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 benefi cially 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 Regulations on or before April 1 as to the capital stock owned as of December 31 and/or a report containing the information required by Part 245.13 of the CAB's Economic Regulations within 10 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 accord ance 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 inter est 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 Aero nautics Board, Washington, D.C. 20428. Eorm 10-K: Stockholders may obtain free of charge a copy of the company's annual report on form 10-K as filed with the Securities and Exchange Commission by writing to the Secretary, P.O. Box 92005, World Way Postal Center, Los Angeles, California 90009. Cover: Western's DC-10 over Miami Beach. The company started serving Miami on August 1,1976. 1 Western Air Lines, Inc., 1976 Annual Report Description of Business Western Air Lines, Inc. is a certificated air carrier providing scheduled air transportation over approxi mately 32,000 route miles. The company serves 41 cities in 15 states, Canada and Mexico. Western has competition from other airlines on substantially all of its routes. It is regulated hy the United States, cer tain state and foreign governments. Index 3 Chairman's Letter 5 Financial Review 9 Corporate Review 17 Western's Route System 21 Ten Years of Western Progress 23 Balance Sheets 25 Statements of Earnings 26 Statements of Changes in Financial Position 27 Statements of Shareholders' Equity 27 Notes to Einancial Statements 32 Accountant's Report 34 Corporate Officers Cliairnians Letter I ho year 197(i, in which WcstcM ii completed its lirst hall-ceiiturv of continuous service, was an excellent one in many respects. We are pleased to report that your company achieved a net profit of nearly $15 million, or $1.10 j)er share. This was a ^ratilyim; level of earnings in \'iew of all factors which impacted our industry. Western's oj)eratins4 revenues passed the $()()() mil lion mark foi' the first time. We were able to add more than 5,0()() miles to onr route system and increase our ax ailahle seat miles 15 percent while holdini; operat ing expenses to a 1.5 j)ercent increase. Onr hreakeven load factor (the {)oint at which we realize a profit) was reduced significantly from 50.8 percent in 1975 to 55.8 percent in 1976. Onr passenger traffic for the year increased 10 }X*r- cent, and cari^o traffic, which includes air freiy,ht and mail, increased 24 percent. Althoinj;h Western's aver age passenger load factor in 1976 was down slightly to 58.2 percent, it remained one of the hij^hest in the industry. (iivil Aeronautics Board decisions ;las DC-fOs. At the same time, we will modify all Boeing 737 aircraft which remain in the fleet and either modify or replace the five 7{)7s. While this will be a costly program overall, it will result in fewer aircraft types in oiir fleet, which in the lon|> run shoidd ]>roduce improved economy and efficiency of operations. Of continuing concern also is the price of jet fuel. Although Western is one of the most efficient fuel users in the industry, our total hill for 1976 amounted to $108 million, compared to $93 million in 1975 and $44 million in 1973 before the fuel crunch took effect. Almost all of the increase experienced has been the residt of price escalation. Our last major contract covering fuel prices ex])ired on December 31, and fuel prices are now based on "open market" conditions. As a residt, we are estimating that our cost will con tinue to rise in 1977. With an expected consumption of 386 million gallons, each cent-a-gallon increase results in nearly $4 million annual increase in fuel expense. Labor costs in the airline industry continue to pre sent a difficidt control problem, and Western's are no exception. We will be or are presently negotiating new agreements with unions representing aj)j)roximately 88 percent of our labor force. In each of these, we are studying ways to attain the increased jnoductivity which we feel is essential if we are to keep W'estern's oj:)eration reasonably j)rofitable. Western has a sound record on which to stand and we are proud to he serving 41 cities, 15 states, Canada and Mexico, as part of the nation's vital transporta tion system. We will do our best to operate Western's routes in a manner which will provide good service to the traveling and shijiping pidilic at reasonable fares and rates and, at the same time, return sullicient })rofit to justify the continuation of a sound dividend Cdiairman and Chief Executive Officer March 21,1977 4 Financial Review 1976 1975 1974 1976 vs. Amount Che 1975 % inge 1975 vs Amount Operating revenues: Passenger $544,188 1465,081 $437,345 79,107 17 27,736 Cargo 37,926 31,329 27,662 6,597 21 3,667 Other 23,091 22,563 23,390 528 2 -827 605,205 518,973 488,397 86,232 17 30,576 Operating expenses: Wages, salaries and employee benefits 226,367 201,661 182,334 24,706 12 19,327 Fuel 108,279 93,134 71,437 15,145 16 21,697 Depreciation and amortization . . . 38,058 36,054 40,478 2,004 6 -4,424 Other 202,643 179,563 155,788 23,080 13 23,775 575,347 510,412 450,037 64,935 13 60,375 Operating income 29,858 8,561 38,360 21,297 249 -29,799 Other income (expenses): Interest expense, net (8,889) (8,524) (10,334) (365) 4 -(1,810) Gain on disposal of equipment . . . 1,809 379 9,575 1,430 377 -9,196 Other, net 1,237 3,919 4,222 -2,682 -68 -303 Earnings before provision for taxes on income and cumulative effect of accounting change . . 24,015 4,335 41,823 19,680 454 -37,488 Provision for taxes on income .... 9,050 (825) 17,725 9,875 * -18,550 Earnings before cumulative effect of accounting change 14,965 5,160 24,098 9,805 190 -18,938 Cumulative effect of accounting change -- 7,160 -- -7,160 -100 7,160 Net earnings $ 14,965 $ 12,320 $ 24,098 2,645 21 -11,778 Earnings per share: Primary: Earnings before cumulative effect of accounting change $ 1.10 $ 0.34 $ 1.59 Cumulative effect of accounting change Net earnings $ 1.10 0.47 $ 0.81 $ 1.59 Fully diluted: Earnings before cumulative effect of accounting change $ 0.98 $ 0.33 $ 1.41 Cumulative effect of accounting change Net earnings Passengers carried (000) $ 0.98 8,098 0.41 $ 0.74 7,531 $ 1.41 7,391 567 8 140 Available seat miles (000,000) .... 13,450 11,696 11,124 1,754 15 572 Revenue passenger miles (000,000) . . 7,834 7,103 6,747 731 10 356 Passenger load factor--actual (%) . 58.2 60.7 60.7 -2.5 -4 - -- breakeven (%) . 55.8 59.8 56.0 -4.0 -7 3.8 Note: In thousands of dollars except per share amounts. *Not computed. 5 Management's Discussion The adjacent table of Financial Review compares Western's activities during the past three years --1976, 1975 and 1974. Items in the table which in the opinion of Western's manage ment need explanation are discussed in the following section. A 10-yearfinancial and statistical summary follows the report's Corporate Review. Western's net earnings of $14,965,000 for 1976 repre sented a 21 percent increase from the $12,320,000 reported for 1975. Comparing the two years, but exclud ing a $7,160,000 after-tax credit from a change in the company's method of accounting for maintenance of aircraft in 1975, the 1976 earnings were almost triple those of 1975. Earnings in both years were substantially below the record 1974 earnings of $24,098,000. Operating revenues increased primarily because of higher passenger revenues reflecting traffic growth and higher average revenue per passenger mile (yield). Traffic growth was 10 percent in 1976 and five percent in 1975. Yield increased six percent in 1976 and one percent in 1975 as a result of fare increases. Cargo revenues increased on traffic growth of 24 per cent in 1976 and 14 percent in 1975. Passenger revenues constitute 90 percent of West ern's operating revenues and of these passenger revenues 93 percent come from coach and economy travelers. Negotiated increases as a result of collective bargain ing were the primary factor in the increases shown in wages, salaries and employee benefits. The greatest impact was from wage increases. These agreements are open for amendment in 1977 and early 1978. Included in the 1976 increase was a $4.3 million increase in the costs of retirement plans, group insur ance and payroll taxes. The major factor was higher pension expenses due to higher wages and participa tion in the plans by a larger number of employees. Costs of retirement plans for 1976 were $1.2 million lower than they would have been had not certain actu arial assumptions been changed. The 1975 increase of $5.5 million was attributable mainly to higher group insurance premiums. In both years payroll taxes increased because of legislated changes. In 1976, 55 percent of the fuel expense increase reflected higher consumption and 45 percent reflected price increases. Western increased its available seat miles by 15 percent in 1976 but used only nine percent more fuel.The 1975 fuel expense increase was due to price increases. Effective January 1, 1977, Western's fuel prices were no longer under contract and are subject to open market conditions. The 1976 depreciation and amortization expense would have been $1.2 million greater if the depre ciable lives of 727 and 737 aircraft had not been extended from 12 years to 15 and 14 years, respectively. In 1975 this expense showed a decrease because the depreciable lives of the 720B aircraft were extended to Dominic P. Renda President and Chief Operating Officer 6 1978. Amortization of pre-opcrating; costs increased in 1976 because of costs incurred in inaugurating services on the bos Angeles-Mianii and Honolulu- Vancouver routes. "Other" expenses increased approximately S23 million in both 1976 and 197.6. The major increases were in travel agent commissions, passenger food expense, rentals, materials and repairs for aircraft maintenance and Mutual Aid expenses. The proportion of total sales being made by travel agents continued to increase and together with traffic increases resulted in the increases in travel agent commission expen.ses--by 15 million, or 2.3 percent, in 1976 and $2.5 million, or 13 percent, in 1975. Traffic growth was also the cause of a $2.9 million, or 16 percent, increase in passenger food expense in 1976. Rentals increased 22 percent in both years, or by $4.2 million in 1976 and $3.5 million in 1975. Contrib uting factors were leases of two DC-10 aircraft, one in June 1976 and one in ]une 1975, and the leasing of a DC-10 hangar and a parking structure in April 1975. Materials and repairs for aircraft maintenance increased by $2.9 million, or 10 percent, in 1976 as the result of a greater number of cyclical replacements of engine components and higher costs for parts. In 1975 higher prices of parts and materials resulted in the $3.6 million, or 14 percent, increase. Mutual Aid increased $3.6 million in 1975 because of payments made to other carriers under this agree ment but declined sharply in 1976. See Note 11 of Notes to Financial Statements. Traffic growth and fare increases in 1976 outpaced inflation and resulted in higher operating income. In 1975 Western's inability to offset inflated operating expenses with either traffic growth or fare increases resulted in lower operating income than in 1974. In 1976 interest expense increa.ses reflect the issu ance of $23 million in principal amount of the 10% Subordinated Sinking Fund Notes. The decrease in "Other--net" resulted from the fact that 1975 included $2.1 million in interest income related to a federal tax refund. See Note 6 of Notes to Financial Statements. These were partially offset by gain on the sale of a 737 aircraft. The 1975 interest expense decrease was produced by a combination of a reduction of outstanding debt and a reduction in interest rates on the bank debt.The gain on sale of equipment decreased from 1974 to 1975 because 10 aircraft were sold in 1974. The provision for taxes on income is reconciled to the tax rate of 48 percent in Note 6 of Notes to Finan cial Statements. Financial Position Sources of working capital totaled $87,717,000 in 1976. Working capital from operations increased from $45,412,000 in 1975 to $54,807,000 in 1976 because of higher earnings. The other major source was the issu ance of $23,000,000 in principal amount of 10% Subor dinated Sinking Fund Notes. Applications of working capital were $102,471,000. Expenditures for the repurchase of common stock totaled $30,527,000. Reductions in debt totaling $20,000,000 included scheduled maturities of long term tlebt and that portion of the revolving fund credit which management intends to repay in 1977. Purchases of property and equipment, including advance deposits of approximately $25 million, were $42,362,000. Seven 727 aircraft are scheduled for delivery in 1977 at an approximate cost of $78 million. Western will lease five and purchase two out of internally gener ated funds. During January 1977, Western exercised options to purchase five 727 aircraft and agreed to purchase two DC-10 aircraft, all for delivery in 1978, at a total cost of approximately $116 million. These orders are subject to lender approval. The aircraft to be delivered in 1977 and 1978 will accommodate forecast traffic growth and will also replace some of those aircraft which Western will retire before January 1, 1985, in accordance with cur rent noise regulations. External equity and debt finan cing or a combination thereof will be required. The Bank Loan Agreement, dated June 30, 1976, provides Western with a $75 million revolving line of credit until December 31, 1978. On this date the line of credit can be replaced by a term note in an amount not to exceed $75 million which will mature on June 30,1983, with quarterly payments of principal starting March 31,1979. Operating Income--(Dollars in Millions) 0.9% from other 2.1% from transport related 0.7% from charter 6.3% from cargo 6.0% from deluxe passenger service. Operating Revenue 84.0 % from coach passenger service- Dollar 39.3% for wages, salaries : and employee benefits - j 18.8% for aircraft fuel } 6.6% for depreciation j 5.8% for materials and repair ! 5.0% for utilities and services ] 4.7% for commissions I 3.7% for food and beverages 2.0% for advertising and publicity 14,1% for other 7 Finance and Administration Division is headed by Robert O. Kinsey, Senior Vice President- Finance and Administration, with (from left) Pan! V. Donahue, Vice President-Procurement; FI.S.Gray, Vice President-Financial Planning; Dan A. Zaich, Vice President- Personnel Relations; Richard O. Hammond, Vice President and Treasurer, and Roderick G. Leith, Vice President and Controller. Corporate Review Annual Meeting I'he 1977 meeting; of sliarcholders will be held at the Beverly Hilton Hotel, Beverly Hills, Calif., on April 28. Formal notice of the meeting and proxy material are enclosed with this report. Shareholders, Stock and Debentures As of December 31, 197h, there were 12,659,(K)() shares of Western stock outstanding, d'he number of shares outstanding had been reduced in May by 2,508,832 from 1975's year-end total of 15,164,000 after share holders approved at the 1976 annual meeting the com pany's proposal to purchase Kirk Kerkorian's hold ings. At that meeting 85.4 percent of all outstanding shares were represented in person or by proxy. An additional 2,465,(XK) shares are reserved for the conversion of the company's 574% Convertible Subordi nated Debentures. Holders of the debentures received interest payments on February 1 and August 1. Shareholders' equity at December 31, 1976 was $117,100,000, or $9.25 per share, compared to $137,938,000, or $9.10 per share, at the end of 1975. The company's stock was held by approximately 16,900 shareholders of record at year's end, compared to approximately 17,500 shareholders at the end of 1975. The stock is traded on the New York and Pacific Stock Exchanges. The following table sets forth the range of sale prices of the stock on the New York Stock Exchange: 1975 High Low First Quarter 9V2 57/8 Second Quarter 87/8 71/8 Third Quarter 91/2 6% Fourth Quarter 93/8 6^4 1976 First Quarter 117/8 91/8 Second Quarter 107/8 91/8 Third Quarter 125/8 10 Fourth Quarter 101/4 83/4 Dividends Shareholders received four regular cash dividends during 1976. These dividends in the amount of 10 cents per share were paid in March, June, August and November. In January 1977, the hoard of directors declared the first regular quarterly cash dividend of 1977 in the amount of 10 cents per share, payable on February 28 to shareholders of record on February 8. Equipment and Facilities At the end of 1976, as at the end of 1975, Western oper ated 75 jet aircraft. One McDonnell Douglas DC-10 was added to the fleet in June and one Boeing 737 was sold during the first quarter. Scheduled for delivery during 1977 are seven Boeing 727-200s.'Fhree of the 727s are being delivered in March, two in May and the remaining two in December. Western has arranged to lease the five air craft being delivered in the spring. In January 1977 the company announced it had reached agreements to purchase two DC-lOs and five 727s for delivery in the first half of 1978. In addition to these firm orders, Western obtained options on two additional DC-lOs for delivery in 1979 and on 10 addi tional 727s for delivery in 1979 and 1980. The two DC-lOs and the five 727s being acquired in 1978 are part of the company's re-equipment pro gram designed to meet anticipated traffic growth and, at the same time, to bring the fleet into conformity with new regulations limiting aircraft noise emissions. The F'ederal Aviation Administration has issued aircraft noise abatement regulations which require that all airline aircraft meet FAA noise standards which have previously applied only to newly manu factured aircraft within specified periods prior to January 1, 1985. To meet the standards, non-conform ing aircraft must either he replaced by newer, quieter aircraft or modified to reduce their noise output. Four- engine aircraft must be replaced or modified on the following schedule: one-quarter of the aircraft within four years, one-half of the aircraft within six years and all aircraft within eight years. Two- and three- engine aircraft must be replaced or modified to meet the standards within six years with one-half of such aircraft to be replaced or modified within four years. The company presently has in its fleet 24 two-engine Boeing 737 aircraft and 23 four-engine aircraft (five Boeing 707s and 18 Boeing 720B's) which do not com ply with the prescribed noise limitations. (By the end of 1977 all of its three-engine aircraft will meet the noise standards prescribed in the regulation.) Within the prescribed time limits, the company presently intends to modify some of its two-engine aircraft and to dispose of the remainder, and to replace all eighteen 720B aircraft. The total cost of retrofit of two-engine aircraft cannot be estimated with any degree of cer tainty until a decision is made as to the number to be modified, but it has been decided that such retrofits are economically and operationally feasible. Retrofit of the five 707 aircraft may be economically and opera tionally feasible, but such does not seem to he the case with the eighteen 720Bs. 9 Western became the first U.S. carrier to connect Vancouver, B.C. (top) and Honolulu on June 25,1976. Legislation has been introdnced in Congress which wonld provide financial assistance to the airlines by authorizing them to collect surcharges on passenger fares and cargo rates. Funds produced by such sur charges would be available for use by the airlines to assist in financing the costs of modification of non complying aircraft and of acquisition of replacement aircraft. The legislation also propo.ses that grants be made to the airlines from funds in the Airport and Airways Development Trust Fund to finance the pro gram if and to the extent that funds produced by the surcharges are insufficient for that purpose. The amount and kind of financial assistance which the airlines may receive from this legislation will depend upon whether and in what form it is enacted. In any event, with or without governmental assistance the requirement that all Western's aircraft, except the DC-lOs and 727-200s, be modified or prematurely replaced in eight years or less will impose a substan tial financial burden upon Western. Western's Fleet 1977 1978 Owned Leased Delivery Delivery DC-10 3 4 - 2 B707--300C 5 - - - B720B 18 -- - - B727-200 15 8* 5 5 B737-200 24 -- -- -- As of March 1,'j, 1977. 65 12 5 7 *I'wo were delivered in early March 1977. Western continued to modernize and, in some cases, expand its ground facilities at a number of locations during 1976. A new all-purpose building including an air cargo terminal was constructed at Honolulu and a new cargo terminal/maintenance building was completed at Salt Lake City. A new Western cargo facility at Denver's Stapleton International Airport is scheduled for completion in mid-1977 and one is in the design development stages at Seattle-Tacoma International Airport. Major expansion to the pas senger terminal buildings at Salt Lake City, San Diego, Phoenix and Honolulu will give Western improved passenger facilities. Fares and Rates Most of Western's fares and rates underwent changes in 1976. Western's passenger fare structure is divided into six geographical areas--domestic U.S., Hawaii, intra-California, Alaska, Mexico and Canada--with each area regulated separately by the Civil Aeronau tics Board, agencies of other national governments or, in the case of intra-California markets, by the state Public Utilities Commission. Domestic U.S. fares were increased one percent in February and two percent in March, in May and in September while fares between Alaska and the "Lower 48" fares were increased three percent in October. Although the company applied for a five percent increase in all Mainland-Hawaii fares, effective May 15, the increase was approved only for discount fares. The Hawaii discount fares underwent another 4.5 per cent increase on January 1, 1977, and regular fares went up two percent. California intra-state fares were increased eight per cent in January and fares between the U.S. and Canada were increased seven percent in May. These fare increases were partially responsible for a six percent increa.se in Western's average yield in 1976. Nevertheless, our system average yield was still the lowest in the industry at 7.05 cents. For the 12 months ended September 30, 1976, the industry aver age was 7.52 cents, whereas Western's average was only 6.9 cents, or eight percent below the industry average. Operating Income --(Dollars in Millions 1976 \975 1 H 8.6 1974 1973 1972 38.4 40.1 11 Corporate Planning Division headed by James L. Mitchell, Senior Vice President-Corporate Planning, with (from left) VV. Jeffrey Terrill, Director-Regulatory Proceedings; Carleton E. Nesbitt, Director-Profit Planning; William E. Lindsey, Director-Fleet Planning; Charles S. Fisher, Vice President- Schedule Planning; Eugene D. Olson, Vice President-Data Processing and Systems; Peter P. Wolf, Vice President- Communications. While Western continues to try to improve its yield throui^h fare increases and reduced emphasis on dis count fares, it has maintained certain discount fares for the purposes of stimulatinj; specific markets or attracting large group movements as well as for the purpose of remaining competitive in other markets. Air freight rates underwent increases in April, Sep tember and October. Marketing Western's 1976 marketing was headlined by a new advertising theme entitled,"We've Got A Good Thing Going'' and highlighted by the challenges of inaugu rating two major new routes--Honolulu to Vancouver, in June and the company's first transcontinental route, Los Angeles to Miami/Ft. Lauderdale, in August. A total of 8,098,000 passengers were carried in 1976, compared to 7,531,000 in 1975. Passenger load factor for the year was 58.2 percent, compared to 60.7 per cent in 1975. The two new routes are primarily vacation-oriented, and they have given Western yet another opportunity to demonstrate its marketing expertise in such mar kets. Marketing over both routes was launched with attractive Triangle Fares. For example, over the Los Angeles-Miami route, this fare permits travelers to take a side trip to Mexico City for no additional cost. This same theme has been used most successfully for a number of years in the California-Alaska-Hawaii market. Western is increasingly optimistic about the potential of its first transcontinental route. Since approximately two-thirds of the traffic on this route historically has been generated on the West Coast-- where Western is experienced in promoting leisure travel --the company is in an excellent position to stimulate new traffic to Florida and the Caribbean. Within four months after service was launched, the company had established commitments with two major cruise ship lines operating out of Miami and was launching joint advertising programs with these operators as well as tourism organizations in Florida and the Caribbean. As part of its continuing program of joint advertis ing and promotion with the Hawaii Visitors Bureau, the company will be concentrating new efforts on the promotion of traffic between Hawaii and Western Canada. The company's success in the Hawaii market was recognized nationally in January 1977 when it received the third annual Market Development Award from Air Transport World magazine. The award was pre sented for Western's "...outstanding performance in the development of the Hawaiian market. From a non existent position in this market prior to 1969, it has moved upward rapidly to become the second-largest airline to Hawaii, carrying close to 850,000 passengers in 1976!' More updating of Western's services to the traveling public during the year resulted in the installation of high-speed ticket printers at 15 locations, the develop ment of a fare quote system which covers 90 percent of the possible itineraries in the reservations computers and the placing of an 18-month schedule in these same computers. The 18-month schedule now makes it pos sible for Western's sales force to confirm space by specific flight and time for individuals and groups who are making long-range travel plans. The Alaska pipeline construction plus the new busi ness attention it has focused on Alaska continued to have a favorable impact on Western's passenger and cargo traffic between the Mainland and the 49th state. Systemwide, Western's cargo, expressed in revenue ton miles, increased 24 percent for the year. Cargo marketing studies, plus the increase in the use of air transportation for mail by the U.S. Postal Service, indicate that this portion of Western's business will continue to grow at a healthy rate. Available Seat Miles vs. Revenue Passenger Miles 13,450 1975 L L Ll.:! ii. j 7,103 .! .i 11,696 1974 6,747 1973 6,476 5,996 124 11,176 Millions Seat Miles 300 Passenger Miles 13 Marketing Division headed by Richard P. Ensign, Senior Vice President-Marketing, with (from left) Bert D. Lynn, Vice President- Advertising and Sales Promotion; Jack M. Slichter, Vice President- Field Management; Willis R. Balfour, Vice President-Sales and Service; Lawrence H. Lee, Vice President-Inflight Service, and J.S. Neel,Vice President-Marketing Administration. Route Proceedings Western is involved in a number of route proceedings now under consideration by tbe (livil Aeronautics Board. If approved, tbe company's proposals in these cases woldd give Western access to new cities or would provide new service between cities presently served by tbe company. riie Civil Aeronautics Board did award to Western two e.xtremely inn)ortant new routes in 1976. First, in February came tbe award of a 2,7()()-mile segment between N^uicouver, British Columbia, and Honolulu. \Vith this new service, inaugurated June 25, Western became the first U.S. flag carrier to provide service between tbe 5()tb state and Canada. In March the CAB gaveW'estern a long-sought-after transcontinental route --covering tbe 2,.`145 miles between Los Angeles and Miami/Ft. Lauderdale. Although tbe decision is tbe subject of appeals by .some unsuccessfid applicants, we inaugurated service over this route on August 1. In tbe Oklahoma-Denver-Southeast Points Investiga tion, Western .seeks to provide nonstop service between Denver and Atlanta,Tidsa, Tampa and Miami as well as between Tulsa and Florida points. Western also pro posed through service via Denver between Calgary/ Fdmonton and Tulsa and Florida and from Salt Lake City and San Francisco to Florida. A route for Western was not recommended in tbe administrative law judge's initial decision,which was issued in November; however, the case is being reviewed by the five-member board, and Western continues to be an active applicant. This case should be concluded in 1977. I'wo important international route cases are cur- rentlv awaiting initial decisions by CAB administra tive law judges. The first is an international route case which will be decided by the end of 1977 involving new U.S. flag carrier routes between tbe California cities of San Francisco and Los Angeles and the Canadian cities of Calgary and Edmonton. These routes were added by amendment of tbe U.S.-Canadian bilateral agreement in 1974. In the second. Western is seeking to extend its route system to Tokyo from the U.S. gateway cities of Seattle/Tacoma and Portland. In September, the CAB awarded a nonstop route between Calgarv/Edmonton and Las Vegas to Hughes Airwest. I bis is a route which Western had been actively seeking.The company has appealed this deci sion to a federal court of apj^eals. Western also has applications in pending cases for the following routes: Los Angeles to Columbus, Ohio, and Pbiladeljjbia; Sacramento to Denver; Spokane to Billings and Denver; Las Vegas to Dal las/Et. Worth; LasVTgas to Reno and Sacramento to Seattle/l'acoma. 4'be Transatlantic Route Proceeding m which Western sought to provide tbe first direct service from Minne apolis/St. Paid to London, Paris and Frankfurt was sent to the White House for Presidential approval in 1976. It did not include a recommendation for Western. However, the White House returned the decision to tbe CAB for further consideration and for what West ern hopes will he a more favorable decision. Another important apjjlication now under CAB consideration is Western's route realignment proposal which would consolidate all Mainland route segments into one linear segment and eliminate certain out dated conditions which impede Western's ojierating flexibility. Western is also seeking additional routes into Mexico from the California cities of .San Francisco, Los Angeles and San Diego. The company currently serves Acapulco from Los Angeles and Mexico City from Los Angeles and San Diego. Application has been filed to also provide .service to La Paz, Mazatlan, Puerto Vallarta, Guadalajara, Manzanillo and Zihuatanejo. No action has been taken on this applica tion pending possible amendment to the bilateral agreement between the United States and Mexico which is due to expire April .30,1977. Another case which recently has been set for hear ing is the West Coast-Alaska Investigation in which West ern is seeking nonstop authority from Los Angeles and San Francisco to Anchorage as well as nonstop authority from Portland and Seattle to Fairbanks. Passenger Load Factor--Actual vs. Breakeven Actual Breakeven Legal Division headed by (erald P. O'Grady, Senior V'ice President- Legal and Secretary, with (from left) Thomas J. Greene, Assistant Secretary and Director-Corporate Law; Henry M. deButts, V'ice President-Regidatory Law, and Donald F. Drews, Director- Properties and Facilities. FAIRB^KS KODIAK KETCHIKAN ,\ VANCOUVER SEATTL^TACOMA SPOKANE WHO F/y-LS OCATELLO iRENO COLUMBUS SACRAM^I CHEYENNI LAS VEGAS TULSA ONTAI OKLAHOMA Cr DALLAS?^ ^ FORT WORTH JAM PA :atlan HONOLULU HILO MANZANILLO Western's Route System WESTERN AIR LINES SYSTEM PROPOSED ROUTES Western/Continental Interchange `Service temporarily suspended by order of CAB ANCHORAG CALGARY GREAT FALLS MINNEAPOLIS/ST. PAUL N PIERRE = SIOUX FALLS RAP D CITY BILLINGS SHERIDAN SAN FRANCISCO OAKLAND SAN JOSE LOS ANGELES V PALM SPRINGS ^ V \ PHOENIX SAN DIEGO (TO LONDON) (TO FRANKhUHiT (TO PARIS) --^ PHILADELPHIA ATLANTA JUNEAU* EDMONTON ZIHUATANEJO ACAPULCO MIAi^ - S FORT LAUDERIII/VLE' W ^ GUADALAJARA 0 VALLARTA MEXICO CITY 17 18 Management Changes Iwo new directors were elected to Western's board at the annual meeting in April. They were Robert H. Volk, chairman of llnionamerica, Inc. (now Westmor Ciorporation) and Roy Ash, president of Idtton Indus tries from 1961 until 1972 and Director of the Office of Management and Budget from 1972 until 1975. Mr. Ash's election required approval by the Civil Aeronautics Board because he is also a director of Bankamerica Corporation; Bank of America has been one of Western's major lenders for many years. After CAB action on an application for such approval was not forthcoming for nearly 10 months, the application was withdrawn, and he will not stand for election as a member of the hoard this year. With shareholder approval of the purchase of Kirk Kerkorian's holdings, Mr. Kerkorian and five other directors who are or had been associated with him did not stand for re-election. They included Fred Benninger, who had served as Western's chairman since 1971; James D. Aljian, Peter M. Kennedy, Walter M. Sharp and William Singleton. Following the annual meeting, the board elected Arthur F. Kelly, formerly president and chief execu tive officer, as chairman and chief executive officer, and elevated Dominic P. Renda, formerly executive vice president, to president and chief operating officer. Early in 1977, James L. Mitchell was elected senior vice president-corporate planning to succeed Robert O. Kinsey, who became senior vice president-finance and administration following the retirement of Charles J. J. Cox on January 31,1977. Mitchell returned to We.stern after eight years with Continental Airlines where he was most recently vice president of regidatory proceedings. He first joined Western in 1946 and was named assistant vice presi dent of research in 1965. Kinsey was controller and assistant to the president at Pacific Northern Airlines prior to the 1967 merger of PNA into Western. He came to Western as vice president and assistant to the president and was elected senior vice president- corporate planning in 1974. Cox had been with Western for 25 years having joined the company as controller and assistant trea surer in 1951. He was elected vice president and con troller in 1966, vice president-finance in 1969 and .senior vice president-finance in 1972. Edwin W. Mitchell, who joined Western in 1941, was elected vice president-maintenance to succeed Jo.seph M. Fogarty who retired on September 30, 1976. Mitchell was previously director of base maintenance in Los Angeles. Fogarty was hired by National Parks Airways (which was merged into Western) in 1931 and retired from Western after completing more than 45 years of service. Personnel As of December 31, Western employed 10,113 people, compared to 9,4,30 at the entl of 1975. Wages and salaries for 1976 amounted to .'S188,418,000, up 12 percent from the 1168,029,000 in the previous year. Social Security taxes and company contributions to group insurance and employee retirement plans increased 13 percent, from $3.3,632,000 in 1975 to $37,949,000 in 1976. Western is committed to a policy of equal employ ment. Job assignments are determined on the basis of qualifications without discrimination in race, color, creed, age, sex or national origin. The company confirms its continuous commitment, and, in this regard, maintains Equal Employment Opportunity/Affirmative Action Plans which are filed with the Federal Aviation Administration and the Department of the Interior (in Alaska). Approximately 88 percent of the company's employees are represented by labor unions. These unions include the International Brotherhood of Teamsters, Air Line Pilots Association and Associa tion of Flight Attendants (affiliate of ALPA), Brother hood of Railway and Airline Clerks (U.S. and Canada), Sindicate Nacional de Trabajadores de Aviacion y Similares (in Mexico), and the Transport Workers Union. Following is the contractual status of each group of these employees: Employee Group Number of Employees 12/31/76 Union Contract Open for Amendment Flis^ht .-Xttenclants 1 ,.')86 ALPA/AFA Aug. 1, 1977 Assent & Clerical 3,674 BRAC Jan. 1, 1978 -- Canada 39 BRAC Jan. 1,1978 -- Mexico 155 SNTA Jan. 1,1978 Pilots 1,374 ALPA Sept. 1. 1977 Flight Superintendents 33 TWU April .30, 1978 Mechanics & Related 1,921 IBT Nov. 16,1976 Employees (Presently in mediation) 19 Operations Division headed by Anton B. Favero, Senior V'ice President-Operations, with (froi left) Mark E. Leafstedt, Director Operations Budgets and Cost Control; Robert V. Johnson, Vic President-Flight Operations; Richard B. Ault,\'ice President Engineering, and Fldwin \V. Mitchell, Vice President- Maintenance. Ten Yeai's of Western Proi^ess Financial 1976 1975 1974 Operating^ revenues;'^ Passen2;er $544,188 465,081 4.37,.34.5 Cargjo 37,926 31,.329 27,662 Other 23,091 22,.563 23,.390 Total operatintr revenues 605,205 518,973 488,.397 Operatinir expenses:^ VV'atres, salaries and employee benefits 226,367 201,661 182,3.34 Fuel 108,279 93,1.34 71,4.37 l)ej)reciation 38,058 .36,054 40,478 Other 202,643 179,56.3 155,788 Total operating; expenses 575,347 510,412 4.50,037 Operating; income (loss)^ 29,858 8,.561 38,360 Interest expense, net of amounts capitalized^. (8,889) (8,524) (10,.3.34) Gain (loss) on disposal of equipmentZ 1,809 379 9,.575 Other income and expense, net^ 1,237 3,919 4,222 Earning;s (loss) before taxes on income and cumulative effect of accounting; chang;e^ 24,015 4,3.35 41,82.3 Taxes on income (tax credits)^. 9,050 (825) 17,725 Earning;s (loss) before cumulative effect of accountini^ change ^ . 14,965 5,160 24,098 Cumulative effect of accounting change^ -- 7,16(d - Net earnings (loss)"^ S 14,965 12,.320 24,098 Earnings (loss) per share: Primary: Before cumulative effect of accounting change $ 1.10 0..34 1.59 Net earnings (loss) $ 1.10 0.81 1.59 Eully diluted: Before cumulative effect of accounting change S 0.98 0..3.3 1.41 Net earnings (loss) $ 0.98 0.74 1.41 Pro-forma amounts assuming the accounting change is applied retroactively: Net earnings (loss)^ $ 14,965 5,160 24,608 Net earnings (loss) per share --primary >-2 $ 1.10 0..34 1.6.3 Net earnings (loss) per share --fully diluted $ 0.98 0.3.3 1.44 Return on investment (%) 9.7 8.0 13.1 Cash dividends paid per share $ 0.40 0.47 0.39 Average shares outstanding'-^:^ 13,601 15,163 15,125 Shareholders'equity ^ $117,100 137,938 132,718 Long-term debt 7 $110,420 107,617 114,917 Property and equipment --net $308,112 309,685 307,307 Total assets^ $431,133 420,093 .396,825 Operations Airplanes operated at end of year 75 75 72 Passengers carried^'^ 8,098 7,531 7,391 Available seat miles'^ 13,450,395 11,696,478 11,123,.544 Revenue passenger miles 3.7 7,8.33,843 7,102,917 6,747,451 Passenger load factor--actual (%) 58.2 60.7 60.7 -- breakeven point (%) .55.8 59.8 56.0 -- profit margin (point difference) 2.4 0.9 4.7 Average revenue per passenger mile $ .0705 .0665 .0660 Average length in miles per passenger trip 963 943 913 Operating expense per available seat mile $ .0428 .04.36 .0405 Cargo revenue ton miles^'^ 134,955 108,619 95,2.39 Average number of employees 9,799 9,.357 9,696 1. Stock dividends were: 3% and 57o in 1974, 3% in 1973 and 10% in 1971. Stock split was: 2V!i for 1 in 1972. 2. Per share data are adjusted to f^ive retroactive effect to stock splits and stock dividends. 3. Operations of other carriers were substantially suspended from October 23 to November 16, 1976; September 1, 1975 to January 4,1976; December 6 to December 21,1975; [uly 14 to October 30, 1974; November 5 to December 18, 1973; June 30 to October 2,1972; December 15, 1971 to April 10,1972; July 8 to December 14, 1970. Operations of a competing intrastate carrier were partially suspended.during the fourth quarter, 1973. Western's operations 1973 1972 1971 1970 19693 1968 1967 376,722 342,851 295,807 274,792 220,5.30 205,753 178,527 23,040 20,819 20,231 18,745 16,472 13,459 11,802 21,524 10,321 12,009 9,926 5,245 4,454 3,209 421,286 373,991 328,047 303,463 242,247 22.3,666 193,5.38 165,363 147,282 127,075 113,116 97,156 78,535 64,024 44,510 40,137 38,663 .37,-357 .32,857 27,191 21,9.37 38,304 36,224 35,144 .36,583 .34,821 25,051 20,085 132,987 126,741 110,859 104,-596 89,814 73,207 62,152 381,164 350,384 311,741 291,652 254,648 203,984 168,198 40,122 23,607 16,306 11,811 (12,401) 19,682 25,-340 (9,016) (8,787) (11,162) (14,586) (14,748) (6,536) (3,011) 945 582 1,349 111 26 (7.3) (304) 3,235 2,114 3,114 1,009 (151) 88 321 35,286 17,516 9,607 (1,655) (27,274) 13,161 22,346 14,900 6,,300 3,150 (2,2-50) (15,075) 4,725 10,125 20,386 11,216 6,457 595 (12,199) 8,4,36 12,221 20,386 11,216 6,457^ 595 (12,199) 8,4.36 12,221 1.35 0.75 0.43 0.04 (0.81) 0.-56 0.82 1.35 0.75 0.43 0.04 (0.81) 0.-56 0.82 1.21 0.68 0.41 0.04 (0.81) 0.-54 1.21 0.68 0.41 0.04 (0.81) 0.-54 16,074 10,573 8,247 3,290 (10,664) 9,527 13,263 1.07 0.70 0.55 0.22 (0.71) 0.64 0.89 0.96 0.65 0.52 0.22 (0.71) 0.60 12.3 8.5 6.7 5.4 1.1 7.6 10.6 0.23 0.08 -- -- 0.16 0.3.3 0.33 15,050 15,0.30 15,012 15,011 15,010 14,981 14,892 113,652 96,723 86,-397 79,905 79,310 93,862 90,016 124,387 130,487 152,040 174,184 197,1.50 183,718 80,189 269,374 239,029 216,7.38 247,426 285,757 284,787 183,106 377,457 342,531 340,352 355,168 -367,588 349,039 2.31,342 74 71 70 72 78 64 51 7,382 6,931 6,206 6,188 5,7-52 5,693 5,108 11,175,518 10,300,178 9,776,869 9,8-39,299 8,-509,441 7,096,229 5,879,442 6,476,087 5,995,925 5,251,989 5,159,081 4,021,296 3,841,864 3,-327,160 57.9 58.2 53.7 52.4 47.3 -54.1 .56.6 52.4 54.4 52.2 52.2 53.1 -50.7 49.5 5.5 3.8 1.5 .2 (5.8) 3.4 7.1 .0597 .0578 .0577 .0542 .0551 .0537 .0537 877 865 846 8.34 699 675 651 .0341 .0340 .0319 .0296 . .0299 .0287 .0286 76,474 76,233 73,249 68,646 60,514 47,446 38,940 9,826 9,383 8,951 8,961 9,286 8,052 6,920 were suspended from July 29 to Aui^ust 16,1969. 4. See Note 2 of Notes to Financial Statements. 5. Includes $560,000 from involuntary conversion of an aircraft. 6. The methodolof;^ used to compute the rate of return is the CAB Corporate Return on Investment. 7. OOO's omitted. 22 Balance Sheets WES FERN AIR LINES, INC. Dt'CcMiibor :il, 1976 and 1975 (in tliousaiuls of dollars ) ASSETS 1976 Current Assets: Cash (-ertificatos of dcj)osit Coniinercial paper at cost and accrued interest (which approximate market) Receivables (net of allowance for doubtful accounts of $1,S45--1976 and $950--1975) Flight equi})ment expendable parts, at average cost (less allowance for obsolescence of $11,525-1976 and $9,65.5-1975) Prepaid exj^enses and other current assets Total current assets Properties and Equipment at Cost (Notes 2, 3 and 4): Flight equi{)ment Facilities and ground eciuipment Deposits on aircraft purchase contracts .... Less allowance for tlepreciation and amortization $ 11,476 7,748 25,911 45,L55 48,951 16,311 6,264 116,661 480,1.36 94,1,37 19,418 593,691 285,579 .308,112 Deferred Charges and Other Assets: Preoperating costs Other 4,.504 1,856 6,360 $431,133 See accompanying notes to financial statements. 1975 $ 10,.546 16,878 9,960 37,.384 48,5.39 14,943 6,944 107,810 477,816 88,241 613 566,670 256,985 309,685 1,045 1..5.53 2..598 $420,093 23 LIABILITIES AND SHAREHOLDERS' EQUITY 1976 1975 Current Liabilities: Accounts payable Salaries, wages and vacation benefits payable Accrued liabilities (Note 5) Income taxes payable (Note 6) Advance ticket sales Current portion of debt (Note 7) Total current liabilities $ 28,760 28,345 13,912 5,825 29,563 27,800 129,205 Long-Term Debt (Note 7) 110,420 Deferred Credits (Notes 6 and 8): Deferred federal taxes on income Unamortized investment credits Other Shareholders' Equity (Notes 7, 9 and 10): Common stock --$1.00 par value per share Authorized 25,000,000 shares Issued 12,659,000 shares-1976 and 15,164,0(X) shares-1975 Capital in excess of par value Retained earnings 47,007 17,644 9,757 74,408 12,659 28,937 75,504 117,100 Commitments and Contingent Liabilities (Notes 3 and 8) $431,133 $ 28,857 19,680 13,088 679 27,546 15,750 105,600 107,617 42,435 18,645 7,858 68,938 15,164 37,461 85,313 137,938 $420,093 24 Statements of Earnings For the vcars ended December 31, 197b and 1975 (in thousands ol dollars except per share amounts) 197b 1975 Operating revenues: Passenger 1544,188 I4b5,081 (largo 37,92b 31,329 Other 23,091 22,5b3 b()5,2()5 518,973 Operating expenses: Fuel 108,279 93,134 Wages, salaries and employee henelits (Note 5) 22b,3b7 201,bbl Depreciation and amortization (Note 2) 38,058 .3b,054 Other (Note 11) 202,b43 179,.5b3 575,347 510,412 Operating income 29,858 8,5b 1 Other income (expenses): Interest, principally on long-term debt (9,b75) (8,9b4) Interest capitalized 78b 440 Interest income 1,941 3,b30 (iain on sale of equi}>mcnt 1,809 379 Other --net (704) 289 Farnings helore provision lor taxes on income and cumulative effect of a change in accounting (5,843) (4,22b) princi{)le 24,015 4,335 Provision for taxes on income (Note b) 9,050 (825) Farnings before cumidative effect of a change in accounting principle 14,9b5 5,lb0 (Inmnlative effect of a change in accounting principle (Note 2) . . -- 7,lb0 Net earnings S 14,9b5 1 12,320 Farnings per share (Note 12): Primary: Farnings before cumidative effect of a change in accounting principle $ 1.10 $ 0.34 (lumulative effect of a change in accounting prineijile -- 0.47 Net earnings $ 1.10 $ 0.81 Fully tliluted (assuming conversion of debentures): Farnings before cumulative effect of a change in accounting principle $ 0.98 $ 0.33 (Inmidative effect of a change in accounting principle -- 0.41 Net earnings $ 0.98 $ 0.74 See accompanying notes to financial statements. 25 Statements of Changes in Financial Position For the years ended December 31,1976 and 1975 (in thousands of dollars) Sources of Working Capital: Earnings before cumulative effect of a change in accounting principle Add (deduct) items which did not affect working capital: Depreciation and amortization (Note 2) Taxes (Note 6): Deferred income taxes Deferred investment credits Amortization of deferred investment credits Ciain on disposal of property and equipment Other Total from operations before cumulative effect of a change in accounting principle Cumulative effect of a change in accounting princij)le in 1975 amounting to $7,160 which did not affect working capital (Note 2) Total from operations Reimbursements upon leasing of DC-10 aircraft and facilities. Proceeds from disposal of {)roperty and equipment Proceeds from issuance of long-term debt Other--net 1976 $ 14,965 36,132 2,350 4,145 (2,925) (1,809) 1,949 54,807 54,807 7,295 3,771 23,000 (1,156) 87,717 Applications of Working Capital: Purchase of property and equipment and advances thereon Repurchase of common stock (Note 10) .... Reduction of long-term debt including transfers to current liabilities Cash dividends Preoperating costs related to route development Increase (decrease) in working capital 42,362 30,527 20,000 5,312 4,270 102,471 $(14,754) Summary of Increases (Decreases) in Working Capital: Cash, certificates of deposit and commercial paper Receivables Expendable parts and prepaid expenses .... Accounts payable, advance ticket sales, accrued and other liabilities Net increase (decrease) $ 7,751 412 688 (23,605) $(14,754) See accompanying notes to financial statements. 1975 $ 5,160 34,781 9,905 (2,555) (2,975) (379) 1,475 45,412 45,412 15,882 2,535 8,450 2,816 75,095 41,985 15,750 7,126 64,861 $10,234 $10,017 9,401 3,834 (13,018) $10,234 26 SlaleiiitMils of Shareliolders Equity For the years ended December 31, 1976 and 1975 (in tlionsands of dollars ) Balance at |annarv 1, 1975 Kxercise ol stock oj)tions Net earnin^;s (iash dividends Balance at Decembei' 31, 1975 Kxercise of stock options Rej)nrcbase of common stock Net earnings (iasb dividends Balance at December 31,1976 (Notes 7, 9 and 10) See accompanving notes to financial statements. (lonimon Stoc k (lapital in SI.00 Excc'ss ol Rotainc'd Sha rc'holdcrs' 'ar \'alnc* Par \'aliic` Earnings Ecpiity $15,1.59 $37,440 $80,119 $132,718 5 21 -- 26 -- -- 12,320 12,.320 -- -- (7,126) (7,126) 15,164 .37,461 85,31.3 1.37,9.38 4 .32 -- .3() (2,.509) (8,.5.56) (19,462) (.30,.527) -- -- 14,965 14,965 -- -- (5,312) (5,312) $12,6.59 $28,9.37 $75,.504 $117,100 Notes to Financial Statements (In tlionsands of dollars excejit per share amounts). Note 1. Summary of Significant Accounting Policies. Property and Equipment: Propertv and ecpiipment, exclusive of residual values, are depreciated ovei' esti mated nsefid lives bv the straight-line method. Main tenance and repairs are expensed as incurred. (See Note 2.) Major l enewals and betterments are charged to jii'opertv and eqnijiment accounts. Preoperating Costs: Significant costs, such as those for traffic jiromotion and personnel training, related to the inangnration of service over major new routes and to the introduction of new tvpes of aircraft arc deferred and amortized over five vears. Interest Capitalized: Interest related to dejiosits on aircraft jiurchasecontracts iscapitalized and amortized over the useftd lives of the aircraft. Investment Credits: Investment credits generated by acquisition of assets are amortized to income on a straight-line basis over the useful lives of the related assets. Amortization for financial statement purposes may exceed accumulated amounts utilized on West ern's tax returns to the extent of available deferred lederal taxes on income on the accompanving balance sheets. Obsolescence of Expendable Parts: An allowance for obsolescence of flight ccjuipment exjiendable parts is accrued over the useftd lives of the related aircraft types. Advance Ticket Sales: Passenger ticket sales are recorded as a current liahilitv until hilled by other carriers for trans])ortation provided by them or until recognized as revenues for services provided bv West ern. At December 31, 1976, S12,.343 (1975-Sl 1,476) was estimated to he })ayahle to other carriers and $17,220 (1975 --$16,070) was estimated to be related to trans portation to be pro\'ided b\AVestern. Note 2. Depreciation and Amortization. The estimated useful lives and residual values of air craft are as follows: Estimated Rcsidttal I'sclul I.ile N'ulue DC-IO 16 years 10% 727 l.'j years* 13% I'M 11 years* 13% 707 12 years 13% 720B C.ommoii Retirement Date -- December 31. 1978 Slot) *Elle(tiye October 1. 1976 tbe estimated dejireciable lices ol lilteeii 727 iiircrtilt and twenty-loni 737 tiirc ralt were extended Irom 12 years. 1 his change recognizes mtinagement's decision to continue using these iiircralt beyond the period in which they would base become hilly de|)reciated. For 197(). depreciation expense was decreased approximately SI.200; net earnings was incieased by approximately S600 or SO.01 |)er share (primary). Khe estimatctl useful lives of ground ecini})ment range from four to ten years. For buildings and im])rovements on leased property, the estimated use ful lives are generallv the periods of the leases. "Other" operating expenses included de])reciation and amortization expense of $350 in 1976. In 1975 Western changed its method of accounting for costs of major flight equipment maintenance from 27 one of charging; such costs to reserves (accumulated by charges to income on an hours-flown basis) to one of direct expensing of such costs as incurred. The $7,f60 cumulative effect of this change on prior years ($13,7H5 less deferred income taxes of $6,625) is included in net earnings for the year f975. This change had no other material effect on net earnings for 1975. Note 3. Commitments and Contingent Liabilities. At December 31, 1976 WTstern had on order seven 727 aircraft for deliverv in 1977.The total purchase {)rice, including related spares, is estimated to be $78,000 of which approximately $23,500 has been paid in advance dejiosits. Lease financing for five of these aircraft is being finalized. During January, 1977, subject to lender ajiproval. Western exercised options to }>urchase five 727 air craft and agreed to purchase two DC-10 aircraft for deliverv in 1978. The cost of these aircraft will be approximately $116,000. Outstanding commitments for flight ecpiipment modifications amounted to approximately $6,200 anti lor lacilities and ground equipment amounted to approximatelv $2,500 at December 31, 1976. At December 31, 1976 various legal actions were pending against the Citv of Los Angeles anti various cross complaints were pending against Western anti other airlines because of aircraft noise and engine emissions. Western's counsel in these actions, which also rejnesents most of the other airlines, is of the opinion that the airlines have substantial tlefenses to the imposition of any liability. Along with Northwest Airlines, Inc., Western is a tlefentlant in an action brought by Alaska Airlines, Inc. alleging vit)lation of anti-trust laws on particidar routes common to all three airlines. In the o})inion of Western's counsel, such action will not result in any material liability to Western. Western is also involved in various other litigation, including certain cases alleging discrimination in emplovment {practices, that management believes will not have a materially adverse effect upon Western. Western is required by Federal Aviation Adminis tration regidations,effective Januarv 1, 1977, to retrofit or replace aircraft which do not comply with the speci fied noise limitations. Modifications must take place according to stipulated timetables and all affected air craft must be modified or replaced by Januarv 1, 1985. The company j)resentlv intends to replace its eighteen 72()B aircraft and to retrofit or re})lace an undeter mined number of its twenty-four 737 aircraft and five 707 aircraft. The cost of replacing and retrofitting these aircraft cannot be determined with any degree of certainty. External equity and debt financing or a combination thereof will be requirefl to finance air craft necessarv for growth and replacement. Note 4. General Description of the Impact of Inflation (Unaudited). Inflation is reflected in operating expenses in the year in which the jn ice increases occur except for the cost of replacing capital assets. Historically because of the regidatory process fare increases have lagged these [)rice increases. Replacing capital assets, j)rimarily aircraft and ground [)ro})erty with aji.sets having equivalent pro ductive caj^acity has usually retjuired a greater capital investment than was required to ])urcha.se the original productive caj)acity. d'he.se higher acquisition costs reflect the cumidative imj)act of inflation. Western's annual report on form lO-K (a copy of which is available iq)on request) contains information with resjiect to year-end 1976 replacement cost of productive capacity and the ajjproximate effect which re])lacement cost woidd have had on the computation of depreciation expense for the year. Note 5. Retirement Plans. Retirement j>lans cover all classes of emjjloyees. West ern makes contributions to the comjjany sponsored plans which, together with the participant's required contributions, are sufficient to fund current service costs annually and prior service costs over 10 to 20 years. Actuarial gains and losses are amortized over ten-year periods. The cost of retirement plans charged to operating expense amounted to $18,211 for 1976 ($15,453-1975) which included company contributions to a union sponsored plan for mechanics and related employees of $1,929 for 1976 ($1,724--1975). The increase in ex pense was caused by higher wages and by a larger number of employees participating in the plans. Effective January 1, 1976, Western amended certain plans to comply with pension legislation and to stream line benefits. In addition the actuarial method was changed for one plan and certain actuarial assump tions were changed for all plans. These amendments and changes decreased expense in 1976 by approxi mately $1,200 and increased net earnings by $600 or $0.04 per share (primary). Western's actuaries are of the opinion that total assets under the plans exceed liabilities for accrued vested benefits. Lhifunded prior service costs of the plans amounted to approximately $18,897 at December 31,1976. Note 6. Taxes on Income. I he provision for taxes on income before cumulative effect of a change in accounting principle is summa rized as follows: 1976 1975 Current income taxes: Federal $4,405 $(5,425) State 1,075 225 Deferred federal income taxes 2,550 9,905 Deferred investment credits 4,145 (2,555) 11,975 2,150 Amortization of investment credits (2,925) (2,975) $9,050 $ (825) 28 In 1975 the Internal Revenue Service concluded examinations of Western's federal income tax returns throust;h 1972. Western was successful in accelerating dej)reciation for tax purj)oses which residted in a refund for certain of the years under review. I'he pro vision for taxes on income for 1975 includes reclassifi cations relating to timing differences (decreased cur rent federal income taxes of $4,025 and restored deferred investment credits of $1,150, which are offset by increased deferred federal income taxes of $5,155). Deferred income taxes ari.se from timing differences between financial and tax reporting. The tax effects of these differences follow: 1976 1975 Depreciation $ 464 $9,575 Interest capitalized (IW) (429) Preoperatint;; expense 1,668 (200) Other . . 382 959 $2,3.50 $9,905 Investment credits unapplied on tax returns amounted to $17,705 at December 31, 1976 ($19,925 -- 1975) with $1,502 expiring in 1979, $4,093 in 1980, $6,176 in 1981, $4,036 in 1982 and $1,898 in 1983. Of the $17,644 unamortized investment credit bal ance at December 31, 1976 ($18,645-- 1975), $4,170 ($3,082 -- 1975) remains from investment credits uti lized by reduction of taxes paid and $13,474 ($15,563 -- 1975) is related to investment credits not yet utilized for reduction of taxes paid. A reconciliation between the amount of reported taxes on income and the amount computed by multi plying earnings before provision for taxes on income by the expected tax rate of 48% follows: 1976 197.6 Taxes on income at 48% $11,527 $ 2,081 Increases (reductions) in taxes resultin;^ from: Amortization of deferred investment credits (2,925) (2,975) State income taxes net of federal income tax benefit 559 117 Other (Ill) (48) Taxes on income $ 9,050 $ (825) The federal income tax returns for 1973 and 1974 are being examined by the Internal Revenue Service. Note 7. Unsecured Debt. At December 31,1976 and 1975 debt was as follows: 1976 1975 Current portion of debt: Revolving bank line of credit Current maturities of long-term debt . . . $19,500 8,300 $ 9,750 6,000 $27,800 $15,750 Long-term debt: Senior Revolving bank line of credit 5%% in.stallment notes due Se])tember 1, 1981 with annual [trincipal payments $ - $ 11,700 on September 1 ol $4,000 678% installment notes due September 1, 1984 with annual principal payments of $2,(X)0 on September 1 which will 16,000 20,0(X) increase to $7,0(K) a year starting in 1982 8%7o installment notes due November 16, 1985 with quarterly principal j)ayments 29,0(K) 31,(MX) of $768 starting in 1981 15,362 15,362 iibordinated .5V47o convertible subordinated debentures due February 1,1993, with sinking fund payments of $1,500 60,362 78,0f)2 a year starting in 1979 107o subordinated sinking fund notes due April 15,1984, less unamortized discount of $198,with sinking fund payments of $2,300 a year starting 29,555 29,555 in 1977 20,503 -- .50,058 29,555 $110,420 $107,617 On June .30, 1976 borrowings under a Bank Loan Agreement, dated July 1,1968, as amended, which pro vided a line of credit in the total amount of $65,000 were repaid and a new Bank Loan Agreement w^as consummated. This new Bank Loan Agreement pro- vitles Western with a $75,000 revolving line of credit until December 31,1978. On this date the line of credit can be re})laced by a term note in an amount not to exceed $75,000 which will mature on June .30, 1983 with quarterly payments of principal starting March 31, 1979. The interest rate on funds borrowed is 1/2%) over the bank's prime commercial rate until June 30, 1979 when it will increase to 5/87o over such rate. The commitment fee is l/27o per annum on the unused portion. On December 31, 1976 the interest rate for Western was 6%% and $55,500 was available for future drawdowns. Amounts outstanding under this agreement which management intended to repay within 12 months were classified as current liabilities. The remaining amounts outstanding were classified as long-term debt. Although this Bank Loan Agreement does not require compensating balances. Western has infor mally agreed to maintain on deposit average balances equal to 10%) of the total credit available plus f07o of borrowings. The agreements relating to this line of credit and other long-term debt contain provisions which limit retained earnings from which restricted payments (cash dividends and purchases of Western's common stock) can be made. The most restrictive of these pro visions limited amounts available for such payments to $13,666 at December 31,1976. These agreements also contain, among other things, requirements pertaining to cash and working capital levels and provisions which may restrict additional borrowings. 29 The following schedule shows the amount of long term debt due in each of the five following calendar years excluding borrowings under the revolving line of credit: 1977 J 8,900 1978 8,300 1979 9,800 1980 9,8(K) 1981 12,872 At December 31, 1976, 2,465,000 shares of common stock were reserved for conversion of debentures at a conversion price of 111.99 per share. Note 8. Lease Commitments. Total rental expense was 123,703 for 1976 (119,483--1975). Rental expense for noncapitalized "financing" leases was $14,332 for 1976 ($11,740--1975). For disclosure purposes required by regulations of the Securities and Exchange Commission, a "financing" lease is one which, during the noncancelable lease period, either (i) covers 75% or more of the economic life of the property or (ii) has terms which assure the lessor a fidl recovery of the fair market value of the property at the mception of the lease, plus a reasonable return on investment. At December 31, 1976 minimum rental expense under all noncancelable leases expiring after December 31, 1977 was as follows: Totals Flight Airport Other Financing All Other Flquipment Facilities Facilities Leases Leases Annually 1977 111,766 $ 4,984 $ 2,652 S15,529 $ 3,873 1978 11,766 4,983 2,592 15,529 3,812 1979 11,766 4,766 2,415 15,575 3,372 1980 11,766 4,343 2,316 15,547 2,878 1981 11,766 4,198 2,133 15,408 2,689 Five-year periods 1982-1986 49,537 19,439 8,061 66,751 10,286 1987-1991 34,361 15,768 6,201 48,310 8,020 1992-1996 -- 9,298 1,548 6,434 4,412 Thereafter 1997-2007 6,596 - 3,515 3,081 Flight equipment leases cover six 727 aircraft acquired in 1969 under a lease expiring in 1984, two DC--10 aircraft acquired in 1973 under a lease expiring in 1991, one DC-10 aircraft acquired in 1975 under a lease expiring in 1991, and one DC-10 aircraft acquired in 1976 under a lease expiring in 1991. The rental expenses for certain leases included in the above tabulation are normalized on a straight-line basis. At December 31, 1976 other deferred credits in the accompanying balance sheets include $5,330 ($5,116--1975) representing the excess of normalized rental expense over cash payments. The present values, in the aggregate and by major categories, of minimum lease commitments applicable to noncapitalized "financing" leases at December 31,1976 and 1975 were as follows: Interest Rates Used in Computations Present Values Weighted Average Range 1976 1975 1976 1975 1976 1975 Flight equipment $ 84,251 $ 67,888 9.5% 9.4% 8.4-10..5% 8.4-10.5% Terminal and hangar facilities 32,416 33,932 7.0% 7.5% 3.7- 9.2%. 3.7- 9.2% Other facilities 2,131 2,407 9.5% 7.1% 6.9-10.4% 6.9-10.47o $118,798 $104,227 If (for purposes of disclosure required by regulations of the Securities and Exchange Commission) (i) all of the above "financing" leases were capitalized, (ii) the related property rights were amortized on a straight-line basis, and (iii) interest costs were accrued on the basis of the present value of outstanding lease commitments, amortization would have been $6,992 and interest would have been $9,785 for 1976 (5,564 and $7,848, respectively, for 1975). Net earnings for 1976 would have been reduced by $1,174 or $0.09 per share (primary) [$802 or $0.05 per share (primary) for 1975]. The interest rates used in these computations are based on the interest rates of the underlying debt. In November, 1976, the Financial Accounting Standards Board issued Statement No. 13,"Accounting For Leases'.' Based on criteria set forth in this document, leases for flight equipment and other facilities will be capitalized in the financial statements. Capital leases under Statement No. 13 do not include noncapitalized "financing" leases for terminal and hangar facilities as disclosed in the above tabulation. Note 9. Stock Options. Western presentlv has a qnalilied stock option |)lan adopted in 1964 lor ollicers and a nontinalilied stock option plan adopted in 1974 lor ollicers and key per sonnel. I'hese })lans are summarized as lollows: Number ol Average Shares Price |anuarv 1,107.') . ,')0.'),699 S9.66 Options granted l.'),0(K) 8.0() Options exercised (1,.')89) i').60 Options cancelled and expired (l.'),76}) 8.74 December 01,197.'). .')00,0`16 9.68 Options granted t,0(X) 9.,'')6 Options exercised (1,120) 8.80 Options cancelled and ex])ired (20,678) 11.21 December 01, 1970 479,.')48 9.60 Shares exercisable at: December 01,1976 :i(K),082 9.80 December 01.197.') . 201,2.'-)2 9.99 No additional o})tions may be granted under the 1964 stock option plan; however 643,805 shares were reserved under the 1974 stock option plan at December 31,1976 lor the issuance of additional options. Note 10. Repurchase of Common Stock. On April 28, 1976 Western rejtnrchased 2,508,832 shares of its common stock from a shareholder for S7,307 in cash and 523,000 in jjrincipal amount of 10% subordinated sinkini; fund notes. (See Note 7.) These notes were sold to the public on April 29, 1976 at 99% of princij)al amount. Note 11. Mutual Aid Agreement. W'estern is a jiartv to the Mutual Aid Agreement which ])rovides for financial aid in the event that any of the participating carriers is forced to suspend operations becau.se of certain tvpes of strikes. Payments to other carriers included in "other" operating expenses were 5899 in 1976(54,832-1975). Note 12. Earnings per Share. Earnings per common share are based on the weighted average number of shares of common stock outstand ing which were 13,601,()()() shares in 1976 (15,163,000-- 1975). Earnings per common share assuming dilution trom conversion of the debentures were based on 16,066,000 shares in 1976 (17,628,000-1975). Ont.stand- ing stock options have no material dilutive effect on earnings per common share. Note 13. Quarterly Financial Data (Unaudited). Summarized quarterly financial data for 1976 is as follows: riirco Months KiuU'd Mar. 01 June 00 Sept. !?() Dec. 01 ()perat ing revenues $ 1 09,48,'') SI 46,272 $166,026 $1,`)0,122 ()|)erat ing income 1,().')() 8,000 16,840 0,929* Net earnings 1,420 0,812 7,821 1,909* *()|K"ratin^ income and net earnings were increased bv SI,200 and StiOO, respectively, as a result ol a change in estimated depreciable lives ol I'M and 727 aircralt. (See Note 2.) 31 Accountants Report Peat, Marwick, Mitchell 8c Co. 555 SOUTH FLOWER STREET LOS ANGELES, CALIFORNIA 90071 The Board of Directors We have examined the balance sheets of Western Air Lines, Inc. as of December 31,1976 and 1975 and the related statements of earnings, shareholders' equity, and changes in financial position for the years then ended. Our examinations were made in accordance with generally accepted auditing standards, and accordingly included such tests of the accounting records and such other auditing procedures as we considered necessary in the circumstances. In our opinion, the aforementioned financial statements present fairly the financial position of Western Air Lines, Inc. at December 31,1976 and 1975, and the results of its operations and the changes in its financial position for the years then ended, in conformity with generally accepted accounting principles consistently applied during the period subsequent to the change, with which we concur, made as of January 1,1975, in the method of accounting for costs of major flight equipment maintenance as described in Note 2. February 25,1977 Board of Directors President, Inter-American Commercial Arbitration Commission, Mexico City, Mexico Victor L. Brown* Presiding Bishop, The Church ofJesus Christ of Latter-day Saints, Salt Lake City, Utah Tames. D ^Garibaldi Homey at Laxvf.Garibaldi & Sausser, Los Angeles, California Chairman ofthe Board, Hickel Investment Company Anchorage, Alaska Mii^iiel M. Blasquez Vidor L. Brown Bert T. Kobayashi, Jr. Attorney-at-Law, Kobayashi, Koshiba & Watanabe, Honolulu, Hawaii rfi . 1 elevtston'Producer and Broadcaster Chairman ofthe Board, LinkletterEnterprises, Inc. [rvine, Califomia, Assistant to the President, SaintJohn's University, St. Paul, Minnesota Dominic P. Renda*,i^ Leo H. Dwerlkotte `v' Las Vegas, Nevada] Director and Executive, Faberge, Inc., Beverly Hills, Califomia Dr. Donald H. McLaughlin Edwin W. Pauley .Arthur G. Linkletter John H. Myers Chairman ofthe Board, Pauley Petroleum, Inc., Los Angeles, Califomia .Vernon .0_Underwood Chairman ofthe Board and ChiefExecutive Officer, Young's Market Company, Inc., Los Angeles, Califomia Chairman ofthe Board, Union Bancorp, Inc., Los Angeles, Califomia Walker Bank & Tmst Company, Salt Lake City, Utah Arthur G. Woodley Bellevue, Washington President, Mountain States Employers Council, Inc., Denver, Colorado Dominic P. Rencta Robert H. \ oik President and Chief Operating Officer, Western Air Lines, Inc., Los Angeles, Califomia Chairman ofthe Board, Westmor Corporation (formerly Unionamerica, Inc.) Los Angeles, Califomia Member, Executive Committee Directors Emeriti Attomey-at-Law, Darling, Hall, Rae & Gute, Los Angeles, Califomia Chairman ofthe Board, Homestake Mining Company, San Francisco, Califomia Chairman ofthe Board and ChiefExecutive Officer, Western Air Lines, Inc., Los Angeles, Califomia Corporate Officers Executive Officers [Chat? Board and ChiefExecutive Officer Presideyit and Chief Operating Officer Corporate Planning Division James L. Mitchell Senior Vice President-Corporate Planning ^ice President-Schedule Planning Vice President-Data Processing and Systems Vice President-Cornmunications Finance and Administration Division 1-- ` SentorjVice Pj-esident-Finance and Administration Paul V^Donahue Vice President-Procurement Yice President-Financial Planning Vice President and Treasurer President and Controller President-Personnel Relations Assistant Vice President-Special Projects \Senior_Vice'^Presiderit-Lesal and Secretarv iViceTj-esident-Regulatorv Law Assistant Secretary and Director-Corporate Law Marketing Division Sen ioriVi^President-Marketing Vice President-Sales and Service Vice President-Passenger Sales Lawrence H. Lee Vice President-Inflight Service Vice President-Passenger Service [Vice President -Advertising and Sales Promotion 'i^Preside n t-Ma rketing A dministration ^wPPresident-FieId Management Assistant Vice President-Cargo Sales and Service Operations Division Senio^VicPPresident-Operations reside nt-Engineering wicCPresident-Flight Operations Vice President-Maintenance ; Corporate Affairs esident-Corporate Affairs Assistant Vice President-Consumer Affairs Government and Industry Affairs NeirS: Stewart Vice President-Government and Industry Affairs Regional Officers Regional Vice President-Seattle/Tacoma Regional Vice President-San Francisco iEllHntfan?aaa Regional Vice President-Hawaii Regional Vice President-Denver Regional ViceJ^^esident-Salt Lake City R egionaijVi^President-Fie Id R egional Vice Preside nt-Mexico jResional Vice President-A laska }Re[ional Vice President-Los A ngeles Regional Vice President-Minneapolis/St. Paul The principal occupation ofeach ofthe officers is his position with Western. General Offices Western Air Lines Building, 6060 Avion Drive Los Angeles International Airport Los Angeles, California 90009 State Registrars/Transfer Agents Bank of America National Trust & Savings Assn. Ill West Seventh Street, Los Angeles, California 90014 Debenture and Subordinated Note Trustee The Chase Manhattan Bank 1 Chase Manhattan Plaza, New York, New York 10015 Stock Listing New York Stock Exchange Pacific Stock Exchang New York Stock Exchange Pacific Stock Exchange General Counsel Hugh W. Darling Darling, Hall, Rae & Cute 523 West Sixth Street, Los Angeles, California 90014 Independent Accountants Peat, Marwick, Mitchell &: Co. 555 South Flower Street, Los Angeles, California 90071 Fourth Thursday in April