ITEM 1. BUSINESS.
TruServ Corporation ("TruServ" or the "Company") was organized as Cotter & Company ("Cotter"), a Delaware corporation, in 1953. Upon its organization, it succeeded to the business of Cotter & Company, an Illinois corporation organized in 1948. On July 1, 1997 Cotter & Company merged with ServiStar Coast to Coast Corporation ("SCC") (the "Merger"). SCC was a hardware wholesaler organized in 1935 with a strong presence in retail lumber and building materials. Following the Merger, the Company was renamed TruServ Corporation. The Company's principal executive offices are located at 8600 West Bryn Mawr Avenue, Chicago, Illinois, 60631-3505. Its telephone number is (773) 695-5000.
The Company is a Member-owned wholesaler of hardware, lumber/building materials and related merchandise. It is the largest wholesaler of hardware, lumber/building materials and related merchandise in the United States. The Company also manufactures paint and paint applicators. For reporting purposes, the Company operates in a single industry as a Member-owned wholesaler cooperative.
Membership, depending on the terms of the Member's Retail Member Agreement with TruServ (the "Retail Member Agreement"), entitles TruServ Members to use certain TruServ trademarks and trade names, including the federally registered Coast to Coast(R), ServiStar(R) and True Value(R) trademarks, service marks and collective membership marks. The True Value(R) collective membership mark has a present expiration date of January 2, 2003; the ServiStar(R) mark has a present expiration date of September 13, 2003; the Coast to Coast(R) mark expires on November 3, 2004; the InduServe Supply(R) mark has a present expiration date of January 23, 2006; the Grand Rental Station(R) mark has a present expiration date of June 4, 2005; the Taylor Rental(R) mark has a present expiration date of January 15, 2004; the Home & Garden Showplace(R) mark has a present expiration date of February 13, 2009 and the Commercial Sales(R) mark has a present expiration date of December 16, 2007. Members are continuing to conduct their businesses under the same retail banners as before the Merger but, beginning in year 2000, all Members with the retail banners of Coast to Coast(R) and ServiStar(R) started to conduct their business under the single retail banner of True Value(R). Membership entitles the Members to have access to all private label product and entitles a Member to receive annual patronage dividends based upon the Member's purchases from TruServ (See Distribution of Patronage Dividend). In accordance with TruServ's By-Laws and the Retail Member Agreements, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors.
The Company serves approximately 8,700 Coast to Coast(R), ServiStar(R) and True Value(R) Hardware Stores throughout the United States. Primary concentrations of Members exist in New York (approximately 9%), Pennsylvania (approximately 8%), California, Florida, Illinois, Massachusetts, Michigan, Ohio and Texas (approximately 4% each).
The Company's total sales of merchandise to its U.S. Members were divided among the following general classes of merchandise:
The Company serves its Members by functioning as a low cost distributor of goods and maximizing its volume purchasing abilities, primarily through vendor rebates and discount programs, for the benefit of its Members. These benefits are passed along to its Members in the form of lower prices and/or patronage dividends. The Company has numerous individual agreements or commitments from its suppliers, virtually all of which are terminable by such suppliers or the Company without cause. Such provisions, either individually or in the aggregate, have not had any material adverse effect on the Company's ability to conduct its business. The goods and services purchased by the Company from these suppliers are generally available from a wide variety of sources. The Company is not dependent upon any one supplier or group of suppliers and has not experienced a problem in obtaining necessary goods. The Company holds conventions and meetings for its Members in order to keep them better informed as to industry trends and the availability of new merchandise. The Company also provides each of its Members with an illustrated price catalog showing the products available from the Company. The Member can access this catalog through the newly developed internet site for Members or a printed version can be sent to them. The Company's sales to its Members are divided into three categories, as follows: (1) warehouse shipment sales (approximately 37% of total sales); (2) direct shipment sales (approximately 58% of total sales); and (3) relay sales (approximately 5% of total sales). Warehouse shipment sales are sales of products purchased, warehoused, and resold by the Company upon orders from the Members. Direct shipment sales are sales of products purchased by the Company but delivered directly to Members from manufacturers. Relay sales are sales of products purchased by the Company in response to the requests of several Members for a product which is (i) included in future promotions, (ii) not normally held in inventory and (iii) is not susceptible to direct shipment. Generally, the Company will give notice to all Members of its intention to purchase products for relay shipment and then purchases only so many of such products as the Members order. When the product shipment arrives at the Company, it is not warehoused; rather, the Company breaks up the shipment and "relays" the appropriate quantities to the Members who placed orders.
The Company also manufactures paint and paint applicators. The principal raw materials used by the Company are chemicals. All raw materials are purchased from outside sources. The Company has been able to obtain adequate sources of raw materials and other items used in production and no shortages of such materials which will materially impact operations are currently anticipated.
The Company annually sponsors two "markets" (one in the Spring and one in the Fall). In fiscal year 2000, these markets will be held in Dallas, Texas and New Orleans, Louisiana. Members are invited to the markets and generally place substantial orders for delivery during the period prior to the next market. During such markets, new merchandise and seasonal merchandise for the coming season is displayed to attending Members.
As of February 26, 2000 and February 27, 1999, respectively, the Company had a backlog of firm orders (including relay orders) of approximately $21,514,000 and $18,700,000. It is anticipated that the entire backlog existing at February 26, 2000 will be filled by April 30, 2000. The Company's backlog at any given time is made up of two principal components: (i) normal resupply orders and (ii) market orders for future delivery. Resupply orders are orders from Members for merchandise to keep inventories at normal levels.
Generally, such orders are filled the day following receipt, except that relay orders for future delivery (which are in the nature of resupply orders) are not intended to be filled for several months. Market orders for future delivery are Member orders for new or seasonal merchandise given at the Company's two markets, for delivery during the several months subsequent to the markets. Thus, the Company will have a relatively high backlog at the end of each market which will diminish in subsequent months until the next market.
The retail hardware industry is characterized by intense competition. Independent retail hardware businesses served by the Company continue to face intense competition from chain stores, discount stores, home centers, and warehouse operations. Increased operating expenses for the retail stores, including increased costs due to longer open-store hours and higher rental costs of retail space, have cut into operating margins and brought pressures for lower merchandise costs, to which the Company has been responsive through a retail-oriented competitive pricing strategy on high-turnover, price-sensitive items. The trueAdvantage(R) program was introduced in 1995 and upgraded in 1997 to promote higher retail standards in order to build consumer goodwill and create a positive image for all Member stores.
The Company competes with other Member-owned and non-member-owned wholesalers as a source of supply and merchandising support for independent retailers. Competitive factors considered by independent retailers in choosing a source of supply include pricing, servicing capabilities, promotional support and merchandise selection and quality. Increased operating expenses and decreased margins have resulted in several non-member-owned wholesalers withdrawing from business.
The Company, through a Canadian subsidiary, owns a majority equity interest in TruServ Canada Cooperative, Inc., a Canadian wholesaler of hardware, variety and related merchandise. This cooperative serves approximately 550 True Value(R) and V&S(R) Stores, all located in Canada. The cooperative has approximately 335 employees and generated less than 5% of the Company's consolidated revenue in fiscal year 1999.
The Company operates several other subsidiaries, most of which are engaged in businesses providing additional services to the Company's Members. In the aggregate, these subsidiaries are not significant to the Company's results of operations.
The Company employs approximately 5,500 persons in the United States on a full-time basis. Due to the widespread geographical distribution of the Company's operations, employee relations are governed by the practices prevailing in the particular area and are generally dealt with locally. Approximately 22% of the Company's hourly-wage employees are covered by collective bargaining agreements which are generally effective for periods of three or four years. In general, the Company considers its relationship with its employees to be good.
RETAIL MEMBER AGREEMENT; FRANCHISE AND LICENSE AGREEMENTS
The TruServ Retail Member Agreement provides, among other things, that each Member:
(i) will be required to own 60 shares of Class A common stock of TruServ for each store owned by such Member (up to a maximum of 300 shares for five or more stores);
(ii) will conduct its businesses under the True Value(R), ServiStar(R) or Coast to Coast(R) names (or other affiliated names or marks) subject to the terms of the Retail Member Agreement;
(iii) will conduct a retail hardware, lumber, building materials, home center, rental or industrial/ commercial operation at a designated location;
(iv) will comply with TruServ's By-Laws as in effect from time to time;
(v) will accept patronage dividends in a form complying with the requirement of the Internal Revenue Code for deduction from gross income by TruServ;
(vi) may receive different services and pay different charges based on the volume of merchandise purchased by the Member;
(vii) agrees to have its Retail Member Agreement terminated in certain circumstances by unilateral action by TruServ's Board of Directors;
(viii) agrees to have its Retail Member Agreement automatically modified upon notice to the Member by TruServ of any change in its Certificate of Incorporation or By-Laws or any resolution of the Board of Directors;
(ix) agrees to have its Retail Member Agreement governed by Illinois law, and enforced or interpreted only in courts located in Cook County, Illinois or any contiguous county; and
(x) may terminate the Retail Member Agreement upon 60 days written notice to TruServ.
In view of current circumstances, the Company has initiated a moratorium on the redemption of its stock. The Board of Directors will review this matter from time to time in light of the then current financial circumstances of the Company.
Some of the licenses and franchise agreements of former SCC Members have been assigned by TruServ to a new wholly-owned limited liability company which was created for the purpose of continuing to operate any license or franchise activities, which have been continued in that format after July 1, 1997. TruServ will review any retail activities which continue to be carried out as franchises. It is anticipated that additional licenses may be entered into periodically with respect to the Taylor Rental Centers and Grand Rental Stations. It is less likely that any additional franchise or license agreements will be entered into with respect to the other retail programs operated as franchises by SCC prior to the Merger. Rather, it is contemplated that these programs will initially be operated as part of the cooperative activities of TruServ.
DISTRIBUTION OF PATRONAGE DIVIDENDS
TruServ operates on a cooperative basis with respect to business transacted with or for Members. All Members are entitled to receive patronage dividend distributions from TruServ on the basis of gross margins of merchandise and/or services purchased by each Member. In accordance with TruServ's By-Laws and Retail Member Agreement, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors. No dividend will be distributed for 1999.
Patronage dividends are usually paid to Members within 90 days after the close of TruServ's fiscal year; however, the Internal Revenue Code (the "Code") permits distribution of patronage dividends as late as the 15th day of the ninth month after the close of TruServ's fiscal year, and TruServ may elect to distribute the annual patronage dividend at a later time than usual in accordance with the provisions of the Code.
TruServ's By-Laws provide for the payment of year-end patronage dividends, after payment of at least 20% of such patronage dividends in cash, in qualified written notices of allocation including (i) Class B common stock based on par value thereof, to a maximum of 2% of the Member's net purchases of merchandise from TruServ for the year (except in unusual circumstances of individual hardships, in which case the Board of Directors reserves the right to make payments in cash), (ii) promissory (subordinated) notes, or (iii) other property. Such promissory (subordinated) notes are for a five year term, bear interest at a fixed rate based on a premium spread above comparable U.S. Treasury notes as approved by the Board of Directors, and are subordinated to all other debt of TruServ. TruServ may also issue nonqualified written notices of allocation to its Members as part of its annual patronage dividend. See "Payment of Patronage Dividends in Accordance with the Internal Revenue Code."
In determining the form of the annual patronage dividend, a Member's required investment in Class B common stock of TruServ had historically been limited by the Board of Directors to an amount, the cumulative value of which will not exceed two percent (2%) of the Member's net purchases of merchandise from the Company. Commencing in 1996, the Board established minimum Class B ownership requirements (currently $25,000 for hardware stores and $15,000 for lumber stores) which may be varied from time to time and is comprised of the aggregate of a Member's various types of annual purchases multiplied by a specific percentage, that varies from 1% to 14%, decreasing as total dollar purchases by category increase. The amount of such required investment is determined by majority vote of the Board of Directors, and may be increased or
decreased by such vote. The basis for determining the necessity of an increase or decrease is through evaluation of the financial needs of TruServ, while considering the needs of its membership. The consideration and method of payment for such shares is by way of the required amount being calculated as part of the annual patronage dividend distribution amount.
PAYMENT OF PATRONAGE DIVIDENDS IN ACCORDANCE WITH THE INTERNAL REVENUE CODE
The Code specifically provides for the taxation of cooperatives (such as TruServ) and their patrons (such as TruServ's Members) so as to ensure that the business earnings of cooperatives are currently taxable either to the cooperatives or to the patrons.
The shares of Class B nonvoting common stock and other written notices, which disclose to the recipient the stated amount allocated to him by TruServ and the portion thereof which is a patronage dividend, distributed by TruServ to its Members are "written notices of allocation" within the meaning of that phrase as used in the Code. For such written notices to be "qualified written notices of allocation" within the meaning of the Code, it is necessary that TruServ pay 20% or more of the annual patronage dividend in cash and that the Members consent to having the allocations (at their stated dollar amount) treated as being constructively received by them and includable in their gross income. Such written notices that do not meet these requirements are "nonqualified written notices of allocation" within the meaning of the Code. Cash, qualified written notices, and other property (except nonqualified written notices of allocation) are currently deducted from earnings in determining the taxable income of TruServ and, accordingly such qualified written notices of allocation are includable in gross income of the patron (Member). Section 1385(a) of the Code provides, in substance, that the amount of any patronage dividend which is paid in cash, qualified written notices of allocation or other property (except nonqualified written notices of allocation) shall be included in the gross income of the patron (Member) for the taxable year in which it receives such cash or such qualified written notices of allocation. In general, with respect to nonqualified written notices of allocation, no amounts are deductible by TruServ or includable in gross income of the patron (Member) until redeemed by TruServ.
Thus, every year each Member may receive, as part of the Member's patronage dividend, non-cash "qualified written notices of allocation", which may include Class B nonvoting common stock, the stated dollar amount of which must be recognized as gross income for the taxable year in which received. The portion of the patronage dividend paid in cash (at least 20%) may be insufficient, depending on the tax bracket in each Member's case, to provide funds for the payment of income taxes for which the Member will be liable as a result of the receipt of the entire patronage dividend, including cash and Class B nonvoting common stock.
In response to the provisions of the Code, TruServ's By-Laws provide for the treatment of the shares of Class B nonvoting common stock and such other notices as the Board of Directors may determine, distributed in payment of patronage dividends as "qualified written notices of allocation." The By-Laws provide in effect:
(i) for payment of patronage dividends partly in cash, partly in qualified written notices of allocation (including the Class B nonvoting common stock as described above), other property or in nonqualified written notices of allocation, and
(ii) that membership in the organization (i.e. the status of being a Member of TruServ) shall constitute consent by the Member to take the qualified written notices of allocation or other property into account in the Member's gross income as provided in Section 1385(a) of the Code.
Under the provisions of the Code, persons who become or became Members of TruServ or who retained their status as Members after adoption of the By-Laws providing that membership in the organization constitutes consent, and after receiving written notification and a copy of the By-Laws are deemed to have consented to the tax treatment of the cash and the qualified written notices of allocation in which the patronage dividends are paid, in accordance with Section 1385(a) of the Code. Written notification of the adoption of the By-Laws and its significance, and a copy of the By-Laws, were sent to each then existing Member and have been, and will continue to be, delivered to each party that became, or becomes a Member thereafter. Such consent is then effective except as to patronage occurring after the distributee ceases to be a Member of the organization or after the By-Laws of the organization cease to contain the provision with
respect to the above described consent. Such consent may be revoked by the Member only by terminating its membership in TruServ in the manner provided in its Retail Member Agreement.
Each year since 1978, TruServ has paid its Members 30% of the annual patronage dividend in cash in respect to patronage (excluding nonqualified written notices of allocation) occurring in the preceding year. It is the judgment of management that the payment of 30% or more of patronage dividends in cash will not have a material adverse effect on the operations of TruServ or its ability to maintain adequate working capital for the normal requirements of its business. However, TruServ is obligated to distribute only 20% of the annual patronage dividend (excluding nonqualified written notices of allocation) in cash and it may distribute this lesser percentage in future years.
In order to avoid the administrative inconvenience and expense of issuing separate certificates representing shares of Class B nonvoting common stock to each Member, TruServ deposits a bulk certificate with Harris Trust and Savings Bank, Chicago, Illinois for safekeeping for and on behalf of its Members and sends a written notice to each Member of these deposits and the allocation thereof to such Member.
ITEM 2.
ITEM 2. PROPERTIES.
The Company's national headquarters is located in Chicago, Illinois. Information with respect to the Company's owned and leased warehousing and office facilities is set forth below:
No location owned by the Company is subject to a mortgage.
In December 1983, the Company completed construction of a 150,000 square foot addition to its regional distribution center in Manchester, New Hampshire. This addition was financed with the proceeds from the sale of $4,000,000 State of New Hampshire Industrial Development Authority Revenue Bonds (TruServ Corporation Project) Series 1982. On October 1, 1997, and every three-year period thereafter, the interest rate on the 4.50% industrial revenue bonds will be adjusted based on a bond index. These bonds may be redeemed at face value at either the option of the Company or the bondholders at each interest reset date through maturity in 2003.
The Ft. Smith, Arkansas and Peachtree City, Georgia properties, which were closed in 1997, are under lease and are currently under a sublease. The Butler, Pennsylvania office building was closed in 1997 and sold in 1999. The Parkesburg, Pennsylvania; Piedmont, South Carolina and Portland, Oregon properties were closed in 1998 and sold in 1999. In 1999, the Company announced the closing of its Westfield, Massachusetts distribution center. The Henderson, North Carolina distribution center was sold in 1999 and is currently being leased back to the Company.
Information with respect to the Company's manufacturing facilities is set forth below:
The Company's facilities are suitable for their respective uses and are, in general, adequate for the Company's present needs.
The Company owns and leases transportation equipment for use at its regional distribution centers for the primary purpose of delivering merchandise from the Company's regional distribution centers to its Members. Additional information concerning these leases can be found in note 5 to the consolidated financial statements included elsewhere herein.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or of which any of their property is the subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is no existing market for the common stock of the Company and there is no expectation that any market will develop. The Company's Class A common stock is owned exclusively by retailers of hardware, lumber/building materials and related products each of whom is a Member of the Company and purchases sixty shares of the Company's Class A common stock (the only class of voting stock) upon becoming a Member. The Company is organized as a Delaware stock corporation and operates as a Member-owned wholesaler cooperative corporation. The shares of the Company's Class B nonvoting common stock now outstanding were issued to Members in partial payment of the annual patronage dividend to which they became entitled as a result of patronage business transacted by such Members with the Company. In accordance with the Company's By-Laws, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors.
The number of holders of record (as of February 26, 2000) of each class of stock of the Company is as follows:
Dividends (other than patronage dividends) on the Class A common stock and Class B nonvoting common stock, subject to the provisions of the Company's Certificate of Incorporation, may be declared out of gross margins of the Company, other than gross margins from operations with or for Members and other patronage source income, after deduction for expenses, reserves and provisions authorized by the Board of Directors. Dividends may be paid in cash, in property, or in shares of the common stock, subject to the
provisions of the Certificate of Incorporation. Other than the payment of patronage dividends, including the redemption of all nonqualified written notices of allocation, the Company has not paid dividends on its Class A common stock or Class B nonvoting common stock. The Board of Directors does not plan to pay dividends on either class of stock. See the discussion of patronage dividends under Item 1 - -Business.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
SELECTED FINANCIAL DATA
- --------------- (a) The net margins (loss) for fiscal years 1999, 1998 and 1997 include deductions of $26,196,000, $20,034,000 and $13,650,000, respectively, for merger integration costs. (b) No patronage dividend was issued in 1999.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS COMBINATION
On July 1, 1997, TruServ Corporation (the "Company"), formerly Cotter & Company ("Cotter") merged with Servistar Coast to Coast Corporation ("SCC") (the "Merger"). The transaction was accounted for using the purchase accounting method. Accordingly, the financial information for the years ended December 31, 1998 and 1999 reflect the results of the post-Merger Company and the financial information for the year ended December 31,1997 reflects the results of the pre-Merger Company for the twenty-six weeks ended June 28, 1997 and the results of the post-Merger Company for the twenty-six weeks ended December 31, 1997. To facilitate the comparison of results for 1999, 1998 and 1997, supplemental comparisons have been provided using pro forma financial information. This pro forma information has been prepared for comparative purposes only and does not purport to be indicative of the results of operations that actually would have resulted had the Merger been in effect on the dates indicated, or which may result in the future.
- --------------- (1) Assumes the Merger was consummated at January 1, 1997.
FISCAL YEAR 1999 COMPARED TO FISCAL YEAR 1998
RESULTS OF OPERATIONS
Revenues for the fiscal year 1999 totaled $4,502,326,000. This represented an increase of $174,088,000 or 4.0% compared to the comparable period last year. The increase was due primarily to increases in direct shipment sales, which increased 7.8% and lumber/building materials sales which increased 15.1%.
Gross margins decreased by $116,670,000 or 39.1%, and as a percentage of revenues, decreased to 4.0% from 6.9% for the comparable period last year. The decrease in gross margin percentage was due to a change in sales mix, which consisted of an increase in direct shipment and lumber sales, which have lower gross margin percentages compared to handled merchandise. Also, gross margin was impacted by increased Member claims and other inventory adjustments that were related to the closing of distribution centers caused by the finalization of the distribution network strategy.
Warehouse, general and administrative expenses remained consistent as a percent of revenue with the prior year at 4.8% and 4.7% respectively. The reduction of expense that began in 1998 continued in 1999 with headcount reductions and the elimination of fixed costs by closing and selling idle distribution centers and was offset by a $15.6 million reduction in capitalized warehouse, general and administrative expense due to inventory reduction.
Interest paid to Members decreased by $1,892,000 or 11.5% primarily due to a lower average interest rate and lower principal balance. Other interest expense increased $7,494,000 due to an increase in the Company's borrowing rate.
The gain on sale of properties totaled $11,724,000 for fiscal year 1999, and is attributable to the sale of redundant distribution centers and associated property.
Income tax expense increased by $16,423,000 because of the uncertainty of the future realization of the tax benefit. The previously recorded tax asset related to the merger was written off due to the extent of the net operating loss that has occurred in 1999.
The cumulative effect on prior years of a change in accounting principle of $6,484,000 reflects the start-up costs of converting the systems used by SCC distribution centers prior to the merger to those systems currently used by the Company. This reduction in net margins is in compliance with SOP 98-5, Reporting the Costs of Start-up Activities.
Merger integration costs for the fiscal year 1999 were $26,196,000 compared to $20,034,000 for the comparable period last year. Merger integration costs consist of one time non-recurring expenses directly attributable to the Merger including distribution center closings, severance pay, information systems costs and general and administrative costs.
The combination of decreased gross margins, as well as increased borrowing costs, increased income tax expense and the cumulative effect of a change in accounting principle resulted in a net loss of $131,143,000 compared to a net margin of $20,480,000 for the same period last year.
FISCAL YEAR 1998 COMPARED TO FISCAL YEAR 1997
RESULTS OF OPERATIONS
Revenues in fiscal year 1998 totaled $4,328,238,000. This represented an increase of $996,552,000 or 29.9% compared to the comparable period last year. The increase was primarily due to the addition of Servistar Coast to Coast revenues that resulted from the July 1, 1997 merger of Cotter and SCC. The departments with the largest increase are the lumber/building material department, manufactured products, and the Canadian business. In the hardware department the largest increase was reflected in the direct shipment categories with TruServ Members responding to improved pricing programs.
Gross margins increased by $57,115,000 or 23.7% but as a percentage of revenues decreased to 6.9% from 7.2% for the comparable period last year. This is the seventh year in a row that the gross margin as a percentage of revenue has decreased. The decrease in gross margin percentage resulted primarily from a change in the sales mix. The change in sales mix consisted of large volume increases in Lumber/Building Materials and Direct Shipments, which have lower gross margins. Pricing improvements resulted in lower direct shipment markups and a lower pricing on manufactured products.
Warehouse, general and administrative expenses as a percentage of revenues increased to 4.7% from 4.5% compared with the prior year. The Company incurred additional warehousing expenses in association with commonizing inventory assortments, increased inventory levels, and the implementation of the distribution network strategy. Many of the potential cost efficiencies related to the Merger have not yet been realized and costs should be reduced as the Merger strategy is further implemented.
Certain estimates of warehouse, general and administrative expenses are recorded throughout the year including expenses related to capitalizable inventory related costs and other expense items. During the fourth quarter of fiscal 1998, the Company recorded approximately $60,000,000 of net reductions in warehouse, general and administrative expenses relating to the refinement of these estimates recorded in the prior three quarters.
Interest paid to Members decreased by $1,475,000 or 8.3% primarily due to a lower average interest rate and lower principal balance. Other interest expense increased $19,610,000 due to higher borrowings compared to the same period last year. The higher borrowings were required because of the increased cash requirement resulting from the merger and increased inventory levels. The effective borrowing rate for 1998 was lowered due to the renegotiation of the rates since the date of the Merger. The Company is required to meet certain financial ratios and covenants pertaining to certain debt arrangements. The Company's lenders have waived compliance with a covenant as of December 31, 1998 in lieu of amendments to the debt agreements, which were finalized by the Company during the first quarter of 1999.
The combination of increased gross margins, offset by increased expenses and increased borrowing costs, resulted in a net margin before Merger integration costs of $40,514,000 in fiscal year 1998 compared to $56,366,000 in fiscal year 1997. Merger integration costs consist of one time non-recurring expenses directly attributable to the Merger including distribution center closings, severance pay, information systems costs and general and administrative costs. Merger integrations costs were $20,034,000 and $13,650,000 for fiscal years 1998 and 1997, respectively. The net margin after Merger integration cost was $20,480,000 and $42,716,000 for fiscal year 1998 and 1997, respectively.
ACTUAL FISCAL 1998 COMPARED TO PRO FORMA FISCAL 1997
RESULTS OF OPERATIONS
Revenues for the fiscal year totaled $4,328,238,000. This represented an increase of $104,023,000 or 2.5% compared to the prior year on a pro forma basis. The increase was attributable to revenue increases in lumber/ building materials and direct shipments.
Gross margins increased by $13,779,000 or 4.8% and as a percentage of revenues, increased to 6.9% from 6.7% for the prior year on a pro forma basis. The increased gross margins came about primarily from the increase in revenue along with a reduction in the estimated capitalizable inventory-related costs.
Warehouse, general and administrative expenses increased by $28,746,000 or 16.4% and as a percentage of revenues increased to 4.7% from 4.2% for the prior year on a pro forma basis. The Company incurred additional warehousing expenses in association with commonizing inventory assortments, increased inventory levels, and the implementation of the distribution network strategy. Many of the potential cost efficiencies related to the Merger have not yet been realized and costs should be reduced as the Merger strategy is further implemented.
Interest expense increased from $43,459,000 to $55,100,000 primarily due to higher short-term borrowings because of the increased cash requirement resulting from increased inventory levels.
Integration costs consist of costs associated with the implementation of the Merger plan.
The combination of increased gross margin partially offset by higher warehouse, general and administrative expense and higher interest expense, resulted in a net margin of $20,480,000 compared to $67,357,000 for the prior year on a pro forma basis.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities for the year end December 31, 1999 was $177,695,000 compared to cash used for operating activities of $102,092,000 for the year ended December 31, 1998. As of December 31, 1999, inventories decreased by $112,703,000 as the Company completed its efforts to commonize inventory assortment and implement the Company's distribution network strategic plan. Accounts and notes receivable decreased by $63,059,000 due to improved collection efforts. The accounts payable increase of $52,175,000 is associated with improved terms with vendors and better inventory turns.
Cash flows used for investing activities were $10,532,000. Total capital expenditures, including those made under capital leases, were $45,235,000 for the fiscal year 1999 compared to $71,343,000 during the comparable period in 1998. These capital expenditures relate to additional equipment and technological improvements at the regional distribution centers and at the corporate headquarters. Additionally, the company has sold four redundant distribution centers during fiscal 1999. Proceeds from the sale of these properties were $39,714,000. The Parksburg, Pennsylvania; Piedmont, South Carolina and Portland, Oregon distribution centers were sold in 1999. The Henderson, North Carolina distribution center was sold in 1999 and is currently being leased back to the Company.
The cash flows generated from operations was used to reduce the Company's financing activities by $166,998,000. This decrease was in both long and short-term debt.
At July 1, 1997, the Company had established a $300,000,000 five-year revolving credit facility with a group of banks. These agreements were amended during March 1999. The borrowings under these agreements were $135,000,000 and $227,000,000 at December 31, 1999 and December 31, 1998, respectively.
Under the senior notes and revolving credit facility the Company is required to meet certain financial ratios and covenants. The Company's lenders have waived compliance with certain covenants as of December 31, 1999 and amended and restated the debt agreements including increased interest rates, new financial ratios and covenants and the securitization of the Company's assets, which were finalized by the Company during April of 2000.
At December 31, 1999, net working capital decreased to $79,240,000 from $241,533,000 at December 31, 1998. The current ratio decreased to 1.09 at December 31, 1999 compared to 1.26 at December 31, 1998.
The Company's capital is primarily derived from Class A common stock and retained earnings, together with promissory (subordinated) notes and nonvoting Class B common stock issued in connection with the Company's annual patronage dividend. The Company believes the funds derived from these capital resources, as well as operations and the credit facilities noted above, will be sufficient to satisfy capital needs.
YEAR 2000
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $3,800,000 during 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are subject to certain market risks, primarily interest rate risk and credit risk. Interest rate risk pertains to the Company's variable rate debt which totals approximately $150 million at December 31, 1999. A 50 basis point movement in the interest rates would result in an approximate $750,000 annualized increase or decrease in interest expense and cash flows. For the most part, interest rate risk is managed through a combination of variable and fixed-rate debt instruments with varying maturities. Credit risk pertains mostly to the Company's trade receivables. The Company extends credit to its members as part of its day-to-day operations. The Company believes that as no specific receivable or group of receivables comprises a significant percentage of total trade accounts, its risk in respect to trade receivables is limited. Additionally, the Company believes that its allowance for doubtful accounts is adequate in respect to member credit risks.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The Company's consolidated financial statements and report of independent auditors are listed on Page.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The directors and senior and executive officers of the Company are:
- --------------- During the past five years, the principal occupation of each director of the Company, other than Donald J. Hoye, was the operation of retail hardware stores or lumber/building materials stores.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION COMMITTEE
The Human Resource Development Committee of the Board of Directors (the "Committee") consists of four non-employee directors: Jay B. Feinsod, Jerrald T. Kabelin, Peter G. Kelly and Robert J. Ladner. In addition, Joe W. Blagg, served as an ex-officio member of the Committee. The Committee assists the Board of Directors in fulfilling its responsibilities for setting and administering the policies which govern annual compensation and monitoring the Company's pension and certain other benefit plans. The Committee calls upon outside consultants for assistance, as necessary.
The Committee meets at least annually. Primary responsibilities of the Committee include:
- Establishing the Chairman and President's salary and annual and long-term incentive opportunities.
- Approving other executive officer salaries recommended by the President.
- Setting performance goals for the annual and long-term incentive plans.
- Assessing performance achievement relative to goals and approving incentive payments.
The Committee makes recommendations to the Board of Directors regarding compensation of the Company's executive officers. The philosophy of the Committee is to maintain an executive compensation program to help the Company attract, retain and motivate the executive resources needed to maintain industry leadership, provide high levels of service to Members, and achieve the financial objectives as determined by the Board of Directors.
To achieve its stated goals, the Company has developed three executive compensation policies.
- The Company provides levels of salaried compensation that are competitive.
- The Company provides annual incentive compensation for executives that vary in a consistent and predictable manner with the performance of the Company.
- The Company provides an incentive program which enables selected executives to achieve incentive awards based on the long-term (multiple year) performance of the Company.
The combination of these three compensation policies is intended to provide competitive earnings opportunities when performance reaches desired levels. Both the annual and long-term incentive plans are cancelable by the Board of Directors at any time.
The Company provides salary levels that are competitive with the median (50th percentile) of the executive marketplace. The industry comparison groups used to evaluate competitiveness include: member owned organizations, wholesale distribution firms, mass merchandising firms and general industry and manufacturing organizations. Competitiveness is measured using data from a number of sources, including published information, proxies and surveys by consulting firms.
The annual incentive plan is designed to ensure that executive compensation varies in relation to achievement of annual performance goals. Each executive's incentive award is determined by Company results and individual goals.
The long-term incentive plan assures a continuing focus on the Company's future. Goals are set for performance achievement over three-year intervals. A new performance period starts each year and goals for each three-year cycle currently underway are related to achievement of financial goals.
EXECUTIVE COMPENSATION
The following table sets forth the total annual compensation paid to the Company's five most highly compensated executive officers during fiscal year 1999 and the total compensation paid to each such individual for the Company's two previous fiscal years:
SUMMARY COMPENSATION TABLE
- --------------- (1) Fiscal 1997 salary for Donald J. Hoye and Donald C. Belt is for the period from July 1, 1997 to December 31, 1997.
(2) Annual bonus amounts are earned and accrued during the fiscal years indicated, and paid subsequent to the end of each fiscal year. In 1997 special one-time bonuses were granted for the successful completion of the merger.
(3) Other compensation consists of Company contributions to the TruServ Corporation Employee's Savings and Compensation Deferral Plan (the "Savings Plan") and automobile allowances. Under the Savings Plan, each participant may elect to make a contribution in an amount of up to fifteen percent (15%) of his annual compensation, not to exceed $30,000 (including Company contributions) a year, of which $10,000 of the executive officer's salary in fiscal year 1999 may be deferred. The Company's contribution to the Savings Plan is equal to seventy-five percent (75%) of the participant's contribution, but not to exceed four and one-half percent (4 1/2%) of the participant's annual compensation.
In 1999 other compensation for Mr. Hoye and Mr. Belt consists primarily of a transition bonus of $20,000 and $10,000, respectively. For Mr. Schnabel the 1999 other compensation consists primarily of relocation payments of $23,380.
In 1998 other compensation for Mr. Hoye and Mr. Belt consists primarily of a transition bonus of $40,000 and $20,000, respectively. For Mr. Schnabel the 1998 other compensation consists primarily of relocation payments of $228,116.
In 1997 other compensation for Mr. Hoye and Mr. Belt consists primarily of $61,491 and $47,286, respectively for relocation payments.
(4) Long-term incentives for each open three year cycle were computed as of the effective date of the merger and paid on a pro-rata basis during the fiscal year.
(5) Daniel A. Cotter retired on December 31, 1999 and Daniel T. Burns retired on February 29, 2000.
The Company has a severance policy providing termination benefits based upon annual compensation and years of service. Officers of the Company are also offered agreements providing for severance in the event of termination with the imposition of certain restrictions regarding competition and confidentiality.
No loans were made by the Company to its executive officers or to its directors during the last three fiscal years.
LONG-TERM PERFORMANCE CASH AWARDS
The Board of Directors adopted a long-term incentive plan for the officers of the Company. Officers are eligible for cash payouts based on a percentage of their annual salary if performance goals established for the plan are met. Performance goals for the current plans relate to the achievement of financial goals of sales growth, net earnings and cash flow. No awards were earned in 1999.
DEFINED BENEFIT RETIREMENT PLANS
The Company has a defined benefit pension plan, the TruServ Corporation Defined Lump Sum Pension Plan (the "Plan"), which is qualified under the Code. The Plan was amended and restated effective January 1, 1998. The amount of the Company's annual contribution to the Plan is determined for the total of all participants covered by the Plan, and the amount of payment with respect to a specified person is not and cannot readily be separated or individually calculated by the actuaries for the Plan. The Plan provides fully vested lump sum benefits to eligible employees who have served a minimum of five years of service. Annuities are also available and are the actuarial equivalent of the lump sum payment. Each of the executive officers listed in the foregoing Summary Compensation Table is a participant in the Plan.
For each year of service, a participant receives a percentage of his or her "average compensation" in the form of a lump sum. The percentages range from two percent of average compensation for years of service performed prior to age 26, to twelve percent of average compensation for years of service performed at or after age 61. Participants with average compensation in excess of two-thirds of the Social Security Taxable Wage Base in the year of termination of employment or retirement receive an additional benefit on this excess compensation equal to half of the percentage applied to their full average compensation. Participants who were age 50 with at least fifteen years of service as of January 1, 1996 receive an additional 25% of their average compensation. The benefits under the Plan cannot be less than benefits already earned by the participant under the Plan as it existed prior to its amendment.
The Plan was amended effective January 2, 1998 to include former employees of SERVISTAR/Coast to Coast. These employees get credit under the Plan for all years for which they received credit under the SERVISTAR/Coast to Coast Retirement Income Plan ("the SERVISTAR Plan"). In addition, any of these employees who had attained age 50 and completed 15 years of service as of January 1, 1998 receive an additional 25% of their average compensation. Also, the benefits under this Plan cannot be less than benefits already earned by the participant under the SERVISTAR Plan as of December 31, 1997.
"Average compensation" means the average of the compensation paid to an eligible employee during the three highest consecutive calendar years within the ten consecutive calendar years immediately preceding the date of termination of employment. Compensation considered in determining benefits includes salary, overtime pay, commissions, bonuses, deferral contributions under the Savings Plan, and pre-tax medical premiums.
The Company amended and restated effective July 24, 1998, a Supplemental Retirement Plan (the "Supplemental Plan") for certain employees as designated by the Company's President and Chief Executive Officer. The Plan was amended on July 1, 1997 to include certain former SCC employees. For each year of
service, participants receive a percentage of their "average compensation" in the form of a lump sum. The percentages are 33 percent of average compensation for years of service performed prior to age 55, to 42 percent of average compensation for years of service performed at or after age 55. Service is limited to 20 years, and the maximum aggregate percentage is 660%. This amount is reduced by any benefits payable under the Plan and eight times the participant's primary Social Security benefit. "Average Compensation" for the Supplemental Plan is defined the same as for the Plan, as discussed above. The benefits under the Supplemental Plan cannot be less than benefits already earned by the participant under the Supplemental Plan as it existed prior to its amendment.
The Supplemental Plan is not a qualified plan under the Code. Benefits payable under the Supplemental Plan will be financed through internal operations. The estimated annual retirement benefits which may be payable pursuant to the Plan to the officers named in the Summary Compensation Table is currently limited under Section 401(a)(17) of the Code, which outlines the maximum earnings amounts which may be considered under the Plan in determining retirement benefits. This limit was $160,000 for 1999. Section 415 of the Code outlines the maximum annual benefit which may be payable from the Plan during the year; the dollar limit is $135,000 for 2000 for a participant retiring at age 65, with reduced amounts at younger ages. The actuarial equivalent of the annual amount may be payable as a lump sum.
The following table reflects the combined estimated annual retirement benefits which may be payable pursuant to the Plan and the Supplemental Plan to the officers named in the Summary Compensation Table at retirement under various assumed conditions, assuming retirement at age 65.
The present credited years of service for the officers listed in the above table are as follows: Daniel A. Cotter, 33 years; Donald J. Hoye, 29 years; Daniel T. Burns, 19 years; Donald C. Belt, 15 years; Robert Ostrov, 3 years; Brian T. Schnabel, 1 year.
There is no existing market for the Company's common stock and there is no expectation that any market will develop. There are no broad market or peer group indexes the Company believes would render meaningful comparisons. Accordingly, a performance graph of the Company's cumulative total shareholder return for the previous five years, with a performance indicator of the overall stock market for the Company's peer group, has not been prepared.
In fiscal year 1999 directors of the Company were each paid $2,000 per month and advisory board members received $1,000 per month. The two Vice Chairmen of the Board are each paid to a maximum of $54,000 per year, when serving in the capacity as Vice Chairmen.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
As of February 26, 2000, each of the directors of the Company, except for Donald J. Hoye, was the beneficial owner of 60 shares of Class A common stock of the Company comprising .3% of such shares issued and outstanding. No executive officer owns any shares of Class A common stock.
The directors own in the aggregate approximately .5% of Class B nonvoting common stock as of February 26, 2000. No executive officer owns any shares of Class B nonvoting common stock.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
[None]
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS
The consolidated financial statements listed in the accompanying index (page) to the consolidated financial statements are filed as part of this annual report.
2. FINANCIAL STATEMENT SCHEDULES
No schedules have been filed because the required information is not applicable or is not material or because the required information is included in the consolidated financial statements or the notes thereto.
3. EXHIBITS
The exhibits listed on the accompanying index to exhibits (pages E-1 and E-2) are filed as part of this annual report.
(B) REPORTS ON FORM 8-K
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 ANNUAL REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
TRUSERV CORPORATION
By: /s/ LEONARD G. KUHR -------------------------------------- Leonard G. Kuhr, Senior Vice President and Chief Financial Officer DATED: April 14, 2000
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS ANNUAL REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
ITEM 14(A). INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT AUDITORS
To the Members and the Board of Directors TruServ Corporation
We have audited the accompanying consolidated balance sheets of TruServ Corporation (formerly Cotter & Company) as of December 31, 1999 and 1998, and the related consolidated statements of operations, cash flows, and capital stock and retained earnings (deficit) for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of TruServ Corporation at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the financial statements, in 1999 the Company changed its method of accounting for start-up costs.
/s/ Ernst & Young LLP
Chicago, Illinois April 14, 2000
TRUSERV CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
See Notes to Consolidated Financial Statements
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
See Notes to Consolidated Financial Statements
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Consolidated Financial Statements
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF CAPITAL STOCK AND RETAINED EARNINGS (DEFICIT)
Class A common stock amounts are net of unpaid amounts of $3,874,000 relating to 106,380 issued shares at December 31, 1999; $5,890,000 relating to 178,020 issued shares at December 31, 1998; $6,289,000 relating to 149,875 issued shares at December 31, 1997; and $1,000 for 290 subscribed shares at December 28, 1996.
See Notes to Consolidated Financial Statements.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND ACCOUNTING POLICIES
TruServ Corporation ("TruServ" or the "Company") is a Member-owned wholesaler of hardware, lumber/building materials and related merchandise. The Company also manufactures paint and paint applicators. The Company's goods and services are sold predominantly within the United States, primarily to retailers of hardware, lumber/building materials and related lines, each of whom has purchased 60 shares per store (up to a maximum of 5 stores) of the Company's Class A common stock upon becoming a Member. The Company operates in a single industry as a Member-owned wholesaler cooperative. All Members are entitled to receive patronage dividend distributions from the Company on the basis of gross margins of merchandise and/or services purchased by each Member. In accordance with the Company's By-laws, the annual patronage dividend is paid to Members out of gross margins from operations and other patronage source income, after deduction for expenses and provisions authorized by the Board of Directors.
On July 1, 1997, TruServ Corporation, formerly Cotter & Company ("Cotter"), merged with ServiStar Coast to Coast Corporation ("SCC") (the "Merger"). SCC was a hardware wholesaler with a strong presence in retail lumber and building materials. The transaction was accounted for using the purchase accounting method. The Consolidated Balance Sheet at December 31, 1999 and December 31, 1998 reflect the post-Merger Company. The Consolidated Statements of Operations and Cash Flows for the years ended December 31, 1999 and December 31, 1998 reflect the results of the post-Merger Company. The Consolidated Statements of Operations and Cash Flows for the year ended December 31, 1997 reflect the results of the post-Merger Company, which include the results of the former SCC since July 1, 1997. The significant accounting policies of the Company are summarized below:
Business Combination
On July 1, 1997, pursuant to an Agreement and Plan of Merger dated December 9, 1996 between Cotter, a Delaware corporation, and SCC, SCC merged with and into Cotter, with Cotter being the surviving corporation. Cotter was renamed TruServ Corporation effective with the Merger. Each outstanding share of SCC common stock and SCC Series A stock (excluding those shares canceled pursuant to Article III of the Merger Agreement) were converted into the right to receive one fully paid and nonassessable share of TruServ Class A common stock and each two outstanding shares of SCC preferred stock were converted into the right to receive one fully paid and non-assessable share of TruServ Class B common stock. A total of 270,500 and 1,170,670 shares of TruServ Class A common stock and Class B common stock, respectively, were issued in connection with the Merger. Also 231,000 additional shares of TruServ Class A common stock were issued in exchange for Class B common stock to pre-Merger stockholders of Cotter to satisfy the Class A common stock ownership requirement of 60 shares per store (up to a maximum of 5 stores) applicable to such Members as a result of the Merger.
In connection with the purchase business combination, an estimated liability of $38,200,000 was recognized for costs associated with the Merger plan. During 1998, an adjustment was recorded reducing this liability and goodwill by $2,500,000. The Merger plan specifies the elimination of certain former SCC employment positions, approximately 1,500 in total, substantially within one year. As of December 31, 1999, approximately 99% of these employees have been terminated resulting in a $13,648,000 charge against the liability. The Merger plan specifies the closure of four redundant former SCC distribution centers substantially within a one-year period. Distribution center closing costs include net occupancy and other costs after facilities are vacated. As of December 31, 1999, four distribution centers have been closed and $3,569,000 relating to distribution center closing costs has been charged against the liability. As of December 31, 1999, additional costs of $17,800,000 related to moving and relocation and the closure of the former SCC headquarters have been charged against the liability. The remaining liability balance at December 31, 1999 of $683,000 is for costs expected to be incurred in the first quarter of 2000 in connection with elimination of the remaining employment positions. Merger integration costs of $26,196,000 and $20,034,000 for the years ended
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1999 and 1998, respectively, consist of one time non-recurring expenses directly attributable to the Merger including former Cotter distribution center closings, severance pay, information service costs and general and administrative costs.
Consolidation
The consolidated financial statements include the accounts of the Company and all wholly owned subsidiaries. The consolidated financial statements also include the accounts of TruServ Canada Cooperative, Inc., a Canadian Member-owned wholesaler of hardware, variety and related merchandise, in which the Company has a majority equity interest.
Capitalization
The Company's capital (Capitalization) is derived from Class A voting common stock and retained earnings, together with promissory (subordinated) notes and Class B nonvoting common stock issued in connection with the Company's annual patronage dividend. The By-laws provide for partially meeting the Company's capital requirements by payment of the year-end patronage dividend.
Patronage Dividend
No Patronage dividends were declared for fiscal year ended December 31, 1999. Patronage dividends earned for fiscal year 1998 were declared and were paid to TruServ Members in the first quarter of 1999 with at least thirty percent of the patronage dividend paid in cash and the remainder paid through the issuance of the Company's Class B nonvoting common stock. The Class B nonvoting common stock for December 31, 1998 patronage dividend has been designated as non-qualified notices of allocation and are not taxable to the Member until redeemed at a future date. The non-qualified notices in addition to not being taxable will be included as part of a Member's required investment in Class B nonvoting common stock. Any further distributions after meeting the Class B nonvoting common stock requirements agreed upon in the Merger Agreement will be in cash rather than in promissory notes. TruServ follows the practice of accounting for deferred patronage charges and credits as a separate component of capitalization. Deferred patronage consists of net charges and expenses primarily related to the merger integration process which are included in the computation of net margin in different periods for financial statement purposes than for patronage purposes.
Membership may be terminated without cause by either the Company or the Member upon ninety days' written notice. In the event membership is terminated, the Company undertakes to purchase, and the Member is required to sell to the Company, all of the Member's Class A common stock and Class B nonvoting common stock at par value. Payment for the Class A common stock will be in cash. Payment for the qualified Class B nonvoting common stock will be a note payable in five equal annual installments.
In view of current circumstances, the Company has initiated a moratorium on the redemption of its stock. The Board of Directors will review this matter from time to time in light of the then current financial circumstances of the Company.
Cash equivalents
The Company classifies its temporary investments in highly liquid debt instruments, with an original maturity of three months or less, as cash equivalents.
Inventories
Inventories are stated at the lower of cost, determined on the 'first-in, first-out' basis, or market.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Properties
Properties are recorded at cost. Depreciation and amortization are computed by using the straight-line method over the following estimated useful lives: buildings and improvements -- 10 to 40 years; machinery and warehouse, office and computer equipment -- 5 to 10 years; transportation equipment -- 3 to 7 years; and leasehold improvements -- the life of the lease without regard to options for renewal.
Goodwill
Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized using the straight-line method over 40 years. Amortization of goodwill was approximately $2,931,000 and $2,738,000 for the years ended December 31, 1999 and 1998, respectively.
Asset Impairment
For purposes of determining impairment, management groups long-lived assets based on a geographic region or revenue producing activity as appropriate. Such review includes, among other criteria, management's estimate of future cash flows for the region or activity. If the estimated future cash flows (undiscounted and without interest charges) were not sufficient to recover the carrying value of the long-lived assets, including associated goodwill, of the region or activity, such assets would be determined to be impaired and would be written down to fair value. There was no asset impairment as of December 31, 1999.
Start-up Costs
In April 1998, the AICPA issued SOP 98-5, Reporting the Costs of Start-up Activities. The SOP is effective beginning on January 1, 1999, and requires that start-up costs capitalized prior to January 1, 1999 be written-off and any future start-up costs to be expensed as incurred. The unamortized balance of start-up costs were written off as a cumulative effect of an accounting change as of January 1, 1999 and resulted in an increase of 1999 net loss of approximately $6,500,000.
Revenue Recognition
The Company recognizes revenue when merchandise is shipped or services are rendered.
Retirement plans
The Company sponsors two noncontributory defined benefit retirement plans covering substantially all of its employees. Company contributions to union-sponsored defined contribution plans are based on collectively bargained rates times hours worked. The Company's policy is to fund annually all tax-qualified plans to the extent deductible for income tax purposes.
Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Reporting year
The Company's reporting year-end was changed to December 31 from the Saturday closest to December 31 starting December 31, 1997.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVENTORIES
Inventories consisted of:
3. PROPERTIES
Properties consisted of:
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. LONG-TERM DEBT AND BORROWING ARRANGEMENTS
Long-term debt consisted of:
The principal payments for the 9.10/8.60% senior note are due quarterly in incrementally increasing amounts through maturity in 2007, the 7.88%/7.38% senior note are due annually in the amount of $4,545,000 starting in 2002 through maturity in 2012, the 7.41%/6.91% senior note are due annually in the amount of $3,571,000 starting November 2001 until maturity in 2007, the 7.35%/6.85% senior note are due annually in the increasing amounts starting January 2002 through maturity in July 2008, the 7.29%/6.79% senior note are due annually in the amount of $10,000,000 starting June 2006 until June 2010, and the 7.23%/6.73% senior note is due in full in November 2002. The variable term loan was paid in 1999.
The redeemable (subordinated) term notes have two to four year terms and are issued in exchange for promissory (subordinated) notes that were held by promissory note holders, who do not own the Company's Class A common stock. They are also available for purchase by investors that are affiliated with the Company.
On October 1, 1997, and every three-year period thereafter, the interest rate on the industrial revenue bonds will be adjusted based on a bond index. These bonds may be redeemed at face value at the option of either the Company or the bondholders at each interest reset date through maturity in 2003.
Total maturities of long-term debt for fiscal years 2000, 2001, 2002, 2003, 2004 and thereafter are $18,916,000 $18,948,000, $51,329,000, $34,871,000, $28,217,000, and $176,431,000, respectively.
At July 1, 1997, the Company had established a $300,000,000 five-year revolving credit facility with a group of banks. The borrowings under the agreement were $135,000,000 and $227,000,000 at December 31, 1999 and 1998, respectively. A commitment fee of .025% per annum is paid on the unused portion of the commitments. Also, the Company has borrowings from a Commercial Paper program of $19,000,000 and $25,000,000 at December 31, 1999 and 1998, respectively. The weighted average interest rate on these borrowings was 7.3% and 6.0%, respectively.
Under the senior notes and revolving credit facility the Company is required to meet certain financial ratios and covenants. The Company's lenders have waived compliance with certain covenants as of December 31, 1999 and amended and restated the debt agreements including increased interest rates, new
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
financial ratios and covenants and the securitization of the Company's assets, which were finalized by the Company during April of 2000.
The Company provides guarantees for certain member loans, but is not required to provide a compensating balance for the guarantees. The amount guaranteed was approximately $6,443,000 and $9,224,000 as of December 31, 1999 and 1998, respectively.
See note 7 regarding the fair value of financial instruments.
5. LEASE COMMITMENTS
The Company rents buildings and warehouses, office, computer and transportation equipment under operating and capital leases. The following is a schedule of future minimum lease payments under capital and long-term non-cancelable operating leases, together with the present value of the net minimum lease payments as of December 31, 1999:
Capitalized leases expire at various dates and generally provide for purchase options but not renewals. Purchase options provide for purchase prices at either fair market value or a stated value which is related to lessor's book value at expiration of the lease term. During 1999, the Company entered into an agreement for the sale and leaseback of its Henderson facility, which resulted in a recognized loss of $1,295,000. The 30 month Henderson lease commenced in May, 1999 and has annual payments of approximately $612,000. During 1998, the Company entered into an agreement for the sale and leaseback of its Harvard facility. The $2,139,000 gain realized on the sale has been deferred and will be amortized over the 15-year lease term. The lease commenced in November, 1998 and has annual payments of approximately $2,700,000.
The Hagerstown, Maryland distribution center is subject to a synthetic lease. The lease payment commitments are for three years with two one-year renewal options. All obligations under this lease arrangement are guaranteed by the Company.
Rent expense under operating leases was $31,702,000, $28,291,000 and $19,890,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. CAPITALIZATION
Promissory (subordinated) and installment notes consisted of:
Prior to 1997, promissory notes were issued for partial payment of the annual patronage dividend. Promissory notes are subordinated to indebtedness to banking institutions, trade creditors and other indebtedness of the Company as specified by its Board of Directors. Prior experience indicates that the maturities of a significant portion of the notes due within one year are extended, for a three year period, at interest rates substantially equivalent to competitive market rates of comparable instruments. The Company anticipates that this practice of extending notes will continue.
Total maturities of promissory and installment notes for fiscal years 2000, 2001, 2002 and 2003 are $69,172,000, $41,818,000, $40,567,000, and $1,419,000 respectively.
Term notes were issued in connection with the redemption of excess B stock. Term notes are subordinated to indebtedness to banking institutions, trade creditors and other indebtedness of the Company as specified by its Board of Directors.
See note 7 regarding the fair value of financial instruments.
7. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments approximate fair value. Fair value was estimated using discounted cash flow analyses, based on the Company's incremental borrowing rate for similar borrowings.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
Significant components of the provision (benefit) for income taxes are as follows:
The Company operates as a nonexempt cooperative and is allowed a deduction in determining its taxable income for amounts paid as qualified patronage dividend based on margins from business done with or for Members and for the redemption of nonqualified notices of allocation. The reconciliation of income tax expense to income tax computed at the U.S. federal statutory tax rate of 35% in fiscal year 1999, 1998 and 1997 is as follows:
Deferred income taxes reflect the net tax effects of net operating loss carryforwards which expire in years through 2019; alternative minimum tax credit carryforwards and nonqualified notices of allocations, which do not expire; and temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. To the extent tax benefits are subsequently recognized in excess of the net deferred tax assets, approximately $28,800,000 of the reduction in the valuation
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
allowance for deferred tax assets will result in a reduction of goodwill. Significant components of the Company's deferred tax assets and liabilities are as follows:
9. CASH FLOW
On July 1, 1997, the Company merged with SCC. The transaction was accounted for using the purchase accounting method. The Merger was accomplished by converting SCC shares into TruServ shares. See note 1 for additional comments.
The patronage dividend and promissory (subordinated) and redeemable (subordinated) term note renewals relating to non-cash operating and financing activities are as follows:
The Company's non-cash financing and investing activities in fiscal years 1999 and 1998 include, respectively, a $305,000 and $610,000 acquisition of transportation equipment by entering into capital leases.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Cash paid for interest during fiscal years 1999, 1998, and 1997 totaled $58,730,000, $52,722,000, and $34,693,000, respectively. Cash paid for income taxes during fiscal years 1999, 1998, and 1997 totaled $848,000, $903,000, and $1,148,000, respectively.
10. RETIREMENT PLANS
The change in the benefit obligation and plan assets for the Company administered pension plans consisted of:
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of net pension cost for the Company administered pension plans consisted of:
One of the Company's pension plans is the supplemental executive retirement plan ("SERP"), which is an unfunded defined benefit plan. The funded status in the table above is net of an accrued pension expense liability of $10,165,000 and $13,266,000 related to the SERP at December 31, 1999 and 1998, respectively.
The Company also participates in union-sponsored defined contribution plans. Pension costs related to these plans were $315,000, $861,000 and $654,000 for fiscal years 1999, 1998 and 1997, respectively.
The Company sponsors a defined benefit retirement medical plan for those SCC employees and former employees that met certain age and service criteria as of the Merger dated July 1, 1997. The plan was frozen effective with the Merger.
The components of the retiree medical plan costs for the Company administered plan consist of interest cost of $335,000 with no curtailment gain in 1999, compared to an interest cost of $351,000 and a curtailment gain totaling $1,582,000 for a $1,231,000 benefit in 1998.
The accumulated post retirement benefit obligation ("APBO") of $6,646,000 on December 31, 1997 was reduced in 1998 by a curtailment gain of $1,582,000 and claims paid of $500,000 offset by interest cost of $351,000 and an actuarial loss of $274,000, for an APBO of $5,189,000 at December 31, 1998. Reductions to the APBO in 1999 were an actuarial gain of $510,000 and claims paid of $460,000, offset by interest cost of $335,000, for an APBO of $4,554,000 at December 31, 1999.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The funded status at December 31, 1998 was a liability of $4,922,000, which includes the APBO of $5,189,000 offset by an unrecognized actuarial loss of $267,000. The funded status at December 31, 1999 was a liability of $4,797,000, which includes the APBO of $4,554,000 plus an unrecognized actuarial gain of $243,000.
The plan has no assets. During 1999 and 1998, the Company contributed to the plan $460,000 and $500,000, respectively, and there were benefit payments of $460,000 and $500,000, respectively.
The effect of a 1% increase in the medical trend rate would increase service and interest cost components by $16,000 and postretirement benefit obligation by $234,000. The effect of a 1% decrease in the medical trend rate would decrease service and interest cost components by $13,000 and postretirement benefit obligation by $189,000.
11. SEGMENT INFORMATION
Statement of Financial Accounting Standards No. 131 "Disclosure about Segments of an Enterprise and Related Information," requires companies to report financial and descriptive information about its reportable operating segments, including segment profit or loss, certain specific revenue and expense items, and segment assets, as well as information about the revenues derived from the Company's products and services, information about geographic areas and information about major customers. This statement requires the use of the management approach to determine the information to be reported. The management approach is based on the way management organizes the enterprise to assess performance and make operating decisions regarding the allocation of resources. It is management's opinion that, at this time, the Company has several operating segments, however only one reportable segment. The following discussion sets forth the required single segment information:
The Company operates as a single reportable segment as the largest Member-owned wholesaler cooperative of hardware, lumber/building materials and related merchandise in the United States, operations outside the United States were immaterial, with 1999 net sales of $4.5 billion. The Company's sales to its Members are divided into three categories, as follows: (1) warehouse shipment sales (approximately 37% of total sales); (2) direct shipment sales (approximately 58% of total sales); and (3) relay sales (approximately 5% of total sales). Warehouse shipment sales are sales of products purchased, warehoused and resold by the Company upon orders from the Members. Direct shipment sales are sales of products purchased by the company but delivered directly to Members from manufacturers. Relay sales are sales of products purchased by the Company in response to the requests of several Members for a product which is (i) included in future promotions, (ii) not normally held in inventory and (iii) is not susceptible to direct shipment. Generally, the Company will give notice to all Members of its intention to purchase products for relay shipment and then purchase only so many of such products as the Members order. When the product shipment arrives at the Company, it is not warehoused; rather, the Company breaks up the shipment and "relays" the appropriate quantities to the Members who placed orders.
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company's product offerings, comprised of more than 72,000 stockkeeping units ("SKUs"), may be divided into seven classes of merchandises which are set forth, with their corresponding percentage of total revenues in the following table:
INDEX TO EXHIBITS
* Filed herewith
E-1
E-2
E-3