Ace Hardware 2005 Annual Report Download - page 39

14 ACE HARDWARE CORP. NEW FRONTIERS. NEW OPPORTUNITIES.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (CONTINUED)
Cash used in investing activities for the year ended December 31,
2005 was $24.0 million compared to $6.8 million in the same
period of the prior year. The increase in cash used was primarily
driven by the receipt of proceeds from the sale and leaseback
of property in 2004 partially offset by net proceeds from the sale of
company-owned retail locations and lower capital expenditures
in 2005.
Cash used in financing activities for the year ended December 31,
2005 was $33.8 million compared to $91.2 million in the
comparable period last year. The decrease in net cash used was
driven by the reduction in short-term borrowings in 2004 from
the proceeds of the sale and leaseback of property partially offset
by an issuance of $25.0 million in long-term debt in 2004.
Ace has an established, unsecured revolving credit facility with a
group of banks. Ace has unsecured lines of credit of $270.0 million
of which $205.0 million was available at December 31, 2005.
Borrowings under these lines of credit bear interest at a spread
over LIBOR based upon quarterly debt to EBITDA ratios.
Long-term financing is arranged as determined necessary to
meet Ace’s capital or other requirements, with principal amount,
timing and form dependent on prevailing debt markets and
general economic conditions.
As a cooperative, Ace distributes substantially all of its patronage
sourced earnings to its members in the form of patronage dividends,
which are deductible for income tax purposes.
Ace expects that existing and internally generated funds, along
with new and established lines of credit and long-term financing,
will continue to be sufficient in the foreseeable future to finance
the Company’s working capital requirements, patronage dividends
and capital expenditure programs.
Critical Accounting Policies
The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of
assets, liabilities, sales and expenses in the financial statements. On
an ongoing basis, Ace evaluates its estimates and judgments based
on historical experience and various other factors that are believed
to be reasonable under the circumstances. Actual results may differ
from these estimates, and our estimates would vary under different
assumptions or conditions. Management believes these estimates
and assumptions are reasonable.
Ace annually reviews its financial reporting and disclosure practices
and accounting policies to ensure that they provide accurate and
comprehensive information relative to the current economic and
business environment. Ace’s significant accounting policies are
described in the Notes to Consolidated Financial Statements.
The following represents those critical accounting policies which
involve a relatively higher degree of judgment, estimates and
complexity and where materially different amounts could be
reported under different conditions or using different assumptions.
Valuation of Inventories
When necessary, Ace provides allowances to adjust the carrying
value of inventories to the lower of cost or market, including costs
to sell or dispose of surplus or damaged/obsolete inventory, and for
estimated shrinkage. Estimates of the future demand for Ace’s
products are key factors used by management in assessing the net
realizable value of the inventories. While management believes that
the estimates used are appropriate, an unanticipated decline in sales
at retail outlets or a significant decline in demand for products in
selected product categories, could result in valuation adjustments.
Allowance for Doubtful Accounts
The allowance for doubtful accounts reflects management’s estimate
of the future amount of receivables that will not be collected.
Management records allowances for doubtful accounts based on
judgments made considering a number of factors, including
historical collection statistics, current member retailer credit
information, the aging of receivables, the current economic
environment and the offsetting amounts due to members for stock,
notes, interest and declared and unpaid dividends. While Ace
believes it has appropriately considered known or expected
outcomes, its customers’ ability to pay their obligations, including
those to Ace, could be adversely affected by declining sales of
hardware at retail resulting from such factors as contraction in the
economy or competitive conditions in the wholesale and retail
hardware industry including increased competition from discount
stores, chain stores and other mass merchandisers.
Insurance Reserves
Insurance reserves for unreported claims related to Ace’s self-
insured property, general liability, workers’ compensation and auto
liability insurance programs are dependent on assumptions used in
calculating such amounts. These assumptions include projected
ultimate losses and confidence levels of the reserve requirement and
consider historical loss levels and other factors. While management
believes that the assumptions used are appropriate, differences in
actual claims experience or changes in assumptions may affect Ace’s
insurance reserves.
Inflation and Changes in Prices
The Company’s business is not generally governed by contracts that
establish prices substantially in advance of the receipt of goods or
services. As vendors increase their prices for merchandise supplied
to the Company, the Company increases the price to its retailers in
an equal amount plus the normal handling charge on such amounts.
In the past, these increases have provided adequate gross profit to
offset the impact of inflation on operating expenses.