PAGE 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
___TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from N/A to N/A
COMMISSION FILE NUMBER 1-5046
CNF TRANSPORTATION INC.
Incorporated in the State of Delaware
I.R.S. Employer Identification No. 94-1444798
3240 Hillview Avenue, Palo Alto, California 94304
Telephone Number (650) 494-2900
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months and (2) has been subject to such
filing requirements for the past 90 days. Yes xx No
Number of shares of Common Stock, $.625 par value,
outstanding as of October 31, 2000: 48,605,487
PAGE 2
CNF TRANSPORTATION INC.
FORM 10-Q
Quarter Ended September 30, 2000
___________________________________________________________________________
___________________________________________________________________________
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2000 and December 31, 1999 3
Statements of Consolidated Income -
Three and Nine months Ended September 30, 2000
and 1999 5
Statements of Consolidated Cash Flows -
Nine months Ended September 30, 2000 and 1999 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
PAGE 3
ITEM 1. FINANCIAL STATEMENTS
CNF TRANSPORTATION INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2000 1999
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 79,896 $ 146,263
Trade accounts receivable, net of
allowances 884,674 914,307
Other accounts receivable 18,181 25,419
Operating supplies, at lower of average
cost or market 42,505 46,019
Prepaid expenses 49,543 41,971
Deferred income taxes 79,530 26,254
Net current assets of discontinued
operations (Note 2) 71,054 -
Total Current Assets 1,225,383 1,200,233
PROPERTY, PLANT AND EQUIPMENT, NET
Land 119,836 119,403
Buildings and leasehold improvements 665,011 573,688
Revenue equipment 808,669 854,519
Other equipment 415,902 447,962
2,009,418 1,995,572
Accumulated depreciation and amortization (920,281) (864,538)
1,089,137 1,131,034
OTHER ASSETS
Deferred charges and other assets 147,772 200,739
Capitalized software, net 88,963 88,157
Unamortized aircraft maintenance (Note 1) 270,949 226,629
Goodwill, net 257,593 265,896
Net long-term assets of discontinued
operations (Note 2) 138,419 -
903,696 781,421
TOTAL ASSETS $3,218,216 $3,112,688
The accompanying notes are an integral part of these statements.
PAGE 4
CNF TRANSPORTATION INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2000 1999
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 408,582 $ 407,605
Accrued liabilities 370,488 422,470
Accrued claims costs 129,011 99,940
Current maturities of long-term debt and
capital leases 7,553 6,452
Short-term borrowings 5,000 40,000
Income taxes payable 42,667 53,455
Total Current Liabilities 963,301 1,029,922
LONG-TERM LIABILITIES
Long-term debt and guarantees (Note 3) 424,096 322,800
Long-term obligations under capital leases 110,562 110,646
Accrued claims costs 49,868 81,978
Employee benefits 242,190 217,519
Other liabilities and deferred credits 44,321 45,450
Aircraft lease return provision (Note 1) 100,504 82,910
Deferred income taxes 116,286 128,515
Total Liabilities 2,051,128 2,019,740
COMMITMENTS AND CONTINGENCIES (Note 8)
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 828,678 and 840,407
shares, respectively 8 8
Additional paid-in capital, preferred stock 126,034 127,817
Deferred compensation, Thrift and Stock Plan (82,173) (87,600)
Total Preferred Shareholders' Equity 43,869 40,225
Common stock, $.625 par value; authorized
100,000,000 shares; issued 55,379,531
and 55,306,947 shares, respectively 34,612 34,567
Additional paid-in capital, common stock 330,160 328,721
Retained earnings 826,702 747,936
Deferred compensation, restricted stock (1,423) (2,010)
Cost of repurchased common stock
(6,792,782 and 6,856,567 shares,
respectively) (167,485) (169,057)
1,022,566 940,157
Accumulated foreign currency translation
adjustment (19,952) (8,039)
Minimum pension liability adjustment (4,395) (4,395)
Accumulated Other Comprehensive Loss (24,347) (12,434)
Total Common Shareholders' Equity 998,219 927,723
Total Shareholders' Equity 1,042,088 967,948
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $3,218,216 $3,112,688
The accompanying notes are an integral part of these statements.
PAGE 5
<TABLE>
CNF TRANSPORTATION INC.
STATEMENTS OF CONSOLIDATED INCOME
(Dollars in thousands except per share amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
<S> <C> <C> <C> <C>
REVENUES $ 1,410,586 $ 1,290,182 $ 4,140,497 $ 3,670,757
Costs and Expenses
Operating expenses 1,186,955 1,041,670 3,427,082 2,969,221
General and administrative 127,104 125,098 375,385 360,624
Depreciation 41,118 37,646 121,687 108,655
Net gain on sale of assets of
parts distribution operation - - - (10,112)
Net gain on legal settlement - - - (16,466)
1,355,177 1,204,414 3,924,154 3,411,922
OPERATING INCOME 55,409 85,768 216,343 258,835
.
Other Income (Expense)
Investment income 327 35 1,191 155
Interest expense (8,536) (6,822) (22,817) (21,300)
Dividend requirement on
preferred securities of
subsidiary trust (Note 7) (1,563) (1,563) (4,689) (4,689)
Miscellaneous, net 1,664 784 5,652 1,543
(8,108) (7,566) (20,663) (24,291)
Income from Continuing Operations
before Income Taxes 47,301 78,202 195,680 234,544
Income Taxes 19,633 34,018 82,694 102,246
Income from Continuing Operations 27,668 44,184 112,986 132,298
Income from Discontinued Operations,
net of Income Taxes (Note 2) - - - 2,966
Loss from Discontinuance, net of
Income Tax Benefits (Note 2) (13,508) - (13,508) -
(13,508) - (13,508) 2,966
Net Income 14,160 44,184 99,478 135,264
Preferred Stock Dividends 2,047 2,037 6,153 6,125
NET INCOME AVAILABLE TO
COMMON SHAREHOLDERS $ 12,113 $ 42,147 $ 93,325 $ 129,139
Weighted-Average Common Shares
Outstanding (Note 6)
Basic 48,511,156 48,306,902 48,464,021 48,131,556
Diluted 56,349,127 56,032,549 56,379,755 55,908,199
Earnings per Common Share (Note 6)
Basic
Income from Continuing Operations $ 0.53 $ 0.87 $ 2.21 $ 2.62
Income from Discontinued Operations - - - 0.06
Loss from Discontinuance (0.28) - (0.28) -
Net Income $ 0.25 $ 0.87 $ 1.93 $ 2.68
Diluted
Income from Continuing Operations $ 0.48 $ 0.77 $ 1.96 $ 2.33
Income from Discontinued Operations - - - 0.05
Loss from Discontinuance (0.24) - (0.24) -
Net Income $ 0.24 $ 0.77 $ 1.72 $ 2.38
</TABLE>
The accompanying notes are an integral part of these statements.
PAGE 6
CNF TRANSPORTATION INC.
STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
Nine Months Ended
September 30,
2000 1999
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD $ 146,263 $ 73,897
OPERATING ACTIVITIES
Net income 99,478 135,264
Adjustments to reconcile net income to net cash
provided by operating activities:
Discontinued operations, net of tax 13,508 -
Depreciation and amortization 157,842 139,646
Increase (decrease) in deferred income taxes (3,415) 46,570
Amortization of deferred compensation 5,785 9,125
Provision for uncollectable accounts 11,422 8,446
Gain from sale of equity securities, net (2,619) -
Loss (gain) from sales of property, net (773) 35
Net gain from sale of assets of parts
distribution operation - (10,112)
Loss from sale of assets of truckload
operation 5,459 -
Changes in assets and liabilities:
Receivables (202,160) (19,208)
Prepaid expenses (9,230) (24,463)
Unamortized aircraft maintenance (44,320) (31,416)
Accounts payable 10,317 1,567
Accrued liabilities (29,139) 64,725
Accrued claims costs (2,850) 30,145
Income taxes (10,788) (12,340)
Employee benefits 25,739 25,109
Aircraft lease return provision 17,594 18,584
Deferred charges and credits 22,377 (9,935)
Other (6,926) (15,919)
Net Cash Provided by Operating Activities 57,301 355,823
INVESTING ACTIVITIES
Capital expenditures (170,887) (239,070)
Software expenditures (14,327) (27,897)
Proceeds from sale of equity securities 2,619 -
Proceeds from sales of property 10,206 10,667
Proceeds from sale of assets of parts
distribution operation - 29,260
Proceeds from sale of assets of truckload
operation 7,263 -
Net Cash Used in Investing Activities (165,126) (227,040)
FINANCING ACTIVITIES
Proceeds from issuance of long-term debt 198,752 -
Payments for issuance costs of long-term debt (1,300) -
Repayment of long-term debt, guarantees and
capital leases (96,482) (32,977)
Repayment of short-term borrowings, net (35,000) (18,000)
Proceeds from exercise of stock options 950 7,106
Payments of common dividends (14,559) (14,473)
Payments of preferred dividends (10,903) (11,078)
Net Cash Provided by (Used in) Financing
Activities 41,458 (69,422)
Increase (Decrease) in Cash and Cash
Equivalents (66,367) 59,361
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 79,896 $ 133,258
The accompanying notes are an integral part of these statements.
PAGE 7
CNF TRANSPORTATION INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Principal Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements of CNF
Transportation Inc. and its wholly owned subsidiaries (the Company) have
been prepared by the Company, without audit by independent public
accountants, pursuant to the rules and regulations of the Securities and
Exchange Commission. In the opinion of management, the consolidated
financial statements include all normal recurring adjustments necessary to
present fairly the information required to be set forth therein. Certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted from these statements pursuant to such rules and
regulations and, accordingly, should be read in conjunction with the
consolidated financial statements included in the Company's 1999 Annual
Report to Shareholders.
Reclassification
In March 2000, the Securities and Exchange Commission (SEC)
communicated its interpretation of certain accounting issues related to
major maintenance expenditures. As a result of the SEC's comments, the
Company reclassified Emery's aircraft lease return provision. Accordingly,
the aircraft lease return provision is reported separately as a liability
rather than being shown as a reduction of Unamortized Aircraft Maintenance.
Prior periods have been reclassified.
Certain other amounts in prior year financial statements have been
reclassified to conform to current year presentation.
PAGE 8
2. Discontinued Operations
On November 3, 2000, Emery Worldwide Airlines (EWA) and the U.S. Postal
Service (USPS) announced an agreement to terminate their contract for the
transportation and sortation of Priority Mail. Under terms of the
agreement, the USPS on January 7, 2001 will assume operating responsibility
for services covered under the contract. The contract was originally
scheduled to terminate in the first quarter of 2002, subject to renewal
options. As a part of the transition of the Priority Mail operations from
Emery to the USPS, Emery has agreed to provide certain air transportation
and related services to the USPS for a period of not less than ninety days
beginning on January 7, 2001.
The USPS has agreed to reimburse the Company 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 or before January 7, 2001, the USPS is
obligated to pay EWA $60 million toward the termination costs. This
provisional payment will be adjusted if actual termination costs are
greater or less than $60 million, in which case either the USPS will be
required to make an additional payment or EWA will be required to return a
portion of the provisional payment.
Under the termination agreement, EWA agreed to dismiss a complaint
filed in April 2000 in the U.S. Court of Federal Claims that requested a
declaration of contract rights under the Priority Mail contract and a
ruling that the USPS was in breach of contractual payment obligations.
However, the termination agreement preserves EWA's right to pursue claims
for underpayment under the contract. EWA intends to pursue these claims,
and has initiated litigation in the U.S. Court of Federal Claims for those
claims that are ripe for disposition there. These claims, and recent
payments made by the USPS toward these claims, are described under
"Discontinued Operations" in "Management Discussion and Analysis". The
Company's accounting policy for revenue recognition under the Priority Mail
contract, including claims for underpayment relating to any period until
the effective termination date on January 7, 2001, is described below.
As a result of the contract termination, the results of operations of
the Company's Priority Mail contract have been reclassified as discontinued
operations in the Statements of Consolidated Income for all periods
presented. Assets and liabilities have been reclassified in the
Consolidated Balance Sheet as of September 30, 2000 from their historical
classifications to separately reflect them as net assets of discontinued
operations. The Consolidated Balance Sheet as of December 31, 1999 has not
been restated. Cash flows related to discontinued operations have not been
segregated in the Statements of Consolidated Cash Flows, and, as a result,
amounts on the Statements of Consolidated Income and Consolidated Balance
Sheets may not agree with certain captions on the Statements of
Consolidated Cash Flows.
PAGE 9
The summarized results of discontinued operations were as follows:
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Revenue $ 124,317 $ 118,209 $ 386,362 $ 354,594
Operating income
before taxes - - - 4,862
Income taxes - - - 1,896
---------- ---------- ---------- ----------
Income from
discontinued
operations $ - $ - $ - $ 2,966
========== ========== ========== ==========
Loss from
discontinuance,
net of tax benefits $ (13,508) $ - $ (13,508) $ -
========== ========== ========== ==========
The loss from discontinuance of $13.5 million recognized in the third
quarter of 2000, which is reported net of $8.6 million of income tax
benefits, includes estimates for the write-down of non-reimbursable assets,
legal and advisory fees, costs of providing transportation services for a
three-month period following the effective termination date, certain
employee-related costs and other non-reimbursable costs from
discontinuance.
The net assets of discontinued operations as of September 30, 2000
were as follows:
(Dollars in thousands)
Current Assets
Trade accounts receivable, net $ 115,583
Other 6,715
----------
122,298
Property, plant and equipment, net 68,647
Long-term receivables and other assets 132,238
----------
Total assets of discontinued
operations $ 323,183
----------
Current Liabilities $ 51,244
Long-term liabilities 62,466
----------
Total liabilities of
discontinued operations $ 113,710
----------
Net assets of discontinued
operations $ 209,473
==========
For periods prior to the effective termination date on January 7,
2001, the Priority Mail contract provides for the re-determination of
prices paid to EWA under the contract, which gives rise to unbilled
revenue. Unbilled revenue representing contract change orders or claims is
included in revenue only when it is probable that the change order or claim
will result in additional contract revenue and if the amount can be
reliably estimated. The Company recognizes unbilled revenue related to
claims sufficient only to recover costs. When adjustments in contract
revenue are determined, any changes from prior estimates will be reflected
in operating results for discontinued operations in the current period.
PAGE 10
The amount of unbilled revenue related to the Company's Priority Mail
contract recognized at September 30, 2000 and December 31, 1999 was $194.4
million and $123.7 million, respectively. As described above and under
"Discontinued Operations" in "Management's Discussion and Analysis", EWA
received payments from the U.S. Postal Service in October 2000 totaling
$102.1 million, reducing the $194.4 million recognized by EWA as unbilled
revenue as of September 30, 2000 to $92.3 million. As of September 30,
2000, $102.1 million of unbilled revenue was classified as Trade Accounts
Receivable and $92.3 million was classified as Other Long-Term Receivables.
3. Long-Term Debt
In August 1999, the aggregate principal amount of $117.7 million of
the Company's unsecured 9 1/8% Notes was paid in full at maturity. The
repayment of these notes was made in part with $90.0 million of borrowings
under lines of credit.
In March 2000, the Company issued $200 million in notes with a coupon
rate of 8 7/8% and a maturity date of May 1, 2010. Interest on the notes
is payable semi-annually on May 1 and November 1 of each year, commencing
May 1, 2000, and principal is payable at maturity. The notes contain a
covenant that limits the incurrence of liens. A portion of the proceeds
was used to repay a total of $152 million of short-term and long-term
borrowings outstanding under lines of credit.
4. Comprehensive Income
Comprehensive Income, which is a measure of all changes in equity
except those resulting from investments by owners and distributions to
owners, was as follows:
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Net income $ 14,160 $ 44,184 $ 99,478 $ 135,264
Foreign currency
translation adjustment (3,996) 1,704 (11,913) 2,398
---------- ---------- ---------- ----------
$ 10,164 $ 45,888 $ 87,565 $ 137,662
========== ========== ========== ==========
PAGE 11
5. Business Segments
Selected financial information about the Company's operating segments
is shown below and reflects only continuing operations. Prior periods have
been reclassified to exclude discontinued operations.
Three Months Ended Nine Months Ended
(Dollars in thousands) September 30, September 30,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Revenues
Con-Way
Transportation $ 520,864 $ 496,589 $1,569,404 $1,404,200
Emery Worldwide 662,621 620,470 1,908,329 1,742,105
Menlo Logistics 228,992 181,473 684,363 529,310
Other 11,283 11,651 40,988 53,255
---------- ---------- ---------- ----------
1,423,760 1,310,183 4,203,084 3,728,870
Intercompany Eliminations
Con-Way Transportation (2,730) (5,931) (12,160) (16,616)
Emery Worldwide (5,160) (3,154) (18,925) (9,514)
Menlo Logistics (3,353) (2,791) (10,270) (8,466)
Other (1,931) (8,125) (21,232) (23,517)
---------- ---------- ---------- ----------
(13,174) (20,001) (62,587) (58,113)
External Revenues
Con-Way Transportation 518,134 490,658 1,557,244 1,387,584
Emery Worldwide 657,461 617,316 1,889,404 1,732,591
Menlo Logistics 225,639 178,682 674,093 520,844
Other 9,352 3,526 19,756 29,738
---------- ---------- ---------- ----------
$1,410,586 $1,290,182 $4,140,497 $3,670,757
========== ========== ========== ==========
Operating Income (Loss)
Con-Way
Transportation (1) $ 52,189 $ 56,938 $ 175,980 $ 171,715
Emery Worldwide (2) (5,788) 22,551 14,588 43,527
Menlo Logistics 8,628 6,298 24,739 16,127
Other (3) 380 (19) 1,036 27,466
---------- ---------- ---------- ----------
$ 55,409 $ 85,768 $ 216,343 $ 258,835
========== ========== ========== ==========
(1) For the three and nine months ended September 30, 2000, results
include a $5.5 million loss on the sale of certain assets of Con-Way
Truckload Services.
(2) For the three and nine months ended September 30, 2000, results
include an $11.9 million loss from the termination of certain aircraft
leases.
(3) The Other segment includes the operating results of Road Systems and,
prior to the sale of its assets in May 1999, VantageParts.
For the nine months ended September 30, 1999, the Other segment
included a $10.1 million net gain recognized in May 1999 from the sale
of the assets of VantageParts, the Company's wholesale parts
distribution operation, and a $16.5 million net gain on a lawsuit
settled in January 1999.
PAGE 12
6. Earnings Per Share
Basic earnings per share was computed by dividing income from
continuing operations by the weighted-average common shares outstanding.
The calculation for diluted earnings per share on continuing operations was
calculated as shown below. Prior periods have been reclassified to exclude
discontinued operations.
Three Months Ended Nine Months Ended
(Dollars in thousands except September 30, September 30,
per share data) 2000 1999 2000 1999
---------- ---------- --------- ----------
Earnings:
Income from Continuing
Operations $ 25,621 $ 42,147 $ 106,833 $ 126,173
Add-backs:
Dividends on Series B
preferred stock, net
of replacement funding 345 309 1,051 980
Dividends on preferred
securities of subsidiary
trust, net of tax 954 954 2,862 2,862
---------- ---------- ---------- ----------
$ 26,920 $ 43,410 $ 110,746 $ 130,015
---------- ---------- ---------- ----------
Shares:
Basic shares (weighted-
average common shares
outstanding) 48,511,156 48,306,902 48,464,021 48,131,556
Stock option dilution 267,471 630,513 345,234 681,509
Series B preferred stock 4,445,500 3,970,134 4,445,500 3,970,134
Preferred securities of
subsidiary trust 3,125,000 3,125,000 3,125,000 3,125,000
---------- ---------- ---------- ----------
56,349,127 56,032,549 56,379,755 55,908,199
---------- ---------- ---------- ----------
Diluted Earnings Per
Share for Continuing
Operations $ 0.48 $ 0.77 $ 1.96 $ 2.33
========== ========== ========== ==========
7. Preferred Securities of Subsidiary Trust
On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust
wholly owned by the Company, issued 2,500,000 of its $2.50 Term Convertible
Securities, Series A (TECONS) to the public for gross proceeds of $125
million. The combined proceeds from the issuance of the TECONS and the
issuance to the Company of the common securities of the Trust were invested
by the Trust in $128.9 million aggregate principal amount of 5% convertible
subordinated debentures due June 1, 2012 (the Debentures) issued by the
Company. The Debentures are the sole assets of the Trust.
Holders of the TECONS are entitled to receive cumulative cash
distributions at an annual rate of $2.50 per TECONS (equivalent to a rate
of 5% per annum of the stated liquidation amount of $50 per TECONS). The
Company has guaranteed, on a subordinated basis, distributions and other
payments due on the TECONS, to the extent the Trust has funds available
therefor and subject to certain other limitations (the Guarantee). The
Guarantee, when taken together with the obligations of the Company under
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 13
The Debentures are redeemable for cash, at the option of the Company,
in whole or in part, on or after June 1, 2000, at a price equal to 103.125%
of the principal amount, declining annually to par if redeemed on or after
June 1, 2005, plus accrued and unpaid interest. In certain circumstances
relating to federal income tax matters, the Debentures may be redeemed by
the Company at 100% of the principal plus accrued and unpaid interest. Upon
any redemption of the Debentures, a like aggregate liquidation amount of
TECONS will be redeemed. The TECONS do not have a stated maturity date,
although they are subject to mandatory redemption upon maturity of the
Debentures on June 1, 2012, or upon earlier redemption.
Each TECONS is convertible at any time prior to the close of business
on June 1, 2012, at the option of the holder into shares of the Company's
common stock at a conversion rate of 1.25 shares of the Company's common
stock for each TECONS, subject to adjustment in certain circumstances.
8. Contingencies
In connection with the December 2, 1996 spin-off of Consolidated
Freightways Corporation (CFC), the Company's former long-haul LTL segment,
the Company agreed to indemnify certain states, insurance companies and
sureties against the failure of CFC to pay certain worker's compensation,
tax and public liability claims that were pending as of September 30, 1996.
In some cases, these indemnities are supported by letters of credit under
which the Company is liable to the issuing bank and by bonds issued by
surety companies. In order to secure CFC's obligation to reimburse and
indemnify the Company against liability with respect to these claims, as of
October 1, 2000, CFC had provided the Company with approximately $6.0
million of letters of credit. However, the letters of credit provided by
CFC are less than the Company's maximum contingent liability under these
indemnities.
The Company is currently under examination by the Internal Revenue
Service (IRS) for tax years 1987 through 1998 on various issues. In
connection with that examination, the IRS proposed adjustments for tax
years 1987 through 1990. The Company filed a protest concerning the
proposed adjustments for tax years 1987 through 1990 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 CFC
for years prior to the spin-off, which are described below. Based upon the
Notice, the total amount of the deficiency for items in years 1987 through
1990, including taxes and interest, was $145 million as of September 30,
2000. The amount due under the Notice was reduced in the third quarter by
a portion of the Company's $93.4 million payment to the IRS, which is
described below.
Under the Notice, the IRS has assessed a substantial adjustment for
tax years 1989 and 1990 based on the IRS' position that certain aircraft
maintenance costs should have been capitalized rather than expensed for
federal income tax purposes. The Company believes that its practice of
expensing these types of aircraft maintenance costs is consistent with
industry practice. As described below, the IRS has proposed an additional
adjustment, based on the same IRS position with respect to aircraft
maintenance, for subsequent tax years not included under the Notice.
Under the Notice, the IRS is also seeking additional taxes, plus
interest, for certain matters relating to CFC for those periods. As part
of the spin-off, the Company and CFC entered into a tax sharing agreement
that provided a mechanism for the allocation of any additional tax
liability and related interest that arise due to adjustments by the IRS for
years prior to the spin-off. In May 2000, the Company and CFC settled
certain federal tax matters relating to CFC on issues for tax years 1984
through 1990. Under the settlement agreement, the Company received from
CFC cash of $16.7 million, a $20.0 million note due in 2004, and a
commitment to transfer to the Company land and buildings with an estimated
value of $21.2 million. In September 2000, the Company received real
property with an estimated value of $13.8 million as partial settlement of
CFC's commitment to transfer land and buildings.
PAGE 14
As discussed above, the IRS is seeking to recover $145 million under
the Notice. In addition to the issues covered under the Notice for tax
years 1987 through 1990, the IRS in May 2000 proposed substantial additional
adjustments for tax years 1991 through 1996 with respect to various issues,
including aviation excise taxes, matters relating to CFC for years prior to
the spin-off, and, as mentioned above, aircraft maintenance costs.
The Company settled the tax issue relating to the manner in which
Emery Worldwide calculated and paid aviation excise taxes. In June 2000,
the Company paid $29.6 million to the IRS in settlement of proposed excise
tax adjustments for tax years 1990 through 1999, which approximated the
amount previously accrued by the Company for the excise tax issue.
In the third quarter of 2000, the Company paid $93.4 million to the
IRS 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 all issues except aircraft maintenance costs.
The Company intends to vigorously contest the Notice and the proposed
adjustments as they pertain to the aircraft maintenance issue, and is
evaluating courses of action for the other items covered under the Notice
and proposed adjustments. However, there can be no assurance that the
Company will not be liable for all of the amounts due under the Notice and
proposed adjustments. As a result, the Company is unable to predict the
ultimate outcome of this matter and there can be no assurance that this
matter will not have a material adverse effect on the Company's financial
condition or results of operations.
In addition to the matters discussed above and under "Legal
Proceedings" below, the Company and its subsidiaries are defendants in
various lawsuits incidental to their businesses. It is the opinion of
management that the ultimate outcome of these actions will not have a
material impact on the Company's financial condition or results of
operations.
PAGE 15
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
---------------------
On November 3, 2000, Emery Worldwide Airlines (EWA) and the U.S.
Postal Service (USPS) announced an agreement to terminate their contract
for the transportation and sortation of Priority Mail. Accordingly, the
results of operations and net assets of the Priority Mail operation have
been classified as discontinued operations. A summary of selected terms of
the agreement, summary financial data, and related information are included
in Note 2 of the Notes to Consolidated Financial Statements. Background
and additional information are described below under "Discontinued
Operations".
Continuing Operations
---------------------
Income from continuing operations (hereinafter, reduced by preferred
stock dividends) for the third quarter of 2000 was $25.6 million ($0.53 per
basic share and $0.48 per diluted share) compared to $42.1 million ($0.87
per basic share and $0.77 per diluted share) in the same quarter of last
year. The third quarter of 2000 included an $11.9 million non-recurring
loss ($0.14 per basic share and $0.12 per diluted share) from the
termination of certain aircraft leases and a $5.5 million loss from the
sale of certain assets of Con-Way Truckload Services ($0.07 per basic share
and $0.06 per diluted share). Excluding these non-recurring charges,
income from continuing operations in the third quarter of 2000 was $35.8
million, a 15.1% decline from the same quarter last year.
Income from continuing operations for the first nine months of 2000
was $106.8 million ($2.21 per basic share and $1.96 per diluted share)
compared to $126.2 million ($2.62 per basic share and $2.33 per diluted
share) in the same period last year. In addition to the non-recurring
charges discussed above, the first nine months of 2000 included a $2.6
million non-recurring net gain ($0.03 per basic and diluted share) from the
sale of securities. The first nine months of last year benefited from a
$10.1 million non-recurring net gain ($0.12 per basic share and $0.10 per
diluted share) from the sale of assets of the Company's former wholesale
parts distribution operation and a $16.5 million non-recurring net gain
($0.19 per basic share and $0.17 per diluted share) from the settlement of
a lawsuit. Except for the gain from the sale of securities in 2000, the
non-recurring items in the first nine months of 2000 and 1999 were included
in operating income. Excluding the non-recurring items in both nine-month
periods, income from continuing operations for the first nine months of
2000 increased 3.7% over the first nine months of 1999.
Revenue for the third quarter and first nine months of 2000 increased
9.3% and 12.8%, respectively, over the third quarter and first nine months
of last year due to higher revenue from the Company's three largest
segments.
Operating income of $55.4 million for the third quarter and $216.3
million for the first nine months of 2000 decreased 35.4% and 16.4%,
respectively, from the comparable periods last year. Excluding the non-
recurring charges in 2000 and the non-recurring gains in 1999, operating
income for the third quarter and first nine months of 2000 decreased 15.2%
and 0.6%, respectively. In the third quarter of 2000, an operating loss
from Emery and lower operating income from Con-Way (including the Con-Way
Truckload Services asset sale) was partially offset by record operating
income earned by Menlo. For the nine-month period, higher operating income
from Menlo and Con-Way was more than offset by lower operating income from
Emery and the Other segment. The Other segment, which includes the
operating results of Road Systems, also included the non-recurring gains
recognized in the first nine months of 1999.
PAGE 16
Other net expenses in the third quarter of 2000 increased 7.2% from
the same quarter last year due primarily to a 25.1% increase in interest
expense. Other net expenses in the first nine months of 2000 fell 14.9%
due primarily to a $2.6 million net gain from the sale of securities in
March 2000 and interest income on a note receivable from CFC (described in
Note 8 of the Notes to Consolidated Financial Statements), partially offset
by a 7.1% increase in interest expense. Long-term debt transactions
discussed in Note 3 of the Notes to Consolidated Financial Statements
resulted in higher interest expense on long-term borrowings in the third
quarter and first nine months of 2000 compared to the respective periods
last year.
The effective tax rate during the third quarter and first nine months
of 2000 was 41.5% and 42.3%, respectively, compared to 43.5% in the third
quarter of 1999 and 43.6% in the first nine months of 1999. The reduction
was due primarily to resolution of certain tax issues and tax planning
strategies in 2000.
Con-Way Transportation Services
Third-quarter revenue from Con-Way Transportation Services (Con-Way)
in 2000 increased 5.6% over the same period last year due primarily to
higher revenue per hundredweight (yield) and essentially flat tonnage
(weight). Revenue in the first nine months of 2000 increased 12.2% over
the same period last year due primarily to higher tonnage and yield. Total
and less-than-truckload (LTL) weight transported by Con-Way's regional
carriers in the first nine months of 2000 increased 5.3% and 5.2%,
respectively, over the same period last year. Tonnage in the third quarter
and first nine months of 2000 was positively impacted by continued growth
in inter-regional joint services. Con-Way's management believes that flat
tonnage growth in the third quarter of 2000 was due in part to the closures
of two of Con-Way's competitors in the second quarter of 1999, which
created additional demand for Con-Way's services in the third quarter of
last year.
In the third quarter of 2000, revenue per hundredweight for the
regional carriers increased 7.9% over the third quarter of last year and
the regional carriers' revenue per hundredweight for the first nine months
of 2000 was 6.9% higher than the first nine months of 1999. The increases
in yield were due primarily to higher rates obtained for Con-Way's core
premium services; a larger percentage of inter-regional joint services,
which command higher rates on longer lengths of haul; and, to a lesser
extent, fuel surcharges.
Con-Way's operating income in the third quarter of 2000 fell 8.3% from
the same period last year due in part to a $5.5 million loss from the sale
of certain assets of Con-Way Truckload Services. Excluding the non-
recurring charge, operating income for the 2000 third quarter increased
1.2% from the third quarter of 1999. Operating income in the first nine
months of 2000 rose 2.5% from the same period last year. Excluding the non-
recurring charge, higher operating income in the third quarter and first
nine months of 2000 was due primarily to higher revenue and continued
emphasis on operating efficiencies, including increased load factor.
Higher diesel fuel costs in the first nine months of 2000 were
substantially mitigated by a fuel surcharge implemented by Con-Way in
August 1999. The first nine months of 2000 and 1999 were negatively
affected by operating losses from Con-Way's new multi-client warehousing
and logistics business, which was formed in the fourth quarter of 1998.
PAGE 17
Emery Worldwide
Emery's revenue for the third quarter and first nine months of 2000
increased 6.5% and 9.1%, respectively, over the same periods last year due
primarily to higher international airfreight revenue and, to a lesser
extent, fuel surcharges.
International airfreight revenue for the third quarter and first nine
months of 2000, excluding fuel surcharges, increased 14.7% and 17.5%,
respectively, over the third quarter and first nine months of 1999 due
primarily to increases in pounds transported (weight) and revenue per pound
(yield). Weight and yield for the third quarter of 2000 increased 9.8% and
4.4%, respectively, over the third quarter of last year. In the first nine
months of 2000, weight and yield rose 13.2% and 3.8%, respectively, over
the first nine months of 1999. Weight and yield in the third quarter and
first nine months of 2000 were favorably affected by improved economic
conditions in the international markets served by Emery.
North American airfreight revenue for the third quarter and first nine
months of 2000, excluding fuel surcharges, fell 6.6% and 3.2%,
respectively, from the comparable periods last year. Including fuel
surcharges, North American airfreight revenue for the third quarter
declined 2.8% when compared to the third quarter of last year and North
American airfreight revenue in the first nine months of 2000 was
essentially flat compared to the same period last year. In the third
quarter of 2000, a 9.0% decline in North American airfreight weight was
partially offset by a 2.7% increase in yield (excluding fuel surcharges).
In the first nine months of 2000, a 6.3% reduction in North American
airfreight weight was partially offset by a 3.3% increase in revenue per
pound (excluding fuel surcharges). Lower weight transported in North
America for the third quarter and first nine months of 2000 was due in part
to a decline in demand from certain industries served by Emery. Improved
revenue per pound in the third quarter and first nine months of 2000 was
due in part to an increase in the percentage of higher-yielding guaranteed
delivery service and Emery's ongoing yield management, which is designed to
eliminate or reprice certain low-margin business.
Emery's operating results declined to a third-quarter operating loss
of $5.8 million in 2000 from operating income of $22.6 million in 1999.
Operating income for the nine-month period declined to $14.6 million, down
from $43.5 million in the same period last year. Operating results in 2000
were adversely affected by an $11.9 million non-recurring charge from the
termination of certain aircraft leases in the third quarter and higher
airhaul costs. Domestically, airhaul expense was negatively impacted by
higher aircraft maintenance costs, including an increase in amortization
from shortened maintenance cycles. Internationally, reduced airlift
capacity in some international markets adversely impacted airhaul rates.
Higher jet fuel costs in the third quarter and first nine months of 2000
were substantially mitigated by a fuel surcharge implemented by Emery in
September 1999.
In September 2000, Chutta Ratnathicam was named Chief Executive
Officer of Emery Worldwide, succeeding Roger Piazza, who retired. Mr.
Ratnathicam most recently served as CNF's Senior Vice President and Chief
Financial Officer and served as Emery's interim CEO for a brief period in
1998 prior to Mr. Piazza's appointment.
Under Mr. Ratnathicam, Emery's management intends to continue
positioning Emery as a premium service provider, focusing on achieving
higher yield with a reduced cost structure. In North America, management
will seek to improve yield by earning compensation that is commensurate
with premium services. Internationally, management will focus on expanding
Emery's variable-cost-based operations and continuously renegotiating
airhaul rates to improve operating margins. Management will continue
efforts to increase Emery's international revenue as a percentage of its
total revenue.
PAGE 18
In September 2000, Emery and the Airline Pilots Association, the union
representing Emery's pilots, signed a four-year collective bargaining
agreement.
Menlo Logistics
Menlo's revenue in the third quarter and first nine months of 2000
exceeded the comparable periods last year by 26.3% and 29.4%, respectively.
Higher revenue was due in part to existing contracts and consulting fees
earned on contracts entered into in the first nine months of 2000. A
portion of Menlo's revenue is attributable to logistics contracts for which
Menlo manages the transportation of freight but subcontracts the actual
transportation and delivery of products to third parties. Menlo refers to
this as purchased transportation. Menlo's revenue in the third quarter, net
of purchased transportation, increased 31.1% from the same quarter last
year to $67.5 million. For the first nine months of 2000, Menlo's revenue,
net of purchased transportation, increased 33.0% from the same period last
year to $197.7 million.
Operating income for Menlo in the third quarter and first nine months
of 2000 increased 37.0% and 53.4%, respectively, over the third quarter and
first nine months of 1999. Higher operating income was primarily
attributable to increased revenue and an increase in the percentage of
revenue from higher-margin consulting fees.
Other Segment
The Other segment includes the operating results of Road Systems and,
prior to the sale of its assets in May 1999, VantageParts. Also included
in the Other segment for 1999 were net gains from the VantageParts asset
sale and settlement of a lawsuit in January 1999.
The Other segment's revenue for the nine-month period decreased in
2000 due to the loss of revenue from VantageParts following the sale of its
assets in May 1999.
The Other segment's third-quarter operating income of $380,000
increased from a $19,000 operating loss in the third quarter of 1999. The
Other segment's operating income of $1.0 million in the first nine months
decreased from $27.5 million in the same period of 1999. Last year's first
nine months of operating income included a $16.5 million net gain from the
settlement of a lawsuit in January 1999, and a $10.1 million net gain from
the VantageParts asset sale.
PAGE 19
Discontinued Operations
-----------------------
Recent Events
On November 3, 2000, Emery Worldwide Airlines (EWA) and the U.S.
Postal Service (USPS) announced an agreement to terminate their contract
for the transportation and sortation of Priority Mail. Under the
agreement, EWA agreed to dismiss a complaint filed in April 2000 in the
U.S. Court of Federal Claims that requested a declaration of contract
rights under the Priority Mail contract and a ruling that the USPS was in
breach of contractual payment obligations. However, the agreement
preserves EWA's right to pursue claims for underpayment under the contract,
which are described below, and EWA intends to do so.
As a result of the above, the results of operations and net assets of
the Priority Mail operation have been classified as discontinued
operations. A summary of selected terms of the agreement, summary
financial data, and related information are included in Note 2 of the Notes
to Consolidated Financial Statements.
Background
In accordance with the Priority Mail contract, in February 1999, EWA,
our subsidiary that operates the Priority Mail contract, submitted a
proposal to the USPS for 1999 pricing. We believe that our proposal was
reasonably determined and justifiable based upon EWA's experience of
operating under the Priority Mail contract.
EWA did not receive a satisfactory response from the USPS.
Consequently, EWA in the third quarter of 1999 filed a claim with the USPS
for proposed higher prices. Also, in August 1999, the USPS denied EWA's
previously filed claim for reimbursement of additional costs incurred
during the 1998 holiday season.
Through the second quarter of 1999, Priority Mail contract revenue was
billed at a provisional rate set by the USPS, pending a final price
determination. The USPS responded to the EWA claim with unilateral price
reductions for both prior and future periods.
Consistent with our accounting policy described in Note 2 of the Notes
to Consolidated Financial Statements, EWA recognizes unbilled revenue
related to claims sufficient only to recover costs of operating under the
contract. Accordingly, no operating profit has been recognized in
connection with the Priority Mail contract since the first half of 1999.
Until the contract's effective termination on January 7, 2001, we expect
that any shortfall between EWA's billed revenue from the Priority Mail
contract and its costs of operating under the contract will be recognized
as unbilled revenue and as a result, we will generally continue to record
break-even operating results under the Priority Mail contract in our
financial statements under discontinued operations. If we determine that
the unbilled revenue is not collectable, the uncollectable amount will be
charged as expense to discontinued operations in the period when and if
that determination is made.
Unbilled revenue excludes profit under the contract and interest
attributable to unbilled revenue and profit. However, our claims discussed
herein are to recover costs of operating under the Priority Mail contract
as well as profit and interest thereon. Under the termination agreement,
EWA preserves the right to pursue these claims for underpayment under the
Priority Mail contract.
PAGE 20
As a result of the claims discussed above and the USPS's decision to
assert price reductions, EWA recognized $21.0 million and $70.7 million of
unbilled revenue in the third quarter and first nine months of 2000,
respectively. EWA has recognized a total of $194.4 million of unbilled
revenue since the beginning of the Priority Mail contract through September
30, 2000, which amount is in dispute.
In March 2000, EWA filed a claim with the USPS related to the Priority
Mail contract to recover actual and expected reductions to EWA's contract
pricing. This claim was filed in response to the reduction by the USPS in
contract pricing for both prior and future periods as discussed above. The
claim is in addition to EWA's previous claim for 1999 pricing as discussed
above and substantially covers the remaining initial term of the contract.
In April 2000, EWA filed a complaint in the U.S. Court of Federal Claims in
Washington, D.C. that requested a declaration of contract rights under the
Priority Mail contract and a ruling that the USPS is in breach of
contractual payment obligations.
As a result of a decision in August 2000 in the U.S. Court of Federal
Claims, the USPS increased its provisional rate paid to EWA for
transportation and sortation of Priority Mail for 2000. The USPS also
increased the provisional rate paid to EWA for 1999. Based on these rate
adjustments, early in the fourth quarter of 2000 EWA received payments
totaling $102.1 million from the U.S. Postal Service, reducing the total
amount recognized by EWA as unbilled revenue to approximately $92.3
million. The current rate is below EWA's cost to service this contract.
Until the Priority Mail contract is terminated on January 7, 2001, EWA will
be compensated below its cost of operating the contract.
We believe our position with respect to the Priority Mail contract is
reasonable and well founded; however, there can be no assurance as to the
outcome. Accordingly, we can give no assurance that matters relating to
the Priority Mail contract with the USPS will not have a material adverse
effect on our financial condition or results of operations.
PAGE 21
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
As described in Note 2 of the Notes to Consolidated Financial
Statements, cash flows related to discontinued operations have not been
segregated in the Statements of Consolidated Cash Flows, and, as a result,
amounts on the Statements of Consolidated Income and Consolidated Balance
Sheets may not agree with certain captions on the Statements of
Consolidated Cash Flows.
In the first nine months of 2000, cash and cash equivalents decreased
$66.4 million to $79.9 million. The net use of cash from investing
activities of $165.1 million was funded with $57.3 million of cash provided
by operating activities, $41.5 million provided by financing activities and
a reduction in cash.
Operating activities in the first nine months of 2000 generated net
cash of $57.3 million. Net income of $113.0 million (excluding loss on
discontinuance) and depreciation and amortization of $157.8 million were
partially offset by a $202.2 million increase in receivables and a $44.3
million increase in unamortized aircraft maintenance. The increase in
receivables was due in part to higher revenue and an increase in the amount
of unbilled revenue from the Priority Mail contract. As described under
"Results of Operations" for "Discontinued Operations", payments from the
U.S. Postal Service in October 2000 totaling $102.1 million reduced the
total amount recognized by EWA as unbilled revenue from $194.4 million at
September 30, 2000 to $92.3 million.
Investing activities in the first nine months of 2000 used $165.1
million of cash, $61.9 million less than the first nine months of 1999.
Capital expenditures of $170.9 million in the first nine months of 2000
declined $68.2 million from the same period last year. For the first nine
months of 2000, Con-Way spent $82.4 million of cash primarily on
infrastructure and Emery spent $51.0 million of cash primarily on
infrastructure and aircraft equipment. Capital expenditures by Con-Way and
Emery in the first nine months of 2000 declined $70.1 million and $20.5
million, respectively, from the same period last year and were partially
offset by the in-process construction of a CNF corporate administrative
facility. In the first nine months of 2000, $66.7 million of revenue
equipment was acquired by Con-Way under operating leases while no new
capital items were acquired by Con-Way under operating leases in the same
period of last year. Proceeds from the sale of equity securities and the
sale of certain assets of Con-Way Truckload Services generated cash of $2.6
million and $7.3 million, respectively, in the first nine months of 2000.
Software expenditures in the first nine months of 2000 declined $13.6
million from the first nine months of last year.
Financing activities in the first nine months of 2000 provided $41.5
million compared to the reduction of $69.4 million in the same period last
year. As discussed in Note 3 of the Notes to Consolidated Financial
Statements, a portion of the net proceeds of $197.5 million from the
issuance in March 2000 of $200 million of 8 7/8% Notes due 2010 were used
to repay short-term and long-term borrowings outstanding under lines of
credit.
As discussed above under "Results of Operations" for "Discontinued
Operations", the provisional rate currently being paid to EWA by the U.S.
Postal Service under the Priority Mail contract is below EWA's cost to
service the contract. Until the effective termination date on January 7,
2001, our liquidity will be negatively affected by the shortfall between
EWA's compensation from the contract and its cost of operating under the
contract.
As discussed in Note 8 of the Notes to Consolidated Financial
Statements, the Company is currently under examination by the Internal
Revenue Service (IRS) for tax years 1987 through 1998 on various issues.
In connection with that examination, we paid the IRS $93.4 million in
August 2000 for tax and interest related to issues raised under the
examination. We paid the IRS by liquidating short-term investments and
with proceeds from short-term borrowings.
PAGE 22
We maintain a $350 million unsecured credit facility with no
borrowings outstanding at September 30, 2000. The $350 million facility is
also available for issuance of letters of credit. Under that facility,
outstanding letters of credit totaled $49.6 million at September 30, 2000.
Available capacity under the $350 million facility was $300.4 million at
September 30, 2000.
At September 30, 2000 we also had $100.0 million of uncommitted lines
with $5.0 million outstanding. Under other unsecured facilities, $67.6
million in letters of credit were outstanding at September 30, 2000.
Our ratio of total debt to capital increased to 31.7% from 30.5% at
December 31, 1999, primarily due to the March 2000 issuance of $200 million
of 8 7/8% Notes due 2010.
CYCLICALITY AND SEASONALITY
---------------------------
Our businesses operate in industries that are affected directly by
general economic conditions and seasonal fluctuations, both of which affect
demand for transportation services. In the trucking and airfreight
industries, for a typical year, the months of September and October usually
have the highest business levels while the months of January and February
usually have the lowest business levels. Operations under the Priority
Mail contract, which are reported as "Discontinued Operations", peak in
December primarily due to higher shipping demand related to the holiday
season.
MARKET RISK
-----------
We are exposed to a variety of market risks, including the effects of
interest rates, commodity prices and foreign currency exchange rates. Our
policy is to enter into derivative financial instruments only in
circumstances that warrant the hedge of an underlying asset, liability or
future cash flow against exposure to some form of commodity, interest rate
or currency-related risk. Additionally, the designated hedges should have
high correlation to the underlying exposure such that fluctuations in the
value of the derivatives offset reciprocal changes in the underlying
exposure. Our policy prohibits entering into derivative instruments for
trading purposes.
We may be exposed to the effect of interest rate fluctuations in the
fair value of our long-term debt and capital lease obligations, as
summarized in Notes 3 and 4 of our consolidated financial statements
included in our 1999 Annual Report to Shareholders. Changes in our long-
term debt since December 31, 1999 are discussed herein in Note 3 of the
Notes to Consolidated Financial Statements. The change in the fair value of
our long-term obligations given a hypothetical 10% change in interest rates
would be approximately $26 million at September 30, 2000.
We use interest rate swaps to mitigate the impact of interest rate
volatility on cash flows and the fair value of our long-term debt. Cash
flow hedges include interest rate swaps on variable-rate equipment lease
obligations. As of September 30, 2000, we estimate that the net payments
under these swaps given a hypothetical adverse change of 10% in market
interest rates would not have a material effect on our financial condition
or results of operations.
In April 2000, we entered into interest rate swaps designated as fair
value hedges. The underlying exposure of these swaps is the fluctuation in
fair value of the $200 million of 8 7/8% Notes due 2010 issued in March
2000. Under the measurement criteria of hedge effectiveness of SFAS 133,
the value of these fair value hedges vary inversely with the fluctuation in
fair value of the $200 million 8 7/8% Notes. As of September 30, 2000, the
change in the fair value of these interest rate swaps given a hypothetical
10% change in interest rates would be approximately $12 million.
PAGE 23
ACCOUNTING STANDARDS
--------------------
In June 1999, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective
Date of FASB Statement No. 133" (SFAS 137). SFAS 137 delays by one year
the effective date of FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes
accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value and that changes in fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
Qualifying hedges allow a derivative's gains and losses to offset related
results on the hedged item in the income statement. SFAS 133 will now be
effective January 1, 2001. We plan to adopt the statement in the first
quarter of 2001 and are evaluating the impact of adoption on our financial
condition and results of operations.
YEAR 2000
---------
Since 1996, our Information Technology professionals have coordinated
our continuing Year 2000 (Y2K) compliance effort. We believe our efforts
to address Y2K issues have been successful and do not expect any material
adverse effect on our financial condition or results of operations. We
will continue to monitor for Y2K-related problems. Should problems arise,
we will implement the Y2K business resumption contingency plans we
previously established.
From 1996 through December 31, 1999, we expensed $38.1 million on Y2K
compliance through December 31, 1999. All Y2K costs have been funded from
operations. A portion of our capitalized software costs was for new
financial and administrative systems that are Y2K compliant. Some of these
systems replaced non-compliant systems.
FORWARD-LOOKING STATEMENTS
--------------------------
Certain statements included herein constitute "forward-looking
statements" within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended, and are subject to a number of risks and
uncertainties. Any such forward-looking statements contained herein should
not be relied upon as predictions of future events. Certain such forward-
looking statements can be identified by the use of forward-looking
terminology such as "believes," "expects," "may," "will," "should,"
"seeks," "approximately," "intends," "plans," "estimates" or "anticipates"
or the negative thereof or other variations thereof or comparable
terminology, or by discussions of strategy, plans or intentions. Such
forward-looking statements are necessarily dependent on assumptions, data
or methods that may be incorrect or imprecise and they may be incapable of
being realized. In that regard, the following factors, among others and in
addition to the matters discussed below and elsewhere in this document,
could cause actual results and other matters to differ materially from
those in such forward-looking statements: changes in general business and
PAGE 24
economic conditions; increasing domestic and international competition and
pricing pressure; changes in fuel prices; uncertainty regarding EWA's
Priority Mail contract with the United States Postal Service, including
uncertainties regarding EWA's claims under the contract described herein;
labor matters, including changes in labor costs, renegotiations of labor
contracts and the risk of work stoppages or strikes; changes in
governmental regulation; environmental and tax matters, including aircraft
maintenance and other tax matters discussed herein; and matters relating to
the spin-off of CFC. In that regard, we are or may be subject to
substantial liabilities with respect to certain matters relating to CFC's
business and operations, including, without limitation, guarantees of
liabilities of CFC for employment-related, tax and environmental matters,
including the tax matters described herein. Although CFC is, in general,
either the primary or secondary obligor or jointly and severally liable
with us with respect to these matters, a failure to pay or other default by
CFC with respect to the obligations as to which we are or may be, or may be
perceived to be, liable, whether because of CFC's bankruptcy or insolvency
or otherwise, could lead to substantial claims against us. As a result of
the foregoing, no assurance can be given as to future results of operations
or financial condition.
PAGE 25
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
As previously reported, the Company has been designated a potentially
responsible party (PRP) by the EPA with respect to the disposal of
hazardous substances at various sites. The Company expects its share of
the clean-up costs will not have a material adverse effect on the Company's
financial condition or results of operations.
The Department of Transportation, through its Office of Inspector
General, and the Federal Aviation Administration has been conducting an
investigation relating to the handling of so-called hazardous materials by
Emery. The Department of Justice has joined in the investigation and is
seeking to obtain additional information. The investigation is ongoing and
Emery is cooperating fully. Because the investigation is at a preliminary
stage, the Company is unable to predict the outcome of this investigation.
On February 16, 2000, a DC-8 cargo aircraft operated by EWA crashed
shortly after take-off from Mather Field, near Sacramento, California. The
crew of three was killed. There were no reported injuries on the ground.
The cause of the crash has not been determined. The National
Transportation Safety Board is conducting an investigation. The Company is
currently unable to predict the outcome of this matter or the effect it may
have on the Company. The Company may be subject to claims and proceedings
relating to the crash, which could include private lawsuits seeking
monetary damages and governmental proceedings. Although EWA maintains
insurance that is intended to cover claims that may arise in connection
with an airplane crash, the Company cannot assure that the insurance will
in fact be adequate to cover all possible types of claims. In particular,
any claims for punitive damages or any impact of possible government
proceedings or other sanctions would not be covered by insurance.
Certain legal matters are discussed in Note 8 in the Notes to
Consolidated Financial Statements in Part I of this form.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
99(a) Computation of Ratios of Earnings to Fixed
Charges -- the ratios of earnings to fixed charges
were 3.6x and 4.3x for the nine
months ended September 30, 2000 and 1999,
respectively.
(b) Computation of Ratios of Earnings to Combined
Fixed Charges and Preferred Stock Dividends -- the
ratios of earnings to combined fixed charges and
preferred stock dividends were 3.4x and 4.1x for
the nine months ended September 30, 2000 and 1999,
respectively.
(b)Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
September 30, 2000.
PAGE 26
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 benine months by the undersigned,
thereunto duly authorized.
CNF Transportation Inc.
(Registrant)
November 14, 2000 /s/Greg Quesnel
Greg Quesnel
President, Chief Executive Officer
and Interim Chief Financial Officer
