:lent/i ANNUAL REPORT 1950 C o M P A N Y SAN FRANCISCO AIRPORT SOUTH SAN FRANCISCO, CALIFORNIA .. Southwest Airways Company General Offices LELAND HAYWARD . JOHN H. CONNELLY TED R. MITCHELL . ALWIN W. JOHNSON HARRY S. WHITE . WALTER ROCHE CORNELIUS H. SULLAVAN FLOYD HENDRICKSON BERT ALLENBERG JOHN H. CONNELLY LELAND HAYWARD FLOYD HENDRICKSON San Francisco Airport South San Francisco, California Chairman President Vice-President Treasurer Sales Manager Secretary Assistant Secretary Assistant Secretary ALWIN W. JOHNSON DANIEL O'SHEA WALTER ROCHE HARRY S. WHITE PRICE, WATERHOUSE & COMPANY 3 51 California Street, San Francisco, California WALTER ROCHE 309 First National Bank Building, Phoenix, Arizona To the Stockholders and Employees of Southwest Airways Company In the year 1950, which was the fourth full year of operation by Southwest Airways as a Federally cer- tificated local service air carrier, the Company con- tinued to progress and earned a net pro.fit of $135,- 473.05, equivalent to $.2079 a share 90 the outstand- ing capital stock, ~fter provision for Federal income Operating Revenues: 1950 Passenger, express ~r~ight, charter, etc. . . . . .. . . . . . $1,269,857 Mail .......................... 943,888 Total operating revenues .... $2,213,745 Operating Expenses ........... 1,968,883 Operating Pro.fit.~ ... ..... -.. $ 244,862 Non~operating 'expense (net) .... 16,856 Net Profit Before Federal Income Taxes . ............... $ 228,006 Federal income taxes ........... 92,533 Net Profit After . Taxes ...... ~ ... $ 135,473 taxes of $92,532.50. This compares with a net profit of $81,143.17 for the year 1949, or $.1253 a share after Federal income taxes of $53,078.45. A sum- mary of the Company's operations fr9m the inception of certificated flight operations on December 2, 1946 is set forth in the following table: 1949 1948 $1,148,588 $ 962,421 $ 1947* 710,451 1,249,992 1,401,332 1,504,510 $2,398,580 $2,363,753 $2,214,961 2,263,878 2,283,989 2,172,077 $ 134,702 $ 79,764 $ 42,884 481 15,602 37,403 $ 134,221 $ 64,162 $ 5,481 53,078 36,100 $ 81,143 $ 28,062 $ 5,481 *Covers Jhe 13 month period e.nding Dec.ember 31, 1947. Southwest Airways Company OPERATING STATISTICS 1950 1949 1948 1947* Revenue miles flown ............ 2,375,224 2,419,695 2,363,827 1,854,117 Revenue passenger miles ........ 22,236,008 20,947,484 18,046,778 15,348,113 Passenger load factors .......... 45.80% 41.56% 36.56% 39.73% Number of passengers carried: Scheduled service ............ 118,860 114,573 97,424 83,994 Charter service . . . . . . . . . . . . .. 3,111 1,345 530 1,082 Total passengers carried ..... 121,971 11 5,918 97,954 85,076 Mail ton miles . ................ 46,406 51,136 45,892 35,146 Express ton miles ............... 49,394 34,199 31,856 32,177 Freight ton miles . ... . .......... 126,773 90,177 75,064 10,431 Excess baggage ton miles ........ 7,495 6,746 6,142 5,142 *C011 ers the 13 month period ending December 31, 194i . The above statements show the Company's consistent trend of increasing non-mail operating revenues and the lessening necessity for Government support in the form of mail pay. Operating revenue from passen- gers, express, freight, charter, etc., increased 10.5% in 1950 over 1949. Revenue received for transporting mail by aircraft decreased 24.5% in 1950 over 1949. Operating expenses in 1950 decreased approximately 13% over 1949, caused principally by a reduction in depreciation of flight and other equipment of $274,- 805 due to certain equipment reaching a fully depre- ciated status, and a change in flight equipment depre- ciation rates effective January 1, 1950. Prior to that date, flight equipment costs were amortized over three years to a residual value of lOo/o. Beginning January 1, 1950 the estimated residual value was reduced to 5% and the then book value of flight equipment was amortized over the four years ending December 31, 1953. Other factors resulting in lower costs were greater efficiency on the part of the Com- pany's employees and the approval by the Civil Aero- nautics Administration of substantial increases in the intervals of time of use before overhaul of the various aircraft components. The Company began the year operating flight equip- ment consisting of nine DC-3 Douglas aircraft of 24 seats each. These nine aircraft are now undergoing conversion to 28 seats each. The Company also owned two C-47 Douglas aircraft held in reserve, which were converted in the Company's own shops in the spring and summer of 1950 to DC-3 aircraft of 27 seats each. This fleet of eleven operating air- craft will make it possible for the Company to furnish better service to the public and participate to an even greater degree in the available charter, freight and scheduled passenger business. 0 perating revenues ( exclusive On January 1, 1950, the Civil Aeronautics Board re- duced the Company's mail rate to an amount which yielded 40.83 cents per scheduled mile flown in 1950, as compared with 52.08 cents per mile received in 1949. This reduction in mail pay requirements mani- fests a very healthy trend for the Company and is brought about principally by an increase in non-mail revenues and a decrease in operating expenses which has been previously discussed. The following state- ment shows the extent to which the Company's break- even need per revenue aircraft mile fl.own has de- creased in the past four years. It has been the constant aim of the Company's management to reach a self- sufficient status so that the compensation received for carrying the mail will be for services rendered with- out any element of subsidy. In furtherance of this policy, the Company has voluntarily petitioned the Civil Aeronautics Board to lower its mail compensa- tion to a rate which will yield 33.5 cents per sched- uled mile flown effective May 1, 1951. 1950 1949 1948 1947* of mail pay) ............. .... $ .5346 $ .4747 $ .4071 $ .3832 0 perating expenses . ............ .8289 .9356 .9662 1.1715 Amount of mail pay needed to break even ................ $ .2943 $ .4609 $ .5591 $ .7883 *Co1 1 ers the 13 month period ending December 31, 1947. Southwest Airways Company Simplified Comparative Statement of INCOME and EXPENSES Income Received from Following Sources: Passengers . . . . . . . . . . . . . . . . . Express ................... . Freight ................... . Excess baggage ............. . Charter ................... . Incidental operating revenues .. . Other income .............. . Mail ..................... . Gross Income ............ . Disposition of Gross Income: Wages and salaries paid to employees ............. . Gasoline and oil ............ . Telephone, telegraph and teletype ................. . Other materials, supplies, and services . . . . . . . . . . . . . . . Rentals and landing fees ...... . Insurance ................. . Travel and incidental ...... , .. Advertising and publicity ..... . Depreciation ............... . Taxes other than Federal income taxes ............. . Amortization of extension and development expenses ...... . Federal income taxes ......... . Total Expenses ........... . Balance retained by the Company for use in the development of the business . . . . . . . . . . . . . . . . . 1950 Per $1.00 Amount of Revenue $1,139,969 $ .5121 18,877 .0085 43,925 .0198 4,056 .0018 41,898 .0188 21,132 .0095 12,207 .0055 $1,282,064 $ .5760 943,888 .4240 $2,225,952 $1.0000 $1,013,610 $ .4554 243,729 .1095 78,106 .0351 215,050 .0966 65,323 .0293 69,994 .0314 52,320 .0235 83-,5 72 .0375 82,256 .0369 72,054 .0324 21,932 .0099 92,533 .0416 $2,090,479 $ .9391 $ 135,473 $ .0609 1949 Per $1.00 Amount of Revenue $1,059,558 $ .4400 14,136 .0059 36,007 .0149 3,796 .0016 15,607 .0065 19,484 .0081 9,448 .0039 $1,158,036 $ .4809 1,249,992 .5191 $2,408,028 $1.0000 $ 990,789 $ .4115 249,126 .1035 68,724 .0285 283,727 .1178 63,771 .0265 68,314 .0284 54,697 .0227 65,649 .0273 357,061 .1483 70,610 .0293 1,339 .0005 53,078 .0220 $2,326,885 $ .9663 $ 81,143 $ .0337 s SHOWN by the certified finan- cial statements included in this report, the Company is in excel- lent condition, having a work- ing capital ratio of 2.6 to 1 and a net worth of $1,070,952.28, equivalent to $1.64 a share of outstanding capital stock. The eleven operating aircraft are included therein at an average book value on December 31, 1950 of $22,500 each and are insured for a value of $85,000 each. On, April 10, 1950, the Company and West Coast Airlines, Inc. jointly filed a petition with the Civil Aeronautics Board proposing a merger of West Coast into Southwest. This joint petition was the result of resolutions by the Board of Directors of West Coast Airlines, Inc. on December 2, 1949 and of Southwest Airways Company on February 27, 1950, authprizing such action. Under the terms of the proposed merger agreement, Southwest will ac- quire a maximum of out of 187,3711/2 outstand- ing shares of capital stock of West Coast for $5.25 per share and the balance of the West Coast stock will be acquired by Southwest in exchange for South- west stock under a formula involving an adjusted book value of the respective shares of stock. Although September 1949 financial statements of both com- panies formed the basis on which a merger agreement was reached, it should be pointed out that the actual ratio of exchange of stock will be determined from the financial condition of each of the companies at the end of the second month preceding the date of approval of the merger by the Civil Aeronautics Board. As of December 31, 1950 this exchange would have been 2.07 shares of Southwest for 1 share of West Coast. The following condensed pro-forma bal- ance sheets before and after merger show the finan- cial changes that have taken place between the time immediately before the merger negotiations took place and the end of 1950. AS OF SEPTEMBER 30, 1949 AS OF DECEMBER 31, 1950 Southwest West Coast Current assets $ 813,510 $ 675,061 Equipment (net) 335,123 341,390 Other assets 107,836 109,420 Total Assets $1,256,46') $1,125,871 Current Liabilities $ 295,191 $ 187,958 Long term debt ------ 145,000 Reserves 38,159 9,848 $ 333,350 $ 342,806 NET WORTH: Capital stock $ 323,830 $ 187,371 Surplus 599,289 595,694 $ 923,119 $ 783,065 Total Liabilities $1,256,469 $1,125,871 A public hearing on the merger was conducted by the Civil Aeronautics Board in November 1950 during which the merger was opposed by United Airlines, Inc. and Western Air Lines, Inc. It is not believed, however, that the Civil Aeronautics Board will allow such oppo- sition to in any way deter the Board's sound develop- ment of the nation's air transport system on the West Coast. Under date of April 11, 1_951 the Examiner After Merger Southwest West Coast After Merger $ 911,445 $1,002,074 .$ 732,117 $1,152,088 676,513 369,940 224,398 594,338 217,256 131,574 65,333 196,907 $1,805,214 $1,503,588 $1,021,848 $1,943,333 $ 483,149 $ 383,536 $ 155,458 $ 538,994 145,000 - 75,000 75,000 48,007 49,100 14,933 64,033 $ 676,156 $ 432,636 $ 245,391 $ 678,027 t, 415,224 $ 325,805 $ 187,371 $ 416,745 713,834 745,147 589,086 848,561 $1,129,058 $1,070,952 $ 776,457 $1,265,306 $1,805,214 $1,5.03,588 $1,021,848 $1,943,333 rendered his report on the merger headng and recom- mended that the Civil Aeronautics Board approve the merger of Southwest and West Coast and transfer the certificate of public convenience and necessity of West Coast to Southwest. The oral argument will probably be held in the summer of 1951 and the Board's decision should be forthcoming shortly thereafter. If the Civil Aeronautics Board renders a decision favorable to the merger and the transaction is consummated in the man- ner provided for and outlined above, Southwest Airways will emerge as the continuing operating company. It will be observed from Note C to the financial state- ments that there is a contingent stock option outstand- ing which entitles the holder to purchase 32,500 shares of the unissued common stock of th~ Company at $1.50 per share. This option was granted to Mr. Nick Bez, President of West Coast Airlines, Inc. as an induce- ment for him to continue his activities on behalf of the merged company. Mr. Bez has a history of long success- ful association in the Pacific Northwest and as one of its leading citizens is well-known throughout the area. The directors of Southwest believe that the continued interest of Mr. Bez is very important and desirable for the successful development of the merged company in the Pacific Northwest and offered the option method as being the most economical manner of assuring the continuation of his services. The following is a copy of the option agreement. ~ or BY .~ e.si~J . Jo~ ~ tar ..:;.- Southwest Airways Company As a result of the merger application mentioned above, the Civil Aeronautics Board reopened the case involving the Southwest certificate renewal .and the United Airlines suspension issues in order to deter- mine the effect of the merger on these points. A deci- sion in this case is expected to be made by the Civil Aeronautics Board in the near future. On December 19, 1949, the Company was awarded a certificate for local service operations between Los Angeles, California and Phoenix, Arizona via seven intermediate points. After several postponements by the Civil Aeronautics Board of the date of activation of this route, the Board on March 10, 1950 rescinded the operating certificate for this route segment be- cause of certain legal complications which the Board (AN ARIZONA CORPORATION) felt required reconsideration. The Board then re- opened the "Additional California-Nevada Service Case" for rehearing and redetermination of the serv- ice requirements between Los Angeles and Phoenix. In this reopened case, the public hearing of which - was completed in February 1951, Southwest is apply- ing for authority to serve Santa Ana-Laguna Beach, Oceanside, San Diego, El Centro, Indio, Blythe, Palm Springs, Banning-Beaumont, San Bernardino-River- side, Ontario-Pomona, California, and Yuma, Ajo, and Phoenix, Arizona. There are two other air car- rier applicants in this case, and it is not possible at this time to determine whether the Board will author- ize any new local service in this area or when the decision will be rendered. President Current Assets, Cash in banks and on hand . . . . . . . . . . . . . . . . . . . U. S. Government securities, at cost . . . . . . . . . . . .. Accounts receivable: U. S. Post Office Department, for carrying mail . . Traffic and agents ....................... . Miscellaneous, less allowances for possible losses in collection (1950-$1,248.58; 1949- $1,511.46 ............................ . Employees ............................ . Inventories of mo.tor fuels, lubricants and materials and supplies, at approximate cost Investments in Stocks of Service Organizations, at cost ........ : ......... . Property and Equipment, at cost Flight equipment ......................... . Ground and shop equipment ................ . Leasehold improvements ................... . Ocher .................................. . Less-Accumulated depreciation ............. . Deferred Charges: Prepaid insurance and taxes ................. . Extension and development expense .......... . Engine overhaul in process, etc ............... . BALANCE December 31 1950 1949 $ 299,569.43 $ 293,775.80 299,473.84 300,075.23 168,705.25 115,117.36 123,339.79 68,246.62 29,238.12 20,795.92 1,323.08 1,081.07 80,424.77 87,510.63 $1,002,074.28 $ 886,602.63 $ 511.00 $ 511.00 $1,183,974.30 $1,008,468.26 107,652.49 91,591.10 120,697.22 103,299.31 94,064.48 134,592.02 $1,506,388.49 $1,337,950.69 1,136,448.33 1,056,609.54 $ 369,940.16 $ 281,341.15 $ 33,027.23 $ 28,298.03 72,597.78 37,253.26 25,437.21 19,704.68 $ 131,062.22 $ 85,255.97 $1,503,587.66 $1,253,710.75 SHEET Southwest Airways Company Current Liabilities: Accounts payable .......................... Taxes collected or withheld from others ......... Accrued expenses ......................... Transportation sold, not yet used or refunded .... Federal taxes on income ( estimated-Note D) ... . Reserve for Aircraft Engine Overhaul Capital Stock and Surplus: Common stock: Authorized, 10,000,000 shares of 50c par value per share (Note C) Issued. December 31, 1949-647,660 shares ........ . December 31, 1950-651,610shares ........ . Paid-in surplus (Note C) ................. . Earnings retained for use in the business, per accompanying statement (Note B) ..... . (AN ARIZONA CORPORATION) 1950 $ 196,825.63 37,424.94 41,966.09 13,305.27 94,013.51 $ 383,535.44 $ 49,099.94 $ 325,805.00 231,275.50 513,871.78 $1,070,952.28 $1,503,587.66 December 31 1949 $ 129,141.62 25,161.98 53,804.90 8,672.88 53,000.00 $ 269,781.38 $ 53,427.14 $ 323,830.00 228,273.50 378,398.73 $ 930,502.23 $1,,253,710.75 ST A TEMENT of INCOME and EARNINGS RETAINED for USE in the BUSINESS 0 peratin g revenues: Passenger ................................ . Mail .................................... . Express ................................. . Freight ................................. . Charter and special revenue ................. Total operating revenue . . ...... f Operating expenses: Flying operations .......................... . Flight equipment maintenance-direct ....... .... . Depreciation-flight equipment ............. . Ground operations ........................ . Ground and indirect maintenance ............. . Passenger service . . . . . . . . . . . . . . . . . . . ...... . Traffic and sales .......................... . Advertising and publicity .................... . General and administrative ................. . Depreciation-ground equipment ............ . Total operating expense ............... . Operating profit ...................... . Other income: Discounts earned . . . . . . . . . . . . . . . . . . . . . . ... . Interest. . . . . . . . . . . . . . . . . . . . . . . . . . ,. . . . ... . Other .................................. . Other deductions. Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ~ . . Extension and development ................. . Other ...... ~ ........................... . Provision for estimated federal taxes on income ........ . Net income for year . ....................... . Earnings retained for use in the business, b I egtnntng o year . ........................ . Earnings retained for use in the business, end of year . .................... . 1950 $1,139,969.14 943,888.17 18,876.53 43,925.17 67,086.39 $2,213,745 .40 $ 609,883.90 173,418.87 56,928.45 $ 840,231.22 333,900.90 142,953.25 90,807.50 261,842.13 86,954.44 186,866.23 25,327.30 $1,968,882.97 $ 244,862.43 $ 1,603.14 3,612.44 6,991.98 $ 12,207.56 $ 1,272.82 21,932.32 5,859.30 $ 29,064.44 $ 228,005.55 92,532.50 $ 135,473.05 378,398.73 $ 513,871.78 December 31 1949 $1,059,557.84 1,249,992.46 14,135.60 36,007.30 38,887.36 $2,398,580.56 $ 601,064.56 265,073.65 293,193.55 $1,159,331.76 334,936.72 124,316.64 85,629.60 237,491.75 70,700.73 187,603.78 63,867.14 $2,263,878.12 $ 134,702.44 $ 1,390.96 671.17 8,435.13 $ 10,497.26 $ 3,427.17 1,338.93 6,211.98 $ 10,978.08 $ 134,221.62 53,078.45 $ 81,143.17 297,255.56 $ 378,398.73 I The Company is operating under an amended certificate of public convenience and neces- sity, issued by the Civil Aeronautics Board, the authority con- tained in which is continued beyond the expiration date therein prescribed (November 21, 1949) by the Adminis- trative Procedure Act pending final disposition by the Board of applications by the Company for extension of its operating authority. The Civil Aeronautics Board examiner has recom- mended that the Board extend the Company's certificate to September 30, 1954. On April 6, 1950, a joint application was filed with the Civil Aeronautics Board by the Company and West Coast Airlines, Inc., requesting approval of a plan of merger of these companies, under which plan Southwest Airways Company would be the survivor corpora- tion. The hearing before the Civil Aeronautics Board with respect to the merger plan has been completed but a decision thereon has not as yet been rendered. Under the terms of the plan of merger, no dividends or other di~tributions to stockholders may be made by either party thereto without prior written consent of the other. Stock options have been .granted to certain officers and employees of the Company; these options, which entitle the holders to purchase 19,800 shares of unissued common stock of the Company at $1.26 per share, expire on December 31, 19 5 2, except that an option in respect of 375 shares held by a former employee expires on April 10, 1951. Similar options on 3,950 shares were exercised during 1950 and the proceeds of $4,977 was cred- ited $1,975 to capital stock account and $3,002 to paid-in surplus. A contingent stock option is also outstanding, which entitles the holder to purchase 32,500 shares of unissued common stock of the Company at $1.50 per share. This option may not be exercised until thirty days after the date the Civil Aeronautics Board approves the proposed merger, mentioned in Note B, and continues in effect for five years thereafter. In the event such approval is not obtained on or before January 1, 195 3, this option will expire. The Company's federal income tax returns for the taxable periods to and including the year ended December 31, 1947 have been examined by a Revenue Agent and additional taxes proposed to be assessed have been provided for in the accounts. In the opinion of officials of the Company the liability for federal income taxes as shown in the accounts is sufficient to provide for all federal income tax liabilities applicable to all open years; however, the liabilities for these years cannot be finally determined until the related returns have been reviewed by the Bureau of Internal Revenue. December 31, 19.50 PRICE,WATERHOUSE & Co. To the Board of Directors of Southwest Airways Company SAN FFI.AN" C ISCO 4 l'ebruary 21 1951 In our opinion, the acccmpan;ying financial statements, together With the explanatory- notes thereto, present fairly the position ot .Southwest AirWays Company as of December 31 1950 and the results of its operations tor the year then ended, 1n contol'lllity with generally accepted accounting principles applied on a basis consistent with that of the preceding ;year. Our exam1nat1on ot suoh financial statements was made in accordance with generally accepted auditing standards and accordingly included such tests of the accounting records and such other auditing procedures a we considered necessary 1n the oircumatances. It was not practicable to confil'lll the amount receivable from the United State Poat Office Department, as to which we have satisfied ourselves by M&rul o~ other auditing procedures. From the commencement of flight operations in December 1946 to December 31, 1949, sufficient depreciation had been provided from income to reduce the net carrying value of flight equipment to an amount approximating residual value. The depreciation pro- vided for flight equipment since January 1, 1950 consists primarily of the amortization of recent major air frame over- hauls, conversions and current additions. Because of the fore- going, the depreciation provided during 1950 for flight equipment was $236,000 less than the amount provided dur- ing 1949. Recognizing that the principal flight equipment was substantially depreciated, and therefore the Company required less reliance on mail pay, the Civil Aeronautics Board established a lower rate of pay for carrying mail, effec- tive January 1, 1950; this decrease in mail rate largely ac- counts for the reduction of approximately $305,000 in mail revenue for 1950 as compared with 1949. JIONAL DAff TY lJNCll 1949 AVIATION SAFETY AWARD TO SOUTHWEST AIR~MAYS tO. in rec"!}nici,,n of irs co11tribution to $,ifo .::fir1i,111s.jl\'rt,HiN1 htwimJ operated 3 )X'U-S ,1,nd, n.s of 'i:>ec.zmber 31, 194-9 57~ 9411 llitft,,uta J"l!'s;i119et .-,y .:r,m fotalit}, in .,-.dwdufod. pass.>fl9i?r c.myi119 fli9ltr op,imtfons Aviation Safety Award The National Safety Council presented the above award to Southwest in 1950 in recognition of the Company's e-ontinuously safe operations through 1949. A similar award was earned by the Company for the year 1950. Soutnwest C 0 M p A N y