Western Airlines Nineteen Seventy-Two Annual Report Notice to Stockholders A rule adopted by the Civil Aeronautics Board ("CAB") in July 1970, as amended on December 29, 1972, imposes obligations on certain stockholders of air carriers. Any person who owns as of December 31 of any year or subsequently acquires, either beneficially or as a trustee, more than 5% of any class of capital stock of an air carrier must file with the CAB a report containing the information required by Part 245.12 of the CAB's Economic Regula- tions on or before April 1 as to the capital stock owned as of December 31 and/or a report corrtaining the information required by Part 245.13 of the CAB's Economic Regulations within 1 O days after acquisition as to the capital stock acquired after December 31 . Any bank or broker which holds as trustee more than 5% of any class of capital stock of an air carrier on the last day of any quarter of a calendar year must file with the CAB within 30 days after the end of the quarter a report in accordance with the provisions of Part 245.14 of the CAB's Economic Regulations. Any person required to report under either Part 245.12, Part 245.13 or Part 245.14 of the CAB 's Economic Regulations who grants a security interest in more than 5% of any class of capital stock of an air carrier must within 30 days after granting such security interest file with the CAB a report containing the informa- tion required in Part 245.15. Any stockholder 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, Washington, D.C. 20428. Western Air Lines, Inc. 1972 Annual Report 2 Highlights of 1972 3 President's Letter 5 Year in Review 22 Ten Years of Growth 24 Balance Sheet 26 Statement of Earnings 27 Statement of Changes in Financial Position 28 Statement of Shareholders' Equity 28 Notes to Financial Statements 30 Accountants' Report Highlights of 1972 2 Operating 1972 1971 Change Available seat miles 10,300,178,000 9,776,869,000 + 5.4% Revenue passenger miles Passengers carried . Passenger load factor-actual % - breakeven point % . Financial Operating revenues Operating income Net earnings . Net earnings per share Net earnings per share assuming conversion of the debentures Cash dividends per share . Stock dividend paid (3% in April 1973) Shares of common stock outstanding Shareholders' equity Shareholders' equity per share . Cash, certificates of deposit, and short-term securities . Working capital . Unused bank cred it Property and equipment at cost . Long-term debt . Number of employees at year end Wages and salaries paid . Operations of a competing trunk carrier were sub- stantially suspended from June 30 to October 2, 1972, and operations of a competing regional carrier were substantially suspended from December 15, 1971 , to April 10, 1972 Affected data adjusted where appropriate throughout 5,995,925,000 5,251,989,000 + 14.2 6,931,000 6,206,000 + 11 .7 58.2 53.7 + 4.5 pts. 54.4 52.2 + 2.2 pts. $365,663,000 $325,595,000 + 12.3% $ 23,607,000 $ 16,306,000 + 44.8 $ 11 ,216,000 $ 6,457,000 +73.7 $ 0.81 $ 0.46 $ 0.74 $ 0.45 $ 0.09 $ 10% 13,926,000 13,894,000 + 0.2 $ 96,723,000 $ 86,397,000 +12.0 $ 6.95 $ 6.22 $ 55,382,000 $ 81 ,024,000 - 31.6 $ 20,592,000 $ 53,207,000 - 61 .3 $ 65,000,000 $452,333,000 $413,612,000 + 9.4 $1 30,487,000 $152,040,000 - 14.2 9,676 9,039 + 7.0 $126,618,000 $111 ,584,000 + 13.5 this Annual Report for the 3% stock divide nd declared on January 22, 1973, payable on April 10, 1973, to shareholders of record on February 20, 1973, and for the 2 for 1 stock split effected on September 13, 1972, and distributed on October 30, 1972. Presidents Letter To Our Stockholders: The year 1972 was one of the best in Western Air Lines' 46-year history. Despite the uncer- tainty of a pending merger that ultimately was denied, and the continuing problems that faced the airline industry, the performance of your company was excellent. Profits increased 7 4 percent; we resumed payment of dividends to stockholders, provided outstanding service to a record number of travelers and shippers, and finished the year in a strong financial position. Much of the credit for the company's gratify- ing progress must go to its 9,600 employees, who, notwithstanding the difficulties, demon- strated great poise, professionalism and dedi- cation . As a result of their support and the able leadership of J. Judson Taylor, who guided the company from heavy losses in 1969 to profitability in 1972, Western today is in an excellent position to continue its growth. From late 1970 until the summer of 1972 your company pursued a merger application with American Airlines in the belief that the consolidation of these two companies would produce worthwhile benefits to our share- holders and to the public. At the same time, however, we recognized that the proposed merger would face opposition and that it might not be approved by the Civil Aeronautics Board and the President. Accordingly, we were deter- mined to conduct our day-to-day operations as efficiently and profitably as possible and con- tinue our planning in a manner that would per- mit Western to move ahead as a viable carrier should the merger be turned down. As our 1972 results detailed in this report indicate, we have been successful in attaining these objectives. Western is today - and in the future will be more than ever- a performance-oriented com - pany. In 1972, based on Civil Aeronautics Fred Benninger Chairman Arthur F. Kelly President Board standards, we had the best on-time record of any trunk airline. In providing coach and economy passengers - who represent 87 percent of our revenue - with first class leg- space on every flight, we believe we did more to make the passenger comfortable in a mean- ingful way than any other airline. Our ratio of commendations-to- complaints improved sig- nificantly during the year. Western had fewer consumer complaints filed with the Civil Aero- nautics Board than any other trunkline. Of continuing concern for the future is the matter of traffic growth vs. cost increases. We believe traffic will continue to grow at a healthy rate. Most estimates for our industry indicate that revenue passenger miles should increase 10-11 percent in 1973. We believe these fore- casts are reasonable. In order to benefit from this growth, however, we must insure that costs are carefully controlled. Every item of operat- 3 4 ing expense is being considered from a profit- planning standpoint. In the summer of 1973, Western will intro- duce its first wide-bodied jets, four DC-1 Os. The aircraft will make the company's service more competitive on major routes where other carriers operate wide-bodied aircraft. When combined with a full-year's utilization of the five Boeing 727s that were received in 1972, they will permit us to increase our capacity by approximately 12 percent for the year. Our revenue per passenger mile in 1972 was essentially the same as in 1971 despite the September fare increase that amounted to approximately 1.8 percent for Western's sys- tem . The carry-over effect for 1973 will be approximately 1.2 percent. We are continuing our efforts to obtain fare increases for Main- land-Hawaii and certain intra-California routes. The stringent new security measures ordered by the government that were introduced throughout our system in January 1973 will increase the company's costs. We are hopeful that the Civil Aeronautics Board will permit the airlines to recover these added costs by a sur- charge to be paid by the passengers. In order to meet our goals of improved per- formance and greater efficiency, we have in- creased our emphasis on corporate planning. We recently established a corporate planning department which we believe is unique in the airline industry. Not only is it responsible for developing both near-term and long -range forecasts, but it also includes flight scheduling, cost control and fleet planning. Consolidation of these important functions with economic research and analysis will permit the depart- ment to develop an annual profit plan and to adjust schedules and establish budgets to con- form with the plan. We are optimistic about the future of Western. We feel we have a strong management team, dedicated and resourceful employees and a route system that, although in need of expan- sion, will produce continuing traffic growth. We have been aggressive and innovative competi- tors and we intend to be even more so in the future. Your continued support will help us in this endeavor. We hope you will fly and ship on Western whenever possible and encourage your friends, neighbors and associates to do likewise. Arthur F. Kelly President and Chief Executive Officer March 8, 1973 Year Rln. ev1ew Earnings Net earnings in 1972 were $11,216,000, a 7 4 percent increase over 1971 net earnings of $6,457,000. (All per-share figures appearing throughout this report are adjusted for stock splits and stock dividends, including the three percent stock dividend declared January 22, 1973.) Net earnings per share, based on the weighted average number of shares outstand- ing during the year were 81 cents a share, compared to 46 cents a share for 1971. For purposes of comparison to interim reporting made during 1972, the net earnings per share unadjusted for the stock dividend were 83 cents a share compared to 48 cents a share for 1971 . Fully diluted net earnings per share, assum- ing that all holders of the company's 5 per- cent Convertible Subordinated Debentures had converted their debentures into common stock, were 7 4 cents a share, compared to 45 cents a share for 1971. Operating income totaled $23,607,000, equal to 6.5 percent of operating revenues, com- pared to $16,306,000, or 5.0 percent of operat- ing revenues, for 1971. Interest expense (before reduction for inter- est capitalized) decreased from $11,278,000 in 1971 to $10,240,000, reflecting both a de- crease in long-term debt and lower effective interest rates on notes payable to a bank. Interest rates on such notes are fixed at one- quarter percent over the bank's prime com- mercial rate and vary with changes in the prime rate, which was on the average lower in 1972 than in 1971. In 1972 the prime rate fluctuated between 4 percent and six percent com- pared to between 5 percent and 6 percent in 1971 . Interest income decreased from $3,190,000 for 1971 to $2,832,000 for 1972. The decrease resulted from a decline in investments in certif- icates of deposit and short-term marketable securities as the company used cash to pay for 5 6 aircraft acquired in 1972 and to make deposits on the DC-10 aircraft to be delivered in 1973. Earnings before income taxes for 1972 totaled $17 ,516 ,000, more than double Western's pre-tax earnings for 1971 . Taxes on income were $6,300,000. Before amortization of deferred investment credits of $2,300,000 for 1972 and $2,325,000 for 1971 , the federal tax expense was $7,525,000 for 1972, compared with $3,950,000 for 1971. State income taxes increased from $975 ,000 to $1,075,000. Revenues Total operating revenues for 1972 were a record $365,663,000 (after reduction of $5,181,000 for payments to struck carriers under the airlines' Mutual Aid Agreement) , a 12.3 percent increase over the $325,595,000 of the previous year. Passenger revenues increased 15.9 percent, and represented 93.8 percent of total operating revenues. Revenues from coach traffic REVENUE DOLLAR 86.7% from coach passenger services 7 .1 % from deluxe passenger services 4.3% from express. freight, excess baggage 1.9% from mail and other increased 16.5 percent and represented 92.4 percent of passenger revenues, or 86.7 per- cent of the company's revenue dollar; deluxe traffic increased 9.1 percent and contributed 7 .1 percent of the revenue dollar. Express, freight and baggage increased 4.9 percent to $15,819,000 and represented 4.3 percent of operating revenues. Mail revenues decreased 3.0 percent and were 1 .4 percent of the total. Charter revenues decreased from $4,284,000 to $2,100,000. The average revenue per passenger mile for 1972 was 5.78 cents, almost identical to the previous year 's 5.77 cents. The Civil Aero- nautics Board in the fare level phase of the Domestic Passenger Fare Investigation approved a 2.7 percent fare increase on do- mestic routes effective in September. However, the increase did not apply on Hawaii, ,1\laska, Mexico or intra-California routes and, accord- ingly, represented an average increase of only 1.8 percent for Western's system. Offsetting this fare increase was an increase in discount travel, from 31.4 percent of all revenue passen- EXPENSE DOLLAR 37.0% for wages and salaries 6.1 % for social security, group insurance. retirement plan 11. 7% for aircraft fuel 10.6% for depreciation and amortization 5.8% for materials and repairs 5.4% for food and beverages 5.4% for utilities and services 3.8% for commissions 3.3% for advertising and publicity 10.9% for all other expenses ger miles in 1971 to 37.6 percent in 1972. This trend may be counteracted in part by the effect of the Civil Aeronautics Board's decision, which has yet to be implemented, holding that youth standby, youth reservation and family plan fares, some of the most popular discount fares, are unlawful. Expenses Inflation continued to play a major role in Western's expense picture in 1972 as operat- ing expenses increased 10.6 percent on a 5.4 percent increase in available seat miles. Operating expenses totaled $342,056,000, compared to $309,289,000 for 1971 . Personnel costs, which accounted for 43.1 percent of the expense dollar, increased 15.9 percent despite the fact that the increase in the number of employees was only seven percent. Of the $32,767,000 increase in operating ex- penses, $20,207,000-61 .7 percent-was for wages and salaries , plus related costs for Social Security, group insurance and retire- ment plans. Other major items of expense and compari- sons with 1971 levels are detailed in the ex- penses section of the Brief Statement of Earn- ings. The cost of producing a seat mile increased 5.1 percent, from 3.16 cents to 3.32 cents. Breakeven load factor increased from 52.2 percent to 54.4 percent. Finances The company continues in a strong financial position. The Statement of Changes in Financial Position shows total working capital from all sources provided $49,261,000 in 1972, com- pared with $50,661,000 for 1971 . Workin g capital generated by operations totaled $47,206,000, compared to $45,017,000 in 1971 . Earnings before extraordinary gains increased $5,319,000. However, the add back for depreciation, amortization and accrued air- craft overhauls was $3,353,000 less because of a decrease in accrued overhaul costs. Application of working capital totaled $81,876,000, with $36,403,000 invested in five Boeing 727 aircraft and other property and equipment and $22,793,000 advanced to man- ufacturers of four DC-10 aircraft and five spare engines which will be delivered in 1973. Addi- tionally, $21,463,000 was used for scheduled repayment of long-term debt and $1,217,000 for the payment of cash dividends. As a result, working capital decreased by $32,615,000, from $53,207,000 to $20,592,000. This decrease is primarily reflected in an in- crease of $12,423,000 in current liabilities and a decrease of $25,642,000 in cash, certificates of deposit, and short-term securities which totaled $55,382,000 at the close of 1972. The company did not find it necessary to use any part of the $65 million line of credit which was arranged in 1972 (for details, see OPERATING REVENUE VS. OPERATING EXPENSE OPERATING REVENUE OPERATING EXPENSE 340 320 (I.I ~ 300 ~ ~ :i 280 I (I.I ~ 280 ~ 240 220 200 180 160 1968 1969 1970 1971 1972 7 Brief Statement of Earnings Brief Balance Sheet (in thousands of dollars) (in thousands of dollars) Western's revenues came from: 1972 1971 Change Western owns: 1972 1971 Change Passengers Cash, certificates of deposit, and Coach $316,908 $272,038 +16.5% short-term securities . $ 55,382 $ 81,024 31.6 % Deluxe 25,943 23,769 + 9.1 Receivables due from others . 28,760 22,943 + 25.4 342,851 295,807 +15.9 Flight equipment Express, freight, and baggage 15,819 15,075 + 4.9 expendable parts . 10,456 9,733 + 7.4 Mail 5,000 5,156 - 3.0 Buildings and improvements, net 12,290 12,955 5.1 Charter 2,100 4,284 - 51.0 Flight and other equipment, net . 201,967 196,635 + 2.7 Interest income 2,832 3,190 - 11 .2 Deposits on purchase contracts . 24,772 7,148 +246.6 Other income 5,075 5,274 - 3.8 Prepaid expenses 4,332 5,422 20.1 Provisions for mutual aid Equipment not used in payments (5,181) operations, net 2,952 2,214 + 33.3 368,496 328,786 +12.1 Deferred charges and other . 1,620 2,278 28.9 342,531 340,352 - 0.6 Western's expenses were for: Wages and salaries 126,618 111,584 +13.5 Social security, group Western owes: insurance and retirement Payables due to vendors plans 20,664 15,491 +33.4 and others . 50,032 39,171 + 27.7 Aircraft fuel . 40,137 38,663 + 3.8 Federal income taxes-deferred. 19,033 19,433 2.1 Depreciation and amortization . 36,224* 35,144 + 3.1 Unamortized investment credits . 12,596 12,271 + 2.6 Materials and repairs 19,808 20,487 - 3.3 Tickets sold but not yet used . 6,843 5,281 + 29.6 Food and beverages 18,584 14,644 +26.9 Other deferred items 5,354 4,296 + 24.6 Utilities and services . 18,343 16,600 +10.5 Notes payable- current and Commissions 12,949 10,067 +28.6 long-term 151,950 173,503 12.4 Advertising and publicity 11,156 10,191 + 9.5 245,808 253,955 3.2 Interest, net of amounts Excess of what is owned over capitalized 8,787 11,162 - 21 .3 what is owed, or Landing fees 7,519 6,824 +10.2 shareholders' equity $ 96,723 $ 86,397 + 12.0 Property, fuel and other taxes 6,759 7,163 - 5.6 Rentals of ground facilities . 6,275 5,793 + 8.3 Insurance and related costs 5,285 5,869 - 10.0 Rentals of flying equipment 4,135 3,843 + 7.6 Other costs . 7,737 6,764 +14.4 Taxes on income 8,600 4,925 +74.6 Amortization of investment tax credits (2,300) (2,325) - 1.1 357,280 322,889 +10.7 Earnings before extraordinary gain 11 ,216 5,897 +90.2 Extraordinary gain- net 560 Net earnings $ 11,216 $ 6,457 +73.7 * Includes writedown of Boeing 720 nonfan aircraft amounting to $1 ,000 ($500 , or $0.04 a share, after taxes). 8 Note 3 of the Notes to Financial Statements). Long-term debt, exclusive of current matu- rities amounting to $21,463,000 reflected under current liabilities, totaled $130,487,000 and consisted of $38,925,000 of installment notes to a bank, $62 million of installment notes to insurance companies, and the 5 percent Convertible Subordinated Debentures amount- ing to $29,562,000. Although the bank loan agreement does not require Western to main- tain compensating balances, it is Western's practice to maintain deposits approximating 15 percent of borrowings under its loan agree- ment with each of the participating banks. Annual Meeting The 1973 meeting of shareholders will be held at the Beverly Hilton Hotel, Beverly Hills, Cali- fornia, on April 26. On or about March 26, for- mal notice of the meeting and proxy material will be mailed to each stockholder. Corporate Award Western received for the third consecutive year an award from the Financial Analysts Federa- tion for excellence in corporate reporting dur- ing 1971 . The company was one of only four airlines to win the honor which is given to com- panies who are judged superior in reporting financial information to stockholders and the financial community through press releases, reports to stockholders and interviews with financial analysts. Dividends At a special meeting held in August, your board of directors voted to resume payment of divi - dends by declaring a cash dividend of 1 O cents a share on pre-split shares (four cents on split shares) which was paid on September 12. An additional cash dividend of five cents a share on the split shares was paid on November 28. In September 1972, Western's board of direc- tors expressed by resolution its intention to declare regular quarterly dividends, consistent with sound business principles, either in cash, stock or a combination of cash and stock, equivalent on the average to 50 percent of earnings. At its first regular quarterly meeting of 1973, the board of directors voted a stock dividend of three percent. The value of the stock dividend on the day it was declared plus the two cash dividends paid in 1972, amounts to somewhat more than 50 percent of 1972 earnings. At the same meeting , the board also voted a cash dividend of five cents a share. Both divi- dends are payable on April 10 to shareholders of record on February 20. Shareholders, Stock and Debentures On September 6, 1972, at a special meeting of shareholders , a proposal by the board of directors to increase authorized stock from 10 million shares to 25 million shares and to split outstanding shares 2-for-one was over- whelmingly approved. The split increased the NET EARNINGS (PROFIT) 14 12 10 8 - 6 - - u, 4 - - z 0 :::; 2 - - ~ 2 I 0 u, a: 5 - 2 ~ 0 -4 0 - 6 - 8 - 10 - 12 - 14 1968 1969 1970 1971 1972 Record profit was $18 million in 1966 9 10 "Determine that the thing can and shall be done, and then we shall find the way" - Abraham Lincoln Senior members of Western's management team are UPPER LEFT - Executive Vice PresideAt Dominic P. Renda (center) with members of corporate planning department. LOWER LEFT- Charles J. J. Cox (left), senior vice president-finance, with Eugene D. Olson, vice president-data processlng .. and systems. UPPER RIGHT-Arthur F. Gardner, senior vice president-operations, conducts on-time meeting which is attended daily by key members of executive staff to analyze previous day's operation. LOWER RIGHT -Senior Vice President- Marketing Philip E. Peirce (second from left) discusses return of " Very Important Bird" television commercials with members of advertising department. 11 12 number of Western shares outstanding from 5,404,000 to 13,511,000. Adjusted for the three percent stock divi- dend, there were 13,926,000 shares outstand- ing at the end of 1972 and 2,279,000 shares were reserved for conversion of the 5 per- cent Convertible Subordinated Debentures. The conversion price is $12.97 per share. Holders of the debentures receive interest pay- ments on February 1 and August 1. The company's stock was held by approxi- mately 10,500 shareholders at year end. At the 1972 annual meeting of shareholders in Beverly Hills in April, nearly 79 percent of all shares were represented in person or by proxy. Shareholders' equity at December 31, 1972, was $96,723,000, or $6.95 a share, compared to $86,397,000, or $6.22 a share, at December 31,1971. Equipment and Facilities At the end of 1972, Western operated 71 jet aircraft, compared to 69 at the end of 1971 . During the year, five Boeing 727-200s (ex- tended version) were added to the fleet. In Sep- tember 1972, three Boeing 720s which do not have the fanjet engines were removed from scheduled service and were transferred to "Flight equipment for sale" under Deferred Charges and Other Assets on the Balance Sheet. Three Lockheed Electras, which are leased to others , are carried in the same account. In early 1972, Western converted its five Boeing 707s to the " wide-body look" by install- ing sculptured wall panels, sculptured ceilings with indirect lighting and overhead baggage compartments instead of hat racks to make them more competitive with the wide-body jets. The five Boeing 727s which Western acquired in 1972 are all equipped with these modern interiors. The company plans to convert its six leased 727s to the same interior late this year. With the termination of the merger agree- ment with American, Western assumed respon- sibility for the purchase of the four DC-1 Os that had been ordered by American contingent upon successful consummation of the pro- posed merger. The purchase agreement be- tween Western and the manufacturer provided that if the merger were not approved, the four DC-1 Os would be acquired by Western and that Western would pay the progress payments on the aircraft which would have been due at an earlier date had Western ordered the aircraft originally. Payments of $16.9 million, including interest payments of $700,000, were made in August and an additional $6.6 million was paid during the balance of the year. One of the DC-10 aircraft will be delivered in April, two in June and one in July. All four air- craft will go into service by August 1 on long- haul, high-density routes where the company is now competing with wide-body jets or ex- pects to in the near future. In connection with the operation of DC-1 0 RETURN ON INVESTMENT 12% 1 2 % - - - - - - - - - - - - CAB GUIDELINE 10.5% 1 0 % - - - - - - - - - - - - 8%--===-- - - - - - - - - 1968 1969 1970 1971 1972 '1972 Figure for Trunk Carriers and PA is for Year-Ended 9/30/72. "A fair exterior is a silent recommendation" - Publilius Syrus As each of Western's facilities needs refurbishing , it is redecorated in the company's modern, bright and efficient " new look," typified by this ticket counter at Los Angeles International Airport. Western Airl, 13 14 aircraft, Western expects to expend substantial sums for airport terminal building improve- ments, a hangar addition and other related facilities that will be required to efficiently oper- ate and service these new-generation aircraft. Included will be a single "high bay" hangar and an employee parking structure at the com - pany's Los Angeles International Airport head - quarters at an estimated cost of nearly $1 O million, a $6 million expansion of passenger terminal facilities to provide four DC-10 gates at Los Angeles International Airport and major modifications of terminal facilities to accom- modate the DC-1 Os at San Francisco, Minne- apolis-St. Paul, Denver and Seattle-Tacoma. Western's Jet Fleet DC-10 8707-300C 87208 8727-200 8737-200 Owned 4 * 5 25 5 30 Leased 6 *To be delivered in April, June (2) and July 1973. Marketing Western carried a record 6,931,000 passen- gers in 1972, an 11 . 7 percent increase over the previous year. Passenger load factor for the year increased 4.5 points to 58.2 percent, its highest level since 1966. Passenger loads were increased by strikes which affected operations of a competing re- gional carrier in the first quarter and of a com - peting trunk carrier from July through Septem- ber. However, these gains were offset in part by the suspension of the company's authority to serve Juneau and Ketchikan, effective Febru - ary 7, 1972. Traffic to these two Alaska cities had accounted for three percent of the com - pany's total revenues during 1971 . Highlighting the company's marketing pro- grams during the year were: . . . continued advertising and promotion of first class legspace for every passenger on every flight, a Western feature that no other major carrier offers; . .. increased emphasis on providing our passengers with the best on-time performance in the industry; . . . a quality of total service both on the ground and in the air to give Western the best record in the industry in customer reaction; . .. and , in order to emphasize the company's overall attitude of hospitality and sincerity for the comfort of its passengers , champagne service was selected as the company's major marketing theme for the year. Enhanced by the teamwork and enthusiasm of the company's employees, each of these major programs was carried out efficiently and effectively. Reaction of coach and economy passengers (who represent approximately 88 percent of the nation 's air travel) continues to be enthusiastic. In its efforts to achieve the best possible on- time performance, your company's executive staff- president, division heads and appropri- ate department heads-meet every weekday at 8 a.m. to analyze the previous day's opera- tions. As a result, based on Civil Aeronautics Board standards, Western was No. 1 in the industry in on-time performance for 1972. Among the methods your company uses to determine customer attitudes toward its serv- ice is careful evaluation of commendations and complaints to the company and to the Civil Aeronautics Board. In 1972, the trend of both commendations and complaints addressed to the company was highly favorable. For ex- ample, Western had fewer complaints filed with the CAB than any other trunkline and had one of the lowest ratios of complaints per 100,000 passengers carried in the industry. As in the past, Western continued to stress in its marketing programs the many attractive leisure destinations that we serve. In 1972, your company carried more passengers between "The use of travelling is to regulate imagination by reality, and instead of thinking how things may be, to see them as they are" -Samuel Johnson 15 16 "Socieiy is built upon trust and trust upon one another's integriiy" - Robert South 17 18 the U.S. and Mexico than any other U.S. carrier, was the leading carrier between Alaska and the 48 contiguous states, and again was third in total traffic in the highly competitive Mainland-Hawaii market. For 1973, your company has geared itself to be even more aggressive and innovative in pursuit of larger market shares and higher load factors. Late in 1972, the sales and service divisions were combined into a new marketing division that also integrated product research and de- velopment and all phases of marketing into one closely knit organization. Introduced late in the year was a new internal program that encour- ages every employee and family member to participate more actively in selling Western's services and to receive appropriate recogni- tion for those efforts. The program is called "Team Up." It was introduced to employees and their families by 11 teams of company officers who held meetings in every city on the system. During 1973, Western plans to intensify its seasonal vacation-selling campaigns such as Ski Western's World, North Country Adventures and Take a Sunbreak. Western continues to be the industry leader in ethnic marketing. In California, for example, your company advertises in black-oriented newspapers and radio stations, Spanish-lan- guage newspapers and television, and both Japanese and Chinese-language newspapers. The company will continue to develop group travel which maintains a steady growth, partic- ularly in the leisure markets Western serves. A close working relationship also continues with travel agents and tour operators - who in 1972 accounted for 42 percent of the company's passenger sales. One of the most significant developments in group travel is a "Travel Group Charter" con- cept approved by the Civil Aeronautics Board in 1972. Western does not plan at present to operate these charters, but instead intends to compete aggressively against them and to sell our own product which in many respects is superior. Our program will be to explain through advertising that, as a result of the com- plexities of the travel group charters, a passen- ger may be far better off to select one of West- em's more reliable group package plans. Aiding our efforts in all of these areas will be the introduction of the four DC-10s that will go into service in the summer of 1973. The addi- tional capacity of these large wide-bodied air- craft (239 seats vs. 137 for the largest aircraft now in our fleet and much greater cargo ca- pacity) will permit the company to gain a larger share of available passengers and air cargo during peak travel periods without increasing frequency. Your company also will continue to expand its services to our customers who purchase travel through the use of Western's own "TravelCard" and other credit plans. In 1972, credit purchases on all credit plans utilized by 60% 59% 58% 57% 56% 55% 51% 50% 49% PASSENGER LOAD FACTOR ACTUALVS.BREAKEVEN ~ - ~ f- - 46%-----:.-,.... _ _ _ _ _ _ _ _ 47% - - - - - - - - - - - - - 4 6 % - - - - - - - - - - - - - 4 5 % - - - - - - - - - - - - - - 1968 1969 1970 1971 1972 our customers increased 20 percent to a total of $95,759,000, or 29 percent of total passen- ger sales. Personnel As of December 31, Western had 9,676 em- ployees, compared to 9,039 at the end of 1971 . Wages and salaries for 1972 amounted to $126,618,000 (37.0 percent of operating ex- penses) compared to $111,584,000 (36.1 per- cent of operating expenses) in the previous year. Company contributions to Social Secu- rity, group insurance and employee retirement plans increased 33.4 percent to $20,664,000. Approximately 85 percent of the company's employees are represented by four unions. Following is the contractual status for each group of these employees. Employee No. of Contract Open Employees Group on 12/31 /72 for Amendment Clerical , Office, 3,673 October 1, 1972 Fleet & Passen- (in mediation on ger Service date of this report) Pilots 1,222 March 1, 1973 Dispatchers 39 June 30, 1973 Mechanics 1,830 November 16, 1973 & Related Employees Stock Clerks 117 November 16, 1973 Flight Attendants 1,312 April1,1974 Management Changes Elected to the board of directors at the board 's October meeting was Walter J. Hickel, former Secretary of the Interior and governor of Alaska. Hickel succeeded William Boyd, who resigned effective September 15, 1972. At its first meeting of 1973, the board of directors elected Arthur F. Kelly, a veteran of 35 years with the company, president and chief executive officer to succeed J. Judson Taylor, 64, who was elected vice chairman at the same meeting. Mr. Kelly, who had been promoted from senior vice president-marketing to executive vice president in October, joined the company in 1937 as a regional manager. He was elected vice president in 1949, a senior vice president in 1965 and to the board of directors in 1968. Also elected a vice chairman at the October directors' meeting was Stanley R. Shatto, for- mer executive vice president-transportation. Mr. Shatto, 64, had headed up the company's operations division since 1947. Returning to Western as an executive vice president on January 1; 1973, was Dominic P. Renda, a veteran of 27 years in the air trans- portation industry. Mr. Renda had served with Western at the executive level from 1946 to 1968 and for the past five years has been senior vice president-international and public affairs of Continental Airlines and president of Air Micronesia. At the board of directors' first meeting of 1973, Mr. Renda also was elected to the board succeeding Edwin W. Pauley who resigned and was named a director-emeritus. Other officers elected to increased responsi- bilities during 1972 were: Charles J. J. Cox to 11,000 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 PASSENGER MILES VS. SEAT MILES SEAT MILES PASSENGER MILES 1968 1969 1970 1971 1972 19 20 senior vice president-finance from vice presi- dent-finance; Arthur F. Gardner to senior vice president-operations from line captain; Gerald P. O'Grady to senior vice president-legal and secretary from vice president-corporate affairs and secretary; Philip E. Peirce to senior vice president- marketing from senior vice presi- dent-service; Richard 0. Hammond to vice president and treasurer from treasurer and assistant secretary; Roderick G. Leith to vice president and controller from assistant treas- urer and controller; and Robert Leinster from assistant vice president-service (staff) to vice president. In January 1973, Robert 0. Kinsey, formerly vice president and assistant to the president, was named vice president-corpo- rate planning. Regulatory Matters Merger Case-On July 28, 1972, the Civil Aeronautics Board denied the application of Western and American Airlines for approval of a merger that had been proposed in an agree- ment reached in late 1970. The CAB indicated that the application was denied principally because approval of the merger would have given American routes to Hawaii from the western states which would have been incon- sistent with the CAB's 1969 decision on Trans- pacific route patterns. Alaska Service Case Appeal- In December 1971, the CAB suspended effective February 7, 1972, the company's authority to serve Ketchikan and Juneau for a period of seven years. Western appealed the decision to the U.S. Court of Appeals for the District of Colum- bia Circuit seeking a reversal of the CAB deci- sion on the grounds that the agency exceeded its statutory authority and set a dangerous precedent when it took away from one carrier a profitable, permanently certificated route not for the purpose of correcting any deficiencies in service but for the purpose of providing financial assistance to another carrier. Argu - ments before the court were completed on June 16, 1972, but at the time this report was written no decision had been announced. The Miami-Los Angeles Competitive Non- stop Case-Western is an applicant, along with eight other carriers, for competitive authority on the Miami-Los Angeles nonstop route which is now served exclusively by National Airlines. Hearings in the case were completed on February 12, 1973. A final decision is not expected until late in 1973 or early 197 4. Reopened San Diego Service Case - In 1970, Western was awarded authority to pro- vide the first nonstop service between San Diego and Denver and inaugurated the service in June of that year. In April 1971, the CAB ordered further hearings to receive additional evidence on the question of authorizing com- petition over the route. On December 12, 1972, the CAB decided to permit Western to continue to operate the route on an exclusive basis. Certain parties have requested the CAB to reconsider and reverse its December action and to authorize a competing carrier over the route. Such requests remain pending at the time of the writing of this report. Las Vegas/ Reno-Portland I Seattle Nonstop Service Investigation-Western is an applicant for the nonstop service between Las Vegas and Portland/Seattle, between Reno and Portland/Seattle and between Las Vegas and Reno. The administrative law judge's initial decision issued in January 1971, concluded that Western should be authorized to operate between Las Vegas and Portland/Seattle, that another carrier should be authorized to oper- ate between Reno and Portland/Seattle and that Western's request for authority to operate between Las Vegas and Reno should be denied. Upon review, the CAB remanded the case to the administrative law judge for further proceedings. Hearings were completed on February 15, 1973. A final decision is not expected until late 1973 or early 1974. \\Eternal vigilance is the price of liberiy" - John Philpot Curran Strict security measures, including checkpoints similar to this one at Los Angeles International Airport, are in effect at all Western facilities and airports served by the company. 21 Ten Years of Growth Financial 1972/1971 1972 1971 1970 19694 1968 1967 19664 1965 1964 1963 Revenues:7 Passenger + 15.9% $ 342,851 295,807 274,792 220,530 205,753 178,527 164,186 129,704 121,928 103,183 Express, freight and excess baggage . + 4.9 15,819 15,075 13,993 11,969 9,331 7,581 6,848 5,991 5,897 5,055 Mail 3.0 5,000 5,156 4,752 4,503 4,128 4,221 4,255 3,135 2,962 2,603 Other . 24.9 7,174 9,557 7,272 3,350 2,741 2,153 1,895 1,768 2,095 3,472 Provisions for mutual aid payments (5,181) (2,700) Total Revenues . + 12.3 365,663 325,595 298,109 240,352 221,953 192,482 177,184 140,598 132,882 114,313 Operating Expenses:7 Depreciation and amortization . + 3.1 36,224 35,144 36,583 34,821 25,051 20,085 15,779 14,676 12,980 12,373 Payroll + 13.5 126,618 11.1 ,584 100,629 87,495 71 ,885 57,975 47,350 38,73 1 34,500 30,114 Other . + 10.2 179,214 162,561 149,086 130,437 105,335 89,082 77,708 62,391 57,650 50,969 Total Operating Expenses + 10.6 342,056 309,289 286,298 252,753 202,271 167,142 140,837 115,798 105,130 93,456 Operating Income (Loss) 7 + 44.8 23,607 16,306 11,811 (12,401) 19,682 25,340 36,347 24,800 27,752 20,857 Interest expense, net of amounts capitalized7 . 21.3 (8,787) (11,162) (14,586) 0 4,748) (6,536) (3,011) (3,239) (2,553) (2,491) (2,916) Other Income and Expenses- Net7 19.6 2,696 3,353 1,120 (125) 15 17 775 253 783 621 Earnings (loss) before extraordinary gains and taxes on income5 7 +106.1 17,516 8,497 (1,655) (27,274) 13,161 22,346 33,883 22,500 26,044 18,562 Taxes on Income (Tax Credits)7 +142.3 6,300 2,600 (2,250) (15,075) 4,725 10,125 15,558 10,337 12,493 9,252 Earnings (loss) before extraordinary gains5 7 + 90.2 11,216 5,897 595 (12,199) 8,436 12,221 18,325 12,163 13,551 9,310 Extraordinary gains (less applicable income taxes) 5 7 560 883 191 Net Earnings (Loss) 7 + 73.7 $ 11,216 6,457 595 (12,199) 8,436 12,221 18,325 13,046 13,551 9,501 Primary earnings (loss) per share before extraordinary items2 5 . $ 0.81 0.42 0.04 (0.88) 0.61 0.89 1.34 0.89 0.99 0.68 Primary net earnings per share2 $ 0.81 0.46 0.04 (0.88) 0.61 0.89 1.34 0.95 0.99 0.70 Fully diluted earnings (loss) per share before extraordinary items5 $ 0.74 0.41 0.04 (0.88) 0.58 Fully diluted net earnings (loss) per share . $ 0.74 0.45 0.04 (0.88) 0.58 Return on investment % 6 6.35 5.93 5.22 0.71 6.54 10.28 16.28 15.37 18.72 14.49 Cash dividends paid per share3 $ 0.09 0.18 0.35 0.35 0.35 0.28 0.23 0.13 Stock dividends paid per share (3% in April 1973) . 10% Shares outstanding - actual 7 +150.6 13,521 5,395 4,904 4,904 4,902 4,893 4,835 4,826 4,826 1,609 -adjusted 7 + 0.2 13,926 13,894 13,890 13,890 13,884 13,860 13,696 13,670 13,670 13,670 Shareholders' equity-total 1 + 12.0 $ 96,723 86,397 79,905 79,310 93,862 90,016 81,750 67,361 57,748 46,988 Shareholders' equity-a share 6.95 6.22 5.75 5.71 6.76 6.50 5.97 4.93 4.22 3.44 Working capital7 61.3 20,592 53,207 35,238 20,447 25,764 19,585 18,047 11,522 8,274 5,031 Long-term debt7 14.2 130,487 152,040 174,184 197,150 183,718 80,189 54,867 47,411 33,938 41,106 Property and equipment-net7 + 10.3 239,029 216,738 247,426 285,757 284,787 183,106 145,771 124,096 99,928 93,284 Total assets 7 + 0.6 342,531 340,352 355,168 367,588 349,039 231 ,342 192,008 157,973 138,335 125,806 Operations Airplanes operated at end of year: Boeing 720-B 25 25 26 26 27 27 22 18 12 10 Boeing 707-300C 5 5 5 5 5 Boeing 737 30 30 30 30 17 Boeing 727-200-owned 5 Boeing 727-200- leased 6 6 6 6 Other . 4 5 11 15 24 26 26 35 35 Airplane miles flown7 . + 5.2 90,925 86,425 86,298 72,650 60,125 51,692 42,830 36,554 36,746 33,388 Available ton miles7 + 5.0 1,328,871 1,266,130 1,266,124 1,077,657 891,001 728,200 585,378 483,033 450,856 400,395 Revenue ton miles4 7 . + 12.9 675,825 598,448 584,554 448,420 418,856 360,791 314,137 244,588 231,303 191,229 Available seat miles7 + 5.4 10,300,178 9,776,869 9,839,299 8,509,441 7,096,229 5,879,442 4,800,901 4,016,921 3,794,648 3,335,083 Revenue passenger miles 7 + 14.2 5,995,925 5,251,989 5,159,081 4,021,296 3,841,864 3,327,160 2,898,088 2,243,695 2,124,582 1,753,037 Express, freight and mail revenue ton miles7 + 4.1 76,233 73,249 68,646 60,514 47,446 38,940 33,070 26,435 24,625 20,622 Passengers carried+ . + 11 .7 6,930,874 6,206,440 6,187,527 5,752,072 5,692,947 5,107,672 4,700,839 3,807,706 3,717,189 2,970,909 Express, freight and mail tons carried 2.7 75,649 77,731 73,140 66,107 58,129 48,579 42,714 33,511 30,956 25,890 Passenger load factor- actual + 4.5 pts % 58.2 53.7 52.4 47.3 54.1 56.6 60.4 55.9 56.0 52.5 -breakeven point + 2.2 pts % 54.4 52.2 52.7 53.1 50.7 49.5 47.9 46.2 44.4 44.3 Average length in miles per passenger trip . + 2.2% 865 846 834 699 675 651 616 589 572 590 Operating expenses per available seat mile + 5.1 $ .0332 .0316 .0291 .0297 .0285 .0284 .0293 .0288 .0277 .0280 Average revenue per revenue passenger mile. + 0.2 $ .0578 .0577 .0542 .0551 .0537 .0537 .0567 .0578 .0574 .0589 Employees at end of year + 7.0 9,676 9,039 8,830 9,225 8,919 7,282 6,294 5,068 4,719 4,126 1 All financial data in this report give effect, retroactively throughout the March 5, 1971 , the May 1964 three-for-one split, and the equivalent operat i ons of a competing trunk carrier were substantially suspended from 5 Extraordinary gains are from the involuntary conversion of and major periods prior to 1968, to the merger of Pacific Northern Airlines into outstanding shares of Pacific Northern Airl ines, Inc., merged into the June 30, 1972, to October 2, 1972. Operations of a competing regional sales of aircraft. Western on July 1, 1967, which was accounted for as a pooling of interests. Company on July 1, 1967. carrier were substantially suspended from December 15, 1971 to April 10, bThe methodology used to compute the rate of return is essentially 2 Based on the weighted average number of shares of the Company 3 Cash dividends per share for periods prior to January 1, 1967, are stated 1972. Operations of a competing trunk carrier were substantially that used by the CAB. outstanding during the respective periods, adjusted to give retroactive on the basis of the Company's shares (exclusive of equ ival ent Pacific suspended from July 8 to December 14, 1970. Western's operations were 7 OOOs omitted . effect to the 3% stock dividend declared January 22, 1973, the 2-for-1 Northern shares) outstanding at the date such dividend s were declared as suspended from July 29 to August 16, 1969, because of a strike. 22 stock split effected September 13, 1972, the 10% stock dividend paid adjusted for the stock dividends and the stock spl its. Five other major carriers were struck from July 8 to August 19, 1966. 23 Balance Sheet Western Air Lines, Inc. December 31, 1972 and 1971 (in thousands of dollars) ASSETS Current Assets: Cash . Certificates of deposit Short-term securities (at amortized cost, including accrued interest, which approximates market) Receivables (net of allowance for doubtful accounts of $475 in 1972 and $475 in 1971) Flight equipment expendable parts, at average cost less allowance for obsolescence of $5,371 in 19n and $4,281 in 1971 (Note 1) Prepaid expenses . Total current assets . Properties and Equipment at Cost: Flight equipment . Ground equipment Deposits on aircraft purchase contracts (Notes 1 and 4) Less allowance for depreciation and amortization (including reserves for overhauls of flight equipment of $18,164 in 1972 and $20,237 in 1971) (Notes 1 and 9) Deferred Charges and Other Assets: Flight equipment for sale Other items . See accompanying Notes to Financial Statements. 24 1972 1971 Change $ 10,506 $ 13,446 21.9% 19,502 30,056 35.1 25,374 37,522 32.4 55,382 81,024 31.6 28,760 22,943 + 25.4 10,456 9,733 + 7.4 4,332 5,422 20.1 98,930 119,122 17.0 363,957 345,539 + 5.3 63,604 60,925 + 4.4 24,772 7,148 +246.6 452,333 413,612 + 9.4 213,304 196,874 + 8.3 239,029 216,738 + 10.3 2,952 2,214 + 33.3 1,620 2,278 28.9 4,572 4,492 + 1.8 $342,531 $340,352 + 0.6 LIABILITIES AND SHAREHOLDERS' EQUITY 1972 1971 Change Current Liabilities: Accounts payable. $ 20,726 $ 16,606 + 24.8% Accrued salaries, wages and vacation benefits 15,550 13,374 + 16.3 Accrued liabilities. 7,459 6,893 + 8.2 Accrued income taxes 6,297 2,298 +174.0 Advance ticket sales . 6,843 5,281 + 29.6 Current maturities of long-term debt (Note 3) 21,463 21,463 Total current liabilities . 78,338 65,915 + 18.8 Long-Term Debt (Note 3) . 130,487 152,040 14.2 Deferred Credits (Notes 1 and 2): Deferred federal taxes on income 19,033 19,433 2.1 Unamortized investment tax credits 12,596 12,271 + 2.6 Reserves for overhauls of leased flight equipment 1,707 1,632 + 4.6 Other . 3,647 2,664 + 36.9 36,983 36,000 + 2.7 Shareholders' Equity (Notes 3, 6 and 8): Common stock-$1.00 par value per share Authorized 25,000,000 shares Issued 13,521,000 and 5,395,000 shares 13,521 5,395 +150.6 Capital in excess of par value . 21,951 29,750 - 26.2 Retained earnings 61,251 51,252 + 19.5 96,723 86,397 + 12.0 Commitments and Contingent Liabilities (Note 4). $342,531 $340,352 + 0.6 25 Statement of Earnings For the years ended December 31, 1972 and 1971 (in thou sands of dollars) Operating Revenues: Passenger Express, freight and excess baggage Mail Other . Provisions for mutual aid payments (Note 7) Operating Expenses: Flying operations . Maintenance Passenger service Aircraft and traffic servicing Marketing and administrative Depreciation and amortization (Notes 1 and 9) Operating income Other Income (Expense): Interest expense Interest capitalized (Note 1) Interest income Other- net . Earnings before taxes on income and extraordinary gain Taxes on income (Notes 1 and 2) Earnings before extraordinary gain Extraordinary gain net of income taxes (Note 2) Net earnings Per share data (Note 10): Primary: Earnings before extraordinary gain Net earnings. Fully diluted (assuming conversion of the debentures) : Earnings before extraordinary gain Net earnings . * Includes write -down of Boeing 720 nonfan aircraft amounting to $1,000 ($500, or $0.04 a share, after taxes) . * *The extraordinary gain resulted from the involuntary conversion of an aircraft. See accompanying Notes to Financial Statements. 26 1972 $342,851 15,819 5,000 7,174 (5,181) 365,663 91,213 37,1 02 40,964 69,390 67,163 36,224* 342,056 23,607 (10,240) 1,453 2,832 (136) 17,516 6,300 11 ,216 $ 11 ,216 $ 0.81 0.81 0.74 0.74 1971 Change $295,807 + 15.9% 15,075 + 4.9 5,156 3.0 9,557 24.9 325,595 + 12.3 82,958 + 10.0 39,422 5.9 34,652 + 18.2 58,173 + 19.3 58,940 + 14.0 35,144 + 3.1 309,289 + 10.6 16,306 + 44.8 (11,278) 9.2 116 3,190 11 .2 163 8,497 + 106.1 2,600 + 142.3 5,897 + 90.2 560 ** $ 6,457 + 73.7 $ 0.42 0.46 0.41 0.45 Statement of Changes in Financial Position For the years ended December 31, 1972 and 1971 (in thousands of dollars) Sources of Working Capital: Earnings before extraordinary gain Add back charges (credits) which did not affect working capital: Depreciation, amortization and provision for overhauls (Notes 1 and 9) Taxes (Notes 1 and 2): Deferred income taxes Investment credits applied and deferred to future periods Amortization of investment credits . Other . Total from operations before extraordinary gain . Extraordinary gain, after deducting credits of $1 ,960 which did not affect working capital . Total from operations Proceeds from disposition of property: Involuntary conversion of an aircraft . Other . Exercise of stock options . Other Total sources of working capital . Applications of Working Capital: Cash dividends . Purchases of property and equipment, net of deposits previously made Deposits on aircraft purchase contracts (Notes 1 and 4) . Payments of long-term debt and transfers to current liabilities Total applications of working capital . Increase (Decrease) in Working Capital Summary of Changes in Working Capital: Increases (decreases) in current assets: Cash, certificates of deposit, and short-term securities . Inventories, receivables, and prepaid expenses . Decreases (increases) in current liabilities Increase (decrease) in working capital . *The net proceeds from the involuntary conversion of an aircraft were $3,500 after current income taxes of $1,400. See accompanying Notes to Financial Statements. $ 1972 11,216 35,254 (3,275) 5,500 (2,300) 811 47,206 47,206 1,689 236 130 49,261 1,217 36,403 22,793 21,463 81,876 $ (32,615) $ (25,642) 5,450 (12,423) $ (32,615) 1971 $ 5,897 38,607 2,600 1,200 (2,325) 438 46,417 (1 ,400)* 45,01 7 4,900* 526 35 183 50,661 3,400 7,148 22,144 32,692 $17,969 $16,423 684 862 $17,969 27 Statement of Shareholders' Equity For the years ended December 31, 1972 and 1971 (in thousands of dollars) Balance at December 31, 1970 Exercise of stock options 10% stock dividend Net earnings Balance at December 31, 1971 Exercise of stock options Conversion of debentures 2 for 1 stock split (Note 8) Net earnings Cash dividends ($0.09 per share) . Balance at December 31, 1972 (Notes 3 and 8) See accompanying Notes to Financial Statements. Common Stock $1.00 Par Value $ 4,904 1 490 5,395 16 3 8,107 $13,521 Capital in Excess of Retained Shareholders' Par Value Earnings Equit $19,235 $55,766 $79,905 34 35 10,481 (10,971) 6,457 6,457 29,750 51,252 86,397 220 236 88 91 (8,107) 11,216 11,216 (1,217) (1,217) $21,951 $61,251 $96,723 Notes to Financial Statements Note 1. Summary of Significant Accounting Policies. a. Depreciation Method: Depreciation is provided by allocating costs of property and equipment, exclusive of estimated residual values, over estimated useful lives by using the straight-line method. See Note 9 for estimated useful lives. b. Preoperating Costs: When new types of aircraft are introduced, major costs, principally related to training, necessary to put new aircraft into service are deferred and amortized during the estimated periods to be benefited. c. Reserves for Aircraft Overhauls: The estimated future costs of airframe and engine overhauls are provided for by charges to maintenance expense based on hours flown. d. Interest Capitalized: Interest related to deposits on aircraft purchase contracts with manufacturers is capital- ized and amortized over the useful lives of the equipment. e. Investment Tax Credits: Investment tax credits gener- ated by acquisitions of assets to the extent used to reduce current and/or deferred taxes are amortized to income over the useful lives of the related assets. f. Obsolescence of Expendable Parts: An allowance for obsolescence of flight equipment expendable parts is accrued over the useful lives of the related aircraft types. Note 2. Taxes on Income: The 1972 and 1971 income taxes are summarized as follows (in thousands) : Exclusive of taxes related to extraordinary gain: 28 Current income taxes- Federal State Deferred income taxes (credit) Investment credits applied and deferred to future periods Amortization of deferred investment credits . 1972 1971 $5,300 $ 150 1,075 975 (3,275) 2,600 5,500 1,200 (2,300) (2,325) 6,300 2,600 Related to extraordinary gain: Current income taxes . Deferred income taxes (credit) 1972 1971 1,400 (850) 550 $6,300 $3,150 Deferred income taxes arise from timing differences between financial and tax reporting. These differences are caused primarily by depreciation practices. Investment credits unapplied on tax returns amounted to $14,434,000 at December 31, 1972 ($17,308,000 - 1971) with $8,205,000 expiring in 1978 and $6,229,000 expiring in 1979. Of the $12,596,000 unamortized investment credit balance at December 31, 1972 ($12,271,000 - 1971 ), $3,000,000 ($1,340,000-1971) remains from investment credits uti- I ized by reduction of taxes paid and $9,596,000 ($10,931,000-1971) is related to investment credits not yet utilized for reduction of taxes paid. The federal income tax returns for 1968, 1969 and 1970 are being examined by the Internal Revenue Service. Note 3. Long-term Debt (Unsecured): At December 31, 1972, and December 31, 1971, long-term debt was as follows (in thousands) : Senior Debt: Installment note* due December 31, 1975, with quarterly principal payments of $4,865. The interest rate is % over the bank's 1972 1971 prime commercial rate . . . $ 58,388 $ 77,850 5 % installment notes due September 1, 1981, with annual principal payments of $1,000 from September 1, 1972, which will increase to $4,000 a year starting in 1976 . 27,000 28,000 65/a% installment notes due September 1, 1984, with annual principal payments of $1,000 from September 1, 1972, which will increase to $2,000 a year starting in 1975 and further increase to $7,000 a year starting in 1982 Less current maturities Subordinated Debt: 5 % convertible subordinated debentures due February 1, 1993, with sinking fund payments of $1,500 a year starting in 1979 1972 1971 37,000 122,388 21,463 100,925 29,562 38,000 143,850 21,463 122,387 29,653 $130,487 $152,040 *The agreement under which the installment note to a bank is issued was amended in late 1972 to provide for an addi- tional $65,000,000 line of credit. The new borrowings will be on a revolving basis until December 31, 1973, at which time the amount borrowed may be converted by Western into a term loan due June 30, 1979, and payable in sub- stantially equal quarterly installments commencing March 31, 1976. The interest rate will be % over the bank's prime rate until the end of 1973 when it will become % over the bank's prime rate prevailing during the remaining term of the loan. The following schedule shows the amount of long-term debt maturing in each of the five following calendar years (assuming that $65,000,000 of funds available under the line of credit will be drawn down and converted into a long-term loan): 1973 1974 1975 1976 1977 $21,463,000 21,463,000 22,463,000 25,460,000 25,460,000 The financial agreements related to the senior debt pro- vide, among other things (including restrictions on addi- tional borrowings) , conditions and requirements which operate to restrict retained earnings from which cash divi- dend distributions can be made. In addition, the Indenture for the debentures provides, among other things, a require- ment restricting retained earnings from which cash divi- dend distributions can be made. Under the most restrictive requirements of these agreements, retained earnings not restricted from cash dividends were $10,387,000 at December 31, 1972 ($1 ,363,000-1971). At December 31 , 1972, 2,213,000 shares of common stock were reserved for conversion of debentures (2,279,000 shares at a conversion price of $12.97 a share after giving effect to the three percent stock dividend declared on January 22, 1973). Note 4. Commitments and Contingent Liabilities: The estimated minimum annual rentals under long-term leases of ground facilities with expiration dates ranging to the year 2000, were approximately $4,000,000 at December 31, 1972 ($3,200,000- 1971). Annual rentals through 1984 under a lease agreement covering six Boeing 727 aircraft aggregate $4,130,000. At December 31 , 1972, Western had on order four McDonnell Douglas DC-10 aircraft for delivery in April , June (two) and July 1973. The cost, including spare parts and five spare engines, is estimated to be $90,000,000 of which $22,793,000 has been paid in advance deposits. At December 31 , 1972, various legal actions were pending against the City of Los Angeles and various actions and cross actions were pending against Western and other airlines, alleging excessive aircraft noise in the vicinity of Los Angeles International Airport. Western's counsel in these actions, which also represents most of the other air- lines, is of the opinion that the airlines have substantial defenses to the imposition of any liability. In three such actions against the City of Los Angeles, judgments (one of which is being appealed) have been entered against the City for damages aggregating $1 ,184,000 to approximately 578 property owners on the theory of inverse condemna- tion. In another action wherein the plaintiff was awarded judgment against the City for $14,000, the court decided in favor of the airline cross-defendants on the issue of indemnification and the City has appealed such ruling . Western is a defendant along with other domestic airlines in numerous actions seeking repayment and damages involving the collection of allegedly illegal fares. In the opinions of Western and of the counsel representing the carriers, the carriers involved are not liable for the repay- ment of any or all of the fares in question. Western and other domestic airlines are also defendants in various purported class actions including actions seeking refunds of alleged overcharges in construction of joint fares over interline routings. In the opinion of management, such action will not result in a material adverse effect upon Western 's financial statements. Note 5. Retirement Plans: Retirement plans cover all classes of employees except mechanics and related employees who are covered by a union sponsored plan toward which the company makes monthly contributions. Costs of company sponsored plans are funded annually as benefits accrue. Actuarial gains and losses and costs of changes in benefits are amortized over ten-year periods. The costs of all plans charged to operating expenses totaled $9,622,000 in 1972 and $6,504,000 in 1971. The increase in 1972 costs over 1971 costs was caused pri- marily by an increased number of pilots becoming eligible for coverage. The company's actuaries are of the opinion that the assets under each company administered plan ex- ceed the related liabilities for the accrued vested benefits. Note 6. Stock Options: The qualified stock option plan for officers is summarized as follows (adjusted for stock splits and stock dividends) : 1972 1971 Average Average per per Shares share Shares share Granted . 17,382 $15.20 16,738 $12.20 Exercised 25,542 9.25 3,811 9.17 Exercisable at end of year . 182,775 9.64 125,300 9.42 Outstanding at end of year . 311 ,248 9.90 319,408 9.56 An additional 186,809 shares were reserved at December 31 , 1972, for the issuance of additional options. Note 7. Mutual Aid Agreement: Western is a party to the Mutual Aid Agreement which provides for mutual financial aid in the event that any of the participating carriers is forced to suspend operations because of certain types of strikes. Operations of a competing trunk carrier were sub- stantially suspended from June 30 to October 2, 1972, and operations of a competing local service carrier were sub- 29 stantially suspended from December 15, 1971, to April 10, 1972. Both of these carriers were parties to this agreement. Note 8. Stock Split and Stock Dividend: An increase in authorized capital stock from 10,000,000 to 25,000,000 shares and a two and one-half for one stock split were effected September 13, 1972. The stock split, requiring issuance of 8,107,000 additional shares, was recorded by a transfer of $8,107,000 from capital in excess of par value to common stock. On January 22, 1973, a three percent stock dividend, requiring issuance of 405,000 additional shares was declared payable on April 10, 1973, to shareholders of record on February 20, 1973. The dividend will be recorded in 1973 by a transfer from retained earnings of $405,000 to common stock and of $4,513,000 to capital in excess of par value. Note 9. Depreciation and Amortization: The estimated useful lives over which costs of operating property and equipment are amortized are as follows: for the five Boeing 707-300C aircraft acquired in 1968, the thirty Boeing 737- 200 aircraft acquired in 1968 and 1969, and the five Boeing Accountants' Report 727 aircraft acquired in 1972, 12 years to a residual value of 15%; for the seventeen Boeing 720B aircraft acquired during 1961 to 1965, 1 Oto 15 years with a common retire- ment of December 31, 1975 and a residual value of $100,000 per aircraft; and for the eight Boeing 720B aircraft acquired in 1966 and 1967, 10 years to a residual value of $100,000 per aircraft. For ground equipment the- useful lives range from four to ten years. For buildings and im- provements on leased property the estimated useful lives are generally the period of the leases. Note 10. Earnings per Share: Earnings per common share are based on the weighted average number of shares of common stock outstanding during the respective periods, adjusted when appropriate to give retroactive effect to stock splits and stock dividends including the 3% stock dividend declared on January 22, 1973. Earnings per common share assuming dilution from conversion of the debentures are calculated as if the debentures were con - verted at the beginning of the period with related adjust- ments to interest and income tax expense. Outstanding stock options have no material dilutive effect on earnings per common share. PEAT, MARWICK, MITCHELL & Co. 30 CERTIFIED PUBLIC ACCOUNTANTS 555 SOUTH FLOWER STREET LOS ANGELES, CALIFORNIA 90071 The Board of Directors Western Air Lines, Inc.: We have examined the balance sheet of Western Air Lines, Inc. as of December 31, 1972 and 1971 and the related statements of earnings, shareholders' equity, and changes in financial position for the respective years 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. In our opinion, the aforementioned financial statements present fairly the financial posi- tion of Western Air Lines, Inc. at December 31, 1972 and 1971, and the results of its operations and changes in its financial position and shareholders' equity for the respec- tive years then ended in conformity with generally accepted accounting principles applied on a consistent basis. Los Angeles, California February 16, 1973 Board of Directors James D. Aljian General Manager, Tracinda Investment Company, Beverly Hills, California Fred Benninger Chairman of the Board, Western Air Lines, Inc., Los Angeles, California Chairman of the Board, Metro-Goldwyn-Mayer, Inc., Culver City, California Chairman of the Board , MGM Grand Hotel, Inc., Las Vegas, Nevada Hugh W. Darling Senior Partner, Darling , Hall, Rae & Gute, Attorneys-at-Law, Los Angeles, California Leo H. Dwerlkotte Las Vegas, Nevada James D. Garibaldi Attorney-at-Law, Garibald i & Lane, Los Angeles, California Cary Grant Actor-Producer, Beverly Hills, California Director and Executive, Faberge, Inc., New York, New York Walter J. Hickel Chairman of the Board , Hickel Investment Company, Anchorage, Alaska Arthur F. Kelly President, Western Air Lines, Inc., Los Angeles, California Peter M. Kennedy Chairman, Dominick & Domin ick, New York, New York Kirk Kerkorian Sole Proprietor, Tracinda Investment Company, Beverly Hills, California Arthur G. Linkletter Radio and Television Performer Chairman of the Board , Linkletter Productions, Beverly Hills, California Dominic P. Renda Executive Vice President, Western Air Lines, Inc., Los Angeles, California Walter M. Sharp President, Community Bank, Huntington Park, California Stanley R. Shatto Vice Chairman of the Board , Western Ai r Lines, Inc., Los Angeles, California William Singleton Vice Presfdent-Corporate Development, Metro-Goldwyn-Mayer, Inc., Culver City, California J. Judson Taylor Vice Chairman of the Board , Western Air Lines, Inc., Los Angeles, California Vernon 0. Underwood President, Young 's Market Company, Inc., Los Angeles, California Harry J. Volk Chairman, Unionamerica, Inc., Los Angeles, California Chairman, Union Bank, Los Angeles, California Arthur G. Woodley Bellevue, Washington Richard W. Wright President, Mountain States Employers Council , Inc., Denver, Colorado Directors Emeriti Dr. Donald H. Mclaughlin. Chairman of the Board , Homestake Mining Company, San Francisco, California Edwin W. Pauley Chairman of the Board, Pauley Petroleum, Inc., Los Angeles, California John M. Wallace Walker Bank & Trust Company, Salt Lake City, Utah Sidney F. Woodbury President, Pine Street Company, Portland, Oregon In Memoriam Alexander Warden, a director from 1950 until his retirement in 1968 and a director-emeritus since that time, passed away on March 7, 1973. His contributions to the development of the com- pany are deeply appreciated by his friends and associates at Western. 31 Corporate Officers Fred Benninger, Chairman of the Board Arthur F. Kelly, President and Chief Executive Officer J. Judson Taylor, Vice Chairman of the Board Stanley R. Shatto, Vice Chairman of the Board Dominic P. Renda, Executive Vice President Charles J. J. Cox, Senior Vice President-Finance Arthur F. Gardner, Senior Vice President-Operations Philip E. Peirce, Senior Vice President-Marketing Administration Division Dominic P. Renda, Executive Vice President Gerald P. O'Grady, Senior Vice President-Legal and Secretary Robert 0. Kinsey, Vice President-Corporate Planning Lawrence H. Lee, Vice President- Industrial Relations Ray Silvius, Vice President-Public Relations Jack M. Slichter, Vice President-Government and Industry Affairs Henry M. deButts, Vice President-Washington, D.C. Ernest T. Kaufmann, Vice President-Regulatory Affairs Charles S. Fisher, Assistant Vice President- Product Planning H. S. Gray, Assistant Treasurer-Financial Planning Thomas J. Greene, Assistant Secretary Neil S. Stewart, Assistant Vice President-Government Affairs Dan A. Zaich, Assistant Vice President-Labor Relations Finance Division Charles J. J. Cox, Senior Vice President-Finance Richard 0. Hammond, Vice President and Treasurer Roderick G. Leith, Vice President and Controller Jack P. Maginnis, Vice President-Procurement Eugene D. Olson, Vice President-Data Processing and Systems Marketing Division Philip E. Peirce, Senior Vice President-Marketing Willis R. Balfour, Vice President-Marketing, Passenger Sales Robert Leinster, Vice President-Marketing, Passenger Services Bert D. Lynn, Vice President-Marketing, Advertising and Sales Promotion J. S. Neel, Vice President-Marketing, Pacific Rim Division Harry L. White, Vice President-Marketing, Central-Hawaii Division Luis Pasquel, Vice President-Sales and Service, Mexico David E. Holt, Assistant Vice President- Marketing for Travel Agency and Vacation Sales S. J. Rogers, Assistant Vice President-Marketing, Pricing/Budget Operations Division Arthur F. Gardner, Senior Vice President-Operations Richard B. Ault, Vice President-Engineering Harold W. Caward, Vice President-Flight Operations Anton B. Favero, Vice President-Maintenance Peter P. Wolf, Vice President-Communications Joseph M. Fogarty, Assistant Vice President-Maintenance 32 Western Airlines Route System HONOLULU HILO KODIAK ANCHORAGE JUNEAU KETCHIKAN VANCOUVER CALGARY SEATTLE/TACOMA GREAT FALLS HELENA BUTTE BILLINGS MINNEAPOLIS PORTLAND ST. PAUL W. YELLOWSTONE SHERIDAN IDAHO FALLS PIERRE POCATELLO RAPID CITY SIOUX FALLS CASPER SACRAMENTO CHEYENNE SAN FRANCISCO OAKLAND SAN JOSE RENO SALT LAKE CITY DENVER LOS ANGELES LONG BEACH ONTARIO SAN DIEGO LAS VEGAS PALM SPRINGS PHOENIX Service Temporarily Suspended by Order of Civil Aeronautics Board MEXICO CITY ACAPULCO General Offices Western Air Lines Building, 6060 Avian Drive Los Angeles International Airport Los Angeles, California 90009 Stock Registrars Bank of America National Trust & Savings Assn. 111 West Seventh Street, Los Angeles, California 90014 The Chase Manhattan Bank 1 Chase Manhattan Plaza, New York, New York 10015 Stock Transfer Agents Security Pacific National Bank* 124 West Fourth Street, Los Angeles, California 90014 Chemical Bank* 20 Pine Street, New York, New York 10015 Debenture Trustee The Ohase Manhattan Bank 1 Chase Manhattan Plaza, New York, New York 10015 Stock Listing Listed and traded on New York Stock Exchange Pacific Coast Stock Exchange Debenture Listing Listed and traded on New.York Stock Exchange General Counsel Hugh W. Darling Darling, Hall, Rae & Gute 523 West Sixth Street, Los Angeles, California 90014 Independent Accountants Peat, Marwick, Mitchell & Co. 555 South Flower Street, Los Angeles, California 90071 Annual Meeting Fourth Thursday in April * -As of May 1, 1973, Bank of America National Trust & Savings Association will replace Security Pacific National Bank as Los Angeles Transfer Agent and Chemical Bank will replace the Chase Manhattan Bank as New York Registrar. Thereafter, Bank of America National Trust & Savings Association will function as Los Angeles Registrar-Transfer Agent and Chemical Bank will function as New York Registrar-Transfer Agent.