J I j J l 1959 ANNUAL REPORT - PNA ROUTES -- CONNECTING AIRLINES To the Stockholders of Pacific Northern Airlines: During 1959, Pacific Northern again established new records in total revenues, revenue ton miles and revenue passenger miles, and further strengthened its position as the leading airline serving Alaska. Total revenues for the year amounted to $11 ,481,000, an increase of $1 ,113,000 over last year. Revenue ton miles increased substantially from 15,937,000 in the preceding year to 17,013,000 in 1959, and revenue passenger miles increased to 113,389,000 from 105,595,000 for the previous year. In spite of these increases, net earnings fell $55,000 below last year, due primarily to a strike in Alaska's important construction industry and an unsatisfactory commercial fishing yield. Because of these factors, revenues fell off during the last quarter of the year when certain expenses, such as depreciation, interest and opera- tional costs, could not be reduced proportionately. The Company petitioned the Civil Aeronautics Board for increased rates of mail compensation effective from October 23, 1959. In the opinion of management, final settlement of this claim will result in 1959 net earnings of $338,000, or 32c per share, compared to 37c per share in 1958. Management confidently considers that neither of these eco- nomic factors is likely to recur, and that the continued growth of Alaska's economy will not be interrupted during the coming year. On the whole, 1959 was a year of satisfactory progress for Pacific Northern. The Company's growth last year and during the preceding five years is best illustrated by the following tabulation: Calendar Total Revenue Revenue Year Revenues Ton Miles Passenger Miles 1959 $11,481,000 17,013,000 113,389,000 1958 10,368,000 15,937,000 105,595,000 1957 10,030,000 15,564,000 105,820,000 1956 9,608,000 14,211,000 92,103,000 1955 7,538,000 12,671,000 76,110,000 1954 6,475,000 10,440,000 59,610,000 During the year, Pacific Northern flew its one millionth passen- ger, marking the first time an airline has reached that significant 1 2 milestone in Alaska service. It is interesting to note that although it took almost 25 years before the 500,000th passenger was carried in the fall of 1956, the rapid growth of Alaska made it possible to tally up the second 500,000 passengers in only three years, and the Company expects to carry the second million passengers within the next five years. Pacific Northern continued its unbroken record of 28 years with- out a passenger fatality, thus again qualifying for the annual award of the National Safety Council. The Company in May, 1959 inaugurated a new route from Seattle direct to Kodiak, Alaska, and the new service has been well patronized. This route represents an addition of 1,441 route miles and brings the Company's system to a total of 5,061 unduplicated route miles, all permanently certificated for persons, property and mail. This route now links the 13th Naval District Headquarters in Seattle and the Headquarters of the 17th Na val District in Kodiak, which embraces all of the Northwestern sea frontier northward to the Arctic Ocean and westward along the Aleutian Chain to Japan. The route provides considerable savings in distance and time for access to this vast area and to the large commercial fishing opera- tions of the Kodiak Archipelago and Shumagin Islands. During the year, the Company added two Lockheed Constella- tions to its flight equipment and profitably retired by sale its remaining DC-4 aircraft and one DC-3. The Company's aircraft now consist of three DC-3's which are used exclusively between Alaskan points, and six Lockheed Constellations which are em- ployed primarily in overseas operations between Portland-Seattle and Alaska. No further acquisition of piston-engine equipment is contemplated. Extensive evaluation studies have been made regarding various types of jet and turbo-prop aircraft in relation to the Company's flight equipment replacement planning. Thus far no definite de- cision has been reached in this matter. It is recognized that no problem currently posed is of greater importance than the proper selection of new equipment, not only from the immediate stand- point, but with respect to the changing circumstances of the future. Jet aircraft design is experiencing rapid technological changes, and modifications and improvements already are being incorporated in aircraft types now in production with resultant improvements in operating performance and economy. The Company keenly appre- ciates the advantages of an early decision on the selection of new equipment. It firmly believes, however, that its conservative ap- proach to the situation and its careful appraisal of the special problems involved will best ensure Pacific Northern's profitable entry into the jet era. Commercial and industrial activities in Alaska are expected to reach record highs during 1960, which should be reflected in ex- panded airline traffic and earnings. The petroleum industry has reported successful explorations near Anchorage and drilling of these fields will be accelerated. New construction projects, as well as those backlogged because of the 1959 strike, will establish a new peak in building activity and employment for the year. Advance bookings indicate that 1960 will be the biggest year for tourist travel to Alaska. During January and February, many of Pacific Northern's summer flights have been completely booked by travel groups. This situation has never existed in prior years and reflects the great increase in tourism engendered by nationwide interest in the new status of Alaska as a state. During 1959, Pacific Northern provided more schedules and carried more Alaskan traffic than any other airline serving the 49th State. The Company's routes extend to virtually all of the areas in Alaska which are experiencing rapid growth in population and where major efforts are focused on petroleum exploration, pulp and timber enterprises, defense installations, construction projects and commercial developments. In fact, the richest natural re- sources of the huge state are located along the routes of PNA, and it is these areas which also offer the best attractions for tourists and for commercial opportunity. These inherent route advantages assure an active share by Pacific Northern in Alaska's vigorous development. PRESIDENT AND GENERAL MANAGER 3 4 PEAT, MARWICK, MITCHELL & Co. The Board of Directors CERTIFIED PUBLIC ACCOUNTANTS STU.A.RT BUILDING SEATTLE 11 WASHINGTON ACCOUNTANTS' REPORT Pacific Northern Airlines, Inc.: We have examined the balance sheet of Pacific Northern Airlines, Inc. as of December 31, 1959 and the related statement of earnings and retained earnings 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, It was not practicable to confirm amounts due from certain United States Government agencies by communication with them, but we satisfied ourselves as to these amounts by means of other auditing procedures. In our opinion, subject to the finalization of retroactive mail pay as mentioned in note 1, the accompanying balance sheet and statement of earnings and retained earnings present fairly the financial position of Pacific Northern Airlines, Inc. at December 31, 1959 and the results of its operations for the year then ended, in conformity with generally accepted accounting principles applied on a consistent basis, except for the changes described in note 2 (which we approve). Seattle, Washington March 11, 1960 PACIFIC NORTHERN AIRLINES, INC. (AN ALASKA CORPORATION) Statement of Earnings and Retained Earnings Year ended December 31, 1959 OPERATING REVENUES: Passenger . Mail ( note 1 ) Cargo and excess baggage Other transport service Incidental revenues, net . Total operating revenues OPERATING EXPENSES: Flying operations Maintenance and repairs (note 2) Aircraft and traffic servicing Passenger service Promotion and sales General and administrative Depreciation and amortization ( note 2) Operating profit NON-OPERATING INCOME: Gains on disposal of flight equipment and other assets ( note 4) Other NON-OPERATING EXPENSES: Interest, net . Provision for obsolescence in inventories of Constellation aircraft maintenance materials Federal and state taxes on income ( notes 1 and 4) Net earnings Special charge, amortization of property acquisition adjustment Retained earnings January 1, 1959 . Retained earnings, December 31, 1959 . See accompanying notes to financial statements. $7,015,239 3,242,550 1,068,774 28,602 126,033 11,481,198 $ 3,201,612 2,191,572 2,178,730 755,458 778,962 780,838 948,888 10,836,060 645,138 202,711 219 202,930 848,068 153,241 29,688 182,929 5 665,139 326,705 338,434 43,340 295,094 1,281,331 $ 1,576,425 6 PACIFIC NORTHERN AIRLINES, INC. Balance Sheet, December 31, 1959 Current assets: Cash Receivables : Traffic ASSETS United States Government agencies ( note 1 ) Other Less allowance for doubtful receivables . Maintenance and operating supplies, at average cost Less allowance for obsolescence Prepaid expenses, principally insurance Total current assets Accrual of estimated retroactive mail pay (less provision for applicable income taxes) ( note 1 ) . Investments, principally cash surrender value of life insurance Operating properties and equipment, at cost (notes 2, 3 and 4): Assets Flight equipment $ 7,207,105 Ground equipment 654,036 Buildings and improvements to leased property 136,834 Replacement parts for flight equipment 540,910 Construction work in progress . 16,891 $ 8,555,776 Deferred charges, net of amortization: Route extension and development . Preoperating expenses-Constellation aircraft . Preoperating expenses-airport hangar building Other See accompanying notes to financial statements. $ 589,297 564,628 343,405 1,497,330 28,642 471,403 29,688 Allowances for depreciation, amortization and overhauls $ 2,940,305 448,764 118,490 224,232 $ 3,731,791 5,674 21,773 8,055 10,359 $ 236,685 1,468,688 441,715 116,565 2,263,653 164,000 44,729 4,823,985 45,861 $ 7,342,228 (AN ALASKA CORPORATION) LIABILITIES Current liabilities: Note payable to bank, unsecured Current installments on long-term debt Accounts payable: Trade Airline traffic accounts Collections as agents Accrued wages, taxes, etc. Federal and state taxes on income, estimated . Air travel plan deposits Unearned transportation revenue Total current liabilities Long-term debt: Chattel mortgage notes to bank, non-current portion ( note 3) . Stockholder equity: Common stock-$1.00 par value per share. Authorized 2,000,000 shares; issued and outstanding 1,068,109 shares Paid-in surplus-no change during 1959 Retained earnings, all of which are restricted (note 3) . Contingent liabilities and commitments (notes 5, 6 and 7) See accompanying notes to financial statements. $ 555,1~7 541,448 133,955 1,068,109 584,905 1,653,014 1,576,425 $ 200,000 944,676 1,230,570 195,494 79,750 21,250 149,891 2,821,631 1,291,158 7 3,229,439 $ 7,342,228 e Notes to Financial Statements (1) U. S. MAIL PAY: The Company is a certificated air carrier sub- ject to regulation by the Civil Aeronautics Board. Under the provisions of the Federal Aviation Act, the Company is entitled to a reasonable return on investment after income taxes. Since October 23, 1959 the Company has been receiving mail pay based on temporary rates which are subject to final negotiation and settlement. Management be- lieves, based on past experience, that there will be a favorable retroactive adjustment to October 23, 1959 when rates are finally reviewed and settled and has accrued such estimated adjust- ment in the amount of $353,000 through De- cember 31, 1959. The effect on net earnings of accrual of such estimated additional mail pay is $164,000, after reduction for applicable income taxes of $189,000 ( assessable in year of receipt) . These amounts have been included in their re- spective categories in the statement of earnings. (2) ALLOWANCES FOR DEPRECIATION AND OVERHAULS-FLIGHT EQUIPMENT: Effective January 1, 1959 the Company adopted the accounting procedure of excluding from the de- preciable bases of Constellation aircraft amounts estimated to represent the cost of built-in over- hauls of engines and of amortizing such costs over the service lives of the engines. Prior to 1959 the procedure was followed of depreciating en- gine costs, less allowances for residual values, over the lives of the related aircraft. Also effec- tive January 1, 1959, the depreciable bases of air- frames were revised through redetermination of residual values thereof. In addition, the estimated useful lives of Constellation aircraft were ad- justed to provide for approximate common retire- ment dates. The effect of these changes in ac- counting procedure upon the financial statements is not considered to be of material significance. (3) LONG-TERM DEBT: The Company is indebted under a Loan Agree- ment which had a balance at December 31, 1959 amounting to $2,235,834, of which $944,676 rep- resents principal payments due within one year and is included in current liabilities. Substan- tially all of the Company's flight equipment is pledged as collateral under the Loan Agreement. Among other provisions, the Loan AgTeement to- gether with amendments thereto require that the Company shall maintain specified amounts of working capital and shall not declare or pay any dividends or purchase, redeem or otherwise ac- quire for value any of its capital stock. (4) DEFERRED INCOME TAXES: In accordance with a requirement of the uni- form system of accounts prescribed by the Civil Aeronautics Board, the Company includes in in- come gains on trade-ins of flight equipment whereas for income tax purposes the gains must be applied as a reduction of the cost of the flight equipment acquired in the related purchase trans- action. In 1958 and 1959 gains of approximately $145,000 and $173,000, respectively, were in- cluded in income. The Company has adopted de- ferred tax accounting procedures to provide for the estimated effect on income of future years of the resulting difference between book and taxable income and, accordingly, has provided for de- ferred tax reserves of approximately $36,000 and $43,000. Such amounts have been included in the allowance for depreciation and are being credited against income tax provisions over the lives of the applicable flight equipment. (5) LONG-TERM LEASES: On June 1, 1959 the Company executed a fifty- year lease with the Port of Seattle requiring the construction of an airport hangar building on the leased premises at Seattle-Tacoma International Airport. Concurrent with the execution of the above lease agreement the Company assigned the lease to a third party under an agreement where- by such third party is to construct the facility and lease it back to the Company. The Company is required under the lease-back agreement to pay one year's rent ( $187,920 ) in advance prior to occupancy and thereafter to pay corresponding rent on a monthly basis with an option to pur- chase the facility at the end of the twenty-five year lease-back period. The Company is also re- quired to pay the ground rentals under the lease with the Port of Seattle of $500 a month until the earlier of building completion or May 31, 1960; $1 ,530.92 per month from that date through May 31 , 1969 and thereafter at such amount or at a newly negotiated rate. The Company is fur- ther required to pay all taxes relating to the premises and improvements thereon. On December 30, 1959 the Company sold all of its terminal buildings and facilities in the State of Alaska at book value and concurrently ex- ecuted an agreement to lease such properties for a period of fifteen years at the monthly rental of $4,000, with an option to renew under certain conditions. The agreement also gives the Com- pany an option to repurchase the properties upon expiration of the lease. (6) RETIREMENT PLANS: The Company has two contributory retirement plans covering ( 1) flight officers and ( 2) other employees of the Company. During 1959 the Com- pany charged to operating expenses and other accounts provisions totaling $174,712 of which $33,886 was for past service benefits. The un- funded past service benefits of both plans have been estimated by the Company's independent actu- aries to aggregate $260,642 at December 31, 1959. (7) CONTINGENT LIABILITIES: At December 31, 1959 the Company was con- tingently liable for claims arising in the normal course of business in which it is or may be a defendant, but in the opinion of legal counsel the ultimate liability, if any, would not materially affect the financial statements. PACIFIC NORTHERN AIRLINES, INC. Directors G. P. O'GRADY J. A. CUNNINGHAM PAUL PORZELT R. A. ROWAN M. B. KIRKPATRICK C. W. NELSON A. G. WOODLEY Officers A. G. WOODLEY H. A. OLSEN J. A. CUNNINGHAM J. H . FOSTER FELIX AUBUCHON T. D. STUART C. W. NELSON M. E. DIAMOND D. B. HART GENERAL COUNSEL GENERAL OFFICES CITY TICKET OFFICES AUDITORS TRANSFER AGENT REGISTRAR COMMON STOCK LISTED Washington, D. C. Seattle, Washington New York, New York Los Angeles, California Anchorage, Alaska Seattle, Washington Seattle, Washington President and General Manager Vice President-Traffic and Sales Vice President-Operations Vice President- Engineering and Maintenance Vice President-Alaska Operations Vice President- Industrial Relations Secretary-Treasurer Assistant Secretary Assistant Secretary G. P. O1 GRADY, 1625 EYE STREET, N. W. , WASHINGTON , D.C . 400 NORTON BUILDING , SEATTLE, WASHINGTON ANCHORAGE HOMER KETCHIKAN KODIAK CORDOVA KENAI PEAT, MARWICK, MITCHELL & CO . JUNEAU PORTLAND SEATTLE BANKERS TRUST COMPANY, NE,'V YORK, NEW YORK MANUFACTURERS TRUST COMPANY, NEW YORK, NEW YORK AMERICAN STOCK EXCHANGE PACIFIC COAST STOCK EXCHANGE