SOUTHERN AIRWAYS, INC. 1971 ANNUAL REPORT CHICAG08 KNOXVILLE BRISTOL-KINGSPORT- JOHNSON CITY NEW YORK LaGuardia NEWARKe e e WASHINGTON, D.C . STLOUIS. NASHVILLE GREENVILLE- CHARLOTTE MEMPHISe GREENVILLE JACKSON TUPELO UNIVERSITY OXFORD SHELBYVILLE- TULLAHOMA CROSSVILLE HUNTSVILLE-DECATUR CHATTANOOGA FLORENCE- SHEFHELD- TUSCUMBIA COLUMBtJ3 - (West Pomt) (Starkville) TUSCALOOSA GADSDEN ANNISTON BIRMINGHAM GREENWOOD MONROE JACKSON MERIDIAN MONTGOMERY BATON ROUGE VICKSBURG LAUREL \ATCHEZ HATTIESBURG GULFPORT BILOXI MOBILE PASCAGOULA DOTHAN SPARTANBURG GREENWOOD ANDERSON ATHENS ATLANTA CQLUMBIA COLUMBUS ALBANY MOULTRIE-THOMASVILLE VALDOSTA CHARLESTON TALLAHASSEE JACKSONVILLE NEW ORLEANS e EGLIN AFB (Fort Walton Beach) SELECTED OPERATING STATISTICS* 1971 Plane Miles (000) (all services) 20,003 Passengers 1,875,205 Passenger Miles (000) 527,552 Available Seat Miles (000)(all services) 1,336,982 PANAMA CITY 1970 18,580 1,589,481 430,736 1,228,373 Passenger Load Factor 43.2% 38.8% Yield Per Passenger Mile $ .086 $ .086 Average Passenger Fare $ 24.11 $ 23.36 Average Passenger Load 28.3 25.2 Average Length of Passenger Haul (Miles) 281.3 271.0 Total Cost Per Available Seat Mile ( all services) $ .046 $ .043 *In scheduled service unless otherwise specified. ORLANDO .MIAMI 1969 1968 1967 14,679 12,260 11,803 1,377,421 1,271,497 1,180.297 323,472 254,028 222,142 862,388 611,795 498,322 42.4% 45.8% 45.9% $ .087 $ .081 $ .077 $ 20.33 $ 16.08 $ 14.49 24.3 22.3 19.4 234.8 199.8 188.2 $ .045 $ .049 $ .050 Stockholders, Customers, Employees and Friends: During the immediate past years, your management has worked to strengthen the Company for the long term. As a result of this program, we have seen our revenues rise from $22,054,000 in 1966 to $60,334,000 in 1971. Our system has been expanded into New York, Washington, Miami, Chicago and St. Louis. Cities now on Southern Airways' system generate one-third of the nation's airline passengers. Expansion during the recent period of depressed airline traffic was expensive for your Company, but it has enabled Sou them to build a strong base for future earnings. With the improvement in economic conditions during 1971, we flew a record 527,552,000 revenue passenger miles, an increase of 22.5 per cent over 1970. This 22.5 per cent increase in revenue passenger miles was accomplished with only a 10 per cent increase in capacity, that is, available seat miles. During the same period we upgraded our service by the replacement of two 75-passenger DC-9's with two 95-passenger stretched DC-9's and expanded jet service into other communities. Although Southern's recovery during the year was substantial, resulting in an operating profit of $407,000, this was not sufficient to offset nonoperating expenses of $1,701,000 which, after reduction for deferred income tax credit, resulted in a loss of $1,059,000 for the year. Nevertheless, this result was a major improvement over the 1970 loss of $3,333,000. We were saddened by the untimely death in early January of Richard A. Trippeer, a long-time Director from. Memphis, Tennessee. Over the years, he had been one of our staunchest supporters. He has been replaced by Richard A. Trippeer, Jr., a capable, seasoned young businessman, also of Memphis. I should like to take this opportunity to express my appreciation to our employees and to all our supporters who have stood by us during the recent difficult economic times. I am confident that we have now established a firm foundation and that our prospects for the future are indeed bright. Respectfully yours, Frank W. Hulse President SOUTHERN AIRWAYS, INC. BALANCE SHEET DECEMBER 31, 1 _ 971 and 1970 1971 ASSETS CURRENT ASSETS Cash and short-term investments - Note D . . . . . . . . . . . . . . . . . . . . . $ 5,057,849 Accounts Receivable: U.S. Government - Transportation and public service revenue - Note A . . . . . . . . . . . 1,481,210 Trade receivables, less allowance for doubtful accounts (1971 - $41,849; 1970 - $110,000) . . . . . . . . . . . . . . 4,989,452 Maintenance and operating supplies, at average cost less allowance for obsolescence {1971 - $695,787; 1970 - $513,170) ..................... . Prepaid expense ...................................... . Total Current Assets OTHER ASSETS (Including aircraft lease deposits of $490,000 at December 31, 1970) ...................... . PROPERTY AND EQUIPMENT - on the basis of cost - Notes Band D Flight equipment ..................................... . Less allowances for depreciation and maintenance ............... . Other property and equipment ............................ . Less allowance for depreciation ............................ . DEFERRED CHARGES - Note C Unamortized preoperating, route extension and development costs ............................... . Deferred lease costs ................................... . Unamortized long-term debt expense ........................ . -2- 6,470,662 2,015,280 791,765 14,335,556 90,621 27,237,131 9,333,934 17,903,197 3,625,547 2,790,039 835,508 18,738,705 691,245 217,788 580,524 1,489,557 $34,654,439 1970 $ 2,674,346 2,912,941 4,642,234 7,555,I 75 1,641,659 508,819 12,379,999 568,742 26,504,600 7,754,761 18,749,839 3,980,501 2,394,742 I ,585,759 20,335 ,598 1,049,442 247,000 671,134 1,967,576 LIABILITIES CURRENT LIABILITIES Accounts payable ..................................... . 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 - Note D ........... . Total Current Liabilities LONG-TERM DEBT - Note D Notes payable, less current maturities ........................ . Convertible subordinated debentures ....................... , . DEFERRED TAXES ON INCOME - Note E ............... ...... . STOCKHOLDERS' EQUITY - Notes D and F Preferred Stock, $1 par value, authorized 2,000,000 shares issuable in series: Series A $.36 convertible - voting (liquidation value $6 per share - aggregate of$ 1,523,316 at December 31, 1971) issued and outstanding - 253,886 shares at December 31, 1971 ................. . Series B $.36 convertible - non-voting (liquidation value $6 per share - aggregate of $1,000,002 at December 31, 1971) issued and outstanding - 166,667 shares at December 31, 1971 ......... , ....... . Common Stock, $2 par value: Authorized shares - 7,500,000 in 1971 and 5,000,000 in 1970 Issued and outstanding - 1,061,766 shares at December 31, 1971 and 1,024,871 shares at December 31, 1970 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Other paid-in capital ................................... . Retained-earnings (Deficit) ................................ . COMMITMENTS AND CONTINGENCIES- Note H See Notes to Financial Statements. -3- 1971 $ 2,983,250 3,298,405 1,647,268 248,002 462,807 102,000 212021471 1029442203 8,535,032 1226821000 2122171032 253,886 166,667 2,123,532 3,372,559 (3,423,440) 2,493,204 $34,654,439 1970 $ 3,79 I ,053 2,627,662 1,332,254 455,676 535,915 108,37.S 11 8142 055 1026642990 10,755,316 122 682poo 23!4372316 235,000 2,049,742 1,229,523 (2,364,656) 914.609 $35,251,915 SOUTHERN AIRWAYS, INC. ST A TEMENT OF OPERA TIO NS FOR THE YEARS ENDED DECEMBER 31, 1971 and 1970 OPERATING REVENUES Passenger ...................................... . Mail, express and freight ............................ . Public service revenue - Note A ....................... . Charter ........................................ . Other operating revenues - net ........................ . OPERA TING EXPENSES Flying operations ................................. . Maintenance ...... ... ........................... . Aircraft and traffic servicing .......................... . Passenger 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 deductions less miscellaneous income ............... . (LOSS) BEFORE INCOME TAX CREDIT ................ . DEFERRED INCOME TAX CREDIT - Note E ................... . NET {LOSS) .................................... . AVERAGE SHARES OF COMMON STOCK OUTSTANDING NET (LOSS) PER SHARE OF COMMON STOCK - Note I See Notes to Financial Statements. -4- 1971 $45,301,780 3,090,002 6,973,875 4,067,008 9001907 60,333,572 20,949,971 10,807,844 13,522,854 3,313,744 4,774,385 3,921,265 226361732 5929262795 406,777 1,678,112 221449 1,700,561 (1,293,784) 2351000 $ (l !058!784) 1,035,048 $ (1.02) 1970 $37,187,312 2,865,938 4,822,621 3,835,306 7351949 49,447,126 18,071,509 9,045,318 11,351,075 2,661,228 4,273,431 3,191,875 226321284 5122262720 (1,779,594) 1,788,784 (286,609) 51 443 1,5532 6 I 8 (3,333,212) ${323332212) 1,024,871 $ (3.25) SOUTHERN AIRWAYS, INC. STATEMENT OF CHANGES IN FINANCIAL POSITION FOR THE YEARS ENDED DECEMBER 31, 1971 and 1970 SOURCE OF WORKING CAPITAL From operations: Net (loss) ........................... . Items not requiring outlay of working capital in current period: Provision for depreciation ....... . Provision for airframe and engine overhaul Amortization of deferred charges ..... Deferred income tax credit Total From Operations ......... . Additional long-term borrowing ......... . Sale of Series A and B Preferred Stock - Note F .. Conversion of Series A Preferred Stock to Common Stock Net carrying amount of property converted to a lease Proceeds from sale of property and equipment, less gain included in net (loss) . . . . . . . . . . . APPLICATION OF WORKING CAPITAL Additions to property and equipment Expenditures for airframe and engine overhaul Reductions of long-term debt ........ . Conversion of Series A Preferred Stock to Common Stock Deposits on leased aircraft Increase in deferred charges Increase in other assets . . INCREASE (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 and short-term investments Accounts receivable ....... . Maintenance and operating supplies Prepaid expenses . . . . . . . . . . Increase (decrease) in working capital liabilities: Accounts payable ............ . Collection and withholding as agents Salaries, wages and vacations ...... . Accrued interest, taxes and other expenses Ait travel plan deposits . . . .... Current maturities of long-term debt INCREASE (DECREASE) IN WORKING CAPITAL See Notes to Financial Statements. -5- 1971 $ ( 1.058,784) 2,094,99) 2,039.344 484,478 (235,000) $ 3,325,029 787,757 2,637,379 36.895 5 I 9,166 69,749 7,375,975 1,409,959 1,716,398 3,008,041 36.895 (490,000) 6,459 111879 5,699,631 1,676,344 1,715,009 3,391,353 $ 2,383,503 (1,084,513) 373,621 282,946 1,955,557 (807,803) 670,743 315,014 (280,782) (6,375) 388,416 279,213 $ 1,676,344 1970 $ (3,333,212) 2,090,915 1,728,630 55 J ,944 1,038,277 2,372,606 274,976 3,685,859 2,134,662 1,209,281 1,520,442 280,000 412,012 151552 5,571.,949 (C886,090) 3!601 p99 $ 1,715,009 $ ( I ,629 ,817) 2,385,833 179,325 (863,159) 72,182 2,099,236 (82,452) 289,032 (448,535) (3,825) 104,816 1,958,272 $ (1,886,090) SOUTHERN AIRWAYS, INC. STATEMENT OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1971 and 1970 Preferred Stock Series A Par Value $1.00 a Share Shares Amount Balance, January 1, 1970 Net (loss) for the year ended December 31, 1970 Balance, December 31, 1970 Issuance of 290,781 shares of Series A $.36 Convertible Preferred Stock with detachable warrants to purchase 290,781 shares of $2.00 par value Common Stock at $6.00 a share, less related expenses of $107,309 - Note F 290,781 $ 290,781 Issuance of 166,667 shares of Series B $.36 Convertible Preferred Stock with detachable warrants to purchase 166,667 shares of $2.00 par value Common Stock at $6.00 a share - Note F Issuance of 36,895 shares of Common Stock upon conversion of 36,895 shares of Series A Preferred Stock (36,895) (36,895) Net (loss) for the year ended December 31, 1971 Balance, December 31, 1971 253,886 $ 253,886 SOUTHERN AIRWAYS, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1971 NOTE A - PUBLIC SERVICE REVENUE Series B Par Value $1.00 a Share Shares Amount 166,667 $ 166,667 166,667 $ 166,667 Public service revenues recorded for the period July 1, 1971, to December 31, 1971, are based upon the rate in effect for the year ended June 30, 1971. The rate for the period July 1, 1971, through June 30, 1972, has not been determined by the Civil Aeronautics Board and, therefore, amounts recorded in the last six months of 1971 are subject to adjustment upon final determination. 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. Estimated useful lives are as follows: Airframes, engines, pro- pellers, communications equipment and rotable M-404 parts (A) Ground equipment Ground DC-9 Equipment 15 years 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 these aircraft will be essentially exhausted by the end of 1973. The Company's net investment in Martin -6- Common Stock Other Retained- Par Value $2.00 a Share Paid-In Earnings Shares Amount Capital (Deficit) Total 1,024,871 $ 2,049,742 $ 1,229,523 $ 968,556 $ 4,247,821 {323332212} (323331212} 1,024,871 2,049,742 1,229,523 (2,364,656) 914,609 1,346,596 1,637,377 833,335 1,000,002 36,895 73,790 (36,895) (1,058,784} (1,058,784} 1,061,766 $ 2,123,532 $ 3,372,559 $ (3,423,440) $ 2,493,204 aircraft amounted to $3,793,000 and $4,365,000 at December 31, 1971 and 1970, respectively. At December 31, 1971, seven Martin aircraft had been withdrawn from service; one had been sold and the remaining six will be sold or used in maintaining the remaining Martin aircraft in an airworthy condition. Any proceeds from the sale of these aircraft are 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 disposals of flight equipment (exclusive of rotable parts) are credited or charged to operations. Proceeds from the disposal of rotable parts are credited to tpe 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 is as follows at December 31, 1971 and 1970: Notes payable to banks in quarterly installments through 1976 (1)(2) (3)(4) Notes payable to banks, due December 31, 1975 ( 1 )(2)(3)( 4)( 5) Notes payable to banks in quarterly installments through 197 4 ( 1 )(2) (3)( 4) -7- 1971 $ 4,530,000 3,000,000 1,173,913 1970 $ 5,392,500 3,000,000 1,695,652 (l} Note payable to bank in equal quarterly installments to January 1973 ( 4)( 6) Notes payable to lessor, due December 31, 1972 ( l) Note payable to vendor in equal installments in October and November 1972 (I) Notes payable to bank for deferred lease payments in equal installments in April, May and June l 973 (1) Notes payable to fuel supplier in September 1972 ( 1) Notes payable to lessor due in equal installments in Apnl, May and June 1973 (1) 8% to 9% notes payable to fuel supplier due in December 1971 6% notes payable due in monthly installments to Oc~ober 1975 Other notes payable 5% Convertible Subordinated Debentures due December 1, 1981 (3). (7) 6% Convertible Subordinated Debentures with warrants attached, due November 1, 1983 (3) (8) Less current maturities (1) 1971 510,833 315,000 420,000 433,757 220,000 134,000 4,682,000 8,ooopoo 23,419,503 2,202,471 $21,217,032 1970 613,000 315,000 420,000 250,780 392,439 490,000 4,682,000 8,000,000 25,251,371 1,814,055 $23,437,316 In May, 1971, effective as of February J, 1971, the Company entered into a deferral agreement with creditor banks, lessors of aircraft, a fuel supplier and an equipment vendor (Creditors) for the deferral of certain principal and rental payments due in 1971 and 1972. Principal payments of $1,254,184 toriginally due $612,500 in 1971 and $641,684 in 1972) due to creditor banks were deferred and will be paid in three installments in October, November and December, 1973; payment of a note payable to a lessor in the amount of $315,000 was deferred to December 31, 1972, and $420,000 due on an engine purchase contract was deferred and will be paid in two equal monthly installments in October and November, 1972. In addition, a fuel supplier agreed to accept notes in the amount of $330,000 due in September, 1972, for fuel deliveries which were made in April and May, 1971 ($220,000) and will be made in March, I 972 ($110,000} and aircraft lease payments of $275,000 ( originally due $134,000 in 1971 and $141,000 in 1972) have been deferred and will be paid in three installments in April, May and June, 1973. The Company also entered into an agreement with a bank for loans of $617,794 to be used for lease payments (originally due $433,756 in 1971 and $184,038 in 1972) and these notes will be paid in three equal installments in April, May and June, 1973. Under the terms of the agreement with Creditors, the Company will make deposits in a "Revolving Cash Collateral Account" consisting of (1) amounts equal to the deferred payments on the original due date of such payments, and (2) cash in excess of projected requirements for a sixty day period as defined in the agreement. The Company may withdraw funds from this collateral account based upon their projected cash needs for the next sixty days. At December 31, 1971, the balance of the account was $2,670,604, consisting of cash ($46,604) and short-term investments, and was pledged as collateral for indebtedness due to Creditors participating in the Deferral Agreement. The interest rates on these deferred payments are: creditor banks at 2% above the prime rate, but not less than 7% (7% at December 31, 1971 ): deferred lease payments at 9%; note payable to bank for deferred lease payments at 2% above the bank's prime rate, but not less than 7% (7% at December 11, 1971); and notes payable to fuel supplier, equipment vendor and another lessor at 10%. Prepayments on the deferred amounts are required in amounts equal to net income for the twelve month period ending the preceding December 31, and after such deferred amounts have been paid, the balance is to be applied to the prepayment requirement outlined in (5) below. See other restrictions outlined in (3) below. (2) Based on the agreement with Creditors which became effective May 28, 1971, the interest rate, retroactively to February 1, 1971, is of 1 % above the lead bank's prime rate, except while the deferral program continues the interest rate is 1 % above the lead bank's prime rate ( 6% at December 31-, 1971). Scheduled payments actually deferred under the program will bear interest at 2% above the lead bank's prime rate, but not less than 7%. (3) Under the terms of the amendment of the agreement with creditor banks and the Deferral Agreement, both of which are dated as of February 1, 1971, the creditor banks amended their agreements with the Company to waive all events of default (at December 31, 1970, the Company did not comply with certain requirements with respect to working capital, indebtedness and lease obligations and on February 28, 1971, also did not comply with requirements with respect to minimum net worth, which were also conditions of default under the terms of a long-term aircraft lease agreement) which may have existed prior to execution of the amendment, and the restrictive covenants applicable to such agreements were revised. The terms of the Deferral Agreement and both issues of Convertible Subordinated Debentures place certain requireI11ents and restrictions upon, among other things, (a) working capital, (b) indebtedness and lease obligations, (c) net worth, (d) capital expenditures, (e) losses from operations and (f) payments relating to Capital Stock, including dividends (no amounts were available for such payments at December 31, 1971 or 1970). Under the most restrictive terms of these agreements, the Company will be in default with all creditors if (1) the cumulative net loss for -8- 1972 exceeds $1,600,000 or the net loss for any one month during 1972 exceeds $750,000 or (2) the cumulative net loss for the first three months of 1973 exceeds $550,000; or additional losses are incurred thereafter. ( 4) All aircraft, engines and related equipment are pledged as collateral on this indebtedness. (5) 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 $1,000,000 for the twelve month period ending the preceding December 31, after certain deferred payments have been made as described in (1) above. (6) This note is payable in quarterly installments commencing December 31, 1971, with a final payment on January 31, 1973. It bears interest at the rate of 9% and is guaranteed by McDonnell Douglas Corporation. It is subordinated in certain aspects to the notes payable due through 1976 and the notes payable due through 1974. Payment of this note is collateralized by a second mortgage on the DC-9 flight equipment. (7) The 5% Convertible Subordinated Debentures due December 1, 1981, are convertible (until maturity or prior redemption) into Common Stock at$ 10.86 per share (see Note F); are subordinated, generally, to all existing and future indebtedness for borrowed money; are callable at premiums ranging from 4% downward; and require annual sinking fund payments beginning December 1, 1976, in an amount equal to 10% of the principal amount outstanding at December I, 1975. Also, the Company may make additional voluntary sinking fund payments equal to the required amount. (8) The 6% Convertible Subordinated Debentures due November 1, 1983, are convertible (until maturity or prior redemption) into Common Stock at $ 10 per share (see Note F); are issued in integral multiples of $1,000 with an attached warrant for the purchase of 18 shares at$ 10 a share (see Note F); 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% downward; and require annual prepayments 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 November 1, 1977. Also, the Company may make additional voluntary prepayments equal to the required amount. NOTE E - INCOME TAXES The loss for income tax purposes for 1970 and 1971 varies from the loss shown in the Statement of Operations because of timing differences related to public service revenue payments, certain expenses deferred for financial statements purposes, and the use of accelerated depreciation applicable to certain assets. At December 31, 1971, there is a net operating loss carryforward to future years for income tax purposes of approximately $7,557,000, which expires in 1974 ($970,000), 1975 ($4,880,000) and 1976 ($1,707,000). The net operating loss carryforward for financial statement purposes at December 31, 1971, is approximately $3,573,000. The Company will change the depreciation method and lives applicable to certain assets for tax purposes in its 1971 tax returns. Because of these changes and the carryforward of the 1971 operating loss described above, deferred taxes ($235,000) provided in prior years will not be paid and, accordingly, have been recognized as an income tax credit in the Statement of Operations for 1971. - The Company uses the flow-through method of accounting for investment credit and the available investment credit is recognized to the extent that it can be realized or offset against current or deferred income taxes. Investment credit carryover at December 31, 1971, for use in off setting federal income tax in future income tax returns amounted to approximately $1,246,000 and expires in 1976 ($65,000), 1977 ($810,000), 1978 ($37,000), 1979 ($308,000), and 1981 ($26,000). NOTE F - CHANGES IN CAPITAL The stockholders approved an amendment to the Company's charter in May 1971, to increase the authorized $2 par value Common Stock from 5,000,000 shares to 7,500,000 shares, and to authorize 2,000,000 shares of $1 par value Preferred Stock in one or more series; the terms of each series of Preferred Stock to be determined by the Board of Directors upon issuance. In June 1971, the Board of Directors authorized the issuance of up to 1,350,000 shares of $ .36 Convertible Preferred Stock, Series A and 200,000 shares of$ .36 Convertible Preferred Stock, Series B. Each share of Convertible Preferred Stock is entitled to a $.36 cumulative dividend if earned during the year, subject to the dividend restrictions of the Convertible Subordinated Debentures (see Note D). No dividends have accumulated at December 31, 1971. The Preferred Stock is convertible into one share of Common Stock at $6 per share; is entitled upon liquidation to $6 per share; and can be redeemed after July 1, 1976, at $6 per share. The Series A Stock is voting and the Series B Stock is non-voting. During 1971, 290,781 Series A Units and 166,667 Series B Units were sold. Each Unit consisted of one share of Series A or Series B Convertible Preferred Stock, respectively, with a detachable warrant to purchase one share of Common Stock at $6 per share through July 1, 1981. At December 31, 1971 and 1970, there were 2,323,125 shares and 1,006,625 shares of Common Stock of the Company reserved as follows: (Continues next page) -9- 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 Exercisable one-third each year beginning in 1973 at a price of $5 .25 per share Shares available for additional options which may be granted under the Plan Shares available for options which may be granted under the Employee Stock Option Plan approved by Board of Directors in 1967 Shares reserved for conversion of 5 % Convertible Subordinated Debentures (1) Shares reserved for conversion of 6% Convertible Subordinated Debentures (2) Shares reserved for sale pursuant to stock purchase warrants issued with 6% Convertible Subordinated Debentures at a price of $10 per share (2) Shares reserved for conversion of Preferred Stock: Series A Series B Shares reserved for sale pursuant to stock purchase warrants issued with the Preferred Stocks at a price of $6 per share: Series A Series B TOTAL 1971 1,000 900 6,100 36,000 1,000 45,000 25,000 431,124 800,000 144,000 253,886 166,667 290,781 166,667 2,323,125 1970 1,000 900 7,100 36,000 45,000 25,000 292,625 500,000 144,000 1,006,625 (1) Pollo.wing the sale of 290,781 Series A Units to stockholders, employees, and a supplier and taking into consideration the 166,667 Series B Units sold, the conversion price of the 5% Convertible Subordinated Debentures was reduced from $ 16 per share to $ 10.86 per share. (2) As additional consideration for the holders of the 6% Convertible Subordinated Debentures who purchased the 166,667 Series B Units, the conversion price of the Deb en tu res and the exercise price of the stock purchase warrants attached were each reduced from $16 per share to $10 per share. Data with respect to stock options outstanding at December 31, 1971 and 1970, is summarized as follows: December 31, 1971 December 31, 1970 Year of Number of Option and Market Number of Option and Market Grant Shares Price Per Share Total Shares Price Per Share Total 1967 1,000 (a) $19.18 $ 19,180 1,000 $19.18 $ 19,180 1968 900 (a) 13.75 12,375 900 13.75 12,375 1969 6,100 (a) 8.69 - 11.76 65,376 7,100 8.69 - 11.76 77,136 1971 36,000 5.25 189,000 44,000 $285,931 9,000 $108,691 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, 1971, no options were exercised and options became exercisable as follows: - 10- Quoted Market Price at Option Price Date Exercisable Number of 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 ,~83 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 1971 2,998 8.69 - 19.18 362214 4.125 - 6.75 l 7 2314 $417,372 $485,158 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. (a) The Company has granted options to purchase 8,000 shares of Common Stock, exercisable at $5 .25 per share, to become effective after the expiration of presently outstanding options. NOTE G - 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 assumptions used in computing pension costs. Total pension expense, including amounts paid under a defined contribution plan, for the years ended December 31, 1971 and 1970, was $868,779 and $661,734, respectively. Pension plan assets were sufficient to cover the unfunded past service costs at December 31, 1971. The Company's policy is to fund pension cost accrued. NOTE H - COMMITMENTS AND CONTINGENCIES At December 31, 1971, the Company was leasing eleven DC-9 jet aircraft under leases expiring in 1979 through 1983, at a minimum annual rental of $4,722,208. The Company also leases certain office, ticketing, hangar, computer and shop facilities with minimum aggregate annual rentals of approximately $1,622,000 under various leases with expiration dates through 1992. The Company has a five year agreement to receive passenger reservation service at an estimated annual charge of approximately $500,000. In November 1970, a DC-9 jet aircraft leased by the Company was involved in an accident, in which all passengers 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. The United States Court of Appeals for the District of Columbia remanded to the Civil Aeronautics Board The Southern Airways, Inc. Route Realignment Investigation. At issue before the Board in this remanded case, now in progress, is extension of the Company's system to Miami/Ft. Lauderdale via Tallahassee and Orlando as well as Memphis-Miami and Atlanta-Nashville non-stop authority. A Board examiner has recommended that this Florida extension and the two non-stop authorizations be granted on a permanent basis to the Company. He also recommended non-stop authority for another carrier in the Memphis-Miami market. The examiner's recommendations are being reviewed by the Board. Meanwhile, the Company will continue to operate the Florida service in question pursuant to temporary Board authority. 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 provision has been made in the accompanying financial statements for amounts to be paid under the terms of these agreements. NOTE I - 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. Assumed conversion of debentures and Preferred Stocks, and exercise of warrants would not increase the net loss per common share. (Notes continue next page.) -11 - NOTE J - SUPPLEMENTARY PROFIT AND LOSS INFORMATION Provision for Depreciation - Operating Expenses 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 at airports served) There were no management fees, service contract fees or royalties. - 12- 1971 $2,094,991 $2,039,344 $ 359,124 125,354 $ 484,478 $ 182,617 $ 804,765 161,003 327,568 130,412 951020 $1,518,768 $7,610,311 1970 $2,090,915 $1,728,630 $ 331,3q7 220,577 $ 551,944 $ 210,002 $ 640,629 216,261 233,500 91,698 65,469 $1,247,557 $6,512,753 Board of Directors Southern Airways, Inc. Atlanta, Georgia REPORT OF INDEPENDENT ACCOUNTANTS We have examined the balance sheets of Southern Airways, Inc. as of December 31, 1971 and 1970, and the related statements of operations, stockholders' equity, and changes in financial position for the two years ended December 31, 1971. 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. As reflected in the accompanying financial statements, the Company had net losses of $1,058,784 and $3,333,212 in 1971 and 1970, respectively, and had a retained-earnings deficit of $3,423,440 at December 31, 1971. As explained in items (1) and (3) of Note D, in May 1971 the Company obtained an amendment to its agreement with creditor banks. dated as of February 1, 1971, providing for the deferral of certain principal payments and a waiver of all events of default which may have existed prior to the execution of the amendment. The terms of the agreements place certain requirements and restrictions upon, among other things, (a) working capital, (b) indebtedness and lease obligations, (c) net worth, (d) capital expenditures, (e) losses from operations and (f) payments relating to capital stock, including dividends. With respect to the provision applicable to losses from operations, the Company will be in default with all creditors if (1) the cumulative net loss for 1972 exceeds $1,600,000 or the net loss for any one month.during 1972 exceeds $750,000 or(2) the cumulative net loss for the first three months of 1973 exceeds $550,000, or additional losses are incurred thereafter. The Company's continuation as a going concern is dependent upon its ability to develop future profitable operations, which currently contemplates receiving public service revenue in the future at a level not substantially below the level presently being received. As discussed in Note A, the Company is presently receiving public service revenue on a temporary rate which is subject to adjustment. In our opinion, subject to the ability of the Company to attain profitable operations and any adjustments which may result from the final settlement of public service revenue as discussed in the preceding paragraph, the accompanying balance sheets and statements of operations, stockholders' equity, and changes in financial position present fairly the financial position of Southern Airways, Inc. at December 31, 1971 and 1970, and the results of its operations, changes in stockholders' equity and changes in financial position for the two years ended December 31, 1971, in conformity with generally accepted accounting principles applied on a consistent basis. Atlanta, Georgia February 28, 1972 ERNST & ERNST SOUTH~RWAYS GENERAL OFFICES Hartsfield Atlanta International 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 Notice to Stockholders of Southern Airways, Inc. Under a 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 per cent 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 preceding year and within 10 days of the acquisition, 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 required to file such a report may obtain further information by writing to the Director, Bureau of Operating Rights, Civil Aeronautics Board, Wash- ington, D.C. 20428. OFFICERS FRANK W. HULSE President GRAYDON HALL Executive Vice President and General Manager GEORGE M. GROSS Vice President and Associate General Manager J. KENNETH CO UR TENA Y Vice President-Economic Regulations and Secretary A. L. MAXSON Vice President-Fiscal and Treasurer VICTOR C. PRUITT Vice President- Technical Services THOMAS A. WILEY, JR. Vice President-Marketing J. W. GODWIN Assistant Vice President- Flight OWEN L. McREE Assistant Vice President- Personnel WILLIAM E. OAKES Assistant Vice President- Economic Research J. R. PRICE Assistant Vice Pr,esident- Contracts and Properties DAVIDE. RUSSELL Assistant Vice President- Systems and Computer Services FRANK H. WHEELER Assistant Vice President- Sales and Services JAMES H. ISHEE Controller RAY W. BURDEN Assistant Treasurer MRS. MARY C. HA YES Assistant Secretary CECIL A. BEASLEY, Jr. Assistant Secretary WM. BEW WHITE, JR. Assistant Secretary EXECUTIVE COMMITTEE FRANK W. HULSE GRAYDON HALL G. GUNBY JORDAN ELTON B. STEPHENS WM. BEW WHITE, JR. 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 Southern 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. A. F. Irby & 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, JR. R. A. Trippeer, Inc. Memphis, Tennessee WM. BEW WHITE, JR. Bradley, Arant, Rose & White Birmingham, Alabama