Moneyline News Hour

Dow Falls 120.28; Nasdaq Dives 199.66 to 199.66; UAL Makes Offer to Buy US Airways; Disney Closes Toysmart.com

THIS IS A RUSH TRANSCRIPT. THIS COPY MAY NOT BE IN ITS FINAL FORM AND MAY BE UPDATED.

STUART VARNEY, CNN ANCHOR: Tonight on MONEYLINE, a dramatic late-day plunge. The Nasdaq tumbles again and into the worst bear market of the past two decades.

WILLOW BAY, CNN ANCHOR: It is the single-worst session for the index since the monster mid-April sell-off: what drove the index under for the fifth-straight day?

VARNEY: We'll also have the latest casualty of the brutal dot.com shakeout: Toysmart. We'll ask the chief executive exactly what happened.

BAY: And countdown to the explosive vote tomorrow in the House over trade with China: Is it still too close to call?

ANNOUNCER: This is the MONEYLINE NEWS HOUR. Reporting tonight from New York, Willow Bay and Stuart Varney.

VARNEY: Good evening, everyone. We have breaking news tonight from the airline business. ULA, the nation's biggest carrier, offering to buy US Airways. That's according to "The Financial Times."

(AUDIO GAP)

BAY: ... Wall Street: what began as a day of relative calm ended with a drastic downturn in high-tech stocks. The Dow and Nasdaq once again tumbled in a wave of late-day selling, a session that wiped out more than $300 billion in the market's value.

But clearly, it was tech stocks hit hardest today, the Nasdaq closing at its lowest point for the year. The index plunged a stunning 6 percent to 3,164, erasing all of the gains for the Nasdaq since early November. The Dow lost 120 points with blue chip tech names accounting for more than half of that loss.

But today's huge sell-off is a bit of a market mystery coming on a day with no big bombshells.

Susan Lisovicz reports.

(BEGIN VIDEOTAPE) SUSAN LISOVICZ, CNN CORRESPONDENT (voice-over): Investors bailed out of tech stocks driving the Nasdaq down to a new low for the year as fears continue to mount that possible interest rate hikes yet to come will eat into tech profits.

Analysts say the absence of any major economic news, low trading- volume, and volatility will continue to drive the markets until the Fed's next meeting in June.

PETER LANDINI, FREMONT FUNDS: There really is no news in the market, no great inflation news we're looking at. So everyone's speculating: What's the Fed going to do? And as you know, the Fed is really driving this market right now.

We're worried about another 25 basis point tightening move on June 27th and 28th.

LISOVICZ: Virtually no large cap tech stock was spared. Stocks like Cisco and Qualcomm closed down at levels not seen since last winter. Of the major tech sectors, chip stocks took the brunt of the selling, with some posting double-digit losses.

Tech stocks also drove the Dow industrials lower. But there was some downward pressure from more traditional names, like General Motors, and International Paper, which slid on negative analyst comments about IP and other paper stocks.

Curiously, for a market lacking conviction, there's a consensus that everyone is waiting on the Fed. Some even see a light at the end of the tunnel.

ERIK GUSTAFSON, STEIN ROE & FARNHAM: I think the Fed is closer to being finished than it is to getting started on this interest rate- increasing binge, if you will. With that in mind, the markets being forward-looking vehicles, I think they will sense the Fed is almost finished. We'll probably go through one more in June, and then I think we heal and go higher as we go into the third and fourth quarters.

(END VIDEOTAPE)

LISOVICZ: In the meantime, investors could turn to Thursday's preliminary report on first-quarter gross domestic product for signs of whether inflation still remains a threat -- Willow.

BAY: The market waiting for signs of some major news. Susan Lisovicz, thank you.

VARNEY: Well, it's been one week since the Fed hiked interest rates, and oh, what a week it's been for the Nasdaq. Over the past five sessions, the index has lost more than 550 points. That's nearly 15 percent.

Among the biggest losers of the big cap Nasdaq stocks, Lycos, down 28 percent in five sessions after announcing its deal with Terra. Ciena, Conexant, CNet and Broadvision all down 27 percent or more. These stocks were all well below their 52-week highs even before this five-session sell-off began.

Today's tumble leaves the Nasdaq down 22 percent on the year and down 37 percent from its high.

BAY: That is not to say that blue chip stocks have emerged unscathed this year or this past week. Over five sessions, the Dow has lost nearly 5 percent, falling every day except for one, when it gained a mere seven points. For the year, the index is down more than 9 percent, down 11 percent from the high.

VARNEY: Taking a closer look at today's damage on Wall Street, the Standard & Poor's 500 index not immune either to today's sell-off. It fell 2 percent, a loss there of 26 points. On the big board, declining issues beat out advancers: The margin was 6-5. There were 31 stocks that hit new highs today, but 88 that fell to new lows on the big board.

The one average that managed to buck today's downdraft, the Dow transports. Strong airline stocks helped lift that index 34 points higher to 2,754.

And breaking news tonight about a major merger in the airline business. "The Financial Times" is reporting that UAL, the parent of United Airlines, has made a $4 billion offer to buy US Airways. And sources tell MONEYLINE that the board of US Airways was meeting this afternoon to discuss the offer.

Check those stocks: US Airways closed at just under $26 today, up nearly a point. UAL also gained nearly a point.

For more on this breaking story, we're joined now by Andrew Edgecliffe-Johnson. He is the reporter at "The Financial Times."

Andrew, welcome to MONEYLINE.

Andrew, can you tell us, was this a formal bid by UAL, or is it simply talks about talks? What exactly do we have here?

ANDREW EDGECLIFFE-JOHNSON, "FINANCIAL TIMES": ... if you can hear me, but...

VARNEY: I apparently...

JOHNSON: Hi. It's Andrew Edgecliffe-Johnson.

VARNEY: Andrew, can you hear me OK?

JOHNSON: This deal is a significant one. It's the largest airline consolidation we've had for many years. It's the world's largest airline taking over the sixth-largest U.S. carrier. And for this to succeed, two groups of people will be vital: One is the employees; the other is the regulators.

Now, United Airlines is controlled by employees, and deals in this industry have had a terrible history of falling apart because the employees and the unions simply couldn't agree on them. Now, we understand there will be no significant job losses in this transaction, but there's the question of whether the regulators will be satisfied, as it will lead to a significant measure of control being held by United Airlines over the East Coast of the U.S. and the routes out of New York, Washington, et cetera.

So there may be some problems there, particularly because it strengthens the hand of the Star Alliance, one of the two key airline alliances.

VARNEY: Andrew Edgecliffe-Johnson, reporter for "The Financial Times," thank you very much for joining us, Andrew -- Willow.

BAY: Now more on our top story: a brutal market sell-off. The Nasdaq meltdown has commanded most of the concern of market pundits this year, and with good reason. From the high reached on March 10th through today, Nasdaq stocks have lost more than $2 trillion: more than twice the value of Canada's entire economy.

Will it get even worse? Our first quest tonight says be prepared to see the Nasdaq fall below 3,000.

Ned Riley, chief strategist at State Street Global Advisors, joins us now from Boston.

Ned, welcome.

NED RILEY, CHIEF STRATEGIST, STATE STREET GLOBAL ADVISORS: Good morning. Good afternoon, Willow.

BAY: Before we -- before get to your rather dire predictions, what happened today? Because not only were there no bombshells, there really wasn't any news? What do you make of it?

RILEY: Well, I think it's more of a continuation of last week's trend. What we're seeing right now is sort of an unwinding of the excesses that we had from October through middle of February.

Clearly, it was the Nasdaq, technology, Internet, and media stocks that were the darlings of the market, and they clearly drew all of the liquidity from neutral fund investors and the retail public.

So what we are having now, I think, is just a correction. This is the fourth phase of what I call a "typical market correction." And now we're getting into what I call the "capitulation" phase of it, and we're starting to see stock prices plummet for no reason.

BAY: So you say the market's heading below 3,000, which at this point is less than -- less than 200 points away. Then where is it headed?

RILEY: Well, I think on the Nasdaq it needs three things to happen. The first is I think we need to see some mutual fund redemptions in those tech and aggressive growth funds. I haven't seen the capitulation of the public yet.

Two, there's still...

BAY: Ned, what will that look like, that capitulation of the public?

RILEY: Well, I think you'll see more comments from people saying that they don't believe that this is the bottom, they don't that there is a floor under stock prices.

Right now, irrational exuberance is when we saw no ceiling for stock prices, and clearly, capitulation is when investors feel there's no floor. Right now, people still believe on the bounce-on-dip theory, and I'm afraid you need to get that out of the market first.

BAY: That having been said, are there any names that you buy at this point, any beaten down...

RILEY: Technology stocks?

BAY: Yes.

RILEY: Well, I think there are some that you can start nibbling away at.

BAY: For example?

RILEY: Microsoft is one.

BAY: Microsoft at 63. You'd go for that.

RILEY: Yes, it's been cut in half. I mean, clearly Cisco probably at a much lower price than we're seeing today. Lucent Technology is another one that's already been damaged quite badly in the marketplace.

But investors shouldn't look for a pinpoint prediction in terms of what price to come into. They should think about averaging for a long term and not try to find the bottom, because most of us don't know when that bottom will occur, and for the average investor, I'd suggest they'll never know when the bottom has occurred.

BAY: And wish we did know about that bottom.

(LAUGHTER)

Ned Riley, thank you.

RILEY: My pleasure.

VARNEY: (UNINTELLIGIBLE)

(LAUGHTER)

BAY: Right, exactly. Oh well.

Coming up on MONEYLINE, one day to go before a pivotal vote on China trade. We'll have the very latest, and we'll show you why it could affect the upcoming presidential race.

VARNEY: Plus, Toysmart.com logs off the World Wide Web. Find out why Disney is pulling the plug on the online company: a talk with Toysmart chief executive David Lord.

BAY: And judgment day for Microsoft: The penalty phase begins tomorrow. We'll look back at this historic antitrust battle and more when MONEYLINE returns.

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VARNEY: The landmark trade deal with China is going down to the wire in Washington. Supporters of the permanent normal trade relations, or PNTR measure, are growing more confident by the hour that they will have the numbers to win, when the votes are counted on the issue tomorrow, that's when the House votes.

Bob Beard has more on the last-ditch lobbying efforts by those on both sides of this issue.

(BEGIN VIDEOTAPE)

BOB BEARD, CNN CORRESPONDENT (voice-over): On the eve of a make- or-break vote on permanent trade privileges for China, nine previously undecided House Democrats announced they'll vote yes, including one representative MONEYLINE chronicled last week weighing the decision in his home district of Queens, New York.

REP. GREGORY MEEKS (D), NEW YORK: By a preponderance of the evidence, it is in the best interest of the people of the United States of America and the people of China to pass PNTR.

BEARD: The latest vote count is too close to call, but supporters say they're about a dozen shy of 218 votes, the simple majority needed to win. Business lobbyists continue pressing hard for every vote. Tom Donahue, head of the U.S. Chamber of Commerce, is pressuring undecideds, like Sanford Bishop from a mostly agricultural district in south Georgia.

REP. SANFORD BISHOP (D), GEORGIA: There are people within my district who feel very, very strongly on both sides of the issue, and so it's a very, very difficult but careful process that I have to go through.

BEARD: Union leaders blanketed Capitol Hill, too. Organized labor fears liberalizing trade with China will cost U.S. jobs.

TOM BUFFENBARGER, INTL. ASSOC. OF MACHINISTS: Nearly 900,000 jobs will be lost if this legislation is enacted. Thousands of IAM members will lose their jobs.

BEARD: President Clinton calls China trade his most important legislative battle this year. While he has the votes in the Senate, he has not declared victory in the House, and continues lavishing attention on undecided members. It did not hurt for him to unveil new tax credits for business investment in low-income communities, important to some wavering congressmen.

(END VIDEOTAPE)

BEARD: Now, the House has already started debate on the China trade bill. Some House Republican leaders are bluntly predicting the bill will pass. The vote comes probably tomorrow afternoon -- Stuart, Willow.

VARNEY: We'll be watching it. Bob Beard from Washington, thanks, Bob.

BAY: Vice President Al Gore's position on China trade is costing him a major endorsement in his White House run.

More now from Wolf Blitzer in the MONEYLINE "News Digest" -- Wolf?

WOLF BLITZER, CNN ANCHOR: Thanks, Willow.

The United Auto Workers Union today announced that it will not endorse Al Gore because of his support for normal trade relations with China. A statement from UAW president Stephen Yokich says the union is, in his words, "deeply disappointed" in Gore. Yokich also accuses Gore of "trying to have it both ways" on free trade with China.

Yokich also rejected Gore's Republican challenger George W. Bush for his views on issues related to working families. Yokich says the union will actively explore backing a third-party candidate in November, possibly consumer activist Ralph Nader.

Meanwhile, Bush today spelled out his nuclear defense plan saying the United States and Russia no longer need to depend on a balance of terror for peace.

(BEGIN VIDEO CLIP)

GOV. GEORGE W. BUSH (R-TX), PRESIDENTIAL CANDIDATE: It is possible to build a missile defense and diffuse confrontation with Russia. America should do both.

(END VIDEO CLIP)

BLITZER: Bush wants a large missile defense system covering all 50 states and a reduction in nuclear weapons.

Also today, President Clinton, threatened with disbarment over his testimony in the Monica Lewinsky matter, says he'll leave his defense to his lawyers.

And Washington is using its contacts in the Middle East to push for calm along the Lebanon-Israel border. The State Department wants more U.N. peacekeepers deployed as Syrian-backed Hezbollah fighters move into southern Lebanon and Israeli-supported militia men pull out.

I'll have those stories and much more later on "THE WORLD TODAY," that's at 8:00 p.m. Eastern, 5:00 p.m. on the West Coast -- Willow. BAY: Thanks, Wolf.

VARNEY: Still to come on MONEYLINE, a bid to create a global online powerhouse hits a wall.

BAY: Lycos and Terra Networks out of favor. Are investors now betting against their merger? We'll talk with the CEO of Lycos, Robert Davis, when MONEYLINE returns.

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VARNEY: If you combine the Nasdaq and the big board, 246 stocks hit new lows today and they include some big names: AT&T, Abercrombie & Fitch, Cendant, Microsoft, and Priceline.com.

An after-the-bell surprise from three tech companies tonight: Intuit beat third-quarter profit estimates by 3 cents a share, as revenue jumped 26 percent to $329 million. The personal finance software maker cited a strong tax season. Novell managed to squeak by already lowered profit estimates. The Internet software provider earned 2 cents a share, revenues fell to $302 million. VA Linux also out with results late today. That company reported a third quarter loss of 13 cents per share, 10 cents smaller than expected. VA Linux said revenues jumped more than eight-fold to $34 million. In light after hours trading: Intuit gained nearly a point, Novell lost more than 1 1/2, VA Linux jumped more 2 1/2. That was late trading, after losing 5 3/4 during the regular trading session.

BAY: In tonight's tech watch: another disappointing day for Lycos shareholders. The stock lost another $1.50 today. It has taken a beating since it formally announced plans to merge with Terra Networks. On May 16, the two companies spelled out their merger plans, and since then, Lycos shares have plummeted 28 percent. So why are investors giving it the thumbs down? Robert Davis, CEO of Lycos, joins us now from Boston.

Welcome back.

ROBERT DAVIS, PRESIDENT & CEO, LYCOS: How are you?

BAY: Good.

Lycos today at $52.46, below the deal price. The market seems to be saying either that the deal is not going to go through or that Terra is too expensive. Do you have another alternative?

DAVIS: Well, I object to the characterization, Willow. I think it's off-base. Really, the market in this same period of time, the Nasdaq, has fallen 15 percent. Amazon.com, without a deal, has fallen 35 percent in the same period of time. Today, the Nasdaq was down 6 percent and Lycos was down 3. I would say that's outperforming the market.

One last point I want to give you, is in the three weeks preceding the deal, three weeks preceding the deal, Lycos was up 90 percent, despite a horrible market. And in the three weeks preceding the deal to today, Lycos is still up 37 percent, despite the fact that so many other Internet stocks have been crushed. The investigator enthusiasm for this deal is overwhelming. But as we all know, we never fight a red tape, and that's exactly what's going on in the market.

BAY: I'm sorry, I'm not understanding what you think the market is saying about this deal?

DAVIS: The market is enthusiastic about this deal. I've spent plenty of time with investor over the course of the last few days. Overwhelmingly, investors are supportive of the transactions.

The point that I'm making is that the Nasdaq itself is being punished. If you look the rumors of this deal, of course, were widely reported just leading up to this; Lycos stock ran up on solely the rumor of this transaction. The Lycos stock was running up pretty handsomely because of this. And the thing I don't want the lose sight of, is that if we start with the period from the time that people started to report about this deal until today, Lycos was up 37 percent, and Internets stocks and the Nasdaq overall has been punished in a big way. The enthusiasm for this is very, very strong.

VARNEY: A broader-based question, if I may. Almost everything Internet, from b-2-b to e-commerce is taking a dreadful beating in this market. On a broad picture here, do you think that perhaps our idea of what the Internet could do has gone too far to fast, we've overstepped ourselves here, do you think?

DAVIS: Yes, that I might with. I think in some cases, that's very much been the case. We had, unfortunately, I think a lot of companies group together in one very broad-based segment and said this is the Web, and that's really not the case. We have, as in many market, we have some very strong companies that are doing quite well for themselves, and weaker some businesses. There are far too many companies on the Web today that haven't identified an earnings model for themselves, and dome of that I think adds to the challenges that we look at when we sector there classified overall.

BAY: Bob, this is ideal you described to me as a match made in heaven, one with every conceivable benefit. Are you shocked by the market reaction? How do you feel?

DAVIS: Well, I'm disappointed by the downturn, but I guess timing is everything. It's impossible to fight a market that is off as much as it was today and what we've seen since the deal. I mean, you've been reporting this evening, accurately so, how much the Nasdaq has been off.

What I'm very encouraged by is the dialogue that I have with key shareholders with Lycos, almost to a person, they're expressing tremendous support for the transaction. In fact, I go a step further and say, I've yet to find a single shareholder, at any scale, that has expressed anything but very, very positive support for the transaction, and the reason is we're just a much stronger company after this combination. We'll generate, pro forma, 2001 $900 million in revenue. We're in 37 countries around the world. BAY: Clearly a vigorous attempt. Bob Davis, thanks for joining us tonight.

DAVIS: Great to see you.

VARNEY: And we've got a lot more news, including a breaking news on the Airlines. UAL reportedly makes a bid for U.S. Airways.

BAY: MONEYLINE continues right after this.

(COMMERCIAL BREAK)

VARNEY: And coming up in our next half hour, more on the late- day sell-off that knocked the Nasdaq to its knees. With the techs now down five days in a row, we'll take a look at what could lie ahead.

BAY: Plus, is the nation's biggest airline angling for U.S. Airways? We'll have the latest on that breaking story.

VARNEY: And as Disney pulls the plug on toysmart.com, we'll talk with the e-tailers chief executive to find out what went wrong.

All that and more next on MONEYLINE.

(COMMERCIAL BREAK)

BAY: In tonight's headlines, new that could rock the airline industry. "The Financial Times" reports that United parent has made a big bid for U.S. Airways. And we're down to the final hours before Congress votes on China trade. Will the White House muster the votes for a landmark piece of legislation? Plus, on the eve of hearings whether to split up Microsoft, we take a special look at the software giant and why a federal judge ruled that the company broke the law.

VARNEY: But first, much more on our top story: another terrible day on Wall Street as the tech picked up speed and momentum. The Nasdaq fell for the fifth-straight session to its lowest point of the year. It's down a huge 22 percent since January 1. After drifting lower in the morning, the Nasdaq lost its footing in the final few hours of trading, closing down 199 points -- that is 6 percent -- all the way back to 3164. The same pattern held true on the Dow, as the blue chips nearly held their own midafternoon before a late-day slide brought it down to 10,422, off 120 points.

Now checking some of the biggest movers, first on the Nasdaq: Intel dropped 8 1/2. Cisco down nearly 5. Sun Microsystems down 8. Qualcomm truly slumped, down more than 9. And Oracle lost nearly 5 1/4 points. Now check the blue chips: Microsoft was down a point. Hewlett-Packard off more than 2. GM down another near 2 1/2 points. IBM was off more than 1 1/2 on the day.

Behind the market bloodshed, the looming shadow of the Federal Reserve. As the Fed tightens credit to slow the red-hot U.S. economy, a whole lot of investors are getting nervous about what is happening to their portfolios.

Kitty Pilgrim has more.

(BEGIN VIDEOTAPE)

KITTY PILGIRM, CNN CORRESPONDENT (voice-over): Slowly but steadily notching lower, the Nasdaq composite has dropped more than 550 points, or nearly 15 percent, since last Tuesday, when the Federal Reserve hiked interest rates by 50 basis points. Many analysts point to the weakness of the market and the low volume and say, now is not the time to fight the facts.

LOUISE YAMADA, SALOMON SMITH BARNEY: You don't fight the Fed. And the Fed always seems to put a lid on the market when interest rates are going up, but in terms of technology, you've already burst a speculative bubble, and when you've done that kind of damage, it takes time to repair.

PILGRIM: The situation is so bad, historical comparisons are being made. Ned Davis calls this -- quote -- the "worst bear market ever" for the high-tech Nasdaq as we know now it. Davis' evidence: the Nasdaq sold of 36 percent in the crash of 1987 and is down 37 percent since the high on March 10 of this year.

Several factors are working against recovery. One is the probability of yet another Fed move pushing interest rates higher this summer, the traditional slow season for technology.

UNIDENTIFIED MALE: The headwinds are out there. The Fed is going to slow down the economy. That means we're going to have less liquidity in the system, and liquidity is the gasoline that runs the engine. And if there's less liquidity, there's less money available going into capital spending and there's less money available going into stocks and bonds.

PILGRIM: And even optimists admit, until the next Fed meeting, don't look for miracles.

THOMAS GALVIN, DONALDSON, LUFKIN & JENRETTE: The market, obviously, I think, continues to be possessed with the demon of the Fed, and that continues to lead it to this buyer strike. So I don't think the fundamentals have changed. Obviously investor sentiment has been crushed, and that's going to take several weeks to continue to try and build it back.

(END VIDEOTAPE)

PILGRIM: One positive note: Many of the solid tech companies have sold off and are at valuations that are starting to appeal. Now with some cash building up on the sidelines, recovery may be swift once investors decide to wade in again -- Stuart, Willow.

BAY: Thank you.

VARNEY: All right, let's move on now to the hottest debate in Washington. It's the down-to-the-wire vote on granting permanent normal trade relations to China. At stake, whether Congress will do away with its annual review of China's market and social conditions. For the latest on the vote, we go to Chris Black at the White House.

CHRIS BLACK, CNN CORRESPONDENT: Stuart, I'm on Capitol Hill.

And as the debate has begun and this evening on the House floor, the momentum in running strongly in favor of passage tomorrow. Buy emotions are running high on both sides, particularly among opponents. Nine Democrats came out in favor of the legislation today. One Democrat, Jim Oberstar, a Democrat from Minnesota, just announced that he would vote against the bill tomorrow morning because he can't be guaranteed that the iron workers in his home district will be protected against unfair competition from China.

There's tense lobbying on both sides from organized labor and even corporate CEOs, who are buttonholing undecided members. President Clinton has cleared his schedule for tomorrow to be available, to make last-minute appeals to Democrats and Republicans. The president has been the lobbyist-in-chief on this issue. He's been offering all sorts of blandishments to undecided lawmakers, from rides on Air Force One to invitations to state dinners.

But in the end, everyone is predicting a very, very close vote. Democrats and some Republicans who represent swing districts are not inclined to antagonize organized labor in an election year, unless they have to -- Stuart.

VARNEY: Chris Black on Capitol Hill. Thank you, Chris.

Up next on MONEYLINE, more on that breaking news story we've been following, "The Financial Times" reports that UAL is making a bid for U.S. Air. We'll have the report of who broke this story up next.

VARNEY: MONEYLINE continues.

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VARNEY: A developing story in the airline story tonight: "The Financial Times" reports that UAL, the parent of United Airlines, has made a $4 billion bid for U.S. Airways.

Joining us now is the man who broke that story for the "FT," Andrew Edgecliffe-Johnson.

Andrew, welcome to MONEYLINE.

ANDREW EDGECLIFFE-JOHNSON, "FINANCIAL TIMES": Thank you.

VARNEY: Now is this a formal bid, not just talked about, it's a formal bid.

EDGECLIFFE-JOHNSON: We're just describing it as advanced negotiations, because we understand that the United board of directors has already approved the board. The U.S. Airways board is still negotiating and discussing money stuff as we speak. But we have every expectation they will approve it, too. But two other groups of people will be crucial in whether this deal succeeds or fails, and that's employees and the regulators.

VARNEY: Can you tell us why United is making this bid? What is their strategy here? Picking up a cheap asset?

EDGECLIFFE-JOHNSON: A lot of airline stocks have been in the doldrums, probably because fuel prices went through the roof early this year and there's been a lot of speculation about consolidation in the industry. For once, at last, things are beginning to go right for this industry, demand is exceeding supply, and so it's a more stable background against which they these companies can consider consolidation. Now this deal would give United real supremacy on the east coast of the U.S. And I would also significantly boost the Star Alliance, which is United's alliance with Lufthansa of Germany, and that's one in the eye for the American Allies and British Airways alliance, One World.

BAY: You mentioned two groups, employees, regulators. Start with employees. What issues are they likely to face there?

EDGECLIFFE-JOHNSON: Well, between these two companies, they employ almost 150,000 people. And historically, deals in this industry have foundered on employee issues. Pilot unions and flight attendant issues have been very hostile to some mergers, which of course heavy cuts. Now we understand the job cuts in this deal will not be heavy at all. They've been very sensitive to that issue. And so they seem to have gone all out to try and counteract that.

BAY: You've been very clear about putting that forward as part of the deal's proposal.

EDGECLIFFE-JOHNSON: That's what we're hearing at the "FT."

VARNEY: Did the U.S. Airways board meet this afternoon to discuss this deal? Is there any word as to their reaction to it?

EDGECLIFFE-JOHNSON: We believe it's an agreed friendly deal. As we understand it, Steven Wolf, who has been the architect of U.S. Airways turnaround over the last four years, has agreed to step down and hand over the reigns of power to the United board, by and large.

BAY: How long do you suspect before we hear something about this formally? Any way to tell?

EDGECLIFFE-JOHNSON: These are very advanced negotiations, so I would expect confirmation as early as tomorrow.

VARNEY: Forgive me for asking a reporter to speculate, but would you speculate that this may set off some consolidation within the whole airline industry in America?

EDGECLIFFE-JOHNSON: We're seeing some signs of that, not just in America, but globally already. And so I'd say the background is a little bit more favorable now for these deals. We've got British Airways today in the U.s. saying that it is in the market for a European alliance of some sort, and there is a lot of talk that it might get into bed with the Dutch carrier KLM. VARNEY: Andrew Edgecliffe-Johnson from the "Financial Times." Thank you very much for joining us, Andrew.

EDGECLIFFE-JOHNSON: Thank you.

VARNEY: Willow.

BAY: In tonight's "Corporate Briefs," drug giants Merck and Schering-Plough are teaming up to develop and sell two new drugs. Merck's Zocor and Schering-Plough's Ezetimibe will be combined into one tablet for cholesterol control. And Schering-Plough's well-known Claritin will be combined with Merck's Singulair to combat asthma and allergies. The two drugs will be equally owned and managed by both companies.

And Philips Electronics is buying 60 percent of medical transcription service MedQuist in a $1.2 billion deal.

Checking how Wall Street reacted to the news: Schering-Plough up nearly 1 3/4, Merck rose 1 1/2, Philips Electronics down nearly a half, and MedQuist up 3 3/4.

VARNEY: And in tonight's "Sector Focus," we have paper stocks: heavy selling today following a downgrade from Deutsche Banc Alex Brown. The brokerage house warned of weak domestic demand and rising inventory levels. Georgia Pacific, the biggest loser: It was down more than 3 1/2 points. That's over 10 percent. Weyerhaeuser, Boise Cascade, Mead, and the Dow component International Paper also dropped on the day.

BAY: Still to come on MONEYLINE, tales of woe on the Web. The dot.com shakeout claims another casualty.

VARNEY: We'll talk to the chief executive of Toysmart.com, and that is next.

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BAY: Lately it seems everyone is doing it: issuing a tracking stock. The New York Times today said its shareholders have approved a plan to create a new class of stock to track its Internet business. But the owner of The New York Times and the "Boston Globe" said it would carefully think about market conditions before going ahead with the offering.

The New York Times stock added more than one point.

VARNEY: "The Times" has good reason to be cautious. The once red-hot IPO market seems to have entered a deep freeze. A popular industry and a high-tech-sounding name used to be enough to attract hordes of buyers to a new stock. But that wasn't the case today for Integrated Circuit Systems. The chipmaker's Nasdaq debut fell flat. The stock went public at $13 a share, $2 below the expected price range, and then it actually closed below the offering price. It was down a point on the day. BAY: And one company has been completely turned off by the recent turmoil in the IPO market: Noosh, which provides a business-to- business services for the print industry today, pulled its stock offering. The company said it doubted whether it could get the price it wanted in the current market. It had planned to raise at least $44 million with the IPO.

VARNEY: The tech tremors ripping through the IPO market are doing the same to the Internet business. The latest example: furniture retailer Living.com says it's laid off 13 percent of its work force. It let go of 50 workers yesterday, saying it needed to streamline operations. Amazon owns an 18 percent stake in Living.com.

Another dot.com casualty: Toysmart. Disney is shutting it down, just nine months after buying a majority stake in the online toy store. When MONEYLINE tried to log onto the Web site, we saw this message that Toysmart is no longer taking orders.

Now, joining us now from Boston to talk about this Web shakeout, David Lord, Toysmart's present and chief executive.

David, thanks very much for joining us on a rather difficult day. Thanks for being with us, sir.

DAVID LORD, CEO, TOYSMART: Thank you, Stuart.

VARNEY: Can you put this in a nutshell as to exactly what went wrong?

LORD: Well, I don't know if there's a nutshell large enough to contain it, but I think the combination of financial markets, the competitive toy industry, and Disney's changing its Internet strategy -- any one of which I think we could have overcome -- but the combination of the three was just too great a challenge for us to overcome.

VARNEY: Now, your publicity says that you only sell "good toys": no guns, no Barbie dolls, no gender -- I mean gender-neutral toys. Did you think that you had a problem with the product line?

LORD: No, I don't think we have a problem with the product line. Our customers are extremely satisfied, among the most loyal on the Internet. We've won the customer service ratings. We're No. 1 on Bizrate.com. I think the customers have spoken, and especially today: all of the feedback I've gotten from customers -- Where am I going to go now?

I think the problem in this industry is it's a niche industry, and the products themselves are not marketed as opposed to Barbie and those products.

VARNEY: Now, your average demographic was a woman with two or more children, 25 to 39 years old, with a household income of about $80,000 a year.

LORD: Correct. VARNEY: Now, were you not reaching enough of those people or did those people not want your product?

LORD: Well, I think we fell victim to what many of the Internet companies really felt in the holiday season, which was the incredible noise on the Internet. I think it devalued everyone's investment in marketing and advertising, and we certainly fell victim to that. I think that's why we partnered with the Walt Disney Company, because we realized that was coming on and we felt like that was the security blanket, that we needed to really go out and reach those -- those parents.

VARNEY: I just have sort of a technical question here.

LORD: Yes.

VARNEY: But I believe you got 1.6 million visitors to your site in the month of December. Can you tell me how many sales resulted from those 1.6 million visits?

LORD: That's still not public information, but I will say we averaged a 6 percent conversion rate.

VARNEY: Is that high for the industry or low? I mean, can you give us some perspective on that?

LORD: It's high for a shopping site. So we were one of the higher-rated sites. We reached -- we averaged top 40 for Media Metrix again, Nielsen for the holiday shopping season. So we think we did quite well.

VARNEY: Could you just give us a big picture view here? My question is this: Is e-commerce just not going to be as big or come on as fast as we thought just a few months ago?

LORD: Well, I certainly think the heard mentality of the marketplace over the last 12 months has hurt many of the companies that have been struggling to build a good business model. So I think where we are 3 years old and have been building, and unfortunately we fall victim to the marketplace itself, I think it always falls back to fundamentals. You have to build a good company. You have to have a path of profitability. And we ran out of cash and time to really do those things.

VARNEY: David Lord from Toysmart.com, we thank you very much for your candor, and thanks very much for being with us on a difficult day.

Thank you, sir.

LORD: Thank you, Stuart.

BAY: Next on MONEYLINE, a crash course on the most important antitrust battle of the digital age.

VARNEY: Everything you need to know about the U.S. versus Microsoft as a federal judge prepares for penalty hearings in the antitrust battle. That's coming up in a special MONEYLINE briefing book report.

(COMMERCIAL BREAK)

VARNEY: Paul Allen is known as, shall we say, a cagey investor. Well, it turns out he also has an uncanny sense of timing. The co- founder of Microsoft today revealed that he sold $3.4 billion worth of the software company's shares from mid-February until the beginning of March. The stock was selling for around $97 a share at that time. It's now trading 35 percent below that level, at 63. Allen's spokesperson says, well, yes, he routinely sells stock just to diversify his portfolio.

BAY: The battle for the future of the company that Paul Allen co-founded reaches a critical moment tomorrow. Microsoft and the government return to court for hearings in the so-called "remedy phase" of the antitrust trial. Both sides will argue over how to punish the company. Judge Thomas Penfield Jackson may hint at whether he'll move to break up Microsoft, as the Justice Department has proposed. If the complexity of the case makes your eyes glaze over, we have a refresher course for you.

Stave Young with our special MONEYLINE "Briefing Book" on the Microsoft antitrust case.

(BEGIN VIDEOTAPE)

STEVE YOUNG, CNN CORRESPONDENT (voice-over): The trial was triggered by the tactics Microsoft used to crush Netscape. The software giant said it put its Web browser into Windows as a consumer convenience. But the judge found Microsoft welded its browser into the operating system used by 95 percent of desktop PCs to stop Netscape from becoming a Windows alternative. Dozens of Microsoft e- mails show that strategy was devised at the highest level, and the judge found it to be monopoly abuse.

He also cited government testimony from Netscape's former CEO, Jim Barksdale, and its co-founder, Marc Andreessen, that Microsoft tried to force Netscape into an illegal division of markets. He didn't believe Microsoft chairman Bill Gates, who said in videotaped testimony he knew nothing about that.

(BEGIN VIDEO CLIP)

BILL GATES, CHAIRMAN, MICROSOFT: First I heard anything about that meeting and somebody trying to characterize that in some negative way it was an Andreessen quote that was in "The Wall Street Journal" very recently and it surprised me.

(END VIDEO CLIP)

YOUNG: The trial widened from the initial Netscape focus and the judge found Microsoft illegally pressured many companies, including Intel, AOL, IBM, AT&T, Compaq, Intuit and Apple. Microsoft says a bedrock principle is its right to innovate, but the judge ruled that Microsoft killed innovation from other companies it considered threatening. For example, multimedia technology from Intel called Native Signal Processing, or NSP. The judge was convinced by testimony that Microsoft warned it would shun Intel's next microprocessor unless the chip giant dropped NSP. An Intel witness called that threat credible and terrifying.

DAVID BOIES, GOVERNMENT LEAD LAWYER: What Microsoft was attempting to do was deliberately to stop Intel from competing, not because they feared Intel had poor quality, but because they knew Intel had good quality.

YOUNG: The judge was also disturbed by some of Microsoft's videotaped demonstrations that looked fake.

TODD NIELSEN, MICROSOFT: The filming was done on actors, or acting machines, that were over in a separate building on the Microsoft campus. Those acting machines were not under the same strict clean room, you know, virgin constituencies.

YOUNG: The company's credibility wore thinnest in tense exchanges between its chairman and the government's hired gun. For example, Boies asked Gates if he was concerned about competition from Netscape.

(BEGIN VIDEO CLIP)

GATES: I don't know. What do you mean concerned?

BOIES: What is it about the word "concerned" that you don't understand?

GATES: I'm not sure what you mean by it.

(END VIDEO CLIP)

YOUNG: And was Gates recollection refreshed by e-mail Boies showed him?

(BEGIN VIDEO CLIP)

GATES: I don't know, you mean, repress my recollection.

(END VIDEO CLIP)

YOUNG: The judge found Microsoft obtained a monopoly legally, but broke the law to maintain that monopoly. He said the arrows in Microsoft's quiver included withholding critical technical information, imposing exclusionary contracts, employing sabotage, and using the price of Windows as a weapon.

That came up in some of the most riveting testimony when an IBM witness talked about Big Blue's acquisition of Lotus Development Corporation and its plans to put Lotus application software on IBM PCs. The witness said Microsoft retaliated by withholding a license for Windows '95 until 15 minutes before the launch, depriving IBM of a sales boost from all the publicity.

In light of all that, the government wants Bill Gates' company broken into two parts which would be free to compete. Initially, one would sell Windows, the other would sell software applications and everything else. The government also wants Bill Gates and CEO Steve Ballmer to accept restrictions on Microsoft's business practices that would stay in place for 10 years.

(END VIDEOTAPE)

YOUNG: Microsoft says the break-up idea should be thrown out immediately and the company placed under fewer and less sweeping restrictions for four years. That's the final fight over the so- called remedy that starts to play out tomorrow in Judge Thomas Penfield Jackson's court -- Stuart, Willow.

BAY: Steve, what do you think we'll see tomorrow?

YOUNG: I think we'll see about an hour to two hours from each side and I suspect the judge won't make a final decision about break up, he'll want to hear more from Microsoft.

BAY: Steve, never eye glazed when you're around, thank you.

VARNEY: Good one.

BAY: Up next, "Ahead of the Curve," some of what you need to know tonight before those markets open tomorrow.

VARNEY: You're watching MONEYLINE.

(COMMERCIAL BREAK)

VARNEY: Here is some of what could move the markets tomorrow. Do watch the shares of U.S. Airways. "The Financial Times" is reporting that UAL has made a $4 billion bid for the company. Also, as we mentioned, the penalty phase begins in the government's antitrust trial against Microsoft. And things really start to heat up on the China trade front. A vote on the country's permanent normal trade relations slated for tomorrow in the House of Representatives.

Also tomorrow, expect earnings reports from several retailers, including Neiman Marcus. The company is due out with third-quarter results, expected, 85 cents a share. Polo Ralph Lauren also expected out tomorrow with fourth-quarter earnings of maybe 32 cents. Costco Wholesale on tap to report third-quarter results, maybe 27 cents. And keep an eye on shares of VA Linux, Intuit, and Novell. All three tech companies reported better than expected results after today's closing bell.

BAY: That is MONEYLINE for this Tuesday. I'm Willow Bay.

VARNEY: And I'm Stuart Varney, and we thank you for joining us. Good night from New York. "CROSSFIRE" is next.

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