EX-13 11 ex13-1.txt MD&A AND FINANCIAL STATEMENTS EXHIBIT 13.1 LANDSTAR SYSTEM, INC. AND SUBSIDIARY MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Introduction Landstar System, Inc. and its subsidiary, Landstar System Holdings, Inc. ("Landstar" or the "Company"), provide transportation services to a variety of market niches throughout the United States and to a lesser extent in Canada and between the United States and Canada and Mexico through its operating subsidiaries. The Company has three reportable business segments. These are the carrier, multimodal and insurance segments. The carrier segment consists of Landstar Ranger, Inc., Landstar Inway, Inc., Landstar Ligon, Inc. and Landstar Gemini, Inc. The carrier segment primarily provides truckload transportation for a wide range of general commodities over irregular routes with its fleet of dry and specialty vans and unsided trailers, including flatbed, drop deck and specialty. It also provides short-to-long haul movement of containers by truck, dedicated power-only truck capacity and truck brokerage. The carrier segment markets its services primarily through independent commission sales agents and utilizes independent contractors who provide truck capacity to the Company under exclusive lease arrangements (the "Independent Contractors") and other third party truck capacity providers. Historically, the Company's carrier segment has primarily relied on capacity provided by Independent Contractors. Pursuant to a plan to augment its available capacity and increase its revenue, the Company has begun to increase the carrier segment's use of capacity provided by other third party truck capacity providers. A significant decrease in available capacity provided by either the Company's Independent Contractors or other third party capacity providers could have a material adverse effect on Landstar, including its results of operations and revenue. The nature of the carrier segment's business is such that a significant portion of its operating costs varies directly with revenue. The carrier segment typically contributes approximately 78% of Landstar's consolidated revenue. The multimodal segment is comprised of Landstar Logistics, Inc. and Landstar Express America, Inc. Transportation services provided by the multimodal segment include the arrangement of intermodal moves, contract logistics, truck brokerage and emergency and expedited ground and air freight. The multimodal segment markets its services through independent commission sales agents and utilizes capacity provided by Independent Contractors and other third party capacity providers, including truck brokerage carriers, railroads and air cargo carriers. The nature of the multimodal segment's business is such that a significant portion of its operating costs also varies directly with revenue. The multimodal segment typically contributes approximately 20% of Landstar's consolidated revenue. The insurance segment is comprised of Signature Insurance Company ("Signature"), a wholly-owned offshore insurance subsidiary, and Risk Management Claim Services, Inc. The insurance segment provides risk and claims management services to Landstar's operating subsidiaries. In addition, it reinsures certain property, casualty and occupational accident risks of certain Independent Contractors who have contracted to haul freight for Landstar and provides certain property and casualty insurance directly to Landstar's operating subsidiaries. The insurance segment typically contributes approximately 2% of Landstar's consolidated revenue. 41 Purchased transportation represents the amount an Independent Contractor or other third party capacity provider is paid to haul freight. The amount of purchased transportation paid to an Independent Contractor is primarily based on a contractually agreed-upon percentage of revenue generated by the haul. Purchased transportation for the brokerage services operations of the carrier and multimodal segments is based on a negotiated rate for each load hauled. Purchased transportation for the intermodal services operations and the air freight operations of the multimodal segment is based on a contractually agreed-upon fixed rate. Purchased transportation as a percentage of revenue for brokerage services and rail intermodal operations is normally higher than that of Landstar's other transportation operations. Purchased transportation is the largest component of costs and expenses and, on a consolidated basis, increases or decreases in proportion to the revenue generated through Independent Contractors and other third party capacity providers. Commissions to agents are primarily based on contractually agreed-upon percentages of revenue at the carrier segment and of gross profit, defined as revenue less the cost of purchased transportation, at the multimodal segment. Commissions to agents as a percentage of consolidated revenue will vary directly with the percentage of consolidated revenue generated by the carrier segment, the multimodal segment and Signature and with changes in gross profit at the multimodal segment. Trailing equipment rent and maintenance costs are the largest components of other operating costs. Potential liability associated with accidents in the trucking industry is severe and occurrences are unpredictable. Landstar retains liability for individual commercial trucking claims up to $5,000,000 per occurrence. For commercial trucking claims incurred prior to May 1, 2001, Landstar retains liability up to $1,000,000 per occurrence. To reduce its exposure to unladen liability claims (claims incurred while a vehicle is being operated without a trailer attached or is being operated with an attached trailer which does not contain or carry any cargo), Landstar requires its Independent Contractors to maintain unladen truckers liability coverage of $1,000,000 per occurrence. Under the Company's unladen truckers liability program, Independent Contractors purchase unladen truckers liability coverage from a third party insurance company. Signature then reinsures unladen liability coverage for Independent Contractors who participate in the Company's unladen program up to $1,000,000 per occurrence. For unladen claims incurred prior to January 1, 2002, Landstar retains liability up to $25,000 per occurrence. The Company also retains liability for each general liability claim up to $1,000,000, $250,000 for each workers' compensation claim and $250,000 for each cargo claim. The Company's exposure to liability associated with accidents incurred by other third party capacity providers who haul freight on behalf of the Company is reduced by various factors including the extent to which they maintain their own insurance coverage. A material increase in the frequency or severity of accidents, cargo or workers' compensation claims or the unfavorable development of existing claims could be expected to materially adversely affect Landstar's results of operations. Employee compensation and benefits account for over half of the Company's selling, general and administrative expense. Other significant components of selling, general and administrative expense are communications costs and rent expense. Depreciation and amortization primarily relates to depreciation of trailing equipment and management information services equipment. On July 17, 2002, Landstar declared a two-for-one stock split of its common stock to be effected in the form of a 100% stock dividend. Stockholders of record on August 2, 2002 received one additional share of common stock for each share held. The additional shares were distributed on August 12, 2002. All share and per share amounts have been restated to give retroactive effect to this stock split. 42 The following table sets forth the percentage relationships of expense items to revenue for the periods indicated:
Fiscal Years ------------------------ 2002 2001 2000 ------ ------ ------ Revenue 100.0% 100.0% 100.0% Investment income 0.1 0.3 0.3 Costs and expenses: Purchased transportation 74.1 74.0 73.8 Commissions to agents 7.9 7.9 8.0 Other operating costs 2.3 2.3 2.1 Insurance and claims 2.8 2.4 2.2 Selling, general and administrative 6.7 7.2 7.1 Depreciation and amortization 0.7 1.0 0.9 Non-recurring costs 0.4 ------ ------ ------ Total costs and expenses 94.5 94.8 94.5 ------ ------ ------ Operating income 5.6 5.5 5.8 Interest and debt expense 0.3 0.5 0.6 ------ ------ ------ Income before income taxes 5.3 5.0 5.2 Income taxes 2.0 1.9 2.0 ------ ------ ------ Net income 3.3% 3.1% 3.2% ====== ====== ======
FISCAL YEAR ENDED DECEMBER 28, 2002 COMPARED TO FISCAL YEAR ENDED DECEMBER 29, 2001 Revenue for the fiscal year 2002 was $1,506,555,000, an increase of $113,784,000, or 8.2%, compared to revenue for the 2001 fiscal year. Revenue increased $79,995,000, $29,867,000 and $3,922,000 at the carrier, multimodal and insurance segments, respectively. Overall, revenue miles (volume) increased approximately 11%. Revenue per load increased approximately 5% while revenue per revenue mile (price) decreased approximately 3%, reflecting changes in freight mix, including an 8% increase in the average length of haul at the carrier segment. Revenue at the insurance segment increased primarily due to an increase in the level of reinsurance underwritten for unladen truckers liability for certain of the Company's Independent Contractors from $25,000 per occurrence to $1,000,000 per occurrence effective January 1, 2002. Investment income at the insurance segment was $1,950,000 and $3,567,000 for fiscal year 2002 and 2001, respectively. The decrease in investment income was primarily due to a reduced rate of return, attributable to the decline in interest rates, on investments held by the insurance segment. Purchased transportation was 74.1% of revenue in 2002 compared with 74.0% in 2001. The increase in purchased transportation as a percentage of revenue was primarily attributable to increased brokerage revenue at the carrier segment and increased rail intermodal revenue at the multimodal segment. Commissions to agents were 7.9% of revenue in both 2002 and 2001, as increased agent commissions at the multimodal segment were offset by reduced agent commissions on brokerage revenue at the carrier segment and increased premium revenue at the insurance segment. 43 Other operating costs were 2.3% of revenue in both 2002 and 2001, as increased trailer maintenance costs were offset by reductions in Independent Contractor recruiting, qualification and incentive costs and reduced net costs of plates and permits. Insurance and claims were 2.8% of revenue in 2002 compared with 2.4% in 2001. The increase in insurance and claims as a percentage of revenue was primarily due to increased commercial trucking claims in the $4 million excess of $1 million layer and increased unladen truckers liability claims due to the increased level of risk assumed by Signature under the Company's unladen truckers liability program effective January 1, 2002. These increases were partially offset by a reduction in insurance claims resulting from increased revenue hauled by other third party capacity providers. Selling, general and administrative costs were 6.7% of revenue in 2002 and 7.2% in 2001. The decrease in selling, general and administrative costs as a percentage of revenue was primarily due to decreased wages, travel and entertainment expenses and communication costs, as a result of implementation of certain cost reduction initiatives, and a decreased provision for customer bad debt, partially offset by an increased provision for bonuses under the Company's incentive compensation plans, increased costs for the Company's employee benefit programs and increased legal fees. Depreciation and amortization was 0.7% of revenue in 2002 and 1.0% of revenue in 2001. The decrease in depreciation and amortization as a percentage of revenue was primarily due to the January 1, 2002 implementation of Statement of Financial Accounting Standards ("SFAS") No. 142, which eliminated the amortization of goodwill, and reduced depreciation expense for company-owned trailing equipment and information technology assets. Interest and debt expense was 0.3% of revenue in 2002 and 0.5% of revenue in 2001. This decrease was primarily attributable to lower interest rates, reduced average borrowings on the Company's senior credit facility and decreased average capital lease obligations for trailing equipment. The provisions for income taxes for the 2002 and 2001 fiscal years were based on effective income tax rates of 38.0% and 38.5%, respectively, which are higher than the statutory federal income tax rate primarily as a result of state income taxes and the meals and entertainment exclusion in both years and amortization of certain goodwill in 2001. At December 28, 2002, the valuation allowance of $491,000 was attributable to deferred state income tax benefits, which primarily represented state operating loss carryforwards at one subsidiary. The valuation allowance and goodwill will be reduced by $463,000 when realization of deferred state income tax benefits becomes likely. The Company believes that deferred income tax benefits, net of the valuation allowance, are more likely than not to be realized because of the Company's ability to generate future taxable earnings. The decrease in the effective income tax rate was primarily attributable to the elimination of goodwill amortization in 2002. Net income was $49,221,000, or $3.05 per common share ($2.94 per diluted share), in 2002 compared with $42,794,000, or $2.57 per common share ($2.50 per diluted share), in 2001. FISCAL YEAR ENDED DECEMBER 29, 2001 COMPARED TO FISCAL YEAR ENDED DECEMBER 30, 2000 Revenue for the fiscal year 2001 was $1,392,771,000, a decrease of $25,721,000, or 1.8%, compared to revenue for the 2000 fiscal year. Revenue decreased $18,774,000, $6,238,000 and $709,000 at the carrier, multimodal and insurance segments, respectively. The decrease was primarily attributable to the extra week in the 53-week fiscal year 2000 compared to the 52-week fiscal year 2001. As a result, revenue miles decreased approximately 3% compared to fiscal year 2000, which was partially offset by an increase in revenue per revenue mile of approximately 1%, which reflected improved freight quality primarily at the multimodal segment. 44 Investment income at the insurance segment was $3,567,000 and $4,317,000 for fiscal year 2001 and 2000, respectively. The decrease in investment income was primarily due to a reduced rate of return, attributable to the decline in interest rates, on investments held by the insurance segment. Purchased transportation was 74.0% of revenue in 2001 compared with 73.8% in 2000. The increase in purchased transportation as a percentage of revenue was primarily attributable to increased rates charged by other third party capacity providers at the multimodal segment as a result of higher fuel costs, increased brokerage revenue at the carrier segment and decreased premium revenue at the insurance segment. Commissions to agents were 7.9% of revenue in 2001 and 8.0% of revenue in 2000. The decrease in commissions to agents as a percentage of revenue was primarily due to the increased purchased transportation costs incurred at the multimodal segment which negatively impacted gross profit, and resulted in lower agent commissions. Other operating costs were 2.3% of revenue in 2001 compared with 2.1% in 2000. The increase in other operating costs as a percentage of revenue was primarily due to higher net trailer costs, an increased provision for contractor bad debts and increased Independent Contractor recruiting and qualification costs. Insurance and claims were 2.4% of revenue in 2001 compared with 2.2% in 2000 primarily due to greater favorable development of prior year claims in 2000 than realized in 2001, partially offset by reduced premiums for commercial trucking liability insurance and increased brokerage revenue as a percentage of total revenue, which has a lower claims risk profile. The reduction in premiums for commercial trucking liability insurance was attributable to the increase in the level of self-insured retention from $1,000,000 to $5,000,000 per occurrence effective May 1, 2001. Selling, general and administrative costs were 7.2% of revenue in 2001 and 7.1% in 2000. The increase in selling, general and administrative costs as a percentage of revenue was primarily due to an increased provision for customer bad debts and increased wages and benefits, partially offset by a decrease in the provision for bonuses under the Company's management incentive compensation plan. Depreciation and amortization was 1.0% of revenue in 2001 and 0.9% of revenue in 2000. The increase in depreciation and amortization as a percentage of revenue was due to an increase in company-owned trailing equipment. Interest and debt expense was 0.5% of revenue in 2001 and 0.6% of revenue in 2000. This decrease was primarily attributable to lower interest rates. At December 25, 1999, approximately 100 Landstar Ranger, Inc. ("Landstar Ranger") drivers were represented by the International Brotherhood of Teamsters (the "Teamsters"). The vast majority of these unionized drivers participated in the Teamsters' Central States Southeast and Southwest Areas Pension Fund (the "Fund"). As a result of the terms of a new collective bargaining agreement, the Trustees of the Fund terminated participation in the Fund by Landstar Ranger effective October 1, 2000. The Trustees of the Fund regarded this action as a withdrawal by Landstar Ranger. Landstar Ranger recorded a charge in the third quarter of 2000 in the amount of $2,230,000 for the cost of withdrawal from the Fund. At December 28, 2002, 43 Landstar Ranger drivers were represented by the Teamsters and neither Landstar nor any of its subsidiaries participates in any multi-employer pension plans. 45 On March 28, 2000, the Company announced a plan to restructure the operations of Landstar Ligon, Inc. and to relocate its headquarters from Madisonville, Kentucky to Jacksonville, Florida in June of 2000. As a result of the restructuring and relocation, a one-time charge in the amount of $3,040,000 was recorded during the second quarter of 2000 representing approximately $1,370,000 of employee and office relocation costs, $1,000,000 of severance costs and $670,000 of other costs. The restructuring and relocation were substantially completed by September 23, 2000. The provisions for income taxes for the 2001 and 2000 fiscal years were based on an effective income tax rate of 38.5%, which is higher than the statutory federal income tax rate primarily as a result of state income taxes, amortization of certain goodwill and the meals and entertainment exclusion. Net income was $42,794,000, or $2.57 per common share ($2.50 per diluted share), in 2001 compared with $45,194,000, or $2.57 per common share ($2.52 per diluted share), in 2000. After deducting related income tax benefits of $2,105,000, the non-recurring costs reduced net income by $3,165,000 in 2000. Excluding non-recurring costs, net income would have been $48,359,000, or $2.75 per common share ($2.69 per diluted share), in 2000. CAPITAL RESOURCES AND LIQUIDITY On December 20, 2001, Landstar renegotiated its existing credit agreement with a syndicate of banks and JPMorgan Chase Bank, as administrative agent (the "Third Amended and Restated Credit Agreement"). The Third Amended and Restated Credit Agreement provides $175,000,000 of borrowing capacity in the form of a revolving credit facility, $50,000,000 of which may be utilized in the form of letter of credit guarantees. At December 28, 2002, Landstar had commitments for letters of credit outstanding in the amount of $18,060,000, primarily as collateral for estimated insurance claims, $9,080,000 of which were supported by the Third Amended and Restated Credit Agreement and $8,980,000 secured by assets deposited with a financial institution. The Third Amended and Restated Credit Agreement expires on January 5, 2005. Borrowings under the Third Amended and Restated Credit Agreement bear interest at rates equal to, at the option of Landstar, either (i) the greatest of (a) the prime rate as publicly announced from time to time by JPMorgan Chase Bank, (b) the three month CD rate adjusted for statutory reserves and FDIC assessment costs plus 1% and (c) the federal funds effective rate plus 1/2%, or, (ii) the rate at the time offered to JPMorgan Chase Bank in the Eurodollar market for amounts and periods comparable to the relevant loan plus a margin that is determined based on the level of the Company's Leverage Ratio, as defined in the Third Amended and Restated Credit Agreement. The margin is subject to an increase of .125% if the aggregate amount outstanding under the Third Amended and Restated Credit Agreement exceeds 50% of the total borrowing capacity. As of December 28, 2002, the margin was equal to 87.5/100 of 1%. 46 The unused portion of the Third Amended and Restated Credit Agreement carries a commitment fee determined based on the level of the Leverage Ratio, as therein defined. As of December 28, 2002, the commitment fee for the unused portion of the Third Amended and Restated Credit Agreement was 0.250%. At December 28, 2002, the weighted average interest rate on borrowings outstanding under the Third Amended and Restated Credit Agreement was 2.27%. The Third Amended and Restated Credit Agreement contains a number of covenants that limit, among other things, the incurrence of additional indebtedness, the incurrence of operating or capital lease obligations and the purchase of operating property. The Third Amended and Restated Credit Agreement also requires Landstar to meet certain financial tests. Landstar is required to, among other things, maintain minimum levels of Net Worth, as defined in the Third Amended and Restated Credit Agreement, and Interest and Fixed Charge Coverages, as therein defined. Under the most restrictive covenant, Interest Coverage, earnings before interest and taxes exceeded the required minimum by approximately $64,000,000 for the fiscal year ended December 28, 2002. The Third Amended and Restated Credit Agreement provides for an event of default related to a person or group acquiring 25% or more of the outstanding capital stock of the Company or obtaining the power to elect a majority of the Company's directors. Borrowings under the Third Amended and Restated Credit Agreement are unsecured, however, the Company and all but one of Landstar System Holdings, Inc.'s ("LSHI") subsidiaries guarantee LSHI's obligations under the Third Amended and Restated Credit Agreement. Shareholders' equity was $149,093,000, or 66% of total capitalization, at December 28, 2002, compared with $117,440,000, or 54% of total capitalization, at December 29, 2001. The increase in shareholders' equity was a result of current year net income, repayment of notes receivable arising from exercises of stock options and exercises of stock options, partially offset by the purchase of 554,879 shares of the Company's common stock at a total cost of $26,306,000. As of December 28, 2002, the Company may purchase an additional 445,121 shares of its common stock under its authorized stock purchase program. Long-term debt including current maturities was $77,360,000 at December 28, 2002, $24,514,000 lower than at December 29, 2001. Working capital and the ratio of current assets to current liabilities were $120,630,000 and 1.78 to 1, respectively, at December 28, 2002, compared with $121,808,000 and 1.92 to 1, respectively, at December 29, 2001. Landstar has historically operated with current ratios within the range of 1.5 to 1 to 2.0 to 1. Cash provided by operating activities was $84,313,000 in 2002 compared with $49,794,000 in 2001. The increase in cash provided by operating activities was primarily attributable to increased earnings and timing of payments. During the 2002 fiscal year, Landstar purchased $4,421,000 of operating property and acquired $16,370,000 of revenue equipment by entering into capital leases. Landstar anticipates it will acquire between $18,000,000 to $30,000,000 of operating property during fiscal year 2003 either by purchase or by lease financing. At December 28, 2002, the Company's obligations and commitments to make future payments under contracts, such as debt and lease agreements, were as follows (in thousands): Payments Due By Period Contractual Less than 1-3 4-5 After 5 Obligation Total 1 Year Years Years Years Long-term debt $44,000 $44,000 Capital lease obligations 36,285 $13,631 19,511 $3,143 Operating leases 25,724 2,784 6,546 2,087 $14,307 -------- ------- ------- ------ ------- $106,009 $16,415 $70,057 $5,230 $14,307 ======== ======= ======= ====== ======= Capital lease obligations above include $2,925,000 of imputed interest. Operating leases include $22,488,000 related to the Company's main office facility located in Jacksonville, Florida. 47 Management believes that cash flow from operations combined with its borrowing capacity under the Third Amended and Restated Credit Agreement will be adequate to meet Landstar's debt service requirements, fund continued growth, both internal and through acquisitions, complete any purchases under its announced stock purchase program and meet working capital needs. Management does not believe inflation has had a material impact on the results of operations or financial condition of Landstar in the past five years. However, inflation higher than that experienced in the past five years might have an adverse effect on the Company's results of operations. The Company and Ford Motor Co., Inc. are defendants in a suit alleging breach of contract, misrepresentation and certain other causes of action arising out of a contract between Landstar Logistics, Inc. and the plaintiff involving a trans-Gulf of Mexico roll-on/roll-off shipping venture developed by the plaintiff, Gulf Bridge RoRo, Inc. The suit makes claim for $25,000,000 damages for breach of contract and $50,000,000 punitive and other damages related to the misrepresentation counts. The Company has filed motions for summary judgment with the court seeking, in addition to a judgment in its favor, to dismiss Landstar System, Inc. from the litigation, to limit the amount of damages obtainable by the plaintiff, to preclude fraud and other theories upon which plaintiff seeks to obtain damages, and to exclude certain evidence concerning damages sought to be introduced at trial by plaintiff, among other things. Subject to the outcome of these motions, which is anticipated in March 2003, discovery has been substantially completed in this matter, and the Company anticipates that the matter will be tried in April 2003. The Company believes it has meritorious defenses to this litigation and intends to continue to defend it vigorously. The Company also believes that if this litigation were determined adversely to it, the liability of the Company, exclusive of any available insurance recoveries, would not be reasonably likely to have a material adverse effect on the financial condition of the Company but that it could have a material adverse effect on the results of operations in a given quarter or year. The Company has notified its third party insurance carrier that it believes that a portion of the claims made in this lawsuit are covered under insurance provided by that carrier, and the carrier has agreed to pay the fees and expenses and to participate in the defense of this litigation, subject to a reservation of rights. The Company also intends to pursue its rights with respect to this coverage vigorously. No assurances can be given as to the outcome of this litigation or any related matter, however. On November 1, 2002, the Owner Operator Independent Drivers Association, Inc. ("OOIDA") and six individual Independent Contractors filed a putative class action suit in the U.S. Court in Jacksonville, Florida, against the Company. The suit alleges that certain aspects of Landstar's motor carrier's leases with owner operators violate the federal leasing regulations. OOIDA seeks injunctive relief, damages and attorney's fees. On December 17, 2002, the Company filed a Motion to Dismiss and a Motion to Stay and Compel Arbitration with respect to all of the leases that contain arbitration clauses. Landstar believes it has meritorious defenses to this litigation and intends to defend it vigorously. Landstar also believes that it treats its Independent Contractors fairly and in a manner which reflects the important role they play in the Company's operations. 48 The Company is involved in certain other claims and pending litigation arising from the normal conduct of business. Based on knowledge of the facts and, in certain cases, opinions of outside counsel, management believes that adequate provisions have been made for probable losses with respect to the resolution of all such other claims and pending litigation and that the ultimate outcome, after provisions thereof, will not have a material adverse effect on the financial condition of Landstar, but could have a material effect on the results of operations in a given quarter or year. SIGNIFICANT ACCOUNTING POLICIES AND ESTIMATES The allowance for doubtful accounts for both trade and other receivables represents management's estimate of the amount of outstanding receivables that will not be collected. During 2002, the Company experienced its second consecutive year with an abnormally high level of bad debt expense. Management believes this resulted from the difficult economic environment experienced by the Company's customers and Independent Contractors. Although management believes the amount of the allowance for both trade and other receivables at December 28, 2002 is appropriate, a prolonged period of low or no economic growth may adversely affect the collection of these receivables. Correspondingly, a more robust economic environment may result in the realization of some portion of the estimated uncollectible receivables. As described in the accounting policy footnote to the financial statements, Landstar provides for the estimated costs of self-insured claims primarily on an actuarial basis. The amount recorded for the estimated liability for claims incurred is based upon the facts and circumstances known on the balance sheet date. The ultimate resolution of these claims may be for an amount greater or less than the amount estimated by management. The Company utilizes certain income tax planning strategies to reduce its overall cost of income taxes. Upon audit, it is possible that certain strategies might be disallowed resulting in an increased liability for income taxes. The Company has provided for its estimated exposure attributable to income tax planning strategies. Management believes that the provision for liabilities resulting from the implementation of income tax planning strategies is appropriate. Significant variances from management's estimates for the amount of uncollectible receivables, for the ultimate resolution of claims or the provision for liabilities for income tax planning strategies can be expected to positively or negatively affect Landstar's earnings in a given quarter or year. However, management believes that the ultimate resolution of these items, given a range of reasonably likely outcomes, will not significantly affect the long-term financial condition of Landstar or its ability to fund its continuing operations. 49 In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations." This Statement, effective for fiscal years beginning after June 15, 2002, requires an enterprise to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of a tangible long-lived asset. The enterprise is also to record a corresponding increase to the carrying amount of the long-lived asset. Management believes that this Statement will not have a material effect on the financial position or results of operations of the Company. FORWARD-LOOKING STATEMENTS The following is a "safe harbor" statement under the Private Securities Litigation Reform Act of 1995. Statements contained in this document that are not based on historical facts are "forward-looking statements." This Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Form 10-K statement contain forward- looking statements, such as statements which relate to Landstar's business objectives, plans, strategies and expectations. Terms such as "anticipates," "believes," "estimates," "plans," "predicts," "may," "should," "will," the negative thereof and similar expressions are intended to identify forward- looking statements. Such statements are by nature subject to uncertainties and risks, including but not limited to: an increase in the frequency or severity of accidents or workers' compensation claims; unfavorable development of existing accident claims; dependence on independent sales agents; dependence on third party capacity providers; disruptions or failures in our computer systems; a downturn in domestic economic growth or growth in the transportation sector; substantial industry competition; and other operational, financial or legal risks or uncertainties detailed in this and Landstar's other SEC filings from time to time. These risks and uncertainties could cause actual results or events to differ materially from historical results or those anticipated. Investors should not place undue reliance on such forward-looking statements, and the Company undertakes no obligation to publicly update or revise any forward-looking statements. SEASONALITY Landstar's operations are subject to seasonal trends common to the trucking industry. Results of operations for the quarter ending in March are typically lower than the quarters ending June, September and December. 50 LANDSTAR SYSTEM, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except per share amounts)
December 28, December 29, 2002 2001 ----------- ----------- ASSETS Current assets: Cash $ 65,447 $ 47,886 Short-term investments 3,130 2,982 Trade accounts receivable, less allowance of $3,953 and $4,416 190,052 185,206 Other receivables, including advances to independent contractors, less allowance of $5,331 and $4,740 12,640 13,779 Prepaid expenses and other current assets 3,338 4,020 -------- -------- Total current assets 274,607 253,873 -------- -------- Operating property, less accumulated depreciation and amortization of $52,841 and $44,455 76,774 68,532 Goodwill 31,134 31,134 Other assets 18,233 11,112 -------- -------- Total assets $400,748 $364,651 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Cash overdraft $ 16,545 $ 13,018 Accounts payable 60,297 55,813 Current maturities of long-term debt 12,123 9,965 Insurance claims 24,419 21,602 Other current liabilities 40,593 31,667 -------- -------- Total current liabilities 153,977 132,065 -------- -------- Long-term debt, excluding current maturities 65,237 91,909 Insurance claims 25,276 21,585 Deferred income taxes 7,165 1,652 Shareholders' equity: Common stock, $.01 par value, authorized 20,000,000 shares, issued 16,337,506 and 13,328,834 shares 163 133 Additional paid-in capital 2,609 75,036 Retained earnings 173,817 258,162 Cost of 554,879 and 5,241,841 shares of common stock in treasury (26,306) (209,926) Notes receivable arising from exercise of stock options (1,190) (5,965) -------- -------- Total shareholders' equity 149,093 117,440 -------- -------- Total liabilities and shareholders' equity $400,748 $364,651 ======== ======== See accompanying notes to consolidated financial statements.
51 LANDSTAR SYSTEM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (Dollars in thousands, except per share amounts)
Fiscal Years Ended December 28, December 29, December 30, 2002 2001 2000 ------------ ------------ ------------ Revenue $ 1,506,555 $ 1,392,771 $ 1,418,492 Investment income 1,950 3,567 4,317 Costs and expenses: Purchased transportation 1,116,009 1,030,454 1,046,183 Commissions to agents 118,864 110,513 113,721 Other operating costs 34,325 32,750 29,568 Insurance and claims 42,188 32,930 31,935 Selling, general and administrative 101,918 99,762 100,516 Depreciation and amortization 11,520 13,543 13,003 Non-recurring costs 5,270 ------------ ------------ ------------ Total costs and expenses 1,424,824 1,319,952 1,340,196 ------------ ------------ ------------ Operating income 83,681 76,386 82,613 Interest and debt expense 4,292 6,802 9,127 ------------ ------------ ------------ Income before income taxes 79,389 69,584 73,486 Income taxes 30,168 26,790 28,292 ------------ ------------ ------------ Net income $ 49,221 $ 42,794 $ 45,194 ============ ============ ============ Earnings per common share (1) $ 3.05 $ 2.57 $ 2.57 ============ ============ ============ Diluted earnings per share (1) $ 2.94 $ 2.50 $ 2.52 ============ ============ ============ Average number of shares outstanding: Earnings per common share (1) 16,141,000 16,672,000 17,562,000 Diluted earnings per share (1) 16,767,000 17,092,000 17,962,000 (1) All earnings per share amounts and average number of shares outstanding have been restated to give retroactive effect to a two-for-one stock split effected in the form of a 100% stock dividend declared July 17, 2002. See accompanying notes to consolidated financial statements.
52 LANDSTAR SYSTEM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Years Ended December 28, December 29, December 30, 2002 2001 2000 (Dollars in thousands) ------------ ------------ ------------ OPERATING ACTIVITIES Net income $ 49,221 $ 42,794 $ 45,194 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization of operating property 11,520 12,327 11,787 Amortization of goodwill 1,216 1,216 Non-cash interest charges 273 97 324 Provisions for losses on trade and other accounts receivable 7,514 8,153 4,592 Losses (gains) on sales and disposals of operating property 642 (273) (244) Deferred income taxes, net 5,513 1,776 3,911 Non-cash charge in lieu of income taxes 124 43 Changes in operating assets and liabilities: Decrease (increase) in trade and other accounts receivable (11,221) 1,382 8,230 Decrease (increase) in prepaid expenses and other assets 933 1,194 (1,405) Increase (decrease) in accounts payable 4,484 (7,189) (4,320) Increase (decrease) in other liabilities 8,926 (8,294) (7,410) Increase (decrease) in insurance claims 6,508 (3,513) (7,871) ------------ ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 84,313 49,794 54,047 ------------ ------------ ------------ INVESTING ACTIVITIES Purchases of investments (8,889) (496) (1,435) Maturities of investments 2,500 1,484 1,060 Purchases of operating property (4,421) (5,443) (7,305) Proceeds from sales of operating property 387 906 1,958 ------------ ------------ ------------ NET CASH USED BY INVESTING ACTIVITIES (10,423) (3,549) (5,722) ------------ ------------ ------------ FINANCING ACTIVITIES Increase (decrease) in cash overdraft 3,527 (4,478) (1,975) Borrowings on revolving credit facility 135,500 27,500 Principal payments on long-term debt and capital lease obligations (40,884) (128,269) (18,603) Proceeds from repayment of notes receivable arising from exercises of stock options 4,867 1,372 51 Proceeds from exercises of stock options 2,467 1,789 92 Purchases of common stock (26,306) (37,199) (46,185) ------------ ------------ ------------ NET CASH USED BY FINANCING ACTIVITIES (56,329) (31,285) (39,120) ------------ ------------ ------------ Increase in cash 17,561 14,960 9,205 Cash at beginning of period 47,886 32,926 23,721 ------------ ------------ ------------ Cash at end of period $ 65,447 $ 47,886 $ 32,926 ============ ============ ============ See accompanying notes to consolidated financial statements.
53 LANDSTAR SYSTEM, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY For the Fiscal Years Ended December 28, 2002, December 29, 2001 and December 30, 2000 (Dollars in thousands)
Notes Treasury Stock Receivable Common Stock Additional at Cost Arising from ----------------- Paid-In Retained ------------------- Exercises of Shares Amount Capital Earnings Shares Amount Stock Options Total ---------- ------ ------- -------- --------- --------- ------------- -------- Balance December 25, 1999 13,063,974 $ 131 $65,833 $170,174 3,909,041 $(127,560) $ (1,694) $106,884 Net income 45,194 45,194 Purchases of common stock 864,000 (46,185) (46,185) Exercises of stock options and related income tax benefit 169,900 1 5,048 (4,596) 453 Repayment of notes receivable arising from exercises of stock options 51 51 Incentive compensation paid in common stock 444 (31,200) 1,018 1,462 ---------- ------ ------- -------- --------- --------- ------------- -------- Balance December 30, 2000 13,233,874 132 71,325 215,368 4,741,841 (172,727) (6,239) 107,859 Net income 42,794 42,794 Purchases of common stock 500,000 (37,199) (37,199) Exercises of stock options and related income tax benefit 94,960 1 3,711 (1,098) 2,614 Repayment of notes receivable arising from exercises of stock options 1,372 1,372 ---------- ------ ------- -------- --------- --------- ------------- -------- Balance December 29, 2001 13,328,834 133 75,036 258,162 5,241,841 (209,926) (5,965) 117,440 Net income 49,221 49,221 Retirement of treasury stock (5,241,841) (52) (76,389) (133,485) (5,241,841) 209,926 - Purchases of common stock 554,879 (26,306) (26,306) Exercises of stock options and related income tax benefit 116,160 1 3,962 (92) 3,871 Repayment of notes receivable arising from exercises of stock options 4,867 4,867 Stock split effected in the form of a 100% stock dividend 8,134,353 81 (81) - ---------- ------ ------- -------- --------- --------- ------------- -------- Balance December 28, 2002 16,337,506 $ 163 $ 2,609 $173,817 554,879 $ (26,306) $ (1,190) $149,093 ========== ====== ======= ======== ========= ========= ============= ======== See accompanying notes to consolidated financial statements.
54 LANDSTAR SYSTEM, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Significant Accounting Policies Consolidation The consolidated financial statements include the accounts of Landstar System, Inc. and its subsidiary Landstar System Holdings, Inc. ("LSHI"). Landstar System, Inc. and its subsidiary are herein referred to as "Landstar" or the "Company." Significant inter-company accounts have been eliminated in consolidation. The preparation of the consolidated financial statements requires the use of management's estimates. Actual results could differ from those estimates. Fiscal Year Landstar's fiscal year is the 52 or 53 week period ending the last Saturday in December. Revenue Recognition Revenue and the related direct freight expenses are recognized upon completion of freight delivery. Fuel surcharges billed to customers for freight hauled by the independent contractors who provide truck capacity to the Company under exclusive lease arrangements are excluded from revenue and paid in entirety to the independent contractors. Insurance Claim Costs Landstar provides, primarily on an actuarially determined basis, for the estimated costs of cargo, property, casualty, general liability and workers' compensation claims both reported and for claims incurred but not reported. Landstar retains liability for individual commercial trucking claims up to $5,000,000 per occurrence. For commercial trucking claims incurred prior to May 1, 2001, Landstar retains liability up to $1,000,000 per occurrence. The Company also retains liability for each general liability claim up to $1,000,000, $250,000 for each workers' compensation claim and $250,000 for each cargo claim. Tires Tires purchased as part of trailing equipment are capitalized as part of the cost of the equipment. Replacement tires are charged to expense when placed in service. Investments Investments, all of which are intended to be held to maturity, consist of investment grade bonds having maturities of up to five years and are carried at amortized cost, which approximates fair value. Short-term investments represent the current portion of these bonds. There are $7,648,000 and $1,407,000 of these bonds included in other assets at December 28, 2002 and December 29, 2001, respectively. Operating Property Operating property is recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the related assets. Trailing equipment is being depreciated over 7 years. 55 Goodwill The Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" in the first quarter of fiscal year 2002. SFAS No. 142 eliminated the requirement to amortize goodwill and requires that it be tested for impairment on an annual basis. During the first quarter of 2002, the Company completed the transitional goodwill impairment test and determined that the fair value of each reporting unit exceeded the carrying value of the net assets of each reporting unit. The Company updated its test for impairment for the fiscal year ended December 28, 2002 and determined that the fair value of each reporting unit exceeded the carrying value of the net assets of each reporting unit. Accordingly, no impairment loss was recognized. Adoption of SFAS No. 142 resulted in the elimination of goodwill amortization expense beginning with the first quarter of 2002. During each of 2001 and 2000, the Company recorded goodwill amortization expense of $1,216,000. Elimination of this amortization expense would have resulted in net income of $44,010,000, or an increase of $0.07 in earnings per share ($0.07 per diluted share), and $46,410,000, or an increase of $0.07 in earnings per share ($0.06 per diluted share), in 2001 and 2000, respectively. The Company has no other intangible assets subject to the provisions of SFAS No. 142. Income Taxes Income tax expense is equal to the current year's liability for income taxes and a provision for deferred income taxes. Deferred tax assets and liabilities are recorded for the future tax effects attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. 56 Stock-Based Compensation At December 28, 2002, the Company has two stock-based employee compensation plans and one stock-based plan for members of its Board of Directors, which are described more fully in footnote 9. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation is reflected in net income, as all options granted under those plans had an exercise price equal to the fair market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation.
Fiscal Years --------------------------------- 2002 2001 2000 ------- ------- ------- Net income, as reported $49,221 $42,794 $45,194 Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related income tax benefits (3,102) (1,187) (1,469) ------- ------- ------- Pro forma net income $46,119 $41,607 $43,725 ======= ======= ======= Earnings per common share: As reported $ 3.05 $ 2.57 $ 2.57 Pro forma $ 2.86 $ 2.50 $ 2.49 Diluted earnings per share: As reported $ 2.94 $ 2.50 $ 2.52 Pro forma $ 2.80 $ 2.47 $ 2.46
Earnings Per Share Earnings per common share amounts are based on the weighted average number of common shares outstanding and diluted earnings per share amounts are based on the weighted average number of common shares outstanding plus the incremental shares that would have been outstanding upon the assumed exercise of all dilutive stock options. (2) Stock Split On July 17, 2002, Landstar declared a two-for-one stock split of its common stock to be effected in the form of a 100% stock dividend. Stockholders of record on August 2, 2002 received one additional share of common stock for each share held. The additional shares were distributed on August 12, 2002. All share and per share amounts have been restated to give retroactive effect to this stock split. 57 (3) Non-recurring Costs At December 25, 1999, approximately 100 Landstar Ranger, Inc. ("Landstar Ranger") drivers were represented by the International Brotherhood of Teamsters (the "Teamsters"). The vast majority of these unionized drivers participated in the Teamsters' Central States Southeast and Southwest Areas Pension Fund (the "Fund"). As a result of the terms of a new collective bargaining agreement, the Trustees of the Fund terminated participation in the Fund by Landstar Ranger effective October 1, 2000. The Trustees of the Fund regarded this action as a withdrawal by Landstar Ranger. In the third quarter of 2000, the Company recorded a charge in the amount of $2,230,000 for the cost of withdrawal from the Fund. After deducting related income tax benefits of $880,000, this charge reduced fiscal year 2000 net income by $1,350,000, or $0.08 per common share ($0.08 per diluted share). At December 28, 2002, 43 Landstar Ranger drivers were represented by the Teamsters and neither Landstar nor any of its subsidiaries participate in any multi-employer pension plans. On March 28, 2000, the Company announced a plan to restructure the operations of Landstar Ligon, Inc. and to relocate its headquarters from Madisonville, Kentucky to Jacksonville, Florida in June of 2000. As a result of this restructuring and relocation, a one-time charge in the amount of $3,040,000 was recorded during the second quarter of 2000 representing approximately $1,370,000 of employee and office relocation costs, $1,000,000 of severance costs and $670,000 of other costs. The restructuring and relocation were substantially completed by September 23, 2000. After deducting related income tax benefits of $1,225,000, this one-time restructuring charge reduced fiscal year 2000 net income by $1,815,000, or $0.10 per common share ($0.10 per diluted share). 58 (4) Income Taxes The provisions for income taxes consisted of the following (in thousands):
Fiscal Years ------------------------------ 2002 2001 2000 ---- ---- ---- Current: Federal $23,362 $23,636 $21,525 State 1,293 1,254 2,813 ------- ------- ------- 24,655 24,890 24,338 Deferred: Federal 4,273 1,454 4,208 State 1,240 322 (297) ------ ------- ------- 5,513 1,776 3,911 Non-cash charge in lieu of income taxes 124 43 ------- ------- ------- Income taxes $30,168 $26,790 $28,292 ======= ======= =======
Temporary differences and carryforwards which gave rise to deferred tax assets and liabilities consisted of the following (in thousands):
Dec. 28, 2002 Dec. 29, 2001 ------------- ------------- Deferred tax assets: Receivable valuations $ 4,092 $ 4,128 Deferred state income tax benefits 2,134 1,700 State net operating loss carryforwards 1,669 1,933 Self-insured claims 3,023 3,252 Other 2,421 5,052 --------- ---------- 13,339 16,065 Valuation allowance (491) (491) --------- ---------- $ 12,848 $ 15,574 ========= ========== Deferred tax liabilities: Operating property $ 13,827 $ 11,378 Other 6,186 5,848 --------- ---------- $ 20,013 $ 17,226 ========= ==========
59 At December 28, 2002, the valuation allowance of $491,000 was attributable to deferred state income tax benefits, which primarily represented state operating loss carryforwards at one subsidiary. The valuation allowance and goodwill will be reduced by $463,000 when realization of deferred state income tax benefits becomes likely. The following table summarizes the differences between income taxes calculated at the federal income tax rate of 35% on income before income taxes and the provisions for income taxes (in thousands):
Fiscal Years --------------------------- 2002 2001 2000 ------- ------- ------- Income taxes at federal income tax rate $27,786 $24,354 $25,720 State income taxes, net of federal income tax benefit 1,646 1,024 1,635 Amortization of goodwill 258 258 Meals and entertainment exclusion 786 892 597 Other, net (50) 262 82 ------- ------- ------- Income taxes $30,168 $26,790 $28,292 ======= ======= =======
Landstar paid income taxes of $23,540,000 in 2002, $24,778,000 in 2001 and $25,089,000 in 2000. (5) Operating Property Operating property is summarized as follows (in thousands):
Dec. 28, 2002 Dec. 29, 2001 ------------- ------------- Land $ 1,999 $ 2,045 Leasehold improvements 8,353 8,307 Buildings and improvements 8,168 7,963 Trailing equipment 85,034 71,957 Other equipment 26,061 22,715 -------- -------- 129,615 112,987 Less accumulated depreciation and amortization 52,841 44,455 -------- -------- $ 76,774 $ 68,532 ======== ========
Included above is $64,278,000 in 2002 and $48,795,000 in 2001 of operating property under capital leases, $45,465,000 and $35,613,000, respectively, net of accumulated amortization. Landstar acquired operating property by entering into capital leases in the amount of $16,370,000 in 2002 and $18,448,000 in 2000. Landstar did not acquire any property by entering into capital leases in 2001. 60 (6) Retirement Plans Landstar sponsors an Internal Revenue Code section 401(k) defined contribution plan for the benefit of full-time employees who have completed one year of service. Eligible employees make voluntary contributions up to 75% of their base salary, subject to certain limitations. Landstar contributes an amount equal to 100% of the first 3% and 50% of the next 2% of such contributions, subject to certain limitations. Prior to the October 1, 2000 withdrawal (see note 3), Landstar Ranger made contributions in accordance with a negotiated labor contract (generally based on the number of weeks worked) to union sponsored multi-employer pension plans. The expense for the Company-sponsored defined contribution plan was $1,093,000 in 2002, $1,090,000 in 2001 and $1,105,000 in 2000. The expense for union-sponsored plans, excluding the estimated cost of withdrawal (see note 3), was $935,000 in 2000. (7) Debt Long-term debt is summarized as follows (in thousands):
Dec. 28, 2002 Dec. 29, 2001 ------------- ------------- Capital leases $ 33,360 $ 27,374 Revolving credit facility 44,000 74,500 -------- -------- 77,360 101,874 Less current maturities 12,123 9,965 -------- -------- Total long-term debt $ 65,237 $ 91,909 ======== ========
On December 20, 2001, Landstar renegotiated its existing Credit Agreement with a syndicate of banks and JPMorgan Chase Bank, as administrative agent (the "Third Amended and Restated Credit Agreement"). The Third Amended and Restated Credit Agreement provides $175,000,000 of borrowing capacity in the form of a revolving credit facility, $50,000,000 of which may be utilized in the form of letter of credit guarantees. The Third Amended and Restated Credit Agreement expires on January 5, 2005. 61 Borrowings under the Third Amended and Restated Credit Agreement bear interest at rates equal to, at the option of Landstar, either (i) the greatest of (a) the prime rate as publicly announced from time to time by JPMorgan Chase Bank, (b) the three month CD rate adjusted for statutory reserves and FDIC assessment costs plus 1% and (c) the federal funds effective rate plus 1/2%, or, (ii) the rate at the time offered to JPMorgan Chase Bank in the Eurodollar market for amounts and periods comparable to the relevant loan plus a margin that is determined based on the level of the Company's Leverage Ratio, as defined in the Third Amended and Restated Credit Agreement. The margin is subject to an increase of .125% if the aggregate amount outstanding under the Third Amended and Restated Credit Agreement exceeds 50% of the total borrowing capacity. As of December 28, 2002, the margin was equal to 87.5/100 of 1%. The unused portion of the Third Amended and Restated Credit Agreement carries a commitment fee determined based on the level of the Company's Leverage Ratio, as therein defined. As of December 28, 2002, the commitment fee for the unused portion of the Third Amended and Restated Credit Agreement was 0.250%. At December 28, 2002, the weighted average interest rate on borrowings outstanding under the Third Amended and Restated Credit Agreement was 2.27%. Based on the borrowing rates in the Third Amended and Restated Credit Agreement and the repayment terms, the fair value of the outstanding borrowings under the Third Amended and Restated Credit Agreement was estimated to approximate carrying value. The Third Amended and Restated Credit Agreement contains a number of covenants that limit, among other things, the incurrence of additional indebtedness, the incurrence of operating or capital lease obligations and the purchase of operating property. The Third Amended and Restated Credit Agreement also requires Landstar to meet certain financial tests. Landstar is required to, among other things, maintain minimum levels of Net Worth, as defined in the Third Amended and Restated Credit Agreement, and Interest and Fixed Charge Coverages, as therein defined. Under the most restrictive covenant, Interest Coverage, earnings before interest and taxes exceeded the required minimum by approximately $64,000,000 for the fiscal year ended December 28, 2002. The Third Amended and Restated Credit Agreement provides for an event of default related to a person or group acquiring 25% or more of the outstanding capital stock of the Company or obtaining the power to elect a majority of the Company's directors. Borrowings under the Third Amended and Restated Credit Agreement are unsecured, however, the Company and all but one of LSHI's subsidiaries guarantee LSHI's obligations under the Third Amended and Restated Credit Agreement. The amount outstanding on the Third Amended and Restated Credit Agreement is due and payable on January 5, 2005. There are no other installments of long-term debt, excluding capital lease obligations, maturing in the next five years. Landstar paid interest of $4,480,000 in 2002, $7,874,000 in 2001 and $9,658,000 in 2000. (8) Leases The future minimum lease payments under all noncancelable leases at December 28, 2002, principally for trailing equipment and the Company's headquarters facility in Jacksonville, Florida, are shown in the following table (in thousands): 62
Capital Operating Leases Leases ------- --------- 2003 $13,631 $ 2,784 2004 10,222 2,260 2005 5,698 2,192 2006 3,591 2,094 2007 3,143 2,087 Thereafter 14,307 ------- --------- 36,285 $ 25,724 ========= Less amount representing interest (3.6% to 8.3%) 2,925 Present value of minimum ------- lease payments $33,360 =======
Total rent expense, net of sublease income, was $19,250,000 in 2002, $19,976,000 in 2001 and $19,620,000 in 2000. (9) Stock Option Plans All of the share and per share amounts that follow have been adjusted to reflect a two-for-one stock split effected in the form of a 100% stock dividend distributed on August 12, 2002 to stockholders of record on August 2, 2002. The Company maintains three stock option plans. Under the 1993 Stock Option Plan, as amended, the Compensation Committee of the Board of Directors may grant options to Company employees for up to 2,230,000 shares of common stock. Under the 2002 Employee Stock Option Plan, the Compensation Committee of the Board of Directors may grant options to Company employees for up to 1,600,000 shares of common stock. Under the 1994 Directors Stock Option Plan, as amended, (the "DSOP"), outside members of the Board of Directors will be granted up to an aggregate of 420,000 options to purchase common stock. Under the DSOP, each outside Director will be granted 18,000 options to purchase common stock upon election or re-election to the Board of Directors. Subject to approval of its shareholders at the Company's 2003 annual meeting, the DSOP will be replaced by a new Directors Stock Compensation Plan. Under the terms of the proposed plan, each Director, upon election or re-election to the Board, will receive 1,500 shares of the Company's common stock subject to certain restrictions. Options granted under the existing plans become exercisable in either three or five equal annual installments, commencing on the first anniversary of the date of grant, subject to acceleration in certain circumstances, and expire on the tenth anniversary of the date of grant. Under the existing plans, the exercise price of each option equals the fair market price of the Company's common stock on the date of grant. At December 28, 2002, there were 3,172,160 shares of the Company's common stock reserved for issuance upon exercise of options granted under the plans. 63 Information regarding the Company's stock option plans is as follows:
Options Outstanding Options Exercisable --------------------------- -------------------------- Weighted Average Weighted Average Exercise Price Exercise Price Shares Per Share Shares Per Share -------- ----------------- -------- ---------------- Options at December 25, 1999 1,138,400 $ 15.71 573,040 $ 14.26 Granted 214,800 $ 23.90 Exercised (339,800) $ 13.80 Forfeited (3,600) $ 12.75 --------- Options at December 30, 2000 1,009,800 $ 18.11 424,120 $ 15.59 Granted 396,200 $ 33.02 Exercised (189,920) $ 15.20 Forfeited (93,040) $ 25.13 --------- Options at December 29, 2001 1,123,040 $ 23.28 415,360 $ 17.22 Granted 414,000 $ 36.88 Exercised (163,520) $ 15.67 --------- Options at December 28, 2002 1,373,520 $ 28.28 465,438 $ 21.17 =========
The fair value of each option grant on its grant date was calculated using the Black-Scholes option pricing model with the following assumptions for grants made in 2002, 2001 and 2000: risk-free interest rate of 3.5% in 2002, 5.0% in 2001 and 6.0% in 2000, expected lives of 5 years and no dividend yield. The expected volatility used in calculating the fair market value of stock options granted was 40% in 2002 and 2001 and 41% in 2000. The weighted average grant date fair value of stock options granted was $14.88, $14.16 and $10.81 per share in 2002, 2001 and 2000, respectively. The following table summarizes stock options outstanding at December 28, 2002:
Options Outstanding ------------------- Range of Exercise Weighted Average Weighted Average Prices Number Outstanding Remaining Contractual Exercise Price Per Share Dec. 28, 2002 Life (years) Per Share ----------------- ------------------ --------------------- ---------------- $14.055 - $20.250 429,000 5.8 $ 17.87 $20.251 - $34.129 416,920 7.8 $ 28.85 $34.130 - $51.895 527,600 8.9 $ 36.31 ---------------- $14.055 - $51.895 1,373,520 7.6 $ 28.28 ================
64
Options Exercisable ------------------- Range of Exercise Number Weighted Average Prices Exercisable Exercise Price Per Share Dec. 28, 2002 Per Share ----------------- ---------------- ---------------- $14.055 - $17.867 158,280 $ 16.09 $17.868 - $20.250 165,118 $ 19.56 $20.251 - $34.224 142,040 $ 28.69 --------------- $14.055 - $34.224 465,438 $ 21.17 ===============
(10) Shareholders' Equity During 2002, Landstar purchased 554,879 shares of its common stock at a total cost of $26,306,000 pursuant to a previously announced stock purchase program. As of December 28, 2002, Landstar may purchase an additional 445,121 shares of its common stock under its authorized stock purchase program. During 1998, the Company established an employee stock option loan program. Under the terms of the program, the Company provided employees financing in order for them to exercise fully vested stock options. The loans are full recourse with the principal repayable in lump sum on the fifth anniversary of the loan. During 2002, 2001 and 2000, $92,000, $1,098,000 and $4,596,000 of such loans were issued, respectively. Effective May 1, 2002, the Company ceased making loans under the employee stock option loan program and terminated the program with respect to future stock option exercises. The Company has 2,000,000 shares of preferred stock authorized and unissued. 65 (11) Segment Information The Company has three reportable business segments. These are the carrier, multimodal and insurance segments. The carrier segment provides truckload transportation for a wide range of general commodities over irregular routes with its fleet of dry and specialty vans and unsided trailers, including flatbed, drop deck and specialty. It also provides short-to-long haul movement of containers by truck, dedicated power-only truck capacity and truck brokerage. The carrier segment markets its services primarily through independent commission sales agents and utilizes tractors provided by independent contractors who provide truck capacity to the Company under exclusive lease arrangements (the "Independent Contractors") and other third party truck capacity providers. Transportation services provided by the multimodal segment include the arrangement of intermodal moves, contract logistics, truck brokerage and emergency and expedited ground and air freight. The multimodal segment markets its services through independent commission sales agents and primarily utilizes capacity provided by Independent Contractors and other third party capacity providers, including truck brokerage carriers, railroads and air cargo carriers. The nature of the carrier and multimodal segments' business is such that a significant portion of their operating costs varies directly with revenue. The insurance segment provides risk and claims management services to Landstar's operating subsidiaries. In addition, it reinsures certain property, casualty and occupational accident risks of certain Independent Contractors who have contracted to haul freight for Landstar and provides certain property and casualty insurance directly to Landstar's operating subsidiaries. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates a segment's performance based on operating income. Internal revenue for transactions between the carrier and multimodal segments is based on quoted rates which are believed to approximate the cost that would have been incurred had similar services been obtained from an unrelated third party. Internal revenue for premiums billed by the insurance segment to the carrier and multimodal segments is calculated each fiscal period based on an actuarial calculation of historical loss experience and is believed to approximate the cost that would have been incurred by the carrier and multimodal segments had similar insurance been obtained from an unrelated third party. No single customer accounts for more than 10% of consolidated revenue. However, during 2002 approximately 12% of the Company's revenue was attributable to the automotive industry. Substantially all of the Company's revenue is generated in the United States. 66 The following tables summarize information about the Company's reportable business segments as of and for the fiscal years ending December 28, 2002, December 29, 2001 and December 30, 2000 (in thousands):
2002 Carrier Multimodal Insurance Other Total ------- ---------- --------- ----- ----- External revenue $1,178,263 $ 300,716 $ 27,576 $1,506,555 Internal revenue 23,703 2,483 29,860 56,046 Investment income 1,950 1,950 Interest and debt expense $ 4,292 4,292 Depreciation and amortization 7,546 126 3,848 11,520 Operating income 87,777 7,793 22,754 (34,643) 83,681 Expenditures on long-lived assets 329 4,092 4,421 Goodwill 20,496 10,638 31,134 Capital lease additions 16,370 16,370 Total assets 241,068 59,571 70,198 29,911 400,748 2001 Carrier Multimodal Insurance Other Total ------- ---------- --------- ----- ----- External revenue $1,098,268 $ 270,849 $ 23,654 $1,392,771 Internal revenue 28,587 2,367 27,313 58,267 Investment income 3,567 3,567 Interest and debt expense $ 6,802 6,802 Depreciation and amortization 8,382 783 4,378 13,543 Operating income 76,105 5,343 30,644 (35,706) 76,386 Expenditures on long-lived assets 2,994 159 2,290 5,443 Goodwill 20,496 10,638 31,134 Total assets 234,164 47,795 46,440 36,252 364,651 2000 Carrier Multimodal Insurance Other Total ------- ---------- --------- ----- ----- External revenue $1,117,042 $ 277,087 $ 24,363 $1,418,492 Internal revenue 34,669 1,241 21,919 57,829 Investment income 4,317 4,317 Interest and debt expense $ 9,127 9,127 Depreciation and amortization 7,999 905 4,099 13,003 Non-recurring costs 5,270 5,270 Operating income 88,507 9,346 24,464 (39,704) 82,613 Expenditures on long-lived assets 687 177 6,441 7,305 Goodwill 21,291 11,183 32,474 Capital lease additions 18,448 18,448 Total assets 256,690 54,294 33,267 26,111 370,362
67 (12) Commitments and Contingencies At December 28, 2002, Landstar had commitments for letters of credit outstanding in the amount of $18,060,000, primarily as collateral for estimated insurance claims, $9,080,000 of which were supported by the Third Amended and Restated Credit Agreement and $8,980,000 secured by assets deposited with a financial institution. The Company and Ford Motor Co., Inc. are defendants in a suit alleging breach of contract, misrepresentation and certain other causes of action arising out of a contract between Landstar Logistics, Inc. and the plaintiff involving a trans-Gulf of Mexico roll-on/roll-off shipping venture developed by the plaintiff, Gulf Bridge RoRo, Inc. The suit makes claim for $25,000,000 damages for breach of contract and $50,000,000 punitive and other damages related to the misrepresentation counts. The Company has filed motions for summary judgment with the court seeking, in addition to a judgment in its favor, to dismiss Landstar System, Inc. from the litigation, to limit the amount of damages obtainable by the plaintiff, to preclude fraud and other theories upon which plaintiff seeks to obtain damages, and to exclude certain evidence concerning damages sought to be introduced at trial by plaintiff, among other things. Subject to the outcome of these motions, which is anticipated in March 2003, discovery has been substantially completed in this matter, and the Company anticipates that the matter will be tried in April 2003. The Company believes it has meritorious defenses to this litigation and intends to continue to defend it vigorously. The Company also believes that if this litigation were determined adversely to it, the liability of the Company, exclusive of any available insurance recoveries, would not be reasonably likely to have a material adverse effect on the financial condition of the Company but that it could have a material adverse effect on the results of operations in a given quarter or year. The Company has notified its third-party insurance carrier that it believes that a portion of the claims made in this lawsuit are covered under insurance provided by that carrier, and the carrier has agreed to pay the fees and expenses and to participate in the defense of this litigation, subject to a reservation of rights. The Company also intends to pursue its rights with respect to this coverage vigorously. No assurances can be given as to the outcome of this litigation or any related matter, however. On November 1, 2002, the Owner Operator Independent Drivers Association, Inc. ("OOIDA") and six individual Independent Contractors filed a putative class action suit in the U.S. Court in Jacksonville, Florida, against the Company. The suit alleges that certain aspects of Landstar's motor carrier's leases with owner operators violate the federal leasing regulations. OOIDA seeks injunctive relief, damages and attorney's fees. On December 17, 2002, the Company filed a Motion to Dismiss and a Motion to Stay and Compel Arbitration with respect to all of the leases that contain arbitration clauses. Landstar believes it has meritorious defenses to this litigation and intends to defend it vigorously. Landstar also believes that it treats its Independent Contractors fairly and in a manner which reflects the important role they play in the Company's operations. The Company is involved in certain other claims and pending litigation arising from the normal conduct of business. Based on knowledge of the facts and, in certain cases, opinions of outside counsel, management believes that adequate provisions have been made for probable losses with respect to the resolution of all such other claims and pending litigation and that the ultimate outcome, after provisions thereof, will not have a material adverse effect on the financial condition of Landstar, but could have a material effect on the results of operations in a given quarter or year. 68 Independent Auditors' Report ---------------------------- Landstar System, Inc. and Subsidiary The Board of Directors and Shareholders Landstar System, Inc.: We have audited the accompanying consolidated balance sheets of Landstar System, Inc. and subsidiary as of December 28, 2002 and December 29, 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the fiscal years ended December 28, 2002, December 29, 2001 and December 30, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Landstar System, Inc. and subsidiary as of December 28, 2002 and December 29, 2001, and the results of their operations and their cash flows for the fiscal years ended December 28, 2002, December 29, 2001 and December 30, 2000 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1 to the consolidated financial statements, effective December 30, 2001, Landstar System, Inc. and subsidiary adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets". /s/ KPMG LLP Jacksonville, Florida February 5, 2003 69 LANDSTAR SYSTEM, INC. AND SUBSIDIARY QUARTERLY FINANCIAL DATA (Dollars in thousands, except per share amounts)
Fourth Third Second First Quarter Quarter Quarter Quarter 2002 2002 2002 2002 ---------- ---------- ---------- ---------- Revenue $ 393,986 $ 385,660 $ 391,216 $ 335,693 ========== ========== ========== ========== Operating income $ 24,191 $ 23,451 $ 20,999 $ 15,040 ---------- ---------- ---------- ---------- Income before income taxes $ 23,417 $ 22,485 $ 19,755 $ 13,732 Income taxes 8,899 8,544 7,507 5,218 ---------- ---------- ---------- ---------- Net income $ 14,518 $ 13,941 $ 12,248 $ 8,514 ========== ========== ========== ========== Earnings per common share (1,2) $ 0.91 $ 0.86 $ 0.75 $ 0.53 ========== ========== ========== ========== Diluted earnings per share (1,2) $ 0.88 $ 0.83 $ 0.72 $ 0.51 ========== ========== ========== ==========
Fourth Third Second First Quarter Quarter Quarter Quarter 2001 2001 2001 2001 ---------- ---------- ---------- ---------- Revenue $ 347,788 $ 355,684 $ 358,018 $ 331,281 ========== ========== ========== ========== Operating income $ 20,093 $ 21,000 $ 19,486 $ 15,807 ---------- ---------- ---------- ---------- Income before income taxes $ 18,820 $ 19,403 $ 17,776 $ 13,585 Income taxes 7,243 7,473 6,843 5,231 ---------- ---------- ---------- ---------- Net income $ 11,577 $ 11,930 $ 10,933 $ 8,354 ========== ========== ========== ========== Earnings per common share (1,2) $ 0.72 $ 0.72 $ 0.64 $ 0.49 ========== ========== ========== ========== Diluted earnings per share (1,2) $ 0.70 $ 0.70 $ 0.63 $ 0.48 ========== ========== ========== ==========
(1) Due to the changes in the number of average common shares and common stock equivalents outstanding during the year, the sum of earnings per share amounts for each quarter do not necessarily add to the earnings per share amounts for the full year. (2) All earnings per share amounts have been restated to give retroactive effect to a two-for-one stock split effected in the form of a 100% stock dividend declared July 17, 2002. 70 LANDSTAR SYSTEM, INC. AND SUBSIDIARY SELECTED CONSOLIDATED FINANCIAL DATA (Dollars in thousands, except per share amounts)
Fiscal Years 2002 2001 2000 1999 1998 ------------------------------------------------------------- Income Statement Data: Revenue $1,506,555 $1,392,771 $1,418,492 $1,388,083 $1,283,607 Investment income 1,950 3,567 4,317 2,502 1,689 Costs and expenses: Purchased transportation 1,116,009 1,030,454 1,046,183 1,022,203 950,343 Commissions to agents 118,864 110,513 113,721 111,666 101,409 Other operating costs 34,325 32,750 29,568 30,000 27,516 Insurance and claims 42,188 32,930 31,935 34,064 39,388 Selling, general and administrative 101,918 99,762 100,516 99,240 95,028 Depreciation and amortization 11,520 13,543 13,003 11,698 10,158 Non-recurring costs 5,270 --------- --------- --------- --------- --------- Total costs and expenses 1,424,824 1,319,952 1,340,196 1,308,871 1,223,842 --------- --------- --------- --------- --------- Operating income 83,681 76,386 82,613 81,714 61,454 Interest and debt expense 4,292 6,802 9,127 4,509 3,503 --------- --------- --------- --------- --------- Income from continuing operations before income taxes 79,389 69,584 73,486 77,205 57,951 Income taxes 30,168 26,790 28,292 31,268 23,470 --------- --------- --------- --------- --------- Income from continuing operations 49,221 42,794 45,194 45,937 34,481 Discontinued operations, net of income taxes (22,589) --------- --------- --------- --------- --------- Net income $ 49,221 $ 42,794 $ 45,194 $ 45,937 $ 11,892 ========= ========= ========= ========= ========= Earnings per common share: Income from continuing operations (1)$ 3.05 $ 2.57 $ 2.57 $ 2.30 $ 1.56 Loss from discontinued operations (1) (1.02) --------- --------- --------- --------- --------- Earnings per common share (1) $ 3.05 $ 2.57 $ 2.57 $ 2.30 $ 0.54 ========= ========= ========= ========= ========= Diluted earnings per share: Income from continuing operations (1)$ 2.94 $ 2.50 $ 2.52 $ 2.27 $ 1.55 Loss from discontinued operations (1) (1.02) --------- --------- --------- --------- --------- Diluted earnings per share (1) $ 2.94 $ 2.50 $ 2.52 $ 2.27 $ 0.53 ========= ========= ========= ========= ========= (1) All earnings per share amounts have been restated to give retroactive effect to a two-for-one stock split effected in the form of a 100% stock dividend declared July 17, 2002. Dec. 28, Dec. 29, Dec. 30, Dec. 25, Dec. 26, 2002 2001 2000 1999 1998 --------- --------- --------- --------- --------- Balance Sheet Data: Total assets $ 400,748 $ 364,651 $ 370,362 $ 365,441 $ 313,665 Long-term debt, including current maturities 77,360 101,874 94,643 67,298 34,440 Shareholders' equity 149,093 117,440 107,859 106,884 111,848
71