TRUSERV CORP - 10-K Annual Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-K

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

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COMMISSION FILE NUMBER 2-20910

TRUSERV CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 36-2099896
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

8600 WEST BRYN MAWR AVENUE, CHICAGO, ILLINOIS 60631-3505
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (773) 695-5000

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act: NONE

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X. NO__.

INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K (SEC.229.405 OF THIS CHAPTER) IS NOT CONTAINED HEREIN, AND
WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE
PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS
FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [X]

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS
DEFINED IN RULE 12B-2 OF THE ACT). YES __. NO X.

STATE THE AGGREGATE MARKET VALUE OF THE VOTING AND NON-VOTING COMMON EQUITY
HELD BY NON-AFFILIATES COMPUTED BY REFERENCE TO THE PRICE AT WHICH THE COMMON
EQUITY WAS LAST SOLD, OR THE AVERAGE BID AND ASKED PRICE OF SUCH COMMON EQUITY,
AS OF THE LAST BUSINESS DAY OF THE REGISTRANT'S MOST RECENTLY COMPLETED SECOND
FISCAL QUARTER.

There is no public market for registrant's Class A and Class B common
stock. The registrant's Class A common stock is offered by the registrant in
units of 60 shares each, exclusively to retailers of hardware and related
merchandise, in connection with their becoming members of the registrant. The
Class B common stock is issued as part of the patronage dividend to members of
the registrant. The terms of the Class A and Class B common stock limit its
transferability. The Class B common has no voting rights.

INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE REGISTRANT'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE.

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TABLE OF CONTENTS

PART I

THIS ANNUAL REPORT AND THE DOCUMENTS INCORPORATED HEREIN BY REFERENCE
CONTAIN FORWARD-LOOKING STATEMENTS THAT ARE BASED ON MANAGEMENT'S EXPECTATIONS,
ESTIMATES AND ASSUMPTIONS. THE FORWARD-LOOKING STATEMENTS ARE MADE PURSUANT TO
THE SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. THESE STATEMENTS ARE NOT GUARANTIES OF FUTURE PERFORMANCE AND INVOLVE
CERTAIN RISKS AND UNCERTAINTIES THAT ARE DIFFICULT TO PREDICT. THEREFORE, ACTUAL
FUTURE RESULTS AND TRENDS MAY DIFFER MATERIALLY FROM WHAT WE FORECAST DUE TO A
VARIETY OF FACTORS, INCLUDING WITHOUT LIMITATION, OUR ASSUMPTIONS ABOUT
FINANCING REQUIREMENTS AND TERMS, INTEREST RATE FUNCTIONS, SALES GROWTH, CAPITAL
REQUIREMENTS OF TRUSERV AND TRENDS IN OUR INDUSTRY.

ITEM 1. BUSINESS.
($ IN THOUSANDS -- EXCEPT PER SHARE INFORMATION)

THE COMPANY

TruServ Corporation was organized as Cotter & Company, a Delaware
corporation, in 1953. Upon its organization, it succeeded to the business of
Cotter & Company, an Illinois corporation organized in 1948. On July 1, 1997,
Cotter & Company merged with ServiStar Coast to Coast Corporation ("SCC"). SCC
was a hardware wholesaler incorporated in 1935, under the name American Hardware
Supply Company, with a strong presence in retail lumber and building materials.
Following the merger, Cotter & Company was renamed TruServ Corporation.
TruServ's main executive offices are located at 8600 West Bryn Mawr Avenue,
Chicago, Illinois 60631-3505. Its main telephone number is (773) 695-5000. Its
web page address is www.truserv.com.

The merger united two similar organizations under the name of TruServ
Corporation, creating one of the largest hardware/home center cooperatives in
the United States. The goals were to: (i) lower pricing for the members by
increasing buying power, (ii) increase potential for rebates by combining vendor
purchases, and (iii) better leverage operating expenses by consolidating
distribution centers and reducing duplicate corporate overhead costs.

In 2000, TruServ sold its lumber and building materials business (the
"Lumber Business"), consisting primarily of intangibles and inventory, to
Builder Marts of America, Inc. ("BMA"). TruServ concluded that BMA would be able
to provide lumber and building materials to TruServ members at lower cost.
Moreover, the Lumber Business had been a low-margin and working capital
intensive business for TruServ. In connection with the sale of the Lumber
Business to BMA, TruServ entered into non-compete, cooperation, trademark
license and lease agreements with BMA for various terms ranging from five to ten
years. TruServ and BMA terminated these agreements in April 2003.

In 2001, TruServ sold its ownership interest in TruServ Canada Cooperative,
Inc. (the "Canadian Business") and related real estate interests in Winnipeg,
Manitoba to the current member group of the cooperative. The proceeds received
enabled TruServ to recover its capital investment in the Canadian Business as
well as the appraised value of the real estate and to retire all indebtedness
relating to Canadian activities. TruServ has a licensing agreement with the
Canadian Business to enable it and its members to continue to do business under
the principal TruServ trademarks. In addition, TruServ continues to provide True
Value paints and supplies to the Canadian Business.

On December 31, 2002, TruServ completed a sale leaseback transaction of
seven of its distribution centers. The sale generated net proceeds of $121,438,
which were used to pay down the revolving credit facility, senior notes and
synthetic lease obligation (the "Senior Debt"), pursuant to an intercreditor
agreement between all parties of the Senior Debt. The facilities are being
leased back by TruServ under 20-year lease agreements that contain extension
periods on the lease at TruServ's option. See "Properties -- Sale Leaseback
Transaction."

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GENERAL DESCRIPTION OF THE BUSINESS

TruServ, organized as a cooperative, is one of the largest member-owned
wholesalers of hardware and related merchandise in the United States, serving
approximately 6,200 retail and industrial distribution outlets for its members
as of December 31, 2003. TruServ also manufactures and sells paint and paint
applicators.

TruServ sells its products to hardware retailers, industrial distributors,
garden centers and rental stores with whom it has entered into Retail Member
Agreements. TruServ serves its members by principally functioning as a low cost
distributor of goods, maximizing its volume purchasing abilities primarily
through vendor rebates and discount programs, for the benefit of its members.
These benefits are passed along to its members in the form of lower prices
and/or patronage dividends. TruServ also provides to its members value-added
services such as marketing, advertising, merchandising, and store location and
design services.

Generally, members are entitled to use one of certain TruServ trademarks
and trade names, including the federally registered True Value(R), Grand Rental
Station(R), Taylor Rental(R), Party Central(R), Home & Garden Showplace(R) and
Induserve Supply(R) trademarks, service marks and collective membership marks.
See "Trademarks, Service Marks and Collective Membership Marks" below. Members
have access to certain TruServ private label products and when there are annual
profits they are entitled to receive annual patronage dividends based upon their
purchases from TruServ. In accordance with TruServ's By-Laws and the Retail
Member Agreements, the annual patronage dividend is paid to members out of the
gross margins from operations and other patronage source income, after deduction
for expenses, reserves and other provisions as may be authorized by the board of
directors. See "Distribution of Patronage Dividends" below.

As of December 31, 2003, TruServ serves approximately 6,200 retail and
industrial distribution outlets for its members throughout the United States and
in 54 other countries. Primary concentrations of members exist in New York
(approximately 9%), Pennsylvania (approximately 7%), California (approximately
6%), Texas (approximately 5%), Illinois, Michigan, Massachusetts, Minnesota and
Wisconsin (approximately 4% each) and New Jersey, Ohio, and Washington
(approximately 3% each).

SALES AND SUPPLIERS

TruServ provides each of its members with an illustrated price catalog
showing the products available from TruServ, which the members can access
through the member Internet site. Upon request, a member will also receive a
printed or CD version of the catalog. These products, comprised of more than
70,000 stockkeeping units ("SKUs") maintained at TruServ's distribution centers,
are divided into seven categories of merchandise. In addition to purchasing
products, which are maintained at the distribution centers, members can purchase
additional SKUs directly from TruServ approved vendors and have those purchases
drop shipped directly to them, but have the product billed through TruServ.
Collectively, these products represent the products sold by TruServ's two
operating segments in 2003 and 2002 and three operating segments in 2001. See
Note 10, "Segment Information" to the Consolidated Financial Statements
beginning at page F-1 for additional segment information.

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The seven product categories are set forth in the following table, along
with the corresponding dollars of total revenues for each category during the
last three years:

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(1) The Canadian Business was sold on October 22, 2001. Total sales from
Canadian operations were $84,397 in 2001 and such sales are reflected in the
above amounts for each of the seven categories.

TruServ's merchandise sales to its members are divided into three logistics
categories, as follows:

Warehouse shipment sales are sales of products that are purchased,
warehoused and resold by TruServ in response to orders from the members. Direct
shipment sales are sales of products that are purchased through TruServ by the
members but delivered directly to members from vendors and TruServ accepts the
credit risk. Relay sales are sales of products that are purchased through
TruServ in response to the requests of several members for a product that
typically is:

- to be included in future promotions,

- seasonal in nature,

- not normally held in inventory, and

- not conducive to direct shipment.

Generally, TruServ will give notice to all members of its intention to
purchase products for relay shipment and will then purchase only as many items
as the members order. When the product shipment arrives at TruServ, it is not
warehoused; rather, TruServ breaks up the shipment and "relays" the appropriate
quantities to the members who placed orders.

TruServ has numerous individual agreements with or commitments from its
vendors, most of which are terminable by the vendors or TruServ without cause.
These termination provisions, either individually or in the aggregate, have not
had any material adverse effect on TruServ's ability to conduct its business.
The goods and services purchased by TruServ from these suppliers are generally
available from a wide variety of sources. TruServ is not dependent upon any one
supplier or group of suppliers.

TruServ also manufactures and sells paint and paint applicators. The
principal raw materials used by TruServ in its paint manufacturing activities
are chemicals. All raw materials are purchased from outside sources. In the
past, TruServ has been able to obtain adequate sources of raw materials and
other items used in production. TruServ does not currently anticipate shortages
of materials that would materially impact its paint manufacturing operations.

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OTHER SERVICES

TruServ annually sponsors two principal "markets", a separate rental market
and an outdoor power equipment show all funded primarily by vendors through
booth fees, at which it features the products available for purchase by members,
including new merchandise and seasonal items. In addition, the markets permit
members and prospective members to keep better informed as to industry trends,
attend continuing education classes and network with other members. In the year
2004, one of the principal markets will be held in Dallas, Texas, and the other
principal market will be held in Orlando, Florida, where the 2004 rental market
was recently held. As the markets generate income and stimulate member
purchases, the timing of markets impact the timing of sales and income
recognition for TruServ. All members are invited to the markets and attending
members generally place substantial orders for delivery of merchandise during
the period between markets.

BACKLOG

As of January 31, 2004 and January 25, 2003, respectively, TruServ had a
backlog of firm orders (including relay orders) of approximately $18,149 and
$11,260. TruServ's backlog at any given time is made up of two principal
components:

- normal resupply orders, and

- market orders for future delivery.

Normal resupply orders are orders from members for merchandise to keep
store inventories at normal levels. Generally, such orders are filled the day
following receipt, except that relay orders for future delivery are not intended
to be filled for several months. Market orders for future delivery are member
orders placed at TruServ's markets for new or seasonal merchandise, to be
delivered during the subsequent period between markets. Thus, TruServ generally
has a relatively high backlog at the end of each market, which decreases in
subsequent months until the next market occurs.

COMPETITION

The retail hardware industry is characterized by intense competition.
Independent retail hardware businesses, including those served by TruServ, face
intense competition from chain stores, discount stores, home centers and
warehouse operations such as Wal-Mart, Home Depot, Menards, Sears and Lowe's.
Increased operating expenses for the retail stores, including increased costs
due to longer store hours and higher retail occupancy costs, have cut into
operating margins for members and brought pressure on TruServ to achieve lower
merchandise costs for its members. In response, TruServ works with its members
to drive profitability through operational improvement programs such as AIM
(advanced inventory management) which focuses on assortments of fast turning
products as well as retail programs which focus on areas such as pricing,
merchandising, store design and signage. In addition, TruServ has introduced
wholesale pricing strategies, Priced 2 Win(TM) and Connect 4 Profit(R), which
are designed to improve retail competitiveness. In 2002, TruServ developed the
program Store of First Choice(R) to focus on incentivizing members to adopt
retail best practices.

Competitive conditions in the wholesale hardware industry are similarly
intense and increasing, particularly as a result of the intense pressure on
hardware retailers to obtain low-cost wholesale supply sources for merchandise
acquisition. TruServ competes with other member-owned and non-member-owned
wholesalers to be a source of supply and merchandising support for independent
retailers. Competitive factors considered by independent retailers in choosing a
source of supply include pricing, servicing capabilities, promotional support
and merchandise selection, quality and patronage dividends. TruServ is
concentrating on its supply channel strategies and practices for gaining
sustainable competitive advantage. In many markets in the United States, TruServ
competes directly with other member-owned wholesalers such as Ace Hardware
Corporation and Do-it-Best Corporation, as well as independently owned
wholesalers.

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TRADEMARKS, SERVICE MARKS AND COLLECTIVE MEMBERSHIP MARKS

TruServ's trademarks, service marks and collective membership marks are of
prime importance to TruServ. Many of the marks are highly recognized and
utilized in extensive advertising and marketing campaigns, and TruServ
vigorously defends its marks. As of December 31, 2003, TruServ's members have
approximately 6,200 retail and industrial distribution outlets that operate
predominately as retail hardware stores, rental facilities, horticulture outlets
as well as commercial and industrial distributors, throughout the United States
and in 54 countries, most of which sell merchandise and services under the
marks.

The marks include the True Value(R) marks, the ServiStar(R) mark, the Coast
to Coast(R) mark, the Induserve Supply(R) mark, the Party Central(R) mark, the
Grand Rental Station(R) mark, the Taylor Rental(R) mark, the Home & Garden
Showplace(R) mark and the Commercial Sales(R) mark. The marks also include E-Z
Kare(R), Weatherall(R), and Easy Color(R) for paint. All of the marks are
currently used in commerce and TruServ intends to use the marks in commerce in
the future. Each of the marks is renewable at TruServ's option and TruServ
intends to renew them upon expiration. Members have continued to conduct their
businesses under the same retail banners as before the merger of Cotter and SCC;
however, beginning in year 2000, many members with the retail banners of Coast
to Coast(R) and ServiStar(R) started to conduct their business under the single
retail banner of True Value(R). TruServ's marks also include Help is Just Around
the Corner(R), Christmas is Just Around the Corner(R) and Summer is Just Around
the Corner(R).

EMPLOYEES

As of December 31, 2003, TruServ employed approximately 3,000 persons in
the United States on a full-time basis. Due to the widespread geographical
distribution of TruServ's operations, employee relations are governed by the
practices prevailing in the particular area where the employees are located and
are generally implemented locally. Approximately 35% of TruServ's 2,100
hourly-wage employees are covered by collective bargaining agreements that are
generally effective for periods of three or four years. In general, TruServ
considers its relationship with its employees to be good.

RETAIL MEMBER AGREEMENT

The TruServ Retail Member Agreement provides, among other things, that each
member:

- will be required to purchase 60 shares of Class A common stock at a
purchase price of $100 per share for each store owned by the member,
up to a maximum of 300 shares for five or more stores that are owned
by a member;

- will conduct its businesses subject to the terms of the Retail
Member Agreement;

- will conduct a retail hardware store, home or garden center, a
commercial/industrial distribution business or a full-service rental
operation at a designated location;

- will comply with TruServ's By-Laws, as may be amended from time to
time;

- will accept patronage dividends in a form complying with the
requirements of the Internal Revenue Code (the "Code") for deduction
from gross income by TruServ;

- may receive different services or charges based upon the amount of
merchandise purchased by the member;

- agrees to have its Retail Member Agreement terminated unilaterally
in certain circumstances by TruServ's board of directors;

- agrees to have its Retail Member Agreement automatically modified
upon notice from TruServ to the member of any relevant change in the
Certificate of Incorporation and/or By-Laws of TruServ, or by
resolution of the board of directors;

- agrees to utilize TruServ as its primary supplier for the types of
merchandise offered by TruServ;

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- agrees to have its Retail Member Agreement governed by Illinois law,
enforced only in courts located in Cook County, Illinois or any
Illinois county contiguous to Cook County, and only interpreted in
accordance with the substantive laws of Illinois without giving
effect to its conflict of laws principles; and

- may terminate the Retail Member Agreement upon 60 days written
notice mailed to any executive officer of TruServ at TruServ's
principal office.

CAPITAL STOCK

In general, members of TruServ own shares of Class A and Class B common
stock. Each of the two classes of stock has a par value of $100 per share. The
Class A common stock is sold in units of 60 shares. Each TruServ member is
required to purchase one unit of Class A common stock for each store owned;
however, no TruServ member is permitted to acquire more than five units of Class
A common stock. (TruServ has waived the Class A common stock ownership
requirement for new members pending effectiveness of a new registration
statement for the Class A common stock.) The Class B common stock is issued only
to members in connection with the patronage dividend distributed to them for
purchases in the year of the patronage dividend, as discussed below. See
"Distribution of Patronage Dividends" below.

Neither class of TruServ common stock accrues dividends and each has
limited transferability. TruServ has a right of first offer to repurchase at par
value a member's stock before the member can offer the stock to another member.
Historically, TruServ has always exercised this right. In any event, a member
may not transfer the Class A common stock to anyone without TruServ's consent.
TruServ also retains an automatic lien on both classes of stock for any
indebtedness due to TruServ by a member. Therefore, there is no existing market
for either class of TruServ common stock.

Participation in the earnings or losses of a cooperative is based on member
patronage purchasing and reflected by the payment of patronage dividends. In
general, these patronage dividends are based on a member's purchasing volume and
margins applicable to merchandise purchased by the member, less any expenses
related to such business and less certain cooperative reserves. Patronage
dividends are determined on a yearly basis for purchasing activity conducted the
prior year, and are allocated no later than the 15th day of the ninth month
following the end of the calendar year. TruServ has been paying patronage
dividends in a combination of cash and Class B common stock. As TruServ reported
a net loss for 2001, there was no patronage dividend payable in 2002 related to
2001 results. TruServ paid a patronage dividend for 2002 results in 2003 and
will pay a dividend for 2003 results in 2004. Such dividends were or will be a
combination of cash, Class B common stock and loss allocation account reduction
(for members with such an account). See "Allocation of Patronage Dividends
against Loss Allocation Account" below.

MORATORIUM ON REDEMPTIONS OF CAPITAL STOCK

In March 2000, the board of directors of TruServ declared a moratorium on
redemptions of the capital stock. In reaching its decision to declare the
moratorium, the board of directors of TruServ reviewed the financial condition
of TruServ and considered its fiduciary obligations and corporate law principles
under Delaware law. The board of directors concluded that it should not redeem
any of the capital stock (which TruServ's By-Laws required to be redeemed at par
value) while its net asset value was substantially less than par value, as that
would likely violate legal prohibitions against "impairment of capital." In
addition, the board of directors concluded that it would be a violation of its
fiduciary duties to all members and that it would constitute a fundamental
unfairness to members if some members were allowed to have their shares redeemed
before the 1999 loss was allocated to them and members who did not request
redemption were saddled with the losses of those members who requested
redemption. Moreover, the board of directors considered TruServ's debt
agreements and, in particular, the financial covenants thereunder, which
prohibited redemption when TruServ, among other things, did not attain profit
margins.

At the time the board of directors declared the moratorium on redemptions,
TruServ's By-Laws did not impose limitations on the board's discretion to
initiate or to continue a moratorium on redemption. The By-Laws merely provided
that, upon termination of a member's agreement, TruServ was to redeem the
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member's shares at par value. Nevertheless, the board of directors concluded
that its fiduciary obligations to TruServ and its members would not permit it to
effect redemptions under the circumstances described above. After the board of
directors declared the moratorium, the board of directors amended the By-Laws to
provide that if TruServ's funds available for redemption are insufficient to pay
all or part of the redemption price of shares of capital stock presented for
redemption, the board of directors may, in its sole discretion, delay the
payment of all or part of the redemption price.

The board of directors will consider the financial condition of TruServ,
and will not lift the moratorium unless it can conclude that effecting
redemptions of TruServ's capital stock will not "impair the capital" of TruServ,
unfairly advantage some members to the disadvantage of others, or violate the
financial covenants under its debt agreements. In light of the current financial
circumstances of TruServ, the board of directors is reviewing the continued need
for the stock moratorium and has informed its members that a decision whether to
maintain or lift the moratorium will be made prior to and announced at the March
28, 2004 annual shareholders' meeting. If a decision is made to lift the stock
moratorium, the effective date of the end of the moratorium would be determined
by the date of the annual shareholders' meeting and announced at such time.

As of December 31, 2003, the deferred stock redemption liability on
TruServ's financial statements totals $33,725. Historically, TruServ has offset
amounts due by its members against amounts that it pays to the members on
redemption of their stock. The deferred stock redemption liability is the
aggregate value of the terminated members' equity investments after the offset
of the loss allocations resulting from the 1999 loss, the 2001 loss and the
accounts receivable owed by the former members. In accordance with TruServ's By-
Laws, certain equity interests are paid in cash at the time of redemption and
the remaining equity interests are paid out by means of a five-year subordinated
installment note, with annual installments commencing December 31 of the year
the moratorium is lifted. The December 31, 2003 deferred stock redemption
liability of $33,725 has approximately $7,458 payable in cash at the time the
moratorium is lifted and TruServ will issue the remaining balance in
subordinated installment notes with an aggregate principal amount of $26,267.

DISTRIBUTION OF PATRONAGE DIVIDENDS

TruServ operates on a cooperative basis with respect to business transacted
with or for members. All members are entitled to receive patronage dividend
distributions from TruServ, calculated on the basis of gross margins of
merchandise purchased by each member. In accordance with TruServ's By-Laws and
Retail Member Agreement, the annual patronage dividend, as authorized by the
board of directors, is paid to members out of patronage source income, less
certain deductions, calculated as provided in the following sentence. The total
patronage dividend paid to members is based on pre-tax net margins calculated in
accordance with accounting principles generally accepted in the United States of
America after reducing or increasing net margins for non-member income/(losses),
reasonable reserves and deferred patronage amortization. The total dividend is
allocated to each purchase category, with the main purchase categories being
warehouse, relay, direct shipment and paint. Once the patronage dividend is
allocated to the purchase categories, it is distributed to members based on the
relative gross margin participation of the member for each type of purchase
category.

Patronage dividends are usually paid to members within 90 days after the
close of TruServ's year; however, the Code permits distribution of patronage
dividends as late as the 15th day of the ninth month after the close of
TruServ's year, and TruServ may elect to distribute the annual patronage
dividend at a later time than usual in accordance with the provisions of the
Code.

TruServ's By-Laws provide for the payment of annual patronage dividends,
after payment of at least 20% of such patronage dividends in cash, in "qualified
written notices of allocation" including:

- Class B common stock based on its par value, up to a maximum of 2% of the
member's net purchases of merchandise from TruServ for the year (except
in unusual circumstances of individual hardship, in which case the board
of directors reserves the right to make payments in cash),

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- Promissory (subordinated) notes, or

- Other property.

Promissory (subordinated) notes are customarily issued for a five-year term
and bear interest at a rate fixed from time to time by the board of directors.
The notes are subordinated to all other debt of TruServ. TruServ may also issue
"nonqualified written notices of allocation" to its members as part of its
annual patronage dividend. "Non-qualified written notices of allocation" are
usually issued in the form of Class B common stock. See "Payment of Patronage
Dividends in Accordance with the Internal Revenue Code" below.

In determining the form of the annual patronage dividend, a member's
required investment in Class B common stock of TruServ had historically been
limited by the board of directors to a certain amount, the cumulative value of
which would not exceed 2% of the member's net purchases of merchandise from
TruServ. Commencing in 1996, the board established a minimum Class B common
stock ownership requirement for each type of retail member, which may be varied
from time to time. However, not all members have achieved the minimum target.
This minimum is generally the greater of (1) $25,000 or (2) the aggregate of a
member's various types of annual purchases, each multiplied by a specific
percentage, which varies from 1% to 14% and which decreases as total dollar
purchases by category increase. The board of directors determined the amount of
the minimum required investment by majority vote, and the minimum may be
increased or decreased from time to time. TruServ will make an increase or
decrease determination based on an evaluation of its financial needs and the
needs of its membership.

ALLOCATION OF PATRONAGE DIVIDENDS AGAINST LOSS ALLOCATION ACCOUNT

During the third quarter of 2000, TruServ management developed and the
board of directors approved a plan to equitably allocate to members the loss
incurred in 1999. This loss was previously recorded as a reduction of retained
earnings. TruServ has distributed the 1999 loss allocation among its members by
establishing a loss allocation account as a contra-equity account in the
consolidated balance sheet with the offsetting credit recorded to the
accumulated deficit account. The loss allocation account reflects the sum of
each member's proportionate share of the 1999 loss, after being reduced by
certain amounts that were not allocated to members. The allocation was generally
based on a member's proportionate equity investment relative to the total equity
investments of all the members, and therefore a member could not be allocated a
loss in excess of their equity investment. The loss allocation account will be
satisfied, on a member by member basis, by applying the portion of future
non-cash patronage dividends as a reduction to the loss allocation account until
fully satisfied. The loss allocation amount may also be satisfied, on a member
by member basis, by applying the par value of maturing member notes and related
interest payments as a reduction to the loss allocation account until such
account is fully satisfied. However, in the event a member should terminate as a
stockholder of TruServ, any unsatisfied portion of that member's loss allocation
account will be satisfied by reducing the redemption amount paid for the
member's stock investment in TruServ. See related discussion in "Legal
Proceedings."

The board of directors determined that TruServ will retain the 2001 loss as
part of the accumulated deficit account. All or a portion of patronage income
and all non-patronage income, if any, may be retained in the future to reduce
the accumulated deficit account. TruServ has determined for each member that was
a stockholder in 2001, its share of the 2001 loss that has been retained in the
accumulated deficit account. The 2001 loss was allocated based upon both the
member's proportionate stock investment, net of any 1999 loss allocation
account, and also based on the member's purchases from the co-op in 2001. No
member was allocated a loss amount greater than their net equity investments
held as of year end 2001. In the event a member terminates its status as a
stockholder of TruServ, any remaining 2001 loss in the accumulated deficit
account that is allocable to the terminating member will be distributed to the
terminating member and satisfied by reducing the redemption amount paid for the
member's stock investment in TruServ.

A member's proportionate share of the 1999 and/or 2001 losses has been
limited to the extent of their equity investment in TruServ. Any portion of a
loss allocation that exceeds a member's equity investment is retained by TruServ
in the accumulated deficit account. All or a portion of patronage income and all
non-patronage income, if any, may be retained in the future to reduce the
accumulated deficit account.
8

PAYMENT OF PATRONAGE DIVIDENDS IN ACCORDANCE WITH THE INTERNAL REVENUE CODE

The Code specifically provides for the taxation of cooperatives (such as
TruServ) and their patrons (such as TruServ's members) so as to ensure that the
business earnings of a cooperative are currently taxable either to the
cooperative or to its patrons, but not both.

The shares of Class B common stock and other written notices distributed by
TruServ to its members, which disclose to the recipient the stated amount
allocated to the member by TruServ and the portion thereof that is a patronage
dividend, are "written notices of allocation" as that phrase is used in the
Code. For such written notices to be "qualified written notices of allocation"
within the meaning of the Code, it is necessary that TruServ pay 20% or more of
the annual patronage dividend in cash and that the members consent to having the
allocations (at their stated dollar amounts) treated as being constructively
received by them and includable in their gross income. Any written notices that
do not meet these requirements are "nonqualified written notices of allocation"
within the meaning of the Code.

TruServ deducts the sum of cash, the face value of qualified written
notices and the fair market value of any other property distributed to the
members (except nonqualified written notices of allocation) from its earnings in
determining its taxable income. Accordingly, all of these items, including such
qualified written notices of allocation, are includable in the gross income of
the members. Section 1385(a) of the Code provides, in substance, that the amount
of any patronage dividend which is paid in cash, qualified written notices of
allocation or other property (except nonqualified written notices of allocation)
shall be included in the gross income of the patron (member) for the taxable
year in which the patron (member) receives such distribution. In general, for
nonqualified written notices of allocation, no amounts are either deductible by
TruServ or includable in a member's gross income until the notices are redeemed
by TruServ. TruServ itself therefore includes any earnings reflected in
nonqualified written notices of allocation in its own gross income and pays tax
on them.

Thus, every year each member may receive, as part of the member's patronage
dividend, non-cash "qualified written notices of allocation," which may include
Class B common stock (which is determined to be qualified for tax purposes), the
stated dollar amount of which must be recognized as gross income by the member
for the taxable year in which received. The portion of the patronage dividend
paid in cash (at least 20%) may be insufficient, depending on a member's
individual tax bracket, to pay income taxes due from the member on its receipt
of the full amount of the patronage dividend, including cash and Class B common
stock.

TruServ has historically paid its members approximately 30% of the
patronage dividend in cash (excluding nonqualified written notices of
allocation). However, TruServ is only obligated to distribute 20% of the annual
patronage dividend (excluding nonqualified written notices of allocation) in
cash, and it may distribute this lesser percentage in future years.

TruServ's By-Laws, reflecting the Code provision applicable to
cooperatives, usually treat shares of Class B common stock and such other
notices as the board of directors may determine, if distributed in payment of
patronage dividends, as "qualified written notices of allocation." The By-Laws
provide:

(1) for payment of patronage dividends in a combination of cash,
qualified written notices of allocation (including Class B common stock),
other property and nonqualified written notices of allocation; and

(2) that membership in the organization (i.e., the status of being a
member of TruServ) constitutes the member's consent to recognize the stated
amount of any qualified written notices of allocation or other property
distributed to it as includable in the member's gross income as provided in
Section 1385(a) of the Code.

Under the Code, any person who becomes or became a member of TruServ, or
who remains a member after adoption of the By-Laws providing that membership in
TruServ constitutes consent to be taxed on receipt of qualified written notices
of allocation, is deemed to have consented to be taxed on receipt of patronage
dividends in cash and in qualified written notices of allocation, in accordance
with Section 1385(a) of the Code. Written notification of the adoption of the
By-Laws and its significance, and a copy of the By-

9

Laws, were sent to each then existing member and have been, and will continue to
be, delivered to each person prior to becoming a member. Such consent is then
effective as to patronage dividends. Such consent may be revoked by the member
only by terminating its membership in TruServ in the manner provided in his or
its Retail Member Agreement. See "Retail Member Agreement" above.

In order to avoid the administrative inconvenience and expense of issuing
separate certificates representing shares of Class B common stock to each
member, TruServ deposits a certificate, representing all the shares of Class B
common stock then being issued, with Harris Trust and Savings Bank, Chicago,
Illinois, for safekeeping for and on behalf of its members. TruServ keeps the
allocations of Class B common stock in book entry form. TruServ then sends a
written notice to each member of these deposits and the allocation thereof to
the member.

SET OFF RIGHTS OF TRUSERV

TruServ's Certificate of Incorporation and By-Laws specifically provide
that TruServ, but not the member, may set off its obligation to make any payment
to a member for such member's stock, notes, interest and declared and unpaid
dividends against any obligation owed by the member to TruServ. TruServ
exercised these set off rights in 2003 and 2002, when TruServ notes and interest
came due to former members with outstanding merchandise accounts receivable to
TruServ and current members with past due merchandise accounts receivable to
TruServ. TruServ also set off its obligation to former members against their
related loss allocation balance. The set off rights were exercised in an
aggregate amount of $8,329 during 2003 and $16,526 during 2002.

As TruServ maintains stock records for its members on a store-by-store
basis, members with multiple stores who elect to sell one or more, but not all,
of their stores can transfer the stock registered on TruServ's records with
respect to a store location that is terminating its relationship with TruServ,
to the store locations that are not being terminated, with proper evidence of
succession, assignment or authority to transfer. Otherwise, TruServ may exercise
its right to offset the par value of the stock recorded for the store location
to be closed against the loss allocation account balance.

ITEM 2. PROPERTIES.
($ IN THOUSANDS)

WAREHOUSING AND OFFICE FACILITIES

TruServ's worldwide headquarters is located in Chicago, Illinois.
Information with respect to TruServ's owned and leased warehousing and office
facilities at December 31, 2003 is set forth below:

10

- ---------------

(1) TruServ has subleases with third parties for approximately 72,000 of the
228,100 square feet of the Chicago, Illinois space.

(2) Facility was part of the December 31, 2002 sale leaseback transaction. See
"Properties -- Sale Leaseback Transaction" below.

(3) Facility is assigned as collateral under the asset-based revolving credit
facility ("Bank Facility").

Facilities not used in the operations of the business consist of:

- - 476,200 sq. ft. of owned office and warehouse space in East Butler,
Pennsylvania that is currently for sale;

- - 840,000 sq. ft. of vacant facility space in Hagerstown, Maryland that is
leased until July 2005 and is subject to landlord cancellation upon 10 days
notice. TruServ received on January 12, 2004 a notice of cancellation with
respect to 454,000 sq. ft. of the facility that is effective April 1, 2004,
which will reduce the obligation under the lease to 386,000 sq. ft.; and

- - 60,500 sq. ft. facility in Peachtree City, Georgia leased until November 2005
that is sublet to third parties.

See Note 13, "Restructuring Charges and Other Related Expenses," to the
Consolidated Financial Statements, beginning at page F-1 for a further
discussion of the Hagerstown, Maryland facility.

SALE LEASEBACK TRANSACTION

On December 31, 2002, TruServ sold seven of its distribution centers to
unrelated third parties for an aggregate purchase price of $125,753. The sale
resulted in net proceeds to TruServ of $121,438, which were used to pay Senior
Debt. The net reduction in Senior Debt was $108,743, as a result of new
make-whole notes of $12,695 issued due to the prepayment on senior notes.
TruServ concurrently agreed to lease the distribution centers for a period of 20
years. The transaction was recorded as a real property sale and as operating
leases in TruServ's financial statements. The resulting gain on sale of $55,564
was recorded as deferred gain in the balance sheet and is being amortized to
income on a straight line basis over the initial 20 year lease term.

TruServ sold the distribution facilities located in Corsicana, Texas and
Woodland, California to and now leases them from Wrench (DE) Limited
Partnership. TruServ sold the distribution facilities located in Kingman,
Arizona, Fogelsville, Pennsylvania and Springfield, Oregon to and now leases
them from Bolt (DE) Limited Partnership. TruServ sold the distribution
facilities located in Jonesboro, Georgia and Kansas City, Missouri to and now
leases them from Hammer (DE) Limited Partnership. The three limited partnerships
are affiliated with W.P. Carey Investments, an investment firm independent of
TruServ. TruServ pays rent under each lease quarterly in January, April, July
and October. The aggregate annual rent payments under all three leases for 2003,
the first year of the lease, totals $12,007. Rent payments under the leases
increases 2% each year during the initial 20 year lease term.

Each lease is a "triple-net" lease under which TruServ is obligated to pay
all operating expenses of the property, all taxes and other impositions related
to the property, to maintain and insure the property and, with minor exceptions,
to rebuild the improvements after a casualty or condemnation. TruServ also
indemnifies the landlord from any loss, cost, damage or liability arising out of
the use, ownership or operation of the property, including any liability related
to hazardous materials.

TruServ's obligation to pay rent under the leases is absolute, with no
right to offset or abatement. The three leases are cross-defaulted, such that a
default under one of the leases constitutes a default under each of the other
leases. Events of default under the leases relate to TruServ's "triple-net"
lease obligations, as described above, and do not include any financial
covenants. TruServ has no right to terminate any of the leases, with minor
exceptions as described in the leases.

TruServ has the right to extend each lease for two additional periods of
approximately 10 years each. TruServ may elect to renew a lease or leases with
respect to any one or more of the properties without renewing the lease or
leases with respect to all of the properties subject thereto. TruServ has the
right to assign the lease without the landlord's prior written consent, but
subject to certain conditions described in the leases.

11

Provided that TruServ assigns the rent thereunder to the landlord, TruServ may
sublet all or any part of any property without the landlord's consent.

TruServ continues to evaluate opportunities to capitalize on the increase
in market value over the historical book value of its owned real estate assets
through additional sale leaseback transactions, mortgages or other financing
methods.

OTHER PROPERTY SALES

The Brookings, South Dakota regional distribution center was closed and
sold in 2002. In 2001, TruServ closed its Henderson, North Carolina distribution
center and the lease agreement on the facility expired on November 11, 2001. The
Indianapolis, Indiana distribution center was closed and sold in 2001. TruServ's
interest in the Canadian Business was sold in October of 2001, which included
the sale of the Winnipeg, Manitoba property. TruServ had been exiting and
consolidating distribution facilities since the merger with SCC in 1997 to both
realize the benefit of reduced operating costs of the merged cooperatives and to
reflect a level of contraction of its operations.

MANUFACTURING FACILITIES

TruServ's facilities are suitable for their respective uses and are, in
general, adequate for TruServ's present needs. Information with respect to
TruServ's manufacturing facilities is set forth below:

- ---------------

(1) Assigned as collateral under the Bank Facility

OTHER LEASES

TruServ owns and leases transportation equipment for use at its
distribution centers for the primary purpose of delivering merchandise from
TruServ's distribution centers to its members. Additional information concerning
these leases can be found in Note 5, "Lease Commitments," to the Consolidated
Financial Statements beginning at page F-1.

ITEM 3. LEGAL PROCEEDINGS.
($ IN THOUSANDS)

BESS ACTION

In May 2000, TruServ filed a complaint in the Circuit Court of McHenry
County, Illinois against Bess Hardware and Sports, Inc., ("Bess") to recover an
accounts receivable balance in excess of $400. Bess filed a counterclaim,
seeking a setoff against its accounts receivable balance for the par redemption
value of Bess's shares of TruServ Stock. Bess contested the validity of a March
17, 2000 corporate resolution declaring a moratorium on the redemption of all
TruServ capital stock, as well as an allocation of Bess' proportionate share of
the loss, which TruServ declared for its fiscal year 1999. On August 2, 2003,
the Circuit Court entered judgment in favor of TruServ on its accounts
receivable claim in the amount of $391,683.01, and entered judgment in favor of
Bess on its counterclaim. Bess did not appeal the judgment on the accounts
receivable claim. TruServ appealed the judgment on Bess's counterclaim. On
January 21, 2004, the Second District of the Illinois Appellate Court issued a
decision reversing the portion of the Circuit Court's ruling that had refused to
enforce the Moratorium. In validating the Moratorium, the Second District found
that TruServ's capital was impaired, and held that TruServ "was prohibited from
immediately remitting the redemption price for [Bess's] TruServ stock". The
Second District also held that as of April 10, 2000 -- the effective date of

12

the termination of Bess's membership -- Bess ceased to be a TruServ stockholder
and thus was not subject to the loss allocation plan passed by resolution of the
TruServ board of directors on August 29, 2000. On February 9, 2004, Bess filed a
Petition For Rehearing in the Second District of the Illinois Appellate Court.
The petition is pending.

KENNEDY ACTION

In June 2000, various former members of TruServ filed an action against
TruServ in the Circuit Court of the 19th Judicial Circuit (McHenry County,
Illinois) (the "Kennedy action"). The plaintiffs in the Kennedy action each
allege that, based upon representations made to them by TruServ and its
predecessors that the Coast to Coast brand name would be maintained, they voted
for the merger of ServiStar/Coast to Coast and Cotter & Company. The plaintiffs
allege that after the merger, the Coast to Coast brand name was eliminated and
that each plaintiff thereafter terminated or had its membership in TruServ
terminated. The plaintiffs further claim that TruServ breached its obligations
by failing to redeem their stock and by creating loss allocation accounts for
the plaintiffs. The plaintiffs have each asserted claims for
fraud/misrepresentation, negligent misrepresentation, claims under the state
securities laws applicable to each plaintiff, claims under the state
franchise/dealership laws applicable to each plaintiff, breach of fiduciary
duty, unjust enrichment, estoppel and recoupment. Similar claims were filed
against TruServ as counterclaims to various complaints filed by TruServ in
McHenry County to recover accounts receivable balances from other former
members. Those claims were consolidated with the Kennedy action. In March 2001,
the Kennedy complaint was amended to add additional plaintiffs. Also in March
2001, another action was filed against TruServ on behalf of additional former
members, in the same court, by the same law firm (the "A-Z action"). The A-Z
complaint alleges substantially similar claims as those in the Kennedy action,
with the principal difference being that the claims relate to the elimination of
the ServiStar brand name. The Kennedy and A-Z actions have been consolidated for
purposes of discovery, which is ongoing. The plaintiffs seek damages for stock
repurchase payments, lost profits and goodwill, out of pocket expenses, attorney
fees and punitive damages. In July 2002, the plaintiffs in these consolidated
actions amended their complaints to name as defendants two former officers of
TruServ.

TruServ intends to vigorously defend the remaining cases. Litigation is
subject to many uncertainties, and the outcome of the individual litigated
matters is not predictable with assurance. It is possible that the matters
discussed above could be decided unfavorably to TruServ. Although the amount of
liability with respect to these matters cannot be ascertained, potential
liability is not expected to materially affect the consolidated financial
position or results of operations of TruServ, in light of TruServ's insurance
coverage.

DERIVATIVE ACTION SETTLEMENT

In August 2000, an action was brought in Delaware Chancery Court (New
Castle County) by a former TruServ member ("Hudson City Properties") against
certain present and former directors and certain former officers of TruServ and
against TruServ. The complaint was brought derivatively on behalf of TruServ and
alleged that the individual defendants breached fiduciary duties in connection
with the accounting adjustments made by TruServ in the fourth quarter of 1999.
Hudson City Properties also sought to proceed on a class action basis against
TruServ on behalf of all those affected by the moratorium on stock redemption
and the creation of the loss allocation accounts. Hudson City Properties alleged
that TruServ breached, and the named directors caused TruServ to breach,
agreements with members by suspending payment of the members' 1999 annual
patronage dividend, by declaring the moratorium on the redemption of members'
TruServ stock and by imposing annual minimum purchase requirements upon members.
On May 12, 2003, the parties to this action signed a Stipulation of Settlement
resolving the lawsuit, subject to court approval. On May 15, 2003, the Delaware
Chancery Court entered an Order preliminarily approving the Settlement. The
Court conducted a Settlement Hearing on July 8, 2003, and approved the
Stipulation of Settlement as fair, reasonable, adequate and in the best interest
of TruServ and the class. On July 14, 2003, the Court entered a Final Order and
Judgment dismissing the lawsuit with prejudice. The Stipulation of Settlement
became final and binding 30 days after the date the Final Order and Judgment was
entered. Under the terms of the Stipulation of Settlement, at such time as
TruServ's board of directors determines that it is in the best interests of
TruServ to

13

lift the moratorium on stock redemptions, the loss allocation accounts for all
current and former members who are parties to the Stipulation of Settlement will
be reduced by approximately $5 million on a pro rata basis as more fully
described in the Stipulation of Settlement agreement. The majority of the
settlement was provided by TruServ's insurance carrier. Additionally, all of the
current and former members who participated in the Stipulation of Settlement
released TruServ and its current and former officers and directors from any
liability with respect to the moratorium on stock redemptions and the creation
of the 1999 loss allocation accounts.

CLAIM AGAINST ERNST & YOUNG LLP

TruServ is pursuing claims against its former outside auditors, Ernst &
Young LLP ("E&Y"), for professional malpractice, breach of contract, deceptive
business practices and fraud. TruServ contends that E&Y failed to properly
discharge its duties to TruServ and failed to identify, in a timely manner, and
indeed concealed, certain material weaknesses in TruServ's internal financial
and operational controls. As a result, TruServ was forced to make an
unanticipated accounting adjustment in the fourth quarter of 1999 in the total
amount of $121,333 (the "Fourth Quarter Charge"). As a result, TruServ reported
a net loss of $130,803 for the fiscal year ended December 31, 1999. It is
TruServ's belief that had E&Y properly discharged its duties, the scope and
breadth of the Fourth Quarter Charge, as well as the accounting and operational
control deficiencies that necessitated the charge, would have been substantially
lessened. As a result of E&Y's failures, TruServ has suffered significant
financial damages. The factual allegations that form the basis for TruServ's
claim against E&Y include, in part, the issues identified in the Securities and
Exchange Commission (the "Commission") cease and desist order described below.
TruServ began discussion of its claims with E&Y early in the fall of 2001.
Pursuant to the dispute resolution procedures required by TruServ's engagement
letter with E&Y, TruServ and E&Y attempted to mediate this dispute during the
first six months of 2002. When those attempts proved unsuccessful, and again
pursuant to the dispute resolution procedures, TruServ filed its claim with the
American Arbitration Association on July 31, 2002. The arbitration, which is
subject to certain confidentiality requirements, is currently pending. Hearings
are currently scheduled to begin in the spring of 2004. Recoveries under this
matter, if any, may be subrogated to the rights of TruServ's insurer to the
extent that it has made payments to or on behalf of TruServ associated with the
1999 loss.

TRUSERV ORDER

On March 4, 2003, the Commission entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
TruServ Corporation, SEC File No. 3-11050 (the "Order"). TruServ consented to
the entry of the Order without admitting or denying the findings in the Order.

The Commission entered the Order following an investigation by the staff of
the Commission of the circumstances that led to significant financial
adjustments resulting in the 1999 loss of $130,803. The Order found that, from
approximately July 1997 through the end of 1999, TruServ's accounting systems
and internal controls related to inventory management were inadequate. The Order
also found that these deficiencies caused TruServ to understate expenses, which
resulted in overstatement of net income, during 1998 and 1999. According to the
Order, TruServ filed erroneous reports on Form 10-Q for the first, second and
third quarters of 1998 and 1999 and an erroneous report on Form 10-K for 1998.
In 1999, TruServ reported a loss, caused by weaknesses in the accounting
practices and internal controls at TruServ, of approximately $130,803.

Pursuant to the Order, TruServ has agreed to continue to maintain the
procedures that it has adopted since the Spring of 2000 and otherwise to comply
with the accounting, record keeping and internal control provisions of the
Securities and Exchange Act of 1934 (the "Exchange Act"). In addition, TruServ
will continue to employ as a member of its management team, during the fiscal
years ending 2002, 2003 and 2004, a Director of Internal Audit who will be
responsible for executing TruServ's internal audit plan and will continue to
engage a public accounting firm to assist the Director of Internal Audit in
performing internal audit procedures.

Also pursuant to the Order, within 90 days after the close of each fiscal
year ending 2002, 2003 and 2004, the Director of Internal Audit prepared or will
prepare and deliver to TruServ's board audit committee, with

14

copies to the Commission, TruServ's auditors and the public accounting firm
assisting the Director of Internal Audit, a report describing the scope of the
audit plan during the preceding year, confirmation that the audit plan was
carried out, an overview of significant control weaknesses identified that
require improvement and a review of the steps taken to improve the system of
internal controls.

On March 4, 2003, the Commission also entered an Order Instituting
Cease-and-Desist Proceedings, Making Findings and Imposing Cease-and-Desist
Order Pursuant to Section 21C of the Securities and Exchange Act of 1934 as to
Kerry Kirby, File No. 3-11053 (the "Kirby Order"). The Kirby Order made
substantially all of the findings that were made in the Order. In addition, the
Kirby Order found that Kerry Kirby, the chief financial officer of TruServ from
July 1997 to May 1999, in part due to his failure to act on the internal audit
report that TruServ's accounting systems were flawed, was a cause of TruServ's
violations of securities laws requiring the accurate financial reporting,
accurate books and records and adequate internal controls.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

There is no existing market for the common stock of TruServ and there is no
expectation that any market will develop. TruServ's Class A common stock is
owned exclusively by retailers of hardware and related products, garden center
retailers and industrial distributors as well as rental retailers, each of whom
is a member or former member of TruServ and purchased at least 60 shares of
TruServ's Class A common stock (the only class of voting stock) upon becoming a
member. TruServ is organized as a Delaware stock corporation and operates as a
member-owned wholesaler cooperative corporation. The shares of TruServ's Class B
common stock now outstanding were issued to members in partial payment of the
annual patronage dividend that accrued as a result of patronage business
transacted by such members with TruServ. In accordance with TruServ's By-Laws,
the annual patronage dividend is paid to members out of the gross margins from
operations and other patronage source income, after deduction for expenses,
reserves and other provisions authorized by the board of directors.

The number of holders of record as of January 31, 2004 of each class of
stock of TruServ is as follows:

(1) Includes holders of record whose shares have been reclassified from member's
equity to liabilities due to the adoption of Statement of Financial
Accounting Standards No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity." See Note 1,
"Description of Business and Accounting Policies -- New Accounting
Pronouncements," to the Consolidated Financial Statements beginning at page
F-1 for a further discussion of the adoption of this standard.

Dividends (other than patronage dividends) on the Class A common stock and
Class B common stock, subject to the provisions of TruServ's Certificate of
Incorporation, may be declared out of gross margins of TruServ, other than gross
margins from operations with or for members and other patronage source income,
after deduction for expenses, reserves and provisions as may be authorized by
the board of directors. Dividends may be paid in cash, in property, or in shares
of the Class B common stock, subject to the provisions of the Certificate of
Incorporation and the By-Laws. Other than the payment of patronage dividends,
including the redemption of all nonqualified written notices of allocation,
TruServ has not paid dividends on its Class A

15

common stock or Class B common stock. The board of directors does not plan to
pay non-patronage dividends on either class of stock.

In February 2004, the board of directors authorized the payment of a
patronage dividend related to 2003. The patronage dividend will be paid in March
2004. See "Business -- Distribution of Patronage Dividends", and "-- Allocation
of Patronage Dividends Against Loss Allocation Account."

ITEM 6. SELECTED FINANCIAL DATA.
($ IN THOUSANDS)

- ---------------

(1) The Lumber Business was sold on December 29, 2000.

(2) TruServ had for several years, from at least February 1997 through at least
the end of 1999, inadequate internal controls relating to, among other
things, various aspects of inventory management, accounts payable, cost of
goods sold and accounting for certain income and expense items. Principally
as a result of these deficiencies, TruServ reported a loss of $130,803 for
1999. Because the problems identified above were caused by systemic flaws in
internal controls, TruServ does not have information available to confirm
the accuracy of these results or that would cause it to conclude that the
1999 and 1998 financial statements for the 1999 and 1998 years,
respectively, can or should be modified.

On March 4, 2003, the Commission entered the Order following an
investigation by the staff of the Commission of the circumstances that led
to significant financial adjustments resulting in the 1999 loss. Pursuant to
the Order, TruServ will be required to maintain books and records in
accordance with the record keeping requirements of the Exchange Act and to
perform certain other undertakings. See "Legal Proceedings."

(3) No patronage dividends were issued in 2001 or 1999 due to net losses of
$50,687 and $130,803, respectively, which were reported for those years.

(4) The non-current portion of promissory and installment notes payable to
members is included in members' capitalization on the balance sheet for
1999 -- 2002 and in long-term debt for 2003. See Note 1, "Description of
Business and Accounting Policies -- Capitalization" to the Consolidated
Financial Statements beginning at Page F-1 for additional information.

(5) In 2003, Class A common stock and Class B common stock excludes
approximately $18,841 and $82,718, respectively, of amounts not redeemed due
to the stock moratorium. Class B common stock also excludes

16

$33,868 of non-qualified Class B common stock. These amounts are included in
Deferred stock redemptions and Redeemable nonqualified Class B common stock
and are offset by Loss allocation of $27,941, Accumulated deficit of $9,933
and an offset of accounts receivable of $6,821 pursuant to TruServ's
contracts with its members. In 2002, Class A common stock and Class B common
stock include approximately $15,475 and $47,033, respectively, of amounts
not redeemed due to the stock moratorium. In 2001, Class A common stock and
Class B common stock include approximately $11,699 and $34,712,
respectively, of amounts not redeemed due to the stock moratorium. See
"Business -- Moratorium on Redemptions of Capital Stock."

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
($ IN THOUSANDS)

OVERVIEW

TruServ continues to make progress towards completing the turnaround of its
business. Operational, financial and internal control breakdowns during the
integration period following the merger of Cotter & Company and ServiStar Coast
to Coast Corporation on July 1, 1997 culminated in a $130,803 loss in 1999.
Since then, new management has returned TruServ to profitability by reducing
costs significantly, restructuring operations, improving operational
performance, reducing and refinancing its debt, improving internal accounting
controls and changing its corporate culture. These accomplishments, as well as
other management actions, have slowed the rate of membership attrition in the
co-op, which increased after the 1999 loss, and have increased the rate of
member accretion.

TruServ achieved several milestones of the turnaround in 2002 and 2003.
Management restored TruServ to profitability in 2002 by reducing costs,
implementing efficiency initiatives, amending the Senior Debt agreements
(following a 2001 debt default), completing a sale leaseback transaction,
closing two regional distribution centers and significantly reducing excess and
obsolete inventory. All of these initiatives produced cash to reduce Senior
Debt. In 2003, TruServ entered into a new debt agreement that consolidated and
refinanced its third party senior notes and revolving credit facility, reducing
its weighted average interest rate to 4% from the prior rate of 13% and
negotiating cash savings of $21,291 in senior lender obligations. The amount of
$7,706 of this savings related to forgiveness of existing indebtedness and
$13,585 related to negotiating a reduction in refinancing related make-whole
obligations. (The $13,585 is a non-GAAP financial measure. It represents the
difference between the contractual amount of the make-whole obligation in
accordance with the old senior note agreements compared to the amounts
negotiated with the old senior note holders.) In 2003, TruServ settled a
derivative action against it for the benefit of nearly all TruServ members,
reduced pricing to members nearly $10,000, and continued implementing efficiency
initiatives and improving operational profitability.

Management utilizes a variety of key performance measures to monitor the
health and progress of TruServ's business. These measures are store count,
revenue, operational and interest expense reductions and debt reduction.

17

The following is a summary of the trends of the most significant key
performance measures identified above:

STORE COUNT:

(YEAR END STORE COUNT GRAPH)
YEAR END STORE COUNT

2000 8,096
2001 7,196
2002 6,567
2003 6,178

Management begins its analysis of the financial health of TruServ by
measuring the number of stores and the level of patronage from TruServ members.
Management considers that one of the critical elements of a turnaround has been
stabilizing the membership base. As demonstrated on the preceding chart, the
rate of TruServ's net store count decline has tapered off significantly in the
last few years. The net store count decline reflects store gains of 116, 148 and
212 in 2001, 2002 and 2003, respectively. Management is projecting a modest 3%
net decline in overall store count in 2004, assuming general economic conditions
and current competitive conditions remain constant and the continued improvement
of the financial condition of TruServ. Management considers this a modest
decline, as the number of industry-wide independent hardware stores is projected
to decline at about a 1.5% rate for the next several years. With the improvement
in the financial condition of TruServ, management expects new store revenues to
be greater in 2004 than in 2003.

REVENUE:

(REVENUE CHART)

REVENUE ($ IN MILLIONS)

Consistent with the tapering off of the rate of member attrition, the rate
of same store revenue decline has been improving over the last few years. As
demonstrated by the preceding chart, the decline in hardware and paint revenue
decreased from a rate of 13.5% in 2002 to a rate of 7.0% in 2003. Assuming
general economic
18

conditions and current competitive conditions remain constant, management
believes that the decline in revenue has stopped and that TruServ will
experience nearly flat revenue in 2004.

OPERATING AND INTEREST EXPENSES:

(OPERATING AND INTEREST EXPENSES CHART)
OPERATING AND INTEREST EXPENSES
($ IN MILLIONS)

2000 $286
2001 $291
2002 $225
2003 $220

A key component of management's turnaround strategy has been to reduce the
cost structure of TruServ. Management's actions, including restructuring
actions, have focused on reducing the following expenses: logistic and
manufacturing, selling, general and administrative, and interest paid to members
and third parties. In 2003, third party interest expense includes the cost of
$26,927 incurred with the refinancing of the Senior Debt, resulting from the
write-off of the remaining unamortized balance of prepaid bank fees and old and
new senior note make-whole interest costs. In 2000 and 2001, TruServ incurred
sizable restructuring charges mainly in connection with distribution facility
closures and corporate layoffs. These restructuring actions and other corporate
cost reductions have been key to the improved profitability of TruServ.
Management estimates that the interest rate reduction resulting from the
refinancing completed August 29, 2003, together with continuous improvement in
working capital management resulting in lower borrowing levels, and projected
product cost reductions will be the primary drivers of further cost reductions
in 2004.

DEBT:

(YEAR-END DEBT CHART)
TOTAL YEAR-END DEBT INCLUDING MEMBER DEBT
($ IN MILLIONS)

Many of the actions management initiated in 2001 and 2002 in connection
with the turnaround were intended to generate cash to pay down debt. TruServ has
reduced its year-end debt levels by approximately
19

two-thirds in the last three years and anticipates further reduction in the next
several years. Total debt as shown above includes all third party debt and the
current and long-term portions of subordinated member debt. Improved working
capital management, the sale of idle or underutilized assets, the sale leaseback
of seven distribution centers at the end of 2002 and lower payroll costs from
headcount reductions were the primary contributors to TruServ's effort to reduce
debt. The combination of improved operating performance and lower debt levels
allowed TruServ to refinance its third party senior notes and revolving credit
facility and reduce the interest rate on these borrowings from an average
interest rate of 13% to 4%. The interest rate reduction resulting from the
refinancing transaction will be a major contributor to improved profitability in
2004 due to lower interest expense, assuming general economic conditions and
current competitive conditions remain constant.

TruServ's revenues consist of the following:

- Warehouse and relay revenue consists of revenue generated from the sale
of product from the warehouses to the members. The product is either
shipped from stock or relay inventory, and revenue is recognized upon
delivery of the product to the members.

- Vendor direct revenue consists of revenue generated from the sale of
product that is shipped directly from the vendor to the member, and
revenue is recognized upon TruServ's receipt of validated invoice from
the vendor for product delivered to the members.

- Paint revenue consists of revenue generated through the sale of paint and
paint related products to the members, and revenue is recognized upon
delivery of the product to the members.

- Advertising, transportation and other revenue consists of revenue
generated from other services provided to the members. These services
include various forms of advertising, from national advertising to local
direct mail circulars. The advertising revenue is recognized when the
underlying advertisement is run or when the related circulars are
provided to the members. Transportation revenue is recognized when
services are provided to the members.

TruServ's expenses consist of the following:

- Cost of revenue includes the acquisition costs of the products, costs
related to readying the product for sale, net of any purchase discounts
and certain financial incentives received from the vendor, and costs
related to the services provided to the members.

- Logistics (outbound to the members' stores) and manufacturing expenses
(the paint business) include the costs related to the warehousing and
delivery of products to the members and the overhead costs related to the
paint manufacturing facility. These expenses include warehouse and
transportation and manufacturing personnel expenses, depreciation and
lease expense, repair and maintenance expenses and other facility
expenses.

- Selling, general and administrative expenses consist of headquarters and
field personnel expenses and advertising and marketing expenses.

- Restructuring charges consist of expenses incurred as a result of the
closure of distribution centers and workforce reductions.

- Third party interest expenses include interest and related costs for the
respective debt financing owed to parties other than members.

The success of TruServ is dependent upon continued support from its members
in the form of purchases of merchandise and services for their retail and/or
industrial distribution outlets. Significant declines in membership or in the
levels at which members purchase from TruServ, or both; an increase in market
share of the various entities that compete in the hardware industry; and a
decline in the general U.S. economy could have a significant negative effect on
TruServ's profitability.

The following discussion and analysis provides information that management
believes to be relevant to understanding TruServ's financial condition and
results of operations. This discussion should be read in

20

conjunction with TruServ's consolidated financial statements and the related
notes thereto included in this report, beginning at page F-1.

RESULTS OF OPERATIONS FOR 2003 COMPARED TO 2002

TruServ experienced a net decline of its total number of outlets of 5.9% in
2003 and 8.7% in 2002. The decline can be attributed to retailer competition and
members leaving TruServ to find an alternate source of supply principally due to
concerns about TruServ's financial health. TruServ's improved financial
stability with the new financing in place, its ability to lower prices
(reversing a substantial portion, to date, of the price increases put in place
in 2001, its improved profitability and its enhancement and introduction of
marketing programs have served to slow member attrition, increase member
accretion and slow the reduction of market share of members' purchases. Further,
members are buying more merchandise from the distribution centers resulting in a
favorable mix of higher margin warehouse sales and fewer low margin direct
sales. The price reductions, which commenced in October 2002 and continue
incrementally in 2003, have resulted in a net decline in revenue and gross
margin, but have been of benefit to the members.

During 2003, TruServ was successful in completing a refinancing of the
existing senior credit facility and senior notes with a four-year revolving
credit facility. The new Bank Facility resulted in a substantial reduction in
interest expense as a result of a lower interest rate from September 2003
through December 2003. TruServ believes the new Bank Facility will continue to
provide interest savings of approximately $15,400 in 2004, based upon the
expected borrowing levels and assuming market rates (i.e., London Interbank
Offering Rate ("LIBOR")) remain in relatively the same range as they were in
2003. (The $15,400 of interest expense savings is a non-GAAP financial measure.
It is management's estimate, based on projected borrowing levels in 2004, of the
interest savings generated from the lower interest rate of 4% on the new Bank
Facility compared to the 13% average rate on the old lending agreements.)

21

REVENUES AND GROSS MARGIN

A reconciliation of revenue and gross margin between 2003 and 2002 follows:

Net revenue for the year ended December 31, 2003 totaled $2,024,340, a
decrease of $151,111, or 6.9%, as compared to the same period last year. The
overall decline in revenue was predominately due to a decline in the number of
participating member retail outlets. TruServ had a net decline in the number of
participating member outlets of 5.9% compared to the prior year that resulted in
a revenue reduction of $94,013, or 4.3%. Same store sales declined $40,076, or
1.8%, as compared to the prior year, due to TruServ members shifting some of
their merchandise purchases to other sources and the effect of a slow economy
through the first three quarters. A contributing factor in the decline of
revenue in same store sales and participating member outlets was a product price
reduction that lowered revenue by approximately $9,884, as compared to the prior
year. Advertising, transportation and other revenue declined $17,022, or 0.8%,
primarily due to lower advertising dollars as a result of TruServ experiencing
lower merchandise sales on which the advertising amount is calculated and due
from members. Also, the adoption of the accounting rule EITF Issue No. 02-16
(See Note 1, "Description of Business and Accounting Policies -- New Accounting
Pronouncements," to the Consolidated Financial Statements beginning at page F-1
for a further discussion of the adoption of this standard) had an impact of
reducing revenue by $4,284. Further, reduced volume shipments to members reduced
freight revenue from members by $3,049.

Gross margin for the year ended December 31, 2003 decreased by $26,741, or
10.8%, over the prior year. The net decline in participating member outlets
contributed $13,374 of the reduction in gross margin. Gross

22

margin from same store sales was impaired by $1,643. A contributing factor in
the decline of gross margin in same store sales and participating member retail
outlets was a product price reduction that lowered gross margin by approximately
$9,884, as compared to the prior year. The product price reduction was partially
offset by lower product acquisition costs from both domestic and global
suppliers.

Advertising, transportation and other gross margin increased $1,641, as a
result of advertising costs being reduced by an amount greater than the related
revenue reduction. Indirect costs of revenue, which is comprised of freight-in,
vendor rebates, cash discounts and other costs incurred to prepare goods for
resale, negatively impacted gross margin by $13,365, as compared to the same
period last year. This negative impact was due to an increase in freight costs
and lower discounts and rebates associated with the global sourcing of product
and lower purchasing volume.

Logistics and manufacturing expenses decreased by $6,433, or 9.3%, as
compared to the prior year. TruServ experienced a decrease in expense due to
lower operating costs resulting from the closure of two distribution centers
during 2002, together with increased labor productivity resulting from ongoing
process changes. In 2001, TruServ had implemented a distribution center closure
plan in response to a reduction in the member base. These savings, which started
to be recognized in 2002, were partially offset in 2003 by increased rent
expense of $14,442, net of reduced depreciation expense of $1,814 and gain
amortization of $2,646, as a result of a sale leaseback transaction, which
occurred on December 31, 2002. See "Interest expense" below for a discussion of
the related impact from the sale leaseback transaction.

Selling, general and administrative ("SG&A") expenses increased $6,573, or
7.1%, as compared to the prior year. The increase in SG&A expenses was due
mainly to higher health care cost, which reflects the upward trends in health
care self insurance cost in the year compared to the same period last year. Also
professional fees, which relate to higher litigation costs as well as
professional outside services work related to Sarbanes-Oxley preparations were
unfavorable compared to the prior year.

Interest expense to members decreased by $812, or 12.3%, as compared to the
prior year, due to a lower average principal balance of debt outstanding,
partially offset by a higher average interest rate. The 8.3% interest rate that
TruServ offered to members to renew their maturing subordinated debt for an
additional three years was higher than the 7.9% average coupon rate of their
maturing debt.

Third party interest expense decreased $3,560, or 6.4%, as compared to the
same period last year. On August 29, 2003, TruServ completed the refinancing of
the Senior Debt resulting in the write-off of the remaining unamortized balance
of prepaid bank fees and old and new senior note make-whole interest costs
totaling $26,927. See "Other income, net" below for related debt forgiveness. In
addition, the amortization of make-whole costs incurred by the early pay down of
debt from the asset sales that occurred in the second half of 2002 are included
in interest expense. These write-offs and increased amortization were offset by
lower interest costs of approximately $30,486 as a result of lower average
principal balance of senior debt outstanding, as compared to the prior year, and
lower interest rates on the new Bank Facility. TruServ achieved the lower
average principal balance by generating cash from operations and asset sales,
which includes the sale leaseback of seven facilities at December 31, 2002.

23

Other income, net increased by $18,586, as compared to the same period last
year. This increase in other income included $7,706 of debt forgiveness from the
refinancing of the Senior Debt. Additionally, TruServ recognized $7,133 of
income from deferred credits related to the termination in April 2003 of the
non-compete, cooperation and trademark license agreements that were part of the
sale of the Lumber Business to BMA in 2000. These agreements with BMA had terms
ranging from five to ten years and the related amounts received for these
agreements were being amortized over those terms. Also, TruServ recorded income
from litigation settlements of $5,538. The Derivative Action Settlement requires
on the effective date of lifting the moratorium that TruServ reduce the loss
allocation accounts for all current and former members who are parties to the
Stipulation of Settlement by approximately $5,000. TruServ's board of directors
is considering whether to continue the moratorium and has informed its members
that a decision whether to maintain or lift the moratorium will be made prior to
and announced at the March 28, 2004 annual shareholders' meeting. The income of
$3,000 relates to the receipt of insurance proceeds in 2003 to fund a portion of
this adjustment between the loss allocation account and retained deficit. The
remaining $2,538 of income relates to settlement of a dispute with vendors.

The net margin of $21,221 was up from a net margin of $21,153 for the same
period a year ago. TruServ maintained its net margin in light of a $151,111
revenue reduction including $9,884 in wholesale price reductions. The adverse
effect of revenue reductions on gross margin due to the wholesale price
reductions and lower volume were offset by expense reductions from logistic and
manufacturing efficiencies, other productivity improvements and the net effect
of the sale leaseback transaction. Further, net margin was impacted by the net
cost of $11,531 from refinancing the Senior Debt. This amount, however, was
offset by the gain of $7,133 from the termination of the long-term BMA
agreements and gains from litigation settlements in the aggregate amount of
$5,538.

RESULTS OF OPERATIONS FOR 2002 COMPARED TO 2001

TruServ has experienced a net decline of its total number of outlets of
8.7% in 2002 and 11.1% in 2001. The decline can be attributed to retailer
competition and members leaving TruServ to find an alternate source of supply
principally out of concerns about TruServ's financial stability. TruServ is
regaining financial stability and is starting to lower prices to members on
select items and implementing certain marketing programs and sales initiatives.
Management believes that as a result of these programs and initiatives,
retention of members is continuing to improve and members are buying more
merchandise from the distribution centers and in a favorable mix of higher
margin warehouse sales and less low margin direct sales. The price reductions,
which commenced in October 2002, have resulted in a net decline in revenue and
gross margin during the fourth quarter, but have been of benefit to the members.

At the close of 2002, TruServ was successful in completing a sale leaseback
of seven of its distribution centers and applying the proceeds to pay down the
Senior Debt.

24

REVENUES AND GROSS MARGIN

A reconciliation of revenue and gross margin between 2002 and 2001 follows:

- ---------------

(1) The Lumber Business was sold on December 29, 2000. The revenue and the cost
of revenue from merchandise shipped and billed in 2001, but negotiated prior
to December 29, 2000, were recorded in TruServ's results of operations in
2001.

(2) The Canadian Business was sold on October 22, 2001. The amount of $84,397 in
revenue reduction represents sales from the Canadian Business from January
1, 2001 through October 22, 2001, the date of sale of the Canadian Business.

Revenues for 2002 totaled $2,175,451. This represented a decrease in
revenues of $443,983, or 16.9%, from 2001. A key contributor to the decrease in
revenue was a 8.7% net decline in the number of participating member retail
outlets in 2002, representing a 7.9% revenue reduction. Additional contributors
to the decrease in revenue were a 4.6% decline in same store sales and the
effect of the sale of the Canadian and Lumber businesses, representing a 4.0%
revenue reduction. TruServ increased prices in September 2001. The direct impact
of these price increases on 2002 member purchases was $13,340. In October 2002,
TruServ announced it would commence lowering prices monthly in 2002 and continue
price reductions into 2003. The direct impact of the reduction in pricing on
fourth quarter 2002 sales to members was a $1,100 reduction. A

25

favorable trend that TruServ management has observed is that as a result of
marketing programs and sales initiatives, together with the impact of a
slow-down in the national economy, members are buying more merchandise from the
distribution centers. This trend has favorably improved the sales mix toward
more warehouse sales from the less profitable direct sales and has minimally
affected revenues, as the lower volume has been offset by higher prices
positively impacting gross margin.

Gross margin for 2002 totaled $248,632. This represented a decrease in
gross margin dollars of $25,343, or 9.3%, as compared to 2001. The sale of the
Canadian Business and the decline in the number of participating member retail
outlets are the key contributors to the negative variance relative to the prior
year. However, the gross margin as a percent of revenue increased to 11.4% in
2002 from 10.5% for 2001. The shift in the sales mix to warehouse sales from
vendor direct orders and certain product price increases initiated in September
2001 contributed to the increase in gross margin as a percent of revenue. Price
reductions commenced in October 2002. The indirect cost of revenues favorably
impacted the gross margin dollars as a result of distribution center closures
and headcount reduction, which reduced the direct inbound logistics costs and
labor and related overhead incurred to bring merchandise to the distribution
centers. Additional impact to gross margin was due to a reduction in advertising
support fees of $7,956, which was partially offset by a reduction in gross
advertising costs of $2,868. These reductions reflect lower member participation
in the distribution of direct mail circulars, but these costs were partially
offset by additional expenditures for network advertising for the new power
event promotions.

Logistics (outbound to members' stores) and manufacturing (the paint
business) expenses decreased $20,173, or 22.5%, as compared to the prior year.
Approximately $11,223 of this decrease resulted from the exclusion of expenses
associated with the Canadian Business, which was sold in October 2001. An
additional $3,444 was due to the closure of several distribution centers in late
2001 through 2002, in response to a reduction in the member base. Also, a
decrease of approximately $4,388 was caused by lower expense spending related to
the manufacturing operations, predominately related to lower advertising.

Selling, general and administrative expenses ("SG&A") decreased by $44,598,
or 32.4%, in 2002, as compared to the prior year. TruServ achieved significant
reductions in SG&A as a result of lower labor costs and reduced benefit
expenses. TruServ's restructuring initiatives in 2000 and 2001, which included
headcount reductions, generated a savings of $4,090 in labor costs. The $15,126
reduction in benefit plan costs were generated from lower headcount, changes in
the benefits, a reduction in pension settlements with terminated employees, and
the elimination in 2002 of a requirement that existed in 2001 to cover exposure
of an insurance carrier in liquidation. An additional reduction of $6,041 in
SG&A expenses for 2002, as compared to 2001, is the result of lower bad debt
expense due to TruServ's improved ability to collect receivables. Also in 2002,
TruServ adopted Statement of Financial Accounting Standards ("SFAS") No. 142,
"Goodwill and Other Intangible Assets," which changed the accounting for
goodwill from an amortization method to an impairment only approach. Goodwill
amortization for 2001 was $2,577. Other areas of reductions in SG&A include
lower refinancing fees of $7,368, lower software license fees of $2,483 relating
to retail point of sale software and lower non-restructuring related severance
of $1,386.

In 2002, TruServ incurred restructuring charges and other related expenses
of $6,284, of which $3,313 related to restructuring, and $2,971 related to other
post-employment and asset impairment charges. The restructuring charge of $3,313
in 2002 resulted from TruServ's continued workforce reductions initiated in 2000
and 2001 and related to distribution center closures and workforce reductions in
the organization. This
26

charge was comprised of $2,316 for severance and $2,296 for facility exit costs,
offset by a $1,299 reduction in asset impairment charges. The severance charges
of $2,316 primarily consisted of additional workforce reductions at the
corporate headquarters in Chicago, Illinois. The facility exit costs of $2,296
related to closing the Hagerstown, Maryland distribution center, which was
completed prior to December 31, 2002. The $1,299 reduction of asset impairment
charges consisted of a $927 favorable adjustment to the asset value for the
closing of the Brookings, South Dakota distribution center, based on actual
proceeds received on the sale of this facility in 2002. The other charges of
$2,971 consisted of $1,769 for asset impairment and $1,202 for post-employment
charges. The asset impairment charge of $1,769 related to the write-down of the
East Butler, Pennsylvania facility. The post-employment charge of $1,202 was
comprised of $352 relating to severance charges for the Cary, Illinois facility,
and $850 relating to severance charges for the corporate headquarters in
Chicago, Illinois.

In 2001, TruServ recorded a charge to income of $38,522, of which $10,722
was for severance, $18,901 was for facility exit costs for the distribution
centers, and $8,899 was for asset impairments. The largest component of these
exit costs related to the Hagerstown, Maryland distribution center closure,
which is subject to a synthetic lease. The difference of approximately $14,800
between the lease obligation at December 31, 2001 of $40,000 and management's
estimate of the fair value of the building was the major component of its
facility exit costs in 2001. This obligation and the original cost of the
facility are not recorded on TruServ's balance sheet because it does not meet
the requirement for capital lease treatment under SFAS No. 13, "Accounting for
Leases." At December 31, 2002, the synthetic lease had a balance of $33,383,
which is due at the end of the amended lease term, which is the earlier of
December 31, 2003 or the termination of the existing revolving credit facility.

As a result of management's effort in restructuring and accomplishing
operating efficiencies, TruServ achieved an estimated annualized cost saving of
$28,957, relating to charges reserved through 2001, with $4,350 of cost saving
relating to additional reserve charges in 2002. Headcount reductions of 909 were
related to charges reserved through 2001, with additional headcount reductions
of 80 related to charges reserved for in 2002.