Financials ACE HARDWARE 2011 ANNUAL REPORT

Transcription

1 Financials ACE HARDWARE 2011 ANNUAL REPORT

2 ACE HARDWARE CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Auditors Consolidated Balance Sheets as of December 31, 2011 and January 1, 2011 Consolidated Statements of Income for the years ended December 31, 2011, January 1, 2011 and January 2, 2010 Consolidated Statements of Equity for the years ended December 31, 2011, January 1, 2011 and January 2, 2010 Consolidated Statements of Cash Flows for the years ended December 31, 2011, January 1, 2011 and January 2, 2010 Notes to the Consolidated Financial Statements 21 Management s Discussion and Analysis of Financial Condition and Results of Operations Five-Year Summary of Earnings and Distributions Management s Responsibility for Financial Statements

3 REPORT OF INDEPENDENT AUDITORS The Board of Directors of Ace Hardware Corporation We have audited the accompanying consolidated balance sheets of Ace Hardware Corporation as of December 31, 2011 and January 1, 2011, and the related consolidated statements of income, equity, and cash flows for each of the three fiscal years in the period ended December 31, These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ace Hardware Corporation at December 31, 2011 and January 1, 2011, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 31, 2011 in conformity with U.S. generally accepted accounting principles. Chicago, Illinois February 9, 2012 ACE Financials

4 ACE HARDWARE CORPORATION CONSOLIDATED BALANCE SHEETS Assets December 31, 2011 January 1, 2011 (In thousands, except share data) Cash and cash equivalents... $15,817 $9,357 Marketable securities... 50,980 49,358 Receivables, net of allowance for doubtful accounts of $9,836 and $10,369, respectively , ,349 Inventories , ,785 Prepaid expenses and other current assets... 28,230 28,612 Total current assets , ,461 Property and equipment, net , ,195 Notes receivable, net of allowance for doubtful accounts of $12,126 and $12,051 respectively... 41,206 43,892 Other assets... 59,843 59,083 Total assets... $1,346,024 $1,316,631 Liabilities and Equity Current maturities of long-term debt... $5,835 $4,441 Short-term borrowings ,500 Accounts payable , ,609 Patronage distributions payable in cash... 30,433 28,514 Patronage refund certificates payable... 17,259 17,054 Accrued expenses , ,956 Total current liabilities , ,074 Long-term debt , ,617 Patronage refund certificates payable... 15,798 25,609 Other long-term liabilities... 51,344 49,993 Total liabilities... $998,287 $988,293 ACE Financials Member Retailers Equity Class A voting common stock, $1,000 par value, 10,000 shares authorized, 2,758 and 2,857 issued and outstanding, respectively... 2,758 2,857 Class C nonvoting common stock, $100 par value, 4,000,000 shares authorized, 2,982,828 and 3,059,006 issued and outstanding, respectively , ,901 Class C nonvoting common stock, $100 par value, issuable to retailers for patronage distributions, 246,727 and 223,805 shares issuable, respectively... 24,673 22,380 Additional stock subscribed, net Contributed capital... 20,888 6,986 Variance allocation... (484) (1,687) Accumulated deficit... (6,184) (9,410) Accumulated other comprehensive income Equity attributable to Ace member retailers , ,338 Equity attributable to noncontrolling interests... 7,763 - Total equity... $347,737 $328,338 Total liabilities and equity... $1,346,024 $1,316,631 See accompanying notes to the consolidated financial statements.

5 ACE HARDWARE CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2011 January 1, 2011 January 2, 2010 (52 Weeks) (52 Weeks) (52 Weeks) (In thousands) Revenues... $3,709,203 $3,530,731 $3,457,182 Cost of revenues... 3,261,869 3,086,418 3,009,599 Gross profit , , ,583 Distribution operations expenses... 95,152 87,263 91,030 Selling, general and administrative expenses , , ,642 Retail success and development expenses , , ,169 Total operating expenses , , ,841 Operating income , , ,742 Interest expense... (36,415) (35,199) (35,397) Loss on early extinguishment of debt... (62) - (85) Interest income... 5,054 5,151 4,183 Other income, net... 7,625 4,809 3,531 Income tax expense... (3,122) (2,963) (4,247) Net income... 77,926 75,105 95,727 Less: net income attributable to noncontrolling interests Net income attributable to Ace Hardware Corporation... $77,684 $75,105 $95,727 Accrued patronage distributions... $74,458 $69,854 $89,031 See accompanying notes to the consolidated financial statements. ACE Financials

6 ACE Financials ACE HARDWARE CORPORATION CONSOLIDATED STATEMENTS OF EQUITY BALANCES AT JANUARY 3, 2009 $2,989 $6,499 $287,915 $14,271 $148 $13,485 $(29,210) $(19,716) $(2,836) $(10,406) $ - $263,139 Comprehensive income Net income , ,727 Unrecognized postretirement cost Foreign currency translation adjustment Net change in unrealized gain/loss on investments , ,732 Total Comprehensive Income 98,583 Change in accounting for income tax uncertainties (849) (849) Net payments on subscriptions , ,015 Stock issued ,808 (14,271) (1,000) Stock repurchased (138) (28) (15,074) - - (28) (15,268) Patronage distributions issuable , ,234 Patronage distributions payable (68,761) (68,761) Variance allocation applications - - (903) ,250 (21,058) ,289 Treasury stock retirement - (5,203) (5,203) , Class B common stock redemption - (1,268) (1,268) (2,536) _ BALANCES AT JANUARY 2, 2010 $2,955 $ - $287,746 $30,234 $163 $6,986 $(5,960) $(14,657) $20 $ - $ - $307,487 Comprehensive income Net income , ,105 Unrecognized postretirement cost (60) - - (60) Foreign currency translation adjustment (49) - - (49) Net change in unrealized gain/loss on investments Total Comprehensive Income 75,963 Net payments on subscriptions Stock issued 47-30,091 (30,234) (491) (587) Stock repurchased (145) - (11,307) (11,452) Patronage distributions issuable , ,380 Patronage distributions payable (66,440) (66,440) Variance allocation applications - - (629) ,273 (3,418) _ BALANCES AT JANUARY 1, 2011 $2,857 $ - $305,901 $22,380 $433 $6,986 $(1,687) $(9,410) $878 $ - $ - $328,338 Comprehensive income Shareowners of Ace Hardware Corporation Class C Accumulated Stock Other Issuable to Additional Compre- Retailers for Stock hensive Non- Capital Stock Patronage Sub- Contributed Variance Accumulated Income Treasury controlling Total Class A Class B Class C Dividends scribed Capital Allocation Deficit (loss) Stock Interests Equity Net income , ,926 Unrecognized postretirement cost Foreign currency translation adjustment (1) 20 Net change in unrealized gain/loss on investments (983) - - (983) Total Comprehensive Income 77,077 Net payments on subscriptions Stock issued ,879 (22,380) (1,235) Sale of noncontrolling interests (63) - (13,065) - (5) 13, ,522 8,291 Stock repurchased (151) - (18,405) (18,556) Patronage distributions issuable , ,673 Patronage distributions payable (73,661) (73,661) Variance allocation applications - - (27) ,203 (797) _ BALANCES AT DECEMBER 31, 2011 $2,758 $ - $298,283 $24,673 $10 $20,888 $(484) $(6,184) $30 $- $7,763 $347,737 See accompanying notes to the consolidated financial statements.

7 ACE HARDWARE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Operating Activities December 31, 2011 January 1, 2011 January 2, 2010 (52 Weeks) (52 Weeks) (52 Weeks) (In thousands) Net income... $77,926 $75,105 $95,727 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization... 38,687 38,299 33,316 Amortization of deferred gain on sale leaseback... (1,234) (1,234) (1,269) Amortization of deferred financing costs... 2,884 2,778 2,728 Loss on early extinguishment of debt Provision for doubtful accounts... 4,524 6,666 5,544 (Gain) loss on disposal of assets, net... (1,616) (495) 563 Other Changes in operating assets and liabilities: Receivables... (35,795) (85,105) 32,961 Inventories... (24,540) (71,851) 21,497 Other current assets... 7,644 (5,462) (446) Other long-term assets... (11,179) (2,277) (706) Accounts payable and accrued expenses... 36,723 17,755 (45,159) Other long-term liabilities... 2,719 (4,343) (6,377) Deferred taxes... (420) 1,960 1,438 Net cash provided by (used in) operating activities... 96,421 (28,204) 139,902 Investing Activities Years Ended Purchase of marketable securities... (41,483) (24,133) (29,011) Proceeds from sale of marketable securities... 40,447 22,662 16,865 Purchase of property and equipment... (25,589) (35,969) (53,707) Decrease (increase) in notes receivable, net ,041 (1,438) Other (577) (583) Net cash used in investing activities... (26,196) (36,976) (67,874) Financing Activities (Payments of) proceeds from short-term borrowings, net... (22,500) 22,500 (1,100) Principal payments on long-term debt... (6,516) (5,271) (5,019) Payments of cash portion of patronage distribution... (26,422) (29,208) (15,599) Payments of patronage refund certificates... (17,924) (19,487) (19,543) Proceeds from sale of noncontrolling interests... 8, Other (5,370) Net cash used in financing activities... (63,765) (31,186) (46,631) Increase (decrease) in cash and cash equivalents... 6,460 (96,366) 25,397 Cash and cash equivalents at beginning of period... 9, ,723 80,326 Cash and cash equivalents at end of period... $15,817 $9,357 $105,723 Supplemental disclosure of cash flow information: Interest paid (net of amounts capitalized)... $34,429 $33,260 $34,693 Income taxes paid... $701 $1,224 $8,589 See accompanying notes to the consolidated financial statements. ACE Financials

8 ACE HARDWARE CORPORATION Notes to the Consolidated Financial Statements (In thousands) (1) Summary of Significant Accounting Policies The Company and Its Business Ace Hardware Corporation ( the Company ) is a wholesaler of hardware and other related products and is a manufacturer and wholesaler of paint products. The Company also provides to its retail members value-added services such as advertising, marketing, merchandising and store location and design services. Ace s goods and services are sold predominately within the United States, primarily to retailers that operate hardware stores and with whom the Company has a retail membership agreement. As a retailer-owned cooperative, the Company distributes substantially all of its patronage sourced income in the form of patronage distributions to member retailers based on their volume of merchandise purchases. See Note 6, Patronage Distributions and Refund Certificates Payable, for further discussion regarding patronage distributions. Effective in 2011, the Company restructured its international operations into a stand-alone legal entity with its own management team and board of directors as opposed to a division within the Ace cooperative structure. This entity also has its own subsidiaries. The new entity ( Ace Hardware International Holdings, Ltd. ) is a majority-owned and controlled subsidiary of the Company with a noncontrolling interest owned by its international retailers. International retailers no longer own shares of stock in the Company or receive patronage dividends. Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ( GAAP ). The Company s fiscal year ends on the Saturday nearest December 31st. Accordingly, fiscal years 2011, 2010 and 2009 ended on December 31, 2011, January 1, 2011 and January 2, 2010, respectively, and consisted of 52 weeks each. Subsequent events have been evaluated through February 9, 2012, the date these statements were available to be issued. Principles of Consolidation The accompanying consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with GAAP 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. Actual results could differ from those estimates. Reclassifications Certain prior period amounts have been reclassified to conform to the current financial statement presentation, with no net effect on the consolidated financial statements. Cash, Cash Equivalents and Marketable Securities The Company classifies all highly liquid investments with original maturities of three months or less as cash equivalents. The Company determines the appropriate classification of its investments in marketable securities, which are predominately held by the Company s New Age Insurance, Ltd. ( NAIL ) subsidiary, at the time of purchase and re-evaluates such designation at each balance sheet date. All marketable securities have been classified and accounted for as available for sale. The Company may hold debt securities until maturity. In response to changes in the availability of and the yield on alternative investments as well as liquidity requirements, securities are occasionally sold prior to their stated maturities. Debt securities with maturities beyond twelve months are viewed by the Company as available to support current operations and are thereby classified as current assets in the accompanying consolidated balance sheets. Marketable securities are carried at fair value based on quoted market prices, with unrealized gains and losses, net of taxes, reported as a component of accumulated other comprehensive income. Realized gains and losses on securities are determined using the specific identification method. ACE Financials Revenue Recognition The Company recognizes revenue when products are shipped and the retailer takes ownership and assumes risk of loss and when services are rendered, provided collection of the resultant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed and determinable. The Company records shipping and handling amounts billed to retailers as revenues, with the related costs recorded in cost of revenues. Direct expenses related to retail services are included in cost of revenues and indirect expenses from these activities are included in operating expenses. The Company also records amounts billed to the retailers for advertising activities, brand building initiatives and fees generated for various retail services as revenues. Provisions for sales returns are provided at the time the related sales are recorded.

9 Receivables Receivables from retailers include amounts invoiced from the sale of merchandise and services and equipment used in the operation of retailers businesses. Notes Receivable The Company makes available to its retailers various lending programs whose terms exceed one year. The notes bear interest at various rates based on market rates, the loan program or the retailer s credit quality and are recorded at face value. Interest is recognized over the life of the note on the effective interest method. Loan origination fees were not material for any period presented. Allowance for Doubtful Accounts Management records an allowance for doubtful accounts based on judgments considering a number of factors, primarily historical collection statistics, current member retailer credit information, the current economic environment, the aging of receivables, the evaluation of compliance with lending covenants and the offsetting amounts due to members for stock, notes, interest and anticipated but unpaid patronage distributions. The Company considers accounts and notes receivable past due if invoices remain unpaid past their due date and provides for the write-off of uncollectible receivables after exhausting all commercially reasonable collection efforts. Inventories Inventories are valued at the lower of cost or net realizable value. Cost is determined primarily using the last-in, first-out ( LIFO ) method for all inventories other than paint, for which the first-in, first-out method is used to determine cost. Vendor Funds The Company receives funds from vendors in the normal course of business principally as a result of purchase volumes, sales, early payments or promotions of vendors products. Based on the provisions of the vendor agreements in place, management develops accrual rates by estimating the point at which the Company will have completed its performance under the agreement and the amount agreed upon will be earned. Due to the complexity and diversity of the individual vendor agreements, the Company performs analyses and reviews of historical trends throughout the year to ensure the amounts earned are appropriately recorded. As part of these analyses, the Company validates its accrual rates based on actual purchase trends and applies those rates to actual purchase volumes to determine the amount of funds accrued by the Company and receivable from the vendor. Amounts accrued throughout the year could be impacted if actual purchase volumes differ from projected annual purchase volumes, especially in the case of programs that provide for increased funding when graduated purchase volumes are met. Vendor funds are treated as a reduction of inventory cost, unless they represent a reimbursement of specific, incremental and identifiable costs incurred by the Company to sell the vendor s product. Substantially all of the vendor funds that the Company receives do not meet the specific, incremental and identifiable criteria. Therefore, the Company treats a majority of these funds as a reduction in the cost of inventory as the amounts are accrued and recognizes these funds as a reduction of cost of revenues when the inventory is sold. Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Expenditures for maintenance, repairs and renewals of relatively minor items are generally charged to expense. Significant improvements or renewals are capitalized. Depreciation expense is computed on the straight-line method based on estimated useful lives of 6 to 40 years for buildings and improvements and 3 to 20 years for equipment. Leasehold improvements are generally amortized on a straight-line basis over the lesser of the lease term or the estimated useful life of the asset. The Company evaluates long-lived assets, such as property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds its fair value. Internal-Use Software Included in fixed assets is the capitalized cost of internal-use software. The Company capitalizes costs incurred during the application development stage of internal-use software and amortizes these costs over its estimated useful life. Costs incurred related to design or maintenance of internal-use software are expensed as incurred. For the years ended 2011, 2010 and 2009, the Company capitalized $851, $2,805 and $3,482, respectively, of software development costs related to internal programming time. Amortization of these previously capitalized amounts was $1,086, $787 and $119 for 2011, 2010 and 2009, respectively. Deferred Charges Deferred charges consist of deferred financing costs related to the issuance of long-term debt and the revolving credit facility. Amortization is provided using the effective-interest method over the life of the related agreements. Leases The Company leases certain warehouse and distribution space, office space, retail locations, equipment and vehicles. Most of the Company s leases are operating leases. As leases expire, management expects that in the normal course of business, certain leases will be renewed or replaced. ACE Financials

10 Certain lease agreements include escalating rent over the lease terms and rent holidays and concessions. The Company expenses rent on a straight-line basis over the life of the lease, which commences on the date the Company has the right to control the property. The cumulative expense recognized on a straight-line basis in excess of the cumulative payments is included in other long-term liabilities in the consolidated balance sheets. Advertising Expense The Company expenses advertising costs when incurred. Gross advertising expenses amounted to $98,648, $102,129 and $99,061 in 2011, 2010 and 2009, respectively. Retirement Plans The Company participates in a multi-employer defined benefit retirement plan covering a limited number of union employees. Costs with respect to the noncontributory pension plan are determined actuarially and consist of current costs and amounts to amortize unrecognized prior service costs and unrecognized gains and losses. The Company also sponsors health benefit plans for its retired officers and a limited number of non-officer employees. The Company also sponsors a defined contribution profit sharing plan for substantially all employees. The Company s contribution under this plan is determined annually by the Board of Directors and charged to expense in the period in which it is earned by employees. Income Taxes The Company accounts for income taxes under the asset and liability method. Under this approach, deferred taxes are recognized for the future tax consequences of differences between the financial statement and income tax bases of existing assets and liabilities, and measured based upon enacted tax laws and rates. Self Insurance The Company has a wholly-owned subsidiary, NAIL, that operates as a captive insurance company. This entity provides the reinsurance of property and casualty insurance policies for some retailer members and is the direct insurer for certain property and casualty insurance policies of the Company. These insurance programs are subject to varying retention levels of self insurance. Such self insurance relates to losses and liabilities primarily associated with property, general liability, workers compensation and auto liability insurance programs. Losses are accrued based upon the Company s estimates of the aggregate liability for claims incurred using certain actuarial assumptions based on Company experience and insurance industry metrics. Concentration of Credit Risk Credit risk pertains primarily to the Company s trade and notes receivables. The Company extends credit to its members as part of its day-to-day operations. Management believes that as no specific receivable or group of receivables comprises a significant percentage of total trade accounts, its concentration of credit risk with respect to trade receivables is limited. Additionally, management believes that its allowance for doubtful accounts is adequate with respect to overall member credit risks. Also, the Company s certificate of incorporation and by-laws specifically provide that the Company may set-off its obligation to make any payment to a member for such member s stock, notes, interest and declared and unpaid distributions against any obligation owed by the member to the Company. The Company, but not the member, may at its sole discretion exercise these set-off rights when any such funds become due to former members with outstanding accounts and notes receivable owed to the Company and current members with past due receivables owed to the Company. New Accounting Pronouncements In June 2011, the Financial Accounting Standards Board ( FASB ) issued Accounting Standards Update No , Comprehensive Income (Topic 220): Presentation of Comprehensive Income, ( ASU ) which was subsequently amended by Accounting Standards Update No ( ASU ). ASU eliminates the option the Company currently follows to report other comprehensive income and its components in the statement of changes in equity. ASU requires that all nonowner changes in stockholders equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This new guidance will be effective for the Company s 2012 interim and annual financial statements and is to be applied retrospectively. ACE Financials In May 2011, the FASB issued Accounting Standards Update No , Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, ( ASU ). ASU changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards ( IFRS ). ASU also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This new guidance is effective for the Company in 2012 and is not expected to materially impact the Company s consolidated financial statements.

11 (2) Receivables, net Receivables, net include the following amounts: December 31, 2011 January 1, 2011 Trade... $253,253 $244,812 Other... 55,022 53,600 Notes receivable current portion... 9,111 7,306 Less: allowance for doubtful accounts... (9,836) (10,369) Receivables, net... $307,550 $295,349 Other receivables are principally amounts due from suppliers for promotional and advertising allowances. (3) Inventories Inventories consist primarily of merchandise inventories. Substantially all of the Company s inventories are valued on the LIFO method. The excess of replacement cost over the LIFO value of inventory was $93,861 and $79,856 at December 31, 2011 and January 1, 2011, respectively. During 2009, the Company incurred a LIFO decrement of $10,649. The liquidation of prior year layers resulted in a $1,794 increase in net income for There were no LIFO decrements in 2011 or 2010, respectively. Inventories consisted of: December 31, 2011 January 1, 2011 Manufacturing inventories: Raw materials... $9,161 $5,339 Work-in-process and finished goods... 19,989 15,336 29,150 20,675 Merchandise inventories: Warehouse inventory , ,110 Inventories... $535,325 $510,785 (4) Property and Equipment, net Property and equipment, net is summarized as follows: December 31, 2011 January 1, 2011 Land... $17,186 $17,186 Buildings and improvements , ,346 Warehouse equipment , ,117 Office equipment , ,871 Manufacturing equipment... 18,267 18,066 Transportation equipment... 41,752 38,572 Leasehold improvements... 14,255 14,044 Construction in progress... 2,071 2, , ,368 Less: accumulated depreciation and amortization... (348,570) (325,173) Property and equipment, net... $307,073 $320,195 Depreciation and amortization expense for fiscal years 2011, 2010 and 2009 was $38,687, $38,299 and $33,316, respectively. (5) Notes Receivable, net The Company makes available to its retailers various lending programs whose terms exceed one year. The notes bear interest at various rates based on the retailer s credit quality and are recorded at face value. Interest is recognized over the life of the note based on the outstanding balance and stated interest rate, which approximates the effective interest method. During fiscal years 2011, 2010 and 2009, $2,467, $2,408 and $2,239, respectively, were recorded as interest income related to the notes. ACE Financials

12 At December 31, 2011 and January 1, 2011, the outstanding balance of the notes was $62,443 and $63,249, respectively, of which the current portion of $9,111 and $7,306, respectively, was recorded in receivables, net. At December 31, 2011 and January 1, 2011, $37,331 and $42,464, respectively, of the notes receivable were from the Company s Equity Match Financing ( EMF ) program, which offered financing to qualified retailers to facilitate new store growth. Pursuant to the Company s Amended and Restated Certificate of Incorporation and the Company s by-laws, the above referenced notes (like all obligations owed to the Company by the Company s retailers) are secured by the Company stock owned by the retailers. However, for some retailers, the redemption value of their stock does not fully cover their obligations. Payments on these notes are primarily collected by the Company through the application of future patronage distributions, retailer billings or stock repurchases. In the event a retailer cancels their membership with the Company, any outstanding notes receivable, and related allowance for doubtful accounts, are transferred to trade receivables as the retailer is billed for any unpaid principal and interest balances. During fiscal 2011 and 2010, $7,125 and $5,580 of notes receivable were transferred to trade receivables as an event occurred which made the note due immediately. Upon transfer of the notes receivable to accounts receivable, $1,380 and $4,648 of the notes receivable allowance for doubtful accounts was transferred to the accounts receivable allowance for doubtful accounts to properly match the reserve against the asset on the balance sheet. During 2011 and 2010, $3,009 and $2,248 of these notes were written-off. The Company evaluates risk on its loan portfolio by categorizing each loan into an internal risk category. The Company s risk categories include: Low The retailer possesses a strong financial position, above average payment record to both Ace and other vendors, and the business is well established. Medium The retailer possesses an average financial position, an average payment record to both Ace and other vendors, and the business is somewhat established. High The retailer possesses a weak financial position, a substandard payment record to Ace or other vendors, or the business is somewhat new. The Company has evaluated the collectability of the notes and has established an allowance for doubtful accounts of $12,126 and $12,051 at December 31, 2011 and January 1, 2011, respectively. Management records the allowance for doubtful accounts based on judgments made considering a number of factors, primarily historical collection statistics, current member retailer credit information, the current economic environment and the offsetting amounts due to members for stock, notes, interest and declared and unpaid patronage distributions. The following table illustrates the balances related to the Company s notes receivable and related allowance for doubtful accounts: Allowance for doubtful accounts: Beginning balance... $12,051 $15,249 Charge-offs... - (85) Provision... 1,455 2,718 Reclassified to A/R allowance... (1,380) (4,648) Other... - (1,183) Ending balance... $12,126 $12,051 Ending balance individually evaluated for impairment... 9,589 9,682 Ending balance collectively evaluated for impairment... 2,537 2,369 Total allowance... 12,126 12,051 Notes receivable: Ending balance individually evaluated for impairment... 9,902 10,453 Ending balance collectively evaluated for impairment... 60,457 59,320 Ending principal balance... 70,359 69,773 Less: estimated patronage applications... (7,916) (6,524) ending balance... 62,443 63,249 ACE Financials Corporate Credit Exposure: Low risk... 49,694 49,248 Moderate risk... 9,781 8,805 High risk... 10,884 11,720 Total... $70,359 $69,773

13 For substantially all of the Company s notes receivable, any amounts due are expected to be collected through the non-cash portion of the patronage distribution. In the event a retailer cancels their membership with the Company, any outstanding loans are transferred from notes receivable to accounts receivable and are due immediately. As the non-cash portion of the patronage distribution is used to settle the notes receivable, there are no loans that are currently past due. The patronage distribution for each retailer can vary from year to year based on the Company s financial performance as well as the volume of patronage-based merchandise that each retailer purchases from the Company. The estimated maturities of the notes receivable are as follows: 0-4 years $19, years 41, years 9,192 Total $70,359 (6) Patronage Distributions and Refund Certificates Payable The Company operates as a cooperative organization and has paid or may pay patronage distributions to member retailers on a portion of patronage based income derived from business done with such retailers. Patronage distributions are allocated in proportion to the volume of purchases by member retailers during the period. In December 2007, the Company s Board of Directors approved an Equity Restoration Plan to restore its equity position due to the loss of equity incurred from the inventory accounting error that the Company announced on September 5, Under the plan, the Company established a variance allocation account in the amount of $148,556, which allocates the overstatement of the Company s net income stemming from the inventory accounting error to the Company s retailer members, based on the retailer members proportionate share of warehouse distribution pool purchases for the fiscal years 2002 through At December 31, 2011, the balance remaining in the variance allocation account was $484. In 2009, the Board of Directors approved a revised patronage distribution plan which changed the amount of the patronage distribution paid in cash to 35% from 20% effective for the 2009 fiscal year which was paid in The remaining balance of the patronage distribution was applied to the retailer member s variance allocation account until the account was reduced to zero and any remaining patronage distribution was distributed in the Company s Class C stock. Additionally, member retailers may choose to use any patronage certificates, shares of Class C stock issued as part of the patronage distribution in prior years or cash to pay all or a portion of their variance allocation account balance. In 2010, the Board of Directors revised the patronage distribution plan again which changed the amount of the patronage distribution paid in cash to 40% from 35% effective for the 2010 fiscal year which was paid in The cash portion of the patronage distribution will again be 40% for the 2011 patronage distribution to be paid in The patronage distribution composition is summarized as follows: Years Ended December 31, 2011 January 1, 2011 January 2, 2010 Cash portion... $30,433 $28,514 $32,018 Class C stock... 24,673 22,380 30,234 Patronage refund certificates... 9,076 7,582 - Patronage financing deductions... 9,479 7,964 6,509 Patronage distributions applied to variance allocation ,414 20,270 Total patronage distributions... $74,458 $69,854 $89,031 Patronage distributions are allocated on a fiscal year basis with issuance in the following year. Prior to 2007 and in 2010, a portion of the patronage distribution was distributed in the form of a patronage refund certificate having maturity dates and bearing interest as determined by the Company s Board of Directors. The Company also plans to issue patronage refund certificates with maturity dates and bearing interest as determined by the Company s Board of Directors in those instances where the maximum Class C stock requirements have been met for the 2011 patronage distribution. ACE Financials

14 The patronage refund certificates outstanding at December 31, 2011 are payable as follows: Amount Interest Rate $17, % , % , % (7) Debt Line of Credit On May 15, 2008, the Company entered into a $300,000 senior secured revolving credit facility with a group of banks, which matures on May 15, 2013 and includes $175,000 available for letters of credit. Borrowings, if any, under this facility bear interest at a spread of 175 to 250 basis points over the London Interbank Offered Rate ( LIBOR ) based on availability. Fees are assessed on a monthly basis for the unused portion of the line of credit at 50 basis points per annum. This fee decreases to 37.5 basis points when more than 50% of the line is outstanding. This credit facility is available to fund short-term working capital needs. At December 31, 2011 and January 1, 2011, the Company had remaining availability under the credit facility of $264,034 and $209,731 as total availability of $264,034 and $232,231 was offset by outstanding borrowings of $0 and $22,500, respectively. The credit facility availability is calculated by considering the qualified underlying asset collateral and is reduced by outstanding letters of credit as defined by the credit facility agreement. At December 31, 2011, the credit facility availability was calculated by considering $300,000 of qualified pledged collateral less $35,966 of outstanding letters of credit. The credit agreement requires the Company to comply with various financial and nonfinancial covenants. The financial covenant is a minimum fixed charge coverage ratio triggered if borrowing availability, as determined under the credit agreement, is less than $30,000. The Company was in compliance with its covenants at December 31, In connection with the restructuring of the Company s international operations, the Company amended its senior secured revolving credit facility to allow the Company to make revolving loans and other extensions of credit to Ace Hardware International Holdings, Ltd. in an aggregate principal amount not to exceed $50,000 at any time the amounts are outstanding. At December 31, 2011, there were no loans or other extensions of credit provided to this entity. Long-Term Debt On May 15, 2008, the Company issued $300,000 of senior secured notes maturing June 1, 2016 and bearing an interest coupon of 9.125%. The effective interest rate on this debt is 9.37%. Long-term debt is comprised of the following: December 31, 2011 January 1, 2011 $288,180 and $289,005 face value senior notes less unamortized discount of $2,216 and $2,725, due at maturity with interest payable semi-annually, bearing an interest coupon rate of 9.125% and a maturity date of June 1, 2016 $285,964 $286,280 Installment notes with maturities through 2015 at a fixed rate of 6.00% 13,382 10,778 Total long-term debt , ,058 Less: maturities within one year... (5,835) (4,441) Long-term debt... $293,511 $292,617 The weighted average interest rate on long-term debt was 9.23% for both years ended December 31, 2011 and January 1, 2011, respectively. The aggregate scheduled maturities of long-term debt at December 31, 2011 are as follows: ACE Financials Fiscal Year Amount $5, , , , ,180 Thereafter... - Total long-term debt... $301,562

15 The indenture governing the 9.125% senior secured notes contains covenants, representations and events of default that management considers typical of an indenture of this nature. These covenants limit the Company s ability to: (i) incur additional indebtedness; (ii) create liens; (iii) pay dividends or make other restricted payments; and (iv) make asset sales and enter into sale and leaseback transactions. The Company was in compliance with these covenants at December 31, During fiscal years 2011 and 2009, the Company repurchased $825 and $1,000, respectively, of senior secured notes on the open market for $866 and $1,050, respectively, plus accrued interest and recognized a loss of $62 in 2011 and $85 in 2009, net of the writeoff of related deferred financing and bond discount costs. These amounts were recorded in loss on early extinguishment of debt in the consolidated statements of income. There were no debt repurchases in fiscal (8) Retirement Plans The Company has healthcare plans under which a limited number of qualified retired employees receive certain health care, dental care, life insurance or related benefits. Amounts expensed under these plans totaled $101, $105 and $129 in fiscal 2011, 2010 and 2009, respectively. The Company participates in one multi-employer plan covering union employees. Amounts expensed for this plan totaled $163, $148 and $165 in fiscal years 2011, 2010 and 2009, respectively. The Company also maintains a profit sharing plan for substantially all employees. The Company made cash contributions to the plan during fiscal 2011, 2010 and 2009 of $14,220, $16,378 and $17,857, respectively. (9) Accrued Expenses Accrued expenses include the following components: December 31, 2011 January 1, 2011 Salaries and wages... $38,080 $35,151 Insurance reserves... 12,717 12,895 Profit sharing... 8,283 6,029 Interest... 3,927 4,839 Other... 56,796 69,042 Accrued expenses... $119,803 $127,956 (10) Fair Value Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There is a three-level hierarchy for disclosure to show the extent and level of judgment used to estimate fair value measurements. Level 1 Uses unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date. Level 2 Uses inputs other than Level 1 that are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data. Level 3 Uses inputs that are unobservable and are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management s estimates of market participant assumptions. The tables below set forth, by level, the Company s assets that were accounted for at fair value as of December 31, 2011 and January 1, The tables do not include cash on hand and also do not include assets and liabilities that are measured at historical cost or any basis other than fair value. The carrying values for other current financial assets and liabilities, such as accounts receivable and accounts payable, approximate fair value due to the short maturity of such instruments. ACE Financials

16 Carrying Value Measured at Fair Value Items measured at fair value on a recurring basis: December 31, 2011 Level 1 Level 2 Level 3 Cash equivalents: Money market funds... $1,037 $1,037 $ - $ - Marketable securities: Corporate fixed income securities... 8,806-8,806 - Equity securities... 20,344 20, Mortgage-backed securities... 9,835-9,835 - U.S. government notes... 10,980 10, Other... 1,015-1,015 - Total marketable securities... $50,980 $31,324 $19,656 $ - Carrying Value Measured at Fair Value Items measured at fair value on a recurring basis: January 1, 2011 Level 1 Level 2 Level 3 Cash equivalents: Money market funds... $962 $962 $ - $ - Marketable securities: Corporate fixed income securities... 20,878-20,878 - Equity securities... 14,139 14, Mortgage-backed securities... 11,958-11,958 - U.S. government notes... 1,803 1, Other Total marketable securities... $49,358 $15,942 $33,416 $ - The Company s valuation techniques used to measure the fair values of money market funds, equity securities and U.S. government notes, that were classified as Level 1 in the tables above, were derived from quoted market prices as active markets for these instruments exist. The Company s valuation techniques used to measure the fair values of all other instruments listed in the tables above were derived from the following: non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models, such as discounted cash flow techniques, with all significant inputs derived from or corroborated by observable market data. There were no material differences between the fair value and cost basis of the Company s marketable securities at December 31, 2011 and January 1, 2011, respectively. Gross proceeds from the sale of marketable securities were $40,447, $22,662 and $16,865 during the years ended December 31, 2011, January 1, 2011 and January 2, 2010, respectively. Gross realized gains and losses from the sale of marketable securities for the year ended December 31, 2011 were $2,022 and $203, respectively. Gross realized gains and losses from the sale of marketable securities for the years ended January 1, 2011 and January 2, 2010 were not material. The following table summarizes the contractual maturity distributions of the Company s debt securities at December 31, Actual maturities may differ from the contractual or expected maturities since borrowers may have the right to prepay obligations with or without prepayment penalties. Due After Due After Due in One Year Five Years One Year through through Due After Fair value of available-for-sale debt securities or Less Five Years Ten Years Ten Years Total ACE Financials Corporate fixed income securities... $472 $3,375 $3,931 $1,028 $8,806 Mortgage-backed securities ,829 9,835 U.S. government notes... 3,478 3,095 1,503 2,904 10,980 Other ,015 Total... $3,950 $6,470 $6,212 $14,004 $30,636 The principal balance of the Company s senior secured notes outstanding at December 31, 2011 and January 1, 2011 was $288,180 and $289,005, respectively. Based on market activity, the fair value of the notes was $304,750 and $307,790 at December 31, 2011 and January 1, 2011, respectively.

17 (11) Income Taxes Income tax expense includes the following components: Years Ended December 31, 2011 January 1, 2011 January 2, 2010 Current: Federal... $(2,439) $(667) $(2,496) State (188) (288) Foreign... (722) (319) (231) Total... (3,091) (1,174) (3,015) Deferred: Federal (1,415) (1,451) State... (662) (374) 219 Foreign Total... (31) (1,789) (1,232) Income tax expense... $(3,122) $(2,963) $(4,247) Income tax expense differs from the amount computed by applying the statutory U.S. Federal income tax rate of 35% to income before income taxes because of the effect of the following items: Years Ended December 31, 2011 January 1, 2011 January 2, 2010 Expected tax at U.S. Federal income tax rate... $(28,367) $(27,324) $(34,991) Patronage distribution deductions... 26,060 24,449 31,161 Other, net... (815) (88) (417) Income tax expense... $(3,122) $(2,963) $(4,247) Deferred income taxes reflect the tax effects of temporary differences between the carrying amounts of existing assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company s deferred tax assets and liabilities are as follows: December 31, 2011 January 1, 2011 Deferred tax assets: Capital loss carryforwards... $ - $485 AMT and other tax credit carryforwards... 12,694 12,535 Net operating loss carryforwards... 8,200 - Unearned insurance premium and loss reserves... 1,532 1,280 Other reserves... 48,225 48,020 Total deferred tax assets... 70,651 62,320 Less: valuation allowance... (150) (485) Deferred tax assets... 70,501 61,835 Deferred tax liabilities: Depreciation and deferred gains on property and equipment... 13,395 8,344 Prepaid expenses and deferred income (646) Inventory valuation... 26,948 24,993 Deferred tax liabilities... 40,536 32,691 Net deferred tax assets... $29,965 $29,144 ACE Financials