Financial Condition

Financial Condition

Management's Discussion and Analysis of
Financial Condition and Results of Operations

Financial Condition

Liquidity

Our liquidity needs arise primarily from capital investment in new equipment, land and structures, and information technology, as well as funding working capital requirements. To provide shortterm and longer-term liquidity, we maintain capacity under a bank credit agreement and an ABS agreement involving Yellow Transportation accounts receivable.We believe these facilities provide adequate capacity to fund current working capital and capital expenditure requirements. It is not unusual for us to have a deficit working capital position, as we can operate in this position due to rapid turnover of accounts receivable, effective cash management and ready access to funding.

Bank Credit Agreement

We maintain a $300 million bank credit agreement scheduled to expire in April 2004. In addition to funding short-term liquidity needs, we also use the facility to provide letters of credit that reduce available borrowings under the credit agreement. Letters of credit serve as collateral for our selfinsurance programs, primarily in the areas of workers' compensation and bodily injury and property damage. Collateral requirements for letters of credit increased significantly in 2002 as insurance providers responded to the events of September 11, 2001 and the bankruptcies of several large companies. In addition, the availability of surety bonds, an alternative form of self-insurance collateral, decreased due to the same factors. The price and availability of surety bonds fluctuates over time with general conditions in the insurance market. In 2002, the lack of availability of surety bonds resulted in the need for us to issue additional letters of credit. The following table summarizes the availability under the bank credit agreement as of December 31 for each period presented:

(in millions)		2002			2001



Total capacity	$	300.0		$	300.0
Outstanding borrowings		-			(85.0	)
Letters of credit		(146.2	)		(89.9	)

Available unused capacity	$	153.8		$	125.1

Our outstanding letters of credit at December 31, 2002 included $10.6 million for property damage and workers' compensation claims against SCST. Yellow agreed to maintain the letters of credit outstanding at the spin-off date until SCST obtained replacement letters of credit or third party guarantees. SCST agreed to use its reasonable best efforts to obtain these letters of credit or guarantees, which in many cases would allow Yellow to obtain a release of its letters of credit. SCST also agreed to indemnify Yellow for any claims against the letters of credit provided by Yellow. SCST reimburses Yellow for all fees incurred related to the remaining outstanding letters of credit.We also provide a guarantee of $6.6 million regarding certain lease obligations of SCST.

Asset Backed Securitization Facility

Our ABS facility provides us with additional liquidity and lower borrowing costs through access to the asset backed commercial paper market (ABCP). By using the ABS facility, we obtain a variable rate based on the A1 commercial paper rate plus a fixed increment for utilization and administration fees. A1 rated commercial paper comprises more than 90 percent of the commercial paper market, significantly increasing our liquidity.We averaged a rate of 2.3 percent on the ABS facility in 2002.

Process for the ABS
Borrowing under our ABS facility involves two primary steps. In the first step, Yellow Transportation sells an ongoing pool of receivables to a special purpose entity, Yellow Receivables Corporation (YRC). YRC is a wholly owned consolidated subsidiary of Yellow Transportation designed to isolate the receivables for bankruptcy purposes.

As the second step, YRC transfers the receivables to a conduit administered by a large financial institution. The conduit bundles the receivables from Yellow and numerous unrelated companies and then sells them to investors as ABCP. The conduit receives the proceeds from investors and forwards them to YRC who then forwards the proceeds to Yellow Transportation. Repayments of these obligations, along with related charges, occur in the reverse sequence of the steps just described.

The table below provides the borrowing and repayment activity, as well as the resulting balances, for the years ending December 31 of each period presented:

(in millions)		2002			2001



ABS obligations outstanding at January 1	$	141.5		$	177.0
Transfer of receivables to conduit (borrowings)		421.5			152.0
Redemptions from conduit (repayments)		(513.0	)		(187.5	)

ABS obligations outstanding at December 31	$	50.0		$	141.5

Our ABS facility involves receivables of Yellow Transportation only and has a limit of $200 million. Under the terms of the agreement, Yellow Transportation provides servicing of the receivables and retains the associated collection risks. Although the facility has no stated maturity, there is an underlying letter of credit with the administering financial institution that has a 364-day maturity.

Accounting for the ABS
Prior to December 31, 2002, activity under the ABS facility was treated as a sale of assets for financial reporting purposes. As a result, we did not reflect the receivables sold by YRC to the conduit and the related ABS obligations on our Consolidated Balance Sheets. However, we provided this information in the notes to the financial statements and management's discussion and analysis when discussing our financial position.

On December 31, 2002, we amended the ABS agreement to provide YRC the right to repurchase, at any time, 100 percent of the receivable interests held by the conduit. Prior to the amendment, the right to repurchase receivable interests was limited to instances when ABS borrowings were below $10 million, or 5 percent of the $200 million limit. The amendment does not alter the costs associated with operating the ABS facility. Due to the amendment, we will reflect the ABS activity as a financing activity rather than a sale of assets. This will result in changes to our financial reporting as summarized in the following table:

Financial Statement

At December 31, 2002 and
for the periods thereafter

Prior to the December 31,
2002 amendment

Consolidated
Balance Sheets

Receivables transferred
will be reflected under
"Accounts receivable"

Receivables sold by YRC
to the conduit were not
reflected

Consolidated
Balance Sheets

Amounts borrowed will be
reflected as current liabilities
under "ABS borrowings"

Amounts borrowed were
not reflected

Statements of
Consolidated Operations

ABS facility charges will
be reflected as "Interest
expense"

Reflected as "ABS facility
charges" in nonoperating
expenses

Statements of
Consolidated Cash Flows

Financing activities will
increase by the amount of
ABS borrowings and
decrease by the amount
of repayments

Operating activities were
increased by the amount of
receivables sold and
decreased by the amount
of repayments

We believe that reflecting the assets and liabilities associated with the ABS facility on our financial statements makes it easier for investors to understand our financial position. If the ABS had been reflected on our December 31, 2001 balance sheet, accounts receivable would have been $266.4 million compared to the December 31, 2002 balance of $327.9 million. Total debt including the ABS obligations would have been $361.5 million at December 31, 2001 compared to $124.3 million at December 31, 2002.

Free Cash Flow

We use free cash flow as a measurement to manage working capital and capital expenditures. Free cash flow indicates excess cash available to fund additional capital expenditures, to reduce outstanding debt, or to invest in our growth strategies. This measurement is used for internal management purposes and should not be construed as a better measurement than net cash from operating activities as defined by generally accepted accounting principles. The following table illustrates our calculation for determining free cash flow for the years ended December 31:

(in millions)		2002			2001



Net cash from operating activities	$	43.1		$	88.3
Net change in operating activities of discontinued operations		(17.3	)		(76.1	)
Accounts receivable securitizations, net		91.5			35.5
Net property and equipment acquisitions		(82.8	)		(81.4	)
Proceeds from stock options		13.7			16.6

Free cash flow	$	48.2		$	(17.1	)

The improvement of $65.3 million in free cash flow from 2001 to 2002 resulted primarily from increases in income from continuing operations of $13.4 million, claims and insurance of $18.1 million, accounts payable of $19.6 million and other working capital fluctuations of $136.0 million. Increased accounts receivable, resulting from higher revenue levels in 2002 compared to 2001, of $93.7 million mostly offset the improvements. Deferred income taxes also reduced free cash flow by $15.3 million from 2001 to 2002. The remaining variance of $12.8 million largely consisted of changes in stock option proceeds and equity investments.

Other working capital fluctuations resulted primarily from performance incentive accruals, income tax refunds and prefunded benefit contributions. Incentive accruals accounted for $44.0 million of the fluctuation between 2001 and 2002. Due to favorable operating results in 2000, cash incentives of $30.0 million were paid in 2001, causing a decrease in our free cash flow. In 2002, we did not pay cash incentives related to 2001 operating results but did accrue $14.0 million, payable in early 2003, for 2002 performance.We increased the funding of our prefunded benefit contribution by $15.0 million in 2001 from 2000.We also accrued a receivable for income tax refunds of $10.5 million in 2001 that we received in 2002, resulting in a $21.0 million variance.

The items discussed above impact net cash from operating activities in addition to free cash flow. Other variances included in net cash from operating activities were changes in accounts receivable securitizations related to our ABS facility and net operating activities of discontinued operations. In 2001, we reduced ABS obligations by $35.5 million. In 2002, we reduced ABS obligations by $91.5 million, thereby repaying $56.0 million more in 2002 than 2001. Changes in operating activities of discontinued operations relate to SCST activity until the spin-off. The variance primarily results from nine months of activity compared to twelve months and changes in accounts receivable and accounts payable of approximately $33 million.

Nonunion Pension Obligations

We provide defined benefit pension plans for employees not covered by collective bargaining agreements, or approximately 4,000 employees. Increases in our pension benefit obligations combined with market losses in 2002 and 2001 have negatively impacted the funded status of our plans, resulting in additional funding and expense over the next several years. Due to these same factors, we recorded an adjustment in 2002 to shareholders' equity of $30.8 million, net of tax of $17.2 million, to reflect the minimum liability associated with the plans. As we record the additional pension expense, we expect the minimum liability reflected in shareholders' equity to decrease, as reflected in the table below. Using our current plan assumptions of a 9.0 percent return on assets and discount rate of 6.75 percent, we either recorded or expect to record the following:

(in millions)		Cash Funding		Pension Expense	Shareholders' Equity Increase/ (Decrease)



2002 Actual	$	11.5	$	14.4	$	(30.8	)
2003 Expected		35.0		24.0		2.5
2004 Expected		25.0		28.8		5.9

Credit Ratings

We have investment grade credit ratings, with stable outlooks, of Baa3 from Moody's and BBB from Standard & Poor's.We expect to maintain investment grade status for the foreseeable future. However, in the unlikely event we were to be rated below investment grade, no ratings-driven triggers exist that would have an immediate or material adverse impact on our liquidity.

Capital Expenditures

Our capital expenditures focus primarily on the replacement of revenue equipment, land and structures, and additional investments in information technology and acquisitions. As reflected on our Consolidated Balance Sheets, our business remains capital intensive with significant investments in terminal facilities and a fleet of tractors and trailers.We determine the amount and timing of capital expenditures based on numerous factors, including anticipated growth, economic conditions, new or expanded services, regulatory actions and availability of financing.

The table below summarizes our actual net capital expenditures by type:

(in millions)		2002		2001	2000



Revenue equipment	$	72	$	58	$	72
Land, structures and technology		11		23		(1	)
Acquisitions		18		20		5

Total excluding discontinued	$	101	$	101	$	76
Discontinued operations		24		20		59

Total	$	125	$	121	$	135

Capital expenditures for 2002 included the Meridian IQ acquisitions of MegaSys and Clicklogistics for a total of $18 million.We expect 2003 capital spending to approximate $100 to $110 million, including about $65 million for replacement of revenue equipment. Our philosophy is to consistently fund capital expenditures even during economic downturns while still generating free cash flow.We believe our strong financial condition and access to capital, as they exist today, are adequate to fund our anticipated capital expenditures and future growth opportunities.

Our expectation regarding our ability to fund our capital expenditures out of existing financing facilities and cash flow is only our forecast regarding this matter. This forecast may be substantially different from actual results. In addition to the factors previously described in "Forward-Looking Statements", the following factors could affect levels of capital expenditures: the accuracy of our estimates regarding our spending requirements; the occurrence of any unanticipated acquisition opportunities; changes in our strategic direction; and the need to replace any unanticipated losses in capital assets.

Contractual Obligations and Other Commercial Commitments

The following tables provide aggregated information regarding our contractual obligations and commercial commitments as of December 31, 2002. Most of these obligations and commitments have been discussed in detail either in the preceding paragraphs or the notes to the financial statements.

Contractual Cash Obligations

Payments Due by Period

(in millions)

Less than
1 year

2-3 years

4-5 years

After 5 years

Total

Balance sheet obligations:

ABS borrowings

50.0

Long-term debt

24.3

32.5

7.0

10.5

74.3

Off-balance sheet obligations:

Operating leases

26.2

31.6

7.1

5.6

70.5

⁽¹⁾

Total contractual

obligations

100.5

64.1

14.1

16.1

194.8

(1)	The net present value of operating leases, using a discount rate of 10 percent, was $56.3 million at December 31, 2002.

Other Commercial Commitments

The following table reflects other commercial commitments or potential cash outflows that may result from a contingent event.

Amount of Commitment Expiration Per Period

(in millions)

Less than
1 year

2-3 years

4-5 years

After 5 years

Total

Available line of credit

153.8

⁽¹⁾

153.8

Letters of credit

146.2

Lease guarantees for SCST

3.1

2.5

1.0

6.6

Surety bonds

54.7

0.3

1.2

56.2

Total commercial

commitments

204.0

156.6

2.2

362.8

(1)	The line of credit renews in April 2004. Although we have no assurance we will be able to renew the facility, we expect to begin the renewal process well in advance of the expiration and we believe other sources of funding are readily available.

Market Risk Position

We have exposure to a variety of market risks, including the effects of interest rates, foreign currency exchange rates and fuel prices.

Interest Rate Risk

To provide adequate funding through seasonal business cycles and minimize overall borrowing costs, we utilize both fixed rate and variable rate financial instruments with varying maturities. At December 31, 2002, we had approximately 40 percent of our debt at variable rates with the balance at fixed rates.We use an interest rate swap to hedge our exposure to variable interest rates. We hedged 100 percent of our variable debt under the swap agreement at December 31, 2002.

The table below provides information regarding our interest rate risk as of December 31, 2002. For fixed-rate debt, principal cash flows are stated in millions and weighted average interest rates are by contractual maturity. The fair value of fixed-rate debt has been estimated by discounting the principal and interest payments at current rates available for debt of similar terms and maturity. The fair value of variable-rate debt is estimated to approximate the carrying amounts due to the fact that the interest rates are generally set for periods of three months or less, and is excluded from the following table. For the interest rate swap, the table presents the notional amount and contractual interest rate.

(in millions)

2003

2004

2005

2006

2007

There-
after

Total

Fair
Value

Fixed-rate debt

24.3

16.1

16.4

7.0

0.0

10.5

74.3

81.5

Average interest rate

6.00

6.77

6.58

6.71

6.06

Interest rate swap:

Notional amount

50.0

⁽¹⁾

50.0

52.3

Avg. pay rate (fixed)

6.06

Avg. receive rate

(variable)

1.38

(1)	Interest rate swap on the ABS facility. The variable rate is based on the 3-month LIBOR as of December 31, 2002.

Foreign Currency Exchange Rates

Revenue, operating expenses, assets and liabilities of our Canadian and Mexican subsidiaries are denominated in local currencies, thereby creating exposure to fluctuations in exchange rates. The risks related to foreign currency exchange rates are not material to our consolidated financial position or results of operations.

Fuel Price Volatility

Yellow Transportation has an effective fuel surcharge program in place. These programs are well established within the industry and customer acceptance of fuel surcharges remains high. Since the amount of fuel surcharge is based on average, national diesel fuel prices and is reset weekly, our exposure to fuel price volatility is significantly reduced.

Financial Condition