Boise Cascade Office Products
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1. Organization and Basis of Presentation Boise Cascade Office Products Corporation (together with its subsidiaries, the "Company" or "we"), headquartered in Itasca, Illinois, is a distributor of products for the office through its contract stationer and direct marketing channels. The Company was incorporated on January 3, 1995, and until April 13, 1995, was a wholly-owned subsidiary of Boise Cascade Corporation ("BCC"). The Company consists of the former Boise Cascade Office Products Distribution Division (the "Division") whose assets (including the stock of two wholly-owned subsidiaries of BCC but excluding certain accounts receivable) and liabilities (see Note 6) were transferred to the Company (the "Transfer of Assets") effective April 1, 1995 (the "Transfer Date"), and subsequent acquisitions made by the Company. The accompanying historical financial statements include the financial position and results of operations of the Division prior to the Transfer Date. BCC's net investment in the Company prior to the Transfer Date, including net cash transfers of the Division, has been reflected in "Additional paid-in capital" in the financial statements. Results of operations of the Company prior to 1995 are also included in "Additional paid-in capital." All significant intercompany transactions have been eliminated. These financial statements may not necessarily be representative of results that would have been attained if the above entities had operated within a separate consolidated entity. The following table summarizes the results of our foreign operations: 
 We did not have any significant foreign operations prior to 1996. Export sales to foreign unaffiliated customers are immaterial. No single customer accounts for 10% or more of net sales. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. 2. Summary of Significant Accounting PoliciesCASH AND cash equivalents Cash and cash equivalents include time deposits and highly liquid investments with original maturities of three months or less. INVENTORIES Inventories consist of finished goods and are valued at the lower of cost or market, with cost based on an approximation of the first-in, first-out valuation method. CATALOGS Costs of producing and distributing sales catalogs are capitalized and charged to expense in the periods in which the related sales occur. PROPERTY Property and equipment are recorded at cost. Cost consists of expenditures for major improvements and replacements including interest cost associated with capital additions. No interest was capitalized in 1997, 1996, or 1995. Depreciation is computed using the straight-line method. Gains and losses from sales and retirements are included in income as they occur. Estimated service lives of principal items of property and equipment range from 3 to 40 years. DEFERRED SOFTWARE COSTS We defer certain software costs that benefit future years. These costs are amortized on the straight-line method over a maximum of five years or the expected life of the product, whichever is less. "Other assets" in the Balance Sheets include deferred software costs of $17,511,000 and $9,420,000 at December 31, 1997 and 1996. Amortization of deferred software costs totaled $3,596,000, $1,685,000, and $907,000 in 1997, 1996, and 1995 and is included in "Selling and warehouse operating expense." REVENUE RECOGNITION Revenues are recorded at the time of shipment of products or performance of services. COST OF SALES Cost of sales related to merchandise inventory is primarily determined using estimated product costs and adjusted to actual at the time of physical inventories, which are taken at all locations at least annually. Additional adjustments to reflect actual experience are recognized as appropriate throughout the year. Cost of sales also includes delivery and occupancy expenses. EARNINGS PER SHARE In May 1996, we effected a two-for-one split of our common stock in the form of a 100% stock dividend. Each shareholder of record at the close of business on May 6, 1996, received one additional share for each share held on that date. The new shares were distributed on May 20, 1996. All references in these financial statements and notes to share amounts, earnings per share, average shares outstanding, and common stock prices have been adjusted to reflect the stock split. Basic and diluted earnings per share were calculated as follows: 
Basic earnings per share for the years ended December 31, 1997 and 1996, were computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share for the years ended December 31, 1997 and 1996, include the weighted average impact of stock options assumed exercised using the treasury method. Basic and diluted earnings per share for the year ended December 31, 1995, has been presented assuming the 50,750,000 common shares issued to BCC and the 10,637,500 common shares issued in the Offerings (see Note 6) had taken place on January 1, 1995. In 1997, we adopted Statement of Financial Accounting Standards No. 128, "Earnings Per Share." The only impact of the adoption was to reduce EPS for 1996 by $.01. GOODWILL Costs in excess of values assigned to the underlying net assets of acquired companies are being amortized on the straight-line method over 40 years. Annually, we review the recoverability of goodwill. The measurement of possible impairment is based primarily on the ability to recover the balance of the goodwill from expected future operating cash flows of the businesses acquired on an undiscounted basis. In management's opinion, no material impairment exists at December 31, 1997. FOREIGN CURRENCY TRANSLATION Local currencies are considered the functional currencies for our operations outside the United States. Assets and liabilities are translated into U.S. dollars at the rate of exchange in effect at the balance sheet date. Revenues and expenses are translated into U.S. dollars at average monthly exchange rates prevailing during the year. Resulting translation adjustments are reflected in Shareholders' equity. As a result of these translation adjustments, "Retained earnings" were decreased by $8,135,000 at December 31, 1997, and increased by $1,520,000 at December 31, 1996. PRE-OPENING COSTS Costs associated with opening new locations are expensed as incurred. FINANCIAL INSTRUMENTS The recorded value of our financial instruments, which include accounts receivable, accounts payable, and debt approximates market value. In the opinion of management, we do not have any significant concentration of credit risks. Concentration of credit risks with respect to trade receivables is limited due to the wide variety of customers and channels to and through which our products are sold, as well as their dispersion across many geographic areas. We have only limited involvement with derivative financial instruments and do not use them for trading purposes. Financial instruments such as interest rate swaps, rate hedge agreements, and forward exchange contracts may be used periodically to manage well-defined risks. Interest swaps and rate hedge agreements are used to hedge underlying debt obligations or anticipated transactions. For qualifying hedges, the interest rate differential is reflected as an adjustment to interest expense over the life of the swaps or underlying debt. Gains and losses related to qualifying hedges of foreign currency firm commitments and anticipated transactions are deferred and are recognized in income or as adjustments of carrying amounts when the hedged transaction occurs. All other forward exchange contracts are marked-to-market, and unrealized gains and losses are included in current period net income. NEW ACCOUNTING STANDARDS In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." This Statement establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. We will adopt this Statement in the first quarter of 1998. Also issued was Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information." This Statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. We are still evaluating what impact, if any, this Statement will have on us. We will adopt this Statement at year-end 1998. Adoption of these Statements will have no impact on net income. 3. Income TaxesWe account for income taxes in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires that deferred taxes be provided on temporary differences between the book and tax bases of assets and liabilities. In addition, the Statement requires adjustment of deferred tax liabilities to reflect enacted changes in statutory income tax rates. Income taxes are provided based on a calculation of the income tax expense that would be incurred if we operated as an independent entity. However, as long as BCC owns at least 80% of our outstanding common stock, we will be included in the consolidated federal income tax return of the BCC affiliated group. Accordingly, the Company and BCC have entered into a tax matters agreement whereby we remit to BCC amounts representing the current tax liability that we would incur if we were an independent taxpayer. Pursuant to this agreement, we paid BCC $40,610,000 in 1997 and $37,633,000 in 1996. In 1995, we paid BCC $20,453,000, representing current tax liabilities incurred after the Transfer Date. The amount for the period before the Transfer Date was included in "Net equity transactions with Boise Cascade Corporation" and was $6,550,000. 
At December 31, 1997, our foreign subsidiaries had approximately $30,508,000 of undistributed earnings which are intended to be indefinitely reinvested. If these earnings were distributed, foreign tax credits should become available under current law to reduce or eliminate the resulting U.S. income tax liability. 
4. Debt In addition to borrowings under the revolving credit agreement and short-term notes payable, debt related to acquisitions was $20,500,000 at December 31, 1997. The scheduled payments of long-term debt, excluding our revolving credit agreement, are $2,905,000 in 1998, $1,905,000 in 1999, $1,905,000 in 2000, $714,000 in 2001, and $12,741,000 in 2002. In December 1997, we entered into agreements to hedge against a rise in Treasury rates. We entered into the transactions in anticipation of our issuance of debt securities in the first half of 1998. The hedge agreements have a notional amount of $70,000,000 and will be settled in late March 1998. If the settlement rate, based on the yield on 10-year U.S. Treasury bonds, is greater than the agreed upon initial rate, we will receive a cash payment. If the difference is less, we will make a cash payment. The amount paid or received will be recognized as an adjustment to interest expense over the life of the debt securities to be issued. The settlement amount of $259,000 as of December 31, 1997, was recorded as a deferred loss.
5. Transactions with Boise Cascade Corporation A summarization of net equity transactions by type is as follows:
In conjunction with the Offerings (see Note 6), the Company and BCC have entered into intercompany agreements under which BCC, among other things, provides to us certain administrative support functions, certain paper and paper products under a long-term sales agreement, and use (without charge) of the trade names and trademark of BCC. Under the Administrative Services Agreement ("Admin Agreement"), BCC provides various services to us that had been previously performed by BCC for the Division. The services will be provided for varying periods, from one to five years, as identified in the Admin Agreement, subject to renewal or termination in accordance with the terms of that agreement. We will pay for each of these services at rates set forth in the agreement. These rates are generally consistent with amounts that have been charged by BCC in the past. Prior to the Admin Agreement, the costs of similar services were allocated to us by BCC based on estimations of BCC's costs for these services. For the years ended December 31, 1997, 1996, and 1995, charged or allocated costs amounted to $2,578,000, $2,362,000, and $2,382,000 and have been included in "Corporate general and administrative expense" in the Statements of Income. Under the Paper Sales Agreement, we agreed to purchase, and BCC agreed to sell, subject to certain exceptions, all of our cut-size paper requirements. The price we pay is based upon a formula meant to approximate prevailing market prices for the paper. The agreement has an initial term of 20 years, and will be automatically renewed for five-year periods thereafter, subject to certain conditions. We supplied office products to BCC and purchased certain paper and paper products from BCC. During the year ended December 31, 1997, our sales to BCC were $1,589,000, and our purchases from BCC were $231,188,000. Sales and purchases during the same period of 1996 were $2,047,000 and $192,837,000 and in 1995 were $2,046,000 and $164,417,000. We are included as a participating employer in certain broad-based employee benefit plans sponsored by BCC which cover our work force. Most assets and liabilities under BCC's employee benefit plans for retirement and postretirement costs arising out of service with the Company were not transferred to us by BCC. Accordingly, no significant assets or liabilities related to retirement and postretirement benefits are included in these financial statements. During each of the years presented, most of our employees participated in a defined benefit pension plan sponsored by BCC. In addition, certain of our employees were eligible for participation in defined contribution plans sponsored by BCC. The Statements of Income for the years ended December 31, 1997, 1996, and 1995, include expenses of $7,995,000, $6,079,000, and $4,159,000 attributable to participation by our employees in these plans. Postretirement expenses attributable to participation in BCC's postretirement plans included in the Statements of Income totaled $88,000, $92,000, and $140,000 for the years ended December 31, 1997, 1996, and 1995.
6. Shareholders' Equity On April 13, 1995, we completed the sale of 10,637,500 shares of common stock at a price of $12.50 per share in an initial public offering in the United States and in a concurrent international offering (the "Offerings"). After the Offerings, BCC owned 82.7% of our outstanding common stock. The net proceeds to the Company were approximately $123,076,000. A total of $100,000,000 of the net proceeds were used by the Company to replace the working capital retained by BCC in the Transfer of Assets. Of the remaining proceeds, we retained $21,217,000 for general corporate purposes, and $1,859,000 was paid as a dividend to BCC. On June 17, 1996, we filed a registration statement with the Securities and Exchange Commission covering approximately 4,400,000 shares of common stock to be offered by the Company from time to time in connection with acquisitions. As of December 31, 1997, we had 3,489,000 unissued shares remaining under this registration statement. On September 25, 1997, we issued 2,250,000 shares of common stock to BCC at the price of $21.55 per share for proceeds of approximately $48,500,000. At December 31, 1997, BCC owned 81.4% of our outstanding common stock.
7. Accounting for Stock-based Compensation If we had determined compensation cost for these plans consistent with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," 1997 net income would have been reduced pro forma by $2,464,000, and earnings per share would have been reduced pro forma by $.04. Our 1996 net income would have been reduced pro forma by $2,064,000, and earnings per share would have been reduced pro forma by $.03. Our 1995 net income would have been reduced pro forma by $914,000 and earnings per share would have been reduced pro forma by $.01. The pro forma compensation cost may not be representative of that to be expected in future years. The KESOP provides for the granting of options to purchase shares of our common stock to key employees of the Company. The exercise price of the options is equal to the fair market value of our common stock on the date the options are granted. The options are vested upon grant; however, except under unusual circumstances, only one-third of the options become exercisable in each of the three years following the grant date. The options expire, at the latest, 10 years after the grant date. As of December 31, 1997, a total of 3,000,000 shares of our common stock was authorized for issuance under the KESOP. A summary of the status of the KESOP at December 31, 1997, 1996, and 1995, and changes during the years then ended is presented in the table and narrative below. 
The 1,490,139 options outstanding at December 31, 1997, have exercise prices between $12.50 and $26.63 and a weighted average remaining contractual life of nine years. Beginning in 1995, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model, with the following weighted average assumptions used for grants in 1997, 1996, and 1995: risk-free interest rates of 6.1%, 5.2%, and 7.3%; no expected dividends; expected lives of 4.2 years for all years; and expected stock price volatility of 35% for all years. The DSOP, available only to our nonemployee directors, provides for annual grants of options. The exercise price of options under this plan is equal to the fair market value of our common stock on the date the options are granted. The options are vested upon grant, and except under unusual circumstances may not be exercised until one year following the date of grant, and expire the earlier of three years after the director ceases to be a director or 10 years after the grant date. Total shares outstanding at December 31, 1997, 1996, and 1995, were 39,000, 24,000, and 12,000 with weighted average exercise prices of $18.58, $17.50, and $12.50. As of December 31, 1997, a total of 150,000 shares of our common stock was authorized for issuance under the DSOP.
8. Leases We have various operating leases with remaining terms of more than one year. These leases have minimum lease payment requirements, net of sublease rentals, of $16,692,000 for 1998, $9,284,000 for 1999, $6,526,000 for 2000, $5,072,000 for 2001, and $3,301,000 for 2002, with total payments thereafter of $13,506,000. Substantially all lease agreements have fixed payment terms based upon the lapse of time. Certain lease agreements provide us with the option to purchase the leased property. In addition, certain lease agreements contain renewal options exercisable by the Company ranging up to 15 years, with fixed payment terms similar to those in the original lease agreements. We also lease certain equipment and buildings under capital leases; aggregate obligations under capital leases were not material at December 31, 1997 and 1996.
9. Acquisitions We acquired eight businesses and entered into a joint venture during 1997, 19 businesses during 1996, and 10 businesses during 1995. Amounts paid, acquisition liabilities recorded, debt assumed, and stock issued for these transactions were as follows: 
The 1997 amounts include the acquisition of 100% of the shares of Jean-Paul Guisset S.A. ("JPG") for approximately FF850,000,000 (US$144,000,000) plus a price supplement payable in the year 2000, if certain earnings and sales growth targets are reached. If 1997 results are duplicated in 1998 and 1999, the price supplement to be paid would be approximately US$16,000,000. No liability has been recorded for the price supplement as the amount of payment, if any, is not assured beyond a reasonable doubt. Approximately FF128,500,000 (US$20,500,000) was repatriated to us from JPG during the third quarter of 1997. In addition to the cash paid, we recorded approximately US$5,800,000 of acquisition liabilities and assumed US$10,100,000 million of long-term debt. JPG is a direct marketer of office products in France. Also included in the 1997 amounts is the purchase of the promotional products business of OstermanAPI, Inc., based in Maumee, Ohio. In conjunction with the acquisition of Osterman, we formed a majority-owned subsidiary, Boise Marketing Services, Inc. ("BMSI"), of which we own 88%. Our previously acquired promotional products company, OWNCO, also became part of BMSI. The 1996 amounts include the acquisition of 100% of the shares of Grand & Toy Limited ("Grand & Toy") from Cara Operations Limited (Toronto) for approximately C$140,000,000 (US$102,084,000). In addition, we recorded acquisition liabilities of approximately US$9,907,000. Grand & Toy owns and operates office products distribution centers and approximately 70 retail stores across Canada. The 1995 amounts include $21,747,000 of cash paid; the issuance of 431,352 shares of common stock and the equivalent of 434,390 shares of common stock in a stock note, payable by issuing the shares at the end of two years; and the recording of $2,999,000 of acquisition liabilities. These were part of the purchase of the net assets of office supply and computer distribution businesses in New York and Missouri. In 1997, we issued 427,630 shares to satisfy the stock note and a portion of the acquisition liabilities related to these acquisitions. Unaudited pro forma results of operations reflecting the acquisitions would have been as follows. If the 1997 acquisitions had occurred January 1, 1997, sales for the year ended December 31, 1997, would have increased to $2,749,000,000, net income would have decreased to $56,387,000, and earnings per share would have decreased to $.88. If the 1997 and 1996 acquisitions had occurred January 1, 1996, sales for the year ended December 31, 1996, would have increased to $2,403,000,000, net income would have increased to $56,780,000, and earnings per share would have increased to $.90. If the 1996 and 1995 acquisitions had occurred January 1, 1995, sales for the year ended December 31, 1995, would have increased to $1,895,000,000, net income would have decreased to $43,082,000, and earnings per share would have decreased to $.69. Prior to its acquisition by the Company, Grand & Toy recorded a restructuring charge. Excluding the impact of this charge, our pro forma net income for the year ended December 31, 1995, would have been $45,624,000, and earnings per share would have been $.73. This unaudited pro forma financial information does not necessarily represent the actual results of operations that would have occurred if the acquisitions had taken place on the dates assumed. In January 1997, we formed a joint venture with Otto Versand ("Otto"), of which we own 50%, to direct market office products in Europe, initially in Germany. In December 1997, Otto purchased a 10% interest in JPG for approximately FF72,200,000 (US$13,000,000). Additionally, Otto has the option to purchase an additional 40% interest in JPG, for a total of 50%. The option may be excercised at any time between December 15, 1998, and January 15, 1999. If Otto elects not to exercise the option, we will re-acquire the 10% interest from Otto. As a result of our acquisition activity, we had short-term acquisition liabilities of $14,642,000 and $21,538,000 at December 31, 1997 and 1996, which were included in "Other current liabilities." Additionally, we had long-term acquisition liabilities of $15,869,000 and $15,192,000 at December 31, 1997 and 1996, which were included in "Other long-term liabilities."
10. Litigation and Legal Matters 
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