1
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 JUNE 30, 2001 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 [ ] : No [X]
The number of shares outstanding of each of the issuer's classes of common
stock, as of July 28, 2001.
Class A Common Stock, $100 Par Value.................450,420 Shares
Class B Common Stock, $100 Par Value...............1,731,490 Shares
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ITEM 1. FINANCIAL STATEMENTS
TRUSERV CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
JUNE 30, DECEMBER 31,
2001 2000
---- ----
(UNAUDITED)
(000'S OMITTED)
Current assets:
Cash and cash equivalents................................................... $ 16,513 $ 18,316
Restricted cash ............................................................ 1,000 1,000
Accounts and notes receivable, net of allowance for doubtful accounts of
$9,964,000 and $7,170,000............................................. 391,659 396,587
Inventories (Note 6)........................................................... 417,654 443,663
Other current assets........................................................... 20,031 12,274
--------------- ---------------
Total current assets.................................................. 846,857 871,840
Properties, net................................................................ 205,852 216,146
Goodwill, net.................................................................. 92,763 94,051
Other assets................................................................... 41,907 53,977
--------------- ---------------
Total assets.......................................................... $ 1,187,379 $ 1,236,014
=============== ===============
See Notes to Condensed Consolidated Financial Statements
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TRUSERV CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
LIABILITIES AND MEMBERS' CAPITALIZATION
JUNE 30, DECEMBER 31,
2001 2000
---- ----
(UNAUDITED)
(000'S OMITTED)
Current liabilities:
Accounts payable............................................................ $ 415,442 $ 356,196
Outstanding checks ......................................................... 56,716 129,490
Accrued expenses............................................................... 87,648 85,161
Short-term borrowings ......................................................... 128,700 138,085
Current maturities of notes, long-term debt and capital lease..................
obligations (Note 2).................................................... 339,345 341,188
Patronage dividend payable in cash............................................. 412 10,459
--------------- ---------------
Total current liabilities............................................. 1,028,263 1,060,579
Long-term debt, including capital lease obligations,
less current maturities (Note 2)............................................ 8,153 9,091
Deferred credits .............................................................. 9,290 9,821
--------------- ---------------
Total liabilities and deferred credits......................................... 1,045,706 1,079,491
--------------- ---------------
Minority interest.............................................................. 4,650 4,999
Commitments and contingencies.................................................. -- --
Members' capitalization:
Promissory (subordinated) and installment notes ............................ 62,025 65,846
Members' equity:
Redeemable Class A voting common stock, $100 par value; 750,000 shares
authorized; 448,320 and 411,180 shares issued and fully paid; 61,740 and
98,880 shares issued (net of subscriptions receivable of
$1,748,000 and $1,922,000).............................................. 49,427 49,084
Redeemable Class B non-voting common stock and paid-in capital, $100
par value; 4,000,000 shares authorized; 1,731,482 and 1,731,482 shares
issued and fully paid.................................................... 174,448 174,448
Loss allocation (Note 5)................................................. (92,074) (92,460)
Deferred patronage....................................................... (26,914) (27,288)
Retained deficit......................................................... (28,971) (17,134)
Accumulated other comprehensive loss..................................... (918) (972)
--------------- ----------------
Total Members' equity................................................. 74,998 85,678
--------------- ---------------
Total Members' capitalization.................................... 137,023 151,524
--------------- ---------------
Total liabilities and Members' capitalization............... $ 1,187,379 $ 1,236,014
=============== ===============
See Notes to Condensed Consolidated Financial Statements
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TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
For the thirteen weeks ended For the twenty-six weeks ended
------------------------------- -------------------------------
June 30, July 1, June 30, July 1,
2001 2000 2001 2000
----------- ----------- ----------- -----------
(000'S OMITTED)
Revenues............................. $ 747,765 $ 1,137,262 $ 1,402,115 $ 2,164,867
Costs and expenses:
Cost of revenues.................. 670,365 1,060,354 1,274,065 2,025,293
Logistics and manufacturing
expenses....................... 25,150 22,780 45,798 46,534
Selling, general and
administrative expenses........ 33,774 24,313 62,941 58,547
Interest paid to Members.......... 1,979 2,816 3,932 5,631
Other interest expense............ 14,923 16,325 28,327 27,925
Gain on sale of properties........ (53) (963) (115) (1,067)
Other income, net................. (1,220) (303) (1,780) (1,067)
----------- ----------- ----------- -----------
744,918 1,125,322 1,413,168 2,161,796
----------- ----------- ----------- -----------
Net margin /(loss) before
income taxes....................... 2,847 11,940 (11,053) 3,071
Income tax expense................... 274 17 310 72
----------- ----------- ----------- -----------
Net margin /(loss)................... $ 2,573 $ 11,923 $ (11,363) $ 2,999
=========== =========== =========== ===========
See Notes to Condensed Consolidated Financial Statements.
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TRUSERV CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
FOR THE TWENTY-SIX WEEKS ENDED
------------------------------
JUNE 30, JULY 1,
2001 2000
---- ----
(000'S OMITTED)
Operating activities:
Net loss ....................................................................... $ (11,363) $ 2,999
Adjustments to reconcile net loss to cash and
cash equivalents used for operating activities:
Depreciation and amortization................................................ 21,346 22,655
Provision for allowance for doubtful accounts................................ 3,643 4,167
Net change in working capital components..................................... 87,460 (84,134)
------------- --------------
Net cash and cash equivalents provided by/(used for) operating activities....... 101,086 (54,313)
------------- ---------------
Investing activities:
Additions to properties owned................................................... (6,989) (6,639)
Proceeds from sale of properties owned.......................................... 80 7,532
Changes in other assets......................................................... 746 202
------------- --------------
Net cash and cash equivalents provided by/(used for) investing activities....... (6,163) 1,095
-------------- --------------
Financing activities:
Payment of patronage dividend................................................... (9,213) --
Proceeds from long-term borrowings.............................................. -- 954
Payment of notes, long-term debt and lease obligations.......................... (5,697) (7,617)
Decrease in outstanding checks.................................................. (72,774) (23,543)
Proceeds from/(repayments of) short-term borrowings, net of repayments.......... (9,385) 85,139
Purchase of common stock........................................................ -- (1,505)
Proceeds from Class A common stock subscription receivable...................... 343 266
------------- --------------
Net cash and cash equivalents provided by/(used for) financing activities....... (96,726) 53,694
-------------- --------------
Net increase/(decrease) in cash and cash equivalents............................... (1,803) 476
Cash and cash equivalents at beginning of period................................... 18,316 1,815
------------- --------------
Cash and cash equivalents at end of period......................................... $ 16,513 $ 2,291
============= ==============
See Notes to Condensed Consolidated Financial Statements.
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TRUSERV CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - GENERAL
The condensed consolidated balance sheet at June 30, 2001, the condensed
consolidated statement of operations for the thirteen and twenty-six weeks ended
June 30, 2001 and July 1, 2000, and the condensed consolidated statement of cash
flows for the twenty-six weeks ended June 30, 2001 and July 1, 2000 are
unaudited and, in the opinion of the management of the company, 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, 2000
included in the company's 2000 Annual Report on Form 10-K.
NOTE 2 - DEBT COVENANT VIOLATION
Under the senior notes and the revolving credit facility the company is required
to meet certain restrictive financial ratios and covenants relating to minimum
EBITDA, minimum fixed charge coverage, minimum borrowing base to debt ratio,
maximum capital expenditures and maximum asset sales, as well as other customary
covenants, representations and warranties, funding conditions and events of
default. As of December 31, 2000, the company was in compliance with the
covenant requirements.
However, as of February 24, 2001, the company failed to comply with a covenant
under the revolving credit facility and the senior note agreements which
requires the company to achieve a minimum monthly borrowing base ratio. As a
result, either the senior note holders or the participants in the revolving
credit facility could declare this failure to comply with the covenant as an
"event of default," in which case the senior notes and the amounts outstanding
under the revolving credit facility would become callable as immediately
payable.
On March 30, 2001, the participants in the revolving credit facility issued to
the company "reservation of rights" letters under which the participants
effectively stated their intention to not call as immediately payable the
company's outstanding debt obligations until May 1, 2001, although they were not
precluded from doing so. All other rights of the participants were preserved.
Additional letters were issued on April 30, 2001 and July 3, 2001, which
extended the reservation of rights until July 30, 2001 and September 30, 2001,
respectively. The senior note holders also issued letters reserving their right
to accelerate the maturity of the notes although agreeing not to do so at this
time.
The reservation of rights letters provided by the participants in the revolving
credit facility required that the upper limit of the total amount that may be
borrowed under the Credit Agreement at any time prior to September 30, 2001 be
lowered from $275,000,000 to $225,000,000. The credit limit under this facility
was reduced on May 11, 2001 from $275,000,000 to $250,000,000. Additionally, the
interest rate on the amounts outstanding under the revolving credit facility was
increased by approximately 2%; this increased interest rate also applies to the
outstanding senior notes. As a result of this increased interest rate, the
company will incur additional interest expense in fiscal year 2001. If this
increased interest rate continues through December 31, 2001, the additional
interest expense would aggregate approximately $6.0 million.
The company is in discussions with the current lenders and with potential
lenders regarding refinancing the senior note agreements and the revolving
credit facility and, if successful, will replace the current senior note
agreements and the revolving credit facility with an asset-based lending
agreement with a new lending group in the fourth quarter of 2001. An alternative
may be to amend the existing agreements with the existing lenders. However, no
assurances can be given as to the outcome. The company's failure to
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successfully refinance or amend its current borrowing arrangements could cause
the current lending group to call as immediately payable the company's currently
outstanding debt obligations. The company's resulting inability to satisfy its
debt obligations would force the company to pursue other alternatives to improve
liquidity, possibly including, among other things, restructuring actions, sales
of assets and seeking additional sources of funds or liquidity. In particular,
the company has engaged an investment banking firm to assist it in exploring the
sale of the paint manufacturing business. No assurances can be given that the
company will be successful in pursuing such possible alternatives or, even if
successful, that such undertakings would not have a material adverse impact on
the company.
Accordingly, the balances outstanding under the senior note agreements and the
revolving credit facility have been classified as current liabilities as of
December 31, 2000 and June 30, 2001. However, the financial statements do not
include any other adjustments that might result from the outcome of this
uncertainty.
NOTE 3 - RECLASSIFICATIONS
Certain reclassifications have been made to the prior year's condensed
consolidated financial statements to conform with the current year's
presentation. These reclassifications had no effect on net margin/(loss) for
any period or on Total Members' equity at the balance sheet dates.
NOTE 4 - ESTIMATED PATRONAGE DIVIDENDS
If financial and operating conditions permit, patronage dividends are declared
and paid by the company after the close of each fiscal year. Patronage dividends
in the amount of $34,705,000 were paid on March 31, 2001 relating to the fiscal
year ended December 31, 2000, approximately thirty percent of which were paid in
cash (TruServ by-laws and the IRS require the payment of at least twenty percent
of patronage dividends be in cash). The remainder was paid through the issuance
of the company's Class B common stock, which is redeemable by the company and
has no voting rights (the "Redeemable Class B common stock") and, in certain
cases, a small portion of the dividend was paid by means of Promissory
(Subordinated) Notes of the company. The Redeemable Class B common stock issued
as part of the December 31, 2000 patronage dividend has been designated as
qualified notices of allocation. Over ninety-five percent of the Redeemable
Class B common stock issued with the fiscal year 2000 patronage dividend was
applied to the loss allocation account. There is no estimated patronage dividend
for the period ended June 30, 2001 and the estimated patronage dividend for the
corresponding period in 2000 was $2,949,000.
NOTE 5 - LOSS ALLOCATION TO MEMBERS
During the third quarter of fiscal year 2000, company 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. The company has allocated the 1999 loss by establishing a loss
allocation account as a contra-equity account in the consolidated balance sheet
with the offsetting credit recorded to retained deficit. The loss allocation
account reflects the sum of each member's proportionate share of the 1999 loss,
after being reduced by certain amounts that are not allocable to members. The
loss allocation account is not a receivable from members and does not represent
an amount currently due from members. Rather, the loss allocation account will
be satisfied, on a member by member basis, by withholding the portion of future
patronage dividends that would have been paid in qualified Redeemable Class B
common stock, at par value, and applying such amount as a reduction in the loss
allocation account until fully satisfied. The current levels of members' stock
investments in the company will not be affected. However, in the event a member
should terminate as a stockholder of the company, 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 the company.
8
NOTE 6 - INVENTORIES
INVENTORIES CONSISTED OF:
JUNE 30, DECEMBER 31,
2001 2000
---- ----
(000'S OMITTED)
Manufacturing inventories:
Raw materials............................... $ 3,040 $ 2,242
Work-in-process and finished goods.......... 29,718 30,705
-------------- --------------
32,758 32,947
Merchandise inventories........................... 384,896 410,716
-------------- --------------
Total....................................... $ 417,654 $ 443,663
============== ==============
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 June 30, 2001 and December 31,
2000 was $26,205,000 and $29,144,000, respectively.
NOTE 7 - RESTRUCTURING CHARGE
In the second quarter of fiscal 2001, the company continued the workforce
reductions initiated in fiscal year 2000 (related to distribution center
closures and workforce reductions at the company's corporate headquarters). The
second quarter corporate headquarters workforce reduction resulted in the
severance of 150 additional employees, all of whom were notified as to the terms
and conditions of their severance and the benefits they would receive.
Additional shutdown costs necessary to exit the distribution centers were also
identified. As a result of the above-described actions, the company recorded a
charge in second quarter of $4.4 million to selling, general and administrative
expenses in the condensed consolidated statement of operations. As a result of
the above described actions, the company expects annual savings of approximately
$11.9 million.
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NOTE 8 - SEGMENT INFORMATION
The company is principally engaged as a wholesaler of hardware and related
products and is a manufacturer of paint products. The company identifies
segments based on management responsibility and the nature of the business
activities of each component of the company. The company 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 JUNE 30, 2001
(000'S OMITTED)
ELIMINATION
OF INTERSEGMENT CONSOLIDATED
HARDWARE PAINT OTHER ITEMS TOTALS
Net sales to external customers $681,838 $ 40,611 $ 25,316 $ - $ 747,765
Intersegment sales - 638 - (638) -
Interest expense 15,663 1,064 175 - 16,902
Depreciation and amortization 10,021 441 182 - 10,644
Segment net margin/(loss) (133) 2,585 121 - 2,573
Expenditures for long-lived assets 3,639 7 131 - 3,777
THIRTEEN WEEKS ENDED JULY 1, 2000
(000'S OMITTED)
ELIMINATION
OF INTERSEGMENT CONSOLIDATED
HARDWARE PAINT OTHER ITEMS TOTALS
Net sales to external customers $1,067,429 $ 41,922 $ 27,911 $ - $ 1,137,262
Intersegment sales - 855 - (855) -
Interest expense 17,284 1,609 248 - 19,141
Depreciation and amortization 10,700 443 198 - 11,341
Segment net margin/(loss) 7,856 3,865 202 - 11,923
Expenditures for long-lived assets 3,012 112 126 - 3,250
TWENTY-SIX WEEKS ENDED JUNE 30, 2001
(000'S OMITTED)
ELIMINATION
OF INTERSEGMENT CONSOLIDATED
HARDWARE PAINT OTHER ITEMS TOTALS
Net sales to external customers $1,281,976 $ 69,060 $ 51,079 $ - $ 1,402,115
Intersegment sales - 1,185 - (1,185) -
Interest expense 29,605 2,343 311 - 32,259
Depreciation and amortization 20,113 878 355 - 21,346
Segment net margin/(loss) (16,796) 5,192 241 - (11,363)
Identifiable segment assets 1,105,937 56,376 25,066 - 1,187,379
Expenditures for long-lived assets 6,553 272 164 - 6,989
TWENTY-SIX WEEKS ENDED JULY 1, 2000
(000'S OMITTED)
ELIMINATION
OF INTERSEGMENT CONSOLIDATED
HARDWARE PAINT OTHER ITEMS TOTALS
Net sales to external customers $2,036,912 $ 73,661 $ 54,294 $ - $ 2,164,867
Intersegment sales - 1,347 - (1,347) -
Interest expense 29,929 3,213 414 - 33,556
Depreciation and amortization 21,379 885 391 - 22,655
Segment net margin/(loss) (3,290) 6,070 219 - 2,999
Identifiable segment assets 1,359,761 73,235 27,818 - 1,460,814
Expenditures for long-lived assets 5,994 446 199 - 6,639
NOTE 9 - ASSET SALE
Effective December 29, 2000, the company sold the assets, primarily inventory,
of the Lumber and Building Material business to Builder Marts of America, Inc.
The Lumber and Building Materials business generated approximately $1.1 billion
of the company's revenue in fiscal year 2000; however, the sale of the business
will not materially impact net margin.
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NOTE 10 - NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2000, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities." These new standards require that
all derivative instruments be recognized as either assets or liabilities in the
balance sheet and measured at their fair value. The new standards also require
changes in the fair value of derivatives to be recorded in each period in
current earnings or comprehensive income, depending on the intended use of the
derivatives. The adoption of these new standards had no impact on the Company's
results of operations, its financial position or its cash flows.
In June 2001, the Financial Accounting Standards Board approved SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 addresses the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
No. 142 requires, among other things, that goodwill and other indefinite-lived
intangible assets no longer be amortized and that such assets be tested for
impairment at least annually. SFAS No. 142 is effective for fiscal years
beginning after December 15, 2001. The Company is currently evaluating the
impact this standard will have on its financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIRTEEN WEEKS ENDED JUNE 30, 2001 COMPARED TO THIRTEEN WEEKS ENDED JULY 1, 2000
RESULTS OF OPERATIONS:
Revenues for the thirteen weeks ended June 30, 2001 totaled $747,765,000. This
represented a decrease of $389,497,000, or 34.2%, compared to the same period
last year. The key contributor to the decreased revenue is the sale of the
lumber and building materials business to Builder Marts of America, Inc. in
December 2000, which accounts for $301,997,000 of the negative variance in
comparison to the prior year. In addition, a reduction in direct shipment sales
contributed approximately $48,400,000 to the decrease in revenue. 62% of this
reduction in direct shipment sales occurred in same store sales, predominately
due to the company's "Connect 4 Profit" initiative to shift shipments from
direct sales to handled sales (stock and relay shipments). The remaining
reduction in direct shipment sales was caused by a decrease in the number of
members participating in the cooperative.
Although revenue declined, gross margins for the thirteen weeks ended June 30,
2001 increased by $492,000, or 0.6%, over the prior year. Gross margin as a
percent of revenue increased to 10.4% from 6.8% for the comparable period last
year. The increase in the gross margin percentage resulted from a change in
sales mix, as the higher margin handled sales are 56% of revenue in 2001
compared to 39% in 2000. The change in sales mix is due to a shift away from
direct shipment sales and the sale of the lumber and building materials
business, which have lower margin percentages.
Logistics and manufacturing expenses increased $2,370,000, or 10.4%, as
compared to the same period last year. The variance is primarily due to
$824,000 of inventory capitalization expense due to declining inventory levels
and approximately $700,000 of product launch costs.
Selling, general and administrative (S,G&A) expenses increased $9,461,000, or
38.9%, as compared to the same period last year. The company's restructuring
initiative accounts for approximately $4,400,000 of the negative variance from
the prior year. The restructuring expense recorded in the second quarter of 2001
relates to staff reductions at corporate headquarters, distribution centers and
field sales positions. The additional negative variance in S,G&A expenses was
due to higher benefit and severance costs.
Interest paid to members decreased by $837,000, or 29.7%, as compared to the
same period last year, primarily due to a lower average principal balance of
debt outstanding. Other interest expense decreased $1,402,000, or 8.6%, as
compared to the same period last year. The interest expense savings from the
lower average principle balance of senior debt outstanding as compared to the
same period last year was partially offset by the interest rate increase of
approximately 2% from the debt covenant violation under the revolving credit
facility and the senior note agreements. The incremental increase in interest
expense for the thirteen weeks ended June 30, 2001 aggregated approximately
$2,400,000 for this rate increase.
Although the company has maintained gross margins on lower sales, net margin was
impacted by the expenses related to the restructuring initiative and the
incremental increase in interest expense due to the debt covenant
11
violation, (see note 2 to the company's condensed consolidated financial
statements) resulting in a net margin of $2,573,000 for the second quarter of
2001 as compared to a net margin of $11,923,000 for the second quarter of 2000.
TWENTY-SIX WEEKS ENDED JUNE 30, 2001 COMPARED TO TWENTY-SIX WEEKS ENDED JULY 1,
2000
RESULTS OF OPERATIONS:
Revenues for the twenty-six weeks ended June 30, 2001 totaled $1,402,115,000.
This represented a decrease of $762,752,000, or 35.2%, compared to the same
period last year. The key contributor to the decrease in revenue is the sale of
the lumber and building materials business to Builder Marts of America, Inc. in
December 2000, which accounts for $608,187,000 of the negative variance in
comparison to the prior year. Revenues were negatively impacted due to the
decrease in the number of members participating in the cooperative, which
accounts for approximately $87,019,000 of the variance to prior year. The
remaining revenue reduction occurred in same store sales, with 82% of this
reduction in direct sales, which generate a lower gross margin for the company.
Gross margins decreased by $11,524,000, or 8.3%, as compared to the same period
last year, but the gross margin as a percent of revenue, increased to 9.1% from
6.4% for the comparable period last year. The increase in the gross margin
percentage resulted from a change in sales mix, as the higher margin handled
sales are 54% of revenue in 2001 compared to 38% in 2000. The change in sales
mix on a year-to-date basis is predominately driven by the sales of the lumber
and building materials business. The sale of the lumber and building materials
business contributed $9,790,000 to the reduction in gross margin.
Logistics and manufacturing expenses decreased $736,000, or 1.6%, as compared to
the same period last year. The reduction in warehouse labor resulting from
reduced sales and inventory levels had a downward impact on expenses.
Selling, general and administrative (S,G&A) expenses increased $4,394,000, or
7.5%, as compared to the same period last year. The company reduced headcount in
corporate staff and operational expenses as a result of the sale of the lumber
and building materials business in December 2000; however, the expenses that
were eliminated did not fully offset the restructuring expenses recorded in the
second quarter of 2001.
Interest paid to members decreased by $1,699,000, or 30.2%, as compared to the
same period last year, primarily due to a lower average principal balance of
debt outstanding. Other interest expense increased $402,000, or 1.4%, as
compared to same period last year. The interest expense savings from the lower
average principle balance of senior debt outstanding did not fully offset the
increase in the interest rate of approximately 2% due to the debt covenant
violation under the revolving credit facility and the senior note agreements.
Although the company has reduced logistics, manufacturing and S,G&A expenses by
consolidating the distribution network and reducing corporate overhead staff,
the expenses that were eliminated did not fully offset the gross margin impact
from the decreased revenue, the restructuring costs and the incremental increase
in interest expense from the debt covenant violation, resulting in a net loss of
$11,363,000 for the twenty-six weeks ended June 30, 2001 as compared to a net
margin of $2,999,000 for the comparable period last year.
LIQUIDITY AND CAPITAL RESOURCES:
Cash provided by operating activities for the twenty-six weeks ended June 30,
2001, was $101,086,000, compared to cash used of $54,313,000 for the twenty-six
weeks ended July 1, 2000. Inventories decreased by $26,009,000 from December 31,
2000 as a result of the company's initiative to improve inventory turns by
reducing inventory. Accounts payable increased by $59,246,000 since December 31,
2000 as a result of the seasonal terms obtained from vendors. The company used
the cash generated from operating activities in the first half of fiscal 2001 to
reduce its outstanding debt balance.
12
Investing activities used cash of $6,163,000 for the twenty-six weeks ended
June 30, 2001, compared to cash generated of $1,095,000 for the same period last
year. The company sold its distribution center located in Westfield,
Massachusetts in the second quarter of fiscal 2000, which generated proceeds of
$6,250,000. The company used $6,989,000 in cash for additions to properties
owned, which is comparable to the same period last year of $6,639,000. These
capital expenditures are comprised of various building improvements and
purchases of additional equipment and technology at the company's regional
distribution centers and at its corporate headquarters.
At June 30, 2001, the company's working capital deficit was ($181,406,000), as
compared to ($188,739,000) at December 31, 2000. The current ratio was 0.824 at
June 30, 2001, as compared to 0.822 at December 31, 2000.
At July 1, 1997, the company established a $300,000,000 five-year revolving
credit facility with a group of banks. These agreements were amended and
restated in April 2000 after a default was triggered as a result of the loss in
1999. The amendments include increased interest rates, new financial ratios and
covenants, and the collateralization of the company's assets. The company had
borrowed under the agreement $115,000,000 and $127,000,000 at June 30, 2001 and
December 31, 2000, respectively. The company also pays a commitment fees of .05%
per annum on the unused portion of the commitments.
Under the senior notes and the revolving credit facility the company is required
to meet certain restrictive financial ratios and covenants relating to minimum
EBITDA, minimum fixed charge coverage, minimum borrowing base to debt ratio,
maximum capital expenditures and maximum asset sales, as well as other customary
covenants, representations and warranties, funding conditions and events of
default. As of December 31, 2000, the company was in compliance with the
covenant requirements.
However, as of February 24, 2001, the company failed to comply with a covenant
under the revolving credit facility and the senior note agreements which
requires the company to achieve a minimum monthly borrowing base ratio. As a
result, either the senior note holders or the participants in the revolving
credit facility could declare this failure to comply with the covenant as an
"event of default," in which case the senior notes and the amounts outstanding
under the revolving credit facility would become callable as immediately
payable.
On March 30, 2001, the participants in the revolving credit facility issued to
the company "reservation of rights" letters under which the participants
effectively stated their intention to not call as immediately payable the
company's outstanding debt obligations until May 1, 2001, although they were not
precluded from doing so. All other rights of the participants were preserved.
Additional letters were issued on April 30, 2001 and July 3, 2001, which
extended the reservation of rights until July 30, 2001 and September 30, 2001,
respectively. The senior note holders also issued letters reserving their right
to accelerate the maturity of the notes although agreeing not to do so at this
time.
The reservation of rights letters provided by the participants in the revolving
credit facility required that the upper limit of the total amount that may be
borrowed under the Credit Agreement at any time prior to September 30, 2001 be
lowered from $275,000,000 to $225,000,000. The credit limit under this facility
was reduced on May 11, 2001 from $275,000,000 to $250,000,000. Additionally, the
interest rate on the amounts outstanding under the revolving credit facility was
increased by approximately 2%; this increased interest rate also applies to the
outstanding senior notes. As a result of this increased interest rate, the
company will incur additional interest expense in fiscal year 2001. If this
increased interest rate continues through December 31, 2001, the additional
interest expense would aggregate approximately $6.0 million.
The company is in discussions with the current lenders and with potential
lenders regarding refinancing the senior note agreements and the revolving
credit facility and, if successful, will replace the current senior note
agreements and the revolving credit facility with an asset-based lending
agreement with a new lending group in the fourth quarter of 2001. An alternative
may be to amend the existing agreements with the existing lenders. However, no
assurances can be given as to the outcome. The company's failure to successfully
refinance or amend its current borrowing arrangements could cause the current
lending group to call as immediately payable the company's currently outstanding
debt obligations. The company's resulting inability to satisfy its debt
obligations would force the company to pursue other alternatives to improve
liquidity, possibly including, among other things, restructuring actions, sales
of assets and seeking additional sources of funds or liquidity. In particular,
13
the company has engaged an investment banking firm to assist it in exploring
the sale of the paint manufacturing business. No assurances can be given that
the company will be successful in pursuing such possible alternatives or, even
if successful, that such undertakings would not have a material adverse impact
on the company.
Accordingly, the balances outstanding under the senior note agreements and the
revolving credit facility have been classified as current liabilities as of
December 31, 2000 and June 30, 2001. However, the financial statements do not
include any other adjustments that might result from the outcome of this
uncertainty.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The company's operations are subject to certain market risks, primarily interest
rate risk and credit risk. Interest rate risk pertains to the company's variable
rate debt, which totals approximately $125,000,000 at June 30, 2001. A 50 basis
point movement in the interest rates would result in an approximate $625,000
annualized change in interest expense and cash flows. For the most part,
interest rate risk is managed through a combination of variable and fixed-rate
debt instruments with varying maturities. Credit risk pertains mostly to the
company's trade receivables. The company extends credit to its members as part
of its day-to-day operations. The company believes that as no specific
receivable or group of receivables comprises a significant percentage of total
trade receivables, its risk with respect to trade receivables is limited.
Additionally, the company believes that its allowance for doubtful accounts is
adequate with respect to member credit risks.
14
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June, 2000, an action was filed against TruServ by 19 former members of the
company in the Circuit Court of the 19th Judicial Circuit (McHenry County,
Illinois). (Certain other former TruServ members have filed similar claims.) The
plaintiffs in the action each allege that, based upon representations made to
them by the company and its predecessors that the Coast to Coast brand name
would be maintained, they voted for the merger of Servistar Coast to Coast and
Cotter & Company. The plaintiffs allege, however, that after the merger the
Coast to Coast brand name was eliminated and that each plaintiff thereafter
terminated or had its membership in TruServ terminated. The plaintiffs further
claim that TruServ breached its obligations by failing to redeem their stock and
by creating loss allocation accounts for the plaintiffs. Based upon this alleged
conduct, the plaintiffs have each asserted claims for fraud/misrepresentation,
negligent misrepresentation, claims under the state securities laws applicable
to each plaintiff, claims under the state franchise/dealership laws applicable
to each plaintiff, breach of fiduciary duty, unjust enrichment, estoppel and
recoupment. The complaint states that each plaintiff is entitled to in excess of
$50,000 in damages; however, the damages being sought are not specified.
Discovery has recently commenced in this action and it is too early to determine
the extent of the damages being claimed. In March, 2001, a similar action was
brought on behalf of former SCC members in the same court, by the same law firm.
The complaint alleges substantially similar cases as those made by the former
TruServ members. The lawsuit is in an early stage and the extent of damages
being claimed has not yet been determined.
In August, 2000, an action was brought in Delaware Chancery Court (New Castle
County) by an alleged former TruServ member against certain present and former
directors of the company and against the company. The plaintiffs in the lawsuit
seek to proceed on a class-action basis. The complaint alleges that the named
directors breached their fiduciary duties in connection with the accounting
adjustments taken by the company in the fourth quarter of 1999 and 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 a moratorium on the redemption of members' TruServ stock and by
imposing minimum annual purchase requirements upon members. The plaintiffs seek
monetary and non-monetary relief in connection with the various claims asserted
in the complaint. The lawsuit is in an early stage and the extent of damages
being claimed has not yet been determined.
In October, 1999, Paul Pentz, the former president of the company, filed a claim
in the Circuit Court of the 20th Judicial Circuit (Collier County, Florida)
against the company alleging he is due bonus and retirement compensation
payments in addition to amounts already paid to him. The company has filed a
counterclaim against Mr. Pentz alleging that he breached his fiduciary duties as
president of the company. Mr. Pentz's motion to dismiss the counterclaim was
denied.
The company intends to vigorously defend all of these cases and, accordingly,
has recorded no related reserves at December 31, 2000 or at June 30, 2001.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In March, 2000, the board of directors of TruServ declared a moratorium on
redemption of the capital stock. In reaching its decision to declare the
moratorium, the board of directors of TruServ reviewed the financial condition
of the company. The board also 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 impact of the 1999
loss were allocated to them. Members did not request redemption would be saddled
with the losses of those members who requested redemption. Moreover, the board
considered the company's debt agreements, and in particular, the financial
covenants thereunder, which prohibit redemptions when the company, among other
things, does not attain certain profit margin.
15
On August 28, 2000, the board of directors of TruServ decided to allocate a
substantial portion of its 1999 operating losses among the TruServ members, on a
pro rata basis, in proportion to each member's ownership of Class B common stock
as of December 31, 1999. A loss allocation account was established for each
member during the third quarter of 2000, reflecting that member's allocated loss
as of December 31, 1999. The loss account will be satisfied by offsetting future
qualified Class B common stock issued as part of the patronage dividend against
the amount in the account. In the event of the dissolution of a member or
termination of his or its membership and upon release of the moratorium, the
redemption proceeds to which that member would have been entitled would also be
offset against the amount of the loss allocated to the member that had not yet
been satisfied.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Under the senior notes and the revolving credit facility the company is required
to meet certain restrictive financial ratios and covenants relating to minimum
EBITDA, minimum fixed charge coverage, minimum borrowing base to debt ratio,
maximum capital expenditures and maximum asset sales, as well as other customary
covenants, representations and warranties, funding conditions and events of
default. As of February 24, 2001, the company failed to comply with a covenant
under the revolving credit facility and the senior note agreements which
requires the company to achieve a minimum monthly borrowing base ratio. As a
result, either the senior note holders or the participants in the revolving
credit facility could declare this failure to comply with the covenant as an
"event of default," in which case the senior notes and the amounts outstanding
under the revolving credit facility would become callable as immediately
payable.
On March 30, 2001, the participants in the revolving credit facility issued to
the company "reservation of rights" letters under which the participants
effectively stated their intention to not call as immediately payable the
company's outstanding debt obligations until May 1, 2001, although they were not
precluded from doing so. All other rights of the participants were preserved.
Additional letters were issued on April 30, 2001 and July 3, 2001, which
extended the reservation of rights until July 30, 2001 and September 30, 2001,
respectively. The senior note holders also issued letters reserving their right
to accelerate the maturity of the notes although agreeing not to do so at this
time.
The reservation of rights letters provided by the participants in the revolving
credit facility required that the upper limit of the total amount that may be
borrowed under the Credit Agreement at any time prior to September 30, 2001 be
lowered from $275,000,000 to $225,000,000. The credit limit under this facility
was reduced on May 11, 2001 from $275,000,000 to $250,000,000. Additionally, the
interest rate on the amounts outstanding under the revolving credit facility was
increased by approximately 2%; this increased interest rate also applies to the
outstanding senior notes. As a result of this increased interest rate, the
company will incur additional interest expense in fiscal year 2001. If this
increased interest rate continues through December 31, 2001, the additional
interest expense would aggregate approximately $6.0 million.
The company is in discussions with the current lenders and with potential
lenders regarding refinancing the senior note agreements and the revolving
credit facility and, if successful, will replace the current senior note
agreements and the revolving credit facility with an asset-based lending
agreement with a new lending group in the fourth quarter of 2001. An alternative
may be to amend the existing agreements with the existing lenders. However, no
assurances can be given as to the outcome. The company's failure to successfully
refinance or amend its current borrowing arrangements could cause the current
lending group to call as immediately payable the company's currently outstanding
debt obligations. The company's resulting inability to satisfy its debt
obligations would force the company to pursue other alternatives to improve
liquidity, possibly including, among other things, restructuring actions, sales
of assets and seeking additional sources of funds or liquidity. In particular,
the company has engaged an investment banking firm to assist it in exploring the
sale of the paint manufacturing business. No assurances can be given that the
company will be successful in pursuing such possible alternatives or, even if
successful, that such undertakings would not have a material adverse impact on
the company.
Accordingly, the balances outstanding under the senior note agreements and the
revolving credit facility have been classified as current liabilities as of
December 31, 2000 and June 30, 2001. However, the financial statements do not
include any other adjustments that might result from the outcome of this
uncertainty.
16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the company's Annual Meeting of Stockholders held on May 6, 2001,
the election results were as follows:
1. Election of directors for a term of one year:
Votes for Votes Withheld
Bryan R. Ableidinger 235,680 16,560
Benjamin J. Andre 235,740 16,500
J.W. Blagg 233,400 18,840
James D. Burnett 234,180 18,060
Harold A. Douthitt 235,740 16,500
Jay B. Feinsod 233,640 18,600
James D. Howenstine 233,280 18,960
Peter G. Kelly 232,200 20,040
Robert J. Ladner 233,040 19,200
George V. Sheffer 233,520 18,720
John M. West, Jr. 233,880 18,360
Barbara B. Wilkerson 233,460 18,780
2. Appointment of PricewaterhouseCoopers LLP as the audit firm of
the company for the Year 2001:
For Against Abstain
--- ------- -------
237,480 6,240 8,520
3. Approval of Proxy authorization to vote on other business:
For Against Abstain
--- ------- -------
213,540 18,540 20,160
ITEM 5. OTHER INFORMATION.
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
1) Current Reports on Form 8-K, filed April 9, 2001, May 3, 2001,
and May 17, 2001.
17
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: August 14, 2001 By /s/ PAMELA FORBES LIEBERMAN
---------------------------
Pamela Forbes Lieberman
Chief Operating Officer,
Chief Financial Officer and
Senior Vice President