10-Q 1 sep0610q.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE --- SECURITIES EXCHANGE ACT OF 1934 For the transition period from N/A to N/A COMMISSION FILE NUMBER 1-5046 Con-way Inc. Incorporated in the State of Delaware I.R.S. Employer Identification No. 94-1444798 2855 Campus Drive, Suite 300, San Mateo, California 94403 Telephone Number (650) 378-5200 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. X Large accelerated filer Accelerated filer Non-accelerated filer --- --- --- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X ---- ---- Number of shares of Common Stock, $.625 par value, outstanding as of October 31, 2006: 47,061,104 CON-WAY INC. FORM 10-Q Quarter Ended September 30, 2006 _______________________________________________________________________________ _______________________________________________________________________________ INDEX PART I.FINANCIAL INFORMATION Page Item 1. Financial Statements Consolidated Balance Sheets - September 30, 2006 and December 31, 2005 3 Statements of Consolidated Income - Three and Nine Months Ended September 30, 2006 and 2005 5 Statements of Consolidated Cash Flows - Nine Months Ended September 30, 2006 and 2005 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23 Item 3. Quantitative and Qualitative Disclosures about Market Risk 39 Item 4. Controls and Procedures 40 PART II. OTHER INFORMATION Item 1. Legal Proceedings 41 Item 1A. Risk Factors 41 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 42 Item 6. Exhibits 43 Signatures 44 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CON-WAY INC. CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands) September 30, December 31, ASSETS 2006 2005 ------------- ------------- Current Assets Cash and cash equivalents $ 293,235 $ 514,275 Marketable securities 181,950 202,350 Trade accounts receivable, net 504,010 541,507 Other accounts receivable (Note 1) 48,152 42,529 Operating supplies, at lower of average cost or market 19,917 19,069 Prepaid expenses (Note 1) 51,802 53,883 Deferred income taxes 48,796 49,434 Assets of discontinued operations (Note 2) 10,522 21,000 ------------- ------------- Total Current Assets 1,158,384 1,444,047 ------------- ------------- Property, Plant and Equipment, at cost Land 158,458 150,413 Buildings and leasehold improvements 680,684 649,786 Revenue equipment 935,700 778,958 Other equipment 234,009 217,269 ------------- ------------- 2,008,851 1,796,426 Accumulated depreciation and amortization (913,112) (845,428) ------------- ------------- 1,095,739 950,998 ------------- ------------- Other Assets Deferred charges and other assets (Note 3) 42,841 42,578 Capitalized software, net 37,453 42,949 ------------- ------------- 80,294 85,527 ------------- ------------- Total Assets $ 2,334,417 $ 2,480,572 ============= ============= The accompanying notes are an integral part of these statements. CON-WAY INC. CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands except per share amounts) September 30, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 2006 2005 ------------- ------------- Current Liabilities Accounts payable $ 271,389 $ 274,742 Accrued liabilities (Note 1) 249,858 209,824 Self-insurance accruals (Note 1) 88,676 91,342 Current maturities of long-term debt 18,633 15,033 Liabilities of discontinued operations (Note 2) 16,037 40,555 ------------- ------------- Total Current Liabilities 644,593 631,496 ------------- ------------- Long-Term Liabilities Long-term debt and guarantees 559,038 581,469 Self-insurance accruals (Note 1) 109,464 102,416 Employee benefits (Note 5) 173,589 212,824 Other liabilities and deferred credits 20,711 19,142 Deferred income taxes 38,239 22,307 ------------- ------------- Total Liabilities 1,545,634 1,569,654 ------------- ------------- Commitments and Contingencies (Notes 10 and 11) Shareholders' Equity Preferred stock, no par value; authorized 5,000,000 shares: Series B, 8.5% cumulative, convertible, $.01 stated value; designated 1,100,000 shares; issued 614,465 and 641,359 shares, respectively 6 6 Additional paid-in capital, preferred stock 93,454 97,544 Deferred compensation, DC Plan (33,775) (40,628) ------------- ------------- Total Preferred Shareholders' Equity 59,685 56,922 ------------- ------------- Common stock, $.625 par value; authorized 100,000,000 shares; issued 61,601,799 and 61,204,263 shares, respectively 38,425 38,253 Additional paid-in capital, common stock 546,762 528,743 Retained earnings 777,451 620,565 Deferred compensation, nonvested stock (Note 8) -- (3,078) Cost of repurchased common stock (Note 7) (14,270,504 and 8,928,008 shares, respectively) (596,752) (293,380) ------------- ------------- Total Common Shareholders' Equity 765,886 891,103 ------------- ------------- Accumulated Other Comprehensive Loss (Note 6) (36,788) (37,107) ------------- ------------- Total Shareholders' Equity 788,783 910,918 ------------- ------------- Total Liabilities and Shareholders' Equity $ 2,334,417 $ 2,480,572 ============= ============= The accompanying notes are an integral part of these statements. CON-WAY INC. STATEMENTS OF CONSOLIDATED INCOME (Unaudited) (Dollars in thousands except per share amounts) Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Revenues $1,076,807 $1,084,457 $3,222,851 $3,041,617 Costs and Expenses Operating expenses 848,024 871,019 2,561,516 2,436,055 Selling, general and administrative expenses (Note 8) 93,868 80,363 272,855 240,949 Depreciation 32,600 29,319 96,424 82,895 ----------- ----------- ----------- ----------- 974,492 980,701 2,930,795 2,759,899 ----------- ----------- ----------- ----------- Operating Income 102,315 103,756 292,056 281,718 ----------- ----------- ----------- ----------- Other Income (Expense) Investment income 5,399 5,668 19,021 15,830 Interest expense (8,761) (8,426) (25,226) (28,580) Miscellaneous, net (511) (732) 145 (3,317) ----------- ----------- ----------- ----------- (3,873) (3,490) (6,060) (16,067) ----------- ----------- ----------- ----------- Income from Continuing Operations Before Income Tax Provision 98,442 100,266 285,996 265,651 Income Tax Provision (Note 9) 33,664 35,244 97,273 90,322 ----------- ----------- ----------- ----------- Income from Continuing Operations 64,778 65,022 188,723 175,329 ----------- ----------- ----------- ----------- Discontinued Operations, net of tax (Note 2) Loss from Discontinued Operations -- (549) (1,929) (1,849) Gain (Loss) from Disposal -- 3,335 (4,850) (3,490) ----------- ----------- ----------- ----------- -- 2,786 (6,779) (5,339) Net Income 64,778 67,808 181,944 169,990 Preferred Stock Dividends 1,748 1,816 5,319 5,841 ----------- ----------- ----------- ----------- Net Income Available to Common Shareholders $ 63,030 $ 65,992 $ 176,625 $ 164,149 =========== =========== =========== =========== Net Income From Continuing Operations (after preferred dividends) $ 63,030 $ 63,206 $ 183,404 $ 169,488 =========== =========== =========== =========== Weighted-Average Common Shares Outstanding (Note 1) Basic 47,601,175 52,081,891 49,717,418 52,198,251 Diluted 50,857,496 55,966,289 53,092,636 56,259,541 Earnings (Loss) per Common Share (Note 1) Basic Net Income from Continuing Operations $ 1.32 $ 1.21 $ 3.69 $ 3.25 Loss from Discontinued Operations -- (0.01) (0.04) (0.04) Gain (Loss) from Disposal -- 0.07 (0.10) (0.07) ----------- ----------- ----------- ----------- Net Income Available to Common Shareholders $ 1.32 $ 1.27 $ 3.55 $ 3.14 =========== =========== =========== =========== Diluted Net Income from Continuing Operations $ 1.24 $ 1.13 $ 3.47 $ 3.03 Loss from Discontinued Operations -- (0.01) (0.04) (0.04) Gain (Loss) from Disposal -- 0.06 (0.09) (0.06) ----------- ----------- ----------- ----------- Net Income Available to Common Shareholders $ 1.24 $ 1.18 $ 3.34 $ 2.93 =========== =========== =========== =========== The accompanying notes are an integral part of these statements. CON-WAY INC. STATEMENTS OF CONSOLIDATED CASH FLOWS (Unaudited) (Dollars in thousands) Nine Months Ended September 30, -------------------------- 2006 2005 ------------ ------------ Cash and Cash Equivalents, Beginning of Period $ 514,275 $ 346,581 ------------ ------------ Operating Activities Net income 181,944 169,990 Adjustments to reconcile net income to net cash provided by operating activities: Discontinued operations, net of tax 6,779 5,339 Depreciation and amortization, net of accretion 103,615 90,928 Increase (Decrease) in deferred income taxes 17,667 (17,043) Amortization of deferred compensation 6,853 6,432 Share-based compensation (Note 8) 5,555 1,359 Provision for uncollectible accounts 2,152 3,467 Equity in earnings of joint venture (10,858) (10,833) Gain from sales of property and equipment, net (1,052) (443) Gain on sale of business (6,231) -- Changes in assets and liabilities: Receivables 25,915 (109,963) Prepaid expenses 2,081 4,617 Accounts payable (5,792) 16,060 Accrued incentive compensation 13,200 (1,214) Accrued liabilities, excluding accrued incentive compensation 26,613 29,894 Self-insurance accruals 4,382 2,769 Income taxes 8,929 61,379 Employee benefits (39,235) (39,807) Deferred charges and credits 13,699 26,643 Other (5,970) (5,491) ------------ ------------ Net Cash Provided by Operating Activities 350,246 234,083 ------------ ------------ Investing Activities Capital expenditures (243,297) (168,031) Software expenditures (7,500) (6,326) Proceeds from sales of property and equipment, net 4,630 3,756 Proceeds from sale of business, including discontinued operations 8,000 108,366 Net decrease in marketable securities 20,400 236,350 ------------ ------------ Net Cash Provided by (Used in) Investing Activities (217,767) 174,115 ------------ ------------ Financing Activities Repayment of long-term debt and guarantees (15,024) (112,722) Proceeds from exercise of stock options 11,771 56,844 Excess tax benefit from stock option exercises (Note 8) 2,518 -- Payments of common dividends (15,004) (15,782) Payments of preferred dividends (8,457) (9,664) Repurchases of common stock (Note 7) (305,925) (111,562) ------------ ------------ Net Cash Used in Financing Activities (330,121) (192,886) ------------ ------------ Net Cash Provided by (Used in) Continuing Operations (197,642) 215,312 ------------ ------------ Discontinued Operations Net Cash Used In Operating Activities (23,220) (14,033) Net Cash Used In Investing Activities (178) (40) ------------ ------------ Net Cash Used in Discontinued Operations (23,398) (14,073) ------------ ------------ Increase (Decrease) in Cash and Cash Equivalents (221,040) 201,239 ------------ ------------ Cash and Cash Equivalents, End of Period $ 293,235 $ 547,820 ============ ============ Supplemental Disclosure Cash paid for income taxes, net $ 65,044 $ 40,916 ============ ============ Cash paid for interest, net of amounts capitalized $ 21,295 $ 28,187 ============ ============ The accompanying notes are an integral part of these statements. CON-WAY INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Principal Accounting Policies Re-branding Initiative and Organization The term "Con-way" or "Company" refers to Con-way Inc. (formerly CNF Inc.) and its subsidiaries. On April 18, 2006, shareholders approved management's proposal to change the Company's name to Con-way Inc. from CNF Inc. The corporate name change marks the launch of a strategy to bring the Company's operations under a single master brand. Company management and the Board of Directors believe that the corporate name change and the re-branding initiative will result in better understanding of the Company's core businesses, operating strengths, corporate culture and values, thereby enabling the Company to compete more effectively in the markets it serves. Included in the initiative is a new Con-way logo and graphic identity. In December of 2004, Con-way completed the sale of Menlo Worldwide Forwarding, Inc. and its subsidiaries and Menlo Worldwide Expedite!, Inc. (hereinafter collectively referred to as "MWF") to United Parcel Service, Inc. and United Parcel Service of America, Inc. (collectively, "UPS"). Prior to the sale, the collective results of MWF and Emery Worldwide Airlines, Inc. ("EWA") were reported as the Menlo Worldwide Forwarding reporting segment. EWA is a separate wholly owned subsidiary of Con-way that was not sold to UPS. In addition, on June 2, 2006, Con-way closed the operations of its domestic air freight forwarding business known as Con-way Forwarding. As a result, for the periods presented, the results of operations, net liabilities, and cash flows of the Menlo Worldwide Forwarding ("Forwarding") segment and the Con-way Forwarding operating unit have been segregated and reported as discontinued operations, as more fully discussed in Note 2, "Discontinued Operations." Refer to Note 4, "Reporting Segments," for additional discussion of the re-branding initiative and other organizational changes. Basis of Presentation Pursuant to the rules and regulations of the Securities and Exchange Commission, the accompanying consolidated financial statements of Con-way Inc. and its wholly owned subsidiaries have been prepared by Con-way, without audit by an independent registered public accounting firm. In the opinion of management, the consolidated financial statements include all normal recurring adjustments necessary to present fairly the information required to be set forth therein. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States ("GAAP") have been condensed or omitted from these statements pursuant to such rules and regulations and, accordingly, should be read in conjunction with the consolidated financial statements included in Con-way's 2005 Annual Report on Form 10-K. Results for the periods presented are not necessarily indicative of annual results. Earnings per Share ("EPS") Basic EPS is computed by dividing reported earnings (loss) by the weighted- average common shares outstanding. Diluted EPS is calculated as follows: (Dollars in thousands except Three Months Ended Nine Months Ended per share data) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Numerator: Continuing operations (after preferred stock dividends), as reported $ 63,030 $ 63,206 $ 183,404 $ 169,488 Add-backs: Dividends on Series B preferred stock, net of replacement funding 262 269 807 830 ----------- ----------- ----------- ----------- Continuing operations 63,292 63,475 184,211 170,318 ----------- ----------- ----------- ----------- Discontinued operations -- 2,786 (6,779) (5,339) ----------- ----------- ----------- ----------- Available to common shareholders $ 63,292 $ 66,261 $ 177,432 $ 164,979 =========== =========== =========== =========== Denominator: Weighted-average common shares outstanding 47,601,175 52,081,891 49,717,418 52,198,251 Stock options and nonvested stock 363,420 786,186 482,317 963,078 Series B preferred stock 2,892,901 3,098,212 2,892,901 3,098,212 ----------- ----------- ----------- ----------- 50,857,496 55,966,289 53,092,636 56,259,541 =========== =========== =========== =========== Anti-dilutive stock options not included in denominator 400,900 -- 324,500 44,000 =========== =========== =========== =========== Earnings (Loss) per Diluted Share: Continuing operations $ 1.24 $ 1.13 $ 3.47 $ 3.03 Discontinued operations -- 0.05 (0.13) (0.10) ----------- ----------- ----------- ----------- Available to common shareholders $ 1.24 $ 1.18 $ 3.34 $ 2.93 =========== =========== =========== =========== Income Taxes Deferred income taxes are provided for the tax effect of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. Con-way uses the liability method to account for income taxes, which requires deferred taxes to be recorded at the statutory rate to be in effect when the taxes are paid. At September 30, 2006 and December 31, 2005, income tax receivables of $28.7 million and $31.5 million, respectively, were included in other accounts receivable in Con-way's consolidated balance sheets. Self-Insurance Accruals Con-way uses a combination of purchased insurance and self-insurance programs to provide for the costs of medical, casualty, liability, vehicular, cargo and workers' compensation claims. Con-way participates in a re-insurance pool to reinsure a portion of its workers' compensation liabilities. Annually, each participant in the pool reinsures claims with the pool and assumes claims of an approximately equal amount. Reinsurance does not relieve Con-way of its liabilities under the original policy. In the 2006 plan year, Con-way increased its participation in the re-insurance pool when compared to the 2005 plan year. Con-way's higher participation level in 2006 resulted in a $13.9 million increase in the amount of annual premiums Con-way is obligated to pay the re-insurance pool and resulted in a similar increase in unearned annual premiums the re-insurance pool is obligated to pay to Con- way. Con-way's prepaid premiums and unearned premiums are recognized ratably over the year and the unamortized amounts are reported in the consolidated balance sheets in prepaid expenses and accrued liabilities, respectively. Property, Plant and Equipment Con-way periodically evaluates whether changes to estimated useful lives are necessary to ensure that these estimates accurately reflect the economic use of the assets. In the second quarter of 2006, Con-way completed an analysis of equipment lives and extended the estimated useful lives for certain classes of revenue equipment from 10 years to 13 years. Revenue equipment is depreciated on a straight-line basis over its estimated useful life, which ranges from 5 to 13 years. The effect of this change did not have a material effect on Con-way's results of operations for the periods presented. New Accounting Standards In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment" ("SFAS 123R"), a revision of SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS 123") that supersedes Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and its related implementation guidance. SFAS 123R eliminates the alternative to use APB 25's intrinsic-value method of accounting that was provided in SFAS 123 as originally issued, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions) over the period during which an employee is required to provide service in exchange for the award. The adoption of SFAS 123R also requires new disclosures and additional accounting related to income taxes, earnings per share, and the cash flow effects of share-based compensation. See Note 8, "Share-Based Compensation" for more information on the effects of this accounting standard. In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of SFAS 109" ("FIN 48"), which clarifies the accounting for uncertainty in tax positions. FIN 48 is a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Tax positions shall be recognized only when it is more likely than not that the position will be sustained upon examination by a taxing authority. If the position meets the more-likely-than-not criteria, it should be measured using a probability- weighted approach as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement. It requires previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold to be derecognized in the first subsequent financial reporting period in which the threshold is no longer met. FIN 48 requires expanded disclosure, including a reconciliation of the unrecognized tax benefits at the beginning and end of the period. The effective date of FIN 48 is the first fiscal year beginning after December 15, 2006. Con-way does not expect the adoption of FIN 48 to have a material effect on its financial statements. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair-value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair-value measurements and does not require any new fair-value measurements. The effective date of SFAS 157 is the first fiscal year beginning after November 15, 2007, and interim periods within those years, which for Con-way is the first quarter of 2008. Con-way does not expect the adoption of SFAS 157 to have a material effect on its financial statements. In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"), as more fully discussed in Note 5, "Employee Benefits - New Accounting Standard." Reclassification Certain amounts in the prior-period financial statements have been reclassified to conform to the current-period presentation, including Con- way's reclassification of variable-rate demand notes in its financial statements from cash and cash equivalents to marketable securities in the fourth quarter of 2005. In the consolidated statements of cash flows for the nine months ended September 30, 2005, the revised classification of these securities decreased beginning cash and cash equivalents by $40.0 million and reduced investing activities by $53.9 million from the amounts reported in Con-way's 2005 third-quarter report on Form 10-Q. 2. Discontinued Operations Discontinued operations in the periods presented relate to the closure of Con-way Forwarding, the sale of MWF, and the shut-down of EWA and its terminated Priority Mail contract with the U.S. Postal Service ("USPS"). The results of operations, net liabilities, and cash flows of discontinued operations have been segregated from continuing operations, except where otherwise noted. Results of discontinued operations are summarized below: Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- (Dollars in thousands) 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Revenues Con-way Forwarding $ -- $ 14,694 $ 21,699 $ 39,092 Loss from Discontinued Operations Con-way Forwarding Loss before income tax benefit -- (723) (2,963) (2,900) Income tax benefit -- 174 1,034 1,051 ----------- ----------- ----------- ----------- $ -- $ (549) $ 1,929) $ (1,849) =========== =========== =========== =========== Gain (Loss) from Disposal, net of tax Con-way Forwarding $ -- $ -- $ (5,128) $ -- MWF 8,967 644 2,824 EWA and Other (5,632) (366) (6,314) ----------- ----------- ----------- ----------- $ -- $ 3,335 $ (4,850) $ (3,490) =========== =========== =========== =========== The assets and liabilities of discontinued operations are presented in the consolidated balance sheets under the assets (or liabilities) of discontinued operations. At September 30, 2006 and December 31, 2005, assets of discontinued operations were $10.5 million and $21.0 million respectively, and liabilities of discontinued operations were $16.0 million and $40.6 million, respectively. As of the balance sheet dates reported, assets of discontinued operations consisted primarily of deferred taxes, while liabilities of discontinued operations included primarily accrued liabilities. Con-way Forwarding On June 2, 2006, Con-way closed the operations of its domestic air freight forwarding business known as Con-way Forwarding. The decision to close the operating unit was made following management's detailed review of the unit's competitive position and its prospects in relation to Con-way's long-term strategies. As a result of the closure, Con-way recognized a second-quarter $5.1 million loss (net of a $2.8 million tax benefit), due to a $4.0 million write-off of non-transferable capitalized software and other assets, a $2.2 million loss related to non-cancelable operating leases, $0.7 million of employee severance costs, and $1.0 million of other costs. Reflecting the write-off of assets and accrual of related costs, the remaining assets and liabilities related to the Con-way Forwarding operating unit at September 30, 2006 were $0.9 million and $3.3 million, respectively. MWF In October 2004, Con-way and Menlo Worldwide, LLC ("MW") entered into a stock purchase agreement with UPS to sell all of the issued and outstanding capital stock of MWF. Con-way completed the sale in December 2004, as more fully discussed below. The stock purchase agreement excludes certain assets and liabilities of MWF and includes certain assets and liabilities of Con-way or its subsidiaries related to the business conducted by MWF. Among the assets and liabilities so excluded are those related to EWA, and the obligation related to MWF employees covered under Con-way's domestic pension, postretirement medical and long-term disability plans. Under the agreement, UPS agreed to pay to Con-way an amount equal to MWF's cash position as of December 31, 2004, and to pay the estimated present value of Con-way's retained obligations related to MWF employees covered under Con-way's long- term disability and postretirement medical plans, as agreed to by the parties. Under the stock purchase agreement, Con-way has agreed to a three- year non-compete covenant that, subject to certain exceptions, will limit Con-way's annual air freight and ocean forwarding and/or customs brokerage revenues to $175 million through December 19, 2007. Con-way has also agreed to indemnify UPS against certain losses that UPS may incur after the closing of the sale with certain limitations. Any losses related to these indemnification obligations or any other costs, including any future cash expenditures, related to the sale that have not been estimated and recognized at this time will be recognized in future periods as an additional loss from disposal when and if incurred. Upon completion of the sale of MWF on December 19, 2004, Con-way received cash consideration of $150 million, subject to certain post-closing adjustments, including adjustments for cash held by MWF at closing and MWF's net working capital as of closing. Following settlement of the MWF cash balance in March 2005, Con-way received cash of $29.4 million and recognized a first-quarter net loss from disposal in 2005 of $9.8 million, primarily to recognize the difference between the actual cash received and Con-way's estimate of the cash position at December 31, 2004, and to accrue additional estimated transaction costs. As a result of additional adjustments in its estimated disposition loss, Con- way in 2005 reported a $3.6 million second-quarter gain for revisions to disposal-related cost estimates. Under an agreement reached in August 2005, UPS paid $79.0 million to Con-way for the agreed-upon estimated present value of the retained obligations of reimbursable long-term disability and postretirement medical plans. No additional gain or loss was recognized in connection with the cash reimbursement as the carrying value of these obligations was equal to the cash reimbursement. However, in the third quarter of 2005, Con-way recognized a $9.0 million gain, primarily to recognize an increase in its estimate of deferred tax assets associated with pension and postretirement plans retained by Con-way. Con-way's disposal of MWF generated a capital loss for tax purposes. Under current tax law, capital losses can only be used to offset capital gains. Since Con-way did not forecast any significant taxable capital gains in the five-year tax carry-forward period, the $40.8 million cumulative disposal- related tax benefit at December 31, 2004 was fully offset by a valuation allowance of an equal amount. The cumulative disposal-related tax benefit and the associated valuation allowance declined to $30.0 million at December 31, 2005, due primarily to third-quarter sale-related proceeds received from UPS in 2005 and revisions to the tax effect of sale-related estimates in 2005, partially offset by the first-quarter disposal-related capital loss in 2005. At September 30, 2006, the cumulative disposal-related tax benefit and the associated valuation allowance declined to $26.5 million due to the capital gain recognized in connection with the sale of assets related to Con- way Expedite, as more fully discussed in Note 4, "Reporting Segments." See Note 2, "Discontinued Operations," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K for a complete description of the disposition of MWF, including a discussion of losses from impairment and disposal of MWF and of cash payments received from UPS in connection with sale of MWF. EWA The results of EWA relate to the cessation of its air-carrier operations in 2001 and to the termination of its Priority Mail contract with the USPS in 2000. EWA's estimated loss reserves declined to $14.1 million at September 30, 2006, from $34.1 million at December 31, 2005, due primarily to litigation settlements described below. EWA's remaining loss reserves at September 30, 2006 were reported in liabilities of discontinued operations and consisted of Con-way's estimated remaining exposure related to the labor matters described below, and other litigation-related losses, as more fully discussed in Note 11, "Commitments and Contingencies." In connection with the cessation of its air-carrier operations in 2001, EWA terminated the employment of all of its pilots and flight crewmembers. Those pilots and crewmembers were represented by the Air Line Pilots Association ("ALPA") under a collective bargaining agreement. Subsequently, ALPA filed grievances on behalf of the pilots and flight crewmembers protesting the cessation of EWA's air-carrier operations and MWF's use of other air carriers. These matters have been the subject of litigation in U.S. District Court and state court in California, including litigation brought by ALPA and by former EWA pilots and crewmembers no longer represented by ALPA. On June 30, 2006, EWA, for itself and for Con-way Inc. and Menlo Worldwide Forwarding, Inc. ("MWF, Inc."), concluded a final settlement of the California state court litigation. Under the terms of the settlement, plaintiffs received a cash payment of $9.2 million from EWA, and the lawsuit was dismissed with prejudice. The cash settlement reduced by an equal amount its estimated loss reserve applicable to the grievances filed by ALPA. On August 8, 2006, EWA paid $10.9 million to settle the litigation brought by ALPA that finally concluded litigation with former EWA pilots and flight crewmembers still represented by ALPA as of that date. The remaining ALPA matters are also the subject of a claim by former EWA pilots and flight crewmembers no longer represented by ALPA that has been ordered by the court to binding arbitration. Other former pilots have also initiated litigation in federal court. Based on management's current evaluation, Con-way believes that it has provided for its estimated remaining exposure related to the ALPA matters. However, there can be no assurance in this regard as Con-way cannot predict with certainty the ultimate outcome of these matters. 3. Investment in Unconsolidated Joint Venture Vector SCM, LLC ("Vector") is a joint venture formed with General Motors ("GM") in December 2000 for the purpose of providing logistics management services on a global basis for GM, and for customers in addition to GM. As more fully discussed below, on June 23, 2006, GM exercised its right to purchase MW's membership interest in Vector ("Call Right"). The joint venture agreements provide a valuation methodology for the fair value of MW's membership interest in Vector and a framework for transition. MW Capital and Profit Interest in Vector Under the agreements, MW's membership interest in Vector consists of MW's capital account, its portion of Vector's undistributed earnings, and its profit interest in Vector. At September 30, 2006 and December 31, 2005, MW's capital account and undistributed earnings totaled $44.4 million and $33.6 million, respectively, and were reported net of Con-way's payable to Vector in deferred charges and other assets in Con-way's consolidated balance sheets. In exchange for assets contributed, MW's capital account on Vector's date of formation was $10.0 million. No additional capital account contributions have been made subsequent to the date of formation. Although MW owns a majority interest in Vector, MW's portion of Vector's operating results are reported as an equity-method investment based on GM's ability to control certain operating decisions. MW's equity-method income from its investment in Vector is reported in Con-way's statements of consolidated income as a reduction of operating expenses and, in Note 4, "Reporting Segments," is reported as operating income in the Menlo Worldwide reporting segment. Profit and loss are allocated to MW and GM on a percentage basis. MW's portion of Vector's net income does not include any provision for U.S. federal income taxes that will be incurred by Con-way, but does include a provision for MW's portion of Vector's income taxes on foreign and state income, as more fully discussed in Note 3, "Investment in Unconsolidated Joint Venture," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K. MW's undistributed earnings from Vector at September 30, 2006 and December 31, 2005, before provision for Con- way's related parent income taxes, were $34.4 million and $23.6 million, respectively. Con-way's Affiliate Payable to Vector and Transition-Related Accounts Vector participates in Con-way's centralized cash management system, and, consequently, Vector's domestic trade accounts payable and payroll costs are paid by Con-way and, prior to June 30, 2006, were settled through Vector's affiliate accounts with Con-way. In addition, excess cash balances in Vector's bank accounts, if any, are invested by Con-way and, prior to June 30, 2006, were settled through affiliate accounts that earn interest income based on a rate earned by Con-way's cash-equivalent investments and marketable securities. As a result of Vector's excess cash invested by Con- way prior to June 30, 2006, Con-way's affiliate payable to Vector as of September 30, 2006 and December 31, 2005 was $32.9 million and $22.0 million, respectively, as reported in deferred charges and other assets in Con-way's consolidated balance sheets. Subsequent to June 30, 2006, Vector's excess cash balances invested by Con-way are reported separately as accrued transition-related liabilities, as more fully discussed below. GM Exercise of Call Right As a result of GM's exercise of the Call Right, Con-way is entitled to receive the fair value of MW's membership interest in Vector as of June 22, 2006. Con-way believes that the fair value of MW's membership interest in Vector consists of the amount of MW's capital account, the amount of MW's portion of Vector's undistributed earnings, and the fair value of MW's portion of Vector's future profit. At the agreed-upon effective valuation date of June 30, 2006, MW's capital account and MW's portion of undistributed earnings in Vector totaled $42.4 million. Following June 30, 2006, only profits associated with the settlement of business case activity for the period prior to June 30, 2006 are reported as operating income in the Menlo Worldwide reporting segment. Pursuant to the agreements, each party engaged a financial advisor to develop a valuation within 75 days of the call date. Because the parties were unable to resolve a difference in excess of ten percent between the financial advisors' valuations, they are retaining a third financial advisor to perform a valuation that will be used to arrive at the final valuation. The third financial advisor will have 30 days from the receipt of valuation-related information from Con-way and GM to complete the valuation, and the proceeds from the valuation are to be paid within an additional 30 days following the completion of the valuation or the end of the transition period described below, whichever occurs later. Proceeds received in excess of MW's capital account and MW's portion of undistributed earnings in Vector will be reported as a gain from continuing operations, based on Vector's classification as an equity-method investment in Con-way's consolidated financial statements. Exercise of the Call Right results in MW retaining commercialization contracts involving customers other than GM. Con-way will provide transition-support services for a transition period up to nine months from the call date. Customary costs incurred by Con-way during this transition period, including those related to personnel, technology and other intellectual property, are required to be reimbursed by GM. Subsequent to June 30, 2006, Vector's excess cash balances invested by Con- way are reported in accrued liabilities in Con-way's consolidated balance sheets as a transition-related liability to Vector. At September 30, 2006, Con-way's transition-related liability to Vector was $4.5 million and is reported net of amounts receivable from Vector for unreimbursed costs for transition-support services provided by Con-way. As part of the sale of MW's membership interest, Con-way expects to settle its affiliate payable to Vector, as described above. In addition, the $10 million line of credit provided by Con-way to Vector was automatically terminated effective on June 23, 2006. Con-way is currently in discussions with GM as to the valuation amount and transition terms for Vector's operations. While Con-way believes that it is entitled to receive the payments described above and therefore expects to realize a gain from the sale of MW's membership interest to GM, it has not reached agreement with GM and cannot predict with certainty the ultimate outcome of these matters. 4. Reporting Segments Con-way discloses segment information in the manner in which the components are organized for making operating decisions, assessing performance and allocating resources. For financial reporting purposes, Con-way is divided into three reporting segments: Con-way Freight and Transportation, Menlo Worldwide and Con-way Other. Menlo Worldwide consists of the operating results of Menlo Worldwide Logistics ("Logistics") and Vector, the joint venture with GM that is accounted for as an equity-method investment. Certain corporate activities are reported in the Con-way Other reporting segment. Re-branding Initiative and Organization On April 18, 2006, shareholders approved management's proposal to change the Company's name to Con-way Inc. As a part of the strategy to bring the Company's operations under a single master brand, reporting units and segments were revised as described below. Con-way Freight and Transportation includes the combined operating results of Con-way Freight and Con-way Transportation. Con-way Freight includes the U.S. less-than-truckload ("LTL") companies, formerly known as Con-Way Western Express, Con-Way Central Express and Con-Way Southern Express, which are being converted to the single Con-way Freight logo and colors. Also included in Con-way Freight are Con-Way Canada Express, which is renamed Con-way Canada, and Con-way Mexico. Collectively, these units provide primarily next-day and second-day LTL freight transportation throughout the U.S., Canada and Mexico within an integrated regional-carrier network. Con-way Transportation provides asset-based regional and transcontinental full- truckload services, and domestic brokerage services for truckload and intermodal shipments. Under the new master brand initiative, the former Con- Way NOW expediting unit and Con-Way Full Load brokerage units were renamed, collectively, Con-way Expedite and Brokerage. As more fully discussed below, the expedited-shipping portion of that business was sold in July 2006 and the truckload brokerage portion of that business was merged into Con-way Truckload in September 2006. Con-way Truckload will retain its existing name. Also within Con-way Transportation is Road Systems, a trailer manufacturing company. Logistics will continue to operate under its existing name within the corporate Con-way master brand while Con-way examines global trademark issues. Once the research is completed, a decision to change the Menlo name to Con-way will be considered. Segment results reported below reflect (1) the integration of the former Con- way Logistics with Menlo Worldwide Logistics effective in the second quarter of 2005, (2) the reporting of Road Systems in the Con-way Freight and Transportation operating segment rather than the Con-way Other reporting segment effective in the first quarter of 2006, and (3) the closure of Con- way's domestic air freight forwarding business known as Con-way Forwarding in June 2006, which requires that the operating unit be excluded from the Con- way Freight and Transportation operating segment and reported separately as discontinued operations. Prior-period segment results have been reclassified to reflect the above and to conform to the current-period presentation. On June 23, 2006, GM exercised its Call Right. As more fully discussed in Note 3, "Investment in Unconsolidated Joint Venture," following June 30, 2006, only profits associated with the settlement of business case activity for the period prior to June 30, 2006 are reported as operating income in the Menlo Worldwide reporting segment. On July 21, 2006, Con-way executed an agreement with Panther II Transportation, Inc. ("Panther") for Panther to purchase a portion of the former Con-way Expedite and Brokerage business unit. Under the agreement, Con-way sold to Panther the customer list, owner-operator relationships and certain equipment of its expedited-shipping business and retained the portion of business involved in truckload brokerage. As part of the transaction, Con-way executed a non-compete agreement with Panther and agreed to exit the expedited-shipping market immediately. In connection with the sale, Con-way received proceeds of $8.0 million in the third quarter of 2006 and reported a third-quarter gain in continuing operations of $6.2 million. Financial Data Management evaluates segment performance primarily based on revenue and operating income (loss), except for Vector, which is evaluated based on MW's proportionate share of Vector's income before taxes. Accordingly, interest expense, investment income and other non-operating items are not reported in segment results. Corporate expenses are generally allocated based on measurable services provided to each segment or, for general corporate expenses, based on segment revenue and capital employed. Inter-segment revenue and related operating income have been eliminated to reconcile to consolidated revenue and operating income. Three Months Ended Nine Months Ended (Dollars in thousands) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Revenues from External Customers Con-way Freight and Transportation $ 735,938 $ 729,660 $2,186,421 $2,067,835 Menlo Worldwide Logistics 340,869 354,797 1,036,430 973,782 ----------- ----------- ----------- ----------- $1,076,807 $1,084,457 $3,222,851 $3,041,617 =========== =========== =========== =========== Inter-segment Revenues Con-way Freight and Transportation $ 11,345 $ 25,379 $ 56,974 $ 57,102 Menlo Worldwide Logistics -- -- 226 -- ----------- ----------- ----------- ----------- $ 11,345 $ 25,379 $ 57,200 $ 57,102 =========== =========== =========== =========== Revenues before Inter-segment Eliminations Con-way Freight and Transportation $ 747,283 $ 755,039 $2,243,395 $2,124,937 Menlo Worldwide Logistics 340,869 354,797 1,036,656 973,782 Inter-segment Revenue Eliminations (11,345) (25,379) (57,200) (57,102) ----------- ----------- ----------- ----------- $1,076,807 $1,084,457 $3,222,851 $3,041,617 =========== =========== =========== =========== Operating Income (Loss) Con-way Freight and Transportation $ 95,524 $ 95,340 $ 264,603 $ 255,508 Menlo Worldwide Logistics 5,462 7,889 17,740 18,553 Vector 1,019 4,220 13,068 13,196 ----------- ----------- ----------- ----------- 6,481 12,109 30,808 31,749 ----------- ----------- ----------- ----------- Con-way Other (670) (2,852) (1,145) (3,176) ----------- ----------- ----------- ----------- $ 101,335 $ 104,597 $ 294,266 $ 284,081 ----------- ----------- ----------- ----------- Reconciliation of segments to consolidated amount: Income tax benefit (provision) related to Vector, an equity-method investment 980 (841) (2,210) (2,363) ----------- ----------- ----------- ----------- $ 102,315 $ 103,756 $ 292,056 $ 281,718 =========== =========== =========== =========== 5. Employee Benefit Plans Employees of Con-way and its subsidiaries in the U.S. are covered under several benefit plans, including defined benefit pension plans, a defined contribution retirement plan, and a postretirement medical plan. On October 13, 2006, Con-way's Board of Directors approved changes to Con-way's retirement benefit plans intended to preserve the retirement benefits earned by existing employees under Con-way's primary defined benefit pension plan while expanding benefits earned under its defined contribution plan. The major provisions of the plan amendments are effective on January 1, 2007 and are more fully discussed below. Defined Benefit Pension Plans Con-way's defined benefit pension plans primarily consist of a plan that covers the non-contractual employees and former employees of Con-way's continuing operations as well as former employees of its discontinued operations (the "DB Plan"). Under current terms of the DB Plan, benefits are generally based on an employee's five highest consecutive amounts of annual compensation earned during the ten years immediately preceding retirement. Con-way's annual pension expense and contributions are based on actuarial computations at the actuarial plan measurement date of November 30 of each year. Con-way has contributed $75 million to the DB Plan in 2006, which represents all of the estimated contributions for 2006. The table below summarizes the components of net periodic benefit expense for the DB Plan and does not include amounts related to separate defined benefit pension plans that cover only the former employees of the discontinued Forwarding segment (the "Forwarding DB Plans"). Also, the benefit expense associated with employees of MWF and EWA covered under the DB Plan was reported in the consolidated statements of income as discontinued operations in 2005, but is reported as continuing operations in 2006, as more fully discussed in Note 9, "Benefit Plans," of Item 8, "Financial Statements and Supplementary Data" in Con-way's 2005 Annual Report on Form 10-K. The portion of benefit expense that relates to discontinued operations was immaterial for the periods presented. Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- (Dollars in thousands) 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Service cost - benefits earned during the quarter $ 13,451 $ 12,209 $ 40,553 $ 36,213 Interest cost on benefit obligation 13,576 13,117 40,930 38,905 Expected return on plan assets (16,347) (14,611) (49,283) (43,337) Net amortization and deferral 1,820 882 5,485 2,616 ----------- ----------- ----------- ----------- Net periodic benefit expense $ 12,500 $ 11,597 $ 37,685 $ 34,397 =========== =========== =========== =========== Under the recent amendments described above, the following major provisions to the DB Plan will take effect on January 1, 2007: - Participation in the DB plan will be limited to those employees participating as of December 31, 2006. No new employees will be eligible to participate in the DB Plan. - Employees who are participants in the DB Plan as of December 31, 2006 will retain all accrued benefits and credited service time earned, with credited service capped at December 31, 2006. Future benefit plan payments will reflect participants' eligible compensation increases through 2016, after which the benefit will be capped. - Benefits paid under the DB Plan will be determined based on years of credited service and final average pay. Final average eligible compensation will be calculated from the five highest years of earnings in any of the past ten years preceding retirement or, for employees retiring after December 31, 2016, in any of the past ten years preceding December 31, 2016. - Vesting rules remain unchanged. Con-way also has an unfunded non-qualified supplemental defined benefit pension plan (the "Supplemental DB Plan") that provides additional benefits for certain employees who are affected by Internal Revenue Code ("IRC") limitations on benefits available under the qualified DB Plan. The benefit expense for the Supplemental DB Plan is based on actuarial computations that are consistent with the DB Plan. Effective January 1, 2007, the changes described above for the DB Plan will also affect the Supplemental DB Plan. Defined Contribution Retirement Plan Con-way sponsors the Con-way Retirement Savings Plan, a voluntary defined contribution retirement plan for non-contractual U.S. employees with a salary-deferral feature qualified under Section 401(k) of the Internal Revenue Code (the "DC Plan"). Under current terms of the DC Plan (formerly the "Thrift and Stock Plan" or "TASP"), Con-way contributes common and preferred stock equal to 50% of the first 3 percent of the employee's pay. The DC Plan also operates as a leveraged employee stock ownership plan, as more fully discussed in Note 9, "Benefit Plans," of Item 8, "Financial Statements and Supplementary Data" in Con-way's 2005 Annual Report on Form 10-K Under the recent amendments described above, the following major provisions to the DC Plan will take effect on January 1, 2007: - Con-way's matching contributions to an employee's 401(k) account will double from the current level to 50% of the first 6 percent of the employee's eligible compensation. - In addition to the matching contribution, Con-way will make a new Basic Contribution to the 401(k) accounts of all employees that will equal 3 to 5 percent of the employee's eligible compensation, depending on years of service, with the size of the contribution increasing (up to the maximum 5% contribution) as years of service increase. The contribution will be made quarterly in every succeeding year of employment and will vest immediately. - In addition to the matching contribution and the Basic Contribution, Con-way will make a new Transition Contribution to the 401(k) accounts of qualifying employees that will equal 1 to 3 percent of the employee's eligible compensation, depending on the employee's combined age and years of service as of December 31, 2006. The contribution will be made quarterly in every succeeding year of employment and will vest immediately. Concurrent with plan amendments affecting the Supplemental DB Plan described above, Con-way established a new supplemental defined contribution retirement plan (the "Supplemental DC Plan') to provide benefits for certain employees affected by IRC limitations on benefits and compensation available under the qualified DC Plan. The Supplemental DC Plan provides benefits to the extent that employees' elective deferrals and Con-way's matching, Basic and Transition Contributions exceed the IRC benefits and compensation limitations that apply to the qualified DC Plan. Postretirement Medical Plan The table below summarizes the components of net periodic benefit expense for Con-way's postretirement medical plan (the "Postretirement Plan"). Like the DB Plan, the benefit expense associated with employees of MWF and EWA covered under the Postretirement Plan was reported in the consolidated statements of income as discontinued operations in 2005, but is reported as continuing operations in 2006. The portion of benefit expense that relates to discontinued operations was $1.0 million and $2.7 million in the third quarter and first nine months of 2006, respectively, and was $3.2 million in both the third quarter and first nine months of 2005. Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- (Dollars in thousands) 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Service cost - benefits earned during the quarter $ 582 $ 791 $ 1,650 $ 1,053 Interest cost on benefit obligation 1,800 3,315 5,101 4,413 Net amortization and deferral 618 1,141 1,754 1,518 ----------- ----------- ----------- ----------- Net periodic benefit expense $ 3,000 $ 5,247 $ 8,505 $ 6,984 =========== =========== =========== =========== New Accounting Standard In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"). The standard requires a company to: - Recognize in its balance sheet an asset for a plan's over-funded status or a liability for a plan's under-funded status. - Recognize as a component of other comprehensive income the gains or losses and prior-service costs and credits that arise during the period but are not recognized as components of net periodic benefit costs. - Measure a plan's assets and its obligations as of the end of the fiscal year rather than at an earlier measurement date, as allowed under current accounting standards. - Provide additional disclosures in the notes to the financial statements. The effective date for the recognition and disclosure elements of SFAS 158 is the first fiscal year ending after December 15, 2006 and the effective date for the end-of-fiscal-year measurement-date requirement is the first fiscal year ending after December 15, 2008. At September 30, 2006 and December 31, 2005, Con-way reported a net liability of $47.8 million and $82.7 million, respectively, for its obligation related to its defined benefit pension plans, including the DB Plan, the Supplemental DB Plan and the Forwarding DB Plans. The net-of-tax accumulated other comprehensive loss associated with those plans at those dates was $36.2 million. Based on projected actuarial estimates as of December 31, 2006, which reflect the recent retirement benefit plan changes described above, Con-way estimates that it would be required to report a liability for pension benefits of $128 million and a net-of-tax accumulated other comprehensive loss of $63 million in shareholders' equity. At September 30, 2006 and December 31, 2005, Con-way reported a liability of $95.8 million and $96.4 million, respectively, for its obligation related to its postretirement medical plan. Based on projected actuarial estimates as of December 31, 2006, Con-way estimates that it would be required to report a liability for postretirement benefits of $129 million and a net-of-tax accumulated other comprehensive loss of $21 million in shareholders' equity. The effect of adoption of SFAS 158 on Con-way's consolidated financial statements is based on projections and actuarial assumptions, and accordingly, is subject to variation based on changes in interest rates, asset returns, and other factors. 6. Comprehensive Income Comprehensive income, which is a measure of all changes in equity except those resulting from investments by owners and distributions to owners, was as follows: Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- (Dollars in thousands) 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Net income $ 64,778 $ 67,808 $ 181,944 $ 169,990 Other comprehensive income (loss): Foreign currency translation adjustment (182) 31 319 642 ----------- ----------- ----------- ----------- Comprehensive income $ 64,596 $ 67,839 $ 182,263 $ 170,632 =========== =========== =========== =========== The following is a summary of the components of accumulated other comprehensive loss, net of tax: September 30, December 31, (Dollars in thousands) 2006 2005 -------------- -------------- Accumulated foreign currency translation adjustments $ (613) $ (932) Minimum pension liability adjustment (36,175) (36,175) -------------- -------------- Accumulated other comprehensive loss $ (36,788) $ (37,107) ============== ============== 7. Common Stock Repurchase Program In January 2005, the Board of Directors authorized the repurchase of up to $300 million in Con-way's common stock from time to time during a two-year period in open-market and privately negotiated transactions. As described below, Con-way's Board of Directors on April 24, 2006 authorized an expanded repurchase program that replaced the $300 million program approved in January 2005. Under the old program, Con-way repurchased common stock of $189.6 million from January 1, 2005 through April 24, 2006, and no additional shares will be repurchased under that program. Under the new program, Con-way is authorized to repurchase an additional $400 million of common stock through open-market purchases and privately negotiated transactions from time to time in such amounts as management deems appropriate through June 30, 2007. Under the new program, Con-way repurchased common stock of $265.4 million from April 27, 2006 through September 30, 2006, leaving $134.6 million available for future repurchases of common stock. 8. Share-Based Compensation Under terms of Con-way's share-based compensation plans, employees and directors may be granted options to purchase Con-way's common stock and, in some cases, may be awarded nonvested shares of Con-way's common stock (also known as restricted stock). Stock options are granted at prices equal to the market value of the common stock on the date of grant and expire 10 years from the date of grant. Generally, stock options are granted with three- or four-year graded-vesting terms, under which one-third or one-fourth of the award vests each year, respectively. Stock options granted in and after December 2004 generally have three-year graded-vesting terms, while stock options issued before that date generally have four-year graded-vesting terms. Certain option awards provide for accelerated vesting if there is a change in control (as defined in the stock option plans). Shares of nonvested stock are valued at the market price of Con-way's common stock at the date of award and are generally granted with three-year graded-vesting terms. At September 30, 2006, Con-way had 6,339,147 common shares available for the grant of stock options, restricted stock, or other share-based compensation under its equity plans. Effective January 1, 2006, Con-way adopted the provisions of SFAS 123R, which requires recognition of compensation expense to share-based payment awards issued to Con-way's employees and directors. Con-way previously applied the recognition provisions of APB 25 and provided the required pro forma disclosures under SFAS 123. Pro Forma Information for Periods Prior to Adoption of SFAS 123R Prior to the adoption of SFAS 123R, Con-way did not recognize compensation expense for stock option awards, as all options had an exercise price equal to the market value of the underlying common stock on the date of grant. For shares of nonvested stock, Con-way recognized expense using the accelerated amortization method under FIN 28, "Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans," based on the estimated grant-date fair value. In accordance with the disclosures required under SFAS 123, as amended by SFAS 148, "Accounting for Stock-Based Compensation," Con-way provided pro forma disclosures in periods prior to adoption of SFAS 123R. In the pro forma disclosures, compensation expense attributable to stock options and shares of nonvested common stock has been amortized on a straight-line basis over the requisite service period stated in the award and forfeitures have been recognized as they occurred. The table below is presented for comparative purposes and illustrates the pro forma effect on net income and earnings per share as if Con-way had applied the fair-value recognition provisions of SFAS 123 to share-based compensation prior to January 1, 2006: (Dollars in thousands, Three Months Ended Nine Months Ended except per share data) September 30, 2005 September 30, 2005 -------------------- -------------------- Net income available to common shareholders, as reported $ 65,992 $ 164,149 Share-based compensation expense included in reported 434 829 income, net of tax Compensation expense, net of tax, that would have been included in net income if the fair-value method had been applied (1,407) (4,570) -------------------- -------------------- Pro forma net income as if the fair-value method had been applied $ 65,019 $ 160,408 ==================== ==================== Earnings per share: Basic: As reported $ 1.27 $ 3.14 ==================== ==================== Pro forma $ 1.25 $ 3.07 ==================== ==================== Diluted: As reported $ 1.18 $ 2.93 ==================== ==================== Pro forma $ 1.17 $ 2.87 ==================== ==================== Effect of the Adoption of SFAS 123R Con-way adopted SFAS 123R using the modified prospective transition method beginning January 1, 2006. Under the modified prospective method, compensation expense recognized in the first nine months of 2006 includes (1) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, adjusted for estimated forfeitures, and (2) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In accordance with SFAS 123R, compensation expense for options granted subsequent to January 1, 2006 will be recorded on a straight-line basis over the shorter of (1) the requisite service period stated in the award or (2) the period from the grant date of the award up to the date the employee is no longer obligated to perform service in order to retain the award. For awards granted prior to, but not yet vested upon adoption of SFAS 123R, compensation expense will be recognized over the requisite service period stated in the award. The following is the effect of adopting SFAS 123R: Three Months Ended Nine Months Ended September 30, 2006 September 30, 2006 ----------------------- ----------------------- (Dollars in thousands) Stock Nonvested Stock Nonvested Options Stock Options Stock ----------- ----------- ----------- ----------- Compensation expense recognized Selling, general and administrative expenses $ 1,566 $ 504 $ 4,408 $ 1,147 Deferred income tax benefit 611 196 1,719 447 ----------- ----------- ----------- ----------- Decrease in net income $ 955 $ 308 $ 2,689 $ 700 =========== =========== =========== =========== As a result of adopting SFAS 123R, Con-way's basic and diluted earnings per share for the third quarter of 2006 was $0.02 lower and for the first nine months of 2006 was $0.05 lower than if Con-way had continued to account for share-based compensation under APB 25. SFAS 123R requires the benefits on tax deductions in excess of recognized compensation expense to be reported as a financing cash flow rather than as an operating activity, as required by APB 25. In accordance with SFAS 123R, $2.5 million of excess tax benefits were reported as financing cash flows in the first nine months of 2006. In the first nine months of 2005, Con-way recognized excess tax benefits of $15.9 million. Prior-period cash flows have not been reclassified. Valuation Assumptions The fair value of each stock option grant is estimated using the Black- Scholes option pricing model. The following is a summary of the weighted- average assumptions used and the calculated weighted-average fair value: Nine Months Ended September 30, ------------------------ 2006 2005 ----------- ----------- Estimated fair value $ 16.96 $ 17.98 Risk-free interest rate 4.8% 3.8% Expected term (years) 4.50 5.53 Expected volatility 31% 42% Expected dividend yield 1.09% 1.19% The risk-free interest rate is determined using the U.S. Treasury zero-coupon issue with a remaining term equal to the expected life of the option. The expected life of the option is derived from a binomial lattice model, which is based on the historical rate of voluntary exercises, post-vesting terminations and volatility. Expected volatility is based on the historical volatility of Con-way's common stock over the most recent period equal to the expected term of the option. Share-Based Payment Award Activity The following table summarizes stock-option award activity for the nine months ended September 30, 2006: Stock Options ----------------------------- Number of Wtd-Avg. Options Exercise Price ----------- ---------------- Outstanding at December 31, 2005 1,729,550 $ 34.29 Granted 325,900 55.19 Exercised (377,350) 31.19 Expired or cancelled (29,010) 43.24 ----------- Outstanding at September 30, 2006 1,649,090 $ 38.97 =========== Exercisable at September 30, 2006 911,444 $ 32.83 =========== Outstanding Exercisable ------------- ------------- Weighted-average remaining contractual term 6.68 years 5.27 years Aggregate intrinsic value (in thousands) $ 13,422 $ 11,159 The aggregate intrinsic value reported in the table above represents the total pretax value, based on Con-way's closing common stock price of $44.82 at September 30, 2006, which would have been received by employees and directors had all of the holders exercised their in-the-money stock options on that date. The aggregate intrinsic value of options exercised in the first nine months of 2006 was $9.5 million, the total amount of cash received from the exercise of options was $11.8 million and the related tax benefit realized from the exercise of options was $3.7 million. The total unrecorded deferred compensation cost on stock options, net of forfeitures, was $7.8 million, which is expected to be recognized over a weighted-average period of 1.62 years. The following table summarizes nonvested stock award activity for the nine months ended September 30, 2006: Nonvested Stock ------------------------------ Number of Wtd-Avg. Awards Grant-Date Price ----------- ----------------- Outstanding at December 31, 2005 158,048 $ 38.43 Awarded 20,186 51.51 Vested (55,825) 36.89 ----------- Outstanding at September 30, 2006 122,409 $ 44.12 =========== The total fair value of nonvested stock that became vested in the first nine months of 2006 was $3.1 million, based on Con-way's closing common stock price on the vesting date. The total unrecorded deferred compensation cost on shares of nonvested stock, net of forfeitures, was $3.0 million, which is expected to be recognized over a weighted-average period of 2.08 years. In connection with the adoption of SFAS 123R, Con-way eliminated the amount of deferred compensation related to shares of nonvested stock, as recorded in shareholder's equity in the consolidated balance sheets on dates before adoption. As required by SFAS 123R, Con-way also reduced an equal and related amount of additional paid-in capital on common stock. 9. Income Taxes Con-way's effective tax rate of 34.2% in the third quarter of 2006 decreased from 35.2% in the third quarter in 2005, while the effective tax rate in the first nine months of both 2006 and 2005 was 34.0%. Con-way's effective tax rate in both nine-month periods reflects the effect of second-quarter discrete tax items related to the settlement with the IRS of previous tax filings, which reduced the tax provision in 2006 and 2005 by $6.9 million and $7.0 million, respectively. Also, the third quarter and the first nine months of 2006 include the utilization of a tax-loss carry-forward realized in connection with a capital gain on the sale of Con-way Expedite. The lower taxable income related to the use of the tax-loss carry-forward reduced Con- way's tax provision in the third quarter of 2006 by $2.9 million. Excluding the effect of the second-quarter adjustments, the effect of the third-quarter tax-loss carry-forward in 2006, and other less significant discrete items, the effective tax rate in the third quarter and first nine months of 2006 was 37.5% and 37.7%, respectively, compared to 35.7% and 37.0% in the third quarter and first nine months of 2005, respectively. 10. Debt In September 2006, Con-way's $400 million revolving credit facility was amended to revise the pricing and to extend the term from March 11, 2010 to September 30, 2011. The revised pricing reduced the credit facility fee from a range of 0.10% to 0.25% to a range of 0.07% to 0.175% and decreased the borrowing margin paid on outstanding balances. Borrowings under the agreement bear interest at a rate based upon the lead bank's base rate or Eurodollar rate plus a margin dependent on either Con-way's senior debt credit ratings or a ratio of "net debt" (i.e., indebtedness net of cash, cash equivalents and certain marketable securities) to earnings before interest, taxes and depreciation/amortization. 11. Commitments and Contingencies Spin-Off of CFC On December 2, 1996, Con-way completed the spin-off of Consolidated Freightways Corporation ("CFC") to Con-way's shareholders. CFC was, at the time of the spin-off, a party to certain multiemployer pension plans covering some of its current and former employees. The cessation of its U.S. operations in 2002 resulted in CFC's "complete withdrawal" (within the meaning of applicable federal law) from these multiemployer plans, at which point it became obligated, under federal law, to pay its share of any unfunded vested benefits under those plans. It is possible that the trustees of CFC's multiemployer pension plans may assert claims that Con-way is liable for amounts owing to the plans as a result of CFC's withdrawal from those plans and, if so, there can be no assurance that those claims would not be material. Con-way has received requests for information regarding the spin-off of CFC from representatives from some of the pension funds, and, in accordance with federal law, Con-way has responded to those requests. Con-way believes that it would ultimately prevail if any such claims were made, although there can be no assurance in this regard. Con-way believes that the amount of those claims, if asserted, could be material, and a judgment against Con-way for all or a significant part of these claims could have a material adverse effect on Con-way's financial condition, results of operations and cash flows. Prior to the enactment in April 2004 of the Pension Funding Equity Act of 2004, if the multiemployer funds had asserted such claims against Con-way, Con-way would have had a statutory obligation to make cash payments to the funds prior to any arbitral or judicial decisions on the funds' determinations. Under the facts related to the CFC withdrawals and the law in effect after enactment of the Pension Funding Equity Act of 2004, Con-way would no longer be required to make such payments to the multiemployer funds unless and until final decisions in arbitration proceedings, or in court, upheld the funds' determinations. As a result of the matters discussed above, Con-way can provide no assurance that matters relating to the spin-off of CFC will not have a material adverse effect on Con-way's financial condition, results of operations or cash flows. The likelihood of such claims being asserted by multiemployer funds continues to diminish with the passage of time. Other In February 2002, a lawsuit was filed against EWA in the District Court for the Southern District of Ohio, alleging violations of the Worker Adjustment and Retraining Notification Act (the "WARN Act") in connection with employee layoffs and ultimate terminations due to the August 2001 grounding of EWA's airline operations and the shutdown of the airline operations in December 2001. The court subsequently certified the lawsuit as a class action on behalf of affected employees laid off between August 11 and August 15, 2001. The WARN Act generally requires employers to give 60-days notice, or 60-days pay and benefits in lieu of notice, of any shutdown of operations or mass layoff at a site of employment. The estimated range for potential loss on this matter is zero to approximately $8 million. Con-way intends to continue to vigorously defend the lawsuit. In September 2003, Con-way received notice from the U.S. Attorney's Office for the District of Columbia that EWA is being considered for possible civil action under the False Claims Act for allegedly submitting false invoices to the USPS for payment under the Priority Mail contract. EWA subsequently entered into a tolling agreement with the government in order to give the parties more time to investigate the allegations. In November 2004, Con-way representatives met with the government to discuss the government's allegations, and at that time received certain information relating to the government's investigation. In addition, Con-way, on behalf of EWA, conducted its own investigation into the allegations. Under the False Claims Act, the government would be entitled to recover treble damages, plus penalties, if a court were to ultimately conclude that EWA knowingly submitted false invoices to the USPS. Based on management's current evaluation, Con-way believes that it has provided for its estimated exposure related to the allegations. However, there can be no assurance in this regard as Con-way cannot predict with certainty the outcome of this matter. Con-way 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 effect on Con-way's financial condition, results of operations or cash flows. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction Management's Discussion and Analysis of Financial Condition and Results of Operations (referred to as "Management's Discussion and Analysis") is intended to assist in a historical and prospective understanding of Con-way's results of operations, financial condition and cash flows, including a discussion and analysis of the following: * Overview of Business * Results of Operations * Liquidity and Capital Resources * Estimates and Critical Accounting Policies * Other Matters This discussion and analysis should be read in conjunction with the information included in Con-way's 2005 Annual Report on Form 10-K. Overview of Business Con-way provides transportation, logistics and supply chain management services for a wide range of manufacturing, industrial, and retail customers. For financial reporting purposes, Con-way is divided into three reporting segments: Con-way Freight and Transportation, primarily a provider of regional less-than-truckload ("LTL") freight services; Menlo Worldwide, a provider of integrated contract logistics solutions; and Con-way Other, which includes certain corporate activities. Menlo Worldwide consists of the operating results of Menlo Worldwide Logistics ("Logistics") and Vector, a joint venture with GM that is accounted for as an equity-method investment. Con-way's operating-unit results depend on the number and weight of shipments transported, the prices received on those shipments, and the mix of services provided to customers, as well as the fixed and variable costs incurred by Con-way in providing the services and the ability to manage those costs under changing shipment levels. Con-way Freight and Transportation primarily transports shipments through a freight service center network while Logistics and Vector manage the logistics functions of their customers and primarily utilize third-party transportation providers for the movement of customer shipments. Re-branding Initiative and Organization On April 18, 2006, shareholders approved management's proposal to change the Company's name to Con-way Inc., as more fully discussed in Note 1, "Principal Accounting Policies - Re-branding Initiative and Organization," of Item 1, "Financial Statements." Con-way has begun a re-branding initiative to introduce a new Con-way logo and graphic identity as the master brand. Con- way's regional LTL operations have been renamed Con-way Freight, while the Company's truckload, expediting, brokerage and trailer manufacturing operations were made part of Con-way Transportation. As more fully discussed under "Results of Operations - Con-way Freight and Transportation," the expediting portion of that business was sold in July 2006. Logistics will continue to operate under its existing name within the corporate Con-way master brand while Con-way examines global trademark issues. Once the research is completed, a decision to change the Menlo name to Con-way will be considered. The Con-way re-branding initiative is expected to incur costs of $25 million to $35 million. Complete conversion to the Company's new graphic identity is scheduled to take 24 to 36 months. In the third quarter and first nine months of 2006, Con-way recognized re-branding expense of $0.4 million and $1.7 million, respectively. As more fully discussed in Note 2, "Discontinued Operations," of Item 1, "Financial Statements," Con-way and Menlo Worldwide, LLC ("MW") in 2004 sold MWF to UPS, and on June 2, 2006, Con-way closed the operations of its domestic air freight forwarding business known as Con-way Forwarding. Accordingly, the results of operations, net liabilities, and cash flows of the Menlo Worldwide Forwarding segment and the Con-way Forwarding operating unit have been segregated and reported as discontinued operations, except where otherwise noted. Refer to Note 4, "Reporting Segments," of Item 1, "Financial Statements," for additional discussion of organizational changes. On June 23, 2006, GM exercised its call right to purchase MW's membership interest in Vector ("Call Right"). Accordingly, following June 30, 2006, only profits associated with the settlement of business case activity for the period prior to June 30, 2006 are reported as operating income in the Menlo Worldwide reporting segment, as more fully discussed in Note 3, "Investment in Unconsolidated Joint Venture," of Item 1,"Financial Statements." Results of Operations The following table summarizes Con-way's consolidated operating results for continuing and discontinued operations: (Dollars in thousands, Three MonthsEnded Nine Months Ended except per share amounts) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Net Income (Loss) Continuing Operations 1 $ 63,030 $ 63,206 $ 183,404 $ 169,488 Discontinued Operations -- 2,786 (6,779) (5,339) ----------- ----------- ----------- ----------- Available to Common Shareholders $ 63,030 $ 65,992 $ 176,625 $ 164,149 =========== =========== =========== =========== Diluted Earnings (Loss) per Share Continuing Operations $ 1.24 $ 1.13 $ 3.47 $ 3.03 Discontinued Operations -- 0.05 (0.13) (0.10) ----------- ----------- ----------- ----------- Available to Common Shareholders $ 1.24 $ 1.18 $ 3.34 $ 2.93 =========== =========== =========== =========== 1 After preferred stock dividends Con-way's net income from continuing operations (after preferred stock dividends) of $63.0 million in the third quarter of 2006 was essentially unchanged from $63.2 million in 2005, and in the first nine months of 2006, grew 8.2% to $183.4 million from $169.5 million in 2005. Net income from continuing operations in both the third quarter and first nine months of 2006 primarily reflects higher operating income from Con-way Freight and Transportation and lower operating income from Menlo Worldwide. Con-way's diluted earnings per share from continuing operations increased 9.7% to $1.24 in the third quarter of 2006 and improved 14.5% to $3.47 in the first nine months of 2006, due primarily to the accretive effect of Con-way's share repurchase program, which included the repurchase in May 2006 of 3.75 million shares in two significant privately negotiated transactions. Primarily as the result of share repurchases, Con-way's third-quarter average diluted shares outstanding declined to 50.9 million shares in 2006 from 56.0 million shares in 2005, and in the nine-month period, declined to 53.1 million shares from 56.3 million shares. In 2006, net income from continuing operations in the first nine months was partially offset by losses from discontinued operations, which primarily reflect a $5.1 million second-quarter charge related to the closure of Con- way Forwarding in June 2006. In 2005, discontinued operations primarily includes a $9.8 million first-quarter loss related to the disposal of MWF, a $3.0 million second-quarter net gain due to revisions of cost estimates for the disposal of MWF and EWA, and a third-quarter net gain of $3.3 million primarily related to MWF gains that more than offset EWA losses. For periods prior to its closure in June 2006, discontinued operations in all periods presented include operating losses reported by Con-way Forwarding. The resulting third-quarter net income available to common shareholders declined to $63.0 million ($1.24 per diluted share) in 2006 from $66.0 million ($1.18 per diluted share) in 2005, while in the first nine months, net income available to common shareholders grew 7.6% to $176.6 million ($3.34 per diluted share) in 2006 from $164.1 million ($2.93 per diluted share) in 2005. Continuing Operations The following table compares Con-way's segment operating results of continuing operations: Three Months Ended Nine Months Ended (Dollars in thousands) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Revenues Con-way Freight and Transportation $ 735,938 $ 729,660 $2,186,421 $2,067,835 Menlo Worldwide Logistics 340,869 354,797 1,036,430 973,782 ----------- ----------- ----------- ----------- $1,076,807 $1,084,457 $3,222,851 $3,041,617 =========== =========== =========== =========== Operating Income (Loss) Con-way Freight and Transportation $ 95,524 $ 95,340 $ 264,603 $ 255,508 Menlo Worldwide Logistics 5,462 7,889 17,740 18,553 Vector 1,019 4,220 13,068 13,196 ----------- ----------- ----------- ----------- 6,481 12,109 30,808 31,749 ----------- ----------- ----------- ----------- Con-way Other (670) (2,852) (1,145) (3,176) ----------- ----------- ----------- ----------- $ 101,335 $ 104,597 $ 294,266 $ 284,081 ----------- ----------- ----------- ----------- Reconciliation of segments to consolidated amount: Income tax benefit (provision) related to Vector, an equity-method investment 980 (841) (2,210) (2,363) ----------- ----------- ----------- ----------- $ 102,315 $ 103,756 $ 292,056 $ 281,718 =========== =========== =========== =========== The overview below provides a high-level summary of Con-way's results from continuing operations in the periods presented. This introductory section is intended to facilitate an executive-level understanding that provides context for the remainder of the discussion on reporting segments. Refer to "Reporting Segment Review" below for more complete and detailed discussion and analysis. Con-way's consolidated revenue for the third quarter of 2006 decreased 0.7% from the same period last year, due to lower revenue from Logistics, which was partially offset by revenue growth from Con-way Freight and Transportation. In the first nine months of 2006, consolidated revenue increased 6.0% due to increases from the prior-year period from Con-way Freight and Transportation and from Logistics. Revenues at Con-way Freight and Transportation reflect the effect of Con-way Freight's pricing initiatives, which emphasized the achievement of yield targets. Although yields in the third quarter and first nine months of 2006 grew 6.4% and 4.9%, respectively, the focus on yield adversely affected tonnage, resulting in a weight-per-day decline of 3.9% in the third quarter and modest growth of 2.1% in the first nine months. Consolidated operating income in 2006 declined 1.4% in the third quarter due primarily to essentially unchanged operating income at Con-way Freight and Transportation and to a decline at Menlo Worldwide, which reflects lower operating income from Logistics and a decrease in operating income from Vector following GM's exercise of its Call Right on June 23, 2006. In the first nine months of 2006, consolidated operating income increased 3.7% on higher operating income from Con-way Freight and Transportation, partially offset by lower operating income from the Menlo Worldwide operating segment. Consolidated operating income in the third quarter and first nine months of 2006 was adversely affected by higher selling, general and administrative costs, which increased 16.8% and 13.2%, respectively, due to a decline in costs reimbursed by UPS under a transition services agreement, increases in employee benefits expense, higher marketing and advertising costs, and the re-branding initiative. Following the sale of MWF to UPS, a portion of Con- way's corporate administrative costs in 2005 were charged to UPS under a transition services agreement. In the third quarter and first nine months 2005, Con-way was reimbursed by UPS for $3.1 million and $10.4 million of costs, respectively, while no costs were reimbursed by UPS in 2006. Employee benefits expense increased 13.0% and 15.7% in the third quarter and first nine months of 2006, respectively, due primarily to increases in share-based compensation expense and in pension and postretirement benefits expense. In the third quarter and first nine months of 2006, Con-way recognized share- based compensation expense of $1.6 million and $4.4 million, respectively, in connection with the adoption of SFAS 123R effective January 1, 2006. Pension and postretirement benefits expense increased $1.6 million and $2.8 million in the third quarter and first nine months of 2006, respectively, due substantially to the retention of benefit plan obligations following the sale of MWF. Marketing and advertising costs in the third quarter and first nine months of 2006 increased $0.8 million and $2.9 million, respectively, due primarily to customer-focused advertising and employee-focused events that support Con-way's re-branding initiative. Con-way's selling, general and administrative expenses consist of costs incurred directly by its business units as well as corporate charges that are allocated to its business units from Con-way's corporate shared-services administrative center and executive headquarters. Corporate administrative expenses are generally allocated based on measurable services provided to each segment, or for general corporate expenses, based on segment revenue or capital employed. Con-way Freight and Transportation's operating income in the third quarter of 2006 included a $6.2 million gain from the sale of the expedited-shipping portion of its former Con-way Expedite and Brokerage business. Excluding this gain, Con-way Freight and Transportation's operating income declined 6.3% in the third quarter of 2006 and increased 1.1% in the first nine months of 2006 when compared to the same prior-year periods. Logistics' operating income in the third quarter and first nine months of 2006 decreased 30.8% and 4.4%, respectively, from the same periods of last year. Third-quarter segment operating income reported from MW's equity investment in Vector declined to $1.0 million in 2006 from $4.2 million in 2005, and for the nine- month period, declined to $13.1 million in 2006 from $13.2 million in 2005. Vector's results in 2006 reflect GM's exercise of its Call Right. Other net expense of $3.9 million in the third quarter of 2006 was relatively unchanged from the prior-year period, and in the first nine months of 2006, other net expense decreased $10.0 million due primarily to an increase in investment income, a reduction in interest expense, and foreign exchange gains. Investment income in the first nine months of 2006 rose $3.2 million on higher interest rates earned on cash-equivalent investments and marketable securities. Interest expense decreased $3.4 million in the first nine months of 2006 due largely to the $100.0 million repayment in June 2005 of the 7.35% Notes. In the first nine months of 2006, other miscellaneous non-operating income primarily reflects positive variations in foreign exchange transactions, which improved comparative operating results by $2.3 million. Con-way's effective tax rate of 34.2% in the third quarter of 2006 decreased from 35.2% in the third quarter in 2005, while the effective tax rate in the first nine months of both 2006 and 2005 was 34.0%. Con-way's effective tax rate in both nine-month periods reflects the effect of second-quarter discrete tax items related to the settlement with the IRS of previous tax filings, which reduced the tax provision in 2006 and 2005 by $6.9 million and $7.0 million, respectively. Also, the third quarter and the first nine months of 2006 include the utilization of a tax-loss carry-forward realized in connection with a capital gain on the sale of Con-way Expedite. The lower taxable income related to the use of the tax-loss carry-forward reduced Con- way's tax provision in the third quarter of 2006 by $2.9 million. Excluding the effect of the second-quarter adjustments, the effect of the third-quarter tax-loss carry-forward in 2006, and other less significant discrete items, the effective tax rate in the third quarter and first nine months of 2006 was 37.5% and 37.7%, respectively, compared to 35.7% and 37.0% in the third quarter and first nine months of 2005, respectively. Reporting Segment Review Con-way Freight and Transportation ---------------------------------- The following table compares operating results, operating margins, and the percentage change in selected operating statistics of the Freight and Transportation reporting segment: Three Months Ended Nine Months Ended (Dollars in thousands) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Summary of Operating Results Revenues $ 735,938 $ 729,660 $2,186,421 $2,067,835 Operating Income 95,524 95,340 264,603 255,508 Operating Margin 13.0% 13.1% 12.1% 12.4% 2006 vs. 2005 2006 vs. 2005 --------------- --------------- Selected Freight Operating Statistics Revenue per day +2.2% +7.0% Weight per day -3.9 +2.1 Revenue per hundredweight ("yield") +6.4 +4.9 Weight per shipment +0.6 +1.9 Con-way Freight and Transportation's revenue in the third quarter and first nine months of 2006 increased 0.9% and 5.7%, respectively, over the same periods in 2005, due to revenue increases from Con-way Freight that were partially offset by declines in revenue from Con-way Transportation following the sale of the expedited-shipping portion of the former Con-way Expedite and Brokerage business in July 2006, as described below. Revenue increases at Con-way Freight in the third quarter and first nine months of 2006 reflect higher revenue per day, partially offset by the effects of 1.5 fewer working days when compared to the same periods last year. In the third quarter of 2006, revenue per day for Con-way Freight rose 2.2% on a 6.4% increase in yield and a 3.9% decline in weight per day, and in the first nine months of 2006, revenue per day grew 7.0% over 2005 on increases in yield and weight per day of 4.9% and 2.1%, respectively. Both yield and weight per day in the third quarter and first nine months were affected by Con-way Freight's pricing initiatives, which emphasized the achievement of yield targets. Although yields increased, the yield focus adversely affected tonnage in a market of slowing demand for freight transportation services, particularly in the third quarter of 2006. In response to the decreased tonnage volumes, Con-way management has implemented a number of targeted sales initiatives, which it believes will lead to tonnage growth by the second quarter of 2007. Yield increases in the third quarter and first nine months of 2006 primarily reflect an increase in fuel surcharges, general rate increases and the results of the pricing initiatives discussed above. Like other LTL carriers, Con-way Freight assesses many of its customers with a fuel surcharge. As fuel prices have risen, the fuel surcharge has increased Con-way Freight's yield and revenue. Excluding fuel surcharges, yield in the third quarter and first nine months of 2006 increased 3.1% and 1.6%, respectively. However, the fuel surcharge is only one part of Con-way Freight's overall rate structure, and the total price that Con-way Freight receives from customers for its services is governed by market forces. At times, in the interest of its customers, Con-way has temporarily capped the fuel surcharge at a fixed percentage. Following a sharp increase in fuel costs in the aftermath of hurricane Katrina in the U.S., Con-way imposed a temporary cap on its fuel surcharge in 2005 that was in effect from August 29 through October 24. Yield increases in 2006 were partially offset by the effects of 0.6% and 1.9% increases in weight per shipment in the third quarter and first nine months of 2006, respectively. For the periods presented, higher weight per shipment in 2006 was due in part to Con-way's spot-quote program, which places lower- yielding large shipments into empty linehaul segments, making use of excess trailer capacity. Commensurate with the lower transportation cost per unit of weight, spot-quote and other lower-cost higher-weight shipments generally have lower yields. In 2006, greater capacity among truckload carriers has resulted in lower growth rates of weight per shipment when compared to last year. As more fully discussed in Note 4, "Reporting Segments," of Item 1, "Financial Statements," Con-way sold the expedited-shipping portion of its former Con-way Expedite and Brokerage business on July 21, 2006. In connection with the sale, Con-way received proceeds of $8.0 million in the third quarter of 2006 and recognized a $6.2 million third-quarter gain. Excluding this gain, Con-way Freight and Transportation's operating income declined 6.3% in the third quarter of 2006 and increased 1.1% in the first nine months of 2006 when compared to the prior-year periods. Operating income in the third quarter of 2006 was adversely affected by a 9.5% increase in administrative costs, which was due primarily to a $6.7 million or 21.5% increase in allocated corporate administrative expenses, as described above under "- Continuing Operations," partially offset by a $2.1 million or 6.3% decrease in administrative business-unit expenses. Lower business-unit administrative expenses were primarily due to a decline in administrative employee costs, as more fully discussed below. In response to lower volumes handled by Con-way Freight, in the third quarter of 2006, management reduced operations- related and administrative employee costs at Con-way Freight and Transportation by 2.9% from the same quarter of last year. The third-quarter decline in employee costs, which also represented a decline in employee costs as a percentage of revenue, was achieved with decreases in incentive compensation, base compensation and employee benefits. Compensation earned under the general annual incentive compensation plan in the third quarter of 2006 declined by $6.8 million based on variations in operating income and other performance measures relative to incentive plan targets. Lower base compensation reflects improved employee productivity and declines in time worked by hourly employees, partially offset by the effects of wage and salary rate increases, which typically take effect in the second and third quarters of each year. In the third quarter of 2006, employee benefits expense reflects decreases in payroll taxes, long-term disability costs and long-term incentive compensation for executives, partially offset by an increase in health and welfare benefits and higher expenses for pension benefits. Purchased transportation costs in the third quarter of 2006 decreased 16.1% from the same quarter of last year due primarily to an increase in Con-way Freight's utilization of Con-way Truckload for linehaul services, which reduced the amount of linehaul services provided by third- party carriers. Third-quarter fuel costs in 2006 increased 18.3% from last year due primarily to increased volumes at Con-way Truckload and to higher average diesel fuel prices. Higher fuel costs and fuel-related increases in purchased transportation costs were more than recovered through fuel surcharges, as more fully discussed below in Item 3, "Quantitative and Qualitative Disclosures About Market Risk - Fuel." In response to long-term expectations for business volumes and equipment-replacement needs, depreciation expense increased 12.5% in the third quarter of 2006 due to planned investments in strategic real estate and tractor and trailer acquisitions by Con-way Freight and Con-way Truckload, which began operations in January 2005. Other operating costs increased 7.2% in the third quarter, due primarily to increased cargo claims and vehicular-insurance costs. Operating income in the first nine months of 2006 was adversely affected by an 11.6% increase in administrative costs, which was due primarily to a $17.3 million or 18.2% increase in allocated corporate administrative expenses, as described above, and to a $2.1 million or 2.2% increase in administrative business-unit expenses. Higher business-unit administrative expenses were primarily due to an increase in administrative employee costs and higher advertising expenses. In the first nine months of 2006, operations-related and administrative employee costs increased 4.3%, but declined as a percentage of revenue. Employee costs reflect increases in base compensation and employee benefits, partially offset by lower incentive compensation. Base compensation in the first nine months 2006 rose 5.7% due primarily to headcount increases, mostly at Con-way Truckload, and to wage and salary rate increases, partially offset by improved employee productivity. Employee benefits expense increased 4.4% due primarily to an increase in the cost of health and welfare benefits and higher expenses for pension benefits, partially offset by a decline in long-term incentive compensation for executives. Compensation earned under the general annual incentive plan in the first nine months of 2006 declined by $11.6 million. Fuel costs in the first nine months of 2006 increased 35.6% and purchased transportation decreased 6.7%, due in part to an increase in Con-way Freight's utilization of Con-way Truckload for linehaul services, which increased fuel consumption but lowered purchased transportation requirements. Purchased transportation and fuel expense in the first nine months of 2006 were adversely affected by an increase in average diesel fuel prices. However, as discussed above, higher fuel costs and fuel-related increases in purchased transportation costs were more than recovered through fuel surcharges. Depreciation expense increased 18.2% in the first nine months of 2006 due to planned investments in strategic real estate and tractor and trailer acquisitions by Con-way Freight and Con-way Truckload, as discussed above. Other operating costs, which include fuel-related taxes, cargo claims costs and facility costs, increased 10.2% in the first nine months of 2006. Menlo Worldwide --------------- The Menlo Worldwide reporting segment consists of the operating results of Logistics and Vector. Menlo Worldwide in 2006 reported third-quarter operating income of $6.5 million, a decrease of 46.5% from last year. In the first nine months of 2006, segment operating income was $30.8 million, a 3.0% decline from the same prior-year period. Results in 2006 reflect GM's exercise of its Call Right, as further discussed below under "Menlo Worldwide - Vector, GM Exercise of Call Right." Accordingly, following June 30, 2006, only profits associated with the settlement of business case activity for the period prior to June 30, 2006 are included in Menlo Worldwide's segment results. Although MW owns a majority equity interest, the operating results of Vector are reported as an equity-method investment based on GM's ability to control certain operating decisions. Accordingly, Con-way's consolidated statements of income do not include any revenue from Vector and only MW's proportionate share of the net income from Vector is reported as a reduction of operating expenses. The table below compares operating results and operating margins of the Menlo Worldwide reporting segment for the three and nine months ended September 30. The table summarizes Logistics net revenues (revenues less purchased transportation expenses) as well as gross revenues. Carrier-management revenue is attributable to contracts for which Logistics manages the transportation of freight but subcontracts the actual transportation and delivery of products to third parties, which Logistics refers to as purchased transportation. Logistics' management believes that net revenues are a meaningful measure of the relative importance of its principal services since gross revenues earned on most carrier-management services include the third- party carriers' charges to Logistics for transporting the shipments. Three Months Ended Nine Months Ended (Dollars in thousands) September 30, September 30, ----------------------- ----------------------- 2006 2005 2006 2005 ----------- ----------- ----------- ----------- Summary of Operating Results Logistics Revenues $ 340,869 $ 354,797 $1,036,430 $ 973,782 Purchased Transportation (241,097) (260,680) (745,687) (699,595) ----------- ----------- ----------- ----------- Net Revenues 99,772 94,117 290,743 274,187 Operating Income 5,462 7,889 17,740 18,553 Operating Margin on Revenue 1.6% 2.2% 1.7% 1.9% Operating Margin on Net Revenue 5.5% 8.4% 6.1% 6.8% Vector Operating Income $ 1,019 $ 4,220 $ 13,068 $ 13,196 Menlo Worldwide - Logistics Logistics' revenue in the third quarter of 2006 decreased 3.9% due to a 6.9% decrease in carrier-management services, partially offset by an 8.0% increase in warehouse-management services. Revenue for the first nine months of 2006 increased 6.4%, due to increases in revenue from carrier-management and warehouse-management services of 6.4% and 6.7%, respectively. Revenues in the third quarter and first nine months of 2006 reflect management's decision to terminate in May 2006 a carrier-management contract that accounted for 2.9% of Logistics' annual segment revenues in 2005. In the third quarter of 2006, Logistics' net revenue grew 6.0% as a 3.9% decline in revenue was more than offset by a 7.5% reduction in purchased transportation costs, due primarily to an increase in the percentage of revenue derived from warehouse- management services, which has the effect of increasing gross and net revenue without an associated increase in purchased transportation. Net revenue in the first nine months of 2006 also grew 6.0%, but was the result of growth in both revenue and purchased transportation of 6.4% and 6.6%, respectively. In the first nine months of 2006, higher purchased transportation costs were due to an increase in carrier-management revenue and to fuel-related increases in carrier rates. Logistics' operating income in the third quarter and first nine months of 2006 decreased 30.8% and 4.4%, respectively, from the same periods of last year, due primarily to administrative expenses, which increased 37.3% and 23.4%, respectively. Higher administrative expenses primarily reflect increases in both administrative business-unit expenses and allocated corporate administrative expenses. Business-unit administrative expenses in the third quarter of 2006 increased 42.4% or $3.4 million, and in the nine- month period, increased 23.9% or $6.1 million, due primarily to employee- related costs, as more fully discussed below, and to $1.0 million of third- quarter costs related to a bid for a significant contract. Corporate administrative costs allocated to Logistics in the third quarter of 2006 increased $2.0 million or 21.4%, and in the nine-month period, increased $3.8 million or 13.2%, as described above under " - Continuing Operations." Purchased labor and employee costs collectively increased 13.3% and 13.2% in the third quarter and first nine months of 2006, respectively. In the third quarter and first nine months of 2006, purchased labor costs increased $3.3 million or 25.6% and $8.0 million or 21.4%, respectively, due to new warehouse-management projects, primarily those secured in the second quarter of 2006. Logistics utilizes purchased labor for warehouse-management services due to the flexibility provided in responding to varying customer demand. Employee costs in 2006, including both operations-related and administrative personnel, reflect increases in base compensation, employee benefits, and incentive compensation. Base compensation in the third quarter and first nine months of 2006 rose $1.1 million or 4.5% and $4.7 million or 6.4%, respectively, due primarily to growth in headcount and, to a lesser extent, wage and salary rate increases that typically take effect in the first and third quarters of each year. Employee benefits expense increased $1.4 million or 19.1% and $3.9 million or 17.6% in the third quarter and first nine months of 2006, respectively, primarily from an increase in the cost of health and welfare benefits and other employee benefit costs. Incentive compensation in the third quarter and first nine months of 2006 increased by $0.5 million and $2.1 million, respectively, based on variations in operating income, working capital and other performance measures relative to incentive plan targets. In an effort to improve margins, management continues the transition to a shared-resource process-based approach that leverages a centralized transportation group, utilizes multi-client warehouses, and creates technological solutions that benefit multiple customers. Beginning in the second quarter of 2005, Logistics integrated into its operations the former Con-Way Logistics business, which was previously reported in the Con-way Freight and Transportation segment. Accordingly, the operating results of Con-Way Logistics are reported with Menlo Worldwide Logistics and prior periods have been reclassified to conform to the current- period presentation. Menlo Worldwide - Vector Operating Results Third-quarter segment operating income reported from MW's equity investment in Vector declined to $1.0 million in 2006 from $4.2 million in 2005, and for the nine-month period, declined to $13.1 million in 2006 from $13.2 million in 2005. Results in 2006 reflect GM's exercise of its Call Right, as further discussed below. Accordingly, following June 30, 2006, only profits associated with the settlement of business case activity for the period prior to June 30, 2006 are included in Menlo Worldwide's segment results. GM Exercise of Call Right As more fully discussed in Note 3, "Investment in Unconsolidated Joint Venture," of Item 1, "Financial Statements," on June 23, 2006, GM exercised its Call Right. As a result, Con-way is entitled to receive the fair value of MW's membership interest in Vector as of June 22, 2006. Con-way believes that the fair value of MW's membership interest in Vector consists of the amount of MW's capital account, the amount of MW's portion of Vector's undistributed earnings, and the fair value of MW's portion of Vector's future profit. At the agreed-upon effective valuation date of June 30, 2006, MW's capital account and MW's portion of undistributed earnings in Vector totaled $42.4 million. Proceeds received in excess of MW's capital account and MW's portion of undistributed earnings in Vector will be reported as a gain from continuing operations, based on Vector's classification as an equity-method investment in Con-way's consolidated financial statements. Con-way is currently in discussions with GM as to the valuation amount and transition terms for Vector operations. While Con-way believes that it is entitled to receive the payments described above and therefore expects to realize a gain, it has not reached agreement with GM and cannot predict with certainty the ultimate outcome of these matters. Con-way Other ------------- The Con-way Other reporting segment consists of certain corporate activities for which the related income or expense has not been allocated to other reporting segments. All periods presented include results from corporate re- insurance activities and operating costs on corporate properties. The Con- way Other third-quarter operating loss decreased to $0.7 million in 2006 from $2.9 million in 2005, which included a $2.2 million loss resulting from an insurance settlement. In the first nine months, the $1.1 million operating loss in 2006 decreased from $3.2 million in 2005 as losses from re-insurance activities and operating costs on corporate properties were partially offset by gains from the sale of communication frequencies in the first nine months of 2006. Losses from corporate re-insurance activities were $0.2 million in the third quarter of 2006 compared to a $0.1 million gain in the third quarter of 2005. The first nine months of 2006 included a $0.9 million loss from corporate re-insurance activities, while the same period last year included a $1.1 million gain from corporate re-insurance activities. Costs associated with corporate properties were $0.4 million and $0.5 million in the third quarter of 2006 and 2005, respectively, and $1.3 million in the first nine months of both 2006 and 2005. Partially offsetting the losses were gains on the sale of communication frequencies of $1.3 million in the first half of 2006. Discontinued Operations ----------------------- Discontinued operations in the periods presented relate to the closure of Con-way Forwarding, the sale of MWF, and the shut-down of EWA and its terminated Priority Mail contract with the U.S. Postal Service ("USPS"). The results of operations, net liabilities, and cash flows of discontinued operations have been segregated from continuing operations, except where otherwise noted. See Note 2, "Discontinued Operations," of Item 1, "Financial Statements" for a summary of operating results and a description of related loss reserves and contingencies. See Note 2, "Discontinued Operations," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K for a complete description of the disposition of MWF, including a discussion of losses from impairment and disposal of MWF and of cash payments received from UPS in connection with the sale of MWF. Liquidity and Capital Resources ------------------------------- In the first nine months of 2006, cash of $547.9 million used in investing and financing activities was funded with $350.2 million of cash provided by operating activities and $221.0 million of cash and cash equivalents, which fell to $293.2 million at September 30, 2006 from $514.3 million at December 31, 2005. Investing activities in the first nine months of 2006 used $217.8 million due primarily to capital expenditures of $243.3 million while financing activities used $330.1 million, primarily for the repurchase of $305.9 million of common stock. Con-way's cash flows are summarized in the table below. Nine Months Ended (Dollars in thousands) September 30, ----------------------- 2006 2005 ----------- ----------- Operating Activities Net income $ 181,944 $ 169,990 Discontinued operations 6,779 5,339 Non-cash adjustments (1) 117,701 73,867 ----------- ----------- 306,424 249,196 Changes in assets and liabilities 43,822 (15,113) Net Cash Provided by Operating Activities 350,246 234,083 ----------- ----------- Net Cash Provided by (Used in) Investing Activities (217,767) 174,115 ----------- ----------- Net Cash Used in Financing Activities (330,121) (192,886) ----------- ----------- Net Cash Provided by (Used in) Continuing Operations (197,642) 215,312 Net Cash Used in Discontinued Operations (23,398) (14,073) ----------- ----------- Increase (Decrease) in Cash and Cash Equivalents $ (221,040) $ 201,239 =========== =========== (1) "Non-cash adjustments" refer to depreciation, amortization, deferred income taxes, provision for uncollectible accounts, equity in earnings of joint venture, and non-cash income and expenses. Continuing Operations Operating Activities Cash flow from operating activities in the first nine months of 2006 was $350.2 million, a $116.2 million increase from the same prior-year period, on growth in net income before non-cash items and from the net cash provided by changes in assets and liabilities. Receivables in the first nine months of 2006 provided $25.9 million on a decline in the average collection period for Logistics' receivables due to improved processing of invoices and receipts. In the first nine months of 2005, receivables used $110.0 million on increased revenues and an increase in the average collection period. The change in accrued incentive compensation provided $13.2 million in the first nine months of 2006, while the same prior-year period reflects a $1.2 million use of cash. In the first nine months of 2006 and 2005, expense accruals for incentive compensation were $46.0 million and $56.1 million, respectively, while incentive compensation payments in those periods, which relate to the prior year, were $32.8 million and $57.3 million, respectively. For the first nine months of 2006, cash provided by changes in income taxes decreased $52.5 million from the prior-year period, due in part to a $32.0 million estimated tax payment in September 2006. In 2005, a third-quarter tax payment was not made based on estimated taxable income. The use of cash from the decline in employee benefit liabilities for the first nine months of 2006 and 2005 reflects the net effect of defined benefit plan funding contributions of $75.0 million in both 2006 and 2005, partially offset by expense accruals related to Con-way's defined benefit pension plan and other benefit plans. Cash provided by changes in deferred charges and credits decreased to $13.7 million in the first nine months of 2006 from $26.6 million provided in the same period of 2005. In both periods presented, cash provided by deferred charges and credits reflects increases in Con-way's affiliate payable to Vector, which increased $10.9 million and $22.2 million in the first nine months of 2006 and 2005, respectively. As more fully discussed in Note 3, "Investment in Unconsolidated Joint Venture," of Item 1, "Financial Statements," on June 23, 2006, GM exercised its Call Right. Under the Vector agreements, Con-way is entitled to receive the fair value of MW's membership interest in Vector as of June 22, 2006. As part of the sale of MW's membership interest, Con-way expects to settle its affiliate payable to Vector, which at September 30, 2006 was $32.9 million. Subsequent to June 30, 2006, Vector's excess cash balances invested by Con- way are reported in accrued liabilities, net of amounts receivable from Vector for unreimbursed costs for transition services provided by Con-way. The net transition-related liability increased $4.5 million in the third quarter of 2006. Investing Activities Investing activities in the first nine months of 2006 used $217.8 million compared to $174.1 million provided in the first nine months of 2005. Proceeds from the sale of businesses declined to $8.0 million in the first nine months of 2006 from $108.4 million in the same period last year. In the third quarter of 2006, Con-way sold the expedited-shipping portion of its former Con-way Expedite and Brokerage business for $8.0 million. In 2005, Con-way collected non-trade receivables from UPS, including a $29.4 million payment in March 2005 from UPS in connection with the sale of MWF and a $79.0 million third-quarter payment received from UPS for Con-way's retained obligations related to MWF employees covered under Con-way's long-term disability and postretirement medical plans. In both periods presented, investing activities also reflect fluctuations in short-term marketable securities and capital expenditures. Investments in marketable securities decreased in the first nine months of 2006 by $20.4 million, while the first nine months of 2005 reflect a $236.4 million decrease due primarily to the conversion in March 2005 of auction-rate securities into cash and cash equivalents. Capital expenditures in the first nine months of 2006 increased $75.3 million from the same period of 2005 due primarily to increased tractor and trailer expenditures at Con-way Freight and Transportation. Financing Activities Financing activities in the first nine months of 2006 used cash of $330.1 million compared to $192.9 million used in the first nine months of 2005. For the periods presented, common stock repurchases of $305.9 million in 2006 and $111.6 million in 2005 were made under Con-way's repurchase programs described below. The significant increase in stock repurchases in 2006 was attributable to the repurchase in May 2006 of 3.75 million shares in two significant privately negotiated transactions. Under a program more fully discussed in Note 7, "Common Stock Repurchase Program," of Item 1, "Financial Statements," Con-way is authorized to repurchase an additional $134.6 million of common stock through June 30, 2007. Financing activities in both periods presented also reflect dividend payments and scheduled principal payments for debt. Cash provided by the exercise of stock options decreased to $11.8 million in the first nine months of 2006 from $56.8 million in the same period last year. The higher level of stock option exercises in the first nine months of 2005 was the result of an increase in the market price of Con-way's common stock during that period, combined with more outstanding exercisable options. Con-way has a $400 million revolving credit facility that matures on September 30, 2011. The revolving credit facility is available for cash borrowings and for the issuance of letters of credit up to $400 million. At September 30, 2006, no borrowings were outstanding under the facility and $209.3 million of letters of credit were outstanding, leaving $190.7 million of available capacity for additional letters of credit or cash borrowings, subject to compliance with financial covenants and other customary conditions to borrowing. Con-way had other uncommitted unsecured credit facilities totaling $35.0 million at September 30, 2006, which are available to support letters of credit, bank guarantees, and overdraft facilities; at that date, a total of $18.7 million was outstanding under these facilities. The total letters of credit outstanding under the revolving credit facility at September 30, 2006 provided collateral for Con-way's self-insurance programs. On September 29, 2006, Con-way entered into an agreement to amend the revolving credit facility, which revised the pricing and extended the term from March 11, 2010 to September 30, 2011. See "Forward-Looking Statements" below, Note 10, "Debt," of Item 1, "Financial Statements," and Note 5, "Debt and Other Financing Arrangements," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K for additional information concerning Con-way's $400 million credit facility and some of its other debt instruments. Contractual Cash Obligations Con-way's contractual cash obligations as of December 31, 2005 are summarized in Con-way's 2005 Annual Report on Form 10-K under Item 7, "Management's Discussion and Analysis - Liquidity and Capital Resources - Contractual Cash Obligations." In the first nine months of 2006, there have been no material changes in Con-way's contractual cash obligations outside the ordinary course of business. In 2006, Con-way estimates annual capital and software expenditures of approximately $325 million, or approximately $74 million of additional expenditures in the fourth quarter of 2006, before any adjustment for proceeds received from sales of property or equipment. Con-way's estimate for capital expenditures primarily includes acquisitions of additional tractor and trailer equipment and land and buildings. Con-way's actual 2006 capital expenditures may differ from the estimated amount, depending on factors such as the availability and timing of delivery of equipment, the availability of land in desired locations for new facilities, and the timing of obtaining permits, environmental studies and other approvals necessary for the development of new and existing facilities. Other Con-way's ratio of total debt to capital increased to 42.3% at September 30, 2006 from 39.6% at December 31, 2005, due primarily to the decrease in common shareholders' equity as a result of share repurchases in the first nine months of 2006. The effect of the share repurchases was partially offset by the increase in retained earnings resulting from net income earned in the first nine months of 2006 and the $15.0 million debt repayment in January. On February 1, 2006, Standard & Poor's raised its rating on Con-way's senior unsecured debt to "BBB" from "BBB-." In addition, Fitch Ratings initiated coverage of Con-way on January 25, 2006 with a rating of "BBB." Both agencies reported the rating outlook for Con-way as "stable." Discontinued Operations Discontinued operations in the periods presented relate to the closure of Con-way Forwarding, the sale of MWF, and the shut-down of EWA and its terminated Priority Mail contract with the USPS. Except as described below under " - MWF," the cash flows from discontinued operations have been segregated from continuing operations and reported separately as discontinued operations. MWF See Note 2, "Discontinued Operations," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K for a complete description of the disposition of MWF, including a discussion of losses from impairment and disposal of MWF and of cash payments received from UPS in connection with sale of MWF. As more fully discussed above, sales- related amounts received from UPS in 2005 are reported in proceeds from sale of discontinued operations in investing activities. EWA As more fully discussed in Note 2, "Discontinued Operations - EWA," on June 30, 2006, EWA, MWF Inc. and Con-way Inc. concluded a final settlement of a lawsuit filed in state court in California by approximately 140 former EWA pilots and crewmembers. Under the settlement, the plaintiffs received a cash payment of $9.2 million and the lawsuit was dismissed with prejudice. Also, on August 8, 2006, EWA, MWF Inc. and Con-way Inc. concluded a final settlement of a lawsuit filed by ALPA on behalf of certain former EWA pilots and crewmembers. Under the settlement, the plaintiffs received a cash payment of $10.9 million and the lawsuit was dismissed with prejudice. Estimates and Critical Accounting Policies ------------------------------------------ The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. requires management to adopt accounting policies and make significant judgments and estimates. In many cases, there are alternative policies or estimation techniques that could be used. Con-way maintains a process to evaluate the appropriateness of its accounting policies and estimation techniques, including discussion with and review by the Audit Committee of its Board of Directors and its independent auditors. Accounting policies and estimates may require adjustment based on changing facts and circumstances and actual results could differ from estimates. The policies and estimates discussed below include those that are most critical to the financial statements. Employee Retirement Benefit Plans Employees of Con-way and its subsidiaries in the U.S. are covered under several retirement benefit plans, including defined benefit pension plans and a defined contribution retirement plan. On October 13, 2006, Con-way's Board of Directors approved changes to Con-way's retirement benefits plans. The changes are intended to preserve the retirement benefits earned by existing employees under Con-way's primary defined benefit pension plan (the "DB Plan") while expanding benefits earned under its defined contribution plan (the "DC Plan"). The major provisions of the plan amendments are effective on January 1, 2007 and are more fully discussed in Note 5, "Employee Benefit Plans," of Item 2, "Financial Statements." These provisions will primarily result in increased expense related to the DC Plan and in the elimination of future service cost associated with the DB Plan. The effect of plan changes on Con-way's results of operations, financial condition, and cash flows is more fully discussed below under "Amendments to Employee Retirement Benefit Plans." Defined Benefit Pension Plans The amount recognized as pension expense and the accrued pension liability for Con-way's defined benefit pension plans depend upon a number of assumptions and factors, the most significant being the discount rate used to measure the present value of pension obligations and the expected rate of return on plan assets. Con-way assesses its plan assumptions for the discount rate, expected rate of return on plan assets, and other significant assumptions on a continuous basis, but concludes on those assumptions at the actuarial plan measurement date of November 30 of each year. Con-way's most significant assumptions used in determining pension expense for the periods presented and for 2006 are summarized below. 2006 2005 ----------- ----------- Weighted-average assumptions: Discount rate 6.00% 6.25% Expected long-term rate of return on plan assets 8.50% 8.50% Discount Rate. In determining the appropriate discount rate, Con-way utilizes a bond model that incorporates expected cash flows of plan obligations. The bond model uses a selected portfolio of Moody's Aa-or- better rated bonds with cash flows and maturities that match the projected benefit payments of Con-way's pension plans. Con-way's discount rate is equal to the yield on the portfolio of bonds, which will typically exceed the Moody's Aa corporate bond index due to the long duration of expected benefit payments from Con-way's plan. If all other factors were held constant, a 0.25% decrease (increase) in the discount rate would result in an estimated $7 million increase (decrease) in 2006 annual pension expense. Return on Plan Assets. Con-way adjusts its expected rate of return on plan assets based on current market expectations and historical returns. The rate of return is based on an expected 20-year return on the current asset allocation and the effect of actively managing the plan, net of fees and expenses. Using year-end plan asset values, a 0.25% decrease (increase) in the expected rate of return on plan assets would result in an estimated $2 million increase (decrease) in 2006 annual pension expense. Differences between the expected and actual rate of return on plan assets and/or changes in the discount rate may result in cumulative unrecognized actuarial losses. These unrecognized actuarial losses primarily reflect the declining discount rate and lower market returns in recent years. Although these amounts may be recovered in future periods through actuarial gains, any portion of the unrecognized actuarial loss outside of a corridor amount must be amortized and recognized as expense over the average service period for employees. Con-way expects its annual defined benefit pension expense in 2006 will exceed the annual expense in 2005 by approximately $6 million based on increases in service cost, interest cost, and amortization of the unrecognized actuarial loss, partially offset by a higher expected return on plan assets. The increase in service cost is due in part to the effect in 2006 of revised mortality assumptions while the increase in interest cost is due to the lower discount rate that increases the plan obligation. In its determination of the plan obligation at December 31, 2005 and of pension expense in 2006, Con-way revised its mortality assumption for plan participants from one based on 1983 U.S. census data to one based on 2000 U.S. census data, which results in a longer-life assumption for plan participants. Despite unchanged expectations on the long-term rate of return on plan assets, Con-way expects an increase in the return on plan assets in 2006 based on plan contributions that increase plan assets. Amortization of the unrecognized actuarial loss in 2006 will increase $5 million from 2005, based primarily on the higher unrecognized actuarial loss at December 31, 2005. Under assumptions applied at the 2005 measurement date, the accumulated benefit obligation of certain Con-way pension plans exceeded the fair value of plan assets. Accordingly, Con-way recorded a minimum pension liability adjustment in the accumulated other comprehensive loss in shareholders' equity to recognize the shortfall between the fair value of the assets and the accumulated benefit obligation of these plans. At September 30, 2006 and December 31, 2005, the cumulative additional minimum pension liability was $36.2 million (net of $23.1 million of tax benefits). Con-way periodically reviews the funded status of its defined benefit pension plans for non-contractual employees, and makes contributions from time to time as necessary to comply with the funding requirements of the Employee Retirement Income Security Act ("ERISA"). In determining the amount and timing of its pension contributions, Con-way considers both the ERISA- and GAAP-based measurements of funded status as well as the tax deductibility of contributions. Con-way contributed $126.5 million to its defined benefit pension plans in 2005 and has contributed $75 million in 2006, which represents all of the estimated contributions for 2006. Con- way's estimates of its defined benefit plan contributions are subject to variation based on changes in interest rates and asset returns. Amendments to Employee Retirement Benefit Plans The recent amendments to Con-way's retirement benefit plans are generally expected to decrease the financial statement effect associated with the defined benefit pension plans and to increase the financial statement effect associated with the defined contribution plan. Although employee participants in the DB Plan as of December 31, 2006 will retain all benefits and credited service time earned, years of credited service will be capped at December 31, 2006. Future benefit plan payments will consider participants' pay increases through 2016, after which the benefit will be capped. In 2007, Con-way estimates that increased benefits expense related to higher company contributions to the DC Plan will, in whole or in part, be offset by lower benefits expense associated with the elimination of service cost related to the DB Plan. Con-way estimates that, as of December 31, 2006, the changes to the DB Plan will not affect the related accumulated benefit obligation. However, those changes will decrease the projected benefit obligation of the DB Plan at December 31, 2006 by approximately $37 million and that decline will be recognized as an actuarial gain of approximately $3 million each year for approximately 12 years, the average estimated remaining years of service. Thereafter, any changes in Con-way's projected benefit obligation, as well as the related asset or liability of the defined benefit pension plans reported in the consolidated balance sheets, will be based on changes in actuarial assumptions, primarily the discount rate and rate of return on plan assets, as described above, and Con-way's funding contributions to the plans. Con-way's funding practice for its defined benefit pension plans is unchanged and Con-way will continue to evaluate its tax and cash position and the funded status of the defined benefit pension plans to maximize the tax deductibility of its contributions for the year. Although Con-way expects to make additional future contributions to the defined benefit pension plans, it expects that the plan changes will reduce the defined benefit pension plan funding payments that otherwise would have been required without plan amendments. However, Con-way believes that the decline in funding requirements for the defined benefit pension plans will, in whole or in part, be offset by higher contributions to the DC Plan. Self-Insurance Accruals Con-way uses a combination of purchased insurance and self-insurance programs to provide for the costs of medical, casualty, liability, vehicular, cargo and workers' compensation claims. In the measurement of these costs, Con-way considers historical claims experience, medical costs, demographic and severity factors and other assumptions. Self-insurance accruals are developed based on the estimated, undiscounted cost of claims, including those claims incurred but not reported as of the balance sheet date. The long-term portion of self-insurance accruals relates primarily to workers' compensation and vehicular claims that are expected to be payable over several years. The actual costs may vary from estimates. Income Taxes In establishing its deferred income tax assets and liabilities, Con-way makes judgments and interpretations based on the enacted tax laws and published tax guidance that are applicable to its operations. Con-way records deferred tax assets and liabilities and periodically evaluates the need for a valuation allowance to reduce deferred tax assets to realizable amounts. The likelihood of a material change in Con-way's expected realization of these assets is dependent on future taxable income, future capital gains, its ability to use foreign tax credit carry forwards and carry backs, final U.S. and foreign tax settlements, and the effectiveness of its tax planning strategies in the various relevant jurisdictions. Con-way is also subject to examination of its income tax returns for multiple years by the IRS and other tax authorities. Con-way periodically assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision and related accruals for income taxes. Disposition and Restructuring Estimates As more fully discussed in Note 2, "Discontinued Operations," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K, Con-way's management made significant estimates and assumptions in connection with the disposition of MWF in 2004. Actual results could differ from estimates, which could affect related amounts reported in the financial statements. Significant estimates and assumptions were also made in connection with the disposition of Con-way Forwarding and EWA, as more fully discussed herein in Note 2, "Discontinued Operations," of Item 1, "Financial Statements." Uncollectible Accounts Receivable Con-way and its subsidiaries report accounts receivable at net realizable value and provide an allowance for uncollectible accounts when collection is considered doubtful. Con-way Freight and Transportation provides for uncollectible accounts based on various judgments and assumptions, including revenue levels, historical loss experience, and composition of outstanding accounts receivable. Logistics, based on the size and nature of its client base, performs a frequent and periodic evaluation of its customers' creditworthiness and accounts receivable portfolio and recognizes expense from uncollectible accounts when losses are both probable and reasonably estimable. Property, Plant and Equipment and Other Long-Lived Assets In accounting for property, plant, and equipment, Con-way makes estimates about the expected useful lives and the expected residual values of the assets, and the potential for impairment based on the fair values of the assets and the cash flows generated by these assets. The depreciation of property, plant, and equipment over their estimated useful lives and the determination of any salvage value requires management to make judgments about future events. Con-way periodically evaluates whether changes to estimated useful lives or salvage values are necessary to ensure these estimates accurately reflect the economic use of the assets. Con-way's periodic evaluation may result in changes in the estimated lives and/or salvage values used to depreciate its assets, which can affect the amount of periodic depreciation expense recognized and, ultimately, the gain or loss on the disposal of the asset. As a result of Con-way's periodic evaluation, the useful lives of certain classes of revenue equipment were changed in the second quarter of 2006, as more fully discussed in Note 1, "Principal Accounting Policies - Property, Plant and Equipment," of Item 1, "Financial Statements." Con-way performs an impairment analysis of long-lived assets whenever circumstances indicate that the carrying amount may not be recoverable. For assets that are to be held and used, an impairment charge is recognized when the estimated undiscounted cash flows associated with the asset or group of assets is less than carrying value. If impairment exists, a charge is recognized for the difference between the carrying value and the fair value. Fair values are determined using quoted market values, discounted cash flows, or external appraisals, as applicable. Assets held for disposal are carried at the lower of carrying value or estimated net realizable value. Other Matters ------------- New Accounting Standard In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)" ("SFAS 158"). The standard requires a company to: - Recognize in its balance sheet an asset for a plan's over-funded status or a liability for a plan's under-funded status. - Recognize as a component of other comprehensive income the gains or losses and prior-service costs and credits that arise during the period but are not recognized as components of net periodic benefit costs. - Measure a plan's assets and its obligations as of the end of the fiscal year rather than at an earlier measurement date, as allowed under current accounting standards. - Provide additional disclosures in the notes to the financial statements. The effective date for the recognition and disclosure elements of SFAS 158 is the first fiscal year ending after December 15, 2006 and the effective date for the end-of-fiscal-year measurement-date requirement is the first fiscal year ending after December 15, 2008. At September 30, 2006 and December 31, 2005, Con-way reported a net liability of $47.8 million and $82.7 million, respectively, for its obligation related to its defined benefit pension plans, including the DB Plan, the Supplemental DB Plan and the Forwarding DB Plans. The net-of-tax accumulated other comprehensive loss associated with those plans at those dates was $36.2 million. Based on projected actuarial estimates as of December 31, 2006, which reflect the recent retirement benefit plan changes described above, Con-way estimates that it would be required to report a liability for pension benefits of $128 million and a net-of-tax accumulated other comprehensive loss of $63 million in shareholders' equity. At September 30, 2006 and December 31, 2005, Con-way reported a liability of $95.8 million and $96.4 million, respectively, for its obligation related to its postretirement medical plan. Based on projected actuarial estimates as of December 31, 2006, Con-way estimates that it would be required to report a liability for postretirement benefits of $129 million and a net-of-tax accumulated other comprehensive loss of $21 million in shareholders' equity. The effect of adoption of SFAS 158 on Con-way's consolidated financial statements is based on projections and actuarial assumptions, and accordingly, is subject to variation based on changes in interest rates, asset returns, and other factors. 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, yield, volumes, income or other financial or operating items, any statements of the plans, strategies, expectations or objectives of Con-way's management for future operations or other future items, any statements concerning proposed new products or services, any statements regarding Con-way's estimated future contributions to pension plans, any statements as to the adequacy of reserves, any statements regarding the outcome of any claims that may be brought against Con-way by CFC's multi-employer pension plans or any statements regarding future economic conditions or performance, any statements regarding the outcome of legal and other claims and proceedings against Con-way, 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 Con-way 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 global economy; * the creditworthiness of Con-way's customers and their ability to pay for services rendered; * increasing competition and pricing pressure; * availability of fuel and changes in fuel prices or fuel surcharges; * the effects of the cessation of EWA's air carrier operations; * the possibility that Con-way may, from time to time, be required to record impairment charges for long-lived assets; * the possibility of defaults under Con-way's $400 million credit agreement and other debt instruments, and the possibility that Con-way may be required to repay certain indebtedness in the event that the ratings assigned to its long-term senior debt by credit rating agencies are reduced; * labor matters, including the grievances by furloughed EWA pilots and crewmembers, labor organizing activities, work stoppages or strikes; * enforcement of and changes in governmental regulations, including the effects of new regulations issued by the Department of Homeland Security; * environmental and tax matters; * matters relating to Con-way's 1996 spin-off of CFC, including the possibility that CFC's multi-employer pension plans may assert claims against Con-way, that Con-way may not prevail in those proceedings and may not have the financial resources necessary to satisfy amounts payable to those plans; * matters relating to the sale of MWF, including Con-way's obligation to indemnify UPS for certain losses in connection with the sale; * matters relating to GM's exercise of its call right to purchase MW's membership interest in Vector; * matters relating to Con-way's defined benefit and contribution pension plans. As a result of the foregoing, no assurance can be given as to future financial condition, results of operations, or cash flows. See Note 11, "Commitments and Contingencies," of Item 1, "Financial Statements." ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Con-way is exposed to a variety of market risks, including the effects of interest rates, fuel prices and foreign currency exchange rates. Con-way enters 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 interest rate, commodity, 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. Derivative financial instruments held by Con-way at September 30, 2006 did not have a material effect on Con-way's consolidated financial statements. Interest Rates Con-way is subject to the effect of interest rate fluctuations on the fair value of its long-term debt. Based on the fixed interest rates and maturities of its long-term debt, fluctuations in market interest rates would not significantly affect operating results or cash flows, but may have a material effect on the fair value of long-term debt, as more fully discussed in Note 5, "Debt and Other Financing Arrangements," of Item 8, "Financial Statements and Supplementary Data," in Con-way's 2005 Annual Report on Form 10-K. Fuel Con-way is exposed to the effects of changes in the availability and price of diesel fuel. Generally, fuel can be obtained from various sources and in the desired quantities. However, an inability to obtain fuel due to fuel shortages or any other reason could have a material adverse effect on Con- way. Con-way and its subsidiaries (primarily Con-way Freight and Transportation) are subject to the risk of price fluctuations. Like other LTL carriers, Con-way Freight assesses many of its customers with a fuel surcharge. As fuel prices have risen, the fuel surcharge has increased Con- way Freight's yields and revenue, and Con-way Freight has more than recovered higher fuel costs and fuel-related increases in purchased transportation. However, the fuel surcharge is only one part of Con-way Freight's overall rate structure, and the total price that Con-way Freight receives from customers for its services is governed by market forces. At times, in the interest of its customers, Con-way Freight has temporarily capped the fuel surcharge at a fixed percentage. Following a sharp increase in fuel costs in the aftermath of hurricanes in the U.S., Con-way Freight imposed a temporary cap on its fuel surcharge in 2005 that was in effect from August 29 through October 24. Con-way cannot predict the future movement of fuel prices, Con-way Freight's ability to recover higher fuel costs through fuel surcharges, the effect that changes in fuel surcharges may have on Con-way Freight's overall rate structure or the total price that Con-way Freight receives from customers for its services. Con-way Freight's operating income would be adversely affected by a rapid and significant decline in fuel prices as lower fuel surcharges would reduce Con-way Freight's yield and revenue. Whether fuel prices increase, decrease, or remain constant, Con-way's operating income may be adversely affected if competitive pressures limited Con-way Freight's ability to assess its fuel surcharges. Foreign Currency The assets and liabilities of Con-way's foreign subsidiaries are denominated in foreign currencies, which create exposure to changes in foreign currency exchange rates. However, the market risk related to foreign currency exchange rates is not material to Con-way's financial condition, results of operations or cash flows. ITEM 4. CONTROLS AND PROCEDURES (a) Disclosure Controls and Procedures. Con-way's management, with the participation of Con-way's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Con- way's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation, Con-way's Chief Executive Officer and Chief Financial Officer have concluded that Con-way's disclosure controls and procedures are effective as of the end of such period. (b) Internal Control Over Financial Reporting. There have not been any changes in Con-way's internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Con- way's internal control over financial reporting. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Certain legal proceedings of Con-way are also discussed in Note 2, "Discontinued Operations," and Note 11, "Commitments and Contingencies," of Part 1, Item 1, "Financial Statements." In 2003, prior to the sale of MWF to UPS, Con-way became aware of information that Emery Transnational, a Philippines-based joint venture in which MWF, Inc. may be deemed to be a controlling partner, may have made certain payments in violation of the Foreign Corrupt Practices Act. Con-way promptly notified the Department of Justice and the Securities and Exchange Commission of this matter, and MWF, Inc. instituted policies and procedures in the Philippines designed to prevent such payments from being made in the future. Con-way was subsequently advised by the Department of Justice that it is not pursuing an investigation of this matter. Con-way conducted an internal investigation of approximately 40 other MWF, Inc. international locations and has shared the results of the internal investigation with the SEC. The internal investigation revealed that Menlo Worldwide Forwarding (Thailand) Limited, a Thailand-based joint venture, also may have made certain payments in violation of the Foreign Corrupt Practices Act. MWF, Inc. made certain personnel changes and instituted policies and procedures in Thailand designed to prevent such payments from being made in the future. In December 2004, Con-way completed the sale of its air freight forwarding business (including the stock of MWF, Inc., Emery Transnational and Menlo Worldwide Forwarding (Thailand) Limited) to an affiliate of UPS. In connection with that sale, Con-way agreed to indemnify UPS for certain losses resulting from violations of the Foreign Corrupt Practices Act. Con-way is currently unable to predict whether it will be required to make payments under the indemnity. ITEM 1A. RISK FACTORS There are no material changes to the risk factors previously disclosed in Item 1A, "Risk Factors," in Con-way's 2005 Annual Report on Form 10-K. ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS The following table provides a summary of shares repurchased by Con-way during the quarter ended September 30, 2006: Total Number Maximum Dollar Total Average of Shares Purchased Value of Shares Number of Price as Part of that May Yet Be shares Paid per Publicly Announced Purchased Under Purchased[1] Share Program [1] the Program[1] ------------ ----------- ------------------- --------------- July 1, 2006 - July 31, 2006 244,700 $ 52.01 244,700 $ 166,039,673 August 1, 2006 - August 31, 2006 530,000 $ 48.90 530,000 $ 140,124,201 September 1, 2006 - September 30, 2006 120,000 $ 45.82 120,000 $ 134,625,785 ------------ ------------------- Total 894,700 $ 49.34 894,700 $ 134,625,785 ============ =================== [1] In April 2006, the Board of Directors authorized the repurchase of up to $400 million in Con-way's common stock through open-market transactions and privately negotiated transactions from time to time in such amounts as management deems appropriate through June 30, 2007. ITEM 6. EXHIBITS Exhibit No. (10) Material Contracts 10.1 Summary of Material Executive Employee Relocation Package (Item 1.01 to Con-way's Report on Form 8-K filed on August 25, 2006.*#) 10.2 Con-way Inc. 2006 Equity and Incentive Plan (2006 Amendment) (Exhibit 99.1 to Con-way's Report on Form 8-K filed on September 29, 2006.*#) 10.3 Amended Form of Stock Option Agreement (Exhibit 99.2 to Con-way's Report on Form 8-K filed on September 29, 2006.*#) 1.4 Summary of Revisions to Incentive Compensation and Value Management Plan Awards (Item 1.01 (c) to Con-way's Report on Form 8-K filed on September 29, 2006.*#) 1.5 Summary of Executive Stock Ownership Guidelines (Item 1.01 (d) to Con-way's Report on Form 8-K filed on September 29, 2006.*#) 1.6 Amendment No. 1 dated September 30, 2006 to the $400 million Credit Agreement dated March 11, 2005 (Exhibit 99.3 to Con-way's Report on Form 8-K filed on September 29, 2006.*) 1.7 Summary of Changes to Con-way's Pension and Retirement Benefits Programs (Exhibit 99.1 to Con-way's Report on Form 8-K filed on October 17, 2006.*) (31) Certification of Officers pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (32) Certification of Officers pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * Previously filed with the Securities and Exchange Commission and incorporated herein by reference. # Designates a contract or compensation plan for Management or Directors. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Con-way Inc. (Registrant) November 8, 2006 /s/ Kevin C. Schick ---------------------- Kevin C. Schick Senior Vice President and Chief Financial Officer