UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
----------------
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ___
----------------
Commission File No. 33-10122
----------------
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
State of Organization: California
IRS Employer Identification No. 94-3023671
201 High Ridge Road, Stamford, Connecticut 06927
Telephone - (203) 357-3776
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, and (2) has been subject to such filing requirements
for the past 90 days.
Yes X No
--- ---
This document consists of 17 pages.
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
FORM 10-Q - For the Quarterly Period Ended September 30, 2001
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
a) Balance Sheets - September 30, 2001 and
December 31, 2000...........................................3
b) Statements of Operations - Three and Nine Months
Ended September 30, 2001 and 2000...........................4
c) Statements of Changes in Partners' Capital
(Deficit) - Year Ended December 31, 2000
and Nine Months Ended September 30, 2001....................5
d) Statements of Cash Flows - Nine Months
Ended September 30, 2001 and 2000...........................6
e) Notes to Financial Statements...............................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..........11
Part II. Other Information
Item 1. Legal Proceedings......................................16
Item 6. Exhibits and Reports on Form 8-K.......................16
Signature .......................................................17
2
Part I. Financial Information
-----------------------------
Item 1. Financial Statements
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
BALANCE SHEETS
(Unaudited)
September 30, December 31,
2001 2000
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 3,020,129 $ 12,523,907
RENT AND OTHER RECEIVABLES 192,005 597,732
AIRCRAFT HELD FOR SALE 905,000 1,585,753
AIRCRAFT, net of accumulated depreciation
of $36,794,837 in 2001 and $34,508,556 in 2000 4,347,600 6,633,881
OTHER ASSETS -- 14,291
------------ ------------
Total Assets $ 8,464,734 $ 21,355,564
============ ============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 322,596 $ 220,339
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 153,461 130,936
DEFERRED INCOME 1,212,498 4,258,474
NOTES PAYABLE -- 204,871
------------ ------------
Total Liabilities 1,688,555 4,814,620
------------ ------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (3,876,190) (3,778,433)
Limited Partners, 499,960 units
issued and outstanding 10,652,369 20,319,377
------------ ------------
Total Partners' Capital 6,776,179 16,540,944
------------ ------------
Total Liabilities and Partners' Capital $ 8,464,734 $ 21,355,564
============ ============
The accompanying notes are an integral part of these statements.
3
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----
REVENUES:
Rent from operating leases $ 1,038,889 $ 2,247,342 $ 5,590,478 $ 6,742,026
Interest and other 73,391 199,325 391,600 556,746
----------- ----------- ----------- -----------
Total Revenues 1,112,280 2,446,667 5,982,078 7,298,772
----------- ----------- ----------- -----------
EXPENSES:
Depreciation 1,460,234 917,650 2,967,035 2,752,950
Management fees to general partner 14,525 86,787 6,081 260,360
Interest -- 44,203 4,960 202,623
Operating 83,154 3,722 136,316 11,166
Legal fees 73,433 436 166,364 2,808
Administration and other 89,270 71,973 278,173 252,055
----------- ----------- ----------- -----------
Total Expenses 1,720,616 1,124,771 3,558,929 3,481,962
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (608,336) $ 1,321,896 $ 2,423,149 $ 3,816,810
=========== =========== =========== ===========
NET INCOME ALLOCATED
TO THE GENERAL PARTNER $ 815,769 $ 145,695 $ 1,121,034 $ 435,597
=========== =========== =========== ===========
NET INCOME (LOSS) ALLOCATED
TO LIMITED PARTNERS $(1,424,105) 1,176,201 $ 1,302,115 $ 3,381,213
=========== =========== =========== ===========
NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ (2.85) $ 2.35 $ 2.60 $ 6.76
=========== =========== =========== ===========
The accompanying notes are an integral part of these statements.
4
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
(Unaudited)
Year Ended December 31, 2000 and
Nine Months Ended September 30, 2001
------------------------------------
General Limited
Partner Partners Total
------- -------- -----
Balance, December 31, 1999 $ (3,657,030) $ 32,332,929 $ 28,675,899
Net income 467,439 (6,713,976) (6,246,537)
Cash distributions to partners (588,842) (5,299,576) (5,888,418)
------------ ------------ ------------
Balance, December 31, 2000 (3,778,433) 20,319,377 16,540,944
Net income 1,121,034 1,302,115 2,423,149
Cash distribution to partners (1,218,791) (10,969,123) (12,187,914)
------------ ------------ ------------
Balance, September 30, 2001 $ (3,876,190) $ 10,652,369 $ 6,776,179
============ ============ ============
The accompanying notes are an integral part of these statements.
5
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,
-------------------------------
2001 2000
---- ----
OPERATING ACTIVITIES:
Net income $ 2,423,149 $ 3,816,810
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation 2,967,035 2,752,950
Changes in operating assets and
liabilities:
Decrease in other assets 14,291 11,640
Decrease (increase) in rent and other
receivables 405,726 (14,290)
Increase in payable to affiliates 102,257 37,260
Increase (decrease) in accounts payable
and accrued liabilities 22,525 (40,774)
Increase (decrease) in deferred income (3,045,976) 907,974
------------ ------------
Net cash provided by operating
activities 2,889,007 7,471,570
------------ ------------
FINANCING ACTIVITIES:
Principal payments on notes payable (204,871) (2,944,268)
Cash distributions to partners (12,187,914) (4,416,314)
------------ ------------
Net cash used in financing
activities (12,392,785) (7,360,582)
------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS (9,503,778) 110,988
CASH AND CASH EQUIVALENTS AT
BEGINNING OF PERIOD 12,523,907 12,317,505
------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF PERIOD $ 3,020,129 $ 12,428,493
============ ============
SUPPLEMENTAL INFORMATION:
Interest paid $ 4,960 $ 205,732
============ ============
The accompanying notes are an integral part of these statements.
6
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Accounting Principles and Policies
In the opinion of management, the financial statements presented herein include
all adjustments, consisting only of normal recurring items, necessary to
summarize fairly Polaris Aircraft Income Fund III's (the Partnership's)
financial position and results of operations. The financial statements have been
prepared in accordance with the instructions of the Quarterly Report to the
Securities and Exchange Commission (SEC) Form 10-Q and do not include all of the
information and note disclosures required by generally accepted accounting
principles (GAAP). These statements should be read in conjunction with the
financial statements and notes thereto for the years ended December 31, 2000,
1999, and 1998 included in the Partnership's 2000 Annual Report to the SEC on
Form 10-K.
2. TWA Bankruptcy and Transaction with American Airlines
As described in greater detail in Item 5 of the Current Report on Form 8-K dated
February 28, 2001 and first filed by the Partnership on or about March 24, 2001
(as amended, the "8-K"), TWA filed a voluntary petition in the United States
Bankruptcy Court of the District of Delaware (the "Bankruptcy Court") for
reorganization relief under Chapter 11 of the Bankruptcy Code on January 10,
2001. One day prior to filing its bankruptcy petition, TWA entered into an Asset
Purchase Agreement with American that provided for the sale to American of
substantially all of TWA's assets and permitted American to exclude certain TWA
contracts (including aircraft leases) from the assets of TWA to be acquired by
American. On February 28, 2001, American presented the General Partner of the
Partnership ("General Partner") with a written proposal to assume, on modified
terms and conditions, the Prior Leases applicable to seven of the ten Aircraft.
For reasons discussed more fully in the 8-K, the General Partner decided to
accept American's proposal, although consummation of the transactions with
American remained subject to a number of contingencies, including the approval
of the Bankruptcy Court and other regulatory approvals at the time of the
preparation and filing of the 8-K.
On April 9, 2001, the American acquisition of the selected TWA assets was
consummated. As a result of this closing, American assumed the Prior Leases
applicable to seven of the ten Aircraft, and simultaneously, such Prior Leases
were amended to incorporate the modified terms described in the 8-K (as so
assumed and amended, the "Assumed Leases"). As indicated in the 8-K, the Assumed
Leases are substantially less favorable to the Partnership than the Prior
Leases. In particular, the monthly rental rate for each Aircraft has been
reduced from $85,000 to $40,000, and the reduced rate was made effective as of
March 12, 2001 by a rent credit granted to American for the amount of rent above
$40,000 previously paid by TWA in respect of the period from and after March 12,
2001. In addition, the term of each Assumed Lease is scheduled to expire at the
time of the next scheduled heavy maintenance check of the applicable Aircraft,
compared to the scheduled expiry dates of November 27, 2004 and February 7, 2005
under the Prior Leases, provided that the aggregate average number of months for
which all seven Aircraft are on lease to American would not be less than 19
months from and after March 12, 2001. Finally, the maintenance condition of the
aircraft to be met at lease expiry was eased in favor of American, as compared
to the corresponding conditions required under the Prior Leases.
7
With respect to the three Aircraft that American did not elect to acquire, TWA
officially rejected the Prior Leases applicable to these Aircraft (collectively,
the "Rejected Leases") as of April 20, 2001. As aircraft are returned to the
Partnership they are parked in storage in Arizona while the General Partner
remarkets them for sale. In addition, the General Partner is in the process of
filing administrative claims in the TWA bankruptcy proceeding in an effort to
recover (i) the fair value of TWA's actual use, if any, of these three Aircraft
during the 60-day period following TWA's filing of its bankruptcy petition, and
(ii) claims relating to these Aircraft for the period from March 12, 2001 (the
expiration of the 60-day automatic stay period after the filing of bankruptcy
petition) to April 20, 2001, the date on which these Prior Leases were rejected
by TWA. Furthermore, it is anticipated that the General Partner will also file
general unsecured claims for damages arising from TWA's breach of the Rejected
Leases. However, there can be no assurances as to whether, or when, the General
Partner will be successful in asserting the value of the claims or be able to
collect any amounts out of the TWA bankruptcy estate, either in respect of
administrative claims or other claims.
Effect of the TWA Bankruptcy
As previously disclosed in the 8-K, the TWA bankruptcy is expected to have a
material adverse effect on the Partnership's results of operations and financial
position. As a result of the TWA bankruptcy and the transactions with American
described above, aggregate rentals to be received by the Partnership in 2001
have been reduced from approximately $10.2 million, had all ten aircraft
remained on lease at the former lease rate, to approximately $3.5 million, and
the average lease term for the seven Aircraft that remain on lease has been
reduced from 47 to 21 months remaining at December 31, 2000. Three of the
Partnership's Aircraft, would have been expected to generate aggregate rentals
in 2001 under the terms of the Prior Leases of approximately $3.0 million
(included in the $10.2 million above). As of September 30, 2001, a total of five
aircraft were being marketed for sale at scrap value (which the General Partner
believes will be materially less than the aggregate rental amount).
The amount and timing of the Partnership's distributions of cash available for
distribution depends upon many factors, including whether the General Partner is
able to collect any amounts in respect to the administrative and other claims
filed with the Bankruptcy Court. The amount of cash available for distribution
for the quarter ended March 31, 2001 was not materially different from the
corresponding quarter in 2000, however, after the distribution of July 16, 2001,
as discussed under Cash Distributions, below, the General Partner expects the
amount of cash available for distribution for the subsequent quarters in 2001 to
be materially less.
The Accounting Treatment of the TWA Transaction
As a result of the TWA bankruptcy and the modified lease terms reflected in the
Assumed Leases, the Partnership was required to review the carrying value of the
Aircraft pursuant to applicable accounting standards including Statement of
Financial Accounting Standards ("SFAS") 121. Any downward adjustment in the
estimated residual value or decrease in the projected remaining economic life of
any of the Aircraft dictates an increase in depreciation expense over the
projected economic life of such Aircraft. Further, if the projected net cash
flow for any of the 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 such Aircraft, an impairment loss must be
recorded. After a review of the carrying value of the Aircraft pursuant to
applicable accounting standards including SFAS 121, the Partnership recognized
an impairment loss as increased depreciation expense in the fourth quarter of
2000 of approximately $11 million, or $22.26 per limited partnership unit.
8
In accordance with GAAP, the Partnership recognized rental income and management
fees on a straight line basis over the original TWA lease terms. As a result,
deferred revenue and accrued management fees were recorded each month since the
inception of each Prior Lease, resulting in balances of deferred rental income
and accrued management fees of $3,899,131 and $180,107, respectively as of March
12, 2001. Since the Prior Leases were effectively modified on March 12, 2001,
the Partnership must recognize the balances of deferred revenue and accrued
management fees over the new lease terms, from the date the leases were
modified. For the three Rejected Leases, the deferred revenue and accrued
management fees amounting to $1,275,431 and $59,691 were recognized as income in
March 2001. For the seven Assumed Leases, the deferred revenue and accrued
management fees associated with each Aircraft will be recognized over the new
lease terms, ranging from 2 months to 33 months as of March 31, 2001. During the
quarter ended September 30, 2001, deferred revenue of $390,888 and accrued
management fees of $17,874 were recognized as income. The remaining lease terms
as of September 30, 2001 range from 1 month to 27 months.
3. Related Parties
Under the Limited Partnership Agreement, the Partnership paid or agreed to pay
the following amounts for the current quarter to the general partner, Polaris
Investment Management Corporation, in connection with services rendered or
payments made on behalf of the Partnership:
Payments for
Three Months Ended Payable at
September 30, 2001 September 30, 2001
------------------ ------------------
Aircraft Management Fees $ - $205,050
Out-of-Pocket Administrative Expense
Reimbursement 334,890 117,546
-------- --------
$334,890 $322,596
======== ========
4. 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.
Such allocations are made using income or loss calculated under GAAP for book
purposes, which 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.
9
5. Impairment Loss
The Partnership recognized impairment losses on aircraft held for sale
aggregating approximately $280,000, and impairment losses on aircraft on-lease
of approximately $571,000 as increased depreciation expense in the quarter ended
September 30, 2001. As discussed in Note 7, on October 19, 2001 the Partnership
sold three of its aircraft held for sale on an "as-is, where-is" basis for an
aggregate $535,000. The negotiations for this sale were in advanced stages as of
September 30, 2001 and, as a result, the Partnership reviewed carrying values of
aircraft held for sale as of September 30, 2001. In determining the impairment
loss the Partnership estimated the fair value of the aircraft based on the sales
price less estimated cost to sell. The Partnership recorded an impairment loss
to the extent the carrying value exceeded the estimated fair value as of
September 30, 2001. Management believes the assumptions related to fair value of
impaired assets represents best estimates based on reasonable and supportable
projections.
In addition, the Partnership made downward adjustments to the estimated residual
value of certain of its aircraft on-lease as of September 30, 2001. This
decrease reflected the weakening used aircraft market and reflected the
additional facts and circumstances resulting from the advanced negotiations with
Aeroturbine, which resulted in a sale of three held for sale aircraft on October
19, 2001. As a result, the Partnership decreased the residual values as of
September 30, 2001 to reflect the depressed market. This decrease in residual
values will be reflected in greater depreciation expense over the remaining life
of the aircraft, which range from 1 month to 27 months as of September 30, 2001.
The events of September 11, 2001 and the resulting impact on the used aircraft
market constituted an event requiring the Partnership to review the carrying
values of its aircraft for impairment by comparing the carrying values of the
aircraft to the future undiscounted cash flows expected from the aircraft. As a
result of the decrease in estimated residual values, one of the Partnership's
aircraft was impaired and written down to its estimated fair value.
6. New Accounting Pronouncements
On January 1, 2001, the Partnership adopted SFAS 133 "Accounting for Derivative
Instruments and Hedging Activities", as amended by SFAS 138, which establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The Partnership does not own any derivative instruments, and as
such, the implementation of this statement did not have a material impact on the
Partnership's financial position or results of operations.
7. Subsequent Event
On October 19, 2001 Aeroturbine Inc. purchased three of the Partnership's
aircraft that were held for sale on an "as-is, where-is" basis for $535,000. All
proceeds of the sale were received by October 19, 2001.
10
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
At September 30, 2001, Polaris Aircraft Income Fund III, a California limited
partnership (the "Partnership") owned ten McDonnell Douglas DC-9-30 aircraft
(the "Aircraft"). Prior to the closing of the transactions described below, all
of the Aircraft were on lease to Trans World Airlines, Inc. ("TWA")
(collectively, the "Prior Leases"). As a result of the transactions described
below, at September 30, 2001, five of the Aircraft were on lease to Trans World
Airlines, LLC (TWA), and the five remaining Aircraft were no longer on lease to
any operator and were being actively remarketed for sale. On October 19, 2001
three of the Partnership's aircraft were sold to Aeroturbine Inc. as discussed
below.
TWA Bankruptcy and Transaction with American Airlines
As described in greater detail in Item 5 of the Current Report on Form 8-K dated
February 28, 2001 and first filed by the Partnership on or about March 24, 2001
(as amended, the "8-K"), TWA filed a voluntary petition in the United States
Bankruptcy Court of the District of Delaware (the "Bankruptcy Court") for
reorganization relief under Chapter 11 of the Bankruptcy Code on January 10,
2001. One day prior to filing its bankruptcy petition, TWA entered into an Asset
Purchase Agreement with American that provided for the sale to American of
substantially all of TWA's assets and permitted American to exclude certain TWA
contracts (including aircraft leases) from the assets of TWA to be acquired by
American. On February 28, 2001, American presented the General Partner of the
Partnership ("General Partner") with a written proposal to assume, on modified
terms and conditions, the Prior Leases applicable to seven of the ten Aircraft.
For reasons discussed more fully in the 8-K, the General Partner decided to
accept American's proposal, although consummation of the transactions with
American remained subject to a number of contingencies, including the approval
of the Bankruptcy Court and other regulatory approvals at the time of the
preparation and filing of the 8-K.
On April 9, 2001, the American acquisition of the selected TWA assets was
consummated. As a result of this closing, American assumed the Prior Leases
applicable to seven of the ten Aircraft, and simultaneously, such Prior Leases
were amended to incorporate the modified terms described in the 8-K (as so
assumed and amended, the "Assumed Leases"). As indicated in the 8-K, the Assumed
Leases are substantially less favorable to the Partnership than the Prior
Leases. In particular, the monthly rental rate for each Aircraft has been
reduced from $85,000 to $40,000, and the reduced rate was made effective as of
March 12, 2001 by a rent credit granted to American for the amount of rent above
$40,000 previously paid by TWA in respect of the period from and after March 12,
2001. In addition, the term of each Assumed Lease is scheduled to expire at the
time of the next scheduled heavy maintenance check of the applicable Aircraft,
compared to the scheduled expiry dates of November 27, 2004 and February 7, 2005
under the Prior Leases, provided that the aggregate average number of months for
which all seven Aircraft are on lease to American would not be less than 19
months from and after March 12, 2001. Finally, the maintenance condition of the
aircraft to be met at lease expiry was eased in favor of American, as compared
to the corresponding conditions required under the Prior Leases.
With respect to the three Aircraft that American did not elect to acquire, TWA
officially rejected the Prior Leases applicable to these Aircraft (collectively,
the "Rejected Leases") as of April 20, 2001. As aircraft are returned to the
Partnership they are parked in storage in Arizona while the General Partner
remarkets them for sale. In addition, the General Partner is in the process of
filing administrative claims in the TWA bankruptcy proceeding in an effort to
recover (i) the fair value of TWA's actual use, if any, of these three Aircraft
during the 60-day period following TWA's filing of its bankruptcy petition, and
11
(ii) claims relating to these Aircraft for the period from March 12, 2001 (the
expiration of the 60-day automatic stay period after the filing of bankruptcy
petition) to April 20, 2001, the date on which these Prior Leases were rejected
by TWA. Furthermore, it is anticipated that the General Partner will also file
general unsecured claims for damages arising from TWA's breach of the Rejected
Leases. However, there can be no assurances as to whether, or when, the General
Partner will be successful in asserting the value of the claims or be able to
collect any amounts out of the TWA bankruptcy estate, either in respect of
administrative claims or other claims.
Effect of the TWA Bankruptcy
As previously disclosed in the 8-K, the TWA bankruptcy is expected to have a
material adverse effect on the Partnership's results of operations and financial
position. As a result of the TWA bankruptcy and the transactions with American
described above, aggregate rentals to be received by the Partnership in 2001
have been reduced from approximately $10.2 million, had all ten aircraft
remained on lease at the former lease rate, to approximately $3.5 million, and
the average lease term for the seven Aircraft that remain on lease has been
reduced from 47 to 21 months remaining at December 31, 2000. Three of the
Partnership's Aircraft, would have been expected to generate aggregate rentals
in 2001 under the terms of the Prior Leases of approximately $3.0 million
(included in the $10.2 million above). As of September 30, 2001, a total of five
aircraft were being marketed for sale at scrap value (which the General Partner
believes will be materially less than the aggregate rental amount).
The amount and timing of the Partnership's distributions of cash available for
distribution depends upon many factors, including whether the General Partner is
able to collect any amounts in respect to the administrative and other claims
filed with the Bankruptcy Court. The amount of cash available for distribution
for the quarter ended March 31, 2001 was not materially different from the
corresponding quarter in 2000, however, after the distribution of July 16, 2001,
as discussed under Cash Distributions, below, the General Partner expects the
amount of cash available for distribution for the subsequent quarters in 2001 to
be materially less.
The Accounting Treatment of the TWA Transaction
As a result of the TWA bankruptcy and the modified lease terms reflected in the
Assumed Leases, the Partnership was required to review the carrying value of the
Aircraft pursuant to applicable accounting standards including SFAS 121. Any
downward adjustment in the estimated residual value or decrease in the projected
remaining economic life of any of the Aircraft dictates an increase in
depreciation expense over the projected economic life of such Aircraft. Further,
if the projected net cash flow for any of the 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 such Aircraft,
an impairment loss must be recorded. After a review of the carrying value of the
Aircraft pursuant to applicable accounting standards including SFAS 121, the
Partnership recognized an impairment loss as increased depreciation expense in
the fourth quarter of 2000 of approximately $11 million, or $22.26 per limited
partnership unit.
In accordance with GAAP, the Partnership recognized rental income and management
fees on a straight line basis over the original lease terms of the Prior Leases.
As a result, deferred revenue and accrued management fees were recorded each
month since the inception of each Prior Lease, resulting in balances of deferred
rental income and accrued management fees of $3,899,131 and $180,107,
respectively as of March 12, 2001. Since the Prior Leases were effectively
modified on March 12, 2001, the Partnership must recognize the balances of
deferred revenue and accrued management fees over the new lease terms, from the
date the leases were modified. For the three Rejected Leases, the deferred
12
revenue and accrued management fees amounting to $1,275,431 and $59,691 were
recognized as income in March 2001. For the seven Assumed Leases, the deferred
revenue and accrued management fees associated with each Aircraft will be
recognized over the new lease terms, ranging from 2 months to 33 months as of
March 31, 2001. During the quarter ended September 30, 2001, deferred revenue of
$390,888 and accrued management fees of $17,874 were recognized as income. The
remaining lease terms as of September 30, 2001 range from 1 month to 27 months.
Terrorist Attacks
On September 11, 2001, terrorists high-jacked and crashed four commercial jet
aircraft in the United States, with attendant significant loss of life, property
damage and economic disruption. As a result, air travel in the United States was
suspended for several days, restrictions have been placed on United States air
travel, airline costs such as aircraft insurance and aircraft security have
increased and passenger demand for air travel has significantly declined. These
events may also affect the ability of airlines to obtain insurance.
Consequently, lessees are likely to incur higher costs and lower revenues, which
would adversely impact their financial position. Most U.S. carriers have already
announced their intention of furloughing a significant percentage of their
workforce. Any additional terrorist attacks or any military or economic
responses by the United States may further increase airline costs and cause
further declines in air travel demand.
The on-going effects of the terrorist attacks of September 11, 2001 on the
airline industry cannot be completely assessed at this time. The U.S. and
European governments are considering providing grants, loan guarantees and other
forms of financial assistance to help stabilize the industry. These economic
conditions, particularly if they continue, may affect the lessee's ability to
make rent payments, and may reduce the value of the aircraft.
Impairment Loss
The Partnership recognized impairment losses on aircraft held for sale
aggregating approximately $280,000, and impairment losses on aircraft on-lease
of approximately $571,000 as increased depreciation expense in the quarter ended
September 30, 2001. As discussed in Notes 5 and 7, on October 19, 2001 the
Partnership sold three of its aircraft held for sale on an "as-is, where-is"
basis for an aggregate $535,000. The negotiations for this sale were in advanced
stages as of September 30, 2001 and, as a result, the Partnership reviewed
carrying values of aircraft held for sale as of September 30, 2001. In
determining the impairment loss the Partnership estimated the fair value of the
aircraft based on the sales price less estimated cost to sell. The Partnership
recorded an impairment loss to the extent the carrying value exceeded the
estimated fair value as of September 30, 2001. Management believes the
assumptions related to fair value of impaired assets represents best estimates
based on reasonable and supportable projections.
In addition, the Partnership made downward adjustments to the estimated residual
value of certain of its aircraft on-lease as of September 30, 2001. This
decrease reflected the weakening used aircraft market and reflected the
additional facts and circumstances resulting from the advanced negotiations with
Aeroturbine, which resulted in a sale of three held for sale aircraft on October
19, 2001. As a result, the Partnership decreased the residual values as of
September 30, 2001 to reflect the depressed market. This decrease in residual
values will be reflected in greater depreciation expense over the remaining life
of the aircraft, which range from 1 month to 27 months as of September 30, 2001.
The events of September 11, 2001 and the resulting impact on the used aircraft
market constituted an event requiring the Partnership to review the carrying
values of its aircraft for impairment by comparing the carrying values of the
13
aircraft to the future undiscounted cash flows expected from the aircraft. As a
result of the decrease in estimated residual values, one of the Partnership's
aircraft was impaired and written down to its estimated fair value.
Sale of Aircraft
On October 19, 2001 Aeroturbine Inc. purchased three of the Partnership's
aircraft that were held for sale on an "as-is, where-is" basis for $535,000. All
proceeds of the sale were received by October 19, 2001.
Partnership Operations
The Partnership recorded net loss of $608,336, or $2.85 per limited partnership
unit, for the three months ended September 30, 2001, as compared to net income
of $1,321,896, or $2.35 per limited partnership unit, for the three months ended
September 30, 2000. The Partnership recorded net income of $2,423,149 or $2.60
per limited partnership unit, for the nine months ended September 30, 2001
compared to net income of $3,816,810 or $6.76 per limited partnership unit, for
the nine months ended September 30, 2000.
The decrease in net income for the three and nine months ended September 30,
2001 is primarily due to decreased rental and interest revenue as well as
increased operating, legal and administration fees, along with increased
depreciation expense, partially offset by lower management fees and interest
expenses.
Rent from operating leases decreased to $1,038,889 and $5,590,478 in the three
and nine months ended September 30, 2001 as compared to $2,247,342 and
$6,742,026 for the corresponding periods in 2000. This was primarily due to the
TWA bankruptcy and acquisition of TWA by American Airlines. Three of the
Partnership's 10 leases were rejected by American, and the monthly rental rate
for the remaining 7 Accepted Aircraft was reduced from $85,000 each to $40,000
each. Two additional aircraft leases have expired subsequent to March 31, 2001,
further reducing rental revenue. The decreased rental rates were offset by the
recognition of deferred revenue of $390,888 and $3,045,977 in the three and nine
months ended September 30, 2001. As discussed in Note 2, the deferred revenue
existing at the time of the lease revisions in March 2001 is being recognized
over the new lease terms or was recognized upon lease rejection for the three
Rejected Aircraft.
Interest income decreased during the three and nine months ended September 30,
2001, as compared to the same periods in 2000, primarily due to lower average
cash reserves and a lower rate of return on those cash reserves.
Depreciation expense increased during the three and nine months ended September
30, 2001, as compared to the same periods in 2000, primarily due to downward
adjustment of the book value of the aircraft at September 30, 2001 as discussed
above. This was partly offset by a decrease of depreciation expense due to the
downward adjustment to the book value of the aircraft in the fourth quarter of
2000, and several aircraft not being depreciated for a portion of 2001 as a
result of being classified as held for sale. At September 30, 2001, five of the
Partnership's aircraft were classified as held for sale and were carried at the
lower of cost or fair value less cost to sell. These aircraft were written down
to their estimated sales prices based on negotiated values as of September 30,
2001. This resulted in additional depreciation being recognized of $850,815 in
the three months ended September 30, 2001.
Management fees decreased during the three and nine months ended September 30,
2001 as compared to the same periods in 2000, primarily due to the lower monthly
rentals earned on the five aircraft that remain on lease with TWA as well as by
14
the amortization of accrued management fees of $17,874 and $124,573 during the
three and nine months ended September 30, 2001, respectively, which are being
amortized similar to deferred revenue, as discussed above.
Interest expense decreased during the three and nine months ended September 30,
2001, as compared to the same periods in 2000, due to the final payoff of the
notes payable for the TWA hushkits in April 2001.
Operating expense increased during the three and nine months ended September 30,
2001, as compared to the same periods in 2000, primarily due to maintenance and
storage related costs associated with the return of the aircraft held for sale.
Legal expenses increased during the three and nine months ended September 30,
2001, as compared to the same periods in 2000, primarily due to legal costs
incurred in connection with the TWA Bankruptcy.
Administration and other expenses increased during the three and nine months
ended September 30, 2001, as compared to the same periods in 2000, primarily due
to printing and postage costs incurred in connection with the TWA Bankruptcy.
Liquidity and Cash Distributions
Liquidity - The Partnership received lease payments from its sole lessee, TWA
LLC, for the Assumed Leases, as discussed above, during the nine months ended
September 30, 2001.
Polaris Investment Management Corporation, the general partner, has determined
that cash reserves be maintained 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 during the three
months ended September 30, 2001 and 2000 were $8,219,343, or $16.44 per limited
partnership unit, and $1,324,894, or $2.65 per limited partnership unit,
respectively. Cash distributions to limited partners during the nine months
ended September 30, 2001 and 2000 were $10,969,123, or $21.94 per limited
partnership unit, and $3,974,682, or $7.95 per limited partnership unit,
respectively. The Partnership's distributions of cash made during 2001, were
supplemented by a reduction of Partnership reserves and were, therefore, larger
than the amount the Partnership would have distributed based solely on cash
generated from operations. As reported previously the Partnership's cash
generated from operations has decreased due to the lower rental revenues from
TWA LLC and the off lease aircraft. Due to this decrease, the General Partner
expects to distribute any cash that the Partnership has available for
distribution on an annual basis, rather than a quarterly basis, beginning in
2002. The General Partner anticipates paying the fourth quarter 2001
distribution of cash available for distribution in January 2002, and paying the
next distribution of cash available for distribution in January 2003. If the
Partnership completes a substantial sale of Aircraft prior to the date for an
expected annual distribution, and as a result the Partnership generates a
substantial amount of cash available for distribution, the General Partner would
expect to distribute available net sales proceeds following the sale rather than
holding such amounts until the date for the annual distribution of cash
available for distribution. Notwithstanding the foregoing expectations, 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
15
Partnership), the need to retain cash reserves as previously discussed in the
Liquidity section and the receipt of rental payments from TWA LLC.
Part II. Other Information
--------------------------
Item 1. Legal Proceedings
As discussed in Item 3 of Part I of Polaris Aircraft Income Fund III's (the
Partnership) 2000 Annual Report to the Securities and Exchange Commission (SEC)
on Form 10-K (Form 10-K) and in Item 1 of Part II of the Partnership's Quarterly
Report to the SEC on Form 10-Q (Form 10-Q) for the period ended June 30, 2001,
there are several pending legal actions or proceedings involving the
Partnership. There have been no material developments with respect to any such
actions or proceedings during the period covered by this report.
Other Proceedings - Item 10 in Part III of the Partnership's 2000 Form 10-K and
Item 1 of Part II of the Partnership's Form 10-Q for the period ended June 30,
2001 discuss certain actions which have been filed against Polaris Investment
Management Corporation and others in connection with the sale of interests in
the Partnership and the management of the Partnership. The Partnership is not a
party to these actions. There have been no material developments with respect to
any of the actions described therein during the period covered by this report.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
None.
b) Reports on Form 8-K
No reports on Form 8-K were filed by the Registrant during the quarter
for which this report is filed.
16
SIGNATURE
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 III,
A California Limited Partnership
(Registrant)
By: Polaris Investment
Management Corporation,
General Partner
November 7, 2001 By: /S/Keith Helming
---------------------- -----------------------
Keith Helming
Chief Financial Officer
17