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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 October 2, 2004 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]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of October 30, 2004.
Class A common stock, $100 Par Value..................... 330,360 Shares
Class B common stock, $100 Par Value..................... 1,216,734 Shares
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
($ in thousands - except per share information)
TRUSERV CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
ASSETS
October 2, December 31,
2004 2003
--------- -----------
Current assets:
Cash and cash equivalents $ 6,997 $ 9,234
Accounts and notes receivable, net of allowance for doubtful
accounts of $6,351 and $8,395 213,191 203,010
Inventories 275,763 276,725
Other current assets 18,535 18,225
-------- --------
Total current assets 514,486 507,194
Properties, net of accumulated depreciation of $287,782 and $283,233 69,731 73,055
Goodwill 91,474 91,474
Other assets 7,648 9,737
-------- --------
Total assets $683,339 $681,460
======== ========
See Notes to Condensed Consolidated Financial Statements.
2
LIABILITIES AND MEMBERS' EQUITY
October 2, December 31,
2004 2003
--------- -----------
Current liabilities:
Accounts payable $ 243,535 $ 238,180
Drafts payable 33,176 44,540
Accrued expenses 76,700 72,931
Current maturities of long-term debt, notes, borrowings and capital
lease obligations 61,569 91,958
Patronage dividend payable in cash 9,643 8,983
--------- ---------
Total current liabilities 424,623 456,592
--------- ---------
Long-term liabilities and deferred credits:
Long-term debt, including capital lease obligations, less current
maturities 149,109 100,324
Deferred gain on sale leaseback 47,907 50,135
Other long-term liabilities 17,008 13,656
Deferred stock redemptions - 33,725
Redeemable nonqualified Class B non-voting common stock,
$100 par value; 218,600 and 231,392 shares issued and fully paid 21,860 23,139
--------- ---------
Total long-term liabilities and deferred credits 235,884 220,979
--------- ---------
Total liabilities and deferred credits 660,507 677,571
--------- ---------
Commitments and contingencies - -
Members' equity:
Redeemable Class A voting common stock, $100 par value; 750,000 shares
authorized; 299,139 and 304,560 shares issued and fully paid; 16,311
and 9,840 shares issued (net of subscriptions receivable of $1,038
and $112) 30,507 31,440
Redeemable qualified Class B non-voting common stock and paid-in
capital, $100 par value; 4,000,000 shares authorized;
900,391 and 952,436 shares issued and fully paid 91,338 96,542
Loss allocation (23,919) (40,502)
Deferred patronage (24,485) (25,045)
Accumulated deficit (48,630) (56,567)
Accumulated other comprehensive loss (1,979) (1,979)
--------- ---------
Total members' equity 22,832 3,889
--------- ---------
Total liabilities and members' equity $ 683,339 $ 681,460
========= =========
See Notes to Condensed Consolidated Financial Statements.
3
TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
For the thirteen weeks ended For the thirty-nine weeks ended
October 2, September 27, October 2, September 27,
2004 2003 2004 2003
----------- ------------ ----------- -----------
Net revenue $ 474,516 $ 478,811 $ 1,549,223 $ 1,504,100
Cost of revenue 418,560 423,106 1,381,766 1,337,523
----------- ----------- ----------- -----------
Gross margin 55,956 55,705 167,457 166,577
Operating expenses:
Logistics and manufacturing expenses 14,551 14,812 46,528 48,426
Selling, general and adminstrative expenses 25,010 27,515 79,800 72,105
Other income, net (527) (11,420) (1,590) (19,276)
----------- ----------- ----------- -----------
Operating income: 16,922 24,798 42,719 65,322
Interest expense to members 1,602 1,462 4,353 4,277
Third party interest expense 1,899 32,964 5,797 49,747
----------- ----------- ----------- -----------
Net margin / (loss) before income taxes 13,421 (9,628) 32,569 11,298
Income tax expense 20 142 129 288
----------- ----------- ----------- -----------
Net margin / (loss) $ 13,401 $ (9,770) $ 32,440 $ 11,010
=========== =========== =========== ===========
See Notes to Condensed Consolidated Financial Statements.
4
TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
For the thirty-nine weeks ended
October 2, September 27,
2004 2003
--------- ------------
Operating activities:
Net margin $ 32,440 $ 11,010
Adjustments to reconcile net margin to net cash and cash
equivalents provided by operating activities:
Depreciation and amortization 12,748 20,333
Allowance for doubtful accounts (704) (1,379)
Loss on sale of assets 155 43
Provision for inventory reserves 8,315 5,116
Restructuring charges & other related expenses - 485
Gain from debt forgiveness - (7,706)
Amortization of deferred gain on sale leaseback (2,052) (1,961)
Net change in working capital components (6,077) (17,432)
--------- ---------
Net cash and cash equivalents provided by
operating activities 44,825 8,509
--------- ---------
Investing activities:
Additions to properties (8,101) (4,676)
Proceeds from sale of properties 450 300
Changes in restricted cash - 3,602
Changes in other assets 493 1,861
--------- ---------
Net cash and cash equivalents provided by / (used for)
investing activities (7,158) 1,087
--------- ---------
Financing activities:
Payment of patronage dividend (8,452) (5,790)
Payment of notes, long-term debt and lease obligations (851) (155,657)
Increase / (decrease) in drafts payable (11,364) 7,941
Increase / (decrease) in revolving credit facilities, net (13,003) 142,767
Proceeds from common stock and stock subscription receivable 997 24
Purchase of common stock (7,231) -
--------- ---------
Net cash and cash equivalents used for
financing activities (39,904) (10,715)
--------- ---------
Net decrease in cash and cash equivalents (2,237) (1,119)
Cash and cash equivalents at beginning of period 9,234 9,001
--------- ---------
Cash and cash equivalents at end of period $ 6,997 $ 7,882
========= =========
See Notes to Condensed Consolidated Financial Statements.
5
TRUSERV CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
($ in thousands)
NOTE 1 - GENERAL
The condensed consolidated balance sheet at October 2, 2004, the condensed
consolidated statement of operations for the thirteen weeks and thirty-nine
weeks ended October 2, 2004 and September 27, 2003, and the condensed
consolidated statement of cash flows for the thirty-nine weeks ended October 2,
2004 and September 27, 2003 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, 2003 included in TruServ's 2003 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 October 2,
2004 was $9,643, which was 30% of the first nine month's estimated patronage
income of $32,144. The estimated cash portion of the patronage dividend for the
corresponding period for 2003 was $8,538, which was 30% of the estimated
patronage income before the net effect of the refinancing of the prior existing
senior revolving credit facility and senior notes. TruServ's By-Laws and
Internal Revenue Service regulations require that the payment of at least 20% of
patronage dividends be 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 2004, to the
extent TruServ declares a patronage dividend, it intends to issue, in 2005, 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 below). TruServ currently estimates that 50% of the non-cash portion
of the patronage dividend will be applied to the Loss allocation account and has
accordingly recorded $11,250 of the estimated patronage dividend in the Loss
allocation account. TruServ estimates the remainder will be issued as Redeemable
qualified Class B non-voting common stock and has left that amount in
Accumulated deficit until the shares are issued with the patronage dividend. To
the extent TruServ declares a patronage dividend, it is allowed a deduction in
that amount to determine taxable income. Based on the estimated patronage
dividend, the U.S. federal effective income tax rate is 0%.
NOTE 4 - LOSS ALLOCATION TO MEMBERS
During the third quarter of 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 in the Accumulated deficit account.
TruServ has allocated and distributed 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 allocation was generally
based on a member's proportionate equity investment relative to the total equity
investments of all the members, and therefore a member could not be allocated a
loss in excess of its equity investment. 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 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 2001 loss that has been retained in the
Accumulated deficit account. Approximately 18% of the $50.7 million 2001 loss
was allocated based upon the member's proportionate stock investment, net of any
1999 loss allocation account, and 82% of the total 2001 loss was allocated based
on the member's purchases from TruServ in 2001. No member was allocated a loss
amount greater than its net equity investments held as of year-end 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 distributed to the terminating member and satisfied
by reducing the redemption amount paid for the member's stock investment in
TruServ.
A member's proportionate share of the 1999 and/or 2001 losses has been limited
to the extent of its equity investment in TruServ. Any portion
6
of a loss allocation that exceeds a member's equity investment is retained by
TruServ in 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.
NOTE 5 - INVENTORIES
October 2, December 31,
2004 2003
--------- -----------
Manufacturing inventories:
Raw materials $ 2,166 $ 1,979
Work-in-process and finished goods 23,146 19,020
Manufacturing inventory reserves (164) (258)
--------- ---------
25,148 20,741
--------- ---------
Merchandise inventories:
Warehouse inventory 258,165 262,444
Merchandise inventory reserves (7,550) (6,460)
--------- ---------
250,615 255,984
--------- ---------
Total $ 275,763 $ 276,725
========= =========
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 October 2, 2004 and December 31,
2003 was $18,210 and $18,386, respectively.
NOTE 6 - DEBT
On August 29, 2003, TruServ entered into a new four-year $275,000 asset based
revolving credit facility (the "Bank Facility"). The Bank Facility was used to
refinance the existing third party senior debt. The interest rate for the
initial term of the Bank Facility through April 30, 2004 was a variable rate (at
TruServ's option) of the London Interbank Offering Rate ("LIBOR") plus 2.25% or
the prime rate plus 0.25%. Letters of credit issued under the Bank Facility
originally carried a fee of 2.25%. Under the terms of the Bank Facility, pricing
is determined by a performance grid based upon a fixed charge coverage ratio,
measured quarterly beginning in March 2004. Based on this performance pricing
grid, TruServ achieved improved variable pricing after the first quarter of
2004. Effective May 1, 2004 and at least through January 2005, TruServ's
variable interest rate became (at TruServ's option) LIBOR plus 2.0% or the prime
rate and letters of credit will carry fees of 2.0%. The unused commitment fee is
0.375%. As of October 2, 2004, the weighted average interest rate was 3.84%.
Fees paid for closing the Bank Facility totaled $3,752 and these fees are being
amortized by TruServ over the four-year term.
The Bank Facility has no financial covenants, unless average daily availability
for the last 60 days of each quarter drops below $35,000. As of October 2, 2004,
TruServ's average availability for the last 60 days was greater than $35,000 and
TruServ is therefore not subject to a maximum fixed charge coverage ratio of 1.1
to 1.0. Additionally, TruServ is required to maintain $15,000 of availability at
all times. Availability is defined as 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. Availability at October 2, 2004 was $83,568, as
TruServ had outstanding borrowings of $118,597 and letters of credit and
reserves of $15,815. As of October 2, 2004, TruServ is in compliance with all
terms and conditions of the Bank Facility.
At October 2, 2004, TruServ had Current maturities of long-term debt, notes,
borrowings and capital lease obligations of $61,569. Only $27,972 of this amount
has required payments during the next twelve months and the remaining $33,597 is
the current portion of the Bank Facility and as explained below reflects the
seasonality of TruServ's business. The required payments consist of $7,614 of
subordinated installment notes, of which $4,523 have been reclassified from
Deferred stock redemptions due to the lifting of the moratorium (See Note 12 to
the Financial Statements in Item 1, "Rescinding of the Moratorium"), $19,712 of
subordinated promissory notes and $646 of capital leases. Historically, a
minimum of 50% of the subordinated promissory notes have been renewed, extending
the maturity for an additional three years. In 2003, this renewal rate was
approximately 85%. The current and long-term portions of the Bank Facility do
not have any required payments until 2007. At October 2, 2004, TruServ had
$118,597 in revolving credit loans, of which $33,597 is included in Current
maturities of long-term debt, notes and capital lease obligations, and $85,000
is included in Long-term debt, notes and capital lease obligations, less current
maturities. Based on management'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 7 - 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 October 2, 2004
----------------------------------------
Consolidated
Hardware Paint Totals
----------------------------------------
Net sales to external customers $ 443,135 $ 31,381 $ 474,516
Interest expense 2,820 681 3,501
Depreciation and amortization 3,458 323 3,781
Segment net margin 9,555 3,846 13,401
7
Thirteen weeks ended September 27, 2003
---------------------------------------------------
Consolidated
Hardware Paint Totals
---------------------------------------------------
Net sales to external customers $ 449,860 $ 28,951 $ 478,811
Interest expense 28,928 5,498 34,426
Depreciation and amortization 5,789 346 6,135
Segment net margin / (loss) (10,445) 675 (9,770)
Thirty-nine weeks ended October 2, 2004
---------------------------------------------------
Consolidated
Hardware Paint Totals
---------------------------------------------------
Net sales to external customers $ 1,462,347 $ 86,876 $ 1,549,223
Interest expense 8,378 1,772 10,150
Depreciation and amortization 11,737 1,011 12,748
Segment net margin 21,722 10,718 32,440
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 45,396 8,628 54,024
Depreciation and amortization 19,259 1,074 20,333
Segment net margin 4,718 6,292 11,010
NOTE 8 - COMMITMENTS AND CONTINGENCIES
On February 12, 2003, a former TruServ member, Flegles Inc. ("Flegles"), filed
suit against TruServ in the Circuit Court of Carlisle County, Kentucky. The
complaint alleges that TruServ is liable to Flegles for the role TruServ played
with respect to Flegles' construction of a new retail store facility in
Bardwell, Kentucky that has allegedly incurred financial losses. Flegles sought
$2,400 in compensatory damages and also an award of punitive damages. On July
30, 2004, a jury found TruServ liable to Flegles for certain losses incurred by
Flegles and awarded Flegles $1,300 in compensatory damages. The jury did not
award any punitive damages. TruServ believes that the verdict was rendered in
error and is vigorously pursuing post-trial motions before the Circuit Court
including a request that the verdict be set aside or that TruServ be awarded a
new trial. If necessary, TruServ will pursue that relief in a higher court.
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, ranging
from 0-20% of the member's outstanding balance, in the event that a member
defaults on its loan, after which 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 $364 and
$998 as of October 2, 2004 and September 27, 2003, respectively. The balance of
$364 as of October 2, 2004 includes approximately $45 that will mature in fiscal
2004. The remaining guarantees will expire periodically through 2013. TruServ
carries a reserve of $36 relating to these guarantees.
Additionally, TruServ sold certain member note receivables to a third party in
2002, payment of which TruServ has fully guaranteed. TruServ is required to pay
off 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 notes at
October 2, 2004 and September 27, 2003 was $245 and $574, respectively. TruServ
has recorded a liability and related receivable for $245 relating to these
member notes, and carries a $25 reserve relating to these guarantees. The
balance of $245 as of October 2, 2004 includes approximately $42 that will
mature in fiscal 2004. 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 9 - BENEFITS
Pensions Plans
The components of net periodic pension cost for TruServ administered pension
plans were as follows for the thirteen and thirty-nine weeks ended October 2,
2004 and September 27, 2003:
For the thirteen weeks ended For the thirty-nine weeks ended
October 2, September 27, October 2, September 27,
2004 2003 2004 2003
-------------- ------------ ------------- ---------------
Components of net periodic pension cost:
Service cost $ 1,300 $ 1,300 $ 4,200 $ 3,900
Interest cost 1,100 1,000 3,200 3,000
Expected return on assets (1,200) (1,100) (3,400) (3,200)
Amortization of transition assets - - - (100)
Amortization of prior service cost - - (100) 100
Amortization of actuarial loss 400 200 1,100 700
Settlement loss 700 900 2,400 2,800
------- ------- ------- -------
Net pension cost $ 2,300 $ 2,300 $ 7,400 $ 7,200
======= ======= ======= =======
Contributions
TruServ expects to contribute approximately $3,858 to its qualified pension plan
and $1,577 to its supplemental retirement plan in 2004. As of October 2, 2004,
TruServ had contributed $3,858 to its qualified plan and $1,502 to its
supplemental retirement plan.
8
Retirement Medical Plan
The components of net periodic post-retirement benefit cost were as follows for
the thirteen and thirty-nine weeks ended October 2, 2004 and September 27, 2003:
For the thirteen weeks ended For the thirty-nine weeks ended
October 2, September 27, October 2, September 27,
2004 2003 2004 2003
------------ -------------- ----------- ------------
Component of net periodic post-retirement benefit cost:
Interest cost $ 100 $ 100 $ 300 $ 300
--------- ----------- ---------- ----------
Net periodic benefit cost $ 100 $ 100 $ 300 $ 300
========= =========== ========== ==========
Contributions
TruServ expects to contribute $500 to its retirement medical plan to cover the
cost of premiums and subsidies during 2004. As of October 2, 2004, TruServ
estimated that it had contributed approximately 75% of the expected 2004
contribution to its retirement medical plan.
NOTE 10 - OTHER INCOME, NET
Effective April 21, 2003, TruServ terminated certain non-compete, cooperation,
and trademark and license agreements entered into with Builder Marts of America,
Inc. ("BMA") on December 29, 2000, in connection with the sale of the lumber and
building materials business. In consideration for the termination of these
agreements, TruServ agreed to give up its equity option and its position on the
board of directors of BMA. 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
TruServ recognizing the unamortized credits, which constituted approximately
$7,100 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 (see Note 6).
Additional other income was recognized from a gain on settlement of litigation.
NOTE 11 - CONSIDERATION GIVEN BY A VENDOR
On January 1, 2003, TruServ adopted Emerging Issues Task Force ("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. Most of TruServ's
arrangements with vendors in 2003 were initiated before January 1, 2003 and did
not have a material impact on the first 9 months of 2003. However, most
arrangements with vendors for 2004 were initiated in the fourth quarter of 2003,
and the application of EITF 02-16 has impacted the first 9 months 2004 results
of operations and financial position as net margin was negatively impacted in
the first 9 months of 2004 compared to the same period last year by $1,233. The
first 9 months of 2004 was impacted by the application of EITF 02-16 as vendor
advertising funds are being earned in 2004 based on merchandise purchases and
the vendor advertising funds are recognized in income when the merchandise is
sold. In 2003, the vendor advertising funds were matched and recognized in net
revenue when the advertising took place and the costs were incurred.
Additionally, net revenue will be impacted by the application of EITF 02-16, as
the advertising revenue that was recognized as the advertising occurred will now
be recorded as part of the cost of the product. Also impacting net revenue is
the recording of monies earned for holding markets that are now considered a
service to vendors and members. Monies earned from prior year markets were
recorded as an offset in SG&A expenses and are now recorded into net revenue for
2004. Also, the expenses related to providing the markets were previously
recorded in SG&A expenses and are now recorded in cost of revenue for 2004.
NOTE 12 - RESCINDING OF THE MORATORIUM
Effective July 6, 2004, TruServ rescinded its moratorium on stock redemptions
that had been effective since March 2000. In accordance with TruServ's By-Laws,
TruServ paid $7,231 of stock redemption liability in cash in the third quarter
of 2004 and $24,773 was paid with subordinated installment notes. As of October
2, 2004, the remaining stock redemption liability was $6,236 and is currently
estimated to be paid in cash of $1,713 and $4,523 of subordinated installment
notes. The subordinated installment notes are payable in five equal annual
installments and bear interest at the rate of 4.36%, paid annually on December
31. The first installment payment of principal and interest on the subordinated
installment notes will be due in December 2004. As of October 2, 2004, TruServ
has classified its $6,236 Deferred stock redemption liability as $2,618 in
Current maturities of long-term debt, notes, borrowings and capital lease
obligations and $3,618 in Long-term debt, including capital lease obligations,
less current maturities.
Deferred stock redemptions were comprised of the aggregate net equity
investments for each shareholder that has discontinued its purchasing activities
with TruServ and requested its stock be redeemed and had such redemption
deferred due to TruServ's declaration in March of 2000 of a moratorium on stock
redemptions. These net equity investments are the aggregate par value of Class A
common stock, qualified Class B common stock and nonqualified Class B common
stock reduced by the aggregate amount that TruServ may legally offset by the
Loss allocation, Accumulated deficit and Accounts and notes receivable accounts.
9
NOTE 13 - NEW ACCOUNTING PRONOUNCEMENTS
In July 2004, TruServ adopted the Financial Accounting Standards Board ("FASB")
Staff Position ("FSP") No. FAS 106-2, "Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and Modernization Act of
2003." FSP FAS 106-2 provides guidance on accounting for the effects of the new
Medicare prescription drug legislation. The adoption of this standard did not
have a material impact on its financial statements.
NOTE 14 - SUBSEQUENT EVENT
Effective November 2, 2004, at the request of TruServ's Board of Directors,
Pamela Forbes Lieberman resigned as President, Chief Executive Officer and as a
director of TruServ.
Effective November 2, 2004, current Board member Thomas S. Hanemann was
appointed President and Chief Executive Officer on an interim basis until a
permanent successor is named, which is expected to occur in 2005. Mr. Hanemann,
65 years of age, was first elected to TruServ's Board of Directors in 2002 and
has been Chief Manager of Chandler-Hanemann, LLC since 1999. Prior positions
include President and Director of AutoZone, a Fortune 500 national chain of auto
parts stores and President of Super D Drugstores, a division of Malone & Hyde.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
($ in thousands)
Overview
TruServ's revenue was down slightly for the third quarter of 2004, as revenue
decreased $4,295 or 0.9%, but was up $45,123 or 3.0% in the first 9 months of
the year, each as compared to last year. Approximately 50% of the increased
revenue in the first 9 months of 2004 was related to the existence of four extra
shipping days in the first 9 months of 2004 compared to the same period in 2003.
A significant portion of the increase in 2004 generated from the extra shipping
days will be offset by year end, as there will be three less shipping days in
the fourth quarter of 2004 as compared to the fourth quarter of 2003.
In the third quarter of 2004, 72 new members were signed up with TruServ,
bringing the total new member signings for the first 9 months of 2004 to 159.
Additionally, in the third quarter of 2004, 96 members terminated their
membership in TruServ, bringing the first 9 months of 2004 membership
termination total to 262, which is the lowest level of terminations since the
merger in 1997. Approximately 82.5% of these third quarter terminations and
74.5% of the year-to-date terminations were members who on average had warehouse
and relay purchases of less than $40 from TruServ in the full year 2003. When
member terminations are offset against member additions, TruServ's store count
dropped by 24 locations in the third quarter and 103 locations in the first 9
months of 2004 to a total of 6,075. Management is continuing to see an increase
in TruServ's success rate in attracting new stores away from other hardware
cooperatives.
TruServ had a net margin in the third quarter this year of $13,401 compared to a
net loss of $9,770 last year, bringing the net margin in the first 9 months of
2004 to $32,440 compared to a net margin of $11,010 in 2003. The primary driver
impacting the change in net margin was the August 29, 2003 refinancing of
TruServ's third party debt. The net impact of the refinancing resulted in a 2004
net expense reduction of $22,982 for the third quarter and $35,570 year-to-date.
The components of the interest expense reduction generated from the refinancing
consisted of the 2003 write-off of expenses incurred of $26,927 and the
elimination of make-whole amortization as of the date of the refinancing of $964
in the quarter and $4,579 year-to-date, partially offset by debt forgiveness of
$7,706 at the time of refinancing. Additional components of the interest expense
reduction were a lower interest rate, which reduced interest expense by $2,218
in the quarter and $9,187 year-to-date, and reduced amortization of bank fees of
$579 in the quarter and $2,583 year-to-date. Also impacting the change in
year-to-date net margin was the 2003 income of $7,100 related to the terminated
agreements with BMA (see Note 10 the Financial Statements in Item 1, "Other
Income, Net").
TruServ's new revolving credit facility has performance pricing. This means
TruServ can cause favorable and unfavorable adjustments to its credit facility
interest rate based on its financial performance as determined each quarter.
TruServ's financial performance for the first three quarters of 2004 has been
such that TruServ lowered its interest rate by 0.25% (from LIBOR + 2.25% to
LIBOR + 2.0%) effective May 1, 2004. The favorable rate adjustment due to
TruServ's performance was offset in 2004 by increases in underlying LIBOR due to
normal fluctuations in market conditions.
Effective July 6, 2004, TruServ rescinded its moratorium on stock redemptions
that had been effective since March 2000. In the third quarter of 2004, 80.3% of
the stores and 84.8% of the dollars that were deferred due to the moratorium
were paid.
THIRTEEN WEEKS ENDED OCTOBER 2, 2004 COMPARED TO THIRTEEN WEEKS ENDED SEPTEMBER
27, 2003
RESULTS OF OPERATIONS:
Revenue and Gross Margin
A reconciliation of net revenue and gross margin for the 13 weeks ending October
2, 2004 and September 27, 2003 follows:
10
Gross
Net % of Net Gross Margin %
Revenue Revenue Margin of Revenue
---------- -------- --------- ----------
($ in thousands)
Thirteen weeks ended September 27, 2003 results $ 478,811 100.0% $ 55,705 11.6%
Same store sales:
Warehouse and relay revenue (421) (0.1) 1,298
Vendor direct revenue 1,598 0.3 (34)
Paint Revenue 2,762 0.6 595
---------- -------- ---------
Net same store sales 3,939 0.8 1,859
---------- -------- ---------
Change in participating members:
Terminated members:
Warehouse and relay revenue (8,171) (1.7) (1,339)
Vendor direct revenue (3,264) (0.7) (22)
Paint Revenue (795) (0.2) (362)
---------- -------- ---------
Net terminated members (12,230) (2.6) (1,723)
---------- -------- ---------
New members:
Warehouse and relay revenue 4,595 1.0 715
Vendor direct revenue 1,906 0.4 9
Paint Revenue 463 0.1 168
---------- -------- ---------
Net new members 6,964 1.5 892
---------- -------- ---------
Net change in participating members (5,266) (1.1) (831)
---------- -------- ---------
Other revenue and cost of revenue (2,968) (0.6) (777)
---------- -------- ---------
Total change (4,295) (0.9) 251
---------- -------- ---------
Thirteen weeks ended October 2, 2004 results $ 474,516 99.1% $ 55,956 11.8%
========== ======== ========= =======
Net revenue for the 13 weeks ended October 2, 2004 totaled $474,516, a decrease
of $4,295, or 0.9%, as compared to the same period last year. The decrease in
net revenue was in the participating member sales and other revenue categories
and was partially offset by an increase in same store sales. TruServ's net
change in participating member sales decreased $5,266, or 1.1%, due to a net
decline in the number of participating member retail outlets of 3.5%, as
compared to the same period last year. Although there is a net decline in
revenue from the reduction in participating member retail outlets in the third
quarter of 2004, this represents an improvement relative to the net decline of
$17,084 experienced in the third quarter of 2003. Other revenue, which consists
mainly of advertising and transportation revenue, decreased by $2,968, or 0.6%.
This decrease was mainly due to the EITF 02-16 net impact on vendor advertising
fund and market and related items revenue recognition as disclosed in Note 11 to
the Financial Statements in Item 1, "Consideration Given by a Vendor." Partially
offsetting the unfavorable net revenue variance was an increase in the same
store sales category of $3,939, or 0.8%, as compared to the same period last
year. TruServ's same store sales increased due to the impact of hurricanes, as
well as various TruServ programs and initiatives to drive merchandise sales.
Additionally, TruServ had a product price reduction (excluding commodity items)
that lowered revenue by an incremental $1,588, which had a negative impact on
both the same store sales and change in participating member categories as
compared to the third quarter of 2003.
Gross margin for the 13 weeks ended October 2, 2004 increased by $251, or 0.5%,
as compared to the third quarter of 2003. The same store sales gross margin
increase of $1,859 over the prior year was partially offset by the $831
unfavorable variance related to net reduction in participating member stores.
Although the net decline in participating member stores caused a gross margin
reduction, the trend shows improvement, as the third quarter of 2003 had a gross
margin loss of $2,788 from a net decline in participating member stores. The
wholesale product price reduction that lowered revenue did not unfavorably
impact gross margin, as lower product acquisition cost from suppliers more than
offset the wholesale product price reduction. In addition, the other gross
margin category, which consists mainly of advertising, transportation,
freight-in, vendor rebates, cash discounts and other costs incurred to prepare
goods for resale, decreased by $777. The main drivers of this unfavorable
variance were higher inventory reserve requirements related to increased levels
of unproductive inventory, as well as lower rebates and discounts. Partially
offsetting this unfavorable variance was the application of EITF 02-16 (See Note
11 to the Financial Statements in Item 1, "Consideration Given by a Vendor") on
net monies earned and expenses incurred in holding markets and related items,
which was recorded in Selling, general and administrative ("SG&A") expenses in
2003.
2004 2003 $ Expense (Decrease)
---- ---- --------------------
Logistics and manufacturing expenses $14,551 $14,812 $(261)
Logistics and manufacturing expenses decreased by $261, or 1.8%, as compared to
the same period last year. The main driver was lower variable expenses due to
lower warehouse sales volume compared to the same period last year.
2004 2003 $ Expense (Decrease)
---- ---- --------------------
Selling, general and administrative expenses $25,010 $27,515 $(2,505)
SG&A expenses decreased $2,505, or 9.1%, as compared to the third quarter of
2003. The decrease in expense was mainly due to lower depreciation and
amortization. The $2,131 reduction in depreciation and amortization expense was
due to capital investments incurred after the 1997 merger that became fully
depreciated or amortized by the end of fiscal 2003. Incentive compensation
expense was lower by $1,292 in the quarter compared to the same period last year
mainly due to lower attainment of targets in 2004 compared to attainment in
2003. Partially offsetting this favorability is the application of EITF 02-16
(See Note 11 to the Financial Statements in Item 1, "Consideration Given by a
Vendor"). Net monies earned from prior year markets and related items were
recorded in SG&A expenses in 2003 and the 2004 net monies of $1,104 are now
recorded in revenue and cost of revenue as appropriate.
2004 2003 $ Income (Decrease)
---- ---- -------------------
Other income, net $(527) $(11,420) $(10,893)
Other income, net decreased $10,893, or 95.4%, as compared to the same period
last year. This decrease in income was mainly due to a gain from the debt
forgiveness in 2003 of $7,706 related to the debt refinancing
11
on August 29, 2003 and a 2003 gain of $3,000 from a litigation settlement.
2004 2003 $ Expense (Decrease)
---- ---- --------------------
Third party interest expense $1,899 $32,964 $(31,065)
Third party interest expense decreased $31,065, or 94.2%, as compared to the
same period last year. The main driver of this favorable variance was related to
the August 29, 2003 refinancing, which lowered interest expense by $30,688 due
to the 2003 write-off of expenses incurred of $26,927, the 2003 amortization of
senior note make-whole interest cost related to prior years senior note
prepayments of $964, reduced amortization of bank fees of $579 and the resulting
2004 lower interest rate, which reduced interest expense by $2,218. See "Other
income, net" for related debt forgiveness.
2004 2003 $ Net margin Increase
---- ---- ---------------------
Net margin / (loss) $13,401 $(9,770) $23,171
The net margin of $13,401 for the quarter was up from a net loss of $9,770 for
the same period a year ago. The increase in net margin of $23,171 was mainly due
to the net impact of $22,982 related to the August 29, 2003 refinancing of
TruServ's third party debt. The refinancing components that resulted in the 2004
net expense reduction consisted of the interest expense reduction of $30,688,
partially offset by debt forgiveness of $7,706 incurred at the time of
refinancing. Another significant favorable impact to net margin was lower
depreciation and amortization expense of $2,131. Partially offsetting the
favorable net margin was a 2003 gain of $3,000 from a litigation settlement.
THIRTY-NINE WEEKS ENDED OCTOBER 2, 2004 COMPARED TO THIRTY-NINE WEEKS ENDED
SEPTEMBER 27, 2003
RESULTS OF OPERATIONS:
Revenue and Gross Margin
A reconciliation of net revenue and gross margin for the 39 weeks ending October
2, 2004 and September 27, 2003 follows:
Gross
Net % of Net Gross Margin %
Revenue Revenue Margin of Revenue
----------- --------- ----------- ------------
($ in thousands)
Thirty-nine weeks ended September 27, 2003 results $ 1,504,100 100.0% $ 166,577 11.1%
Same store sales:
Warehouse and relay revenue 39,028 2.6 7,732
Vendor direct revenue 19,765 1.3 1
Paint Revenue 6,877 0.5 392
----------- ----- -----------
Net same store sales 65,670 4.4 8,125
----------- ----- -----------
Change in participating members:
Terminated members:
Warehouse and relay revenue (29,943) (2.0) (4,905)
Vendor direct revenue (13,079) (0.9) (112)
Paint Revenue (2,759) (0.2) (1,224)
----------- ----- -----------
Net terminated members (45,781) (3.1) (6,241)
----------- ----- -----------
New members:
Warehouse and relay revenue 13,878 0.9 1,907
Vendor direct revenue 7,392 0.5 36
Paint Revenue 1,262 0.1 440
----------- ----- -----------
Net new members 22,532 1.5 2,383
----------- ----- -----------
Net change in participating members (23,249) (1.6) (3,858)
----------- ----- -----------
Other revenue and cost of revenue 2,702 0.2 (3,387)
----------- ----- -----------
Total change 45,123 3.0 880
----------- ----- -----------
Thirty-nine weeks ended October 2, 2004 results $ 1,549,223 103.0% $ 167,457 10.8%
=========== ===== =========== ====
Net revenue for the 39 weeks ended October 2, 2004 totaled $1,549,223, an
increase of $45,123, or 3.0%, as compared to the same period last year. The
increase in net revenue was in the same store sales and other revenue categories
and was partially offset by a decline in participating member store sales.
Approximately 50% of the increase was due to four additional ship days in the
first 9 months of 2004 and mainly impacted the same store sales and change in
participating members' categories. A significant portion of the increase in 2004
generated from the extra shipping days will be offset by year end, as there will
be three less shipping days in the fourth quarter of 2004, as compared to the
fourth quarter of 2003. TruServ's same store sales increased $65,670, or 4.4%.
In addition to the four additional ship days, same store sales were also
favorably impacted by an improved economy, renewed member confidence in their
business and in TruServ, as well as various TruServ programs and initiatives to
drive merchandise sales. Partially offsetting the favorable net revenue variance
was a net decline in TruServ's number of participating member retail outlets of
3.5%, as compared to the same period last year, which resulted in revenue
reduction of $23,249, or 1.6%. Although there is a net decline in revenue from
the change in participating member stores in the first 9 months of 2004, this
represents an improvement relative to the net decline of $76,049 experienced in
the first 9 months of 2003. Additionally, a factor reducing net revenue in the
same store sales and change in participating member store categories is a
wholesale product price reduction (excluding commodity items) that lowered
revenue by an incremental $7,727, as compared to the first 9 months of 2003.
12
Gross margin for the 39 weeks ended October 2, 2004 increased by $880, or 0.5%,
as compared to the first 9 months of 2003. Same store sales gross margin
increased $8,125 due to the volume increase in same store sales and was
partially offset by lower paint margins due to costs of $1,794 incurred to
implement the new "Color Made Simple" paint program and the write-off of the old
paint color center support material. Another contributing factor reducing gross
margin was the net decline in participating member stores that lowered gross
margin by $3,858. Although the net decline in participating member stores caused
a gross margin reduction, the trend shows improvements, as the first 9 months of
2003 had a gross margin loss of $11,249 from a net decline in participating
member stores. In addition, the other gross margin category, which consists
mainly of advertising, transportation, freight-in, vendor rebates, cash
discounts and other costs incurred to prepare goods for resale, decreased by
$3,387. The main drivers of this unfavorable variance were higher inventory
reserve requirements related to the increased levels of unproductive inventory,
higher costs incurred to prepare goods for resale, and the EITF 02-16 impact as
it relates to the change in vendor recognition (See Note 11 to the Financial
Statements in Item 1, "Consideration Given by a Vendor"). Partially offsetting
this unfavorable variance was the EITF 02-16 impact from the net monies earned
and expenses incurred in holding markets and related items compared to 2003 (See
Note 11 to the Financial Statements in Item 1, "Consideration Given by a
Vendor"). The wholesale product price reduction that lowered revenue did not
unfavorably impact gross margin, as lower product acquisition cost from
suppliers more than offset the wholesale product price reduction.
2004 2003 $ Expense (Decrease)
------- ------- --------------------
Logistics and manufacturing expenses $46,528 $48,426 $(1,898)
Logistics and manufacturing expenses decreased by $1,898, or 3.9%, as compared
to the same period last year. As the result of continuing cost reduction
initiatives, TruServ was able to reduce its handling cost as a percent of
warehouse sales by 0.2% compared to the same period last year.
2004 2003 $ Expense Increase
------- ------ ------------------
Selling, general and administrative expenses $79,800 $72,105 $7,695
SG&A expenses increased by $7,695, or 10.7%, as compared to 2003. The increase
in SG&A expenses was primarily due to the application of EITF 02-16 (See Note 11
to the Financial Statements in Item 1, "Consideration Given by a Vendor"). Net
monies earned from prior year markets and related items were recorded in SG&A
expenses in 2003 and the 2004 net monies of $7,388 are now recorded in revenue
and cost of revenue as appropriate. Other increases are in salaries of $2,134
due to annual merit increases and investments in additional headcount in order
to deliver on TruServ initiatives to drive merchandise sales. In addition,
health care costs were unfavorable by $1,332 relative to last year, which
reflects the upward trends in health care self-insurance costs in the first 9
months of 2004 compared to the same period last year and severance charges were
unfavorable by $763 due to departmental reorganizations. Partially offsetting
the increase in expense was lower depreciation and amortization. The $6,697
reduction in depreciation and amortization expense was due to capital
investments incurred after the 1997 merger that became fully depreciated or
amortized by the end of fiscal 2003.
2004 2003 $ Income (Decrease)
------- -------- -------------------
Other income, net $(1,590) $(19,276) $(17,686)
Other income, net decreased $17,686, or 91.8%, as compared to the same period
last year. This decrease in income was mainly due to three 2003 gains. First,
was an April 2003 gain of $7,100 of unamortized income related to terminated
agreements associated with the sale of the lumber business to BMA in December
2000. Second was the 2003 debt forgiveness of $7,706 related to the debt
refinancing on August 29, 2003. Third was a 2003 gain of $3,000 from a
litigation settlement.
2004 2003 $ Expense (Decrease)
---- ---- --------------------
Third party interest expense $5,797 $49,747 $(43,950)
Third party interest expense decreased $43,950, or 88.3%, as compared to the
same period last year. The main driver of this favorable variance was related
to the August 29, 2003 refinancing, which lowered interest expense by $42,787
due to the 2003 refinancing, which lowered interest expense by $43,276 due to
the 2003 write-off of expenses incurred of $26,927, the 2003 amortization of
senior note make-whole interest cost related to prior years senior note
prepayments of $4,579, reduced amortization of bank fees of $2,583 and the
resulting 2004 lower interest rate, which reduced interest expense by $9,187.
See "Other income, net" for related debt forgiveness.
2004 2003 $ Net margin Increase
------- ------- ---------------------
Net margin $32,440 $11,010 $21,430
The first 9 months of 2004 net margin of $32,440 was up from a net margin of
$11,010 for the same period a year ago. The increase in net margin of $21,430
was mainly due to the net impact of $35,570 related to the August 29, 2003
refinancing of TruServ's third party debt. The refinancing components that
resulted in the 2004 net expense reduction consisted of the interest expense
reduction of $43,276, partially offset by debt forgiveness of $7,706 incurred at
the time of refinancing. Other significant favorable impacts to net margin were
increased sales volume and lower depreciation and amortization expense of
$6,697. Partially offsetting the favorable net margin was the 2003 gain of
$7,100 from terminated agreements with BMA, a 2003 gain of $3,000 from a
litigation settlement, as well as an increase in 2004 salaries and severance
charges of $2,897 and health insurance of $1,332.
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, 2003, describes TruServ's debt, credit facilities, guarantees and future
commitments, in order to facilitate a review of TruServ's liquidity.
13
TruServ generated cash from operating activities for the 39 weeks ended
October 2, 2004 and September 27, 2003 of $44,825 and $8,509, respectively.
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 TruServ 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 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 increase in cash generated from collections on accounts receivable and from
the future sale of inventory. The favorable change in cash provided by operating
activities was mainly due to a significant increase in net margin in the first 9
months of 2004 compared to the prior year, as well as a decrease in cash used
for working capital components.
Inventory as of October 2, 2004 was $275,763, down $962 since the beginning of
the year. This decrease in the first 9 months of 2004 compares to an inventory
increase of $45,614 from year-end 2002 to September 2003. The change in the
trend is due to the fact that TruServ increased its December 31, 2003 inventory
by approximately $40,000 relative to December 31, 2002 in a program to improve
fill rates and as a result of increasing its import program. Inventory, as
compared to the same period last year, was down $4,299 as TruServ continues to
maintain inventory levels in line with the size of its membership.
TruServ used cash from investing activities of $7,158 for the 39 weeks ended
October 2, 2004, as compared to generating cash of $1,087 for the same period
last year. This is mainly due to additions to properties owned using cash of
$8,101, which is up from $4,676 compared to the same period last year. These
capital expenditures are comprised of various building improvements and
purchases of additional equipment and technology at TruServ's distribution
centers and at its corporate headquarters. Additionally, TruServ generated cash
from the reduction in restricted cash of $3,602 in 2003 as the refinancing of
the prior debt agreements removed the requirement for restricted cash.
TruServ used cash generated from its operating activities to provide cash for
its financing activities of $39,904. The main uses of cash for financing
activities in the first 9 months of 2004 were the cash payments of the Bank
Facility, drafts payable, patronage dividends and repurchase of common stock due
to the lifting of the moratorium (See Note 12 to the Financial Statements in
Item 1, "Rescinding of the Moratorium"). The interest rate for the initial term
of the Bank Facility through April 30, 2004 was a variable rate (at TruServ's
option) of LIBOR plus 2.25% or the prime rate plus 0.25%. Letters of credit
issued under the Bank Facility originally carried a fee of 2.25%. Under the
terms of the Bank Facility, pricing is determined by a performance grid based
upon a fixed charge coverage ratio, measured quarterly beginning in March 2004.
Based on this performance pricing grid, TruServ achieved improved variable
pricing after the first quarter of 2004. Effective May 1, 2004 and at least
through January 2005, TruServ's variable interest rate became LIBOR plus 2.0% or
the prime rate and letters of credit will carry fees of 2.0%. The unused
commitment fee is 0.375%. As of October 2, 2004, the weighted average interest
rate was 3.84%.
The Bank Facility has no financial covenants, unless average daily availability
for the last 60 days of each quarter drops below $35,000. As of October 2, 2004,
TruServ's average availability for the last 60 days was greater than $35,000 and
TruServ is therefore not subject to a maximum fixed charge coverage ratio of 1.1
to 1.0. Additionally, TruServ is required to maintain $15,000 of availability at
all times. Availability is defined as 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. Availability at October 2, 2004 was $83,568, as
TruServ had outstanding borrowings of $118,597 and letters of credit and
reserves of $15,815. As of October 2, 2004 TruServ is in compliance with all
terms and conditions of the Bank Facility.
In the 39 weeks ended October 2, 2004, TruServ had a net decrease in cash and
cash equivalents of $2,237. At October 2, 2004, TruServ's working capital was
$89,863, as compared to $50,602 at December 31, 2003. The current ratio was 1.21
at October 2, 2004, as compared to 1.11 at December 31, 2003. The increase in
working capital and the current ratio is mainly due to an additional $25,000 of
the Bank Facility being classified in long-term debt, including capital lease
obligations, less current maturities at October 2, 2004 compared to December 31,
2003, as management's estimate of the lowest level of borrowings during the next
twelve months increased by $25,000 due to increased working capital needs.
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 2004.
At October 2, 2004, TruServ had Current maturities of long-term debt, notes,
borrowings and capital lease obligations of $61,569. Only $27,972 of this amount
has required payments during the next twelve months and the remaining $33,597 is
the current portion of the Bank Facility that reflects the seasonality of
TruServ's business (See Note 6 to the Financial Statements in Item 1, "Debt").
The required payments consist of $7,614 of subordinated installment notes, of
which $4,523 have been reclassified from Deferred stock redemptions due to the
lifting of the moratorium (See Note 12 to the Financial Statements in Item 1,
"Rescinding of the Moratorium"), $19,712 of subordinated promissory notes and
$646 of capital leases. Historically, TruServ members have renewed a minimum of
50% of the subordinated promissory notes, extending the maturity for an
additional three years. In 2003, this renewal rate was approximately 85%. The
$27,972, however, assumes no renewal of notes. The current and long-term
portions of the Bank Facility do not have any required payments until 2007.
CASH REQUIREMENTS:
Below is the current schedule of the expected cash outflows necessary to meet
financial commitments existing as of October 2, 2004 and thereafter:
14
2005 & 2007 &
2004 2006 2008 Thereafter Total
-------- -------- -------- ---------- --------
($ in thousands)
Bank Facility (1) $ 33,597 $ - $ 85,000 $ - $118,597
Installment (subordinated) notes (2) 7,614 11,718 11,718 - 31,050
Promissory (subordinated) notes (3) 19,712 39,866 - - 59,578
Capital lease obligations 704 806 187 - 1,697
Operating lease obligations 6,403 58,353 48,640 241,423 354,819
Purchase obligations (4) 98,078 511 - - 98,589
Redeemable non-qualified Class B non-voting
common stock - - - 21,860 21,860
-------- -------- -------- -------- --------
Total $166,108 $111,254 $145,545 $263,283 $686,190
======== ======== ======== ======== ========
(1) The amount shown due in 2004 represents management's estimate of the
amount necessary to reduce the outstanding balance to the expected lowest
level of borrowings during the next twelve months. There are no required
payments until the maturity of the Bank Facility in August 2007.
(2) Effective July 6, 2004, TruServ rescinded its moratorium on stock
redemptions that had been effective since March 2000. In accordance with
TruServ's By-Laws, TruServ paid $7,355 of stock redemption liability in
cash in the third quarter of 2004 and $24,773 was paid with subordinated
installment notes. As of October 2, 2004, the remaining stock redemption
liability of $6,236 is estimated to be paid in the fourth quarter as $1,713
of cash and $4,523 of subordinated installment notes. The subordinated
installment notes are payable in five equal annual installments and bear
interest at the rate of 4.36%, paid annually on December 31. The first
installment payment of principal and interest on the subordinated
installment notes will be due in December 2004. As of October 2, 2004,
TruServ has classified its $6,236 Deferred stock redemption liability as
$2,618 in Current maturities of long-term debt, notes, borrowings and
capital lease obligations and $3,618 in Long-term debt, including capital
lease obligations, less current maturities.
(3) The amounts shown are scheduled payments; however, historically a
minimum of 50% of the promissory (subordinated) notes have been renewed,
extending the maturity for an additional three years. In 2003, this renewal
rate was approximately 85%.
(4) Purchase obligations are typically short-term and fluctuate with the
seasonality of TruServ's business. Also, purchase obligations are part of a
cycle where they are continuously converted into inventory and new purchase
obligations are created.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
($ 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, which had approximately $118,600 outstanding at October 2, 2004. A 50
basis point movement in interest rates would result in an approximate $593
annualized increase or decrease in interest expense and cash flows based on the
outstanding balance at October 2, 2004.
For the most part, TruServ manages interest rate risk through a combination of
variable and fixed-rate debt instruments with varying maturities. As required by
the Bank Facility, TruServ has purchased interest rate caps that limit its risk
on $25,000 of variable rate debt for the entire term of the Bank Facility to a
maximum underlying LIBOR rate of 3.5%, approximately 1.5% increase over current
LIBOR. Credit risk pertains primarily to TruServ's trade receivables. TruServ
extends credit to its members as part of its day-to-day operations. TruServ's
management believes that as no specific receivable or group of receivables
comprises a significant percentage of total trade accounts, its risk in respect
to trade receivables is limited. Additionally, TruServ's management believes
that its allowance for doubtful accounts is adequate with respect to member
credit risks. TruServ performs no speculative hedging activities. TruServ does
not have any interest in variable interest entities ("VIE's") and all related
party transactions (i.e., transactions with members) are at arm's length.
ITEM 4. CONTROLS AND PROCEDURES
TruServ's Chief Executive Officer and Chief Financial Officer have concluded
that as of October 2, 2004 TruServ's disclosure controls and procedures are
effective. There has been no change in TruServ's internal control over financial
reporting identified in connection with reaching the conclusion described above
that occurred during TruServ's last fiscal quarter that has materially affected,
or is reasonably likely to materially affect, TruServ's internal control over
financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
($ in thousands)
FLEGLES ACTION
On February 12, 2003, a former TruServ member, Flegles Inc. ("Flegles"), filed
suit against TruServ in the Circuit Court of Carlisle County, Kentucky. The
complaint alleges that TruServ is liable to Flegles for the role TruServ played
with respect to Flegles' construction of a new retail store facility in
Bardwell, Kentucky that has allegedly incurred financial losses. Flegles sought
$2,400 in compensatory damages and also an award of punitive damages. On July
30, 2004, a jury found TruServ liable to Flegles for certain losses incurred by
Flegles and awarded Flegles $1,300 in compensatory damages. The jury did not
award any punitive damages. TruServ believes that the verdict was rendered in
error and is vigorously pursuing post-trial motions before the Circuit Court
including a request that the verdict be set aside or that TruServ be awarded a
new trial. If necessary, TruServ will pursue that relief in a higher court.
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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 $130,803 for the fiscal year ended December 31, 1999. It is
TruServ's belief that had E&Y properly discharged its duties, the scope and
breadth of the Fourth Quarter Charge, as well as the accounting and operational
control deficiencies that necessitated the charge, would have been substantially
lessened. As a result of E&Y's failures, TruServ has suffered significant
financial damages. The factual allegations that form the basis for TruServ's
claim against E&Y include, in part, the issues identified in the Securities and
Exchange Commission cease and desist order of 2003, finding that, from
approximately July 1997 through the end of 1999, TruServ's accounting systems
and internal controls related to inventory management were inadequate, and
further finding that these deficiencies caused TruServ to understate expenses,
which resulted in overstatement of net income, during 1998 and 1999. TruServ
began discussion of its claims with E&Y early in the fall of 2001. Pursuant to
the dispute resolution procedures required by TruServ's engagement letter with
E&Y, TruServ and E&Y attempted to mediate this dispute during the first six
months of 2002. When those attempts proved unsuccessful and again pursuant to
the dispute resolution procedures, TruServ filed its claim with the American
Arbitration Association on July 31, 2002. The arbitration, which is subject to
certain confidentiality requirements, is currently pending. Another effort at
non-binding mediation is currently scheduled to occur between the parties in
December 2004. If that mediation attempt is unsuccessful, hearings before the
arbitration panel are currently scheduled to begin in the first quarter of 2005.
A portion of the recoveries under this matter, if any, may be subrogated to the
rights of TruServ's insurer to the extent that it has made payments to or on
behalf of TruServ associated with the 1999 loss.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
($ in thousands)
USE OF PROCEEDS
TruServ uses the proceeds from the offering of the Class A common stock for
general working capital, including the purchase of merchandise for resale to its
members.
ISSUER PURCHASES OF EQUITY SECURITIES
The number of shares of TruServ's Class A common stock redeemed and the average
price paid per share for each month in the three months ended October 2, 2004
are as follows:
Average Total Number Approximate $
Total Number Price Paid of Shares as part Value that May
of Shares per Share of Announced Yet Be Purchased
Redeemed (1) before offsets Plan under Plan
------------ -------------- ----------------- ----------------
CLASS A COMMON STOCK
July 4 - July 31, 2004 138,638 $ 100 - $ -
August 1 - August 28, 2004 22,828 100 - -
August 29 - October 2, 2004 9,316 100 - -
------- ------- --- ---
Total 170,782 - $ -
======= === ===
(1) In March 2000, the board of directors of TruServ declared a moratorium on
redemptions of the capital stock. On June 29, 2004, the board of directors
of TruServ announced that it had voted to rescind the moratorium on stock
redemptions effective July 6, 2004. In accordance with TruServ's By-Laws,
TruServ offsets amounts due by its members against any amounts that it pays
to the members on redemption of either their stock or their notes. This
stock redemption liability is the aggregate value of the former members'
equity investments after the offset of the loss allocation resulting from
the 1999 loss, the 2001 loss and the accounts receivable owed by the former
members. The net investment value of Class A common stock is paid in cash
at the time of redemption.
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
Exhibit 4-A Second Amendment to Loan and Security Agreement
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)
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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 15, 2004 By /s/ DAVID A. SHADDUCK
----------------------------------------
David A. Shadduck
Senior Vice President and
Chief Financial Officer
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