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PAGE 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 July 31, 2002: 49,246,406
PAGE 2
CNF INC.
FORM 10-Q
Quarter Ended June 30, 2002
___________________________________________________________________________
___________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2002 and December 31, 2001 3
Statements of Consolidated Operations -
Three and Six Months Ended June 30, 2002 and 2001 5
Statements of Consolidated Cash Flows -
Three and Six Months Ended June 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
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 35
Item 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 37
PAGE 3
CNF INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
2002 2001
ASSETS
Current Assets
Cash and cash equivalents $ 355,512 $ 400,763
Trade accounts receivable, net 710,287 677,684
Other accounts receivable 93,823 56,860
Operating supplies, at lower of average cost
or market 20,078 20,244
Prepaid expenses 49,983 46,948
Deferred income taxes 157,831 125,347
----------- -----------
Total Current Assets 1,387,514 1,327,846
----------- -----------
Property, Plant and Equipment, at Cost
Land 151,213 149,499
Buildings and leasehold improvements 754,276 739,197
Revenue equipment 617,849 618,329
Other equipment 411,138 411,546
----------- -----------
1,934,476 1,918,571
----------- -----------
Accumulated depreciation and
amortization (889,328) (848,042)
----------- -----------
1,045,148 1,070,529
----------- -----------
Other Assets
Deferred charges and other assets
(Note 2) 248,633 224,605
Capitalized software, net 77,834 79,891
Goodwill, net (Note 1) 240,567 240,523
Deferred income taxes - 46,626
----------- -----------
567,034 591,645
----------- -----------
Total Assets $2,999,696 $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)
June 30, December 31,
LIABILITIES AND SHAREHOLDERS' EQUITY 2002 2001
Current Liabilities
Accounts payable $369,295 $338,730
Accrued liabilities (Note 2) 342,866 307,676
Accrued claims costs 140,047 126,981
Accrued aircraft leases and return provision 197,748 77,483
Current maturities of long-term debt and
capital leases 15,292 11,765
Income taxes payable - 21,501
----------- -----------
Total Current Liabilities 1,065,248 884,136
Long-Term Liabilities
Long-term debt and guarantees 433,440 436,055
Long-term obligations under capital leases 110,559 129,760
Accrued claims costs 110,209 122,273
Employee benefits 282,997 275,764
Other liabilities and deferred credits (Note 2) 124,488 120,858
Accrued aircraft leases and return provision 12,695 258,087
Deferred income taxes 55,073 -
----------- -----------
Total Liabilities 2,194,709 2,226,933
----------- -----------
Commitments and Contingencies (Note 9)
Company-Obligated Mandatorily Redeemable
Preferred Securities of Subsidiary Trust
Holding Solely Convertible Debentures of
the Company (Note 7) 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 792,503 and 805,895
shares, respectively 8 8
Additional paid-in capital, preferred stock 120,532 122,568
Deferred compensation, Thrift and Stock Plan (69,521) (73,320)
----------- -----------
Total Preferred Shareholders' Equity 51,019 49,256
----------- -----------
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,819,270 and
55,559,909 shares, respectively 34,887 34,725
Additional paid-in capital, common stock 337,747 332,066
Retained earnings 461,222 432,918
Deferred compensation, restricted stock (806) (1,013)
Cost of repurchased common stock
(6,604,919 and 6,669,393 shares,
respectively) (162,853) (164,441)
----------- -----------
670,197 634,255
Accumulated Other Comprehensive Loss (Note 4) (41,229) (45,424)
----------- -----------
Total Common Shareholders' Equity 628,968 588,831
----------- -----------
Total Shareholders' Equity 679,987 638,087
----------- -----------
Total Liabilities and Shareholders' Equity $2,999,696 $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 Six Months Ended
June 30, June 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
REVENUES $1,186,273 $1,256,608 $2,253,347 $2,535,073
Costs and Expenses
Operating expenses 993,667 1,095,964 1,873,372 2,169,749
General and administrative
expenses 113,060 127,913 224,221 255,115
Depreciation 35,637 44,187 71,481 87,937
Restructuring charges - 340,531 - 340,531
----------- ----------- ----------- -----------
1,142,364 1,608,595 2,169,074 2,853,332
----------- ----------- ----------- -----------
OPERATING INCOME (LOSS) 43,909 (351,987) 84,273 (318,259)
Other Income (Expense)
Investment income 1,677 641 3,285 1,370
Interest expense (5,638) (7,234) (11,523) (15,027)
Dividend requirement on preferred
securities of subsidiary
trust (Note 7) (1,563) (1,563) (3,126) (3,126)
Miscellaneous, net (2,501) 482 (3,803) 1,309
----------- ----------- ----------- -----------
(8,025) (7,674) (15,167) (15,474)
----------- ----------- ----------- -----------
Income (Loss) before Taxes 35,884 (359,661) 69,106 (333,733)
Income Tax Benefit (Provision) (13,995) 133,852 (26,951) 123,481
----------- ----------- ----------- -----------
Net Income (Loss) 21,889 (225,809) 42,155 (210,252)
Preferred Stock Dividends 2,043 2,079 4,048 4,119
----------- ----------- ----------- -----------
NET INCOME (LOSS) AVAILABLE TO COMMON
SHAREHOLDERS $ 19,846 $ (227,888) $ 38,107 $ (214,371)
=========== =========== =========== ===========
Weighted-Average Common Shares
Outstanding (Note 6)
Basic shares 49,074,627 48,760,668 49,001,489 48,704,866
Diluted shares 56,713,022 48,760,668 56,610,935 48,704,866
Earnings (Loss) per Common Share (Note 6)
Basic $ 0.40 $ (4.67) $ 0.78 $ (4.40)
=========== =========== =========== ===========
Diluted $ 0.37 $ (4.67) $ 0.72 $ (4.40)
=========== =========== =========== ===========
The accompanying notes are an integral part of these statements.
PAGE 6
CNF INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
Six Months Ended
June 30,
2002 2001
---------- ----------
Cash and Cash Equivalents, Beginning of Period $ 400,763 $ 104,515
Operating Activities
Net income (loss) 42,155 (210,252)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Restructuring charges - 340,531
Loss from business failure of a customer - 31,605
Depreciation and amortization 81,079 102,831
Increase (Decrease) in deferred income taxes 68,524 (135,469)
Amortization of deferred compensation 4,419 3,650
Provision for uncollectible accounts 6,998 6,408
Losses (Gains) from sales of property and
equipment (13,318) 1,136
Changes in assets and liabilities:
Receivables (71,282) 76,648
Prepaid expenses (3,035) (7,738)
Unamortized aircraft maintenance - 5,970
Accounts payable 30,629 (26,792)
Accrued liabilities 39,651 (31,600)
Accrued claims costs 1,002 21,922
Income taxes (21,501) (1,777)
Employee benefits 7,233 14,927
Accrued aircraft leases and return provision (125,127) (13,356)
Deferred charges and credits (1,092) (26)
Other 1,253 (6,467)
---------- ----------
Net Cash Provided by Operating Activities 47,588 172,151
---------- ----------
Investing Activities
Capital expenditures (51,900) (113,063)
Software expenditures (6,872) (9,159)
Proceeds from sales of property, net 6,287 1,006
---------- ----------
Net Cash Used in Investing Activities (52,485) (121,216)
---------- ----------
Financing Activities
Repayments of long-term debt, guarantees and
capital leases (25,774) (7,559)
Proceeds from exercise of stock options 4,958 2,234
Payments of common dividends (9,803) (9,754)
Payments of preferred dividends (5,274) (5,376)
---------- ----------
Net Cash Used in Financing Activities (35,893) (20,455)
---------- ----------
Net Cash Provided by (Used in) Continuing
Operations (40,790) 30,480
---------- ----------
Net Cash Used in Discontinued Operations (4,461) (3,525)
---------- ----------
Increase (Decrease) in Cash and Cash Equivalents (45,251) 26,955
---------- ----------
Cash and Cash Equivalents, End of Period $ 355,512 $ 131,470
========== ==========
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 5, "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 periodic
impairment testing. 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 $2.8 million and $5.5 million, respectively, in the second
quarter and first half 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 recognized 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.
PAGE 8
Reclassification
Certain amounts in prior-year financial statements have been reclassified
to conform to current-year presentation.
2. Discontinued Operations
On November 3, 2000, Emery Worldwide Airlines (EWA) and the U.S. Postal
Service (USPS) announced an agreement (the "Termination Agreement") to
terminate their contract for the transportation and sortation of Priority
Mail (the "Priority Mail contract"). The Priority Mail contract was
originally scheduled to terminate in the first quarter of 2002, subject to
renewal options. Under the terms of the Termination Agreement, the USPS on
January 7, 2001 assumed operating responsibility for services covered under
the Priority Mail contract, except certain air transportation and related
services, which were terminated effective April 23, 2001.
The Termination Agreement preserved EWA's right to pursue claims for
underpayment of amounts owed to EWA under the contract, which were
ultimately settled in September 2001 as described below. The USPS agreed
to reimburse EWA for Priority Mail contract termination costs, including
costs of contract-related equipment, inventory, and operating lease
commitments, up to $125 million (the "Termination Liability Cap"). On
January 7, 2001, the USPS paid EWA $60 million toward the termination
costs. The Termination Agreement provided for this provisional payment to
be adjusted if actual termination costs were greater or less than $60
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. In July 2002, EWA and
the USPS entered into an agreement that required the USPS to pay $6 million
to EWA, in addition to the $60 million provisional payment on January 7, as
the final settlement of EWA's Priority Mail contract termination costs.
On September 26, 2001, EWA entered into an agreement with the USPS to
settle claims relating to the underpayment of amounts owed to EWA under the
Priority Mail contract with the USPS (the "Settlement Agreement"). Under
the Settlement Agreement, EWA received a $235 million payment from the USPS
on September 28, 2001 to settle all non-termination claims under the
Priority Mail contract. These claims were to recover costs of operating
under the contract as well as profit and interest thereon. The Priority
Mail Termination Agreement described above was unaffected by the Settlement
Agreement.
Under the Settlement Agreement, on September 28, 2001, EWA also received a
$70 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 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 June 30, 2002 and December 31, 2001, the $70 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 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,
including the $70 million provisional payment, may not exceed $150 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 million provisional
payment received in 2001.
Results of the former Express Mail contract are included in the Emery
Forwarding reporting segment and not as discontinued operations.
PAGE 9
Operating Results and Gain from Discontinuance
----------------------------------------------
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 discontinued operations of $3.1 million at June 30, 2002 and
December 31, 2001 were included in Deferred Charges and Other Assets in the
Consolidated Balance Sheets. Net current liabilities of discontinued
operations of $1.1 million and $5.6 million at June 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.
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.
3. 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 cash flows for North
American 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
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 terrorist actions
described below in Note 9, "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.
PAGE 10
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 half of 2002, Emery paid $125.1 million for
aircraft leases and return costs, primarily due to the negotiated early
return of approximately one-half of EWA's aircraft fleet. At June 30,
2002, $197.7 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 9, "Commitments and Contingencies-Restructuring
Charges and Regulatory Matters."
The following table represents the cumulative activity related to Emery's
2001 restructuring plan:
(In Millions) Total Cumulative Charged Reserves at
Charges Cash Against June 30,
Usage Assets 2002
---------- ---------- ---------- ----------
Employee separations $ 6.1 $ (3.3) $ -- $ 2.8
Asset impairments 278.0 -- (278.0) --
Aircraft and other costs 368.1 (129.4) -- 238.7
---------- ---------- ---------- ----------
$ 652.2 $ (132.7) $ (278.0) $ 241.5
========== ========== ========== ==========
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 9, "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 11
4. Comprehensive Income (Loss)
Comprehensive Income (Loss), which is a measure of all changes in equity
except those resulting from investments by owners and distributions to
owners, was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
(Dollars in thousands) 2002 2001 2002 2001
--------- ---------- ---------- ----------
Net income (loss) $ 21,889 $(225,809) $ 42,155 $(210,252)
Other comprehensive income (loss)
Cumulative effect of accounting
change, net of tax (Note 8) -- -- -- 3,005
Change in fair value of cash
flow hedges (Note 8) (99) 175 1,080 (2,621)
Foreign currency translation
adjustment 4,397 (3,096) 3,115 (4,570)
---------- ---------- ---------- ----------
4,298 (2,921) 4,195 (4,186)
---------- ---------- ---------- ----------
Comprehensive income (loss) $ 26,187 $(228,730) $ 46,350 $(214,438)
========== ========== ========== ==========
The following is a summary of the components of Accumulated Other
Comprehensive Loss:
June 30, December 31,
(Dollars in thousands) 2002 2001
----------- -----------
Cumulative effect accounting change, net
of tax (Note 8) $ -- $ 3,005
Accumulated change in fair value of cash
flow hedges (Note 8) (463) (4,548)
Accumulated foreign currency translation
adjustments (29,667) (32,782)
Minimum pension liability adjustment (11,099) (11,099)
----------- -----------
Accumulated other comprehensive loss $ (41,229) $ (45,424)
=========== ===========
5. 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. The
prior period has been reclassified to exclude discontinued 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.
PAGE 12
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 Six Months Ended
June 30, June 30,
(Dollars in thousands) 2002 2001 2002 2001
Revenues Including Intersegment
Con-Way Transportation Services $ 504,097 $ 489,386 $ 958,896 $ 958,587
Menlo Worldwide
Emery Forwarding 439,849 530,205 834,645 1,113,495
Menlo Worldwide Logistics 245,037 237,574 464,993 462,938
684,886 767,779 1,299,638 1,576,433
CNF Other 3,277 7,718 6,695 16,920
1,192,260 1,264,883 2,265,229 2,551,940
Intersegment Revenue Eliminations
Con-Way Transportation Services (129) (193) (197) (424)
Menlo Worldwide
Emery Forwarding (62) (47) (97) (139)
Menlo Worldwide Logistics (3,426) (3,071) (6,873) (5,840)
(3,488) (3,118) (6,970) (5,979)
CNF Other (2,370) (4,964) (4,715) (10,464)
(5,987) (8,275) (11,882) (16,867)
Revenues
Con-Way Transportation Services 503,968 489,193 958,699 958,163
Menlo Worldwide
Emery Forwarding 439,787 530,158 834,548 1,113,356
Menlo Worldwide Logistics 241,611 234,503 458,120 457,098
681,398 764,661 1,292,668 1,570,454
CNF Other 907 2,754 1,980 6,456
$1,186,273 $1,256,608 $2,253,347 $2,535,073
Operating Income (Loss)
Con-Way Transportation Services $ 35,115 $ 42,431 $ 68,836 $ 79,166
Menlo Worldwide
Emery Forwarding (5,908) (370,442) (11,621) (376,989)
Menlo Worldwide Logistics 7,059 (22,253) 14,812 (14,082)
Menlo Worldwide Other 9,320 (1,681) 10,629 (6,295)
10,471 (394,376) 13,820 (397,366)
CNF Other (1,677) (42) 1,617 (59)
$ 43,909 $ (351,987) $ 84,273 $ (318,259)
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) - (340,531)
Loss from a legal settlement on
returned aircraft - (4,696) - (4,696)
Goodwill amortization - (2,758) - (5,458)
Express Mail operating income - 77 - 3,638
Menlo Worldwide Logistics -
Net gain from a contract termination - - 1,850 -
Loss from the business failure of a
customer - (31,605) - (31,605)
CNF Other -
Net gain from the sale of property - - 2,367 -
PAGE 13
6. Earnings Per Common Share
Basic earnings (loss) per common share (EPS) was computed by dividing net
income (loss) by the weighted-average common shares outstanding. The
calculation for diluted EPS was calculated as shown below.
Three Months Ended Six Months Ended
(Dollars in thousands except June 30, June 30,
per share data) ---------------------- -----------------------
2002 2001 2002 2001
---------- ---------- ---------- -----------
Earnings (Loss):
Net income (loss) applicable
to common shareholders $ 19,846 $(227,888) $ 38,107 $ (214,371)
Add-backs:
Dividends on preferred
stock, net of
replacement funding 310 - 593 -
Dividends on preferred
securities of subsidiary
trust, net of tax 954 - 1,908 -
---------- ---------- ---------- -----------
$ 21,110 $(227,888) $ 40,608 $ (214,371)
---------- ---------- ---------- -----------
Shares:
Basic shares (weighted-average
common shares outstanding) 49,074,627 48,760,668 49,001,489 48,704,866
Stock options 782,286 - 753,337 -
Series B preferred stock 3,731,109 - 3,731,109 -
Preferred securities of
subsidiary trust 3,125,000 - 3,125,000 -
----------- ---------- ---------- -----------
56,713,022 48,760,668 56,610,935 48,704,866
----------- ---------- ---------- -----------
Diluted earnings (loss) per
common share $ 0.37 $ (4.67) $ 0.72 $ (4.40)
=========== ========== ========== ===========
For the three and six months ended June 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 June 30, 2001:
stock options - 475,043 shares, series B preferred stock - 4,067,561
shares, preferred securities of subsidiary trust - 3,125,000 shares. For
the six months ended June 30, 2001, the shares would have been as follows:
stock options - 547,625 shares, series B preferred stock - 4,067,561
shares, preferred securities of subsidiary trust - 3,125,000 shares.
7. 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.
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.
PAGE 14
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.
8. 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.
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.
PAGE 15
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 second quarter and the first six months of 2002, the estimated fair
value of CNF's fair value hedges increased $9.0 million and $7.4 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 in the second quarter of 2002 decreased $0.2 million ($0.1
million after tax), while cash flow hedges in the first half of 2002
increased $1.8 million ($1.1 million after tax).
9. Commitments and Contingencies
IRS Matters
CNF is currently under examination by the Internal Revenue Service (IRS)
for tax years 1987 through 1999 on various issues. In connection with those
examinations, the IRS proposed adjustments for tax years 1987 through 1990
after which CNF filed a protest and engaged in discussions with the Appeals
Office of the IRS. After those discussions failed to produce a settlement,
in March 2000, the IRS issued a Notice of Deficiency (the Notice) for the
years 1987 through 1990 with respect to various issues, including aircraft
maintenance and matters related to years prior to the spin-off of
Consolidated Freightways Corporation (CFC), CNF's former long-haul less-
than-truckload (LTL) segment, on December 2, 1996. Based upon the Notice,
the total amount of the deficiency for items in years 1987 through 1990,
including taxes and interest, was $170.8 million as of June 30, 2002. The
amount originally due under the Notice was reduced in the third quarter of
2000 by a portion of CNF's $93.4 million payment to the IRS, which is
described below.
In addition to the issues covered under the Notice for tax years 1987
through 1990, the IRS in May 2000 proposed additional adjustments for tax
years 1991 through 1996 with respect to various issues, including aircraft
maintenance and matters relating to CFC for years prior to the spin-off.
Under the Notice, the IRS has assessed a substantial adjustment for tax
years 1989 and 1990 based on the IRS' position that certain aircraft
maintenance costs should have been capitalized rather than expensed for
federal income tax purposes. CNF believes that its practice of expensing
these types of aircraft maintenance costs is consistent with industry
practice and Treasury Ruling 2001-4. CNF intends to vigorously contest the
Notice and the proposed adjustments as they pertain to the aircraft
maintenance issue.
CNF paid $93.4 million to the IRS in the third quarter of 2000 to stop the
accrual of interest on amounts due under the Notice for tax years 1987
through 1990 and under proposed adjustments for tax years 1991 through 1996
for matters relating to CFC for years prior to the spin-off and for all
other issues except aircraft maintenance costs.
There can be no assurance that CNF will not be liable for all of the
amounts due under the Notice and proposed adjustments. As a result, CNF 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 CNF's
financial condition, cash flows, or results of operations.
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off to its shareholders of CFC.
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. Any failure by CFC to pay its
workers' compensation, tax or public liability claims when due could result
in demands for payment being made against CNF under its indemnity, or in
demands for payment being made under the surety bonds and letters of credit
supporting these claims, for which CNF would be liable. CNF estimates that
the aggregate amount of these claims could be as much as $20 million.
Although CFC is obligated to reimburse and indemnify CNF against liability
with respect to these claims, CFC's obligation is not secured by any
collateral and there can be no assurance that CFC will, in fact, reimburse
and indemnify CNF.
PAGE 16
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multi-employer pension plans covering its current and former
employees. If CFC were to make a complete or partial withdrawal from some
or all of these pension plans, CFC would be obligated to pay its share of
any unfunded vested liabilities under the applicable plans.
If CFC were to completely or partially withdraw from one or more
underfunded multi-employer plans, the pension plan trustees might assert
claims that CNF is liable for the amounts owed by CFC. Based on advice of
legal counsel and its current knowledge of the facts, CNF believes that it
would ultimately prevail if any such claims were made. However, if such
claims were made, unless relieved of the obligation, CNF would be required,
under federal law, to make periodic cash payments in an aggregate amount of
up to the full amount of CFC's share of the unfunded vested liabilities
until the claims were adjudicated. Under federal law, those payments would
be refunded, with interest, if CNF were to prevail on the claims. The
computation of the amount of the periodic payments depends on facts
specific to CFC, including CFC's historical plan contribution rates and
service-hour data, and, as a result, CNF cannot accurately estimate the
amount of those payments. However, those payments could be substantial
and could have a significant adverse effect on CNF's liquidity.
As a result of the foregoing, there can be no assurance that matters
relating to CFC will not have a material adverse effect on CNF's financial
condition, cash flows or results of operations.
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 3, "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 fourth-
quarter 2001 restructuring charge also resulted in defaults under financial
covenants in agreements pursuant to which EWA leased some of its aircraft.
However, these aircraft leases under default were terminated and settled in
the second quarter of 2002 in connection with the negotiated early return
of approximately one-half of EWA's parked aircraft fleet. 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 "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.
PAGE 17
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 for income taxes. Changes to CNF's income tax provision or in
the valuation of deferred tax assets and liabilities may affect its annual
effective income tax rate.
PAGE 19
Restructuring Reserves
- ----------------------
The restructuring charges recognized in 2001 were based on significant
estimates and assumptions made by management. Refer to the "Emery
Forwarding - Restructuring Charges" section under "Results of Operations"
below for a description of assumptions used and to Note 3, "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 4.5% 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 $5 to $7 million. However, the estimate is subject to
assumptions and uncertainties and there can be no assurance that the actual
change in 2002 pension expense will not be different. If market trends
continue, pension expense in 2003 may also increase over 2002. Plan
funding requirements, which are determined independently from pension
expense, are governed by the Employee Retirement Income Security Act
(ERISA). See "Liquidity and Capital Resources" under "Management's
Discussion and Analysis."
=====================
RESULTS OF OPERATIONS
=====================
Net income available to CNF common shareholders of $19.8 million ($0.37 per
diluted share) in the second quarter of 2002 and $38.1 million ($0.72 per
diluted share) in the first half of 2002 compared to a net loss applicable
to common shareholders of $227.9 million ($4.67 per diluted share) in last
year's second quarter and $214.4 million ($4.40 per diluted share) in the
first half of last year. The first half of 2002 included $22.8 million of
unusual first-quarter pre-tax net gains, as summarized below. The second
quarter and first half of last year included charges of $379.5 million and
$378.7 million, respectively, from the net effect of unusual and/or non-
recurring items in 2001, including a $340.5 million restructuring charge at
Emery and a $31.6 million loss at Menlo Worldwide Logistics from the
business failure of a customer. Excluding unusual and/or non-recurring
items, second-quarter and first-half net income available to common
shareholders in 2002 of $19.8 million and $24.2 million, respectively,
increased from $9.8 million in the second quarter of last year and $22.8
million in the first half of last year due primarily to a decline in
Emery's operating loss, partially offset by declines in operating income at
Con-Way and Menlo Worldwide Logistics.
PAGE 20
Pre-tax Income (Expense) from unusual and/or non-recurring items:
Three Months Ended Six Months Ended
June 30, June 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) - (340,531)
Loss from a legal settlement on
returned aircraft - (4,696) - (4,696)
Goodwill amortization - (2,758) - (5,458)
Express Mail operating income - 77 - 3,638
Menlo Worldwide Logistics
Net gain from a contract termination - - 1,850 -
Loss from the business failure of a
customer - (31,605) - (31,605)
CNF Other -
Net gain from the sale of property - - 2,367 -
CONTINUING OPERATIONS
=====================
CNF's second-quarter and first-half revenue in 2002 fell 5.6% and 11.1%,
respectively, from the same periods last year due substantially to lower
revenue from Emery Forwarding, partially offset by higher revenue from Con-
Way and Menlo Worldwide Logistics.
Second-quarter and first-half operating income in 2002 was $43.9 million
and $84.3 million, respectively, compared to operating losses of $352.0
million and $318.3 million in the second quarter and first half of last
year, respectively. Excluding unusual gains in the first quarter of 2002
and the adverse net effect of last year's unusual and/or non-recurring
items, second-quarter operating income of $43.9 million in 2002 increased
from $27.5 million in 2001 and first-half operating income of $61.5 million
in 2002 rose from $60.4 million last year due primarily to a decline in
Emery's operating loss, partially offset by lower operating income at Con-
Way and Menlo Worldwide Logistics.
Other net expense in the second quarter of 2002 rose 4.6% over the same
quarter last year, but fell 2.0% in the first half of 2002 compared to the
first half of last year. The second quarter and first half 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 the first two quarters of 2002
compared to the same periods last year, which benefited from gains on those
policies.
The effective tax rate in the first two quarters of 2002 was 39.0% compared
to last year's second-quarter and first-half effective tax benefit rates of
37.2% and 37.0%, which resulted primarily from the significant unusual
charges recognized in June 2001.
PAGE 21
Con-Way Transportation Services
- -------------------------------
Second-quarter revenue for Con-Way Transportation Services (Con-Way) in
2002 increased 3.0% over last year's second quarter due primarily to
increased revenue from Con-Way's regional carriers, which had a 1.4%
increase in revenue per hundredweight (yield) on essentially flat less-than-
truckload (LTL) and total weight per day (weight). Con-Way's second-
quarter revenue in 2002 also benefited from a $5.1 million increase in
revenue from Con-Way Air Express (CAX), which began operations in May 2001,
and Con-Way NOW (NOW) and Con-Way Logistics (CLI). Con-Way's revenue in
the first half of 2002 increased 0.1% from the first half of 2001 as a
decline in revenue from the regional carriers was substantially offset by a
$10.7 million increase in revenue from NOW, CLI and CAX. The decrease in
first-half revenue from the regional carriers in 2002 was due primarily to
LTL and total-weight declines of 1.2% and 1.1%, respectively, a 1.1% drop
in yield, and one fewer working day in the first half of 2002 compared to
the same period last year. Weight shipped by the regional carriers in the
second quarter and first half of 2002 reflects the loss of a major customer
in the first quarter of 2002, which last year accounted for minimal profit
on an estimated $75 million of annual revenue. Yield over the same
comparative periods was positively affected by a higher percentage of inter-
regional joint services, which typically command higher rates on longer
lengths of haul, but was negatively impacted by a decline in fuel
surcharges and a more competitive pricing environment when compared to the
same periods last year.
Con-Way's second-quarter operating income in 2002 fell 17.2% from 2001 to
$35.1 million and first-half operating income in 2002 declined 13.1% from
last year to $68.8 million. Excluding an unusual $8.7 million 2002 first-
quarter net gain from the sale of excess property, second-quarter and first-
half operating income in 2002 fell 17.2% and 24.0% from the respective
periods last year due primarily to an increase in employee compensation and
benefits expense, and to a lesser extent, a rise in vehicular claims costs.
The second quarter and first half 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 addition of next-day and second-day
delivery service to over six thousand cities within the Con-Way LTL
network. The new project, called "Extended Service Lanes," utilizes
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.
Menlo Worldwide
- ---------------
Emery Forwarding
----------------
Operating Results
Second-quarter and first-half revenue for Emery Forwarding (Emery) declined
in 2002 by 17.1% and 25.0%, respectively, from the same periods last year
due primarily to lower North American revenue. International airfreight
revenue increased slightly in the second quarter of 2002 compared to the
same quarter of last year, while first-half international airfreight
revenue in 2002 declined from the same period last year. Emery's revenue
decline in the second quarter and first half of 2002 was also due in part
to the termination by the USPS of EWA's contract to transport Express Mail,
effective August 26, 2001, as described below under " - Express Mail
Contract." In the second quarter and first half of last year, Emery
recognized revenue of $41.9 million and $89.4 million, respectively, from
the Express Mail contract. Emery's second quarter of 2002 included 0.5
more working days than the same quarter of last year while the first half
of 2002 included 1.0 fewer working day than the first half of 2001.
Average international airfreight revenue per day in the second quarter of
2002, including fuel surcharges, increased 0.3% from the same quarter of
last year as international average pounds transported per day (weight)
increased 5.1% and revenue per pound (yield) fell 4.5%. International
airfreight revenue per day in the first half of 2002 decreased 7.3% from
the first half of last year due primarily to a 2.0% drop in weight and a
5.4% decline in yield. Emery's management believes the slight increase in
2002 second-quarter weight reflects an improving freight market in
international regions served by Emery, particularly the Asian region.
However, Emery's management believes that international airfreight market
conditions in the first half of 2002 were comparatively weaker than the
first half of 2001, which contributed to the 2.0% decline in weight over
the same comparative half-year period. International yields in the second
quarter and first half of 2002 were negatively affected by a decline in
fuel surcharges from the same periods last year.
PAGE 22
Average North American airfreight revenue per day in the second quarter and
first half of 2002, including surcharges, fell 21.0% and 26.0%,
respectively, from the second quarter and first half of last year due
largely to declines in weight and yield. Second-quarter and first-half
North American weight in 2002 decreased 9.7% and 16.4%, respectively, while
yield fell 12.5% and 11.5%, respectively, from the second quarter and first
half of last year. Emery's management believes that lower second-quarter
and first-half weight in 2002 was due primarily to comparatively weaker
U.S. economic conditions in the first two quarters of 2002 compared to the
same period in 2001, a reduction in the number of aircraft routes and
domestic markets served by Emery, loss of business to ground transportation
providers, and lower fuel surcharges in the second quarter and first half
of 2002 compared to the same periods last year. Emery's management also
believes that lower weight and yield in the second quarter and first half
of 2002 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 second-quarter and first-half operating loss in 2002 was $5.9
million and $11.6 million, respectively, compared to last year's second-
quarter and first-half operating loss of $370.4 million and $377.0 million,
respectively. 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 second quarter and first half of last year included several
unusual and/or non-recurring items, including a restructuring charge; a
loss from a legal settlement; goodwill amortization, which was eliminated
upon the adoption of SFAS 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002; and 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's second-quarter
operating loss of $5.9 million in 2002 declined from $22.5 million in 2001,
and Emery's first-half operating loss declined to $21.5 million in 2002
from $29.9 million last year due primarily to cost reductions. Despite
lower revenues, the second-quarter and first-half operating losses in 2002
were reduced from the same periods last year primarily through decreases in
airhaul costs, employee compensation and benefits, 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.
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 cash flows for North
American 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
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 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.
PAGE 23
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 half of 2002, Emery paid $125.1 million for
aircraft leases and return costs, primarily due to the negotiated early
return of approximately one-half of EWA's aircraft fleet. At June 30,
2002, $197.7 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 "-Regulatory Matters" and "Liquidity and Capital
Resources-Restructuring Charges and Regulatory Matters" below.
Refer to Note 3, "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
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 own 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 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. EWA is currently involved in arbitration with
respect to this claim. 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. In addition, ALPA has 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.
PAGE 24
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, although there can be no assurance in this
regard. However, while the matter is not free from doubt, the surrender of
EWA's certificate may constitute a default under leases pursuant to which
EWA leases some of its remaining aircraft. The fourth-quarter 2001
restructuring charge relating to the cessation of EWA's air carrier
operations resulted in defaults under financial covenants in agreements
pursuant to which EWA leased some of its aircraft. However, these aircraft
leases in default were terminated and settled in the second quarter of 2002
in connection with the negotiated early return of approximately one-half of
EWA's parked aircraft fleet. 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
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.
PAGE 25
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 million
payment from the USPS on September 28, 2001 to settle all non-termination
claims under the Priority Mail contract and a $70 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 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 June 30, 2002 and December 31, 2001, the $70 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 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 million provisional
payment, may not exceed $150 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 million provisional payment received in 2001.
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 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 expects a more flexible variable-cost-based operating
structure in North America with a decline in revenue from next-day freight
services and an increase in revenue from second-day and deferred 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
-------------------------
Second-quarter 2002 revenue of $241.6 million for Menlo Worldwide Logistics
increased 3.0% over the same quarter last year, while revenue of $458.1
million in the first half of 2002 rose 0.2% from the first half of last
year. The second-quarter and first-half increases in 2002 were due in part
to higher second-quarter revenue recognized from carrier and warehouse
management services. However, the first half of 2002 was adversely
affected by lower first-quarter revenue from transaction-based contracts
compared to the first quarter of last year, which Menlo Worldwide
Logistics' management believes was due to the adverse effect of weak
economic conditions in the first quarter of 2002.
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 second quarter and first
half of 2002 was $69.0 million and $132.1 million, respectively, compared
to $72.8 million and $140.2 million, respectively, in the same periods of
2001.
PAGE 26
Menlo Worldwide Logistics' operating income in the second quarter and first
half of 2002 was $7.1 million and $14.8 million, respectively, compared to
a second-quarter and first-half operating loss of $22.3 million and $14.1
million in the respective periods last year. Excluding a $1.9 million net
gain from the early termination of a contract in the first quarter of 2002
and a $31.6 million loss from the business failure of a customer in the
second quarter of last year, second-quarter operating income in 2002 of
$7.1 million declined from $9.4 million last year and operating income in
the first half of 2002 declined to $13.0 million from $17.5 million in the
first half of last year due primarily to higher employee and benefits
costs. Prior-year operating income in the second quarter and first half of
2002 included $0.6 million and $2.6 million of operating income recognized
prior to the failure of a customer that 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. The operating results of Vector are reported
as an equity-method investment.
Vector earned operating income of $9.3 million and $10.6 million in the
second quarter and first half of 2002, respectively, compared to last
year's second-quarter and first-half operating losses of $1.7 million and
$6.3 million, which were incurred during Vector's start-up phase. In the
first half of 2002, CNF reported substantially all of Vector's profit, as
CNF is contractually entitled to substantially all of Vector's profit to
the extent of Vector's cumulative losses, of which all were allocated to
CNF in prior periods. During the second quarter of 2002, CNF's allocated
cumulative losses from the Vector joint venture had been recouped through
allocated profit. As a result, General Motors will begin sharing in
Vector's profit in the third quarter of 2002. Accordingly, quarterly
operating income reported by CNF in the future will be comparatively lower
than what would be reportable by CNF if CNF continued to be allocated
substantially all of Vector's profit, as was the case in the first half of
2002.
CNF Other
- ---------
The CNF Other segment includes the results of Road Systems and certain
corporate activities. The second-quarter operating loss in 2002 was $1.7
million, which reflects primarily corporate expenses. Operating income of
$1.6 million in the first half of 2002 was due primarily to a $2.4 million
net gain from the sale of excess corporate properties.
DISCONTINUED OPERATIONS
=======================
On November 3, 2000, EWA and the USPS announced an agreement (the
"Termination Agreement") to terminate their contract for the transportation
and sortation of Priority Mail (the "Priority Mail contract"). The Priority
Mail contract was originally scheduled to terminate in the first quarter of
2002, subject to renewal options. Under the terms of the Termination
Agreement, the USPS on January 7, 2001 assumed operating responsibility for
services covered under the Priority Mail contract, except certain air
transportation and related services, which were terminated effective April
23, 2001.
The Termination Agreement preserved EWA's right to pursue claims for
underpayment of amounts owed to EWA under the contract, which were
ultimately settled in September 2001 as described below. The USPS agreed
to reimburse EWA for Priority Mail contract termination costs, including
costs of contract-related equipment, inventory, and operating lease
commitments, up to $125 million (the "Termination Liability Cap"). On
January 7, 2001, the USPS paid EWA $60 million toward the termination
costs. The Termination Agreement provided for this provisional payment to
be adjusted if actual termination costs were greater or less than $60
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. In July 2002, EWA and
the USPS entered into an agreement that required the USPS to pay $6 million
to EWA, in addition to the $60 million provisional payment on January 7, as
the final settlement of EWA's Priority Mail contract termination costs.
PAGE 27
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 (the "Settlement Agreement"). Under the Settlement
Agreement, EWA received a $235 million payment from the USPS on September
28, 2001 to settle all non-termination claims under the Priority Mail
contract. These claims were to recover costs of operating under the
contract as well as profit and interest thereon. The Priority Mail
Termination Agreement described above was unaffected by the Settlement
Agreement.
Under the Settlement Agreement, on September 28, 2001, EWA also received a
$70 million provisional payment from the USPS to provisionally pay EWA for
termination costs and other claims related to EWA's Express Mail contract,
which is described above under "Emery Forwarding-Express Mail Contract."
Results of the former Express Mail contract are included in the Emery
Forwarding reporting segment and not under Discontinued Operations.
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, "Discontinued
Operations."
===============================
LIQUIDITY AND CAPITAL RESOURCES
===============================
In the first half of 2002, cash and cash equivalents decreased by $45.3
million to $355.5 million at June 30, 2002. Net capital expenditures of
$52.5 million and $35.9 million of net cash used in financing activities
were funded with the reduction in cash and from operating activities, which
generated $47.6 million of cash despite significant payments for aircraft
leases and return costs in the first half of 2002.
Operating activities in the first half of 2002 generated net cash of $47.6
million compared to $172.2 million of cash generated by operating
activities in the first half of 2001. Cash from operations in the first
half 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
half 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 included primarily aircraft lease payments
and return costs, which are described below under "- Restructuring Charges
and Regulatory Matters"; an increase in accounts receivable; and a decline
in income taxes.
Investing activities in the first half of 2002 used $52.5 million, a $68.7
million decline from the first half of 2001. Capital expenditures of $51.9
million in the first half of 2002 fell from $113.1 million in the first
half of 2001 primarily due to capital expenditure reductions at all
reporting segments, including primarily a $39.5 million decline at Con-Way
and an $11.7 million reduction at Emery Forwarding. Financing activities
in the first half of 2002 used cash of $35.9 million compared to $20.5
million used in the first half of 2001, due primarily to capital lease
payments on aircraft in the first half 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 June 30, 2002, no borrowings were outstanding under the facility
and $203.1 million of letters of credit were outstanding, leaving $181.9
million of available capacity for letters of credit or cash borrowings,
subject to compliance with financial covenants and other customary
conditions to borrowing. Also, at June 30, 2002, CNF had $20.0 million of
uncommitted lines of credit with no outstanding borrowings. Under other
unsecured facilities, $61.0 million in letters of credit, bank guarantees,
and overdraft facilities were outstanding at June 30, 2002. Of the total
letters of credit outstanding at June 30, 2002, $197.4 million provided
collateral for CNF workers compensation and vehicular self-insurance
programs.
PAGE 28
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-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, its $100 million aggregate principal amount of
7.35% notes due 2005, and $111.8 million aggregate principal amount of
Thrift and Stock Plan notes due through 2009, 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 own 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 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 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 have a material adverse
effect on CNF's financial condition, cash flows, and results of operations.
PAGE 29
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, although there can be no assurance in this
regard. However, while the matter is not free from doubt, the surrender of
EWA's certificate may result in a default under leases pursuant to which
EWA leases some of its remaining aircraft. The fourth-quarter 2001
restructuring charge relating to the cessation of EWA's air carrier
operations resulted in defaults under financial covenants in agreements
pursuant to which EWA leased some of its aircraft. However, these aircraft
leases in default were terminated and settled in the second quarter of
2002 in connection with the negotiated early return of approximately one-
half of EWA's parked aircraft fleet. Any further unusual charges could
also result in defaults under additional aircraft leases. Upon the
occurrence of a default under any of EWA's remaining aircraft leases, the
lessors generally are entitled to terminate the leases and demand
termination payments or, in certain cases, liquidated damages or similar
payments, which could be substantial. As a result, any future defaults
under these leases could require that EWA make substantial cash payments to
the lessors and otherwise could have a material adverse effect on CNF's
financial condition, cash flows, and results of operations. In addition,
certain of the leases are guaranteed by Emery or CNF, and upon a default
the lessors under those leases would be entitled to seek recovery from the
guarantors.
Holders of certain notes issued by CNF's Thrift and Stock Plan ("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 June 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, or to make payments to the
lessors as a result of default under aircraft leases, 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.
In the first half of 2002, Emery paid $125.1 million for aircraft leases
and return costs, primarily due to the negotiated early return of
approximately one-half of EWA's aircraft fleet. At June 30, 2002, $197.7
million of accrued aircraft leases and return costs were classified as
current liabilities in the Consolidated Balance Sheets based on Emery's
intention to negotiate the early termination of the remaining aircraft
leases or in connection with defaults under aircraft leases. 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.
PAGE 30
At June 30, 2002, CNF had $355.5 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
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 could
have a material adverse effect on its financial condition, cash flows, and
results of operations.
IRS Matters
CNF is currently under examination by the Internal Revenue Service (IRS)
for tax years 1987 through 1999 on various issues. In connection with
those examinations, the IRS issued a Notice of Deficiency (the Notice) with
respect to various issues, including aircraft maintenance and matters
related to years prior to the spin-off of Consolidated Freightways
Corporation (CFC). Based upon the Notice, the total amount of the
deficiency for items in years 1987 through 1990, including taxes and
interest, was $170.8 million as of June 30 2002. CNF believes that its
practice of expensing certain types of aircraft maintenance costs is
consistent with industry practice and Treasury Ruling 2001-4. CNF intends
to vigorously contest the Notice and the proposed adjustments as they
pertain to the aircraft maintenance issue. However, there can be no
assurance that CNF will not be liable for all of the amounts due under the
Notice and proposed adjustments. As a result, CNF 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 CNF's financial
condition, cash flows, or results of operations. See Note 9 "Commitments
and Contingencies."
Spin-Off of CFC
On December 2, 1996, CNF completed the spin-off to its shareholders of CFC.
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. Any failure by CFC to pay its
workers' compensation, tax or public liability claims when due could result
in demands for payment being made against CNF under its indemnity, or in
demands for payment being made under the surety bonds and letters of credit
supporting these claims, for which CNF would be liable. CNF estimates that
the aggregate amount of these claims could be as much as $20 million.
Although CFC is obligated to reimburse and indemnify CNF against liability
with respect to these claims, CFC's obligation is not secured by any
collateral and there can be no assurance that CFC will, in fact, reimburse
and indemnify CNF.
In addition, CFC was, at the time of the spin-off, and remains a party to
certain multi-employer pension plans covering its current and former
employees. If CFC were to make a complete or partial withdrawal from some
or all of these pension plans, CFC would be obligated to pay its share of
any unfunded vested liabilities under the applicable plans.
If CFC were to completely or partially withdraw from one or more
underfunded multi-employer plans, the pension plan trustees might assert
claims that CNF is liable for the amounts owed by CFC. Based on advice of
legal counsel and its current knowledge of the facts, CNF believes that it
would ultimately prevail if any such claims were made. However, if such
claims were made, unless relieved of the obligation, CNF would be required,
under federal law, to make periodic cash payments in an aggregate amount of
up to the full amount of CFC's share of the unfunded vested liabilities
until the claims were adjudicated. Under federal law, those payments would
be refunded, with interest, if CNF were to prevail on the claims. The
computation of the amount of the periodic payments depends on facts
specific to CFC, including CFC's historical plan contribution rates and
service-hour data, and, as a result, CNF cannot accurately estimate the
amount of those payments. However, those payments could be substantial
and could have a significant adverse effect on CNF's liquidity.
PAGE 31
As a result of the foregoing, there can be no assurance that matters
relating to CFC will not have a material adverse effect on CNF's financial
condition, cash flows or 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. CNF currently estimates that it
will be required to contribute a total of approximately $75 million in cash
to the plan in 2002 and $75 million in cash in 2003. However, these
estimates are 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. CNF has not made any contributions to the plan 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, long-term debt and guarantees, capital and
operating leases, and the preferred securities of a subsidiary trust, which
are in part discussed above and in Note 3, "Restructuring Charges," and
Note 7, "Preferred Securities of Subsidiary Trust."
CNF's ratio of total debt to capital decreased to 41.0% at June 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 half 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, in 2001 EWA received payments from the USPS related
to the discontinued Priority Mail operations. In January 2001, EWA received
a $60 million provisional payment toward reimbursable termination costs, as
provided under the Termination Agreement signed by EWA and the USPS in
November 2000. In September 2001, EWA received a $305 million payment from
the USPS, including $235 million to settle all non-termination claims under
the Priority Mail contract, as described above under "Results of
Operations-Discontinued Operations." In July 2002, EWA and the USPS
entered into an agreement that required the USPS to pay $6 million to EWA,
in addition to the $60 million provisional payment on January 7, as the
final settlement of 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.
PAGE 32
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 8 to the
Consolidated Financial Statements, 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
June 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.
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 periodic
impairment testing. 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 $2.8 million and $5.5 million, respectively, in the second
quarter and first half 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.
PAGE 33
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 recognized 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, 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
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 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 grounded aircraft fleet, the possibility of
substantial 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,
existing defaults and possibility of future 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
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 aircraft leases requiring substantial cash payments to the lessors,
defaults under CNF's $385 million credit agreement and the reduction in the
ratings assigned to CNF's long term senior debt by credit rating agencies;
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
PAGE 34
organizing activities, work stoppages or strikes; enforcement of and
changes in governmental regulations; environmental and tax matters
(including claims made by the Internal Revenue Service with respect to
aircraft maintenance tax matters); the Department of Transportation, FAA
and Department of Justice investigation relating to Emery Worldwide's
handling of hazardous materials; the February 2000 crash of an EWA aircraft
and related investigation and litigation; and matters relating to CNF's
1996 spin-off of Consolidated Freightways (see Note 9 to the Consolidated
Financial Statements and "Management's Discussion of Financial Condition
and Results of Operations-Liquidity and Capital Resources" include
elsewhere herein). As a result of the foregoing, no assurance can be given
as to future financial condition, cash flows, or results of operations See
Note 9 to the Consolidated Financial Statements and "Management's
Discussion of Financial Condition and Results of Operations-Liquidity and
Capital Resources" included elsewhere herein.
PAGE 35
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.
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. EWA is currently involved in arbitration with
respect to this claim. 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. In addition, ALPA has 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 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 9, "Commitments and Contingencies," CNF is subject to
certain legal and administrative proceedings with the IRS and the FAA.
There can be no assurance that these proceedings will not have a material
adverse effect on CNF's financial condition, cash flows, or results of
operations.
PAGE 36
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 June 30,
2002 and 2001, the ratios of earnings to fixed
charges were 3.2x and -6.3x, respectively.
[b] Computation of Ratios of Earnings
to Combined Fixed Charges - For the six months ended
June 30, 2002 and 2001, the ratios of earnings to
combined fixed charges and preferred stock dividends
were 3.0x and -5.9x, 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 May 30, 2002, was filed during
the quarter ended June 30, 2002, reporting a change in
auditors from Arthur Andersen LLP to KPMG LLP.
PAGE 37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company (Registrant) has duly caused this Form
10-Q Quarterly Report to be signed on its behalf by the undersigned,
thereunto duly authorized.
CNF Inc.
-------------------------
(Registrant)
August 9, 2002 /s/Chutta Ratnathicam
-------------------------
Chutta Ratnathicam
Senior Vice President and
Chief Financial Officer