1970 Annual Report AIRWAYS,/NC CHICAGOe SOUTHTWAYS NEW YORK LaGuardia NEWARKe e BRISTOL-KINGSPORT- KNOXVILLE ~ JOHNSON CITY e WASHINGTON, D.C. ST. LOUISe GREENVILLE JACKSON TUPELO UNIVERSITY- OXFORD GREENWOOD NASHVILLE SHELBYVILLE- TULLAHOMA HUNTSVILLE-DECATUR FLORENCE- SHEFFIELD- TUSCUMBIA COLUMBUS MONROE JACKSON- MERIDIAN VICKSBURG LAOREL \ATCHEZ HATTIESBURG MOBILE BATON ROUGE GULFPORT- BILOXI PASCAGOULA NEW ORLEANS e :..:----------- EGLIN AFB FT. WALTON BEACH SELECTED OPERATING STATISTICS* 1970 Plane Miles (000) (all services) 18,580 Passengers 1,589,481 Passenger Miles (000) 430,736 Available Seat Miles (000) (all services) 1,228,373 CROSSVILLE CHATTANOOGA PANAMA CITY 1969 14,679 1,377,421 323,472 862,388 GREENVILLE- SPARTANBURG CHARLOTTE e ATLANTA GREENWOOD ANDERSON COLUMBIA MOULTRIE-THOMASVILLE VALDOSTA CHARLESTON JACKSONVILLE ORLANDO eMIAMI 1968 1967 1966 12,260 11,803 11 ,287 1,271 ,497 1,180,297 1,051,554 254,028 222,142 196,366 611,795 498,322 416,738 Passenger Load Factor 38.8% 42.4% 45.8% 45.9% 48.6% Yield Per Passenger Mile $ .086 $ .087 $ .081 $ .077 $ .077 Average Passenger Fare $ 23.36 $ 20.33 $ 16.08 $ 14.49 $ 14.39 Average Passenger Load 25.2 24.3 22.3 19.4 18.0 Average Length of Passenger Haul (miles) 271.0 234.8 199.8 188.2 186.7 Total Cost Per Available Seat Mile ( all services) $ .043 $ .045 $ .049 $ .050 $ .049 *In scheduled service unle s otherwise specified. SOUTHERN AIRWAYS, INC. PRESIDENT'S REPORT STOCKHOLDERS, CUSTOMERS, EMPLOYEES AND FRIENDS: The airline industry suffered record losses during 1970 and, unfortunately, Sout_hern was no exception. Its loss of $3,333,212 or $3.25 per share, was caused by depressed economic conditions, higher costs due to inflation, and start-up expenses on new, long-haul services to Miami, Newark and Chicago. On the other hand, our revenues reached all time highs. Revenue passenger miles were up 33.2 percent over 1969, and total revenues were 30.7 percent above last year. The growth enjoyed by Southern in 1970 was, by no means, universal in the industry. Indeed, I believe this growth -- soundly based upon valuable long-haul route additions -- points the way to a better future for your Company if the economy improves. In late 1969, the Company began arranging a program to cover the financial requirements of expanding the size of Southern's operations and to provide for slackening in the economic climate of areas which we serve. This program is now in the final stage of completion and involves raising equity capital by offering stock purchase rights to existing stockholders of the Company and to others. The members of the Company's Board of Directors have agreed to purchase up to $1,500,000 of the stock to be offered and tentative arrangements have been made to sell to others approximately $1,000,000 of the stock. A registration statement was filed with the Securities and Exchange Commission on March 18, 1971 with respect to the proposed offering of these securities. The proposed financing program also involves deferring certain payments due by the Company in 1971 and 1972. The Company has reached a tentative agreement with the banks under its credit agree- ment, as well as certain lessors of aircraft and certain other creditors, in which the creditors and lessors would agree to defer payments due them totaling approximately $3,200,000, asset out in Note M to the financial statements contained in this Annual Report. Since January 31, 1971, the Company has not made certain payments to the aforementioned creditors in anticipation of a portion of those payments being deferred under the proposed financing program. The failure to pay those amounts when due constitutes defaults under the Company's long-term debt and lease agreements. On October 1, 1970 the Company was not in compliance with the requirements of its agreements with banks and lessors of aircraft, as explained in Note D to the financial statements, which also constituted conditions of default under the terms of both issues of Convertible Subordinated Debentures. I hope that you will attend the reconvened Annual Meeting on Monday, May 3, 1971, which will be held at 10:00 o'clock A.M. Eastern Daylight Time in the Scott Hudgens Building, Hapeville, Georgia. Whether or not you plan to attend the meeting in person, please execute and return the enclosed proxy. Respectfully Submitted, Frank W. Hulse President March 30, 1971 SOUTHERN AIRWA VS, INC. BALANCE SHEET December 31, 1970 and 1969 ASSETS CURRENT ASSETS Cash ............................................. . Accounts Receivable: U.S. Government: Transportation and public service revenue - Note A .......... . Refundable income taxes ................. .... ..... .. . Trade receivables, less allowance for doubtful accounts (1970 - $110,000; 1969 - $40,154) .................... . Maintenance and operating supplies, at average cost less allowance for obsolescence (1970 - $513,170; 1969 - $279,420) ..................... . Prepaid expense ...................................... . Total Current Assets OTHER ASSETS Aircraft lease rental deposits - Note E ....................... . Other ............................................. . PROPERTY AND EQUIPMENT - on the basis of cost - Notes B, D and J Flight equipment ..................................... . Less allowances for depreciation and maintenance ............... . Other property and equipment ............................ . Less allowances for depreciation ......................... . . . DEFERRED CHARGES - Note C Unamortized preoperating, route extension and development costs ............................... . Deferred lease costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Unamortized long-term debt expense ........................ . 1970 1969 $ 2,674,346 $ 4,304,163 2,912,941 1,222,777 436,338 4,642,234 3,510,227 7,555,175 5,169,342 1,641,659 1,462,334 508,819 1,371,978 12,379,999 12,307,817 490,000 210,000 78,742 63,190 568,742 273,190 26,504,600 25,611,105 7,754,761 5,736,717 18,749,839 19,874,388 3,980,501 3,206,850 2,394,742 1,995,062 1,585,759 1,211,788 20,335,598 21,086,176 1,049,442 985,521 247,000 363,566 671,134 758,421 1,967,576 2,107,508 $35,251,915 $35,774,691 LIABILITIES CURRENT LIABILITIES Accounts payable ..................................... . Amount due on engine purchase contract ..................... . Collections and withholding as agents ........................ . Salaries, wages and vacations ............................. . Accrued interest payable ................................ . Accrued taxes and other expense ........................... . Air travel plan deposits ................................. . Current maturities of long-term debt - Notes D and L ............ . Total Current Liabilities LONG-TERM DEBT- Note M Notes payable, less current maturities - Notes D and L ............ . Convertible subordinated debentures - Notes D and L ............ . Other - Note E ...................................... . DEFERRED TAXES ON INCOME - Note F STOCKHOLDERS' EQUITY - Notes D and G Common stock, $2 par value Authorized - 5,000,000 shares Issued and outstanding - 1,024,871 shares .................. . Other paid-in capital . .................................. . Retained earnings ( deficit) ............................... . COMMITMENTS AND CONTINGENCIES - Note I See Notes to Financial Statements. $ 1970 1969 3,573,753 637,300 2,627,662 1,332,254 455,676 535,915 108,375 2,741,555 12,012,490 8,917,816 12,682,000 490,000 22,089,816 235,000 2,049,742 1,229,523 (2,364,656) 914,609 $ 1,691,817 2,710,114 1,043,222 453,269 986,857 112,200 1,709,239 8,706,718 9,763,152 12,682,000 140,000 22,585,152 235,000 2,049,742 1,229,523 968,556 4,247,821 $35,251,915 $35,774,691 SOUTHERN AIRWAYS, INC. STATEMENT OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1970 and 1969 OPERA TING REVENUES Passenger ................................... . Mail, express and freight, ......................... . Public service revenue - Note A ..................... . Charter ..................... ....... ......... . Other operating revenues - net 1 OPERA TING EXPENSES Flying operations ............................... . Maintenance . .- ............ . .................. . Aircraft and traffic servicing ....................... . Pa$senger service ............................... . Promotion and sales ............................. . General and administrative ......................... . Amortization and provision for depreciation - Note B ...... . OTHER DEDUCTIONS AND (INCOME) Interest on long-term debt-net of interest capitalized ....... . Insurance proceeds from loss of leased aircraft net of applicable expenses ....................... . Other (income), less miscellaneous deductions ........... . (LOSS) BEFORE INCOME TAX CREDIT ...... .. ............ . INCOME TAX CREDIT - Note F ......................... . 1970 $37,187,312 2,865,938 4,822,621 3,835,306 735,949 49,447,126 18,071 ,509 9,045,318 11,351,075 2,661,228 4,273,431 3,191,875 2,632,284 51,226,720 (1,779,594) 1,788,784 (286,609) 51 ,443 1,553,618 (3,333,212) NET (LOSS) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (3,333,212) AVERAGESHARESOFCOMMONSTOCK OUTSTANDING .. .......... ~ ................... . NET (LOSS) PER SHARE OF COMMON STOCK - Note K . . . . . . . . $ 1,024,871 (3.25) See Notes to Financial Statements. SOUTHERN AIRWAYS, INC. STATEMENT OF RETAINED EARNINGS (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1970 and 1969 1970 RETAINED EARNINGS, beginning of period . . . . . . . . . . . . . . . . . . $ 968,556 Net (Loss) for the period ............. .... .............. . (3,333,212) RETAINED EARNINGS (DEFICIT), end of period $ (2,364,656) See Notes to Financial Statements. 1969 $28,050,097 2,163,178 3,579,639 3,358,146 $ $ 684,448 37,835,508 12,659,124 6,110,720 9,078,742 1,875,449 3,002,821 2,286,399 2,395,905 37,409,160 426,348 1,719,541 15,695 1,735,237 (1,308,889) 486 961 (821,928) 1,024,87 1 (.80) 1969 $ 1,790,484 (821,928) $ 968,556 SOUTHERN AIRWAYS, INC. STATEMENT OF CHANGES IN WORKING CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1970 and 1969 SOURCE OF WORKING CAPITAL From operations: Net (loss) ................................. . Non-cash items Provision for depreciation ..................... . Provision for airframe and engine overhaul ........... . Amortization of deferred charges ................. . Total From Operations Additional long-term borrowing ..................... . Proceeds from sale of property and equipment, less gain included in net (loss) .............. . ...... . Refund of equipment purchase deposits ............... . APPLICATION OF WORKING CAPITAL Additions to property and equipment ................. . Expenditures for airframe and engine overhaul ........... . Amounts transferred to current maturities of long-term debt .. . Deposits on leased aircraft ......................... . Increase in deferred charges ....................... . Increase in other assets ........... .. ............. . (DECREASE) IN WORKING CAPITAL .............. . Working capital at beginning of year ................. . WORKING CAPITAL AT END OF YEAR ............. . CHANGES IN COMPONENTS OF WORKING CAPITAL Increase (decrease) in working capital assets Cash ..................................... . Certificates of deposit ......................... . Accounts receivable ........................... . Maintenance and operating supplies ................. . Prepaid expenses ............................. . Increase (decrease) in working capital liabilities Accounts payable ............................. . Amount due on engine purchase contract ............. . Collection and withholding as agents ................. . Salaries, wages and vacations ..................... . Accrued interest, taxes and Qther expenses ....... ...... . Air travel plan deposits ......................... . Current maturities of long-term debt ................. . (DECREASE) IN WORKING CAPITAL .......... .... . See Notes to Financial Statements. 1970 $ (3,333,212) 2,090,915 1,728,630 551 ,944 1,038,277 1,952,606 274,976 3,265,859 2,134,662 1,209,281 2,447,942 280,000 412,012 15,552 6,499,449 (3,233,590) 3,601,099 $ 367,509 $ (1,629,817) 2,385,833 179,325 (863,159) 72,182 1,881,936 637,300 (82,452) 289,032 (448,535) (3,825) 1,032,316 3,305,772 $(3,233,590) 1969 $ (821,928) 2,160,358 1,251,043 376,638 2,966,111 140,000 219,784 3,179,958 6,505,853 6,363,077 1,201,687 2,465,085 210,000 707,356 15,735 10,962,940 (4,457,087) 8,058,186 $ 3,601,099 $ 160,311 (5,534,316) 877,996 451,233 598,264 (3,446,512) 370,520 250,590 221,056 281,334 (425) (112,500) 1,010,575 $( 4,457,087) SOUTHERN AIRWAYS, INC. NOTES TO FINANCIAL STATEMENTS December 31, 1970 NOTE A - SUBSIDY For the period August 1, 1970 through June 30, 1971, Southern and the other local service carriers are receiving Public Service Revenues (subsidy) based upon a new formula (Class Rate V) which significantly increases the level of subsidy otherwise payable to the carriers under the old formula (Class Rate IV-A), from the $36 300 000 actually paid the carriers in 1969 to an ann~al r;te of approximately $60,000,000. This rate will require an additional appropriation of approximately $8,000,000 in order for the Civil Aeronautics Board to have sufficient funds to pay this new rate through June 30, 1971. It is expected that Congress will make these additional funds available to the CAB. Under the new formula, the Company has accrued subsidy for the period August 1, 1970 through December 31, 1970 in the-amount of $2,863,444, as contrasted to the amount which would have been payable to the Company under the old formula of $1,378,799, resulting in total Public Service Revenues of $4,822,621 for the year ended December 31, 1970. The new Class Rate V Subsidy Formula, which is based on the service being pro- vided to small communities during May, 1970, is esti- mated to produce subsidy for the Company at an annual rate of about $6,800,000. NOTE B - PROPERTY, EQUIPMENT, DEPRECIATION, MAINTENANCE AND REPAIRS Provisions for depreciation of property and equipment are computed on the straight-line method calculated to amortize the cost of the properties over their estimated useful lives. Reference is made to Note J regarding changes in accounting applicable to depreciation and repairs and maintenance. Estimated useful lives are as follows: Airframes, engines, pro- pellers, communications equipment and rotable M-404 parts (A) Ground equipment DC-9 15 years Ground Equipment 3-10 years (A) Common depreciation point of December 31, 1973 Based upon a review during 1970 of the useful life of the Martin 404 aircraft, the Company believes that the economic useful lives of those aircraft will be essentially exhausted by the end of 1973. Prior to 1970, these air- craft and related capitalized spares were being depreciated over a seven-year period which would result in all air- frames being reduced to a salvage value by the end of 1973, and would result in significant undepreciated balances in overhaul and spare parts accounts at that time. Accordingly, in order to more properly match expenses of the Martin fleet with revenues obtained therewith, the Company has adopted, effective as of the beginning of 1970, a common depreciation and amortization point of December 31, 1973, for the complete write-off of the Company's investment in Martin aircraft, which at December 31, 1970 amounted to $4,365,000. At Decem- ber 31 1970 five Martin aircraft had been withdrawn from s;rvice ~nd will be sold or used in maintaining the remaining Martin aircraft in an airworthy condition. Any proceeds from the sale of these aircraft will be credited to the allowance for depreciation. Expenditures for ordinary maintenance and repairs are charged to expense. Expenditures for major spare parts are capitalized and minor parts are recorded in inventory accounts and charged to expense as used. Residual amounts of property and equipment are not eliminated from the accounts until the items are retired. At the time properties are retired, the amounts of cost and allowance for depreciation and maintenance are eliminated from the accounts. Profits and losses on dis- posals of flight equipment ( exclusive of rotable parts) are credited or charged to operations. Proceeds from the disposal of rotable parts are credited to the allowance for depreciation account. NOTE C - DEFERRED CHARGES Expenditures for preoperating and route extension and development costs are deferred and are amortized over a period of five years from the dates operations of the routes are started. Costs associated with obtaining leased DC-9 aircraft are being amortized over the lives of the leases. Expenditures associated with obtaining long-term debt are being amortized over the life of the financing arrangements. NOTED - LONG-TERM DEBT Long-term debt at December 31, 1970 and December 31, 1969 is summarized as follows: December 31 1970 1969 Notes payable to banks in quarterly installments through 197 6 ( 1 )( 5)( 6) $5,392,500 $6,255,000 . Notes payable to banks due December 31, 1975 (1) (5) (6) (7) 3,000,000 3,000,000 Notes payable to banks in quarterly installments through 1974 (2) (5) (6) 1,695,652 2,217,39 1 Note payable to bank due December 31, 1971 through January 31, 1973 (5) (8) 613,000 Notes payable to fuel supplier due December 31, 1971(9) 250,780 10% notes payable to lessor due January 31, 1971 315,000 6% note due in monthly in- stallments to October 1975 392,439 5% Convertible Sub- ordinated Debentures due December 1, 1981 (3)(6) 4,682,000 4,682,000 6% Convertible Sub- ordinated Debentures with warrants attached due November 1, 1983 (4) (6) 8,000,000 8,000,000 Other - Note E 490,000 140,000 24,831,371 24,294,391 Less current maturities 2,741,555 1,709,239 $22,089,816 $22,585,152 (1) The interest rate is of 1 % above the lead bank's prime rate. (2) The interest rate is of 1 % above the lead bank's prime rate. (3) The 5% Convertible Subordinated Debentures due December 1, 1981, are convertible (until maturity or prior redimption) in to Common Stock at $ 16 per share (see Note G) are sub- ordinated, generally, to all existing and future in- debtedness for borrowed money; are callable at premiums ranging from 4.75% downward; and require annu~l sinking fund payments beginning December 1, 1976, in an amount equal to 10%of the principal amount outstanding at December 1, 1975. Also, the Company may make additional voluntary sinking fund payments equal to the required amount. ( 4) The 6% Convertible Subordinated Debentures due November 1, 1983, are convertible (until maturity or prior redemption) into Common Stock at $16 per share (see Note G); are issued in integral multiples of $1,000 with a warrant for the purchase of 18 shares at $16 a share attached; are subordinated, generally, to all existing and future indebtedness for borrowed money; are callable on or after November 1, 1973, at premiums ranging from 6.5% downward; and require annual prepay- ments beginning November 1, 1978, in an amount equal to 10% of the principal amount outstanding at November 1, 1977, less credit for principal amount converted or called subsequent to Novem- ber 1, 1977. Also, the Company may make addi- tional voluntary prepayments equal to the required amount. (5) All aircraft, engines and related equipment are pledged as collateral on this indebtedness. (6) The agreements relating to these notes payable and both issues of Convertible Subordinated Debentures place certain requirements and restric- tions upon, among other things, (a) net current assets, (b) indebtedness and lease obligations, ( c) net worth, (d) capital expenditures, and (e) pay- ments relating to capital stock including dividends. On October 1, 1970 and December 31, 1970, the Company did not comply with these requirements with respect to net current assets and indebtedness and lease obligations which are also conditions of default under the terms of its long-term aircraft lease agreements. The Company plans to obtain an amendmenc to its agreements with creditor banks and lessors of aircraft to enable compliance with these requirements and restrictions. (7) Prepayments are required equal to 25% of the first $1,000,000 of net income of the Company, plus 35% of the net income in excess of $1,000,000 for the 12 month period ending the preceding December 31. (8) This note is payable in quarterly installments com- mencing December 31, 1971, with a final payment on January 31, 1973. It bears interest at the rate of 9% and is guaranteed by McDonnell Douglas Corporation. It is subordinated in certain aspects to the notes payable due through 1976 and the notes payable through 197 4. Payment of this note is collateralized by a second mortgage on the DC-9 flight equipment. (9) These notes payable bear interest at 8% to 9% and are in some respects subordinated to the notes payable due through 1976 and the notes payable due through 1974. Minimum aggregate principal payments on long-term debt for the next five years are as follows: Year Amount 1971 $2,741,555 1972 1,970,780 1973 1,605,579 1974 1,117,489 1975 3,950,229 NOTE E - OTHER NOTES PAY ABLE Other notes payable represent six month notes payable, with interest at 10%, to a lessor for security deposits on aircraft leased under renewable six month leases. Since the Company plans to renew the leases ap- plicable to these planes and continue to renew these notes as they mature, the deposits on leased aircraft have been included in other assets and the notes payable have been included as other long-term debt in the accompanying financial statements. The amounts for 1969 have been reclassified from current assets and current liabilities. NOTE F - INCOME TAXES The loss for income tax purposes for 1969 and 1970 exceeds the loss shown in the Statement of Operations because of certain expenses deferred for financial state- ments and additional depreciation to be claimed for income tax purposes. Depreciation for financial state- ments is computed on the straight line method, but certain assets are depreciated on accelerated methods for NOTE G - COMMON STOCK AND OTHER PAID-IN CAPITAL In May, 1 %9, the charter of the Company was amended to increase the authorized capital of the Company from 2,000,000 shares of $2 par value Common Stock to 5,000,000 shares of $2 par value Common Stock. income tax purposes. Because of the aforementioned differences in treatment of certain items for income tax purposes, there is a net operating loss carryforward to future years for income tax purposes of approximately $5 ,850,000 at December 31, 1970, which expires in 1974 ($970,000) and 1975 ($4,880,000). Net operating loss carryforward for financial statement purposes at Decem- ber 31, 1970, was approximately $3,300,000. The Company use~ the flow-through method of accounting for investment credit and the available invest- ment credit is recognized to the extent that it can be realized or off set against current or deferred income taxes. Investment credit realized as a reduction of deferred income taxes amounted to approximately $207,000 at December 31, 1970. Investment credit carryover at December 31, 1970, for use in offsetting federal income taxes in future income tax returns amounted to approximately $1,220,000 and expires in 1976 ($65,000), 1977 ($810,000), 1978 ($37,000), and 1979 ($308,000). This change constitutes the only change in Common Stock and other paid-in capital for the two years ended December 31, 1970. At December 31, 1970 and December 31, 1969, 1,006,625 shares of Common Stock of the Company were reserved as follows: Shares Reserved December 31 1970 1969 Qualified Stock Option Plan approved by Board of Directors in 1965 : Exercisable one-third each year beginning in 1969 at a price of $19 .18 per share Exercisable one-third each year beginning in 1970 at a price of $13.75 per share Exercisable one-third each year beginning in 1971 at prices ranging from $8.69 to $11.76 per share Currently exercisable at a price of $10.16-2/3 per share Shares available for additional options which may be granted under the Plan Employee Stock Option Plan approved by Board of Directors in 1967: Exercisable in June, 1970 at a price of $11.52 per share Shares available for options which may be granted under the Plan Shares reserved for conversion of 5% Convertible Subordinated Debentures Shares reserved for conversion of 6% Convertible Subordinated Debentures Shares reserved for sale pursuant to stock purchase warrants issued with 6% Convertible Subordinated Debentures at a price of $16 per share TOTAL 1,000 900 7,100 36,000 45,000 25,000 25,000 292,625 500,000 144,000 1,006,625 1,000 900 7,100 33,750 2,250 45 ,000 1,833 23,167 25,000 292,625 500,000 144,000 1,006,625 Data with respect to stock options outstanding at December 31, 1970 and December 31, 1969 is summarized as follows: December 31, 1970 December 31, 1969 Year of Number of Option and Market Number of Option and Market Grant Shares Price Per Share Total Shares Price Per Sh are Total 1965 $ $ 33,750 $10.16- 2/3 $343,123 1967 1,000 19.18 19,180 2,833 11.52 - 19.18 40,296 1968 900 13.75 12,375 900 13.75 12,375 1969 7,100 8.69 - 11.76 77,136 7,100 8.69 - 11.76 77,136 9,000 $108,691 44,583 $472,930 The options generally become exercisable in three annual installments beginning two years after date of grant and expire five years after date of grant. During the five years ended December 31, 1970, no options were exercised and options became exercisable as follows: Quoted Market Price At Number of Option Price Date Exercisable Exercisable Shares Per Share Total Per Share Total 1967 11 ,250 $10.16- 2/3 $114,381 $14.50 $163,125 1968 11 ,250 10.16- 2/3 114,381 13.875 156,094 1969 11 ,583 10.16- 2/3 - 19.18 120,768 11.50 - 11.625 133,250 1970 2,466 11.52 - 19.18 31,628 5.50 - 6.375 15,375 $381,158 $467,844 Upon exercise of the option, the amount received in excess of the par value of the stock is credited to other paid-in capital and no charge is made to income. NOTE H - PENSION PLANS The Company has several pension plans, including a defined contribution plan, covering substantially all of its employees. During 1970, the Company changed its plans from deposit administration plans to trustee self- administered plans, increased employee benefits payable under one of these plans, and changed the actuarial as~umptions used in computing pension costs (See Note J). Total pension expense, including amounts paid under a defined contribution plan, for the two years ended December 31 , 1970 and 1969 was $661,734 and $774,638, respectively. As a result of changing actuarial assumptions, pension plan assets were sufficient to cover the unfunded past service costs - of approximately $519,000 as reported at December 31, 1969. The Company's policy is to fund pension cost accrued. At December 31 , 1970, the total of the pension funds exceeded the actuarially computed value of vested benefits. NOTE I - COMMITMENTS AND CONTINGENCIES At December 31 , 1970, the Company was leasing four DC-9 jet aircraft under leases expiring in 1980 and 1981, at a minimum annual rental of $1,561,129 ; seven DC-9 jet aircraft under six month leases, which assuming the air- craft are retained for a full year, would result in rentals of $2,903,000 in 1971; and a communications system lease expiring in 1977 with a minimum rental of $79,000. The Company also leases certain office, ticketing, hangar and shop facilities with minimum aggregate annual rentals of approximately $1 ,220,000 under various leases with expiration dates through 1988. In November 1970, a DC-9 jet aircraft leased by the Company was involved in an accident, in which all pas- sengers and crew members were killed, while on a charter flight to Huntington, West Virginia. Claims may be made against the Company for damage to property and loss of life as a result of this accident, and in the opinion of the Company, all potential claims are adequately covered by insurance. There is pending in the United States Circuit Court of Appeals for the District of Columbia Circuit cases brought by certain unsuccessful applicants before the CAB who attacked the Board's extension of the Company's system from Tallahassee to Orlando and Miami, from Memphis to Chicago, from Memphis to St. Louis, and one-stop authority between St. Louis and New Orleans. In the opinion of management and legal counsel of the Company, the final settlement of all of these matters will have no material effect on the financial position or operations of the Company. The Company has an employment agreement with its President providing for his employment to September 12, 1977 at an annual salary of not less than $48,500. In addition, upon his retirement the Company has agreed to pay $833 per month to him for life, or in the event of his death, to his lineal descendants for 180 months. No pro- vision has been made in1 the accompanying financial state- ments for amounts to be paid under the terms of these agreements. NOTE J - CHANGES IN ACCOUNTING During 1969, the Company redetermined the economic useful life of cylinders used in Martin 404 air- craft and reduced the useful life of these assets from seven years to three years. This change had the effect of in- creasing the provisions for depreciation approximately $153,000 and $146,000 for the years ended December 31, 1969 and December 31, 1970, respectively, and in- creasing the net loss approximately $98,000 ($.10 per share) and $146,000 ($.14 per share) for the years ended December 31, 1969 and December 31, 1970, respectively. The Company has consistently followed the policy of providing for DC-9 engine overhaul based on hours of service. Based upon a review of its maintenance program applicable to DC-9 engines, the Company reduced the rate from $12.50 per hour to $7 .50 per hour effective Jan- uary, 1969. This change had the effect of reducing the provisions for maintenance approximately $205,000 and $45,000 for the years ended December 31, 1969, and Decrease (increase) in net loss: December 31, 1970, respectively, and decreasing the net loss approximately $131,000 ($ .13 per share) and $45,000 ($.04 per share) for the years ended December 31, 1969 and December 31, 1970, respectively. During 1970 the Company redetermined the esti- mated economic useful life of Martin 404 aircraft and related equipment (See Note B). This change had the effect of increasing the provision for maintenance approx- imately $206,000 and increasing the provision for depre- ciation approximately $74,000, which resulted in an increase in the net loss for 1970 of approximately $280,000 ($.27 per share). During 1970, the Company changed actuarial assump- tions used in computing pension costs (See Note H). This change had the effect of decreasing pension cost and the net loss approximately $340,000 ($.33 per share). A summary of the decrease (increase) in the net loss for 1970 and 1969 resulting from these changes is as follows: 1970 1969 Change in useful life of cylinders used in Martin 404 aircraft Change in rate for providing for DC-9 engine overhaul Change in useful life of Martin 404 aircraft and $( 146,000) 45,000 $( 98,000) 131,000 related equipment Change in actuarial assumptions used in computing pension costs DECREASE (INCREASE) IN NET LOSS Decrease (increase) in net loss per Common Share NOTE K - LOSS PER COMMON SHARE Net loss per common share was computed by dividing the net loss by the weighted average number of shares of Common Stock outstanding. Conversion of debentures and exercise of warrants would not have increased the net loss per common share. NOTE L - SUBSEQUENT EVENTS In January and February 1971, the Company did not (1) make payments of $612,500 due under the terms of its agreement with creditor banks, (2) repay notes of $315,000 due to a lessor, and (3) make lease payments of $358,923 due under the terms of its long-term lease agreements. NOTE M - PROPOSED FINANCING ARRANGEMENTS The Company proposes to enter into an agreement in 1971 with creditor banks, lessors of aircraft and suppliers (Creditors) for the deferral of certain principal and rental payments due in 1971 and 1972. Principal pay- ments of $1,254,185 (originally due $612,500 in 1971 and $641,685 in 1972) due to creditor banks will be deferred and paid in three equal installments in October, November and December, 1973, and payment of a note payable to a lessor in the amount of $315,000 will be ( 280,000) 340,000 $( 41,000) $( .04) $ 33,000 $ .03 deferred to December 31, 1972. In addition, a certain fuel supplier will agree to accept notes in the amount of $330,000 due in three equal installments in September, October and November, 1972, for a portion of fuel de- liveries to be made in March and April, 1971 ($220,000) and March, 1972 ($110,000), an engine supplier will accept notes amounting to $420,000 due in three equal installments in September, October and November, 1972, and aircraft lease payments of $893,000 ( originally due $568,000 in 1971 and $325,000 in 1972) will be deferred and paid in three equal installments in April, May and June, 1973. This agreement will be contingent upon the Company's obtaining proceeds of at least $2,500,000 from the sale of its equity securities. In addition, the Company proposes that creditor banks and lessors amend their agreements with the Company to enable the Company to be in compliance with all terms and provisions of these agreements. Under the most restrictive terms of these proposed amendments, the Company will be in default with all creditors if ( 1) the cumulative net loss for 1971 exceeds $2,500,000 or the net loss for any one month during 1971 exceeds $1,000,000 or (2) the cumulative net loss for 1972 exceeds $1,000,000 or the net loss for any one month during 1972 exceeds $750,000. NOTE N - SUPPLEMENTARY PROFIT AND LOSS INFORMATION Provision for Depreciation- Operating Expenses Other Provision for Airframe and Engine Overhaul - Operating Expenses Amortization- Operating Expenses Other Obsolescence - Operating Expenses Taxes other than Income Taxes Charged to Operating Expenses - Payroll Fuel and Oil Property Sales and Use Other Rents (including landing fees and rental of airports served) SOUTH~RWAYS 1970 $2,090,915 $2,090,915 $1,728,630 $ 331,367 220,577 $ 551,944 $ 210,002 $ 640,629 216,261 233,500 91,698 65,469 $1,247,557 $6,512,753 1969 $2,129,330 31,028 $2,160,358 $1,251,043 $ 205,837 170,801 $ 376,638 $ 60,738 $ 621,309 354,954 150,000 78,199 26,404 $1,230,866 $3,847,277 Board of Directors Southern Airways, Inc. Atlanta, Georgia REPORT OF INDEPENDENT ACCOUNT ANTS We have examined the balance sheets of Southern Airways, Inc. as of December 31, 1970, and December 31, 1969, and the related statements of operations, retained earnings ( deficit) and changes in working capital for the years then ended. Our examinations were 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. During 1969, the Company reduced the economic life of cylinders used in Martin 404 aircraft and decreased the provision for overhaul applicable to DC-9 engines. During 1970, the Company changed the economic useful life of its Martin 404 aircraft and related equipment and changed the actuarial assumptions used in computing pension costs. These changes, with which we concur, as discussed in Note J of Notes to Financial Statements, had the effect of decreasing the net loss approximately $33,000 ($ .03 per share) for the year ended December 31, 1969, and increasing the net loss approximately $41,000 ($.04 per share) for the year ended December 31 , 1970. As reflected in the accompanying financial statements, the Company had net losses of $821,928 and $3,333,212 in 1969 and 1970, and had a retained-earning deficit of $2,364,656 at December 31, 1970. As explained in item 6 of Note D of Notes to Financial Statements, the Company is not in compliance with the requirements and restrictions of its agreements with creditor banks and lessors of aircraft which also constitutes conditions of default under the terms of both issues of Convertible Subordinated Debentures. In addition, as indicated in Note L of Notes to Financial Statements, in January and February 1971, the Company did not (1) make payments of $612,500 due under terms of its a~reement with creditor banks, (2) repay notes of $315,000 due to a lessor, and (3) make lease payments of $358,923 due under the terms of its long-term lease agreements. The Company's continuation as a going concern is dependent upon (1) its ability to develop future profitable operations, which contemplates receiving public service revenue in the future based upon the new formula (Class Rate V) as discussed in Note A of Notes to Financial Statements, (2) obtaining amendments to its agreements with creditor banks, lessors of aircraft and suppliers providing for the deferral of approximately $3,200,000 of payments due in 1971 and 1972,(3) obtaining proceeds of $2,500,000 from the sale of its equity securities, and ( 4) the creditor banks and Convertible Subordinated Debenture holders not accelerating maturity of the Company's indebtedness to them. Reference is made to Note M of Notes to Financial Statement. s for information regarding the Company's proposed financing arrangements. Because of the materiality of the matters discussed in the preceding paragraphs and the uncertainty of their resolution, we are unable to and do not express an opinion on the aforementioned financial statements as of or for the years ended December 31, 1970 and December 31, 1969. Atlanta, Georgia February 10, 1971 except as to Note L as to which the date is February 24, 1971, and Note M as to which the date is March 30, 1971. EXECUTIVE COMMITTEE FRANK W. HULSE G. GUNBY JORDAN W. B. WHITE, JR. GRAYDON HALL ELTON B. STEPHENS DIRECTORS IV AN ALLEN, JR. Ivan Allen Company Atlanta, Georgia CECIL A. BEASLEY, JR. Ballard & Beasley Washington, D. C. ALEXANDER J. BRUNINI Brunini, Everett, Grantham & Quin Vicksburg, Mississippi GEORGE M. GROSS Sou them Airways, Inc. Atlanta , Georgia GRAYDON HALL Southern Airways, Inc. Atlanta, Georgia F. BARTON HARVEY, JR. Alex. Brown & Sons Baltimore, Maryland FRANK W. HULSE Southern Airways, Inc. Birmingham, Alabama ALTON F. IRBY, JR. Irby-Adams-Cates Company Atlanta, Georgia HENRY P. JOHNSTON Radio and Television Consultant Birmingham, Alabama G. GUNBY JORDAN The Jordan Company Columbus, Georgia SARTAIN LANIER Oxford Industries, Inc. Atlanta, Georgia R. EUGENE ORR Orr & Company, Inc. Jacksonville, Florida G. FRANK PURVIS, JR. Pan American Life Insurance Company New Orleans, Louisiana F. D. SCHAS Bullington-Schas & Company Memphis, Tennessee ELTON B. STEPHENS EBSCO Industries, Inc. Birmingham, Alabama RICHARD A. TRIPPEER R. A. Trippeer, Inc. Memphis, Tennessee W. B. WHITE, JR. Bradley, Arant , Rose & White Birmingham, Alabama OFFICERS FRANK W. HULSE, President GRAYDON HALL Executive Vice President- General Manager GEORGE M. GROSS Vice President-Associate General Manager W. S. MAGILL, JR. Senior Vice President Industry and Government Affairs J. KENNETH COURTENAY Vice President-Economic Regulations and Secretary RICHARD N. HARBOTTLE Vice President-Technical Services W. BAYNE GRUBB Vice President- Flight Operations THOMAS A. WILEY, JR. Vice President- Sales and Marketing JOHN J. JANISCH Vice President- Customer Services A. L. MAXSON Vice President - Fiscal and Treasurer RICHARD K. ROBINSON Controller WILLIAM E. OAKES Assistant Vice President Economic Research J. R. PRICE Assistant Vice President- Contracts and Properties VICTOR C. PRUITT Assistant Vice President- System Planning DAVIDE. RUSSELL Assistant Vice President- Systems and Computer Services ARNOLD D. WINHAM Assistant Vice President- Marketing Administration A.D. YAWN Assistant Vice President- Agency and Pleasure Sales RAY W. BURDEN Assistant Treasurer MRS. MARY C. HAYES Assistant Secretary CECIL A. BEASLEY, JR. Assistant Secretary W. B. WHITE, JR. Assistant Secretary Notice to Stockholders of Southern Airways, Inc. Under a new rule adopted by the Civil Aeronautics Board in July 1970, any person who owns as of December 31 of any year or acquires ownership, either beneficially or as a trustee, of more than five percent of any class of capital stock of an air carrier shall file with the CAB a report containing information required by Subpart B of Part 245.13 of the Board's Economic Regulations. This report must be filed with the Civil Aeronautics Board on or before April 1 of each year as to capital stock or capital owned as of December 31 of the preced- ing year and within 10 days of the acqui- sition, unless such person has otherwise filed with the CAB a report covering such acquisition or ownership. Any stock- holder who believes that he may be re- quired 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. GENERAL OFFICES Atlanta Airport Atlanta, Georgia COUNSEL Bradley, Arant , Rose & White Birmingham, Alabama Ballard & Beasley Washington, D. C. AUDITORS Ernst & Ernst Atlanta, Georgia STOCK TRANSFER AGENT Trust Company of Georgia Atlanta, Georgia ADVERTISING COUNSEL Harris & Weinstein Associates, Inc. Atlanta, Georgia AIRWAYS,/NC General Office: Atlanta Airport, Atlanta, Georgia 30320