1 Northeast Airlines AnnualReport1970 i To Northeast Stockholders: Financially, 1970 wa s still very much a troubl ed year for Northeast, although improved from 1969 (partially attributabl e to th e National Airline strike in early 1970). Th e bottom line loss of $10)00,000 furni shes littl e comfort except as a compari son to th e $28,800,000 loss realized in 1969. Despite significant cutbacks in both operation s and personn el, th e sam e fundam ental economic probl ems still exist, and w e are at the point wh ere additiona l cutbacks pose revenu e ri sks that mu st be carefully w eighed again st th e potential saving in exp ense. Thi s is being thoroughly explored by our operation s, marketing and planning peopl e as w e go, but th ere is no easy answer. M erg er w ith a financially strong entity sti ll appears to be th e only long- term solution . One of th e major proj ects of th e year, of course, was th e proposed merg er between Northeast and Northwest Airlin es, fil ed w ith th e Civil A eronautics Board in January of 1970. Th is agreement was finally terminated by Northwest on March 10, 1971, under its option to do so due to restriction s th e Civil A eronautics Board placed on th e tran sfer of th e Miami-Los Angeles route in its conditional approval of th e merger. Both Northwest and North east petition ed for reconsideration of thi s restriction, but th e petition s w ere d eni ed on March 1 and Northwest subsequently gave notice of termination . It is th e intention of North east to proceed to negotiate a merger with on e of th e oth er airlines which have already expressed specific interest. Since thi s letter is being written on March 11 to fulfill publication d eadlin es for th e annual report, which is only on e day after receiving Northwest' s notice of cancellation, no negotiations have begun with any of th e parti es. In closing, I take thi s opportunity to convey the thanks o f all the Northeast directors to th e loyal executives and line employees who have he lped us weather this trying year. It has not been easyi it may not get any easier. They all can take great persona l pride in their individual contribution in keeping the " Ye llowbirds" flying, and maintaining the high standard of service in spite of the many obstacles. Very truly yours, ~~ Bill M ichae ls President 1 Northeast Airlines, Inc. Balance Sheet Assets Current assets: Cash Accounts receivable less allowance for doubtful accounts of $1 ,084,000 in 1970 and $823,000 in 1969 Aircraft parts and suppli es at average cost (less reserve for obsolescence of $652,000 in 1970 and $362,000 in 1969) (note D) Pre pa id expenses Total current assets Restricted deposit with mortgage trustee Property and equi pment at cost (notes B, C and D): Flight equi pment and related spare parts Ground property and equi pment Less allowance for depreciation and amortization Non-operating property and equipment: Flight equipment and related spare parts held for sa le or lease at estimated realizable value (note H) Leased flight equipment (note B) Deferred charges and other assets (note D): J et aircraft integration Route development Debt expenses Other The dCcompdnying notes dre dn integrdl pdrt of the findncidl stdtements. 2 December 31 1970 1969 $ 3,798,261 $ 4,435,912 10,870,893 12,529,283 5,642,602 4,956,621 2,360,963 2,781,807 22,672,719 24,703,623 1,637,884 1,727,785 28,053,075 27,780,834 9,409,422 9,451,361 37,462,497 37,232,195 10,007,947 7,611,001 27,454,550 29,621,194 4,300,000 5,581,720 4,985,562 5,951,515 900,181 1,050,031 722,809 780,409 576,155 365,072 7,184,707 8,147,027 $63,249,860 $69,781,349 Liabilities Current I iabi I ities: Current maturities of lon g-term debt (note C) Accounts payable Accrued sa laries and wages Accrued vacation Contributions to employee pension plans (note E) Unearned transportation revenu e Collections as agent Total current liabilities (note C) Estimated future liability for employee sick leave less discount of $1)18,292 in 1970and $1,548)95 in 1969 Convertible subordinated debentures and lon g-term debt, net of cu rrent maturities (note C) Notes payable to Storer Broadcasting Company (notes A and I) Liability to Storer Broadcasti ng Company on reassignment of certain flight equipment contracts Commitments and contingencies (notes 8, C G and I) Stockholders' Equity Common stock, par va lue $1 .00 per share Authorized 10,000,000 shares (notes C and F) Issued 6,685,155 shares Additional paid-in capital Accumulated ddicit since January 1, 1966 (note C) Tota I stockholders' ddicit The dCcompdnying notes are dn integrdl part of the find ncid l stdtements. December 31 1970 $ 2,854,032 8,927,903 833,749 2,239,398 137,593 4,025,522 4,479,174 23,497,371 2,012,398 40,449,522 26,000,000 3,968,764 6,685,155 9,135,950 (48,499,300) (32,678,195) $63,249,860 1969 $ 2,846,859 10,960,518 978,544 2A83J60 1 A48,088 4,345,238 4,320,089 27,383,096 1,837,923 43,307,606 15,241,014 3,968)64 6,685,155 9,1 35,950 (37)78,159) (21,957,054) $69,781,349 3 Northeast Airlines, Inc. Statement of Income Years Ended Operating revenues: Passenger Express, freight and baggage Mail Charter and other, net Total operating revenues Operating expenses: Flight operations, including direct maintenance Other maintenance and repairs Aircraft and traf~ic servicing Promotion and sales Depreciation and amortization (note D) Passenger service G eneral and administrative Total operating expenses Operating loss Other expenses: Interest expense Other-net Tota I other expenses Loss before extraord inary items Extraordinary items (note H) Net loss Losses per share of common stock: Loss before extraordinary items Extraordinary items Net loss Statement of Accumulated Deficit Balance at beg inning of year Net loss per statement of income Ba lance at end of year (si nee January 1, 1966) The accompanying notes are an integral pa rt o f the financia l statements. 4 December 31 1970 1969 $113,027,583 $113,347,434 4,190,674 4,587,031 1,579,450 1,242,137 4,038,669 2,912,008 122,836,376 122,088,610 55,444,025 58,590,153 8,275,637 10,354,384 22,180,715 23,185,119 18,600,746 20,424,355 3,996,096 4,654,179 12,816,385 14,089,617 6,224,648 7,859,781 127,538,252 139,157,588 4,701,876 17,068,978 4,876,491 3,436,740 442,774 550,846 5,319,265 3,987,586 10,021,141 21 ,056,564 700,000 7,786,898 $ 10,721,141 $ 28,843,462 $1 .50 $3.15 .10 1.16 $1.60 $4.31 $ 37,778,159 $ 8,934,697 10,721,141 28,843,462 $ 48,499,300 $ 37,778,159 Northeast Airlines, Inc. Source and Use of Funds (Working Capital) Years Ended Source of funds: Issuance of: Notes payable to Storer Broadcasting Company Long-term debt Equipment deposits reimbursed by lessor Disposal of property and equipment Other Use of funds : Operations: Net loss Charges not requiring funds currently: Extraordinary items (note H) Depreciation and amortization Other Current maturities on long-term debt Property and equipment: Ai rcraft and parts including deposits Ground property and equipment Other, net Increase (decrease) in working capita l Th e dccompdnyi ng no tes dre dn inte grdl pdrt of the fi ndncidl stdtements . December 31 1970 $11 ,000 ,000 625,164 11,625,164 10,721,141 (700,000) (3,996,096) (282,318) 5,742,727 2,854,032 348,275 330,634 494,675 9,770,343 $ 1,854,821 1969 $15,241 ,014 926,021 1,597,053 189,435 338,543 18,292,066 28,843,462 (7,786,898) (4,654,179) (786,065) 15,616,320 2,846,859 2,041 ,026 2,083,458 769,320 23,356,983 ($ 5,064,917) 5 Northeast Airlines, Inc. Notes to Financial Statements A. Basis of Presentation The 1969 and 1970 financia I statements have been prepared on a going concern basis which contemplates the realization o f assets and the liquidation of liabilities in the ordinary course of business, the continuation of which was (as to the 1969 Financial statements) and is (as to the 1970 financia l statements) dependent on the Company's ability either to obtain continued Financing and Financial support or to consummate a merger. The Company's majority stockholder, Storer Broadcasting Company: ( a) in an agreement dated January 19, 1970, with Northwest Air I ines, Inc. was committed to advance additional funds to the Company pending consum- mation of a proposed merger; and (b) has warranted, in conn ection with certain loan agreements, that it would cause the Company to maintain a minimum specified amount of working capita l (see note C). The Company has continued to suffer operating losses, the proposed Agreement of Merger has been terminated (note I), and there is uncertainty as to the continued Financing of the Company by Storer, all of which creates doubt as to the ability of the Company to continue as a going concern . B. Equipment Program and Lease Commitments On December 31, 1970, the Company's operating fleet consisted of the following : Model of Aircraft Owned Leased Total Boeing 727-100 2 6 8 Boeing 727-200 13 13 Douglas DC9-30 4 10 14 6 29 35 Of the leased aircraft, all except seven Boeing 727-200's are being leased from Storer Leasing Corporation (a wholl y owned subsidiary of Storer Broadcasting Company), from which the Company is also leasing certain related spare parts. Lease expense on all of the foregoing flight equipment approxi- mated $14,800,000 in 1970 ( and annually thereafte r) until the leases expire at various dates from 1978 to 1982. Rentals under long-term leases in effect at December 31, 1970 for hangar, terminal and reservations facilities approximate $2,600,000 annually until 1977, when the first major lease expires. C. Convertible Subordinated Debentures and Long-Term Debt Long-term debt at December 31, 1970 consisted of the following : Series A secured notes, 6%, due quarterly throug h 1973 $ 6,988,663 Series B secured notes, 7%, due semi-annually from 197 4 through 1979 Subordinated notes to aircraft manufacturers, 6% and 63/4% due quarterl y through 1979 Convertible subordinated debentures, 6 %, due 1986 Fuel Farm Construction Contract, 7%, due monthl y through 1977 Other Total debt Less insta llments due in 1971 Long-term portion 10,000,000 3,373,307 22,000,000 750,588 190,996 43,303,554 2,854,032 $40,449,522 The 6% convertible subordinated d ebentures due August 1, 1986 are convertible into common stock at $25 per share, subject to an adjustment in certain events, and 880,000 shares of common stock are reserved for such conversion . The Company is required to provide $1,100,000 annually from 1976 to 1985 for sinking fund redemptions. The debentures impose certain restrictions on cash d ivid ends and stock repurchases, but these are less restrictive than those provided under other loan agreements, which are noted below. So long as certain indebtedness (with maturiti es extending to 1979) is outstanding under loan agreements between Storer Broadcasting Company and th e Company, respecti ve ly, and certain banks and institu- tional investors in conjunction with financing the acquisitions of jet Flight equipment leased by Storer Leasi ng Corporation ( note B) to or purchased by the Company, Storer and the Company have respectively warranted that, without prior consent of the lenders, the Company will not pay divid ends in excess of 50% of net ea rnings subsequent to January 1, 1966 and w ill mainta in a specified amount of net working capital, as defined in the loan agreements. At December 31, 1970, the Company's defin ed net working capital was approximately $5,700,000 less than the stipulated amount and waivers were obtained from the lenders, effective until Apri 11 , 1971. In the event additional waivers are not granted, the lenders have the option to declare the total amount of the notes due and payable. Substantiall y all of the Company's owned Flight equipment and related spare parts are pledged as co llatera l under the Series A and B notes and subordinated notes to aircraft manufacturers. 6 D . Depreciation, Amortization and Maintenance The Company charges depreciation expense on a straight- line basis. Depreciable lives are Fifteen years for owned operating aircraft and certai n parts, principally five years for ground properties and equipment and the lease period or useful life, wh ichever is less, for leasehold improvements. Depreciation and amortization of property, plant and equipment charg ed against income approximated $2,740,000 in 1970 and $3,388,000 in 1969. E. Training and other aircraft integration costs incurred in conjunction with the Company's major re-equipment program in 1966 and 1967 are being amortized over ten years. Similar costs incurred after 1967, none in 1970, for expansion of the aircraft Fleet are being amortized over five years. Amortization charged against income approximated $966,000 in 1970 and $987,000 in 1969. Provision for obsolescence of aircraft parts and supplies, which is made ratabl y over the lives of the related aircraft, amounted to $290,000 in 1970 and $279,000 in 1969. Such parts and supplies are reflected in cu rrent assets in accordance with the Uniform System of Accounts prescribed by the Civil Aeronautics Board, although some portion of quantities on hand represent in excess of one yea r's expected usage. Overhaul s of owned and leased Boeing 727 and Douglas DC-9 airfram es and engines are charged to expense when the overhaul s are performed . Expenditures extending materially the life of property and those for additiona l equipment are capitalized. Retirement Plans The Company has various contributory and non-contributory trusteed retirement plans for substantially all employees. The total pension expense was approximate ly $3,154,000 in 1970 and $2,362,000 in 1969, which includes, as to the non-contributory plans, normal cost and interest on past service cost, which the Company funds currently. The actuarially estimated present value of vested benefits of non-contributory plans at December 31, 1970 exceeded the amounts funded and accrued by approximately $175,000. F. Employee Stock Option Plan At December 31, 1970, 256,250 shares of authorized and unissued common stock were reserved under the Company's 196 4 Oualified Stock Option Plan and options were outstanding and exercisab le to purchase, at prices not less than fa ir market va lue on dates granted, 50,000 shares at prices ranging from $11 .625 to $32.875 per share ( total price of $985,218). During 1970, no options to purchase shares were granted, options for 73,750 shares were terminated, and no options were exercised. G. Contingencies Available tax loss carryforwards from periods prior to July 31, 1965, which aggregate approximately $2 million (subject to Internal Revenue Service examination) at January 1, 1971 will expire in 1971. There are pending against Northeast various claims by certain defendants who were enjoined in December, 1964, in proceedings instituted by Northeast against alleged illegal charter Flights. Although th e injunctions w ere upon revi ew later substantially affirmed, the defendants allege wrongful injunctions, abuse of process, antitrust violations and interference with contractual and advantageous relations, and seek substantial damages. The District Court has ruled that damages for interference with enjoined flights can be recovered, if at all, only to the amount of $200,000 previously on deposit with th e Court as security, and that, in any event, there can be no recovery for interference with illega l flights . In view of the decisions in favor of Northeast in the case to date, that defendants' charter program was illegal, counsel for Northeast has advised that, in their opinion, the claims are without merit, but that th e outcome of the litigation cannot be predicted . Certain stockholders of Northeast have commenced actions against Northeast, Northwest, and Storer Broadcasting Company challenging th e proposed merger with Northwest. In such actions, the pla intiffs allege that they are acting for themselves and for the minority stockholders of Northeast as a class, that the terms of the proposed merg er are unfair to the stockholders of Northeast, and that Storer Broadcasting Company and certain of its officers and directors violated fiduciary duties as directors of Northeast in negotiating and approving the proposed merg er. These actions have been consolidated by order of the United States District Court for the Southern District of New York. Plaintiffs' motions for certain injunctive relief have been denied by the District Court and such d enial has been affirmed by the Court of Appeals for the Second Circuit. Proceedings have been commenced in certain jurisdictions against Northeast and other airlines, alleging violations of various environmental conditions, principally air pollution and noise in the vicinity of airports. The airlines are seeking dismissal of these proceedings on the ground, among others, that these are matters of federal regulation . The airlines have agreed to install smoke reduction devices on certain aircraft engines substantially by the end of 1972, and will be subject to regulation under recent federal legis lation. Proceedings are pending against Northeast, in which the union representing Northeast's pilots is seeking reinstatement with back pay of a number of pilots furloughed as part of a reduction in force of employees. Northeast has contended that the furloughs were lawful and in accordance w ith existing collective bargaining agreements. There are other claims and proceedings pending against the Company, d eve loped during the ordinary course of bus iness, which in the opinion of counsel are without merit or will not result in any material liability. H. Extraordinary Items Extraordinary items in the Statement of Income consist of the following : Write-down of Fairchild FH-227 fleet and related spare parts and engines to estimated realizable value, including in 1969 a write-off of $562,450 in FH-227 deferred training and aircraft integration costs Provision for loss incurred in the cancella- tion of eight Lockheed Model L-1011 jet aircraft and on related contracts for engines Loss on sale of remaining Douglas DC-6B aircraft, spare engines and parts Write-off of certain ground equipment Total I. Merger Plans 1970 1969 $700,000 $3,690,317 3,642,059 226,666 227,856 $700,000 $7,786,898 During 1970, the Boards of Directors and the stockholders of the Company and Northwest Airlines, Inc. approved an Agreement of Merger, under the terms of which Northwest would be the surviving entity. On December 31, 1970, the CAB pub I ished its order, as approved by the President of the United States, approving the merger subject to certain conditions including a stay of Northwest's authorization to operate the Company's route segment between Miami and Los Angeles pending final d ecision in a new CAB proceed ing. The Company, Northwest and others filed petitions for reconsid eration . Northwest indicated that if the condition staying the Miami-Los Angeles authorization was not deleted, it would terminate th e Agreement of Merger. On March 1, 1971, the CAB reaffirmed its approva I of the merger subject to the aforementioned conditions, and on March 10, 1971, Northwest terminated the Merger Agreement. The Company has indicated its intention to commence negotiations with other potential merger partners, some of which have publicly indicated a desire to negotiate a merger with Northeast, with or without the conditions imposed by the CAB on the previous proposed merger. Auditors' Opinion Lybrand, Ross Bros. & Montgomery Certified Public Accountants To the Stockholders and Directors of Northeast Airlines, Inc. Boston, Massachusetts We have examined the accompanying balance sheet of Northeast A irlines, Inc. as at December 31, 1970 and the related statements of income, accumulated deficit, and source and use of funds (working capita l) for the year then end ed . Our examination was made in accordance w ith 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. We previously examined and reported upon the financial statements of the Company for the year ended December 31, 1969. In our opinion, subject (as to the 1970 financial statements) to the ability of the Company to continue as a going concern as discussed in note A, the aforementioned financial statements present fairly the financial position of Northeast Airlines, Inc. at December 31, 1970 and 1969 and the results of its operations and source and use of its funds (working capital) for the years then ended, in conformity w ith generally accepted accounting principles applied on a consistent basis. Boston, Massachusetts February 22, 1971 (except for notes A and I of notes to financial statements as to which the date is March 10, 1971) 7 NOTICE Part 245 of the Economic Regulations of the Civil Aeronautics Board requires that each Air Carrier notify its shareholders by notice in the carriers annual report to shareholders, "that any person who owns as of December 31 of any year or acquires ownership, either beneficially or as trustee, of more than 5 per centum, in the aggregate, of any class of capital stock or capital of the air carrier shall file with the Board a report containing the information required (by Subsection 13 of Part 245) on or before April 1 as to capital stock or capital owned as of December 31 of the preceding year and within 10 days of the acquisition, unless such person has otherwise filed with the Board a report covering such acquisition or ownership". And "that any shareholder who believes that he may be required to file such a report may obtain further information by writing to the Director, Bureau of Operating Rights, Civil Aeronautics Board, Washington, D.C. 20428". 8 Officers Directors Executive Committee Reg istrars & Transfer Agents General Counsel Auditors George B. Storer Bill Michaels Lewis E. Lyle Dan D. Chandler Garner W. Mi ller Stuart W . Patton N . Ralph Tipa ldi Edwin H. Bishop Arno W . Mueller John C. Nebbia, Jr. Henry E. Foley Clarence I. Peterson James W. Austin Jacqueline Cochran Leonard Dalsemer A. D. Davis RobertC. Hill Curtis M . Hutchins Stanton P. Kettler Lewis E. Lyle Bill Michaels Arno W . Mueller Stuart W . Patton Harry M. Stevens, 11 George B. Storer George B. Storer, Jr. Peter Storer David A. Stretch Francis W . Sullivan George B. Storer, Chairman Leonard Dalsemer A. D. Davis Chairman of the Board President and C hief Executive Officer Executive Vice President and General Manager Vice President-Flight Vice President-Technical Services Vice President-Law Vice President-Marketing Vice President-Marketing, Southern Region Treasurer Assistant Treasurer and Corporate Controller Clerk Assistant Clerk Consu ltant Rancher Executive Vice President, International Paper Co. Vice Chairman, Winn-Dixie Stores, Inc. Ambassador to Spain Chairman, Dead River Company Vice C hairman, Storer Broadcasting Company Executive Vice President and General Manager President, Northeast Airlines, Inc. and Storer Broadcasting Company Treasurer, Northeast Airlines, Inc. and Vice President-Finance and Treasurer, Storer Broad- casting Company V ice President-Law Vice President and Treasurer, H. M. Stevens, Inc. Chairman of the Board, Northeast Airlines, Inc. and Storer Broadcasting Company Consultant Executive Vice President, Storer Broadcasting Company Cha irman, Executive Committee, Texas Industries, Inc. Attorney at Law Lewis E. Lyle Bill Michaels Stuart W . Patton The First Nationa l Bank of Boston, Boston, Massachusetts The Chase Manhattan Bank, New York, New York Foley, Hoag & Eliot, Boston, Massachusetts Lybrand, Ross Bros. & Montgomery