POLARIS AIRCRAFT INCOME FUND III, 10-K, 1996-03-29

POLARIS AIRCRAFT INCOME FUND III
10-K, 1996-03-29
EQUIPMENT RENTAL & LEASING, NEC

Previous: SERVICEMASTER LTD PARTNERSHIP, 10-K, 1996-03-29

Next: ADVANCED TECHNOLOGY LABORATORIES INC/, 10-K, 1996-03-29

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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

FORM 10-K

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

X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
--- SECURITIES EXCHANGE ACT OF 1934 (Fee Required)
For the fiscal year ended December 31, 1995

--- TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from to
--- ---

Commission File No. 33-10122

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

California 94-3023671
------------------------------- ----------------------
(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)

201 Mission Street, 27th Floor, San Francisco, California 94105
--------------------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (415) 284-7400

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

Securities registered pursuant to Section 12(g) of the Act:
Depository Units Representing Assignments of Limited Partnership Interests

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

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

No formal market exists for the units of limited partnership interest and
therefore there exists no aggregate market value at December 31, 1995.

Documents incorporated by reference: None

This document consists of 45 pages.

<PAGE>

PART I

Item 1. Business

The principal objectives of Polaris Aircraft Income Fund III, A California
Limited Partnership (PAIF-III or the Partnership), are 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 management services to GPA
Group plc, a public limited company organized in Ireland, together with its
consolidated subsidiaries (GPA), which acquires, leases and sells aircraft.
Accordingly, in seeking to re-lease and sell its aircraft, the Partnership may
be in competition with the general partner, its affiliates, and GPA.

A brief description of the aircraft owned by the Partnership is set forth in
Item 2. The following table describes certain material terms of the
Partnership's leases to Continental Airlines, Inc. (Continental) and Trans World
Airlines, Inc. (TWA) as of December 31, 1995:

Number of Lease
Lessee Aircraft Type Aircraft Expiration Renewal Options
- ------ ------------- -------- ---------- ---------------

Continental Boeing 727-200 Advanced 5 10/96(1) up to three
one-year periods

TWA McDonnell Douglas DC-9-30 13 2/98(2) none

(1) The Continental leases were modified in 1991. The leases for the Boeing
727-200 Advanced aircraft were extended for 37 months beyond the
initial lease expiration date in September 1993 at approximately 90% of
the original lease rates. The Partnership also agreed to pay for
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. Continental has the option to renew the leases
annually for up to three one-year periods at a lease rate to be
determined as provided for in the lease agreement.

(2) TWA may specify a lease expiration date for each aircraft up to six
months before the date shown, provided the average date for the 13
aircraft is February 1998. The TWA leases were modified in 1991; the
leases were extended for an aggregate of 75 months beyond the initial
lease expiration date in November 1991 at approximately 46% of the
original lease rates. The Partnership also agreed to share in the costs
of certain Airworthiness Directives (ADs). If such costs are incurred
by TWA, they will be credited against rental payments, subject to
annual limitations with a maximum of $500,000 per aircraft over the
lease terms.

<PAGE>

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).

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 have been disassembled for sale of their
component parts. Disassembly of the six Boeing 727-100 aircraft began in
December 1994. It is anticipated that the disassembly and sales process will
take at least three years. The leases for three Boeing 727-200 aircraft to
Continental expired in April 1994. These aircraft were subsequently sold to
Continental.

Industry-wide, approximately 475 commercial aircraft are currently available for
sale or lease, approximately 125 less than a year ago. From 1991 through 1994,
depressed demand for air travel limited airline expansion plans, with new
aircraft orders and scheduled deliveries being canceled or substantially
deferred. As profitability declined, some airlines took action to downsize or
liquidate assets and many airlines were forced to file for bankruptcy
protection. Following two years of good traffic growth accompanied by rising
yields, this trend is improving with new aircraft orders last year exceeding
deliveries for the first time since 1990. To date, this recovery has mainly
benefited Stage 3 narrow-bodies and younger Stage 2 narrow-bodies, many of which
are now being upgraded with noise suppression hardware, commonly known as
"hushkits," which, when installed on the aircraft, bring Stage 2 aircraft into
compliance with Federal Aviation Administration (FAA) Stage 3 noise restrictions
as discussed in the Industry Update section of Item 7. Older Stage 2
narrow-bodies have shown marginal signs of recovery. The Partnership has been
forced to adjust its estimates of the residual values realizable from its
aircraft and aircraft inventory, which resulted in an increase in depreciation
expense, as discussed in Item 7. A discussion of the current market condition
for the type of aircraft owned by the Partnership follows:

Boeing 727-200 Advanced - The Boeing 727 was the first tri-jet introduced into
commercial service. The Boeing 727 is a short- to medium-range jet used for
trips of up to 1,500 nautical miles. In 1972, Boeing introduced the Boeing
727-200 Advanced model, a higher gross weight version with increased fuel
capacity as compared with the non-advanced model. Hushkits which bring the
Boeing 727-200 Advanced into compliance with FAA Stage 3 noise restrictions, are
now available at an average cost of approximately $2.6 million per aircraft.
Hushkits may not be cost effective on all aircraft due to the age of some of the
aircraft and the time required to fully amortize the additional investment.
Certain ADs applicable to all models of the Boeing 727 have been issued to
prevent fatigue cracks and control corrosion as discussed in Item 7. The market
for this type of aircraft, as for all Stage 2 narrowbody aircraft, has improved
over the previous year.

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 Hushkits at a cost of approximately $1.7 million per
aircraft. Hushkits may not be cost effective on all aircraft due to the age of
some of the aircraft and the time required to fully amortize the additional

<PAGE>

investment. Certain ADs applicable to the McDonnell Douglas DC-9 have been
issued to prevent fatigue cracks and control corrosion. The market for this type
of aircraft, as for all Stage 2 narrowbody aircraft, has improved over the
previous year.

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

PAIF-III owns a portfolio of 18 commercial jet aircraft and certain inventoried
aircraft parts out of its original portfolio of 38 aircraft. The portfolio
includes 13 McDonnell Douglas DC-9-30 aircraft leased to TWA and five Boeing 727
Series 200 Advanced aircraft leased to Continental. The Partnership's entire
fleet consists of Stage 2 aircraft. All leases are operating leases. The
Partnership transferred three McDonnell Douglas DC-9-10 aircraft, formerly
leased to Midway, and six Boeing 727-100 aircraft, formerly leased to
Continental, to aircraft inventory. The inventoried aircraft, which are not
included in the following table, have been or are being disassembled for sale of
their component parts.

The following table describes the Partnership's current aircraft portfolio in
greater detail:

Year of Cycles
Aircraft Type Serial Number Manufacture As of 11/30/95(1)
- ------------- ------------- ----------- -----------------
Boeing 727-200 Advanced 21247 1976 32,108
Boeing 727-200 Advanced 21248 1976 31,419
Boeing 727-200 Advanced 21249 1976 31,435
Boeing 727-200 Advanced 21363 1977 30,066
Boeing 727-200 Advanced 21366 1977 29,809
McDonnell Douglas DC-9-30 47028 1967 80,157
McDonnell Douglas DC-9-30 47029 1967 79,255
McDonnell Douglas DC-9-30 47030 1967 79,645
McDonnell Douglas DC-9-30 47095 1967 75,316
McDonnell Douglas DC-9-30 47109 1968 78,441
McDonnell Douglas DC-9-30 47134 1967 74,526
McDonnell Douglas DC-9-30 47136 1968 74,990
McDonnell Douglas DC-9-30 47172 1968 75,590
McDonnell Douglas DC-9-30 47173 1968 78,490
McDonnell Douglas DC-9-30 47248 1968 82,250
McDonnell Douglas DC-9-30 47250 1968 79,742
McDonnell Douglas DC-9-30 47344 1969 76,098
McDonnell Douglas DC-9-30 47491 1970 71,866

(1) Cycle information as of 12/31/95 is not yet available.

<PAGE>

Item 3. Legal Proceedings

Continental Airlines, Inc. (Continental) Bankruptcy - On December 3, 1990,
Continental Airlines Holdings, Inc. and its subsidiaries, including Continental,
filed a petition under Chapter 11 of the United States Bankruptcy Code in the
United States Bankruptcy Court for the District of Delaware. Polaris Aircraft
Income Fund III (the Partnership) filed an administrative claim for the fair
rental value of aircraft operated by Continental during the bankruptcy period
and a general unsecured claim for the rental value of aircraft that were not so
operated. The Bankruptcy Court approved a negotiated agreement between
Continental and the Partnership on August 23, 1991, and Continental emerged from
bankruptcy under a plan of reorganization approved by the Bankruptcy Court
effective April 28, 1993. On January 30, 1995, the Bankruptcy Court approved a
stipulation between Continental and the Partnership settling the Partnership's
administrative expense priority claims against Continental with respect to
certain Boeing 727-100 aircraft that Continental returned to the Partnership in
January 1992. As discussed in Item 7, Continental is to pay the Partnership an
aggregate amount of $1.3 million. The Partnership received an initial payment of
approximately $311,000 in February 1995 and is entitled to receive the balance
of the settlement in equal monthly installments through February 1996, with
respect to the Partnership's administrative priority claims pursuant to the
terms of the stipulation.

Midway Airlines, Inc. (Midway) Bankruptcy - In March 1991, Midway commenced
reorganization proceedings under Chapter 11 of the United States 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 action has been taken
to pay or settle the Partnership's bankruptcy claims.

Trans World Airlines, Inc. (TWA) - On June 30, 1995, TWA filed a reorganization
proceeding under Chapter 11 of the United States Bankruptcy Code in the United
States Bankruptcy Court for the Eastern District of Missouri. Immediately before
the filing, the Partnership and TWA entered into an Amended Deferral Agreement,
pursuant to which TWA agreed to bring lease rents current over a period of
several months and to confirm all of its leases with the Partnership. As agreed,
TWA proposes a plan of reorganization in which, among other things, it confirmed
all of its leases with the Partnership, and the plan was confirmed by the
Bankruptcy Court on August 4, 1995. TWA has emerged from its bankruptcy
proceeding and has repaid all outstanding rent deferrals in accordance with its
commitment to the Partnership and in accordance with its plan of reorganization.
TWA has since remained current on all of its payment obligations to the
Partnership.

Kepford, et al. v. Prudential Securities, et al. - On April 13, 1994, an action
entitled Kepford, et al. v. Prudential Securities, Inc. was filed in the
District Court of Harris County, Texas. The complaint names 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, as defendants. Certain defendants were
served with a summons and original petition on or about May 2, 1994. Plaintiffs'
original petition alleges that defendants violated the Texas Securities Act, the
Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act
of 1933 and committed common law fraud, fraud in the inducement, negligent

<PAGE>

misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by
misrepresenting and failing to disclose material facts in connection with the
sale of limited partnership units in the Partnership and the other Polaris
Aircraft Income Funds. Plaintiffs seek, among other things, an award of
compensatory damages in an unspecified amount plus interest thereon, and double
and treble damages under the Texas Deceptive Trade Practices Act.

Certain defendants, including Polaris Investment Management Corporation and the
Partnership, filed a general denial on June 29, 1994 and a motion for summary
judgment on June 17, 1994 on the basis that the statute of limitations has
expired. On June 29, 1994 and July 14, 1994, respectively, plaintiffs filed
their first amended original petition and second amended original petition, both
of which added plaintiffs. On July 18, 1994, plaintiffs filed their response and
opposition to defendants' motion for partial summary judgment and also moved for
a continuance on the motion for partial summary judgment. On August 11, 1994,
after plaintiffs again amended their petition to add numerous plaintiffs, the
defendants withdrew their summary judgment motion and motion to stay discovery,
without prejudice to refiling these motions at a later date.

Riskind, et al. v. Prudential Securities, Inc., et al. - An action entitled
Riskind, et al. v. Prudential Securities, Inc., et al. has been filed in the
District Court of the 165 Judicial District, Maverick County, Texas. This action
is on behalf of over 3,000 individual investors who purchased units in "various
Polaris Aircraft Income Funds," including the Partnership. The Partnership and
Polaris Investment Management Corporation received service of plaintiffs' second
amended original petition and, on June 13, 1994, filed an original answer
containing a general denial.

The second amended original petition names the Partnership, Polaris Investment
Management Corporation, Prudential Securities, Inc. and others as defendants and
alleges that these defendants violated the Texas Securities Act and the Texas
Deceptive Trade Practices Act and committed common law fraud, fraud in the
inducement, negligent misrepresentation, negligent breach of fiduciary duty and
civil conspiracy by misrepresenting and failing to disclose material facts in
connection with the sale of limited partnership units in the Partnership and the
other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an
award of compensatory damages in an unspecified amount plus interest thereon,
and double and treble damages under the Texas Deceptive Trade Practices Act.
Kidder, Peabody & Co. was added as an additional defendant by virtue of an
Intervenor's Amended Plea in Intervention filed on or about April 7, 1995.

Prudential Securities, Inc. reached a settlement with the plaintiffs. The trial
of the claims of one plaintiff, Robert W. Wilson, against Polaris Aircraft
Income Funds I-VI, Polaris Investment Management Corporation and various
affiliates of Polaris Investment Management Corporation, including General
Electric Capital Corporation, was commenced on July 10, 1995. On July 26, 1995,
the jury returned a verdict in favor of the defendants on all counts. Subsequent
to this verdict, all of the defendants (with the exception of Prudential
Securities, Inc., which had previously settled) entered into a settlement with
the plaintiffs. None of the Polaris Aircraft Income Funds were required to
contribute to this settlement.

Howland, et al. v. Polaris Holding Company, et al. - On or about February 4,
1994, a purported class action entitled Howland, et al. v. Polaris Holding
Company, et al. was filed in the United States District Court for the District
of Arizona on behalf of investors in Polaris Aircraft Income Funds I-VI. The
complaint names each of 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 Securities Group, Inc., Prudential

<PAGE>

Insurance Company of America, George W. Ball, Robert J. Sherman, James J. Darr,
Paul J. Proscia, Frank W. Giordano, William A. Pittman, Joseph H. Quinn, Joe W.
Defur, James M. Kelso and Brian J. Martin, as defendants. The complaint alleges
that defendants violated federal RICO statutes, committed negligent
misrepresentations, and breached their fiduciary duties by misrepresenting and
failing to disclose material facts in connection with the sale of limited
partnership units in the Partnership and the other Polaris Aircraft Income
Funds. Plaintiffs seek, among other things, an accounting of all monies invested
by plaintiffs and the class and the uses made thereof by defendants, an award of
compensatory, punitive and treble damages in unspecified amounts plus interest
thereon, rescission, attorneys' fees and costs. On August 3, 1994, the action
was transferred to the Multi-District litigation in the Southern District of New
York entitled In re Prudential Securities Limited Partnerships Litigation,
discussed in Part III, Item 10 below.

Mary C. Scott v. Prudential Securities Inc. et al. - On or around August 15,
1995, a complaint entitled Mary C. Scott v. Prudential Securities Inc. et al.
was filed in the Court of Common Pleas, County of Summit, Ohio. The complaint
names as defendants Prudential Securities Inc., the Partnership, Polaris
Aircraft Income Fund II, Polaris Aircraft Income Fund IV, Polaris Aircraft
Income Fund VI, P-Bache/A.G. Spanos Genesis Income Partners LP 1,
Prudential-Bache Properties, Inc., A.G. Spanos Residential Partners - 86,
Polaris Securities Corporation and Robert Bryan Fitzpatrick. Plaintiff alleges
claims of fraud and violation of Ohio securities law arising out of the public
offerings of the Partnership, Polaris Aircraft Income Fund II, Polaris Aircraft
Income Fund IV, Polaris Aircraft Income Fund VI, and P-Bache/A.G. Spanos Genesis
Income Partners LP 1. Plaintiff seeks compensatory damages, general,
consequential and incidental damages, punitive damages, rescission, costs,
attorneys' fees and other and further relief as the Court deems just and proper.
On September 15, 1995, defendants removed this action to the United States
District Court, Eastern District of Ohio. On September 18, 1995, defendants
sought the transfer of this action to the Multi-District Litigation and sought a
stay of all proceedings by the district court, which stay was granted on
September 25, 1995. The Judicial Panel transferred this action to the
Multi-District Litigation on or about February 7, 1996.

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. With the exception of Novak, et al
v. Polaris Holding Company, et al, where the Partnership is named as a
defendant, the Partnership is not a party to these actions. In Novak, a
derivative action, the Partnership is named as a defendant for procedural
purposes but the plaintiffs in such lawsuit do not seek an award from the
Partnership.

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

None.

<PAGE>

PART II

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

a) Polaris Aircraft Income Fund 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, 1995
-------------- -----------------------

Depository Units Representing Assignments
of Limited Partnership Interests: 18,220

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 1995
and 1994 totaled $11,250,000 and $25,000,000, respectively. Cash
distributions per limited partnership unit were $22.50 and $50.00 in
1995 and 1994, respectively.

<PAGE>

Item 6. Selected Financial Data

<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------

1995 1994 1993 1992 1991
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Revenues $21,096,762 $13,486,506 $16,574,900 $16,910,098 $16,574,900

Net Income (Loss) 7,897,946 (181,996) 2,707,789 (4,800,779) (20,128,461)

Net Income (Loss)
allocated to Limited
Partners 6,694,079 (2,679,926) 1,430,836 (5,752,671) (21,239,545)

Net Income (Loss) per
Limited Partnership 13.39 (5.36) 2.86 (11.51) (42.48)

Cash Distributions per
Limited Partnership
Unit 22.50 50.00 25.00 20.00 26.25

Amount of Cash
Distributions Included
Above Representing
a Return of Capital on
a Generally Accepted
Accounting Principle
Basis per Limited
Partnership Unit* 22.50 50.00 25.00 20.00 26.25

Total Assets 82,001,364 86,552,826 114,953,271 128,585,579 142,116,664

Partners' Capital 81,264,915 85,866,969 113,826,743 125,007,844 140,919,734

</TABLE>

* The portion of such distributions which represents a return of capital on an
economic basis will depend in part on the residual sale value of the
Partnership's aircraft and thus will not be ultimately determinable until the
Partnership disposes of its aircraft. However, such portion may be significant
and may equal, exceed or be smaller than the amount shown in the above table.

<PAGE>

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

Polaris Aircraft Income Fund III (the Partnership) owns a portfolio of 18 used
commercial jet aircraft and certain inventoried aircraft parts out of its
original portfolio of 38 aircraft. The portfolio includes 13 McDonnell Douglas
DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA) and five Boeing
727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental).
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. The inventoried aircraft
have been disassembled for sale of their component parts. Of its original
aircraft portfolio, the Partnership sold one former Continental DC-9-10 aircraft
in December 1992, one former Midway DC-9-10 aircraft in January 1993, one former
Aero California S.A. de C.V. DC-9-10 aircraft in September 1993, five of the
former Continental DC-9-10 aircraft at various dates in 1993, and three former
Continental Boeing 727-200 aircraft in May 1994.

Remarketing Update

The leases of five Boeing 727-200 Advanced aircraft to Continental expire in
October 1996. The Partnership is currently remarketing these aircraft for sale
or re-lease.

Partnership Operations

The Partnership recorded net income of $7,897,946, or 13.39 per limited
partnership unit for the year ended December 31, 1995, compared to a net loss of
$181,996, or $5.36 per limited partnership unit, and net income of $2,707,789,
or $2.86 per limited partnership unit, for the years ended December 31, 1994 and
1993, respectively. The net loss for 1994 resulted primarily from the loss of
$3,588,919 recorded on the sale of three Boeing 727-200 aircraft to Continental
combined with a reduction in rental revenue recognized on the leases with TWA
and operating expenses incurred from the TWA leases. The improvement in
operating results in 1995 was primarily the result of substantially increased
revenues resulting from collection of rents deferred in 1994 combined with lower
operating expenses and partially offset by increased depreciation expense in
1995 as compared to 1994.

Rental revenues, net of related management fees, declined during 1994 as
compared to 1993. The leases of three Boeing 727-200 aircraft to Continental
expired in April 1994 and the aircraft were subsequently sold to Continental in
May 1994 for an aggregate sale price of $3,019,719. The Partnership recorded a
note receivable for the sale price and recognized a loss on sale of $3,588,919
in 1994. In addition, rental revenue recognized on the Partnership's leases with
TWA decreased during 1994. As discussed below, in December 1994, GE Capital
Aviation Services, Inc. (GECAS) negotiated a standstill agreement with TWA. That
agreement provided for a deferral of the rent due the Partnership in November
1994 and 75% of the rents due the Partnership from December 1994 through March
1995. The Partnership did not recognize the rental amount deferred in 1994 of
$1,137,500 as rental revenue until it was received in 1995. The Partnership has
received from TWA all scheduled rent payments beginning in April 1995 and all
scheduled deferred rental payments were paid in full beginning in May 1995
through October 1995, including interest at a rate of 12% per annum.

In consideration for the rent deferral, TWA agreed to make a lump sum payment of
$1,000,000 to GECAS for the TWA lessors for whom GECAS provides management
services and who agreed to the Deferral Agreement. The Partnership received

<PAGE>

$157,568 in January 1995 as its share of such payment by TWA. This amount was
recognized as other revenue in 1995. In addition, TWA agreed to issue warrants
to the Partnership for TWA Common Stock. The Partnership received warrants to
purchase 159,919 shares of TWA Common Stock from TWA in November 1995 and has
recognized the net warrant value as of the date of receipt of $1,247,768 as
revenue in 1995. The Partnership exercised the warrants on December 29, 1995 for
the strike price of $0.01 per share and has recognized a gain on the value of
the warrants of $409,792 in 1995.

Further impacting the increased revenues in 1995 as compared to 1994, in January
1995, the United States Bankruptcy Court approved an agreement between the
Partnership and Continental which specifies 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 is entitled to receive the balance of the
settlement in equal monthly installments of $72,222 through February 1996. The
Partnership has received all payments due from Continental for the settlement,
which are recorded as revenue when received. The Partnership recorded payments
of $1,105,556 as other revenue during 1995.

During 1994, the Partnership recognized as revenue in 1994 $400,000 that it had
previously held as maintenance reserves relating to two aircraft formerly on
lease to Continental. Revenues for 1993 include the gain on the sale of two
aircraft totaling $233,387 and income from a forfeited deposit of $25,000.

Operating expenses decreased in 1995 as compared to 1994 and 1993. As part of
the TWA lease extension in 1991 as discussed in Note 4 to the financial
statements (Item 8), the Partnership agreed to share the cost of meeting certain
Airworthiness Directives (ADs) after TWA successfully reorganized in 1993. The
agreement stipulated that such costs incurred by TWA may be credited against
monthly rentals, subject to annual limitations and a maximum of $500,000 per
aircraft through the end of the leases. In accordance with the cost sharing
agreement, the Partnership recognized as operating expense $2.6 million and
$1.95 million of these expenses during 1994 and 1993, respectively. No operating
expenses relating to the TWA aircraft were recognized by the Partnership during
1995. In addition, operating expenses for 1993 reflect the estimated costs of
disassembling of the former Midway and Continental aircraft. No aircraft
disassembly expenses were recognized during 1994 and 1995.

Partially offsetting the improved operating results in 1995 as compared to 1994,
the Partnership recognized substantially higher depreciation expense in 1995. 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
approximately $1,771,000 of this deficiency as increased depreciation expense in
1995. The increased depreciation expense reduces the aircraft's carrying value
and reduces the amount of future depreciation expense that the Partnership will
recognize over the projected remaining economic life of the aircraft. The
Partnership also made downward adjustments to the estimated residual value of
certain of its on- lease aircraft as of December 31, 1995, 1994 and 1993. 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 1995, 1994 and 1993 and the downward
adjustments to the estimated residual values recorded in 1995, 1994 and 1993 as
discussed later in the Industry Update section.

<PAGE>

Liquidity and Cash Distributions

Liquidity - The Partnership has received from Continental all payments due under
the modified lease agreement, the aircraft sale agreement, and the settlement
agreement for the return of the six Boeing 727-100 aircraft. In addition,
payments totaling $1,915,820, $748,740 and $593,923 have been received during
1995, 1994 and 1993, respectively, from the sale of parts from the nine
disassembled aircraft and have been applied against aircraft inventory. The net
book value of the Partnership's aircraft inventory is $686,670 as of December
31, 1995.

As discussed above, TWA repaid its deferred rents in full with interest by
October 1995. The Partnership also received from TWA warrants to purchase
159,919 shares of TWA Common Stock and a payment of $157,568 in consideration
for the rent deferral. The Partnership exercised the warrants in 1995 and sold
the TWA Common Stock in the first quarter of 1996, net of broker commissions,
for $1,698,057.

As discussed in Note 5 to the financial statements (Item 8), the Continental
leases provide for payment by the Partnership of the costs of certain
maintenance work, AD compliance, aircraft modification and refurbishment costs,
which are not to exceed approximately $3.2 million, a portion of which will be
recovered with interest through payments from Continental over the lease terms.
In accordance with the Continental leases, the Partnership financed $315,145 and
$165,937 for new image modifications during 1994 and 1993, respectively. As
discussed above and in Note 4 to the financial statements (Item 8), the
Partnership agreed to share the cost of meeting certain ADs with TWA. In
accordance with the cost-sharing agreement, TWA may offset up to an additional
$1.95 million against rental payments, subject to annual limitations, over the
remaining lease terms. The Partnership's cash reserves are being retained to
finance future modification costs for Continental and to meet the obligations
under the TWA leases.

Cash Distributions - Cash distributions to limited partners were $11,250,000,
$25,000,000, and $12,500,000 in 1995, 1994 and 1993, respectively. Cash
distributions per limited partnership unit totaled $22.50, $50.00, and $25.00 in
1995, 1994 and 1993, respectively. The timing and amount of future cash
distributions are not yet known and will depend on the Partnership's future cash
requirements including the potential costs of remarketing the Partnership's
aircraft; continued receipt of the renegotiated rental payments from Continental
and TWA; the receipt of the deferred rental payments from Continental; the
receipt of modification financing payments from Continental; the receipt of
payments from Continental for the sale of three Boeing 727-200 aircraft; the
receipt of payments generated from the aircraft disassembly process; and the
receipt of payments from Continental as settlement for the return of six Boeing
727-100 aircraft.

TWA Restructuring

In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, GECAS negotiated a
standstill arrangement, as set forth in a letter agreement dated December 16,
1994 (the Deferral Agreement), with TWA for the 46 aircraft that are managed by
GECAS, 13 of which are owned by the Partnership. As required by its terms, the
Deferral Agreement (which has since been amended as discussed below) was
approved by PIMC on behalf of the Partnership with respect to the Partnership's
aircraft.

The Deferral Agreement provided for (i) a moratorium on 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

<PAGE>

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. The
Partnership received $157,568 in January 1995 as its share of such payment by
TWA. This amount was recognized as other revenue in the accompanying 1995
statement of operations. 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. The
amount of such maintenance reimbursement has not been finally determined.

TWA agreed that, upon filing of its prepackaged plan, it would take all
reasonable steps to implement the terms of the Amended Deferral Agreement and
would immediately assume all of the Partnership's leases. TWA also agreed that,
not withstanding the 60-day cure period provided by section 1110 of the United
States Bankruptcy Code, it would remain current on the performance of its
obligations under the leases, as amended by the Amended Deferral Agreement.

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. While TWA has committed to an uninterrupted flow of lease payments, there
is no assurance that TWA will continue to honor its obligations in the future.

<PAGE>

$409,792 in the 1995 statement of operations. The TWA Common Stock is classified
as trading securities because the Partnership intends to sell the stock in the
near term. The fair market value of the TWA stock at December 31, 1995 of
$1,659,160 is reflected in the Partnership's December 31, 1995 balance sheet
(Item 8). The Partnership sold the TWA Common Stock in the first quarter of
1996, net of broker commissions, for $1,698,057.

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 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
FAA estimates the cost of compliance with this AD to be approximately $1.0
million per Boeing 727 aircraft, if none of the required work had been done
previously. In general, the new maintenance requirements must be completed by
the later of March 1994, or 60,000 cycles for each Boeing 727. A similar AD was
adopted on September 24, 1990, applicable to McDonnell Douglas aircraft. The AD
requires specific work to be performed at various cycle thresholds between
50,000 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 December 1990, 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 December 31, 1991 on Boeing aircraft.

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
Continental and 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

<PAGE>

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 current U.S. fleet is comprised of
approximately 68% Stage 3 aircraft and 32% Stage 2 aircraft. 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.

The Partnership's entire fleet consists of Stage 2 aircraft. Hushkit
modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are
currently available for the Partnership's aircraft. However, while technically
feasible, hushkits may not be cost effective on all models due to the age of
some of the aircraft and the time required to fully amortize the additional
investment. The general partner will evaluate, as appropriate, the potential
benefits of installing hushkits on some or all of the Partnership's aircraft. It
is unlikely that the Partnership would incur such costs unless they can be
substantially recovered through a lease.

Implementation of the Stage 3 standards has adversely affected the value of
Stage 2 aircraft, as these aircraft will require eventual modification to be
operated in the U.S. or other countries with Stage 3 standards after the
applicable dates.

Demand for Aircraft - Industry-wide, approximately 475 commercial aircraft are
currently available for sale or lease, approximately 125 less than a year ago.
From 1991 through 1994, depressed demand for air travel limited airline
expansion plans, with new aircraft orders and scheduled deliveries being
canceled or substantially deferred. As profitability declined, many airlines
took action to downsize or liquidate assets and some airlines were forced to

<PAGE>

file for bankruptcy protection. Following two years of good traffic growth
accompanied by rising yields, this trend is improving with new aircraft orders
last year exceeding deliveries for the first time since 1990. To date, this
recovery has mainly benefited Stage 3 narrow-bodies and younger Stage 2
narrow-bodies, many of which are now being hushkitted, whereas older Stage 2
narrow- bodies have shown marginal signs of recovery.

Effects on the Partnership's Aircraft - The Partnership periodically reviews the
estimated realizability of the residual values at the projected end of each
aircraft's economic life based on estimated residual values obtained from
independent parties which provide current and future estimated aircraft values
by aircraft type. The Partnership made downward adjustments to the estimated
residual value of certain of its on-lease aircraft as of December 31, 1995, 1994
and 1993. 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. As a result of
the 1993 adjustments to the estimated residual values, the Partnership is
recognizing increased depreciation expense of approximately $693,000 per year
beginning in 1994 through the end of the estimated economic lives of the
aircraft. As a result of the 1994 adjustments to the estimated residual values,
the Partnership is recognizing increased depreciation expense of approximately
$1,227,000 per year beginning in 1995 through the end of the estimated economic
lives of the aircraft.

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 $1,771,000, or $3.51 per limited
Partnership unit, of this deficiency as increased depreciation expense in 1995.
The deficiency in 1995 was generally the result of declining estimates in the
residual values of the aircraft. The increased depreciation expense reduces the
aircraft's carrying value and reduces the amount of future depreciation expense
that the Partnership will recognize over the projected remaining economic life
of the aircraft.

The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying value of the aircraft recorded in 1995 (which has
the effect of decreasing future depreciation expense), and the downward
adjustments to the estimated residual values recorded in 1995 (which has the
effect of increasing future depreciation expense). The net effect of the 1995
adjustments to the estimated residual values and the adjustments to the carrying
value of the aircraft recorded in 1995 is to cause the Partnership to recognize
increased depreciation expense of approximately $194,000 per year beginning in
1996 through the end of the estimated economic lives of the aircraft.

<PAGE>

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 the statement, measurement of an impairment loss
for long-lived assets will be based on the "fair value" of the asset as defined
in the statement.

SFAS No. 121 states that the fair value of an asset is the amount at which the
asset could be bought or sold in a current transaction between willing parties,
i.e., other than in a forced or liquidation sale. Quoted market prices in active
markets are the best evidence of fair value and will be used as the basis for
the measurement, if available. If quoted market prices are not available, the
estimate of fair value will be based on the best information available in the
circumstances. Pursuant to the statement, the estimate of fair value will
consider prices for similar assets and the results of valuation techniques to
the extent available in the circumstances. Examples of valuation techniques
include the present value of estimated expected future cash flows using a
discount rate commensurate with the risks involved, option-pricing models,
matrix pricing, option-adjusted spread models, and fundamental analysis.

Beginning in 1996, the Partnership will periodically review its aircraft for
impairment in accordance with SFAS No. 121. Using an estimate of the fair value
of the Partnership's aircraft to measure impairment may result in greater
write-downs than would be recognized under the accounting method currently
applied by the Partnership. 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's leases expire between October 1996 and February 1998. To the
extent that the Partnership's non-advanced Boeing and McDonnell Douglas aircraft
continue to be significantly affected by industry events, the Partnership will
evaluate each aircraft as it comes off lease to determine whether a re-lease or
a sale at the then-current market rates would be most beneficial for unit
holders.

<PAGE>

Item 8. Financial Statements and Supplementary Data

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

FINANCIAL STATEMENTS AS OF DECEMBER 31, 1995 AND 1994

TOGETHER WITH

AUDITORS' REPORT

<PAGE>

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, 1995 and 1994, 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, 1995.
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, 1995 and 1994, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995, in conformity with generally accepted accounting
principles.

ARTHUR ANDERSEN LLP

San Francisco, California,
January 31, 1996 (except with
respect to the matter discussed
in Note 10, as to which the
date is March 22, 1996)

<PAGE>

<TABLE>
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

BALANCE SHEETS

DECEMBER 31, 1995 AND 1994

<CAPTION>
1995 1994
---- ----
<S> <C> <C>
ASSETS:

CASH AND CASH EQUIVALENTS $ 25,014,205 $ 15,810,799

MARKETABLE SECURITIES, trading 1,659,160 -

RENT AND OTHER RECEIVABLES 8,171 485,551

NOTES RECEIVABLE, net of allowance for credit
losses of $1,993,095 in 1995 and $5,006,929 in 1994 1,546,407 2,749,401

AIRCRAFT, net of accumulated depreciation
of $75,198,827 in 1995 and $63,166,880 in 1994 53,060,662 65,092,609

AIRCRAFT INVENTORY 686,670 2,388,377

OTHER ASSETS 26,089 26,089
---------------- ----------------

$ 82,001,364 $ 86,552,826
================ ================

LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):

PAYABLE TO AFFILIATES $ 130,584 $ 121,658

ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 84,084 42,418

DEFERRED INCOME 521,781 521,781
---------------- ----------------

Total Liabilities 736,449 685,857
---------------- ----------------

PARTNERS' CAPITAL (DEFICIT):
General Partner (1,392,716) (1,346,583)
Limited Partners, 500,000 units
issued and outstanding 82,657,631 87,213,552
---------------- ----------------

Total Partners' Capital 81,264,915 85,866,969
---------------- ----------------

$ 82,001,364 $ 86,552,826
================ ================

The accompanying notes are an integral part of these statements.
</TABLE>
20

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993

<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Rent from operating leases $ 16,186,560 $ 15,023,940 $ 18,056,395
Gain (loss) on sale of aircraft - (3,588,919) 233,387
Receipt of lessee stock warrants 1,247,768 - -
Gain on trading securities 409,792 - -
Interest 1,989,518 1,651,485 2,185,883
Other 1,263,124 400,000 25,000
--------------- --------------- ---------------

Total Revenues 21,096,762 13,486,506 20,500,665
--------------- --------------- ---------------

EXPENSES:
Depreciation and amortization 12,031,947 9,891,093 13,939,172
Management fees to general partner 809,328 738,809 871,021
Operating 29,282 2,745,928 2,727,105
Administration and other 328,259 292,672 255,578
--------------- --------------- ---------------

Total Expenses 13,198,816 13,668,502 17,792,876
--------------- --------------- ---------------

NET INCOME (LOSS) $ 7,897,946 $ (181,996) $ 2,707,789
=============== =============== ===============

NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 1,203,867 $ 2,497,930 $ 1,276,953
=============== =============== ===============

NET INCOME (LOSS)
ALLOCATED TO THE
LIMITED PARTNERS $ 6,694,079 $ (2,679,926) $ 1,430,836
=============== =============== ===============

NET INCOME (LOSS) PER
LIMITED PARTNERSHIP
UNIT $ 13.39 $ (5.36) $ 2.86
=============== =============== ===============

The accompanying notes are an integral part of these statements.
</TABLE>
21

<PAGE>

<TABLE>
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)

FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993

<CAPTION>
General Limited
Partner Partners Total
------- -------- -----
<S> <C> <C> <C>
Balance, December 31, 1992 $ (954,798) $ 125,962,642 $ 125,007,844

Net income 1,276,953 1,430,836 2,707,789

Cash distributions to partners (1,388,890) (12,500,000) (13,888,890)
--------------- ---------------- ----------------

Balance, December 31, 1993 (1,066,735) 114,893,478 113,826,743

Net income (loss) 2,497,930 (2,679,926) (181,996)

Cash distributions to partners (2,777,778) (25,000,000) (27,777,778)
--------------- ---------------- ----------------

Balance, December 31, 1994 (1,346,583) 87,213,552 85,866,969

Net income 1,203,867 6,694,079 7,897,946

Cash distributions to partners (1,250,000) (11,250,000) (12,500,000)
--------------- ---------------- ----------------

Balance, December 31, 1995 $ (1,392,716) $ 82,657,631 $ 81,264,915
=============== ================ ================

The accompanying notes are an integral part of these statements.
</TABLE>
22

<PAGE>

<TABLE>
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993

<CAPTION>
1995 1994 1993
---- ---- ----
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ 7,897,946 $ (181,996) $ 2,707,789
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 12,031,947 9,891,093 13,939,172
Loss (gain) on sale of aircraft - 3,588,919 (233,387)
Changes in operating assets and liabilities:
Increase in marketable securities, trading (1,659,160) - -
Decrease (increase) in rent and other
receivables 477,380 173,750 (563,692)
Decrease in inventory - - 465,000
Increase (decrease) in payable to affiliates 8,926 (69,089) 80,086
Increase (decrease) in accounts payable
and accrued liabilities 41,666 28,418 (88,451)
Decrease in deferred income - - (1,313,500)
Decrease in lessee security deposits - - (366,707)
Decrease in maintenance reserves - (400,000) (762,635)
--------------- ---------------- ---------------

Net cash provided by operating activities 18,798,705 13,031,095 13,863,675
--------------- ---------------- ---------------

INVESTING ACTIVITIES:
Net proceeds from sale of aircraft - - 6,228,388
Net proceeds from sale of aircraft inventory 1,915,820 748,740 593,923
Inventory disassembly costs (214,113) - (141,630)
Increase in notes receivable (499,868) (315,145) (165,937)
Principal payments on notes receivable 1,702,862 1,041,771 123,481
--------------- ---------------- ---------------

Net cash provided by investing activities 2,904,701 1,475,366 6,638,225
--------------- ---------------- ---------------

FINANCING ACTIVITIES:
Cash distributions to partners (12,500,000) (27,777,778) (13,888,890)
--------------- ---------------- ---------------

Net cash used in financing activities (12,500,000) (27,777,778) (13,888,890)
--------------- ---------------- ---------------

CHANGES IN CASH AND CASH
EQUIVALENTS 9,203,406 (13,271,317) 6,613,010

CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 15,810,799 29,082,116 22,469,106
--------------- ---------------- ---------------

CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 25,014,205 $ 15,810,799 $ 29,082,116
=============== ================ ===============

The accompanying notes are an integral part of these statements.
</TABLE>
23

<PAGE>

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1995

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 requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. 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.

Marketable Securities, trading - Marketable Securities, trading are carried at
fair value, which was determined based on quoted market prices. These securities
are held for sale in the near term (Note 4).

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

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

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.

<PAGE>

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.

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 for the years ended December 31, 1995, 1994
and 1993.

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

Financial Accounting Pronouncements - The Partnership adopted Statement of
Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for
Impairment of a Loan," and the related SFAS No. 118 as of January 1, 1995. SFAS
No. 114 and SFAS No. 118 require that certain impaired loans be measured based
on the present value of expected cash flows discounted at the loan's effective
interest rate; or, alternatively, at the loan's observable market price or the
fair value of the collateral if the loan is collateral dependent. The
Partnership had previously measured the allowance for credit losses using
methods similar to that prescribed in SFAS No. 114. As a result, no additional
provision was required by the adoption of this pronouncement. The Partnership
has recorded an allowance for credit losses for certain impaired loans as a
result of uncertainties regarding their collection due to cash flow deficiencies
of the lessee or restrictions regarding the cash flow by the Bankruptcy Court.
The Partnership recognizes revenue on these loans only as payments are received.

1995
----
Impaired loans or receivables with
allowances for credit losses $ 1,993,095
Impaired loans or receivables without
allowances for credit losses --
-----------
Total impaired loans 1,993,095
Allowance for credit losses (1,993,095)
-----------
$ --
===========

Allowance for credit losses,
beginning of year $(5,006,929)
Provision for credit losses --
Write-downs --
Collections 3,013,834
-----------
Allowance for credit losses,
end of year $(1,993,095)
===========

SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires
the Partnership to disclose the fair value of financial instruments. Cash and
Cash Equivalents is stated at cost, which approximates fair value. Marketable

<PAGE>

Securities, trading (Note 4) are carried at fair value, which was determined
based on quoted market prices. The fair value of the Notes Receivable is
estimated by discounting future estimated cash flows using current interest
rates at which similar loans would be made to borrowers with similar credit
ratings and remaining maturities. As discussed in Note 5, the carrying value of
the notes receivable from Continental for deferred rents is zero due to a
recorded allowance for credit losses equal to the balance of the notes. As of
December 31, 1995, the aggregate fair value of the Continental deferred rent
notes receivable was estimated to be approximately $1.9 million. The carrying
value of the Partnership's remaining notes receivable discussed in Notes 3 and 5
approximate their estimated fair value.

SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," requires that long-lived assets and
certain identifiable intangibles to be held and used by an entity be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. This Statement will be
adopted by the Partnership as of January 1, 1996 and will be applied
prospectively. The Partnership estimates that the adoption of this pronouncement
will not have an immediate material impact on the Partnership's financial
position or results of operations unless events or circumstances change that
would cause projected net cash flows to be adjusted. The estimate of fair value
and measurement of impairment loss is described in Note 3.

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.

Polaris Investment Management Corporation (PIMC), the sole general partner of
the Partnership, supervises the day-to-day operations of the Partnership.
Polaris Depositary 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 Note 7.

3. Aircraft

The Partnership owns 18 aircraft and certain inventoried aircraft parts 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 (FAA) 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

<PAGE>

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 December 1992, seven aircraft in 1993, and three aircraft in 1994.
In addition, nine aircraft have been disassembled for sale of their component
parts (Note 6).

The following table describes the Partnership's current aircraft portfolio in
greater detail:

Year of
Aircraft Type Serial Number Manufacture
- ------------- ------------- -----------
Boeing 727-200 Advanced 21247 1976
Boeing 727-200 Advanced 21248 1976
Boeing 727-200 Advanced 21249 1976
Boeing 727-200 Advanced 21363 1977
Boeing 727-200 Advanced 21366 1977
McDonnell Douglas DC-9-30 47028 1967
McDonnell Douglas DC-9-30 47029 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 47248 1968
McDonnell Douglas DC-9-30 47250 1968
McDonnell Douglas DC-9-30 47344 1969
McDonnell Douglas DC-9-30 47491 1970

Thirteen McDonnell Douglas DC-9-30s - These 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
as discussed in Note 4.

Four McDonnell Douglas DC-9-10s - These aircraft were acquired for $15,768,766
in 1987 and leased to Midway Airlines, Inc. (Midway). In March 1991, Midway
commenced reorganization proceedings under Chapter 11 of the United States
Bankruptcy Code. In August 1991, the Bankruptcy Court approved Midway's proposal
to discontinue use of the Partnership's aircraft, and the aircraft were
subsequently returned to the Partnership. The aircraft were not in compliance
with the return conditions specified under the lease. The general partner has
retained counsel on behalf of the Partnership to pursue all legal remedies
available to protect the interests of unit holders. Although Midway remains
liable for expenses for which it was responsible under its lease, including the
costs of complying with return conditions, the Partnership is unlikely to
recover material damages resulting from Midway's failure to meet its obligations
under the leases, as Midway's bankruptcy estate is minimal. During 1992, the
Partnership transferred the four aircraft to aircraft inventory and subsequently
disassembled three of the aircraft for sale of their component parts (Note 6).
The remaining aircraft was sold to Target Airways, Ltd. during January 1993 for
$925,000 resulting in a gain on sale of $146,500 during 1993.

Fourteen Boeing 727s (Series 100, 200 and 200 Advanced) and Seven McDonnell
Douglas DC-9-10s - These aircraft were acquired for $111,830,728 in 1987 and

<PAGE>

leased to Continental Airlines, Inc. (Continental) for terms of 72 months for
the Boeing aircraft and 42 months for the McDonnell Douglas aircraft.
Continental filed for Chapter 11 bankruptcy protection in December 1990. In
1991, the Partnership and Continental entered into an agreement for
Continental's continued lease of three Boeing 727-200 aircraft and five Boeing
727-200 Advanced aircraft; however, Continental rejected the leases on six
Boeing 727-100s and the seven McDonnell Douglas DC-9-10s and returned these
aircraft to the Partnership. Note 5 contains a detailed discussion of the
Continental events.

In December 1992, the Partnership sold one of the ex-Continental McDonnell
Douglas DC-9-10 aircraft to Lear 25, Inc. for $1,025,000. In March 1993, the
Partnership agreed to sell to Intercontinental five additional McDonnell Douglas
DC-9-10 aircraft formerly on lease to Continental. Two aircraft were sold in
March 1993, a third aircraft was sold in April 1993, a fourth aircraft was sold
in June 1993, and a fifth aircraft was sold in October 1993 for total proceeds
of $3.4 million for the five aircraft. The Partnership recorded no gain or loss
on the sales, as the aircraft sales prices equaled book values.

During 1993, the six Boeing 727-100s were transferred to aircraft inventory and
are being disassembled for sale of their component parts (Note 6). Upon
transferring the aircraft to aircraft inventory in 1992, the Partnership
recorded downward adjustments to the aircraft value, which are included in the
adjustment discussed below and in Note 6.

The leases of the three Boeing 727-200 aircraft expired in April 1994. In May
1994, the Partnership sold these aircraft to Continental for an aggregate sale
price of $3,019,719. The Partnership agreed to accept payment of the sale price
in 29 monthly installments of $115,500, with interest at a rate of 9.5% per
annum. The Partnership recorded a note receivable for the sale price and
recognized a loss on sale of $3,588,919 in 1994. The Partnership has received
all scheduled payments due under the note. The note receivable balance at
December 31, 1995 and 1994 was $998,858 and $2,223,875, respectively.

In June 1991, one of the DC-9-10 aircraft formerly leased to Continental was
leased to Aero California S.A. de C.V. (Aero California) for a lease term of 18
months at approximately 76% of the original lease rate with Continental. The
aircraft was subsequently sold to Aero California in September 1993 for a
purchase price of approximately $1.1 million. The Partnership recognized a gain
of $86,887 on the sale in 1993.

The following is a schedule by year of future minimum rental revenue under the
existing leases including the deferred rental payments specified in the
Continental lease modifications (Note 5):

Continental
Deferred
Year Amount(1) Rental Payments Total
- ---- --------- --------------- -----
1996 $ 1,781,940 $12,400,000 $14,181,940
1997 159,582 7,800,000 7,959,582
1998 -- 1,300,000 1,300,000
1999 and thereafter -- -- --
----------- ----------- -----------
$ 1,941,522 $21,500,000 $23,441,522
=========== =========== ===========

(1) Rental payments for the period from December 1990 through September
1991 are payable with interest commencing in July 1992 according to the
Continental lease modification agreement. Rental payments for the
period from November 1992 through January 1993 are payable with
interest commencing in October 1993 according to the additional lease

<PAGE>

modification agreement with Continental. Future minimum rental payments
may be offset or reduced by future costs as described in Note 4.

As discussed in Note 1, the Partnership periodically reviews the estimated
realizability of the residual values at the projected end of each aircraft's
economic life based on estimated residual values obtained from independent
parties which provide current and future estimated aircraft values by aircraft
type. The Partnership made downward adjustments to the estimated residual value
of certain of its on-lease aircraft as of December 31, 1995, 1994 and 1993. 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. As a result of the 1993 adjustments
to the estimated residual values, the Partnership is recognizing increased
depreciation expense of approximately $693,000 per year beginning in 1994
through the end of the estimated economic lives of the aircraft. As a result of
the 1994 adjustments to the estimated residual values, the Partnership is
recognizing increased depreciation expense of approximately $1,227,000 per year
beginning in 1995 through the end of the estimated economic lives of the
aircraft.

As discussed in Note 1, 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
$1,771,000, or $3.51 per limited Partnership unit, of this deficiency as
increased depreciation expense in 1995. The deficiency in 1995 was generally the
result of declining estimates in the residual values of the aircraft. The
increased depreciation expense reduces the aircraft's net book value and
therefore reduces the amount of future depreciation expense that the Partnership
will recognize over the projected remaining economic life of the aircraft.

Effective January 1, 1996, the Partnership adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of." This statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. In performing the review for recoverability,
the statement provides that the Partnership should estimate the future cash
flows expected to result from the use of the asset and its eventual disposition.
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 the statement, measurement of an impairment loss
for long-lived assets will be based on the "fair value" of the asset as defined
in the statement.

<PAGE>

the measurement, if available. If quoted market prices are not available, the
estimate of fair value will be based on the best information available in the
circumstances. Pursuant to the statement, the estimate of fair value will
consider prices for similar assets and the results of valuation techniques to
the extent available in the circumstances. Examples of valuation techniques
include the present value of estimated expected future cash flows using a
discount rate commensurate with the risks involved, option-pricing models,
matrix pricing, option-adjusted spread models, and fundamental analysis.

4. TWA Reorganization

During 1991, TWA defaulted under its leases with the Partnership when it failed
to pay its March lease payments. In December 1991, the leases for all 13
aircraft were amended further, to extend the terms to February 1998 at
approximately 46% of the initial lease rates. In addition, the Partnership
agreed to share in the costs of certain ADs after TWA successfully reorganized.
The agreement stipulated that such costs incurred by TWA may be credited against
monthly rentals, subject to annual limitations and a maximum of $500,000 per
aircraft through the end of the applicable lease. Pursuant to this cost-sharing
agreement, since TWA emerged from its reorganization proceedings in 1993,
expenses totaling $4.55 million ($1.95 million in 1993 and $2.6 million in 1994)
have been offset against rental payments. Under the terms of this agreement, TWA
may offset up to an additional $1.95 million against rental payments, subject to
annual limitations, over the remaining lease terms.

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 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 accompanying 1994 balance
sheet. 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 and corresponding allowance for credit losses were $1,137,500 as

<PAGE>

of December 31, 1994. 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.

The Partnership received warrants to purchase 159,919 shares of TWA Common Stock
from TWA in November 1995 and has recognized the net warrant value as of the
date of receipt of $1,247,768 as revenue in the 1995 statement of operations.
The Partnership exercised the warrants on December 29, 1995 for the strike price
of $0.01 per share and has recognized a gain on the value of the warrants of
$409,792 in the 1995 statement of operations. The TWA Common Stock is classified
as trading securities because the Partnership intends to sell the stock in the
near term. The fair market value of the TWA stock at December 31, 1995 of
$1,659,160 is reflected in the accompanying December 31, 1995 balance sheet. As
discussed in Note 10, the Partnership sold the TWA Common Stock in the first
quarter of 1996.

<PAGE>

5. Continental Lease Modification

Continental filed for Chapter 11 bankruptcy protection in December 1990.
Continental terminated the leases on the six 727-100s and returned these
aircraft to the Partnership. The Continental leases for the Partnership's three
Boeing 727-200 aircraft and five Boeing 727-200 Advanced aircraft were modified.
The modified agreement specifies (i) extension of the leases for the three
727-200s (which were subsequently sold to Continental as discussed in Note 3) to
the earlier of April 1994 or 60,000 cycles, and for the five 727-200 Advanced
aircraft to October 1996; (ii) renegotiated rental rates averaging approximately
73% of the original lease rates; (iii) payment of ongoing rentals at the reduced
rates beginning in October 1991; (iv) payment of deferred rentals with interest
beginning in July 1992; and (v) payment by the Partnership of 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 may be capitalized and depreciated over the remaining lease terms,
subject to the capitalized cost policy as described in Note 1. The Partnership
has 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. The Partnership's
balance sheets reflect the net reimbursable costs incurred of $547,549 and
$525,526 as of December 31, 1995 and 1994, respectively, as notes receivable.
Continental will be entitled, under certain circumstances related to a possible
future substantial downsizing by Continental, which is not currently
anticipated, to reject the remaining existing leases.

The agreement with Continental included an extended deferral of the dates when
Continental will 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 net of which is reflected
in the accompanying balance sheets. The note receivable and corresponding
allowance for credit losses are reduced by the principal portion of payments
received. In addition, the Partnership recognizes rental revenue and interest
revenue in the period the deferred rental payments are received.

The allowances for credit losses on the principal and interest portions due were
$1,993,095 and $3,869,429 as of December 31, 1995 and 1994, respectively. The
unrecognized Deferred Amounts as of December 31, 1995 and 1994 were $1,941,522
and $3,670,582, respectively. In accordance with the aforementioned agreement,
Continental began making supplemental payments for the Deferred Amount plus
interest on July 1, 1992. During 1995, 1994 and 1993, the Partnership received
supplemental payments of $2,200,465, $2,999,666 and $4,109,607, of which
$1,729,060, $2,211,440 and $2,832,895 was recognized as rental revenue in 1995,
1994 and 1993, respectively.

Continental continues to pay all other amounts due under the prior agreement. As
of December 31, 1995, Continental is current on all payments due the
Partnership. The Partnership has not recorded an allowance for credit losses on
the additional Continental aircraft finance sale note receivable described in
Note 3 or the Continental modification financing note receivable described
above, as they are currently deemed to be collectible. The Partnership's rights
to receive payments under the agreements fall into various categories of
priority under the Bankruptcy Code. In general, the Partnership's claims are
administrative claims. If Continental's reorganization is not successful, it is
likely that a portion of the Partnership's claims will not be paid in full.

<PAGE>

In January 1995, the United States Bankruptcy Court approved an agreement
between the Partnership and Continental which specifies 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 is entitled to receive the balance of
the settlement in equal monthly installments of $72,222 through February 1996.
The Partnership has received all payments due from Continental for the
settlement, which are recorded as revenue when received. The Partnership
recorded payments of $1,105,556 as other revenue during 1995.

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 (Note 3) and the
six Boeing 727-100 aircraft formerly leased to Continental (Note 5), the
Partnership entered into an agreement with Soundair, Inc. (Soundair) for the
disassembly and sale of these aircraft. Disassembly of the McDonnell Douglas
DC-9-10s began in January 1993. Disassembly of the Boeing 727-100s began in
December 1994. It is anticipated that the disassembly and sales process will
take at least three years.

The Partnership recognized the estimated cost of disassembly of approximately
$50,000 per aircraft in 1993, and will receive the proceeds from the sale of
such parts net of overhaul expenses if necessary, and commission paid to
Soundair. During 1993, the Partnership paid $141,630 for aircraft disassembly
costs of the three McDonnell Douglas DC-9-10s. During 1995, the Partnership paid
$214,113 aircraft disassembly costs for the six Boeing 727-100s. During 1995,
1994 and 1993, the Partnership received net proceeds from the sale of aircraft
inventory of $1,915,820, $748,740 and $593,923, respectively.

The nine aircraft are recorded as aircraft inventory in the Partnership's
balance sheets. Upon transferring the aircraft to inventory in 1992, the
Partnership recorded downward adjustments to the inventory value of $1,050,000.
During 1994 and 1993, the Partnership recorded additional downward adjustments
to the inventory value of $144,000 and $801,590, respectively, to reflect the
then current estimate of net realizable aircraft inventory value. These
adjustments are reflected as increased depreciation expense in the corresponding
years' statements of operations.

7. 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 1995, 1994 and 1993, the Partnership paid management fees to PIMC of
$809,328, $746,684 and $893,701, respectively. Management fees payable to
PIMC were $23,000 at December 31, 1995 and 1994.

<PAGE>

b. Reimbursement of certain out-of-pocket expenses incurred in connection
with the management of the Partnership and supervision of its assets. In
1995, 1994 and 1993, the Partnership reimbursed PIMC for expenses of
$521,705, $483,077 and $754,345, respectively. Reimbursements totaling
$107,584 and $98,658 were payable to PIMC at December 31, 1995 and 1994,
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.

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.

8. 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, 1995 and 1994 are as
follows:

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

1995: Assets $ 82,001,364 $ 49,382,724 $ 32,618,640
Liabilities 736,449 359,814 376,635

1994: Assets $ 86,552,826 $ 59,622,993 $ 26,929,833
Liabilities 685,857 452,549 233,308

9. 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:

<PAGE>

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

1995 1994 1993
---- ---- ----

Book net income (loss) per limited partnership unit $13.39 $(5.36) $ 2.86
Adjustments for tax purposes represent differences
between book and tax revenue and expenses:
Rental revenue (4.94) (0.23) (6.99)
Management fee expense 0.28 0.04 0.21
Depreciation (4.96) (8.47) (6.13)
Gain or loss on sale of aircraft - 1.57 (10.10)
Capitalized costs - 5.25 3.76
Basis in inventory (1.35) (1.17) (11.11)
Other revenue and expense items (0.01) (1.29) (0.73)
------ ------ -------
Taxable net income (loss) per limited
partnership unit $ 2.41 $(9.66) $(28.23)
====== ====== =======

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. As a result, the current year tax depreciation expense is greater than
the book depreciation expense. 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. 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.

10. Subsequent Event

Sale of TWA Common Stock - As discussed in Note 4, the Partnership exercised the
TWA warrants on December 29, 1995. The fair market value of the TWA stock at
December 31, 1995 was $1,659,160. The Partnership sold the TWA Common Stock by
February 1996, net of broker commissions, for $1,698,057 and will recognize a
gain on trading securities of $38,897 in the first quarter of 1996.

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

None.

<PAGE>

PART III

Item 10. Directors and Executive Officers of the Registrant

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

The officers and directors of PIMC are:

Name PIMC Title

James W. Linnan President; Director
Richard J. Adams Vice President; Director
Norman C. T. Liu Vice President; Director
Edward Sun Vice President
John E. Flynn Vice President
Robert W. Dillon Vice President; Assistant Secretary
Marc A. Meiches Chief Financial Officer
Richard L. Blume 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. Linnan, 54, assumed the position of President and Director of PIMC effective
March 31, 1995. Mr. Linnan had previously held the positions of Vice President
of PIMC effective July 1, 1994, Vice President - Financial Management of PIMC
and PALC effective April 1991, and Vice President - Investor Marketing of PIMC
and PALC since July 1986.

Mr. Adams, 62, Senior Vice President - Aircraft Marketing, North America, served
as Senior Vice President - Aircraft Sales and Leasing of PIMC and PALC effective
August 1992, having previously served as Vice President - Aircraft Sales &
Leasing - Vice President, North America, and Vice President - Corporate Aircraft
since he joined PALC in August 1986. Effective July 1, 1994, Mr. Adams held the
positions of Vice President and Director of PIMC.

Mr. Liu, 38, has assumed the position of Vice President of PIMC effective May 1,
1995 and has assumed the position of Director of PIMC effective July 31, 1995.
Mr. Liu presently holds the position of Executive Vice President - Marketing of
GECAS, having previously held the position of Executive Vice President - Capital
Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was
with General Electric Capital Corporation for nine years. He has held management
positions in corporate Business Development and in Syndications and Leasing for
Transportation and Industrial Funding Corporation (TIFC). Mr. Liu previously
held the position of managing director of Kidder, Peabody & Co., Incorporated.

<PAGE>

Mr. Sun, 46, has assumed the position of Vice President of PIMC effective May 1,
1995. Mr. Sun presently holds the position of Senior Vice President - Structured
Finance of GECAS. Prior to joining GECAS, Mr. Sun held various positions with
TIFC since 1990.

Mr. Flynn, 55, Vice President - Marketing of GECAS, served as Senior Vice
President - Aircraft Marketing for PIMC and PALC effective April 1991, having
previously served as Vice President North America of PIMC and PALC effective
July 1989. Mr. Flynn joined PALC in March 1989 as Vice President - Cargo. For
the two years prior to joining PALC, Mr. Flynn was a transportation consultant.
Effective July 1, 1994, Mr. Flynn held the position of Vice President of PIMC.

Mr. Dillon, 54, became Vice President - Aviation Legal and Insurance Affairs,
effective April 1989. Previously, he served as General Counsel of PIMC and PALC
effective January 1986. Effective July 1, 1994, Mr. Dillon held the positions of
Vice President and Assistant Secretary of PIMC. Mr. Dillon presently holds the
position of Senior Vice President of GECAS.

Mr. Blume, 54, has assumed the position of Secretary of PIMC effective May 1,
1995. Mr. Blume presently holds the position of Executive Vice President and
General Counsel of GECAS. Prior to joining GECAS, Mr. Blume was counsel at GE
Aircraft Engines since 1987.

Mr. Meiches, 43, has assumed the position of Chief Financial Officer of PIMC
effective October 9, 1995. Mr. Meiches presently holds the positions of
Executive Vice President and Chief Financial 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.

<PAGE>

Certain Legal Proceedings:

On October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v.
Polaris Holding Company, et al. was filed in the Supreme Court of the State of
New York for the County of New York. The complaint sets forth various causes of
action which include allegations against certain or all of the defendants (i)
for alleged fraud in connection with certain public offerings, including that of
the Partnership, on the basis of alleged misrepresentation and alleged omissions
contained in the written offering materials and all presentations allegedly made
to investors; (ii) for alleged negligent misrepresentation in connection with
such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged
breach of third party beneficiary contracts; (v) for alleged violations of the
NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for
alleged breach of implied covenants in the customer agreements by certain
registered brokers. The complaint seeks an award of compensatory and other
damages and remedies. On January 19, 1993, plaintiffs filed a motion for class
certification. On March 1, 1993, defendants filed motions to dismiss the
complaint on numerous grounds, including failure to state a cause of action and
statute of limitations. On July 20, 1994, the court entered an order dismissing
almost all of the claims in the complaint and amended complaint. Certain claims,
however, remain pending. Plaintiffs filed a notice of appeal on September 2,
1994. The Partnership is not named as a defendant in this action.

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. Plaintiffs
seek class action certification on behalf of a class of investors in Polaris
Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft
Income Fund VI who purchased their interests while residing in Florida.
Plaintiffs allege the violation of Section 517.301, Florida Statutes, in
connection with the offering and sale of units in such Polaris Aircraft Income
Funds. Among other things, plaintiffs assert that the defendants sold interests
in such Polaris Aircraft Income Funds while "omitting and failing to disclose
the material facts questioning the economic efficacy of" such Polaris Aircraft
Income Funds. Plaintiffs seek rescission or damages, in addition to interest,
costs, and attorneys' fees. On April 5, 1993, defendants filed a motion to stay
this action pending the final determination of a prior filed action in the
Supreme Court for the State of New York entitled Weisl v. Polaris Holding
Company. On that date, defendants also filed a motion to dismiss the complaint
on the grounds of failure to attach necessary documents, failure to plead fraud
with particularity and failure to plead reasonable reliance. On April 13, 1993,
the court denied the defendants' motion to stay. On May 7, 1993, the court
stayed the action pending an appeal of the denial of the motion to stay.
Defendants subsequently filed with the Third District Court of Appeal a petition
for writ of certiorari to review the lower court's order denying the motion to
stay. On October 19, 1993, the Court of Appeal granted the writ of certiorari,
quashed the order, and remanded the action with instruction to grant the stay.
The Partnership is not named as a defendant in this action.

On or around May 14, 1993, a purported class action entitled Moross, et al., v.
Polaris Holding Company, et al., was filed in the United States District Court
for the District of Arizona. This purported class action was filed on behalf of
investors in Polaris Aircraft Income Funds I - VI by nine investors in such
Polaris Aircraft Income Funds. The complaint alleges that defendants violated
Arizona state securities statutes and committed negligent misrepresentation and
breach of fiduciary duty by misrepresenting and failing to disclose material
facts in connection with the sale of limited partnership units in the
above-named funds. An amended complaint was filed on September 17, 1993, but has
not been served upon defendants. On or around October 4, 1993, defendants filed
a notice of removal to the United States District Court for the District of
Arizona. Defendants also filed a motion to stay the action pending the final

<PAGE>

determination of a prior filed action in the Supreme Court for the State of New
York entitled Weisl v. Polaris Holding Company ("Weisl") and to defendants' time
to respond to the complaint until 20 days after disposition of the motion to
action pending resolution of the motions for class certification and motions to
dismiss pending in Weisl. On January 20, 1994, the court stayed the action and
required defendants to file status reports every sixty days setting forth the
status of the motions in Weisl. On April 18, 1995, this action was transferred
to the Multi-District Litigation described below. The Partnership is not named
as a defendant in this action.

On September 21, 1993, a purported derivative action entitled Novak, et al., v.
Polaris Holding Company, et al., was filed in the Supreme Court of the State of
New York, County of New York. This action was brought on behalf of the
Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund II.
The complaint names as defendants Polaris Holding Company, its affiliates and
others. Each of the Partnership, Polaris Aircraft Income Fund I and Polaris
Aircraft Income Fund II is named as a defendant for procedural purposes, but no
recovery is sought from these defendants. The complaint alleges, among other
things, that defendants mismanaged the Partnership and the other Polaris
Aircraft Income Funds, engaged in self-dealing transactions that were
detrimental to the Partnership and the other Polaris Aircraft Income Funds and
failed to make required disclosure in connection with the sale of the units in
the Partnership and the other Polaris Aircraft Income Funds. The complaint
alleges claims of breach of fiduciary duty and constructive fraud and seeks,
among other things an award of compensatory and punitive damages in an
unspecified amount, re-judgment interest, and attorneys' fees and costs. On
January 13, 1994, certain of the defendants, including Polaris Holding Company,
filed motions to dismiss the complaint on the grounds of, among others, failure
to state a cause of action and failure to plead the alleged wrong in detail. On
August 11, 1994, the court denied in part and granted in part defendants'
motions to dismiss. Specifically, the court denied the motions as to the claims
for breach of fiduciary duty, but dismissed plaintiffs' claim for constructive
fraud with leave to replead. On October 7, 1994, defendants filed a notice of
appeal. On November 15, 1994, defendants submitted an answer to the remaining
causes of action. On July 7, 1995, defendants filed briefs in support of their
appeal from that portion of the trial court's order denying the motion to
dismiss. On March 14, 1996, the appellate court reversed the trial court's order
denying the motion to dismiss, and dismissed the complaint.

On or around March 13, 1993, a purported class action entitled Kahn v. Polaris
Holding Company, et al., was filed in the Supreme Court of the State of New
York, County of New York. This purported class action on behalf of investors in
Polaris Aircraft Income Fund V was filed by one investor in the fund. The
complaint names as defendants Polaris Investment Management Corporation, Polaris
Holding Company, its affiliates and others. The complaint charges defendants
with common law fraud, negligent misrepresentation and breach of fiduciary duty
in connection with certain misrepresentations and omissions allegedly made in
connection with the sale of interests in Polaris Aircraft Income Fund V.
Plaintiffs seek compensatory and consequential damages in an unspecified amount,
plus interest, disgorgement and restitution of all earnings, profits and other
benefits received by defendants as a result of their alleged practices, and
attorneys' fees and costs. Defendants' time to move, answer or otherwise plead
with respect to the complaint was extended by stipulation up to and including
April 24, 1995. On April 18, 1995, the action was discontinued without
prejudice. The Partnership is not named as a defendant in this action.

On June 8, 1994, a consolidated complaint captioned In re Prudential Securities
Inc. Limited Partnerships Litigation was filed in the United States District
Court for the Southern District of New York, purportedly consolidating cases
that had been transferred from other federal courts by the Judicial Panel on
Multi-District Litigation. The consolidated complaint names as defendants
Prudential entities and various other sponsors of limited partnerships sold by

<PAGE>

Prudential, including Polaris Holding Company, one of its former officers,
Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation
and Polaris Securities Corporation. The complaint alleges that the Prudential
defendants created a scheme for the sale of approximately $8-billion of limited
partnership interests in 700 assertedly high-risk limited partnerships,
including the Partnership, to approximately 350,000 investors by means of false
and misleading offering materials; that the sponsoring organizations (including
the Polaris entities) participated with the Prudential defendants with respect
to, among other things, the partnerships that each sponsored; and that all of
the defendants conspired to engage in a nationwide pattern of fraudulent conduct
in the marketing of all limited partnerships sold by Prudential. The complaint
alleges violations of the federal Racketeer Influenced and Corrupt Organizations
Act and the New Jersey counterpart thereof, fraud, negligent misrepresentation,
breach of fiduciary duty and breach of contract. The complaint seeks rescission,
unspecified compensatory damages, treble damages, disgorgement of profits
derived from the alleged acts, costs and attorneys fees. On October 31, 1994,
Polaris Investment Management Corporation and other Polaris entities filed a
motion to dismiss the consolidated complaint on the grounds of, inter alia,
statute of limitations and failure to state a claim. The Partnership is not
named as a defendant in this action. Prudential Securities, Inc., on behalf of
itself and its affiliates has made an Offer of Settlement. A class has been
certified for purposes of the Prudential Settlement and notice to the class has
been sent. Any questions concerning Prudential's Offer of Settlement should be
directed to 1-800- 327-3664, or write to the Claims Administrator at:

Prudential Securities Limited Partnerships
Litigation Claims Administrator
P.O. Box 9388
Garden City, New York 11530-9388

A further litigation captioned Romano v. Ball et. al, an action by Prudential
Insurance Company policyholders against many of the same defendants (including
Polaris Investment Management Corporation and Polaris Aircraft Leasing
Corporation), has also been commenced by policy holders of the Prudential
Insurance Company as a purported derivative action on behalf of the Prudential
Insurance Company. The complaint alleges claims under the federal Racketeer
Influenced and Corrupt Organizations Act, as well as claims for waste,
mismanagement and intentional and negligent misrepresentation, and seeks
unspecified compensatory, treble and punitive damages. The case is being
coordinated with In re Prudential.

On or about February 13, 1995, an action entitled Adams, et al. v. Prudential
Securities, Inc. et al. was filed in the Court of Common Pleas, Stark County,
Ohio. The action names Prudential Securities, Inc., Prudential Insurance Company
of America, Polaris Investment Management Corporation, Polaris Securities
Corporation, Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, Polaris Aircraft Income Fund I, Polaris
Aircraft Income Fund IV, Polaris Aircraft Income Fund V and James Darr as
defendants. The complaint alleges that defendants committed common law fraud,
fraud in the inducement, negligent misrepresentation, negligence, breach of
fiduciary duty and civil conspiracy by misrepresenting and failing to disclose
material facts in connection with the sale of limited partnership units in
Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, and Polaris
Aircraft Income Fund V. Plaintiffs seek, among other things, rescission of their
investments in the Polaris Aircraft Income Funds, an award of compensatory
damages in an unspecified amount plus interest thereon, and punitive damages in
an unspecified amount. On or about March 15, 1995, this action was removed to
the United States District Court for the Northern District of Ohio, Eastern
Division. Subsequently, the Judicial Panel transferred this action to the
Multi-District Litigation filed in the United States District Court for the
Southern District of New York, discussed above. The Partnership is not named as
a defendant in this action.

<PAGE>

On or about February 6, 1995, a class action complaint entitled Cohen, et al. v.
J.B. Hanauer & Company, et al. was filed in the Circuit Court of the Fifteenth
Judicial Circuit in and for Palm Beach County, Florida. The complaint names J.B.
Hanauer & Company, General Electric Capital Corporation, General Electric
Financial Services, Inc., and General Electric Company as defendants. The action
purports to be on behalf of "approximately 5,000 persons throughout the United
States" who purchased units in Polaris Aircraft Income Funds I through VI. The
complaint sets forth various causes of action which include allegations against
certain or all of the defendants (i) for violation of Section 12(2) of the
Securities Act of 1933, as amended, by a registered broker dealer and for
violation of Section 15 of such act by all defendants in connection with certain
public offerings, including that of the Partnership, on the basis of alleged
misrepresentation and alleged omissions contained in the written offering
materials and all presentations allegedly made to investors; (ii) for alleged
fraud in connection with such offerings; (iii) for alleged negligent
misrepresentation in connection with such offerings; (iv) for alleged breach of
fiduciary duties; (v) for alleged breach of third party beneficiary contracts;
(vi) for alleged violations of the NASD Rules of Fair Practice by a registered
broker dealer; and (vii) for alleged breach of implied covenants in the customer
agreements by a registered broker dealer. The complaint seeks an award of
compensatory and punitive damages and other remedies. On June 7, 1995,
plaintiffs filed an amended complaint which did not include as defendants
General Electric Capital Corporation, General Electric Financial Services, Inc.,
and General Electric Company, thus effectively dismissing without prejudice the
case against these entities. The Partnership is not named as a defendant in this
action.

On or about January 12, 1995, a class action complaint entitled Cohen, et al. v.
Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the
Fifteenth Judicial Circuit in and for Palm Beach County, Florida, and on March
31, 1995 the case was removed to the United States District Court for the
Southern District of Florida. An amended class action complaint (the "amended
complaint"), which re-named this action Bashein, et al. v. Kidder, Peabody &
Company Inc., et al., was filed on June 13, 1995. The amended complaint names
Kidder Peabody & Company, Inc., General Electric Capital Corporation, General
Electric Financial Services, Inc., and General Electric Company as defendants.
The action purports to be on behalf of "approximately 20,000 persons throughout
the United States" who purchased units in Polaris Aircraft Income Funds III
through VI. The amended complaint sets forth various causes of action
purportedly arising in connection with the public offerings of the Partnership,
Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, and Polaris
Aircraft Income Fund VI. Specifically, plaintiffs assert claims for violation of
Sections 12(2) and 15 of the Securities Act of 1933, fraud, negligent
misrepresentation, breach of fiduciary duty, breach of third party beneficiary
contract, violation of NASD Rules of Fair Practice, breach of implied covenant,
and breach of contract. Plaintiffs seek compensatory damages, interest, punitive
damages, costs and attorneys' fees, as well as any other relief the court deems
just and proper. Defendants moved to dismiss the amended complaint on June 26,
1995. On October 2, 1995, the court denied the defendants' motion to dismiss.
The Partnership is not named as a defendant in this action.

On or around April 13, 1995, a class action complaint entitled B & L Industries,
Inc., et al. v. Polaris Holding Company, et al. was filed in the Supreme Court
of the State of New York. The complaint names as defendants Polaris Holding
Company, Polaris Aircraft Leasing Corporation, Polaris Investment Management
Corporation, Polaris Securities Corporation, Peter G. Pfendler, Marc P.
Desautels, General Electric Capital Corporation, General Electric Financial
Services, Inc., General Electric Company, Prudential Securities Inc., and Kidder
Peabody & Company Incorporated. The complaint sets forth various causes of
action purportedly arising out of the public offerings of the Partnership and
Polaris Aircraft Income Fund IV. Plaintiffs allege claims of fraud, negligent
misrepresentation, breach of fiduciary duty, knowingly inducing or participating
in breach of fiduciary duty, breach of third party beneficiary contract,

<PAGE>

violation of NASD Rules of Fair Practice, breach of implied covenant, and unjust
enrichment. Plaintiffs seek compensatory damages, interest, general,
consequential and incidental damages, exemplary and punitive damages,
disgorgement, rescission, costs, attorneys' fees, accountants' and experts'
fees, and other legal and equitable relief as the court deems just and proper.
On October 2, 1995, defendants moved to dismiss the complaint. The Partnership
is not named as a defendant in this action.

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. 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.
The Partnership is not named as a defendant in this action.

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. Plaintiffs allege claim 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 the Partnership and Polaris
Aircraft Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees,
interest, costs and general relief. The Partnership is not named as a defendant
in this action.

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. 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 the Partnership and Polaris Aircraft
Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief. The Partnership is not named as a defendant in this
action.

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. 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 the Partnership and Polaris Aircraft Income Fund IV. Plaintiffs seek
compensatory damages, attorneys' fees, interest, costs and general relief. The
Partnership is not named as a defendant in this action.

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. 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

<PAGE>

Income Fund IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief. The Partnership is not named as a defendant in this
action.

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

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

Based solely on its review of the copies of such forms received or written
representations from certain reporting persons that no Forms 3, 4, or 5 were
required for those persons, the Partnership believes that, during 1995 all
filing requirements applicable to its officers, directors and greater than ten
percent beneficial owners were met.

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 $809,328 were paid to PIMC in 1995 in addition to a 10%
interest in all cash distributions as described in Note 7 to the financial
statements (Item 8).

Item 12. Security Ownership of Certain Beneficial Owners and Management

a) No person owns of record, or is known by PAIF-III to own beneficially
more than five percent of any class of voting securities of PAIF-III.
<TABLE>
b) The General Partner of PAIF-III owns the equity securities of PAIF-III
as set forth in the following table:
<CAPTION>
Title Name of Amount and Nature of Percent
of Class Beneficial Owner Beneficial Ownership of Class
<S> <C> <C> <C> <C>
General Polaris Investment Represents a 10.0% interest of all cash 100%
Partner Management distributions, gross income in an
Interest Corporation amount equal to 9.09% of distributed
cash available from operations, and a
1% interest in net income or loss
</TABLE>
c) There are no arrangements known to PAIF-III, including any pledge by
any person of securities of PAIF-III, the operation of which may at a
subsequent date result in a change in control of PAIF-III.

Item 13. Certain Relationships and Related Transactions

None.

<PAGE>

PART IV

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

1. Financial Statements.

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

Report of Independent Public Accountants 19
Balance Sheets 20
Statements of Operations 21
Statements of Changes in Partners' Capital (Deficit) 22
Statements of Cash Flows 23
Notes to Financial Statements 24

2. Reports on Form 8-K.

None.

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

27. Financial Data Schedules (Filed electronically only).

4. Financial Statement Schedules.

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

<PAGE>

SIGNATURES

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

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

March 25, 1996 By: /S/ James W. Linnan
-------------- -------------------------
Date James W. Linnan, 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/James W. Linnan President and Director of Polaris March 25, 1996
- ------------------- Investment Management Corporation, --------------
(James W. Linnan) General Partner of the Registrant

/S/Norman C. T. Liu Vice President and Director of Polaris March 25, 1996
- ------------------- Investment Management Corporation, --------------
(Norman C. T. Liu) General Partner of the Registrant

/S/Marc A. Meiches Chief Financial Officer of Polaris March 25, 1996
- ------------------- Investment Management Corporation, --------------
(Marc A. Meiches) General Partner of the Registrant

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 25014205
<SECURITIES> 0
<RECEIVABLES> 1554578
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 128946159
<DEPRECIATION> 75198827
<TOTAL-ASSETS> 82001364
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 81264915
<TOTAL-LIABILITY-AND-EQUITY> 82001364
<SALES> 0
<TOTAL-REVENUES> 21096762
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 13198816
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 7897946
<INCOME-TAX> 0
<INCOME-CONTINUING> 7897946
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7987946
<EPS-PRIMARY> 13.39
<EPS-DILUTED> 0

</TABLE>