orthwest Airlines celebrated its 60th year of service in 1986. To mark this milestone, a historical supplement to the 1986 annual report has been prepared that features photographs of the people, events and aircraft that contributed to the airline's rich and vaned history as America's oldest airline with continuous name identification. Northwest's first flight on October 1, 1926, hauled airmail between Minneapolis/St. Paul and Chicago with passenger flights beginning in July 1927. Since then, Northwest operated bomber modification plants and military cargo routes dunng World War II, pioneered the Great Circle route to Asia, developed a nationwide route system and, 1n 1979, inaugurated service to Europe. Today it is the only US airline serving multiple destinations in both Asia and Europe. Much has happened since Northwest's first bi-plane flight 1n 1926, but unchanged is the airline's commitment to affordable, efficient, service-conscious air transportation. Contents Highlights Letter to Shareholders Operations Review Management's Discussion and Analysis Financial Statements Notes to Financial Statements Report of Independent Accountants Stock Price and Dividend Information Ten.Year Summary Directors and Officers 1 2 6 16 22 27 33 33 34 36 Corporate Profile NWA Inc. is the parent of six transportation-related subsidiaries: Northwest Airlines, Inc.; Northwest Aircraft Inc.; MainlineTravel, Inc., and the newly formed Northwest Aerospace Training Corporation, Northwest PARS, Inc. and Northwest Computer Services, Inc. Principal activities include commercial pas- senger and freight transportation; aircraft purchasing, sales and leas- ing; tour wholesaling of vacation travel packages; flight crew training for Northwest and other clients worldwide, and sales and service of a computerized reservations system. NWA lnc.'s principal subsidiary, Northwest Airlines, became America's fifth largest airline in 1986 through its acquisition of Republic Airlines in the largest transaction in the history of commercial aviation. Northwest now provides scheduled passenger and freight transportation at 135 cities in 40 U.S. states and 19 foreign countries. Its route system spans 261,334 miles with flights on three continents. Northwest is the leading U.S. airline transporting passengers across the Pacific and is the largest hauler of air freight among U.S. combination airlines. NWA Inc. is headquartered in Eagan, Minnesota, near Minneapolis/St. Paul International Airport. Its common stock is traded under the NWA symbol on the New York Stock Exchange. Highlights 1986 Financial Operating Revenues $3,589,174,000 Operating Expenses 3,422,529,000 Operating Income 166,645,000 Operating Margin 4.6% Net Earnings 76,941,000 Per Share 3.26 Stockholders' Equity 1,105,916,000 Per Share 46.29 Dividends Paid 19,645,000 Number of Shares Outstanding at Year End 23,890,000 Statistical (Scheduled) Passengers Revenue Passenger Miles Available Seat Miles Passenger Load Factor Yield Per Revenue Passenger Mile Ton Miles-Mail, Freight and Express Operating Expenses Per Available Seat Mile Per Available Ton Mile Number of Employees at Year End 1986 $166.6 1985 $771 1984 $96.3 1983 $68.9 1982 $(8.4)* Operating Income (In Millions) Operating results we.re affected by a 29-day strike. 23,167,000 28,814,957,000 48,408,440,000 59.5% 10.14 1,253,847,000 6.8 41.2 33,427 1986 $76 9 1985 $73 l 1984 $56 0* 1983 $50.1 1982 $5.0** Net Earnings (In Millions) After extraordinary charge of $30.9 million from the settlement of a lawsuit. **Results were affected by a 29-day strike. Percent 1985 Change $2,655,491,000 35.2 2,578,404,000 32.7 77,087,000 116.2 2.9% 1.7 pts. 73,119,000 5.2 3.18 2.5 947,001,000 16.8 43.49 6.4 19,586,000 0.3 21,774,000 9.7 14,539,000 59.3 22,341,334,000 29.0 37,148,562,000 30.3 60.1 % (0.6) pts. 9.64 5.2 1,100,124,000 14.0 6.8 39.8 3.5 16,864 98.2 1986 18 I 28 i; 1985 1- I 2 '! 1984 ,!. 7 198 1983 29 5 1- 7 1982 2b ~ l'i 7 Capacity and Traffic-Scheduled (In Billions) A\ ailable Seat l'vltles Revenue Passenger Miles To Our Shareholders WA Inc., through its principal subsidiary, Northwest Airlines, Inc., continued its 37-year trend as an airline industry profit leader. NWA Inc. posted 1986 earnings of $76.9 million, or $3.26 per share, on annual revenues of $3.59 billion. The 1986 profits were reduced by approximately $12 million due to a change in tax laws that limited allowable 1986 investment tax credits. Always at the forefront of the airline industry, NWA Inc. undertook dramatic steps in 1986. Following a carefully crafted business plan, NWA Inc. fashioned a foundation that will solidify its leadership position into the 21st century. NWA Inc. accurately forecasted an industry-wide trend toward consolidation, then led the industry by announcing, on January 23, 1986, a plan to acquire Republic Airlines. This $862 million transaction was the largest in the history of commercial aviation and was the first of several airline mergers and acquisitions that have changed the stmcture of commercial air travel. Your companys management had recognized that, to join the ranks of the nations megacarriers, it must not only continue its aggressive internal expansion but also must quickly acquire the necessary cntical mass to defend its routes and capitalize on growth opportunities. Thus, on October 1, 1986-the very.day the airline celebrated the 60th anniversary of its inaugural airmail flight- Northwest melded Republics flight schedule into its own, becoming one of Amenca s largest airlines. Despite our initial integration difficulties, the benefits of the merger were demonstrated clearly during the remainder of the year as Northwest year-over-year traffic increased 70 percent in October, 83 percent in November and 79 percent in December. Significantly, traffic dunng the fourth quarter was 11 percent greater than the two airlines generated individually during the fourth quarter of 1985-concrete evidence of the expected, positive synergy developed by the Republic acquisition. 2 As it examined potential merger partners, Northwest focused on its need for an expanded, though carefully structured, domestic route network that was strong in its own nght and that also could support Northwest's established and growing international service. From Republic, Northwest acquired traffic centers at Detroit and Memphis and was able to enlarge the Northwest hub at Minneapolis/St. Paul. Passengers flow through these three key airports across the 135-city system. The merger brought to Northwest a fleet of 171 narrow-bodied aircraft that allows the airline to carefully match aircraft size with market demand, ensunng maximum productivity from the company's 314-aircraft fleet. Concurrent with the Republic acquisition, the executive management of NWA Inc. was restructured both to accommodate the vastly enhanced operations and to chart the continued development of the corporation. Steven G Rothmeier, previously president and chief executive officer, was named chairman of the board and chief executive officer, and James A. Abbott, executive vice 3 left, John F. Horn, President and Chief Operating Officer; Steven G. Rothmeier, Chairman and Chief Executive Officer president of finance and administration and general counsel, was named vice chairman and general counsel. John F Hom, who held the position of executive vice president of corporate planning and international, was elected president and chief operating ofh'cer. Further strengthening Northwest was the leadership gained from a number of former Republic executives who joined Northwest in marketing, finance, maintenance and engineenng, and government affairs. A particularly dynamic marketing staff emerged through the combination of Northwest and Republic personnel. Northwest's ''Look To Us" advertising campaign and the grouping of the airline's business traveler products under the WorldPerks, WorldClubs and WorldClass themes have emphasized Northwest's global route structure and its commitment to quality customer service. 1986 marked Northwest's third year as the leading US airline 1n the Pacific. In fact, its third- quarter Pacific load factor reached 75 percent-the best quarterly performance in Northwest's 39 years of trans-Pacific operations. The integration of the Republic and Northwest domestic flight schedules enables Northwest to solidify its number one US airline position in the Pacific. Further, Northwest's strategic plan calls for continued expansion in the Pacific in 1987 with Bangkok, Thailand, being served nonstop from Tokyo and with the opening of a Detroit-Tokyo nonstop route, both in ApnI In addition to the Republic acquisition, NWA Inc. took bold steps last year in three areas to ensure its position as a leader in a broad range of transportation services. Investments in these areas include 50 percent ownership in the TWA PARS computerized reservations system, formation of Northwest Aerospace Training Corporation as a flight training unit for Northwest and others, and agreement for up to JOO Airbus A320 aircraft, to be delivered between 1990 and 1995, plus other aircraft acquisitions. These important developments are discussed 1n detail in other sections of this annual report. 4 Viewing the Far East as a pivotal focus of world trade, Northwest last year decided to expand its position as the only major US. passenger airline with a commitment to an all-cargo operation. Two more all-cargo Boeing 747 aircraft were ordered. The new freighters, which will increase the cargo fleet to eight Boeing 747Fs, will be delivered in mid-1987 in time to capitalize on peak demand for trans-Pacific cargo service. NWA Inc. made a considerable and carefully calculated investment in its future in 1986 and is poised in 1987 and beyond to benefit from that decision. Nevertheless, the best investment the corporation has is in its people. The size of NWA Inc., as a result of the merger, nearly doubled in the past year to almost 33,500 dedicated, industn"ous employees who stnve diligently to serve the traveling and shipping public. The Republic acquisition, PARS transaction, formation of Northwest Aerospace Training Corporation, Airbus agreement, freighter purchases, and quality of the NWA Inc. work force enable us to enter 1987 with confidence. Sincerely, Steven G. Rothmeier JohnF Hom Chairman and Chief Executive O/h"cer President and Chief Operating Officer March 20, 1987 5 ~ ~ ---- ::- ... __ -= -J_"--:c A New Competitive Position in \_ the Airline ....,..,..,._ ~ = Industry ith approximately 1, 600 daily departures to 135 cities over a 261,334-mile route system spanning three continents, Northwest joined the ranks of the megacamers in 1986. A key element in Northwest's growth was its decision-announced January 23, 1986- to acquire Republic Airlines. The $862 million acquisition was the largest transaction in the history of civil aviation. Northwest recognized that, despite vigorous internally generated growth, it must combine with another airline to establish sufficient market presence to retain its leadership position in the airline industry. Thus it sought a merger partner with a strong domestic route network and with a fleet of aircraft that would complement Northwest. 6 Republic met this set of cntena and became the proper choice. Through the Republic acquisition, Northwest added more than 60 US cities to its schedule of flights plus five international destinations-two each in Canada and Mexico and one in the Canbbean. Domestic flights focus on three traffic centers-Detroit, Minneapolis/St. Paul and Memphis-each offenng more than 200 daily departures with nonstop service to more than 60 cities each. In addition to a focused domestic route system, Northwest also acquired from Republic a vaned fleet mixture that allows the airline the flexibility of matching properly sized aircraft to each city's seat demand. Republic's 171 aircraft averaged 105 seats, while the Northwest pre-merger fleet averaged 228 seats. Today's Northwest fleet is well tailored to serve both Lis domestic and international routes. A Three-Hub System -~- Promoting Domestic and International Growth orthwest flights reach destinations in 40 US states and 19 foreign countnes. Northwest remains the largest US passenger airline across the Pacific and the largest freight camer among US airlines that carry both passengers and cargo. Northwest also is the only US airline serving multiple destinations in both Asia and Europe. These impressive statements are indicative of Northwest's continued growth since its first airmail flight 60 years ago. That 350-mile route from Minneapolis/St. Paul to Chicago was the forerunner of a route system that today spans 20 time zones and crosses the international dateline. The route system underwent a fundamental restructunng in 1986 through the acquisition of Republic Airlines. Domestic flights now flow passengers through three traffic centers-Detroit with 262 flights a day, Minneapolis/St. Paul with 249 and Memphis with 208. iD NORTHWEST INTERNATIONAL ROUTE MAP e ~ =:--::;.:;'::: <~2.-:.,::;- -- ""'rENzg;:i:ff1f,fif::;Ea 8 , C/ff l"' Attch.,1flgt< g ea,vn C1rttilrl c,ntotl criuoo Cvpo/lhlQlfl Octrrurl :,~~:,:1~n H g~~~0 c':t~n ~ i:::Kano ; Hanr,ltJl1, /J. :::~~;~es g ::~~~IS i :,:: 1 ,po~s : M011l1e11I f Nf" Yor f O,tlerj C Okjflll~II K O1d0 K ~:~:g ~ A.,erfo Vel/ottl { StPauf s,nfr1nc1sco C Startle s~ovl s11.1n9~n1 ShalVIOM s,11g1pore " :;:~~:rm ~ ::~~:' ; TotQrtlO f W,rmlplg E 8 - - - ---- - ...... ,, ( / " / Important new nonstop service has been added in 1987 to Northwest's expanding global system, including Detroit-Tokyo, Tokyo-Bangkok, Memphis-Montego Bay and Memphis-Grand Cayman. New trans-Atlantic nonstop service includes Boston-Oslo, Boston-Frankfurt and daily nonstop Boston-Dublin service. ,,,,,/ Another significant element in Northwests domestic system is its Northwest Air/ink marketing partnersh1iJs with regional air camers. Northwests far-flung US and international route system ,:c; extended to another 85 domestic cities via Northwest Air/ink service. By matching their flight schedules with Northwest, Air/ink partners offer convenient connections to and from Northwest flights, thus linking more of America to the Northwest !->)'Stem. Express Airlines I is a Northwest Air/ink at both Memphis and Minneapolis/St. Paul. Mesaba Aviation carries passengers to and from Northwest at the Minneapolis/St. Paul hub. In Detroit, Air/ink flights are offered by Simmons Airlines. Northwest and Big Sky Airlines exchange passengers at Billings, 81:smarck and Spokane. A special arrangement exists with Pacific Southwest Airlines, pn'ncipally for international travelers using Northwest's extensive trans-Pacific service. Connections are available at Northwest's West 9 Coast international gateways for flights to two dozen cities in California, Oregon, Washington, Nevada, Arizona and New Mexico. Northwests potent market presence, particularly in Detroit, Minneapolis/St. Paul and Memphis, results in a route system that not only is strong domestically but also is a significant contnbutor to the success of Northwests international flights. Consolidating passengers at these three hubs permits Northwest to efficiently marshal traffic for its international services from JO US gateways: Boston, New York, Chicago, Detroit, Minneapolis/St. Paul, Seattle/Tacoma, San Francisco, Los Angeles, Memphis and Honolulu. Detroit will become a trans-Pacific gateway in Apn'/ 1987 when nonstop service is inaugurated to Tokyo. The effectiveness of the new route structure was demonstrated in the fourth quarter of 1986. Dunng the final three months of the year, traffic grew nearly 77 percent year-over-year on capacity increases of 71 percent, resulting in a systemwide load factor improvement of two points. The domestic load factor alone rose nearly five points. - ------- . O~!!~!;~AP UNITED STA~ g,r,odcJrootoute rou11ontf _ _ _ - Tunezanes * Sta,ecapitals RourrM:111ndacrtyonth111 nonalR,wraMdP ~o~~~c;:~1~';.:;P~;;~ Kl , ____ Enhanced Marketing Abilities Through PARS ore than 80 percent of Northwest's passenger sales last year were generated by travel agencies and virtually all of these sales were made by travel agents using computerized reservations systems. Thus, Northwest recognized that ownership of a reservations system is as important to an airline as its flying assets. As a result, Northwest became, at year-end, half owner of PARS, formerly the reservations network of Trans World Airlines. The $140 million investment means that PARS can be developed into a leading travel agency and airline reservations system. Through aggressive mar- keting, the PARS system can expand beyond its present share of more than 3,800 of the nation's 29,000 travel agencies. Already Northwest has sold more than 250 PARS terminals to one of America's leading travel services for installation at 43 key locations. As the number of PARS subscribers enlarges so too will the revenue generated by seg- ment booking fees that each airline pays for selling its products through the PARS system. Northwest will share in these profits or elect to reinvest them into expanding the capabilities of the PARS system. Northwest took a major step toward strengthening its marketing abilities in 1986 by acquiring a 50 percent interest in PARS, a leading travel agency and airline reserva tions system. While the overall potential of PARS is impressive, of significant importance is Northwest's ability to tap the PARS data base to learn more about the travel patterns of passengers booked by PARS This, combined with information purchased from other travel agency computer reservations systems, will assist the airline with pndng, seat inventory control, flight scheduling, long-range forecasting and marketing programs. Northwest will take advantage of PARS' capabilities for its own reservations system during 1988. 11 Leadership in Worldwide . Flight Training n 1986 NWA Inc. formed a wholly owned subsidiary to capitalize on Northwest's established reputation for supenor airmanship and to meet the challenges of a projected pilot shortage for the world's airlines. The result is the Northwest Aerospace Training Corporation (NATCO), a facility that will train Northwest pilots and will provide crew training to other airlines, governments and corporations on a contract basis. NATCO undertook several impressive formative steps in late 1986 and early 1987. Construction is under way on a $19. 6 million training center, adjacent to NWA Inc. World Headquarters, with occupancy set for late 1987. The center, when expanded to full design capacity, will house 32 full- flight simulators. Nine new high-technology simulators were ordered in the largest single simulator pro- 12 curement in the history of commercial aviation. The simulator contract, representing a $50 million invest- ment, includes construction of simulators for two of Northwest's airliners of the future: the Boeing 747-400 and the Airbus A320-200. In addition, the company has contracted to modify and upgrade the 12 simulators it currently owns. Also, NATCO has agreed to open a division in Grand Forks, North Dakota, to participate in a joint venture with the Center for Aerospace Sciences (CAS) at the University of North Dakota. Advanced flight simulators will be placed at NATCO 's North Dakota division for the training of entry-level pilots up to turbojet ratings. Through the joint venture program, CAS and NATCO will develop computen'zed flight training systems and undertake research that would benefit the aerospace industry. The goal of NATCO is to become one of the world's leading flight training centers. 13 The Airbus A320-200: Building a Fleet for the Future n October 1, 1986, Northwest announced plans to acquire up to JOO Airbus A320-200 aircraft to be delivered between 1990 and 1995. The A320 agreement, which is valued at $3. 6 billion, offers Northwest two cn'tical components: an advanced and efficient 150-seat jetliner to serve Northwest into the next century, and valuable flexibility in long-term fleet planning. Operationally, the A320 will consume fuel at a rate approximately 50 percent less per seat mile than the predominant aircraft in the Northwest fleet, providing fuel efficiency unmatched by any aircraft in its category. The A320, which made its initial flight Febmary 22, 1987, incorporates advanced design concepts and technology that make it the safest and quietest airliner aloft. Adopting a fly-by-wire flight control system using side-stick controllers in the cockpit, the A320 will give Northwest crews and passengers wind shear protection and constant, guaranteed flying qualities as seven real-time computers assess, coordinate and respond to the pilots' flight control inputs. The A320 offers more than technological supenonty. The agreement also gives Northwest flexibility in its fleet planning. Northwest now is committed to JO A320-200s. The remaining 90 aircraft are available to Northwest in blocks of 15 that Northwest can confirm or cancel. Because of the confirm or cancel provisions, Airbus lndustn'e is shanng the risk with Northwest in developing a competitive fleet by giving the airline the advantage of adjusting its aircraft requirements based on future market and economic needs. The first confirmation is required in 1987 for airplanes to be delivered m 1991 and 1992, with the balance of the confir- mations beginning in 1990 for airplanes to be delivered from 1992 through 1995. With this phased delivery schedule, Northwest can reduce the lead time in forecasting air travel trends and economic fluctuations before deciding whether to acquire the A320s. The A320s added to Northwest's fleet either can provide increased capacity or can replace older, less efficient aircraft. This flexibility is vitally important to effective airline management. Northwest gained a subs1antial degree of flexibility in planning for future fleet needs through the decision to acquire up to 100 advanced-technology Airbus A320-200 aircraft for delivery between 1990 and 1995. Fleet Schedule fleet as of No. of On \larch I, 1987 Seats Owned Leased Total Order Airbus A320 150 100 Boeing 727-100 118 9 9 727-200 146 71 71 747 400 27 5 32 747-400 430 10 747F 5 6 2 757 184 9 20*+- 29 7 l\1cDonnell Douglas: DC-10 284 19 20 MD-80 143 7 8 DC-9-50 122 16 12 28 DC-9-30 100 56 8 64 DC-9-10 78 31 3 34 Convair 580 48 13 13 Total 263 51 314 119 *Ten A '320 are under firm order Sub1ect to confrrmation by the Compam an additional 90 deli1 erv positwns are available betueen /991 and 1995 * *The Company plans to transfer operating leases for six Boeing 7:;7 aircraft to a third part} during 1987. Management's Discussion and Analysis of Financial Condition and Results of Operations As part of an approved plan of reorganization, Northwest Airlines, Inc. ("Northwest") became a wholly owned subsidiary of NWA Inc. ("NWA") in 1984. The creation of NWA as a holding company did not result in any changes in the operation of Northwest, and the shareholders of Northwest automatically became shareholders of NWA. In October 1985 NWA purchased Mainline Travel, Inc. ("MLT"). MLT is a major wholesaler of low-cost vacation travel packages. On August 12, 1986, NWA purchased all of the outstand- ing stock of Republic Airlines, Inc. ("Republic"), a major U.S. air carrier. Airline operations of Northwest and Republic were com- bined on October 1, 1986, and Republic was merged into North- west in November 1986. Airline operations comprise over 97% of consolidated operating revenues and expenses of NWA. Consolidated financial statements of the Company include results of operations for Republic since August 12, 1986, which accounts for the majority of the increase in revenues and expenses from 1985 to 1986. Other significant factors affecting NWA's consolidated results are discussed below. Results of Operations Earnings and Dwidends NWA's 1986 consolidated net earnings totaled $76,941,000 ($3.26 per share) and compare with net earn- ings of $73,119,000 ($3.18 per share) in 1985 and $55,964,000 ($2.44 per share) in 1984. The 1984 earnings reflect an extraordinary charge of $30,903,000 ($1.30 per share) resulting from the settle- ment of a 15-year old lawsuit (see Note H of Notes to Consoli- dated Financial Statements). 1986 1985 1984 $2 44* 1983 $2.19 1982 - $.23** Net Earnings per Share * After extraordinary charge of $1.30 per share from the ettlement of a lawsuit. **Results were affected by a 29-dav strike. $3.26 $3.18 Total operating revenues increased 35.2% to $3,589,174,000 during 1986, primarily from substantial growth in passenger revenues. Operating expenses grew 32. 7% to $3,422,529,000 resulting in operating income of $166,645,000 compared with $77,087,000 in 1985. 1984 operating income was $96,276,000. The 1986 operating margin of 4.6% increased from 2.9% in 1985 and 3.9% in 1984. In 1986 NWA paid dividends to shareholders totaling $19,645,000 (90 per share) continuing an unbroken string of quarterly cash dividends paid for over 31 years. This compares with $19,586,000 (90 per share) in 1985 and $17,933,000 (82.5 per share) in 1984. NWA common stock is principally traded on the New York Stock Exchange. A table showing sales prices and dividends paid per share in 1986 and 1985 is included on page 33. Operating Revenues Passenger revenues for 1986 rose 35.6% to $2,920,458,000, representing more than 81 % of total operating revenues. This resulted from a 29.0% increase in traf- fic (revenue passenger miles) and a 5.2% increase in yield (reve- nue per passenger mile) from 9.64 in 1985 to 10.14 in 1986. 1985 passenger revenues of $2,154,394,000 were 8.5% greater than 1984 due to a 13.0 % increase in traffic and a 4.0% decline in yield. The acquisition of Republic in 1986, together with a strong economy and discount fares which stimulated leisure travel, contributed to the growth in traffic. While the industry had recently been experiencing some price increases, competitors introduced fare reductions effective February 1, 1987, which undercut supersaver fares. The new fares are subject to certain restrictions, including nonrefundabilitv, a Saturday stay requirement and roundtrip ticket purchase. While it is believed the new fares will increase traffic levels, their ulti- mate impact on 1987 vields and passenger revenues is unknown at this time. 1986 $3.59 $3 l2 1985 $2 {j{j i:? ,8 1984 $2 45 $2 15 1983 $2 20 $2 1 3 1982 Operating Revenues and Expenses (In Bil11ons) Revenues Expenses *Operating results were affected by a 29-day stnke. 16 The 29.0% increase in revenue passenger miles in 1986 compares with a 30.3% increase in capacity (available seat miles), resulting in a slight drop in passenger load factor to 59.5 % from 60.1 % in 1985. Load factor in 1984 was 60.5%. Break-even pas- senger load factors were 56.0% in 1986, 58.0% in 1985 and 57.6% in 1984 Freight revenues increased 23.9% to $406,726,000 in 1986 due to a 15.4% increase in freight ton miles and a 7.2% increase in yield per ton mile. 1985 freight revenues totaled $328,400,000 and were 7.6% lower than 1984, due to an 8.2% decrease in freight ton miles and .3% increase in yield per ton mile. Mail revenues increased 9.2% to $87,459,000 in 1986 and compare with $80,126,000 in 1985 and $58,339,000 in 1984. Charter and other transportation revenues increased 39.6% to $78,110,000 in 1986, primarily due to combined airline operations, increased charters and increased cancellation fee revenues. Charter and other transportation revenues totaled $55,959,000 in 1985 and $38,559,000 in 1984, with the 1985 increase primarily due to a higher level of military charter activ- ity. Other revenues totaled $96,421,000 in 1986, $36,612,000 in 1985 and $7,741,000 in 1984. Revenues of MLT subsequent to its purchase in October 1985 are included in other revenues and account for the majority of the increase in 1986 and 1985. Operating Expenses Salaries and benefits, which represent 30.1 % of operating expenses in 1986, increased $313,306,000, or 43.8%, in 1986 and $75,566,000, or 11.8%, in 1985. The 1986 increase was largely due to the acquisition of Republic. The 1985 increase resulted from increased employees, wages and payroll taxes. Full-time equivalent employees numbered 33,427 at December 31, 1986; 16,864 at December 31, 1985 and 15,185 at December 31, 1984. 1986 - - - - - - - - - - - - - - - - - 1022.9 1985 - - - - - - - - - - - - - - - 886.4 1984 - - - - - - - - - - - - - - - - 965.9 1983 - - - - - - - - - - - - - 835.2 1982 - - - - - - - - - - 600 2 Freight Ton Miles-Scheduled (In Millions) 17 During 1985 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 87- Employers' Accounting for Pensions. The Company will pro- spectively adopt the new expense and disclosure portion of the standards in the first quarter of 1987. Based on a preliminary review, it is expected that pension expense in 1987 will increase under the new requirements. Fuel, oil and taxes decreased $81,933,000, or 11.4%, in 1986 due to a 32.9% decline in the average fuel price partially offset by a 17.0% increase in gallons consumed. The 3.7% increase in 1985 fuel expense reflects a 9.3% increase in gallons consumed partially offset by a 5.3% decline in the fuel price per gallon. Expansion of service, together with the net addition of 181 aircraft in 1986 and 11 aircraft in 1985 resulted in the additional fuel consumption. Fuel prices averaged 55.78 in 1986, 83.07 in 1985 and 87.76 in 1984. Instability of fuel prices is expected throughout 1987. Commission expenses increased $146,090,000 due to increased revenues, higher levels of sales by commission agents and increased commission rates. Increased rentals and landing fees in 1986 reflect the combination with Republic. Departures increased 81.9% in 1986 over 1985. The Company also assumed 15 aircraft operating leases from Republic and entered into 9 additional operating lease agreements in 1986, resulting in increased r_ental expense. There were no operating leases for aircraft in 1985 or 1984. 1986 ~~~~~~~~~111111111111~ 5 ~ 6.~ o -----sg s Passenger load Factor (Percent) Actual Break Even Management's Discussion and Analysis of Financial Condition and Results of Operations - Continued Aircraft maintenance materials and repairs increased $62,117,000, or 55.6%, in 1986 with the acquisition of Republic, higher level of operations and aircraft modifications. Depreciation and amortization expense rose 32.7% in 1986 to $242,213,000 compared with $182,563,000 in 1985 and $167,203,000 in 1984. The 1986 increase was primarily the result of additional depreciation for assets purchased in the Republic acquisition and for nine additional 757s under capital leases while the 1985 increase reflects the addition of 11 new 757 passenger aircraft. Other operating expenses increased $259,542,000, or 62.2%, in 1986 and $83,026,000, or 24.9%, in 1985. Both years reflect higher marketing and passenger service expenses. In addition, 1986 includes a full year, and 1985 a partial year, of MLT expenses. Other Income (Expense) Other income (expense) in 1986 includes $17,231,000 of integration expense, representing non- recurring costs associated with the combination of Northwest and Republic Airlines. Interest expense totaled $76,537,000 in 1986 compared with $19,873,000 in 1985 and $4,268,000 in 1984. Increases in both years reflect higher levels of debt and capital lease obligations. See Cash Flow, Liquidity and Capital Resources for further discussion of the increase in debt because of the acquisition of Republic. The gain on disposition of assets was $14,722,000 in 1986; $2,780,000 in 1985 and $19,864,000 in 1984. The 1985 and 1986 gains resulted from the sale of miscel- laneous assets, whereas the 1984 gain resulted primarily from $2 920,458 Passenger 81 4% $49-t 185 Cargo 13 8% $17-1 ,53 1 Charier 3nd Other 4 3w 1986 Sources of Operating Revenues (In Thousands) 18 the sale of three DC-10 aircraft. Other nonoperating items pro- duced income of $9,141,000 in 1986 and $8,000 in 1985, and expense of $1,698,000 in 1984. Income Taxes Income taxes were $25,300,000 in 1986 compared with a credit of $8,376,000 in 1985 and expense of $2,427,000 in 1984 (after a $28,094,000 income tax credit resulting from an extraordinary item). Earned investment tax credits totaled $22,266,000 in 1986, $37,749,000 in 1985 and $23,576,000 in 1984. The Company estimated that 1986 earn- ings were reduced by approximately $12 million due to changes in the tax laws that limited allowable investment tax credits. The Company also passed the benefit of approximately $22.5 million of investment tax credits to lessors of certain of its air- craft in 1986. Investment tax credits are applied on tax returns as allowed by income tax regulations. Credits not currently applied are offset against deferred taxes for accounting purposes, and as of December 31, 1986, these credits totaled $55,379,000. Under the Tax Reform Act of 1986, these investment tax credit carry- forwards will be reduced by 17% in 1987 and an additional 17% in 1988. Effects of the Tax Reform Act of 1986 The Tax Reform Act of 1986 will affect future cash flows, results of operations and the Company's financial position. Certain provisions of the Act, such as the repeal of investment tax credits, the reduction of invest- ment tax credit carryforwards, the lengthening of depreciable lives for property and equipment and the new alternative mini- mum tax, will result in larger future U.S. income tax payments for the Company. Partially offsetting these negative provisions, however, will be the reduction in future corporate income tax rates. $635,937 ~U( I Otl dnd Taxts 18.6)6 ~ 1,028 4 78 Salar1Ps ,111d Benefits 30.l '(, ~l 0-12,103 RfftdiS L..rnd17g FPtS .lO I'(, \l