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«2015 ACE HARDWARE ANNUAL REPORT FINANCIALS INDEX TO ANNUAL REPORT Page Summary Our Company Ace’s Capital Stock Structure Membership Applications ...»

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2015 ACE HARDWARE ANNUAL REPORT

FINANCIALS

INDEX TO ANNUAL REPORT

Page

Summary

Our Company

Ace’s Capital Stock Structure

Membership Applications – Subscription for Class A and Class C Stock

Repurchase of Shares by Ace

Patronage Distributions and Income Tax Treatment

Risks of Membership

Ace’s Business

Company History

Our Retailer Base

New Store Growth

Our Industry and Our Retailers’ Core Customers

Competitive Strengths

Merchandise Sales to Our Network of Retailers

Private Label Programs

Retailer Conventions

Ace Service Offerings

Other Ace Retailer Programs and Benefits

Distribution

Suppliers

Technology

Ace International

Trademark and Service Mark Registrations

Employees

Legal Proceedings

Regulation

Competition

Properties

Company Management and Directors

Members of the Board of Directors

Committees of the Board of Directors

How to Communicate with the Board of Directors

Senior Management

–  –  –

Domestic Store Count

Results of Operations

Liquidity and Capital Resources

Cash Flows

Off-Balance Sheet Arrangements

Contractual Obligations and Commitments

Application of Critical Accounting Policies and Estimates

Impact of New Accounting Standards

Qualitative and Quantitative Disclosure About Market Risk

Disclosure Regarding Forward-Looking Statements

Five Year Summary of Earnings and Distributions

Management’s Responsibility for Financial Statements

Membership Information

Membership Application, Agreements and Stock Subscription

Retailer Assessments and Charges

Patronage Distributions

Description of Capital Stock

Dividend Rights

Voting Rights

Liquidation Rights

Preemptive Rights

Redemption Provisions

Limitations on Ownership of Stock

Other Restrictions and Rights

Federal Income Taxes

Status of Class A and Class C Shares

Tax Treatment of Patronage Distributions

Risks of Membership

Risks Associated With Retail Business Generally

Risks Associated With the Retail Hardware Business

Risks Specifically Related to the Ace Retail Hardware Business

Risks Particularly Associated With Your Prospective Store

Risks Associated With Ace as Wholesaler and Primary Supplier

Risks Associated With Being a Member of the Ace Hardware Cooperative

This Annual Report contains information about our company. Unless otherwise indicated or required by the context, the terms “Ace,” “we,” “our,” “us” and the “Company” refer to Ace Hardware Corporation and all of its subsidiaries that are consolidated under U.S. generally accepted accounting principles (“GAAP”). The terms “member,” “retailer,” “member retailer,” “dealer,” “you,” “your” and similar words refer to someone who becomes a member of Ace and purchases our stock. In this Annual Report, we reference some of our own trademarked products (e.g., Clark + Kensington® paints) and services, as well as those of unrelated third parties with whom we do business (e.g., Valspar® paints); all trademarks appearing in this Annual Report are the property of their respective owners. Our fiscal years for the years 2015, 2014 and 2013 ended on January 2, 2016, January 3, 2015, and December 28, 2013, respectively. When we refer to a year, we are referring to the fiscal year ended on those respective dates. Data in this summary is as of January 2, 2016 unless indicated otherwise.

–  –  –

Our Company Ace Hardware Corporation markets and distributes hardware products and paint to our network of independent retailers around the world. We also provide value-added services such as advertising, market research, merchandising assistance, promotion support, assistance with site location, store format design, retail training services, insurance and store technology services. We have been an important part of the American business landscape for more than 90 years and are the largest cooperative, by sales, in the hardware industry. Ace today serves approximately 2,700 individual domestic retailers who operate approximately 4,300 domestic stores located in all 50 states and the District of Columbia. Ace Hardware International Holdings, LTD. (“AIH”), a majority-owned subsidiary of Ace, also serves international retailers in approximately 60 foreign countries.

Ace positions itself as “The Helpful Place”—a conveniently located hardware store that provides not only quality goods but also knowledgeable store staff. We believe that “The Helpful Place” is one of the most recognized slogans in the hardware and home improvement industry.

In 2015, Ace ranked “Highest in Customer Satisfaction with Home Improvement Retail Stores, Nine Years in a Row,” according to J.D. Power. We believe that we received this award for the ninth consecutive year because helpfulness is a promise that all associates at local Ace stores seek to fulfill every day as they serve their retail customers across the United States and around the world.





As the principal supplier to our retailer network, Ace purchases hardware and related products in quantity lots and resells this merchandise in smaller lots to our retailers. Ace’s aggregate purchasing volume and supplier relationships enable us to realize substantial purchasing savings and to pass such savings on to our retailers. This enables Ace’s retailers to have consistent access to a broad range of hardware and related products and to better compete in their local markets.

We operate 14 retail support centers (“RSCs”), nine freight consolidation/redistribution facilities and three other warehouse facilities across the United States that total over 11 million square feet of distribution space. Eleven of these facilities, for a total of approximately 8.2 million square feet of distribution space, are Company-owned. In addition, Ace and its subsidiaries also have distribution capabilities in Laredo, Texas; Dubai, United Arab Emirates; Panama City, Panama; and Shanghai, China. In 2014, the Company started shipping product out of new RSCs in Ohio and Texas which replaced existing facilities in those same areas. These new leased facilities increased Ace’s total distribution space without any increase to the total number of RSCs. Additionally, during 2014 a newly formed subsidiary of the Company, Ace Wholesale Holdings LLC (“AWH”), added warehouse facilities in Portland, Maine and Pittston, Pennsylvania through the acquisition of The Emery-Waterhouse Company (“Emery”) and a warehouse facility in Spokane, Washington through the acquisition of Jensen-Byrd Co., LLC (“Jensen”).

To help foster our retailers’ continued success, fuel their entrepreneurial spirit and enhance their viability in an increasingly competitive home improvement marketplace, Ace provides two basic programs for its member retailers—Ace Branded stores and Individually Branded stores.

Approximately 500 stores, or 11%, of our network of domestic stores are individually branded. Sales to these retailers represented approximately 7% of our 2015 fiscal year domestic merchandise sales. Our Individually Branded Retailer program is ideal for retailers who have strong individual name recognition in their local communities and do not rely as much on the Ace brand for their success. While they do not participate in Ace’s marketing programs, as members of Ace they still rely on Ace’s broad product assortment (including Ace private label products), low product pricing, extensive distribution network, and eligibility for patronage distributions. They go to market under their own business name and identity.

The remaining approximately 3,800 domestic stores, or 89%, of our network of domestic stores operate under the Ace brand.

Sales to these retailers represented approximately 93% of our 2015 fiscal year domestic merchandise sales.

Ace also supports 20/20 Vision, its long-term retail growth strategy. The strategy builds on Ace’s commitments to enhance retailer performance and ensure retailer growth, not only today, but long term. 20/20 Vision provides Ace and our retailers with a clear path to the future. The strategy is consumer-focused, aligned with our corporate strategy and contains two paths for growth that can be implemented separately or concurrently. The two paths for growth are Pinnacle Performance Retailing and Accelerated Store Growth. Pinnacle Performance Retailing is designed to help Ace retailers improve their store performance by increasing sales and net profits. Accelerated Store Growth is designed to encourage Ace retailers with the desire and ability to open new stores. It is also intended to increase store count through new investors, conversions of competitors’ stores and by reducing the number of stores that leave Ace or close.

Ace’s Capital Stock Structure

Our capital stock is divided into two classes: Class A and Class C. Only Class A Stock has voting rights. Class C Stock is issued in connection with all store memberships and annually as part of our patronage distribution. Our Board of Directors has the right to redeem portions or all of the outstanding shares of Class C Stock that have been issued as patronage distributions. If Ace is ever liquidated, the outstanding shares of Class C Stock have priority over the outstanding shares of Class A Stock in the distribution of our net assets. Were our net assets to exceed that priority amount, they would be distributed proportionately among the stockholders of both classes of our stock. (See “Description of Capital Stock—Voting Rights,” “—Liquidation Rights” and “— Redemption Provisions.”) Ace operates as a cooperative. Accordingly, the declaring of dividends on any shares of any class of our stock is prohibited.

(See “Description of Capital Stock—Dividend Rights.”) Membership Applications – Subscriptions for Class A and Class C Stock The purchase of our stock enables retailers to obtain membership in Ace. Membership entitles our retailers to purchase merchandise and services from us. Members are also eligible to receive patronage distributions based on the volume of merchandise they purchase from us, but these distributions are dependent on Ace’s patronage-based business being profitable. (See “Membership Information—Patronage Distributions—Patronage Distribution Determinations.”) We cannot guarantee that patronage distributions will be made for any year.

Our stock is sold only to approved retailers of hardware and related products who apply for membership in Ace Hardware Corporation. The purchase price (par value) for each share of Class A Stock is $1,000 and the purchase price (par value) for each share of Class C Stock is $100.

For an initial membership, you must subscribe and pay for one share of Class A Stock plus 40 shares of Class C Stock, with an aggregate subscription price of $5,000. You must also pay a $5,000 fee for processing your membership application. If you apply for membership for an additional store location that you own or control, you must subscribe and pay for 50 shares of Class C Stock ($5,000) for that location and pay another $5,000 processing fee.

Your membership may generally be terminated upon various notice periods and for various reasons, including voluntary termination, as provided in the Membership Agreement.

Ace also sells merchandise to retailers that are not members of Ace through its AWH and AIH subsidiaries, but such nonmember retailers do not own any Ace stock and are not eligible to receive any patronage distributions.

Repurchase of Shares by Ace If your membership for a store location terminates, your Class A share and all of your Class C shares for that location must be sold back to us, generally at par value, unless the shares are transferred to another party whom we agree to accept as a retailer for that location. We generally pay the repurchase price in a combination of cash and an interest-bearing four-year installment note. (See “Description of Capital Stock—Other Restrictions and Rights.”) Under Delaware corporate law, we are not allowed to repurchase any of our shares if our net assets are less than the par value of our aggregate outstanding shares of capital stock or if our net assets would be reduced below that amount by virtue of the repurchase.

Patronage Distributions and Income Tax Treatment As a cooperative, we distribute patronage annually to member retailers based on their merchandise purchases from us. Under our current plan, which can be modified by our Board of Directors, 40% of the total annual patronage distribution to each retailer is paid in cash. The remainder is paid in shares of Class C Stock and in Patronage Refund Certificates. The cash portion of any patronage distribution payable to a past due or terminated retailer is generally applied against that retailer’s indebtedness or other obligations to us, if any. (See “Membership Information—Patronage Distributions.”) The cash payments and stated dollar amounts of Class C Stock and Patronage Refund Certificates along with the fair market value of any other property that we distribute as patronage, must be taken into your gross income for federal income tax purposes.

(See “Federal Income Taxes—Tax Treatment of Patronage Distributions.”)

Risks of Membership

Owning and operating a retail hardware store as an Ace retailer, especially a group of such stores, can be rewarding, both financially and otherwise. There are, however, a number of risks that one should consider carefully before making a decision to become an Ace retailer. See “Risks of Membership” for some of the more important risks. There may be other issues, risks and benefits particularly relevant to you that are not summarized in the “Risks of Membership” section.

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