NORTHEAST AIRLINES ANNUAL REPORT TABLE OF CONTENTS Page Board of Directors and Officers 1 Letter from the Chairman of the Board 2 Balance Sheet 6 Statement of Income and Expense and Deficit 8 Notes to Financial Statements 9 Opinion of Independent Public Accountants 10 Northeast System Map 11 The First National Bank of Boston Logan International Airport, Boston 28, Mass. AUDITORS Lybrand, Ross Bros, and Montgomery BOARD OF DIRECTORS ANNUAL REPORT for year ending December 31, 1963 JAMES W. AUSTIN Chairman of the Board and President DAVID A. STRETCH Chairman of the Executive Committee President, Atlas Corporation, New York JACQUELINE COCHRAN President, Jacqueline Cochran, Inc., New York PAUL F. COLLINS President, Fibremold, Inc., Woburn, Mass. CHESTER C. DAVIS Counsel, Hughes Tool Company JAMES F. FITZGERALD President, J. F. Fitzgerald Construction Co., Canton, Mass. GEORGE E. GARDNER Aviation Consultant, Lake Alfred, Florida OSWALD L. JOHNSTON Partner, Simpson Thacher & Bartlett, New York ALBERT C. MCMENIMEN Vice President and Treasurer, Boston Edison Company EUGENE L. VIDAL Gene Vidal Designs and Processes, Avon, Ct. OFFICERS JAMES W. AUSTIN Chairman of the Board and President EDMUND O. SCHROEDER Executive Vice President -- Operations ARTHUR A. BRENNAN Vice President -- Personnel JOSEPH W. CANNON Treasurer F. M. COATES Vice President -- Finance and Administration RICHARD E. FISHER (1) Vice President and Director -- Public Relations THOMAS L. GRACE (1) Vice President -- Operations HAMILTON HEARD (2) Vice President -- Administration REMBRANDT P. LANE, JR. (1) Vice President -- Finance and Treasurer WHEATON W. MIES Vice President -- Technical Services M. WILLSON OFFUTT, III Vice President -- Traffic and Sales ALFRED S. WALKER Vice President -- Ground Operations H. F. ZIMMERMAN Vice President -- Controller HENRY E. FOLEY Clerk (1) Resigned (2) Deceased Page 1 TO OUR SHAREHOLDERS: The May 8, 1964 decision of the United State? Circuit Court of Appeals setting aside the actions of the Civil Aeronautics Board refusing to renew Northeast's authorization south of New York City has been most encouraging, after the difficult setbacks suffered during 1963. The Court found "vital flaws in the Board's decision" and commented adversely on each of the factors which the majority of the Board had mentioned in its denial of our Florida route renewal. The Court has directed the CAB to take further proceedings not inconsistent with the Court's opinion, and the CAB has stated that it will not petition for rehearing. We have, in the light of the Court's decision, requested the CAB to make Northeast's Florida authorization permanent on the basis of the existing record or, at the least, to reopen the record before the CAB and to reconsider its decision on the basis of current evidence. Your management is convinced more than ever that the East Coast-Florida route requires three air carriers and that Northeast's certification over this route should be made permanent. The tremendous response in support of our position which has arisen from every sector -- from our passengers, employees, stockholders, suppliers, the communities we serve, public officials and the public generally -- has been most enheartening. Northeast is entitled to continue to operate over its route extension south of New York pending final decision on its application, and we look forward with confidence to a successful outcome. Notwithstanding the difficult handicap of operating over the major portion of the Company's', route system without a permanent certification -- a handicap which no other airline trunk carrier has ever been compelled to assume -- Northeast began 1963 optimistically. During each of the first four months of 1963, Northeast's operating revenues were more than 5% higher than those of the corresponding month in 1962, resulting in an operating profit in excess of $150,000 for the four months ended April 30, 1963, which was a more than $1,000,000 improvement over the $960,000 loss for the corresponding period in 1962. Even more significant, however, was Northeast's increasing participation in the Florida traffic. During this period, as compared with the same four months of 1962, Northeast increased its share of the Boston-Miami traffic from 50% to more than 61%, increased its share of the Philadelphia-Miami traffic from less than 25% to over 39%, and increased its participation in the total East Coast-Florida market from less than 17% to more than 23%. Unfortunately, the continued high participation in the growing long-haul Florida market indicated by the Company's actual experience in the first four months of 1963 failed to materialize during the balance of the year which was marked by a series of nearly disastrous blows -- including the unfavorable report of the CAB Examiner in the Florida route proceedings in April, the demands for repossession of all of our Convair 880 jets and our Viscount turbo-jet fleet in May and June and the return of such equipment during the succeeding months, the public announcement of the vote of the majority of the CAB against continuing our Florida certification in July, and the formal filing of the adverse decision in August, each such event adding to the unfavorable publicity making it nigh impossible for the Company to maintain its rightful position in the market. The Company was forced to curtail operations, particularly during the latter months of the year, resulting in a total of approximately 1,280,000 available seat miles flown during the year and an average passenger load factor of slightly less than 50%, as compared with approximately 1,382,000 available seat miles flown and a passenger load factor in excess of 53% in 1962. The marked deterioration in Northeast's position during the latter half of the year when the potential loss of its Florida authorization and the repossession of the bulk of its aircraft fleet were being widely publicized is demonstrated by the drop in its average passenger load factor from approximately 56% during the first six months (a 5% improvement over 1962) to approximately 43% for the balance of the year. In fact, during the months of February and March, Northeast achieved the best system load factor of all the nation's airlines. Northeast carried approximately 350,000 Florida passengers, representing more than one-sixth of the entire East Coast-Florida traffic. Although this was a decrease from 1962, which was to be expected under the circumstances, we are convinced that the traveling public wants and uses our service and that, given a fair opportunity, Northeast can and will continue to serve a public need in this market. Total operating revenues for the year, excluding Federal subsidy, were somewhat less than $43,000,000, or more than $8,000,000 less than 1962's record high of nearly $51,400,000, and the small but encouraging operating profit for the first third of the year became an operating loss of $8,642,736 at the end of the year. In August 1963, Northeast petitioned the CAB for mail pay subsidy payments based upon the historically unprofitable operation in New England, and an order to this effect was adopted shortly thereafter, effective from and after September 13, 1963. Northeast received the sum of $987,528 as mail pay subsidy during 1963, but the full benefit of the subsidy on an annual basis, which would be approximately $3,800,000, has not yet been realized. As a consequence of the CAB's investigation of the needs of various smaller New England communities for scheduled certificated air service, Northeast has been permitted to eliminate, or transfer to regional airports, Page 3 its service at five low traffic density points in New England and to limit service at two other such points to the summer vacation period. Northeast and the New England Council have supported the CAB Examiner's recommendations, pending before the full Board, which would, in the public interest, permit similar actions at certain other stations. During April, 1963, Northeast led the entire airline industry in its operational performance. Later in the year, one of our aircraft mechanics won the Federal Aviation Agency's Aviation Mechanic Safety Award, becoming one of only seven men throughout the country to be so honored. As part of our cost control programs, we centralized at Boston numerous reservations facilities, enabling the Company to handle telephone reservations from twenty-three cities, as far south as Washington, D. C. and as far north as Portland, Maine. This new system eliminated the need for separate reservations facilities at each of these points and at the same time has resulted in twenty-four hours a day, seven days a week, coverage being available to the public for the first time in all of these locations. The improved service is at no additional cost to the public, and at the same time produces substantial savings to the Company. We have also put into effect World's Fair and other promotional fares and attractive schedules which we believe will stimulate traffic. Total operating expenses for the year were $52,557,540, nearly 10% below 1962, due in part to the forced curtailment of the Company's operations and in part to a close control of costs. In addition, your management elected to charge as special expenses during 1963 certain additional items aggregating $5,248,370, including certain expenses and estimated losses incident to the redelivered jet and Viscount aircraft, various pre-1963 deferred charges and a write-down of the Company's piston aircraft in line with current market values. Northeast presently owns and operates ten seventy-six passenger Douglas DC-6B aircraft and six twenty-four passenger Douglas DC-3 aircraft. It also leases and operates four ninety-nine passenger Convair 880 jet aircraft and five additional Douglas DC-6B aircraft and, from time to time during the peak Florida season, has leased additional Convair 880 and Boeing 707 jet aircraft from Trans World Airlines, Inc. Your management is presently reviewing the economic and operational characteristics of various types of aircraft for use on the Company's New England and Florida routes. This report would not be complete if we did not acknowledge the extensive assistance and continued support of our majority stockholder, Hughes Tool Company. In December, 1962, Hughes Tool Company leased two Convair 880 jet aircraft to Northeast for use during the peak winter season in the Florida market. This lease was later extended and increased to four aircraft when Northeast's other jets were required to be returned to the original lessors in the summer of 1963. The rental of the Tool Company aircraft has been fixed at amounts equal to or less than the rentals previously paid by Northeast for the jet equipment so returned, but pending CAB approval of the leasing arrangements with the Tool Company, such rentals have been accrued but not paid by Northeast. In July, 1963, Hughes Tool Company expressed its willingness to cancel and discharge notes of Northeast in the principal amount of $16,251,745 Page 4 which evidenced cash loans made to Northeast by Atlas Corporation and which had been acquired from Atlas by the Tool Company. These notes were, in fact, cancelled and discharged early in January, 1964. During 1963, Hughes Tool Company also stated that it was willing to exchange notes of Northeast in the principal amount of $9,500,000, which evidenced cash loans made to Northeast by the Tool Company, for shares of Northeast common stock at the rate of $3,625 per share. An application for CAB approval of such exchange has been filed and is pending before the Board. During the year, Northeast's bank loan, guaranteed by Hughes Tool Company, was increased by $1,000,000 to $5,000,000, and this loan has since been paid by the Tool Company. In addition, Hughes Tool Company made available to Northeast during 1963 sums aggregating approximately $4,000,000 for working capital support. At the Company's stockkholders' meeting in November, representatives of the Hughes Tool Company were elected to the Northeast Board of Directors, and a CAB Order of Approval has been adopted under the Federal Aviation Act. On behalf of the Company, I extend our sincere thanks to the Hughes Tool Company for its support and encouragement. Many obstacles have been placed in our path with the obvious intention of eliminating Northeast as an effective trunk carrier. We do not consider this report, however, to be the rostrum from which to charge those responsible for these attempts or for their tactics. Suffice it to say, we are confident that we shall ultimately prevail because we are convinced that the public interest requires Northeast's survival on our routes south of New York. Our continually improving operations prior to the Board's action in 1963 demonstrate that we can succeed, and the widespread public support of our cause assures that we will. On behalf of your management, I wish to express our sincere appreciation to you, our shareholders, as well as to our employees and many other friends, for your support and loyalty. I sincerely hope that you will patronize Northeast's services whenever and wherever possible and that you will urge your friends to do so. You will be welcome on Northeast Airlines. RESPECTFULLY SUBMITTED, James W. Austin CHAIRMAN OF THE BOARD AND PRESIDENT Page 5 NORTHEAST AIRLINES, INC- BALANCE SHEET /Is at December 31, 1963 ASSETS LIABILITIES CURRENT ASSETS: Cash $ 823,441 Accounts receivable 3,744,616 Flight equipment expendable parts, substantially at cost (note D) 2,223,423 Prepaid expenses 271,486 Miscellaneous supplies, at cost 359,735 CURRENT LIABILITIES: Debt instalments, including past due amounts: 4 44% notes payable to banks under credit agreement (note D) 6% trade obligations (note C) Collections as agent Trade accounts payable Accrued compensation, vacation pay and pension costs Provision for sick leave ' Unearned passenger revenue Provision for estimated liabilities: jet flight equipment leases and equipment trust agreement (note A) TOTAL CURRENT ASSETS 7,422,701 Property and equipment, at cost: Flight equipment and related spare parts (note D) $19,789,341 Ground property and equipment . . . . 5,191,789 Nonoperating property and equipment 777,804 25,758,934 Less allowances for depreciation, amortization and maintenance ... 19,697,784 6,061,150 Other assets 284,177 $13,768,028 Current liabilities (noteC), excluding amounts due Hughes Tool Company 6% trade obligations, due principally in 1965 (note C) Debt due Hughes Tool Company (note B) : Instalment obligations for spare parts, $422,312 due currently, balance due 1965 to 1968 . Accrued jet flight equipment rentals, currently due . . 6% demand notes 6/2% notes, due 1964 to 1967 Other (noninterest bearing) CAPITAL Common stock, par value $1.00 per share: Authorized -- 6,500,000 shares (notes B and F) Issued and outstanding -- 1,783,688 shares Paid-in surplus (note I) Deficit, per accompanying statement (note A) The accompanying notes are an integral part of this balance sheet. $ 358,774 4,599,531 1,523,315 3,035,571 2,410,716 1,286,546 912,629 7,812,805 21,939,887 2,426,508 1,113,840 2,057,198 7,429,394 9,500,000 1,196,639 1,783,688 25,553,280 (59,232,406) $13,768,028 Page 6 Page 7 NORTHEAST AIRLINES , INC. STATEMENT OF INCOME AND EXPENSE AND DEFICIT For the Year Ended December 31, 1963 OPERATING REVENUES (note G): Passengers $39,888,763 Express, freight and baggage 1,623,775 Air mail 423,041 Public service (subsidy) [effective September 13, 1963] 987,528 Other, net 991,697 TOTAL OPERATING REVENUES 43,914,804 OPERATING EXPENSES : Flying operations 16,558,190 Maintenance and repairs 12,240,735 Aircraft and traffic servicing 9,043,366 Reservations, sales, advertising and publicity 6,127,257 Depreciation and amortization 3,847,889 Passenger service 2,962,300 General and administrative 1,777,803 TOTAL OPERATING EXPENSES 52,557,540 OPERATING LOSS 8,642,736 NONOPERATING CHARGES : Interest expense (note B) 1,301,959 Other, net 107,965 NET LOSS BEFORE EXTRAORDINARY CHARGES 10,052,660 EXTRAORDINARY CHARGES (note H) 5,248,370 NET LOSS FOR THE YEAR 15,301,030 DEFICIT AT BEGINNING OF YEAR 43,931,376 DEFICIT AT END OF YEAR (note A) $59,232,406 The accompanying notes are an integral part of this statement. Page 8 NORTHEAST AIRLINES, INC. -- NOTES TO FINANCIAL STATEMENTS A JET FLIGHT EQUIPMENT LEASES AND EQUIPMENT TRUST AGREEMENT: In 1963 the leases of six Convair jet aircraft and thirty-four related engines were terminated due to defaults in rental payments, and the equipment was re turned to the lessors. Also in 1963, Vickers Viscount aircraft and related Rolls-Royce engines which had been acquired in 1958 and 1959 were repossessed by the trustee under a related equipment trust agreement due to defaults in required payments, and proceeds of resale of the equipment has been applied to reduce the indebtedness. The provision for liabilities shown in the accompanying balance sheet under the foregoing flight equipment leases and equipment trust agreement and the re lated loss included in extraordinary charges in the accompanying statement of income and expense and deficit (note H) are estimated amounts. The final liability with respect to these items is subject to the outcome of negotiations presently being conducted with the lessors and the trustee. B DEBT DUE HUGHES TOOL COMPANY: The 6% and 6/2% notes and certain of the noninterest bearing debt due Hughes Tool Company (majority stockholder of Northeast Airlines, Inc.) are subject to certain prior rights of the 4 94% notes payable, the 6% trade notes payable and of the trustee under the equipment trust agreement. Under certain conditions, the principal amount of the 6/2% notes may be ex changed for common stock of Northeast Airlines, Inc. at the rate of one share for each $3,625 of such indebtedness. North east Airlines, Inc. has applied to the Civil Aeronautics Board for permission to make such exchange. Hughes Tool Company waived all interest for 1963 on the 6/2% notes and on the 5/2% notes of $16,251,745 which were canceled in January, 1964. The cancella tion of the 5/2% notes has been reflected in the accompanying balance sheet as at December 31, 1963 as paid-in surplus. C TRADE OBLIGATIONS: In 1962, certain suppliers and trade creditors agreed to defer payment of ac counts payable to them as at June 30, 1962, principally on the basis of thirty- six monthly payments commencing Janu ary 31, 1963, with 6% interest. At De cember 31, 1963, the company was in default on monthly payments aggregating $2,222,500 for principal and interest due in 1963 on certain of these trade obliga tions; as a result, these holders have the right to accelerate the due dates of their obligations. D MORTGAGES ON FLIGHT EQUIPMENT AND SPARE PARTS: The 494% notes payable to banks under credit agreement (under which payments are in default) are secured by a mortgage on company-owned flight equipment and related spare parts. The trustee under the equipment trust agreement (see note A) holds a second mortgage on certain of the company's flight equipment and spare parts. E LONG-TERM LEASE COMMITMENTS: Annual rentals under long-term leases for hangar, terminal and reservations facili ties will approximate $1,300,000 in 1964. In addition to the annual rentals, certain of the leases obligate the company to pay maintenance and operating costs. F EMPLOYEE STOCK OPTION PLAN: At December 31, 1963, 100,000 shares of authorized and unissued common stock were reserved under the company's stock option plan for key employees. Options have been granted at prices not less than 85% of the fair market value of the stock on the dates granted. At December 31, 1963 options to purchase 19,000 shares were outstanding which were exercisable at prices aggregating $80,750. G FLORIDA ROUTE RENEWAL: In October, 1963 the Civil Aeronautics Board denied the company's application for permanent authorization to operate its route south of New York City and or dered the company to terminate this por tion of its operations. The company ap pealed this decision, and on May 8, 1964 the Circuit Court of Appeals in Boston set aside the Board's order and, while retaining jurisdiction, remanded the case to the Civil Aeronautics Board for further proceedings. The company continues to serve the route pending final determina tion of the matter. Page 9 H -- EXTRAORDINARY CHARGES : Extraordinary charges shown in the ac companying statement of income and ex pense and deficit consist of the following items: I -- PAID-IN SURPLUS : Paid-in surplus as at December 31, 1963 consists of $9,301,535 excess of amount paid in on common stock prior to 1963 over related par value, and $16,251,745 arising from the cancellation by Hughes Tool Company in January, 1964 of 5/2% notes payable. Estimated losses from ter mination of jet flight equip ment leases and repossession of flight equipment under trust agreement, including writeoff of unamortized bal ances of training and pre operating costs (see note A) $3,200,866 Writeoff of certain other deferred charges incurred prior to 1963 407,996 Adjustment of estimated residual value of piston flight equipment 1,639,508 $5,248,370 LYBRAND, ROSS BROS. MONTGOMERY ACCOUNTANTS AND AUDITORS COOPERS tx LYBRAND IN AREAS OF THE WORLD Northeast Airlines, Inc. Boston, Massachusetts We have examined the balance sheet of Northeast Airlines, Inc. as at December 31, 1963 and the related statement of income and expense and deficit for the year then ended. Our examination was made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, subject to the final determination of certain liabilities described in note A to the financial statements, the accompanying statements present fairly the financial position of Northeast Airlines, Inc. at December 31, 1963 and the results of its operations for the year then ended, in conformity with generally accepted accounting principles applied on a basis consistent with that of the preceding year. Boston, Massachusetts May 29, 1964 &4L Page 10 MONTREAL PRESQUE ISLE-HOULTON BURLINGTON MONTPELIER-BARRE HANOVER-LEBANON-WHITE RIVER JC' KEENE I WORCESTER SPRING FI ELO-HARTFO NEW YORK PHILADELPHIA BALTIMORE WASHINGTON JACKSONVILLE ST. PETERSBURG -CLEARWATER BANGOR BAR HARBOR AUOUSTA-WATERVILLE ROCKLAND PORTLAND MANCHESTER-CONCORD NEW BEDFORO-FALL RIVER HYANNIS NANTUCKET MARTHA'S VINEYARD Routes of NORTHEAST FORT LAUDERDALE MIAMI Page 11 NORTHEAST AIRLINES Logan International Airport Boston, Massachusetts