ITEM 1. Business.
Summary
KFC National Purchasing Cooperative, Inc. (the "Cooperative"), was formed to serve as a national purchasing cooperative on behalf, and for the benefit, of Kentucky Fried Chicken ("KFC") retail outlet owners and operators, including KFC National Management Company ("KFC Management"), a subsidiary of KFC Corporation ("KFCC"). The Cooperative was incorporated under the General Corporation Law of the State of Delaware in September 1978. In 1992, the Cooperative's members adopted amendments to its Certificate of Incorporation and Bylaws to provide for membership in the Cooperative by owners and operators of Taco Bell retail outlets. The Cooperative currently does business under the name of FoodService Purchasing Cooperative, Inc. The term "Operator" when used in this document includes (i) owners and operators of Taco Bell retail outlets, (ii) KFC Management and Tricon Global Restaurants (Canada), Inc., and (iii) owners and operators of KFC franchised retail outlets.
The Cooperative makes volume purchases of various equipment, food, pack aging, and other consumable or disposable supplies ("Equipment and Supplies") from manufacturers and suppliers for sale to Operators whether or not they are members of the Cooperative, as well as to independent distributors who supply Operators. The Cooperative endeavors to obtain low purchase prices by making volume purchase commitments at fixed prices and by assuming other procurement functions and risks that reduce the suppliers' costs. Cost savings will be dependent upon a number of factors, including the volume of purchases and resales to Operators and distributors, negotiation of favorable purchase agreements, competitive conditions and the amount of overhead expenses. In an effort to achieve additional cost savings, the Cooperative is actively working with its suppliers and distributor customers with electronic data interchange. The Cooperative hopes to achieve cost savings for its members; however, there can be no assurance that it will be able to do so on a sustained basis.
The Cooperative provides its members with advisory services related to the distribution of Equipment and Supplies, including industry data on distribution costs and service levels to enable the members to negotiate more effectively with distributors. The Cooperative also sponsors a Distributor Monitoring Program to enhance the system of independent distributors available to retail outlet operators.
The Cooperative, through its wholly-owned subsidiary, KFC Franchisee Insurance Program, Inc. (the "Insurance Subsidiary"), sponsors programs of property, casualty and workers' compensation insurance, and employee benefits, including life, health, long-term disability and dental coverages for owners and operators of fast food retail outlets. These programs are marketed through the Cooperative's indirect subsidiary, Kenco Insurance Agency, Inc. (the "Insurance Agency"). See "OPERATIONS - INSURANCE PROGRAM."
The Cooperative has an equipment staging operation with warehousing facilities in Louisville, Kentucky.
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The Cooperative has provided financing from time to time under certain circumstances for its stockholder members. In 1987, the Cooperative initiated an equipment financing program to finance for franchisee members their purchases from the Cooperative of equipment required for Operators to participate in KFC's introduction of two new menu items. In 1992, the Cooperative reactivated on a limited basis an equipment financing program to finance equipment purchases for KFC franchisee members participating in the KFC buffet bar, rotisserie chicken, and KFC signage rollouts. Although the Cooperative has now terminated its equipment financing program, it does actively help Operators obtain information concerning alternative financing options.
The Cooperative's Board of Directors is currently contemplating a reorganization. For a description of the Cooperative's proposed reorganization, see "Proposed Corporate Reorganization."
"Dairy Queen," "Domino's Pizza," "Long John Silver's," "Fazoli's," "Taco Bell," and "KFC" are registered trademarks of American Dairy Queen Corporation, Domino's Pizza, Inc., Long John Silver's, Inc., Taco Bell Corporation, Seed Restaurant Group, Inc., and KFCC, respectively, and are used in these materials for identification purposes only. The Cooperative is an independent provider of products and is not affiliated with American Dairy Queen Corporation, Domino's Pizza, Inc., Long John Silver's Inc., Taco Bell Corporation, or KFCC, except that KFCC is a stockholder member of the Cooperative.
HISTORY
The Cooperative was organized by KFCC and the National Franchisee Advisory Council (the "NFAC") with the objectives of: (i) obtaining Equipment and Sup plies at the lowest prices; and (ii) having the procurement function on behalf of Operators of KFC retail outlets handled on an arm's-length basis rather than through KFCC. The organization of the Cooperative was an outgrowth of a feasibility study conducted by a consulting firm, engaged by KFCC in conjunction with the Equipment and Supply Committee of the NFAC. The consulting firm made recommendations about possible procurement alternatives to the then current KFC Master Supply Agreement mechanism.
A primary premise upon which the Cooperative was founded was that greater cost savings for Operators in the purchase of Equipment and Supplies could be realized through one central procurement organization that made firm purchase commitments, took title to goods, and made sales to Operators and distributors, thereby relieving suppliers of certain costs of doing business with numerous, small volume purchasers. These costs include credit, sales, marketing, and billing expenses which would otherwise be expected to be reflected ultimately in higher prices charged by the suppliers. Purchase commitments made by the Cooperative also allow suppliers to plan production, purchase raw materials, and control inventory levels, thereby further providing suppliers with reduced costs.
In determining to organize the Cooperative, KFCC and the NFAC concluded that, notwithstanding the inherent administrative complexity of a member-con trolled cooperative, the Cooperative better than any alternative, could meet five important criteria:
- Provide potential for lowest delivered cost of Equipment and Supplies;
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- Promote confidence among Operators and KFCC that the best interests of the entire KFC system would be served;
- Minimize complexity of legal issues;
- Support high product quality and consistency and maintain service reliability; and
- Support competition among distributors and suppliers and allow for free selection of distributors and suppliers outside the central procurement system.
In 1997, the NFAC was merged with the KFC National Council and Advertising Cooperative, Inc. (the "NCAC"). The NCAC has replaced the NFAC as a stockholder member of the Cooperative.
OPERATING PRINCIPLE
The Cooperative is a central procurement organization which, among other functions, makes firm commitments to purchase Equipment and Supplies in its own name and at its own risk, and takes title to and sells the Equipment and Supplies to distributors and Operators. Members participate in establishing strategic procurement policies through the Cooperative's Board of Directors (the "Board").
The success of the Cooperative depends on it being able to purchase and resell goods at prices that will attract the business of Operators and/or their distributors. The Cooperative attempts to obtain the lowest possible purchase price by making firm commitments to purchase in large volumes and by assuming other procurement functions and risks, such as dealing with numerous purchasers, that should reduce the suppliers' costs.
The Cooperative provides the convenience of "one-stop" shopping for distributors and Operators which otherwise might be required to deal with a number of suppliers. The operation of the Cooperative also allows Operators to benefit from the Cooperative's full-time professional purchasing staff working solely for the benefit of Operators.
OPERATIONS
The following is a description of the Cooperative's operations, primarily with respect to KFC and Taco Bell related activities. The Cooperative organizes its operations with a focus on concepts versus products. The Cooperative has assigned general managers responsibilities for each significant fast food concept with which the Cooperative does business. These general managers are responsible for the success associated with their particular concept.
In an effort to achieve additional cost savings, the Cooperative is actively coordinating its purchasing and distribution activities with its suppliers and distributor customers using the computer-to-computer exchange of business documents, i.e., electronic data interchange ("EDI"). Using EDI facilitates the timely and efficient execution of the Cooperative's purchases and sales.
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PRICING POLICY
The primary objective of the Cooperative is to purchase and resell Equipment and Supplies to Operators and distributors at the lowest prices that can be achieved by volume purchase commitments and the assumption of other procurement functions and risks previously described. Consistent with this objective, the Cooperative marks up the purchased Equipment and Supplies by the least amount which it estimates to be sufficient to cover the Cooperative's costs and to pro vide for working capital and prudent levels of reserves. The Cooperative expects to maintain its minimal margins mark-up policy even though it has implemented a patronage dividend program. See Item 5. "MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS."
SEASONALITY
The Cooperative's sales reflect the somewhat seasonal nature of the volume of business done by Operators. Thus, the Cooperative's sales are generally expected to be at their relatively lowest levels during the winter months and are generally expected to be at their relatively highest levels in the summer months. However, because of the growth in the Cooperative's sales volume since it commenced operations as of March 1, 1980, no pattern of absolute, rather than relative, seasonal changes has emerged.
CORN PROGRAM
The Cooperative makes substantial purchase commitments for frozen cob corn on or about October 1, the beginning of a cob corn crop year, and takes physical delivery of the purchased cob corn shortly thereafter. The cob corn is stored by the Cooperative in freezer equipped storage facilities at various locations across the United States until resold to distributors or franchisees. For the crop year which commenced in October 1998, the Cooperative purchased or committed to purchase approximately 770,000 cases of cob corn for purchase prices totaling approximately $5,029,000.
INSURANCE PROGRAM
The following is a description of the Cooperative's insurance programs for owners and operators of fast food retail outlets. During fiscal 1982, the Cooperative organized the Insurance Subsidiary to engage in activities related to a new KFC franchisee insurance program. The KFC franchisee insurance program was developed as a voluntary insurance program by the Association of Kentucky Fried Chicken Franchisees, Inc., and the Cooperative.
Through the Insurance Agency, the Cooperative currently offers two types of insurance coverage through different insurance carriers, one offering property, casualty, and workers' compensation coverage (the "Property and Casualty Program"), and the other offering employee benefits, including life, health, long-term disability and dental coverages (the "Life and Health Pro gram"). The Cooperative, through its Insurance Subsidiary, is the sponsor of the two Programs. The Insurance Subsidiary's role in the two Programs is to monitor the Programs and the performance of its insurance carriers and to distribute general information about the Programs.
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The Insurance Agency and its agents maintain Kentucky-resident insurance licenses and nonresident licenses in all states. The Insurance Agency is compensated for the administrative and operational activities it performs by receiving a commission from insurance companies providing policies to the franchisees. In fiscal 1998, the premium volume from the fully insured Property and Casualty Program was $6.9 million and for the Life and Health Program was $1.5 million.
FINANCING PROGRAMS
The Cooperative has provided or facilitated equipment financing from time to time under certain circumstances for franchisee members. In April 1996, the Cooperative established a finance program for stockholder members co-sponsored by the National Cooperative Bank (the "Bank"). The program provided up to $20,000,000 in loans to Cooperative members. The Cooperative agreed to guarantee from 10% to 25% of the declining balance of each loan based on the loan's risk classification, with a maximum guarantee of $100,000 per any loan with an initial principal balance greater than $2,000,000. The program was terminated in 1997, although the Cooperative's guarantee of certain loans under the program continues. As of October 31, 1998, the Bank has funded approximately $6.5 million of borrowings outstanding under this program. See Note 8 of "NOTES TO CONSOLIDATED FINANCIAL STATEMENT."
EQUIPMENT STAGING
The Cooperative offers equipment staging services, which involve the purchasing and warehousing of equipment by the Cooperative in an effort to consolidate equipment into packages for timely shipment to owners and operators of KFC, Taco Bell and other fast food retail outlets. The Cooperative has leased warehouse space in Louisville, Kentucky, for its equipment staging operation. See Item 2.
ITEM 2. Properties.
The Cooperative does not own any real property or warehousing facilities. The Cooperative currently leases approximately 51,474 square feet of office space at 950 Breckinridge Lane, in Louisville, Kentucky, for its executive offices under leases expiring on February 28, 2005. The Cooperative leases commercial frozen food warehouse facilities on a short-term basis in various locations in connection with its frozen cob corn purchase program. The Cooperative currently leases approximately 19,650 square feet of warehouse space in Louisville, Kentucky, for its equipment staging operation. The Canadian Subsidiary also leases approximately 1,400 square feet of office space in Mississauga, Ontario.
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ITEM 3.
ITEM 3. Legal Proceedings.
On July 31, 1998, the Cooperative filed a complaint in Jefferson County Kentucky Circuit Court against Fred Jeffrey, a former consultant to the Cooperative, and his wife, Julianna Jeffrey (collectively, the "Jeffreys"), alleging breach of contract, conversion and unjust enrichment. The Cooperative alleges in its complaint that the Jeffreys breached certain contracts with the Cooperative by not fully repaying a $600,000 loan from the Cooperative and for converting certain funds that were to be used to repay that loan. At the time of filing the complaint, the Jeffreys were in default for approximately $194,036.95 under the loan. The Jeffreys each filed separate answers to the complaint, denying that they are in default and asserting that the loan was non-recourse in nature. Fred Jeffrey filed a counterclaim against the Cooperative, alleging that in 1991 the Cooperative fraudulently induced him into selling his business and becoming a consultant to the Cooperative, and various other claims including wrongful termination of his consulting agreement with the Cooperative. The matter is in the early stages of discovery. Management, after consultation with legal counsel, believes that these claims by Mr. Jeffrey are without merit.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders.
No matter was submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters
No market for the Cooperative's capital stock exists nor is any expected to develop. Described below are the Cooperative's dividend policy, patronage dividend program, and Membership Common Stock and Store Common Stock.
DIVIDEND POLICY
Although the Cooperative does not and will not engage in business to generate profits, it may nonetheless, in any fiscal year, generate revenues in excess of amounts needed to cover expenses, amortize indebtedness, and provide for reasonable working capital and reserves. Thus, even though the Cooperative will endeavor to minimize purchasing fees and mark-ups on Equipment and Supplies to the least amount required to cover their anticipated cost of operations, the Cooperative may have funds available for distribution to members as patronage dividends. Prior to the implementation of the Cooperative's patronage dividend program, the Board declared a dividend of $25.00 per share of Store Common Stock which was paid on March 31, 1982. There is no current intention to pay any dividends in the future on Store Common Stock on a per share basis. The Cooperative will not pay dividends at any time on Membership Common Stock.
The Cooperative has established a patronage dividend program. See "PATRONAGE DIVIDEND PROGRAM." The payment of dividends based upon patronage tends, of course, to reduce or eliminate funds available for dividends based upon the number of shares of Store Common Stock owned.
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PATRONAGE DIVIDEND PROGRAM
INTRODUCTION
In 1982, the Cooperative implemented a program for the payment of patronage dividends to members on the basis of the value of business done by the Cooperative with regard to each member, respectively. Beginning with fiscal 1995, through an amendment to Section 9.2 of its Bylaws set forth in its entirety herein, the Board is authorized to distribute as patronage dividends amounts determined in accordance with Section 9.2. Under the revised program, solely for purposes of determining the amount of patronage dividends distributable to a particular stockholder member, the Cooperative has established two separate pools of allocated net earnings for purposes of making patronage dividend determinations, the "KFC Pool" and the "Taco Bell Pool," as defined in Section 9.2, such that patronage dividends to stockholder members operating Taco Bell retail outlets will be paid from the Taco Bell Pool and patronage dividends to stockholder members operating KFC outlets will be paid from the KFC Pool. In addition, in August 1996, the Board determined that the Cooperative would pay patronage dividends to its stockholder members, based separately for KFC stockholder members on pre-tax income available from the KFC Pool and for Taco Bell stockholder members based on pre-tax income available from the Taco Bell Pool, for the period from November 1, 1996, through October 31, 1997, in an aggregate amount equal to the lesser of (a) 70% of the Cooperative's total "pre-tax income," as defined in the Cooperative's 1997 fiscal year budget, or (b) the amount of the Cooperative's total "pre-tax income" for fiscal 1997 reasonably allocable to sales with respect to which a patronage dividend is payable. In August 1997, the Board determined that a patronage dividend for fiscal 1998 would be paid on a formula similar to that adopted for fiscal 1997, except that the patronage dividend would be based upon 80% of "pre-tax income," rather than 70%. In August 1998, the Board determined that a patronage dividend for fiscal 1999 would be paid on a formula similar to that adopted for fiscal 1998.
The Cooperative paid a patronage dividend totaling $2,762,000 in March 1997 for patronage in fiscal 1996. The Cooperative paid a patronage dividend totaling $2,890,000 in March 1998 for patronage in fiscal 1997. For patronage during fiscal 1998, a dividend totaling $2,619,000 is payable in March 1999. KFC-related sales volumes and net income have historically been higher than Taco Bell sales volumes and net income. For fiscal 1998, patronage dividends for KFC Operator members will average approximately $800 per store, while patronage dividends for Taco Bell Operator members will average approximately $300 per store.
BYLAW PROVISION
The Bylaw provision regarding patronage dividends is as follows:
Article IX Patronage Dividends
9.1 Cooperative Basis. The Cooperative shall at all times be operated on a cooperative basis for the benefit of its stockholder members. The Cooperative shall always do more than fifty percent (50%) in value
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of its business with its stockholder members either directly or through distributors ("participating distributors") which shall have agreed to participate in the Cooperative's patronage dividend program for its stockholder members by entering into distributor participation agreements with the Cooperative in such form as the President shall prescribe from time to time. The Cooperative may operate on a for-profit basis with respect to non-members.
9.2 Patronage Dividend Distributions.
(a) The Board of Directors is authorized, after considering the Cooperative's need for capital and reserves, to distribute as patronage dividends directly to each stockholder member of the Cooperative amounts determined as set forth below. Solely for the purpose of determining the amount of patronage dividends distributable to a particular stockholder member of the Cooperative, the Cooperative's business with its stock holder members shall be segregated into two distinct pools: (i) the "KFC Pool," under which shall be deter mined the net earnings of the Cooperative from business done by the Cooperative directly with stockholder members for use by the stockholder members in KFC retail outlets owned or operated by the stockholder members and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder members for such use; and (ii) the "Taco Bell Pool," under which shall be determined the net earnings of the Cooperative from business done by the Cooperative directly with stock holder members for use by the stockholder members in Taco Bell retail outlets owned or operated by the stock holder members and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder members for such use.
The amount distributable by the Cooperative as patronage dividends directly to each stockholder member of the Cooperative shall be based on
(A) The ratio of
(i) the value of business done by the Cooperative directly with such stockholder member for use by the stockholder member in KFC retail outlets owned or operated by the stockholder member and the value of business done by the Cooperative with participating distributors resulting in resales by such distributors to such stockholder member for such use, to
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(ii) the net earnings of the Cooperative in the KFC Pool, plus
(B) The ratio of
(i) the value of business done by the Cooperative directly with such stockholder member for use by the stockholder member in Taco Bell retail outlets owned or operated by the stockholder member and the value of business done by the Cooperative with participating distributors resulting in resale by such distributors to such stockholder member for such use, to
(ii) the net earnings of the Cooperative in the Taco Bell Pool.
(b) The distribution described in subparagraph (a), is among all stockholder members, shall be directly proportional for each taxable year of the Cooperative to the purchases by each stockholder member, whether such purchases are direct or through a participating distributor.
9.3 Timing of Payment of Patronage Dividends. Each distribution of patronage dividends shall be made within the payment period beginning with the first day of a taxable year for which the Cooperative claims a deduction for patronage dividends paid in the form of such distributions and ending with the 15th day of the 9th month following the close of such taxable year.
9.4 Character of Distributions. Twenty percent or more of the amount of each distribution shall be paid in cash or by a "qualified check" as defined in Section 1388(c)(4) of the Internal Revenue Code of 1986, as amended. All amounts of such distributions not paid in money or by "qualified check" shall be paid a "qualified written notice of allocation" as defined in Section 1388(c)(1) of the Internal Revenue Code of 1986, as amended.
9.5 Consent to Stockholder Members. Membership in the Cooperative by stockholder members shall constitute a consent of each such member to include in its gross income the amount of any patronage dividend which is paid with respect to direct sales from the Cooperative, and indirect sales through participating distributors in money, "qualified checks," "qualified written notices of allocation" or other property (except "non-qualified written notices of allocation" as defined in Section 1388(d) of the Internal Revenue Code of 1986, as amended) and which is received by it during the taxable year from the Cooperative. Each stockholder member of
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the Cooperative, through initiating or retaining its membership after adoption of this Article IX of these Bylaws, as amended from time to time, consents to be bound hereby. The provisions of this Article IX, as amended from time to time, shall be a contract between the Cooperative and each stockholder member as fully as though each stockholder member had signed a specific separate instrument in which the stockholder member agreed to be bound by all of the terms and provisions of this Article IX, as amended from time to time.
9.6 Application of Patronage Dividends to Amounts Due the Cooperative. Notwithstanding any of the foregoing provisions of this Article IX, the portion of any patronage dividends which would otherwise be payable in cash under any provision of this Article IX to a stockholder member may be applied by the Cooperative to the payment of any indebtedness, the repayment of which is in default, owed to the Cooperative by any such stockholder member to the extent of such indebtedness instead of being distributed in cash, provided, however, that an amount equal to twenty percent (20%) (or, in the case of a stockholder member located in a jurisdiction to which the special withholding requirements of Sections 1441 or 1442 of the Internal Revenue Code of 1986, as amended, apply, thirty percent (30%)) of the total annual patronage dividends distributable for the applicable year to any such stockholder member shall nevertheless be paid in cash within the period set forth in Section 9.3 if any such stockholder member so requests in a writing received by the Cooperative within thirty (30) days of the first day of the Cooperative's fiscal year as established under Section 6.3.
FEATURES OF PROGRAM
The patronage dividend program implemented pursuant to the Bylaw provision has the following, among other, features:
1. Members who are United States residents must consent to report any patronage dividends received as gross income for federal income tax purposes. The Cooperative will file with the Internal Revenue Service a report, currently on Form 1099-PATR, of the amount of patronage dividends paid to each member. Members resident of countries other than the United States generally are subject to a flat United States tax of 30% on the amount of patronage dividends paid by the Cooperative. The Cooperative is required to withhold the 30% tax from the patronage dividend payment, unless the treaty between the United States and a particular country provides for a lower withholding rate. For example, a treaty between the United States and Canada provides for withholding at a 15% rate (although the Canadian member remains liable for the remaining 15% tax).
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2. While the Bylaw provision permits the Cooperative to operate on a "for-profit basis" with respect to non-members, the Cooperative has no intention of changing its pricing policy, as described above, pursuant to which the Cooperative endeavors to mark up prices on Equipment and Supplies by the least amount necessary.
3. The validity of the Cooperative's allocation of participating distributor purchases to the distributors' respective customer Opera tors will depend upon the accuracy and timeliness of the records maintained by the distributors and provided to the Cooperative pursuant to agreements between the distributors and the Cooperative. The Cooperative anticipates that distributors serving members will perform the recordkeeping functions in an accurate and timely manner. However, the Cooperative cannot assume responsibility, as between the Cooperative and its members, for the information provided, or not provided, the Cooperative by distributors with respect to purchases by individual Operators.
4. While the Cooperative is authorized to make distributions, in part, in a form other than cash, the Cooperative anticipates that in the foreseeable future any distributions would be solely in the form of cash, subject to offset as discussed below. In 1993, the Cooperative's Board of Directors adopted Article 9.6 set forth above providing for a possible offset of a stockholder member's patronage dividend against the payment of any indebtedness to the Cooperative, the repayment of which is in default. As a matter of policy, the Cooperative currently notifies any franchisee against whose patron age dividend the Cooperative intends to offset against an obligation of its intention by certified mail return receipt requested, and the Cooperative will require any member requesting that 20% of any patronage dividend to be offset nevertheless be paid to the member in cash make the request by certified mail return receipt requested.
5. KFC Management and Harman are eligible as are all other members to receive patronage dividends on the same basis as other members.
6. Distributions of patronage dividends are based solely on patronage with the Cooperative and not on the basis of the number of shares of Store Common Stock owned by a member. The payment of dividends based on patronage with the Cooperative necessarily reduces or eliminates funds available for dividends based on the number of shares of Store Common Stock owned.
7. Non-member Operators are ineligible to receive patronage dividends, just as they are ineligible to receive dividends on Store Common Stock.
8. The treatment of the Cooperative's payment of patronage dividends under the federal income tax laws of the United States is not free from uncertainty. See "UNITED STATES TAX ASPECTS OF THE PATRONAGE DIVIDEND PROGRAM." If favorable tax treatment of patronage dividends becomes unavailable, the Cooperative will reevaluate the patronage dividend program and may discontinue or modify it.
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9. If the Cooperative is liquidated, any funds available after redemption of Membership Common Stock will be distributed on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock owned.
UNITED STATES TAX ASPECTS OF THE PATRONAGE DIVIDEND PROGRAM
The United States Internal Revenue Code of 1986, as amended (the "Code"), provides that corporations "operating on the cooperative basis" generally may exclude from their taxable income amounts paid as "patronage dividends." "Patronage dividends" are amounts paid to patrons (a) on the basis of the quantity or value of business done with or for such patron, (b) under an obligation of an organization to pay such amount, which obligation existed before the organization received the amount so paid, and (c) which is determined by reference to the net earnings of the organization from business done with or for its patrons. The patronage dividend program described above calls for the payment of patronage dividends, (a) to members with respect to their purchases of Equipment and Supplies from the Cooperative, (b) pursuant to an obligation to pay in the context of the provisions of the Bylaws set forth above, and (c) determined on the basis of the net earnings of the Cooperative from such business done with all of its members in accordance with Article 9.2. Accordingly, the Cooperative believes that its patronage dividend program meets the standards of the Code.
The Cooperative has been advised by the U.S. Internal Revenue Service that the Service will not issue a favorable advance ruling concerning the Cooperative's proposed exclusion from its taxable income of amounts paid as patronage dividends. Accordingly, there can be no assurance that the Cooperative's treatment will not be challenged on audit of the Cooperative's federal income tax returns. If such a challenge were successful, the Cooperative would be liable for taxes and interest for any amounts disallowed as exclusions from its taxable income.
PATRONAGE DIVIDEND PROGRAM FOR CANADIAN STOCKHOLDERS
The payment of patronage dividends to members is based on the value of business done by the Cooperative with regard to each member. Because substantially all of the Cooperative's Canadian sales to Operators will be with the Canadian Subsidiary, and not with the Cooperative itself, the value of business done by Canadian stockholder members with the Cooperative will be minimal. The amount of the patronage dividend paid to Canadian stockholder members will be correspondingly minimal. The Cooperative, therefore, has determined to provide a sales allowance to Canadian stockholder members based on patronage with the Canadian Subsidiary. This allowance is intended to provide the Canadian stock holder members with a program based on Canadian sales similar to the current patronage dividend program. For fiscal 1999, the sales allowance will be based on 80% of the Canadian Subsidiary's net income. There can be no assurance that the Canadian Subsidiary's operations will be successful on a sustained basis and that any such price reduction program will continue.
As noted above in "Features of Program," upon liquidation of the Cooperative any funds available after redemption of Membership Common Stock will be distributed on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock. In part, because such a liquidating distribution with respect to Canadian stockholders would be minimal, the Coop-
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erative will enter into an agreement to repurchase any Canadian stockholder member's Store Common Stock at its original purchase price at any time after two years from the date of purchase. Under Delaware law, the Cooperative may not repurchase any shares of its common stock when the capital of the Cooperative is impaired or when such repurchase would cause any impairment of the capital of the Cooperative. CAPITAL STOCK
Membership Common Stock
The Cooperative is authorized to issue 2,000 shares of Membership Common Stock, no par value, of which 707 shares were issued and outstanding on October 31, 1998. The summary description of Membership Common Stock provisions which follows is subject in all respects to the Certificate of Incorporation and the Bylaws of the Cooperative.
Issuance in Series. Membership Common Stock is offered and issued in series as indicated in the discussion below of Series A through Series Q. The Cooperative's Certificate of Incorporation also provides for nine Series of Membership Common Stock which are designated Series R through Series Z. The Board has no current specific intention to issue any shares of the Series R through Z Membership Common Stock and is prohibited from doing so without further amendment of the Bylaws.
KFC Operators. Operators of KFC retail outlets, except for KFC Management, the NCAC, Harman and Scott's, are entitled to purchase one share of Membership Common Stock of Series A through Series G, inclusive, depending upon their being deemed to operate a KFC retail outlet in one or more of the states designated below:
Harman has purchased one share of Series H Membership Common Stock. Scott's has purchased one share of Series I Membership Common Stock. Operators of KFC retail outlets in Foreign Territories are entitled to purchase one share of Series J Membership Common Stock. KFC Management has purchased one share of Series K Membership Common Stock and the NCAC has purchased one share of Series
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L Membership Common Stock. Operators of KFC retail outlets in Canada, including Tricon Global Restaurants (Canada), Inc., are entitled to purchase one share of Series M Membership Common Stock.
The Series H and Series I Membership Common Stock held by Harman and Scott's, respectively, each provides for the election of one director and the series of such stock held by KFC Management and the NCAC each provide for the election of two directors. The Bylaws of the Cooperative provide that if Harman or Scott's at any time owns or operates fewer than 100 KFC outlets, or if KFC Management owns or operates fewer than 200 KFC outlets, then the share of Membership Common Stock owned by said Operator must be exchanged for one share of Membership Common Stock of such other Series as such Operator is otherwise eligible to purchase.
Taco Bell Operators. Section 2.4 of the Cooperative's Bylaws designates Series N through Q as Series available to Taco Bell Franchisees. Depending upon the number of shares of Store Common Stock issued with respect to Taco Bell retail outlets ("Taco Bell Store Common Stock"), Taco Bell Operators will be issued and hold Series N, O, P or Q.
If less than 400 shares of Store Common Stock are issued and outstanding with respect to Taco Bell retail outlets, only Series N will be issued to Taco Bell Operators. If and when 400 or more but less than 650 shares of Taco Bell Store Common Stock are issued and outstanding, all Taco Bell Operators will hold Series O Membership Common Stock. If and when 650 or more but less than 900 shares of Taco Bell Store Common Stock are issued and outstanding, then Taco Bell Operators will hold Series O or Series P Membership Common Stock (depending on the region in which the Stockholder Members' retail outlets are located). If and when 900 or more shares of Taco Bell Store Common Stock are issued and outstanding, then Taco Bell Operators will hold Series O, P, or Q Membership Common Stock (depending on the region in which the Stockholder Members' retail outlets are located).
When the number of shares of Store Common Stock issued and outstanding with respect to Taco Bell retail outlets increases or decreases to the various thresholds described above, then the shares of Membership Common Stock held by Taco Bell Operators will automatically convert into the appropriate Series. Because of the possibility of this conversion, certificates representing shares of Membership Common Stock held by Taco Bell Operators will bear a legend indicating that there could be a conversion from one Series to another Series.
The various Series, number of shares of Store Common Stock required to trigger a conversion into a new Series and the various Taco Bell regions are set forth below:
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The Taco Bell regions listed in Column 1 below include the areas set forth in the corresponding line(s) of Column 2 below.
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Voting Rights. Each class of Series A through Series J and Series M and Series N Membership Common Stock is entitled to elect one member of the Board, and Series K and Series L stockholders are entitled to elect two members of the Board; provided, however, that until and unless the holders of Series J and Series M Membership Common Stock hold 100 or more shares of Store Common Stock purchased or held with respect to retail outlets located in the specified region, the Series J or Series M member of the Board shall be nominated by a holder of Series J or Series M Membership Common Stock, as the case may be, but shall be elected by a plurality vote of all the shares of Membership Common Stock entitled to vote at the annual meeting of stockholders. When and if shares of Series O, P and/or Q are issued and outstanding, holders of those series (i) will nominate and elect a director to represent their respective series and (ii) will collectively be entitled to elect the Taco Bell at large director. Each stockholder member is entitled to cast one vote to elect a member of the Board to represent its series except for the members of Series K and Series L, which are entitled to cast one vote to elect each of two members of the Board from their respective series. On all matters except the election of the Board, each holder of Membership Common Stock is entitled to cast one vote on each matter on which members are entitled to vote. The Bylaws provide that directors may be elected by a plurality of the Series entitled to elect such director. Unless otherwise provided by the Bylaws or required by law, the affirmative vote of two-thirds of the members present at a meeting at which a quorum is in attendance is necessary to decide in favor of any matter.
Dividend Rights. Dividends may not be declared or paid with respect to Membership Common Stock.
Limitations on Ownership and Transfer; Redemption. Membership Common Stock may be issued only to persons who satisfy the membership requirements and no more than one share of such stock shall be issued to any one Operator, except for the limited circumstances described below. Section 2.3 of the Bylaws reflects the Cooperative's one franchisee, one vote principle for franchisees as applied to multiple franchises. See "ISSUANCE IN SERIES." When a corporation, partnership or other entity is a franchisee Operator, the owner of more than 50% of the corporation, partnership or other entity is deemed to be the owner of the share of Membership Common Stock issued by the Cooperative. Where no person, corporation, partnership or other entity owns more than 50% of the outstanding ownership interest of a franchisee Operator, the owners of the corporation, partnership or other entity must designate among themselves who will be deemed to own the share of Membership Common Stock.
Section 2.3 of the Cooperative's Bylaws concerns the Cooperative's determination of precisely who is entitled to vote certain shares of Membership Common Stock in situations involving individuals who, through different corporations, partnerships or other affiliations, may have an interest in more than one share of Membership Common Stock. The Bylaws provide that no person, firm or entity is entitled to own or have an interest in, directly or indirectly, more than one share of Membership Common Stock (the "Base Share"), except for (a) any interest a franchisee may have in the share of Membership Common Stock held by the NCAC, (b) any interest which a franchisee may have in either (i) one (but only one) share of the Cooperative's Series A through I Membership Common Stock if a franchisee's Base Share is a share of the Cooperative's Series N through Q Membership Common
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Stock or (ii) one (but only one) share of the Cooperative's Series N through Q Membership Common Stock if a franchisee's Base Share is a share of the Cooperative's Series A through I Membership Common Stock, (c) if a franchisee's Base Share is not a share of the Cooperative's Series J Membership Common Stock, any interest a franchisee may have in one (but only one) share of the Series J Membership Common Stock, (d) if a franchisee's Base Share is not a share of the Cooperative's Series M Membership Common Stock, any interest a franchisee may have in one (but only one) share of the Series M Membership Common Stock, (e) any interest which KFC Management may have in Tricon Global Restaurants (Canada), Inc.'s Series M share, and any interest which Tricon Global Restaurants (Canada), Inc. may have in KFC Management's Series K share by reason of KFC Management and Tricon Global Restaurants (Canada), Inc., and (f) any interest a franchisee may have in a share of Membership Common Stock held by a firm or entity in which the franchisee owns fifty percent or less and with respect to which the franchisee refrains from voting or participating in the voting of the share of Membership Common Stock. For these purposes, a franchisee includes a licensee.
If any holder of Membership Common Stock has ceased to be a member of the Cooperative because it is no longer an Operator or owns less than the required amount of Store Common Stock, such stock will be called for redemption at $10.00 per share. Under Delaware law, the Cooperative may not repurchase any shares of its common stock when the capital of the Cooperative is impaired or when such repurchase would cause any impairment of the capital of the Cooperative. Member ship Common Stock may not be transferred to any person or entity other than the Cooperative.
Liquidation Rights. In the event of any liquidation of the Cooperative or other disposition of its assets, the holders of Membership Common Stock would be entitled to receive $10.00 per share before any distributions to the holders of Store Common Stock are made. Any net assets remaining after the payment of the $10.00 per share to the holders of Membership Common Stock shall be distributed to holders of the Store Common Stock.
General. Membership Common Stock has no preemptive rights. The shares of Membership Common Stock are, when issued, duly authorized, validly issued and fully paid and nonassessable and the holders thereof will not be liable for any payment of the Cooperative's debts.
Store Common Stock
The Cooperative is authorized to issue 10,000 shares of Store Common Stock, no par value, of which 6,730 shares were issued and outstanding on October 31, 1998. The summary description of Store Common Stock provisions which follows is subject in all respects to the Certificate of Incorporation and the Bylaws of the Cooperative.
Voting Rights. The holders of Store Common Stock are not thereby entitled to vote for directors, to participate in meetings or management of the Cooperative or to vote in any proceedings except in such statutory proceedings as to which their votes are required by law.
Dividend Rights. The holders of Store Common Stock are entitled to receive dividends if, when, and as declared by the Board. See "DIVIDEND POLICY" and "PATRONAGE DIVIDEND PROGRAM."
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Limitations on Ownership and Transfer; Redemption. Store Common Stock may be issued only to persons who satisfy the stockholder membership requirements, and generally each member must purchase that number of shares of Store Common Stock equal to the total number of KFC or Taco Bell retail outlets which such member owns and operates. For these purposes, (a) the term "total number...of retail outlets" means the total number of traditional retail outlets, plus one-half rounded up to the nearest even number of the total number of non-traditional outlets, and (b) the term "non-traditional retail outlet" means an outlet with more than one of the following characteristics: (i) a five-year or shorter license, (ii) a limited menu, (iii) sales from a kiosk or other transportable unit, (iv) sales from a segregated food service area at a location in a facility (such as an airport, athletic stadium, university or school) established for a primary purpose other than selling food for reasonably immediate consumption, (v) anticipated sales volume less than anticipated sales volume for a traditional unit, (vi) sales in conjunction with sales of another food concept, or (vii) such other characteristics as the Board may determine are indicative of a non-traditional retail outlet. Only holders of record of a share of Membership Common Stock may purchase shares of Store Common Stock. Store Common Stock may be transferred to persons, firms or entities who qualify for membership in the Cooperative only if the Cooperative does not exercise its right of first refusal to purchase such shares. A member desiring to transfer one or more shares of Store Common Stock must first offer such shares to the Cooperative on the same terms and conditions to which the member has agreed with such other person, firm or entity making an offer to purchase said stock. If the Cooperative declines its right of first refusal or does not respond to the offer within 90 days, the member, within 60 days thereafter, may sell, assign or otherwise transfer the shares to the person, firm or entity making the offer to purchase the shares, provided such person, firm or entity qualifies for membership in the Cooperative. If the shares are not sold or otherwise transferred within the 60 day period referred to above, the shares may not be sold or transferred without the member again offering the shares to the Cooperative.
Pursuant to a policy adopted by the Board, the Cooperative is authorized to purchase, for not more than the amount of the member's equity per share at the end of the Cooperative's fiscal year next preceding the date of purchase, a certain number of shares of Store Common Stock in each of the Cooperative's fiscal quarters. The Cooperative therefor may, but generally has no obligation to, repurchase shares of Store Common Stock from a member which owns shares in excess of the number required for membership. See "Proposed Corporate Reorganization --Taco Bell Split-Off." For a discussion of a commitment by the Cooperative to repurchase from Canadian stockholders shares of Store Common Stock at the original purchase price, see "Patronage Dividend Program - Patronage Dividend Program for Canadian Stockholders."
Liquidation Rights. In the event of any liquidation of the Cooperative or other disposition of its assets, the holders of Store Common Stock shall be entitled to receive the net assets of the Cooperative remaining after payment of all debts and liabilities of the Cooperative and payment of $10.00 per share to the holders of Membership Common Stock. Liquidating distributions will be made on the basis of past patronage with the Cooperative rather than number of shares of Store Common Stock owned. See "PATRONAGE DIVIDEND PROGRAM."
General. Store Common Stock has no preemptive or conversion rights. The shares of Store Common Stock are, when issued, duly authorized, validly issued and fully paid and nonassessable and the holders thereof will not be liable for any payment of the Cooperative's debts.
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Reports to Stockholders
The Cooperative intends to send to its stockholders annual reports containing audited financial statements and quarterly reports containing unaudited financial statements.
ITEM 6.
ITEM 6. Selected Financial Data.
The selected financial data set forth below for the Cooperative as of October 31, 1998 and 1997 and for each of the three years in the period ended October 31, 1998 are derived from audited financial statements included elsewhere herein. The selected financial data set forth below as of October 31, 1996, 1995 and 1994 and for each of the two years in the period ended October 31, 1995 are derived from financial statements not included elsewhere herein.
SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS)
ITEM 7.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ANALYSIS AND OPERATIONS
The Cooperative offers supplies and most major equipment used principally by KFC and Taco Bell Operators. The Cooperative's increases in net sales over the years have resulted primarily from increased sales volume, the expansion of product lines and services, and the addition of new customers.
Net sales for fiscal 1998 were $664,792,000 compared to $600,132,000 for fiscal 1997, an increase of 10.8%. The fiscal 1998 increase is primarily attributable to sales related to the Taco Bell concept. Taco Bell food and packaging sales increased 41.5% while Taco Bell's equipment sales increased 52% in fiscal 1998. The Cooperative's overall food and packaging sales increased 13.1% in fiscal 1998 from fiscal 1997. Overall sales to KFC Operators located in the United States increased approximately 7.0% in fiscal 1998 from fiscal 1997. The termination of sales related to the Fazoli's restaurant concept and the bankruptcy of Long John Silver's decreased sales during fiscal 1998. The Cooperative has also determined to terminate sales to Dairy Queen Operators by not later than March 31, 1999.
Net sales for fiscal 1997 were $600,132,000 compared to $580,441,000 for fiscal 1996, an increase of 3.4%. The fiscal 1997 increase is primarily attributable to sales related to the Taco Bell, Dairy Queen and Fazoli's concepts
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and sales to KFC Operators located in the United States. The Cooperative's food and packaging sales increased 2.2% in fiscal 1997 from fiscal 1996, with significant percentage increases from the Fazoli's and Long John Silver's concepts. The Cooperative's equipment sales increased by 12.2% in fiscal 1997 from fiscal 1996. Overall sales to KFC-U.S. increased approximately 2.5% in fiscal 1997 from fiscal 1996. KFC-U.S. equipment sales increased by approximately 19.2% in fiscal 1997. Sales related to the Cooperative's Canadian subsidiary increased approximately 1.5% in fiscal 1997 from fiscal 1996, primarily driven by increased equipment sales. Dairy Queen sales increased approximately 3.3% for fiscal 1997 compared to fiscal 1996, attributable primarily to an increase in food and packaging sales. Taco Bell sales increased approximately 9.7% for fiscal 1997 compared to fiscal 1996. Sales related to Fazoli's increased 5.4% in fiscal 1997 compared to fiscal 1996.
In October 1997, PepsiCo spun off its three primary restaurant divisions -- KFC, Taco Bell and Pizza Hut into a new public company, Tricon Global Restaurants, Inc. ("Tricon"). Also during fiscal 1997, PepsiCo sold its restaurant distribution subsidiary, Pepsi Food Systems ("PFS") to AmeriServe Food Distribution, Inc. ("AmeriServe"). AmeriServe is the third largest Cooperative customer, purchasing goods for distribution to primarily KFC franchisees. When AmeriServe purchased PFS, it acquired rights under a distribution agreement which as amended may extend until 2007. This agreement binds Tricon to use AmeriServe distribution services for Tricon-owned KFC, Taco Bell, and Pizza Hut outlets. The agreement also extends to Taco Bell and Pizza Hut restaurants sold as part of Tricon's announced program of refranchising certain Tricon-owned restaurants to existing and new franchisees. AmeriServe does not purchase goods through the Cooperative for distribution under its Tricon agreement. On May 21, 1998, AmeriServe acquired ProSource, Inc. (ProSource). For the year ended October 31, 1997, ProSource was the cooperative's sixth largest distributor with total sales of approximately $19,000,000. AmeriServe has stated in its public filings that AmeriServe is and will continue to be highly leveraged as a result of the indebtedness incurred primarily in connection with its acquisition of PFS. The Cooperative and its members continue to monitor their relationship with AmeriServe. The impact of Tricon's formation, AmeriServe's acquisition of PFS and the merger with ProSource on the business of the Cooperative remains uncertain.
The operations of the Canadian subsidiary (in U.S. dollars) contributed approximately $48,219,000, $51,397,000 and $50,600,000 in sales in fiscal 1998, 1997 and 1996, respectively. The Canadian subsidiary contributed net income of approximately $14,000 in 1998 and $62,000 in each of 1997 and 1996. As of October 31, 1998, 1997 and 1996, the Canadian subsidiary had identifiable assets (in U.S. dollars) of approximately $2,721,000, $3,829,000 and $4,300,000, respectively, consisting of accounts receivable, property and equipment, and amortizable costs. The operations of the Canadian subsidiary are substantially dependent on its business connected with Scott's Restaurants Inc. ("Scott's"), which operates approximately 353 KFC outlets in Canada. On October 10, 1997, following a court ruling favorable to KFC (Canada), KFC (Canada) delivered a notice terminating Scott's license to operate KFC outlets. Scott's obtained a stay of the termination pending judicial appeal, which resulted in an appealable ruling favorable to Scott's. On October 30, 1998, Scott's and KFC (Canada) announced that they had signed an agreement providing for the sale to the public of the Scott's KFC outlets and selected KFC (Canada) owned outlets throughout Canada by way of a newly organized income trust. The proposed sale is subject to approval by the shareholders of Scott's and market conditions at the time of the public offering of income trust securities. It is the intention of the parties that the transaction be completed irrespective of further litigation between the parties regarding Scott's franchise agreement. The closing date for the transaction is scheduled for March 1, 1999. Once closed, the parties
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will exchange mutual releases with respect to the litigation. If the transaction is not successfully completed, their agreement provides that the parties will negotiate alternate strategies for the disposition of Scott's KFC business. The loss by the Canadian subsidiary of Scott's KFC business would have an adverse effect on the Cooperative's Canadian operations.
Income before patronage dividend and income taxes for fiscal 1998 was $2,757,000, a decrease of $1,396,000 compared to fiscal 1997. The decrease is primarily attributable to an increase in selling, general and administrative expenses and an increase in provisions for bad debt reserve. The cost associated with the operation of the Cooperative's international subsidiary for an entire year in 1998, along with increased travel associated with the Cooperative's efforts to focus on working more closely with its customers and additional board meetings were the primary contributors to the increase in expenses. The increase in the provision for losses on receivables was a result of the bankruptcy filing of Long John Silver's in October 1998. Management believes it has adequately reserved for the impact of the potential loss. The carrying values of all intangibles are periodically reviewed by management and impairments are recognized when the expected undiscounted future operating cash flows derived from operations associated with such intangible assets are less than their carrying value. As a result of this review, all remaining goodwill was written off in the year ended October 31, 1998 resulting in a charge to earnings of approximately $303,000.
Income before patronage dividend and income taxes for fiscal 1997 was $4,153,000, a decrease of $904,000 over fiscal 1996. The decrease is attributable to an increase in selling, general and administrative expenses, primarily associated with additional staff positions to support expanded involvement with the customer base, including services relative to distribution and project teams, and the related expanded travel costs. The development of the international division, including new staff positions and startup cost, accounts for approximately one-third of the total increase in expenses.
Other income (expenses) for fiscal 1998 decreased by $40,000 compared to fiscal 1997. The two major components of this change were (i) a net decrease in interest income (expense) of $79,000, due primarily to lower cash balances available for investment, and (ii) and a $29,000 decline in service charge income.
Other income (expense) for fiscal 1997 decreased by $45,000 compared to fiscal 1996. Service charge income doubled in fiscal 1997, primarily as a result of the payment practice of one distributor customer who chose to make late payments on a significant number of invoices for which service charges were collected. Interest income was lower in fiscal 1997 reflecting the effect of the increased equipment volume on the Cooperative's cash flow needs.
Selling, general and administrative expenses for fiscal 1998 increased by approximately 10.9% compared to fiscal 1997. As a percentage of sales, the expenses remained constant at 2.0% in 1998 compared to fiscal 1997. The Cooperative is constantly monitoring costs to provide the required service at the lowest cost to the stockholder members. Improvements in the area of technology have allowed the Cooperative to deliver on this objective.
Selling, general and administrative expenses for fiscal 1997 increased by approximately 11.5% compared to fiscal 1996. As a percentage of sales, the expenses went from 1.9% in fiscal 1996 to 2.0% in fiscal 1997. Four factors contributed to the increase in expenses for fiscal 1997. First, in response to employees leaving the Cooperative for other jobs in the headquarters' community, a wage and salary survey was conducted and, based on the results, a significant number of employees received upward adjustments in compensation to be competitive in the Louisville market for comparable positions. Second, additional staff was added to focus more directly on the franchisee customers. Field representatives were added to all concepts to work directly
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with the franchisees and the franchisor on project teams. Third, five new positions were added in fiscal 1997 to form the international division. The growth in our equipment business is the fourth contributing factor. Expenses associated with equipment are significantly higher than expenses associated with food and packaging.
The volume of business added from non-member concepts has created synergies in purchasing power and economies of scale, and has allowed the Cooperative to maintain and expand its level of service to all customers. In fiscal 1998, the Cooperative determined to terminate its business with Operators of non-member concepts in anticipation of establishing a unified purchasing cooperative with only Tricon and Operators of KFC, Taco Bell, and Pizza Hut restaurants. During fiscal 1998, sales to operators of retail outlets of quick service restaurant systems other than KFC and Taco Bell Operators in the United States were approximately 17% of sales.
The Cooperative pays its member stockholders a patronage dividend based on a formula approved by the board of directors. The percentage of patronage earnings to be paid as patronage dividends increased for fiscal 1998 compared to 1997. For fiscal 1998, the dividend to be paid is $2,619,000 compared to $2,890,000 in fiscal 1997. The patronage dividend is currently calculated and allocated through separate pools based on a percentage of the patronage earnings derived from the participating concepts, KFC and Taco Bell. Under the allocation formula, all expenses, including provisions for losses, are allocated to each participating concept and the patronage dividend for each concept's stockholder members are directly related to these results.
Net income for fiscal 1998 was $60,000, a decrease of $688,000 compared to fiscal 1997. The decrease is due primarily to the increase in selling, general and administrative expenses, and the provision for losses in fiscal 1998 and the board of directors' decision to pay out a greater percentage of patronage earnings as patronage dividends for fiscal 1998 compared to fiscal 1997.
Net income for fiscal 1997 was $748,000, a decrease of $638,000 compared to fiscal 1996. The decrease is primarily attributable to the increase in selling, general and administrative expenses in fiscal 1997 and the board of directors' decision to pay out a greater percentage of patronage earnings as patronage dividends for fiscal 1997 compared to fiscal 1996.
INFLATION
The prices paid by the Cooperative for equipment and supplies are, of course, subject to the effects of inflation. In an effort to mitigate the effects of inflation on both the Cooperative and its customers, the Cooperative makes advance purchase commitments (but does not take delivery, except for certain items, such as cob corn, salsa, and equipment for staging), at fixed prices, for the volume of equipment and supplies it anticipates selling within a reasonable period of time. The Cooperative has provided its customers with the benefit of forward purchase commitments on price-volatile commodities. By virtue of the Cooperative's pricing policy, which is to minimize the margin between the Cooperative's advanced purchase costs and sales prices, and the Cooperative's purchase program, the effects of inflation on the Cooperative's financial condition may be less than on other businesses.
YEAR 2000
The Cooperative's Year 2000 project is substantially complete. The project addressed the ability of computer programs and embedded computer chips to distinguish the 20th century date from the 21st century date. The Cooperative is
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currently surveying, and will continue to survey through 1999, all of its trading partners with respect to year 2000 compliance. The Cooperative has received certifications or representations from the vendors of its personal computer hardware and software, including desktops, servers and third party software, that they are Year 2000 compliant. (By January 1, 2000, the Cooperative expects to replace 12 desktop PC's that are not year 2000 compliant.) The Cooperative leased its IBM model 510 AS400 in January, 1997. IBM has verified the system as year 2000 compliant, both for hardware and operating systems, and the Cooperative has tested this verification. The Cooperative is currently using Version 3 Release 7 of IBM's OS400 software, which is compliant. Plans are to implement Version 4 Release 3 of the operating software before January 1, 2000.
The Cooperative's core business operations are run on a third party software that was purchased from American Software, Inc. (ASI) in 1989; the Cooperative, however, has not received any maintenance updates for this software since mid-1990. The Cooperative's in-house programmers have maintained this software since its implementation. In early 1996, the Cooperative contracted with a consulting firm to modify all accounting ASI applications to make them Year 2000 compliant. This project was completed and tested during January 1997. The system date was set to 01/01/00 and all accounting processing was completed, including, but not limited to, daily billing functions, accounts receivable functions, accounts payable functions, general ledger closing and financial statement preparation. The remaining ASI applications (order entry, purchasing, master files, etc.) have been modified to be Year 2000 compliant by the internal programming staff. The Cooperative's Electronic Data Interchange (EDI) system is currently capable of sending and receiving all required electronic documents in both non-compliant and compliant format. The Cooperative uses third party software for its EDI operations. During August 1998, the Cooperative upgraded its telephone system's hardware and software to be Year 2000 compliant.
Management believes the external total cost incurred in connection with the Year 2000 project was approximately $80,000. The Cooperative does not expect any subsequent costs to have a material effect on its results of operations or financial conditions.
Based on the progress the Cooperative has made in addressing its Year 2000 issues, management does not foresee interruption in normal business activities or operations associated with its Year 2000 compliance at this time. However, if the Cooperative identifies significant risks related to its compliance management, then it will develop a contingency plan to address those risks. Even given best efforts and execution of the aforementioned planning and testing, disruptions and unexpected business problems may occur as a result of the Year 2000 issue.
The failure to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Such failures could materially adversely affect the company's results of operations, liquidity and financial condition. Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party suppliers, including utility companies and customers, the company is unable to conclude that the consequences of Year 2000 failures will not have a material impact on the company's results of operations, liquidity or financial position.
The discussion and analysis of the Year 2000 issue included herein contains forward-looking statements and are based on management's best estimates of future events. Risks related to completing the Cooperative's Year 2000 plan include the availability of resources, the Cooperative's ability to timely discover and correct the potential Year 2000 sensitive problems which could have a serious impact on the Cooperative's operations, the ability of suppliers to bring their systems into Year 2000 compliance, and the Cooperative's ability to identify and implement effective contingency plans to address Year 2000 failures.
PROPOSED CORPORATE REORGANIZATION
In conjunction with Tricon and franchisee owners and operators of KFC, Taco Bell with Pizza Hut restaurants, on October 21, 1998, the Cooperative publicly announced the proposed formation of a "unified" purchasing cooperative focusing on the purchase of food, packaging, supplies, equipment, and related services used in these restaurants. The Cooperative would transfer most operating assets and liabilities and its employees to the unified cooperative in exchange for its membership interest therein. In connection with forming the new unified cooperative, the Cooperative expects to split-off to a newly organized Taco Bell purchasing cooperative the portion of its business which operates purchasing programs for its Taco Bell members. Through this new entity, owners and operators of Taco Bell restaurants, including Tricon, would participate with the Cooperative and a newly organized Pizza Hut purchasing cooperative in the purchasing programs of the unified cooperative. Although administered by the new unified cooperative,
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the KFC purchasing program would be subject to significant control, advice and counsel of the Cooperative. The Cooperative would continue to exercise policy-making decisions and administer the patronage dividend program in accordance with past practices. The consummation of this proposed corporate reorganization is subject to a number of conditions, including approval by the Cooperative's members.
CAPITAL EXPENDITURES
In fiscal 1998, the Cooperative invested approximately $508,000 in office furniture and equipment. The Cooperative spent approximately $174,000 to purchase personal computers. The balance was expended to upgrade the telephone and voice mail systems, purchase office furniture, and upgrade hardware and software for the mainframe computer. The Cooperative is constantly evaluating the technical needs of the business in light of the demands of both customers and vendors. Given the Cooperative's business environment, the Cooperative believes that investments in technology result in cost savings.
LIQUIDITY AND CAPITAL RESOURCES
The working capital needs of the Cooperative for sales growth and the related accounts receivable, and for the inventories associated with the Cooperative's various programs, have been met through a combination of (i) net income of $60,000 in fiscal 1998, which increased the retained earnings of the Cooperative, and (ii) combined bank financing, of which $3,444,000 was outstanding on October 31, 1998. The ability of the Board to increase or decrease the percentage of "pre-tax income" to be paid in patronage dividends is an additional potential source of liquid assets.
The Cooperative's line of credit with its primary bank is currently $8,000,000 and is available to meet short-term working capital needs. The Cooperative's $8,000,000 line of credit expires on May 2, 1999. The Cooperative's line of credit with the National Cooperative Bank is currently $3,000,000 and expires on May 1, 1999. On October 31, 1998, the Cooperative had a total of $10,900,000 remaining credit available under these lines of credit. The Canadian subsidiary has established a line of credit for $4,000,000 (Canadian dollars) of which $3,469,000 (Canadian dollars) is available as of October 31, 1998 to provide working capital in support of that subsidiary. The Canadian line of credit expires on May 16, 1999. The Cooperative has provided a guarantee for the payment to the bank.
In 1994, the Cooperative negotiated a long-term financing arrangement with its primary bank. Under the agreement, the Cooperative was provided a $3,000,000 term loan at a fixed interest rate of 6.95%. The loan requires monthly interest payments with the entire principal due on May 2, 1999. The costs associated with obtaining these financing arrangements are being amortized over the term of the loan.
The Cooperative's net working capital at October 31, 1998, was $16,346,000, a decrease of $1,959,000 since October 31, 1997. The primary changes in working capital for fiscal 1998 include (i) increases in accounts receivable and inventories of $10,614,000 and $1,554,000, respectively, (ii) a decrease of $832,000 in notes receivable, (iii) an increase in accounts payable of $12,430,000, and (iv) decreases in accrued expenses and accrued patronage dividend of $803,000 and $271,000, respectively.
The Cooperative expects to be able to fund its business in fiscal 1999 with the capital resources available from its continuing operations and lines of credit
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as discussed above. If the Cooperative successfully expands its activities and adds new customers related to fast food concepts, the Cooperative may require an increase in its lines of credit on a temporary basis. Management believes that its current banking relationships will be able to provide for these possible increases.
This report contains forward-looking statements under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Although the Cooperative believes that the forward-looking statements are based upon reasonable assumptions, there can be no assurance that the forward-looking statements will prove to be accurate. Factors that could cause actual results to differ from the results anticipated in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Cooperative and its customers operate); competition for the Cooperative's customers from other distributors; material unforeseen changes in the liquidity, results of operations, or financial condition of the Cooperative's customers; material unforeseen complications related to addressing the Year 2000 Problem experienced by the Cooperative, its suppliers, customers and governmental agencies; and other risks detailed in the Cooperative's filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Cooperative. The Cooperative undertakes no obligation to republish forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data.
See accompanying Index to Consolidated Financial Statements and Schedule.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Upon recommendation of the Cooperative's Audit Committee, the Board dismissed KPMG Peat Marwick LLP, now KPMG LLP ("KPMG") as its principal accountants on May 18, 1998. KPMG's report on the Cooperative's financial statements for the past two fiscal years did not contain any adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles. Furthermore, during the Cooperative's two most recent fiscal years and through the date of dismissal, there were no disagreements with KPMG on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.
Upon recommendation of the Cooperative's Audit Committee, on May 18, 1998, the Board engaged PricewaterhouseCoopers LLP as its principal accountants to audit the Cooperative's financial statements.
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PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant.
MANAGEMENT
DIRECTORS AND OFFICERS
The Cooperative's Bylaws provide for a Board consisting of up to twenty voting members plus the Cooperative's President, who is a non-voting member. Up to nineteen directors will be elected by the holders of various series of Membership Common Stock. Each series of Membership Common Stock is generally entitled to elect one director, except that the NCAC and KFC Management are each entitled to elect two directors. In addition, when and if shares of Series O, P and/or Q are issued and outstanding, holders of those series are also collectively entitled to elect the Taco Bell at large director. One director (the "Independent Director") is nominated by the Board and elected by a plurality vote of the shares of all series of Membership Common Stock entitled to vote. The Independent Direc tor must not be affiliated in any way with any Operator. With the exception of the President and the Independent Director, each director of the Cooperative must be a member of the Cooperative or a shareholder, officer, employee or partner of the entity which is a member of the Cooperative. Additionally, each director (other than the President and the Independent Director) must be a member or an officer, director, shareholder, employee or partner of the organization which is entitled to vote for such director. All voting members of the Board serve three-year staggered terms. In addition to the twenty voting members and the President described above, the Cooperative's Bylaws provide that the Board may from time to time appoint one or more non-voting members of the Board to serve at the pleasure and upon such terms and conditions as the Board may provide. Pursuant to this provision, the Board has established a non-voting membership for a Taco Bell stockholder member after consultation with the Taco Bell Operators serving as directors and the Franchise Management Advisory Council ("FRANMAC"); David Paradise currently serves in this position.
For a description of the Cooperative's directors and executive officers and certain related information, see Item 12. "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT."
During the last five years, Messrs. Allen, Basile, Carle, Cocolin, Edwards, Henriquez, Houston, Moss, Neal, Olson, Paradise, Royster, Sorgdrager and Young and Ms. Foust and Ms. Pfeiffer have been principally engaged in business as Operators, and Mr. Rhawn has been Chairman and owner of Rhawn Enterprises, Inc., a Louisville financial services holding company.
Kenneth L. Hartung has served as a Vice President of the Cooperative since 1993. From 1991 to February 1993, Mr. Hartung was Vice President of Sales and Marketing for the E. S. Robbins Container Division. He had previously served as Vice President of Development of the Liqui-Box Corporation and in several positions, including Vice President of Marketing, with the B-Bar-B Corporation.
Thomas D. Henrion joined the staff of the Cooperative in March 1980 as its President and in 1993 also became Chief Executive Officer.
William V. Holden has been Vice President of the Cooperative since 1989 and served as Controller of the Cooperative from 1985 until he was appointed Chief
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Financial Officer in 1991. Mr. Holden also serves the Cooperative as Assistant Treasurer.
W. Thomas Hutcherson has served as the Cooperative's Vice President of Purchasing since 1994. He served as Vice President-Equipment Purchasing and Sales from 1982 until 1994.
John W. Inwright has served as Vice President of Operations, responsible for purchasing and customer service for both Equipment and Supplies since 1996. From 1991 to 1996, he served as Vice President of Purchasing. Mr. Inwright has served the Cooperative in its purchasing operations since 1984.
Alice LeBlanc joined the Cooperative in 1996 as Vice President and General Manager of the Cooperative's Canadian Operations. In March of 1998, Ms. LeBlanc became Vice President and General Manager for KFC Operations. Prior to joining the Cooperative, Ms. LeBlanc was a director of purchasing for Cara Operations Limited from 1992 to 1996 and Pepsico Food Service International from 1985 to 1992.
Carol L. Mudd joined the staff of the Cooperative in 1986 in Administration. She became manager of administration and communications in 1991 and director of human resources, administration and communications in 1994. In December 1997, Ms. Mudd was appointed Vice President of Human Resources.
Except for Mr. Henrion, all officers of the Cooperative who are also directors serve in such offices on a limited, part-time basis without remuneration.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Personnel Committee is comprised of Messrs. Houston, Olson, Paradise and Rhawn and Ms. Pfeiffer and met seven times during fiscal 1998. Also, during fiscal 1998, Mr. Peck served as a member of the Personnel Committee. Pursuant to a former provision of the Cooperative's Bylaws, Mr. Peck, as Chairman of the Board, served as the Cooperative's Chief Executive Officer until May 1993; he received no compensation from the Cooperative except for the reimbursement for expenses as provided below under "Compensation of Directors." The Personnel Committee considers personnel policy and practices of the Cooperative and makes recommendations to the Board concerning the compensation of all officers.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, (the "1934 Act") requires the Cooperative's directors, executive officers and certain persons to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission (the "SEC"). Based solely upon a review of forms filed by the appropriate persons and written representations from such persons, the Cooperative believes that all such filing requirements were complied with in fiscal 1998.
ITEM 11.
ITEM 11. Executive Compensation.
The following table shows all cash compensation paid by the Cooperative for the years ended October 31, 1998, 1997 and 1996 to the most highly compensated executive officers as to whom the total cash and cash-equivalent remuneration exceeded $100,000 during fiscal 1998.
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SUMMARY COMPENSATION TABLE
Annual Compensation
(1) The Cooperative has established bonus programs for all officers under which, if they achieve certain objectives, they may receive a bonus of not greater than 40% of their base salaries.
(2) Includes employer contribution to the Cooperative's Money Purchase Pension Plan in fiscal 1998 as follows: Mr. Henrion $11,200; Mr. Holden $8,926; Mr. Inwright $8,896; Mr. Hartung $8,755; and Ms. LeBlanc $6,105. For Mr. Henrion, the fiscal 1998 amount includes $5,000, representing the value to Mr. Henrion of the Cooperative's payments with respect to the insurance policy described below. For Ms. LeBlanc, the fiscal 1998 amount includes $66,817 paid to Ms. LeBlanc in connection with moving expenses and the sale of her home to relocate from Toronto to the Cooperative's headquarters in Louisville.
In addition, as part of the proposed Corporate Reorganization discussed above, Thomas D. Henrion, President of the Cooperative, the Cooperative, and the Unified Coop have executed a Separation and Consulting Agreement (the "Separation and Consulting Agreement"). The Separation and Consulting Agreement provides for Mr. Henrion to resign his employment on the Closing Date and, thereafter, to provide consulting services for two years. Mr. Henrion also agrees to non-compete provisions whereby, for two years following the date of the Separation and Consulting Agreement, Mr. Henrion will not work for companies that are specifically listed in the Separation and Consulting Agreement. Under the Separation and Consulting Agreement, Mr. Henrion will be paid $500,000 upon consummation of the Corporate Reorganization and $456,300 on the first business day of January 2000 along with health insurance coverage for 10 years. The Separation and Consulting Agreement replaces the Supplemental Benefits/Consulting
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Agreement (the "Supplemental Agreement") between Mr. Henrion and the Cooperative.
Under the Supplemental Agreement, upon Mr. Henrion's retirement or termination, he would have received (i) monthly compensation equal to one-twelfth of 18% of his annual base compensation averaged over a three-year period (his "Averaged Annual Compensation") for the number of months Mr. Henrion had worked for the Cooperative since January 1, 1994 and (ii) for one year following the expiration of the above compensation, monthly payments equal to one-twelfth of his Averaged Annual Compensation. As of the end of fiscal 1998, Mr. Henrion's Averaged Annual Compensation was approximately $209,000. As of January 1, 1999, Mr. Henrion would have been entitled to aggregate payments of approximately $397,000 under the Supplemental Agreement. The Supplemental Agreement also provided that if Mr. Henrion chose to consult with the Cooperative following his departure, in lieu of the monthly retirement benefits discussed in (i) above, he would receive monthly compensation equal to one-twelfth of 30% of his Averaged Annual Compensation for so long as he provided consulting services to the Cooperative, but for no longer than the number of months he was actually employed after January 1, 1994 (aggregate value of approximately $538,175). Finally, the Supplemental Agreement provided Mr. Henrion with one-half ownership of a whole life split-dollar insurance policy in an initial face amount of $147,384, a car allowance and health insurance while he consulted.
COMPENSATION OF DIRECTORS
No director, other than the Independent Director, receives any remuneration from the Cooperative other than reimbursement for long distance travel, hotel accommodations, and $400 per board meeting for out-of-pocket expenses. The Independent Director receives an annual fee of $10,000, plus fees of $1,000 per board meeting attended.
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ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management
MANAGEMENT OF THE COOPERATIVE
Directors and Executive Officers
The following table lists, in addition to other information, the directors and certain executive officers of the Cooperative as of December 31, 1998, their ages, their position with the Cooperative, their present principal occupations, and the number and percentages of shares of Store Common Stock beneficially owned, directly or indirectly, by each. The information provided with respect to the ages and number of shares beneficially owned is as of December 31, 1998.
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* KFC Management has purchased one share of Series K Membership Common Stock. In 1989, both directors representing KFC Management resigned as members of the Board. KFC Management has not taken any action to fill the vacancies. The total number of shares of Store Common Stock listed as owned by directors and officers does not include the 2,028 shares of Store Common Stock believed by the Cooperative to be owned by KFC Management or affiliates, representing approximately 33.0% of the Store Common Stock outstanding.
** Less than one-half of one percent.
+ Mr. Neal has previously served on the Board as one of the two directors representing the National Franchise Advisory Council, the former holder of the Series L share of Membership Common Stock. He first began serving on the Board as a representative of Series E in February 1991.
++ Previously served as a director appointed by the National Franchisee Advisory Council.
+++ Mr. Paradise is a Taco Bell Operator chosen to serve at the pleasure of the Board as a non-voting member of the Board of Directors after consultation with the Taco Bell Operators serving as directors and FRANMAC.
++++ Each director, other than Messrs. Henrion and Rhawn, is, or is affiliated with a member which is, the owner of one share of Membership Common Stock; All directors and officers as a group (24 persons) own 16 shares of Membership Common Stock, 2.3 percent of the total number of Shares of Membership Common Stock outstanding. The Store Common Stock ownership reflects the number of shares which each director, other than Messrs. Henrion and Rhawn, owns or which is owned by the member with which the director is affiliated. Except as required by law, Store Common Stock has no voting rights. Messrs. Henrion and Rhawn are neither the owners, nor affiliates of the owners, of any Membership or Store Common Stock.
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ITEM 13.
ITEM 13. Certain Relationships and Related Transactions.
TRANSACTIONS WITH STOCKHOLDERS, DIRECTORS AND OFFICERS
All present voting members of the Board, except the Independent Director, are Operators or represent Operators and have purchased or may purchase Equipment and Supplies from the Cooperative or from distributors who purchase from the Cooperative. All purchases by directors or their affiliates from the Cooperative are made on the same terms and conditions as purchases by any other Operator. Several Operators, including KFC Management, are also in the business of purchasing Equipment and Supplies for sale and distribution to other Operators and may purchase such Equipment and Supplies from the Cooperative. See Note 5 of the "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS."
PART IV
ITEM 14.
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)(1) Financial Statements. See accompanying Index to Consolidated Financial Statements and Schedule.
(a)(2) Financial Statement Schedules. See accompanying Schedule II - -- Valuation and Qualifying Accounts.
(a)(3) Exhibits. Following is a list of Exhibits to this Form 10-K:
*2.1 Agreement and Plan of Corporate Separation
*2.2 Form of Asset Contribution and Liability Assumption Agreement
**3.1 Certificate of Incorporation of Registrant, as amended.
3.2 Bylaws of Registrant, as amended.
**4.1 Article IV of Certificate of Incorporation of Registrant, as amended, filed as Exhibit 3.1 to this Form 10-K.
4.2 Articles II, III, IV and IX of Bylaws of Registrant, as amended, filed as Exhibit 3.2 to this Form 10-K.
***10.1 Loan and Security Agreement, dated May 6, 1994, between Registrant and Bank One, Kentucky, NA.
****10.2 Employment Agreement between Thomas D. Henrion and the Registrant (management contract required to be filed pursuant to Item 601(10) of Regulation S-K).
****10.3 Lease, dated as of June 21, 1983, between Registrant, as Lessee, and General Electric Corporation, as Lessor, and amended on June 20, 1988.
****10.4 Form of Distributor Participation Agreement between Registrant and various distributors.
****10.5 Lease, dated April 8, 1988, between NTS/Breckinridge, Ltd. d/b/a The Springs, as Lessor, and the Registrant, as Lessee.
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***10.6 Purchasing Affiliation Agreement dated as of June 15, 1994, between the International Franchisee Advisory Council, Inc., and the Registrant.
***10.7 Supplemental Benefits/Consulting Agreement between Thomas D. Henrion and the Registrant effective as of January 1, 1994 (management contract required to be filed pursuant to Item 601(10) of Regulation S-K).
*****10.8 Amendment No. 1 to Supplemental Benefits/Consulting Agreement between Thomas D. Henrion and the Registrant effective January 1996 (management contract required to be filed pursuant to Item 601(10) of Regulation S-K).
******10.9 Loan Origination and Purchase Agreement dated as of April 18, 1996 between the Registrant and National Cooperative Bank.
******10.10 Guaranty Agreement dated as of April 18, 1996 between the Registrant and National Consumer Cooperative Bank.
*******10.11 Separation and Consulting Agreement between Thomas D. Henrion, Registrant and the Unified FoodService Purchasing Coop, LLC (management contract required to be filed pursuant to Item 601(10) of Regulation S-K).
10.12 Sixth and Seventh Amendments to Lease between NTS/Springs Office, Ltd. and the Registrant.
**21 Subsidiaries of the Registrant.
24 Powers of Attorney.
27 Financial Data Schedule.
*99.1 Form of Operating Agreement for Unified FoodService Purchasing Coop, LLC
*99.2 Form of Purchasing Program Management Agreement
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* Incorporated by reference to the Amendment No. 2 to the Proxy Statement of the Registrant on Schedule 14A [File No. 000-23496].
** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended October 31, 1997 [File No. 2-63640].
*** Incorporated by reference to the Post-Effective Amendment No. 2 to the Registration Statement on Form S-1 of the Registrant [File No. 33-56982].
**** Incorporated by reference to the Registration Statement on Form S-1 of the Registrant [File No. 33-33801].
***** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year ended October 31, 1995 [File No. 2-63640].
****** Incorporated by reference to the Registrant's Annual Report on Form 10-K for the fiscal year end October 31, 1996 [File No. 2-63640].
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******* Incorporated by reference to the Amendment No. 2 to the Tender Offer of the Registrant on Schedule 13E-4 [File No. 5-54907].
(b) Reports on Form 8-K.
None.
(c) Exhibits.
The exhibits listed in response to Item 14(a)(3) are filed as a part of this report.
(d) Financial Statement Schedules.
The financial statement schedule listed in response to Item 14(a)(2) is filed as a part of this report.
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KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES
(D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.)
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
All other schedules are omitted, as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders KFC National Purchasing Cooperative, Inc.
In our opinion, the accompanying consolidated balance sheet as of October 31, 1998 and the related consolidated statements of income, members' equity and cash flows for the year then ended present fairly, in all material respects, the financial position of KFC National Purchasing Cooperative, Inc. (d/b/a FoodService Purchasing Cooperative, Inc.) and Subsidiaries at October 31, 1998, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule for the year ended October 31, 1998 as listed in the accompanying index, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. 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 audit. We conducted our audit of these statements in accordance with generally accepted auditing standards 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 audit provides a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Louisville, Kentucky January 26, 1999
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders KFC National Purchasing Cooperative, Inc.
We have audited the accompanying consolidated balance sheet of KFC National Purchasing Cooperative, Inc. (d/b/a FoodService Purchasing Cooperative, Inc.) and Subsidiaries as of October 31, 1997, and the related consolidated statements of income, members' equity, and cash flows for each of the years in the two-year period ended October 31, 1997. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule for the years ended October 31, 1997 and 1996 as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of the Cooperative's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of KFC National Purchasing Cooperative, Inc. and Subsidiaries as of October 31, 1997, and the results of their operations and their cash flows for each of the years in the two-year period ended October 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
KPMG LLP
Louisville, Kentucky December 8, 1997
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) CONSOLIDATED BALANCE SHEETS October 31, 1998 and 1997 (Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) CONSOLIDATED STATEMENTS OF INCOME for the years ended October 31,1998, 1997 and 1996 (Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) CONSOLIDATED STATEMENTS OF MEMBERS' EQUITY for the years ended October 31, 1998, 1997 and 1996 (Dollars in thousands, except per share amounts)
The accompanying notes are an integral part of the consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended October 31, 1998, 1997 and 1996 (Dollars in thousands)
The accompanying notes are an integral part of the consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION:
The primary purpose of KFC National Purchasing Cooperative, Inc. (d/b/a FoodService Purchasing Cooperative, Inc.) and Subsidiaries (the Cooperative) is to operate as a central procurement organization, making volume purchases of various foods, equipment and supplies primarily for the benefit of Kentucky Fried Chicken (KFC) and Taco Bell retail operators and their distributors.
KFC Franchisee Purchasing of Canada, Inc., a wholly-owned subsidiary, is a procurement organization for the benefit of Canadian KFC retail operators and their distributors. FoodService Purchasing Cooperative International, Inc., a wholly-owned subsidiary, was formed in 1997 to provide similar services to international franchisees, other than Canada. Kenco Insurance Agency, Inc. sponsors and helps administer insurance programs primarily for KFC franchisees. KFC Franchisee Finance Company, Inc., another wholly-owned subsidiary, has provided financing for equipment purchases of KFC franchisees. In view of the overall nature of its operations, the Cooperative is considered to operate in a single industry segment. The more significant accounting policies of the Cooperative are as follows:
A. CONSOLIDATION: The accompanying financial statements include the accounts of KFC National Purchasing Cooperative, Inc. and its wholly-owned subsidiaries, KFC Franchisee Insurance Program, Inc. and its wholly-owned subsidiary, Kenco Insurance Agency, Inc., KFC Franchisee Purchasing of Canada, Inc., FoodService Purchasing Cooperative International, Inc. and KFC Franchisee Finance Company, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. The operation of KFC Franchisee Purchasing of Canada, Inc. and FoodService Purchasing Cooperative International, Inc. represent less than 10% of net sales and total assets of the Cooperative.
B. REVENUE RECOGNITION: The Cooperative purchases a majority of merchandise for its customers from suppliers without taking physical possession of the products. The suppliers ship directly to the customers. The Cooperative takes title to the merchandise and assumes the risk related to taking title upon shipment to the customer based on purchase order terms. For accounting purposes, the Cooperative recognizes revenues and the related costs upon receipt of notification of shipment, primarily an invoice, from the supplier. Management believes the consistent application of this accounting method does not have a significant impact upon the consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. BASIS OF PRESENTATION, CONTINUED:
C. INVENTORIES: Inventories are stated at the lower of cost, primarily determined on the last-in, first-out (LIFO) method, or market. If inventories were valued using the first-in, first-out (FIFO) method, they would have been approximately $41,000 and $19,000 higher at October 31, 1998 and 1997, respectively.
During 1996, LIFO inventory layers were reduced. This reduction resulted in charging lower inventory costs prevailing in previous years to cost of goods sold, thus reducing costs of goods sold by approximately $18,000, below the amount that would have resulted from replacing the liquidated inventory at end of year prices.
D. CHECKS DRAWN IN EXCESS OF BOOK BALANCE: Included in accounts payable are checks drawn in excess of book balance. Such amounts were approximately $8,870,000 and $2,406,000 at October 31, 1998 and 1997, respectively.
E. DEPRECIATION AND AMORTIZATION EXPENSE: Provision for depreciation and amortization is made on the basis of the estimated useful lives of the assets. Principally, the double declining-balance method is used for depreciation of office equipment and the straight-line method is used for amortization of other assets.
Other assets principally consist of the unamortized portion of non-competition agreements, goodwill and loan origination fees. The non-competition agreements are being amortized over 13 and 5 years. The loan origination fees are being amortized over 5 and 3 years. Goodwill was being amortized over 15 years. The carrying values of all intangibles are periodically reviewed by management and impairments are recognized when the expected undiscounted future operating cash flows derived from operations associated with such intangible assets are less than their carrying value. As a result of this review, all remaining goodwill was written off in the year ended October 31, 1998 resulting in a charge to earnings of approximately $303,000.
F. STATEMENT OF CASH FLOWS: For purposes of the consolidated statements of cash flows, the Cooperative considers all short-term highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
G. TRANSLATION OF FOREIGN CURRENCY: The financial statements of KFC Franchisee Purchasing of Canada, Inc. are translated in accordance with Statement of Financial Accounting Standards (SFAS) No. 52, "Foreign Currency Translation." Foodservice Purchasing Cooperative International, Inc. operates in U.S. funds. Foreign currency transaction gains and losses were not significant in 1998, 1997 and 1996.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. BASIS OF PRESENTATION, CONTINUED:
H. INCOME TAXES: Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
I. USE OF ESTIMATES: Management of the Cooperative has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates.
2. ACCOUNTS RECEIVABLE AND SIGNIFICANT GROUP CONCENTRATION OF CREDIT RISK:
As of October 31, 1998 and 1997, substantially all of the Cooperative's receivables are obligations of retail operators and their distributors. The Cooperative does not require collateral or other security on most of these accounts. The credit risk on these accounts is controlled through credit approvals, limits and monitoring procedures.
The note receivable of approximately $832,000 at October 31, 1997 was due from a former distributor customer. In 1995, the Cooperative converted an account receivable from this customer to a note receivable. As of October 31, 1997, the customer had not made timely payments as prescribed by the note and was in default; however, payment was received by the Cooperative during 1998 for the full amount of the note.
3. BORROWING ARRANGEMENTS:
The Cooperative has a $3,000,000 term note with its primary bank. Accounts receivable and other property are pledged as collateral. Terms require monthly interest payments, with a balloon principal payment due May 2, 1999. The outstanding balance accrues interest at an annual fixed rate of 6.95%.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. BORROWING ARRANGEMENTS, CONTINUED:
The Cooperative has a line of credit of $8,000,000 with its primary bank, of which $7,900,000 was available on October 31, 1998. Accounts receivable and other property are pledged as collateral for borrowings under the line. Borrowings on the line of credit bear interest at an annual rate equal to the Federal Funds Rate plus 120 basis points (6.07% as of October 31, 1998). This line of credit expires on May 2, 1999.
The Cooperative has a $3,000,000 line of credit with National Cooperative Bank (the Bank), of which the entire amount was available as of October 31, 1998. Equipment accounts receivable and equipment inventory are pledged as collateral for borrowings under the line. Borrowings on this line of credit bear interest at LIBOR plus 140 basis points (6.74% as of October 31, 1998). This line of credit expires May 1, 1999. The President of the Cooperative served as a director of the Bank from May 1991 to May 1997.
The Cooperative has a $4,000,000 (Canadian dollars) line of credit with a Canadian bank, of which approximately $3,469,000 (Canadian dollars) is available at October 31, 1998. Accounts receivable of the Cooperative's Canadian subsidiary are pledged as collateral for borrowings under this line. Borrowings on this line of credit bear interest at an annual rate equal to the bank's prime lending rate with respect to Canadian dollar commercial loans made in Canada (7.00% as of October 31, 1998). This line of credit expires on May 16, 1999.
4. INCOME TAXES:
Income tax expense for the years ended October 31, 1998, 1997 and 1996 consists of:
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
4. INCOME TAXES, CONTINUED:
A reconciliation of the difference between income tax expense computed at the Federal statutory rate of 34% and income tax expense follows:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at October 31, 1998 and 1997 are presented below:
Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, management believes it is more likely than not the Cooperative will realize the benefits of these temporary differences. Accordingly, no valuation allowance for deferred tax assets was recorded as of October 31, 1998, 1997 and 1996.
The Board of Directors is authorized, after considering the Cooperative's need for capital and reserves, to distribute patronage cash dividends. The patronage dividend for 1998 is based upon shareholder members' retaining membership in the Cooperative through October 31, 1998 and the value of any purchase of equipment and supplies made from the Cooperative, or through participating distributors from November 1, 1997 through October 31, 1998. The patronage dividends for 1997 and 1996 were based upon similar facts as described in the preceding sentence.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
4. INCOME TAXES, CONTINUED:
The Internal Revenue Code of 1986, as amended, provides that corporations "operating on the cooperative basis" generally may exclude from their taxable income amounts paid as patronage dividends. The Cooperative would be liable for taxes associated with the disallowance of any patronage dividend deduction.
5. MEMBERSHIP AND STORE COMMON STOCK:
Membership common stock may be issued only to persons who satisfy shareholder membership requirements and generally no more than one share of such stock will be issued to any one person. Membership common stock may not be transferred to any person other than the Cooperative. In the event that a shareholder no longer qualifies for membership, the Cooperative is required to redeem such shareholder's membership common stock at a redemption price of $10.00 per share.
Store common stock may be issued only to persons who satisfy the shareholder membership requirements and each shareholder member must generally purchase one share of store common stock for each KFC or Taco Bell retail outlet which such shareholder member owns and operates. Store common stock may be transferred to persons, firms or entities who qualify for membership in the Cooperative if the Cooperative does not exercise its right of first refusal to purchase such shares.
6. MAJOR CUSTOMERS:
The Cooperative had sales to certain distributors in excess of 10% of net sales. One customer accounted for sales of approximately $134,000,000, $104,000,000 and $120,000,000 for the years ended October 31, 1998, 1997 and 1996, respectively. This customer's outstanding accounts receivable balances were approximately $12,003,000, $6,659,000 and $7,094,000 at October 31, 1998, 1997 and 1996, respectively. A second customer accounted for sales of approximately $94,700,000, $99,874,000 and $84,000,000 for the years ended October 31, 1998, 1997 and 1996, respectively. This customer's outstanding accounts receivable balances were approximately $4,880,000, $6,306,000 and $6,104,000 at October 31, 1998, 1997 and 1996, respectively. A third customer accounted for sales of approximately $94,754,000, $86,773,000 and $80,300,000 for the years ended October 31, 1998, 1997 and 1996, respectively. This customer's outstanding accounts receivable balances were approximately $5,633,000, $5,552,000 and $4,758,000 at October 31, 1998, 1997 and 1996, respectively.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
6. MAJOR CUSTOMERS, CONTINUED:
In October 1997, PepsiCo, Inc. spun off its three primary restaurant divisions - KFC, Taco Bell, and Pizza Hut - into a new public company, Tricon Global Restaurants, Inc. (Tricon). Also during fiscal 1997, PepsiCo sold its restaurant distribution subsidiary, Pepsi Food Service (PFS) to AmeriServe Food Distribution, Inc. (AmeriServe). AmeriServe has been and continues to be the second largest Cooperative customer, purchasing goods for distribution primarily to KFC franchisees. When AmeriServe purchased PFS, it acquired rights under a distribution agreement which as amended may extend until 2007. This agreement binds Tricon to use AmeriServe distribution services for Tricon owned KFC, Taco Bell, and Pizza Hut outlets. The agreement also extends to Taco Bell and Pizza Hut restaurants sold as part of Tricon's announced program of refranchising certain Tricon-owned restaurants to existing and new franchisees. AmeriServe does not purchase goods through the Cooperative for distribution under its Tricon agreement. On May 21, 1998, AmeriServe acquired ProSource, Inc. (ProSource). For the year ended October 31, 1997, ProSource was the Cooperative's sixth largest distributor with total sales of approximately $19,000,000. AmeriServe has stated in its public filings that AmeriServe is and will continue to be highly leveraged as a result of the indebtedness incurred primarily in connection with its acquisition of PFS. The Cooperative and its members continue to monitor their relationship with AmeriServe. The impact of Tricon's formation, AmeriServe's acquisition of PFS and the merger with ProSource on the business of the Cooperative remains uncertain.
Scott's Restaurants, Inc. (Scott's) is the largest KFC franchisee in Canada, with approximately 353 retail outlets. The operations of the Canadian subsidiary are substantially dependent on its business connected with Scott's. On October 10, 1997, following a court ruling favorable to KFC (Canada), KFC (Canada) delivered a notice terminating Scott's franchise license agreement to operate KFC outlets. Scott's obtained a stay of the termination pending judicial appeal which resulted in an appealable ruling favorable to Scott's. On October 30, 1998, Scott's and KFC (Canada) announced that they had signed an agreement providing for the sale to the public of the Scott's KFC outlets and selected KFC (Canada) owned outlets throughout Canada by way of a newly organized income trust. The proposed sale is subject to approval by the shareholders of Scott's and market conditions at the time of the public offering of income trust securities. It is the intention of the parties that the transaction be completed irrespective of further litigation between the parties regarding Scott's franchise agreement. The closing date for the transaction is scheduled for March 1, 1999. Once closed, the parties will exchange mutual releases with respect to the litigation. If the transaction is not successfully completed, their agreement provides that the parties will negotiate alternate strategies for the disposition of Scott's KFC business. The Cooperative continues to monitor the Scott's situation. The loss by the Canadian subsidiary of Scott's KFC business would have an adverse effect on the Cooperative's Canadian operations.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. RETIREMENT PLAN:
The Cooperative has a thrift and profit-sharing plan and a money purchase pension plan which covers all employees who meet certain requirements as to age and length of service. The thrift and profit-sharing plan is funded under two allocation methods. The first is funded through a thrift plan agreement under Section 401(k) of the Internal Revenue Code whereby contributions made by those employees who elect to participate are matched, in accordance with plan guidelines and limitations, by the Cooperative. The second allocation, which covers all employees and was introduced in 1986, is funded by the Cooperative as determined by the Board of Directors, subject to certain limitations. The money purchase pension plan, established November 1, 1991, provides for an employer matching contribution of 2% to 7% of eligible compensation.
The Cooperative's combined contributions relating to these plans were approximately $609,000, $556,000 and $498,000 for 1998, 1997 and 1996, respectively.
8. COMMITMENTS AND CONTINGENCIES:
The Cooperative's leasing arrangements include office space and equipment leased under customary leasing arrangements which include in some instance options to renew or purchase the leased items. All such leases are considered operating leases.
The following is a schedule of future lease obligations:
Rental expense was approximately $839,000, $774,000 and $719,000 in 1998, 1997 and 1996, respectively.
In the ordinary course of business, the Cooperative becomes involved in various claims and legal actions. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Cooperative's consolidated financial statements.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. COMMITMENTS AND CONTINGENCIES, CONTINUED:
The Cooperative endeavors to obtain the lowest purchase prices by making large volume purchase commitments at fixed prices and by assuming other procurement functions and risks that reduce the suppliers' cost. These commitments are made throughout the year based on anticipated demands of the restaurant operators, with terms usually of less than a year and conditions varying from product to product. Commitments made in the past have resulted in minimal losses. No significant losses are expected from existing commitments.
In April 1996, the Cooperative entered into a finance program for stockholder members cosponsored by the Bank. The program initially provided up to $20,000,000 in loans to Cooperative members which range from $100,000 to an individual maximum of $2,000,000. The Cooperative has guaranteed from 10% to 25% of the declining balance based on each loan's classification. The Bank has agreed to maintain a reserve account which will be applied to losses prior to the Cooperative incurring any loss. The reserve account is funded pursuant to the program agreements. The Bank's commitment to provide such loans terminated in June 1997. As of October 31, 1998, the Bank has funded approximately $6.5 million of borrowings outstanding under this program. The Cooperative evaluates the credit risk associated with their guarantees through credit and monitoring procedures associated with their approval and periodic payments and reporting from the primary lender, the Bank. Currently, no losses are expected by the Cooperative under this program.
9. FINANCIAL INSTRUMENTS:
The fair value of a financial instrument represents the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. Differences can arise between the fair value and carrying amount of financial instruments that are recognized at historical amounts.
The carrying amounts of cash and cash equivalents, accounts receivable (net), short-term borrowings, accounts payable and accrued expenses approximate the fair value of these instruments because of the short maturity of these instruments.
The carrying amount of the long-term note payable approximates fair value because the interest rate approximates that currently offered to the Cooperative for similar debt instruments.
It is not practical to estimate the fair value of the note receivable from related party due to the related party nature of that instrument.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
10. IMPACT OF NEW ACCOUNTING STANDARDS:
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income." Management believes that the adoption of SFAS No. 130 in fiscal 1999 will not have a material adverse affect on the Cooperative's consolidated financial statements.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." This statement is effective for financial statements for fiscal years beginning after December 15, 1997. Management is continuing to assess the disclosure impacts of adopting SFAS No. 131 in fiscal 1999.
In February 1998, the Financial Accounting Standards Board issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This statement is effective for financial statements for fiscal years beginning after December 15, 1997. Management is continuing to assess the disclosure impacts of adopting SFAS No. 132 in fiscal 1999.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Management believes that the adoption of SFAS No. 133 in fiscal 1999 will not have a material adverse affect on the Cooperative's consolidated financial statements.
11. PROPOSED CORPORATE REORGANIZATION:
In conjunction with Tricon Global Restaurants, Inc. and franchisee owners and operators of KFC, Taco Bell and Pizza Hut restaurants, on October 21, 1998, the Cooperative publicly announced the proposed formation of a "unified" purchasing cooperative focusing on the purchase of the food, packaging, supplies, equipment, and related services used in these restaurants. The Cooperative would transfer most operating assets and liabilities and its employees to the unified cooperative in exchange for its membership interest therein. In connection with forming the new unified cooperative, the Cooperative expects to split-off to a newly organized Taco Bell purchasing cooperative the portion of its business which operates purchasing programs for its Taco Bell members. Through this new entity, owners and operators of Taco Bell restaurants, including Tricon, would participate with the Cooperative and a newly organized Pizza Hut purchasing cooperative in the purchasing programs of the unified cooperative. Although administered by the new unified cooperative, the KFC purchasing program would be subject to significant control, advice and counsel of the Cooperative. The Cooperative would continue to exercise policy-making decisions and administer the patronage dividend program in accordance with past practices.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. PROPOSED CORPORATE REORGANIZATION, CONTINUED:
The process is subject to the approval of the members of the Cooperative, Proxy statements soliciting such approval will be distributed to holders of record of the Cooperative's outstanding shares of membership common stock as of the close of business on January 27, 1999. Concurrently with the solicitation of proxies, the Cooperative is making a tender offer to holders of Taco Bell series membership common stock to transfer to the tendering members all of the shares of the newly organized Toco Bell cooperative in exchange for the surrender by the tendering members of all of their shares of the Cooperative membership common stock and store common stock.
KFC NATIONAL PURCHASING COOPERATIVE, INC. AND SUBSIDIARIES (D/B/A FOODSERVICE PURCHASING COOPERATIVE, INC.) SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
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SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KFC NATIONAL PURCHASING COOPERATIVE, INC.
January 29, 1999 By /s/ Thomas D. Henrion ----------------------------------------- Thomas D. Henrion, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.