PAGE 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
___TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
COMMISSION FILE NUMBER 1-5046
CNF Inc.
(Formerly CNF Transportation Inc.)
Incorporated in the State of Delaware
I.R.S. Employer Identification No. 94-1444798
3240 Hillview Avenue, Palo Alto, California 94304
Telephone Number (650) 494-2900
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months and (2) has been subject to such
filing requirements for the past 90 days. Yes xx No
Number of shares of Common Stock, $.625 par value,
outstanding as of July 31, 2001: 48,842,907
PAGE 2
CNF INC.
FORM 10-Q
Quarter Ended June 30, 2001
___________________________________________________________________________
___________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2001 and December 31, 2000 3
Statements of Consolidated Operations -
Three and six months Ended June 30, 2001 and 2000 5
Statements of Consolidated Cash Flows -
Six months Ended June 30, 2001 and 2000 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 27
SIGNATURES 27
PAGE 3
ITEM 1. FINANCIAL STATEMENTS
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
2001 2000
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 131,470 $ 104,515
Trade accounts receivable, net 757,310 881,268
Other accounts receivable (Note 11) 86,351 59,478
Operating supplies, at lower of average
cost or market 23,166 42,271
Prepaid expenses 55,039 47,301
Deferred income taxes 107,391 105,502
Net current assets of discontinued
operations (Note 2) 2,904 -
Total Current Assets 1,163,631 1,240,335
PROPERTY, PLANT AND EQUIPMENT, AT COST
Land 148,451 130,101
Buildings and leasehold improvements 716,358 692,312
Revenue equipment 694,732 797,444
Other equipment 440,064 420,788
1,999,605 2,040,645
Accumulated depreciation and amortization (915,820) (934,123)
1,083,785 1,106,522
OTHER ASSETS
Deferred charges and other assets (Note 10) 134,799 137,393
Capitalized software, net 85,291 89,829
Unamortized aircraft maintenance 52,301 242,468
Goodwill, net 249,864 254,887
Net non-current assets of discontinued
operations (Note 2) 105,914 173,507
628,169 898,084
TOTAL ASSETS $2,875,585 $3,244,941
The accompanying notes are an integral part of these statements.
PAGE 4
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
2001 2000
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 393,960 $ 418,157
Accrued liabilities (Note 11) 318,443 317,650
Accrued claims costs 139,906 145,558
Current maturities of long-term debt and
capital leases 8,753 7,553
Income taxes payable - 1,777
Net current liabilities of discontinued
operations (Note 2) - 68,214
Total Current Liabilities 861,062 958,909
LONG-TERM LIABILITIES
Long-term debt and guarantees (Notes 4 and 10) 430,653 424,116
Long-term obligations under capital leases 110,473 110,533
Accrued claims costs 110,076 82,502
Employee benefits 267,409 252,482
Other liabilities and deferred credits 43,271 51,163
Aircraft lease return provision 76,998 33,851
Deferred income taxes 11,129 144,463
Total Liabilities 1,911,071 2,058,019
COMMITMENTS AND CONTINGENCIES (Note 11)
COMPANY-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES OF SUBSIDIARY TRUST
HOLDING SOLELY CONVERTIBLE DEBENTURES OF
THE COMPANY (Note 9) 125,000 125,000
SHAREHOLDERS' EQUITY
Preferred stock, no par value; authorized
5,000,000 shares:
Series B, 8.5% cumulative, convertible,
$.01 stated value; designated 1,100,000
shares; issued 815,632 and 824,902
shares, respectively 8 8
Additional paid-in capital, preferred stock 124,049 125,459
Deferred compensation, Thrift and Stock Plan (76,952) (80,602)
Total Preferred Shareholders' Equity 47,105 44,865
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,559,257
and 55,426,605 shares, respectively 34,725 34,642
Additional paid-in capital, common stock 333,879 331,282
Retained earnings 631,189 855,314
Deferred compensation, restricted stock (1,561) (1,423)
Cost of repurchased common stock (6,725,170
and 6,770,628 shares, respectively) (165,818) (166,939)
832,414 1,052,876
Accumulated Other Comprehensive Loss (Note 6) (40,005) (35,819)
Total Common Shareholders' Equity 792,409 1,017,057
Total Shareholders' Equity 839,514 1,061,922
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,875,585 $3,244,941
The accompanying notes are an integral part of these statements.
PAGE 5
CNF INC.
STATEMENTS OF CONSOLIDATED OPERATIONS
(Dollars in thousands except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
REVENUES $1,256,608 $1,401,146 $2,535,073 $2,723,040
Costs and Expenses
Operating expenses (Note 5) 1,095,964 1,148,795 2,169,749 2,235,590
General and administrative 127,913 124,926 255,115 248,280
Depreciation 44,187 40,294 87,937 80,570
Restructuring and related charges (Note 5) 340,531 - 340,531 -
1,608,595 1,314,015 2,853,332 2,564,440
OPERATING INCOME (LOSS) (351,987) 87,131 (318,259) 158,600
Other Income (Expense)
Investment income 641 593 1,370 864
Interest expense (7,234) (7,881) (15,027) (14,281)
Dividend requirement on preferred securities
of subsidiary trust (Note 9) (1,563) (1,563) (3,126) (3,126)
Miscellaneous, net 482 1,309 1,309 3,988
(7,674) (7,542) (15,474) (12,555)
Income (Loss) from Continuing Operations
before Taxes (359,661) 79,589 (333,733) 146,045
Income Tax Benefit (Provision) 133,852 (33,825) 123,481 (62,069)
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE ACCOUNTING CHANGE (225,809) 45,764 (210,252) 83,976
Cumulative Effect of Accounting
Change, net of tax (Note 1) - - - (2,744)
Net Income (Loss) (225,809) 45,764 (210,252) 81,232
Preferred Stock Dividends 2,079 2,072 4,119 4,106
NET INCOME (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS $ (227,888) $ 43,692 $ (214,371) $ 77,126
Weighted-Average Common Shares Outstanding
Basic shares 48,760,668 48,463,040 48,704,866 48,440,350
Diluted shares 48,760,668 56,361,884 48,704,866 56,377,108
Earnings (Loss) per Common Share (Note 8)
Basic
Net Income (Loss) before Accounting
Change $ (4.67) $ 0.90 $ (4.40) $ 1.65
Accounting Change, net of tax - - - (0.06)
Net Income (Loss) Applicable to Common
Shareholders $ (4.67) $ 0.90 $ (4.40) $ 1.59
Diluted
Net Income (Loss) before Accounting
Change $ (4.67) $ 0.80 $ (4.40) $ 1.46
Accounting Change, net of tax - - - (0.05)
Net Income (Loss) Applicable to Common
Shareholders $ (4.67) $ 0.80 $ (4.40) $ 1.41
The accompanying notes are an integral part of these statements.
PAGE 6
CNF INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
Six Months Ended
June 30,
2001 2000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 104,515 $ 146,263
OPERATING ACTIVITIES
Net income (loss) (210,252) 81,232
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Cumulative effect of accounting change,
net of tax - 2,744
Restructuring and related charges (Note 5) 340,531 -
Depreciation and amortization 102,831 91,785
Decrease in deferred income taxes (135,469) (14,184)
Amortization of deferred compensation 3,650 3,961
Provision for uncollectible accounts (Note 5) 38,013 7,964
Loss (gain) from sales of property 1,136 (641)
Gain from sale of securities - (2,619)
Changes in assets and liabilities:
Receivables 76,648 (80,122)
Prepaid expenses (7,738) (12,416)
Unamortized aircraft maintenance 5,970 (24,608)
Accounts payable (26,792) 5,661
Accrued liabilities (5,709) (31,668)
Accrued incentive compensation (24,790) 647
Accrued claims costs 21,922 3,816
Income taxes (1,777) 48,572
Employee benefits 14,927 16,877
Aircraft lease return provision (14,457) (1,091)
Deferred charges and credits (26) 28,286
Other (6,467) (3,702)
Net Cash Provided by Operating Activities 172,151 120,494
INVESTING ACTIVITIES
Capital expenditures (113,063) (111,183)
Software expenditures (9,159) (11,022)
Proceeds from sale of securities - 2,619
Proceeds from sales of property 1,006 6,223
Net Cash Used in Investing Activities (121,216) (113,363)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt - 197,452
Repayment of long-term debt, guarantees and
capital leases (7,559) (96,455)
Repayment of short-term borrowings, net - (40,000)
Proceeds from exercise of stock options 2,234 707
Payments of common dividends (9,754) (9,702)
Payments of preferred dividends (5,376) (5,470)
Net Cash Provided by (Used in) Financing
Activities (20,455) 46,532
Net Cash Provided by Continuing Operations 30,480 53,663
Net Cash Used in Discontinued Operations (3,525) (63,484)
Increase (Decrease) in Cash and Cash
Equivalents 26,955 (9,821)
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 131,470 $ 136,442
The accompanying notes are an integral part of these statements.
PAGE 7
CNF INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principal Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements of CNF Inc.
(formerly CNF Transportation Inc.) and its wholly owned subsidiaries (the
Company) have been prepared by the Company, without audit by independent
public accountants, pursuant to the rules and regulations of the Securities
and Exchange Commission. In the opinion of management, the consolidated
financial statements include all normal recurring adjustments necessary to
present fairly the information required to be set forth therein. Certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted from these statements pursuant to such rules and
regulations and, accordingly, should be read in conjunction with the
consolidated financial statements included in the Company's 2000 Annual
Report to Shareholders.
Recognition of Revenues
As a result of recent pronouncements, including SEC Staff Accounting
Bulletin No. 101, the Company elected to prospectively adopt, effective
January 1, 2000, a change in accounting method for recognition of its
freight transportation revenue to a preferable method. The Company now
recognizes the allocation of freight transportation revenue between
reporting periods based on relative transit time in each reporting period
with expenses recognized as incurred. Previously, revenue was recognized
when freight was received for shipment and the estimated costs of
performing the transportation service were accrued.
Reclassification
Certain amounts in prior year financial statements have been
reclassified to conform to current year presentation.
2. Discontinued Operations
On November 3, 2000, Emery Worldwide Airlines (EWA) and the U.S.
Postal Service (USPS) announced an agreement to terminate their contract
for the transportation and sortation of Priority Mail (the "Priority Mail
contract"). The contract was originally scheduled to terminate in the first
quarter of 2002, subject to renewal options. Under terms of the agreement,
the USPS on January 7, 2001, assumed operating responsibility for services
covered under the contract, except certain air transportation and related
services, which were terminated effective April 23, 2001.
PAGE 8
The USPS agreed to reimburse EWA for Priority Mail contract
termination costs, including costs of contract-related equipment,
inventory, and operating lease commitments, up to $125 million (the
"Termination Liability Cap"). On January 7, 2001, the USPS paid EWA $60
million toward the termination costs. The termination agreement provides
for this provisional payment to be adjusted if actual termination costs are
greater or less than $60 million, in which case either the USPS will be
required to make an additional payment or EWA will be required to return a
portion of the provisional payment.
The termination agreement preserves EWA's right to pursue claims for
underpayment that it believes are owed by the USPS under the Priority Mail
contract and EWA has initiated litigation in the U.S. Court of Federal
Claims for that purpose. These claims are to recover costs of operating
under the contract as well as profit and interest thereon.
As a result of the contract termination, the results of operations of
EWA's Priority Mail contract have been segregated and classified as
discontinued operations in the Statements of Consolidated Operations for
all periods presented. Assets and liabilities have been reclassified in the
Consolidated Balance Sheets from their historical classifications to
separately reflect them as net assets of discontinued operations. Cash
flows related to discontinued operations have been segregated and
classified separately as net cash flows from discontinued operations in the
Statements of Consolidated Cash Flows.
The net assets of discontinued operations were as follows:
(Dollars in thousands)
June 30, December 31,
2001 2000
---------- -----------
Current assets $ 12,882 $ 26,120
Property, plant and equipment, net - 66,316
Long-term receivables and other assets 169,599 184,348
---------- -----------
Total assets of discontinued operations 182,481 276,784
---------- -----------
Current liabilities 9,978 94,334
Long-term liabilities 63,685 77,157
---------- -----------
Total liabilities of
discontinued operations 73,663 171,491
---------- -----------
Net assets of discontinued operations $ 108,818 $ 105,293
========== ===========
PAGE 9
The Priority Mail contract provided for the re-determination of prices
paid to EWA, which gave rise to unbilled revenue. Unbilled revenue
representing contract change orders or claims was included in revenue only
when it was probable that the change order or claim would result in
additional contract revenue and if the amount could be reliably estimated.
Unbilled revenue represents the accrual of revenue sufficient only to
recover costs and therefore does not include profit or interest on either
unbilled revenue or profit. Any unbilled revenue that EWA does not recover
would be written off and reflected in operating results for discontinued
operations in the then current period. Any amount of litigation award in
excess of unbilled revenue would be reflected as income from discontinued
operations in the then current period. Accordingly, no operating profit
was recognized in connection with the Priority Mail contract since the
third quarter of 1999, when EWA filed a claim for proposed higher prices.
As described above, no operating profit has been recognized in
connection with the Priority Mail contract since the third quarter of 1999.
Revenue of $10.2 million was recognized in the first quarter of 2001 for
the period prior to the USPS assuming operating responsibility for services
covered under the contract on January 7, 2001. Subsequent to January 7,
2001, no revenue was recognized under the Priority Mail contract. In the
second quarter and first half of last year, revenue from the Priority Mail
contract was $126.8 million and $262.0 million, respectively.
As a result of the termination of the Priority Mail contract, a loss
from discontinuance of $13.5 million was recognized in the third quarter of
2000, net of $8.6 million of income tax benefits. The loss from
discontinuance included estimates for the write-down of non-reimbursable
assets, legal and advisory fees, costs of providing transportation services
for approximately three months following the effective termination date,
certain employee-related costs and other non-reimbursable costs from
discontinuance. The amount of accrued loss from discontinuance related to
EWA's Priority Mail contract recognized at June 30, 2001 and December 31,
2000 was $1.1 million and $22.1 million, respectively, and was included in
net current assets (liabilities) of discontinued operations in the
Consolidated Balance Sheets.
The amount of unbilled revenue and reimbursable contract termination
costs related to EWA's Priority Mail contract recognized at June 30, 2001
and December 31, 2000 was $189.0 million and $176.2 million, respectively.
Unbilled revenue and reimbursable termination costs at June 30, 2001 and
December 31, 2000 were included in net non-current assets of discontinued
operations in the Consolidated Balance Sheets. As described above, the
Company is pursuing recovery of this amount plus profit and interest
thereon. Long-term Receivables and Other Assets for the discontinued
Priority Mail operations at June 30, 2001 has been reduced by certain
payments received from the USPS in the first half of 2001.
Unbilled revenue at June 30, 2001 and December 31, 2000 was reduced by
a $102.1 million payment received from the USPS in the fourth quarter of
2000. The payment was based on rate adjustments resulting from a decision
in August 2000 in the U.S. Court of Federal Claims under which the USPS
increased its provisional rate paid to EWA for transportation and sortation
of Priority Mail for 2000. The USPS also increased the provisional rate
paid to EWA for 1999.
PAGE 10
3. New Accounting Standards
As described in Note 10 of the Notes to Consolidated Financial
Statements, we adopted SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities" effective January 1, 2001. The $3.0 million cumulative
effect of adopting the new accounting standard decreased Other
Comprehensive Loss.
In June 2001, the Financial Accounting Standards Board issued SFAS
141, "Business Combinations", effective July 1, 2001, and SFAS 142,
"Goodwill and Other Intangible Assets", effective for CNF on January 1,
2002. SFAS 141 prohibits pooling-of-interests accounting for acquisitions.
SFAS 142 specifies that goodwill and some intangible assets will no longer
be amortized but instead will be subject to periodic impairment testing.
The Company is in the process of evaluating the financial statement impact
of adoption of SFAS 142.
4. Debt
In July 2001, the Company entered into a new five-year $350 million
unsecured revolving credit facility that replaced an existing five-year
facility. The new revolving facility is available for cash borrowings and
issuance of letters of credit. Borrowings under the agreement, which
terminates on July 3, 2006, bear interest at a rate based upon specified
indices plus a margin dependent on the Company's credit rating. The
agreement contains various restrictive covenants, including a limitation on
the incurrence of additional indebtedness and the requirement for specified
levels of consolidated net worth and fixed-charge coverage.
PAGE 11
5. Significant Unusual Items
Emery Restructuring Charge
On June 14, 2001, the Company announced an operational restructuring
of Emery Worldwide's North American operations. The redesigned North
American network is intended to restructure Emery's capacity to align with
management's estimates of future business prospects for the domestic heavy
airfreight segment. The air transportation provided by Emery Worldwide
Airlines (EWA), a separate CNF subsidiary included in the Emery Worldwide
reporting segment, is the primary cost component of the North American
network.
Emery's restructuring plan includes a redesign of the North American
operations, revisions to service areas, and removing underutilized aircraft
from service. These actions are designed to address changes in market
conditions, which have deteriorated due to an adverse domestic economy, and
to a lesser extent, loss of business to ground transportation providers and
the recent loss of the Express Mail and Priority Mail contracts with the
U.S. Postal Service.
The $340.5 million restructuring charge consisted primarily of non-
cash impairment charges, including $184.2 million for unamortized aircraft
maintenance and $89.7 million for aircraft operating supplies, equipment
and other assets. Asset impairment charges were based on an evaluation of
cash flows for North American operations and, for certain assets,
independent appraisal. Also included in the restructuring charge was
$66.6 million for estimated future cash expenditures for aircraft lease
rental, return and other obligations. As of June 30, 2001, no cash
payments had been made to reduce the accrued aircraft lease obligations and
return provision. The Company expects the timing of the payments will be
based on the planned disposition dates of the aircraft.
Menlo Write-Off Due to Failure of Customer
On July 13, 2001, the Company announced that Menlo would take a write-
off over two quarters due to the business failure of Homelife, a retail
furniture business and customer of Menlo Logistics. The $31.6 million
second-quarter charge in 2001, which was recorded in Operating Expenses,
includes primarily the write-off of uncollectable accounts receivable.
Menlo expects to recognize an additional loss of approximately $6 million
in the third quarter of 2001, primarily for the write-off of uncollectable
accounts receivable from revenue to be billed in the third quarter of 2001.
Also, Menlo announced that it would lay-off approximately 400 full-time
employees who worked on the Homelife account.
PAGE 12
6. Comprehensive Income (Loss)
Comprehensive Income (Loss), which is a measure of all changes in
equity except those resulting from investments by owners and distributions
to owners, was as follows:
Three Months Ended Six Months Ended
(Dollars in thousands) June 30, June 30,
2001 2000 2001 2000
--------- --------- --------- ---------
Net income (loss) $(225,809) $ 45,764 $(210,252) $ 81,232
Other comprehensive income (loss)
Cumulative effect of change
in accounting for derivative
instruments and hedging
activities (Note 10) - - 3,005 -
Change in fair value of cash
flow hedges (Note 10) 175 - (2,621) -
Foreign currency translation
adjustments (3,096) (3,297) (4,570) (7,917)
--------- --------- --------- ---------
(2,921) (3,297) (4,186) (7,917)
--------- --------- --------- ---------
Comprehensive income (loss)$(228,730) $ 42,467 $(214,438) $ 73,315
========= ========= ========= =========
The following is a summary of the components of Accumulated Other
Comprehensive Loss:
June 30, December 31,
(Dollars in thousands) 2001 2000
----------- -----------
Cumulative effect of change in accounting
for derivative instruments and hedging
activities (Note 10) $ 3,005 $ -
Accumulated change in fair value of cash
flow hedges (Note 10) (2,621) -
Accumulated foreign currency translation
adjustments (31,948) (27,378)
Minimum pension liability adjustment (8,441) (8,441)
----------- -----------
Accumulated other comprehensive loss $ (40,005) $ (35,819)
=========== ===========
PAGE 13
7. Business Segments
Selected financial information about the Company's continuing
operations is shown below. The Company evaluates performance of the
segments based on several factors. However, the primary measurement focus
is based on segment operating results, excluding significant non-recurring
and/or unusual items. The prior period has been reclassified to exclude
discontinued operations.
Three Months Ended Six Months Ended
(Dollars in thousands) June 30, June 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Revenues
Con-Way Transportation $ 489,386 $ 528,672 $ 958,587 $1,037,424
Emery Worldwide 530,205 637,138 1,113,495 1,241,122
Menlo Logistics 237,574 241,600 462,938 455,176
Other 7,718 10,275 16,920 25,527
---------- ---------- ---------- ----------
1,264,883 1,417,685 2,551,940 2,759,249
Intercompany Eliminations
Con-Way Transportation (193) (250) (424) (598)
Emery Worldwide (47) (7,517) (139) (13,766)
Menlo Logistics (3,071) (3,049) (5,840) (6,722)
Other (4,964) (5,723) (10,464) (15,123)
---------- ---------- ---------- ----------
(8,275) (16,539) (16,867) (36,209)
External Revenues
Con-Way Transportation 489,193 528,422 958,163 1,036,826
Emery Worldwide 530,158 629,621 1,113,356 1,227,356
Menlo Logistics 234,503 238,551 457,098 448,454
Other 2,754 4,552 6,456 10,404
---------- ---------- ---------- ----------
$1,256,608 $1,401,146 $2,535,073 $2,723,040
========== ========== ========== ==========
Operating Income (Loss)
before Significant
Unusual Items
Con-Way Transporation$ 42,431 $ 65,452 $ 79,166 $ 122,148
Emery Worldwide [1] (29,911) 12,861 (36,458) 19,685
Menlo Logistics 9,352 8,473 17,523 16,111
Other [2] (1,723) 345 (6,354) 656
---------- ---------- ---------- ----------
$ 20,149 $ 87,131 $ 53,877 $ 158,600
---------- ---------- ---------- ----------
Significant Unusual Items:
Emery restructuring
charge $ (340,531) $ - $ (340,531) $ -
Menlo loss on failure
of customer (31,605) - (31,605) -
---------- ---------- ---------- ----------
Operating Income (Loss) $ (351,987) $ 87,131 $ (318,259) $ 158,600
========== ========== ========== ==========
[1] For the three and six months ended June 30, 2001, results included a
$4.7 million loss from a legal settlement on previously returned
aircraft.
[2] For the three and six months ended June 30, 2001, results included
$1.7 million and $6.3 million, respectively, of operating losses
related to startup costs for Vector SCM, a joint venture formed with
General Motors in December 2000 that is accounted for under the equity
method.
PAGE 14
8. Earnings Per Share
Basic earnings per share was computed by dividing net income (loss)
from continuing operations before accounting change by the weighted-average
common shares outstanding. The calculation for diluted earnings per share
from continuing operations was calculated as shown below. For the three
and six months ended June 30, 2001, convertible securities and stock
options were anti-dilutive and were therefore excluded from the calculation
of diluted earnings per share.
Three Months Ended Six Months Ended
(Dollars in thousands except June 30, June 30,
per share data) 2001 2000 2001 2000
---------- ---------- ---------- ----------
Earnings (Loss):
Net income (loss) from
Continuing Operations $ (227,888) $ 43,692 $ (214,371)$ 79,870
Add-backs:
Dividends on Series B
preferred stock, net
of replacement funding - 377 - 706
Dividends on preferred
securities of subsidiary
trust, net of tax - 954 - 1,908
---------- ---------- ---------- ----------
$ (227,888) $ 45,023 $ (214,371)$ 82,484
---------- ---------- ---------- ----------
Shares:
Basic shares (weighted-average
common shares outstanding) 48,760,668 48,463,040 48,704,866 48,440,350
Stock option dilution - 320,860 - 358,774
Series B preferred stock - 4,452,984 - 4,452,984
Preferred securities of
subsidiary trust - 3,125,000 - 3,125,000
---------- ---------- ---------- ----------
48,760,668 56,361,884 48,704,866 56,377,108
---------- ---------- ---------- ----------
Diluted Earnings (Loss) Per
Share from Continuing
Operations before
Accounting Change $ (4.67) $ 0.80 $ (4.40)$ 1.46
========== ========== ========== ==========
9. Preferred Securities of Subsidiary Trust
On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust
wholly owned by the Company, issued 2,500,000 of its $2.50 Term Convertible
Securities, Series A (TECONS) to the public for gross proceeds of $125
million. The combined proceeds from the issuance of the TECONS and the
issuance to the Company of the common securities of the Trust were invested
by the Trust in $128.9 million aggregate principal amount of 5% convertible
subordinated debentures due June 1, 2012 (the Debentures) issued by the
Company. The Debentures are the sole assets of the Trust.
Holders of the TECONS are entitled to receive cumulative cash
distributions at an annual rate of $2.50 per TECONS (equivalent to a rate
of 5% per annum of the stated liquidation amount of $50 per TECONS). The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the TECONS, to the extent the Trust has funds available
therefore and subject to certain other limitations (the Guarantee). The
Guarantee, when taken together with the obligations of the Company under
the Debentures, the Indenture pursuant to which the Debentures were issued,
and the Amended and Restated Declaration of Trust of the Trust including
its obligations to pay costs, fees, expenses, debts and other obligations
of the Trust (other than with respect to the TECONS and the common
securities of the Trust), provide a full and unconditional guarantee of
amounts due on the TECONS.
PAGE 15
The Debentures are redeemable for cash, at the option of the Company,
in whole or in part, on or after June 1, 2000, at a price equal to 103.125%
of the principal amount, declining annually to par if redeemed on or after
June 1, 2005, plus accrued and unpaid interest. In certain circumstances
relating to federal income tax matters, the Debentures may be redeemed by
the Company at 100% of the principal plus accrued and unpaid interest. Upon
any redemption of the Debentures, a like aggregate liquidation amount of
TECONS will be redeemed. The TECONS do not have a stated maturity date,
although they are subject to mandatory redemption upon maturity of the
Debentures on June 1, 2012, or upon earlier redemption.
Each TECONS is convertible at any time prior to the close of business
on June 1, 2012, at the option of the holder into shares of the Company's
common stock at a conversion rate of 1.25 shares of the Company's common
stock for each TECONS, subject to adjustment in certain circumstances.
10. Derivative Instruments and Hedging Activities
Effective January 1, 2001, the Company adopted SFAS 133, "Accounting
for Derivative Instruments and Hedging Activities," as amended by SFAS 137
and SFAS 138. SFAS 133 establishes accounting and reporting standards
requiring that every derivative instrument, as defined, be recorded on the
balance sheet as either an asset or liability measured at fair value and
that changes in fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. Qualifying hedges allow a
derivative's gains or losses to offset related results on the hedged item
in the income statement or be deferred in Other Comprehensive Income (Loss)
until the hedged item is recognized in earnings.
The Company is exposed to a variety of market risks, including the
effects of interest rates, commodity prices, foreign currency exchange
rates and credit risk. The Company's policy is to enter into derivative
financial instruments only in circumstances that warrant the hedge of an
underlying asset, liability or future cash flow against exposure to the
related risk. Additionally, the designated hedges should have high
correlation to the underlying exposure such that fluctuations in the value
of the derivatives offset reciprocal changes in the underlying exposure.
The Company's policy prohibits entering into derivative instruments for
speculative purposes.
The Company formally documents its hedge relationships, including
identifying the hedge instruments and hedged items, as well as its risk
management objectives and strategies for entering into the hedge
transaction. At hedge inception and at least quarterly thereafter, the
Company assesses whether the derivatives are effective in offsetting
changes in either the cash flows or fair value of the hedged item. If a
derivative ceases to be a highly effective hedge, the Company will
discontinue hedge accounting, and any gains or losses on the derivative
instrument would be recognized in earnings during the period it no longer
qualifies for hedge accounting.
PAGE 16
For derivatives designated as cash flow hedges, changes in the
derivative's fair value are recognized in Other Comprehensive Income (Loss)
until the hedged item is recognized in earnings. Any change in fair value
resulting from ineffectiveness is recognized immediately in earnings. For
derivatives designated as fair value hedges, changes in the derivative's
fair value are recognized in earnings and offset by changes in the fair
value of the hedged item, which are recognized in earnings to the extent
that the derivative is effective.
The Company's cash flow hedges include interest rate swap derivatives
designated to mitigate the effects of interest rate volatility on floating-
rate operating lease payments. Fair value hedges include interest rate
swap derivatives designated to mitigate the effects of interest rate
volatility on the fair value of fixed-rate long-term debt. The Company's
current interest rate swap derivatives qualify for hedge treatment under
SFAS 133.
In accordance with the transition provisions of SFAS 133, the Company
recorded in Other Assets a transition adjustment of $20.6 million to
recognize the estimated fair value of interest rate swap derivatives, a
$4.9 million ($3.0 million after tax) transition adjustment in Accumulated
Other Comprehensive Income (Loss) to recognize the estimated fair value of
interest rate swap derivatives designated as cash flow hedges, and a $15.7
million transition adjustment in Long-Term Debt to recognize the difference
between the carrying value and estimated fair value of fixed-rate debt
hedged with interest rate swap derivatives designated as fair value hedges.
In the second quarter and first half of 2001, the change in the
estimated fair value of the Company's fair value hedges declined $4.9
million and $0.5 million, respectively. The estimated fair value of cash
flow hedges in the second quarter of 2001 increased $287,000 ($175,000
after tax) and declined $4.3 million ($2.6 million after tax) in the first
half of 2001.
11. Commitments and Contingencies
The Company is currently under examination by the Internal Revenue
Service (IRS) for tax years 1987 through 1999 on various issues. In
connection with those examinations, the IRS proposed adjustments for tax
years 1987 through 1990 after which the Company filed a protest and engaged
in discussions with the Appeals Office of the IRS. After those discussions
failed to produce a settlement, in March 2000, the IRS issued a Notice of
Deficiency (the Notice) for the years 1987 through 1990 with respect to
various issues, including aircraft maintenance and matters related to years
prior to the spin-off of Consolidated Freightways Corporation (CFC), the
Company's former long-haul LTL segment, on December 2, 1996. Based upon
the Notice, the total amount of the deficiency for items in years 1987
through 1990, including taxes and interest, was $157 million as of June 30,
2001. The amount originally due under the Notice was reduced in the third
quarter of 2000 by a portion of the Company's $93.4 million payment to the
IRS, which is described below.
In addition to the issues covered under the Notice for tax years 1987
through 1990, the IRS in May 2000 proposed additional adjustments for tax
years 1991 through 1996 with respect to various issues, including aircraft
maintenance and matters relating to CFC for years prior to the spin-off.
Under the Notice, the IRS has assessed a substantial adjustment for
tax years 1989 and 1990 based on the IRS' position that certain aircraft
maintenance costs should have been capitalized rather than expensed for
federal income tax purposes. The Company believes that its practice of
expensing these types of aircraft maintenance costs is consistent with
industry practice and the recently issued Treasury Ruling 2001-4. The
Company intends to vigorously contest the Notice and the proposed
adjustments as they pertain to the aircraft maintenance issue.
PAGE 17
The Company paid $93.4 million to the IRS in the third quarter of 2000
to stop the accrual of interest on amounts due under the Notice for tax
years 1987 through 1990 and under proposed adjustments for tax years 1991
through 1996 for matters relating to CFC for years prior to the spin-off
and for all other issues except aircraft maintenance costs.
There can be no assurance that the Company will not be liable for all
of the amounts due under the Notice and proposed adjustments. As a result,
the Company is unable to predict the ultimate outcome of this matter and
there can be no assurance that this matter will not have a material adverse
effect on the Company's financial condition or results of operations.
As part of the spin-off, the Company and CFC entered into a tax
sharing agreement that provided a mechanism for the allocation of any
additional tax liability and related interest that arise due to adjustments
by the IRS for years prior to the spin-off. In May 2000, the Company and
CFC settled certain federal tax matters relating to CFC on issues for tax
years 1984 through 1990. Under the settlement agreement, the Company
received from CFC cash of $16.7 million, a $20.0 million note due in 2004,
and a commitment to transfer to the Company land and buildings with an
estimated value of $21.2 million.
In the last half of 2000, the Company received real property with an
estimated value of $21.2 million in settlement of CFC's commitment to
transfer land and buildings. Prior to its transfer, the real property
collateralized CFC's obligation to the Company.
In March 2001, the Company entered into an agreement to acquire real
property owned by CFC in settlement of CFC's $20.0 million note due in
2004. The agreement requires a three-way exchange among the Company, CFC
and a third party. In March 2001, the Company acquired real property, which
was previously owned by CFC, from a third party in exchange for a note
payable. Under the agreement, the Company will pay in full the note
payable due to the third party while concurrently receiving an
approximately equal amount of cash from CFC in settlement of the Company's
$20.0 million note receivable due from CFC. If CFC's third party exchange
transaction does not close by late September 2001, the Company has the
right to tender the $20.0 million CFC note in exchange for the Company's
note payable. At June 30, 2001, the third-party note payable and the CFC
note receivable were included in Accrued Liabilities and Other Accounts
Receivable, respectively, in the Consolidated Balance Sheets.
In connection with the spin-off of CFC, the Company agreed to
indemnify certain states, insurance companies and sureties against the
failure of CFC to pay certain worker's compensation, tax and public
liability claims that were pending as of September 30, 1996. In some cases,
these indemnities are supported by letters of credit under which the
Company is liable to the issuing bank and by bonds issued by surety
companies. In order to secure CFC's obligation to reimburse and indemnify
the Company against liability with respect to these claims, CFC had
provided the Company with certain letters of credit. However, the letters
of credit have been terminated, and as of June 30, 2001, CFC's
reimbursement obligations to the Company were unsecured.
In addition to the matters discussed above, the Company and its
subsidiaries are defendants in various lawsuits incidental to their
businesses. It is the opinion of management that the ultimate outcome of
these actions will not have a material impact on the Company's financial
condition or results of operations.
PAGE 18
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unusual Items
On June 14, 2001, we announced an operational restructuring of Emery
Worldwide's North American operations. The redesigned North American
network is intended to restructure Emery's capacity to align with
management's estimates of future business prospects for the domestic heavy
airfreight segment. The air transportation provided by Emery Worldwide
Airlines (EWA), a separate CNF subsidiary included in the Emery Worldwide
reporting segment, is the primary cost component of the North American
network. The $340.5 million restructuring charge ($4.26 per diluted share)
is described below in the Emery Worldwide segment.
In addition to the restructuring charge, Emery in June 2001 also
incurred a $4.7 million loss ($0.06 per diluted share) from a legal
settlement on previously returned aircraft.
On July 13, 2001, we announced that Menlo Logistics would take a write-
off over two quarters due to the business failure of Homelife, a retail
furniture business and customer of Menlo. The $31.6 million second-quarter
charge in 2001 ($0.40 per diluted share), primarily the write-off of
uncollectable accounts receivable, is described below in the Menlo
Logistics segment.
RESULTS OF OPERATIONS
=====================
Net losses applicable to common shareholders of $227.9 million ($4.67
per diluted share) in the second quarter of 2001 and $214.4 million ($4.40
per diluted share) in the first half of 2001 include the unusual items
described above. The significant charges contributed to an effective tax
benefit rate of 37.0% for the first half of 2001. Excluding unusual items,
net income applicable to common shareholders for the second quarter and
first half of 2001 was $8.2 million and $21.7 million, respectively, based
on an effective tax rate of 40.0%. In the second quarter of last year, net
income applicable to common shareholders was $43.7 million ($0.80 per
diluted share). Last year's first-half net income applicable to common
shareholders of $77.1 million ($1.41 per diluted share) included a $2.6
million net gain ($0.03 per diluted share) from the sale of securities and
a $2.7 million net-of-tax loss from the cumulative effect of an accounting
change.
Excluding unusual items, the decline in net income applicable to
common shareholders in the second quarter and first half of 2001, compared
to the same periods last year, was due primarily to lower operating income
and higher other net expenses.
Revenue in the second quarter and first half of 2001 fell 10.3% and
6.9% from the respective periods last year due primarily to declines in
revenue from Con-Way and Emery. We believe that revenue from all reporting
segments in the second quarter and first half of 2001 was adversely
affected by the continuing downturn in the U.S. economy.
The operating loss in the second quarter and first half of 2001 was
$352.0 million and $318.3 million, respectively. Excluding unusual items,
operating income in the second quarter of 2001 declined to $24.8 million
from $87.1 million in the same quarter last year and operating income in
the first half of 2001 declined to $58.6 million from $158.6 million in
last year's first half. The drop in second-quarter and first-half
operating income in 2001 was due primarily to lower operating income from
all reporting segments except Menlo. Excluding the loss on the failure of
Homelife, Menlo's 2001 second-quarter and first-half operating income rose
10.4% and 8.8%, respectively, over the same periods in 2000.
PAGE 19
Other net expense in the second quarter of 2001 increased 1.8% from
last year's second quarter due primarily to a decline in miscellaneous
income, partially offset by an 8.2% decline in interest expense. Lower
interest expense in the 2001 second quarter was due in part to lower
interest expense on long-term debt, which was effectively converted from a
fixed rate to a floating rate with interest rate swaps entered into in
April 2000. Other net expense in the first half of 2001 rose 23.2% due
primarily to a 5.2% increase in interest expense and a $2.6 million net
gain from the sale of securities in the first quarter of last year. The
increase in interest expense in the first half of 2001 was due primarily to
higher interest expense on $200 million of 8 7/8% Notes issued in March
2000, partially offset by an increase in income from the interest rate
swaps that hedge the 8 7/8% Notes and higher capitalized interest compared
to the first half of last year.
The effective tax benefit rate in the second quarter and first half of
2001 of 37.2% and 37.0%, respectively, was revised from the effective tax
rate in 2001 of 42.5% in the second quarter and first half of 2000 due
primarily to the significant unusual charges recognized in June 2001.
Con-Way Transportation Services
Revenue from Con-Way Transportation Services in the second quarter and
first half of 2001 fell 7.4% and 7.6% from the respective periods last
year. The regional carriers' revenue per hundredweight (yield) in the
second quarter and first half of 2001 increased slightly, rising 0.6% and
1.7%, respectively, over last year's second quarter and first half. LTL
tonnage per day (weight) for the same periods fell 3.3% and 3.4%,
respectively, and total weight fell 3.9% for the same second-quarter and
first-half periods last year. Con-Way's management believes that tonnage
declines in the second quarter and first half of 2001 were primarily due to
the continuing downturn in the U.S. economy. Also, Con-Way Truckload
Services, which was sold in August 2000, accounted for revenue of $26.0
million and $50.0 million in last year's second quarter and first six
months, respectively. Yield in the second quarter and first half of 2001
was positively affected by a higher percentage of inter-regional joint
services, which typically command higher rates on longer lengths of haul,
and, to a lesser extent, fuel surcharges.
Con-Way's second-quarter and first-half operating income in 2001
declined 35.2% from the same periods in 2000 due primarily to lower
revenue, higher employee benefit expenses and an increase in costs for
vehicular claims. Higher diesel fuel costs in the second quarter and first
half of 2001 were mitigated by Con-Way's fuel surcharge. The second
quarter and first half of 2001 were adversely affected by higher losses
from Con-Way Logistics (formerly Con-Way Integrated Services) compared to
the same periods last year and operating losses incurred during the start-
up of Con-Way Air Express, a domestic air freight forwarding company that
began operations in May 2001.
Emery Worldwide
In June 2001, we announced an operational restructuring of Emery
Worldwide's North American operations. The redesigned North American
network is intended to restructure Emery's capacity to align with
management's estimates of future business prospects for the domestic heavy
airfreight segment. The air transportation provided by Emery Worldwide
Airlines (EWA), a separate CNF subsidiary included in the Emery Worldwide
reporting segment, is the primary cost component of the North American
network.
PAGE 20
Emery's restructuring plan includes a redesign of the North American
operations, revisions to service areas, and the parking of underutilized
aircraft. These actions are designed to address changes in market
conditions, which have deteriorated due to an adverse domestic economy, and
to a lesser extent, loss of business to ground transportation providers and
the recent loss of the Express Mail and Priority Mail contracts with the
U.S. Postal Service.
The $340.5 million restructuring charge consisted primarily of non-
cash impairment charges, including $184.2 million for unamortized aircraft
maintenance and $89.7 million for aircraft operating supplies, equipment
and other assets. Asset impairment charges were based on an evaluation of
cash flows for North American operations and, for certain assets,
independent appraisal. Also included in the restructuring charge was
$66.6 million for estimated future cash expenditures for aircraft lease
rental, return and other obligations. As of June 30, 2001, no cash
payments had been made to reduce the accrued aircraft lease obligations
and return provision. The Company expects the timing of the payments
will be based on the planned disposition dates of the aircraft.
Emery's management intends to continue to pursue aggressive growth in
its "asset-light" businesses, such as international air and ocean
forwarding, customs brokerage, logistics management and expedited delivery
services.
In its North American airfreight business, Emery's management intends
to continue positioning Emery as a premium service provider, focusing on
achieving higher yield with a reduced cost structure. With its redesigned
North American network, Emery's management intends to focus on increasing
revenue from second-day and deferred services.
Internationally, Emery's management will focus on expanding its
variable-cost-based operations and actively renegotiating airhaul rates in
an effort to improve operating margins, mitigate higher fuel prices, and
balance directional capacity.
In the second quarter and first half of 2001, Emery's revenue declined
15.8% and 9.3%, respectively, from the same periods last year due primarily
to lower North American and International airfreight revenue and lower
revenue from an Express Mail contract with the U.S. Postal Service.
International airfreight revenue per day in the second quarter and
first half of 2001, including fuel surcharges, fell 11.8% and 5.4%,
respectively, from the same periods last year due primarily to a decline in
pounds transported per day (weight), partially offset by higher revenue per
pound (yield). Second-quarter and first-half International yield in 2001
increased 1.7% and 4.5%, respectively, from last year's second quarter and
first half. International weight over the same period declined 13.3% and
8.8%, respectively. Emery's management believes that lower international
weight in the second quarter and first half of 2001 was due in part to a
worsening global economy, which adversely affected business levels in Latin
America, Asia and other international markets served by Emery.
North American second-quarter and first-half airfreight revenue per
day, including fuel surcharges, declined 23.9% and 18.5%, respectively,
from the same periods last year. Although North American airfreight yield
in the second quarter and first half of 2001 increased 7.8% and 8.7%,
respectively, over the second quarter and first half of 2000, weight per
day over the same periods declined 29.4% and 24.5%, respectively. The 2001
second-quarter and first-half decline in North American weight was
attributable in part to lower business levels from the manufacturing
industry, particularly the automotive and technology sectors. Emery's
management believes that the lower business levels in the first two
quarters of 2001 were adversely affected by the continuing downturn in the
U.S. economy and, to a lesser extent, loss of business to ground
transportation providers and Emery's ongoing yield management, which is
designed to eliminate or reprice certain low-margin business. Yields in
the second quarter and first half of 2001 were positively affected by an
increase in the percentage of higher-yielding guaranteed services and
Emery's ongoing yield management efforts.
PAGE 21
Emery's operating loss in the second quarter and first half of 2001
was $370.4 million and $377.0 million, respectively. The second-quarter
and first-half operating loss for Emery in 2001, excluding the
restructuring charge and loss from a legal settlement on returned aircraft,
was $25.2 million and $31.8 million, respectively. In the same periods
last year, Emery earned operating income of $12.9 million and $19.7
million, respectively. The decline in operating results in the second
quarter and first half of 2001 was primarily due to lower North American
and International airfreight revenue, lower revenue from the Express Mail
contract referred to below; an increase in North American airhaul costs as
a percentage of revenue, and higher employee benefit costs. Higher jet
fuel costs in the first two quarters of 2001 were mitigated by Emery's fuel
surcharge.
In January 2001, the USPS and Federal Express Corporation (FedEx)
announced an exclusive agreement under which FedEx will transport Express
Mail and Priority Mail. EWA presently transports Express Mail and other
classes of mail under a contract with the USPS scheduled to expire in
January 2004, (the "Express Mail Contract"). In January 2001, EWA filed a
lawsuit in the U.S. Court of Federal Claims against the USPS, alleging that
the contract with FedEx violates the USPS procurement regulations, which
require that all purchases over $10,000 "must be made on the basis of
adequate competition whenever feasible or appropriate," and that the
contract violates the USPS regulatory requirement to provide "fair and
equal treatment" to all potential suppliers. The Court ruled against EWA.
The matter is now on appeal.
In May 2001, EWA received from the USPS a notice of termination for
convenience of the Express Mail Contract, effective as of August 26, 2001.
In the second quarter and first half of 2001, EWA recognized revenue
of $41.9 million and $89.4 million, respectively, from the transportation
of the Express Mail Contract, compared to $49.4 million and $99.8 million
in the respective periods last year. Operating income from the Express
Mail contract in the second quarter and first half of 2001 was just $64,000
and $3.6 million, respectively, compared to $5.5 million and $11.6 million,
respectively, in the same periods last year. EWA believes it is entitled
to its costs of early termination of the Express Mail Contract. The USPS's
early termination of the Express Mail Contract will likely have a material
adverse effect on our consolidated results of operations and financial
condition.
Menlo Logistics
In July 2001, we announced that Menlo would take a write-off over two
quarters due to the business failure of Homelife, a retail furniture
business and customer of Menlo. The $31.6 million second-quarter charge in
2001, which was recorded in Operating Expenses, includes primarily the
write-off of uncollectable accounts receivable. Menlo expects to recognize
an additional loss of approximately $6 million in the third quarter of
2001, primarily for the write-off of uncollectable accounts receivable from
revenue to be billed in the third quarter of 2001. Also, Menlo announced
that it would lay-off approximately 400 fulltime employees who worked on
the Homelife account. In the second quarter and first half of 2001, Menlo
recognized revenue from Homelife of $27.4 million and $45.4 million,
respectively, compared to $3.7 million for both the second quarter and
first half of last year. Excluding Menlo's significant charge, operating
income earned by Menlo from the Homelife account in the second quarter and
first half of 2001 was $0.6 million and $2.6 million, respectively,
compared to $1.1 million earned from Homelife in both the second quarter
and first half of last year.
PAGE 22
Menlo's second-quarter revenue in 2001 declined 1.7% from last year's
second quarter and first-half revenue in 2001 increased 1.9% from the same
period in 2000 due to growth in logistics contracts and consulting fees,
including higher revenue from the Homelife account. Menlo's management
believes that the continuing downturn in the U.S. economy had an adverse
effect on business levels of some of its other customers but the resulting
adverse effect on Menlo's revenue was partially mitigated by Menlo's
ability to secure new logistics contracts.
A portion of Menlo's revenue is attributable to logistics contracts
for which Menlo manages the transportation of freight but subcontracts the
actual transportation and delivery of products to third parties. Menlo
refers to this as purchased transportation. Menlo's net revenue (revenue
less purchased transportation) in the second quarter and first half of 2001
was $70.3 million and $137.7 million, respectively, compared to $65.1
million and $130.1 million in the respective periods last year.
Menlo's operating loss in the second quarter and first half of 2001
was $22.3 million and $14.1 million. Excluding the loss on the failure of
Homelife, Menlo's 2001 second-quarter and first-half operating income rose
10.4% and 8.8%, respectively, over the same periods in 2000 due primarily
to increased revenue from core supply chain projects and consulting fees.
Other Operations
In the second quarter and first half of 2001, the Other segment
included the operating results of Road Systems and Vector SCM, a joint
venture formed with General Motors in December 2000 to provide logistics
services to General Motors. The operating results of Vector SCM are
reported as an equity investment in the Other segment. Operating losses
related to the start-up of Vector SCM in the second quarter and first half
of 2001 were $1.7 million and $6.3 million, respectively.
Discontinued Operations
- -----------------------
On November 3, 2000, EWA and the USPS announced an agreement to
terminate their contract for the transportation and sortation of Priority
Mail. Under terms of the agreement, the USPS on January 7, 2001 assumed
operating responsibility for services covered under the contract, except
certain air transportation and related services, which were terminated
effective April 23, 2001. Accordingly, the results of operations, net
assets, and cash flows of the Priority Mail operations have been segregated
and classified as discontinued operations. A summary of selected terms of
the agreement, summary financial data, and related information are included
in Note 2 of the Notes to Consolidated Financial Statements.
PAGE 23
The USPS agreed to reimburse EWA for Priority Mail contract
termination costs, including costs of contract-related equipment,
inventory, and operating lease commitments, up to $125 million (the
"Termination Liability Cap"). On January 7, 2001, the USPS paid EWA $60
million toward the termination costs. The termination agreement provides
for this provisional payment to be adjusted if actual termination costs are
greater or less than $60 million, in which case either the USPS will be
required to make an additional payment or EWA will be required to return a
portion of the provisional payment. We believe that contract termination
costs incurred by EWA are reimbursable under the termination agreement and
do not exceed the Termination Liability Cap. However, there can be no
assurance that all termination costs incurred by Emery will be recovered.
The termination agreement preserves EWA's right to pursue claims for
underpayment that it believes are owed by the USPS under the Priority Mail
contract and EWA has initiated litigation in the U.S. Court of Federal
Claims for that purpose. These claims are to recover costs of operating
under the contract as well as profit and interest thereon.
The amount of unbilled revenue and reimbursable contract termination
costs related to EWA's Priority Mail contract recognized at June 30, 2001
and December 31, 2000 was $189.0 million and $176.2 million, respectively.
Unbilled revenue represents the accrual of revenue sufficient only to
recover costs and therefore does not include profit or interest on either
unbilled revenue or profit. Any unbilled revenue that EWA does not recover
would be written off and reflected in operating results for discontinued
operations in the then current period. Any amount of litigation award in
excess of unbilled revenue would be reflected as income from discontinued
operations in the then current period. We believe our position with
respect to claims for underpayment under the Priority Mail contract is
reasonable and well founded; however, there can be no assurance that
litigation will result in an award sufficient to recover unbilled revenue
recognized under the contract or any award at all. The government is
investigating matters relating to the Priority Mail contract, and EWA has
received subpoenas for documents from a grand jury in Massachusetts and the
USPS Inspector General. Accordingly, we can give no assurance that matters
relating to the Priority Mail contract with the USPS will not have a
material adverse effect on our financial condition or results of
operations.
LIQUIDITY AND CAPITAL RESOURCES
===============================
Continuing Operations
- ---------------------
In the first half of 2001, cash and cash equivalents increased $27.0
million to $131.5 million. Cash provided by operating activities in the
2001 first half was sufficient to fund investing and financing activities.
Operating activities in the 2001 first half generated net cash of
$172.2 million compared to $120.5 million of cash generated by operating
activities in the same period last year. Cash from operations in the first
half of 2001 was provided primarily by depreciation and amortization, which
are adjustments to reconcile net income (loss) to net cash provided by
operating activities, and the collection of receivables. Positive cash
flow was also provided by net income before the significant non-cash
charges described in "Results of Operations" and the related tax effect,
which contributed to a significant decline in deferred taxes. Positive
operating cash flows in the first half of 2001 were partially offset by a
decline in accounts payable and accrued incentive compensation.
PAGE 24
Investing activities in the first half of 2001 consumed $121.2 million
compared to $113.4 million used in the first half of last year. Capital
expenditures of $113.1 million in the 2001 first half increased slightly
from $111.2 million in last year's first half due primarily to a $22.3
million increase in Con-Way's capital expenditures, partially offset by a
$17.0 million reduction at Emery. Higher capital expenditures from Con-Way
were primarily due to $53.2 million of cash spent for the planned periodic
replacement of linehaul equipment. In the first half of last year, Con-Way
financed the acquisition of $50.7 million of equipment with operating
leases.
Financing activities in the first half of 2001 used cash of $20.5
million compared to first-half financing activities that provided $46.5
million last year. In the first half of last year, a portion of the net
proceeds of $197.5 million from the issuance in March 2000 of $200 million
of 8 7/8% Notes due 2010 were used to repay short-term and long-term
borrowings outstanding under lines of credit.
In July 2001, we entered into a new five-year $350 million unsecured
revolving credit facility that replaced an existing five-year facility
completed in 1996. The new revolving facility matures July 3, 2006 and is
also available for the issuance of letters of credit. At June 30, 2001, no
borrowings were outstanding under the existing $350 million facility and
$62.5 million of letters of credit were outstanding, leaving available
capacity of $287.5 million. Also, at June 30, 2001, we had $100.0 million
of uncommitted lines with no outstanding borrowings. Under other unsecured
facilities, $83.5 million in letters of credit and bank guarantees were
outstanding at June 30, 2001.
Our ratio of total debt to capital increased to 36.3% at June 30, 2001
from 31.4% at December 31, 2000 due primarily to the significant unusual
charges described in "Results of Operations".
Discontinued Operations
- -----------------------
As described above under "Results of Operations," cash flows from the
Priority Mail operations have been segregated and classified as net cash
flows from discontinued operations in the Statements of Consolidated Cash
Flows. As described in Note 2 of the Notes to Consolidated Financial
Statements, EWA in January 2001 received a $60 million provisional payment
toward reimbursable termination costs, as provided under a termination
agreement signed by EWA and the USPS in November 2000.
CYCLICALITY AND SEASONALITY
===========================
Our businesses operate in industries that are affected directly by
general economic conditions and seasonal fluctuations, both of which affect
demand for transportation services. In the trucking and airfreight
industries, for a typical year, the months of September and October usually
have the highest business levels while the months of January and February
usually have the lowest business levels.
MARKET RISK
===========
We are exposed to a variety of market risks, including the effects of
interest rates, commodity prices, foreign currency exchange rates and
credit risk. Our policy is to enter into derivative financial instruments
only in circumstances that warrant the hedge of an underlying asset,
liability or future cash flow against exposure to some form of commodity,
interest rate or currency-related risk. Additionally, the designated
hedges should have high correlation to the underlying exposure such that
fluctuations in the value of the derivatives offset reciprocal changes in
the underlying exposure. Our policy prohibits entering into derivative
instruments for speculative purposes.
PAGE 25
We may be exposed to the effect of interest rate fluctuations in the
fair value of our long-term debt and capital lease obligations, as
summarized in Notes 4 and 5 of our consolidated financial statements
included in our 2000 Annual Report to Shareholders. As described in Note
10 of the Notes to Consolidated Financial Statements, we use interest rate
swaps to mitigate the impact of interest rate volatility on cash flows
related to operating lease payments and on the fair value of our fixed-rate
long-term debt. At June 30, 2001, we had not entered into any derivative
contracts to hedge our foreign currency exchange exposure.
ACCOUNTING STANDARDS
====================
As described in Note 10 of the Notes to Consolidated Financial
Statements, we adopted SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities" effective January 1, 2001. The $3.0 million cumulative
effect of adopting the new accounting standard decreased Other
Comprehensive Loss.
In the second quarter and first half of 2001, the decline in the
estimated fair value of our fair value hedges of $4.9 million and $0.5
million, respectively, resulted in reductions to Other Assets and Long-Term
Debt. During the second quarter of 2001, the estimated fair value of cash
flow hedges increased $287,000 ($175,000 net of tax). In the first half of
2001, the estimated fair value of cash flow hedges declined $4.3 million
($2.6 million net of tax). Changes in the estimated fair value of cash
flow hedges were included in Other Assets and Other Comprehensive Income
(Loss).
In June 2001, the Financial Accounting Standards Board issued SFAS
141, "Business Combinations", effective July 1, 2001, and SFAS 142,
"Goodwill and Other Intangible Assets", effective for CNF on January 1,
2002. SFAS 141 prohibits pooling-of-interests accounting for acquisitions.
SFAS 142 specifies that goodwill and some intangible assets will no longer
be amortized but instead will be subject to periodic impairment testing.
The Company is in the process of evaluating the financial statement impact
of adoption of SFAS 142.
PAGE 26
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
As previously reported, the Company has been designated a potentially
responsible party (PRP) by the EPA with respect to the disposal of
hazardous substances at various sites. The Company expects its share of
the clean-up costs will not have a material adverse effect on the Company's
financial condition or results of operations.
The Department of Transportation, through its Office of Inspector
General, and the Federal Aviation Administration has been conducting an
investigation relating to the handling of so-called hazardous materials by
Emery. The Department of Justice has joined in the investigation and is
seeking to obtain additional information through the grand jury process.
The investigation is ongoing and Emery is cooperating fully. The Company
is unable to predict the outcome of this investigation.
EWA has received subpoenas issued by a grand jury in Massachusetts and
the USPS Inspector General for documents relating to the Priority Mail
contract. EWA has provided, or is in the process of providing, the
documents.
On February 16, 2000, a DC-8 cargo aircraft operated by EWA personnel
crashed shortly after take-off from Mather Field, near Sacramento,
California. The crew of three was killed. The cause of the crash has not
been conclusively determined. The National Transportation Safety Board is
conducting an investigation and has scheduled a public hearing for August
22 and 23, 2001. The Company is currently unable to predict the outcome of
this investigation or the effect it may have on Emery or the Company.
Emery, EWA and the Company have been named as defendants in wrongful
death lawsuits brought by the families of the three deceased crew members,
seeking compensatory and punitive damages. Emery, EWA and the Company also
may be subject to other claims and proceedings relating to the crash, which
could include other private lawsuits seeking monetary damages and
governmental proceedings. Although Emery, EWA and the Company maintain
insurance that is intended to cover claims that may arise in connection
with an airplane crash, there can be no assurance that the insurance will
in fact be adequate to cover all possible types of claims. In particular,
any claims for punitive damages or any sanctions resulting from possible
governmental proceedings would not be covered by insurance.
As a domestic airline, EWA operates under a certificate issued by the
Federal Aviation Administration ("FAA"). As such, EWA is subject to
maintenance, operating and other safety-related regulations promulgated by
the FAA, and routinely undergoes FAA inspections. Based on recent
inspections, the FAA has identified a number of instances where it believes
EWA has failed to comply with applicable regulations, and in some cases has
issued notices of proposed civil penalties. EWA disagrees with certain of
the FAA's findings, and is engaged in discussions with the FAA to try to
resolve the matters in dispute. However, there can be no assurance that
EWA will be able to reach agreement with the FAA on all matters in dispute,
and if no agreement is reached, the FAA may seek to impose sanctions on
EWA. The FAA has the authority to seek civil and criminal penalties and to
suspend or revoke an airline's operating certificate.
Emery and the Company had been named as defendants in a lawsuit
arising from a dispute with an aircraft lessor regarding the return of six
McDonnell Douglas DC-8 aircraft following lease termination. Plaintiff was
seeking damages in the amount of approximately $16 million, in addition to
holdover rent and interest. This suit was dismissed after Emery agreed to
pay certain holdover rent and make certain repairs to the aircraft before
returning them to the lessor.
PAGE 27
Con-Way and the Company have been named as defendants in a class
action lawsuit filed in Federal District Court in San Francisco for alleged
violations of federal and state wage and hour laws regarding classification
of freight operations supervisors for purposes of overtime pay. No motion
has yet been made for certification of the class. Because the lawsuit is
at a preliminary stage, the Company is unable to predict the outcome of
this litigation or the effect it may have on Con-Way or the Company.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99(a) Computation of Ratios of Earnings (Loss) to Fixed
Charges -- the ratios of earnings to fixed charges
were -6.3x and 3.9x for the six months ended
June 30, 2001 and 2000, respectively.
(b) Computation of Ratios of Earnings (Loss) to Combined
Fixed Charges and Preferred Stock Dividends -- the
ratios of earnings to combined fixed charges and
preferred stock dividends were -5.9x and 3.7x for the
six months ended June 30, 2001 and 2000, respectively.
(b)Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
June 30, 2001.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company (Registrant) has duly caused this Form
10-Q Quarterly Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CNF Inc.
(Registrant)
August 9, 2001 /s/Greg Quesnel
Greg Quesnel
President, Chief Executive Officer
and Chief Financial Officer