EX-13 5 0005.txt EXHIBIT 13 Exhibit 13 PAGE 14 MANAGEMENT'S DISCUSSION AND ANALYSIS 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. Under terms of the agreement, the USPS, on January 7, 2001, assumed responsibility for services covered under the contract, except for certain air transportation and related services described below under "Discontinued Operations." Accordingly, the results of operations, net assets, and cash flows of the Priority Mail operations have been segregated and 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. Net income available to common shareholders in 2000 was $126.8 million ($2.36 per diluted share), including a $13.5 million after-tax loss ($0.24 per diluted share) from discontinuance of the Priority Mail operations, and a $2.7 million after-tax loss ($0.05 per diluted share) from the cumulative effect of an accounting change. The change in our accounting policy for revenue recognition on in-transit freight is described in Note 1 of the Notes to Consolidated Financial Statements. Comparative results of continuing operations were also affected byunusual items discussed below under "Continuing Operations." Net income available to common shareholders of $182.3 million ($3.35 per diluted share) in 1999 benefited from after-tax income of $3.0 million ($0.06 per diluted share) from discontinued Priority Mail operations. In 1998, net income available to common shareholders was $130.8 million ($2.45 per diluted share), including an after-tax loss of $2.1 million ($0.04 per diluted share) from discontinued operations. CONTINUING OPERATIONS Net income from continuing operations (income from continuing operations reduced by preferred stock dividends) for 2000 declined to $143.1 million ($2.65 per diluted share) from $179.3 million ($3.29 per diluted share) in 1999 due to lower operating income and higher other net expenses, partially offset by a lower effective tax rate. Operating income of $290.0 million in 2000 declined from $354.2 million in 1999 due primarily to lower operating income from Emery and the Other segment, partially offset by record operating income from Menlo. Revenue of $5.57 billion in 2000 increased 10.6% from $5.04 billion in 1999 due primarily to higher revenue from Con-Way, Emery and Menlo. Operating income for all reporting segments in 2000 was adversely affected by a 20.8% increase in health and welfare costs, including prescription drug coverage. In 2001, health and welfare costs are expected to continue increasing at a lower rate than in 2000. This increase, along with higher anticipated pension expense, will likely have an adverse effect on operating results in 2001. Management believes that a slowing domestic economy in the fourth quarter of 2000 adversely affected the operating results of all reporting segments. If the slowing trend continues, 2001 revenue will likely decline and operating income will likely be adversely affected unless proportionate cost reductions can be made. Excluding the unusual items described below, net income from continuing operations was $151.9 million ($2.81 per diluted share) in 2000 compared to $158.9 million ($2.93 per diluted share) in 1999. Excluding unusual items, operating income in 2000 was $307.8 million compared with $327.7 million in 1999. Net income from continuing operations in 1999 increased 34.9% from net income of $132.9 million ($2.49 per diluted share) earned from continuing operations in 1998 due primarily to higher operating income, lower other net expenses and a lower tax rate. Operating income of $354.2 million in 1999 increased 20.5% over 1998, reflecting growth in operating income at all of our reporting segments. Revenue in 1999 increased 11.2% from $4.53 billion in 1998 due primarily to higher revenue from Con-Way, Emery and Menlo. An improved international economy and a strong domestic economy aided revenue and operating income in 1999. Excluding the unusual items, net income from continuing operations in 1999 increased 19.5% from 1998 and operating income in 1999 increased 11.5% from 1998. Unusual Items Results of continuing operations included various unusual or non-recurring items that affected reported results in 2000 and 1999: For 2000, operating income for Emery included an $11.9 million unusual loss ($0.12 per diluted share) from the termination of certain aircraft leases and Con-Way's operating income included a $5.5 million non-recurring loss from the sale of certain assets of Con-Way Truckload Services ($0.06 per diluted share). Other net expenses in 2000 included a $2.6 million unusual net gain ($0.03 per diluted share) from the sale of securities. PAGE 15 Operating income in 1999 benefited from a $16.5 million net gain ($0.17 per diluted share) from the settlement of a lawsuit. Another non-recurring net gain of $10.1 million ($0.10 per diluted share) was recognized in operating income on the sale of the assets of VantageParts, our former wholesale distributor of truck parts and supplies. These unusual gains in 1999 are included in operating income for the Other segment. In addition, other net expenses in 1999 included a $9.6 million net gain from the sale of securities ($0.10 per diluted share). Con-Way Transportation Services Con-Way's revenue in 2000 increased 8.9% over 1999 to $2.04 billion due primarily to higher revenue per hundredweight (yield) and an increase in weight per day (weight or tonnage). In 2000, revenue per hundredweight for the regional carriers increased 7.1% over 1999 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. Total and less-than-truckload (LTL) weight per day transported by Con-Way's regional carriers in 2000 increased 3.2% and 3.3%, respectively, over 1999. Tonnage in 2000 was positively impacted by continued growth in inter-regional joint services. Con-Way's management believes that tonnage growth in 2000 compared to 1999 was adversely affected by a slowing domestic economy in the last half of 2000 and by the closures of two of Con-Way's competitors in the second quarter of 1999, which management believes created additional demand for Con-Way's services in the last half of 1999. Revenue in 1999 was 11.5% higher than in 1998 as Con-Way's regional carriers increased total weight per day by 7.2%, LTL weight per day by 7.4%, and yield by 5.7%. Con-Way's operating income in 2000 fell just shy of the record $228.8 million earned by Con-Way in 1999 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 2000 increased 1.7% from 1999 due primarily to higher revenue and continued emphasis on operating efficiencies, including increased utilization of the freight network, partially offset by higher employee benefit costs. Higher diesel fuel costs in 2000 and in the last half of 1999 were mitigated by a fuel surcharge implemented by Con-Way in August 1999. Operating losses from Con-Way's multi-client warehousing and logistics business, which was formed in the fourth quarter of 1998, negatively affected operating income in 2000 and 1999. Con-Way's record operating income in 1999 grew 10.6% over operating income of $206.9 million in 1998 due primarily to higher revenue and operating efficiencies. Emery Worldwide Emery's revenue in 2000 increased 8.3% to a record $2.61 billion. Higher revenue in 2000 was due primarily to an increase in international airfreight revenue and, to a lesser extent, fuel surcharges. International airfreight revenue for 2000, including fuel surcharges, increased 20.4% over 1999 due primarily to increases in weight (freight volume) and revenue per pound (yield). Weight and yield in 2000, which were favorably affected by improved economic conditions in the international markets served by Emery, increased 11.6% and 7.8%, respectively, over 1999. North American airfreight revenue for 2000, including fuel surcharges, was essentially unchanged from 1999. In 2000, a 7.9% decline in North American airfreight weight was partially offset by a 9.1% increase in yield (including fuel surcharges). Improved yield in 2000 was due in part to an increase in the percentage of higher-yielding guaranteed delivery service provided and Emery's ongoing yield management, which is designed to eliminate or reprice certain low-margin business. Lower weight transported in North America for 2000 was due in part to a slowing domestic economy, which adversely affected certain industries served by Emery, and Emery's ongoing yield management. Emery's revenue in 1999 was 9.3% higher than revenue of $2.20 billion in 1998. Increases in international airfreight revenue and revenue from an Express Mail contract with the U.S. Postal Service were partially offset by slightly lower North American revenue. Growth in international revenue was accomplished with a 10.2% increase in weight per day and 2.4% higher yield. The small 0.7% decline in North American airfreight revenue was primarily the result of a 5.7% drop in weight partially offset by a 5.3% increase in yield. Emery's operating income was $28.4 million in 2000 compared to operating income of $75.5 million in 1999. Operating income in 2000 was adversely affected by an $11.9 million charge for the termination of certain aircraft leases and by higher airhaul costs. Domestically, airhaul expense was negatively impacted by higher aircraft maintenance costs, including an increase in amortization from shortened maintenance cycles resulting from a recent Federal Aviation Administration directive. Internationally, reduced airlift capacity in some international markets adversely affected airhaul margins. Higher jet fuel costs in 2000 and the last quarter of 1999 were substantially mitigated by a fuel surcharge implemented by Emery in September 1999. Operating income in 1999 increased 17.4% from 1998 due primarily to higher international airfreight revenue and revenue from the Express Mail contract. PAGE 16 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 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 requiring compensation that is commensurate with premium services. Internationally, management will focus on expanding Emery's variable-cost-based operations and actively renegotiating airhaul rates in an effort to improve operating margins, mitigate higher fuel prices, and balance directional capacity. Management will continue efforts to increase Emery's international revenue as a percentage of its total revenue. In January 2001, the USPS and Federal Express Corporation (FedEx) announced an exclusive agreement in which the USPS will pay FedEx to haul Express Mail and Priority Mail. In 2000, EWA recognized revenue of $229.1 million and operating income of $28.2 million from a 10-year contract with the USPS to transport Express Mail and other classes of mail. This contract expires in January 2004. Even though EWA has received no notice of termination of its Express Mail contract from the USPS, there can be no assurance that the USPS will not terminate EWA's Express Mail contract prior to its scheduled expiration in January 2004. Any termination or non-renewal of this contract will likely have a material adverse effect on our results of operations or financial condition. EWA filed a lawsuit against the USPS alleging that an exclusive contract with FedEx violates the USPS' own procurement regulations, which require that all purchases over $10,000 "must be made on the basis of adequate competition whenever feasible or appropriate," and that such a contract violates the USPS' regulatory requirement to provide "fair and equal treatment" to all potential suppliers. The U.S. Court of Federal Claims in January 2001 declined to issue a temporary restraining order barring the USPS from signing the exclusive contract for air transportation network services with FedEx; however, EWA's lawsuit against the USPS over the Express Mail contract is still before the courts. If the USPS terminates the Express Mail contract with EWA before its scheduled expiration date, EWA would be entitled to reimbursement of costs related to servicing the contract. Menlo Logistics Menlo's revenue in 2000 was a record $890.8 million, exceeding revenue of $716.0 million in 1999 by 24.4%. Higher revenue in 2000 was due to continued growth in logistics contracts, including several large contracts secured in the fourth quarter of 1999, and consulting fees earned on contracts entered into in 2000. Revenue in 1999 increased 22.0% over revenue of $586.8 million in 1998 due partially to a full year of revenue from several large logistics contracts awarded in the second quarter of 1998 and higher revenue from other contracts awarded prior to 1998. A portion of Menlo's revenue is attributable to logistics contracts for which Menlo manages the transportation of freight but subcontracts the actual transportation and delivery of products to third parties. Menlo refers to this as purchased transportation. Menlo's net revenue (revenue less purchased transportation) was $265.6 million in 2000, $206.6 million in 1999, and $189.1 million in 1998. Operating income for Menlo in 2000 was a record $33.3 million, a 49.6% increase over operating income of $22.3 million in 1999. Higher operating income was primarily attributable to increased revenue from core supply chain projects and an increase in the percentage of revenue from higher-margin consulting fees. Operating income in 1999 increased 14.4% from $19.5 million earned by Menlo in 1998 due primarily to increased revenue. Higher business development and information systems costs incurred during 1999 contributed to lower operating income as a percentage of revenue than in 1998. Other Operations In 2000, the Other segment included the operating results of Road Systems and Vector SCM, a new joint venture described below. In 1999, the Other segment included Road Systems, and prior to the sale of its assets in May 1999, VantageParts. Also included in the Other segment in 1999 were a $16.5 million non-recurring net gain from the settlement of a lawsuit, and a $10.1 million non-recurring net gain from the VantageParts asset sale. In 1998, the Other segment included Road Systems and VantageParts. In December 2000, CNF and General Motors formed a joint venture, Vector SCM, to provide logistics services to General Motors. The operating results of Vector SCM are reported as an equity investment in the Other segment. Startup costs for Vector SCM in 2000 were $560,000 and are expected to be approximately $6 million in the first quarter of 2001. PAGE 17 Other Net Expense Other net expenses in 2000 increased 30.9% from 1999 due primarily to a $9.6 million net gain from the sale of securities in December 1999. Higher interest expense in 2000 also contributed to the increase in other net expenses, but was partially offset by higher investment income in 2000 and a $2.6 million net gain from the sale of securities in March 2000. Long-term debt transactions described in Note 4 of the Notes to Consolidated Financial Statements contributed to a 15.4% increase in interest expense in 2000 compared to 1999. Other net expense in 1999 decreased 45.2% from 1998 due primarily to the $9.6 million net gain from the sale of securities in 1999 and lower interest expense. The decline in interest expense was partially due to a net reduction of long-term debt as described in Note 4 of the Notes to Consolidated Financial Statements. Income Taxes The effective tax rate for 2000 was 42.1% compared to 43.6% in 1999 and 44.4% in 1998. The reductions in the effective tax rate were primarily attributable to the implementation of tax planning strategies and resolution of tax issues. DISCONTINUED OPERATIONS On November 3, 2000, EWA and the 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 assumed operating responsibility for services covered under the contract, except certain air transportation and related services. As a part of the termination agreement, EWA agreed to provide certain air transportation and related services to the USPS for a transition period of not less than ninety days. In January 2001, EWA received notification from the USPS of its intention to terminate the requirement for EWA to provide transition air transportation and related services, effective April 23, 2001. The USPS has agreed to reimburse EWA for Priority Mail contract termination costs, including costs of contract-related equipment, inventory, and operating lease commitments, up to $125 million (the "Termination Liability Cap"). On January 7,2001, the USPS paid EWA $60 million toward the termination costs. The termination agreement provides for this provisional payment to be adjusted if actual termination costs are greater or less than $60 million, in which case either the USPS will be required to make an additional payment or EWA will be required to return a portion of the provisional payment. We believe that contract termination costs incurred by EWA are reimbursable under the termination agreement and do not exceed the Termination Liability Cap. However, there can be no assurance that all termination costs incurred by Emery will be recovered. 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 which it believes are owed by the USPS under the contract. EWA intends to pursue these claims and has initiated litigation in the U.S. Court of Federal Claims for that purpose. These claims are to recover costs of operating under the contract as well as profit and interest thereon. At December 31, 2000, our financial statements included $176.2 million of unbilled revenue with respect to the Priority Mail contract. Unbilled revenue represents the accrual of revenue sufficient only to recover costs and therefore does not include profit or interest on either unbilled revenue or profit. Any unbilled revenue that we do not recover would be written off and reflected in operating results for discontinued operations in the current period. Any amount of litigation award in excess of unbilled revenue would be reflected as income from discontinued operations in the current period. We believe our position with respect to claims for underpayment under the Priority Mail contract is reasonable and well founded; however, there can be no assurance that litigation will result in an award sufficient to recover unbilled revenue recognized under the contract. 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. As a result of the above, the results of operations and net assets of the Priority Mail operations have been segregated and 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. PAGE 18 LIQUIDITY AND CAPITAL RESOURCES Continuing Operations In 2000, cash and cash equivalents decreased $41.7 million to $104.5 million. The net use of cash from investing activities of $234.1 million was funded with $162.7 million of cash provided by operating activities, $32.4 million provided by financing activities and a reduction in cash. Operating activities in 2000 generated net cash of $162.7 million compared to $396.0 million of cash generated by operating activities in 1999. Cash from operations in 2000 was provided primarily by income from continuing operations before depreciation and amortization (excluding the cumulative after-tax effect of an accounting change). Positive operating cash flows in 2000 were partially offset by changes in receivables, unamortized aircraft maintenance, accrued liabilities and accrued income taxes. In 2000, a $15.8 million increase in unamortized aircraft maintenance was the result of $55.4 million of cash used in capitalized maintenance costs, partially offset by a $39.6 million non-cash write-off of unamortized aircraft maintenance costs against the lease return provision, related in part to the termination of certain aircraft leases. As described in Note 13 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. Funding was provided by liquidating short-term investments and with borrowings under short-term credit lines. Also described in Note 13 of the Notes to Consolidated Financial Statements, the decline in accrued liabilities in 2000 was due in part to a $29.6 million payment to the IRS in settlement of a proposed IRS adjustment related to excise taxes. Cash from operations in 1999 increased $112.7 million over 1998 and was provided primarily by income from continuing operations before depreciation and amortization, and an increase in accrued liabilities. Investing activities in 2000 used $69.4 million less cash than in 1999. Capital expenditures of $235.2 million in 2000 declined $89.4 million from 1999. For 2000, Con-Way spent $122.6 million of cash primarily on infrastructure and Emery spent $68.1 million of cash primarily on infrastructure and aircraft equipment. Capital expenditure declines by Con-Way and Emery in 2000 of $89.4 million and $32.1 million, respectively, were partially offset by the in-process construction of a CNF corporate administration and information technology facility. In 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 1999. Proceeds from sales of securities in 2000 were $2.6 million, down from $9.6 million in 1999. The sale of certain assets of Con-Way Truckload Services in 2000 generated cash of $7.3 million in 2000 compared to $29.3 million of cash provided by the sale of assets of VantageParts in 1999. Software expenditures in 2000 declined $15.6 million from 1999. Cash used in investing activities in 1999 was $52.4 million higher than in 1998 due primarily to a $109.7 million increase in capital expenditures by Con-Way, partially offset by proceeds from the sale of VantageParts and securities in 1999. Financing activities in 2000 provided cash of $32.4 million compared to a $58.9 million reduction in cash in 1999. As discussed in Note 4 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 borrowings outstanding under lines of credit. The net cash used by financing activities in 1999 compared to $12.7 million of positive financing cash flow in 1998 was due primarily to long-term debt transactions described in Note 4 of the Notes to Consolidated Financial Statements and fluctuations in short-term borrowings. We maintain a $350 million unsecured credit facility with no borrowings outstanding at December 31, 2000. The $350 million facility is also available for issuance of letters of credit. Under that facility, outstanding letters of credit totaled $71.8 million at December 31, 2000. Available capacity under the $350 million facility was $278.2 million at December 31, 2000. At December 31, 2000 we also had $100.0 million of uncommitted lines with no outstanding borrowings. Under other unsecured facilities, $73.6 million in letters of credit and bank guarantees were outstanding at December 31, 2000. Our ratio of total debt to capital increased to 31.4% at December 31, 2000 from 30.5% at December 31, 1999, primarily due to the March 2000 issuance of $200 million of 8 7/8% Notes due 2010. PAGE 19 Discontinued Operations As described above under "Results of Operations," cash flows from the Priority Mail operations have been segregated and classified as net cash flows from discontinued operations in the Statements of Consolidated Cash Flows. As described in Note 2 of the Notes to Consolidated Financial Statements, EWA received payments in the fourth quarter of 2000 totaling $102.1 million from the USPS for rate adjustments. Also described in Note 2, EWA in January 2001 received a $60 million provisional payment toward reimbursable termination costs, as provided under a termination agreement signed by EWA and the USPS in November 2000. 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. 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 speculative 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 4 and 5 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 $23 million at December 31, 2000. We use interest rate swaps to mitigate both the impact of interest rate volatility on cash flows related to lease payments and on the fair value of our long-term debt. Cash flow hedges include interest rate swaps on variable-rate equipment lease obligations. As of December 31, 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 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, which we plan to adopt effective January 1, 2001, the value of these fair value hedges varies inversely with the fluctuation in fair value of the $200 million 8 7/8% Notes. As of December 31, 2000, the change in the fair value of these interest rate swaps given a hypothetical 10% change in interest rates would be approximately $14 million. At December 31, 2000, we had not entered into any derivative contracts to hedge our foreign currency exchange exposure. 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 delayed 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 without a material impact on our financial condition and results of operations. PAGE 20 CNF TRANSPORTATION INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31 (Dollars in thousands) 2000 1999 ASSETS Current Assets Cash and cash equivalents $ 104,515 $ 146,263 Trade accounts receivable, net (Note 1) 881,268 781,802 Other accounts receivable 59,478 49,416 Operating supplies, at lower of average cost or market 42,271 45,314 Prepaid expenses 47,301 41,132 Deferred income taxes (Note 6) 105,502 76,032 Net current assets of discontinued operations (Note 2) - 25,710 Total Current Assets 1,240,335 1,165,669 Property, Plant and Equipment, at Cost Land 130,101 119,403 Buildings and leasehold improvements 692,312 564,278 Revenue equipment 797,444 816,172 Other equipment 420,788 375,482 2,040,645 1,875,335 Accumulated depreciation and amortization (934,123) (828,088) 1,106,522 1,047,247 Other Assets Deferred charges and other assets (Note 13) 137,393 177,442 Capitalized software, net (Note 1) 89,829 86,097 Unamortized aircraft maintenance, net (Note 1) 242,468 226,629 Goodwill, net (Note 1) 254,887 265,896 Net non-current assets of discontinued operations (Note 2) 173,507 90,354 898,084 846,418 Total Assets $3,244,941 $3,059,334 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. PAGE 21 CNF TRANSPORATION INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31 (Dollars in thousands except per share data) LIABILITIES AND SHAREHOLDERS' EQUITY 2000 1999 Current Liabilities Accounts payable $ 418,157 $ 395,617 Accrued liabilities (Note 3) 317,650 377,919 Accrued claims costs (Note 1) 145,558 121,917 Current maturities of long-term debt and capital leases (Notes 4 and 5) 7,553 6,452 Short-term borrowings (Note 4) - 40,000 Income taxes payable (Notes 6 and 13) 1,777 53,455 Net current liabilities of discontinued operations (Note 2) 68,214 - Total Current Liabilities 958,909 995,360 Long-Term Liabilities Long-term debt and guarantees (Note 4) 424,116 322,800 Long-term obligations under capital leases (Note 5) 110,533 110,646 Accrued claims costs (Note 1) 82,502 77,774 Employee benefits (Note 9) 252,482 216,500 Other liabilities and deferred credits 51,163 45,450 Aircraft lease return provision (Note 1) 33,851 82,910 Deferred income taxes (Note 6) 144,463 114,946 Total Liabilities 2,058,019 1,966,386 Commitments and Contingencies (Notes 4, 5 and 13) Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Convertible Debentures of the Company (Note 7) 125,000 125,000 Shareholders' Equity (Note 8) 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 824,902 and 840,407 shares, respectively 8 8 Additional paid-in capital, preferred stock 125,459 127,817 Deferred compensation, Thrift and Stock Plan (Note 10) (80,602) (87,600) Total Preferred Shareholders' Equity 44,865 40,225 Common stock, $.625 par value; authorized 100,000,000 shares; issued 55,426,605 and 55,306,947 shares, respectively 34,642 34,567 Additional paid-in capital, common stock 331,282 328,721 Retained earnings 855,314 747,936 Deferred compensation, restricted stock (Note 11) (1,423) (2,010) Cost of repurchased common stock (6,770,628 and 6,856,567 shares, respectively) (166,939) (169,057) 1,052,876 940,157 Accumulated foreign currency translation adjustments (27,378) (8,039) Minimum pension liability adjustment (Note 9) (8,441) (4,395) Accumulated Other Comprehensive Loss (35,819) (12,434) Total Common Shareholders' Equity 1,017,057 927,723 Total Shareholders' Equity 1,061,922 967,948 Total Liabilities and Shareholders' Equity $3,244,941 $3,059,334 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. PAGE 22 CNF TRANSPORTATION INC. AND SUBSIDIARIES STATEMENTS OF CONSOLDATED INCOME YEARS ENDED DECEMBER 31 (Dollars in thousands except per share data) 2000 1999 1998 REVENUES $5,572,377 $5,037,301 $4,530,686 Costs and Expenses Operating expenses 4,611,079 4,079,152 3,658,583 General and administrative expenses 506,986 483,661 442,799 Depreciation 164,346 146,828 135,385 Net gain on sale of assets of parts distribution operation - (10,112) - Net gain on legal settlement - (16,466) - 5,282,411 4,683,063 4,236,767 OPERATING INCOME 289,966 354,238 293,919 Other Income (Expense) Investment income 2,373 189 327 Interest expense (29,972) (25,972) (32,627) Dividend requirement on preferred securities of subsidiary trust (Note 7) (6,250) (6,250) (6,250) Miscellaneous, net (Note 12) 5,079 10,055 (1,557) (28,770) (21,978) (40,107) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 261,196 332,260 253,812 Income taxes (Note 6) 109,880 144,752 112,756 Income from Continuing Operations before Accounting Change 151,316 187,508 141,056 Discontinued operations, net of tax (Note 2) - 2,966 (2,078) Loss from discontinuance, net of tax (Note 2) (13,508) - - (13,508) 2,966 (2,078) Cumulative effect of accounting change, net of tax (Note 1) (2,744) - - Net income 135,064 190,474 138,978 Preferred stock dividends 8,261 8,218 8,169 NET INCOME AVAILABLE TO COMMON SHAREHOLDERS $ 126,803 $ 182,256 $ 130,809 Weighted-Average Common Shares Outstanding (Note 1) Basic 48,490,662 48,189,618 47,659,745 Diluted 55,901,374 56,019,317 55,514,318 Earnings Per Share (Note 1) Basic Income from continuing operations $ 2.95 $3.72 $ 2.79 Discontinued operations, net of tax - 0.06 (0.05) Loss from discontinuance, net of tax (0.28) - - Cumulative effect of accounting change, net of tax (0.06) - - Net Income Available to Common Shareholders $ 2.61 $3.78 $ 2.74 Diluted Income from continuing operations $ 2.65 $3.29 $ 2.49 Discontinued operations, net of tax - 0.06 (0.04) Loss from discontinuance, net of tax (0.24) - - Cumulative effect of accounting change, net of tax (0.05) - - Net Income Available to Common Shareholders $ 2.36 $3.35 $ 2.45 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. PAGE 23 CNF TRANSPORTATION INC. AND SUBSIDIARIES STATEMENTS OF CONSOLDIATED CASH FLOWS YEARS ENDED DECEMBER 31 (Dollars in thousands) 2000 1999 1998 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR $ 146,263 $ 73,897 $ 97,617 Operating Activities Net income 135,064 190,474 138,978 Adjustments to reconcile net income to net cash provided by operating activities: Discontinued operations, net of tax 13,508 (2,966) 2,078 Cumulative effect of accounting change, net of tax 2,744 - - Depreciation and amortization 190,651 164,876 145,840 Increase in deferred income taxes 47 27,686 26,069 Amortization of deferred compensation 7,356 11,858 9,764 Provision for uncollectible accounts 9,070 15,229 11,050 Loss (gain) from sales of property, net 692 3,038 (1,220) Loss (gain) from sales of assets of businesses, net 5,459 (10,112) - Gain from sales of equity securities (2,619) (9,625) - Changes in assets and liabilities: Receivables (131,694) (94,539) (70,857) Prepaid expenses (6,169) (8,454) 2,164 Unamortized aircraft maintenance (55,419) (34,999) (16,170) Accounts payable 22,634 50,749 1,375 Accrued liabilities (54,931) 51,571 17,387 Accrued claims costs 24,923 35,459 16,494 Income taxes (49,761) (11,885) 2,226 Employee benefits 31,936 29,987 32,050 Aircraft lease return provision 5,366 34,629 (3,827) Deferred charges and credits 18,340 (38,723) (19,234) Other (4,502) (8,245) (10,830) Net Cash Provided by Operating Activities 162,695 396,008 283,337 Investing Activities Capital expenditures (235,221) (324,604) (217,725) Software expenditures (19,211) (34,811) (48,245) Proceeds from sales of equity securities 2,619 9,625 - Proceeds from sales of assets of businesses 7,263 29,260 - Proceeds from sales of property 10,441 16,986 14,872 Net Cash Used in Investing Activities (234,109) (303,544) (251,098) Financing Activities Proceeds from issuance of long-term debt 198,752 162,400 46,000 Proceeds for issuance costs of long-term debt (1,300) - - Repayment of long-term debt, guarantees and capital leases (96,513) (195,396) (51,469) Proceeds from (repayment of) short-term borrowings, net (40,000) (3,000) 43,000 Proceeds from exercise of stock options 1,792 7,474 5,483 Payments of common dividends (19,425) (19,311) (19,068) Payments of preferred dividends (10,903) (11,078) (11,212) Net Cash Provided by (Used in) Financing Activities 32,403 (58,911) 12,734 Net Cash Provided by (Used in) Continuing Operations (39,011) 33,553 44,973 Net Cash Provided by (Used in) Discontinued Operations (2,737) 38,813 (68,693) Increase (Decrease) in Cash and Cash Equivalents (41,748) 72,366 (23,720) CASH AND CASH EQUIVALENTS, END OF YEAR $ 104,515 $ 146,263 $ 73,897 Supplemental Disclosure Cash paid for income taxes, net of refunds $ 82,002 $ 63,207 $ 67,955 Cash paid for interest, net of amounts capitalized 32,806 35,833 33,141 The accompanying Notes to Consolidated Financial Statements are an integral part of these statements. PAGE 24 CNF TRANSPORTATION INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY (Dollars in thousands except per share data)
Preferred Stock Series B Common Stock Additional Number of Number of Paid-in Deferred Retained Shares Amount Shares Amount Capital Compensation Earnings BALANCE, DECEMBER 31, 1997 865,602 $ 9 54,370,182 $33,981 $433,905 $(104,347) $473,250 Net income - - - - - - 138,978 Other comprehensive loss: Foreign currency translation adjustment - - - - - - - Minimum pension liability adjustment - - - - - - - Comprehensive income - - - - - - - Exercise of stock options including tax benefits of $2,576 - - 321,079 201 7,858 - - Issuance of restricted stock, net of forfeitures - - 106,446 67 3,935 (4,852) - Issuance of employee stock awards - - - - 13 - - Recognition of deferred compensation - - - - - 9,764 - Repurchased common stock issued for conversion of preferred stock (11,411) - - - (1,357) - - Common dividends declared ($.40 per share) - - - - - - (19,068) Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,982 - - - - - - (8,169) BALANCE, DECEMBER 31, 1998 854,191 9 54,797,707 34,249 444,354 (99,435) 584,991 Net income - - - - - - 190,474 Other comprehensive income: Foreign currency translation adjustment - - - - - - - Minimum pension liability adjustment - - - - - - - Comprehensive income - - - - - - - Exercise of stock options including tax benefits of $4,198 - - 446,128 279 11,393 - - Issuance of restricted stock, net of forfeitures - - 63,112 39 2,387 (2,033) - Issuance of employee stock awards - - - - 12 - - Recognition of deferred compensation - - - - - 11,858 - Repurchased common stock issued for conversion of preferred stock (13,784) (1) - - (1,608) - - Common dividends declared ($.40 per share) - - - - - - (19,311) Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,774 - - - - - - (8,218) BALANCE, DECEMBER 31, 1999 840,407 8 55,306,947 34,567 456,538 (89,610) 747,936 Net income - - - - - - 135,064 Other comprehensive loss: Foreign currency translation adjustment - - - - - - - Minimum pension liability adjustment - - - - - - - Comprehensive income - - - - - - - Exercise of stock options including tax benefits of $281 - - 115,732 72 2,001 - - Issuance of restricted stock, net of forfeitures - - 3,926 3 295 229 - Issuance of employee stock awards - - - - 1 - - Recognition of deferred compensation - - - - - 7,356 - Repurchased common stock issued for conversion of preferred stock (15,505) - - - (2,094) - - Common dividends declared ($.40 per share) - - - - - - (19,425) Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,547 - - - - - - (8,261) BALANCE, DECEMBER 31, 2000 824,902 $ 8 55,426,605 $34,642 $456,741 $ (82,025) $855,314
CNF TRANSPORTATION INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY (Dollars in thousands except per share data)
Accumulated Cost of Other Repurchased Comprehensive Comprehensive Common Stock Income (Loss) Income BALANCE, DECEMBER 31, 1997 $(172,048) $ (6,647) Net income - - $138,978 Other comprehensive loss: Foreign currency translation adjustment - (2,493) (2,493) Minimum pension liability adjustment - (7,995) (7,995) Comprehensive income - - $128,490 Exercise of stock options including tax benefits of $2,576 - - Issuance of restricted stock, net of forfeitures - - Issuance of employee stock awards 13 - Recognition of deferred compensation - - Repurchased common stock issued for conversion of preferred stock 1,357 - Common dividends declared ($.40 per share) - - Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,982 - - BALANCE, DECEMBER 31, 1998 (170,678) (17,135) Net income - - $190,474 Other comprehensive income: Foreign currency translation adjustment - 1,101 1,101 Minimum pension liability adjustment - 3,600 3,600 Comprehensive income - - $195,175 Exercise of stock options including tax benefits of $4,198 - - Issuance of restricted stock, net of forfeitures - - Issuance of employee stock awards 13 - Recognition of deferred compensation - - Repurchased common stock issued for conversion of preferred stock 1,608 - Common dividends declared ($.40 per share) - - Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,774 - - BALANCE, DECEMBER 31, 1999 (169,057) (12,434) Net income - - $135,064 Other comprehensive loss: Foreign currency translation adjustment - (19,339) (19,339) Minimum pension liability adjustment - (4,046) (4,046) Comprehensive income - - $111,679 Exercise of stock options including tax benefits of $281 - - Issuance of restricted stock, net of forfeitures - - Issuance of employee stock awards 24 - Recognition of deferred compensation - - Repurchased common stock issued for conversion of preferred stock 2,094 - Common dividends declared ($.40 per share) - - Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,547 - - BALANCE, DECEMBER 31, 2000 $(166,939) $(35,819) The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
PAGE 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE ONE: DESCRIPTION OF BUSINESS AND PRINCIPAL ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation The consolidated financial statements include the accounts of CNF Transportation Inc. and its wholly owned subsidiaries (the Company or CNF). Organization CNF is a management company of global supply chain services with businesses in primarily regional less-than-truckload trucking, domestic and international air freight, full service logistics management, and trailer manufacturing. As described in Note 2 "Discontinued Operations," the sortation and transportation operations with the U.S. Postal Service are reflected as discontinued operations due to the termination of the Priority Mail contract, effective January 7, 2001, and except where otherwise noted, is excluded from the accompanying notes. See Note 14 "Segment Reporting" for further discussion of the Company's operating segments, markets and product lines. Estimates Management makes estimates and assumptions when preparing the financial statements in conformity with generally accepted accounting principles. These estimates and assumptions affect the amounts reported in the accompanying financial statements and notes thereto. Actual results could differ from those estimates. Recognition of Revenues As a result of recent pronouncements, including SEC Staff Accounting Bulletin No. 101, the Company elected to prospectively adopt, effective January 1, 2000, a change in accounting method for recognition of its freight transportation revenue to a preferable method. CNF now recognizes the allocation of freight transportation revenue between reporting periods based on relative transit time in each reporting period with expenses recognized as incurred. Previously, revenue was recognized when freight was received for shipment and the estimated costs of performing the transportation service were accrued. The pro forma effect of the accounting change on prior years' operating results is not material. Revenue from long-term contracts is recognized in accordance with contractual terms as services are provided. Cash Equivalents Short-term interest-bearing instruments with maturities of three months or less at the date of purchase are considered cash equivalents. Trade Accounts Receivable, Net Trade accounts receivable are net of allowances of $21,722,000 and $26,163,000 at December 31, 2000 and 1999, respectively. Property, Plant and Equipment Property, plant and equipment are depreciated on a straight-line basis over their estimated useful lives, which are generally 25 years for buildings and improvements, 10 years or less for aircraft, 5 to 10 years for tractor and trailer equipment and 3 to 10 years for most other equipment. Leasehold improvements are amortized over the shorter of the terms of the respective leases or the useful lives of the assets. Expenditures for equipment maintenance and repairs, except for aircraft, are charged to operating expenses as incurred; betterments are capitalized. Gains (losses) on sales of equipment are recorded in operating expenses. Capitalized Software Capitalized software, net, consists of costs to purchase and develop internal-use software. Amortization of capitalized software is computed on an item-by-item basis over a period of 3 to 10 years, depending on the estimated useful life of the software. Unamortized Aircraft Maintenance The costs to perform required maintenance inspections of engines and aircraft frames for leased and owned aircraft are capitalized and amortized to expense over the shorter of the period until the next scheduled maintenance or the remaining term of the lease agreement. Goodwill Goodwill, which represents the costs in excess of net assets of businesses acquired, is capitalized and amortized on a straight-line basis up to a 40-year period. Accumulated amortization at December 31, 2000 and 1999 was $116,810,000 and $105,887,000, respectively. Impairment of Long-Lived Assets The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the total amount of an asset may not be recoverable. An impairment loss is recognized when estimated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. If the asset is not considered recoverable, an amount equal to the excess of the carrying amount over the estimated discounted cash flows will be charged against the asset with a corresponding expense to the income statement. PAGE 27 Income Taxes The Company follows the liability method of accounting for income taxes. Accrued Claims Costs The Company provides for the uninsured costs of medical, casualty, liability, vehicular, cargo and workers' compensation claims. Such costs are estimated each year based on historical claims and unfiled claims relating to operations conducted through December 31. The actual costs may vary from estimates based on trends of losses for filed claims and claims estimated to be incurred but not filed. The long-term portion of accrued claims costs relate primarily to workers' compensation and vehicular claims that are payable over several years. Beginning January 1, 1999, the Company began to participate in a reinsurance pool to reinsure mostly workers compensation and vehicular liabilities. Insurer participants in the pool cede and each reinsurer participant assumes an equivalent amount of its percentage participation. Reinsurance does not relieve the Company of its liabilities under the original policy. However, in the opinion of management, the Company's reinsurers are sound and any potential exposure to the Company for non-payment is minimal. Aircraft Lease Return Provision Under certain of the Company's aircraft lease agreements, the Company is expected to return the aircraft with a stipulated number of hours remaining on the aircraft and engines until the next scheduled maintenance. The aircraft lease return provision represents the costs accrued for this obligation and any estimated unusable maintenance at the date of lease return or other disposal. 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. Foreign Currency Translation Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the Foreign Currency Translation Adjustment as Other Comprehensive Income (Loss) in the Statements of Consolidated Shareholders' Equity. Earnings Per Share (EPS) Basic EPS for continuing operations is computed by dividing reported income from continuing operations (after preferred dividends) by the weighted-average shares outstanding. Diluted EPS for continuing operations is calculated as follows: (Dollars in thousands except per share data) 2000 1999 1998 Earnings: Net income from continuing operations $143,055 $179,290 $132,887 Add-backs: Dividends on preferred stock, net of replacement funding 1,424 1,337 1,274 Dividends on preferred securities of subsidiary trust, net of tax 3,816 3,816 3,816 $148,295 $184,443 $137,977 Shares: Weighted-average shares outstanding 48,490,662 48,189,618 47,659,745 Stock option and restricted stock dilution 342,826 695,099 708,042 Series B preferred stock 3,942,886 4,009,600 4,021,531 Preferred securities of subsidiary trust 3,125,000 3,125,000 3,125,000 55,901,374 56,019,317 55,514,318 Diluted earnings per share from continuing operations $2.65 $3.29 $2.49 Reclassification Certain amounts in prior years' financial statements have been reclassified to conform to the current year presentation. NOTE TWO: 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. The contract was originally scheduled to terminate in the first quarter of 2002, subject to renewal options. Under terms of the agreement, the USPS on January 7, 2001, assumed operating responsibility for services covered under the contract, except certain air transportation and related services. As a part of the termination agreement, EWA agreed to provide certain air transportation and related services to the USPS for a transition period of not less than ninety days. In January 2001, EWA received notification from the USPS of its intention to terminate the requirement for EWA to provide transition air transportation and related services, effective April 23, 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"). PAGE 28 On January 7, 2001, the USPS paid EWA $60 million toward the termination costs. The termination agreement provides for this provisional payment to be adjusted if actual termination costs are greater or less than $60 million, in which case either the USPS will be required to make an additional payment 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, and EWA has initiated litigation in the U.S. Court of Federal Claims for that purpose. These claims are to recover costs of operating under the contract as well as profit and interest thereon. The Company's accounting policy for revenue recognition under the Priority Mail contract, including claims for underpayment relating to the period through 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 segregated and classified as discontinued operations in the Statements of Consolidated Income for all periods presented. Assets and liabilities have been reclassified in the Consolidated Balance Sheet from their historical classifications to separately reflect them as net assets of discontinued operations. Cash flows related to discontinued operations have been segregated and classified separately as net cash flows from discontinued operations in the Statements of Consolidated Cash Flows. The summarized results of discontinued operations were as follows: Years Ended December 31 (Dollars in thousands) 2000 1999 1998 Revenues $593,952 $555,509 $410,804 Operating income (loss) before taxes - 4,862 (3,401) Income taxes (benefits) - 1,896 (1,323) Income (loss) from discontinued operations $ - $ 2,966 $ (2,078) Loss from discontinuance, net of tax benefits $ (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 were as follows: (Dollars in thousands) 2000 1999 Current Assets Accounts receivable $ 10,324 $132,505 Other 15,796 1,545 26,120 134,050 Property, plant and equipment, net 66,316 83,787 Long-term receivables and other assets 184,348 25,355 Total assets of discontinued operations 276,784 243,192 Current Liabilities 94,334 108,340 Long-term liabilities 77,157 18,788 Total liabilities of discontinued operations 171,491 127,128 Net assets of discontinued operations $105,293 $116,064 The Priority Mail contract provided for the re-determination of prices paid to EWA under the contract, which gave rise to unbilled revenue. Unbilled revenue representing contract change orders or claims were included in revenue only when it was probable that the change order or claim would result in additional contract revenue and if the amount could be reliably estimated. The Company recognized unbilled revenue related to claims sufficient only to recover costs. Unbilled revenue excludes profit under the contract and interest attributable to both unbilled revenue and profit. Any unbilled revenue that EWA does not recover would be written off and reflected in operating results for discontinued operations in the current period. Any amount of litigation award in excess of unbilled revenue would be reflected as income from discontinued operations in the current period. Accordingly, no operating profit has been recognized in connection with the Priority Mail contract beginning in the third quarter of 1999, when EWA filed a claim for proposed higher prices, and including periods prior to the effective termination date on January 7, 2001. The amount of unbilled revenue related to EWA's Priority Mail contract recognized at December 31, 2000 and 1999 was $176.2 million and $123.7 million, respectively. Unbilled revenue at December 31, 2000 is included in net non-current assets of discontinued operations in the Consolidated Balance Sheets. As described above, the Company is pursuing recovery of this amount plus profit and interest thereon. 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. PAGE 29 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. Unbilled revenue at December 31, 2000 has been reduced by the $102.1 million payment from the USPS. NOTE THREE: ACCRUED LIABILITIES Accrued liabilities consist of the following as of December 31: (Dollars in thousands) 2000 1999 Other accrued liabilities $107,819 $137,081 Holiday and vacation pay 70,506 63,256 Taxes other than income taxes 38,576 69,251 Wages and salaries 31,571 33,270 Incentive compensation 34,206 35,874 Estimated revenue adjustments 29,352 30,733 Interest 5,620 8,454 Total accrued liabilities $317,650 $377,919 NOTE FOUR: DEBT AND GUARANTEES As of December 31, long-term debt and guarantees consisted of the following: (Dollars in thousands) 2000 1999 Long-term borrowings under lines of credit $ - $ 90,000 7.35% Notes due 2005 (interest payable semi-annually) 100,000 100,000 TASP Notes guaranteed, 6.00% to 8.54%, due through 2009 (interest payable semi-annually) 128,000 134,400 8 7/8% Notes due 2010 (interest payable semi-annually) 198,816 - 6.84% Industrial Revenue Bonds due 2014 (interest payable quarterly) 4,800 4,800 431,616 329,200 Less current maturities (7,500) (6,400) Total long-term debt and guarantees $424,116 $322,800 The Company has a $350 million unsecured credit facility to provide for letter of credit and working capital needs. Borrowings under the agreement, which expires in December 2001, bear interest at a rate based upon select indices plus a margin dependent on the Company's credit rating. The agreement contains various restrictive covenants that limit the incurrence of additional indebtedness and require the Company to maintain minimum amounts of net worth and fixed-charge coverage. At December 31, 2000, the Company had no borrowings and $71.8 million in letters of credit outstanding under this agreement. At December 31, 1999, $50.0 million of borrowings were outstanding with $59.8 million in letters of credit. At December 31, 2000, the Company had $100.0 million of other uncommitted lines of credit with no outstanding borrowings. At December 31, 1999, $150.0 million of other uncommitted lines of credit had no outstanding borrowings and $80.0 million was outstanding under a $100.0 million supplemental credit facility that expired in September 2000. At December 31, 1999, $40.0 million of the $130.0 million outstanding under the unsecured credit lines were classified as short-term with the remaining $90.0 million classified as long-term based on the Company's ability and intent to refinance this amount on a long-term basis. The aggregate principal amount of $117.7 million of the Company's unsecured 9 1/8% Notes was paid in full on the August 15, 1999 maturity date. The redemption of these notes was made in part with $90.0 million of borrowings under lines of credit. The weighted-average interest rate on borrowings outstanding under lines of credit at December 31, 1999 was 7.2%. The Company guarantees the notes issued by the Company's Thrift and Stock Plan (TASP). On July 1, 1999, the Company refinanced $45.25 million of Series "A" and $27.15 million of Series "A restructured" TASP notes. These notes, with respective interest rates of 8.42% and 9.04%, were replaced with $72.4 million of new TASP notes with a rate of 6.0% and a maturity date of January 1, 2006. At December 31, 2000, $66.0 million was outstanding under these refinanced notes, which contain financial covenants that require the Company to maintain minimum amounts of net worth and fixed-charge coverage. The remaining $62.0 million of TASP Notes outstanding at December 31, 2000 are subject to redemption at the option of the holders should a certain designated event occur or ratings by both Moody's and S&P of senior unsecured indebtedness decline below investment grade. The 7.35% Notes due in 2005 contain certain covenants limiting the incurrence of additional liens. The Company's consolidated interest expense as presented on the Statements of Consolidated Income is net of capitalized interest of $4,636,000 in 2000, $5,864,000 in 1999, and $2,342,000 in 1998. The aggregate annual maturities and sinking fund requirements of Long-Term Debt and Guarantees for the next five years ending December 31 are $7,500,000 in 2001, $8,700,000 in 2002, $10,100,000 in 2003, $12,000,000 in 2004 and $112,700,000 in 2005. PAGE 30 NOTE FIVE: LEASES The Company and its subsidiaries are obligated under various non-cancelable leases. The principal capital lease covers a sorting facility in Dayton, Ohio (the Hub). The Hub is financed by City of Dayton, Ohio revenue bonds. These bonds consist of $46 million of Series A refinancing bonds due in February 2018 with an interest rate of 5.625%. The remaining $62 million are due in 2009 and bear rates of interest between 6.05% and 6.20%, and have various call provisions. Included in property, plant and equipment is $83 million of Hub-related equipment and leasehold improvements, including recent expansion costs. Future minimum lease payments under all leases with initial or remaining non-cancelable lease terms in excess of one year, at December 31, 2000, are as follows: Capital Operating (Dollars in thousands) Leases Leases Year ending December 31: 2001 $ 6,819 $175,146 2002 6,819 144,747 2003 6,819 96,899 2004 6,819 68,401 2005 6,819 38,975 Thereafter (through 2018) 156,570 61,006 Total minimum lease payments 190,665 $585,174 Amount representing interest (80,079) Present value of minimum lease payments 110,586 Current maturities of obligations under capital leases (53) Long-term obligations under capital leases $110,533 Certain operating leases contain financial covenants. The most restrictive covenant requires Emery to maintain minimum amounts of fixed-charge coverage. Rental expense for operating leases is comprised of the following: (Dollars in thousands) 2000 1999 1998 Minimum rentals $240,429 $221,047 $203,714 Sublease rentals (6,069) (7,436) (4,001) Amortization of deferred gains (1,147) (1,639) (4,012) $233,213 $211,972 $195,701 NOTE SIX: INCOME TAXES The components of pretax income and income taxes are as follows: (Dollars in thousands) 2000 1999 1998 Pretax income U.S. corporations $230,391 $319,458 $244,239 Foreign corporations 30,805 12,802 9,573 Pretax income from continuing operations $261,196 $332,260 $253,812 Income taxes (benefits) Current U.S. federal $ 89,020 $ 95,629 $ 74,076 State and local 7,383 14,285 8,458 Foreign 13,430 7,152 4,153 $109,833 $117,066 $ 86,687 Deferred U.S. federal $ (1,583) $ 26,787 $ 25,048 State and local 1,630 899 1,021 47 27,686 26,069 Total income taxes $109,880 $144,752 $112,756 The components of deferred tax assets and liabilities at December 31, relate to the following: (Dollars in thousands) 2000 1999 Deferred tax assets Reserves for accrued claims costs $ 48,092 $ 40,688 Reserves for post retirement health benefits 45,843 42,411 Reserves for employee benefits 87,192 81,064 Other reserves not currently deductible 52,181 43,016 233,308 207,179 Deferred tax liabilities Depreciation and amortization 224,013 200,924 Unearned revenue 1,220 3,530 Other 47,036 41,639 272,269 246,093 Net deferred tax liability $ 38,961 $ 38,914 Deferred tax assets and liabilities in the Consolidated Balance Sheets are classified based on the related asset or liability creating the deferred tax. Deferred taxes not related to a specific asset or liability are classified based on the estimated period of reversal. Although realization is not assured, management believes it more likely than not that all deferred tax assets will be realized. PAGE 31 Income taxes vary from the amounts calculated by applying the U.S. statutory income tax rate to the pretax income as set forth in the following reconciliation: 2000 1999 1998 U.S. statutory tax rate 35.0% 35.0% 35.0% State income taxes (net of federal income tax benefit) 2.8 3.3 3.8 Foreign taxes in excess of U.S. statutory rate 1.0 0.8 0.9 Non-deductible operating expenses 0.8 1.0 1.0 Amortization of goodwill 1.2 0.9 1.2 Foreign tax credits, net (0.5) (0.4) (1.6) Other, net 1.8 3.0 4.1 Effective income tax rate 42.1% 43.6% 44.4% The cumulative undistributed earnings of the Company's foreign subsidiaries (approximately $35.4 million at December 31, 2000), which, if remitted, are subject to withholding tax, have been reinvested indefinitely in the respective foreign subsidiaries' operations unless it becomes advantageous for tax or foreign exchange reasons to remit these earnings. Therefore, no withholding or U.S. taxes have been provided. The amount of withholding tax that would be payable on remittance of the undistributed earnings would approximate $3.7 million. Certain contingencies related to income taxes are discussed in Note 13 "Commitments and Contingencies." NOTE SEVEN: PREFERRED SECURITIES OF SUBSIDIARY TRUST On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust wholly owned by the Company, issued 2,500,000 of its $2.50 Term Convertible Securities, Series A (TECONS) to the public for gross proceeds of $125 million. The combined proceeds from the issuance of the TECONS and the issuance to the Company of the common securities of the Trust were invested by the Trust in $128.9 million aggregate principal amount of 5% convertible subordinated debentures due June 1, 2012 (the Debentures) issued by the Company. The Debentures are the sole assets of the Trust. Holders of the TECONS are entitled to receive cumulative cash distributions at an annual rate of $2.50 per TECONS (equivalent to a rate of 5% per annum of the stated liquidation amount of $50 per TECONS). The Company has guaranteed, on a subordinated basis, distributions and other payments due on the TECONS, to the extent the Trust has funds available therefore and subject to certain other limitations (the "Guarantee"). The Guarantee, when taken together with the obligations of the Company under the Debentures, the Indenture pursuant to which the Debentures were issued, and the Amended and Restated Declaration of Trust of the Trust [including its obligations to pay costs, fees, expenses, debts and other obligations of the Trust (other than with respect to the TECONS and the common securities of the Trust)], provide a full and unconditional guarantee of amounts due on the TECONS. The Debentures are redeemable for cash, at the option of the Company, in whole or in part, on or after June 1, 2000 at a price equal to 103.125% of the principal amount, declining annually to par if redeemed on or after June 1, 2005, plus accrued and unpaid interest. In certain circumstances relating to federal income tax matters, the Debentures may be redeemed by the Company at 100% of the principal plus accrued and unpaid interest. Upon any redemption of the Debentures, a like aggregate liquidation amount of TECONS will be redeemed. The TECONS do not have a stated maturity date, although they are subject to mandatory redemption upon maturity of the Debentures on June 1, 2012, or upon earlier redemption. Each TECONS is convertible at any time prior to the close of business on June 1, 2012 at the option of the holder into shares of the Company's common stock at a conversion rate of 1.25 shares of the Company's common stock for each TECONS, subject to adjustment in certain circumstances. NOTE EIGHT: SHAREHOLDERS' EQUITY Series B Preferred Stock In 1989, the Board of Directors designated a series of 1,100,000 preferred shares as Series B Cumulative Convertible Preferred Stock, $.01 stated value, which is held by the CNF Thrift and Stock Plan (TASP). The Series B preferred stock is convertible into common stock, as described in Note 10 "Thrift and Stock Plan," at the rate of 4.71 shares for each share of preferred stock subject to antidilution adjustments in certain circumstances. Holders of the Series B preferred stock are entitled to vote with the common stock and are entitled to a number of votes in such circumstances equal to the product of (a) 1.3 multiplied by (b) the number of shares of common stock into which the Series B preferred stock is convertible on the record date of such vote. PAGE 32 Holders of the Series B preferred stock are also entitled to vote separately as a class on certain other matters. The TASP trustee is required to vote the allocated shares based upon instructions from the participants; unallocated shares are voted in proportion to the voting instructions received from the participants with allocated shares. Comprehensive Income SFAS 130, "Reporting Comprehensive Income," requires companies to report a measure of all changes in equity except those resulting from investment by owners and distribution to owners, in a financial statement for the period in which they are recognized. The Company has disclosed Comprehensive Income in the Statements of Consolidated Shareholders' Equity. NOTE NINE: EMPLOYEE BENEFIT PLANS Pension Plans The Company has a non-contributory defined benefit pension plan (the Plan) covering non-contractual employees in the United States. The Company's annual pension provision and contributions are based on an independent actuarial computation. Although it is the Company's funding policy to contribute the minimum required tax-deductible contribution for the year, it may increase its contribution above the minimum if appropriate to its tax and cash position and the Plan's funded status. Benefits under the Plan are based on a career average final five-year pay formula. Approximately 95% of the Plan assets are invested in publicly traded stocks and bonds. The remainder is invested in temporary cash investments, real estate funds and investment capital funds. The reported information for the defined benefit pension plan was not restated for discontinued operations due to the immaterial effect on the periods presented. The Company recognized a gain from the curtailment of the projected benefit obligation of $2.4 million in 2000, which is included in the Loss from Discontinuance. The following sets forth the change in funded status and the determination of the accrued benefit cost included in Employee Benefits in the Consolidated Balance Sheets at December 31. (Dollars in thousands) 2000 1999 Change in benefit obligation: Projected benefit obligation at beginning of year $ 397,121 $ 390,867 Service cost-benefits earned during the year 33,866 37,733 Interest cost on projected benefit obligation 33,571 30,525 Actuarial loss (gain) 12,493 (51,645) Benefits paid (11,808) (10,359) Projected benefit obligation at end of year 465,243 397,121 Change in plan assets: Fair value of plan assets at beginning of year 434,347 354,550 Actual return on plan assets (12,804) 88,878 Transfers from defined contribution plan 1,209 1,278 Benefits paid (11,808) (10,359) Fair value of plan assets at end of year 410,944 434,347 Funded status (54,299) 37,226 Unrecognized actuarial gain (66,084) (135,214) Unrecognized prior service costs 11,206 6,632 Unrecognized net asset at transition (3,388) (4,517) Accrued benefit cost $(112,565) $ (95,873) Weighted-average assumptions as of December 31: Discount rate 7.75% 8.00% Expected long-term rate of return on assets 9.50% 9.50% Rate of compensation increase 5.00% 5.00% Net pension cost includes the following: (Dollars in thousands) 2000 1999 1998 Service cost-benefits earned during the year $ 33,866 $ 37,733 $ 30,497 Interest cost on projected benefit obligation 33,571 30,525 25,338 Expected return on plan assets (40,866) (33,298) (29,386) Net amortization and deferral (7,523) 21 56 Net pension cost $ 19,048 $ 34,981 $ 26,505 The Company also has a supplemental retirement program that provides additional benefits for compensation excluded from the basic Plan. The annual provision for these programs is based on independent actuarial computations using assumptions consistent with the Plan. At December 31, 2000 and 1999, the accrued benefit cost was $20,058,000 and $16,706,000, respectively, and the net periodic pension cost was $4,951,000 in 2000, $4,290,000 in 1999, and $4,036,000 in 1998. Also included in Employee Benefits in the Consolidated Balance Sheet at December 31, 2000, was a minimum pension liability for the unfunded supplemental program. The non-cash adjustment for the minimum pension liability of $9,580,000 was offset by an intangible asset of $1,139,000 and accumulated other comprehensive loss of $8,441,000. Post Retirement Plans The Company has a retiree health plan that provides benefits to all non-contractual employees at least 55 years of age with 10 years or more of service. PAGE 33 The retiree health plan limits benefits for participants who were not eligible to retire before January 1, 1993, to a defined dollar amount based on age and years of service and does not provide employer-subsidized retiree health care benefits for employees hired on or after January 1, 1993. The following sets forth the change in accumulated benefit obligation and the determination of the accrued benefit cost included in Employee Benefits in the Consolidated Balance Sheets at December 31: (Dollars in thousands) 2000 1999 Change in benefit obligation: Accumulated benefit obligation at beginning of year $84,774 $89,947 Service cost-benefits earned during the year 1,449 1,558 Interest cost on accumulated benefit obligation 6,669 6,289 Benefit payments (5,138) (4,343) Actuarial gain (3,124) (8,677) Accumulated benefit obligation at end of year 84,630 84,774 Unrecognized net actuarial gain 13,889 10,854 Unrecognized prior service benefit 279 334 Accrued benefit cost $98,798 $95,962 Assumptions as of December 31: Weighted-average discount rate 7.75% 8.00% At December 31, 2000, a 9.5% annual rate of increase in the per capita cost of covered medical benefits was assumed for 2001 and was assumed to decrease gradually to 5.5% for 2006 and remain at that level thereafter. A 5.5% annual rate of increase in the per capita cost of dental and vision benefits was assumed for 2001 and was assumed to remain at that level thereafter. Net periodic post retirement benefit cost includes the following: (Dollars in thousands) 2000 1999 1998 Service cost-benefits earned during the year $1,449 $1,558 $2,228 Interest cost on accumulated benefit obligation 6,669 6,289 6,046 Net amortization and deferral (144) (55) (55) Net periodic post retirement benefit cost $7,974 $7,792 $8,219 A one-percentage-point change in assumed health care cost trend rates would change the aggregate service and interest cost by $697,000 and the accumulated benefit obligation by approximately $6,230,000. Other Compensation Plans The Company and each of its subsidiaries have adopted various plans relating to the achievement of specific goals to provide incentive compensation for designated employees. Total compensation earned by salaried participants of those plans was $36,134,000, $47,068,000, and $33,809,000 in 2000, 1999, and 1998, respectively, and by hourly participants was $30,612,000, $24,053,000, and $36,500,000 in 2000, 1999, and 1998, respectively. NOTE TEN: THRIFT AND STOCK PLAN The Company sponsors the CNF Thrift and Stock Plan (TASP), a voluntary defined contribution plan with a leveraged ESOP feature, for non-contractual U.S. employees. In 1989, the TASP borrowed $150,000,000 to purchase 986,259 shares of the Company's Series B Cumulative Convertible Preferred Stock. This stock is only issuable to the TASP trustee. The TASP satisfies the Company's contribution requirement by matching up to 50% of the first 3% percent of a participant's basic compensation. Company contributions to the TASP were $13,282,000 in 2000, $13,735,000 in 1999, and $10,491,000 in 1998, in the form of common and preferred stock. The Series B Preferred Stock earns a dividend of $12.93 per share and is used to repay the TASP debt. Any shortfall is paid in cash by the Company. Dividends on these preferred shares are deductible for income tax purposes and, accordingly, are reflected net of their tax benefits in the Statements of Consolidated Income. Allocation of preferred stock to participants' accounts is based upon the ratio of the current year's principal and interest payments to the total TASP debt. Since the Company guarantees the debt, it is reflected in Long-term Debt and Guarantees in the Consolidated Balance Sheets. The TASP guarantees are reduced as principal is paid. Each share of preferred stock is convertible into common stock, upon an employee ceasing participation in the plan, at a rate generally equal to that number of shares of common stock that could be purchased for $152.10, but not less than the minimum conversion rate of 4.71 shares of common stock for each share of Series B preferred stock. Deferred compensation expense is recognized as the preferred shares are allocated to participants and is equivalent to the cost of the preferred shares allocated and the TASP interest expense for the year, reduced by the dividends paid to the TASP. During 2000, 1999, and 1998, $6,998,000, $7,236,000, and $6,983,000, respectively, of deferred compensation expense was recognized. PAGE 34 At December 31, 2000, the TASP owned 824,902 shares of Series B preferred stock, of which 299,255 shares have been allocated to employees. At December 31, 2000, the Company has reserved, authorized and unissued common stock adequate to satisfy the conversion feature of the Series B preferred stock. NOTE ELEVEN: STOCK-BASED COMPENSATION Stock Options Officers and non-employee directors have been granted options under the Company's stock option plans to purchase common stock of the Company at prices equal to the market value of the stock on the date of grant. Options granted prior to June 30, 1998 generally are exercisable one year from the date of grant. Stock option grants awarded subsequent to June 30, 1998 generally vest ratably over four years following the grant date. The options generally expire 10 years from the dates of grant. The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation cost for the Company's stock-based compensation plans been determined in accordance with SFAS 123, "Accounting for Stock-Based Compensation," pro forma net income from continuing operations as reported net of preferred dividends would have been $133.2 million, $177.3 million and $130.8 million for the years 2000, 1999 and 1998, respectively. Diluted earnings per share would have been $2.38, $3.16 and $2.36 per share for the years 2000, 1999 and 1998, respectively. These pro forma effects of applying SFAS 123 are not indicative of future amounts. The weighted-average grant-date fair value of options granted in 2000, 1999 and 1998 was $14.26, $15.65, and $17.22 per share, respectively. The following assumptions were used with the Black-Scholes options pricing model to calculate the option values: risk free, weighted-average rate, 5.6%-6.9%; expected life, 5.8 years; dividend yield, 1.4%; and volatility, 60.0%. The following is a summary of stock option data: Wtd. Avg. Number of Exercise Options Price Outstanding at December 31, 1997 2,587,598 $20.12 Granted 711,350 38.29 Exercised (321,079) 17.07 Expired or canceled (46,850) 38.24 Outstanding at December 31, 1998 2,931,019 24.60 Granted 751,100 30.92 Exercised (446,128) 16.75 Expired or canceled (10,995) 30.78 Outstanding at December 31, 1999 3,224,996 27.13 Granted 1,749,950 26.24 Exercised (115,732) 15.48 Expired or canceled (131,267) 33.02 Outstanding at December 31, 2000 4,727,947 $26.90 Options exercisable as of December 31: 2000 2,013,257 $24.78 1999 2,020,646 23.66 1998 2,194,975 20.66 The following is a summary of the stock options outstanding and exercisable at December 31, 2000: Outstanding Options Exercisable Options Remaining Wtd. Avg. Wtd. Avg. Range of Number Life in Exercise Number Exercise Exercise Prices of Options Years Price of Options Price $11.08-$16.26 371,636 2.8 $14.26 371,636 $14.26 $18.05-$27.06 2,551,678 5.3 23.75 863,378 19.40 $29.63-$43.06 1,804,633 7.8 33.95 778,243 35.77 Restricted Stock Under terms of the Company's stock-based compensation plans, shares of the Company's common stock are awarded to executive officers and, to a lesser extent, directors. Restrictions on the shares generally expire one-third per year dependent on the achievement of certain market prices of the Company's common stock. Shares are valued at the market price of the Company's common stock at the date of award. The following table summarizes information about restricted stock awards for the years ended December 31: 2000 1999 1998 Wtd. Wtd. Wtd. Avg. Fair Avg. Fair Avg. Fair Shares Value Shares Value Shares Value Awarded 19,258 $34.50 63,112 $33.08 112,113 $38.51 Forfeited 15,332 23.87 - - 5,667 34.41 PAGE 35 The weighted-average fair value for shares awarded in 2000 excludes 15,276 shares awarded for settlement of pension liabilities due to certain directors. Total compensation expense recognized for restricted stock in 2000, 1999, and 1998 was $358,000, $4,622,000, and $2,781,000, respectively. At December 31, 2000, the Company had 2,658,550 common shares available for the grant of stock options, restricted stock, or other stock-based incentive compensation. NOTE TWELVE: FINANCIAL INSTRUMENTS The Company has several interest rate swap agreements. Interest rate swaps that effectively convert $128.3 million of variable-rate lease obligations to fixed-rate obligations expire through 2005. Interest rate differentials to be paid or received are recognized over the life of each agreement as adjustments to operating expense. Interest rate swaps that effectively convert the Company's 8 7/8% Notes due 2010 to floating-rate obligations expire in 2010. Interest rate differentials are recognized as adjustments to interest expense. The Company is exposed to credit loss on the interest rate swaps, but does not anticipate any loss due to the creditworthiness of its swap counterparties. The fair values of the interest rate swaps, as presented below, reflect the estimated amounts that the Company would receive if the contracts were terminated at the reported date. The following table presents the carrying amounts and estimated fair values of the Company's financial instruments at December 31: 2000 1999 Carrying Carrying (Dollars in thousands) Amount Fair Value Amount Fair Value Short-term borrowings $ - $ - $ 40,000 $ 40,000 Long-term debt 431,616 451,000 329,200 315,000 Off-balance sheet receivables: Interest rate swaps - 20,600 - 7,600 Fuel purchase contracts - - - 1,100 In December 1999, the Company recognized a $9.6 million net gain on the sale of Emery's holdings in the equity securities of Equant N.V., an international data network service provider. Approximately 34% of Emery's holdings in the securities were sold in December 1999 and the resulting gain was recognized in Miscellaneous, net in the Statements of Consolidated Income. The remaining shares held by Emery are carried at essentially no cost at December 31, 2000, and are subject to transferability restrictions. NOTE THIRTEEN: COMMITMENTS AND CONTINGENCIES In addition to letters of credit outstanding under its $350 million unsecured credit facility and other uncommitted lines of credit discussed in Note 4 "Debt and Guarantees," the Company at December 31, 2000, had $73.6 million in letters of credit outstanding under other unsecured letter of credit facilities. 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 December 31, 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 those examinations, 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 $149 million as of December 31, 2000. The amount due under the Notice was reduced in the third quarter of 2000 by a portion of the Company's $93.4 million payment to the IRS, which is described below. PAGE 36 Under the Notice, the IRS has assessed a substantial adjustment for tax years 1989 and 1990 based on the IRS' position that certain aircraft maintenance costs should have been capitalized rather than expensed for federal income tax purposes. The Company believes that its practice of expensing these types of aircraft maintenance costs is consistent with industry practice and the recently issued Treasury Ruling 2001-4. 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. At December 31, 1999, the Company had recognized approximately $53 million in Deferred Charges and Other Assets in the Consolidated Balance Sheets for amounts receivable from CFC and a corresponding payable for amounts due the IRS but reimbursable by CFC under the tax sharing agreement. In May 2000, the Company and CFC settled certain federal tax matters relating to CFC on issues for tax years 1984 through 1990. Under the settlement agreement, the Company received from CFC cash of $16.7 million, a $20.0 million note due in 2004, and a commitment to transfer to the Company land and buildings with an estimated value of $21.2 million. In the last half of 2000, the Company received real property with an estimated value of $21.2 million in settlement of CFC's commitment to transfer land and buildings. Prior to its transfer, the real property collateralized CFC's obligation to the Company. As discussed above, the IRS is seeking to recover $149 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 additional adjustments for tax years 1991 through 1996 with respect to various issues, including matters relating to CFC for years prior to the spin-off, and as mentioned above, aircraft maintenance costs. In June 2000, the Company settled the tax issue relating to the manner in which Emery Worldwide calculated and paid aviation excise taxes. 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 aviation 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, 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. NOTE FOURTEEN: SEGMENT REPORTING The operations of the Company are comprised of four business segments: Con-Way Transportation Services, Emery Worldwide, Menlo Logistics, and Other. Con-Way provides regional one- and two-day LTL freight trucking and full-service truckload freight delivery throughout the U.S., Canada and Mexico, expedited and guaranteed ground transportation, and integrated supply chain services. Emery provides expedited and deferred domestic and international air cargo services, ocean delivery, and customs brokerage. Domestically, Emery relies primarily on its dedicated aircraft and ground fleet to provide its services. Internationally, Emery acts principally as a freight forwarder. Menlo is a full-service contract logistics company that specializes in developing and managing complex distribution networks. The Other segment consists primarily of Road Systems, a trailer manufacturer, and Vector SCM, a joint venture formed with General Motors in December 2000. Vector SCM will serve as a logistics service provider to General Motors. VantageParts, the Company's former wholesale distributor of truck parts and supplies, was also included in the Other segment prior to the sale of its assets in May 1999. Intersegment revenue and related operating income have been eliminated to reconcile consolidated revenue and operating income. Management evaluates segment performance primarily based on revenue and operating income; therefore, other items included in pretax income, consisting primarily of interest income or expense, are not reported in segment results. PAGE 37 Operating income is net of all corporate expenses, which are allocated based on measurable services provided each segment or for general corporate expenses allocated on a revenue and capital basis. Identifiable corporate assets consist primarily of deferred charges and other assets, property and equipment and deferred taxes. Certain corporate assets that are used to provide shared data processing and other administrative services are not allocated to individual segments. For geographic reporting, freight transportation revenues are allocated to international locations (except for Canada) when one or both of the shipment origination or destination locations are outside of the United States. Canada, which operates as an integrated part of the North America freight operations, is allocated 50 percent of the revenue when either the origination or destination location is in Canada and the other location is in the United States or an international location. Revenues for contract services are allocated to the country in which the services are performed. Long-lived assets outside of the United States were immaterial for all periods presented. (Dollars in thousands) 2000 1999 1998 Revenues United States $4,127,040 $3,810,177 $3,459,918 Canada 149,862 132,190 112,721 North America 4,276,902 3,942,367 3,572,639 International 1,295,475 1,094,934 958,047 Total $5,572,377 $5,037,301 $4,530,686 CNF TRANSPORTATION INC. AND SUBSIDIARIES OPERATING SEGMENTS YEAR ENDED DECEMBER 31, 2000 (Dollars in thousands)
Adjustments, Discontinued Operations, Con-Way Eliminations and Transportation Emery Menlo Consolidated the Parent Services Worldwide Logistics Other Revenues $5,572,377 $ (56,664) $2,045,580 $2,628,816 $903,964 $ 50,681 Inter-company eliminations - 56,664 (684) (20,674) (13,164) (22,142) Net revenues 5,572,377 - 2,044,896 2,608,142 890,800 28,539 Operating income 289,966 - 227,312(a) 28,365(b) 33,303 986 Depreciation and amortization 190,651 9,544 93,115 80,620 6,939 433 Capital expenditures 235,221 31,992 122,592 68,087 12,291 259 Identifiable assets 3,244,941 520,689 1,011,734 1,516,394 170,326 25,798 Year Ended December 31, 1999 Revenues $5,037,301 $ (56,880) $1,879,053 $2,420,220 $727,593 $ 67,315 Inter-company eliminations - 56,880 (837) (11,804) (11,585) (32,654) Net revenues 5,037,301 - 1,878,216 2,408,416 716,008 34,661 Operating income 354,238 - 228,820 75,514 22,255 27,649(c) Depreciation and amortization 164,876 10,242 85,418 61,781 6,842 593 Capital expenditures 324,604 6,359 211,971 100,219 5,642 413 Identifiable assets 3,059,334 479,671 968,507 1,439,957 141,184 30,015 Year Ended December 31, 1998 Revenues $4,530,686 $ (77,826) $1,684,879 $2,232,815 $598,750 $ 92,068 Inter-company eliminations - 77,826 (888) (29,341) (11,915) (35,682) Net revenues 4,530,686 - 1,683,991 2,203,474 586,835 56,386 Operating income 293,919 - 206,945 64,299 19,459 3,216 Depreciation and amortization 145,840 6,601 77,269 55,025 6,138 807 Capital expenditures 217,725 6,052 102,290 101,935 7,115 333 Identifiable assets 2,659,105 397,184 825,615 1,278,228 125,728 32,350 (a) Includes a $5.5 million loss, $3.2 million after tax, from the sale of certain assets of Con-Way Truckload Services. (b) Includes an $11.9 million loss, $6.9 million after tax, from the termination of certain aircraft leases. (c) Includes a $16.5 million net gain, $9.3 million after tax, from a lawsuit settlement, and a $10.1 million net gain, $5.7 million after tax, from the sale of a truck parts operation.
PAGE 38 NOTE FIFTEEN: QUARTERLY FINANCIAL DATA (UNAUDITED) (Dollars in thousands except per share data)
March 31 June 30 September 30 December 31 2000-QUARTER ENDED Revenues $1,321,894 $1,401,146 $1,409,613 $1,439,724 Operating income 71,469 87,131 54,940(c)(d) 76,426 Income from continuing operations before income taxes 66,456(b) 79,589 46,832 68,319 Income taxes 28,244 33,825 19,435 28,376 Net income from continuing operations(a) 36,178 43,692 25,350 37,835 Discontinued operations, net of tax - - (13,508) - Cumulative effect of accounting change, net of tax (2,744) - - - Net income available to common shareholders 33,434 43,692 11,842 37,835 Per share: Basic earnings Continuing operations 0.75 0.90 0.52 0.78 Discontinued operations, net of tax - - (0.28) - Cumulative effect of accounting change, net of tax (0.06) - - - Net income available to common shareholders 0.69 0.90 0.24 0.78 Diluted earnings Continuing operations 0.67 0.80 0.47 0.70 Discontinued operations, net of tax - - (0.24) - Cumulative effect of accounting change, net of tax (0.05) - - - Net income available to common shareholders 0.62 0.80 0.23 0.70 Market price range $26.19-$34.75 $22.73-$34.38 $20.25-$29.50 $21.94-$33.81 Common dividends 0.10 0.10 0.10 0.10
March 31 June 30 September 30 December 31 1999-QUARTER ENDED Revenues $1,137,137 $1,243,438 $1,290,182 $1,366,544 Operating income 79,127(e) 93,940(f) 85,768 95,403 Income from continuing operations before income taxes 71,393 84,949 78,202 97,716(g) Income taxes 31,212 37,016 34,018 42,506 Net income from continuing operations(a) 38,154 45,872 42,147 53,117 Discontinued operations, net of tax 2,115 851 - - Net income available to common shareholders 40,269 46,723 42,147 53,117 Per share: Basic earnings Continuing operations 0.80 0.95 0.87 1.10 Discontinued operations, net of tax 0.04 0.02 - - Net income available to common shareholders 0.84 0.97 0.87 1.10 Diluted earnings Continuing operations 0.71 0.84 0.77 0.97 Discontinued operations, net of tax 0.03 0.02 - - Net income available to common shareholders 0.74 0.86 0.77 0.97 Market price range $34.15-$44.55 $32.56-$45.52 $34.64-$45.19 $28.28-$38.38 Common dividends 0.10 0.10 0.10 0.10 (a) Reduced by preferred stock dividends. (b) Includes a $2.6 million net gain, $1.5 million after tax, ($0.03 per basic and diluted share) from the sale of securities. (c) Includes a $5.5 million loss, $3.2 million after tax, ($0.07 per basic share and $0.06 per diluted share) from the sale of certain assets of Con-Way Truckload Services. (d) Includes an $11.9 million loss, $6.9 million after tax, ($0.14 per basic share and $0.12 per diluted share) from the termination of certain aircraft leases. (e) Includes a $16.5 million net gain, $9.3 million after tax, ($0.19 per basic share and $0.17 per diluted share) from a lawsuit settlement. (f) Includes a $10.1 million net gain, $5.7 million after tax, ($0.12 per basic share and $0.10 per diluted share) from the sale of a truck parts operation. (g) Includes a $9.6 million net gain, $5.4 million after tax, ($0.11 per basic share and $0.10 per diluted share) from the sale of securities.
PAGE 39 REPORTS MANAGEMENT REPORT ON REPONSIBILITY FOR FINANCIAL REPORTING The management of CNF Transportation Inc. has prepared the accompanying financial statements and is responsible for their integrity. The statements were prepared in accordance with generally accepted accounting principles, after giving consideration to materiality, and are based on management's best estimates and judgments. The other financial information in the annual report is consistent with the financial statements. Management has established and maintains a system of internal control. Limitations exist in any control structure based on the recognition that the cost of such system should not exceed the benefits derived. Management believes its control system provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition, and the prevention and detection of fraudulent financial reporting. The system of internal control is documented by written policies and procedures that are communicated to employees. The Company's internal audit staff independently assesses the adequacy and the effectiveness of the internal controls which are also tested by the Company's independent public accountants. The Board of Directors, through its audit committee consisting of five independent directors, is responsible for engaging the independent accountants and assuring that management fulfills its responsibilities in the preparation of the financial statements. The Company's financial statements have been audited by Arthur Andersen LLP, independent public accountants. Both the internal auditors and Arthur Andersen LLP have access to the audit committee without the presence of management to discuss internal accounting controls, auditing and financial reporting matters. Gregory L. Quesnel President, Chief Executive and Chief Financial Officer Kevin S. Coel Controller REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of CNF Transportation Inc. We have audited the accompanying consolidated balance sheets of CNF Transportation Inc. (a Delaware Corporation) and subsidiaries as of December 31, 2000 and 1999, and the related statements of consolidated income, cash flows and shareholders' equity for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of CNF Transportation Inc. and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. As explained in Note 1 to the Consolidated Financial Statements, effective January 1, 2001, the Company changed its method of accounting for recognition of its in-transit freight transportation revenue. Arthur Andersen LLP San Francisco, California January 26, 2001 PAGE 40 FIVE YEAR FINANCIAL SUMMARY (Dollars in thousands except per share data)
2000 1999 1998 1997 1996 SUMMARY OF OPERATIONS Revenues $5,572,377 $5,037,301 $4,530,686 $4,215,165 $3,662,183 Con-Way Transportation Services 2,044,896 1,878,216 1,683,991 1,473,188 1,292,082 Emery Worldwide 2,608,142 2,408,416 2,203,474 2,249,594 1,968,058 Menlo Logistics 890,800 716,008 586,835 455,892 359,377 Other 28,539 34,661 56,386 36,491 42,666 Operating income (loss) 289,966 354,238 293,919 277,865 192,148 Con-Way Transportation Services 227,312(c) 228,820 206,945 147,155 101,049 Emery Worldwide 28,365(d) 75,514 64,299 113,963 78,415 Menlo Logistics 33,303 22,255 19,459 17,178 10,918 Other 986 27,649(f) 3,216 (431) 1,766 Depreciation and amortization 190,651 164,876 145,840 123,391 95,746 Interest expense 29,972 25,972 32,627 39,553 39,766 Income from continuing operations before income taxes 261,196(e) 332,260(g) 253,812 234,812 147,132 Income taxes 109,880 144,752 112,756 106,839 66,951 Income from continuing operations(a) 143,055 179,290 132,887 120,087 71,589 Discontinued operations, net of tax(b) - 2,966 (2,078) (7,929) (36,386) Loss from discontinuance, net of tax(b) (13,508) - - - (16,247) Cumulative effect of accounting change, net of tax (2,744) - - - - Net Income available to common shareholders 126,803 182,256 130,809 112,158 18,956 PER SHARE Net income from continuing operations, basic 2.95 3.72 2.79 2.59 1.63 Discontinued operations, net of tax(b) - 0.06 (0.05) (0.17) (0.83) Loss from discontinuance, net of tax(b) (0.28) - - - (0.37) Cumulative effect of accounting change, net of tax (0.06) - - - - Net income available to common shareholders 2.61 3.78 2.74 2.42 0.43 Net income from continuing operations, diluted 2.65 3.29 2.49 2.33 1.48 Discontinued operations, net of tax(b) - 0.06 (0.04) (0.15) (0.73) Loss from discontinuance, net of tax(b) (0.24) - - - (0.33) Cumulative effect of accounting change, net of tax (0.05) - - - - Net income available to common shareholders 2.36 3.35 2.45 2.18 0.42 Dividends declared and paid on common stock 0.40 0.40 0.40 0.40 0.40 Common shareholders' equity 20.90 19.15 15.48 13.26 10.86 STATISTICS Total assets $3,244,941 $3,059,334 $2,659,105 $2,421,496 $2,081,866 Long-term obligations 534,649 433,446 467,635 473,488 477,201 Capital expenditures 235,221 324,604 217,725 183,164 200,835 Effective income tax rate 42.1% 43.6% 44.4% 45.5% 45.5% Basic average shares 48,490,662 48,189,618 47,659,745 46,236,688 44,041,159 Market price range $20.25-$34.75 $28.28-$45.52$21.63-$49.94 $20.25-$50.88 $17.25-$29.38 Number of shareholders 8,802 9,520 9,870 15,560 16,090 Number of regular full-time employees 28,700 28,300 26,500 26,300 25,100 (a) Reduced by preferred stock dividends. (b) Includes the results of Priority Mail operations, except for 1996, which reflects the results of CFC, the Company's former long-haul LTL segment. (c) Includes a $5.5 million loss, $3.2 million after tax, ($0.07 per basic share and $0.06 per diluted share) from the sale of certain assets of Con-Way Truckload Services. (d) Includes an $11.9 million loss, $6.9 million after tax, ($0.14 per basic share and $0.12 per diluted share) from the termination of certain aircraft leases. (e) Includes a $2.6 million net gain, $1.5 million after tax, ($0.03 per basic and diluted share) from the sale of securities. (f) Includes a $16.5 million net gain, $9.3 million after tax, ($0.19 per basic share and $0.17 per diluted share) from a lawsuit settlement, and a $10.1 million net gain, $5.7 million after tax, ($0.12 per basic share and $0.10 per diluted share) from the sale of a truck parts operation. (g) Includes a $9.6 million net gain, $5.4 million after tax, ($0.11 per basic share and $0.10 per diluted share) from the sale of securities.