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 September 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 October 31, 2001: 48,844,527
PAGE 2
CNF INC.
FORM 10-Q
Quarter Ended September 30, 2001
___________________________________________________________________________
___________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2001 and December 31, 2000 3
Statements of Consolidated Operations -
Three and nine months Ended September 30,
2001 and 2000 5
Statements of Consolidated Cash Flows -
Nine months Ended September 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 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 6. Exhibits and Reports on Form 8-K 38
SIGNATURES 38
PAGE 3
ITEM 1. FINANCIAL STATEMENTS
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2001 2000
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 395,008 $ 104,515
Trade accounts receivable, net 731,273 881,268
Other accounts receivable 54,926 59,478
Operating supplies, at lower of average
cost or market 22,590 42,271
Prepaid expenses 49,027 47,301
Deferred income taxes 108,548 105,502
Total Current Assets 1,361,372 1,240,335
PROPERTY, PLANT AND EQUIPMENT, AT COST
Land 148,260 130,101
Buildings and leasehold improvements 733,646 692,312
Revenue equipment 705,368 797,444
Other equipment 447,940 420,788
2,035,214 2,040,645
Accumulated depreciation and amortization (939,128) (934,123)
1,096,086 1,106,522
OTHER ASSETS
Deferred charges and other assets (Note 10) 170,720 137,393
Capitalized software, net 85,773 89,829
Unamortized aircraft maintenance 41,076 242,468
Goodwill, net 247,302 254,887
Net non-current assets of discontinued
operations (Note 2) - 173,507
544,871 898,084
TOTAL ASSETS $3,002,329 $3,244,941
The accompanying notes are an integral part of these statements.
PAGE 4
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2001 2000
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 360,037 $ 418,157
Accrued liabilities 300,021 317,650
Accrued claims costs 130,910 145,558
Current maturities of long-term debt and
capital leases 8,753 7,553
Income taxes payable 65,517 1,777
Net current liabilities of discontinued
operations (Note 2) 12,265 68,214
Total Current Liabilities 877,503 958,909
LONG-TERM LIABILITIES
Long-term debt and guarantees (Notes 4 and 10) 447,823 424,116
Long-term obligations under capital leases 110,441 110,533
Accrued claims costs 119,156 82,502
Employee benefits 266,778 252,482
Other liabilities and deferred credits 108,674 51,163
Aircraft lease return provision 76,998 33,851
Deferred income taxes 6,444 144,463
Total Liabilities 2,013,817 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 812,259 and 824,902
shares, respectively 8 8
Additional paid-in capital, preferred stock 123,536 125,459
Deferred compensation, Thrift and Stock Plan (75,127) (80,602)
Total Preferred Shareholders' Equity 48,417 44,865
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,544,049
and 55,426,605 shares, respectively 34,715 34,642
Additional paid-in capital, common stock 333,605 331,282
Retained earnings 654,904 855,314
Deferred compensation, restricted stock (1,019) (1,423)
Cost of repurchased common stock
(6,707,799 and 6,770,628 shares,
respectively) (165,389) (166,939)
856,816 1,052,876
Accumulated Other Comprehensive Loss (Note 6) (41,721) (35,819)
Total Common Shareholders' Equity 815,095 1,017,057
Total Shareholders' Equity 863,512 1,061,922
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,002,329 $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 Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
REVENUES $1,184,959 $1,409,613 $3,720,032 $4,132,653
Costs and Expenses
Operating expenses (Note 5) 1,029,824 1,186,451 3,199,573 3,422,041
General and administrative 121,008 127,105 376,123 375,385
Depreciation 39,497 41,117 127,434 121,687
Restructuring and related charges (Note 5) - - 340,531 -
1,190,329 1,354,673 4,043,661 3,919,113
OPERATING INCOME (LOSS) (5,370) 54,940 (323,629) 213,540
Other Income (Expense)
Investment income 470 327 1,840 1,191
Interest expense (6,608) (8,536) (21,635) (22,817)
Dividend requirement on
preferred securities of
subsidiary trust (Note 9) (1,563) (1,563) (4,689) (4,689)
Miscellaneous, net (143) 1,664 1,166 5,652
(7,844) (8,108) (23,318) (20,663)
Income (Loss) from Continuing Operations
before Taxes (13,214) 46,832 (346,947) 192,877
Income Tax Benefit (Provision) 4,889 (19,435) 128,370 (81,504)
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE ACCOUNTING CHANGE (8,325) 27,397 (218,577) 111,373
Gain (Loss) from Discontinuance, net of
tax (Note 2) 38,975 (13,508) 38,975 (13,508)
Cumulative Effect of Accounting
Change, net of tax (Note 1) - - - (2,744)
Net Income (Loss) 30,650 13,889 (179,602) 95,121
Preferred Stock Dividends 2,052 2,047 6,171 6,153
NET INCOME (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS $ 28,598 $ 11,842 $ (185,773) $ 88,968
Weighted-Average Common Shares Outstanding
Basic shares 48,778,789 48,511,156 48,728,252 48,464,021
Diluted shares 48,778,789 56,349,127 48,728,252 56,379,755
Earnings (Loss) per Common Share (Note 8)
Basic
Net Income (Loss) from Continuing Operations $ (0.21) $ 0.52 $ (4.61) $ 2.17
Gain (Loss) from Discontinuance, net of tax 0.80 (0.28) 0.80 (0.28)
Accounting Change, net of tax - - - (0.06)
Net Income (Loss) Applicable to Common
Shareholders $ 0.59 $ 0.24 $ (3.81) $ 1.83
Diluted
Net Income (Loss) from Continuing Operations $ (0.21) $ 0.47 $ (4.61) $ 1.94
Gain (Loss) from Discontinuance, net of tax 0.80 (0.24) 0.80 (0.24)
Accounting Change, net of tax - - - (0.05)
Net Income (Loss) Applicable to Common
Shareholders $ 0.59 $ 0.23 $ (3.81) $ 1.65
The accompanying notes are an integral part of these statements.
PAGE 6
CNF INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
Nine Months Ended
September 30,
2001 2000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 104,515 $ 146,263
OPERATING ACTIVITIES
Net income (loss) (179,602) 95,121
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Loss (Gain) from discontinuance, net of tax (38,975) 13,508
Cumulative effect of accounting change,
net of tax - 2,744
Restructuring and related charges (Note 5) 340,531 -
Depreciation and amortization 149,819 139,002
Decrease in deferred income taxes (139,898) (2,157)
Amortization of deferred compensation 5,523 5,785
Provision for uncollectible accounts (Note 5) 44,483 11,422
Loss (gain) from sales of property 2,150 (771)
Gain from sale of securities - (2,619)
Loss from sale of assets of truckload operation - 5,459
Changes in assets and liabilities:
Receivables 100,021 (114,434)
Prepaid expenses (1,726) (8,411)
Unamortized aircraft maintenance 8,143 (44,320)
Accounts payable (58,019) 15,747
Accrued liabilities (9,831) (31,684)
Accrued incentive compensation (19,090) 16,116
Accrued claims costs 30,817 14,959
Income taxes (15,771) (11,978)
Employee benefits 14,296 22,946
Aircraft lease return provision (14,457) 17,594
Deferred charges and credits 64,206 17,980
Other (13,060) (1,743)
Net Cash Provided by Operating Activities 269,560 160,266
INVESTING ACTIVITIES
Capital expenditures (166,743) (166,930)
Software expenditures (14,268) (14,326)
Proceeds from sale of securities - 2,619
Proceeds from sales of property 5,291 10,201
Proceeds from sale of assets of truckload
operation - 7,263
Net Cash Used in Investing Activities (175,720) (161,173)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt - 197,452
Repayment of long-term debt, guarantees and
capital leases (7,592) (96,482)
Repayment of short-term borrowings, net - (35,000)
Proceeds from exercise of stock options 2,358 950
Payments of common dividends (14,637) (14,559)
Payments of preferred dividends (10,709) (10,903)
Net Cash Provided by (Used in) Financing
Activities (30,580) 41,458
Net Cash Provided by Continuing Operations 63,260 40,551
Net Cash Provided by (Used in) Discontinued
Operations 227,233 (106,919)
Increase (Decrease) in Cash and Cash Equivalents 290,493 (66,368)
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 395,008 $ 79,895
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 (the "Termination Agreement")
to terminate their contract for the transportation and sortation of
Priority Mail (the "Priority Mail contract"). The Priority Mail contract
was originally scheduled to terminate in the first quarter of 2002, subject
to renewal options. Under the terms of the Termination Agreement, the USPS
on January 7, 2001, assumed operating responsibility for services covered
under the Priority Mail contract, except certain air transportation and
related services, which were terminated effective April 23, 2001.
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 with interest or EWA will be
required to return a portion of the provisional payment with interest. The
Termination Agreement preserved EWA's right to pursue other contractual
claims, which were ultimately settled in September 2001 as described below.
PAGE 8
On September 26, 2001, EWA entered into an agreement with the USPS to
settle all non-termination claims under the Priority Mail contract with the
USPS (the "Settlement Agreement"). Under the Settlement Agreement, EWA
received a $235 million payment from the USPS on September 28, 2001 to
settle all claims under the Priority Mail contract, other than termination
claims. These claims were to recover costs of operating under the contract
as well as profit and interest thereon. The Priority Mail Termination
Agreement described above is unaffected by the Settlement Agreement.
Under the Settlement Agreement, on September 28, 2001, EWA also
received a $70 million provisional payment from the USPS for termination
costs and other claims related to the termination of EWA's Express Mail
contract, which was terminated by the USPS "for convenience" effective
August 26, 2001. The Settlement Agreement provides for the provisional
payment to be adjusted if the actual termination costs and other agreed
upon claims related to the termination of the Express Mail contract are
greater or less than $70 million, in which case either the USPS will be
required to make an additional payment with interest or EWA will be
required to return a portion of the provisional payment with interest. As
of September 30, 2001, the $70 million payment was included in Deferred
Credits in the Consolidated Balance Sheet until it is used to retire the
remaining assets related to the Express Mail contract. The Settlement
Agreement provides that the total amount payable by the USPS for
termination costs and other claims relating to the termination of the
Express Mail contract may not exceed $150 million.
Results of the Express Mail contract are included in the Emery
Worldwide reporting segment and are therefore not reported as Discontinued
Operations.
PAGE 9
Operating Results and Gain (Loss) from Discontinuance
-----------------------------------------------------
As a result of the Priority Mail contract termination, the results of
operations under that 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 (liabilities) 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 (liabilities) of discontinued operations were as
follows:
(Dollars in thousands)
September 30, December 31,
2001 2000
---------- -----------
Current assets $ - $ 26,120
Property, plant and equipment, net - 66,316
Long-term receivables and other assets - 184,348
---------- -----------
Total assets of discontinued
operations - 276,784
---------- -----------
Current liabilities 12,265 94,334
Long-term liabilities - 77,157
---------- -----------
Total liabilities of
discontinued operations 12,265 171,491
---------- -----------
Net assets (liabilities) of
discontinued operations $ (12,265) $ 105,293
========== ===========
The Priority Mail contract provided for an annual re-determination of
prices paid to EWA. Because of disputes between the USPS and EWA, these
prices never were re-determined and, as a result, EWA did not receive any
additional payments to which it would have been entitled upon a favorable
re-determination. Unbilled revenue represented the accrual of revenue
sufficient only to recover costs and therefore did not include profit or
interest. No operating profit was recognized in connection with the
Priority Mail contract since the third quarter of 1999, when EWA filed a
claim for re-determined higher prices.
In the first quarter of 2001, revenue of $10.2 million was recognized
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 third quarter and first nine months of last year, revenue
from the Priority Mail contract was $124.3 million and $386.4 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 September 30, 2001 and December
31, 2000 was $3.1 million and $22.1 million, respectively, and was included
in net current assets (liabilities) of discontinued operations in the
Consolidated Balance Sheets. The accrued loss from discontinuance was
increased in the third quarter of 2001 by $2.9 million for revised
estimates of terminations costs related to insurance and legal fees. The
accrued loss at September 30, 2001 was reduced by third-quarter payments of
$0.7 million.
PAGE 10
As a result of the Settlement Agreement, a gain from discontinuance of
$39.0 million, net of $24.9 million of income taxes, was recognized in the
third quarter of 2001.
3. New Accounting Standards
As described in Note 10 to the Financial Statements, the Company 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 (FASB) 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.
In June 2001, the FASB issued SFAS 143, "Accounting for Asset
Retirement Obligations", which will be effective for CNF on January 1,
2003. SFAS 143 addresses the financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs. The Company is in the process
of evaluating the financial statement impact of adoption of SFAS 143.
In August 2001, the FASB issued SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". SFAS 144 also supercedes the accounting and
reporting provisions of APB No. 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions",
for the disposal of a segment of a business. The effective date for
implementation of SFAS 144 is for fiscal years beginning after December 15,
2001; however, early adoption is permitted. SFAS 144 retains many of the
fundamental provisions of SFAS 121, but resolves certain implementation
issues. The Company is in the process of evaluating the financial
statement impact of adoption of SFAS 144.
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. Financial
covenants relating to the $350 million revolving credit facility and
certain of the Company's other debt agreements are discussed under
"Regulatory Matters" in Note 11 to the Financial Statements.
PAGE 11
5. Unusual Items
Unusual items in the third quarter and/or the first nine months of
2001 included the following:
Terrorist Attacks
-----------------
Operating results at Emery Worldwide (Emery) were significantly
affected by the terrorist attacks on September 11, 2001. Contractors
providing air carrier service to Emery were grounded on September 11 and 12
and did not resume service until the evening of September 13, which
adversely affected Emery's results of operations for the third quarter of
2001. In addition, the Company believes that operating results at Emery
and the Company's other reporting segments continue to be adversely
affected by the impact of these attacks.
In response to the terrorist attacks, the U.S. Congress passed the Air
Transportation Safety and System Stabilization Act (the "Act"), a $15
billion emergency economic assistance package to mitigate financial losses
in the air carrier industry. The legislation provides for $10 billion in
federal loan guarantees and credits, expands war risk insurance coverage
for air carriers, and provides some government assistance for short-term
increases in insurance premiums. Emery is seeking assistance under the
Act; however, the Company can provide no assurance that Emery will receive
any payments under the Act or as to the timing or amount of any payments
Emery may be entitled to receive under the Act.
Following the attacks, security requirements for air carriers have
been heightened and additional increases in security requirements may be
forthcoming. The Company is unable to predict what effect such measures
will have on its financial condition or results of operations.
Regulatory Matters
------------------
As a domestic airline, EWA, a separate subsidiary included in the
Emery Worldwide reporting segment, operates under an air carrier
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 issues identified during inspections conducted by
the FAA, on August 13, 2001, EWA was required to suspend its air carrier
operations as part of a settlement agreement with the FAA. In response to
EWA's suspension of its air carrier operations, Emery made arrangements to
service customers in North America utilizing aircraft operated by several
other air carriers and, as a result, Emery's air freight operations
continued without interruption. The Company estimates that, in the third
quarter of 2001, Emery incurred approximately $17 million of additional net
expense as a result of the suspension of EWA's air carrier operations, due
primarily to the expense of utilizing aircraft operated by other air
carriers in Emery's North American operations, partially offset by savings
resulting from the furlough of approximately 800 EWA employees.
The Company expects that the suspension of EWA's air carrier
operations will continue to have an adverse effect on its financial
condition and results of operations. The continued suspension or cessation
of EWA's air carrier operations could result in defaults under, among other
things, the Company's $350 million bank credit facility and under aircraft
leases and could also result in the incurrence of additional charges. See
Note 11 to the Financial Statements.
PAGE 12
Restructuring Charge and Legal Settlement
-----------------------------------------
In June 2001, the Company began an operational restructuring of Emery
Worldwide's North American operations to align it with management's
estimates of future business prospects for domestic heavy airfreight. The
air transportation provided by EWA has historically been the largest cost
component of Emery's North American network.
Emery's restructuring plan included a redesign of its North American
operations, revisions to service areas, and a reduction in the size of
Emery's fleet of leased aircraft. These actions were designed to address
changes in market conditions, which have deteriorated due to a slowing
domestic economy, and to a lesser extent, loss of business to ground
transportation providers, as well as the recent loss of the Express Mail
and Priority Mail contracts with the USPS.
The $340.5 million restructuring charge recognized in the second
quarter of 2001 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 related primarily to the return to the lessors of certain
aircraft leased to Emery and the termination of the related leases. The
Company expects that future payments relating to the termination of
aircraft leases will be based upon the respective termination dates of
those leases.
In addition to the restructuring charge, Emery in June 2001 also
incurred a $4.7 million loss from a legal settlement relating to previously
returned aircraft.
As described in Note 11 to the Financial Statements, as a result of
the continuing slowdown in the global economy and the grounding of EWA's
aircraft fleet, Emery is considering a further reduction in the size of
EWA's fleet of leased aircraft. Although the Company is currently unable
to predict with certainty whether or the extent to which this will occur,
any such further reduction in the size of EWA's fleet will likely result in
additional charges relating to the return of the leased aircraft and the
termination of the related leases, which could have a material adverse
effect on the Company's financial condition and results of operations.
Write-off Due to Business Failure of a Customer
-----------------------------------------------
In July 2001, the Company announced that Menlo Logistics (Menlo) would
take a charge over two quarters due to the business failure of Homelife, a
retail furniture business and customer of Menlo. The resulting $37.9
million charge in the first nine months of 2001, comprising primarily write-
offs of accounts receivable, included a second-quarter charge of $31.6
million and a third-quarter charge of $6.3 million. In the third quarter
of 2001, Menlo eliminated approximately 280 jobs relating to the Homelife
account.
PAGE 13
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 Nine Months Ended
(Dollars in thousands) September 30, September 30,
2001 2000 2001 2000
--------- --------- --------- ---------
Net income (loss) $ 30,650 $ 13,889 $(179,602) $ 95,121
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) (2,210) - (4,831) -
Foreign currency translation
adjustments 494 (3,996) (4,076) (11,913)
--------- --------- --------- ---------
(1,716) (3,996) (5,902) (11,913)
--------- --------- --------- ---------
Comprehensive income (loss) $ 28,934 $ 9,893 $(185,504) $ 83,208
========= ========= ========= =========
The following is a summary of the components of Accumulated Other
Comprehensive Loss:
September 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) (4,831) -
Accumulated foreign currency translation
adjustments (31,454) (27,378)
Minimum pension liability adjustment (8,441) (8,441)
----------- -----------
Accumulated other comprehensive loss $ (41,721) $ (35,819)
=========== ===========
PAGE 14
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 periods have been reclassified to exclude
discontinued operations.
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Revenues
Con-Way Transportation $ 491,296 $ 517,842 $1,449,883 $1,555,266
Emery Worldwide 471,540 662,149 1,585,035 1,903,271
Menlo Logistics 224,694 229,187 687,632 684,363
Other 6,986 15,461 23,906 40,988
---------- ---------- ---------- ----------
1,194,516 1,424,639 3,746,456 4,183,888
Intercompany Eliminations
Con-Way Transportation (145) (210) (569) (808)
Emery Worldwide (55) (5,159) (194) (18,925)
Menlo Logistics (2,976) (3,548) (8,816) (10,270)
Other (6,381) (6,109) (16,845) (21,232)
---------- ---------- ---------- ----------
(9,557) (15,026) (26,424) (51,235)
External Revenues
Con-Way Transportation 491,151 517,632 1,449,314 1,554,458
Emery Worldwide 471,485 656,990 1,584,841 1,884,346
Menlo Logistics 221,718 225,639 678,816 674,093
Other 605 9,352 7,061 19,756
---------- ---------- ---------- ----------
$1,184,959 $1,409,613 $3,720,032 $4,132,653
========== ========== ========== ==========
Operating Income (Loss) before
Significant Unusual Items
Con-Way Transportation[1]$ 42,617 $ 51,791 $ 121,783 $ 173,939
Emery Worldwide [2][3] (46,975) (5,859) (83,433) 13,826
Menlo Logistics 7,304 8,628 24,827 24,739
Other [4][5] (2,016) 380 (8,370) 1,036
---------- ---------- ---------- ----------
$ 930 $ 54,940 $ 54,807 $ 213,540
---------- ---------- ---------- ----------
Significant Unusual Items:
Emery - Restructuring
charge $ - $ - $ (340,531) $ -
Menlo - Loss on failure
of customer (6,300) - (37,905) -
---------- ---------- ---------- ----------
Operating Income (Loss) $ (5,370) $ 54,940 $ (323,629) $ 213,540
========== ========== ========== ==========
[1] For the three and nine months ended September 30, 2000, results
included a $5.5 million loss from the sale of certain assets of Con-
Way Truckload Services.
[2] For the nine months ended September 30, 2001, results included a $4.7
million loss from a legal settlement on previously returned aircraft.
[3] For the three and nine months ended September 30, 2000, results
included an $11.9 million loss from the termination of certain
aircraft leases.
PAGE 15
[4] For the three and nine months ended September 30, 2001, the Other
reporting segment included the operating results of Vector SCM, a
joint venture formed with General Motors in December 2000 that is
accounted for under the equity method. Vector SCM reported
essentially break-even results in the third quarter of 2001 while
start-up costs contributed to a $6.2 million operating loss in the
first nine months of 2001.
[5] For the three and nine months ended September 30, 2001, results
included a $7.2 million operating loss incurred by the Company's
insurance subsidiary, partially offset by a $5.1 million reversal of
accrued expenses on executive compensation plans.
PAGE 16
8. Earnings (Loss) Per Common Share
Basic earnings (loss) per common share (EPS) was computed by dividing
net income (loss) from continuing operations before accounting change by
the weighted-average common shares outstanding. The calculation for
diluted EPS from continuing operations was calculated as shown below.
Three Months Ended Nine Months Ended
(Dollars in thousands except September 30, September 30,
per share data) 2001 2000 2001 2000
---------- ---------- ---------- ----------
Earnings (Loss):
Net income (loss) from
continuing operations $ (10,377) $ 25,350 $ (224,748)$ 105,220
Add-backs:
Dividends on Series B
preferred stock, net
of replacement funding - 345 - 1,051
Dividends on preferred
securities of subsidiary
trust, net of tax - 954 - 2,862
---------- ---------- ---------- ----------
$ (10,377) $ 26,649 $ (224,748)$ 109,133
---------- ---------- ---------- ----------
Shares:
Basic shares (weighted-average
common shares
outstanding) 48,778,789 48,511,156 48,728,252 48,464,021
Stock option dilution - 267,471 - 345,234
Series B preferred stock - 4,445,500 - 4,445,500
Preferred securities of
subsidiary trust - 3,125,000 - 3,125,000
---------- ---------- ---------- ----------
48,778,789 56,349,127 48,728,252 56,379,755
---------- ---------- ---------- ----------
Diluted EPS from continuing
operations before
accounting change $ (0.21) $ 0.47 $ (4.61)$ 1.94
========== ========== ========== ==========
For the three and nine months ended September 30, 2001, convertible
securities and stock options were anti-dilutive. As a result, the assumed
shares and related add-back to operating results under the if-converted
method have been excluded from the calculation of diluted EPS. If the
securities were dilutive for those periods, the assumed shares under the
if-converted method would have been as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------- ---------- ---------- ----------
Stock options 409,344 - 472,440 -
Series B preferred stock 4,427,742 - 4,427,742 -
Preferred securities of
subsidiary trust 3,125,000 - 3,125,000 -
PAGE 17
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.
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.
PAGE 18
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.
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 third quarter and first nine months of 2001, the estimated fair
value of the Company's fair value hedges increased $17.1 million and $16.6
million, respectively, and offset equal increases in the estimated fair
value of the Company's fixed-rate long-term debt. The estimated fair value
of cash flow hedges in the third quarter of 2001 decreased $3.6 million
($2.2 million after tax) and declined $7.9 million ($4.8 million after tax)
in the first nine months of 2001.
11. Commitments and Contingencies
IRS Matters
-----------
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 $160.5 million as of
September 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.
PAGE 19
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 Treasury Ruling 2001-4. The Company intends to
vigorously contest the Notice and the proposed adjustments as they pertain
to the aircraft maintenance issue.
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.
Spin-off of CFC
---------------
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 obligations 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. In September 2001, the
real property was effectively swapped, in a non-cash exchange, for CFC's
$20.0 million note due in 2004 following a three-way exchange among the
Company, CFC and a third party.
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. Although CFC is obligated to reimburse and indemnify the
Company against liability with respect to these claims, CFC's obligation is
not secured by any collateral and there can be no assurance that CFC will,
in fact, reimburse and indemnify the Company. Any failure by CFC to
reimburse or indemnify the Company for a substantial amount of these claims
could have a material adverse affect on the Company's results of operations
and financial condition.
PAGE 20
Regulatory Matters
------------------
Internationally, Emery operates primarily as an air freight forwarder
using commercial airlines, while utilizing owned or leased aircraft only on
a limited basis. In its North American operations, Emery has historically
provided air transportation services using aircraft operated by EWA and, to
a lesser extent, aircraft operated by third parties.
As a domestic airline, EWA operates under an air carrier certificate
issued by the 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 issues identified during inspections
conducted by the FAA, on August 13, 2001, EWA was required to suspend its
air carrier operations as part of an interim settlement agreement with the
FAA. In response to EWA's suspension of its air carrier operations, Emery
made arrangements to service customers in North America utilizing aircraft
operated by several other air carriers and, as a result, Emery's air
freight operations continued without interruption. The Company estimates
that, in the third quarter of 2001, Emery incurred approximately $17 million
of additional net expense as a result of the suspension of EWA's air carrier
operations, due primarily to the expense of utilizing aircraft operated by
other air carriers in Emery's North American operations, partially offset by
savings resulting from the furlough of approximately 800 EWA employees as
described in the next paragraph.
As a result of the suspension of its air carrier operations, EWA
furloughed approximately 400 pilots and crew members and approximately 400
other employees. The union representing these pilots and crew members has
filed a grievance as a result of this furlough.
In a final settlement agreement with the FAA entered into on September
17, 2001, EWA agreed to pay a $1 million civil penalty related to alleged
operations, avionics, and maintenance irregularities. The final settlement
agreement does not constitute an admission of FAA violations but does
require EWA to demonstrate that it is in compliance with applicable federal
aviation regulations. The agreement provides that the FAA may initiate
appropriate enforcement action, which may include action to revoke EWA's
air carrier certificate, if EWA does not meet these requirements within 240
days after September 17, 2001.
Unless and until these problems are remedied, EWA will not be
permitted to resume its air carrier operations and will be required to
continue to use aircraft operated by other air carriers in order to service
customers in North America. This will, in turn, continue to result in
certain additional, or "duplicate", costs, primarily because Emery will be
required to pay both the ongoing lease and other costs associated with
EWA's fleet of grounded aircraft in addition to the costs of having
other air carriers provide aircraft to service Emery's North American
customers. Unless and until EWA is able to resume its air carrier
operations or Emery otherwise is able to eliminate or substantially reduce
these duplicate costs, Emery will continue to incur substantial additional
costs for substitute aircraft. As a result, the Company expects that the
suspension of EWA's air carrier operations will continue to have a material
adverse effect on its financial condition and results of operations.
PAGE 21
As a result of the continued slowdown in the global economy and the
grounding of EWA's aircraft fleet, Emery's management is evaluating a
possible reduction in the size of EWA's fleet of leased aircraft, which
would be in addition to the previously announced reduction described under
"-Restructuring Charge and Legal Settlement" in Note 5 above. Any such
further reduction in EWA's fleet will likely result in charges relating to
the return of leased aircraft and the termination of the related leases,
which could be substantial and could have a material adverse effect on the
Company's financial condition and results of operations.
In the event that EWA does not resume its operations as an air
carrier, EWA will incur substantial charges in connection with the
cessation of EWA's air carrier operations. The Company believes that these
charges would likely result in a breach of some of the financial covenants
under its $350 million revolving credit facility. Moreover, whether or not
the Company incurs these charges, the Company believes that it may breach
one or more of the financial covenants contained in the $350 million
revolving credit facility by the end of the fourth quarter of 2001 due
primarily to lower anticipated revenues in a slowing global economy and
Emery's duplicate fleet costs described above. If any of the financial
covenants are violated, the Company will be required to obtain appropriate
waivers or amendments from the requisite banks under the credit facility.
If the Company is unable to obtain these amendments or waivers, the Company
would be prohibited from making borrowings under the revolving credit
facility and could be required by the banks to repay any outstanding
borrowings and replace outstanding letters of credit under the facility.
Under cross-default clauses contained in other debt instruments to which
the Company is a party, these events could also result in other
indebtedness becoming or being declared due and payable prior to its stated
maturity. There can be no assurance that the Company would be able to
obtain the necessary waivers or amendments under the $350 million bank
credit agreement and any failure to obtain such amendments or waivers would
likely have a material adverse effect on the Company's financial condition
and results of operations.
In addition, if EWA does not resume its airline operations, this may
result in defaults under some agreements pursuant to which EWA leases its
aircraft. Upon the occurrence of these defaults, the lessors generally
would be entitled to terminate the leases and demand termination payments
from the Company, which, in certain cases, could be substantial. As a
result, default under these leases could have a material adverse effect on
the Company's financial condition and results of operations unless the
Company were able to obtain waivers from the lessors, and there can be no
assurance that the Company would be able to do so.
Holders of certain notes issued by the Company's Thrift and Stock Plan
("TASP"), which are guaranteed by the Company, have the right to require
the Company to repurchase those notes if, among other things, both Moody's
and Standard & Poor's have publicly rated the Company's long-term senior
debt at less than investment grade unless, within 45 days, the Company
shall have obtained, through a guarantee, letter of credit or other
permitted credit enhancement or otherwise, a credit rating for such notes
of at least "A" from Moody's or Standard & Poor's (or another nationally
recognized rating agency selected by the holders of such notes) and shall
maintain a rating on such notes of "A" or better thereafter. As of
September 30, 2001, $62.0 million aggregate principal amount of these TASP
notes was outstanding. The Company's long-term senior debt is currently
rated "Baa3" by Moody's and "BBB" by Standard & Poor's; "Baa3" is the
lowest investment grade rating from Moody's and "BBB" is the next-to-lowest
investment grade rating from Standard & Poor's. Following EWA's suspension
of its air carrier operations, both Moody's and Standard & Poor's placed
the Company's long-term senior debt ratings on credit watch for a possible
reduction in those ratings. The occurrence of any event or condition
requiring the Company to repay these TASP notes would likely have a
material adverse effect on the Company's financial condition and results of
operations.
PAGE 22
Other
-----
The Company and its subsidiaries are defendants in various other
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 23
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONSOLIDATED RESULTS OF OPERATIONS
==================================
Net income available to common shareholders was $28.6 million ($0.59
per share) in the third quarter of 2001 and net loss applicable to common
shareholders was $185.8 million ($3.81 per share) in the first nine months
of 2001. The settlement with the U.S. Postal Service (USPS) described
below under "Discontinued Operations" resulted in a $39.0 million net-of-
tax gain reported in the third quarter and first nine months of 2001 as a
gain from discontinuance of the Priority Mail operations. Net loss from
continuing operations in the third quarter and first nine months of 2001,
including unusual losses, was $10.4 million ($0.21 per share) and $224.7
million ($4.61 per share), respectively.
Last year's net income available to common shareholders of $11.8
million ($0.23 per diluted share) in the third quarter and $89.0 million
($1.65 per diluted share) in the first nine months included a $13.5 million
net-of-tax loss from discontinuance of the Priority Mail operations and a
$2.7 million net-of-tax loss from the cumulative effect of an accounting
change. Last year's net income from continuing operations of $25.4 million
($0.47 per diluted share) in the third quarter and $105.2 million ($1.94
per diluted share) in the first nine months included a $5.5 million unusual
loss ($0.06 per diluted share) from Con-Way Truckload Service's asset sale
and an $11.9 million unusual loss ($0.12 per diluted share) from the
termination of certain aircraft leases.
Revenue in the third quarter and first nine months of 2001 fell 15.9%
and 10.0% from the respective periods last year due primarily to declines
in revenue at Emery Worldwide (Emery) and Con-Way Transportation Services
(Con-Way). We believe that revenue from all reporting segments in the
third quarter and first nine months of 2001 was adversely affected by the
continuing downturn in the U.S. economy.
The operating loss in the third quarter and first nine months of 2001
was $5.4 million and $323.6 million, respectively. Last year, operating
income in the third quarter and first nine months was $54.9 million and
$213.5 million, respectively. Lower operating results from continuing
operations in the third quarter and first nine months of 2001 were due
primarily to operating losses from Emery, which was affected by lower
revenue and several unusual items described below, and lower operating
income from Con-Way, which was also adversely affected by lower revenue.
Other net expense in the third quarter of 2001 decreased 3.3% from
last year's third quarter due primarily to lower interest expense. Other
net expense in the first nine months of 2001 increased 12.8% due primarily
to a $2.6 million net gain from the sale of securities in the first quarter
of last year, partially offset by lower interest expense in 2001. Lower
interest expense in the first three quarters of 2001 was due primarily 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.
The effective tax benefit rate of 37.0% in the third quarter and first
nine months of 2001 was revised from last year's effective tax rate of
41.5% in the third quarter and 42.3% in the first nine months due primarily
to losses from the significant unusual charges recognized in the second
quarter of 2001.
PAGE 24
Unusual items in the third quarter and/or the first nine months of
2001 are summarized below and described in more detail under "Emery
Worldwide" and "Menlo Logistics" below.
Terrorist Attacks
-----------------
Operating results at Emery were significantly affected by the
terrorist attacks on September 11, 2001. Contractors providing air carrier
services to Emery were grounded on September 11 and 12 and did not resume
service until the evening of September 13, which adversely affected Emery's
results of operations for the third quarter of 2001. In addition, we
believe that operating results at Emery and our other reporting segments
continue to be adversely affected by the impact of these attacks.
Regulatory Matters
------------------
As a domestic airline, Emery Worldwide Airlines (EWA), a separate
subsidiary included in the Emery Worldwide reporting segment, operates
under an air carrier 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 issues identified during inspections
conducted by the FAA, on August 13, 2001, EWA was required to suspend its
air carrier operations as part of a settlement agreement with the FAA. In
response to EWA's suspension of its air carrier operations, Emery made
arrangements to service customers in North America utilizing aircraft
operated by several other air carriers and, as a result, Emery's air
freight operations continued without interruption. We estimate that, in
the third quarter of 2001, Emery incurred approximately $17 million of
additional net expense as a result of the suspension of EWA's air carrier
operations, due primarily to the expense of utilizing aircraft operated by
other air carriers in Emery's North American operations, partially offset by
savings resulting from the furlough of approximately 800 EWA employees.
We expect that the suspension of EWA's air carrier operations will
continue to have a material adverse effect on our financial condition and
results of operations. The continued suspension or cessation of EWA's air
carrier operations could result in defaults under, among other things, our
$350 million bank credit facility and under aircraft leases and could also
result in the incurrence of substantial charges. See Notes 5 and 11 to the
Financial Statements above and "Emery Worldwide-Regulatory Matters", "Emery
Worldwide-Restructuring Charge and Legal Settlement" and "Liquidity and
Capital Resources" below.
Restructuring Charge and Legal Settlement
-----------------------------------------
In June 2001, we began an operational restructuring of Emery
Worldwide's North American operations that included a redesign of its North
American operations, revisions to service areas, and a reduction in the
size of Emery's fleet of leased aircraft. The $340.5 million second-
quarter 2001 restructuring charge consisted primarily of non-cash asset
impairment charges and estimated future cash expenditures related primarily
to the return to the lessors of certain aircraft leased to Emery and the
termination of the related leases. In addition to the restructuring
charge, Emery in June 2001 also incurred a $4.7 million loss from a legal
settlement relating to previously returned aircraft. See "Emery Worldwide-
Restructuring Charge and Legal Settlement" below.
As described below under "Emery Worldwide-Regulatory Matters," due to
the continuing slowdown in the global economy and the grounding of EWA's
aircraft fleet, Emery is considering a further reduction in the size of
EWA's fleet of leased aircraft. Although we are currently unable to
predict with certainty whether or the extent to which this will occur, any
such further reduction in the size of EWA's fleet will likely result in
additional charges relating to the return of the leased aircraft and the
termination of the related leases, which could have a material adverse
effect on our financial condition and results of operations.
PAGE 25
Write-off Due to Business Failure of a Customer
-----------------------------------------------
In July 2001, we announced that Menlo Logistics (Menlo) would take a
charge over two quarters due to the business failure of Homelife, a retail
furniture business and customer of Menlo. The resulting $37.9 million
charge in the first nine months of 2001 included a second-quarter charge of
$31.6 million and a third-quarter charge of $6.3 million.
Con-Way Transportation Services
- -------------------------------
Con-Way's revenue in the third quarter and first nine months of 2001
fell 5.1% and 6.8% from the respective periods last year due primarily to
lower tonnage transported. Also, Con-Way Truckload Services, which was
sold in August 2000, accounted for revenue of $12.6 million and $62.6
million in the third quarter and first nine months of last year,
respectively.
Con-Way regional carriers' less-than-truckload (LTL) tonnage per day
(weight) for the third quarter and first nine months of 2001 fell 3.2% and
3.3%, respectively, and total weight fell 3.6% and 3.8%, respectively,
compared to the same third-quarter and nine-month periods last year. Con-
Way regional carriers' revenue per hundredweight (yield) over the same
periods of 2001 varied only slightly, falling 1.1% from last year's third
quarter and rising 0.7% over the first nine months of last year. Con-Way's
management believes that yield and weight in the third quarter and first
nine months of 2001 were adversely affected by the continuing downturn in
the U.S. economy. Also, a decrease in fuel surcharges on lower fuel prices
contributed to the decline in third-quarter yield in 2001. Yield in the
third quarter and first nine months of 2001 was positively affected by a
higher percentage of inter-regional joint services, which typically command
higher rates on longer lengths of haul.
Con-Way's operating income in the third quarter and first nine months
of 2001 declined 17.7% and 30.0%, respectively, from the same periods in
2000. Excluding last year's $5.5 million third-quarter loss from the Con-
Way Truckload Service's asset sale, operating income over the same periods
declined 25.6% and 32.1%, respectively, due primarily to lower revenue and,
to a lesser extent, an increase in costs for insurance claims. The third
quarter and first nine months of 2001 were also adversely affected by
operating losses from the start-up of Con-Way Air Express, a domestic air
freight forwarding company that began operations in May 2001.
Emery Worldwide
- ---------------
Operating Results
-----------------
In the third quarter and first nine months of 2001, Emery's revenue
declined 28.2% and 15.9%, respectively, from the same periods last year due
primarily to lower North American and international airfreight revenue and
lower revenue from EWA's contract to transport Express Mail for the USPS,
which was terminated "for convenience" effective August 26, 2001 as described
below under "-Express Mail Contract".
PAGE 26
International airfreight revenue per day in the third quarter and
first nine months of 2001, including fuel surcharges, fell 18.3% and 9.5%,
respectively, from the same periods last year due primarily to declines in
pounds transported per day (weight) of 17.8% and 11.9%, respectively.
Third-quarter international yield in 2001 declined 0.6% from last year's
third quarter, while yield in the first nine months of 2001 increased 2.8%
over the same period last year. Emery's management believes those declines
in international weight in the third quarter and first nine months of 2001
were due in part to a worsening global economy and in part to lost revenue
resulting from the terrorist incident described below under "-Terrorist
Attacks". Emery's management believes that a slowing global economy
adversely affected business levels in Latin America, Asia and other
international markets served by Emery. Third-quarter international yield
in 2001 decreased slightly from last year's third quarter due in part to a
decline in fuel surcharges earned on lower fuel prices.
North American airfreight revenue per day in the third quarter and
first nine months of 2001, including fuel surcharges, declined 38.2% and
24.9%, respectively, from the same periods last year on declines in weight
per day of 38.2% and 29.1%, respectively. North American yield was flat in
the third quarter of 2001 compared to the third quarter of last year while
yield in the first nine months of 2001 rose 5.9% over the same period last
year. Lower North American weight was attributable primarily to lower
business levels from the manufacturing industry, particularly the
automotive and technology sectors, and from lost revenue following the
terrorist attacks. Emery's management believes that the lower business
levels in the first three 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.
Emery's operating loss in the third quarter and first nine months of
2001 was $47.0 million and $424.0 million, respectively. Excluding the
2001 second-quarter unusual charges that are described below under
"Restructuring Charge and Legal Settlement", Emery's operating loss in the
first nine months of 2001 was $78.7 million. Emery's operating loss in
last year's third quarter was $5.9 million and operating income in the
first nine months of last year was $13.8 million. Excluding an $11.9
million unusual loss from a legal settlement on returned aircraft in last
year's third quarter, operating income in the third quarter and first nine
months of last year was $6.0 million and $25.7 million, respectively.
Excluding these unusual items in 2001 and 2000, lower operating results in
the first nine months of 2001 were due primarily to lower North American
and international airfreight revenue, lower revenue from the Express Mail
contract, and approximately $17 million of additional net expense as a
result of the suspension of EWA's air carrier operations, which is
described below under "-Regulatory Matters".
Terrorist Attacks
-----------------
Operating results at Emery were significantly affected by the
terrorist attacks on September 11, 2001. Contractors providing air carrier
services to Emery were grounded on September 11 and 12 and did not resume
service until the evening of September 13, which adversely affected Emery's
results of operations for the third quarter of 2001. In addition, we
believe that operating results at Emery and our other reporting segments
continue to be adversely affected by the impact of these attacks.
In response to the terrorist attacks, the U.S. Congress passed the Air
Transportation Safety and System Stabilization Act described in Note 5 to
the Financial Statements. Emery is seeking assistance under the Act;
however, we can provide no assurance that Emery will receive any payments
under the Act or as to the timing or amount of any payments Emery may be
entitled to receive under the Act.
PAGE 27
Following the attacks, security requirements for air carriers have
been heightened and additional increases in security requirements may be
forthcoming. We are unable to predict what effect such measures will have
on our financial condition or results of operations.
Regulatory Matters
------------------
Internationally, Emery operates primarily as an air freight forwarder
using commercial airlines, while utilizing owned or leased aircraft only on
a limited basis. In its North American operations, Emery has historically
provided air transportation services using aircraft operated by EWA and, to
a lesser extent, aircraft operated by third parties.
As a domestic airline, EWA operates under an air carrier certificate
issued by the 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 issues identified during inspections
conducted by the FAA, on August 13, 2001, EWA was required to suspend its
air carrier operations as part of an interim settlement agreement with the
FAA. In response to EWA's suspension of its air carrier operations, Emery
made arrangements to service customers in North America utilizing aircraft
operated by several other air carriers and, as a result, Emery's air
freight operations continued without interruption. We estimate that, in
the third quarter of 2001, Emery incurred approximately $17 million of
additional net expense as a result of the suspension of EWA's air carrier
operations, due primarily to the expense of utilizing aircraft operated by
other air carriers in Emery's North American operations, partially offset by
savings resulting from the furlough of approximately 800 EWA employees as
described in the next paragraph.
As a result of the suspension of its air carrier operations, EWA
furloughed approximately 400 pilots and crew members and approximately 400
other employees. The union representing these pilots and crew members has
filed a grievance as a result of this furlough. See "Legal Proceedings"
below.
In a final settlement agreement with the FAA entered into on September
17, 2001, EWA agreed to pay a $1 million civil penalty related to alleged
operations, avionics, and maintenance irregularities. The final settlement
agreement does not constitute an admission of FAA violations but does
require EWA to demonstrate that it is in compliance with applicable federal
aviation regulations. The agreement provides that the FAA may initiate
appropriate enforcement action, which may include action to revoke EWA's
air carrier certificate, if EWA does not meet these requirements within 240
days after September 17, 2001.
Unless and until these problems are remedied, EWA will not be
permitted to resume its air carrier operations and will be required to
continue to use aircraft operated by other air carriers in order to service
customers in North America. This will, in turn, continue to result in
certain additional, or "duplicate", costs, primarily because Emery will
be required to pay both the ongoing lease and other costs associated with
EWA's own fleet of grounded aircraft in addition to the costs of having
other air carriers provide aircraft to service Emery's North American
customers. Unless and until EWA is able to resume its air carrier
operations or Emery otherwise is able to eliminate or substantially reduce
these duplicate costs, Emery will continue to incur substantial additional
costs for substitute aircraft. As a result, we expect that the suspension
of EWA's air carrier operations will continue to have a material adverse
effect on our financial condition and results of operations.
PAGE 28
As a result of the continued slowdown in the global economy and the
grounding of EWA's aircraft fleet, Emery's management is evaluating a
possible reduction in the size of EWA's fleet of leased aircraft, which
would be in addition to the previously announced reduction described below
under "-Restructuring Charge and Legal Settlement". Any such further
reduction in EWA's fleet will likely result in charges relating to the
return of leased aircraft and the termination of the related leases, which
could be substantial and could have a material adverse effect on our
financial condition and results of operations.
In the event that EWA does not resume its operations as an air
carrier, we will incur substantial charges in connection with the cessation
of EWA's air carrier operations. We believe that these charges would
likely result in a breach of one or more of the financial covenants under
our $350 million revolving credit facility. Moreover, whether or not we
incur these charges, we believe that we may breach some of the financial
covenants contained in our $350 million revolving credit facility by the
end of the fourth quarter of 2001 due primarily to lower anticipated
revenues in a slowing global economy and Emery's duplicate fleet costs
described above. If any of the financial covenants are violated, we will
be required to obtain appropriate waivers or amendments from the requisite
banks under the credit facility. If we are unable to obtain these
amendments or waivers, we would be prohibited from making borrowings under
our revolving credit facility and could be required by the banks to repay
any outstanding borrowings and replace outstanding letters of credit under
the facility. Under cross-default clauses contained in other debt
instruments to which we are a party, these events could also result in
other indebtedness becoming or being declared due and payable prior to its
stated maturity. There can be no assurance that we would be able to obtain
the necessary waivers or amendments under the $350 million bank credit
agreement and any failure to obtain such amendments or waivers would likely
have a material adverse effect on our financial condition and results of
operations.
In addition, if EWA does not resume its airline operations, this may
result in defaults under some agreements pursuant to which EWA leases its
aircraft. Upon the occurrence of these defaults, the lessors generally
would be entitled to terminate the leases and demand termination payments
from us, which, in certain cases, could be substantial. As a result,
default under these leases could have a material adverse effect on our
financial condition and results of operations unless we were able to obtain
waivers from the lessors, and there can be no assurance that we would be
able to do so.
Holders of certain notes issued by our Thrift and Stock Plan ("TASP"),
which are guaranteed by us, have the right to require us to repurchase
those notes if, among other things, both Moody's and Standard & Poor's have
publicly rated our long-term senior debt at less than investment grade
unless, within 45 days, we shall have obtained, through a guarantee, letter
of credit or other permitted credit enhancement or otherwise, a credit
rating for such notes of at least "A" from Moody's or Standard & Poor's (or
another nationally recognized rating agency selected by the holders of such
notes) and shall maintain a rating on such notes of "A" or better
thereafter. As of September 30, 2001, $62.0 million aggregate principal
amount of these TASP notes was outstanding. Our long-term senior debt is
currently rated "Baa3" by Moody's and "BBB" by Standard & Poor's; "Baa3" is
the lowest investment grade rating from Moody's and "BBB" is the next-to-
lowest investment grade rating from Standard & Poor's. Following EWA's
suspension of its air carrier operations, both Moody's and Standard &
Poor's placed our long-term senior debt ratings on credit watch for a
possible reduction in those ratings. The occurrence of any event or
condition requiring us to repay these TASP notes would likely have a
material adverse effect on our financial condition and results of
operations.
PAGE 29
Restructuring Charge and Legal Settlement
-----------------------------------------
In June 2001, we began an operational restructuring of Emery
Worldwide's North American operations to align it with management's
estimates of future business prospects for domestic heavy airfreight. The
air transportation provided by EWA has historically been the largest cost
component of Emery's North American network.
Emery's restructuring plan included a redesign of its North American
operations, revisions to service areas, and a reduction in the size of
Emery's fleet of leased aircraft. These actions were designed to address
changes in market conditions, which have deteriorated due to a slowing
domestic economy, and to a lesser extent, loss of business to ground
transportation providers, as well as the recent loss of the Express Mail
and Priority Mail contracts with the USPS.
The $340.5 million restructuring charge recognized in the second
quarter of 2001 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 related primarily to the return to the lessors of certain
aircraft leased to Emery and the termination of the related leases. We
expect that future payments relating to the termination of aircraft leases
will be based upon the respective termination dates of those leases.
In addition to the restructuring charge, Emery in June 2001 also
incurred a $4.7 million loss from a legal settlement relating to previously
returned aircraft.
As described above under "-Regulatory Matters", as a result of the
continuing slowdown in the global economy and the grounding of EWA's
aircraft fleet, Emery is considering a further reduction in the size of
EWA's fleet of leased aircraft. Although we are currently unable to
predict with certainty whether or the extent to which this will occur, any
such further reduction in the size of EWA's fleet will likely result in
additional charges relating to the return of the leased aircraft and the
termination of the related leases, which could have a material adverse
effect on our financial condition and results of operations.
Express Mail Contract
---------------------
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 transported Express Mail and other classes of
mail under a contract with the USPS (the "Express Mail contract"), which
was originally scheduled to expire in January 2004; however, the USPS
terminated the Express Mail contract "for convenience" effective August 26,
2001.
As described below under "Discontinued Operations", on November 3,
2000, EWA and the USPS announced an agreement (the "Termination Agreement")
to terminate their contract for the transportation and sortation of
Priority Mail (the "Priority Mail contract"). On September 26, 2001, EWA
entered into an agreement with the USPS to settle claims relating to the
Priority Mail contract with the USPS (the "Settlement Agreement"). Under
the Settlement Agreement, EWA received a $235 million payment from the USPS
on September 28, 2001 to settle all non-termination claims under the
Priority Mail contract. Under the Settlement Agreement, on September 28,
2001, EWA also received a $70 million provisional payment from the USPS for
termination costs and other claims related to the termination of the
Express Mail contract. The Settlement Agreement provides for the
provisional payment to be adjusted if actual termination costs and other
agreed upon claims relating to the termination of the Express Mail contract
are greater or less than $70 million, in which case either the USPS will be
required to make an additional payment with interest or EWA will be
required to return a portion of the provisional payment with interest.
PAGE 30
As of September 30, 2001, the $70 million payment was included in
Deferred Credits in the Consolidated Balance Sheet until it is used to
retire the remaining assets related to the Express Mail contract. The
Settlement Agreement provides that the total amount payable by the USPS for
termination costs and other claims relating to the termination of the
Express Mail contract may not exceed $150 million.
In the third quarter and first nine months of 2001, EWA recognized
revenue of $24.5 million and $113.8 million, respectively, from the
transportation of mail under the Express Mail contract, compared to $48.6
million and $148.4 million in the respective periods last year. Operating
income from the Express Mail contract in the third quarter and first nine
months of 2001 was $1.8 million and $5.4 million, respectively, compared to
$5.7 million and $17.3 million, respectively, in the same periods last
year. The USPS' termination of the Express Mail contract will likely have
a material adverse effect on our financial condition and results of
operations.
Menlo Logistics
- ---------------
Operating Results
-----------------
Menlo's revenue in the 2001 third quarter declined 1.7% from last
year's third quarter and revenue in the first nine months of 2001 increased
0.7% over the same period last year. Revenue in the first three quarters
of 2001 was positively affected by growth in logistics contracts and
consulting fees. Over the same period, business levels of some of its
customers were adversely affected by the continuing downturn in the U.S.
economy. The impact of the business failure of Homelife, a retail
furniture business and customer of Menlo, is described below. Menlo's
management believes the resulting adverse effect on Menlo's revenue was
partially mitigated by its ability to secure new logistics contracts. On
October 8, 2001, Menlo announced that it had finalized logistics services
agreements with six new customers.
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 third quarter and first nine months
of 2001 was $66.3 million and $206.5 million, respectively, compared to
$67.9 million and $265.6 million in the respective periods last year.
Including the Homelife write-off described below, Menlo earned
operating income of $1.0 million in the third quarter of 2001 and incurred
a $13.1 million operating loss in the first nine months of 2001. Excluding
the loss on the failure of Homelife, Menlo's operating income in the third
quarter and first nine months of 2001 was $7.3 million and $24.8 million,
respectively, a decrease of 15.4% from last year's third quarter and
essentially unchanged from the first nine months of last year. Lower third-
quarter operating income, excluding the Homelife charge, was primarily due
to lower revenue.
PAGE 31
Write-off Due to Business Failure of a Customer
-----------------------------------------------
In July 2001, we announced that Menlo would take a charge over two
quarters due to the business failure of Homelife, a customer of Menlo. The
resulting $37.9 million charge in the first nine months of 2001, comprising
primarily write-offs of accounts receivable, included a second-quarter
charge of $31.6 million and a third-quarter charge of $6.3 million. In the
third quarter of 2001, Menlo eliminated approximately 280 jobs relating to
the Homelife account. In the third quarter and first nine months of 2001,
Menlo recognized revenue from Homelife of $8.5 million and $53.9 million,
respectively, compared to $4.0 million and $7.8 million in the third
quarter and first nine months of last year, respectively. Excluding the
loss, operating income earned by Menlo from the Homelife account in the
third quarter and first nine months of 2001 was $0.1 million and $2.6
million, respectively, compared to an operating loss of $0.4 million earned
from Homelife in the third quarter of last year and operating income from
Homelife of $0.7 million in the first nine months of last year.
Other Operations
- ----------------
In the third quarter and first nine months of 2001, the Other segment
included the operating results of Road Systems, Vector SCM, and other
corporate items. The operating results of Vector SCM, a joint venture
formed with General Motors in December 2000 to provide logistics services
to General Motors, are reported as an equity investment in the Other
segment. Vector SCM reported essentially break-even operating results in
the third quarter of 2001 while start-up costs contributed to a $6.2
million operating loss in the first three quarters of 2001.
The Other segment in the third quarter and first nine months of 2001
was affected by certain corporate items, including a $7.2 million operating
loss incurred by our insurance subsidiary, partially offset by a $5.1
million reversal of accrued expenses on executive compensation plans.
Discontinued Operations
- -----------------------
On November 3, 2000, EWA and the USPS announced an agreement (the
"Termination Agreement") to terminate their contract for the transportation
and sortation of Priority Mail (the "Priority Mail contract"). The
Priority Mail contract was originally scheduled to terminate in the first
quarter of 2002, subject to renewal options. Under the terms of the
Termination Agreement, the USPS on January 7, 2001 assumed operating
responsibility for services covered under the Priority Mail contract,
except certain air transportation and related services, which were
terminated effective April 23, 2001.
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 with interest or EWA will be
required to return a portion of the provisional payment with interest. The
Termination Agreement preserved EWA's right to pursue claims for
underpayment of other amounts owed to EWA under the contract, which were
ultimately settled in September 2001 as described below. 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
EWA will be recovered.
PAGE 32
On September 26, 2001, EWA entered into an agreement with the USPS to
settle claims relating to the underpayment of amounts owed to EWA under the
Priority Mail contract with the USPS (the "Settlement Agreement"). Under
the Settlement Agreement, EWA received a $235 million payment from the USPS
on September 28, 2001 to settle all non-termination claims under the
Priority Mail contract. These claims were to recover costs of operating
under the contract as well as profit and interest thereon. The Priority
Mail Termination Agreement described above is unaffected by the Settlement
Agreement.
Under the Settlement Agreement, on September 28, 2001, EWA also
received a $70 million payment from the USPS to provisionally pay EWA for
termination costs and other claims related to the termination of EWA's
Express Mail contract, which is described above under "Emery Worldwide-
Express Mail Contract".
Gain (Loss) from Discontinuance
-------------------------------
As a result of the termination of the Priority Mail contract, the
results of operations, net assets, and cash flows of the Priority Mail
operations have been segregated and classified as discontinued operations.
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, as a result of
the Priority Mail contract termination. As a result of the Settlement
Agreement, a gain from discontinuance of $39.0 million, net of $24.9
million of income taxes, was recognized in the third quarter of 2001.
Summary financial data and related information are included in Note 2 to
the Financial Statements.
PAGE 33
LIQUIDITY AND CAPITAL RESOURCES
===============================
Continuing Operations
- ---------------------
In the first nine months of 2001, cash and cash equivalents increased
$290.5 million to $395.0 million due primarily to the $305 million payment
from the USPS described above under "Consolidated Results of Operations--
Discontinued Operations." Cash provided by operating activities in the
first nine months of 2001 was sufficient to fund investing and financing
activities.
Operating activities in the first nine months of 2001 generated net
cash of $269.6 million compared to $160.3 million of cash generated by
operating activities in the same period last year. Cash from operations in
the first nine months of 2001 was provided primarily by net income from
continuing operations before Emery's net-of-tax restructuring charge; other
non-cash charges, including depreciation, amortization and bad debt
provision; the collection of receivables; and an increase in deferred
credits. Deferred credits at September 30, 2001 includes a $70 million
provisional payment from the USPS for termination costs and other claims
related to the termination of the Express Mail contract, which is described
under "Consolidated Results of Operations--Emery Worldwide--Express Mail
Contract." Positive operating cash flows in the first nine months of 2001
were partially offset by declines in accounts payable and accrued incentive
compensation.
Investing activities in the first nine months of 2001 used $175.7
million of cash compared to $161.2 million used in the first nine months of
last year. Capital expenditures of $166.7 million in the first nine months
of 2001 decreased slightly from $166.9 million in last year's first nine
months. For the first nine months of 2001, Con-Way's capital expenditures
increased $46.6 million, largely offset by a $31.4 million reduction at
Emery and a $17.7 million reduction at CNF. Higher capital expenditures
from Con-Way were primarily due to $74.4 million of cash spent for the
planned periodic replacement of linehaul equipment. In the first nine
months of last year, Con-Way acquired $66.7 million of equipment with
operating leases. The first nine months of last year included expenditures
on the construction of a CNF corporate administration facility.
Financing activities in the first nine months of 2001 used cash of
$30.6 million compared to financing activities that provided cash of $41.5
million during the first nine months of last year. In the first nine
months 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 September 30,
2001, no borrowings were outstanding under the $350 million facility and
$61.8 million of letters of credit were outstanding, leaving available
capacity of $288.2 million, subject to compliance with customary conditions
to borrowing. Also, at September 30, 2001, we had $100.0 million of
uncommitted lines of credit with no outstanding borrowings. Under other
unsecured facilities, $75.1 million in letters of credit and bank
guarantees were outstanding at September 30, 2001.
On August 13, 2001, EWA was required to suspend its air carrier
operations as part of a settlement agreement with the FAA. As described
above under "Consolidated Results of Operations--Emery Worldwide--
Regulatory Matters", events relating to the grounding of EWA's fleet may
result in defaults under, among other things, our $350 million revolving
credit facility and the agreements pursuant to which EWA leases a
substantial majority of its aircraft. These defaults could require that we
repay any outstanding borrowings and replace outstanding letters of credit
under our credit facility and make substantial termination payments under
these aircraft leases. In addition, if these or other events were to
result in certain reductions in the credit ratings on our long-term senior
debt, we may be required to repay certain outstanding indebtedness issued
by the TASP. There can be no assurance that we would have sufficient funds
to repay these borrowings or other indebtedness, to replace these letters
of credit, or to make payments to the lessors under these aircraft leases
or that we would be able to arrange financing for those purposes. Moreover,
upon the occurrence of a default under our revolving credit facility, we
would be prohibited from making additional borrowings thereunder. There
can be no assurance that we would be able to obtain the necessary waivers
or amendments from the requisite banks under our $350 million bank credit
agreement were any breaches of the nature described above to occur.
Accordingly, any of these events could have a material adverse effect on
our financial condition, including our liquidity, and results of
operations.
PAGE 34
Our ratio of total debt to capital increased to 36.5% at September 30,
2001 from 31.4% at December 31, 2000 due primarily to the significant
unusual charges described in "Consolidated Results of Operations".
Discontinued Operations
- -----------------------
As described above under "Consolidated 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 to the Financial
Statements, in 2001 EWA received payments from the USPS related to the
discontinued Priority Mail operations. In January 2001, EWA received a $60
million provisional payment toward reimbursable termination costs, as
provided under the Termination Agreement signed by EWA and the USPS in
November 2000. In September 2001, EWA received a $305 million payment from
the USPS, including $235 million to settle all non-termination claims under
the Priority Mail contract, as described above under "Consolidated Results
of Operations--Discontinued Operations."
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. However, results of operations in
September, 2001 were adversely affected by the September 11, 2001 terrorist
attacks and the grounding of EWA's fleet of aircraft.
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 35
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 to the 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
September 30, 2001, we had not entered into any derivative contracts to
hedge our foreign currency exchange exposure.
ACCOUNTING STANDARDS
====================
As described in Note 10 to the 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 third quarter and first nine months of 2001, the decline in the
estimated fair value of our fair value hedges of $17.1 million and $16.6
million, respectively, resulted in reductions to Other Assets and Long-Term
Debt. During the third quarter of 2001, the estimated fair value of cash
flow hedges decreased $3.6 million ($2.2 million net of tax). In the first
nine months of 2001, the estimated fair value of cash flow hedges declined
$7.9 million ($4.8 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 (FASB) 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.
We are in the process of evaluating the financial statement impact of
adoption of SFAS 142.
In June 2001, the FASB issued SFAS 143, "Accounting for Asset
Retirement Obligations", which will be effective for CNF on January 1,
2003. SFAS 143 addresses the financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets
and the associated asset retirement costs. We are in the process of
evaluating the financial statement impact of adoption of SFAS 143.
In August 2001, the FASB issued SFAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supersedes SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". SFAS 144 also supercedes the accounting and
reporting provisions of APB No. 30, "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions",
for the disposal of a segment of a business. The effective date for
implementation of SFAS 144 is for fiscal years beginning after December 15,
2001; however, early adoption is permitted. SFAS 144 retains many of the
fundamental provisions of SFAS 121, but resolves certain implementation
issues. We are in the process of evaluating the financial statement impact
of adoption of SFAS 144.
PAGE 36
FORWARD-LOOKING STATEMENTS
--------------------------
Certain statements included herein constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended, and are subject to a number of risks and
uncertainties, and should not be relied upon as predictions of future
events. All statements other than statements of historical fact are
forward-looking statements, including any projections of earnings,
revenues, tonnage, volumes, income or other financial or operating items,
any statements of the plans, strategies, expectations or objectives of the
Company or management for future operations or other future items, any
statements concerning proposed new products or services, any statements
regarding future economic conditions or performance, any statements of
estimates or belief and any statements or assumptions underlying the
foregoing. Certain such forward-looking statements can be identified by
the use of forward-looking terminology such as "believes", "expects",
"may", "will", "should", "seeks", "approximately", "intends", "plans",
"estimates" or "anticipates" or the negative of those terms or other
variations of those terms or comparable terminology or by discussions of
strategy, plans or intentions. Such forward-looking statements are
necessarily dependent on assumptions, data and methods that may be
incorrect or imprecise and there can be no assurance that they will be
realized. In that regard, the following factors, among others and in
addition to the matters discussed elsewhere in this document and in the
Company's 2000 Annual Report on Form 10-K and other reports and documents
filed by the Company with the Securities and Exchange Commission, could
cause actual results and other matters to differ materially from those
discussed in such forward-looking statements: changes in general business
and economic conditions, including the slowdown in the global economy which
the Company expects will continue; the creditworthiness of the Company's
customers and their ability to pay for services rendered; increasing
competition and pricing pressure; changes in fuel prices; the effects of
the continued suspension or possible cessation of the operations of Emery
Worldwide Airlines' (EWA) fleet of aircraft, including the expense of using
aircraft operated by other air carriers in Emery's North American
operations, the possibility of additional charges, relating to the further
reduction of its fleet of aircraft or the possibility of defaults under
debt instruments and aircraft leases, and the possibility of future loss of
business due to publicity surrounding the grounding of EWA's fleet of
aircraft; uncertainties regarding EWA's ability to recover all termination
costs relating to the termination of its former Priority Mail contract with
the United States Postal Service (USPS); uncertainties regarding EWA's
ability to recover all termination costs and other claims relating to the
termination of its former Express Mail contract with the USPS; labor
matters, including the grievance by furloughed pilots and crew members
discussed below under "Legal Proceedings", renegotiations of labor
contracts and the risk of work stoppages or strikes; enforcement of and
changes in governmental regulations; environmental and tax matters
(including claims made by the Internal Revenue Service with respect to
aircraft maintenance tax matters); the Department of Transportation, FAA
and Department of Justice investigation relating to Emery Worldwide's
handling of hazardous materials; the February 2000 crash of an EWA aircraft
and related investigation and litigation; and matters relating to the
Company's 1996 spin-off of Consolidated Freightways. As a result of the
foregoing, no assurance can be given as to future financial position or
results of operations.
PAGE 37
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 (FAA) 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.
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. A public hearing originally scheduled for
August 22 and 23, 2001 was cancelled and has not been rescheduled. 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.
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. The
plaintiff has agreed to settle this lawsuit, subject to court approval,
upon payment of a nominal amount by the Company.
As discussed above under "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Consolidated Results of
Operations-Emery Worldwide", as a result of EWA's suspension of its air
carrier operations on August 13, 2001, EWA furloughed approximately 400
pilots and crew members. Those pilots and crew members are represented by
the Air Line Pilots Association ("ALPA") union under a collective
bargaining agreement and ALPA has filed a grievance on their behalf
protesting the furlough. The grievance seeks reinstatement of their jobs
and back pay, and the Company is currently involved in arbitration with
respect to these claims. Although the Company believes that these claims
are without merit, because this proceeding is at a preliminary stage, the
Company is unable to predict the outcome of this matter or the effect it
may have on the Company.
PAGE 38
As described in Notes 5 and 11 to the Financial Statements and under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", the Company is subject to certain legal and administrative
proceedings with the IRS and the FAA. There can be no assurance that these
proceedings will not have a material adverse effect on the Company's
financial condition or results of operations.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99(a) Computation of Ratios of Earnings (Loss) to Fixed
Charges -- For the nine months ended September 30,
2001, earnings were insufficient to cover fixed
charges by $355,614 (in thousands). For the nine
months ended September 30, 2000, the ratio of
earnings to fixed charges was 3.5x.
(b) Computation of Ratios of Earnings (Loss) to
Combined Fixed Charges-- For the nine months ended
September 30, 2001, earnings were insufficient to
cover combined fixed charges by $355,614 (in thousands).
For the nine months ended September 30, 2000, the ratio
of earnings to combined fixed charges was 3.3x.
(b) Reports on Form 8-K
One report on Form 8-K, dated August 14, 2001, was filed
during the quarter ended September 30, 2001, reporting a
temporary agreement between the FAA and EWA. The agreement is
described in "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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)
November 13, 2001 /s/Greg Quesnel
Greg Quesnel
President, Chief Executive Officer
and Chief Financial Officer