UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K/A
Amendment No. 1
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_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from__to__
Commission File No. 33-10122
POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership
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(Exact name of registrant as specified in its charter)
California 94-3023671
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(State or other jurisdiction of (IRS Employer I.D. No.)
incorporation or organization)
201 High Ridge Road, Stamford, Connecticut 06927
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (203) 357-3776
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Depository Units Representing Assignments of Limited Partnership Interests
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes _X_ No___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ___
No formal market exists for the units of limited partnership interest and
therefore there exists no aggregate market value at December 31, 1997.
Documents incorporated by reference: None
This document consists of 10 pages.
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The undersigned registrant hereby amends Item 7 of its Annual Report on Form
10-K for the year ended December 31, 1997 in its entirety as follows:
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
At December 31, 1997, Polaris Aircraft Income Fund III (the Partnership) owned a
portfolio of 10 used McDonnell Douglas DC-9-30 aircraft leased to Trans World
Airlines, Inc. (TWA) and certain inventoried aircraft parts out of its original
portfolio of 38 aircraft. The Partnership transferred three McDonnell Douglas
DC-9-10 aircraft and six Boeing 727-100 aircraft to aircraft inventory in 1992.
The inventoried aircraft have been disassembled for sale of their component
parts. Of its original aircraft portfolio, the Partnership sold eight DC-9-10
aircraft in 1992 and 1993 and three Boeing 727-200 aircraft in May 1994. In June
1997, the Partnership sold three McDonnell Douglas DC-9-30 aircraft leased to
TWA, and five Boeing 727-200 Advanced aircraft leased to Continental Airlines,
Inc. (Continental) to Triton Aviation Services III LLC.
Remarketing Update
General - Polaris Investment Management Corporation (the General Partner or
PIMC) evaluates, from time to time, whether the investment objectives of the
Partnership are better served by continuing to hold the Partnership's remaining
portfolio of Aircraft or marketing such Aircraft for sale. This evaluation takes
into account the current and potential earnings of the Aircraft, the conditions
in the markets for lease and sale and future outlook for such markets, and the
tax consequences of selling rather than continuing to lease the Aircraft.
Recently, the General Partner has had discussions with third parties regarding
the possibility of selling some or all of these Aircraft. While such discussions
may continue, and similar discussions may occur again in the future, there is no
assurance that such discussions will result in the Partnership receiving a
purchase offer for all or any of the Aircraft which the General Partner would
regard as acceptable.
Sale of Aircraft - On May 28, 1997, PIMC, on behalf of the Partnership, executed
definitive documentation for the purchase of 8 of the Partnership's 18 remaining
aircraft (the "Aircraft") and certain of its notes receivables by Triton
Aviation Services III LLC, a special purpose company (the "Purchaser"). The
closings for the purchase of the 8 Aircraft occurred from June 5, 1997 to June
25, 1997. The Purchaser is managed by Triton Aviation Services, Ltd. ("Triton
Aviation" or the "Manager"), a privately held aircraft leasing company which was
formed in 1996 by Triton Investments, Ltd., a company which has been in the
marine cargo container leasing business for 17 years and is diversifying its
portfolio by leasing commercial aircraft. Each Aircraft was sold subject to the
existing leases.
The General Partner's Decision to Approve the Transaction - In determining
whether the transaction was in the best interests of the Partnership and its
unitholders, PIMC evaluated, among other things, the risks and significant
expenses associated with continuing to own and remarket the Aircraft (many of
which were subject to leases that were nearing expiration). The General Partner
determined that such a strategy could require the Partnership to expend a
significant portion of its cash reserves for remarketing and that there was a
substantial risk that this strategy could result in the Partnership having to
reduce or even suspend future cash distributions to limited partners. The
General Partner concluded that the opportunity to sell the Aircraft at an
attractive price would be beneficial in the present market where demand for
Stage II aircraft is relatively strong rather than attempting to sell the
aircraft "one-by-one" over the coming years when the demand for such Aircraft
might be weaker. GE Capital Aviation Services, Inc. ("GECAS"), which provides
aircraft marketing and management services to the General Partner, sought to
obtain the best price and terms available for these Stage II aircraft given the
aircraft market and the conditions and types of planes owned by the Partnership.
Both the General Partner and GECAS approved the sale terms of the Aircraft as
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being in the best interest of the Partnership and its unit holders because both
believe that this transaction will optimize the potential cash distributions to
be paid to limited partners. To ensure that no better offer could be obtained,
the terms of the transaction negotiated by GECAS included a "market-out"
provision that permitted the Partnership to elect to accept an offer for all
(but not less than all) of the assets to be sold by it to the Purchaser on terms
which it deemed more favorable, with the ability of the Purchaser to match the
offer or decline to match the offer and be entitled to be compensated in an
amount equal to 1.5% of the Purchaser's proposed purchase price. The Partnership
did not receive any other offers and, accordingly, the General Partner believes
that a valid market check had occurred confirming that the terms of this
transaction were the most beneficial that could have been obtained.
The Terms of the Transaction - The total contract purchase price (the "Purchase
Price") to the Purchaser was $10,947,000 which was allocated to the Aircraft and
a note receivable by the Partnership. The Purchaser paid into an escrow account
$1,233,289 of the Purchase Price in cash at the closing of the first aircraft
and delivered a promissory note (the "Promissory Note") for the balance of
$9,713,711. The Partnership received payment of $1,233,289 from the escrow
account on June 26, 1997. On December 30, 1997, the Partnership received
prepayment in full of the outstanding note receivable and interest earned by the
Partnership to that date.
Under the purchase agreement, the Purchaser purchased the Aircraft effective as
of April 1, 1997 notwithstanding the actual closing dates. The utilization of an
effective date facilitated the determination of rent and other allocations
between the parties. The Purchaser had the right to receive all income and
proceeds, including rents and receivables, from the Aircraft accruing from and
after April 1, 1997, and the Promissory Note commenced bearing interest as of
April 1, 1997 subject to the closing of the Aircraft. Each Aircraft was sold
subject to the existing leases.
Neither PIMC nor GECAS received a sales commission in connection with the
transaction. In addition, PIMC was not paid a management fee with respect to the
collection of the Promissory Note or on any rents accruing from or after April
1, 1997 with respect to the 8 Aircraft. Neither PIMC nor GECAS or any of its
affiliates holds any interest in Triton Aviation or any of Triton Aviation's
affiliates. John Flynn, the current President of Triton Aviation, was a Polaris
executive until May 1996 and has over 15 years experience in the commercial
aviation industry. At the time Mr. Flynn was employed at PIMC, he had no
affiliation with Triton Aviation or its affiliates.
Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund IV, Polaris
Aircraft Income Fund V and Polaris Aircraft Income Fund VI have also sold
certain aircraft assets to separate special purpose companies under common
management with the Purchaser (collectively, together with the Purchaser, the
"SPC's") on terms similar to those set forth above, with the exception of the
Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.
The Accounting Treatment of the Transaction - In accordance with generally
accepted accounting principles (GAAP), the Partnership recognized rental income
up until the closing date for each aircraft which occurred from June 5, 1997 to
June 25, 1997. However, under the terms of the transaction, the Purchaser was
entitled to receive any payments of the rents, interest income and receivables
accruing from April 1, 1997. As a result, the Partnership made payments to the
Purchaser for the amounts due and received from April 1, 1997 to the closing
date. Amounts totaling $1,341,968 during this period are included in rents from
operating leases, interest and other income. For financial reporting purposes,
the cash down payment portion of the sales proceeds of $1,233,289 has been
adjusted by the following; income and proceeds, including rents and receivables
from the effective date of April 1, 1997 to the closing date, interest due from
the Purchaser on the cash portion of the purchase price, interest on the
Promissory Note from the effective date of April 1, 1997 to the closing date and
estimated selling costs. As a result of these GAAP adjustments, the net adjusted
sales price recorded by the Partnership, including the Promissory Note, was
$9,827,305.
The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 had been classified as aircraft held for sale from that date until the
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actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $1,092,046 during 1997. This adjustment to the net
carrying value of the aircraft held for sale is included in depreciation and
amortization expense on the statement of operations.
Partnership Operations
The Partnership reported net income of $4,989,096, or $9.88 per limited
partnership unit for the year ended December 31, 1997, compared to a net loss of
$6,803,529, or $17.25 per limited partnership unit for the year ended December
31, 1996, and net income of $7,897,946, or $13.39 per limited partnership unit,
for the year ended December 31, 1995.
The decrease in rental revenues, depreciation expense and management fees during
1997, is attributable to the sale of 8 aircraft to Triton during 1997. This
decrease in rental revenues and depreciation expense was offset in part by
increased depreciation expense attributable to the acquisition in November 1996
of noise-suppression devices, commonly known as "hushkits", for the 10 aircraft
currently leased to TWA. The hushkits are being financed over 50 months at an
interest rate of 10% per annum. The leases for these 10 aircraft were extended
for a period of eight years until November 2004. The rent payable by TWA under
the leases has been increased by an amount sufficient to cover the monthly debt
service payments on the hushkits and fully repay, during the term of the TWA
leases, the amount borrowed. The Partnership recorded $1,205,566 and $122,197 in
interest expense on the amount borrowed to finance the hushkits during 1997 and
1996, respectively.
The Partnership recorded an increase in other income during 1997. This increase
in other income was the result of the receipt of $743,476 related to amounts due
under the TWA maintenance credit and rent deferral agreement.
Rental revenues, net of related management fees, declined in 1996 as compared to
1995 due to the extension of the Continental leases at a current market rate
that was lower than the prior lease rate. Additionally, TWA rental revenues were
higher in 1995 due to the receipt, during 1995, of certain deferred rental
amounts from 1994 as discussed below under TWA Restructuring.
In consideration for the rent deferral discussed later under TWA Restructuring,
the Partnership received $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 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. In 1996, the
Partnership sold its TWA Common Stock.
In January 1995, the United States Bankruptcy Court approved an agreement
between the Partnership and Continental which specified payment to the
Partnership by Continental of approximately $1.3 million as final settlement for
the return of six Boeing 727-100 aircraft. The Partnership received an initial
payment of $311,111 in February 1995 and received the balance of the settlement
in equal monthly installments of $72,222 through February 1996. The Partnership
received all payments due from Continental for the settlement, which were
recorded as revenue when received. The Partnership recorded payments of
$1,105,556 and $144,444 as other revenue during 1995 and 1996, respectively.
The Partnership recognized substantially higher depreciation expense in 1996, as
compared to the prior year. As discussed in the Industry Update section, if the
projected net cash flow for each aircraft (projected rental revenue, net of
management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, the Partnership
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recognizes the deficiency currently as increased depreciation expense. The
Partnership recognized impairment losses on aircraft to be held and used by the
Partnership of approximately $12.5 million and $1.8 million in 1996 and 1995 as
increased depreciation expense. In 1996, the impairment loss was the result of
several significant factors. As a result of industry and market changes, a more
extensive review of the Partnership's aircraft was completed in the fourth
quarter of 1996 which resulted in revised assumptions of future cash flows
including reassessment of projected re-lease terms and potential future
maintenance costs. As discussed in Note 4, the Partnership accepted an offer to
purchase eight of the Partnership's remaining aircraft subject to each
aircraft's existing lease. This offer constituted an event that required the
Partnership to review the aircraft carrying value pursuant to SFAS 121. In
determining this additional impairment loss, the Partnership estimated the fair
value of the aircraft based on the purchase price reflected in the offer, less
the estimated costs and expenses of the proposed sale. The partnership is deemed
to have an impairment loss to the extent that the carrying value exceeded the
fair value. Management believes the assumptions related to fair value of
impaired assets represents the best estimates based on reasonable and
supportable assumptions and projections.
The increased depreciation expense reduces the aircraft's carrying value and
reduces the amount of future depreciation expense that the Partnership will
recognize over the projected remaining economic life of the aircraft. The
Partnership also made downward adjustments to the estimated residual value of
certain of its on-lease aircraft as of December 31, 1995. For any downward
adjustment to the estimated residual values, future depreciation expense over
the projected remaining economic life of the aircraft is increased. The
Partnership's earnings are impacted by the net effect of the adjustments to the
aircraft carrying values recorded in 1996 and 1995, and the downward adjustments
to the estimated residual values recorded in 1995 as discussed later in the
Industry Update section.
Liquidity and Cash Distributions
Liquidity - The Partnership received prepayment in full of all amounts due from
Triton and all lease payments from lessees, except for the December 27, 1997
payment due from TWA. On January 2, 1998, the Partnership received its $850,000
rental payment from TWA that was due on December 27, 1997. This amount was
included in rent and other receivables on the balance sheet at December 31,
1997. In addition, proceeds totaling $590,981 have been received for the sale of
parts from the nine disassembled aircraft during 1997, as compared to proceeds
of and $902,733 and $1,915,820 during 1996 and 1995, respectively. The net book
value of the Partnership's aircraft inventory was recovered in full during 1996.
As a result, the payments received during 1997 have been recorded as gain on
sale of aircraft inventory.
PIMC has determined that the Partnership maintain cash reserves as a prudent
measure to ensure that the Partnership has available funds in the event that the
aircraft presently on lease to TWA require remarketing, and for other
contingencies including expenses of the Partnership. The Partnership's cash
reserves will be monitored and may be revised from time to time as further
information becomes available in the future.
As discussed above and in Note 6 to the financial statements (Item 8), the
Partnership agreed to share the cost of meeting certain Airworthiness Directives
(ADs) with TWA. In accordance with the cost-sharing agreement, TWA may offset up
to an additional $1.0 million against rental payments, subject to annual
limitations, over the remaining lease terms.
Cash Distributions - Cash distributions to limited partners were $11,100,000,
$18,875,000 and $11,250,000 in 1997, 1996 and 1995, respectively. Cash
distributions per limited partnership unit totaled $22.20, $37.75 and $22.50 in
1997, 1996 and 1995, respectively. The timing and amount of future cash
distributions are not yet known and will depend on the Partnership's future cash
requirements (including expenses of the Partnership) and need to retain cash
reserves as previously discussed in the Liquidity section; the receipt of rental
payments from TWA; and payments generated from the aircraft disassembly process.
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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
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.
On June 30, 1995, TWA filed its prepackaged Chapter 11 bankruptcy in the United
States Bankruptcy Court for the Eastern District of Missouri. On August 4, 1995,
the Bankruptcy Court confirmed TWA's plan of reorganization, which became
effective on August 23, 1995. Pursuant to the Amended Deferral Agreement, on the
confirmation date of the plan, August 4, 1995, the Partnership received a
payment of $881,480 from TWA which represented fifty percent (50%) of the
deferred rent outstanding plus interest as of such date. The remaining balance
of deferred rent plus interest was paid in full to the Partnership on October 2,
1995. TWA has been current with its obligation to the Partnership since August
1995. While TWA has committed to an uninterrupted flow of lease payments, there
can be no assurance that TWA will continue to honor its obligations in the
future.
The Partnership received warrants to purchase 159,919 shares of TWA Common Stock
from TWA in November 1995 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
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of $0.01 per share and recognized a gain on the value of the warrants of
$409,792 in the 1995 statement of operations. The TWA Common Stock was
classified as trading securities in 1995 because the Partnership intended 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, applicable to McDonnell Douglas aircraft,
requires replacement or modification of certain structural items on a specific
timetable. These structural items were formerly subject to periodic inspection,
with replacement when necessary. The AD requires specific work to be performed
at various cycle thresholds between 40,000 and 100,000 cycles, and on specific
date or age thresholds. The estimated cost of compliance with all of the
components of this AD is approximately $850,000 per aircraft. The extent of
modifications required to an aircraft varies according to the level of
incorporation of design improvements at manufacture.
In January 1993, the FAA adopted another AD intended to mitigate corrosion of
structural components, which would require repeated inspections from 5 years of
age throughout the life of an aircraft, with replacement of corroded components
as needed. Integration of the new inspections into each aircraft operator's
maintenance program was required by January 31, 1994.
The Partnership's existing leases require the lessees to maintain the
Partnership's aircraft in accordance with an FAA-approved maintenance program
during the lease term. At the end of the leases, each lessee is generally
required to return the aircraft in airworthy condition, including compliance
with all ADs for which action is mandated by the FAA during the lease term. The
Partnership agreed to bear a portion of certain maintenance and/or AD compliance
costs, as discussed in Item 1, with respect to the aircraft leased to
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
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.
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On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2
aircraft by the end of this decade. The key features of the rule include:
- Compliance can be accomplished through a gradual process of
phase-in or phase-out (see below) on each of three interim
compliance dates: December 31, 1994, 1996 and 1998. All Stage
2 aircraft must be phased out of operations in the contiguous
United States by December 31, 1999, with waivers available in
certain specific cases to December 31, 2003.
- All operators have the option of achieving compliance through
a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25%
of its Stage 2 fleet on each of the compliance dates noted
above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%,
65% and 75% of an operator's fleet must consist of Stage 3
aircraft by the respective interim compliance dates noted
above).
The federal rule does not prohibit local airports from issuing more stringent
phase-out rules. In fact, several local airports have adopted more stringent
noise requirements which restrict the operation of Stage 2 and certain Stage 3
aircraft.
Other countries have also adopted noise policies. The European Union (EU)
adopted a non-addition rule in 1989, which directed each member country to pass
the necessary legislation to prohibit airlines from adding Stage 2 aircraft to
their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the
year 2002. The International Civil Aviation Organization has also endorsed the
phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.
Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3
requirements, are currently available for the Partnership's aircraft. Hushkits
were added to 10 of the Partnership's Stage 2 aircraft in 1996.
Demand for Aircraft - Industry-wide, approximately 330 commercial jet aircraft
were available for sale or lease at December 31, 1997, approximately 50 more
than a year ago. At under 3% of the total available jet aircraft fleet, this is
still a relatively low level of availability by industry historic standards.
From 1991 to 1994, depressed demand for travel limited airline expansion plans,
with new aircraft orders and scheduled deliveries being canceled or
substantially deferred. As profitability declined, many airlines took action to
downsize or liquidate assets and some airlines were forced to file for
bankruptcy protection. Following four years of strong traffic growth accompanied
by rising yields, this trend reversed with many airlines reporting substantial
profits since 1995. As a result of this improving trend, just over 1200 new jet
aircraft were ordered in 1996 and a further 1300 were ordered in 1997, making
this the second highest ever order year in the history of the industry. To date,
this strong recovery has mainly benefited Stage 3 narrow-bodies and younger
Stage 2 narrow-bodies, many of which are now being upgraded with hushkits,
whereas older Stage 2 narrow-bodies and early wide-bodies have shown only
marginal signs of recovery since the depressed 1991 to 1994 period. Economic
turmoil in Asia in the second half of 1997 has brought about a significant
reduction in traffic growth in much of that region which is resulting in a
number of new aircraft order deferrals and cancellations, mainly in the
wide-body sector of the market with as yet no impact evident in other world
markets.
The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control and structural inspection
and modification as previously discussed.
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Effects on the Partnership's Aircraft - The Partnership periodically reviews the
estimated realizability of the residual values at the projected end of each
aircraft's economic life based on estimated residual values obtained from
independent parties which provide current and future estimated aircraft values
by aircraft type. The Partnership made downward adjustments to the estimated
residual value of certain of its on-lease aircraft as of December 31, 1995. For
any downward adjustment in estimated residual value or decrease in the projected
remaining economic life, the depreciation expense over the projected remaining
economic life of the aircraft is increased. As a result of the 1995 adjustments
to the estimated residual values, the Partnership is recognizing increased
depreciation expense of approximately $194,000 per year beginning in 1996
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 $12.5 million and $1.8 million, or $24.95
and $3.54 per limited Partnership unit, of this deficiency as increased
depreciation expense in 1996 and 1995. In 1996, the impairment loss was the
result of several significant factors. As a result of industry and market
changes, a more extensive review of the Partnership's aircraft was completed in
the fourth quarter of 1996 which resulted in revised assumptions of future cash
flows including reassessment of projected re-lease terms and potential future
maintenance costs. As discussed in Note 4, the Partnership accepted an offer to
purchase eight of the Partnership's remaining aircraft subject to each
aircraft's existing lease. This offer constituted an event that required the
Partnership to review the aircraft carrying value pursuant to SFAS 121. In
determining this additional impairment loss, the Partnership estimated the fair
value of the aircraft based on the proposed purchase price reflected in the
offer, and then deducted this amount from the carrying value of the aircraft.
The partnership recorded an impairment loss to the extent that the carrying
value exceeded the fair value. Management believes the assumptions related to
fair value of impaired assets represents the best estimates based on reasonable
and supportable assumptions and projections. The 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 in 1996.
The Partnership periodically reviews its aircraft for impairment in accordance
with SFAS No. 121. The Partnership uses information obtained from third party
valuation services in arriving at its estimate of fair value for purposes of
determining residual values. The Partnership will use similar information, plus
available information and estimates related to the Partnership's aircraft, to
determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.
9
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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
May 27, 1998 By: /S/ Marc A. Meiches
- --------------------------- ----------------------------------------
Date Marc A. Meiches, Chief Financial Officer
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