ITEM 1. BUSINESS
GENERAL
The Company, with annual net sales of almost $2.4 billion in 1997, is one of the largest broad-line, full-service wholesale distributors of packaged consumer products to the convenience retail industry in western North America. The Company's principal customers include traditional and petroleum convenience stores, grocery stores, drug stores, mass merchandisers and liquor stores. The Company offers its customers a wide variety of products including cigarettes, candy, snacks, fast food, groceries, health and beauty care products and other general merchandise.
The Company's principal markets include the western United States and western Canada. The Company services its United States customers from 15 distribution facilities, seven of which are located in California. In Canada, the Company services its customers from four distribution facilities.
HISTORY
The Company's origins date back to 1888, when Glaser Bros., a family-owned-and-operated candy and tobacco distribution business, was founded. In late 1994, the Company repurchased the common stock in the Company from its previous ownership. In early 1995, members of senior management and certain lenders acquired equity in a new holding company which held all of the stock of the Company. In August 1996, the Company completed a recapitalization. The Company's equity is now held 75% by Jupiter Partners, L.P. ("Jupiter") and 25% by senior management.
INDUSTRY OVERVIEW
Wholesale distributors provide valuable services to both manufacturers of consumer products and convenience retailers. Manufacturers benefit from wholesale distributors' broad retail coverage, inventory management and efficient processing of small orders. Wholesale distributors provide convenience retailers access to a broad product line, the ability to place small quantity orders, inventory management and access to trade credit. In addition, large full-service wholesale distributors such as the Company offer retailers the ability to participate in manufacturer-sponsored marketing programs, merchandising and category management services and systems focused on minimizing customers' investment in inventory.
The wholesale distribution industry is highly fragmented and has historically consisted of a large number of small, privately-owned businesses and a small number of large, full-service wholesale distributors serving multiple geographic regions. Relative to smaller competitors, large distributors such as the Company benefit from several competitive advantages, including purchasing power, the ability to service chain accounts, economies of scale in sales and operations, the ability to spread fixed corporate costs over a larger revenue base and the resources to invest in Management Information Services ("MIS") and other productivity enhancing technology. These factors have led to a consolidation of the wholesale distribution industry as companies either exit the industry or are acquired by large distributors seeking to further leverage their existing operations.
BUSINESS STRATEGY
The Company's business strategy is to increase net sales and improve operating margins. To achieve these goals, the Company intends to: (i) increase sales to existing customers, particularly of higher gross margin, non-cigarette products; (ii) add new customer locations in existing markets, particularly along existing routes; (iii) continue to implement distribution productivity enhancement programs; and (iv) make selective acquisitions.
INCREASE SALES TO EXISTING CUSTOMERS. Because the Company generally carries many products that its typical retail store customer purchases from other suppliers, a primary element of its growth strategy is to increase sales to existing customers. The Company's typical customer purchases its products from the Company, from manufacturers who distribute directly to retailers, and from a variety of smaller local distributors or jobbers. The Company is particularly focused on becoming the retail customer's primary supplier. This will be accomplished by implementing programs designed to eliminate the need for secondary means of delivery provided by local distributors and jobbers. Such programs are centered on increasing non-cigarette sales that provide higher gross margins than those associated with the distribution of cigarettes. As part of the effort, the Company provides compensation incentives to its sales force as well as a number of value-added services and marketing programs to its customers. These programs include: (i) Convenience 2000-Registered Trademark-(which offers enhanced purchasing power and promotions to independent convenience stores); (ii) Smart Sets (which helps ensure that retailers display the right product in the right place); (iii) SmartStock-Registered Trademark-(which provides state of the art category management for key, high-volume, high-impulse convenience retail categories); and (iv) Profit Builder and Promo Power (regular Company publications which describe new products and manufacturer promotions).
ADD NEW CUSTOMER LOCATIONS IN EXISTING MARKETS. The Company also seeks to leverage its existing distribution network by securing additional customers on existing routes. The Company believes it has many opportunities to add additional customers at low marginal distribution costs. The Company continues to focus on a number of new trade channels, including hotel gift shops, military bases, correctional facilities, college bookstores, movie theaters and video rental stores. The Company believes that there is significant opportunity to increase net sales and profitability by adding new customers and maximizing economies of scale.
PRODUCTIVITY ENHANCEMENT PROGRAMS. During the past five years, the Company has devoted a significant portion of its capital spending to a variety of productivity enhancement programs. These productivity enhancement programs include: (i) BOSS, a batch order selection system that increases the efficiency and reduces the cost of full-case order fulfillment; (ii) Pick-to-Light, a paperless picking system that reduces the travel time for the selection of less-than-full-case order fulfillment; (iii) Radio Frequency, a hand-held wireless computer technology that eliminates paperwork and updates receiving inventory levels and stocking requirements on a real-time basis; (iv) Checker Automation, an on-line order verification system that has significantly reduced labor costs by automating inspection of order accuracy; and (v) fleet management tools such as Roadshow, a software program that optimizes the routing of customer deliveries. The Company intends to continue to pursue cost reductions by completing the roll-out of some of these and other programs.
SELECTIVE ACQUISITIONS. The wholesale distribution industry is highly fragmented and comprised mainly of a large number of small, privately-held businesses. Management believes that the consolidation that has taken place in recent years will continue and that numerous attractive acquisition opportunities will arise. Given the current utilization rates of the Company's existing warehouse and distribution facilities as well as the quality of the Company's in-house MIS capability, management believes that a significant amount of incremental revenues can be integrated into the Company's operations without significant additions to fixed costs.
PRODUCTS DISTRIBUTED
The products distributed by the Company include cigarettes, food products such as candy, fast food, snacks, groceries and non-alcoholic beverages, and non-food products such as film, batteries and other sundries, health and beauty care products and tobacco products other than cigarettes. Cigarette net sales constituted approximately 67% of the Company's total net sales in 1997.
CIGARETTE PRODUCTS
The Company offers substantially all brands of cigarettes from all of the major manufacturers, including national premium labels such as Marlboro, Winston and Player; discount labels such as Viceroy and Doral; and deep discount labels such as the Company's private label brand, Best Buy-Registered Trademark-, as well as Basic, Best Value, Monarch and GPC.
FOOD AND NON-FOOD PRODUCTS
The Company offers its customers a wide variety of food and non-food products (over 35,000 stock keeping units (SKU's)), including candy, snacks, fast food, groceries, non-alcoholic beverages, health and beauty care products and general merchandise. The Company's strategy is to offer its convenience retail store customers a variety of food and non-food products at reasonable prices in flexible quantities.
FOOD PRODUCTS. The Company's candy products include such brand name items as Snickers, Hershey Kisses, M&M's, Lifesavers and Dentyne. The Company also offers its own private label "Cable Car"-Registered Trademark- candy line. The Company's snack products include brand names such as Keebler, Nabisco and Planters.
The Company's grocery products include national brand name items such as Del Monte, Carnation, Kellogg's and Purina ranging from canned vegetables, soups, cereals, baby food, frozen foods, soaps and paper products to pet foods. The Company offers a variety of non-alcoholic beverages, including juices and sports drinks under brand names such as Tropicana, Veryfine and Gatorade.
The Company's fast food products include prepared sandwiches, hot deli foods, slush drinks, hot beverages, pastries and pizza, as well as packaged supplies and paper goods, including brand name items such as Superior Coffee, Tyson chicken, Oscar Mayer meats and Kraft and Heinz condiments. Since 1994, the Company has targeted the fountain, slush, hot beverage (coffee and hot chocolate) and frozen food product categories, which present significant growth opportunities as sales in these product categories are among the fastest growing product offerings of the convenience store industry.
NON-FOOD PRODUCTS. General merchandise products range from film, tape, batteries, cigarette lighters and glue to automotive products and include brand names such as Fuji, Kodak, Scotch and Mead Envelope. Health and beauty care products include analgesics, hair care, cosmetics, hosiery, dental products and lotions, from manufacturers of brand names such as Crest, Tylenol, Johnson & Johnson Band-Aid, Vicks, Gillette and Jergens. The Company's broad assortment of tobacco products includes imported and domestic cigars, smokeless tobacco (snuff), chewing tobacco, smoking tobacco and smoking accessories.
CUSTOMERS
The Company's current customer base is comprised of a wide range of retailers, including traditional and petroleum convenience stores, grocery stores, drug stores, mass-merchandisers and liquor stores. The Company also provides services to hotel gift shops, military bases, correctional facilities, college bookstores, movie theaters and video rental stores. In 1997, the Company's largest customer accounted for 4.0% of net sales, and the Company's ten largest customers accounted for approximately 27% of net sales. As a result of its size and geographic coverage, the Company supplies a number of regional and national chain corporations and, therefore, is able to distribute products to all or substantially all such customers' individual store locations in the Company's market area.
The Company strives to offer its customers greater flexibility, service and value than other distributors. The Company's willingness to work with retailers to arrive at a suitable delivery time, thereby allowing the store owner to schedule its labor requirements effectively, is an important facet of this flexibility. The Company believes that its ability to provide fully integrated technological services (EDI services, store automation integration, data exchange, consultative services, retail price management systems and UPC control), bar-coded shelf labels to assist in effective shelf space management, timely communication of manufacturer price change information, seasonal and holiday special product/promotional offerings and salesperson assistance in order preparation are also important to the retailer in its selection of the Company as its supplier.
SUPPLIERS AND MANUFACTURERS
The Company purchases products for resale to its customers from over 2,400 suppliers and manufacturers located throughout the United States and Canada. Although the Company purchases cigarette and tobacco products from all major United States and Canadian manufacturers, approximately 29%, 14%, 12% and 8% of the Company's net sales in 1997 were derived from products purchased by the Company from Philip Morris, R.J. Reynolds, Imperial Tobacco and Brown & Williamson, respectively. No other supplier's products represented more than 10% of net sales. In addition, Philip Morris manufactures the Company's private label Best Buy-Registered Trademark- cigarettes. The loss of or a major change in the Company's relationships with any of these manufacturers or in any of the structured incentive programs could have a material adverse effect on the Company's business and financial results.
The Company generally has no long-term purchase agreements (other than for Best Buy-Registered Trademark- products) and buys substantially all its products as needed.
CIGARETTE PRODUCTS
The Company controls major purchases of cigarettes centrally in order to minimize inventory levels. Daily replenishment of cigarette inventory and brand selection is controlled by the local division based on demands of the local market. The U.S. cigarette manufacturers charge all wholesale customers the same price for national brand cigarettes regardless of volume purchased. However, cigarette manufacturers do offer certain structured incentive programs (including Philip Morris' Masters Program and R.J. Reynolds' Partners Program) to wholesalers instead of the routine allowances associated with non-cigarette products. These programs are based upon, among other things, purchasing volume and often include performance-based criteria related to the quality of the Company's efforts to keep certain brands and volumes of cigarettes on the retail shelves.
FOOD PRODUCTS
Food products (other than frozen foods) are purchased directly from manufacturers by buyers in each of the Company's distribution facilities. Management believes that decentralized purchasing of food products results in higher service levels, improved product availability tailored to individual markets and reduced inventory investment. Although each division has individual buyers, the Company negotiates corporate pricing where possible to maximize purchasing power.
In February 1996, the Company established its Artic Cascade division, a consolidated frozen warehouse which purchases frozen foods for all of the Company's United States divisions. By consolidating the frozen food purchases, the Company is able to obtain such products at lower cost. Buying in one location also allows the Company to offer a wide selection of quality products to retailers at more competitive prices.
NON-FOOD PRODUCTS
The majority of the Company's non-food products, other than cigarettes and tobacco products (primarily health and beauty care products and general merchandise), are purchased by Allied Merchandising Industry ("AMI"), one of the Company's operating divisions that specializes in these categories. This specialization seeks to ensure a better selection and more competitive wholesale costs and enables the Company to reduce its overall general merchandise and health and beauty care inventory levels. Tobacco products, other than cigarettes, are purchased directly from the manufacturers by each of the divisions.
DISTRIBUTION
The Company maintains 19 distribution facilities, of which 15 are located in the western United States and four are located in western Canada. These distribution facilities include two consolidating warehouse facilities, AMI and Artic Cascade. Each distribution facility is outfitted with modern equipment (including freezers and coolers as required) for receiving, stocking, order selection and loading a large volume of customer orders on trucks for delivery. Each facility provides warehouse, distribution, sales and support functions for its geographic area under the supervision of a division manager. In addition, the Company believes that the majority of its distribution facilities have the capacity to absorb significant future growth in net sales.
The Company's trucking system includes straight trucks and tractors (primarily leased by the Company) and trailers (primarily owned by the Company). The Company's standard is to maintain its transportation fleet to an average age of five years or less. The Company employs a state-of-the-art, computerized truck routing system generated by software called "Roadshow" to efficiently construct delivery routes.
COMPETITION
The convenience retail distribution business is comprised of one national distributor in the United States (McLane, a subsidiary of Wal-Mart) and several national distributors in Canada, a number of large, multi-regional competitors (participants with a presence in several contiguous regional markets) and a large number of small, privately-owned businesses that compete in one or two markets. Multi-regionals include the Company in the west, GSC Enterprises in the south and southeast, H.T. Hackney in the southeast, and Eby-Brown Company in the midwest. Relative to smaller competitors, multi-regional distributors such as the Company benefit from several competitive advantages including greater purchasing power, the ability to service chain accounts, scale cost advantages in sales and warehouse operations, the ability to spread fixed corporate costs over a larger revenue base and the resources to invest in both MIS and productivity enhancing technology. These factors have led to a consolidation of the industry as small competitors exit the industry and some larger convenience retail distributors seek acquisitions to increase the utilization of their existing operations.
The Company also competes with wholesale clubs and certain retail stores whose sales are primarily cigarettes, characterized by high volumes and very aggressive pricing. These competitors have become a factor in the industry within recent years, particularly in California markets. The wholesale clubs have been aggressive in their pricing of cigarettes and candy, and wholesalers have been forced to reduce margins to compete in densely populated markets with a large number of wholesale clubs. Wholesale clubs require the convenience store owner to take the time to travel, to shop at their location, pay cash and choose from a very limited selection. They also provide none of the merchandising support that the Company routinely offers. Consequently, national chains do not routinely purchase product at the wholesale clubs.
The principal competitive factors in the Company's business include price, customer order fill rates, trade credit and the level and quality of value-added services offered. Management believes the Company competes effectively by offering a full product line, flexible delivery schedules, competitive prices, high levels of customer service and an efficient distribution network.
EMPLOYEES
As of December 31, 1997, the Company had 2,312 employees.
The Company is a party to local collective bargaining agreements with the International Brotherhood of Teamsters covering clerical, warehouse and transportation personnel at its facilities in Hayward, California, and covering warehouse and transportation personnel in Las Vegas, Nevada. The Company is party to a collective bargaining agreement with United Food Commercial Workers covering warehouse and transportation personnel in Calgary, Alberta. The Company is a party to a collective bargaining agreement with Industrial Wood and Allied Workers of Canada covering warehouse personnel in Victoria, British Columbia. The agreements covering employees in Hayward and Las Vegas expire on January 15, 2000 and March 31, 1999, respectively. The agreement covering employees in Calgary expires on August 31, 1998. The agreement covering employees in Victoria expires on April 5, 1999. These agreements cover an aggregate of less than 10% of the Company's employees.
Management believes that the Company's relations with its employees are good.
ITEM 2.
ITEM 2. PROPERTIES
The Company does not own any real property. The principal executive offices of the Company are located in South San Francisco, California, and consist of approximately 22,000 square feet of leased office space. In addition, the Company leases approximately 24,000 square feet in Vancouver, British Columbia for its Canadian regional corporate, tax and management information systems departments and 11 small offices for use by sales personnel in certain parts of the United States and Canada. The Company also leases its 19 distribution facilities, 15 of which are located in the western United States and four in western Canada. Each distribution facility is equipped with modern equipment (including freezers and coolers at 18 facilities) for receiving, stocking, order selection and shipping a large volume of customer orders. The Company believes that it currently has sufficient capacity at its distribution facilities to meet its anticipated needs and that its facilities are in satisfactory condition.
The Company's leases expire on various dates between 1998 and 2007, and in many instances give the Company renewal options. The aggregate rent paid in connection with the Company's distribution facilities, regional sales offices and corporate and administrative offices was approximately $6.1 million in 1996 and $6.7 million in 1997. The Company's distribution facilities range from 14,000 to 200,000 square feet and account for approximately 1.6 million square feet in aggregate. Management believes that the Company's current utilization of warehouse facilities is approximately 70% to 80% in the aggregate.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
REGULATORY MATTERS
The tobacco industry is currently subject to significant regulatory restrictions, such as the requirement that product packages display warning labels, a prohibition on television and radio advertising and prohibitions on sales to minors. In August 1996, the United States Food and Drug Administration (the "FDA") determined that it had jurisdiction over cigarettes and smokeless tobacco products and issued regulations restricting the sale, distribution and advertising of cigarette and smokeless tobacco products, especially to minors. The regulations are significant not only because of their substance but also because the FDA determined that it has jurisdiction over cigarettes and smokeless tobacco as "combination products having both a drug component, including nicotine, and device components." The regulations regulate such products as "devices." The major tobacco manufacturers have challenged the jurisdiction of the FDA to regulate tobacco products as "drugs" or "devices," and in April 1997 the U.S. District Court for the Middle District of North Carolina held that the FDA could impose restrictions on access to tobacco products and on labeling of tobacco products, but did not have authority to restrict the promotion and advertisement of such products. The court stayed implementation of the FDA regulations except for those establishing a federal minimum age of 18 for the sale of tobacco products and requiring proof of age for anyone under the age of 27. An appeal by both the tobacco companies and the FDA is pending. In addition, a number of bills have been introduced in Congress during 1997 and 1998 that would confirm or expand the FDA's jurisdiction. In addition, in recent years, proposals have been made to require additional warning notices on tobacco products, to disallow advertising and promotional expenses as deductions under federal tax law and to further regulate the production and distribution of cigarettes and smokeless tobacco. While neither the FDA regulations nor the pending legislation would impose restrictions on the sale of cigarettes and smokeless tobacco products to adults, there can be no assurance such restrictions will not be proposed in the future or that any such proposed legislation or regulations would not result in a material reduction of the consumption of tobacco products in the United States or would not have a material adverse effect on the Company's business and financial position.
Over the past decade, various state and local governments have imposed significant regulatory restrictions on tobacco products, including sampling and advertising bans or restrictions, packaging regulations and prohibitions on smoking in restaurants, office buildings and public places. Additional state and local legislative and regulatory actions are being considered and are likely to be promulgated in the future. The Company is unable to assess the future effects that these various proposals may have on the sale of the Company's products. The FDA's regulation of cigarette and smokeless tobacco products does not preempt individual states from issuing more stringent state or local requirements, provided those state or local requirements do not conflict with the FDA regulations, and a number of state and local jurisdictions have applied for exemption from the FDA regulations in order to impose such stricter rules.
The Company is subject to various federal, state and local environmental, health and safety laws and regulations. Generally, these laws impose limitations on the discharge of pollutants and the presence of hazardous substances in the workplace and establish standards for vehicle and employee safety and for the handling of solid and hazardous wastes. These laws include the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Clean Air Act, the Hazardous Materials Transportation Act and the Occupational Safety and Health Act. Future developments, such as stricter environmental or employee health and safety laws and regulations thereunder, could affect the Company's operations. The Company does not currently anticipate that the cost of its compliance with or of any foreseeable liabilities under environmental and employee health and safety laws and regulations will have a material adverse affect on its business and financial condition.
LEGAL MATTERS
In May 1996, the Court of Appeals for the Fifth Circuit decertified a federal class action purportedly brought on behalf of all cigarette smokers in the United States. Following the decertification, lawyers for the class brought state class action lawsuits in a number of states, with the objective of filing such lawsuits in all fifty states, the District of Columbia and Puerto Rico. Several of these state lawsuits name cigarette distributors such as the Company as defendants.
In October 1996, a subsidiary of the Company was named as a defendant in a class action lawsuit filed in State Court in New Mexico. The other defendants include the principal U.S. tobacco manufacturers as well as other distributors. The case is brought on behalf of a putative class of smokers who reside in New Mexico, each of whom is allegedly nicotine dependent. The suit seeks, on behalf of the class, compensatory damages, punitive damages and equitable relief, including medical monitoring of the class members.
In May 1997, a subsidiary of the Company was named as a defendant in an action brought by the Attorney General of New Mexico in an action filed in State Court in Santa Fe, New Mexico. The other defendants include the principal U.S. tobacco manufacturers as well as other distributors. The Attorney General alleges, among other things, that the defendants realized significant profits from the manufacture, distribution, and sale of tobacco products, and that these activities have caused residents of New Mexico to suffer illnesses and diseases. The State of New Mexico seeks both monetary damages and a permanent injunction to require defendants to fund public education and smoking cessation programs.
In January 1998, the Company was served with a summons and First Amended Complaint in an action brought by Operating Engineers Local 12 Health and Welfare Trust (on behalf of itself and all others similarly situated), in the United States District Court for the Central District of California, against major tobacco manufacturers, the Company, and other distributors and retailers of tobacco products. The complaint seeks, inter alia, compensatory and punitive damages, restitution for monies expended by the Trust for health care of its members who have used tobacco products, and forms of injunctive relief.
In March 1998, the Company was named as a defendant in a class action complaint filed in a state court in Salt Lake City, Utah. The other defendants include the principal U.S. tobacco manufacturers as well as several other distributors. The case is brought on behalf of a class of smokers who reside in Utah and who have purchased cigarette products distributed by the Company, and alleges, among other things, the members of the class have suffered personal injuries and economic losses from the use of such cigarettes. The suit seeks, on behalf of the class, compensatory damages, punitive damages, equitable relief including the establishment of a medical monitoring fund and return of monies spent to purchase cigarette products.
The Company does not believe that these actions will have a material adverse effect on the Company's financial condition. The Company has been indemnified with respect to certain claims alleged in each of the above actions.
In addition, the Company is a party to other lawsuits incurred in the ordinary course of its business. The Company believes it is adequately insured with respect to such lawsuits or that such lawsuits will not result in losses material to its consolidated financial position or results of operations.
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
Not applicable.
ITEM 6.
ITEM 6. SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA
The following table sets forth selected historical consolidated financial and other data for the Company. The historical financial data as of the end of and for each year in the five year period ended December 31, 1997 have been derived from the Company's audited consolidated financial statements which have been audited by KPMG Peat Marwick LLP, independent accountants. Such financial statements for the three year period ended December 31, 1997 are included herein together with the report of such accountants thereon. The consolidated financial data set forth below should be read in conjunction with the historical consolidated financial statements of the Company and the related notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations," all contained elsewhere in this Form 10-K.
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES Notes to Selected Historical Consolidated Financial And Other Data
(a) In the second quarter of 1995, the Company completed two acquisitions which added approximately $62 million in net sales for the year ended December 31, 1995. In February 1997, the Company completed the acquisition of the Sosnick Companies which added approximately $136 million in net sales for the year ended December 31, 1997.
(b) The Company's U.S. inventories are valued at the lower of cost or market. Cost of goods sold is determined on a last-in, first-out (LIFO) basis. During the year ended December 31, 1993, the Company's U.S. cigarette inventory quantities declined and the wholesale cost of U.S. premium cigarettes significantly declined. These factors resulted in a substantially lower inventory cost being charged to cost of goods sold ("LIFO income") under the LIFO method of valuation compared to the FIFO method in an amount of $23.0 million, materially impacting the results of operations during such fiscal year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for more information on the impact of the LIFO inventory valuation method on other accounting periods.
(c) Debt refinancing costs include all costs associated with restructuring and refinancing debt and amortization of debt issuance costs.
(d) EBITDAL represents operating income plus depreciation, amortization and LIFO expense, and minus LIFO income (each as defined herein). EBITDAL should not be considered in isolation or as a substitute for net income, operating income, cash flows or other consolidated income or cash flow data prepared in accordance with generally accepted accounting principles, or as a measure of a company's profitability or liquidity. EBITDAL is included because it is one measure used by certain investors to determine a company's ability to service its indebtedness.
(e) Depreciation and amortization includes depreciation on property and equipment, amortization of goodwill and other non-cash charges, and excludes amortization of debt refinancing costs.
(f) Series B Preferred Stock, with a $50.0 million stated value and a mandatory redemption date of December 31, 1995, was issued in conjunction with a restructuring in 1991 and was initially recorded at a discounted fair value and accreted through March 1995, at which time it was exchanged, along with warrants owned by the senior lenders, for equity in a holding company that was also owned by certain members of management. At that time, the carrying value of the Preferred Stock was reclassified into additional paid-in capital.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the "Selected Historical Consolidated Financial and Other Data" and the consolidated financial statements of Core-Mark International, Inc. (the "Company") and notes thereto included elsewhere in this Form 10-K.
GENERAL
The Company is one of the largest broad-line, full-service wholesale distributors of packaged consumer products to the convenience retail industry in western North America. The products distributed by the Company include cigarettes, food products such as candy, fast food, snacks, groceries and non-alcoholic beverages, and non-food products such as film, batteries and other sundries, health and beauty care products and tobacco products other than cigarettes. In the year ended December 31, 1997, approximately 67%, 22% and 11% of the Company's net sales were derived from cigarettes, food products and non-food products, respectively.
TOBACCO INDUSTRY BUSINESS ENVIRONMENT
Manufacturers and distributors of cigarettes and other tobacco products in the United States are currently facing a number of significant issues that affect the business environment in which they operate including proposed additional governmental regulation (see Item 3. "Legal Proceedings - Regulatory Matters"); actual and proposed excise tax increases (see "Impact of Tobacco Taxes" ); increased litigation involving health and other effects of cigarette smoking and other uses of tobacco (see Item 3. "Legal Proceedings - Legal Matters"); and proposed legislative action to resolve certain regulatory and litigation issues affecting the U.S. tobacco industry described below.
In June 1997, a so called "national settlement" of many of these issues was proposed (referred to herein as the "Proposed Settlement") following negotiations among major U.S. tobacco manufacturers, state attorneys general, representatives of the public health community and attorneys representing plaintiffs in certain smoking and health litigation. The Proposed Settlement can be implemented only by federal legislation. The President as well as several members of Congress have criticized aspects of the Proposed Settlement and certain members of Congress have introduced alternative legislation that would substantially increase taxes on tobacco products without affording the tobacco manufacturers and other industry participants protection from private litigation, which is a significant aspect of the Proposed Settlement. At the present time, there can be no assurance that federal legislation reflecting the Proposed Settlement will be enacted or if changes will be made to the terms of the Proposed Settlement before it is enacted. The major U.S. cigarette manufacturers have disclosed in a report dated October 8, 1997 to a U.S. Senate task force that, if the Proposed Settlement were enacted in its current form, among other things, prices of cigarettes would increase significantly and cigarette consumption would decline, although it is not possible to forecast , with any degree of confidence, the magnitude of the decline in consumption.
During the most recent five year period, the Company's sales of cigarettes were:
The Company believes that, if the Proposed Settlement were enacted in its current form, the Company's business of distributing tobacco products would be negatively affected by decreases in the volume of sales of tobacco products and by the impact of increases in cigarette prices on its working capital (see "Liquidity and Capital Resources"). The Company does not believe it is able to quantify the impact that the proposed legislation or other future legislation or governmental regulation affecting cigarettes and other tobacco products will have on future sales of cigarettes and other tobacco products. However, based upon current industry estimates of wholesale price increases (including enacted federal excise tax increases (See "Impact of Tobacco Taxes")) ranging from $4.00 to $8.00 per carton of cigarettes over the next two to three years as a result of the Proposed Settlement, the Company believes that it would be able to adequately finance the corresponding increase in its working capital requirements relating to its existing business under its existing and proposed credit facilities.
If such price increases were to occur, the Company's debt levels and interest expense would significantly increase. However, if the actual level of wholesale price increases (including enacted federal excise tax increases) exceeds $8 per carton; federal excise taxes were increased to levels beyond those which have already been enacted; payment terms for state and provincial excise taxes were adversely changed (see "Impact of Tobacco Taxes"); or the volume of cigarettes sold by the Company declines significantly as a result of higher prices or taxes, or both, the Company may be required to seek additional financing in order to meet such higher working capital requirements.
The Company's business strategy has included and continues to include increasing sales of higher margin, non-tobacco products, a strategy which is intended to lessen the impact of potential future declines in unit sales and profitability of its tobacco distribution business.
IMPACT OF LIFO INVENTORY VALUATION METHOD
The Company's U.S. inventories are valued at the lower of cost or market. Cost of goods sold is determined on a last-in, first-out (LIFO) basis using Producer Price Indices as determined by the U.S. Department of Labor Statistics. The Company's Canadian inventories are valued on a first-in, first-out (FIFO) basis. The LIFO method of determining cost of goods sold has had a significant impact on the results of operations, which is quantified separately in the discussion below.
During periods of price inflation in the Company's product line, the LIFO methodology generally results in the impact of inflation on year end inventories being charged as additional expenses to cost of goods sold ("LIFO expense") while lower costs are retained in inventories. Historically, increases in the Company's cost of cigarettes resulted from a combination of cost increases by cigarette manufacturers and increases in federal and state excise taxes. In 1995, cigarette and candy manufacturers increased prices contributing to LIFO expense of $3.4 million during 1995. In 1996 and 1997, LIFO expense of $1.4 million and $3.3 million, respectively, is primarily the result of increases in cigarette prices.
RESULTS OF OPERATIONS
The following table sets forth certain operating results as a percentage of net sales, for the periods indicated:
(a) LIFO expense is included in cost of goods sold.
The following table sets forth gross profit and operating income as a percentage of net sales, after adjusting for LIFO expense, for the periods indicated:
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES. Net sales for 1997 were $2,395.9 million, an increase of $220.5 million or 10.1% over 1996. The increase in net sales was due to the Sosnick acquisition (which contributed approximately $136 million in sales during 1997) and higher net sales of food and non-food products.
Net sales of cigarettes for 1997 were $1,603.4 million, an increase of $97.6 million or 6.5% over 1996. The increase in net sales of cigarettes was principally due to the acquisition of the Sosnick Companies (which contributed approximately $74 million in cigarette net sales in 1997) and an increase in cigarette prices offset by a general decline in cigarette unit volume (excluding Sosnick unit volume). The Company's total cigarette unit volume in 1997 was 92.4 million cartons, an increase of 1.5 million cartons or 1.6% over 1996. The Sosnick acquisition contributed approximately 4.8 million in unit sales in 1997, offsetting declines in unit volumes in the U.S. and Canada of approximately 3.0 and 0.4 million cartons, respectively. Unit declines are primarily the result of lower cigarette sales by the Company's customer base, and the termination of some high volume, marginally profitable cigarette business.
Net sales of food and non-food products in 1997 were $792.5 million, an increase of $122.9 million or 18.4% over 1996. The increase was primarily due to the Company's continued focus on increasing food and non-food product sales and to the Sosnick acquisition (which contributed approximately $62 million in net sales in 1997). The increase occurred primarily in fast food sales, which increased $29.2 million or 46.1%, candy sales, which grew $28.6 million or 12.7%, and snack sales, which were higher by $15.4 million or 39.7%.
GROSS PROFIT. Gross profit for 1997 was $179.7 million, an increase of $22.0 million or 13.9% over 1996. The improvement was primarily due to increased gross profits from continued sales growth in the food and non-food product categories and the Sosnick acquisition. The gross profit margin for the year ended December 31, 1997 increased to 7.5% of net sales as compared to 7.3% of net sales for the year ended December 31, 1996. This increase resulted primarily from the growth in food and non-food sales (which carry significantly higher margins than cigarettes) to 33.1% of the Company's total 1997 net sales, from 30.8% for 1996. In 1997, the Company recognized LIFO expense of $3.3 million compared to $1.4 million in 1996. This increase in LIFO expense was primarily due to several increases in domestic cigarette wholesale prices totaling approximately $1.20 per carton during 1997 (compared to $0.40 per carton in 1996), which was more than offset by higher profits related to such price increases.
OPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative expenses for 1997 were $148.9 million, an increase of $18.4 million or 14.1% over 1996. Such expenses for 1997 increased to 6.2% of net sales as compared to 6.0% for 1996. The increase reflects approximately $2.4 million (0.1% of net sales) of one-time duplicative facility costs as a result of the Sosnick acquisition, higher levels of staffing during the initial integration process and other integration costs associated with the acquisition. The remaining increase in expenses as a percentage of sales is primarily attributable to the decline in cigarette volumes and the slightly higher handling costs associated with the increased sales growth of the higher margin food and non-food product categories.
OPERATING INCOME. As a result of the factors discussed above, operating income for 1997 was $30.8 million, an increase of $3.6 million or 13.2% over 1996. As a percentage of net sales, operating income for 1997 and 1996 remained constant at 1.3%.
NET INTEREST EXPENSE. Net interest expense for 1997 was $18.2 million, an increase of $8.3 million or 83.4% over 1996. This increase resulted from an increase in average debt levels and the Company's average interest rate primarily due to the recapitalization and senior subordinated note offering which occurred in the third quarter of 1996, as well as additional debt incurred to finance the Sosnick acquisition.
DEBT REFINANCING COSTS. The Company successfully completed a refinancing and note offering (see "Recapitalization and Note Offering" below) in the third quarter of 1996. The costs directly related to such transactions are being amortized over the terms of the related debt. Debt refinancing costs for 1997 were $1.5 million, compared to $1.3 million in 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
NET SALES. Net sales for 1996 were $2,175.4 million, an increase of $128.2 million or 6.3% over 1995. The increase was the result of growth in all categories of the Company's operations.
Net sales of cigarettes for 1996 were $1,505.8 million, an increase of $59.1 million or 4.1% over 1995. The Company's total cigarette unit volume in 1996 was 90.9 million cartons, an increase of 2.0 million cartons or 2.2% over 1995. This increase was comprised of unit volume growth in both the U.S. and Canada. During 1996, prices of U.S. and Canadian cigarettes increased slightly, contributing to an increase in cigarette net sales.
Net sales of food and non-food products in 1996 were $669.6 million, an increase of $69.1 million or 11.5% over 1995. This increase was due to the Company's focus on increasing food and non-food product sales. The increase occurred primarily in candy sales, which increased $19.8 million or 9.7%, general merchandise sales, which increased $11.8 million or 27.3%, and fast food sales, which increased $5.7 million or 9.9%.
GROSS PROFIT. Gross profit for 1996 was $157.7 million, an increase of $12.1 million or 8.3% over 1995. The improvement resulted primarily from growth in food and non-food product categories. For 1996, the Company recognized LIFO expense of $1.4 million compared to LIFO expense of $3.4 million in 1995. Also, in 1996, gross profit margins were impacted by higher profits from forward buying of cigarettes and candy in advance of manufacturers' price increases.
OPERATING AND ADMINISTRATIVE EXPENSES. Operating and administrative expenses for 1996 were $130.5 million, an increase of $5.2 million or 4.2% over 1995. However, such expenses declined as a percentage of net sales from 6.1% to 6.0% compared to 1995, as a result of the Company's continued aggressive efforts to control costs.
OPERATING INCOME. As a result of the factors discussed above, operating income for 1996 was $27.2 million, an increase of $6.9 million or 33.8% over 1995. As a percentage of net sales, operating income for 1996 was 1.3%, as compared to 1.0% in 1995.
NET INTEREST EXPENSE. Net interest expense for 1996 was $9.9 million, an increase of $2.9 million or 41.9% over 1995. The net increase resulted from the additional debt incurred in connection with the Recapitalization described below.
DEBT REFINANCING COSTS. The Company successfully completed a refinancing and note offering (see "Recapitalization and Note Offering" below) in the third quarter of 1996. The costs directly related to such transactions are being amortized over the terms of the debt. Debt refinancing costs for 1996 were $1.3 million, compared to $1.1 million in 1995.
EXTRAORDINARY ITEM. During the third quarter of 1996, the Company fully repaid its outstanding debt under a previous credit facility (see "Recapitalization and Note Offering" below). The early extinguishment of the previously existing debt resulted in a one-time extraordinary charge to income to write-off unamortized debt refinancing costs of $1.8 million which is net of a $1.2 million income tax benefit.
RECAPITALIZATION AND NOTE OFFERING
On August 7, 1996, the Company completed a recapitalization (the "Recapitalization") which resulted in the purchase of newly issued common stock of the Company by Jupiter Partners L.P. ("Jupiter") for $41.3 million in cash and the redemption of all of the common stock held by three financial institutions and a portion of the common stock held by six members of senior management ("Senior Management") for $135.0 million in cash and $6.3 million initial value of subordinated notes due 2004. Upon completion of the Recapitalization, Jupiter and Senior Management owned 75% and 25%, respectively, of the outstanding common stock of the Company. Jupiter also purchased from the Company an $18.8 million subordinated note due 2004. Both of these subordinated notes were repaid prior to December 31, 1996 as discussed below. As a result of the Recapitalization, the Company has a total shareholders' deficit at December 31, 1996 and 1997.
In connection with the Recapitalization, the Company entered into a credit facility with a group of banks, which initially provided for aggregate borrowings of up to $210.0 million, consisting of: (i) a $35.0 million term loan (the "Term Loan"), which was repaid as discussed below and is no longer available for reborrowing, and (ii) a revolving credit facility (the "Revolving Credit Facility"), under which borrowings up to $175.0 million are available (subject to compliance with a borrowing base) for working capital and general corporate purposes.
On September 27, 1996, the Company issued $75.0 million of 11 3/8% Senior Subordinated Notes (the "Notes") which mature on September 15, 2003. The proceeds of the issuance of the Notes were principally used to repay in full the subordinated notes and Term Loan discussed above. Interest on the Notes is payable semi-annually on March 15 and September 15 of each year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity requirements arise primarily from the funding of its working capital needs, capital expenditure programs and debt service requirements with respect to the Revolving Credit Facility and the Notes. The Company has no mandatory payments of principal on the Notes scheduled prior to their final maturity on September 15, 2003, and has no mandatory payments of principal scheduled under the Revolving Credit Facility, which matures June 30, 2001. The Company has historically financed its operations through internally generated funds and borrowings under its credit facilities.
Significant increases in the cost of cigarettes to the Company would occur if legislation were approved to enact the Proposed Settlement (See "Tobacco Industry Business Environment"). Based upon current industry estimates of wholesale price increases (including enacted federal excise tax increases (see "Impact of Tobacco Taxes")) ranging from $4.00 to $8.00 per carton of cigarettes over the next two to three years as a result of the Proposed Settlement, the Company believes that it will be able to adequately finance the corresponding increase in its working capital requirements relating to its existing business under its existing and proposed credit facilities. If such price increases were to occur, the Company's debt levels and interest expense would significantly increase. However, if the actual level of wholesale price increases (including enacted federal excise tax increases) exceeds $8 per carton; federal excise taxes were increased to levels beyond those which have already been enacted; payment terms for state and provincial excise taxes were adversely changed (see "Impact of Tobacco Taxes"); or the volume of cigarettes sold by the Company declines significantly as a result of higher prices or taxes, or both, the Company may be required to seek additional financing in order to meet such higher working capital requirements.
The Company's debt obligations totaled $197.0 million at December 31, 1997, a slight increase of $3.5 million or 1.8% from $193.5 million at December 31, 1996. As of December 31, 1997, the amount outstanding under the Revolving Credit Facility was $122.0 million; an additional $36.7 million, after taking into account the borrowing base, was available to be drawn. The net increase in outstanding debt is due primarily to an increase in working capital funding requirements resulting principally from increases in accounts receivable and inventory, primarily as a result of the Sosnick acquisition. Debt requirements are generally the highest at December 31 when the Company historically carries higher inventory.
The Company's principal sources of liquidity are net cash provided by operating activities and its Revolving Credit Facility. In 1997, net cash provided by operating activities was $17.6 million as compared to $26.6 million in 1996. The decrease resulted principally from changes in net working capital. In 1995, net cash provided by operating activities was $12.5 million. The increase from 1995 to 1996 resulted principally from a $6.9 million increase in operating income and changes in net working capital.
As discussed in Note 10, "Acquisition of the Sosnick Companies", to the Consolidated Financial Statements, on February 3, 1997, the Company acquired certain assets and the business of the Sosnick Companies. The assets acquired included trade accounts receivable, inventories and warehouse equipment that the Company is using in its business. The aggregate purchase price for the assets and business acquired was $21.4 million. The acquisition was financed primarily by borrowings under the Company's existing Revolving Credit Facility. The total amount of incremental borrowings required to acquire the Sosnick Companies at closing was $18.4 million. The remaining purchase price was due and payable in installments subsequent to closing in varying amounts specified in the purchase agreement.
The Company made capital expenditures of $9.4 million in 1997. In 1998, the Company estimates it will spend approximately $8 million for capital requirements, principally consisting of warehouse facilities and other equipment.
The Company intends to consummate a series of transactions to securitize its U.S. trade accounts receivable portfolio in early 1998. In connection with this proposed transaction, the Company will form a wholly-owned special purpose, bankruptcy-remote subsidiary, to which the U.S. trade accounts receivable originated by the Company will be sold, without recourse. The receivables will be assigned to a trust, as collateral for the issuance of up to $75 million of fixed amount term certificates and variable certificates. The revolving period of the securitization is expected to expire in January 2003, or earlier based on certain events. The initial net proceeds of this transaction will be used to reduce the balance outstanding under the Revolving Credit Facility. In connection with this proposed transaction, the Company will modify its Revolving Credit Facility. The modification is expected to reduce the available credit commitment facility from $175 million to a proposed $100 million and extend the maturity through 2003. As a result of this modification, the Company is expected to write off approximately $1.2 million of unamortized refinancing costs related to the Revolving Credit Facility in 1998. The Company expects to realize lower interest rates as a result of these transactions, as compared to its current Revolving Credit Facility.
The Company is currently in the process of modifying or replacing its computer systems for the year 2000 compliance. This activity is expected to continue through 1999, and is not expected to have a material impact on the financial position or results of operations of the Company in any given year. However, due to the interrelated nature of computer systems, the Company may be impacted in the year 2000 depending on whether entities not affiliated with the Company have addressed this issue successfully. Expenses related to this process are being expensed as incurred.
IMPACT OF TOBACCO TAXES
State and Canadian provincial tobacco taxes represent a significant portion of the Company's net sales and cost of goods sold attributable to cigarettes and other tobacco products. During 1997, such taxes on cigarettes represented approximately 26% of cigarette net sales in the U.S. and 47% in Canada. In general, such taxes have been increasing, and many states and Canadian provinces are currently weighing proposals for higher excise taxes on cigarettes and other tobacco products.
Under current law, almost all state and Canadian provincial taxes are payable by the Company under credit terms which, on the average, exceed the credit terms the Company has approved for its customers to pay for products which include such taxes. This practice has benefited the Company's cash flow. If the Company were required to pay such taxes at the time such obligation was incurred without the benefit of credit terms, the Company would incur a substantial permanent increase in its working capital requirements and might be required to seek additional financing in order to meet such higher working capital requirements. Consistent with industry practices, the Company has secured a bond to guarantee its tax obligations to those states requiring such a surety (a majority of states in the Company's operating areas).
The U.S. federal excise tax on cigarettes is currently $2.40 per carton of cigarettes. In August 1997, legislation was enacted that will raise the federal excise tax by $1.00 per carton of cigarettes starting in the year 2000 and by an additional $.50 per carton of cigarettes in 2002. Unlike the state and provincial taxes described above, U.S. federal excise taxes on cigarettes are paid by the cigarette manufacturers and passed through to the Company as a component of the cost of cigarettes. Such increases in U.S. federal taxes increase the Company's working capital requirements by increasing the balances of its inventories and accounts receivable. The President as well as various members of Congress have suggested additional excise taxes on cigarette and tobacco products, either as part of the proposed legislative resolution of various issues affecting the U.S. tobacco industry discussed above or to finance unrelated federal spending. If the actual level of wholesale cigarette price increases (including enacted federal excise taxes) exceeds $8.00 per carton over the next two to three years or if federal excise taxes were increased to levels beyond those which have already been enacted, the Company may be required to seek additional financing in order to meet its higher working capital requirements.
CURRENCY FLUCTUATIONS
During 1997, on average, the Canadian dollar weakened approximately 1.5%, decreasing the U.S. dollar value of Canadian revenues in the Company's consolidated financial statements. During 1996, on average, the Canadian dollar strengthened less than 1%, increasing the U.S. dollar value of Canadian revenues in the Company's consolidated financial statements. The change in the U.S./Canadian exchange rate had no impact on the overall financial results of the Canadian operations as virtually all revenues and expenses are Canadian dollar based.
INFLATION
In response to increases or decreases in manufacturers' prices with respect to any of the Company's products, the Company historically has adjusted its selling price in order to maintain its gross profit. Therefore, inflation and deflation generally do not have a material impact on the Company's gross profit. However, as described in "Tobacco Industry Business Environment," significant increases in the manufacturers' prices of cigarettes would occur if the Proposed Settlement described therein were to be enacted or if additional federal excise taxes are enacted. While the Company expects to pass on to its customers any price increases that result from the Proposed Settlement or federal excise tax increases, it is not possible to predict, with any degree of confidence, the magnitude of any volume decline which might result from the higher prices. In addition, during the past several years, low levels of overall inflation and resulting low interest rates have benefited the Company's results of operations because of the Company's high degree of leverage. If interest rates increase (as a result of increased inflation or otherwise), the Company could be adversely affected.
NEW ACCOUNTING STANDARDS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," which prescribes standards for reporting comprehensive income and its components. Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly in a separate component of equity). SFAS 130 requires that components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for financial statements issued for periods beginning after December 15, 1997, and is expected to first be reflected in the Company's first quarter of 1998 interim financial statements.
In 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 changes the way companies report segment information and requires segments to be determined and reported based on how management measures performance and makes decisions about allocating resources. SFAS 131 is effective for financial statements issued for periods beginning after December 15, 1997, and will first be reflected in the Company's financial statements for the year ended December 31, 1998.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . 19
Consolidated Balance Sheets as of December 31, 1996 and 1997 . . . . . . . 20
Consolidated Statements of Income for the years ended December 31, 1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1995, 1996 and 1997 . . . . . . . . . . . . . . . . . . . . 22
Consolidated Statements of Cash Flows for the years ended December 31, 1995, 1996 and 1997. . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 24
INDEPENDENT AUDITORS' REPORT
TO THE BOARD OF DIRECTORS CORE-MARK INTERNATIONAL, INC.:
We have audited the accompanying consolidated balance sheets of Core-Mark International, Inc. and subsidiaries (the "Company") as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. 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 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Core-Mark International, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles.
/S/ KPMG Peat Marwick LLP
SAN FRANCISCO, CALIFORNIA FEBRUARY 20, 1998
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1997 (IN THOUSANDS OF DOLLARS)
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS OF DOLLARS)
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS OF DOLLARS, EXCEPT SHARE DATA)
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS OF DOLLARS)
Core-Mark International, Inc. and Subsidiaries Notes to Consolidated Financial Statements For the Years Ended December 31, 1995, 1996 and 1997
1. ORGANIZATION AND FORM OF BUSINESS
Core-Mark International, Inc. and subsidiaries (the "Company") is a full-service wholesale distributor of tobacco, food and other consumer products to convenience stores, grocery stores, mass merchandisers and liquor and drug stores in western North America.
On March 2, 1995, the Company's common and preferred shareholders contributed their equity interest in the Company in exchange for the equity interest in a newly formed limited liability company, Core-Mark L.L.C. ("LLC"). Accordingly, the LLC became the Company's sole common shareholder.
On August 7, 1996, the Company completed a recapitalization as described in Note 3. Upon completion of the recapitalization, and at December 31, 1996 and December 31, 1997, Jupiter Partners L.P. owned 75% and senior management retained ownership of 25%, respectively, of the outstanding stock of the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
These financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management believes any differences resulting from estimates will not have a material effect on the Company's consolidated financial position.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions are eliminated.
FOREIGN CURRENCY
Assets and liabilities of the Company's Canadian operations are translated at exchange rates in effect at year-end. Income and expenses have been translated at average rates for the year. Adjustments resulting from such translation are included in cumulative currency translation adjustments, a separate component of shareholders' equity.
EXCISE TAXES
State and provincial excise taxes paid by the Company on cigarettes were $466.5 million, $479.2 million, and $505.4 million, for the years ended December 31, 1995, 1996 and 1997, respectively, and are included in net sales and cost of goods sold.
INVENTORIES
Inventories are valued at the lower of cost or market. In the U.S., cost is determined on a last-in, first-out (LIFO) basis (using Producer Price Indices as determined by the Department of Labor and Statistics). Under LIFO, current costs of goods sold are matched against current sales. Inventories in Canada amount to $23.8 million and $20.3 million at December 31, 1996 and 1997, respectively, and are valued on a first-in, first-out (FIFO) basis.
During periods of rising prices, the LIFO method of costing inventories generally results in higher current costs being charged against income while lower costs are retained in inventories. An increase in cost of goods sold and a decrease in inventories of $3.4 million, $1.4 million and $3.3 million resulted from using the LIFO method for the years ended December 31, 1995, 1996 and 1997, respectively.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost, net of accumulated depreciation and amortization. Depreciation and amortization are provided on the straight-line method over the estimated useful lives of owned assets. The estimated useful lives for equipment are principally 4 to 10 years. Leasehold improvements are amortized over the estimated useful life of the property or over the term of the lease, whichever is shorter.
GOODWILL
Goodwill, which is the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over a forty-year period. Amortization expense for each of the years ended December 31, 1995 and 1996 was $2.0 million and for the year ended December 31, 1997 was $2.1 million.
The Company assesses the recoverability of long-lived assets, including goodwill, by determining whether the amortization of such assets over the remaining life can be recovered through undiscounted future operating cash flows of the related operations. Based on this calculation, the Company is of the opinion that there is no impairment of long-lived assets as of December 31, 1997.
REVENUE RECOGNITION
The Company recognizes revenue at the time the product is shipped to the customer.
STOCK-BASED COMPENSATION PLAN
In 1997, the Company adopted a Stock Option Plan for its key employees. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation."
PENSION COSTS AND OTHER POSTRETIREMENT BENEFIT COSTS
Pension costs and other postretirement benefit costs charged to earnings are determined on the basis of annual valuations by an independent actuary. Adjustments arising from plan amendments, changes in assumptions and experience gains and losses are amortized over the expected average remaining service life of the employee group.
RECLASSIFICATIONS
Prior years' amounts in the consolidated financial statements have been reclassified where necessary to conform to the current year's presentation.
3. CAPITAL TRANSACTIONS
AUGUST 7, 1996 RECAPITALIZATION
On August 7, 1996, the Company completed a recapitalization (the "Recapitalization") which resulted in the purchase of newly issued common stock of the Company by Jupiter Partners L.P. ("Jupiter") for $41.3 million in cash, the redemption of all of the common stock held by three financial institutions and a portion of the common stock held by six members of senior management for $135.0 million in cash and $6.3 million initial value of subordinated notes due 2004. Pursuant to the stock subscription agreement between the Company and Jupiter, the Company paid an affiliate of Jupiter an advisory fee of $2.2 million on August 7, 1996. Upon completion of the Recapitalization, Jupiter and senior management owned 75% and 25%, respectively, of the outstanding common stock of the Company. Jupiter also purchased from the Company an $18.8 million subordinated note due 2004. Both of these subordinated notes were repaid during 1996 using the proceeds of the senior subordinated notes discussed in Note 4.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
3. CAPITAL TRANSACTIONS (CONTINUED)
Simultaneously with the closing of the stock purchase and the redemptions, the Company fully repaid the outstanding debt under the previously existing credit facility. The early extinguishment of the previously existing debt resulted in a one-time extraordinary charge to income to write-off unamortized debt refinancing costs of $1.8 million, which is net of a $1.2 million income tax benefit.
MARCH 2, 1995 EXCHANGE OF CAPITAL STOCK
On March 2, 1995, the Company's common and preferred shareholders contributed their equity interest, including common stock, preferred stock, and warrants, in the Company for the equity interest in the LLC, which became the sole shareholder of the Company. As a result of this exchange, the carrying value of the preferred stock, net of transaction costs, $42.0 million, was reclassified to additional paid-in capital, increasing total common shareholder's equity.
4. FINANCING
Long-term debt consisted of the following at December 31 (in thousands):
EXISTING CREDIT FACILITY
On August 7, 1996, the Company entered into the existing credit facility which replaced the previous credit facility. The existing credit facility initially provided for aggregate borrowings of up to $210.0 million, consisting of: (i) a $35.0 million term loan (the "Term Loan"), which was repaid as discussed below and is no longer available for reborrowing, and (ii) a revolving credit facility (the "Revolving Credit Facility"), under which borrowings in the amount of up to $175.0 million are available for working capital and general corporate purposes. The Revolving Credit Facility expires on June 30, 2001 and borrowings are subject to borrowing base limitations based upon levels of eligible inventories, accounts receivable, other receivables and cash. Included in this facility are letters of credit up to a maximum of $40.0 million. As of December 31, 1997, the amount outstanding under the Revolving Credit Facility was $122.0 million; an additional $36.7 million, after taking into account the borrowing base, was available to be drawn.
Under the existing credit facility, the Company has the option to borrow: (i) under Revolving Credit Loans which bear interest at 1.5% above the bank's Prime Rate; or (ii) Eurodollar Loans which bear interest at 2.5% above the bank's Eurodollar Rate. The bank's Prime Rate and Eurodollar Rate was 8.50% and 5.97%, respectively, at December 31, 1997. There is a commitment fee of 0.5% on the unused portion of the working capital revolving credit facility. The obligations are secured by all assets of the Company, including inventories, trade accounts receivable and property and equipment.
Under the existing credit facility, the Company must maintain certain financial covenants as prescribed in the credit agreement, including, but not limited to, current ratio, net worth, leverage and interest coverage, and operating income before certain non-cash items. The existing credit facility limits certain activities of the Company, including, but not limited to, indebtedness, creation of liens, acquisitions and dispositions, capital expenditures, investments and dividends.
The Canadian credit facility allows for borrowings up to $10.0 million for general corporate use and is secured by letters of credit under the existing credit facility. The Canadian dollar advances bear interest at the Canadian bank's prime rate which was 6.00% at December 31, 1997. There were no borrowings under this facility at December 31, 1996 and 1997.
The Company had letters of credit of $9.0 million and $8.3 million outstanding at December 31, 1996 and 1997, respectively. The letters of credit are issued primarily to secure the Company's bond and insurance programs. The Company pays fees of 2.50% per annum on the outstanding portion of letters of credit.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
4. FINANCING (CONTINUED)
The Company incurred approximately $8.7 million for legal, professional, and other costs related to the structuring of the existing credit facility and issuance of the senior subordinated notes described below. These costs were capitalized and classified as other assets and are being amortized on a straight-line basis over the term of the existing credit facility. Amortization of these costs for the years ended December 31, 1996 and 1997 was approximately $0.6 million and $1.5 million, respectively.
SENIOR SUBORDINATED NOTES
On September 27, 1996, the Company issued $75.0 million of 11 3/8% Senior Subordinated Notes (the "Notes") which mature on September 15, 2003, the proceeds of which were used to repay in full the Term Loan discussed above and the subordinated notes discussed in Note 3. Interest on the Notes is payable semi-annually on March 15 and September 15 of each year. The Notes limit certain activities of the Company, including, but not limited to, changes in control, indebtedness, creation of liens, acquisitions and dispositions, investments and dividends.
5. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases the majority of its sales and warehouse distribution facilities, automobiles and trucks under lease agreements expiring at various dates through 2007, excluding renewal options. The leases generally require the Company to pay taxes, maintenance and insurance. Management expects that in the normal course of business, leases that expire will be renewed or replaced by other leases.
Future minimum rental payments under non-cancelable operating leases (with initial or remaining lease terms in excess of one year) were as follows as of December 31, 1997 (in thousands):
Rental expense for operating leases was $11.3 million, $11.7 million and $13.3 million for the years ended December 31, 1995, 1996 and 1997, respectively.
CLAIMS AND ASSESSMENTS
The Company and its subsidiaries are defendants to claims seeking damages for injuries allegedly arising from the use of tobacco products. The Company has been indemnified with respect to certain claims in each of the lawsuits regarding tobacco products. The Company and its subsidiaries are also defendants to claims arising in the ordinary course of business. Management has provided reserves it believes are adequate and is of the view that the disposition of these matters will not have a material adverse effect on the Company's consolidated financial position.
6. EMPLOYEE BENEFIT PLANS
PENSION PLAN
The Company sponsors a defined benefit pension plan for qualified employees. As of September 30, 1986, the plan was frozen and plan participants ceased accruing benefits as of that date. The most recent actuarial valuation of the plan was performed as of January 1, 1997.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
6. EMPLOYEE BENEFIT PLANS (CONTINUED)
The following table sets forth the funded status of the plan and amounts recognized in the Company's consolidated balance sheets as of December 31 (in thousands):
The additional minimum pension liability is equal to the accumulated benefit obligation in excess of plan assets at estimated fair value, plus prepaid pension costs.
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company sponsors a defined benefit postretirement health care plan for qualified employees. As of September 30, 1986, the plan was frozen and is only available to those who qualify for the pension plan as described previously in this note. The plan pays stated percentages of most necessary medical expenses incurred by retirees, after subtracting payments by Medicare or other providers and after a stated deductible has been met. Participants become eligible for the benefit if they retire from the Company after reaching age 55 with 5 or more years of service and qualify under the Company defined benefit pension plan. The plan is contributory, with retiree contributions adjusted annually. The Company does not fund this plan.
The components of the expense under Statement of Financial Accounting Standards No. 106 ("SFAS 106") "Employers' Accounting for Postretirement Benefits Other Than Pensions" are summarized in the following table for the years ended December 31 (in thousands):
The accumulated postretirement benefit obligation is summarized in the following table at December 31 (in thousands):
Core-Mark International, Inc. Notes to Consolidated Financial Statements
6. EMPLOYEE BENEFIT PLANS (CONTINUED)
For measurement purposes, a 11% annual rate of increase in the per capita cost of covered health care claims was assumed for 1997; the rate was assumed to decrease gradually to 6% for 2002, and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. Increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1997 by $371,000 and the aggregate of the service and interest cost components of net postretirement health care cost for the year ended December 31, 1997 by $35,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5%.
SAVINGS PLAN
The Company maintains defined contribution plans in the U.S., subject to Section 401(k) of the Internal Revenue Code, and in Canada, subject to the Department of National Revenue Taxation Income Tax Act. Eligible employees may elect to contribute on a tax deferred basis from 1% to 10% of their compensation. A contribution of up to 6% is considered to be a "basic contribution" and the Company makes a matching contribution of $0.50 for each dollar of a participant's basic contribution. The Company's contributions to the plans were $953,000, $1,017,000 and $1,158,000 for 1995, 1996 and 1997, respectively.
STOCK-BASED COMPENSATION PLAN
During 1997, the Company adopted a Stock Option Plan ("Option Plan") for its key employees, which provides for equity-based incentive awards. Upon adoption of the Option Plan, the Company had 300,000 options available for granting. Granted options vest over five years and become exercisable after eight years, with certain exercise acceleration provisions, including a change of control of the Company or an initial public stock offering. The Company issues options to employees with a grant price equal to the fair value. Accordingly, no compensation expense has been recognized on the Company's Option Plan.
During 1997, the Company granted 213,000 options with an exercise price of $10.00, of which 2,000 were forfeited during the year. The Company had 211,000 options outstanding at December 31, 1997 with an exercise price of $10.00 and a weighted-average remaining contractual life of seven years. As of December 31, 1997, the options granted under the Option Plan have not become exercisable.
Pro forma information regarding net income is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of this statement. The fair value for the options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions: risk free interest rate of 5.76%; volatility of 0.00%; dividend yield of 0.00%; and an expected life of the option of 5 years. The weighted-average estimated fair value per option granted in 1997 was $2.47. For the purpose of pro forma disclosure, the estimated fair value of the options is amortized to expense over the options' vesting period. Based on these assumptions, pro forma net income for 1997 would be $6,186,000.
7. INCOME TAXES
The Company's income tax expense, before extraordinary items, consists of the following for the years ended December 31 (in thousands):
Core-Mark International, Inc. Notes to Consolidated Financial Statements
7. INCOME TAXES (CONTINUED)
A reconciliation between the Company's income tax expense and income taxes computed by applying the statutory federal income tax rate to income before income taxes and extraordinary items is as follows for the years ended December 31 (in thousands):
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The tax effects of significant temporary differences which comprise deferred tax assets and liabilities are as follows at December 31 (in thousands):
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. At each balance sheet date, a valuation allowance has been established against the deferred tax assets based on management's assessment. During 1995, 1996 and 1997, the Company recorded a reduction of $1.0 million, $1.5 million and $1.6 million, respectively in the valuation allowance due to changes in factors affecting the realizability of the Company's deferred tax assets including generation of taxable income and changes in limitations on utilization of net operating loss carryforwards.
At December 31, 1997, the Company has available for U.S. federal income tax return purposes net operating losses totaling approximately $26.0 million, subject to certain limitations, which will expire between the years 2005 and 2007. The Company also has available for U.S. income tax return purposes investment tax credits and alternative minimum tax credits totaling $0.5 million and $1.1 million, respectively. The investment tax credits expire by the year 2000 while the alternative minimum tax credits have an indefinite utilization period.
8. FAIR MARKET VALUE OF FINANCIAL INSTRUMENTS
The carrying amount for the Company's cash, trade accounts receivable, other receivables, trade accounts payable, cigarette and tobacco taxes payable and other accrued liabilities approximates fair market value because of the short maturity of these financial instruments.
The carrying amount of the Revolving Credit Facility, a variable rate instrument, approximates fair market value. The rate of interest, which is tied to either the bank's Prime Rate or Eurodollar Rate, fluctuates with market conditions. The fair value of the Notes, calculated based on quoted market prices, was $ 76,875,000 and $79,313,000 at December 31, 1996 and 1997, respectively.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
9. SEGMENT INFORMATION
The Company's revenues are generated from the distribution of cigarettes, tobacco products, candy, food, health and beauty aids, and general merchandise. The Company operates in the United States and Canada. Foreign and domestic net sales, operating income, and identifiable assets are as follows at and for years ended December 31, (in thousands):
10. ACQUISITION OF THE SOSNICK COMPANIES
On February 3, 1997, the Company consummated a transaction, pursuant to a Purchase Agreement dated January 31, 1997, to acquire certain assets and the business of two related companies, Melvin Sosnick Company and Capital Cigar Company (collectively "Sosnick" or the "Sosnick Companies"), a wholesale distributor to the convenience retail market in northern California and northern Nevada.
The assets acquired included trade accounts receivable, inventories and warehouse equipment that the Company intends to continue to use in its business. The acquisition excluded the assumption of substantially all of the liabilities of Sosnick (such as notes payable, trade accounts payable, commitments to lease warehouse facilities and other liabilities). The acquisition has been accounted for using the purchase method of accounting.
The purchase price for the assets and the business totaled $21.4 million and has been allocated as follows (in thousands):
The excess of the purchase price over the fair value of assets acquired and liabilities assumed was $4.1 million and has been recorded as goodwill, which will be amortized on a straight-line basis over a period of forty years.
Core-Mark International, Inc. Notes to Consolidated Financial Statements
10. ACQUISITION OF THE SOSNICK COMPANIES (CONTINUED)
The acquisition was primarily financed by borrowings under the Company's existing revolving credit facility. The total amount of incremental borrowings required to acquire Sosnick at closing was $18.4 million. The remaining purchase price was due and payable in installments subsequent to closing in varying amounts specified in the purchase agreement.
The Company's net sales for the year ended December 31, 1996 would have been $2,409 million if the acquisition had occurred as of January 1, 1996. The Company's net sales for the year ended December 31, 1997 would have been $2,410 million if the acquisition had occurred as of January 1, 1997. The impact of the acquisition on net income before the effect of the extraordinary item would not have been material for the years ended December 31, 1996 and 1997.
11. NEW ACCOUNTING PRONOUNCEMENTS
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income," which prescribes standards for reporting comprehensive income and its components. Comprehensive income consists of net income or loss for the current period and other comprehensive income (income, expenses, gains and losses that currently bypass the income statement and are reported directly in a separate component of equity). SFAS 130 requires that components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 is effective for financial statements issued for periods beginning after December 15, 1997, and is expected to first be reflected in the Company's first quarter of 1998 interim financial statements.
In 1997, the FASB issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 changes the way companies report segment information and requires segments to be determined and reported based on how management measures performance and makes decisions about allocating resources. SFAS 131 is effective for financial statements issued for periods beginning after December 15, 1997, and will first be reflected in the Company's financial statements for the year ended December 31, 1998.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
(a) Previous independent accountants
(1) (i) On January 27, 1998, the Registrant determined not to engage KPMG Peat Marwick LLP as the independent public accountants for its 1998 fiscal year and has appointed Deloitte & Touche LLP as its independent public accountants for its 1998 fiscal year.
(ii) The reports of KPMG Peat Marwick LLP on the Registrant's consolidated financial statements for the fiscal years ended December 31, 1997 and 1996 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.
(iii) The Audit Committee of the Registrant's Board of Directors recommended the decision to change independent accountants, whose decision was approved by the Board of Directors.
(iv) In connection with the audits of the Registrant's consolidated financial statements for the fiscal years ended December 31, 1997 and 1996, and through the date of this report, there were no disagreements with KPMG Peat Marwick LLP on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of KPMG Peat Marwick LLP, would have caused KPMG Peat Marwick LLP to make reference to the matter in connection with its report.
(v) During the Registrant's two most recent fiscal years and through the date of this report, there were no "reportable events" as defined in Item 304 (a)(1)(v) of Regulation S-K.
(2) The Registrant has received from KPMG Peat Marwick LLP a letter addressed to the Securities and Exchange Commission stating whether or not it agrees with the above statements. The copy of the letter from KPMG Peat Marwick LLP to the Securities and Exchange Commission dated March 20, 1998 is attached hereto as Exhibit 16.1.
(b) New Independent Auditors
(i) On January 27, 1998, the Registrant determined to engage Deloitte & Touche LLP as its new independent accountants effective for the 1998 fiscal year. During the Registrant's two most recent fiscal years and through January 27, 1998, neither the Registrant nor anyone else on its behalf consulted Deloitte & Touche LLP regarding any of the matters or events set forth in Item 304 (a)(2)(i) and (ii) of Regulation S-K.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company are as follows (as of December 31, 1997):
GARY L. WALSH has been Chairman and Chief Executive Officer of the Company from 1990 to 1997. Effective January 1, 1998, Mr. Walsh retired from his position as Chief Executive Officer. Mr. Walsh served as President from 1990 until 1996. He has been a director of the Company since 1990.
ROBERT A. ALLEN has been President and Chief Operating Officer of the Company from January 1996 to December 1997. Upon the retirement of Mr. Walsh, effective January 1, 1998, Mr. Allen became Chief Executive Officer. Prior to 1996, he served as Senior Vice President, Distribution from 1992 through 1995, and as Vice President, Distribution from 1989 to 1992. He has been a director of the Company since 1994.
LEO GRANUCCI has been Senior Vice President, Sales and Marketing since 1994. Prior thereto, he served for seven years as Executive Vice President of Sales and Marketing at Bergen Brunswig, a wholesale pharmaceutical distribution company.
LEO F. KORMAN has been Senior Vice President and Chief Financial Officer since January 1994 and served as Vice President and Chief Financial Officer from 1991 to 1994.
BASIL P. PROKOP has been President of the Canada Division since 1992. Mr. Prokop joined the Company in 1984.
J. MICHAEL WALSH has been Senior Vice President, Distribution since January 1996. Prior thereto, he served as Senior Vice President, Operations since 1992 and served as Vice President, Operations from 1991 to 1992.
THOMAS A. BERGLUND has been a director of the Company since August 1996. He has been a Vice President at Jupiter since 1994. Prior to that he served for three years as an employee of the Invus Group, a privately funded buy-out group specializing in food-related companies.
TERRY J. BLUMER has been a director of the Company since August 1996. Prior to co-founding Jupiter in 1994, Mr. Blumer was associated with Goldman, Sachs & Co. for over eight years, most recently as an Executive Director.
JOHN F. KLEIN has been a director of the Company since August 1996. He has been an associate at Jupiter since November 1995. Prior to that, he served for three years as a consultant at Bain & Company, a management consulting firm, and as a manager in the Turnaround and Corporate Recovery Services Group at Price Waterhouse.
JOHN A. SPRAGUE has been a director of the Company since August 1996. Prior to co-founding Jupiter in 1994, Mr. Sprague was associated with Forstmann Little & Co. for eleven years, most recently as a partner. He is a director of Heartland Wireless Communications, Inc.
Directors are elected for one year terms and hold office until their successors are elected and qualified or until their earlier resignation or removal. Executive officers of the Company are appointed by and serve at the discretion of the Board of Directors. The only family relationship between any of the executive officers or directors is between Gary L. Walsh and J. Michael Walsh, who are brothers.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF DIRECTORS
Directors of the Company do not receive compensation for service as directors other than reimbursement for reasonable expenses incurred in connection with attending the meetings.
EXECUTIVE COMPENSATION
The following table summarizes the compensation paid to the Company's chief executive officer and its four other most highly compensated executive officers for the years ended December 31, 1997, 1996 and 1995.
SUMMARY COMPENSATION TABLE
___________
(1) These figures for 1997 consist of the sum of: (i) Company matching contributions to the Savings Plan (defined below) in the following amounts: Mr. Allen, $4,500; Mr. Granucci, $4,500; Mr. Korman, $4,500; and Mr. J.M. Walsh, $4,440; (ii) life and other insurance premiums in the following amounts: Mr. G.L. Walsh, $3,311; Mr. Allen, $2,703; Mr. Granucci, $2,301; Mr. Korman, $2,286; and Mr. J.M. Walsh, $2,223.
(2) These figures for 1996 consist of the sum of: (i) Company matching contributions to the Savings Plan in the following amounts: Mr. Allen, $4,750; Mr. Granucci, $4,711; Mr. Korman, $4,620; and Mr. J.M. Walsh, $4,094; (ii) life and other insurance premiums in the following amounts: Mr. G.L. Walsh, $3,606; Mr. Allen, $2,908; Mr. Granucci, $2,479; Mr. Korman, $2,462; and Mr. J.M. Walsh, $2,390.
(3) These figures for 1995 consist of the sum of: (i) Company matching contributions to the Savings Plan in the following amounts: Mr. Allen, $4,620; Mr. Granucci, $1,415; Mr. Korman, $4,620; and Mr. J.M. Walsh, $3,976; (ii) life and other insurance premiums in the following amounts: Mr. G.L. Walsh, $4,862; Mr. Allen, $3,111; Mr. Granucci, $3,234; Mr. Korman, $3,207; and Mr. J.M. Walsh, $3,022; and (iii) income received in connection with the cancellation of certain stock options in the following amounts: Mr. G.L. Walsh, $30,759; Mr. Allen, $30,759; Mr. Korman, $15,380; and Mr. J.M. Walsh, $15,380.
(4) Consists of relocation expenses.
CERTAIN AGREEMENTS WITH MANAGEMENT
Each member of Senior Management, constituting the Company's top six executive officers, has entered into a Severance and Non-Competition Agreement with the Company, dated as of August 7, 1996 (collectively, the "Severance and Non-Competition Agreements"), which provides that if the employment of such officer party thereto is terminated other than for Cause (as defined therein) or other than as a result of such officer's resignation for Good Reason (as defined therein), the Company may, in its sole discretion, continue to pay to such officer, for a period of up to one year following such termination, such officer's base salary as in effect on the effective date of such termination. Under the Severance and Non-Competition Agreements, each of such officers has agreed not to engage in activities that compete with those of the Company (i) while such officer is an employee of the Company and (ii) if the Company makes the severance payments described above to such officer, for an additional period of one year after such employment terminates if such officer's employment with the Company terminates for Cause or as a result of his resignation other than for Good Reason.
INDEMNIFICATION AGREEMENTS
Each of the Company's directors and Mr. Leo F. Korman, the Company's Chief Financial Officer, and Ms. Debra L. Varian, the Company's Controller (collectively, the "Indemnitees"), is party to an identical indemnification agreement with the Company. Pursuant to such agreements, the Company has agreed generally to indemnify and hold harmless each Indemnitee against any losses incurred in connection with any suit, arbitration or proceeding resulting from such Indemnitee's service as an officer, agent, employee or director of the Company, provided that the Company will generally not be required to indemnify an Indemnitee in connection with losses arising out of the Indemnitee's own fraudulent or willful misconduct. Each indemnification agreement terminates upon the occurrence of a Change of Control (as defined in the agreements) of the Company, provided that the Company's obligations to indemnify for events occurring prior to such Change of Control continue.
THE SAVINGS PLAN
The Company maintains the Core-Mark International, Inc. Nest Egg Savings Plan (the "Savings Plan"), which is a defined contribution plan with a cash or deferred arrangement (as described under Section 401(k) of the Internal Revenue Code of 1986, as amended). All non-union U.S. employees of the Company and its affiliates (unless a bargaining agreement expressly provides for participation) are eligible to participate in the Savings Plan after completing one year of service.
Eligible employees may elect to contribute on a tax deferred basis from 1% to 10% of their compensation (as defined in the Savings Plan), subject to statutory limitations. A contribution of up to 6% is considered to be a "basic contribution" and the Company makes a matching contribution of $0.50 for each dollar of a participant's basic contribution (all of which may be subject to certain statutory limitations).
Each participant has a fully vested (nonforfeitable) interest in all contributions made by the individual and all earnings thereon. Each participant must be employed at the end of each quarter to receive an allocation of matching contribution for the most recent calendar quarter.
The amount of Company matching contributions that the following officers have accrued in the Savings Plan as of December 31, 1997 is as follows: Robert A. Allen $23,956; Leo Granucci $10,626; Leo F. Korman $23,213; and J. Michael Walsh $23,839. Gary L. Walsh is not a participant in the Savings Plan.
THE REGISTERED RETIREMENT SAVINGS PLAN (CANADA)
The Company maintains the Core-Mark International, Inc. Group Retirement Savings Plan (Canada) (the "Registered Retirement Savings Plan" or "RRSP"), which is a defined contribution plan with a cash or deferred arrangement (as described under the Department of National Revenue Taxation Income Tax Act). All non-union Canadian employees of the Company and its affiliates (unless a bargaining agreement expressly provides for participation) are eligible to participate in the Registered Retirement Savings Plan after completing one year of service.
Eligible employees may elect to contribute on a tax deferred basis from 1% to 10% of their compensation (as defined in the RRSP), subject to statutory limitations. A contribution of up to 6% is considered to be a "basic contribution" and the Company makes a matching contribution of $0.50 for each dollar of a participant's basic contribution (all of which may be subject to certain statutory limitations).
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth as of December 31, 1997, certain information regarding the beneficial ownership of the common stock of the Company (i) by each person who is known by the Company to own beneficially more than 5% of the outstanding shares of common stock of the Company, (ii) by each of the Company's directors and executive officers, and (iii) by all directors and executive officers as a group. The Company believes that the beneficial owners of the securities listed below, based on information furnished by such owners, have sole investment and voting power with respect to all the shares of common stock of the Company shown as being beneficially owned by them.
___________
(a) The address for Jupiter, Mr. Berglund, Mr. Blumer, Mr. Klein and Mr. Sprague is 30 Rockefeller Plaza, Suite 4525, New York, New York 10112. The address for Gary L. Walsh, Mr. Allen, Mr. Granucci, Mr. Korman, Mr. Prokop and J. Michael Walsh is 395 Oyster Point Boulevard, Suite 415, South San Francisco, California 94080.
(b) Represents the shares owned by Jupiter. Messrs. Sprague and Blumer exercise investment and voting power over the shares owned by Jupiter and accordingly are deemed to "beneficially own" such shares in accordance with Rule 13d-3 promulgated under the Exchange Act. Each of Messrs. Blumer and Sprague disclaim beneficial ownership of all shares of the Company owned by Jupiter, except to the extent of their respective ownership interests in such partnership.
STOCKHOLDERS AGREEMENT
On August 7, 1996, the Company entered into a Stockholders Agreement (the "Stockholders Agreement") with Jupiter and the Senior Management (the "Management Stockholders"), which parties constitute all of the Company's common stockholders. The Stockholders Agreement (a) places significant restrictions on the ability of a Management Stockholder to transfer, pledge or otherwise dispose of 60% of his shares of common stock of the Company (the "Restricted Shares") prior to the Company's initial public offering of common stock, and limits the amount of Restricted Shares that may be sold by such Management Stockholder after such initial public offering, (b) restricts the ability of a Management Stockholder to pledge his shares of common stock that do not constitute Restricted Shares, (c) grants "tag-along" rights (i.e., rights to participate in a sale on a PRO RATA basis) to each stockholder in connection with the sale (i) by Jupiter of any of its common stock of the Company and (ii) by a Management Stockholder of any of his Restricted Shares, and (d) grants to Jupiter "drag-along" rights (i.e., the right to require Management Stockholders to participate on a PRO RATA basis in a sale by Jupiter) with respect to shares of common stock held by the Management Stockholders, whether or not Restricted Shares, in connection with a sale by Jupiter of common stock constituting at least 1% of the Company's common stock. The Stockholders Agreement also grants to the Company, first, and Jupiter, second, certain call rights with respect to the purchase of Restricted Shares held by a Management Stockholder in the event that, prior to the fifth anniversary of the date of the Stockholders Agreement, such Management Stockholder's employment with the Company is terminated (other than as a result of death, disability or resignation for Good Reason (as defined therein)). The call provision also applies in the event such Management Stockholder breaches his obligations under the Severance and Non-Competition Agreement described under "Certain Agreements with Management". The purchase price with respect to such call rights under the Stockholders Agreement is the lower of $10 per share and a specified formula described therein (the "Repurchase Formula"), in the event the call right arises as a result of such Management Stockholder's termination for Cause (as defined therein), his resignation other than for Good Reason or a breach of his obligations under the Severance and Non-Competition Agreement to which he is a party. The purchase price with respect to a call right arising as a result of any other employment termination is the Repurchase Formula. Jupiter has agreed that neither it nor the Company will exercise their respective call rights with respect to the Restricted Shares held by Gary L. Walsh in the event that, after December 31, 1997, his employment with the Company is terminated without cause or he resigns without cause or for good reason.
REGISTRATION RIGHTS AGREEMENT
Pursuant to a Registration Rights Agreement, dated as of August 7, 1996 (the "Registration Rights Agreement"), the Company granted certain demand registration rights to Jupiter and certain "piggy-back" registration rights to Jupiter and the Management Stockholders with respect to the sale of common stock of the Company held by them. In addition to customary priority cut-back provisions relating to underwritten offerings, the Registration Rights Agreement imposes limitations on the number of shares of common stock of the Company that may be included in a "piggy-back" registration by a Management Stockholder.
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) The following financial statements, schedules and exhibits are filed as part of this report or are incorporated herein as indicated.
1. Financial Statements
The consolidated financial statements listed in Item 8. Financial Statements, which appear on page 18, are included herein.
2. Financial Statement Schedule
The following financial statement schedule of Core-Mark International, Inc. for the fiscal years ended December 31, 1995, 1996, and 1997 is filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Core-Mark International, Inc. and subsidiaries.
Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.
3. Exhibits
The following Exhibits are filed as part of, or incorporated by reference into, this Report:
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized in the City of South San Francisco, California, on March 20, 1998.
CORE-MARK INTERNATIONAL, INC.
By /s/ Leo F. Korman ________________________________________ Leo F. Korman, Senior Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
INDEPENDENT AUDITORS' REPORT
To The Board of Directors Core-Mark International, Inc.
Under date of February 20, 1998, we reported on the consolidated balance sheets of Core-Mark International, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1997. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/S/ KPMG Peat Marwick LLP
SAN FRANCISCO, CALIFORNIA FEBRUARY 20, 1998
SCHEDULE II
CORE-MARK INTERNATIONAL, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS)