lieu of NWT performing required maintenance work on the aircraft it
was leasing prior to its return to the Partnership. The Partnership also
recognized as other revenue in 1995 maintenance reserves aggregating
approximately $91,000 that were previously paid to the Partnership by Delta for
the aircraft that was sold to AIA in February 1995.
Operating expenses significantly decreased in 1995 as compared to 1994 and 1993.
As part of the TWA lease extension in 1991 as discussed in Note 6 to the
financial statements (Item 8), the Partnership agreed to share the cost of
meeting certain Airworthiness Directives (ADs) after TWA successfully
reorganized in 1993. The agreement stipulated that such costs incurred by TWA
may be credited against monthly rentals, subject to annual limitations and a
maximum of $500,000 per aircraft through the end of the leases. In accordance
with the cost sharing agreement, the Partnership recognized as operating expense
$3.6 million and $2.7 million of these AD expenses during 1994 and 1993,
respectively. No operating expenses relating to the TWA aircraft were recognized
by the Partnership during 1995.
As discussed later in the Industry Update section, if the projected net cash
flow for each aircraft (projected rental revenue, net of management fees, less
projected maintenance costs, if any, plus the adjusted estimated residual value)
is less than the carrying value of the aircraft, the Partnership recognizes the
deficiency currently as increased depreciation expense. The Partnership
recognized approximately $2.4 million and approximately $1.6 million of this
deficiency as increased depreciation expense in 1995 and 1994, respectively. The
1995 downward adjustment was the result of the reduction of the net book value
to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold
to Westjet in 1996 as previously discussed. Approximately $1.03 million of the
1994 adjustment was the result of the reduction of the net book value to the
estimated net realizable value of the Boeing 727-200 aircraft sold to AIA in
February 1995 as previously discussed.
The increased depreciation expense reduces the aircraft's carrying value and
reduces the amount of future depreciation expense that the Partnership will
13
recognize over the projected remaining economic life of the aircraft. The
Partnership also made downward adjustments to the estimated residual value of
certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. For any
downward adjustment to the estimated residual values, future depreciation
expense over the projected remaining economic life of the aircraft is increased.
The Partnership's earnings are impacted by the net effect of the adjustments to
the aircraft carrying values recorded in 1995 and 1994 and the downward
adjustments to the estimated residual values recorded in 1995, 1994 and 1993 as
discussed later in the Industry Update section.
Liquidity and Cash Distributions
Liquidity - The Partnership received all lease payments due from NWT,
Continental, Continental Micronesia and TWA. As discussed above, TWA repaid its
deferred rents in full with interest by October 1995. The Partnership also
received from TWA warrants to purchase 227,133 shares of TWA Common Stock and a
payment of $218,171 in consideration for the rent deferral. The Partnership
exercised the warrants in 1995 and sold the TWA Common Stock in the first
quarter of 1996, net of broker commissions, for $2,406,479.
As discussed below, prior to January 1, 1996, the Partnership had been in
discussions with Viscount to restructure certain of Viscount's existing
financial obligations to the Partnership. While such discussions were underway,
Viscount had undertaken to pay in full, by the end of each month, beginning in
June 1995, the current month's obligations by making partial periodic payments
during that month. Viscount is presently in default on its financial obligations
to the Partnership, and as discussed below, the aircraft Viscount was leasing is
currently in the possession of a maintenance facility located in Arizona. 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. Legal counsel has been retained and the general partner is
evaluating the rights, remedies and courses of action available to the
Partnership with respect to Viscount's default and bankruptcy filing. All
payments due from Viscount may be affected by Viscount's filing for protection
under Chapter 11.
As of December 31, 1995, the Partnership's rent, maintenance reserve, loan and
interest receivables from Viscount aggregated approximately $336,000. Viscount's
failure to perform on its financial obligations with the Partnership is expected
to have 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 legal costs related to the
Partnership's aircraft.
As discussed above, the Partnership agreed to share in the cost of meeting
certain 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 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.
14
ALG, Inc. (ALG) was required to pay the Partnership a balloon payment of
$897,932 in January 1995 on their promissory note. 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 specified 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. The
Partnership received all scheduled renegotiated payments due from ALG through
December 31, 1995. ALG did not pay the balloon payment due 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 one 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 Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA
in February 1995 as previously discussed. The agreement with AIA specifies
payment of the sales price in 36 monthly installments of $55,000 beginning in
March 1995. The Partnership has received all scheduled payments due from AIA.
In March 1996, the Partnership sold the airframe and one engine from its Boeing
737-200 Combi aircraft to Westjet as previously discussed. The Partnership
received a security deposit of approximately $88,000 from Westjet in December
1995 which was applied to the sales price of approximately $896,000. 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. The Partnership has received all scheduled payments from Westjet.
The Partnership receives 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 $179,185 as of December 31, 1995.
Payments of $275,130 have been received during 1995 from the sale of inventoried
parts from the six disassembled aircraft. The Partnership is retaining cash
reserves to meet obligations under the TWA, Continental and Continental
Micronesia lease agreements and to cover the potential costs that the
Partnership may incur relating to the Viscount default and bankruptcy filing,
including potential aircraft maintenance, remarketing and transition costs.
Cash Distributions - Cash distributions to limited partners were $6,874,959,
$12,499,925 and $9,999,940 in 1995, 1994 and 1993, respectively. Cash
distributions per limited partnership unit were $13.75, $25.00 and $20.00 per
limited partnership unit in 1995, 1994 and 1993, 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 potential costs that may 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 Continental Micronesia; the
receipt of sales proceeds from AIA and Westjet; the receipt of renegotiated
promissory note payments from ALG; the receipt of payments generated from the
aircraft disassembly process; and the receipt of current and delinquent rental
and loan payments from Viscount.
15
TWA Restructuring
In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, 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 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 recorded
a note receivable and corresponding allowance for credit losses equal to the
total of the 1994 deferred rents of $1.575 million, the net of which was
reflected in the Partnership's 1994 balance sheet (Item 8). 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 note receivable and
corresponding allowance for credit losses were reduced by the principal portion
of the payments received. The Partnership received all scheduled rent payments
beginning in April 1995 and all scheduled deferred rental payments beginning in
May 1995, including interest at a rate of 12% per annum, from TWA and has
recognized the $3.6 million deferred rents as rental revenue during 1995. 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 share of such payment by
TWA. This amount was recognized as other revenue in the Partnership's 1995
statement of operations (Item 8). 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.
TWA agreed that, upon filing of its prepackaged plan, it would take all
reasonable steps to implement the terms of the Amended Deferral Agreement and
would immediately assume all of the Partnership's leases. TWA also agreed that,
not withstanding the 60-day cure period provided by section 1110 of the United
States Bankruptcy Code, it would remain current on the performance of its
obligations under the leases, as amended by the Amended Deferral Agreement.
16
On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United
States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995,
the Bankruptcy Court confirmed TWA's plan of reorganization, which became
effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the
confirmation date of the plan, August 4, 1995, the Partnership received a
payment of $1,217,989 from TWA which represented fifty percent (50%) of the
deferred rent outstanding plus interest as of such date. The remaining balance
of deferred rent plus interest was paid in full to the Partnership on October 2,
1995. While TWA has committed to an uninterrupted flow of lease payments, there
is no assurance that TWA will continue to honor its obligations in the future.
The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995 and has recognized the net warrant value as of the
date of receipt of $1,772,206 as revenue in the 1995 statement of operations.
The Partnership exercised the warrants on December 29, 1995 for the strike price
of $0.01 per share and has recognized a gain on the value of the warrants of
$582,028 in the 1995 statement of operations. The TWA Common Stock is classified
as trading securities because the Partnership intends to sell the stock in the
near term. The fair market value of the TWA stock at December 31, 1995 of
$2,356,506 is reflected in the Partnership's December 31, 1995 balance sheet
(Item 8). The Partnership sold the TWA Common Stock in the first quarter of
1996, net of broker commissions, for $2,406,479.
Viscount Default and Bankruptcy Filing
In July 1994, the Partnership entered into a restructuring agreement with
Viscount to defer certain rents due the Partnership which aggregated $196,800;
to extend a line of credit to Viscount for a total of $127,000 to be used
primarily for maintenance expenses relating to the Partnership's aircraft; and
to give the Partnership the option to acquire approximately 0.6% of the issued
and outstanding shares of Viscount stock as of July 26, 1994 for an option price
of approximately $91,000. It was not practicable to estimate the fair value of
the stock options as of December 31, 1995, as they are not publicly traded,
although Viscount's recent bankruptcy filing would have an adverse impact on the
value of the stock options, if any.
The deferred rents, which were being repaid by Viscount with interest at a rate
of 6% per annum over the remaining terms of the leases, were recognized as
revenue in the period earned. The unpaid balances of the deferred rents, which
are reflected in rent and other receivables in the December 31, 1995 and 1994
balance sheets (Item 8), were $130,511 and $182,982, respectively. The line of
credit, which was advanced to Viscount during 1994, was being repaid by Viscount
over a 30-month period, beginning in January 1995, with interest at a rate of
11.53% per annum. The line of credit balances, which are reflected in notes
receivable in the December 31, 1995 and 1994 balance sheets, were $88,641 and
$127,000, respectively.
During 1995, the Partnership had been in discussions with Viscount to
restructure additional existing financial obligations of Viscount to the
Partnership. While such discussions were underway, Viscount had undertaken to
pay in full, by the end of each month, beginning in June 1995, the current
month's obligations by making partial periodic payments during that month.
Viscount is presently in default on these financial obligations to the
Partnership. On December 13, 1995, the Partnership issued a notice of default to
Viscount demanding, within 10 days, full payment of all delinquent amounts due
the Partnership. On January 9, 1996, Viscount was notified that the Partnership
had elected to terminate the lease and the Partnership demanded return of the
aircraft. 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. As discussed below, Tucson Aerospace, a maintenance
17
facility located in Arizona, presently has possession of the Partnership's
aircraft. Legal counsel has been retained and the general partner is evaluating
the rights, remedies and courses of action available to the Partnership with
respect to Viscount's default and bankruptcy filing. The Partnership has
received no additional payments from Viscount subsequent to December 31, 1995.
One of the Partnership's Boeing 737-200 commercial jet aircraft was on lease to
Viscount prior to the lease termination notification. As of December 31, 1995,
the Partnership's aggregate rent, maintenance reserve, loan and interest
receivable from Viscount was approximately $336,000. All payments due from
Viscount may be affected by Viscount's filing for protection under Chapter 11.
During 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance
facility 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. The aircraft is currently in the possession of Tucson Aerospace and it
may assert a lien against the aircraft to secure payment of its claim. 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. The Partnership
has been in discussions with the various parties to resolve these disputes and
is currently evaluating all of its options, including alternative procedures to
obtain repossession of this aircraft.
The balance of the line of credit advanced to Viscount in 1994 of $88,641 at
December 31, 1995, plus accrued interest, is guaranteed by certain affiliates of
the principal shareholder of Viscount and 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
including the aggregate of the unpaid rents, outstanding deferred rent balance
and accrued interest as of December 31, 1995. The aggregate allowance for credit
losses of $241,964 for these obligations is reflected in the provision for
credit losses in the Partnership's 1995 statement of operations (Item 8).
Viscount's failure to perform on its financial obligations with the Partnership
is expected to have 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 legal costs
related to the Partnership's aircraft and engines, which cannot be estimated at
this time. The outcome of Viscount's Chapter 11 proceeding cannot be predicted.
Industry Update
Maintenance of Aging Aircraft - The process of aircraft maintenance begins at
the aircraft design stage. For aircraft operating under Federal Aviation
Administration (FAA) regulations, a review board consisting of representatives
of the manufacturer, FAA representatives and operating airline representatives
is responsible for specifying the aircraft's initial maintenance program. The
general partner understands that this program is constantly reviewed and
modified throughout the aircraft's operational life.
18
Since 1988, the FAA, working with the aircraft manufacturers and operators, has
issued a series of ADs which mandate that operators conduct more intensive
inspections, primarily of the aircraft fuselages. The results of these mandatory
inspections may result in the need for repairs or structural modifications that
may not have been required under pre-existing maintenance programs.
In addition, an AD adopted in 1990 requires replacement or modification of
certain structural items on a specific timetable. These structural items were
formerly subject to periodic inspection, with replacement when necessary. The
FAA estimates the cost of compliance with this AD to be approximately $1.0
million and $900,000 per Boeing 727 and Boeing 737 aircraft, respectively, if
none of the required work had been done previously. The FAA also issued several
ADs in 1993 updating inspection and modification requirements for Boeing 737
aircraft. The FAA estimates the cost of these requirements to be approximately
$90,000 per aircraft. In general, the new maintenance requirements must be
completed by the later of March 1994, or 75,000 and 60,000 cycles for each
Boeing 737 and 727, respectively. A similar AD was adopted on September 24,
1990, applicable to McDonnell Douglas aircraft. The AD requires specific work to
be performed at various cycle thresholds between 50,000 and 100,000 cycles, and
on specific date or age thresholds. The estimated cost of compliance with all of
the components of this AD is approximately $850,000 per aircraft. The extent of
modifications required to an aircraft varies according to the level of
incorporation of design improvements at manufacture.
In December 1990, the FAA adopted another AD intended to mitigate corrosion of
structural components, which would require repeated inspections from 5 years of
age throughout the life of an aircraft, with replacement of corroded components
as needed. Integration of the new inspections into each aircraft operator's
maintenance program was required by December 31, 1991 on Boeing aircraft.
The Partnership's existing leases require the lessees to maintain the
Partnership's aircraft in accordance with an FAA-approved maintenance program
during the lease term. At the end of the leases, each lessee is generally
required to return the aircraft in airworthy condition including compliance with
all ADs for which action is mandated by the FAA during the lease term. An
aircraft returned to the Partnership as a result of a lease default would most
likely not be returned to the Partnership in compliance with all return
conditions required by the lease. The Partnership has agreed to bear a portion
of the costs of compliance with certain ADs with respect to the aircraft leased
to TWA, Continental and Continental Micronesia, as described in Item 1. In
negotiating subsequent leases, market conditions may require that the
Partnership bear some or all of the costs of compliance with future ADs or ADs
that have been issued, but which did not require action during the previous
lease term. The ultimate effect on the Partnership of compliance with the FAA
maintenance standards is not determinable at this time and will depend on a
variety of factors, including the state of the commercial aircraft industry, the
timing of the issuance of ADs, and the status of compliance therewith at the
expiration of the current leases.
Aircraft Noise - Another issue which has affected the airline industry is that
of aircraft noise levels. The FAA has categorized aircraft according to their
noise levels. Stage 1 aircraft, which have the highest noise level, are no
longer allowed to operate from civil airports in the United States. Stage 2
aircraft meet current FAA requirements, subject to the phase-out rules discussed
below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all
new aircraft.
On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2
aircraft by the end of this decade. The current U.S. fleet is comprised of
approximately 68% Stage 3 aircraft and 32% Stage 2 aircraft. The key features of
the rule include:
19
- Compliance can be accomplished through a gradual process of
phase-in or phase-out (see below) on each of three interim
compliance dates: December 31, 1994, 1996, and 1998. All
Stage 2 aircraft must be phased out of operations in the
contiguous United States by December 31, 1999, with waivers
available in certain specific cases to December 31, 2003.
- All operators have the option of achieving compliance
through a gradual phase-out of Stage 2 aircraft (i.e.,
eliminate 25% of its Stage 2 fleet on each of the
compliance dates noted above), or a gradual phase-in of
Stage 3 aircraft (i.e., 55%, 65% and 75% of an operator's
fleet must consist of Stage 3 aircraft by the respective
interim compliance dates noted above).
The federal rule does not prohibit local airports from issuing more stringent
phase-out rules. In fact, several local airports have adopted more stringent
noise requirements which restrict the operation of Stage 2 and certain Stage 3
aircraft.
Other countries have also adopted noise policies. The European Union (EU)
adopted a non-addition rule in 1989, which directed each member country to pass
the necessary legislation to prohibit airlines from adding Stage 2 aircraft to
their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the
year 2002. The International Civil Aviation Organization has also endorsed the
phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.
The Partnership's entire fleet consists of Stage 2 aircraft. Hushkit
modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are
currently available for the Partnership's aircraft. However, while technically
feasible, hushkits may not be cost effective due to the age of the aircraft and
the time required to fully amortize the additional investment. The general
partner will evaluate, as appropriate, the potential benefits of installing
hushkits on some or all of the Partnership's aircraft. It is unlikely, however,
that the Partnership would incur such costs unless they can be substantially
recovered through a lease.
Implementation of the Stage 3 standards has adversely affected the value of
Stage 2 aircraft, as these aircraft will require eventual modification to be
operated in the U.S. or other countries with Stage 3 standards after the
applicable dates.
Demand for Aircraft - Industry-wide, approximately 475 commercial aircraft are
currently available for sale or lease, approximately 125 less than a year ago.
From 1991 through 1994, depressed demand for air travel limited airline
expansion plans, with new aircraft orders and scheduled deliveries being
canceled or substantially deferred. As profitability declined, many airlines
took action to downsize or liquidate assets and some airlines were forced to
file for bankruptcy protection. Following two years of good traffic growth
accompanied by rising yields, this trend is now improving with new aircraft
orders last year exceeding deliveries for the first time since 1990. To date,
this recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2
narrow-bodies, many of which are now being ungraded with hushkits, whereas older
Stage 2 narrow-bodies have shown marginal signs of recovery.
The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control and structural inspection
and modification as previously discussed.
20
Effects on the Partnership's Aircraft - 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. The Partnership made downward adjustments to the estimated
residual value of certain of its on-lease aircraft as of December 31, 1995, 1994
and 1993. 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, the Partnership
recognizes the deficiency currently as increased depreciation expense. The
Partnership recognized approximately $2.4 million and approximately $1.6
million, or $4.75 and $3.18 per limited Partnership unit, of this deficiency as
increased depreciation expense in 1995 and 1994, respectively. The 1995 downward
adjustment was the result of the reduction of the net book value to the
estimated net realizable value of the Boeing 737-200 Combi aircraft sold to
Westjet in 1996. Approximately $1.03 million of the 1994 adjustment was the
result of the reduction of the net book value to the estimated net realizable
value of the Boeing 727-200 aircraft sold to AIA in February 1995. The increased
depreciation expense reduces the aircraft's carrying value and reduces the
amount of future depreciation expense that the Partnership will recognize over
the projected remaining economic life of the aircraft.
The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying value of the aircraft recorded in 1995 and 1994
(which has the effect of decreasing future depreciation expense) and the
downward adjustments to the estimated residual values recorded in 1995, 1994 and
1993 (which has the effect of increasing future depreciation expense). No
additional depreciation expense was recorded in 1993. Therefore, as a result of
the downward adjustments to the residual values in 1993, the Partnership is
recognizing increased depreciation expense of approximately $514,000 per year
beginning in 1994 through the end of the estimated economic lives of the
aircraft. The net effect of the 1994 adjustments to the estimated residual
values and the adjustments to the carrying value of the aircraft recorded in
1994 is to cause the Partnership to recognize increased depreciation expense of
approximately $626,000 per year beginning in 1995 through the end of the
estimated economic lives of the aircraft. The net effect of the 1995 adjustments
to the estimated residual values and the adjustments to the carrying value of
the aircraft recorded in 1995 is to cause the Partnership to recognize increased
depreciation expense of approximately $866,000 per year beginning in 1996
through the end of the estimated economic lives of the aircraft.
Effective January 1, 1996, the Partnership adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." This statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. In performing the review for recoverability,
the statement provides that the Partnership should estimate the future cash
flows expected to result from the use of the asset and its eventual disposition.
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 the statement, measurement of an impairment loss
for long-lived assets will be based on the "fair value" of the asset as defined
in the statement.
SFAS No. 121 states that the fair value of an asset is the amount at which the
asset could be bought or sold in a current transaction between willing parties,
21
i.e., other than in a forced or liquidation sale. Quoted market prices in active
markets are the best evidence of fair value and will be used as the basis for
the measurement, if available. If quoted market prices are not available, the
estimate of fair value will be based on the best information available in the
circumstances. Pursuant to the statement, the estimate of fair value will
consider prices for similar assets and the results of valuation techniques to
the extent available in the circumstances. Examples of valuation techniques
include the present value of estimated expected future cash flows using a
discount rate commensurate with the risks involved, option-pricing models,
matrix pricing, option-adjusted spread models, and fundamental analysis.
Beginning in 1996, the Partnership will periodically review its aircraft for
impairment in accordance with SFAS No. 121. Using an estimate of the fair value
of the Partnership's aircraft to measure impairment may result in greater
write-downs than would be recognized under the accounting method currently
applied by the Partnership. The Partnership uses information obtained from third
party valuation services in arriving at its estimate of fair value for purposes
of determining residual values. The Partnership will use similar information,
plus available information and estimates related to the Partnership's aircraft,
to determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.
To the extent that the Partnership's Boeing and McDonnell Douglas aircraft
continue to be adversely affected by industry events, the Partnership will
evaluate each aircraft as it comes off lease or is returned to the Partnership
to determine whether a re-lease or a sale at the then-current market rates would
be most beneficial for unit holders.
22
Item 8. Financial Statements and Supplementary Data
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994
TOGETHER WITH
AUDITORS' REPORT
23
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of Polaris Aircraft Income Fund II, A California Limited
Partnership:
We have audited the accompanying balance sheets of Polaris Aircraft Income Fund
II, A California Limited Partnership as of December 31, 1995 and 1994, and the
related statements of operations, changes in partners' capital (deficit) and
cash flows for each of the three years in the period ended December 31, 1995.
These financial statements are the responsibility of the general partner. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
general partner, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Polaris Aircraft Income Fund
II, A California Limited Partnership as of December 31, 1995 and 1994, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
San Francisco, California,
January 31, 1996 (except with
respect to the matters discussed
in Note 12 , as to which the
date is March 22, 1996)
24
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
BALANCE SHEETS
DECEMBER 31, 1995 AND 1994
1995 1994
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 25,884,742 $ 14,662,147
MARKETABLE SECURITIES, trading 2,356,506 --
RENT AND OTHER RECEIVABLES, net of
allowance for credit losses of $241,964 in
1995 and $0 in 1994 8,965 292,061
NOTES RECEIVABLE, net of allowance for credit
losses of $0 in 1995 and $1,575,000 in 1994 2,679,486 2,781,432
AIRCRAFT, net of accumulated depreciation of
$97,407,528 in 1995 and $90,004,933 in 1994 76,487,365 91,954,354
AIRCRAFT INVENTORY 373,483 848,613
OTHER ASSETS 29,770 29,770
------------- -------------
$ 107,820,317 $ 110,568,377
============= =============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 92,511 $ 702,841
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 87,356 38,663
SECURITY DEPOSITS 450,000 171,140
MAINTENANCE RESERVES 179,185 722,690
DEFERRED INCOME 642,742 642,742
------------- -------------
Total Liabilities 1,451,794 2,278,076
------------- -------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (1,139,155) (1,119,868)
Limited Partners, 499,997 units
issued and outstanding 107,507,678 109,410,169
------------- -------------
Total Partners' Capital 106,368,523 108,290,301
------------- -------------
$ 107,820,317 $ 110,568,377
============= =============
The accompanying notes are an integral part of these statements.
25
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1995 1994 1993
---- ---- ----
REVENUES:
Rent from operating leases $16,114,000 $ 12,933,795 $ 14,397,683
Net loss on sale of equipment -- -- (513,395)
Receipt of lessee stock warrants 1,772,206 -- --
Gain on trading securities 582,028 -- --
Interest 1,667,397 820,362 736,719
Other 957,710 689,745 937,859
----------- ------------ ------------
Total Revenues 21,093,341 14,443,902 15,558,866
----------- ------------ ------------
EXPENSES:
Depreciation 13,895,184 13,045,238 11,114,846
Management fees to general partner 752,384 615,940 685,950
Provision for credit losses 241,964 -- --
Operating 150,161 3,738,938 3,445,325
Administration and other 336,583 260,958 264,631
----------- ------------ ------------
Total Expenses 15,376,276 17,661,074 15,510,752
----------- ------------ ------------
NET INCOME (LOSS) $ 5,717,065 $ (3,217,172) $ 48,114
=========== ============ ============
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 744,597 $ 1,217,696 $ 1,000,375
=========== ============ ============
NET INCOME (LOSS) ALLOCATED
TO LIMITED PARTNERS $ 4,972,468 $ (4,434,868) $ (952,261)
=========== ============ ============
NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ 9.94 $ (8.87) $ (1.91)
=========== ============ ============
The accompanying notes are an integral part of these statements.
26
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
General Limited
Partner Partners Total
------- -------- -----
Balance, December 31, 1992 $ (837,954) $ 137,297,163 $ 136,459,209
Net income (loss) 1,000,375 (952,261) 48,114
Cash distributions to partners (1,111,104) (9,999,940) (11,111,044)
----------- ------------- -------------
Balance, December 31, 1993 (948,683) 126,344,962 125,396,279
Net income (loss) 1,217,696 (4,434,868) (3,217,172)
Cash distributions to partners (1,388,881) (12,499,925) (13,888,806)
----------- ------------- -------------
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
=========== ============= =============
The accompanying notes are an integral part of these statements.
27
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993
1995 1994 1993
---- ---- ----
OPERATING ACTIVITIES:
Net income (loss) $ 5,717,065 $ (3,217,172) $ 48,114
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 13,895,184 13,045,238 11,114,846
Net loss on sale of equipment -- -- 513,395
Provision for credit losses 241,964 -- --
Changes in operating assets and liabilities:
Increase in marketable securities, trading (2,356,506) -- --
Decrease (increase) in rent and other
receivables 41,132 (254,328) 339,579
Decrease in other assets -- -- 6,420
Increase (decrease) in payable to affiliates (610,330) 650,567 (1,141,850)
Increase (decrease) in accounts payable
and accrued liabilities 48,693 (2,517,662) 694,921
Increase (decrease) in security deposits 278,860 (18,424) 3,244
Decrease in maintenance reserves (543,505) (146,673) (215,383)
Decrease in deferred income -- -- (1,808,383)
------------ ------------ ------------
Net cash provided by operating activities 16,712,557 7,541,546 9,554,903
------------ ------------ ------------
INVESTING ACTIVITIES:
Increase in notes receivable -- (2,304,533) --
Net proceeds from sale of aircraft equipment -- -- 2,585,000
Principal proceeds from notes receivable 1,873,751 545,409 727,692
Net proceeds from sale of aircraft inventory 275,130 323,448 1,169,483
Inventory disassembly costs -- -- (327,750)
------------ ------------ ------------
Net cash provided by (used in)
investing activities 2,148,881 (1,435,676) 4,154,425
------------ ------------ ------------
FINANCING ACTIVITIES:
Cash distributions to partners (7,638,843) (13,888,806) (11,111,044)
------------ ------------ ------------
Net cash used in financing activities (7,638,843) (13,888,806) (11,111,044)
------------ ------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS 11,222,595 (7,782,936) 2,598,284
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 14,662,147 22,445,083 19,846,799
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 25,884,742 $ 14,662,147 $ 22,445,083
============ ============ ============
The accompanying notes are an integral part of these statements.
28
POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. Accounting Principles and Policies
Accounting Method - Polaris Aircraft Income Fund II, A California Limited
Partnership (PAIF-II or the Partnership), maintains its accounting records,
prepares its financial statements and files its tax returns on the accrual basis
of accounting. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The most
significant estimates with regard to these financial statements are related to
the projected cash flows analysis in determining the fair value of assets.
Cash and Cash Equivalents - This includes deposits at banks and investments in
money market funds.
Marketable Securities, trading - Marketable Securities, trading, are carried at
fair value, which was determined based on quoted market prices. These securities
are held for sale in the near term (Note 6).
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, the Partnership
recognizes the deficiency currently as increased depreciation expense. Off-lease
aircraft are carried at the lower of depreciated cost or estimated net
realizable value.
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.
29
Aircraft Inventory - Aircraft held in inventory for sale are reflected at the
lower of depreciated cost or estimated net realizable value. Proceeds from sales
are applied against inventory until the book value is fully recovered.
Operating Leases - The aircraft leases are accounted for as operating leases.
Lease revenues are recognized in equal installments over the terms of the
leases.
Maintenance Reserves - The Partnership receives maintenance reserve payments
from certain of its lessees that may be reimbursed to the lessee or applied
against certain costs incurred by the Partnership or lessee for maintenance work
performed on the Partnership's aircraft or engines, as specified in the leases.
Maintenance reserve payments are recognized when received and balances remaining
at the termination of the lease, if any, may be used by the Partnership to
offset future maintenance expenses or recognized as revenue.
Operating Expenses - Operating expenses include costs incurred to maintain,
insure, lease and sell the Partnership's aircraft, including costs related to
lessee defaults and costs of disassembling aircraft inventory.
Net Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited
partnership unit is based on the limited partners' share of net income or loss
and the number of units outstanding for the years ended December 31, 1995, 1994
and 1993.
Income Taxes - The Partnership files federal and state information income tax
returns only. Taxable income or loss is reportable by the individual partners.
Reclassification - Certain 1994 and 1993 balances have been reclassified to
conform to the 1995 presentation.
Financial Accounting Pronouncements - The Partnership adopted Statement of
Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for
Impairment of a Loan," and the related SFAS No. 118 as of January 1, 1995. SFAS
No. 114 and SFAS No. 118 require that certain impaired loans be measured based
on the present value of expected cash flows discounted at the loan's effective
interest rate; or, alternatively, at the loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. The
Partnership had previously measured the allowance for credit losses using
methods similar to that prescribed in SFAS No. 114. As a result, no additional
provision was required by the adoption of this pronouncement. The Partnership
has recorded an allowance for credit losses for certain impaired loan and rents
receivable as a result of uncertainties regarding their collection. The
Partnership recognizes revenue on impaired loans and receivables only as
payments are received.
30
1995
----
Impaired loans or receivables with
allowances for credit losses $ 241,964
Impaired loans or receivables without
allowances for credit losses 412,761
-----------
Total impaired loans 654,725
Allowance for credit losses (241,964)
-----------
$ 412,761
===========
Allowance for credit losses,
beginning of year $(1,575,000)
Provision for credit losses (241,964)
Write-downs --
Collections 1,575,000
-----------
Allowance for credit losses,
end of year $ (241,964)
===========
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 6) are carried at fair value, which was determined
based on quoted market prices. The fair value of the 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 3, the note
receivable from American International Airways, Inc. (AIA) discussed in Note 3
and the note receivable from ALG, Inc. (ALG) discussed in Note 4 approximate
their estimated fair value. The carrying value of the line of credit note
receivable from Viscount discussed in Note 7 approximates its estimated fair
value as this note is guaranteed by certain affiliates of Viscount. 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 December
31, 1995, the estimated fair value of the rents receivable from Viscount was
also zero.
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," 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. This statement will be
adopted by the Partnership as of January 1, 1996 and will be applied
prospectively. The Partnership estimates that the adoption of this pronouncement
will not have an immediate 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. The estimate of fair value
and measurement of impairment loss is described in Note 3.
2. Organization and the Partnership
The Partnership was formed on June 27, 1984 for the purpose of acquiring and
leasing aircraft. The Partnership will terminate no later than December 2010.
Upon organization, both the general partner and the initial limited partner
contributed $500. The Partnership recognized no profits or losses during the
31
periods ended December 31, 1985 and 1984. The offering of limited partnership
units terminated on December 31, 1986, at which time the Partnership had sold
499,997 units of $500, representing $249,998,500. All partners were admitted to
the Partnership on or before December 1, 1986.
Polaris Investment Management Corporation (PIMC), the sole general partner of
the Partnership, supervises the day-to-day operations of the Partnership. PIMC
is a wholly-owned subsidiary of Polaris Aircraft Leasing Corporation (PALC).
Polaris Holding Company (PHC) is the parent company of PALC. General Electric
Capital Corporation (GE Capital), an affiliate of General Electric Company, owns
100% of PHC's outstanding common stock. PIMC has entered into a services
agreement dated as of July 1, 1994 with GE Capital Aviation Services, Inc.
(GECAS). Allocations to related parties are described in Note 9.
3. Aircraft
The Partnership owns 23 aircraft and certain inventoried aircraft parts from its
original portfolio of 30 used commercial jet aircraft, which were acquired,
leased or sold as discussed below, including one airframe and engine which were
sold in March 1996 as discussed in Note 12. All aircraft acquired from an
affiliate were purchased within one year of the affiliate's acquisition at the
affiliate's original price paid. The aircraft leases are net operating leases,
requiring the lessees to pay all operating expenses associated with the aircraft
during the lease term. While the leases require the lessees to comply with
Airworthiness Directives (ADs) which have been or may be issued by the Federal
Aviation Administration (FAA) and require compliance during the lease term, in
certain of the leases the Partnership has agreed to share in the cost of
compliance with ADs. In addition to basic rent, certain lessees are required to
pay supplemental amounts based on flight hours or cycles into a maintenance
reserve account, to be used for heavy maintenance of the engines or airframe.
The leases generally state a minimum acceptable return condition for which the
lessee is liable under the terms of the lease agreement. In the event of a
lessee default, these return conditions are not likely to be met. Certain leases
also provide that, if the aircraft are returned at a level above the minimum
acceptable level, the Partnership must reimburse the lessee for the related
excess, subject to certain limitations. The related liability to these lessees,
if any, cannot currently be estimated and therefore is not reflected in the
financial statements.
32
The following table describes the Partnership's current aircraft portfolio in
greater detail:
Year of
Aircraft Type Serial Number Manufacture
- ------------- ------------- -----------
Boeing 727-200 Advanced 21426 1977
Boeing 727-200 Advanced 21427 1977
Boeing 727-200 Advanced 21947 1979
Boeing 737-200 19609 1968
Boeing 737-200 Combi (1) 19743 1969
McDonnell Douglas DC-9-30 47082 1967
McDonnell Douglas DC-9-30 47096 1967
McDonnell Douglas DC-9-30 47135 1968
McDonnell Douglas DC-9-30 47137 1968
McDonnell Douglas DC-9-30 47249 1968
McDonnell Douglas DC-9-30 47251 1968
McDonnell Douglas DC-9-30 47343 1969
McDonnell Douglas DC-9-30 47345 1969
McDonnell Douglas DC-9-30 47411 1969
McDonnell Douglas DC-9-30 47412 1969
McDonnell Douglas DC-9-30 47027 1967
McDonnell Douglas DC-9-30 47107 1968
McDonnell Douglas DC-9-30 47108 1968
McDonnell Douglas DC-9-30 47174 1968
McDonnell Douglas DC-9-30 47324 1969
McDonnell Douglas DC-9-30 47357 1969
McDonnell Douglas DC-9-30 47734 1977
McDonnell Douglas DC-9-40 47617 1975
(1) Aircraft sold in 1996 (Note 12)
One Boeing 737-200 - This aircraft was acquired for $6,766,166 in 1986 and
leased to various lessees until 1989, when Braniff, Inc. (Braniff) defaulted on
its lease. The aircraft remained off lease until March 1991. The aircraft was
then leased to SABA Airlines, S.A. (SABA) at approximately 70% of the prior rate
until February 1992, when the aircraft was repossessed by the Partnership after
SABA defaulted under its lease. In November 1992, the aircraft was re-leased for
five years to Viscount Air Services, Inc. (Viscount) at approximately 56% of the
prior lease rate. The lease specifies that Viscount, a charter carrier based in
Arizona, has the option to purchase the aircraft for the then-current fair
market value at the end of the lease term. As discussed in Note 7, at December
31, 1995 Viscount was in default on certain payments due to the Partnership.
Note 12 contains a further discussion of the Viscount situation subsequent to
December 31, 1995. An engine for the aircraft has been leased from an affiliate
(Note 9) following the return of an inoperable engine from SABA as discussed in
Note 4. The Partnership has an agreement with Viscount to defer certain rents
due the Partnership and to provide financing to Viscount for maintenance
expenses relating to the Partnership's aircraft (Note 7).
Seven Boeing 727-200 - These aircraft were acquired for $38,986,145 during 1986
and leased to Pan American World Airways, Inc. (Pan Am) until 1991, when the
lease was terminated due to Pan Am's bankruptcy filing. The Partnership has
transferred six of these aircraft to aircraft inventory and has disassembled
them for sale of the component parts (Note 5). One hushkit set from the aircraft
was sold in January 1993 and two additional hushkit sets from the aircraft were
sold in September 1993 (Note 4).
33
The remaining aircraft was leased to Delta Airlines, Inc. (Delta) in September
1991. Delta returned the aircraft at the end of September 1993, following
several month-by-month lease extensions since the original lease termination
date in April 1993. The Partnership has adjusted the book value of this aircraft
to its estimated net realizable value by increasing depreciation expense
approximately $1.03 million in 1994. During 1995, the Partnership recognized as
other revenue maintenance reserves aggregating approximately $91,000 that were
previously paid to the Partnership by Delta. The aircraft was sold 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 December 31, 1995, including one additional principal
payment of $410,229 received in May 1995. The note receivable balance as of
December 31, 1995 was $889,351.
One Boeing 737-200 Combi - This aircraft was acquired for $7,582,572 in 1986 and
leased to Presidential Airways, Inc. (Presidential), until Presidential's
default in 1989. The aircraft remained off lease until June 1990, when it was
leased to Air Zaire, Inc. (Air Zaire). The lease required that Air Zaire
maintain the aircraft in accordance with FAA requirements. However, Air Zaire
was unable to obtain FAA approval for its proposed maintenance program, thus
prompting the early termination of the lease in 1991. Air Zaire provided a
$610,000 letter of credit, the proceeds of which the Partnership applied to
outstanding rent, reserves and interest due in 1991. Air Zaire paid additional
amounts in 1993 and 1992 as a result of legal action commenced by the
Partnership (Note 8).
In August 1992, the Partnership leased the aircraft to Northwest Territorial
Airways, Ltd. (NWT) through March 1993 at approximately 45% of the prior rental
rate, then extended the lease through March 1994 at approximately 80% of the
previous rental rate. An engine for the aircraft was leased from an affiliate
through April 1994 (Note 9). The aircraft was returned to the Partnership in
April 1994 and NWT subsequently paid to the Partnership approximately $860,000
in lieu of meeting return conditions as specified in the lease. During the
off-lease period, the Partnership performed certain maintenance and modification
work on the aircraft which was offset by the payment received from NWT. The
Partnership recognized the balance of approximately $89,000 as other revenue in
the accompanying 1995 statement of operations.
The Partnership negotiated a new lease with NWT for 16 months commencing in June
1994. The new lease rate was approximately 108% of NWT's prior rental rate. The
new lease expired in October 1995. As specified in the lease, NWT was required
to perform certain maintenance work on the aircraft prior to its return. NWT
returned the aircraft without performing the required maintenance work, which
constituted a default under the lease. The Partnership and NWT subsequently
reached an agreement by which NWT paid to the Partnership in December 1995
approximately $457,000 and the Partnership was entitled to retain NWT's security
deposit of approximately $101,000 in lieu of NWT performing the required
maintenance work on the aircraft. The Partnership recorded these amounts as
other revenue in the accompanying 1995 statement of operations.
The airframe and one engine from this aircraft were subsequently sold to Westjet
Airlines, Ltd. (Westjet) in March 1996 as discussed in Note 12. The Partnership
has adjusted the net book value of this aircraft to its estimated net realizable
value by increasing depreciation expense approximately $2.4 million in the 1995
statement of operations. The Partnership is currently remarketing the remaining
engine for sale.
34
17 McDonnell Douglas DC-9-30 and One McDonnell Douglas DC-9-40 - These aircraft
were acquired for $122,222,040 during 1986 and leased to Ozark Air Lines, Inc.
(Ozark). In 1987, Trans World Airlines, Inc. (TWA) merged with Ozark and assumed
the leases. The leases were modified and extended in 1991 prior to TWA's
bankruptcy filing as discussed in Note 6.
Three Boeing 727-200 Advanced - These aircraft were acquired for $36,364,929
during 1987 and leased to Alaska Airlines, Inc. (Alaska) until September 1992.
Upon return of the aircraft, an additional amount of $509,000 was received from
Alaska for deferred maintenance and applied in 1993 as an offset to maintenance
expenses incurred on the aircraft. One of the aircraft was re-leased to
Continental from April 1993 until April 1998. The remaining two aircraft were
released to Continental Micronesia, Inc. (Continental Micronesia), an affiliate
of Continental, from May and June 1993 until April 1998. All three of the
aircraft are leased at approximately 55% of the prior lease rates. The three
leases stipulate that the Partnership will reimburse costs for cockpit
modifications up to $600,000 per aircraft, C-check labor costs up to $300,000
per aircraft for two of the aircraft and the actual cost of C-check parts for
these two aircraft. In addition, the Partnership will provide financing of up to
$815,000 for new image modifications, to be repaid with interest over the lease
term for each aircraft. In accordance with the cost sharing agreement, in
January 1994, the Partnership reimbursed Continental (partially on behalf of its
affiliate Continental Micronesia) $1.8 million for cockpit modifications. The
Partnership also reimbursed Continental $742,325 for C-check labor and parts,
which was included in operating expense in the statement of operations for the
year ended December 31, 1993. In addition, the Partnership financed $2,177,533
for new image modifications, which is being repaid with interest over the lease
terms of the aircraft, beginning in February 1994. The Partnership has received
all scheduled principal and interest payments due from Continental and
Continental Micronesia through December 31, 1995. The aggregate note receivable
balance as of December 31, 1995 and 1994 was $1,289,328 and $1,764,167,
respectively. 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 following is a schedule by year of future minimum rental revenue under the
existing leases but excluding rental payments for one aircraft leased to
Viscount due to the bankruptcy filing discussed in Notes 7 and 12:
Year Amount
---- ------
1996 $13,680,000
1997 13,680,000
1998 3,410,000
1999 and thereafter -
-----------
Total $30,770,000
===========
Future minimum rental payments may be offset or reduced by future costs as
described above and in Note 6.
As discussed in Note 1, 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. The Partnership made downward adjustments to the estimated residual value
of certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. For
any downward adjustment in estimated residual value or decrease in the projected
35
remaining economic life, the depreciation expense over the projected remaining
economic life of the aircraft is increased.
As discussed in Note 1, 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, the Partnership recognizes the deficiency currently as
increased depreciation expense. The Partnership recognized approximately $2.4
million and approximately $1.6 million, or $4.75 and $3.18 per limited
Partnership unit, of this deficiency as increased depreciation expense in 1995
and 1994, respectively. The 1995 downward adjustment was the result of the
reduction of the net book value to the estimated net realizable value of the
Boeing 737-200 Combi aircraft sold to Westjet in 1996 as discussed in Note 12.
Approximately $1.03 million of the 1994 adjustment was the result of the
reduction of the net book value to the estimated net realizable value of the
Boeing 727-200 aircraft sold to AIA in February 1995 as previously discussed.
The increased depreciation expense reduces the aircraft's net book value and
therefore reduces the amount of future depreciation expense that the Partnership
will recognize over the projected remaining economic life of the aircraft.
The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying values of the aircraft recorded in 1995 and 1994
(which has the effect of decreasing future depreciation expense) and the
downward adjustments to the estimated residual values recorded in 1995, 1994 and
1993 (which has the effect of increasing future depreciation expense). No
additional depreciation expense was recorded in 1993. Therefore, as a result of
the downward adjustments to the residual values in 1993, the Partnership is
recognizing increased depreciation expense of approximately $514,000 per year
beginning in 1994 through the end of the estimated economic lives of the
aircraft. The net effect of the 1994 adjustments to the estimated residual
values and the adjustments to the carrying values of the aircraft recorded in
1994 is to cause the Partnership to recognize increased depreciation expense of
approximately $626,000 per year beginning in 1995 through the end of the
estimated economic lives of the aircraft. The net effect of the 1995 adjustments
to the estimated residual values and the adjustments to the carrying values of
the aircraft recorded in 1995 is to cause the Partnership to recognize increased
depreciation expense of approximately $866,000 per year beginning in 1996
through the end of the estimated economic lives of the aircraft.
Effective January 1, 1996, the Partnership adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." This statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. In performing the review for recoverability,
the statement provides that the Partnership should estimate the future cash
flows expected to result from the use of the asset and its eventual disposition.
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 the statement, measurement of an impairment loss
for long-lived assets will be based on the "fair value" of the asset as defined
in the statement.
SFAS No. 121 states that the fair value of an asset is the amount at which the
asset could be bought or sold in a current transaction between willing parties,
i.e., other than in a forced or liquidation sale. Quoted market prices in active
markets are the best evidence of fair value and will be used as the basis for
the measurement, if available. If quoted market prices are not available, the
estimate of fair value will be based on the best information available in the
circumstances. Pursuant to the statement, the estimate of fair value will
consider prices for similar assets and the results of valuation techniques to
36
the extent available in the circumstances. Examples of valuation techniques
include the present value of estimated expected future cash flows using a
discount rate commensurate with the risks involved, option-pricing models,
matrix pricing, option-adjusted spread models, and fundamental analysis.
Beginning in 1996, the Partnership will periodically review its aircraft for
impairment in accordance with SFAS No. 121. Using an estimate of the fair value
of the Partnership's aircraft to measure impairment may result in greater
write-downs than would be recognized under the accounting method currently
applied by the Partnership. The Partnership uses information obtained from third
party valuation services in arriving at its estimate of fair value for purposes
of determining residual values. The Partnership will use similar information,
plus available information and estimates related to the Partnership's aircraft,
to determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.
4. Sale of Equipment
One hushkit set from the aircraft formerly leased to Pan Am (Note 3) was sold in
January 1993 to ALG for $1,750,000, which resulted in a $259,809 gain in 1993.
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. The Partnership has received all scheduled renegotiated
payments due from ALG through December 31, 1995. The note receivable balances as
of December 31, 1995, 1994 and 1993 were $412,166, $890,265 and $1,022,308,
respectively. In January 1996, the Partnership and ALG once again restructured
the terms of the promissory note as discussed in Note 12. No allowance for
credit losses is provided for ALG receivables in 1995 or 1994.
In September 1993, two additional hushkit sets from the disassembled Pan Am
aircraft were sold to Emery Worldwide Airlines for $1,250,000 each, which
resulted in a $398,192 aggregate loss. The decline in sales price from the
previous hushkit sale in January 1993 reflected a softening market for this
equipment.
The Partnership sold one used engine to International Aircraft Support, L.P. in
July 1993 for $85,000, which resulted in a $375,012 loss. The engine, along with
its airframe, was repossessed from the former lessee, SABA in February 1992. At
the time of its default, SABA had not maintained the aircraft as required under
the lease agreement, rendering the engine inoperable. The Partnership determined
the costs to repair the engine would be in excess of the amounts recoverable
from sale or lease. As a result, the engine was sold for its component parts.
5. Disassembly of aircraft
In an attempt to maximize the economic return from the remaining six aircraft
formerly leased to Pan Am, the Partnership entered into an agreement with
37
Soundair, Inc. (Soundair) in October 1992, for the disassembly and sale of
certain of the Partnership's aircraft. The Partnership has incurred the cost of
disassembly and will receive the proceeds from the sale of such parts, net of
overhaul expenses if necessary, and commissions paid to Soundair. Disassembly of
the six aircraft has been completed. During 1993 and 1992, the Partnership paid
$327,750 and $135,750, respectively, for aircraft disassembly costs. The
Partnership has received net proceeds from the sale of aircraft inventory of
$275,130, $323,448 and $1,169,483 during 1995, 1994 and 1993, respectively.
The six aircraft were recorded as aircraft inventory in the amount of $3.0
million in 1992 as discussed in Note 3. During 1995, 1994 and 1993, the
Partnership recorded downward adjustments to the inventory value of $200,000,
$72,000 and $300,000, respectively, to reflect the then current estimate of net
realizable aircraft inventory value. These adjustments are reflected as
increased depreciation expense in the accompanying statements of operations.
6. TWA Reorganization
During 1991, TWA defaulted under its leases with the Partnership when it failed
to pay its March lease payments. In December 1991, the leases for all 18
aircraft were amended, with extensions to various dates in 1998. The
renegotiated lease rates represent approximately 46% of the initial lease rates.
In addition, the Partnership agreed to share in the costs of certain ADs after
TWA successfully reorganized. The agreement stipulated that such costs incurred
by TWA may be credited against monthly rentals, subject to annual limitations
and a maximum of $500,000 per aircraft through the end of the applicable lease.
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 this agreement, TWA may offset up to an additional $2.7
million against rental payments, subject to annual limitations, over the
remaining lease terms.
In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, 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 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 recorded
a note receivable and corresponding allowance for credit losses equal to the
total of the 1994 deferred rents of $1.575 million, the net of which was
reflected in the accompanying 1994 balance sheet. 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 note receivable and
corresponding allowance for credit losses were reduced by the principal portion
of the payments received. The Partnership received all scheduled rent payments
beginning in April 1995 and all scheduled deferred rental payments beginning in
May 1995, including interest at a rate of 12% per annum, from TWA and has
recognized the $3.6 million deferred rents as rental revenue during 1995. The
deferred rents were paid in full by October 1995.
38
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 share of such payment by
TWA. This amount was recognized as other revenue in the accompanying 1995
statement of operations. 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 and has recognized the net warrant value as of the
date of receipt of $1,772,206 as revenue in the 1995 statement of operations.
The Partnership exercised the warrants on December 29, 1995 for the strike price
of $.01 per share and has recognized a gain on the value of the warrants of
$582,028 in the 1995 statement of operations. The TWA Common Stock is classified
as trading securities because the Partnership intends to sell the stock in the
near term. 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. As
discussed in Note 12, the Partnership sold the TWA Common Stock in the first
quarter of 1996.
TWA agreed that, upon filing of its prepackaged plan, it would take all
reasonable steps to implement the terms of the Amended Deferral Agreement and
would immediately assume all of the Partnership's leases. TWA also agreed that,
not withstanding the 60-day cure period provided by section 1110 of the United
States Bankruptcy Code, it would remain current on the performance of its
obligations under the leases, as amended by the Amended Deferral Agreement.
On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United
States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995,
the Bankruptcy Court confirmed TWA's plan of reorganization, which became
effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the
confirmation date of the plan, August 4, 1995, the Partnership received a
payment of $1,217,989 from TWA which represented fifty percent (50%) of the
deferred rent outstanding plus interest as of such date. The remaining balance
of deferred rent plus interest was paid in full to the Partnership on October 2,
1995. While TWA has committed to an uninterrupted flow of lease payments, there
is no assurance that TWA will continue to honor its obligations in the future.
39
7. Viscount Restructuring Agreement and Default
In July 1994, the Partnership entered into a restructuring agreement with
Viscount to defer certain rents due the Partnership which aggregated $196,800;
to extend a line of credit to Viscount for a total of $127,000 to be used
primarily for maintenance expenses relating to the Partnership's aircraft; and
to give the Partnership the option to acquire approximately 0.6% of the issued
and outstanding shares of Viscount stock as of July 26, 1994 for an option price
of approximately $91,000. It was not practicable to estimate the fair value of
the stock options as of December 31, 1995, as they are not publicly traded,
although Viscount's recent bankruptcy filing (Note 12) would have an adverse
impact on the value of the stock options, if any.
The deferred rents, which were being repaid by Viscount with interest at a rate
of 6% per annum over the remaining terms of the leases, were recognized as
revenue in the period earned. The unpaid balances of the deferred rents, which
are reflected in rent and other receivables in the December 31, 1995 and 1994
balance sheets, were $130,511 and $182,982, respectively. The line of credit,
which was advanced to Viscount during 1994, was being repaid by Viscount over a
30- month period, beginning in January 1995, with interest at a rate of 11.53%
per annum. The line of credit balances, which are reflected in notes receivable
in the December 31, 1995 and 1994 balance sheets, were $88,641 and $127,000,
respectively.
During 1995, the Partnership had been in discussions with Viscount to
restructure additional existing financial obligations of Viscount to the
Partnership. While such discussions were underway, Viscount had undertaken to
pay in full, by the end of each month, beginning in June 1995, the current
month's obligations by making partial periodic payments during that month.
Viscount is presently in default on these financial obligations to the
Partnership. On December 13, 1995, the Partnership issued a notice of default to
Viscount demanding, within 10 days, full payment of all delinquent amounts due
the Partnership. Note 12 contains a further discussion of the Viscount situation
subsequent to December 31, 1995 including the Partnership's notice of
termination of the lease with Viscount and Viscount's subsequent filing for
protection under Chapter 11 of the United States Bankruptcy Code.
One of the Partnership's Boeing 737-200 commercial jet aircraft was on lease to
Viscount prior to the lease termination notification. As of December 31, 1995,
the Partnership's aggregate rent, maintenance reserve, loan and interest
receivable from Viscount was approximately $336,000. All payments due from
Viscount may be affected by Viscount's filing for protection under Chapter 11.
The balance of the line of credit advanced to Viscount in 1994 of $88,641 at
December 31, 1995, plus accrued interest, is guaranteed by certain affiliates of
the principal shareholder of Viscount. 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 as of December 31, 1995. The aggregate allowance for credit losses of
$241,964 for these obligations is reflected in the provision for credit losses
in the accompanying 1995 statement of operations. Viscount's failure to perform
on its financial obligations with the Partnership is expected to have an adverse
effect on the Partnership's financial position.
8. Claims Related to Lessee Defaults
Receipt of Braniff Bankruptcy Claim - In July 1992, the Bankruptcy Court
approved a stipulation embodying a settlement among the Partnership, the Braniff
creditor committees and Braniff in which it was agreed that the Partnership
40
would be allowed an administrative claim in the bankruptcy proceeding of
approximately $230,769. In 1992, the Partnership received full payment of the
claim subject to the requirement that 25% of total proceeds be held by PIMC in a
separate, interest-bearing account pending notification by Braniff that all of
the allowed administrative claims have been satisfied. The Partnership
recognized 75% of the total claim as other revenue in 1992. During 1994, the
Partnership was advised that the 25% portion of the administrative claim
proceeds with interest could be released by PIMC to the Partnership. As a
result, the Partnership recognized $67,958 as other revenue in the 1994
statement of operations.
Air Zaire - As a result of legal action commenced by the general partner, a
final settlement was reached with Air Zaire. Air Zaire paid to the Partnership
approximately $2,885,000, of which approximately $1,570,000 has been applied to
legal and maintenance expenses related to the default. The final expenses were
paid in 1993 and approximately $915,000 was reflected as other revenue in the
1993 statement of operations. The remaining amount of $400,000 was recognized as
other revenue in 1994.
9. Related Parties
Under the Limited Partnership Agreement (Partnership Agreement), the Partnership
paid or agreed to pay the following amounts to PIMC and/or its affiliates in
connection with services rendered:
a. An aircraft management fee equal to 5% of gross rental revenues with
respect to operating leases or 2% of gross rental revenues with
respect to full payout leases of the Partnership, payable upon
receipt of the rent. In 1995, 1994 and 1993, the Partnership paid
management fees to PIMC of $763,774, $604,551 and $681,241,
respectively. Management fees payable to PIMC at December 31, 1995
and 1994 were zero and $11,389, respectively.
b. Reimbursement of certain out-of-pocket expenses incurred in
connection with the management of the Partnership and supervision of
its assets. In 1995, 1994 and 1993, $299,588, $228,357 and $407,582,
respectively, were reimbursed by the Partnership for administrative
expenses. Administrative reimbursements of $63,159, and $101,277 were
payable at December 31, 1995 and 1994, respectively. Reimbursements
for maintenance and remarketing costs of $972,284, $305,200 and
$2,608,523 were paid by the Partnership in 1995, 1994 and 1993,
respectively. Maintenance and remarketing reimbursements of $29,352
and $590,175 were payable at December 31, 1995 and 1994,
respectively.
c. A 10% interest to PIMC in all cash distributions and sales proceeds,
gross income in an amount equal to 9.09% of distributed cash
available from operations and 1% of net income or loss and taxable
income or loss, as such terms are defined in the Partnership
Agreement.
d. A subordinated sales commission to PIMC of 3% of the gross sales
price of each aircraft for services performed upon disposition and
reimbursement of out-of-pocket and other disposition expenses.
Subordinated sales commissions will be paid only after limited
partners have received distributions in an aggregate amount equal to
their capital contributions plus a cumulative non-compounded 8% per
annum return on their adjusted capital contributions, as defined in
the Partnership Agreement. The Partnership did not pay or accrue a
sales commission on any aircraft sales to date as the above
subordination threshold has not been met.
41
e. One engine owned by Polaris Aircraft Income Fund I (PAIF-I) is leased
to Viscount beginning in April 1993 through a joint venture with the
Partnership. The rental payments of $146,000, $146,000 and $98,000
were offset against rent from operating leases in the 1995, 1994 and
1993 statement of operations, respectively. Viscount is currently in
default with respect to this lease agreement as discussed in Notes 7
and 12.
f. One engine was leased from PHC from September 1993 through April 1994
for use on the aircraft leased to NWT. The rental payments of $38,400
and $42,000 were offset against rent from operating leases in the
1994 and 1993 statement of operations, respectively.
10. Income Taxes
Federal and state income tax regulations provide that taxes on the income or
loss of the Partnership are reportable by the partners in their individual
income tax returns. Accordingly, no provision for such taxes has been made in
the financial statements.
The net differences between the tax basis and the reported amounts of the
Partnership's assets and liabilities at December 31, 1995 and 1994 are as
follows:
Reported Amounts Tax Basis Net Difference
---------------- --------- --------------
1995: Assets $107,820,317 $103,582,640 $4,237,677
Liabilities 1,451,794 698,747 753,047
1994: Assets $110,568,377 $108,560,932 $2,007,445
Liabilities 2,278,076 1,049,849 1,228,227
11. Reconciliation of Net Book Income (Loss) to Taxable Net Income (Loss)
The following is a reconciliation between net income (loss) per limited
partnership unit reflected in the financial statements and the information
provided to limited partners for federal income tax purposes:
For the years ended December 31,
1995 1994 1993
---- ---- ----
Book net income (loss) per limited partnership unit $ 9.94 $ (8.87) $ (1.91)
Adjustments for tax purposes represent differences
between book and tax revenue and expenses:
Rental and maintenance reserve revenue recognition (2.60) 5.18 (3.18)
Management fee expense 0.14 (0.27) (0.06)
Depreciation (0.78) (2.76) (5.39)
Gain or loss on sale of aircraft (1.60) -- 1.49
Capitalized costs 0.93 7.13 5.35
Basis in inventory (1.08) (0.39) (19.17)
Other revenue and expense items (0.36) (1.18) 1.47
----- ----- ------
Taxable net income (loss) per limited partnership unit $ 4.59 $ (1.16) $ (21.40)
===== ===== ======
42
The differences between net income and loss for book purposes and net income and
loss for tax purposes result from the temporary differences of certain revenue
and deductions.
For book purposes, rental revenue is generally recorded as it is earned. For tax
purposes, certain temporary differences exist in the recognition of revenue. For
tax purposes, management fee expense is accrued in the same year as the tax
basis rental revenue. Increases in the Partnership's book maintenance reserve
liability were recognized as rental revenue for tax purposes. Disbursements from
the Partnership's book maintenance reserves are capitalized or expensed for tax
purposes, as appropriate.
The Partnership computes depreciation using the straight-line method for
financial reporting purposes and generally an accelerated method for tax
purposes. As a result, the current year tax depreciation expense is greater than
the book depreciation expense. The Partnership also periodically evaluates the
ultimate recoverability of the carrying values and the economic lives of its
aircraft for book purposes and, accordingly, recognized adjustments which
increased book depreciation expense. These differences in depreciation methods
result in book to tax differences on the sale of aircraft. In addition, certain
costs were capitalized for tax purposes and expensed for book purposes.
For book purposes, aircraft held in inventory are reflected at the lower of
depreciable cost or estimated net realizable value. Differences in book and tax
revenue and loss from inventory result from the differences in the book and tax
carrying value of the inventory.
12. Subsequent Events
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 NWT as discussed in Note 3, 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 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.
Sale of TWA Common Stock - As discussed in Note 6, the Partnership exercised the
TWA warrants on December 29, 1995. The fair market value of the TWA stock at
December 31, 1995 was $2,356,506. The Partnership sold the TWA Common Stock by
February 1996 for $2,406,479 and will recognize a gain on trading securities of
$49,973 in the first quarter of 1996.
Promissory Note from ALG - As discussed in Note 4, the promissory note from ALG
required a balloon payment of $416,631 due in January 1996. The Partnership and
ALG 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.
Viscount Default and Bankruptcy Filing - As discussed in Note 7, as of December
31, 1995 Viscount was delinquent on certain rent, deferred rent, maintenance
reserve and note payments due the Partnership. On January 9, 1996, Viscount was
notified that the Partnership had elected to terminate the lease (which is
disputed by Viscount) and the Partnership demanded return of the aircraft. 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
43
Tucson, Arizona. Legal counsel has been retained and the general partner is
evaluating the rights, remedies and courses of action available to the
Partnership with respect to Viscount's default and bankruptcy filing. The
Partnership has received no additional payments from Viscount subsequent to
December 31, 1995. As a result of Viscount's defaults and Chapter 11 bankruptcy
filing, the Partnership may incur maintenance, legal, remarketing, transition
and sale costs related to the Partnership's aircraft and engines, which cannot
be estimated at this time. The outcome of Viscount's Chapter 11 proceeding
cannot be predicted.
During 1995, Viscount delivered the aircraft to Tucson Aerospace, a maintenance
facility 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. The aircraft is currently in the possession of Tucson Aerospace and it
may assert a lien against the aircraft to secure payment of its claim. 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. The Partnership
has been in discussions with the various parties to resolve these disputes and
is currently evaluating all of its options, including alternative procedures to
obtain repossession of this aircraft.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
44
PART III
Item 10. Directors and Executive Officers of the Registrant
Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or
the Partnership) has no directors or officers. Polaris Holding Company (PHC) and
its subsidiaries, including Polaris Aircraft Leasing Corporation (PALC) and
Polaris Investment Management Corporation (PIMC), the general partner of the
Partnership (collectively Polaris), restructured their operations and businesses
(the Polaris Restructuring) in 1994. In connection therewith, PIMC entered into
a services agreement dated as of July 1, 1994 (the Services Agreement) with GE
Capital Aviation Services, Inc. (the Servicer or GECAS), a Delaware corporation
which is a wholly owned subsidiary of General Electric Capital Corporation, a
New York corporation (GE Capital). GE Capital has been PHC's parent company
since 1986. As subsidiaries of GE Capital, the Servicer and PIMC are affiliates.
The officers and directors of PIMC are:
Name PIMC Title
---- -----------
James W. Linnan President; Director
Richard J. Adams Vice President; Director
Norman C. T. Liu Vice President; Director
Edward Sun Vice President
John E. Flynn Vice President
Robert W. Dillon Vice President; Assistant Secretary
Marc A. Meiches Chief Financial Officer
Richard L. Blume Secretary
Substantially all of these management personnel will devote only such portion of
their time to the business and affairs of PIMC as deemed necessary or
appropriate.
Mr. Linnan, 54, assumed the position of President and Director of PIMC effective
March 31, 1995. Mr. Linnan had previously held the positions of Vice President
of PIMC effective July 1, 1994, Vice President - Financial Management of PIMC
and PALC effective April 1991, and Vice President - Investor Marketing of PIMC
and PALC since July 1986.
Mr. Adams, 62, Senior Vice President - Aircraft Marketing, North America, served
as Senior Vice President - Aircraft Sales and Leasing of PIMC and PALC effective
August 1992, having previously served as Vice President - Aircraft Sales &
Leasing - Vice President, North America, and Vice President - Corporate Aircraft
since he joined PALC in August 1986. Effective July 1, 1994, Mr. Adams held the
positions of Vice President and Director of PIMC.
Mr. Liu, 38, has assumed the position of Vice President of PIMC effective May 1,
1995 and has assumed the position of Director of PIMC effective July 31, 1995.
Mr. Liu presently holds the position of Executive Vice President - Marketing of
GECAS, having previously held the position of Executive Vice President - Capital
Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was
with General Electric Capital Corporation for nine years. He has held management
positions in corporate Business Development and in Syndications and Leasing for
Transportation and Industrial Funding Corporation (TIFC). Mr. Liu previously
held the position of managing director of Kidder, Peabody & Co., Incorporated.
45
Mr. Sun, 46, has assumed the position of Vice President of PIMC effective May 1,
1995. Mr. Sun presently holds the position of Senior Vice President - Structured
Finance of GECAS. Prior to joining GECAS, Mr. Sun held various positions with
TIFC since 1990.
Mr. Flynn, 55, Vice President - Marketing of GECAS, served as Senior Vice
President - Aircraft Marketing for PIMC and PALC effective April 1991, having
previously served as Vice President North America of PIMC and PALC effective
July 1989. Mr. Flynn joined PALC in March 1989 as Vice President - Cargo. For
the two years prior to joining PALC, Mr. Flynn was a transportation consultant.
Effective July 1, 1994, Mr. Flynn held the position of Vice President of PIMC.
Mr. Dillon, 54, became Vice President - Aviation Legal and Insurance Affairs,
effective April 1989. Previously, he served as General Counsel of PIMC and PALC
effective January 1986. Effective July 1, 1994, Mr. Dillon held the positions of
Vice President and Assistant Secretary of PIMC. Mr. Dillon presently holds the
position of Senior Vice President of GECAS.
Mr. Blume, 54, has assumed the position of Secretary of PIMC effective May 1,
1995. Mr. Blume presently holds the position of Executive Vice President and
General Counsel of GECAS. Prior to joining GECAS, Mr. Blume was counsel at GE
Aircraft Engines since 1987.
Mr. Meiches, 43, has assumed the position of Chief Financial Officer of PIMC
effective October 9, 1995. Mr. Meiches presently holds the positions of
Executive Vice President and Chief Financial Officer of GECAS. Prior to joining
GECAS, Mr. Meiches has been with General Electric Company (GE) and its
subsidiaries since 1978. Since 1992, Mr. Meiches held the position of Vice
President of the General Electric Capital Corporation Audit Staff. Between 1987
and 1992, Mr. Meiches held Manager of Finance positions for GE Re-entry Systems,
GE Government Communications Systems and the GE Astro-Space Division.
46
Certain Legal Proceedings:
On October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v.
Polaris Holding Company, et al. was filed in the Supreme Court of the State of
New York for the County of New York. The complaint sets forth various causes of
action which include allegations against certain or all of the defendants (i)
for alleged fraud in connection with certain public offerings, including that of
the Partnership, on the basis of alleged misrepresentation and alleged omissions
contained in the written offering materials and all presentations allegedly made
to investors; (ii) for alleged negligent misrepresentation in connection with
such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged
breach of third party beneficiary contracts; (v) for alleged violations of the
NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for
alleged breach of implied covenants in the customer agreements by certain
registered brokers. The complaint seeks an award of compensatory and other
damages and remedies. On January 19, 1993, plaintiffs filed a motion for class
certification. On March 1, 1993, defendants filed motions to dismiss the
complaint on numerous grounds, including failure to state a cause of action and
statute of limitations. On July 20, 1994, the court entered an order dismissing
almost all of the claims in the complaint and amended complaint. Certain claims,
however, remain pending. Plaintiffs filed a notice of appeal on September 2,
1994. The Partnership is not named as a defendant in this action.
On or around February 17, 1993, a civil action entitled Einhorn, et al. v.
Polaris Public Income Funds, et al., was filed in the Circuit Court of the 11th
Judicial Circuit in and for Dade County, Florida against, among others, Polaris
Investment Management Corporation and Polaris Depositary Company. Plaintiffs
seek class action certification on behalf of a class of investors in Polaris
Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft
Income Fund VI who purchased their interests while residing in Florida.
Plaintiffs allege the violation of Section 517.301, Florida Statutes, in
connection with the offering and sale of units in such Polaris Aircraft Income
Funds. Among other things, plaintiffs assert that the defendants sold interests
in such Polaris Aircraft Income Funds while "omitting and failing to disclose
the material facts questioning the economic efficacy of" such Polaris Aircraft
Income Funds. Plaintiffs seek rescission or damages, in addition to interest,
costs, and attorneys' fees. On April 5, 1993, defendants filed a motion to stay
this action pending the final determination of a prior filed action in the
Supreme Court for the State of New York entitled Weisl v. Polaris Holding
Company. On that date, defendants also filed a motion to dismiss the complaint
on the grounds of failure to attach necessary documents, failure to plead fraud
with particularity and failure to plead reasonable reliance. On April 13, 1993,
the court denied the defendants' motion to stay. On May 7, 1993, the court
stayed the action pending an appeal of the denial of the motion to stay.
Defendants subsequently filed with the Third District Court of Appeal a petition
for writ of certiorari to review the lower court's order denying the motion to
stay. On October 19, 1993, the Court of Appeal granted the writ of certiorari,
quashed the order, and remanded the action with instruction to grant the stay.
The Partnership is not named as a defendant in this action.
On or around May 14, 1993, a purported class action entitled Moross, et al., v.
Polaris Holding Company, et al., was filed in the United States District Court
for the District of Arizona. This purported class action was filed on behalf of
investors in Polaris Aircraft Income Funds I - VI by nine investors in such
Polaris Aircraft Income Funds. The complaint alleges that defendants violated
Arizona state securities statutes and committed negligent misrepresentation and
breach of fiduciary duty by misrepresenting and failing to disclose material
facts in connection with the sale of limited partnership units in the
above-named funds. An amended complaint was filed on September 17, 1993, but has
not been served upon defendants. On or around October 4, 1993, defendants filed
a notice of removal to the United States District Court for the District of
Arizona. Defendants also filed a motion to stay the action pending the final
47
determination of a prior filed action in the Supreme Court for the State of New
York entitled Weisl v. Polaris Holding Company ("Weisl") and to defendants' time
to respond to the complaint until 20 days after disposition of the motion to
action pending resolution of the motions for class certification and motions to
dismiss pending in Weisl. On January 20, 1994, the court stayed the action and
required defendants to file status reports every sixty days setting forth the
status of the motions in Weisl. On April 18, 1995, this action was transferred
to the Multi-District Litigation described below. The Partnership is not named
as a defendant in this action.
On September 21, 1993, a purported derivative action entitled Novak, et al., v.
Polaris Holding Company, et al., was filed in the Supreme Court of the State of
New York, County of New York. This action was brought on behalf of the
Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund
III. The complaint names as defendants Polaris Holding Company, its affiliates
and others. Each of the Partnership, Polaris Aircraft Income Fund I and Polaris
Aircraft Income Fund III is named as a defendant for procedural purposes, but no
recovery is sought from these defendants. The complaint alleges, among other
things, that defendants mismanaged the Partnership and the other Polaris
Aircraft Income Funds, engaged in self-dealing transactions that were
detrimental to the Partnership and the other Polaris Aircraft Income Funds and
failed to make required disclosure in connection with the sale of the units in
the Partnership and the other Polaris Aircraft Income Funds. The complaint
alleges claims of breach of fiduciary duty and constructive fraud and seeks,
among other things an award of compensatory and punitive damages in an
unspecified amount, re-judgment interest, and attorneys' fees and costs. On
January 13, 1994, certain of the defendants, including Polaris Holding Company,
filed motions to dismiss the complaint on the grounds of, among others, failure
to state a cause of action and failure to plead the alleged wrong in detail. On
August 11, 1994, the court denied in part and granted in part defendants'
motions to dismiss. Specifically, the court denied the motions as to the claims
for breach of fiduciary duty, but dismissed plaintiffs' claim for constructive
fraud with leave to replead. On October 7, 1994, defendants filed a notice of
appeal. On November 15, 1994, defendants submitted an answer to the remaining
causes of action. On July 7, 1995, defendants filed briefs in support of their
appeal from that portion of the trial court's order denying the motion to
dismiss. On March 14, 1996, the appellate court reversed the trial court's order
denying the motion to dismiss, and dismissed the complaint.
On or around March 13, 1993, a purported class action entitled Kahn v. Polaris
Holding Company, et al., was filed in the Supreme Court of the State of New
York, County of New York. This purported class action on behalf of investors in
Polaris Aircraft Income Fund V was filed by one investor in the fund. The
complaint names as defendants Polaris Investment Management Corporation, Polaris
Holding Company, its affiliates and others. The complaint charges defendants
with common law fraud, negligent misrepresentation and breach of fiduciary duty
in connection with certain misrepresentations and omissions allegedly made in
connection with the sale of interests in Polaris Aircraft Income Fund V.
Plaintiffs seek compensatory and consequential damages in an unspecified amount,
plus interest, disgorgement and restitution of all earnings, profits and other
benefits received by defendants as a result of their alleged practices, and
attorneys' fees and costs. Defendants' time to move, answer or otherwise plead
with respect to the complaint was extended by stipulation up to and including
April 24, 1995. On April 18, 1995, the action was discontinued without
prejudice. The Partnership is not named as a defendant in this action.
On June 8, 1994, a consolidated complaint captioned In re Prudential Securities
Inc. Limited Partnerships Litigation was filed in the United States District
Court for the Southern District of New York, purportedly consolidating cases
that had been transferred from other federal courts by the Judicial Panel on
Multi-District Litigation. The consolidated complaint names as defendants
Prudential entities and various other sponsors of limited partnerships sold by
48
Prudential, including Polaris Holding Company, one of its former officers,
Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation
and Polaris Securities Corporation. The complaint alleges that the Prudential
defendants created a scheme for the sale of approximately $8-billion of limited
partnership interests in 700 assertedly high-risk limited partnerships,
including the Partnership, to approximately 350,000 investors by means of false
and misleading offering materials; that the sponsoring organizations (including
the Polaris entities) participated with the Prudential defendants with respect
to, among other things, the partnerships that each sponsored; and that all of
the defendants conspired to engage in a nationwide pattern of fraudulent conduct
in the marketing of all limited partnerships sold by Prudential. The complaint
alleges violations of the federal Racketeer Influenced and Corrupt Organizations
Act and the New Jersey counterpart thereof, fraud, negligent misrepresentation,
breach of fiduciary duty and breach of contract. The complaint seeks rescission,
unspecified compensatory damages, treble damages, disgorgement of profits
derived from the alleged acts, costs and attorneys fees. On October 31, 1994,
Polaris Investment Management Corporation and other Polaris entities filed a
motion to dismiss the consolidated complaint on the grounds of, inter alia,
statute of limitations and failure to state a claim. The Partnership is not
named as a defendant in this action. Prudential Securities, Inc., on behalf of
itself and its affiliates has made an Offer of Settlement. A class has been
certified for purposes of the Prudential Settlement and notice to the class has
been sent. Any questions concerning Prudential's Offer of Settlement should be
directed to 1-800- 327-3664, or write to the Claims Administrator at:
Prudential Securities Limited Partnerships
Litigation Claims Administrator
P.O. Box 9388
Garden City, New York 11530-9388
A further litigation captioned Romano v. Ball et. al, an action by Prudential
Insurance Company policyholders against many of the same defendants (including
Polaris Investment Management Corporation and Polaris Aircraft Leasing
Corporation), has also been commenced by policy holders of the Prudential
Insurance Company as a purported derivative action on behalf of the Prudential
Insurance Company. The complaint alleges claims under the federal Racketeer
Influenced and Corrupt Organizations Act, as well as claims for waste,
mismanagement and intentional and negligent misrepresentation, and seeks
unspecified compensatory, treble and punitive damages. The case is being
coordinated with In re Prudential.
On or about February 13, 1995, an action entitled Adams, et al. v. Prudential
Securities, Inc. et al. was filed in the Court of Common Pleas, Stark County,
Ohio. The action names Prudential Securities, Inc., Prudential Insurance Company
of America, Polaris Investment Management Corporation, Polaris Securities
Corporation, Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, Polaris Aircraft Income Fund I, Polaris
Aircraft Income Fund IV, Polaris Aircraft Income Fund V and James Darr as
defendants. The complaint alleges that defendants committed common law fraud,
fraud in the inducement, negligent misrepresentation, negligence, breach of
fiduciary duty and civil conspiracy by misrepresenting and failing to disclose
material facts in connection with the sale of limited partnership units in
Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, and Polaris
Aircraft Income Fund V. Plaintiffs seek, among other things, rescission of their
investments in the Polaris Aircraft Income Funds, an award of compensatory
damages in an unspecified amount plus interest thereon, and punitive damages in
an unspecified amount. On or about March 15, 1995, this action was removed to
the United States District Court for the Northern District of Ohio, Eastern
Division. Subsequently, the Judicial Panel transferred this action to the
Multi-District Litigation filed in the United States District Court for the
Southern District of New York, discussed above. The Partnership is not named as
a defendant in this action.
49
On or about February 6, 1995, a class action complaint entitled Cohen, et al. v.
J.B. Hanauer & Company, et al. was filed in the Circuit Court of the Fifteenth
Judicial Circuit in and for Palm Beach County, Florida. The complaint names J.B.
Hanauer & Company, General Electric Capital Corporation, General Electric
Financial Services, Inc., and General Electric Company as defendants. The action
purports to be on behalf of "approximately 5,000 persons throughout the United
States" who purchased units in Polaris Aircraft Income Funds I through VI. The
complaint sets forth various causes of action which include allegations against
certain or all of the defendants (i) for violation of Section 12(2) of the
Securities Act of 1933, as amended, by a registered broker dealer and for
violation of Section 15 of such act by all defendants in connection with certain
public offerings, including that of the Partnership, on the basis of alleged
misrepresentation and alleged omissions contained in the written offering
materials and all presentations allegedly made to investors; (ii) for alleged
fraud in connection with such offerings; (iii) for alleged negligent
misrepresentation in connection with such offerings; (iv) for alleged breach of
fiduciary duties; (v) for alleged breach of third party beneficiary contracts;
(vi) for alleged violations of the NASD Rules of Fair Practice by a registered
broker dealer; and (vii) for alleged breach of implied covenants in the customer
agreements by a registered broker dealer. The complaint seeks an award of
compensatory and punitive damages and other remedies. On June 7, 1995,
plaintiffs filed an amended complaint which did not include as defendants
General Electric Capital Corporation, General Electric Financial Services, Inc.,
and General Electric Company, thus effectively dismissing without prejudice the
case against these entities. The Partnership is not named as a defendant in this
action.
On or about January 12, 1995, a class action complaint entitled Cohen, et al. v.
Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the
Fifteenth Judicial Circuit in and for Palm Beach County, Florida, and on March
31, 1995 the case was removed to the United States District Court for the
Southern District of Florida. An amended class action complaint (the "amended
complaint"), which re-named this action Bashein, et al. v. Kidder, Peabody &
Company Inc., et al., was filed on June 13, 1995. The amended complaint names
Kidder Peabody & Company, Inc., General Electric Capital Corporation, General
Electric Financial Services, Inc., and General Electric Company as defendants.
The action purports to be on behalf of "approximately 20,000 persons throughout
the United States" who purchased units in Polaris Aircraft Income Funds III
through VI. The amended complaint sets forth various causes of action
purportedly arising in connection with the public offerings of Polaris Aircraft
Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund
V, and Polaris Aircraft Income Fund VI. Specifically, plaintiffs assert claims
for violation of Sections 12(2) and 15 of the Securities Act of 1933, fraud,
negligent misrepresentation, breach of fiduciary duty, breach of third party
beneficiary contract, violation of NASD Rules of Fair Practice, breach of
implied covenant, and breach of contract. Plaintiffs seek compensatory damages,
interest, punitive damages, costs and attorneys' fees, as well as any other
relief the court deems just and proper. Defendants moved to dismiss the amended
complaint on June 26, 1995. On October 2, 1995, the court denied the defendants'
motion to dismiss. The Partnership is not named as a defendant in this action.
On or around April 13, 1995, a class action complaint entitled B & L Industries,
Inc., et al. v. Polaris Holding Company, et al. was filed in the Supreme Court
of the State of New York. The complaint names as defendants Polaris Holding
Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management
Corporation, Polaris Securities Corporation, Peter G. Pfendler, Marc P.
Desautels, General Electric Capital Corporation, General Electric Financial
Services, Inc., General Electric Company, Prudential Securities Inc., and Kidder
Peabody & Company Incorporated. The complaint sets forth various causes of
action purportedly arising out of the public offerings of Polaris Aircraft
Income Fund III and Polaris Aircraft Income Fund IV. Plaintiffs allege claims of
fraud, negligent misrepresentation, breach of fiduciary duty, knowingly inducing
or participating in breach of fiduciary duty, breach of third party beneficiary
50
contract, violation of NASD Rules of Fair Practice, breach of implied covenant,
and unjust enrichment. Plaintiffs seek compensatory damages, interest, general,
consequential and incidental damages, exemplary and punitive damages,
disgorgement, rescission, costs, attorneys' fees, accountants' and experts'
fees, and other legal and equitable relief as the court deems just and proper.
On October 2, 1995, defendants moved to dismiss the complaint. The Partnership
is not named as a defendant in this action.
On or around September 27, 1995, a complaint entitled Martha J. Harrison v.
General Electric Company, et al., was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and Prudential Securities Incorporated. Plaintiff alleges
claims of tort, breach of fiduciary duty in tort, contract and quasi-contract,
violation of sections of the Louisiana Blue Sky Law and violation of the
Louisiana Civil Code concerning the inducement and solicitation of purchases
arising out of the public offering of Polaris Aircraft Income Fund IV. Plaintiff
seeks compensatory damages, attorney's fees, interest, costs and general relief.
The Partnership is not named as a defendant in this action.
On or around December 8, 1995, a complaint entitled Overby, et al. v. General
Electric Company, et al. was filed in the Civil District Court for the Parish of
Orleans, State of Louisiana. The complaint names as defendants General Electric
Company and General Electric Capital Corporation. Plaintiffs allege claim of
tort, breach of fiduciary duty, in tort, contract and quasi-contract, violation
of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil
Code in connection with the public offering of Polaris Aircraft Income Funds III
and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs
and general relief. The Partnership is not named as a defendant in this action.
In or around November 1994, a complaint entitled Lucy R. Neeb, et al. v.
Prudential Securities Incorporated et al., was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company, General Electric
Capital Corporation and Smith Barney, Inc. Plaintiffs allege claims of tort,
breach of fiduciary duty, in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
in connection with the public offering of Polaris Aircraft Income Funds III and
IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief. The Partnership is not named as a defendant in this action.
In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v.
Prudential Securities, Incorporated et al., was filed in the Civil District
Court for the Parish of Orleans, State of Louisiana. The complaint named as
defendants Prudential Securities Incorporated and Stephen Derby Gisclair. On or
about January 18, 1996, plaintiff filed a First Supplemental and Amending
Petition adding defendants General Electric Company and General Electric Capital
Corporation. Plaintiff alleges claims of tort, breach of fiduciary duty in tort,
contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law
and violation of the Louisiana Civil Code in connection with the public offering
of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory
damages, attorneys' fees, interest, costs and general relief. The Partnership is
not named as a defendant in this action.
On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v.
General Electric Co., et al., was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and General Electric Capital Corporation. Plaintiffs allege
claims of tort, breach of fiduciary duty in tort, contract and quasi-contract,
violation of sections of the Louisiana Blue Sky Law and violation of the
51
Louisiana Civil Code in connection with the public offering of Polaris Aircraft
Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief. The Partnership is not named as a defendant in this
action.
Other Proceedings - Part I, Item 3 discusses certain other actions arising out
of certain public offerings, including that of the Partnership, to which both
the Partnership and its general partner are parties.
Disclosure pursuant to Section 16, Item 405 of Regulation S-K:
Based solely on its review of the copies of such forms received or written
representations from certain reporting persons that no Forms 3, 4, or 5 were
required for those persons, the Partnership believes that, during 1995 all
filing requirements applicable to its officers, directors and greater than ten
percent beneficial owners were met.
Item 11. Executive Compensation
PAIF-II has no directors or officers. PAIF-II is managed by PIMC, the General
Partner. In connection with management services provided, management and
advisory fees of $763,773 were paid to PIMC in 1995 in addition to a 10%
interest in all cash distributions as described in Note 9 to the financial
statements (Item 8).
Item 12. Security Ownership of Certain Beneficial Owners and Management
a) No person owns of record, or is known by PAIF-II to own beneficially,
more than five percent of any class of voting securities of PAIF-II.
b) The General Partner of PAIF-II owns the equity securities of PAIF-II
as set forth in the following table:
Title Name of Amount and Nature of Percent
of Class Beneficial Owner Beneficial Ownership of Class
- -------- ---------------- -------------------- --------
General Polaris Investment Represents a 10.0% interest of all cash 100%
Partner Management distributions, gross income in an
Interest Corporation amount equal to 9.09% of distributed
cash available from operations, and a
1% interest in net income or loss
c) There are no arrangements known to PAIF-II, including any pledge by
any person of securities of PAIF-II, the operation of which may at a
subsequent date result in a change in control of PAIF-II.
Item 13. Certain Relationships and Related Transactions
None.
52
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
1. Financial Statements.
The following are included in Part II of this report:
Page No.
Report of Independent Public Accountants 24
Balance Sheets 25
Statements of Operations 26
Statements of Changes in Partners' Capital (Deficit) 27
Statements of Cash Flows 28
Notes to Financial Statements 29
2. Reports on Form 8-K.
None.
3. Exhibits required to be filed by Item 601 of Regulation S-K.
27. Financial Data Schedules (Filed electronically only).
4. Financial Statement Schedules.
All financial statement schedules are omitted because they are not
applicable, not required or because the required information is
included in the financial statements or notes thereto.
53
SIGNATURES
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
March 25, 1996 By: /S/ James W. Linnan
- ------------------------------- -------------------
Date James W. Linnan, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/S/James W. Linnan President and Director of Polaris March 25, 1996
- ------------------ Investment Management Corporation, --------------
(James W. Linnan) General Partner of the Registrant
/S/Norman C. T. Liu Vice President and Director of Polaris March 25, 1996
- ------------------- Investment Management Corporation, --------------
(Norman C. T. Liu) General Partner of the Registrant
/S/Marc A. Meiches Chief Financial Officer of Polaris March 25, 1996
- ------------------ Investment Management Corporation, --------------
(Marc A. Meiches) General Partner of the Registrant
54