UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission File Number 1-5046

 

Con-way Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(650) 378-5200

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act:
87/8% Notes Due 2010
6.70% Senior Debentures due 2034
(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Aggregate market value of voting stock held by persons other than Directors, Officers and those shareholders holding more than 5% of the outstanding voting stock, based upon the closing price per share on June 30, 2006: $2,204,814,815

 

Number of shares of Common Stock outstanding as of January 31, 2007: 46,549,567

 

DOCUMENTS INCORPORATED BY REFERENCE
Part III

 

Proxy Statement for Con-way’s Annual Meeting of Shareholders to be held on April 17, 2007 (only those portions referenced specifically herein are incorporated in this Form 10-K).

 

 

Con-way Inc.
FORM 10-K
Year Ended December 31, 2006

 

 

INDEX

 

 

 

Con-way Inc.

 

FORM 10-K

Year Ended December 31, 2006

 

Overview

 

Con-way Inc. and its subsidiaries (“Con-way” or “the Company”) provide transportation, logistics and supply-chain management services for a wide range of manufacturing, industrial and retail customers. Con-way’s principal component companies operate in regional and transcontinental less-than-truckload and full-truckload freight transportation, truckload brokerage, global logistics management, and trailer manufacturing.

 

Con-way Inc. was incorporated in Delaware in 1958. In April 2006, shareholders approved management’s proposal to change the Company’s name from “CNF Inc.” to “Con-way 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. Con-way’s re-branding initiative is more fully discussed in Note 12, “Segment Reporting,” of Item 8, “Financial Statements and Supplementary Data.”

 

Information Available on Website

 

Con-way makes available, free of charge, on its website at “www.con-way.com,” under the headings “Investor Relations/Annual Report, Proxy and Other SEC Filings,” copies of its annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K, and any amendments to those reports, in each case as soon as reasonably practicable after such reports are electronically filed with or furnished to the Securities and Exchange Commission.

 

In addition, Con-way makes available, free of charge, on its website at “www.con-way.com,” under the headings “Investor Relations/Corporate Governance,” current copies of the following documents: (1) the charters of the Audit, Compensation, and Director Affairs Committees of its Board of Directors; (2) its Corporate Governance Guidelines; (3) its Code of Ethics for Chief Executive and Senior Financial Officers; (4) its Code of Business Conduct and Ethics for Directors; and (5) its Code of Ethics for employees. Copies of these documents are also available in print to shareholders upon request, addressed to the Corporate Secretary at 2855 Campus Drive, Suite 300, San Mateo, California 94403.

 

None of the information on Con-way’s website shall be deemed to be a part of this report.

 

Regulatory Certifications

 

In 2006, Con-way filed the written affirmations and Chief Executive Officer certifications required by Section 303A.12(a) of the NYSE Listing Manual and Section 302 of the Sarbanes-Oxley Act.

 

Reporting Segments

 

For financial reporting purposes, Con-way Inc. is divided into three reporting segments: Con-way Freight and Transportation, Menlo Worldwide, and Con-way Other. For financial information concerning Con-way’s geographic and reporting segment operating results, refer to Note 12, “Segment Reporting,” of Item 8, “Financial Statements and Supplementary Data.”

 

Con-way Freight and Transportation

 

Con-way Freight and Transportation includes the combined operating results of Con-way Freight and Con-way Transportation. Collectively, Con-way Freight and Transportation primarily provides regional next-day, second-day, and transcontinental freight trucking throughout the U.S., and in Canada, Puerto Rico, and Mexico.

 

Con-way Freight

 

Con-way Freight consists of regional less-than-truckload (“LTL”) motor carriers that operate a combined network of freight service centers to provide market coverage in North America. The regional carriers provide day-definite delivery service to manufacturing, industrial, and retail customers, and consist of Con-way Freight-Western, which serves 13 Western states, including Hawaii and Alaska; Con-way Freight-Central, which serves 25 central and eastern states; Con-way Freight-Southern, which serves 12 southeastern states, the District of Columbia and Puerto Rico; Con-way Canada, which serves 9 Canadian provinces; and Con-way Mexico, which began operations in July 2005 to facilitate the movement of cross-border freight as well as freight between points in Mexico. In 2006, Con-way Freight accounted for 97.3% of Con-way Freight and Transportation’s revenue.

 

Typically, LTL carriers transport shipments weighing between 100 and 15,000 pounds from multiple shippers utilizing a network of freight service centers combined with a fleet of linehaul and pickup-and-delivery tractors and trailers. Freight is picked up from customers and consolidated for shipment at the originating service center. The freight is then loaded into trailers and transferred to the destination service center providing service to the delivery area. From the destination service center, the freight is delivered to the customer.

 

In September 2006, Con-way Freight partnered with APL Logistics to introduce a time-definite less-than-container-load cargo service that provides overseas freight transportation to customers seeking port-to-door delivery from originating ports in Asia to destinations in the U.S. This service was offered in response to customer demand for a cost-effective alternative to more-expensive air freight services.

 

Con-way Transportation

 

Con-way Transportation’s business units consist of Con-way Truckload, an asset-based regional and transcontinental full-truckload carrier, Con-way Brokerage, a provider of brokerage services for domestic truckload and intermodal shipments, and Road Systems, a trailer manufacturer. Con-way Truckload serves Con-way Freight by providing linehaul service on full loads of LTL shipments moving in transcontinental lanes and also offers regional and transcontinental services to other customers. The formation of Con-way Truckload was intended to reduce linehaul expense and protect service with inter-company operations that operate in conjunction with current truckload vendors. Con-way Truckload utilizes Con-way Freight and Transportation’s existing infrastructure and administrative support services to minimize the capital employed. Road Systems primarily manufactures and refurbishes trailers for Con-way Freight and Transportation.

 

Under the new master-brand initiative, the Company’s expediting and brokerage operations were made part of Con-way Transportation and were renamed, collectively, Con-way Expedite and Brokerage. The expedited-shipping portion of that business was sold in July 2006 and the remaining truckload-brokerage operation was merged into Con-way Truckload. As more fully discussed below under “Menlo Worldwide — Logistics,” the truckload-brokerage operation was combined with Menlo Worldwide Logistics effective in January 2007.

 

Competition

 

The trucking and truck-brokerage industry segments are intensely competitive. Principal competitors of Con-way Freight and Transportation include global, integrated transportation service providers and regional and national LTL and truckload companies. Competition in the trucking industry segment is based on freight rates, service, reliability, transit times and scope of operations.

 

Menlo Worldwide

 

Menlo Worldwide consists of the operating results of Menlo Worldwide Logistics (“Logistics”) and a proportionate share of the net income from Vector SCM, LLC (“Vector”), a joint venture with General Motors

(“GM”). Prior to GM’s purchase of the membership interest of Menlo Worldwide, LLC (“MW”) in Vector on June 23, 2006, Vector served as the lead logistics manager for GM.

 

Menlo Worldwide — Logistics

 

The global supply-chain and logistics-services market has grown significantly since the formation of Logistics in 1990, based on the complexity of customers’ supply chains and the need for innovative solutions. The outsourcing of distribution and other non-core functions has become more commonplace as businesses increasingly evaluate overall logistics costs. The ability to access information through computer networks increases the value of capturing real-time logistics information to track inventories, shipments, and deliveries. Logistics specializes in developing and managing complex regional, national and global supply chains. The term “supply chain” generally refers to a strategically designed process that directs the movement of materials and related information from the acquisition of raw materials to the delivery of products to the end-user. Logistics’ supply-chain management offerings are primarily related to transportation-management and contract-warehousing services.

 

Transportation management refers to the management of asset-based carriers and third-party transportation providers for customers’ inbound and outbound supply-chain needs through the use of state-of-the-art logistics management systems to consolidate, book and track shipments. Contract warehousing refers to the optimization of warehouse operations for customers using technology and warehouse-management systems to reduce inventory carrying costs and supply-chain cycle times. For several customers, contract-warehousing operations include light assembly or kitting operations. Logistics’ ability to link these systems with its customers’ internal enterprise resource-planning systems is intended to provide customers with improved visibility to their supply chains. Compensation from Logistics’ customers takes different forms, including cost-plus, gain-sharing, transactional, fixed-dollar, and consulting-fee arrangements.

 

Logistics provides its services using a customer- or project-based approach when the supply-chain solution requires customer-specific transportation management, single-client warehouses, and/or single-customer technological solutions. However, Logistics increasingly utilizes a shared-resource, process-based approach that leverages a centralized transportation-management group, uses multi-client warehouses, and creates technological solutions to benefit multiple customers. This approach is expected to leverage Logistics’ resources to provide scaleable services to a growing number of middle-market customers. Logistics began growing its shared-resource, process-based approach in 2005, when it segmented its business based on customer type. The industry-focused groups leverage the capabilities of personnel, systems and solutions throughout the organization to give customers expertise in specific automotive, high-tech, and consumer-products sectors.

 

Although Logistics’ client base includes a growing number of middle-market companies, Logistics’ primary customers are Fortune 200 businesses. Four customers collectively accounted for 47.8% of the revenue reported for the Logistics reporting segment in 2006, and each had a Standard & Poor’s investment-grade credit rating. In 2006, Logistics’ largest customer accounted for 5.3% of the consolidated revenue of Con-way. The loss of significant revenue from any of Logistics’ major customers by termination of the customer relationship for any reason, including the business failure of the customer, may have a material adverse effect on Con-way’s financial condition, results of operations, and cash flows.

 

Integration of Former Con-way Transportation Businesses

 

In recent years, Logistics has integrated into its operations two supply-chain management businesses that were previously reported in the Con-way Freight and Transportation reporting segment. In the second quarter of 2005, Logistics integrated the former Con-Way Logistics business and, in January 2007, Logistics integrated the truckload-brokerage business.

 

The integration of Con-Way Logistics was intended to provide an enterprise solution offering for Logistics’ customers that want to use Con-way Freight as a primary transportation provider in addition to those customers that want a vendor-neutral transportation solution. The integration also expanded Con-Way Logistics’ multi-client warehousing service model to Logistics’ larger warehouse network. Effective in January 2007, Logistics integrated into its operations the truckload-brokerage business. The move is expected to leverage Logistics’ significant procurement of purchased transportation to improve both the value to customers and to improve the margin earned

on the services provided. The integration of the truckload-brokerage business is also expected to expand logistics-services opportunities through access to truckload-brokerage customers and to leverage the shared expertise of the logistics and truckload-brokerage professionals.

 

Competition

 

The supply-chain management and logistics-services industry segment is intensely competitive. Competition for larger projects is generally based on the ability to rapidly implement technology-based transportation and logistics solutions, while competition for projects with middle-market customers is more influenced by price. Competitors in the logistics segment are numerous and include domestic and foreign logistics companies, the logistics arms of integrated transportation companies, and contract manufacturers. However, Logistics primarily competes against a limited number of major competitors that have resources sufficient to provide services under large logistics contracts.

 

Menlo Worldwide — Vector

 

Vector was a joint venture formed with 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. Although MW owned a majority interest in Vector, MW’s proportionate share of Vector’s net income has been reported as an equity-method investment based on GM’s ability to control certain operating decisions.

 

GM Exercise of Call Right

 

On June 23, 2006, GM exercised its right to purchase MW’s membership interest in Vector (“Call Right”). On December 11, 2006, an independent third-party advisor established a fair value for Vector, and accordingly, Con-way recognized a $41.0 million sale-related gain in December 2006, as more fully discussed in Note 3, “Investment in Unconsolidated Joint Venture,” of Item 8, “Financial Statements and Supplementary Data.” Following exercise of the Call Right, Menlo Worldwide Logistics assumed all contracts for which Vector was providing services to non-GM entities.

 

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, including results from corporate re-insurance activities and operating costs on corporate properties.

 

Discontinued Operations

 

Discontinued operations affecting the periods presented in Con-way’s consolidated financial information reported in Item 8, “Financial Statements and Supplementary Data,” relate to (1) the closure of the freight forwarding business known as Con-way Forwarding in June 2006, (2) the sale of Menlo Worldwide Forwarding, Inc. and its subsidiaries and Menlo Worldwide Expedite!, Inc. (collectively “MWF”) in December 2004, (3) the shut-down of Emery Worldwide Airlines, Inc. (“EWA”) in November 2000, and (4) the spin-off of Consolidated Freightways Corporation (“CFC”) in 1996.

 

For more information, refer to Note 2, “Discontinued Operations,” and Note 11, “Commitments and Contingencies,” of Item 8, “Financial Statements and Supplementary Data.”

 

General

 

Employees

 

At December 31, 2006, Con-way had approximately 21,800 regular full-time employees. The approximate number of regular full-time employees by segment was as follows: Con-way Freight and Transportation, 18,170; Menlo Worldwide Logistics, 2,720; Con-way Other, 910. The 910 employees included in the Con-way Other segment consist primarily of executive, technology, and administrative positions that support Con-way’s operating subsidiaries.

 

Cyclicality and Seasonality

 

Con-way’s operations are affected, in large part, by conditions in the cyclical markets of its customers and on the U.S. and global economies, as more fully discussed in Item 1A, “Risk Factors.”

 

Price and Availability of Fuel

 

Con-way is exposed to the effects of changes in the availability and price of diesel fuel, as more fully discussed in Item 1A, “Risk Factors.”

 

Regulation

 

Ground Transportation

 

The motor-carrier industry is subject to federal regulation by the Federal Motor Carrier Safety Administration (“FMCSA”), the Pipeline and Hazardous Materials Safety Agency (“PHMSA”), and the Surface Transportation Board (“STB”), which are units of the U.S. Department of Transportation (“DOT”). The FMCSA promulgates and enforces comprehensive trucking safety regulations and performs certain functions relating to such matters as motor-carrier registration, cargo and liability insurance, extension of credit to motor-carrier customers, and leasing of equipment by motor carriers from owner-operators. The PHMSA promulgates and enforces regulations regarding the transportation of hazardous materials. The STB has authority to resolve certain types of pricing disputes and authorize certain types of intercarrier agreements.

 

At the state level, federal preemption of economic regulation does not prevent the states from regulating motor-vehicle safety on their highways. In addition, federal law allows all states to impose insurance requirements on motor carriers conducting business within their borders, and empowers most states to require motor carriers conducting interstate operations through their territory to make annual filings verifying that they hold appropriate registrations from FMCSA. Motor carriers also must pay state fuel taxes and vehicle registration fees, which normally are apportioned on the basis of mileage operated in each state.

 

In April 2003, the FMCSA issued a final rule to change the regulations governing hours of service (“HOS”) for commercial truck drivers. The rule increased the total consecutive off-duty hours a driver must take prior to driving in interstate commerce and reduced the total daily consecutive driving and on-duty hours allowed. In July 2004, the United States Court of Appeals for the District of Columbia voided the HOS rules that were issued by the FMCSA. However, the United States Congress extended the existing HOS rules until September 2005. In October 2005, a final rule issued by FMCSA became effective. The new rule changed the way that drivers utilizing sleeper berths may split their off-duty time, raising concern that the efficiency of sleeper-team truckload operations similar to those utilized by Con-way Truckload may be adversely affected.

 

The same advocacy groups that challenged the 2003 FMCSA HOS rules, along with the International Brotherhood of Teamsters (“IBT”) and the Owner Operators Independent Driver’s Association (“OOIDA”), have mounted another challenge to the rules that became effective in October 2005. Given the uncertainty in the status of the HOS rules, Con-way cannot predict whether the current rules will remain intact or whether the rules as finally adopted will materially affect its operations.

 

Environmental

 

Con-way is subject to laws and regulations that (1) govern activities or operations that may have adverse environmental effects such as discharges to air and water, as well as handling and disposal practices for solid and hazardous waste, and (2) impose liability for the costs of cleaning up, and certain damages resulting from sites of past spills, disposals, or other releases of hazardous materials. Environmental liabilities relating to Con-way’s properties may be imposed regardless of whether Con-way leases or owns the properties in question and regardless of whether such environmental conditions were created by Con-way or by a prior owner or tenant, and also may be imposed with respect to properties that Con-way may have owned or leased in the past. Con-way has provided for its estimate of remediation costs at these sites.

 

Con-way’s operations involve the storage, handling, and use of diesel fuel and other hazardous substances. In particular, Con-way is subject to environmental laws and regulations dealing with fuel storage tanks and the transportation of hazardous materials.

 

Homeland Security

 

Con-way is subject to compliance with cargo security and transportation regulations issued by the Transportation Security Administration (“TSA”) and by the Department of Homeland Security (“DHS”), including regulation by the Bureau of Customs and Border Protection (“CBP”). Con-way believes that it will be able to comply with potential TSA, DHS, and CBP rules, which will require additional security measures affecting the transportation of both domestic and international shipments.

 

Con-way’s regional carriers, as well as certain other subsidiaries, are approved by the CBP to participate in the voluntary Customs-Trade Partnership Against Terrorism program (“C-TPAT”). The C-TPAT program was designed in 2002 to provide a process to facilitate the efficient release of goods and provide resolution of any outstanding issues affecting CBP processing of cross-border shipments. As participants of C-TPAT, these subsidiaries have developed security measures that continue to evolve along with the C-TPAT program requirements. These subsidiary C-TPAT security plans have been reviewed and certified by the CBP.

 

C-TPAT does not provide a sector category for third-party logistics companies; as a result, Logistics cannot obtain C-TPAT certification. To address this issue, Logistics has voluntarily adopted C-TPAT “Importer” requirements into its security plan, which incorporates regulatory DHS requirements, and also voluntarily participates in non-regulatory DHS programs that secure customer and international supply chains against terrorism and theft.

 

Menlo Worldwide Logistics Government Services, LLC, a subsidiary of Menlo Logistics, Inc., has been approved by TSA as an Indirect Air Carrier (“IAC”), and has developed security measures that have been reviewed and certified by the TSA. TSA is expected to release new IAC rules in the near future. Con-way cannot predict the impact the new rules might have on its IAC operations but does not believe that the rules as finally adopted will materially affect its operations.

 

Business Interruption

 

Con-way and its subsidiaries rely on a centralized shared-service facility for the performance of shared administrative and technology services in the conduct of their businesses. Con-way’s computer facilities and its administrative and technology employees are located at the shared-service facility. Although Con-way maintains backup systems and has disaster-recovery processes and procedures in place, a sustained interruption in the operation of these facilities, whether due to terrorist activities, earthquakes, floods or otherwise, could have a material adverse effect on Con-way’s financial condition, results of operations, and cash flows.

 

Customer Concentration

 

Menlo Worldwide Logistics and many of its competitors in the third-party logistics segments are subject to risk related to customer concentration because of the relative importance of their largest customers and the increased ability of those customers to influence pricing and other contract terms. Although Logistics continues to broaden and diversify its customer base, a significant portion of its revenue and operating results are derived from a relatively small number of customers, as more fully discussed in Item 1, “Business.” Consequently, a significant loss of business from, or adverse performance by, any of Logistics’ major customers, may have a material adverse effect on Con-way’s financial condition, results of operations, and cash flows. Similarly, the renegotiation of major customer contracts may also have an adverse effect on Con-way.

 

Cyclicality

 

Con-way’s operating results are affected, in large part, by conditions in the cyclical markets of its customers and on the U.S. and global economies. While economic conditions affect most companies, the transportation industry is cyclical and susceptible to trends in economic activity. When individuals and companies purchase and

produce fewer goods, Con-way’s businesses transport fewer goods. In addition, Con-way Freight and Transportation has a relatively high fixed-cost structure, which is difficult to adjust to match shifting volume levels. Accordingly, any sustained weakness in demand or continued downturn or uncertainty in the economy generally would have an adverse effect on Con-way’s businesses.

 

Employees

 

The workforce of Con-way and its subsidiaries is not affiliated with labor unions. Con-way believes that the non-unionized operations of its subsidiaries have advantages over comparable unionized competitors in providing reliable and cost-competitive customer services, including greater efficiency and flexibility. There can be no assurance that Con-way’s subsidiaries will be able to maintain their non-unionized status.

 

Con-way hires drivers primarily for its Con-way Freight and Transportation business segment. There is significant competition for qualified drivers in the transportation industry. As a result of driver shortages, Con-way Freight and Transportation may be required to increase driver compensation, utilize lower-quality drivers or face difficulty meeting customer demands, all of which could adversely affect Con-way’s results of operations.

 

Employee Benefit Costs

 

Con-way maintains health-care plans and defined benefit pension plans, and provides certain other benefits to its employees. In recent years, health-care costs have risen dramatically. The combination of lower interest rates and weak returns on plan assets may cause increases in the expense of, and funding requirements for, Con-way’s defined benefit pension plans. As more fully discussed in Item 7, “Management’s Discussion and Analysis,” Con-way amended its retirement benefit plans in 2006 and the resulting plan changes are generally expected to decrease the future financial-statement effect associated with the defined benefit pension plans. Despite the changes to the retirement benefit plans, Con-way remains subject to volatility associated with interest rates, returns on plan assets, and funding requirements. As a result, Con-way is unable to predict the effect of continuing to provide these benefits to employees on Con-way’s financial condition, results of operations, and cash flows.

 

Government Regulation

 

Con-way is subject to compliance with many laws and regulations that apply to its business activities. These include regulations relating to hours of service for its drivers, and cargo security and transportation regulations issued by the Department of Homeland Security and the Department of Transportation. Con-way is not able to accurately predict how new governmental laws and regulations, or changes to existing laws and regulations, will affect the transportation industry generally, or Con-way in particular. Although government regulation that affects Con-way and its competitors may simply result in higher costs that can be passed to customers with no adverse consequences, there can be no assurance that this will be the case. As a result, Con-way believes that any additional security and other measures that may be required by future laws and regulations or changes to existing laws and regulations could result in additional costs and could have an adverse effect on its ability to serve customers and on its financial condition, results of operations, and cash flows.

 

Capital Intensity

 

Con-way’s primary business is capital-intensive. Con-way Freight and Transportation makes significant investments in revenue equipment and freight service centers. The amount and timing of capital investments depend on various factors, including anticipated volume levels, and the price and availability of appropriate-use property for service centers and newly manufactured tractors and diesel engines, which are subject to restrictive Environmental Protection Agency engine-design requirements. If anticipated service-center and fleet requirements differ materially from actual requirements, Con-way Freight and Transportation may have too much or too little capacity. Con-way’s investments in revenue equipment and freight service centers depend on its ability to generate cash flow from operations and its access to debt and equity capital markets. A decline in the availability of these funding sources could adversely affect Con-way’s reinvestment activities.

 

Price and Availability of 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 could have a material adverse effect on Con-way. Con-way Freight and Transportation is subject to the risk of price fluctuations. Like other LTL carriers, Con-way Freight assesses many of its customers with a fuel surcharge. The fuel surcharge is a part of Con-way Freight’s overall rate structure for customers and is intended to compensate Con-way Freight for the adverse effects of higher fuel costs. 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. 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, or the effect that changes in fuel surcharges may have on Con-way Freight’s overall rate structure. Con-way Freight’s operating income may be adversely affected by a decline in fuel prices as lower fuel surcharges would reduce its 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.

 

None.

 

Con-way believes that its facilities are suitable and adequate, that they are being appropriately utilized, and that they have sufficient capacity to meet current operational needs. Management continuously reviews anticipated requirements for facilities and may acquire additional facilities and/or dispose of existing facilities as appropriate.

 

Con-way Freight and Transportation

 

At December 31, 2006, Con-way Freight operated 346 freight service centers, of which 155 were owned and 191 were leased. The service centers, which are strategically located to cover the geographic areas served by Con-way Freight, represent physical buildings and real property with dock, office, and/or shop space. These facilities do not include meet-and-turn points, which generally represent small owned or leased real property with no physical structures. The total number of trucks, tractors, and trailers utilized by Con-way Freight at December 31, 2006 was approximately 33,800.

 

At December 31, 2006, Con-way Truckload operated approximately 1,335 tractors and trailers. Based on projected LTL and truckload volume levels and driver availability, Con-way Truckload in 2007 intends to transfer to Con-way Freight approximately 81 new tractors that have not yet been placed in operation due to driver shortages.

 

Road Systems owns and operates a manufacturing facility in Searcy, Arkansas.

 

Menlo Worldwide Logistics

 

At December 31, 2006, Logistics operated 56 warehouses in North America, of which 41 were leased by Logistics and 15 were leased or owned by clients of Logistics. Outside of North America, Logistics operated an additional 29 warehouses, of which 17 were leased by Logistics and 12 were leased or owned by clients.

 

At December 31, 2006, Logistics owned and operated approximately 69 trucks, tractors, and trailers.

 

Con-way Other

 

Principal properties of the Con-way Other segment included Con-way’s leased executive offices in San Mateo, California, and its owned shared-services center in Portland, Oregon.

 

Certain legal proceedings of Con-way are also discussed in Note 2, “Discontinued Operations,” and Note 11, “Commitments and Contingencies,” of Item 8, “Financial Statements and Supplementary Data.”

 

In 2003, prior to the sale of MWF to United Parcel Service, Inc. (“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 or whether the SEC will impose fines or other penalties directly on Con-way as of result of the actions of Emery Transnational.

 

Con-way did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year covered by this Annual Report.

 

The Executive Officers of Con-way, their ages at December 31, 2006, and their applicable business experience are as follows:

 

Douglas W. Stotlar, 46, President and Chief Executive Officer of Con-way. Mr. Stotlar was named to his current position in April 2005. He previously served as President and Chief Executive Officer of Con-way Freight and Transportation and Senior Vice President of Con-way, a position he held since December 2004. Prior to this, he served as Executive Vice President and Chief Operating Officer of Con-way Freight and Transportation, a position he held since June 2002. From 1999 to 2002, he was Executive Vice President of Operations for Con-way Freight and Transportation. Prior to joining Con-way Freight and Transportation’s corporate office, Mr. Stotlar served as Vice President and General Manager of the former Con-Way NOW. Mr. Stotlar joined the Con-way organization in 1985 as a Freight Operations Supervisor for Con-way Freight-Central. He subsequently advanced to management posts in Columbus, Ohio, and Fort Wayne, Indiana, where he was named Regional Manager. Mr. Stotlar earned his bachelor’s degree in transportation and logistics from Ohio State University.

 

Kevin C. Schick, 55, Senior Vice President and Chief Financial Officer of Con-way. Mr. Schick was named to his current position in March 2005. He previously served as Vice President and Controller of Con-way Freight and Transportation, a position he held since 1989. Mr. Schick joined the Con-way organization in 1983 as Controller for Con-way Freight-Central. Mr. Schick earned his bachelor’s degree in Finance from Marquette University and a master’s degree in business administration from Northwestern University.

 

Jennifer W. Pileggi, 42, Senior Vice President, General Counsel and Corporate Secretary of Con-way. Ms. Pileggi was named to her current position in December 2004. Ms. Pileggi joined Menlo Worldwide Logistics in 1996 as Corporate Counsel and was promoted to Vice President in 1999. She was promoted to Vice President and Corporate Counsel of Menlo Worldwide in 2003. Ms. Pileggi is a graduate of Yale University and New York University School of Law, where she achieved a juris doctorate degree. Ms. Pileggi is a member of the American Bar Association and the California State Bar Association.

 

David S. McClimon, 51, President of Con-way Freight, and Senior Vice President of Con-way. Mr. McClimon was named to his current position in June 2005. He previously served as President and Chief Executive Officer for two of Con-way’s regional trucking companies: Con-way Freight-Central from 2002 to 2005, and Con-way Freight-Western from 2000 to 2002. He was Vice President of Sales for Con-way Freight-Central from 1997 to 2000. Prior to this, he was Vice President of National Sales for Con-way Freight, from 1993 to 1997. Mr. McClimon joined the Con-way organization in 1983 as a day-one employee of Con-way Freight-Central and subsequently was promoted to a variety of sales and operations positions. Mr. McClimon earned his bachelor’s degree in marketing from Miami University in Ohio.

 

John G. Labrie, 40, President of Con-way Transportation and Senior Vice President of Con-way. Mr. Labrie was promoted in February 2007 to Senior Vice President of Con-way, in charge of Strategy and Enterprise Operations. Mr. Labrie was named President of Con-way Transportation in June 2005. He previously served as Executive Vice President of Operations for Con-way Freight, a position he held since January 2005. Prior to this, he served as President and Chief Executive Officer for Con-way Freight-Western, a position he held since June 2002. From May 1998 to June 2002, he was Vice President of Operations for Con-way Freight-Western. He joined the Con-way organization in 1990 as a sales account manager. Mr. Labrie earned his bachelor’s degree in Finance from Central Michigan University. He holds a master’s degree in business administration from Indiana Wesleyan University.

 

Robert L. Bianco Jr., 42, President of Menlo Worldwide and Senior Vice President of Con-way. Mr. Bianco was promoted in February 2007 to Senior Vice President of Con-way and was named President of Menlo Worldwide in June 2005. He previously served as President of Menlo Worldwide Logistics, a position he held since December 2001. He joined the Con-way organization in 1989 as a management trainee and joined Menlo in 1992 as a logistics manager. He subsequently advanced to Vice President of Operations for Menlo Worldwide Logistics in 1997. He is a graduate of the University of California at Santa Barbara and earned a master’s degree from the University of San Francisco.

 

Jackie Barretta, 45, Vice President and Chief Information Officer of Con-way. Ms. Barretta was named to her current position in February 2005. She previously served as Vice President of Information Services for Con-way Freight and Transportation, a position she held since August 2000. Prior to this, she served as Director of Information Services, a position she held since 1997. She joined Con-way as a systems analyst in 1996. Ms. Barretta earned her bachelor’s degree in Computer Science from the University of North Carolina.

 

Mark C. Thickpenny, 54, Vice President and Treasurer of Con-way. Mr. Thickpenny joined Con-way in 1995 as Treasury Manager. In 1997, he was named Director and Assistant Treasurer, and in 2000 was promoted to Vice President and Treasurer. Mr. Thickpenny holds a bachelor’s degree in business administration from the University of Notre Dame and a master’s degree in business administration from the University of Chicago.

 

Kevin S. Coel, 48, Vice President and Corporate Controller of Con-way. Mr. Coel joined Con-way in 1990 as Con-way’s Corporate Accounting Manager. In 2000, he was named Corporate Controller, and in 2002, was promoted to Vice President. Mr. Coel holds a bachelor’s degree in economics from the University of California at Davis and a master’s degree in business administration from San Jose State University. Mr. Coel is also a member of the American Institute of CPAs.

 

Con-way’s common stock is listed for trading on the New York Stock Exchange (“NYSE”) under the symbol “CNW.”

 

See Note 14, “Quarterly Financial Data,” of Item 8, “Financial Statements and Supplementary Data” for the range of common stock prices as reported on the NYSE and common stock dividends paid for each of the quarters in 2006 and 2005. At January 31, 2007, Con-way had 7,065 common shareholders of record.

 

The following table provides a summary of share repurchases made by Con-way during the quarter ended December 31, 2006:

 

 

 

 

The following performance graph compares Con-way’s stockholder return (assuming reinvestment of dividends) for the fiscal year-ends from 2001 through 2006, with the S&P Midcap 400 and the Dow Jones Transportation Average.

 

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL SHAREHOLDER RETURN*
Con-way Inc., S&P Midcap 400 Index, Dow Jones Transportation Average

 

 

 

 

 

The following table includes selected financial and operating data for Con-way as of and for the five years ended December 31, 2006. This information should be read in conjunction with Item 7, “Management’s Discussion and Analysis,” and Item 8, “Financial Statements and Supplementary Data.”

 

Con-way Inc.
Five-Year Financial Summary

 

 

 

Accounting events:

 

 

Unusual income:

 

 

(b) The comparability of Con-way’s tax provision and net income was affected by the following:

 

 

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 financial condition, results of operations, and cash flows, including a discussion and analysis of the following:

 

 

Overview of Business

 

The Company 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 has been accounted for as an equity-method investment.

 

Con-way’s operating-unit results depend on the number, weight and distance 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 circumstances. Con-way Freight and Transportation primarily transports shipments through a freight service center network while Menlo Worldwide manages the logistics functions of its customers and primarily utilizes third-party transportation providers for the movement of customer shipments.

 

Organizational and Accounting Events Affecting Financial Reporting

 

Organization

 

In June 2006, Con-way closed the operations of its domestic air freight forwarding business known as Con-way Forwarding, and in 2004, Con-way and Menlo Worldwide LLC (“MW”) sold MWF to UPS. 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.

 

In December 2006, Con-way recognized the sale to GM of MW’s membership interest in Vector. The sale of Vector did not qualify as a discontinued operation due to its classification as an equity-method investment, and accordingly, the $41.0 million sale-related gain is reported in net income from continuing operations in the Menlo Worldwide reporting segment. In July 2006, Con-way sold the expedited-shipping portion of the former Con-way Expedite and Brokerage business. As a sale of assets, the $6.2 million gain recognized from the sale is reported in net income from continuing operations in the Con-way Freight and Transportation reporting segment.

 

Change in Accounting Policy for Tires

 

During the fourth quarter of 2006, Con-way changed its accounting policy for tires. Prior to the change, the cost of original and replacement tires mounted on new and existing equipment was reported in current assets as a prepaid expense and amortized based on estimated usage. Under the new policy, the cost of replacement tires are expensed at the time those tires are placed into service, as is the case with other repairs and maintenance costs. The cost of tires on new revenue equipment will be capitalized and depreciated over the estimated useful life of the related equipment. Con-way believes that this new policy is preferable under the circumstances because it provides a more precise and less subjective method for recognizing expenses related to tires that is consistent with industry practice. Under SFAS 154, “Accounting Changes and Error Corrections,” Con-way is required to report a change in accounting policy by retrospectively applying the new policy to all prior periods presented, unless it is impractical to determine the prior-period effect. Accordingly, Con-way has adjusted its previously reported financial information for all periods presented. The effect of this accounting policy change had an immaterial effect in 2006, but reduced net income from continuing operations by $1.3 million ($0.02 per diluted share) in 2005 and $2.0 million ($0.03 per diluted share) in 2004. The accounting policy change also affected Con-way’s consolidated balance sheets in the periods presented by increasing reported amounts for revenue equipment and reducing amounts for prepaid expenses and retained earnings.

 

New Accounting Standards

 

Effective on January 1, 2006, Con-way adopted the recognition and related disclosure provisions of SFAS No. 123R, “Share-Based Payment”, a revision of SFAS 123, “Accounting for Stock-Based Compensation” that supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and its related implementation guidance. SFAS 123R 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 over the period during which an employee is required to provide service in exchange for the award. Con-way adopted SFAS 123R using the modified prospective transition method, which requires the recognition of compensation expense in 2006, as determined under SFAS 123R, but does not result in the retrospective application of

the recognition provisions of SFAS 123R to prior-period financial statements. As a result of adopting SFAS 123R, Con-way in 2006 recognized $5.8 million of share-based compensation expense ($0.07 per diluted share) that would not have been recognized had Con-way continued to account for share-based compensation under APB 25.

 

Effective on December 31, 2006, Con-way adopted the recognition and related disclosure provisions of SFAS 158, “Employers’ Accounting for Defined Benefit and Other Postretirement Plans — an amendment of SFAS 87, 88, 106, and 132R.” Under the recognition provisions of SFAS 158, Con-way is required to recognize the overfunded or underfunded status of its defined benefit pension and postretirement plans as an asset or liability, respectively, in its balance sheet at December 31, 2006. SFAS 158 gives recognition to the effect of changes in the funded status on the plan liability and on shareholders’ equity, but when compared to prior accounting standards, SFAS 158 generally does not result in changes to recognized periodic benefits expense, except in certain conditions. Since retrospective adoption of SFAS 158 is prohibited, different recognition provisions have been applied in determining the plan-related amounts reported in Con-way’s consolidated balance sheets at December 31, 2006 and 2005. In connection with the adoption of SFAS 158 effective on December 31, 2006, Con-way increased reported amounts for its employee benefits liability by $155.3 million and reduced shareholders’ equity by $95.5 million (net of $61.1 million of deferred tax benefits).

 

Results of Operations

 

The table below summarizes Con-way’s consolidated operating results for continuing and discontinued operations:

 

 

 

 

Con-way’s net income from continuing operations (after preferred stock dividends) grew 19.1% to $265.2 million in 2006 from $222.6 million in 2005 due to gains of $47.3 million related to the sale of MW’s membership interest in Vector and to the sale of Con-way Expedite. In 2005, net income from continuing operations increased 55.2% from $143.4 million in 2004 due to improved operating results from all Con-way reporting segments.

 

Con-way’s diluted earnings per share from continuing operations increased 27.9% to $5.09 in 2006 due to higher net income and 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 average diluted shares outstanding declined to 52.3 million shares in 2006 from 56.2 million shares in 2005. In 2005, Con-way’s diluted earnings per share from continuing operations increased 53.7% to $3.98 from $2.59, primarily reflecting higher net income.

 

In 2006, net income from continuing operations was partially offset by losses from discontinued operations, which primarily reflect a $4.2 million net loss related to the closure of Con-way Forwarding. For periods prior to its closure in June 2006, discontinued operations in all periods presented include operating losses reported by Con-way Forwarding. In 2005, discontinued operations also include a $6.2 million net loss that was primarily related to the disposal of MWF and to the shut-down of EWA. The resulting net income applicable to common shareholders increased to $259.0 million ($4.98 per diluted share) in 2006 from $214.0 million ($3.83 per diluted share) in 2005.

In 2004, net income from continuing operations was offset by a $269.5 million net loss ($4.77 per diluted share) from discontinued operations, which primarily reflects the loss from the disposition of MWF. The resulting net loss applicable to common shareholders in 2004 was $126.1 million ($2.18 per diluted share).

 

Continuing Operations

 

 

The overview below provides a high-level summary of Con-way’s results from continuing operations for 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.

 

Overview — 2006 Compared to 2005

 

In 2006, Con-way’s net income from continuing operations increased 19.1% to $265.2 million in 2006 from $222.6 million in 2005 due primarily to higher consolidated operating income, a decline in non-operating expenses, and a lower effective tax rate. Consolidated operating income benefited from revenue growth and gains from the sale of Vector and Con-way Expedite, but was adversely affected by lower operating margins (excluding sale-related gains).

 

Con-way’s revenue of $4.2 billion in 2006 increased 2.6% from the prior-year period, due to increases from both revenue-generating segments. Revenue at Con-way Freight and Transportation reflects Con-way Freight’s pricing initiatives that emphasized higher yields, which grew 4.4%. The focus on yield adversely affected tonnage in a market of slowing demand for freight transportation, resulting in a weight-per-day decline of 0.5%. Revenue from Menlo Worldwide Logistics increased 1.2% due primarily to growth in warehouse-management services.

 

Consolidated operating income in 2006 increased 8.3% from the same period last year due to gains of $47.3 million related to the sale of MW’s membership interest in Vector and to the sale of Con-way Expedite. Excluding the gains, consolidated operating income declined 4.4% due largely to lower operating income from Con-way Freight and Transportation, Vector, and to a lesser extent, Logistics. The decline in Con-way’s operating income primarily reflects increases in depreciation, maintenance, and self-insurance costs as well as higher allocated corporate costs, as more fully discussed below. Due to the sale of Vector, Con-way after June 30, 2006 recognized only $2.0 million of operating income associated with Vector business cases that were in-process at

June 30, 2006, resulting in $14.0 million of operating income in 2006 (excluding the sale-related gain) compared to $20.3 million in 2005.

 

Consolidated operating income in 2006 was adversely affected by a decline in costs reimbursed by UPS under a transition-services agreement. 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 2005, Con-way was reimbursed by UPS for $11.3 million of general and administrative costs, while no costs were reimbursed by UPS in 2006. Also, in 2006, Con-way began recognizing expense related to employee stock-option awards and the re-branding initiative. In 2006, Con-way recognized additional share-based compensation expense of $5.8 million in connection with the adoption of SFAS 123R effective January 1, 2006. In 2006, Con-way’s advertising expense increased from 2005 by $5.1 million to $9.7 million, due largely to customer-focused advertising and employee-focused events, including $0.9 million of costs related to Con-way’s re-branding initiative. Certain advertising programs implemented in 2006 will continue in 2007 and, accordingly, advertising expense in 2007 is expected to approximate the costs incurred in 2006. Corporate administrative costs related to Con-way’s shared-services center and executive headquarters, including the costs described above, are generally allocated based on measurable services provided to each segment, or for general corporate expenses, based on segment revenue or capital employed.

 

In connection with the re-branding initiative, Con-way in 2006 recognized expense of $1.8 million, primarily for costs related to advertising and legal services. Through 2008, Con-way estimates that it will incur additional costs of approximately $20 million to $24 million due primarily to the cost of re-branding tractors and trailers, which is recognized as maintenance expense when incurred. Approximately $12 million to $14 million of re-branding costs are estimated to be incurred in 2007.

 

Other net expense in 2006 decreased $9.1 million to $9.5 million due primarily to a reduction in interest expense, an increase in investment income, and foreign exchange gains. Interest expense decreased $3.3 million in 2006 due largely to the $100.0 million repayment in June 2005 of the 7.35% Notes. Investment income increased $2.1 million on higher interest rates earned on cash-equivalent investments and marketable securities, partially offset by lower average balances of interest-earning financial instruments. In 2006, other miscellaneous non-operating expense primarily reflects positive variations in foreign exchange transactions, which improved comparative operating results by $3.3 million.

 

Con-way’s effective tax rate of 30.6% in 2006 declined from 34.6% in 2005 as the tax provision in 2006 benefited from the utilization of capital-loss carryforwards, which offset tax of $2.9 million on the sale of Con-way Expedite and $14.8 million on the sale of MW’s membership interest in Vector. Con-way’s effective tax rate in both periods reflects the effect of net tax credits that were primarily related to the settlement with the IRS of previous tax filings. These net tax credits consisted of reversals of accrued tax in the amount of $12.1 million in 2006 and $7.8 million in 2005.

 

Overview — 2005 Compared to 2004

 

Con-way’s net income from continuing operations in 2005 increased 55.2% to $222.6 million from $143.4 million in 2004 due primarily to significantly higher operating income, a decline in non-operating expenses, and a lower effective tax rate. Higher operating income was due primarily to revenue growth and to improvement in operating margins.

 

In 2005, Con-way’s revenue increased 12.5% to $4.1 billion, due to higher revenue at Con-way Freight and Transportation and from Logistics. Con-way Freight and Transportation’s revenue growth in 2005 primarily reflects increases at Con-way Freight, which increased weight per day by 12.4% and improved yield by 4.2%.

 

Consolidated operating income in 2005 rose 30.5% on significantly higher operating income from Con-way Freight and Transportation and improved results from Menlo Worldwide. Con-way Freight and Transportation’s operating income increased 34.0% due largely to revenue growth of 11.8% and improved Con-way Freight operating margins. Con-way Freight and Transportation’s revenue increase in 2005 reflects Con-way Freight tonnage growth and yield improvement on increased fuel surcharges. Improved operating margins primarily reflect productivity gains and a decline in employee costs as a percentage of revenue, due largely to lower incentive

compensation that resulted from variations in operating income and other performance factors relative to incentive plan targets. Menlo Worldwide’s operating income in 2005 increased 14.5% on improved results at Logistics and higher income from Vector’s foreign operations. Logistics’ operating income increased 17.4% on revenue growth of 14.0% and reported segment income from Vector increased 11.0%.

 

Other net expense in 2005 decreased $17.0 million to $18.6 million, due primarily to increases in investment income, which rose $15.2 million on higher interest rates earned on a larger average balance of cash-equivalent investments and marketable securities. Interest expense decreased $2.2 million in 2005 due largely to the net effect on interest from financing transactions, including the $100.0 million repayment in June 2005 of the 7.35% Notes, the $128.9 million redemption in June 2004 of 5% Convertible Debentures, and the $292.6 million net issuance in April 2004 of 6.7% Senior Debentures.

 

Reporting Segment Review

 

Con-way Freight and Transportation

 

The table below compares operating results, operating margins, and the percentage increase in selected operating statistics of the Con-way Freight and Transportation reporting segment for the years ended December 31:

 

 

 

2006 Compared to 2005

 

In 2006, Con-way Freight and Transportation’s revenue rose 3.3% 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 2006 reflect higher revenue per day, partially offset by the effects of 1.5 fewer working days when compared to the same period last year. Revenue per day grew 3.9% on a 4.4% increase in yield and a 0.5% decrease in weight per day. Both yield and weight per day were affected by Con-way Freight’s pricing initiatives that emphasized higher yields. The yield focus adversely affected tonnage in a market of slowing demand for freight transportation, particularly in the third and fourth quarter of 2006. Weight per day declined in the third and fourth quarter by 3.9% and 8.0%, respectively, compared to the same prior-year periods. In response to the third- and fourth-quarter declines in weight per day, Con-way management implemented targeted sales initiatives, which it believes will lead to tonnage growth by the second quarter of 2007.

 

Yield increases in 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, yields in 2006 increased 2.0%. Fuel surcharges improved the yield comparisons in every quarter of the years presented, except for the fourth quarter of 2006. Yields in the fourth quarter of 2006 improved 2.9% from the same quarter of 2005, while yields excluding surcharges rose 3.5% in the same comparative period. Fuel surcharges are 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, as more fully discussed under Item 1A, “Risk Factors.” Yield increases in 2006 were partially offset by the effect of a 0.7% increase in weight per shipment. Commensurate with the lower transportation cost per unit of weight, lower-cost higher-weight shipments generally have lower yields.

 

As more fully discussed in Note 12, “Segment Reporting,” of Item 8, “Financial Statements and Supplementary Data,” Con-way sold the expedited-shipping portion of its former Con-way Expedite and Brokerage business in July 2006, and the remaining truckload-brokerage operation was merged into Con-way Truckload. The truckload-brokerage business was integrated with Menlo Worldwide Logistics effective in January 2007, as more fully discussed below under “— Menlo Worldwide — Logistics.”

 

In connection with the sale of Con-way Expedite, Con-way received proceeds of $8.0 million in 2006 and recognized a $6.2 million gain. Excluding this gain, Con-way Freight and Transportation’s operating income declined 4.1% when compared to the prior-year period. Operating income in 2006 was adversely affected by higher depreciation, maintenance and self-insurance costs, and a $19.8 million or 15.5% increase in allocated corporate administrative expenses, as discussed above under “— Continuing Operations.”

 

Depreciation expense increased 15.2% in 2006 due to planned investments in service centers and tractor and trailer acquisitions by Con-way Freight and Con-way Truckload. Maintenance costs increased 10.6% due to technology requirements relating to the repair and maintenance of newer equipment and to costs related to maintaining trailers over a longer estimated useful life. Increased maintenance costs also reflect major repair programs undertaken in 2006 to address specific issues. Other operating costs, which include costs for cargo claims, vehicular insurance and fuel-related taxes, increased 9.1% in 2006. A $3.7 million increase in advertising expense reflects customer-focused advertising and employee-focused events, a portion of which support Con-way’s re-branding initiative.

 

Fuel costs in 2006 increased 20.4% and purchased transportation costs decreased 10.8%, 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 2006 were adversely affected by an increase in average diesel fuel prices. Higher fuel costs and fuel-related increases in purchased transportation costs were more than recovered through fuel surcharges.

 

In 2006, employee costs increased 2.8%, but declined as a percentage of revenue, as administrative-related employee costs increased 4.5% and operations-related employee costs increased 2.6%. Employee costs reflect increases in base compensation and employee benefits, partially offset by lower incentive compensation. Base compensation in 2006 rose 3.3% due primarily to wage and salary rate increases. Employee benefits expense increased 5.8% due primarily to higher costs for health-care benefits, paid time off, and pension benefits, partially offset by a decline in long-term incentive compensation for executives. Compensation earned under the general annual incentive plan in 2006 declined by $19.6 million based on variations in operating income and other performance measures relative to incentive plan targets.

 

2005 Compared to 2004

 

In 2005, Con-way Freight and Transportation’s revenue rose 11.8% due to higher revenue from both Con-way Freight and Con-way Transportation. Revenue per day from Con-way Freight rose 12.4% from 2004 on a 7.9% increase in weight and a 4.2% increase in yield. Yield increases in 2005 primarily reflect an increase in fuel surcharges, continued growth in higher-rated interregional services, and general rate increases, partially offset by growth in lower-yielding lower-cost shipments. Excluding fuel surcharges, yields in 2005 were unchanged compared to 2004. Yields in 2005 were adversely affected by a 3.6% increase in weight per shipment, which was largely driven by a spot-quote program that contributed to an increase in the number of shipments in excess of 10,000 pounds.

 

Con-way Freight and Transportation’s operating income in 2005 increased 34.0%, due largely to improved margins, which primarily reflect revenue growth, productivity gains, and a decline in employee costs as a percentage of revenue. Employee costs in 2005 increased 5.3%, reflecting higher base compensation and employee benefits, partially offset by lower incentive compensation. Base compensation rose 10.0%, due primarily to

headcount increases attributable to higher business volumes, and to a lesser extent, wage and salary rate increases. Incentive compensation in 2005 declined by $27.5 million or 34.5%. Employee benefits expense increased 2.6%, as an increase in health-care costs, due largely to growth in headcount, was partially offset by a decline in workers’ compensation expense. In 2005, fuel and purchased transportation costs increased 64.5% and 22.9%, respectively. However, higher fuel costs and fuel-related increases in purchased transportation costs were more than recovered through fuel surcharges.

 

Menlo Worldwide

 

The Menlo Worldwide reporting segment consists of the operating results of Logistics and Vector. Menlo Worldwide in 2006 reported operating income of $80.7 million, compared to $46.9 million in 2005 and $41.0 million in 2004. Results in 2006 include a $41.0 million gain due to the sale of MW’s membership interest in Vector to GM.

 

Although MW owned a majority equity interest in Vector, MW’s portion of Vector’s operating results have been reported as an equity-method investment based on GM’s ability to control certain operating decisions. Accordingly, Con-way’s statements of consolidated operations 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 years ended December 31. The table summarizes Logistics gross revenues as well as net revenues (revenues less purchased transportation expenses). 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.

 

 

Menlo Worldwide — Logistics

 

2006 Compared to 2005

 

Logistics’ revenue in 2006 increased 1.2% due to a 4.5% increase in warehouse-management services, and a 0.3% increase in carrier-management services. Growth in carrier-management revenue was slowed by management’s decision to terminate in May 2006 a low-margin carrier-management contract that accounted for 2.9% of Logistics’ annual segment revenues in 2005. Net revenues in 2006 increased 6.8% due to the 1.2% increase in revenue and a 0.9% reduction in purchased transportation expense. Lower transportation costs in 2006 were

achieved through better carrier rates on carrier-management services and to an increase in the percentage of revenue derived from warehouse-management services, which has the effect of increasing gross and net revenues without an associated increase in purchased transportation.

 

Logistics’ operating income in 2006 decreased 3.8% from the same period of last year, due primarily to higher employee costs and purchased labor, which collectively increased 12.0% in 2006. Employee costs increased 9.2% as operations-related employee costs increased 8.0% and administrative-related employee costs increased 14.4%. Higher employee costs reflect increases in base compensation, employee benefits and incentive compensation. Base compensation in 2006 increased 5.8% due primarily to growth in headcount and wage and salary rate increases. Employee benefits expense increased 16.2% primarily from an increase in the cost of health-care benefits and other employee benefit costs. Incentive compensation in 2006 increased by $2.6 million or 40.0% based on variations in operating income, working capital and other performance measures relative to incentive plan targets. Purchased labor costs increased 20.0% due to new warehouse-management projects. Logistics utilizes purchased labor for warehouse-management services due to the flexibility provided in responding to varying customer demand. Expenses for supplies increased 39.8%, reflecting volume increases related to certain warehouse-management customers. Corporate administrative costs allocated to Logistics in 2006 increased $5.1 million or 13.3%, as described above under “— Continuing Operations.” Expenses for outside services increased 14.1% due primarily to $1.3 million of costs related to a bid for a significant contract.

 

2005 Compared to 2004

 

In 2005, Logistics’ revenue increased 14.0% over 2004, due to a 15.9% increase in carrier-management services and a 7.6% increase in warehouse-management services. Logistics’ net revenue in 2005 increased 6.5% from 2004 as revenue growth was partially offset by a 17.2% increase in purchased transportation costs, which was due to higher business levels and fuel-related increases in carrier rates.

 

In 2005, Logistics’ operating income increased 17.4% due primarily to growth in net revenue and lower employee costs, which were due largely to declines in health-care costs, workers’ compensation, and incentive compensation. Incentive compensation in 2005 declined by $1.0 million or 13.7% based on variations in operating income and other performance measures relative to incentive plan targets.

 

Integration of Former Con-way Transportation Businesses

 

In recent years, Logistics has integrated into its operations two supply-chain management businesses that were previously reported in the Con-way Freight and Transportation reporting segment. In the second quarter of 2005, Logistics integrated the former Con-Way Logistics business and prior periods were reclassified. In January 2007, Logistics also integrated the truckload-brokerage business.

 

The integration of the truckload-brokerage business is expected to leverage Logistics’ significant procurement volumes of purchased transportation to improve both the value to customers and to improve the margin earned on the services provided. The integration of the truckload-brokerage business is also expected to expand logistics-services opportunities through access to truckload-brokerage customers and to leverage the shared expertise of the logistics and truckload-brokerage professionals.

 

Menlo Worldwide — Vector

 

Operating Results

 

In 2006, segment income reported from MW’s equity investment in Vector increased to $55.1 million from $20.3 million in 2005. Higher reported segment income from Vector was due to a $41.0 million gain recognized from the sale of MW’s membership interest in Vector to GM. In 2005, segment income from Vector increased to $20.3 million from $18.3 million in 2004, due primarily to higher income earned in GM’s international regions, partially offset by a decline in income from GM’s North America region.

 

GM Exercise of Call Right

 

On June 23, 2006, GM exercised its Call Right. On December 11, 2006, an independent financial advisor established a fair value for Vector that was agreed upon by Con-way and GM. The advisor established a fair value of $96.4 million for the membership interests of both joint-venture partners, including a fair value of $84.8 million that was attributable to MW’s membership interest in Vector.

 

As a result of the agreed-upon valuation, Con-way in December 2006 recognized a receivable from GM of $51.9 million (an amount equal to the $84.8 million fair value of MW’s membership interest reduced by Con-way’s $32.9 million payable to Vector) and also recognized a $41.0 million gain (an amount equal to the $51.9 million receivable reduced by Con-way’s $9.0 million net investment in Vector and $1.9 million of sale-related costs). On the settlement date of January 5, 2007, Con-way received a $51.9 million payment from GM.

 

Con-way’s sale of MW’s membership interest in Vector is more fully discussed in Note 3, “Investment in Unconsolidated Joint Venture,” of Item 8, “Financial Statements and Supplementary Data.”

 

Con-way Other

 

The Con-way Other reporting segment consists of certain corporate activities for which the related income (loss) has not been allocated to other reporting segments. The table below summarizes the operating results for Con-way Other:

 

 

Discontinued Operations

 

Discontinued operations in the periods presented relate to the closure of Con-way Forwarding, the sale of MWF, the shut-down of EWA and its terminated Priority Mail contract with the U.S. Postal Service (“USPS”), and to the spin-off of Consolidated Freightways Corporation (“CFC”). 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 8, “Financial Statements and Supplementary Data” for summary financial information and related discussion.

 

Liquidity and Capital Resources

 

In 2006, cash of $687.9 million used in investing activities, financing activities and discontinued operations was funded with $433.7 million provided by operating activities and $254.2 million of cash and cash equivalents, which declined to $260.0 million at December 31, 2006 from $514.3 million at December 31, 2005. Investing activities in 2006 used $274.2 million due primarily to capital expenditures of $299.2 million while financing activities used $378.5 million, primarily for the repurchase of $350.2 million of common stock. Con-way’s cash flows are summarized in the table below.

 

 

 

 

Continuing Operations

 

Operating Activities

 

Cash flow from operating activities in 2006 was $433.7 million, a $212.4 million increase from 2005, due to an increase in net income before non-cash items and cash provided by changes in assets and liabilities, primarily receivables. In 2006, receivables provided $86.4 million, primarily due to improvement in the average collection period for Logistics’ receivables. In 2005, receivables used $124.2 million on higher revenue and an increase in the average collection period for Logistics’ receivables, which was due in part to longer customer-negotiated payment terms and processing delays. The decline in accrued incentive compensation used $4.4 million in 2006, while the same prior-year period used $20.0 million. In 2006 and 2005, expense accruals for incentive compensation were $50.0 million and $68.3 million, respectively, while incentive compensation payments in those periods were $54.4 million and $88.3 million, respectively. The use of cash from the decline in employee benefit liabilities for the years presented reflects the net effect of defined benefit pension plan funding contributions of $75.0 million in 2006, $126.5 million in 2005, and $90.8 million in 2004, partially offset by expense accruals related to Con-way’s benefit plans. In all years presented, cash provided by deferred charges and credits reflects variations in Con-way’s affiliate payable to Vector. Proceeds related to the sale of Vector were not received until the settlement date of January 5, 2007, as more fully discussed in Note 3, “Investment in Unconsolidated Joint Venture,” of Item 8, “Financial Statements and Supplementary Data,” and accordingly, are not reflected in Con-way’s consolidated cash flows for 2006.

 

Cash flow from operating activities in 2005 was $221.3 million, a $162.7 million decrease from 2004, as an increase in net income before non-cash items was more than offset by the net use of cash due to changes in assets and liabilities, primarily receivables. In 2005, receivables used $124.2 million compared to $33.1 million used in

2004, based on revenue growth and an increase in the average collection period for Logistics in 2005. Accrued incentive compensation decreased $20.0 million in 2005, while 2004 reflects a $29.2 million increase. Cash provided by changes in deferred charges and credits declined to $27.5 million in 2005 from $67.1 million provided in 2004 due primarily to $54.5 million of cash payments received in 2004 in connection with the liquidation of corporate-owned life insurance policies.

 

Investing Activities

 

Investing activities in 2006 used $274.2 million compared to $178.0 million provided in 2005. Capital expenditures in 2006 increased $87.7 million from 2005 due primarily to increased tractor and trailer expenditures at Con-way Freight and Transportation. Capital expenditures in 2005 increased $58.7 million from 2004, also due to increases at Con-way Freight and Transportation.

 

Proceeds from the sale of businesses were $8.0 million in 2006 compared to $108.4 million in 2005. In 2006, Con-way sold the expedited-shipping portion of its former Con-way Expedite and Brokerage business for $8.0 million. In 2005 and 2004, Con-way received payments of $108.4 million and $150.0 million, respectively, in connection with the sale of MWF to UPS.

 

In all periods presented, investing activities also reflect fluctuations in short-term marketable securities. Marketable securities in 2006 provided $17.8 million, and in 2005, provided $284.0 million, primarily due to the first-quarter conversion of auction-rate securities into cash and cash equivalents. Investments in marketable securities in 2004 used $225.9 million.

 

Financing Activities

 

Financing activities used cash of $378.5 million in 2006 compared to $216.4 million used in 2005. Common stock repurchases of $350.2 million in 2006 and $149.1 million in 2005 were made under Con-way’s repurchase programs. 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 8, “Shareholders’ Equity,” of Item 8, “Financial Statements and Supplementary Data,” Con-way is authorized to repurchase an additional $90.3 million of common stock through June 30, 2007. Financing activities in 2005 reflect the repayment at maturity on June 1 of the $100 million 7.35% Notes, while 2004 reflects the $292.6 million net issuance of 6.7% Senior Debentures and the $128.9 million redemption of 5% Convertible Debentures. Financing activities in all periods presented also reflect dividend payments and scheduled principal payments for notes related to Con-way’s defined contribution retirement plan. Cash provided by the exercise of stock options decreased to $12.2 million in 2006 from $76.1 million in 2005 and from $56.1 million in 2004. The lower level of stock-option exercises in 2006 primarily reflects a decline in the number of exercisable options following the high volume of stock-option exercises in 2005 and 2004.

 

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 December 31, 2006, no borrowings were outstanding under Con-way’s revolving credit facility and, at December 31, 2006, $210.3 million of letters of credit were outstanding, leaving $189.7 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 December 31, 2006, which are available to support letters of credit, bank guarantees, and overdraft facilities; at that date, a total of $17.2 million of letters of credit was outstanding under these facilities. See “— Forward-Looking Statements” below, and Note 5, “Debt and Other Financing Arrangements,” of Item 8, “Financial Statements and Supplementary Data,” for additional information concerning Con-way’s $400 million credit facility and its other debt instruments.

 

Contractual Cash Obligations

 

The table below summarizes contractual cash obligations for Con-way as of December 31, 2006. Some of the amounts in the table are based on management’s estimates and assumptions about these obligations, including their duration, the possibility of renewal, and other factors. Because of these estimates and assumptions, the actual future payments may vary from those reflected in the table. Certain liabilities, including those related to self-insurance accruals, are reported in Con-way’s consolidated balance sheets but not reflected in the table below due to the absence of stated maturities.

 

 

As presented above, contractual obligations on long-term fixed-rate debt and guarantees represent principal and interest payments. The amounts representing principal and the portion of interest payable in 2007 are reported in the consolidated balance sheets.

 

Contractual obligations for operating leases represent the payments under the lease arrangements. In accordance with GAAP, future operating lease payments are not included in Con-way’s consolidated balance sheets. Con-way’s operating leases were determined to provide economic benefits preferable to ownership based primarily on after-tax cash flows, financial and operating flexibility, and the effect on Con-way’s capitalization.

 

The employee benefit plan payments in the table represent estimated payments under Con-way’s non-qualified defined benefit pension plans and postretirement medical plan through December 31, 2016. Expected benefit payments for Con-way’s qualified defined benefit pension plans are not included in the table, as these plans are funded. Con-way expects to contribute approximately $13 million to its qualified defined benefit pension plans in 2007, which is subject to variation based on changes in interest rates and asset returns. Based on the funded status of Con-way’s qualified pension plans, expected future contributions do not represent contractual obligations, but are governed by Con-way’s funding practices. The amount of estimated defined benefit pension plan contributions reflects plan amendments that were effective on January 1, 2007. However, Con-way believes that a decline in funding requirements for the defined benefit pension plans will, in whole or in part, be offset by higher contributions to Con-way’s defined contribution pension plan, as more fully discussed below under “— Critical Accounting Policies and Estimates.”

 

In 2007, Con-way anticipates capital expenditures of approximately $185 million (including software expenditures), primarily for the acquisition of additional tractor and trailer equipment. Con-way’s actual 2007 capital expenditures may differ from the estimated amount, depending on factors such as 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. The planned expenditures do not represent contractual obligations at December 31, 2006.

 

As described above under “Financing Activities,” letters of credit of $210.3 million were outstanding at December 31, 2006. These letters of credit are generally required under self-insurance programs and do not represent additional liabilities as the underlying self-insurance accruals are already included in Con-way’s consolidated balance sheets.

 

For further discussion, see Note 5, “Debt and Other Financing Arrangements,” and Note 6, “Leases,” of Item 8, “Financial Statements and Supplementary Data.”

 

Other

 

Con-way’s ratio of total debt to capital increased to 43.8% at December 31, 2006 from 39.9% at December 31, 2005, due primarily to share repurchases in 2006, and to a lesser extent, the decrease in common shareholders’ equity on adoption of SFAS 158. The share repurchases and the adoption of SFAS 158 were partially offset by the increase in retained earnings from net income earned in 2006 and the $15.0 million debt repayment in January.

 

At December 31, 2006, Con-way’s senior unsecured debt was rated as investment grade by both Moody’s (Baa3) and Standard and Poor’s (BBB). In addition, Fitch Ratings initiated coverage of Con-way on January 25, 2006 with a rating of “BBB.”

 

Con-way believes that its working capital requirements and capital expenditure plans in the foreseeable future will be adequately met with various sources of liquidity and capital, including Con-way’s cash and cash equivalents, marketable securities, cash flow from operations, credit facilities and access to capital markets.

 

Discontinued Operations

 

Discontinued operations in the periods presented relate to the closure of Con-way Forwarding, the sale of MWF, the shut-down of EWA and its terminated Priority Mail contract with the USPS and to the spin off of CFC. For periods prior to its closure in June 2006, cash flow from discontinued operations relate primarily to Con-way Forwarding. Except as described below, the cash flows from discontinued operations have been segregated from continuing operations and reported separately as discontinued operations.

 

In 2006, Con-way settled lawsuits filed by former EWA pilots and crew members, which resulted in payments of $9.2 million in June 2006 and $10.9 million in August 2006, as more fully discussed in Note 2, “Discontinued Operations,” of Item 8, Financial Statements and Supplementary Data.”

 

Also in 2006, Con-way paid $10.0 million to settle a dispute pertaining to the Priority Mail contract, as more fully discussed in Note 11, “Commitments and Contingencies,” of Item 8, Financial Statements and Supplementary Data.”

 

As more fully discussed above under “Continuing Operations — Investing Activities,” sales-related amounts received from UPS in 2005 and 2004 are reported as proceeds in investing activities. See Note 2, “Discontinued Operations — MWF,” of Item 8, “Financial Statements and Supplementary Data,” 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.

 

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. As more fully discussed in Note 1, “Principal Accounting Policies,” of Item 8, “Financial Statements and Supplementary Data,” effective in the fourth quarter of 2006, Con-way retrospectively applied a change in its accounting policy for tires from a capitalize-and-amortize method to an expense-as-incurred method. The policies and estimates discussed below include those that are most critical to the financial statements.

 

Employee Retirement Benefit Plans

 

In the periods presented, employees of Con-way and its subsidiaries in the U.S. were covered under several retirement benefit plans, including several qualified and non-qualified defined benefit pension plans and a defined contribution retirement plan. In October 2006, Con-way’s Board of Directors approved changes to Con-way’s retirement benefits plans that are intended to preserve the retirement benefits earned by existing employees under

Con-way’s primary qualified defined benefit pension plan (the “Primary DB Plan”) and its primary non-qualified supplemental defined benefit pension plan (the “Supplemental DB Plan”), while expanding benefits earned under its primary defined contribution plan (the “Primary DC Plan”) and a new supplemental defined contribution plan (the “Supplemental DC Plan”). The major provisions of the plan amendments are effective on January 1, 2007 and are more fully discussed in Note 9, “Employee Benefit Plans,” of Item 8, “Financial Statements and Supplementary Data.” These provisions will result in increased expense related to the Primary DC Plan and in the elimination of future service cost associated with the Primary DB Plan and the Supplemental DB Plan. The effect of plan changes on Con-way’s financial condition, results of operations 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 for the funded qualified plans. 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 2007 are summarized below.

 

 

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 approximate 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 plans. If all other factors were held constant, a 0.25% decrease (increase) in the discount rate would result in an estimated $50 million increase (decrease) in the cumulative unrecognized actuarial loss, and the related loss or credit would be amortized to future-period earnings as described below.

 

Return on Plan Assets.  For its qualified funded defined benefit pension plans, 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 $3 million increase (decrease) in 2007 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 gains or losses. For Con-way’s defined benefit pension plans, 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.

 

Plan amendments effective January 1, 2007 will result in the elimination of future service cost for the Primary DB Plan and the Supplemental DB Plan, and no material service cost is recognized under Con-way’s other defined benefit pension plans. Accordingly, the future effect of the defined benefit pension plans on Con-way’s operating results will consist primarily of the net effect of the interest cost on plan obligations for the qualified and non-qualified defined benefit pension plans and the expected return on plan assets for the funded qualified defined benefit pension plans. In 2007, Con-way estimates that the defined benefit pension plans will result in income of $12 million based primarily on an increase in plan assets, which was mostly due to plan contributions and an increase in the actual rate of return on plan assets, and a discount-rate decline that increased the plan obligation. As

more fully discussed below, in 2007, Con-way estimates that lower benefits expense (or income) related to the Primary DB Plan and the Supplemental DB Plan will be offset, in whole or in part, with higher company contributions to the Primary DC Plan.

 

Con-way’s annual defined benefit pension expense in 2006 exceeded the annual expense in 2005 by approximately $12.0 million, reflecting an increase of $11.3 million related to the funded qualified defined benefit pension plans. Higher pension expense in 2006 was due primarily to increases in service cost, interest cost, and amortization of the unrecognized actuarial loss, partially offset by higher expected return on plan assets for qualified funded plans. The higher pension expense in 2006 was also attributable to a $1.6 million curtailment loss recognized in connection with the plan amendments discussed below. The increase in service cost in 2006 was due in part to the effect in 2006 of revised mortality assumptions while the increases in interest cost were due to a discount-rate decline that increased the plan obligation. Effective with the year-end 2005 valuation, 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. Plan asset returns for qualified funded plans in 2006, which exceeded the plan assumption for the return on plan assets, increased from 2005 based on plan contributions that increased plan assets. Amortization of the unrecognized actuarial loss for the defined benefit pension plans in 2006 increased $5.8 million from 2005, based primarily on the higher unrecognized actuarial loss at December 31, 2005.

 

Effective on December 31, 2006, Con-way adopted the recognition and related disclosure provisions of SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of SFAS 87, 88, 106, and 132R,” as more fully discussed in Note 9, “Employee Benefit Plans,” of Item 8, “Financial Statements and Supplementary Data.” Under the recognition provisions of SFAS 158, Con-way is required to recognize the overfunded or underfunded status of its defined benefit plans as an asset or liability, respectively, in its balance sheet at December 31, 2006. For Con-way’s defined benefit pension plans, the funded status is measured as the difference between the projected benefit obligation and the fair value of plan assets. Under the transition provisions of SFAS 158, actuarial gains or losses and prior-service costs or credits that have not yet been included in net periodic benefit expense as of the adoption date are recognized in shareholders’ equity as components of the ending balance of accumulated other comprehensive income (loss), net of tax. Accordingly, SFAS 158 gives recognition to the effect of changes in the funded status on the plan liability and on shareholders’ equity, but when compared to prior accounting standards, SFAS 158 does not result in changes to recognized periodic benefits expense, except in certain conditions.

 

Since retrospective adoption of SFAS 158 is prohibited, different recognition provisions have been applied in determining the plan-related amounts reported in Con-way’s consolidated balance sheets at December 31, 2006 and 2005. Prior to adoption of SFAS 158, accounting standards allowed an employer to recognize in its balance sheets an asset or liability that was almost always different from the plan’s overfunded or underfunded status, primarily by delaying the effect of changes in plan design and actuarial assumptions. Under the previous standards, an employer was only required to recognize an additional minimum pension liability adjustment to recognize the shortfall between the fair value of its pension plan assets and the accumulated benefit obligation (rather than the projected benefit obligation, as required by SFAS 158). Accordingly, for an underfunded plan, the plan-related liability reported under SFAS 158 exceeds the amount reported under prior accounting standards. In connection with the adoption of SFAS 158 effective on December 31, 2006, Con-way increased reported amounts for employee benefits liabilities by $155.3 million and reduced shareholders equity by $95.5 million (net of $61.1 million of deferred tax benefits).

 

Con-way periodically reviews the funded status of its qualified defined benefit pension plans 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 made contributions of $75 million and $126.5 million to its defined benefit pension plans in 2006 and 2005, respectively, and in 2007, expects to contribute approximately $13 million. 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 plans.

 

Although employee participants in the Primary DB Plan and the Supplemental 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 lower benefits expense (or income) related to the Primary DB Plan and the Supplemental DB Plan will be offset, in whole or in part, with higher company contributions to the Primary DC Plan.

 

The changes to the Primary DB Plan and the Supplemental DB Plan decreased the plans’ projected benefit obligation at December 31, 2006 by $42.0 million and that decline will be amortized over approximately 12 years (the average estimated remaining years of service). Thereafter, the related asset or liability 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. In addition to the actuarial gain to be recognized in future periods, Con-way in 2006 recognized a curtailment loss of $1.6 million for immediate recognition of net unrecognized prior-service costs.

 

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 funding payments for the Primary DB Plan that otherwise would have been required without plan amendments. However, Con-way believes that the decline in funding requirements for the Primary DB Plan will, in whole or in part, be offset by higher contributions to the Primary 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. 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. Con-way periodically evaluates the level of insurance coverage and adjusts insurance levels based on risk tolerance and premium expense.

 

The measurement and classification of self-insured costs requires the consideration of historical cost experience, demographic and severity factors, and judgments about the current and expected levels of cost per claim and retention levels. These methods provide estimates of undiscounted liability associated with claims incurred as of the balance sheet date, including claims not reported. Con-way believes its actuarial methods are appropriate for measuring these highly judgmental self-insurance accruals. However, the use of any estimation method is sensitive to the assumptions and factors described above, based on the magnitude of claims and the length of time from incurrence of the claims to ultimate settlement. Accordingly, changes in these assumptions and factors can materially affect actual costs paid to settle the claims and those amounts may be different than 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 tax loss and credit carryforwards and carrybacks, 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,” Con-way’s management made significant estimates and assumptions in connection with the disposition of MWF, EWA, and Con-way Forwarding , including those related to asset impairment and disposition costs. Actual results could differ from estimates, which could affect related amounts reported in the financial statements.

 

Revenue Recognition

 

Con-way Freight and Transportation generally recognizes revenue upon delivery of shipments and the related costs of delivery are recognized as incurred. For shipments that are in transit at the end of the accounting period, Con-way Freight and Transportation recognizes the portion of revenue earned at the balance-sheet date and recognizes the related delivery costs as incurred. Revenue-related estimates for Con-way Freight and Transportation primarily include those related to revenue adjustments, uncollectible accounts receivable, and in-transit shipments.

 

Estimated Revenue Adjustments.  As with other companies in the transportation industry, the pricing assessed by Con-way Freight and Transportation to its customers may be subsequently adjusted due to several factors, including weight verifications, or pricing discounts. Although the majority of pricing adjustments occur in the same month as the original pricing, a portion occurs during subsequent periods. Revenue adjustments are estimated based on revenue levels and historical experience. The estimated liability for revenue adjustments are reported as accrued liabilities in the consolidated balance sheets.

 

Uncollectible Accounts Receivable.  Con-way Freight and Transportation reports accounts receivable at net realizable value and provides an allowance for uncollectible accounts when collection is considered doubtful. Estimates for uncollectible accounts are based on various judgments and assumptions, including revenue levels, historical loss experience, and the aging of outstanding accounts receivable.

 

In-transit Revenue.  At the end of the accounting period, Con-way Freight and Transportation estimates the amount of revenue earned on shipments in transit based on actual shipments picked up from customers, the scheduled day of delivery, and the expected completion time for delivery.

 

Menlo Worldwide Logistics recognizes revenue in accordance with contractual terms as services are provided. Revenue-related judgments and estimates for Logistics primarily include those related to the determination of gross- or net-basis revenue recognition and to uncollectible accounts receivable.

 

Gross- or Net-basis Revenue Recognition.  Revenue is recorded on a gross basis, without deducting third-party purchased transportation costs, on transactions for which Logistics acts as a principal. Revenue is recorded on a net basis, after deducting purchased transportation costs, on transactions for which Logistics acts as an agent. Determining whether revenue should be reported as gross or net is based on an assessment of whether Logistics is acting as the principal or the agent in the transaction and involves judgment based on the terms of the arrangement.

 

Uncollectible Accounts Receivable.  Logistics, based on the size and nature of its client base, performs a periodic evaluation of its customers’ creditworthiness and accounts receivable portfolio and recognizes expense from uncollectible accounts when losses are both probable and reasonably estimable.

 

Con-way believes that its use of revenue-related estimates and judgments provide a reasonable approximation of the actual revenue earned.

 

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 2006, as more fully discussed in Note 1, “Principal Accounting Policies — Property, Plant and Equipment,” of Item 8, “Financial Statements and Supplementary Data.”

 

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.

 

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:

 

 

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:

 

 

 

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 8, “Financial Statements and Supplementary Data.”

 

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.

 

As more fully discussed in Note 5, “Debt and Other Financing Arrangements,” of Item 8, “Financial Statements and Supplementary Data,” Con-way in December 2002 terminated four interest rate swap derivatives designated as fair value hedges of fixed-rate long-term debt. Except for the effect of these terminated interest rate swaps, derivative financial instruments did not have a material effect on Con-way’s financial condition, results of operations, or cash flows.

 

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 Con-way’s operating results or cash flows, but may have a material effect on the fair value of long-term debt. The table below summarizes the carrying value of Con-way’s fixed-rate long-term debt, the estimated fair value, and the effect of a 10% hypothetical change in interest rates on the estimated fair value. The estimated fair value is calculated as the net present value of principal and interest payments discounted at interest rates offered for debt with similar terms and maturities.

 

 

At December 31, 2006 and 2005, Con-way held cash-equivalent investments of $249.6 million and $496.8 million, respectively, and marketable securities of $184.5 million and $202.4 million, on which the company earned $24.8 million and $22.7 million of investment income, respectively. The potential change in annual investment income resulting from a hypothetical 10% change to variable interest rates at December 31, 2006 and 2005 would be approximately $3 million and $2 million, respectively.

 

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 could have a material adverse effect on Con-way. Con-way Freight and Transportation is subject to the risk of price fluctuations. Like other LTL carriers, Con-way Freight assesses many of its customers with a fuel surcharge. The fuel surcharge is a part of Con-way Freight’s overall rate structure for customers and is intended to compensate Con-way Freight for the adverse effects of higher fuel costs. 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. 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, or the effect that changes in fuel surcharges may have on Con-way Freight’s overall rate structure. Con-way Freight’s operating income may be adversely affected by a decline in fuel prices as lower fuel surcharges would reduce its 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.

 

The Board of Directors and Shareholders

Con-way Inc.:

 

We have audited the accompanying consolidated balance sheets of Con-way Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Con-way Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Note 1 to the consolidated financial statements, the Company adopted Statement of Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plan, which was adopted as of December 31, 2006.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Con-way Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2007, expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.

 

 

Portland, Oregon

February 27, 2007

 

Con-way Inc.

 

Consolidated Balance Sheets

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

Con-way Inc.

 

Consolidated Balance Sheets

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

Con-way Inc.

 

Statements of Consolidated Operations

 

 

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

Con-way Inc.

 

Statements of Consolidated Cash Flows