UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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
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(Exact name of registrant as specified in its charter)
California 94-3023671
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(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
201 High Ridge Road, Stamford, Connecticut 06927
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(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:
Depository Units Representing Assignments of Limited Partnership Interests
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
--- ---
No formal market exists for the units of limited partnership interest and
therefore there exists no aggregate market value at December 31, 2002.
Documents incorporated by reference: None
This document consists of 42 pages.
PART I
Item 1. Business
Polaris Aircraft Income Fund III, A California Limited Partnership (PAIF-III 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-III was
organized as a California Limited Partnership on June 27, 1984 and will
terminate no later than December 2020.
PAIF-III 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, Polaris Investment Management
Corporation (PIMC or the General Partner), and its affiliates, including GE
Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation
(PALC), Polaris Holding Company (PHC) and General Electric Capital Corporation
(GE Capital), acquire, lease, finance, sell and remarket aircraft for their own
accounts and for existing aircraft and aircraft leasing programs managed by
them. Further, GECAS provides a significant range of aircraft management
services to third parties, including without limitation, Airplanes Group,
together with its subsidiaries (APG), which 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, APG, and other third
parties to whom GECAS provides aircraft management services from time to time.
As of December 31, 2001, the Partnership had 3 McDonnell Douglas DC-9-30
aircraft (DC-9-30) on operating lease to TWA Airlines LLC (TWA LLC) a wholly
owned subsidiary of American Airlines, Inc. (American) (the Current Leases). On
January 10, 2001, TWA filed a voluntary petition in the United States Bankruptcy
Court of the District of Delaware for reorganization relief under Chapter 11 of
the Federal Bankruptcy Code (the Bankruptcy Code). One day prior to filing its
bankruptcy petition, TWA entered into an Asset Purchase Agreement (the Purchase
Agreement) with American Airlines, Inc. (American) that provided for the sale to
American of substantially all of TWA's assets. On February 28, 2001, American
presented the General Partner with a draft letter of intent reflecting a
proposal to take assignment of seven of the ten then existing leases
(collectively the Previous Leases) on modified terms and conditions as part of
the TWA leased assets that American wished to acquire (collectively the Assumed
Leases). The General Partner evaluated American's proposal and determined that
accepting such a proposal was in the best interests of the Partnership. The
lease term, rental and maintenance terms of the Assumed Leases were changed
materially under American's proposal from the terms of the Previous 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 TWA LLC 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 date of November 27, 2004 under the Previous
Leases, provided that the aggregate average number of months for which all seven
Aircraft are on lease to TWA LLC would not be less than 22 months from and after
March 12, 2001. The maintenance condition of the aircraft to be met at lease
expiry was eased in favor of TWA LLC, as compared to the corresponding
conditions required under the Previous Leases.
2
See additional discussion of TWA LLC and of Trans World Airlines, Inc. (TWA) in
"Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations".
Item 2. Properties
At December 31, 2002, the Partnership owned three DC-9-30 aircraft on operating
lease to TWA LLC, and one DC-9-30 aircraft held for sale, on the ground in New
Mexico out of its original portfolio of 38 aircraft. The Partnership sold three
DC-9-30 aircraft to Aeroturbine, Inc. in October 2001. The Partnership sold two
DC-9-30 aircraft to Amtec Corporation, one in December 2001 and the second in
February 2002. The Partnership sold one DC-9-30 aircraft to American in May
2002.
The following table describes the Partnership's aircraft portfolio at December
31, 2002:
Year of Cycles
Aircraft Type Serial Number Manufacture As of 12/31/02
- ------------- ------------- ----------- --------------
McDonnell Douglas DC-9-30 47028 1967 90,508
McDonnell Douglas DC-9-30 47095 1967 85,183
McDonnell Douglas DC-9-30 47173 1968 89,031
McDonnell Douglas DC-9-30 47491 1970 82,599
The McDonnell Douglas DC-9-30 (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 noise
restrictions. Hushkits have been installed on the remaining Partnership
aircraft. Certain ADs applicable to the DC-9-30 have been issued to prevent
fatigue cracks and control corrosion.
Item 3. Legal Proceedings
Midway Airlines, Inc. (Midway) Bankruptcy - As previously reported in the
Partnership's 2001 Form 10-K, in March 1991, Midway commenced reorganization
proceedings under Chapter 11 of the Federal Bankruptcy Code in the United States
Bankruptcy Court for the Northern District of Illinois, Eastern Division. On
August 9, 1991, the Bankruptcy Court approved Midway's rejection of the leases
of the Partnership's four DC-9-10 aircraft, and the aircraft were returned to
the Partnership on August 12, 1991. On September 18, 1991, the Partnership filed
a proof of claim in Midway's bankruptcy proceeding to recover damages for lost
rent and for Midway's failure to meet return conditions with respect to the four
aircraft. In light of Midway's cessation of operations, on April 30, 1992, the
Partnership amended and restated its prior proof of claim and filed an
additional proof. To date no payment or settlement of the Partnership's
bankruptcy claims has been offered.
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 PIMC,
Polaris Securities Corporation, PHC, PALC, the Partnership, Polaris Aircraft
Income Fund I, Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV,
Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, GE Capital,
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,
3
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 sought, among other things, an
award of compensatory damages in an unspecified amount plus interest, and double
and treble damages under the Texas Deceptive Trade Practices Act. The trial date
for this action was set and rescheduled by the trial court several times, and on
September 2, 1999, the court granted a stay of this action pending the
submission of the remaining plaintiffs' claims to arbitration. Subsequently,
several of the plaintiffs filed a motion with the Court to dismiss their claims,
which the court granted.
On June 5, 2001, the remaining plaintiffs who did not ask the court to dismiss
their claims, Gerald and Judy Beckman, made a motion to retain the case on the
docket of the District Court of Harris County, Texas with respect to their
purported claims against all defendants except Prudential Insurance Company of
America and James J. Darr. On June 27, 2001, the Court entered a docket control
order providing for a schedule for discovery and a trial date of December 3,
2001. On October 17, 2001, the remaining plaintiffs entered into a settlement
agreement with PIMC, Polaris Securities Corporation, PHC, PALC, the Partnership,
Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund II, Polaris
Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income
Fund VI, and GE Capital. The Partnership did not contribute to the settlement
payments and has no further liability in respect of such matter. On December 11,
2002 the court entered an order non-suiting this action as to the remaining
plaintiffs and accordingly the case has been finally disposed.
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.
4
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
a) PAIF-III's Limited Partnership interests (Units) are not publicly
traded. Currently there is no market for PAIF-III'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, 2002
----------------------------------------- --------------------------
Depository Units Representing Assignments
Of Limited Partnership Interests: 14,933
General Partnership Interest: 1
c) Dividends:
The Partnership distributed cash to partners on a quarterly basis
beginning April 1987. As of January 2002 the Partnership switched to
making distributions on an annual basis. Cash distributions to Unit
Holders during 2002 and 2001 totaled $1,249,900 and $11,469,083
respectively. Cash distributions per Limited Partnership unit were
$2.50 and $22.94 in 2002 and 2001, respectively. On January 15, 2003,
the Partnership distributed $2,499,120 to the Limited Partners, or
$5.00 per Limited Partnership Unit.
5
Item 6. Selected Financial Data
For the years ended December 31,
--------------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Revenues $ 2,887,590 $ 6,891,556 $ 9,742,030 $ 9,590,876 $10,055,914
Net Income (Loss) $ 713,149 $ 2,514,059 $(6,246,537) $ 5,605,780 $ 5,287,954
Net Income (Loss)
allocated to Limited
Partners $ 477,982 $ 1,342,125 $(6,713,976) $ 4,912,337 $ 3,948,438
Net Income (Loss) per
Limited Partnership Unit $ 0.96 $ 2.68 $ (13.43) $ 9.83 $ 7.90
Cash Distributions per
Limited Partnership
Unit $ 2.50 $ 22.94 $ 10.60 $ 12.75 $ 38.30
Limited Partnership Units 499,824 499,960 499,960 499,960 499,960
Amount of Cash
Distributions Included
Above Representing
a Return of Capital on
a Generally Accepted
Accounting Principle
Basis per Limited
Partnership Unit* $ 0.00 $ 19.78** $ 10.60 $ 12.75 $ 38.30
Total Assets $ 6,165,241 $ 7,927,561 $21,355,564 $36,199,898 $40,019,792
Partners' Capital $ 5,635,949 $ 6,311,578 $16,540,944 $28,675,899 $30,152,885
* 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.
** During 2001 total cumulative distributions, per unit, reached $500, the
initial capital contribution per unit, such that all further distributions would
be considered a return on capital.
6
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Critical Accounting Policies
In response to the Securities and Exchange Commission's (SEC) Release No.
33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting
Policies," we identified the most critical accounting principles upon which our
financial reporting depends. We determined the critical principles by
considering accounting policies that involve the most complex or subjective
decisions or assessments. We identified our most critical accounting policies to
be those related to lease revenue recognition, depreciation policies, and
valuation of aircraft. We state these accounting policies in the notes to the
financial statements and in relevant sections in this discussion and analysis.
Business Overview
At December 31, 2002, Polaris Aircraft Income Fund III (PAIF-III or the
Partnership) owned a portfolio of 4 used McDonnell Douglas DC-9-30 commercial
jet aircraft (DC-9-30) out of its original portfolio of 38 aircraft. Three of
these aircraft were leased to TWA Airlines, LLC (TWA LLC) (collectively the
Current Leases). The one remaining DC-9-30 aircraft was being stored in New
Mexico. The Partnership sold three DC-9-30 aircraft to Aeroturbine, Inc. in
October 2001 that resulted in neither a gain nor loss to the Partnership. The
Partnership sold two DC-9-30 aircraft to Amtec Corporation, one in December 2001
that resulted in a gain of $115,000 to the Partnership and the second in
February 2002 that resulted in a gain of $65,000. In May 2002 the Partnership
sold one DC-9-30 aircraft to American that resulted in a gain of $115,000.
Industry Update
Demand for Aircraft - At year end 2002, there were approximately 17,500 western
built passenger and freighter jet aircraft in the world fleet. As a result of a
slowdown in travel that began in the spring of 2001 as well as the large shift
in travel levels in the wake of the September 11th tragedy, 2,100 of those
aircraft are currently stored or out of active service. Air travel as measured
by global revenue passenger miles for 2002 is expected to be 1-2% less than the
poor results from the year 2001 when the final numbers are compiled. 2003
traffic levels are expected to show growth from this low base, but many
uncertainties remain. The threat of war with Iraq and continued threat of global
terrorism continue to impact traffic levels as does the sluggish economy. While
production rates are coming down and retirements are increasing, the number of
surplus aircraft is still at record levels.
The unprecedented and worldwide decrease in demand has had profound implications
to airlines as well as aircraft owners and manufacturers. Airlines are still
experiencing huge losses, and are struggling to match capacity and pricing to
demand. Manufacturers have attempted to deliver the aircraft that were in the
backlog and the modest orders in 2002 and achieve some stability in their
production lines. Trading values and lease rates have declined further,
particularly on older aircraft as the demand shock took a cyclical downturn into
a deep trough. The bankruptcy of two of the largest carriers in the world,
subsequent aircraft availability and renegotiation of terms has just added to an
already bad situation. As manufacturers reduce production, airlines accelerate
retirements of older aircraft, and a recovering air travel market begins to
reduce the aircraft surplus, this cyclical downturn is expected to reverse
itself and the market is expected to return to a stable condition. This will
take more time as manufacturers cannot drop production overnight and owners will
be reluctant to scrap aircraft that they own despite the lack of a current
market for them.
7
Low cost carriers are the only ones able to prosper in this environment of
commoditized airfare pricing. The bulk of the orders that were actually placed
during 2002 came from those carriers like Easyjet. Asia is another bright spot
where the traffic levels have been least impacted by the terrorism in the US and
the economic downturn.
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 Airworthiness Directives (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.
The Partnership's Current Leases require TWA LLC to maintain the Partnership's
aircraft in accordance with an FAA-approved maintenance program during the lease
term. Under the Previous Leases, TWA was 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.
Three of the Partnership's Aircraft were returned by TWA without meeting the
return conditions specified in the Previous Leases, and the return conditions
under the modified lease terms and conditions for the Partnership's remaining
Aircraft were quite limited. The costs of compliance with FAA maintenance
standards caused the Partnership to sell for scrap value the three Aircraft
returned by TWA under the Rejected Leases and the three aircraft returned in
2001 were likewise marketed at scrap value. Similarly, such costs will likely
cause the Partnership to sell for scrap value, at the end of the lease term, the
Partnership's remaining Aircraft.
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.
Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3
requirements, are currently available for the Partnership's aircraft and were
added to the Partnership's aircraft in 1996.
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.
Legislation had been drafted and was under review by the EU for sometime to
adopt anti-hushkitting regulations within member states. The legislation sought
to ban hushkitted aircraft from being added to member states registers and
precluded all operation of hushkitted aircraft within the EU after certain
specific dates. Due to criticism by the US Government, the enactment of this
legislation has been deferred twice and it is now uncertain if it will ever be
8
enacted at this point. However, the effect of this proposal has been to reduce
the demand for hushkitted aircraft within the EU and its neighboring states,
including the former Eastern Block states.
Remarketing Update
The General Partner evaluates, from time to time, whether the investment
objectives of the Partnership are better served by continuing to hold the
Partnership's remaining portfolio of Aircraft or marketing such Aircraft for
sale. This evaluation takes into account the current and potential earnings of
the Aircraft, the conditions in the markets for lease and sale and future
outlook for such markets, and the tax consequences of selling rather than
continuing to lease the Aircraft.
Partnership Operations
The Partnership reported net income of $713,149 or $0.96 per Limited Partnership
unit for the year ended December 31, 2002, compared to a net income of
$2,514,059 or $2.68 per Limited Partnership unit for the year ended December 31,
2001 and a net loss of $6,246,537, or $13.43 per Limited Partnership unit for
the year ended December 31, 2000. Variances in net income may not correspond to
variances in net income per Limited Partnership unit due to the allocation of
components of income and loss in accordance with the Partnership agreement.
The decrease in net income in 2002 as compared to 2001 was primarily due to
decreases in rental and interest income and an increase in management fees to
the general partner, partially offset by increases in gain on sale of aircraft,
other income and decreases in depreciation, operating expenses, legal fees, and
administration and other expenses. The increase in net income in 2001 as
compared to 2000 was primarily due to decreases in depreciation expense as a
result of impairment charges recorded in 2000, management fees, bad debt expense
and interest expense, as well as a gain on the sale of an aircraft during 2001
and higher other income. These increases to net income during 2001 as compared
to 2000 were partially offset by decreases in rental and interest income and
increases in operating and legal expense.
Rental income decreased in 2002 as compared to 2001, and in 2001 as compared to
2000 primarily due to the lower lease rates and fewer aircraft on lease as a
result of the TWA bankruptcy. Additionally, the decrease in rent from operating
leases was also caused by lower recognition of deferred revenue. As discussed in
Note 5 to the financial statements, the deferred revenue balance existing at the
time of the lease revisions in March 2001 is being recognized over the new lease
terms for the Accepted Aircraft, while it was recognized upon lease rejection
for the three Rejected Aircraft.
Interest income decreased in 2002 as compared to 2001, and in 2001 as compared
to 2000, primarily due to lower interest rates and lower average cash balances.
Gain on sale of aircraft during 2002 was due to the sale of two aircraft for
$550,000. A gain of $180,000 over book value was recognized on the sale of these
aircraft. Gain on sale of aircraft during 2001 was due to the sale of four
aircraft for $835,000. A gain of $115,000 over book value was recognized on the
sale of one of these aircraft, the other three aircraft were sold at an amount
equal to their book value. There were no such sales in 2000.
Other Income during 2002 was due to $47,861 received from a settlement related
to the TWA bankruptcy as discussed further in Note 5 to the financial
statements, and also due to $57,855 due to the Partnership at the return of one
9
aircraft due to the engine conditions being below target levels as discussed
further in Note 3 to the financial statements. Other Income during 2001 was due
to $35,381 received due to one aircraft being returned to the Partnership with
engine conditions being below target levels as discussed in Note 3 to the
financial statements, and also due to $21,003 received from TWA for late
payments of rents related to the TWA bankruptcy as discussed further in Note 5
to the financial statements. Other Income in 2000 was due to $1,388 due from TWA
for late payments of rents.
Depreciation expense decreased in 2002 as compared to 2001 primarily as a result
of fewer aircraft remaining on lease and being depreciated. Depreciation expense
decreased in 2001 as compared to 2000 primarily as a result of $11 million of
impairment charge recognized in 2000 while only $850,000 was recognized in 2001
as discussed below. Also there were fewer aircraft being depreciated in 2001 as
a result of six aircraft no longer being on lease during the year.
The Partnership periodically reviews the estimated realizability of the residual
values at the projected end of each aircraft's economic life based on estimated
fair values at that time. The Partnership's future earnings are impacted by the
net effect of the adjustments to the carrying value of the aircraft (which has
the effect of decreasing future depreciation expense), and the downward
adjustments to the estimated residual values (which has the effect of increasing
future depreciation expense).
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 an impairment loss for the amount by which the carrying amount
exceeds its fair value. The impairment loss is recognized as depreciation
expense. The Partnership recognized impairment losses on aircraft to be held and
used or held for sale by the Partnership aggregating approximately $850,000, or
$1.70 per Limited Partnership unit in 2001, and $11 million, or $22.26 per
Limited Partnership unit in 2000 as increased depreciation expense as a result
of the TWA bankruptcy and the modified lease terms with TWA LLC. As discussed
below under "TWA Bankruptcy Filing and Transaction with American Airlines", the
Partnership decided to accept American's proposal to take assignment of seven of
the ten existing leases on modified terms and conditions (collectively the
Previous Leases). This acceptance constituted an event that required the
Partnership to review the aircraft carrying values pursuant to Statement of
Financial Accounting Standards 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" (SFAS 121). As a result of a
review of the Aircraft, future cash flows expected to be derived from the
Aircraft over the projected lease terms were less than the carrying value of the
Aircraft, so the Partnership recorded impairment losses as of December 31, 2000,
and September 30, 2001. Management believes the assumptions related to fair
value of impaired assets represented the best estimates based on reasonable and
supportable assumptions and projections.
Management fees to the General Partner increased in 2002 as compared to 2001,
and decreased in 2001 as compared to 2000, primarily as a result of the
amortization of deferred management fees being accelerated during 2001 for the
three Rejected Leases and for leases expiring during 2001 due to the TWA
bankruptcy.
Interest expense decreased in 2002 as compared to 2001, and in 2001 as compared
to 2000 primarily due to the debt incurred to install hushkits on the
Partnership's aircraft being fully repaid in 2001. In November 1996, hushkits
were installed on the ten Partnership aircraft. The leases for these ten
aircraft were then extended for a period of eight years until November 2004. 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.
10
Bad debt expense decreased in 2002 and 2001 as compared to 2000, primarily due
to the TWA Bankruptcy Filing. As discussed in Note 5, TWA subsequently cured
outstanding defaults on seven of the ten Previous Leases. Three leases which
were not cured by TWA had a rent payment due on December 27, 2000. In 2000, the
Partnership recorded an allowance for credit losses and bad debt expense equal
to the rent payment due December 27, 2000.
Operating expense decreased in 2002 as compared to 2001 primarily due to reduced
costs incurred associated with the storage of aircraft from the time of their
return to the time of their sale. During 2002, one aircraft was prepared for
storage and stored for 1 month, and two aircraft prepared for storage during
2001 were stored for an average of three months during 2002. During 2001, six
aircraft were prepared for storage and stored for an average of 5 months each at
a facility that was more expensive than the facility aircraft are now flown to
at lease expiration. Operating expense increased in 2001 as compared to 2000
primarily due to these same storage costs as there were no aircraft returned or
stored during 2000.
Legal expenses were significantly higher in 2001, as compared to 2002 and 2000,
primarily due to the costs incurred in connection with the TWA bankruptcy.
Administration and other expenses decreased in 2002 as compared to 2001 and
increased in 2001 as compared to 2000, primarily due to increased printing and
postage costs incurred during 2001 due to the TWA bankruptcy. Printing and
postage costs were further reduced in 2002 primarily due to the transition from
quarterly to annual distributions.
Liquidity and Cash Distributions
Liquidity - The Partnership received all rent payments due in 2002 from the
lessee according to the modified terms of the Current Leases. As discussed below
under "TWA Bankruptcy Filing and Transaction with American Airlines", the
General Partner has filed 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 Previous Leases
were rejected by TWA.
PIMC has determined that the Partnership maintain cash reserves as a prudent
measure to ensure that the Partnership has available funds for 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.
The General Partner evaluates, from time to time, whether the investment
objectives of the Partnership are better served by continuing to hold the
Partnership's remaining portfolio of Aircraft or marketing such Aircraft for
sale. This evaluation takes into account the current and potential earnings of
the Aircraft, the conditions in the markets for lease and sale and future
outlook for such markets, and the tax consequences of selling rather than
continuing to lease the Aircraft. The General Partner has had discussions with
third parties regarding the possibility of selling some or all of these
Aircraft. While such discussions may continue, and similar discussions may occur
again in the future, there is no assurance that such discussions will result in
the Partnership receiving a purchase offer for all or any of the Aircraft which
the General Partner would regard as acceptable.
11
Cash Distributions - Cash distributions to holders of depository units
representing assignments of Limited Partnership interests (Limited Partners)
were $1,249,900, $11,469,083 and $5,299,576, in 2002, 2001 and 2000,
respectively. Cash distributions per Limited Partnership unit were $2.50,
$22.94, and $10.60 in 2002, 2001 and 2000, 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 discussed above, the receipt of rental
payments from TWA LLC; and payments generated from the aircraft disassembly and
sales proceeds.
The Partnership does not have any material off balance sheet commitments or
obligations.
TWA Bankruptcy Filing and Transaction with American Airlines
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 with a written proposal to
assume, on modified terms and conditions, the Previous Leases applicable to
seven of the ten Aircraft. 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.
On April 9, 2001, the American acquisition of the selected TWA assets was
consummated. As a result of this closing, TWA LLC assumed the Previous Leases
applicable to seven of the ten Aircraft, and simultaneously, such Previous
Leases were amended to incorporate modified terms (as so assumed and amended,
the Assumed Leases). The Assumed Leases are substantially less favorable to the
Partnership than the Previous Leases. In particular, the monthly rental rate for
each Aircraft was 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 TWA LLC 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 date of November 27,
2004 under the Previous Leases, provided that the aggregate average number of
months for which all seven Aircraft are on lease to TWA LLC is not less than 22
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 TWA LLC, as compared to
the corresponding conditions required under the Previous Leases.
With respect to the three Aircraft that TWA LLC did not elect to acquire, TWA
officially rejected the Previous Leases applicable to these Aircraft
(collectively, the Rejected Leases) as of April 20, 2001. All three Aircraft
have been returned to the Partnership. As aircraft were returned to the
Partnership they were parked in storage in Arizona while the General Partner
remarketed them for sale. The three aircraft were sold on October 19, 2001, for
$535,000, resulting in neither a gain nor a loss for the Partnership. In
addition, the General Partner has filed administrative rent claims in the amount
of $465,277 in the TWA bankruptcy proceeding in an effort to recover the fair
value of TWA's actual use, if any, of these three Aircraft under the Rejected
Leases during the 60-day period following TWA's filing of its bankruptcy
petition. These administrative rent claims have been approved by the estate with
the plan of reorganization on June 25, 2002 (the Plan) and will be paid to the
Partnership through periodic distributions over the next one to two years. These
funds will be recognized on a cash basis as they are received. The General
12
Partner also filed administrative claims in the amount of $64,254 in the TWA
bankruptcy proceeding in connection with certain legal expenses incurred by the
Partnership in connection with the bankruptcy proceeding which were settled for
$47,861 with the estate under the Plan. The settlement was received by the
Partnership on September 26, 2002. Furthermore, the General Partner has filed
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 general unsecured
claims or be able to collect any amounts out of the TWA bankruptcy estate.
The Accounting Treatment of the TWA Transaction
In accordance with accounting principles generally accepted in the United States
(GAAP), the Partnership recognized rental income and management fees on a
straight line basis over the original lease terms of the Previous Leases. As a
result, deferred revenue and accrued management fees were recorded each month
since the inception of each Previous 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 Previous Leases were effectively
modified on March 12, 2001, the Partnership recognized 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 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 beginning as of March 31, 2001.
As of December 31, 2002, the Partnership had deferred revenue balance of
$350,601, and deferred management fee balance of $16,009 included in Payable to
Affiliates on the Balance Sheet, which will be recognized over the remaining
useful life varying between 8 and 12 months.
Sale of Aircraft
Sales of McDonnell Douglas DC-9-30 Aircraft - On October 19, 2001, PIMC, on
behalf of the Partnership, sold three DC-9-30 aircraft to Aeroturbine, Inc. for
$535,000 cash. The Partnership recognized neither a loss nor a gain on the
transaction due to an impairment expense being taken in anticipation of the
sales. On December 19, 2001 PIMC on behalf of the Partnership, sold one DC-9-30
aircraft to Amtec Corporation for $300,000 cash. The Partnership recognized a
gain of $115,000 over its book value. On February 13, 2002, the General Partner
sold one DC-9-30 to Amtec Corp for $250,000 resulting in a gain of $65,000. On
May 29, 2002 the General Partner sold one DC-9-30 to American for $300,000
resulting in a gain of $115,000.
Aircraft Impairment Assessment
The Partnership periodically reviews the estimated realizability of the residual
values at the projected end of each aircraft's economic life. For any downward
adjustment in estimated residual value or decrease in the projected remaining
economic life, the depreciation expense over the projected remaining economic
life of the aircraft 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
13
loss is recognized by the amount by which the carrying amount exceeds its fair
value.
The Partnership uses available information and estimates related to the
Partnership's aircraft, to determine an estimate of fair value to measure
impairment as required by SFAS 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets" (SFAS 144), and to determine residual values. The
estimates of fair value can vary dramatically depending on the condition of the
specific aircraft and the actual marketplace conditions at the time of the
actual disposition of the asset. If assets are deemed impaired, there could be
substantial write-downs in the future.
The Partnership made downward adjustments to the estimated residual value of
certain of its aircraft 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. The Partnership recognized an impairment loss as increased
depreciation expense in 2001 of approximately $850,000, or $1.70 per Limited
Partnership unit.
The Partnership made previous downward adjustments to the estimated net book
values and residual value of its aircraft as of December 31, 2000 as a result of
the TWA bankruptcy and the modified lease terms proposed by American as
previously discussed. After a review of the carrying value of the Aircraft
pursuant to applicable accounting literature including SFAS 121 (which was
superceded by SFAS 144), the Partnership recognized an impairment loss as
increased depreciation expense in 2000 of approximately $11 million, or $22.26
per Limited Partnership unit.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The following discussion about market risk disclosures involves forward-looking
statements. Market risks may include exposure to changes in equity prices,
interest rates and foreign currency exchange rates. Actual results could differ
materially from those projected in the forward-looking statements. The
Partnership does not use derivative financial instruments for speculative,
trading or any other purpose.
Equity Price Risk - The potential for changes in the market value of marketable
securities is referred to as "market risk". The Partnership does not own any
marketable securities.
Interest Rate Risk - Exposure to market risk resulting from changes in interest
rates relates primarily to the Partnership's lease portfolio. Income and cash
flows would not be impacted by changes in the general level of U.S. interest
rates since the Partnership's leases are fixed rate. The General Partner would
not expect an immediate 10% increase or decrease in current interest rates to
have a material effect on the fair market value of the Partnership's lease
portfolio.
Foreign Currency Risk - The Partnership does not have any foreign currency
denominated assets or liabilities or purchase commitments and has not entered
into any foreign currency contracts. Accordingly, the Partnership is not exposed
to fluctuations in foreign currency exchange rates.
14
Item 8. Financial Statements and Supplementary Data
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
FINANCIAL STATEMENTS AS OF DECEMBER 31, 2002 AND 2001
AND FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
TOGETHER WITH THE
REPORT OF INDEPENDENT AUDITORS
15
REPORT OF INDEPENDENT AUDITORS
The Partners
Polaris Aircraft Income Fund III
We have audited the accompanying balance sheet of Polaris Aircraft Income Fund
III (a California limited partnership) as of December 31, 2002, and the related
statements of operations, changes in partners' capital and cash flows for year
then ended. These financial statements are the responsibility of the General
Partner. Our responsibility is to express an opinion on these financial
statements based on our audit. The 2001 and 2000 financial statements were
audited by other auditors who have ceased operations. Those auditors expressed
an unqualified opinion on those financial statements in their report dated
February 1, 2002.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. 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 audit provide a reasonable basis for
our opinion.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the financial position of Polaris Aircraft Income Fund
III as of December 31, 2002, and the results of its operations and its cash
flows for the year then ended in conformity with accounting principles generally
accepted in the United States.
/s/ Ernst & Young LLP
San Francisco, California,
February 5, 2003
16
This is a copy of the audit report previously issued by Arthur Andersen LLP in
connection with the Polaris Aircraft Income Fund III's filing on Form 10-K for
the year ended December 31, 2001. This audit report has not been reissued by
Arthur Andersen LLP in connection with this filing on Form 10-K.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of Polaris Aircraft Income Fund III, A California Limited
Partnership:
We have audited the accompanying balance sheets of Polaris Aircraft Income Fund
III, A California Limited Partnership as of December 31, 2001 and 2000, 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, 2001.
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 auditing standards generally accepted
in the United States. 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
III, A California Limited Partnership as of December 31, 2001 and 2000, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
San Francisco, California,
February 1, 2002 (except with respect to the matter discussed in Note 11, as to
which the date is February 13, 2002)
17
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
---- ----
ASSETS:
CASH AND CASH EQUIVALENTS $ 4,118,926 $ 3,784,951
RENT RECEIVABLE 120,000 160,000
OTHER RECEIVABLES 59,691 1,516
AIRCRAFT HELD FOR SALE 185,000 370,000
AIRCRAFT ON OPERATING LEASE, net of accumulated
depreciation of $22,922,026 in 2002 and
$29,344,167 in 2001 1,681,624 3,611,094
------------ ------------
Total Assets $ 6,165,241 $ 7,927,561
============ ============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 31,637 $ 467,332
ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 147,054 162,636
DEFERRED INCOME 350,601 986,015
------------ ------------
Total Liabilities 529,292 1,615,983
------------ ------------
PARTNERS' CAPITAL (DEFICIT):
General Partner (3,784,552) (3,880,841)
Limited Partners, 499,824 units (499,960
in 2001) issued and outstanding 9,420,501 10,192,419
------------ ------------
Total Partners' Capital 5,635,949 6,311,578
------------ ------------
Total Liabilities and Partners' Capital $ 6,165,241 $ 7,927,561
============ ============
The accompanying notes are an integral part of these statements.
18
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
REVENUES:
Rent from operating leases $ 2,544,748 $ 6,364,964 $ 8,989,368
Interest 57,126 355,208 751,274
Gain on sale of aircraft 180,000 115,000 --
Other 105,716 56,384 1,388
------------ ------------ ------------
Total Revenues 2,887,590 6,891,556 9,742,030
------------ ------------ ------------
EXPENSES:
Depreciation 1,744,470 3,518,540 14,799,502
Management fees to General Partner 67,057 22,654 347,147
Interest -- 4,960 222,525
Bad debt -- -- 255,000
Operating 53,596 287,674 14,887
Legal 31,624 168,646 9,899
Administration and other 277,694 375,023 339,607
------------ ------------ ------------
Total Expenses 2,174,441 4,377,497 15,988,567
------------ ------------ ------------
NET INCOME (LOSS) $ 713,149 $ 2,514,059 $ (6,246,537)
============ ============ ============
NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 235,167 $ 1,171,934 $ 467,439
============ ============ ============
NET INCOME (LOSS) ALLOCATED TO
THE LIMITED PARTNERS $ 477,982 $ 1,342,125 $ (6,713,976)
============ ============ ============
NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ 0.96 $ 2.68 $ (13.43)
============ ============ ============
UNITS USED TO CALCULATE
NET INCOME (LOSS) PER
LIMITED PARTNERSHIP UNIT 499,824 499,960 499,960
The accompanying notes are an integral part of these statements.
19
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
General Limited
Partner Partners Total
------- -------- -----
Balance, December 31, 1999 $ (3,657,030) $ 32,332,929 $ 28,675,899
Net income (loss) 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 1,171,934 1,342,125 2,514,059
Cash distributions to partners (1,274,342) (11,469,083) (12,743,425)
------------ ------------ ------------
Balance, December 31, 2001 (3,880,841) 10,192,419 6,311,578
Net income 235,167 477,982 713,149
Cash distributions to partners (138,878) (1,249,900) (1,388,778)
------------ ------------ ------------
Balance, December 31, 2002 $ (3,784,552) $ 9,420,501 $ 5,635,949
============ ============ ============
The accompanying notes are an integral part of these statements.
20
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
---- ---- ----
OPERATING ACTIVITIES:
Net income (loss) $ 713,149 $ 2,514,059 $ (6,246,537)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 1,744,470 3,518,540 14,799,502
Gain on sale of aircraft (180,000) (115,000) --
Bad debt expense -- -- 255,000
Changes in operating assets and liabilities:
Decrease (increase) in rent and other
receivables (18,175) 436,216 10,525
Decrease (increase) in other assets -- 14,291 (14,291)
Increase (decrease) in payable to affiliates (435,695) 246,993 50,065
Increase (decrease) in accounts payable
and accrued liabilities (15,582) 31,700 2,988
Increase (decrease) in deferred income (635,414) (3,272,459) 1,210,631
------------ ------------ ------------
Net cash provided by operating activities 1,172,753 3,374,340 10,067,883
------------ ------------ ------------
INVESTING ACTIVITIES:
Proceeds from sale of aircraft 550,000 835,000 --
------------ ------------ ------------
Net cash provided by investing activities 550,000 835,000 --
------------ ------------ ------------
FINANCING ACTIVITIES:
Principal payments on notes payable -- (204,871) (3,973,063)
Cash distributions to partners (1,388,778) (12,743,425) (5,888,418)
------------ ------------ ------------
Net cash used in financing activities (1,388,778) (12,948,296) (9,861,481)
------------ ------------ ------------
CHANGES IN CASH AND CASH
EQUIVALENTS 333,975 (8,738,956) 206,402
CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 3,784,951 12,523,907 12,317,505
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 4,118,926 $ 3,784,951 $ 12,523,907
============ ============ ============
The accompanying notes are an integral part of these statements.
21
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2002
1. Organization and the Partnership
Polaris Aircraft Income Fund III, A California Limited Partnership (PAIF-III or
the Partnership) was formed on June 27, 1984 for the purpose of acquiring and
leasing aircraft. The Partnership will terminate no later than December 2020.
Upon organization, both the General Partner and the initial Limited Partner
contributed $500 to capital. The Partnership recognized no profits and losses
during the periods ended December 31, 1984 and 1985. The offering of depositary
units (Units), representing assignments of Limited Partnership interest,
terminated on September 30, 1987 at which time the Partnership had sold 500,000
units of $500, representing $250,000,000. All unit holders were admitted to the
Partnership on or before September 30, 1987 and are referred to collectively as
the Limited Partners. During January 1998, 40 units were redeemed by the
Partnership in accordance with section 18 of the Limited Partnership Agreement.
During 2002, 136 units were abandoned. At December 31, 2002, there were 499,824
units outstanding, net of redemptions.
Polaris Investment Management Corporation (PIMC), the sole General Partner of
the Partnership, supervises the day-to-day operations of the Partnership.
Polaris Depository Company III (PDC) serves as the depositary. PIMC and PDC are
wholly-owned subsidiaries 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 affiliates are described in Notes 7 and 8.
2. Accounting Principles and Policies
Accounting Method - The Partnership maintains its accounting records, and
prepares its financial statements on the accrual basis of accounting. The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States (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 the residual values of the
aircraft, the useful lives of the aircraft, and the estimated amount and timing
of cash-flows associated with each aircraft which are used to determine
impairment, if any.
Cash and Cash Equivalents - This includes deposits at banks and investments in
money market funds. Cash and Cash Equivalents is stated at cost, which
approximates fair value.
Aircraft and Depreciation - The aircraft are recorded at cost, which includes
acquisition costs. Depreciation to an estimated residual value is computed using
the straight-line method over the estimated economic life of the aircraft which
was originally estimated to be 30 years from the date of manufacture or the end
of the remaining lease term if beyond the 30 year life. Depreciation in the year
22
of acquisition was calculated based upon the number of days that the aircraft
were in service.
The Partnership periodically reviews the estimated realizability of the residual
values at the projected end of each aircraft's economic life. For any downward
adjustment in estimated residual value or decrease in the projected remaining
economic life, the depreciation expense over the projected remaining economic
life of the aircraft will be increased.
If the projected net cash flow for each aircraft (projected rental revenue, net
of management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, an impairment
loss is recognized. Pursuant to Statement of Financial Accounting Standards 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144), 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. Aircraft held for sale
are carried at the lower of cost or fair value less cost to sell.
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 or the remaining lease term, if shorter. These
costs are also subject to periodic impairment evaluation as discussed above.
Operating Leases - The aircraft leases are accounted for as operating leases.
Lease revenues are recognized in equal installments over the terms of the
leases. Due to the fact that the Partnership received greater payments in the
beginning of the lease than at the end of the lease under the terms of the
leases in effect at the time of the TWA bankruptcy filing (the Previous Leases)
(See Note 5), this has resulted in deferred income on the balance sheet.
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 as liabilities 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 and lease the Partnership's aircraft, including costs related to lessee
defaults.
Net Income Per Limited Partnership Unit - Net income per depository unit
representing assignment of Limited Partnership interest (Limited Partnership
unit) is based on the Limited Partners' share of net income or loss and the
number of units outstanding of 499,824 for the year ended December 31, 2002, and
499,960 for the years ended December 31, 2001, and 2000.
Income Taxes - The Partnership files federal and state information income tax
returns only. Taxable income or loss is reportable by the individual partners.
3. Aircraft
At December 31, 2002, Polaris Aircraft Income Fund III (the Partnership) owned
four aircraft from its original portfolio of 38 used commercial jet aircraft
which were acquired and leased or sold as discussed below. Of these, three are
23
leased to TWA LLC and one is held for sale. All aircraft were acquired from an
affiliate and 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. The leases generally state a minimum acceptable return
condition for which the lessee is liable under the terms of the lease agreement.
Of its original portfolio of 38 aircraft, the Partnership sold one aircraft in
1992, seven aircraft in 1993, three aircraft in 1994, eight aircraft in 1997,
four aircraft in 2001 and two aircraft in 2002. In addition, nine aircraft were
disassembled for sale of their component parts, the remainder of which was sold
to Soundair, Inc. in 1998.
The following table describes the Partnership's aircraft portfolio at December
31, 2002:
Year of
Aircraft Type Serial Number Manufacture
- ------------- ------------- -----------
McDonnell Douglas DC-9-30 47028 1967
McDonnell Douglas DC-9-30 47095 1967
McDonnell Douglas DC-9-30 47173 1968
McDonnell Douglas DC-9-30 47491 1970
Initially thirteen aircraft were acquired for $86,163,046 during 1986 and 1987,
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 prior to TWA's 1995 bankruptcy filing. In June 1997, three of the
thirteen aircraft were sold, subject to the existing leases, to Triton Aviation
Services III LLC. The leases for 10 of the 13 aircraft were extended again for
eight years until November 2004. As a result of the bankruptcy of TWA in 2001,
modified terms and conditions were accepted that were substantially less
favorable to the Partnership than the terms and conditions specified in the
Previous Leases (see Note 5). In particular, rather than returning the Aircraft
at the previously scheduled expiry date under the Previous Leases, TWA LLC, who,
in 2001, assumed seven of the ten then existing TWA leases of the Partnership's
aircraft under modified terms, would return each Aircraft at the time when such
Aircraft requires a heavy maintenance check of the airframe, provided that the
aggregate average number of months for which all seven Aircraft are on lease to
TWA LLC is not less than 22 months from and after March 12, 2001. In addition,
TWA LLC reduced the rental rate for each of the Aircraft to $40,000 per month.
Further, at lease expiry, TWA LLC is required to return each airframe in a
"serviceable" condition, rather than being required to meet the more stringent
maintenance requirements of the Previous Leases. Finally, TWA LLC is required to
return the installed engines on each Aircraft with a target level of average
cycle life remaining to replacement for all life limited parts of 25%. If the
average cycle life remaining on the installed engines on an Aircraft is below
the 25% target level, a financial adjustment is payable by TWA LLC to the
Partnership (but no payment will be owed by the Partnership to TWA LLC if cycle
life remaining at return exceeds the target level). For the one aircraft
returned to the Partnership during 2002, $57,855, included in Other Receivable
on the Balance Sheet, was due from the lessee for the engines being below such
target level. Payment was received for this on January 14, 2003.
24
The following is a schedule by year of future minimum rental revenue:
Year Amount
---- ------
2003 1,182,667
----------
$1,182,667
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. The Partnership's future earnings are impacted by the net effect
of the adjustments to the carrying value of the aircraft (which has the effect
of decreasing future depreciation expense), and the downward adjustments to the
estimated residual values (which has the effect of increasing future
depreciation expense).
The Partnership made a downward adjustment to the estimated net book values and
residual value of its aircraft as of September 30, 2001 as a result of the
anticipated sale of three aircraft to Aeroturbine. After a review of the
carrying value of the Aircraft pursuant to applicable accounting literature
including SFAS 121, the Partnership recognized an impairment loss as increased
depreciation expense in 2001 of approximately $570,000, or $1.14 per Limited
Partnership unit for aircraft on lease and $280,000 or $0.56 per Limited
Partnership unit for aircraft held for sale. The Partnership recorded losses on
aircraft that were deemed impaired to the extent that the carrying value
exceeded the fair value. For Aircraft held for sale the Partnership records
losses to the extent that carrying value exceeds the fair value less cost to
sell. Management believes the assumptions related to the fair value of impaired
assets represented the best estimates based on reasonable and supportable
assumptions and projections.
The Partnership recognized an impairment loss on aircraft held and used by the
Partnership aggregating approximately $11 million, or $22.26 per limited
Partnership unit as increased depreciation expense in 2000. The impairment loss
was the result of the TWA bankruptcy and the modified lease terms proposed by
American as discussed in Note 5, which constituted an event that required the
Partnership to review the aircraft carrying values pursuant to SFAS 121. In
determining the impairment loss, the Partnership estimated fair value based on
the present value of the estimated future net cash flows of the aircraft
(projected rental revenue, net of management fees, less projected maintenance
costs, if any, plus the estimated residual value) using the current incremental
borrowing rate as the discount rate. The Partnership recorded an impairment loss
to the extent that the carrying value exceeded the fair value. Management
believes the assumptions related to the fair value of impaired assets
represented the best estimates based on reasonable and supportable assumptions
and projections.
The Partnership made a downward adjustment to the estimated residual value of
its aircraft as of October 1, 1999. As a result of the 1999 adjustment to the
estimated residual value, the Partnership recognized increased depreciation
expense in 1999 of approximately $311,641 or $.62 per Limited Partnership unit.
4. Sale of Aircraft
On October 19, 2001, PIMC, on behalf of the Partnership, sold three DC-9-30
aircraft to Aeroturbine, Inc. for $535,000 cash. The Partnership recognized
neither a loss nor a gain on the transaction due to an impairment expense being
taken on these aircraft in anticipation of the sales. On December 19, 2001 PIMC
on behalf of the Partnership, sold one DC-9-30 aircraft to Amtec Corporation for
$300,000 cash. The Partnership recognized a gain of $115,000 over its book
value. On February 13, 2002 PIMC on behalf of the Partnership, sold one DC-9-30
aircraft to Amtec Corporation for $250,000. The Partnership recognized a gain of
$65,000 over its book value. On May 29, 2002 PIMC on behalf of the Partnership,
25
sold one DC-9-30 aircraft to American for $300,000. The Partnership recognized a
gain of $115,000 over its book value.
5. TWA Bankruptcy Filing and Transaction with American Airlines
Trans World Airlines, Inc. (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 Airlines, Inc. (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 Previous Leases applicable to seven of the
ten Aircraft. The General Partner decided to accept American's proposal.
On April 9, 2001, the American acquisition of the selected TWA assets was
consummated. As a result of this closing, TWA LLC assumed the Previous Leases
applicable to seven of the ten Aircraft, and simultaneously, such Previous
Leases were amended to incorporate modified terms (as so assumed and amended,
the Assumed Leases). The Assumed Leases are substantially less favorable to the
Partnership than the Previous 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 TWA LLC 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 date of November 27,
2004 under the Previous Leases, provided that the aggregate average number of
months for which all seven Aircraft are on lease to TTW LLC were not less than
22 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 TWA LLC, as
compared to the corresponding conditions required under the Previous Leases.
With respect to the three Aircraft that TWA LLC did not elect to acquire, TWA
officially rejected the Previous Leases applicable to these Aircraft
(collectively, the Rejected Leases) as of April 20, 2001. All three Aircraft
have been returned to the Partnership. As aircraft were returned to the
Partnership they were parked in storage in Arizona while the General Partner
remarketed them for sale. The three aircraft were sold on October 19, 2001, for
$535,000, resulting in neither a gain nor a loss for the Partnership. In
addition, the General Partner has filed administrative rent claims in the amount
of $465,277 in the TWA bankruptcy proceeding in an effort to recover the fair
value of TWA's actual use, if any, of these three Aircraft under the Rejected
Leases during the 60-day period following TWA's filing of its bankruptcy
petition. These administrative rent claims have been approved by the estate with
the plan of reorganization on June 25, 2002 (the Plan) and will be paid to the
Partnership through periodic distributions over the next one to two years. These
funds will be recognized on a cash basis as they are received. The General
Partner also filed administrative claims in the amount of $64,254 in the TWA
bankruptcy proceeding in connection with certain legal expenses incurred by the
Partnership in connection with the bankruptcy proceeding which were settled for
$47,861 with the estate under the Plan. The settlement was received by the
Partnership on September 26, 2002. Furthermore, the General Partner has filed
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
26
Partner will be successful in asserting the value of the general unsecured
claims or be able to collect any amounts out of the TWA bankruptcy estate.
The Accounting Treatment of the TWA Transaction
In accordance with GAAP, the Partnership recognized rental income and management
fees on a straight line basis over the original lease terms of the Previous
Leases. As a result, deferred revenue and accrued management fees were recorded
each month since the inception of each Previous 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 Previous Leases were effectively
modified on March 12, 2001, the Partnership is recognizing 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 rental revenue and a reduction of management fee respectively in
March 2001. For the Assumed Leases, the deferred revenue and accrued management
fees associated with each Aircraft are being recognized over the new lease
terms, ranging from 2 months to 33 months as of March 31, 2001. As of December
31, 2002, the Partnership had deferred revenue balance of $350,601, and deferred
management fee balance of $16,009 included in Payable to Affiliates on the
Balance Sheet, which will be recognized over the remaining useful life varying
between 8 and 12 months.
6. Notes Payable
In 1996, GECAS, on behalf of the Partnership, negotiated with TWA for the
acquisition of noise-suppression devices, commonly known as "hushkits", for the
ten Partnership aircraft formerly on lease to TWA, as well as other aircraft
owned by affiliates of PIMC and leased to TWA. The ten aircraft that received
hushkits were designated by TWA. The hushkits recondition the aircraft so as to
meet Stage 3 noise level restrictions. Installation of the ten hushkits on the
Partnership's aircraft was completed in November 1996.
The aggregate cost of the hushkit reconditioning was $15,930,822, or
approximately $1.6 million per aircraft, which was capitalized by the
Partnership. The Partnership paid $3.0 million of the aggregate hushkit cost and
the balance of $12,930,822 was financed by the engine/hushkit manufacturer over
50 months (through December 2000) at an interest rate of approximately 10% per
annum. Cash paid for interest on all the loans was $0, $4,960 and $226,937 in
2002, 2001 and 2000, respectively. The notes were completely paid off in 2001.
7. Related Parties
Under the Limited Partnership Agreement (the 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 2002, 2001 and 2000, the Partnership paid management fees to
PIMC of $265,205, $-0-, and $300,000, respectively. Management fees
payable to PIMC were $23,476 and $221,624 at December 31, 2002 and
2001, respectively.
27
b. Reimbursement of certain out-of-pocket expenses incurred in connection
with the management of the Partnership and supervision of its assets.
In 2002, 2001 and 2000, the Partnership reimbursed PIMC for expenses of
$616,191, $668,867, and $397,831, respectively. Reimbursements totaling
$8,161 and $245,708 were payable to PIMC at December 31, 2002 and 2001,
respectively.
c. 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
original aircraft cost, gains from additional sales or disposals must
be allocated to the General Partner's capital account until the General
Partner's capital account is no longer in a deficit position.
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 unit holders
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 subordination threshold
has not been met.
e. In the event that, immediately prior to the dissolution and termination
of the Partnership, the General Partner shall have a deficit balance in
its tax basis capital account, then the General Partner shall
contribute in cash to the capital of the Partnership an amount which is
equal to such deficit (see Note 8).
8. 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 7). Such allocations are made using income or loss calculated under
GAAP for book purposes, which, as more fully described in Note 10, 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. Cash distributions paid in 2002 were $138,878 and $1,249,900 to the
General Partner and the Limited Partners, respectively. In January 2003,
distributions of $277,6680 and $2,499,120 were paid to the General Partner and
the Limited Partners, respectively.
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, 2002 at
the current carrying value, the tax basis capital (deficit) accounts of the
General Partner and the Limited Partners is estimated to be $0 and $5,748,819,
respectively.
28
9. 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, 2002 and 2001 are as
follows:
Reported Amounts Tax Basis Net Difference
---------------- --------- --------------
2002: Assets $6,165,241 $5,927,510 $ 237,731
Liabilities 529,292 178,691 350,601
2001: Assets $7,927,561 $6,781,047 $1,146,514
Liabilities 1,615,983 582,820 1,033,163
10. Reconciliation of Book Net Income to Taxable Net Income
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,
2002 2001 2000
---- ---- ----
Book net income (loss) per Limited
Partnership unit $ 0.96 $ 2.68 $(13.43)
Adjustments for tax purposes represent
differences between book and tax
revenue and expenses:
Rental revenue (1.26) (4.97) 2.90
Gain (Loss) on sale of aircraft 0.02 (1.59) -
Management fee expense (0.09) - 0.09
Depreciation 1.95 4.32 25.40
------- ------- -------
Taxable net income per Limited Partnership
unit $ 1.58 $ 0.44 $ 14.96
======= ======= =======
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 on a
straight line basis for operating leases. For tax purposes, revenue is generally
recognized when legally earned. For tax purposes, management fee expense is
accrued in the same year as the tax basis rental revenue while management fees
are accrued using GAAP revenue for book purposes.
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
29
depreciation expense. As a result, the current year book depreciation expense is
greater than the tax 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.
11. Selected Quarterly Financial Data (unaudited)
The following is a summary of the quarterly results of operations for the years
ended December 31, 2002 and 2001:
2002 March 31 June 30 Sept. 30 Dec. 31
----------- ----------- ----------- -----------
Total Revenues $ 718,128 $ 769,471 $ 703,192 $ 696,799
Net Income $ 179,838 $ 209,360 $ 176,773 $ 147,178
Net Income - General
Partner $ 115,984 $ 115,943 $ 1,768 $ 1,472
Net Income - Limited
Partners $ 63,854 $ 93,417 $ 175,005 $ 145,706
Net Income Per Limited
Partnership Unit $ 0.13 $ 0.19 $ 0.35 $ 0.29
2001 March 31 June 30 Sept. 30 Dec. 31
----------- ----------- ----------- -----------
Total Revenues $ 3,065,985 $ 1,803,813 $ 1,112,280 $ 909,478
Net Income (Loss) $ 2,235,894 $ 795,591 $ (608,336) $ 90,910
Net Income - General
Partner $ 172,332 $ 132,933 $ 815,769 $ 50,900
Net Income (Loss) -
Limited Partners $ 2,063,562 $ 662,658 $(1,424,105) $ 40,010
Net Income (Loss) Per
Limited Partnership Unit $ 4.13 $ 1.33 $ (2.85) $ 0.07
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On August 1, 2002, the Board of Directors of the general partner of the
Partnership, on behalf of the Partnership, adopted a resolution dismissing
Arthur Andersen LLP (Andersen) as the Partnership's auditors and appointed Ernst
& Young LLP (E&Y) to replace Andersen.
Andersen's reports on the Partnership's financial statements as of and for each
of the years ended December 31, 2001 and 2000 did not contain an adverse opinion
or disclaimer of opinion, nor were they qualified or modified as to uncertainty,
audit scope or accounting principles.
During the years ended December 31, 2001 and 2000 and through the date hereof,
there were no disagreements with Andersen on any matter of accounting principles
or practices, financial statement disclosure, or auditing scope or procedure
which, if not resolved to Andersen's satisfaction, would have caused Andersen to
make reference to the subject matter in connection with its report on the
Partnership's financial statements for such years; and there were no reportable
events as described in Item 304(a)(1)(v) of Regulation S-K.
30
During the years ended December 31, 2001 and 2000 and through the date hereof,
the Partnership did not consult E&Y with respect to the application of
accounting principles to a specified transaction, either completed or proposed,
or the type of audit opinion that might be rendered on the Partnership's
financial statements, or any other matters or reportable events as set forth in
Items 304(a)(2)(i) and (ii) of Regulation S-K.
The Partnership has provided Andersen with a copy of the foregoing statements.
Because the Partnership has been informed by Andersen that as of July 1, 2002 it
would not be providing the letter stating that it was in agreement with the
statements contained herein, no such letter is attached to this filing as an
Exhibit. The inability to obtain such letter from Andersen and not attaching a
letter to this filing is permitted by Item 304T(b)(2) of Regulation S-K.
31
PART III
Item 10. Directors and Executive Officers of the Registrant
Polaris Aircraft Income Fund III, A California Limited Partnership (PAIF-III 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 Delaware
corporation (GE Capital). GE Capital has been PHC's parent company since 1986.
As subsidiaries of GE Capital, GECAS and PIMC are affiliates.
The officers and directors of PIMC are:
Name PIMC Title
--------------------- ------------------------------------
William Carpenter President; Director
Stephen E. Yost Chief Financial Officer
Melissa Hodes Vice President; 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. Carpenter, 39, assumed the position of President and Director of PIMC
effective October 1, 2001. Mr. Carpenter holds the position of Executive Vice
President and Chief Risk Manager of GECAS, having previously held the position
of Vice President - Chief Risk Manager of GECAS (Acting). Prior to joining GECAS
eight years ago, Mr. Carpenter was an aerospace engineer specializing in
aircraft handling qualities. Prior to that, Mr. Carpenter was a commissioned
officer and pilot in the United States Armed Forces.
Mr. Yost 41, assumed the position of Chief Financial Officer of PIMC effective
April 17, 2002. Mr. Yost presently holds the position of Senior Vice President
and Manager Transaction Advisory for GECAS. Mr Yost has been with the General
Electric Company (GE) and its subsidiaries since 1994. Prior to joining GECAS,
Mr. Yost held the position of European Controller for GE Capital Fleet Services
and prior to that Controller of GE Capital Commercial Finance. Mr. Yost is a
Certified Public Accountant and prior to joining GE was an audit manager with
Coopers & Lybrand.
Ms. Hodes, 37, assumed the position of Director of PIMC effective May 19, 2000.
Ms. Hodes presently holds the position of Senior Vice President, Financial
Planning and Analysis for GECAS. Ms. Hodes has been with the General Electric
Company (GE) and its subsidiaries since 1987. Prior to joining GECAS, Ms. Hodes
held various financial management positions with GE Capital Card Services, GE
Audit Staff and GE Power Systems.
32
Mr. Liu, 45, 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 - Sales and Marketing of GECAS, having
previously held the position of Executive Vice President - Capital Funding and
Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was with General
Electric Capital Corporation for nine years. He has held management positions in
corporate Business Development for General Electric Capital Corporation and in
Syndications and Leasing for the Transportation & Industrial Funding division of
General Electric Capital Corporation. Mr. Liu previously held the position of
managing director of Kidder, Peabody & Co., Incorporated.
Mr. Warman, 54, 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, 61, held the position of Vice President - Aviation Legal and
Insurance Affairs, from April 1989 to October 1997. Previously, he served as
General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994,
Mr. Dillon assumed the position of Assistant Secretary of PIMC. Mr. Dillon
presently holds the position of Senior Vice President and Associate General
Counsel of GECAS.
Certain Legal Proceedings:
On or around September 27, 1995, a complaint entitled Martha J. Harrison v.
General Electric Company, et. al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and Prudential Securities Incorporated. The Partnership is not
named as a defendant in this action. Plaintiff alleges claims of tort, breach of
fiduciary duty in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning
the inducement and solicitation of purchases arising out of the public offering
of Polaris Aircraft Income Fund IV. Plaintiff seeks compensatory damages,
attorney's fees, interest, costs and general relief.
On or around December 8, 1995, a complaint entitled Overby, et al. v. General
Electric Company, et al. was filed in the Civil District Court for the Parish of
Orleans, State of Louisiana. The complaint names as defendants General Electric
Company and General Electric Capital Corporation. The Partnership is not named
as a defendant in this action. Plaintiffs allege claims of tort, breach of
fiduciary duty, in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in
connection with the public offering of Polaris Aircraft Income Funds III and IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.
In or around November 1994, a complaint entitled Lucy R. Neeb, et al. v.
Prudential Securities Incorporated, et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company, General Electric
Capital Corporation and Smith Barney, Inc. The Partnership is not named as a
defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary
duty, in tort, contract and quasi-contract, violation of sections of the
Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection
with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs
seek compensatory damages, attorneys' fees, interest, costs and general relief.
33
In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v.
Prudential Securities. Incorporated, et al. was filed in the Civil District
Court for the Parish of Orleans, State of Louisiana. The complaint named as
defendants Prudential Securities Incorporated and Stephen Derby Gisclair. On or
about January 18, 1996, plaintiff filed a First Supplemental and Amending
Petition adding defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of sections of the Louisiana Blue Sky Law and
violation of the Louisiana Civil Code in connection with the public offering of
Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages,
attorneys' fees, interest, costs and general relief.
On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v.
General Electric Co., et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
in connection with the public offering of Polaris Aircraft Income Fund IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.
In or around December 1994, a complaint entitled John J. Jones, Jr. v.
Prudential Securities Incorporated, et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company and General Electric
Capital Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of section of the Louisiana Blue Sky Law and violation
of the Louisiana Civil Code concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Fund
III. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and
general relief.
On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v.
General Electric Company, et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint named as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
concerning the inducement and solicitation of purchases arising out of the
public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek
compensatory damages, attorneys' fees, interest, costs and general relief.
On or about May 7, 1996, a petition entitled Charles Rich. et al. v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
District Court for the Parish of Orleans, State of Louisiana. The complaint
names as defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiffs allege claims of tort concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Funds
III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief.
On or about March 4, 1996, a petition entitled Richard J. McGiven v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
34
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.
Sara J. Bishop, et al. v. Kidder, Peabody & Co., et al., Superior Court of
California, County of Sacramento; Wilson et al. v. Polaris Holding Company et
al., Superior Court of California, County of Sacramento, and ten other
California Actions(1) - In the California actions filed in 1996, approximately
4000 plaintiffs who purchased limited partnership units in Polaris Aircraft
Income Funds I through VI and other limited partnerships sold by Kidder, Peabody
named Kidder, Peabody, 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, and General Electric Credit
Corporation and Does 1-100 as defendants. The Partnership was not named as a
defendant in these actions. The complaints all allege 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
complaints seek 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. The California actions have been settled.
An additional settlement was entered into with certain plaintiffs who had
refused to participate in the first settlement. Plaintiffs' counsel advised the
Court that they would withdraw from representing the remaining plaintiffs --
approximately 330 -- who refused to participate in either of the settlements. In
July, 2000, plaintiffs' counsel submitted to the Court motions to withdraw as
counsel of record for all of the actions. The Court indicated that it would
grant such motions and thereafter would consider dismissing each of the actions
if no plaintiff came forward to prosecute. On August 2, 2001, the Court
conducted a series of status conferences in connection with each of the twelve
California actions and at the conferences dismissed most of the remaining
plaintiffs in those actions. On November 9, 2001, defendants moved for summary
judgment against most of the remaining plaintiffs based upon a settlement and
bar order entered in a multi-district litigation in 1997. On March 1, 2002 the
judge granted the defendants' summary judgment motions and on August 15, 2002,
the judge entered a judgment of dismissal in each of the California actions.
- --------
1 The ten other actions are Abrams, et al. v. Polaris Holding Company, et al.,
Elphick, et al. v. Kidder Peabody & Co., et al., Johnson, et al. v. Polaris
Holding Company, et al., Kuntz, et al. v. Polaris Holding Company, et al.,
McDevitt, et al. v. Polaris Holding Company, et al., Ouellette, et al. v. Kidder
Peabody & Co., et al., Rolph, et al. v. Polaris Holding Company, et al., Self,
et al. v. Polaris Holding Company, et al., Tarrer, et al. v. Kidder Peabody &
Co., et al., Zicos, et al. v. Polaris Holding Company, et al., all filed in
Superior Court of California, County of Sacramento.
35
Other Proceedings - Part I, Item 3 discusses certain other actions arising out
of certain public offerings, including that of the Partnership, to which both
the Partnership and its general partner are parties.
Item 11. Executive Compensation
The Partnership has no directors or officers. The Partnership is managed by
PIMC, the General Partner. In connection with management services provided,
management and advisory fees of $262,205 were paid to PIMC in 2002, in addition
to a 10% interest in all cash distributions as described in Note 7 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-III to own beneficially
more than five percent of any class of voting securities of PAIF-III.
b) The General Partner of PAIF-III owns the equity securities of PAIF-III
as set forth in the following table:
Title Name of Amount and Nature of Percent
of Class Beneficial Owner Beneficial Ownership of Class
-------- ---------------- -------------------- --------
General Polaris Investment Represents a 10.0% interest 100%
Partner Management of all cash distributions,
Interest Corporation gross income in an amount
equal to 9.09% of distributed
cash available from operations,
and a 1% interest in net
income or loss
c) There are no arrangements known to PAIF-III, including any pledge by
any person of securities of PAIF-III, the operation of which may at a
subsequent date result in a change in control of PAIF-III.
Item 13. Certain Relationships and Related Transactions
None.
Item 14. Controls and Procedures
PIMC management, including the Chief Executive Officer and Chief Financial
Officer, have conducted an evaluation of the effectiveness of disclosure
controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective in ensuring that all
material information required to be filed in this annual report has been made
known to them in a timely fashion. There have been no significant changes in
internal controls, or in factors that could significantly affect internal
controls, subsequent to the date the Chief Executive Officer and Chief Financial
Officer completed their evaluation.
36
PART IV
Item 15. 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 Auditors 16
Balance Sheets 18
Statements of Operations 19
Statements of Changes in Partners' Capital (Deficit) 20
Statements of Cash Flows 21
Notes to Financial Statements 22
2. Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December 31,
2002.
3. Exhibits required to be filed by Item 601 of Regulation S-K.
99.1 Certification of President.
99.2 Certification of Chief Financial Officer.
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.
37
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 III,
A California Limited Partnership
(REGISTRANT)
By: Polaris Investment
Management Corporation
General Partner
March 31, 2003 By: /S/ William Carpenter
- --------------------------- ---------------------
Date William Carpenter, 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/William Carpenter President and Director of Polaris March 31, 2003
- -------------------- Investment Management Corporation, --------------
(William Carpenter) General Partner of the Registrant
/S/Stephen E. Yost Chief Financial Officer of Polaris March 31, 2003
- ------------------ Investment Management Corporation, --------------
(Stephen E. Yost) General Partner of the Registrant
/S/Melissa Hodes Vice President and Director of Polaris March 31, 2003
- ---------------- Investment Management Corporation, --------------
(Melissa Hodes) General Partner of the Registrant
/S/Norman C. T. Liu Vice President and Director of Polaris March 31, 2003
- ------------------- Investment Management Corporation, --------------
(Norman C. T. Liu) General Partner of the Registrant
38
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION
I, William R. Carpenter, certify that:
1. I have reviewed this annual report on Form 10-K of Polaris Aircraft Income
Fund III (A California Limited Partnership);
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant is made known to us by
others, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the Evaluation Date); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
39
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: Polaris Investment Management Corporation,
General Partner
/s/ William R. Carpenter
- ------------------------
William R. Carpenter
President
40
CERTIFICATION
- -------------
I, Stephen E. Yost, certify that:
1. I have reviewed this annual report on Form 10-K of Polaris Aircraft Income
Fund III (A California Limited Partnership);
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant is made known to us by
others, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the Evaluation Date); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
41
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 31, 2003
By: Polaris Investment Management Corporation,
General Partner
/s/ Stephen E. Yost
- -------------------
Stephen E. Yost
Chief Financial Officer
42