-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C8dlVGBuUPkPqJABujf8RXdl3BYTrgAk+w6/g/OwYlaoK9x6Dv2Auw4nPFWhr+uK ztMs/CacNlPZwlfCEKW1iQ== 0000023675-02-000003.txt : 20020415 0000023675-02-000003.hdr.sgml : 20020415 ACCESSION NUMBER: 0000023675-02-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020326 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNF INC CENTRAL INDEX KEY: 0000023675 STANDARD INDUSTRIAL CLASSIFICATION: TRUCKING (NO LOCAL) [4213] IRS NUMBER: 941444798 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-05046 FILM NUMBER: 02585089 BUSINESS ADDRESS: STREET 1: 3240 HILLVIEW AVE CITY: PALO ALTO STATE: CA ZIP: 94304 BUSINESS PHONE: 6504942900 MAIL ADDRESS: STREET 1: 1717 NW 21ST AVE CITY: PORTLAND STATE: OR ZIP: 97209 FORMER COMPANY: FORMER CONFORMED NAME: CNF TRANSPORTATION INC DATE OF NAME CHANGE: 19970509 FORMER COMPANY: FORMER CONFORMED NAME: CONSOLIDATED FREIGHTWAYS INC DATE OF NAME CHANGE: 19920703 10-K 1 cnf_10k01final.txt 10-K DOCUMENT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2001 Commission File Number 1-5046 CNF INC. Incorporated in the State of Delaware I.R.S. Employer Identification No. 94-1444798 3240 Hillview Avenue, Palo Alto, California 94304 Telephone Number (650) 494-2900 Securities Registered Pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on Which Registered ------------------------------ ---------------------- Common Stock ($.625 par value) New York Stock Exchange Pacific Stock Exchange Securities Registered Pursuant to Section 12(g) of the Act: 8 7/8% Notes Due 2010 7.35% Notes Due 2005 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes X No ----- ----- Aggregate market value of voting stock held by persons other than Directors, Officers and those shareholders holding more than 5% of the outstanding voting stock, based upon the closing price per share Composite Tape on January 31, 2002: $1,232,949,696 Number of shares of Common Stock outstanding as of February 28, 2002: 48,981,828 DOCUMENTS INCORPORATED BY REFERENCE Parts I, II and IV CNF Inc. 2001 Annual Report to Shareholders (only those portions specifically referenced herein are incorporated in this Form 10- K). Part III Proxy Statement dated March 22, 2002 (only those portions referenced specifically herein are incorporated in this Form 10- K). PAGE 2 CNF INC. FORM 10-K Year Ended December 31, 2001 ------------------------------ INDEX ----- Item Page - ---- ---- PART I 1. Business 3 2. Properties 16 3. Legal Proceedings 18 4. Submission of Matters to a Vote of Stockholders 19 PART II 5. Market for the Registrant's Common Equity and Related Stockholder Matters 20 6. Selected Financial Data 20 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 7A. Quantitative and Qualitative Disclosures about Market Risk 20 8. Financial Statements and Supplementary Data 21 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 21 PART III 10. Directors and Executive Officers of the Registrant 22 11. Executive Compensation 23 12. Security Ownership of Certain Beneficial Owners and Management 23 13. Certain Relationships and Related Transactions 23 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 24 PAGE 3 CNF INC. FORM 10-K Year Ended December 31, 2001 ---------------------------- PART I ------ ITEM 1. BUSINESS CNF Inc. (formerly Consolidated Freightways, Inc.) and subsidiaries is a management company of global supply chain services incorporated in Delaware in 1958. Following the 1996 spin-off of Consolidated Freightways Corporation, CNF's former less-than-truckload motor carrier, the Company changed its name to CNF Transportation Inc. In 2001, the Company changed its name to CNF Inc. As used hereinafter, all references to "CNF", "the Registrant", "the Company","we," "us," and "our" and all similar references mean CNF Inc. and its subsidiaries, unless otherwise expressly stated or the context otherwise requires. CNF is a management company of global supply chain services with operations primarily represented by four reporting segments: Con-Way Transportation Services (Con-Way) provides regional next- day and second-day less-than-truckload (LTL) freight trucking throughout the U.S., Canada and Mexico, as well as expedited transportation, logistics, air freight forwarding and truckload brokerage services. Emery Worldwide (Emery) provides expedited and deferred domestic and international heavy air freight services, ocean delivery, and customs brokerage. Internationally, Emery operates primarily as an air freight forwarder using commercial airlines. Prior to the suspension and subsequent cessation of its air carrier operations in the fourth quarter of 2001, Emery provided air transportation services in North America using owned and leased aircraft operated by Emery Worldwide Airlines (EWA) and owned and leased aircraft operated by third parties. EWA, a separate subsidiary of CNF, is included in the Emery Worldwide reporting segment, except that EWA's operations under a contract (the "Priority Mail contract") with the United States Postal Service (USPS) for the sortation and transportation of Priority Mail are reported separately as discontinued operations as a result of the termination of that contract in November 2000. Since the suspension in August 2001 and subsequent cessation of EWA's air carrier operations, Emery has been utilizing aircraft operated by third parties and its existing dedicated ground fleet to provide its services. See "Emery Worldwide - Restructuring Charges," and "Emery Worldwide - Regulatory Matters." Through other business units, Emery also provides customs brokerage, ocean container services, and logistics services. Menlo Logistics (Menlo) provides integrated contract logistics services, including the development and management of complex distribution networks, and supply chain engineering and consulting. PAGE 4 The Other segment in 2001 included the operating results of Road Systems, a trailer manufacturer, Vector SCM, and certain corporate items. Vector SCM is a joint venture formed with General Motors in December 2000 to provide logistics services to General Motors. CNF owns a majority of the Vector SCM joint venture; however, the operating results of Vector SCM are reported in the Other segment as an equity method investment based on General Motors' ability to control certain operating decisions. In 2000, the Other reporting segment included the operating results of Road Systems and Vector SCM. In 1999, the Other reporting segment included Road Systems, a gain from a corporate legal settlement and, prior to the sale of its assets in May 1999, VantageParts, CNF's former wholesale distributor of truck parts and supplies. As described under "Discontinued Operations," EWA's operations under a Priority Mail contract with the USPS are reflected as discontinued operations due to the termination of the contract, effective January 7, 2001. As described below in "Emery Worldwide - Restructuring Charges," CNF announced on December 5, 2001 that Emery in 2002 would become part of CNF's new Menlo Worldwide group of supply chain service providers and would continue to provide full North American freight forwarding services utilizing aircraft operated by other air carriers and its existing dedicated ground fleet. As a result, beginning with the first quarter of 2002, CNF's operations will consist of three primary lines of business: Con- Way, Menlo Worldwide, and Other. In compliance with Statement of Financial Accounting Standards 131, "Disclosures about Segments of an Enterprise and Related Information", CNF discloses segment information in the manner in which the components are organized for making operating decisions, assessing performance and allocating resources. For financial information concerning CNF's reporting segments, refer to Note 15 to the Consolidated Financial Statements contained in the CNF 2001 Annual Report to Shareholders, which Note is incorporated herein by reference. CNF's operations are primarily conducted in the U.S. but to an increasing extent are conducted in foreign countries. For geographic group information, also refer to Note 15 to the Consolidated Financial Statements contained in the CNF 2001 Annual Report to Shareholders, which Note is incorporated herein by reference. PAGE 5 - --------------------- CONTINUING OPERATIONS - --------------------- Con-Way Transportation Services - ------------------------------- The Con-Way reporting segment comprises Con-Way Transportation Services Inc. and its subsidiaries. Con-Way Regional Carriers Con-Way's primary business units are three regional LTL motor carriers that operate regional trucking networks. These regional LTL carriers principally serve core geographic territories with next-day and second-day service to manufacturing, industrial, commercial and retail business-to-business customers. Con-Way's regional carriers include Con-Way Central Express (CCX), which serves 25 states in the central and northeast U.S., Ontario and Quebec, Canada and Puerto Rico; Con-Way Southern Express (CSE), which serves a 12-state southern market from Texas to Virginia and Florida, and also operates in Puerto Rico and parts of Mexico; and Con-Way Western Express (CWX), which serves 13 western states and parts of Canada and Mexico. Con-Way offers coast-to-coast service in all 50 states by fully linking its three regional carriers. Con-Way refers to this linked service as joint service. This permits Con-Way's regional carriers to provide full service throughout the U.S. and to some major cities in Canada. By offering joint services, the regional carriers provide next-day and second-day freight delivery between their respective core territories utilizing existing infrastructure. The joint service allows each regional carrier to provide service into other regions on routes that would not otherwise be serviced as part of its core territory. Con-Way NOW, Con-Way Logistics and Con-Way Air Express Con-Way NOW specializes in time-definite shipments, such as replacement parts, medical equipment and other urgent shipments, where expedited delivery is critical. Con-Way NOW has delivery service in 48 states and parts of Canada. In 1998, Con-Way created Con-Way Logistics (formerly Con-Way Integrated Services) to provide logistics solutions to customers. Con-Way Logistics offers integrated supply chain services for shippers, using its own warehouses, transportation provided by other ground and air carriers as well as Con-Way's regional carriers, and alliances with leading supply chain software firms to offer semi-customized solutions configured to its customers' needs. In May 2001, Con-Way opened Con-Way Air Express (CAX), an air freight forwarder that arranges freight shipments using transportation provided by other operators, including commercial airlines, dedicated air operators and drayage companies. Through an agency network and connections with other Con-Way components, CAX provides full coverage in the United States and Puerto Rico. PAGE 6 In January 2002, Con-Way announced the opening of Con-Way FULL LOAD, a truckload brokerage operation that will provide truckload services in the United States and parts of Canada through contract arrangements with numerous truckload fleet operators. Prior to the sale of most of its assets in August 2000, Con-Way Truckload Services (CWT) was a full-service, multi-modal truckload company that provided door-to-door delivery of truckload shipments. Con-Way - Competitive Conditions The trucking, logistics, and air freight forwarding industries are intensely competitive. Principal competitors of Con-Way include regional and national LTL companies. Competition in the trucking industry is based on freight rates, service, reliability, transit times and scope of operations. Emery Worldwide - --------------- The Emery Worldwide reporting segment includes the combined accounts of Emery Air Freight Corporation and its subsidiaries (EAFC), a portion of the operations of Emery Worldwide Airlines, Inc. (EWA), and Emery Expedite!, Inc. CNF is the owner of 100% of the outstanding shares of these companies. Emery provides expedited and deferred domestic and international heavy air freight services, ocean container services, and customs brokerage. Internationally, Emery operates primarily as an air freight forwarder using commercial airlines. Prior to the suspension and subsequent cessation of its air carrier operations in the fourth quarter of 2001, Emery provided air transportation services in North America using owned and leased aircraft operated by EWA and owned and leased aircraft operated by third parties. EWA, a separate subsidiary of CNF, is included in the Emery Worldwide reporting segment except for EWA's operations under the Priority Mail contract, which are reported separately as discontinued operations. Since the suspension in August 2001 and subsequent cessation of EWA's air carrier operations, Emery has been utilizing aircraft operated by third parties and EAFC's existing dedicated ground fleet to provide its services. See "Emery Worldwide - Restructuring Charges," and "Emery Worldwide - Regulatory Matters," below. Restructuring Charges In June 2001, Emery began an operational restructuring to align it with management's estimates of future business prospects for domestic heavy air freight and address changes in market conditions, which had deteriorated due to a slowing domestic economy, loss of EWA's contracts with the USPS to transport Express Mail (refer to "-Express Mail Contract" below) and Priority Mail (refer to "Discontinued Operations" below) and, to a lesser extent, loss of business to ground transportation providers. The $340.5 million restructuring charge recognized in the second quarter of 2001 consisted primarily of non-cash impairment charges and estimated future cash expenditures related primarily to the return to the lessors of certain aircraft leased to Emery and the termination of the related leases. PAGE 7 As described below under "-Regulatory Matters," the Federal Aviation Administration (FAA) required EWA to suspend its air carrier operations on August 13, 2001. In response to the FAA action, as well as the effects of the September 11 terrorist attacks and a deepening global economic recession, Emery's management re-evaluated Emery's restructuring plan. CNF announced on December 5, 2001 that Emery in 2002 would become part of CNF's new Menlo Worldwide group of supply chain service providers and would continue to provide full North American freight forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, and that EWA would cease air carrier operations. In connection with the revised restructuring plan, in the fourth quarter of 2001 Emery recognized additional restructuring charges of $311.7 million for the planned disposal of leased aircraft, cessation of EWA's remaining operations, employee separation costs, and other costs. Refer to the information appearing under the captions "Emery Worldwide - Restructuring Charges" and "Liquidity and Capital Resources - Restructuring Charges and Regulatory Matters" under "Management's Discussion and Analysis" contained in the 2001 Annual Report to Shareholders, which information is incorporated herein by reference. Regulatory Matters Until August 13, 2001, EWA operated as an airline. Although EWA has ceased air carrier operations, EWA still has an air carrier certificate issued by the FAA and is subject to maintenance, operating and other safety-related regulations promulgated by the FAA and is subject to FAA inspections. Based on issues identified during inspections conducted by the FAA, on August 13, 2001 EWA was required to suspend its air carrier operations as part of an interim settlement agreement with the FAA. As described above, CNF announced on December 5, 2001 that EWA was ceasing its air carrier operations. Since EWA's suspension of its air carrier operations on August 13, 2001, Emery has been providing freight forwarding service to its customers in North America by utilizing aircraft operated by other air carriers. Emery intends to continue to use aircraft operated by third parties and its existing dedicated ground fleet to provide freight forwarding service to its customers in North America. Refer to the information appearing under the captions "Emery Worldwide - Regulatory Matters" and "Liquidity and Capital Resources - Restructuring Charges and Regulatory Matters" under "Management's Discussion and Analysis" contained in the 2001 Annual Report to Shareholders, which information is incorporated herein by reference. Express Mail Contract In January 2001, the USPS and Federal Express Corporation (FedEx) announced an exclusive agreement under which FedEx will transport Express Mail and Priority Mail. EWA transported Express Mail and other classes of mail for the USPS under a contract (the "Express Mail contract"), which was originally scheduled to expire in January 2004; however, the USPS terminated the Express Mail contract effective August 26, 2001. As described below under "Discontinued Operations," on November 3, 2000, EWA and the USPS announced an agreement (the "Termination Agreement") to terminate their contract for the transportation and sortation of Priority Mail (the "Priority Mail contract"). On September 26, 2001, EWA entered into an agreement with the USPS to settle claims relating to the Priority Mail contract with the USPS (the "Settlement Agreement"). Under the Settlement Agreement, EWA received a $235 million payment from the USPS on September 28, 2001 to settle all non-termination claims under the Priority Mail contract. Under the Settlement Agreement, on September 28, 2001, EWA also received a $70 million provisional payment from the USPS for termination costs and other claims related to the Express Mail contract. The Settlement Agreement provides for the provisional payment to be adjusted if actual termination costs and other agreed upon claims relating to the Express Mail contract are greater or less than $70 million, in which case either the USPS will be required to make an additional payment with interest or EWA will be required to return a portion of the provisional payment with interest to the USPS. PAGE 8 The Settlement Agreement provides that the total amount payable by the USPS for termination costs and other claims relating to the Express Mail contract may not exceed $150 million. On December 14, 2001, EWA filed a termination settlement proposal with the USPS for recovery of EWA's costs of providing service under the terminated Express Mail contract as well as costs incurred by EWA's subcontractors for performing services under the Express Mail contract. Any recovery of such costs would be offset in whole or in part by the $70 million provisional payment received in 2001. In 2001, Emery recognized revenue of $117.0 million from the transportation of mail under the Express Mail contract, compared to $229.1 million in 2000 and $226.2 million in 1999. Operating income from the Express Mail contract in 2001 was $6.3 million compared to $28.2 million in 2000 and $35.5 million in 1999. In addition to mail transported under the Express Mail contract, EWA also transported mail under other separate contracts with the USPS. Excluding revenue from the Priority Mail contract, which is described under "Discontinued Operations", total revenue from EWA's Express Mail contract and other contracts with the USPS was $144.0 million in 2001, $258.2 million in 2000, and $252.6 million in 1999. Emery Air Freight Corporation - International Internationally, Emery operates as an air freight forwarder using mostly commercial airlines. (International business comprises shipments that either originate or terminate outside of the United States). EAFC provides services internationally through foreign subsidiaries, branches, service centers and agents. EAFC's expansion plans have been focused on international operations due to the expectation of greater opportunities in an expanding worldwide economy and the generally lower capital requirements of its variable-cost-based international operations. From 1996 to 2001, EAFC's international air freight revenue, including fuel surcharges, increased at an average annual rate of 6.2%, compared with a 5.6% average annual rate of decline, including fuel surcharges, in North American air freight revenue for the same period. For 2001, international airfreight revenue, including fuel surcharges, was $1.05 billion or 58.3% of Emery's total airfreight revenue. PAGE 9 Emery Air Freight Corporation - North America Following the suspension and subsequent cessation of EWA's air carrier operations in 2001, EAFC has continued to provide full North American freight forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft. EAFC's hub-and-spoke system is centered at the Dayton, Ohio International Airport, where its leased air cargo facility (the Hub) and related support facilities are located. The Hub handles a wide variety of shipments, ranging from small packages to heavyweight cargo. While Emery's freight system is designed to handle parcels, packages and shipments of a variety of sizes and weights, its air freight operations are focused primarily on heavy air freight (defined as shipments of 70 pounds or more). In addition to the Hub, EAFC operates nine regional hubs, strategically located around the United States, and a system of service centers and sales offices. Emery Expedite!, Emery Ocean Services, Emery Customs Brokerage, and Emery Global Logistics Emery has established several variable-cost-based "strategic business units" to enhance the range of services it can offer to its customers. Emery Expedite! is a rapid-response freight- handling subsidiary providing door-to-door delivery of shipments in North America and overseas. Emery Ocean Services provides global less-than-container, full-container and charter services. Emery Customs Brokerage provides full-service customs clearance regardless of mode or carrier. Emery Global Logistics operates North American and international warehouses and distribution centers for a variety of customers. In connection with the announcement of the new Menlo Worldwide group described above, Emery Global Logistics in 2002 will be integrated with Menlo Logistics. Competition The air freight industry is intensely competitive. Principal competitors of Emery include integrated air freight carriers, air freight forwarders and international airlines and, to a lesser extent, trucking companies and passenger and cargo air carriers. Competition in the air freight industry is based on, among other things, freight rates, quality of service, reliability, transit times and scope of operations. Outlook As described above, CNF on December 5, 2001 announced that Emery would become part of CNF's new Menlo Worldwide group effective in 2002 and would continue to provide North American freight forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, and that EWA would cease air carrier operations. As a result, John Williford, President of the Menlo Worldwide group of supply chain service providers, will have responsibility for the newly-aligned Emery Forwarding business unit. Chutta Ratnathicam, Emery's former Chief Executive Officer, returned to his former position as CNF's Chief Financial Officer. Management will continue Emery's focus on expanding its variable-cost-based international operations and actively renegotiating airhaul rates in an effort to improve international operating margins. In North America, management will continue to position Emery as a freight forwarder utilizing aircraft operated by other carriers. As a result, management expects a more flexible variable-cost-based operating structure in North America with an increase in second-day and deferred services. Management will continue its efforts to reduce Emery's North American cost structure, including the service center and hub network. PAGE 10 Menlo Logistics - --------------- The Menlo reporting segment comprises Menlo Logistics, Inc., which was founded in 1990, and its subsidiaries (Menlo). Menlo specializes in developing and managing complex national and global supply and distribution networks, including transportation management, dedicated contract warehousing and dedicated contract carriage. In serving its customers, Menlo uses and develops logistics optimization and customer order and shipment tracking software, and also provides real-time warehouse, transportation and order management systems. Menlo has developed the ability to link these systems with its customers' internal systems. Menlo believes that its technology skills, operations processes, and design expertise with sophisticated logistics systems have established it as a leader in the field of contract logistics and has provided it with a competitive advantage in managing carrier networks, dedicated vehicle fleets and automated warehouses as an integrated system. Menlo believes that three industry trends have contributed to its growth. First, Menlo believes a number of businesses are increasingly evaluating their overall logistics costs, including transportation, warehousing and inventory carrying costs. Second, outsourcing of non-core services, such as distribution, has become more commonplace with many businesses. Finally, Menlo believes the ability to access information through computer networks has increased the value of capturing real-time logistics information to track inventories, shipments and deliveries. Menlo believes that its ability to provide solutions to intricate distribution issues for large companies with complex supply chains has helped Menlo to secure new projects and expand services for existing customers. Compensation from Menlo's customers takes different forms, including cost-plus, gain- sharing, per-piece, fixed-dollar and consulting fees. In most cases, customers reimburse Menlo's customer-specific start-up and development costs. In 2001, three customers individually accounted for 19%, 13%, and 12% of Menlo's revenues, respectively. The loss of significant revenue from any of Menlo's major customers by termination of the customer relationship for any reason, including the business failure of the customer, could negatively affect Menlo's results of operations. Refer to the information appearing under the caption "Menlo Worldwide - Loss from the Business Failure of a Customer" under Management's Discussion and Analysis" contained in the 2001 Annual Report to Shareholders, which information is incorporated herein by reference. Menlo seeks to reduce its reliance on individual customers through continued growth in its customer base and will also continue to evaluate the credit-worthiness of its customers. Menlo generally seeks to reduce risks related to the termination of a customer relationship, for reasons other than the business failure of a customer, by requiring that any facility or major equipment lease that it enters into on behalf of a customer must be assumed by the customer upon termination of the contract with Menlo. In addition, Menlo's logistics contracts generally require that, if a customer terminates a contract, the customer must purchase from Menlo any contract-specific assets purchased by Menlo in order to provide service under the contract. PAGE 11 Menlo - Competition Menlo operates in the intensely competitive third-party logistics industry. Competition for larger projects is generally based on computer system skills and the ability to rapidly implement logistics solutions. Competitors in the logistics industry are numerous and include domestic and foreign logistics companies and the logistics arms of integrated transportation companies; however, Menlo primarily competes against a limited number of major competitors that have resources sufficient to service large logistics contracts. Outlook As described above, CNF on December 5, 2001 announced the formation of CNF's new Menlo Worldwide group effective in 2002, which will consist of Menlo Logistics, Emery Forwarding, Vector SCM, and Menlo Worldwide Technologies, a new information technology, supply chain engineering and consulting unit of Menlo Worldwide. Menlo Worldwide's strategy is intended to capitalize on the growth prospects of the global supply chain management market by providing customers around the world with a full range of logistics services from a single source. Menlo's management believes that its customers will benefit from being a part of Emery's extensive worldwide network and from Emery's extensive international logistics projects and locations, which will be absorbed into the new organization. Other Segment - ------------- In 2001, the Other segment included the operating results of Road Systems, Vector SCM and other corporate items. In 2000, the Other reporting segment included the operating results of Road Systems and Vector SCM. In 1999, the Other reporting segment included Road Systems, a gain from a corporate legal settlement, and prior to the sale of its assets in May 1999, VantageParts. Road Systems and VantageParts A majority of the revenue from Road Systems and, prior to the sale of its assets in May 1999, VantageParts, was from sales to other CNF subsidiaries and to Consolidated Freightways Corporation, CNF's former less-than-truckload motor carrier that was spun-off to CNF's shareholders in 1996. Road Systems primarily manufactures and rebuilds trailers, converter dollies and other transportation equipment. Prior to the sale of its assets in May 1999, VantageParts served as a distributor and remanufacturer of vehicle component parts and accessories to the heavy-duty truck and trailer industry. Vector SCM In December 2000, General Motors (GM) and CNF formed a joint venture company called Vector SCM (supply chain management). Vector SCM was established to reduce GM's supply chain costs and improve GM's supply chain management by bringing increased speed, flexibility and reliability to GM's global supply chain, including shipment of parts to manufacturing plants and its vehicles to dealers. With more dependable deliveries, GM's goal is to build a vehicle to schedule when necessary and deliver that vehicle as promised to the consumer with a shortened cycle time. PAGE 12 Vector SCM provides logistics services through the development and implementation of technology and physical infrastructure to provide end-to-end visibility of the progression of products and materials through GM's supply chain. Under the terms of the joint venture agreement, the transition of GM's logistics services and management to Vector SCM is expected to occur over the three-year period from 2001 through 2003. In the first full contract year, logistics services in North America included a redesign of processes related to inbound production materials, vehicle distribution and visibility, premium transportation, international export/import and rail operations monitoring. Vector SCM implementation is expected to expand to other regions in varying degrees in accordance with regional business requirements. Under the terms of the joint venture agreement, CNF would share in any savings realized by GM as a result of reductions in its supply chain costs. CNF owns a majority of the Vector SCM joint venture; however, the operating results of Vector SCM are reported in the Other segment as an equity method investment based on GM's ability to control certain operating decisions. - ----------------------- DISCONTINUED OPERATIONS - ----------------------- On November 3, 2000, EWA and the USPS announced an agreement (the "Termination Agreement") to terminate their contract for the transportation and sortation of Priority Mail (the "Priority Mail contract"). The Priority Mail contract was originally scheduled to terminate in the first quarter of 2002, subject to renewal options. Under the terms of the Termination Agreement, the USPS on January 7, 2001 assumed operating responsibility for services covered under the Priority Mail contract, except certain air transportation and related services, which were terminated effective April 23, 2001. The USPS agreed to reimburse EWA for Priority Mail contract termination costs, including costs of contract-related equipment, inventory, and operating lease commitments, up to $125 million (the "Termination Liability Cap"). On January 7, 2001, the USPS paid EWA $60 million toward the termination costs. The Termination Agreement 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 with interest or EWA will be required to return a portion of the provisional payment with interest to the USPS. The Termination Agreement preserved EWA's right to pursue claims for underpayment of other amounts owed to EWA under the contract, which were ultimately settled in September 2001 as described below. CNF believes 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 EWA will receive any additional payments relating to these termination costs or that all termination costs incurred by EWA will be recovered. PAGE 13 On September 26, 2001, EWA entered into an agreement with the USPS to settle claims relating to the underpayment of amounts owed to EWA under the Priority Mail contract (the "Settlement Agreement"). Under the Settlement Agreement, EWA received a $235 million payment from the USPS on September 28, 2001 to settle all non-termination claims under the Priority Mail contract. These claims were to recover costs of operating under the contract as well as profit and interest thereon. The Priority Mail Termination Agreement described above is unaffected by the Settlement Agreement. Under the Settlement Agreement, on September 28, 2001, EWA also received a $70 million provisional payment from the USPS to provisionally pay EWA for termination costs and other claims related to EWA's Express Mail contract, which was terminated by the USPS in August 2001 as described above under "Emery Worldwide-Express Mail Contract." Results of the Express Mail contract are included in the Emery Worldwide reporting segment and are therefore not reported under "Discontinued Operations." As a result of the termination of the Priority Mail contract, the results of operations, net assets, and cash flows of the Priority Mail operations have been segregated and classified as discontinued operations. Summary financial data and related information are included in Note 2 to the Consolidated Financial Statements contained in the 2001 Annual Report to Shareholders, which Note 2 is incorporated herein by reference. GENERAL - ------- Employees At December 31, 2001, CNF's operations had approximately 26,100 regular full-time employees. Regular full-time employees by segment were as follows: Con-Way, 15,200; Emery Worldwide, 7,700; Menlo, 2,100; Other segment, 1,100. Of the 1,100 regular full- time employees included in the Other segment, approximately 800 were employed by CNF in executive, administrative and technology positions to support CNF's operating subsidiaries. Seasonality CNF operates in industries that are affected directly by general economic conditions and seasonal fluctuations, both of which affect demand for transportation services. In a typical year for the trucking and air freight industries, 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. Regulation - Ground Transportation The motor carrier industry is subject to federal regulation by the Federal Highway Administration (FHWA) and the Surface Transportation Board (STB), both of which are units of the United States Department of Transportation (DOT). The FHWA performs certain functions inherited from the Interstate Commerce Commission (ICC) relating chiefly to motor carrier registration, cargo and liability insurance, extension of credit to motor carrier customers, and leasing of equipment by motor carriers from owner-operators and also enforces comprehensive trucking safety regulations. The STB has authority to resolve certain types of pricing disputes and authorize certain types of intercarrier agreements under jurisdiction inherited from the ICC. PAGE 14 At the state level, federal preemption of economic regulation does not prevent the states from regulating motor vehicle safety on their highways. In addition, federal law allows all states to impose insurance requirements on motor carriers conducting business within their borders, and empowers most states to require motor carriers conducting interstate operations through their territory to make annual filings verifying that they hold appropriate registrations from FHWA. Motor carriers also must pay state fuel taxes and vehicle registration fees, which normally are apportioned on the basis of mileage operated in each state. Regulation - Air Transportation The air transportation industry is subject to extensive regulation by various federal, state and foreign governmental entities. The industry is subject to federal regulation under the Federal Aviation Act of 1958, as amended (Aviation Act) and regulations issued by the DOT pursuant to the Aviation Act. EAFC, as an air freight forwarder, is exempt from most DOT economic regulations and is not subject to Federal Aviation Administration (FAA) safety regulations, except security-related rules. Although EWA ceased air carrier operations on August 13, 2001, EWA still has an air carrier certificate issued by the FAA and is subject to maintenance, operating and other safety-related regulations promulgated by the FAA and is subject to FAA inspections. See the information appearing under the caption "Emery Worldwide - Regulatory Matters" under Management's Discussion and Analysis" contained in the 2001 Annual Report to Shareholders, which information is incorporated herein by reference. During recent years, operations at several airports have been subject to restrictions or curfews on arrivals or departures during certain night-time hours designed to reduce or eliminate noise for surrounding residential areas. None of these restrictions has materially affected Emery's operations. If such restrictions were to be imposed with respect to the airports at which EAFC's activities are centered (particularly EAFC's major Hub at the Dayton International Airport), and no alternative airports were available to serve the affected areas, there could be a material adverse effect on Emery's operations. Regulation - Environmental CNF is subject to stringent laws and regulations that (i) govern activities or operations that may have adverse environmental effects such as discharges to air and water, as well as handling and disposal practices for solid and hazardous waste, and (ii) impose liability for the costs of cleaning up, and certain damages resulting from, sites of past spills, disposals or other releases of hazardous materials. In particular, under applicable environmental laws, CNF may be responsible for remediation of environmental conditions and may be subject to associated liabilities (including liabilities resulting from lawsuits brought by private litigants) relating to its operations and properties. Environmental liabilities relating to CNF's properties may be imposed regardless of whether CNF leases or owns the properties in question and regardless of whether such environmental conditions were created by CNF or by a prior owner or tenant, and also may be imposed with respect to properties which CNF may have owned or leased in the past. PAGE 15 CNF's operations involve the storage, handling and use of diesel and jet fuel and other hazardous substances. In particular, CNF is subject to stringent environmental laws and regulations dealing with underground fuel storage tanks and the transportation of hazardous materials. CNF has been designated a Potentially Responsible Party (PRP) by the EPA with respect to the disposal of hazardous substances at various sites. CNF expects that its share of the clean-up costs will not have a material adverse effect on CNF's financial condition or results of operations. PAGE 16 ITEM 2. PROPERTIES - --------------------- CONTINUING OPERATIONS - --------------------- Con-Way Transportation Services Segment - --------------------------------------- As of December 31, 2001, Con-Way's regional carriers operated 332 freight service centers, of which 103 were owned and 229 were leased. The service centers, which are strategically located to cover the geographic areas served by Con-Way, represent physical buildings and real property with dock, office and/or shop space ranging in size from approximately 1,400 to 229,000 square feet. These facilities do not include meet-and-turn points, which generally represent small owned or leased real property with no physical structures. The total number of trucks, tractors and trailers utilized by the Con-Way regional carriers at December 31, 2001 was approximately 27,400. In addition, Con-Way Logistics at December 31, 2001 leased 7 warehouses near Mira Loma, California; Chicago, Illinois; Atlanta, Georgia; Cranbury, New Jersey; Tigard, Oregon; Houston, Texas; and Dallas, Texas. The warehouses range in size from approximately 25,000 to 240,000 square feet. As of December 31, 2001, Con-Way Air Express operated 14 leased warehouse and service center facilities ranging in size from 4,800 square feet to 11,000 square feet. Emery Worldwide Segment - ----------------------- Emery's hub system is centered at the Dayton, Ohio International Airport (the Hub), where its leased air cargo facility and related support facilities are located. The Hub, which encompasses approximately 800,000 square feet, was financed by City of Dayton, Ohio revenue bonds, of which $108 million in principal amount was outstanding as of December 31, 2001. The Hub and related property secures the industrial revenue bonds. As of December 31, 2001, EAFC operated 121 freight facilities in North America, including service centers and logistics warehouses, of which 15 were owned and 106 were leased. The freight service centers are strategically located to cover the geographic areas served by Emery. These facilities range in size from approximately 1,000 to 112,000 square feet of office, dock and/or shop space. At December 31, 2001, Emery operated approximately 100 leased facilities in international locations, including service centers, logistics warehouses and office space. At December 31, 2001, EAFC operated approximately 1,500 trucks, tractors and trailers, as well as equipment provided by its agents. In addition, Emery Global Logistics at December 31, 2001 leased 6 warehouses in Los Angeles and Milpitas, California; Mt. Vernon, New York; Vandalia, Ohio; Allentown, Pennsylvania; and Saltillo, Mexico ranging in size from 5,200 square feet to 170,000 square feet. PAGE 17 As described above under "Emery Worldwide - Restructuring Charges", CNF announced on December 5, 2001 that EWA would cease air carrier operations and that Emery would continue to provide full North American freight forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, including 11 aircraft leased by Emery and operated by another air carrier. As a result of the cessation of EWA's air carrier operations, 37 aircraft leased by EWA were grounded and placed in storage at December 31, 2001. As described above under "Emery Worldwide - Express Mail Contract", the USPS terminated the Express Mail contract effective August 26, 2001. As a result, 18 aircraft owned by EWA and previously used in providing service under the Express Mail contract were grounded and placed in storage at December 31, 2001. On December 14, 2001, EWA filed a termination settlement proposal with the USPS for recovery of EWA's costs of providing service under the terminated Express Mail contract, including costs related to owned aircraft. Menlo Logistics Segment - ----------------------- As of December 31, 2001, Menlo operated 42 warehouses. Of these warehouses operated by Menlo, 26 were leased by Menlo and 16 were leased or owned by Menlo's clients. The 26 facilities leased by Menlo ranged in size from approximately 12,000 to 311,000 square feet. At December 31, 2001, Menlo operated approximately 500 trucks, tractors and trailers. Other Segment - ------------- Principal properties of the Other segment include CNF's leased executive offices in Palo Alto, California, and its Administrative and Technology (AdTech) Center in Portland, Oregon. As of December 31, 2001, CNF's administrative and technology employees were located at three owned AdTech Center buildings comprising approximately 476,000 square feet. - ----------------------- DISCONTINUED OPERATIONS - ----------------------- As described above in Item 1, "Discontinued Operations", the USPS has agreed to reimburse CNF for Priority Mail contract termination costs, including costs of contract-related equipment, inventory and operating lease commitments. Reimbursement by the USPS is subject to the Termination Liability Cap and the terms discussed above. PAGE 18 ITEM 3. LEGAL PROCEEDINGS Certain legal proceedings of CNF are summarized in Note 14 to the Consolidated Financial Statements contained in the 2001 Annual Report to Shareholders, which Note is incorporated herein by reference. Discussion of environmental matters is presented in Item 1 above. The Department of Transportation, through its Office of Inspector General, and the FAA have been conducting an investigation relating to the handling of so-called hazardous materials by Emery. The Department of Justice has joined in the investigation and is seeking to obtain additional information through the grand jury process. The investigation is ongoing and Emery is cooperating fully. CNF is unable to predict the outcome of this investigation. EWA has received subpoenas issued by federal grand juries in Massachusetts and the District of Columbia, and the USPS Inspector General for documents relating to the Priority Mail contract. EWA has provided, and is continuing to provide, the documents. On February 16, 2000, a DC-8 cargo aircraft operated by EWA personnel crashed shortly after take-off from Mather Field, near Sacramento, California. The crew of three was killed. The cause of the crash has not been conclusively determined. The National Transportation Safety Board (NTSB) is conducting an investigation. EWA has been informed that a NTSB hearing has been scheduled for May 9, 2002, although EWA has not yet received a formal notice of hearing for that date. EWA is currently unable to predict the outcome of this investigation or the effect it may have on Emery or CNF. Emery, EWA and CNF have been named as defendants in wrongful death lawsuits brought by the families of the three deceased crew members, seeking compensatory and punitive damages. Emery, EWA and CNF also may be subject to other claims and proceedings relating to the crash, which could include other private lawsuits seeking monetary damages and governmental proceedings. Although Emery, EWA and CNF maintain insurance that is intended to cover claims that may arise in connection with an airplane crash, there can be no assurance that the insurance will in fact be adequate to cover all possible types of claims. In particular, any claims for punitive damages or any sanctions resulting from possible governmental proceedings would not be covered by insurance. As a result of EWA's suspension of its air carrier operations on August 13, 2001, EWA furloughed approximately 400 pilots and crewmembers. Those pilots and crewmembers are represented by the Air Line Pilots Association (ALPA) union under a collective bargaining agreement and ALPA filed a grievance on their behalf protesting the furlough. The grievance sought pay during the course of the suspension. CNF is currently involved in arbitration with respect to this claim. On December 5, 2001, EWA announced that it would cease operating as an air carrier, and in connection therewith terminated the employment of all pilots and crewmembers, bringing the total number of terminated employees in 2001 to 800. EWA is currently engaged in effects bargaining with ALPA regarding EWA's cessation of air carrier operations. In addition, ALPA has filed a grievance on behalf of the pilots and crewmembers protesting the cessation of EWA's air carrier operations and Emery's use of other air carriers. Some aspects of the ALPA matters may be subject to binding arbitration. Based on CNF's current evaluation, management has addressed its estimated exposure related to the ALPA matters. However, CNF cannot predict with certainty the ultimate outcome of these matters. PAGE 19 EWA has been named as a defendant in a lawsuit and arbitration proceeding brought by a subcontractor that operated aircraft under EWA's former Express Mail contract with the USPS. The USPS terminated the Express Mail contract for convenience on August 26, 2001. The subcontractor is seeking $28.5 million and other unspecified damages in connection with such termination. EWA believes it is entitled to and intends to seek recovery from the USPS of any termination costs to which the subcontractor may be entitled. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS Not applicable. PAGE 20 PART II ------- Information for Items 5 through 8 of Part II of this Report appears in CNF's 2001 Annual Report to Shareholders on the pages indicated below and the information responsive to the following Items appearing on those pages is incorporated herein by reference. ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS CNF's common stock is listed for trading on the New York and Pacific Stock Exchanges under the symbol "CNF". Page Number of Annual Report to Shareholders ---------------------- Range of common stock prices for each of the quarters in 2001 and 2000 51 Common shareholders of record at December 31, 2001 53 Common stock dividends for each of the quarters in 2001 and 2000 51 ITEM 6. SELECTED FINANCIAL DATA Selected Consolidated Financial Data 53 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14-27 ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 25 Certain statements included or incorporated by reference herein constitute "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to a number of risks and uncertainties, and should not be relied upon as predictions of future events. All statements other than statements of historical fact are forward- looking statements, including any projections of earnings, revenues, weight, volumes, income or other financial or operating items, any statements of the plans, strategies, expectations or objectives of CNF or management for future operations or other future items, any statements concerning proposed new products or services, any statements regarding future economic conditions or performance, any statements of estimates or belief and any statements or assumptions underlying the foregoing. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates" or "anticipates" or the negative of those terms or other variations of those terms or comparable terminology or by discussions of strategy, plans or intentions. Such forward- looking statements are necessarily dependent on assumptions, data and methods that may be incorrect or imprecise and there can be no assurance that they will be realized. In that regard, the following factors, among others and in addition to the matters discussed elsewhere in this document, in documents incorporated by reference herein and other reports and documents filed by CNF with the Securities and Exchange Commission, could cause actual PAGE 21 results and other matters to differ materially from those discussed in such forward-looking statements: changes in general business and economic conditions, including the slowdown in the global economy; the creditworthiness of CNF's customers and their ability to pay for services rendered; increasing competition and pricing pressure; changes in fuel prices; the effects of the cessation of EWA's air carrier operations, including the expense of using aircraft operated by other air carriers in Emery's North American operations while also bearing the cash costs of EWA's grounded aircraft fleet, the possibility of substantial cash payments in connection with the early termination of aircraft leases, the possibility of additional unusual charges and other costs and expenses relating to Emery's operations, existing defaults and possibility of future defaults under aircraft leases, and the possibility of future loss of business due to publicity surrounding the grounding of EWA's fleet of aircraft; the possibility of defaults under CNF's $385 million credit agreement and other debt instruments and aircraft leases, including defaults resulting from additional unusual charges or CNF's failure to perform in accordance with management's expectations, and the possibility that CNF may be required to pledge collateral to secure some of its indebtedness or to repay other indebtedness in the event that the ratings assigned to its long-term senior debt by credit rating agencies are reduced; uncertainties regarding EWA's ability to recover all termination costs relating to the termination of its former Priority Mail contract with the USPS; uncertainties regarding EWA's ability to recover all termination costs and other claims relating to the termination of its former Express Mail contract with the USPS; labor matters, including the grievance by furloughed pilots and crewmembers, renegotiations of labor contracts and the risk of work stoppages or strikes; enforcement of and changes in governmental regulations; environmental and tax matters (including claims made by the Internal Revenue Service with respect to aircraft maintenance tax matters); the Department of Transportation, FAA and Department of Justice investigation relating to Emery Worldwide's handling of hazardous materials; the February 2000 crash of an EWA aircraft and related investigation and litigation; and matters relating to CNF's 1996 spin-off of Consolidated Freightways. As a result of the foregoing, no assurance can be given as to future financial condition, cash flows, or results of operations. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Number of Annual Report to Shareholders ---------------------- Consolidated Balance Sheets 28 Statements of Consolidated Operations 30 Statements of Consolidated Cash Flows 31 Statements of Consolidated Shareholders' Equity 32 Notes to Consolidated Financial Statements 34-51 Selected Quarterly Financial Data 51 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PAGE 22 PART III -------- Information for Items 10 through 12 of Part III of this Report appears in the Proxy Statement for CNF's 2001 Annual Meeting of Shareholders to be held on April 23, 2002, as indicated below and that information on those pages is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The Executive Officers of CNF, their ages at December 31, 2001, and their applicable business experience are as follows: Gregory L. Quesnel, 53, President and Chief Executive Officer of CNF. Mr. Quesnel joined the CNF organization as Director of Accounting in 1975, following several years of professional experience with major corporations in the petroleum and wood products industries. Mr. Quesnel advanced through increasingly responsible positions and, in 1990, was elected Vice President and Treasurer of CNF; in 1991, he was elected Senior Vice President and Chief Financial Officer; and he was promoted to Executive Vice President and Chief Financial Officer in 1994. As part of a planned succession, Mr. Quesnel was elected President and Chief Operating Officer in July 1997. In May 1998, Mr. Quesnel was named President and Chief Executive Officer of CNF. At that time, he was also elected as a member of the CNF Board of Directors. Mr. Quesnel is a member of the California Business Roundtable and the Conference Board. He also serves as a member of the Executive Committee of the Bay Area Council of the Boy Scouts of America and is a member of the Board of Directors of Potlatch Corporation. Mr. Quesnel earned a bachelor's degree in finance from the University of Oregon and holds a master's degree in business administration from the University of Portland. Mr. Quesnel is a member of the Executive Committee of the Board. Chutta Ratnathicam, 54, Chief Financial Officer and Senior Vice President of CNF (formerly Chief Executive Officer of Emery Worldwide). Mr. Ratnathicam joined CNF in 1977 as a corporate auditor and following several increasingly responsible positions was named Vice President Internal Audit for CNF in 1989. In 1991, he was promoted to Vice President-International for Emery. In 1997, Mr. Ratnathicam was named Senior Vice President and Chief Financial Officer of CNF. In September 2000, Mr. Ratnathicam was named Chief Executive Officer of Emery Wordwide, succeeding Roger Piazza, who retired. Mr. Ratnathicam returned as Chief Financial Officer of CNF upon Emery in 2002 becoming part of CNF's new Menlo Worldwide group of supply chain service providers. Gerald L. Detter, 57, President and Chief Executive Officer of Con-Way Transportation Services and Senior Vice President of CNF. Mr. Detter joined the former Consolidated Freightways Corporation of Delaware (CFCD) in 1964 as a dockman and advanced through several positions of increasing responsibility to become Division Manager in Detroit, Michigan in 1976. In 1982, he was named the first President and Chief Executive Officer of Con-Way Central Express. In 1997, Mr. Detter was named to his current position. PAGE 23 Eberhard G.H. Schmoller, 58, Senior Vice President, General Counsel and Corporate Secretary of CNF. Mr. Schmoller joined CFCD in 1974 as a staff attorney and in 1976 was promoted to CFCD Assistant General Counsel. In 1983, he was appointed Vice President and General Counsel of the former CF AirFreight and assumed the same position with Emery after the acquisition in 1989. Mr. Schmoller was named Senior Vice President and General Counsel of CNF in 1993. John H. Williford, 45, President and Chief Executive Officer of Menlo Worldwide and Senior Vice President of CNF. Mr. Williford joined CNF in 1981 as an Economics/Senior Marketing Analyst. In 1984, he was named Director of Marketing for CNF's international operations and was later appointed Director of Marketing for CNF. Since its inception in 1990, Mr. Williford served as the principal executive in charge of Menlo Logistics, first as General Manager and then as President and Chief Executive Officer. In 1998, Mr. Williford was named Senior Vice President of CNF. In 2002, John Williford was named President and Chief Executive Officer of Menlo Worldwide. Information regarding members of CNF's Board of Directors is presented on pages 3 through 8, inclusive, of CNF's Proxy Statement dated March 22, 2002 and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Page Number of Proxy Statement --------------- Compensation Information 13 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Stock Ownership - Directors and Executive Officers 9 Stock Ownership - Significant shareholders 26 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. PAGE 24 PART IV ------- ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS The consolidated financial statements of CNF, together with the Notes to Consolidated Financial Statements, and the report thereon of Arthur Andersen LLP, dated January 25, 2002 (except with respect to the increase in the unsecured revolving credit facility as discussed in Note 5, as to which the date is February 22, 2002), are presented on pages 28 through 52 of CNF's 2001 Annual Report to Shareholders and are incorporated herein by reference. With the exception of the information incorporated by reference in Items 1, 3, 5, 6, 7, 7A, 8 and 14 hereof, CNF's 2001 Annual Report to Shareholders is not to be deemed as filed as part of this Report. 2. FINANCIAL STATEMENT SCHEDULE Page Number in Form 10-K ------------ Report of Independent Public Accountants on Financial Statement Schedule S-1 Schedule II - Valuation and Qualifying Accounts S-2 All other financial statement schedules have been omitted because they are not applicable or the required information is included in the consolidated financial statements, or the notes thereto, contained in CNF's 2001 Annual Report to Shareholders and incorporated herein by reference. 3. EXHIBITS Exhibits are being filed in connection with this Report and are incorporated herein by reference. The Exhibit Index on pages E-1 through E-6 is incorporated herein by reference. (b) REPORTS ON FORM 8-K On August 14, 2001, CNF filed a Report on Form 8-K reporting the suspension of EWA's air carrier operations as part of an interim settlement agreement with the FAA, which is described further in Item 1, "Emery Worldwide - Regulatory Matters". PAGE 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. CNF INC. (Registrant) /s/ Gregory L. Quesnel March 25, 2002 --------------------------------- Gregory L. Quesnel President and Chief Executive Officer /s/ Chutta Ratnathicam March 25, 2002 --------------------------------- Chutta Ratnathicam Senior Vice President and Chief Financial Officer /s/ Kevin S. Coel March 25, 2002 --------------------------------- Kevin S. Coel Controller PAGE 26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. March 25, 2002 /s/ Donald E. Moffitt --------------------------------- Donald E. Moffitt Chairman of the Board /s/ Gregory L. Quesnel March 25, 2002 --------------------------------- Gregory L. Quesnel President, Chief Executive Officer and Director /s/ Robert Alpert March 25, 2002 --------------------------------- Robert Alpert, Director March 25, 2002 --------------------------------- Richard A. Clarke, Director March 25, 2002 /s/ Margaret G. Gill --------------------------------- Margaret G. Gill, Director /s/ Robert Jaunich II March 25, 2002 --------------------------------- Robert Jaunich II, Director /s/ W. Keith Kennedy, Jr. March 25, 2002 --------------------------------- W. Keith Kennedy, Jr., Director PAGE 27 SIGNATURES /s/ Richard B. Madden March 25, 2002 --------------------------------- Richard B. Madden, Director /s/ Michael J. Murray March 25, 2002 --------------------------------- Michael J. Murray, Director /s/ Robert D. Rogers March 25, 2002 --------------------------------- Robert D. Rogers, Director /s/ William J. Schroeder March 25, 2002 --------------------------------- William J. Schroeder, Director /s/ Robert P. Wayman March 25, 2002 --------------------------------- Robert P. Wayman, Director S-1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------- As independent public accountants, we hereby consent to the incorporation of our reports included and incorporated by reference in this Form 10-K, into the Company's previously filed Registration Statement File Nos. 2-81030, 33-52599, 33-60619, 33- 60625, 33-60629, 333-26595, 333-30327, 333-48733, 333-56667, 333- 92399, 333-36180 and 333-54558. /s/Arthur Andersen LLP ---------------------- ARTHUR ANDERSEN LLP San Francisco, California March 25, 2002 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ---------------------------------------- To the Shareholders and Board of Directors of CNF Inc.: We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements included in CNF Inc.'s 2001 Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 25, 2002 (except with respect to the increase in the unsecured revolving credit facility as discussed in Note 5, as to which the date is February 22, 2002). Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The Schedule II-- Valuation and Qualifying Accounts on page S-2 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/Arthur Andersen LLP ---------------------- ARTHUR ANDERSEN LLP San Francisco, California January 25, 2002 S-2 SCHEDULE II CNF INC. VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 2001 (In thousands) DESCRIPTION - ----------- ALLOWANCE FOR DOUBTFUL ACCOUNTS ADDITIONS ------------------------------------ BALANCE AT CHARGED TO CHARGED TO BALANCE BEGINNING COSTS AND OTHER DEDUCTIONS AT END OF PERIOD EXPENSES ACCOUNTS (a) PERIOD --------- -------- -------- ---------- ------- 2001 $21,722 $17,435 $ - $(16,482) $22,675 2000 26,163 9,070 - (13,511) 21,722 1999 21,098 15,229 - (10,164) 26,163 (a) Accounts written off net of recoveries. ALLOWANCE FOR COSTS OF DISCONTINUED OPERATIONS ADDITIONS ------------------------------------ BALANCE AT CHARGED TO CHARGED TO BALANCE BEGINNING COSTS AND OTHER DEDUCTIONS AT END OF PERIOD EXPENSES ACCOUNTS PERIOD --------- -------- -------- ---------- ------- 2001 $22,144 $3,561 $ - $(22,448) $3,257 2000 - 22,144 $ - - 22,144 E-1 INDEX TO EXHIBITS ITEM 14(a)(3) Exhibit No. - ----------- (3) Articles of incorporation and by-laws: 3.1 CNF Transportation Inc. Certificate of Incorporation, as amended. (Exhibit 4(a) to CNF's registration statement on Form S-3 dated May 6, 1997.*) 3.2 CNF Transportation Inc. By-laws, as amended September 28, 1998 (Exhibit 4(b) to CNF's registration statement on Form S-3 dated November 10, 1998.*). (4) Instruments defining the rights of security holders, including debentures: 4.1 Certificate of Designations of the Series B Cumulative Convertible Preferred Stock. (Exhibit 4.1 as filed on Form SE dated May 25, 1989*) 4.2 Indenture between the Registrant and Bank One, Columbus, NA, as successor trustee, with respect to 9-1/8% Notes Due 1999, Medium-Term Notes, Series A and 7.35% Notes due 2005. (Exhibit 4.1 as filed on Form SE dated March 20, 1990*) 4.3 Indenture between the Registrant and The First National Bank of Chicago Bank, trustee, with respect to debt securities. (Exhibit 4(d) as filed on Form S-3 dated June 27, 1995*) 4.4 Indenture between the Registrant and Bank One, Columbus, NA, trustee, with respect to subordinated debt securities. (Exhibit 4(e) as filed on Form S-3 dated June 27, 1995*) 4.5 Form of Security for 7.35% Notes due 2005 issued by Consolidated Freightways, Inc. (Exhibit 4.4 as filed on Form S-4 dated June 27, 1995*) 4.6 Declaration of Trust of the Trust (Exhibit 4(k) to CNF's Amendment 1 to Form S-3 dated May 30, 1997*) 4.7 Form of Amended and Restated Declaration of Trust of the Trust, including form of Trust Preferred Security. (Exhibit 4(l) to CNF's Amendment 1 to Form S-3 dated May 9, 1997*) 4.8 Form of Guarantee Agreement with respect to Trust Preferred Securities. (Exhibit 4(m) to CNF's Amendment 1 to Form S-3 dated May 30, 1997*) E-2 4.9 Form of Indenture between CNF Transportation Inc. and Bank One Trust Company, National Association (Exhibit 4(d)(i) to CNF's Form 8-K dated March 3, 2000*). 4.10 Form of Security for 8 7/8% Notes due 2010 issued by CNF Transportation Inc. (Exhibit 4(i) to CNF's Form 8-K dated March 3, 2000*). Instruments defining the rights of security holders of long-term debt of CNF Transportation Inc., and its subsidiaries for which financial statements are required to be filed with this Form 10-K, of which the total amount of securities authorized under each such instrument is less than 10% of the total assets of CNF Transportation Inc. and its subsidiaries on a consolidated basis, have not been filed as exhibits to this Form 10-K. CNF agrees to furnish a copy of each applicable instrument to the Securities and Exchange Commission upon request. (10) Material contracts: 10.1 Consolidated Freightways, Inc. Long-Term Incentive Plan of 1988 as amended through Amendment 3. (Exhibit 10.2 as filed on Form SE dated March 25, 1991*#) 10.2 Consolidated Freightways, Inc. Stock Option Plan of 1988 as amended. (Exhibit 10(i) to CNF's Form 10-K for the year ended December 31, 1987 as amended in Form S-8 dated December 16, 1992*#) 10.3 Emery Air Freight Plan for Retirees, effective October 31, 1987. (Exhibit 4.23 to the Emery Air Freight Corporation Quarterly Report on Form 10-Q dated November 16, 1987**) 10.4 Consolidated Freightways, Inc. Common Stock Fund (formerly Emery Air Freight Corporation Employee Stock Ownership Plan, as effective October 1, 1987 ("ESOP"). (Exhibit 4.33 to the Emery Air Freight Corporation Annual Report on Form 10-K dated March 28,1988**) 10.5 Employee Stock Ownership Trust Agreement, dated as of October 8, 1987, as amended, between Emery Air Freight Corporation and Arthur W. DeMelle, Daniel J. McCauley and Daniel W. Shea, as Trustees under the ESOP Trust. (Exhibit 4.34 to the Emery Air Freight Corporation Annual Report on Form 10-K dated March 28, 1988**) E-3 10.6 Amended and Restated Subscription and Stock Purchase Agreement dated as of December 31, 1987 between Emery Air Freight Corporation and Boston Safe Deposit and Trust Company in its capacity as successor trustee under the Emery Air Freight Corporation Employee Stock Ownership Plan Trust ("Boston Safe"). (Exhibit B to the Emery Air Freight Corporation Current Report on Form 8-K dated January 11, 1988**) 10.7 Supplemental Subscription and Stock Purchase Agreement dated as of January 29, 1988 between Emery Air Freight Corporation and Boston Safe. (Exhibit B to the Emery Air Freight Corporation Current Report on Form 8-K dated February 12, 1988**) 10.8 Trust Indenture, dated as of November 1, 1988, between City of Dayton, Ohio and Security Pacific National Trust Company (New York), as Trustee and Bankers Trust Company, Trustee. (Exhibit 4.1 to Emery Air Freight Corporation Current Report on Form 8-K dated December 2, 1988**) 10.9 Bond Purchase Agreement dated November 7, 1988, among the City of Dayton, Ohio, the Emery Air Freight Corporation and Drexel Burnham Lambert Incorporated. (Exhibit 28.7 to the Emery Air Freight Corporation Current Report on Form 8-K dated December 2, 1988**) 10.10 Lease agreement dated November 1, 1988 between the City of Dayton, Ohio and Emery Air Freight Corporation. (Exhibit 10.1 to the Emery Air Freight Corporation Annual Report on Form 10-K for the year ended December 31, 1988**) 10.11 $350 million Amended and Restated Credit Agreement dated November 21, 1996 among Consolidated Freightways, Inc. and various financial institutions. (Exhibit 10.18 to CNF's Form 10-K for the year ended December 31, 1996*). 10.12 Official Statement of the Issuer's Special Facilities Revenue Refunding Bonds, 1993 Series E and F dated September 29, 1993 among the City of Dayton, Ohio and Emery Air Freight Corporation. (Exhibit 10.1 to CNF's Form 10-Q for the quarterly period ended September 30, 1993*). 10.13 Trust Indenture, dated September 1, 1993 between the City of Dayton, Ohio and Banker's Trust Company as Trustee. (Exhibit 10.2 to CNF's Form 10-Q for the quarterly period ended September 30, 1993*). E-4 10.14 Supplemental Lease Agreement dated September 1, 1993 between the City of Dayton, Ohio, as Lessor, and Emery Air Freight Corporation, as Lessee. (Exhibit 10.3 to CNF's Form 10-Q for the quarterly period ended September 30, 1993*). 10.15 Supplemental Retirement Plan dated January 1, 1990. (Exhibit 10.31 to CNF's Form 10-K for the year ended December 31, 1993*#) 10.16 Directors' 24-Hour Accidental Death and Dismemberment Plan. (Exhibit 10.32 to CNF's Form 10-K for the year ended December 31, 1993*#) 10.17 Executive Split-Dollar Life Insurance Plan dated January 1, 1994. (Exhibit 10.33 to CNF's Form 10-K for the year ended December 31, 1993*#) 10.18 Board of Directors' Compensation Plan dated January 1, 1994. (Exhibit 10.34 to CNF's Form 10-K for the year ended December 31, 1993*#) 10.19 Directors' Business Travel Insurance Plan. (Exhibit 10.36 to CNF's Form 10-K for the year ended December 31, 1993*#) 10.20 Deferred Compensation Plan for Executives 1998 Restatement. (Exhibit 10.20 to CNF's Form 10-K for the year ended December 31, 1997. *#) 10.21 Amended and Restated 1993 Nonqualified Employee Benefit Plans Trust Agreement dated January 1, 1995. (Exhibit 10.38 to CNF's Form 10-K for the year ended December 31, 1994.*#) 10.22 CNF Transportation Inc., 1997 Equity and Incentive Plan for Non-Employee Directors, as amended June 30, 1997. (Exhibit 10.33 to CNF's Form 10-K for the year ended December 31, 1997. *#) 10.23 Amended and Restated Retirement Plan for Directors of Consolidated Freightways, Inc. dated January 1, 1994. (Exhibit 10.40 to CNF's Form 10-K for the year ended December 31, 1994.*#) 10.24 CNF Transportation Inc. Return on Equity Plan, as amended through Amendment No. 1 (Exhibit 10.24 to CNF's Form 10-K for the year ended December 31, 1997. *#) 10.25 Employee Benefit Matters Agreement by and between Consolidated Freightways, Inc. and Consolidated Freightways Corporation dated December 2, 1996. (Exhibit 10.33 to CNF's form 10-K for the year ended December 31, 1996.*#) E-5 10.26 Distribution Agreement between Consolidated Freightways, Inc., and Consolidated Freightways Corporation dated November 25, 1996. (Exhibit 10.34 to CNF's Form 10-K for the year ended December 31, 1996.*#) 10.27 Transition Services Agreement between CNF Service Company, Inc. and Consolidated Freightways Corporation dated December 2, 1996. (Exhibit to CNF's Form 10-K for the year ended December 31, 1996.*#) 10.28 Tax Sharing Agreement between Consolidated Freightways, Inc., and Consolidated Freightways Corporation dated December 2, 1996. (Exhibit to CNF's Form 10-K for the year ended December 31, 1996.*#) 10.29 CNF Transportation Inc. 1997 Equity and Incentive Plan as amended as of January 31, 2000. (Exhibit A to CNF's Proxy Statement dated March 20, 2000. *#) 10.30 CNF Transportation Inc. Deferred Compensation Plan for Directors 1998 Restatement. (Exhibit 10.34 to CNF's Form 10-K for the year ended December 31, 1997. *#) 10.31 CNF Transportation Inc. Executive Severance Plan. (Exhibit 10.32 to CNF's Form 10-K for the year ended December 31, 1998.*#) 10.32 CNF Inc. Summary of Incentive Compensation plans for 2002. # 10.33 Value Management Plan dated June 28, 1999.# (12a)Computation of ratios of earnings to fixed charges (12b)Computation of ratios of earnings to combined fixed charges and preferred stock dividends. (13) Annual report to security holders: CNF Inc. 2001 Annual Report to Shareholders (Only those portions referenced herein are incorporated in this Form 10- K. Other portions such as "Letter to Shareholders" are not required and, therefore, are not "filed" as part of this Form 10-K.) (21) Significant Subsidiaries of CNF. E-6 (99) Additional documents: 99.1 CNF Transportation Inc. 2001 Notice of Annual Meeting and Proxy Statement dated March 22, 2002 and filed on Form DEF 14A. (Only those portions referenced herein are incorporated in this Form 10-K. Other portions are not required and, therefore, are not "filed" as a part of this Form 10-K. *) 99.2 Note Agreement dated as of July 17, 1989, between the ESOP, Consolidated Freightways, Inc. and the Note Purchasers named therein. (Exhibit 28.1 as filed on Form SE dated July 21, 1989*) 99.3 Guarantee and Agreement dated as of July 17, 1989, delivered by Consolidated Freightways, Inc. (Exhibit 28.2 as filed on Form SE dated July 21, 1989*). 99.4 Form of Restructured Note Agreement between Consolidated Freightways, Inc., Thrift and Stock Ownership Trust as Issuer and various financial institutions as Purchasers named therein, dated as of November 3, 1992. (Exhibit 28.4 to CNF's Form 10-K for the year ended December 31, 1992*). 99.5 Confirmation of Arthur Andersen Representations The remaining exhibits have been omitted because either (1) they are neither required nor applicable or (2) the required information has been included in the consolidated financial statements or notes thereto. Footnotes to Exhibit Index --------------------------- * Previously filed with the Securities and Exchange Commission and incorporated herein by reference. ** Incorporated by reference to indicated reports filed under the Securities Act of 1934, as amended, by Emery Air Freight Corporation File No. 1-3893. # Designates a contract or compensation plan for Management or Directors. EX-21 2 cnf_01ex21.txt EXHIBIT 21 Exhibit 21 CNF INC. SIGNIFICANT SUBSIDIARIES OF THE COMPANY December 31, 2001 The Company and its significant subsidiaries were: State or Percent of Province or Stock Owned Country of Parent and Significant Subsidiaries by Company Incorporation CNF Inc. Delaware Significant Subsidiaries of CNF Inc: Con-Way Transportation Services, Inc. 100 Delaware Emery Air Freight Corporation 100 Delaware Emery Worldwide Airlines, Inc. 100 Nevada Menlo Logistics, Inc. 100 California Road Systems, Inc. 100 California EX-99 3 cnf_01ex995.txt EXHIBIT 99.5 Exhibit 99.5 March 25, 2002 Securities and Exchange Commission 450 Fifth Street, N.W. Judiciary Plaza Washington, DC 20549 Re: CONFIRMATION OF ARTHUR ANDERSEN REPRESENTATIONS This letter confirms that CNF Inc. has received from Arthur Andersen LLP, the independent public accountant engaged by the company to examine the company's financial statements that are included in the Form 10-K to which this letter is filed as an exhibit, a representation letter addressed to the company and stating that: the audit conducted by Andersen was subject to Andersen's quality control system for the U.S. accounting and auditing practice to provide reasonable assurance that the engagement was conducted in compliance with professional standards; and there was appropriate continuity of Andersen personnel working on audits, availability of national office consultation and availability of personnel at foreign affiliates of Andersen to conduct the relevant portions of the audit. Chutta Ratnathicam Senior Vice President and Chief Financial Officer EX-12 4 cnf_01ex12a.txt EXHIBIT 12 Exhibit 12(a) CNF INC. COMPUTATION OF RATIOS OF EARNINGS (LOSS) TO FIXED CHARGES Year Ended December 31,
(dollars in thousands) 2001 2000 1999 1998 1997 Fixed Charges: Interest expense $27,992 $29,972 $25,972 $32,627 $39,553 Capitalized interest 864 4,636 5,864 2,342 2,077 Dividend requirement on Series B Preferred Stock (1) 10,606 10,808 10,992 12,133 12,377 Interest component of rental expense (2) 25,033 38,161 41,363 40,750 35,607 Fixed Charges $64,495 $83,577 $84,191 $87,852 $89,614 Earnings (Loss): Income (Loss) from continuing operations before taxes (3) $(695,933) $261,196 $332,260 $253,812 $234,812 Fixed charges 64,495 83,577 84,191 87,852 89,614 Capitalized interest (864) (4,636) (5,864) (2,342) (2,077) Preferred dividend requirements (4) (10,606) (10,808) (10,992) (12,133) (12,377) $(642,908) $329,329 $399,595 $327,189 $309,972 Ratio (10.0)x 3.9x 4.7x 3.7x 3.5x Deficiency in the coverage of fixed charges by earnings (loss) before fixed charges (707,403) - - - - (1) Dividends on shares of the Series B cumulative convertible preferred stock are used to pay debt service on notes issued by the Company's Thrift and Stock Plan. (2) Estimate of the interest portion of lease payments. (3) For the year ended December 31, 2001, results included a $652.2 million loss from restructuring charges at Emery Worldwide and Menlo Logistics' $47.5 million loss from the business failure of a customer. (4) Preferred stock dividend requirements included in Fixed Charges but not deducted in the determination of Income from Continuing Operations Before Income Taxes.
EX-12 5 cnf_01ex12b.txt EXHIBIT 12 Exhibit 12(b) CNF INC. COMPUTATION OF RATIOS OF EARNINGS (LOSS) TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS "Year Ended December 31,
(dollars in thousands) 2001 2000 1999 1998 1997 Combined Fixed Charges and Preferred Stock Dividends: Interest expense $27,992 $29,972 $25,972 $32,627 $39,553 Capitalized interest 864 4,636 5,864 2,342 2,077 Dividend requirement on Series B Preferred Stock(1) 10,606 10,808 10,992 12,133 12,377 Dividend requirement on preferred securities of subsidiary trust 6,250 6,250 6,250 6,250 3,471 Interest component of rental expense (2) 25,033 38,161 41,363 40,750 35,607 Fixed Charges $70,745 $89,827 $90,441 $94,102 $93,085 Earnings (Loss): Income (Loss) from continuing operations before taxes (3) $(695,933) $261,196 $332,260 $253,812 $234,812 Fixed charges: 70,745 89,827 90,441 94,102 93,085 Capitalized interest (864) (4,636) (5,864) (2,342) (2,077) Preferred dividend requirements(4) (10,606) (10,808) (10,992) (12,133) (12,377) $(636,658) $335,579 $405,845 $333,439 $313,443 Ratio (9.0)x 3.7x 4.5x 3.5x 3.4x Deficiency in the coverage of fixed charges by earnings (loss) before fixed charges (707,403) - - - - (1) Dividends on shares of the Series B cumulative convertible preferred stock are used to pay debt service on notes issued by the Company's Thrift and Stock Plan. (2) Estimate of the interest portion of lease payments. (3) For the year ended December 31, 2001, results included a $652.2 million loss from restructuring charges at Emery Worldwide and Menlo Logistics' $47.5 million loss from the business failure of a customer. (4) Preferred stock dividend requirements included in Combined Fixed Charges but not deducted in the determination of Income from Continuing Operations Before Income Taxes.
EX-13 7 cnf_01ex13.txt ANNUAL REPORT TO SHAREHOLDERS PAGE 14 CONSOLIDATED RESULTS OF OPERATIONS Net loss applicable to CNF's common shareholders of $402.9 million ($8.26 per share) was due primarily to a net loss from continuing operations (after preferred dividends) of $441.8 million ($9.06 per share). The net loss from continuing operations in 2001 reflects several unusual items, including pre-tax restructuring charges of $652.2 million at the Emery Worldwide reporting segment (Emery), costs of Emery Worldwide Airlines' (EWA) grounded aircraft fleet incurred while also bearing costs of utilizing aircraft operated by other air carriers following cessation of air carrier operations by EWA, losses from the failure of a significant customer at Menlo Logistics, and other unusual items described below. Excluding unusual items, net income from continuing operations in 2001 was $34.2 million. The loss from continuing operations in 2001 was partially offset by a $39.0 million after-tax gain ($0.80 per share) from discontinued operations resulting from a contract settlement with the U.S. Postal Service (USPS) described below under "Discontinued Operations." Net income available to common shareholders in 2000 of $126.8 million ($2.36 per diluted share) included net income from continuing operations of $143.1 million ($2.65 per diluted share), a $13.5 million after-tax loss ($0.24 per diluted share) from discontinuance of operations under EWA's former Priority Mail contract with the USPS, and a $2.7 million after-tax loss ($0.05 per diluted share) from the cumulative effect of an accounting change. Net income available to common shareholders in 1999 was $182.3 million ($3.35 per diluted share), including income from continuing operations of $179.3 million ($3.29 per diluted share) and after-tax income of $3.0 million ($0.06 per diluted share) from discontinued operations. As used in Management's Discussion and Analysis, all references to CNF, "we," "us," and "our" and all similar references mean CNF Inc. and its subsidiaries, unless otherwise expressly stated or the context otherwise requires. CONTINUING OPERATIONS In 2001, the $441.8 million net loss from continuing operations reflects $652.2 million of restructuring charges at Emery, costs of EWA's grounded aircraft fleet incurred while also bearing costs of utilizing aircraft operated by other air carriers following cessation of air carrier operations by EWA, losses from the failure of a significant customer at the Menlo Logistics reporting segment (Menlo), and other unusual items shown in the table below. The operating loss of $660.7 million in 2001 declined from operating income of $290.0 million earned in 2000 due primarily to these 2001 unusual items and lower revenue. The decline in revenue to $4.86 billion in 2001 from $5.57 billion in 2000 was due primarily to a deepening global economic recession in 2001 and lower revenue from EWA's Express Mail contract with the USPS, which was terminated in 2001. Net income from continuing operations for 2000 declined to $143.1 million from $179.3 million 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 higher 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 the Con-Way Transportation Services reporting segment (Con-Way), Emery and Menlo. Unusual items for the three years ended December 31, 2001 are summarized below and described in the discussion of operating results for CNF's reporting segments. Pre-tax Diluted Expense Loss (Income) (Earnings) Per Share (dollars in millions except per share data) ---------- ---------- Year ended December 31, 2001: Charge for restructuring of Emery, including cessation of air carrier operations by EWA $652.2 $8.33 Costs for an EWA legal settlement on returned aircraft 4.7 0.06 Costs of EWA's grounded aircraft fleet incurred while also bearing costs of utilizing aircraft operated by other air carriers following cessation of air carrier operations by EWA 55.8 0.71 Write-off and related costs from the failure of a significant Menlo Logistics customer 47.5 0.61 Net corporate charges, including a $5.3 million non-operating 3.9 0.05 investment loss Year ended December 31, 2000: Loss from the sale of certain assets of Con-Way Truckload Services 5.5 0.06 Loss from the termination of EWA aircraft leases 11.9 0.12 Non-operating investment gain (2.6) (0.03) Year ended December 31, 1999: Net gain from a corporate legal settlement (16.5) (0.17) Net gain from the sale of the assets of CNF's former wholesale parts and supplies distributor (10.1) (0.10) Non-operating investment gain (9.6) (0.10) PAGE 15 As discussed below under "Emery Worldwide-Regulatory Matters," EWA, a separate subsidiary included in the Emery Worldwide reporting segment, previously operated as an airline under an air carrier certificate issued by the Federal Aviation Administration (FAA). On August 13, 2001, EWA was required to suspend its air carrier operations as part of a settlement agreement with the FAA and, on December 5, 2001, CNF announced that EWA would cease operating as an air carrier. As discussed below under "Emery Worldwide-Restructuring Charges," in 2001 Emery recognized a total of $652.2 million of restructuring charges in connection with the realignment of Emery's operations and the suspension and subsequent cessation of EWA's air carrier operations. These charges and other related costs and expenses had a material adverse effect on CNF's financial condition and results of operations in 2001. These restructuring charges reflect CNF's estimate of the costs of terminating EWA's air carrier operations and restructuring Emery's business and related matters. CNF believes that the estimate is adequate to cover these costs based on information currently available and assumptions management believes are reasonable under the circumstances. However, there can be no assurance that actual costs will not differ from this estimate, and if actual costs exceed CNF's estimate Emery will be required to recognize additional charges which could result in defaults under debt instruments and aircraft leases, or recognize other costs and expenses in connection with these matters. See "Emery Worldwide-Restructuring Charges," "Emery Worldwide-Regulatory Matters," "Liquidity and Capital Resources- Restructuring Charges and Regulatory Matters" and Notes 3, 5, 6 and 14 to the Consolidated Financial Statements. Operating results at Emery in 2001 were also adversely affected by the terrorist attacks on September 11, 2001. Contractors providing air carrier service to Emery were grounded on September 11 and 12 and did not resume service until the evening of September 13, which adversely affected Emery's 2001 results of operations. In addition, CNF believes that operating results at Emery and CNF's other reporting segments continue to be adversely affected by the general decline in economic conditions that occurred after these terrorist attacks. Con-Way Transportation Services Revenue for Con-Way in 2001 fell 6.5% to $1.91 billion due primarily to declines in weight per day (weight) and, to a lesser extent, revenue per hundredweight (yield). Total and less-than-truckload (LTL) tonnage for Con-Way's regional carriers in 2001 decreased 3.8% and 3.2%, respectively. Con- Way's management believes that decreases in weight in 2001 were due primarily to an economic recession in the U.S. Total yield was down 0.5% from 2000 due to lower fuel surcharges and pricing pressures partially offset by an increase in the percentage of inter-regional joint services, which typically command higher rates on longer lengths of haul. Also, Con-Way Truckload Services, which accounted for revenue of $62.6 million in 2000, ended operations after the sale of certain of its assets in August 2000. Revenue in 2000 increased 8.9% from 1999 as Con-Way's regional carriers increased total weight by 3.2% and LTL weight by 3.3%. Yield in 2000 increased 7.1% over 1999. Con-Way's operating income in 2001 of $157.5 million was 30.7% lower than 2000 due primarily to lower revenue, a 10.5% increase in health and welfare costs, and operating losses from the start-up of Con-Way Air Express, a domestic air freight forwarding company that began operations in May 2001. Con-Way's operating income of $227.3 million in 2000 included a $5.5 million loss from the sale of certain assets of Con-Way Truckload Services. Excluding the non-recurring asset sale, operating income rose 1.7% from 1999 due primarily to an increase in revenue, partially offset by higher employee benefit costs. Con-Way continues to pursue its strategy of broadening its revenue with new services that require minimal capital investments. In addition to Con-Way Air Express, which began operations in May 2001, Con-Way in January 2002 introduced Con-Way Full Load, a truckload brokerage service. In early 2002, Con-Way was unsuccessful at retaining a major account after the customer's decision to solicit new bids for all of its ground transportation business. In 2001, revenue related to this account was estimated at $75 million. Con-Way is expecting to lose much or all of this business in 2002. Con- Way is seeking to obtain new business to offset the loss of this major account. PAGE 16 Emery Worldwide Operating Results. In 2001, Emery's revenue was $2.04 billion, a 21.6% decline from 2000, due primarily to lower North American and international air freight revenue and the termination by the USPS of EWA's contract to transport Express Mail, effective August 26, 2001, as described below under "-Express Mail Contract." Average international air freight revenue per day in 2001, including fuel surcharges, fell 13.2% from 2000 due to a 14.1% decline in average pounds transported per day (weight), partially offset by a 1.1% increase in average revenue per pound (yield). Emery's management believes that declines in international weight in 2001 were due primarily to a global economic recession, which adversely affected business levels in international markets served by Emery, and lost revenue from the terrorist incident described below under "-Terrorist Attacks. Average North American air freight revenue per day, including fuel surcharges, declined 28.4% in 2001 due to a 30.8% drop in weight, offsetting a 3.6% increase in yield. Emery's management believes that lower weight in North America in 2001 was primarily attributable to a global economic recession, lost revenue following the terrorist attacks of September 11, 2001, and, to a lesser extent, loss of business to ground transportation providers. Lower weight in 2001 was also due in part to Emery's ongoing yield management program, which is designed to eliminate or reprice lower-margin business, and to a reduction in the number of aircraft flown and domestic markets served by Emery. Emery's revenue in 2000 increased 8.3% over 1999 to $2.61 billion due largely to higher international air freight revenue and, to a lesser extent, fuel surcharges. International air freight revenue for 2000, including fuel surcharges, rose 20.4% over 1999 due in part to improved international economic conditions, which Emery's management believes contributed to an 11.6% increase in weight and a 7.8% increase in yield in 2000 over 1999. North American air freight revenue for 2000, including fuel surcharges, was essentially unchanged from 1999 on a 7.9% decline in North American weight and a 9.1% increase in yield. Emery's operating loss of $790.3 million in 2001 reflects restructuring charges aggregating $652.2 million, $55.8 million for costs of EWA's grounded aircraft fleet incurred while also bearing costs of utilizing aircraft operated by other air carriers following cessation of air carrier operations by EWA, as described below, as well as a $4.7 million loss from a legal settlement in 2001 relating to previously returned aircraft. Emery's operating income of $28.4 million in 2000 included a $11.9 million unusual loss from the termination of EWA aircraft leases. Excluding unusual items in both years, Emery recorded an operating loss of $77.6 million in 2001 compared to operating income of $40.3 million in 2000, due primarily to lower revenue in 2001. Operating income of $28.4 million in 2000 declined from $75.5 million in 1999 due primarily to an increase in airhaul expense, which was negatively affected by higher maintenance costs, and from the $11.9 million unusual loss from the termination of EWA aircraft leases in 2000. Restructuring Charges. In June 2001, Emery began an operational restructuring to align it with management's estimates of future business prospects for domestic heavy air freight and address changes in market conditions, which deteriorated due to a slowing domestic economy, loss of EWA's contracts with the USPS to transport Express Mail and Priority Mail and, to a lesser extent, loss of business to ground transportation providers. The $340.5 million restructuring charge recognized in the second quarter of 2001 consisted primarily of non-cash impairment charges, including the write-off of $184.2 million for unamortized aircraft maintenance and $89.7 million for aircraft operating supplies, equipment and other assets. Consistent with CNF's accounting policy for the impairment of long-lived assets, which is described further in Note 1 to the Consolidated Financial Statements, asset impairment charges were based on an evaluation of cash flows for North American operations and, for certain assets, independent appraisals. Also included in the restructuring charge was $66.6 million for estimated future cash expenditures related primarily to the return to the lessors of certain aircraft leased to Emery and the termination of the related leases. As described below under "-Regulatory Matters," the FAA required EWA to suspend its air carrier operations on August 13, 2001. In response to the FAA action, as well as the terrorist actions described below under "-Terrorist Attacks" and a deepening global economic recession, Emery's management re-evaluated Emery's restructuring plan. As described above, CNF announced on December 5, 2001 that Emery in 2002 would become part of CNF's new Menlo Worldwide group of supply chain service providers and would continue to provide full North American forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, and that EWA would cease air carrier operations. In connection with the revised restructuring plan, in the fourth quarter of 2001 Emery recognized additional restructuring charges of $311.7 million for the planned disposal of leased aircraft, cessation of EWA's remaining operations, employee separation costs for 157 Emery employees, and other costs. Consistent with CNF's accounting policy related to the use of estimates, which is described further in Note 1 to the Consolidated Financial Statements, the restructuring charges in 2001 were based in part on significant estimates and assumptions made by Emery's management as to the amount and timing of aircraft rental payments and the costs of returning those aircraft upon expiration of the leases. The $311.7 million restructuring charge recognized in the fourth quarter of 2001 includes primarily accruals for scheduled undiscounted rental payments for aircraft leased to Emery and estimated costs of returning those aircraft upon expiration of the related leases. Actual costs may differ from those estimates and that difference would be recognized as additional expense or income in the period when and if that determination can be made. For 2002, the scheduled rental payments of the aircraft aggregate $61.0 million. However, Emery may pay a larger portion of its scheduled rental payments in 2002 or thereafter, which could be substantial, if EWA successfully negotiates the early termination of aircraft leases or in connection with defaults by EWA under aircraft leases. See "-Regulatory Matters" and "Liquidity and Capital Resources-Restructuring Charges and Regulatory Matters" below. The following table represents the cumulative activity related to Emery's 2001 restructuring plan: Total Cash Charged Reserves at Charges Payments Against December 31, (In Millions) Assets 2001 --------- ---------- --------- ------------ Employee separations $ 6.1 $ (0.8) -- $ 5.3 Asset impairments 278.0 -- (278.0) -- Aircraft and other costs 368.1 (2.9) -- 365.2 --------- ---------- ---------- ------------ $ 652.2 $ (3.7) $(278.0) $370.5 Regulatory Matters. Internationally, Emery operates as an air freight forwarder using mostly commercial airlines. Prior to the suspension and subsequent cessation of EWA's air carrier operations in 2001, Emery provided air transportation services in North America using owned and leased aircraft operated by EWA and aircraft operated by third parties. Until August 13, 2001, EWA operated as an airline. Although EWA has ceased air carrier operations, EWA still has an air carrier certificate issued by the FAA and is subject to maintenance, operating and other safety-related regulations promulgated by the FAA and is subject to FAA inspections. Based on issues identified during inspections conducted by the FAA, on August 13, 2001 EWA was required to suspend its air carrier operations as part of an interim settlement agreement with the FAA. On December 5, 2001, CNF announced that EWA was ceasing its air carrier operations. Since EWA's suspension of its air carrier operations on August 13, 2001, Emery has been providing services to its customers in North America by utilizing aircraft operated by other air carriers. This resulted in substantial additional expense during 2001, partially offset by savings resulting from the furlough of approximately 800 EWA employees as described in the next paragraph. Emery intends to continue to use aircraft operated by third parties to provide service to its customers in North America, which will result in Emery continuing to pay both the ongoing lease payments and other costs associated with EWA's own fleet of grounded aircraft in addition to the cost of having other air carriers provide service to Emery's North American customers. However, for financial reporting purposes, Emery's operating expense will continue to include the cost of aircraft operated by other carriers, but will not include the scheduled rental payments relating to EWA's fleet of grounded aircraft and the costs of returning those aircraft upon expiration of the related leases, except in the event and to the extent that those rental payments and the costs of returning those aircraft upon expiration of the related leases differ from the corresponding amounts already accrued as part of the 2001 restructuring charges. PAGE 18 As a result of EWA's suspension of its air carrier operations on August 13, 2001, EWA furloughed approximately 400 pilots and crewmembers. Those pilots and crewmembers are represented by the Air Line Pilots Association (ALPA) union under a collective bargaining agreement and ALPA filed a grievance on their behalf protesting the furlough. The grievance sought pay during the course of the suspension. CNF is currently involved in arbitration with respect to this claim. On December 5, 2001, EWA announced that it would cease operating as an air carrier, and in connection therewith terminated the employment of all pilots and crewmembers, bringing the total number of terminated employees in 2001 to 800. EWA is currently engaged in effects bargaining with ALPA regarding EWA's cessation of air carrier operations. In addition, ALPA has filed a grievance on behalf of the pilots and crewmembers protesting the cessation of EWA's air carrier operations and Emery's use of other air carriers. Some aspects of the ALPA matters may be subject to binding arbitration. Based on CNF's current evaluation, management has addressed its estimated exposure related to the ALPA matters. However, CNF cannot predict with certainty the ultimate outcome of these matters. In a final settlement agreement with the FAA entered into on September 17, 2001, EWA agreed to pay a $1 million civil penalty related to alleged operations, avionics, and maintenance irregularities. The final settlement agreement was amended on December 4, 2001 as a result of Emery's decision to terminate EWA's air carrier operations. Under the amended settlement agreement, the FAA has agreed not to take action to revoke EWA's air carrier certificate until, at the earliest, May 15, 2002. CNF can provide no assurance that the FAA will continue to allow EWA to maintain its air carrier certificate after May 15, 2002 and, while the matter is not free from doubt, the revocation of this certificate could result in a default under leases pursuant to which EWA leases a substantial number of aircraft. In addition, the fourth-quarter 2001 restructuring charge relating to the cessation of EWA's air carrier operations has resulted in defaults under agreements pursuant to which EWA leases some of its aircraft. Defaults under these leases could require substantial payments to be made to the lessors prior to scheduled payment dates. See "Liquidity and Capital Resources-Restructuring Charges and Regulatory Matters" for further discussion. Due in large part to the fourth-quarter 2001 restructuring charge incurred in connection with the cessation of EWA's air carrier operations, CNF was required to obtain amendments to its bank revolving credit agreement in December 2001 in order to remain in compliance with the financial covenants in that agreement. CNF can provide no assurance that events relating to the cessation of EWA's air carrier operations will not result in a future breach of the financial covenants under CNF's revolving credit facility. See "Liquidity and Capital Resources-Restructuring Charges and Regulatory Matters" for further discussion. Terrorist Attacks. Operating results at Emery were adversely affected by the terrorist attacks on September 11, 2001. Contractors providing air carrier service to Emery were grounded on September 11 and 12 and did not resume service until the evening of September 13, which adversely affected Emery's results of operations. In addition, CNF believes that operating results at Emery Worldwide and its other reporting segments continue to be adversely affected by the general decline in economic conditions that occurred after these terrorist attacks. In response to the terrorist attacks, the U.S. Congress passed the Air Transportation Safety and System Stabilization Act (the "Act"), a $15 billion emergency economic assistance package intended to mitigate financial losses in the air carrier industry. The legislation provides for $5 billion in direct loss reimbursement and $10 billion in federal loan guarantees and credits, expands war risk insurance coverage for air carriers, and provides some government assistance for short-term increases in insurance premiums. Emery is seeking assistance under the Act for direct loss reimbursement; however, CNF can provide no assurance that Emery will receive any payments under the Act or as to the timing or amount of any payments Emery may be entitled to receive under the Act. As such, Emery has not currently recorded any gains or receivables that may result from a recovery by Emery under the Act. PAGE 19 Express Mail Contract. In January 2001, the USPS and Federal Express Corporation (FedEx) announced an exclusive agreement under which FedEx will transport Express Mail and Priority Mail. EWA transported Express Mail and other classes of mail for the USPS under a contract (the "Express Mail contract"), which was originally scheduled to expire in January 2004; however, the USPS terminated the Express Mail contract "for convenience" effective August 26, 2001. As described below under "Discontinued Operations," on November 3, 2000, EWA and the USPS announced an agreement (the "Termination Agreement") to terminate their contract for the transportation and sortation of Priority Mail (the "Priority Mail contract"). On September 26, 2001, EWA entered into an agreement with the USPS to settle claims relating to the Priority Mail contract with the USPS (the "Settlement Agreement"). Under the Settlement Agreement, EWA received a $235 million payment from the USPS on September 28, 2001 to settle all non-termination claims under the Priority Mail contract. Under the Settlement Agreement, on September 28, 2001, EWA also received a $70 million provisional payment from the USPS for termination costs and other claims related to the Express Mail contract. The Settlement Agreement provides for the provisional payment to be adjusted if actual termination costs and other agreed upon claims relating to the Express Mail contract are greater or less than $70 million, in which case either the USPS will be required to make an additional payment with interest or EWA will be required to return a portion of the provisional payment with interest. As of December 31, 2001, the $70 million payment was included in deferred credits in CNF's Consolidated Balance Sheets; this amount will continue to be included in deferred credits until it is used to retire the remaining assets related to the Express Mail contract. The Settlement Agreement provides that the total amount payable by the USPS for termination costs and other claims relating to the Express Mail contract may not exceed $150 million. On December 14, 2001, EWA filed a termination settlement proposal with the USPS for recovery of EWA's costs of providing service under the terminated Express Mail contract as well as costs incurred by EWA's subcontractors for performing services under the Express Mail contract. Any recovery of such costs would be offset in whole or in part by the $70 million provisional payment received in 2001. In 2001, Emery recognized revenue of $117.0 million from the transportation of mail under the Express Mail contract, compared to $229.1 million in 2000 and $226.2 million in 1999. Operating income from the Express Mail contract in 2001 was $6.3 million compared to $28.2 million in 2000 and $35.5 million in 1999. Outlook. As described above, CNF on December 5, 2001 announced that Emery would become part of CNF's new Menlo Worldwide group in 2002 and would continue to provide North American forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, and that EWA would cease air carrier operations. As a result, John Williford, President of the Menlo Worldwide group of supply chain service providers, will have responsibility for the newly-aligned Emery business unit. Chutta Ratnathicam, Emery's former Chief Executive Officer, will return to his former position as CNF's Chief Financial Officer. Management will continue Emery's focus on expanding its variable-cost- based international operations and actively renegotiating airhaul rates in an effort to improve international operating margins. In North America, management will continue to position Emery as a freight forwarder utilizing aircraft operated by other carriers. As a result, management expects a more flexible variable-cost-based operating structure in North America with a decline in next-day freight services and an increase in second-day and deferred services. Management will continue its efforts to reduce Emery's North American cost structure, including the service center and hub network. PAGE 20 Menlo Logistics Menlo's revenue in 2001 rose 0.8% over 2000 to $898.2 million. Revenue in 2001 was adversely affected by a global economic recession, which resulted in lower business levels for some of Menlo's customers and the business failure of a furniture retailer that was a significant customer of Menlo as described below. Menlo's revenue of $890.8 million in 2000 exceeded revenue of $716.0 million in 1999 by 24.4%. Revenue growth in 2000 was due primarily to continued growth in logistics contracts and consulting fees. 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) in 2001 was $268.5 million, compared to $265.6 million in 2000 and $206.6 million in 1999. Including the loss described below from the failure of a significant customer, Menlo incurred a $15.8 million operating loss in 2001. Excluding this loss, Menlo's operating income in 2001 was $31.6 million, a decrease of 5.0% from 2000. Lower operating income in 2001, excluding the unusual charge, was due in part to a decline in the percentage of higher-margin consulting fees earned by Menlo partially offset by an increase in the percentage of lower- margin transportation management services provided by Menlo. Operating income of $33.3 million in 2000 increased 49.6% over operating income of $22.3 million in 1999 due largely to higher revenue from supply chain projects and an increase in the percentage of higher-margin consulting fees. Loss From the Business Failure of a Customer. In 2001, Menlo recognized losses of $47.5 million from the business failure of a furniture retailer that was a significant customer of Menlo. The losses were primarily composed of write-offs of accounts receivable and accrued lease costs on vacated facilities, as well as employee separation costs for approximately 280 jobs relating to the account. In 2001, Menlo recognized revenue from this customer of $54.8 million, compared to $13.6 million in 2000. Excluding the loss, operating income earned by Menlo from this customer's account in 2001 was $2.6 million compared to operating income of $0.3 million earned from the account in 2000. Other Segment In 2001, the Other segment included the operating results of Road Systems, Vector SCM and other corporate items. Vector SCM is a joint venture formed with General Motors in December 2000 to provide logistics services to General Motors. CNF owns 80% of the Vector SCM joint venture; however, the operating results of Vector SCM are reported in the Other segment as an equity method investment based on General Motors' ability to control certain operating decisions. In 2000, the reporting segment included the operating results of Road Systems and Vector SCM. In 1999, the reporting segment included Road Systems, a gain from a corporate legal settlement, and prior to the sale of its assets in May 1999, Vantage Parts. The $12.0 million operating loss from the Other segment in 2001 was due primarily to $9.4 million of operating losses incurred during the start-up phase of Vector SCM, and certain corporate items. These items included a $7.2 million underwriting loss, partially offset by a $5.1 million reversal of accrued expenses on executive compensation plans (excluding $3.4 million of expense reversals allocated to other reporting segments). The decline to essentially break- even results in 2000 from operating income of $27.6 million in 1999 was due primarily to a $16.5 million net gain from a corporate legal settlement in January 1999, and a $10.1 million net gain from the sale of assets of VantageParts, CNF's former distributor of wholesale parts and supplies. Other Net Expense and Income Taxes Other net expense in 2001 was 22.6% higher than in 2000 due largely to non-operating corporate items, including a $5.3 million investment loss in 2001 and a $2.6 million gain from the sale of securities in March 2000. Interest expense in 2001 fell 6.6% from 2000, reflecting lower interest expense on long-term debt, which was effectively converted from fixed rate to floating rate with interest rate swaps entered into in April 2000. Other net expense in 2000 increased 30.9% from 1999 due primarily to a $9.6 million net gain from the sale of securities in December 1999 and higher interest expense, partially offset by the $2.6 million investment gain in March 2000. PAGE 21 Losses from the significant unusual charges in 2001 contributed to an effective tax benefit rate of 37.7%, compared to an effective tax rate of 42.1% in 2000 and 43.6% in 1999. The reduction in the effective tax rate in 2000 from 1999 was primarily attributable to tax planning strategies and resolution of tax issues. DISCONTINUED OPERATIONS On November 3, 2000, EWA and the USPS announced an agreement (the "Termination Agreement") to terminate their contract for the transportation and sortation of Priority Mail (the "Priority Mail contract"). The Priority Mail contract was originally scheduled to terminate in the first quarter of 2002, subject to renewal options. Under the terms of the Termination Agreement, the USPS on January 7, 2001 assumed operating responsibility for services covered under the Priority Mail contract, except certain air transportation and related services, which were terminated effective April 23, 2001. The USPS agreed to reimburse EWA for Priority Mail contract termination costs, including costs of contract-related equipment, inventory, and operating lease commitments, up to $125 million (the "Termination Liability Cap"). On January 7, 2001, the USPS paid EWA $60 million toward the termination costs. The Termination Agreement 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 with interest or EWA will be required to return a portion of the provisional payment with interest. The Termination Agreement preserved EWA's right to pursue claims for underpayment of other amounts owed to EWA under the contract, which were ultimately settled in September 2001 as described below. CNF believes 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 EWA will receive any additional payments relating to these termination costs or that all termination costs incurred by EWA will be recovered. On September 26, 2001, EWA entered into an agreement with the USPS to settle claims relating to the underpayment of amounts owed to EWA under the Priority Mail contract (the "Settlement Agreement"). Under the Settlement Agreement, EWA received a $235 million payment from the USPS on September 28, 2001 to settle all non-termination claims under the Priority Mail contract. These claims were to recover costs of operating under the contract as well as profit and interest thereon. The Priority Mail Termination Agreement described above is unaffected by the Settlement Agreement. Under the Settlement Agreement, on September 28, 2001, EWA also received a $70 million provisional payment from the USPS to provisionally pay EWA for termination costs and other claims related to EWA's Express Mail contract, which is described above under "Emery Worldwide-Express Mail Contract." Results of the Express Mail contract are included in the Emery Worldwide reporting segment and are therefore not reported under Discontinued Operations. As a result of the termination of the Priority Mail contract, the results of operations, net assets, and cash flows of the Priority Mail operations have been segregated and classified as discontinued operations. As a result of the Settlement Agreement, a gain from discontinuance of $39.0 million, net of $24.9 million of income taxes, was recognized in the third quarter of 2001. A loss from discontinuance of $13.5 million was recognized in 2000, net of $8.6 million of income tax benefits, as a result of the Priority Mail contract termination. In 1999, after-tax operating income of $3.0 million was recognized prior to termination of the Priority Mail contract. Summary financial data and related information are included in Note 2 to the Consolidated Financial Statements. LIQUIDITY AND CAPITAL RESOURCES In 2001, cash and cash equivalents increased by $296.2 million over December 31, 2000 to $400.8 million at December 31, 2001, due primarily to payments of $365 million from the USPS described above under "Consolidated Results of Operations-Discontinued Operations." Cash provided by operating activities in 2001 was sufficient to fund investing and financing activities. PAGE 22 Operating activities in 2001 generated net cash of $307.4 million compared to $162.7 million of cash generated by operating activities in 2000. Cash from operations in 2001 was provided primarily by net income from continuing operations before Emery's after-tax restructuring charge; other non-cash charges, including depreciation, amortization and provision for uncollectible accounts; the collection of receivables; and an increase in deferred credits. Deferred credits at December 31, 2001 included the $70 million provisional payment from the USPS for termination costs and other claims related to the Express Mail contract, which are described under "Consolidated Results of Operations-Emery Worldwide-Express Mail Contract." Positive operating cash flows in 2001 were partially offset by declines in accounts payable and accrued liabilities. Cash from operations in 2000 declined $233.3 million from 1999 due in part to payments to the Internal Revenue Service (IRS), including a $93.4 million payment for various issues under examination by the IRS, and a $29.6 million payment in settlement of a proposed IRS adjustment related to excise taxes. IRS matters are discussed further in Note 14 to the Consolidated Financial Statements. Investing activities in 2001 used $194.0 million of cash compared to $234.1 million used in 2000. Capital expenditures of $192.1 million in 2001 fell from $235.2 million in 2000 due to a $44.2 million reduction at Emery and a $25.3 million reduction in corporate capital expenditures, partially offset by a $26.5 million increase at Con-Way. Higher capital expenditures from Con-Way were primarily due to $79.4 million of cash spent for the planned periodic replacement of linehaul equipment. In 2000, Con-Way acquired the use of $66.7 million of equipment through operating lease agreements. Capital expenditures in 2000 included the construction of a CNF corporate administration and technology facility. Cash consumed by investing activities in 2000 was $69.4 million less than 1999 due primarily to lower capital expenditures by Con-Way and Emery, partially offset by proceeds from the VantageParts asset sale in 1999. Financing activities in 2001 used cash of $34.6 million compared to financing activities that provided cash of $32.4 million in 2000. In 2000, a portion of the net proceeds of $197.5 million from the issuance in March 2000 of $200 million of 8 7/8% Notes Due 2010 were used to repay short- term and long-term borrowings outstanding under lines of credit. Financing activities in 1999 used $58.9 million, primarily due to net reduction in long-term debt. In July 2001, CNF entered into a new five-year $350 million unsecured revolving credit facility that replaced an existing five-year facility. In February 2002 the facility was increased to $385 million when a new participant joined the bank group. The new revolving facility matures July 3, 2006 and is also available for the issuance of letters of credit. At December 31, 2001, no borrowings were outstanding under the facility and $126.3 million of letters of credit were outstanding, leaving available capacity of $223.7 million, subject to compliance with financial covenants and other customary conditions to borrowing. Also, at December 31, 2001, CNF had $20.0 million of uncommitted lines of credit with no outstanding borrowings. Under other unsecured facilities, $56.4 million in letters of credit and bank guarantees were outstanding at December 31, 2001. Restructuring Charges and Regulatory Matters Due in large part to the restructuring charge incurred in connection with the cessation of EWA's air carrier operations as described above under "Consolidated Results of Operations-Emery Worldwide-Restructuring Charges," CNF was required to obtain amendments to its bank revolving credit agreement in December 2001 in order to remain in compliance with the financial covenants in that agreement. The amended credit agreement provides that, if CNF's senior unsecured long-term debt securities are rated at less than "BBB-" by Standard & Poor's and less than "Baa3" by Moody's, CNF, including its principal subsidiaries, will be required to pledge its accounts receivable as collateral to secure borrowings and other amounts due under the credit facility, subject to specified limitations, and, if the aggregate borrowings and other amounts due under the credit facility exceed a specified amount, CNF, including its principal subsidiaries, will be required to provide such additional collateral as the agent bank under the credit facility may reasonably request. CNF's senior unsecured long-term debt is currently rated "BBB-" by Standard & Poor's with a stable outlook and "Baa3" by Moody's with a negative outlook, and, as a result, any further reduction in CNF's senior unsecured long-term debt ratings by both of these credit rating agencies will require that CNF, including its principal subsidiaries, pledge collateral to secure the credit facility as described above. To the extent CNF, including its principal subsidiaries, pledges collateral to secure amounts due under the debt facility, CNF, including its principal subsidiaries, may also be required to pledge some or all of that collateral to equally and ratably secure its $200 million aggregate principal amounts of 8 7/8% notes due 2010, its $100 million aggregate principal amount of 7.35% notes due 2005, and $120.5 million aggregate principal amount of Thrift and Stock Plan notes due through 2009, which are guaranteed by CNF. PAGE 23 CNF cannot provide assurance that matters relating to the cessation of EWA's air carrier operations will not have a material adverse effect on CNF's financial condition, cash flows, or results of operations in the future. Emery intends to continue to use aircraft operated by third parties to provide service to its customers in North America, which will continue to result in Emery making additional cash payments, primarily because Emery will be required to pay both the ongoing lease payments and other payments associated with EWA's own fleet of grounded aircraft in addition to payments to other air carriers providing service to Emery's North American customers. In addition, the restructuring charges recognized by Emery during 2001 reflect CNF's estimate of the costs of terminating EWA's air carrier operations and restructuring Emery's business and related matters. CNF believes that the estimate is adequate to cover these costs based on information currently available and assumptions management believes are reasonable under the circumstances. However, there can be no assurance that actual costs will not differ from this estimate, and if such costs exceed CNF's estimate Emery will be required to recognize additional charges, which could result in defaults under CNF's $385 million credit facility and other debt instruments and under aircraft leases, or other costs and expenses in connection with these matters. If any of the financial covenants are breached, CNF will be required to obtain appropriate waivers or amendments from the requisite banks under the credit facility. If CNF is unable to obtain these amendments or waivers, CNF would be in default under the credit facility, and would be prohibited from making borrowings under the revolving credit facility and could be required by the banks to repay any outstanding borrowings and replace letters of credit outstanding under the facility. Under cross-default or cross-acceleration clauses contained in other debt instruments to which CNF is a party, these events could also result in other indebtedness becoming or being declared due and payable prior to its stated maturity. Moreover, to the extent that collateral was provided to secure borrowings and other amounts due under the $385 million facility or the notes described above, the banks or the noteholders would generally be entitled to take possession of the collateral following a default. There can be no assurance that CNF would be able to obtain the necessary waivers or amendments under the $385 million bank credit agreement were any such defaults to occur or to obtain additional financing to repay indebtedness or replace letters of credit that may become due as a result of those defaults. As a result, if a default were to occur under CNF's $385 million credit facility and if CNF is unable to obtain all required amendments or waivers, this would likely have a material adverse effect on CNF's financial condition, cash flows, and results of operations. Emery's fourth-quarter 2001 restructuring charge resulted in defaults under agreements pursuant to which EWA leases some of its aircraft. Moreover, EWA's amended settlement agreement with the FAA allows the FAA to revoke EWA's air carrier certificate as early as May 15, 2002. While the matter is not free from doubt, the revocation of this certificate could result in a default under additional leases pursuant to which EWA leases a substantial number of its aircraft. In addition, any further unusual charges could also result in defaults under additional aircraft leases. Upon the occurrence of a default under any of EWA's aircraft leases, the lessors generally are entitled to terminate the leases and demand termination payments or, in certain cases, liquidated damages or similar payments, which could be substantial. As a result, both the current and any future defaults under these leases could require that EWA make substantial cash payments to the lessors and otherwise could have a material adverse effect on CNF's financial condition, cash flows, and results of operations. In addition, certain of the leases are guaranteed by Emery or CNF, and upon a default the lessors under those leases would be entitled to seek recovery from the guarantors. PAGE 24 Holders of certain notes issued by CNF's Thrift and Stock Plan ("TASP"), which are guaranteed by CNF, have the right to require CNF to repurchase those notes if, among other things, both Moody's and Standard & Poor's have publicly rated CNF's long-term senior debt at less than investment grade unless, within 45 days, CNF shall have obtained, through a guarantee, letter of credit or other permitted credit enhancement or otherwise, a credit rating for such notes of at least "A" from Moody's or Standard & Poor's (or another nationally recognized rating agency selected by the holders of such notes) and shall maintain a rating on such notes of "A" or better thereafter. As of December 31, 2001, $62.0 million in aggregate principal amount of these TASP notes was outstanding. CNF's long-term senior debt is currently rated "Baa3" by Moody's with a negative outlook and "BBB-" by Standard & Poor's with a stable outlook; "Baa3" is the lowest investment grade rating from Moody's and "BBB-" is the lowest investment grade rating from Standard & Poor's. As a result, any further decrease in CNF's long-term senior debt ratings by both of these credit rating agencies would give the holders of TASP notes the right to require CNF to repurchase those notes unless CNF was able to obtain appropriate credit enhancement as described above, and there can be no assurance that CNF would be able to do so. The occurrence of any event or condition requiring CNF to repay these TASP notes would or could likely have a material adverse effect on CNF's financial condition, cash flows, and results of operations. In the event that CNF is required to repay any borrowings or other indebtedness before its scheduled maturity date or to replace any letters of credit before their scheduled expiry date, whether upon a default under its revolving credit facility, as a result of a reduction in the credit ratings on its long-term debt or otherwise, or to make payment to the lessors as a result of default under aircraft leases, there can be no assurance that CNF would have sufficient funds to do so or be able to arrange financing for those purposes. Accordingly, any of these events could have a material adverse effect on CNF's financial condition, cash flows, and results of operations. EWA is currently seeking to reach agreement with lessors of many of its aircraft in order to terminate the leases prior to their scheduled expiration dates. However, CNF can provide no assurance that EWA will be able to enter into any such agreements with the lessors. If EWA negotiates for the early termination of one or more of these aircraft leases, EWA will substantially accelerate the timing of scheduled cash payments to the lessors. Historically, CNF has utilized surety bonds as collateral for its workers compensation and vehicular self-insurance programs. In the first quarter of 2002, CNF experienced difficulty in renewing existing surety bonds and in obtaining new surety bonds. CNF believes that this is the result of a general collapse of the surety bond market in the wake of certain recent developments in the financial markets caused by, among other things, accounting matters at other companies and bankruptcy filings by companies that extensively utilize surety bonds. As a result, CNF anticipates that it will be required to obtain letters of credit in place of a number of expiring and new surety bonds. CNF currently estimates that it will be required to obtain up to $75 million of letters of credit for these purposes in the first quarter of 2002. CNF intends to obtain these letters of credit under its $385 million bank credit facility, subject to compliance with financial covenants and customary conditions. Any letters of credit issued under the credit facility will reduce the amount of available borrowings under that facility and there can be no assurance that the amount of letters of credit issued in place of surety bonds will not exceed CNF's current estimates. Likewise, there can be no assurance that CNF will not continue to experience difficulty in renewing existing or obtaining new surety bonds or that CNF will be able to obtain letters of credit in place of surety bonds, whether under its revolving credit facility or otherwise. PAGE 25 At December 31, 2001, CNF had $400.8 million in cash and cash equivalents available to meet its cash needs, including payment of amounts due under or in connection with aircraft leases. In addition, CNF intends to use borrowings and letters of credit issued under its $385 million credit facility to meet cash needs and in place of surety bonds, respectively, subject to compliance with financial covenants and satisfaction of customary conditions precedent. However, there can be no assurance that CNF will be able to comply with these financial covenants or meet these conditions precedent and any inability of CNF to obtain additional borrowings or letters of credit under this credit facility could have a material adverse effect on its financial condition, cash flows, and results of operations. Other In general, CNF expects its future liquidity to be affected by the timing and amount of cash flows related to restructuring charge reserves, long-term debt and guarantees, capital and operating leases, and the preferred securities of a subsidiary trust, which are in part discussed above as well as in Notes 3, 5, 6 and 8 to the Consolidated Financial Statements, respectively. CNF'S ratio of total debt to capital increased to 43.4% at December 31, 2001 from 31.4% at December 31, 2000 due primarily to the effect on capital resulting from the significant unusual charges described in "Consolidated Results of Operations." Discontinued Operations As described above under "Consolidated Results of Operations-Discontinued Operations," cash flows from the Priority Mail operations have been segregated and classified as net cash flows from discontinued operations in the Statements of Consolidated Cash Flows. As described in Note 2 to the Consolidated Financial Statements, in 2001 EWA received payments from the USPS related to the discontinued Priority Mail operations. In January 2001, EWA received a $60 million provisional payment toward reimbursable termination costs, as provided under the Termination Agreement signed by EWA and the USPS in November 2000. In September 2001, EWA received a $305 million payment from the USPS, including $235 million to settle all non-termination claims under the Priority Mail contract, as described above under "Consolidated Results of Operations-Discontinued Operations." CYCLICALITY AND SEASONALITY CNF's businesses operate in industries that are affected directly by general economic conditions and seasonal fluctuations, both of which affect demand for transportation services. In the trucking and air freight 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. However, results of operations in September 2001 were adversely affected by the September 11, 2001 terrorist attacks and the grounding of EWA's fleet of aircraft. MARKET RISK CNF is exposed to a variety of market risks, including the effects of changes in interest rates, commodity prices and foreign currency exchange rates. CNF's policy is to enter into derivative financial instruments only in circumstances that warrant the hedge of an underlying asset, liability or future cash flow against exposure to some form of commodity, interest rate or currency-related risk. Additionally, the designated hedges should have high correlation to the underlying exposure such that fluctuations in the value of the derivatives offset reciprocal changes in the underlying exposure. CNF is subject to the effects of interest rate fluctuations in the fair value of its long-term debt and capital lease obligations, as summarized in Notes 5 and 6 to the Consolidated Financial Statements. The change in the fair value of CNF's long-term obligations given a hypothetical 10% change in interest rates would be approximately $15 million at December 31, 2001. PAGE 26 CNF uses 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 its long-term debt. Cash flow hedges include interest rate swaps on variable-rate equipment lease obligations. As of December 31, 2001, CNF estimates 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 its financial condition, cash flows, or results of operations. Fair value hedges include interest rate swaps on $200 million of 8 7/8% Notes Due 2010. Under the measurement criteria of hedge effectiveness of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," which CNF adopted 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, 2001, the change in the fair value of these interest rate swaps given a hypothetical 10% change in interest rates would be approximately $10 million. At December 31, 2001, CNF had not entered into any derivative contracts to hedge its foreign currency exchange exposure. ACCOUNTING STANDARDS As described in Note 9 to the Consolidated Financial Statements, CNF adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" effective January 1, 2001. The $3.0 million cumulative effect of adopting a new accounting standard decreased Accumulated Other Comprehensive Loss. In 2001, the increase in the estimated fair value of its fair value hedges of $4.9 million resulted in increases to Other Assets and Long-term Debt. The estimated fair value of cash flow hedges decreased $7.5 million ($4.5 million net of tax). Changes in the estimated fair value of cash flow hedges were included in Other Assets and Accumulated Other Comprehensive Income (Loss). In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS 141, "Business Combinations," effective July 1, 2001, and SFAS 142, "Goodwill and Other Intangible Assets," effective for CNF on January 1, 2002. SFAS 141 requires use of the purchase method of accounting for acquisitions. SFAS 142 specifies that goodwill and some intangible assets will no longer be amortized but instead will be subject to periodic impairment testing. After adoption, annual goodwill amortization of approximately $10 million will cease. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 142. In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations," which will be effective for CNF on January 1, 2003. SFAS 143 addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 143. In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS 144 also supercedes the accounting and reporting provisions of APB No. 30, Reporting the Effects of Disposal of a Segment of a Business, for the disposal of a segment of a business. The effective date for implementation of SFAS 144 is for fiscal years beginning after December 15, 2001; however, early adoption is permitted. SFAS 144 retains many of the fundamental provisions of SFAS 121, but resolves certain implementation issues. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 144. PAGE 27 FORWARD LOOKING STATEMENTS Certain statements included herein constitute "forward- looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to a number of risks and uncertainties, and should not be relied upon as predictions of future events. All statements other than statements of historical fact are forward-looking statements, including any projections of earnings, revenues, weight, volumes, income or other financial or operating items, any statements of the plans, strategies, expectations or objectives of CNF or management for future operations or other future items, any statements concerning proposed new products or services, any statements regarding future economic conditions or performance, any statements of estimates or belief and any statements or assumptions underlying the foregoing. Certain such forward-looking statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "will," "should," "seeks," "approximately," "intends," "plans," "estimates" or "anticipates" or the negative of those terms or other variations of those terms or comparable terminology or by discussions of strategy, plans or intentions. Such forward-looking statements are necessarily dependent on assumptions, data and methods that may be incorrect or imprecise and there can be no assurance that they will be realized. In that regard, the following factors, among others and in addition to the matters discussed elsewhere in this document and other reports and documents filed by CNF with the Securities and Exchange Commission, could cause actual results and other matters to differ materially from those discussed in such forward-looking statements: changes in general business and economic conditions, including the slowdown in the global economy; the creditworthiness of CNF's customers and their ability to pay for services rendered; increasing competition and pricing pressure; changes in fuel prices; the effects of the cessation of EWA's air carrier operations, including the expense of using aircraft operated by other air carriers in Emery's North American operations while also bearing the cash costs of EWA's grounded aircraft fleet, the possibility of substantial cash payments in connection with the early termination of aircraft leases, the possibility of additional unusual charges and other costs and expenses relating to Emery's operations, existing defaults and possibility of future defaults under aircraft leases, and the possibility of future loss of business due to publicity surrounding the grounding of EWA's fleet of aircraft; the possibility of defaults under CNF's $385 million credit agreement and other debt instruments and aircraft leases, including defaults resulting from additional unusual charges or CNF's failure to perform in accordance with management's expectations, and the possibility that CNF may be required to pledge collateral to secure some of its indebtedness or to repay other indebtedness in the event that the ratings assigned to its long-term senior debt by credit rating agencies are reduced; uncertainties regarding EWA's ability to recover all termination costs relating to the termination of its former Priority Mail contract with the USPS; uncertainties regarding EWA's ability to recover all termination costs and other claims relating to the termination of its former Express Mail contract with the USPS; labor matters, including the grievance by furloughed pilots and crewmembers, renegotiations of labor contracts and the risk of work stoppages or strikes; enforcement of and changes in governmental regulations; environmental and tax matters (including claims made by the Internal Revenue Service with respect to aircraft maintenance tax matters); the Department of Transportation, FAA and Department of Justice investigation relating to Emery Worldwide's handling of hazardous materials; the February 2000 crash of an EWA aircraft and related investigation and litigation; and matters relating to CNF's 1996 spin-off of Consolidated Freightways. As a result of the foregoing, no assurance can be given as to future financial condition, cash flows, or results of operations. PAGE 28 CONSOLIDATED BALANCE SHEETS DECEMBER 31 2001 2000 ASSETS (Dollars in thousands) Current Assets Cash and cash equivalents $ 400,763 $ 104,515 Trade accounts receivable, net (Note 1) 677,684 881,268 Other accounts receivable 56,860 59,478 Operating supplies, at lower of average cost or market 20,244 42,271 Prepaid expenses 46,948 47,301 Deferred income taxes (Note 7) 125,347 105,502 Total Current Assets 1,327,846 1,240,335 Property, Plant and Equipment, at Cost Land 149,499 130,101 Buildings and leasehold improvements 739,197 692,312 Revenue equipment 618,329 797,444 Other equipment 411,546 420,788 1,918,571 2,040,645 Accumulated depreciation and amortization (848,042) (934,123) 1,070,529 1,106,522 Other Assets Deferred charges and other assets (Note 2) 221,555 137,393 Capitalized software, net 79,891 89,829 Unamortized aircraft maintenance (Note 3) - 242,468 Goodwill, net (Note 1) 240,523 254,887 Deferred income taxes (Note 7) 46,626 - Net non-current assets of discontinued operations (Note 2) 3,050 173,507 591,645 898,084 Total Assets $2,990,020 $3,244,941 The accompanying Notes to Consolidated Finanicial Statements are an integral part of these statements. PAGE 29 DECEMBER 31 LIABILITIES AND SHAREHOLDERS' EQUITY 2001 2000 (Dollars in thousands except per share data) Current Liabilities Accounts payable $ 338,730 $ 418,157 Accrued liabilities (Note 4) 379,425 317,650 Accrued claims costs (Note 1) 126,981 145,558 Current maturities of long-term debt and capital leases (Notes 5 and 6) 11,765 7,553 Income taxes payable (Note 7) 21,501 1,777 Net current liabilities of discontinued operations (Note 2) 5,573 68,214 Total Current Liabilities 883,975 958,909 Long-Term Liabilities Long-term debt and guarantees (Note 5) 436,055 424,116 Long-term obligations under capital leases (Note 6) 129,760 110,533 Accrued claims costs (Note 1) 122,273 82,502 Employee benefits (Note 11) 275,764 252,482 Other liabilities and deferred credits (Note 2) 120,858 51,163 Accrued aircraft leases 159,362 - Aircraft lease return provision (Note 3) 98,886 33,851 Deferred income taxes (Note 7) - 144,463 Total Liabilities 2,226,933 2,058,019 Commitments and Contingencies (Notes 5, 6 and 14) Company-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Convertible Debentures of the Company (Note 8) 125,000 125,000 Shareholders' Equity (Note 10) 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 805,895 and 824,902 shares, respectively 8 8 Additional paid-in capital, preferred stock 122,568 125,459 Deferred compensation, Thrift and Stock Plan (Note 12) (73,320) (80,602) Total Preferred Shareholders' Equity 49,256 44,865 Common stock, $.625 par value; authorized 100,000,000 shares; issued 55,559,909 and 55,426,605 shares, respectively 34,725 34,642 Additional paid-in capital, common stock 332,066 331,282 Retained earnings 432,918 855,314 Deferred compensation, restricted stock (Note 13) (1,013) (1,423) Cost of repurchased common stock (6,669,393 and 6,770,628 shares, respectively) (164,441) (166,939) 634,255 1,052,876 Accumulated Other Comprehensive Loss (Note 10) (45,424) (35,819) Total Common Shareholders' Equity 588,831 1,017,057 Total Shareholders' Equity 638,087 1,061,922 Total Liabilities and Shareholders' Equity $2,990,020 $3,244,941 The accompanying Notes to Consolidated Finanicial Statements are an integral part of these statements. PAGE 30 STATEMENTS OF CONSOLIDATED OPERATIONS YEARS ENDED DECEMBER 31 (Dollars in thousands except per share data) 2001 2000 1999 REVENUES $4,862,731 $5,572,377 $5,037,301 Costs and Expenses Operating expenses 4,224,023 4,611,079 4,079,152 General and administrative expenses 481,916 506,986 483,661 Depreciation 165,202 164,346 146,828 Restructuring charges (Note 3) 652,241 - - Net gain on sale of assets of wholesale parts and supplies distributor - - (10,112) Net gain on corporate legal settlement - - (16,466) 5,523,382 5,282,411 4,683,063 OPERATING INCOME (LOSS) (660,651) 289,966 354,238 Other Income (Expense) Investment income 3,981 2,373 189 Interest expense (27,992) (29,972) (25,972) Dividend requirement on preferred securities of subsidiary trust (Note 8) (6,250) (6,250) (6,250) Miscellaneous, net (5,021) 5,079 10,055 (35,282) (28,770) (21,978) Income (Loss) from continuing operations before income taxes (benefits) (695,933) 261,196 332,260 Income tax (benefit) provision (Note 7) (262,367) 109,880 144,752 INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE ACCOUNTING CHANGE (433,566) 151,316 187,508 Income from discontinued operations, net of tax (Note 2) - - 2,966 Gain (Loss) from discontinuance, net of tax (Note 2) 38,975 (13,508) - 38,975 (13,508) 2,966 Cumulative effect of accounting change, net of tax (Note 1) - (2,744) - Net income (loss) (394,591) 135,064 190,474 Preferred stock dividends 8,283 8,261 8,218 NET INCOME (LOSS) APPLICABLE TO COMMON SHAREHOLDERS $(402,874) $126,803 $182,256 Weighted-Average Common Shares Outstanding (Note 1) Basic 48,752,480 48,490,662 48,189,618 Diluted 48,752,480 55,901,374 56,019,317 Earnings (Loss) Per Share (Note 1) Basic Income (Loss) from continuing operations $(9.06) $2.95 $3.72 Income from discontinued operations, net of tax - - 0.06 Gain (Loss) from discontinuance, net of tax 0.80 (0.28) - Cumulative effect of accounting change, net of tax - (0.06) - Net income (loss) applicable to common shareholders $(8.26) $2.61 $3.78 Diluted Income (Loss) from continuing operations $(9.06) $2.65 $3.29 Income from discontinued operations, net of tax - - 0.06 Gain (Loss) from discontinuance, net of tax 0.80 (0.24) - Cumulative effect of accounting change, net of tax - (0.05) - Net income (loss) applicable to common shareholders $(8.26) $2.36 $3.35 The accompanying Notes to Consolidated Finanicial Statements are an integral part of these statements. PAGE 31 STATEMENTS OF CONSOLIDATED CASH FLOWS YEARS ENDED DECEMBER 31 (Dollars in thousands) 2001 2000 1999 Cash and Cash Equivalents, Beginning of Year $104,515 $146,263 $73,897 Operating Activities Net income (loss) (394,591) 135,064 190,474 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Loss (Gain) from discontinued operations, net of tax (38,975) 13,508 (2,966) Cumulative effect of accounting change, net of tax - 2,744 - Restructuring charges 652,241 - - Loss from the business failure a customer 47,454 - - Depreciation and amortization 195,397 190,651 164,876 Increase (Decrease) in deferred income taxes (209,947) 47 27,686 Amortization of deferred compensation 7,402 7,356 11,858 Provision for uncollectible accounts 17,435 9,070 15,229 Loss on sales of property and equipment, net 4,636 692 3,038 Loss (Gain) from sale of assets of businesses, net - 5,459 (10,112) Loss (Gain) from investments 5,251 (2,619) (9,625) Changes in assets and liabilities: Receivables 134,265 (131,694) (94,539) Prepaid expenses 353 (6,169) (8,454) Unamortized aircraft maintenance 12,776 (55,419) (34,999) Accounts payable (81,963) 22,634 50,749 Accrued liabilities (67,492) (54,931) 51,571 Accrued claims costs 30,005 24,923 35,459 Income taxes (59,787) (49,761) (11,885) Employee benefits 21,763 31,936 29,987 Aircraft lease return provision (16,169) 5,366 34,629 Deferred charges and credits 66,942 18,340 (38,723) Other (19,633) (4,502) (8,245) Net Cash Provided by Operating Activities 307,363 162,695 396,008 Investing Activities Capital expenditures (192,125) (235,221) (324,604) Software expenditures (15,668) (19,211) (34,811) Proceeds from investments - 2,619 9,625 Proceeds from sale of assets of businesses - 7,263 29,260 Proceeds from sales of property and equipment 13,833 10,441 16,986 Net Cash Used in Investing Activities (193,960) (234,109) (303,544) Financing Activities Net proceeds from issuance of long-term debt - 197,452 162,400 Repayments of long-term debt, guarantees and capital leases (7,625) (96,513) (195,396) Repayments of short-term borrowings, net - (40,000) (3,000) Proceeds from exercise of stock options 3,210 1,792 7,474 Payments of common dividends (19,522) (19,425) (19,311) Payments of preferred dividends (10,709) (10,903) (11,078) Net Cash Provided by (Used in) Financing Activities (34,646) 32,403 (58,911) Net Cash Provided by (Used in) Continuing Operations 78,757 (39,011) 33,553 Net Cash Provided by (Used in) Discontinued Operations 217,491 (2,737) 38,813 Increase (Decrease) in Cash and Cash Equivalents 296,248 (41,748) 72,366 Cash and Cash Equivalents, End of Year $400,763 $104,515 $146,263 Supplemental Disclosure Cash paid (refunded) for income taxes $(9,639) $82,002 $63,207 Cash paid for interest, net of amounts capitalized $28,908 $32,806 $35,833 The accompanying Notes to Consolidated Finanicial Statements are an integral part of these statements. PAGE 32 STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY (Dollars in thousands except per share data)
Preferred Stock Series B Common Stock ------------------------ ----------------- Additional Number of Number of Par Paid-in Deferred Retained Shares Amount Shares Amount Capital Compensation Earnings 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 Net loss - - - - - - (394,591) Other comprehensive income (loss): Foreign currency translation adjustment - - - - - - - Cumulative effect of accounting change, net of tax (Note 9) - - - - - - - Change in fair value of cash flow hedges (Note 9) - - - - - - - Minimum pension liability adjustment - - - - - - - Comprehensive loss (Note 11) - - - - - - - Exercise of stock options including tax benefits of $930 - - 178,377 111 4,028 - - Issuance of restricted stock, net of forfeitures - - (45,073) (28) (3,662) 3,690 - Issuance of employee stock awards - - - - 6 - - Recognition of deferred compensation - - - - - 4,002 - Repurchased common stock issued for conversion of preferred stock (19,007) - - - (2,479) - - Common dividends declared ($.40 per share) - - - - - - (19,522) Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,323 - - - - - - (8,283) Balance, December 31, 2001 805,895 $8 55,559,909 $34,725 $454,634 $(74,333) $432,918
PAGE 33 CNF INC. AND SUBSIDIARIES STATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY (Dollars in thousands except per share data)
Cost of Accumulated Repurchased Other Common Comprehensive Comprehensive Stock Income (Loss) Income (Loss) 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) Net loss - - $(394,591) Other comprehensive income (loss): Foreign currency translation adjustment - (5,404) (5,404) Cumulative effect of accounting change, net of tax (Note 9) - 3,005 3,005 Change in fair value of cash flow hedges (Note 9) - (4,548) (4,548) Minimum pension liability adjustment - (2,658) (2,658) Comprehensive loss (Note 11) - - $(404,196) Exercise of stock options including tax benefits of $930 - - Issuance of restricted stock, net of forfeitures - - Issuance of employee stock awards 19 - Recognition of deferred compensation - - Repurchased common stock issued for conversion of preferred stock 2,479 - Common dividends declared ($.40 per share) - - Series B, Preferred dividends ($12.93 per share) net of tax benefits of $2,323 - - Balance, December 31, 2001 $(164,441) $(45,424) The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
PAGE 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE1: PRINCIPAL ACCOUNTING POLICIES Basis of Presentation and Principles of Consolidation The consolidated financial statements include the accounts of CNF Inc. and its wholly owned subsidiaries (the Company or CNF). Organization CNF is a management company of global supply chain services with operations primarily represented by four reporting segments: Con-Way Transportation Services (Con-Way) provides regional next-day and second-day less-than-truckload (LTL) and truckload (TL) freight trucking throughout the U.S., Canada, and Mexico, expedited transportation, logistics, air freight forwarding and truckload brokerage services. Emery Worldwide (Emery) provides expedited and deferred domestic and international heavy air freight services, ocean delivery, and customs brokerage. Internationally, Emery operates primarily as an air freight forwarder using commercial airlines. Prior to the suspension and subsequent cessation of its air carrier operations in the fourth quarter of 2001, Emery provided air transportation services in North America using owned and leased aircraft operated by Emery Worldwide Airlines (EWA) and owned and leased aircraft operated by third parties. EWA, a separate subsidiary of CNF, is included in the Emery Worldwide reporting segment. After the suspension and subsequent cessation of EWA's air carrier operations, Emery utilized aircraft operated by third parties as well as a dedicated ground fleet to provide its services. See Note 3, "Restructuring Charges," and Note 14, "Contingencies and Other Commitments-Restructuring Charges and Regulatory Matters." Through other business units, Emery also provides customs brokerage, ocean container services, and logistics services. Menlo Logistics (Menlo) provides third- and fourth-party integrated contract logistics services, including the development and management of complex distribution networks, and supply chain engineering and consulting. The Other segment in 2001 included the operating results of Road Systems, a trailer manufacturer; Vector SCM, and certain corporate items. Vector SCM is a joint venture formed with General Motors in December 2000 to provide logistics services to General Motors. CNF owns 80% of the Vector SCM joint venture; however, the operating results of Vector SCM are reported in the Other segment as an equity method investment based on General Motors' ability to control certain operating decisions. In 2000, the reporting segment included the operating results of Road Systems and Vector SCM. In 1999, the reporting segment included Road Systems, a gain from a corporate legal settlement, and prior to the sale of its assets in May 1999, Vantage Parts, CNF's former wholesale distributor of truck parts and supplies. As described in Note 2, "Discontinued Operations," the operations under a Priority Mail contract with the U.S. Postal Service are reflected as discontinued operations due to the termination of the contract, effective January 7, 2001. As described in Note 3, "Restructuring Charges," CNF announced on December 5, 2001 that Emery would become part of a new Menlo Worldwide group of supply chain service providers and would continue to provide full North American service utilizing aircraft operated by other air carriers, and that EWA would cease air carrier operations. Beginning with the first quarter of 2002, CNF's results will be comprised of three primary lines of business-Con-Way, Menlo Worldwide and Other. Estimates Management makes estimates and assumptions when preparing the financial statements in conformity with accounting principles generally accepted in the United States. These estimates and assumptions affect the amounts reported in the accompanying financial statements and notes thereto. Actual results could differ from those estimates. Recognition of Revenues Effective January 1, 2000, CNF prospectively adopted a change in accounting method for recognition of its freight transportation revenue and 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 for Con- Way and Emery 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-year operating results is not material. PAGE 35 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 $22,675,000 and $21,722,000 at December 31, 2001 and 2000, respectively. Property, Plant and Equipment Property, plant and equipment are depreciated primarily 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 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. 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, 2001 and 2000 was $122,282,000 and $116,810,000, respectively. See also "-New Accounting Standards" below. Impairment of Long-Lived Assets CNF reviews long-lived assets and certain identifiable intangibles for impairment whenever events or 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. See Note 3, "Restructuring Charges" for information concerning impairment charges recognized in 2001. See also "-New Accounting Standards" below. Income Taxes CNF follows the liability method of accounting for income taxes. Accrued Claims Costs CNF 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, CNF 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 of participation. Reinsurance does not relieve CNF of its liabilities under the original policy. However, in the opinion of management, CNF's reinsurers are sound and any potential exposure to CNF for non-payment is minimal. Foreign Currency Translation Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are included in the Foreign Currency Translation Adjustment in the Statements of Consolidated Shareholders' Equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the local currency are included in results of operations. PAGE 36 Earnings (Loss) Per Share (EPS) Basic EPS for continuing operations is computed by dividing reported income (loss) from continuing operations before accounting change (after preferred dividends) by the weighted-average common shares outstanding. The calculation of diluted EPS for continuing operations is calculated as follows: (Dollars in thousands except per share data) 2001 2000 1999 Earnings (Loss): Net income (loss) from continuing operations, before accounting change $ (441,849) $ 143,055 $ 179,290 Add-backs: Dividends on preferred stock, net of replacement funding - 1,424 1,337 Dividends on preferred securities of subsidiary - 3,816 3,816 trust, net of tax ---------- ---------- ---------- $ (441,849) 148,295 184,443 Shares: Weighted-average shares 48,752,480 48,490,662 48,189,618 outstanding Stock option and restricted - 342,826 695,099 stock dilution Series B preferred stock - 3,942,886 4,009,600 Preferred securities of subsidiary trust - 3,125,000 3,125,000 ---------- ---------- ---------- 48,752,480 55,901,374 56,019,317 Diluted earnings (loss) per share from continuing operations $ (9.06) $ 2.65 $ 3.29 For the year ended December 31, 2001, convertible securities and stock options were anti-dilutive. As a result, the assumed shares and related add-back to net income (loss) from continuing operations under the if-converted method have been excluded from the calculation of diluted EPS. If the securities were dilutive, the assumed shares under the if-converted method would have been as follows: stock options-461,040 shares, series B preferred stock-3,794,159, preferred securities of subsidiary trust-3,125,000 shares. Derivative Instruments and Hedging Activities As described in Note 9, "Derivative Instruments and Hedging Activities," CNF adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," effective January 1, 2001. The $3.0 million after-tax gain representing the cumulative effect of adopting the new accounting standard decreased Accumulated Other Comprehensive Loss. New Accounting Standards In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS 141, "Business Combinations," effective July 1, 2001, and SFAS 142, "Goodwill and Other Intangible Assets," effective for CNF on January 1, 2002. SFAS 141 requires use of the purchase method of accounting for acquisitions. SFAS 142 specifies that goodwill and some intangible assets will no longer be amortized but instead will be subject to periodic impairment testing. After adoption, CNF projects annual goodwill amortization of approximately $10 million will cease. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 142. In June 2001, the FASB issued SFAS 143, "Accounting for Asset Retirement Obligations," which will be effective for CNF on January 1, 2003. SFAS 143 addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 143. In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which supersedes SFAS 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed Of." SFAS 144 also supercedes the accounting and reporting provisions of APB No. 30, Reporting the Effects of Disposal of a Segment of a Business, for the disposal of a segment of a business. The effective date for implementation of SFAS 144 is for fiscal years beginning after December 15, 2001; however, early adoption is permitted. SFAS 144 retains many of the fundamental provisions of SFAS 121, but resolves certain implementation issues. CNF is in the process of evaluating the financial statement impact of adoption of SFAS 144. Reclassification Certain amounts in prior years' financial statements have been reclassified to conform to the current year presentation. NOTE 2: DISCONTINUED OPERATIONS On November 3, 2000, EWA and the U.S. Postal Service (USPS) announced an agreement (the "Termination Agreement") to terminate their contract for the transportation and sortation of Priority Mail (the "Priority Mail contract"). The Priority Mail contract was originally scheduled to terminate in the first quarter of 2002, subject to renewal options. Under the terms of the Termination Agreement, the USPS on January 7, 2001, assumed operating responsibility for services covered under the Priority Mail contract, except certain air transportation and related services, which were terminated effective April 23, 2001. PAGE 37 The USPS agreed to reimburse EWA for Priority Mail contract termination costs, including costs of contract-related equipment, inventory, and operating lease commitments, up to $125 million (the "Termination Liability Cap"). On January 7, 2001, the USPS paid EWA $60 million toward the termination costs. The Termination Agreement 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 with interest or EWA will be required to return a portion of the provisional payment with interest. The Termination Agreement preserved EWA's right to pursue claims for underpayment of other amounts owed to EWA under the contract, which were ultimately settled in September 2001 as described below. On September 26, 2001, EWA entered into an agreement with the USPS to settle claims relating to the underpayment of amounts owed to EWA under the Priority Mail contract with the USPS (the "Settlement Agreement"). Under the Settlement Agreement, EWA received a $235 million payment from the USPS on September 28, 2001 to settle all claims under the Priority Mail contract. These claims were to recover costs of operating under the contract as well as profit and interest thereon. The Priority Mail Termination Agreement described above is unaffected by the Settlement Agreement. Under the Settlement Agreement, on September 28, 2001, EWA also received a $70 million provisional payment from the USPS for termination costs and other claims related to EWA's Express Mail contract, which was terminated by the USPS "for convenience" effective August 26, 2001. The Settlement Agreement provides for the provisional payment to be adjusted if actual termination costs and other agreed upon claims related to the Express Mail contract are greater or less than $70 million, in which case either the USPS will be required to make an additional payment with interest or EWA will be required to return a portion of the provisional payment with interest. As of December 31, 2001, the $70 million payment was included in Deferred Credits in CNF's Consolidated Balance Sheets; this amount will continue to be included in Deferred Credits until it is used to retire the remaining $80 million in assets included in deferred charges related to the Express Mail contract. The Settlement Agreement provides that the total amount payable by the USPS for termination costs and other claims relating to the Express Mail contract may not exceed $150 million. On December 14, 2001, EWA filed a termination settlement proposal with the USPS for recovery of EWA's costs of providing service under the terminated Express Mail contract as well as costs incurred by EWA's subcontractors for performing services under the Express Mail contract. Any recovery of such costs would be offset in whole or in part by the $70 million provisional payment received in 2001. Results of the Express Mail contract are included in the Emery Worldwide reporting segment and are therefore not reported as discontinued operations. Operating Results and Gain (Loss) from Discontinuance As a result of the termination of the Priority Mail contract, the results of operations, net assets, and cash flows of the Priority Mail operations have been segregated and classified as discontinued operations. The summarized results of discontinued operations were as follows: (Dollars in thousands) 2001 2000 1999 Revenue $ 10,152 $ 593,952 $ 555,509 Operating income before taxes - - 4,862 Income taxes - - 1,896 ------- ------- ------- Net income from discontinued operations $ - $ - $ 2,966 Gain (loss) from discontinuance, net of taxes (benefits) $ 38,975 $ (13,508) $ - The Priority Mail contract provided for an annual re- determination of prices paid to EWA. Because of disputes between the USPS and EWA, these prices never were re- determined and, as a result, EWA did not receive any additional payments to which it would have been entitled upon a favorable re-determination. Unbilled revenue represented the accrual of revenue sufficient only to recover costs. As a result, no operating profit was recognized in connection with the Priority Mail contract since the third quarter of 1999, when EWA filed a claim for re-determined higher prices. Prior to the January 7, 2001 settlement CNF recorded revenues in amounts up to the costs incurred. As a result of the Settlement Agreement, unbilled revenue was fully recovered and EWA in 2001 recognized a gain from discontinuance of $39.0 million, net of $24.9 million of income taxes. Unbilled revenues at December 31, 2000 was $176.2 million. The loss from discontinuance of $13.5 million recognized in 2000, which is reported net of $8.6 million of income tax benefits, included 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. PAGE 38 In 2001, revenue of $10.2 million was recognized for the period prior to the USPS assuming operating responsibility for services covered under the contract on January 7, 2001. Subsequent to January 7, 2001, no revenue was recognized under the Priority Mail contract. The amount of accrued loss from discontinuance related to EWA's Priority Mail contract recognized at December 31, 2001 and 2000 was $3.3 million and $22.1 million, respectively, and was included in Net Current Liabilities of Discontinued Operations in the Consolidated Balance Sheets. The accrued loss from discontinuance was increased in 2001 by $3.6 million for revised estimates of termination costs related to insurance and legal fees and reduced by 2001 payments of $22.4 million. The net assets (liabilities) of discontinued operations were as follows: December 31, December 31, (Dollars in thousands) 2001 2000 ------------ ------------ Current assets Accounts Receivable $ - $ 10,324 Other 6,346 15,796 ------------ ------------ 6,346 26,120 Property, plant and equipment, net - 66,316 Long-term receivables and other assets 3,050 184,348 ------------ ------------ Total assets of discontinued operations 9,396 276,784 ------------ ------------ Current liabilities 11,919 94,334 Long-term liabilities - 77,157 ------------ ------------ Total liabilities of discontinued operations 11,919 171,491 ------------ ------------ Net assets (liabilities) of discontinued operations $ (2,523) $ 105,293 NOTE 3: RESTRUCTURING CHARGES In June 2001, Emery began an operational restructuring to align it with management's estimates of future business prospects for domestic heavy air freight and address changes in market conditions, which deteriorated due to a slowing domestic economy, loss of EWA's contracts with the USPS to transport Express Mail and Priority Mail and, to a lesser extent, loss of business to ground transportation providers. The $340.5 million restructuring charge recognized in the second quarter of 2001 consisted primarily of non-cash impairment charges, including the write-off of $184.2 million for unamortized aircraft maintenance and $89.7 million for aircraft operating supplies, equipment and other assets. Asset impairment charges were based on an evaluation of cash flows for North American operations and, for certain assets, independent appraisals. Also included in the restructuring charge was $66.6 million for estimated future cash expenditures related primarily to the return to the lessors of certain aircraft leased to Emery and the termination of the related leases. As described in "Emery Worldwide-Regulatory Matters" under "Management's Discussion and Analysis," the Federal Aviation Administration (FAA) required EWA to suspend its air carrier operations on August 13, 2001. In response to the FAA suspension, as well as the terrorist actions described below in Note 14, "Contingencies and Other Commitments-Terrorist Attacks," and a deepening global economic recession, Emery's management re-evaluated Emery's restructuring plan. CNF announced on December 5, 2001 that Emery in 2002 would become part of CNF's new Menlo Worldwide group of supply chain service providers and would continue to provide full North American forwarding services utilizing aircraft operated by other air carriers instead of EWA's fleet of aircraft, and that EWA would cease air carrier operations. In connection with the revised restructuring plan, in the fourth quarter of 2001 Emery recognized additional restructuring charges of $311.7 million for the planned disposal of leased aircraft, cessation of EWA's remaining operations, employee separation costs for 157 Emery employees, and other costs. The $311.7 million restructuring charge recognized in the fourth quarter of 2001 includes primarily accruals for scheduled undiscounted rental payments for aircraft leased to Emery and estimated costs of returning those aircraft upon expiration of the related leases. For 2002, the scheduled rental payments of the aircraft aggregate $61.0 million. However, Emery may pay a larger portion of its scheduled rental payments in 2002 or thereafter, which could be substantial, if EWA successfully negotiates the early termination of aircraft leases or in connection with defaults by EWA under aircraft leases. See Note 14, "Contingencies and Other Commitments-Restructuring Charges and Regulatory Matters." The following table represents the cumulative activity related to Emery's 2001 restructuring plan: Total Cash Charged Reserves at Charges Payments Against December 31, (In Millions) Assets 2001 --------- ---------- --------- ------------ Employee separations $ 6.1 $ (0.8) -- $ 5.3 Asset impairments 278.0 -- (278.0) -- Aircraft and other costs 368.1 (2.9) -- 365.2 --------- ---------- ---------- ------------ $ 652.2 $ (3.7) $(278.0) $ 370.5 PAGE 39 As a result of the restructuring charge recognized in the second quarter of 2001, Emery wrote off all remaining unamortized aircraft maintenance. Prior to the write-off, Emery capitalized the costs to perform required maintenance inspections of engines and aircraft frames for leased and owned aircraft and amortized these costs over the shorter of the period until the next scheduled maintenance or remaining term of the lease agreement. Also, the 2001 restructuring charges included accruals for obligations related to scheduled rental payments and the estimated costs of returning the leased aircraft. The obligation for scheduled rental payments was accrued based on the estimate of undiscounted cash payments payable under the lease agreements.Under certain of Emery's aircraft lease agreements, Emery is expected to return the aircraft with a stipulated number of hours remaining on the aircraft, engines, and landing gear until the next scheduled maintenance. The aircraft lease return provision includes the costs accrued to satisfy this obligation at the date of lease return or other disposal. There can be no assurance that Emery will not be required to incur additional charges or expend additional amounts in the future in connection with matters relating to the cessation of EWA's air carrier operations or the termination of EWA's aircraft leases, particularly if one or more of the events described in Note 14, "Contingencies and Other Commitments" were to occur, which could have a material adverse effect on CNF's financial condition, cash flows, and results of operations. NOTE 4: ACCRUED LIABILITIES Accrued liabilities consisted of the following as of December 31: (Dollars in thousands) 2001 2000 Other accrued liabilities $ 110,329 $ 87,038 Accrued aircraft leases and restructuring liabilities 92,926 20,781 Holiday and vacation pay 66,757 70,506 Taxes other than income taxes 37,197 38,576 Wages and salaries 32,848 31,571 Estimated revenue adjustments 23,781 29,352 Incentive compensation 10,019 34,206 Interest 5,568 5,620 Total accrued liabilities $ 379,425 $ 317,650 NOTE 5: DEBT AND OTHER FINANCING AGREEMENTS As of December 31, long-term debt and guarantees consisted of the following: (Dollars in thousands) 2001 2000 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) 120,500 128,000 8 7/8% Notes due 2010 (interest payable semi-annually), net of discount and including fair market value adjustment 219,455 198,816 at December 31, 2001 Industrial Revenue Bonds due 2014 (interest payable quarterly at a floating rate of 3.65% at 4,800 4,800 December 31, 2001) --------- --------- 444,755 431,616 Less current maturities (8,700) (7,500) Total long-term debt and guarantees $ 436,055 $ 424,116 In July 2001, CNF entered into a new five-year $350 million unsecured revolving credit facility that replaced an existing five-year facility. In February 2002 the facility was increased to $385 million when a new participant joined the bank group. The new revolving facility is available for cash borrowings and issuance of letters of credit. Borrowings under the agreement, which terminates on July 3, 2006, bear interest at a rate based upon specified indices plus a margin dependent on CNF's credit rating. The agreement contains various restrictive covenants, including a limitation on the incurrence of additional indebtedness and the requirement for specified levels of consolidated net worth and fixed-charge coverage. At December 31, 2001, CNF had no borrowings and $126.3 million of letters of credit outstanding under this agreement. At December 31, 2000, CNF had no borrowings outstanding under the previous revolving credit facility. CNF guarantees the notes issued by CNF's Thrift and Stock Plan (TASP). On July 1, 1999, CNF 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, 2001, $58.5 million was outstanding under these refinanced notes, which contain financial covenants that require CNF to maintain minimum amounts of net worth and fixed-charge coverage. The remaining $62.0 million of TASP Notes outstanding at December 31, 2001 are subject to redemption at the option of the holders should a certain designated event occur or ratings by both Moody's and Standard & Poor's of senior unsecured indebtedness decline below investment grade. PAGE 40 The 7.35% Notes due in 2005 contain certain covenants limiting the incurrence of additional liens.CNF's consolidated interest expense as presented on the Statements of Consolidated Operations is net of capitalized interest of $864,000 in 2001, $4,636,000 in 2000, and $5,864,000 in 1999. The aggregate annual maturities and sinking fund requirements of Long-Term Debt and Guarantees for the next five years ending December 31 are $8,700,000 in 2002, $10,100,000 in 2003, $12,000,000 in 2004, $112,700,000 in 2005 and $15,000,000 in 2006. CNF has interest rate swap agreements designated as fair value hedges, which expire in 2010 and effectively convert CNF's 8 7/8% Notes due 2010 to floating rate obligations. With the adoption of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," on January 1, 2001, the interest rate swaps are recorded on the balance sheet at fair value, which reflects the estimated amounts that CNF would receive or pay to terminate the contracts at the reported date. At December 31, 2001 the $20.6 million estimated fair value of the interest rate swaps was included in Other Assets with a corresponding fair market value adjustment to debt. See Note 9, "Derivative Instruments and Hedging Activities." Long-term debt, exclusive of capital leases, had carrying values of $431,615,000 and $431,616,000 at December 31, 2001 and 2000, respectively, compared with fair values of approximately $447,208,000 and $450,756,000 at those dates. The estimated fair values were determined based on quoted market prices or on the current rates offered for debt with similar terms and maturities. As described in Note 3, "Restructuring Charges," EWA in August 2001 was required to suspend its air carrier operations as part of a settlement agreement with the FAA and, on December 5, 2001, CNF announced that EWA would cease operating as an air carrier. Emery's fourth-quarter 2001 restructuring charge incurred in connection with the cessation of EWA's air carrier operations required CNF to obtain amendments to its bank revolving credit agreement in December 2001 in order to remain in compliance with the financial covenants in that agreement. In addition to provisions described in Note 14, "Contingencies and Other Commitments," the amendment temporarily relaxes minimum fixed-charge coverage financial covenants through 2002 and also restricts CNF's capital expenditures. Moreover, if both Moody's and Standard & Poor's reduce their ratings below an investment grade level on CNF's senior long-term debt securities, CNF, including its principal subsidiaries, would be required to pledge collateral to secure the borrowings under the $385 million revolving credit facility and in addition could be required to purchase the TASP notes under covenants in those agreements. See Note 14, "Contingencies and Other Commitments," for a discussion of the impact of regulatory matters and the restructuring charges on CNF's financing arrangements. NOTE 6: LEASES CNF and its subsidiaries are obligated under 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 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 call provisions. Included in property, plant and equipment is $77 million of Hub-related equipment and leasehold improvements. Future minimum lease payments with initial or remaining non- cancelable lease terms in excess of one year, at December 31, 2001, were as follows: (Dollars in thousands) Capital Operating Leases Leases Year ending December 31: 2002 $ 9,832 $ 102,306 2003 26,170 85,932 2004 6,819 68,173 2005 6,819 53,665 2006 6,819 32,527 Thereafter (through 2018) 149,752 47,473 Total minimum lease payments 206,211 $ 390,076 Amount representing interest (73,386) Present value of minimum lease payments 132,825 Current maturities of obligations under capital leases (3,065) Long-term obligations under capital leases $ 129,760 PAGE 41 Certain operating and capital leases contain financial covenants. The most restrictive covenants require Emery to maintain minimum amounts of fixed-charge coverage and net worth. Certain operating leases also contain provisions that allow CNF to extend the leases for various renewal periods. Rental expense for operating leases comprised the following: (Dollars in thousands) 2001 2000 1999 Minimum rentals $ 226,604 $ 240,429 $ 221,047 Sublease rentals (3,668) (6,069) (7,436) Amortization of deferred gains (193) (1,147) (1,639) $ 222,743 $ 233,213 $ 211,972 CNF has interest rate swap agreements designated as cash flow hedges which expire through 2005 and effectively convert $96.4 million of variable rate lease obligations to fixed rate obligations. Interest rate differentials to be paid or received are recognized over the life of each agreement as adjustments to operating expense. With the adoption of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," on January 1, 2001, the cash flow hedges are recorded on the balance sheet at fair value, which reflects the estimated amounts that CNF would receive or pay to terminate the contracts at the reported date. At December 31, 2001, the estimated fair value of the cash flow hedges was a liability of $2.5 million. See Note 9, "Derivative Instruments and Hedging Activities." As described in Note 3, "Restructuring Charges," EWA in August 2001 was required to suspend its air carrier operations as part of a settlement agreement with the FAA and, on December 5, 2001, CNF announced that EWA would cease operating as an air carrier. Emery's fourth-quarter 2001 restructuring charge incurred in connection with the cessation of EWA's air carrier operations has resulted in defaults under agreements pursuant to which EWA leases some of its aircraft. See Note 14, "Contingencies and Other Commitments-Restructuring Charges and Regulatory Matters," for a discussion of the impact of regulatory matters and the restructuring charges on CNF's financing arrangements. NOTE 7: INCOME TAXES The components of the provision (benefit) for income taxes for the years ended December 31 were as follows: (Dollars in thousands) 2001 2000 1999 Income Taxes Current provision (benefit) Federal $(59,859) $89,020 $95,629 State and local (2,801) 7,383 14,285 Foreign 4,628 13,430 7,152 $(58,032) $109,833 $117,066 Deferred provision (benefit) Federal $(183,077) $(1,583) $26,787 State and local (21,258) 1,630 899 (204,335) 47 27,686 Total income taxes (benefits) $(262,367) $109,880 $144,752 Income taxes have been provided for foreign operations based upon the various tax laws and rates of the countries in which operations are conducted. There is no direct relationship between CNF's overall foreign income tax provision and foreign pretax book income due to the different methods of taxation used by countries throughout the world. The components of deferred tax assets and liabilities at December 31 related to the following: (Dollars in thousands) 2001 2000 Deferred tax assets Reserves for employee benefits $93,408 $87,192 Reserves for accrued claims costs 64,652 48,092 Reserves for post retirement health benefits 29,602 45,843 Reserves for restructuring charges 123,678 - Other reserves not currently deductible 27,222 52,181 ------- ------- 338,562 233,308 Deferred tax liabilities Depreciation and amortization 117,559 224,013 Other 49,030 48,256 ------- ------- 166,589 272,269 ------- ------- Net deferred tax asset (liability) $171,973 $(38,961) 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 42 Income taxes (benefits) varied from the amounts calculated by applying the U.S. statutory income tax rate to the pretax income (loss) as set forth in the following reconciliation: 2001 2000 1999 Federal statutory tax (benefit) rate (35.0%) 35.0% 35.0% State income taxes (benefits) (net of federal income tax benefit) (3.3) 2.8 3.3 Foreign taxes in excess of U.S. - 1.0 0.8 statutory rate Non-deductible operating expenses 0.4 0.8 1.0 Amortization of goodwill 0.5 1.2 0.9 Foreign tax credits, net - (0.5) (0.4) Other, net (0.3) 1.8 3.0 Effective income tax rate (37.7%) 42.1% 43.6% The cumulative undistributed earnings of CNF's foreign subsidiaries (approximately $40.1 million at December 31, 2001), 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 $4.3 million. Certain contingencies related to income taxes are discussed in Note 14, "Contingencies and Other Commitments." NOTE 8: PREFERRED SECURITIES OF SUBSIDIARY TRUST On June 11, 1997, CNF Trust I (the Trust), a Delaware business trust wholly owned by CNF, issued 2,500,000 of its $2.50 Term Convertible Securities, Series A (TECONS) to the public for gross proceeds of $125 million. The combined proceeds from the issuance of the TECONS and the issuance to CNF of the common securities of the Trust were invested by the Trust in $128.9 million aggregate principal amount of 5% convertible subordinated debentures due June 1, 2012 (the Debentures) issued by CNF. The Debentures are the sole assets of the Trust. Holders of the TECONS are entitled to receive cumulative cash distributions at an annual rate of $2.50 per TECONS (equivalent to a rate of 5% per annum of the stated liquidation amount of $50 per TECONS). CNF has guaranteed, on a subordinated basis, distributions and other payments due on the TECONS, to the extent the Trust has funds available therefore and subject to certain other limitations (the "Guarantee"). The Guarantee, when taken together with the obligations of CNF under the Debentures, the Indenture pursuant to which the Debentures were issued, and the Amended and Restated Declaration of Trust of the Trust [including its obligations to pay costs, fees, expenses, debts and other obligations of the Trust (other than with respect to the TECONS and the common securities of the Trust)], provide a full and unconditional guarantee of amounts due on the TECONS. The Debentures are redeemable for cash, at the option of CNF, in whole or in part, on or after June 1, 2000 at a price equal to 103.125% of the principal amount, declining annually to par if redeemed on or after June 1, 2005, plus accrued and unpaid interest. In certain circumstances relating to federal income tax matters, the Debentures may be redeemed by CNF at 100% of the principal plus accrued and unpaid interest. Upon any redemption of the Debentures, a like aggregate liquidation amount of TECONS will be redeemed. The TECONS do not have a stated maturity date, although they are subject to mandatory redemption upon maturity of the Debentures on June 1, 2012, or upon earlier redemption. Each TECONS is convertible at any time prior to the close of business on June 1, 2012 at the option of the holder into shares of CNF's common stock at a conversion rate of 1.25 shares of CNF's common stock for each TECONS, subject to adjustment in certain circumstances. PAGE 43 NOTE 9: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES Effective January 1, 2001, CNF adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and SFAS 138. SFAS 133 establishes accounting and reporting standards requiring that every derivative instrument, as defined, be recorded on the balance sheet as either an asset or liability measured at fair value and that changes in fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Qualifying hedges allow a derivative's gains or losses to offset related results on the hedged item in the income statement or be deferred in Accumulated Other Comprehensive Income (Loss) until the hedged item is recognized in earnings. CNF is exposed to a variety of market risks, including the effects of interest rates, commodity prices, foreign currency exchange rates and credit risk. CNF's policy is to enter into derivative financial instruments only in circumstances that warrant the hedge of an underlying asset, liability or future cash flow against exposure to the related risk. Additionally, the designated hedges should have high correlation to the underlying exposure such that fluctuations in the value of the derivatives offset reciprocal changes in the underlying exposure. CNF formally documents its hedge relationships, including identifying the hedge instruments and hedged items, as well as its risk management objectives and strategies for entering into the hedge transaction. At hedge inception and at least quarterly thereafter, CNF assesses whether the derivatives are effective in offsetting changes in either the cash flows or fair value of the hedged item. If a derivative ceases to be a highly effective hedge, CNF will discontinue hedge accounting, and any gains or losses on the derivative instrument would be recognized in earnings in the period it no longer qualifies for hedge accounting. For derivatives designated as cash flow hedges, changes in the derivative's fair value are recognized in Accumulated Other Comprehensive Income (Loss) until the hedged item is recognized in earnings. Any change in fair value resulting from ineffectiveness is recognized immediately in earnings. For derivatives designated as fair value hedges, changes in the derivative's fair value are recognized in earnings and offset by changes in the fair value of the hedged item, which are recognized in earnings to the extent that the derivative is effective. CNF's cash flow hedges include interest rate swap derivatives designated to mitigate the effects of interest rate volatility on floating-rate operating lease payments. Fair value hedges include interest rate swap derivatives designated to mitigate the effects of interest rate volatility on the fair value of fixed-rate long-term debt. CNF's current interest rate swap derivatives qualify for hedge accounting treatment under SFAS 133. In accordance with the transition provisions of SFAS 133, CNF recorded in Other Assets a transition adjustment of $20.6 million to recognize the estimated fair value of interest rate swap derivatives, a $4.9 million ($3.0 million after tax) transition adjustment in Accumulated Other Comprehensive Loss to recognize the estimated fair value of interest rate swap derivatives designated as cash flow hedges, and a $15.7 million transition adjustment in Long- Term Debt to recognize the difference between the carrying value and estimated fair value of fixed-rate debt hedged with interest rate swap derivatives designated as fair value hedges. During 2001, the estimated fair value of CNF's fair value hedges increased $4.9 million and offset equal increases in the estimated fair value of CNF's fixed-rate long-term debt. The estimated fair value of cash flow hedges in 2001 declined $7.5 million ($4.5 million after tax). PAGE 44 NOTE 10: 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 12, "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. 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. Accumulated Other Comprehensive Income (Loss) 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. CNF has disclosed Comprehensive Income (Loss) in the Statements of Consolidated Shareholders' Equity. The following is a summary of the components of Accumulated Other Comprehensive Loss: December 31, December 31, (Dollars in thousands) 2001 2000 Cumulative effect of change in accounting for derivative instruments and hedging activities (Note 9) $ 3,005 $ - Accumulated change in fair value of cash flow hedges (Note 9) (4,548) - Accumulated foreign currency translation adjustments (32,782) (27,378) Minimum pension liability adjustment (11,099) (8,441) Accumulated other comprehensive loss $ (45,424) $ (35,819) NOTE 11: EMPLOYEE BENEFIT PLANS Pension Plans CNF has a non-contributory defined benefit pension plan (the Plan) covering non-contractual employees in the United States. CNF's annual pension provision and contributions are based on an independent actuarial computation. Although it is CNF'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 91% 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. CNF 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, 2001 and 2000, the accrued benefit cost was $24,040,000 and $20,058,000, respectively, and the net periodic pension cost was $5,540,000 in 2001, $4,951,000 in 2000, and $4,290,000 in 1999. Included in Employee Benefits in the Balance Sheet at December 31, 2001, was a minimum pension liability adjustment for the supplemental retirement program of $11,099,000 offset by an accumulated other comprehensive loss of the same amount. Post Retirement Medical Plans CNF has a retiree medical plan that provides benefits to all non-contractual employees at least 55 years of age with 10 years or more of service. The retiree medical 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 medical benefits for employees hired on or after January 1, 1993. PAGE 45 The following sets forth the changes in pension and post retirement medical benefit obligations and the determination of the accrued benefit costs that are included in Employee Benefits in the Consolidated Balance Sheets at December 31: Pension Plan Post Retirement Plan (Dollars in thousands) 2001 2000 2001 2000 Change in benefit obligation: Projected benefit obligation at beginning of year $465,243 $397,121 $53,923 $84,774 Service cost - benefits earned during the year 37,936 33,866 1,178 1,449 Interest cost on projected benefit obligation 39,400 33,571 5,006 6,669 Curtailment gain (15,787) (2,356) -- -- Actuarial loss (gain) 42,466 8,685 20,986 (3,124) Amendments and benefit obligations 996 6,164 (1,055) (30,707) Benefits paid (13,213) (11,808) (4,398) (5,138) Projected benefit obligation at end of year 557,041 465,243 75,637 53,923 Change in plan assets: Fair value of plan assets at beginning of year 410,944 434,347 -- -- Actual return on plan assets (18,586) (12,804) -- -- Company Contributions 13,112 -- 4,398 5,138 Transfers from defined contribution plan 20,985 1,209 -- -- Benefits paid (13,213) (11,808) (4,398) (5,138) Fair value of plan assets at end of year 413,242 410,944 -- -- Funded status of the plans (143,799) (54,299) (75,637) (53,923) Unrecognized actuarial (gain) loss 7,384 (66,084) 7,097 (13,889) Unrecognized prior service costs (benefit) 8,736 11,206 (1,279) (279) Unrecognized net asset at transition (2,181) (3,388) -- -- Accrued benefit cost $(129,860) $(112,565) $(69,819) $(68,091) Weighted-average assumptions as of December 31: Discount rate 7.25% 7.75% 7.25% 7.75% Expected long-term rate of return on assets 9.50% 9.50% -- -- Rate of compensation increase 4.50% 5.00% -- -- Net periodic benefit costs for the years ended December 31 includes the following:
Pension Plan Post Retirement Plan ------------------------------- ------------------------------- (Dollars in Thousands) 2001 2000 1999 2001 2000 1999 Service cost - benefits earned during the year $37,936 $33,866 $37,733 $ 1,178 $ 1,449 $ 1,558 Interest cost on benefit obligation 39,400 33,571 30,525 5,003 6,669 6,289 Expected return on plan assets (38,944) (40,866) (33,298) -- -- -- Net amortization and deferral (292) (7,523) 21 (55) (144) (55) Net benefit cost $38,100 $19,048 $34,981 6,126 $7,974 $7,792
PAGE 46 In 2001, CNF transferred obligations related to disabled employees totaling $30,707,000 from the post retirement medical plan into a long-term disability plan as these medical benefits are more appropriately classified as part of that plan. This transfer was reflected in the change in the 2000 post retirement benefit obligation as part of plan amendments and benefit adjustments. At December 31, 2001 the accrued long-term disability plan liability was $36,913,000. At December 31, 2001, a 10.25% annual rate of increase in the per capita cost of covered medical benefits was assumed for 2002 and was assumed to decrease gradually to 5.5% for 2008 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 2002 and was assumed to remain at that level thereafter. A one-percentage-point change in assumed health care cost trend rates would change the aggregate service and interest cost by $355,000 and the accumulated benefit obligation by approximately $4,000,000. Other Compensation Plans CNF 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 $8,712,000, $36,134,000, and $47,068,000 in 2001, 2000, and 1999, respectively, and by hourly participants was $7,308,000, $30,612,000, and $24,053,000 in 2001, 2000, and 1999, respectively. NOTE 12: THRIFT AND STOCK PLAN CNF 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 CNF's Series B Cumulative Convertible Preferred Stock. This stock is only issuable to the TASP trustee. The TASP satisfies CNF's contribution requirement by matching up to 50% of the first 3% of a participant's basic compensation. CNF contributions to the TASP were $12,314,000 in 2001, $13,282,000 in 2000, and $13,735,000 in 1999, 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 CNF. 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 Operations. 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 CNF 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 2001, 2000, and 1999, $7,282,000, $6,998,000, and $7,236,000, respectively, of deferred compensation expense was recognized. At December 31, 2001, the TASP owned 805,895 shares of Series B preferred stock, of which 329,131 shares have been allocated to employees. At December 31, 2001, CNF has reserved, authorized and unissued common stock adequate to satisfy the conversion feature of the Series B preferred stock. NOTE 13: STOCK-BASED COMPENSATION Stock Options Officers and non-employee directors have been granted options under CNF's stock option plans to purchase common stock of CNF 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. PAGE 47 CNF applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees." Had compensation cost for CNF's stock-based compensation plans been determined in accordance with SFAS 123, "Accounting for Stock-Based Compensation," pro forma net income (loss) from continuing operations as reported net of preferred dividends was ($451.4) million, $133.2 million and $177.3 million for the years 2001, 2000 and 1999, respectively. Diluted earnings (loss) per share would have been ($9.26), $2.38 and $3.16 per share for the years 2001, 2000 and 1999, 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 2001, 2000 and 1999 was $11.71, $14.26, and $15.65 per share, respectively, and were estimated using the Black-Scholes options pricing model with the following assumptions: 2001 2000 1999 Risk-free interest rate 4.2%-5.1% 5.6%-6.9% 5.0%-6.5% Expected life (years) 5.9 5.8 5.8 Expected volatility 49% 60% 50% Expected dividend yield 1.2% 1.4% 1.0% The following is a summary of stock option data: Number of Wtd. Avg. Options Exercise Price 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 Granted 1,311,404 25.48 Exercised (178,377) 18.01 Expired or canceled (137,200) 33.43 Outstanding at December 31, 2001 5,723,774 $26.69 Options exercisable as of December 31: 2001 2,462,480 $26.17 2000 2,013,257 24.78 1999 2,020,646 23.66 The following is a summary of the stock options outstanding and exercisable at December 31, 2001: Outstanding Options Exercisable Options ------------------------------- -------------------- Range of Remaining Wtd. Avg. Wtd. Avg. Exercise Number of Life in Exercise Number of Exercise Prices Options Years Price Options Price $11.08-$16.26 275,868 1.6 $14.17 275,868 $14.17 $18.05-$27.06 3,717,394 3.7 24.28 1,148,010 21.19 $29.63-$43.06 1,730,512 18.5 33.89 1,038,602 34.86 Restricted Stock Under terms of CNF's stock-based compensation plans, shares of CNF's common stock were awarded to executive officers in 1999 and are awarded annually to directors. Restrictions on the shares generally expire one-third per year dependent on the achievement of certain market prices of CNF's common stock. Shares are valued at the market price of CNF's common stock at the date of award. The following table summarizes information about restricted stock awards for the years ended December 31: 2001 2000 1999 ------------------ ------------------ ------------------ Wtd. Wtd. Wtd. Avg.Fair Avg. Fair Avg. Fair Shares Value Shares Value Shares Value Awarded 4,059 33.81 19,258 $34.50 63,112 $ 33.08 Forfeited 49,132 29.82 15,332 23.87 -- -- The weighted-average fair value for shares awarded in 2000 excludes 15,276 shares awarded for settlement of pension liabilities due to certain directors. CNF reversed net compensation expense recognized for restricted stock in the amount of $3,300,000 in 2001. Total compensation expense recognized for restricted stock in 2000, and 1999 was $358,000 and $4,622,000, respectively. At December 31, 2001, CNF had 1,529,413 common shares available for the grant of stock options, restricted stock, or other stock-based incentive compensation. NOTE 14: CONTINGENCIES AND OTHER COMMITMENTS IRS Matters CNF is currently under examination by the Internal Revenue Service (IRS) for tax years 1987 through 1999 on various issues. In connection with those examinations, the IRS proposed adjustments for tax years 1987 through 1990 after which CNF filed a protest and engaged in discussions with the Appeals Office of the IRS. After those discussions failed to produce a settlement, in March 2000, the IRS issued a Notice of Deficiency (the Notice) for the years 1987 through 1990 with respect to various issues, including aircraft maintenance and matters related to years prior to the spin-off of Consolidated Freightways Corporation (CFC), CNF's former long-haul LTL segment, on December 2, 1996. Based upon the Notice, the total amount of the deficiency for items in years 1987 through 1990, including taxes and interest, was $164.2 million as of December 31, 2001. The amount originally due under the Notice was reduced in the third quarter of 2000 by a portion of CNF's $93.4 million payment to the IRS, which is described below. PAGE 48 In addition to the issues covered under the Notice for tax years 1987 through 1990, the IRS in May 2000 proposed additional adjustments for tax years 1991 through 1996 with respect to various issues, including aircraft maintenance and matters relating to CFC for years prior to the spin- off.Under the Notice, the IRS has assessed a substantial adjustment for tax years 1989 and 1990 based on the IRS' position that certain aircraft maintenance costs should have been capitalized rather than expensed for federal income tax purposes. CNF believes that its practice of expensing these types of aircraft maintenance costs is consistent with industry practice and Treasury Ruling 2001-4. CNF intends to vigorously contest the Notice and the proposed adjustments as they pertain to the aircraft maintenance issue. CNF paid $93.4 million to the IRS in the third quarter of 2000 to stop the accrual of interest on amounts due under the Notice for tax years 1987 through 1990 and under proposed adjustments for tax years 1991 through 1996 for matters relating to CFC for years prior to the spin-off and for all other issues except aircraft maintenance costs.There can be no assurance that CNF will not be liable for all of the amounts due under the Notice and proposed adjustments. As a result, CNF is unable to predict the ultimate outcome of this matter and there can be no assurance that this matter will not have a material adverse effect on CNF's financial condition, cash flows, or results of operations. Spin-off of CFC As part of the spin-off, CNF and CFC entered into a tax sharing agreement that provided a mechanism for the allocation of any additional tax liability and related interest that arise due to adjustments by the IRS for years prior to the spin-off. In May 2000, CNF and CFC settled certain federal tax matters relating to CFC on issues for tax years 1984 through 1990. Under the settlement agreement, CNF received from CFC cash of $16.7 million, a $20.0 million note due in 2004, and a commitment to transfer to CNF land and buildings with an estimated value of $21.2 million. In the last half of 2000, CNF 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 obligations to CNF. In March 2001, CNF entered into an agreement to acquire real property owned by CFC in settlement of CFC's $20.0 million note due in 2004. In September 2001, the real property was effectively swapped, in a non-cash exchange, for CFC's $20.0 million note due in 2004 following a three- way exchange among CNF, CFC and a third party. In connection with the spin-off of CFC, CNF agreed to indemnify certain states, insurance companies and sureties against the failure of CFC to pay certain 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 CNF is liable to the issuing bank and by bonds issued by surety companies. Although CFC is obligated to reimburse and indemnify CNF against liability with respect to these claims, CFC's obligation is not secured by any collateral and there can be no assurance that CFC will, in fact, reimburse and indemnify CNF. Any failure by CFC to reimburse or indemnify CNF for a substantial amount of these claims could have a material adverse affect on CNF's financial condition, cash flows, or results of operations. Restructuring Charges and Regulatory Matters Due in large part to the restructuring charge incurred in connection with the cessation of EWA's air carrier operations as described in Note 3, "Restructuring Charges," CNF was required to obtain amendments to its bank revolving credit facility, as described in Note 5, "Debt and Other Financing Arrangements," which provide for the pledge of collateral by CNF and its principal subsidiaries upon specified downgrades of CNF's senior unsecured long-term debt securities. This restructuring charge also resulted in defaults under leases, as described in Note 6, "Leases," pursuant to which EWA leases some of its aircraft. In addition, the restructuring charges recognized by Emery during 2001 reflect CNF's estimate of the costs of terminating EWA's air carrier operations and restructuring Emery's business and related matters. Although CNF believes that the estimate is adequate to cover these costs based on information currently available and assumptions management believes are reasonable under the circumstances, Emery will be required to recognize additional charges or credits if actual results differ from management's estimates. Additional charges could result in defaults under CNF's bank revolving credit facility and other debt instruments and under aircraft leases. For further detailed discussion of these matters, see "Continuing Operations-Emery Worldwide-Regulatory Matters" and "Liquidity and Capital Resources-Restructuring Charges and Regulatory Matters," under "Management's Discussion and Analysis." PAGE 49 As a result of the matters discussed above, CNF can provide no assurance that these matters will not have a material adverse effect on CNF's financial condition, cash flows, or results of operations in the future. Terrorist Attacks Operating results at Emery were adversely affected by the terrorist attacks on September 11, 2001. Contractors providing air carrier service to Emery were grounded on September 11 and 12 and did not resume service until the evening of September 13, which adversely affected Emery's results of operations. In response to the terrorist attacks on September 11, 2001, the U.S. Congress passed the Air Transportation Safety and System Stabilization Act (the "Act"), a $15 billion emergency economic assistance package intended to mitigate financial losses in the air carrier industry. The legislation provides for $5 billion in direct loss reimbursement and $10 billion in federal loan guarantees and credits, expands war risk insurance coverage for air carriers, and provides some government assistance for short- term increases in insurance premiums. Emery is seeking assistance under the Act for direct loss reimbursement; however, CNF can provide no assurance that Emery will receive any payments under the Act or as to the timing or amount of any payments Emery may be entitled to receive under the Act. As such, Emery has not currently recorded any gains or receivables that may result from a recovery by Emery under the Act. Other CNF is a defendant in various other lawsuits incidental to its businesses. It is the opinion of management that the ultimate outcome of these actions will not have a material impact on CNF's financial condition, cash flows, or results of operations. In 1999, Emery recognized a $9.6 million non-operating net gain from the sale of its holdings in Equant N.V., an international data network service provider, which was reported in Miscellaneous Net Expense. Approximately 34% of Emery's holdings in the securities were sold in December 1999, and the remaining shares held by Emery are carried at essentially no cost at December 31, 2001, and are subject to transferability restrictions. NOTE 15: SEGMENT REPORTING In 2001, CNF's operations comprised four business segments: Con-Way Transportation Services, Emery Worldwide, Menlo Logistics, and Other. See Note 1, "Principal Accounting Policies-Organization." Intersegment revenue and related operating income have been eliminated to reconcile to 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. 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) 2001 2000 1999 Revenues United States $3,609,692 $4,127,040 $3,810,177 Canada 117,740 149,862 132,190 North America 3,727,432 4,276,902 3,942,367 International 1,135,299 1,295,475 1,094,934 Total 4,862,731 5,572,377 5,037,301 PAGE 50 OPERATING SEGMENTS (Dollars in thousands)
Adjustments, Eliminations Con-Way and Transportation Emery Menlo Consolidated the Parent Services Worldwide Logistics Other Year Ended December 31, 2001 Revenues $4,862,731 $(34,778) $1,913,021 $2,045,044 $909,694 $29,750 Inter-company eliminations - 34,778 (708) (250) (11,512) (22,308) Net revenues 4,862,731 - 1,912,313 2,044,794 898,182 7,442 Operating income (loss) (660,651) - 157,467 (790,345)[a] (15,818)[b] (11,955) Depreciation and amortization 195,397 13,220 101,749 71,966 8,044 418 Capital expenditures 192,125 6,821 149,113 23,910 12,184 97 Identifiable assets 2,990,020 670,400 1,021,800 1,090,670 183,501 23,649 Year Ended December 31, 2000 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[c] 28,365[d] 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[e] 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 [a] Includes a $652.2 million loss from restructuring charges, $55.8 million from costs of EWA's grounded aircraft and a $4.7 million loss from a legal settlement on returned aircraft. [b] Includes a $47.5 million loss from the business failure of a customer. [c] Includes a $5.5 million loss from the sale of certain assets of Con-Way Truckload Services. [d] Includes an $11.9 million loss from the termination of aircraft leases. [e] Includes a $16.5 million net gain from a corporate legal settlement and a $10.1 million net gain from the sale of the assets of CNF's former wholesale parts and supplies distributor.
PAGE 51 NOTE 16: QUARTERLY FINANCIAL DATA (UNAUDITED) (Dollars in thousands except per share data)
2001 - Quarter Ended March 31 June 30 September 30 December 31 Revenues $1,278,465 $1,256,608 $1,184,959 $1,142,699 Operating income (loss) 33,728 (351,987)[b][c] (5,370)[c] (337,022)[b][c] Income (Loss) from continuing operations before income taxes 25,928 (359,661) (13,214) (348,986)[d] Income tax provision (benefit) 10,371 (133,852) (4,889) (133,997) Net income (loss) from continuing operations [a] 13,517 (227,888) (10,377) (217,101) Gain (loss) from discontinuance, net of tax -- -- 38,975 -- Net Income (Loss) Applicable to Common Shareholders 13,517 (227,888) 28,598 (217,101) Per share: Basic earnings (loss) Income (Loss) from continuing operations 0.28 (4.67) (0.21) (4.45) Gain (Loss) from discontinuance, net of tax -- -- 0.80 -- Net income (loss) applicable to common shareholders 0.28 (4.67) 0.59 (4.45) Diluted earnings (loss) Income (loss) from continuing operations 0.26 (4.67) (0.21) (4.45) Gain (Loss) from discontinuance, net of tax -- -- 0.80 -- Net Income (Loss) Applicable to Common Shareholders 0.26 (4.67) 0.59 (4.45) Market price range $27.23-$39.88 $25.86-$33.74 $21.05-$32.91 $21.60-$33.25 Common dividends 0.10 0.10 0.10 0.10 2000 - Quarter Ended March 31 June 30 September 30 December 31 Revenues $1,321,894 $1,401,146 $1,409,613 $1,439,724 Operating income 71,469 87,131 54,940[f][g] 76,426 Income from continuing operations before income taxes 66,456[e] 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 Loss from discontinuance, net of tax -- -- (13,508) -- Cumulative effect of accounting change, net of tax (2,744) -- -- -- Net Income Applicable to Common Shareholders 33,434 43,692 11,842 37,835 Per share: Basic earnings Income from continuing operations 0.75 0.90 0.52 0.78 Loss from discontinuance, net of tax -- -- (0.28) -- Cumulative effect of accounting change, net of tax (0.06) -- -- -- Net Income Applicable to Common Shareholders 0.69 0.90 0.24 0.78 Diluted earnings Income from continuing operations 0.67 0.80 0.47 0.70 Loss from discontinuance, net of tax -- -- (0.24) -- Cumulative effect of accounting change, net of tax (0.05) -- -- -- Net Income Applicable 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 (a) Reduced by preferred stock dividends. (b) Includes a $340.5 million loss, $213.9 million after tax, in June ($4.67 per share), a $311.7 million loss, $192.1 million after tax, in December ($3.93 per share) from restructuring charges and a $4.7 million loss, $2.9 million after tax, ($0.06 per share) from a legal settlement on returned aircraft. (c) Includes a $31.6 million loss, $19.3 million after tax, in June ($0.40 per share), a $6.3 million loss, $3.8 million after tax, in July ($0.08 per share), a $9.5 million loss, $5.9 million after tax, in December ($0.12 per share) from the business failure of a customer, a $17.0 million loss, $10.4 million after tax, in the third quarter ($0.21 per share) and a $38.8 million loss, $23.9 million after tax, in the fourth quarter ($0.49 per share) from costs of EWA's grounded aircraft. (d) Includes a $5.3 million loss, $3.3 million after tax, ($0.07 per share) from investments. (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 $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. (g) 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 aircraft leases.
PAGE 52 REPORTS MANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING The management of CNF 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. /s/ Gregory L. Quesnel - ---------------------- Gregory L. Quesnel President, Chief Executive Officer /s/ Chutta Ratnathicam - ---------------------- Chutta Ratnathicam Senior Vice President, Chief Financial Officer /s/ Kevin S. Coel - ---------------------- Kevin S. Coel Controller REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Directors of CNF Inc. We have audited the accompanying consolidated balance sheets of CNF Inc. (a Delaware Corporation) and subsidiaries as of December 31, 2001 and 2000, and the related statements of consolidated operations, cash flows and shareholders' equity for each of the three years in the period ended December 31, 2001. 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 Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. As explained in Note 1 to the Consolidated Financial Statements, effective January 1, 2000, the Company changed its method of accounting for recognition of its in-transit freight transportation revenue. /s/ Arthur Andersen LLP San Francisco, California January 25, 2002 (except with respect to the increase in the unsecured revolving credit facility as discussed in Note 5, as to which the date is February 22, 2002) PAGE 53 FIVE YEAR FINANCIAL SUMMARY (Dollars in thousands except per share data)
2001 2000 1999 1998 1997 SUMMARY OF OPERATIONS Revenues $4,862,731 $5,572,377 $5,037,301 $4,530,686 $4,215,165 Con-Way Transportation Services 1,912,313 2,044,896 1,878,216 1,683,991 1,473,188 Emery Worldwide 2,044,794 2,608,142 2,408,416 2,203,474 2,249,594 Menlo Logistics 898,182 890,800 716,008 586,835 455,892 Other 7,442 28,539 34,661 56,386 36,491 Operating income (loss) (660,651) 289,966 354,238 293,919 277,865 Con-Way Transportation Services 157,467 227,312(f) 228,820 206,945 147,155 Emery Worldwide (790,345)(c) 28,365(g) 75,514 64,299 113,963 Menlo Logistics (15,818)(d) 33,303 22,255 19,459 17,178 Other (11,955) 986 27,649(i) 3,216 (431) Depreciation and amortization 195,397 190,651 164,876 145,840 123,391 Interest expense 27,992 29,972 25,972 32,627 39,553 Net income (loss) from continuing operations before income taxes (benefits) (695,933)(e) 261,196(h) 332,260(j) 253,812 234,812 Income taxes (benefits) (262,367) 109,880 144,752 112,756 106,839 Income (Loss) from continuing operations (a) (441,849) 143,055 179,290 132,887 120,087 Discontinued operations, net of tax (b) - - 2,966 (2,078) (7,929) Gain (Loss) from discontinuance, net of tax (b) 38,975 (13,508) - - - Cumulative effect of accounting change, net of tax - (2,744) - - - Net Income (Loss) Applicable to Common Shareholders (402,874) 126,803 182,256 130,809 112,158 PER SHARE Net income (loss) from continuing operations, basic $(9.06) $2.95 $3.72 $2.79 $2.59 Discontinued operations, net of tax (b) - - 0.06 (0.05) (0.17) Gain (Loss) from discontinuance, net of tax (b) 0.80 (0.28) - - - Cumulative effect of accounting change, net of tax - (0.06) - - - Net income (loss) Applicable to Common Shareholders (8.26) 2.61 3.78 2.74 2.42 Net income (loss) from continuing operations, diluted (9.06) 2.65 3.29 2.49 2.33 Discontinued operations, net of tax (b) - - 0.06 (0.04) (0.15) Gain (Loss) from discontinuance, net of tax (b) 0.80 (0.24) - - - Cumulative effect of accounting change, net of tax - (0.05) - - - Net Income (Loss) Applicable to Common Shareholders (8.26) 2.36 3.35 2.45 2.18 Common dividends 0.40 0.40 0.40 0.40 0.40 Common shareholders' equity 12.04 20.90 19.15 15.48 13.26 STATISTICS Total Assets $2,990,020 $3,244,941 $3,059,334 $2,659,105 $2,421,496 Long-term obligations 565,815 534,649 433,446 467,635 473,488 Capital expenditures 192,125 235,221 324,604 217,725 183,164 Effective income tax rate 37.7% 42.1% 43.6% 44.4% 45.5% Basic average shares 48,752,480 48,490,662 48,189,618 47,659,745 46,236,688 Market price range $21.05-$39.88 $20.25-$34.75 $28.28-$45.52 $21.63-$49.94 $20.25-$50.88 Number of shareholders 8,561 8,802 9,520 9,870 15,560 Number of regular full-time employees 26,100 28,700 28,300 26,500 26,300 (a) Reduced by preferred stock dividends. (b) Includes the results of Priority Mail operations. (c) Includes a $652.2 million loss, $406.3 million after tax, ($8.33 per share) from restructuring charges, a $4.7 million loss, $2.9million after tax, ($0.06 per share) from a legal settlement on returned aircraft, and a $55.8 million loss, $34.8 million after tax, ($0.71 per share) from costs of EWA's grounded aircraft. (d) Includes a $47.5 million loss, $29.0 million after tax, ($0.59 per share) from the business failure of a customer. (e) Includes a $5.3 million loss, $3.3 million after tax, ($0.07 per share) from investments. (f) 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. (g) 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 aircraft leases. (h) Includes a $2.6 million net gain, $1.5 million after tax, ($0.03 per basic and diluted share) from the sale of securities. (i) 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 corporate legal 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 the assets of CNF's former wholesale parts and supplies distributor. (j) 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.
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