Our Cover: On May 1, 1982, Western will launch a major restructuring of its route system . The key feature will be the establishment of a hub-and-spoke oper- ation at Salt Lake City where arrival and departure times of flights will be coordinated to provide connecting services to a broad range of destina- tions. This system will permit Western to "feed " its flights with passenger and cargo from connect- ing services and will increase fleet utilization . Routes serving the new hub are shown in white. Description of Business Western Air Lines, Inc. is a certificated air carrier originally organized in 1925. The company is engaged in one industry - the scheduled air trans- WESTERN AIR LINES, INC. 1981 ANNUAL REPORT portation of passengers, air cargo and mail . It serves cities in the United States, Canada and Mexico. LETTER TO SHAREHOLDERS 1981 was a disastrous year for Western Airlines. Capped by a fourth quarter loss of $56.1 million , the largest quarterly deficit in company history, Western experienced a net loss of $73.4 million for the year. There were a number of reasons for this result: a recession-related slowdown in air travel , excess capacity in the marketplace, rate wars that diluted revenues, and continuing inflation that drove up costs. Hardest hit by these conditions were a number of established carriers like Western that had developed their route systems and their cost structures in the regulated environment that ex- isted prior to October 1978 and had not changed them significantly since that time. These systems, based almost entirely on point- to-point linear routes, were generally profitable during the era of controlled competition . However, because this type of system does not produce or control connecting traffic, linear routes are vulnerable to competition and rate wars. Com- 2 pounding the problem for Western was the fact that it had higher costs than many of its com- petitors, which left the company in the position of either matching competitors fare cuts at a loss or abandoning markets. When I came to Western Airlines on December 8, I found the company on the verge of collapse. It had lost money for two years and monthly losses had increased at a frightening rate. It was virtually out of cash, and because it was not in compliance with certain tests under its loan agreements, it was unable to borrow additional funds. As a conse- quence, Western had retained bankruptcy counsel , which the new management team decided was premature. A thorough analysis of the problems showed that in order to survive and prosper West- ern would have to make major changes in its structure and its way of doing business and that it must develop a strategy that would be respon- sive to the deregulated environment. We determined that because of its sizeable fixed costs the company would have great diffi- culty becoming profitable by shrinking to a new size or shape. Under-utilized aircraft and facilities, which could not be disposed of at anywhere near their true value, would have to be put to more productive use along with Western's employees. In short, we would have to fly our way back into the black by doing more, not less. And in order to do this and survive, we would have to control our costs. As essential elements of this plan we concluded that we would have to: develop a new marketing organization and a more competitive marketing philosophy; reduce overhead costs by eliminating excess layers of management, by cutting salaries and by getting more productivity out of those who remain ; obtain from unionized employees wage cuts and changes in work rules that would increase productivity; convince our lenders that we have formulated a workable short-term survival plan and a long- term strategy for profitability in order to obtain additional working capital and waivers of defaults under existing loan agreements. Programs to accomplish all of these objectives are well underway. On May 1, Western will launch the most dramatic route realignment in its history. The new route system will reflect our conviction that the proper role for Western Airlines is as a strong regional carrier serving the West through a strategically located hub and a cohesive pattern of regional service. Our objective is to develop a hub-and- spoke system that will enable us to control a greater share of the passenger and cargo travel that emanates from cities we serve. Western's hub will be at Salt Lake City, a city that is located in a rapidly growing region , is near the center of our route system and is an established Western city in which we have excellent facilities and a long history of service. Most flights from throughout our system will be routed through Salt Lake City where con- nections will be available to other Western cities. We will strengthen the hub furth. er by inaugurat- ing service to new cities in the West and to New York City, Baltimore and Washington , D.Cs Dulles Airport. Our Seattle/Tacoma gateway to Alaska and California gateways to Mexico and Hawaii also will be strengthened by direct links with the Salt Lake City hub. Implementation of these changes will not require additional aircraft or other major capital expenditures. The realignment will be achieved by increasing the use of existing resources. For example, we will increase the average daily utili- zation of our fleet by almost two hours per day per aircraft. This figure will rise even more as additional routes .and schedules are blended into the new system . Our marketing strategy will be very simple. We will price our product competitively, prqvide good schedules and service and make it easy for our customers to do business with us by answering our reservations phones promptly, simplifying our fare structure and making ticketing easier. In order to be a tough competitor we also must reduce our costs to a level that will permit us to make a profit from the low fares that now dominate 3 and will conti nue to dominate high-density routes. Since December, we have been taking the necessary steps to lower Western's costs. We have reduced annual payroll costs for the management staff, have obtained wage concessions from some of our unionized employees and we are attempt- ing to obtain similar concessions from the re- maining group. Although our new schedules and contractual concessions from our pilots will pro- vide some gains in productivity, we need more and are working toward that end. We are confident that the route realignment and our marketing program will stimulate traffic over the Western system and increase revenues. We are not optimistic that we will receive any help from an improvement in the economy in 1982 nor are we relying on such an upswing to make Western profitable, although such a development certainly would be beneficial and welcome. The key to 1982 and the future of Western Airlines lies in our ability to control our costs and increase the productivity of our work force. We believe that Western can be a viable company. Your management is doing everything possible to ensure that this objective is achieved as soon as possible. Chairman and Chief Executive Officer April 22, 1982 The Year At A Glance (in millions of dollars) Operating revenues Operating expenses Operating loss Other Income (Expenses): Interest expense, net Gain on disposition of equipment Other-net Loss before income taxes Income tax Net loss Passengers carried (000) Available seat miles (000,000) Revenue passenger miles (000,000) Passenger load factor - actual % - breakeven % 1981 $1 ,059.8 1,125.8 (66.0) (45.0). 16.9 1.3 (92.8) (19.4) $ (73.4) 8,402 14,496 8,548 59.0 65.8 4 1980 % Change 995.7 6 1,041.5 8 ( 45.8) 44 (38.5) 17 32.1 (47) 3.0 (57) (49.2) 89 (19.6) ( 1 ) (29.6) 148 9,130 (8) 15,516 (7) 8,832 (3) 56.9 4 62.0 6 MANAGEMENT'S DISCUSSION Results of Operations The last several years have been very difficult for Western. The company reported net losses in 1980 and 1981 and a 24 percent decline in net profits in 1979. Prior to December 1981, when the company's new management embarked on a rebuilding program , the company had responded to this downturn by reducing its production of available seat miles (ASM's) in 1981 and 1980. Since 1979 ASM 's have decreased 13 percent; however, revenues escalated 14 percent because of fare increases. This level of revenue growth was not adequate to support the cost base Western had established in the regulated environ- ment. Operating expenses increased 23 percent from the 1979 level, more than offsetting the 14 percent increase in revenues and creating the company's substantial operating losses. The largest contributor to the rise in operating expenses was fuel costs, which increased 45 percent since 1979. Consumption actually de- creased du ring this period by 21 percent but the average cost per gallon increased 82 percent, from $0.57 in 1979 to $1.04 in 1981. Early in 1982 fuel prices dropped to slightly under $1.00 per gallon. They are expected to remain at this level or decline slightly throughout 1982. Wages, salaries and employee benefits in- creased by nearly $47 million from 1979 through 1981 despite the fact that the number of em- ployees decreased by more than 1,100 during that period . The company is currently negotiating with its labor unions to reduce wage levels and increase productivity during 1982. Labor costs for the company in 1982 and subsequent years depend in large part on these negotiations. Other operating expenses, which are suscep- tible to inflationary pressures, include costs such as aircraft and ground equipment rentals, adver- tising and commissions. Commission expense in- creased 20 percent from 1980 to 1981 , reflecting the impact of deregulation on the industry. Because scheduled carriers are no longer permitted to jointly establish travel agency commission rates, competition for the agents' business has forced commission rates up. This has resulted in increas- ing the commission rate paid by Western to travel agents from an average of 8.9 percent in 1980 to 10.4 percent in 1981. Also, higher fares and increased ticket purchases through agencies 5 have contributed to the rapid growth in commis- sion expense. These conditions are not expected to change in 1982. New equipment financed at higher interest rates, as well as a higher level of interest rates in general, have resulted in increased interest expense of the company in 1979, 1980, and 1981. Depreciation expense also has increased because of significant equipment purchases. In 1981 , sales of aircraft helped maintain the level of depre- ciation expense despite the acquisition of three new aircraft. For a detailed discussion of the impact of infla- tion on operating results see Note 13 to financial statements. Western's operations have been affected in these years by activities within the industry. In 1981 , revenues during the peak season of the third quarter were reduced slightly by the walkout of air traffic controllers on August 3. The grounding of the DC-10 aircraft in 1979 affected operations in that year, as did strikes against major competitors. Liquidity During the first six months of 1981 Western was able to fund current operations and debt repayment with cash generated from operations and the sales of excess aircraft. In addition, $30 million of the $50 million outstanding at December 31 , 1980, on its revolving line of credit was repaid . In the second half of 1981 , however, traffic and revenues were significantly lower than anticipated . Operations no longer generated enough cash to meet operating requirements. The company borrowed additional funds of $20 million from two foreign banks and $7 million on its revolving line of credit. During that same period the com- p~ny also sold and leased back two 737s and sold tax benefits under the provisions of the Economic Recovery Tax Act of 1981 , generating cash of approximately $11 million and $5 .6 million , re- spectively. Throughout 1981 Western made all scheduled debt payments and paid preferred dividends regularly. The effects of the losses on retained earnings and equity resulted in Western's default of some of the covenants of its various loan agreements. Since these defaults allow certain of Western's lenders to demand immediate payment of the total amounts owed to them and because Western has not obtained waivers for a period in excess of one year, a portion of the long-term debt has been classified as current. Decisive steps have been taken by Western to cut its labor force , reduce the wages paid to remaining employees, modify current labor contracts, negotiate the sale of additional assets and negotiate additional loan and security agreements with its various lenders. Western entered into agreements in January 1982 with its lenders to waive the company's defaults under its loan agreements until June 10, 1982. Western also entered into an agreement with its previously unsecured lenders to secure their loans with 29 of Western's aircraft and 77 of its engines. In addition , the company obtained a $30 million line of credit due April 30, 1982, all of which had been drawn down as of March 15, 1982. (See Note 6 to financial statements.) The company is continuing to negotiate with its lenders to restructure a portion of its debt. This restruc- turing is essential to the continuing operations of the company. Western has entered into agree- ments with third parties to sell certai n other assets, which will generate approximately $31 million . Western is required to use the proceeds from asset sales to pay off any amounts outstanding on the new line of credit. See Note 14 to financial statements. Capital Resources Western has on order six 767 aircraft and three 767 spare engines, the deliveries of which have been delayed until 1984 and 1985. The total com- mitment for the acquisition of these aircraft and spare engines is approximately $305 million . Long- term secured debt or capital lease financing is expected to be utilized to finance these acquisi- tions although no assurances can be given that su_ ch methods of financing will be available. West- ern also holds options for the purchase of six additional 767s which would be delivered in 1985 and 1986. (See Note 3 to financial statements.) Shareholders and Stock As of December 31 , 1981 , there were 13,043,621 shares of Western common stock outstanding held by approximately 15,000 individuals and insti- tutions. Holders of the common stock last received a dividend in the t_ hird quarter of 1980. Because of continuing losses, Western has not paid a dividend on the common stock since that time. Retained earnings available for payment of common stock dividends are restricted by various debt agree- ments. At December 31, 1981 , no retained earn- ings were available for dividends on common or preferred stock. Western has 2,992,300 shares of common stock reserved for issuance upon conversion of its preferred stock and an additional 1,952,554 shares reserved for issuance upon conversion of its 5% Convertible Subordinated Debentures. At December 31 , 1981 , there were 1,196,920 shares of the $2.00 Series A Cumulative Con- vertible Preferred Stock outstanding held by 1,353 individuals and institutions who have been paid regular quarterly dividends. On January 29, 1982, Western's board of directors voted to defer pay- ment of the quarterly dividend payable at the end of March 1982 on the preferred stock. This is the first preferred stock dividend to be omitted since the stock was issued in September 1977. If six consecutive dividends are omitted , the holders of the preferred stock have the right, voting as a class, to elect two board members. See Note 6 to financial statements. Western's common and preferred stock are traded on the New York and Pacific Stock Exchanges. Market Prices Common Stock Preferred Stock 1980 High Low High Low First Quarter 11 % 6 29 19 Second Quarter ?'fa 6 23Ya 19 Third Quarter 8 6 24 21 Fourth Quarter 10 6 25 20% 1981 First Quarter 10 8 26. 21 Second Quarter 11 8 30 22Ya Third Quarter 11 6 29 15% Fourth Quarter 8Ya 4% 20 14 On December 8, 1981 , the Board of Directors of Western elected Neil G. Bergt as Chairman and Chief Executive Officer. Bergt is a principal shareholder of Eagle International Corporation (Eagle), a privately held corporation which agreed in November 1981 to acquire Wien Air Alaska, Inc., (Wien) from Household International , Inc. In connection with Bergt's selection as Chief Executive Officer, Western , Eagle, and Mr. Bergt 6 signed an agreement in principle dated December 8, 1981, regarding (a) Eagle completing its acquisition of Wien, and (b) the preparation and execution of a definitive agreement pursuant to which Western shall acquire Wien or a business combination shall otherwise be accomplished between Western and Wien . The letter of intent indicates that in connection with the acquisition by Western of Wien, 5,000,000 shares of a new series of preferred stock of Western or the surviving corporation (the "Pre- ferred Stock") will be issued to Eagle or its share- holders. The Preferred Stock will be convertible into 12,500,000 shares of common stock and will be substantially equivalent to the outstanding Western Series A Preferred Stock, except that it will have voting rights equivalent to those of the common shares issuable upon conversion and no dividends will be payable in respect of the Preferred Stock for the first year after it is issued . The proposed acquisition will be subject to approval of Western's shareholders, lenders, and the Civil Aeronautics Board . Regulatory Matters The required filings in the Bergt-AIA-Western- Wien Acquisition and Control Case have been made with the Civil Aeronautics Board, and the board's decision should be announced by the end of July 1982. Details of this proposed acquisition, which is subject to approval of Western's share- holders and lenders, are contained in proxy mate- rials being mailed to shareholders in connection with the 1982 Annual Meeting of shareholders, presently scheduled for June 1982. The Civil Aeronautics Board has approved Air Florida System, lnc.'s application to acquire control of Western . Air Florida had filed its appli- cation with the CAB in July 1981 and been given permission to purchase up to 50 percent of Western's outstanding common stock to be placed in a voting trust pending the outcome of the CAB's hearings. The final CAB decision in the matter was announced January 29, 1982. Air Florida, which holds approximately 12.6 percent of Western's common stock, has not announced its intentions. Western's planned merger with Continental Air Lines, Inc. was thwarted by the successful takeover of that carrier by Texas International. 7 Western withdrew from the merger agreement in September 1981 . With the suspension of its services to Great Britain in late 1981 and to Nassau, the Bahamas, earlier in the year, Western now serves three countries - the United States, Canada, and Mexico. In its service to Canada and Mexico, Western is subject to conditions of bilateral agreements be- tween these nations and the United States as well as to policies of each of the governments with respect to air transportation and pricing. Service within the United States has been given increased flexibility since the passage of the Airline Deregulation Act of 1978. Effective January 1, 1982, Western and other air carriers have author- ity to fly between any points within the U.S. that they desire. However, the air traffic controllers strike has temporarily limited flights at 22 busy airports in the U.S. Under terms of the Deregulation Act, the Civil Aeronautics Board will cease to exist January 1, 1985. Certain of the Board 's functions will be transferred to other governmental departments, primarily the Departments of Transportation and Justice. Western's Fleet In Operation* 1984/1985 1985/1986 Owned Leased Delivery Options DC-10-10 7 3 OC-10-30 727-200 33 14 737-200 10 2 767-20Q 6 6 *As of March 15, 1982. Western's present fleet is in compliance with fed- eral noise regulations with the exception of the two-engine 737s. An undetermined number of these aircraft will be retrofitted at a cost of approxi- mately $275,000 each in advance of the 1985 deadline for compliance. Schedule reductions in 1981 caused Western's traditionally high level of aircraft utilization to drop. The 727s, which represent more than half of the company's available seat miles, flew a daily hourly average of 7:58, down from 8:23 in 1980, while DC-10-10 utilization was down to 9:18 from 10:46 in 1980. Average daily hours flown by all aircraft during 1981 was 7:57, compared with 8:24 the year before. Ground Properties and Equipment Western's general office and principal overhaul and maintenance base are located at LosAngeles International Airport. These facilities, including a DC-10 hangar and a parking structure com- pleted in 1975, have been built by the company as improvements on leased land. The lease on the land and buildings expires in 1993, subject to the right of the City of Los Angeles to terminate the lease on March 31 , 1988, or any March 31 thereafter. The company also leases hangars at Seattle/ Tacoma, San Francisco and Minneapolis/St. Paul , as well as terminal faci lities at all airports served , plus ticket and administrative offices throughout its system. A leasehold interest in a hangar at Denver was transferred to another carrier in March 1982. Public airports are utilized for flight operations generally under contractual arrangements with municipalities or agencies controlling them . Western's Management Major changes took place in Western's manage- ment structure during the latter part of 1981 and early 1982. On December 8, 1981 , Neil G. Bergt was elected chairman and chief executive officer of Western . Mr. Bergt, 46 , is chairman and sole owner of Alaska International Industries, Inc., which has subsidiaries active in construction , energy devel- opment and international air cargo . He also is the principal shareholder of Eagle International Corporation , a privately held corporation that was formed in November 1981 to acquire Wien Air Alaska Inc. from Household International, Inc. Employees The number of Western employees during 1981 averaged 10,120, down from an average of 10,657 in 1980. Labor unions represent approxi- mately 92 percent of Western's employees. These unions include the Air Line Pilots Association , Air Transport Employees, Association of Flight Attendants, Brotherhood of Railway and Airline Clerks, International Brotherhood of Teamsters, Sindicato Nacional de Trabajadores de Aviacion y Similares and the Transport Workers Union . Following is the contractual status of each of these collective bargaining groups: Number of Contract Employees Open for 1-1-82 Union Amendment Mechanics & Related Employees and Stock Clerks 1,810 IBT 1-1-83 Pilots 1,27 1 ALPA 5-1-84 Flight Attendants 1,677 AFA 1 2-31 -82 Agent & Clerical - U.S. 3,740 ATE 7-1 -82 Canada 110 BRAC 7-1-82 Mexico 212 SNTA 1-18-83 Flight Superintendents 21 TWU 10-3 1-83 Ground School Instructors 30 IBT 1-1-83 Legal Proceedings Western and other airlines are parties to numerous actions in state courts wherein owners of property located in the vicinity of major airports, primarily Los Angeles International Airport, are seeking to enjoin certain aircraft operations at the airport and/or to recover damages because of aircraft noise and engine emissions. Most of these cases have been brought in the Los Angeles County Superior Court against the City of Los Angeles, which in a number of these cases has in turn cross- complained against the airlines for indemnifica- tion . The aggregate amount of damages sought in cases against the city has been reported by the city to be in excess of $57 million. The aggregate amount of damages sought in actions to which Western is a party as cross-defendant is in excess of $36 million . Western and its counsel in these actions, O'Melveny & Myers of Los Angeles, believe that the damages claimed are not a real istic measure of the airlines' exposure and that in most cases the request for relief is wholly out of proportion to any actual damage that may have been suffered. Western's counsel , which also represents most of the other airlines, is of the opinion , based on the current state of the law, that the airlines have sub- stantial defenses to the imposition of any liability. Moreover, in each case to date in which the issue of the airlines' duty to indemnify the airport pro- prietor has been tried , the airlines have obtained favorable rulings. However, all the issues of law involved in these matters have not been finally settled, and , pending further judicial clarification , the relative rights and liabilities among such owners of adjacent areas, the airport operators, 8 the air carriers and the federal, state, and local governments are not entirely clear. Unfavorable decisions against Western in these actions could have a materially adverse effect on the company. Further, any liability of airport operators, or the granting of any injunctive relief against them, could result in higher costs to air carriers, for example through higher landing fees. In light of this litigation , operators of certain airports, includ- ing those at Los Angeles, Orange County, San Diego, Calif. , and Washington , D.C.'s National, have imposed or are considering imposition of limitations on frequency and timing of airline flights or upon the proportion of an airline's fleet which may continue to operate without complying with specified noise standards. In the case of Orange County, the local board of supervisors adopted an airport access plan for John Wayne Airport which would have the effect of denying Western access to that airport. Implementation of the plan was enjoined by a Federal District Court and that decision presently is on appeal . Generally speaking , enforcement of such restrictions at a major airport served by Western could have a materially adverse effect upon its operations. A number of actions have been filed in both federal and state courts against Western and other defendants seeking damages for death or injury suffered in the October 31 , 1979, crash of a Western aircraft at the Mexico City airport. Western has ample insurance coverage for this type of accident, although insurance may not cover liabil- ity for punitive damages which are sought in sev- eral of the actions premised on bodily injury. Most of the claims arising from the accident have been settled , and Western does not believe that such claims for punitive damages will result in any material liability to Western . Western is also involved in various other liti- gation , including cases alleging discrimination (including age discrimination) in employment practices. In one such action involving the ability of Western pilots to continue after age 60 as second officers, a judgment was entered during 1981 directing the company to allow three pilots to continue working as second officers after age 60 and awarding those pilots back pay and attorneys fees. That case presently is on appeal , and at least one other similar action has been filed . Western does not believe such claims will result in any material liability to Western . 9 (In millions except per share amou nts and other items indicated by*) Summary of Operations Operating Revenues: Passenger . . . . . ........ . Carg o, charter, and other . Total operating revenues . Operating Expenses: Wages, salaries, and em ployee benefits . . Fuel. Othera . Total operating expenses . Operating income (loss) .. Interest expense, net . . ...... . Other income, net Earnings (loss) before income taxes and cum ulative effect of changes in accounting princi ples . Income taxes . Ea rning s (loss) before cumulative effect of changes in accounting principles . Cumu lative effect of changes in accounting principles . Net earnings (loss) ... . .. .... . Preferred stock dividends . Net earn ings (loss) available for common stock Earn ings (Loss) per Com mon Share: Primary: Before cumulative effect of changes in accounting principles . Net earnings (loss) . Fu lly diluted : Before cumulative effect of changes in accounting principles . Net earn ings (loss) . . ... ... ..... .... ......... . Number of Shares Used to Com pute Earni ngs (Loss) per Share: Primary . . ............................. .. . . Fully diluted. . ........ . . . . . . .. ..... . ........ . ....... . . Other Financial Data Cash dividends paid per share of com mon stock . Total assets ........... ........ . ........... . . . .. .. ...... . Property and equipment-net . Long-term obligations . Shareholders' eq uity ........ . Operations Ai rplanes operated at end of year* . Passengers carried . Available seat miles . . ............ . Revenue passenger miles . . . . . . . . . . . . . . . . . . ............ . Passenger load factor - actual (%)* ......... .. ..... . ..... .. .... . - breakeven point (%)* ...................... . . - profit marg in (point difference)* . . ....... . Average revenue per passenger mile* . . .... .. ..... . ..... .. ....... . . . Average length in miles per passenger trip* . . ...... . Operati ng expense per available seat mile* . . .. . . . ..... .. . .... ... . Cargo revenue ton miles ... ... .......... ... ..... ... .... . . . Average number of employees* . (in millions of dollars except per share amounts) 1981 $ 949.6 110.2 1,059.8 403.4 326.6 395.8 1,125.8 (66.0) (45.0) 18.2 (92.8) (19.4) (73.4) (73.4) 2.4 $ (75.8) $ (5.81) $ (5.81) $ (5.81) $ (5.81) $ 13.0 13.0 $ 834.6 $ 662.4 $ 248.5 $ 121.7 70 8.4 14,495.8 8,547.9 59.0 65.8 (6.8) $ .1113 1,017 $ .0777 151.3 10,120 1980 887.9 107.8 995.7 384.2 296.4 360.9 1,041 .5 (45.8) (38.5) 35.1 (49.2) (19.6) (29.6) (29.6) 2.4 (32.0) (2.46) (2.46) (2.46) (2.46) 13.0 13.0 0.25 917.0 718.8 435.1 197.3 71 9.1 15,515.6 8,832.1 56.9 62.0 (5.1) .1010 965 .0671 163.2 10,657 (a) C hanges in the estimated useful lives of certain aircraft were implemented in January 1978 and October 1976. These changes increased net income in 1978 and 1977 by approximately $1 .5, or $0.12 per share (primary) , and $2.4 , or $0.19 per share (primary) , respective ly. 10 1979 827.7 104.4 932.1 356.6 225.7 331 .6 913.9 18.2 (24.9) 46.1 39.4 (2.1) 41.5 41.5 2.4 39.1 2.99 2.99 2.31 2.31 13.1 18.2 0.40 821 .4 634.6 318.3 232.6 76 11.2 16,630.5 10,494.8 63.1 63.2 (0.1) .0807 926 .0550 162.0 11 ,256 1978 734.0 100.5 834.5 309.4 154.9 315.3 779.6 54.9 (20.2) 10.7 45.4 6.9 38.5 16.2b 54.7 2.4 52.3 2.82 4.09 2.15 3.04 12.8 18.2 0.40 710.1 519.7 265.7 198.5 78 10.4 16,254.9 10,634.8 65.4 61.1 4.3 .0720 994 .0480 176.3 10,787 1977 614.6 76.9 691 .5 263.1 138.0 260.9 662.0 29.5 (17.5) 7.8 19.8 7.1 12.7 12.7 0.5 12.2 0.96 0.96 0.85 0.85 12.7 15.9 0.40 574.9 427.9 214.5 147.4 77 8.8 14,963.8 8,588.8 57.4 56.1 1.3 .0734 966 .0442 157.3 10,413 1976 544.2 61.0 605.2 226.4 108.3 235 .1 569.8 35.4 ( 16 3) 3.1 22 .2 8.2 14.0 14.0 14.0 1.03 1.03 0.92 0.92 13.6 16.1 0.40 515.1 378.6 192.5 112.1 75 8.1 13,450.4 7,833.8 58.2 56 .0 2.2 .0705 963 .0424 135.0 9,799 1975 465 .1 53.9 5'19.0 20 1.7 93. 1 21 1 .1 505.9 13. 1 (14.4) 4.3 3.0 ( 1 .5) 4.5 7.2 11. 7 11 .7 0.30 0.77 0.29 0.70 15.2 17.6 0.47 488 .3 367 .6 175.4 133.9 75 7.5 11 ,696.5 7,102.9 60.7 59 .7 1 .0 .0665 942 .0433 108.6 9,357 1974 437.3 51.1 488.4 182.3 71.4 192.5 446.2 42.2 (15.3) 13.8 40.7 17.2 23.5 23.5 23.5 1.55 1.55 1.38 1.38 15.1 17.6 0.39 448.8 350.3 167.4 129.3 72 7.4 11 ,123.5 6,747 .5 60.7 56.1 4.6 .0660 902 .0401 95.2 9,696 1973 376.7 44.6 42 1.3 165.4 44.5 168.3 378.2 43. 1 (13.0) 4.2 34.3 14.4 19.9 19.9 19.9 1.32 1.32 1.18 1 .18 15.1 17.5 0.23 431 .7 316.4 178.0 110.8 74 7.4 11,175.5 6,476.1 57 .9 52.5 5.4 .0593 877 .0338 76.5 9,826 (b) Effective January 1, 1978, Western changed its method of accounting for post-1971 investment credi ts for financial reporting purposes from the deferral to the flow-through method . The cumulative effect of the change, amounting to $16.2, has been included in net earnings for 1978. 11 1972 342.9 31 .1 374.0 147.3 40.1 160.8 348.2 25.8 (11 .8) 2.7 16.7 5.9 10.8 10.8 10.8 0.72 0.72 0.66 0.66 15.0 17.5 0.08 372.7 262.1 158.6 94.4 71 6.9 10,300.2 5,995 .9 58.2 54.6 3.6 .0578 865 .0338 76.2 9,383 December 31 , 1981 and 1980 (in thousands of dollars) ASSETS Current Assets: Cash (Note 6) . . . . .. . ..... . . . . . .. . Temporq.ry investments ..... . . . . . . . . . Receivables (less allowance for doubtful accounts of $2,959 - 1981 and $2,379 - 1980) . . . Receivable from sale of aircraft (Note 11) . . . Flight equipment expendable parts at average cost (less allowance for obsolescence of $15,422 - 1981 and $14,062 - 1980) ... . Prepaid expenses and other current assets . Total current assets . . .. .... . Property and Equipment at Cost (Notes 2, 3, and 6): Flight equipment . . . . . . . . . . . . . . . . . . . ... . .. . Facilities and ground equipment .. ... .... . . . ... .. . . Deposits on equipment purchase contracts .. . . .... .. . . .. . . .. . .. .. . Less allowance for depreciation and amortization .... . Deferred Charges and Other Assets . .. . .. . .. . .. . .. . .. . . .. . . . . . See accompanying notes to financial statements. 12 1981 $ 24,057 24,057 89,311 20,212 20,953 12,646 167,179 828,276 139,400 21,508 989,184 326,737 662,447 4,944 $834,570 1980 8,759 25 ,579 34,338 121,859 26,908 8,025 191 ,130 848,111 130,703 37 ,966 1,016,780 297,962 718,818 7,100 917 ,048 LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Current portion of debt (Note 6) . . .... . ........... ... .... . Current portion of capital leases (Note 2) . . ............. . .. . Notes payable (Note 6) . . . . ..... . ..... . .... . Long-term debt classified as current (Note 6) ..... . .... . .... . . . Accounts payable . Airline traffic liability . . . . . ....... . . . Salaries, wages and vacation benefits payable . . . . . . . . ....... . Accrued liabilities . . . . . .. . ...... . Total current liabilities . .......... . Long-term Obligations: Debt (Note 6) . . . . . .. . . . . Capital leases (Notes 2 and 6) .. Deferred Credits and Other Liabilities: Deferred taxes on income (Note 5). . .... .. ... . . Deferred gain on sale and lease back of aircraft (Note 11). Other . . . . . . . . . . . . . . . . . ... . Shareholders' Equity (Notes 6, 7, and 9): Preferred stock - authorized 25,000,000 shares $2.00 Series A Cumulative Convertible $25.00 stated value per share Issued 1,196,920 - 1981 and 1,196,940 - 1980 ... Common stock - authorized 35 ,000,000 shares $1 .00 par valu_ e per share Issued 13,043,621 - 1981 and 13,030,915 - 1980 .......... . ...... . Additional paid-in capital . . . . . . . . . . . . . . . . . . ..... . Retained earnings . . . . . .............................. . Commitments and Contingent Liabilities (Notes 2 and 3) 13 1981 1980 $ 26,650 7,962 20,000 153,369 76,504 81 ,006 41 ,838 24,460 431 ,789 149,331 99,184 248,515 11 ,002 9,335 12,265 32,602 29,923 13,044 31 ,062 47,635 121 ,664 $834,570 23,756 7,183 58,965 90,058 43,624 22,947 246,533 353,525 81 ,526 435,051 29,067 9,051 38, 11 8 29,923 13,031 30,963 123,429 197,346 917 ,048 Years ended December 31, 1981 , 1980 and 1979 (in thousands of dollars except per share amounts) Operating Revenues: Passenger . . . . . . . . . . . . . . . . . .. ........ . .. .. . . Cargo . . ..... . .... . . . . . . . . . . . . . . . . . ...... . Charter and other . . . . . . . . .. . .... . Operating Expenses: Wages, salaries, and employee benefits (Note 4) . . ...... . Fuel .... ........ . ... . ........... . . ........ ... . Depreciation and amortization ....... ... . Other . . . . . . . . . . . . . . . . . . . . . . ... . . ... . ..... . Operating income (loss) . . . .. . . ................ . Other Income (Expenses): Interest, principally on long-term obligations ... .. ...... . Interest capitalized . . . . . . . . . .. . . .... . Interest income . . . . . . . . . . . ....... . Gains on disposition of equipment . . . . . ..... . Settlement with vendor .. Other, net (Note 11 ) . .... . .... . ... . Earnings (loss) before income taxes . Income taxes (Note 5) ..... . Net earnings (loss) . .. . . .. . Earnings (Loss) per Common Share (Note 8): Primary . . . . .. .. . . . . ...... . .. . . . Fully diluted .. ..... . See accom panying notes to financial statements. 14 1981 $ 949,576 62,983 47,282 1,059,841 403,428 326,606 63,632 332,129 1,125,795 (65,954) (49,836) 4,805 4,641 16,869 (3,333) (26,854) (92,808) (19,408) $ (73,400) $ $ (5.81) (5.81) 1980 887,901 63,82 1 44,033 995,755 384,201 296,365 61 ,310 299,640 1,041,516 (45,76 1) (43,507) 4,940 3,168 32 ,099 (178) (3,47 8) (49,239) (19,607) (29 ,632) (2.46) (2 .46) 1979 827 ,675 61,209 43,235 932, 11 9 356,62 1 225,682 50,058 28 1,522 913,883 18,236 (29,600) 4,706 4,957 31 ,332 10,000 (192) 21,203 39,439 (2,101) 41 ,540 2.99 2.31 Years ended December 31 , 1981, 1980 and 1979 (in thousand s of dollars) Sources of Working Capital: Earnings (loss) . . . . . . . . . . . ........ . Add (Deduct) Items Which did not Affect Working Capital: Depreciation and amortization . . . . . .. . .. . Deferred income taxes . . .. . ..... . Gains on disposition of equipment . Other . . . . . .. . ...... . Total provided (used) by operations . . . ..... . Reimbursements of deposits and capital expenditures upon acquisition of aircraft. . . .. . .. . Proceeds from disposition of equipment .. . Proceeds from issuance of long-term obligations .. Other, net . . . . . . . . . . . . . . . . . . . ....... . Total sources ....... . Applications of Working Capital: Purchase of and deposits on property and equipment . Reduction of long-term obligations including transfers to current liabilities . Long-term debt classified as current (Note 6) .. Cash dividends. . . .... ..... . Total applications ........ . Decrease in working capital . Summary of Increases (Decreases) in Working Capital: Cash and temporary investments ........ .. ........ . . . Receivables - trade . . . .................... . - from sale of aircraft ......... . ... . .. . ... . Expendable parts and prepaid expenses . . ....... . Current liabilities - long-term debt classified as current . - other . . ......... . Decrease in working capital . .... . . . .. .. .. .. . See accompanying notes to financial statements. 15 1981 $ (73,400) 61,780 (18,617) (16,869) (4,005) (51 ,111) 15,457 61 ,208 73,212 4,000 102,766 49,810 106,400 153,369 2,394 311 ,973 $(209,207) $ (10,281) (32,548) 20,212 (1 ,334) (153,369) (31 ,887) $(209,207) 1980 (29,632) 60,146 (21 ,2 19) (32 ,099) (3,557) (26,361) 10,746 50,120 198,350 172 233,027 171 ,123 81 ,667 5,652 258,442 (25,415) (15,975) 16,568 9,143 (35 ,151 ) (25,415) 1979 41 ,540 49,581 (4,788) (31 ,332) (4,706) 50,295 10,563 50,950 104,941 (5,097) 211 ,652 182,752 52 ,402 7,604 242,758 (3 1,106) (2 1,147) 13,252 3,718 (26,929) (3 1,106) Years ended December 31 , 1981, 1980 and 1979 (In thousands of dollars) Preferred Stock Common Additional Total $25.00 Stated Stock $1.00 Paid-in Retained Shareholders' Value Par Value Capital Earnings Eq uity Balance at January 1, 1979 . ....... $29,923 13,010 30,792 124,777 198,502 Exercise of stock options . . 17 132 149 Conversion of debentures . 3 35 38 Net earnings ... ......... 41 ,540 41 ,540 Cash Dividends: Preferred stock . . .. . (2, 394) (2 ,394) Common stock ...... ........ (5,210) (5 ,210) Balance at December 31 , 1979 ... 29,923 13,030 30,959 158,713 232,625 Conversion of debentures . 4 5 Net loss .. .. .. (29,632) (29,632) Cash Dividends: Preferred stock. (2,394) (2 ,394) Common stock . (3,258) (3,258) Balance at December 31 , 1980 ..... 29,923 13,031 30,963 123,429 197,346 Exercise of stock options . . . . . . . . 12 90 102 Conversion of debentures ... 1 9 10 Net loss ...... . ....... (73,400) (73,400) Cash Dividends: Preferred stock (Note 9) . (2,394) (2 ,394) Balance at December 31 , 1981 (Notes 6, 7, and 9) . ... . .. . $29,923 13,044 31 ,062 47 ,635 121 ,664 See accompanying notes to financial statements. 16 (In thousands of dollars except per share amounts) Note 1. Summary of Significant Accounting Policies Property and Equipment Owned property and equipment, exclusive of residual values, are depreciated over the estimated useful lives by the straight-li ne method . Assets recorded under capital leases are depreciated over the life of the lease by the straight-line method . The estimated useful lives and residual values of owned aircraft are as follows: Estimated Residual Useful Life Value DC-10 . . . . . . . . . . . . . . . . . . . . . . . . . . 16 years 10% 727 .... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 years 15% 737 . 14 years 15% Estimated useful lives of ground equipment range from four to ten years. Bu ildings and improvements on leased property are depreciated over the life of the lease. Depreciation expense for assets recorded under capital leases is included in depreciation and amortization expense Interest Capitalized Certain interest costs, primarily related to deposits on aircraft purchase contracts, are capitalized and amortized over the lives of the related assets. Investment Credits Investment cred its are accounted for by the flow-through method . Obsolescence of Expendable Parts An allowance for obsolescence of expendable parts is accrued over the estimated useful lives of the related aircraft types. Airline Traffic Liability Passenger ticket sales are recorded as a current liability until recognized as revenues for services provided by Western , refunded , or billed by other carriers for transportation provided by them . Note 2. Lease Commitments Western leases certain flight equipment and facilities and ground equipment. Lease terms for flight equipment are 11 to 15 years for 727 aircraft, 4 years for737 aircraft, and 15 to 18 years for DC-10 aircraft. Lease terms for facilities and ground equipment range up to 29 years. Interest expense is accrued on the basis of the outstanding obligations under capital leases. Equipment under capital leases included in the balance sheets at December 31 , 1981 and 1980, follows: 1981 1980 Flight equipment . $137,283 113,2 19 Ground equipment ................................... . 2,006 2,006 139,289 115,225 Less allowance for depreciation . 57,501 49,028 $ 81 ,788 66,197 At December 31 , 1981 , minimum lease payments under leases expiring after December 31 , 1982, were as follows: Capital Operating Leases Leases 1982 . $ 20,451 22,619 1983 .. . ....... . 20,399 21 ,429 1984 .. 19,969 19,588 1985 . 15,784 16,223 1986 . 15,790 12,784 Thereafter . 100,113 106,688 Total minimum lease payments . 192,506 199,331 Less: Amount representing interest 85,360 Present value of obligations - capital leases 107,146 Less: Current portion of capital leases 7,962 Long-term obligations - capital leases . $ 99,184 See the second and th ird paragraphs of Note 6 regarding defaults and potential payment acceleration. Rental expense for operating leases amounted to $25,967, $20,050, and $17,384 in 1981 , 1980, and 1979, respectively. Note 3. Commitments and Contingent Liabilities At December 31 , 1981 , Western had on firm order flight equipment which included six 767-200 aircraft scheduled for delivery in 1984 and 1985 and three 767 engines scheduled for delivery in 1984. Western recorded advance deposits on these orders which amounted to $15,799 as of December 31 , 1981 . The balance of the purchase price on delivery will be approximately $288,700. 17 Outstanding commitments for flight equipment modificati on and spare parts amounted to approximately $3,300 and for facilities and ground equipment amounted to approximately $1,100 as of December 31, 1981. Western has options to purchase six 767-200 aircraft for delivery in 1985 and 1986 . Deposits on these options amounted to $1,125 at December 31, 1981. For information regarding the status of legal proceedings at December 31, 1981, see " Legal Proceedings" on pages 8 and 9 of this report. Note 4. Retirement Plans Western has retirement plans, including a union-sponsored plan, which cover substantially all employees. Western's contributions to the Company-sponsored plans, together with the participants' required contributions, are sufficient to fund current service costs annually and prior service costs over ten to twenty years. Actuarial gains and losses are amortized over ten year periods. Western participates in a collectively bargained multi-employer pension plan and is therefore subject to the provisions of the Multi-employer Pension Plan Amendments Act of 1980. Under this complex law the union plan Board of Trustees, as sponsor, is required to obtain an actuarial valuation of the present value of vested and nonvested accumulated plan benefits. Western has been advised that its share of the liability for unfunded vested benefits in thi s plan is not available. According ly, the table that follows excludes data applicable to this multi-employer pension plan. A comparison of accumulated plan benefits and plan net assets for the Company-sponso red defined benefit plans follows: Jan uary 1, 1981 1980 1979 Actuarial Present Value of Accumulated Plan Benefits: Vested . $140,331 137,246 114,597 Nonvested . . . . ' . . . . 11 ,984 9,876 9,015 $152,315 147,122 123,612 Net assets available for benefits . $163,995 139,000 111 ,559 The weighted average assumed rate of return used in determining the actuarial present value of accumulated plan benefits was six percent for all years. The cost of the retirement plans, including the union-sponsored plan , charged to operating expense, was $34,711 , $34 ,193 and $30,304 for 1981 , 1980 and 1979, respectively, which included amortization of prior service costs over periods ranging from ten to twenty years for certain of the plans. Note 5. Income Taxes Income taxes are summarized as follows: 1981 1980 1979 Current Federal: Provision . i , Ii I I I I I 0 0 I (3,647) 18,901 Investment credits applied . . . . . . . .... 5,75 1 (17,792) 2, 104* 1,109* State. (791) (492) 1,578 Deferred : Provision ... . . . . . . . . . . (12,974) (5 ,073) (5,597) Operating loss carryforward recognized . (5,091) (15 ,533) Investment Credits: Applied . . . . . . . . . . . . . . . . . . . . . . . . . 5,697 (16,420) Transferred to current . ... . .. . . . (5,751) 17,792 (18,065) (20,660) (4,225) Amortization of deferred investment credits . (552) (559) (563) $ (19,408) (19,607) (2,101) *The Tax Reform Act of 1976 provided for 90% application of unapplied investment credits against Federal income tax liabilities for 1979. This application was reduced to 80% for 1980. Under the Revenue Act of 1978 the application remains at 80% in 1981 and retu rns to 90% for 1982 and beyond Deferred income taxes arise from timing differences between fi nancial and tax reporting. The effects of these differ- ences on income taxes are as follows: 1981 1980 1979 Depreciation and amortization . . ... . .. . . . $ (13,409) (3,454) (4,825) Sale of tax benefits . . . ..... . 2,560 Capital leases . (1,754) (1 ,084) ( 114) Interest capitalized . 1,1 83 1,140 1,903 Employee benefits . (847) (718) (1,626) Other . (707) (957) (935) $ (12,974) (5 ,073) (5,597) 18 Reconciliations of income taxes at the United States statutory rate lo the provision for incomo taxos follow: 1981 1 980 1 97 Income taxes at tho United States statutory rate . $ (42,692) (22,650) 18, 14 2 Increases (reductions) in laxes resulting from : !feet of operating loss carryforward for which no tax credi l may be recogni7ed . Amortization of dGferred investment credits. Investment cred its recogn ized on flow through method . State income taxes net of federal income tax benefit .. Capi tal gains . Other . Income taxes . 24,490 (552) (427) (227) $ (19,408) (559) (563) 5,697 (16,420) (266) 85 2 (3, 800) ( 1 ,829) (3 12) ( 19,607) (2, 101 ) A net operating loss carryforward of $98,400 has not been utilized on tax returns. For income tax purposes, $34,100 expires in 1995 and $64,300 expires in 1996. For financial statement purposes, $53,200 of the carryforward has not been recognized and expires in 1996. Investment credits available to reduce future years' Federal income tax liability for financial and tax purposes amount to $23,000 at December 31 , 1981 . For income tax purposes, $5,800 expires in 1994, $16,200 expires in 1995, and $1,000 expires in 1996. In November 1981 tax benefits were sold under the provisions of the Economic Recovery Tax Act of 1981 . The proceeds from this sale of $5,565 are included in Other income (expenses) on the statements of operations. Note 6. Debt At December 31 , 1981 and 1980 long-term debt included : 9.55% equipment trust certificates due May 1, 1993, with semi-annual principal payments of $3,458 . . ... .. ... . 10% equipment trust certificates due April 1, 1994, with quarterly principal payments of $1 ,000 . Floating-rate equipment trust certificates due June 30, 1995, with semi-annual principal payments of $2 ,609 starting June 30, 1984 . 13.29% installment notes due May 1, 1995, with semi-annual principal payments of $1", 1 00 . Revolving credit notes .. 5% installment notes due September 1, 1981 . 6%% installment notes due September 1, 1984, with annual principal payments of $2,000 on September 1 which will increase to $7,000 in 1982 . 7% installment notes due May 4, 1986, with semi-annual principal payments of $352 starting November 4, 1981 . . ....... .. ..... . Notes payable to manufacturers,% above prime and 8%, payable in varying installments to 1985. 5% convertible subordinated debentures due February 1, 1993, with annual sinking fund payments of $1 ,500 starting in 1983 . 10% subordinated sinking fund notes due April 15, 1984, with annual sinking fund payments of $2,300 . Less: Current portion . Long term amounts classified as current .. 1981 1980 $ 79,525 86,440 48,992 52,991 60,000 60,000 29,700 31 ,900 27,000 50,000 4,000 21 ,000 23,000 3,165 2,869 27,166 29,844 22,552 23,562 10,250 12,675 329,350 377 ,281 (26,650) (23,756) (153,369) $ 149,331 353,525 The revolving credit notes represent borrowings under the 1978 Amended and Restated Bank Loan Agreement. This line of credit was reduced to $27,000 in 1981 and extends to June 30, 1982, at which date it may be replaced by term notes. The term notes are due June 30, 1990, with quarterly payments starting September 30, 1982. The interest rate at December 31 , 1981 , was 105% of prime commercial rate on $15,000 (domestic loans) and 13.2% on $12,000 (Eurodollar loans). Although the 1978 Bank Loan Agreement does not require compensating balances, Western had on deposit with its banks until November 1981 non-interest bearing certificates of deposit of approxi- mately $2,500. Since November 1981 , no compensating balances have been maintained . Western's various debt agreements contain requirements pertaining to working capital , liquid assets, and net worth levels, as well as restrictions on amounts of cash dividends and creation of rental liabilities and additional debt. At December 31, 1981 , Western was not in compliance with some of these requirements. This non-compliance resulted in technical non-compliance with certain other debt agreements. Western may not resume the payment of cash dividends on its common stock, which were discontinued in 1980, nor may it pay dividends on its preferred stock, until certain of the financial tests referred to above have been met. The agreements with which Western was not in compliance at December 31 , 1981 , include provisions whereby the lenders may, at their option , accelerate the scheduled maturities. Western has not obtained waivers of these defaults for a period in excess of one year. Therefore, a portion of the long-term debt has been classified as current obligations. All of Western's long-term obligations, including all capital leases, contain provisions by which the lenders may accelerate scheduled maturities if Western fails to make any required payment on its obligations. As of December 31 , 1981 , and March 15, 1982, Western had met all required payments of its obligations. 19 In January 1982 , Western entered into ag reements with its revolving c redit note lenders and certain insurance companies to create short-term loans of up to $30,000. As of March 15, 1982 , the entire $30,000 had been received by Western . This loan is due no later than April 30, 1982 . The interest rate on fund s borrowed is equal to 105% of the agent bank's prime commercial rate. As part of the new short-term loan ag reement, the interest rate on previously issued 6%% installment notes was increased to 105% of prime while any part of the new short-term notes is out- standing . The commitment fee under the new short-term loans is % per annum on the average daily unused portion of the $30,000 . As part of the January 1982 short-term loan, Western was granted waivers on its existing defaults until June 10, 1982. Also granted was forbea rance fro m acceleration and collection of previously unsecured debt. In connection with these arrangements, Western provided security on existing and new debt in th e form of a chattel m ortgage. The chattel mortg age grants a first priority security interest in 29 aircraft and 77 aircraft engines to th e previously unsecured lenders. The net book value of the aircraft and engines encumbered was $141,467 at December 31, 1981. The amount of collateral must be maintained at specified levels until substantially all of Western's debt has been repaid . Western anticipates that following the lenders' evaluation in March 1982 of an appraisal of the existing collateral, additional collateral may be required . Equipment trust certificates and 13.29% installment notes outstanding at December 31, 1981 , are secured by aircraft and engines with a net book value of $255 ,310 at December 31, 1981. In addition, two holders of equipment tru st certificates who are also participants in the new short-term loa ns referred to above are also collateralized by the c hattel mortgage as described above. The following schedu le shows the amount of long-term debt due in each of the five following calendar years, excluding such amounts, if any, which may be due on acceleration , as desc ribed above: 1982 . . ..... $26,650 1984 . . . . $50,977 1986 . . . . . . . . . . . . . $23, 56 1 1983 . 29,618 1985 . 31,771 During September 1981 , Western entered into agreements with two foreign banks for lines of credit up to $10,000 eac h. In connection with these credit lines, $20,000 was outstanding under demand notes at December 31, 198 1. The interest rate on these demand notes, outstanding at December 31, ranged from 17.8% to 13.2% during the out- standing period in 1981. These demand notes also became secured by the collateralization of loans referred to above. Note 7. Stock Options Western has a non-qualified stock option plan adopted in 1974 for officers and key personnel. This plan-provides for options to purc hase a maximum of 1,030 ,000 shares of Western's common stock at prices not less than the fair market value of the stock at date of grant. The options are exercisable in equal annual increments over a five-year period The options expire ten years after the date of grant. A summary of activity in the plan follows: Options granted and outstanding at December 31 , 1978 . Options granted . . ............... . Options exercised . . . . . . . . . . . . . . . . .. . .... . Options cancelled or expired .......... . ..... . ....... . .. . Options granted and outstanding at December 31 , 1979 . Options granted ... Options cancelled or expired .. Options granted and outstanding at December 31 , 1980 . Options granted . . ....... . Options exercised . . .. . .... . .. . Options cancelled or expi red ........ . Options granted and outstanding at December 31 , 1981 . Options Exercisable at: December 31, 1981 ... December 31 , 1980 . .. .. . . . . Number of Shares Average Price 790,835 $8.56 71 ,000 8.62 (17,630) 8.47 (6,550) 9.12 837,655 8.56 21 ,500 7.27 (12,500) 8.65 846,655 8.53 12,500 9.29 (12,050) 8.46 (84,430) 8.49 762,675 $8.55 697,319 $8.57 683,493 $8.63 At December 31, 1981 , 200 ,21 0 shares (128 ,280 shares at December 31 , 1980) were reserved for the issuance of future grants. Note 8. Earnings (Loss) per Common Share Earnings (loss) per common share is calculated as follows: Adjustment of Net Earnings (Loss) Primary: Net earnings (loss) .. Preferred stock cash dividends . Net earnings (loss) available for common stock . Fully Diluted: Net earni ngs (loss). Preferred stock cash dividends Reduction in interest expense, net of income taxes, fo r the assumed conversion of 5% convertible subordinated debentures Adjusted net earnings (loss) assuming full dilution 20 1981 $(73,400) (2,394) (75,794) $(73,400) (2,394) * $(75,794) 1980 (29,632) (2,394) (32 ,026) (29,632) (2,394) (32,026) 1979 41 ,540 (2,394) 39,146 41 ,540 653 42, 193 1981 1980 1979 Adjustment of Shares Outstanding (in thousands) Primary: Weighted average shares outstanding ....... 13,037 13,031 13,026 Assumed exercise of stock options . * * 58 Total average common shares for primary . 13,037 13,031 13,084 Fully Diluted : Weighted average shares outstanding . 13,037 13,031 13,026 Assumed conversion of subordinated debentures . * 2,073 Assumed conversion of preferred stock .. * 2,992 Assumed exercise of stock options .. * * 146 Total average common shares assuming full dilution . 13,037 13,031 18,237 Earnings (Loss) per Common Share: Primary . $ (5.81) (2.46) 2.99 Fully diluted . . . . . . . . . $ (5.81) (2.46) 2.31 *The exercise of stock options and conversion of the convertible subordinated debentures and/or the preferred stock into common shares has not been assumed , since the effect of such an assumption would be anti-dilutive. Note 9. Preferred Stock The shares of preferred stock are convertible into common stock at the rate of 2.5 shares of common stock for each share of preferred stock, subject to adjustment under certain conditions, and may be redeemed in whole or in part at any time at the option of Western. The redemption price of $26 .20 at December 31 , 1981 , decreases peri- odically until 1987 after which it remains at $25.00 per share. The preference on !iquidation is at the stated value plus all accrued and unpaid dividends. On January 29, 1982, the Board of Directors voted to defer payment of the preferred cash dividend of $0.50 per share payable at the end of March 1982 on the 1,196,920 shares of $2 Series A Cumulative Convertible Preferred Stock outstanding . Note 10. Regulatory Matters Western has announced its intention to acquire Wien Air Alaska, Inc., an Alaska regional carrier, and merge it into the Western system. The Civil Aeronautics Board has approved Air Florida System , lnc'.s, application to acquire control of Western . Air Florida, which holds approximately 12.6 percent of Western's common stock, has not announced its intentions. Western's planned merger with Continental Air Lines, Inc., was thwarted by the successful takeover of that carrier by Texas International. Western withdrew from the merger agreement in September 1981. For additional information see the first four paragraphs under Regulatory Matters on Pages 6 and 7 of this report. Note 11. Other Matters In May 1981 , Western sold two DC-10-10 aircraft to International Air Leases, Inc. for $2,000 of cash and $28,000 of 12% notes which are payable in monthly principal and interest installments of $480 over 50 months with the balance payable in 1985. In December 1981 , Western decided to sell the notes receivable and has reached agreement in principle to sell these notes with recourse. This transaction is expected to be consummated by April 30, 1982. During the fourth quarter of 1981 , the notes were written down by $6,557 to their estimated net realizable value. In December 1981 , Western sold two 737 aircraft for $11 ,000 to Batch-Air Leasing , Inc., and then leased back the aircraft from International Air Leases, Inc. , under a four-year operating lease with monthly rental payments of $130 per aircraft. The gain on the sale of the aircraft is being recognized on a straight-line basis over the lease term . The owner of International Air Leases, Inc., and Batch-Air Leasing , Inc., holds approximately 7% of the outstanding common stock of Western . In the opinion of Western's management, the transactions described above were at terms comparable to those which would have been negotiated with unrelated parties. Note 12. Quarterly Financial Data (Unaudited) Summarized quarterly financial data (unaudited) for 1981 and 1980 is as follows: 1981 Operating revenues ... Operating (loss) Net (loss) . Net (Loss) per Common Share: Primary 1980 Operating revenues . . Operating income (loss) . Net (loss) . Net (Loss) per Common Share: March 31 $262,159 (3,497) ( 1,692) $ (0.18) $232,153 (23,006) (8,868) Three Months Ended June 30 270,844 (15,003) (8,399) (0.69) 237,707 (20, 1 77) (5,379) September 30 293,621 (3,753) (7,255) (0.60) 273,720 7,658 (6,397) December 31 233,217 (43,701 ) (56,054) ( 4 34) 252, 175 (10,236) (8,988) Primary $ (0.72) (0 46) (0 54) (0.74) Western revised its procedures for recording commission expense in the first quarter of 1981 to more closely identify the expense with the period in which the related revenue is recognized . The effect of this change on the first through the fourth quarters of 1981 was to reduce (increase) the net loss by $3,244 ($0.25 per share) , $504 ($0.04 per share) , $(1 ,040) ($0.08 per share) , and $630 ($0.05 per share) . 21 The quarterly inco me tax benefits fo r the first, second , and third quarters of 1981 are based on the statutory rate. The tax benefit available fo r the fourth quarter 1981 was limited fo r financial reporting purposes to approximately 5% of the pretax accounting loss because the tax benefits of the remaining net operating loss could not be recog ni7ed currently. In the th ird quarter of 1980, previously recorded investment credits of $12,507 ($0.96 per share) were reversed since they could not be utilized for fin ancial reporting purposes. No investm ent c red its were recog nized during 1981. Note 13. Description of Impact of Inflation (Unaudited) Statem ent of Financial Acco unting Standard s No. 33 (SFAS No. 33) prescribes two supplemen tary incom e compu- tations for estim ating the im pact of inflatio n. These co m putations estimate the effects of general inflation (constant dollars) and the effects of changes in specific prices (current cost). SFAS No. 33 defines co nstant dollar accounting as a method of repo rting fin ancial statem ent elements in dollars each of wh ich have the same general purchasing power. Current cost accounting is defin ed as a m ethod of measuring and reporting assets and expenses associated with the use or sale of assets at their current cost or lower recoverable amo unt at the balance sheet date o r at the date of use o r sale. Both m ethods involve the use of assumptio ns and estim ates. Therefore, th e resulting m easurem ents sho uld be viewed as esti mates rather than as precise ind icators of the effects of inflation. The amounts reported in the primary fin ancial statements have been adjusted fo r depreciation and am ortization expense. Revenues and all other operating expenses are co nsidered to reflect the average price levels and have not been adjusted.,Further, there have been no adjustm ents made to provisions for inco m e taxes. Co nstant dollar values were determined by restating histo rica l costs, accumu lated depreciation and am ortization, and depreciation expense of property and equipment into average 1981 dollars using the Consumer Price Index for all urban consumers (C PI-U) published by the Bureau of Labor Statistics. Current costs for aircraft were determi ned by using the direct pricing method. Current costs for spare engines and ca pital rotable spares and assem blies were computed based on the ratio by which the c urrent cost of aircraft fleets exceeds the histo ric cost of such fleets. Current cost for other prope rty and eq uipment were determined by indexation using the C PI -U. An estimate of the net (loss) adjusted for changing prices for the year ended December 31, 1981, follows: Net (loss) as repo rted in the statement of operations $ (73,400) Adjustment to Restate Costs for the Effect of General Inflation : Depreciation and amortization expense (32,706) Net (loss) adjusted for general inflation . Ad justment to Reflect the Difference Between General Inflation and Changes in Specific Prices (current costs): Depreciation and amortization expense . Net (loss) adjusted for changes in specific prices . Gain from decli ne in purchasing power of net amounts owed . Increase in specific prices (current cost) of properties and equipment held during the year* . Effect of increase in general price level . Excess of increase in specific prices over increase in the general price level . (106,106) (26,582) $(132,688) $ 41,716 $186,912 (108,810) $ 78 ,102 *At December 31 , 1981 current cost of properties and equipment, net of accumulated depreciation and amortization , was $1 ,189,243. A five-yea r comparison indicating the effect of adjusting historical revenues, purchasing power gains or losses on net m o netary items, cash dividends, and common stock market prices to dollar am ounts expressed in terms of average 1981 dollars as measured by the C PI-U follows: Year Ended December 31 , 1981 1980 1979 1978 1977 Operating revenues . $1 ,059,841 1,095 ,330 1,165,149 1,159,973 1,037 ,196 Historical Cost Information Adjusted for General Inflation Net earnings (loss). (106,106) (62, 434) 26,162 Net earnings (loss) per common share . $ (8.32) ( 4.99) 1.77 Net assets at year-end . 384,364 483 ,525 524 ,169 Current Cost Information Net earnings (loss) . (132,688) (78, 1.20) 13,904 Net earnings (loss) per com mon share . $ (10.36) (619) .84 Excess of increase in specific prices over increase in the general price level 78,102 125,487 7,157 Net assets at year-end . 654,403 739 ,133 670 ,431 Gain from decline in purchasing power of net amounts owed .. 41 ,716 51,532 45 ,947 Cash dividends declared per common share . $ .27 .50 .56 .60 Market price per common share at year-end . $ 4.87 10 04 12.97 11.47 11.44 Average Consumer Price Index . 272.4 246.8. 217.4 195.4 181 .5 Note 14. Continued Operations Early in 1982, Western began to implem ent a new strateg ic plan designed to return the company to profitability and to streng then its financial co nditio n. This plan includes, am ong other factors: (1) establ ishi ng a hub and spoke system with operations centered at Salt Lake City, (2) introd ucing service to nine new cities and increasing service to a number of cities presently on Western's system as a means to more fully uti lize the available capacity in Western's fleet, (3) wage and/o r wo rk rule co ncessions fro m Western's organized labor groups, and ( 4) conti nued cooperation from Western's lenders. If this plan is not substantially achieved , Western may not be able to co ntin ue in existence. 22 Peat, Marwick, Mitchell & Co. The Board of Directors Western Air Lines, Inc.: ertificd Public Accountants 555 South Flower Street Los Angeles, alifornia 90071 We have examined the balance sheets of Western Air Lines, Inc. as of December 31, 1981 and 1980 and the related statements of operations, shareholders' eq uity and changes in financial position for each of the years in the th ree-year period ended December 31, 1981. Our examinations were made in accordance with generally accepted audi ting standard s, and accordingly included such tests of the accounting record s and such other auditing proced ures as we considered necessary in the circumstances. As shown in the financial statements, the Company incurred net losses of $73,400,000 and $29,632 ,000 during the years ended December 31, 1981 and 1980, respectively, and , as of December 31, 1981, certain of the Company's long-term debt is subject to demand for accelerated payment after June 10, 1982 . These factors, among others, as discussed in Notes 6 and 14, indicate th at the Company may be unable to continue in existence. The fina ncial statements do not include any adjustm ents relating to th e recoverability and classification of record ed asset amou nts or to the amounts and classification of liabilities that might be necessary should th e Com pany be unable to con tinue in existence. In our opinion, subject to the effects on the 1981 financial statements of such adjustments, if any, as might have been required had the outcome of the uncertainty abou t the recoverability and classification of recorded asset amounts and the amounts and classification of liabilities referred to in the preceding paragraph been known , the aforementioned financial statements presen t fai rly the financial position of Western Air Lines, Inc., at December 31 , 1981 and 1980 and the results of its operations and the changes in its financial position for each of the years in the th ree-year period ended Decem ber 31, 1981 , in conform ity with generally accepted accounting principles applied on a consistent basis. March 1, 1982, except for the fourth and fifth paragraphs of Note 6, which are as of March 15, 1982. 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 stockh olders of air carriers. Any person who owns as of December 31 of any year or subse- quently 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 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 broke r 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 req uired to report under either Part 245.12, Part 245 .13 or Part 245 .14 of the CAB's Economic Regula tions 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 information 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 Di rector, Bureau of Pricing and Domestic Aviation , Civil Aeronautics Board , Washington , D.C. 204 28. Form 10-K: Stockholders may obtain free of charge a copy of the company's ann ual report on form 10-K as fi led with the Securities and Exchange Commission by writing to the Secretary, P.O. Box 92005 , World Way Postal Cen ter, Los Angeles, California 90009. 23 BOARD OF DIRECTORS Fred Benninger President Tracinda Corporation Las Vegas, Nevada Neil G. Bergt Chairman of the Board and Chief Executive Officer Western Air Lines, Inc. Los Angeles, California Miguel M. Blasquez President Inter-American Commercial Arbitration Commission Mexico City, Mexico DIRECTORS EMERITI Hugh W. Darling Attorney-at-Law Darling, Hall & Rae Los Angeles, California Leo H. Dwerlkotte Las Vegas, Nevada James D. Garibaldi Attorney-at-Law Los Angeles, California Victor L. Brown Presiding Bishop The Church of Jesus Christ of Latter-day Saints Salt Lake City, Utah Gerald Grinstein Attorney-at-Law Preston, Thorgrimson , Ellis and Holman Seattle, Washington Walter J. Hickel Chairman of the Board Hickel. Investment Company Anchorage, Alaska Arthur F. Kelly Los Angeles, California Robert 0. Kinsey Los Angeles, California Dr. Donald H. Mclaughlin Chairman of the Board Homestake Mining Company San Francisco, California John H. Myers Assistant to the President St . .John's University St. Paul, Minnesota Dominic P. Renda Los Angeles, California 24 Bert T. Kobayashi, Jr. Attorney-at-Law Kobayashi , Watanabe, Sugita & Kawashima Honolulu, Hawaii Arthur G. Linkletter Television Producer and Broadcaster Chairman of the Board Linkletter Productions Beverly Hills, California John G. McMillian Chairman of the Board and Chief Executive Officer Northwest Energy Company Salt Lake City, Utah Vernon 0. Underwood Chairman of the Board and Chief Executive Officer Young's Market Company Los Angeles, California Harry J. Volk Union Bancorp, Inc. Los Angeles, California George S. Suddock Chairman of the Board Alaska National Insurance Company Anchorage, Alaska Capt. Roy G. Utter Pilot Western Air Lines, Inc. Los Angeles, California Robert H. Volk Chairman/Owner Martin Aviation , Inc. Torrance, California John M. Wallace Walker Bank & Trust Company Salt Lake City, Utah Arthur G. Woodley Bellevue, Washington CORPORATE OFFICERS Neil G. Bergt Chairman of the Board and Chief Executive Officer Robert D. Heath Senior Vice President - Administration Lawrence H. Lee Senior Vice President - Service George M. Sullivan Senior Vice President - Alaska Region Harold Achtziger Vice President - Airport Operations Craig B. Benedetti Vice President - Marketing Anthony Colletti Vice President - Maintenance & Engineering General Offices Howard L. Culver Vice President - Regulatory Affairs Andre C. Dimitriadis Vice President - Finance Thomas J. Greene Acting Vice President, General Counsel & Secretary Steven S. Lay Vice President - Passenger & Cargo Sales Seth M. Oberg Vice President - Flight Operations Western Air Lines Building , 6060 Avian Drive Los Angeles International Airport Los Angeles, California 90045 (213) 646-2345 Registrar/Transfer Agent-Common & Preferred Stock Bank of America National Trust & Savings Assn . 555 South Flower St., Los Angeles, California 90071 Debenture and Subordinated Note Trustee United States Trust Company of New York 45 Wall Street, New York, New York 10005 Exchange Listing-Common & Preferred Stock Debentures and Subordinated Notes New York Stock Exchange Pacific Stock Exchange Marvin Rich Vice President - Data Processing & Communica tions Ray Silvius Vice President - Corporate Affairs Glen L. Stewart Vice President and Controller C. F. Van Every Vice President - Airport Services Donald W. Vena Vice President - Personnel Relations George Varney Assistant Vice President - Flight Control Ticker Symbols Common Stock WAL Preferred Stock WALA 5% Debentures WALK 10% Notes WAL. Independent Accountants Peat, Marwick, Mitchell & Co . 555 South Flower St., Los Angeles, California 90071 General Offices Western Air Lines Building, 6060 Avion Drive, Los Angeles International Airport, Los Angeles, California 90045