ITEM 1. BUSINESS.
Cotter & Company (the "Company") was organized as a Delaware corporation in 1953. Upon its organization, it succeeded to the business of Cotter & Company, an Illinois corporation organized in 1948. The Company's principal executive offices are located at 8600 West Bryn Mawr Avenue, Chicago, Illinois, 60631-3505. Its telephone number is (773) 695-5000.
The Company is a Member-owned wholesaler of hardware and related merchandise. Historically, it has been the largest cooperative wholesaler of hardware and related merchandise in the United States. The Company also manufactures paint and paint applicators. For reporting purposes, the Company operates in a single industry as a Member-owned wholesaler cooperative.
On December 9, 1996, the Boards of Directors of the Company and ServiStar Coast to Coast Corporation ("SCC") agreed to merge the two companies pursuant to an Agreement and Plan of Merger (the "Merger Agreement"). SCC is a $1,700,000,000 hardware wholesaler with a strong presence in retail lumber and building materials. The transaction is subject to customary closing conditions, including approval by the stockholders of both companies, and is expected to be completed on July 1, 1997. Following completion of the merger, the Company will be renamed TruServ Corporation.
Membership entitles a Member to use certain Company trademarks and trade names, including the federally registered collective membership trademark indicating membership in "True Value(R) Hardware Stores". The "True Value(R)" collective membership mark has a present expiration date of January 2, 2003.
The Company serves approximately 5,300 True Value(R) Hardware Stores throughout the United States. Primary concentrations of Members exist in California (approximately 8%), Illinois and New York (approximately 6% each), Pennsylvania and Texas (approximately 5% each) and Michigan and Wisconsin (approximately 4% each).
The Company's total sales of merchandise to its U.S. Members were divided among the following general classes of merchandise:
The Company serves its Members by functioning as a low cost distributor of goods and maximizing its volume purchasing abilities, primarily through vendor rebates and discount programs, for the benefit of its Members. These benefits are passed along to its Members in the form of lower prices and/or patronage dividends. The Company has numerous individual agreements or commitments from its suppliers, virtually all of which are terminable by such suppliers without cause. Such provisions, either individually or in the aggregate, have not had any material adverse effect on the Company's ability to conduct its business. The goods and services purchased by the Company from these suppliers are generally available from a wide variety of sources. The Company is not dependent upon any one supplier or group of suppliers and has not experienced a problem in obtaining necessary goods. The Company holds conventions and meetings for its Members in order to keep them better informed as to industry trends and the availability of new merchandise. The Company also provides each of its Members with an illustrated price catalog showing the products available from the Company. The Company's sales to its Members are divided into three categories, as follows: (1) warehouse shipment sales (approximately 49% of total sales); (2) direct shipment sales
(approximately 41% of total sales); and (3) relay sales (approximately 10% of total sales). Warehouse shipment sales are sales of products purchased, warehoused, and resold by the Company upon orders from the Members. Direct shipment sales are sales of products purchased by the Company but delivered directly to Members from manufacturers. Relay sales are sales of products purchased by the Company in response to the requests of several Members for a product which is not normally held in inventory and is not susceptible to direct shipment. Generally, the Company will give notice to all Members of its intention to purchase products for relay shipment and then purchase only so many of such products as the Members order. When the product shipment arrives at the Company, it is not warehoused; rather, the Company breaks up the shipment and "relays" the appropriate quantities to the Members who placed orders.
The Company also manufactures paint and paint applicators. The principal raw materials used by the Company are chemicals including among other ingredients, resins, solvents, coalescent extenders and pigments. All raw materials are purchased from outside sources. There are no minimum/maximum purchase obligations with the vendors and they have the right to terminate their agreements at any time. Currently, there is no shortage, nor is any anticipated, of such raw materials which would materially impact operations. The raw materials purchased by the Company from these vendors are generally available from a variety of sources. The Company is not dependent upon any one supplier and has not experienced a problem in obtaining necessary raw materials.
The Company annually sponsors two "markets" (one in the Spring and one in the Fall). In fiscal year 1997, these markets will be held in Atlanta and New Orleans. Members are invited to the markets and generally place substantial orders for delivery during the period prior to the next market. During such markets, new merchandise and seasonal merchandise for the coming season are displayed to attending Members.
As of February 22, 1997 and February 24, 1996, the Company had a backlog of firm orders (including relay orders) of approximately $16,000,000 and $23,000,000 respectively. It is anticipated that the entire backlog existing at February 22, 1997 will be filled by April 1, 1997. The Company's backlog at any given time is made up of two principal components: (i) normal resupply orders and (ii) market orders for future delivery. Resupply orders are orders from Members for merchandise to keep inventories at normal levels. Generally, such orders are filled the day following receipt, except that relay orders for future delivery (which are in the nature of resupply orders) are not intended to be filled for several months. Market orders for future delivery are Member orders for new or seasonal merchandise placed at the Company's two markets, for delivery during the several months subsequent to the markets. Thus, the Company will have a relatively high backlog at the end of each market which will diminish in subsequent months until the next market.
The retail hardware industry is characterized by intense competition. Independent retail hardware businesses served by the Company continue to face intense competition from chain stores, discount stores, home centers and warehouse operations. Increased operating expenses for the retail stores, including increased costs due to longer open-store hours and higher rental costs of retail space, have cut into operating margins and brought pressures for lower merchandise costs, to which the Company has been responsive through a retail oriented competitive pricing strategy on high turnover, price sensitive items (Pinpoint Pricing program). The trueAdvantage(TM) program was introduced in 1995 to promote higher retail standards in order to build consumer loyalty and create a positive image for all True Value(R) stores. The trueAdvantage(TM) program is a voluntary program developed to help Members meet the wants and needs of the retail customer coming into hardware stores. The program establishes twelve standards to be met for the benefit of the retail customer. Included are state-of-the-art, high-tech standards like in-store computerization and participation in the Cotter Satellite Network as well as various "low-tech" essentials. The benefits of being a trueAdvantage(TM) Member include below market-rate business improvement financing and a 5% year-end discount on increases in their warehouse purchases. Over 1,000 Members have committed to the trueAdvantage(TM) program.
The Company competes with other Member-owned and non-member-owned wholesalers as a source of supply and merchandising support for independent retailers. Competitive factors considered by independent retailers in choosing a source of supply include price, service capabilities, promotional support and merchandise selection and quality. Increased operating expenses and decreased margins have resulted in several non-member-owned wholesalers withdrawing from business.
The Company, through a Canadian subsidiary, owns a majority equity interest in Cotter Canada Hardware and Variety Cooperative, Inc., a Canadian wholesaler of hardware, variety and related merchandise. This cooperative serves 505 True Value(R) Hardware and V&S(R) Variety Stores, all located in Canada. The cooperative has approximately 325 employees and generated less than 5% of the Company's consolidated revenue in fiscal year 1996.
The Company operates several other subsidiaries, most of which are engaged in businesses providing additional services to the Company's Members. In the aggregate, these subsidiaries are not significant to the Company's results of operations.
The Company employs approximately 3,500 persons in the United States on a full-time basis. Due to the widespread geographical distribution of the Company's operations, employee relations are governed by the practices prevailing in the particular area and are generally dealt with locally. Approximately 34% of the Company's hourly-wage employees are covered by collective bargaining agreements which are generally effective for periods of three or four years. In general, the Company considers its relationship with its employees to be good.
DISTRIBUTION OF PATRONAGE DIVIDENDS
The Company operates on a cooperative basis with respect to business done with or for Members. All Members are entitled to receive patronage dividend distributions from the Company on the basis of gross margins of merchandise and/or services purchased by each Member. In accordance with the Company's By-Laws and Retail Member Agreement, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors.
Patronage dividends are usually paid to Members within 60 days after the close of the Company's fiscal year; however, the Internal Revenue Code (the "Code") permits distribution of patronage dividends as late as the 15th day of the ninth month after the close of the Company's fiscal year, and the Company may elect to distribute the annual patronage dividend at a later time than usual in accordance with the provisions of the Code.
The Company's By-Laws provide for the payment of year-end patronage dividends, after payment of at least 20% of such patronage dividends in cash, in qualified written notices of allocation including (i) Class B common stock based on book value thereof, to a maximum of 2% of the Member's net purchases of merchandise from the Company for the year (except in unusual circumstances of individual hardships, in which case the Board of Directors reserves the right to make payments in cash), (ii) promissory (subordinated) notes, or (iii) other property. Such promissory (subordinated) notes are for a five year term, bear interest at a fixed rate based on a premium spread above comparable U.S. Treasury notes as approved by the Board of Directors, and are subordinated to all other debt of the Company. The Company may also issue nonqualified written notices of allocation to its Members as part of its annual patronage dividend. See "Payment of Patronage Dividends in Accordance with the Internal Revenue Code."
In determining the form of the annual patronage dividend, a Member's required investment in Class B common stock of the Company had been limited by the Board of Directors to an amount in the aggregate not exceeding an amount (computed on the basis of par value thereof and to the nearest multiple of $100) equal to (i) two percent (2%) of a Member's net purchases of direct shipment sales from the Company and purchases of direct shipment sales of 'Competitive Edge Program Lumber' materials computed separately at one percent (1%), (ii) four percent (4%) of a Member's net purchases of relay sales from the Company and (iii) eight percent (8%) of a Member's net warehouse purchases from the Company in the year of the highest total net purchases of the three preceding years. In 1996, the Board of Directors adopted a plan to continue to adequately capitalize the Company. The percentage method described in items (i) through (iii) has been superseded by the Board of Directors' 1996 plan, which plan is set forth in the Merger Agreement. The annual application of the requirements set forth in the Merger Agreement results in the issuance of a number of shares of Class B common stock, the cumulative value of which will not exceed two percent (2%) of the
Member's net purchases of merchandise from the Company. In that each Member currently has equal voting power (voting rights being limited to Class A common stock), acquisition of Class B common stock as patronage dividends generally results in the larger-volume Members having greater common stock equity in the Company but a lesser proportionate voting power per dollar of common stock owned than smaller-volume Members. See the Merger Agreement for the amounts of Class B common stock a Member is required to acquire through his or her patronage dividend. The indicated percentages are multiplied by the Member's purchase levels of the merchandise categories set forth in the Merger Agreement. The amount of such required investment is determined by majority vote of the Board of Directors, and may be increased or decreased by such vote. The basis for determining the necessity of an increase or decrease is through evaluation of the financial needs of the Company, keeping in mind the needs of the membership. The consideration and method of payment for such shares is by way of the required amount being calculated as part of the annual patronage dividend distribution amount.
PAYMENT OF PATRONAGE DIVIDENDS IN ACCORDANCE WITH THE INTERNAL REVENUE CODE
The Code specifically provides for the taxation of cooperatives (such as the Company) and their patrons (such as the Company's Members) so as to ensure that the business earnings of cooperatives are currently taxable either to the cooperatives or to the patrons.
The shares of Class B common stock, the promissory (subordinated) notes and other written notices, which disclose to the recipient the stated amount allocated to him by the Company and the portion thereof which is a patronage dividend, distributed by the Company to its Members are "written notices of allocation" within the meaning of that phrase as used in the Code. For such written notices to be "qualified written notices of allocation" within the meaning of the Code, it is necessary that the Company pay 20% or more of the annual patronage dividend in cash and that the Members consent to having the allocations (at their stated dollar amount) treated as being constructively received by them and includable in their gross income. Such written notices that do not meet these requirements are "nonqualified written notices of allocation" within the meaning of the Code. Cash, qualified written notices, and other property (except nonqualified written notices of allocation) are currently deducted from earnings in determining the taxable income of the Company and, accordingly such qualified written notices of allocation are includable in gross income of the patron (Member). Section 1385(a) of the Code provides, in substance, that the amount of any patronage dividend which is paid in cash, qualified written notices of allocation or other property (except nonqualified written notices of allocation) shall be included in the gross income of the patron (Member) for the taxable year in which it receives such cash or such qualified written notices of allocation. In general, with respect to nonqualified written notices of allocation, no amounts are deductible by the Company or includible in gross income of the patron (Member) until redeemed by the Company.
Thus, every year each Member may receive, as part of the Member's patronage dividend, non-cash "qualified written notices of allocation", which may include Class B common stock or promissory (subordinated) notes, the stated dollar amount of which must be recognized as gross income for the taxable year in which received. The portion of the patronage dividend paid in cash (at least 20%) may be insufficient, depending on the tax bracket in each Member's case, to provide funds for the payment of income taxes for which the Member will be liable as a result of the receipt of the entire patronage dividend, including cash, Class B common stock and promissory (subordinated) notes.
In response to the provisions of the Code, the Company's By-Laws provide for the treatment of the shares of Class B common stock, promissory (subordinated) notes and such other notices as the Board of Directors may determine, distributed in payment of patronage dividends as "qualified written notices of allocation." The By-Laws provide in effect:
(i) for payment of patronage dividends partly in cash, partly in qualified written notices of allocation (including the Class B common stock and promissory (subordinated) notes as described above), other property or in nonqualified written notices of allocation, and
(ii) that membership in the organization (i.e. the status of being a Member of the Company) shall constitute consent by the Member to take the qualified written notices of allocation or other property into account in the Member's gross income as provided in Section 1385(a) of the Code.
Under the provisions of the Code, persons who become or became Members of the Company or who retained their status as Members after adoption of the By-Laws providing that membership in the organization constitutes consent, and after receiving written notification and a copy of the By-Laws are deemed to have consented to the tax treatment of the cash and the qualified written notices of allocation in which the patronage dividends are paid, in accordance with Section 1385(a) of the Code. Written notification of the adoption of the By-Laws and its significance, and a copy of the By-Laws, were sent to each then existing Member and have been, and will continue to be, delivered to each party that became, or becomes a Member thereafter. Such consent is then effective except as to patronage occurring after the distributee ceases to be a Member of the organization or after the By-Laws of the organization cease to contain the provision with respect to the above described consent. Such consent may be revoked by the Member only by terminating its membership in the Company in the manner provided in its Retail Member Agreement.
Each year since 1978, the Company has paid its Members 30% of the annual patronage dividend in cash in respect to patronage (excluding nonqualified written notices of allocation) occurring in the preceding year. It is the judgment of management that the payment of 30% or more of patronage dividends in cash will not have a material adverse effect on the operations of the Company or its ability to maintain adequate working capital for the normal requirements of its business. However, the Company is obligated to distribute only 20% of the annual patronage dividend (excluding nonqualified written notices of allocation) in cash and it may distribute this lesser percentage in future years.
MERGER
At the Company's Annual Meeting, holders of Class A common stock will be asked to consider and vote upon a proposal to approve the Merger Agreement, including the issuance of the shares of common stock pursuant to the Merger Agreement, amendment and restatement of the Certificate of Incorporation as set forth in the Merger Agreement, ratification of revised By-Laws for TruServ Corporation ("TruServ"), and ratification of the revised form of the Retail Member Agreement as set forth in the Merger Agreement. The Amended and Restated Certificate of Incorporation will, among other things, increase the number of authorized shares of Class A common stock to 750,000 shares and the number of Class B common stock to 4,000,000 shares, eliminate cumulative voting, eliminate the requirement that all stockholders own the same number of shares of Class A common stock and change the name of the Company to TruServ. At the same meeting, holders of Class B common stock will be asked to consider and vote upon approving the increase in the number of authorized shares of Class B common stock to 4,000,000 shares. By approving the Merger, Members will be voting to increase their investment in TruServ with respect to the same retail stores for which they have already made their existing investment.
Votes Required; Record Date. Approval of the Merger Proposal requires the affirmative vote of the holders of a majority of the Company's outstanding shares of Class A common stock. Holders of Class A common stock are entitled to one vote per share on all matters. Approval of the proposal to increase the maximum authorized amount of Class B common stock requires the affirmative vote of the holders of a majority of the outstanding shares of Class B common stock. Holders of Class B common stock are entitled to one vote per share on such proposal. Only holders of the Company's Stock at the close of business on February 10, 1997 (the "Record Date") are entitled to notice of and to vote at the Company's Annual Meeting.
Conversion of Securities. Upon consummation of the transactions contemplated by the Merger Agreement, (i) SCC will be merged with and into the Company, with the Company being the surviving corporation (and thereafter known as TruServ Corporation), and (ii) each outstanding share of SCC common stock and SCC Series A stock (excluding those shares thereof canceled pursuant to Article III of the Merger Agreement) will be converted into the right to receive one fully paid and non-assessable share of TruServ Class A common stock and each two outstanding shares of SCC preferred stock will be converted into the
right to receive one fully paid and non-assessable share of TruServ Class B common stock. No fractional shares of TruServ stock will be issued in connection with such exchange. Cash will be delivered in lieu of fractional or canceled shares. Based on the number of shares of SCC stock outstanding on the SCC record date, it is expected that approximately 262,348 and 1,083,752 shares of TruServ Class A common stock and Class B common stock, respectively, will be issued in connection with the Merger. It is anticipated that an additional approximately 250,000 shares of TruServ Class A common stock will be purchased by those pre- Merger stockholders of the Company to satisfy the new Class A common stock ownership requirement applicable to such Members as contemplated by the Merger Agreement.
Retail Member Agreement. After the Effective Time of the Merger, all the Company's Members, and those SCC Members who voted in favor of the Merger Agreement, will be governed by the form of Retail Member Agreement attached to the Merger Agreement as Exhibit 3.8. Such Retail Member Agreement is an amendment and restatement of the existing Retail Member Agreement. All the Company stockholders, regardless of their vote for or against the Merger or their abstention from such vote, will be deemed to be bound by the agreement, as amended. A vote to approve the Merger Agreement by an SCC Member will be deemed to constitute that Member's agreement to accept and be bound by the terms of the Retail Member Agreement, in cancelation and replacement of such SCC Member's existing Retailers/Distributors Agreement(s) with SCC. The Hardware/Lumber Operations of such Member will after the Effective Time be conducted as part of the cooperative activities of TruServ and be governed by the Certificate of Incorporation, By-Laws and Retail Member Agreement of TruServ as in effect from time to time. The SCC Membership Agreement of each SCC Member voting against the Merger, or abstaining with respect thereto, together with any related license or franchise agreements, shall be assigned by SCC to TruServ without further action, subject to any terminations and replacements as may be agreed upon between each such SCC Member and TruServ. Whether or not an individual Member votes for, against or abstains from the Merger, if the Merger is approved by the requisite vote of SCC and the Company's Members, going forward all Members will belong to and be a part of TruServ, sharing in the benefits and advantages of membership in the new cooperative. The TruServ Class A common shares received by SCC Members as a result of the Merger will satisfy applicable Class A common stock ownership requirements for such Members. As members of TruServ, all Members will be bound by TruServ's By-Law consent provision.
ITEM 2.
ITEM 2. PROPERTIES.
The Company's national headquarters is located in Chicago, Illinois. Information with respect to the Company's owned and leased warehousing and office facilities is set forth below:
No location owned by the Company is subject to a mortgage.
In December 1983, the Company completed construction of a 150,000 square foot addition to its regional distribution center in Manchester, New Hampshire. This addition was financed with the proceeds from the sale of $4,000,000 State of New Hampshire Industrial Development Authority Revenue Bonds (Cotter & Company Project) Series 1982. On October 1, 1997, and every three-year period thereafter, the interest rate on the 5.28% industrial revenue bonds will be adjusted based on a bond index. These bonds may be redeemed at face value at either the option of the Company or the bondholders at each interest reset date through maturity in 2003.
In August 1995, the Company closed, but is currently sub-leasing, a portion of the 720,000 square foot Harvard, Illinois facility formerly used to manufacture outdoor power equipment.
In 1996, the Company closed the 980,000 square foot Chicago, Illinois facility formerly used as the Company's national headquarters. The facility is available for sale.
Information with respect to the Company's manufacturing facilities is set forth below:
The Company's facilities are suitable for their respective uses and are, in general, adequate for the Company's present needs.
The Company owns and leases transportation equipment for use at its regional distribution centers for the primary purpose of delivering merchandise from the Company's regional distribution centers to its Members. Additional information concerning these leases can be found in Notes 3 and 5 to the consolidated financial statements included elsewhere herein.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is no existing market for the common stock of the Company and there is no expectation that any market will develop. The Company's Class A common stock is owned almost exclusively by retailers of hardware and related products each of whom is a Member of the Company and purchases ten shares (which number will increase to 60 after consummation of the Merger described in Item 1 above) of the Company's Class A common stock (the only class of voting stock) upon becoming a Member. The Company is organized as a Delaware stock corporation and operates as a Member-owned wholesaler cooperative corporation. The shares of the Company's Class B common stock now outstanding were issued to Members in partial payment of the annual patronage dividend to which they became entitled as a result of patronage business done by such Members with the Company. In accordance with the Company's By-Laws, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors.
The number of holders of record (as of February 22, 1997) of each class of stock of the Company is as follows:
Dividends (other than patronage dividends) on the Class A common stock and Class B common stock, subject to the provisions of the Company's Certificate of Incorporation, may be declared out of gross margins of the Company, other than gross margins from operations with or for Members and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors. Dividends may be paid in cash, in property, or in shares of the common stock, subject to the provisions of the Certificate of Incorporation. Other than the payment of patronage dividends, including the redemption of all nonqualified written notices of allocation, the Company has not paid dividends on its Class A common stock or Class B common stock. The Board of Directors does not plan to pay dividends on either class of common stock. See the discussion of patronage dividends under Item 1 - -Business.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA
- --------------- (a) The book value per share of the Company's Class A common stock and Class B common stock is the value, determined in accordance with generally accepted accounting principles, of such shares as shown by the respective year-end consolidated balance sheets of the Company, included elsewhere herein as reported on by the Company's independent auditors, after eliminating therefrom all value for goodwill, and other intangible assets and any retained earnings specifically appropriated by the Company's Board of Directors.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
FISCAL YEAR 1996 COMPARED TO FISCAL YEAR 1995
In fiscal year 1996, the Company's revenues were $2,441,707,000, an increase of 0.2% from fiscal year 1995. Current year revenues were influenced by the 1995 phase-out of the V&S(R) Variety and General Power Equipment divisions. Comparable store revenues increased 4.4% due to improved Member participation. Fiscal year 1996 revenue increases were concentrated in the core merchandise categories of Electrical and Plumbing, up 4.0%, Painting and Cleaning, up 5.0%, Farm and Garden, up 3.8% and Lumber and Building Materials, up 2.4%. Additionally, the Company continued to pursue business opportunities such as International and trueAdvantage, which both increased 14.2%. Also, the Company further expanded the Pinpoint Pricing program to further reduce the selling price of many core hardware and related products.
Overall gross margins, as a percent of revenues, decreased for the fifth year in a row to 8.1% from 8.3% in fiscal year 1995. The reduction in gross margin was the result of a more competitive pricing strategy, which included the expanded Pinpoint Pricing program that resulted in a $7,100,000 price reduction to the Members. Other strategies, predominantly the trueAdvantage program, returned an additional $2,000,000 to the Members.
Warehouse, general and administrative expenses increased slightly compared to the prior year but as a percent of revenues remained comparable at 4.7% with the prior year, due to management's continued effort
to control operating expense and an expense recovery associated with prior years' favorable risk loss experience.
Certain estimates of warehouse, general and administrative expenses are recorded throughout the year including expenses related to incurred but not reported healthcare claims, premiums for comprehensive insurance, capitalizable inventory related costs and other expense items. During the fourth quarter of fiscal 1996, the Company recorded approximately $11 million of net reductions in warehouse, general and administrative expenses relating to the refinement of these estimates recorded in the prior three quarters, a refund of insurance premiums of approximately $7 million and cost recoveries from manufacturers of approximately $5 million related to the Fall market.
Interest paid to Members decreased by $2,167,000 or 10.5% primarily due to a lower principal balance and lower average interest rates.
Other interest expense increased by $877,000 or 9.4% compared to last year primarily due to higher short-term borrowings partially offset by a lower average interest rate.
Net margins were $52,410,000 for the year ended December 28, 1996 compared to $59,037,000 for the year ended December 30, 1995.
FISCAL YEAR 1995 COMPARED TO FISCAL YEAR 1994
In fiscal year 1995, the Company's revenues were $2,437,002,000, a decrease of 5.3% from fiscal year 1994. This decrease was attributable to the phase-out of the V&S(R) Variety division and the sale of the General Power Equipment manufacturing division. Comparable sales categories were flat with the prior year due to the soft economy and unusual weather in the United States, combined with the declining sales in Mexico. In addition, the Company expanded the Pinpoint Pricing program which reduced the selling price of many core hardware and related products.
Overall merchandise gross margins, as a percentage of revenues, decreased for the fourth year in a row. This reduction in gross margin percentage was the result of an expanded Pinpoint Pricing program and the withdrawal from the resigned businesses of V&S(R) Variety division and General Power Equipment manufacturing division.
Warehouse, general and administrative expenses decreased by $18,652,000 or 14.0% compared to the prior year. As a percentage of revenue, these expenses were 4.7% in 1995 compared to 5.2% in 1994. The decrease in operating expenses was attributable to continued efforts to reduce operating costs, an expense recovery associated with prior years' favorable risk loss experience and efficiencies derived from the resigned businesses.
Interest paid to Members decreased by $2,267,000 or 9.9% primarily due to a lower average principal balance and a decrease in the average interest rate.
Other interest increased due to the increase in the Company term note program.
Net margins were $59,037,000 for the year ended December 30, 1995 compared to $60,318,000 for the year ended December 31, 1994.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased from $22,473,000 at December 30, 1995, to $1,662,000 at December 28, 1996. This decrease was primarily due to cash flow used for operating activities. Cash used for operating activities was $9,609,000 for the year ended December 28, 1996 compared to cash flow provided by operating activities of $106,640,000 for the year ended December 30, 1995. The decrease in cash flow from operating activities resulted from increased inventory levels to better service the needs of Members with expanded inventory selection and improved service levels. Inventory levels increased by $32,243,000 in fiscal year 1996 compared to a $69,436,000 decrease in fiscal year 1995. Additionally, accounts and notes receivables used cash flow from operating activities of $38,581,000 due to seasonal payment terms extended to Members.
Cash flows of $21,767,000 used for investing activities increased slightly from the previous fiscal year.
These uses of cash flows were funded by financing activities which provided cash flow of $10,565,000 in fiscal year 1996.
At December 28, 1996, net working capital decreased slightly to $201,304,000 from $202,999,000 at December 30, 1995. The current ratio decreased to 1.43 at December 28, 1996 from 1.47 at December 30, 1995.
The Company has established a $125,000,000 five-year revolving credit facility with a group of banks. In addition, the Company has various short-term lines of credit available under informal agreements with lending banks, cancelable by either party under specific circumstances. The Company pays commitment fees for these lines. The borrowings under these agreements were $70,594,000 at December 28, 1996 and $2,657,000 at December 30, 1995. In addition, the Company has a private shelf agreement with available borrowings up to $50,000,000.
The Company's capital is primarily derived from Class A common stock and retained earnings, together with promissory (subordinated) notes and nonvoting Class B common stock issued in connection with the Company's annual patronage dividend. Funds derived from these capital resources are usually sufficient to satisfy long-term capital needs.
Total capital expenditures, including those made under capital leases, were $23,708,000 in fiscal year 1996 compared to $28,912,000 in fiscal year 1995 and $21,427,000 in fiscal year 1994. These capital expenditures were principally related to additional equipment and technological improvements at the regional distribution centers and national headquarters. Funding of capital expenditures in fiscal year 1997 is anticipated to come from operations and external sources if necessary.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's consolidated financial statements and report of independent auditors are listed on Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The directors and executive officers of the Company are:
- --------------- During the past five years, the principal occupation of each director of the Company, other than Daniel A. Cotter, was the operation of retail hardware stores.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION COMMITTEE
The Management Development and Compensation Committee of the Board of Directors (the "Committee") consists of five non-employee directors: Samuel D. Costa, Jr. (Chairman), Jerrald T. Kabelin, Lewis W.
Moore , Kenneth M. Noble and Dennis A. Swanson. In addition, Robert J. Ladner, Chairman of the Board of Directors, and Daniel A. Cotter, President and Chief Executive Officer, served as ex-officio members of the Committee. The Committee assists the Board of Directors in fulfilling its responsibilities for setting and administering the policies which govern annual compensation and monitoring the Company's pension and certain other benefit plans. The Committee calls upon outside consultants for assistance, as necessary.
The Committee meets at least annually. In fiscal year 1996, the Committee met on three occasions. Primary responsibilities of the Committee include:
- Establishing the President's salary and annual and long-term incentive opportunities.
- Approving other executive officer salaries recommended by the President.
- Setting performance goals for the annual and long-term incentive plans.
- Assessing performance achievement relative to goals and approving incentive payments.
The Committee makes recommendations to the Board of Directors regarding compensation of the Company's executive officers. The philosophy of the Committee is to maintain an executive compensation program to help the Company attract, retain and motivate the executive resources needed to maintain industry leadership, provide high levels of service to Members, and achieve the financial objectives as determined by the Board of Directors.
To achieve its stated goals, the Company has developed three executive compensation policies.
- The Company provides levels of salaried compensation that are competitive.
- The Company provides annual incentive compensation for executives that vary in a consistent and predictable manner with the performance of the Company.
- The Company provides an incentive program which enables selected executives to achieve incentive awards based on the long-term (multiple year) performance of the Company.
The combination of these three compensation policies is intended to provide competitive earnings opportunities when performance reaches desired levels. Both the annual and long-term incentive plans are cancelable by the Board of Directors at any time.
The Company provides salary levels that are competitive with the median (50th percentile) of the executive marketplace. The industry comparison groups used to evaluate competitiveness include: member owned organizations, wholesale distribution firms, mass merchandising firms and general industry and manufacturing organizations. Competitiveness is measured using data from a number of sources, including published information, proxies and surveys by consulting firms.
The annual incentive plan is designed to ensure that executive compensation varies in relation to achievement of annual performance goals. In fiscal year 1996, the plan's overall Company goal was based on achieving Member payout and revenue objectives. Each executive's incentive award was determined by Member payout results.
The long-term incentive plan assures a continuing focus on the Company's future. Goals are set for performance achievement over three-year intervals. A new performance period starts each year and goals for each three-year cycle currently underway are related to achievement of revenue growth.
EXECUTIVE COMPENSATION
The following table sets forth the total annual compensation paid to the Company's five most highly compensated executive officers during fiscal year 1996 and the total compensation paid to each such individual for the Company's two previous fiscal years:
SUMMARY COMPENSATION TABLE
- --------------- (1) Annual bonus amounts are earned and accrued during the fiscal years indicated, and paid subsequent to the end of each fiscal year.
(2) Other compensation consists primarily of Company contributions to the Cotter & Company Employee's Savings and Compensation Deferral Plan (the "Savings Plan"). Under the Savings Plan, each participant may elect to make a contribution in an amount of up to ten percent (10%) of his annual compensation, not to exceed $30,000 (including Company contributions) a year, of which $9,500 of the executive officer's salary in fiscal year 1996 may be deferred. The Company's contribution to the Savings Plan is equal to seventy-five percent (75%) of the participant's contribution, but not to exceed four and one-half percent (4 1/2%) of the participant's annual compensation. Mr. Porter's other compensation includes $56,891 of relocation payments in fiscal year 1994.
(3) Steven J. Porter and David W. Christmas resigned from their positions in the first quarter of 1997.
Daniel A. Cotter is employed under a long-term contract which commenced January 1, 1985 for a period of 15 years terminating December 31, 1999. Mr. Cotter agreed, in 1990, to revise his contract to conform his compensation to that applicable to all other executives.
The Company has a severance policy providing termination benefits based upon annual compensation and years of service. Officers of the Company are also offered agreements providing for severance in the event of termination with the imposition of certain restrictions regarding competition and confidentiality.
No loans were made by the Company to its executive officers or to its directors during the last three fiscal years.
LONG-TERM PERFORMANCE CASH AWARDS
The Board of Directors adopted a long-term incentive plan for selected senior executive officers of the Company. Senior executives of the Company are eligible for cash payouts ranging from 10% to 75% of their annual salary if performance goals established for the plan are met. Performance goals for the current plans relate to the achievement of revenue growth.
A new plan starts each year with goals set for the next three-year period. A range of estimated payouts which could be earned by the individuals listed in the Summary Compensation Table in fiscal year 1997, and paid in fiscal year 1998 is shown in the following table:
DEFINED BENEFIT RETIREMENT PLANS
The Company has a defined benefit pension plan, the Cotter & Company Defined Lump Sum Pension Plan (the "Plan"), which is qualified under the Code. The Plan was amended and restated effective January 1, 1996. The amount of the Company's annual contribution to the Plan is determined for the total of all participants covered by the Plan, and the amount of payment with respect to a specified person is not and cannot readily be separated or individually calculated by the actuaries for the Plan. The Plan provides fully vested lump sum benefits to eligible employees who have served a minimum of five years of service. Annuities are also available and are the actuarial equivalent of the lump sum payment. Each of the executive officers listed in the foregoing Summary Compensation Table is a participant in the Plan.
For each year of service, a participant receives a percentage of his or her "average compensation" in the form of a lump sum. The percentages range from two percent of average compensation for years of service performed prior to age 26, to twelve percent of average compensation for years of service performed at or after age 61. Participants with average compensation in excess of two-thirds of the Social Security Taxable Wage Base in the year of termination of employment or retirement receive an additional benefit on this excess compensation equal to half of the percentage applied to their full average compensation. Participants who were age 50 with at least fifteen years of service as of January 1, 1996 receive an additional 25% of their average compensation. The benefits under the Plan cannot be less than benefits already earned by the participant under the Plan as it existed prior to its amendment.
"Average compensation" means the average of the compensation received by an eligible employee during the three highest consecutive calendar years within the ten consecutive calendar years immediately preceding the date of termination of employment. Compensation considered in determining benefits includes salary, overtime pay, commissions, bonuses, deferral contributions under the Savings Plan, and pre-tax medical premiums.
The Company amended and restated effective January 1, 1996, a Supplemental Retirement Plan (the "Supplemental Plan") for certain employees as designated by the Company's President and Chief Executive Officer. For each year of service, participants receive a percentage of their "average compensation" in the form of a lump sum. The percentages are 22 percent of average compensation for years of service performed prior to age 55, to 28 percent of average compensation for years of service performed at or after age 55. Service is limited to 20 years, and the maximum aggregate percentage is 500%. This amount is reduced by any benefits payable under the Plan and eight times the participant's primary Social Security benefit. "Average Compensation" for the Supplemental Plan is defined the same as for the Plan, as discussed above. The benefits under the Supplemental Plan cannot be less than benefits already earned by the participant under the Supplemental Plan as it existed prior to its amendment.
The Supplemental Plan is not a qualified plan under the Code. Benefits payable under the Supplemental Plan will be financed through internal operations. The estimated annual retirement benefits which may be payable pursuant to the Plan to the officers named in the Summary Compensation Table is currently limited under Section 401(a)(17) of the Code, which outlines the maximum earnings amounts which may be considered under the Plan in determining retirement benefits. This limit is $160,000 for 1997. Section 415 of the Code outlines the maximum annual benefit which may be payable from the Plan during the year; The dollar limit is $125,000 for 1997 for a participant retiring at age 65, with reduced amounts at younger ages. The actuarial equivalent of the annual amount may be payable as a lump sum.
The following table reflects the combined estimated annual retirement benefits which may be payable pursuant to the Plan and the Supplemental Plan to the officers named in the Summary Compensation Table at retirement under various assumed conditions, assuming retirement at age 65.
The present credited years of service for the officers listed in the above table are as follows: Daniel A. Cotter, 30 years; Kerry J. Kirby, 21 years and Daniel T. Burns, 16 years.
There is no existing market for the Company's common stock and there is no expectation that any market will develop. There are no broad market or peer group indexes the Company believes would render meaningful comparisons. Accordingly, a performance graph of the Company's cumulative total stockholder return for the previous five years, with a performance indicator of the overall stock market for the Company's peer group, has not been prepared.
In fiscal year 1996, directors of the Company were each paid $1,500 per month. The Chairman of the Board is paid $1,000 per day to a maximum of $100,000 per year, when serving in the capacity as Chairman.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
As of February 22, 1997, each of the directors of the Company was the beneficial owner of 10 shares of Class A common stock of the Company comprising .3% of such shares issued and outstanding. Other than Daniel A. Cotter, no executive officer owns any shares of Class A common stock.
The directors own in the aggregate approximately 1.7% of Class B common stock as of February 22, 1997. No executive officer owns any shares of Class B common stock.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying index (page) to the consolidated financial statements are filed as part of this annual report.
2. FINANCIAL STATEMENT SCHEDULES
No schedules have been filed because the required information is not applicable or is not material or because the required information is included in the consolidated financial statements or the notes thereto.
3. EXHIBITS
The exhibits listed on the accompanying index to exhibits (pages E-1 and E-2) are filed as part of this annual report.
(B) REPORTS ON FORM 8-K
1. Current Report on Form 8-K, dated as of December 17, 1996.
2. Current Report on Form 8-K, dated as of March 5, 1997.
3. Form 8-K/A Amendment to Current Report on Form 8-K, dated as of March 26, 1997.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS ANNUAL REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
COTTER & COMPANY
By: /s/ KERRY J. KIRBY
-------------------------------------- Kerry J. Kirby, Vice President, Treasurer and
DATED: March 27, 1997 Chief Financial Officer
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS ANNUAL REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
ITEM 14(A). INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.
------------------------------------- THIS PAGE INTENTIONALLY LEFT BLANK -------------------------------------
REPORT OF INDEPENDENT AUDITORS
To the Members and the Board of Directors Cotter & Company
We have audited the accompanying consolidated balance sheets of Cotter & Company as of December 28, 1996 and December 30, 1995, and the related consolidated statements of operations, cash flows and capital stock and retained earnings for each of the three years in the period ended December 28, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cotter & Company at December 28, 1996 and December 30, 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 28, 1996, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Chicago, Illinois February 10, 1997
COTTER & COMPANY
------------------
CONSOLIDATED BALANCE SHEET
ASSETS
See Notes to Consolidated Financial Statements.
COTTER & COMPANY
------------------
CONSOLIDATED BALANCE SHEET
LIABILITIES AND CAPITALIZATION
See Notes to Consolidated Financial Statements.
COTTER & COMPANY
------------------
CONSOLIDATED STATEMENT OF OPERATIONS
See Notes to Consolidated Financial Statements.
COTTER & COMPANY
------------------
CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Consolidated Financial Statements.
COTTER & COMPANY
------------------
CONSOLIDATED STATEMENT OF CAPITAL STOCK AND RETAINED EARNINGS
FOR THE THREE YEARS ENDED DECEMBER 28, 1996
- --------------- Subscribed Class A common stock amounts are net of unpaid amounts of $1,000 at December 28, 1996, December 30, 1995 and December 31, 1994 and $14,000 at January 1, 1994 (for 290, 240, 360, and 590 shares subscribed, respectively).
See Notes to Consolidated Financial Statements.
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND ACCOUNTING POLICIES
Cotter & Company (the Company) is a Member-owned wholesaler of hardware and related merchandise. The Company also manufactures paint and paint applicators. The Company's goods and services are sold predominantly within the United States, primarily to retailers of hardware and related lines, each of whom has purchased ten shares of the Company's Class A common stock upon becoming a Member. The Company operates in a single industry as a Member-owned wholesaler cooperative. All Members are entitled to receive patronage dividend distributions from the Company on the basis of gross margins of merchandise and/or services purchased by each Member. In accordance with the Company's By-laws, the annual patronage dividend is paid to Members out of gross margins from operations and other patronage source income, after deduction for expenses and provisions authorized by the Board of Directors.
On December 9, 1996, the Boards of Directors of the Company and ServiStar Coast to Coast Corporation agreed to merge the two companies. ServiStar Coast to Coast is a $1,700,000,000 hardware wholesaler with a strong presence in retail lumber and building materials. The transaction is subject to customary closing conditions, including approval by the stockholders of both companies, and is expected to be completed on July 1, 1997. Following completion of the merger, the Company will be renamed TruServ Corporation.
The significant accounting policies of the Company are summarized below:
Consolidation. The consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries. The consolidated financial statements also include the accounts of Cotter Canada Hardware and Variety Cooperative, Inc., a Canadian Member-owned wholesaler of hardware, variety and related merchandise, in which the Company has a majority equity interest.
On January 13, 1995, the Company agreed to the sale of certain inventory of its V&S(R) Variety division to a national wholesaler who agreed to supply the majority of the V&S(R) Stores. Also, on January 31, 1995, the Company sold certain assets of its outdoor power equipment manufacturing division to a nationally recognized company and secured a favorable supply agreement for such equipment. These transactions did not have a material impact on the Company's results of operation or financial position.
Capitalization. The Company's capital (Capitalization) is derived from Class A voting common stock and retained earnings, together with promissory (subordinated) notes and Class B nonvoting common stock issued in connection with the Company's annual patronage dividend. The By-laws provide for partially meeting the Company's capital requirements by payment of the year-end patronage dividend, of which at least twenty percent must be paid in cash, and the balance in five-year promissory (subordinated) notes and $100 par value Class B common stock.
Membership may be terminated without cause by either the Company or the Member upon sixty days' written notice. In the event membership is terminated, the Company undertakes to purchase, and the Member is required to sell to the Company, all of the Member's Class A common stock and Class B common stock at book value. Payment for the Class A common stock will be in cash. Payment for the Class B common stock will be a note payable in five equal annual instalments bearing interest at the same rate per annum as the promissory (subordinated) notes most recently issued as part of the Company's patronage dividend.
Cash equivalents. The Company classifies its temporary investments in highly liquid debt instruments, with an original maturity of three months or less, as cash equivalents.
Inventories. Inventories are stated at the lower of cost, determined on the "first-in, first-out" basis, or market.
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Properties. Properties are recorded at cost. Depreciation and amortization are computed by using the straight-line method over the following estimated useful lives: buildings and improvements--10 to 40 years; machinery and warehouse, office and computer equipment--5 to 10 years; transportation equipment--3 to 7 years; and leasehold improvements--the life of the lease without regard to options for renewal.
Revenue Recognition. The Company recognizes revenue when merchandise is shipped or services are rendered.
Retirement plans. The Company sponsors two noncontributory defined benefit retirement plans covering substantially all of its employees. Company contributions to union-sponsored defined contribution plans are based on collectively bargained rates times hours worked. The Company's policy is to fund annually all tax-qualified plans to the extent deductible for income tax purposes.
Use of estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reporting year. The Company's reporting year-end is the Saturday closest to December 31.
2. INVENTORIES
Inventories consisted of:
3. PROPERTIES
Properties owned or leased under capital leases consisted of:
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. LONG-TERM DEBT AND BORROWING ARRANGEMENTS
Long-term debt consisted of:
Principal payments for the 8.60% senior note are due quarterly in incrementally increasing amounts through maturity in 2007.
Principal payments for the 5.97% term loan are due quarterly beginning in 1996 through maturity in 1999. Payment for the variable term loan is due in 1999.
The redeemable (subordinated) term notes have two to four year terms and are issued in exchange for promissory (subordinated) notes that were held by promissory note holders, who do not own the Company's Class A common stock. Also, effective October 1, 1996 the term notes were opened for purchase by investors that are affiliated with the Company.
On October 1, 1997, and every three-year period thereafter, the interest rate on the 5.28% industrial revenue bonds will be adjusted based on a bond index. These bonds may be redeemed at face value at the option of either the Company or the bondholders at each interest reset date through maturity in 2003.
Total maturities of long-term debt for fiscal years 1997, 1998, 1999, 2000, 2001 and thereafter are $8,640,000, $16,481,000, $17,574,000, $7,625,000, $4,000,000 and $32,000,000, respectively.
The Company has established a $125,000,000 five-year revolving credit facility with a group of banks. In addition, the Company has various short-term lines of credit available under informal agreements with lending banks, cancelable by either party under specific circumstances. The borrowings under these agreements were $70,594,000 at December 28, 1996 and were at a weighted average interest rate of 5.5%. At December 30, 1995, the Company's Canadian subsidiary had short-term borrowings at an interest rate of 7.5%.
The Company is required to meet certain financial ratios and covenants pertaining to certain debt arrangements.
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. CAPITAL LEASES AND OTHER LEASE COMMITMENTS
The Company rents buildings and warehouse, office, computer and transportation equipment under operating and capital leases. The following is a schedule of future minimum lease payments under long-term non-cancelable leases, together with the present value of the net minimum lease payments, as of December 28, 1996:
Capital leases expire at various dates and generally provide for purchase options but not renewals. Purchase options provide for purchase prices at either fair market value or a stated value which is related to the lessor's book value at expiration of the lease term.
Rent expense under operating leases was as follows:
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. CAPITALIZATION
Promissory (subordinated) and instalment notes consisted of:
The promissory notes are issued principally in payment of the annual patronage dividend. Promissory notes are subordinated to indebtedness to banking institutions, trade creditors and other indebtedness of the Company as specified by its Board of Directors. Notes to be issued relate to the patronage dividend which is distributed after the end of the year. Prior experience indicates that the maturities of a significant portion of the notes due within one year are extended, for a three year period, at interest rates substantially equivalent to competitive market rates of comparable instruments. The Company anticipates that this practice will continue.
Total maturities of promissory and instalment notes for fiscal years 1997, 1998, 1999, 2000 and 2001 are $33,454,000, $42,690,000, $64,603,000, $52,950,000 and $25,123,000, respectively.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
Due to the uncertainty of the ultimate maturities of the promissory (subordinated) notes, management believes it is impracticable to estimate their fair value. The carrying amounts of the Company's other financial instruments approximate fair value. Fair value was estimated using discounted cash flow analyses, based on the Company's incremental borrowing rate for similar borrowings.
8. INCOME TAXES
At December 28, 1996, the Company has alternative minimum tax credit carryforwards of approximately $900,000 which do not expire. The carryforwards are available to offset future federal tax liabilities.
Significant components of the Company's deferred tax assets and liabilities as of December 28, 1996 resulted primarily from alternative minimum tax credit carryforwards and temporary differences between
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
income tax and financial reporting for depreciation, inventory capitalization, bad debts, vacation pay and contributions to fund retirement plans.
Significant components of the provision (benefit) for income taxes are as follows:
The Company operates as a nonexempt cooperative and is allowed a deduction in determining its taxable income for amounts paid as patronage dividend based on margins from business done with or for Members. The reconciliation of income tax expense to income tax computed at the U.S. federal statutory tax rate of 35% in fiscal year 1996, 1995 and 1994 is as follows:
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
9. CASH FLOW
The Company's noncash financing and investing activities in fiscal year 1996 and 1995 include acquisition of transportation equipment by entering into capital leases and the acquisition of property for resale. These transactions aggregate $178,000 and $4,008,000 in fiscal years 1996 and 1995, respectively. In addition, the annual patronage dividend and promissory (subordinated) note renewals relating to noncash operating and financing activities are as follows:
Cash paid for interest during fiscal years 1996, 1995 and 1994 totaled $28,694,000, $29,624,000 and $30,583,000, respectively. Cash paid for income taxes during fiscal years 1996, 1995 and 1994 totaled $694,000, $1,012,000 and $1,709,000, respectively.
10. RETIREMENT PLANS
The components of net pension cost for the Company administered pension plans consisted of:
The discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were respectively, 7.75% and 4.50% in fiscal year 1996, 7.25% and 4.50% in fiscal year 1995 and 8.50% and 4.50% in fiscal year 1994. These changes in actuarial assumptions did not have a material impact on net pension cost for fiscal years 1996 and 1995 and the Company does not
COTTER & COMPANY
------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
anticipate that these changes will have a material impact on net pension cost in future years. In fiscal years 1996, 1995 and 1994, the expected long-term rate of return on assets was 9.50%. During 1995, the Company amended its pension plan, and such amendment had no material impact on the projected benefit obligation or pension expense. During 1996, the Company settled $8,520,000 of pension obligations under it's amended plan that resulted in a reduction of $798,000 in pension expense for fiscal year 1996.
Plan assets are composed primarily of corporate equity and debt securities. Benefits are based on years of service and the employee's compensation during the last ten years of employment, offset by a percentage of Social Security retirement benefits. Trusteed net assets and actuarially computed benefit obligations for the Company administered pension plans are presented below:
The Company also participates in union-sponsored defined contribution plans. Pension costs related to these plans were $641,000, $720,000 and $757,000, for fiscal years 1996, 1995 and 1994, respectively.
INDEX TO EXHIBITS
E-1
E-2
E-3