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March 28, 1996
Securities and Exchange Commission
Judiciary Plaza
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: 1934 Act Filing Department
Re: Pegasus Aircraft Partners II, L.P. (the "Registrant")
Commission File Number 0-18387
Ladies and Gentlemen:
On behalf of the Registrant, we are delivering herewith for filing
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as
amended, and the Rules and Regulations promulgated thereunder, the following:
(1) One (1) complete copy which has been manually executed, of the
Registrant's Annual report on Form 10-K for 1995 (the "Form
10-K");
(2) Two (2) conformed copies of the complete Form 10-K; and
(3) Five (5) conformed copies of the Form 10-K, excluding
exhibits.
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Please acknowledge receipt of this letter and the enclosures on the
attached copy of this letter and return it to us in the enclosed, self-addressed
envelope.
Very truly yours,
Joseph P. Ciavarella, Vice President
Air Transport Leasing, Inc.
JPC/mm
Enclosures
cc: Laura Banchini
Lorna G. Bell / Moody's
Gregory Harding-Brown
Carol L. Chase, Esq.
Hugh Connelly (Corestates)
Paul J. Derenthal, Esq.
Richard W. Doust
Stephen R. Dyer
Gerald F. Goertz, Jr.
Spencer Jefferies
Anthony Anderson (Coopers and Lybrand)
Clifford B. Wattley
Meta Herzog (Finova)
Richard S. Wiley
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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[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, 1996
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 number 0-18387
Pegasus Aircraft Partners II, L.P.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 84-1111757
-------- ----------
(State of organization) (I.R.S. Employer
Identification No.)
Four Embarcadero Center
35th Floor
San Francisco, California 94111
------------------------- ----------
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (415) 434-3900
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
-------------------------------------
(Title of Class)
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 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. [ ]
State the aggregate market value of the voting stock held by
non-affiliates of the Registrant: Not applicable.
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Pegasus Aircraft Partners II, L.P.
Annual Report on Form 10-K for the
Fiscal Year Ended December 31, 1996
Table of Contents
Page
----
Part I
Item 1 Business........................................................ 1
Item 2 Properties...................................................... 13
Item 3 Legal Proceedings............................................... 14
Item 4 Submission of Matters to a Vote
of Security Holders......................................... 16
Part II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters............................. 16
Item 6 Selected Financial Data......................................... 17
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations................................... 18
Item 8 Financial Statements............................................ F-1
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure........................................ 24
Part III
Item 10 Directors and Executive Officers
of the Registrant........................................... 24
Item 11 Executive Compensation.......................................... 27
Item 12 Security Ownership of Certain
Beneficial Owners and Management............................ 27
Item 13 Certain Relationships and
Related Transactions........................................ 28
Part IV
Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K..................................... 30
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PART I
Item 1. Business
General
Pegasus Aircraft Partners II, L.P. (the "Partnership" or the
"Registrant") is a limited partnership organized under the laws of the State of
Delaware on April 26, 1989. The general partners of the Partnership are Pegasus
Aircraft Management Corporation, the Managing General Partner, a California
corporation that is a wholly owned subsidiary of Pegasus Capital Corporation,
and Air Transport Leasing, Inc., the Administrative General Partner, a Delaware
corporation that is a wholly owned subsidiary of PaineWebber Group Inc.
(collectively, the "General Partners").
On August 15, 1989, the Partnership commenced an offering of units of
limited partnership interest ("Units"). The offering of the Units was terminated
during the third quarter of 1990, when the total capitalization of the
Partnership reached $145.1 million. The Partnership incurred $16,295,000 of
commissions and other expenses in connection with the sale of these Units.
Although the Partnership was organized on April 26, 1989, the
Partnership conducted no activities and recognized no revenues, profits or
losses prior to September 20, 1989 at which time the Partnership commenced
operations. During the period between September 21, 1989 and August 22, 1990,
the Partnership acquired its portfolio of used commercial aircraft which are
principally subject to triple net operating leases with domestic and foreign
commercial air carriers.
The Partnership is required to dissolve and distribute all of its
assets no later than December 31, 2007. The Partnership may reinvest the
proceeds from sales of aircraft occurring prior to August 21, 1998, provided
that the aggregate amount of sales proceeds so reinvested will in no event
exceed $60,000,000, and provided further that prior to any such reinvestment the
Partnership distributes to the Limited Partners cash in an amount sufficient to
pay any federal and state income taxes to be incurred by Limited Partners as a
result of the aircraft sale. Thereafter, the net proceeds of any sales of
aircraft will be distributed to the partners.
At a meeting of the Board of Directors of Air Transport Leasing, Inc.
("Board"), the Board adopted the Policy Regarding Requests for Partner Lists
attached as Exhibit 11.
Outlook for the Airline and Aircraft Leasing Industries
The US airline industry had a profitable year in 1996 with net earnings
estimated at $6 billion, which continued the industry's profitability trend.
However, the year was marred by the ValueJet and TWA crashes which raised
questions about aircraft maintenance and aging aircraft. With new aircraft
orders increasing, it was a robust year in aircraft production. The demand for
used aircraft was reflected in, for the most part, stable lease rates for such
aircraft. Continental Airlines Inc. ("Continental") continued to report positive
financial results in 1996 and USAirways Group Inc., (formerly USAir, Inc.)
("USAir") continued to show financial improvements. TWA was hurt by the incident
discussed above and continued to report losses while announcing a reduction in
European service and its fleet of 747 widebody aircraft. Kiwi
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International Air Lines Inc. ("Kiwi") continued to have significant liquidity
concerns and in September 1996 filed for protection from its creditors under
Chapter 11 of the US Bankruptcy Code. The Partnership recovered the aircraft and
committed to lease the aircraft to two start-up carriers. Aircraft leasing
continues to be a highly competitive business and the Partnership's lessees
continue to face significant competitive challenges. Air traffic has been and
continued to be correlated to overall economic activity.
Recent Partnership Developments
Immediately below is a table which shows the December 31, 1996 appraised value
of the Partnership's aircraft to be approximately $69.7 million, or
approximately 49% of the original acquisition cost plus related capital
expenditures (excluding acquisition-related fees). Based upon these appraised
values, the Partnership's net asset value at December 31, 1996 was equal to
$8.20 per Unit. It should be noted that these are only estimates of value as of
that date, and not necessarily representative of the values that will ultimately
be realized when these aircraft are disposed of nor does this represent the
value that may be realized upon the disposition of a Unit.
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Aircraft Portfolio
The following table describes the Partnership's aircraft portfolio at
December 31, 1996:
December Current
1996 Lease Original Noise Cumulative Cumulative
Current Aircraft Ownership Acquisition Appraised Expiration Delivery Abatement Flight Flight
Lessee Type Interest Costs(1) Value(2) Date(3) Date Compliance Hours(4) Cycles(4)
------ -------- --------- ----------- ---------- ---------- -------- ---------- ----------- ----------
(in millions) (in millions)
Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100% $8.9 $ 3.3 7/06/97 1970 Stage 2 59,285 56,507
Aerovias de
Mexico, S.A. McDonnell
de C.V. Douglas DC-9-31 100 8.9 3.3 7/23/97 1971 Stage 2 64,757 61,918
Continental Boeing 727-200
Airlines, Inc. Advanced 100 4.5(8) 3.7 5/31/99 1973 Stage 2 68,646 49,088
Continental Boeing 727-200
Airlines, Inc. Advanced 100 4.1(8) 3.6 1/31/98 1973 Stage 2 68,906 49,184
Continental McDonnell
Micronesia Inc. Douglas
DC-10-10 100 18.3 8.7 6/30/98 1973 Stage 3 76,411 27,930
(7) Airbus Industrie
A300-B4-103 100 28.1 8.0 (7) 1979 Stage 3 46,107 19,527
(9) Boeing 727-200
Non-Advanced 100 9.5 6.0 (9) 1970 Stage 3 72,952 53,632
(10) Boeing 727-200
Advanced 100 11.7 8.8 (10) 1973 Stage 2 57,736 30,892
Trans World McDonnell
Airlines. Douglas MD-82 100 21.0 16.0 11/01/04 1983 Stage 3 42,343 21,790
(11) Lockheed
L-1011 100 17.7 2.8 (11) 1974 Stage 3 61,207 22,906
US Airways McDonnell
Group, Inc. Douglas MD-81 50(5) 10.0 5.5 6/01/98(6) 1982 Stage 3 40,871 37,116
------ -----
$142.7 $69.7
====== =====
Notes: (1) Acquisition costs do not include related acquisition fees of
$3.0 million paid to the General Partners. The cost amounts shown
include capital expenditures incurred during 1996, 1995, 1994 and
1993 of $2.5 million, $26,000, $.3 million and $2.2 million,
respectively. Such amounts include two Boeing 727-200 Advanced
aircraft received in connection with the A-300 settlement.
(2) The December 1996 appraised values were determined by an
independent aircraft appraisal firm. Appraised values include the
present value of rents due under leases in place plus the present
value of an estimated residual value for the aircraft at the end
of the lease. It should be noted that appraisals are only
estimates of value and should not be relied on as measures of
realizable value.
(3) Lease expiration dates do not include renewal options except in
the case of US Air.
(4) The number of cumulative flight cycles and cumulative flight hours
shown are as of December 31, 1996, except they are as of March 6,
1997 with respect to the TWA MD-82.
(5) The remaining one-half beneficial interest is owned by Pegasus
Aircraft Partners, L.P., an affiliated partnership.
(6) If US Air does not renew the lease for an initial three-year
renewal period to June 2001, the partnership is entitled to a
lease termination payment.
(7) Aircraft off lease at December 31, 1996. Appraised value
represents the approximate current market value unencumbered by
lease.
(8) Represents aircraft received in connection with the A-300
settlement.
(9) Substantially all of the $2.5 million in capital expenditures in
1996 relate to this aircraft and represent hushkit ($1.9 million)
purchased as well as a portion of the last phase of maintenance
check aircraft completed as of December 31, 1996 ($.6 million).
An additional amount of approximately $.7 million was incurred
in 1997 with respect to this maintenance check prior to delivery
to Falcon Air Express, Inc. subject to a 60 month lease
commencing March 1997. This lease is reflected in the appraised
value.
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(10) Aircraft was committed to cargo conversion which was in the
process of being completed in early 1997. The aircraft is
scheduled to be delivered to Capital Cargo International Airlines
Inc. for a term of approximately 96 months. The hushkit
(approximately $3 million), cargo conversion ($1.6 million) and
replacement engines ($2 million) are reflected in the appraised
value.
(11) Lease terminated and aircraft returned on October 1996. TWA
prepaid the lease, on a discounted basis and paid the Partnership
$3,000,000 in lieu of meeting certain lease return conditions. The
aircraft is valued based upon its current condition.
The following is a description of the principal financial terms of the
leases listed in the table.
a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental, originally
scheduled to expire on May 31, 1997, with rents of $252,000 per month.
Continental also had three two-year renewal options, with rent payable during
the first two such renewal periods at the lesser of the then fair market rental
value or the rental rate during the initial term, and during the third such
renewal period at the then fair market rental rate. In addition, the lessee has
a right of first refusal to purchase or re-lease the aircraft after the last
renewal period on the same terms as those included in any bona fide offer made
to the Partnership by a third party. This lease was modified in 1995 as
discussed below.
During September 1989, the Partnership acquired a Boeing 727-200
non-advanced aircraft for a total purchase price of $6,116,000, subject to an
operating lease with Continental. This aircraft was returned during
Continental's bankruptcy and subsequently leased to Kiwi (see discussion of Kiwi
below).
During August 1990, the Partnership acquired an Airbus Industrie Model
A-300-B4-103 ("A-300") aircraft for a total purchase price of $28,070,000,
subject to an operating lease with Continental, originally scheduled to expire
on December 29, 2000 and with monthly, in advance, rentals of $312,000.
Continental did not make the monthly rental payments due under the
three leases with the Partnership on December 1, 1990 and filed for Chapter 11
bankruptcy protection on December 3, 1990. The Partnership entered into various
lease modifications and financing arrangements with Continental as a result of
the bankruptcy. At December 31, 1996, the Partnership had aircraft modification
advances outstanding from Continental totaling $93,000, which are being repaid
monthly with interest.
In January 1995, Continental announced that it was grounding its fleet
of Airbus Industrie A-300 aircraft, including the A-300 aircraft leased to it by
the Partnership, and notified the Partnership of its intention to return the
aircraft to the Partnership. Continental paid $150,000 of the $312,000 monthly
rental payment due in February through May 1995. The Partnership did not accrue
as rental revenue the difference between the amount due and the amount paid by
Continental for such months. Continental took the A-300 out of service in May
1995, and the Partnership prepared the aircraft for delivery in June 1995 to a
new lessee, Akdeniz Air Mediterranean, Inc. ("Akdeniz") based in Turkey.
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On June 1995, the Partnership executed a lease of the A-300 aircraft to
Akdeniz for a scheduled term of four years, under which Akdeniz subsequently
defaulted. The Partnership recovered the A-300 aircraft, returned it to FAA
registry, and is currently remarketing it. The Partnership estimates that it
will spend approximately $2.5 million for a scheduled heavy maintenance check
and other modifications that will be required prior to delivery of the aircraft
to a new lessee. The Partnership received $557,000 from Continental pursuant to
the A-300 Settlement discussed below which will be applied towards such
maintenance.
On November 15, 1995, the Partnership reached an agreement with
Continental regarding the settlement of its lease obligations under the A-300
lease ("A-300 Lease Settlement"), which also included a restructuring of the
DC-10-10 aircraft lease ("DC-10 Restructuring").
Under the terms of the A-300 Lease Settlement, the Partnership received
a cash payment of approximately $3,721,000, including approximately $325,000 as
reimbursement for certain integration and transaction expenses, and (i) title to
a Boeing 727-200 advanced aircraft subject to lease with Continental for a term
of approximately 26 months at a lease rate of $85,000 per month and (ii) title
to a second Boeing 727-200 advanced aircraft subject to a lease with Continental
for a term of approximately 42 months at a lease rate of $85,000 per month.
Additionally, the Partnership received approximately $557,000 as an economic
settlement in lieu of Continental performing certain maintenance work and the
aircraft meeting certain return conditions required by the lease.
Under the DC-10 Restructuring, the Partnership received approximately
$3,100,000, the lease expiration date was changed from May 31, 1997 to October
31, 1996 and the monthly lease payments were reduced from $252,000 to $135,000
effective September 15, 1995. All other terms and conditions of the DC-10-10
lease remain unchanged. During 1996, Continental and the Partnership reached
agreement to extend the lease to June 30, 1998 at a lease rate of $150,000 per
month.
b. Trans World Airlines Leases During December 1989, the Partnership
acquired a McDonnell Douglas MD-82 aircraft for a total purchase price of
$20,763,000, subject to an operating lease with TWA, which was originally
scheduled to expire on April 13, 1993, but was amended and extended until
November 1, 1998 with monthly, in advance, rental payments of $185,000. As
described below, this lease was further extended to November 2004 during TWA's
prepackaged bankruptcy in 1995.
Upon execution of the lease amendment, the Partnership reimbursed TWA
for $225,000 of capital improvements which were made to the aircraft and
advanced $750,000 to TWA to finance certain major maintenance procedures, which
is being repaid over the remaining lease term, in monthly installments with
interest at a fixed rate of 9.70%. At December 31, 1996, the balance of the
receivable was $295,000. All 1997 repayments of advances have been made by TWA.
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During January 1990, the Partnership acquired a Lockheed L-1011
aircraft for a total purchase price of $17,555,000, subject to an operating
lease with TWA, originally scheduled to expire on June 30, 1993. The lease was
amended and extended to October 1,1998 with rental payments payable monthly, in
advance, at the rate of $130,000.
Upon execution of the lease amendment, the Partnership reimbursed TWA
for $225,000 of capital improvements which were made to the aircraft and
advanced $550,000 to TWA to finance certain major maintenance procedures, which
is being repaid over the remaining lease term in monthly installments with
interest at 9.68%. At December 31, 1996, the balance of the receivable was
$210,000. All 1997 repayments of advances have been made by TWA as scheduled.
In mid-October 1994, because of operating and financial problems, TWA
announced that it would seek a global restructuring of its capital by offering
common stock for its debt securities, preferred stock obligations and lease
deferrals negotiated with aircraft lessors such as the Partnership ("Exchange
Offer") with the objective of an orderly financial reorganization through a
prepackaged bankruptcy filing. In conjunction with this restructuring, TWA and
the Partnership agreed ("TWA Agreement") to a deferral of 50% of the rent
scheduled for November 1994, and 75% of the rent scheduled from December 1994 to
April 1995 for the MD-82 aircraft (50% of the December 1994 through April 1995
rent with respect to the L-1011 aircraft) followed by a return to the original
payment schedule. Under the terms of the TWA Agreement all rents deferred during
the November 1994 to April 1995 period were repaid with interest at 12% from the
date of deferral over an 18-month period which commenced May 1, 1995.
Additionally, TWA and the Partnership agreed to extend the lease of the MD-82
aircraft six years beyond the scheduled expiration date (to November 2004) at
the current lease rate of $185,000 per month. On June 30, 1995, TWA filed its
prepackaged reorganization plan under Chapter 11 of the U.S. Bankruptcy Code. On
August 23, 1995 the reorganization plan which included the foregoing lease
modification was confirmed by the Bankruptcy Court and TWA emerged from
bankruptcy. TWA has made all rental payments, advance repayments and payments of
deferred rent when due. However, there can be no assurance that it will be able
to meet its obligations in the future.
In mid-1996, as part of its fleet restructuring, TWA offered to return
the L-1011 aircraft it leases from the Partnership. The lease, which provided
for monthly rental of $130,000, was originally scheduled to expire in September
1998. TWA agreed to pay the Partnership $2,846,000, which represents rents due
under the remaining term of the lease, discounted at 5% plus $3,000,000 as an
economic settlement for noncompliance with certain lease return conditions
("L-1011 Lease Settlement"). The lease was terminated, the aircraft was returned
and the amounts aggregating $5,846,000 were received on October 16, 1996. The
Partnership is reviewing alternatives for the use of the proceeds received,
including the use of the economic settlement to purchase an additional aircraft
or engines. It is possible that the Partnership will lease the engines that were
a part of the L-1011 separately and sell the airframe for parts.
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The L-1011 aircraft was originally purchased in 1990 for $ 18,205,000
(including related fees) and had a net book value of approximately $6.1 million
(unadjusted for the $3,000,000 economic settlement accounted for as a lease
settlement reserve) at December 31, 1996.
c. Aeromexico Leases During July 1992, the Partnership released two
McDonnell Douglas DC-9-31 aircraft previously leased to Midway Airlines Inc. to
Aerovias de Mexico, S.A. de C.V. ("Aeromexico"). The leases are operating leases
that originally required quarterly rental payments, in advance, in the amount of
$234,000 per aircraft. The terms of the leases expire on July 6, 1997 and July
23, 1997. Aeromexico has the right to renew the leases for up to five
consecutive one-year renewal periods for the then fair market rental value.
The DC-9-31 aircraft had originally been acquired in April and March
1990 for purchase prices aggregating $14,295,000. At the time the Partnership
repossessed these two aircraft from Midway, the aircraft were in need of
substantial maintenance work. As a precondition to accepting the aircraft for
lease, Aeromexico required the Partnership to complete the needed maintenance
procedures and also to make certain capital improvements to the aircraft. The
Partnership incurred approximately $5.5 million in completing these maintenance
procedures and capital improvements.
In October 1994, Aeromexico failed to make the quarterly in advance
rental payments for both aircraft. Aeromexico announced it was having financial
and operating problems and, in response, made significant management changes and
began to develop a revised business plan. Aeromexico agreed to and paid monthly
rental payments equal to the monthly equivalent rent ($78,000 per aircraft)
beginning November 1994 in return for a four-month standstill agreement
("Standstill Agreement") from lessors and lenders, including the Partnership,
not to pursue their rights and remedies with respect to Aeromexico's failure to
pay rent and other debt due in October 1994. The Standstill Agreement was
extended an additional three months to allow Aeromexico to complete a financial
restructuring. Aeromexico repaid the October 1994 rent with interest and has
continued to pay the monthly rental equivalent for each aircraft.
The Partnership has entered into negotiations with Aeromexico to extend
each of the two leases to January 2000 at a slightly lower lease rate. Such
extensions are subject to final documentation.
d. USAir Lease During September 1989, the Partnership acquired one-half
of the beneficial interest in a trust ("Trust") which is the owner/lessor of a
McDonnell Douglas MD-81 aircraft for a total purchase price of $10,041,000. The
remaining one-half interest in the Trust is owned by Pegasus Aircraft Partners,
L.P., an affiliated partnership. The aircraft is subject to an operating lease
with USAir, the term of which ends on June 1, 1998. The lease may be terminated
after August 1993 subject to the lessee's guarantee that the Partnership will
receive contractually defined minimum termination values upon remarketing of the
aircraft. Rental payments are payable quarterly, in arrears, at the rate of
$304,000 (for the Partnership's one-half interest in the aircraft). The lease
provides for one three-year renewal option, at the same quarterly rental rate.
If the lease is not renewed for this first renewal period, the lessee must make
a termination payment of $1,113,000 to the Partnership. The lessee also has
three additional one-year renewal options at the then fair market rental rates.
The lessee may elect to
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purchase the aircraft at its then fair market value at the end of any renewal
term.
The McDonnell Douglas MD-81 aircraft under lease to USAir was purchased
subject to a tax benefit transfer lease ("TBT lease") which provided for the
transfer of the investment tax credits and depreciation deductions with respect
to the aircraft to a tax lessor. Under the TBT lease, the Trust, as the owner of
the aircraft and the tax lessee under the TBT lease, has agreed to indemnify the
tax lessor if certain anticipated tax benefits are lost by the tax lessor as a
result of, among other things, acts or omissions by the Trust, breach of
covenants by the Trust under the TBT lease, loss or damage to the aircraft or
use of the aircraft outside the United States. The TBT lease requires that a
letter of credit be posted to collateralize this obligation. The Partnership
shares in the annual cost of the letter of credit and is obligated for one-half
of any calls on the letter of credit.
The letter of credit has a current face amount of approximately $1.7
million. The letter of credit agreement originally obligated the Partnership to
deposit $35,000 per quarter (beginning on June 1, 1992) as cash collateral to
collateralize the Partnership's obligation under the letter of credit agreement.
In July 1995, the Partnership consummated an agreement with the issuer of the
letter of credit under which the issuer released its interest in the cash in the
cash collateral account.
Under the operating lease, the lessee, USAir, has assumed all
liabilities, indemnities and obligations of the Trust to the tax lessor under
the TBT lease and has agreed to indemnify the Trust for any liability, indemnity
or obligation to the tax lessor under the TBT lease except for liability
resulting from breaches by the Trust of covenants under the operating lease.
USAir has not posted a letter of credit to secure this obligation. As a result
of the foregoing, if the tax lessor draws on the letter of credit as a result of
action by the lessee, the Partnership and Pegasus Aircraft Partners, L.P.
through the trust will be responsible for the loss to the tax lessor until and
if the lessee performs under its indemnification. To date there have been no
calls on the letter of credit.
The tax lessor is entitled to call on the letter of credit whether its
loss of tax benefits is caused by Pegasus Aircraft Partners, L.P. or the
Partnership. Pegasus Aircraft Partners, L.P. and the Partnership have agreed to
indemnify each other for any loss occasioned by the acts of the other.
e. Kiwi International Air Lines Leases The Partnership leased its two
Boeing 727-200 aircraft, to Kiwi International Air Lines, Inc. ("Kiwi"). The
aircraft were originally purchased in 1989 (Non-advanced) and 1990 (Advanced)
for purchase prices of $6,261,000 and $10,748,000 respectively (including
related fees). The leases were operating leases which required monthly rental
payments, in advance, in the amounts of $60,000 (Non-advanced) and $115,000
(Advanced). The terms of the leases were originally scheduled to expire on April
15, 1998 and June 30, 1998, respectively. In 1995, the leases were amended and
extended to December 31, 1999. Kiwi was also obligated to make monthly payments
of $250 per flight hour for maintenance reserve funds administered by the
Partnership. An affiliated partnership and affiliates of the Managing General
Partner also own aircraft leased to Kiwi.
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In connection with the delivery of the aircraft the Partnership
expended $2,228,000 with respect to the 727 Advanced aircraft, of which $971,000
was capitalized and $1,257,000 represented maintenance expense which were paid
out of funds received in a maintenance settlement with the prior lessee.
Capitalized improvements of $743,000 were made with respect to the non-advanced
aircraft.
The Partnership also received Kiwi stock and rights to warrants in
connection with these leasing transactions. The Partnership is subject to
significant restrictions on its ability to dispose of these securities. Based
upon the price at which Kiwi sold similar securities to unrelated third parties,
the Partnership originally recorded the securities at a value of $600,000. The
securities were valued at approximately $156,000 at December 31, 1995 and were
written down to $1,000 at December 31, 1996.
During 1994, the Partnership funded approximately $633,000 of costs
related to maintenance of the Kiwi aircraft, including compliance with certain
FAA airworthiness directives, $308,000 of which was scheduled to be repaid by
Kiwi over a one-year period. In March 1996, Kiwi signed a promissory note
("Bellyskin Note") scheduling the repayment of the latter amount, with interest
from February 1996 at 12% per annum, over eighteen months, commencing June 1,
1996.
In August 1996, the Partnership paid $1.9 million to hushkit the
non-advanced 727 aircraft. The purchase price was funded out of cash reserves
previously generated.
In June 1996, Kiwi agreed with the FAA to ground 25% of its fleet due
to certain pilot training handbook deficiencies. In August 1996, Kiwi and the
FAA resolved the deficiencies and Kiwi returned to full capacity. In addition to
the FAA grounding, Kiwi was also negatively impacted by the market reaction to
the ValuJet incident. During 1996, Kiwi did not meet its financial goals. In
July 1996, an institutional investor contributed $4,000,000 in return for a
convertible note due in March 1997, for up to 32% of Kiwi's common stock and two
seats on Kiwi's Board of Directors. The investor had options to invest an
additional $6,000,000 in convertible preferred stock which expires in March
1997. Existing shareholders (including directors and employees) were given the
opportunity to make additional investments.
Kiwi requested and was granted by the Partnership a deferral of its
August 1996 rental and July 1996 maintenance payments for the advanced aircraft
and the July rental and June maintenance reserves with respect to the
non-advanced aircraft. Kiwi was also unable to make its September rental and
August maintenance payments for each aircraft and was placed in default by the
Partnership.
In late September, Kiwi proposed a restructuring of its obligations
with certain creditors, including the Partnership. On September 30, 1996, Kiwi
filed a voluntary petition for reorganization under Chapter 11 of the Federal
Bankruptcy Code ("Bankruptcy Code") and did not make any subsequent payments.
The Kiwi leases accounted for approximately 11% of the Partnership's rental
revenue in 1996 and the aircraft had net book values aggregating approximately
$8,100,000 (including the hushkit), net of the provision for decline in market
value of aircraft of $100,000 at December 31, 1996 excluding the cost of the
heavy maintenance check being completed as of December 31, 1996 prior to a new
lease discussion below. Additionally, the unpaid balance of the Bellyskin Note,
plus
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interest (which went to non-accrual status at September 30, 1996) was $290,000
at December 31, 1996. The Partnership currently holds maintenance deposits
aggregating approximately $2.2 million, which the Partnership believes will not
be sufficient to complete work required on the aircraft and the related engines
to meet lease return conditions. On October 15, 1996, Kiwi ceased scheduled
flight operations while still exploring financial alternatives. The court
approved Kiwi's motion to reject both leases as of November 15, 1996. The
Partnership provided an allowance for bad debts in the amount of $640,000 in
respect of amounts due at December 31, 1996. The Partnership recovered the
aircraft in late 1996.
In December 1996, the Partnership entered into a lease agreement with
Falcon Air Express, Inc. ("Falcon") a charter airline with respect to the
727-200 non-advanced aircraft formerly leased to Kiwi. The lease is for a term
of 60 months and provides for a monthly rental of $95,000. Falcon provided a
security deposit of $95,000. The lease also requires Falcon to fund, on a
monthly basis, maintenance reserves of $317 per flight hour. In connection with
the delivery of the aircraft, the Partnership completed a heavy maintenance
check on the aircraft, of which $583,000 had been expended as of December 31,
1996 and approximately $700,000 was paid or payable prior to delivery. The
Partnership also purchased an engine at cost of $760,000 prior to delivery of
the aircraft. The aircraft was delivered to Falcon in March 1997.
Significant Lessees
The Partnership leased its aircraft to five different airlines during
1996. Revenue from four airlines which accounted for greater than 10% of the
total rental revenue of the Partnership during 1996 are as follows:
Airline Percentage of Total Rental Revenue
------- ----------------------------------
Continental Airlines, Inc.* 44.4%
Trans World Airlines, Inc. 24.7%
Aerovias de Mexico S.A. de C.V. 12.3%
Kiwi International Air Lines, Inc.(1) 10.6%
* Includes rental revenue from Continental Micronesia, Inc., a
subsidiary of Continental Airlines, Inc.
(1) Includes rentals totaling $350,000 with regard to Kiwi for
which an allowance for bad debts was provided.
Safety Requirements and Aircraft Aging
In addition to registration, the FAA imposes strict requirements
governing aircraft inspection and certification, maintenance, equipment
requirements, general operating and flight rules (including limits on arrivals
and departures), noise levels, certification of personnel and recordkeeping in
connection with aircraft maintenance. FAA regulations establish standards for
repairs, periodic overhauls and alterations, and require that the owner or
operator of an aircraft establish an airworthiness inspection program to be
carried out by certified mechanics. No aircraft of the Partnership may be
operated without a current airworthiness certificate.
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The FAA periodically reviews Service Bulletins which are issued by the
aircraft manufacturers. These bulletins focus on safety problems that have
developed during the aircraft's operation. The FAA may incorporate these Service
Bulletins in Airworthiness Directives ("ADs"), which are mandates requiring the
airline to perform specific maintenance within a specified period of time.
Aircraft aging is a significant issue in aircraft safety regulation. In
the past, certain aviation incidents and accidents raised concerns over the
structural integrity of older aircraft. In 1989, in its "Report to Congress on
the Status of the U.S. Stage 2 Commercial Aircraft Fleet", the FAA stated that
"no correlation has been established between the chronological age of an
aircraft and its structural airworthiness. A more accurate assessment of the
physical "age" of an aircraft is the total number of flight cycles and flight
hours flown." A flight cycle is defined as one takeoff and one landing. A flight
cycle is important because of the added stress on the airframe, landing gear and
other components from repeated takeoffs, landings and pressurizations. As
different types of aircraft have different missions and carriers fly a variety
of routes, flight cycles can vary widely among aircraft of the same
chronological age. In general, narrow-body aircraft which are used for
short-haul service will have greater cycles per year than wide-body aircraft
used for longer routes. Other factors which contribute to the aging of an
aircraft are the number of hours actually flown, the predominant environment in
which an aircraft has flown, and its actual age in years.
The FAA has adopted certain ADs for Boeing and McDonnell Douglas
aircraft models, including Boeing 727s, 737s and 747s and McDonnell Douglas
DC-9s, MD-80s and DC-10s. These ADs make mandatory the periodic replacement or
modification of structural materials, fittings and skin at certain times in the
life of an aircraft, typically when the aircraft reaches a certain number of
flight cycles or age threshold. Previously, these aircraft were subject only to
periodic inspection, and the replacement and modification of materials and parts
was done where deemed necessary. Similar ADs for Lockheed and Airbus
manufactured aircraft are expected to be proposed and adopted by the FAA. In
addition, it is widely expected that foreign civil aviation authorities,
especially in Europe and Japan, will adopt similar measures to protect the
structural integrity of older aircraft.
These aging aircraft ADs will initially impact only a limited number of
older aircraft, but additional aircraft will be covered as they accumulate
time-and-service and reach the thresholds for the required modifications.
Significantly, in the case of each aircraft type, a significant majority of
replacements or modifications are mandated when a plane reaches a certain number
of flight cycles and relatively few required replacements are triggered when a
plane reaches a certain chronological age or number of flight hours.
The following table summarizes the age, flight cycle, and flight hour
thresholds for each major aircraft type under the ADs. In general, these
thresholds are based on the "economic design goal" of an aircraft, which is
typically considered to be the period of service after which an increase in
maintenance costs is expected to take place in order to assure continued
operational safety. In addition, the table provides an estimate by the FAA of
the costs of complying with all of the mandated replacements and modifications
of the ADs. It is important to note that since most of the proposed work under
the ADs is based on flight cycle thresholds,
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those lower-cycle aircraft which reach the aircraft age or flight hour
thresholds should incur significantly lower AD compliance cost than the total
amounts estimated below.
Aircraft Flight Flight Estimated
Aircraft Age Cycle Hour AD
Type Threshold Threshold Threshold Costs
-------- --------- --------- --------- ---------
(Years)
Boeing 727 20 60,000 N/A $1,100,000
Boeing 737 20 75,000 N/A $ 934,000
Boeing 747 20 20,000* N/A $3,400,000
McDonnell Douglas DC-9 20 100,000 75,000 $ 79,000
McDonnell Douglas MD-80 20 75,000 75,000 $ 4,000
McDonnell Douglas DC-10 None 42,000 60,000 $ 187,000
* Substantially cycle limited
Flight cycle and flight hour information with respect to the
Partnership's aircraft are included in the aircraft portfolio table included
earlier on Page 3.
The Partnership's leases generally require the lessees to bear the
costs of compliance with ADs which require action during the lease terms. The
only exceptions relate to the McDonnell Douglas DC-10 aircraft on lease to
Continental, the two McDonnell Douglas DC-9-31 aircraft on lease to Aeromexico
and the two Boeing 727-200 aircraft previously on lease to Kiwi. Under certain
circumstances, for these leases the Partnership is obligated to share in the
costs of complying with certain ADs. All of the Partnership's Boeing 727
aircraft have had the major calendar modifications performed as required. It is
anticipated that the 60,000-cycle aging modifications will not be due to be
performed until approximately the end of or beyond the end of, each of the
leases.
Overall, the General Partners believe that the increased maintenance
costs mandated for older aircraft may have some negative impact on re-lease and
resale values for these planes, but counterbalancing this, compliance with the
ADs should also serve to prolong the revenue lives of the affected aircraft.
Aircraft Noise Regulations
On November 5, 1990, Congress enacted into law the Airport Noise and
Capacity Act of 1990 (the "Act"). On September 24, 1991, the FAA issued the
final rules of implementation for the Act. The Act provides that Stage 2
aircraft will be phased out from operation within United States airspace by
December 31, 1999.
Implementing regulations proposed by the FAA required or require each
United States operator to increase its Stage 3 airplane fleet to 50 percent by
December 31, 1996; to 75 percent by December 31, 1998, and to 100 percent by
December 31, 1999.
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However, the Act further provides, that if by July 1, 1999, at least
85% of an air carrier's fleet complies with Stage 3 noise levels, the carrier
may apply for a waiver of the operational ban for the remaining aircraft in the
operator's fleet until December 31, 2003. The application for such a waiver must
be submitted to the Secretary of the Department of Transportation no later than
January 1, 1999 and must include a plan with firm orders for making all aircraft
operated by the air carrier comply with Stage 3 noise levels by December 31,
2003.
Stage 3 hushkitting and re-engineering for the Boeing 727-200 and the
McDonnell Douglas DC-9-30 aircraft have been approved by the FAA. Certain
airlines have determined that it is economically feasible to hushkit certain
Stage 2 aircraft to achieve Stage 3 noise standards. The Partnership continues
to monitor the marketplace based upon the availability of aircraft, pricing for
Stage 2 and Stage 3 aircraft and the timetable for implementation of Stage 3, to
best position the Partnership's aircraft for continued and future deployment.
Competition
The aircraft leasing industry is highly competitive, depending, in
part, upon the type of leased aircraft and prospective lessees. The Partnership
competes with aircraft manufacturers, distributors, airlines and other
operators, equipment managers, leasing companies, financial institutions and
other parties engaged in leasing, managing or remarketing aircraft, many of
which have significantly greater financial resources and greater experience than
the Partnership. Such competitors may lease aircraft at lower rates than the
Partnership and provide benefits, such as direct maintenance, crews, support
services and trade-in privileges, which the Partnership does not intend to
provide. Competitors may include certain affiliates of the General Partners.
Employees
The Partnership has no employees. The officers, directors and employees
of the General Partners and their affiliates perform services on behalf of the
Partnership. The General Partners are entitled to certain fees and
reimbursements of certain out-of-pocket expenses incurred in connection with the
performance of these management services. See Item 10 of this Report, "Directors
and Executive Officers of the Registrant", and Item 13 of this Report, "Certain
Relationships and Related Transactions", which are incorporated herein by
reference.
Item 2. Properties
The Partnership does not own or lease any physical properties other
than the aircraft which are discussed in Item 1 of this Report, "Business",
which is incorporated herein by reference.
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Item 3. Legal Proceedings
In November 1994, a series of purported class actions (the "New York
Limited Partnership Actions") were filed in the United States District Court for
the Southern District of New York ("District Court") concerning PaineWebber
Incorporated sale and sponsorship of various limited partnership investments,
including those offered by the Partnership. The lawsuits were brought against
PaineWebber Incorporated and Paine Webber Group, Inc. (together, "PaineWebber"),
among others, by allegedly dissatisfied partnership investors. In March 1995,
after the actions were consolidated under the title In re: PaineWebber Limited
Partnerships Litigation, the plaintiffs amended their complaint to assert claims
against a variety of other defendants, including Air Transport Leasing, Inc., an
affiliate of PaineWebber and the Administrative General Partner in the
Partnership ("Administrative General Partner").
The amended complaint in the New York Limited Partnership Actions
alleged, among other things, that, in connection with the sale of interests in
Pegasus Aircraft Partners II, L.P., PaineWebber and the Administrative General
Partners (1) failed to provide adequate disclosure of the risks involved with
each partnership; (2) made false and misleading representations about the safety
of the investments and the partnership's anticipated performance; and (3)
marketed the partnership to investors for whom such investments were not
suitable. The plaintiffs also alleged that following the sale of the partnership
investments PaineWebber and the Administrative General Partner misrepresented
financial information about the partnership's value and performance. The amended
complaint alleged that PaineWebber and the Administrative General Partner
violated the Racketeer Influenced and Corrupt Organizations Act ("RICO") and the
federal securities laws. The plaintiffs sought unspecified damages, including
reimbursement for all sums invested by them in the partnerships, as well as
disgorgement of all fees and other income derived by PaineWebber from the
limited partnerships. In addition, the plaintiffs also sought treble damages
under RICO.
On May 30, 1995, the District Court certified class action treatment of
the plaintiffs' claims in the New York Limited Partnership Actions.
In January 1996, PaineWebber signed a memorandum of understanding with
the plaintiffs in the class action outlining the terms under which the parties
agreed to settle the case. A definitive settlement was signed in July 1996 and
in March 1997, the District Court approved the settlement as fair and
reasonable. Under the terms of the settlement, PaineWebber agreed to pay $125
million and additional consideration to class members.
In April 1995, two investors in the Pegasus limited partnerships filed
a purported class action in the Circuit Court of the State of Illinois for Cook
County entitled Robert M. Jacobson, et al. v. PaineWebber, Inc., et al., making
allegations substantially similar to those in the New York Limited Partnership
Actions, but limited in subject matter to the sale of the Pegasus partnerships,
and without a RICO claim. The plaintiffs in the Jacobson case simultaneously
remained as participants in the New York Limited Partnership Actions, and
challenged the proposed settlement of these cases. Their objections were
overruled when the District Court approved the class action settlement with
respect to the New York Limited Partnership Actions. The Illinois case has been
dismissed.
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Three actions were filed in the District Court for Brazoria County,
Texas, relating to the sale and sponsorship of interests in the Partnership and
an affiliated partnership. The complaints make state law claims, specifically,
common law fraud, conspiracy, violations of section 27.01 of the Texas Business
and Commerce Code, fraud in the inducement, negligent misrepresentation,
negligence, breach of fiduciary duty, violations of the Texas Securities Act,
and violations of the Texas Deceptive Trade Practices Act.
The plaintiffs seek unspecified damages, including attorneys' fees,
reimbursement for all sums invested by them in the partnerships, exemplary
damages, and treble damages under the Texas Deceptive Trade Practices Act. All
three actions have been removed to federal court and two have been transferred
to the District Court and consolidated under the title, Mallia vs. PaineWebber,
Inc. The third action has been dismissed with the consent of the parties on the
grounds that it is duplicative of the two actions now before the federal court
in New York.
In February 1996, approximately 230 plaintiffs filed an action entitled
Abbate v. PaineWebber Inc. in Sacramento, California Superior Court against
PaineWebber Incorporated and various affiliated entities concerning the
plaintiff's purchases of various limited partnership interests. The complaint
alleges, among other things, that PaineWebber and its related entities committed
fraud and misrepresentation and breached fiduciary duties allegedly owed to the
plaintiffs by selling or promoting limited partnership investments that were
unsuitable for the plaintiffs and by overstating the benefits, understating the
risks and failing to state material facts concerning the investments. The
complaint seeks compensatory damages of $15 million plus punitive damages. In
September 1996, the California Superior Court dismissed many of the plaintiffs'
claims as barred by the applicable statutes of limitation.
In June 1996, counsel for the Abbate plaintiffs instituted two
additional actions containing allegations nearly identical to those set forth in
Abbate. Bandrowski v. PaineWebber Incorporated. et al. was filed in California
Superior Court and Barstad v. Paine Webber Incorporated. et al. was filed in
Arizona Superior Court. Collectively, the two additional actions are brought by
approximately 50 plaintiffs and seek compensatory damages of approximately $4
million plus punitive damages. In March 1997, all of these actions were settled.
Under certain limited circumstances, pursuant to the Partnership
Agreement and other contractual obligations, PaineWebber and its affiliates,
including the Administrative General Partner were entitled to indemnification
from the Partnership for expenses and liabilities in connection with the above
actions. PaineWebber and its affiliates have agreed to not seek any
indemnification from the Partnership for any amounts prepared in connection with
the New York Partnership Actions. The General Partners do not believe that the
settlement of the Abbate, Bandrowski and Barstad actions will have a material
effect on the Partnership's financial statements taken as a whole.
On September 30, 1996, Kiwi filed a voluntary petition for
reorganization under Chapter 11 of the Federal Bankruptcy Code and the
Partnership recovered the aircraft. The Partnership has a claim against Kiwi for
all unpaid items under the leases as well as rejection damages. The Partnership
filed an adversarial complaint seeking the Bankruptcy Court's authority to use
maintenance reserves ($2.2 million) collected from Kiwi. The parties are in
settlement
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discussions with a hearing date scheduled for June 1997. The Partnership
estimates that the cost to meet return condition would be approximately
$4,100,000. The Partnership is also involved in a litigation with the company
that acted as Kiwi's manager regarding each party's compliance with a settlement
agreement into facilitate the recovery of the aircraft.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Limited Partners of the
Partnership, through the solicitation of proxies or otherwise, during the fourth
quarter of the fiscal year ended December 31, 1996.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
There is no organized trading market for the purchase and sale of the
Units and certain measures have been adopted and implemented to assure that no
organized trading market will develop.
As of March 1, 1997, the number of Limited Partners of record was
approximately 8,300.
The Partnership declared the following distributions to its Limited Partners out
of cash flow received from operations during 1996 and 1995:
Amount Of
Distribution
Period Per Unit Record Date Payment Date
------ ------------ ----------- ------------
1st Quarter 1996 $.40 March 31, 1996 April 29, 1996
2nd Quarter 1996 .40 June 30, 1996 July 29, 1996
3rd Quarter 1996 .40 September 30, 1996 October 21, 1996
4th Quarter 1996 .40 December 31, 1996 January 24, 1997
1st Quarter 1995 .40 March 31, 1995 April 29, 1995
2nd Quarter 1995 .40 June 30, 1995 July 29, 1995
3rd Quarter 1995 .40 September 30, 1995 October 29, 1995
4th Quarter 1995 .40 December 31, 1995 January 28, 1996
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Total distributions to all partners for 1996 and 1995 were declared as
follows (in thousands):
1996 1995
---- ----
Limited Partners $11,608 $11,608
General Partners 117 117
------- -------
$11,725 $11,725
======= =======
Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital, or both. The portion of
each cash distribution by a partnership which exceeds its net income may be
deemed a return of capital. Based on the amount of net income reported by the
Partnership for accounting purposes, approximately 75%, 83%, and 88%
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1996, 1995 and 1994 constituted a return of capital. Also, based on
the amount of cumulative net income reported by the Partnership for accounting
purposes, approximately 82% of the cash distributions paid to the partners from
the inception of the Partnership through December 31, 1996 constituted a return
of capital. However, the total actual return on capital over the Partnership's
life can be determined only at the termination of the Partnership after all cash
flows, including proceeds from the sale of the aircraft, have been realized.
Item 6. Selected Financial Data
The following selected financial data of the Partnership was derived
from the audited financial statements for the indicated periods. The information
set forth below should be read in conjunction with the Partnership's Financial
Statements and Supplementary Data thereto and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in Items 8
and 7, respectively, of this Report.
As of December 31, 31,
or Year Ended December
1996 1995 1994 1993 1992
------------------------------------------------------------------
(in thousands, except per unit amounts)
Rental Revenue $15,231 $14,026 $15,537 $14,985 $14,556
Net Income 2,898 2,019 1,413 1,549 1,949
Net Income per Limited
Partnership Unit .40 .28 .19 .21 .27
Distributions per Partnership
Unit(1) 1.60 1.60 1.60 1.60 1.90
Total Assets 72,039 80,799 86,350 95,842 101,690
Notes Payable 4,751 6,638 7,382 7,735 4,000
Partners' Equity 54,540 63,367 73,073 83,385 93,561
- ------------
(1) Distribution amounts are reflected during the period in which the cash
for the distribution was generated. A portion of the actual cash
distributions are paid subsequent to such period.
(See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations".) As has historically been the case, the
amount of future cash distributions will be determined on a quarterly basis
after an evaluation of the Partnership's operating results and its current and
expected financial position.
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Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Liquidity and Capital Resources
The Partnership owns and manages a diversified portfolio of leased
commercial aircraft and makes quarterly distributions to the partners of net
cash flow generated by operations. In certain situations, the Partnership may
retain cash flow from operations to finance authorized capital expenditures.
Cash distributions declared and cash distributions paid by the
Partnership were approximately $11.7 million ($1.60 per Unit) in each of 1996,
1995 and 1994, respectively. Net cash provided by operating activities was $13.5
million in 1996, $17.6 million in 1995 and $14.2 million in 1994. In the
aggregate, for this three-year period net cash provided by operating activities
totaled $45.3 million and cash distributions declared by the Partnership totaled
$35.17 million. In 1996, the Partnership received $3,000,000 as part of the
lease settlement and return of the L-1011 by TWA in lieu of TWA complying with
certain lease return conditions. Such amount was included as a lease settlement
reserve and thus was not included in cash from operating activities.
Additionally, in 1995, the Partnership received the A-300 Lease Settlement
proceeds, a portion of which was accounted for under the cost recovery method
and thus, was not included in cash from operating activities.
Partnership equity declined by approximately $8,827,000 from December
31, 1995 to December 31, 1996 as a result of the declaration and payment of cash
distributions to the partners in excess of the Partnership's net income. This
resulted primarily from the fact that, unlike net income, cash flow generated
from operations, which is the source of the cash utilized to make the
distributions, is not reduced by depreciation expense and provisions for decline
in market value of aircraft attributable to the Partnership's aircraft.
Distributions may be characterized for tax, accounting and economic
purposes as a return of capital, a return on capital, or both. The portion of
each cash distribution by a partnership which exceeds its net income may be
deemed a return of capital. Based on the amount of net income reported by the
Partnership for accounting purposes, approximately 75%, 83%, and 88%
respectively, of the cash distributions paid to the partners for the years ended
December 31, 1996, 1995, and 1994 constituted a return of capital. Also, based
on the amount of cumulative net income reported by the Partnership for
accounting purposes, approximately 82% of the cash distributions paid to the
partners from the inception of the Partnership through December 31, 1996
constituted a return of capital. However, the total actual return on capital
over the Partnership's life can be determined only at the termination of the
Partnership after all cash flows, including proceeds from the sale of the
aircraft, have been realized.
The primary reason for the net increase in liquidity was the L-1011
Settlement. In mid-1996, as part of its fleet restructuring, TWA offered to
return the L-l011 aircraft it leases from the Partnership. The lease, which
provided for monthly rental of $130,000, was originally scheduled to expire in
September 1998. TWA agreed to pay the Partnership $2,846,000, which represents
rents due under the remaining term of the lease, discounted at 5% plus
$3,000,000 as
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an economic settlement for noncompliance with certain lease return conditions.
The lease was terminated, the aircraft was returned and the amounts aggregating
$5,846,000 were received on October 16, 1996. The Partnership is reviewing
alternatives for the use of the proceeds received, including the use of the
economic settlement to purchase an additional aircraft or engines. It is likely
that the Partnership will lease the engines that were a part of the L-1011
separately and sell the airframe for parts.
At December 31, 1996, the Partnership had $9,842,000 of unrestricted
cash and cash equivalents in excess of declared, but unpaid, distributions to
the partners. This represents a slight increase from a similarly computed amount
at December 31, 1995 of $9,024,000.
Rent and other receivables decreased $1,799,000 from $2,557,000 at
December 31, 1995 to $758,000 at December 31, 1996. This primarily decrease is
primarily the result of the continued repayment of deferred rentals and advances
by Continental and TWA during 1996. Additionally, the Partnership provided an
allowance for bad debts of $640,000 with respect to amounts outstanding with
respect to Kiwi at December 31, 1996.
The payable to affiliates decreased $257,000 from $893,000 at December
31, 1995 to $636,000 at December 31, 1996 principally due to the payment of
amounts previously deferred on a voluntary basis by the Administrative General
Partner.
Deferred income decreased by $893,000 from $4,672,000 at December 31,
1995 to $3,779,000 at December 31, 1996. This decrease was attributable to the
amortization of amounts recognized in connection with the A-300 Lease Settlement
and the DC-10 Lease Restructuring and the removal of deferred income associated
with the Kiwi stock held by the Partnership offset by the proceeds relating to
the lease prepayment derived from the L-1011 Lease received in 1996.
The Partnership's liquidity increased in 1996, principally because of
the proceeds received with respect to the L-1011 Lease Settlement which
aggregated $5,846,000 partially offset by capital improvements made principally
to the non-advanced 727-200 aircraft formerly leased to Kiwi in the amount of
$2,500,000 and the impact of the Kiwi bankruptcy which reduced cash flow.
Additionally, since December 31, 1996, the Partnership committed or expended an
additional $700,000 for the 727-200 Non-advanced aircraft with respect to the
C-10 check prior to its delivery to Falcon Air Express, purchased a replacement
engine at a cost of $760,000 and committed $1,600,000 towards a cargo conversion
of the 727-200 advanced aircraft (with a further commitment to hushkit the
aircraft prior to December 31, 1999 at a cost of approximately $3,000,000). The
Partnership will also be required to replace or overhaul certain engines that
were installed on the former Kiwi aircraft. It is anticipated that the A-300
aircraft will require a heavy maintenance check in connection with its
remarketing which, along with estimated modifications and FAA mandated
maintenance is expected to cost approximately $2,500,000, of which $557,000
was provided and set aside as reserve for maintenance as part of the A-300 Lease
Settlement. In order to finance these obligations, in December 1996, the
Partnership established a new $10,000,000 loan facility with an unaffiliated
third party lender. The loan commitment is for a period of 36 months,
terminating December 31, 1999, at which time outstanding principal is due. The
loan provides for interest at a rate of 1% over the lender's prime rate of
interest which is payable monthly. The Partnership must maintain a minimum
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balance outstanding of $4,000,000 during the loan commitment period. The loan is
collateralized by the Partnership's interest in the MD-82 aircraft leased to TWA
and the two 727-200 advanced aircraft leased to Continental. The Partnership
utilized $4,751,000 of this loan to pay off its prior two loan facilities.
The Partnership entered into an agreement to lease the 727-200 non-advanced
aircraft to a start-up charter carrier for a term of five years and entered into
an agreement to lease the 727-200 advanced aircraft to a start-up cargo carrier
for a term of eight years. Further, the Partnership began discussions with a
foreign airline with respect to the lease of the A-300 aircraft and has had
discussions with Aeromexico regarding the extension of the leases of the
aircraft scheduled to expire in July 1997. The L-1011 aircraft will require a C
check shortly and it is possible that the Partnership will lease the engines and
sell the airframe for parts. Finally, Continental extended the lease of the
DC-10-10 aircraft to June 30, 1998 at a lease rate of $150,000 per month.
Additionally the Partnership may utilize the portion of the settlement received
with respect to lease return conditions from the L-1011 Lease Settlement ($3
million) to purchase an additional aircraft. The Partnership currently holds
$2.2 million of maintenance reserves collected from Kiwi which are subject to
the Kiwi bankruptcy proceedings and which are not sufficient to meet the lease
return conditions. However, even with the remarketed leases of the two ex-Kiwi
aircraft described above, the Partnership's expected cash flow for 1997 from its
leases will be less than its previous level of cash distributions to partners.
It is anticipated that the Partnership will utilize cash reserves to fund its
distribution requirements.
Litigation
See Item 3, "Legal Proceedings", for a discussion of certain class action
lawsuits.
Results of Operations
Substantially all of the Partnership's revenue was generated from the
leasing of the Partnership's aircraft to commercial air carriers under operating
leases.
Under the terms of the triple net leases, substantially all of the
expenses related to the operation and maintenance of the aircraft during 1996,
were paid for by the lessees or funded out of maintenance reserves collected.
The direct lease expenses incurred by the Partnership represent the costs of
providing insurance coverage for the Partnership's aircraft in excess of the
amounts required to be carried by the lessees, trustee fees related to the
ownership of the aircraft, the cost of the letter of credit required under the
terms of the TBT lease on the McDonnell Douglas MD-81 leased to USAir, the
amortization of costs incurred in connection with the Aeromexico leases, the
costs of storing the A-300 aircraft and the costs relating to the recovery of
the Kiwi aircraft.
The Partnership also records depreciation expense pertaining to the
aircraft and incurs interest expense and management fee and certain general and
administrative expenses in connection with the operations of the Partnership.
General and administrative expenses consist primarily of investor reporting
expenses, transfer agent and audit fees, and the cost of accounting services.
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1996 as compared to 1995
The increase in the Partnership's net income for the year ended
December 31, 1996 ("1996 Period") as compared to the year ended December 31,
1995 ("1995 Period") was attributable to the rental income recognized with
respect to the two 727-200 aircraft received in the A-300 Lease Settlement,
partially offset by the effect of the Kiwi bankruptcy (the Partnership did not
record any rental revenue with respect to Kiwi beyond the bankruptcy date), the
provision for bad debts and loss in value of stock. Further, net income was
positively impacted because interest income increased due primarily to an
increase in cash available for investment, interest expense decreased due to the
continued repayment of outstanding indebtedness and the necessity for provisions
for decline in market valued decreased. However, net income was reduced in the
1996 Period as compared to the 1995 Period due to aircraft direct lease costs
relating to insurance, storage of the A-300 and the recovery of the Kiwi
aircraft increasing substantially.
Rental income increased by $1,205,000, or 9% in the 1996 Period, as
compared to the 1995 Period reflecting the difference between the income
recognized with respect to the A-300 Lease Settlement (including the rent
associated with the two 727 aircraft received in the Lease settlement) and DC-10
Restructuring in the 1996 Period and the rents recognized in the 1995 Period,
which included the DC-10-10 rentals at the original lease rate ($252,000) and
the rents recognized under the A-300 Lease under which rentals of $312,000 were
recognized in January 1995 and reduced rents ($150,000 per month) were
recognized in February through May 1995. This increase was partially offset by
the impact of the Kiwi bankruptcy filing. The Partnership did not recognize any
rental revenue after the bankruptcy filing and recovered the aircraft in late
1996 after Kiwi rejected the leases (see Item 8, Financial Statements, Note 5,
"Kiwi-Bankruptcy" for a further discussion).
Interest income increased $135,000, or 22%, for the 1996 Period, in
comparison to the 1995 Period. This increase was primarily attributable to the
interest income earned with respect to the cash reserves held by the Partnership
during the 1996 Period (substantially provided by the A-300 Lease Settlement and
DC 10-10 Restructuring discussed above).
Depreciation and amortization expense increased $39,000, or less than
1%, for the 1996 Period in comparison to the 1995 Period. The increase was
attributable to the increase in depreciation relating to the DC 10-10 aircraft
(based upon a change in estimate of the aircraft's end of lease residual value)
as well as the depreciation relating to the two 727 aircraft received in the
A-300 Lease Settlement, which were not in place in the 1995 Period, offset by a
reduction in depreciation expense with respect to the A-300 which was off lease
during the 1996 Period (thus no depreciation was recognized) and the L-1011
aircraft and the Kiwi aircraft which were taken out of service during the fourth
quarter of 1996.
Management and re-lease fees for the 1996 Period, decreased by $93,000
or 8%, in comparison to the 1995 Period primarily because certain of the amounts
received in the A-300 Settlement and DC 10-10 Restructuring in 1995 were
accounted for under the cost recovery method (making the base upon which certain
fees are deemed different), partially offset by an increase in rental revenue
recognized and net income (adjusted for depreciation) in 1996, which
21
26
serve as bases upon which such fees are derived.
Interest expense for the 1996 Period, decreased by $165,000 or 20% in
comparison to the 1995 Period, primarily because of the continued repayment of
the notes resulting in a reduction in the principal outstanding.
General and administrative expenses increased by $36,000 or 12% during
the 1996 Period, as compared to the 1995 Period primarily due to legal fees
incurred in connection with the Kiwi bankruptcy.
Direct lease expenses increased by $199,000 in the 1996 Period, or 101%
as compared to the 1995 Period, due primarily to an increase in insurance
premiums and certain storage costs and technical consulting costs related to the
A-300 aircraft which was off lease during the 1996 Period, and certain costs
relating to the recovery of the Kiwi aircraft in late 1996.
At December 31, 1996 the Partnership provided an allowance for bad
debts in the amount of $640,000 which represented rents, advances (Bellyskin
Note) and related interest due from Kiwi (See Item 8, Financial Statements, Note
5, "Aircraft, Kiwi - Bankruptcy").
Additionally, as of December 31, 1996, the Partnership recognized a
loss of $155,000 with respect to Kiwi securities received in prior transactions.
The securities will be carried at a nominal value (See Item 8, Financial
Statements, Note 5, "Aircraft, Kiwi - Bankruptcy").
1995 Compared to 1994
The Partnership's net income for the year ended 1995 Period was
$2,019,000 as compared to $1,413,000 for the year ended December 31, 1994 ("1994
Period").
The increase in the Partnership's net income in the 1995 Period as
compared to the 1994 Period was due primarily to the fact that the Partnership
provided for a decline in market value of aircraft of $450,000 in the 1995
Period as compared to $2,600,000 in the 1994 Period offset by a reduction in
rental revenue principally due to the reduction in lease payments, and return of
the aircraft to off lease status as the result of the A-300 Lease Settlement and
subsequent default by Akdeniz.
Rental revenue decreased by approximately 10% or $1,511,000 for the
1995 Period, as compared to the 1994 Period, principally due to the recognition
of reduced rental income in the 1995 Period with respect to the A-300 Aircraft
discussed above.
Interest income increased by 47% or $193,000 for the 1995 Period in
comparison to the 1994 Period. This increase was primarily attributable to the
interest income earned on the balances of the deferred of rentals by TWA, Kiwi
and Aeromexico, which were not outstanding during the 1994 Period as well as the
cash received pursuant to the A-300 Lease Settlement and DC-10-10 Lease
Restructuring partially offset by continued repayments of advances and
deferrals.
22
27
Depreciation and amortization decreased 1% or $54,000 in the 1995
Period as compared to the 1994 Period. The decrease was the result of the
reserve for decline in market value of certain aircraft which the Partnership
recorded at December 31, 1994, which reduced the depreciable basis of the
related aircraft. This was offset by a change (reduction) to the estimated
residual value of the DC-10-10, which resulted in an increase in related
depreciation expense in the 1995 period.
Provision for decline in market value in aircraft was $450,000 in the
1995 Period as compared to $2,600,000 in the 1994 Period and reflected
management's estimate of the recoverability of the value of the leased aircraft
at the end of the respective periods based upon third party cash flows, third
party appraisals and market conditions.
Management and re-lease fees for the 1995 Period increased by 2% or
$22,000 in comparison to the 1994 Period. This increase was attributable
primarily to the fees recognized with respect to the A-300 Lease Settlement (a
portion of which was recognized under the cost recovery method) and the DC-10-10
Lease Restructuring, which was partially offset by a reduction in rental income
recognized during 1995.
Interest expense for the 1995 Period increased by $85,000 or 11% in
comparison to the 1994 Period primarily because of the increase in interest
rates which increased the rate on the variable rate note payable, which was
slightly offset by the continued repayment of the fixed rate loan.
General and administrative expenses increased by $61,000 or 26% in the
1995 Period as compared to the 1994 Period due to an increase in the level of
certain administrative expenses, including transfer agent fees and legal
expenses.
Direct lease expenses increased by 11% or $19,000 in the 1995 Period as
compared to the 1994 Period. The increase of the 1995 Period as compared to the
1994 Period was due principally to expenses incurred in the first quarter in the
1995 Period associated with the Aeromexico transaction offset by a reduction in
the letter of credit fee.
Inflation and Changing Prices
Inflation has had no material impact on the operations or financial
condition of the Partnership from inception through December 31, 1996. However,
market and worldwide economic conditions and changes in federal regulations have
in the past, and may in the future, affect the airline industry and thus lease
rates and aircraft values. Additionally, inflation and changing prices, may
affect subsequent lease rates and the eventual selling price of the aircraft.
23
28
Item 8. Financial Statements
PEGASUS AIRCRAFT PARTNERS II, L.P.
List of Financial Statements
Page
----
Report of Independent Accountants F-2
Balance Sheets -- December 31, 1996 and 1995 F-3
Statements of Income for the years ended
December 31, 1996, 1995 and 1994 F-4
Statements of Partners' Equity for the years ended
December 31, 1996, 1995 and 1994 F-5
Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994 F-6
Notes to Financial Statements F-8
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission have been omitted since
(1) the information required is disclosed in the financial statements and notes
thereto; (2) schedules are not required under the related instructions; or (3)
the schedules are inapplicable.
F-1
29
REPORT OF INDEPENDENT ACCOUNTANTS
To the Limited Partners of
Pegasus Aircraft Partners II, L.P.
We have audited the accompanying financial statements as listed in the
index on Page F-1 herein. These financial statements are the responsibility of
the Partnership's management. 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
management, 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 Pegasus Aircraft
Partners II, L.P. as of December 31, 1996 and 1995, and the results of its
operations and its cash flows for the years ended December 31, 1996, 1995 and
1994, in conformity with generally accepted accounting principles.
New York, New York
March 7, 1997
F-2
30
PEGASUS AIRCRAFT PARTNERS II, L.P.
BALANCE SHEETS - DECEMBER 31, 1996 AND 1995
ASSETS
1996 1995
-------- --------
(in thousands, except unit data)
Cash and cash equivalents (Note 4) $ 12,831 $ 11,955
Restricted cash (Notes 1 and 5) 2,248 2,104
Rent and other receivables, net (Note 5) 758 2,557
Aircraft, net (Notes 5, 9 and 12) 56,177 63,482
Other assets 25 701
-------- --------
Total Assets $ 72,039 $ 80,799
======== ========
LIABILITIES AND PARTNERS' EQUITY
LIABILITIES:
Lease settlement reserve (Note 5) $ 3,000 $ -
Accounts payable and accrued expenses 95 148
Payable to affiliates (Note 7) 636 893
Maintenance reserves payable (Notes 1 and 5) 2,248 2,104
Notes payable (Note 6) 4,751 6,638
Deferred income (Note 5) 3,779 4,672
Distributions payable to partners 2,989 2,931
Interest payable 1 46
-------- --------
Total Liabilities 17,499 17,432
-------- --------
CONTINGENCIES (Notes 5, 6, 10 and 12)
PARTNERS' EQUITY:
General Partners (904) (816)
Limited Partners (7,255,000 units outstanding
in 1996 and 1995) 55,444 64,183
-------- --------
Total Partners' Equity 54,540 63,367
-------- --------
Total Liabilities and Partners' Equity $ 72,039 $ 80,799
======== ========
The accompanying notes are an integral part of these financial statements.
F-3
31
PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
---------- ---------- ----------
(in thousands, except unit data
and per unit amounts)
REVENUE:
Rentals from operating leases $ 15,231 $ 14,026 $ 15,537
Interest 736 601 408
Other (Note 5) - - 81
---------- ---------- ----------
15,967 14,627 16,026
---------- ---------- ----------
EXPENSES:
Depreciation and amortization 9,701 9,662 9,716
Provision for decline in market
value of aircraft (Note 5) 100 450 2,600
Loss in value of securities (Note 5) 155 - -
Provisions for bad debts 640 - -
Management and re-lease fees (Note 7) 1,069 1,162 1,140
Interest 674 839 754
General and administrative (Note 7) 334 298 237
Direct lease (Note 7) 396 197 166
---------- ---------- ----------
13,069 12,608 14,613
---------- ---------- ----------
NET INCOME $ 2,898 $ 2,019 $ 1,413
========== ========== ==========
NET INCOME ALLOCATED:
To the General Partners 29 20 $ 14
To the Limited Partners 2,869 1,999 1,399
---------- ---------- ----------
$ 2,898 $ 2,019 $ 1,413
========== ========== ==========
NET INCOME PER LIMITED
PARTNERSHIP UNIT $ .40 $ .28 $ .19
========== ========== ==========
WEIGHTED AVERAGE NUMBER OF
LIMITED PARTNERSHIP
UNITS OUTSTANDING 7,255,000 7,255,000 7,255,000
========== ========== ==========
The accompanying notes are an integral part of these financial statements.
F-4
32
PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF PARTNERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
GENERAL LIMITED
PARTNERS PARTNERS TOTAL
-------- -------- ---------
(in thousands)
Balance, December 31, 1993 $(616) $ 84,001 $ 83,385
Net income 14 1,399 1,413
Distribution to partners declared (117) (11,608) (11,725)
----- -------- --------
Balance, December 31, 1994 (719) 73,792 73,073
Net income 20 1,999 2,019
Distributions to partners declared (117) (11,608) (11,725)
----- -------- --------
Balance, December 31, 1995 (816) 64,183 63,367
Net income 29 2,869 2,898
Distributions to partners declared (117) (11,608) (11,725)
----- -------- --------
Balance, December 31, 1996 $(904) $ 55,444 $ 54,540
===== ======== ========
The accompanying notes are an integral part of these financial statements.
F-5
33
PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
1996 1995 1994
-------- -------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,898 $ 2,019 $ 1,413
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 9,701 9,662 9,716
Provision for maintenance costs and decline
in market value of aircraft 100 450 2,600
Provision for bad debts 640
Maintenance funds received from lessee 557
Loss (income) from securities received in
leasing transaction 155 (81)
Change in assets and liabilities:
Rent and other receivables 711 590 34
Other assets 77 56 76
Accounts payable and accrued expenses (53) 58 35
Deferred income (449) 3,733 70
Payable to affiliates (257) 442 355
Interest payable (45) (2) 6
-------- -------- --------
Net cash provided by operating activities 13,478 17,565 14,224
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capitalized aircraft costs (2,496) (26) (325)
Lease settlement reserve 3,000
Lease settlement proceeds accounted for under the cost
recovery method 1,565
Advances to lessees (537)
Repayment of advances by lessees 448 422 426
-------- -------- --------
Net cash provided by (used in) investing
activities 952 1,961 (436)
-------- -------- --------
The accompanying notes are an integral part of these financial statements.
F-6
34
PEGASUS AIRCRAFT PARTNERS II, L.P.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (continued)
1996 1995 1994
-------- -------- --------
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Proceeds from notes payable $ 4,751 $ - $ -
Repayment of notes payable (6,638) (744) (353)
Transfers from (to) restricted cash 385 (140)
Cash distributions paid to partners (11,667) (11,725) (11,725)
-------- -------- --------
Net cash used in financing activities (13,554) (12,084) (12,218)
-------- -------- --------
NET INCREASE IN CASH AND CASH
EQUIVALENTS 876 7,442 1,570
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 11,955 4,513 2,943
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF
YEAR $ 12,831 $ 11,955 $ 4,513
======== ======== ========
Supplemental schedule of cash flow information:
Interest paid $ 719 $ 841 $ 748
======== ======== ========
Restricted maintenance reserves collected, net of
maintenance drawdowns $ 144 $ 668 $ 788
======== ======== ========
NONCASH TRANSACTIONS
Leased aircraft received in lease settlement
accounted for under the cost recovery method $ - $ 8,550 $ -
Distributions to partners declared but unpaid $ 2,989 $ 2,931 $ 2,931
Other assets and deferred income removed from
the books related to Kiwi bankruptcy $ 444 $ - $ -
The accompanying notes are an integral part of these financial statements.
F-7
35
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation Pegasus Aircraft Partners II, L.P. (the
"Partnership"), a Delaware limited partnership, maintains its accounting records
and prepares financial statements 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 dates of the financial statements and
the reported amounts of revenues and expenses during the reporting periods. The
most significant assumptions and estimates relate to useful life and
recoverability of the aircraft and tax indemnity provisions described below.
Actual results could differ from those estimates.
Cash and Cash Equivalents The Partnership invests funds not immediately
required for operations or distributions in temporary investments until such
time as the funds are required to meet its obligations. The short term, highly
liquid investments are recorded at cost which approximates fair market value.
For purposes of the balance sheets and the statements of cash flows, the
Partnership considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents.
Restricted Cash Restricted cash represents maintenance reserves (also
described below) collected from Kiwi International Air Lines, Inc. ("Kiwi") with
respect to the two aircraft formerly leased to Kiwi. (See also Note 5, "Aircraft
- - Kiwi Bankruptcy").
Aircraft and Depreciation The aircraft are recorded at cost, which
includes acquisition costs and the acquisition fee and the financial management
advisory fee paid to the General Partners. Depreciation to an estimated salvage
value (in general, 10%) is computed using the straight-line method over an
estimated economic life of twelve years. Improvements to aircraft are
capitalized when incurred and depreciated over the useful life of the
improvement. Depreciation is not recorded for aircraft that are off lease. The
Partnership evaluates these costs based upon changes in market conditions in
accordance with generally accepted accounting principles and accordingly,
records a provision for decline in market value of aircraft to recognize loss in
the value of an aircraft when the General Partners believe that the
recoverability of the Partnership's investment in an aircraft has been impaired.
Proceeds received in lease settlements are accounted for under the cost recovery
method when based upon third party appraisals and market conditions, there has
been a diminution to the carrying value of the aircraft.
Tax Benefit Transfer Lease The McDonnell Douglas MD-81 aircraft under
lease to USAirways Group, Inc. ("US Air"), was purchased subject to a tax
benefit transfer lease which provided for the transfer of the investment tax
credits and depreciation deductions with respect to
F-8
36
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
the aircraft to a tax lessor. The transfer was accomplished by the sale, for
income tax purposes only, of the aircraft to the tax lessor for cash and a note
and a leaseback of the aircraft for rental payments which match the payments on
the note. Under the terms of the tax benefit transfer lease, the Partnership's
required rental payments are contingent upon and may, by agreement, be offset by
the lessor's required note payments. Accordingly, no asset or liability for the
tax benefit transfer lease has been recorded.
Maintenance Reserve Funds Two of the Partnership's former leases
required the lessee to make monthly payments to maintenance reserve funds
administered by the Partnership. These funds are included in restricted cash on
the balance sheets.
Operating Leases The aircraft leases, which are structured principally
as triple net leases, are accounted for as operating leases. Lease revenues are
recognized in equal installments over the terms of the related leases.
Deferred Income Some of the Partnership's operating leases require
rental payments to be paid monthly, or quarterly, in advance. Lease revenues not
yet earned are deferred and recognized as income when earned.
The Partnership received stock and rights to warrants of the lessee in
connection with two of its leases. The Partnership recorded the securities at
their estimated value and previously recognized a portion of such associated
income ratably over the respective lease terms. The Partnership stopped
recognizing such income in the fourth quarter of 1994 (See Note 5, "Aircraft -
Kiwi Bankruptcy").
Lease settlement payments received in connection with the termination
or modification of a lease of an aircraft, the carrying value of which has not
been impaired, are recognized ratably over the original lease term in the case
of a lease termination and over the modified lease term in connection with a
lease modification.
Income Taxes No provision for income taxes has been made in the
financial statements since such taxes are the responsibility of the individual
partners rather than the Partnership.
Net Income Per Limited Partnership Unit The net income per limited
partnership unit is computed by dividing the net income allocated to the Limited
Partners by the weighted average number of Units outstanding during the year.
Reclassifications Certain reclassifications have been made to the 1995
financial statements to conform to the classifications used in 1996.
F-9
37
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
2. ORGANIZATION OF THE PARTNERSHIP
The Partnership was formed on April 26, 1989 for the purpose of
acquiring, leasing and ultimately selling used commercial aircraft. The Managing
General Partner of the Partnership is Pegasus Aircraft Management Corporation, a
wholly owned subsidiary of Pegasus Capital Corporation, and the Administrative
General Partner is Air Transport Leasing, Inc., a wholly owned subsidiary of
PaineWebber Group Inc. (collectively, the "General Partners"). The Partnership
is required to dissolve and distribute all of its assets no later than December
31, 2007. The Partnership may reinvest the proceeds from sales of aircraft
occurring prior to August 21, 1998, provided that the aggregate amount of sales
proceeds so reinvested will in no event exceed $60,000,000, and provided further
that, prior to any such reinvestment the Partnership distributes to Limited
Partners cash in an amount sufficient to pay any federal and state income taxes
to be incurred by the Limited Partners as a result of the aircraft sale.
Thereafter, the net proceeds of any sales of aircraft will be distributed to the
partner.
Upon formation of the Partnership, the General Partners each
contributed $500 to the capital of the Partnership. An additional 7,255,000
units of limited partnership interest ("Units") were then sold at a price of $20
per Unit with the Partnership receiving gross offering proceeds of $145,100,000.
Title to the aircraft owned by the Partnership is held by
non-affiliated trustees of trusts of which the Partnership is the beneficiary or
one of two beneficiaries. The purpose of this method of holding title is to
satisfy certain registration requirements of the Federal Aviation
Administration. The Partnership's share of the assets of the trusts are
recorded herein on a proportional consolidation basis.
3.PARTNERSHIP ALLOCATIONS
The Partnership Agreement provides that cash flow from operations be
distributed on a quarterly basis at the General Partners' discretion, 99% to the
Limited Partners and 1% to the General Partners. Cash flow is defined in the
Partnership Agreement as including cash receipts from operations and interest
income earned, less expenses incurred and paid in connection with the ownership
and operation of the aircraft. Depreciation and amortization expenses are not
deducted from cash receipts in determining cash flow. Distributable proceeds
from sales of aircraft upon liquidation of the Partnership will be distributed
in accordance with the partners' capital accounts after all allocations of
income and losses.
F-10
38
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Income and losses generally will be allocated 99% to the Limited
Partners and 1% to the General Partners. Upon the sale of aircraft, gain
generally will be allocated, first, to the General Partners in an amount equal
to the difference between their capital contributions and 1.01% of the aggregate
capital contributions of the Limited Partners, and, then, 99% to the Limited
Partners, and 1% to the General Partners.
4. CASH EQUIVALENTS
The Partnership invests funds not immediately required for operations
or distributions in short-term highly liquid investments. The investments are
primarily commercial paper issued by large domestic corporations. At December
31, 1996, the Partnership held short-term commercial paper with various
maturities as follows:
Issuer Purchase Date Purchase Price Par value
------ ------------- -------------- ---------
(in thousands) (in thousands)
Fleet Funding Inc. December 5, 1996 $ 1,986 $ 2,000
Ford Motor Credit Inc. Various 4,900 4,925
United Parcel Services, Inc. December 31, 1996 5,930 5,950
------- -------
$12,816 $12,875
======= =======
F-11
39
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
5. AIRCRAFT
Rents and other receivables were composed as follows at December 31,
1996 and 1995 (in thousands):
1996 1995
------- ------
Rent receivables $ 440 $1,144
Advances to lessees 879 1,327
Accrued interest and other 79 86
------- ------
1,398 2,557
Allowance for bad debts (640) --
------- ------
Rent and other receivables $ 758 $2,557
======= ======
Net Investment in Aircraft
The Partnership's net investment in aircraft as of December 31, 1996
and 1995 consisted of the following (in thousands):
1996 1995
-------- ---------
Aircraft on operating leases $ 77,189 $ 114,460
Less: Accumulated depreciation (39,518) (45,775)
Reserve for decline in market
value of aircraft (3,339) (12,246)
-------- ---------
$ 34,332 $ 56,439
-------- ---------
Aircraft held for lease $ 68,495 $ 28,728
Less: Accumulated depreciation (26,971) (11,013)
Reserve for decline in market value
of aircraft (9,007) --
Amounts received, including value of
aircraft, in Lease Settlement accounted
for under the cost recovery method (10,115) (10,115)
Reserves for maintenance (557) (557)
-------- ---------
21,845 7,043
-------- ---------
$ 56,177 $ 63,482
======== =========
F-12
40
PEGASUS AIRCRAFT PARTNERS II, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1996
Financial Terms of Leases
a. Continental Airlines Leases During September 1989, the Partnership
acquired a McDonnell Douglas DC-10-10 aircraft for a total purchase price of
$18,301,000, subject to an operating lease with Continental, originally
scheduled to expire on May 31, 1997, with rents of $252,000 per month.
Continental also had three two-year renewal options, with rent payable during
the first two such renewal periods at the lesser of the then fair market rental
value or the rental rate during the initial term, and during the third such
renewal period at the then fair market rental rate. In addition, the lessee has
a right of first refusal to purchase or release the aircraft after the last
renewal period on the same terms as those included in any bona fide offer made
to the Partnership by a third party. This lease was modified in 1995 as
discussed below.
During September 1989, the Partnership acquired a Boeing 727-200
non-advanced aircraft for a total purchase price of $6,116,000, subject to an
operating lease with Continental. This aircraft was returned during
Continental's bankruptcy and subsequently leased to Kiwi (see discussion of Kiwi
below).
During August 1990, the Partner