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, the General Partner, Polaris Investment Management Corporation (PIMC), and its affiliates, including GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris Holding Company (PHC) and General Electric Capital Corporation (GE Capital), acquire, lease, finance, sell and remarket aircraft for their own accounts and for existing aircraft and aircraft leasing programs managed by them. Further, GECAS provides a significant range of aircraft management services to third parties, including without limitation, AerFi Group plc (formerly GPA Group plc), a public limited company organized in Ireland, together with its consolidated subsidiaries (AerFi), and Airplanes Group, together with its subsidiaries (APG), each of which two groups leases and sells aircraft. Accordingly, in seeking to re-lease and sell its aircraft, the Partnership may be in competition with the General Partner, its affiliates, AerFi, APG, and other third parties to whom GECAS provides aircraft management services from time to time.
A brief description of the aircraft owned by the Partnership is set forth in Item 2.
Item 2. The following table describes certain material terms of the Partnership's leases to Trans World Airlines, Inc. (TWA) as of December 31, 1998:
Number of Lease Lessee Aircraft Type Aircraft Expiration Renewal Options - ------ ------------- -------- ---------- ---------------
TWA McDonnell Douglas DC-9-30 10 11/04 (1) none
(1) TWA may specify a lease expiration date for each aircraft up to six months before the date shown, provided the average date for the 10 aircraft is November 2004. The TWA leases were modified in 1991 and were extended for an aggregate of 75 months beyond the initial lease expiration date in November 1991 at approximately 46% of the original lease rates. In 1996, the leases were extended for a period of eight years until November 2004. The Partnership also agreed to share in the costs of certain Airworthiness Directives (ADs). If such costs are incurred by TWA, they will be credited against rental payments, subject to annual limitations with a maximum of $500,000 per aircraft over the lease terms.
As discussed in Item 7, in October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill agreement with TWA which was approved on behalf of the Partnership by PIMC. That agreement provided for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995, with the deferred rents, which aggregated $2.6 million, plus interest being repaid in monthly installments between May 1995 through December 1995. The Partnership received as consideration for the agreement $157,568 and warrants for TWA Common Stock (Item 7).
In 1996, GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of noise-suppression devices, commonly known as "hushkits", for the 10 Partnership aircraft currently on lease to TWA, as well as other aircraft owned by affiliates of PIMC and leased to TWA. The 10 aircraft were designated by TWA. The hushkits reconditioned the aircraft so as to meet Stage 3 noise level restrictions. The installation of the 10 hushkits was completed on the Partnership's aircraft in November 1996 and the leases for these 10 aircraft were 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. The loan from the engine/hushkit manufacturer is non-recourse to the Partnership and secured by a security interest in the lease receivables.
The Partnership transferred three McDonnell Douglas DC-9-10 aircraft, formerly leased to Midway Airlines, Inc. (Midway), and six Boeing 727-100 aircraft, formerly leased to Continental, to aircraft inventory in 1992. The three McDonnell Douglas DC-9-10 aircraft were disassembled for sale of their component parts, the remainder of which was sold to Soundair, Inc. in 1998. Disassembly of the six Boeing 727-100 aircraft commenced in December 1994. The leases for three Boeing 727-200 aircraft to Continental expired in April 1994. These aircraft were subsequently sold to Continental.
At year end 1998, there were approximately 12,600 jet aircraft in the world fleet. Approximately 1,500 aircraft were leased or sold during 1998, an increase of 14% over 1997. Air travel has grown strongly during the past 28 years, with the last nineteen years showing better than 5.5% annual growth, and not until recently has it subsided after what had been a robust period from 1994 to 1997. This strong period has mainly benefited Stage 3 narrow bodies and younger Stage 2 narrow bodies, many of which have been or are being upgraded with hushkits. During 1998, the industry saw many alliances taking place. There was more consolidation in the U.S. Airline Industry via alliances than had been seen in the previous 20 years since deregulation. Booming traffic demand coupled with reductions in the price of aviation fuel has resulted in record profits for many airlines in North America and Europe. However, slower traffic lies ahead, the cycle has peaked in 1998, as may have airline profits. Manufacturers continue to produce at high levels compared to what demand will require in the future years. Asia continues its economic turmoil which has brought about a significant reduction in traffic growth in that region. This is resulting in a number of new aircraft order deferrals and cancellations, mainly in the wide body sector, with over capacity moving from Asia into the other regions around the world. Timing of when the down cycle ends or how severe it will be is still in question, but will be closely watched as we move into the next millennium. Several airline accidents that occurred in 1996, involving older Stage 2 aircraft, continue to dampen the market for such aircraft. The Partnership has been forced in the past to adjust its estimates of the residual values realizable from its aircraft, which resulted in an increase in depreciation expense, as discussed in Items 7 and 8. A discussion of the current market condition for the type of aircraft owned by the Partnership follows:
McDonnell Douglas DC-9-30 - The McDonnell Douglas DC-9-30 is a short- to medium-range twin-engine jet that was introduced in 1967. Providing reliable, inexpensive lift, these aircraft fill thin niche markets, mostly in the United States. Hushkits are available to bring these aircraft into compliance with Stage 3 noise restrictions at a cost of approximately $1.6 million per aircraft. As noted above, hushkits have been installed on the 10 remaining aircraft. Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent fatigue cracks and control corrosion as discussed in the Industry Update section of Item 7.
The General Partner believes that, in addition to the factors cited above, the deteriorated market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control, and structural inspection and modification as discussed in the Industry Update section of Item 7.
Item 2. Properties
At December 31, 1998, Polaris Aircraft Income Fund III (the Partnership) owns a portfolio of 10 used commercial jet aircraft out of its original portfolio of 38 aircraft. The portfolio includes 10 McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA). The Partnership transferred three McDonnell Douglas DC-9-10 aircraft and six Boeing 727-100 aircraft to aircraft inventory in 1992. The inventoried aircraft were disassembled for sale of their component parts, the remainder of which was sold to Soundair, Inc. in 1998. Of its original aircraft portfolio, the Partnership sold eight DC-9-10 aircraft in 1992 and 1993 and three Boeing 727-200 aircraft in May 1994. In June 1997, the Partnership sold three McDonnell Douglas DC-9-30 aircraft leased to TWA, and five Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental) to Triton Aviation Services III LLC.
The following table describes the Partnership's aircraft portfolio at December 31, 1998 in greater detail:
Year of Cycles Aircraft Type Serial Number Manufacture As of 11/30/98 (1) - ------------- ------------- ----------- ------------------ McDonnell Douglas DC-9-30 47028 1967 85,687 McDonnell Douglas DC-9-30 47030 1967 85,129 McDonnell Douglas DC-9-30 47095 1967 80,921 McDonnell Douglas DC-9-30 47109 1968 84,331 McDonnell Douglas DC-9-30 47134 1967 79,923 McDonnell Douglas DC-9-30 47136 1968 79,981 McDonnell Douglas DC-9-30 47172 1968 81,333 McDonnell Douglas DC-9-30 47173 1968 84,274 McDonnell Douglas DC-9-30 47250 1968 85,403 McDonnell Douglas DC-9-30 47491 1970 77,527
(1) Cycle information as of 12/31/98 was not available.
Item 3.
Item 3. Legal Proceedings
Midway Airlines, Inc. (Midway) Bankruptcy - As previously reported in the Partnership's 1997 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 Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Insurance Company of America and James J. Darr. The complaint alleges violations of the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act of 1933, common law fraud, fraud in the
inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy arising from the defendants' alleged misrepresentation and failure to disclose material facts in connection with the sale of Limited Partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest, and double and treble damages under the Texas Deceptive Trade Practices Act. The trial court has issued a revised scheduling order setting the trial date for this action for September 7, 1999.
Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about June 18, 1997, a purported class action entitled Ron Wallace v. Polaris Investment Management Corporation, et al. was filed on behalf of the unitholders of Polaris Aircraft Income Funds II through VI in the Superior Court of the State of California, County of San Francisco. The complaint names each of Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company, General Electric Capital Corporation, certain executives of PIMC and GECAS and John E. Flynn, a former PIMC executive, as defendants. The complaint alleges that defendants committed a breach of their fiduciary duties with respect to the Sale Transaction involving the Partnership as described in Item 7, under the caption "Sale of Aircraft -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs, and on December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively.
On November 9, 1998, defendants, acting through their counsel, entered into a settlement agreement with plaintiffs and with the plaintiff in a related action, "Accelerated" High Yield Income Fund II, Ltd., L.P. v. Polaris Investment Management Corporation, et al. The settlement agreement does not provide for any payments to be made to the Partnership. Plaintiff's counsel sought reimbursement from the Partnership for its attorneys' fees and expenses. A settlement notice setting forth the terms of the settlement was mailed to the last known address of each unitholder of the Partnership on November 20, 1998. On December 24, 1998, the Court approved the terms of the settlement and approved plaintiffs' attorneys' fees and expenses in the amount of $288,949.
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.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters
a) Polaris Aircraft Income Fund III's (PAIF-III or the Partnership) units representing assignments of Limited Partnership interest (Units) are not publicly traded. The Units are held by Polaris Depositary III on behalf of the Partnership's investors (Unit Holders). 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, 1998 -------------- ------------------------
Depository Units Representing Assignments 16,333 of Limited Partnership Interests:
General Partnership Interest: 1
c) Dividends:
The Partnership distributed cash to partners on a quarterly basis beginning April 1987. Cash distributions to Unit Holders during 1998 and 1997 totaled $19,148,468 and $11,100,000, respectively. Cash distributions per Limited Partnership unit were $38.30 and $22.20 in 1998 and 1997, respectively.
Item 6.
Item 6. Selected Financial Data
* 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.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
At December 31, 1998, Polaris Aircraft Income Fund III (the Partnership) owned a portfolio of 10 used McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA) out of its original portfolio of 38 aircraft. The Partnership transferred three McDonnell Douglas DC-9-10 aircraft and six Boeing 727-100 aircraft to aircraft inventory in 1992. The inventoried aircraft were disassembled for sale of their component parts, the remainder of which was sold to Soundair, Inc. in 1998. Of its original aircraft portfolio, the Partnership sold eight DC-9-10 aircraft in 1992 and 1993 and three Boeing 727-200 aircraft in May 1994. In June 1997, the Partnership sold three McDonnell Douglas DC-9-30 aircraft leased to TWA, and five Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental) to Triton Aviation Services III LLC.
Remarketing Update
General - Polaris Investment Management Corporation (the General Partner or PIMC) evaluates, from time to time, whether the investment objectives of the Partnership are better served by continuing to hold the Partnership's remaining portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes into account the current and potential earnings of the Aircraft, the conditions in the markets for lease and sale and future outlook for such markets, and the tax consequences of selling rather than continuing to lease the Aircraft.
Sale of Aircraft Inventory to Soundair, Inc. - The Partnership sold its remaining inventory of aircraft parts from the six disassembled aircraft, to Soundair, Inc. The remaining inventory, with a net carrying value of $-0-, was sold effective February 1, 1998 for $100,000, less amounts previously received for sales as of that date. The net purchase price of $88,596 was paid in September 1998, and is included in gain on sale of aircraft inventory.
Partnership Operations
The Partnership reported net income of $5,287,954, or $7.90 per Limited Partnership unit for the year ended December 31, 1998, compared to net income of $4,989,096, or $9.88 per Limited Partnership unit and a net loss of $6,803,529, or $17.25 per Limited Partnership unit, for the years ended December 31, 1997 and 1996, respectively. Variances in net income may not correspond to variances in net income per Limited Partnership unit due to the allocation of components of income and loss in accordance with the Partnership agreement.
The decrease in rental revenues, depreciation expense and management fees during 1998 and 1997, was primarily attributable to the sale of 8 aircraft to Triton during 1997. This decrease in rental revenues and depreciation expense was offset in part by increased depreciation expense attributable to the acquisition, in November 1996, of noise-suppression devices, commonly known as "hushkits", for the 10 aircraft currently leased to TWA. The hushkits are being financed over 50 months at an interest rate of 10% per annum. The leases for these 10 aircraft were extended for a November 2004. The rent payable by TWA under the leases has been increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. The Partnership recorded $908,701, $1,205,566 and $122,197 in interest expense on the amount borrowed to finance the hushkits during 1998, 1997 and 1996, respectively.
The Partnership recorded other income of $785,094 during 1997 compared to $-0- during 1998. This other income, in 1997, was primarily the result of the receipt of $743,476 related to amounts due under the TWA maintenance credit and rent deferral agreement, as discussed below under TWA Restructuring.
Interest income decreased during 1998, as compared to 1997, primarily due to the payoff of notes receivable from Continental Airlines, Inc. and Triton during 1997.
Operating expense increased due to legal expense related to the Ron Wallace Litigation Settlement as more fully described below.
In January 1995, the United States Bankruptcy Court approved an agreement between the Partnership and Continental which specified payment to the Partnership by Continental of approximately $1.3 million as final settlement for the return of six Boeing 727-100 aircraft. The Partnership received an initial payment of $311,111 in February 1995 and received the balance of the settlement in equal monthly installments of $72,222 through February 1996. The Partnership received all payments due from Continental for the settlement, which were recorded as revenue when received. The Partnership recorded payments of $144,444 as lessee settlements during 1996.
The Partnership recognized substantially higher depreciation expense in 1996, as compared to the prior year. As discussed in the Industry Update section, if the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized an impairment loss on aircraft to be held and used by the Partnership of approximately $12.5 million in 1996 as increased depreciation expense. In 1996, the impairment loss was the result of several significant factors. As a result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase eight of the Partnership's remaining aircraft subject to each aircraft's existing lease. This offer constituted an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the purchase price reflected in the offer, less the estimated costs and expenses of the proposed sale. The partnership is deemed to have an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections.
The increased depreciation expense reduces the aircraft's carrying value and reduces the amount of future depreciation expense that the Partnership will recognize over the projected remaining economic life of the aircraft. For any downward adjustment to the estimated residual values, future depreciation expense over the projected remaining economic life of the aircraft is increased. The Partnership's earnings are impacted by the net effect of the adjustments to the aircraft carrying values recorded in 1996, as discussed later in the Industry Update section.
Liquidity and Cash Distributions
Liquidity - The Partnership received prepayment in full of all amounts due from Triton and all lease payments from lessees, except for the $850,000 December 27, 1998 payment due from TWA, which was received on January 4, 1999. This amount was included in rent and other receivables on the balance sheet at December 31, 1998.
During 1998, 1997 and 1996, the Partnership received net proceeds from the sale of aircraft inventory of $230,577, $590,981 and $902,733, respectively. This includes the sale of remaining inventory of aircraft parts from the four disassembled aircraft to Soundair in 1998 for $100,000.
The Partnership sold its remaining inventory of aircraft parts from the nine disassembled aircraft, to Soundair, Inc. The remaining inventory, with a net carrying value of $-0-, was sold effective February 1, 1998 for $100,000, less
amounts previously received for sales as of that date. The net purchase price of $88,596 was paid in September 1998, and is included in gain on sale of aircraft inventory.
PIMC has determined that the Partnership maintain cash reserves as a prudent measure to ensure that the Partnership has available funds in the event that the aircraft presently on lease to TWA require remarketing, and for other contingencies including expenses of the Partnership. The Partnership's cash reserves will be monitored and may be revised from time to time as further information becomes available in the future.
As discussed above and in Note 7 to the financial statements (Item 8), the Partnership agreed to share the cost of meeting certain Airworthiness Directives (ADs) with TWA. In accordance with the cost-sharing agreement, TWA may offset up to an additional $1.0 million against rental payments, subject to annual limitations, over the remaining lease terms.
Cash Distributions - Cash distributions to Limited Partners were $19,148,468, $11,100,000, and $18,875,000 in 1998, 1997 and 1996, respectively. Cash distributions per Limited Partnership unit totaled $38.30, $22.20, and $37.75 in 1998, 1997 and 1996, respectively. The timing and amount of future cash distributions are not yet known and will depend on the Partnership's future cash requirements (including expenses of the Partnership) and need to retain cash reserves as previously discussed in the Liquidity section, and the receipt of rental payments from TWA.
Impact of the Year 2000 Issue
The inability of business processes to continue to function correctly after the beginning of the Year 2000 could have serious adverse effects on companies and entities throughout the world. As discussed in prior filings with the Securities and Exchange Commission, the General Partner has engaged GE Capital Aviation Services, Inc. ("GECAS") to provide certain management services to the Partnership. Both the General Partner and GECAS are wholly-owned subsidiaries (either direct or indirect) of General Electric Capital Corporation ("GECC"). All of the Partnership's operational functions are handled either by the General Partner and GECAS or by third parties (as discussed in the following paragraphs), and the Partnership has no information systems of its own.
GECC and GECAS have undertaken a global effort to identify and mitigate Year 2000 issues in their information systems, products and services, facilities and suppliers as well as to assess the extent to which Year 2000 issues will impact their customers. Each business has a Year 2000 leader who oversees a multi-functional remediation project team responsible for applying a Six Sigma quality approach in four phases: (1) define/measure -- identify and inventory possible sources of Year 2000 issues; (2) analyze -- determine the nature and extent of Year 2000 issues and develop project plans to address those issues; (3) improve -- execute project plans and perform a majority of the testing; and (4) control -- complete testing, continue monitoring readiness and complete necessary contingency plans. The progress of this program is monitored at each business, and company-wide reviews with senior management are conducted monthly. GECC and GECAS management plan to have completed the first three phases of the program for a substantial majority of mission-critical systems by the end of 1998 and to have nearly all significant information systems, products and services, facilities and suppliers in the control phase of the program by mid-1999.
As noted elsewhere, the Partnership has ten aircraft remaining in its portfolio at this time. All of these remaining aircraft are on lease with Trans World Airlines, Inc. ("TWA"). TWA has advised GECAS that it has adopted procedures to identify and address Year 2000 issues and that it has developed a plan to implement required changes in its equipment, operations and systems. To the extent, however, that TWA suffers any material disruption of its business and operations due to Year 2000 failure of equipment or information systems, such disruption would likely have a material adverse effect on the Partnership's operations and financial condition.
Aside from maintenance and other matters relating to the Partnership's aircraft-related assets discussed above, the principal third-party vendors to the Partnership are those providing the Partnership with services such as accounting, auditing, banking and investor services. GECAS intends to apply the same standards in determining the Year 2000 capabilities of the Partnership's third-party vendors as GECAS will apply with respect to its outside vendors pursuant to its internal Year 2000 program.
The scope of the global Year 2000 effort encompasses many thousands of applications and computer programs; products and services; facilities and facilities-related equipment; suppliers; and, customers. The Partnership, like all business operations, is also dependent on the Year 2000 readiness of infrastructure suppliers in areas such as utility, communications, transportation and other services. In this environment, there will likely be instances of failure that could cause disruptions in business processes or that could affect customers' ability to repay amounts owed to the Partnership or vendors' ability to provide services without interruption. The likelihood and effects of failures in infrastructure systems, over which the Partnership has no control, cannot be estimated. However, aside from the impact of any such possible failures or the possibility of a disruption of TWA's business caused by Year 2000 failures, the General Partner does not believe that occurrences of Year 2000 failures will have a material adverse effect on the financial position, results of operations or liquidity of the Partnership.
To date, the Partnership has not incurred any Year 2000 expenditures nor does it expect to incur any material costs in the future. However, the activities involved in the Year 2000 effort necessarily involve estimates and projections of activities and resources that will be required in the future. These estimates and projections could change as work progresses.
Sale of Aircraft
Sale of Aircraft to Triton - On May 28, 1997, PIMC, on behalf of the Partnership, executed definitive documentation for the purchase of 8 of the Partnership's 18 remaining aircraft (the "Aircraft") and certain of its notes receivables by Triton Aviation Services III LLC, a special purpose company (the "Purchaser"). The closings for the purchase of the 8 Aircraft occurred from June 5, 1997 to June 25, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton Aviation" or the "Manager"), a privately held aircraft leasing company which was formed in 1996 by Triton Investments, Ltd., a company which has been in the marine cargo container leasing business for 17 years and is diversifying its portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the existing leases.
The General Partner's Decision to Approve the Transaction - In determining whether the transaction was in the best interests of the Partnership and its unitholders, PIMC evaluated, among other things, the risks and significant expenses associated with continuing to own and remarket the Aircraft (many of which were subject to leases that were nearing expiration). The General Partner determined that such a strategy could require the Partnership to expend a significant portion of its cash reserves for remarketing and that there was a substantial risk that this strategy could result in the Partnership having to reduce or even suspend future cash distributions to Limited Partners. The General Partner concluded that the opportunity to sell the Aircraft at an attractive price would be beneficial in the present market where demand for Stage II aircraft is relatively strong rather than attempting to sell the aircraft "one-by-one" over the coming years when the demand for such Aircraft might be weaker. GE Capital Aviation Services, Inc. ("GECAS"), which provides aircraft marketing and management services to the General Partner, sought to obtain the best price and terms available for these Stage II aircraft given the aircraft market and the conditions and types of planes owned by the Partnership. Both the General Partner and GECAS approved the sale terms of the Aircraft as being in the best interest of the Partnership and its unit holders because both believe that this transaction will optimize the potential cash distributions to be paid to Limited Partners. To ensure that no better offer could be obtained, the terms of the transaction negotiated by GECAS included a "market-out" provision that permitted the Partnership to elect to accept an offer for all (but not less than all) of the assets to be sold by it to the Purchaser on terms which it deemed more favorable, with the ability of the Purchaser to match the
offer or decline to match the offer and be entitled to be compensated in an amount equal to 1.5% of the Purchaser's proposed purchase price. The Partnership did not receive any other offers and, accordingly, the General Partner believes that a valid market check had occurred confirming that the terms of this transaction were the most beneficial that could have been obtained.
The Terms of the Transaction - The total contract purchase price (the "Purchase Price") to the Purchaser was $10,947,000 which was allocated to the Aircraft and a note receivable by the Partnership. The Purchaser paid into an escrow account $1,233,289 of the Purchase Price in cash at the closing of the first aircraft and delivered a promissory note (the "Promissory Note") for the balance of $9,713,711. The Partnership received payment of $1,233,289 from the escrow account on June 26, 1997. On December 30, 1997, the Partnership received prepayment in full of the outstanding note receivable and interest earned by the Partnership to that date.
Under the purchase agreement, the Purchaser purchased the Aircraft effective as of April 1, 1997 notwithstanding the actual closing dates. The utilization of an effective date facilitated the determination of rent and other allocations between the parties. The Purchaser had the right to receive all income and proceeds, including rents and receivables, from the Aircraft accruing from and after April 1, 1997, and the Promissory Note commenced bearing interest as of April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold subject to the existing leases.
Neither PIMC nor GECAS received a sales commission in connection with the transaction. In addition, PIMC was not paid a management fee with respect to the collection of the Promissory Note or on any rents accruing from or after April 1, 1997 with respect to the 8 Aircraft. Neither PIMC nor GECAS or any of its affiliates holds any interest in Triton Aviation or any of Triton Aviation's affiliates. John Flynn, the current President of Triton Aviation, was a Polaris executive until May 1996 and has over 15 years experience in the commercial aviation industry. At the time Mr. Flynn was employed at PIMC, he had no affiliation with Triton Aviation or its affiliates.
Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold certain aircraft assets to separate special purpose companies under common management with the Purchaser (collectively, together with the Purchaser, the "SPC's") on terms similar to those set forth above, with the exception of the Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.
The Accounting Treatment of the Transaction - In accordance with GAAP, the Partnership recognized rental income up until the closing date for each aircraft which occurred from June 5, 1997 to June 25, 1997. However, under the terms of the transaction, the Purchaser was entitled to receive any payments of the rents, interest income and receivables accruing from April 1, 1997. As a result, the Partnership made payments to the Purchaser for the amounts due and received from April 1, 1997 to the closing date. Amounts totaling $1,341,968 during this period are included in rents from operating leases, interest and other income. For financial reporting purposes, the cash down payment portion of the sales proceeds of $1,233,289 has been adjusted by the following; income and proceeds, including rents and receivables from the effective date of April 1, 1997 to the closing date, interest due from the Purchaser on the cash portion of the purchase price, interest on the Promissory Note from the effective date of April 1, 1997 to the closing date and estimated selling costs. As a result of these GAAP adjustments, the net adjusted sales price recorded by the Partnership, including the Promissory Note, was $9,827,305.
The Aircraft sold pursuant to the definitive documentation executed on May 28, 1997 had been classified as aircraft held for sale from that date until the actual closing date. Under GAAP, aircraft held for sale are carried at their fair market value less estimated costs to sell. The adjustment to the sales proceeds described above and revisions to estimated costs to sell the Aircraft required the Partnership to record an adjustment to the net carrying value of the aircraft held for sale of $1,092,046 during the three months ended June 30, 1997. This adjustment to the net carrying value of the aircraft held for sale is included in depreciation expense on the statement of operations.
TWA Restructuring
In October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that were managed by GECAS, 13 of which were owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft.
The Deferral Agreement provided for (i) a moratorium on all the rent due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership recorded a note receivable and an allowance for credit losses equal to the total of the deferred rents, the net of which was reflected in the Partnership's 1994 balance sheet (Item 8). The Partnership did not recognize either the $1,137,500 rental amount deferred in 1994 or the $1,462,500 rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The Partnership received all scheduled rent payments beginning in April 1995, and all scheduled deferred rental payments beginning in May 1995, including interest at a rate of 12% per annum, from TWA and has recognized the $2.6 million deferred rents as rental revenue during 1995. The deferred rents were paid in full by October 1995.
In consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. In addition, TWA agreed to issue warrants to the Partnership for TWA Common Stock.
In order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents.
On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995, the Bankruptcy Court confirmed TWA's plan of reorganization, which became effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the confirmation date of the plan, August 4, 1995, the Partnership received a payment of $881,480 from TWA which represented fifty percent (50%) of the deferred rent outstanding plus interest as of such date. The remaining balance of deferred rent plus interest was paid in full to the Partnership on October 2, 1995. TWA has been current with its obligation to the Partnership since August 1995. While TWA has committed to an uninterrupted flow of lease payments, there can be no assurance that TWA will continue to honor its obligations in the future.
The Partnership received warrants to purchase 159,919 shares of TWA Common Stock from TWA in November 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share. The fair market value of the TWA stock at December 31, 1995 was $1,659,159, which was determined based on quoted market prices. The Partnership sold the TWA Common Stock in February
1996, net of broker commissions, for $1,698,057 and recognized a gain on trading securities of $38,898 in 1996.
Ron Wallace Litigation Settlement
Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about June 18, 1997, a purported class action entitled Ron Wallace v. Polaris Investment Management Corporation, et al. was filed on behalf of the unitholders of Polaris Aircraft Income Funds II through VI in the Superior Court of the State of California, County of San Francisco. The complaint names each of Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company, General Electric Capital Corporation, certain executives of PIMC and GECAS and John E. Flynn, a former PIMC executive, as defendants. The complaint alleges that defendants committed a breach of their fiduciary duties with respect to the Sale Transaction involving the Partnership as described in Item 7, under the caption "Sale of Aircraft -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs, and on December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively.
On November 9, 1998, defendants, acting through their counsel, entered into a settlement agreement with plaintiffs and with the plaintiff in a related action, "Accelerated" High Yield Income Fund II, Ltd., L.P. v. Polaris Investment Management Corporation, et al. The settlement agreement does not provide for any payments to be made to the Partnership. Plaintiff's counsel sought reimbursement from the Partnership for its attorneys' fees and expenses. A settlement notice setting forth the terms of the settlement was mailed to the last known address of each unitholder of the Partnership on November 20, 1998. On December 24, 1998, the Court approved the terms of the settlement and approved plaintiffs' attorney's fees and expenses in the amount of $288,949, which is included in operating expenses.
Industry Update
Maintenance of Aging Aircraft - The process of aircraft maintenance begins at the aircraft design stage. For aircraft operating under Federal Aviation Administration (FAA) regulations, a review board consisting of representatives of the manufacturer, FAA representatives and operating airline representatives is responsible for specifying the aircraft's initial maintenance program. The General Partner understands that this program is constantly reviewed and modified throughout the aircraft's operational life.
Since 1988, the FAA, working with the aircraft manufacturers and operators, has issued a series of ADs which mandate that operators conduct more intensive inspections, primarily of the aircraft fuselages. The results of these mandatory inspections may uncover the need for repairs or structural modifications that may not have been required under pre-existing maintenance programs.
In addition, an AD adopted in 1990, applicable to McDonnell Douglas aircraft, requires replacement or modification of certain structural items on a specific timetable. These structural items were formerly subject to periodic inspection, with replacement when necessary. The AD requires specific work to be performed at various cycle thresholds between 40,000 and 100,000 cycles, and on specific date or age thresholds. The estimated cost of compliance with all of the components of this AD is approximately $850,000 per aircraft. The extent of modifications required to an aircraft varies according to the level of incorporation of design improvements at manufacture.
In January 1993, the FAA adopted another AD intended to mitigate corrosion of structural components, which would require repeated inspections from 5 years of age throughout the life of an aircraft, with replacement of corroded components
as needed. Integration of the new inspections into each aircraft operator's maintenance program was required by January 31, 1994.
The Partnership's existing leases require the lessees to maintain the Partnership's aircraft in accordance with an FAA-approved maintenance program during the lease term. At the end of the leases, each lessee is generally required to return the aircraft in airworthy condition, including compliance with all ADs for which action is mandated by the FAA during the lease term. The Partnership agreed to bear a portion of certain maintenance and/or AD compliance costs, as discussed in Item 1, with respect to the aircraft leased to TWA. 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. In negotiating subsequent leases, market conditions currently generally require that the Partnership bear some or all of the costs of compliance with future ADs or ADs that have been issued, but which did not require action during the previous lease term. The ultimate effect on the Partnership of compliance with the FAA maintenance standards is not determinable at this time and will depend on a variety of factors, including the state of the commercial aircraft industry, the timing of the issuance of ADs, and the status of compliance therewith at the expiration of the current leases.
Aircraft Noise - Another issue which has affected the airline industry is that of aircraft noise levels. The FAA has categorized aircraft according to their noise levels. Stage 1 aircraft, which have the highest noise level, are no longer allowed to operate from civil airports in the United States. Stage 2 aircraft meet current FAA requirements, subject to the phase-out rules discussed below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all new aircraft.
On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2 aircraft by the end of this decade. The key features of the rule include:
- Compliance can be accomplished through a gradual process of phase-in or phase-out (see below) on each of three interim compliance dates: December 31, 1994, 1996 and 1998. All Stage 2 aircraft must be phased out of operations in the contiguous United States by December 31, 1999, with waivers available in certain specific cases to December 31, 2003.
- All operators have the option of achieving compliance through a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25% of its Stage 2 fleet on each of the compliance dates noted above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%, 65% and 75% of an operator's fleet must consist of Stage 3 aircraft by the respective interim compliance dates noted above).
The federal rule does not prohibit local airports from issuing more stringent phase-out rules. In fact, several local airports have adopted more stringent noise requirements which restrict the operation of Stage 2 and certain Stage 3 aircraft.
Other countries have also adopted noise policies. The European Union (EU) adopted a non-addition rule in 1989, which directed each member country to pass the necessary legislation to prohibit airlines from adding Stage 2 aircraft to their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the year 2002. The International Civil Aviation Organization has also endorsed the phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.
Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are currently available for the Partnership's aircraft. Hushkits were added to 10 of the Partnership's Stage 2 aircraft in 1996.
Currently, legislation has been drafted and is under review by the EU to adopt anti-hushkitting regulations within member states. The legislation seeks to ban hushkitted aircraft from being added to member states registers after April 1, 1999 and will preclude all operation of hushkitted aircraft within the EU by
April 1, 2002. The effect of this proposal has been to reduce the demand for hushkitted aircraft within the EU and its neighboring states, including the former Eastern Block states.
Demand for Aircraft - At year end 1998, there were approximately 12,600 jet aircraft in the world fleet. Approximately 1,500 aircraft were leased or sold during 1998, an increase of 14% over 1997. Air travel has grown strongly during the past 28 years, with the last nineteen years showing better than 5.5% annual growth, and not until recently has it subsided after what had been a robust period from 1994 to 1997. This strong period has mainly benefited Stage 3 narrow bodies and younger Stage 2 narrow bodies, many of which have been or are being upgraded with hushkits. During 1998, the industry saw many alliances taking place. There was more consolidation in the U.S. Airline Industry via alliances than had been seen in the previous 20 years since deregulation. Booming traffic demand coupled with reductions in the price of aviation fuel has resulted in record profits for many airlines in North America and Europe. However, slower traffic lies ahead, the cycle has peaked in 1998, as may have airline profits. Manufacturers continue to produce at high levels compared to what demand will require in the future years. Asia continues its economic turmoil which has brought about a significant reduction in traffic growth in that region. This is resulting in a number of new aircraft order deferrals and cancellations, mainly in the wide body sector, with over capacity moving from Asia into the other regions around the world. Timing of when the down cycle ends or how severe it will be is still in question, but will be closely watched as we move into the next millennium.
Effects on the Partnership's Aircraft - The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft is increased.
If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, the Partnership recognizes the deficiency currently as increased depreciation expense. The Partnership recognized approximately $12.5 million, or $24.95 per Limited Partnership unit, of this deficiency as increased depreciation expense in 1996. In 1996, the impairment loss was the result of several significant factors. As a result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase eight of the Partnership's remaining aircraft subject to each aircraft's existing lease. This offer constituted an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the proposed purchase price reflected in the offer, and then deducted this amount from the carrying value of the aircraft. The partnership recorded an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections.
The Partnership periodically reviews its aircraft for impairment in accordance with SFAS No. 121. The Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future.
Item 8.
Item 8. Financial Statements and Supplementary Data
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
FINANCIAL STATEMENTS AS OF DECEMBER 31, 1998 AND 1997
AND FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
TOGETHER WITH THE
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
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, 1998 and 1997, 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, 1998. These financial statements are the responsibility of the General Partner. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the General Partner, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Polaris Aircraft Income Fund III, A California Limited Partnership as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California, January 25, 1999
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
1998 1997 ---- ---- ASSETS:
CASH AND CASH EQUIVALENTS $ 13,423,701 $ 28,632,488
RENT AND OTHER RECEIVABLES 850,748 850,760
AIRCRAFT, net of accumulated depreciation of $56,439,234 in 1998 and $53,612,863 in 1997 25,745,343 28,571,714 ------------ ------------
$ 40,019,792 $ 58,054,962 ============ ============
LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):
PAYABLE TO AFFILIATES $ 115,888 $ 123,242
ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 121,632 80,211
DEFERRED INCOME 1,837,210 626,578
NOTES PAYABLE 7,792,177 11,080,004 ------------ ------------
Total Liabilities 9,866,907 11,910,035 ------------ ------------
PARTNERS' CAPITAL (DEFICIT): General Partner (3,642,196) (2,854,104) Limited Partners, 499,960 and 500,000 units outstanding in 1998 and 1997 33,795,081 48,999,031 ------------ ------------
Total Partners' Capital 30,152,885 46,144,927 ------------ ------------
$ 40,019,792 $ 58,054,962 ============ ============
The accompanying notes are an integral part of these statements.
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ---- ---- ----
REVENUES: Rent from operating leases $ 8,989,368 $ 11,965,617 $ 15,230,936 Interest 835,969 1,617,688 1,438,839 Gain on sale of aircraft inventory 230,577 590,981 206,781 Lessee settlements -- -- 144,444 Gain on trading securities -- -- 38,898 Other -- 785,094 17,860 ------------ ------------ ------------
Total Revenues 10,055,914 14,959,380 17,077,758 ------------ ------------ ------------
EXPENSES: Depreciation 2,826,371 7,930,392 22,661,686 Management fees to General Partner 347,147 420,482 761,547 Interest 908,701 1,205,566 122,197 Operating 318,160 33,158 24,549 Administration and other 367,581 380,686 311,308 ------------ ------------ ------------
Total Expenses 4,767,960 9,970,284 23,881,287 ------------ ------------ ------------
NET INCOME (LOSS) $ 5,287,954 $ 4,989,096 $ (6,803,529) ============ ============ ============
NET INCOME ALLOCATED TO THE GENERAL PARTNER $ 1,339,516 $ 49,891 $ 1,819,276 ============ ============ ============
NET INCOME (LOSS) ALLOCATED TO THE LIMITED PARTNERS $ 3,948,438 $ 4,939,205 $ (8,622,805) ============ ============ ============
NET INCOME (LOSS) PER LIMITED PARTNERSHIP UNIT $ 7.90 $ 9.88 $ (17.25) ============ ============ ============
The accompanying notes are an integral part of these statements.
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
General Limited Partner Partners Total ------- -------- -----
Balance, December 31, 1995 $ (1,392,716) $ 82,657,631 $ 81,264,915
Net income (loss) 1,819,276 (8,622,805) (6,803,529)
Cash distributions to partners (2,097,222) (18,875,000) (20,972,222) ------------ ------------ ------------
Balance, December 31, 1996 (1,670,662) 55,159,826 53,489,164
Net income 49,891 4,939,205 4,989,096
Cash distributions to partners (1,233,333) (11,100,000) (12,333,333) ------------ ------------ ------------
Balance, December 31, 1997 (2,854,104) 48,999,031 46,144,927
Net income 1,339,516 3,948,438 5,287,954
Capital redemptions -- (3,920) (3,920)
Cash distributions to partners (2,127,608) (19,148,468) (21,276,076) ------------ ------------ ------------
Balance, December 31, 1998 $ (3,642,196) $ 33,795,081 $ 30,152,885 ============ ============ ============
The accompanying notes are an integral part of these statements.
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
The accompanying notes are an integral part of these statements.
POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. Accounting Principles and Policies
Accounting Method - Polaris Aircraft Income Fund III, A California Limited Partnership (PAIF-III or the Partnership), maintains its accounting records, prepares its financial statements and files its tax returns on the accrual basis of accounting. The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect reported amounts and related disclosures. Actual results could differ from those estimates. The most significant estimates with regard to these financial statements are related to the projected cash flows analysis in determining the fair value of assets.
Cash and Cash Equivalents - This includes deposits at banks and investments in money market funds. Cash and Cash Equivalents is stated at cost, which approximates fair value.
Marketable Securities, trading - Marketable Securities, trading were carried at fair value, which was determined based on quoted market prices. These securities were held for sale in the near term (Note 7).
Aircraft and Depreciation - The aircraft are recorded at cost, which includes acquisition costs. Depreciation to an estimated residual value is computed using the straight-line method over the estimated economic life of the aircraft which was originally estimated to be 30 years from the date of manufacture. Depreciation in the year of acquisition was calculated based upon the number of days that the aircraft were in service.
The Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life. For any downward adjustment in estimated residual value or decrease in the projected remaining economic life, the depreciation expense over the projected remaining economic life of the aircraft will be increased.
If the projected net cash flow for each aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of the aircraft, an impairment loss is recognized. Pursuant to Statement of Financial Accounting Standards (SFAS) No. 121, as discussed in Note 3, measurement of an impairment loss will be based on the "fair value" of the asset as defined in the statement.
Capitalized Costs - Aircraft modification and maintenance costs which are determined to increase the value or extend the useful life of the aircraft are capitalized and amortized using the straight-line method over the estimated useful life of the improvement. These costs are also subject to periodic evaluation as discussed above.
Aircraft Inventory - Aircraft held in inventory for sale are reflected at the lower of depreciated cost or estimated net realizable value. Proceeds from sales are applied against inventory until the book value is fully recovered. The remaining book value of the inventory was recovered in 1996. The Partnership sold its remaining inventory of aircraft parts in 1998. Proceeds in excess of the inventory net book value are recorded as revenue when received.
Operating Leases - The aircraft leases are accounted for as operating leases. Lease revenues are recognized in equal installments over the terms of the leases.
Operating Expenses - Operating expenses include costs incurred to maintain, insure and lease the Partnership's aircraft, including costs related to lessee defaults and costs of disassembling aircraft inventory.
Net Income (Loss) Per Limited Partnership Unit - Net income (loss) per Limited Partnership unit is based on the Limited Partners' share of net income or loss and the number of units outstanding of 499,960 for the year ended December 31, 1998, and 500,000 for the years ended December 31, 1997 and 1996, respectively.
Income Taxes - The Partnership files federal and state information income tax returns only. Taxable income or loss is reportable by the individual partners.
Notes Receivable - The Partnership had recorded an allowance for credit losses for certain impaired notes as discussed in Note 9. The Partnership recognizes revenue on these notes only as payments are received.
1998 1997 ---- ---- Allowance for credit losses, beginning of year $ -- $(160,571) Collections -- 160,571 --------- --------- Allowance for credit losses, end of year $ -- $ -- ========= =========
2. Organization and the Partnership
The Partnership was formed on June 27, 1984 for the purpose of acquiring and leasing aircraft. The Partnership will terminate no later than December 2020. Upon organization, both the General Partner and the depositary 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. During January 1998, 40 units were redeemed by the Partnership in accordance with section 18 of the Limited Partnership agreement. At December 31, 1998, there were 499,960 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 10 and 11.
3. Aircraft
At December 31, 1998, the Partnership owned 10 aircraft from its original portfolio of 38 used commercial jet aircraft, which were acquired and leased or sold as discussed below. 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. While the leases require the lessees to comply with Airworthiness Directives (ADs) which have been or may be issued by the Federal Aviation Administration and require compliance during the lease term, in certain of the leases, the Partnership has agreed to share in the cost of compliance with ADs. The leases generally state a minimum acceptable return condition for which the lessee is liable under the terms of the lease agreement. Certain leases also provide that if the aircraft are returned at a level above the minimum acceptable level, the Partnership must reimburse the lessee for the related excess, subject to certain limitations. The related liability, if any, is currently inestimable and therefore is not reflected in the financial statements. Of its original portfolio of 38 aircraft, the Partnership sold one aircraft in 1992, seven aircraft in 1993, three aircraft in 1994 and eight aircraft in 1997. In addition, nine aircraft were disassembled for sale of their component parts (Note 6), the remainder of which was sold to Soundair, Inc. in 1998.
The following table describes the Partnership's aircraft portfolio at December 31, 1998 in greater detail:
Year of Aircraft Type Serial Number Manufacture - ------------- ------------- ----------- McDonnell Douglas DC-9-30 47028 1967 McDonnell Douglas DC-9-30 47030 1967 McDonnell Douglas DC-9-30 47095 1967 McDonnell Douglas DC-9-30 47109 1968 McDonnell Douglas DC-9-30 47134 1967 McDonnell Douglas DC-9-30 47136 1968 McDonnell Douglas DC-9-30 47172 1968 McDonnell Douglas DC-9-30 47173 1968 McDonnell Douglas DC-9-30 47250 1968 McDonnell Douglas DC-9-30 47491 1970
Ten McDonnell Douglas DC-9-30s - 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 bankruptcy filing. In June 1997, three of the thirteen aircraft were sold, subject to the existing leases, to Triton Aviation Services III LLC, as discussed in Note 4. The leases for 10 of the 13 aircraft were extended again for eight years until November 2004, as discussed in Note 8.
The following is a schedule by year of future minimum rental revenue under the existing leases:
Year Amount ---- ------ 1999 $10,200,000 2000 10,200,000 2001 10,200,000 2002 7,450,000 2003 and thereafter 13,200,000 ----------- $51,250,000 ===========
Future minimum rental payments may be offset or reduced by future costs as described in Note 7.
As discussed in Note 1, the Partnership periodically reviews the estimated realizability of the residual values at the projected end of each aircraft's economic life based on estimated residual values obtained from independent parties which provide current and future estimated aircraft values by aircraft type.
The Partnership's future earnings are impacted by the net effect of the adjustments to the carrying 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).
As discussed above, the Partnership uses information obtained from third party valuation services in arriving at its estimate of fair value for purposes of determining residual values. The Partnership will use similar information, plus available information and estimates related to the Partnership's aircraft, to determine an estimate of fair value to measure impairment as required by the statement. The estimates of fair value can vary dramatically depending on the condition of the specific aircraft and the actual marketplace conditions at the time of the actual disposition of the asset. If assets are deemed impaired, there could be substantial write-downs in the future.
The Partnership recognized an impairment loss on aircraft held and used by the Partnership aggregating approximately $12.5 million, or $24.95 per Limited Partnership unit, as increased depreciation expense in 1996. The impairment loss was the result of several significant factors. As a result of industry and market changes, a more extensive review of the Partnership's aircraft was completed in the fourth quarter of 1996 which resulted in revised assumptions of future cash flows including reassessment of projected re-lease terms and potential future maintenance costs. As discussed in Note 4, the Partnership accepted an offer to purchase eight of the Partnership's remaining aircraft subject to each aircraft's existing lease. This offer constitutes an event that required the Partnership to review the aircraft carrying value pursuant to SFAS 121. In determining this additional impairment loss, the Partnership estimated the fair value of the aircraft based on the purchase price reflected in the offer, less the estimated costs and expenses of the proposed sale. The partnership recorded an impairment loss to the extent that the carrying value exceeded the fair value. Management believes the assumptions related to fair value of impaired assets represents the best estimates based on reasonable and supportable assumptions and projections.
The General Partner evaluates, from time to time, whether the investment objectives of the Partnership are better served by continuing to hold the Partnership's remaining portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes into account the current and potential earnings of the Aircraft, the conditions in the markets for lease and sale and future outlook for such markets, and the tax consequences of selling rather than continuing to lease the Aircraft. The General Partner has had discussions with third parties regarding the possibility of selling some or all of these Aircraft. While such discussions may continue, and similar discussions may occur again in the future, there is no assurance that such discussions will result in the Partnership receiving a purchase offer for all or any of the Aircraft which the General Partner would regard as acceptable.
4. Sale of Aircraft
Sale of Aircraft to Triton - On May 28, 1997, PIMC, on behalf of the Partnership, executed definitive documentation for the purchase of 8 of the Partnership's 18 remaining aircraft (the "Aircraft") and certain of its notes receivables by Triton Aviation Services III LLC, a special purpose company (the "Purchaser"). The closings for the purchase of the 8 Aircraft occurred from June 5, 1997 to June 25, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton Aviation" or the "Manager"), a privately held aircraft leasing company which was formed in 1996 by Triton Investments, Ltd., a company which has been in the marine cargo container leasing business for 17 years and is diversifying its portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the existing leases.
The Terms of the Transaction - The total contract purchase price (the "Purchase Price") to the Purchaser was $10,947,000 which was allocated to the Aircraft and a note receivable by the Partnership. The Purchaser paid into an escrow account $1,233,289 of the Purchase Price in cash at the closing of the first aircraft and delivered a promissory note (the "Promissory Note") for the balance of $9,713,711. The Partnership received payment of $1,233,289 from the escrow account on June 26, 1997. On December 30, 1997, the Partnership received
prepayment in full of the outstanding note receivable and interest earned by the Partnership to that date.
Under the purchase agreement, the Purchaser purchased the Aircraft effective as of April 1, 1997 notwithstanding the actual closing dates. The utilization of an effective date facilitated the determination of rent and other allocations between the parties. The Purchaser had the right to receive all income and proceeds, including rents and receivables, from the Aircraft accruing from and after April 1, 1997, and the Promissory Note commenced bearing interest as of April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold subject to the existing leases.
Neither PIMC nor GECAS received a sales commission in connection with the transaction. In addition, PIMC was not paid a management fee with respect to the collection of the Promissory Note or on any rents accruing from or after April 1, 1997 with respect to the 8 Aircraft. Neither PIMC nor GECAS or any of its affiliates holds any interest in Triton Aviation or any of Triton Aviation's affiliates. John Flynn, the current President of Triton Aviation, was a Polaris executive until May 1996 and has over 15 years experience in the commercial aviation industry. At the time Mr. Flynn was employed at PIMC, he had no affiliation with Triton Aviation or its affiliates.
Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold certain aircraft assets to separate special purpose companies under common management with the Purchaser (collectively, together with the Purchaser, the "SPC's") on terms similar to those set forth above, with the exception of the Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.
The Accounting Treatment of the Transaction - In accordance with GAAP, the Partnership recognized rental income up until the closing date for each aircraft which occurred from June 5, 1997 to June 25, 1997. However, under the terms of the transaction, the Purchaser was entitled to receive any payments of the rents, interest income and receivables accruing from April 1, 1997. As a result, the Partnership made payments to the Purchaser for the amounts due and received from April 1, 1997 to the closing date. Amounts totaling $1,341,968 during this period are included in rents from operating leases, interest and other income. For financial reporting purposes, the cash down payment portion of the sales proceeds of $1,233,289 has been adjusted by the following; income and proceeds, including rents and receivables from the effective date of April 1, 1997 to the closing date, interest due from the Purchaser on the cash portion of the purchase price, interest on the Promissory Note from the effective date of April 1, 1997 to the closing date and estimated selling costs. As a result of these GAAP adjustments, the net adjusted sales price recorded by the Partnership, including the Promissory Note, was $9,827,305.
The Aircraft sold pursuant to the definitive documentation executed on May 28, 1997 had been classified as aircraft held for sale from that date until the actual closing date. Under GAAP, aircraft held for sale are carried at their fair market value less estimated costs to sell. The adjustment to the sales proceeds described above and revisions to estimated costs to sell the Aircraft required the Partnership to record an adjustment to the net carrying value of the aircraft held for sale of $1,092,046 during the three months ended June 30, 1997. This adjustment to the net carrying value of the aircraft held for sale is included in depreciation and amortization expense on the statement of operations.
5. Ron Wallace Litigation Settlement
Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about June 18, 1997, a purported class action entitled Ron Wallace v. Polaris Investment Management Corporation, et al. was filed on behalf of the unitholders of Polaris Aircraft Income Funds II through VI in the Superior Court of the State of California, County of San Francisco. The complaint names each of Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, certain executives of PIMC and GECAS and John E. Flynn, a former PIMC executive, as defendants. The complaint alleges that defendants committed a breach of their fiduciary duties with respect to the Sale Transaction involving the Partnership as described in Note 4, under the caption "Sale of Aircraft -- Sale of Aircraft to Triton." On September 2, 1997, an amended complaint was filed adding additional plaintiffs, and on December 18, 1997, the plaintiffs filed a second amended complaint asserting their claims derivatively.
On November 9, 1998, defendants, acting through their counsel, entered into a settlement agreement with plaintiffs and with the plaintiff in a related action, "Accelerated" High Yield Income Fund II, Ltd., L.P. v. Polaris Investment Management Corporation, et al. The settlement agreement does not provide for any payments to be made to the Partnership. Plaintiff's counsel sought reimbursement from the Partnership for its attorneys' fees and expenses. A settlement notice setting forth the terms of the settlement was mailed to the last known address of each unitholder of the Partnership on November 20, 1998. On December 24, 1998, the Court approved the terms of the settlement and approved plaintiffs' attorney's fees and expenses in the amount of $288,949, which is included in operating expenses.
6. Disassembly of Aircraft
In an attempt to maximize the economic return from three of the remaining four McDonnell Douglas DC-9-10 aircraft formerly leased to Midway Airlines, Inc. (Midway) and the six Boeing 727-100 aircraft formerly leased to Continental Airlines, Inc. (Continental) (Note 9), the Partnership entered into an agreement with Soundair, Inc. (Soundair) for the disassembly and sale of these aircraft in 1992.
The Partnership has incurred the cost of disassembly and received the proceeds from the sale of such parts, net of necessary overhaul expenses, and commissions paid to Soundair. During 1998, 1997 and 1996, the Partnership received net proceeds from the sale of aircraft inventory of $230,577 (including the proceeds discussed below), $590,981 and $902,733, respectively.
The Partnership sold its remaining inventory of aircraft parts from the nine disassembled aircraft, to Soundair, Inc. The remaining inventory, with a net carrying value of $-0-, was sold effective February 1, 1998 for $100,000, less amounts previously received for sales as of that date. The net purchase price of $88,596 was paid in September 1998, and is included in gain on sale of aircraft inventory.
7. TWA Reorganization
The Partnership renegotiated the TWA leases after TWA defaulted under its leases with the Partnership during 1991. The renegotiated agreement stipulated that the Partnership share in the cost of certain ADs after TWA successfully reorganized. Pursuant to this cost-sharing agreement, since TWA emerged from its reorganization proceedings in 1993, expenses totaling $4.7 million have been offset against rental payments. Under the terms of this agreement, TWA may offset up to an additional $1.0 million against rental payments, subject to annual limitations, over the remaining lease terms.
In October 1994, TWA notified its creditors, including the Partnership, of another proposed restructuring of its debt. Subsequently, GECAS negotiated a standstill arrangement, as set forth in a letter agreement dated December 16, 1994 (the Deferral Agreement), with TWA for the 46 aircraft that were managed by GECAS, 13 of which were owned by the Partnership. As required by its terms, the Deferral Agreement (which has since been amended as discussed below) was approved by PIMC on behalf of the Partnership with respect to the Partnership's aircraft.
The Deferral Agreement provided for (i) a moratorium on the rents due to the Partnership in November 1994 and on 75% of the rents due to the Partnership from December 1994 through March 1995, and (ii) all of the deferred rents, together with interest thereon, to be repaid in monthly installments beginning in May 1995 and ending in December 1995. The repayment schedule was subsequently accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not recognize either the $1,137,500 rental amount deferred in 1994 or the $1,462,500 rental amount deferred during the first quarter of 1995 as rental revenue until the deferred rents were received. The deferred rents were paid in full by October 1995.
In consideration for the partial rent moratorium described above, TWA agreed to make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom GECAS provides management services and who agreed to the Deferral Agreement. While TWA has committed to an uninterrupted flow of lease payments, there can be no assurance that TWA will continue to honor its obligations in the future.
In order to resolve certain issues that arose after the execution of the Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27, 1995, pursuant to which they agreed to amend certain provisions of the Deferral Agreement (as so amended, the Amended Deferral Agreement). The effect of the Amended Deferral Agreement, which was approved by PIMC with respect to the Partnership's aircraft, is that TWA, in addition to agreeing to repay the deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable in warrants, the number of which was determined by formula) in consideration for the aircraft owners' agreement to defer rent under the Deferral Agreement, and, (ii) to the extent the market value of the warrants is less than the payment amount, to supply maintenance services to the aircraft owners having a value equal to such deficiency. The payment amount was determined by subtracting certain maintenance reimbursements owed to TWA by certain aircraft owners, including the Partnership, from the aggregate amount of deferred rents.
The Partnership received warrants to purchase 159,919 shares of TWA Common Stock from TWA in November 1995. The Partnership exercised the warrants on December 29, 1995 for the strike price of $0.01 per share. The fair market value of the TWA stock at December 31, 1995 of $1,659,159, which was determined based on quoted market prices. The Partnership sold the TWA Common Stock in February 1996, net of broker commissions, for $1,698,057 and recognized a gain on trading securities of $38,898 in 1996.
8. TWA Lease Extension
GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of noise-suppression devices, commonly known as "hushkits", for the 10 Partnership aircraft currently on lease to TWA, as well as other aircraft owned by affiliates of PIMC and leased to TWA. The 10 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 10 hushkits on the Partnership's aircraft was completed in November 1996 and the leases for these 10 aircraft were extended for a period of eight years until November 2004.
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 at an interest rate of approximately 10% per annum. Cash paid for interest expense on the loan was $912,172, $1,100,648 and $215,416 in 1998, 1997 and 1996, respectively.
The rent payable by TWA under the leases was increased by an amount sufficient to cover the monthly debt service payments on the hushkits and fully repay, during the term of the TWA leases, the amount borrowed. The loan from the
engine/hushkit manufacturer is non-recourse to the Partnership and secured by a security interest in the lease receivables.
9. Continental Lease Modification
The aircraft leases with Continental were modified after Continental filed for Chapter 11 bankruptcy protection in December 1990. The modified agreement stipulated that the Partnership pay certain aircraft maintenance, modification and refurbishment costs, not to exceed approximately $3.2 million, a portion of which will be recovered with interest through payments from Continental over the extended lease terms. The Partnership's share of such costs were capitalized and depreciated over the remaining lease terms, subject to the capitalized cost policy as described in Note 1. The Partnership approved invoices aggregating $1,698,106 for interior modifications on the Partnership's aircraft. The Partnership financed the aggregate amount of these invoices to Continental from 1992 through 1995 to be repaid by Continental with interest over the remaining lease terms of the aircraft. This note was paid in full during 1996.
The agreement with Continental included an extended deferral of the dates when Continental would remit its rental payments for the period from December 3, 1990 through September 30, 1991 and for a period of three months, beginning in November 1992, aggregating $9,917,500 (the Deferred Amount). The Partnership recorded a note receivable and an allowance for credit losses equal to the total of the deferred rents and prior accrued interest. The note receivable and corresponding allowance for credit losses were reduced by the principal portion of payments received. In addition, the Partnership recognized rental revenue and interest revenue in the period the deferred rental payments were received.
The allowance for credit losses on the principal and prior interest portion due was $160,571 as of December 31, 1996. The unrecognized Deferred Amount as of December 31, 1996 was $159,582. In accordance with the aforementioned agreement, Continental began making supplemental payments for the Deferred Amount plus interest on July 1, 1992. During 1996, the Partnership received supplemental payments of $1,942,267, of which $1,781,940 was recognized as rental revenue in 1996.
10. Related Parties
Under the Limited Partnership Agreement (Partnership Agreement), the Partnership paid or agreed to pay the following amounts to PIMC and/or its affiliates in connection with services rendered:
a. An aircraft management fee equal to 5% of gross rental revenues with respect to operating leases or 2% of gross rental revenues with respect to full payout leases of the Partnership, payable upon receipt of the rent. In 1998, 1997 and 1996, the Partnership paid management fees to PIMC of $300,000, $369,396, and $752,014, respectively. Management fees payable to PIMC were $104,676 and $57,530 at December 31, 1998 and 1997, respectively.
b. Reimbursement of certain out-of-pocket expenses incurred in connection with the management of the Partnership and supervision of its assets. In 1998, 1997 and 1996, the Partnership reimbursed PIMC for expenses of $714,049, $470,603, and $396,504, respectively. Reimbursements totaling $11,211 and $65,712 were payable to PIMC at December 31, 1998 and 1997, respectively.
c. A 10% interest to PIMC in all cash distributions and sales proceeds, gross income in an amount equal to 9.09% of distributed cash available from operations and 1% of net income or loss and taxable income or loss, as such terms are defined in the Partnership Agreement. After the Partnership has sold or disposed of aircraft representing 50% of the total aircraft cost, gains from the sale or other disposition of aircraft are generally allocated first to the General Partner until such time that the General
Partner's capital account is equal to the amount to be distributed to the General Partner from the proceeds of such sale or disposition.
d. A subordinated sales commission to PIMC of 3% of the gross sales price of each aircraft for services performed upon disposition and reimbursement of out-of-pocket and other disposition expenses. Subordinated sales commissions will be paid only after 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 11).
11. Partners' Capital
The Partnership Agreement (the Agreement) stipulates different methods by which revenue, income and loss from operations and gain or loss on the sale of aircraft are to be allocated to the General Partner and the Limited Partners (see Note 10). Such allocations are made using income or loss calculated under GAAP for book purposes, which, as more fully described in Note 13, varies from income or loss calculated for tax purposes.
Cash available for distributions, including the proceeds from the sale of aircraft, is distributed 10% to the General Partner and 90% to the Limited Partners.
The different methods of allocating items of income, loss and cash available for distribution combined with the calculation of items of income and loss for book and tax purposes result in book basis capital accounts that may vary significantly from tax basis capital accounts. The ultimate liquidation and distribution of remaining cash will be based on the tax basis capital accounts following liquidation, in accordance with the Agreement.
Had all the assets of the Partnership been liquidated at December 31, 1998 at the current carrying value, the tax basis capital accounts of the General Partner and the Limited Partners is estimated to be $3,015,288 and $27,137,597, respectively.
12. Income Taxes
Federal and state income tax regulations provide that taxes on the income or loss of the Partnership are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the financial statements.
The net differences between the tax basis and the reported amounts of the Partnership's assets and liabilities at December 31, 1998 and 1997 are as follows:
Reported Amounts Tax Basis Net Difference ---------------- --------- --------------
1998: Assets $40,019,792 $23,550,781 $16,469,011 Liabilities 9,866,907 8,144,706 1,722,201
1997: Assets $58,054,962 $42,276,950 $15,778,012 Liabilities 11,910,035 11,323,507 586,528
13. Reconciliation of Book Net Income (Loss) to Taxable Net Income (Loss)
The following is a reconciliation between net income (loss) per Limited Partnership unit reflected in the financial statements and the information provided to Limited Partners for federal income tax purposes:
For the years ended December 31, --------------------------------
1998 1997 1996 ---- ---- ----
Book net income (loss) per Limited Partnership unit $ 7.90 $ 9.88 $(17.25) Adjustments for tax purposes represent differences between book and tax revenue and expenses: Rental revenue 2.40 (0.53) (3.65) Management fee expense (0.15) 0.06 0.16 Depreciation (1.37) 5.12 16.36 Gain or loss on sale of aircraft - 9.00 - Basis in inventory - (0.40) (0.62) Other revenue and expense items 0.84 - (0.48) ------- ------- ------
Taxable net income (loss) per Limited Partnership unit $ 9.62 $ 23.13 $ (5.48) ======= ======= =======
The differences between net income and loss for book purposes and net income and loss for tax purposes result from the temporary differences of certain revenue and deductions.
For book purposes, rental revenue is generally recorded as it is earned. For tax purposes, certain temporary differences exist in the recognition of revenue. For tax purposes, management fee expense is accrued in the same year as the tax basis rental revenue.
The Partnership computes depreciation using the straight-line method for financial reporting purposes and generally an accelerated method for tax purposes. The Partnership also periodically evaluates the ultimate recoverability of the carrying values and the economic lives of its aircraft for book purposes and, accordingly recognized adjustments which increased book depreciation expense. As a result, the current year 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.
For book purposes, aircraft held in inventory are reflected at the lower of depreciable cost or estimated net realizable value. Differences in book and tax revenue and loss from inventory result from the differences in the book and tax carrying value of the inventory.
14. Subsequent Events
The Partnership made a cash distribution of $2,299,816 or $4.60 per Limited Partnership unit, to Limited Partners, and $255,535 to the General Partner on January 15, 1999.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
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 New York corporation (GE Capital). GE Capital has been PHC's parent company since 1986. As subsidiaries of GE Capital, GECAS and PIMC are affiliates.
The officers and directors of PIMC are:
Name PIMC Title ------------ -------------------
Eric M. Dull President; Director Marc A. Meiches Chief Financial Officer Barbara Macholl Director Norman C. T. Liu Vice President; Director Ray Warman Secretary Robert W. Dillon Assistant Secretary
Substantially all of these management personnel will devote only such portion of their time to the business and affairs of PIMC as deemed necessary or appropriate.
Mr. Dull, 38, assumed the position of President and Director of PIMC effective January 1, 1997. Mr. Dull previously was a Director of PIMC from March 31, 1995 to July 31, 1995. Mr. Dull holds the position of Executive Vice President - Risk and Portfolio Management of GECAS, having previously held the positions of Executive Vice President - Portfolio Management and Senior Vice President - Underwriting Risk Management of GECAS. Prior to joining GECAS, Mr. Dull held various positions with Transportation and Industrial Funding Corporation (TIFC).
Mr. Meiches, 46, assumed the position of Chief Financial Officer of PIMC effective October 9, 1995. Previously, he held the position of Vice President of PIMC from October 1995 to October 1997. Mr. Meiches presently holds the positions of Executive Vice President and Chief Financial and Operating Officer of GECAS. Prior to joining GECAS, Mr. Meiches has been with General Electric Company (GE) and its subsidiaries since 1978. Since 1992, Mr. Meiches held the position of Vice President of the General Electric Capital Corporation Audit Staff. Between 1987 and 1992, Mr. Meiches held Manager of Finance positions for GE Re-entry Systems, GE Government Communications Systems and the GE Astro-Space Division.
Ms. Macholl, 45, assumed the position of Director of PIMC effective February 27, 1999. Ms. Macholl presently holds the position of Senior Vice President, Marketing Finance for GECAS. Prior to joining GECAS, Ms. Macholl has been with the General Electric Company (GE) and its subsidiaries since 1977. Ms. Macholl previously held the position of Vice President Finance for CBSI Inc., a wholly owned subsidiary of the General Electric Company. Ms. Macholl has also held various financial management positions for the GE Lighting business.
Mr. Liu, 41, assumed the position of Vice President of PIMC effective May 1, 1995 and Director of PIMC effective July 31, 1995. Mr. Liu presently holds the position of Executive Vice President - Marketing and Structured Finance of GECAS, having previously held the position of Executive Vice President - Capital Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was with General Electric Capital Corporation for nine years. He has held management positions in corporate Business Development and in Syndications and Leasing for TIFC. Mr. Liu previously held the position of managing director of Kidder, Peabody & Co., Incorporated.
Mr. Warman, 50, 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, 57, held the position of Vice President - Aviation Legal and Insurance Affairs, from April 1989 to October 1997. Previously, he served as General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994, Mr. Dillon assumed the position of Assistant Secretary of PIMC. Mr. Dillon presently holds the position of Senior Vice President and Managing Counsel of GECAS.
Certain Legal Proceedings:
On or around February 17, 1993, a civil action entitled Einhorn, et al. v. Polaris Public Income Funds, et al. was filed in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida against, among others, Polaris Investment Management Corporation and Polaris Depositary Company. The Partnership is not named as a defendant in this action. Plaintiffs seek class action certification on behalf of a class of investors in Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI who purchased their interests while residing in Florida. Plaintiffs allege the violation of Section 517.301, Florida Statutes, in connection with the offering and sale of units in such Polaris Aircraft Income Funds. Plaintiffs seek rescission or damages, in addition to interest, costs, and attorneys' fees. On May 7, 1993, the court granted the defendants' motion to stay this action, and subsequently this suit was dismissed.
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.
In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v. Prudential Securities, Incorporated et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities Incorporated and Stephen Derby Gisclair. On or about January 18, 1996, plaintiff filed a First Supplemental and Amending Petition adding defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief.
On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v. General Electric Co., et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection with the public offering of Polaris Aircraft Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief.
In or around December 1994, a complaint entitled John J. Jones, Jr. v. Prudential Securities Incorporated et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition adding as additional defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of section of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund III. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief.
On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v. General Electric Company, et al. was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint named as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary duty in tort, contract and quasi-contract, violation of sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief.
On or about May 7, 1996, a petition entitled Charles Rich, et al. v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiffs allege claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and general relief.
On or about March 4, 1996, a petition entitled Richard J. McGiven v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief.
On or about March 4, 1996, a petition entitled Alex M. Wade v. General Electric Company and General Electric Capital Corporation was filed in the Civil District Court for the Parish of Orleans, State of Louisiana. The complaint names as defendants General Electric Company and General Electric Capital Corporation. The Partnership is not named as a defendant in this action. Plaintiff alleges claims of tort concerning the inducement and solicitation of purchases arising out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and general relief.
Other Proceedings - Part I, Item 3 discusses certain other actions arising out of certain public offerings, including that of the Partnership, to which both the Partnership and its General Partner are parties.
Item 11.
Item 11. Executive Compensation
PAIF-III has no directors or officers. PAIF-III is managed by PIMC, the General Partner. In connection with management services provided, management and advisory fees of $300,000 were paid to PIMC in 1998 in addition to a 10% interest in all cash distributions as described in Note 10 to the financial statements (Item 8).
Item 12.
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.
Item 13. Certain Relationships and Related Transactions
None.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
1. Financial Statements.
The following are included in Part II of this report: Page No. --------
Report of Independent Public Accountants 18 Balance Sheets 19 Statements of Operations 20 Statements of Changes in Partners' Capital (Deficit) 21 Statements of Cash Flows 22 Notes to Financial Statements 23
2. Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December 31, 1998.
3. Exhibits required to be filed by Item 601 of Regulation S-K.
27. Financial Data Schedule (in electronic format only).
4. Financial Statement Schedules.
All financial statement schedules are omitted because they are not applicable, not required or because the required information is included in the financial statements or notes thereto.
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 24, 1999 By: /S/ Eric M. Dull -------------- ------------------------- Date Eric M. Dull, President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature Title Date --------- ----- ----
/S/Eric M. Dull President and Director of Polaris March 24, 1999 --------------- Investment Management Corporation, -------------- (Eric M. Dull) General Partner of the Registrant
/S/Marc A. Meiches Chief Financial Officer of Polaris March 24, 1999 ------------------ Investment Management Corporation, -------------- (Marc A. Meiches) General Partner of the Registrant
/S/Barbara Macholl Director of Polaris Investment March 24, 1999 ------------------- Management Corporation, General -------------- (Barbara Macholl) Partner of the Registrant
/S/Norman C. T. Liu Vice President and Director of March 24, 1999 ------------------- Polaris Investment Management -------------- (Norman C. T. Liu) Corporation, General Partner of the Registrant