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, 1999
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 TRANSPORTATION INC.
Incorporated in the State of Delaware
I.R.S. Employer Identification No. 94-1444798
3240 Hillview Avenue, Palo Alto, California 94304
Telephone Number (650) 494-2900
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months and (2) has been subject to such
filing requirements for the past 90 days. Yes xx No
Number of shares of Common Stock, $.625 par value,
outstanding as of October 31, 1999: 48,376,186
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CNF TRANSPORTATION INC.
FORM 10-Q
Quarter Ended September 30, 1999
___________________________________________________________________________
___________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 1999 and December 31, 1998 3
Statements of Consolidated Income -
Three and Nine Months Ended
September 30, 1999 and 1998 5
Statements of Consolidated Cash Flows -
Nine Months Ended September 30, 1999 and 1998 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results
of Operations 13
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 22
PAGE 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CNF TRANSPORTATION INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
1999 1998
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 133,258 $ 73,897
Trade accounts receivable, net of allowances 809,377 810,550
Other accounts receivable 58,487 51,865
Operating supplies, at lower of average
cost or market 45,050 41,764
Prepaid expenses 57,147 32,741
Deferred income taxes 63,705 89,544
Total Current Assets 1,167,024 1,100,361
PROPERTY, PLANT AND EQUIPMENT, NET
Land 113,155 114,146
Buildings and leasehold improvements 543,436 468,123
Revenue equipment 793,079 714,195
Other equipment 469,624 425,476
1,919,294 1,721,940
Accumulated depreciation and amortization (829,975) (737,464)
1,089,319 984,476
OTHER ASSETS
Deferred charges and other assets 136,905 128,627
Capitalized software, net 84,027 64,285
Unamortized aircraft maintenance, net 156,181 143,349
Goodwill, net 268,504 268,314
645,617 604,575
TOTAL ASSETS $2,901,960 $2,689,412
The accompanying notes are an integral part of these statements.
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CNF TRANSPORTATION INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
1999 1998
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 295,712 $ 285,832
Accrued liabilities 499,849 446,171
Accrued claims costs 118,471 108,028
Current maturities of long-term debt and
capital leases 6,460 5,259
Short-term borrowings 25,000 43,000
Accrued income taxes - 12,340
Total Current Liabilities 945,492 900,630
LONG-TERM LIABILITIES
Long-term debt and guarantees (Note 2) 322,800 356,905
Long-term obligations under capital leases 110,657 110,730
Accrued claims costs 79,510 58,388
Employee benefits 215,377 190,268
Other liabilities and deferred credits 56,457 55,268
Deferred income taxes 136,599 115,868
Total Liabilities 1,866,892 1,788,057
COMMITMENTS AND CONTINGENCIES (Note 7)
COMPANY-OBLIGATED MANDATORILY REDEEMABLE
PREFERRED SECURITIES OF SUBSIDIARY TRUST
HOLDING SOLELY CONVERTIBLE DEBENTURES OF
THE COMPANY (Note 6) 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 843,274 and 854,191 shares,
respectively 8 9
Additional paid-in capital, preferred stock 128,253 129,914
Deferred compensation, Thrift and Stock Plan (89,409) (94,836)
Total Preferred Shareholders' Equity 38,852 35,087
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,237,405
and 54,797,707 shares, respectively 34,523 34,249
Additional paid-in capital, common stock 322,557 314,440
Retained earnings 699,658 584,991
Deferred compensation, restricted stock (1,388) (4,599)
Cost of repurchased common stock
(6,870,334 and 6,922,285 shares,
respectively) (169,397) (170,678)
885,953 758,403
Accumulated foreign currency translation
adjustments (6,742) (9,140)
Minimum pension liability adjustment (7,995) (7,995)
Accumulated Other Comprehensive Loss (14,737) (17,135)
Total Common Shareholders' Equity 871,216 741,268
Total Shareholders' Equity 910,068 776,355
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,901,960 $2,689,412
The accompanying notes are an integral part of these statements.
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CNF TRANSPORTATION INC.
STATEMENTS OF CONSOLIDATED INCOME
(Dollars in thousands except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
REVENUES $ 1,408,391 $ 1,282,510 $ 4,025,351 $ 3,572,030
Costs and Expenses
Operating expenses 1,147,254 1,033,071 3,281,700 2,900,858
General and administrative 133,727 119,670 384,527 343,847
Depreciation 41,642 40,726 122,005 109,474
Net gain on sale of assets of
parts distribution operation - - (10,112) -
Net gain on legal settlement - - (16,466) -
1,322,623 1,193,467 3,761,654 3,354,179
OPERATING INCOME 85,768 89,043 263,697 217,851
Other Income (Expense)
Interest expense (6,822) (8,154) (21,300) (25,135)
Dividend requirement on
preferred securities of
subsidiary trust (Note 6) (1,563) (1,563) (4,689) (4,689)
Miscellaneous, net 819 (99) 1,698 (190)
(7,566) (9,816) (24,291) (30,014)
Income before Income Taxes 78,202 79,227 239,406 187,837
Income Taxes 34,018 35,257 104,142 83,588
Net Income 44,184 43,970 135,264 104,249
Preferred Stock Dividends 2,037 2,031 6,125 6,078
NET INCOME AVAILABLE TO
COMMON SHAREHOLDERS $ 42,147 $ 41,939 $ 129,139 $ 98,171
Weighted-Average Common Shares
Outstanding (Note 5)
Basic 48,306,902 47,698,568 48,131,556 47,607,124
Diluted 56,032,549 55,636,785 55,908,199 55,652,417
Earnings per Common Share (Note 5)
Basic $ 0.87 $ 0.88 $ 2.68 $ 2.06
Diluted $ 0.77 $ 0.78 $ 2.38 $ 1.83
The accompanying notes are an integral part of these statements.
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CNF TRANSPORTATION INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
Nine Months Ended
September 30,
1999 1998
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 73,897 $ 97,617
OPERATING ACTIVITIES
Net income 135,264 104,249
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation and amortization 139,646 119,515
Increase in deferred income taxes 46,570 2,601
Amortization of deferred compensation 9,125 6,465
Provision for doubtful accounts 8,446 8,309
Losses (Gains) on sales of property, net 35 (1,544)
Net gain on sale of assets of parts
distribution operation (10,112) -
Changes in assets and liabilities:
Receivables (19,208) (63,577)
Prepaid expenses (24,463) (2,633)
Accounts payable 13,393 (9,262)
Accrued liabilities 52,899 57,194
Accrued claims costs 30,145 8,834
Income taxes (12,340) 40,895
Employee benefits 25,109 23,704
Deferred charges and credits (22,767) (21,197)
Other (15,919) (14,431)
Net Cash Provided by Operating Activities 355,823 259,122
INVESTING ACTIVITIES
Capital expenditures (239,070) (199,437)
Software expenditures (27,897) (35,430)
Proceeds from sales of property 10,667 12,925
Proceeds from sale of assets of parts
distribution operation 29,260 -
Net Cash Used in Investing Activities (227,040) (221,942)
FINANCING ACTIVITIES
Net repayment of long-term debt and capital
lease obligations (32,977) (5,443)
Net repayment of short-term borrowings (18,000) -
Proceeds from exercise of stock options 7,106 4,161
Payments of common dividends (14,473) (14,288)
Payments of preferred dividends (11,078) (11,212)
Net Cash Used in Financing Activities (69,422) (26,782)
Increase in Cash and Cash Equivalents 59,361 10,398
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 133,258 $ 108,015
The accompanying notes are an integral part of these statements.
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CNF TRANSPORTATION INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principal Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements of CNF
Transportation Inc. and subsidiaries (the Company) have been prepared by
the Company, without audit by independent public accountants, pursuant to
the rules and regulations of the Securities and Exchange Commission. In
the opinion of management, the consolidated financial statements include
all normal recurring adjustments necessary to present fairly the
information required to be set forth therein. Certain information and note
disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted from these statements pursuant to such rules and
regulations and, accordingly, should be read in conjunction with the
consolidated financial statements included in the Company's 1998 Annual
Report to Shareholders.
Recognition of Revenues
Revenue from long-term contracts is recognized in accordance with
contractual terms as services are provided. Under certain long-term
contracts, there are provisions for price re-determinations that give rise
to unbilled revenue. Unbilled revenue representing contract change orders
or claims is included in revenue only when it is probable that they will
result in additional contract revenue and if the amount can be reliably
estimated. The Company recognizes unbilled revenue related to claims
sufficient only to recover costs. When adjustments in contract revenue are
determined, any changes from prior estimates are reflected in earnings in
the current period. The amount of unbilled revenue recognized in accounts
receivable in the Balance Sheet at September 30, 1999, was $34.1 million.
In addition, as a result of the U.S. Postal Service's unilateral
provisional price reductions discussed under "Other Segment" in
"Management's Discussion and Analysis of Financial Condition and Results
of Operations", $26.0 million of revenue actually collected by the Company
is now in dispute.
Reclassification
Certain amounts in prior year financial statements have been
reclassified to conform to current year presentation.
2. Long-term Debt and Guarantees
The aggregate principal amount of $117.7 million of the Company's
unsecured 9 1/8% notes were paid in full on the August 15, 1999 maturity
date. The redemption of these notes was made in part with $90.0 million of
borrowings under lines of credit. At September 30, 1999, the $90.0
million of borrowings under lines of credit were classified as long-term
debt based on the Company's ability and intent to refinance this amount on
a long-term basis. Only $90.0 million of the total $115.0 million
outstanding under all of the Company's revolving credit facilities are
classified as long-term debt; the remaining $25.0 million outstanding under
lines of credit are not intended to be refinanced on a long-term basis and
are classified as short-term borrowings.
The Company guarantees the restructured and non-restructured notes
issued by the Company's Thrift and Stock Plan (TASP). On July 1, 1999, the
Company refinanced $45.25 million of Series "A" and $27.15 million of
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Series "A restructured" TASP notes. These notes, with respective interest
rates of 8.42% and 9.04%, were replaced with $72.4 million of new TASP
notes with a rate of 6.0% and a maturity date of January 1, 2006.
3. Comprehensive Income
SFAS 130, "Reporting Comprehensive Income", requires companies to
report a measure of all changes in equity except those resulting from
investments by owners and distributions to owners. Comprehensive income
was as follows:
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Net Income $ 44,184 $ 43,970 $ 135,264 $ 104,249
Foreign currency
translation adjustment 1,704 1,403 2,398 60
---------- ---------- ---------- ----------
$ 45,888 $ 45,373 $ 137,662 $ 104,309
========== ========== ========== ==========
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4. Business Segments
SFAS 131, "Disclosures about Segments of an Enterprise and Related
Information", established standards for reporting information about
operating segments in annual financial statements and requires selected
information in interim financial statements. Selected financial
information is reported below:
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Revenues
Con-Way Transportation $ 496,589 $ 443,559 $1,404,200 $1,268,334
Emery Worldwide 620,470 562,382 1,742,105 1,623,374
Menlo Logistics 181,473 165,313 529,310 439,415
Other 132,854 133,588 416,445 310,228
---------- ---------- ---------- ----------
1,431,386 1,304,842 4,092,060 3,641,351
Intercompany Eliminations
Con-Way Transportation (5,931) (4,964) (16,616) (11,516)
Emery Worldwide (3,154) (6,206) (9,514) (18,839)
Menlo Logistics (2,791) (2,853) (8,466) (8,312)
Other (11,119) (8,309) (32,113) (30,654)
---------- ---------- ---------- ---------
(22,995) (22,332) (66,709) (69,321)
External Revenues
Con-Way Transportation 490,658 438,595 1,387,584 1,256,818
Emery Worldwide 617,316 556,176 1,732,591 1,604,535
Menlo Logistics 178,682 162,460 520,844 431,103
Other 121,735 125,279 384,332 279,574
---------- ---------- ---------- ----------
$1,408,391 $1,282,510 $4,025,351 $3,572,030
========== ========== ========== ==========
Operating Income (Loss)
Con-Way Transportation $ 56,938 $ 50,666 $ 171,715 $ 155,157
Emery Worldwide 22,551 21,599 43,527 51,325
Menlo Logistics 6,298 5,571 16,127 14,369
Other (1) (19) 11,207 32,328 (3,000)
---------- ---------- ---------- ----------
$ 85,768 $ 89,043 $ 263,697 $ 217,851
========== ========== ========== ==========
(1)For the nine months ended September 30, 1999, the Other segment included
a $10.1 million net gain on the VantageParts asset sale in May 1999 and
a $16.5 million net gain on a lawsuit settled in January 1999.
PAGE 10
5. Earnings Per Share
Basic earnings per share was computed by dividing net income available
to common shareholders by the weighted-average common shares outstanding.
Diluted earnings per share was calculated as follows:
Three Months Ended Nine Months Ended
(Dollars in thousands except September 30, September 30,
per share data) 1999 1998 1999 1998
---------- ---------- --------- ----------
Earnings:
Net Income Available
to Common Shareholders $ 42,147 $ 41,939 $ 129,139 $ 98,171
Add-backs:
Dividends on Series B
preferred stock, net
of replacement funding 309 316 980 979
Dividends on preferred
securities of subsidiary
trust, net of tax 954 954 2,862 2,862
---------- ---------- ---------- ----------
$ 43,410 $ 43,209 $ 132,981 $ 102,012
---------- ---------- ---------- ----------
Shares:
Basic shares (weighted-
average common shares
outstanding) 48,306,902 47,698,568 48,131,556 47,607,124
Stock option and restricted
stock dilution 630,513 667,151 681,509 774,227
Series B preferred stock 3,970,134 4,146,066 3,970,134 4,146,066
Preferred securities of
subsidiary trust 3,125,000 3,125,000 3,125,000 3,125,000
---------- ---------- ---------- ----------
56,032,549 55,636,785 55,908,199 55,652,417
---------- ---------- ---------- ----------
Diluted Earnings
Per Share $ 0.77 $ 0.78 $ 2.38 $ 1.83
========== ========== ========== ==========
6. Preferred Securities of Subsidiary Trust
On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust
wholly owned by the Company, issued 2,500,000 of its $2.50 Term Convertible
Securities, Series A (TECONS) to the public for gross proceeds of $125
million. The combined proceeds from the issuance of the TECONS and the
issuance to the Company of the common securities of the Trust were invested
by the Trust in $128.9 million aggregate principal amount of 5% convertible
subordinated debentures due June 1, 2012 (the Debentures) issued by the
Company. The Debentures are the sole assets of the Trust.
Holders of the TECONS are entitled to receive cumulative cash
distributions at an annual rate of $2.50 per TECONS (equivalent to a rate
of 5% per annum of the stated liquidation amount of $50 per TECONS). The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the TECONS, to the extent the Trust has funds available
therefor and subject to certain other limitations (the Guarantee). The
Guarantee, when taken together with the obligations of the Company under
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the Debentures, the Indenture pursuant to which the Debentures were issued,
and the Amended and Restated Declaration of Trust of the Trust (including
its obligations to pay costs, fees, expenses, debts and other obligations
of the Trust (other than with respect to the TECONS and the common
securities of the Trust)), provide a full and unconditional guarantee of
amounts due on the TECONS.
The Debentures are redeemable for cash, at the option of the Company,
in whole or in part, on or after June 1, 2000, at a price equal to 103.125%
of the principal amount, declining annually to par if redeemed on or after
June 1, 2005, plus accrued and unpaid interest. In certain circumstances
relating to federal income tax matters, the Debentures may be redeemed by
the Company at 100% of the principal plus accrued and unpaid interest. Upon
any redemption of the Debentures, a like aggregate liquidation amount of
TECONS will be redeemed. The TECONS do not have a stated maturity date,
although they are subject to mandatory redemption upon maturity of the
Debentures on June 1, 2012, or upon earlier redemption.
Each TECONS is convertible at any time prior to the close of business
on June 1, 2012, at the option of the holder into shares of the Company's
common stock at a conversion rate of 1.25 shares of the Company's common
stock for each TECONS, subject to adjustment in certain circumstances.
7. Contingencies
In connection with the spin-off of Consolidated Freightways
Corporation (CFC) on December 2, 1996, the Company agreed to indemnify
certain states, insurance companies and sureties against the failure of CFC
to pay certain worker's compensation, tax and public liability claims that
were pending as of September 30, 1996. In some cases, these indemnities are
supported by letters of credit under which the Company is liable to the
issuing bank and by bonds issued by surety companies. In order to secure
CFC's obligation to reimburse and indemnify the Company against liability
with respect to these claims, as of September 30, 1999 CFC had provided the
Company with approximately $13.5 million of letters of credit and $22.0
million of real property collateral.
The Company entered into a Transition Services Agreement to provide
CFC with certain information systems, data processing and other
administrative services and administers CFC's retirement and benefits
plans. The agreement has a three-year term, which expires on December 2,
1999. Services performed by the Company under the agreement, which were
minimal at September 30, 1999, are paid by CFC on an arm's-length
negotiated basis.
The Company is currently under examination by the Internal Revenue
Service (IRS) for tax years 1987 through 1996 on various issues. In
connection with those examinations, the IRS is seeking additional taxes,
plus interest, for certain matters relating to CFC for periods prior to its
spin-off from the Company in 1996. Although the Company is currently
contesting these additional taxes proposed by the IRS, the Company may
elect to pay a substantial portion of these taxes prior to resolution.
As the former parent of CFC, the Company is primarily liable to the
IRS for CFC's tax liability relating to such periods. However, as part of
the spin-off, the Company and CFC entered into a tax sharing agreement that
provides a mechanism for the allocation of any additional tax liability and
related interest that arise due to adjustments by the IRS for years prior
to the spin-off. The Company believes it is entitled to and will pursue
reimbursement from CFC under the tax sharing agreement for any payments
that the Company makes to the IRS with respect to these additional taxes.
PAGE 12
The IRS has also proposed a substantial adjustment for tax years 1987
through 1990 based on the IRS' position that certain aircraft maintenance
costs should have been capitalized rather than expensed for federal income
tax purposes. In addition, the Company believes it is likely that the IRS
will propose an additional adjustment, based on the same IRS position with
respect to aircraft maintenance costs, for subsequent tax years.
The Company has filed a protest concerning the proposed adjustment for
tax years 1987 through 1990 and is engaged in discussions with the Appeals
Office of the IRS. The Company is unable to predict whether or not it will
be able to resolve this issue with the Appeals Office. The Company expects
that, if it is unable to resolve this issue with the Appeals Office, it
will receive a statutory notice of assessment from the IRS within one year.
If this occurs, the Company intends to contest the assessment by
appropriate legal proceedings.
The Company believes that its practice of expensing these types of
aircraft maintenance costs is consistent with industry practice and intends
to continue to vigorously contest the proposed adjustment. However, if this
matter is determined adversely to the Company, there can be no assurance
that the Company will not be liable for substantial additional taxes, plus
accrued interest. As a result, the Company is unable to predict the
ultimate outcome of this matter and there can be no assurance that this
matter will not have a material adverse effect on the Company.
The IRS has proposed adjustments that would require Emery Worldwide to
pay substantial additional aviation excise taxes for the period from
January 1, 1990 through September 30, 1995. The Company has filed protests
contesting these proposed adjustments and is engaged in discussions with
the Appeals Office of the IRS. However, the Company believes it is unlikely
that the issue will be resolved with the Appeals Office and expects to
receive a statutory notice of assessment from the IRS before the end of
2000. Upon receipt of the notice, the Company will be required to pay all
or a portion of the adjustment with accrued interest before seeking a
refund of that payment through appropriate legal proceedings.
The Company believes that there is legal authority to support the
manner in which it has calculated and paid the aviation excise taxes and,
accordingly, the Company intends to continue to vigorously challenge the
proposed adjustments. Nevertheless, the Company is unable to predict the
ultimate outcome of this matter. As a result, there can be no assurance
that the Company will not be liable for a substantial amount of additional
aviation excise taxes for the 1990 through 1995 tax period, plus interest.
In addition, it is possible that the IRS may seek to increase the amount of
the aviation excise tax payable by Emery Worldwide for periods subsequent
to September 30, 1995. As a result, there can be no assurance that this
matter will not have a material adverse effect on the Company.
In addition to the matters discussed above, the Company and its
subsidiaries are defendants in various lawsuits incidental to their
businesses. It is the opinion of management that the ultimate outcome of
these actions will not have a material impact on the Company's financial
position or results of operations.
PAGE 13
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
- ---------------------
Consolidated Results
Net income available to common shareholders for the third quarter of
1999 increased to $42.1 million ($0.87 per basic share and $0.77 per
diluted share) from $41.9 million ($0.88 per basic share and $0.78 per
diluted share) in the same quarter of last year, due primarily to a decline
in other net expenses and a lower effective tax rate, partially offset by
slightly lower operating income.
Net income available to common shareholders for the first nine months
of 1999 was the best in the Company's history at $129.1 million ($2.68 per
basic share and $2.38 per diluted share). The record results increased
31.5% from $98.2 million ($2.06 per basic share and $1.83 per diluted
share) in the first nine months of last year. Higher net income available
to common shareholders was primarily the result of higher operating income,
a decline in other net expenses, and a lower effective tax rate. Operating
income in the first nine months of 1999 benefited from a $16.5 million gain
($0.19 per basic share and $0.17 per diluted share) on the settlement of a
lawsuit in January 1999. In May 1999, another non-recurring gain of $10.1
million ($0.12 per basic share and $0.10 per diluted share) was recognized
on the sale of the assets of VantageParts, the Company's wholesale parts
distribution operation. Excluding non-recurring gains, net income available
to common shareholders for the first nine months of 1999 would have been
$114.1 million ($2.37 per basic share and $2.11 per diluted share).
Revenue for the third quarter of 1999 increased 9.8% over the same
quarter of 1998 due primarily to double-digit percentage revenue growth at
Con-Way, Emery, and Menlo. Lower revenue for the Other segment, which
primarily includes operations under a Priority Mail contract with the U.S.
Postal Service, partially offset the higher revenue from the Company's
three largest operating segments. Revenue for the first nine months of 1999
increased 12.7% on higher revenue from all reporting segments. Revenue for
the first nine months of 1999 reflects operations under the Priority Mail
contract for the entire period.
Operating income for the 1999 third quarter declined 3.7% from the
same quarter last year despite a 10.2% increase in the collective operating
income of Con-Way, Emery, and Menlo. Priority Mail operations, which
declined from operating income of $10.5 million in last year's third
quarter to break-even results in the third quarter of 1999, more than
offset higher operating income from the Company's three largest segments.
Operating income for the first nine months of 1999 increased 21.0% over the
same period last year due primarily to higher operating income from Con-
Way, Priority Mail, and Menlo, and gains on the settlement of a lawsuit and
the sale of assets of VantageParts. Lower operating income from Emery for
the first nine months of 1999 partially offset increases from the Company's
other reporting segments.
Other net expenses in the third quarter and first nine months of 1999
decreased 22.9% and 19.1%, respectively, from the same periods last year
due primarily to lower interest expense and gains on property sales. The
decline in interest expense was partially due to the July 1998 refinancing
of a capital lease obligation at a lower interest rate and the repayment of
the Company's 9 1/8% notes at maturity. The repayment of $117.7 million of
9 1/8% notes in August 1999 was funded in part with $90.0 million of lower-
interest rate long-term borrowings under unsecured lines of credit.
Capitalized interest on construction projects in the third quarter and
PAGE 14
first nine months of 1999 also contributed to lower interest expense
compared to the same periods last year.
The effective tax rate for the third quarter and first nine months of
1999 was 43.5% compared to 44.5% in 1998. The reduction was primarily the
result of higher income in 1999.
Con-Way Transportation Services
Con-Way's revenue in the third quarter and first nine months of 1999
increased 11.9% and 10.4%, respectively, over the comparable periods last
year due primarily to higher tonnage (weight) and revenue per hundredweight
(yield).
In the third quarter of 1999, total and less-than-truckload (LTL)
weight increased 9.8% and 9.6%, respectively, over the third quarter of
1998. Total and LTL weight in the first nine months of 1999 increased 6.5%
and 6.8%, respectively, over the same period last year. Higher tonnage
reflects growth in core regional service and inter-regional joint services.
The entire first nine months of 1999 benefited from inter-regional joint
services between all of Con-Way's regional carriers. The inter-regional
joint service between the western and central carriers was not implemented
until the second quarter of last year. The Company believes that the
closures of two of Con-Way's competitors in the second quarter of 1999
created additional demand for Con-Way's services in the third quarter of
1999. The first quarter of last year included benefits received from
freight diverted by shippers concerned about possible strikes at unionized
national LTL carriers.
Yield for Con-Way's regional carriers in the third quarter and first
nine months of 1999 increased 3.1% and 5.3%, respectively, over the same
periods last year. Higher yield was primarily due to increased rates
obtained for Con-Way's core premium services and a larger percentage of
inter-regional joint services, which command higher rates on longer lengths
of haul. In prior years, Con-Way implemented its annual revenue rate
increase on January 1 of each year. Consistent with the practice initiated
by many of its competitors last year, Con-Way announced a revenue rate
increase effective early in the fourth quarter of 1999 rather than January
1, 2000.
Con-Way's operating income in the third quarter and first nine months
of 1999 increased 12.4% and 10.7%, respectively, over the same periods of
1998 due primarily to higher revenue, increased load factor, greater
emphasis on operating efficiencies and better cost control. Rising diesel
fuel prices resulted in higher fuel expense in the third quarter of 1999
compared to the same quarter last year. In an effort to mitigate the
adverse impact of the higher fuel costs, Con-Way implemented a fuel
surcharge in August 1999. Weather-related costs of Hurricane Floyd in
September 1999 and start-up costs incurred in the first nine months for Con-
Way's new multi-client warehousing and logistics business also negatively
impacted operating income in 1999. The Company believes that operating
income in the third quarter of 1999 benefited from the closure of two of
Con-Way's competitors while the first quarter of last year benefited from
the strike concerns of shippers mentioned above.
Emery Worldwide
Emery's revenue in the third quarter and first nine months of 1999 was
11.0% and 8.0% higher, respectively, than the same periods last year due
primarily to increased international airfreight revenue and higher revenue
from the Express Mail contract with the U.S. Postal Service. North American
airfreight revenue was higher in the third quarter of 1999 but was slightly
lower for the first nine months of 1999 when compared to the respective
periods last year.
PAGE 15
North American airfreight revenue for the third quarter of 1999
increased 1.5% over the same quarter last year due primarily to a 5.3%
increase in revenue per pound (yield) partially offset by a 3.7% decline in
pounds transported (weight or freight volume). Although yield for the first
nine months of 1999 was 5.0% higher than the same period last year, a 5.4%
decline in weight contributed to a 0.8% decrease in North American
airfreight revenue. Improved revenue per pound was due in part to an
increase in the percentage of higher yielding guaranteed delivery service,
which was introduced in January 1999, and Emery's yield management program,
which was designed to eliminate or reprice certain low margin business.
Although Emery's yield management program was a factor in achieving higher
yield, it also contributed to lower freight volume.
International airfreight revenue for the third quarter of 1999 was
15.0% higher than the third quarter last year due primarily to freight
volume and yield increases of 12.7% and 2.1%, respectively. In the first
nine months of 1999, a 6.4% increase in weight and 1.9% higher yield
contributed to an improvement of 8.4% in international airfreight revenue
over the same period last year. Freight volume and yield in the third
quarter and first nine months of 1999 were favorably impacted by improved
economic conditions in the international markets served by Emery.
Emery's third-quarter 1999 operating income increased 4.4% over last
year's third quarter and operating income for the first nine months of 1999
was down 15.2% from the same period last year. Although revenue was higher,
operating margins for the third quarter and first nine months of 1999
declined from the comparable periods last year due primarily to higher
airhaul costs, which were in part related to an ongoing initiative to
reposition Emery as a premium service carrier. This initiative is intended
to improve service by, among other things, improving infrastructure and
aircraft dependability and modifying freight handling processes. Weather-
related costs of Hurricane Floyd and higher fuel costs compared to the same
quarter last year also negatively impacted operating income in the third
quarter of 1999. Emery's fuel index fee went into effect in September 1999,
partially mitigating the adverse impact of higher fuel costs.
Management will continue to focus on positioning Emery as a premium
service provider. In North America, management intends to continue to
develop an infrastructure capable of servicing a higher volume of premium
and guaranteed delivery services and to reduce the costs associated with
its infrastructure by replacing older and less reliable aircraft with newer
aircraft having lower maintenance costs, including wide-body aircraft.
Internationally, Emery's management will focus on expanding its variable-
cost-based operations. Management will continue its efforts to increase
international revenue as a percentage of total revenue.
Menlo Logistics
Menlo's revenue in the third quarter and first nine months of 1999
exceeded the same periods last year by 10.0% and 20.8%, respectively.
Results for the first nine months of 1999 included revenue generated from
several large logistics contracts secured in the second quarter of 1998.
The third quarter and first nine months of 1999 also included higher
revenue from existing contracts compared with the same periods last year.
Operating income for Menlo in the third quarter and first nine months
of 1999 increased 13.0% and 12.2%, respectively, over the comparable
periods last year. Higher operating income was primarily attributable to
increased revenue. However, higher business development and information
PAGE 16
system costs incurred during the third quarter and first nine months of
1999 contributed to lower operating income as a percentage of revenue than
in the same periods last year.
Other Segment
The Other segment consists primarily of the operations under a
Priority Mail contract with the U.S. Postal Service, and includes the
operating results of Road Systems and, prior to its sale of assets by the
Company in May 1999, VantageParts. Also included in the Other segment for
1999 were net gains on the settlement of a lawsuit in January 1999 and on
the VantageParts asset sale.
Third-quarter revenue for the Other segment in 1999 decreased 2.8%
from the third quarter last year due primarily to the absence of revenue
from VantageParts following the asset sale. Higher 1999 third-quarter
revenue of $118.2 million from the Priority Mail operations partially
offset the loss of third-quarter revenue from VantageParts. The Other
segment's revenue for the first nine months of 1999 increased 37.5% due
primarily to higher Priority Mail revenue of $354.6 million. The Priority
Mail operations were not fully implemented until late in the second quarter
of last year.
For the third quarter of 1999, operating income for the Other segment
decreased by $11.2 million from the third quarter of 1998 due substantially
to break-even Priority Mail operating results in the 1999 third quarter,
which decreased from operating income of $10.5 million in the third quarter
of last year. For the first nine months of 1999, operating income improved
by $35.3 million from the first nine months of 1998 due primarily to a
$10.1 million net gain on the sale of assets of VantageParts and a $16.5
million net gain from a lawsuit settled in January 1999. In addition, the
Priority Mail operations in the first nine months of 1999 generated
operating income of $4.8 million compared to an operating loss of $5.0
million in the same period last year. The first nine months of last year
included losses incurred during the start-up phase of the Priority Mail
contract.
In accordance with the Priority Mail contract, in February 1999, Emery
Worldwide Airlines (EWA), the Company's subsidiary that operates the
contract, submitted a proposal to the U.S. Postal Service (USPS) for 1999
pricing. The Company believes that its proposal was reasonably determined
and justifiable based upon EWA's experience of operating the Priority Mail
contract.
EWA has not received a counter-proposal from the USPS. Consequently,
EWA in the third quarter filed a claim with the USPS reflecting its
proposed prices.
Through the second quarter of 1999, Priority Mail contract revenue was
billed at a provisional rate set by the USPS, pending a final price
determination. The USPS responded to the EWA claim with unilateral
provisional price reductions for both prior and future periods. The current
provisional rate is below EWA's cost to service this contract. Unless the
rate is increased or until negotiation or litigation determines the price,
EWA will be compensated below its cost of operation.
Also, in August 1999, the USPS denied EWA's previously filed claim for
reimbursement of additional costs incurred during the 1998 holiday season.
Consistent with the Company's accounting policies described in Note 1
of the Notes to Consolidated Financial Statements, unbilled revenue from
the Priority Mail contract is recognized in the financial statements when
it is probable that the claim will result in additional contract revenue
and if the amount can be reliably estimated. In accordance with generally
accepted accounting principles, EWA recognizes unbilled revenue related to
claims sufficient only to recover costs. No profit was recognized in
PAGE 17
connection with the Priority Mail contract in the third quarter of 1999. As
a result of the claims discussed above and the USPS's decision to assert
price reductions, EWA through September 30, 1999 recognized $60.1 million
of revenue now in dispute and attributable to claims by the Company under
the contract, of which $23.1 million was recognized in the third quarter of
1999. Until the dispute is resolved, any shortfall between EWA's
compensation from the Priority Mail contract and its cost of operation will
be recognized as unbilled revenue.
If, as a result of new facts or circumstances, the Company determines
that the actual receipt of unbilled revenues is not probable, the
uncollectable amount will be charged as expense to operations in the period
when and if that determination is made.
The Company disagrees with the USPS's conclusion and intends to
vigorously contest its claim for price determination and denial of the 1998
holiday claim by appropriate action. The Company believes its position is
well founded; nonetheless, since the claims are subject to negotiation
and/or litigation, there can be no assurance as to their outcome.
Likewise, if determined adversely to the Company, there can be no assurance
that this matter will not have a material adverse effect on the Company.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
In the first nine months of 1999, the Company's cash and cash
equivalents increased $59.4 million to $133.3 million. Cash from operations
of $355.8 million provided funding for $267.0 million of capital and
software expenditures, $51.0 million of net debt reduction and $25.6
million of dividend payments.
Cash from operations in the first nine months of 1999 was provided
primarily by net income before depreciation, amortization and deferred
taxes.
Capital expenditures of $239.1 million in the first nine months of
1999 increased $39.6 million from the same period last year due primarily
to a $71.2 million increase in Con-Way's capital expenditures partially
offset by a $33.5 million decline in capital expenditures for the Priority
Mail contract. For the first nine months of 1999, Con-Way spent $152.5
million primarily on revenue equipment and infrastructure in connection
with its capital reinvestment program. For the remainder of 1999,
additional expenditures of approximately $50 million are expected under Con-
Way's reinvestment program. Capital expenditures related to the Priority
Mail contract in the first nine months of 1999 declined compared to the
same period last year given required capital expenditures in the prior
period related to the start-up phase of the Priority Mail contract.
The sale of assets of VantageParts in May 1999 generated proceeds of
$29.3 million and a non-recurring net gain of $10.1 million.
As discussed above under "Results of Operations" for the "Other
Segment", the provisional rate currently being paid to EWA by the U.S.
Postal Service under the Priority Mail contract is below EWA's cost to
service the contract. Until the dispute over pricing is resolved, the
Company's liquidity will be negatively impacted by the shortfall between
EWA's compensation from the contract and its cost of operation.
At September 30, 1999, the Company had $80.0 million of borrowings
outstanding under its $350 million unsecured credit facility and $35.0
million outstanding under $95.0 million of uncommitted lines of credit. Of
the $115.0 million outstanding under both the unsecured credit facility and
PAGE 18
the uncommitted lines, $90.0 million were classified as long-term debt
based on the Company's ability and intent to refinance the borrowings on a
long-term basis. The $90.0 million of long-term borrowings under lines of
credit were used to partially fund the redemption of $117.7 million
outstanding under the Company's 9 1/8% notes, which matured in August 1999.
In September 1999, the Company secured a supplemental $100 million
unsecured credit facility to provide additional liquidity until designated
long-term borrowings under lines of credit are refinanced with a longer-
term instrument; no borrowings were outstanding under this new facility at
September 30, 1999.
The $350 million facility is also available for issuance of letters of
credit. Under that facility, outstanding letters of credit totaled $63.6
million at September 30, 1999, which left available capacity of $206.4
million. In addition, the Company had available capacity of $60.0 million
under other uncommitted lines of credit. Under several other unsecured
facilities, $49.2 million of letters of credit were outstanding at
September 30, 1999.
The Company filed a shelf registration statement with the Securities
and Exchange Commission in June 1998 that covers $250 million of debt and
equity securities for future issuance with terms to be decided when and if
issued.
The Company's ratio of total debt to capital decreased to 31.0% at
September 30, 1999, from 36.4% at December 31, 1998, primarily due to lower
borrowings and higher shareholders' equity from net income.
MARKET RISK
- -----------
There have been no material changes in the Company's market risk
sensitive instruments and positions since its disclosure in its Annual
Report on Form 10-K for the year ended December 31, 1998.
CYCLICALITY AND SEASONALITY
- ---------------------------
The Company operates 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, the months of September and October of each year usually have
the highest business levels while the months of January and February of
each year usually have the lowest business levels. Operations under the
Priority Mail contract peak in December due primarily to higher shipping
demand related to the holiday season.
YEAR 2000
- ---------
Renovation of all business-critical Information Technology (IT)
Systems was complete at September 30, 1999. Validation was substantially
completed in October 1999.
Like many other companies, an issue affecting the Company is the
ability of its computer systems and software to process the year 2000 (Y2K
or Year 2000). To ensure that the Company's systems are Year 2000
compliant, a team of IT professionals began preparing for the Y2K issue in
1996. In 1997, the Company formed a Steering Committee composed of senior
executives to address compliance issues. The Y2K team developed, and the
Steering Committee approved, a Company-wide initiative to address issues
associated with the year 2000. Company management designated the Y2K
project as the highest priority of the Company's Information Technology
Department.
PAGE 19
The Company's Y2K compliance efforts are focused on business-critical
items. Systems and software are considered "business-critical" if a failure
would either have a material adverse impact on the Company's business,
financial condition or results of operations or involve a safety exposure
to employees or customers.
State of Readiness
The Company has identified distinct categories for its Y2K compliance
efforts: (1) IT Systems, (2) Non-IT Systems, and (3) third parties with
which the Company has major relationships. The Company fixed or replaced
non-compliant software and systems through a process that involved taking
inventory of its systems, assessing risks and impact, correcting non-
compliant systems through renovation or replacement, and validating
compliance through testing. The has Company committed the resources necessary
to bring any residual aspects of the project to scheduled completion.
IT Systems - IT Systems include mainframes, mid-range computers and
servers, networks and workstations, related operating systems and
application software. The Company inventoried and assessed all business-
critical IT Systems and renovation efforts are complete. Mainframe
hardware, operating systems and applications have been fully renovated. Mid-
range computers and servers are also complete, as are the related operating
systems and application software programs. Network hardware and computer
workstations have also been fully renovated. An estimated 80% of the
computer workstation operating systems and application software programs
have been upgraded. The portion of operating systems and application
software programs that has not been confirmed as Y2K compliant is not
business-critical and represents vendor software that is being remedied as
compliant upgrades are provided by the vendor. The Company continues to
monitor, test, and install vendor-related upgrades or "patches" as they
become available.
Non-IT Systems - Non-IT Systems include operating equipment, security
systems, and other equipment that may contain microcontrollers with
embedded technology. Certain IT Systems may also include embedded
technology. The Company has contacted all business-critical operating and
support facilities to identify the extent of its embedded technology and
has received responses from all of those surveyed locations. All of the
business-critical embedded technology the Company is aware of has been
confirmed as Y2K compliant.
Third Party Systems - In addition to its own IT and Non-IT Systems,
the Company is also reliant upon system capabilities of third parties
(including, among others, customers, vendors, domestic and international
government agencies, and U.S. and international airports). The Company
believes these third party risks are inherent in the industry and not
specific to the Company.
The Company has communicated with third parties with which the Company
has material business relationships to determine the extent to which the
Company's systems are vulnerable to those third parties' failure to make
necessary changes related to Y2K issues. All of the Company's critical
vendors have been contacted and responded to the surveys. If a vendor was
determined to be non-compliant, the Company is working to identify a Y2K-
compliant vendor as a replacement. In an effort to mitigate risks related
to the system capabilities of certain customers, the Company developed Y2K-
compliant software upgrades to its tracking and tracing software and other
proprietary software utilized by its customers.
The International Air Transport Association and the Air Transport
Association of America are involved in global and industry-wide studies
aimed at assessing the Y2K compliance status of airports and other U.S. and
PAGE 20
international government agencies. As a member of these associations, Emery
Worldwide is analyzing the results of these studies as they become
available.
Costs to Address Y2K Compliance
Since 1996, the Company has expensed approximately $35.7 million on
Y2K compliance and expects that approximately $4.4 million of additional
Y2K compliance costs will be expensed through December 31, 1999. All Y2K
costs have been and are expected to be funded from operations. In the nine-
months ended September 30, 1999, the Company capitalized $4.5 million of
purchased software costs and $23.4 million of internally developed software
costs. A portion of the capitalized software costs was for new financial
and administrative systems that are Y2K compliant. These systems replaced
certain non-compliant systems.
Risks
While the Company believes its efforts to address the Year 2000 issue
will be successful in avoiding any material adverse effect on the Company's
operations or financial condition, it recognizes that failing to resolve
Year 2000 issues on a timely basis would, in a most reasonably likely worst
case scenario, significantly limit its ability to provide its services for
a period of time, especially if such failure is coupled with a third-party
failure. As a result, there can be no assurance that this matter will not
have a material adverse effect on the Company.
Contingency Plans
The Company established Y2K business resumption contingency plans by
evaluating business disruption scenarios and identifying and implementing
preemptive strategies. Detailed contingency plans for critical business
processes have been completed by all of the Company's operations
facilities. The testing of potential scenarios, which are occurring and
will continue to take place through the remainder of the year, may result
in modifications to the contingency plans. Management plans to incorporate
business resumption contingency plans into the Company's normal and future
risk management activities.
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. Any such forward-looking statements contained herein should
not be relied upon as predictions of future events. 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 thereof or other variations thereof or comparable
terminology, or by discussions of strategy, plans or intentions. Such
forward-looking statements are necessarily dependent on assumptions, data
or methods that may be incorrect or imprecise and they may be incapable of
being realized. In that regard, the following factors, among others and in
addition to the matters discussed below and elsewhere in this document,
could cause actual results and other matters to differ materially from
those in such forward-looking statements: changes in general business and
economic conditions; increasing domestic and international competition and
pricing pressure; changes in fuel prices; uncertainty regarding the
Company's Priority Mail contract with the United States Postal Service,
including uncertainties regarding the Company's claims under the contract
described herein; labor matters, including changes in labor costs,
PAGE 21
renegotiations of labor contracts and the risk of work stoppages or
strikes; changes in governmental regulation; environmental and tax matters,
including the aviation excise tax and aircraft maintenance tax matters
discussed herein; Y2K matters; and matters relating to the spin-off of CFC.
In that regard, the Company is or may be subject to substantial liabilities
with respect to certain matters relating to CFC's business and operations,
including, without limitation, guarantees of certain indebtedness of CFC
and liabilities for employment-related, tax and environmental matters,
including the tax matters described herein. Although CFC is, in general,
either the primary or secondary obligor or jointly and severally liable
with the Company with respect to these matters, a failure to pay or other
default by CFC with respect to the obligations as to which the Company is
or may be, or may be perceived to be, liable, whether because of CFC's
bankruptcy or insolvency or otherwise, could lead to substantial claims
against the Company. As a result of the foregoing, no assurance can be
given as to future results of operations or financial condition.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
As previously reported, the Company has been designated a potentially
responsible party (PRP) by the EPA with respect to the disposal of
hazardous substances at various sites. The Company expects its share of
the clean-up costs will not have a material adverse effect on the Company's
financial position or results of operations. The Company expects the costs
of complying with existing and future federal, state and local
environmental regulations to continue to increase. On the other hand, it
does not anticipate that such cost increases will have a material adverse
effect on the Company.
The Department of Transportation, through its Office of Inspector
General, and the Federal Aviation Administration are conducting an
investigation relating to the handling of so-called hazardous materials by
Emery. The investigation is ongoing and Emery is cooperating fully.
Because the investigation is at a preliminary stage, the Company is unable
to predict the outcome of this investigation.
Certain legal matters are discussed in Note 7 in the Notes to
Consolidated Financial Statements in Part I of this form.
PAGE 22
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10 Material contracts:
$100,000,000 Credit Agreement dated as of September
30, 1999 among CNF Transportation Inc., The Banks
Party Hereto and Morgan Guaranty Trust Company of
New York, as Administrative Agent
27 Financial Data Schedule
99(a) Computation of Ratios of Earnings to Fixed Charges --
the ratios of earnings to fixed charges were 4.2x and
3.8x for the nine months ended September 30, 1999 and
1998, respectively.
(b) Computation of Ratios of Earnings to Combined Fixed
Charges and Preferred Stock Dividends -- the ratios of
earnings to combined fixed charges and preferred stock
dividends were 4.0x and 3.6x for the nine months ended
September 30, 1999 and 1998, respectively.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
September 30, 1999.
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 Transportation Inc.
(Registrant)
November 12, 1999 /s/Chutta Ratnathicam
Chutta Ratnathicam
Senior Vice President and
Chief Financial Officer