POLARIS AIRCRAFT INCOME FUND III - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-K

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_X_ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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
--------------------------------
(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 High Ridge Road, Stamford, Connecticut 06927
------------------------------------------ ----------
(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 48 pages.

PART I

Item 1. Business

Polaris Aircraft Income Fund III, A California Limited Partnership (PAIF-III or
the Partnership), was formed primarily to purchase and lease used commercial jet
aircraft in order to provide quarterly distributions of cash from operations, to
maximize the residual values of aircraft upon sale and to protect Partnership
capital through experienced management and diversification. PAIF-III was
organized as a California limited partnership on June 27, 1984 and will
terminate no later than December 2020.

PAIF-III has many competitors in the aircraft leasing market, including
airlines, aircraft leasing companies, other limited partnerships, banks and
several other types of financial institutions. This market is highly competitive
and there is no single competitor who has a significant influence on the
industry. In addition to other competitors, 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 Trans World Airlines, Inc. (TWA) as of December 31,
1997:

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

TWA McDonnell Douglas DC-9-30 10 11/04 (1) none

(1) TWA may specify a lease expiration date for each aircraft up to six
months before the date shown, provided the average date for the 10
aircraft is November 2004. The TWA leases were modified in 1991 and
were extended for an aggregate of 75 months beyond the initial lease
expiration date in November 1991 at approximately 46% of the original
lease rates. In 1996, the leases were extended for a period of eight
years until November 2004. The Partnership also agreed to share in the
costs of certain Airworthiness Directives (ADs). If such costs are
incurred by TWA, they will be credited against rental payments, subject
to annual limitations with a maximum of $500,000 per aircraft over the
lease terms.

As discussed in Item 7, in October 1994, TWA notified its creditors,
including the Partnership, of a proposed restructuring of its debt.
Subsequently, GECAS negotiated a standstill agreement with TWA which
was approved on behalf of the Partnership by PIMC. That agreement
provided for a moratorium of the rent due the Partnership in November
1994 and 75% of the rents due the Partnership from December 1994
through March 1995, with the deferred rents, which aggregated $2.6
million, plus interest being repaid in monthly installments between May
1995 through December 1995. The Partnership received as consideration
for the agreement $157,568 and warrants for TWA Common Stock (Item 7).

In 1996, GECAS, on behalf of the Partnership, negotiated with TWA for
the acquisition of noise-suppression devices, commonly known as
"hushkits", for the 10 Partnership aircraft currently on lease to TWA,

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as well as other aircraft owned by affiliates of PIMC and leased to
TWA. The 10 aircraft were designated by TWA. The hushkits reconditioned
the aircraft so as to meet Stage 3 noise level restrictions. The
installation of the 10 hushkits was completed on the Partnership's
aircraft in November 1996 and the leases for these 10 aircraft were
extended for a period of eight years until November 2004.

The rent payable by TWA under the leases was increased by an amount
sufficient to cover the monthly debt service payments on the hushkits
and fully repay, during the term of the TWA leases, the amount
borrowed. The loan from the engine/hushkit manufacturer is non-recourse
to the Partnership and secured by a security interest in the lease
receivables.

The Partnership transferred three McDonnell Douglas DC-9-10 aircraft, formerly
leased to Midway Airlines, Inc. (Midway), and six Boeing 727-100 aircraft,
formerly leased to Continental, to aircraft inventory in 1992. The three
McDonnell Douglas DC-9-10 aircraft have been disassembled for sale of their
component parts. Disassembly of the six Boeing 727-100 aircraft commenced in
December 1994. The leases for three Boeing 727-200 aircraft to Continental
expired in April 1994. These aircraft were subsequently sold to Continental.

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, 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 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. In 1996, several airline accidents also impacted the market for
older Stage 2 aircraft. The Partnership has been forced in the past to adjust
its estimates of the residual values realizable from its aircraft, which
resulted in an increase in depreciation expense, as discussed in Items 7 and 8.
A discussion of the current market condition for the type of aircraft owned by
the Partnership follows:

McDonnell Douglas DC-9-30 - The McDonnell Douglas DC-9-30 is a short- to
medium-range twin-engine jet that was introduced in 1967. Providing reliable,
inexpensive lift, these aircraft fill thin niche markets, mostly in the United
States. Hushkits are available to bring these aircraft into compliance with
Stage 3 noise restrictions at a cost of approximately $1.6 million per aircraft.
As noted above, hushkits have been installed on the 10 remaining aircraft.
Certain ADs applicable to the McDonnell Douglas DC-9 have been issued to prevent
fatigue cracks and control corrosion as discussed in the Industry Update section
of Item 7.

The general partner believes that, in addition to the factors cited above, the
deteriorated market for the Partnership's aircraft reflects the airline
industry's reaction to the significant expenditures potentially necessary to
bring these aircraft into compliance with certain ADs issued by the FAA relating
to aging aircraft, corrosion prevention and control, and structural inspection
and modification as discussed in the Industry Update section of Item 7.

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Item 2. Properties

At December 31, 1997, Polaris Aircraft Income Fund III (the Partnership) owns a
portfolio of 10 used commercial jet aircraft and certain inventoried aircraft
parts out of its original portfolio of 38 aircraft. The portfolio includes 10
McDonnell Douglas DC-9-30 aircraft leased to Trans World Airlines, Inc. (TWA).
The Partnership transferred three McDonnell Douglas DC-9-10 aircraft and six
Boeing 727-100 aircraft to aircraft inventory in 1992. The inventoried aircraft
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.

The following table describes the Partnership's aircraft portfolio at December
31, 1997 in greater detail:

Year of Cycles
Aircraft Type Serial Number Manufacture As of 12/31/97
- ------------- ------------- ----------- --------------
McDonnell Douglas DC-9-30 47028 1967 83,627
McDonnell Douglas DC-9-30 47030 1967 83,415
McDonnell Douglas DC-9-30 47095 1967 78,881
McDonnell Douglas DC-9-30 47109 1968 82,256
McDonnell Douglas DC-9-30 47134 1967 78,370
McDonnell Douglas DC-9-30 47136 1968 77,960
McDonnell Douglas DC-9-30 47172 1968 79,255
McDonnell Douglas DC-9-30 47173 1968 82,151
McDonnell Douglas DC-9-30 47250 1968 83,526
McDonnell Douglas DC-9-30 47491 1970 75,576

Item 3. Legal Proceedings

Midway Airlines, Inc. (Midway) Bankruptcy - As previously reported in the
Partnership's 1996 Form 10-K, in March 1991, Midway commenced reorganization
proceedings under Chapter 11 of the Federal Bankruptcy Code in the United States
Bankruptcy Court for the Northern District of Illinois, Eastern Division. On
August 9, 1991, the Bankruptcy Court approved Midway's rejection of the leases
of the Partnership's four DC-9-10 aircraft, and the aircraft were returned to
the Partnership on August 12, 1991. On September 18, 1991, the Partnership filed
a proof of claim in Midway's bankruptcy proceeding to recover damages for lost
rent and for Midway's failure to meet return conditions with respect to the four
aircraft. In light of Midway's cessation of operations, on April 30, 1992, the
Partnership amended and restated its prior proof of claim and filed an
additional proof. To date no payment or settlement of the Partnership's
bankruptcy claims has been offered.

Kepford, et al. v. Prudential Securities, et al. -On April 13, 1994, this action
was filed in the District Court of Harris County, Texas against Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris
Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris
Aircraft Income Fund I, Polaris Aircraft Income Fund II, Polaris Aircraft Income
Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI,
General Electric Capital Corporation, Prudential Securities, Inc., Prudential
Insurance Company of America and James J. Darr. The complaint alleges violations
of the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections
11 and 12 of the Securities Act of 1933, common law fraud, fraud in the
inducement, negligent misrepresentation, negligence, breach of fiduciary duty

4

and civil conspiracy arising from the defendants' alleged misrepresentation and
failure to disclose material facts in connection with the sale of limited
partnership units in the Partnership and the other Polaris Aircraft Income
Funds. Plaintiffs seek, among other things, an award of compensatory damages in
an unspecified amount plus interest, and double and treble damages under the
Texas Deceptive Trade Practices Act. On December 2, 1997, the trial court issued
a scheduling order setting a September 7, 1998 trial date.

Riskind, et al. v. Prudential Securities, Inc., et al. - This action was filed
in the District Court of the 165 Judicial District, Maverick County, Texas, on
behalf of over 3,000 individual investors who purchased units in "various
Polaris Aircraft Income Funds," including the Partnership. A 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, 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.

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. On February 26, 1997, the court issued an order
notifying the remaining plaintiffs that the action would be dismissed on April
21, 1997 for want of prosecution unless the plaintiffs showed cause why the
action should not be dismissed. This action was dismissed for want of
prosecution in April of 1997.

Howland, et al. v. Polaris Holding Company, et al. - This action was transferred
to the multi-district litigation in the Southern District of New York entitled
In re Prudential Securities Limited Partnerships Litigation, which has been
settled as discussed in Part III, Item 10 below.

Mary C. Scott v. Prudential Securities Inc. et al. -This action was transferred
to the action entitled In re Prudential Securities Limited Partnerships
Litigation, which has been settled as discussed in Part III, Item 10 below.

Equity Resources, Inc., et al. v. Polaris Investment Management Corporation, et
al. - On or about April 18, 1997, an action entitled Equity Resources Group,
Inc., et al. v. Polaris Investment Management Corporation, et al. was filed in
the Superior Court for the County of Middlesex, Commonwealth of Massachusetts.
The complaint names each of Polaris Investment Management Corporation (PIMC),
the Partnership, Polaris Aircraft Income Fund II, Polaris Aircraft Income Fund
IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI, as
defendants. The complaint alleges that PIMC, as general partner of each of the
partnerships, committed a breach of its fiduciary duties, violated applicable
partnership law statutory requirements and breached provisions of the

5

partnership agreements of each of the foregoing partnerships by failing to
solicit a vote of the limited partners in each of such partnerships in
connection with the Sale Transaction described in Item 7, under the caption
"Remarketing Update -- Sale of Aircraft to Triton" and in failing to disclose
material facts relating to such transaction. The plaintiffs sought to enjoin the
Sale Transaction, but the Superior Court denied their motion on May 6, 1997. The
plaintiffs appealed the Superior Court's denial of their motion to enjoin, but
ultimately, the Supreme Court of Massachusetts denied their appeal on May 29,
1997. On May 23, 1997, the defendants filed a motion to dismiss this action.
Subsequently, the plaintiffs voluntarily sought dismissal of their suit without
prejudice. On September 16, 1997, the court dismissed the plaintiffs' complaint
without prejudice.

Ron Wallace v. Polaris Investment Management Corporation, et al. - On or about
June 18, 1997, a purported class action entitled Ron Wallace v. Polaris
Investment Management Corporation, et al. was filed on behalf of the unitholders
of Polaris Aircraft Income Funds II through VI in the Superior Court of the
State of California, County of San Francisco. The complaint names each of
Polaris Investment Management Corporation (PIMC), GE Capital Aviation Services,
Inc. (GECAS), Polaris Aircraft Leasing Corporation, Polaris Holding Company,
General Electric Capital Corporation, certain executives of PIMC and GECAS and
John E. Flynn, a former PIMC executive, as defendants. The complaint alleges
that defendants committed a breach of their fiduciary duties with respect to the
Sale Transaction involving the Partnership as described in Item 7, under the
caption "Remarketing Update -- Sale of Aircraft to Triton."

On September 2, 1997, an amended complaint was filed adding additional
plaintiffs. On September 16, 1997, the defendants filed a motion to stay
discovery and a demurrer seeking to dismiss the amended complaint. On November
5, 1997, the Superior Court granted the demurrer with leave to replead. On
December 18, 1997, the plaintiffs filed a second amended complaint asserting
their claims derivatively. On January 26, 1998, defendants filed a demurrer
seeking to dismiss the second amended complaint on the grounds that plaintiffs
had failed to satisfy the pre-litigation demand requirements under California
law for commencing a derivative action.

Other Proceedings - Part III, Item 10 discusses certain other actions which have
been filed against the general partner in connection with certain public
offerings, including that of the Partnership. The Partnership is not a party to
these actions.

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

None.

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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, 1997
----------------------------------- ---------------------------

Depository Units Representing Assignments
of Limited Partnership Interests: 16,971

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 1997
and 1996 totaled $11,100,000 and $18,875,000 respectively. Cash
distributions per limited partnership unit were $22.20 and $37.75 in
1997 and 1996, respectively.

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Item 6. Selected Financial Data

For the years ended December 31,

1997 1996 1995 1994 1993
---- ---- ---- ---- ----

Revenues $ 14,959,380 $ 17,077,758 $ 21,096,762 $ 13,486,506 $ 20,500,665

Net Income (Loss) 4,989,096 (6,803,529) 7,897,946 (181,996) 2,707,789

Net Income (Loss)
allocated to Limited
Partners 4,939,205 (8,622,805) 6,694,079 (2,679,926) 1,430,836

Net Income (Loss) per
Limited Partnership Unit 9.88 (17.25) 13.39 (5.36) 2.86

Cash Distributions per
Limited Partnership
Unit 22.20 37.75 22.50 50.00 25.00

Amount of Cash
Distributions Included
Above Representing
a Return of Capital on
a Generally Accepted
Accounting Principle
Basis per Limited
Partnership Unit* 22.20 37.75 22.50 50.00 25.00

Total Assets 58,054,962 67,014,686 82,001,364 86,552,826 114,953,271

Partners' Capital 46,144,927 53,489,164 81,264,915 85,866,969 113,826,743

* 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.

8

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

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aircraft market and the conditions and types of planes owned by the Partnership.
Both the General Partner and GECAS approved the sale terms of the Aircraft as
being in the best interest of the Partnership and its unit holders because both
believe that this transaction will optimize the potential cash distributions to
be paid to limited partners. To ensure that no better offer could be obtained,
the terms of the transaction negotiated by GECAS included a "market-out"
provision that permitted the Partnership to elect to accept an offer for all
(but not less than all) of the assets to be sold by it to the Purchaser on terms
which it deemed more favorable, with the ability of the Purchaser to match the
offer or decline to match the offer and be entitled to be compensated in an
amount equal to 12% 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
actual closing date. Under GAAP, aircraft held for sale are carried at their

10

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

11

residual value) is less than the carrying value of the aircraft, the Partnership
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.

12

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.

13

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 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

14

longer allowed to operate from civil airports in the United States. Stage 2
aircraft meet current FAA requirements, subject to the phase-out rules discussed
below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all
new aircraft.

On September 24, 1991, the FAA issued final rules on the phase-out of Stage 2
aircraft by the end of this decade. The key features of the rule include:

- Compliance can be accomplished through a gradual process of
phase-in or phase-out (see below) on each of three interim
compliance dates: December 31, 1994, 1996 and 1998. All Stage
2 aircraft must be phased out of operations in the contiguous
United States by December 31, 1999, with waivers available in
certain specific cases to December 31, 2003.

- All operators have the option of achieving compliance through
a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25%
of its Stage 2 fleet on each of the compliance dates noted
above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%,
65% and 75% of an operator's fleet must consist of Stage 3
aircraft by the respective interim compliance dates noted
above).

The federal rule does not prohibit local airports from issuing more stringent
phase-out rules. In fact, several local airports have adopted more stringent
noise requirements which restrict the operation of Stage 2 and certain Stage 3
aircraft.

Other countries have also adopted noise policies. The European Union (EU)
adopted a non-addition rule in 1989, which directed each member country to pass
the necessary legislation to prohibit airlines from adding Stage 2 aircraft to
their fleets after November 1, 1990, with all Stage 2 aircraft phased-out by the
year 2002. The International Civil Aviation Organization has also endorsed the
phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.

Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3
requirements, are currently available for the Partnership's aircraft. Hushkits
were added to 10 of the Partnership's Stage 2 aircraft in 1996.

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

15

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.

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.

16

Item 8. Financial Statements and Supplementary Data

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

FINANCIAL STATEMENTS AS OF DECEMBER 31, 1997 AND 1996

TOGETHER WITH

AUDITORS' REPORT

17

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, 1997 and 1996, 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, 1997.
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, 1997 and 1996, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles.

ARTHUR ANDERSEN LLP

San Francisco, California,
January 23, 1998

18

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

BALANCE SHEETS

DECEMBER 31, 1997 AND 1996

1997 1996
---- ----
ASSETS:

CASH AND CASH EQUIVALENTS $ 28,632,488 $ 20,229,105

RENT AND OTHER RECEIVABLES 850,760 351,508

AIRCRAFT, net of accumulated depreciation
of $53,612,863 in 1997 and $97,860,513 in 1996 28,571,714 46,329,798

OTHER ASSETS -- 104,275
------------ ------------

58,054,962 $ 67,014,686
============ ============

LIABILITIES AND PARTNERS' CAPITAL (DEFICIT):

PAYABLE TO AFFILIATES $ 123,242 $ 86,005

ACCOUNTS PAYABLE AND ACCRUED
LIABILITIES 80,211 72,159

DEFERRED INCOME 626,578 460,080

NOTES PAYABLE 11,080,004 12,907,278
------------ ------------

Total Liabilities 11,910,035 13,525,522
------------ ------------

PARTNERS' CAPITAL (DEFICIT):
General Partner (2,854,104) (1,670,662)
Limited Partners, 500,000 units
issued and outstanding 48,999,031 55,159,826
------------ ------------

Total Partners' Capital 46,144,927 53,489,164
------------ ------------

$ 58,054,962 $ 67,014,686
============ ============

The accompanying notes are an integral part of these statements.

19

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF OPERATIONS

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

1997 1996 1995
---- ---- ----

REVENUES:
Rent from operating leases $ 11,965,617 $ 15,230,936 $ 16,186,560
Interest 1,617,688 1,438,839 1,989,518
Gain on sale of aircraft
inventory 590,981 206,781 --
Lessee settlements -- 144,444 1,263,124
Receipt of lessee stock
warrants -- -- 1,247,768
Gain on trading securities -- 38,898 409,792
Other 785,094 17,860 --
------------ ------------ ------------

Total Revenues 14,959,380 17,077,758 21,096,762
------------ ------------ ------------

EXPENSES:
Depreciation 7,930,392 22,661,686 12,031,947
Management fees to general
partner 420,482 761,547 809,328
Interest 1,205,566 122,197 --
Operating 33,158 24,549 29,282
Administration and other 380,686 311,308 328,259
------------ ------------ ------------

Total Expenses 9,970,284 23,881,287 13,198,816
------------ ------------ ------------

NET INCOME (LOSS) $ 4,989,096 $ (6,803,529) $ 7,897,946
============ ============ ============

NET INCOME ALLOCATED TO
THE GENERAL PARTNER $ 49,891 $ 1,819,276 $ 1,203,867
============ ============ ============

NET INCOME (LOSS) ALLOCATED
TO THE LIMITED PARTNERS $ 4,939,205 $ (8,622,805) $ 6,694,079
============ ============ ============

NET INCOME (LOSS) PER LIMITED
PARTNERSHIP UNIT $ 9.88 $ (17.25) $ 13.39
============ ============ ============

The accompanying notes are an integral part of these statements.

20

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

General Limited
Partner Partners Total
------- -------- -----

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

Net income (loss) 1,819,276 (8,622,805) (6,803,529)

Cash distributions to
partners (2,097,222) (18,875,000) (20,972,222)
------------ ------------ ------------

Balance, December 31, 1996 (1,670,662) 55,159,826 53,489,164

Net income 49,891 4,939,205 4,989,096

Cash distributions to
partners (1,233,333) (11,100,000) (12,333,333)
------------ ------------ ------------

Balance, December 31, 1997 $ (2,854,104) $ 48,999,031 $ 46,144,927
============ ============ ============

The accompanying notes are an integral part of these statements.

21

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995

1997 1996 1995
---- ---- ----

OPERATING ACTIVITIES:
Net income (loss) $ 4,989,096 $ (6,803,529) $ 7,897,946
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 7,930,392 22,661,686 12,031,947
Gain on sale of aircraft inventory (590,981) (206,781) --
Changes in operating assets and liabilities:
Increase in marketable securities, trading -- 1,659,160 (1,659,160)
Decrease (increase) in rent and other
receivables (498,866) (343,337) 477,380
Decrease (increase) in other assets 104,275 (78,186) --
Increase (decrease) in payable to affiliates 37,237 (44,579) 8,926
Increase (decrease) in accounts payable
and accrued liabilities (43,147) (11,925) 41,666
Increase (decrease) in deferred income 166,498 (61,701) --
------------ ------------ ------------

Net cash provided by operating activities 12,094,504 16,770,808 18,798,705
------------ ------------ ------------

INVESTING ACTIVITIES:
Increase in aircraft capitalized costs -- (15,930,822) --
Proceeds from sale of aircraft inventory 590,981 902,733 1,915,820
Proceeds from sale of aircraft 1,506,762 -- --
Payments to Purchaser related to sale of aircraft (1,341,968) -- --
Inventory disassembly costs -- (9,282) (214,113)
Increase in notes receivable -- -- (499,868)
Principal payments on notes receivable 9,713,711 1,546,407 1,702,862
------------ ------------ ------------

Net cash provided by (used in)
investing activities 10,469,486 (13,490,964) 2,904,701
------------ ------------ ------------

FINANCING ACTIVITIES:
Increase in notes payable -- 12,930,822 --
Principle payments on notes payable (1,827,274) (23,544) --
Cash distributions to partners (12,333,333) (20,972,222) (12,500,000)
------------ ------------ ------------

Net cash used in financing activities (14,160,607) (8,064,944) (12,500,000)
------------ ------------ ------------

CHANGES IN CASH AND CASH
EQUIVALENTS 8,403,383 (4,785,100) 9,203,406

CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR 20,229,105 25,014,205 15,810,799
------------ ------------ ------------

CASH AND CASH EQUIVALENTS AT
END OF YEAR $ 28,632,488 $ 20,229,105 $ 25,014,205
============ ============ ============

The accompanying notes are an integral part of these statements.

22

POLARIS AIRCRAFT INCOME FUND III,
A California Limited Partnership

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1997

1. Accounting Principles and Policies

Accounting Method - Polaris Aircraft Income Fund III, A California Limited
Partnership (PAIF-III or the Partnership), maintains its accounting records,
prepares its financial statements and files its tax returns on the accrual basis
of accounting. The preparation of financial statements in conformity with
generally accepted accounting principles (GAAP) requires management to make
estimates and assumptions that affect reported amounts and related disclosures.
Actual results could differ from those estimates. The most significant estimates
with regard to these financial statements are related to the projected cash
flows analysis in determining the fair value of assets.

Cash and Cash Equivalents - This includes deposits at banks and investments in
money market funds. Cash and Cash Equivalents is stated at cost, which
approximates fair value.

Marketable Securities, trading - Marketable Securities, trading were carried at
fair value, which was determined based on quoted market prices. These securities
were held for sale in the near term (Note 6).

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.

If the projected net cash flow for each aircraft (projected rental revenue, net
of management fees, less projected maintenance costs, if any, plus the estimated
residual value) is less than the carrying value of the aircraft, an impairment
loss is recognized. Pursuant to Statement of Financial Accounting Standards
(SFAS) No. 121, as discussed in Note 3, measurement of an impairment loss will
be based on the "fair value" of the asset as defined in the statement.

Capitalized Costs - Aircraft modification and maintenance costs which are
determined to increase the value or extend the useful life of the aircraft are
capitalized and amortized using the straight-line method over the estimated
useful life of the improvement. These costs are also subject to periodic
evaluation as discussed above.

23

Aircraft Inventory - Aircraft held in inventory for sale are reflected at the
lower of depreciated cost or estimated net realizable value. Proceeds from sales
are applied against inventory until the book value is fully recovered. The
remaining book value of the inventory was recovered in 1996. Proceeds in excess
of the inventory net book value are recorded as revenue when received.

Operating Leases - The aircraft leases are accounted for as operating leases.
Lease revenues are recognized in equal installments over the terms of the
leases.

Operating Expenses - Operating expenses include costs incurred to maintain,
insure and lease the Partnership's aircraft, including costs related to lessee
defaults and costs of disassembling aircraft inventory.

Net Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited
partnership unit is based on the limited partners' share of net income or loss
and the number of units outstanding for the years ended December 31, 1997, 1996
and 1995.

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

Notes Receivable - The Partnership had recorded an allowance for credit losses
for certain impaired notes as discussed in Note 8. The Partnership recognizes
revenue on these notes only as payments are received.

1997 1996
---- ----
Allowance for credit losses,
beginning of year $ (160,571) $(1,993,095)
Provision for credit losses -- --
Write-downs -- --
Collections 160,571 1,832,524
----------- -----------
Allowance for credit losses,
end of year $ -- $ (160,571)
=========== ===========

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 Depository Company III (PDC) serves as the depositary. PIMC and PDC are
wholly-owned subsidiaries of Polaris Aircraft Leasing Corporation (PALC).
Polaris Holding Company (PHC) is the parent company of PALC. General Electric
Capital Corporation (GE Capital), an affiliate of General Electric Company, owns

24

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 9.

3. Aircraft

At December 31, 1997, the Partnership owned 10 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 and require compliance during the lease
term, in certain of the leases, the Partnership has agreed to share in the cost
of compliance with ADs. The leases generally state a minimum acceptable return
condition for which the lessee is liable under the terms of the lease agreement.
Certain leases also provide that if the aircraft are returned at a level above
the minimum acceptable level, the Partnership must reimburse the lessee for the
related excess, subject to certain limitations. The related liability, if any,
is currently inestimable and therefore is not reflected in the financial
statements. Of its original portfolio of 38 aircraft, the Partnership sold one
aircraft in 1992, seven aircraft in 1993, three aircraft in 1994 and eight
aircraft in 1997. In addition, nine aircraft have been disassembled for sale of
their component parts (Note 5).

The following table describes the Partnership's aircraft portfolio at December
31, 1997 in greater detail:

Year of
Aircraft Type Serial Number Manufacture
- ------------- ------------- -----------
McDonnell Douglas DC-9-30 47028 1967
McDonnell Douglas DC-9-30 47030 1967
McDonnell Douglas DC-9-30 47095 1967
McDonnell Douglas DC-9-30 47109 1968
McDonnell Douglas DC-9-30 47134 1967
McDonnell Douglas DC-9-30 47136 1968
McDonnell Douglas DC-9-30 47172 1968
McDonnell Douglas DC-9-30 47173 1968
McDonnell Douglas DC-9-30 47250 1968
McDonnell Douglas DC-9-30 47491 1970

Ten McDonnell Douglas DC-9-30s - Initially thirteen aircraft were acquired for
$86,163,046 during 1986 and 1987, and leased to Ozark Air Lines, Inc. (Ozark).
In 1987, Trans World Airlines, Inc. (TWA) merged with Ozark and assumed the
leases. The leases were modified and extended prior to TWA's bankruptcy filing.
In June 1997, three of the ten aircraft were sold, subject to the existing
leases, to Triton Aviation Services III LLC, as discussed in Note 4. The leases
for 10 of the 13 aircraft were extended again for eight years until November
2004, as discussed in Note 7.

25

The following is a schedule by year of future minimum rental revenue under the
existing leases:

Year Amount
---- ------
1998 $ 10,200,000
1999 10,200,000
2000 10,200,000
2001 10,200,000
2002 and thereafter 20,650,000
------------

$ 61,450,000
============

Future minimum rental payments may be offset or reduced by future costs as
described in Note 6.

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. As a result, the Partnership made downward adjustments to the estimated
residual value of certain of its on-lease aircraft as of December 31, 1995.

The Partnership's future earnings are impacted by the net effect of the
adjustments to the carrying value of the aircraft (which has the effect of
decreasing future depreciation expense), and the downward adjustments to the
estimated residual values (which has the effect of increasing future
depreciation expense).

As discussed above, the Partnership uses information obtained from third party
valuation services in arriving at its estimate of fair value for purposes of
determining residual values. The Partnership will use similar information, plus
available information and estimates related to the Partnership's aircraft, to
determine an estimate of fair value to measure impairment as required by the
statement. The estimates of fair value can vary dramatically depending on the
condition of the specific aircraft and the actual marketplace conditions at the
time of the actual disposition of the asset. If assets are deemed impaired,
there could be substantial write-downs in the future.

The Partnership recognized impairment losses on aircraft to be held and used by
the Partnership aggregating approximately $12.5 million and $1.8 million, or
$24.95 and $3.51 per limited Partnership unit, as increased depreciation expense
in 1996 and 1995, respectively. In 1996, the impairment loss was the result of
several significant factors. As a result of industry and market changes, a more
extensive review of the Partnership's aircraft was completed in the fourth
quarter of 1996 which resulted in revised assumptions of future cash flows
including reassessment of projected re-lease terms and potential future
maintenance costs. As discussed in Note 4, the Partnership accepted an offer to
purchase eight of the Partnership's remaining aircraft subject to each
aircraft's existing lease. This offer constitutes an event that required the
Partnership to review the aircraft carrying value pursuant to SFAS 121. In
determining this additional impairment loss, the Partnership estimated the fair
value of the aircraft based on the purchase price reflected in the offer, less
the estimated costs and expenses of the proposed sale. The partnership recorded
an impairment loss to the extent that the carrying value exceeded the fair
value. Management believes the assumptions related to fair value of impaired
assets represents the best estimates based on reasonable and supportable
assumptions and projections.

The General Partner evaluates, from time to time, whether the investment
objectives of the Partnership are better served by continuing to hold the

26

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.

4. 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 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

27

management with the Purchaser (collectively, together with the Purchaser, the
"SPC's") on terms similar to those set forth above, with the exception of the
Polaris Aircraft Income Fund VI aircraft, which were sold on an all cash basis.

The Accounting Treatment of the Transaction - In accordance with GAAP, the
Partnership recognized rental income up until the closing date for each aircraft
which occurred from June 5, 1997 to June 25, 1997. However, under the terms of
the transaction, the Purchaser was entitled to receive any payments of the
rents, interest income and receivables accruing from April 1, 1997. As a result,
the Partnership made payments to the Purchaser for the amounts due and received
from April 1, 1997 to the closing date. Amounts totaling $1,341,968 during this
period are included in rents from operating leases, interest and other income.
For financial reporting purposes, the cash down payment portion of the sales
proceeds of $1,233,289 has been adjusted by the following; income and proceeds,
including rents and receivables from the effective date of April 1, 1997 to the
closing date, interest due from the Purchaser on the cash portion of the
purchase price, interest on the Promissory Note from the effective date of April
1, 1997 to the closing date and estimated selling costs. As a result of these
GAAP adjustments, the net adjusted sales price recorded by the Partnership,
including the Promissory Note, was $9,827,305.

The Aircraft sold pursuant to the definitive documentation executed on May 28,
1997 had been classified as aircraft held for sale from that date until the
actual closing date. Under GAAP, aircraft held for sale are carried at their
fair market value less estimated costs to sell. The adjustment to the sales
proceeds described above and revisions to estimated costs to sell the Aircraft
required the Partnership to record an adjustment to the net carrying value of
the aircraft held for sale of $1,092,046 during the three months ended June 30,
1997. This adjustment to the net carrying value of the aircraft held for sale is
included in depreciation and amortization expense on the statement of
operations.

5. Disassembly of Aircraft

In an attempt to maximize the economic return from three of the remaining four
McDonnell Douglas DC-9-10 aircraft formerly leased to Midway Airlines, Inc.
(Midway) and the six Boeing 727-100 aircraft formerly leased to Continental
Airlines, Inc. (Continental) (Note 8), the Partnership entered into an agreement
with Soundair, Inc.(Soundair) for the disassembly and sale of these aircraft in
1992.

The Partnership has incurred the cost of disassembly and will receive the
proceeds from the sale of such parts, net of overhaul expenses if necessary, and
commission paid to Soundair. Disassembly of the aircraft has been completed.
During 1995, the Partnership paid $214,113 aircraft disassembly costs for the
six Boeing 727-100s. During 1997, 1996 and 1995, the Partnership received net
proceeds from the sale of aircraft inventory of $590,981, $902,733 and
$1,915,820, respectively.

6. TWA Reorganization

The Partnership renegotiated the TWA leases after TWA defaulted under its leases
with the Partnership during 1991. The renegotiated agreement stipulated that the
Partnership share in the cost of certain ADs after TWA successfully reorganized.
Pursuant to this cost-sharing agreement, since TWA emerged from its
reorganization proceedings in 1993, expenses totaling $4.7 million have been

28

offset against rental payments. Under the terms of this agreement, TWA may
offset up to an additional $1.0 million against rental payments, subject to
annual limitations, over the remaining lease terms.

In October 1994, TWA notified its creditors, including the Partnership, of
another proposed restructuring of its debt. Subsequently, GECAS negotiated a
standstill arrangement, as set forth in a letter agreement dated December 16,
1994 (the Deferral Agreement), with TWA for the 46 aircraft that 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 the rents due to the
Partnership in November 1994 and on 75% of the rents due to the Partnership from
December 1994 through March 1995, and (ii) all of the deferred rents, together
with interest thereon, to be repaid in monthly installments beginning in May
1995 and ending in December 1995. The repayment schedule was subsequently
accelerated upon confirmation of TWA's bankruptcy plan. The Partnership did not
recognize either the $1,137,500 rental amount deferred in 1994 or the $1,462,500
rental amount deferred during the first quarter of 1995 as rental revenue until
the deferred rents were received. The deferred rents were paid in full by
October 1995.

In consideration for the partial rent moratorium described above, TWA agreed to
make a lump sum payment of $1,000,000 to GECAS for the TWA lessors for whom
GECAS provides management services and who agreed to the Deferral Agreement. The
Partnership received $157,568 in January 1995 as its pro-rata share of such
payment by TWA. This amount was recognized as other revenue in the accompanying
1995 statement of operations. While TWA has committed to an uninterrupted flow
of lease payments, there can be no assurance that TWA will continue to honor its
obligations in the future.

In order to resolve certain issues that arose after the execution of the
Deferral Agreement, TWA and GECAS entered into a letter agreement dated June 27,
1995, pursuant to which they agreed to amend certain provisions of the Deferral
Agreement (as so amended, the Amended Deferral Agreement). The effect of the
Amended Deferral Agreement, which was approved by PIMC with respect to the
Partnership's aircraft, is that TWA, in addition to agreeing to repay the
deferred rents to the Partnership, agreed (i) to a fixed payment amount (payable
in warrants, the number of which was determined by formula) in consideration for
the aircraft owners' agreement to defer rent under the Deferral Agreement, and,
(ii) to the extent the market value of the warrants is less than the payment
amount, to supply maintenance services to the aircraft owners having a value
equal to such deficiency. The payment amount was determined by subtracting
certain maintenance reimbursements owed to TWA by certain aircraft owners,
including the Partnership, from the aggregate amount of deferred rents.

The Partnership received warrants to purchase 159,919 shares of TWA Common Stock
from TWA in November 1995. The Partnership exercised the warrants on December
29, 1995 for the strike price of $0.01 per share. The fair market value of the
TWA stock at December 31, 1995 of $1,659,160, which was determined based on
quoted market prices, is reflected in the accompanying December 31, 1995 balance
sheet. The Partnership sold the TWA Common Stock by February 1996, net of broker
commissions, for $1,698,057 and recognized a gain on trading securities of
$38,898 in 1996.

29

7. TWA Lease Extension

GECAS, on behalf of the Partnership, negotiated with TWA for the acquisition of
noise-suppression devices, commonly known as "hushkits", for the 10 Partnership
aircraft currently on lease to TWA, as well as other aircraft owned by
affiliates of PIMC and leased to TWA. The 10 aircraft that received hushkits
were designated by TWA. The hushkits recondition the aircraft so as to meet
Stage 3 noise level restrictions. Installation of the 10 hushkits on the
Partnership's aircraft was completed in November 1996 and the leases for these
10 aircraft were extended for a period of eight years until November 2004.

The aggregate cost of the hushkit reconditioning was $15,930,822, or
approximately $1.6 million per aircraft, which was capitalized by the
Partnership. The Partnership paid $3.0 million of the aggregate hushkit cost and
the balance of $12,930,822 was financed by the engine/hushkit manufacturer over
50 months at an interest rate of approximately 10% per annum. Cash paid for
interest expense on the loan was $1,100,648 and $215,416 in 1997 and 1996,
respectively.

The rent payable by TWA under the leases was increased by an amount sufficient
to cover the monthly debt service payments on the hushkits and fully repay,
during the term of the TWA leases, the amount borrowed. The loan from the
engine/hushkit manufacturer is non-recourse to the Partnership and secured by a
security interest in the lease receivables.

8. Continental Lease Modification

The aircraft leases with Continental were modified after Continental filed for
Chapter 11 bankruptcy protection in December 1990. The modified agreement
stipulates that the Partnership pay certain aircraft maintenance, modification
and refurbishment costs, not to exceed approximately $3.2 million, a portion of
which will be recovered with interest through payments from Continental over the
extended lease terms. The Partnership's share of such costs may be capitalized
and depreciated over the remaining lease terms, subject to the capitalized cost
policy as described in Note 1. The Partnership approved invoices aggregating
$1,698,106 for interior modifications on the Partnership's aircraft. The
Partnership financed the aggregate amount of these invoices to Continental from
1992 through 1995 to be repaid by Continental with interest over the remaining
lease terms of the aircraft. This note was paid in full during 1996.

The agreement with Continental included an extended deferral of the dates when
Continental 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 prior interest portions
due were $160,571 and $1,993,095 as of December 31, 1996 and 1995, respectively.
The unrecognized Deferred Amounts as of December 31, 1996 and 1995 were $159,582
and $1,941,522, respectively. In accordance with the aforementioned agreement,
Continental began making supplemental payments for the Deferred Amount plus
interest on July 1, 1992. During 1996, 1995 and 1994, the Partnership received

30

supplemental payments of $1,942,267, $2,200,465 and $2,999,666, respectively, of
which $1,781,940, $1,729,060 and $2,211,440 was recognized as rental revenue in
1996, 1995 and 1994, respectively.

9. 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 1997, 1996 and 1995, the Partnership paid management fees to PIMC of
$369,396, $752,014 and $809,328, respectively. Management fees payable to
PIMC were $57,530 and $17,500 at December 31, 1997 and 1996, respectively.

b. Reimbursement of certain out-of-pocket expenses incurred in connection
with the management of the Partnership and supervision of its assets. In
1997, 1996 and 1995, the Partnership reimbursed PIMC for expenses of
$470,603, $396,504 and $521,705, respectively. Reimbursements totaling
$65,712 and $68,505 were payable to PIMC at December 31, 1997 and 1996,
respectively.

c. A 10% interest to PIMC in all cash distributions and sales proceeds, gross
income in an amount equal to 9.09% of distributed cash available from
operations and 1% of net income or loss and taxable income or loss, as
such terms are defined in the Partnership Agreement. After the Partnership
has sold or disposed of aircraft representing 50% of the total aircraft
cost, gains from the sale or other disposition of aircraft are generally
allocated first to the General Partner until such time that the General
Partner's capital account is equal to the amount to be distributed to the
General Partner from the proceeds of such sale or disposition.

d. A subordinated sales commission to PIMC of 3% of the gross sales price of
each aircraft for services performed upon disposition and reimbursement of
out-of-pocket and other disposition expenses. Subordinated sales
commissions will be paid only after unit holders have received
distributions in an aggregate amount equal to their capital contributions
plus a cumulative non-compounded 8% per annum return on their adjusted
capital contributions, as defined in the Partnership Agreement. The
Partnership did not pay or accrue a sales commission on any aircraft sales
to date as the subordination threshold has not been met.

e. In the event that, immediately prior to the dissolution and termination of
the Partnership, the General Partner shall have a deficit balance in its
tax basis capital account, then the General Partner shall contribute in
cash to the capital of the Partnership an amount which is equal to such
deficit (see Note 10).

10. 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

31

aircraft are to be allocated to the General Partner and the Limited Partners
(see Note 9). Such allocations are made using income or loss calculated under
GAAP for book purposes, which, as more fully described in Note 12, varies from
income or loss calculated for tax purposes.

Cash available for distributions, including the proceeds from the sale of
aircraft, is distributed 10% to the General Partner and 90% to the Limited
Partners.

The different methods of allocating items of income, loss and cash available for
distribution combined with the calculation of items of income and loss for book
and tax purposes result in book basis capital accounts that may vary
significantly from tax basis capital accounts. The ultimate liquidation and
distribution of remaining cash will be based on the tax basis capital accounts
following liquidation, in accordance with the Agreement.

Had all the assets of the Partnership been liquidated at December 31, 1997 at
the current carrying value, the tax basis capital accounts of the General
Partner and the Limited Partners is estimated to be $4,733,066 and $41,411,861
respectively.

11. 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, 1997 and 1996 are as
follows:

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

1997: Assets $ 58,054,962 $ 42,276,950 $ 15,778,012
Liabilities 11,910,035 11,323,507 586,528

1996: Assets $ 67,014,686 $ 40,308,934 $ 26,705,752
Liabilities 13,525,522 13,121,491 404,031

32

12. Reconciliation of Book Net Income (Loss) to Taxable Net Income (Loss)

The following is a reconciliation between net income (loss) per limited
partnership unit reflected in the financial statements and the information
provided to limited partners for federal income tax purposes:

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

1997 1996 1995
---- ---- ----

Book net income (loss) per limited
partnership unit $ 9.88 $ (17.25) $ 13.39
Adjustments for tax purposes represent
differences between book and tax
revenue and expenses:
Rental revenue (0.53) (3.65) (4.94)
Management fee expense 0.06 0.16 0.28
Depreciation 5.12 16.36 (4.96)
Gain or loss on sale of aircraft 9.00 - -
Basis in inventory (0.40) (0.62) (1.35)
Other revenue and expense items - (0.48) (0.01)
--------- ---------- --------

Taxable net income (loss) per limited
partnership unit $ 23.13 $ (5.48) $ 2.41
========= ========== ========

The differences between net income and loss for book purposes and net income and
loss for tax purposes result from the temporary differences of certain revenue
and deductions.

For book purposes, rental revenue is generally recorded as it is earned. For tax
purposes, certain temporary differences exist in the recognition of revenue. For
tax purposes, management fee expense is accrued in the same year as the tax
basis rental revenue.

The Partnership computes depreciation using the straight-line method for
financial reporting purposes and generally an accelerated method for tax
purposes. The Partnership also periodically evaluates the ultimate
recoverability of the carrying values and the economic lives of its aircraft for
book purposes and, accordingly recognized adjustments which increased book
depreciation expense. As a result, the current year book depreciation expense is
greater than the tax depreciation expense. These differences in depreciation
methods result in book to tax differences on the sale of aircraft. In addition,
certain costs were capitalized for tax purposes and expensed for book purposes.

For book purposes, aircraft held in inventory are reflected at the lower of
depreciable cost or estimated net realizable value. Differences in book and tax
revenue and loss from inventory result from the differences in the book and tax
carrying value of the inventory.

13. Subsequent Events

The Partnership made a cash distribution of $1,874,850 or $3.75 per limited
partnership unit, to limited partners, and $208,317 to the General Partner on
January 15, 1998.

33

The Partnership made a special cash distribution of $12,923,966, or $25.85 per
limited partnership unit, to limited partners, and $1,435,996 to the General
Partner on February 23, 1998, as a result of the prepayment of the Promissory
Note from Triton, as discussed in Note 4.

34

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

None.

35

PART III

Item 10. Directors and Executive Officers of the Registrant

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

Eric M. Dull President; Director
Marc A. Meiches Chief Financial Officer
Richard J. Adams Director
Norman C. T. Liu Vice President; Director
Ray Warman Secretary
Robert W. Dillon Assistant Secretary

Substantially all of these management personnel will devote only such portion of
their time to the business and affairs of PIMC as deemed necessary or
appropriate.

Mr. Dull, 37, assumed the position of President and Director of PIMC effective
January 1, 1997. Mr. Dull previously was a Director of PIMC from March 31, 1995
to July 31, 1995. Mr. Dull holds the position of Executive Vice President - Risk
and Portfolio Management of GECAS, having previously held the positions of
Executive Vice President - Portfolio Management and Senior Vice President -
Underwriting Risk Management of GECAS. Prior to joining GECAS, Mr. Dull held
various positions with Transportation and Industrial Funding Corporation (TIFC).

Mr. Meiches, 45, assumed the position of Chief Financial Officer of PIMC
effective October 9, 1995. Previously, he held the position of Vice President of
PIMC from October 1995 to October 1997. Mr. Meiches presently holds the
positions of Executive Vice President and Chief Financial and Operating Officer
of GECAS. Prior to joining GECAS, Mr. Meiches has been with General Electric
Company (GE) and its subsidiaries since 1978. Since 1992, Mr. Meiches held the
position of Vice President of the General Electric Capital Corporation Audit
Staff. Between 1987 and 1992, Mr. Meiches held Manager of Finance positions for
GE Re-entry Systems, GE Government Communications Systems and the GE Astro-Space
Division.

Mr. Adams, 64, held the position of Senior Vice President - Aircraft Sales and
Leasing of PIMC and PALC from August 1992 until October 1997, 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 assumed the position of Director of

36

PIMC. Mr. Adams presently holds the position of Senior Vice President - Fleet
Advisory Services of GECAS, having previously held the position of Senior Vice
President - Stage II Aircraft.

Mr. Liu, 40, assumed the position of Vice President of PIMC effective May 1,
1995 and Director of PIMC effective July 31, 1995. Mr. Liu presently holds the
position of Executive Vice President - Marketing and Structured Finance of
GECAS, having previously held the position of Executive Vice President - Capital
Funding and Portfolio Management of GECAS. Prior to joining GECAS, Mr. Liu was
with General Electric Capital Corporation for nine years. He has held management
positions in corporate Business Development and in Syndications and Leasing for
TIFC. Mr. Liu previously held the position of managing director of Kidder,
Peabody & Co., Incorporated.

Mr. Warman, 49, assumed the position of Secretary of PIMC effective March 23,
1998. Mr. Warman has served as a GECAS Senior Vice President and Associate
General Counsel since March 1996, and for 13 years theretofore was a partner,
with an air-finance and corporate practice of the national law firm of Morgan,
Lewis & Bockius LLP.

Mr. Dillon, 56, held the position of Vice President - Aviation Legal and
Insurance Affairs, from April 1989 to October 1997. Previously, he served as
General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994,
Mr. Dillon assumed the position of Assistant Secretary of PIMC. Mr. Dillon
presently holds the position of Senior Vice President and Managing Counsel of
GECAS.

Certain Legal Proceedings:

On 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 Partnership is not named as a defendant in this action.
The complaint seeks an award of compensatory and other damages and remedies. On
July 20, 1994, the court entered an order dismissing almost all of the claims in
the complaint and amended complaint. Plaintiffs filed a notice of appeal on
September 2, 1994. On April 25, 1996, the Appellate Division for the First
Department affirmed the trial court's order which had dismissed most of
plaintiffs' claims. On September 25, 1997, this action was discontinued with
prejudice by stipulation of the parties.

On or around February 17, 1993, a civil action entitled Einhorn, et al. v.
Polaris Public Income Funds, et al. was filed in the Circuit Court of the 11th
Judicial Circuit in and for Dade County, Florida against, among others, Polaris
Investment Management Corporation and Polaris Depositary Company. The
Partnership is not named as a defendant in this action. Plaintiffs seek class

37

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.

Moross, et al. v. Polaris Holding Company, et al. was transferred to the
Multi-District Litigation, which has been settled as described below.

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
Prudential, including Polaris Holding Company, one of its former officers,
Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation
and Polaris Securities Corporation. The Partnership is not named as a defendant
in this action. The complaint alleges that the Prudential defendants created a
scheme for the sale of approximately $8-billion of limited partnership interests
in 700 allegedly 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 April 22, 1997, the Polaris defendants entered into a settlement agreement
with plaintiffs pursuant to which, among other things, the Polaris defendants
agreed to make a payment to a class of unitholders previously certified by the
Court. On August 1, 1997, the Court approved a class settlement with the Polaris
defendants.

38

Adams, et al. v. Prudential Securities, Inc. et al. was transferred to the
Multi-District Litigation filed in the United States District Court for the
Southern District of New York, which has been settled as discussed above.

On or about January 12, 1995, a class action complaint entitled Cohen, et al. v.
Kidder Peabody & Company, Inc. (Kidder Peabody), 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 Partnership is not named as a defendant in this action. 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 Polaris Aircraft Income Fund
III, 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. Plaintiffs filed a motion for leave to
file a second amended complaint, which was granted on October 3, 1995. On March
18, 1996, plaintiffs moved for class certification. On the eve of class
discovery, April 26, 1996, plaintiffs moved for a voluntary dismissal of Counts
I and II (claims brought pursuant to the Securities Act of 1933) of the Second
Amended Complaint and simultaneously filed a motion to remand this action to
state court for lack of federal jurisdiction. Plaintiff's motion for voluntary
dismissal of the federal securities law claims and motion for remand were
granted on July 10, 1996. On November 5, 1997, the Superior Court granted the
demurrer with leave to replead. On December 18, 1997, the plaintiffs filed a
second amended complaint asserting their claims derivatively. On January 26,
1998, defendants filed a demurrer seeking to dismiss the second amended
complaint on the grounds that plaintiffs had failed to satisfy the
pre-litigation demand requirements under California law for commencing a
derivative 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 Partnership is not named as a defendant in
this action. The complaint sets forth various causes of action purportedly
arising out of the public offerings of Polaris Aircraft Income Fund III and

39

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,
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 August 16, 1996, defendants filed a motion to dismiss plaintiffs' amended
complaint. On October 8, 1997, this action was discontinued with prejudice by
stipulation of the parties.

On or around September 27, 1995, a complaint entitled Martha J. Harrison v.
General Electric Company, et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and Prudential Securities Incorporated. The Partnership is not
named as a defendant in this action. Plaintiff alleges claims of tort, breach of
fiduciary duty in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code concerning
the inducement and solicitation of purchases arising out of the public offering
of Polaris Aircraft Income Fund IV. Plaintiff seeks compensatory damages,
attorney's fees, interest, costs and general relief.

On or around December 8, 1995, a complaint entitled Overby, et al. v. General
Electric Company, et al. was filed in the Civil District Court for the Parish of
Orleans, State of Louisiana. The complaint names as defendants General Electric
Company and General Electric Capital Corporation. The Partnership is not named
as a defendant in this action. Plaintiffs allege claims of tort, breach of
fiduciary duty, in tort, contract and quasi-contract, violation of sections of
the Louisiana Blue Sky Law and violation of the Louisiana Civil Code in
connection with the public offering of Polaris Aircraft Income Funds III and IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.

In or around November 1994, a complaint entitled Lucy R. Neeb, et al. v.
Prudential Securities Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
December 20, 1995, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company, General Electric
Capital Corporation and Smith Barney, Inc. The Partnership is not named as a
defendant in this action. Plaintiffs allege claims of tort, breach of fiduciary
duty, in tort, contract and quasi-contract, violation of sections of the
Louisiana Blue Sky Law and violation of the Louisiana Civil Code in connection
with the public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs
seek compensatory damages, attorneys' fees, interest, costs and general relief.

In or about January of 1995, a complaint entitled Albert B. Murphy, Jr. v.
Prudential Securities, Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities Incorporated and Stephen Derby Gisclair. On or about
January 18, 1996, plaintiff filed a First Supplemental and Amending Petition
adding defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.

40

Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of sections of the Louisiana Blue Sky Law and
violation of the Louisiana Civil Code in connection with the public offering of
Polaris Aircraft Income Funds III and IV. Plaintiffs seek compensatory damages,
attorneys' fees, interest, costs and general relief.

On or about January 22, 1996, a complaint entitled Mrs. Rita Chambers, et al. v.
General Electric Co., et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint names as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
in connection with the public offering of Polaris Aircraft Income Fund IV.
Plaintiffs seek compensatory damages, attorneys' fees, interest, costs and
general relief.

In or around December 1994, a complaint entitled John J. Jones, Jr. v.
Prudential Securities Incorporated et al. was filed in the Civil District Court
for the Parish of Orleans, State of Louisiana. The complaint named as defendants
Prudential Securities, Incorporated and Stephen Derby Gisclair. On or about
March 29, 1996, plaintiffs filed a First Supplemental and Amending Petition
adding as additional defendants General Electric Company and General Electric
Capital Corporation. The Partnership is not named as a defendant in this action.
Plaintiff alleges claims of tort, breach of fiduciary duty in tort, contract and
quasi-contract, violation of section of the Louisiana Blue Sky Law and violation
of the Louisiana Civil Code concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Fund
III. Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and
general relief.

On or around February 16, 1996, a complaint entitled Henry Arwe, et al. v.
General Electric Company, et al. was filed in the Civil District Court for the
Parish of Orleans, State of Louisiana. The complaint named as defendants General
Electric Company and General Electric Capital Corporation. The Partnership is
not named as a defendant in this action. Plaintiffs allege claims of tort,
breach of fiduciary duty in tort, contract and quasi-contract, violation of
sections of the Louisiana Blue Sky Law and violation of the Louisiana Civil Code
concerning the inducement and solicitation of purchases arising out of the
public offering of Polaris Aircraft Income Funds III and IV. Plaintiffs seek
compensatory damages, attorneys' fees, interest, costs and general relief.

On or about May 7, 1996, a petition entitled Charles Rich, et al. v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
District Court for the Parish of Orleans, State of Louisiana. The complaint
names as defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.
Plaintiffs allege claims of tort concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Funds
III and IV. Plaintiffs seek compensatory damages, attorneys' fees, interest,
costs and general relief.

On or about March 4, 1996, a petition entitled Richard J. McGiven v. General
Electric Company and General Electric Capital Corporation was filed in the Civil
District Court for the Parish of Orleans, State of Louisiana. The complaint
names as defendants General Electric Company and General Electric Capital
Corporation. The Partnership is not named as a defendant in this action.

41

Plaintiff alleges claims of tort concerning the inducement and solicitation of
purchases arising out of the public offering of Polaris Aircraft Income Fund V.
Plaintiff seeks compensatory damages, attorneys' fees, interest, costs and
general relief.

On or about March 4, 1996, a petition entitled Alex M. Wade v. General Electric
Company and General Electric Capital Corporation was filed in the Civil District
Court for the Parish of Orleans, State of Louisiana. The complaint names as
defendants General Electric Company and General Electric Capital Corporation.
The Partnership is not named as a defendant in this action. Plaintiff alleges
claims of tort concerning the inducement and solicitation of purchases arising
out of the public offering of Polaris Aircraft Income Fund V. Plaintiff seeks
compensatory damages, attorneys' fees, interest, costs and general relief.

The following actions were settled pursuant to a settlement agreement entered
into on June 6, 1997. An additional settlement was entered into on November 19,
1997 with certain plaintiffs who had refused to participate in the first
settlement:

A complaint entitled Joyce H. McDevitt, et al. v. Polaris Holding Company, et
al., which was filed in the Superior Court of the State of California, County of
Sacramento, on or about October 15, 1996, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint
names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory
damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Mary Grant Tarrer, et al. v. Kidder Peabody & Co. (Kidder
Peabody), et al., which was filed in the Superior Court of the State of
California, County of Sacramento, on or about October 16, 1996, by individual
plaintiffs who purchased limited partnership units in Polaris Aircraft Income
Funds III-VI and other limited partnerships sold by Kidder Peabody. The
complaint names Kidder, Peabody & Co. Incorporated, KP Realty Advisors, Inc.,
Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory
damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds III-VI and all other limited
partnerships alleged to have been sold by Kidder Peabody to the plaintiffs.

42

A complaint entitled Janet K. Johnson, et al. v. Polaris Holding Company, et
al., which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 6, 1996, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds I-VI. The complaint
names Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris
Investment Management Corporation, Polaris Securities Corporation, Polaris Jet
Leasing, Inc., Polaris Technical Services, Inc., General Electric Company,
General Electric Financial Services, Inc., General Electric Capital Corporation,
General Electric Credit Corporation and Does 1-100 as defendants. The
Partnership is not named as a defendant in this action. The complaint alleges
violations of state common law, including fraud, negligent misrepresentation,
breach of fiduciary duty, and violations of the rules of the National
Association of Securities Dealers. The complaint seeks to recover compensatory
damages and punitive damages in an unspecified amount, interest, and rescission
with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Wayne W. Kuntz, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 13, 1996, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Thelma Abrams, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about November 26, 1996, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

A complaint entitled Enita Elphick, et al. v. Kidder Peabody & Co.,et al., which
was filed in the Superior Court of the State of California, County of
Sacramento, on or about January 16, 1997, by individual plaintiffs who purchased
limited partnership units in Polaris Aircraft Income Funds III-VI and other
limited partnerships sold by Kidder Peabody. The complaint names Kidder, Peabody
& Co. Incorporated, KP Realty Advisors, Inc., Polaris Holding Company, Polaris
Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Financial Services, Inc.,
General Electric Capital Corporation, General Electric Credit Corporation and

43

Does 1-100 as defendants. The Partnership is not named as a defendant in this
action. The complaint alleges violations of state common law, including fraud,
negligent misrepresentation, breach of fiduciary duty, and violations of the
rules of the National Association of Securities Dealers. The complaint seeks to
recover compensatory damages and punitive damages in an unspecified amount,
interest, and rescission with respect to Polaris Aircraft Income Funds III-VI
and all other limited partnerships alleged to have been sold by Kidder Peabody
to the plaintiffs.

A complaint entitled George Zicos, et al. v. Polaris Holding Company, et al.,
which was filed in the Superior Court of the State of California, County of
Sacramento, on or about February 14, 1997, by individual plaintiffs who
purchased limited partnership units in Polaris Aircraft Income Funds I-VI. The
complaint names Polaris Holding Company, Polaris Aircraft Leasing Corporation,
Polaris Investment Management Corporation, Polaris Securities Corporation,
Polaris Jet Leasing, Inc., Polaris Technical Services, Inc., General Electric
Company, General Electric Financial Services, Inc., General Electric Capital
Corporation, General Electric Credit Corporation and Does 1-100 as defendants.
The Partnership is not named as a defendant in this action. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds I-VI.

Three complaints which were filed on or about March 21, 1997, in the Superior
Court of the State of California, County of Sacramento naming as defendants
Kidder, Peabody & Company, Incorporated, Polaris Holding Company, Polaris
Aircraft Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Capital Services, General
Electric Capital Corporation, GE Capital Aviation Services and Does 1-100. The
first complaint, entitled Michael J. Ouellette, et al. v. Kidder Peabody & Co.,
et al., was filed by over 50 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
second complaint, entitled Thelma A. Rolph, et al. v. Polaris Holding Company,
et al., was filed by over 500 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
third complaint, entitled Carl L. Self, et al. v. Polaris Holding Company, et
al., was filed by over 500 individual plaintiffs who purchased limited
partnership units in one or more of Polaris Aircraft Income Funds I-VI. The
Partnership is not named as a defendant in any of these actions. Each complaint
alleges violations of state common law, including fraud, negligent
misrepresentation and breach of fiduciary duty, and violations of the rules of
the National Association of Securities Dealers, Inc. Each complaint seeks to
recover compensatory damages and punitive damages in an unspecified amount,
interest and rescission with respect to Polaris Aircraft Income Funds I-VI and
all other limited partnerships alleged to have been sold by Kidder Peabody to
the plaintiffs.

A summons and First Amended Complaint entitled Sara J. Bishop, et al. v. Kidder
Peabody & Co., et al., which was filed in the Superior Court of the State of
California, County of Sacramento, on or about April 9, 1996, by over one hundred
individual plaintiffs who purchased limited partnership units in Polaris
Aircraft Income Funds III, IV, V and VI and other limited partnerships sold by
Kidder Peabody. The complaint names Kidder, Peabody & Co. Incorporated, KP
Realty Advisors, Inc., Polaris Holding Company, Polaris Aircraft Leasing
Corporation, Polaris Investment Management Corporation, Polaris Securities
Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services, Inc.,
General Electric Company, General Electric Financial Services, Inc., General

44

Electric Capital Corporation, General Electric Credit Corporation and Does 1-100
as defendants. The Partnership is not named as a defendant in this action. The
complaint alleges violations of state common law, including fraud, negligent
misrepresentation, breach of fiduciary duty, and violations of the rules of the
National Association of Securities Dealers. The complaint seeks to recover
compensatory damages and punitive damages in an unspecified amount, interest,
and rescission with respect to Polaris Aircraft Income Funds III-VI and all
other limited partnerships alleged to have been sold by Kidder Peabody to the
plaintiffs.

A complaint entitled Wilson et al. v. Polaris Holding Company et al., which was
filed in the Superior Court of the State of California, for the County of
Sacramento, on October 1, 1996, by over 500 individual plaintiffs who purchased
limited partnership units in one or more of Polaris Aircraft Income Funds I
through VI. The complaint names Polaris Holding Company, Polaris Aircraft
Leasing Corporation, Polaris Investment Management Corporation, Polaris
Securities Corporation, Polaris Jet Leasing, Inc., Polaris Technical Services,
Inc., General Electric Company, General Electric Capital Services, Inc., General
Electric Capital Corporation, GE Capital Aviation Services, Inc. and Does 1-100
as defendants. The Partnership has not been named as a defendant. The complaint
alleges violations of state common law, including fraud, negligent
misrepresentation, negligence, breach of contract, and breach of fiduciary duty.
The complaint seeks to recover compensatory damages and punitive damages in an
unspecified amount, interest and rescission with respect to the Polaris Aircraft
Income Funds sold to plaintiffs.

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 1997 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 $369,396 were paid to PIMC in 1997 in addition to a 10%
interest in all cash distributions as described in Note 9 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.

45

b) The General Partner of PAIF-III owns the equity securities of PAIF-III
as set forth in the following table:

Title Name of Amount and Nature of Percent
of Class Beneficial Owner Beneficial Ownership of Class
-------- ---------------- -------------------- --------

General Polaris Investment Represents a 10.0% interest 100%
Partner Management of all cash distributions,
Interest Corporation gross income in an amount
equal to 9.09% of distributed
cash available from operations,
and a 1% interest in net income
or loss

c) There are no arrangements known to PAIF-III, including any pledge by
any person of securities of PAIF-III, the operation of which may at a
subsequent date result in a change in control of PAIF-III.

Item 13. Certain Relationships and Related Transactions

None.

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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 18
Balance Sheets 19
Statements of Operations 20
Statements of Changes in Partners' Capital
(Deficit) 21
Statements of Cash Flows 22
Notes to Financial Statements 23

2. Reports on Form 8-K.

No reports on Form 8-K were filed during the quarter ended December 31,
1997.

A current report on Form 8-K was filed on January 5, 1998 to report the
prepayment in full of the Promissory Note due from Triton Aviation
Services III LLC on December 30, 1997.

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

27. Financial Data Schedule (in electronic format only).

4. Financial Statement Schedules.

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

47

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 27, 1998 By: /S/ Eric M. Dull
-------------- ------------------------
Date Eric M. Dull, President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

Signature Title Date
--------- ----- ----

/S/Eric M. Dull President and Director of Polaris March 27, 1998
--------------- Investment Management Corporation, --------------
(Eric M. Dull) General Partner of the Registrant

/S/Marc A. Meiches Chief Financial Officer of Polaris March 27, 1998
------------------ Investment Management Corporation, --------------
(Marc A. Meiches) General Partner of the Registrant

/S/Richard J. Adams Director of Polaris Investment March 27, 1998
------------------- Management Corporation, General --------------
(Richard J. Adams) Partner of the Registrant

48