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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 2-20910
TRUSERV CORPORATION
(Exact name of Registrant as specified in its charter)
<Table>
DELAWARE 36-2099896
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</Table>
<Table>
8600 WEST BRYN MAWR AVENUE, CHICAGO, ILLINOIS 60631-3505
(Address of principal executive offices) (Zip Code)
</Table>
Registrant's telephone number, including area code: (773) 695-5000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
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 IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K (SEC.229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND
WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE
PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS
FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [X]
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE ACT). YES __. NO X.
STATE THE AGGREGATE MARKET VALUE OF THE VOTING AND NON-VOTING COMMON EQUITY
HELD BY NON-AFFILIATES COMPUTED BY REFERENCE TO THE PRICE AT WHICH THE COMMON
EQUITY WAS LAST SOLD, OR THE AVERAGE BID AND ASKED PRICE OF SUCH COMMON EQUITY,
AS OF THE LAST BUSINESS DAY OF THE REGISTRANT'S MOST RECENTLY COMPLETED SECOND
FISCAL QUARTER.
There is no public market for Registrant's Class A and Class B common
stock. The Registrant's Class A common stock is offered by the Registrant in
units of 60 shares each, exclusively to retailers of hardware and related
merchandise, in connection with their becoming members of the Registrant. The
Class B common stock is issued as part of the patronage dividend to members of
the Registrant. The terms of the Class A and Class B common stock limit its
transferability. The Class B common has no voting rights.
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE.
<Table>
<Caption>
Outstanding at
February 22, 2003
Class -----------------
Class A common stock, $100 Par Value................ 475,020
Class B common stock, $100 Par Value................ 1,756,457
</Table>
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TABLE OF CONTENTS
<Table>
<Caption>
PAGE
PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 13
Item 3. Legal Proceedings........................................... 15
Item 4. Submission of Matters to a Vote of Security Holders......... 18
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 18
Item 6. Selected Financial Data..................................... 19
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 35
Item 8. Financial Statements and Supplementary Data................. 36
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 36
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 36
Item 11. Executive Compensation...................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
Item 13. Certain Relationships and Related Transactions.............. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 44
</Table>
PART I
THIS ANNUAL REPORT AND THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE
CONTAIN FORWARD-LOOKING STATEMENTS THAT ARE BASED ON MANAGEMENT'S EXPECTATIONS,
ESTIMATES AND ASSUMPTIONS. THE FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO
THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. THESE STATEMENTS ARE NOT GUARANTIES OF FUTURE PERFORMANCE AND INVOLVE
CERTAIN RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT. THEREFORE, ACTUAL
FUTURE RESULTS AND TRENDS MAY DIFFER MATERIALLY FROM WHAT WE FORECAST DUE TO A
VARIETY OF FACTORS, INCLUDING WITHOUT LIMITATION, OUR ASSUMPTIONS ABOUT
FINANCING REQUIREMENTS AND TERMS, INTEREST RATE FUNCTIONS, CAPITAL REQUIREMENTS
OF TRUSERV AND TRENDS IN OUR INDUSTRY.
ITEM 1. BUSINESS.
($ IN THOUSANDS -- EXCEPT PER SHARE INFORMATION)
THE COMPANY
TruServ Corporation was organized as Cotter & Company, a Delaware
corporation, in 1953. Upon its organization, it succeeded to the business of
Cotter & Company, an Illinois corporation organized in 1948. On July 1, 1997,
Cotter & Company merged with ServiStar Coast to Coast Corporation ("SCC"). SCC
was a hardware wholesaler incorporated in 1935, under the name American Hardware
Supply Company, with a strong presence in retail lumber and building materials.
Following the merger, Cotter & Company was renamed TruServ Corporation.
TruServ's main executive offices are located at 8600 West Bryn Mawr Avenue,
Chicago, Illinois 60631-3505. Its main telephone number is (773) 695-5000. Its
web page address is www.truserv.com.
The merger united two similar organizations under the name of TruServ
Corporation, creating one of the largest hardware/home center cooperatives in
the United States. The goals were to: (i) lower pricing for the members by
increasing buying power, (ii) increase potential for rebates by combining vendor
purchases, and (iii) better leverage operating expenses by consolidating
distribution centers and reducing duplicate corporate overhead costs.
In fiscal year 2000, TruServ sold its lumber and building materials
business, consisting primarily of intangibles and inventory, to Builder Marts of
America, Inc. ("BMA"). TruServ concluded that BMA would be able to provide
lumber and building materials to TruServ members at lower cost. The lumber and
building materials business had been a low-margin business for TruServ. In
connection with the sale of the lumber and building materials business to BMA,
TruServ entered into non-compete, cooperation, trademark license and lease
agreements with BMA. The terms of these agreements range from two to ten years.
In fiscal year 2001, TruServ sold its ownership interest in TruServ Canada
Cooperative, Inc. along with the headquarters and warehouse building and other
parcels of real estate in Winnipeg, Manitoba to the current member group of the
cooperative. The proceeds received enabled TruServ to recover its capital
investment in the Canadian cooperative as well as the appraised value of the
real estate and to retire all indebtedness relating to Canadian activities. In
connection with the transaction, TruServ revised and extended a license
agreement with the Canadian cooperative to enable it and its members to continue
to do business under the principal TruServ trademarks. In addition, TruServ
continues to provide True Value paints and supplies to the Canadian cooperative.
On December 31, 2002, TruServ completed a sale leaseback transaction of
seven of its distribution centers. The sale generated net proceeds of $121,438,
which were used to pay down the revolving credit facility, senior notes and
synthetic lease obligation (the "Senior Debt"), all of whom are parties to the
intercreditor agreement. The net reduction in Senior Debt was $108,743, as a
result of new make-whole notes of $12,695 issued due to the prepayment on senior
notes. The facilities are being leased back by TruServ under three 20-year lease
agreements that each contain, at TruServ's option, two extension periods on the
lease. See "Properties -- Sale Leaseback Transaction." The proceeds from the
sale will help TruServ reduce outstanding Senior Debt less make-whole notes to
below $270,000 at June 30, 2003. See "Business -- Financing Agreements" below.
1
GENERAL DESCRIPTION OF THE BUSINESS
TruServ, organized as a cooperative, is one of the largest member-owned
wholesalers of hardware and related merchandise in the United States, serving
approximately 6,600 retail and industrial distribution outlets for its members
as of December 31, 2002. TruServ also manufactures and sells paint and paint
applicators.
TruServ sells its products to hardware retailers, industrial distributors
and rental retailers who have entered into retail member agreements with it.
TruServ serves its members by principally functioning as a low cost distributor
of goods and maximizing its volume purchasing abilities, primarily through
vendor rebates and discount programs, for the benefit of its members. These
benefits are passed along to its members in the form of lower prices and/or
patronage dividends. TruServ also provides to its members value-added services
such as marketing, advertising, merchandising, and store location and design
services.
Generally, members are entitled to use one of certain TruServ trademarks
and trade names, including the federally registered True Value(R), Grand Rental
Station(R), Taylor Rental(R), Party Central(R), Home & Garden Showplace(R) and
Induserve Supply(R) trademarks, service marks and collective membership marks.
See "Trademarks, Service Marks and Collective Membership Marks" below. Members
have access to certain TruServ private label products and when there are annual
profits they are entitled to receive annual patronage dividends based upon their
purchases from TruServ. In accordance with TruServ's By-Laws and the Retail
Member Agreements, the annual patronage dividend is paid to members out of the
gross margins from operations and other patronage source income, after deduction
for expenses, reserves and other provisions as may be authorized by the board of
directors. See "Distribution of Patronage Dividends" below.
As of December 31, 2002, TruServ serves approximately 6,600 retail and
industrial distribution outlets for its members throughout the United States and
in 51 other countries. Primary concentrations of members exist in New York
(approximately 9%), Pennsylvania (approximately 7%), California and Texas
(approximately 5% each), Illinois, Michigan and New Jersey (approximately 4%
each) and Massachusetts, Minnesota, Ohio, Washington and Wisconsin
(approximately 3% each).
SALES AND SUPPLIERS
TruServ provides each of its members with an illustrated price catalog
showing the products available from TruServ, which the members can access
through the member Internet site. Upon request, a member will also receive a
printed version of the catalog. These products, comprised of more than 62,000
stockkeeping units ("SKUs") maintained at TruServ's distribution centers, are
divided into seven categories of merchandise. In addition to purchasing products
which are maintained at the distribution centers, members can purchase
additional SKUs directly from TruServ approved vendors and have those purchases
drop shipped directly to them, but have the product billed through TruServ.
Collectively, these products represent the products sold by TruServ's two
operating segments in 2002 and three operating segments in 2001 and 2000. See
Note 11, "Segment Information" to the Consolidated Financial Statements
beginning at page F-1 for additional segment information.
2
The seven product categories (eight product categories through early 2001)
are set forth in the following table, along with the corresponding dollars of
total revenues for each category during the last three fiscal years:
<Table>
<Caption>
FOR THE FISCAL YEARS ENDED
DECEMBER 31,
------------------------------------
2002 2001(2) 2000(2)
---------- ---------- ----------
($ IN THOUSANDS)
Hardware goods....................... $ 521,450 $ 608,903 $ 682,909
Farm and garden...................... 443,062 514,233 579,375
Electrical and plumbing.............. 385,853 441,259 496,828
Painting and cleaning................ 331,029 379,394 400,386
Appliances and housewares............ 247,786 285,855 322,623
Sporting goods and toys.............. 125,555 148,764 180,372
Other................................ 120,716 219,604 246,047
Lumber and building materials(1)..... -- 21,422 1,085,102
---------- ---------- ----------
$2,175,451 $2,619,434 $3,993,642
========== ========== ==========
</Table>
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(1) The lumber business was sold on December 29, 2000. The revenue and cost of
revenue from merchandise shipped and billed in fiscal year 2001, but
negotiated prior to December 29, 2000, was recorded in TruServ's results of
operations in fiscal year 2001.
(2) The Canadian business was sold on October 22, 2001. Total sales from
Canadian operations were $84,397 in 2001 and $109,009 in 2000 and such sales
are reflected in the above amounts for each of the eight categories.
TruServ's merchandise sales to its members are divided into three logistics
categories, as follows:
- warehouse shipment sales (approximately 65%, 63% and 41% of total sales
for fiscal 2002, 2001 and 2000, respectively);
- direct shipment sales (approximately 31%, 33% and 56% of total sales for
fiscal 2002, 2001 and 2000, respectively); and
- relay shipment sales (approximately 4%, 4%, and 3% of total sales for
fiscal 2002, 2001 and 2000, respectively).
The change in the mix between the three logistic categories is
predominately due to the lumber business that was sold on December 29, 2000. All
lumber business sales were generated through the direct shipment logistic
category. Excluding lumber business transactions in 2000, the mix of sales would
have been 60% warehouse shipment, 36% direct shipment and 4% relay shipment.
Warehouse shipment sales are sales of products that are purchased,
warehoused and resold by TruServ in response to orders from the members. Direct
shipment sales are sales of products that are purchased through TruServ by the
members but delivered directly to members from vendors and TruServ accepts the
credit risk. Relay sales are sales of products that are purchased through
TruServ in response to the requests of several members for a product that
typically is:
- to be included in future promotions,
- seasonal in nature,
- not normally held in inventory, and
- not conducive to direct shipment.
Generally, TruServ will give notice to all members of its intention to
purchase products for relay shipment and will then purchase only as many items
as the members order. When the product shipment arrives at TruServ, it is not
warehoused; rather, TruServ breaks up the shipment and "relays" the appropriate
quantities to the members who placed orders.
3
TruServ has numerous individual agreements with or commitments from its
vendors, most of which are terminable by the vendors or TruServ without cause.
These termination provisions, either individually or in the aggregate, have not
had any material adverse effect on TruServ's ability to conduct its business.
The goods and services purchased by TruServ from these suppliers are generally
available from a wide variety of sources. TruServ is not dependent upon any one
supplier or group of suppliers.
TruServ also manufactures and sells paint and paint applicators. The
principal raw materials used by TruServ in its paint manufacturing activities
are chemicals. All raw materials are purchased from outside sources. In the
past, TruServ has been able to obtain adequate sources of raw materials and
other items used in production. TruServ does not currently anticipate shortages
of materials that would materially impact its paint manufacturing operations.
OTHER SERVICES
TruServ annually sponsors two "markets", funded in part by vendors through
booth fees, at which it features the products available for purchase by members,
including new merchandise and seasonal items. The markets permit members and
prospective members to keep better informed as to industry trends and the
availability of merchandise including new and seasonal products. In the year
2003, one of the markets will be held in Atlanta, Georgia, and the other will be
held in Las Vegas, Nevada. As the markets generate income and stimulate member
purchases, the timing of markets impact the timing of sales and income
recognition for TruServ. All members are invited to the markets and attending
members generally place substantial orders for delivery of merchandise during
the period between markets.
BACKLOG
As of February 22, 2003 and February 23, 2002, respectively, TruServ had a
backlog of firm orders (including relay orders) of approximately $10,764 and
$56,177. TruServ's backlog at any given time is made up of two principal
components:
- normal resupply orders; and
- market orders for future delivery.
Resupply orders are orders from members for merchandise to keep inventories
at normal levels. Generally, such orders are filled the day following receipt,
except that relay orders are for future delivery. Relay orders for future
delivery are not intended to be filled for several months. Market orders for
future delivery are member orders placed at one of TruServ's two markets for new
or seasonal merchandise, to be delivered during the subsequent period between
markets. Thus, TruServ generally has a relatively high backlog at the end of
each market, which decreases in subsequent months until the next market occurs.
The substantial decrease in backlog orders in 2003 relative to 2002 is due to
the timing of the markets held in those two periods. In 2002, the spring market
was held in early February but in 2003 it will not be held until late April.
COMPETITION
The retail hardware industry is characterized by intense competition.
Independent retail hardware businesses, including those served by TruServ, face
intense competition from chain stores, discount stores, home centers and
warehouse operations such as Wal-Mart, Home Depot, Menards, Sears and Lowe's.
Increased operating expenses for the retail stores, including increased costs
due to longer store hours and higher retail occupancy costs, have cut into
operating margins for members and brought pressure on TruServ to achieve lower
merchandise costs for its members. In response, TruServ works with its members
to drive profitability through operational improvement programs such as AIM
(advanced inventory management) which focuses on assortments of fast turning
products as well as retail programs which focus on areas such as pricing,
merchandising, store design and signage. In addition, TruServ has introduced
wholesale pricing strategies, Priced 2 Win(TM) and Connect 4 Profit(R), which
are designed to improve retail competitiveness. The trueAdvantage(R) program was
introduced in 1995 and was subsequently upgraded to promote higher retail
4
standards in order to build consumer goodwill and create a positive image for
all member retail outlets. In 2002, TruServ changed the program to Store of
First Choice(R) to focus on incentivizing members to adopt retail best
practices.
Competitive conditions in the wholesale hardware industry are similarly
intense and increasing, particularly as a result of the intense pressure on
hardware retailers to obtain low-cost wholesale supply sources for merchandise
acquisition. TruServ competes with other member-owned and non-member-owned
wholesalers as a source of supply and merchandising support for independent
retailers. Competitive factors considered by independent retailers in choosing a
source of supply include pricing, servicing capabilities, promotional support
and merchandise selection, quality and patronage dividends. TruServ is
concentrating on its supply channel strategies and practices for gaining
sustainable competitive advantage. In several markets in the United States,
TruServ competes directly with other member-owned wholesalers such as Ace
Hardware Corporation and Do-it-Best Corporation.
TRADEMARKS, SERVICE MARKS AND COLLECTIVE MEMBERSHIP MARKS
TruServ's trademarks, service marks and collective membership marks are of
prime importance to TruServ. Many of the marks are highly recognized and
utilized in extensive advertising and marketing campaigns, and TruServ
vigorously defends its marks. As of December 31, 2002, TruServ's members have
approximately 6,600 retail and industrial distribution outlets that operate
predominately as retail hardware stores, rental facilities, horticulture outlets
as well as commercial and industrial distributors, throughout the United States
and in 51 countries, most of which sell merchandise and services under the
marks.
The marks include the True Value(R) marks, the ServiStar(R) mark, the Coast
to Coast(R) mark, the Induserve Supply(R) mark, the Party Central(R) mark, the
Grand Rental Station(R) mark, the Taylor Rental(R) mark, the Home & Garden
Showplace(R) mark and the Commercial Sales(R) mark. The marks also include E-Z
Kare(R), Weatherall(R), and Easy Color(R) for paint. All of the marks are
currently used in commerce and TruServ intends to use the marks in commerce in
the future. Each of the marks is renewable at TruServ's option and TruServ
intends to renew them upon expiration. Members have continued to conduct their
businesses under the same retail banners as before the merger of Cotter and SCC;
however, beginning in year 2000, many members with the retail banners of Coast
to Coast(R) and ServiStar(R) started to conduct their business under the single
retail banner of True Value(R). TruServ's marks also include Help is Just Around
the Corner(R), Christmas is Just Around the Corner(R) and Summer is Just Around
the Corner(R).
EMPLOYEES
As of December 31, 2002, TruServ employed approximately 3,200 persons in
the United States on a full-time basis. Due to the widespread geographical
distribution of TruServ's operations, employee relations are governed by the
practices prevailing in the particular area where the employees are located and
are generally implemented locally. Approximately 43% of TruServ's 2,400
hourly-wage employees are covered by collective bargaining agreements that are
generally effective for periods of three or four years. In general, TruServ
considers its relationship with its employees to be good.
FINANCING AGREEMENTS
On December 30, 2002, TruServ amended the Senior Debt agreements that had
previously been amended in April 2002 in order to allow for a sale leaseback
transaction that was completed on December 31, 2002 (the "December 2002
Amendments"). TruServ applied the net proceeds of the sale leaseback
transaction, $121,438, to pay down the Senior Debt, all of whom are parties to
the intercreditor agreement. The net reduction in Senior Debt was $108,743, as a
result of new make-whole notes of $12,695 issued due to the prepayment of senior
notes. The December 2002 Amendments mainly set preliminary financial covenants
to allow for the substantial reduction in debt and the corresponding increase in
rent payments resulting from the sale leaseback transaction. On March 13, 2003,
TruServ amended the Senior Debt agreements that had previously been amended on
December 30, 2002 (the "March 2003 Amendments"). The March 2003 Amendments
primarily finalized the financial covenants resulting from the sale leaseback
transaction and
5
extended the maturity date of the Hagerstown facility's synthetic lease
obligation to the earlier of December 31, 2003 or a refinancing of the revolving
credit facility. See Note 5, "Lease Commitments" and Note 16, "Subsequent
Events" to the Consolidated Financial Statements beginning at page F-1.
The Senior Debt agreements were previously amended on April 11, 2002 when
TruServ entered into various amendments that eliminated the event of default
created when TruServ failed to comply with a covenant as of February 24, 2001
(the "April 2002 Amendments"). The April 2002 Amendments to the revolving credit
facility extended the term of the facility from June 2002 to June 2004. The
amount of the commitment at the time of amendment was $200,000. The commitment
under the revolving credit facility is permanently reduced by the amount of any
prepayments allocated to and paid on the revolving credit facility.
Borrowings under the revolving credit facility are subject to borrowing
base limitations that fluctuate in part with the seasonality of the business.
The borrowing base formula limits advances to the sum of 85% of eligible
accounts receivable, 50% of eligible inventory, 60% of the appraised value of
eligible real estate and 50% of the appraised value of eligible machinery and
equipment; availability is further increased by seasonal over-advances and
decreased by reserves against availability. The revolving credit facility has
certain minimum unusable commitment amounts, which vary based upon the projected
seasonal working capital needs of TruServ. The interest rate on the revolving
credit facility was increased to the prime rate plus 3.25% resulting in a rate
of 7.5% as of December 31, 2002. The unused commitment fee is 0.75% per annum.
Since the April 2002 Amendments, the revolving credit facility commitment
has been permanently reduced to $143,200 at December 31, 2002 due to prepayments
in 2002 from the proceeds of asset sales. TruServ had available, under the
revolving credit facility, approximately $115,300 at December 31, 2002.
The April 2002 Amendments to the various senior note agreements maintained
the existing debt amortization schedules of the various notes. Interest rates on
the notes are at the pre-default rates, which ranged at December 31, 2002 from
10.04% to 11.85%. The senior notes and revolving credit facility amendments also
require initial, quarterly and annual maintenance fees. All of the cash proceeds
from certain asset sales and certain notes receivable, and 80% of any excess
cash flow, as defined in the amended senior notes and revolving credit facility
agreements, are to be used to prepay all parties to these amendments in
accordance with an amended intercreditor agreement.
For 2002, cash proceeds from certain asset sales and notes receivable
totaling $157,312 were used to prepay all parties to the intercreditor
agreement. No additional payment as a result of excess cash flow is required to
be made at this time. The intercreditor agreement establishes how the assets of
TruServ, which are pledged as collateral, are shared and how certain debt
prepayments are allocated among the senior lenders. For the year ended December
31, 2002, the prepayments to senior note holders of $93,915 resulted in
make-whole liabilities of $18,710, which are recorded as additional debt with an
offsetting entry to a prepaid interest account. As previously described, the
$12,695 of make-whole notes from the sale leaseback transaction, is a component
of the $18,710. The prepaid interest account will be amortized to interest
expense over the remaining life of the original notes.
The terms of the senior note agreements, that comprise a portion of the
Senior Debt, have always provided that in the event of early termination or a
prepayment of all or a portion of the notes, make-whole liabilities are
triggered. The nature of the transaction giving rise to the prepayment, the
length of time to maturity of a particular note, the magnitude of the prepayment
relative to the remaining debt outstanding and prevailing market interest rates
relative to the interest rates on the senior notes are factors in determining
the amount of potential make-whole liabilities. In the event of full prepayment
of the senior notes, the entire prepaid interest amount will be immediately
charged to interest expense. Management currently intends to pursue a
refinancing of the existing Senior Debt in the first half of 2004. Management
anticipates significantly lower interest rates upon refinancing. However, based
upon current market interest rates, make-whole expense of a refinancing, before
considering the impact of any negotiations with the senior note holders, could
range up to approximately $27,000, in addition to fully expensing the remaining
prepaid balance of existing make-whole, which was $17,864 at December 31, 2002.
TruServ management negotiated a reduction of approximately 50% in the make-whole
notes when it made prepayments on the senior notes from the proceeds of the sale
leaseback transaction.
6
The April 2002 Amendments all require TruServ to meet certain restrictive
covenants relating to minimum sales, minimum adjusted EBITDA (earnings before
interest, taxes, depreciation and amortization), minimum fixed charge coverage,
minimum interest coverage and maximum capital expenditures. The senior note
holders may accelerate the due date of their notes, if TruServ does not have a
revolving credit facility in place to fund its seasonal cash flows. As described
above, some of these covenants were adjusted in March 2003, as a result of the
sale leaseback transaction. TruServ was in compliance with all of these
covenants as of December 31, 2002 as shown in the chart below:
<Table>
<Caption>
RESTRICTIVE COVENANT COVENANT ACTUAL
- -------------------- ---------- ----------
($ IN THOUSANDS)
Minimum sales............................................... $1,975,000 $2,175,451
Minimum adjusted EBITDA..................................... $ 100,000 $ 120,062
Minimum fixed charge coverage............................... 0.70 1.01
Minimum interest coverage................................... 1.75 1.97
Maximum capital expenditures................................ $ 16,000 $ 12,838
</Table>
TruServ believes it will continue to remain in compliance with its debt
covenants. For fiscal 2003, TruServ believes operating results will be
sufficient to comply with the covenants established in the March 2003
Amendments.
The term of the revolving credit facility will accelerate to June 30, 2003
from June 30, 2004, if on that date, total Senior Debt outstanding less the
aggregate principal amount of the make-whole notes is in excess of $270,000, or
total Senior Debt outstanding less the aggregate principal amount of the
make-whole notes, plus the unused amount of the commitment under the revolving
credit facility, less $30,000, is in excess of $320,000. At December 31, 2002,
the total Senior Debt outstanding less the aggregate principal amount of the
make-whole notes was $167,965 and the related commitments outstanding less
$30,000 totaled $253,323. Although the revolver portion of total Senior Debt
outstanding can fluctuate with the seasonal cash flow requirements of the
business, TruServ believes it will maintain a sufficiently low level of Senior
Debt outstanding with cash from operating activities to meet the June 30, 2003
requirement.
The April 2002 Amendments limit the amount of the cash portion of patronage
dividends to the 20% minimum required to be paid under applicable IRS
regulations in order for TruServ to maintain its status as a cooperative, unless
TruServ's operating performance achieves certain EBITDA targets, in which case,
up to 30% of the patronage dividend may be paid in cash. TruServ exceeded the
EBITDA target for 2002 and, as such, the cash portion of the 2002 patronage
dividend paid in 2003 averaged 30%.
The April 2002 Amendments also require the continuation of the stock
redemption moratorium through June 30, 2004. Further, it is an event of default
under the April 2002 Amendments to exceed certain levels of subordinated note
payments. TruServ did not exceed the maximum payment level of $24,000 in 2002
and, accordingly, was in compliance. In addition, an event of default arises
under the April 2002 Amendments in the event that TruServ fails to comply with
its corporate governance policy requiring the retention by TruServ of at least
two outside directors prior to May 31, 2002, at least four outside directors
prior to September 1, 2002 and at least five outside directors prior to November
1, 2002. As of October 7, 2002, TruServ appointed its fifth outside director
and, as such, TruServ was in compliance with the corporate governance covenant
as of December 31, 2002.
The April 2002 Amendments also contain requirements for other customary
covenants, representations and warranties, funding conditions and events of
default. As of December 31, 2002, and as of the filing date of this Annual
Report on Form 10-K, TruServ was in compliance with all applicable covenants and
has not triggered any events of default.
7
RETAIL MEMBER AGREEMENT
The TruServ Retail Member Agreement provides, among other things, that each
member:
(1) will be required to purchase 60 shares of Class A common stock at
a purchase price of $100 per share for each store owned by the member, up
to a maximum of 300 shares for five or more stores that are owned by a
member;
(2) will conduct its businesses subject to the terms of the Retail
Member Agreement;
(3) will conduct a retail hardware store, home or garden center, or a
full-service rental operation at a designated location;
(4) will comply with TruServ's By-Laws, as may be amended from time to
time;
(5) will accept patronage dividends in a form complying with the
requirements of the Internal Revenue Code for deduction from gross income
by TruServ;
(6) may receive different services or charges based upon the amount of
merchandise purchased by the member;
(7) agrees to have its Retail Member Agreement terminated in certain
circumstances by unilateral action by TruServ's board of directors;
(8) agrees to have its Retail Member Agreement automatically modified
upon notice from TruServ to the member of any relevant change in the
Certificate of Incorporation and/or By-Laws of TruServ, or by resolution of
the board of directors;
(9) agrees to utilize TruServ as its primary supplier for the types of
merchandise offered by TruServ;
(10) agrees to have its Retail Member Agreement governed by Illinois
law, enforced only in courts located in Cook County, Illinois or any
Illinois county contiguous to Cook County and only interpreted in
accordance with the substantive laws of Illinois without giving effect to
its conflict of laws principles; and
(11) may terminate the Retail Member Agreement upon 60 days written
notice mailed to any executive officer of TruServ at TruServ's principal
office.
CAPITAL STOCK
In general, members of TruServ own shares of Class A and Class B common
stock. Each of the two classes of stock has a par value of $100 per share. The
Class A common stock is sold in units of 60 shares. Each TruServ member is
required to purchase one unit of Class A common stock for each store owned;
however, no TruServ member is permitted to acquire more than five units of Class
A common stock. The Class B common stock is issued only to holders of the Class
A common stock in connection with the patronage dividend distributed to the
members for purchases in the year of the patronage dividend, as discussed below.
See "Distribution of Patronage Dividends" below.
Neither class of TruServ common stock accrues dividends and each has
limited transferability, by virtue of TruServ's right of first refusal to
repurchase at par value a member's stock before it can be transferred.
Historically, TruServ has always exercised this right. TruServ also retains an
automatic lien on both classes of stock for any indebtedness due to TruServ by a
member. There is no existing market for either class of TruServ common stock.
Participation in the earnings of a cooperative is based on member patronage
purchasing and reflected by the payment of patronage dividends. In general,
these patronage dividends are based on a member's purchasing volume and margins
applicable to merchandise or services purchased by the member, less any expenses
related to such business and less certain cooperative reserves. Patronage
dividends are determined on a yearly basis for purchasing activity conducted the
prior year, and are allocated no later than the 15th day of the ninth month
following the end of the calendar year. TruServ has been paying patronage
dividends in a
8
combination of cash and Class B common stock. As TruServ reported a net loss for
2001, there was no patronage dividend payable in 2002 related to 2001 results.
As TruServ reported a net margin for 2002, there was a patronage dividend paid
in 2003 related to 2002 results. Such dividend was a combination of cash, Class
B common stock and loss allocation account reduction (for members with such an
account). See "Allocation of Patronage Dividends against Loss Allocation
Account" below.
MORATORIUM ON REDEMPTIONS OF CAPITAL STOCK
In March 2000, the board of directors of TruServ declared a moratorium on
redemptions of the capital stock. In reaching its decision to declare the
moratorium, the board of directors of TruServ reviewed the financial condition
of TruServ and considered its fiduciary obligations and corporate law principles
under Delaware law. The board of directors concluded that it should not redeem
any of the capital stock while its net asset value was substantially less than
par value, as that would likely violate legal prohibitions against "impairment
of capital." In addition, the board of directors concluded that it would be a
violation of its fiduciary duties to all members and that it would constitute a
fundamental unfairness to members if some members were allowed to have their
shares redeemed before the 1999 loss was allocated to them and members who did
not request redemption were saddled with the losses of those members who
requested redemption. Moreover, the board of directors considered TruServ's debt
agreements and, in particular, the financial covenants thereunder, which
prohibit redemptions when TruServ, among other things, does not attain certain
profit margins.
At the time the board of directors declared the moratorium on redemptions,
TruServ's By-Laws did not impose limitations on the board's discretion to
initiate or to continue a moratorium on redemption. The By-Laws merely provided
that, upon termination of a member's agreement, TruServ was to redeem the
member's shares. Nevertheless, the board of directors concluded that its
fiduciary obligations to TruServ and its members would not permit it to effect
redemptions under the circumstances described above. After the board of
directors declared the moratorium, the board of directors amended the By-Laws to
provide that if TruServ's funds available for redemption are insufficient to pay
all or part of the redemption price of shares of capital stock presented for
redemption, the board of directors may, in its sole discretion, delay the
payment of all or part of the redemption price.
The amended debt agreements preclude the lifting of the stock moratorium
until June 30, 2004 except for certain hardship cases, not to exceed $2,000
annually. Given certain ongoing related litigation (see "Legal Proceedings"),
there are no plans for hardship redemption of stock. Subsequent to the
expiration of the prohibition against stock redemptions under the debt
agreements, which could be in the first half of 2004, if TruServ completes the
refinancing of its Senior Debt, the board of directors will consider the
financial condition of TruServ, and will not lift the moratorium unless it can
conclude that effecting redemptions of TruServ's capital stock will not "impair
the capital" of TruServ, unfairly advantage some members to the disadvantage of
others, or violate the financial covenants under its debt agreements. The board
of directors is monitoring the financial performance of TruServ quarterly.
As of December 31, 2002, the amount of Class A common stock and Class B
common stock presented for redemption but deferred due to the moratorium is
approximately $39,614 after the offset of the loss allocation account. This
amount does not include an offset of approximately $7,343 of accounts receivable
owed by terminated members to the co-op. Historically, TruServ has offset such
amounts due by members to the co-op against amounts the co-op pays the members
on redemption of their stock. This amount does not include any remaining amount
of the 2001 loss that may be allocated, on a member by member basis, from the
accumulated deficit account and reduce the amount paid to a member on the
redemption of their stock. The $39,614 amount of stock presented for redemption,
but deferred due to the moratorium, includes approximately $15,475 related to
the Class A common stock (which was historically paid out at the time of
redemption) and $47,033 related to Class B common stock (which was historically
paid out in five equal annual installments), offset by the amount of the loss
allocation account related to the Class B common stock of $22,894.
9
DISTRIBUTION OF PATRONAGE DIVIDENDS
TruServ operates on a cooperative basis with respect to business transacted
with or for members. All members are entitled to receive patronage dividend
distributions from TruServ, calculated on the basis of gross margins of
merchandise and/or services purchased by each member. In accordance with
TruServ's By-Laws and Retail Member Agreement, the annual patronage dividend, as
authorized by the board of directors, is paid to members out of patronage source
income, less certain deductions, calculated as provided in the following
sentence. The total patronage dividend paid to members is based on pre-tax net
earnings calculated in accordance with accounting principles generally accepted
in the United States of America after reducing or increasing net earnings for
non-member income/(losses), reasonable reserves and deferred patronage
amortization. The total dividend is allocated to each purchase category, with
the main purchase categories being warehouse, relay, direct shipment and paint.
Once the patronage dividend is allocated to the purchase categories, it is
distributed to members based on the relative gross margin participation of the
member for each type of purchase category.
Patronage dividends are usually paid to members within 90 days after the
close of TruServ's fiscal year; however, the Internal Revenue Code (the "Code")
permits distribution of patronage dividends as late as the 15th day of the ninth
month after the close of TruServ's fiscal year, and TruServ may elect to
distribute the annual patronage dividend at a later time than usual in
accordance with the provisions of the Code.
TruServ's By-Laws provide for the payment of annual patronage dividends,
after payment of at least 20% of such patronage dividends in cash, in "qualified
written notices of allocation" including:
- Class B common stock based on its par value, up to a maximum of 2% of the
member's net purchases of merchandise from TruServ for the year (except
in unusual circumstances of individual hardship, in which case the board
of directors reserves the right to make payments in cash),
- promissory (subordinated) notes, or
- other property.
Promissory (subordinated) notes are for a five year term and bear interest
at a rate fixed from time to time by the board of directors. The notes are
subordinated to all other debt of TruServ. TruServ may also issue "nonqualified
written notices of allocation" to its members as part of its annual patronage
dividend. "Non-qualified written notices of allocation" are usually issued in
the form of Class B common stock. See "Payment of Patronage Dividends in
Accordance with the Internal Revenue Code" below.
In determining the form of the annual patronage dividend, a member's
required investment in Class B common stock of TruServ had historically been
limited by the board of directors to a certain amount, the cumulative value of
which would not exceed two percent (2%) of the member's net purchases of
merchandise and services from TruServ. Commencing in 1996, the board established
a minimum Class B common stock ownership requirement, which may be varied from
time to time. However, not all members have achieved the minimum target. This
minimum is calculated as the aggregate of a member's various types of annual
purchases multiplied by a specific percentage, which varies from 1% to 14%,
decreasing as total dollar purchases by category increase. The amount of the
required investment is determined by majority vote of the board of directors,
and may be increased or decreased from time to time. The necessity of an
increase or decrease is determined through an evaluation of the financial needs
of TruServ and the needs of its membership.
ALLOCATION OF PATRONAGE DIVIDENDS AGAINST LOSS ALLOCATION ACCOUNT
During the third quarter of fiscal 2000, TruServ management developed and
the board of directors approved a plan to equitably allocate to members the loss
incurred in 1999. This loss was previously recorded as a reduction of retained
earnings. TruServ has allocated the 1999 loss among its members by establishing
a loss allocation account as a contra-equity account in the consolidated balance
sheet with the offsetting credit recorded to the accumulated deficit account.
The loss allocation account reflects the sum of each member's proportionate
share of the 1999 loss, after being reduced by certain amounts that were not
allocated to
10
members. The loss allocation account will be satisfied, on a member by member
basis, by applying the portion of future non-cash patronage dividends as a
reduction to the loss allocation account until fully satisfied. The loss
allocation amount 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. See related discussion in "Legal Proceedings."
The board of directors has determined that TruServ will retain the fiscal
2001 loss as part of the accumulated deficit account. All or a portion of
patronage income and all non-patronage income, if any, may be retained in the
future to reduce the accumulated deficit account. TruServ has determined for
each member that was a stockholder in 2001, its share of the fiscal 2001 loss
that has been retained in the accumulated deficit account, based upon the
member's proportionate Class A common stock and Class B common stock investment.
TruServ allocated the remainder of the fiscal 2001 loss based on the member's
purchases from the co-op in 2001. In the event a member terminates its status as
a stockholder of TruServ, any remaining 2001 loss in the accumulated deficit
account that is allocable to the terminating member will be satisfied by
reducing the redemption amount paid for the member's stock investment in
TruServ.
PAYMENT OF PATRONAGE DIVIDENDS IN ACCORDANCE WITH THE INTERNAL REVENUE CODE
The Code specifically provides for the taxation of cooperatives (such as
TruServ) and their patrons (such as TruServ's members) so as to ensure that the
business earnings of a cooperative are currently taxable either to the
cooperative or to its patrons, but not both.
The shares of Class B common stock and other written notices distributed by
TruServ to its members, which disclose to the recipient the stated amount
allocated to the member by TruServ and the portion thereof that is a patronage
dividend, are "written notices of allocation" as that phrase is used in the
Code. For such written notices to be "qualified written notices of allocation"
within the meaning of the Code, it is necessary that TruServ pay 20% or more of
the annual patronage dividend in cash and that the members consent to having the
allocations (at their stated dollar amounts) treated as being constructively
received by them and includable in their gross income. Any written notices that
do not meet these requirements are "nonqualified written notices of allocation"
within the meaning of the Code.
TruServ deducts the sum of cash, the face value of qualified written
notices and the fair market value of any other property distributed to the
members (except nonqualified written notices of allocation) from its earnings in
determining its taxable income. Accordingly, all of these items, including such
qualified written notices of allocation, are includable in the gross income of
the members. Section 1385(a) of the Code provides, in substance, that the amount
of any patronage dividend which is paid in cash, qualified written notices of
allocation or other property (except nonqualified written notices of allocation)
shall be included in the gross income of the patron (member) for the taxable
year in which he or it receives such distribution. In general, for nonqualified
written notices of allocation, no amounts are either deductible by TruServ or
includable in a member's gross income until the notices are redeemed by TruServ.
TruServ itself therefore includes any earnings reflected in nonqualified written
notices of allocation in its own gross income and pays tax on them.
Thus, every year each member may receive, as part of the member's patronage
dividend, non-cash "qualified written notices of allocation," which may include
Class B common stock, the stated dollar amount of which must be recognized as
gross income by the member for the taxable year in which received. The portion
of the patronage dividend paid in cash (at least 20%) may be insufficient,
depending on a member's individual tax bracket, to pay income taxes due from the
member on its receipt of the full amount of the patronage dividend, including
cash and Class B common stock.
11
TruServ's By-Laws, reflecting the Code provision applicable to
cooperatives, usually treat shares of Class B common stock and such other
notices as the board of directors may determine, if distributed in payment of
patronage dividends, as "qualified written notices of allocation." The By-Laws
provide:
(1) for payment of patronage dividends in a combination of cash,
qualified written notices of allocation (including Class B common stock),
other property and nonqualified written notices of allocation; and
(2) that membership in the organization (i.e., the status of being a
member of TruServ) constitutes the member's consent to recognize the stated
amount of any qualified written notices of allocation or other property
distributed to it as includable in the member's gross income as provided in
Section 1385(a) of the Code.
Under the Code, any person who becomes or became a member of TruServ, or
who remains a member after adoption of the By-Laws, providing that membership in
TruServ constitutes consent to be taxed on receipt of qualified written notices
of allocation, is deemed to have consented to be taxed on receipt of patronage
dividends in cash and in qualified written notices of allocation, in accordance
with Section 1385(a) of the Code. Written notification of the adoption of the
By-Laws and its significance, and a copy of the By-Laws, were sent to each then
existing member and have been, and will continue to be, delivered to each person
prior to becoming a member. Such consent is then effective as to patronage
dividends. Such consent may be revoked by the member only by terminating its
membership in TruServ in the manner provided in his or its Retail Member
Agreement. See "Retail Member Agreement" above.
TruServ has historically paid its members approximately 30% of the
patronage dividend in cash (excluding nonqualified written notices of
allocation). However, TruServ is only obligated to distribute 20% of the annual
patronage dividend (excluding nonqualified written notices of allocation) in
cash, and it may distribute this lesser percentage in future years. TruServ's
amended debt agreements limit the cash portion of the patronage dividend to 20%
unless certain annual EBITDA targets are achieved, in which case, the cash
portion of the patronage dividend may be paid at a higher percent up to 30%. As
TruServ exceeded the EBITDA target in 2002. The cash portion of the 2002
patronage dividend paid in 2003 averaged 30%.
In order to avoid the administrative inconvenience and expense of issuing
separate certificates representing shares of Class B common stock to each
member, TruServ deposits a certificate, representing all the shares of Class B
common stock then being issued, with Harris Trust and Savings Bank, Chicago,
Illinois, for safekeeping for and on behalf of its members. TruServ keeps the
allocations of Class B common stock in book entry form. TruServ then sends a
written notice to each member of these deposits and the allocation thereof to
the member.
SET OFF RIGHTS OF TRUSERV
TruServ's Certificate of Incorporation and By-Laws specifically provide
that TruServ, but not the member, may set off its obligation to make any payment
to a member for such member's stock, notes, interest and declared and unpaid
dividends against any obligation owed by the member to TruServ. TruServ
exercised these set off rights in 2002 and 2001, when TruServ notes and interest
came due to former members with outstanding merchandise accounts receivable to
TruServ and current members with past due merchandise accounts receivable to
TruServ. TruServ also set off its obligation to former members against their
related loss allocation balance. The set off rights were exercised in an
aggregate amount of $16,526 during 2002 and $7,483 during 2001.
As TruServ maintains stock records for its members on a store-by-store
basis, members with multiple stores who elect to sell one or more, but not all,
of their stores can transfer the stock registered on TruServ's records with
respect to a store location that is terminating its relationship with TruServ,
to the store locations that are not being terminated, with proper evidence of
succession, assignment or authority to transfer. Otherwise, TruServ may exercise
its right to offset the par value of the stock recorded for the store location
to be closed against the loss allocation account balance.
12
ITEM 2. PROPERTIES.
($ IN THOUSANDS)
WAREHOUSING AND OFFICE FACILITIES
TruServ's worldwide headquarters is located in Chicago, Illinois.
Information with respect to TruServ's owned and leased warehousing and office
facilities at December 31, 2002 is set forth below:
<Table>
<Caption>
SQUARE FEET OF
WAREHOUSE AND LEASE
LOCATION OFFICE AREA INTEREST EXPIRATION DATE
-------- -------------- -------- ---------------
Chicago, Illinois(1)....................... 228,100 Leased December 31, 2010
Corsicana, Texas(7)........................ 775,000 Leased December 31, 2022
Denver, Colorado........................... 360,000 Leased June 30, 2004
East Butler, Pennsylvania(2)(6)............ 476,200 Owned
Fogelsville (Allentown), Pennsylvania(7)... 600,000 Leased December 31, 2022
Hagerstown, Maryland(3)(5)................. 840,000 Leased December 31, 2003
Harvard, Illinois.......................... 1,032,000 Leased August 23, 2013
Harvard, Illinois(8)....................... 163,000 Leased August 23, 2005
Jonesboro (Atlanta), Georgia(7)............ 670,000 Leased December 31, 2022
Kansas City, Missouri(7)................... 415,000 Leased December 31, 2022
Kingman, Arizona(7)........................ 375,000 Leased December 31, 2022
Manchester, New Hampshire(6)............... 730,000 Owned
Mankato, Minnesota(6)...................... 320,000 Owned
Peachtree City, Georgia(4)................. 60,500 Leased November 24, 2005
Springfield, Oregon(7)..................... 504,000 Leased December 31, 2022
Westlake (Cleveland), Ohio(6).............. 405,000 Owned
Woodland, California(7).................... 350,000 Leased December 31, 2022
</Table>
- ---------------
(1) TruServ has subleases with third parties for approximately 72,000 of the
228,100 square feet of the Chicago, Illinois space.
(2) The East Butler, Pennsylvania facility is currently for sale.
(3) The Hagerstown, Maryland facility, which was vacated in December 2002, is
assigned as collateral under a synthetic lease obligation and is currently
for sale. Proceeds of a sale will be paid to the lessor as payment on the
outstanding synthetic lease obligation.
(4) TruServ has subleases with third parties for the Peachtree City, Georgia
facility, which is not currently used in operations.
(5) The lease term expires the earlier of December 31, 2003 or the termination
of the existing revolving credit facility.
(6) Facility is assigned as collateral under the senior debt agreements.
(7) Facility was part of the December 31, 2002 sale leaseback transaction. See
next section of Item 2.
(8) TruServ has subleases with third parties for approximately 80,700 of the
163,000 square feet of the Harvard, Illinois space which has a lease
expiration date of August 23, 2005.
SALE LEASEBACK TRANSACTION
On December 31, 2002, TruServ sold seven of its distribution centers to
unrelated third parties for an aggregate purchase price of $125,753. The sale
resulted in net proceeds to TruServ of $121,438, which were used to pay Senior
Debt. The net reduction in Senior Debt was $108,743, as a result of new
make-whole notes of $12,695 issued due to the prepayment on senior notes.
TruServ then entered into leases with each of three purchasers to lease the
distribution centers for a period of 20 years. The transaction was recorded as a
real property sale and as operating leases in TruServ's financial statements.
The resulting gain on sale of $55,564,
13
recorded as deferred gain in the balance sheet, and to be amortized to income on
a straight line basis over the initial 20 year lease term.
Each lease is a "triple-net" lease under which TruServ is obligated to pay
all operating expenses of the property, all taxes and other impositions related
to the property, to maintain and insure the property and, with minor exceptions,
to rebuild the improvements after a casualty or condemnation. TruServ also
indemnifies the landlord from any loss, cost, damage or liability arising out of
the use, ownership or operation of the property, including any liability related
to hazardous materials.
TruServ's obligation to pay rent under the leases is absolute, with no
right to offset or abatement. The three leases are cross-defaulted, such that a
default under one of the leases constitutes a default under each of the other
leases. Events of default under the leases relate to TruServ's "triple-net"
lease obligations, as described above, and do not include any financial
covenants. TruServ has no right to terminate any of the leases, with minor
exceptions as described in the leases.
TruServ sold the distribution facilities located in Corsicana, Texas and
Woodland, California to and now leases them from Wrench (DE) Limited
Partnership. TruServ sold the distribution facilities located in Kingman,
Arizona, Fogelsville, Pennsylvania and Springfield, Oregon to and now leases
them from Bolt (DE) Limited Partnership. TruServ sold the distribution
facilities located in Jonesboro, Georgia and Kansas City, Missouri to and now
leases them from Hammer (DE) Limited Partnership. The three limited partnerships
are affiliated with W.P. Carey Investments, an investment firm independent of
TruServ. TruServ pays rent under each lease quarterly in January, April, July
and October. The aggregate annual rent under all three leases for the first year
of the lease totals $12,007. Rent under the leases increases 2% each year during
the initial 20 year lease term.
TruServ has the right to extend each lease for two additional periods. The
first extension period under each lease is for a term of nine years and 11
months and the second is for a term of 10 years. TruServ may elect to renew a
lease or leases with respect to any one or more of the properties without
renewing the lease or leases with respect to all of the properties subject
thereto. TruServ has the right to assign the lease without the landlord's prior
written consent, but subject to certain conditions described in the leases.
Provided that TruServ assigns the rent thereunder to the landlord, TruServ may
sublet all or any part of any property without the landlord's consent.
TruServ continues to evaluate opportunities to capitalize on the increase
in market value over the historical book value of its owned real estate assets
through additional sale leaseback transactions, mortgages or other financing
methods. See "Manufacturing Facilities" section below with regard to a pending
sale leaseback transaction.
OTHER PROPERTY SALES
The Brookings, South Dakota regional distribution center was closed and
sold in 2002. In 2001, TruServ closed its Henderson, North Carolina distribution
center and the lease agreement on the facility expired on November 11, 2001. The
Indianapolis, Indiana distribution center was closed and sold in 2001. TruServ's
interest in TruServ Canada Cooperative, Inc. was sold in October of 2001, which
included the sale of the Winnipeg, Manitoba property. The Westfield,
Massachusetts distribution center was closed and sold in 2000. TruServ will exit
its operations in the East Butler, Pennsylvania facility during 2003 and that
facility is currently for sale. TruServ has been exiting and consolidating
distribution facilities since the merger with SCC in 1997 to both realize the
benefit of reduced operating costs of the merged cooperatives and to reflect a
level of contraction of its operations.
14
MANUFACTURING FACILITIES
Information with respect to TruServ's manufacturing facilities is set forth
below:
<Table>
<Caption>
SQUARE FEET OF
MANUFACTURING
AND OFFICE PRINCIPAL
LOCATION AREA PRODUCT INTEREST
- -------- -------------- --------- --------
Chicago, Illinois(1)....................... 105,000 Oil based Paint Owned
Cary, Illinois(1).......................... 612,000 Latex based Paint Owned
and Paint
Applicators
</Table>
- ---------------
(1) Facility is assigned as collateral under the senior debt agreements.
In July 2001, TruServ announced its intention to explore a possible sale of
the paint manufacturing business in order to generate cash to pay down senior
debt. In July 2002, after receiving offers which were not commensurate with
management's estimate of the value of the business and as a result of TruServ's
ability to achieve senior debt reductions through operating cash flow, including
significant inventory reductions and certain other asset sales, TruServ
announced it would be retaining ownership of the paint manufacturing business.
TruServ is currently negotiating a sale and short-term leaseback of its Chicago,
Illinois oil based paint facility due to an increase in the value of the real
estate underlying the facility together with a decrease in industry demand for
oil based paint products.
TruServ's facilities are suitable for their respective uses and are, in
general, adequate for TruServ's present needs.
OTHER LEASES
TruServ owns and leases transportation equipment for use at its
distribution centers for the primary purpose of delivering merchandise from
TruServ's distribution centers to its members. Additional information concerning
these leases can be found in Note 5 "Lease Commitments" to the Consolidated
Financial Statements beginning at page F-1.
ITEM 3. LEGAL PROCEEDINGS.
($ IN THOUSANDS)
BESS ACTION
In May 2000, TruServ filed a complaint in the Circuit Court of McHenry
County, Illinois against Bess Hardware and Sports, Inc., ("Bess") to recover an
accounts receivable balance in excess of $400. Bess filed a counterclaim,
seeking a setoff against its accounts receivable balance for the par redemption
value of Bess' shares of TruServ Stock. Bess contested the validity of a March
17, 2000 corporate resolution declaring a moratorium on the redemption of all
TruServ capital stock, as well as an allocation of Bess' proportionate share of
the loss which TruServ declared for its fiscal year 1999. On June 21, 2002, the
court issued an oral ruling granting summary judgment to TruServ on its accounts
receivable claim, and granting summary judgment to Bess on its counterclaim. The
judgment was entered on August 6, 2002. TruServ believes that the court's ruling
on Bess' counterclaim is not supported by either the facts or Delaware corporate
law. TruServ's motion for reconsideration and reversal of the August judgment on
Bess' counterclaim was denied on November 21, 2002. TruServ filed its notice of
appeal in the Second District of Illinois Appellate Court on December 2, 2002.
DERIVATIVE ACTION
In August 2000, an action was brought in Delaware Chancery Court (New
Castle County) by a former TruServ member ("Hudson City Properties") against
certain present and former directors and certain former officers of TruServ and
against TruServ. The complaint is brought derivatively on behalf of TruServ and
15
alleges that the individual defendants breached their fiduciary duties in
connection with the accounting adjustments made by TruServ in the fourth quarter
of 1999. Hudson City Properties also seeks to proceed on a class-action basis
against TruServ on behalf of all those affected by the moratorium on stock
redemption and the creation of the loss allocation accounts. Hudson City
Properties alleges that TruServ breached, and the named directors caused TruServ
to breach, agreements with members by suspending payment of the members' 1999
annual patronage dividend, by declaring the moratorium on the redemption of
members' TruServ stock and by imposing minimum annual purchase requirements upon
members. The plaintiff seeks monetary and non-monetary relief in connection with
the various claims asserted in the complaint. The lawsuit, despite its vintage,
is in an early stage and the extent of the damages claimed has not yet been
determined. The parties have entered into settlement negotiations, but a final
settlement has not been reached at this time and no assurances can be given that
one will be entered into.
KENNEDY ACTION
In June 2000, various former members of TruServ filed an action against
TruServ in the Circuit Court of the 19th Judicial Circuit (McHenry County,
Illinois) (the "Kennedy action"). The plaintiffs in the Kennedy action each
allege that, based upon representations made to them by TruServ 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 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. 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. Similar claims were filed
against TruServ as counterclaims to various complaints filed by TruServ in
McHenry County to recover accounts receivable balances from other former
members. Those claims were consolidated with the Kennedy action. In March 2001,
the Kennedy complaint was amended to add additional plaintiffs. Also in March
2001, another action was filed against TruServ on behalf of additional former
members, in the same court, by the same law firm (the "A-Z action"). The A-Z
complaint alleges substantially similar claims as those in the Kennedy action,
with the principal difference being that the claims relate to the elimination of
the ServiStar brand name. The Kennedy and A-Z actions have been consolidated for
purposes of discovery, which is ongoing. The plaintiffs seek damages for stock
repurchase payments, lost profits and goodwill, out of pocket expenses, attorney
fees and punitive damages. In July 2002, the plaintiffs in these consolidated
actions amended their complaints to name as defendants two former officers of
TruServ. To the extent that TruServ may have indemnification obligations to
these former officers, TruServ's directors and officers' liability insurance
policies may be available to cover such claims.
TruServ intends to vigorously defend all of these cases. However, a ruling
in favor of any or all of the plaintiffs in the Kennedy Action, the Derivative
Action or the Bess Action could have a material adverse effect on TruServ. The
courts could rule that TruServ violated its Agreement with members or its
By-Laws in establishing the loss allocation account; imposing the moratorium on
stock redemptions; or imposing minimum purchase commitments on members. In the
event of such a ruling, TruServ could be required to do one or more of the
following:
- lift the moratorium on stock redemptions; and
- redeem members' stock presented for redemption at its full stated value.
Such actions could constitute events of default under TruServ's Senior
Debt. Unless appropriate waivers were obtained from TruServ's lenders, the
amounts due under the Senior Debt could become immediately due and payable or
the Senior Debt agreements could have to be renegotiated. However, there can be
no assurances that TruServ would be able to obtain the requisite waivers or
successfully renegotiate its Senior Debt agreements. In the event TruServ was
unable to obtain the requisite waivers or successfully renegotiate its Senior
Debt agreements, a material adverse effect on TruServ's liquidity and capital
resources could result.
16
PENTZ SETTLEMENT
In June 2002, TruServ reached a comprehensive and confidential settlement
with Paul Pentz, a former president of TruServ regarding his claims for bonus
and retirement compensation payments.
CLAIM AGAINST ERNST & YOUNG LLP
TruServ is pursuing claims against its former outside auditors, Ernst &
Young LLP ("E&Y"), for professional malpractice, breach of contract, deceptive
business practices and fraud. TruServ contends that E&Y failed to properly
discharge its duties to TruServ and failed to identify, in a timely manner, and
indeed concealed, certain material weaknesses in TruServ's internal financial
and operational controls. As a result, TruServ was forced to make an
unanticipated accounting adjustment in the fourth quarter of 1999 in the total
amount of $121,333 (the "Fourth Quarter Charge"). As a result, TruServ reported
a net loss of $130,803 for the fiscal year ended December 31, 1999. It is
TruServ's belief that had E&Y properly discharged its duties, the scope and
breadth of the Fourth Quarter Charge, as well as the accounting and operational
control deficiencies that necessitated the charge, would have been substantially
lessened, if not eliminated in their entirety. As a result of E&Y's failures,
TruServ has suffered significant financial damages. The factual allegations that
form the basis for TruServ's claim against E&Y include, in part, the issues
identified in the Securities and Exchange Commission (the "Commission") cease
and desist order described below. TruServ began discussion of its claims with
E&Y early in the fall of 2001. Pursuant to the dispute resolution procedures
required by TruServ's engagement letter with E&Y, TruServ and E&Y attempted to
mediate this dispute during the first six months of 2002. When those attempts
proved unsuccessful, and again pursuant to the dispute resolution procedures,
TruServ filed its claim with the American Arbitration Association on July 31,
2002. The arbitration, which is subject to certain confidentiality requirements,
is currently pending.
TRUSERV ORDER
On March 4, 2003, the Commission entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
TruServ Corporation, SEC File No. 3-11050 (the "Order"). TruServ consented to
the entry of the Order without admitting or denying the findings in the Order.
The Commission entered the Order following an investigation by the staff of
the Commission of the circumstances that led to significant financial
adjustments resulting in the 1999 loss of $131,000. The Order found that, from
approximately July 1997 through the end of 1999, TruServ's accounting systems
and internal controls related to inventory management were inadequate. The Order
also found that these deficiencies caused TruServ to understate expenses, which
resulted in overstatement of net income, during 1998 and 1999. According to the
Order, TruServ filed erroneous reports on Form 10-Q for the first, second and
third quarters of 1998 and 1999 and an erroneous report on Form 10-K for 1998.
In 1999, TruServ reported a loss, caused by weaknesses in the accounting
practices and internal controls at TruServ, of approximately $131,000.
The largest component of the 1999 loss of $131,000 represented adjustments
to inventory and merchandise payable. Specifically, the Commission found that
TruServ had in 1998 and the first three quarters of 1999 misstated accounts,
including unbilled merchandise, claims for returned merchandise from members,
and additional stock adjustments, consisting of lost and found merchandise,
damaged goods, and others.
The Order also found that TruServ and its senior management had notice of
its internal control problems as early as February 1997, through a report
prepared by its internal audit department. The report noted several specific,
recurring problems in data entry concerning inventory management that caused
significant discrepancies in TruServ's inventory records. According to the
Order, no one acted on the 1997 report, even though it concluded that TruServ
did not have adequate internal controls over its inventory systems.
TruServ investigated the causes of the inventory and merchandise payable
adjustments, and in order to prevent problems from occurring in the future, it
adopted several changes in procedure to correct accounting weaknesses. According
to the Order, as a result of these systemic flaws, TruServ is not able to
restate any of
17
the erroneous filings made in 1998 and 1999. The Commission made no allegations
of fraud nor did it seek civil monetary penalties in connection with entering
the Order.
Pursuant to the Order, TruServ has agreed to continue to maintain the
procedures that it has adopted since the Spring of 2000 and otherwise to comply
with the accounting, record keeping and internal control provisions of the
Securities and Exchange Act of 1934 (the "Exchange Act"). In addition, TruServ
will continue to employ as a member of its management team, during the fiscal
years ending 2002, 2003 and 2004, a Director of Internal Audit who will be
responsible for executing TruServ's internal audit plan and will continue to
engage a public accounting firm to assist the Director of Internal Audit in
performing internal audit procedures.
Also pursuant to the Order, within 90 days after the close of each fiscal
year ending 2002, 2003 and 2004, the Director of Internal Audit will prepare and
deliver to TruServ's board audit committee, with copies to the Commission,
TruServ's auditors and the public accounting firm assisting the Director of
Internal Audit, a report describing the scope of the audit plan during the
preceding year, confirmation that the audit plan was carried out, an overview of
significant control weaknesses identified that require improvement and a review
of the steps taken to improve the system of internal controls.
On March 4, 2003, the Commission also entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
Kerry Kirby, File No. 3-11053 (the "Kirby Order"). The Kirby Order made
substantially all of the findings that were made in the Order. In addition, the
Kirby Order found that Kerry Kirby, the chief financial officer of TruServ from
July 1997 to May 1999, in part due to his failure to act on the internal audit
report that TruServ's accounting systems were flawed, was a cause of TruServ's
violations of securities laws requiring the accurate financial reporting,
accurate books and records and adequate internal controls.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is no existing market for the common stock of TruServ and there is no
expectation that any market will develop. TruServ's Class A common stock is
owned exclusively by retailers of hardware and related products, garden center
retailers and industrial distributors as well as rental retailers, each of whom
is a member or former member of TruServ and purchased at least 60 shares of
TruServ's Class A common stock (the only class of voting stock) upon becoming a
member. TruServ is organized as a Delaware stock corporation and operates as a
member-owned wholesaler cooperative corporation. The shares of TruServ's Class B
common stock now outstanding were issued to members in partial payment of the
annual patronage dividend that accrued as a result of patronage business
transacted by such members with TruServ. In accordance with TruServ's By-Laws,
the annual patronage dividend is paid to members out of the gross margins from
operations and other patronage source income, after deduction for expenses,
reserves and other provisions authorized by the board of directors.
The number of holders of record (as of February 22, 2003) of each class of
stock of TruServ is as follows:
<Table>
<Caption>
NUMBER OF
HOLDERS OF
RECORD
TITLE OF CLASS ----------
Class A common stock, $100 Par Value........................ 7,621
Class B common stock, $100 Par Value........................ 7,733
</Table>
18
Dividends (other than patronage dividends) on the Class A common stock and
Class B common stock, subject to the provisions of TruServ's Certificate of
Incorporation, may be declared out of gross margins of TruServ, other than gross
margins from operations with or for members and other patronage source income,
after deduction for expenses, reserves and provisions as may be authorized by
the board of directors. Dividends may be paid in cash, in property, or in shares
of the Class B common stock, subject to the provisions of the Certificate of
Incorporation and the By-Laws. Other than the payment of patronage dividends,
including the redemption of all nonqualified written notices of allocation,
TruServ has not paid dividends on its Class A common stock or Class B common
stock. In February 2003, the board of directors authorized the payment of a
patronage dividend related to 2002. Such amounts were paid in March 2003. The
board of directors does not plan to pay non-patronage dividends on either class
of stock in 2003 for the year ended December 31, 2002. See
"Business -- Distribution of Patronage Dividends", and "-- Allocation of
Patronage Dividends Against Loss Allocation Account."
ITEM 6. SELECTED FINANCIAL DATA.
($ IN THOUSANDS)
<Table>
<Caption>
SELECTED FINANCIAL DATA
AS OF AND FOR THE FISCAL YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
2002(1) 2001(1) 2000 1999(2)(3) 1998(2)(3)
---------- ---------- ---------- ---------- ----------
Net revenues......................... $2,175,451 $2,619,434 $3,993,642 $4,502,326 $4,328,238
Gross margin......................... 239,831 264,034 277,397 181,465 298,135
Net margin/(loss).................... 21,153 (50,687) 34,117 (130,803) 12,020
Patronage dividends(4)............... 20,541 -- 34,705 -- 35,024
Total assets......................... 703,371 1,020,837 1,236,014 1,335,397 1,587,674
Short-term borrowings................ 27,852 141,755 138,085 167,007 258,147
Current and non-current long-term
senior and current member debt..... 184,818 329,559 350,279 397,884 407,577
Promissory (subordinated) and
installment member notes
payable(5)......................... 43,531 42,973 65,846 83,804 124,422
Class A common stock(6).............. 50,120 49,896 49,084 47,270 49,880
Class B common stock(6).............. 176,945 174,448 174,448 177,779 195,643
Loss allocation...................... (75,966) (89,972) (92,460) -- --
(Accumulated deficit)/Retained
earnings........................... (68,704) (68,568) (17,134) (130,939) 579
</Table>
- ---------------
(1) The lumber and building materials business was sold on December 29, 2000.
(2) The net margin/(loss) of $(131,143) and $20,480 originally reported in 1999
and 1998, respectively, was restated to $(130,803) and $12,020,
respectively, in the Form 10-K(A) filed for the year ended December 31,
2000. The restatement related to expensing as incurred costs previously
accrued in connection with the merger of Cotter & Company and SCC.
(3) TruServ had for several years, from at least February 1997 through at least
the end of 1999, inadequate internal controls relating to, among other
things, various aspects of inventory management, accounts payable, cost of
goods sold and accounting for certain income and expense items. Principally
as a result of these deficiencies, TruServ reported a loss of $130,803 for
fiscal year 1999. Because the problems identified above were caused by
systematic flaws in internal controls, TruServ does not have information
available to confirm the accuracy of these results or that would cause it to
conclude that the fiscal 1999 and 1998 financial statements for the 1999 and
1998 fiscal years, respectively, can or should be modified.
On March 4, 2003, the Commission entered the Order following an
investigation by the staff of the Commission of the circumstances that led
to significant financial adjustments resulting in the 1999 loss. Pursuant to
the Order, TruServ will be required to maintain books and records in
accordance with the
19
record keeping requirements of the Exchange Act and to perform certain other
undertakings. See "Legal Proceedings."
(4) No patronage dividends were issued in 2001 and 1999 due to the reported net
loss of $50,687 and $130,803, respectively.
(5) This is the non-current portion of promissory and installment notes payable
to members included in members' capitalization on the balance sheet.
(6) In Fiscal 2002, Class A common stock and Class B common stock include
approximately $15,475 and $47,033, respectively, of amounts not redeemed due
to the stock moratorium. In Fiscal 2001, Class A common stock and Class B
common stock include approximately $11,699 and $34,712, respectively of
amounts related to the stock moratorium. See "Business -- Moratorium on
Redemptions of Capital Stock."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
($ IN THOUSANDS)
FISCAL YEAR 2002 COMPARED TO FISCAL YEAR 2001
RESULTS OF OPERATIONS
REVENUES AND GROSS MARGIN
A reconciliation of revenue and gross margin between 2002 and 2001 follows:
<Table>
<Caption>
% OF GROSS
NET 2001 NET GROSS MARGIN %
REVENUES REVENUES MARGIN OF REVENUE
---------- -------- -------- ----------
($ IN THOUSANDS)
FISCAL YEAR 2001 RESULTS.......................... $2,619,434 100.0% $264,034 10.1%
Same store sales:
Product price increases......................... 13,340 0.5 13,340
Product price decreases......................... (1,100) -- (1,100)
Warehouse and relay revenues.................... (72,923) (2.8) (10,766)
Vendor direct revenues.......................... (60,567) (2.3) (593)
Terminated members:
Warehouse and relay............................. (166,083) (6.3) (30,043)
Direct.......................................... (66,084) (2.5) (647)
New members:
Warehouse and relay............................. 19,268 0.7 4,301
Direct.......................................... 7,509 0.3 73
Lumber and building materials business(1)......... (21,422) (0.8) --
Canadian business(2).............................. (84,397) (3.2) (12,344)
Advertising, transportation and other revenues.... (11,524) (0.5) (6,939)
Indirect cost of revenues......................... -- -- 20,515
---------- ----- --------
Total change...................................... (443,983) (16.9) (24,203)
---------- ----- --------
FISCAL YEAR 2002 RESULTS.......................... $2,175,451 83.1% $239,831 11.0%
========== ===== ========
</Table>
- ---------------
(1) The lumber business was sold on December 29, 2000. The revenue and the cost
of revenue from merchandise shipped and billed in fiscal year 2001, but
negotiated prior to December 29, 2000, was recorded in TruServ's results of
operations in fiscal year 2001.
(2) This business was sold on October 22, 2001.
20
Revenues for 2002 totaled $2,175,451. This represented a decrease in
revenues of $443,983, or 16.9%, from 2001. The key contributors to the decrease
in revenue are the 12% decline in the number of participating member retail
outlets in 2002, representing an 8.8% revenue reduction, together with a 4.6%
decline in same store sales and the effect of the sale of the Canadian and
Lumber businesses, representing a 4.0% revenue reduction. TruServ increased
prices in September 2001. The impact of these price increases on 2002 member
purchases was $13,340. In October 2002, TruServ announced it would commence
lowering prices monthly in 2002 and continue price reductions into 2003. The
impact of the reduction in pricing on fourth quarter 2002 member purchases was
$1,100. TruServ has forecasted 2003 price reductions to members to aggregate
$8,000. TruServ has forecasted that a decline in retail outlets will recur in
2003, but the forecast is not as significant as the actual 2002 decline. A
favorable trend that is occurring is that as a result of certain marketing
programs and sales initiatives, together with the impact of a slow-down in the
national economy, members are buying more merchandise from the distribution
centers. This trend has favorably improved the sales mix toward more warehouse
sales from the less profitable direct sales and has minimally affected revenues
due to lower volume offset by higher prices, but has positively affected gross
margin.
Gross margin for 2002 totaled $239,831. This represented a decrease in
gross margin dollars of $24,203, or 9.2%, as compared to 2001. The sale of
TruServ Canada Cooperative, Inc. and the decline in the number of participating
member retail outlets are the key contributors to the negative variance relative
to the prior year. However, the gross margin as a percent of revenue increased
to 11.0% in 2002 from 10.1% for 2001. The shift in the sales mix to warehouse
sales from vendor direct orders and certain product price increases initiated in
September 2001 contributed to the increase in gross margin as a percent of
revenue. Price reductions commenced in October 2002. The indirect cost of
revenues favorably impacted the gross margin dollars as a result of distribution
center closures and headcount reduction, which reduced the direct inbound
logistics costs and labor and related overhead incurred to bring merchandise to
the distribution centers. Additional impact to gross margin was due to a
reduction in advertising support fees of $7,956, which was partially offset by a
reduction in gross advertising costs of $2,868. These reductions relate to lower
member participation in the distribution of direct mail circulars but cost was
partially offset by additional network advertising for the new power event
promotions.
<Table>
<Caption>
$ EXPENSE
2002 2001 DECREASE
------- ------- ---------
Logistics and manufacturing............................. $60,924 $79,970 $19,046
</Table>
Logistics (outbound to members' stores) and manufacturing (the paint
business) expenses decreased $19,046, or 23.8%, as compared to the prior year.
Approximately $11,223 of this decrease resulted from the exclusion of expenses
associated with TruServ Canada Cooperative, Inc., which was sold in October
2001. An additional $3,444 was due to the closure of several distribution
centers in late 2001 through 2002, in response to a reduction in the member
base. Also, a decrease of approximately $4,388 was caused by lower expense
spending related to the manufacturing operations, predominately related to lower
advertising. In 2003, as a result of the sale leaseback of seven facilities at
the end of 2002, rent expense will be increased by a net of $11,786, which
includes an increase in gross rent charges of $14,564 offset by the amortization
of the gain on the sale of these facilities of $2,778. Additionally,
depreciation expense will decrease by approximately $2,585 in 2003 as a result
of the sale leaseback of these facilities.
<Table>
<Caption>
$ EXPENSE
2002 2001 DECREASE
------- -------- ---------
Selling, general and administrative.................... $92,948 $137,533 $44,585
</Table>
Selling, general and administrative expenses ("SG&A") decreased by $44,585,
or 32.4%, in 2002, as compared to the prior year. TruServ achieved significant
reductions in SG&A as a result of lower labor cost and reduced benefit expenses.
TruServ's restructuring initiatives in 2000 and 2001, which included headcount
reductions, generated a savings of $4,090 in labor costs. The $15,126 reduction
in benefit plan costs were generated from lower headcount, changes in the
benefits, a reduction in pension settlements with terminated employees, and the
elimination in 2002 of the requirement in 2001 to cover exposure of an insurance
carrier in liquidation. An additional reduction of $6,041 in SG&A expenses for
fiscal 2002, as compared to fiscal 2001, is the result of lower bad debt expense
due to TruServ's improved ability to collect receivables. Also in 2002,
21
TruServ adopted SFAS No. 142, "Goodwill and Other Intangible Assets", which
changed the accounting for goodwill from an amortization method to an impairment
only approach. Goodwill amortization for fiscal year 2001 was $2,577. Other
areas of reductions in SG&A include lower refinancing fees of $7,368, lower
software license fees of $2,483 relating to retail point of sale software and
lower non-restructuring related severance of $1,386.
<Table>
<Caption>
$ EXPENSE
2002 2001 DECREASE
------ ------- ---------
Restructuring charges and other related expenses......... $6,284 $38,522 $32,238
</Table>
In fiscal 2002, TruServ incurred restructuring and other related charges of
$6,284, of which $3,313 related to restructuring, and $2,971 related to other
post-employment and asset impairment charges. The restructuring charge of $3,313
in fiscal 2002 resulted from TruServ's continued workforce reductions initiated
in fiscal 2000 and 2001 and related to distribution center closures and
workforce reductions in the organization. This charge was comprised of $2,316
for severance and $2,296 for facility exit costs, offset by a $1,299 reduction
in asset impairment charges. The severance charges of $2,316 primarily consisted
of additional workforce reductions at the corporate headquarters in Chicago,
Illinois. The facility exit costs of $2,296 related to exiting the Hagerstown,
Maryland distribution center, which was completed prior to December 31, 2002.
The $1,299 reduction of asset impairment charges consisted of a $927 favorable
adjustment to the asset value for the closing of the of the Brookings, South
Dakota distribution center, based on actual proceeds received on the sale of
this facility in 2002. It also included a $372 favorable adjustment relating to
the transfer of certain Hagerstown, Maryland equipment to other facilities, the
value of which had been fully reserved in 2001. The other charges of $2,971
consisted of $1,769 for asset impairment and $1,202 for post-employment charges.
The asset impairment charge of $1,769 related to the write-down of the East
Butler, Pennsylvania facility. The post-employment charge of $1,202 was
comprised of $352 relating to severance charges for the Cary, Illinois facility,
and $850 relating to severance charges for the corporate headquarters in
Chicago, Illinois.
In fiscal 2001, TruServ recorded a charge to income of $38,522, of which
$10,722 was for severance, $18,901 was for facility exit costs for the
distribution centers, and $8,899 was for asset impairments. The largest
component of these exit costs related to the Hagerstown, Maryland distribution
center closure, which is subject to a synthetic lease. The difference of
approximately $14,800 between the lease obligation at December 31, 2001 of
$40,000 and management's estimate of the fair value of the building was the
major component of its facility exit costs in 2001. This obligation and the
original cost of the facility are not recorded on TruServ's balance sheet
because it does not meet the requirement for capital lease treatment under
Statement of Financial Accounting Standards ("SFAS") No. 13, "Accounting for
Leases." At December 31, 2002, the synthetic lease had a balance of $33,383,
which is due at the end of the amended lease term, which is the earlier of
December 31, 2003 or the termination of the existing revolving credit facility.
A summary of restructuring charges, related uses of reserves and ending
reserve balances is as follows:
<Table>
<Caption>
ADDITIONAL
DECEMBER 31, 2001 RESTRUCTURING ADJUSTMENT DECEMBER 31, 2002
RESTRUCTURING CHARGES/ TO RESTRUCTURING
RESERVE (CREDITS) ASSET VALUE (PAYMENTS) RESERVE
----------------- ------------- ----------- ---------- -----------------
($ IN THOUSANDS)
Severance and outplacement....... $ 8,270 $ 2,316 $ -- $ (6,345) $ 4,241
Facility exit costs.............. 17,979 2,296 -- (9,245) 11,030
Asset impairments................ -- (1,299) 1,299 -- --
------- ------- ------ -------- -------
$26,249 $ 3,313 $1,299 $(15,590) $15,271
======= ======= ====== ======== =======
</Table>
As a result of the restructuring and other efforts, estimated annualized
cost saving of $28,957 were related to charges reserved through 2001, with
$4,350 of cost saving relating to additional reserve charges in 2002. Headcount
reductions of 909 were related to charges reserved through 2001, with additional
headcount
22
reductions of 80 related to charges reserved for in 2002. The following chart
highlights these saving and reductions by facility:
<Table>
<Caption>
ESTIMATED ANNUALIZED SAVINGS HEADCOUNT REDUCTIONS
----------------------------- ---------------------------
THROUGH 2002 THROUGH 2002
2001 ADDITIONS TOTAL 2001 ADDITIONS TOTAL
------- --------- ------- ------- --------- -----
($ IN THOUSANDS)
Henderson, North Carolina.............. $ 798 $ -- $ 798 102 102
Indianapolis, Indiana.................. 1,476 1,476 94 94
Brookings, South Dakota................ 4,041 4,041 166 166
Hagerstown, Maryland................... 7,545 172 7,717 331 1 332
Corporate Headquarters................. 15,097 4,178 19,275 216 79 295
------- ------ ------- --- -- ---
Totals................................. $28,957 $4,350 $33,307 909 80 989
======= ====== ======= === == ===
</Table>
<Table>
<Caption>
$ EXPENSE
2002 2001 DECREASE
------- ------- ---------
Interest expense:
Member............................................... $ 6,611 $ 7,842 $1,231
Third Parties........................................ 55,284 55,431 147
</Table>
Interest paid on member debt decreased by $1,231, or 15.7%, as compared to
the prior year, due to a decrease in the average balance of debt outstanding of
approximately $26,628, which was partially offset by a higher average interest
rate (8.49% average in 2002 compared to 7.50% average in 2001). Third party
interest expense decreased by $147, or 0.3%, as compared to the prior year.
TruServ experienced an interest expense savings of $11,629, as a result of the
lower average balance of senior debt outstanding as compared to 2001. However,
this amount was substantially offset by higher financing fee amortization and
higher interest rates, which increased the effective interest rate by
approximately 2.9%, as compared to 2001 resulting in increased interest expense
of $11,482. TruServ achieved the lower average debt balances in 2002 by
generating cash from operations and asset sales. These amounts were offset in
part, however, by the fees resulting from TruServ amending its existing credit
facility and senior note agreements due to the debt covenant violation under
these agreements in 2001. As a result of various debt paydowns during 2002 from
cash received from asset sales, 2003 interest expense will be reduced by
$14,600, offset by additional make-whole and financing fee amortization of
$6,100, for a net reduction of $8,500. Of this $8,500 reduction, the paydown of
third party debt with cash received from the sale leaseback of seven regional
distribution centers in December, 2002 will reduce interest expense by $12,500,
offset by additional make-whole and financing fee amortization of $5,600, for a
net reduction of $6,900. The remaining reduction in interest expense of $1,600
is from the paydown of debt in 2002 with cash proceeds from other asset sales
and notes receivable in 2001 and 2002, which reduced interest expense by $2,100,
offset by additional make-whole and financing fee amortization of $500.
<Table>
<Caption>
$ GAIN
2002 2001 DECREASE
---- ------- --------
Loss/(gain) on sale of assets.............................. $91 $(1,958) $(2,049)
</Table>
Loss/(gain) on sale of assets decreased $2,049, from a gain of $1,958 in
2001 to a loss of $91 in 2002. The variance was mainly due to the nonrecurrence
of fiscal 2001 gains of $1,588 and $472 recorded upon the sale of TruServ's
Canadian business and the Indianapolis distribution center, respectively.
<Table>
<Caption>
$ NET
MARGIN
2002 2001 INCREASE
------- -------- --------
Net margin/(loss)...................................... $21,153 $(50,687) $71,840
</Table>
The net margin in 2002 was $21,153 compared to a net loss of $50,687 in
2001, an increase in net margin/(loss) of $71,840. Net margin/(loss) was
favorably impacted by the closure of distribution centers and headcount
reductions that occurred from the restructuring activities in 2001, the
non-recurrence of the
23
significant 2001 restructuring charges and a better gross margin percentage.
These favorable impacts were partially offset by the loss of participating
member retail outlets.
FISCAL YEAR 2001 COMPARED TO FISCAL YEAR 2000
RESULTS OF OPERATIONS
REVENUES AND GROSS MARGINS
A reconciliation of revenue and gross margin between 2001 and 2000 follows:
<Table>
<Caption>
% OF
NET 2000 NET GROSS GROSS MARGIN %
REVENUES REVENUES MARGIN OF REVENUE
----------- -------- -------- --------------
($ IN THOUSANDS)
Fiscal year 2000 results...................... $ 3,993,642 100.0% $277,397 6.9%
Lumber and building materials business(1)..... (1,063,680) (26.6) (18,196)
Canadian business(2).......................... (24,611) (0.6) (3,251)
Terminated members............................ (184,223) (4.6) (20,384)
New members................................... 26,436 0.7 3,116
Same store sales:
Warehouse and relay revenues................ (10,665) (0.3) 12,941
Vendor direct revenues...................... (110,875) (2.8) (824)
Advertising, transportation and other
revenues.................................... (6,590) (0.2) (493)
Indirect cost of revenues..................... -- -- 13,728
----------- ----- --------
Total change.................................. (1,374,208) (34.4) (13,363)
----------- ----- --------
Fiscal year 2001 results...................... $ 2,619,434 65.6% $264,034 10.1%
=========== ===== ======== ====
</Table>
- ---------------
(1) This business was sold on December 29, 2000.
(2) This business was sold on October 22, 2001.
A reconciliation of gross margin percentage between 2001 and 2000 follows:
<Table>
<Caption>
GROSS % OF
MARGIN % CHANGE
-------- ------
Fiscal year 2000 results.................................... 6.9%
Effect of sale of lumber and building materials business.... 1.9 61.7%
Effect of shift from vendor direct to warehouse and relay
sales..................................................... 0.7 22.1
All other................................................... 0.6 16.2
---- -----
Total change................................................ 3.2 100.0%
---- =====
Fiscal year 2001 results.................................... 10.1%
====
</Table>
Revenues for 2001 totaled $2,619,434. This represented a decrease in
revenues of $1,374,208 or 34.4% from 2000. The key contributors to the decrease
in revenue were the sale of the lumber and building materials business to BMA in
December 2000, the sale of TruServ Canada Cooperative, Inc. in October 2001, and
the 11% decline in the number of participating member retail outlets in 2001
resulting in a 4.6% sales decline. The remaining revenue reduction occurred in
same store sales, with 90% of this decrease in direct sales to members, which
generated approximately a 1% gross margin for TruServ before consideration of
vendor volume rebates on purchases. The reduction in direct sales was partially
due to a shift in member purchases to warehouse sales. Certain marketing
programs and sales initiatives, together with the impact of a slow down in the
national economy, had encouraged members to buy in the smaller quantities that
are available by purchasing merchandise from the distribution centers. This
trend favorably improved the sales mix toward more warehouse sales from the less
profitable direct sales.
24
Gross margin for 2001 totaled $264,034. This represented a decrease in
gross margin dollars of $13,363, or 4.8%, as compared to 2000. The sale of the
lumber and building materials business, the sale of TruServ Canada Cooperative,
Inc. and the decline in the number of participating member retail outlets were
the key contributors to the negative variance relative to the prior year.
However, the gross margin as a percent of revenue increased to 10.1% in 2001
from 6.9% in 2000. The shift in the sales mix to warehouse sales from vendor
direct orders, a reduction in member returns and allowances, and certain product
price increases contributed to the increase in gross margin as a percent of
revenue. The indirect cost of revenues favorably impacted the gross margin
dollars, as a result of the closure of distribution centers and headcount
reduction, which reduced the direct inbound logistics costs and labor and
related overhead incurred to bring merchandise to the distribution centers. The
reduction in member returns and allowances was principally due to a change in
processes resulting in fewer shipping errors. Additional favorable impact to
gross margin was due to a reduction in gross advertising costs of $23,400, which
was partially offset by a reduction in advertising support fees of $12,527.
These reductions relate to lower member participation in the distribution of
direct mail circulars and a reduction in network advertising.
<Table>
<Caption>
$ EXPENSE
2001 2000 DECREASE
------- ------- ---------
Logistic and manufacturing expenses..................... $79,970 $83,276 $3,306
</Table>
Logistics (outbound to members' stores) and manufacturing expenses
decreased $3,306, or 4.0%, as compared to the prior year primarily due to the
closure of distribution centers, headcount reductions and a reduction in the
member base.
<Table>
<Caption>
$ EXPENSE
2001 2000 INCREASE
-------- -------- ---------
Selling, general and administrative expenses......... $137,533 $124,584 $(12,949)
</Table>
SG&A increased by a net $12,949, or 10.4%, in 2001, as compared to 2000.
Health and pension benefit costs increased $8,894 due to pension settlements
with terminated employees and a decline in the expected investment return on
plan assets. Software license fees related to retail point of sale software
increased $3,553. Financing and legal costs, including consulting and legal fees
related to the debt covenant violation under the senior debt agreements and
other legal matters, were $9,337. The aggregate of this increase, $21,784, was
partially offset principally by $7,146 of lower corporate staff expenses due to
headcount reductions that were part of the 2000 and 2001 restructuring
initiatives and $4,511 of lower headcount and operational expenses as a result
of the December 2000 sale of the lumber and building materials business.
<Table>
<Caption>
$ EXPENSE
2001 2000 INCREASE
------- ------ ---------
Restructuring charges and other related expenses........ $38,522 $4,944 $(33,578)
</Table>
In fiscal 2001, TruServ continued the workforce reductions initiated in
fiscal 1999 and 2000 related to regional distribution center closures and
workforce reductions at its corporate headquarters. TruServ recorded a charge to
income of $38,522 in fiscal 2001. The charge is comprised of $10,722 for
severance, $8,899 for asset impairments related to the regional distribution
centers based upon current estimates of the market values of the assets compared
to their book values and $18,901 of facility exit costs related to the regional
distribution center closures. The largest component of these exit costs relates
to the Hagerstown, Maryland distribution center closure, which is subject to a
synthetic lease. The synthetic lease had a principal balance of $40,000 at
December 31, 2001, which is due at the end of the lease term, which is the
earlier of December 31, 2003 or the termination of the existing credit facility.
This obligation and the original cost of the facility are not recorded on
TruServ's balance sheet because it does not meet the requirement for capital
lease treatment under Statement of Financial Accounting Standards ("SFAS") No.
13, "Accounting for Leases." The difference between the lease obligation and
management's estimate of the fair value of the building as of December 31, 2001
was approximately $14,800 and was the major component of its facility exit
costs.
In fiscal 2000, TruServ recorded a restructuring charge of $4,944,
approximately $2,000 of which was related to the closures of the Henderson,
North Carolina and the Indianapolis, Indiana distribution centers. The closures
of Henderson and Indianapolis were completed by the end of fiscal 2001. The
closures of the
25
Brookings and Hagerstown regional distribution centers were expected to be
substantially completed by the end of fiscal 2002. Brookings was vacated and
sold in the third quarter of fiscal 2002; Hagerstown was vacated in December
2002 and is currently for sale.
A summary of restructuring charges, related uses of reserves and ending
reserve balances is as follows:
<Table>
<Caption>
DECEMBER 31, 2000 ADDITIONAL DECEMBER 31, 2001
RESTRUCTURING RESTRUCTURING ASSET RESTRUCTURING
RESERVE CHARGES IMPAIRMENT PAYMENTS RESERVE
----------------- ------------- ---------- -------- -----------------
($ IN THOUSANDS)
Severance and outplacement... $ 861 $10,722 $ -- $(3,313) $ 8,270
Facility exit costs.......... 1,051 18,901 -- (1,973) 17,979
Asset impairments............ -- 8,899 (8,899) -- --
------ ------- ------- ------- -------
$1,912 $38,522 $(8,899) $(5,286) $26,249
====== ======= ======= ======= =======
<Caption>
ESTIMATED
ANNUALIZED HEADCOUNT
SAVINGS REDUCTION
---------- ---------
($ IN THOUSANDS)
Severance and outplacement...
Facility exit costs..........
Asset impairments............
$28,957 909
======= ===
</Table>
<Table>
<Caption>
$ EXPENSE
2001 2000 DECREASE
------- ------- ---------
Interest expense:
Members............................................... $ 7,842 $11,131 $3,289
Third Party........................................... 55,431 56,575 1,144
</Table>
Interest expense to members decreased by $3,289, or 29.5%, as compared to
the prior year, primarily due to a lower average principal balance of debt
outstanding to members. Third party interest expense decreased by $1,144, or 2%,
as compared to prior year. The interest expense savings from the lower average
principal balance of senior debt outstanding, as compared to the prior year, was
offset by the interest rate increase of approximately 2% imposed as a result of
the debt covenant violation under the revolving credit facility and the senior
note agreements. As a result of this default interest rate, TruServ incurred
additional interest expense of $6,779 in fiscal 2001.
<Table>
<Caption>
$ GAIN
2001 2000 DECREASE
------- -------- --------
Loss/(gain) on sale of assets......................... $(1,958) $(30,337) $(28,379)
</Table>
Loss/(gain) on sale of assets decreased $28,379. The variance was due to
the nonrecurrence of the gain of $28,981 recorded upon the sale of TruServ's
lumber and building materials business in December 2000.
<Table>
<Caption>
$ OTHER INCOME
2001 2000 DECREASE
------ ------ --------------
Other income, net..................................... $3,996 $7,809 $3,813
</Table>
Other income decreased by $3,813, due principally to the nonrecurrence of a
gain of $4,999 recorded in fiscal 2000 from the settlement of certain pension
obligations to fully vested employees through the purchase of annuity contracts.
<Table>
<Caption>
$ NET MARGIN
2001 2000 DECREASE
-------- ------- ------------
Net margin/(loss).................................... ($50,687) $34,117 ($84,804)
</Table>
The net loss in 2001 was $50,687, as compared to a net margin of $34,117 in
2000, reflecting a decrease in net margin of $84,804. Net margin was unfavorably
impacted from gain on the sale of the lumber and building materials business in
fiscal year 2000, TruServ's significant restructuring charges, the loss of
member retail outlets, and the financing and legal cost related to the debt
covenant violation. These unfavorable impacts to net margin were partially
offset by a better gross margin percentage and the favorable impacts from
TruServ's restructuring initiative.
26
LIQUIDITY AND CAPITAL RESOURCES
In 2001, the Commission issued Financial Reporting Release No. 61, which
sets forth the views of the Commission regarding certain disclosures relating to
liquidity and capital resources. The information provided below describing
TruServ's debt, credit facilities, guarantees and future commitments is included
in order to facilitate a review of TruServ's liquidity.
TruServ generated cash from operating activities for the fiscal year 2002,
2001 and 2000 in the amounts of $104,095, $179,441 and $83,573, respectively.
The cash generated from the decrease in inventory in fiscal year 2002, 2001 and
2000 was $99,528, $100,692 and $38,752, respectively. TruServ generated cash in
2002 and 2001 through initiatives to improve inventory turns and eliminate
excess and/or obsolete inventory, as well as a result of closing regional
distribution centers, which in turn reduced stock levels. In addition, TruServ
initiated several inventory reduction programs to keep inventory levels in line
with a reduction in membership. TruServ generated cash in 2000 principally from
distribution network consolidation to respond to the decline in sales. While not
as significant as the decline that occurred in 2002, TruServ is forecasting a
decline in inventory of $10,000 for 2003, as it continues to improve inventory
turns and assortment and to respond to the decrease in the number of
participating member outlets.
TruServ generated cash from the decrease in accounts and notes receivable
for the fiscal year 2002, 2001 and 2000 in the amount of $32,926, $127,000 and
$52,187, respectively. TruServ's 13 month average member receivable DSO (Days
Sales Outstanding) was 39.7, 43.9 and 41.3 days for 2002, 2001 and 2000,
respectively. The cash improvement in 2002 was related to the improved DSO of
4.2 days. In fiscal 2001, the sale of the lumber and building materials business
significantly impacted both cash generated from accounts and notes receivable
and DSO. The sale of the lumber and building materials business accounted for
approximately $64,000 of cash generated in 2001 and caused the DSO to increase
since that business' average terms were approximately 20 days, which was lower
than TruServ's average DSO. The remaining decrease in accounts and notes
receivable is mainly due to a decline in sales, change in sales mix from direct
sales to warehouse sales, and the implementation of improved collection efforts.
In fiscal 2000, the decrease in accounts and notes receivable is related both to
a decline in sales and to the implementation of improved collection efforts.
The other significant impact in operating activities was in accounts
payable. In fiscal 2002, 2001 and 2000, cash used to fund the decrease in
accounts payable was $52,091, $92,216 and $81,944, respectively, which partially
offset the cash generated from inventory and accounts receivable. The decrease
in fiscal 2002 is primarily due to the lower inventory purchases. The decrease
in fiscal 2001 is partially due to the reduction of lumber vendors resulting
from the sale of the lumber and building materials business, which accounts for
approximately $39,000 of the decrease. The remaining decrease is a result of
lower inventory purchases. The decrease in fiscal 2000 is related both to lower
inventory purchases and to lower accounts and notes receivable related to direct
sales.
TruServ generated cash flows from investing activities for fiscal year 2002
in the amount of $145,960. Cash flows used for investing activities for the
fiscal year 2001 and 2000 were $26,502 and $1,954, respectively. Investing
activities include capital expenditures, proceeds from sales of properties,
restricted cash activities and changes in other assets. Total capital
expenditures, including expenditures under capital leases, were $12,838 for the
fiscal year ended December 31, 2002, as compared to $15,151 and $12,526 for the
fiscal years ended December 31, 2001 and December 31, 2000, respectively.
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. TruServ has forecasted that the
capital expenditure investment for fiscal 2003 will approximate fiscal 2002
spending for capital expenditures. In fiscal 2002, the gross proceeds from the
sale of properties were $127,941, which principally related to the sale
leaseback of seven properties (See Note 13 to the Consolidated Financial
Statements beginning at page F-1) and the sale of the Brookings, South Dakota
distribution center. In fiscal 2001, the proceeds from sale of properties were
$10,511, which were generated from the sale of TruServ Canada Cooperative, Inc.
and the sale of its Indianapolis, Indiana property. In fiscal 2000, the proceeds
from the sale of properties were $23,113. The principal amount of cash generated
in 2000 was from the sale of the lumber and building materials business on
December 29, 2000 in
27
the amount of $13,948. Additionally, TruServ generated additional cash from this
transaction in the amount of $5,164 pursuant to non-competition, cooperation,
lease and other agreements.
Restricted cash consisted of the following at December 31:
<Table>
<Caption>
2002 2001
------- -------
($ IN THOUSANDS)
Letters of credit........................................... $11,691 $11,392
Proceeds from sale of assets available for debt reduction by
the collateral agent...................................... 39 10,906
Lockbox cash management deposit requirements................ 4,025 4,000
Redeemable (subordinated) notes............................. -- 1,746
Escrow...................................................... -- 1,031
------- -------
$15,755 $29,075
======= =======
</Table>
TruServ finances its requirements for letters of credit with cash deposited
and invested at the issuing bank. TruServ partially secures its requirement for
banking services by maintaining invested cash deposits with its cash management
banks. The intercreditor agreement amended in April 2002 with TruServ's lenders
requires TruServ to hold the proceeds from the sale of certain assets in a
restricted cash account invested with the collateral agent to be used for debt
reduction. These proceeds were held by the collateral agent in fiscal 2001 and
distributed after the Senior Debt agreements were amended in April 2002.
TruServ generated cash flows from operating and investing activities in
2002 and from operating activities in 2001 and 2000 and used them primarily for
financing activities. In particular, TruServ applied the cash flow to reducing
its long-term and short-term financing and the level of outstanding checks at
year end, which collectively were $329,870, $79,614, and $67,943 for fiscal year
2002, 2001 and 2000, respectively. In fiscal 2002, short-term borrowings for
financing activities used cash of $113,903, as a result of TruServ maintaining
the revolving credit facility borrowings at $140,000 at December 31, 2001. Of
the $140,000 of borrowings outstanding, $57,000 was held in cash and was
recorded in cash and cash equivalents at December 31, 2001. TruServ is
forecasting an additional paydown of debt of $80,000 in fiscal year 2003.
TruServ plans to refinance its senior debt by March 31, 2004.
TruServ's total debt, including member subordinated notes, whose long-term
component is a component of Members' capitalization, was $256,201 and $514,287
at December 31, 2002 and 2001, respectively. TruServ achieved this reduced level
of debt with cash generated from operations, reduction in excess cash, asset
sales and sale leaseback transaction proceeds. See "Properties -- Sale Leaseback
Transaction."
TruServ's debt consisted of the following at December 31:
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Short-term borrowings....................................... $ 27,852 $141,755
Senior notes................................................ 158,920 279,429
Redeemable (subordinated) term notes........................ 3,296 7,819
Capital lease obligations................................... 1,247 2,678
Promissory (subordinated) and installment notes(1).......... 64,886 82,606
-------- --------
256,201 514,287
Cash and cash equivalents borrowed and available to reduce
debt(2)................................................... -- (57,000)
-------- --------
Adjusted debt outstanding................................... $256,201 $457,287
======== ========
</Table>
- -------------------------
(1) $43,531 and $42,973 of amounts shown as of December 31, 2002 and 2001,
respectively, are reflected in member capitalization on the balance sheet as
of the respective dates.
(2) See "Excess cash" in next table.
28
The change in TruServ's debt balances were as follows for fiscal years
ending December 31:
<Table>
<Caption>
2002 2001
--------- --------
($ IN THOUSANDS)
Beginning balance........................................... $ 514,287 $554,210
Miscellaneous asset sale payments (net of makewhole of
$5,989)................................................... (27,802) --
Sale leaseback payments (net of makewhole of $12,695)(1).... (103,624) --
Excess cash................................................. (57,000) 57,000
Paydown from cash generated from operations, net of other
uses...................................................... (69,660) (96,923)
--------- --------
Ending balance.............................................. $ 256,201 $514,287
========= ========
</Table>
- -------------------------
(1) Excludes prepayments on synthetic lease obligation of $5,119.
TruServ had outstanding borrowings under its revolving credit facility
agreement of $27,852 and $140,000 at December 31, 2002 and 2001, respectively.
The $140,000 outstanding as of December 31, 2001 included approximately $57,000
of cash recorded in cash and cash equivalents that was available to reduce
outstanding borrowings to $83,000. The weighted average interest rate on these
borrowings was 8.3% and 9.9% for the years ended December 31, 2002 and 2001,
respectively. The 2001 average interest rate reflects the inclusion of a 2%
default premium. The 2002 average interest rate includes the impact of 3 primary
factors: the elimination of the 2% default rate as of the April 2002 amendment,
the periodic decline in the prime rate, partially offset by higher base rate and
fees instituted in the April 2002 amendments.
TruServ's Hagerstown, Maryland distribution center is subject to a
synthetic lease. The synthetic lease had a principal balance of $33,383 as of
December 31, 2002, which is due at the end of the amended lease term, which is
the earlier of December 31, 2003 or the termination of the existing revolving
credit facility. This obligation and the original cost of the facility are not
recorded in TruServ's balance sheet because the synthetic lease does not meet
the requirement for capital lease treatment under SFAS No. 13, "Accounting for
Leases." The difference between the lease obligation and management's estimate
of the fair value of the building at December 31, 2002 is approximately $8,183
and is the current balance in the restructuring reserve that was accrued in
Fiscal 2001.
The principal payment schedule for long-term debt, promissory and
installment notes is as follows:
<Table>
<Caption>
2003(1) 2004 2005 2006 2007 THEREAFTER
------- ------- ------- ------- ------- ----------
($ IN THOUSANDS)
Senior notes(1)....................... $34,833 $22,138 $24,852 $24,566 $24,566 $27,965
Redeemable (subordinated) term
notes(2)(3)......................... 3,185 111 -- -- -- --
Capital lease obligations............. 424 441 311 71 -- --
Promissory (subordinate) and
installment notes issued to
members(2).......................... 21,322 19,998 23,565 -- -- --
------- ------- ------- ------- ------- -------
$59,764 $42,688 $48,728 $24,637 $24,566 $27,965
======= ======= ======= ======= ======= =======
</Table>
- -------------------------
(1) In addition to the scheduled principal payments, TruServ is obligated under
the terms of the amended debt agreements to use the net proceeds from the
sale of assets or other non-operating sources to pay to the senior note
holders as well as the revolving credit facility banks their prorata share
of the net proceeds. This will reduce principal amounts outstanding and the
revolver commitment level, respectively. The terms of the revolving credit
facility will accelerate to June 30, 2003 from June 30, 2004, if on that
date, total Senior Debt outstanding, less the aggregate principal amount of
the make-whole notes, is in excess of $270,000, or total Senior Debt
outstanding, less the aggregate principal amount of the make-whole notes,
plus the unused amount of the commitment under the revolving credit
facility, less $30,000, is in excess of $320,000. See Footnote 4 "Long-term
Debt and Borrowing Arrangements" to the Consolidated Financial Statements
beginning at page F-1. At December 31, 2002, the total Senior Debt
outstanding, less the aggregate principal amount of the make-whole notes,
was $167,965 and the related commitments
29
outstanding less $30,000 totaled $253,323. Although the revolver portion of
total Senior Debt outstanding can fluctuate with the seasonal cash flow
requirements of the business, TruServ believes it will maintain a
sufficiently low level of Senior Debt outstanding with cash from operating
activities to continue to meet the June 30, 2003 requirement. Management
currently intends to pursue a refinancing of the existing Senior Debt in the
first half of 2004.
(2) Amounts shown are the scheduled repayments on the subordinated notes.
However, the amended debt agreements limit the aggregate payments on the
subordinated notes to $24,000 in 2002 and $14,000 in 2003. TruServ paid an
aggregate of $17,765 with respect to the subordinated notes in 2002. While
the scheduled repayments on the subordinated notes aggregated $44,244,
TruServ was able, with the consent of the holders thereof, to extend the
maturity date of the other subordinated notes that came due in 2002 and,
thus, comply with the covenant in the amended debt agreements. In 2003,
TruServ expects to again seek the consent of the holders in order to extend
a portion of the notes due in 2003, in order to comply with the amended debt
agreements.
(3) The redeemable (subordinated) term notes have two to four year terms and
were issued in exchange for promissory (subordinated) notes that were held
by promissory note holders who do not own the company's Redeemable Class A
voting common stock. They are also available for purchase by investors that
are affiliated with TruServ.
TruServ intends to both honor the amounts outstanding under the member note
agreements and not exceed the maximum allowable payments of $14,000 in fiscal
2003 under the revolving credit facility and senior note agreements through the
consent of the holders of the member notes, to extend a portion of the notes due
in 2003. If TruServ exceeds the maximum allowable payments of $14,000 in fiscal
2003, or violates any negative covenant, it is an event of default under the
revolving credit facility and senior note agreements. Unless appropriate waivers
were obtained from TruServ's lenders, the amounts due under the revolving credit
facility and senior note agreements could become immediately due and payable or
the agreements could have to be renegotiated. However, there can be no
assurances that TruServ would be able to obtain the requisite waivers or
successfully renegotiate its lending agreements. In the event TruServ was unable
to obtain the requisite waivers or successfully renegotiate its lending
agreements, a material adverse effect on TruServ's liquidity and capital
resources could result.
On December 30, 2002, TruServ amended the Senior Debt agreements that had
previously been amended in April 2002 in order to allow for a sale leaseback
transaction that was completed on December 31, 2002 (the "December 2002
Amendments"). TruServ applied the net proceeds of the sale leaseback
transaction, $121,438, to pay down the Senior Debt, all of whom are parties to
the intercreditor agreement. The net reduction in Senior Debt was $108,743, as a
result of new make-whole notes of $12,695 issued due to the prepayment on senior
notes. The December 2002 Amendments mainly set preliminary financial covenants
to allow for the substantial reduction in debt and the corresponding increase in
rent payments resulting from the sale leaseback transaction. On March 13, 2003,
TruServ amended the Senior Debt agreements that had previously been amended on
December 30, 2002 (the "March 2003 Amendments"). The March 2003 Amendments
primarily finalized the financial covenants resulting from the sale leaseback
transaction and extended the maturity date of the Hagerstown facility's
synthetic lease obligation to the earlier of December 31, 2003 or a refinancing
of the revolving credit facility. See Note 5, "Lease Commitments" and Note 16,
"Subsequent Events" to the Consolidated Financial Statements beginning at page
F-1.
The Senior Debt agreements were previously amended on April 11, 2002, when
TruServ entered into various amendments that eliminated the event of default
created when TruServ failed to comply with a covenant as of February 24, 2001
(the "April 2002 Amendments"). The April 2002 Amendments to the revolving credit
facility extended the term of the facility from June 2002 to June 2004. The
amount of the commitment at the time of amendment was $200,000. The commitment
under the revolving credit facility is permanently reduced by the amount of any
prepayments allocated to and paid on the revolving credit facility.
Borrowings under the revolving credit facility are subject to borrowing
base limitations that fluctuate in part with the seasonality of the business.
The borrowing base formula limits advances to the sum of 85% of eligible
accounts receivable, 50% of eligible inventory, 60% of the appraised value of
eligible real estate and
30
50% of the appraised value of eligible machinery and equipment; availability is
further increased by seasonal over-advances and decreased by reserves against
availability. The revolving credit facility has certain minimum unusable
commitment amounts, which vary based upon the projected seasonal working capital
needs of TruServ. The interest rate on the revolving credit facility was
increased to the prime rate plus 3.25% resulting in a rate of 7.5% as of
December 31, 2002. The unused commitment fee is 0.75% per annum.
Since the April 2002 Amendments, the revolving credit facility commitment
has been permanently reduced to $143,200 at December 31, 2002 due to prepayments
in 2002 from the proceeds of asset sales. TruServ had available, under the
revolving credit facility, approximately $115,300 at December 31, 2002.
The April 2002 Amendments to the various senior note agreements maintained
the existing debt amortization schedules of the various notes. Interest rates on
the notes are at the pre-default rates, which ranged at December 31, 2002 from
10.04% to 11.85%. The senior notes and revolving credit facility amendments also
require initial, quarterly and annual maintenance fees. All of the cash proceeds
from certain asset sales and certain notes receivable; and 80% of any excess
cash flow, as defined in the amended senior notes and revolving credit facility
agreements, are to be used to prepay all parties to these amendments in
accordance with an amended intercreditor agreement.
For 2002, cash proceeds from certain asset sales and notes receivable
totaling $157,312 were used to prepay all parties to the intercreditor
agreement. No additional payment as a result of excess cash flow is required to
be made at this time. The intercreditor agreement establishes how the assets of
TruServ, which are pledged as collateral, are shared and how certain debt
prepayments are allocated among the senior lenders. For the year ended December
31, 2002, the prepayments to senior note holders of $93,915 resulted in
make-whole liabilities of $18,710, which are recorded as additional debt with an
offsetting entry to a prepaid interest account. As previously described, the
$12,695 of make-whole notes from the sale leaseback transaction, is a component
of the $18,710. The prepaid interest account will be amortized to interest
expense over the remaining life of the original notes.
The terms of the senior note agreements, that comprise a portion of the
Senior Debt, have always provided that in the event of early termination or a
prepayment of all or a portion of the notes, make-whole liabilities are
triggered. The nature of the transaction giving rise to the prepayment, the
length of time to maturity of a particular note, the magnitude of the prepayment
relative to the remaining debt outstanding and prevailing market interest rates
relative to the interest rates on the senior notes are factors in determining
the amount of potential make-whole liabilities. In the event of full prepayment
of the senior notes, the entire prepaid interest amount will be immediately
charged to interest expense. Management currently intends to pursue a
refinancing of the existing Senior Debt in the first half of 2004. Management
anticipates significantly lower interest rates upon refinancing. However, based
upon current market interest rate, make-whole expense of a refinancing, before
considering the impact of any negotiations with the senior note holders, could
range up to approximately $27,000, in addition to fully expensing the remaining
prepaid balance of existing make-whole, which was $17,864 at December 31, 2002.
TruServ management negotiated a reduction of approximately 50% in the make-whole
notes when it made prepayments on the senior notes from the proceeds of the sale
leaseback transaction.
The April 2002 Amendments all require TruServ to meet certain restrictive
covenants relating to minimum sales, minimum adjusted EBITDA (earnings before
interest, taxes, depreciation and amortization), minimum fixed charge coverage,
minimum interest coverage and maximum capital expenditures. The senior note
holders may accelerate the due date of their notes, if TruServ does not have a
revolving credit facility in place to fund its seasonal cash flows. As described
above, some of these covenants were adjusted in March
31
2003, as a result of the sale leaseback transaction. TruServ was in compliance
with all of these covenants as of December 31, 2002 as shown in the chart below:
<Table>
<Caption>
RESTRICTIVE COVENANT COVENANT ACTUAL
- -------------------- ---------- ----------
($ IN THOUSANDS)
Minimum sales............................................... $1,975,000 $2,175,451
Minimum adjusted EBITDA..................................... $ 100,000 $ 120,062
Minimum fixed charge coverage............................... 0.70 1.01
Minimum interest coverage................................... 1.75 1.97
Maximum capital expenditures................................ $ 16,000 $ 12,838
</Table>
TruServ believes it will continue to remain in compliance with its debt
covenants. For fiscal 2003, TruServ believes operating results will be
sufficient to comply with the covenants established in the March 2003
Amendments.
The term of the revolving credit facility will accelerate to June 30, 2003
from June 30, 2004, if on that date, total Senior Debt outstanding, less the
aggregate principal amount of the make-whole notes, is in excess of $270,000, or
total Senior Debt outstanding, less the aggregate principal amount of the
make-whole notes, plus the unused amount of the commitment under the revolving
credit facility, less $30,000, is in excess of $320,000. At December 31, 2002,
the total Senior Debt outstanding, less the aggregate principal amount of the
make-whole notes was $167,965 and the related commitments outstanding less
$30,000 totaled $253,323. Although the revolver portion of total Senior Debt
outstanding can fluctuate with the seasonal cash flow requirements of the
business, TruServ believes it will maintain a sufficiently low level of Senior
Debt outstanding with cash from operating activities to meet the June 30, 2003
requirement.
The April 2002 Amendments limit the amount of the cash portion of patronage
dividends to the 20% minimum required to be paid under applicable IRS
regulations in order for TruServ to maintain its status as a cooperative, unless
TruServ's operating performance achieves certain EBITDA targets, in which case,
up to 30% of the patronage dividend may be paid in cash. TruServ exceeded the
EBITDA target for 2002 and, as such, the cash portion of the 2002 patronage
dividend paid in 2003 averaged 30%.
The April 2002 Amendments also require the continuation of the stock
redemption moratorium through June 30, 2004. Further, it is an event of default
under the April 2002 Amendments to exceed certain levels of subordinated note
payments. TruServ did not exceed the maximum payment level of $24,000 in 2002
and, accordingly, was in compliance. In addition, an event of default arises
under the April 2002 Amendments in the event that TruServ fails to comply with
its corporate governance policy requiring the retention by TruServ of at least
two outside directors prior to May 31, 2002, at least four outside directors
prior to September 1, 2002 and at least five outside directors prior to November
1, 2002. As of October 7, 2002, TruServ appointed its fifth outside director
and, as such, TruServ was in compliance with the corporate governance covenant
as of December 31, 2002.
The April 2002 Amendments also contain requirements for other customary
covenants, representations and warranties, funding conditions and events of
default. As of December 31, 2002, and as of the filing date of this Annual
Report on Form 10-K, TruServ was in compliance with all applicable covenants and
has not triggered any events of default.
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 15-50% 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 $2,172 and
$3,966 as of December 31, 2002 and 2001, respectively. The balance of $2,172 as
of December 31, 2002 includes approximately $557 that will mature in fiscal
2003. The remaining guarantees will expire periodically through 2013. TruServ
carries a reserve of $217 relating to these guarantees.
32
Additionally, TruServ sold certain member note receivables to a third party
in 2002, which TruServ has fully guaranteed payment. TruServ is required to pay
off 100% of the outstanding balance of the member note 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
December 31, 2002 was $871. TruServ has recorded a liability and related
receivable for $871 relating to these member notes, and carries an $87 reserve
relating to these guarantees. The balance of $871 as of December 31, 2002
includes approximately $264 that will mature in fiscal 2003. The remaining
guarantees will expire periodically through 2007.
Cash and cash equivalents at December 31, 2002 and 2001 were $9,001 and
$88,816, respectively. As of December 31, 2001 the revolving credit facility
borrowings were at $140,000, which included $57,000 of cash recorded in cash and
cash equivalents that was available to reduce outstanding borrowings to $83,000.
At December 31, 2002, TruServ's working capital was $84,051, as compared to
$25,740 at December 31, 2001, and $91,098 at December 31, 2000. The current
ratio was 1.21 at December 31, 2002, as compared to 1.04 at December 31, 2001,
and 1.12 at December 31, 2000. This increase in both the working capital and the
current ratio between 2002 and 2001 primarily resulted from the reduction of
short-term maturities of senior debt due to a large scheduled debt payment in
2002, as well as a reduction in short term revolver debt resulting from paydowns
from proceeds received from various asset sales in 2002. The decrease in the
working capital between 2001 and 2000 primarily resulted from an increase in
short-term maturities of senior debt in 2001 as noted above, as well as an
increase in accrued liabilities in 2001 from additional restructuring charges.
TruServ believes that its cash from operations and existing credit
facilities will provide sufficient liquidity to meet its working capital needs,
planned capital expenditures and debt obligations due to be repaid in fiscal
year 2003.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60 recently released by the SEC recommends
that all registrants include a discussion of "critical" accounting policies or
methods used in the preparation of financial statements.
TruServ's significant accounting policies are contained in the accompanying
Notes to Consolidated Financial Statements. The financial statements have been
prepared in conformity with generally accepted accounting principles and,
accordingly, include amounts based on informed estimates and judgments of
management with due consideration given to materiality. Accordingly, actual
results could differ from those estimates. The following represents those
critical accounting policies where materially different amounts would be
reported under different conditions or using different assumptions.
- Receivables, net of valuation allowances -- At December 31, 2002,
accounts receivable, net of $8,553 in allowance for doubtful accounts,
were $207,709. The valuation allowance was determined based upon
TruServ's evaluation of known requirements, aging of receivables,
historical experience, the current economic environment and the ability
of TruServ to set off against any unpaid receivable amounts due to
members for stock, notes, interest and declared and unpaid dividends.
While TruServ believes it has appropriately considered known or expected
outcomes, its members' ability to pay their obligations, including those
to TruServ, could be adversely affected by declining sales of hardware at
retail resulting from such factors as contraction in the economy, loss of
memberships or intense competition from chain stores, discount stores,
home centers and warehouse stores.
- Inventory valuation -- At December 31, 2002, inventories, net of $10,434
in valuation reserves, were $234,448, and reflect the reductions from
cost in order to state inventories at the lower of cost or market. The
lower of cost or market valuation considers the estimated realizable
value in the current economic environment associated with disposing of
surplus and/or damaged/obsolete inventories. The estimated realizable
value was based on an analysis of historical trends related to distressed
inventory of TruServ. This analysis considers trends to return
merchandise to suppliers, transfer to other distribution centers, the
sell-down of product through the price reduction process and final
liquidation price. Should the current economic climate significantly
contract further resulting in retailers being
33
unwilling to accept deliveries of advance orders placed (or TruServ
electing not to ship inventories to those retailers where additional
credit risk is not deemed appropriate), unanticipated decline in retail
outlets or a significant contraction in TruServ's warehouse stock
replenishment business for selected product categories, additional
downward valuation adjustments could be required. The potential
additional downward valuation adjustments could result from unanticipated
additional excess quantities of finished goods and raw materials, and/or
from lower disposition values offered by the parties who normally
purchase surplus inventories.
- Goodwill -- At December 31, 2002, the accompanying Consolidated Balance
Sheet reflects $91,474 of goodwill. Goodwill is tested for impairment
using a discounted cash flow analysis by each reporting unit. This test
is completed annually, unless significant events necessitate a more
frequent test. The test completed at December 31, 2002 used a discount
rate of 11.15% and TruServ determined that no impairment exists.
- Deferred tax assets -- At December 31, 2002, the accompanying
Consolidated Balance Sheet reflects $97,685 of deferred tax assets,
principally related to net operating loss carryforwards, deferred gain
recognition and nonqualified notices of allocation. These deferred tax
assets, net of deferred tax liabilities of $2,733, are offset by a full
valuation allowance at December 31, 2002. TruServ had approximately
$70,911 of tax operating loss carryforwards available to offset future
taxable income. In general, such carryforwards must be utilized within 20
years of incurring the net operating loss. At December 31, 2002, TruServ
concluded that, based on the weight of available evidence, it is more
likely than not that the deferred tax assets will not be realized, and
that a full valuation allowance is required. Deferred tax assets will
only be realized to the extent future earnings are retained by TruServ
and not distributed to members as patronage dividends.
- Accrued expenses -- At December 31, 2002, the accompanying Consolidated
Balance Sheet reflects $84,082 of accrued expenses, principally related
to restructuring, pension, health and other benefits. TruServ utilized
current real estate market values in writing down the value of the East
Butler, Pennsylvania facility. TruServ will exit its operations in that
facility during 2003, and that facility is for sale. TruServ also used
current real estate market values in adjusting its obligation under a
synthetic lease related to the Hagerstown, Maryland distribution center,
which is closed and is for sale. Should real estate values continue to
decline, an additional provision may be required. Additionally, TruServ
works with an actuarial firm in the valuation of benefit obligations.
TruServ selects certain actuarial assumptions on which to base the
calculation of the actuarial valuation of the obligation, such as the
discount rate (interest rate used to determine present value of
obligations payable in the future), medical trend rate, expected return
on assets and mortality tables to determine the expected future benefit
obligations. The discount rate was based on an analysis of bond rates
with terms that have similar durations as the pension liabilities. The
medical trend rate was based on an analysis of inflation rates and
medical inflation rates and the long-term trend for these rates. The
expected return on assets was based on an analysis of historical real
returns on TruServ's portfolio mix over 30 year periods. This analysis
created a range of rates that were adjusted for a future inflation factor
and the impact for trust fees and the rate used is within this range of
rates. To the extent that the actual rates and mortality vary from the
assumptions used to determine the present actuarial valuation of these
benefits, additional provision for expense may be necessary.
NEW ACCOUNTING PRONOUNCEMENTS
In January 2002, TruServ adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." See Note 1
"Description of Business and Accounting Policies" to the Consolidated Financial
Statements beginning at page F-1.
In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
34
costs. SFAS No. 143 is effective January 1, 2003 for TruServ. TruServ is
currently evaluating the impact this standard will have on its financial
statements, but does not expect the impact of its adoption to be material.
In January 2002, TruServ adopted SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets," replacing SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" and
portions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting the
Results of Operations." SFAS No. 144 provides a single accounting model for
long-lived assets to be disposed of and changes the criteria to be met to
classify an asset as held-for-sale. SFAS No. 144 retains the requirement of APB
Opinion No. 30 to report discontinued operations separately from continuing
operations and extends that reporting to a component of an entity that either
has been disposed of or is classified as held-for-sale. The adoption of this
standard did not have a material impact on TruServ's financial position or
results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS 4, 44 and
64, Amendment of FAS 13 and Technical Corrections as of April 2002." SFAS No.
145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt" (eliminating the extraordinary treatment of gains or losses on debt
modification other than for certain exceptions), rescinds SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," amends SFAS
No. 13, "Accounting for Leases" (to eliminate an inconsistency between the
required accounting for sale leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale leaseback transactions) and amends other existing authoritative
pronouncements (to make various technical corrections, clarify meanings or
describe their applicability under changed conditions). SFAS No. 145 is
effective for TruServ for fiscal 2003 but earlier application is encouraged.
TruServ is currently evaluating the impact this standard will have on its
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The principal
difference between SFAS No. 146 and EITF Issue No. 94-3 relates to the
requirement for recognition of a liability for a cost associated with an exit or
disposal activity. SFAS No. 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized only when the liability is
incurred; under EITF Issue No. 94-3, a liability for an exit cost, as defined in
EITF Issue No. 94-3, was recognized at the date of an entity's commitment to an
exit plan. SFAS No. 146 also requires that a liability for a cost associated
with an exit or disposal activity be recognized and measured initially at fair
value and only when the liability is incurred. SFAS No. 146 is effective for
TruServ for any exit or disposal activities undertaken after December 31, 2002
but earlier application is encouraged.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others."
Interpretation No. 45 requires the disclosure of certain guarantees existing at
December 31, 2002. In addition, Interpretation No. 45 requires the recognition
of a liability for the fair value of the obligation of qualifying guarantee
activities that are initiated or modified after December 31, 2002. Accordingly,
TruServ has disclosed certain guarantees that existed at December 31, 2002 in
this Annual Report on Form 10-K and will apply the recognition provisions of
Interpretation No. 45 prospectively to guarantee activities initiated after
December 31, 2002. See Note 6 to the Consolidated Financial Statements beginning
at page F-1 for a further discussion of guarantees.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
($ IN THOUSANDS)
TruServ's operations are subject to certain market risks, primarily
interest rate risk and credit risk. Interest rate risk pertains to TruServ's
variable rate debt with a borrowing ceiling of $143,200 at December 31, 2002;
approximately $27,852 was outstanding at December 31, 2002. A 50 basis point
movement in interest rates would result in an approximate $139 annualized
increase or decrease in interest expense and cash flows
35
based on the outstanding balance at December 31, 2002. For the most part,
TruServ manages interest rate risk through a combination of variable and
fixed-rate debt instruments with varying maturities. Credit risk pertains
primarily to TruServ's trade receivables. TruServ extends credit to its members
as part of its day-to-day operations. TruServ believes that as no specific
receivable or group of receivables comprises a significant percentage of total
trade accounts, its risk in respect to trade receivables is limited.
Additionally, TruServ believes that its allowance for doubtful accounts is
adequate with respect to member credit risks. TruServ has no investments in
derivative instruments and performs no speculative hedging activities. TruServ
does not have any special purpose entities ("SPE's") and all related party
transactions (i.e., transactions with members) are at arm's length.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
($ IN THOUSANDS)
TruServ's consolidated financial statements and report of independent
accountants are listed in the index on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
DIRECTORS AND EXECUTIVE OFFICERS
The directors and senior executive officers (officers who report directly
to the CEO) of TruServ are:
<Table>
<Caption>
POSITIONS HELD AND
NAME AGE BUSINESS EXPERIENCE
---- --- -------------------
Bryan R. Ableidinger............... 54 Chairman-Elect to take office after the 2003 annual
stockholders' meeting, April 29, 2003. Director since
August 2000. Owner/operator of retail hardware business.
Cathy C. Anderson.................. 53 Senior Vice President, General Counsel and Secretary since
February 17, 2003. Previous position was Executive Vice
President, General Counsel and Secretary, Alliant
Foodservice, Inc. 1995 - 2002.
Laurence L. Anderson............... 61 Director since April 2002. Consultant for Associated
Wholesale Grocers. Prior positions include Executive
Vice-President and President of Super Kmart, President and
Chief Operating Officer of retail food companies for
SuperValu, Inc.
Joe W. Blagg....................... 53 Chairman since January 2000. Director since April 1996.
Owner/operator of retail hardware business. Acting Chief
Executive Officer from July 3, 2001 to November 16, 2001.
Michael Glode...................... 53 Nominated to the Board of Directors and will stand for
election at the 2003 annual stockholders' meeting.
Owner/operator of retail hardware business.
William F. Godwin.................. 48 Senior Vice President, Merchandise Supply Chain since March
2001. Prior positions were Vice President, Merchandise
Supply Chain, from 2000 to 2001, Vice President, Inventory
Management from 1998 to 2000, and Vice President
Merchandising, from 1997 to 1998.
</Table>
36
<Table>
<Caption>
POSITIONS HELD AND
NAME AGE BUSINESS EXPERIENCE
---- --- -------------------
Thomas S. Hanemann................. 63 Director since October 2002. Chief manager of Chander-
Hanemann, L.L.C. Prior positions include President and
Director of AutoZone and President of Super D Drugstores, a
division of Malone & Hyde.
Judith S. Harrison................. 49 Director since August 2002. Principal of and Senior
Consultant for WayPoint Partners, Inc. Prior positions
include Chief Executive Officer of Zanybrainy.com,
President of Cigar Enterprises and, President and Chief
Executive Officer of the Monet Group.
Neil A. Hastie..................... 54 Senior Vice President, Chief Information Officer since
December 1999. Prior position was Director of E-Business
since 1998.
Peter G. Kelly..................... 59 Vice-Chairman since April 2002. Director since July 1997.
Owner/operator of retail hardware business. Formerly
director of ServiStar/Coast to Coast since January 1982 and
Chairman from 1990 to 1997. Formerly co-Vice Chairman for
TruServ from 1997 to 1999.
Fred Kirst......................... 51 Vice President of Maintenance, Repair and Operations niche
business since December 12, 2001. Previous positions were
Vice President, Advertising and Merchandising, April
2001 - December 2001; Vice President, Global Development
and Emerging Business, June 2000 - March 2001; Assistant
Vice President, International, March 1997 - May 2000.
Robert J. Ladner................... 56 Director since April 1994. Owner/operator of retail
hardware business. Formerly Chairman of Cotter & Company
from 1996 to 1997. Formerly co-Vice Chairman of TruServ
from 1997 to 1999. Will not stand for re-election at the
2003 annual stockholders' meeting.
Pamela Forbes Lieberman............ 48 President and Chief Executive Officer and Director since
November 16, 2001. Prior positions with TruServ were Senior
Vice President, Chief Operating Officer and Chief Financial
Officer since July 3, 2001, Senior Vice President and Chief
Financial Officer since April 18, 2001 and Senior Vice
President, Finance since March 12, 2001. Previous positions
were Senior Vice President, Finance and Chief Financial
Officer of Shoptalk, Inc. and of Martin-Brower Company and
Vice-President Finance and Chief Financial Officer of
Fel-Pro Incorporated.
Amy W. Mysel....................... 50 Vice President of Human Resources since September 2002.
Former position was Executive Vice President, Human
Resources, Planning and Communication for Market Day, Inc.
1996 - 2002.
Michael D. Rosen................... 50 Senior Vice President of Sales and Manufacturing since
January 2003. Prior positions were Senior Vice President of
Distribution and Logistics, from 2000 to 2002, Vice
President of Logistics and Retail Systems, from 1999 to
2000, Assistant Vice President of Retailing and Assistant
Vice President of Merger Administration, from 1997 to 1999.
</Table>
37
<Table>
<Caption>
POSITIONS HELD AND
NAME AGE BUSINESS EXPERIENCE
---- --- -------------------
David Y. Schwartz.................. 62 Director since April 2002. Retired Senior Partner and
Managing Partner of the Chicago Office Audit and Business
Consulting Practice for Arthur Andersen through 1997. He is
also a member of the board of directors of Walgreen Co. and
Foot Locker, Inc. and sits on the boards of several
privately held companies.
David A. Shadduck.................. 42 Senior Vice President and Chief Financial Officer since
November 20, 2001. Prior position with TruServ was Vice
President, Corporate Controller since June 2001. Prior
positions were Controller for Tenneco Automotive North
American Aftermarket and Controller for Original Equipment
Business at Fel-Pro Incorporated.
George V. Sheffer.................. 50 Director since July 1994. Owner/operator of retail hardware
business. Will not stand for re-election at the 2003 annual
stockholders' meeting.
Gilbert L. Wachsman................ 55 Director since March 2002. Retired Vice Chairman and
Director of Musicland Group, Inc. Prior position was Senior
Vice President of Kmart Corporation.
Charles W. Welch................... 52 Nominated to the Board of Directors and will stand for
election at the 2003 annual stockholders' meeting.
Owner/operator of retail hardware business.
Carol Wentworth.................... 45 Vice president of Marketing and Advertising since June
2002. Previous positions include Vice President of Sales
Promotion and Marketing and Assistant Vice President of
Sales Promotion at Fred Meyer, in Portland Oregon.
</Table>
- ---------------
Each current director's term expires at the 2003 annual stockholders' meeting.
BOARD AUDIT COMMITTEE
The audit committee of TruServ's board of directors is comprised of four
non-employee members plus the Chairman of the Board as an ex officio member.
David Y. Schwartz is the "audit committee financial expert" serving on the audit
committee. Mr. Schwartz is an independent member of the board of directors of
TruServ, as that term is used in Item 7 (d) (3) (iv) of Schedule 14A under the
Exchange Act and is defined in Section 303.01 (B) (2) (a) and (3) of the New
York Stock Exchange, Inc. Listed Company Manual.
CODE OF ETHICS
TruServ has adopted a code of ethics that applies to its principal
executive officer, principal financial officer, principal accounting officer or
controller and any other person performing a similar function. The code of
ethics has been filed as an exhibit to this Annual Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION.
COMPENSATION COMMITTEE
The Compensation Committee of the board of directors consists of four
non-employee directors plus the Chairman of the Board as an ex officio member.
The committee assists the board of directors in fulfilling its responsibilities
for setting and administering the policies which govern annual compensation and
monitoring TruServ's pension and other benefit plans. The committee, which meets
regularly, calls upon outside consultants for assistance in carrying out its
obligations.
The philosophy of the committee is to maintain an executive compensation
program to help TruServ attract, retain and motivate the executive resources
needed to maintain industry leadership, provide high levels
38
of service to members and achieve the financial objectives determined by the
board of directors. The committee sets performance goals, assesses achievement
relative to the performance goals and recommends to the board salary, bonus or
retention incentives and long-term incentives for the senior executives of
TruServ.
To achieve its goals, the committee has developed three executive
compensation policies for TruServ:
- Salaried compensation should be competitive with the median for
executives of companies of a comparable size within TruServ's industry;
- Annual incentive compensation should vary and reflect TruServ's
performance; and
- A long-term (multiple year) incentive program should be available to help
TruServ retain selected executives.
The combination of these three compensation policies is intended to provide
competitive earning opportunities when performance reaches desired levels. Both
the annual and long-term incentive plans may be terminated by the board of
directors at any time. The annual incentive and long-term components of the
total compensation package are accrued for during the year in which they are
earned based upon a forecast of the year's performance. A final computation is
made in the year following the year in which the incentives are earned. The
annual incentive, if earned, will be paid out on or before March 31st of the
following year. Any potential payout on the long-term incentive plan would not
occur until March 31st following the last year of a performance cycle and the
cumulative performance over the performance period of these two and three year
plans has met the required achievement, at least at the threshold level.
TruServ provides salary levels that are intended to fall within the median
(between the 50th and 60th percentile) of the executive marketplace of
comparable size in TruServ's industry. The following types of organizations are
considered within TruServ's industry: member-owned organizations, wholesale
distribution firms, mass merchandising retail firms and general manufacturing
organizations. Competitiveness is measured using data from a number of sources,
including published information, proxy statements and surveys by consulting
firms.
The 2002 compensation of Pamela Forbes Lieberman, TruServ's President and
Chief Executive Officer, consisted of a base salary of $650,000, effective April
1, 2002. This amount is comparable to base salaries for persons holding this
position at companies of comparable size within TruServ's industry. The
incentive component of Ms. Forbes Lieberman's compensation was set by the
compensation committee to reflect the achievement of TruServ's performance goals
determined by the committee, including the attainment of targets for product
fill rates, net sales, and working capital interest rate adjusted earnings
before income taxes, depreciation and amortization (EBITDA) together with
individual goals relating to completion of a strategic plan, with member
satisfaction improvement and with corporate culture change. The annual incentive
portion of the 2002 compensation to be paid to Ms. Forbes Lieberman will be paid
out on or before March 31, 2003. There are no long-term compensation payments
scheduled to be paid out in 2003 for her performance in 2002 or earlier.
The Compensation Committee, appointed following the 2002 annual
stockholders' meeting of May 2002, with the addition of Judith S. Harrison upon
her joining the Board in August 2002, is as follows:
COMPENSATION COMMITTEE
Gilbert L. Wachsman, Chairman
Judith S. Harrison
Peter G. Kelly
Robert J. Ladner
Joe W. Blagg (ex officio)
39
EXECUTIVE COMPENSATION
The following table sets forth the total annual compensation earned by
individuals serving as TruServ's Chief Executive Officer and the four most
highly compensated executive officers of TruServ during fiscal year 2002 and the
total compensation earned by each such individual for TruServ's two previous
fiscal years:
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
NAME AND OTHER
PRINCIPAL POSITION YEAR SALARY(1) BONUS(2) COMPENSATION(3)
------------------ ---- --------- -------- ---------------
Pamela Forbes Lieberman........................... 2002 $643,750 $531,000 $53,402
President, Chief Executive Officer 2001 318,868 211,657 22,756
and Director 2000 -- -- --
Robert Ostrov..................................... 2002 310,500 129,256 51,752
Senior Vice President, Chief Administrative 2001 308,250 180,285 31,080
Officer and General Counsel 2000 264,080 172,550 31,036
William F. Godwin................................. 2002 293,000 150,916 32,373
Senior Vice President, 2001 266,249 159,808 22,867
Merchandise Supply Chain 2000 233,145 122,400 22,921
David A. Shadduck................................. 2002 266,500 205,735 28,067
Senior Vice President and 2001 124,964 96,690 11,707
Chief Financial Officer 2000 -- -- --
Neil A. Hastie.................................... 2002 267,000 133,676 39,517
Senior Vice President and 2001 246,000 153,763 24,633
Chief Information Officer 2000 206,251 119,250 27,705
</Table>
- ---------------
(1) Earned and paid in fiscal year shown.
(2) Annual incentive amounts are earned and accrued during the fiscal years
indicated, and paid subsequent to the end of each fiscal year. To attain
achievement of the business plan objectives necessary to turn TruServ
around, the board of directors approved effective January 1, 2002, a key
associate annual incentive plan for identified key associates and officers
employed by TruServ in 2002 or joined TruServ by September 30, 2002, who
remained employed through the payment date of the plan (on or before March
31, 2003). To attain achievement of the business plan objectives necessary
to obtain financing necessary to turn TruServ around, the board of directors
approved, effective August 1, 2001 for the five month period ending December
31, 2001, a key associate special retention and restructuring incentive plan
for identified key associates and officers employed by TruServ on or after
August 1, 2001 who remained employed through the payment date of the plan
(subsequent to the filing of the 2001 Annual Report on Form 10-K). Both the
2002 and 2001 incentive plans had targets related to fill rates, sales,
EBITDA, and individual-specific goals associated with one or more of
TruServ's key initiatives established as of the effective date of each
respective plan. In fiscal 2000, a bonus was earned and paid in fiscal 2001
as a result of TruServ's improved service levels to members.
(3) Other compensation consists of TruServ's contributions to the TruServ
Corporation Employee's Savings and Compensation Deferral Plan (the "401k
Plan"), life insurance plan, financial planning services and automobile
allowances. Under the 401k Plan, each participant may elect to make a
contribution in an amount of up to 50% of her/his annual compensation, not
to exceed $40,000 (including TruServ's contributions) per year, of which
$11,000 (in 2002) and $10,000 (in 2001 and 2000) of the executive officer's
salary in any fiscal year may be deferred. TruServ's contribution to the
401k Plan, from January 1 through June 30 of 2000, was equal to 75% of the
participant's contribution, but not to exceed 4 1/2% of the participant's
annual compensation. Effective July 1, 2000, the 401k Plan was amended to
apply only a profit sharing match tied to TruServ's net earnings. Robert
Ostrov, William F. Godwin and Neil A. Hastie did earn a profit sharing match
for the second half of fiscal 2000 that was paid in March 2001. Officers and
associates did not earn a profit sharing match for fiscal 2001. In 2002, as
TruServ achieved its targeted EBITDA, under its 401k Plan, there will be a
match equaling two thirds of a participant's
40
contribution, up to a total of 4% of the participant's annual compensation.
Such match will be funded by March 31, 2003.
TruServ has a severance policy providing termination benefits based upon
annual compensation and years of service. Officers of TruServ are also offered
agreements providing for severance in the event of termination without cause
with the imposition of certain restrictions regarding competition and
confidentiality. The officer severance agreements provide for 12 months, 18
months or 24 months of base compensation based on length of service.
No loans were made by TruServ to its executive officers or to its directors
during the last three fiscal years.
BOARD COMPENSATION
In 2002, directors of TruServ (except the Chairman and Vice Chairman) were
each paid $30,000 per year. The Chairman of the Board was paid $100,000 in
consideration for his services as chairman and the Vice-Chairman of the Board
was paid $54,000 in consideration for his services as vice chairman for 2002.
Committee Chairmen were each paid $5,000 per year, in addition to their annual
retainer. Each director receives a payment for attending meetings that range
from $500 - $1,500 per meeting, along with reimbursement of travel expenses.
The President and Chief Executive Officer does not receive additional
compensation for serving in the capacity of director.
DEFINED BENEFIT RETIREMENT PLANS
TruServ has a defined benefit pension plan, the TruServ Corporation Defined
Lump Sum Pension Plan, which is qualified under the Internal Revenue Code. The
plan was amended and restated effective January 1, 1998 (including amendments
effective after January 1, 1998 where indicated). The amount of TruServ's annual
contribution to the plan is determined for the total of all participants covered
by the plan, and the amount of payment with respect to a specified person is not
and cannot readily be separated or individually calculated by the actuaries for
the plan. The plan provides fully vested lump sum benefits to eligible employees
who have been employed a minimum of five years. Annuities are also available and
are the actuarial equivalent of the lump sum payment. Each of the executive
officers listed in the foregoing Summary Compensation Table is a participant in
the plan.
In accordance with the Defined Lump Sum Pension Plan as amended and
restated as of February 28, 2002 for each year of service, a participant
receives a percentage of his or her "average compensation" in the form of a lump
sum. The percentages range from one percent of average compensation for years of
service performed prior to age 26 to nine percent of average compensation for
years of service performed at or after age 56, for service after December 31,
2001. For service prior to January 1, 2002 the percentages range from two
percent of average compensation for years of service performed prior to age 26
to twelve percent of average compensation for years of service performed at or
after age 61. Participants with average compensation in excess of two-thirds of
the Social Security Taxable Wage Base in the year of termination of employment
or retirement receive an additional benefit on this excess compensation equal to
half of the percentage earned as of December 31, 2001. For participants who had
attained age 50 and completed at least fifteen years of service as of January 1,
1996, the sum of their annual pension credit percentage is increased by 25
percentage points. The benefits under the plan cannot be less than the benefits
already earned by the participant under the plan as it existed prior to its
amendment.
The plan was amended effective January 1, 1998 to include former employees
of ServiStar/Coast to Coast (SCC). These employees received credit under the
plan for all years for which they received credit under the ServiStar/Coast to
Coast Retirement Income Plan (the "ServiStar Plan"). In addition, for any
ServiStar (but not Coast to Coast) employees who had attained age 50 and
completed at least 15 years of service as of January 1, 1998, the sum of their
annual pension credit percentage is increased by 25 percentage
41
points. Also, the benefits under this plan cannot be less than benefits already
earned by the participant under the ServiStar Plan as of December 31, 1997.
"Average compensation" means the average of the compensation paid to an
eligible employee during the three highest calendar years within the ten
calendar years immediately preceding the date of termination of employment.
Compensation considered in determining benefits includes salary, overtime pay,
commissions, bonuses, deferral contributions under the Savings Plan and pre-tax
medical premiums.
The estimated annual retirement benefits which may be payable pursuant to
the qualified plan to the officers named in the Summary Compensation Table is
currently limited under Section 401(a)(17) of the Internal Revenue Code, which
outlines the maximum earnings amounts which may be considered under the
qualified plan in determining retirement benefits. This limit was $200,000 for
2002. Section 415 of the Internal Revenue Code outlines the maximum annual
benefit which may be payable from the qualified plan during the year, the dollar
limit is $160,000 for 2002 for a participant retiring at age 65, with reduced
amounts at younger ages. The actuarial equivalent of the annual amount may be
payable as a lump sum.
No year of service will be credited to any participant for any period of
employment with Coast to Coast, Inc. occurring prior to July 1, 1996 or any
period of employment with Advocate Services, Inc. occurring prior to January 1,
1998.
TruServ maintains a Supplemental Retirement Plan for employees in the
position of Vice President and above. The supplemental plan provides
participants with a benefit equal to 33% of their "average compensation"
multiplied by their years of service, reduced by any benefits payable under the
qualified plan. Service is limited to 20 years and the maximum aggregate
percentage is 660%. "Average Compensation" for the supplemental plan is defined
similarly to the qualified plan, as discussed above. Benefits are payable in a
lump sum following termination of employment.
The supplemental plan is not a qualified plan under the Internal Revenue
Code. Benefits payable under the supplemental plan are financed through
operations.
The following table reflects the combined estimated annual retirement
benefits which may be payable pursuant to the qualified plan and the
supplemental plan to the officers named in the Summary Compensation Table at
retirement under various assumed conditions, assuming retirement at age 65.
<Table>
<Caption>
YEARS OF SERVICE
AVERAGE -----------------------------------------
COMPENSATION 5 10 15 20
------------ -------- -------- -------- --------
$1,500,000......................................... $209,141 $418,283 $627,424 $836,566
1,450,000......................................... 202,170 404,340 606,510 808,680
1,400,000......................................... 195,199 390,397 585,596 780,794
1,350,000......................................... 188,227 376,454 564,682 752,909
1,300,000......................................... 181,256 362,512 543,768 725,023
1,250,000......................................... 174,284 348,569 522,853 697,138
1,200,000......................................... 167,313 334,626 501,939 669,252
1,150,000......................................... 160,342 320,683 481,025 641,367
1,100,000......................................... 153,370 306,741 460,111 613,481
1,050,000......................................... 146,399 292,798 439,197 585,596
</Table>
42
<Table>
<Caption>
YEARS OF SERVICE
AVERAGE -----------------------------------------
COMPENSATION 5 10 15 20
------------ -------- -------- -------- --------
1,000,000......................................... 139,428 278,855 418,283 557,710
950,000......................................... 132,456 264,912 397,369 529,825
900,000......................................... 125,485 250,970 376,454 501,939
850,000......................................... 118,513 237,027 355,540 474,054
800,000......................................... 111,542 223,084 334,626 446,168
750,000......................................... 104,571 209,141 313,712 418,283
700,000......................................... 97,599 195,199 292,798 390,397
650,000......................................... 90,628 181,256 271,884 362,512
600,000......................................... 83,657 167,313 250,970 334,626
550,000......................................... 76,685 153,370 230,056 306,741
500,000......................................... 69,714 139,428 209,141 278,855
450,000......................................... 62,742 125,485 188,227 250,970
400,000......................................... 55,771 111,542 167,313 223,084
</Table>
The present credited years of service for the officers listed in the above
table are as follows: William F. Godwin, 7.5 years; Neil Hastie, 5.0 years;
Pamela Forbes Lieberman, 1.8 years; Robert Ostrov, 5.9 years (Robert Ostrov's
last day of employment with TruServ was February 14, 2003); David Shadduck, 1.6
years.
PERFORMANCE GRAPH
There is no existing market for TruServ's common stock and there is no
expectation that any market will develop. There are no broad market or peer
group indices TruServ believes would render meaningful comparisons. Accordingly,
a performance graph of TruServ's cumulative total stockholder return for the
previous five years, with a performance indicator of the overall stock market
for TruServ's peer group, has not been prepared.
EMPLOYMENT AND SEPARATION AGREEMENTS
On November 15, 2001, TruServ entered into an employment agreement
effective November 16, 2001 with Pamela Forbes Lieberman, in connection with her
assuming the duties of President and Chief Executive Officer of TruServ. The
employment agreement specifies that Ms. Forbes Lieberman will serve in those
capacities at the will of the board of directors.
Pursuant to the employment agreement, the Board of Directors awarded to Ms.
Forbes Lieberman an annual base salary of $650,000 effective April 1, 2002. In
addition, Ms. Forbes Lieberman will be eligible for an annual incentive, if and
when approved by the board of directors of TruServ. At achievement of pre-
established targets, the annual incentives are in an amount of 60% of her base
salary for year 2001 and 70% of her base salary for calendar years thereafter.
There are thresholds and maximums for each year. In addition, Ms. Forbes
Lieberman will be eligible to receive a long-term incentive of 50% of her annual
base salary if TruServ meets a certain threshold financial performance level,
100% of her annual base salary if TruServ attains a targeted financial
performance level with a maximum 150% of her annual base salary at the specified
maximum performance level. See "Summary Compensation Table" under the item
"Executive Compensation" for the amount of salary and incentive earned by Ms.
Forbes Lieberman in 2002 and 2001. None of the TruServ officers earned long-term
incentive compensation in or for 2001. Long-term compensation was earned by Ms.
Forbes Lieberman and other officers of TruServ for year 2002 performance and,
accordingly, was accrued for. Any ultimate payout is based upon cumulative
performance over the performance period of these multi-year plans. Any potential
payout would not occur until March 31st following the last year of a performance
cycle. The first such payout could occur in March 2004 but is dependent on the
aggregate of performance in 2002 and 2003. Ms. Forbes Lieberman is also eligible
to participate in the other benefit plans available from time to time to
executives of TruServ.
In the event that TruServ terminates Ms. Forbes Lieberman's employment
without "cause," she is entitled to receive a severance payment, payable over 24
months, in an amount equal to two times her base
43
salary, but only if she signs a release of claims against TruServ and agrees to
comply with certain obligations upon her departure. "Cause" includes her
inability or unwillingness to perform the material duties of her position or her
performance of any action injurious to TruServ.
If within one year following a "change of control" of TruServ, Ms. Forbes
Lieberman terminates her employment with TruServ for "good reason," she may be
entitled to a severance payment equal to an amount up to two times her base
salary and, in certain cases, a percentage of incentives received in prior
years, but only if she signs a release and agrees to comply with certain
obligations upon her departure. "Change of control" is defined as a business
combination through a merger, consolidation or share exchange in which TruServ
or its shareholders after the combination do not own 51% or more of the voting
equity of the entity. "Good reason" is defined to include a demotion or a
substantial reduction in compensation and benefits within a year after the
change of control.
On February 14, 2003, Robert Ostrov resigned from the position of Senior
Vice President, Chief Administrative Officer and Secretary of TruServ. Pursuant
to the terms of his termination agreement with TruServ, Mr. Ostrov is entitled
to receive $566,000 as severance pay to be paid over two years. In addition,
TruServ will pay certain of Mr. Ostrov's retirement benefits within 45 days of
the effective date of the termination agreement. The termination agreement also
provides for certain medical insurance coverage and outplacement services of the
kind provided to other former senior executives of TruServ. Mr. Ostrov in the
termination agreement, provides TruServ among other things, with a general
release, a covenant not to sue, a confidentiality covenant, a non-solicitation
covenant, a cooperation covenant and an indemnification agreement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
As of February 22, 2003, each of the member directors of TruServ was the
owner of at least 60 shares of Class A common stock of TruServ (but no more than
300 shares), constituting in the aggregate less than 1% of the issued and
outstanding shares of Class A Common Stock. No non-member director or senior
officer owns any shares of Class A common stock.
The member directors own, in the aggregate, less than 1% of Class B common
stock as of February 22, 2003. No non-member director or senior officer owns any
shares of Class B common stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
None
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(A) 1. FINANCIAL STATEMENTS
The consolidated financial statements listed in the index on page
F-1 are filed as part of this annual report.
2. FINANCIAL STATEMENT SCHEDULES
The schedule listed in the index on page F-36 is filed as part of
this annual report.
3. EXHIBITS
The exhibits listed in the index on pages E-1-E-4 are filed as part
of this annual report.
(B) REPORTS ON FORM 8-K
A Current Report on Form 8-K was filed on October 8, 2002 regarding
the appointment of TruServ's fifth outside director.
A Current Report on Form 8-K was filed on November 4, 2002
regarding third quarter earnings.
A Current Report on Form 8-K was filed on November 12, 2002
containing revised Statements of Oath of TruServ's principal
executive officers.
A Current Report on Form 8-K was filed on November 20, 2002
regarding October earnings.
44
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS ANNUAL REPORT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
TRUSERV CORPORATION
By: /s/ DAVID A. SHADDUCK
-------------------------------------
David A. Shadduck
Senior Vice President and Chief
Financial Officer
DATED: March 21, 2003
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
ANNUAL REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ JOE W. BLAGG Chairman of the Board and March 21, 2003
- ----------------------------------------------------- Director
Joe W. Blagg
/s/ PAMELA FORBES LIEBERMAN President, Chief Executive March 21, 2003
- ----------------------------------------------------- Officer and Director
Pamela Forbes Lieberman
/s/ DAVID A. SHADDUCK Senior Vice President and March 21, 2003
- ----------------------------------------------------- Chief Financial Officer
David A. Shadduck
/s/ BRYAN R. ABLEIDINGER Director March 21, 2003
- -----------------------------------------------------
Bryan R. Ableidinger
/s/ LAURENCE L. ANDERSON Director March 21, 2003
- -----------------------------------------------------
Laurence L. Anderson
/s/ THOMAS S. HANEMANN Director March 21, 2003
- -----------------------------------------------------
Thomas S. Hanemann
/s/ JUDITH S. HARRISON Director March 21, 2003
- -----------------------------------------------------
Judith S. Harrison
/s/ PETER G. KELLY Director March 21, 2003
- -----------------------------------------------------
Peter G. Kelly
/s/ ROBERT J. LADNER Director March 21, 2003
- -----------------------------------------------------
Robert J. Ladner
/s/ DAVID Y. SCHWARTZ Director March 21, 2003
- -----------------------------------------------------
David Y. Schwartz
</Table>
45
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GEORGE V. SHEFFER Director March 21, 2003
- -----------------------------------------------------
George V. Sheffer
/s/ GILBERT WACHSMAN Director March 21, 2003
- -----------------------------------------------------
Gilbert Wachsman
</Table>
46
CERTIFICATION
I, Pamela Forbes Lieberman, certify that:
1. I have reviewed this annual report on Form 10-K of TruServ
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of TruServ as of, and for, the periods presented in this annual
report;
4. TruServ's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for TruServ and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to TruServ, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b. evaluated the effectiveness of TruServ's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. TruServ's other certifying officer and I have disclosed, based on
our most recent evaluation, to TruServ's auditors and the audit committee
of TruServ's board of directors:
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect TruServ's ability to
record, process, summarize and report financial data and have identified
for TruServ's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in TruServ's internal
controls; and
6. TruServ's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
TRUSERV CORPORATION
By: /s/ PAMELA FORBES LIEBERMAN
------------------------------------
Pamela Forbes Lieberman
President and Chief Executive
Officer
Date: March 21, 2003
47
CERTIFICATION
I, David A. Shadduck, certify that:
1. I have reviewed this annual report on Form 10-K of TruServ
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly present in all
material respects the financial condition, results of operations and cash
flows of TruServ as of, and for, the periods presented in this annual
report;
4. TruServ's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for TruServ and have:
a. designed such disclosure controls and procedures to ensure that
material information relating to TruServ, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b. evaluated the effectiveness of TruServ's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. TruServ's other certifying officer and I have disclosed, based on
our most recent evaluation, to TruServ's auditors and the audit committee
of TruServ's board of directors:
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect TruServ's ability to
record, process, summarize and report financial data and have identified
for TruServ's auditors any material weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management or
other employees who have a significant role in TruServ's internal
controls; and
6. TruServ's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
TRUSERV CORPORATION
By: /s/ DAVID A. SHADDUCK
------------------------------------
David A. Shadduck
Senior Vice President and
Chief Financial Officer
Date: March 21, 2003
48
ITEM 14(a)(1). INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.
<Table>
<Caption>
PAGE(S)
-------
Report of Independent Accountants........................... F-2
Consolidated Balance Sheet at December 31, 2002 and December
31, 2001.................................................. F-3
Consolidated Statement of Operations for each of the three
years in the period ended December 31, 2002............... F-4
Consolidated Statement of Cash Flows for each of the three
years in the period ended December 31, 2002............... F-5
Consolidated Statement of Members' Equity for each of the
three years in the period ended December 31, 2002......... F-6
Notes to Consolidated Financial Statements.................. F-7 to F-35
</Table>
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Members of TruServ Corporation
In our opinion, the consolidated financial statements of TruServ
Corporation listed in the index appearing under Item 14(a)(1) on page F-1
present fairly, in all material respects, the financial position of TruServ
Corporation and its subsidiaries at December 31, 2002 and 2001, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the index appearing under Item
14(a)(2) on page F-36 present fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the Consolidated Financial Statements, on January
1, 2002, the Company adopted Statement of Financial Accounting Standards No.
142, "Goodwill and Other Intangible Assets."
/s/ PricewaterhouseCoopers LLP
Chicago, Illinois
February 19, 2003, except
as to Note 16 which is as of
March 13, 2003
F-2
TRUSERV CORPORATION
CONSOLIDATED BALANCE SHEET
ASSETS
<Table>
<Caption>
DECEMBER 31,
---------------------
2002 2001
-------- ----------
($ IN THOUSANDS)
Current assets:
Cash and cash equivalents................................. $ 9,001 $ 88,816
Restricted cash (Note 4).................................. 15,755 29,075
Accounts and notes receivable, net of allowance for
doubtful accounts of $8,553 and $9,402................. 207,709 243,275
Inventories, net of valuation reserves of $10,434 and
$15,636 (Note 2)....................................... 234,448 333,976
Other current assets...................................... 23,440 16,688
-------- ----------
Total current assets.............................. 490,353 711,830
Properties, net (Note 3).................................... 91,116 180,347
Goodwill, net of accumulated amortization of $11,549 and
$11,549................................................... 91,474 91,474
Other assets................................................ 30,428 37,186
-------- ----------
Total assets...................................... $703,371 $1,020,837
======== ==========
LIABILITIES AND CAPITALIZATION
Current liabilities
Accounts payable.......................................... $199,566 $ 251,657
Outstanding checks........................................ 28,884 87,385
Accrued expenses.......................................... 84,082 112,002
Short-term borrowings (Note 4)............................ 27,852 141,755
Current maturities of long-term debt, notes and capital
lease obligations (Notes 4, 5 and 7)................... 59,797 93,291
Patronage dividend payable in cash........................ 6,121 --
-------- ----------
Total current liabilities......................... 406,302 686,090
Long-term liabilities and deferred credits Long-term debt,
including capital lease obligations, less current
maturities (Notes 4 and 5)................................ 125,021 236,268
Deferred gain on sale leaseback (Note 13)................. 52,786 --
Deferred credits (Notes 10 and 12)........................ 20,282 16,246
-------- ----------
Total long-term liabilities and deferred
credits......................................... 198,089 252,514
-------- ----------
Total liabilities and deferred credits............ 604,391 938,604
-------- ----------
Commitments and contingencies (Note 6)...................... -- --
Members' capitalization:
Promissory (subordinated) and installment notes, net of
current portion (Note 7)............................... 43,531 42,973
Members' equity:
Redeemable Class A voting common stock, $100 par value;
750,000 shares authorized; 474,360 and 455,220 shares
issued and fully paid; 35,700 and 54,840 shares issued
(net of subscriptions receivable of $886,000 and
$1,110,000)............................................ 50,120 49,896
Redeemable Class B non-voting common stock and paid in
capital, $100 par value; 4,000,000 shares authorized;
1,756,457 and 1,731,490 shares issued and fully paid... 176,945 174,448
Loss allocation (Note 1).................................. (75,966) (89,972)
Deferred patronage (Note 1)............................... (25,793) (26,541)
Accumulated deficit....................................... (68,704) (68,568)
Accumulated other comprehensive loss...................... (1,153) (3)
-------- ----------
Total members' equity............................. 55,449 39,260
-------- ----------
Total members' capitalization..................... 98,980 82,233
-------- ----------
Total liabilities and members' capitalization..... $703,371 $1,020,837
======== ==========
</Table>
The accompanying notes are an integral part of the Consolidated Financial
Statements.
F-3
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------
2002 2001 2000
------------ ------------ ---------------
($ IN THOUSANDS)
Net revenues.......................................... $2,175,451 $2,619,434 $3,993,642
---------- ---------- ----------
Cost and expenses:
Cost of revenues.................................... 1,935,620 2,355,400 3,716,245
Logistics and manufacturing expenses................ 60,924 79,970 83,276
Selling, general and administrative expenses........ 92,948 137,533 124,584
Restructuring charges and other related expenses
(Note 15)........................................ 6,284 38,522 4,944
Interest expense to members......................... 6,611 7,842 11,131
Third party interest expense........................ 55,284 55,431 56,575
Loss/(gain) on sale of assets (Note 12)............. 91 (1,958) (30,337)
Other income, net................................... (3,723) (3,996) (7,809)
---------- ---------- ----------
Total cost and expenses............................... 2,154,039 2,668,744 3,958,609
---------- ---------- ----------
Net margin/(loss) before income taxes................. 21,412 (49,310) 35,033
Income tax expense.................................... 259 1,377 916
---------- ---------- ----------
Net margin/(loss)..................................... $ 21,153 $ (50,687) $ 34,117
========== ========== ==========
</Table>
The accompanying notes are an integral part of the Consolidated Financial
Statements.
F-4
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
($ IN THOUSANDS)
Operating activities:
Net margin/(loss)...................................... $ 21,153 $(50,687) $ 34,117
Adjustments to reconcile net margin/(loss) to net cash
and cash equivalents provided by/(used for)
operating activities:
Depreciation and amortization....................... 34,851 41,519 43,033
Provision for losses on accounts and notes
receivable........................................ 120 6,275 9,147
Restructuring charges and other related expenses.... 6,284 38,522 1,912
Loss/(gain) on sale of assets....................... 91 (1,958) (30,337)
Changes in operating assets and liabilities:
Accounts and notes receivable..................... 32,926 127,000 52,187
Inventories....................................... 99,528 100,692 38,752
Other current assets.............................. (1,659) 3,836 (2,337)
Accounts payable.................................. (52,091) (92,216) (81,944)
Accrued expenses.................................. (36,268) 7,525 14,927
Other adjustments, net.............................. (840) (1,067) 4,116
--------- -------- --------
Net cash and cash equivalents provided by
operating activities......................... 104,095 179,441 83,573
--------- -------- --------
Investing activities:
Additions to properties................................ (12,838) (15,151) (12,526)
Proceeds from sale of properties (Note 12 and 13)...... 127,941 10,511 23,113
Changes in restricted cash (Note 4).................... 13,320 (25,250) (3,825)
Changes in other assets................................ 17,537 3,388 (8,716)
--------- -------- --------
Net cash and cash equivalents provided by/(used
for) investing activities.................... 145,960 (26,502) (1,954)
--------- -------- --------
Financing activities:
Payment of patronage dividend.......................... -- (9,483) --
Payment of notes, long-term debt and lease
obligations......................................... (157,690) (40,138) (67,355)
Proceeds from long-term borrowings..................... -- -- 1,098
(Decrease)/increase in outstanding checks.............. (58,501) (42,105) 26,726
(Decrease)/increase in short-term borrowings........... (113,903) 11,300 (28,922)
Purchase of common stock............................... -- -- (599)
Proceeds from sale of Redeemable Class A common stock
and subscription receivable......................... 224 812 1,109
--------- -------- --------
Net cash and cash equivalents used for
financing activities......................... (329,870) (79,614) (67,943)
--------- -------- --------
Net (decrease)/increase in cash and cash equivalents..... (79,815) 73,325 13,676
Cash and cash equivalents at beginning of year........... 88,816 15,491 1,815
--------- -------- --------
Cash and cash equivalents at end of year................. $ 9,001 $ 88,816 $ 15,491
========= ======== ========
</Table>
See Note 9 for supplemental cash flow information.
The accompanying notes are an integral part of the Consolidated Financial
Statements.
F-5
TRUSERV CORPORATION
CONSOLIDATED STATEMENT OF MEMBERS' EQUITY
<Table>
<Caption>
REDEEMABLE COMMON STOCK
---------------------------------------------- RETAINED
CLASS A CLASS B EARNINGS/
--------------------- ---------------------- LOSS DEFERRED (ACCUMULATED
# OF SHARES AMOUNT # OF SHARES AMOUNT ALLOCATION PATRONAGE DEFICIT)
----------- ------- ----------- -------- ---------- --------- ------------
($ IN THOUSANDS)
Balances at and for the year ended
December 31, 1999................ 511,440 $47,270 1,764,797 $177,779 $ -- $(27,663) $(130,089)
Net margin......................... 34,117
Foreign currency translation
adjustment.......................
Amortization of deferred
patronage........................ 375 (375)
Loss allocation.................... (113,918) 113,918
Patronage dividend................. 30 3 225,510 22,551 (34,705)
Class B stock applied against loss
allocation....................... (214,580) (21,458) 21,458
Payments from stock subscriptions
receivable....................... 14,550 3,407
Stock purchased and retired........ (15,960) (1,596) (44,245) (4,424)
------- ------- --------- -------- --------- -------- ---------
Balances at and for the year ended
December 31, 2000................ 510,060 49,084 1,731,482 174,448 (92,460) (27,288) (17,134)
Net loss........................... (50,687)
Foreign currency translation
adjustment.......................
Amortization of deferred
patronage........................ 747 (747)
Payments from stock subscriptions
receivable....................... -- 812
Other.............................. 8 --
Matured notes applied against loss
allocation....................... 2,488
------- ------- --------- -------- --------- -------- ---------
Balances at and for the year ended
December 31, 2001................ 510,060 49,896 1,731,490 174,448 (89,972) (26,541) (68,568)
Net margin......................... 21,153
Foreign currency translation
adjustment.......................
Amortization of deferred
patronage........................ 748 (748)
Minimum pension liability
adjustment.......................
Patronage dividend................. 144,196 14,420 (20,541)
Payments from stock subscriptions
receivable....................... 224
Class B stock applied against loss
allocation....................... (119,229) (11,923) 11,923
Matured notes applied against loss
allocation....................... 2,083
------- ------- --------- -------- --------- -------- ---------
Balances at and for the year ended
December 31, 2002................ 510,060 $50,120 1,756,457 $176,945 $ (75,966) $(25,793) $ (68,704)
======= ======= ========= ======== ========= ======== =========
<Caption>
ACCUMULATED
OTHER TOTAL TOTAL
COMPREHENSIVE MEMBERS' COMPREHENSIVE
INCOME/(LOSS) EQUITY INCOME/(LOSS)
------------- ---------- -------------
($ IN THOUSANDS)
Balances at and for the year ended
December 31, 1999................ $ (846) $ 66,451 $(130,275)
=========
Net margin......................... 34,117 34,117
Foreign currency translation
adjustment....................... (126) (126) (126)
Amortization of deferred
patronage........................ --
Loss allocation.................... --
Patronage dividend................. (12,151)
Class B stock applied against loss
allocation....................... --
Payments from stock subscriptions
receivable....................... 3,407
Stock purchased and retired........ (6,020)
------- --------- ---------
Balances at and for the year ended
December 31, 2000................ (972) 85,678 33,991
=========
Net loss........................... (50,687) (50,687)
Foreign currency translation
adjustment....................... 969 969 969
Amortization of deferred
patronage........................ --
Payments from stock subscriptions
receivable....................... 812
Other.............................. --
Matured notes applied against loss
allocation....................... 2,488
------- --------- ---------
Balances at and for the year ended
December 31, 2001................ (3) 39,260 (49,718)
=========
Net margin......................... 21,153 21,153
Foreign currency translation
adjustment....................... 3 3 3
Amortization of deferred
patronage........................ --
Minimum pension liability
adjustment....................... (1,153) (1,153) (1,153)
Patronage dividend................. (6,121)
Payments from stock subscriptions
receivable....................... 224
Class B stock applied against loss
allocation....................... --
Matured notes applied against loss
allocation....................... 2,083
------- --------- ---------
Balances at and for the year ended
December 31, 2002................ $(1,153) $ 55,449 $ 20,003
======= ========= =========
</Table>
Redeemable Class A common stock amounts are net of unpaid subscription amounts
of $886 relating to 35,700 issued shares at December 31, 2002; $1,110 relating
to 54,840 issued shares at December 31, 2001; $1,922 relating to 98,880 issued
shares at December 31, 2000; and $3,874 relating to 106,380 issued shares at
December 31, 1999.
The accompanying notes are an integral part of the Consolidated Financial
Statements.
F-6
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
($ IN THOUSANDS)
1. DESCRIPTION OF BUSINESS AND ACCOUNTING POLICIES
Principal business activity
TruServ Corporation ("TruServ" or the "company") is a member-owned
wholesaler of hardware and related merchandise. The company also manufactures
and sells paint and paint applicators. The company's goods and services are sold
predominantly within the United States, primarily to retailers of hardware,
industrial distributors and rental retailers, each of whom has purchased 60
shares per store (up to a maximum of 5 stores (300 shares)) of the company's
Class A common stock upon becoming a member. The Class A stock is redeemable by
the company and has voting rights (the "Redeemable Class A voting common
stock"). The company operates as a member-owned wholesaler cooperative. When
there are annual profits, members in good standing are entitled to receive
patronage dividend distributions from the company on the basis of gross margins
of merchandise and/or services purchased by each member. In accordance with the
company's By-Laws, the annual patronage dividend is paid to members out of gross
margins from operations and other patronage source income, after deduction for
expenses and provisions authorized by the board of directors. TruServ also
provides to its members value-added services such as marketing, advertising,
merchandising and store location and design services.
Consolidation
The consolidated financial statements include the accounts of the company
and all wholly owned subsidiaries. The consolidated statement of operations and
cash flows also include the activities of TruServ Canada Cooperative, Inc., a
Canadian member-owned wholesaler of hardware, through the date of its sale,
October 22, 2001. The consolidated balance sheets at December 31, 2001 and
December 31, 2002 exclude TruServ Canada Cooperative, Inc.
The company does not have any special purpose entities ("SPE's") or
variable interest entities ("VIE's").
Reclassifications
Certain reclassifications have been made to the prior years' 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.
Capitalization
The company's capital (Capitalization) is derived from Members' equity and
Promissory (subordinated) and installment notes. Members' equity is comprised of
Redeemable Class A voting common stock, Redeemable Class B common stock,
Accumulated deficit, Loss allocation, Deferred patronage and Accumulated other
comprehensive loss. TruServ follows the practice of accounting for deferred
patronage charges and credits as a separate component of capitalization.
Deferred patronage consists of net charges and expenses, primarily related to
costs associated with the merger of Cotter & Company and Servistar Coast to
Coast Corporation to form TruServ Corporation (the "Merger"), which are included
in the computation of net margin/(loss) in different periods for financial
statement purposes than for patronage purposes. Promissory (subordinated) notes
and Redeemable Class B common stock had been issued in connection with the
company's annual patronage dividend. For the year ended December 31, 2002, only
Cash and Redeemable Class B common stock will be issued in 2003 in connection
with the company's fiscal 2002 patronage dividend. The By-Laws provide TruServ
the right to allow a member to partially meet the company's capital requirements
by the issuance of stock in payment of the year-end patronage dividend.
F-7
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Patronage dividend
Patronage dividends related to the fiscal year ended December 31, 2002 were
$20,541 (see Note 16). Approximately thirty percent of the dividend was paid in
cash (TruServ By-Laws and the IRS require that the payment of at least twenty
percent of patronage dividends be in cash). The remainder will be paid through
the issuance of the company's Redeemable Class B common stock and, to those
members that had such accounts, used to offset members' loss allocation
accounts. No patronage dividends were declared for the fiscal year ended
December 31, 2001, as the company incurred a loss for the year 2001, which was
retained by the company. Patronage dividends in the amount of $34,705 were paid
on March 31, 2001 related to the fiscal year ended December 31, 2000;
approximately thirty percent of which were paid in cash. The remainder was paid
through the issuance of the company's Redeemable Class B common stock which was
offset to members' loss allocation accounts to those members that had such
accounts. 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 for the December 31, 2002 and 2000 patronage dividend have been
designated as qualified notices of allocation.
Membership may be terminated without cause by either the company or the
member upon sixty days' written notice. In the event membership is terminated,
the company undertakes to purchase, and the member is required to sell to the
company, all of the member's Redeemable Class A voting common stock and
Redeemable Class B common stock at par value. Payment for the Redeemable Class A
voting common stock has historically been in cash. Payment for the qualified
Redeemable Class B common stock has historically been in the form of a note
payable in five equal annual installments and with interest set at comparable
treasury rates plus 2.0%.
In March 2000, the board of directors of TruServ declared a moratorium on
redemptions of the capital stock. In reaching its decision to declare the
moratorium, the board of directors of TruServ reviewed the financial condition
of TruServ and considered its fiduciary obligations and corporate law principles
under Delaware law. The board of directors concluded that it should not redeem
any of the capital stock while its net asset value was substantially less than
par value, as that would likely violate legal prohibitions against "impairment
of capital." In addition, the board of directors concluded that it would be a
violation of its fiduciary duties to all members and that it would constitute a
fundamental unfairness to members if some members were allowed to have their
shares redeemed before the 1999 loss was allocated to them and members who did
not request redemption were saddled with the losses of those members who
requested redemption. Moreover, the board of directors considered TruServ's debt
agreements and, in particular, the financial covenants thereunder, which
prohibit redemptions when TruServ, among other things, does not attain certain
profit margins.
At the time the board of directors declared the moratorium on redemptions,
TruServ's By-Laws did not impose limitations on the board's discretion to
initiate or to continue a moratorium on redemption. The By-Laws merely provided
that upon termination of a member's agreement, TruServ was to redeem the
member's shares. Nevertheless, the board of directors concluded that its
fiduciary obligations to TruServ and its members would not permit it to effect
redemptions under the circumstances described above. After the board of
directors declared the moratorium, the board of directors amended the By-Laws to
provide that if TruServ's funds available for redemption are insufficient to pay
all or part of the redemption price of shares of capital stock presented for
redemption, the board of directors may, in its sole discretion, delay the
payment of all or part of the redemption price.
The amended senior debt agreements preclude the lifting of the stock
moratorium until June 30, 2004 except for certain hardship cases, not to exceed
$2,000 annually. Given certain ongoing related litigation, there are no plans
for hardship redemption of stock. See Note 6, "Commitments and Contingencies."
Subsequent to the expiration of the prohibition against stock redemptions under
the debt agreements, which could be in the first half of 2004, if TruServ
completes the refinancing of its Senior Debt, the board of directors will
consider
F-8
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the financial condition of TruServ, and will not lift the moratorium unless it
can conclude that effecting redemptions of TruServ's capital stock will not
"impair the capital" of TruServ, unfairly advantage some members to the
disadvantage of others, or violate the financial covenants under its debt
agreements. The board of directors is monitoring the financial performance of
TruServ quarterly.
As of December 31, 2002, the amount of Class A common stock and Class B
common stock presented for redemption but deferred due to the moratorium is
approximately $39,614 after the offset of the loss allocation account. This
amount does not include an offset of approximately $7,343 of Accounts receivable
owed by terminated members to the co-op. Historically, the company has offset
such amounts due by members to the co-op against amounts the co-op pays the
members on redemption of their stock. This amount does not include any remaining
amount of the 2001 loss that may be allocated, on a member by member basis, from
the Accumulated deficit account and reduce the amount paid to a member on the
redemption of their stock. The $39,614 amount of stock presented for redemption,
but deferred due to the moratorium, includes approximately $15,475 related to
the Class A common stock (which was historically paid out at the time of
redemption) and $47,033 related to Class B common stock (which was historically
paid out in five equal annual installments), offset by the amount of the Loss
allocation account related to the Class B common stock of $22,894.
Loss allocation to members and Accumulated deficit
During the third quarter of fiscal 2000, TruServ management developed and
the board of directors approved a plan to equitably allocate to members the loss
incurred in 1999. This loss was previously recorded as a reduction of Retained
earnings. TruServ has allocated the 1999 loss among its members by establishing
a Loss allocation account as a contra-equity account in the consolidated balance
sheet with the offsetting credit recorded to the Accumulated deficit account.
The Loss allocation account reflects the sum of each member's proportionate
share of the 1999 loss, after being reduced by certain amounts that were not
allocated to members. The Loss allocation account will be satisfied, on a member
by member basis, by applying the portion of future non-cash patronage dividends
as a reduction to the Loss allocation account until fully satisfied. The Loss
allocation amount 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
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 TruServ.
The board of directors determined that TruServ would retain the fiscal 2001
loss as part of the Accumulated deficit account. All or a portion of patronage
income and all non-patronage income, if any, may be retained in the future to
reduce the Accumulated deficit account. TruServ has determined for each member
that was a stockholder in 2001, its share of the fiscal 2001 loss that has been
retained in the Accumulated deficit account, based upon the member's
proportionate Class A common stock and Class B common stock investment, TruServ
allocated the remainder of the fiscal 2001 loss based on the member's purchases
from the co-op in 2001. In the event a member terminates its status as a
stockholder of TruServ, any remaining 2001 loss in the Accumulated deficit
account that is allocable to the terminating member will be satisfied by
reducing the redemption amount paid for the member's stock investment in
TruServ.
Cash equivalents
The company classifies all highly liquid investments with an original
maturity of three months or less as cash equivalents.
Inventories
Inventories are stated at the lower of cost, determined on the first-in,
first-out basis, or market. The lower of cost or market valuation considers the
estimated realizable value in the current economic environment
F-9
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
associated with disposing of surplus and/or damaged/obsolete inventories. The
estimated realizable value was based on an analysis of historical trends related
to distressed inventory of TruServ. This analysis considers historical data on
TruServ's ability to return inventory to suppliers, to transfer inventory to
other distribution centers, to sell inventory to members through the price
reduction process and to sell remaining inventory to liquidators. The cost of
inventory also includes indirect costs (such as logistics, manufacturing,
freight-in, vendor rebates and support costs) incurred to bring inventory to its
existing location for resale. These indirect costs are treated as product costs,
classified in inventory and subsequently recorded as cost of revenues as the
product is sold (see Note 2).
Properties
Properties are recorded at cost. Depreciation and amortization are computed
by using the straight-line method over the following estimated useful lives:
buildings and improvements -- 10 to 40 years; machinery and warehouse, office
and computer equipment and software -- 5 to 10 years; transportation
equipment -- 3 to 7 years; and leasehold improvements -- the lesser of the life
of the lease, without regard to options for renewal, or the useful life of the
underlying property.
Goodwill
Goodwill represents the excess of cost over the fair value of net assets
acquired and was amortized using the straight-line method over 40 years. In
January 2002, TruServ adopted Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 changed
the accounting for goodwill and certain other intangible assets from an
amortization method to an impairment only approach. In accordance with the
adoption of SFAS No. 142, TruServ stopped amortizing goodwill at the beginning
of fiscal 2002. TruServ has completed its annual impairment assessment as
required by SFAS No. 142 and has determined that no impairment exists. The
reported Net margin/(loss), Goodwill amortization and the resulting adjusted Net
margin/(loss) are as follows:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
----------------------------
2002 2001 2000
------- -------- -------
($ IN THOUSANDS)
Reported Net margin/(loss)............................. $21,153 $(50,687) $34,117
Add back: Goodwill amortization........................ -- 2,577 3,054
------- -------- -------
Adjusted Net margin/(loss)............................. $21,153 $(48,110) $37,171
======= ======== =======
</Table>
Goodwill amortization related to the hardware segment for fiscal year 2001
and 2000 was $2,210 and $2,687, respectively. Goodwill amortization related to
the paint segment for fiscal year 2001 and 2000 was $367 in each year. At
December 31, 2002, the Goodwill was comprised of $78,429 for the hardware
segment and $13,045 for the paint segment.
Conversion funds
In connection with the Merger, the company made funds available to the
members to assist their stores in defraying various conversion costs (i.e.,
costs to change store signage and branding to True Value) associated with the
Merger and costs associated with certain upgrades and expansions of their store.
The total amount of conversion funds distributed was $27,175; the funds are
amortized over a 5 year period representing the period of time over which
members committed to stay with the post merger company. The annual amortization
expense for fiscal year 2002, 2001 and 2000 was $6,056, $5,747 and $4,385,
respectively. The unamortized balance at December 31, 2002 was approximately
$5,324. The members agree to refund to TruServ all or a portion of the
conversion funds in the event of default or termination during the five fiscal
years following the date of the agreement. Any uncollectible amounts are written
off to expense.
F-10
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Asset impairment
For purposes of determining impairment, management reviews long-lived
assets based on a geographic region or revenue producing activity as
appropriate. Such impairment review includes, among other criteria, management's
estimate of future cash flows for the region or activity. If the estimated
future cash flows (undiscounted and without interest charges) are not sufficient
to recover the carrying value of the long-lived assets, including associated
goodwill, of the region or activity, such assets would be determined to be
impaired and would be written down to their fair value. In fiscal 2002, TruServ
recorded asset impairment charges which netted to $470, consisting of a $1,769
charge relating to the East Butler, Pennsylvania facility, offset by a $927
favorable adjustment to the asset impairment charge for the Brookings, South
Dakota distribution center based on actual proceeds on the sale of this facility
in 2002, as well as a $372 favorable adjustment for the transfer of certain
Hagerstown, Maryland equipment, the value of which had been fully reserved for
in 2001, to other facilities. In fiscal 2001, TruServ recorded asset impairment
charges aggregating $8,899 related to its Brookings, South Dakota distribution
center and certain equipment at its Hagerstown, Maryland distribution center
which were for sale; the Hagerstown facility remains for sale. There were no
impairment charges recorded in fiscal 2000.
Revenue recognition
The company's policy is to recognize revenues from product sales and
services when earned, as in accordance with SEC Staff Accounting Bulletin
("SAB") No. 101. Specifically, product revenue is recognized when persuasive
evidence of an arrangement exists, delivery has occurred, the price is fixed or
determinable, and collectibility is reasonably assured. Revenue is not
recognized until title and risk of loss have transferred to the customer, which
is upon delivery of products. Provisions for discounts, rebates to customers,
and returns are provided for at the time the related sales are recorded, and are
reflected as a reduction of sales. Service revenue is comprised of advertising
and transportation and amounted to $69,463 and $52,665 for fiscal 2002,
respectively, and $77,419 and $56,978 for 2001, respectively. Advertising
revenue is recognized when the underlying advertisement is run or when the
related circulars are dropped. Transportation revenue is recognized when the
services are provided.
Advertising expenses
Amounts billed to members for advertising are included in revenues.
Advertising costs are expensed in the period the advertising takes place. Such
costs amounted to $56,407, $59,275 and $82,675 in fiscal year 2002, 2001 and
2000, respectively, and are included in Cost of revenues.
Amortization of financing fees
Amounts paid for financing fees incurred in connection with the company's
financing arrangements are capitalized and amortized to interest expense over
the remaining lives of the underlying financing agreements. The costs incurred
in the fourth quarter of fiscal year 2001 for the potential asset-based lending
refinancing were expensed in the fourth quarter of fiscal 2001, when it was
determined that TruServ would instead amend its existing debt agreements.
Repairs and maintenance expense
Expenditures which extend the useful lives of the company's property and
equipment are capitalized and depreciated on a straight line basis over the
remaining useful lives of the underlying assets. Otherwise, repair and
maintenance expenditures are expensed as incurred.
F-11
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Research and development costs
Research and development costs related to the company's manufacturing
operations are expensed as incurred. Such costs amounted to $941, $1,003 and
$993 in fiscal year 2002, 2001 and 2000, respectively, and are included in
Logistic and manufacturing expenses.
Shipping and handling costs
Amounts billed to members for shipping and handling costs are included in
Revenues. Amounts incurred for shipping and handling are included in Cost of
revenues.
Income taxes
Deferred tax assets and liabilities are determined based on the differences
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to reverse. At December 31, 2002, TruServ concluded that, based on the weight of
available evidence, it is more likely than not that the deferred tax assets will
not be realized, and that a full valuation allowance is required. Deferred tax
assets will only be realized to the extent future earnings are retained by
TruServ and not distributed to members as patronage dividends.
Per share information
There is no existing market for the common stock of the company and there
is no expectation that any market will develop. The company's Redeemable Class A
voting common stock is owned by members and former members whose stock has not
yet been redeemed as a result of the moratorium. The company's Redeemable Class
B non-voting common stock now outstanding was issued to members in partial
payment of the annual patronage dividend. Accordingly, no earnings per share
information is presented in the consolidated financial statements.
Retirement plans
The company sponsors two noncontributory defined benefit retirement plans
covering substantially all of its employees. Company contributions to
union-sponsored defined contribution plans are based on collectively bargained
rates multiplied by hours worked. The company's policy is to fund annually all
tax-qualified plans to the extent deductible for income tax purposes.
Fair value of financial instruments
The carrying amounts of the company's financial instruments, which were
comprised primarily of accounts and notes receivables, accounts payable,
short-term borrowings, long-term debt and promissory (subordinated) and
installment notes, approximate fair value. Fair value was estimated using
discounted cash flow analyses, based on the company's incremental borrowing rate
for similar borrowings. The carrying amount of debt and credit facilities
approximate fair value due to their stated interest rates approximating market
rates and as a result of such facilities having been renegotiated in fiscal 2002
(see Note 4). These estimated fair value amounts have been determined using
available market information or other appropriate valuation methodologies.
Concentration of credit risk
Credit risk pertains primarily to the company's trade receivables. The
company extends credit to its members as part of its day-to-day operations. The
company believes that as no specific receivable or group of receivables
comprises a significant percentage of total trade accounts, its risk with
respect to trade receivables is limited. Additionally, the company believes that
its allowance for doubtful accounts is adequate with respect
F-12
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to member credit risks. Also, TruServ's Certificate of Incorporation and By-Laws
specifically provide that TruServ may set off its obligation to make any payment
to a member for such member's stock, notes, interest and declared and unpaid
dividends against any obligation owed by the member to TruServ. TruServ
exercises these set off rights when TruServ notes and interest become due to
former members with outstanding accounts receivable to TruServ and current
members with past due accounts receivable to TruServ.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
New accounting pronouncements
In January 2002, TruServ adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." See
"Goodwill" above.
In August 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143
addresses financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. SFAS No. 143 is effective January 1, 2003 for TruServ. TruServ is
currently evaluating the impact this standard will have on its financial
statements, but does not expect the impact of its adoption to be material.
In January 2002, TruServ adopted SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets," replacing SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"'
and portions of Accounting Principles Board ("APB") Opinion No. 30, "Reporting
the Results of Operations." SFAS No. 144 provides a single accounting model for
long-lived assets to be disposed of and changes the criteria to be met to
classify an asset as held-for-sale. SFAS No. 144 retains the requirement of APB
Opinion No. 30 to report discontinued operations separately from continuing
operations and extends that reporting to a component of an entity that either
has been disposed of or is classified as held-for-sale. The adoption of this
standard did not have a material impact on the company's financial position or
results of operations.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FAS 4, 44 and
64, Amendment of FAS 13 and Technical Corrections as of April 2002." SFAS No.
145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt" (eliminating the extraordinary treatment of gains or losses on debt
modification other than for certain exceptions), amends SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements," amends SFAS
No. 13, "Accounting for Leases" (to eliminate an inconsistency between the
required accounting for sale leaseback transactions and the required accounting
for certain lease modifications that have economic effects that are similar to
sale leaseback transactions) and amends other existing authoritative
pronouncements (to make various technical corrections, clarify meanings or
describe their applicability under changed conditions). SFAS No. 145 is
effective for TruServ for fiscal 2003 but earlier application is encouraged. The
company is currently evaluating the impact this standard will have on its
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal." SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." The principal
difference between SFAS No. 146 and EITF Issue No. 94-3 relates to the
requirement for recognition of a liability for a cost associated with an exit or
disposal activity. SFAS No. 146 requires that a liability for a cost associated
with an exit or disposal activity be recognized only when the
F-13
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
liability is incurred; under EITF Issue No. 94-3, a liability for an exit cost,
as defined in EITF Issue No. 94-3, was recognized at the date of an entity's
commitment to an exit plan. SFAS No. 146 also requires that a liability for a
cost associated with an exit or disposal activity be recognized and measured
initially at fair value and only when the liability is incurred. SFAS No. 146 is
effective for TruServ for any exit or disposal activities undertaken after
December 31, 2002 but earlier application is encouraged.
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others."
Interpretation No. 45 requires the disclosure of certain guarantees existing at
December 31, 2002. In addition, Interpretation No. 45 requires the recognition
of a liability for the fair value of the obligation of qualifying guarantee
activities that are initiated or modified after December 31, 2002. Accordingly,
the company has disclosed certain guarantees that existed at December 31, 2002
in Note 6 and will apply the recognition provisions of Interpretation No. 45
prospectively to guarantee activities initiated after December 31, 2002. See
Note 6, "Commitments and Contingencies," for a further discussion of guarantees.
2. INVENTORIES
Inventories consisted of the following at December 31:
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Manufacturing inventories:
Raw materials............................................. $ 1,473 $ 1,720
Work-in-process and finished goods........................ 19,655 24,909
Manufacturing inventory reserves.......................... (1,297) (2,724)
-------- --------
19,831 23,905
Merchandise inventories:
Warehouse inventory....................................... 223,754 322,983
Merchandise inventory reserves............................ (9,137) (12,912)
-------- --------
214,617 310,071
-------- --------
$234,448 $333,976
======== ========
</Table>
The amount of indirect costs included in ending inventory at December 31,
2002 and 2001 was $15,753 and $23,272, respectively. Indirect costs incurred for
fiscal year 2002 and 2001 were $95,865 and $115,162, respectively.
In fiscal 2002, the company recorded physical inventory adjustments
aggregating $1,457 (as an increase to Inventory and a reduction to Cost of
revenues) principally in the fourth quarter of the year. In fiscal 2001, the
company recorded physical inventory adjustments aggregating $4,800 (as an
increase to Inventory and a reduction to Cost of revenues) principally in the
third and fourth quarters of the year.
F-14
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. PROPERTIES
Properties consisted of the following at December 31:
<Table>
<Caption>
2002 2001
--------- ---------
($ IN THOUSANDS)
Buildings and improvements.................................. $ 80,016 $ 176,414
Machinery and warehouse equipment........................... 89,284 91,842
Office and computer equipment............................... 156,961 156,644
Transportation equipment.................................... 36,389 40,961
--------- ---------
362,650 465,861
Less accumulated depreciation............................... (274,519) (294,842)
--------- ---------
88,131 171,019
Land........................................................ 2,985 9,328
--------- ---------
$ 91,116 $ 180,347
========= =========
</Table>
As discussed further in Note 13, on December 31, 2002, the company sold
seven of its ten owned distribution centers. This transaction resulted in a
decrease in the net book value of buildings and improvements of $65,762.
Depreciation expense for fiscal year 2002, 2001 and 2000 was $28,795,
$33,195 and $35,594, respectively.
4. DEBT AND BORROWING ARRANGEMENTS
Long-term debt consisted of the following at December 31:
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Senior Notes (rates at December 31, 2002/2001):
11.85% / 13.85%........................................... $ 16,403 $ 28,000
10.63% / 12.63%........................................... 31,610 50,000
10.16% / 12.16%........................................... 11,745 21,429
10.10% / 12.60%........................................... 65,309 105,000
10.04% / 12.04%........................................... 33,853 50,000
9.98% / 11.98%............................................ -- 25,000
Redeemable (subordinated) term notes:
Fixed interest rates ranging from 5.3% to 7.83%........... 3,296 7,819
Capital lease obligations (Note 5).......................... 1,247 2,678
-------- --------
163,463 289,926
Less amounts due within one year............................ (38,442) (53,658)
-------- --------
$125,021 $236,268
======== ========
</Table>
F-15
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Principal payment schedule for long-term debt:
<Table>
<Caption>
BALANCE
AS OF 12/31/02 CURRENT 2004 2005 2006 2007 THEREAFTER
-------------- ------- ------- ------- ------- ------- ----------
($ IN THOUSANDS)
Senior Notes (rates at December 31,
2002/2001):
11.85% / 13.85%............................ $ 16,403 $ 5,727 $ 4,000 $ 6,676 $ -- $ -- $ --
10.63% / 12.63%............................ 31,610 7,998 4,545 4,545 4,545 4,545 5,432
10.16% / 12.16%............................ 11,745 4,563 3,572 3,610 -- -- --
10.10% / 12.60%............................ 65,309 13,358 10,021 10,021 10,021 10,021 11,867
10.04% / 12.04%............................ 33,853 3,187 -- -- 10,000 10,000 10,666
9.98% / 11.98%............................. -- -- -- -- -- -- --
-------- ------- ------- ------- ------- ------- -------
158,920 34,833 22,138 24,852 24,566 24,566 27,965
Redeemable (subordinated) term notes:
Fixed interest rates ranging from 5.3%to
7.83%.................................... 3,296 3,185 111 -- -- -- --
Capital lease obligations (Note 5)........... 1,247 424 441 311 71 -- --
-------- ------- ------- ------- ------- ------- -------
Total........................................ $163,463 $38,442 $22,690 $25,163 $24,637 $24,566 $27,965
======== ======= ======= ======= ======= ======= =======
</Table>
The company had outstanding borrowings under its revolving credit facility
agreement of $27,852 and $140,000 at December 31, 2002 and 2001, respectively.
The $140,000 outstanding as of December 31, 2001 included approximately $57,000
of cash recorded in cash and cash equivalents that was available to reduce
outstanding borrowings to $83,000. The weighted average interest rate on these
borrowings was 8.3% and 9.9% for the years ended December 31, 2002 and 2001,
respectively. The 2001 average interest rate reflects the inclusion of a 2%
default premium.
On December 30, 2002, TruServ amended the revolving credit facility, senior
notes and synthetic lease agreements (the "Senior Debt") that had previously
been amended in April 2002 in order to allow for a sale leaseback transaction
that was completed on December 31, 2002 (the "December 2002 Amendments") (See
Note 13). TruServ applied the net proceeds of the sale leaseback transaction,
$121,438 to pay down the Senior Debt, all of whom are parties to the
intercreditor agreement. The net reduction in Senior Debt was $108,743, as a
result of new make-whole notes of $12,695 issued due to the prepayment on senior
notes. The December 2002 Amendments mainly set preliminary financial covenants
to allow for the substantial reduction in debt and the corresponding increase in
rent payments resulting from the sale leaseback transaction. See Note 5, "Lease
Commitments" and Note 16, "Subsequent Events."
The Senior Debt agreements were previously amended on April 11, 2002, when
TruServ entered into various amendments that eliminated the event of default
created when TruServ failed to comply with a covenant as of February 24, 2001
(the "April 2002 Amendments"). The April 2002 Amendments to the revolving credit
facility extended the term of the facility from June 2002 to June 2004. The
amount of the commitment at the time of amendment was $200,000. The commitment
under the revolving credit facility is permanently reduced by the amount of any
prepayments allocated to and paid on the revolving credit facility.
Borrowings under the revolving credit facility are subject to borrowing
base limitations that fluctuate in part with the seasonality of the business.
The borrowing base formula limits advances to the sum of 85% of eligible
accounts receivable, 50% of eligible inventory, 60% of the appraised value of
eligible real estate and 50% of the appraised value of eligible machinery and
equipment; availability is further increased by seasonal over-advances and
decreased by reserves against availability. The revolving credit facility has
certain minimum unusable commitment amounts, which vary based upon the projected
seasonal working capital needs of TruServ. The interest rate on the revolving
credit facility was increased to the prime rate plus 3.25%, which was 7.5% as of
December 31, 2002. The unused commitment fee is 0.75% per annum.
Since the April 2002 Amendments, the revolving credit facility commitment
has been permanently reduced to $143,200 at December 31, 2002 due to prepayments
in 2002 from the proceeds of asset sales. TruServ had available, under the
revolving credit facility, approximately $115,300 at December 31, 2002.
F-16
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The April 2002 Amendments to the various senior note agreements maintained
the existing debt amortization schedules of the various notes. Interest rates on
the notes are at the pre-default rates, which ranged at December 31, 2002 from
10.04% to 11.85%. The senior note and revolving credit facility amendments also
require initial, quarterly and annual maintenance fees. All of the cash proceeds
from certain asset sales and certain notes receivable, and 80% of any excess
cash flow, as defined in the amended senior note and revolving credit facility
agreements, are to be used to prepay all parties to these amendments in
accordance with an amended intercreditor agreement.
For 2002, cash proceeds from certain asset sales and notes receivable
totaling $157,312 were used to prepay all parties to the intercreditor
agreement. No additional payment as a result of excess cash flow is required to
be made at this time. The intercreditor agreement establishes how the assets of
TruServ, which are pledged as collateral, are shared and how certain debt
prepayments are allocated among the senior lenders. For the year ended December
31, 2002, the prepayments to senior note holders of $93,915 resulted in
make-whole liabilities of $18,710, which are recorded as additional debt with an
offsetting entry to a prepaid interest account. As previously described, the
$12,695 of make-whole notes from the sale leaseback transaction, is a component
of the $18,710. The prepaid interest account will be amortized to interest
expense over the remaining life of the original notes.
The terms of the senior note agreements, that comprise a portion of the
Senior Debt, have always provided that in the event of early termination or a
prepayment of all or a portion of the notes, make-whole liabilities are
triggered. The nature of the transaction giving rise to the prepayment, the
length of time to maturity of a particular note, the magnitude of the prepayment
relative to the remaining debt outstanding and prevailing market interest rates
relative to the interest rates on the senior notes are factors in determining
the amount of potential make-whole liabilities. In the event of full prepayment
of the senior notes, the entire prepaid interest amount will be immediately
charged to interest expense. Management currently intends to pursue a
refinancing of the existing Senior Debt in the first half of 2004. Management
anticipates significantly lower interest rates upon refinancing. However, based
upon current market interest rate, make-whole expense of a refinancing, before
considering the impact of any negotiations with the senior note holders, could
range up to approximately $27,000, in addition to fully expensing the remaining
prepaid balance of existing make-whole, which was $17,864 at December 31, 2002.
TruServ management negotiated a reduction of approximately 50% in the make-whole
notes when it made prepayments on the senior notes from the proceeds of the sale
leaseback transaction.
The April 2002 Amendments all require TruServ to meet certain restrictive
covenants relating to minimum sales, minimum adjusted EBITDA (earnings before
interest, taxes, depreciation and amortization), minimum fixed charge coverage,
minimum interest coverage and maximum capital expenditures. The senior note
holders may accelerate the due date of their notes, if TruServ does not have a
revolving credit facility in place to fund its seasonal cash flows. Some of
these covenants were adjusted in March 2003 as a result of the sale leaseback
transaction. See Note 16, "Subsequent Events." TruServ was in compliance with
all of these covenants as of December 31, 2002 as shown in the chart below:
<Table>
<Caption>
RESTRICTIVE COVENANT COVENANT ACTUAL
- -------------------- ---------- ----------
($ IN THOUSANDS)
Minimum sales............................................... $1,975,000 $2,175,451
Minimum adjusted EBITDA..................................... $ 100,000 $ 120,062
Minimum fixed charge coverage............................... 0.70 1.01
Minimum interest coverage................................... 1.75 1.97
Maximum capital expenditures................................ $ 16,000 $ 12,838
</Table>
TruServ believes it will continue to remain in compliance with its debt
covenants. For fiscal 2003, TruServ believes operating results will be
sufficient to comply with the covenants established in the March 2003
Amendments. See Note 16 "Subsequent Events".
F-17
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The term of the revolving credit facility will accelerate to June 30, 2003
from June 30, 2004, if on that date, total Senior Debt outstanding, less the
aggregate principal amount of the make-whole notes, is in excess of $270,000, or
total Senior Debt outstanding, less the aggregate principal amount of the
make-whole notes, plus the unused amount of the commitment under the revolving
credit facility, less $30,000, is in excess of $320,000. At December 31, 2002,
the total Senior Debt outstanding, less the aggregate principal amount of the
make-whole notes was $167,965 and the related commitments outstanding less
$30,000 totaled $253,323. Although the revolver portion of total Senior Debt
outstanding can fluctuate with the seasonal cash flow requirements of the
business, TruServ believes it will maintain a sufficiently low level of Senior
Debt outstanding with cash from operating activities to continue to meet the
June 30, 2003 requirement.
The April 2002 Amendments limit the amount of the cash portion of patronage
dividends to the 20% minimum required to be paid under applicable IRS
regulations in order for TruServ to maintain its status as a cooperative, unless
TruServ's operating performance achieves certain EBITDA targets, in which case,
up to 30% of the patronage dividend may be paid in cash. TruServ exceeded the
EBITDA target for 2002 and, as such, the cash portion of the 2002 patronage
dividend paid in 2003 averaged 30%.
The April 2002 Amendments also require the continuation of the stock
redemption moratorium through June 30, 2004. As discussed in Note 7, it is an
event of default under the April 2002 Amendments if payments of subordinated
notes exceed $14,000 in fiscal 2003. TruServ did not exceed the maximum payment
level of $24,000 in 2002 and, accordingly, was in compliance. In addition, an
event of default arises under the April 2002 Amendments in the event that
TruServ fails to comply with its corporate governance policy requiring the
retention by TruServ of at least two outside directors prior to May 31, 2002, at
least four outside directors prior to September 1, 2002 and at least five
outside directors prior to November 1, 2002. As of October 7, 2002, TruServ
appointed its fifth outside director and, as such, TruServ was in compliance
with the corporate governance covenant as of December 31, 2002.
The April 2002 Amendments also contain requirements for other customary
covenants, representations and warranties, funding conditions and events of
default. As of December 31, 2002, TruServ was in compliance with all applicable
covenants and has not triggered any events of default.
TruServ intends to both honor the amounts outstanding under the member note
agreements and not exceed the maximum allowable payments of $14,000 in fiscal
2003 under the revolving credit facility and senior note agreements through the
consent of the holders of the member notes, to extend a portion of the notes due
in 2003. If TruServ exceeds the maximum allowable payments of $14,000 in fiscal
2003, or violates any negative covenant, it is an event of default under the
revolving credit facility and senior note agreements. Unless appropriate waivers
were obtained from TruServ's lenders, the amounts due under the revolving credit
facility and senior note agreements could become immediately due and payable or
the agreements could have to be renegotiated. However, there can be no
assurances that TruServ would be able to obtain the requisite waivers or
successfully renegotiate its lending agreements. In the event TruServ was unable
to obtain the requisite waivers or successfully renegotiate its lending
agreements, a material adverse effect on TruServ's liquidity and capital
resources could result.
The redeemable (subordinated) term notes have two to four year terms and
were issued in exchange for promissory (subordinated) notes that were held by
promissory note holders who do not own the company's Redeemable Class A voting
common stock. They were also available for purchase by investors that were
affiliated with the company.
F-18
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Restricted cash consisted of the following at December 31:
<Table>
<Caption>
2002 2001
------- -------
($ IN THOUSANDS)
Letters of credit........................................... $11,691 $11,392
Proceeds from sale of assets available for debt reduction by
the collateral agent...................................... 39 10,906
Lockbox cash management deposit requirements................ 4,025 4,000
Redeemable (subordinated) notes............................. -- 1,746
Escrow...................................................... -- 1,031
------- -------
$15,755 $29,075
======= =======
</Table>
TruServ finances its requirements for letters of credit with cash deposited
and invested at the issuing bank. TruServ partially secures its requirement for
banking services by maintaining invested cash deposits with its cash management
banks. The intercreditor agreement amended in April 2002 with TruServ's lenders
requires TruServ to hold the proceeds from the sale of certain assets in a
restricted cash account invested with the collateral agent to be used for debt
reduction. These proceeds were held by the collateral agent in fiscal 2001 and
distributed after the Senior Debt agreements were amended in April 2002.
5. LEASE COMMITMENTS
The company is a lessee of distribution centers, office space, and computer
and transportation equipment under operating and capital leases. The following
is a schedule of future minimum lease payments under capital and long-term
non-cancelable operating leases, together with the present value of the net
minimum lease payments under capital leases, as of December 31, 2002:
<Table>
<Caption>
CAPITAL OPERATING
------- ---------
($ IN THOUSANDS)
2003........................................................ $ 464 $ 33,461
2004........................................................ 464 31,008
2005........................................................ 358 28,251
2006........................................................ 85 24,079
2007........................................................ -- 22,839
Thereafter.................................................. -- 266,473
------ --------
Net minimum lease payments.................................. $1,371 $406,111
========
Less amount representing interest........................... (125)
------
Present value of net minimum lease payments................. 1,246
Less amount due within one year............................. (424)
------
$ 822
======
</Table>
Capitalized leases expire at various dates and generally provide for
purchase options but not renewals. Purchase options provide for purchase prices
at either fair market value or a stated value, which is related to the lessor's
book value at the expiration of the lease term.
Operating lease obligations increased significantly at the end of 2002 as a
result of the December 31, 2002 sale leaseback of seven regional distribution
centers as discussed in Note 13.
The Hagerstown, Maryland distribution center is subject to a synthetic
lease with monthly payments that are recorded in Third party interest expense.
The lease payment commitments were for three years with two one-year renewal
options and a principal payment due at the expiration of the lease agreement.
All obligations under this lease arrangement are guaranteed by the company. The
synthetic lease had a principal balance of
F-19
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$33,383 at December 31, 2002, which is due at the end of the lease term, which
is the earlier of December 31, 2003 or the termination of the existing revolving
credit facility. This debt and the original cost of the facility are not
recorded in the company's balance sheet because the synthetic lease does not
meet the requirement for capital lease treatment under SFAS No. 13, "Accounting
for Leases." The difference between the lease obligation and management's
estimation of the fair value of the building, which TruServ continues to believe
is reasonable at December 31, 2002, was recorded as a 2001 cost to exit the
facility and remains as a component in accrued expenses at December 31, 2002
(see Note 15).
Rent expense under operating leases was $25,436, $25,338 and $29,942 for
the years ended December 31, 2002, 2001 and 2000, respectively.
6. COMMITMENTS AND CONTINGENCIES
TruServ provides guarantees for certain member loans, but is not required
to provide a compensating balance for the guarantees. The company is required to
pay off a portion of the full amount of these loans under these guarantees,
ranging from 15-50% of the member's outstanding balance, in the event that a
member defaults on their loan, after which the member will be liable to the
company 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 $2,172 and $3,966 as of December 31, 2002 and 2001, respectively.
The balance of $2,172 as of December 31, 2002 includes approximately $557 that
will mature in fiscal 2003. The remaining guarantees will expire periodically
through 2013. TruServ carries a reserve of $217 relating to these guarantees.
Additionally, TruServ sold certain member note receivables to a third party
in 2002 which the company has fully guaranteed. The company is required to pay
100% of the outstanding balance of these member notes under these guarantees in
the event that a member defaults on their notes, after which the member will be
liable to the company for the guaranteed amount. The balance of these notes at
December 31, 2002 was $871. TruServ has recorded a liability and related
receivable for $871 relating to these member notes, and carries a $87 reserve
relating to these guarantees. The balance of $871 as of December 31, 2002
includes approximately $264 that will mature in fiscal 2003. The remaining
guarantees will expire periodically through 2007.
TruServ has a lifetime warranty or a customer satisfaction guarantee on the
majority of the company's TruTest paint products, which covers only replacement
material. The company has historically experienced minimal returns on these
warranties and guarantees and has determined any related liability to be
immaterial.
The company is involved in various claims and lawsuits incidental to its
business. The following significant matters existed at December 31, 2002:
BESS ACTION
In May 2000, TruServ filed a complaint in the Circuit Court of McHenry
County, Illinois against Bess Hardware and Sports, Inc., ("Bess") to recover an
accounts receivable balance in excess of $400. Bess filed a counterclaim,
seeking a setoff against its accounts receivable balance for the par redemption
value of Bess' shares of TruServ Stock. Bess contested the validity of a March
17, 2000 corporate resolution declaring a moratorium on the redemption of all
TruServ capital stock, as well as an allocation of Bess' proportionate share of
the loss which TruServ declared for its fiscal year 1999. On June 21, 2002, the
court issued an oral ruling granting summary judgment to TruServ on its accounts
receivable claim, and granting summary judgment to Bess on its counterclaim. The
judgment was entered on August 6, 2002. TruServ believes that the court's ruling
on Bess' counterclaim is not supported by either the facts or Delaware corporate
law. TruServ's motion for reconsideration and reversal of the August judgment on
Bess' counterclaim was denied on November 21, 2002. TruServ filed its notice of
appeal in the Second District of Illinois Appellate Court on December 2, 2002.
F-20
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DERIVATIVE ACTION
In August 2000, an action was brought in Delaware Chancery Court (New
Castle County) by a former TruServ member ("Hudson City Properties") against
certain present and former directors and certain former officers of TruServ and
against TruServ. The complaint is brought derivatively on behalf of TruServ and
alleges that the individual defendants breached their fiduciary duties in
connection with the accounting adjustments made by TruServ in the fourth quarter
of 1999. Hudson City Properties also seeks to proceed on a class-action basis
against TruServ on behalf of all those affected by the moratorium on stock
redemption and the creation of the loss allocation accounts. Hudson City
Properties alleges that TruServ breached, and the named directors caused TruServ
to breach, agreements with members by suspending payment of the members' 1999
annual patronage dividend, by declaring the moratorium on the redemption of
members' TruServ stock and by imposing minimum annual purchase requirements upon
members. The plaintiff seeks monetary and non-monetary relief in connection with
the various claims asserted in the complaint. The lawsuit, despite its vintage,
is in an early stage and the extent of the damages claimed has not yet been
determined. The parties have entered into settlement negotiations, but a final
settlement has not been reached at this time and no assurances can be given that
one will be entered into.
KENNEDY ACTION
In June 2000, various former members of TruServ filed an action against
TruServ in the Circuit Court of the 19th Judicial Circuit (McHenry County,
Illinois) (the "Kennedy action"). The plaintiffs in the Kennedy action each
allege that, based upon representations made to them by TruServ 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 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. 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. Similar claims were filed
against TruServ as counterclaims to various complaints filed by TruServ in
McHenry County to recover accounts receivable balances from other former
members. Those claims were consolidated with the Kennedy action. In March 2001,
the Kennedy complaint was amended to add additional plaintiffs. Also in March
2001, another action was filed against TruServ on behalf of additional former
members, in the same court, by the same law firm (the "A-Z action"). The A-Z
complaint alleges substantially similar claims as those in the Kennedy action,
with the principal difference being that the claims relate to the elimination of
the ServiStar brand name. The Kennedy and A-Z actions have been consolidated for
purposes of discovery, which is ongoing. The plaintiffs seek damages for stock
repurchase payments, lost profits and goodwill, out of pocket expenses, attorney
fees and punitive damages. In July 2002, the plaintiffs in these consolidated
actions amended their complaints to name as defendants two former officers of
TruServ. To the extent that TruServ may have indemnification obligations to
these former officers, TruServ's directors and officers' liability insurance
policies may be available to cover such claims.
TruServ intends to vigorously defend all of these cases. However, a ruling
in favor of any or all of the plaintiffs in the Kennedy Action, the Derivative
Action or the Bess Action could have a material adverse effect on TruServ. The
courts could rule that TruServ violated its Agreement with members or its
By-Laws in establishing the loss allocation account; imposing the moratorium on
stock redemptions; or imposing minimum purchase commitments on members. In the
event of such a ruling, TruServ could be required to do one or more of the
following:
- lift the moratorium on stock redemptions; and
- redeem members' stock presented for redemption at its full stated value.
F-21
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Such actions could constitute events of default under TruServ's Senior
Debt. Unless appropriate waivers were obtained from TruServ's lenders, the
amounts due under the Senior Debt could become immediately due and payable or
the Senior Debt agreements could have to be renegotiated. However, there can be
no assurances that TruServ would be able to obtain the requisite waivers or
successfully renegotiate its Senior Debt agreements. In the event TruServ was
unable to obtain the requisite waivers or successfully renegotiate its Senior
Debt agreements, a material adverse effect on TruServ's liquidity and capital
resources could result.
PENTZ SETTLEMENT
In June 2002, TruServ reached a comprehensive and confidential settlement
with Paul Pentz, a former president of TruServ regarding his claims for bonus
and retirement compensation payments.
CLAIMS AGAINST ERNST & YOUNG LLP
TruServ is pursuing claims against its former outside auditors, Ernst &
Young LLP ("E&Y"), for professional malpractice, breach of contract, deceptive
business practices and fraud. TruServ contends that E&Y failed to properly
discharge its duties to TruServ and failed to identify, in a timely manner, and
indeed concealed, certain material weaknesses in TruServ's internal financial
and operational controls. As a result, TruServ was forced to make an
unanticipated accounting adjustment in the fourth quarter of 1999 in the total
amount of $121,333 (the "Fourth Quarter Charge"). As a result, TruServ reported
a net loss of $130,803 for the fiscal year ended December 31, 1999. It is
TruServ's belief that had E&Y properly discharged its duties, the scope and
breadth of the Fourth Quarter Charge, as well as the accounting and operational
control deficiencies that necessitated the charge, would have been substantially
lessened, if not eliminated in their entirety. As a result of E&Y's failures,
TruServ has suffered significant financial damages. The factual allegations that
form the basis for TruServ's claim against E&Y include, in part, the issues
identified in the Securities and Exchange Commission cease and desist order
described below. TruServ began discussion of its claims with E&Y early in the
fall of 2001. Pursuant to the dispute resolution procedures required by
TruServ's engagement letter with E&Y, TruServ and E&Y attempted to mediate this
dispute during the first six months of 2002. When those attempts proved
unsuccessful, and again pursuant to the dispute resolution procedures, TruServ
filed its claim with the American Arbitration Association on July 31, 2002. The
arbitration, which is subject to certain confidentiality requirements, is
currently pending.
F-22
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. PROMISSORY (SUBORDINATED) AND INSTALLMENT NOTES
Promissory (subordinated) and installment notes consisted of the following
at December 31:
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Promissory (subordinated) notes:
Due on December 31, 2002 -- 7.86%......................... $ -- $ 23,253
Due on December 31, 2003 -- 7.90%......................... 19,413 19,731
Due on December 31, 2004 -- 9.00% to 10.00%............... 19,902 19,963
Due on December 31, 2005 -- 7.00% to 10.00%............... 23,565 1,304
Term (subordinated) notes
Due on June 30, 2002 -- 8.06%............................. -- 12,393
Installment notes at interest rates of 5.74% to 8.06% with
maturities through 2004................................... 2,006 5,962
-------- --------
64,886 82,606
Less amounts due within one year............................ (21,355) (39,633)
-------- --------
$ 43,531 $ 42,973
======== ========
</Table>
Prior to 1997, promissory notes were issued for partial payment of the
annual patronage dividend. Promissory notes are subordinated to indebtedness to
banking institutions, trade creditors and other indebtedness of TruServ as
specified by its board of directors. Prior experience indicates that the
maturities of a significant portion of the notes due within one year are
extended, for a three-year period, at interest rates substantially equivalent to
competitive market rates of comparable instruments. The company anticipates that
this practice of extending notes, based on historical results, will continue
and, accordingly, these notes are classified as a component of capitalization.
Total maturities of promissory and installment notes for fiscal years 2003,
2004 and 2005 are $21,354, $19,951 and $23,581, respectively.
Amounts shown as scheduled repayments are the stated note amounts; however,
it is an event of default in the amended debt agreements if payments of
subordinated notes exceed $14,000 in 2003. TruServ's payments of such notes
aggregated $17,765 in 2002 against scheduled repayments of $44,244 and maximum
payment level under the debt agreements of $24,000; as such payment amount was
less than the event of default ceiling amount, TruServ was in compliance.
TruServ will seek members' consent in 2003 to extend the note due dates in
exchange for an increase in the interest rate as it did in 2002.
F-23
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
Income tax expense consisted of the following for the years ended December
31:
<Table>
<Caption>
2002 2001 2000
---- ------ ----
($ IN THOUSANDS)
Current:
Federal................................................... $ -- $ 203 $231
State..................................................... 259 194 315
Foreign................................................... -- 641 306
---- ------ ----
Total current............................................. 259 1,038 852
Deferred:
Federal................................................... -- -- --
State..................................................... -- -- --
Foreign................................................... -- 339 64
---- ------ ----
Total deferred............................................ -- 339 64
---- ------ ----
$259 $1,377 $916
==== ====== ====
</Table>
The company operates as a nonexempt cooperative and is allowed a deduction
in determining its taxable income for amounts paid as qualified patronage
dividends based on margins from business done with or on behalf of members and
for the redemption of nonqualified notices of allocation. The reconciliation of
income tax expense to income tax computed at the U.S. federal statutory tax rate
of 35% was as follows for the years ended December 31:
<Table>
<Caption>
2002 2001 2000
------- -------- --------
($ IN THOUSANDS)
Tax at U.S. statutory rate............................ $ 7,494 $(19,224) $ 12,262
Effects of:
Patronage dividend.................................. (7,189) -- (12,233)
State income taxes, net of federal benefit.......... 168 126 205
(Decrease)/increase in valuation allowance.......... (353) 18,353 (2,503)
Non-deductible goodwill............................. -- 902 2,819
Other, net.......................................... 139 1,220 366
------- -------- --------
$ 259 $ 1,377 $ 916
======= ======== ========
</Table>
Deferred income taxes reflect the net tax effects to the company of its net
operating loss carryforwards, which expire in years through 2021; alternative
minimum tax credit carryforwards, which do not expire, nonqualified notices of
allocations, which are deductible when redeemed and do not expire; and temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. The deferred
tax effect of the net operating loss carryforward was reduced in 2002 by
$37,076. $21,895 of the reduction is primarily attributable to changes in other
deferred tax assets and liabilities, mostly due to gains from asset sales
taxable in the year of sale but deferred for financial reporting purposes; and
the remaining $15,181 reduction is the cumulative effect of non-cash patronage
dividends applied to satisfy members' loss allocation accounts (a corresponding
reduction of $15,181 was made to the valuation allowance).
Total deferred tax assets net of deferred tax liabilities have a full
valuation allowance because the company has concluded that, based on the weight
of available evidence it is more likely than not that the deferred tax assets
will not be realized. Deferred tax assets will only be realized to the extent
future earnings are retained by TruServ and not distributed to members as
patronage dividends. If tax benefits are subsequently recognized in excess of
net deferred tax assets, approximately $13,619 of the resulting reduction in the
valuation allowance for deferred tax assets is merger-related and will reduce
goodwill.
F-24
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The significant components of the company's deferred tax assets and
liabilities were as follows for the years ended December 31:
<Table>
<Caption>
2002 2001
-------- ---------
($ IN THOUSANDS)
Deferred tax assets
Net operating loss carryforwards.......................... $ 28,364 $ 65,440
AMT credit carryforward................................... 784 784
Nonqualified notices of allocation........................ 13,548 13,548
Bad debt provision........................................ 3,421 3,761
Vacation pay.............................................. 2,889 2,617
Contributions to fund retirement plans.................... 3,051 --
Deferred gain from sale leaseback......................... 25,026 --
Severance and restructuring costs......................... 6,846 12,878
Inventory reserves........................................ -- 1,272
Rent expense.............................................. 2,714 2,623
Merger-related valuations and accruals.................... 1,861 2,160
Inventory capitalization.................................. 3,126 2,657
Other..................................................... 6,055 5,302
-------- ---------
Total deferred tax assets................................... 97,685 113,042
Valuation allowance for deferred tax assets................. (94,952) (110,537)
-------- ---------
Net deferred tax assets..................................... 2,733 2,505
Deferred tax liabilities:
Tax depreciation in excess of book depreciation........... 1,602 960
Contributions to fund retirement plans.................... -- 414
Other..................................................... 1,131 1,131
-------- ---------
Total deferred tax liabilities.............................. 2,733 2,505
-------- ---------
Net deferred taxes.......................................... $ -- $ --
======== =========
</Table>
9. SUPPLEMENTAL CASH FLOW INFORMATION
The patronage dividend and promissory (subordinated) and redeemable
(subordinated) term note renewals relating to non-cash operating and financing
activities were as follows for the years ended December 31:
<Table>
<Caption>
2002 2001 2000
------- ------- -------
($ IN THOUSANDS)
Patronage dividend payable in cash...................... $ 6,121 $ (976) $10,459
Accrued expenses........................................ (245) (569) --
Promissory (subordinated) notes......................... (4,324) (5,888) (1,820)
Redeemable Class A voting common stock.................. -- -- 3
Redeemable Class B common stock......................... 2,497 -- (2,733)
Installment notes....................................... (34) (50) 2,515
Loss allocation......................................... 14,006 2,488 21,458
Member indebtedness..................................... 2,520 4,995 4,823
------- ------- -------
Patronage dividend.................................... $20,541 $ -- $34,705
======= ======= =======
Member note renewals and interest rollover.............. $36,434 $21,936 $22,525
======= ======= =======
</Table>
TruServ may set off its obligation to make any payment to a member for such
member's stock, notes, interest and declared and unpaid dividends against any
obligation owed by the member to TruServ. TruServ exercised its set off rights
in 2002 when patronage dividends were declared for members with loss allocation
F-25
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accounts. Also the set off rights were exercised when TruServ notes and interest
came due to former members with outstanding accounts receivable to TruServ and
current members with past due accounts receivable to TruServ. TruServ also set
off its obligation to former members against their related loss allocation
balance. The set off rights were exercised in an aggregate amount of $16,526,
which decreased the loss allocation account by $14,006 and accounts receivable
by $2,520 during 2002.
In 2001, TruServ also exercised its set off rights when TruServ notes and
interest came due to former members with outstanding accounts receivable to
TruServ and current members with past due accounts receivable to TruServ.
TruServ also set off its obligation to former members against their related loss
allocation balance. The set off rights were exercised in an aggregate amount of
$7,483, which decreased the loss allocation account by $2,488 and accounts
receivable by $4,995 during 2001. $976 of the offset to accounts receivable was
generated from the payment of the fiscal 2000 patronage dividend in 2001, which
reduced the cash payment from $10,459 to $9,483.
The company's non-cash financing and investing activities in fiscal year
2001 include $1,300 related to a note received for the sale of its Indianapolis,
Indiana property. In fiscal year 2000, the company's non-cash financing and
investing activities are due to an asset sale and related agreements with
Builder Marts of America, Inc. that included a note receivable of $19,500 and
debit memos of $4,000.
Cash paid for interest during fiscal years 2002, 2001 and 2000 totaled
$61,989, $59,048 and $60,059, respectively. Cash paid for income taxes during
fiscal years 2002, 2001 and 2000 totaled $305, $133 and $777, respectively.
10. BENEFIT PLANS
The change in the projected benefit obligation and in the plan assets for
the company administered qualified pension plan were as follows for the years
ended December 31:
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Change in projected benefit obligation:
Projected benefit obligation at beginning of year......... $ 58,991 $ 68,181
Service cost.............................................. 5,045 5,639
Interest cost............................................. 3,693 4,494
Benefit payments.......................................... (26) (1)
Actuarial losses.......................................... 5,144 10,394
Plan amendments........................................... 19 (10,678)
Curtailments.............................................. (1,301) --
Settlements............................................... (11,849) (19,038)
-------- --------
Projected benefit obligation at end of year............... 59,716 58,991
Change in plan assets:
Fair value of plan assets at beginning of year............ 54,376 76,501
Actual return on assets................................... (5,573) (3,086)
Employer contributions.................................... 10,000 --
Benefit payments.......................................... (26) (1)
Settlements............................................... (11,849) (19,038)
-------- --------
Fair value of plan assets at end of year.................. 46,928 54,376
Reconciliation of funded status:
Funded status............................................. (12,788) (4,616)
Unrecognized transition asset............................. (104) (361)
</Table>
F-26
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
2002 2001
-------- --------
($ IN THOUSANDS)
Unrecognized prior service cost........................... (7,616) (9,793)
Unrecognized actuarial loss............................... 26,206 17,468
-------- --------
Prepaid expense........................................... $ 5,698 $ 2,698
======== ========
</Table>
TruServ also has a pension plan that is the supplemental executive
retirement plan ("SERP"), which is an unfunded unqualified defined benefit plan.
The change in the projected benefit obligation and in the plan assets for the
SERP were as follows for the years ended December 31:
<Table>
<Caption>
2002 2001
------- -------
($ IN THOUSANDS)
Change in projected benefit obligation:
Projected benefit obligation at beginning of year......... $ 4,648 $ 8,317
Service cost.............................................. 342 212
Interest cost............................................. 301 380
Benefit payments.......................................... (390) (390)
Actuarial losses.......................................... 129 2,786
Plan amendments........................................... (18) --
Settlements............................................... -- (6,657)
------- -------
Projected benefit obligation at end of year............... 5,012 4,648
Change in plan assets:
Fair value of plan assets at beginning of year............ -- --
Employer contributions.................................... 390 7,047
Benefit payments.......................................... (390) (390)
Settlements............................................... -- (6,657)
------- -------
Fair value of plan assets at end of year.................. -- --
Reconciliation of funded status:
Funded status............................................. (5,012) (4,648)
Unrecognized prior service cost........................... 3,727 4,357
Unrecognized actuarial loss............................... 1,970 1,927
------- -------
Prepaid expense........................................... $ 685 $ 1,636
======= =======
</Table>
The company recorded in Deferred credits, for the SERP plan, an additional
minimum pension liability of $4,880 as of December 31, 2002, which represents
the amount by which the accumulated benefit obligation exceeded the fair value
of plan assets plus the previously recognized prepaid asset. The additional
liability has been offset by an intangible asset, which is included in Other
assets, to the extent of previously unrecognized prior service cost. The amount
in excess of previously unrecognized prior service cost of $1,153 at December
31, 2002 is recorded as a reduction of Members' equity in Accumulated other
comprehensive income.
The company has a prepaid pension expense for both plans of $6,383 and
$4,334 at December 31, 2002 and 2001, respectively. The prepaid pension expense
at December 31, 2002 and December 31, 2001 is classified in "Other current
assets."
F-27
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of net periodic pension cost for the company administered
qualified pension plan were as follows for the years ended December 31:
<Table>
<Caption>
2002 2001 2000
------- ------- --------
($ IN THOUSANDS)
Components of net periodic pension cost:
Service cost......................................... $ 5,045 $ 5,639 $ 6,098
Interest cost........................................ 3,693 4,494 8,716
Expected return on assets............................ (4,618) (5,986) (12,987)
Amortization of transition assets.................... (235) (311) (529)
Amortization of prior service cost................... (519) (62) 340
Amortization of actuarial loss/(gain)................ 96 109 (180)
Curtailment gain..................................... (1,641) -- --
Settlement loss/(gain)............................... 5,179 5,521 (5,376)
------- ------- --------
Net pension cost................................ $ 7,000 $ 9,404 $ (3,918)
======= ======= ========
</Table>
In the third quarter of fiscal year 2000, the company purchased from an
insurance company non-participating annuity contracts to satisfy pension
obligations related to certain former employees who were fully vested in their
pension benefits. As a result of this transaction, the company recognized a
pre-tax gain of approximately $5,000 in fiscal year 2000 related to the
settlement of these pension obligations. Such gain has been recorded as Other
income, net.
The components of net periodic pension cost for the SERP were as follows
for the years ended December 31:
<Table>
<Caption>
2002 2001 2000
------ ------ ------
($ IN THOUSANDS)
Components of net periodic pension cost:
Service cost............................................. $ 342 $ 212 $ 316
Interest cost............................................ 301 380 757
Amortization of prior service cost....................... 611 612 612
Amortization of actuarial loss/(gain).................... 86 169 89
Settlement loss/(gain)................................... -- 2,759 3,411
------ ------ ------
Net pension cost...................................... $1,340 $4,132 $5,185
====== ====== ======
</Table>
The company also participates in union-sponsored defined contribution
plans. Costs related to these plans were $60, $30 and $169 for fiscal year 2002,
2001 and 2000, respectively.
Plan assets consist primarily of publicly traded common stocks and
corporate debt instruments.
The assumptions used to determine TruServ's pension obligations for all
plans were as follows for the years ended December 31:
<Table>
<Caption>
2002 2001
----- -----
Weighted average assumptions:
Discount rate............................................. 6.50% 7.00%
Expected return on assets................................. 8.00% 8.50%
Rate of compensation increase............................. 3.50% 4.50%
</Table>
F-28
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TruServ also maintains a defined benefit retirement medical plan for former
SCC employees who met certain age and service criteria that was frozen at the
time of the Merger. The company contributes $0.105 per month per person for such
employees who elect coverage for themselves and their dependents. The company
also maintains similar benefits for some former SCC executives who were also
contractually eligible for such coverage.
The change in the benefit obligation and in the plan's assets for the
company's post-retirement plan, as well as the components of net periodic
post-retirement benefit cost, was as follows for the years ended December 31:
<Table>
<Caption>
2002 2001
------- -------
($ IN THOUSANDS)
Change in benefit obligation:
Accumulated post-retirement benefit obligation at
beginning of year...................................... $ 4,972 $ 4,747
Interest cost............................................. 415 350
Claims paid............................................... (597) (427)
Actuarial losses.......................................... 1,476 302
------- -------
Accumulated post-retirement benefit obligation at end of
year................................................... 6,266 4,972
------- -------
Change in plan assets:
Fair value of plan assets at beginning of year............ -- --
Employer contribution..................................... 597 427
Claims paid............................................... (597) (427)
------- -------
Fair value of plan assets at end of year.................. -- --
------- -------
Reconciliation of funded status:
Funded status............................................. (6,266) (4,972)
Unrecognized actuarial losses............................. 1,757 326
------- -------
Net amount recognized..................................... (4,509) (4,646)
------- -------
Component of net periodic post-retirement benefit cost:
Interest cost............................................. 415 350
Amortization of (gain)/loss............................... 45 --
------- -------
Net periodic benefit cost................................. $ 460 $ 350
======= =======
</Table>
The effect of a one percentage point increase in the medical trend rate
would increase the interest cost component by $11 and the post-retirement
benefit obligation by $150. The effect of a one percentage point decrease in the
medical trend rate would decrease the interest cost components by $9 and the
post-retirement benefit obligation by $126.
The assumptions used to determine TruServ's health benefit obligations were
as follows for the years ended December 31:
<Table>
<Caption>
2002 2001
---- ----
Weighted average assumptions:
Discount rate............................................. 6.50% 7.00%
Medical trend rate........................................ 5.00% 5.00%
</Table>
11. SEGMENT INFORMATION
The company is principally engaged as a wholesaler of hardware and related
products and is a manufacturer of paint products. The company identifies
segments based on management responsibility and the nature of the business
activities of each component of the company. The company measures segment
earnings
F-29
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
as operating earnings including an allocation for interest expense and income
taxes. Information regarding the identified segments and the related
reconciliation to consolidated information are as follows:
<Table>
<Caption>
DECEMBER 31, 2002
--------------------------------------------
PAINT
MANUFACTURING CONSOLIDATED
HARDWARE AND DISTRIBUTION TOTALS
---------- ---------------- ------------
($ IN THOUSANDS)
Net sales to external customers....................... $2,060,282 $115,169 $2,175,451
Interest expense...................................... 57,349 4,546 61,895
Depreciation and amortization......................... 33,409 1,442 34,851
Segment net margin.................................... 11,967 9,186 21,153
Identifiable segment assets........................... 652,815 50,556 703,371
Expenditures for long-lived assets.................... 12,061 777 12,838
</Table>
<Table>
<Caption>
DECEMBER 31, 2001
------------------------------------------------------------------------
PAINT ELIMINATION
MANUFACTURING OF INTERSEGMENT CONSOLIDATED
HARDWARE AND DISTRIBUTION CANADA ITEMS TOTALS
---------- ---------------- ------- --------------- ------------
($ IN THOUSANDS)
Net sales to external customers.... $2,404,553 $130,484 $84,397 $ -- $2,619,434
Intersegment sales................. -- 1,649 -- (1,649) --
Interest expense................... 58,967 3,819 487 -- 63,273
Depreciation and amortization...... 39,344 1,671 504 -- 41,519
Segment net margin/(loss).......... (64,562) 12,826 1,049 -- (50,687)
Identifiable segment assets........ 963,736 54,757 2,344 -- 1,020,837
Expenditures for long-lived
assets........................... 14,188 615 348 -- 15,151
</Table>
<Table>
<Caption>
DECEMBER 31, 2000
-------------------------------------------------------------------------
PAINT ELIMINATION
MANUFACTURING OF INTERSEGMENT CONSOLIDATED
HARDWARE AND DISTRIBUTION CANADA ITEMS TOTALS
---------- ---------------- -------- --------------- ------------
($ IN THOUSANDS)
Net sales to external customers... $3,745,524 $139,109 $109,009 $ -- $3,993,642
Intersegment sales................ -- 1,856 -- (1,856) --
Interest expense.................. 62,184 4,661 861 -- 67,706
Depreciation and amortization..... 40,482 1,752 799 -- 43,033
Segment net margin................ 24,984 9,000 133 -- 34,117
Identifiable segment assets....... 1,162,319 52,020 21,675 -- 1,236,014
Expenditures for long-lived
assets.......................... 11,365 627 534 -- 12,526
</Table>
The company does not have a significant concentration of members in any
geographic region of the United States or in any foreign countries.
12. ASSET SALES
Effective December 29, 2000, the company sold the assets, primarily
inventory, of the lumber and building materials ("LBM") business, comprising
fiscal year 2000 sales of approximately $1,100,000, to Builder Marts of America,
Inc. ("BMA"). In connection with this sale, the company received consideration
of $20,200 in cash (of which $1,000 was held in escrow until December 31, 2001
to satisfy any contingencies or disputes between the parties and which,
accordingly, is classified as Restricted cash), a $19,500 note receivable
(payable in annual installments through December 31, 2007 and carrying an
interest rate of 7.75% per annum) and $4,000 in debit memos to be used as an
offset against amounts payable to BMA existing at the date of the sale.
Additionally, the company recorded deferred credits totaling $9,500 related to
certain
F-30
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
non-compete, cooperation, trademark and license, and lease agreements entered
into with BMA; such amount will be amortized to income over the lives of the
underlying agreements, generally 5-10 years. The company also relieved $4,600 of
goodwill (net) and $700 of inventory related to the LBM business at the time of
the sale. As a result of the above, the company recognized a gain of $28,900 in
the fourth quarter of 2000, which is recorded in Gain on sale of assets. As of
December 31, 2002, all but $100 of the note receivable was paid by BMA.
Effective October 22, 2001, TruServ sold its ownership interest in TruServ
Canada Cooperative, Inc. along with the headquarters and warehouse building and
other parcels of real estate to the current management group of the cooperative.
Net proceeds from the transaction were $9,654. The company recorded a net gain
of $1,550 which is recorded in Gain on sale of assets.
In August 2002, TruServ sold its Brookings, South Dakota regional
distribution center to Rainbow Play Systems Properties of Brookings, LLC. The
net proceeds after all closing costs for this sale of $6,286 were distributed to
the senior lenders in the third quarter in accordance with the amended
intercreditor agreement to pay down short-term borrowings and prepay long-term
senior debt.
13. SALE LEASEBACK
On December 31, 2002, TruServ sold seven of its distribution centers to
unrelated third parties for an aggregate purchase price of $125,753. The sale
resulted in net proceeds to TruServ of $121,438, which were used to pay Senior
Debt. The net reduction in Senior Debt was $108,743, as a result of new
make-whole notes of $12,695 issued due to the prepayment on senior notes.
TruServ then entered into leases with each of three purchasers to lease the
distribution centers for a period of 20 years. The transaction was recorded as a
real property sale and as operating leases in TruServ's financial statements.
The resulting gain on sale of $55,564, recorded as Deferred gain in the balance
sheet and to be amortized to income on a straight line basis over the initial 20
year lease term.
Each lease is a "triple-net" lease under which TruServ is obligated to pay
all operating expenses of the property, all taxes and other impositions related
to the property, to maintain and insure the property and, with minor exceptions,
to rebuild the improvements after a casualty or condemnation. TruServ also
indemnifies the landlord from any loss, cost, damage or liability arising out of
the use, ownership or operation of the property, including any liability related
to hazardous materials.
TruServ's obligation to pay rent under the leases is absolute, with no
right to offset or abatement. The three leases are cross-defaulted, such that a
default under one of the lease constitutes a default under each of the other
leases. Events of default under the leases relate to TruServ's "triple-net"
lease obligations, as described above, and do not include any financial
covenants. TruServ has no right to terminate any of the leases, with minor
exceptions as described in the leases.
TruServ sold the distribution facilities located in Corsicana, Texas and
Woodland, California to and now leases them from Wrench (DE) Limited
Partnership. TruServ sold the distribution facilities located in Kingman,
Arizona, Fogelsville, Pennsylvania and Springfield, Oregon to and now leases
them from Bolt (DE) Limited Partnership. TruServ sold the distribution
facilities located in Jonesboro, Georgia and Kansas City, Missouri to and now
leases them from Hammer (DE) Limited Partnership. The three limited partnerships
are affiliated with W.P. Carey Investments, an investment firm independent of
TruServ. TruServ pays rent under each lease quarterly in January, April, July
and October. The aggregate annual rent under all three leases for the first year
of the lease totals $12,007. Rent under the leases increases 2% each year during
the initial 20 year lease term.
TruServ has the right to extend each lease for two additional periods. The
first extension period under each lease is for a term of nine years and 11
months and the second is for a term of 10 years. TruServ may elect to renew a
lease or leases with respect to any one or more of the properties without
renewing the lease or
F-31
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
leases with respect to all of the properties subject thereto. TruServ has the
right to assign the lease without the landlord's prior written consent, but
subject to certain conditions described in the leases. Provided that TruServ
assigns the rent thereunder to the landlord, TruServ may sublet all or any part
of any property without the landlord's consent.
TruServ continues to evaluate opportunities to capitalize on the increase
in market value over the historical book value of its owned real estate assets
through additional sale leaseback transactions, mortgages or other financing
methods.
14. QUARTERLY FINANCIAL SUMMARY (UNAUDITED)
Selected quarterly financial information for each of the four quarters in
fiscal 2002 and 2001 is as follows:
<Table>
<Caption>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
($ IN THOUSANDS)
2002
Revenues......................................... $553,228 $597,856 $499,818 $524,549
Net margin before income taxes................... 4,738 10,493 6,031 150
Net margin....................................... 4,648 10,433 5,934 138
2001
Revenues......................................... $654,350 $747,765 $621,977 $595,342
Net margin/(loss) before income taxes............ (13,900) 2,847 (2,345) (35,912)
Net margin/(loss)................................ (13,936) 2,573 (2,477) (36,847)
</Table>
15. RESTRUCTURING CHARGES AND OTHER RELATED EXPENSES
In fiscal 2002, TruServ incurred restructuring and other related charges of
$6,284, of which $3,313 related to restructuring, and $2,971 related to other
post-employment and asset impairment charges. The restructuring charge of $3,313
in fiscal 2002 resulted from TruServ's continued workforce reductions initiated
in fiscal 2000 and 2001 related to distribution center closures and workforce
reductions in the organization. This charge was comprised of $2,316 for
severance and $2,296 for facility exit costs, offset by a $1,299 reduction in
asset impairment charges. The severance charges of $2,316 primarily consisted of
additional workforce reductions at the corporate headquarters in Chicago,
Illinois. The facility exit costs of $2,296 related to exiting the Hagerstown,
Maryland distribution center, which was completed prior to December 31, 2002.
The $1,299 reduction of asset impairment charges consisted of a $927 favorable
adjustment to the asset value for the closing of the of the Brookings, South
Dakota distribution center based on actual proceeds received on the sale of this
facility in 2002. It also included a $372 favorable adjustment relating to the
transfer of certain Hagerstown, Maryland equipment to other facilities, the
value of which had been fully reserved in 2001. The other charges of $2,971
consisted of $1,769 for asset impairment and $1,202 for post-employment charges.
The asset impairment charge of $1,769 related to the write-down of the East
Butler, Pennsylvania facility. The post-employment charge of $1,202 was
comprised of $352 relating to severance charges for the Cary, Illinois facility,
and $850 relating to severance charges for the corporate headquarters in
Chicago, Illinois.
In fiscal 2001, TruServ recorded a charge to income of $38,522, of which
$10,722 was for severance, $18,901 was for facility exit costs for the
distribution centers, and $8,899 was for asset impairments. The largest
component of these exit costs related to the Hagerstown, Maryland distribution
center closure, which is subject to a synthetic lease. The difference of
approximately $14,800 between the lease obligation at December 31, 2001 of
$40,000 and management's estimate of the fair value of the building was the
major component of its facility exit costs in 2001. This obligation and the
original cost of the facility are not recorded on TruServ's balance sheet
because it does not meet the requirement for capital lease treatment under
F-32
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Statement of Financial Accounting Standards ("SFAS") No. 13, "Accounting for
Leases." At December 31, 2002, the synthetic lease had a principal balance of
$33,383, which is due at the end of the amended lease term, which is the earlier
of December 31, 2003 or the termination of the existing revolving credit
facility.
Restructuring initiatives summary (dollar amounts in thousands):
<Table>
<Caption>
DECEMBER 31, 2001 ADDITIONAL DECEMBER 31, 2002
RESTRUCTURING RESTRUCTURING ASSET RESTRUCTURING
RESERVE CHARGES IMPAIRMENTS PAYMENTS RESERVE
----------------- ------------- ----------- -------- -----------------
($ IN THOUSANDS)
Closure of Henderson, North Carolina
distribution center:
Severance and outplacement........ $ 150 $ 12 $ -- $ (162) $ --
------- ------- ------ -------- -------
150 12 -- (162) --
------- ------- ------ -------- -------
Closure of Indianapolis, Indiana
distribution center:
Severance and outplacement........ 78 8 -- (86) --
------- ------- ------ -------- -------
78 8 -- (86) --
------- ------- ------ -------- -------
Closure of Brookings, South Dakota
distribution center:
Severance and outplacement........ 1,608 165 -- (1,621) 152
Facility exit costs............... 979 -- -- (979) --
Asset impairments................. -- (927) 927 -- --
------- ------- ------ -------- -------
2,587 (762) 927 (2,600) 152
------- ------- ------ -------- -------
Closure of Hagerstown, Maryland
distribution center:
Severance and outplacement........ 1,122 501 -- (979) 644
Facility exit costs............... 17,000 2,296 -- (8,266) 11,030
Asset impairments................. -- (372) 372 -- --
------- ------- ------ -------- -------
18,122 2,425 372 (9,245) 11,674
------- ------- ------ -------- -------
Corporate headquarter workforce
reduction:
Severance and outplacement........ 5,312 1,630 -- (3,497) 3,445
------- ------- ------ -------- -------
5,312 1,630 -- (3,497) 3,445
------- ------- ------ -------- -------
Total:
Severance and outplacement........ 8,270 2,316 -- (6,345) 4,241
Facility exit costs............... 17,979 2,296 -- (9,245) 11,030
Asset impairments................. -- (1,299) 1,299 -- --
------- ------- ------ -------- -------
$26,249 $ 3,313 $1,299 $(15,590) $15,271
======= ======= ====== ======== =======
</Table>
F-33
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
DECEMBER 31, 2000 ADDITIONAL DECEMBER 31, 2001
RESTRUCTURING RESTRUCTURING ASSET RESTRUCTURING
RESERVE CHARGES IMPAIRMENTS PAYMENTS RESERVE
----------------- ------------- ----------- -------- -----------------
($ IN THOUSANDS)
Closure of Henderson, North Carolina
distribution center:
Severance and outplacement......... $ -- $ 569 $ -- $ (419) $ 150
Facility exit costs................ 150 780 -- (930) --
------ ------- ------- ------- -------
150 1,349 -- (1,349) 150
------ ------- ------- ------- -------
Closure of Indianapolis, Indiana
distribution center:
Severance and outplacement......... 861 106 -- (889) 78
Facility exit costs................ 901 142 -- (1,043) --
------ ------- ------- ------- -------
1,762 248 -- (1,932) 78
------ ------- ------- ------- -------
Closure of Brookings, South Dakota
distribution center:
Severance and outplacement......... -- 1,656 -- (48) 1,608
Facility exit costs................ -- 979 -- -- 979
Asset impairments.................. -- 5,338 (5,338) -- --
------ ------- ------- ------- -------
-- 7,973 (5,338) (48) 2,587
------ ------- ------- ------- -------
Closure of Hagerstown, Maryland
distribution center:
Severance and outplacement......... -- 1,122 -- -- 1,122
Facility exit costs................ -- 17,000 -- -- 17,000
Asset impairments.................. -- 3,561 (3,561) -- --
------ ------- ------- ------- -------
-- 21,683 (3,561) -- 18,122
------ ------- ------- ------- -------
Corporate headquarter workforce
reduction:
Severance and outplacement......... -- 7,269 -- (1,957) 5,312
------ ------- ------- ------- -------
-- 7,269 -- (1,957) 5,312
------ ------- ------- ------- -------
Total:
Severance and outplacement......... 861 10,722 -- (3,313) 8,270
Facility exit costs................ 1,051 18,901 -- (1,973) 17,979
Asset impairments.................. -- 8,899 (8,899) -- --
------ ------- ------- ------- -------
$1,912 $38,522 $(8,899) $(5,286) $26,249
====== ======= ======= ======= =======
</Table>
16. SUBSEQUENT EVENTS
On March 13, 2003, TruServ amended its synthetic lease, revolving credit
facility and senior note agreements primarily to: (1) finalize the financial
covenants to allow for the substantial reduction in debt and the corresponding
increase in rent payments resulting from the December 31, 2002 sale leaseback
transaction (see Note 13) and (2) to extend the maturity date of the Hagerstown
facility's synthetic lease obligation to the earlier of December 31, 2003 or a
refinancing of the revolving credit facility.
On March 7, 2003, TruServ paid patronage dividends in the amount of $20,541
related to the fiscal year ended December 31, 2002.
On March 4, 2003, the Commission entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
TruServ Corporation, SEC File No. 3-11050 (the "Order"). TruServ consented to
the entry of the Order without admitting or denying the findings in the Order.
F-34
TRUSERV CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Commission entered the Order following an investigation by the staff of
the Commission of the circumstances that led to significant financial
adjustments resulting in the 1999 loss of $131,000. The Order found that, from
approximately July 1997 through the end of 1999, TruServ's accounting systems
and internal controls related to inventory management were inadequate. The Order
also found that these deficiencies caused TruServ to understate expenses, which
resulted in overstatement of net income, during 1998 and 1999. According to the
Order, TruServ filed erroneous reports on Form 10-Q for the first, second and
third quarters of 1998 and 1999 and an erroneous report on Form 10-K for 1998.
In 1999, TruServ reported a loss, caused by weaknesses in the accounting
practices and internal controls at TruServ, of approximately $131,000.
The largest component of the 1999 loss of $131,000 represented adjustments
to inventory and merchandise payable. Specifically, the Commission found that
TruServ had in 1998 and the first three quarters of 1999 misstated accounts,
including unbilled merchandise, claims for returned merchandise from members,
and additional stock adjustments, consisting of lost and found merchandise,
damaged goods, and others.
The Order also found that TruServ and its senior management had notice of
its internal control problems as early as February 1997, through a report
prepared by its internal audit department. The report noted several specific,
recurring problems in data entry concerning inventory management that caused
significant discrepancies in TruServ's inventory records. According to the
Order, no one acted on the 1997 report, even though it concluded that TruServ
did not have adequate internal controls over its inventory systems.
TruServ investigated the causes of the inventory and merchandise payable
adjustments, and in order to prevent problems from occurring in the future, it
adopted several changes in procedure to correct accounting weaknesses. According
to the Order, as a result of these systemic flaws, TruServ is not able to
restate any of the erroneous filings made in 1998 and 1999. The Commission made
no allegations of fraud nor did it seek civil monetary penalties in connection
with entering the Order.
Pursuant to the Order, TruServ has agreed to continue to maintain the
procedures that it has adopted since the Spring of 2000 and otherwise to comply
with the accounting, record keeping and internal control provisions of the
Securities and Exchange Act of 1934 (the "Exchange Act"). In addition, TruServ
will continue to employ as a member of its management team, during the fiscal
years ending 2002, 2003 and 2004, a Director of Internal Audit who will be
responsible for executing TruServ's internal audit plan and will continue to
engage a public accounting firm to assist the Director of Internal Audit in
performing internal audit procedures.
Also pursuant to the Order, within 90 days after the close of each fiscal
year ending 2002, 2003 and 2004, the Director of Internal Audit will prepare and
deliver to TruServ's board audit committee, with copies to the Commission,
TruServ's auditors and the public accounting firm assisting the Director of
Internal Audit, a report describing the scope of the audit plan during the
preceding year, confirmation that the audit plan was carried out, an overview of
significant control weaknesses identified that require improvement and a review
of the steps taken to improve the system of internal controls.
On March 4, 2003, the Commission also entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
Kerry Kirby, File No. 3-11053 (the "Kirby Order"). The Kirby Order made
substantially all of the findings that were made in the Order. In addition, the
Kirby Order found that Kerry Kirby, the chief financial officer of TruServ from
July 1997 to May 1999, in part due to his failure to act on the internal audit
report that TruServ's accounting systems were flawed, was a cause of TruServ's
violations of securities laws requiring the accurate financial reporting,
accurate books and records and adequate internal controls.
F-35
ITEM 14(a)(2). INDEX TO FINANCIAL STATEMENT SCHEDULES.
<Table>
<Caption>
PAGE(S)
-------
Schedule II -- Valuation and Qualifying Accounts............ F-37
</Table>
F-36
TRUSERV CORPORATION
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
FOR FISCAL YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
ALLOWANCE FOR DOUBTFUL ACCOUNTS
<Table>
<Caption>
FISCAL YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
-------- --------- ---------
($ IN THOUSANDS)
Allowance for Doubtful Accounts:
Balance at beginning of year.............................. $9,402 $ 7,170 $ 5,613
Provision for doubtful accounts........................... 120 6,275 9,147
Write-offs of doubtful accounts(1)........................ (969) (4,043) (7,590)
------ ------- -------
Balance at end of year.................................... $8,553 $ 9,402 $ 7,170
====== ======= =======
</Table>
- ---------------
(1) Notes and accounts written off as uncollectible, net of recoveries of
accounts previously written off as uncollectible.
INVENTORY RESERVES
<Table>
<Caption>
FISCAL YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
--------- --------- --------
($ IN THOUSANDS)
Reserve for Inventory:
Balance at beginning of year.............................. $ 15,636 $ 12,717 $ 1,142
Provision for inventory reserves.......................... 10,620 14,977 14,204
Write-off of inventory.................................... (15,822) (12,058) (2,629)
-------- -------- -------
Balance at end of year.................................... $ 10,434 $ 15,636 $12,717
======== ======== =======
</Table>
F-37
ITEM 14(a)(3). INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBITS
ENCLOSED DESCRIPTION
-------- -----------
4-C Specimen certificate of Class A common stock.
4-D Specimen certificate of Class B common stock.
4-E Promissory (subordinated) note form.
4-F Installment note form.
4-U Second Amendment dated December 30, 2002 amends the Amended
and Restated Note Purchase Agreement Dated April 14, 2000
for $105,000,000 Amended and Restated Senior Secured Notes
due 2008.
4-V Fifth Amendment dated December 30, 2002 to the Amended and
Restated Private Shelf Agreement between TruServ Corporation
and Prudential Insurance Company of America dated November
13, 1997 for $150,000,000 and to Note Agreement of
$50,000,000, dated as of April 13, 1992, between Cotter &
Company and Prudential.
4-W First Amendment dated December 30, 2002 to the First Amended
and Restated Intercreditor Agreement among Bank of America,
N.A. as Agent under a Credit Agreement with TruServ
Corporation; Allstate Insurance Company and certain
financial institutions; The Prudential Insurance Company of
America and certain of its affiliates; Shelf Noteholders,
TruServ 1998 Trust, Wilmington Trust Company in its
individual capacity and as owner trustee, BMO Global Capital
Solutions, Inc., Bank of Montreal, as Administrative Agent;
Bank of America, N.A., as Collateral Agent and TruServ
Corporation, et al. dated as of April 11, 2002.
4-X First Amendment dated December 30, 2002 to the Second
Amended and Restated Credit Agreement dated as of April 11,
2002 for $200,000,000 between TruServ Corporation, various
financial institutions, and Bank of America.
4-Y Fifth amendment dated as of December 30, 2002 to the
Participation Agreement dated as of April 30, 1998 for
$40,000,000 between TruServ Corporation, various financial
institutions and Bank of Montreal.
4-Z Third Amendment dated March 13, 2003 amends the Amended and
Restated Note Purchase Agreement Dated April 14, 2000 for
$105,000,000 Amended and Restated Senior Secured Notes due
2008.
4-AA Sixth Amendment dated March 13, 2003 to the Amended and
Restated Private Shelf Agreement between TruServ Corporation
and Prudential Insurance Company of America dated November
13, 1997 for $150,000,000 and to Note Agreement of
$50,000,000, dated as of April 13, 1992, between Cotter &
Company and Prudential.
4-AB Sixth amendment dated as of March 13, 2003 amends the
Participation Agreement dated as of April 30, 1998 for
$40,000,000 between TruServ Corporation, various financial
institutions and Bank of Montreal.
4-AC Second Amendment dated March 13, 2002 to the Second Amended
and Restated Credit Agreement dated as of April 11, 2002 for
$200,000,000 between TruServ Corporation, various financial
institutions, and Bank of America.
10-C TruServ Corporation Defined Lump Sum Pension Plan as Amended
and Restated Effective as of January 1, 1998; including
amendments through December 30, 2002.
10-D TruServ Corporation Savings and Compensation Deferral Plan
as Amended and Restated Effective January 1, 1998; including
amendments through December 2002.
10-E TruServ Supplemental Retirement Plan (As Amended and
Restated Effective December 15, 2002).
10-J Lease Agreement by and between Hammer (DE) Limited
Partnership, a Delaware limited partnership, as Landlord and
TruServ Corporation as Tenant, dated December 26, 2002
</Table>
E-1
<Table>
<Caption>
EXHIBITS
ENCLOSED DESCRIPTION
-------- -----------
10-K Lease Agreement by and between Bolt (DE) Limited
Partnership, a Delaware limited partnership, as Landlord and
TruServ Corporation as Tenant, dated December 26, 2002.
10-L Lease Agreement by and between Wrench (DE) Limited
Partnership, a Delaware limited partnership, as Landlord and
TruServ Corporation as Tenant, dated December 26, 2002.
10-M Termination Agreement and General Release between the
company and Robert Ostrov dated March 20, 2003.
21 Subsidiaries
99.1 Section 906 Certification (Chief Executive Officer)
99.2 Section 906 Certification (Chief Financial Officer)
99.3 Code of Ethics
</Table>
<Table>
<Caption>
EXHIBITS
INCORPORATED
BY REFERENCE
------------
2-A Agreement and Plan of Merger dated as of December 9, 1996
between the company and ServiStar Coast to Coast Corporation
("SCC"). Incorporated by reference--Exhibit 2-A to
Registration Statement on Form S-4 (No. 333-18397).
4-A Amended and Restated Certificate of Incorporation of the
company, effective July 1, 1997. Incorporated by
reference--Exhibit 2-A to Registration Statement on Form S-4
(No. 333-18397).
4-B By-Laws of the company, effective December 17, 2001.
Incorporated by reference--Exhibit 4-B to the Registrant's
Annual Report on Form 10-K for the fiscal year ended
December 31, 2001.
4-G Copy of Note Agreement with Prudential Insurance Company of
America dated April 13, 1992 securing 8.60% Senior Notes in
the principal sum of $50,000,000 with a maturity date of
April 1, 2007. Incorporated by reference--Exhibit 4-J to
Post-Effective Amendment No. 2 to Registration Statement on
Form S-2 (No. 33-39477).
4-H Amended and Restatement dated April 14, 2000 to Credit
Agreement dated September 10, 1998 for $105,000,000 Note
Purchase Agreement between TruServ Corporation and various
purchasers. Incorporated by reference--Exhibit 4-Q to Post
Effective Amendment No. 10 to Registration Statement on Form
S-2 to Form S-4 (No. 333-18397).
4-I Amended and Restated Private Shelf Agreement between TruServ
Corporation and Prudential Insurance Company of America
dated November 13, 1997 for $150,000,000. Incorporated by
reference--Exhibit 4-M to Post-Effective Amendment No. 5 to
Registration Statement on Form S-4 (No. 333-18397)
4-J Second Amended and Restated Credit Agreement dated as of
April 11, 2002 for $200,000,000 Revolving credit between
TruServ Corporation, various financial institutions, and
Bank of America. Incorporated by reference--Exhibit 4-J to
the Registrant's Annual Report on Form 10-K for the fiscal
year ended December 31, 2001.
4-K Amendment dated May 12, 1999 to the Amended and private
Shelf Agreement between TruServ Corporation and Prudential
Insurance Company of America dated November 13, 1997 for
$150,000,000. Incorporated by reference--Exhibit 4-M to the
registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1999 (File No. 2-20910).
</Table>
E-2
<Table>
<Caption>
EXHIBITS
INCORPORATED
BY REFERENCE
------------
4-L Amendment dated April 14, 2000 to the Amended and Private
Shelf Agreement between TruServ Corporation Prudential
Insurance Company of America dated November 13, 1997 for
$150,000,000 and to Note Agreement of $50,000,000, dated as
of April 13, 1992, between Cotter & Company and Prudential.
Incorporated by reference on Exhibit 4-N to Post-Effective
Amendment No. 10 to Registration Statement on Form S-2 to
Form S-4 (No. 333-18397)
4-M Security Agreement dated as of April 14, 2000 among TruServ
Corporation, various subsidiaries of the Company and Bank of
America, N.A., as Collateral Agent. Incorporated by
reference--Exhibit 4-M to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
4-N First Amendment dated as of April 11, 2002 amends the
Security Agreement dated of as April 14, 2000 among TruServ
Corporation, various subsidiaries of the Company and Bank of
America, N.A., as Collateral Agent. Incorporated by
reference--Exhibit 4-N to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
4-O Participation Agreement dated April 30, 1998 for $40,000,000
between TruServ Corporation, various financial institutions
and Bank of Montreal. Incorporated by reference--Exhibit 4-M
to Post-Effective Amendment No. 6 to Registration Statement
on Form S-4 (No. 333-18397)
4-P Fourth amendment dated as of April 11, 2002 amends the
Participation Agreement dated as of April 30, 1998 for
$40,000,000 between TruServ Corporation, various financial
institutions and Bank of Montreal. Incorporated by
reference--Exhibit 4-P to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
4-Q Amendment dated as of April 11, 2002 amends the Amended and
Restated Note Purchase Agreement dated April 14, 2000 to
Credit Agreement dated September 10, 1998 for $105,000,000
Note Purchase Agreement between TruServ Corporation and
various purchasers. Incorporated by reference--Exhibit 4-Q
to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 2001.
4-R Amendment dated April 11, 2002 to the Amended Private Shelf
Agreement between TruServ Corporation and Prudential
Insurance Company of America for $150,000,000 dated April
14, 2000 to the Amended and Restated Private Shelf Agreement
between TruServ Corporation and Prudential Insurance Company
of America dated November 13, 1997 for $150,000,000 and to
Note Agreement of $50,000,000, dated as of April 13, 1992,
between Cotter & Company and Prudential. Incorporated by
reference--Exhibit 4-R to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001.
4-S First Amended and Restated Intercreditor Agreement among
Bank of America, N.A. as Agent under a Credit Agreement with
TruServ Corporation, Allstate Insurance Company and certain
financial institutions. The Prudential Insurance Company of
America and certain of its affiliates. Shelf Noteholders,
TruServ 1998 Trust, Wilmington Trust Company in its
individual capacity and as owner trustee, BMO Global Capital
Solutions, Inc., Bank of Montreal, as Administrative Agent.
Bank of America, N.A., as Collateral Agent and TruServ
Corporation, et al. dated as of April 11, 2002. Incorporated
by reference--Exhibit 4-S to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 2001.
4-T Trust Indenture between Cotter & Company and US Bancorp
(formerly First Trust of Illinois). Incorporated by
reference--Exhibit T3C to Cotter & Company Form T-3 (No.
22-26210).
10-A Current Form of "Retail Member Agreement with TruServ"
between the company and its members that offer primarily
hardware and related items. Incorporated by reference--
Exhibit 10-A to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2000.
</Table>
E-3
<Table>
<Caption>
EXHIBITS
INCORPORATED
BY REFERENCE
------------
10-B Current Form of "Subscription to Shares of TruServ."
Incorporated by reference--Exhibit 10-B to Registration
Statement on Form S-2 (No. 333-18397).
10-F Retail Conversion Funds Agreement dated as of December 9,
1996 between the company and SCC. Incorporated by
reference--Exhibit 10-L to Registration Statement on Form
S-4 (No. 333-18397).
10-G Employment Agreement between the company and Pamela Forbes
Lieberman dated November 15, 2001. Incorporated by
reference--Exhibit 10-H to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 2001
</Table>
SUPPLEMENTAL
INFORMATION
------------
Supplemental Information to be Furnished with Reports Filed Pursuant to
Section 15(d) of the Act by Registrants which have not Registered Securities
Pursuant to Section 12 of the Act.
As of the date of the foregoing Report, no annual report for the
Registrant's year ended December 31, 2002 has been sent to security holders.
Copies of such Annual Report and proxy soliciting materials will subsequently be
furnished to the Securities and Exchange Commission.
E-4