POLARIS AIRCRAFT INCOME FUND II, 10-K, 1998-03-30

POLARIS AIRCRAFT INCOME FUND II
10-K, 1998-03-30
EQUIPMENT RENTAL & LEASING, NEC

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

--------------------

FORM 10-K

--------------------

_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997

___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ___

Commission File No.33-2794

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
-------------------------------
(Exact name of registrant as specified in its charter)

California 94-2985086
------------------------------- -----------------------
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)

201 High Ridge Road, Stamford, Connecticut 06927
------------------------------------------ ----------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (203) 357-3776

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Units of Limited Partnership Interest

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____

No formal market exists for the units of limited partnership interest and
therefore there exists no aggregate market value at December 31, 1997.

Documents incorporated by reference: None

This document consists of 51 pages.

<PAGE>

PART I

Item 1. Business

Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or
the Partnership), was formed primarily to purchase and lease used commercial jet
aircraft in order to provide quarterly distributions of cash from operations, to
maximize the residual values of aircraft upon sale and to protect Partnership
capital through experienced management and diversification. PAIF-II was
organized as a California limited partnership on June 27, 1984 and will
terminate no later than December 2010.

PAIF-II has many competitors in the aircraft leasing market, including airlines,
aircraft leasing companies, other limited partnerships, banks and several other
types of financial institutions. This market is highly competitive and there is
no single competitor who has a significant influence on the industry. In
addition to other competitors, the general partner, Polaris Investment
Management Corporation (PIMC), and its affiliates, including GE Capital Aviation
Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris
Holding Company (PHC) and General Electric Capital Corporation (GE Capital),
acquire, lease, finance, sell and remarket aircraft for their own accounts and
for existing aircraft and aircraft leasing programs managed by them. Further,
GECAS provides a significant range of management services to GPA Group plc, a
public limited company organized in Ireland, together with its consolidated
subsidiaries (GPA), which acquires, leases and sells aircraft. Accordingly, in
seeking to re-lease and sell its aircraft, the Partnership may be in competition
with the general partner, its affiliates, and GPA.

A brief description of the aircraft owned by the Partnership is set forth in
Item 2. The following table describes certain material terms of the
Partnership's leases to Trans World Airlines, Inc. (TWA) as of December 31,
1997.
Scheduled
Number of Lease
Lessee Aircraft Type Aircraft Expiration Renewal Options
- ------ ------------- -------- ---------- ---------------
TWA McDonnell Douglas DC-9-30 11 11/04 (1) none
TWA McDonnell Douglas DC-9-30 3 2/05 (1) none

(1) These leases to TWA were modified in 1991. The leases for these
aircraft were extended for an aggregate of 75 months beyond the initial
lease expiration date in November 1991 at approximately 46% of the
original lease rates. The Partnership also agreed to share in the costs
of certain Airworthiness Directives (ADs). If such costs are incurred
by TWA, they will be credited against rental payments, subject to
annual limitations with a maximum of $500,000 per aircraft over the
lease terms. TWA may specify a lease expiration date for each aircraft
up to six months before the date shown, provided the average date for
all of the aircraft equals the dates shown.

As discussed in Item 7, in October 1994, TWA notified its creditors,
including the Partnership, of a proposed restructuring of its debt.
Subsequently, GECAS negotiated a standstill agreement with TWA which
was approved on behalf of the Partnership by PIMC. That agreement
provided for a moratorium of the rent due the Partnership in November
1994 and 75% of the rents due the Partnership from December 1994
through March 1995. The deferred rents, which aggregated $3.6 million
plus interest, were repaid in monthly installments beginning in May
1995 through October 1995. In 1995, the Partnership received as
consideration for the agreement $218,071 and warrants for 227,133
shares of TWA Common Stock (Item 7).

In 1996, GECAS, on behalf of the Partnership, negotiated with TWA for
the acquisition of noise-suppression devices, commonly known as
"hushkits", for 14 of the Partnership's aircraft on lease to TWA at the
time, as well as other aircraft owned by affiliates of PIMC and leased

<PAGE>

to TWA. The 14 aircraft that received hushkits were designated by TWA.
The hushkits reconditioned the aircraft so as to meet Stage 3 noise
level restrictions. Hushkits were installed on 11 of the Partnership's
aircraft during 1996 and the leases for these 11 aircraft were extended
for a period of eight years until November 2004. Hushkits were
installed on the remaining three aircraft during February 1997 and the
leases for these three aircraft were extended for a period of eight
years until February 2005.

The rent payable by TWA under the leases was increased by an amount
sufficient to cover the monthly debt service payments on the hushkits
and fully repay, during the term of the TWA leases, the amount
borrowed. The loan from the engine/hushkit manufacturer is non-recourse
to the Partnership and secured by a security interest in the lease
receivables.

Industry-wide, approximately 330 commercial jet aircraft were available for sale
or lease at December 31, 1997, approximately 50 more than a year ago. At under
3% of the total available jet aircraft fleet, this is still a relatively low
level of availability by industry historic standards. From 1991 to 1994,
depressed demand for travel limited airline expansion plans, with new aircraft
orders and scheduled deliveries being canceled or substantially deferred. As
profitability declined, many airlines took action to downsize or liquidate
assets and some airlines were forced to file for bankruptcy protection.
Following four years of strong traffic growth accompanied by rising yields, this
trend reversed with many airlines reporting substantial profits since 1995. As a
result of this improving trend, just over 1200 new jet aircraft were ordered in
1996 and a further 1300 were ordered in 1997, making this the second highest
ever order year in the history of the industry. To date, this strong recovery
has mainly benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies,
many of which are now being upgraded with hushkits, which, when installed on the
aircraft, bring Stage 2 aircraft into compliance with Federal Aviation
Administration (FAA) Stage 3 noise restrictions as discussed in the Industry
Update section of Item 7. Older Stage 2 narrow-bodies and early wide-bodies have
shown only marginal signs of recovery since the depressed 1991 to 1994 period.
Economic turmoil in Asia in the second half of 1997 has brought about a
significant reduction in traffic growth in much of that region which is
resulting in a number of new aircraft order deferrals and cancellations, mainly
in the wide-body sector of the market with as yet no impact evident in other
world markets. In 1996, several airline accidents also impacted the market for
older Stage 2 aircraft. The Partnership has been forced in the past to adjust
its estimates of the residual values realizable from its aircraft, which
resulted in an increase in depreciation expense, as discussed in Items 7 and 8.
A discussion of the current market condition for the type of aircraft owned by
the Partnership follows:

McDonnell Douglas DC-9-30 - The McDonnell Douglas DC-9-30 is a short- to
medium-range twin-engine jet that was introduced in 1967. Providing reliable,
inexpensive lift, these aircraft fill thin niche markets, mostly in the United
States. Hushkits are available to bring these aircraft into compliance with
Stage 3 requirements at a cost of approximately $1.6 million per aircraft. As
noted above, hushkits have been installed on the 14 remaining fund aircraft.
Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent
fatigue cracks and control corrosion as discussed in the Industry Update section
of Item 7.

The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control, and structural inspection
and modification as discussed in the Industry Update section of Item 7.

Item 2. Properties

At December 31, 1997, PAIF-II owned 14 McDonnell Douglas DC-9-30 aircraft leased
to TWA out of its original portfolio of 30 aircraft. All leases are operating
leases. Polaris Aircraft Income Fund II (the Partnership) transferred six Boeing
727-200 aircraft, previously leased to Pan Am, to aircraft inventory in 1992.

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<PAGE>

These aircraft, which are not included in the following table, have been
disassembled for sale of their component parts. The Partnership sold one Boeing
727-200 aircraft equipped with a hushkit in February 1995. The Partnership sold
the airframe and one engine from the Boeing 737-200 Combi aircraft in March
1996. The Partnership sold the remaining engine along with a Boeing 737-200 in
January 1997. The Partnership sold three Boeing 727-200, one McDonnell Douglas
DC-9-40 and three McDonnell Douglas DC-9-30 aircraft to Triton Aviation Services
II LLC in May 1997 and June 1997.

The following table describes the Partnership's aircraft portfolio at December
31, 1997 in greater detail:

Year of Cycles
Aircraft Type Serial Number Manufacture As of 12/31/97
- ------------- ------------- ----------- --------------
McDonnell Douglas DC-9-30 47135 1968 79,114
McDonnell Douglas DC-9-30 47137 1968 78,249
McDonnell Douglas DC-9-30 47249 1968 84,418
McDonnell Douglas DC-9-30 47251 1968 82,872
McDonnell Douglas DC-9-30 47343 1969 81,501
McDonnell Douglas DC-9-30 47345 1969 79,873
McDonnell Douglas DC-9-30 47411 1969 77,243
McDonnell Douglas DC-9-30 47412 1969 77,339
McDonnell Douglas DC-9-30 47027 1967 83,328
McDonnell Douglas DC-9-30 47107 1968 82,753
McDonnell Douglas DC-9-30 47108 1968 79,599
McDonnell Douglas DC-9-30 47174 1968 80,692
McDonnell Douglas DC-9-30 47324 1969 76,925
McDonnell Douglas DC-9-30 47357 1969 76,746

Item 3. Legal Proceedings

Braniff, Inc. (Braniff) Bankruptcy - As previously reported in Polaris Aircraft
Income Fund II's (the Partnership) 1996 Form 10-K, the Bankruptcy Court disposed
of the Partnership's claim in this Bankruptcy proceeding by permitting the
Partnership to exchange a portion of its unsecured claim for Braniff's right
(commonly referred to as a "Stage 2 Base Level right") under the Federal
Aviation Administration noise regulations to operate one Stage 2 aircraft and by
allowing the Partnership a net remaining unsecured claim of $769,231 in the
proceedings.

Viscount Air Services, Inc. (Viscount) Bankruptcy - As previously reported in
the Partnership's 1996 Form 10-K, all disputes between the Partnership and
Viscount have been resolved, and there is no further pending litigation with
Viscount. However, when Viscount rejected its lease of one of the Partnership's
aircraft ("306 Aircraft"), as authorized by the Bankruptcy court, the 306
Aircraft was located at a maintenance facility owned by BAE Aviation, Inc. dba
Tucson Aerospace (BAE). BAE and its subcontractors STS Services, Inc. and Piping
Design Services, Inc., dba PDS Technical Services asserted mechanics' liens over
the 306 Aircraft. On May 22, 1996, First Security Bank, National Association
(FSB), as owner trustee, filed suit in the Superior Court of Arizona in Pima
County to recover the 306 Aircraft.

After FSB filed a bond in the penal amount of $1,371,000, the claimants in the
action released the 306 Aircraft and filed a claim against the bond. The
Superior Court heard cross-motions for summary judgment on July 7, 1997. On
September 5, 1997, the Superior Court determined that STS Services, Inc. did not

4
<PAGE>

have a lien under a filing in Tennessee. The Superior Court denied FSB's motion
for summary judgment concerning assignment of the lien, but granted a motion for
summary judgment in part, ruling that the claim against the bond may not exceed
the value of the airframe. The case continues in discovery and pre-trial
preparation. The matter is set for trial on April 14, 1998.

After recovering the 306 Aircraft, the Partnership sold the airframe and certain
engines in January of 1997. In the course of delivering the airframe, GE Capital
Aviation Services, Inc. (GECAS) determined that a painter, Thomas Cook, was
holding the right elevator at his shop due to an unpaid bill incurred in
connection with work on the 306 Aircraft by BAE under contract to Viscount,
which at that time was leasing the 306 Aircraft. On March 20, 1997, FSB, as
owner trustee, filed a lawsuit in the Superior Court of Arizona in Pima County,
Case No. 318585 against Mr. Cook and Hamilton Aviation, Inc., where his shop is
located, to recover possession. On July 29, 1997, the Superior Court denied
FSB's motion for summary judgment and determined that a worker holding an
aircraft part may claim a lien for the charges associated with the particular
item without complying with Arizona's aircraft lien statute. The Superior Court
directed Mr. Cook to provide documentation of his claim limited to work on the
elevator he is holding. The matter is set for trial on April 14, 1998.

Kepford, et al. v. Prudential Securities, et al. -On April 13, 1994, this action
was filed in the District Court of Harris County, Texas against Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris
Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris
Aircraft Income Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft
Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI,
General Electric Capital Corporation, Prudential Securities, Inc., Prudential
Insurance Company of America and James J. Darr. The complaint alleges violations
of the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections
11 and 12 of the Securities Act of 1933, common law fraud, fraud in the
inducement, negligent misrepresentation, negligence, breach of fiduciary duty
and civil conspiracy arising from the defendants' alleged misrepresentation and
failure to disclose material facts in connection with the sale of limited
partnership units in the Partnership and the other Polaris Aircraft Income
Funds. Plaintiffs seek, among other things, an award of compensatory damages in
an unspecified amount plus interest, and double and treble damages under the
Texas Deceptive Trade Practices Act. On December 2, 1997, the trial court issued
a scheduling order setting a September 7, 1998 trial date.

Riskind, et al. v. Prudential Securities, Inc., et al. - This action was filed
in the District Court of the 165 Judicial District, Maverick County, Texas, on
behalf of over 3,000 individual investors who purchased units in "various
Polaris Aircraft Income Funds," including the Partnership. A second amended
original petition names the Partnership, Polaris Investment Management
Corporation, Prudential Securities, Inc. and others as defendants and alleges
that these defendants violated the Texas Securities Act and the Texas Deceptive
Trade Practices Act and committed common law fraud, fraud in the inducement,
negligent misrepresentation, negligent breach of fiduciary duty and civil
conspiracy by misrepresenting and failing to disclose material facts in
connection with the sale of limited partnership units in the Partnership and the
other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an
award of compensatory damages in an unspecified amount plus interest, and double
and treble damages under the Texas Deceptive Trade Practices Act. Kidder,
Peabody & Co. was added as an additional defendant by virtue of an Intervenor's
Amended Plea in Intervention filed on or about April 7, 1995.

The trial of the claims of one plaintiff, Robert W. Wilson, against Polaris
Aircraft Income Funds I-VI, Polaris Investment Management Corporation and
various affiliates of Polaris Investment Management Corporation, including
General Electric Capital Corporation, was commenced on July 10, 1995. On July

5
<PAGE>

26, 1995, the jury returned a verdict in favor of the defendants on all counts.
Subsequent to this verdict, all of the defendants (with the exception of
Prudential Securities, Inc., which had previously settled) entered into a
settlement with the plaintiffs. On February 26, 1997, the court issued an order
notifying the remaining plaintiffs that the action would be dismissed on April
21, 1997 for want of prosecution unless the plaintiffs showed cause why the
action should not be dismissed. This action was dismissed for want of
prosecution in April of 1997.

Howland, et al. v. Polaris Holding Company, et al. - This action was transferred
to the multi-district litigation in the Southern District of New York entitled
In re Prudential Securities Limited Partnerships Litigation, which has been
settled as discussed in Part III, Item 10 below.

Mary C. Scott v. Prudential Securities Inc. et al. - This action was transferred
to the action entitled In re Prudential Securities Limited Partnerships
Litigation, which has been settled as discussed in Part III, Item 10 below.

Equity Resources, Inc., et al. v. Polaris Investment Management Corporation, et
al. - On or about April 18, 1997, an action entitled Equity Resources Group,
Inc., et al. v. Polaris Investment Management Corporation, et al. was filed in
the Superior Court for the County of Middlesex, Commonwealth of Massachusetts.
The complaint names each of Polaris Investment Management Corporation (PIMC),
the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund
IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI, as
defendants. The complaint alleges that PIMC, as general partner of each of the
partnerships, committed a breach of its fiduciary duties, violated applicable
partnership law statutory requirements and breached provisions of the
partnership agreements of each of the foregoing partnerships by failing to
solicit a vote of the limited partners in each of such partnerships in
connection with the Sale Transaction described in Item 7, under the caption
"Remarketing Update -- Sale of Aircraft to Triton" and in failing to disclose
material facts relating to such transaction. The plaintiffs sought to enjoin the
Sale Transaction, but the Superior Court denied their motion on May 6, 1997. The
plaintiffs appealed the Superior Court's denial of their motion to enjoin, but
ultimately, the Supreme Court of Massachusetts denied their appeal on May 29,
1997. On May 23, 1997, the defendants filed a motion to dismiss this action.
Subsequently, the plaintiffs voluntarily sought dismissal of their suit without
prejudice. On September 16, 1997, the court dismissed the plaintiffs' complaint
without prejudice.

Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about
June 18, 1997, a purported class action entitled Ron Wallace v. Polaris
Investment Management Corporation, et al. was filed on behalf of the unitholders
of Polaris Aircraft Income Funds II through VI in the Superior Court of the
State of California, County of San Francisco. The complaint names each of
Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services,
Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, certain executives of PIMC and GECAS and
John E. Flynn, a former PIMC executive, as defendants. The complaint alleges
that defendants committed a breach of their fiduciary duties with respect to the
Sale Transaction involving the Partnership as described in Item 7, under the
caption "Remarketing Update -- Sale of Aircraft to Triton."

On September 2, 1997, an amended complaint was filed adding additional
plaintiffs. On September 16, 1997, the defendants filed a motion to stay
discovery and a demurrer seeking to dismiss the amended complaint. On November
5, 1997, the Superior Court granted the demurrer with leave to replead. On

6
<PAGE>

December 18, 1997, the plaintiffs filed a second amended complaint asserting
their claims derivatively. On January 26, 1998, defendants filed a demurrer
seeking to dismiss the second amended complaint on the grounds that plaintiffs
had failed to satisfy the pre-litigation demand requirements under California
law for commencing a derivative action.

Other Proceedings - Part III, Item 10 discusses certain other actions which have
been filed against the general partner in connection with certain public
offerings, including that of the Partnership. The Partnership is not a party to
these actions.

Item 4. Submission of Matters to a Vote of Security Holders

None.

<PAGE>

PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters

a) Polaris Aircraft Income Fund II's (PAIF-II or the Partnership) limited
partnership interests (Units) are not publicly traded. Currently there
is no market for PAIF-II's Units and it is unlikely that any market
will develop.

b) Number of Security Holders:

Number of Record Holders
Title of Class as of December 31, 1997
----------------------- --------------------------------

Limited Partnership Interest: 15,200

General Partnership Interest: 1

c) Dividends:

The Partnership distributed cash to partners on a quarterly basis
beginning July 1986. Cash distributions to limited partners during 1997
and 1996 totaled $14,349,914 and $17,499,895, respectively. Cash
distributions per limited partnership unit were $28.70 and $35.00 in
1997 and 1996, respectively.

<PAGE>

<TABLE>

Item 6. Selected Financial Data
<CAPTION>

For the years ended December 31,
--------------------------------

1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>

Revenues $ 17,609,635 $ 16,304,608 $ 21,093,341 $ 14,443,902 $ 15,558,866

Net Income (Loss) 4,469,336 (14,708,486) 5,717,065 (3,217,172) 48,114

Net Income (Loss)
Allocated to Limited
Partners 4,424,643 (16,311,216) 4,972,468 (4,434,868) (952,261)

Net Income (Loss) per
Limited Partnership Unit 8.85 (32.62) 9.94 (8.87) (1.91)

Cash Distributions per
Limited Partnership
Unit 28.70 35.00 13.75 25.00 20.00

Amount of Cash
Distributions Included
Above Representing
a Return of Capital on
a Generally Accepted
Accounting Principle
Basis per Limited
Partnership Unit* 28.70 35.00 13.75 25.00 20.00

Total Assets 77,546,425 87,622,742 107,820,317 110,568,377 129,706,547

Partners' Capital 60,740,696 72,215,709 106,368,523 108,290,301 125,396,279

</TABLE>

* 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.

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<PAGE>

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations

At December 31, 1997, Polaris Aircraft Income Fund II (the Partnership) owned a
portfolio of 14 used commercial jet aircraft and certain inventoried aircraft
parts out of its original portfolio of 30 aircraft. The portfolio consists of 14
McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA).
The Partnership transferred six Boeing 727-200 aircraft, previously leased to
Pan American World Airways, Inc., to aircraft inventory in 1992. These aircraft
have been disassembled for sale of their component parts. The Partnership sold
one Boeing 727-200 aircraft in February 1995, one Boeing 737-200 Combi aircraft
in March 1996, and one Boeing 737-200 aircraft in January 1997. During the
second quarter of 1997, the Partnership sold three McDonnell Douglas DC-9-30
aircraft and one McDonnell Douglas DC-9-40 aircraft leased to TWA, two Boeing
727-200 Advanced aircraft leased to Continental Micronesia, Inc. (Continental
Micronesia), and one Boeing 727-200 Advanced aircraft leased to Continental
Airlines, Inc. (Continental), to Triton Aviation Services II LLC.

Remarketing Update

General - Polaris Investment Management Corporation (the General Partner or
PIMC) evaluates, from time to time, whether the investment objectives of the
Partnership are better served by continuing to hold the Partnership's remaining
portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes
into account the current and potential earnings of the Aircraft, the conditions
in the markets for lease and sale and future outlook for such markets, and the
tax consequences of selling rather than continuing to lease the Aircraft.
Recently, the General Partner has had discussions with third parties regarding
the possibility of selling some or all of these Aircraft. While such discussions
may continue, and similar discussions may occur again in the future, there is no
assurance that such discussions will result in the Partnership receiving a
purchase offer for all or any of the Aircraft which the General Partner would
regard as acceptable.

Sale of Boeing 737-200 Aircraft - On January 30, 1997, one Boeing 737-200
formerly on lease to Viscount, was sold to American Aircarriers Support, Inc.
(American Aircarriers) on an "as-is, where-is" basis for $660,000 cash. In
addition, the Partnership retained maintenance reserves from the previous lessee
of $217,075, that had been held by the Partnership, which were recognized as
additional sale proceeds. A net loss of $26,079 was recorded on the sale of the
aircraft.

TWA Lease Extension - GE Capital Aviation Services, Inc. (GECAS), on behalf of
the Partnership, and TWA negotiated for the acquisition of noise-suppression
devices, commonly known as "hushkits," for the 14 Partnership aircraft currently
on lease to TWA, as well as other aircraft beneficially owned by Polaris
Aircraft Income Fund III and Polaris Holding Company and leased to TWA. Hushkit
installation was completed on 11 of the Partnership's aircraft in November 1996.
Installation of hushkits on the remaining three aircraft was completed during
February 1997.

The aggregate cost of the hushkit reconditioning completed in February 1997 for
the three remaining aircraft was $4,784,633, or approximately $1.6 million per
aircraft, which was capitalized by the Partnership during 1997. The Partnership
paid $900,000 of the aggregate hushkit cost and the balance of $3,884,633 was
financed by UT Finance Corporation (UT Finance), a wholly owned subsidiary of
United Technologies Corporation, of which a division is Pratt and Whitney Group,
the hushkit manufacturer, over 50 months at an interest rate of approximately
10% per annum.

The rent payable by TWA under the leases has been increased by an amount
sufficient to cover the monthly debt service payments on the hushkits and fully
repay, during the term of the TWA leases, the amount borrowed. The loan from UT
Finance is non-recourse to the Partnership and secured by a security interest in

10
<PAGE>

the lease receivables. The leases for these three aircraft were extended for a
period of eight years until February 2005.

Sale of Aircraft to Triton - On May 28, 1997, PIMC, on behalf of the
Partnership, executed definitive documentation for the purchase of 7 of the
Partnership's 21 remaining aircraft (the "Aircraft") and certain of its notes
receivables by Triton Aviation Services II LLC, a special purpose company (the
"Purchaser" or "Triton"). The closings for the purchase of the 7 Aircraft
occurred from May 28, 1997 to June 16, 1997. The Purchaser is managed by Triton
Aviation Services, Ltd. ("Triton Aviation" or the "Manager"), a privately held
aircraft leasing company which was formed in 1996 by Triton Investments, Ltd., a
company which has been in the marine cargo container leasing business for 17
years and is diversifying its portfolio by leasing commercial aircraft. Each
Aircraft was sold subject to the existing leases.

The General Partner's Decision to Approve the Transaction - In determining
whether the transaction was in the best interests of the Partnership and its
unitholders, PIMC evaluated, among other things, the risks and significant
expenses associated with continuing to own and remarket the Aircraft (many of
which were subject to leases that were nearing expiration). The General Partner
determined that such a strategy could require the Partnership to expend a
significant portion of its cash reserves for remarketing and that there was a
substantial risk that this strategy could result in the Partnership having to
reduce or even suspend future cash distributions to limited partners. The
General Partner concluded that the opportunity to sell the Aircraft at an
attractive price would be beneficial in the present market where demand for
Stage II aircraft is relatively strong rather than attempting to sell the
aircraft "one-by-one" over the coming years when the demand for such Aircraft
might be weaker. GE Capital Aviation Services, Inc. ("GECAS"), which provides
aircraft marketing and management services to the General Partner, sought to
obtain the best price and terms available for these Stage II aircraft given the
aircraft market and the conditions and types of planes owned by the Partnership.
Both the General Partner and GECAS approved the sale terms of the Aircraft as
being in the best interest of the Partnership and its unit holders because both
believe that this transaction will optimize the potential cash distributions to
be paid to limited partners. To ensure that no better offer could be obtained,
the terms of the transaction negotiated by GECAS included a "market-out"
provision that permitted the Partnership to elect to accept an offer for all
(but not less than all) of the assets to be sold by it to the Purchaser on terms
which it deemed more favorable, with the ability of the Purchaser to match the
offer or decline to match the offer and be entitled to be compensated in an
amount equal to 1 1/2% of the Purchaser's proposed purchase price. The
Partnership did not receive any other offers and, accordingly, the General
Partner believes that a valid market check had occurred confirming that the
terms of this transaction were the most beneficial that could have been
obtained.

The Terms of the Transaction - The total contract purchase price (the "Purchase
Price") to the Purchaser was $13,988,000 which was allocated to the Aircraft and
to certain notes receivable by the Partnership. The Purchaser paid into an
escrow account $1,575,888 of the Purchase Price in cash upon the closing of the
first aircraft and delivered a promissory note (the "Promissory Note") for the
balance of $12,412,112. The Partnership received payment of $1,575,888 from the
escrow account on June 24, 1997. On December 30, 1997, the Partnership received
prepayment in full of the outstanding note receivable and interest earned by the
Partnership to that date.

Under the purchase agreement, the Purchaser purchased the Aircraft effective as
of April 1, 1997 notwithstanding the actual closing dates. The utilization of an
effective date facilitated the determination of rent and other allocations
between the parties. The Purchaser had the right to receive all income and
proceeds, including rents and receivables, from the Aircraft accruing from and
after April 1, 1997, and the Promissory Note commenced bearing interest as of
April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold
subject to the existing leases.

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<PAGE>

1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of its
affiliates holds any interest in Triton Aviation or any of Triton Aviation's
affiliates. John Flynn, the current President of Triton Aviation, was a Polaris
executive until May 1996 and has over 15 years experience in the commercial
aviation industry. At the time Mr. Flynn was employed at PIMC, he had no
affiliation with Triton Aviation or its affiliates.

Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris
Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold
certain aircraft assets to separate special purpose companies under common
management with the Purchaser (collectively, together with the Purchaser, the
"SPC's") on terms similar to those set forth above, with the exception of the
Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.

The Accounting Treatment of the Transaction - In accordance with generally
accepted accounting principles (GAAP), the Partnership recognized rental income
up until the closing date for each aircraft which occurred from May 28, 1997 to
June 16, 1997. However, under the terms of the transaction, the Purchaser was
entitled to receive payment of the rents, receivables and other income accruing
from April 1, 1997. As a result, the Partnership made payments to the Purchaser
in the amount of the rents, receivables and other income due and received from
April 1, 1997 to the closing date of $1,001,067, which is included in rent from
operating leases and interest income. For financial reporting purposes, the cash
down payment portion of the sales proceeds of $1,575,888 has been adjusted by
the following: income and proceeds, including rents and receivables from the
effective date of April 1, 1997 to the closing date, interest due on the cash
portion of the purchase price, interest on the Promissory Note from the
effective date of April 1, 1997 to the closing date and estimated selling costs.
As a result of these GAAP adjustments, the net adjusted sales price recorded by
the Partnership, including the Promissory Note, was $13,205,140.

The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 had been classified as aircraft held for sale from that date until the
actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $749,373 during 1997. This adjustment to the net
carrying value of the aircraft held for sale is included in depreciation and
amortization expense on the statement of operations.

Partnership Operations

The Partnership reported net income of $4,469,336, or $8.85 per limited
partnership unit for the year ended December 31, 1997, compared to a net loss of
$14,708,486, or $32.62 per limited partnership unit and net income of
$5,717,065, or $9.94 per limited partnership unit, for the years ended December
31, 1996 and 1995, respectively. The improved income from operations during
1997, as compared to 1996, is due to a substantial decrease in depreciation
expense related to the sale of aircraft. A substantial increase in depreciation
expense, as discussed later in the Industry Update section, contributed to the
net loss during 1996.

Rental revenues, net of related management fees, increased during 1997, compared
to the same period in 1996. This increase was primarily the result of an
increase in rental revenues from TWA. In November 1996 and February 1997,
installation of hushkits was completed on the 14 aircraft leased to TWA and the
leases were extended for eight years. The rent payable by TWA under the leases
has been increased by an amount sufficient to cover the monthly debt service
payments on the hushkits and fully repay, during the term of the TWA leases, the
amount borrowed.

Rental revenues, net of related management fees, declined in 1996 as compared to
1995 primarily as a result of a decrease in rental revenue recognized in 1996 on
the Partnership's leases with TWA. TWA rental revenues were higher in 1995 due
to the receipt, during 1995, of certain deferred rental amounts, as discussed

12
<PAGE>

later under TWA Restructuring. Other factors contributing to the decreased
rental revenues in 1996 were decreases in rental revenue from Northwest
Territorial Airways, Ltd. (NWT) and Viscount. The lease with NWT expired in
October 1995 and the aircraft was then sold, resulting in higher rental revenues
from this aircraft during 1995 as compared to 1996. Additionally, the default
and bankruptcy by Viscount resulted in the return of the aircraft and engine to
the Partnership during 1996, resulting in higher rental revenues from this
aircraft during 1995 as compared to 1996.

The increase in interest income during 1997, as compared to the same period in
1996, was attributable to interest earned on the Promissory Note related to the
Triton sale that occurred during the second quarter of 1997.

The Partnership recorded an increase in other revenue during 1997. This increase
in other income was the result of the receipt of $802,443 related to amounts due
under the TWA maintenance credit and rent deferral agreement.

On July 10, 1996, the Partnership entered into a proposed Stipulation and Order
in which Pan Am agreed to allow the Partnership $2.5 million as an
administrative expense priority claim and $56 million as a general unsecured
claim. In May 1996, the Partnership received from Pan Am a payment of $567,500
on the administrative expense priority claim. In November 1996, the Partnership
received an additional $9,000 payment on the administrative expense priority
claim. The Partnership has recorded these payments as other revenue in claims
related to lessee defaults in the 1996 statement of operations. It is unlikely
that the Partnership will receive additional payments on the administrative
expense priority claim. It cannot be estimated at this time when and if the
general unsecured claim will be paid.

In consideration for the rent deferral as discussed later under TWA
Restructuring, the Partnership received $218,171 in January 1995 as its share of
such payment by TWA. This amount was recognized as other revenue in 1995. In
addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock.
The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995 and recognized the net warrant value as of the date of
receipt of $1,772,206 as revenue in 1995. The Partnership exercised the warrants
on December 29, 1995 for the strike price of $0.01 per share and recognized a
gain on the value of the warrants of $582,028 in 1995. The Partnership sold its
TWA Common Stock in 1996. In addition, the Partnership recognized as other
revenue in 1995 payments received from NWT aggregating approximately $647,000 in
lieu of NWT performing required maintenance work on the aircraft it was leasing
prior to its return to the Partnership. The Partnership also recognized as other
revenue in 1995 maintenance reserves aggregating approximately $91,000 that were
previously paid to the Partnership by a former lessee for the aircraft that was
sold to AIA in February 1995.

The Partnership incurred interest expense during 1997 and 1996 as the result of
the Partnership installing hushkits on 11 of its aircraft in November 1996 and 3
of its aircraft in February 1997. The aggregate cost of the hushkit
reconditioning for the 11 and 3 aircraft was $17,516,722 and $4,784,633,
respectively, or approximately $1.6 million per aircraft, which was capitalized
by the Partnership during 1996 and 1997. The Partnership paid $3.3 million and
$900,000 in 1996 and 1997, respectively, of the aggregate hushkit cost, and the
balance of $14,216,722 and $3,884,633 in 1996 and 1997, respectively, was
financed by the engine/hushkit manufacturer over 50 months at an interest rate
of 10% per annum.

As discussed later in the Industry Update section, if the projected net cash
flow for each aircraft (projected rental revenue, net of management fees, less
projected maintenance costs, if any, plus the adjusted estimated residual value)
is less than the carrying value of the aircraft, the Partnership recognizes the
deficiency currently as increased depreciation expense.

The Partnership recognized approximately $17.0 million and $2.4 million of this
deficiency as increased depreciation expense in 1996 and 1995, respectively. In
1996, the impairment loss was the result of several significant factors. As a

13
<PAGE>

result of industry and market changes, a more extensive review of the
Partnership's aircraft was completed in the fourth quarter of 1996 which
resulted in revised assumptions of future cash flows including reassessment of
projected re-lease terms and potential future maintenance costs. As discussed in
Note 4, the Partnership accepted an offer to purchase 7 of the Partnership's
remaining aircraft subject to each aircraft's existing lease and certain notes
receivable. This offer constituted an event that required the Partnership to
review the aircraft carrying value pursuant to SFAS 121. In determining this
additional impairment loss, the Partnership estimated the fair value of the
aircraft based on the proposed purchase price reflected in the offer, less the
estimated costs and expenses of the proposed sale. The Partnership is deemed to
have an impairment loss to the extent that the carrying value exceeded the fair
value. Management believes the assumptions related to fair value of impaired
assets represents the best estimates based on reasonable and supportable
assumptions and projections. The 1995 downward adjustment was the result of the
reduction of the net book value to the estimated net realizable value of the
Boeing 737-200 Combi aircraft sold to Westjet in 1996 as previously discussed.

The increased depreciation expense reduces the aircraft's carrying value and
reduces the amount of future depreciation expense that the Partnership will
recognize over the projected remaining economic life of the aircraft. The
Partnership also made downward adjustments to the estimated residual value of
certain of its on-lease aircraft as of December 31, 1995. For any downward
adjustment to the estimated residual values, future depreciation expense over
the projected remaining economic life of the aircraft is increased. The
Partnership's earnings are impacted by the net effect of the adjustments to the
aircraft carrying values recorded in 1996 an 1995, and the downward adjustments
to the estimated residual values recorded in 1995 as discussed later in the
Industry Update section.

Liquidity and Cash Distributions

Liquidity - The Partnership received prepayment in full of all amounts due from
Triton and all payments due from lessees during 1997, except for the December
1997 lease payment from TWA. On January 2, 1998, the Partnership received its
$935,000 rental payment from TWA that was due on December 27, 1997. This amount
was included in rent and other receivables on the balance sheet at December 31,
1997.

As further discussed in Note 8 to the financial statements, the Partnership
recorded allowances for credit losses of $241,964 and $100,409 in 1995 and 1996,
respectively, for the aggregate unsecured receivables from Viscount. The line of
credit, which was advanced to Viscount in 1994, was, in accordance with the
Compromise and Stipulation, secured by certain of Viscount's trade receivables
and spare parts. The Stipulation and Agreement releases the Partnership's claim
against Viscount's trade receivables. As a result, the Partnership recorded an
additional allowance for credit losses of $92,508 during 1996, representing
Viscount's outstanding balance of the line of credit and accrued interest.
Payments received by the Partnership from the sale of the spare aircraft parts
(as discussed above), if any, will be recorded as revenue when received. The
Stipulation and Agreement provides that, upon entry of a final non-appealable
court order approving it, the Partnership would waive its pre- and post-petition
claims against Viscount for all amounts due and unpaid. As a result, the
Partnership considers all receivables from Viscount to be uncollectible and has
written-off, during 1996, all notes, rents and interest receivable balances from
Viscount.

As discussed above, the Partnership agreed to share in the cost of meeting
certain Airworthiness Directives (ADs) with TWA. In accordance with the
cost-sharing agreement, TWA may offset up to an additional $1.7 million against
rental payments, subject to annual limitations, over the remaining lease terms.

The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA
in February 1995 as previously discussed. The agreement with AIA specifies
payment of the sales price in 36 monthly installments of $55,000 beginning in

14
<PAGE>

March 1995. The Partnership has received all scheduled payments due from AIA.
This note was sold to Triton during 1997 as part of the transaction discussed
previously under the Remarketing Update section.

In March 1996, the Partnership sold its Boeing 737-200 Combi aircraft to Westjet
for cash and a note due in 22 monthly installments, with interest at a rate of
10% per annum beginning in March 1996. The Partnership has received all
scheduled payments from Westjet. This note was sold to Triton during 1997 as
part of the transaction discussed previously under the Remarketing Update
section.

Payments of $214,749, $260,234 and $275,130 were received during 1997, 1996 and
1995, respectively, from the sale of inventoried parts from the six disassembled
aircraft.

PIMC has determined that the Partnership maintain cash reserves as a prudent
measure to ensure that the Partnership has available funds in the event that the
aircraft presently on lease to TWA require remarketing, and for other
contingencies including expenses of the Partnership. The Partnership's cash
reserves will be monitored and may be revised from time to time as further
information becomes available in the future.

Cash Distributions - Cash distributions to limited partners were $14,349,914,
$17,499,895, and $6,874,959 in 1997, 1996 and 1995, respectively. Cash
distributions per limited partnership unit were $28.70, $35.00 and $13.75 per
limited partnership unit in 1997, 1996 and 1995, respectively. The timing and
amount of future cash distributions are not yet known and will depend on the
Partnership's future cash requirements (including expenses of the Partnership)
and need to retain cash reserves as previously discussed in the Liquidity
section; the receipt of rental payments from TWA; and payments generated from
the aircraft disassembly process.

TWA Restructuring

In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, GECAS negotiated a
standstill arrangement, as set forth in a letter agreement dated December 16,
1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by
GECAS, 18 of which were owned by the Partnership. As required by its terms, the
Deferral Agreement (which has since been amended as discussed below) was
approved by PIMC on behalf of the Partnership with respect to the Partnership's
aircraft.

The Deferral Agreement provided for (i) a moratorium on all the rent due to the
Partnership in November 1994 and on 75% of the rents due to the Partnership from
December 1994 through March 1995, and (ii) all of the deferred rents, together
with interest thereon, to be repaid in monthly installments beginning in May
1995 and ending in December 1995. The repayment schedule was subsequently
accelerated upon confirmation of TWA's bankruptcy plan. The Partnership recorded
a note receivable and corresponding allowance for credit losses equal to the
total of the 1994 deferred rents of $1.575 million. The Partnership did not
recognize either the $1.575 million rental amount deferred in 1994 or the $2.025
million rental amount deferred during the first quarter of 1995 as rental
revenue until the deferred rents were received. The note receivable and
corresponding allowance for credit losses were reduced by the principal portion
of the payments received. The Partnership received all scheduled rent payments
beginning in April 1995 and all scheduled deferred rental payments beginning in
May 1995, including interest at a rate of 12% per annum, from TWA and has
recognized the $3.6 million deferred rents as rental revenue during 1995. The
deferred rents were paid in full by October 1995.

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<PAGE>

Partnership received $218,171 in January 1995 as its share of such payment by
TWA. This amount was recognized as other revenue in the Partnership's 1995
statement of operations (Item 8). In addition, TWA agreed to issue warrants to
the Partnership for TWA Common Stock.

In order to resolve certain issues that arose after the execution of the
Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27,
1995, pursuant to which they agreed to amend certain provisions of the Deferral
Agreement (as so amended, the Amended Deferral Agreement). The effect of the
Amended Deferral Agreement, which was approved by PIMC with respect to the
Partnership's aircraft, is that TWA, in addition to agreeing to repay the
deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable
in warrants, the number of which was determined by a formula) in consideration
for the aircraft owners' agreement to defer rent under the Deferral Agreement,
and, (ii) to the extent the market value of the warrants is less than the
payment amount, to supply maintenance services to the aircraft owners having a
value equal to such deficiency. The payment amount was determined by subtracting
certain maintenance reimbursements owed to TWA by certain aircraft owners,
including the Partnership, from the aggregate amount of deferred rents.

On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United
States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995,
the Bankruptcy Court confirmed TWA's plan of reorganization, which became
effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the
confirmation date of the plan, August 4, 1995, the Partnership received a
payment of $1,217,989 from TWA which represented fifty percent (50%) of the
deferred rent outstanding plus interest as of such date. The remaining balance
of deferred rent plus interest was paid in full to the Partnership on October 2,
1995. TWA has been current with its obligation to the Partnership since August
1995. While TWA has committed to an uninterrupted flow of lease payments, there
can be no assurance that TWA will continue to honor its obligations in the
future.

The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995 and recognized the net warrant value as of the date of
receipt of $1,772,206 as revenue in the 1995 statement of operations. The
Partnership exercised the warrants on December 29, 1995 for the strike price of
$0.01 per share and has recognized a gain on the value of the warrants of
$582,028 in the 1995 statement of operations. The Partnership sold the TWA
Common Stock in the first quarter of 1996, net of broker commissions, for
$2,406,479.

Viscount Default and Bankruptcy Filing

On January 24, 1996, Viscount filed a petition for protection under Chapter 11
of the United States Bankruptcy Code in the United States Bankruptcy Court in
Tucson, Arizona. In April 1996, GECAS, on behalf of the Partnership, First
Security Bank, National Association (formerly known as First Security Bank of
Utah, National Association) (FSB), the owner/trustee under the Partnership's
leases with Viscount (the Leases), Viscount, certain guarantors of Viscount's
indebtedness and others executed in April 1996 a Compromise of Claims and
Stipulation under Section 1110 of the Bankruptcy Code (the Compromise and
Stipulation), which was subsequently approved by the Bankruptcy Court. The
Compromise and Stipulation provided, among other things, that Viscount rejected
the lease of the Partnership's aircraft. The rejection of the lease gave rise to
a pre-petition unsecured claim in Viscount's bankruptcy for breach of contract
damages. Notwithstanding Viscount's rejection of the Partnership's aircraft
lease, Viscount continued to possess and use the Partnership's engine and
refused to return various aircraft parts removed from the Partnership's
aircraft.

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<PAGE>

filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that
Viscount owes it approximately $866,000 for work done on the aircraft, which is
in addition to the approximately $565,000 already paid by the Partnership from
maintenance reserves. In addition, a third party vendor, who claims it provided
personnel to work on the aircraft, is asserting a claim against Tucson Aerospace
and a lien against the aircraft in the amount of $720,000. Another third-party
vendor, who claims it provided inspectors, is claiming $185,000 from Tucson
Aerospace. On May 22, 1996, First Security Bank, National Association (formerly
known as First Security Bank of Utah, National Association) (FSB), as
owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to
recover the airframe from BAE Aviation, Inc. and certain creditors alleging
mechanics liens and to determine the validity of the claimed liens.

Pursuant to a stipulated order of the Superior Court entered on July 9, 1996,
FSB filed a bond in the penal sum of $1,371,000 for the benefit of the
lienholders, who subsequently released the aircraft to the Partnership on July
11, 1996 and filed a claim against the bond. The matter is set for trial on
April 14, 1998.

On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to
recover the engines and parts leased in connection with the Partnership's
aircraft. GECAS and FSB assert that these engines and parts should have been
delivered to FSB pursuant to the Compromise and Stipulation. Viscount paid to
the Partnership $10,000 for the use of the engine during the month of August
1996, and continued through August 1996 to pay maintenance reserves pursuant to
the lease terms.

On September 18, 1996, GECAS (on behalf of the Partnership, Polaris Holding
Company, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV and
Polaris Aircraft Investors XVIII) (collectively, the Polaris Entities) and
Viscount entered into a Stipulation and Agreement (the Stipulation and
Agreement) by which Viscount agreed to voluntarily return all of the Polaris
Entities' aircraft and engines, turn over possession of the majority of its
aircraft parts inventory, and cooperate with GECAS in the transition of aircraft
equipment and maintenance, in exchange for which, upon Bankruptcy Court approval
of the Stipulation and Agreement, the Polaris Entities would waive their pre-
and post-petition claims against Viscount for amounts due and unpaid.

A consignment agreement has been entered into with a sales agent for the
disposal of the spare parts inventory recovered from Viscount. Given that many
of the parts require repair/overhaul, the cost of which is not accurately
determinable in advance, and the inherent uncertainty of sales prices for used
spare parts, there remains uncertainty as to whether the Partnership will derive
further proceeds from the sale of this inventory.

The Stipulation and Agreement also provides that the Polaris Entities, GECAS and
FSB would release any and all claims against Viscount, Viscount's bankruptcy
estate, and the property of Viscount's bankruptcy estate, effective upon entry
of a final non-appealable court order approving the Stipulation and Agreement.
The Bankruptcy Court entered such an order approving the Stipulation and
Agreement on October 23, 1996.

The Partnership recorded provisions for credit losses of $100,409 and $241,964
in 1996 and 1995, respectively, for the aggregate unsecured receivables from
Viscount. The line of credit, which was advanced to Viscount in 1994, was, in
accordance with the Compromise and Stipulation, secured by certain of Viscount's
trade receivables and spare parts. The Stipulation and Agreement releases the
Partnership's claim against Viscount's trade receivables. As a result, the
Partnership recorded an additional provision for credit losses of $92,508 during
1996, representing Viscount's outstanding balance of the line of credit and
accrued interest. Payments received by the Partnership from the sale of the
spare aircraft parts (as discussed above), if any, will be recorded as revenue
when received. The Stipulation and Agreement provides that, upon entry of a
final non-appealable court order approving it, the Partnership would waive its
pre- and post-petition claims against Viscount for all amounts due and unpaid.
As a result, the Partnership considers all receivables from Viscount to be
uncollectible and has written-off, during 1996, all notes, rents and interest
receivable balances from Viscount.

17
<PAGE>

The Partnership evaluated the airframe and engines previously leased to Viscount
for potential re-lease or sale and estimated that maintenance and refurbishment
costs aggregating approximately $1.6 million would be required to re-lease the
airframe and engines. Alternatively, a sale of the airframe and engines would
likely be made on an "as is, where is" basis, without the Partnership incurring
substantial maintenance costs. The aircraft was sold in January 1997 for
$660,000. As discussed in Note 3, the Partnership recognized an impairment loss
of $300,000 on this aircraft which was recorded as additional depreciation
expense during 1996.

As a result of Viscount's defaults and Chapter 11 bankruptcy filing, the
Partnership has incurred legal costs of approximately $107,000 and $147,000,
which are reflected in operating expense in the Partnership's 1997 and 1996
statement of operations, respectively.

Industry Update

Maintenance of Aging Aircraft - The process of aircraft maintenance begins at
the aircraft design stage. For aircraft operating under Federal Aviation
Administration (FAA) regulations, a review board consisting of representatives
of the manufacturer, FAA representatives and operating airline representatives
is responsible for specifying the aircraft's initial maintenance program. The
general partner understands that this program is constantly reviewed and
modified throughout the aircraft's operational life.

Since 1988, the FAA, working with the aircraft manufacturers and operators, has
issued a series of ADs which mandate that operators conduct more intensive
inspections, primarily of the aircraft fuselages. The results of these mandatory
inspections may result in the need for repairs or structural modifications that
may not have been required under pre-existing maintenance programs.

In addition, an AD adopted in 1990, applicable to McDonnell Douglas aircraft,
requires replacement or modification of certain structural items on a specific
timetable. These structural items were formerly subject to periodic inspection,
with replacement when necessary. The AD requires specific work to be performed
at various cycle thresholds between 40,000 and 100,000 cycles, and on specific
date or age thresholds. The estimated cost of compliance with all of the
components of this AD is approximately $850,000 per aircraft. The extent of
modifications required to an aircraft varies according to the level of
incorporation of design improvements at manufacture.

In January 1993, the FAA adopted another AD intended to mitigate corrosion of
structural components, which would require repeated inspections from 5 years of
age throughout the life of an aircraft, with replacement of corroded components
as needed. Integration of the new inspections into each aircraft operator's
maintenance program was required by January 31, 1994.

The Partnership's existing leases require the lessees to maintain the
Partnership's aircraft in accordance with an FAA-approved maintenance program
during the lease term. At the end of the leases, each lessee is generally
required to return the aircraft in airworthy condition including compliance with
all ADs for which action is mandated by the FAA during the lease term. An
aircraft returned to the Partnership as a result of a lease default would most
likely not be returned to the Partnership in compliance with all return
conditions required by the lease. The Partnership has agreed to bear a portion
of the costs of compliance with certain ADs with respect to the aircraft leased
to TWA, as described in Item 1. In negotiating subsequent leases, market
conditions may require that the Partnership bear some or all of the costs of
compliance with future ADs or ADs that have been issued, but which did not
require action during the previous lease term. The ultimate effect on the
Partnership of compliance with the FAA maintenance standards is not determinable
at this time and will depend on a variety of factors, including the state of the
commercial aircraft industry, the timing of the issuance of ADs, and the status
of compliance therewith at the expiration of the current leases.

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<PAGE>

Aircraft Noise - Another issue which has affected the airline industry is that
of aircraft noise levels. The FAA has categorized aircraft according to their
noise levels. Stage 1 aircraft, which have the highest noise level, are no
longer allowed to operate from civil airports in the United States. Stage 2
aircraft meet current FAA requirements, subject to the phase-out rules discussed
below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all
new aircraft.

On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2
aircraft by the end of this decade. The key features of the rule include:

- Compliance can be accomplished through a gradual process of
phase-in or phase-out (see below) on each of three interim
compliance dates: December 31, 1994, 1996, and 1998. All Stage
2 aircraft must be phased out of operations in the contiguous
United States by December 31, 1999, with waivers available in
certain specific cases to December 31, 2003.

- All operators have the option of achieving compliance through
a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25%
of its Stage 2 fleet on each of the compliance dates noted
above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%,
65% and 75% of an operator's fleet must consist of Stage 3
aircraft by the respective interim compliance dates noted
above).

The federal rule does not prohibit local airports from issuing more stringent
phase-out rules. In fact, several local airports have adopted more stringent
noise requirements which restrict the operation of Stage 2 and certain Stage 3
aircraft.

Other countries have also adopted noise policies. The European Union (EU)
adopted a non-addition rule in 1989, which directed each member country to pass
the necessary legislation to prohibit airlines from adding Stage 2 aircraft to
their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the
year 2002. The International Civil Aviation Organization has also endorsed the
phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.

Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3
requirements, are currently available for the Partnership's aircraft and have
been added to eleven of the Partnership's aircraft in 1996 and to three of their
aircraft in 1997.

Demand for Aircraft - Industry-wide, approximately 330 commercial jet aircraft
were available for sale or lease at December 31, 1997, approximately 50 more
than a year ago. At under 3% of the total available jet aircraft fleet, this is
still a relatively low level of availability by industry historic standards.
From 1991 to 1994, depressed demand for travel limited airline expansion plans,
with new aircraft orders and scheduled deliveries being canceled or
substantially deferred. As profitability declined, many airlines took action to
downsize or liquidate assets and some airlines were forced to file for
bankruptcy protection. Following four years of strong traffic growth accompanied
by rising yields, this trend reversed with many airlines reporting substantial
profits since 1995. As a result of this improving trend, just over 1200 new jet
aircraft were ordered in 1996 and a further 1300 were ordered in 1997, making
this the second highest ever order year in the history of the industry. To date,
this strong recovery has mainly benefited Stage 3 narrow-bodies and younger
Stage 2 narrow-bodies, many of which are now being upgraded with hushkits,
whereas older Stage 2 narrow-bodies and early wide-bodies have shown only
marginal signs of recovery since the depressed 1991 to 1994 period. Economic
turmoil in Asia in the second half of 1997 has brought about a significant
reduction in traffic growth in much of that region which is resulting in a
number of new aircraft order deferrals and cancellations, mainly in the
wide-body sector of the market with as yet no impact evident in other world
markets.

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<PAGE>

The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control and structural inspection
and modification as previously discussed.

Effects on the Partnership's Aircraft - The Partnership periodically reviews the
estimated realizability of the residual values at the projected end of each
aircraft's economic life based on estimated residual values obtained from
independent parties which provide current and future estimated aircraft values
by aircraft type. The Partnership made downward adjustments to the estimated
residual value of certain of its on-lease aircraft as of December 31, 1995. For
any downward adjustment in estimated residual value or decrease in the projected
remaining economic life, the depreciation expense over the projected remaining
economic life of the aircraft is increased.

If the projected net cash flow for each aircraft (projected rental revenue, net
of management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, the Partnership
recognizes the deficiency currently as increased depreciation expense. The
Partnership recognized impairments on aircraft to be held and used by the
Partnership of approximately $17.0 million and $2.4 million, or $33.97 and $4.75
per limited Partnership unit, in 1996 and 1995, respectively. In 1996, the
impairment loss was the result of several significant factors. As a result of
industry and market changes, a more extensive review of the Partnership's
aircraft was completed in the fourth quarter of 1996 which resulted in revised
assumptions of future cash flows including reassessment of projected re-lease
terms and potential future maintenance costs. As discussed in Note 4, the
Partnership accepted an offer to purchase seven of the Partnership's remaining
aircraft subject to each aircraft's existing lease and certain notes receivable.
This offer constituted an event that required the Partnership to review the
aircraft carrying value pursuant to SFAS 121. In determining this additional
impairment loss, the Partnership estimated the fair value of the aircraft based
on the proposed purchase price reflected in the offer, less the estimated costs
and expenses of the proposed sale. The Partnership recorded an impairment loss
to the extent that the carrying value exceeded the fair value. Management
believes the assumptions related to fair value of impaired assets represents the
best estimates based on reasonable and supportable assumptions and projections.
The 1995 downward adjustment was the result of the reduction of the net book
value to the estimated net realizable value of the Boeing 737-200 Combi aircraft
sold to Westjet in 1996. The increased depreciation expense reduced the
aircraft's carrying value and reduces the amount of future depreciation expense
that the Partnership will recognize over the projected remaining economic life
of the aircraft.

The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying value of the aircraft recorded in 1996 and 1995
(which has the effect of decreasing future depreciation expense) and the
downward adjustments to the estimated residual values recorded in 1995 (which
has the effect of increasing future depreciation expense). The net effect of the
1995 adjustments to the estimated residual values and the adjustments to the
carrying value of the aircraft recorded in 1995 is to cause the Partnership to
recognize increased depreciation expense of approximately $866,000 per year
beginning in 1996 through the end of the estimated economic lives of the
aircraft.

The Partnership periodically reviews its aircraft for impairment in accordance
with SFAS No. 121. The Partnership uses information obtained from third party
valuation services in arriving at its estimate of fair value for purposes of
determining residual values. The Partnership will use similar information, plus
available information and estimates related to the Partnership's aircraft, to
determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.

<PAGE>

Item 8. Financial Statements and Supplementary Data

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND 1996

TOGETHER WITH

AUDITORS' REPORT

<PAGE>

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Partners of
Polaris Aircraft Income Fund II,
A California Limited Partnership:

We have audited the accompanying balance sheets of Polaris Aircraft Income Fund
II, A California Limited Partnership as of December 31, 1997 and 1996, and the
related statements of operations, changes in partners' capital (deficit) and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the general partner. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by the
general partner, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Polaris Aircraft Income Fund
II, A California Limited Partnership as of December 31, 1997 and 1996, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.

ARTHUR ANDERSEN LLP

San Francisco, California,
January 23, 1998

<PAGE>

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

BALANCE SHEETS

DECEMBER 31, 1997 AND 1996

1997 1996
---- ----
ASSETS:

CASH AND CASH EQUIVALENTS $ 31,587,494 $ 22,224,813

RENT AND OTHER RECEIVABLES 935,629 6,648

NOTES RECEIVABLE -- 1,522,956

AIRCRAFT, net of accumulated depreciation of
$70,346,578 in 1997 and $120,260,981 in 1996 45,016,731 63,638,062

AIRCRAFT INVENTORY -- 113,248

OTHER ASSETS 6,571 117,015
------------ ------------

$ 77,546,425 $ 87,622,742
============ ============

LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):

PAYABLE TO AFFILIATES $ 142,761 $ 66,631

ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 317,799 209,781

SECURITY DEPOSITS 50,000 116,000

MAINTENANCE RESERVES -- 223,528

DEFERRED INCOME 627,660 597,915

NOTES PAYABLE 15,667,509 14,193,178
------------ ------------

Total Liabilities 16,805,729 15,407,033
------------ ------------

PARTNERS' CAPITAL (DEFICIT):
General Partner (3,030,600) (1,480,858)
Limited Partners, 499,997 units
issued and outstanding 63,771,296 73,696,567
------------ ------------

Total Partners' Capital 60,740,696 72,215,709
------------ ------------

$ 77,546,425 $ 87,622,742
============ ============

The accompanying notes are an integral part of these statements.

23
<PAGE>

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

1997 1996 1995
---- ---- ----
REVENUES:
Rent from operating leases $ 14,792,071 $ 14,172,153 $ 16,114,000
Receipt of lessee stock
warrants -- -- 1,772,206
Gain on trading securities -- 49,974 582,028
Interest 1,939,699 1,505,981 1,667,397
Claims related to lessee
defaults -- 576,500 --
Loss on sale of aircraft (26,079) -- --
Gain on sale of aircraft
inventory 101,501 -- --
Other 802,443 -- 957,710
------------ ------------ ------------

Total Revenues 17,609,635 16,304,608 21,093,341
------------ ------------ ------------

EXPENSES:
Depreciation 10,435,053 29,470,353 13,895,184
Management fees to general
partner 531,135 667,678 752,384
Provision for credit losses -- 192,917 241,964
Operating 145,905 244,494 150,161
Interest 1,659,897 134,341 --
Administration and other 368,309 303,311 336,583
------------ ------------ ------------

Total Expenses 13,140,299 31,031,094 15,376,276
------------ ------------ ------------

NET INCOME (LOSS) $ 4,469,336 $(14,708,486) $ 5,717,065
============ ============ ============

NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 44,693 $ 1,602,730 $ 744,597
============ ============ ============

NET INCOME (LOSS) ALLOCATED
TO LIMITED PARTNERS $ 4,424,643 $(16,311,216) $ 4,972,468
============ ============ ============

NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ 8.85 $ (32.62) $ 9.94
============ ============ ============

The accompanying notes are an integral part of these statements.

24
<PAGE>

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

General Limited
Partner Partners Total
------- -------- -----

Balance, December 31, 1994 $ (1,119,868) $ 109,410,169 $ 108,290,301

Net income 744,597 4,972,468 5,717,065

Cash distributions to
partners (763,884) (6,874,959) (7,638,843)
------------- ------------- -------------

Balance, December 31, 1995 (1,139,155) 107,507,678 106,368,523

Net income (loss) 1,602,730 (16,311,216) (14,708,486)

Cash distributions to
partners (1,944,433) (17,499,895) (19,444,328)
------------- ------------- -------------

Balance, December 31, 1996 (1,480,858) 73,696,567 72,215,709

Net income 44,693 4,424,643 4,469,336

Cash distributions to
partners (1,594,435) (14,349,914) (15,944,349)
------------- ------------- -------------

Balance, December 31, 1997 $ (3,030,600) $ 63,771,296 $ 60,740,696
============= ============= =============

The accompanying notes are an integral part of these statements.

25
<PAGE>

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
<TABLE>
<CAPTION>

1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 4,469,336 $(14,708,486) $ 5,717,065
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation 10,435,053 29,470,353 13,895,184
Provision for credit losses -- 192,917 241,964
Loss on sale of aircraft 26,079 -- --
Gain on sale of aircraft inventory (101,501) -- --
Changes in operating assets and liabilities:
Decrease (increase) in marketable securities,
trading -- 2,356,506 (2,356,506)
Decrease (increase) in rent and other
receivables (929,403) (101,959) 41,132
Decrease (Increase) in other assets 110,444 (87,245) --
Increase (decrease) in payable to affiliates 76,130 (25,880) (610,330)
Increase in accounts payable and
accrued liabilities 42,619 122,425 48,693
Increase (decrease) in security deposits (66,000) (334,000) 278,860
Increase (decrease) in maintenance reserves (6,453) 44,343 (543,505)
Increase (decrease) in deferred income 29,745 (44,827) --
------------ ------------ ------------

Net cash provided by operating activities 14,086,049 16,884,147 16,712,557
------------ ------------ ------------

INVESTING ACTIVITIES:
Proceeds from sale of aircraft 2,519,495 -- --
Increase in aircraft capitalized costs (4,784,633) (17,516,722) --
Principal payments on notes receivable 12,798,106 1,963,561 1,873,751
Payments to Purchaser related to sale of aircraft (1,001,067) -- --
Net proceeds from sale of aircraft inventory 214,749 260,235 275,130
------------ ------------ ------------

Net cash provided by (used in)
investing activities 9,746,650 (15,292,926) 2,148,881
------------ ------------ ------------

FINANCING ACTIVITIES:
Increase in note payable 3,884,633 14,216,722 --
Principal payments on notes payable (2,410,302) (23,544) --
Cash distributions to partners (15,944,349) (19,444,328) (7,638,843)
------------ ------------ ------------

Net cash used in financing activities (14,470,018) (5,251,150) (7,638,843)
------------ ------------ ------------

CHANGES IN CASH AND CASH
EQUIVALENTS 9,362,681 (3,659,929) 11,222,595

CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 22,224,813 25,884,742 14,662,147
------------ ------------ ------------

CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 31,587,494 $ 22,224,813 $ 25,884,742
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these statements.

26
<PAGE>

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1997

1. Accounting Principles and Policies

Accounting Method - Polaris Aircraft Income Fund II, A California Limited
Partnership (PAIF-II or the Partnership), maintains its accounting records,
prepares its financial statements and files its tax returns on the accrual basis
of accounting. The preparation of financial statements in conformity with
generally accepted accounting principles (GAAP) requires management to make
estimates and assumptions that affect reported amounts and related disclosures.
Actual results could differ from those estimates. The most significant estimates
with regard to these financial statements are related to the projected cash
flows analysis in determining the fair value of assets.

Cash and Cash Equivalents - This includes deposits at banks and investments in
money market funds. Cash and Cash Equivalents are stated at cost, which
approximates fair value.

Marketable Securities, trading - Marketable Securities, trading, were carried at
fair value, which was determined based on quoted market prices. These securities
were held for sale in the near term (Note 6).

Aircraft and Depreciation - The aircraft are recorded at cost, which includes
acquisition costs. Depreciation to an estimated residual value is computed using
the straight-line method over the estimated economic life of the aircraft which
was originally estimated to be 30 years from the date of manufacture.
Depreciation in the year of acquisition was calculated based upon the number of
days that the aircraft were in service.

The Partnership periodically reviews the estimated realizability of the residual
values at the projected end of each aircraft's economic life based on estimated
residual values obtained from independent parties which provide current and
future estimated aircraft values by aircraft type. For any downward adjustment
in estimated residual value or decrease in the projected remaining economic
life, the depreciation expense over the projected remaining economic life of the
aircraft is increased.

If the projected net cash flow for each aircraft (projected rental revenue, net
of management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, an impairment
loss is recognized. Pursuant to Statement of Financial Accounting Standards
(SFAS) No. 121, as discussed in Note 3, measurement of an impairment loss will
be based on the "fair value" of the asset as defined in the statement.

Capitalized Costs - Aircraft modification and maintenance costs which are
determined to increase the value or extend the useful life of the aircraft are
capitalized and amortized using the straight-line method over the estimated
useful life of the improvement. These costs are also subject to periodic
evaluation as discussed above.

Aircraft Inventory - Aircraft held in inventory for sale are reflected at the
lower of depreciated cost or estimated net realizable value. Proceeds from sales
are applied against inventory until the book value is fully recovered. The
remaining book value of the inventory was recovered in 1997. Proceeds in excess
of inventory net book value are recorded as revenue when received.

Operating Leases - The aircraft leases are accounted for as operating leases.
Lease revenues are recognized in equal installments over the terms of the
leases.

27
<PAGE>

Maintenance Reserves - The Partnership received maintenance reserve payments
from certain of its lessees that were to be reimbursed to the lessee or applied
against certain costs incurred by the Partnership or lessee for maintenance work
performed on the Partnership's aircraft or engines, as specified in the leases.
Maintenance reserve payments were recognized when received and balances
remaining at the termination of the lease, if any, were used by the Partnership
to offset future maintenance expenses or recognized as revenue.

Operating Expenses - Operating expenses include costs incurred to maintain,
insure, lease and sell the Partnership's aircraft, including costs related to
lessee defaults and costs of disassembling aircraft inventory.

Net Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited
partnership unit is based on the limited partners' share of net income or loss
and the number of units outstanding for the years ended December 31, 1997, 1996
and 1995.

Income Taxes - The Partnership files federal and state information income tax
returns only. Taxable income or loss is reportable by the individual partners.

Receivables - The Partnership recorded an allowance for credit losses for
certain impaired note and rents receivable as a result of uncertainties
regarding their collection as discussed in Note 8. The Partnership recognizes
revenue on impaired notes and receivables only as payments are received.

1996
----

Allowance for credit losses,
beginning of year $ (241,964)
Provision for credit losses (192,917)
Write-downs 434,881
Collections -
-----------
Allowance for credit losses,
end of year $ -
============

2. Organization and the Partnership

The Partnership was formed on June 27, 1984 for the purpose of acquiring and
leasing aircraft. The Partnership will terminate no later than December 2010.
Upon organization, both the general partner and the initial limited partner
contributed $500. The Partnership recognized no profits or losses during the
periods ended December 31, 1985 and 1984. The offering of limited partnership
units terminated on December 31, 1986, at which time the Partnership had sold
499,997 units of $500, representing $249,998,500. All partners were admitted to
the Partnership on or before December 1, 1986.

Polaris Investment Management Corporation (PIMC), the sole general partner of
the Partnership, supervises the day-to-day operations of the Partnership. PIMC
is a wholly-owned subsidiary of Polaris Aircraft Leasing Corporation (PALC).
Polaris Holding Company (PHC) is the parent company of PALC. General Electric
Capital Corporation (GE Capital), an affiliate of General Electric Company, owns
100% of PHC's outstanding common stock. PIMC has entered into a services
agreement dated as of July 1, 1994 with GE Capital Aviation Services, Inc.
(GECAS). Allocations to related parties are described in Note 11.

<PAGE>

3. Aircraft

At December 31, 1997, Polaris Aircraft Income Fund II (the Partnership) owned a
portfolio of 14 used commercial jet aircraft and certain inventoried aircraft
parts out of its original portfolio of 30 aircraft, which were acquired, leased
or sold as discussed below. All aircraft acquired from an affiliate were
purchased within one year of the affiliate's acquisition at the affiliate's
original price paid. The aircraft leases are net operating leases, requiring the
lessees to pay all operating expenses associated with the aircraft during the
lease term. While the leases require the lessees to comply with Airworthiness
Directives (ADs) which have been or may be issued by the Federal Aviation
Administration and require compliance during the lease term, in certain of the
leases the Partnership has agreed to share in the cost of compliance with ADs.
In addition to basic rent, one lessee was required to pay supplemental amounts
based on flight hours or cycles into a maintenance reserve account, to be used
for heavy maintenance of the engines or airframe. The leases generally state a
minimum acceptable return condition for which the lessee is liable under the
terms of the lease agreement. In the event of a lessee default, these return
conditions are not likely to be met. Certain leases also provide that, if the
aircraft are returned at a level above the minimum acceptable level, the
Partnership must reimburse the lessee for the related excess, subject to certain
limitations. The related liability to these lessees, if any, cannot currently be
estimated and therefore is not reflected in the financial statements.

The following table describes the Partnership's aircraft portfolio at December
31, 1997 in greater detail:

Year of
Aircraft Type Serial Number Manufacture
- ------------- ------------- -----------
McDonnell Douglas DC-9-30 47135 1968
McDonnell Douglas DC-9-30 47137 1968
McDonnell Douglas DC-9-30 47249 1968
McDonnell Douglas DC-9-30 47251 1968
McDonnell Douglas DC-9-30 47343 1969
McDonnell Douglas DC-9-30 47345 1969
McDonnell Douglas DC-9-30 47411 1969
McDonnell Douglas DC-9-30 47412 1969
McDonnell Douglas DC-9-30 47027 1967
McDonnell Douglas DC-9-30 47107 1968
McDonnell Douglas DC-9-30 47108 1968
McDonnell Douglas DC-9-30 47174 1968
McDonnell Douglas DC-9-30 47324 1969
McDonnell Douglas DC-9-30 47357 1969

14 McDonnell Douglas DC-9-30 - Initially there were 17 McDonnell Douglas DC-9-30
and one McDonnell Douglas DC-9-40 which were acquired for $122,222,040 during
1986 and leased to Ozark Air Lines, Inc. (Ozark). In 1987, Trans World Airlines,
Inc. (TWA) merged with Ozark and assumed the leases. The leases were modified
and extended in 1991 prior to TWA's bankruptcy filing as discussed in Note 6.
Two of the aircraft had a lease expiration date of February 1998 and two other
aircraft had a lease expiration date of November 1998. These four aircraft were
sold to Triton Aviation Services II LLC in June 1997, as discussed in Note 4.
The leases for 11 of the aircraft that previously had lease expiration dates in
1998 were extended for eight years until November 2004. The leases for three of
the aircraft that previously had lease expiration dates in 1998 were extended in
February 1997 for eight years until February 2005.

<PAGE>

The following is a schedule by year of future minimum rental revenue under the
existing leases:

Year Amount
---- ------
1998 $ 14,280,000
1999 14,280,000
2000 14,280,000
2001 14,280,000
2002 and thereafter 29,675,000
-----------------

Total $ 86,795,000
=================

Future minimum rental payments may be offset or reduced by future costs as
described above and in Note 6.

As discussed in Note 1, the Partnership periodically reviews the estimated
realizability of the residual values at the projected end of each aircraft's
economic life based on estimated residual values obtained from independent
parties which provide current and future estimated aircraft values by aircraft
type. The Partnership made downward adjustments to the estimated residual value
of certain of its on-lease aircraft as of December 31, 1995.

The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying values of the aircraft (which has the effect of
decreasing future depreciation expense) and the downward adjustments to the
estimated residual values (which has the effect of increasing future
depreciation expense).

As discussed above, the Partnership uses information obtained from third party
valuation services in arriving at its estimate of fair value for purposes of
determining residual values. The Partnership will use similar information, plus
available information and estimates related to the Partnership's aircraft, to
determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.

The Partnership recognized impairment losses on aircraft to be held and used by
the Partnership aggregating approximately $17.0 million and $2.4 million, or
$33.97 and $4.75 per limited Partnership unit, as increased depreciation expense
in 1996 and 1995, respectively. In 1996, the impairment loss was the result of
several significant factors. As a result of industry and market changes, a more
extensive review of the Partnership's aircraft was completed in the fourth
quarter of 1996 which resulted in revised assumptions of future cash flows
including reassessment of projected re-lease terms and potential future
maintenance costs. As discussed in Note 4, the Partnership accepted an offer to
purchase seven of the Partnership's remaining aircraft subject to each
aircraft's existing lease. This offer constitutes an event that required the
Partnership to review the aircraft carrying value pursuant to SFAS 121. In
determining this additional impairment loss, the Partnership estimated the fair
value of the aircraft based on the proposed purchase price reflected in the
offer, less the estimated costs and expenses of the proposed sale. The
Partnership recorded an impairment loss to the extent that the carrying value
exceeded the fair value. Management believes the assumptions related to fair
value of impaired assets represents the best estimates based on reasonable and
supportable assumptions and projections. The 1995 downward adjustments were the
result of reductions in the net book value of certain aircraft to their
estimated net realizable value. The increased depreciation expense reduces the
aircraft's carrying value and reduces the amount of future depreciation expense
that the Partnership will recognize over the projected remaining economic life
of the aircraft.

The General Partner evaluates, from time to time, whether the investment
objectives of the Partnership are better served by continuing to hold the
Partnership's remaining portfolio of Aircraft or marketing such Aircraft for
sale. This evaluation takes into account the current and potential earnings of

30
<PAGE>

the Aircraft, the conditions in the markets for lease and sale and future
outlook for such markets, and the tax consequences of selling rather than
continuing to lease the Aircraft. Recently, the General Partner has had
discussions with third parties regarding the possibility of selling some or all
of these Aircraft. While such discussions may continue, and similar discussions
may occur again in the future, there is no assurance that such discussions will
result in the Partnership receiving a purchase offer for all or any of the
Aircraft which the General Partner would regard as acceptable.

4. Sale of Aircraft

Neither PIMC nor GECAS received a sales commission in connection with the
transaction. In addition, PIMC was not paid a management fee with respect to the
collection of the Promissory Note or on any rents accruing from or after April
1, 1997 with respect to the 7 Aircraft. Neither PIMC nor GECAS or any of its
affiliates holds any interest in Triton Aviation or any of Triton Aviation's
affiliates. John Flynn, the current President of Triton Aviation, was a Polaris
executive until May 1996 and has over 15 years experience in the commercial
aviation industry. At the time Mr. Flynn was employed at PIMC, he had no
affiliation with Triton Aviation or its affiliates.

31
<PAGE>

The Accounting Treatment of the Transaction - In accordance with GAAP, the
Partnership recognized rental income up until the closing date for each aircraft
which occurred from May 28, 1997 to June 16, 1997. However, under the terms of
the transaction, the Purchaser was entitled to receive payment of the rents,
receivables and other income accruing from April 1, 1997. As a result, the
Partnership made payments to the Purchaser in the amount of the rents,
receivables and other income due and received from April 1, 1997 to the closing
date of $1,001,067, which is included in rent from operating leases and interest
income. For financial reporting purposes, the cash down payment portion of the
sales proceeds of $1,575,888 has been adjusted by the following: income and
proceeds, including rents and receivables from the effective date of April 1,
1997 to the closing date, interest due on the cash portion of the purchase
price, interest on the Promissory Note from the effective date of April 1, 1997
to the closing date and estimated selling costs. As a result of these GAAP
adjustments, the net adjusted sales price recorded by the Partnership, including
the Promissory Note, was $13,205,140.

The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 had been classified as aircraft held for sale from that date until the
actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $749,373 during the three months ended June 30,
1997. This adjustment to the net carrying value of the aircraft held for sale is
included in depreciation and amortization expense on the statement of
operations.

5. Disassembly of aircraft

In an attempt to maximize the economic return from the remaining six aircraft
formerly leased to Pan Am, the Partnership entered into an agreement with
Soundair, Inc. (Soundair) in October 1992, for the disassembly and sale of
certain of the Partnership's aircraft. The Partnership has incurred the cost of
disassembly and will receive the proceeds from the sale of such parts, net of
overhaul expenses, if necessary, and commissions paid to Soundair. Disassembly
of the six aircraft has been completed. The Partnership has received net
proceeds from the sale of aircraft inventory of $214,749, $260,234 and $275,130
during 1997, 1996 and 1995, respectively, reducing the net book value of the
Partnership's aircraft inventory to zero during 1997. Payments received by the
Partnership of $100,501 in excess of the aircraft inventory net book value were
recorded as gain on sale of aircraft inventory during 1997.

During 1995, the Partnership recorded additional downward adjustments to the
inventory value of $200,000, to reflect the then current estimate of net
realizable aircraft inventory value. These adjustments are reflected as
increased depreciation expense in the accompanying statements of operations.

6. TWA Reorganization

The Partnership renegotiated the TWA leases after TWA defaulted under its leases
with the Partnership during 1991. The renegotiated agreement stipulated that the
Partnership share in the cost of certain ADs after TWA successfully reorganized.
Pursuant to this cost-sharing agreement, since TWA emerged from its
reorganization proceedings in 1993, expenses totaling $6.6 million have been
offset against rental payments or credited to other amounts due from TWA. Under

32
<PAGE>

the terms of this agreement, TWA may offset up to an additional $1.7 million
against rental payments, subject to annual limitations, over the remaining lease
terms.

In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, GECAS negotiated a
standstill arrangement, as set forth in a letter agreement dated December 16,
1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by
GECAS, 18 of which are owned by the Partnership. As required by its terms, the
Deferral Agreement (which has since been amended as discussed below) was
approved by PIMC on behalf of the Partnership with respect to the Partnership's
aircraft.

The Deferral Agreement provided for (i) a moratorium on the rents due to the
Partnership in November 1994 and on 75% of the rents due to the Partnership from
December 1994 through March 1995, and (ii) all of the deferred rents, together
with interest thereon, to be repaid in monthly installments beginning in May
1995 and ending in December 1995. The repayment schedule was subsequently
accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not
recognize either the $1.575 million rental amount deferred in 1994 or the $2.025
million rental amount deferred during the first quarter of 1995 as rental
revenue until the deferred rents were received. The deferred rents were paid in
full by October 1995. While TWA has committed to an uninterrupted flow of lease
payments, there can be no assurance that TWA will continue to honor its
obligations in the future.

In consideration for the partial rent moratorium described above, TWA agreed to
make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom
GECAS provides management services and who agreed to the Deferral Agreement. The
Partnership received $218,171 in January 1995 as its pro-rata share of such
payment by TWA. This amount was recognized as other revenue in the accompanying
1995 statement of operations.

In order to resolve certain issues that arose after the execution of the
Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27,
1995, pursuant to which they agreed to amend certain provisions of the Deferral
Agreement (as so amended, the Amended Deferral Agreement). The effect of the
Amended Deferral Agreement, which was approved by PIMC with respect to the
Partnership's aircraft, is that TWA, in addition to agreeing to repay the
deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable
in warrants, the number of which was determined by formula) in consideration for
the aircraft owners' agreement to defer rent under the Deferral Agreement, and,
(ii) to the extent the market value of the warrants is less than the payment
amount, to supply maintenance services to the aircraft owners having a value
equal to such deficiency. The payment amount was determined by subtracting
certain maintenance reimbursements owed to TWA by certain aircraft owners,
including the Partnership, from the aggregate amount of deferred rents.

The Partnership received warrants to purchase 227,133 shares of TWA Common Stock
from TWA in November 1995. The Partnership exercised the warrants on December
29, 1995 for the strike price of $0.01 per share. The fair market value of the
TWA stock at December 31, 1995 of $2,356,506, which was determined based on
quoted market prices, is reflected in the accompanying December 31, 1995 balance
sheet. The Partnership sold the TWA Common Stock by February 1996, net of broker
commissions, for $2,406,479 and recognized a gain on trading securities of
$49,974 in 1996.

7. TWA Lease Extension

GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of
noise-suppression devices, commonly known as "hushkits", for the 14 Partnership
aircraft currently on lease to TWA, as well as other aircraft owned by
affiliates of PIMC and leased to TWA. The 14 aircraft that received hushkits
were designated by TWA. The hushkits recondition the aircraft so as to meet
Stage 3 noise level restrictions. Hushkits were installed on 11 of the
Partnership's aircraft during 1996 and the leases for these 11 aircraft were
extended for a period of eight years until November 2004. Hushkits were
installed on 3 of the Partnership's aircraft during 1997 and the leases for
these 3 aircraft were extended for a period of eight years until February 2005.

The aggregate cost of the hushkit reconditioning for the 11 aircraft was
$17,516,722, or approximately $1.6 million per aircraft, which was capitalized
by the Partnership during 1996. The Partnership paid $3.3 million of the
aggregate hushkit cost and the balance of $14,216,722 was financed by the
hushkit manufacturer over 50 months at an interest rate of approximately 10% per
annum.

33
<PAGE>

The aggregate cost of the hushkit reconditioning completed in February 1997 for
the 3 remaining aircraft was $4,784,633, or approximately $1.6 million per
aircraft, which was capitalized by the Partnership during 1997. The Partnership
paid $900,000 of the aggregate hushkit cost and the balance of $3,884,633 was
financed by UT Finance Corporation (UT Finance), a wholly owned subsidiary of
United Technologies Corporation, of which a division is Pratt and Whitney Group,
the hushkit manufacturer, over 50 months at an interest rate of approximately
10% per annum.

The rent payable by TWA under the leases was increased by an amount sufficient
to cover the monthly debt service payments on the hushkits and fully repay,
during the term of the TWA leases, the amount borrowed. The loans from the
hushkit manufacturer are non-recourse to the Partnership and secured by a
security interest in the lease receivables. Cash paid for interest expenses on
the loans was $1,551,093 and $236,848 in 1997 and 1996, respectively.

8. Viscount Restructuring Agreement and Default

During 1995, Viscount delivered the Partnership's Boeing 737-200 aircraft to a
repair facility operated by BAE Aviation, Inc., d/b/a Tucson Aerospace, located
in Arizona, to perform a heavy maintenance check on the aircraft. The
Partnership has paid to Tucson Aerospace approximately $565,000 from maintenance
reserves and cash reserves for this aircraft as progress payments on this
maintenance check. Work on the maintenance check was suspended prior to the
filing of the Chapter 11 petition by Viscount. Tucson Aerospace asserts that
Viscount owes it approximately $866,000 for work done on the aircraft, which is
in addition to the approximately $565,000 already paid by the Partnership from
maintenance reserves. In addition, a third party vendor, who claims it provided
personnel to work on the aircraft, is asserting a claim against Tucson Aerospace
and a lien against the aircraft in the amount of $720,000. Another third-party
vendor, who claims it provided inspectors, is claiming $185,000 from Tucson
Aerospace. On May 22, 1996, First Security Bank, National Association (formerly
known as First Security Bank of Utah, National Association) (FSB), as
owner/trustee, filed suit in the Superior Court of Arizona in Pima County, to
recover the airframe from BAE Aviation, Inc. and certain creditors alleging
mechanics liens and to determine the validity of the claimed liens.

On July 12, 1996, GECAS and FSB filed a motion in Viscount's bankruptcy case to
recover the engines and parts leased in connection with the Partnership's
aircraft. GECAS and FSB asserted that these engines and parts should have been
delivered to FSB pursuant to the Compromise and Stipulation. Viscount paid to
the Partnership $10,000 for the use of the engine during the month of August
1996, and continued through August 1996 to pay maintenance reserves pursuant to
the lease terms.

34
<PAGE>

The Partnership recorded allowances for credit losses of $241,964 and $100,409
in 1995 and 1996, respectively, for the aggregate unsecured receivables from
Viscount. The line of credit, which was advanced to Viscount in 1994, was, in
accordance with the Compromise and Stipulation, secured by certain of Viscount's
trade receivables and spare parts. The Stipulation and Agreement releases the
Partnership's claim against Viscount's trade receivables. As a result, the
Partnership recorded an additional allowance for credit losses of $92,508 during
1996, representing Viscount's outstanding balance of the line of credit and
accrued interest. Payments received by the Partnership from the sale of the
spare aircraft parts (as discussed above), if any, will be recorded as revenue
when received. The Stipulation and Agreement provides that, upon entry of a
final non-appealable court order approving it, the Partnership would waive its
pre- and post-petition claims against Viscount for all amounts due and unpaid.
As a result, the Partnership considers all receivables from Viscount to be
uncollectible and has written-off, during 1996, all notes, rents and interest
receivable balances from Viscount.

The Partnership has evaluated the airframe and engines previously leased to
Viscount for potential re-lease or sale and estimated that maintenance and
refurbishment costs aggregating approximately $1.6 million will be required to
re-lease the airframe and engines. Alternatively, a sale of the airframe and
engines would likely be made on an "as is, where is" basis, without the
Partnership incurring substantial maintenance costs. The aircraft was sold in
January 1997 for $660,000. As discussed in Note 3, in accordance with SFAS No.
121, the Partnership recognized an impairment loss of $300,000 on this aircraft
which was recorded as additional depreciation expense during 1996.

Viscount's failure to perform its financial obligations to the Partnership has
had a material adverse effect on the Partnership's financial position. As a
result of Viscount's defaults and Chapter 11 bankruptcy filing, the Partnership
has incurred legal costs of approximately $107,000 and $147,000, which are
reflected in operating expense in the Partnership's 1997 and 1996 statement of
operations, respectively.

9. ALG Default and Restructuring

In 1995, ALG paid to the Partnership $19,138 of the $897,932 balloon payment due
in January 1995, originating an event of default under the note. The Partnership
and ALG subsequently restructured the terms of the promissory note. The
renegotiated terms specify payment by ALG of the note balance with interest at a
rate of 13% per annum with one lump sum payment in January 1995 of $254,733,

35
<PAGE>

eleven monthly payments of $25,600 beginning in February 1995, and a balloon
payment in January 1996 of $416,631. In January 1996, the Partnership and ALG
once again restructured the terms of the promissory note. The renegotiated terms
specify payment by ALG of the note balance with interest at a rate of 13% per
annum with a lump sum payment in January 1996 of $135,258 and eleven payments of
$27,272 beginning in February 1996 through December 1996. ALG paid the note in
full during 1996.

10. Claims Related to Lessee Defaults

Pan Am - The Partnership entered into a proposed Stipulation and Order in which
Pan Am agreed to allow the Partnership $2.5 million as an administrative expense
priority claim and $56 million as a general unsecured claim. In May 1996, the
Partnership received from Pan Am a payment of $567,500 on the administrative
expense priority claim. In November 1996, the Partnership received an additional
$9,000 payment on the administrative expense priority claim. The Partnership has
recorded these payments as revenue in claims related to lessee defaults in the
1996 statement of operations. It is unlikely that the Partnership will receive
additional payments on the administrative expense priority claim. It cannot be
estimated at this time when and if the general unsecured claim will be paid.

11. Related Parties

Under the Limited Partnership Agreement (Partnership Agreement), the Partnership
paid or agreed to pay the following amounts to PIMC and/or its affiliates in
connection with services rendered:

a. An aircraft management fee equal to 5% of gross rental revenues with
respect to operating leases or 2% of gross rental revenues with respect
to full payout leases of the Partnership, payable upon receipt of the
rent. In 1997, 1996 and 1995, the Partnership paid management fees to
PIMC of $440,295, $652,417 and $763,774, respectively. Management fees
payable to PIMC at December 31, 1997 and 1996 were $76,330 and $0
respectively.

b. Reimbursement of certain out-of-pocket expenses incurred in connection
with the management of the Partnership and supervision of its assets.
In 1997, 1996 and 1995, $375,486, $316,061 and $299,588, respectively,
were reimbursed by the Partnership for administrative expenses.
Administrative reimbursements of $50,286 and $65,594 were payable at
December 31, 1997 and 1996, respectively. Reimbursements for
maintenance and remarketing costs of $82,633, $153,699 and $972,284
were paid by the Partnership in 1997, 1996 and 1995, respectively.
Maintenance and remarketing reimbursements of $16,145 and $1,037 were
payable at December 31, 1997 and 1996, respectively.

c. A 10% interest to PIMC in all cash distributions and sales proceeds,
gross income in an amount equal to 9.09% of distributed cash available
from operations and 1% of net income or loss and taxable income or
loss, as such terms are defined in the Partnership Agreement. After the
Partnership has sold or disposed of aircraft representing 50% of the
total aircraft cost, gains from the sale or other disposition of
aircraft are generally allocated first to the General Partner until
such time that the General Partner's capital account is equal to the
amount to be distributed to the General Partner from the proceeds of
such sale or disposition.

d. A subordinated sales commission to PIMC of 3% of the gross sales price
of each aircraft for services performed upon disposition and
reimbursement of out-of-pocket and other disposition expenses.
Subordinated sales commissions will be paid only after limited partners
have received distributions in an aggregate amount equal to their
capital contributions plus a cumulative non-compounded 8% per annum
return on their adjusted capital contributions, as defined in the
Partnership Agreement. The Partnership did not pay or accrue a sales
commission on any aircraft sales to date as the above subordination
threshold has not been met.

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<PAGE>

e. One engine owned by Polaris Aircraft Income Fund I (PAIF-I) was leased
to Viscount beginning in April 1993 through a joint venture with the
Partnership. The rental payments of $146,000 per year were offset
against rent from operating leases in the 1995 statement of operations.

f. In the event that, immediately prior to the dissolution and termination
of the Partnership, the General Partner shall have a deficit balance in
its tax basis capital account, then the General Partner shall
contribute in cash to the capital of the Partnership an amount which is
equal to such deficit (see Note 12).

12. Partners' Capital

The Partnership Agreement (the Agreement) stipulates different methods by which
revenue, income and loss from operations and gain or loss on the sale of
aircraft are to be allocated to the General Partner and the Limited Partners
(see Note 11). Such allocations are made using income or loss calculated under
GAAP for book purposes, which, as more fully described in Note 14, varies from
income or loss calculated for tax purposes.

Cash available for distributions, including the proceeds from the sale of
aircraft, is distributed 10% to the General Partner and 90% to the Limited
Partners.

The different methods of allocating items of income, loss and cash available for
distribution combined with the calculation of items of income and loss for book
and tax purposes result in book basis capital accounts that may vary
significantly from tax basis capital accounts. The ultimate liquidation and
distribution of remaining cash will be based on the tax basis capital accounts
following liquidation, in accordance with the Agreement.

Had all the assets of the Partnership been liquidated at December 31, 1997 at
the current carrying value, the tax basis capital (deficit) accounts of the
General Partner and the Limited Partners is estimated to be ($723,727) and
$61,464,423, respectively.

13. Income Taxes

Federal and state income tax regulations provide that taxes on the income or
loss of the Partnership are reportable by the partners in their individual
income tax returns. Accordingly, no provision for such taxes has been made in
the financial statements.

The net differences between the tax basis and the reported amounts of the
Partnership's assets and liabilities at December 31, 1997 and 1996 are as
follows:

Reported Amounts Tax Basis Net Difference
---------------- --------- --------------

1997: Assets $ 77,546,425 $ 84,836,496 $ (7,290,071)
Liabilities 16,805,729 16,232,563 573,166

1996: Assets $ 87,622,742 $ 98,431,900 $ (10,809,158)
Liabilities 15,407,033 14,654,469 752,564

<PAGE>

14. Reconciliation of Net Book Income (Loss) to Taxable Net Income (Loss)

The following is a reconciliation between net income (loss) per limited
partnership unit reflected in the financial statements and the information
provided to limited partners for federal income tax purposes:

For the years ended December 31,
--------------------------------

1997 1996 1995
---- ---- ----

Book net income (loss) per limited
partnership unit $ 8.85 $ (32.62) $ 9.94
Adjustments for tax purposes represent
differences between book and tax
revenue and expenses:
Rental and maintenance reserve
revenue recognition (1.18) 0.03 (2.60)
Management fee expense 0.06 0.03 0.14
Depreciation (11.31) 30.16 (0.78)
Gain or loss on sale of aircraft (0.02) (0.19) (1.60)
Capitalized costs -- -- 0.93
Basis in inventory (0.07) (0.08) (1.08)
Other revenue and expense items (0.01) (0.16) (0.36)
--------- --------- --------

Taxable net income (loss) per limited
partnership unit $ (3.68) $ (2.83) $ 4.59
========= ========= ========

The differences between net income and loss for book purposes and net income and
loss for tax purposes result from the temporary differences of certain revenue
and deductions.

For book purposes, rental revenue is generally recorded as it is earned. For tax
purposes, certain temporary differences exist in the recognition of revenue. For
tax purposes, management fee expense is accrued in the same year as the tax
basis rental revenue. Increases in the Partnership's book maintenance reserve
liability were recognized as rental revenue for tax purposes. Disbursements from
the Partnership's book maintenance reserves are capitalized or expensed for tax
purposes, as appropriate.

The Partnership computes depreciation using the straight-line method for
financial reporting purposes and generally an accelerated method for tax
purposes. The Partnership also periodically evaluates the ultimate
recoverability of the carrying values and the economic lives of its aircraft for
book purposes and, accordingly, recognized adjustments which increased book
depreciation expense. As a result, the current year tax depreciation expense is
greater than the book depreciation expense. These differences in depreciation
methods result in book to tax differences on the sale of aircraft. In addition,
certain costs were capitalized for tax purposes and expensed for book purposes.

Differences in book and tax revenue from inventory result from the differences
in the book and tax carrying value of the inventory.

15. Subsequent Events

The Partnership made a cash distribution, to limited partners, of $2,424,869 or
$4.85 per limited partnership unit, and $269,430 to the General Partner on
January 15, 1998.

The Partnership made a special cash distribution, to limited partners, of
$10,624,426, or $21.25 per limited partnership unit, and $1,180,492 to the
General Partner on February 23, 1998, as a result of the prepayment of the
Promissory Note by Triton, as discussed in Note 4.

<PAGE>

Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure

None.

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<PAGE>

PART III

Item 10. Directors and Executive Officers of the Registrant

Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or
the Partnership) has no directors or officers. Polaris Holding Company (PHC) and
its subsidiaries, including Polaris Aircraft Leasing Corporation (PALC) and
Polaris Investment Management Corporation (PIMC), the general partner of the
Partnership (collectively Polaris), restructured their operations and businesses
(the Polaris Restructuring) in 1994. In connection therewith, PIMC entered into
a services agreement dated as of July 1, 1994 (the Services Agreement) with GE
Capital Aviation Services, Inc. (GECAS), a Delaware corporation which is a
wholly owned subsidiary of General Electric Capital Corporation, a New York
corporation (GE Capital). GE Capital has been PHC's parent company since 1986.
As subsidiaries of GE Capital, the Servicer and PIMC are affiliates.

The officers and directors of PIMC are:

Name PIMC Title
-------------- --------------------

Eric M. Dull President; Director
Marc A. Meiches Chief Financial Officer
Richard J. Adams Director
Norman C. T. Liu Vice President; Director
Ray Warman Secretary
Robert W. Dillon Assistant Secretary

Substantially all of these management personnel will devote only such portion of
their time to the business and affairs of PIMC as deemed necessary or
appropriate.

Mr. Dull, 37, assumed the position of President and Director of PIMC effective
January 1, 1997. Mr. Dull previously was a Director of PIMC from March 31, 1995
to July 31, 1995. Mr. Dull holds the position of Executive Vice President - Risk
and Portfolio Management of GECAS, having previously held the positions of
Executive Vice President - Portfolio Management and Senior Vice President -
Underwriting Risk Management of GECAS. Prior to joining GECAS, Mr. Dull held
various positions with Transportation and Industrial Funding Corporation (TIFC).

Mr. Meiches, 45, assumed the position of Chief Financial Officer of PIMC
effective October 9, 1995. Previously, he held the position of Vice President of
PIMC from October 1995 to October 1997. Mr. Meiches presently holds the
positions of Executive Vice President and Chief Financial and Operating Officer
of GECAS. Prior to joining GECAS, Mr. Meiches has been with General Electric
Company (GE) and its subsidiaries since 1978. Since 1992, Mr. Meiches held the
position of Vice President of the General Electric Capital Corporation Audit
Staff. Between 1987 and 1992, Mr. Meiches held Manager of Finance positions for
GE Re-entry Systems, GE Government Communications Systems and the GE Astro-Space
Division.

Mr. Adams, 64, held the position of Senior Vice President - Aircraft Sales and
Leasing of PIMC and PALC from August 1992 until October 1997, having previously
served as Vice President - Aircraft Sales & Leasing, Vice President, North
America, and Vice President - Corporate Aircraft since he joined PALC in August
1986. Effective July 1, 1994, Mr. Adams assumed the position of Director of
PIMC. Mr. Adams presently holds the position of Senior Vice President - Fleet
Advisory Services of GECAS, having previously held the position of Senior Vice
President - Stage II Aircraft.

Mr. Liu, 40, assumed the position of Vice President of PIMC effective May 1,
1995 and Director of PIMC effective July 31, 1995. Mr. Liu presently holds the
position of Executive Vice President - Marketing and Structured Finance of
GECAS, having previously held the position of Executive Vice President - Capital

40
<PAGE>

Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was
with General Electric Capital Corporation for nine years. He has held management
positions in corporate Business Development and in Syndications and Leasing for
TIFC. Mr. Liu previously held the position of managing director of Kidder,
Peabody & Co., Incorporated.

Mr. Warman, 49, assumed the position of Secretary of PIMC effective March 23,
1998. Mr. Warman has served as a GECAS Senior Vice President and Associate
General Counsel since March 1996, and for 13 years theretofore was a partner,
with an air-finance and corporate practice of the national law firm of Morgan,
Lewis & Bockius LLP.

Mr. Dillon, 56, held the position of Vice President - Aviation Legal and
Insurance Affairs, from April 1989 to October 1997. Previously, he served as
General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994,
Mr. Dillon assumed the position of Assistant Secretary of PIMC. Mr. Dillon
presently holds the position of Senior Vice President and Managing Counsel of
GECAS.

Certain Legal Proceedings:

On October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v.
Polaris Holding Company, et al. was filed in the Supreme Court of the State of
New York for the County of New York. The complaint sets forth various causes of
action which include allegations against certain or all of the defendants (i)
for alleged fraud in connection with certain public offerings, including that of
the Partnership, on the basis of alleged misrepresentation and alleged omissions
contained in the written offering materials and all presentations allegedly made
to investors; (ii) for alleged negligent misrepresentation in connection with
such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged
breach of third party beneficiary contracts; (v) for alleged violations of the
NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for
alleged breach of implied covenants in the customer agreements by certain
registered brokers. The Partnership is not named as a defendant in this action.
The complaint seeks an award of compensatory and other damages and remedies. On
July 20, 1994, the court entered an order dismissing almost all of the claims in
the complaint and amended complaint. Plaintiffs filed a notice of appeal on
September 2, 1994. On April 25, 1996, the Appellate Division for the First
Department affirmed the trial court's order which had dismissed most of
plaintiffs' claims. On September 25, 1997, this action was discontinued with
prejudice by stipulation of the parties.

On or around February 17, 1993, a civil action entitled Einhorn, et al. v.
Polaris Public Income Funds, et al. was filed in the Circuit Court of the 11th
Judicial Circuit in and for Dade County, Florida against, among others, Polaris
Investment Management Corporation and Polaris Depositary Company. The
Partnership is not named as a defendant in this action. Plaintiffs seek class
action certification on behalf of a class of investors in Polaris Aircraft
Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund
VI who purchased their interests while residing in Florida. Plaintiffs allege
the violation of Section 517.301, Florida Statutes, in connection with the
offering and sale of units in such Polaris Aircraft Income Funds. Among other
things, plaintiffs assert that the defendants sold interests in such Polaris
Aircraft Income Funds while "omitting and failing to disclose the material facts
questioning the economic efficacy of" such Polaris Aircraft Income Funds.
Plaintiffs seek rescission or damages, in addition to interest, costs, and
attorneys' fees. On April 5, 1993, defendants filed a motion to stay this action
pending the final determination of a prior filed action in the Supreme Court for
the State of New York entitled Weisl v. Polaris Holding Company. On that date,
defendants also filed a motion to dismiss the complaint on the grounds of
failure to attach necessary documents, failure to plead fraud with particularity
and failure to plead reasonable reliance. On April 13, 1993, the court denied
the defendants' motion to stay. On May 7, 1993, the court stayed the action
pending an appeal of the denial of the motion to stay. Defendants subsequently
filed with the Third District Court of Appeal a petition for writ of certiorari

41
<PAGE>

to review the lower court's order denying the motion to stay. On October 19,
1993, the Court of Appeal granted the writ of certiorari, quashed the order, and
remanded the action with instruction to grant the stay.

Moross, et al. v. Polaris Holding Company, et al was transferred to the
Multi-District Litigation which has been settled as described below.

On June 8, 1994, a consolidated complaint captioned In re Prudential Securities
Inc. Limited Partnerships Litigation was filed in the United States District
Court for the Southern District of New York, purportedly consolidating cases
that had been transferred from other federal courts by the Judicial Panel on
Multi-District Litigation. The consolidated complaint names as defendants
Prudential entities and various other sponsors of limited partnerships sold by
Prudential, including Polaris Holding Company, one of its former officers,
Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation
and Polaris Securities Corporation. The Partnership is not named as a defendant
in this action. The complaint alleges that the Prudential defendants created a
scheme for the sale of approximately $8-billion of limited partnership interests
in 700 allegedly high-risk limited partnerships, including the Partnership, to
approximately 350,000 investors by means of false and misleading offering
materials; that the sponsoring organizations (including the Polaris entities)
participated with the Prudential defendants with respect to, among other things,
the partnerships that each sponsored; and that all of the defendants conspired
to engage in a nationwide pattern of fraudulent conduct in the marketing of all
limited partnerships sold by Prudential. The complaint alleges violations of the
federal Racketeer Influenced and Corrupt Organizations Act and the New Jersey
counterpart thereof, fraud, negligent misrepresentation, breach of fiduciary
duty and breach of contract. The complaint seeks rescission, unspecified
compensatory damages, treble damages, disgorgement of profits derived from the
alleged acts, costs and attorneys fees.

On April 22, 1997, the Polaris defendants entered into a settlement agreement
with plaintiffs pursuant to which, among other things, the Polaris defendants
agreed to make a payment to a class of unitholders previously certified by the
Court. On August 1, 1997, the Court approved a class settlement with the Polaris
defendants.

Adams, et al. v. Prudential Securities, Inc. et al. was transferred to the
Multi-District Litigation filed in the United States District Court for the
Southern District of New York, which has been settled as discussed above.

On or about January 12, 1995, a class action complaint entitled Cohen, et al. v.
Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the
Fifteenth Judicial Circuit in and for Palm Beach County, Florida, and on March
31, 1995 the case was removed to the United States District Court for the
Southern District of Florida. An amended class action complaint (the "amended
complaint"), which re-named this action Bashein, et al. v. Kidder, Peabody &
Company Inc., et al. was filed on June 13, 1995. The amended complaint names
Kidder Peabody & Company, Inc., General Electric Capital Corporation, General
Electric Financial Services, Inc., and General Electric Company as defendants.
The Partnership is not named as a defendant in this action. The action purports
to be on behalf of "approximately 20,000 persons throughout the United States"
who purchased units in Polaris Aircraft Income Funds III through VI. The amended
complaint sets forth various causes of action purportedly arising in connection
with the public offerings of Polaris Aircraft Income Fund III, Polaris Aircraft
Income Fund IV, Polaris Aircraft Income Fund V, and Polaris Aircraft Income Fund
VI. Specifically, plaintiffs assert claims for violation of Sections 12(2) and
15 of the Securities Act of 1933, fraud, negligent misrepresentation, breach of
fiduciary duty, breach of third party beneficiary contract, violation of NASD
Rules of Fair Practice, breach of implied covenant, and breach of contract.
Plaintiffs seek compensatory damages, interest, punitive damages, costs and

42
<PAGE>

attorneys' fees, as well as any other relief the court deems just and proper.
Plaintiffs filed a motion for leave to file a second amended complaint, which
was granted on October 3, 1995. On March 18, 1996, plaintiffs moved for class
certification. On the eve of class discovery, April 26, 1996, plaintiffs moved
for a voluntary dismissal of Counts I and II (claims brought pursuant to the
Securities Act of 1933) of the Second Amended Complaint and simultaneously filed
a motion to remand this action to state court for lack of federal jurisdiction.
Plaintiff's motion for voluntary dismissal of the federal securities law claims
and motion for remand were granted on July 10, 1996. On December 18, 1997, the
Court ordered that plaintiffs show good cause why the action should not be
dismissed without prejudice for lack of prosecution. On January 14, 1998, a
hearing was held with respect to the order to show cause, and the Court
determined that the action should be dismissed without prejudice for lack of
prosecution.

On or around April 13, 1995, a class action complaint entitled B & L Industries,
Inc., et al. v. Polaris Holding Company, et al. was filed in the Supreme Court
of the State of New York. The complaint names as defendants Polaris Holding
Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management
Corporation, Polaris Securities Corporation, Peter G. Pfendler, Marc P.
Desautels, General Electric Capital Corporation, General Electric Financial
Services, Inc., General Electric Company, Prudential Securities Inc., and Kidder
Peabody & Company Incorporated. The Partnership is not named as a defendant in
this action. The complaint sets forth various causes of action purportedly
arising out of the public offerings of Polaris Aircraft Income Fund III and
Polaris Aircraft Income Fund IV. Plaintiffs allege claims of fraud, negligent
misrepresentation, breach of fiduciary duty, knowingly inducing or participating
in breach of fiduciary duty, breach of third party beneficiary contract,
violation of NASD Rules of Fair Practice, breach of implied covenant, and unjust
enrichment. Plaintiffs seek compensatory damages, interest, general,
consequential and incidental damages, exemplary and punitive damages,
disgorgement, rescission, costs, attorneys' fees, accountants' and experts'
fees, and other legal and equitable relief as the court deems just and proper.
On August 16, 1996, defendants filed a motion to dismiss plaintiffs' amended
complaint. On October 8, 1997, this action was discontinued with prejudice by
stipulation of the parties.

On or around September 27, 1995, a complaint entitled Martha J. Harrison v.
General Electric Company, et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and Prudential Securities Incorporated. The Partnership is not
named as a defendant in this action. Plaintiff alleges claims of tort, breach of
fiduciary duty in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning
the inducement and solicitation of purchases arising out of the public offering
of Polaris Aircraft Income Fund IV. Plaintiff seeks compensatory damages,
attorney's fees, interest, costs and general relief.

On or around December 8, 1995, a complaint entitled Overby, et al. v. General
Electric Company, et al. was filed in the Civil District Court for the Parish of
Orleans, State of Louisiana. The complaint names as defendants General Electric
Company and General Electric Capital Corporation. The Partnership is not named
as a defendant in this action. Plaintiffs allege claims of tort, breach of
fiduciary duty, in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in
connection with the public offering of Polaris Aircraft Income Funds III and IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.

In or around November 1994, a complaint entitled Lucy R. Neeb, et al. v.
Prudential Securities Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants

43
<PAGE>

Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company, General Electric
Capital Corporation and Smith Barney, Inc. The Partnership is not named as a
defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary
duty, in tort, contract and quasi-contract, violation of sections of the
Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection
with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs
seek compensatory damages, attorneys' fees, interest, costs and general relief.

In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v.
Prudential Securities, Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities Incorporated and Stephen Derby Gisclair. On or about
January 18, 1996, plaintiff filed a First Supplemental and Amending Petition
adding defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of sections of the Louisiana Blue Sky Law and
violation of the Louisiana Civil Code in connection with the public offering of
Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages,
attorneys' fees, interest, costs and general relief.

On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v.
General Electric Co., et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
in connection with the public offering of Polaris Aircraft Income Fund IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.

In or around December 1994, a complaint entitled John J. Jones, Jr. v.
Prudential Securities Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company and General Electric
Capital Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of section of the Louisiana Blue Sky Law and violation
of the Louisiana Civil Code concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Fund
III. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and
general relief.

On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v.
General Electric Company, et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint named as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
concerning the inducement and solicitation of purchases arising out of the
public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek
compensatory damages, attorneys' fees, interest, costs and general relief.

On or about May 7, 1996, a petition entitled Charles Rich, et al. v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
District Court for the Parish of Orleans, State of Louisiana. The complaint

44
<PAGE>

names as defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiffs allege claims of tort concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Funds
III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief.

On or about March 4, 1996, a petition entitled Richard J. McGiven v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
District Court for the Parish of Orleans, State of Louisiana. The complaint
names as defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Fund V.
Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and
general relief.

On or about March 4, 1996, a petition entitled Alex M. Wade v. General Electric
Company and General Electric Capital Corporation was filed in the Civil District
Court for the Parish of Orleans, State of Louisiana. The complaint names as
defendants General Electric Company and General Electric Capital Corporation.
The Partnership is not named as a defendant in this action. Plaintiff alleges
claims of tort concerning the inducement and solicitation of purchases arising
out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks
compensatory damages, attorneys' fees, interest, costs and general relief.

The following actions were settled pursuant to a settlement agreement entered
into on June 6, 1997. An additional settlement was entered into on November 19,
1997 with certain plaintiffs who had refused to participate in the first
settlement:

A complaint entitled Joyce H. McDevitt, et al. v. Polaris Holding Company, et
al., which was filed in the Superior Court of the State of California, County of
Sacramento, on or about October 15, 1996, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint
names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory
damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Mary Grant Tarrer, et al. v. Kidder Peabody & Co. (Kidder
Peabody), et al., which was filed in the Superior Court of the State of
California, County of Sacramento, on or about October 16, 1996, by individual
plaintiffs who purchased limited partnership units in Polaris Aircraft Income
Funds III-VI and other limited partnerships sold by Kidder Peabody. The
complaint names Kidder, Peabody & Co. Incorporated, KP Realty Advisors, Inc.,
Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory

45
<PAGE>

damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds III-VI and all other limited
partnerships alleged to have been sold by Kidder Peabody to the plaintiffs.

A complaint entitled Janet K. Johnson, et al. v. Polaris Holding Company, et
al., which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 6, 1996, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint
names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory
damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Wayne W. Kuntz, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 13, 1996, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Thelma Abrams, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 26, 1996, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Enita Elphick, et al. v. Kidder Peabody & Co.,et al., which
was filed in the Superior Court of the State of California, County of
Sacramento, on or about January 16, 1997, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds III-VI and other
limited partnerships sold by Kidder Peabody. The complaint names Kidder, Peabody
& Co. Incorporated, KP Realty Advisors, Inc., Polaris Holding Company, Polaris

46
<PAGE>

Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Financial Services, Inc.,
General Electric Capital Corporation, General Electric Credit Corporation and
Does 1-100 as defendants. The Partnership is not named as a defendant in this
action. The complaint alleges violations of state common law, including fraud,
negligent misrepresentation, breach of fiduciary duty, and violations of the
rules of the National Association of Securities Dealers. The complaint seeks to
recover compensatory damages and punitive damages in an unspecified amount,
interest, and rescission with respect to Polaris Aircraft Income Funds III-VI
and all other limited partnerships alleged to have been sold by Kidder Peabody
to the plaintiffs.

A complaint entitled George Zicos, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about February 14, 1997, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

Three complaints which were filed on or about March 21, 1997, in the Superior
Court of the State of California, County of Sacramento naming as defendants
Kidder, Peabody & Company, Incorporated, Polaris Holding Company, Polaris
Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Capital Services, General
Electric Capital Corporation, GE Capital Aviation Services and Does 1-100. The
first complaint, entitled Michael J. Ouellette, et al. v. Kidder Peabody & Co.,
et al., was filed by over 50 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
second complaint, entitled Thelma A. Rolph, et al. v. Polaris Holding Company,
et al., was filed by over 500 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
third complaint, entitled Carl L. Self, et al. v. Polaris Holding Company, et
al., was filed by over 500 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
Partnership is not named as a defendant in any of these actions. Each complaint
alleges violations of state common law, including fraud, negligent
misrepresentation and breach of fiduciary duty, and violations of the rules of
the National Association of Securities Dealers, Inc. Each complaint seeks to
recover compensatory damages and punitive damages in an unspecified amount,
interest and rescission with respect to Polaris Aircraft Income Funds I-VI and
all other limited partnerships alleged to have been sold by Kidder Peabody to
the plaintiffs.

A complaint entitled Wilson et al. v. Polaris Holding Company et al., which was
filed in the Superior Court of the State of California for the County of
Sacramento on October 1, 1996, by over 500 individual plaintiffs who purchased
limited partnership units in one or more of Polaris Aircraft Income Funds I
through VI. The complaint names Polaris Holding Company, Polaris Aircraft
Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Capital Services, Inc., General
Electric Capital Corporation, GE Capital Aviation Services, Inc. and Does 1-100

47
<PAGE>

as defendants. The Partnership has not been named as a defendant. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, negligence, breach of contract, and breach of fiduciary duty.
The complaint seeks to recover compensatory damages and punitive damages in an
unspecified amount, interest and rescission with respect to the Polaris Aircraft
Income Funds sold to plaintiffs.

A summons and First Amended Complaint entitled Sara J. Bishop, et al. v. Kidder
Peabody & Co., et al., which was filed in the Superior Court of the State of
California, County of Sacramento, on or about April 9, 1996, by over one hundred
individual plaintiffs who purchased limited partnership units in Polaris
Aircraft Income Funds III, IV, V and VI and other limited partnerships sold by
Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP
Realty Advisors, Inc., Polaris Holding Company, Polaris Aircraft Leasing
Corporation, Polaris Investment Management Corporation, Polaris Securities
Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc.,
General Electric Company, General Electric Financial Services, Inc., General
Electric Capital Corporation, General Electric Credit Corporation and Does 1-100
as defendants. The Partnership is not named as a defendant in this action. The
complaint alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds III-VI and all
other limited partnerships alleged to have been sold by Kidder Peabody to the
plaintiffs.

Other Proceedings - Part I, Item 3 discusses certain other actions arising out
of certain public offerings, including that of the Partnership, to which both
the Partnership and its general partner are parties.

Disclosure pursuant to Section 16, Item 405 of Regulation S-K:

Based solely on its review of the copies of such forms received or written
representations from certain reporting persons that no Forms 3, 4, or 5 were
required for those persons, the Partnership believes that, during 1997 all
filing requirements applicable to its officers, directors and greater than ten
percent beneficial owners were met.

Item 11. Executive Compensation

PAIF-II has no directors or officers. PAIF-II is managed by PIMC, the General
Partner. In connection with management services provided, management and
advisory fees of $440,295 were paid to PIMC in 1997 in addition to a 10%
interest in all cash distributions as described in Note 11 to the financial
statements (Item 8).

Item 12. Security Ownership of Certain Beneficial Owners and Management

a) No person owns of record, or is known by PAIF-II to own beneficially,
more than five percent of any class of voting securities of PAIF-II.

<PAGE>

b) The General Partner of PAIF-II owns the equity securities of PAIF-II as
set forth in the following table:

Title Name of Amount and Nature of Percent
of Class Beneficial Owner Beneficial Ownership of Class
-------- ---------------- --------------------- --------

General Polaris Investment Represents a 10.0% interest of 100%
Partner Management all cash distributions, gross
Interest Corporation income in an amount equal to
9.09% of distributed cash
available from operations, and
a 1% interest in net income or loss

c) There are no arrangements known to PAIF-II, including any pledge by any
person of securities of PAIF-II, the operation of which may at a
subsequent date result in a change in control of PAIF-II.

Item 13. Certain Relationships and Related Transactions

None.

49
<PAGE>

PART IV

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K

1. Financial Statements.

The following are included in Part II of this report:
Page No.
--------

Report of Independent Public Accountants 22
Balance Sheets 23
Statements of Operations 24
Statements of Changes in Partners' Capital
(Deficit) 25
Statements of Cash Flows 26
Notes to Financial Statements 27

2. Reports on Form 8-K.

No reports on Form 8-K were filed during the quarter ended December 31,
1997.

A current report on Form 8-K was filed on January 5, 1998 to report the
prepayment in full of the Promissory Note due from Triton Aviation
Services II LLC on December 30, 1997.

3. Exhibits required to be filed by Item 601 of Regulation S-K.

27. Financial Data Schedule (in electronic format only).

4. Financial Statement Schedules.

All financial statement schedules are omitted because they are not
applicable, not required or because the required information is
included in the financial statements or notes thereto.

<PAGE>

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

POLARIS AIRCRAFT INCOME FUND II,
A California Limited Partnership
(REGISTRANT)
By: Polaris Investment
Management Corporation
General Partner

March 27, 1998 By: /S/ Eric M. Dull
-------------- -------------------------
Date Eric M. Dull, President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/S/Eric M. Dull President and Director of Polaris March 27, 1998
--------------- Investment Management Corporation, --------------
(Eric M. Dull) General Partner of the Registrant

/S/Marc A. Meiches Chief Financial Officer of Polaris March 27, 1998
------------------ Investment Management Corporation, --------------
(Marc A. Meiches) General Partner of the Registrant

/S/Richard J. Adams Director of Polaris Investment March 27, 1998
------------------- Management Corporation, General --------------
(Richard J. Adams) Partner of the Registrant

<ARTICLE>5

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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 31587494
<SECURITIES> 0
<RECEIVABLES> 935629
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 115363309
<DEPRECIATION> 70346578
<TOTAL-ASSETS> 77546425
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0
0
<OTHER-SE> 60740696
<TOTAL-LIABILITY-AND-EQUITY> 77546425
<SALES> 0
<TOTAL-REVENUES> 17609635
<CGS> 0
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<OTHER-EXPENSES> 13140299
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 4469336
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