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, 2002
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.
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, 2002: 49,273,140
PAGE 2
CNF INC.
FORM 10-Q
Quarter Ended September 30, 2002
____________________________________________________________________________
____________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2002 and December 31, 2001 3
Statements of Consolidated Operations -
Three and Nine Months Ended September 30, 2002 and 2001 5
Statements of Consolidated Cash Flows -
Nine Months Ended September 30, 2002 and 2001 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 6. Exhibits and Reports on Form 8-K 38
Signatures 39
Certification of Officers pursuant to Section 302
of Sarbanes-Oxley Act of 2002 40
Page 3
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2002 2001
------------- -------------
ASSETS
Current Assets
Cash and cash equivalents $ 338,250 $ 400,763
Trade accounts receivable, net 713,605 677,684
Other accounts receivable 108,358 56,860
Operating supplies, at lower of
average cost or market 19,993 20,244
Prepaid expenses 42,635 46,948
Deferred income taxes 124,114 125,347
------------- -------------
Total Current Assets 1,346,955 1,327,846
------------- -------------
Property, Plant and Equipment, at Cost
Land 151,041 149,499
Buildings and leasehold improvements 773,136 739,197
Revenue equipment 616,970 618,329
Other equipment 395,317 411,546
------------- -------------
1,936,464 1,918,571
Accumulated depreciation and amortization (901,497) (848,042)
------------- -------------
1,034,967 1,070,529
------------- -------------
Other Assets
Deferred charges and other assets (Note 2) 251,034 224,605
Capitalized software, net 76,675 79,891
Goodwill, net (Note 1) 240,567 240,523
Deferred income taxes - 46,626
------------- -------------
568,276 591,645
------------- -------------
Total Assets $ 2,950,198 $ 2,990,020
============= =============
The accompanying notes are an integral part of these statements.
Page 4
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands except per share amounts)
September 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
------------- -------------
Current Liabilities
Accounts payable $ 351,989 $ 338,730
Accrued liabilities (Note 2) 386,635 307,676
Accrued claims costs 161,411 126,981
Accrued aircraft leases
and return provision 140,560 77,483
Current maturities of long-term
debt and capital leases 10,152 11,765
Income taxes payable - 21,501
------------- -------------
Total Current Liabilities 1,050,747 884,136
Long-Term Liabilities
Long-term debt and guarantees 453,897 436,055
Long-term obligations under capital
leases 110,522 129,760
Accrued claims costs 114,857 122,273
Employee benefits 228,209 275,764
Other liabilities and deferred
credits (Note 3) 123,560 120,858
Accrued aircraft leases and return
provision 5,170 258,087
Deferred income taxes 26,579 -
------------- -------------
Total Liabilities 2,113,541 2,226,933
------------- -------------
Commitments and Contingencies (Note 10)
Company-Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary
Trust Holding Solely Convertible
Debentures of the Company (Note 8) 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 787,775 and 805,895
shares, respectively 8 8
Additional paid-in capital, preferred
stock 119,813 122,568
Deferred compensation, Thrift and
Stock Plan (67,622) (73,320)
------------- -------------
Total Preferred Shareholders' Equity 52,199 49,256
------------- -------------
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,841,675
and 55,559,909 shares, respectively 34,901 34,725
Additional paid-in capital, common stock 338,428 332,066
Retained earnings 489,800 432,918
Deferred compensation, restricted
stock (611) (1,013)
Cost of repurchased common stock
(6,581,986 and 6,669,393 shares,
respectively) (162,287) (164,441)
------------- -------------
700,231 634,255
Accumulated Other Comprehensive
Loss (Note 5) (40,773) (45,424)
------------- -------------
Total Common Shareholders' Equity 659,458 588,831
------------- -------------
Total Shareholders' Equity 711,657 638,087
------------- -------------
Total Liabilities and
Shareholders' Equity $ 2,950,198 $ 2,990,020
============= =============
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,
----------------------- -----------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
REVENUES $1,230,147 $1,184,959 $3,483,494 $3,720,032
Costs and Expenses
Operating expenses 1,030,236 1,033,337 2,903,608 3,209,398
General and administrative
expenses 121,612 117,495 345,833 366,298
Depreciation 34,774 39,497 106,255 127,434
Restructuring charges
(Note 4) - - - 340,531
----------- ----------- ----------- -----------
1,186,622 1,190,329 3,355,696 4,043,661
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) 43,525 (5,370) 127,798 (323,629)
Other Income (Expense)
Investment income 1,221 470 4,506 1,840
Interest expense (5,813) (6,608) (17,336) (21,635)
Dividend requirement on
preferred securities
of subsidiary trust
(Note 8) (1,563) (1,563) (4,689) (4,689)
Miscellaneous, net (3,527) (143) (7,330) 1,166
----------- ----------- ----------- -----------
(9,682) (7,844) (24,849) (23,318)
----------- ----------- ----------- -----------
Income (Loss) before Taxes 33,843 (13,214) 102,949 (346,947)
Income Tax Benefit (Provision) 11,801 4,889 (15,150) 128,370
----------- ----------- ----------- -----------
INCOME (LOSS) FROM CONTINUING
OPERATIONS 45,644 (8,325) 87,799 (218,577)
----------- ----------- ----------- -----------
Gain (Loss) from Discontinuance,
net of tax (Note 2) (10,139) 38,975 (10,139) 38,975
----------- ----------- ----------- -----------
Net Income (Loss) 35,505 30,650 77,660 (179,602)
Preferred Stock Dividends 2,002 2,052 6,050 6,171
----------- ----------- ----------- -----------
NET INCOME (LOSS) APPLICABLE TO
COMMON SHAREHOLDERS $ 33,503 $ 28,598 $ 71,610 $ (185,773)
=========== =========== =========== ===========
Weighted-Average Common Shares
Outstanding (Note 7)
Basic shares 49,226,241 48,778,789 49,077,089 48,728,252
Diluted shares 56,755,010 48,778,789 56,700,280 48,728,252
Earnings (Loss) per Common
Share (Note 7)
Basic
Net Income (Loss) from
Continuing Operations $ 0.89 $ (0.21) $ 1.67 $ (4.61)
Gain (Loss) from
Discontinuance,
net of tax (0.21) 0.80 (0.21) 0.80
----------- ----------- ----------- -----------
Net Income (Loss)
Applicable to Common
Shareholders $0.68 $0.59 $1.46 $(3.81)
=========== =========== =========== ===========
Diluted
Net Income (Loss) from
Continuing Operations $0.79 $(0.21) $1.51 $(4.61)
Gain (Loss) from
Discontinuance,
net of tax (0.18) 0.80 (0.18) 0.80
----------- ----------- ----------- -----------
Net Income (Loss)
Applicable to Common
Shareholders $ 0.61 $ 0.59 $ 1.33 $ (3.81)
=========== =========== =========== ===========
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,
----------------------------
2002 2001
----------- -----------
Cash and Cash Equivalents,
Beginning of Period $ 400,763 $ 104,515
----------- -----------
Operating Activities
Net income (loss) 77,660 (179,602)
Adjustments to reconcile net income
(loss) to net cash provided
by operating activities:
Loss (Gain) from discontinuance, net of
tax 10,139 (38,975)
Restructuring charges - 340,531
Loss from business failure of a customer - 37,905
Depreciation and amortization 120,833 149,819
Increase (Decrease) in deferred income
taxes 82,057 (139,898)
Amortization of deferred compensation 6,513 5,523
Provision for uncollectible accounts 11,921 6,578
Losses (Gains) from sales of property and
equipment (12,713) 2,150
Changes in assets and liabilities:
Receivables (93,172) 100,021
Prepaid expenses 4,313 (1,726)
Accounts payable 15,971 (58,019)
Accrued liabilities 80,171 (28,921)
Accrued claims costs 5,714 30,817
Income taxes (21,501) (15,771)
Employee benefits (47,555) 14,296
Accrued aircraft leases and return
provision (189,840) (14,457)
Deferred charges and credits (3,470) 72,349
Other 2,163 (13,060)
----------- -----------
Net Cash Provided by Operating Activities 49,204 269,560
----------- -----------
Investing Activities
Capital expenditures (67,416) (166,743)
Software expenditures (10,354) (14,268)
Proceeds from sales of property, net 12,017 5,291
----------- -----------
Net Cash Used in Investing Activities (65,753) (175,720)
----------- -----------
Financing Activities
Repayments of long-term debt, guarantees
and capital leases (30,951) (7,592)
Proceeds from exercise of stock options 5,500 2,358
Payments of common dividends (14,728) (14,637)
Payments of preferred dividends (10,484) (10,709)
----------- -----------
Net Cash Used in Financing Activities (50,663) (30,580)
----------- -----------
Net Cash Provided by (Used in) Continuing
Operations (67,212) 63,260
----------- -----------
Net Cash Used in Discontinued Operations 4,699 227,233
----------- -----------
Increase (Decrease) in Cash and Cash
Equivalents (62,513) 290,493
----------- -----------
Cash and Cash Equivalents, End of Period $ 338,250 $ 395,008
=========== ===========
The accompanying notes are an integral part of these statements.
PAGE 7
CNF INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Pursuant to the rules and regulations of the Securities and Exchange
Commission, the accompanying consolidated financial statements of CNF Inc.
and its wholly owned subsidiaries (CNF) have been prepared by CNF, without
audit by independent public accountants. 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 CNF's
2001 Annual Report to Shareholders.
On December 5, 2001, CNF announced effective January 1, 2002, the formation
of a new global supply chain services company called Menlo Worldwide, which
for financial reporting purposes includes the operating results of Emery
Forwarding, Menlo Worldwide Logistics, Menlo Worldwide Technologies, and
Vector SCM. Refer to Note 6, "Business Segments," for a description of
CNF's reporting segments.
New Accounting Standards
Effective January 1, 2002, CNF adopted SFAS 142, "Goodwill and Other
Intangible Assets." SFAS 142 specifies that goodwill and some intangible
assets will no longer be amortized but instead will be subject to an annual
fourth-quarter impairment test. Pursuant to SFAS 142, CNF has evaluated
whether its goodwill is impaired and has determined that, as of January 1,
2002, CNF was not required to make an adjustment to the carrying value of
the assets. Effective January 1, 2002, CNF ceased goodwill amortization
associated with the Emery Forwarding segment. Prior to adoption of SFAS
142, CNF amortized goodwill of $2.6 million and $8.1 million, respectively,
in the third quarter and first nine months of last year.
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. CNF is in the process of evaluating the financial
statement impact of adoption of SFAS 143.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements 4,
44, and 64, Amendment of FASB Statement 13, and Technical Corrections."
SFAS 145 updates, clarifies and simplifies existing accounting
pronouncements, by rescinding SFAS 4, which required all gains and losses
from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax effect. As a result,
the criteria in Accounting Principles Board Opinion 30 will now be used to
classify those gains and losses. Additionally, SFAS 145 amends SFAS 13 to
require that certain lease modifications that have economic effects similar
to sale-leaseback transactions be accounted for in the same manner as sale-
leaseback transactions. Finally, SFAS 145 also makes technical corrections
to existing pronouncements. While those corrections are not substantive in
nature, in some instances, they may change accounting practice. CNF adopted
the provisions of SFAS 145 that amended SFAS 13 for transactions occurring
after May 15, 2002 in its consolidated financial statements with no
material impact. CNF will adopt all other provisions of SFAS 145, as
required, effective January 1, 2003. CNF is evaluating the financial
statement impact of adopting these other provisions of SFAS 145.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which is effective for exit or disposal
activities initiated after December 31, 2002. SFAS 146, once adopted,
nullifies EITF Issue No. 94-3. SFAS 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred, whereas EITF No. 94-3 had allowed for recognition of
PAGE 8
the liability at the commitment date to an exit plan. CNF is in the
process of evaluating the financial statement impact of adoption of SFAS
146.
Reclassification
Certain amounts in prior-year financial statements have been reclassified
to conform to current-year presentation.
2. Discontinued Operations
Priority Mail Contract
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"). As described below, all claims
relating to amounts owed to EWA under the Priority Mail contract have been
settled.
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 $125.0 million (the "Termination
Liability Cap"). On January 7, 2001, the USPS paid EWA $60.0 million
toward the termination costs. The Termination Agreement provided for this
provisional payment to be adjusted if actual termination costs were greater
or less than $60.0 million, in which case either the USPS would be required
to make an additional payment with interest or EWA would be required to
return a portion of the provisional payment with interest. On July 3,
2002, EWA received a $6.0 million payment from the USPS, in addition to the
$60.0 million provisional payment on January 7. The additional $6.0
million payment fully settled EWA's Priority Mail contract termination
costs and resulted in a 2002 third-quarter gain from discontinuance of $2.9
million, net of $1.8 million of income taxes.
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 $235.0 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 was unaffected by the Settlement
Agreement.
As a result of the termination of the Priority Mail contract, the results
of operations, and cash flows of the Priority Mail operations have been
segregated and classified as discontinued operations. Net non-current
assets of the discontinued Priority Mail operations of $3.1 million at
December 31, 2001 were included in Deferred Charges and Other Assets in the
Consolidated Balance Sheets. Net current liabilities of discontinued
Priority Mail operations of $4.4 million and $5.6 million at September 30,
2002 and December 31, 2001, respectively, were included in Accrued
Liabilities.
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. Accordingly, beginning in the third quarter of 1999
until January 7, 2001, EWA recognized as "unbilled revenue" under the
Priority Mail contract, an amount of revenue sufficient only to cover costs
of operating under the contract. As a result, no operating profit has been
recognized in connection with the Priority Mail contract since the third
quarter of 1999, when EWA filed a claim for re-determined higher prices.
PAGE 9
Prior to the January 7, 2001 settlement, CNF recorded revenues in amounts
up to the costs incurred.
As a result of the Settlement Agreement, this unbilled revenue was fully
recovered and EWA in the third quarter of 2001 recognized a gain from
discontinuance of $39.0 million, net of $24.9 million of income taxes.
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 Priority Mail contract on January 7, 2001. Subsequent to
January 7, 2001, no revenue was recognized under the Priority Mail
contract.
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off of Consolidated Freightways
Corporation ("CFC") to CNF's shareholders. In connection with the spin-off
of CFC, CNF agreed to indemnify certain states, insurance companies and
sureties against the failure of CFC to pay certain workers' 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 and surety
bonds under which CNF is liable to the issuing bank or the surety company.
In September 2002, CFC filed for bankruptcy and announced that it will
cease most U.S. operations. Following the commencement of its bankruptcy
proceeding, CFC ceased making payments with respect to these workers'
compensation and public liability claims. CNF has taken over payment of
some of these claims, and expects that demands for payment will likely be
made against it with respect to the remaining claims. CNF estimates the
aggregate amount of all of these claims, plus other costs, to be $21.3
million. As a result, CNF accrued additional reserves of $21.3 million in
Accrued Claims Costs in the Consolidated Balance Sheets and recognized a
$13.0 million loss from discontinuance, net of $8.3 million of income
taxes, in the third quarter of 2002. CNF intends to seek reimbursement
from CFC in its bankruptcy proceeding of amounts that CNF pays in respect
of these claims, although there can be no assurance that CNF will be
successful in recovering all or any portion of such payments.
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multiemployer pension plans covering some of its current and former
employees. The cessation of its U.S. operations will result in CFC's
"complete withdrawal" (within the meaning of applicable federal law) from
these multiemployer plans, at which point it will become obligated, under
federal law, to pay its share of any unfunded vested benefits under those
plans. It is possible that the trustees of CFC's multiemployer pension
plans may assert claims that CNF is liable for amounts owing to the plans
as a result of CFC's withdrawal from those plans. For further detailed
discussion of this matter, see "Liquidity and Capital Resources - Spin-Off
of CFC" under "Management's Discussion and Analysis."
3. Express Mail Contract
Under the Settlement Agreement described above under "Discontinued
Operations - Priority Mail Contract", on September 28, 2001, EWA received a
$70.0 million provisional payment from the USPS to provisionally pay for
termination costs and other claims related to 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 actual termination costs and other agreed-upon claims related
to the Express Mail contract are greater or less than $70.0 million, in
which case either the USPS will be required to make an additional payment
with interest, subject to the limitation described in the following
paragraph, or EWA will be required to return a portion of the provisional
payment with interest.
As of September 30, 2002 and December 31, 2001, the $70.0 million
provisional payment was included in Deferred Credits in CNF's Consolidated
Balance Sheets. This amount will continue to be included in Deferred
Credits until it is used to retire the remaining $80.0 million in assets
included in Deferred Charges 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 Express Mail contract,
PAGE 10
including the $70.0 million provisional payment, may not exceed $150.0
million. On December 14, 2001, EWA filed a termination settlement proposal
with the USPS for recovery of EWA's costs of providing service under the
terminated Express Mail contract as well as costs incurred by EWA's
subcontractors for performing services under the Express Mail contract.
Any recovery of such costs would be offset in whole or in part by the $70.0
million provisional payment received in 2001.
Results of the former Express Mail contract are included in the Emery
Forwarding reporting segment.
4. Restructuring Charges
In June 2001, Emery began an operational restructuring to align it with
management's estimates of future business prospects for domestic heavy air
freight and address changes in market conditions, which deteriorated due to
a slowing domestic economy, loss of EWA's contracts with the USPS to
transport Express Mail and Priority Mail and, to a lesser extent, loss of
business to ground transportation providers.
The $340.5 million restructuring charge recognized in the second quarter of
2001 consisted primarily of non-cash impairment charges, including the
write-off of $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 airfreight operations
and, for certain assets, independent appraisals. 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
grounded aircraft leased to Emery and the termination of the related
leases.
As described in "Menlo Worldwide-Emery Forwarding-Regulatory Matters" under
"Management's Discussion and Analysis," the Federal Aviation Administration
(FAA) required EWA to suspend its air carrier operations on August 13,
2001. In response to the FAA suspension, as well as the September 11, 2001
terrorist actions described below in Note 10, "Commitments and
Contingencies - Terrorist Attacks," the growing unpredictability and
uncertainty of the FAA's requalification process, and a worsening global
economic downturn, Emery re-evaluated its restructuring plan. CNF announced
on December 5, 2001 that Emery in 2002 would become part of CNF's new Menlo
Worldwide group of supply chain services providers and would continue to
provide full North American forwarding services utilizing aircraft operated
by other air carriers instead of EWA's fleet of aircraft, and that EWA
would cease air carrier operations. In connection with the revised
restructuring plan, in the fourth quarter of 2001 Emery recognized
additional restructuring charges of $311.7 million for the planned disposal
of leased aircraft, cessation of EWA's remaining operations, employee
separation costs for 157 Emery employees, and other costs.
The restructuring charges in 2001 were based in part on significant
estimates and assumptions made by Emery's management as to the amount and
timing of aircraft rental payments and the costs of returning those
aircraft upon expiration or early termination of the leases. The $311.7
million restructuring charge recognized in the fourth quarter of 2001
includes primarily accruals for scheduled undiscounted rental payments for
aircraft leased to Emery and estimated costs of returning those aircraft
upon expiration or early termination of the related leases. Actual costs
may differ from those estimates (due, among other things, to Emery's
efforts to negotiate the early termination of aircraft leases and potential
defaults under aircraft leases) and that difference would be recognized as
additional expense or income in the period when and if that determination
can be made. In the first nine months of 2002, Emery paid $189.8 million
for aircraft leases and return costs, primarily due to the negotiated early
return of aircraft. At September 30, 2002, $140.6 million of accrued
aircraft leases and return costs were classified as current liabilities in
the Consolidated Balance Sheets based primarily on Emery's intention to
negotiate the early termination of those aircraft leases. See Note 10,
"Commitments and Contingencies-Restructuring Charges and Regulatory
Matters."
PAGE 11
The following table represents the cumulative activity related to Emery's
2001 restructuring plan:
(In Millions) Cumulative Charged Reserves at
Total Cash Against September 30,
Charges Usage Assets 2002
---------- ---------- ---------- -------------
Employee separations $ 6.1 $ (3.9) $ -- $ 2.2
Asset impairments 278.0 -- (278.0) --
Aircraft and other costs 368.1 (197.0) -- 171.1
---------- ---------- ---------- -------------
$ 652.2 $ (200.9) $ (278.0) $ 173.3
========== ========== ========== =============
In October 2002, Emery paid an additional $38.6 million in connection with
the negotiated early return of 3 additional aircraft. As of October 31,
2002, Emery had returned 26 of EWA's fleet of 37 parked aircraft to
lessors, leaving 11 unreturned aircraft.
There can be no assurance that Emery will not be required to incur
additional charges or expend additional amounts in the future in connection
with matters relating to the cessation of EWA's air carrier operations or
the termination of EWA's aircraft leases, particularly if one or more of
the events described in Note 10, "Commitments and Contingencies" were to
occur, which could have a material adverse effect on CNF's financial
condition, cash flows, and results of operations.
PAGE 12
5. 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
September 30, September 30,
---------------------- ----------------------
(Dollars in thousands) 2002 2001 2002 2001
---------------------- ----------------------
Net income (loss) $ 35,505 $ 30,650 $ 77,660 $(179,602)
Other comprehensive income (loss)
Cumulative effect of accounting
change, net of tax (Note 9) -- -- -- 3,005
Change in fair value of cash
flow hedges (Note 9) (16) (2,210) 1,064 (4,831)
Foreign currency translation
adjustment 472 494 3,587 (4,076)
---------- ---------- ---------- ----------
456 (1,716) 4,651 (5,902)
---------- ---------- ---------- ----------
Comprehensive income (loss) $ 35,961 $ 28,394 $ 82,311 $(185,504)
========== ========== ========== ==========
The following is a summary of the components of Accumulated Other Comprehensive
Loss:
September 30, December 31,
(Dollars in thousands) 2002 2001
------------- -------------
Cumulative effect of accounting change, net
of tax (Note 9) $ -- $ 3,005
Accumulated change in fair value of cash
flow hedges (Note 9) (479) (4,548)
Accumulated foreign currency translation
adjustments (29,195) (32,782)
Minimum pension liability adjustment (11,099) (11,099)
------------- -------------
Accumulated other comprehensive loss $ (40,773) $ (45,424)
============= =============
6. Business Segments
Selected financial information for CNF's continuing operations is shown
below. CNF 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.
On December 5, 2001, CNF announced effective January 1, 2002, the formation
of a new global supply chain services company called Menlo Worldwide, which
for financial reporting purposes includes the operating results of Emery
Forwarding, Menlo Worldwide Logistics, Menlo Worldwide Technologies, and
Vector SCM.
PAGE 13
Consistent with SFAS 131, "Disclosures about Segments of an Enterprise and
Related Information," CNF discloses segment information in the manner in
which the components are organized for making operating decisions,
assessing performance and allocating resources. Accordingly, operating
results are reported along CNF's three lines of business: Con-Way
Transportation Services, Menlo Worldwide, and CNF Other. Within the Menlo
Worldwide group, Emery Forwarding, Menlo Worldwide Logistics and Menlo
Worldwide Other individually represent separate segments for financial
reporting purposes. The Emery Forwarding reporting segment consists of
Emery Forwarding and Emery Worldwide Airlines ("EWA"), a separate
subsidiary of CNF that ceased its air carrier operations in December 2001.
The Menlo Worldwide Other reporting segment consists of Menlo Worldwide
Technologies and Vector SCM. The CNF Other reporting segment includes the
operating results of Road Systems and certain CNF corporate activities.
Operating results in the prior period have been reclassified to conform to
the current-year reporting segment presentation.
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in thousands) 2002 2001 2002 2001
----------- ----------- ----------- -----------
Revenues Including Intersegment
Con-Way Transportation Services $ 527,804 $ 491,296 $1,486,700 $1,449,883
Menlo Worldwide
Emery Forwarding 446,851 471,540 1,281,496 1,585,035
Menlo Worldwide Logistics 258,357 224,694 723,350 687,632
----------- ----------- ----------- -----------
705,208 696,234 2,004,846 2,272,667
CNF Other 3,273 6,986 9,968 23,906
----------- ----------- ----------- -----------
1,236,285 1,194,516 3,501,514 3,746,456
----------- ----------- ----------- -----------
Intersegment Revenue Eliminations
Con-Way Transportation Services (115) (145) (312) (569)
Menlo Worldwide
Emery Forwarding (54) (55) (151) (194)
Menlo Worldwide Logistics (3,335) (2,976) (10,208) (8,816)
----------- ----------- ----------- -----------
(3,389) (3,031) (10,359) (9,010)
CNF Other (2,634) (6,381) (7,349) (16,845)
----------- ----------- ----------- -----------
(6,138) (9,557) (18,020) (26,424)
----------- ----------- ----------- -----------
Revenues
Con-Way Transportation Services 527,689 491,151 1,486,388 1,449,314
Menlo Worldwide
Emery Forwarding 446,797 471,485 1,281,345 1,584,841
Menlo Worldwide Logistics 255,022 221,718 713,142 678,816
----------- ----------- ----------- -----------
701,819 693,203 1,994,487 2,263,657
CNF Other 639 605 2,619 7,061
----------- ----------- ----------- -----------
$1,230,147 $1,184,959 $3,483,494 $3,720,032
----------- ----------- ----------- -----------
Operating Income (Loss)
Con-Way Transportation Services $ 41,618 $ 42,617 $ 110,454 $ 121,783
Menlo Worldwide
Emery Forwarding (4,979) (46,975) (16,600) (423,964)
Menlo Worldwide Logistics 8,371 1,004 23,183 (13,078)
Menlo Worldwide Other 2,638 117 13,267 (6,178)
----------- ----------- ----------- -----------
6,030 (45,854) 19,850 (443,220)
CNF Other (4,123) (2,133) (2,506) (2,192)
----------- ----------- ----------- -----------
$ 43,525 $ (5,370) $ 127,798 $ (323,629)
----------- ----------- ----------- -----------
Unusual and/or Non-recurring Items Included in Operating Income (Loss) for the Periods Presented:
Con-Way Transportation Services -
Net gain from the sale of property $ - $ - $ 8,675 $ -
Menlo Worldwide -
Emery Forwarding -
Net gain from a payment under the Air
Transportation Safety and System
Stabilization Act - - 9,895 -
Loss from restructuring charge - - - (340,531)
Loss from a legal settlement on returned
aircraft - - - (4,696)
Goodwill amortization - (2,570) - (8,055)
Express Mail operating income - 1,795 - 5,433
Menlo Worldwide Logistics -
Net gain from a contract termination - - 1,850 -
Loss from the business failure of a
customer - (6,300) - (37,905)
CNF Other -
Loss from the business failure of CFC (3,595) - (3,595) -
Net gain from the sale of property - - 2,367 -
PAGE 14
7. Earnings Per Common Share
Basic earnings (loss) per common share (EPS) from continuing operations was
computed by dividing net income (loss) from continuing operations (after
preferred stock dividends) by the weighted-average common shares
outstanding. The calculation for diluted EPS was calculated as shown
below.
Three Months Ended Nine Months Ended
(Dollars in thousands except September 30, September 30,
per share data) ------------------------ ------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Earnings (Loss):
Net income (loss) from
continuing operations $ 43,642 $ (10,377) $ 81,749 $ (224,748)
Add-backs:
Dividends on preferred
stock, net of
replacement funding 278 -- 871 --
Dividends on preferred
securities of
subsidiary trust,
net of tax 954 -- 2,862 --
----------- ----------- ----------- -----------
$ 44,874 $ (10,377) $ 85,482 $ (224,748)
----------- ----------- ----------- -----------
Shares:
Basic shares (weighted-
average common shares
outstanding) 49,226,241 48,778,789 49,077,089 48,728,252
Stock options 627,607 -- 722,029 --
Series B preferred stock 3,776,162 -- 3,776,162 --
Preferred securities of
subsidiary trust 3,125,000 -- 3,125,000 --
----------- ----------- ----------- -----------
56,755,010 48,778,789 56,700,280 48,728,252
----------- ----------- ----------- -----------
Diluted earnings (loss)
per common share $ 0.79 $ (0.21) $ 1.51 $ (4.61)
=========== =========== =========== ===========
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 net income (loss) from continuing operations
under the if-converted method have been excluded from the calculation of
diluted EPS. If the securities were dilutive, the assumed shares under the
if-converted method would have been as follows for the three months ended
September 30, 2001: stock options - 409,344 shares, series B preferred
stock - 4,427,742 shares, preferred securities of subsidiary trust -
3,125,000 shares. For the nine months ended September 30, 2001, the shares
would have been as follows: stock options - 472,440 shares, series B
preferred stock - 4,427,742 shares, preferred securities of subsidiary
trust - 3,125,000 shares.
8. Preferred Securities of Subsidiary Trust
On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust wholly
owned by CNF, 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 CNF
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 CNF. The Debentures
are the sole assets of the Trust.
PAGE 15
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). CNF 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 CNF 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 CNF, 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 CNF 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 CNF's common stock
at a conversion rate of 1.25 shares of CNF's common stock for each TECONS,
subject to adjustment in certain circumstances.
9. Derivative Instruments and Hedging Activities
Effective January 1, 2001, CNF 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 gain or
loss 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.
CNF is exposed to a variety of market risks, including the effects of
interest rates, commodity prices, foreign currency exchange rates and
credit risk. CNF'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.
CNF 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, CNF 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, CNF 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.
PAGE 16
CNF'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. CNF's current interest rate swap
derivatives qualify for hedge treatment under SFAS 133.
In accordance with the transition provisions of SFAS 133, in the first
quarter of 2001 CNF 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 estimated effect of interest rate changes on the fair value
of fixed-rate debt, which is hedged with interest rate swap derivatives
designated as fair value hedges.
In the third quarter and the first nine months of 2002, the estimated fair
value of CNF's fair value hedges increased $20.5 million and $27.9 million
respectively, and offset an equal increase in the estimated fair value of
CNF's fixed-rate long-term debt attributable to interest rate changes.
Cash flow hedges were essentially unchanged in the third quarter of 2002,
while cash flow hedges in the first nine months of 2002 increased $1.7
million ($1.1 million after tax).
10. Commitments and Contingencies
IRS Matters
In August 2002, CNF entered into settlement agreements with the IRS,
pursuant to which the parties settled an aircraft maintenance issue for the
years 1987 through 2000, and all other open issues under IRS examinations
for the years 1987 through 1996. Accordingly, CNF eliminated the related
tax liabilities and recognized a $25.0 million tax benefit in the third
quarter of 2002. As a result of the settlement agreements, CNF was not
required to make any additional payments to the IRS over and above a $93.4
million payment made in respect to these issues in the third quarter of
2000. Certain issues remain open for the years 1997 through 2000, but
management does not believe that the resolution of those issues is likely
to have a material adverse effect on CNF's financial condition, cash flows,
or results of operations.
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off of Consolidated Freightways
Corporation ("CFC") to CNF's shareholders. In September 2002, CFC filed
for bankruptcy and announced that it will cease most U.S. operations. CNF
in the third quarter of 2002 accrued additional reserves of $21.3 million
in Accrued Claims Costs in the Consolidated Balance Sheets and recognized a
$13.0 million loss from discontinuance, net of $8.3 million of income
taxes, in connection with CNF's indemnities against the failure of CFC to
pay certain workers' compensation and public liability claims that were
pending as of September 30, 1996. For further detailed discussion of this
matter, see Note 2, "Discontinued Operations."
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multiemployer pension plans covering some of its current and former
employees. The cessation of its U.S. operations will result in CFC's
"complete withdrawal" (within the meaning of applicable federal law) from
these multiemployer plans, at which point it will become obligated, under
federal law, to pay its share of any unfunded vested benefits under those
plans. It is possible that the trustees of CFC's multiemployer pension
plans may assert claims that CNF is liable for amounts owing to the plans
as a result of CFC's withdrawal from those plans. For further detailed
discussion of this matter, see "Liquidity and Capital Resources - Spin-Off
of CFC" under "Management's Discussion and Analysis."
PAGE 17
Restructuring Charges and Regulatory Matters
Due in large part to the fourth-quarter 2001 restructuring charge incurred
in connection with the cessation of EWA's air carrier operations as
described in Note 4, "Restructuring Charges," CNF was required to obtain
amendments to its bank revolving credit facility, which provide for the
pledge of collateral by CNF and its principal subsidiaries upon specified
downgrades of CNF's senior unsecured long-term debt securities. The
restructuring charges recognized by Emery during 2001 reflect CNF's
estimate of the costs of terminating EWA's air carrier operations,
returning leased aircraft and restructuring Emery's business and related
matters. Although CNF believes that the estimate is adequate to cover these
costs based on information currently available and assumptions management
believes are reasonable under the circumstances, Emery will be required to
recognize additional charges or credits if actual results differ from
management's estimates. Additional charges could result in defaults under
CNF's bank revolving credit facility and other debt instruments and under
aircraft leases. For further discussion of these matters, see "Results of
Operations - Menlo Worldwide - Emery Forwarding - Regulatory Matters" and
"Liquidity and Capital Resources - Restructuring Charges and Regulatory
Matters" under "Management's Discussion and Analysis."
As a result of the matters discussed above and in "Management's Discussion
and Analysis," CNF can provide no assurance that these matters will not
have a material adverse effect on CNF's financial condition, cash flows, or
results of operations in the future.
Terrorist Attacks
Operating results at Emery were adversely 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.
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 intended to mitigate
financial losses in the air carrier industry. The legislation provides for
$5 billion in direct loss reimbursement and $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. In March 2002, Emery received an $11.9 million
payment under the Act, resulting in the recognition of a $9.9 million first-
quarter net gain in 2002. The payment made to Emery under the Act is
subject to audit. Emery is seeking additional payments under the Act.
Emery is not able to accurately quantify how the events of September 11, or
any subsequent terrorist activities, will affect the global economy,
governmental regulation, the air transportation industry, Emery's costs of
providing airfreight services and the demand for Emery's airfreight
services. However, Emery believes that any additional security measures
that may be required by future regulations could result in additional costs
and could have an adverse effect on its operations and service.
Other
CNF is a defendant in various other lawsuits incidental to its businesses.
It is the opinion of management that the ultimate outcome of these actions
will not have a material impact on CNF's financial condition, cash flows,
or results of operations.
PAGE 18
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
On December 5, 2001, CNF announced effective January 1, 2002, the formation
of a new global supply chain services company called Menlo Worldwide, which
for financial reporting purposes includes the operating results of Emery
Forwarding, Menlo Worldwide Logistics, Menlo Worldwide Technologies, and
Vector SCM.
Consistent with SFAS 131, "Disclosures about Segments of an Enterprise and
Related Information," CNF discloses segment information in the manner in
which the components are organized for making operating decisions,
assessing performance and allocating resources. Accordingly, operating
results are reported along CNF's three lines of business: Con-Way
Transportation Services, Menlo Worldwide, and CNF Other. Within the Menlo
Worldwide group, Emery Forwarding, Menlo Worldwide Logistics and Menlo
Worldwide Other individually represent separate segments for financial
reporting purposes. The Emery Forwarding reporting segment consists of
Emery Forwarding and Emery Worldwide Airlines ("EWA"), a separate
subsidiary of CNF that ceased its air carrier operations in December 2001.
The Menlo Worldwide Other reporting segment consists of Menlo Worldwide
Technologies and Vector SCM. The CNF Other reporting segment includes the
operating results of Road Systems and certain CNF corporate activities.
Operating results in the prior periods have been reclassified to conform to
the current-year reporting segment presentation.
As used in Management's Discussion and Analysis, all references to CNF,
"the Company," "we," "us," and "our" and all similar references mean CNF
Inc. and its subsidiaries, unless otherwise expressly stated or the context
otherwise requires.
==========================================
Estimates and Critical Accounting Policies
==========================================
CNF makes estimates and assumptions when preparing the financial statements
in conformity with accounting principles generally accepted in the United
States. These estimates and assumptions affect the amounts reported in the
accompanying financial statements and notes thereto. Actual results could
differ from those estimates. CNF's most critical accounting policies upon
which management bases estimates are those relating to self-insurance
reserves, income taxes, restructuring reserves and defined benefit pension
plan costs.
Self-Insurance Reserves
- -----------------------
CNF uses a combination of insurance and self-insurance mechanisms to
provide for the potential liabilities for medical, casualty, liability,
vehicular, cargo and workers' compensation claims. Liabilities associated
with the risks that are retained by CNF are estimated, in part, by
considering historical claims experience, demographic factors, severity
factors and other assumptions. The estimated accruals for these liabilities
could be significantly affected if actual costs differ from these
assumptions and historical trends.
Income Taxes
- ------------
In establishing its deferred income tax assets and liabilities, CNF makes
judgments and interpretations based on the enacted tax laws and published
tax guidance that are applicable to its operations. CNF records deferred
tax assets and liabilities and periodically evaluates the need for
valuation allowances to reduce the deferred tax assets to realizable
amounts. The likelihood of a material change in CNF's expected realization
of these assets is dependent on future taxable income, its ability to use
foreign tax credit carryforwards and carrybacks, final U.S. and foreign tax
settlements, and the effectiveness of its tax planning strategies in the
various relevant jurisdictions. CNF is also subject to examination of its
income tax returns for multiple years by the Internal Revenue Service and
other tax authorities. CNF periodically assesses the likelihood of adverse
outcomes resulting from these examinations to determine the adequacy of its
provision and related accruals for income taxes.
PAGE 19
Restructuring Reserves
- ----------------------
The restructuring charges recognized in 2001 were based on significant
estimates and assumptions made by management. Refer to the "Menlo
Worldwide - Emery Forwarding - Restructuring Charges" section under
"Results of Operations" below for a description of some of the assumptions
used and to Note 4 to the Consolidated Financial Statements, "Restructuring
Charges" for the cumulative activity related to Emery's 2001 restructuring
plan.
Defined Benefit Pension Plan
- ----------------------------
CNF has a defined benefit pension plan that covers non-contractual
employees in the United States. The amount recognized as pension expense
depends upon a number of assumptions and factors including (i) the discount
rate used to measure the present value of pension obligations and (ii) the
actual rate of return on plan assets compared to the assumed rate of
return. CNF adjusts its discount rate periodically to reflect market
conditions, taking into account a number of factors including the advice of
its outside actuaries. Rates of return on plan assets are affected by
economic conditions and market fluctuations. CNF's assumed rate of return
on plan assets, which has been unchanged since 1995, is based on the
expected long-term rate of return on plan assets since inception of the
plan.
In 2001, CNF reduced its discount rate to 7.25% from 7.75%. Actual returns
on plan assets were a loss of approximately 4.9% compared to the assumed
rate of return on plan assets of 9.5%. The decline in discount rate and
asset values at December 31, 2001, the measurement date for estimating 2002
pension expense, increased estimated annual pension expense in 2002 by
approximately $7 million. However, the estimate is subject to assumptions
and uncertainties and the actual change in 2002 pension expense could be
different. If market trends continue, pension expense in 2003 may also
increase over 2002. The Employee Retirement Income Security Act (ERISA)
governs plan funding requirements, which are determined independently from
pension expense. See "Liquidity and Capital Resources."
=====================
RESULTS OF OPERATIONS
=====================
Net income available to CNF common shareholders was $33.5 million ($0.61
per diluted share) in the third quarter of 2002 and $71.6 million ($1.33
per diluted share) in the first nine months of 2002 compared to $28.6
million ($0.59 per diluted share) for the third quarter of last year and a
$185.8 million net loss applicable to common shareholders ($3.81 per
diluted share) in the first nine months of last year. As described below
under "Discontinued Operations", net income (loss) applicable to common
shareholders for the third quarter and first nine months of 2002 included a
$10.1 million after-tax net loss ($0.18 per diluted share) from
discontinued operations, while the same periods of the prior year included
a $39.0 million after-tax gain ($0.80 per diluted share) from discontinued
operations.
Net income from continuing operations (Income from continuing operations
after preferred stock dividends) in the third quarter and first nine months
of 2002 was $43.6 million ($0.79 per diluted share) and $81.7 million
($1.51 per diluted share), respectively, compared to net losses from
continuing operations of $10.4 million ($0.21 per diluted share) and $224.7
million ($4.61 per diluted share) in the same periods last year.
Continuing operations in the first nine months of 2002 and 2001 included
unusual and/or non-recurring items, as summarized below, while the third
quarter of 2002 also included a $25.0 million tax benefit from the
settlement of aircraft maintenance and other matters under IRS examinations
as described under "Liquidity and Capital Resources - IRS Matters".
PAGE 20
Pre-tax Income (Expense) from unusual and/or non-recurring items:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
(Thousands of dollars) 2002 2001 2002 2001
---------- ---------- ---------- ----------
Con-Way Transportation Services
Net gain from the sale of
property $ -- $ -- $ 8,675 $ --
Menlo Worldwide
Emery Forwarding
Net gain from a payment under
the Air Transportation Safety
and System Stabilization Act -- -- 9,895 --
Loss from restructuring charge -- -- -- (340,531)
Loss from a legal settlement on
returned aircraft -- -- -- (4,696)
Goodwill amortization -- (2,570) -- (8,055)
Express Mail operating income -- 1,795 -- 5,433
Menlo Worldwide Logistics
Net gain from a contract
termination -- -- 1,850 --
Loss from the business failure
of a customer -- (6,300) -- (37,905)
CNF Other -
Loss from the business failure
of CFC (3,595) -- (3,595) --
Net gain from the sale of property -- -- 2,367 --
CONTINUING OPERATIONS
=====================
CNF's third-quarter revenue in 2002 rose 3.8% from the same period last
year while revenue for the first nine months of 2002 fell 6.4% from the
same period last year. In the third quarter of 2002, higher revenue from
Con-Way and Menlo Worldwide Logistics was partially offset by lower revenue
from Emery Forwarding. In the comparative nine-month period in 2002,
higher revenue from Con-Way and Menlo Worldwide Logistics was more than
offset by the decline in Emery Forwarding's revenue.
Operating income in the third quarter and first nine months of 2002 was
$43.5 million and $127.8 million, respectively, compared to operating
losses of $5.4 million and $323.6 million in the respective periods last
year. Excluding the net effect of the above unusual and/or non-recurring
items in 2002 and 2001, operating income in the third quarter of 2002 would
have been $47.1 million compared to $1.7 million in the third quarter of
2001, and operating income in the first nine months of 2002 would have been
$108.6 million compared to $62.1 million in the same period last year due
primarily to a decline in Emery Forwarding's operating losses.
Other net expense in the third quarter and first nine months of 2002 rose
23.4% and 6.6%, respectively, compared to the same periods last year.
Other net expense in the third quarter and first nine months of 2002 was
positively affected by lower interest expense on long-term debt, which was
effectively converted from fixed-rate to floating-rate with interest rate
swaps. Declines in the cash surrender value of corporate-owned life
insurance policies adversely affected other net expense in the third
quarter and first nine months of 2002 compared to the same periods last
year, which benefited from gains on those policies.
The effective tax benefit rate of 34.9% for the third quarter of 2002 and
the effective tax rate of 14.7% for the first nine months of 2002 reflects
the $25.0 million tax benefit recognized in the third quarter of 2002 upon
PAGE 21
settlement of IRS matters described under "Liquidity and Capital Resources
- - IRS Matters". Last year's third-quarter effective tax rate was 39.0%,
while the tax benefit rate for the first nine months of 2001 was 37.0%,
which resulted primarily from the significant unusual charges recognized in
June 2001.
Con-Way Transportation Services
- -------------------------------
Revenue for Con-Way Transportation Services (Con-Way) in the third quarter
and first nine months of 2002 increased 7.4% and 2.6%, respectively, from
the same periods last year due to higher revenue from Con-Way's regional
carriers and from Con-Way's emerging businesses, including Con-Way NOW
(NOW), Con-Way Logistics (CLI) and Con-Way Air Express (CAX). In the third
quarter and first nine months of 2002, the collective revenue of NOW, CLI
and CAX increased $5.7 million and $16.6 million, respectively, over the
same periods last year. The regional carriers' revenue per day in the
third quarter of 2002 increased 4.9% over last year's third quarter on a
4.5% increase in revenue per hundredweight (yield) and a 0.4% increase in
total and less-than-truckload (LTL) weight per day (weight). Regional-
carrier revenue per day in the first nine months of 2002 increased 1.7%
over the same period last year as total and LTL weight increased 0.9% and
yield rose 0.8%. The slight weight increases in the third quarter and
first nine months of 2002 were achieved despite the loss of a major
customer in the first quarter of 2002, which customer accounted for minimal
profit on an estimated $75 million of annual revenue in 2001. However, the
loss of this customer had a positive effect on yield in the quarter and
nine months ended September 30, 2002 compared to the same periods in the
prior year. Yield in the third quarter and first nine months of 2002 was
also positively affected by a higher percentage of interregional joint
services, which typically command higher rates on longer lengths of haul.
Management believes that weight in the third quarter benefited slightly
from the bankruptcy of a competitor in September 2002. Yield in the first
nine months of 2002 also benefited from higher fuel surcharges compared to
the nine-month period last year.
Con-Way's third-quarter operating income in 2002 fell 2.3% from 2001 to
$41.6 million and operating income in the first nine months of 2002
declined 9.3% from last year to $110.5 million. Excluding an unusual first-
quarter 2002 net gain of $8.7 million from the sale of excess property,
operating income in the third quarter and first nine months of 2002 fell
2.3% and 16.4%, respectively, from the same periods last year due primarily
to higher employee compensation, variable compensation, and benefits expense,
which collectively increased 12.2% and 8.6% over the respective periods last
year. The third quarter and first nine months of both 2002 and 2001 were
adversely affected by operating losses from Con-Way Air Express, which began
operations in May 2001, and Con-Way Logistics.
In July 2002, Con-Way announced the formation of Extended Service Lanes
(ESLs), which added next-day and second-day delivery service to over six
thousand cities within the Con-Way LTL network. ESLs utilize special
sleeper-team operations that are intended to replace two-day service with
next-day service in a large number of markets as well as expand the
coverage of second-day service. In September 2002, Con-Way began offering
Con-Way Deferred, a shipping option to move transcontinental shipments for
price-sensitive customers under the Con-Way Value Zone brand. Con-Way
Deferred is the second lower-cost shipping option introduced by Con-Way in
2002. In January 2002, Con-Way opened Con-Way Full Load, a full truckload
brokerage operation.
Menlo Worldwide
- ---------------
Emery Forwarding
----------------
Operating Results
Third-quarter revenue for Emery Forwarding (Emery) in 2002 declined 5.2%
from the same period last year due primarily to the termination by the
United States Postal Service (the "USPS") of EWA's contract to transport
Express Mail, effective August 26, 2001, as described below under " -
Express Mail Contract." Revenue for the first nine months of 2002
declined 19.1% from the same period last year, due primarily to the
termination of the Express Mail contract and to a decline in North American
revenue from the same period last year. In the third quarter and first
PAGE 22
nine months of last year, Emery recognized revenue of $24.5 million and
$113.8 million, respectively, from the Express Mail contract. Emery's third
quarter of 2002 included one more working day than the same quarter of last
year while the nine months of 2002 included the same number of working days
as the same period of 2001.
Average international airfreight revenue per day in the third quarter of
2002, including fuel surcharges, increased 2.5% from the same quarter of
last year as international average pounds transported per day (weight)
increased 2.4% and revenue per pound (yield) increased 0.2%. International
airfreight revenue per day in the first nine months of 2002 decreased 6.3%
from the first nine months of last year due primarily to a 5.8% drop in
yield and a 0.6% decline in weight. Emery's management believes that
weight in the third quarter of 2002 reflects an improving freight market in
international regions served by Emery, particularly the Asian region, while
weight in the third quarter and first nine months of last year was
adversely affected by the September 11, 2001 terrorist incident described
below under " - Terrorist Attacks." International yields in the third
quarter and first nine months of 2002 were negatively affected by a decline
in fuel surcharges from the same periods last year.
Average North American airfreight revenue per day in the third quarter of
2002, including surcharges, fell 6.2% from the third quarter of 2001 due to
a 10.4% decline in yield, partially offset by a 4.6% increase in weight.
Average North American airfreight revenue per day in the first nine months
of 2002, including surcharges, fell 19.7% due to a decline in weight per
day of 10.2% and a decline in yield of 10.7%. Emery's management believes
weight in the first three quarters of 2002 was negatively affected by
weaker U.S. economic conditions, a reduction in the number of aircraft
routes and domestic markets served by Emery, lower fuel surcharges, and a
loss of business to ground transportation providers, while the same periods
last year were adversely affected by lost business from the September 11,
2001 terrorist attacks. Emery's management also believes that lower yield
in the third quarter and first nine months of last year was due in part to
Emery's efforts to increase second-day and economy service, which
contributed to a higher percentage of lower-yield service offerings and a
lower percentage of higher-yielding next-day service.
Emery's operating loss for the third quarter and first nine months of 2002
was $5.0 million and $16.6 million, respectively, compared to operating
losses of $47.0 million and $424.0 million in the third quarter and first
nine months of last year. The first quarter of 2002 included a $9.9
million net gain from a payment under the Air Transportation Safety and
System Stabilization Act. The third quarter and first nine months of last
year included several unusual and/or non-recurring items, including a
$340.5 million restructuring charge; a $4.7 million loss from a legal
settlement; $8.1 million of goodwill amortization, which was eliminated
upon the adoption of SFAS 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002; and $5.4 million of operating income from the
Express Mail contract with the USPS, which was terminated effective August
26, 2001. Excluding unusual and/or non-recurring items, Emery would have
had an operating loss of $5.0 million in the third quarter of 2002 compared
to an operating loss of $46.2 million in the third quarter of 2001, and an
operating loss of $26.5 million in the first nine months of 2002 compared
to an operating loss of $76.1 million in the first nine months of 2001.
Despite lower revenues, operating losses in the third quarter and first
nine months of 2002 were reduced from the same periods last year, in each
case after excluding unusual and/or non-recurring items, primarily through
decreases in airhaul costs, which in the third quarter of last year
included approximately $17 million of additional net expense as a result of
the suspension of EWA's carrier operations; employee compensation and
benefits, which declined 15.5% and 21.4% from the respective periods last
year; and depreciation, aircraft rentals and other aircraft-related
expenses.
Restructuring Charges
In June 2001, Emery began an operational restructuring to align it with
management's estimates of future business prospects for domestic heavy air
freight and address changes in market conditions, which deteriorated due to
a slowing domestic economy, loss of EWA's contracts with the USPS to
transport Express Mail and Priority Mail and, to a lesser extent, loss of
business to ground transportation providers.
PAGE 23
The $340.5 million restructuring charge recognized in the second quarter of
2001 consisted primarily of non-cash impairment charges, including the
write-off of $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 airfreight operations
and, for certain assets, independent appraisals. 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
grounded aircraft leased to Emery and the termination of the related
leases.
As described below under "-Regulatory Matters," the Federal Aviation
Administration (FAA) required EWA to suspend its air carrier operations on
August 13, 2001. In response to the FAA action, as well as the September
11, 2001 terrorist actions described below under " - Terrorist Attacks,"
the growing unpredictability and uncertainty of the FAA's requalification
process, and a worsening global economic downturn, Emery re-evaluated its
restructuring plan. As described above, CNF announced on December 5, 2001
that Emery in 2002 would become part of CNF's new Menlo Worldwide group of
supply chain services providers and would continue to provide full North
American forwarding services utilizing aircraft operated by other air
carriers instead of EWA's fleet of aircraft, and that EWA would cease air
carrier operations. In connection with the revised restructuring plan, in
the fourth quarter of 2001 Emery recognized additional restructuring
charges of $311.7 million for the planned disposal of leased aircraft,
cessation of EWA's remaining operations, employee separation costs for 157
Emery employees, and other costs.
The restructuring charges in 2001 were based in part on significant
estimates and assumptions made by Emery's management as to the amount and
timing of aircraft rental payments and the costs of returning those
aircraft upon expiration or early termination of the leases. The $311.7
million restructuring charge recognized in the fourth quarter of 2001
includes primarily accruals for scheduled undiscounted rental payments for
aircraft leased to Emery and estimated costs of returning those aircraft
upon expiration or early termination of the related leases. Actual costs
may differ from those estimates (due, among other things, to Emery's
efforts to negotiate the early termination of aircraft leases and potential
defaults under aircraft leases) and that difference would be recognized as
additional expense or income in the period when and if that determination
can be made. In the first nine months of 2002, Emery paid $189.8 million
for aircraft leases and return costs, primarily due to the negotiated early
return of aircraft. At September 30, 2002, $140.6 million of accrued
aircraft leases and return costs were classified as current liabilities in
the Consolidated Balance Sheets based primarily on Emery's intention to
negotiate the early termination of those aircraft leases. In October 2002,
Emery paid an additional $38.6 million in connection with the negotiated
early return of 3 additional aircraft. As of October 31, 2002, Emery had
returned 26 of EWA's fleet of 37 parked aircraft to lessors, leaving 11
unreturned aircraft. See "-Regulatory Matters" and "Liquidity and Capital
Resources-Restructuring Charges and Regulatory Matters" below.
Refer to Note 4 to the Consolidated Financial Statements, "Restructuring
Charges," for the cumulative activity related to Emery's 2001 restructuring
plan.
Regulatory Matters
Internationally, Emery operates as an air freight forwarder using mostly
commercial airlines to transport freight. Prior to the suspension and
subsequent cessation of EWA's air carrier operations in 2001, Emery
provided air transportation services in North America using owned and
leased aircraft operated by EWA and aircraft operated by third parties.
Until August 13, 2001, EWA operated as an airline. Although EWA has ceased
air carrier operations, EWA still has an air carrier certificate issued by
the FAA and is subject to maintenance, operating and other safety-related
regulations promulgated by the FAA and is subject to 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. On December 5, 2001, CNF
announced that EWA was ceasing its air carrier operations. Since EWA's
suspension of its air carrier operations on August 13, 2001, Emery has been
PAGE 24
providing services to its customers in North America by utilizing aircraft
operated by other air carriers. This resulted in substantial additional
expense during 2001, partially offset by savings resulting from the
furlough of approximately 800 EWA employees as described in the next
paragraph. Emery intends to continue to use aircraft operated by third
parties to provide service to its customers in North America, which will
result in Emery continuing to pay both the ongoing lease payments and other
costs associated with EWA's remaining fleet of grounded aircraft in
addition to the cost of having other air carriers provide service to
Emery's North American customers. However, for financial reporting
purposes, Emery's operating expenses will continue to include the cost of
aircraft operated by other carriers but will not include the scheduled
rental payments relating to EWA's remaining fleet of grounded aircraft and
the costs of returning those aircraft upon expiration or early termination
of the related leases, except to the extent that those rental payments and
the costs of returning those aircraft upon expiration or early termination
of the related leases differ from the corresponding amounts already accrued
as part of the 2001 restructuring charges.
As a result of EWA's suspension of its air carrier operations on August 13,
2001, EWA furloughed approximately 400 pilots and crewmembers. Those pilots
and crewmembers are represented by the Air Line Pilots Association (ALPA)
union under a collective bargaining agreement and ALPA filed a grievance on
their behalf protesting the furlough. The grievance sought pay during the
course of the suspension and was subject to binding arbitration. In
October 2002, the arbitrator ruled in favor of EWA, holding that EWA was
excused from compliance with the "no-furlough" provision of the collective
bargaining agreement, and holding that pilots and crewmembers were entitled
only to two weeks' severance pay.
On December 5, 2001, EWA announced that it would cease operating as an air
carrier, and in connection therewith terminated the employment of all of
its pilots and crewmembers, bringing the total number of terminated
employees in 2001 to 800. Subsequently, ALPA filed a grievance on behalf
of the pilots and crewmembers protesting the cessation of EWA's air carrier
operations and Emery's use of other air carriers. Some aspects of the ALPA
matters may be subject to binding arbitration. Based on CNF's current
evaluation, management believes that it has addressed its estimated
exposure related to the ALPA matters. However, there can be no assurance in
this regard as CNF cannot predict with certainty the ultimate outcome of
these matters.
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 was first amended on December 4, 2001 as a result of Emery's
decision to terminate EWA's air carrier operations. Under the first amended
settlement agreement, the FAA agreed not to take action to revoke EWA's air
carrier certificate until, at the earliest, May 15, 2002. The FAA agreed
on May 13, 2002 to an extension of the certificate until December 4, 2002.
Under a second amended settlement agreement, the FAA agreed not to take
action to suspend or revoke the air carrier certificate until December 4,
2002, and EWA agreed to surrender the certificate not later than December
4, 2002. Based on current circumstances, management believes that there is
a reasonable possibility that EWA will be able to complete negotiations
relating to the early termination of leases of substantially all of its
aircraft on acceptable terms before December 4, 2002, although there can be
no assurance in this regard. While the matter is not free from doubt, if
EWA has not terminated all of its aircraft leases before it surrenders its
certificate on December 4, 2002, the surrender of EWA's certificate may
constitute a default under leases pursuant to which EWA leases some of its
remaining aircraft. However, management believes that any lease defaults
that might result from EWA's surrender of its certificate would not have a
material adverse effect on CNF's financial condition or results of
operations. As of October 31, 2002, approximately $15 million of scheduled
rental payments accrued in connection with Emery's restructuring charges
relate to leases for which management believes the surrender of EWA's
certificate may constitute a default. See "Liquidity and Capital
Resources-Restructuring Charges and Regulatory Matters" for further
discussion.
Due in large part to the fourth-quarter 2001 restructuring charge incurred
in connection with the cessation of EWA's air carrier operations, CNF was
required to obtain amendments to its bank revolving credit agreement in
December 2001 in order to remain in compliance with the financial covenants
in that agreement. CNF can provide no assurance that events relating to the
PAGE 25
cessation of EWA's air carrier operations will not result in a future
breach of the financial covenants under CNF's revolving credit facility.
See "Liquidity and Capital Resources-Restructuring Charges and Regulatory
Matters" for further discussion.
Terrorist Attacks
Operating results at Emery were adversely 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.
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 intended to mitigate
financial losses in the air carrier industry. The legislation provides for
$5 billion in direct loss reimbursement and $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. In March 2002, Emery received an $11.9 million
payment under the Act, resulting in the recognition of a $9.9 million first-
quarter net gain in 2002. The payment made to Emery under the Act is
subject to audit. Emery is seeking additional payments under the Act.
Emery is not able to accurately quantify how the events of September 11, or
any subsequent terrorist activities, will affect the global economy,
governmental regulation, the air transportation industry, Emery's costs of
providing airfreight services and the demand for Emery's airfreight
services. However, Emery believes that any additional security measures
that may be required by future regulations could result in additional costs
and could have an adverse effect on its operations and service.
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 for
the USPS under a contract (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.
On September 26, 2001, EWA entered into an agreement with the USPS to
settle claims relating to its Priority Mail contract with the USPS (the
"Settlement Agreement"), which is described below under "Discontinued
Operations." Under the Settlement Agreement, EWA received a $235.0 million
payment from the USPS on September 28, 2001 to settle all non-termination
claims under the Priority Mail contract and a $70.0 million provisional
payment from the USPS for termination costs and other claims related to 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 Express Mail contract are greater or
less than $70.0 million, in which case either the USPS will be required to
make an additional payment with interest, subject to the limitation
described in the following paragraph, or EWA will be required to return a
portion of the provisional payment with interest.
As of September 30, 2002 and December 31, 2001, the $70.0 million
provisional payment was included in Deferred Credits in CNF's Consolidated
Balance Sheets. This amount will continue to be included in Deferred
Credits until it is used to retire the remaining $80.0 million in 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 Express Mail contract, including the $70.0 million
provisional payment, may not exceed $150.0 million. On December 14, 2001,
EWA filed a termination settlement proposal with the USPS for recovery of
EWA's costs of providing service under the terminated Express Mail contract
as well as costs incurred by EWA's subcontractors for performing services
under the Express Mail contract. Any recovery of such costs would be offset
in whole or in part by the $70.0 million provisional payment received in
2001.
PAGE 26
Outlook
Under the new Menlo Worldwide group, management will continue Emery's focus
on expanding its variable-cost-based international operations and actively
renegotiating airhaul rates and customer pricing in an effort to improve
international operating margins. In North America, management will continue
to position Emery as a freight forwarder utilizing aircraft operated by
other carriers. As a result, management strategy is to implement a more
flexible variable-cost-based operating structure in North America with an
increase in revenue from second-day and deferred services and a decline in
revenue from next-day freight services, although there can be no assurance
this will occur. Management will continue its efforts to reduce Emery's
costs by initiatives intended to reduce the cost structure of the North
American service center and hub network and administrative costs.
Menlo Worldwide Logistics
-------------------------
Third-quarter 2002 revenue of $255.0 million for Menlo Worldwide Logistics
increased 15.0% over the same quarter last year, while revenue of $713.1
million in the first nine months of 2002 rose 5.1% from the first nine
months of last year due primarily to higher revenue recognized from carrier
and warehouse management services, partially offset by lower revenue from
contract carriage services.
A portion of Menlo Worldwide Logistics' revenue is attributable to
logistics contracts for which Menlo Worldwide Logistics manages the
transportation of freight but subcontracts the actual transportation and
delivery of products to third parties. Menlo Worldwide Logistics refers to
this as purchased transportation. Menlo Worldwide Logistics' net revenue
(revenue less purchased transportation) in the third quarter and first nine
months of 2002 was $77.3 million and $209.3 million, respectively, compared
to $66.3 million and $206.5 million, respectively, in the same periods of
2001.
Menlo Worldwide Logistics' operating income in the third quarter and first
nine months of 2002 was $8.4 million and $23.2 million compared to
operating income of $1.0 million in the third quarter of last year and an
operating loss of $13.1 million in the first nine months of last year. The
first nine months of 2002 included a $1.9 million first-quarter net gain
from the early termination of a contract. Operating loss in the first nine
months of last year reflects a $31.6 million second-quarter loss and a $6.3
million third-quarter loss from the business failure of a customer.
Excluding these unusual and/or non-recurring items, operating income in the
third quarter of 2002 would have been $8.4 million compared to $7.3 million
in the third quarter of 2001, a 14.6% increase, and operating income in the
first nine months of 2002 would have been $21.3 million compared to $24.8
million in the comparable period of 2001, a decline of 14.1%. The third
quarter and first nine months of 2002 benefited from higher revenues but
were adversely affected by employee compensation and benefits expense,
which collectively increased 11.3% and 7.8%, respectively, from the third
quarter and first nine months of last year. Operating income in the first
nine months of 2001 included $2.6 million of operating income recognized on
a customer that later filed for bankruptcy in the second quarter of last
year.
Menlo Worldwide Other
---------------------
The Menlo Worldwide Other reporting segment includes the results of Vector
SCM and Menlo Worldwide Technologies. Vector SCM (Vector) is a joint
venture formed with General Motors in December 2000 to provide logistics
services to General Motors. Although CNF owns a majority equity interest
in Vector, the operating results of Vector are reported as an equity-method
investment based on General Motors' ability to control certain operating
decisions.
CNF reported operating income from Vector of $2.6 million and $13.3 million
in the third quarter and first nine months of 2002, respectively, compared
to third-quarter operating income of $0.1 million in 2001 and an operating
loss of $6.2 million in the first nine months of 2001, which was incurred
during Vector's start-up phase. CNF's operating income for the first nine
months of 2002 included substantially all of Vector's net income for that
PAGE 27
period (rather than CNF's pro rata portion of that net income), because CNF
is contractually entitled to substantially all of Vector's net income to
the extent of Vector's cumulative losses; under the contract, all of
Vector's losses in prior periods were allocated to CNF. During the second
quarter of 2002, CNF's allocated cumulative losses from the Vector joint
venture had been recouped through allocated net income. As a result,
General Motors began sharing in Vector's net income in the third quarter of
2002. Accordingly, CNF's proportionate share of any quarterly net income
that may be generated by Vector will be lower than what would have been
reportable by CNF if CNF continued to be allocated substantially all of
Vector's net income or losses, as was the case in 2001 and the first half
of 2002. Vector's operating results in the third quarter of 2002 were
adversely affected by delays in implementing new business cases.
CNF Other
- ---------
The CNF Other segment includes the results of Road Systems and certain
corporate activities. Operating losses of $4.1 million and $2.5 million in
the third quarter and first nine months of 2002, respectively, included a
$3.6 million third-quarter loss from the business failure of CFC, which was
partially offset in the nine-month period by a $2.4 million first-quarter
net gain from the sale of excess corporate properties. An operating loss
of $2.1 million in the third quarter and first nine months of last year was
due primarily to the net effect of various corporate items.
DISCONTINUED OPERATIONS
=======================
Priority Mail
On November 3, 2000, 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"). As described more fully in Note 2 to the Consolidated
Financial Statements, "Discontinued Operations", all claims relating to
amounts owed to EWA under the Priority Mail contract have been settled. As
a result of USPS' payments under the Termination Agreement in January 2001
and July 2002, EWA recognized a 2002 third-quarter gain from discontinuance
of $2.9 million, net of $1.8 million of income taxes. As a result of a
USPS payment under the Settlement Agreement in September 2001, EWA
recognized a 2001 third-quarter gain from discontinuance of $39.0 million,
net of $24.9 million of income taxes.
As a result of the termination of the Priority Mail contract, the results
of operations and cash flows of the Priority Mail operations have been
segregated and classified as discontinued operations. Summary financial
data and related information are included in Note 2 to the Consolidated
Financial Statements, "Discontinued Operations."
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off of Consolidated Freightways
Corporation ("CFC") to CNF's shareholders. In connection with the spin-
off of CFC, CNF agreed to indemnify certain states, insurance companies and
sureties against the failure of CFC to pay certain workers' 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 and surety
bonds under which CNF is liable to the issuing bank or the surety company.
In September 2002, CFC filed for bankruptcy and announced that it will
cease most U.S. operations. Following the commencement of its bankruptcy
proceeding, CFC ceased making payments with respect to these workers'
compensation and public liability claims. CNF has taken over payment of
some of these claims, and expects that demands for payment will likely be
made against it with respect to the remaining claims. CNF estimates the
aggregate amount of all of these claims, plus other costs, to be $21.3
million. As a result, CNF accrued additional reserves of $21.3 million in
Accrued Claims Costs in the Consolidated Balance Sheets and recognized a
PAGE 28
$13.0 million loss from discontinuance, net of $8.3 million of income
taxes, in the third quarter of 2002. CNF intends to seek reimbursement
from CFC in its bankruptcy proceeding of amounts that CNF pays in respect
of these claims, although there can no assurance that CNF will be
successful in recovering all or any portion of such payments.
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multiemployer pension plans covering some of its current and former
employees. The cessation of its U.S. operations will result in CFC's
"complete withdrawal" (within the meaning of applicable federal law) from
these multiemployer plans, at which point it will become obligated, under
federal law, to pay its share of any unfunded vested benefits under those
plans. It is possible that the trustees of CFC's multiemployer pension
plans may assert claims that CNF is liable for amounts owing to the plans
as a result of CFC's withdrawal from those plans. For further detailed
discussion of this matter, see "Liquidity and Capital Resources - Spin-Off
of CFC".
===============================
LIQUIDITY AND CAPITAL RESOURCES
===============================
In the first nine months of 2002, cash and cash equivalents decreased by
$62.5 million to $338.3 million at September 30, 2002. Net capital
expenditures of $65.8 million and $50.7 million of net cash used in
financing activities were funded with the reduction in cash and by cash
from operating activities. Net cash provided by operating activities in
the nine months ended September 30, 2002 was $49.2 million despite pension
fund payments and significant payments for aircraft leases and return costs
in that period.
Operating activities in the first nine months of 2002 generated net cash of
$49.2 million compared to $269.6 million of cash generated by operating
activities in the first nine months of 2001. Cash from continuing
operations in the first nine months of 2002 was provided primarily by net
income before non-cash items (including mostly depreciation, amortization,
deferred income taxes, and gains from sales of property). Positive
operating cash flows in the first nine months of 2002 were also provided by
an increase in accrued liabilities, which consisted primarily of a higher
accrual for employee compensation. Cash outflows from operations in the
first nine months of 2002 included primarily aircraft lease payments and
return costs, which are described below under "- Restructuring Charges and
Regulatory Matters"; defined benefit pension plan funding payments of $75.0
million; an increase in accounts receivable; and a decline in income taxes.
Investing activities in the first nine months of 2002 used cash of $65.8
million, a $109.9 million decline from the first nine months of 2001.
Capital expenditures of $67.4 million in the first nine months of 2002 fell
from $166.7 million in the first nine months of 2001 primarily due to
capital expenditure reductions at all reporting segments, including
primarily a $75.4 million decline at Con-Way and a $12.8 million reduction
at Emery Forwarding. Financing activities in the first nine months of 2002
used cash of $50.7 million compared to $30.6 million used in the first nine
months of 2001, due primarily to capital lease payments on aircraft in the
first nine months of 2002.
CNF has a $385 million revolving credit facility that matures on July 3,
2006. The revolving credit facility is also available for the issuance of
letters of credit up to $385 million, although the aggregate amount of
letters of credit outstanding under the facility at any time reduces the
amount of borrowings available under the facility at that time by a like
amount. At September 30, 2002, no borrowings were outstanding under the
facility and $205.5 million of letters of credit were outstanding, leaving
$179.5 million of available capacity for additional letters of credit or
cash borrowings, subject to compliance with financial covenants and other
customary conditions to borrowing. CNF had other uncommitted unsecured
credit facilities totaling $103.0 million at September 30, 2002, which are
available to support letters of credit, bank guarantees, and overdraft
facilities; at that date, a total of $64.2 million was outstanding under
these facilities. Of the total letters of credit outstanding at September
30, 2002, $198.6 million provided collateral for CNF workers compensation
and vehicular self-insurance programs.
PAGE 29
Restructuring Charges and Regulatory Matters
Due in large part to the fourth-quarter 2001 restructuring charge incurred
in connection with the cessation of EWA's air carrier operations as
described above under "Results of Operations-Continuing Operations-Menlo
Worldwide-Emery Forwarding-Restructuring Charges," CNF was required to
obtain amendments to its bank revolving credit agreement in December 2001
in order to remain in compliance with the financial covenants in that
agreement. The amended credit agreement provides that, if CNF's senior
unsecured long-term debt securities are rated at less than "BBB-" by
Standard & Poor's and less than "Baa3" by Moody's, CNF, including its
principal subsidiaries, will be required to pledge its accounts receivable
as collateral to secure borrowings and other amounts due under the credit
facility, subject to specified limitations, and, if the aggregate
borrowings and other amounts due under the credit facility exceed a
specified amount, CNF, including its principal subsidiaries, will be
required to provide such additional collateral as the agent bank under the
credit facility may reasonably request. CNF's senior unsecured long-term
debt is currently rated "BBB-" by Standard & Poor's with a stable outlook
and "Baa3" by Moody's with a negative outlook, and, as a result, any
further reduction in CNF's senior unsecured long-term debt ratings by both
of these credit rating agencies will require that CNF, including its
principal subsidiaries, pledge collateral to secure the credit facility as
described above. To the extent CNF, including its principal subsidiaries,
pledges collateral to secure amounts due under the debt facility, CNF,
including its principal subsidiaries, may also be required to pledge some
or all of that collateral to equally and ratably secure its $200 million
aggregate principal amounts of
8 7/8% notes due 2010 and its $100 million aggregate principal amount of
7.35% notes due 2005, and $111.8 million aggregate principal amount of
notes due through 2009 issued by CNF's Thrift and Stock Plan ("TASP"),
which are guaranteed by CNF.
CNF cannot provide assurance that matters relating to the cessation of
EWA's air carrier operations will not have a material adverse effect on
CNF's financial condition, cash flows, or results of operations in the
future. Emery intends to continue to use aircraft operated by third parties
to provide service to its customers in North America, which will continue
to result in Emery making additional cash payments, primarily because Emery
will be required to pay both the ongoing lease payments and other payments
associated with EWA's remaining fleet of grounded aircraft in addition to
payments to other air carriers providing service to Emery's North American
customers.
In addition, the restructuring charges recognized by Emery during 2001
reflect CNF's estimate of the costs of terminating EWA's air carrier
operations and restructuring Emery's business and related matters. CNF
believes that the estimate is adequate to cover these costs based on
information currently available and assumptions management believes are
reasonable under the circumstances. However, there can be no assurance that
actual costs will not differ from this estimate, and if such costs exceed
CNF's estimate Emery will be required to recognize additional charges,
which could result in defaults under CNF's $385 million credit facility and
other debt instruments and under aircraft leases, or other costs and
expenses in connection with these matters. If any of the financial
covenants in its $385 million debt facility are breached, CNF will be
required to obtain appropriate waivers or amendments from the requisite
banks under the credit facility. If CNF is unable to obtain these
amendments or waivers, CNF would be in default under the credit facility,
and would be prohibited from making borrowings and from obtaining
additional letters of credit under the revolving credit facility and could
be required by the banks to repay any outstanding borrowings and replace
letters of credit outstanding under the facility. Under cross-default or
cross-acceleration clauses contained in other debt instruments to which CNF
is a party, these events could also result in other indebtedness becoming
or being declared due and payable prior to its stated maturity. Moreover,
to the extent that collateral was provided to secure borrowings and other
amounts due under the $385 million facility or the notes described above,
the banks or the noteholders would generally be entitled to take possession
of the collateral following a default. There can be no assurance that CNF
would be able to obtain the necessary waivers or amendments under the $385
million bank credit agreement were any such defaults to occur or to obtain
additional financing to repay indebtedness or replace letters of credit
that may become due as a result of those defaults. As a result, if a
default were to occur under CNF's $385 million credit facility and if CNF
is unable to obtain all required amendments or waivers, this would likely
PAGE 30
have a material adverse effect on CNF's financial condition, cash flows,
and results of operations.
Holders of certain notes issued by CNF's TASP, which are guaranteed by CNF,
have the right to require CNF to repurchase those notes if, among other
things, both Moody's and Standard & Poor's have publicly rated CNF's long-
term senior debt at less than investment grade unless, within 45 days, CNF
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, 2002, $62.0 million in aggregate principal amount of these
TASP notes was outstanding. CNF's long-term senior debt is currently rated
"Baa3" by Moody's with a negative outlook and "BBB-" by Standard & Poor's
with a stable outlook; "Baa3" is the lowest investment grade rating from
Moody's and "BBB-" is the lowest investment grade rating from Standard &
Poor's. As a result, any further decrease in CNF's long-term senior debt
ratings by both of these credit rating agencies would give the holders of
TASP notes the right to require CNF to repurchase those notes unless CNF
was able to obtain appropriate credit enhancement as described above, and
there can be no assurance that CNF would be able to do so. The occurrence
of any event or condition requiring CNF to repay these TASP notes could
likely have a material adverse effect on CNF's financial condition, cash
flows, and results of operations.
In the event that CNF is required to repay any borrowings or other
indebtedness before its scheduled maturity date or to replace any letters
of credit before their scheduled expiry date, whether upon a default under
its revolving credit facility, as a result of a reduction in the credit
ratings on its long-term debt or otherwise, there can be no assurance that
CNF would have sufficient funds to do so or be able to arrange financing
for those purposes. Accordingly, any of these events could have a material
adverse effect on CNF's financial condition, cash flows, and results of
operations.
As discussed more fully above under "Emery Worldwide - Regulatory Matters,"
under EWA's second amended settlement agreement with the FAA, EWA agreed to
surrender its air carrier certificate no later than December 4, 2002.
Based on current circumstances, management believes that there is a
reasonable possibility that EWA will be able to complete negotiations
relating to the early termination of leases of substantially all of its
aircraft on acceptable terms before December 4, 2002, although there can be
no assurance in this regard. While the matter is not free from doubt, if
EWA has not terminated all of its aircraft leases before it surrenders its
certificate on December 4, 2002, the surrender of EWA's certificate may
constitute a default under leases pursuant to which EWA leases some of its
remaining aircraft. However, management believes that any lease defaults
that might result from EWA's surrender of its certificate would not have a
material adverse effect on CNF's financial condition or results of
operations. As of October 31, 2002, approximately $15 million of scheduled
rental payments accrued in connection with Emery's restructuring charges
relate to leases for which management believes the surrender of EWA's
certificate may constitute a default.
In the first nine months of 2002, Emery paid $189.8 million for aircraft
leases and return costs, primarily due to the negotiated early return of
aircraft. At September 30, 2002, $140.6 million of accrued aircraft leases
and return costs were classified as current liabilities in the Consolidated
Balance Sheets based primarily on Emery's intention to negotiate the early
termination of those aircraft leases. In October 2002, Emery paid an
additional $38.6 million in connection with the negotiated early return of
3 additional aircraft. As of October 31, 2002, Emery had returned 26 of
EWA's fleet of 37 parked aircraft to lessors, leaving 11 unreturned
aircraft. EWA is currently seeking to reach agreement with lessors of its
remaining aircraft in order to terminate the leases prior to their
scheduled expiration dates. However, CNF can provide no assurance that EWA
will be able to enter into any such agreements with the lessors. If EWA
negotiates for the early termination of one or more of these remaining
aircraft leases, EWA will substantially accelerate the timing of scheduled
cash payments to the lessors.
At September 30, 2002, CNF had $338.3 million in cash and cash equivalents
available to meet its cash needs, including payment of amounts due under or
in connection with aircraft leases. In addition, CNF intends to use
PAGE 31
borrowings and letters of credit issued under its $385 million credit
facility to meet cash needs subject to compliance with financial covenants
and satisfaction of customary conditions precedent. However, there can be
no assurance that CNF will be able to comply with these financial covenants
or meet these conditions precedent and any inability of CNF to obtain
additional borrowings or letters of credit under this credit facility would
likely have a material adverse effect on its financial condition, cash
flows, and results of operations.
IRS Matters
In August 2002, CNF entered into settlement agreements with the IRS,
pursuant to which the parties settled an aircraft maintenance issue for the
years 1987 through 2000, and all other open issues under IRS examinations
for the years 1987 through 1996. Accordingly, CNF eliminated the related
tax liabilities and recognized a $25.0 million tax benefit in the third
quarter of 2002. As a result of the settlement agreements, CNF was not
required to make any additional payments to the IRS over and above a $93.4
million payment made in respect to these issues in the third quarter of
2000. Certain issues remain open for the years 1997 through 2000, but
management does not believe that the resolution of those issues is likely
to have a material adverse effect on CNF's financial condition, cash flows
or results of operations.
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off of Consolidated Freightways
Corporation ("CFC") to CNF's shareholders. In connection with the spin-off
of CFC, CNF agreed to indemnify certain states, insurance companies and
sureties against the failure of CFC to pay certain workers' 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 and surety
bonds under which CNF is liable to the issuing bank or the surety company.
In September 2002, CFC filed for bankruptcy and announced that it will
cease most U.S. operations. Following the commencement of its bankruptcy
proceeding, CFC ceased making payments with respect to these workers'
compensation and public liability claims. CNF has taken over payment of
some of these claims, and expects that demands for payment will likely be
made against it with respect to the remaining claims. CNF estimates the
aggregate amount of all of these claims, plus other costs, to be $21.3
million. As a result, CNF accrued additional reserves of $21.3 million in
Accrued Claims Costs in the Consolidated Balance Sheets and recognized a
$13.0 million loss from discontinuance, net of $8.3 million of income
taxes, in the third quarter of 2002. CNF intends to seek reimbursement
from CFC in its bankruptcy proceeding of amounts that CNF pays in respect
of these claims, although there can no assurance that CNF will be
successful in recovering all or any portion of such payments.
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multiemployer pension plans covering some of its current and former
employees. The cessation of its U.S. operations will result in CFC's
"complete withdrawal" (within the meaning of applicable federal law) from
these multiemployer plans, at which point it will become obligated, under
federal law, to pay its share of any unfunded vested benefits under those
plans.
It is possible that the trustees of CFC's multiemployer pension plans may
assert claims that CNF is liable for amounts owing to the plans as a result
of CFC's withdrawal from those plans. CNF has received a request for
information regarding the spin-off of CFC from representatives of the
Central States Southeast and Southwest Areas Pension Fund, which is one of
CFC's multiemployer plans, and, in accordance with federal law, CNF is in
the process of responding to that request. Under federal law,
representatives of CFC's multiemployer plans are entitled to request such
information to assist them in determining whether they believe any basis
exists for asserting a claim against CNF.
Based on advice of legal counsel and its knowledge of the facts, CNF
believes that it would ultimately prevail if any such claims were made,
although there can be no assurance in this regard. CNF believes that the
amount of those claims, if asserted, would be material, and a judgment
against CNF for all or a significant part of these claims would likely have
PAGE 32
a material adverse effect on CNF's financial condition, cash flow and
results of operations.
If such claims were made, CNF, unless relieved of the obligation through
appropriate legal proceedings, would be required under federal law to make
periodic cash payments to the multiemployer plans asserting claims against
CNF, in an aggregate amount of up to the full amount of those claims.
However, under federal law, the claims would initially be decided through
arbitration and, upon a final decision by the arbitrator in favor of CNF,
the plan trustees would be required to promptly refund those payments, with
interest. While the length of time required to reach a final decision in
any such arbitration cannot be predicted with certainty, CNF believes that
such a decision could be reached within twelve to eighteen months from
receipt of claims from the plans, although there can be no assurance in
this regard.
CNF currently estimates that the net amount of the periodic payments (after
deductibility for tax purposes) could range from $20 million to $25 million
quarterly (based on certain assumptions), although the actual amount could
be greater or less than this estimate. Based on CNF's current financial
condition and management's projections of CNF's estimated future financial
condition, cash flows and results of operations, as well as a number of
other estimates and assumptions, CNF believes that it would have sufficient
financial resources to make these periodic payments if it were required to
do so. However, there can be no assurance in that regard, and accordingly
any requirement to make these periodic payments could have a material
adverse effect on CNF's cash flows.
As a result of the foregoing, there can be no assurance that matters
relating to CFC and its bankruptcy proceedings will not have a material
adverse effect on CNF's financial condition, cash flows or results of
operations, or that these matters will not have consequences similar to
those described above under "Restructuring Charges and Regulatory Matters,"
which in turn would likely have a material adverse effect on CNF's
financial condition, cash flows and results of operations.
Other
CNF periodically reviews the funding status of its defined benefit pension
plan for non-contractual employees, and makes contributions from time to
time as necessary in order to comply with the funding requirements of the
Employee Retirement Income Security Act. In the first nine months of 2002,
CNF contributed $75.0 million in cash payments to the defined benefit pension
plans. No additional payments are expected to be made in 2002. CNF currently
estimates that it will contribute a total of approximately $75 million in cash
in 2003. However, this estimate is subject to uncertainties and assumptions,
including assumptions as to the rate of return on plan assets and the
number of non-contractual employees, and the actual amount of CNF's cash
contributions may differ. Except for cash payments of $75.0 million in 2002
and $13.1 million in 2001, CNF had not made any contributions to the defined
benefit pension plans since 1995, due in part to the high rate of return
realized on plan assets from 1996 through 2000.
In general, CNF expects its future liquidity to be affected by the timing
and amount of cash flows related to pension plan funding requirements,
restructuring charge reserves, payments in repayment of long-term debt and
guarantees, capital and operating leases and the preferred securities of a
subsidiary trust, some of which are discussed above and in Note 4 to the
Consolidated Financial Statements, "Restructuring Charges," and Note 8 to
the Consolidated Financial Statements, "Preferred Securities of Subsidiary
Trust."
CNF's ratio of total debt to capital decreased to 40.7% at September 30,
2002 from 43.4% at December 31, 2001 due primarily to net income and the
repayment of debt and capital lease obligations in the first nine months of
2002.
Discontinued Operations
As described above under "Results of Operations-Discontinued 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 Consolidated
Financial Statements, "Discontinued Operations," EWA received payments in
PAGE 33
2002 and 2001 from the USPS related to the discontinued Priority Mail
operations
In January 2001, EWA received a $60.0 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 $305.0 million payment from the USPS, including $235.0 million
to settle all non-termination claims under the Priority Mail contract.
In July 2002, EWA received a $6.0 million payment from the USPS, in
addition to the $60.0 million provisional payment in January 2001. The
additional $6.0 million payment fully settled EWA's Priority Mail contract
termination costs.
OTHER MATTERS
=============
Cyclicality and Seasonality
CNF's businesses operate in industries that are affected directly by
general economic conditions and seasonal fluctuations, both of which affect
demand for transportation services. In the trucking and airfreight
industries, for a typical year, the months of September and October usually
have the highest business levels while the months of January and February
usually have the lowest business levels.
Market Risk
CNF is exposed to a variety of market risks, including the effects of
interest rates, commodity prices, foreign currency exchange rates and
credit risk. CNF'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 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.
CNF is subject to the effect of interest rate fluctuations in the fair
value of its long-term debt and capital lease obligations, as summarized in
Notes 5 and 6 to the Consolidated Financial Statements included in CNF's
2001 Annual Report to Shareholders. As described in Note 9 to the
Consolidated Financial Statements, "Derivative Instruments and Hedging
Activities," CNF uses 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 its fixed-rate long-term debt. At September 30,
2002, CNF had not entered into any derivative contracts to hedge foreign
currency exchange exposure.
Business Interruption
Although the operations of CNF's subsidiaries are largely decentralized,
Emery Forwarding maintains a major hub operation at the Dayton
International Airport in Dayton, Ohio. While Emery Forwarding currently
maintains casualty and business interruption insurance covering the Dayton
hub, there can be no assurance that this insurance coverage will be
sufficient. As a result, a major casualty or sustained interruption in the
business operations at the Dayton hub, whether due to terrorist activities
or otherwise, could have a material adverse effect on CNF's financial
condition, cash flows, and results of operations.
In addition, CNF and its subsidiaries rely on centralized computer
facilities located in Portland, Oregon in the conduct of their businesses.
Although CNF maintains backup systems and has disaster recovery processes
and procedures in place, a sustained interruption in the operation of these
facilities, whether due to terrorist activities, earthquakes or otherwise,
could have a material adverse effect on CNF's financial condition, cash
flows, and results of operations.
PAGE 34
Employees
Most of the workforce of CNF and its subsidiaries is composed of non-union
employees. CNF believes that the operations of its subsidiaries have
significant advantages over comparable unionized competitors (particularly
in the trucking industry) in providing reliable and cost-competitive
customer services, including greater efficiency and flexibility. Customer
choice and retention of a freight carrier is beyond a company's control and
there can be no assurance that CNF subsidiaries will be able to maintain
their current advantages over certain of their competitors.
Accounting Standards
Effective January 1, 2002, CNF adopted SFAS 142, "Goodwill and Other
Intangible Assets." SFAS 142 specifies that goodwill and some intangible
assets will no longer be amortized but instead will be subject to an annual
fourth-quarter impairment test. Pursuant to SFAS 142, CNF has evaluated
whether its goodwill is impaired and has determined that, as of January 1,
2002, CNF was not required to make an adjustment to the carrying value of
the assets. Effective January 1, 2002, CNF ceased goodwill amortization
associated with the Emery Forwarding segment. Prior to adoption of SFAS
142, CNF amortized goodwill of $2.6 million and $8.1 million, respectively,
in the third quarter and first nine months of last year.
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. CNF is in the process of evaluating the financial
statement impact of adoption of SFAS 143.
In April 2002, the FASB issued SFAS 145, "Rescission of FASB Statements 4,
44, and 64, Amendment of FASB Statement 13, and Technical Corrections."
SFAS 145 updates, clarifies and simplifies existing accounting
pronouncements, by rescinding SFAS 4, which required all gains and losses
from extinguishment of debt to be aggregated and, if material, classified
as an extraordinary item, net of related income tax effect. As a result,
the criteria in Accounting Principles Board Opinion 30 will now be used to
classify those gains and losses. Additionally, SFAS 145 amends SFAS 13 to
require that certain lease modifications that have economic effects similar
to sale-leaseback transactions be accounted for in the same manner as sale-
leaseback transactions. Finally, SFAS 145 also makes technical corrections
to existing pronouncements. While those corrections are not substantive in
nature, in some instances, they may change accounting practice. CNF adopted
the provisions of SFAS 145 that amended SFAS 13 for transactions occurring
after May 15, 2002 in its consolidated financial statements with no
material impact. CNF will adopt all other provisions of SFAS 145, as
required, effective January 1, 2003. CNF is evaluating the financial
statement impact of adopting these other provisions of SFAS 145.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which is effective for exit or disposal
activities initiated after December 31, 2002. SFAS 146, once adopted,
nullifies EITF Issue No. 94-3. SFAS 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred, whereas EITF No. 94-3 had allowed for recognition of
the liability at the commitment date to an exit plan. CNF is in the
process of evaluating the financial statement impact of adoption of SFAS
146.
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, weight, yield, volumes,
income or other financial or operating items, any statements of the plans,
strategies, expectations or objectives of CNF or management for future
operations or other future items, any statements concerning proposed new
PAGE 35
products or services, any statements regarding CNF's estimated future
contributions to pension plans, any statements regarding expectations as to
the early termination of aircraft leases or the costs thereof, any
statements as to the adequacy of reserves, any statements regarding the
outcome of any claims that may be brought against CNF by CFC's multi-
employer pension plans or regarding the amount of any periodic cash
payments that CNF may be required to make while those claims are pending or
CNF's ability to make those periodic payments, 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 CNF's 2001 Annual Report on Form 10-K and other
reports and documents filed by CNF 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; the creditworthiness of CNF's customers and their
ability to pay for services rendered; increasing competition and pricing
pressure; changes in fuel prices; the effects of the cessation of EWA's air
carrier operations, including the expense of using aircraft operated by
other air carriers in Emery's North American operations while also bearing
the cash costs of EWA's remaining grounded aircraft fleet, the possibility
of cash payments in connection with the early termination of or defaults
under aircraft leases, the possibility of additional unusual charges and
other costs and expenses relating to Emery's operations, the possibility of
defaults under aircraft leases, and the possibility of future loss of
business due to publicity surrounding the grounding of EWA's fleet of
aircraft; the possibility of defaults under CNF's $385 million credit
agreement and other debt instruments and aircraft leases, including
defaults resulting from additional unusual charges or from any costs or
expenses that CNF may incur in connection with CFC's bankruptcy proceedings
or any claims that may be asserted by CFC's multi-employer pension plans or
CNF's failure to perform in accordance with management's expectations, and
the possibility that CNF may be required to pledge collateral to secure
some of its indebtedness or to repay other indebtedness in the event that
the ratings assigned to its long-term senior debt by credit rating agencies
are reduced; the requirement that EWA surrender its air carrier certificate
no later than December 4, 2002, which could potentially result in defaults
under some of EWA's aircraft leases; uncertainties regarding EWA's ability
to recover 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 crewmembers, renegotiations of labor
contracts, labor organizing activities, work stoppages or strikes;
enforcement of and changes in governmental regulations; environmental and
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 CNF's 1996 spin-off
of Consolidated Freightways, including the possibility that CFC's multi-
employer pension plans may assert claims against CNF and that CNF may be
required to make periodic cash payments while those claims are pending. As
a result of the foregoing, no assurance can be given as to future financial
condition, cash flows, or results of operations See Note 10 to the
Consolidated Financial Statements, "Commitments and Contingencies" and
"Management's Discussion of Financial Condition and Results of
Operations-Liquidity and Capital Resources" included elsewhere herein.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. CNF's Chief
Executive Officer and Chief Financial Officer have evaluated the
effectiveness of CNF's disclosure controls and procedures (as such term is
defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934, as amended (the "Exchange Act")) as of a date within 90 days prior
to the filing date of this quarterly report (the "Evaluation Date"). Based
PAGE 36
on that evaluation, the Chief Executive Officer and Chief Financial Officer
have concluded that, as of the Evaluation Date, CNF's disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to CNF (including its consolidated subsidiaries)
required to be included in CNF's reports filed or submitted under the
Exchange Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have
not been any significant changes in CNF's internal controls or in other
factors that could significantly affect these internal controls.
PAGE 37
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
As previously reported, CNF has been designated a potentially responsible
party (PRP) by the EPA with respect to the disposal of hazardous substances
at various sites. CNF expects its share of the clean-up costs will not
have a material adverse effect on its financial condition, cash flows, or
results of operations.
The Department of Transportation, through its Office of Inspector General,
and the FAA have 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 has been seeking to obtain additional
information through the grand jury process. The investigation is ongoing
and Emery is cooperating fully. CNF is unable to predict the outcome of
this investigation or when the outcome will be reached.
EWA has received subpoenas issued by federal grand juries in Massachusetts
and the District of Columbia and the USPS Inspector General for documents
relating to the Priority Mail contract. EWA has provided, and is continuing
to provide, the documents.
On February 16, 2000, a DC-8 cargo aircraft operated by EWA personnel
crashed shortly after take-off from Mather Field, near Sacramento,
California. The crew of three was killed. The cause of the crash has not
been conclusively determined. The National Transportation Safety Board
(NTSB) is conducting an investigation. A NTSB hearing regarding the crash
commenced on May 9 and 10, 2002, and is currently in recess. EWA is
currently unable to predict the outcome of this investigation or the effect
it may have on Emery or CNF. Emery, EWA and CNF 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 CNF 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 CNF maintain
insurance that is intended to cover claims that may arise in connection
with an airplane crash, there can be no assurance that the insurance will
in fact be adequate to cover all possible types of claims. In particular,
any claims for punitive damages or any sanctions resulting from possible
governmental proceedings would not be covered by insurance.
As a result of EWA's suspension of its air carrier operations on August 13,
2001, EWA furloughed approximately 400 pilots and crewmembers. Those pilots
and crewmembers are represented by the Air Line Pilots Association (ALPA)
union under a collective bargaining agreement and ALPA filed a grievance on
their behalf protesting the furlough. The grievance sought pay during the
course of the suspension, and was subject to arbitration. In October 2002,
the arbitrator ruled in favor of EWA, holding that EWA was excused from
compliance with the "no-furlough" provision of the collective bargaining
agreement, and holding that pilots and crewmembers were entitled only to
two weeks' severance pay.
On December 5, 2001, EWA announced that it would cease operating as an air
carrier, and in connection therewith terminated the employment of all
pilots and crewmembers, bringing the total number of terminated employees
in 2001 to 800. Subsequently, ALPA filed a grievance on behalf of the
pilots and crewmembers protesting the cessation of EWA's air carrier
operations and Emery's use of other air carriers. Some aspects of the ALPA
matters may be subject to binding arbitration. Based on CNF's current
evaluation, management believes that it has addressed its estimated
exposure related to the ALPA matters. However, CNF cannot predict with
certainty the ultimate outcome of these matters.
EWA, EAFC, Menlo Worldwide, CNF and certain individuals have been named as
defendants in a lawsuit filed in state court in California by approximately
60 former EWA pilots and crewmembers. The lawsuit includes claims for
wrongful termination and intentional interference with an economic
relationship in connection with the suspension and subsequent cessation of
EWA's air carrier operations, and seeks $500 million and certain other
unspecified damages. The lawsuit was subsequently removed to federal
district court in California. CNF believes that the lawsuit's claims are
without merit, and intends to vigorously defend the lawsuit.
PAGE 38
EWA has been named as a defendant in a lawsuit and arbitration proceeding
brought by a subcontractor that operated aircraft under EWA's former
Express Mail contract with the USPS. The USPS terminated the Express Mail
contract "for convenience" on August 26, 2001. The subcontractor is seeking
$28.5 million and other unspecified damages in connection with such
termination. EWA believes it is entitled to and intends to seek recovery
from the USPS of any termination costs to which the subcontractor may be
entitled.
As described in Note 10 to the Consolidated Financial Statements,
"Commitments and Contingencies," CNF is subject to certain legal and
administrative proceedings with the FAA. There can be no assurance that
these proceedings will not have a material adverse effect on CNF's
financial condition, cash flows, or results of operations.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 [a] Computation of Ratios of Earnings to Fixed Charges - For
the six months ended September 30, 2002 and 2001, the
ratios of earnings to fixed charges were 2.8x and -4.2x,
respectively.
[b] Computation of Ratios of Earnings to Combined Fixed
Charges - For the six months ended September 30, 2002
and 2001, the ratios of earnings to combined fixed
charges and preferred stock dividends were 2.7x and
-3.9x, respectively.
99.2 Certification by the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
99.3 Certification by the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
One report on Form 8-K, dated August 12, 2002, was filed
during the quarter ended September 30, 2002, reporting under
Item 9 the announcement that CNF submitted to the Securities
and Exchange Commission the Statements under Oath of the
principal executive officer and principal financial officer in
accordance with the SEC's June 27, 2002 Order requiring the
filing of sworn statements pursuant to Section 21(a)(1) of the
Securities and Exchange Act of 1934.
PAGE 39
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 12, 2002 /s/Chutta Ratnathicam
---------------------
Chutta Ratnathicam
Senior Vice President and
Chief Financial Officer
PAGE 40
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Gregory L. Quesnel, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CNF Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
November 12, 2002 /s/Gregory L. Quesnel
---------------------
Gregory L. Quesnel
Chief Executive Officer
PAGE 41
I, Chutta Ratnathicam, certify that:
1. I have reviewed this quarterly report on Form 10-Q of CNF Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
November 12, 2002 /s/Chutta Ratnathicam
---------------------
Chutta Ratnathicam
Chief Financial Officer