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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 27, 2003 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
------ ------
COMMISSION FILE NUMBER 2-20910
--------------------------------------
TRUSERV CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-2099896
-------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8600 West Bryn Mawr Avenue
Chicago, Illinois 60631-3505
----------------- ----------
(Address of principal executive offices) (Zip Code)
(773) 695-5000
--------------
(Registrant's telephone number, including area code)
Not applicable
--------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] : No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
The number of shares outstanding of each of the issuer's classes of common
stock, as of October 25, 2003.
Class A Common Stock, $100 Par Value........................ 476,460 Shares
Class B Common Stock, $100 Par Value........................ 1,756,457 Shares
ITEM 1. FINANCIAL STATEMENTS
($ in thousands - except per share information)
TRUSERV CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
September 27,
2003 December 31,
(Unaudited) 2002
------------- ------------
Current assets:
Cash and cash equivalents $ 7,882 $ 9,001
Restricted cash 12,153 15,755
Accounts and notes receivable, net of allowance for doubtful
accounts of $6,624 and $8,553 223,559 207,709
Inventories 280,062 234,448
Other current assets 18,627 23,440
----------- -----------
Total current assets 542,283 490,353
Properties, net of accumulated depreciation of $282,935 and $274,519 78,820 91,116
Goodwill, net 91,474 91,474
Other assets 13,104 30,428
----------- -----------
Total assets $ 725,681 $ 703,371
=========== ===========
See Notes to Condensed Consolidated Financial Statements
LIABILITIES AND MEMBERS' CAPITALIZATION
September 27,
2003 December 31,
(Unaudited) 2002
------------- ------------
Current liabilities:
Accounts payable $ 249,227 $ 199,566
Outstanding checks 36,825 28,884
Accrued expenses 79,952 84,082
Short-term borrowings -- 27,852
Current maturities of long-term debt, notes and
capital lease obligations 120,150 59,797
Patronage dividend payable in cash 8,538 6,121
----------- -----------
Total current liabilities 494,692 406,302
Long-term debt, notes and capital lease obligations,
less current maturities 115,615 125,021
Deferred gain on sale leaseback 50,825 52,786
Deferred credits 13,476 20,282
Deferred stock redemptions 32,092 --
Redeemable nonqualified Class B non-voting common stock,
$100 par value; 234,495 shares issued and fully paid 23,450 --
----------- -----------
Total long-term liabilities and deferred credits 235,458 198,089
Total liabilities and deferred credits 730,150 604,391
Commitments and contingencies -- --
Members' capitalization:
Promissory (subordinated) and installment notes, net
of current portion -- 43,531
Members' equity:
Redeemable Class A voting common stock, $100 par value;
750,000 shares authorized; 304,980 and 474,360 shares
issued and fully paid; 15,117 and 35,700 shares issued
(net of subscriptions receivable of $134,000
and $886,000) 31,876 50,120
Redeemable qualified Class B non-voting common stock
and paid-in capital, $100 par value; 4,000,000
shares authorized; 942,904 and 1,756,457 shares
issued and fully paid 95,590 176,945
Loss allocation (45,937) (75,966)
Deferred patronage (25,232) (25,793)
Accumulated deficit (59,613) (68,704)
Accumulated other comprehensive loss (1,153) (1,153)
----------- -----------
Total members' equity/(deficit) (4,469) 55,449
----------- -----------
Total members' capitalization/(deficit) (4,469) 98,980
----------- -----------
Total liabilities and members' capitalization $ 725,681 $ 703,371
=========== ===========
See Notes to Condensed Consolidated Financial Statements
TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
For the thirteen weeks ended For the thirty-nine weeks ended
------------------------------ ---------------------------------
September 27, September 28, September 27, September 28,
2003 2002 2003 2002
------------- ------------- ------------- --------------
Net revenue $ 478,811 $ 499,817 $ 1,504,100 $ 1,650,901
Costs and expenses:
Cost of revenue 422,887 437,676 1,336,425 1,460,173
Logistics and manufacturing expenses 15,031 18,824 49,524 55,889
Selling, general and administrative expenses 27,538 22,238 71,620 68,091
Restructuring charges and other related expenses (23) 895 485 1,136
Interest expense to members 1,462 1,618 4,277 4,974
Third party interest expense 32,964 13,312 49,747 42,381
(Gain)/loss on sale of assets (166) (67) 43 (292)
Other income, net (11,254) (709) (19,319) (2,712)
------------ ----------- ----------- ------------
Net margin/(loss) before income taxes (9,628) 6,030 11,298 21,261
Income tax expense 142 97 288 247
------------ ----------- ----------- ------------
Net margin/(loss) $ (9,770) $ 5,933 $ 11,010 $ 21,014
============ =========== =========== ============
See Notes to Condensed Consolidated Financial Statements
TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
September 27, September 28,
2003 2002
------------- -------------
Operating activities:
Net margin $ 11,010 $ 21,014
Adjustments to reconcile net margin to cash
and cash equivalents provided by operating
activities:
Depreciation and amortization 20,333 27,112
Provision for allowance for doubtful accounts (1,379) 453
Provision for inventory reserves 6,580 6,538
Restructuring charges and other related expenses 485 1,136
(Gain)/loss on sale of assets 43 (292)
Gain from debt forgiveness (7,706) --
Net change in working capital components (20,857) 38,245
---------- ----------
Net cash and cash equivalents provided by
operating activities 8,509 94,206
---------- ----------
Investing activities:
Additions to properties (4,676) (8,254)
Proceeds from sale of properties 300 6,559
Changes in restricted cash 3,602 14,528
Changes in other assets 1,861 16,778
---------- ----------
Net cash and cash equivalents provided by
investing activities 1,087 29,611
---------- ----------
Financing activities:
Payment of patronage dividend (5,790) --
Payment of notes, long-term debt and lease obligations (155,657) (45,673)
Increase/(decrease) in outstanding checks 7,941 (45,878)
Decrease in senior revolving credit facility, net (24,194) (109,874)
Increase in asset based revolving credit facility, net 166,961 --
Proceeds from Class A common stock subscription
receivable 24 199
---------- ----------
Net cash and cash equivalents used for financing
activities (10,715) (201,226)
---------- ----------
Net decrease in cash and cash equivalents (1,119) (77,409)
Cash and cash equivalents at beginning of period 9,001 88,816
---------- ----------
Cash and cash equivalents at end of period $ 7,882 $ 11,407
========== ==========
See Notes to Condensed Consolidated Financial Statements.
TRUSERV CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
($ in thousands)
NOTE 1 - GENERAL
The condensed consolidated balance sheet at September 27, 2003, the condensed
consolidated statement of operations for the thirteen weeks and thirty-nine
weeks ended September 27, 2003 and September 28, 2002, and the condensed
consolidated statement of cash flows for the thirty-nine weeks ended September
27, 2003 and September 28, 2002 are unaudited and, in the opinion of the
management of TruServ, include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of financial position
at the balance sheet dates and results of operations and cash flows for the
respective interim periods. The accompanying unaudited condensed consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of
America for complete financial statements. These financial statements should be
read in conjunction with the consolidated financial statements for the year
ended December 31, 2002 included in TruServ's 2002 Annual Report on Form 10-K.
NOTE 2 - RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's condensed
consolidated financial statements to conform to the current year's presentation.
These reclassifications had no effect on Net margin for any period or on Total
members' equity at the balance sheet dates.
NOTE 3 - ESTIMATED PATRONAGE DIVIDENDS
If financial and operating conditions permit, patronage dividends are declared
and paid by TruServ after the close of each fiscal year. The estimated cash
portion of the patronage dividend for the nine-month period ended September 27,
2003 was $8,538, which was 30% of the estimated patronage income before the net
effect of the refinancing of the existing senior revolving credit facility and
senior notes. The estimated cash portion of the patronage dividend for the
corresponding period for 2002 was $4,109, which was 20% of the estimated
patronage income. TruServ's By-Laws and Internal Revenue Service regulations
require the payment of at least 20% of patronage dividends in cash. In the past,
TruServ paid the remainder primarily through the issuance of Class B common
stock (in both qualified and nonqualified written notices of allocation, as
those terms are used in the Internal Revenue Code); and in certain cases,
TruServ paid a small portion of the dividend by means of Promissory
(subordinated) notes. For fiscal 2003, if TruServ declares a patronage dividend,
it intends to issue the non-cash portion of the dividend in the form of
Qualified Class B common stock, and, in the case of those members who have loss
allocation accounts, to apply the value of the Qualified Class B common stock to
reduce such account balances (see Note 4).
NOTE 4 - LOSS ALLOCATION TO MEMBERS
During the third quarter of fiscal 2000, TruServ management developed and the
board of directors approved a plan to equitably allocate to members the loss
incurred in 1999. This loss was previously recorded as a reduction of Retained
earnings. TruServ has allocated the 1999 loss among its members by establishing
a Loss allocation account as a contra-equity account in the consolidated balance
sheet with the offsetting credit recorded to the Accumulated deficit account.
The Loss allocation account reflects the sum of each member's proportionate
share of the 1999 loss, after being reduced by certain amounts that were not
allocated to members. The Loss allocation account will be satisfied, on a member
by member basis, by applying the portion of future non-cash patronage dividends
as a reduction to the Loss allocation account until fully satisfied. The Loss
allocation account may also be satisfied, on a member by member basis, by
applying the par value of maturing member notes and related interest payments as
a reduction to the Loss allocation account until such account is fully
satisfied. However, in the event a member should terminate as a stockholder of
TruServ, any unsatisfied portion of that member's Loss allocation account will
be satisfied by reducing the redemption amount paid for the member's stock
investment in TruServ.
The board of directors determined that TruServ would retain the fiscal 2001 loss
as part of the Accumulated deficit account. All or a portion of patronage income
and all non-patronage income, if any, may be retained in the future to reduce
the Accumulated deficit account. TruServ has determined for each member that was
a stockholder in 2001 its share of the fiscal 2001 loss that has been retained
in the Accumulated deficit account. This allocation was based upon a combination
of the member's proportionate Class A common stock and Class B common stock
investment, along with the member's purchases from the co-op in 2001. In the
event a member terminates its status as a stockholder of TruServ, any remaining
2001 loss in the Accumulated deficit account that is allocable to the
terminating member will be satisfied by reducing the redemption amount paid for
the member's stock investment in TruServ.
NOTE 5 - INVENTORIES
September 27, December 31,
2003 2002
------------- ------------
Manufacturing inventories:
Raw materials $ 2,008 $ 1,473
Work-in-process and finished goods 18,170 19,655
Manufacturing inventory reserves (1,658) (1,297)
--------- ---------
18,520 19,831
Merchandise inventories:
Warehouse inventory 267,120 223,754
Merchandise inventory reserves (5,578) (9,137)
--------- ---------
261,542 214,617
--------- ---------
Total $ 280,062 $ 234,448
========= =========
Inventories are stated at the lower of cost, determined on the first-in,
first-out basis, or market. The cost of inventory also includes indirect costs
incurred to bring inventory to its existing location for resale. The amount of
indirect costs included in ending inventory at September 27, 2003 and December
31, 2002 was $18,215 and $15,753, respectively.
NOTE 6 - RESTRUCTURING CHARGES AND OTHER RELATED EXPENSES
Net restructuring and other related charges of $(23) and $485 were incurred in
the thirteen and thirty-nine weeks ended September 27, 2003, respectively, of
which $(23) and $549 related to restructuring costs, as detailed in the chart
below. The year to date amount was offset by a favorable adjustment of $64
resulting from changes in estimates to previously accrued post-employment
severance charges. Restructuring charges primarily consisted of changes in
amounts accrued for severance and exit costs at the Hagerstown, Maryland
distribution center and severance costs at TruServ's corporate headquarters. Net
restructuring expenses of $895 and $1,136 were incurred in the thirteen and
thirty-nine weeks ended September 28, 2002, respectively, which primarily
consisted of additional severance and exits costs for Hagerstown, Maryland and
Brookings, South Dakota distribution centers, and additional severance costs at
TruServ's corporate headquarters. TruServ did not incur any post-employment
charges during the first thirty-nine weeks of 2002.
During the first nine months of 2003 and 2002, TruServ used previously
established restructuring reserves of $14,309 and $5,168, respectively, related
to distribution center closures and workforce reductions at TruServ's corporate
headquarters. In the third quarter 2003, the largest component of the use of
reserves/cash disbursement was $9,254 related to the remaining lease obligation
to a third party, which was converted into a senior term loan and was
subsequently paid off as part of the refinancing arrangement on August 29, 2003
(see Note 7), related buyouts of several operating leases and a payback of a
portion of an existing grant. Additionally, during the first nine months of
2003, TruServ used previously established post-employment reserves of $937,
primarily related to severance payments for former associates at TruServ's
corporate headquarters and the Cary, Illinois facility.
Restructuring Reserve Summary:
For the thirty-nine weeks ended
--------------------------------------------------------------------------------------------
September 27, 2003 September 28, 2002
------------------------------------------- ---------------------------------------------
Severance & Total Severance & Total
Outplacement Facility Restructuring Outplacement Facility Restructuring
Costs Exit Costs Reserve Costs Exit Costs Reserve
------------------------------------------- ---------------------------------------------
Restructuring reserves,
beginning of year $ 4,241 $ 11,030 $ 15,271 $ 8,270 $ 17,979 $ 26,249
First quarter activity:
Restructuring charge 49 32 81 -- -- --
Use of reserves/Cash disbursements (1,110) (1,312) (2,422) (1,864) (988) (2,852)
-------- -------- -------- -------- -------- --------
Restructuring reserves,
end of 1st quarter 3,180 9,750 12,930 6,406 16,991 23,397
Second quarter activity:
Restructuring charge 45 900 945 185 150 335
Restructuring reversals -- (454) (454) (94) -- (94)
Use of reserves/Cash disbursements (930) (942) (1,872) (1,498) (97) (1,595)
-------- -------- -------- -------- -------- --------
Restructuring reserves,
end of 2nd quarter 2,295 9,254 11,549 4,999 17,044 22,043
Third quarter activity:
Restructuring charge -- -- -- 1,822 -- 1,822
Restructuring reversals (23) -- (23) -- (927) (927)
Use of reserves/Cash disbursements (761) (9,254) (10,015) (1,648) 927 (721)
-------- -------- -------- -------- -------- --------
Restructuring reserves,
end of 3rd quarter $ 1,511 $ -- $ 1,511 $ 5,173 $ 17,044 $ 22,217
======== ======== ======== ======== ======== ========
NOTE 7 - DEBT
On August 29, 2003, TruServ closed a new four-year $275,000 asset based
revolving credit facility (the "Bank Facility"). The Bank Facility was used to
refinance the existing senior revolving credit facility and senior notes. Under
the terms of the Bank Facility agreement, the interest rate is variable at
TruServ's option of LIBOR plus 2.25% or prime plus 0.25%. The unused commitment
fee is 0.375%. The Bank Facility pricing includes a performance grid based upon
a fixed charge coverage ratio, measured quarterly beginning in March 2004.
The Bank Facility has no financial covenants unless daily average excess
availability for the last 60 days of each quarter drops below $35,000. If the
average is below $35,000, TruServ is subject to a fixed charge coverage ratio of
1.1 to 1. Additionally, TruServ is required to maintain $15,000 of excess
availability at all times. Availability is the lesser of $275,000 or the
calculated collateral value of eligible assets less the outstanding borrowings,
letters of credit and reserves against availability that may be imposed at the
reasonable discretion of the lenders. TruServ had availability, under the Bank
Facility, of approximately $44,582 on September 27, 2003.
Substantially all of the assets of TruServ and a pledge of 100% of the stock of
TruServ's subsidiaries secure the Bank Facility. Borrowings under the Bank
Facility are subject to borrowing base limitations that fluctuate in part with
the seasonality of the business. Additionally, the qualification of accounts
receivable and inventory items as "eligible" for purposes of the borrowing
base is subject to unilateral change at the discretion of the lenders. The
borrowing base is calculated as follows:
i. 85% of eligible accounts receivable, plus
ii. the lesser of 65% of the value of eligible inventory, 85% of the net
orderly liquidation value of inventory or $160,000, plus
iii. a fixed asset sublimit, calculated as the lesser of $25,000 or 65%
of the fair value of certain real estate and 80% of orderly
liquidation value of certain machinery and equipment. The sublimit
is subject to a seven-year amortization for the portion predicated
on machinery and equipment and a ten-year amortization for the
portion predicated on real estate.
The Bank Facility imposes certain limitations on and requires compliance with
covenants from TruServ that are usual and customary for similar asset based
revolving credit facilities. Unless such terms and conditions are waived by a
majority of the lenders, these terms and conditions include, among other things:
i. limitations on additional lease transactions, additional third-party and
subordinated debt, the granting of certain liens and guarantees, capital
expenditures and cash dividend payments and distributions;
ii. restrictions on mergers, investments, transactions with related parties,
acquisitions and changes in corporate control; and
iii. periodic financial and collateral reporting requirements.
Fees paid for closing the Bank Facility totaled $3,752 and TruServ will amortize
these fees over the four-year term.
Upon closing the Bank Facility, TruServ incurred a net expense of $19,221 to
exit the replaced credit agreements. The net expense consisted of $26,927 of
interest expense relating to the write-off of old and new senior note make whole
obligations and prepaid bank fees offset by $7,706 of other income relating to
debt forgiveness for a portion of the existing refinanced debt.
At September 27, 2003, the Company had $166,961 in revolving credit loans of
which $106,961 is included in Current maturities of long-term debt, notes and
capital lease obligations and $60,000 is included in Long-term debt, notes and
capital lease obligations, less current maturities. Based on the Company's
projection of seasonal working capital needs, the amount classified as Long-term
debt, notes and capital lease obligations, less current maturities represents
the lowest level of borrowings during the next twelve months.
NOTE 8 - SEGMENT INFORMATION
TruServ is principally engaged as a wholesaler of hardware and related products
and is a manufacturer of paint products. TruServ identifies segments based on
management responsibility and the nature of the business activities of each of
its components. TruServ measures segment earnings as operating earnings,
including an allocation for interest expense and income taxes. Information
regarding the identified segments and the related reconciliation to consolidated
information are as follows:
Thirteen weeks ended September 27, 2003
--------------------------------------------------
Consolidated
Hardware Paint Totals
-------- ----- ------------
Net sales to external customers $ 449,860 $ 28,951 $ 478,811
Interest expense 26,409(1) 8,017(1) 34,426(1)
Depreciation and amortization 5,789 346 6,135
Segment net margin/(loss) (8,426)(2) (1,344)(2) (9,770)(2)
Expenditures for long-lived assets 2,437 32 2,469
Thirteen weeks ended September 28, 2002
--------------------------------------------------
Consolidated
Hardware Paint Totals
-------- ----- ------------
Net sales to external customers $ 467,426 $ 32,391 $ 499,817
Interest expense 14,263 667 14,930
Depreciation and amortization 8,242 348 8,590
Segment net margin 1,236 4,697 5,933
Expenditures for long-lived assets 1,540 136 1,676
Thirty-nine weeks ended September 27, 2003
--------------------------------------------------
Consolidated
Hardware Paint Totals
-------- ----- ------------
Net sales to external customers $1,422,603 $ 81,497 $1,504,100
Interest expense 42,993(1) 11,031(1) 54,024(1)
Depreciation and amortization 19,259 1,074 20,333
Segment net margin 4,901(2) 6,109(2) 11,010(2)
Identifiable segment assets 677,855 47,826 725,681
Expenditures for long-lived assets 4,467 209 4,676
Thirty-nine weeks ended September 28, 2002
--------------------------------------------------
Consolidated
Hardware Paint Totals
-------- ----- ------------
Net sales to external customers $1,558,750 $ 92,151 $1,650,901
Interest expense 44,200 3,155 47,355
Depreciation and amortization 26,037 1,075 27,112
Segment net margin 7,322 13,692 21,014
Identifiable segment assets 763,090 50,502 813,592
Expenditures for long-lived assets 7,869 385 8,254
(1) Interest expense includes $20,693 and $6,234 allocated to Hardware and
Paint, relating to the $26,927 write-off of old and new senior note make
whole obligations and prepaid bank fees.
(2) Segment net margin/(loss) includes $13,411 and $5,810 relating to the
$19,221 of net expense to refinance the existing senior revolving credit
facility and senior notes.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
In August 2000, an action (the "Derivative Action") was brought in Delaware
Chancery Court (New Castle County) by a former TruServ member ("Hudson City
Properties") against certain present and former directors and certain former
officers of TruServ and against TruServ. The complaint was brought derivatively
on behalf of TruServ and alleged that the individual defendants breached
fiduciary duties in connection with the accounting adjustments made by TruServ
in the fourth quarter of 1999. Hudson City Properties also sought to proceed on
a class-action basis against TruServ on behalf of all those affected by the
moratorium on stock redemption and the creation of the loss allocation accounts.
Hudson City Properties alleged that TruServ breached, and the named directors
caused TruServ to breach, agreements with members by suspending payment of the
members' 1999 annual patronage dividend, by declaring the moratorium on the
redemption of members' TruServ stock and by imposing annual minimum purchase
requirements upon members. On May 12, 2003, the parties to this action signed a
Stipulation of Settlement resolving the lawsuit, subject to court approval. On
May 15, 2003, the Delaware Chancery Court entered an Order preliminarily
approving the Settlement. The Court conducted a Settlement Hearing on July 8,
2003, and approved the Stipulation of Settlement as fair, reasonable, adequate
and in the best interests of TruServ and the class. On July 14, 2003, the Court
entered a Final Order and Judgment dismissing the lawsuit with prejudice. The
Stipulation of Settlement became final and binding 30 days after the date the
Final Order and Judgment was entered. Under the terms of the Stipulation of
Settlement, at such time as TruServ's board of directors determines that it is
in the best interest of TruServ to lift the moratorium on stock redemptions, the
loss allocation accounts for all current and former members who are parties to
the Stipulation of Settlement will be reduced by approximately $5 million on a
pro rata basis as more fully described in the Stipulation of Settlement
agreement. The majority of the settlement was provided by TruServ's insurance
carrier. Additionally, all of the current and former members who participated in
the Stipulation of Settlement released TruServ and its current and former
officers and directors from any liability with respect to the moratorium on
stock redemptions and the creation of the 1999 loss allocation accounts.
TruServ provides guarantees for certain member loans, but is not required to
provide a compensating balance for the guarantees. TruServ is required to pay
off a portion of the full amount of these loans under these guarantees, which
range from 15-50% of the member's outstanding balance. In the event that a
member defaults on its loan, the member will be liable to TruServ for the
guaranteed amount. The amount of the guaranteed portion of these member loans,
which are not recorded in TruServ's balance sheet, was approximately $998 and
$2,172 as of September 27, 2003 and December 31, 2002, respectively. The balance
of $998 as of September 27, 2003 includes approximately $293 that will mature
over the next twelve months. The remaining guarantees will expire periodically
through 2013. TruServ carries a reserve of $114 relating to these guarantees.
Additionally, TruServ sold certain member note receivables to a third party in
2002 which it has fully guaranteed. TruServ is required to pay 100% of the
outstanding balance of these member notes under these guarantees in the event
that a member defaults on its notes, after which the member will be liable to
TruServ for the guaranteed amount. The balance of these member notes at
September 27, 2003 and December 31, 2002 was $574 and $871, respectively, and is
recorded as a liability and related receivable in TruServ's consolidated balance
sheet. TruServ carries a $57 reserve relating to the guarantees on these notes.
The balance of $574 as of September 27, 2003 includes approximately $241 that
will mature over the next twelve months. The remaining guarantees will expire
periodically through 2007.
TruServ has a lifetime warranty or a customer satisfaction guarantee on the
majority of its True Value paint products, which covers only replacement
material. TruServ has historically experienced minimal returns on these
warranties and guarantees and has determined any related liability to be
immaterial.
NOTE 10 - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, TruServ adopted Statement of Financial Accounting Standards
("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. The adoption of this standard did not have a material impact on TruServ's
financial position or results of operations.
In January 2003, TruServ adopted SFAS No. 145, "Rescission of FAS 4, 44 and 64,
Amendment of FAS 13 and Technical Corrections as of April 2002." SFAS No. 145
rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt"
(eliminating the extraordinary treatment of gains or losses on debt modification
other than for certain exceptions) and its related amendment, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS No.
145 also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor
Carriers" and amends SFAS No. 13, "Accounting for Leases" (to eliminate an
inconsistency between the required accounting for sale leaseback transactions
and the required accounting for certain lease modifications that have economic
effects that are similar to sale leaseback transactions). SFAS No. 145 also
amends other existing authoritative pronouncements (to make various technical
corrections, clarify meanings or describe their applicability under changed
conditions). The adoption of SFAS No. 145 by TruServ did not have a material
impact on TruServ's financial position or results of operations.
In January 2003, TruServ adopted SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal." SFAS No. 146 addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." The principal difference
between SFAS No. 146 and EITF Issue No. 94-3 relates to the requirement for
recognition of a liability for a cost associated with an exit or disposal
activity. SFAS No. 146 requires that a liability for a cost associated with an
exit or disposal activity be recognized only when the liability is incurred;
under EITF Issue No. 94-3, a liability for an exit cost, as defined in EITF
Issue No. 94-3, was recognized at the date of an entity's commitment to an exit
plan. SFAS No. 146 also requires that a liability for a cost associated with an
exit or disposal activity be recognized and measured initially at fair value and
only when the liability is incurred. This standard will be applied to any exit
or disposal activities undertaken after December 31, 2002.
In the third quarter of 2003, TruServ adopted SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity." SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both liabilities
and equity. Adoption of this standard impacted the classification in the
Condensed Consolidated Balance Sheet of Promissory (subordinated) and
installment notes, net of current portion; Redeemable nonqualified Class B
non-voting common stock; and stock presented for redemption but deferred due to
the moratorium. Promissory (subordinated) and installment notes, net of current
portion, which are notes with three year durations with current owners of
TruServ's Class A common stock, are now included in Long-term debt. Promissory
(subordinated) and installment notes, net of current portion previously was
recorded under the caption of Members' capitalization. Redeemable nonqualified
Class B non-voting common stock is now included in long-term liabilities as
these shares of stock have a planned redemption schedule. Redeemable
nonqualified Class B non-voting common stock previously was recorded under the
caption of Members' equity. Redeemable nonqualified Class B non-voting common
stock has a planned redemption schedule of at least 10% of the shares by
December 31, 2011; at least 40% of the shares by December 31, 2019 and all of
the shares by December 31, 2029. Shares of stock presented for redemption but
deferred due to the moratorium are now included in long-term liabilities in
Deferred stock redemptions. Deferred stock redemptions contain the par value of
Class A, Qualified Class B and Nonqualified Class B common stock reduced by the
legal right of offsets from the Loss allocation, Accumulated deficit and
Accounts receivable accounts for each shareholder who has presented their stock
for redemption but has been deferred due to the moratorium. These amounts were
recorded in each of the respective categories. As of September 27, 2003, the
aggregate value of the terminated members' equity investments presented for
redemption but deferred due to the moratorium was approximately $32,092, after
the offset of the loss allocations resulting from the 1999 loss, the 2001 loss
and accounts receivable owed by the former members. Historically, TruServ has
offset amounts due by its members against amounts that it pays to the members on
redemption of their stock.
The effects of SFAS 150 on Member Capitalization are as follows:
Stock
Balance at redemptions
9/27/2003 deferred due to Non-qualified
before Promissory and the moratorium Class B common Balance at
the effect of installment notes reclassified to stock reclassified 9/27/2003 after
adoption of reclassified to Long-term to Long-term adoption of
SFAS 150 Long-term debt liabilities liabilities SFAS 150
----------- ----------------- --------------- --------------- ----------------
Promissory and installment notes $ 55,042 $ (55,042) $ -- $ -- $ --
Redeemable Class A common stock 50,144 -- (18,268) -- 31,876
Redeemable Class B common stock 176,945 -- (57,905) (23,450) 95,590
Loss allocation (73,684) -- 27,747 -- (45,937)
Deferred patronage (25,232) -- -- -- (25,232)
Accumulated deficit (69,069) -- 9,456 -- (59,613)
Accumulated other comprehensive loss (1,153) -- -- -- (1,153)
--------- --------- --------- --------- ---------
Total members' capitalization $ 112,993 $ (55,042) $ (38,970) $ (23,450) $ (4,469)
========= ========= ========= ========= =========
Stock redemptions deferred due to the moratorium of $38,970 are reduced by the
legal right of offset of accounts receivable of $6,878 for the net deferred
stock redemption of $32,092. The Class A common stock and the Non-Qualified
Class B common stock have historically been paid out at the time of redemption.
Qualified Class B common stock has historically been paid out by means of a
five-year subordinated installment note, which has the first installment due at
the end of the calendar year of the time of redemption. On a member by member
basis, the net amount of $32,092 owed to terminated members would be payable
approximately $7,002 at the time of redemption, and $25,090 in five-year
installment notes. Additionally, adoption of this standard did not have a
material impact on TruServ's results of operations or cash flow.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others." FIN 45 requires the disclosure of certain guarantees existing at
December 31, 2002. In addition, FIN 45 requires the recognition of a liability
for the fair value of the obligation of qualifying guarantee activities that are
initiated or modified after December 31, 2002. Accordingly, TruServ has
disclosed certain guarantees that existed at December 31, 2002 in Note 9 and
updated the status of the guarantees at September 27, 2003. In January 2003,
TruServ adopted the recognition provisions of FIN 45 for guarantee activities
initiated after December 31, 2002. TruServ did not have any new guarantees in
the first 39 weeks of 2003.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities, an Interpretation of Accounting
Research Bulletin No. 51." FIN 46 provides guidance on the identification of,
and reporting for, entities over which control is achieved through means other
than voting rights; such entities are known as Variable Interest Entities
("VIE's"). The adoption of this standard did not have a material impact on
TruServ's financial position, results of operations or cash flow.
In November 2002, the EITF reached a consensus on EITF Issue No. 02-16
"Accounting by a Customer (including a Reseller) for Certain Consideration
Received from a Vendor" ("EITF 02-16") which addresses the accounting and income
statement classification for consideration given by a vendor to a retailer in
connection with the sale of the vendor's products or for the promotion of sales
of the vendor's products. The EITF concluded that such consideration received
from vendors should be reflected as a decrease in prices paid for inventory and
recognized in cost of sales as the related inventory is sold, unless specific
criteria are met qualifying the consideration for treatment as reimbursement of
specific, identifiable incremental costs. In January 2003, the EITF clarified
that this issue is effective for arrangements with vendors initiated on or after
January 1, 2003. In March 2003, the EITF addressed the issue again with respect
to the reclassification of prior period amounts and determined that
reclassification is only permitted provided that previously reported net income
would not change as a result of applying the consensus. TruServ adopted the
provisions of EITF 02-16 effective January 1, 2003; however, TruServ applied the
provisions to agreements modified prior to January 1, 2003 effective for 2003
and reclassified prior period amounts of revenue and costs of revenue
accordingly for presentation purposes. The classification provisions should have
been applied on a prospective basis for all agreements entered into or modified
after January 1, 2003. The following table presents revenue and costs of revenue
for the first two quarters of 2002 and the six months ended June 29, 2002 as if
the previous reclassifications for EITF 02-16 had not been applied.
For the Quarter Ending
---------------------------------- Year-to-Date
March 30, 2002 June 29, 2002 June 29, 2002
-------------- ------------- ---------------
Revenue per previously filed $ 548,429 $ 588,033 $1,136,462
2003 Forms 10-Q
Reversal of reclassification 4,799 9,823 14,622
---------- ---------- ----------
Revenue $ 553,228 $ 597,856 $1,151,084
========== ========== ==========
Cost of revenue per $ 494,243 $ 513,632 $1,007,875
previously filed 2003 Forms
10-Q
Reversal of reclassification 4,799 9,823 14,622
---------- ---------- ----------
Cost of revenue $ 499,042 $ 523,455 $1,022,497
========== ========== ==========
The adoption of EITF 02-16 has not had a material impact on the Company's 2003
results of operations, financial position or cash flows.
NOTE 11 -- OTHER INCOME
Effective April 21, 2003, TruServ terminated its non-compete, cooperation, and
trademark and license agreements entered into with Builder Marts of America,
Inc. ("BMA") in connection with the sale of the lumber and building materials
business on December 29, 2000. TruServ has agreed to give up its equity option
and its position on the board of directors of BMA in consideration for the
termination of these agreements. These agreements had deferred credits related
to them that were being amortized to income over the lives of the underlying
agreements, which were generally 5-10 years. The termination of these agreements
resulted in the recognition of the unamortized credits, which constituted
approximately $7,133 of income in the second quarter of 2003.
On August 29, 2003, TruServ recognized $7,706 of other income relating to debt
forgiveness for a portion of the existing refinanced debt (Note 7). Additional
other income was recognized from a gain on settlement of litigation (Note 9).
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
($ in thousands)
THIRTEEN WEEKS ENDED SEPTEMBER 27, 2003 COMPARED TO THIRTEEN WEEKS ENDED
SEPTEMBER 28, 2002
RESULTS OF OPERATIONS:
Revenue and Gross Margin
A reconciliation of net revenue and gross margin for the 13 weeks ending
September 27, 2003 and September 28, 2002 follows:
Gross
Net % of Net Gross Margin %
Revenue Revenue Margin of Revenue
------- --------- ------ ----------
Thirteen weeks ended September 28, 2002 results $ 499,817 100.0% $ 62,141 12.4%
Same store sales:
Warehouse and relay revenue 2,328 0.5 37
Vendor direct revenue (688) (0.1) (99)
Paint Revenue (2,340) (0.5) (1,399)
--------- ----- ---------
Net same store sales (700) (0.1) (1,461)
--------- ----- ---------
Terminated members:
Warehouse and relay revenue (16,364) (3.3) (2,680)
Vendor direct revenue (5,252) (1.1) (45)
Paint Revenue (1,448) (0.3) (901)
--------- ----- ---------
Net terminated members (23,064) (4.6) (3,626)
--------- ----- ---------
New members:
Warehouse and relay revenue 3,870 0.8 629
Vendor direct revenue 1,762 0.4 10
Paint Revenue 348 0.1 199
--------- ----- ---------
Net new members 5,980 1.2 838
--------- ----- ---------
Net change in participating members (17,084) (3.4) (2,788)
--------- ----- ---------
Advertising, transportation and other revenue (3,222) (0.6) 2,395
Indirect cost of revenue -- -- (4,363)
--------- ----- ---------
Total change (21,006) (4.2) (6,217)
--------- ----- ---------
Thirteen weeks ended September 27, 2003 results $ 478,811 95.8% $ 55,924 11.7%
========= ===== =========
Net revenue for the 13 weeks ended September 27, 2003 totaled $478,811, a
decrease of $21,006, or 4.3%, as compared to the same period last year. The
overall decline in net revenue was predominately due to a decline in the number
of participating member retail outlets. TruServ had a net decline in the number
of participating member retail outlets of 5.6% compared to the third quarter of
2002 and resulted in a net revenue reduction of $17,084, or 3.4%. Same store
sales declined slightly, $700, or 0.1% as compared to the third quarter of 2002.
A contributing factor in the decline of revenue in same store sales and
participating member retail outlets was a product price reduction that lowered
revenue by approximately $883, as compared to the same period last year.
Advertising, transportation and other revenue declined $3,222, or 0.6% primarily
due to the timing of advertising and lower freight revenue due to the
merchandise volume decrease.
Gross margin for the 13 weeks ended September 27, 2003 decreased by $6,217, or
10.0%, as compared to the third quarter of 2002. The net decline in
participating member outlets contributed $2,788, or 4.5% of the gross margin
reduction. Same store gross margin was impaired by $1,461, or 2.4% principally
due to a change in sales mix as the higher margin TruServ manufactured paint
products' revenue declined and warehouse and relay revenue increased. An
additional contributing factor in the decline of gross margin in same store
sales and participating member retail outlets was a product price reduction that
lowered gross margin by approximately $883, as compared to the same period last
year. The product price reduction was partially offset by lower
product acquisition costs from both domestic and global suppliers. Advertising,
transportation and other gross margin increase $2,395, or 3.9% as a result of
costs being reduced. Indirect costs of revenue, which is comprised of
freight-in, vendor rebates, cash discounts and other costs incurred to prepare
goods for resale, negatively impacted gross margin by $4,363, or 7.0%, as
compared to the same period last year. This negative impact was due to an
increase in freight costs and lower discounts and rebates associated with the
global sourcing of product and lower purchasing volume.
2003 2002 $ Expense (Decrease)
---- ---- --------------------
Logistics and manufacturing expenses $15,031 $18,824 ($3,793)
Logistics and manufacturing expenses decreased by $3,793, or 20.1%, as compared
to the same period last year. TruServ's decrease in expense was due to lower
operating costs resulting from the closure of a distribution center in the
fourth quarter of 2002 together with increased labor productivity resulting from
process changes. These savings were partially offset by increased rent expense,
net of reduced depreciation expense and gain amortization, as a result of a sale
leaseback transaction, which occurred on December 31, 2002. See "Interest
expense" below for a discussion of the related impact from the sale leaseback
transaction.
2003 2002 $ Expense Increase
---- ---- ------------------
Selling, general and administrative expenses $27,538 $22,238 $5,300
Selling, general and administrative ("SG&A") expenses increased $5,300, or
23.8%, as compared to the third quarter of 2002. The increase in SG&A expenses
was due mainly to higher health care costs, which reflects the upward trends in
health care self insurance costs in the quarter compared to the same period last
year, and professional fees, which relate to higher litigation costs as well as
professional work related to Sarbanes-Oxley preparation.
$ Expense
2003 2002 Increase/(Decrease)
---- ---- -------------------
Interest expense:
Member $1,462 $1,618 ($156)
Third Parties 32,964 13,312 19,652
Interest expense to members decreased by $156, or 9.6%, as compared to the same
period last year, due to a lower average principal balance of debt outstanding,
partially offset by a higher average interest rate. The interest rate that
TruServ offered to members to renew their maturing subordinated debt for an
additional three years was higher than the coupon rate of their maturing debt.
Third party interest expense increased $19,652, or 147.6%, as compared to the
same period last year. On August 29, 2003, TruServ completed the refinancing of
the existing senior revolving credit facility and senior notes resulting in the
write-off of the remaining unamortized balance of prepaid bank fees and old and
new senior note make whole interest cost totaling $26,927. See "Other income,
net" for related debt forgiveness. These write-offs were partially offset by
lower interest costs as a result of lower average principal balance of senior
debt outstanding as compared to the same period last year and lower interest
rates of the new Bank Facility. TruServ achieved the lower average principal
balance by paying down debt through cash generated from both operations and
asset sales, which includes the sale leaseback of seven facilities at December
31, 2002.
2003 2002 $ Income Increase
---- ---- -----------------
Other income, net $(11,254) $(709) $10,545
Other income, net increased by $10,545, as compared to the same period last
year. This increase in income was due to $7,706 of debt forgiveness related to
the refinancing of the existing senior revolving credit facility and senior
notes together with a gain recognition from a litigation settlement.
2003 2002 $ Net margin (Decrease)
---- ---- -----------------------
Net margin/(loss) ($9,770) $5,933 ($15,703)
The quarter resulted in a net loss of $9,770, down from a net margin of $5,933
for the same period a year ago. The net cost of $19,221 ($26,927 interest
expense net of $7,706 debt forgiveness) related to the refinancing of the
existing senior revolving credit facility and senior notes, partially offset by
the settlement of the Derivative Action had the most significant impact to net
margin/(loss).
THIRTY-NINE WEEKS ENDED SEPTEMBER 27, 2003 COMPARED TO THIRTY-NINE WEEKS ENDED
SEPTEMBER 28, 2002
RESULTS OF OPERATIONS:
Revenue and Gross Margin
A reconciliation of net revenue and gross margin for the 39 weeks ending
September 27, 2003 and September 28, 2002 follows:
Gross
Net % of Net Gross Margin %
Revenue Revenue Margin of Revenue
------- -------- ------ ----------
Thirty-nine weeks ended September 28, 2002 results $ 1,650,901 100.0% $ 190,728 11.6%
Same store sales:
Warehouse and relay revenue (27,259) (1.7) (1,623)
Vendor direct revenue (24,772) (1.5) (1,071)
Paint revenue (6,608) (0.4) (4,116)
----------- ----- -----------
Net same store sales (58,639) (3.6) (6,810)
----------- ----- -----------
Terminated members:
Warehouse and relay revenue (62,059) (3.8) (9,943)
Vendor direct revenue (27,156) (1.6) (274)
Paint revenue (4,977) (0.3) (3,295)
----------- ----- -----------
Net terminated members (94,192) (5.7) (13,512)
----------- ----- -----------
New members:
Warehouse and relay revenue 10,567 0.7 1,639
Vendor direct revenue 6,646 0.4 50
Paint revenue 930 0.1 574
----------- ----- -----------
Net new members 18,143 1.1 2,263
----------- ----- -----------
Net change in participating members (76,049) (4.6) (11,249)
----------- ----- -----------
Advertising, transportation and other revenue (12,113) (0.7) 2,091
Indirect cost of revenue -- -- (7,085)
----------- ----- -----------
Total change (146,801) (8.9) (23,053)
----------- ----- -----------
Thirty-nine weeks ended September 27, 2003 results $ 1,504,100 91.1% $ 167,675 11.1%
=========== ===== ===========
Net revenue for the 39 weeks ended September 27, 2003 totaled $1,504,100, a
decrease of $146,801, or 8.9%, as compared to the same period last year. The
overall decline in revenue was predominately due to a decline in the number of
participating member retail outlets. TruServ had a net decline in the number of
participating member retail outlets of 5.6% compared to the thirty-nine weeks of
2002 and resulted in a revenue reduction of $76,049, or 4.5%. Same store sales
declined, $58,639, or 3.6%, as compared to the thirty-nine weeks of 2002, due to
TruServ members shifting some of their merchandise purchases to other sources
and the effect of a slow economy. A contributing factor in the decline of
revenue in same store sales and participating member retail outlets was a
product price reduction that lowered revenue by approximately $4,028, as
compared to the same period last year. Advertising, transportation and other
revenue declined $12,113, or 0.7%, primarily due to the timing of advertising
and lower freight revenue due to the merchandise volume decrease.
Gross margin for the 39 weeks ended September 27, 2003 decreased by $23,053, or
12.1%, over the prior year. The net decline in participating member outlets
contributed $11,249, or 5.9% of the gross margin reduction. Same store gross
margin was impaired by $6,810, or 3.6%. A contributing factor in the decline of
gross margin in same store sales and participating member retail outlets was a
product price reduction that lowered gross margin by approximately $4,028, as
compared to the same period last year. The product price reduction was partially
offset by lower product acquisition costs from both domestic and global
suppliers. Advertising, transportation and other gross margin increased
$2,091, or 1.1%, as a result of costs being reduced. Indirect costs of revenue,
which is comprised of freight-in, vendor rebates, cash discounts and other costs
incurred to prepare goods for resale, negatively impacted gross margin by
$7,085, or 3.7%, as compared to the same period last year. This negative impact
was due to an increase in freight costs and lower discounts and rebates
associated with the global sourcing of product and lower purchasing volume.
2003 2002 $ Expense (Decrease)
---- ---- --------------------
Logistics and manufacturing expenses $49,524 $55,889 ($6,365)
Logistics and manufacturing expenses decreased by $6,365, or 11.4%, as compared
to the same period last year. TruServ's decrease in expense was due to lower
operating costs resulting from the closure of two distribution centers during
2002 together with increased labor productivity resulting from process changes.
In 2001, TruServ had implemented a distribution center closure plan in response
to a reduction in the member base. These savings were partially offset by
increased rent expense, net of reduced depreciation expense and gain
amortization, as a result of a sale leaseback transaction, which occurred on
December 31, 2002. See "Interest expense" below for a discussion of the related
impact from the sale leaseback transaction.
2003 2002 $ Expense Increase
---- ---- ------------------
Selling, general and administrative expenses $71,620 $68,091 $3,529
SG&A expenses increased $3,529, or 5.2%, as compared to the same period last
year. SG&A expenses increased due to higher health care costs and lower service
charge income. These increases in SG&A were partially offset by reduced
depreciation and amortization expense and lower bad debt expense. The increases
in health insurance costs reflect the upward trends in health care
self-insurance costs for the year compared to the same period last year. The
reduction in depreciation and amortization expense was due to capital
expenditures and conversion funds incurred from the 1997 merger; such costs
started to become fully depreciated by the end of fiscal 2002. The lower bad
debt expense and the reduction in service charge income were the result of a
lower accounts receivable balance as a result of lower sales and favorable
account aging.
$ Expense
2003 2002 Increase/(Decrease)
---- ---- -------------------
Interest expense:
Member $4,277 $4,974 ($697)
Third Parties 49,747 42,381 7,366
Interest expense to members decreased by $697, or 14.0%, as compared to the same
period last year, due to a lower average principal balance of debt outstanding,
partially offset by a higher average interest rate. The interest rate that
TruServ offered to members to renew their maturing subordinated debt for an
additional three years was higher than the coupon rate of their maturing debt.
Third party interest expense increased $7,366, or 17.4%, as compared to the same
period last year. On August 29, 2003, TruServ completed the refinancing of the
existing senior revolving credit facility and senior notes resulting in the
write-off of the remaining unamortized balance of prepaid bank fees and old and
new senior note make whole interest cost totaling $26,927. See "Other income,
net" for related debt forgiveness. An additional factor that increased interest
expense compared to the same period last year was an increase in the
amortization of make whole costs incurred by the early paydown of debt from the
asset sales that occurred in the second half of 2002. These write-offs and
increased amortization were partially offset by lower interest costs of
approximately $20,000 as a result of lower average principal balance of senior
debt outstanding as compared to the same period last year and lower interest
rates on the new Bank Facility. TruServ achieved the lower average principal
balance by generating cash from operations and asset sales, which includes the
sale leaseback of seven facilities at December 31, 2002.
2003 2002 $ Income Increase
---- ---- -----------------
Other income, net $(19,319) $(2,712) $16,607
Other income, net increased by $16,607, as compared to the same period last
year. This increase in other income was due to the termination of the agreements
with BMA of $7,133(see Note 11), the forgiveness of debt related to the
refinancing of the existing senior revolving credit facility and senior notes of
$7,706 and gain recognition from a litigation settlement.
2003 2002 $ Net margin (Decrease)
---- ---- -----------------------
Net margin $11,010 $21,014 ($10,004)
The first nine months resulted in net margin of $11,010, down from a net margin
of $21,014 for the same period a year ago. The lower gross margin and the net
cost of refinancing the existing senior revolving credit facility and senior
notes of $19,221 ($26,927 interest expense net of $7,706 debt forgiveness) was
partially offset by lower interest expense of approximately $20,000 related to
the lower average principal balance of senior debt outstanding as compared to
the same period last year and the terminating of the BMA agreements of $7,133.
LIQUIDITY AND CAPITAL RESOURCES:
In 2001, the Securities and Exchange Commission ("SEC") issued Financial
Reporting Release ("FRR") No. 61, which sets forth the views of the SEC
regarding certain disclosures relating to liquidity and capital resources. The
information provided below, which should be read in conjunction with the
information in TruServ's Annual Report on Form 10-K for the year ended December
31, 2002, describes TruServ's debt, credit facilities, guarantees and future
commitments, in order to facilitate a review of TruServ's liquidity.
TruServ generated cash from operating activities for the 39 weeks ended
September 27, 2003 of $8,509, as compared to $94,206 for the 39 weeks ended
September 28, 2002. The change in cash related to operating activities was due
principally to the non-recurrence of significant cash generation from the
liquidation of excess inventory in 2002. While excess inventory was disposed of
in 2003, such disposal was not at the same level in 2003. TruServ's major
working capital components individually move in the same direction with the
seasonality of the business. The spring and early fall are the most active
periods for the co-op and require the highest levels of working capital. The low
point for accounts receivable, inventory and accounts payable is at the end of
the calendar year. The increase in accounts receivable
and inventory from fiscal year end is partially matched by the increase in
accounts payable. The cash needed to meet the future payments for accounts
payable will be provided by the cash generated from collections on accounts
receivable and from the future sale of inventory.
TruServ generated cash from investing activities of $1,087 for the 39 weeks
ended September 27, 2003, as compared to $29,611 of cash generated for the same
period last year. This reduction was primarily due to a decrease in other assets
and restricted cash in 2002. In 2002, the cash generated from other assets were
provided by the early payment of the note receivable from BMA. The restricted
cash generated cash in 2002 as asset sale proceeds that were recorded in
restricted cash were distributed during 2002 to the senior lenders in accordance
with the intercreditor agreement. However, this was partially offset by the
decrease in additions to properties, which was lower by $3,578, as compared to
the same period last year. The additions to capital expenditures consist of
various building improvements and purchases of additional equipment and
technology at TruServ's distribution centers and at its corporate headquarters.
In the 39 weeks ended September 27, 2003, TruServ had a net decrease in cash and
cash equivalents of $1,119. TruServ used the cash generated from operating
activities and in its financing activities to help reduce its debt by $10,715
during 2003. In the 39 weeks ended September 28, 2002, TruServ had a net
decrease in cash and cash equivalents of $77,409. This reduction in cash and
cash equivalents was the result of TruServ using excess cash available at
December 31, 2001 to cover outstanding checks and to pay off short-term
borrowings.
At September 27, 2003, TruServ's working capital was $47,591, as compared to
$84,051 at December 31, 2002. The current ratio was 1.10 at September 27, 2003,
as compared to 1.21 at December 31, 2002. This reduction in working capital and
current ratio was due to TruServ refinancing the existing current and long-term
senior debt into a new Bank Facility. The new Bank Facility moved a significant
portion of TruServ's debt from a long-term liability to a current liability.
On August 29, 2003, TruServ closed a new four-year $275,000 Bank Facility. The
Bank Facility was used to refinance the existing senior revolving credit
facility and senior notes. Under the terms of the Bank Facility agreement, the
interest rate is variable at TruServ's option of LIBOR plus 2.25% or prime plus
0.25%. The unused commitment fee is 0.375%. The Bank Facility pricing includes a
performance grid based upon a fixed charge coverage ratio, measured quarterly
beginning in March 2004.
The Bank Facility has no financial covenants unless daily average excess
availability for the last 60 days of each quarter drops below $35,000. If the
average is below $35,000, TruServ is subject to a fixed charge coverage ratio of
1.1 to 1. Additionally, TruServ is required to maintain $15,000 of excess
availability at all times. Availability is the lesser of $275,000 or the
calculated collateral value of eligible assets less the outstanding borrowings,
letters of credit and reserves against availability that may be imposed at the
reasonable discretion of the lenders. TruServ had availability, under the Bank
Facility, of approximately $44,582 on September 27, 2003.
Substantially all of the assets of TruServ and a pledge of 100% of the stock of
TruServ's subsidiaries secure the Bank Facility. Borrowings under the Bank
Facility are subject to borrowing base limitations that fluctuate in part with
the seasonality of the business. Additionally, the qualification of accounts
receivable and inventories items as "eligible" for purposes of the borrowing
base is subject to unilateral change at the discretion of the lenders. The
borrowing base is calculated as follows:
i. 85% of eligible accounts receivable, plus
ii. the lesser of 65% of the value of eligible inventory, 85% of the net
orderly liquidation value of inventory or $160,000, plus
iii. a fixed asset sublimit, calculated as the lesser of $25,000 or 65% of the
fair value of certain real estate and 80% of orderly liquidation value of
certain machinery and equipment. The sublimit is subject to a seven-year
amortization for the portion predicated on machinery and equipment and a
ten-year amortization for the portion predicated on real estate.
The Bank Facility imposes certain limitations on and requires compliance with
covenants from TruServ that are usual and customary for similar asset based
revolving credit facilities. Unless such terms and conditions are waived by a
majority of the lenders, these terms and conditions include, among other things:
i. limitations on additional lease transactions, additional third-party and
subordinated debt, the granting of certain liens and guarantees, capital
expenditures and cash dividend payments and distributions;
ii. restrictions on mergers, investments, transactions with related parties,
acquisitions and changes in corporate control; and
iii. periodic financial and collateral reporting requirements.
Fees paid for closing the Bank Facility totaled $3,752 and TruServ will amortize
them on a straight-line basis over the four-year term.
Upon closing the Bank Facility, TruServ incurred a net expense of $19,221 to
exit the replaced credit agreements. The net expense consisted of $26,927 of
interest expense relating to the write-off of old and new senior note make whole
obligations offset by $7,706 of other income relating to debt forgiveness for a
portion of the existing refinanced debt.
TruServ believes that its cash from operations and existing credit facility will
provide sufficient liquidity to meet its working capital needs, planned capital
expenditures and debt obligations that are due to be repaid in fiscal year 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
($ in thousands)
TruServ's operations are subject to certain market risks, primarily interest
rate risk and credit risk. Interest rate risk pertains to TruServ's variable
rate debt with a borrowing ceiling of $217,860 at September 27, 2003;
approximately $166,961 was outstanding at September 27, 2003. A 50 basis point
movement in interest rates would result in an approximate $835 annualized
increase or decrease in interest expense and cash flows based on the outstanding
balance at September 27, 2003.
For the most part, TruServ has historically managed interest rate risk through a
combination of variable and fixed-rate debt instruments with varying maturities.
Following the refinancing of its senior debt (Note 7) TruServ is required by the
Bank Facility to enter into certain interest rate protection agreements, which
may include derivative
instruments, to manage its interest rate risk. Credit risk pertains primarily to
TruServ's trade receivables. TruServ extends credit to its members as part of
its day-to-day operations. TruServ believes that as no specific receivable or
group of receivables comprises a significant percentage of total trade accounts,
its risk in respect to trade receivables is limited. Additionally, TruServ
believes that its allowance for doubtful accounts is adequate with respect to
member credit risks. TruServ performs no speculative hedging activities. TruServ
does not have any VIE's and all related party transactions (i.e., transactions
with members) are at arm's length.
ITEM 4. CONTROLS AND PROCEDURES
TruServ's Chief Executive Officer and Chief Financial Officer have concluded
that as of September 27, 2003 TruServ's disclosure controls and procedures are
effective. There have been no significant changes in TruServ's internal controls
or in other factors that could significantly affect TruServ's internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
($ in thousands)
DERIVATIVE ACTION
In August 2000, an action was brought in Delaware Chancery Court (New Castle
County) by a former TruServ member ("Hudson City Properties") against certain
present and former directors and certain former officers of TruServ and against
TruServ. The complaint was brought derivatively on behalf of TruServ and alleged
that the individual defendants breached fiduciary duties in connection with the
accounting adjustments made by TruServ in the fourth quarter of 1999. Hudson
City Properties also sought to proceed on a class-action basis against TruServ
on behalf of all those affected by the moratorium on stock redemption and the
creation of the loss allocation accounts. Hudson City Properties alleged that
TruServ breached, and the named directors caused TruServ to breach, agreements
with members by suspending payment of the members' 1999 annual patronage
dividend, by declaring the moratorium on the redemption of members' TruServ
stock and by imposing annual minimum purchase requirements upon members. On May
12, 2003, the parties to this action signed a Stipulation of Settlement
resolving the lawsuit, subject to court approval. On May 15, 2003, the Delaware
Chancery Court entered an Order preliminarily approving the Settlement. The
Court conducted a Settlement Hearing on July 8, 2003, and approved the
Stipulation of Settlement as fair, reasonable, adequate and in the best interest
of TruServ and the class. On July 14, 2003, the Court entered a Final Order and
Judgment dismissing the lawsuit with prejudice. The Stipulation of Settlement
became final and binding 30 days after the date the Final Order and Judgment was
entered. Under the terms of the Stipulation of Settlement, at such time as
TruServ's board of directors determines that it is in the best interests of
TruServ to lift the moratorium on stock redemptions, the loss allocation
accounts for all current and former members who are parties to the Stipulation
of Settlement will be reduced by approximately $5 million on a pro rata basis as
more fully described in the Stipulation of Settlement agreement. The majority of
the settlement was provided by TruServ's insurance carrier. Additionally, all of
the current and former members who participated in the Stipulation of Settlement
released TruServ and its current and former officers and directors from any
liability with respect to the moratorium on stock redemptions and the creation
of the 1999 loss allocation accounts.
CLAIMS AGAINST ERNST & YOUNG LLP
TruServ is pursuing claims against its former outside auditors, Ernst & Young
LLP ("E&Y"), for professional malpractice, breach of contract, deceptive
business practices and fraud. TruServ contends that E&Y failed to properly
discharge its duties to TruServ and failed to identify, in a timely manner, and
indeed concealed, certain material weaknesses in TruServ's internal financial
and operational controls. As a result, TruServ was forced to make an
unanticipated accounting adjustment in the fourth quarter of 1999 in the total
amount of $121,333 (the "Fourth Quarter Charge"). As a result, TruServ reported
a net loss of $130,803 for the fiscal year ended December 31, 1999. It is
TruServ's belief that had E&Y properly discharged its duties, the scope and
breadth of the Fourth Quarter Charge, as well as the accounting and operational
control deficiencies that necessitated the charge, would have been substantially
lessened, if not eliminated in their entirety. As a result of E&Y's failures,
TruServ has suffered significant financial damages. The factual allegations that
form the basis for TruServ's claim against E&Y include, in part, the issues
identified in the Securities and Exchange Commission (the "Commission") cease
and desist order described below. TruServ began discussion of its claims with
E&Y early in the fall of 2001. Pursuant to the dispute resolution procedures
required by TruServ's engagement letter with E&Y, TruServ and E&Y attempted to
mediate this dispute during the first six months of 2002. When those attempts
proved unsuccessful, and again pursuant to the dispute resolution procedures,
TruServ filed its claim with the American Arbitration Association on July 31,
2002. The arbitration, which is subject to certain confidentiality requirements,
is currently pending. Hearings are currently scheduled to begin in the spring of
2004.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
($ in thousands)
In March 2000, the board of directors of TruServ declared a moratorium on
redemptions of the capital stock. In reaching its decision to declare the
moratorium, the board of directors of TruServ reviewed the financial condition
of TruServ and considered its fiduciary obligations and corporate law principles
under Delaware law. The board of directors concluded that it should not redeem
any of the capital stock while its net asset value was substantially less than
par value, as that would likely violate legal prohibitions against "impairment
of capital." In addition, the board of directors concluded that it would be a
violation of its fiduciary duties to all members and that it would constitute a
fundamental unfairness to members if some members were allowed to have their
shares redeemed before the 1999 loss was allocated to them and members who did
not request redemption were saddled with the losses of those members who
requested redemption.
At the time the board of directors declared the moratorium on redemptions,
TruServ's By-Laws did not impose limitations on the board's discretion to
initiate or to continue a moratorium on redemption. The By-Laws merely provided
that, upon termination of a member's agreement, TruServ was to redeem the
member's shares. Nevertheless, the board of directors concluded that its
fiduciary obligations to TruServ and its members would not permit it to effect
redemptions under the circumstances described above. After the board of
directors declared the moratorium, the board of directors amended the By-Laws to
provide that if TruServ's funds available for redemption are insufficient to pay
all or part of the redemption price of shares of capital stock presented for
redemption, the board of directors may, in its sole discretion, delay the
payment of all or part of the redemption price.
The board of directors will consider the financial condition of TruServ, and
will not lift the moratorium unless it can conclude that effecting redemptions
of TruServ's capital stock will not "impair the capital" of TruServ, unfairly
advantage some members to the disadvantage of others, or violate the financial
covenants under its debt agreements. In light of the current financial
circumstances of TruServ, the board of directors will be reviewing the continued
need for the stock moratorium and has informed its members that a decision
whether to maintain or lift the moratorium will be made prior to and announced
at the March 28, 2004 annual shareholders' meeting. If a decision is made to
lift the stock moratorium, the effective date of such lift would be determined
by then and announced at such time.
As of September 27, 2003, the aggregate value of the terminated members' equity
investments presented for redemption but deferred due to the moratorium was
approximately $32,092, after the offset of the loss allocations resulting from
the 1999 loss, the 2001 loss and accounts receivable owed by the former members.
Historically, TruServ has offset amounts due by its members against amounts that
it pays to the members on redemption of their stock. Details are as follows:
Fair Value of Stock Presented for Redemption but Deferred due to the Moratorium
Class A common stock $ 18,268
Non-qualified Class B common stock 10,419
----------
Amounts historically paid out at time of redemption 28,687
Qualified Class B common stock (historically paid out by means
of a five-year subordinated installment note) 47,486
-------
Gross par value of stock presented for redemption but deferred
due to the moratorium 76,173
Reductions due to legal right of offsets:
1999 loss allocations 27,747
2001 loss allocable to terminated members 9,456
Accounts receivable owed by terminated members 6,878
----------
Reductions due to legal right of offsets 44,081
---------
Fair value of stock presented for redemption but deferred
due to the moratorium $ 32,092
=========
On a member by member basis, the net amount of $32,092 owed to terminated
members would be payable approximately $7,002 at the time of redemption, and
$25,090 in five-year installment notes.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 4-A Loan and Security Agreement dated August 29, 2003
for $275,000,000 revolving credit facility between
TruServ Corporation and various financial
institutions
Exhibit 4-B By-Laws of TruServ Corporation, effective July 31,
2003
Exhibit 10-A Termination Agreement and General Release between
TruServ Corporation and Neil Hastie dated
July 25, 2003
Exhibit 31.1 Section 302 Certification (Chief Executive Officer)
Exhibit 31.2 Section 302 Certification (Chief Financial Officer)
Exhibit 32.1 Section 906 Certification (Chief Executive Officer
and Chief Financial Officer)
(b) Reports on Form 8-K
A Current Report on Form 8-K was filed on August 8, 2003
regarding second quarter earnings.
A Current Report on Form 8-K was filed on September 4,
2003 regarding TruServ's refinancing agreement.
SIGNATURE
Pursuant to the requirements 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.
TRUSERV CORPORATION
Date: November 12, 2003 By /s/ DAVID A. SHADDUCK
-----------------------------------
David A. Shadduck
Senior Vice President and
Chief Financial Officer