-----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, Ftg9x/I9gB7rh5GEjrkrNNvL1lvO4/mZZ3HTyMALO9+ewP6au8bNPg+g3PsoqThT 080kI6Geu81H3rvC1I4l8g== 0000948524-00-000016.txt : 20000411 0000948524-00-000016.hdr.sgml : 20000411 ACCESSION NUMBER: 0000948524-00-000016 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 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-K405 SEC ACT: SEC FILE NUMBER: 033-02794 FILM NUMBER: 581754 BUSINESS ADDRESS: STREET 1: 201 HIGH RIDGE ROAD STREET 2: 27TH FL CITY: STAMFORD STATE: CT ZIP: 06927 BUSINESS PHONE: (203) 357- MAIL ADDRESS: STREET 1: 201 HIGH RIDGE ROAD STREET 2: 27TH FL CITY: STAMFORD STATE: CT ZIP: 06927 10-K405 1 DECEMBER 31, 1999 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, 1999 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. X --- No formal market exists for the units of limited partnership interest and therefore there exists no aggregate market value at December 31, 1999. Documents incorporated by reference: None This document consists of 40 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 aircraft management services to third parties, including without limitation, AerFi Group plc (formerly GPA Group plc), a public limited company organized in Ireland, together with its consolidated subsidiaries (AerFi), and Airplanes Group, together with its subsidiaries (APG), each of which two groups 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, AerFi, APG, and other third parties to whom GECAS provides aircraft management services from time to time. 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, 1999. 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. 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 $218,171 and warrants for 227,133 shares of TWA Common Stock. These warrants were exercised in 1995 and the related stock was subsequently sold in 1996. 2 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 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. A discussion of the current market condition for the type of aircraft owned by the Partnership follows. For further information, see Demand for Aircraft in the Industry Update section of Item 7. 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, 1999, the Partnership owned 14 McDonnell Douglas DC-9-30 aircraft leased to TWA and spare parts inventory (as discussed in Note 8) 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. These aircraft, which are not included in the following table, were disassembled for sale of their component parts, the remainder of which was sold to Soundair, Inc. in 1998. 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. 3 The following table describes the Partnership's aircraft portfolio at December 31, 1999 in greater detail: Year of Cycles Aircraft Type Serial Number Manufacture As of 10/31/99 (1) - ------------- ------------- ----------- ------------------- McDonnell Douglas DC-9-30 47027 1967 86,459 McDonnell Douglas DC-9-30 47107 1968 86,547 McDonnell Douglas DC-9-30 47108 1968 83,343 McDonnell Douglas DC-9-30 47135 1968 82,809 McDonnell Douglas DC-9-30 47137 1968 81,589 McDonnell Douglas DC-9-30 47174 1968 84,046 McDonnell Douglas DC-9-30 47249 1968 88,254 McDonnell Douglas DC-9-30 47251 1968 86,009 McDonnell Douglas DC-9-30 47324 1969 80,814 McDonnell Douglas DC-9-30 47343 1969 84,513 McDonnell Douglas DC-9-30 47345 1969 82,877 McDonnell Douglas DC-9-30 47357 1969 80,140 McDonnell Douglas DC-9-30 47411 1969 80,585 McDonnell Douglas DC-9-30 47412 1969 81,088 (1) Cycle information as of 12/31/99 was not available. Item 3. Legal Proceedings Braniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Orlando Division. The Bankruptcy Court disposed of the Partnership's claim in this bankruptcy 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 FAA noise regulations to operate one Stage 2 aircraft and by allowing the Partnership a net remaining unsecured claim of $769,231 in the proceedings. Braniff's bankrupt estate made a $200,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $15,385 was allocated to the Partnership based on its pro rata share of the total claims. On January 20, 1999, Braniff's bankrupt estate made an additional $84,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $6,462 was allocated to the Partnership based on its pro rata share of the total claims. No further payments have been made in respect of the Partnership's unsecured claim in the bankruptcy proceeding. Viscount Air Services, Inc. (Viscount) Bankruptcy - As previously reported in the Partnership's 1998 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 called 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 4 bond. FSB filed a motion for summary judgment on all claims raised by the claimants in the counterclaim. The Superior Court granted the motion and entered judgment on October 30, 1998 dismissing the counterclaim and exonerating the bond. The Court has stayed exoneration of the bond pending appeal by the claimant. FSB filed a motion seeking recovery of its attorneys' fees and costs incurred in defending the litigation, and the Court entered an order awarding $159,374.51 to FSB, GE Capital Aviation Services, Inc. and Federal Insurance Company, as surety, for partial reimbursement of their attorneys' fees and expenses. On February 4, 2000, the Court denied the claimants' motion for a new trial and denied FSB's supplemental application for award of attorneys' fees and expenses. The claimants have indicated that they will file an appeal. 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. The trial date for this action was set and rescheduled by the trial court several times, and on September 2, 1999, the court granted a stay of this action pending the submission of the remaining plaintiffs' claims to arbitration. 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. 5 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, 1999 ------------------------- ------------------------ Limited Partnership Interest: 14,093 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 1999 and 1998 totaled $8,199,557 and $18,673,991, respectively. Cash distributions per Limited Partnership unit were $16.40 and $37.35 in 1999 and 1998, respectively. 6 Item 6. Selected Financial Data
For the years ended December 31, -------------------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Revenues $ 13,559,480 $ 13,901,118 $ 17,609,635 $ 16,304,608 $ 21,093,341 Net Income (Loss) 6,622,183 3,456,655 4,469,336 (14,708,486) 5,717,065 Net Income (Loss) Allocated to Limited Partners 5,742,360 1,607,397 4,424,643 (16,311,216) 4,972,468 Net Income (Loss) per Limited Partnership Unit 11.49 3.22 8.85 (32.62) 9.94 Cash Distributions per Limited Partnership Unit 16.40 37.35 28.70 35.00 13.75 Amount of Cash Distributions Included Above Representing a Return of Capital on a Generally Accepted Accounting Principle Basis per Limited Partnership Unit* 16.40 37.35 28.70 35.00 13.75 Total Assets 51,760,515 57,461,885 77,546,425 87,622,742 107,820,317 Partners' Capital 40,956,964 43,445,400 60,740,696 72,215,709 106,368,523
* 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. 7 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations At December 31, 1999, Polaris Aircraft Income Fund II (the Partnership) owned a portfolio of 14 used commercial jet aircraft and spare parts inventory (as discussed in Note 8) 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 were disassembled for sale of their component parts. The Partnership sold its remaining inventory of aircraft parts from the six disassembled aircraft, to Soundair, Inc., in 1998. 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. Partnership Operations The Partnership reported net income of $6,622,183, or $11.49 per Limited Partnership unit for the year ended December 31, 1999, compared to net income of $3,456,655, or $3.22 per Limited Partnership unit and net income of $4,469,336, or $8.85 per Limited Partnership unit, for the years ended December 31, 1998 and 1997, respectively. Variances in net income may not correspond to variances in net income per Limited Partnership unit due to the allocation of components of income and loss in accordance with the Partnership agreement. Interest income decreased during 1998, as compared to 1997, primarily due to the December 1997 payoff of the Promissory note related to the aircraft sold to Triton Aviation Services II LLC in 1997. Interest income further decreased during 1999, as compared to 1998 primarily due to a decrease in the cash reserves. The Partnership recorded other income of $802,443 in 1997, compared to $50,000 and $-0- during 1998 and 1999, respectively. Other income in 1997 was comprised of the receipt of amounts due under a TWA maintenance credit and rent deferral agreement. The decrease in rental revenues, depreciation expense and management fees during 1999 and 1998, compared to 1997 was primarily attributable to the sale of aircraft to Triton during 1997. Depreciation expense was further decreased in 1999 and 1998, compared to 1997, as a result of several aircraft having been fully depreciated down to their original estimated residual values during 1998. This decrease was partially offset by additional depreciation, due to the Partnership's downward adjustment of the estimated residual value of the portfolio aircraft, beginning in the fourth quarter of 1999. 8 In November 1996 and February 1997 hushkits were installed on the 14 aircraft currently leased to TWA. The leases for these 14 aircraft were extended for a period of 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. The Partnership recorded $834,791, $1,290,441 and $1,659,897 in interest expense on the amount borrowed to finance the hushkits during 1999, 1998 and 1997, respectively. Operating expense decreased in 1999, when compared to 1998 primarily due to legal expense related to the Ron Wallace Litigation Settlement in 1998 as more fully described below. Administrative expenses decreased in 1999 compared to 1998 and 1997 primarily due to additional printing and postage costs incurred in 1998 as a result of the Triton litigation and settlement. 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's future earnings are impacted by the net effect of the adjustments to the carrying value 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). The Partnership made a downward adjustment to the estimated residual value of its aircraft as of October 1, 1999. As a result of the 1999 adjustment to the estimated residual value, the Partnership recognized increased depreciation expense in 1999 of approximately $144,721 or $.29 per Limited Partnership unit. The Partnership had been holding a security deposit, received from Jet Fleet in 1992, pending the outcome of bankruptcy proceedings. The bankruptcy proceeding of Jet Fleet Corporation was closed on August 6, 1997, and the bankruptcy proceeding of Jet Fleet International Airlines, Inc. was closed on February 10, 1998. Consequently, the Partnership recognized, during the quarter ended March 31, 1998, revenue of $50,000 that had been held as a deposit. The Partnership recorded other revenue during 1997 as compared to 1998 and 1999. This amount reflected in other revenue was the result of the receipt of $802,443 related to amounts due under the TWA maintenance credit and rent deferral agreement as discussed above. Liquidity and Cash Distributions Liquidity - The Partnership received all payments due from lessees during 1999, except for the December 1999 lease payment from TWA. On January 3, 2000, the Partnership received its $935,000 rental payment from TWA that was due on December 27, 1999. This amount was included in rent and other receivables on the balance sheet at December 31, 1999. 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. As discussed in Note 3 to the Financial Statements (Item 8), 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 specified payment of the sales price in 36 monthly installments of $55,000 beginning in 9 March 1995. The Partnership received all scheduled payments due from AIA. This note was sold to Triton during 1997 as part of the transaction discussed later under Sale of Aircraft. 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 later under sale of Aircraft. Payments of $69,700, $133,285, and $214,749 were received during 1999, 1998 and 1997, 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 $8,199,557, $18,673,991, and $14,349,914 in 1999, 1998 and 1997, respectively. Cash distributions per Limited Partnership unit were $16.40, $37.35, and $28.70 per Limited Partnership unit in 1999, 1998 and 1997, 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. Impact of the Year 2000 Issue To date, the Partnership has not incurred any expenditures related to the Year 2000 issue nor does it expect to incur any material costs in the future. 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 10 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. 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 expense on the statement of operations. Ron Wallace Litigation Settlement 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 "Sale of Aircraft -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs, and on December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively. On November 9, 1998, defendants, acting through their counsel, entered into a settlement agreement with plaintiffs and with the plaintiff in a related action, "Accelerated" High Yield Income Fund II, Ltd., L.P. v. Polaris Investment Management Corporation, et al. The settlement agreement does not provide for any 11 payments to be made to the Partnership. Plaintiff's counsel sought reimbursement from the Partnership for its attorneys' fees and expenses. A settlement notice setting forth the terms of the settlement was mailed to the last known address of each unitholder of the Partnership on November 20, 1998. On December 24, 1998, the Court approved the terms of the settlement and approved plaintiffs' attorney's fees and expenses in the amount of $438,766, which is included in 1998 operating expenses. 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 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. FSB filed a motion for summary judgment on all claims raised by the claimants in the counterclaim. The Superior Court granted the motion and entered judgment on October 30, 1998 dismissing the counterclaim and exonerating the bond. The Court has stayed exoneration of the bond pending appeal by the claimants. The Court has denied the claimants' subsequent motion for a new trial seeking reconsideration. FSB filed a motion seeking recovery of its attorneys' fees and costs incurred in defending the litigation, and the Court set a hearing on the motion for March 8, 1999. Subsequently, FSB and the claimants agreed to settle this claim for an agreed judgement of $159,374.51 in attorney's fees to be paid to FSB. The settlement agreement is subject to approval by the Court. The claimants are appealing the Court's rulings. 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. 12 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 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. Viscount's failure to perform its financial obligations to the Partnership 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 had accrued legal costs of approximately $15,000, $116,000 and $107,000, which are reflected in operating expense in the Partnership's 1999, 1998 and 1997 and statement of operations, respectively. In 1998, the Partnership revised its estimate of legal costs and reduced the accrual for legal costs by $68,753. Claims Related to Lessee Defaults Braniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Orlando Division. The Bankruptcy Court disposed of the Partnership's claim in this bankruptcy 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 FAA noise regulations to operate one Stage 2 aircraft and by allowing the Partnership a net remaining unsecured claim of $769,231 in the proceedings. Braniff's bankrupt estate made a $200,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $15,385 was allocated to the Partnership based on its pro rata share of the total claims. On January 20, 1999, Braniff's bankrupt estate made an additional $84,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $6,462 was allocated to the Partnership based on its pro rata share of the total claims. No further payments have been made in respect of the Partnership's unsecured claim in the bankruptcy proceeding. 13 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. 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 14 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. Currently legislation has been drafted and is under review by the EU to adopt anti-hushkitting regulations within member states. The legislation seeks to ban hushkitted aircraft from being added to member states registers after May 1, 2000 (deferred from an April 1, 1999 deadline) and will preclude all operation of hushkitted aircraft within the EU by April 1, 2002. The effect of this proposal has been to reduce the demand for hushkitted aircraft within the EU and its neighboring states, including the former Eastern Block states. Demand for Aircraft - At year end 1999, there were approximately 13,550 jet aircraft in the world fleet. Approximately 1,800 aircraft were leased or sold during 1999, an increase of 9% over 1998. Air travel continued to be strong in 1999 with traffic growth around the 5% level. In 2000 traffic is projected to drop off slightly to an estimated growth rate of 4.5%. Surging fuel prices in 1999 hit the Gulf War levels as airlines added a $20 surcharge to their tickets. The increase in fuel prices cost the industry an approximate $350 million in the fourth quarter of 1999. Alliances continued to evolve in 1999 as airlines aligned themselves with code sharing, joint pricing, schedule integration and corporate agreements. The stage II fleet was projected to drop to 5% at year end 1999 and to 2% in 2002. During 1999 Airbus captured 55% of the orders placed as they outpaced Boeing by 10%. Manufacturers continue to produce at high levels compared to what demand will require in the future years. Asia has improved over 1998, however South America continues its economic turmoil. Timing of when the down cycle ends or how severe it will be is still in question, however it should be less severe than anticipated in 1998. 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. 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. 15 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. 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 SFAS No. 121. 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 made a downward adjustment to the estimated residual value of its aircraft as of October 1, 1999. As a result of the 1999 adjustment to the estimated residual value, the Partnership recognized increased depreciation expense in 1999 of approximately $144,721 or $.29 per Limited Partnership unit. 16 Item 8. Financial Statements and Supplementary Data POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership FINANCIAL STATEMENTS AS OF DECEMBER 31, 1999 AND 1998 AND FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 TOGETHER WITH THE REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS 17 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, 1999 and 1998, 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, 1999. 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, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Francisco, California, January 21, 2000 18 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership BALANCE SHEETS DECEMBER 31, 1999 AND 1998 1999 1998 ---- ---- ASSETS: CASH AND CASH EQUIVALENTS $ 18,789,625 $ 19,228,093 RENT AND OTHER RECEIVABLES 935,004 941,563 AIRCRAFT, net of accumulated depreciation of $83,330,258 in 1999 and $78,075,872 in 1998 32,033,051 37,287,437 OTHER ASSETS 2,835 4,792 ------------ ------------ Total Assets $ 51,760,515 $ 57,461,885 ============ ============ LIABILITIES AND PARTNERS' CAPITAL (DEFICIT): PAYABLE TO AFFILIATES $ 226,242 $ 155,123 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 518,032 456,414 DEFERRED INCOME 4,022,256 2,324,958 NOTES PAYABLE 6,037,021 11,079,990 ------------ ------------ Total Liabilities 10,803,551 14,016,485 ------------ ------------ PARTNERS' CAPITAL (DEFICIT): General Partner (3,287,469) (3,256,230) Limited Partners, 499,973 units issued and outstanding 44,244,433 46,701,630 ------------ ------------ Total Partners' Capital (Deficit) 40,956,964 43,445,400 ------------ ------------ Total Liabilities and Partners' Capital (Deficit) $ 51,760,515 $ 57,461,885 ============ ============ The accompanying notes are an integral part of these statements. 19 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- REVENUES: Rent from operating leases $ 12,582,702 $ 12,582,702 $ 14,792,071 Interest 907,078 1,113,284 1,939,699 Claims related to lessee defaults -- 21,847 -- Loss on sale of aircraft -- -- (26,079) Gain on sale of aircraft inventory 69,700 133,285 101,501 Other -- 50,000 802,443 ------------ ------------ ------------ Total Revenues 13,559,480 13,901,118 17,609,635 ------------ ------------ ------------ EXPENSES: Depreciation 5,254,386 7,729,294 10,435,053 Management fees to General Partner 486,468 486,468 531,135 Interest 834,791 1,290,441 1,659,897 Operating 41,387 581,127 145,905 Administration and other 320,265 357,133 368,309 ------------ ------------ ------------ Total Expenses 6,937,297 10,444,463 13,140,299 ------------ ------------ ------------ NET INCOME $ 6,622,183 $ 3,456,655 $ 4,469,336 ============ ============ ============ NET INCOME ALLOCATED TO THE GENERAL PARTNER $ 879,823 $ 1,849,258 $ 44,693 ============ ============ ============ NET INCOME ALLOCATED TO THE LIMITED PARTNERS $ 5,742,360 $ 1,607,397 $ 4,424,643 ============ ============ ============ NET INCOME PER LIMITED PARTNERSHIP UNIT $ 11.49 $ 3.22 $ 8.85 ============ ============ ============ The accompanying notes are an integral part of these statements. 20 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 General Limited Partner Partners Total ------- -------- ----- 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 Net income 1,849,258 1,607,397 3,456,655 Capital redemptions -- (3,072) (3,072) Cash distributions to partners (2,074,888) (18,673,991) (20,748,879) ------------ ------------ ------------ Balance, December 31, 1998 (3,256,230) 46,701,630 43,445,400 Net income 879,823 5,742,360 6,622,183 Cash distributions to partners (911,062) (8,199,557) (9,110,619) ------------ ------------ ------------ Balance, December 31, 1999 $ (3,287,469) $ 44,244,433 $ 40,956,964 ============ ============ ============ The accompanying notes are an integral part of these statements. 21 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997 ---- ---- ---- OPERATING ACTIVITIES: Net income $ 6,622,183 $ 3,456,655 $ 4,469,336 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 5,254,386 7,729,294 10,435,053 Loss on sale of aircraft -- -- 26,079 Gain on sale of aircraft inventory (69,700) (133,285) (101,501) Changes in operating assets and liabilities: Decrease (increase) in rent and other receivables 6,559 (5,934) (929,403) Decrease in other assets 1,957 1,779 110,444 Increase in payable to affiliates 71,119 12,362 76,130 Increase in accounts payable and accrued liabilities 61,618 138,615 42,619 Decrease in security deposits -- (50,000) (66,000) Decrease in maintenance reserves -- -- (6,453) Increase in deferred income 1,697,298 1,697,298 29,745 ------------ ------------ ------------ Net cash provided by operating activities 13,645,420 12,846,784 14,086,049 ------------ ------------ ------------ INVESTING ACTIVITIES: Proceeds from sale of aircraft -- -- 2,519,495 Increase in aircraft capitalized costs -- -- (4,784,633) Principal payments on notes receivable -- -- 12,798,106 Payments to Purchaser related to sale of aircraft -- -- (1,001,067) Net proceeds from sale of aircraft inventory 69,700 133,285 214,749 ------------ ------------ ------------ Net cash provided by investing activities 69,700 133,285 9,746,650 ------------ ------------ ------------ FINANCING ACTIVITIES: Increase in note payable -- -- 3,884,633 Principal payments on notes payable (5,042,969) (4,587,519) (2,410,302) Capital redemptions -- (3,072) -- Cash distributions to partners (9,110,619) (20,748,879) (15,944,349) ------------ ------------ ------------ Net cash used in financing activities (14,153,588) (25,339,470) (14,470,018) ------------ ------------ ------------ CHANGES IN CASH AND CASH EQUIVALENTS (438,468) (12,359,401) 9,362,681 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 19,228,093 31,587,494 22,224,813 ------------ ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 18,789,625 $ 19,228,093 $ 31,587,494 ============ ============ ============
The accompanying notes are an integral part of these statements. 22 POLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1999 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. 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. 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 will be 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 were 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. 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 23 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 Per Limited Partnership Unit - Net income per Limited Partnership unit is based on the Limited Partners' share of net income, allocated in accordance with the Partnership Agreement, and the number of units outstanding of 499,973 for the years ended December 1999 and 1998, and 499,997 for the year ended December 31, 1997. Income Taxes - The Partnership files federal and state information income tax returns only. Taxable income or loss is reportable by the individual partners. 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. During January 1998, 24 units were redeemed by the Partnership in accordance with section 18 of the Limited Partnership agreement. At December 31, 1999, there were 499,973 units outstanding, net of redemptions. 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 Notes 11 and 12. 3. Aircraft At December 31, 1999, Polaris Aircraft Income Fund II (the Partnership) owned a portfolio of 14 used commercial jet aircraft and spare parts inventory (as discussed in Note 8) 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. TWA may offset up to an additional $1.7 million against rental payments, subject to annual limitations, over the remaining lease terms. 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 24 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, 1999 in greater detail: Year of Aircraft Type Serial Number Manufacture - ------------- ------------- ----------- 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 47135 1968 McDonnell Douglas DC-9-30 47137 1968 McDonnell Douglas DC-9-30 47174 1968 McDonnell Douglas DC-9-30 47249 1968 McDonnell Douglas DC-9-30 47251 1968 McDonnell Douglas DC-9-30 47324 1969 McDonnell Douglas DC-9-30 47343 1969 McDonnell Douglas DC-9-30 47345 1969 McDonnell Douglas DC-9-30 47357 1969 McDonnell Douglas DC-9-30 47411 1969 McDonnell Douglas DC-9-30 47412 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. 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 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. The following is a schedule by year of future minimum rental revenue under the existing leases: Year Amount ---- ----------- 2000 $14,280,000 2001 14,280,000 2002 10,655,000 2003 10,080,000 2004 and thereafter 8,940,000 ----------- Total $58,235,000 =========== Future minimum rental payments may be offset or reduced by future costs as described above. 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'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). The Partnership made a downward adjustment to the estimated residual value of its aircraft as of October 1, 1999. As a result of the 1999 adjustment to the 25 estimated residual value, the Partnership recognized increased depreciation expense in 1999 of approximately $144,721 or $.29 per Limited Partnership unit. 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 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 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. 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. 26 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. Ron Wallace Litigation Settlement 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 Note 4, under the caption "Sale of Aircraft -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs, and on December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively. On November 9, 1998, defendants, acting through their counsel, entered into a settlement agreement with plaintiffs and with the plaintiff in a related action, "Accelerated" High Yield Income Fund II, Ltd., L.P. v. Polaris Investment Management Corporation, et al. The settlement agreement does not provide for any payments to be made to the Partnership. Plaintiff's counsel sought reimbursement from the Partnership for its attorneys' fees and expenses. A settlement notice setting forth the terms of the settlement was mailed to the last known address of each unitholder of the Partnership on November 20, 1998. On December 24, 1998, the Court approved the terms of the settlement and approved plaintiffs' attorney's fees and expenses in the amount of $438,766, which is included in 1998 operating expenses. 6. 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 received the proceeds from the sale of such parts, net of necessary overhaul expenses, and commissions paid to Soundair. The Partnership 27 received net proceeds from the sale of aircraft inventory of $69,700, $133,285 and $214,749 during 1999, 1998 and 1997, respectively. The net book value of the Partnership's aircraft inventory was reduced to zero during 1997. Payments received by the Partnership of $101,501 in excess of the aircraft inventory net book value were recorded as gain on sale of aircraft inventory during 1997. 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. 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. Cash paid for interest expense on the loans was $837,033, $1,292,480 and $1,551,093 in 1999, 1998 and 1997, respectively. 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. The following, is a schedule of note principal payments due under the loans: Year Amount ---- ------ 2000 $5,768,990 2001 268,031 ---------- Total $6,037,021 ========== 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 28 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. FSB filed a motion for summary judgment on all claims raised by the claimants in the counterclaim. The Superior Court granted the motion and entered judgment on October 30, 1998 dismissing the counterclaim and exonerating the bond. The Court has stayed exoneration of the bond pending appeal by the claimants. The Court has denied the claimants' subsequent motion for a new trial seeking reconsideration. FSB filed a motion seeking recovery of its attorneys' fees and costs incurred in defending the litigation, and the Court set a hearing on the motion for March 8, 1999. Subsequently, FSB and the claimants agreed to settle this claim for an agreed judgement of $159,374.51 in attorney's fees to be paid to FSB. The settlement agreement is subject to approval by the Court. The claimants are appealing the Court's rulings. 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. 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. 29 The Bankruptcy Court entered such an order approving the Stipulation and Agreement on October 23, 1996. 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 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. Viscount's failure to perform its financial obligations to the Partnership 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 had accrued legal costs of approximately $15,000, $116,000 and $107,000, which are reflected in operating expense in the Partnership's 1999, 1998 and 1997 statement of operations, respectively. In 1998, the Partnership revised its estimate of legal costs and reduced the accrual for legal costs by $68,753. 9. Claims Related to Lessee Defaults Braniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Orlando Division. The Bankruptcy Court disposed of the Partnership's claim in this bankruptcy 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 FAA noise regulations to operate one Stage 2 aircraft and by allowing the Partnership a net remaining unsecured claim of $769,231 in the proceedings. Braniff's bankrupt estate made a $200,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $15,385 was allocated to the Partnership based on its pro rata share of the total claims. On January 20, 1999, Braniff's bankrupt estate made an additional $84,000 payment in respect of the unsecured claims of the Partnership and other affiliates of Polaris Investment Management Corporation, of which $6,462 was allocated to the Partnership based on its pro rata share of the total claims. No further payments have been made in respect of the Partnership's unsecured claim in the bankruptcy proceeding. 10. 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 1999, 1998 and 1997, the Partnership paid management fees to PIMC of $420,000, $420,000, and $440,295, respectively. Management fees payable to PIMC at December 31, 1999 and 1998 were $209,266 and $142,798 respectively. b. Reimbursement of certain out-of-pocket expenses incurred in connection with the management of the Partnership and supervision of its assets. In 1999, 1998 and 1997, $285,463, $377,665, and $375,486, respectively, were reimbursed by the Partnership to PIMC for administrative expenses. Administrative reimbursements of $16,976 and $10,874 were payable at December 31, 1999 and 1998, respectively. Reimbursements for maintenance and remarketing costs of $5,803, $483,221, and $82,633 were paid by the Partnership in 1999, 1998 and 1997, respectively. Maintenance and remarketing reimbursements of $-0- and $1,451 were payable at December 31, 1999 and 1998, respectively. 30 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. e. 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 11). 11. 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 10). Such allocations are made using income or loss calculated under GAAP for book purposes, which, as more fully described in Note 13, 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, 1999 at the current carrying value, the tax basis capital (deficit) accounts of the General Partner and the Limited Partners is estimated to be $3,203,305 and $41,985,180, respectively. 12. 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, 1999 and 1998 are as follows: 31 Reported Amounts Tax Basis Net Difference ---------------- --------- -------------- 1999: Assets $51,760,515 $59,381,146 $(7,620,631) Liabilities 10,803,551 6,572,029 4,231,522 1998: Assets $57,461,885 $63,662,817 $(6,200,932) Liabilities 14,016,485 11,841,104 2,175,381 13. Reconciliation of Net Book Income 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, -------------------------------- 1999 1998 1997 ---- ---- ---- Book net income per Limited Partnership unit $ 11.49 $ 3.22 $ 8.85 Adjustments for tax purposes represent differences between book and tax revenue and expenses: Rental revenue 3.36 3.36 (1.18) Management fee expense 0.71 (0.19) 0.06 Depreciation 2.81 (2.16) (11.31) Gain or loss on sale of aircraft or inventory (0.01) - (0.02) Basis in inventory - - (0.07) Other revenue and expense items - (0.04) (0.01) ------- ------- ------- Taxable net income (loss) per Limited Partnership unit $ 18.36 $ 4.19 $ (3.68) ======= ======= ======= 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. 14. Subsequent Events The Partnership made a cash distribution, to Limited Partners, of $1,974,893.35 or $3.95 per Limited Partnership unit, and $219,432.59 to the General Partner on January 14, 2000. 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 33 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, GECAS 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 Barbara Macholl 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, 39, 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, 47, 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. Ms. Macholl, 46, assumed the position of Director of PIMC effective February 27, 1999. Ms. Macholl presently holds the position of Senior Vice President, Marketing Finance for GECAS. Prior to joining GECAS, Ms. Macholl has been with the General Electric Company (GE) and its subsidiaries since 1977. Ms. Macholl previously held the position of Vice President Finance for CBSI Inc., a wholly owned subsidiary of the General Electric Company. Ms. Macholl has also held various financial management positions for the GE Lighting business. 34 Mr. Liu, 42, 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 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, 51, 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, 58, 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 Associate General Counsel of GECAS. Certain Legal Proceedings: 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 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. 35 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 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. 36 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. 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. 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 $420,000 were paid to PIMC in 1999 in addition to a 10% interest in all cash distributions as described in Note 10 to the financial statements (Item 8). Item 12. Security Ownership of Certain Beneficial Owners and Management a) No person owns of record, or is known by PAIF-II to own beneficially, more than five percent of any class of voting securities of PAIF-II. b) The General Partner of PAIF-II owns the equity securities of PAIF-II as set forth in the following table: Title Name of Amount and Nature of Percent of Class Beneficial Owner Beneficial Ownership of Class -------- ---------------- -------------------- -------- General Polaris Investment Represents a 10.0% interest 100% Partner Management of all cash distributions, Interest Corporation gross 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. 37 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 18 Balance Sheets 19 Statements of Operations 20 Statements of Changes in Partners' Capital (Deficit) 21 Statements of Cash Flows 22 Notes to Financial Statements 23 2. Reports on Form 8-K. No reports on Form 8-K were filed during the quarter ended December 31, 1999. 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. 38 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 24, 2000 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 24, 2000 --------------- Investment Management Corporation, -------------- (Eric M. Dull) General Partner of the Registrant /S/Marc A. Meiches Chief Financial Officer of Polaris March 24, 2000 ------------------ Investment Management Corporation, -------------- (Marc A. Meiches) General Partner of the Registrant /S/Barbara Macholl Director of Polaris Investment March 24, 2000 ------------------- Management Corporation, General -------------- (Barbara Macholl) Partner of the Registrant /S/Norman C. T. Liu Vice President and Director of March 24, 2000 ------------------- Polaris Investment Management -------------- (Norman C. T. Liu) Corporation, General Partner of the Registrant 39 EX-27 2
5 YEAR DEC-31-1999 DEC-31-1999 18789625 0 935004 0 0 0 115363309 83330258 51760515 0 0 0 0 0 40956964 51760515 0 13559480 0 0 6937297 0 0 6622183 0 6622183 0 0 0 6622183 11.49 0
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