1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended June 30, 1998 Commission File Number 1-6512 AIRBORNE FREIGHT CORPORATION ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware ---------------------------------------- (State of incorporation or organization) 91-0837469 --------------------------------- (IRS Employer Identification No.) 3101 Western Avenue P.O. Box 662 Seattle, Washington 98111-0662 ------------------------------ (Address of Principal Executive Office) Registrant's telephone number, including area code: (206) 285-4600 -------------- 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: XXX No: --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the close of the period covered by this report. Common Stock, par value $1 per share Outstanding (net of 497,078 treasury shares) as of June 30, 1998 50,279,509 shares ----------------- 2 AIRBORNE FREIGHT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF NET EARNINGS (Dollars in thousands except per share data) (Unaudited) Three Months Ended Six Months Ended ------------------ ---------------- June 30 June 30 ------- ------- 1998 1997 1998 1997 ---- ---- ---- ---- REVENUES: Domestic $672,378 $611,999 $1,334,896 $1,174,110 International 91,759 100,785 179,434 194,196 -------- -------- ---------- ---------- 764,137 712,784 1,514,330 1,368,306 OPERATING EXPENSES: Transportation purchased 234,797 228,663 465,120 437,553 Station and ground operations 228,282 210,856 450,976 411,106 Flight operations and maintenance 117,480 100,913 234,883 204,696 General and administrative 61,940 57,271 121,890 109,100 Sales and marketing 17,569 17,901 34,968 34,079 Depreciation and amortization 45,182 42,210 90,070 84,481 -------- -------- ---------- ---------- 705,250 657,814 1,397,907 1,281,015 -------- -------- ---------- ---------- EARNINGS FROM OPERATIONS 58,887 54,970 116,423 87,291 INTEREST, NET 2,960 8,049 6,876 16,496 -------- -------- ---------- ---------- EARNINGS BEFORE INCOME TAXES 55,927 46,921 109,547 70,795 INCOME TAXES 22,100 18,634 43,360 28,134 -------- -------- ---------- ---------- NET EARNINGS $ 33,827 $ 28,287 $ 66,187 $ 42,661 ======== ======== ========== ========== NET EARNINGS PER SHARE: Basic $ .67 $ .66 $ 1.32 $ 1.00 ======== ======== ========== ========== Diluted $ .66 $ .59 $ 1.29 $ .90 ======== ======== ========== ========== DIVIDENDS PER SHARE $ .040 $ .038 $ .078 $ .075 ======== ======== ========== ========== See notes to consolidated financial statements. 3 AIRBORNE FREIGHT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) June 30 December 31 ------- ----------- 1998 1997 ---- ---- (Unaudited) ASSETS ------ CURRENT ASSETS: Cash $ 16,922 $ 25,525 Trade accounts receivable, less allowance of $10,290 and $10,290 310,698 322,549 Spare parts and fuel inventory 39,689 37,966 Deferred income tax assets 16,713 14,530 Prepaid expenses and other 27,872 25,982 ---------- ---------- TOTAL CURRENT ASSETS 411,894 426,552 PROPERTY AND EQUIPMENT, NET 949,417 916,331 EQUIPMENT DEPOSITS and OTHER ASSETS 35,868 23,090 ---------- ---------- TOTAL ASSETS $1,397,179 $1,365,973 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ CURRENT LIABILITIES: Accounts payable $ 144,478 $ 143,966 Salaries, wages and related taxes 70,710 80,154 Accrued expenses 72,043 100,126 Income taxes payable 4,704 5,440 Current portion of debt 393 381 ---------- ---------- TOTAL CURRENT LIABILITIES 292,328 330,067 LONG-TERM DEBT 222,892 250,559 DEFERRED INCOME TAX LIABILITIES 78,154 65,322 OTHER LIABILITIES 63,713 49,110 SHAREHOLDERS' EQUITY: Preferred Stock, without par value - Authorized 5,200,000 shares, no shares issued Common stock, par value $1 per share - Authorized 60,000,000 shares Issued 50,776,587 and 50,428,548 shares 50,777 50,429 Additional paid-in capital 293,697 287,208 Retained earnings 396,384 334,083 ---------- ---------- 740,858 671,720 Treasury stock, 497,078 and 522,300 (766) (805) shares, at cost ---------- ---------- 740,092 670,915 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,397,179 $1,365,973 ========== ========== See notes to consolidated financial statements. 4 AIRBORNE FREIGHT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited) Six Months Ended ---------------- June 30 ---------------- 1998 1997 ---- ---- OPERATING ACTIVITIES: Net Earnings $ 66,187 $ 42,661 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 82,412 78,116 Provision for aircraft engine overhauls 7,658 6,365 Deferred income taxes 10,649 10,387 Other 14,695 229 -------- -------- CASH PROVIDED BY OPERATIONS 181,601 137,758 Change in: Receivables 11,851 (19,238) Inventories and prepaid expenses (3,613) (7,636) Accounts payable 512 (660) Accrued expenses, salaries & taxes payable (37,922) 22,405 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES 152,429 132,629 INVESTING ACTIVITIES: Additions to property and equipment (126,377) (78,716) Dispositions of property and equipment 633 2,615 Expenditures for engine overhauls (8,471) (6,036) Proceeds from insurance on aircraft accident -- 18,000 Other (1,811) 537 -------- -------- NET CASH USED BY INVESTING ACTIVITIES (136,026) (63,600) FINANCING ACTIVITIES: Proceeds (payments) on bank notes, net (27,500) (89,000) Principal payments on debt (155) (143) Proceeds from common stock issuance 6,535 1,357 Dividends paid (3,886) (3,202) -------- -------- NET CASH USED BY FINANCING ACTIVITIES (25,006) (90,988) -------- -------- NET DECREASE IN CASH (8,603) (21,959) CASH AT JANUARY 1 25,525 35,816 -------- -------- CASH AT JUNE 30 $ 16,922 $ 13,857 ======== ======== 		See notes to consolidated financial statements. 5 AIRBORNE FREIGHT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1998 (Unaudited) NOTE A - SUMMARY OF FINANCIAL STATEMENT PREPARATION: The consolidated financial statements included herein are unaudited but include all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations and cash flows for the interim periods reported. Certain amounts for prior periods have been reclassified to conform to the 1998 presentation. NOTE B - LONG-TERM DEBT: Long-term debt consists of the following: June 30 December 31 ------- ----------- 1998 1997 ---- ---- (In thousands) Senior debt: Notes payable 2,500 30,000 Senior notes 200,000 200,000 Revenue bonds 13,200 13,200 Other debt 7,585 7,740 -------- -------- 223,285 250,940 Less current portion 393 381 -------- -------- $222,892 $250,559 ======== ======== NOTE C - EARNINGS PER SHARE: Basic earnings per share are based upon the weighted average number of common shares outstanding during the interim period. Diluted earnings per share are based upon the weighted average number of common shares outstanding during the interim period plus dilutive common equivalent shares applicable to the assumed exercise of outstanding stock options. Diluted earnings per share for the three months and six months ended June 30, 1997, assumes conversion of the Company's convertible subordinated debentures as well as the dilutive common equivalent shares applicable to the assumed exercise of stock options. Net earnings as adjusted for the elimination of interest expense, net of applicable taxes was $29,352,000 for the three month period and $44,791,000 for the six month period. 6 Weighted average shares outstanding used in earnings per share computations were as follows: Three Months Ended Six Months Ended ------------------ ---------------- June 30 June 30 ------- ------- 1998 1997 1998 1997 ---- ---- ---- ---- WEIGHTED AVERAGE SHARES OUTSTANDING: Basic 50,220,364 42,776,526 50,123,331 42,706,891 Diluted 51,288,921 50,134,061 51,235,062 49,833,611 NOTE D - ACCOUNTING FOR DERIVATIVE INSTRUMENTS: In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" which will be effective for fiscal year 2000. SFAS No. 133 requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The Company has entered into certain derivative contracts with financial institutions to limit its exposure to volatility in jet fuel prices. Under terms of the contracts, the Company either makes or receives payments if the market price of heating oil, as determined by an index of monthly NYMEX Heating Oil futures contracts, is lower or exceeds certain prices agreed to between the Company and the financial institutions. The contracts, which have no cost basis, are accounted for as hedges since there has historically existed a high correlation between the changes in the NYMEX index and the price of jet fuel. Settlements are made in cash and are recorded in the earnings statement in the period of settlement as either an increase or decrease to fuel expense. Under the cash flow hedge provisions of SFAS No. 133, the Company will be required to record the contracts at fair value, with corresponding changes in fair value recorded as a component of other comprehensive income. The Company has not adopted the provisions of SFAS No. 133 as of June 30, 1998. However, if the provisions of the statement had been adopted, a cumulative charge of $2,300,000, net of tax, would have been recorded to shareholders' equity and charges to comprehensive income of approximately $400,000 and $1,600,000 would have been reported for the three and six month periods ended June 30, 1998, respectively. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION RESULTS OF OPERATIONS: The Company's operating performance in the second quarter and the first six months of 1998 resulted in operating income and net earnings significantly higher than the comparable periods of 1997. The Company is pleased with this strong operating performance which was achieved in spite of what appears to be a slowing economy in the second quarter. The overall growth in shipments and revenue was positive, and an operating margin of 7.7% was achieved in the second quarter of 1998, the same as experienced in the second quarter of 1997 and the first quarter of 1998, when growth rates were higher. Net earnings for the second quarter of 1998 were $33.8 million, or $.66 per share on a diluted basis, on revenues of $764 million, compared to $28.3 million, or $.59 per share on revenues of $713 million, for the second quarter of 1997. Net earnings for the first six months of 1998 were $66.2 million, or $1.29 per share on revenues of $1.51 billion, compared to $42.7 million, or $.90 per share on revenues of $1.37 billion for the corresponding period in 1997. 8 The following table sets forth selected shipment and revenue data for the periods indicated: Three Months Ended Six Months Ended ------------------ ---------------- 	 June 30 June 30 ------- % ------- % 1998 1997 Change 1998 1997 Change ---- ---- ------ ---- ---- ------ Shipments (in thousands): Domestic Overnight 46,632 42,287 10.3% 92,391 81,926 12.8% Next Afternoon Service 14,718 13,717 7.3% 29,101 25,881 12.4% Second Day Service 17,673 16,657 6.1% 35,684 32,466 9.9% 100 Lbs. and Over 87 80 8.8% 178 154 15.6% ------ ------ ------- ------- Total Domestic 79,110 72,741 8.8% 157,354 140,427 12.1% ------ ------ ------- ------- International Express 1,507 1,271 18.6% 2,896 2,452 18.1% Freight 113 122 (7.4%) 223 238 (6.3%) ------ ------ ------- ------- Total International 1,620 1,393 16.3% 3,119 2,690 15.9% ------ ------ ------- ------- Total Shipments 80,730 74,134 8.9% 160,473 143,117 12.1% ====== ====== ======= ======= Average Pounds per Shipment: Domestic 4.22 4.31 (2.1%) 4.29 4.31 (0.5%) International 41.62 53.65 (22.4%) 42.85 51.88 (17.4%) Average Revenue per Pound: Domestic $1.98 $1.94 2.1% $1.95 $1.93 1.0% International $1.34 $1.32 1.5% $1.33 $1.37 (2.9%) Average Revenue per Shipment: Domestic $8.49 $8.40 1.1% $8.48 $8.35 1.6% International $56.64 $72.35 (21.7%) $57.53 $72.19 (20.3%) 9 Domestic shipments increased 8.8% and 12.1% in the second quarter and first half of 1998, respectively, compared to the same periods in 1997. Domestic revenues increased 9.9% in the second quarter of 1998 and 13.7% for the first half of 1998 compared to 1997. The growth rate in the higher yielding overnight segment increased 10.3% in the second quarter of 1998, a higher growth rate than the other domestic segments. This helped the domestic revenue per shipment improve to $8.49 per shipment, compared to $8.40 for the second quarter of 1997. Overnight shipments accounted for approximately 59.0% of total domestic shipments in the second quarter of 1998 compared to 58.1% in the comparable period of 1997. Domestic revenues for 1997 included $15.5 million of fuel surcharge revenue in the first half of the year, of which $10.6 million was realized in the second quarter of 1997. This fuel surcharge revenue added approximately $.16 per share in the first half of 1997, of which $.11 per share related to the second quarter of 1997. International revenues decreased 9.0% and 7.6% in the second quarter and first six months of 1998, respectively, primarily the result of economic troubles in parts of Asia. Shipments in the heavier weight, higher revenue per shipment freight segment decreased 7.4% in the second quarter and 6.3% in the first half of the year. Mitigating some of the weakness in freight volumes, the Company experienced strong growth in its international express segment. International express shipments increased 18.6% and 18.1% in the second quarter and first six months of 1998, respectively, compared to the corresponding periods of 1997. Operating expenses as a percentage of revenues were 92.3% for the first six months of 1998 compared to 93.6% in the first six months of 1997 and 92.3% for all of 1997. Operating cost per shipment handled decreased 2.7% to $8.71 for the first six months 1998 compared to the first six months of 1997. The operating cost per shipment for the second quarter of 1998 decreased 1.5% to $8.74, compared to the second quarter of 1997 while operating expense as a percentage of revenues was 92.3%. Most of the decrease in operating cost per shipment was attributable to lower costs related to lower international freight volumes. The operating margin of 7.7% in the second quarter of 1998 was the same as that experienced in the first quarter of this year, and in the second quarter of 1997. The Company experienced a 1.5% improvement in productivity for the second quarter of 1998, compared to the second quarter of 1997, as measured by shipments handled per paid employee hour. This productivity improvement, while lower than previous periods, was meaningful given the slower shipment growth. Productivity improvement and continued emphasis on cost control were factors having a positive impact on 1998 operating results. Comparisons of certain operating expense components are discussed below. Transportation purchased decreased as a percentage of revenues to 30.7% in the first six months of 1998 compared to 32.0% in the comparable period of 1997. This decrease was primarily due to commercial airline costs which, although higher in total, were lower as a percentage of total revenues in the first half of 1998 due to the lower volumes of international freight shipments discussed above. The suspension of the Federal Aviation Excise Tax reduced costs in the first quarter of 1997 by $4.3 million. The Aviation Excise Tax moratorium was effective through March 6, 1997, subsequent to which the tax became effective once again; therefore, no cost reduction was realized in 1998. 10 Flight operations and maintenance expense as a percentage of revenues during the first half of 1998 was 15.5%, compared to 15.0% in the first six months of 1997, and was 15.4% in the second quarter of 1998 compared to 14.2% in 1997. During the second quarter of 1997, costs associated with periodic aircraft maintenance were lower as a percentage of revenues, compared to both quarters of 1998 or first quarter of 1997, due to fewer maintenance checks performed. The average aviation fuel price for the second quarter and first six months of 1998 was $.57 per gallon and $.60 per gallon, respectively, compared to $.70 per gallon and $.76 per gallon for the comparable periods of 1997. Aviation fuel consumption increased to 89.8 million gallons in the first half of 1998, a 10.4% increase over the first half of 1997. As a result of fuel hedging contracts, the Company incurred $2.0 million of expense in the second quarter of 1998, compared to $1.0 million of expense in the first quarter of 1998, and $1.7 million benefit in the first quarter of 1997. The station and ground expense, general and administrative expense, and sales and marketing expense categories as a percentage of revenues were very comparable in the second quarter and first half of 1998 compared to the same periods in 1997. The increase in depreciation and amortization expense in the first half of 1998 is due in large part to the increased number of aircraft in service since the first half of 1997. Interest expense in the first six months of 1998 was significantly lower than the same period of 1997. This is attributable to the significant reduction in average outstanding borrowings during the first half of 1998 compared to the corresponding period of 1997. The Company's effective tax rate was 39.6% for the first six months of 1998 compared to 39.7% in the first half of 1997 and 39.2% for all of 1997. YEAR 2000 ISSUE: The Company has implemented a compliance program to address the challenges the Year 2000 may present to its products, systems and applications. This program includes computer systems and applications operated by the Company, computer systems of third parties upon whose data or functionality the Company relies, and certain other fixed assets which contain date sensitive technology critical to its operation. Management anticipates modifications to its own systems, conversions to new software and related testing will be substantially complete by the end of 1998. As part of the compliance program, the Company has also initiated communications with third parties (primarily customers, vendors, airport authorities, and other governmental agencies, including the Federal Aviation Administration) whose failure to timely convert their systems could have an impact on the Company's operations. Although the Company does not believe the Year 2000 issue will have a material impact on the Company's operations, there can be no guarantee that the Company's or any third party Year 2000 remediation efforts will be fully compliant. If non-compliance is extensive, this could have a material effect on the Company's business, financial condition and results of operation. In an attempt to mitigate this risk, the Company is in the process of developing contingency plans regarding critical systems should they fail to become Year 2000 compliant. Management does not consider the incurred or estimated costs of its compliance program to be material. Total costs are not expected to differ from the normal recurring costs that are incurred for systems development, in part, due to the reallocation of internal resources and the deferral of other projects. This assessment could differ materially if either the scope or schedule progress with its compliance program is significantly altered. 11 LIQUIDITY AND CAPITAL RESOURCES: Cash provided by operations net of change in working capital increased for the first six months of 1998 to $152 million, compared to $133 million in the first half of 1997. This increased liquidity is primarily the result of the increase in profitability in 1998. Capital expenditures continue to be a primary factor affecting the financial condition of the Company. The Company anticipates total capital expenditures to approximate $274 million in 1998. During the first six months of 1998, total capital expenditures net of dispositions were $126 million. Cash provided by operations was the primary source for funding capital expenditures. The Company's strong operating cash flow has become the major source of liquidity, whereas, the Company's $250 million unsecured revolving bank credit agreement had traditionally been used as the major source of liquidity for periods between other financing transactions. The Company also has available $65 million under unsecured uncommitted money market lines of credit with several banks, used in conjunction with the revolving credit agreement to facilitate settlement and accommodate short-term borrowing fluctuations. Reliance on the bank facilities has decreased commensurately, with a total of $2.5 million outstanding at June 30, 1998 under the revolving bank credit and money market credit lines, compared to $30.0 million outstanding at December 31, 1997 and $99.5 million outstanding at June 30, 1997. In management's opinion, the available capacity under the bank credit agreements coupled with internally generated cash flow from remaining 1998 operations should provide adequate flexibility to finance anticipated capital expenditures for the balance of 1998. 12 PART II. OTHER INFORMATION -------------------------- Item 6. Exhibits and Reports or Form 8-K. (a) Exhibits - Exhibit No. 27 - Financial Data Schedule 13 SIGNATURES ---------- Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized: AIRBORNE FREIGHT CORPORATION ---------------------------- (Registrant) Date: 8/13/98 /s/Roy C. Liljebeck ------- ------------------------- Roy C. Liljebeck Executive Vice President, Chief Financial Officer Date: 8/13/98 /s/Lanny H. Michael ------- ------------------------- Lanny H. Michael Senior Vice President, Treasurer and Controller