10-Q 1 if3_2q01.txt 06/30/01 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-Q ---------------- X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___ to ___ ---------------- Commission File No. 33-10122 ---------------- POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership State of Organization: California IRS Employer Identification No. 94-3023671 201 High Ridge Road, Stamford, Connecticut 06927 Telephone - (203) 357-3776 Indicate by check mark whether the registrant:(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- This document consists of 16 pages. POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership FORM 10-Q - For the Quarterly Period Ended June 30, 2001 INDEX Part I. Financial Information Page Item 1. Financial Statements a) Balance Sheets - June 30, 2001 and December 31, 2000...........................................3 b) Statements of Operations - Three and Six Months Ended June 30, 2001 and 2000................................4 c) Statements of Changes in Partners' Capital (Deficit) - Year Ended December 31, 2000 and Six Months Ended June 30, 2001..........................5 d) Statements of Cash Flows - Six Months Ended June 30, 2001 and 2000................................6 e) Notes to Financial Statements...............................7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........11 Part II. Other Information Item 1. Legal Proceedings......................................14 Item 6. Exhibits and Reports on Form 8-K.......................14 Signature .......................................................16 2 Part I. Financial Information ----------------------------- Item 1. Financial Statements POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership BALANCE SHEETS (Unaudited) June 30, December 31, 2001 2000 ---- ---- ASSETS: CASH AND CASH EQUIVALENTS $ 11,725,441 $ 12,523,907 RENT AND OTHER RECEIVABLES 232,006 597,732 AIRCRAFT HELD FOR SALE 934,938 1,107,580 AIRCRAFT, net of accumulated depreciation of $43,651,396 in 2001 and $42,317,237 in 2000 5,777,895 7,112,054 OTHER ASSETS -- 14,291 ------------ ------------ Total Assets $ 18,670,280 $ 21,355,564 ============ ============ LIABILITIES AND PARTNERS' CAPITAL (DEFICIT): PAYABLE TO AFFILIATES $ 389,771 $ 220,339 ACCOUNTS PAYABLE AND ACCRUED LIABILITIES 160,006 130,936 DEFERRED INCOME 1,603,385 4,258,474 NOTES PAYABLE -- 204,871 ------------ ------------ Total Liabilities 2,153,162 4,814,620 ------------ ------------ PARTNERS' CAPITAL (DEFICIT): General Partner (3,778,699) (3,778,433) Limited Partners, 499,960 units issued and outstanding 20,295,817 20,319,377 ------------ ------------ Total Partners' Capital 16,517,118 16,540,944 ------------ ------------ Total Liabilities and Partners' Capital $ 18,670,280 $ 21,355,564 ============ ============ The accompanying notes are an integral part of these statements. 3 POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended Six Months Ended June 30, June 30, -------- -------- 2001 2000 2001 2000 ---- ---- ---- ---- REVENUES: Rent from operating leases $ 1,666,428 $ 2,247,342 $ 4,551,589 $ 4,494,684 Interest and other 137,385 185,719 318,209 357,421 ----------- ----------- ----------- ----------- Total Revenues 1,803,813 2,433,061 4,869,798 4,852,105 ----------- ----------- ----------- ----------- EXPENSES: Depreciation 747,877 917,650 1,506,801 1,835,300 Management fees to general partner 2,890 86,786 (8,444) 173,573 Interest 3,269 67,724 4,960 158,420 Operating 49,440 3,722 53,162 7,444 Legal fees 91,556 2,036 92,931 2,372 Administration and other 113,190 95,080 188,903 180,082 ----------- ----------- ----------- ----------- Total Expenses 1,008,222 1,172,998 1,838,313 2,357,191 ----------- ----------- ----------- ----------- NET INCOME $ 795,591 $ 1,260,063 $ 3,031,485 $ 2,494,914 =========== =========== =========== =========== NET INCOME ALLOCATED TO THE GENERAL PARTNER $ 132,933 $ 145,077 $ 305,265 $ 289,902 =========== =========== =========== =========== NET INCOME ALLOCATED TO LIMITED PARTNERS $ 662,658 $ 1,114,986 $ 2,726,220 $ 2,205,012 =========== =========== =========== =========== NET INCOME PER LIMITED PARTNERSHIP UNIT $ 1.33 $ 2.23 $ 5.45 $ 4.41 =========== =========== =========== ===========
The accompanying notes are an integral part of these statements. 4 POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) (Unaudited) Year Ended December 31, 2000 and Six Months Ended June 30, 2001 ------------------------------ General Limited Partner Partners Total ------- -------- ----- Balance, December 31, 1999 $ (3,657,030) $ 32,332,929 $ 28,675,899 Net income 467,439 (6,713,976) (6,246,537) Cash distributions to partners (588,842) (5,299,576) (5,888,418) ------------ ------------ ------------ Balance, December 31, 2000 (3,778,433) 20,319,377 16,540,944 Net income 305,265 2,726,220 3,031,485 Cash distribution to partners (305,531) (2,749,780) (3,055,311) ------------ ------------ ------------ Balance, June 30, 2001 $ (3,778,699) $ 20,295,817 $ 16,517,118 ============ ============ ============ The accompanying notes are an integral part of these statements. 5 POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership STATEMENTS OF CASH FLOWS (Unaudited) Six Months Ended June 30, ------------------------- 2001 2000 ---- ---- OPERATING ACTIVITIES: Net income $ 3,031,485 $ 2,494,914 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 1,506,801 1,835,300 Changes in operating assets and liabilities: Decrease in other assets 14,291 -- Decrease in rent and other receivables 365,726 12,689 Increase in payable to affiliates 169,432 6,028 Increase in accounts payable and accrued liabilities 29,070 27,544 Increase (decrease) in deferred income (2,655,089) 605,315 ------------ ------------ Net cash provided by operating activities 2,461,716 4,981,790 ------------ ------------ FINANCING ACTIVITIES: Principal payments on notes payable (204,871) (1,939,532) Cash distributions to partners (3,055,311) (2,944,209) ------------ ------------ Net cash used in financing activities (3,260,182) (4,883,741) ------------ ------------ CHANGES IN CASH AND CASH EQUIVALENTS (798,466) 98,049 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 12,523,907 12,317,505 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 11,725,441 $ 12,415,554 ============ ============ SUPPLEMENTAL INFORMATION: Interest paid $ 4,960 $ 160,468 ============ ============ The accompanying notes are an integral part of these statements. 6 POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership NOTES TO FINANCIAL STATEMENTS (Unaudited) 1. Accounting Principles and Policies In the opinion of management, the financial statements presented herein include all adjustments, consisting only of normal recurring items, necessary to summarize fairly Polaris Aircraft Income Fund III's (the Partnership's) financial position and results of operations. The financial statements have been prepared in accordance with the instructions of the Quarterly Report to the Securities and Exchange Commission (SEC) Form 10-Q and do not include all of the information and note disclosures required by generally accepted accounting principles (GAAP). These statements should be read in conjunction with the financial statements and notes thereto for the years ended December 31, 2000, 1999, and 1998 included in the Partnership's 2000 Annual Report to the SEC on Form 10-K. 2. TWA Bankruptcy and Transaction with American Airlines As described in greater detail in Item 5 of the Current Report on Form 8-K dated February 28, 2001 and first filed by the Partnership on or about March 24, 2001 (as amended, the "8-K"), TWA filed a voluntary petition in the United States Bankruptcy Court of the District of Delaware (the "Bankruptcy Court") for reorganization relief under Chapter 11 of the Bankruptcy Code on January 10, 2001. One day prior to filing its bankruptcy petition, TWA entered into an Asset Purchase Agreement with American that provided for the sale to American of substantially all of TWA's assets and permitted American to exclude certain TWA contracts (including aircraft leases) from the assets of TWA to be acquired by American. On February 28, 2001, American presented the General Partner of the Partnership ("General Partner") with a written proposal to assume, on modified terms and conditions, the Prior Leases applicable to seven of the ten Aircraft. For reasons discussed more fully in the 8-K, the General Partner decided to accept American's proposal, although consummation of the transactions with American remained subject to a number of contingencies, including the approval of the Bankruptcy Court and other regulatory approvals at the time of the preparation and filing of the 8-K. On April 9, 2001, the American acquisition of the selected TWA assets was consummated. As a result of this closing, American assumed the Prior Leases applicable to seven of the ten Aircraft, and simultaneously, such Prior Leases were amended to incorporate the modified terms described in the 8-K (as so assumed and amended, the "Assumed Leases"). As indicated in the 8-K, the Assumed Leases are substantially less favorable to the Partnership than the Prior Leases. In particular, the monthly rental rate for each Aircraft has been reduced from $85,000 to $40,000, and the reduced rate was made effective as of March 12, 2001 by a rent credit granted to American for the amount of rent above $40,000 previously paid by TWA in respect of the period from and after March 12, 2001. In addition, the term of each Assumed Lease is scheduled to expire at the time of the next scheduled heavy maintenance check of the applicable Aircraft, compared to the scheduled expiry dates of November 27, 2004 and February 7, 2005 under the Prior Leases, provided that the aggregate average number of months for which all seven Aircraft are on lease to American would not be less than 19 months from and after March 12, 2001. Finally, the maintenance condition of the aircraft to be met at lease expiry was eased in favor of American, as compared to the corresponding conditions required under the Prior Leases. 7 With respect to the three Aircraft that American did not elect to acquire, TWA officially rejected the Prior Leases applicable to these Aircraft (collectively, the "Rejected Leases") as of April 20, 2001. Two of these Aircraft have already been returned to the Partnership and are now parked in storage in Arizona. The third Aircraft was ferried to Arizona on June 4, 2001. The General Partner has been actively remarketing these Aircraft for sale and is continuing to pursue these efforts at this time. In addition, the General Partner is in the process of filing administrative claims in the TWA bankruptcy proceeding in an effort to recover (i) the fair value of TWA's actual use, if any, of these three Aircraft during the 60-day period following TWA's filing of its bankruptcy petition, and (ii) claims relating to these Aircraft for the period from March 12, 2001 (the expiration of the 60-day automatic stay period after the filing of bankruptcy petition) to April 20, 2001, the date on which these Prior Leases were rejected by TWA. Furthermore, it is anticipated that the General Partner will also file general unsecured claims for damages arising from TWA's breach of the Rejected Leases. However, there can be no assurances as to whether, or when, the General Partner will be successful in asserting the value of the claims or be able to collect any amounts out of the TWA bankruptcy estate, either in respect of administrative claims or other claims. Effect of the TWA Bankruptcy As previously disclosed in the 8-K, the TWA bankruptcy is expected to have a material adverse effect on the Partnership's results of operations and financial position. As a result of the TWA bankruptcy and the transactions with American described above, aggregate rentals to be received by the Partnership in 2001 have been reduced from approximately $10.2 million, had all ten aircraft remained on lease at the former lease rate, to approximately $3.5 million, and the average lease term for the seven Aircraft that remain on lease has been reduced from 47 to 21 months remaining at December 31, 2000. Three of the Partnership's Aircraft, which would have been expected to generate aggregate rentals in 2001 under the terms of the Prior Leases of approximately $3.0 million (included in the $10.2 million above), are now being marketed for sale at scrap value (which the General Partner believes will be materially less than the aggregate rental amount). The amount and timing of the Partnership's distributions of cash available for distribution depends upon many factors, including whether the General Partner is able to collect any amounts in respect of the administrative and other claims filed with the Bankruptcy Court. The amount of cash available for distribution for the quarter ended March 31, 2001 was not materially different from the corresponding quarter in 2000, but the General Partner expects the amount of cash available for distribution for the subsequent quarters in 2001 to be materially less. The Accounting Treatment of the Transaction As a result of the TWA bankruptcy and the modified lease terms reflected in the Assumed Leases, the Partnership was required to review the carrying value of the Aircraft pursuant to applicable accounting standards including SFAS 121. Any downward adjustment in the estimated residual value or decrease in the projected remaining economic life of any of the Aircraft dictates an increase in depreciation expense over the projected economic life of such Aircraft. Further, if the projected net cash flow for any of the Aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of such Aircraft, an impairment loss must be recorded. After a review of the carrying value of the Aircraft pursuant to applicable accounting standards including SFAS 121, the Partnership recognized an impairment loss as increased depreciation expense in the fourth quarter of 2000 of approximately $11 million, or $22.26 per limited partnership unit. 8 In accordance with generally accepted accounting principles (GAAP), the Partnership recognized rental income and management fees on a straight line basis over the original TWA lease terms. As a result, deferred revenue and accrued management fees were recorded each month since the inception of each Prior Lease, resulting in balances of deferred rental income and accrued management fees of $3,899,131 and $180,107, respectively as of March 12, 2001. Since the Prior Leases were effectively modified on March 12, 2001, the Partnership must recognize the balances of deferred revenue and accrued management fees over the new lease terms, from the date the leases were modified. For the three Rejected Leases, the deferred revenue and accrued management fees amounting to $1,275,431 and $59,691 were recognized as income in March 2001. For the seven Assumed Leases, the deferred revenue and accrued management fees associated with each Aircraft will be recognized over the new lease terms, ranging from 5 months to 36 months as of March 31, 2001. During the quarter ended June 30, 2001, deferred revenue of $839,760 and accrued management fees of $38,443 were recognized as income. 3. Related Parties Under the Limited Partnership Agreement, the Partnership paid or agreed to pay the following amounts for the current quarter to the general partner, Polaris Investment Management Corporation, in connection with services rendered or payments made on behalf of the Partnership: Payments for Three Months Ended Payable at June 30, 2001 June 30, 2001 ------------- ------------- Aircraft Management Fees $ -- $190,525 Out-of-Pocket Administrative Expense Reimbursement 147,145 199,245 -------- -------- $147,145 $389,771 ======== ======== 4. Partners' Capital The Partnership Agreement (the Agreement) stipulates different methods by which revenue, income and loss from operations and gain or loss on the sale of aircraft are to be allocated to the general partner and the limited partners. Such allocations are made using income or loss calculated under GAAP for book purposes, which varies from income or loss calculated for tax purposes. Cash available for distributions, including the proceeds from the sale of aircraft, is distributed 10% to the general partner and 90% to the limited partners. The different methods of allocating items of income, loss and cash available for distribution combined with the calculation of items of income and loss for book and tax purposes result in book basis capital accounts that may vary significantly from tax basis capital accounts. The ultimate liquidation and distribution of remaining cash will be based on the tax basis capital accounts following liquidation, in accordance with the Agreement. 9 5. New Accounting Pronouncements On January 1, 2001, the Partnership adopted Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133), as amended by SFAS 138, which establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The Partnership does not own any derivative instruments, and as such, the implementation of this statement did not have a material impact on the Partnership's financial position or results of operations. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations At June 30, 2001, Polaris Aircraft Income Fund III, a California limited partnership (the "Partnership") owns ten McDonnell Douglas DC-9-30 aircraft (the "Aircraft"). Prior to the closing of the transactions described below, all of the Aircraft were on lease to Trans World Airlines, Inc. ("TWA") (collectively, the "Prior Leases"). As a result of the transactions described below, six of the Aircraft are now on lease to Trans World Airlines, LLC (TWA), and the four remaining Aircraft are no longer on lease to any operator and are being actively remarketed for sale. TWA Bankruptcy and Transaction with American Airlines As described in greater detail in Item 5 of the Current Report on Form 8-K dated February 28, 2001 and first filed by the Partnership on or about March 24, 2001 (as amended, the "8-K"), TWA filed a voluntary petition in the United States Bankruptcy Court of the District of Delaware (the "Bankruptcy Court") for reorganization relief under Chapter 11 of the Bankruptcy Code on January 10, 2001. One day prior to filing its bankruptcy petition, TWA entered into an Asset Purchase Agreement with American that provided for the sale to American of substantially all of TWA's assets and permitted American to exclude certain TWA contracts (including aircraft leases) from the assets of TWA to be acquired by American. On February 28, 2001, American presented the General Partner of the Partnership ("General Partner") with a written proposal to assume, on modified terms and conditions, the Prior Leases applicable to seven of the ten Aircraft. For reasons discussed more fully in the 8-K, the General Partner decided to accept American's proposal, although consummation of the transactions with American remained subject to a number of contingencies, including the approval of the Bankruptcy Court and other regulatory approvals at the time of the preparation and filing of the 8-K. On April 9, 2001, the American acquisition of the selected TWA assets was consummated. As a result of this closing, American assumed the Prior Leases applicable to seven of the ten Aircraft, and simultaneously, such Prior Leases were amended to incorporate the modified terms described in the 8-K (as so assumed and amended, the "Assumed Leases"). As indicated in the 8-K, the Assumed Leases are substantially less favorable to the Partnership than the Prior Leases. In particular, the monthly rental rate for each Aircraft has been reduced from $85,000 to $40,000, and the reduced rate was made effective as of March 12, 2001 by a rent credit granted to American for the amount of rent above $40,000 previously paid by TWA in respect of the period from and after March 12, 2001. In addition, the term of each Assumed Lease is scheduled to expire at the time of the next scheduled heavy maintenance check of the applicable Aircraft, compared to the scheduled expiry dates of November 27, 2004 and February 7, 2005 under the Prior Leases, provided that the aggregate average number of months for which all seven Aircraft are on lease to American would not be less than 19 months from and after March 12, 2001. Finally, the maintenance condition of the aircraft to be met at lease expiry was eased in favor of American, as compared to the corresponding conditions required under the Prior Leases. With respect to the three Aircraft that American did not elect to acquire, TWA officially rejected the Prior Leases applicable to these Aircraft (collectively, the "Rejected Leases") as of April 20, 2001. Two of these Aircraft have already been returned to the Partnership and are now parked in storage in Arizona. The third Aircraft was ferried to Arizona on June 4, 2001. The General Partner has been actively remarketing these Aircraft for sale and is continuing to pursue these efforts at this time. In addition, the General Partner is in the process of filing administrative claims in the TWA bankruptcy proceeding in an effort to recover (i) the fair value of TWA's actual use, if any, of these three Aircraft during the 60-day period following TWA's filing of its bankruptcy petition, and (ii) claims relating to these Aircraft for the period from March 12, 2001 (the 11 expiration of the 60-day automatic stay period after the filing of bankruptcy petition) to April 20, 2001, the date on which these Prior Leases were rejected by TWA. Furthermore, it is anticipated that the General Partner will also file general unsecured claims for damages arising from TWA's breach of the Rejected Leases. However, there can be no assurances as to whether, or when, the General Partner will be successful in asserting the value of the claims or be able to collect any amounts out of the TWA bankruptcy estate, either in respect of administrative claims or other claims. Effect of the TWA Bankruptcy As previously disclosed in the 8-K, the TWA bankruptcy is expected to have a material adverse effect on the Partnership's results of operations and financial position. As a result of the TWA bankruptcy and the transactions with American described above, aggregate rentals to be received by the Partnership in 2001 have been reduced from approximately $10.2 million, had all ten aircraft remained on lease at the former lease rate, to approximately $3.5 million, and the average lease term for the seven Aircraft that remain on lease has been reduced from 47 to 21 months remaining at December 31, 2000. Three of the Partnership's Aircraft, which would have been expected to generate aggregate rentals in 2001 under the terms of the Prior Leases of approximately $3.0 million (included in the $10.2 million above), are now being marketed for sale at scrap value (which the General Partner believes will be materially less than the aggregate rental amount). The amount and timing of the Partnership's distributions of cash available for distribution depends upon many factors, including whether the General Partner is able to collect any amounts in respect of the administrative and other claims filed with the Bankruptcy Court. The amount of cash available for distribution for the quarter ended March 31, 2001 was not materially different from the corresponding quarter in 2000, but the General Partner expects the amount of cash available for distribution for the subsequent quarters in 2001 to be materially less. The Accounting Treatment of the Transaction As a result of the TWA bankruptcy and the modified lease terms reflected in the Assumed Leases, the Partnership was required to review the carrying value of the Aircraft pursuant to applicable accounting standards including SFAS 121. Any downward adjustment in the estimated residual value or decrease in the projected remaining economic life of any of the Aircraft dictates an increase in depreciation expense over the projected economic life of such Aircraft. Further, if the projected net cash flow for any of the Aircraft (projected rental revenue, net of management fees, less projected maintenance costs, if any, plus the estimated residual value) is less than the carrying value of such Aircraft, an impairment loss must be recorded. After a review of the carrying value of the Aircraft pursuant to applicable accounting standards including SFAS 121, the Partnership recognized an impairment loss as increased depreciation expense in the fourth quarter of 2000 of approximately $11 million, or $22.26 per limited partnership unit. In accordance with generally accepted accounting principles (GAAP), the Partnership recognized rental income and management fees on a straight line basis over the original TWA lease terms. As a result, deferred revenue and accrued management fees were recorded each month since the inception of each Prior Lease, resulting in balances of deferred rental income and accrued management fees of $3,899,131 and $180,107, respectively as of March 12, 2001. Since the Prior Leases were effectively modified on March 12, 2001, the Partnership must recognize the balances of deferred revenue and accrued management fees over the new lease terms, from the date the leases were modified. For the three Rejected Leases, the deferred revenue and accrued management fees amounting to $1,275,431 and $59,691 were recognized as income in 12 March 2001. For the seven Assumed Leases, the deferred revenue and accrued management fees associated with each Aircraft will be recognized over the new lease terms, ranging from 5 months to 36 months as of March 31, 2001. During the quarter ended June 30, 2001, deferred revenue of $839,760 and accrued management fees of $38,443 were recognized as income. Partnership Operations The Partnership recorded net income of $795,591, or $1.33 per limited partnership unit, for the three months ended June 30, 2001, as compared to net income of $1,260,063, or $2.23 per limited partnership unit, for the three months ended June 30, 2000. The Partnership recorded net income of $3,031,485 or $5.45 per limited partnership unit, for the six months ended June 30, 2001 compared to net income of $2,494,914 or $4.41 per limited partnership unit, for the six months ended June 30, 2000. The decrease in net income for the three months ended June 30, 2001 is primarily due to decreased rental and interest revenue as well as increased operating, legal and administration fees partially offset by lower depreciation, management fees and interest expenses. The increase in net income for the six months ended June 30, 2001 is primarily due to increased rental revenue as well as decreased depreciation, management fees and interest expense, partially offset by decreased interest income as well as increased operating, legal and administration fees. Rent from operating leases decreased to $1,666,428 in the three months ended June 30, 2001 as compared to $2,247,342 for the corresponding period in 2000. This was primarily due to the TWA bankruptcy and acquisition of TWA by American Airlines. Three of the Partnership's 10 leases were rejected by American, and the monthly rental rate for the remaining 7 Accepted Aircraft was reduced from $85,000 each to $40,000 each. Rent from operating leases increased to $4,551,581 during the six months ended June 30, 2001, as compared to $4,494,684 for the corresponding period in 2000. The decreased rental rates were offset by the recognition of deferred revenue of $839,760 and $1,731,328 in the three and six months ended June 30, 2001. As discussed in Note 2, the deferred revenue existing at the time of the lease revisions in March 2001 is being recognized over the new lease terms or was recognized upon lease rejection for the three Rejected Aircraft. Interest income decreased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, primarily due to lower average cash reserves and a lower rate of return on those cash reserves. Depreciation expense decreased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, primarily due to the downward adjustment to the book value of the aircraft in the fourth quarter of 2000. At June 30, 2001, four of the Partnership's aircraft were classified as held for sale and were carried at the lower of cost or fair value less cost to sell. Management fees decreased during the three and six months ended June 30, 2001 as compared to the same periods in 2000, primarily due to the lower monthly rentals earned on the seven aircraft that remain on lease with TWA as well as the amortization of accrued management fees of $38,443 and $106,699 during the three and six months ended June 30, 2001, respectively, which are being amortized similar to deferred revenue, as discussed above. 13 Interest expense decreased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, due to the final payoff of the notes payable for the TWA hushkits. Operating expense increased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, primarily due to maintenance and storage related costs associated with the return of the three Rejected Aircraft. Legal expenses increased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, primarily due to legal costs incurred in connection with the TWA Bankruptcy. Administration and other expenses increased during the three and six months ended June 30, 2001, as compared to the same periods in 2000, primarily due to printing and postage costs incurred in connection with the TWA Bankruptcy, partially offset by a decrease in consulting fees incurred for the research and reissue of a large number of investor distribution checks during the 2000 periods. Liquidity and Cash Distributions Liquidity - The Partnership received lease payments from its sole lessee, TWA Airlines LLC, for the seven Assumed Leases, as discussed above, during the six months ended June 30, 2001. Polaris Investment Management Corporation, the general partner, has determined that cash reserves be maintained as a prudent measure to ensure that the Partnership has available funds in the event that the aircraft presently on lease to TWA require remarketing, and for other contingencies, including expenses of the Partnership. The Partnership's cash reserves will be monitored and may be revised from time to time as further information becomes available in the future. Cash Distributions - Cash distributions to limited partners during the three months ended June 30, 2001 and 2000 were $1,249,900, or $2.50 per limited partnership unit, and $1,324,894, or $2.65 per limited partnership unit, respectively. Cash distributions to limited partners during the six months ended June 30, 2001 and 2000 were $2,749,780, or $5.50 per limited partnership unit, and $2,649,788, or $5.30 per limited partnership unit, 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), the need to retain cash reserves as previously discussed in the Liquidity section and the receipt of rental payments from TWA. The distributions made on July 16, 2001 were supplemented by a lowering of remarketing reserves and were, therefore exceptionally large. Future cash distributions are expected to be materially affected by the lower lease rates earned under the Assumed Leases. 14 Part II. Other Information -------------------------- Item 1. Legal Proceedings As discussed in Item 3 of Part I of Polaris Aircraft Income Fund III's (the Partnership) 2000 Annual Report to the Securities and Exchange Commission (SEC) on Form 10-K (Form 10-K) and in Item 1 of Part II of the Partnership's Quarterly Report to the SEC on Form 10-Q (Form 10-Q) for the period ended March 31, 2001, there are several pending legal actions or proceedings involving the Partnership. Except as described below, there have been no material developments with respect to any such actions or proceedings during the period covered by this report. Kepford, et al. V. Prudential Securities, et al. - In connection with the action filed in the District Court of Harris County, Texas against Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund III, 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, on June 5, 2001, the remaining plaintiffs who did not ask the court to dismiss their claims, Gerald and Judy Beckman, made a motion to retain the case on the docket of the District Court of Harris County, Texas with respect to their purported claims against all defendants except Prudential Insurance Company of America and James J. Darr. On June 27, 2001, the Court entered a docket control order providing for a schedule for discovery and a trial date of December 3, 2001. Other Proceedings - Item 10 in Part III of the Partnership's 2000 Form 10-K and Item 1 of Part II of the Partnership's Form 10-Q for the period ended March 31, 2001 discuss certain actions which have been filed against Polaris Investment Management Corporation and others in connection with the sale of interests in the Partnership and the management of the Partnership. The Partnership is not a party to these actions. There have been no material developments with respect to any of the actions described therein during the period covered by this report. Item 6. Exhibits and Reports on Form 8-K a) Exhibits (numbered in accordance with Item 601 of Regulation S-K) 27. Financial Data Schedule (in electronic format only). b) Reports on Form 8-K On May 10, 2001, Polaris Aircraft Income Fund III filed an amended report on Form 8-K/A. 15 SIGNATURE Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. POLARIS AIRCRAFT INCOME FUND III, A California Limited Partnership (Registrant) By: Polaris Investment Management Corporation, General Partner August 13, 2001 By: /S/Steve Yost --------------------------------- ------------------------ for Keith Helming Chief Financial Officer 16