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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-23642
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NORTHWEST AIRLINES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-4205287
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
2700 LONE OAK PARKWAY, EAGAN, MINNESOTA 55121
(Address of principal executive offices)
(612) 726-2111
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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COMMON STOCK, PAR VALUE $.01 PER SHARE THE NASDAQ NATIONAL MARKET
PREFERRED STOCK PURCHASE RIGHTS THE NASDAQ NATIONAL MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 26, 1999 was $1.6 billion.
As of February 26, 1999, there were 84,034,905 shares of the registrant's
Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates by reference certain information
from the registrant's Proxy Statement for its Annual Meeting of Stockholders to
be held on April 23, 1999.
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PART I
ITEM 1. BUSINESS
Northwest Airlines Corporation ("NWA Corp." and, together with its
subsidiaries, the "Company"), is the indirect parent corporation of Northwest
Airlines, Inc. ("Northwest"). Northwest operates the world's fourth largest
airline (as measured by 1997 revenue passenger miles ("RPMs")) and is engaged in
the business of transporting passengers and cargo. Northwest's business focuses
on the development of a global airline network through its strategic assets that
include:
- domestic hubs at Detroit, Minneapolis/St. Paul and Memphis;
- an extensive Pacific route system with hubs at Tokyo and Osaka;
- a trans-Atlantic alliance with KLM Royal Dutch Airlines ("KLM") that
operates through a hub in Amsterdam; and
- a global alliance with Continental Airlines, Inc. ("Continental").
OPERATIONS AND ROUTE NETWORK
Northwest operates substantial domestic and international route networks and
directly serves more than 150 cities in 21 countries in North America, Asia and
Europe. Northwest had more than 50.5 million enplanements and flew over 66.7
billion RPMs in 1998. Northwest began operations in 1926.
Northwest has expanded its network and provides greater service to its
customers through the use of domestic and international alliances and code-share
agreements with other airlines. Code-sharing is an agreement under which an
airline's flights can be marketed under the two-letter designator code of
another airline. By coordinating flight schedules, product development and
marketing, Northwest and its alliance partners, provide a global network to over
500 cities and 90 countries in the U.S., Canada, Asia, India, the South Pacific,
Mexico and the Caribbean, Europe, the Middle East, Africa and Latin America.
During 1998, Northwest and Continental entered into a thirteen-year global
strategic commercial alliance that connects the two carriers' networks and
includes extensive code-sharing, frequent flyer program reciprocity and other
cooperative activities. The airlines will continue operating their two networks,
which overlap on only seven routes, under separate identities. The combined
network will result in a domestic presence comparable to that of either United
Air Lines, Inc. or American Airlines, Inc. (based on 1998 ASMs), provide
Northwest access to Latin America and increase its Pacific presence.
In December 1998, Northwest and Continental began implementing their
alliance. Since then, they have initiated code-sharing to several points in Asia
and to many domestic cities. Northwest anticipates that it will add additional
code-sharing with Continental in 1999; however, further international
code-sharing is subject to certain regulatory approvals. Through increased
domestic and international connections, Northwest anticipates increasing its
market share and enhancing its revenue. Other joint activities anticipated to be
implemented include airport facility coordination, joint purchasing, certain
coordinated sales programs, and the inclusion of Continental in Northwest's
trans-Atlantic joint venture alliance with KLM. Through combined purchasing
power and increased efficiencies in airport operations, Northwest also
anticipates reducing its operating costs.
DOMESTIC SYSTEM
Northwest's domestic route system serves 46 states in the U.S., the District
of Columbia, Mexico, Canada and the Caribbean. Northwest operates its domestic
system through its hubs at Detroit, Minneapolis/St. Paul and Memphis. The hub
system gathers passengers from the hub and cities surrounding the hub and
provides more frequent local and connecting service than if each route were
served on a nonstop point-to-point basis. As part of its alliance with
Continental, Northwest's passengers will be able to connect
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through Continental's hubs in Newark, Houston and Cleveland to additional cities
not previously served by Northwest.
Northwest's hubs provide connections to feed traffic into its ten gateway
cities for international service. Northwest operates international flights from
its Detroit and Minneapolis/St. Paul hubs as well as from Anchorage, Boston,
Honolulu, Las Vegas, Los Angeles, New York, Philadelphia, San Francisco, Seattle
and Washington D.C. In addition, KLM operates flights to Amsterdam from Memphis,
Atlanta, Chicago and Houston.
Northwest has exclusive marketing agreements with two regional carriers:
Mesaba Aviation, Inc. ("Mesaba") and Express Airlines I, Inc. ("Express"), a
wholly-owned indirect subsidiary of NWA Corp. Under these agreements, these
regional carriers operate their flights under the Northwest "NW" code and are
identified as Northwest Airlink carriers. The primary purpose of these marketing
agreements is to provide more frequent service to small cities, which increases
connecting traffic at Northwest's hubs. Currently these carriers exclusively
serve 77 airports.
DETROIT. Northwest and Mesaba together serve over 130 cities from Detroit.
For the 12 months ended June 30, 1998, Northwest and Mesaba enplaned 66% of
originating passengers from this hub, while the next largest competitor enplaned
5%. Detroit, which is the sixth largest origination/destination hub in the U.S.,
is Northwest's largest international gateway from the continental U.S., offering
nonstop flights to 17 foreign cities, including 20 nonstop flights to Japan per
week.
MINNEAPOLIS/ST. PAUL. Northwest and Mesaba together serve over 140 cities
from Minneapolis/St. Paul. For the 12 months ended June 30, 1998, Northwest and
Mesaba enplaned 73% of originating passengers from this hub, while the next
largest competitor enplaned 5%. Minneapolis/St. Paul is the eleventh largest
origination/ destination hub in the U.S.
MEMPHIS. Northwest and Express serve over 80 cities from Memphis. For the
12 months ended June 30, 1998, Northwest enplaned approximately 56% of
originating jet passengers from this hub, while the next largest competitor
enplaned approximately 23%. Mesaba began serving this hub in March 1999 with
regional jet service.
Northwest has additional marketing agreements with Alaska Airlines, Horizon
Air, Trans States Airlines, Inc. and America West Airlines, Inc. for
code-sharing on some of these carriers' routes in the western U.S. The primary
purpose of the arrangements with these airlines is to provide increased
connections between Northwest's route network and their route networks to
generate increased traffic into Northwest's domestic system and international
gateways to the Pacific.
Northwest, together with Mesaba, currently operates service to seven cities
in Mexico, 12 cities in Canada and five cities in the Caribbean. Through its
alliance with Continental, Northwest will be able to provide substantial
connecting service to Mexico and Central America, as Continental is one of the
leading airlines providing service to the region, serving more destinations than
any other U.S. airline.
INTERNATIONAL SYSTEM
Northwest has a comprehensive route network to the Pacific, providing
extensive service to Japan and China, and also services destinations to Europe
and India. The Company has joint marketing alliances and code-share agreements
with other foreign carriers that allow it to expand its service and enter
additional markets with minimal capital outlay.
PACIFIC. Northwest has served the Pacific market since 1947 and has one of
the world's largest Pacific route networks, with over 470 weekly flights.
Northwest's Pacific operations are concentrated at its Tokyo hub. Northwest has
the largest slot portfolio of any non-Japanese airline at Tokyo's
slot-constrained Narita International Airport, with 316 weekly takeoff and
landing slots. Northwest uses its route certificate and slot portfolio to
operate a network linking eight U.S. gateways and ten Asian and Micronesian
destinations
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via Tokyo. Northwest has also developed a hub at Osaka's Kansai airport, where
it holds 108 takeoff and landing slots. Northwest currently operates 42 weekly
departures from Osaka, which includes service between four U.S. gateways and
three Asian destinations.
Northwest provides passenger service between various points in the U.S. and
Japan and operates flights between Japan and Korea, Taiwan, the Philippines,
Thailand, Singapore, Northern Mariana Islands,
and China, including Hong Kong. Northwest's Japan presence results from the 1952
U.S.-Japan bilateral aviation agreement, as amended, which establishes rights to
carry traffic between Japan and the U.S. and extensive "fifth freedom" rights
between Japan and India, the South Pacific and other Asian destinations. "fifth
freedom" rights allow Northwest to operate service from any gateway in Japan to
points beyond Japan and carry Japanese originating passengers. Northwest and
United are the only U.S. passenger carriers that have "fifth freedom" rights
from Japan. On March 14, 1998, the U.S. and Japan expanded their aviation
agreement. Primary benefits of the new agreement for Northwest included
unlimited rights and frequencies to operate between any point in the U.S. and
Japan and the ability to code-share with Japanese carriers. The agreement
confirmed and expanded Northwest's "fifth freedom" rights and the U.S. received
assurances that Northwest will retain all its weekly takeoff and landing slots
at Tokyo and Osaka and will have access to new slots as they become available.
In 1998, the Company added nonstop service between Detroit and Nagoya, Las Vegas
and Tokyo, Anchorage and Tokyo, and Nagoya and Manila. In 1999, Northwest began
nonstop service between Kaohsiuing, Taiwan and Osaka and Kuala Lumpur, Malaysia
and Osaka.
Northwest continues to expand its Pacific presence through additional
alliances. Northwest is currently implementing an alliance with Japan Air
System, which has approximately 25% of Japan's domestic traffic. The alliance
includes coordinated flight connections, traffic servicing, and reciprocal
frequent flyer programs and is expected to include code-sharing and other
cooperative activities. Northwest also has code-sharing and marketing agreements
with Hawaiian Airlines and Pacific Island Aviation.
In October 1998, the Company began code-sharing with Air China as part of a
minimum four year alliance entered into in May 1998. The alliance connects the
two carriers' networks and also includes frequent flyer program reciprocity and
joint marketing. At the end of 1998, Northwest and Air China provided 17 flights
each week between the U.S. and China, including four Northwest nonstop flights
between Detroit and Beijing. This is the only regularly scheduled nonstop
service between the U.S. and China's capital operated by a U.S. carrier.
Northwest alliance partners, Alaska Airlines, America West Airlines and
Continental, have entered into alliance agreements with Air China; Northwest and
its partners collectively provide the most nonstop and one-stop service between
the U.S. and China.
On February 2, 1999, Northwest and Malaysia Airlines entered into a
Memorandum of Understanding ("MOU") designed to lead to an operational and
marketing alliance. The MOU provides for coordinated flight connections,
code-sharing, frequent flyer program reciprocity and other coordinated
activities.
ATLANTIC. Northwest provides passenger service from seven U.S. gateway
cities to Amsterdam, Paris, Frankfurt and London (Gatwick) with 70 weekly
nonstop flights. Northwest also provides service to Mumbai and Delhi, India from
Amsterdam. Daily nonstop service from Minneapolis/St. Paul to Oslo, Norway is
scheduled to begin on May 1, 1999 and from Minneapolis/St. Paul to Amsterdam in
April 1999. An additional seasonal daily nonstop flight from Detroit to
Amsterdam is planned to be added in June 1999.
Northwest and KLM operate their trans-Atlantic flights pursuant to a
commercial and operational joint venture alliance. Northwest and KLM have
expanded their trans-Atlantic presence by operating joint service between 13
U.S. cities and Amsterdam, KLM's hub airport. Code-sharing between Northwest and
KLM has been implemented on flights to 61 European, eight Middle Eastern, seven
African, three Asian and over 185 U.S. cities. The Northwest/KLM alliance
benefits from antitrust immunity that facilitates coordinated pricing,
scheduling, product development and marketing.
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In September 1997, Northwest and KLM expanded their alliance for a minimum
of 13 years and expanded their areas of cooperation to include services between
Europe and Canada, India and Mexico. In addition, the two companies plan to
increase the level of cooperation between their respective cargo divisions and
will explore extending their alliance to include additional partners and to
further develop strategies for joint marketing and product development. In
February 1998, a leading aviation trade magazine, AIR TRANSPORT WORLD, awarded
its "1997 Airline of the Year" honor to the Northwest/KLM alliance.
In November 1998, KLM and Alitalia entered into a strategic commercial
alliance and began code-sharing. KLM and Alitalia have stated that they expect
to develop a European multi-hub network based in Amsterdam, Rome and Milan.
Continental and Alitalia currently code-share between the U.S. and Italy and
Northwest anticipates that Alitalia will also join the Northwest/KLM
trans-Atlantic joint venture alliance, subject to regulatory approvals. If
consummated, the addition of Alitalia and Continental to the Northwest/KLM
trans-Atlantic joint venture alliance would create a combination comparable in
scale and scope to other global alliances, resulting in over a 15%
trans-Atlantic market share (based on 1998 ASMs) with service to 48 countries.
To further enhance Northwest's service in Europe, India, and Southeast Asia,
Northwest also has marketing agreements with Eurowings, Braathens, KLM uk, KLM
exel, Jet Airways Private Ltd., Kenya Airways, and Garuda Indonesia. KLM has
similar agreements with Air Engiadina of Switzerland and Regionale Air of
France, and Northwest expects to enter into similar agreements with these two
airlines. Northwest has a marketing agreement with Business Express Airlines for
code-sharing in the Boston area to feed its trans-Atlantic and domestic route
network.
In September 1992, the U.S. and the Netherlands entered into an "open-skies"
bilateral aviation treaty which authorizes the airlines of each country to
provide international air transportation between any U.S.-Netherlands city pair
and to operate connecting service to destinations in other countries. Based
primarily on the open-entry market created by this treaty and the limited
competitive overlap between route systems, Northwest and KLM petitioned the
Department of Transportation (the "DOT") for joint immunity from the U.S.
antitrust laws and, under conditions imposed by the DOT, were granted such
immunity in January 1993. Northwest and KLM re-submitted their alliance
agreement to the DOT in January 1998. The European Commission ("EC") has
commenced a review of all trans-Atlantic airline alliances, including
Northwest/KLM. The EC is considering imposing certain regulatory conditions that
may restrict the areas of permissible cooperation.
LATIN AMERICA. Through the Company's alliance with Continental, Northwest
will increase its Latin American presence. Continental flies to eight cities in
South America and offers additional connecting service through alliances with
foreign carriers. Northwest expects to implement code-sharing in Latin America
with Continental in 1999.
CARGO
Northwest, utilizing eight Boeing 747 freighter aircraft, is the world's
tenth largest cargo air carrier (based on 1997 freight ton miles). Northwest is
one of only two U.S. passenger airlines to operate a dedicated all-cargo
freighter fleet. Cargo accounts for 7% of the Company's operating revenues, and
the majority of its cargo revenues originate in or are destined for Asia.
Through its Tokyo and Anchorage cargo hubs, Northwest serves most major air
freight markets between the U.S. and the Pacific.
OTHER ACTIVITIES
MLT INC. MLT Inc. ("MLT") is among the largest vacation wholesale companies
in the U.S. In addition to its MLT Vacations charter program, MLT markets and
supports Northwest's WorldVacation packages and offers leisure fares to several
domestic and international destinations, primarily on Northwest.
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NORTHWEST AEROSPACE TRAINING CORPORATION. Northwest Aerospace Training
Corporation ("NATCO") provides training and aircraft simulation services to
pilots for Northwest, other airlines, governments and corporations. The NATCO
training facility is among the world's largest aircraft simulation facilities,
with 22 full-flight simulators and training devices. In 1998, 44% of NATCO's
revenues came from third parties. NATCO's customer base includes both domestic
and international airlines.
NORTHWEST PARS, INC. Northwest PARS, Inc. holds a 33.7% limited partnership
interest in WORLDSPAN, L.P. ("WORLDSPAN"). WORLDSPAN operates and markets a
computer reservations and passenger processing system ("CRS") for the travel
industry. Delta Air Lines, Inc. and Trans World Airlines, Inc. own 40% and 26.3%
of WORLDSPAN, respectively.
INDUSTRY CONDITIONS AND COMPETITION
The airline industry is both cyclical and seasonal in nature. Due to
seasonal fluctuations, the Company's operating results for any interim period
are not necessarily indicative of those for the entire year. The Company's
second and third quarter operating results have historically been more favorable
due to increased leisure travel on domestic and international routes during the
spring and summer months.
The airline industry is highly competitive. Airline profit levels are highly
sensitive to adverse changes in fuel costs, average fare levels and passenger
demand. Passenger demand and fare levels have historically been influenced by,
among other things, the general state of the economy, international events,
airline capacity and pricing actions taken by other airlines. For example, from
1990 to 1993, the weak U.S. economy, turbulent international events and
extensive price discounting by carriers resulted in unprecedented losses for
U.S. airlines, including Northwest. Since then, the U.S. economy has improved
and broadly available, deep price discounting has ceased.
Northwest's competitors include all the other major domestic airlines, as
well as foreign, national, regional and new entrant airlines, some of which have
more financial resources or lower cost structures than Northwest. Northwest uses
yield inventory management systems to vary the number of discount seats offered
on each flight in an effort to maximize revenues while remaining price
competitive with lower-cost carriers.
In recent years, the major U.S. airlines have formed marketing alliances
with other U.S. and foreign airlines. Such alliances generally provide for
code-sharing, frequent flyer program reciprocity, coordinated scheduling of
flights to permit convenient connections and other joint marketing activities.
Such arrangements permit an airline to market flights operated by other alliance
members as its own. This increases the destinations, connections and frequencies
offered by the airline, which provide an opportunity to increase traffic on that
airline's segment of flights connecting with alliance partners. Other major U.S.
airlines have alliances or planned alliances that may be more extensive than
Northwest's alliances. Northwest's ability to grow its route network by entering
into alliances depends upon the availability of suitable alliance candidates and
the ability of Northwest and its alliance partners to meet business objectives
and to perform their obligations under the alliance agreements.
Northwest has developed strategies that are designed to utilize the
Company's strategic assets to its competitive advantage. These strategies focus
on providing reliable, convenient and consistent air transportation. In
addition, the Company's frequent flyer program, targeted fare promotions and
customer service improvements are designed to maintain and improve its
competitive position.
WORLDSPAN COMPUTER RESERVATION SYSTEM
The large majority of travel agencies in the U.S. obtain their airline
travel information through access to a CRS. A CRS, which is typically owned or
operated by an airline or airlines, is used by travel agents to make airline,
hotel and car reservations and to issue airline tickets. Northwest's presence
through WORLDSPAN in the CRS market gives it a voice in the distribution of its
airline product. Based on the number of passenger segments sold and the number
of agency locations, WORLDSPAN ranks third in
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market share among travel agents in the U.S. WORLDSPAN is subject to CRS
regulations promulgated by the DOT and the European Economic Community.
MARKETING
Consistent with the experience of other carriers, approximately 80% of
ticket sales for travel on Northwest are sold by travel agents. Travel agents
generally receive commissions on sales of tickets. Airlines often pay additional
commissions in connection with special revenue programs.
Northwest introduced electronic ticketing for its entire U.S. and Canadian
route system in 1996. By the end of 1998, 52% of Northwest's North American
customers were using electronic tickets ("E-Tickets"). Northwest is continuing
to expand electronic ticketing and anticipates that in 1999 E-Tickets will be
available for travel from North America to all Northwest destinations worldwide.
Northwest became the first major airline to deploy compact self-service
kiosks to enhance its electronic ticketing services in 1997. These electronic
service centers enable E-Ticket customers to obtain boarding passes, make
current-day flight or seat changes, obtain WORLDPERKS Gold upgrades and, at some
locations, check their own bags. Electronic service centers are now available at
18 airports in North America, including Detroit, Minneapolis/St. Paul, Memphis,
Baltimore, Boston, Chicago O'Hare, Indianapolis, Kansas City, New York (La
Guardia), Los Angeles, Milwaukee, Newark, Philadelphia, Phoenix, San Francisco,
Seattle/Tacoma, Tampa and Washington D.C. (Ronald Reagan National).
Northwest offers CyberSaver fares through its web site on the World Wide Web
(www.nwa.com). These fares offer travelers the opportunity to realize deep
discounts for weekend travel on selected domestic routes. In 1998, Northwest
became the first airline to allow participants in the WORLDPERKS frequent flyer
program to redeem mileage awards online. In cooperation with KLM, the web site's
expanded booking capability now allows customers from the U.S., Canada, Japan,
the United Kingdom, Sweden, Norway, Denmark and Germany to arrange their travel
online. In 1998, the site was named "best airline web site" by the DOW JONES
BUSINESS DIRECTORY and by the Web Marketing Association.
In conjunction with the Northwest's global alliance with Continental,
Northwest and Continental Micronesia, Inc. ("CMI"), a wholly-owned subsidiary of
Continental operating in the South Pacific, plan to utilize coordinated sales
activities.
FREQUENT FLYER PROGRAM
Northwest operates a frequent flyer marketing program known as "WORLDPERKS"
under which mileage credits are earned by flying on Northwest or participating
airlines and by using the services of participating bank credit cards, hotels,
long-distance companies and car rental firms. Northwest sells mileage credits to
the other companies participating in the program. The program was designed to
retain and increase the business of frequent travelers by offering incentives
for their continued patronage.
The WORLDPERKS program is based on a mileage banking system (miles earned
are accumulated in an account for each member). Mileage credits can be redeemed
for free or upgraded travel on Northwest and other participating airlines or for
other travel industry awards. Additional features include the use of seasonal
awards based on peak/off-peak period travel and a three-tier award structure.
Concurrently with the commencement of its global alliance with Continental,
Northwest enhanced its WORLDPERKS program. Beginning in 1998, WORLDPERKS miles
do not expire, domestic award travel levels starting as low as 20,000 miles are
available nine months of the year and WORLDPERKS members are allowed to earn
WORLDPERKS miles on Northwest and its alliance partners, including Continental.
Northwest accounts for its frequent flyer obligation on the accrual basis
using the incremental cost method. Northwest includes food and beverage, fuel,
insurance, security, miscellaneous claims and WORLDPERKS service center expense
in its incremental cost calculation. The incremental costs do not include any
contribution to overhead or profit. Food, beverage and other costs are based on
average cost
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per passenger for the current twelve-month period. The incremental fuel unit
cost per passenger is based on engineering formulas that determine the average
fuel cost per pound carried. Average year-to-date fuel price and estimated
average weight of each added onboard passenger and luggage are factored into the
incremental cost computation and converted to a rate per passenger per award.
The number of estimated travel awards outstanding at December 31, 1998, 1997
and 1996 was approximately 6,147,000, 5,123,000 and 4,536,000 awards,
respectively (data for 1998 is based on an average of 22,500 miles per domestic
award instead of the previous 23,900 miles per award and an average of 45,500
miles per international award). Northwest estimated its recorded liability based
on 5,073,000, 4,198,000 and 3,642,000 of these awards, respectively. The
estimated liability excludes accounts that have never attained the lowest travel
award level and awards that are expected to be redeemed for upgrades or are not
expected to be redeemed at all, and includes an estimate for partially earned
awards on accounts that previously earned an award. The number of estimated
travel awards used for travel on Northwest during the years ended December 31,
1998, 1997 and 1996 was approximately 1,159,000, 1,111,000 and 1,025,000,
respectively. These awards represented an estimated 6.8%, 5.8% and 5.5% of
Northwest's total RPMs for each such year, respectively. Northwest believes
displacement of revenue passengers is minimal based on the low ratio of
WORLDPERKS award usage to revenue passenger miles, the Company's ability to
manage frequent flyer inventory through seat allocations and blackout dates, and
program incentives to travel during off-peak periods.
AIRCRAFT FUEL
Northwest's worldwide aircraft fuel requirements are met by approximately 50
different suppliers. Northwest has contracts with these suppliers, the terms of
which vary as to price, payment terms, quantities and duration. Northwest also
makes purchases of fuel based on price and availability. In order to provide a
measure of control over price and supply, Northwest trades and ships fuel and
maintains fuel storage facilities to support its flight operations. Petroleum
product prices, including jet fuel, are primarily driven by crude oil costs. The
market's alternate uses of crude oil to produce petroleum products other than
jet fuel (e.g., heating oil and gasoline) as well as the adequacy of refining
capacity and other supply constraints affect the price and availability of jet
fuel. Major changes in the price or availability of fuel could materially affect
the financial results of the Company.
The following table summarizes Northwest's fuel consumption and costs:
YEAR ENDED DECEMBER 31
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1998 1997 1996
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Gallons consumed (in millions)................................... 1,877 1,996 1,945
Total costs (in millions)(1)..................................... $ 1,006 $ 1,295 $ 1,307
Average cost per gallon (cents).................................. 53.60 64.86 67.21
Percentage of operating expenses................................. 10.9% 14.3% 14.8%
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(1) Excludes taxes and into-plane fees.
REGULATION
GENERAL. The Airline Deregulation Act of 1978, as amended, eliminated most
domestic economic regulation of passenger and freight transportation. Northwest
is subject to DOT regulations because it holds certificates of public
convenience and necessity as well as air carrier operating certificates.
Northwest's domestic route authority from the DOT permits it to engage in the
interstate and overseas transportation of passengers, freight and mail between
all points in the U.S. and it territories and possessions.
The DOT has jurisdiction over international route authorities, CRSs and
certain consumer protection matters, such as advertising, denied boarding
compensation and baggage liability. The Federal Aviation Administration (the
"FAA") regulates flight operations, including air space control, and aircraft
and
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security standards. The Department of Justice (the "DOJ") has jurisdiction over
airline competition matters, including mergers and acquisitions. Other federal
agencies have jurisdiction over postal operations, use of radio facilities by
aircraft and certain other aspects of Northwest's operations.
In April 1998, the DOT issued proposed competition guidelines that would
severely limit major carriers' ability to compete with new entrant carriers. In
addition, the DOJ is investigating competition at major hub airports and several
items of legislation have been introduced in Congress that would, if enacted:
(i) create new slots for redistribution to new entrants and smaller carriers,
(ii) provide financial assistance, in the form of guarantees and/or subsidized
loans, to smaller carriers for aircraft purchases and/or (iii) require major
carriers like Northwest to enter into interline agreements with smaller carriers
and authorize the DOT to investigate airline marketing practices that may
inhibit service to small and medium sized communities and impose regulations to
remedy any service problems so identified. The outcomes of the DOT guidelines,
the investigations and the proposed legislation are unknown. However, to the
extent that (i) restrictions are imposed upon Northwest's ability to respond to
competition, or (ii) competitors receive financial assistance or special
regulatory protections, Northwest's business may be adversely impacted.
Northwest operates its international routes under route certificates issued
by the DOT. Substantial portions of Northwest's Pacific route certificates are
permanent and do not require renewal by the DOT. Certain other international
route certificates are temporary and subject to periodic renewal by the DOT.
Northwest requests extensions of these certificates when and as appropriate. The
DOT typically renews temporary authorities on routes when the authorized carrier
is providing a reasonable level of service. With respect to foreign air
transportation, the DOT must approve agreements between air carriers, including
code-sharing agreements, and may grant antitrust immunity for those agreements.
Northwest's rights to operate to foreign countries, including Japan and
other countries in the Pacific and Europe, are governed by aviation agreements
between the U.S. and the respective foreign countries. Many aviation agreements
permit an unlimited number of carriers to operate between the U.S. and the
respective foreign country, while other aviation agreements limit the number of
carriers and flights on a given international route. From time to time, the U.S.
or its foreign country counterpart may seek to renegotiate or cancel an aviation
agreement. In the event an aviation agreement is amended or canceled, such a
change could adversely affect Northwest's ability to maintain and/or expand air
service to the foreign country.
Operations to and from foreign countries are subject to the applicable laws
and regulations of those countries. There are restrictions on the number and
timing of operations at certain international airports served by Northwest,
including Tokyo and Osaka. Additionally, slots for international flights are
subject to certain restrictions on use and transfer.
AIRPORT ACCESS. Four of the nation's airports, Chicago O'Hare, New York
(LaGuardia and Kennedy International) and Washington D.C. (Ronald Reagan
National), have been designated by the FAA as "high density traffic airports,"
and the number of take-offs and landings at such airports ("slots") have been
limited during certain peak demand time periods. Currently the FAA permits the
buying, selling, trading or leasing of these slots, subject to certain
restrictions.
LABOR. The Railway Labor Act ("RLA") governs the labor relations of
employers and employees engaged in the airline industry. Comprehensive
provisions are set forth in the RLA establishing the right of airline employees
to organize and bargain collectively along craft or class lines and imposing a
duty upon air carriers and their employees to exert every reasonable effort to
make and maintain collective bargaining agreements. The RLA contains detailed
procedures that must be exhausted before a lawful work stoppage may occur.
Pursuant to the RLA, Northwest has collective bargaining agreements with six
domestic unions representing 11 separate employee groups. For current status of
agreements, see "Item 1. Business--Employees." In addition, Northwest has
agreements with four unions representing its employees in countries throughout
Asia; such agreements are not subject to the RLA.
9
NOISE ABATEMENT. The Airport Noise and Capacity Act of 1990 ("ANCA")
requires the phase-out of Stage II aircraft operations (as defined in Part 36 of
the Federal Aviation Regulations) by December 31, 1999, subject to certain
exceptions. The FAA regulations, which implement the ANCA, require carriers to
modify or reduce the number of Stage II aircraft operated by 75% by the end of
1998 and 100% by the end of 1999. Alternatively, a carrier could satisfy these
compliance requirements by operating a fleet that is at least 75% Stage III by
the end of 1998 and 100% Stage III by the end of 1999. As of December 31, 1998,
Northwest operated 342 Stage III aircraft and 67 Stage II aircraft. Northwest is
currently in compliance and has plans in place to enable it to meet the 1999
year-end operational requirements.
The ANCA also recognizes the right of airport operators with special noise
problems to implement local noise abatement procedures as long as such
procedures do not interfere unreasonably with the interstate and foreign
commerce of the national air transportation system. The ANCA generally requires
FAA approval of local noise restrictions on Stage II aircraft and establishes a
regulatory notice and review process for local restrictions on Stage II aircraft
first proposed after October 1990. As a result of litigation and pressure from
airport area residents, airport operators have taken local actions over the
years to reduce aircraft noise. These actions include restrictions on nighttime
operations, restrictions on frequency of aircraft operations and various
operational procedures for noise abatement. While to date Northwest has
sufficient operational and scheduling flexibility to accomodate current local
noise restrictions, its operations could be adversely affected if
locally-imposed regulations become more restrictive or widespread.
The European Union is considering a proposed rule that would prohibit the
registration in Europe of aircraft with "hushkits" after April 1, 1999.
Northwest opposes such a rule as it could inhibit its operations in Europe as
well as reduce the Company's fleet strategy options in relation to older
aircraft, which are often retired and sold in Europe, Africa and Asia.
SAFETY. The FAA has jurisdiction over aircraft maintenance and operations,
including equipment, dispatch, communications, training, flight personnel and
other matters affecting air safety. To ensure compliance with its regulations,
the FAA requires all U.S. airlines to obtain operating, airworthiness and other
certificates, which are subject to suspension or revocation for cause.
The Company's aircraft require various levels of maintenance or "checks" and
periodically undergo complete overhauls. Maintenance efforts are monitored
closely by the FAA, with FAA representatives present at the Company's
maintenance facilities. The FAA has issued several Airworthiness Directives
("ADs") which mandate changes to an air carrier's maintenance program for older
aircraft. These ADs (which include structural modifications to certain aircraft)
were issued to ensure that the oldest portion of the nation's transport aircraft
fleet remains airworthy. The Company is currently, and expects to remain, in
compliance with all applicable requirements under the FAA-issued ADs.
A combination of FAA and Occupational Safety and Health Administration
regulations on both the federal and state levels apply to all of Northwest's
ground-based operations.
ENVIRONMENTAL. The Company is subject to regulation under various
environmental laws and regulations, which are administered by numerous state and
federal agencies, including the Clean Air Act, the Clean Water Act and
Comprehensive Environmental Response, Compensation and Liability Act of 1980
("CERCLA"). In addition, many state and local governments have adopted
environmental laws and regulations to which the Company's operations are
subject.
The Massachusetts Department of Environmental Protection has identified a
number of contaminated sites at Boston's Logan Airport. Northwest has been
identified as a potentially responsible party under Massachusetts law.
Management believes that its liability for the cost of the remediation of the
Logan site, if any, will not have a material adverse effect on the Company's
financial statements when taken as a whole.
10
CIVIL RESERVE AIR FLEET PROGRAM. Northwest is a participant in the Civil
Reserve Air Fleet Program pursuant to which Northwest has agreed to make
available, during the period beginning October 1, 1998 and ending September 30,
1999, 33 747 aircraft, 38 DC10 aircraft, and nine 727 aircraft for use by the
U.S. military under certain stages of readiness related to national emergencies.
EMPLOYEES
As of December 31, 1998, the Company had approximately 50,600 full-time
equivalent employees of whom approximately 2,300 were foreign nationals working
primarily in Asia. Unions represent approximately 90% of the Company's
employees. Collective bargaining agreements provide standards for wages, hours
of work, working conditions, settlement of disputes and other matters. The major
agreements with domestic employees became amendable or will become amendable on
various dates as follows:
APPROXIMATE
NUMBER OF
FULL-TIME
EQUIVALENT
EMPLOYEES AMENDABLE
EMPLOYEE GROUP COVERED UNION DATE
- ---------------------------------- ------------- --------------------------------------------------- -----------
Pilots............................ 6,000 Air Line Pilots Association, International 9/13/02
Clerks and Agents................. 10,600 International Association of Machinists & Aerospace
Workers ("IAM") 2/25/03
Equipment Service Employees and
Stock Clerks.................... 7,000 IAM 2/25/03
Flight Attendants................. 9,600 International Brotherhood of Teamsters, Chauffeurs,
Warehousemen & Helpers of America 8/2/96
Mechanics and Related Employees... 9,400 IAM 10/03/96
As previously discussed, the above agreements are governed by the RLA.
Pursuant to the RLA, an agreement becomes amendable at the expiration of its
stated term, and continues in effect while the parties pursue agreement on a new
contract. In addition to the direct negotiation phase, the RLA also provides for
a period of mediation, potential arbitration of unresolved issues, and a 30-day
"cooling off" period before either party can resort to self help. See also "Item
7. Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" for further discussion of
collective bargaining activities.
HOLDING COMPANY REORGANIZATION
In connection with the purchase of its interest in Continental, NWA Corp.
effected a holding company reorganization on November 20, 1998. As a result of
this reorganization, Northwest Airlines Holdings Corporation, which was formerly
known as Northwest Airlines Corporation and was at that time the publicly traded
holding company ("Old NWA Corp."), became a direct wholly-owned subsidiary of
the new holding company, NWA Corp. As a result, NWA Corp. is now the publicly
traded holding company, which owns directly Old NWA Corp. and indirectly the
holding and operating subsidiaries of Old NWA Corp. References in this Annual
Report to NWA Corp., Common Stock and Series C Preferred Stock for time periods
prior to November 20, 1998 refer to Old NWA Corp. and the Common Stock and
Series C Preferred Stock of Old NWA Corp., respectively. See Note A to the
Consolidated Financial Statements included within Item 8. Consolidated Financial
Statements and Supplementary Data.
FORWARD-LOOKING STATEMENTS
Certain of the statements made in this section and elsewhere in this report
are forward-looking and are based upon information available to the Company on
the date hereof. The Company through its
11
management may also from time to time make oral forward-looking statements. In
connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, the Company is hereby identifying important
factors that could cause actual results to differ materially from those
contained in any forward-looking statement made by or on behalf of the Company.
Any such statement is qualified by reference to the following cautionary
statements.
It is not reasonably possible to itemize all of the many factors and
specific events that could affect the outlook of an airline operating in the
global economy. Some factors that could significantly impact expected capacity,
load factors, revenues, expenses and cash flows include the airline pricing
environment, fuel costs, labor negotiations both at the Company and other
carriers, low-fare carrier expansion, capacity decisions of other carriers,
actions of the U.S. and foreign governments, foreign currency exchange rate
fluctuation, inflation, the general economic environment in the U.S. and other
regions of the world and other factors discussed herein.
Developments in any of these areas, as well as other risks and uncertainties
detailed from time to time in the Company's Securities and Exchange Commission
filings, could cause the Company's results to differ from results that have been
or may be projected by or on behalf of the Company. The Company cautions that
the foregoing list of important factors is not exclusive. The Company undertakes
no obligation to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. These
statements deal with the Company's expectations about the future and are subject
to a number of factors that could cause actual results to differ materially from
the Company's expectations.
ITEM 2. PROPERTIES
FLIGHT EQUIPMENT
The Company operated a fleet of 409 aircraft at December 31, 1998,
consisting of 330 narrow-body and 79 wide-body aircraft. The diversity of the
fleet accommodates both the Company's domestic hub-and-spoke system and its
international routes and enhances the Company's ability to match its aircraft to
its route network requirements more efficiently.
As of December 31, 1998, 296 aircraft were owned and 113 aircraft were
leased. The Company currently operates 63 (of which 35 are owned) Airbus A320
aircraft with an average age of 5.7 years. The Company's fleet of Boeing
aircraft includes 38 (of which 29 are owned) 727 aircraft with an average age of
19.6 years, 48 (of which 15 are owned) 757 aircraft with an average age of 9.3
years, 33 (of which 18 are owned) 747 aircraft with an average age of 16.7 years
and eight (of which five are owned) 747 freighters with an average age of 18.9
years. The Company's fleet of McDonnell Douglas aircraft includes 173 (of which
156 are owned) DC9 aircraft with an average age of 28.1 years, 38 (of which 30
are owned) DC10 aircraft with an average age of 24.4 years and eight (all of
which are owned) MD-80 aircraft with an average age of 16.5 years.
Although the DC9 and DC10 average aircraft age exceeds twenty years, these
aircraft have considerable remaining technological life, based upon the cycle
life (capacity for number of landings) expected by the manufacturer and other
factors. The Company also believes that these aircraft have economic value for
the Company given its route network and maintenance programs. The Company has
adopted programs to hushkit and modify the 173 DC9 aircraft. As of December 31,
1998, the Company hushkitted 130 of these aircraft and plans on completing the
remaining aircraft by December 31, 1999. As a result of these programs, the
Company estimates these aircraft could fly on average approximately 14
additional years beyond 1998 based upon the manufacturer's expected cycle life
for such aircraft and their projected annual utilization by Northwest. The
Company estimates that its DC10 aircraft fleet could fly on average at least 20
additional years beyond 1998 based upon the manufacturer's expected cycle life
for such aircraft and their projected annual utilization by Northwest.
12
For further information related to the Company's aircraft leases and
commitments see Notes E, K and N to Consolidated Financial Statements included
within Item 8. Consolidated Financial Statements and Supplementary Data.
OTHER PROPERTY AND EQUIPMENT
Northwest's primary offices are located at or near the Minneapolis/St. Paul
International Airport. The Company owns a 160-acre site east of the
Minneapolis/St. Paul International Airport containing the Company's corporate
offices. Additional owned buildings include reservation centers in Baltimore,
Detroit, Tampa and Chisholm, Minnesota; a data processing center in Eagan,
Minnesota; and several office buildings. The Company owns property in Tokyo,
including a 1.3-acre site in downtown Tokyo and a 33-acre land parcel, 512-room
hotel and flight kitchen located near Tokyo's Narita International Airport.
Northwest leases the majority of its airport facilities, support services
buildings and sales and reservations offices. Expiration dates on these leases
range from 1999 to 2027. The Company leases reservations centers in or near
Honolulu, Los Angeles, New York City and Seattle. Maintenance bases under
operating leases are located in Minneapolis/St. Paul, Atlanta, Georgia and
Duluth, Minnesota. The Company also operates approximately 50 city ticket
offices. In certain cases, the Company has constructed a facility on leased
land, which reverts to the lessor upon expiration of the lease. These facilities
include cargo buildings in Anchorage, Boston, Los Angeles, San Francisco and
Honolulu; support buildings at the Minneapolis/St. Paul International Airport; a
flight kitchen and line maintenance hangar in Seattle; and a 2-bay DC10 hangar
in Detroit that will be completed in 1999. Northwest opened a new international
departures facility in Detroit in September 1997 and is managing the design and
construction of a new $1.2 billion terminal in Detroit which will provide
Northwest with 74 gates compared to the 60 present gates. To improve service for
its cargo customers, Northwest is investing in a new facility at New York's John
F. Kennedy International Airport with scheduled completion in April 1999.
ITEM 3. LEGAL PROCEEDINGS
The Antitrust Division of the U.S. Department of Justice commenced a civil
antitrust action in the United States District Court for the Eastern District of
Michigan (Case No. 98-74611) against the Company and Continental Airlines, Inc.
("Continental") challenging the Company's acquisition of the beneficial
ownership of 8,661,224 shares of Continental Class A Common Stock. The Justice
Department's complaint seeks divestiture by the Company of the acquired
Continental stock or the imposition of additional terms and restrictions on the
Company with respect to the acquired Continental stock. The Company intends to
vigorously defend the lawsuit. The lawsuit did not challenge the alliance
between Northwest and Continental, although the Justice Department has indicated
that they will continue to monitor the alliance.
In January 1998, Northwest received a civil investigative demand ("CID")
from the Antitrust Division of the Department of Justice related to an antitrust
investigation to determine whether there are, have been or may be violations of
Sections 1 and 2 of the Sherman Act related to, among other things,
monopolization of hub markets. Northwest understands that this is part of a
larger Justice Department investigation of competitive practices in the airline
industry. The CID is a request for information in the course of a civil
antitrust investigation and does not constitute the institution of legal
proceedings. Northwest filed information with the Justice Department that it
believes to be responsive to the CID. In February 1999, Northwest received from
the Justice Department a request for additional information relating to the CID.
In addition, in the ordinary course of its business, the Company is party to
various other legal actions which the Company believes are incidental to the
operation of its business. The Company believes that the outcome of the
proceedings to which it is currently a party (including those described above)
will not have a material adverse effect on the Company's consolidated financial
statements taken as a whole.
13
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's security holders during
the fourth quarter of 1998.
MANAGEMENT
EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company, together with their ages and business
experience, are set forth below:
JOHN H. DASBURG, age 56, has served as President and Chief Executive Officer
and a director of NWA Corp. and Northwest since 1990. Mr. Dasburg joined
Northwest in November 1989 as Executive Vice President-Finance and
Administration and was appointed President and Chief Executive Officer in
November 1990. From 1987 to 1989, Mr. Dasburg served as President of Marriott's
Lodging Group and as an Executive Vice President of Marriott Corp. From 1980
through 1987, he held various senior executive positions at Marriott. Prior to
1980, he was a partner of KPMG Peat Marwick. Mr. Dasburg is on the board of
directors of KLM, Owens Corning, The St. Paul Companies, Inc. and the Mayo
Foundation.
RICHARD H. ANDERSON, age 43, was appointed Executive Vice President and
Chief Operating Officer of NWA Corp. and Northwest in December 1998. He was
Executive Vice President-Technical Operations and Airport Affairs from April
1998 to December 1998 and served as Senior Vice President-Technical Operations
and Airport Affairs from January 1997 to April 1998. From July 1994 to December
1996, he was Senior Vice President-Labor Relations, State Affairs and Law. He
joined Northwest in 1990 as Vice President-Deputy General Counsel. Prior to
joining Northwest, Mr. Anderson was Staff Vice President and Deputy General
Counsel of Continental. From 1989 to 1990, Mr. Anderson was Associate General
Counsel of Continental.
MICKEY FORET, age 53, rejoined Northwest in May 1998 as Special Projects
Officer and in September 1998 he was appointed Executive Vice President and
Chief Financial Officer of NWA Corp. and Northwest. He originally joined
Northwest as Senior Vice President-Planning and Finance in December 1992 and
from September 1993 to May 1996 served as Executive Vice President and Chief
Financial Officer. From June 1996 to September 1997, Mr. Foret served as
President and Chief Operating Officer of Atlas Air, Inc. From 1990-1992, Mr.
Foret was a consultant, primarily to aviation-related businesses. In 1992, Mr.
Foret also served as President and Chief Executive Officer of KLH Computers,
Inc. From 1974-1990, Mr. Foret held senior positions with Continental Airlines
Holdings, Inc. and its subsidiary and predecessor companies, including President
and Chief Operating Officer.
J. TIMOTHY GRIFFIN, age 47, was appointed Executive Vice President-Marketing
and Distribution of NWA Corp. and Northwest in January 1999. From June 1993 to
January 1999, he served as Senior Vice President-Market Planning and Systems.
Prior to joining Northwest in 1993, Mr. Griffin held senior positions with
Continental Airlines and American Airlines.
PHILIP C. HAAN, age 43, was appointed Executive Vice
President-International, Sales and Information Services of NWA Corp. and
Northwest in January 1999. From December 1995 to January 1999, he served as
Senior Vice President-International Services. Mr. Haan joined Northwest in April
1991 as Vice President-Revenue Management and served in a number of officer
positions. Prior to joining Northwest, he was with American Airlines and Ford
Motor Company.
DOUGLAS M. STEENLAND, age 47, was named Executive Vice President-General
Counsel and Alliances of NWA Corp. and Northwest in January 1999. Mr. Steenland
served as Executive Vice President-General Counsel and Secretary from June 1998
to January 1999 and as Senior Vice President-General Counsel and Secretary from
July 1994 to June 1998. He joined Northwest as Vice President-Deputy General
Counsel
14
and Secretary in July 1991. Prior to joining Northwest, Mr. Steenland was a
senior partner at the Washington, D.C. law firm of Verner, Liipfert, Bernhard,
McPherson and Hand.
RAYMOND J. VECCI, age 56, joined Northwest as Executive Vice
President-Customer Service of NWA Corp. and Northwest in July 1997 and in
January 1999 was also appointed President-Michigan Operations. From January 1997
to March 1997, he was Executive Vice President and Chief Operating Officer for
Carnival Airlines and President and Chief Executive Officer from March 1997 to
June 1997. He was Executive Vice President and Chief Operating Officer of Tower
Air from September 1996 to December 1996. From 1991 to 1995, Mr. Vecci was
Chairman, President and Chief Executive Officer of Alaska Air Group and Alaska
Airlines.
CHRISTOPHER E. CLOUSER, age 47, has served as Senior Vice President-Human
Resources, Communications and Administration of NWA Corp. and Northwest since
September 1996. From July 1993 to September 1996, he served as Senior Vice
President-Communications, Advertising and Human Resources. He joined Northwest
in April 1991 as Senior Vice President-Corporate Communications and Advertising.
From 1988 to 1991, Mr. Clouser was Vice President-Corporate Relations and
Advertising for Bell Atlantic Corporation. He also served on the board of
directors of the Bell Telephone Company of Pennsylvania. Mr. Clouser has
previously held officer positions at Hallmark Cards, U.S. Sprint and United
Telecommunications, Inc.
RICHARD B. HIRST, age 54, has served as Senior Vice President-Corporate
Affairs of NWA Corp. and Northwest since July 1994. He joined Northwest as
Senior Vice President, General Counsel in 1990. From 1986 to 1990, Mr. Hirst
served as Vice President, General Counsel and Secretary at Continental.
ROLF S. ANDRESEN, age 63, has served as Vice President-Finance and Chief
Accounting Officer of NWA
Corp. and Northwest since June 1998 and served as Vice President-Finance and
Controller from July 1994 to April 1998. Prior to joining Northwest, Mr.
Andresen held the Chief Financial Officer position at Private Jet Corp. in 1994
and various officer positions, including Chief Financial Officer, at Pan
American World Airways from 1991 to 1993.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is quoted on the Nasdaq National Market under
symbol NWAC. The table below shows the high and low sales prices for the
Company's common stock during 1998 and 1997:
1998 1997
-------------------- ---------------------
QUARTER HIGH LOW HIGH LOW
- --------------------------------------------------- --------- --------- ---------- ---------
1(st).............................................. 65 5/16 45 1/2 41 3/4 33 1/8
2(nd).............................................. 62 3/16 37 43 3/4 33 7/8
3(rd).............................................. 44 1/2 25 1/16 42 19/32 35 1/4
4(th).............................................. 27 5/8 18 5/8 49 1/8 40 1/2
As of February 26, 1999, there were 1,269 stockholders of record.
Since the acquisition in 1989 of NWA Corp.'s principal indirect subsidiary,
NWA Inc., which is the parent of Northwest, NWA Corp. has not declared or paid
any dividends on its common stock and does not currently intend to do so. Under
the provisions of certain of the Company's bank credit agreements, NWA Corp.'s
ability to pay dividends on or repurchase its common stock is restricted. Any
future determination to pay cash dividends will be at the discretion of the
Board of Directors, subject to applicable limitations under Delaware law, and
will be dependent upon the Company's results of operations, financial condition,
contractual restrictions and other factors deemed relevant by the Board of
Directors.
15
ITEM 6: SELECTED FINANCIAL DATA
NORTHWEST AIRLINES CORPORATION
YEAR ENDED DECEMBER 31
-------------------------------------------------------------------------
1998(1) 1997 1996 1995 1994
--------- --------- --------- --------- ---------
STATEMENTS OF INCOME (IN MILLIONS, EXCEPT PER
SHARE DATA)
Operating revenues
Passenger.................................. $ 7,606.5 $ 8,822.1 $ 8,598.3 $ 7,762.0 $ 7,010.1
Cargo...................................... 633.5 789.4 745.8 751.2 755.8
Other...................................... 804.8 614.3 536.4 571.7 559.0
--------- --------- --------- --------- ---------
9,044.8 10,225.8 9,880.5 9,084.9 8,324.9
Operating expenses........................... 9,236.2 9,068.6 8,826.7 8,171.5 7,485.3
--------- --------- --------- --------- ---------
Operating income (loss)...................... (191.4) 1,157.2 1,053.8 913.4 839.6
OPERATING MARGIN............................. (2.1)% 11.3% 10.7% 10.1% 10.1%
Income (loss) before extraordinary item...... $ (285.5) $ 605.8 $ 536.1 $ 342.1 $ 295.5
Net income (loss)............................ $ (285.5) $ 596.5 $ 536.1 $ 392.0 $ 295.5
Earnings (loss) per common share:
BASIC.................................... $ (3.48) $ 5.89(2) $ 5.05(2) $ 3.11(2) $ 3.00
DILUTED.................................. $ (3.48) $ 5.29(2) $ 4.52(2) $ 2.90(2) $ 2.90
BALANCE SHEETS (IN MILLIONS)
Cash, cash equivalents and unrestricted
short-term investments..................... $ 480.0 $ 1,039.9 $ 752.1 $ 970.9 $ 968.3
Total assets................................. 10,280.8 9,336.2 8,511.7 8,412.3 8,070.1
Long-term debt, including current
maturities................................. 4,000.7 2,069.3 2,060.4 2,467.1 4,013.5
Long-term obligations under capital leases,
including current obligations.............. 654.9 705.3 772.2 841.2 890.3
Mandatorily redeemable preferred security of
subsidiary................................. 564.1 486.3 549.2 618.4 --
Redeemable stock............................. 260.7 1,154.7 602.6 945.5 795.0
Common stockholders' equity (deficit)(3)..... (476.7) (311.0) 92.9 (818.8) (1,370.7)
OPERATING STATISTICS(4)
Scheduled service:
Available seat miles (ASM) (millions)...... 91,310.7 96,963.6 93,913.7 87,472.0 85,015.6
Revenue passenger miles (millions)......... 66,738.3 72,031.3 68,639.1 62,515.2 57,873.2
Passenger load factor...................... 73.1% 74.3% 73.1% 71.5% 68.1%
Revenue passengers (millions).............. 50.5 54.7 52.7 49.3 45.5
Revenue yield per passenger mile........... 11.26 CENTS 12.11 CENTS 12.53 CENTS 12.42 CENTS 12.11 CENTS
Passenger revenue per scheduled ASM........ 8.23 CENTS 9.00 CENTS 9.16 CENTS 8.87 CENTS 8.25 CENTS
Operating revenue per total ASM(5)........... 9.12 CENTS 9.76 CENTS 9.85 CENTS 9.58 CENTS 8.93 CENTS
Operating expense per total ASM(5)........... 9.21 CENTS 8.63 CENTS 8.78 CENTS 8.66 CENTS 8.08 CENTS
Cargo ton miles (millions)................... 1,954.4 2,282.8 2,215.8 2,246.3 2,322.3
Cargo revenue per ton mile................... 32.4 CENTS 34.5 CENTS 33.7 CENTS 33.4 CENTS 32.5 CENTS
Fuel gallons consumed (millions)............. 1,877.1 1,996.3 1,945.1 1,846.2 1,792.8
Average fuel cost per gallon................. 53.60 CENTS 64.86 CENTS 67.21 CENTS 55.66 CENTS 56.23 CENTS
Number of operating aircraft at year end..... 409 405 399 380 361
Full-time equivalent employees at year end... 50,565 48,984 47,536 45,124 43,673
- ------------------------------
(1) 1998 was affected by labor-related disruptions which included work actions,
a 30-day cooling off period, an 18-day cessation of flight operations due to
the pilots' strike, a seven-day gradual resumption of flight operations and
a rebuilding of traffic demand.
(2) Excludes the effects of the 1997 extraordinary loss ($.10 per basic share
and $.08 per diluted share), the 1996 preferred stock transaction ($.75 per
basic share and $.68 per diluted share), the 1995 preferred stock
transaction ($.64 per basic share and $.58 per diluted share) and the 1995
extraordinary gain ($.55 per basic share and $.50 per diluted share).
(3) No dividends have been paid on common stock for any period presented.
(4) All statistics exclude Express Airlines I, Inc.
(5) Excludes the estimated revenues and expenses associated with the operation
of Northwest's fleet of eight 747 freighter aircraft and MLT Inc.
16
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Northwest Airlines Corporation ("NWA Corp." and, together with its
subsidiaries, the "Company") incurred a net loss of $285.5 million for the year
ended December 31, 1998, compared with net income of $596.5 in 1997. Loss per
share was $3.48 in 1998 compared with diluted earnings per share of $5.21 in
1997. An operating loss of $191.4 million was reported in 1998 compared to
operating income of $1.16 billion in 1997.
The year ended December 31, 1998 was affected by labor-related disruptions
which included the pilots' strike. Because of these events, year-over-year
comparisons are not a useful measure of the underlying operating and financial
performance of the Company. However, for continuity of reporting and as a
measure of the impact of the labor disruptions, the traditional comparisons are
presented herein. The Company estimates the cost of the labor disruptions in
lost revenue and incremental expenses to be approximately $1.04 billion on a
pre-tax basis for the year ended December 31, 1998.
Northwest Airlines, Inc. ("Northwest") is the principal indirect operating
subsidiary of NWA Corp., accounting for more than 95% of the Company's 1998
consolidated operating revenues and expenses. The Company's operating results
are significantly impacted by both general and industry economic environments.
Small fluctuations in revenue per available seat mile ("RASM") and cost per
available seat mile ("CASM") can have significant impacts on the Company's
profitability. The Company acquired Express Airlines I, Inc. ("Express") on
April 1, 1997; the operating results of Express are included in the consolidated
financial statements commencing on that date.
RESULTS OF OPERATIONS--1998 COMPARED TO 1997
OPERATING REVENUES. Operating revenues were $9.04 billion, a decrease of
$1.18 billion (11.5%). Operating revenue per total service available seat mile
("ASM") decreased 6.6%. System passenger revenue decreased $1.22 billion (13.8%)
primarily attributable to a decrease in scheduled service ASMs and a decrease in
passenger RASM due to the labor disruptions. The decrease in RASM was also a
result of a weaker Asian economic environment and weaker foreign currency
exchange rates. Passenger revenue included $93.6 million and $100.1 million of
Express revenues for the years ended December 31, 1998 and 1997, respectively.
The following analysis by market is based on information reported to the
U.S. Department of Transportation ("DOT") and excludes Express:
SYSTEM DOMESTIC PACIFIC ATLANTIC
--------- -------- -------- ------
1998
Passenger revenue (in millions)................ $ 7,512.9 $5,190.1 $1,619.9 $702.9
INCREASE/(DECREASE) FROM 1997:
Passenger revenue (in millions)................ $(1,209.1) $ (691.8) $ (573.1) $ 55.8
Percent...................................... (13.9)% (11.8)% (26.1)% 8.6%
Scheduled service ASMs (capacity).............. (5.8)% (6.3)% (12.1)% 22.2%
Passenger RASM................................. (8.6)% (5.8)% (15.9)% (11.1)%
Yield.......................................... (7.0)% (5.4)% (13.4)% (5.4)%
Passenger load factor.......................... (1.2) pts. (.3) pts. (2.2) pts. (5.1) pts.
Domestic passenger revenue was lower due to decreased capacity and yields
resulting from the labor disruptions.
Pacific passenger revenue decreased due to the labor disruptions, an
unfavorable general economic environment in the Pacific and weaker Asian
currencies, of which the largest impact was due to the
17
Japanese economy and yen. The average yen per U.S. dollar exchange rate for the
year ended December 31, 1998 and 1997 was 133 and 120, respectively, a weakening
of the yen of 10.8%. In response to the continued weak Asian economic
environment, lower demand and increased competition, the Company reduced
capacity in the region during 1998.
Atlantic passenger revenue increased due to an increase in capacity which
resulted primarily from new flying (including service to Mumbai and Delhi, India
from Amsterdam) and the initiation of Philadelphia-Amsterdam and
Seattle-Amsterdam service and increases in Minneapolis/St. Paul-Amsterdam and
Detroit-Amsterdam services, offset by a decrease in RASM as a result of the
labor disruptions.
Cargo revenue decreased $155.9 million (19.7%) due to 14.4% fewer cargo ton
miles and a 6.2% decrease in cargo revenue per ton mile due to the labor
disruptions, a weaker Asian economic environment and weaker Asian currency
exchange rates. Other revenue increased $190.5 million (31.0%) due to increased
revenue from KLM Royal Dutch Airlines ("KLM") joint venture alliance settlements
and MLT Inc.
OPERATING EXPENSES. Operating expenses increased $167.6 million (1.8%).
Operating capacity decreased 5.9% to 91.4 billion total service ASMs which
contributed to the 6.7% increase in operating expense per total service ASM.
Salaries, wages and benefits increased $236.7 million (7.8%) due primarily to an
increase in average full-time equivalent employees of 4.0%, retroactive
compensation related to collective bargaining agreements and the impact of
settled contracts. Aircraft fuel and taxes decreased $296.7 million (21.3%) due
to a 17.4% decrease in the average fuel price per gallon from 64.86 cents to
53.60 cents and a 6.0% decrease in fuel gallons consumed as a result of the
labor disruptions. Commissions decreased $163.3 million (19.1%) due to lower
revenues as a result of the labor disruptions, a lower effective commission rate
caused by a shift in revenue mix and changes to the Company's commission
structure which began in September 1997. Aircraft maintenance, materials and
repairs increased $140.6 million (22.7%) due to higher utilization of outside
suppliers as a result of increased scheduled overhauls and timing of check
cycles, and decreased employee productivity due to the labor disruptions. Other
expenses (the principal components of which include outside services, selling
and marketing expenses, passenger food, personnel, advertising and promotional
expenses, communication expenses and supplies) increased $239.4 million (12.2%),
due primarily to increased business for MLT Inc. claims, advertising and
promotions, as well as the accelerated retirement of seven of the Company's
oldest Boeing 747 aircraft resulting in a fleet disposition charge of $65.9
million recorded in the fourth quarter. See Note A to the Consolidated Financial
Statements for additional discussion of the fleet disposition charge.
OTHER INCOME AND EXPENSE. Interest expense--net increased $78.0 million
(33.3%) primarily due to additional borrowings to fund the Company's cash
requirements. This level of increase is expected to continue into 1999 due to
the higher level of borrowings. The foreign currency loss for the year ended
December 31, 1998 was primarily attributable to balance sheet remeasurement of
foreign currency-denominated assets and liabilities. Other, net increased
primarily due to the sale of an equity investment in GHI Limited.
RESULTS OF OPERATIONS--1997 COMPARED TO 1996
OPERATING REVENUES. Operating revenues were $10.23 billion, an improvement
of $345.3 million (3.5%). Operating revenue per total service ASM decreased .9%.
System passenger revenue increased $223.8 million (2.6%) due to an increase in
scheduled service ASMs and the inclusion of Express revenues of $100.1 million.
These increases were offset by a decrease in passenger RASM driven by
unfavorable foreign currency exchange rates and the reinstatement of federal
ticket taxes in March 1997.
18
The following analysis by market is based on information reported to the DOT
and excludes Express:
SYSTEM DOMESTIC PACIFIC ATLANTIC
-------- -------- -------- ------
1997
Passenger revenue (in millions)................ $8,722.0 $5,881.9 $2,193.0 $647.1
INCREASE/(DECREASE) FROM 1996:
Passenger revenue (in millions)................ $ 123.7 $ 165.5 $ (58.4) $ 16.6
Percent...................................... 1.4% 2.9% (2.6)% 2.6%
Scheduled service ASMs (capacity)................ 3.2% 2.2% 5.6% 1.7%
Passenger RASM................................... (1.7)% .7% (7.7)% .9%
Yield............................................ (3.4)% (2.0)% (7.4)% (1.4)%
Passenger load factor............................ 1.2pts. 1.8pts. (0.4) pts. 1.9pts.
Domestic passenger revenue increased as a result of an increase in capacity
and an increase in RASM. The Company increased frequencies to ten cities and
entered six new markets. The increase in RASM was due to an increase in
passenger load factor offset by a decrease in yield due to the reinstatement of
federal taxes on airline tickets and international departures. The Company
benefited from the absence of ticket taxes for two months in 1997 versus eight
months in 1996.
Pacific passenger revenue decreased due to a decrease in RASM which was
partially offset by an increase in capacity related to the initiation of
Minneapolis/St. Paul-Osaka service and additional trans-Pacific frequencies,
mainly for the Minneapolis/St. Paul-Tokyo service. The decrease in Pacific RASM
was primarily due to a decrease in yield, which was largely attributable to a
weaker Japanese yen. The average yen per U.S. dollar exchange rate for the year
ended December 31, 1997 and 1996 was 120 and 108, respectively, a weakening of
the yen of 11.2%. Atlantic passenger revenue increased due to an increase in
capacity and an increase in RASM.
Cargo revenue increased $43.6 million (5.8%) due to a 2.6% increase in cargo
revenue per ton mile and 3.0% more cargo ton miles primarily due to the
development of a more efficient freighter schedule. The increase in cargo
revenue per ton mile was primarily due to increased import sales driven by the
continued strength of the U.S. dollar versus Asian currencies. Other revenue
increased $77.9 million (14.5%) due to settlements under the joint venture
alliance with KLM and increased charter activity.
OPERATING EXPENSES. Operating expenses increased $241.9 million (2.7%)
compared to the 3.3% capacity increase to 97.1 billion total service ASMs.
Operating expense per total service ASM decreased for the first time in four
years from 8.78 cents per total service ASM to 8.63 cents, a decrease of 1.7%.
Salaries, wages and benefits increased $314.5 million (11.6%) due primarily to
the end of the Wage Savings Period as discussed under "Liquidity and Capital
Resources--LABOR AGREEMENTS" and an increase in average full-time equivalent
employees of 3.3%. The increase in full-time equivalent employees was
attributable to the increased flying of 3.3% and increased traffic of 3.7%.
Offsetting the increased salaries, wages and benefits expense was $49.2 million
in lower pension expense due to a higher pension discount rate applied in 1997
compared to 1996. Aircraft fuel and taxes decreased $3.1 million (.2%) due to a
3.5% decrease in the average fuel price per gallon from 67.21 cents to 64.86
cents offset by an increase of 2.6% in fuel gallons consumed. Commissions
decreased $13.2 million (1.5%) primarily due to increased domestic revenue where
effective commission rates are lower than those paid internationally and also
due to changes in the Company's commission structure beginning in September 1997
which reduced commissions paid from 10% to 8% on tickets purchased in the U.S.
or Canada for travel to destinations outside North America. Aircraft maintenance
materials and repairs increased $64.2 million (11.5%) due primarily to $19.1
million (3.4%) related to Express and an increased number of scheduled airframe
and engine overhauls in accordance with the Company's maintenance program. The
Company contracted for some of its additional maintenance work with outside
suppliers, resulting in labor costs that would normally be classified as
salaries and wages being included in maintenance materials and repairs expense.
Other
19
expenses increased $88.7 million (4.7%) due primarily to increased volume and
rates for outside services, selling and marketing fees and personnel expenses.
OTHER INCOME AND EXPENSE. Interest expense-net decreased $28.4 million
(10.8%) primarily due to the retirement of debt prior to scheduled maturity and
lower interest rates on debt. The foreign currency gain for the year ended
December 31, 1997 was primarily attributable to balance sheet remeasurement of
foreign currency-denominated assets and liabilities.
EXTRAORDINARY ITEM. The Company repurchased for $78.7 million certain NWA
Trust No. 2 aircraft notes in January 1998 pursuant to a tender offer. An
extraordinary loss of $9.3 million, net of tax, was recorded in 1997 as 99% of
the notes were tendered by December 31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1998, the Company had cash and cash equivalents of $480
million and borrowing capacity of $1.0 billion under its revolving credit
facilities, providing total available liquidity of $1.48 billion.
Cash flows from operating activities were $88.3 million for 1998, a decrease
of $1.52 billion compared with 1997 due primarily to the labor disruptions as
well as higher than normal sale proceeds of frequent flyer miles in 1997 of
$387.7 million. Cash flows from operating activities were $1.61 billion for 1997
and $1.37 billion for 1996. Net cash used in investing and financing activities
during 1998, 1997 and 1996 was $348.7 million, $1.43 billion and $1.66 billion,
respectively.
INVESTING ACTIVITIES. Investing activities in 1998 consisted primarily of
the purchase of 13 Airbus A320 aircraft, ten RJ85 aircraft, and three used DC10
aircraft, costs to commission aircraft before entering revenue service, engine
hushkitting, aircraft modifications, deposits on ordered aircraft and ground
equipment purchases. On November 20, 1998, NWA Corp. issued 2.6 million shares
of common stock and paid $399 million in cash to acquire the beneficial
ownership of 8.7 million shares of Class A Common Stock of Continental Airlines,
Inc. ("Continental"). The Company funded its investment in Continental with cash
from its general working capital. In a related transaction, Northwest and
Continental entered into a thirteen-year global strategic commercial alliance
that connects the two carriers' networks and includes extensive code-sharing,
frequent flyer program reciprocity and other cooperative activities.
Investing activities in 1997 consisted primarily of costs to commission
aircraft before entering revenue service, deposits on ordered aircraft, the
refurbishment of DC9 aircraft, engine hushkitting, ground equipment purchases,
the acquisition of Express, the purchase off lease of four aircraft and the
purchase of eight RJ85 aircraft, one DC10-30 aircraft and three DC9-30 aircraft.
Capital expenditures for 1996 pertained primarily to the acquisition of 13
Boeing 757 aircraft, seven DC9-30 aircraft, three DC10-30 aircraft and two
747-200 aircraft; the purchase off lease of 22 aircraft; and the refurbishment
of DC9 aircraft.
FINANCING ACTIVITIES. Financing activities in 1998 included the Company's
repurchase of its remaining Common Stock held by KLM, the issuance of $400
million of unsecured notes, the incurrence of $240 million of debt secured by
six Boeing 757 aircraft, the payment of debt and capital lease obligations, and
the sale and leaseback of 13 A320 aircraft and four RJ85 aircraft. During the
third quarter, in anticipation of potential labor disruptions, the Company
borrowed the $2.08 billion available under its credit facilities, and
subsequently repaid such borrowings. In October 1998, the Company borrowed $835
million to fund its cash requirements.
On May 1, 1998, NWA Corp. purchased from KLM the remaining 18.2 million
shares of NWA Corp. Common Stock which had been reclassified as redeemable
common stock. The Company had previously agreed to repurchase the shares over a
three-year period ending in September 2000. The purchase price of $780.4 million
was paid with a combination of $336.7 million of cash and three senior unsecured
7.88% notes with principal amounts of $206 million, $137.7 million and $100
million. The Company repaid the first note on September 29, 1998; the remaining
two notes are due on September 29, 1999 and 2000, respectively.
20
The Company's Credit Agreement was amended in December 1997 to increase its
existing revolving credit facility from $500 million to $675 million and to
extend the availability period to December 2002. In addition, the facility added
a new $175 million 364-day unsecured revolving credit facility due in December
1998. In December 1998, $10.2 million of the $175 million 364-day revolver was
converted into a term loan due December 2002. The remaining $164.8 million was
renewed for another 364 days; however, to the extent this facility is not
renewed for an additional 364-day period, the Company may borrow up to the
entire non-renewed portion of the facility and all such borrowings mature in
December 2002. In May 1998, the Company provided certain collateral to secure
its previously unsecured term loan and revolving credit facilities under the
Credit Agreement.
In May 1998, the Company obtained a secured 364-day $1.0 billion additional
revolving credit facility. This revolving credit facility was renewed in
February 1999, which extended the expiration date from May 11, 1999 to February
8, 2000 and reduced the amount available from $1.0 billion to $750 million.
Interest is calculated at a floating rate based on the London Interbank Offered
Rate plus 2.25% with a .5% per annum commitment fee payable on the unused
portion of such revolving credit facility.
In February 1999, the Company completed an offering of $421.2 million of
pass through certificates to be used to finance, directly or through leveraged
lease arrangements, the acquisition of four new Boeing 747-400 aircraft
scheduled for delivery in 1999.
Financing activities in 1997 pertained primarily to NWA Corp.'s repurchases
of its Common Stock and Series A and B Preferred Stock, the issuance of $250
million of unsecured notes, the sale and leaseback of eight RJ85 aircraft and
the payment of debt and capital lease obligations. On September 29, 1997, the
Company repurchased 6.8 million shares of NWA Corp. Common Stock held by KLM for
$273.1 million. Concurrently, all of NWA Corp.'s Series A and B Preferred Stock
held by KLM and other holders was repurchased for $251.3 million. Both
repurchases were funded using existing cash resources.
Financing activities in 1996 pertained primarily to the sale and leaseback
of seven Boeing 757 aircraft and the payment of debt and capital lease
obligations, including prepayments of $180 million. In July 1996, NWA Corp.
acquired from KLM 3,691.2 shares of NWA Corp. Series A Preferred Stock and
2,962.8 shares of NWA Corp. Series B Preferred Stock in exchange for $379
million of unsecured promissory notes which were repaid in December 1996.
See Note D to the Consolidated Financial Statements for maturities of
long-term debt for the five years subsequent to December 31, 1998.
CAPITAL COMMITMENTS. The current aircraft delivery schedule provides for
the acquisition of 102 aircraft over the next eight years. See Notes K and N to
the Consolidated Financial Statements for additional discussion of aircraft
capital commitments. Other capital expenditures, including costs to commission
presently owned aircraft that have not yet entered revenue service, but
excluding those costs discussed below, are projected to be approximately $250
million in 1999, which the Company anticipates funding primarily with cash from
operations.
The Company has adopted programs to hushkit and modify 173 DC9 aircraft to
meet noise and aging aircraft requirements. As of December 31, 1998, the Company
hushkitted 130 of these aircraft and plans on completing the remaining aircraft
by December 31, 1999 for $68 million. The aging aircraft modifications are
expected to aggregate $147 million during the next three years for these
aircraft. Capital expenditures for engine hushkits and aging aircraft
modifications were $157 million in 1998. The Company has also elected to upgrade
aircraft systems and refurbish interiors for the 173 DC9 aircraft. Capital
expenditures associated with upgrading systems and interior refurbishment were
$31 million in 1998, which completed the interior refurbishment of the DC9
aircraft. Aircraft system upgrade costs are expected to aggregate $27 million
during the next three years.
The Company completed the interior refurbishment of three 747 aircraft and
five DC10 aircraft and plans to refurbish the interiors of 25 additional 747
aircraft and 21 additional DC10 aircraft. The program
21
to refurbish the interiors of the Company's international 747 and DC10 aircraft
is estimated to aggregate $67 million during the next three years. As of
December 31, 1998, the Company hushkitted 10 of its 29 Boeing 727-200 aircraft.
Remaining costs are estimated to aggregate approximately $13 million in 1999.
In February 1999, the Company entered into an agreement to purchase 54
Canadian Regional Jet aircraft, with options to purchase up to 70 additional
aircraft. The scheduled delivery for such aircraft is nine in 2000, 22 in 2001,
ten in 2002, eight in 2003 and five in 2004. Committed expenditures for these
aircraft, including estimated amounts for contractual price escalations and
predelivery deposits, will be approximately: $50 million in 1999, $175 million
in 2000, $400 million in 2001, $200 million in 2002, $150 million in 2003 and
$100 million in 2004. Financing has been arranged for the committed aircraft.
The Company has not yet selected the operator of these aircraft.
WORKING CAPITAL. The Company operates, like its competitors, with a working
capital deficit, which aggregated $1.59 billion at December 31, 1998. The
working capital deficit is primarily attributable to the $1.11 billion air
traffic liability for advance ticket sales
LABOR AGREEMENTS. The labor cost savings discussed in Note C to the
Consolidated Financial Statements improved the Company's 1993 to 1996 cash flow
from operating activities. The Company's 1993 agreements with the employee
unions provided that wage scales at the end of the Wage Savings Period snapback
to August 1, 1993 levels and snap-up pursuant to formulae based in part on wage
rates and wage rate increases at other large U.S. airlines. Consequently, at the
end of the Wage Savings Period, salaries and wages increased by approximately
$340 million on an annualized basis including $50 million for snap-ups. The
Company's labor contract with each of its unions became amendable as each labor
cost savings agreement ended in 1996. Contract negotiations began at that time
with the unions.
On August 28, 1998, Northwest ceased its flight operations as a result of a
strike by its pilots represented by Air Line Pilots Association, International
("ALPA"). The Northwest Master Executive Council ("Northwest MEC") of ALPA
announced the commencement of the strike as a result of the failure to reach
agreement with Northwest on the terms of a new collective bargaining agreement.
The strike followed the expiration of a 30-day "cooling off" period that began
July 30, 1998, when an impasse was declared by the National Mediation Board
("NMB"). The cessation of flight operations lasted 18 days. On September 13,
1998, a new four-year agreement was ratified. The agreement provides for lump
sum retroactive payments to pilots equal to 3.5% of salaries since October 31,
1996, wage increases of 3% annually through 2001, 2.5 million stock options to
be granted over a three year period, elimination of the "B pay scale" over three
years, enhanced vacation benefits and a profit sharing plan. The agreement also
permits implementation of the Continental alliance.
On October 28, 1998, the Company and its 15 meteorologists reached and
ratified an agreement on a new six-year contract. On October 30, 1998, the 260
members of the Aircraft Technical Support Association, the Company's fourth
largest union, ratified a new six-year agreement. On December 1, 1998, the 170
members of the Transport Workers Union ratified a new five-year contract. On
December 23, 1998, the Company and its 148 flight kitchen employees represented
by the International Association of Machinist and Aerospace Workers ("IAM")
signed a new four-year contract.
The Company and the IAM reached a tentative agreement in June 1998, which
was not ratified by the covered employees, who included mechanics and related
employees, clerks, agents, equipment service employees and stock clerks. In
November 1998, at a representation election, a majority of the mechanics and
related employees elected the Aircraft Mechanics Fraternal Association to be
their collective bargaining representative. The IAM is protesting the election
and certification of the vote is currently under review by the NMB. The
remaining ground employees continue to be represented by the IAM. On February
16, 1999, the IAM ratified a new four-year agreement. The agreement provides for
lump sum retroactive payments equal to 3.5% of salaries since October 2, 1996, a
14% wage increase over the duration of the contract and a 50% increase in
pension benefits. The Company estimates the increased
22
costs under the six ratified agreements will be approximately $145 million for
1999 based on current levels of employment.
The Company remains in direct negotiations with the International
Brotherhood of Teamsters ("IBT"), which represents its flight attendants.
Contract negotiations are being mediated by the NMB. Because the terms of new
labor agreements will be determined by collective bargaining, the Company cannot
predict the outcome of the negotiations at this time.
MARKET RISK SENSITIVE INSTRUMENTS AND POSITIONS
The risk inherent in the Company's market risk sensitive instruments and
positions is the potential loss arising from adverse changes in the price of
fuel, foreign currency exchange rates and interest rates as discussed below. The
sensitivity analyses presented do not consider the effects that such adverse
changes may have on overall economic activity nor do they consider additional
actions management may take to mitigate its exposure to such changes. Actual
results may differ. See Note O to the Consolidated Financial Statements for
accounting policies and additional information.
AIRCRAFT FUEL. The Company's earnings are affected by changes in the price
and availability of aircraft fuel. In order to provide a measure of control over
price and supply, the Company trades and ships fuel and maintains fuel storage
facilities to support its flight operations. The Company also manages the price
risk of fuel costs primarily utilizing futures contracts traded on regulated
exchanges. Market risk is estimated as a hypothetical 10% increase in the
December 31, 1998 cost per gallon of fuel based on projected 1999 fuel usage
which would result in an increase to aircraft fuel expense of approximately $80
million in 1999, net of gains realized from fuel hedge instruments outstanding
at December 31, 1998, compared to an estimated $90 million at December 31, 1997.
As of December 31, 1998, the Company had hedged approximately 10% of its 1999
fuel requirements, including 40% of the first quarter, compared to 28% and 63%,
respectively, at December 31, 1997.
FOREIGN CURRENCY. The Company is exposed to the effect of foreign exchange
rate fluctuations on the U.S. dollar value of foreign currency-denominated
operating revenues and expenses. The Company's largest exposure comes from the
Japanese yen. From time to time, the Company uses financial instruments to hedge
its exposure to the Japanese yen. The result of a uniform 10% strengthening in
the value of the U.S. dollar from December 31, 1998 levels relative to each of
the currencies in which the Company's revenues and expenses are denominated
would result in a decrease in operating income of approximately $60 million for
the year ending December 31, 1999, net of gains realized from yen hedge
instruments outstanding at December 31, 1998, compared to an estimated $48
million decrease at December 31, 1997. This is due to the Company's foreign
currency-denominated revenues exceeding its foreign currency-denominated
expenses. The increase to other income due to the remeasurement of net foreign
currency-denominated liabilities and the increase to common stockholders' equity
deficit due to the translation of net yen-denominated liabilities resulting from
a 10% strengthening in the value of the U.S. dollar is not material for 1998 and
1997. This sensitivity analysis was prepared based upon projected foreign
currency-denominated revenues and expenses and foreign currency-denominated
assets and liabilities as of December 31, 1998 and 1997.
In 1998, the Company's yen-denominated revenues exceeded its yen-denominated
expenses by approximately 38 billion yen (approximately $286 million) and its
yen-denominated liabilities exceeded its yen-denominated assets by an average of
16.4 billion yen ($125 million). In general, each time the yen strengthens
(weakens), the Company's operating income is favorably (unfavorably) impacted
due to net yen-denominated revenue exceeding expenses and a nonoperating foreign
currency loss (gain) is recognized due to the remeasurement of net
yen-denominated liabilities. The Company's operating income was negatively
impacted by approximately $20 million due to the average yen being weaker in
1998 compared to 1997 and $70 million due to the average yen being weaker in
1997 compared to 1996. The yen to U.S. dollar exchange rate at December 31,
1998, 1997 and 1996 was 113 yen to $1, 131 yen to $1 and 116
23
yen to $1, respectively. There was no material impact on 1998 earnings
associated with the Japanese yen put options purchased to hedge its 1998 net
yen-denominated cash flows. As of December 31, 1998, the Company had entered
into forward contracts to hedge approximately 35% of its 1999 yen-denominated
ticket sales, which also represents approximately 95% of the Company's excess of
yen-denominated revenues over expenses.
INTEREST. The Company's earnings are also affected by changes in interest
rates due to the impact those changes have on its interest income from cash
equivalents and short-term investments and its interest expense from floating
rate debt instruments. The Company has mitigated this risk by limiting its
floating rate indebtedness to approximately 46% and 47% of long-term debt and
capital leases at December 31, 1998 and 1997, respectively. If long-term
interest rates average 10% more in 1999 than they did during 1998, the Company's
net interest expense would increase by approximately $14 million, compared to an
estimated $7 million for 1998 measured at December 31, 1997. If short-term
interest rates average 10% more in 1999 than they did during 1998, the Company's
interest income from cash equivalents and short-term investments would increase
by approximately $3 million compared to an estimated $7 million for 1998
measured at December 31, 1997. These amounts are determined by considering the
impact of the hypothetical interest rates on the Company's floating rate
indebtedness, cash equivalent and short-term investment balances at December 31,
1998.
Market risk for fixed-rate indebtedness is estimated as the potential
increase in fair value resulting from a hypothetical 10% decrease in interest
rates and amounts to approximately $50 million during 1999, compared to an
estimated $45 million for 1998 measured at December 31, 1997 for 1998. The fair
values of the Company's indebtedness were estimated using quoted market prices
or discounted future cash flows based on the Company's incremental borrowing
rates for similar types of borrowing arrangements.
OTHER INFORMATION
INCOME TAXES. Sections 382 and 383 of the Internal Revenue Code of 1986, as
amended (the "Code"), and Treasury regulations limit the amounts of net
operating losses ("NOLs"), alternative minimum tax net operating losses
("AMTNOLs") and credits that can be used to offset taxable income (or used as a
credit) in any single tax year if the corporation experiences more than a 50%
ownership change, as defined therein, over a three-year testing period ending on
the testing date. See Note J to the Consolidated Financial Statements for
information regarding income taxes and NOLs, AMTNOLs and credits.
Management believes that an offering of outstanding common stock by existing
stockholders in November 1995 triggered an ownership change, but that no
ownership change occurred before that time. If such an ownership change did
occur as a result of the offering, management believes that, even as limited by
the Code, the Company would use the NOLs, AMTNOLs and credits significantly
earlier than their expiration, and the annual limitation would not adversely
impact the Company. However, if the Internal Revenue Service (the "IRS") were to
successfully assert that an ownership change had occurred on any date prior to
November 1995 (including August 1, 1993 when the Company entered into labor
agreements that provided stock for labor cost savings), the Company's ability to
use its NOLs, AMTNOLs and credits would be significantly impaired because the
value of NWA Corp's stock on certain prior testing dates was relatively low.
Such value would adversely affect the annual limitation.
YEAR 2000 READINESS. The Year 2000 issue is the result of computer programs
being written using two digits to identify the applicable year and not taking
into account the change in century that will occur in the year 2000. As a
result, such systems may fail completely or create erroneous results when the
year 2000 is defined by the system as "00." The Company uses a significant
number of information technology ("IT") and non-IT ("embedded operating
systems") systems that are essential to its operations. As a result, the Company
implemented a Year 2000 project to modify its computer systems to function
properly in 2000
24
and in the years after that. The Year 2000 project is being coordinated through
a senior-level task force that reports periodically to senior management and the
Board of Directors.
The Company is also reviewing the Year 2000 readiness of third parties with
whom the Company's systems interface and exchange data or upon whom the
Company's business depends and is coordinating efforts with these outside third
parties to minimize the extent to which its business will be vulnerable to such
third parties' failure to remediate their own Year 2000 issues. The Company's
business is also dependent upon U.S. and foreign governmental agencies and
certain governmental organizations or entities, which provide essential aviation
industry infrastructure, such as the Federal Aviation Administration ("FAA").
There can be no assurance that the systems of such third parties on which the
Company's business relies (including those of the FAA) will be modified on a
timely basis. As part of this review, the Company is actively involved in
airline industry Year 2000 review efforts led by the Air Transport Association
and the International Air Transport Association. The Company's business,
financial condition or results of operations could be materially adversely
affected by the failure of its systems or equipment to operate properly beyond
1999, or failure of those operated by other parties such as the air traffic
control and related systems of the FAA and international aviation and local
airport authorities.
The five phases of the Company's Year 2000 project used for identifying and
modifying the various programs and systems include inventory, assessment,
conversion, testing and implementation. The Company has completed all phases for
91% of its internal IT systems and anticipates completion of the remaining
systems in the first quarter of 1999. The Company is approximately 80% completed
with the assessment phase of the impact of Year 2000 on its non-IT systems and
third party relationships, which is expected to be completed in the second
quarter of 1999 with all phases anticipated to be completed in 1999. To some
extent, the Company's readiness in this area is dependent on the readiness of
third parties.
As a precautionary measure, the Company is also developing entity-wide
contingency plans designed to allow continued operation in the event of failure
of the Company's or third parties' systems. Contingency plans are expected to be
in place by the end of the second quarter of 1999 and are expected to be
executed as necessary.
The Company has spent $25 million of its initial estimated cost of $55
million, of which $15 million has been spent and expensed during 1998. The
Company now estimates that the total project costs will be somewhat less than
the estimated $55 million. The costs associated with the Year 2000 project are
being funded through cash from operations and are not expected to have a
material effect on the Company's business, financial condition or results from
operations. Maintenance or modification costs associated with making existing
computer systems Year 2000 compliant will be expensed as incurred. A majority of
the estimated total Year 2000 compliance cost has been funded by reallocating
existing resources rather than incurring incremental costs.
The costs of the Company's Year 2000 project and the date on which the
Company believes it will be completed are based on management's best estimates
and include assumptions regarding third party modification plans. However, in
particular due to the potential impact of third party modification plans, there
can be no assurance that these estimates will be achieved and actual results
could differ materially from those anticipated.
This section captioned "Year 2000 Readiness" is a "Year 2000 Readiness
Disclosure" as defined in section 3(9) of the "Year 2000 Information and
Readiness Disclosure Act," (Public Law 105-271), enacted in October 1998.
THE EURO. Effective January 1, 1999, certain European countries adopted a
common currency, the "euro." Full conversion to the euro is scheduled to be
completed by July 1, 2002. The Company has developed a plan to modify the
Company's operating systems to properly handle the euro through the full
conversion. Costs associated with the euro project were accounted for in
accordance with the existing
25
accounting policies and funded through cash from operations. Management does not
believe the implementation of this single currency plan will have a material
effect on the Company's business, financial condition or results from
operations.
U.S. TRANSPORTATION TAXES. The United States passenger ticket tax and other
transportation taxes, which were reinstated in the first quarter of 1997,
expired on September 30, 1997. The Taxpayer Relief Act enacted by Congress
revised transportation taxes and instituted new taxes for tickets for travel
from October 1, 1997 to December 31, 2007. Over a five-year period on a sliding
scale, the passenger ticket tax will be reduced from 10 percent to 7.5 percent
and a $3 per passenger segment fee will be phased in. The fee for international
arrivals and departures was increased from $6 per departure to $12 for each
arrival and departure. The departure tax on travel between the U.S. 48 states
and Alaska or Hawaii remained at $6. Additionally, a 7.5 percent tax was added
on the purchase of frequent flyer miles.
DETROIT MIDFIELD TERMINAL. In October 1996, the Company and Wayne County,
Michigan (the "County") entered into an agreement pursuant to which, subject to
the satisfaction of certain conditions set forth in the agreement, the Company
will manage and supervise the design and construction of a $1.08 billion
terminal at Detroit Metropolitan Wayne County Airport. The new terminal is
scheduled to be completed in 2001 and has been funded by the County's issuance
of airport revenue bonds payable primarily from future passenger facility
charges and federal and State of Michigan grants. The Company and the County
have entered into agreements pursuant to which the Company will lease space in
the new terminal for a term of 30 years from the date the terminal opens.
REGULATION. In April 1998, the DOT issued proposed competition guidelines,
which would severely limit major carriers' ability to compete with new entrant
carriers. In addition, the Department of Justice is investigating competition at
major hub airports. The outcomes of the DOT guidelines and the investigations
are unknown. However, to the extent that restrictions are imposed upon
Northwest's ability to respond to competition, Northwest's business may be
adversely impacted.
NEW ACCOUNTING STANDARDS. See Note A to the Consolidated Financial
Statements for recent accounting standards.
FORWARD-LOOKING STATEMENTS. Certain statements made throughout the
Management's Discussion and Analysis of Financial Condition and Results of
Operations are forward-looking and are based upon information available to the
Company on the date hereof. The Company undertakes no obligation to publicly
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. These statements deal with the
Company's expectations about the future and are subject to a number of factors
that could cause actual results to differ materially from the Company's
expectations.
It is not reasonably possible to itemize all of the many factors and
specific events that could affect the outlook of an airline operating in the
global economy. Some factors that could significantly impact expected capacity,
load factors, revenues, expenses and cash flows include the airline pricing
environment, fuel costs, labor negotiations both at the Company and other
carriers, low-fare carrier expansion, capacity decisions of other carriers,
actions of the U.S. and foreign governments, foreign currency exchange rate
fluctuation, inflation, the general economic environment in the U.S. and other
regions of the world and other factors discussed herein.
26
ITEM 8: CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Stockholders and Board of Directors
Northwest Airlines Corporation
We have audited the accompanying consolidated balance sheets of Northwest
Airlines Corporation as of December 31, 1998 and 1997, and the related
consolidated statements of operations, common stockholders' equity (deficit),
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Northwest
Airlines Corporation at December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
ERNST & YOUNG LLP
Minneapolis, Minnesota
January 18, 1999
27
NORTHWEST AIRLINES CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS)
DECEMBER 31
---------------------
1998 1997
---------- ---------
ASSETS
CURRENT ASSETS
Cash and cash equivalents............................................................... $ 480.0 $ 740.4
Short-term investments.................................................................. 47.9 437.7
Accounts receivable, less allowance (1998--$23.5; 1997--$21.2).......................... 664.7 664.8
Flight equipment spare parts, less allowance (1998--$158.8; 1997--$148.9)............... 386.6 376.1
Deferred income taxes................................................................... 114.3 84.8
Prepaid expenses and other.............................................................. 176.6 294.0
---------- ---------
1,870.1 2,597.8
PROPERTY AND EQUIPMENT
Flight equipment........................................................................ 6,168.4 5,246.7
Less accumulated depreciation........................................................... 1,485.8 1,295.6
---------- ---------
4,682.6 3,951.1
Other property and equipment............................................................ 1,654.5 1,489.0
Less accumulated depreciation........................................................... 678.6 612.4
---------- ---------
975.9 876.6
---------- ---------
5,658.5 4,827.7
FLIGHT EQUIPMENT UNDER CAPITAL LEASES
Flight equipment........................................................................ 873.3 907.1
Less accumulated amortization........................................................... 263.3 270.0
---------- ---------
610.0 637.1
OTHER ASSETS
Investments in affiliated companies..................................................... 675.9 185.9
International routes, less accumulated amortization (1998--$263.4;
1997--$239.9)......................................................................... 704.3 727.8
Other................................................................................... 762.0 359.9
---------- ---------
2,142.2 1,273.6
---------- ---------
$ 10,280.8 $ 9,336.2
---------- ---------
---------- ---------
The accompanying notes are an integral part of these consolidated financial
statements.
28
NORTHWEST AIRLINES CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE DATA)
DECEMBER 31