-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JTSTwOUWGsN9ly41IVoSlvJ1wxBtcbDmL42EaBgf5UiMIYiehXgxnjEQHF7LaXom S5sBwL+mkELkYBTjc9D5MA== 0000948524-98-000029.txt : 19980331 0000948524-98-000029.hdr.sgml : 19980331 ACCESSION NUMBER: 0000948524-98-000029 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: POLARIS AIRCRAFT INCOME FUND II CENTRAL INDEX KEY: 0000789895 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-EQUIPMENT RENTAL & LEASING, NEC [7359] IRS NUMBER: 942985086 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-02794 FILM NUMBER: 98578604 BUSINESS ADDRESS: STREET 1: 201 HIGH RIDGE ROAD STREET 2: 27TH FL CITY: STAMFORD STATE: CT ZIP: 06927 BUSINESS PHONE: (203) 357-3776 MAIL ADDRESS: STREET 1: 201 HIGH RIDGE ROAD STREET 2: 27TH FL CITY: STAMFORD STATE: CT ZIP: 06927 10-K 1 1997 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- FORM 10-K -------------------- _X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___ to ___ Commission File No.33-2794 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership ------------------------------- (Exact name of registrant as specified in its charter) California 94-2985086 ------------------------------- ----------------------- (State or other jurisdiction of (IRS Employer I.D. No.) incorporation or organization) 201 High Ridge Road, Stamford, Connecticut 06927 ------------------------------------------ ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (203) 357-3776 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Units of Limited Partnership Interest Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ____ No formal market exists for the units of limited partnership interest and therefore there exists no aggregate market value at December 31, 1997. Documents incorporated by reference: None This document consists of 51 pages. PART I Item 1. Business Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership), was formed primarily to purchase and lease used commercial jet aircraft in order to provide quarterly distributions of cash from operations, to maximize the residual values of aircraft upon sale and to protect Partnership capital through experienced management and diversification. PAIF-II was organized as a California limited partnership on June 27, 1984 and will terminate no later than December 2010. PAIF-II has many competitors in the aircraft leasing market, including airlines, aircraft leasing companies, other limited partnerships, banks and several other types of financial institutions. This market is highly competitive and there is no single competitor who has a significant influence on the industry. In addition to other competitors, the general partner, Polaris Investment Management Corporation (PIMC), and its affiliates, including GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris Holding Company (PHC) and General Electric Capital Corporation (GE Capital), acquire, lease, finance, sell and remarket aircraft for their own accounts and for existing aircraft and aircraft leasing programs managed by them. Further, GECAS provides a significant range of management services to GPA Group plc, a public limited company organized in Ireland, together with its consolidated subsidiaries (GPA), which acquires, leases and sells aircraft. Accordingly, in seeking to re-lease and sell its aircraft, the Partnership may be in competition with the general partner, its affiliates, and GPA. A brief description of the aircraft owned by the Partnership is set forth in Item 2. The following table describes certain material terms of the Partnership's leases to Trans World Airlines, Inc. (TWA) as of December 31, 1997. Scheduled Number of Lease Lessee Aircraft Type Aircraft Expiration Renewal Options - ------ ------------- -------- ---------- --------------- TWA McDonnell Douglas DC-9-30 11 11/04 (1) none TWA McDonnell Douglas DC-9-30 3 2/05 (1) none (1) These leases to TWA were modified in 1991. The leases for these aircraft were extended for an aggregate of 75 months beyond the initial lease expiration date in November 1991 at approximately 46% of the original lease rates. The Partnership also agreed to share in the costs of certain Airworthiness Directives (ADs). If such costs are incurred by TWA, they will be credited against rental payments, subject to annual limitations with a maximum of $500,000 per aircraft over the lease terms. TWA may specify a lease expiration date for each aircraft up to six months before the date shown, provided the average date for all of the aircraft equals the dates shown. As discussed in Item 7, in October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill agreement with TWA which was approved on behalf of the Partnership by PIMC. That agreement provided for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995. The deferred rents, which aggregated $3.6 million plus interest, were repaid in monthly installments beginning in May 1995 through October 1995. In 1995, the Partnership received as consideration for the agreement $218,071 and warrants for 227,133 shares of TWA Common Stock (Item 7). In 1996, GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of noise-suppression devices, commonly known as "hushkits", for 14 of the Partnership's aircraft on lease to TWA at the time, as well as other aircraft owned by affiliates of PIMC and leased 2 to TWA. The 14 aircraft that received hushkits were designated by TWA. The hushkits reconditioned the aircraft so as to meet Stage 3 noise level restrictions. Hushkits were installed on 11 of the Partnership's aircraft during 1996 and the leases for these 11 aircraft were extended for a period of eight years until November 2004. Hushkits were installed on the remaining three aircraft during February 1997 and the leases for these three aircraft were extended for a period of eight years until February 2005. The rent payable by TWA under the leases was increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. The loan from the engine/hushkit manufacturer is non-recourse to the Partnership and secured by a security interest in the lease receivables. Industry-wide, approximately 330 commercial jet aircraft were available for sale or lease at December 31, 1997, approximately 50 more than a year ago. At under 3% of the total available jet aircraft fleet, this is still a relatively low level of availability by industry historic standards. From 1991 to 1994, depressed demand for travel limited airline expansion plans, with new aircraft orders and scheduled deliveries being canceled or substantially deferred. As profitability declined, many airlines took action to downsize or liquidate assets and some airlines were forced to file for bankruptcy protection. Following four years of strong traffic growth accompanied by rising yields, this trend reversed with many airlines reporting substantial profits since 1995. As a result of this improving trend, just over 1200 new jet aircraft were ordered in 1996 and a further 1300 were ordered in 1997, making this the second highest ever order year in the history of the industry. To date, this strong recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which are now being upgraded with hushkits, which, when installed on the aircraft, bring Stage 2 aircraft into compliance with Federal Aviation Administration (FAA) Stage 3 noise restrictions as discussed in the Industry Update section of Item 7. Older Stage 2 narrow-bodies and early wide-bodies have shown only marginal signs of recovery since the depressed 1991 to 1994 period. Economic turmoil in Asia in the second half of 1997 has brought about a significant reduction in traffic growth in much of that region which is resulting in a number of new aircraft order deferrals and cancellations, mainly in the wide-body sector of the market with as yet no impact evident in other world markets. In 1996, several airline accidents also impacted the market for older Stage 2 aircraft. The Partnership has been forced in the past to adjust its estimates of the residual values realizable from its aircraft, which resulted in an increase in depreciation expense, as discussed in Items 7 and 8. A discussion of the current market condition for the type of aircraft owned by the Partnership follows: McDonnell Douglas DC-9-30 - The McDonnell Douglas DC-9-30 is a short- to medium-range twin-engine jet that was introduced in 1967. Providing reliable, inexpensive lift, these aircraft fill thin niche markets, mostly in the United States. Hushkits are available to bring these aircraft into compliance with Stage 3 requirements at a cost of approximately $1.6 million per aircraft. As noted above, hushkits have been installed on the 14 remaining fund aircraft. Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent fatigue cracks and control corrosion as discussed in the Industry Update section of Item 7. The general partner believes that, in addition to the factors cited above, the deteriorated market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control, and structural inspection and modification as discussed in the Industry Update section of Item 7. Item 2. Properties At December 31, 1997, PAIF-II owned 14 McDonnell Douglas DC-9-30 aircraft leased to TWA out of its original portfolio of 30 aircraft. All leases are operating leases. Polaris Aircraft Income Fund II (the Partnership) transferred six Boeing 727-200 aircraft, previously leased to Pan Am, to aircraft inventory in 1992. 3 These aircraft, which are not included in the following table, have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit in February 1995. The Partnership sold the airframe and one engine from the Boeing 737-200 Combi aircraft in March 1996. The Partnership sold the remaining engine along with a Boeing 737-200 in January 1997. The Partnership sold three Boeing 727-200, one McDonnell Douglas DC-9-40 and three McDonnell Douglas DC-9-30 aircraft to Triton Aviation Services II LLC in May 1997 and June 1997. The following table describes the Partnership's aircraft portfolio at December 31, 1997 in greater detail: Year of Cycles Aircraft Type Serial Number Manufacture As of 12/31/97 - ------------- ------------- ----------- -------------- McDonnell Douglas DC-9-30 47135 1968 79,114 McDonnell Douglas DC-9-30 47137 1968 78,249 McDonnell Douglas DC-9-30 47249 1968 84,418 McDonnell Douglas DC-9-30 47251 1968 82,872 McDonnell Douglas DC-9-30 47343 1969 81,501 McDonnell Douglas DC-9-30 47345 1969 79,873 McDonnell Douglas DC-9-30 47411 1969 77,243 McDonnell Douglas DC-9-30 47412 1969 77,339 McDonnell Douglas DC-9-30 47027 1967 83,328 McDonnell Douglas DC-9-30 47107 1968 82,753 McDonnell Douglas DC-9-30 47108 1968 79,599 McDonnell Douglas DC-9-30 47174 1968 80,692 McDonnell Douglas DC-9-30 47324 1969 76,925 McDonnell Douglas DC-9-30 47357 1969 76,746 Item 3. Legal Proceedings Braniff, Inc. (Braniff) Bankruptcy - As previously reported in Polaris Aircraft Income Fund II's (the Partnership) 1996 Form 10-K, the Bankruptcy Court disposed of the Partnership's claim in this Bankruptcy proceeding by permitting the Partnership to exchange a portion of its unsecured claim for Braniff's right (commonly referred to as a "Stage 2 Base Level right") under the Federal Aviation Administration noise regulations to operate one Stage 2 aircraft and by allowing the Partnership a net remaining unsecured claim of $769,231 in the proceedings. Viscount Air Services, Inc. (Viscount) Bankruptcy - As previously reported in the Partnership's 1996 Form 10-K, all disputes between the Partnership and Viscount have been resolved, and there is no further pending litigation with Viscount. However, when Viscount rejected its lease of one of the Partnership's aircraft ("306 Aircraft"), as authorized by the Bankruptcy court, the 306 Aircraft was located at a maintenance facility owned by BAE Aviation, Inc. dba Tucson Aerospace (BAE). BAE and its subcontractors STS Services, Inc. and Piping Design Services, Inc., dba PDS Technical Services asserted mechanics' liens over the 306 Aircraft. On May 22, 1996, First Security Bank, National Association (FSB), as owner trustee, filed suit in the Superior Court of Arizona in Pima County to recover the 306 Aircraft. After FSB filed a bond in the penal amount of $1,371,000, the claimants in the action released the 306 Aircraft and filed a claim against the bond. The Superior Court heard cross-motions for summary judgment on July 7, 1997. On September 5, 1997, the Superior Court determined that STS Services, Inc. did not 4 have a lien under a filing in Tennessee. The Superior Court denied FSB's motion for summary judgment concerning assignment of the lien, but granted a motion for summary judgment in part, ruling that the claim against the bond may not exceed the value of the airframe. The case continues in discovery and pre-trial preparation. The matter is set for trial on April 14, 1998. After recovering the 306 Aircraft, the Partnership sold the airframe and certain engines in January of 1997. In the course of delivering the airframe, GE Capital Aviation Services, Inc. (GECAS) determined that a painter, Thomas Cook, was holding the right elevator at his shop due to an unpaid bill incurred in connection with work on the 306 Aircraft by BAE under contract to Viscount, which at that time was leasing the 306 Aircraft. On March 20, 1997, FSB, as owner trustee, filed a lawsuit in the Superior Court of Arizona in Pima County, Case No. 318585 against Mr. Cook and Hamilton Aviation, Inc., where his shop is located, to recover possession. On July 29, 1997, the Superior Court denied FSB's motion for summary judgment and determined that a worker holding an aircraft part may claim a lien for the charges associated with the particular item without complying with Arizona's aircraft lien statute. The Superior Court directed Mr. Cook to provide documentation of his claim limited to work on the elevator he is holding. The matter is set for trial on April 14, 1998. Kepford, et al. v. Prudential Securities, et al. -On April 13, 1994, this action was filed in the District Court of Harris County, Texas against Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Insurance Company of America and James J. Darr. The complaint alleges violations of the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act of 1933, common law fraud, fraud in the inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy arising from the defendants' alleged misrepresentation and failure to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest, and double and treble damages under the Texas Deceptive Trade Practices Act. On December 2, 1997, the trial court issued a scheduling order setting a September 7, 1998 trial date. Riskind, et al. v. Prudential Securities, Inc., et al. - This action was filed in the District Court of the 165 Judicial District, Maverick County, Texas, on behalf of over 3,000 individual investors who purchased units in "various Polaris Aircraft Income Funds," including the Partnership. A second amended original petition names the Partnership, Polaris Investment Management Corporation, Prudential Securities, Inc. and others as defendants and alleges that these defendants violated the Texas Securities Act and the Texas Deceptive Trade Practices Act and committed common law fraud, fraud in the inducement, negligent misrepresentation, negligent breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest, and double and treble damages under the Texas Deceptive Trade Practices Act. Kidder, Peabody & Co. was added as an additional defendant by virtue of an Intervenor's Amended Plea in Intervention filed on or about April 7, 1995. The trial of the claims of one plaintiff, Robert W. Wilson, against Polaris Aircraft Income Funds I-VI, Polaris Investment Management Corporation and various affiliates of Polaris Investment Management Corporation, including General Electric Capital Corporation, was commenced on July 10, 1995. On July 5 26, 1995, the jury returned a verdict in favor of the defendants on all counts. Subsequent to this verdict, all of the defendants (with the exception of Prudential Securities, Inc., which had previously settled) entered into a settlement with the plaintiffs. On February 26, 1997, the court issued an order notifying the remaining plaintiffs that the action would be dismissed on April 21, 1997 for want of prosecution unless the plaintiffs showed cause why the action should not be dismissed. This action was dismissed for want of prosecution in April of 1997. Howland, et al. v. Polaris Holding Company, et al. - This action was transferred to the multi-district litigation in the Southern District of New York entitled In re Prudential Securities Limited Partnerships Litigation, which has been settled as discussed in Part III, Item 10 below. Mary C. Scott v. Prudential Securities Inc. et al. - This action was transferred to the action entitled In re Prudential Securities Limited Partnerships Litigation, which has been settled as discussed in Part III, Item 10 below. Equity Resources, Inc., et al. v. Polaris Investment Management Corporation, et al. - On or about April 18, 1997, an action entitled Equity Resources Group, Inc., et al. v. Polaris Investment Management Corporation, et al. was filed in the Superior Court for the County of Middlesex, Commonwealth of Massachusetts. The complaint names each of Polaris Investment Management Corporation (PIMC), the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI, as defendants. The complaint alleges that PIMC, as general partner of each of the partnerships, committed a breach of its fiduciary duties, violated applicable partnership law statutory requirements and breached provisions of the partnership agreements of each of the foregoing partnerships by failing to solicit a vote of the limited partners in each of such partnerships in connection with the Sale Transaction described in Item 7, under the caption "Remarketing Update -- Sale of Aircraft to Triton" and in failing to disclose material facts relating to such transaction. The plaintiffs sought to enjoin the Sale Transaction, but the Superior Court denied their motion on May 6, 1997. The plaintiffs appealed the Superior Court's denial of their motion to enjoin, but ultimately, the Supreme Court of Massachusetts denied their appeal on May 29, 1997. On May 23, 1997, the defendants filed a motion to dismiss this action. Subsequently, the plaintiffs voluntarily sought dismissal of their suit without prejudice. On September 16, 1997, the court dismissed the plaintiffs' complaint without prejudice. Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about June 18, 1997, a purported class action entitled Ron Wallace v. Polaris Investment Management Corporation, et al. was filed on behalf of the unitholders of Polaris Aircraft Income Funds II through VI in the Superior Court of the State of California, County of San Francisco. The complaint names each of Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company, General Electric Capital Corporation, certain executives of PIMC and GECAS and John E. Flynn, a former PIMC executive, as defendants. The complaint alleges that defendants committed a breach of their fiduciary duties with respect to the Sale Transaction involving the Partnership as described in Item 7, under the caption "Remarketing Update -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs. On September 16, 1997, the defendants filed a motion to stay discovery and a demurrer seeking to dismiss the amended complaint. On November 5, 1997, the Superior Court granted the demurrer with leave to replead. On 6 December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively. On January 26, 1998, defendants filed a demurrer seeking to dismiss the second amended complaint on the grounds that plaintiffs had failed to satisfy the pre-litigation demand requirements under California law for commencing a derivative action. Other Proceedings - Part III, Item 10 discusses certain other actions which have been filed against the general partner in connection with certain public offerings, including that of the Partnership. The Partnership is not a party to these actions. Item 4. Submission of Matters to a Vote of Security Holders None. 7 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters a) Polaris Aircraft Income Fund II's (PAIF-II or the Partnership) limited partnership interests (Units) are not publicly traded. Currently there is no market for PAIF-II's Units and it is unlikely that any market will develop. b) Number of Security Holders: Number of Record Holders Title of Class as of December 31, 1997 ----------------------- -------------------------------- Limited Partnership Interest: 15,200 General Partnership Interest: 1 c) Dividends: The Partnership distributed cash to partners on a quarterly basis beginning July 1986. Cash distributions to limited partners during 1997 and 1996 totaled $14,349,914 and $17,499,895, respectively. Cash distributions per limited partnership unit were $28.70 and $35.00 in 1997 and 1996, respectively. 8 Item 6. Selected Financial Data
For the years ended December 31, -------------------------------- 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Revenues $ 17,609,635 $ 16,304,608 $ 21,093,341 $ 14,443,902 $ 15,558,866 Net Income (Loss) 4,469,336 (14,708,486) 5,717,065 (3,217,172) 48,114 Net Income (Loss) Allocated to Limited Partners 4,424,643 (16,311,216) 4,972,468 (4,434,868) (952,261) Net Income (Loss) per Limited Partnership Unit 8.85 (32.62) 9.94 (8.87) (1.91) Cash Distributions per Limited Partnership Unit 28.70 35.00 13.75 25.00 20.00 Amount of Cash Distributions Included Above Representing a Return of Capital on a Generally Accepted Accounting Principle Basis per Limited Partnership Unit* 28.70 35.00 13.75 25.00 20.00 Total Assets 77,546,425 87,622,742 107,820,317 110,568,377 129,706,547 Partners' Capital 60,740,696 72,215,709 106,368,523 108,290,301 125,396,279
* The portion of such distributions which represents a return of capital on an economic basis will depend in part on the residual sale value of the Partnership's aircraft and thus will not be ultimately determinable until the Partnership disposes of its aircraft. However, such portion may be significant and may equal, exceed or be smaller than the amount shown in the above table. 9 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations At December 31, 1997, Polaris Aircraft Income Fund II (the Partnership) owned a portfolio of 14 used commercial jet aircraft and certain inventoried aircraft parts out of its original portfolio of 30 aircraft. The portfolio consists of 14 McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA). The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan American World Airways, Inc., to aircraft inventory in 1992. These aircraft have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft in February 1995, one Boeing 737-200 Combi aircraft in March 1996, and one Boeing 737-200 aircraft in January 1997. During the second quarter of 1997, the Partnership sold three McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft leased to TWA, two Boeing 727-200 Advanced aircraft leased to Continental Micronesia, Inc. (Continental Micronesia), and one Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental), to Triton Aviation Services II LLC. Remarketing Update General - Polaris Investment Management Corporation (the General Partner or PIMC) evaluates, from time to time, whether the investment objectives of the Partnership are better served by continuing to hold the Partnership's remaining portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes into account the current and potential earnings of the Aircraft, the conditions in the markets for lease and sale and future outlook for such markets, and the tax consequences of selling rather than continuing to lease the Aircraft. Recently, the General Partner has had discussions with third parties regarding the possibility of selling some or all of these Aircraft. While such discussions may continue, and similar discussions may occur again in the future, there is no assurance that such discussions will result in the Partnership receiving a purchase offer for all or any of the Aircraft which the General Partner would regard as acceptable. Sale of Boeing 737-200 Aircraft - On January 30, 1997, one Boeing 737-200 formerly on lease to Viscount, was sold to American Aircarriers Support, Inc. (American Aircarriers) on an "as-is, where-is" basis for $660,000 cash. In addition, the Partnership retained maintenance reserves from the previous lessee of $217,075, that had been held by the Partnership, which were recognized as additional sale proceeds. A net loss of $26,079 was recorded on the sale of the aircraft. TWA Lease Extension - GE Capital Aviation Services, Inc. (GECAS), on behalf of the Partnership, and TWA negotiated for the acquisition of noise-suppression devices, commonly known as "hushkits," for the 14 Partnership aircraft currently on lease to TWA, as well as other aircraft beneficially owned by Polaris Aircraft Income Fund III and Polaris Holding Company and leased to TWA. Hushkit installation was completed on 11 of the Partnership's aircraft in November 1996. Installation of hushkits on the remaining three aircraft was completed during February 1997. The aggregate cost of the hushkit reconditioning completed in February 1997 for the three remaining aircraft was $4,784,633, or approximately $1.6 million per aircraft, which was capitalized by the Partnership during 1997. The Partnership paid $900,000 of the aggregate hushkit cost and the balance of $3,884,633 was financed by UT Finance Corporation (UT Finance), a wholly owned subsidiary of United Technologies Corporation, of which a division is Pratt and Whitney Group, the hushkit manufacturer, over 50 months at an interest rate of approximately 10% per annum. The rent payable by TWA under the leases has been increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. The loan from UT Finance is non-recourse to the Partnership and secured by a security interest in 10 the lease receivables. The leases for these three aircraft were extended for a period of eight years until February 2005. Sale of Aircraft to Triton - On May 28, 1997, PIMC, on behalf of the Partnership, executed definitive documentation for the purchase of 7 of the Partnership's 21 remaining aircraft (the "Aircraft") and certain of its notes receivables by Triton Aviation Services II LLC, a special purpose company (the "Purchaser" or "Triton"). The closings for the purchase of the 7 Aircraft occurred from May 28, 1997 to June 16, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton Aviation" or the "Manager"), a privately held aircraft leasing company which was formed in 1996 by Triton Investments, Ltd., a company which has been in the marine cargo container leasing business for 17 years and is diversifying its portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the existing leases. The General Partner's Decision to Approve the Transaction - In determining whether the transaction was in the best interests of the Partnership and its unitholders, PIMC evaluated, among other things, the risks and significant expenses associated with continuing to own and remarket the Aircraft (many of which were subject to leases that were nearing expiration). The General Partner determined that such a strategy could require the Partnership to expend a significant portion of its cash reserves for remarketing and that there was a substantial risk that this strategy could result in the Partnership having to reduce or even suspend future cash distributions to limited partners. The General Partner concluded that the opportunity to sell the Aircraft at an attractive price would be beneficial in the present market where demand for Stage II aircraft is relatively strong rather than attempting to sell the aircraft "one-by-one" over the coming years when the demand for such Aircraft might be weaker. GE Capital Aviation Services, Inc. ("GECAS"), which provides aircraft marketing and management services to the General Partner, sought to obtain the best price and terms available for these Stage II aircraft given the aircraft market and the conditions and types of planes owned by the Partnership. Both the General Partner and GECAS approved the sale terms of the Aircraft as being in the best interest of the Partnership and its unit holders because both believe that this transaction will optimize the potential cash distributions to be paid to limited partners. To ensure that no better offer could be obtained, the terms of the transaction negotiated by GECAS included a "market-out" provision that permitted the Partnership to elect to accept an offer for all (but not less than all) of the assets to be sold by it to the Purchaser on terms which it deemed more favorable, with the ability of the Purchaser to match the offer or decline to match the offer and be entitled to be compensated in an amount equal to 1 1/2% of the Purchaser's proposed purchase price. The Partnership did not receive any other offers and, accordingly, the General Partner believes that a valid market check had occurred confirming that the terms of this transaction were the most beneficial that could have been obtained. The Terms of the Transaction - The total contract purchase price (the "Purchase Price") to the Purchaser was $13,988,000 which was allocated to the Aircraft and to certain notes receivable by the Partnership. The Purchaser paid into an escrow account $1,575,888 of the Purchase Price in cash upon the closing of the first aircraft and delivered a promissory note (the "Promissory Note") for the balance of $12,412,112. The Partnership received payment of $1,575,888 from the escrow account on June 24, 1997. On December 30, 1997, the Partnership received prepayment in full of the outstanding note receivable and interest earned by the Partnership to that date. Under the purchase agreement, the Purchaser purchased the Aircraft effective as of April 1, 1997 notwithstanding the actual closing dates. The utilization of an effective date facilitated the determination of rent and other allocations between the parties. The Purchaser had the right to receive all income and proceeds, including rents and receivables, from the Aircraft accruing from and after April 1, 1997, and the Promissory Note commenced bearing interest as of April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold subject to the existing leases. Neither PIMC nor GECAS received a sales commission in connection with the transaction. In addition, PIMC was not paid a management fee with respect to the collection of the Promissory Note or on any rents accruing from or after April 11 1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of its affiliates holds any interest in Triton Aviation or any of Triton Aviation's affiliates. John Flynn, the current President of Triton Aviation, was a Polaris executive until May 1996 and has over 15 years experience in the commercial aviation industry. At the time Mr. Flynn was employed at PIMC, he had no affiliation with Triton Aviation or its affiliates. Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold certain aircraft assets to separate special purpose companies under common management with the Purchaser (collectively, together with the Purchaser, the "SPC's") on terms similar to those set forth above, with the exception of the Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis. The Accounting Treatment of the Transaction - In accordance with generally accepted accounting principles (GAAP), the Partnership recognized rental income up until the closing date for each aircraft which occurred from May 28, 1997 to June 16, 1997. However, under the terms of the transaction, the Purchaser was entitled to receive payment of the rents, receivables and other income accruing from April 1, 1997. As a result, the Partnership made payments to the Purchaser in the amount of the rents, receivables and other income due and received from April 1, 1997 to the closing date of $1,001,067, which is included in rent from operating leases and interest income. For financial reporting purposes, the cash down payment portion of the sales proceeds of $1,575,888 has been adjusted by the following: income and proceeds, including rents and receivables from the effective date of April 1, 1997 to the closing date, interest due on the cash portion of the purchase price, interest on the Promissory Note from the effective date of April 1, 1997 to the closing date and estimated selling costs. As a result of these GAAP adjustments, the net adjusted sales price recorded by the Partnership, including the Promissory Note, was $13,205,140. The Aircraft sold pursuant to the definitive documentation executed on May 28, 1997 had been classified as aircraft held for sale from that date until the actual closing date. Under GAAP, aircraft held for sale are carried at their fair market value less estimated costs to sell. The adjustment to the sales proceeds described above and revisions to estimated costs to sell the Aircraft required the Partnership to record an adjustment to the net carrying value of the aircraft held for sale of $749,373 during 1997. This adjustment to the net carrying value of the aircraft held for sale is included in depreciation and amortization expense on the statement of operations. Partnership Operations The Partnership reported net income of $4,469,336, or $8.85 per limited partnership unit for the year ended December 31, 1997, compared to a net loss of $14,708,486, or $32.62 per limited partnership unit and net income of $5,717,065, or $9.94 per limited partnership unit, for the years ended December 31, 1996 and 1995, respectively. The improved income from operations during 1997, as compared to 1996, is due to a substantial decrease in depreciation expense related to the sale of aircraft. A substantial increase in depreciation expense, as discussed later in the Industry Update section, contributed to the net loss during 1996. Rental revenues, net of related management fees, increased during 1997, compared to the same period in 1996. This increase was primarily the result of an increase in rental revenues from TWA. In November 1996 and February 1997, installation of hushkits was completed on the 14 aircraft leased to TWA and the leases were extended for eight years. The rent payable by TWA under the leases has been increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. Rental revenues, net of related management fees, declined in 1996 as compared to 1995 primarily as a result of a decrease in rental revenue recognized in 1996 on the Partnership's leases with TWA. TWA rental revenues were higher in 1995 due to the receipt, during 1995, of certain deferred rental amounts, as discussed 12 later under TWA Restructuring. Other factors contributing to the decreased rental revenues in 1996 were decreases in rental revenue from Northwest Territorial Airways, Ltd. (NWT) and Viscount. The lease with NWT expired in October 1995 and the aircraft was then sold, resulting in higher rental revenues from this aircraft during 1995 as compared to 1996. Additionally, the default and bankruptcy by Viscount resulted in the return of the aircraft and engine to the Partnership during 1996, resulting in higher rental revenues from this aircraft during 1995 as compared to 1996. The increase in interest income during 1997, as compared to the same period in 1996, was attributable to interest earned on the Promissory Note related to the Triton sale that occurred during the second quarter of 1997. The Partnership recorded an increase in other revenue during 1997. This increase in other income was the result of the receipt of $802,443 related to amounts due under the TWA maintenance credit and rent deferral agreement. On July 10, 1996, the Partnership entered into a proposed Stipulation and Order in which Pan Am agreed to allow the Partnership $2.5 million as an administrative expense priority claim and $56 million as a general unsecured claim. In May 1996, the Partnership received from Pan Am a payment of $567,500 on the administrative expense priority claim. In November 1996, the Partnership received an additional $9,000 payment on the administrative expense priority claim. The Partnership has recorded these payments as other revenue in claims related to lessee defaults in the 1996 statement of operations. It is unlikely that the Partnership will receive additional payments on the administrative expense priority claim. It cannot be estimated at this time when and if the general unsecured claim will be paid. In consideration for the rent deferral as discussed later under TWA Restructuring, the Partnership received $218,171 in January 1995 as its share of such payment by TWA. This amount was recognized as other revenue in 1995. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and recognized the net warrant value as of the date of receipt of $1,772,206 as revenue in 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share and recognized a gain on the value of the warrants of $582,028 in 1995. The Partnership sold its TWA Common Stock in 1996. In addition, the Partnership recognized as other revenue in 1995 payments received from NWT aggregating approximately $647,000 in lieu of NWT performing required maintenance work on the aircraft it was leasing prior to its return to the Partnership. The Partnership also recognized as other revenue in 1995 maintenance reserves aggregating approximately $91,000 that were previously paid to the Partnership by a former lessee for the aircraft that was sold to AIA in February 1995. The Partnership incurred interest expense during 1997 and 1996 as the result of the Partnership installing hushkits on 11 of its aircraft in November 1996 and 3 of its aircraft in February 1997. The aggregate cost of the hushkit reconditioning for the 11 and 3 aircraft was $17,516,722 and $4,784,633, respectively, or approximately $1.6 million per aircraft, which was capitalized by the Partnership during 1996 and 1997. The Partnership paid $3.3 million and $900,000 in 1996 and 1997, respectively, of the aggregate hushkit cost, and the balance of $14,216,722 and $3,884,633 in 1996 and 1997, respectively, was financed by the engine/hushkit manufacturer over 50 months at an interest rate of 10% per annum. As discussed later in the Industry Update section, if the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the adjusted estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized approximately $17.0 million and $2.4 million of this deficiency as increased depreciation expense in 1996 and 1995, respectively. In 1996, the impairment loss was the result of several significant factors. As a 13 result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase 7 of the Partnership's remaining aircraft subject to each aircraft's existing lease and certain notes receivable. This offer constituted an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the proposed purchase price reflected in the offer, less the estimated costs and expenses of the proposed sale. The Partnership is deemed to have an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections. The 1995 downward adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold to Westjet in 1996 as previously discussed. The increased depreciation expense reduces the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft. The Partnership also made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995. For any downward adjustment to the estimated residual values, future depreciation expense over the projected remaining economic life of the aircraft is increased. The Partnership's earnings are impacted by the net effect of the adjustments to the aircraft carrying values recorded in 1996 an 1995, and the downward adjustments to the estimated residual values recorded in 1995 as discussed later in the Industry Update section. Liquidity and Cash Distributions Liquidity - The Partnership received prepayment in full of all amounts due from Triton and all payments due from lessees during 1997, except for the December 1997 lease payment from TWA. On January 2, 1998, the Partnership received its $935,000 rental payment from TWA that was due on December 27, 1997. This amount was included in rent and other receivables on the balance sheet at December 31, 1997. As further discussed in Note 8 to the financial statements, the Partnership recorded allowances for credit losses of $241,964 and $100,409 in 1995 and 1996, respectively, for the aggregate unsecured receivables from Viscount. The line of credit, which was advanced to Viscount in 1994, was, in accordance with the Compromise and Stipulation, secured by certain of Viscount's trade receivables and spare parts. The Stipulation and Agreement releases the Partnership's claim against Viscount's trade receivables. As a result, the Partnership recorded an additional allowance for credit losses of $92,508 during 1996, representing Viscount's outstanding balance of the line of credit and accrued interest. Payments received by the Partnership from the sale of the spare aircraft parts (as discussed above), if any, will be recorded as revenue when received. The Stipulation and Agreement provides that, upon entry of a final non-appealable court order approving it, the Partnership would waive its pre- and post-petition claims against Viscount for all amounts due and unpaid. As a result, the Partnership considers all receivables from Viscount to be uncollectible and has written-off, during 1996, all notes, rents and interest receivable balances from Viscount. As discussed above, the Partnership agreed to share in the cost of meeting certain Airworthiness Directives (ADs) with TWA. In accordance with the cost-sharing agreement, TWA may offset up to an additional $1.7 million against rental payments, subject to annual limitations, over the remaining lease terms. The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA in February 1995 as previously discussed. The agreement with AIA specifies payment of the sales price in 36 monthly installments of $55,000 beginning in 14 March 1995. The Partnership has received all scheduled payments due from AIA. This note was sold to Triton during 1997 as part of the transaction discussed previously under the Remarketing Update section. In March 1996, the Partnership sold its Boeing 737-200 Combi aircraft to Westjet for cash and a note due in 22 monthly installments, with interest at a rate of 10% per annum beginning in March 1996. The Partnership has received all scheduled payments from Westjet. This note was sold to Triton during 1997 as part of the transaction discussed previously under the Remarketing Update section. Payments of $214,749, $260,234 and $275,130 were received during 1997, 1996 and 1995, respectively, from the sale of inventoried parts from the six disassembled aircraft. PIMC has determined that the Partnership maintain cash reserves as a prudent measure to ensure that the Partnership has available funds in the event that the aircraft presently on lease to TWA require remarketing, and for other contingencies including expenses of the Partnership. The Partnership's cash reserves will be monitored and may be revised from time to time as further information becomes available in the future. Cash Distributions - Cash distributions to limited partners were $14,349,914, $17,499,895, and $6,874,959 in 1997, 1996 and 1995, respectively. Cash distributions per limited partnership unit were $28.70, $35.00 and $13.75 per limited partnership unit in 1997, 1996 and 1995, respectively. The timing and amount of future cash distributions are not yet known and will depend on the Partnership's future cash requirements (including expenses of the Partnership) and need to retain cash reserves as previously discussed in the Liquidity section; the receipt of rental payments from TWA; and payments generated from the aircraft disassembly process. TWA Restructuring In October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by GECAS, 18 of which were owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft. The Deferral Agreement provided for (i) a moratorium on all the rent due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership recorded a note receivable and corresponding allowance for credit losses equal to the total of the 1994 deferred rents of $1.575 million. The Partnership did not recognize either the $1.575 million rental amount deferred in 1994 or the $2.025 million rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The note receivable and corresponding allowance for credit losses were reduced by the principal portion of the payments received. The Partnership received all scheduled rent payments beginning in April 1995 and all scheduled deferred rental payments beginning in May 1995, including interest at a rate of 12% per annum, from TWA and has recognized the $3.6 million deferred rents as rental revenue during 1995. The deferred rents were paid in full by October 1995. In consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The 15 Partnership received $218,171 in January 1995 as its share of such payment by TWA. This amount was recognized as other revenue in the Partnership's 1995 statement of operations (Item 8). In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock. In order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by a formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents. On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995, the Bankruptcy Court confirmed TWA's plan of reorganization, which became effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the confirmation date of the plan, August 4, 1995, the Partnership received a payment of $1,217,989 from TWA which represented fifty percent (50%) of the deferred rent outstanding plus interest as of such date. The remaining balance of deferred rent plus interest was paid in full to the Partnership on October 2, 1995. TWA has been current with its obligation to the Partnership since August 1995. While TWA has committed to an uninterrupted flow of lease payments, there can be no assurance that TWA will continue to honor its obligations in the future. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995 and recognized the net warrant value as of the date of receipt of $1,772,206 as revenue in the 1995 statement of operations. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share and has recognized a gain on the value of the warrants of $582,028 in the 1995 statement of operations. The Partnership sold the TWA Common Stock in the first quarter of 1996, net of broker commissions, for $2,406,479. Viscount Default and Bankruptcy Filing On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in Tucson, Arizona. In April 1996, GECAS, on behalf of the Partnership, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), the owner/trustee under the Partnership's leases with Viscount (the Leases), Viscount, certain guarantors of Viscount's indebtedness and others executed in April 1996 a Compromise of Claims and Stipulation under Section 1110 of the Bankruptcy Code (the Compromise and Stipulation), which was subsequently approved by the Bankruptcy Court. The Compromise and Stipulation provided, among other things, that Viscount rejected the lease of the Partnership's aircraft. The rejection of the lease gave rise to a pre-petition unsecured claim in Viscount's bankruptcy for breach of contract damages. Notwithstanding Viscount's rejection of the Partnership's aircraft lease, Viscount continued to possess and use the Partnership's engine and refused to return various aircraft parts removed from the Partnership's aircraft. During 1995, Viscount delivered the Partnership's Boeing 737-200 aircraft to a repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace, located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the 16 filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft, which is in addition to the approximately $565,000 already paid by the Partnership from maintenance reserves. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third-party vendor, who claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. On May 22, 1996, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), as owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to recover the airframe from BAE Aviation, Inc. and certain creditors alleging mechanics liens and to determine the validity of the claimed liens. Pursuant to a stipulated order of the Superior Court entered on July 9, 1996, FSB filed a bond in the penal sum of $1,371,000 for the benefit of the lienholders, who subsequently released the aircraft to the Partnership on July 11, 1996 and filed a claim against the bond. The matter is set for trial on April 14, 1998. On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to recover the engines and parts leased in connection with the Partnership's aircraft. GECAS and FSB assert that these engines and parts should have been delivered to FSB pursuant to the Compromise and Stipulation. Viscount paid to the Partnership $10,000 for the use of the engine during the month of August 1996, and continued through August 1996 to pay maintenance reserves pursuant to the lease terms. On September 18, 1996, GECAS (on behalf of the Partnership, Polaris Holding Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV and Polaris Aircraft Investors XVIII) (collectively, the Polaris Entities) and Viscount entered into a Stipulation and Agreement (the Stipulation and Agreement) by which Viscount agreed to voluntarily return all of the Polaris Entities' aircraft and engines, turn over possession of the majority of its aircraft parts inventory, and cooperate with GECAS in the transition of aircraft equipment and maintenance, in exchange for which, upon Bankruptcy Court approval of the Stipulation and Agreement, the Polaris Entities would waive their pre- and post-petition claims against Viscount for amounts due and unpaid. A consignment agreement has been entered into with a sales agent for the disposal of the spare parts inventory recovered from Viscount. Given that many of the parts require repair/overhaul, the cost of which is not accurately determinable in advance, and the inherent uncertainty of sales prices for used spare parts, there remains uncertainty as to whether the Partnership will derive further proceeds from the sale of this inventory. The Stipulation and Agreement also provides that the Polaris Entities, GECAS and FSB would release any and all claims against Viscount, Viscount's bankruptcy estate, and the property of Viscount's bankruptcy estate, effective upon entry of a final non-appealable court order approving the Stipulation and Agreement. The Bankruptcy Court entered such an order approving the Stipulation and Agreement on October 23, 1996. The Partnership recorded provisions for credit losses of $100,409 and $241,964 in 1996 and 1995, respectively, for the aggregate unsecured receivables from Viscount. The line of credit, which was advanced to Viscount in 1994, was, in accordance with the Compromise and Stipulation, secured by certain of Viscount's trade receivables and spare parts. The Stipulation and Agreement releases the Partnership's claim against Viscount's trade receivables. As a result, the Partnership recorded an additional provision for credit losses of $92,508 during 1996, representing Viscount's outstanding balance of the line of credit and accrued interest. Payments received by the Partnership from the sale of the spare aircraft parts (as discussed above), if any, will be recorded as revenue when received. The Stipulation and Agreement provides that, upon entry of a final non-appealable court order approving it, the Partnership would waive its pre- and post-petition claims against Viscount for all amounts due and unpaid. As a result, the Partnership considers all receivables from Viscount to be uncollectible and has written-off, during 1996, all notes, rents and interest receivable balances from Viscount. 17 The Partnership evaluated the airframe and engines previously leased to Viscount for potential re-lease or sale and estimated that maintenance and refurbishment costs aggregating approximately $1.6 million would be required to re-lease the airframe and engines. Alternatively, a sale of the airframe and engines would likely be made on an "as is, where is" basis, without the Partnership incurring substantial maintenance costs. The aircraft was sold in January 1997 for $660,000. As discussed in Note 3, the Partnership recognized an impairment loss of $300,000 on this aircraft which was recorded as additional depreciation expense during 1996. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership has incurred legal costs of approximately $107,000 and $147,000, which are reflected in operating expense in the Partnership's 1997 and 1996 statement of operations, respectively. Industry Update Maintenance of Aging Aircraft - The process of aircraft maintenance begins at the aircraft design stage. For aircraft operating under Federal Aviation Administration (FAA) regulations, a review board consisting of representatives of the manufacturer, FAA representatives and operating airline representatives is responsible for specifying the aircraft's initial maintenance program. The general partner understands that this program is constantly reviewed and modified throughout the aircraft's operational life. Since 1988, the FAA, working with the aircraft manufacturers and operators, has issued a series of ADs which mandate that operators conduct more intensive inspections, primarily of the aircraft fuselages. The results of these mandatory inspections may result in the need for repairs or structural modifications that may not have been required under pre-existing maintenance programs. In addition, an AD adopted in 1990, applicable to McDonnell Douglas aircraft, requires replacement or modification of certain structural items on a specific timetable. These structural items were formerly subject to periodic inspection, with replacement when necessary. The AD requires specific work to be performed at various cycle thresholds between 40,000 and 100,000 cycles, and on specific date or age thresholds. The estimated cost of compliance with all of the components of this AD is approximately $850,000 per aircraft. The extent of modifications required to an aircraft varies according to the level of incorporation of design improvements at manufacture. In January 1993, the FAA adopted another AD intended to mitigate corrosion of structural components, which would require repeated inspections from 5 years of age throughout the life of an aircraft, with replacement of corroded components as needed. Integration of the new inspections into each aircraft operator's maintenance program was required by January 31, 1994. The Partnership's existing leases require the lessees to maintain the Partnership's aircraft in accordance with an FAA-approved maintenance program during the lease term. At the end of the leases, each lessee is generally required to return the aircraft in airworthy condition including compliance with all ADs for which action is mandated by the FAA during the lease term. An aircraft returned to the Partnership as a result of a lease default would most likely not be returned to the Partnership in compliance with all return conditions required by the lease. The Partnership has agreed to bear a portion of the costs of compliance with certain ADs with respect to the aircraft leased to TWA, as described in Item 1. In negotiating subsequent leases, market conditions may require that the Partnership bear some or all of the costs of compliance with future ADs or ADs that have been issued, but which did not require action during the previous lease term. The ultimate effect on the Partnership of compliance with the FAA maintenance standards is not determinable at this time and will depend on a variety of factors, including the state of the commercial aircraft industry, the timing of the issuance of ADs, and the status of compliance therewith at the expiration of the current leases. 18 Aircraft Noise - Another issue which has affected the airline industry is that of aircraft noise levels. The FAA has categorized aircraft according to their noise levels. Stage 1 aircraft, which have the highest noise level, are no longer allowed to operate from civil airports in the United States. Stage 2 aircraft meet current FAA requirements, subject to the phase-out rules discussed below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all new aircraft. On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2 aircraft by the end of this decade. The key features of the rule include: - Compliance can be accomplished through a gradual process of phase-in or phase-out (see below) on each of three interim compliance dates: December 31, 1994, 1996, and 1998. All Stage 2 aircraft must be phased out of operations in the contiguous United States by December 31, 1999, with waivers available in certain specific cases to December 31, 2003. - All operators have the option of achieving compliance through a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25% of its Stage 2 fleet on each of the compliance dates noted above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%, 65% and 75% of an operator's fleet must consist of Stage 3 aircraft by the respective interim compliance dates noted above). The federal rule does not prohibit local airports from issuing more stringent phase-out rules. In fact, several local airports have adopted more stringent noise requirements which restrict the operation of Stage 2 and certain Stage 3 aircraft. Other countries have also adopted noise policies. The European Union (EU) adopted a non-addition rule in 1989, which directed each member country to pass the necessary legislation to prohibit airlines from adding Stage 2 aircraft to their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the year 2002. The International Civil Aviation Organization has also endorsed the phase-out of Stage 2 aircraft on a world-wide basis by the year 2002. Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are currently available for the Partnership's aircraft and have been added to eleven of the Partnership's aircraft in 1996 and to three of their aircraft in 1997. Demand for Aircraft - Industry-wide, approximately 330 commercial jet aircraft were available for sale or lease at December 31, 1997, approximately 50 more than a year ago. At under 3% of the total available jet aircraft fleet, this is still a relatively low level of availability by industry historic standards. From 1991 to 1994, depressed demand for travel limited airline expansion plans, with new aircraft orders and scheduled deliveries being canceled or substantially deferred. As profitability declined, many airlines took action to downsize or liquidate assets and some airlines were forced to file for bankruptcy protection. Following four years of strong traffic growth accompanied by rising yields, this trend reversed with many airlines reporting substantial profits since 1995. As a result of this improving trend, just over 1200 new jet aircraft were ordered in 1996 and a further 1300 were ordered in 1997, making this the second highest ever order year in the history of the industry. To date, this strong recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which are now being upgraded with hushkits, whereas older Stage 2 narrow-bodies and early wide-bodies have shown only marginal signs of recovery since the depressed 1991 to 1994 period. Economic turmoil in Asia in the second half of 1997 has brought about a significant reduction in traffic growth in much of that region which is resulting in a number of new aircraft order deferrals and cancellations, mainly in the wide-body sector of the market with as yet no impact evident in other world markets. 19 The general partner believes that, in addition to the factors cited above, the deteriorated market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control and structural inspection and modification as previously discussed. Effects on the Partnership's Aircraft - The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. The Partnership made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased. If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized impairments on aircraft to be held and used by the Partnership of approximately $17.0 million and $2.4 million, or $33.97 and $4.75 per limited Partnership unit, in 1996 and 1995, respectively. In 1996, the impairment loss was the result of several significant factors. As a result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase seven of the Partnership's remaining aircraft subject to each aircraft's existing lease and certain notes receivable. This offer constituted an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the proposed purchase price reflected in the offer, less the estimated costs and expenses of the proposed sale. The Partnership recorded an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections. The 1995 downward adjustment was the result of the reduction of the net book value to the estimated net realizable value of the Boeing 737-200 Combi aircraft sold to Westjet in 1996. The increased depreciation expense reduced the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft. The Partnership's future earnings are impacted by the net effect of the adjustments to the carrying value of the aircraft recorded in 1996 and 1995 (which has the effect of decreasing future depreciation expense) and the downward adjustments to the estimated residual values recorded in 1995 (which has the effect of increasing future depreciation expense). The net effect of the 1995 adjustments to the estimated residual values and the adjustments to the carrying value of the aircraft recorded in 1995 is to cause the Partnership to recognize increased depreciation expense of approximately $866,000 per year beginning in 1996 through the end of the estimated economic lives of the aircraft. The Partnership periodically reviews its aircraft for impairment in accordance with SFAS No. 121. The Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future. 20 Item 8. Financial Statements and Supplementary Data POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND 1996 TOGETHER WITH AUDITORS' REPORT 21 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Partners of Polaris Aircraft Income Fund II, A California Limited Partnership: We have audited the accompanying balance sheets of Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1997 and 1996, and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the general partner. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the general partner, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Francisco, California, January 23, 1998 22 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership BALANCE SHEETS DECEMBER 31, 1997 AND 1996 1997 1996 ---- ---- ASSETS: CASH AND CASH EQUIVALENTS $ 31,587,494 $ 22,224,813 RENT AND OTHER RECEIVABLES 935,629 6,648 NOTES RECEIVABLE -- 1,522,956 AIRCRAFT, net of accumulated depreciation of $70,346,578 in 1997 and $120,260,981 in 1996 45,016,731 63,638,062 AIRCRAFT INVENTORY -- 113,248 OTHER ASSETS 6,571 117,015 ------------ ------------ $ 77,546,425 $ 87,622,742 ============ ============ LIABILITIES AND PARTNERS' CAPITAL (DEFICIT): PAYABLE TO AFFILIATES $ 142,761 $ 66,631 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 317,799 209,781 SECURITY DEPOSITS 50,000 116,000 MAINTENANCE RESERVES -- 223,528 DEFERRED INCOME 627,660 597,915 NOTES PAYABLE 15,667,509 14,193,178 ------------ ------------ Total Liabilities 16,805,729 15,407,033 ------------ ------------ PARTNERS' CAPITAL (DEFICIT): General Partner (3,030,600) (1,480,858) Limited Partners, 499,997 units issued and outstanding 63,771,296 73,696,567 ------------ ------------ Total Partners' Capital 60,740,696 72,215,709 ------------ ------------ $ 77,546,425 $ 87,622,742 ============ ============ The accompanying notes are an integral part of these statements. 23 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995 ---- ---- ---- REVENUES: Rent from operating leases $ 14,792,071 $ 14,172,153 $ 16,114,000 Receipt of lessee stock warrants -- -- 1,772,206 Gain on trading securities -- 49,974 582,028 Interest 1,939,699 1,505,981 1,667,397 Claims related to lessee defaults -- 576,500 -- Loss on sale of aircraft (26,079) -- -- Gain on sale of aircraft inventory 101,501 -- -- Other 802,443 -- 957,710 ------------ ------------ ------------ Total Revenues 17,609,635 16,304,608 21,093,341 ------------ ------------ ------------ EXPENSES: Depreciation 10,435,053 29,470,353 13,895,184 Management fees to general partner 531,135 667,678 752,384 Provision for credit losses -- 192,917 241,964 Operating 145,905 244,494 150,161 Interest 1,659,897 134,341 -- Administration and other 368,309 303,311 336,583 ------------ ------------ ------------ Total Expenses 13,140,299 31,031,094 15,376,276 ------------ ------------ ------------ NET INCOME (LOSS) $ 4,469,336 $(14,708,486) $ 5,717,065 ============ ============ ============ NET INCOME ALLOCATED TO THE GENERAL PARTNER $ 44,693 $ 1,602,730 $ 744,597 ============ ============ ============ NET INCOME (LOSS) ALLOCATED TO LIMITED PARTNERS $ 4,424,643 $(16,311,216) $ 4,972,468 ============ ============ ============ NET INCOME (LOSS) PER LIMITED PARTNERSHIP UNIT $ 8.85 $ (32.62) $ 9.94 ============ ============ ============ The accompanying notes are an integral part of these statements. 24 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 General Limited Partner Partners Total ------- -------- ----- Balance, December 31, 1994 $ (1,119,868) $ 109,410,169 $ 108,290,301 Net income 744,597 4,972,468 5,717,065 Cash distributions to partners (763,884) (6,874,959) (7,638,843) ------------- ------------- ------------- Balance, December 31, 1995 (1,139,155) 107,507,678 106,368,523 Net income (loss) 1,602,730 (16,311,216) (14,708,486) Cash distributions to partners (1,944,433) (17,499,895) (19,444,328) ------------- ------------- ------------- Balance, December 31, 1996 (1,480,858) 73,696,567 72,215,709 Net income 44,693 4,424,643 4,469,336 Cash distributions to partners (1,594,435) (14,349,914) (15,944,349) ------------- ------------- ------------- Balance, December 31, 1997 $ (3,030,600) $ 63,771,296 $ 60,740,696 ============= ============= ============= The accompanying notes are an integral part of these statements. 25 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
1997 1996 1995 ---- ---- ---- OPERATING ACTIVITIES: Net income (loss) $ 4,469,336 $(14,708,486) $ 5,717,065 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation 10,435,053 29,470,353 13,895,184 Provision for credit losses -- 192,917 241,964 Loss on sale of aircraft 26,079 -- -- Gain on sale of aircraft inventory (101,501) -- -- Changes in operating assets and liabilities: Decrease (increase) in marketable securities, trading -- 2,356,506 (2,356,506) Decrease (increase) in rent and other receivables (929,403) (101,959) 41,132 Decrease (Increase) in other assets 110,444 (87,245) -- Increase (decrease) in payable to affiliates 76,130 (25,880) (610,330) Increase in accounts payable and accrued liabilities 42,619 122,425 48,693 Increase (decrease) in security deposits (66,000) (334,000) 278,860 Increase (decrease) in maintenance reserves (6,453) 44,343 (543,505) Increase (decrease) in deferred income 29,745 (44,827) -- ------------ ------------ ------------ Net cash provided by operating activities 14,086,049 16,884,147 16,712,557 ------------ ------------ ------------ INVESTING ACTIVITIES: Proceeds from sale of aircraft 2,519,495 -- -- Increase in aircraft capitalized costs (4,784,633) (17,516,722) -- Principal payments on notes receivable 12,798,106 1,963,561 1,873,751 Payments to Purchaser related to sale of aircraft (1,001,067) -- -- Net proceeds from sale of aircraft inventory 214,749 260,235 275,130 ------------ ------------ ------------ Net cash provided by (used in) investing activities 9,746,650 (15,292,926) 2,148,881 ------------ ------------ ------------ FINANCING ACTIVITIES: Increase in note payable 3,884,633 14,216,722 -- Principal payments on notes payable (2,410,302) (23,544) -- Cash distributions to partners (15,944,349) (19,444,328) (7,638,843) ------------ ------------ ------------ Net cash used in financing activities (14,470,018) (5,251,150) (7,638,843) ------------ ------------ ------------ CHANGES IN CASH AND CASH EQUIVALENTS 9,362,681 (3,659,929) 11,222,595 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 22,224,813 25,884,742 14,662,147 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 31,587,494 $ 22,224,813 $ 25,884,742 ============ ============ ============
The accompanying notes are an integral part of these statements. 26 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1997 1. Accounting Principles and Policies Accounting Method - Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership), maintains its accounting records, prepares its financial statements and files its tax returns on the accrual basis of accounting. The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. The most significant estimates with regard to these financial statements are related to the projected cash flows analysis in determining the fair value of assets. Cash and Cash Equivalents - This includes deposits at banks and investments in money market funds. Cash and Cash Equivalents are stated at cost, which approximates fair value. Marketable Securities, trading - Marketable Securities, trading, were carried at fair value, which was determined based on quoted market prices. These securities were held for sale in the near term (Note 6). Aircraft and Depreciation - The aircraft are recorded at cost, which includes acquisition costs. Depreciation to an estimated residual value is computed using the straight-line method over the estimated economic life of the aircraft which was originally estimated to be 30 years from the date of manufacture. Depreciation in the year of acquisition was calculated based upon the number of days that the aircraft were in service. The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased. If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, an impairment loss is recognized. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 121, as discussed in Note 3, measurement of an impairment loss will be based on the "fair value" of the asset as defined in the statement. Capitalized Costs - Aircraft modification and maintenance costs which are determined to increase the value or extend the useful life of the aircraft are capitalized and amortized using the straight-line method over the estimated useful life of the improvement. These costs are also subject to periodic evaluation as discussed above. Aircraft Inventory - Aircraft held in inventory for sale are reflected at the lower of depreciated cost or estimated net realizable value. Proceeds from sales are applied against inventory until the book value is fully recovered. The remaining book value of the inventory was recovered in 1997. Proceeds in excess of inventory net book value are recorded as revenue when received. Operating Leases - The aircraft leases are accounted for as operating leases. Lease revenues are recognized in equal installments over the terms of the leases. 27 Maintenance Reserves - The Partnership received maintenance reserve payments from certain of its lessees that were to be reimbursed to the lessee or applied against certain costs incurred by the Partnership or lessee for maintenance work performed on the Partnership's aircraft or engines, as specified in the leases. Maintenance reserve payments were recognized when received and balances remaining at the termination of the lease, if any, were used by the Partnership to offset future maintenance expenses or recognized as revenue. Operating Expenses - Operating expenses include costs incurred to maintain, insure, lease and sell the Partnership's aircraft, including costs related to lessee defaults and costs of disassembling aircraft inventory. Net Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited partnership unit is based on the limited partners' share of net income or loss and the number of units outstanding for the years ended December 31, 1997, 1996 and 1995. Income Taxes - The Partnership files federal and state information income tax returns only. Taxable income or loss is reportable by the individual partners. Receivables - The Partnership recorded an allowance for credit losses for certain impaired note and rents receivable as a result of uncertainties regarding their collection as discussed in Note 8. The Partnership recognizes revenue on impaired notes and receivables only as payments are received. 1996 ---- Allowance for credit losses, beginning of year $ (241,964) Provision for credit losses (192,917) Write-downs 434,881 Collections - ----------- Allowance for credit losses, end of year $ - ============ 2. Organization and the Partnership The Partnership was formed on June 27, 1984 for the purpose of acquiring and leasing aircraft. The Partnership will terminate no later than December 2010. Upon organization, both the general partner and the initial limited partner contributed $500. The Partnership recognized no profits or losses during the periods ended December 31, 1985 and 1984. The offering of limited partnership units terminated on December 31, 1986, at which time the Partnership had sold 499,997 units of $500, representing $249,998,500. All partners were admitted to the Partnership on or before December 1, 1986. Polaris Investment Management Corporation (PIMC), the sole general partner of the Partnership, supervises the day-to-day operations of the Partnership. PIMC is a wholly-owned subsidiary of Polaris Aircraft Leasing Corporation (PALC). Polaris Holding Company (PHC) is the parent company of PALC. General Electric Capital Corporation (GE Capital), an affiliate of General Electric Company, owns 100% of PHC's outstanding common stock. PIMC has entered into a services agreement dated as of July 1, 1994 with GE Capital Aviation Services, Inc. (GECAS). Allocations to related parties are described in Note 11. 28 3. Aircraft At December 31, 1997, Polaris Aircraft Income Fund II (the Partnership) owned a portfolio of 14 used commercial jet aircraft and certain inventoried aircraft parts out of its original portfolio of 30 aircraft, which were acquired, leased or sold as discussed below. All aircraft acquired from an affiliate were purchased within one year of the affiliate's acquisition at the affiliate's original price paid. The aircraft leases are net operating leases, requiring the lessees to pay all operating expenses associated with the aircraft during the lease term. While the leases require the lessees to comply with Airworthiness Directives (ADs) which have been or may be issued by the Federal Aviation Administration and require compliance during the lease term, in certain of the leases the Partnership has agreed to share in the cost of compliance with ADs. In addition to basic rent, one lessee was required to pay supplemental amounts based on flight hours or cycles into a maintenance reserve account, to be used for heavy maintenance of the engines or airframe. The leases generally state a minimum acceptable return condition for which the lessee is liable under the terms of the lease agreement. In the event of a lessee default, these return conditions are not likely to be met. Certain leases also provide that, if the aircraft are returned at a level above the minimum acceptable level, the Partnership must reimburse the lessee for the related excess, subject to certain limitations. The related liability to these lessees, if any, cannot currently be estimated and therefore is not reflected in the financial statements. The following table describes the Partnership's aircraft portfolio at December 31, 1997 in greater detail: Year of Aircraft Type Serial Number Manufacture - ------------- ------------- ----------- McDonnell Douglas DC-9-30 47135 1968 McDonnell Douglas DC-9-30 47137 1968 McDonnell Douglas DC-9-30 47249 1968 McDonnell Douglas DC-9-30 47251 1968 McDonnell Douglas DC-9-30 47343 1969 McDonnell Douglas DC-9-30 47345 1969 McDonnell Douglas DC-9-30 47411 1969 McDonnell Douglas DC-9-30 47412 1969 McDonnell Douglas DC-9-30 47027 1967 McDonnell Douglas DC-9-30 47107 1968 McDonnell Douglas DC-9-30 47108 1968 McDonnell Douglas DC-9-30 47174 1968 McDonnell Douglas DC-9-30 47324 1969 McDonnell Douglas DC-9-30 47357 1969 14 McDonnell Douglas DC-9-30 - Initially there were 17 McDonnell Douglas DC-9-30 and one McDonnell Douglas DC-9-40 which were acquired for $122,222,040 during 1986 and leased to Ozark Air Lines, Inc. (Ozark). In 1987, Trans World Airlines, Inc. (TWA) merged with Ozark and assumed the leases. The leases were modified and extended in 1991 prior to TWA's bankruptcy filing as discussed in Note 6. Two of the aircraft had a lease expiration date of February 1998 and two other aircraft had a lease expiration date of November 1998. These four aircraft were sold to Triton Aviation Services II LLC in June 1997, as discussed in Note 4. The leases for 11 of the aircraft that previously had lease expiration dates in 1998 were extended for eight years until November 2004. The leases for three of the aircraft that previously had lease expiration dates in 1998 were extended in February 1997 for eight years until February 2005. 29 The following is a schedule by year of future minimum rental revenue under the existing leases: Year Amount ---- ------ 1998 $ 14,280,000 1999 14,280,000 2000 14,280,000 2001 14,280,000 2002 and thereafter 29,675,000 ----------------- Total $ 86,795,000 ================= Future minimum rental payments may be offset or reduced by future costs as described above and in Note 6. As discussed in Note 1, the Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. The Partnership made downward adjustments to the estimated residual value of certain of its on-lease aircraft as of December 31, 1995. The Partnership's future earnings are impacted by the net effect of the adjustments to the carrying values of the aircraft (which has the effect of decreasing future depreciation expense) and the downward adjustments to the estimated residual values (which has the effect of increasing future depreciation expense). As discussed above, the Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future. The Partnership recognized impairment losses on aircraft to be held and used by the Partnership aggregating approximately $17.0 million and $2.4 million, or $33.97 and $4.75 per limited Partnership unit, as increased depreciation expense in 1996 and 1995, respectively. In 1996, the impairment loss was the result of several significant factors. As a result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase seven of the Partnership's remaining aircraft subject to each aircraft's existing lease. This offer constitutes an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the proposed purchase price reflected in the offer, less the estimated costs and expenses of the proposed sale. The Partnership recorded an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections. The 1995 downward adjustments were the result of reductions in the net book value of certain aircraft to their estimated net realizable value. The increased depreciation expense reduces the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft. The General Partner evaluates, from time to time, whether the investment objectives of the Partnership are better served by continuing to hold the Partnership's remaining portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes into account the current and potential earnings of 30 the Aircraft, the conditions in the markets for lease and sale and future outlook for such markets, and the tax consequences of selling rather than continuing to lease the Aircraft. Recently, the General Partner has had discussions with third parties regarding the possibility of selling some or all of these Aircraft. While such discussions may continue, and similar discussions may occur again in the future, there is no assurance that such discussions will result in the Partnership receiving a purchase offer for all or any of the Aircraft which the General Partner would regard as acceptable. 4. Sale of Aircraft Sale of Boeing 737-200 Aircraft - On January 30, 1997, one Boeing 737-200 formerly on lease to Viscount, was sold to American Aircarriers Support, Inc. (American Aircarriers) on an "as-is, where-is" basis for $660,000 cash. In addition, the Partnership retained maintenance reserves from the previous lessee of $217,075, that had been held by the Partnership, which were recognized as additional sale proceeds. A net loss of $26,079 was recorded on the sale of the aircraft. Sale of Aircraft to Triton - On May 28, 1997, PIMC, on behalf of the Partnership, executed definitive documentation for the purchase of 7 of the Partnership's 21 remaining aircraft (the "Aircraft") and certain of its notes receivables by Triton Aviation Services II LLC, a special purpose company (the "Purchaser" or "Triton"). The closings for the purchase of the 7 Aircraft occurred from May 28, 1997 to June 16, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton Aviation" or the "Manager"), a privately held aircraft leasing company which was formed in 1996 by Triton Investments, Ltd., a company which has been in the marine cargo container leasing business for 17 years and is diversifying its portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the existing leases. The Terms of the Transaction - The total contract purchase price (the "Purchase Price") to the Purchaser was $13,988,000 which was allocated to the Aircraft and to certain notes receivable by the Partnership. The Purchaser paid into an escrow account $1,575,888 of the Purchase Price in cash upon the closing of the first aircraft and delivered a promissory note (the "Promissory Note") for the balance of $12,412,112. The Partnership received payment of $1,575,888 from the escrow account on June 24, 1997. On December 30, 1997, the Partnership received prepayment in full of the outstanding note receivable and interest earned by the Partnership to that date. Under the purchase agreement, the Purchaser purchased the Aircraft effective as of April 1, 1997 notwithstanding the actual closing dates. The utilization of an effective date facilitated the determination of rent and other allocations between the parties. The Purchaser had the right to receive all income and proceeds, including rents and receivables, from the Aircraft accruing from and after April 1, 1997, and the Promissory Note commenced bearing interest as of April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold subject to the existing leases. Neither PIMC nor GECAS received a sales commission in connection with the transaction. In addition, PIMC was not paid a management fee with respect to the collection of the Promissory Note or on any rents accruing from or after April 1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of its affiliates holds any interest in Triton Aviation or any of Triton Aviation's affiliates. John Flynn, the current President of Triton Aviation, was a Polaris executive until May 1996 and has over 15 years experience in the commercial aviation industry. At the time Mr. Flynn was employed at PIMC, he had no affiliation with Triton Aviation or its affiliates. Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold certain aircraft assets to separate special purpose companies under common management with the Purchaser (collectively, together with the Purchaser, the "SPC's") on terms similar to those set forth above, with the exception of the Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis. 31 The Accounting Treatment of the Transaction - In accordance with GAAP, the Partnership recognized rental income up until the closing date for each aircraft which occurred from May 28, 1997 to June 16, 1997. However, under the terms of the transaction, the Purchaser was entitled to receive payment of the rents, receivables and other income accruing from April 1, 1997. As a result, the Partnership made payments to the Purchaser in the amount of the rents, receivables and other income due and received from April 1, 1997 to the closing date of $1,001,067, which is included in rent from operating leases and interest income. For financial reporting purposes, the cash down payment portion of the sales proceeds of $1,575,888 has been adjusted by the following: income and proceeds, including rents and receivables from the effective date of April 1, 1997 to the closing date, interest due on the cash portion of the purchase price, interest on the Promissory Note from the effective date of April 1, 1997 to the closing date and estimated selling costs. As a result of these GAAP adjustments, the net adjusted sales price recorded by the Partnership, including the Promissory Note, was $13,205,140. The Aircraft sold pursuant to the definitive documentation executed on May 28, 1997 had been classified as aircraft held for sale from that date until the actual closing date. Under GAAP, aircraft held for sale are carried at their fair market value less estimated costs to sell. The adjustment to the sales proceeds described above and revisions to estimated costs to sell the Aircraft required the Partnership to record an adjustment to the net carrying value of the aircraft held for sale of $749,373 during the three months ended June 30, 1997. This adjustment to the net carrying value of the aircraft held for sale is included in depreciation and amortization expense on the statement of operations. 5. Disassembly of aircraft In an attempt to maximize the economic return from the remaining six aircraft formerly leased to Pan Am, the Partnership entered into an agreement with Soundair, Inc. (Soundair) in October 1992, for the disassembly and sale of certain of the Partnership's aircraft. The Partnership has incurred the cost of disassembly and will receive the proceeds from the sale of such parts, net of overhaul expenses, if necessary, and commissions paid to Soundair. Disassembly of the six aircraft has been completed. The Partnership has received net proceeds from the sale of aircraft inventory of $214,749, $260,234 and $275,130 during 1997, 1996 and 1995, respectively, reducing the net book value of the Partnership's aircraft inventory to zero during 1997. Payments received by the Partnership of $100,501 in excess of the aircraft inventory net book value were recorded as gain on sale of aircraft inventory during 1997. During 1995, the Partnership recorded additional downward adjustments to the inventory value of $200,000, to reflect the then current estimate of net realizable aircraft inventory value. These adjustments are reflected as increased depreciation expense in the accompanying statements of operations. 6. TWA Reorganization The Partnership renegotiated the TWA leases after TWA defaulted under its leases with the Partnership during 1991. The renegotiated agreement stipulated that the Partnership share in the cost of certain ADs after TWA successfully reorganized. Pursuant to this cost-sharing agreement, since TWA emerged from its reorganization proceedings in 1993, expenses totaling $6.6 million have been offset against rental payments or credited to other amounts due from TWA. Under 32 the terms of this agreement, TWA may offset up to an additional $1.7 million against rental payments, subject to annual limitations, over the remaining lease terms. In October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by GECAS, 18 of which are owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft. The Deferral Agreement provided for (i) a moratorium on the rents due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not recognize either the $1.575 million rental amount deferred in 1994 or the $2.025 million rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The deferred rents were paid in full by October 1995. While TWA has committed to an uninterrupted flow of lease payments, there can be no assurance that TWA will continue to honor its obligations in the future. In consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. The Partnership received $218,171 in January 1995 as its pro-rata share of such payment by TWA. This amount was recognized as other revenue in the accompanying 1995 statement of operations. In order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents. The Partnership received warrants to purchase 227,133 shares of TWA Common Stock from TWA in November 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share. The fair market value of the TWA stock at December 31, 1995 of $2,356,506, which was determined based on quoted market prices, is reflected in the accompanying December 31, 1995 balance sheet. The Partnership sold the TWA Common Stock by February 1996, net of broker commissions, for $2,406,479 and recognized a gain on trading securities of $49,974 in 1996. 7. TWA Lease Extension GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of noise-suppression devices, commonly known as "hushkits", for the 14 Partnership aircraft currently on lease to TWA, as well as other aircraft owned by affiliates of PIMC and leased to TWA. The 14 aircraft that received hushkits were designated by TWA. The hushkits recondition the aircraft so as to meet Stage 3 noise level restrictions. Hushkits were installed on 11 of the Partnership's aircraft during 1996 and the leases for these 11 aircraft were extended for a period of eight years until November 2004. Hushkits were installed on 3 of the Partnership's aircraft during 1997 and the leases for these 3 aircraft were extended for a period of eight years until February 2005. The aggregate cost of the hushkit reconditioning for the 11 aircraft was $17,516,722, or approximately $1.6 million per aircraft, which was capitalized by the Partnership during 1996. The Partnership paid $3.3 million of the aggregate hushkit cost and the balance of $14,216,722 was financed by the hushkit manufacturer over 50 months at an interest rate of approximately 10% per annum. 33 The aggregate cost of the hushkit reconditioning completed in February 1997 for the 3 remaining aircraft was $4,784,633, or approximately $1.6 million per aircraft, which was capitalized by the Partnership during 1997. The Partnership paid $900,000 of the aggregate hushkit cost and the balance of $3,884,633 was financed by UT Finance Corporation (UT Finance), a wholly owned subsidiary of United Technologies Corporation, of which a division is Pratt and Whitney Group, the hushkit manufacturer, over 50 months at an interest rate of approximately 10% per annum. The rent payable by TWA under the leases was increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. The loans from the hushkit manufacturer are non-recourse to the Partnership and secured by a security interest in the lease receivables. Cash paid for interest expenses on the loans was $1,551,093 and $236,848 in 1997 and 1996, respectively. 8. Viscount Restructuring Agreement and Default On January 24, 1996, Viscount filed a petition for protection under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court in Tucson, Arizona. In April 1996, GECAS, on behalf of the Partnership, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), the owner/trustee under the Partnership's leases with Viscount (the Leases), Viscount, certain guarantors of Viscount's indebtedness and others executed in April 1996 a Compromise of Claims and Stipulation under Section 1110 of the Bankruptcy Code (the Compromise and Stipulation), which was subsequently approved by the Bankruptcy Court. The Compromise and Stipulation provided, among other things, that Viscount rejected the lease of the Partnership's aircraft. The rejection of the lease gave rise to a pre-petition unsecured claim in Viscount's bankruptcy for breach of contract damages. Notwithstanding Viscount's rejection of the Partnership's aircraft lease, Viscount continued to possess and use the Partnership's engine and refused to return various aircraft parts removed from the Partnership's aircraft. During 1995, Viscount delivered the Partnership's Boeing 737-200 aircraft to a repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace, located in Arizona, to perform a heavy maintenance check on the aircraft. The Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance reserves and cash reserves for this aircraft as progress payments on this maintenance check. Work on the maintenance check was suspended prior to the filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that Viscount owes it approximately $866,000 for work done on the aircraft, which is in addition to the approximately $565,000 already paid by the Partnership from maintenance reserves. In addition, a third party vendor, who claims it provided personnel to work on the aircraft, is asserting a claim against Tucson Aerospace and a lien against the aircraft in the amount of $720,000. Another third-party vendor, who claims it provided inspectors, is claiming $185,000 from Tucson Aerospace. On May 22, 1996, First Security Bank, National Association (formerly known as First Security Bank of Utah, National Association) (FSB), as owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to recover the airframe from BAE Aviation, Inc. and certain creditors alleging mechanics liens and to determine the validity of the claimed liens. Pursuant to a stipulated order of the Superior Court entered on July 9, 1996, FSB filed a bond in the penal sum of $1,371,000 for the benefit of the lienholders, who subsequently released the aircraft to the Partnership on July 11, 1996 and filed a claim against the bond. The matter is set for trial on April 14, 1998. On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to recover the engines and parts leased in connection with the Partnership's aircraft. GECAS and FSB asserted that these engines and parts should have been delivered to FSB pursuant to the Compromise and Stipulation. Viscount paid to the Partnership $10,000 for the use of the engine during the month of August 1996, and continued through August 1996 to pay maintenance reserves pursuant to the lease terms. 34 On September 18, 1996, GECAS (on behalf of the Partnership, Polaris Holding Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV and Polaris Aircraft Investors XVIII) (collectively, the Polaris Entities) and Viscount entered into a Stipulation and Agreement (the Stipulation and Agreement) by which Viscount agreed to voluntarily return all of the Polaris Entities' aircraft and engines, turn over possession of the majority of its aircraft parts inventory, and cooperate with GECAS in the transition of aircraft equipment and maintenance, in exchange for which, upon Bankruptcy Court approval of the Stipulation and Agreement, the Polaris Entities would waive their pre- and post-petition claims against Viscount for amounts due and unpaid. A consignment agreement has been entered into with a sales agent for the disposal of the spare parts inventory recovered from Viscount. Given that many of the parts require repair/overhaul, the cost of which is not accurately determinable in advance, and the inherent uncertainty of sales prices for used spare parts, there remains uncertainty as to whether the Partnership will derive further proceeds from the sale of this inventory. The Stipulation and Agreement also provides that the Polaris Entities, GECAS and FSB would release any and all claims against Viscount, Viscount's bankruptcy estate, and the property of Viscount's bankruptcy estate, effective upon entry of a final non-appealable court order approving the Stipulation and Agreement. The Bankruptcy Court entered such an order approving the Stipulation and Agreement on October 23, 1996. The Partnership recorded allowances for credit losses of $241,964 and $100,409 in 1995 and 1996, respectively, for the aggregate unsecured receivables from Viscount. The line of credit, which was advanced to Viscount in 1994, was, in accordance with the Compromise and Stipulation, secured by certain of Viscount's trade receivables and spare parts. The Stipulation and Agreement releases the Partnership's claim against Viscount's trade receivables. As a result, the Partnership recorded an additional allowance for credit losses of $92,508 during 1996, representing Viscount's outstanding balance of the line of credit and accrued interest. Payments received by the Partnership from the sale of the spare aircraft parts (as discussed above), if any, will be recorded as revenue when received. The Stipulation and Agreement provides that, upon entry of a final non-appealable court order approving it, the Partnership would waive its pre- and post-petition claims against Viscount for all amounts due and unpaid. As a result, the Partnership considers all receivables from Viscount to be uncollectible and has written-off, during 1996, all notes, rents and interest receivable balances from Viscount. The Partnership has evaluated the airframe and engines previously leased to Viscount for potential re-lease or sale and estimated that maintenance and refurbishment costs aggregating approximately $1.6 million will be required to re-lease the airframe and engines. Alternatively, a sale of the airframe and engines would likely be made on an "as is, where is" basis, without the Partnership incurring substantial maintenance costs. The aircraft was sold in January 1997 for $660,000. As discussed in Note 3, in accordance with SFAS No. 121, the Partnership recognized an impairment loss of $300,000 on this aircraft which was recorded as additional depreciation expense during 1996. Viscount's failure to perform its financial obligations to the Partnership has had a material adverse effect on the Partnership's financial position. As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership has incurred legal costs of approximately $107,000 and $147,000, which are reflected in operating expense in the Partnership's 1997 and 1996 statement of operations, respectively. 9. ALG Default and Restructuring In 1995, ALG paid to the Partnership $19,138 of the $897,932 balloon payment due in January 1995, originating an event of default under the note. The Partnership and ALG subsequently restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1995 of $254,733, 35 eleven monthly payments of $25,600 beginning in February 1995, and a balloon payment in January 1996 of $416,631. In January 1996, the Partnership and ALG once again restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with a lump sum payment in January 1996 of $135,258 and eleven payments of $27,272 beginning in February 1996 through December 1996. ALG paid the note in full during 1996. 10. Claims Related to Lessee Defaults Pan Am - The Partnership entered into a proposed Stipulation and Order in which Pan Am agreed to allow the Partnership $2.5 million as an administrative expense priority claim and $56 million as a general unsecured claim. In May 1996, the Partnership received from Pan Am a payment of $567,500 on the administrative expense priority claim. In November 1996, the Partnership received an additional $9,000 payment on the administrative expense priority claim. The Partnership has recorded these payments as revenue in claims related to lessee defaults in the 1996 statement of operations. It is unlikely that the Partnership will receive additional payments on the administrative expense priority claim. It cannot be estimated at this time when and if the general unsecured claim will be paid. 11. Related Parties Under the Limited Partnership Agreement (Partnership Agreement), the Partnership paid or agreed to pay the following amounts to PIMC and/or its affiliates in connection with services rendered: a. An aircraft management fee equal to 5% of gross rental revenues with respect to operating leases or 2% of gross rental revenues with respect to full payout leases of the Partnership, payable upon receipt of the rent. In 1997, 1996 and 1995, the Partnership paid management fees to PIMC of $440,295, $652,417 and $763,774, respectively. Management fees payable to PIMC at December 31, 1997 and 1996 were $76,330 and $0 respectively. b. Reimbursement of certain out-of-pocket expenses incurred in connection with the management of the Partnership and supervision of its assets. In 1997, 1996 and 1995, $375,486, $316,061 and $299,588, respectively, were reimbursed by the Partnership for administrative expenses. Administrative reimbursements of $50,286 and $65,594 were payable at December 31, 1997 and 1996, respectively. Reimbursements for maintenance and remarketing costs of $82,633, $153,699 and $972,284 were paid by the Partnership in 1997, 1996 and 1995, respectively. Maintenance and remarketing reimbursements of $16,145 and $1,037 were payable at December 31, 1997 and 1996, respectively. c. A 10% interest to PIMC in all cash distributions and sales proceeds, gross income in an amount equal to 9.09% of distributed cash available from operations and 1% of net income or loss and taxable income or loss, as such terms are defined in the Partnership Agreement. After the Partnership has sold or disposed of aircraft representing 50% of the total aircraft cost, gains from the sale or other disposition of aircraft are generally allocated first to the General Partner until such time that the General Partner's capital account is equal to the amount to be distributed to the General Partner from the proceeds of such sale or disposition. d. A subordinated sales commission to PIMC of 3% of the gross sales price of each aircraft for services performed upon disposition and reimbursement of out-of-pocket and other disposition expenses. Subordinated sales commissions will be paid only after limited partners have received distributions in an aggregate amount equal to their capital contributions plus a cumulative non-compounded 8% per annum return on their adjusted capital contributions, as defined in the Partnership Agreement. The Partnership did not pay or accrue a sales commission on any aircraft sales to date as the above subordination threshold has not been met. 36 e. One engine owned by Polaris Aircraft Income Fund I (PAIF-I) was leased to Viscount beginning in April 1993 through a joint venture with the Partnership. The rental payments of $146,000 per year were offset against rent from operating leases in the 1995 statement of operations. f. In the event that, immediately prior to the dissolution and termination of the Partnership, the General Partner shall have a deficit balance in its tax basis capital account, then the General Partner shall contribute in cash to the capital of the Partnership an amount which is equal to such deficit (see Note 12). 12. Partners' Capital The Partnership Agreement (the Agreement) stipulates different methods by which revenue, income and loss from operations and gain or loss on the sale of aircraft are to be allocated to the General Partner and the Limited Partners (see Note 11). Such allocations are made using income or loss calculated under GAAP for book purposes, which, as more fully described in Note 14, varies from income or loss calculated for tax purposes. Cash available for distributions, including the proceeds from the sale of aircraft, is distributed 10% to the General Partner and 90% to the Limited Partners. The different methods of allocating items of income, loss and cash available for distribution combined with the calculation of items of income and loss for book and tax purposes result in book basis capital accounts that may vary significantly from tax basis capital accounts. The ultimate liquidation and distribution of remaining cash will be based on the tax basis capital accounts following liquidation, in accordance with the Agreement. Had all the assets of the Partnership been liquidated at December 31, 1997 at the current carrying value, the tax basis capital (deficit) accounts of the General Partner and the Limited Partners is estimated to be ($723,727) and $61,464,423, respectively. 13. Income Taxes Federal and state income tax regulations provide that taxes on the income or loss of the Partnership are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the financial statements. The net differences between the tax basis and the reported amounts of the Partnership's assets and liabilities at December 31, 1997 and 1996 are as follows: Reported Amounts Tax Basis Net Difference ---------------- --------- -------------- 1997: Assets $ 77,546,425 $ 84,836,496 $ (7,290,071) Liabilities 16,805,729 16,232,563 573,166 1996: Assets $ 87,622,742 $ 98,431,900 $ (10,809,158) Liabilities 15,407,033 14,654,469 752,564 37 14. Reconciliation of Net Book Income (Loss) to Taxable Net Income (Loss) The following is a reconciliation between net income (loss) per limited partnership unit reflected in the financial statements and the information provided to limited partners for federal income tax purposes: For the years ended December 31, -------------------------------- 1997 1996 1995 ---- ---- ---- Book net income (loss) per limited partnership unit $ 8.85 $ (32.62) $ 9.94 Adjustments for tax purposes represent differences between book and tax revenue and expenses: Rental and maintenance reserve revenue recognition (1.18) 0.03 (2.60) Management fee expense 0.06 0.03 0.14 Depreciation (11.31) 30.16 (0.78) Gain or loss on sale of aircraft (0.02) (0.19) (1.60) Capitalized costs -- -- 0.93 Basis in inventory (0.07) (0.08) (1.08) Other revenue and expense items (0.01) (0.16) (0.36) --------- --------- -------- Taxable net income (loss) per limited partnership unit $ (3.68) $ (2.83) $ 4.59 ========= ========= ======== The differences between net income and loss for book purposes and net income and loss for tax purposes result from the temporary differences of certain revenue and deductions. For book purposes, rental revenue is generally recorded as it is earned. For tax purposes, certain temporary differences exist in the recognition of revenue. For tax purposes, management fee expense is accrued in the same year as the tax basis rental revenue. Increases in the Partnership's book maintenance reserve liability were recognized as rental revenue for tax purposes. Disbursements from the Partnership's book maintenance reserves are capitalized or expensed for tax purposes, as appropriate. The Partnership computes depreciation using the straight-line method for financial reporting purposes and generally an accelerated method for tax purposes. The Partnership also periodically evaluates the ultimate recoverability of the carrying values and the economic lives of its aircraft for book purposes and, accordingly, recognized adjustments which increased book depreciation expense. As a result, the current year tax depreciation expense is greater than the book depreciation expense. These differences in depreciation methods result in book to tax differences on the sale of aircraft. In addition, certain costs were capitalized for tax purposes and expensed for book purposes. Differences in book and tax revenue from inventory result from the differences in the book and tax carrying value of the inventory. 15. Subsequent Events The Partnership made a cash distribution, to limited partners, of $2,424,869 or $4.85 per limited partnership unit, and $269,430 to the General Partner on January 15, 1998. The Partnership made a special cash distribution, to limited partners, of $10,624,426, or $21.25 per limited partnership unit, and $1,180,492 to the General Partner on February 23, 1998, as a result of the prepayment of the Promissory Note by Triton, as discussed in Note 4. 38 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 39 PART III Item 10. Directors and Executive Officers of the Registrant Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership) has no directors or officers. Polaris Holding Company (PHC) and its subsidiaries, including Polaris Aircraft Leasing Corporation (PALC) and Polaris Investment Management Corporation (PIMC), the general partner of the Partnership (collectively Polaris), restructured their operations and businesses (the Polaris Restructuring) in 1994. In connection therewith, PIMC entered into a services agreement dated as of July 1, 1994 (the Services Agreement) with GE Capital Aviation Services, Inc. (GECAS), a Delaware corporation which is a wholly owned subsidiary of General Electric Capital Corporation, a New York corporation (GE Capital). GE Capital has been PHC's parent company since 1986. As subsidiaries of GE Capital, the Servicer and PIMC are affiliates. The officers and directors of PIMC are: Name PIMC Title -------------- -------------------- Eric M. Dull President; Director Marc A. Meiches Chief Financial Officer Richard J. Adams Director Norman C. T. Liu Vice President; Director Ray Warman Secretary Robert W. Dillon Assistant Secretary Substantially all of these management personnel will devote only such portion of their time to the business and affairs of PIMC as deemed necessary or appropriate. Mr. Dull, 37, assumed the position of President and Director of PIMC effective January 1, 1997. Mr. Dull previously was a Director of PIMC from March 31, 1995 to July 31, 1995. Mr. Dull holds the position of Executive Vice President - Risk and Portfolio Management of GECAS, having previously held the positions of Executive Vice President - Portfolio Management and Senior Vice President - Underwriting Risk Management of GECAS. Prior to joining GECAS, Mr. Dull held various positions with Transportation and Industrial Funding Corporation (TIFC). Mr. Meiches, 45, assumed the position of Chief Financial Officer of PIMC effective October 9, 1995. Previously, he held the position of Vice President of PIMC from October 1995 to October 1997. Mr. Meiches presently holds the positions of Executive Vice President and Chief Financial and Operating Officer of GECAS. Prior to joining GECAS, Mr. Meiches has been with General Electric Company (GE) and its subsidiaries since 1978. Since 1992, Mr. Meiches held the position of Vice President of the General Electric Capital Corporation Audit Staff. Between 1987 and 1992, Mr. Meiches held Manager of Finance positions for GE Re-entry Systems, GE Government Communications Systems and the GE Astro-Space Division. Mr. Adams, 64, held the position of Senior Vice President - Aircraft Sales and Leasing of PIMC and PALC from August 1992 until October 1997, having previously served as Vice President - Aircraft Sales & Leasing, Vice President, North America, and Vice President - Corporate Aircraft since he joined PALC in August 1986. Effective July 1, 1994, Mr. Adams assumed the position of Director of PIMC. Mr. Adams presently holds the position of Senior Vice President - Fleet Advisory Services of GECAS, having previously held the position of Senior Vice President - Stage II Aircraft. Mr. Liu, 40, assumed the position of Vice President of PIMC effective May 1, 1995 and Director of PIMC effective July 31, 1995. Mr. Liu presently holds the position of Executive Vice President - Marketing and Structured Finance of GECAS, having previously held the position of Executive Vice President - Capital 40 Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was with General Electric Capital Corporation for nine years. He has held management positions in corporate Business Development and in Syndications and Leasing for TIFC. Mr. Liu previously held the position of managing director of Kidder, Peabody & Co., Incorporated. Mr. Warman, 49, assumed the position of Secretary of PIMC effective March 23, 1998. Mr. Warman has served as a GECAS Senior Vice President and Associate General Counsel since March 1996, and for 13 years theretofore was a partner, with an air-finance and corporate practice of the national law firm of Morgan, Lewis & Bockius LLP. Mr. Dillon, 56, held the position of Vice President - Aviation Legal and Insurance Affairs, from April 1989 to October 1997. Previously, he served as General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994, Mr. Dillon assumed the position of Assistant Secretary of PIMC. Mr. Dillon presently holds the position of Senior Vice President and Managing Counsel of GECAS. Certain Legal Proceedings: On October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v. Polaris Holding Company, et al. was filed in the Supreme Court of the State of New York for the County of New York. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for alleged fraud in connection with certain public offerings, including that of the Partnership, on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged negligent misrepresentation in connection with such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged breach of third party beneficiary contracts; (v) for alleged violations of the NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for alleged breach of implied covenants in the customer agreements by certain registered brokers. The Partnership is not named as a defendant in this action. The complaint seeks an award of compensatory and other damages and remedies. On July 20, 1994, the court entered an order dismissing almost all of the claims in the complaint and amended complaint. Plaintiffs filed a notice of appeal on September 2, 1994. On April 25, 1996, the Appellate Division for the First Department affirmed the trial court's order which had dismissed most of plaintiffs' claims. On September 25, 1997, this action was discontinued with prejudice by stipulation of the parties. On or around February 17, 1993, a civil action entitled Einhorn, et al. v. Polaris Public Income Funds, et al. was filed in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida against, among others, Polaris Investment Management Corporation and Polaris Depositary Company. The Partnership is not named as a defendant in this action. Plaintiffs seek class action certification on behalf of a class of investors in Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI who purchased their interests while residing in Florida. Plaintiffs allege the violation of Section 517.301, Florida Statutes, in connection with the offering and sale of units in such Polaris Aircraft Income Funds. Among other things, plaintiffs assert that the defendants sold interests in such Polaris Aircraft Income Funds while "omitting and failing to disclose the material facts questioning the economic efficacy of" such Polaris Aircraft Income Funds. Plaintiffs seek rescission or damages, in addition to interest, costs, and attorneys' fees. On April 5, 1993, defendants filed a motion to stay this action pending the final determination of a prior filed action in the Supreme Court for the State of New York entitled Weisl v. Polaris Holding Company. On that date, defendants also filed a motion to dismiss the complaint on the grounds of failure to attach necessary documents, failure to plead fraud with particularity and failure to plead reasonable reliance. On April 13, 1993, the court denied the defendants' motion to stay. On May 7, 1993, the court stayed the action pending an appeal of the denial of the motion to stay. Defendants subsequently filed with the Third District Court of Appeal a petition for writ of certiorari 41 to review the lower court's order denying the motion to stay. On October 19, 1993, the Court of Appeal granted the writ of certiorari, quashed the order, and remanded the action with instruction to grant the stay. Moross, et al. v. Polaris Holding Company, et al was transferred to the Multi-District Litigation which has been settled as described below. On June 8, 1994, a consolidated complaint captioned In re Prudential Securities Inc. Limited Partnerships Litigation was filed in the United States District Court for the Southern District of New York, purportedly consolidating cases that had been transferred from other federal courts by the Judicial Panel on Multi-District Litigation. The consolidated complaint names as defendants Prudential entities and various other sponsors of limited partnerships sold by Prudential, including Polaris Holding Company, one of its former officers, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation and Polaris Securities Corporation. The Partnership is not named as a defendant in this action. The complaint alleges that the Prudential defendants created a scheme for the sale of approximately $8-billion of limited partnership interests in 700 allegedly high-risk limited partnerships, including the Partnership, to approximately 350,000 investors by means of false and misleading offering materials; that the sponsoring organizations (including the Polaris entities) participated with the Prudential defendants with respect to, among other things, the partnerships that each sponsored; and that all of the defendants conspired to engage in a nationwide pattern of fraudulent conduct in the marketing of all limited partnerships sold by Prudential. The complaint alleges violations of the federal Racketeer Influenced and Corrupt Organizations Act and the New Jersey counterpart thereof, fraud, negligent misrepresentation, breach of fiduciary duty and breach of contract. The complaint seeks rescission, unspecified compensatory damages, treble damages, disgorgement of profits derived from the alleged acts, costs and attorneys fees. On April 22, 1997, the Polaris defendants entered into a settlement agreement with plaintiffs pursuant to which, among other things, the Polaris defendants agreed to make a payment to a class of unitholders previously certified by the Court. On August 1, 1997, the Court approved a class settlement with the Polaris defendants. Adams, et al. v. Prudential Securities, Inc. et al. was transferred to the Multi-District Litigation filed in the United States District Court for the Southern District of New York, which has been settled as discussed above. On or about January 12, 1995, a class action complaint entitled Cohen, et al. v. Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida, and on March 31, 1995 the case was removed to the United States District Court for the Southern District of Florida. An amended class action complaint (the "amended complaint"), which re-named this action Bashein, et al. v. Kidder, Peabody & Company Inc., et al. was filed on June 13, 1995. The amended complaint names Kidder Peabody & Company, Inc., General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company as defendants. The Partnership is not named as a defendant in this action. The action purports to be on behalf of "approximately 20,000 persons throughout the United States" who purchased units in Polaris Aircraft Income Funds III through VI. The amended complaint sets forth various causes of action purportedly arising in connection with the public offerings of Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, and Polaris Aircraft Income Fund VI. Specifically, plaintiffs assert claims for violation of Sections 12(2) and 15 of the Securities Act of 1933, fraud, negligent misrepresentation, breach of fiduciary duty, breach of third party beneficiary contract, violation of NASD Rules of Fair Practice, breach of implied covenant, and breach of contract. Plaintiffs seek compensatory damages, interest, punitive damages, costs and 42 attorneys' fees, as well as any other relief the court deems just and proper. Plaintiffs filed a motion for leave to file a second amended complaint, which was granted on October 3, 1995. On March 18, 1996, plaintiffs moved for class certification. On the eve of class discovery, April 26, 1996, plaintiffs moved for a voluntary dismissal of Counts I and II (claims brought pursuant to the Securities Act of 1933) of the Second Amended Complaint and simultaneously filed a motion to remand this action to state court for lack of federal jurisdiction. Plaintiff's motion for voluntary dismissal of the federal securities law claims and motion for remand were granted on July 10, 1996. On December 18, 1997, the Court ordered that plaintiffs show good cause why the action should not be dismissed without prejudice for lack of prosecution. On January 14, 1998, a hearing was held with respect to the order to show cause, and the Court determined that the action should be dismissed without prejudice for lack of prosecution. On or around April 13, 1995, a class action complaint entitled B & L Industries, Inc., et al. v. Polaris Holding Company, et al. was filed in the Supreme Court of the State of New York. The complaint names as defendants Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Peter G. Pfendler, Marc P. Desautels, General Electric Capital Corporation, General Electric Financial Services, Inc., General Electric Company, Prudential Securities Inc., and Kidder Peabody & Company Incorporated. The Partnership is not named as a defendant in this action. The complaint sets forth various causes of action purportedly arising out of the public offerings of Polaris Aircraft Income Fund III and Polaris Aircraft Income Fund IV. Plaintiffs allege claims of fraud, negligent misrepresentation, breach of fiduciary duty, knowingly inducing or participating in breach of fiduciary duty, breach of third party beneficiary contract, violation of NASD Rules of Fair Practice, breach of implied covenant, and unjust enrichment. Plaintiffs seek compensatory damages, interest, general, consequential and incidental damages, exemplary and punitive damages, disgorgement, rescission, costs, attorneys' fees, accountants' and experts' fees, and other legal and equitable relief as the court deems just and proper. On August 16, 1996, defendants filed a motion to dismiss plaintiffs' amended complaint. On October 8, 1997, this action was discontinued with prejudice by stipulation of the parties. On or around September 27, 1995, a complaint entitled Martha J. Harrison v. General Electric Company, et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and Prudential Securities Incorporated. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund IV. Plaintiff seeks compensatory damages, attorney's fees, interest, costs and general relief. On or around December 8, 1995, a complaint entitled Overby, et al. v. General Electric Company, et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty, in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. In or around November 1994, a complaint entitled Lucy R. Neeb, et al. v. Prudential Securities Incorporated et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants 43 Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition adding as additional defendants General Electric Company, General Electric Capital Corporation and Smith Barney, Inc. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty, in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v. Prudential Securities, Incorporated et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities Incorporated and Stephen Derby Gisclair. On or about January 18, 1996, plaintiff filed a First Supplemental and Amending Petition adding defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v. General Electric Co., et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. In or around December 1994, a complaint entitled John J. Jones, Jr. v. Prudential Securities Incorporated et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition adding as additional defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of section of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund III. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief. On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v. General Electric Company, et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. On or about May 7, 1996, a petition entitled Charles Rich, et al. v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint 44 names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief. On or about March 4, 1996, a petition entitled Richard J. McGiven v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief. On or about March 4, 1996, a petition entitled Alex M. Wade v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief. The following actions were settled pursuant to a settlement agreement entered into on June 6, 1997. An additional settlement was entered into on November 19, 1997 with certain plaintiffs who had refused to participate in the first settlement: A complaint entitled Joyce H. McDevitt, et al. v. Polaris Holding Company, et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about October 15, 1996, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds I-VI. A complaint entitled Mary Grant Tarrer, et al. v. Kidder Peabody & Co. (Kidder Peabody), et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about October 16, 1996, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds III-VI and other limited partnerships sold by Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP Realty Advisors, Inc., Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory 45 damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds III-VI and all other limited partnerships alleged to have been sold by Kidder Peabody to the plaintiffs. A complaint entitled Janet K. Johnson, et al. v. Polaris Holding Company, et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about November 6, 1996, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds I-VI. A complaint entitled Wayne W. Kuntz, et al. v. Polaris Holding Company, et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about November 13, 1996, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds I-VI. A complaint entitled Thelma Abrams, et al. v. Polaris Holding Company, et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about November 26, 1996, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds I-VI. A complaint entitled Enita Elphick, et al. v. Kidder Peabody & Co.,et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about January 16, 1997, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds III-VI and other limited partnerships sold by Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP Realty Advisors, Inc., Polaris Holding Company, Polaris 46 Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds III-VI and all other limited partnerships alleged to have been sold by Kidder Peabody to the plaintiffs. A complaint entitled George Zicos, et al. v. Polaris Holding Company, et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about February 14, 1997, by individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds I-VI. Three complaints which were filed on or about March 21, 1997, in the Superior Court of the State of California, County of Sacramento naming as defendants Kidder, Peabody & Company, Incorporated, Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Capital Services, General Electric Capital Corporation, GE Capital Aviation Services and Does 1-100. The first complaint, entitled Michael J. Ouellette, et al. v. Kidder Peabody & Co., et al., was filed by over 50 individual plaintiffs who purchased limited partnership units in one or more of Polaris Aircraft Income Funds I-VI. The second complaint, entitled Thelma A. Rolph, et al. v. Polaris Holding Company, et al., was filed by over 500 individual plaintiffs who purchased limited partnership units in one or more of Polaris Aircraft Income Funds I-VI. The third complaint, entitled Carl L. Self, et al. v. Polaris Holding Company, et al., was filed by over 500 individual plaintiffs who purchased limited partnership units in one or more of Polaris Aircraft Income Funds I-VI. The Partnership is not named as a defendant in any of these actions. Each complaint alleges violations of state common law, including fraud, negligent misrepresentation and breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers, Inc. Each complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest and rescission with respect to Polaris Aircraft Income Funds I-VI and all other limited partnerships alleged to have been sold by Kidder Peabody to the plaintiffs. A complaint entitled Wilson et al. v. Polaris Holding Company et al., which was filed in the Superior Court of the State of California for the County of Sacramento on October 1, 1996, by over 500 individual plaintiffs who purchased limited partnership units in one or more of Polaris Aircraft Income Funds I through VI. The complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Capital Services, Inc., General Electric Capital Corporation, GE Capital Aviation Services, Inc. and Does 1-100 47 as defendants. The Partnership has not been named as a defendant. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, negligence, breach of contract, and breach of fiduciary duty. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest and rescission with respect to the Polaris Aircraft Income Funds sold to plaintiffs. A summons and First Amended Complaint entitled Sara J. Bishop, et al. v. Kidder Peabody & Co., et al., which was filed in the Superior Court of the State of California, County of Sacramento, on or about April 9, 1996, by over one hundred individual plaintiffs who purchased limited partnership units in Polaris Aircraft Income Funds III, IV, V and VI and other limited partnerships sold by Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP Realty Advisors, Inc., Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric Company, General Electric Financial Services, Inc., General Electric Capital Corporation, General Electric Credit Corporation and Does 1-100 as defendants. The Partnership is not named as a defendant in this action. The complaint alleges violations of state common law, including fraud, negligent misrepresentation, breach of fiduciary duty, and violations of the rules of the National Association of Securities Dealers. The complaint seeks to recover compensatory damages and punitive damages in an unspecified amount, interest, and rescission with respect to Polaris Aircraft Income Funds III-VI and all other limited partnerships alleged to have been sold by Kidder Peabody to the plaintiffs. Other Proceedings - Part I, Item 3 discusses certain other actions arising out of certain public offerings, including that of the Partnership, to which both the Partnership and its general partner are parties. Disclosure pursuant to Section 16, Item 405 of Regulation S-K: Based solely on its review of the copies of such forms received or written representations from certain reporting persons that no Forms 3, 4, or 5 were required for those persons, the Partnership believes that, during 1997 all filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were met. Item 11. Executive Compensation PAIF-II has no directors or officers. PAIF-II is managed by PIMC, the General Partner. In connection with management services provided, management and advisory fees of $440,295 were paid to PIMC in 1997 in addition to a 10% interest in all cash distributions as described in Note 11 to the financial statements (Item 8). Item 12. Security Ownership of Certain Beneficial Owners and Management a) No person owns of record, or is known by PAIF-II to own beneficially, more than five percent of any class of voting securities of PAIF-II. 48 b) The General Partner of PAIF-II owns the equity securities of PAIF-II as set forth in the following table: Title Name of Amount and Nature of Percent of Class Beneficial Owner Beneficial Ownership of Class -------- ---------------- --------------------- -------- General Polaris Investment Represents a 10.0% interest of 100% Partner Management all cash distributions, gross Interest Corporation income in an amount equal to 9.09% of distributed cash available from operations, and a 1% interest in net income or loss c) There are no arrangements known to PAIF-II, including any pledge by any person of securities of PAIF-II, the operation of which may at a subsequent date result in a change in control of PAIF-II. Item 13. Certain Relationships and Related Transactions None. 49 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 1. Financial Statements. The following are included in Part II of this report: Page No. -------- Report of Independent Public Accountants 22 Balance Sheets 23 Statements of Operations 24 Statements of Changes in Partners' Capital (Deficit) 25 Statements of Cash Flows 26 Notes to Financial Statements 27 2. Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended December 31, 1997. A current report on Form 8-K was filed on January 5, 1998 to report the prepayment in full of the Promissory Note due from Triton Aviation Services II LLC on December 30, 1997. 3. Exhibits required to be filed by Item 601 of Regulation S-K. 27. Financial Data Schedule (in electronic format only). 4. Financial Statement Schedules. All financial statement schedules are omitted because they are not applicable, not required or because the required information is included in the financial statements or notes thereto. 50 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership (REGISTRANT) By: Polaris Investment Management Corporation General Partner March 27, 1998 By: /S/ Eric M. Dull -------------- ------------------------- Date Eric M. Dull, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date --------- ----- ---- /S/Eric M. Dull President and Director of Polaris March 27, 1998 --------------- Investment Management Corporation, -------------- (Eric M. Dull) General Partner of the Registrant /S/Marc A. Meiches Chief Financial Officer of Polaris March 27, 1998 ------------------ Investment Management Corporation, -------------- (Marc A. Meiches) General Partner of the Registrant /S/Richard J. Adams Director of Polaris Investment March 27, 1998 ------------------- Management Corporation, General -------------- (Richard J. Adams) Partner of the Registrant 51 EX-27 2
5 YEAR DEC-31-1997 DEC-31-1997 31587494 0 935629 0 0 0 115363309 70346578 77546425 0 0 0 0 0 60740696 77546425 0 17609635 0 0 13140299 0 0 4469336 0 4469336 0 0 0 4469336 8.85 0
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